The following discussion and analysis of our financial condition and results of operations for the years endedDecember 31, 2020 and 2019 should be read in conjunction with our consolidated financial statements and related notes that appear in Item 8, Consolidated Financial Statements and Supplementary Data. In addition to historical information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in Special Note Regarding Forward-Looking Statements and in Item 1A, Risk Factors. Executive Overview GCE is a publicly traded education services company dedicated to serving colleges and universities. GCE has developed significant technological solutions, infrastructure and operational processes to provide services to these institutions on a large scale. GCE's most significant university partner is GCU, a comprehensive regionally accredited university that offers graduate and undergraduate degree programs, emphases and certificates across nine colleges both online and on ground at its campus inPhoenix, Arizona . InJanuary 2019 , GCE began providing education services to numerous university partners acrossthe United States , through our wholly-owned subsidiary, Orbis Education, which we acquired onJanuary 22, 2019 . See Note 3 - Acquisition to consolidated financial statements for a full description of the Acquisition. In the healthcare field, GCE, together with Orbis Education, works in partnership with a growing number of top universities and healthcare networks across the country, offering health care related academic programs at off-campus classroom and laboratory sites located near healthcare providers and developing high-quality, career-ready graduates, who enter the workforce ready to meet the demands of the healthcare industry. As ofDecember 31, 2020 , GCE provides education services to 25 university partners acrossthe United States . We plan to continue to add additional university partners and to introduce additional programs with both our existing partners and with new partners. We may engage with both new and existing university partners to offer healthcare programs, online only or hybrid programs, or, as is the case for our most significant partner, GCU, both healthcare and other programs. Therefore, we will refer to all university partners as "GCE partners" or "our partners" and will no longer differentiate between partners of GCE and partners of Orbis Education; we will, however, continue to disclose significant information for GCU, such as enrollments, due to its size in comparison to our other university partners.
Impact of COVID-19
InMarch 2020 , theWorld Health Organization declared the COVID-19 outbreak to be a global pandemic. This contagious outbreak, which has continued to spread, and the related adverse public health developments, including orders to shelter-in-place, travel restrictions and mandated non-essential business closures, have adversely affected workforces, organizations, customers, economies and financial markets globally, leading to an economic downturn and increased market volatility. It has also disrupted the normal operations of many businesses, including ours, and that of our university partners. Due to the economic disruption caused by the COVID-19 pandemic, theNational Bureau of Economic Research announced inJune 2020 thatthe United States entered into a recession inFebruary 2020 . GCE has a long-term master services agreement with GCU (the "Master Services Agreement") pursuant to which GCE provides education services to GCU in return for 60% of GCU's tuition and fee revenues, which includes fee revenues from room, board, and other ancillary businesses including a student-run golf course and hotel. GCU has three types of students: traditional ground university students, who attend class on its campus inPhoenix, Arizona and of which approximately 70% have historically lived on campus in university owned residence halls; professional studies 47
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students, who are working adult students who attend class one night a week on
the
The COVID-19 outbreak, as well as measures taken to contain its spread, has impacted GCU's students and its business in a number of ways. Beginning inMarch 2020 , GCU's programs for its professional studies students and its traditional ground university students were immediately converted to an online learning environment and residential students were strongly encouraged to move off campus. Summer 2020 semester classes were moved to an online environment as well and most students were given the choice of attending the Fall semester in person or completely online. Given GCE's historical experience delivering online education services and the fact that all of GCU's students and faculty use the university's online learning management system for at least some of the coursework, the transition has been seamless and thus, the university has not incurred a significant decrease in tuition revenue or significant increase in costs associated with this transition. The following impacts from the COVID-19 pandemic, however, did serve to reduce GCU's non-tuition revenue during its Spring, Summer and Fall 2020 semesters and, consequently, the service revenues we earned under the Master Services Agreement:
Traditional ground university students who elected to move off campus near the
? end of the Spring 2020 semester received partial refunds for dormitory and meal
payments, which reduced GCU's revenue and thus the service revenues earned by
GCE in the last nine days of March and the month of April;
Ancillary businesses operated by GCU such as its hotel and merchandise shops
were closed in late March. Some of these businesses remain closed while others
? opened with scaled back operations in mid-September, which reduced and will
continue to reduce GCU's revenues and thus the service revenues earned by GCE
until these businesses are fully reopened;
Limited residential students remained on campus during the Summer semester,
? which reduced GCU's dormitory and ancillary revenues and thus the service
revenues earned by GCE; GCU's doctoral students are required to attend two residencies on the
university's campus and at its hotel in
dissertation. On an annual basis approximately 3,000 learners attend the
week-long residency, most of whom have historically attended in the Summer.
? Most of the residencies who were scheduled for the last week of March through
the end of July were cancelled. The doctoral residencies scheduled for August
through December were held at another location with lower than normal
attendance resulting in lower GCU revenues including at its hotel, and thus
reduced the service revenues earned by GCE;
GCU shifted its start date for the Fall semester for its traditional ground
students from
? moving tuition revenue for all GCU traditional students, and certain ancillary
revenue for residential students, from the third quarter of 2020 to the fourth
quarter of 2020; and GCU shifted its move-in date for its residential students to the week of
for residential students by three weeks. In addition, approximately 4,900 of
? GCU's traditional campus students elected to attend the Fall semester entirely
in the online modality. Residential enrollment for the Fall of 2020 was
approximately 11,500 whereas residential bed capacity is approximately 14,500.
This reduction in residential students caused a reduction in GCU's revenue and
thus the service revenues earned by GCE. InJanuary 2021 , GCU announced the first week of the Spring 2021 semester would be completed in an online modality to provide greater flexibility for students returning to campus after the holidays. Face-to-face instruction for the Spring semester for its traditional ground students commenced onJanuary 11, 2021 . Approximately 3,500 traditional ground students have elected to complete the Spring semester entirely in the online modality. Spring semester face-to-face instruction will endApril 1, 2021 for approximately 80% of classes, followed by two weeks of online instruction fromApril 5, 2021 throughApril 16, 2021 with Spring Break fromApril 19, 2021 toApril 25, 2021 . These changes will have the effect of reducing GCU's dormitory and ancillary revenues in the Spring of 2021 and thus the service revenues earned by GCE. 48 Table of Contents The changes described above at GCU have impacted or will impact GCE's service revenue under the Master Services Agreement. In addition, due to the limited operating expenses that we incur to deliver those services, there has been or will be a direct reduction in our operating profit and operating margin. GCE also has long-term services agreements with numerous other university partners acrossthe United States . The majority of these other university partners' students are studying in the Accelerated Bachelor of Science in Nursing program which is offered in a 12-16 month format in three or four academic semesters. The Spring, Summer and Fall 2020 semesters were completed without interruption and each university partner has started its Spring 2021 semester. Some students who were scheduled to start their program in the Summer 2020 semester delayed their start until the Fall 2020 which resulted in lower enrollments and revenues in the Summer 2020 semester than was planned. In a number of locations, the demand to start in the Fall 2020 semester was greater than initially planned but a number of our university or healthcare partners chose not to increase the Fall 2020 cohort size to compensate for the Summer 2020 start shortfall due to concerns about clinical availability. The Fall 2020 enrollment was only slightly lower than our original expectations as the Summer 2020 new start shortfall was offset by higher retention rates and slightly higher than expected Fall 2020 new starts. No other changes are currently anticipated related to the Spring 2021 semester that would have an impact on GCE's service revenue, operating profit and operating margins. However, if GCU determines that it must send its students home prior to the end of the Spring semester and elects to give partial refunds for dormitory and meal payments or if one of our other university partners closes a location prior to the end of the Spring semester, such an event would reduce the service revenues earned by GCE. The COVID-19 outbreak also presents operational challenges to GCE as approximately 90% of our workforce is currently working remotely and is expected to continue doing so for the foreseeable future. This degree of remote working could increase risks in the areas of internal control, cyber security and the use of remote technology, and thereby result in interruptions or disruptions in normal operational processes. It is not possible for us to completely predict the duration or magnitude of the adverse results of the COVID-19 pandemic and its effects on our business, results of operations or financial condition at this time, but such effects may be material in future quarters. We estimate that the reduction in service revenue attributable to reduced tuition, fees and ancillary revenues of our university partners resulting from COVID-19 will be$4.5 million in the first quarter of 2021 with a comparable reduction in operating profit.
Critical Accounting Policies and Estimates
The discussion of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance withU.S. generally accepted accounting principles, or GAAP. During the preparation of these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including those discussed below. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated financial statements.
We believe that the following critical accounting policies involve our more significant judgments and estimates used in the preparation of our consolidated financial statements:
Revenue recognition. Starting
49 Table of Contents services, marketing and communication services, and as applicable, certain back office services to its university partners in return for a percentage of tuition and fee revenue. GCE's Services Agreements have a single performance obligation, as the promises to provide the identified services are not distinct within the context of these agreements. The single performance obligation is delivered as our partners receive and consume benefits, which occurs ratably over a series of distinct service periods (daily or semester). Service revenue is recognized over time using the output method of measuring progress towards complete satisfaction of the single performance obligation. The output method provides a faithful depiction of the performance toward complete satisfaction of the performance obligation and can be tied to the time elapsed which is consumed evenly over the service period and is a direct measurement of the value provided to our partners. The service fees received from our partners over the term of the agreement are variable in nature in that they are dependent upon the number of students attending the university partner's program and revenues generated from those students during the service period. Due to the variable nature of the consideration over the life of the service arrangement, GCE considered forming an expectation of the variable consideration to be received over the service life of this one performance obligation. However, since the performance obligation represents a series of distinct services, GCE recognizes the variable consideration that becomes known and billable because these fees relate to the distinct service period in which the fees are earned. GCE meets the criteria in the standard and exercises the practical expedient to not disclose the aggregate amount of the transaction price allocated to the single performance obligation that is unsatisfied as of the end of the reporting period. GCE does not disclose the value of unsatisfied performance obligations because the directly allocable variable consideration is allocated entirely to a wholly unsatisfied promise to transfer a service that forms part of a single performance obligation. The service fees are calculated and settled per the terms of the Services Agreements and result in a settlement duration of less than one year for all partners. There are no refunds or return rights under the Services Agreements. Business Combinations, Intangible Assets, andGoodwill . We apply the purchase accounting standards for "Business Combinations," to acquisitions. The purchase price of an acquisition is allocated to individual tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. Any excess purchase price over the assigned values of net assets acquired is recorded as goodwill. OnJanuary 22, 2019 , GCE acquired, by merger, all of the outstanding equity interests of Orbis Education for$361.2 million , net of cash acquired. As a result of this acquisition, GCE recorded$210.3 million of intangible assets, primarily customer relationships, and$157.8 million of goodwill. Refer to Note 3 - Acquisition within the footnotes to the consolidated financial statements for additional information. The acquired goodwill was allocated to the entity level reporting unit. The determination of the fair value and useful lives of the intangible assets acquired involves certain judgements and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. Income taxes. We recognize the amount of taxes payable or refundable for the current year and deferred tax assets and liabilities for future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be realized. Our deferred tax assets are subject to periodic recoverability assessments. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that more likely than not will be realized. Realization of the deferred tax assets is principally dependent upon achievement of projected future taxable income offset by deferred tax liabilities. We evaluate the realizability of the deferred tax assets annually. Since becoming a taxable corporation inAugust 2005 , we have not recorded any valuation allowances to date on our deferred income tax assets. We evaluate and account for uncertain tax positions using a two-step approach. Recognition occurs when we conclude that a tax position based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement determines the amount of benefit that is greater than 50% likely to be realized upon the ultimate settlement with a taxing authority that has full knowledge of the facts. Derecognition of a tax position that was previously recognized occurs when we determine that a tax position no longer meets the more-likely-than-not threshold of being sustained upon examination. As ofDecember 31, 2020 and 2019, GCE has reserved approximately$11,318 and$6,773 , respectively, for uncertain tax positions, including interest and penalties. 50 Table of Contents Results of Operations InJuly 2019 , the FASB issued Accounting Standards Update 2019-07, "Codification Updates to SEC Sections- Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10532, Disclosure Update and Simplification", which makes a number of changes meant to simplify certain disclosures in financial condition and results of operations, particularly by eliminating year-to-year comparisons between prior periods previously disclosed. In complying with the relevant aspects of the rule covering the current year annual report, we now include disclosures on results of operations for fiscal year 2020 versus 2019 only. For a discussion of the results of operations for fiscal year 2019 vs 2018, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K filed with theSEC for the fiscal year endedDecember 31, 2019 incorporated herein by reference. The following table sets forth certain income statement data as a percentage of net revenue for each of the periods indicated. Amortization of intangible assets and the loss on transaction have been excluded from the table below: Year EndedDecember 31, 2020 2019
Costs and expenses Technology and academic services 13.7 % 11.6 % Counseling services and support 27.8 28.7 Marketing and communication 19.5 18.4 General and administrative
5.1 5.7
Year Ended
Service revenue. Our service revenue for the year endedDecember 31, 2020 was$844.1 million , an increase of$65.5 million , or 8.4%, as compared to service revenue of$778.6 million for the year endedDecember 31, 2019 . The increase year over year in service revenue was primarily due to an increase in university partner enrollments between years of 8.5% partially offset by a decrease in revenue per student year over year. Partner enrollments totaled 115,997 atDecember 31, 2020 as compared to 106,861 atDecember 31, 2019 . Enrollments at GCU grew to 111,624 atDecember 31, 2020 , an increase of 8.3% over enrollments atDecember 31, 2019 , while enrollments at our other university partners were 4,373, an increase of 16.6% over enrollments atDecember 31, 2019 . The decrease in revenue per student is primarily due to the service revenue impact of the lower room, board, fee and ancillary revenues at GCU caused by COVID-19 (see - Impact of COVID-19 above). This was partially offset by the fact that our services agreements with our other university partners generally generate a higher revenue per student than our agreement with GCU. This higher revenue is due to our service agreements with other partners generally provide us with a higher revenue share percentage, the partners have higher tuition rates than GCU and the majority of their students are studying in the Accelerated Bachelor of Science in Nursing program so these students take more credits on average per semester. In addition, we opened seven new off-campus classroom and laboratory sites in the third quarter of 2020 bringing the total number of these sites to 30 as compared to 23 atDecember 31, 2019 . Last, we generated slightly more revenues in 2020 as compared to the same period in 2019 due to the timing of the Acquisition onJanuary 22, 2019 , and due to 2020 being aLeap Year and thus providing an extra day of revenue in 2020 as compared to 2019. Technology and academic services. Our technology and academic services expenses for the year endedDecember 31, 2020 were$116.0 million , an increase of$25.5 million , or 28.2%, as compared to technology and academic services expenses of$90.5 million for the year endedDecember 31, 2019 . This increase was primarily due to increases in employee compensation and related expenses including share-based compensation, in occupancy and depreciation including lease expenses, and in other technology and academic supply costs of$19.7 million ,$5.0 million and$0.8 million , respectively. These increases, in turn, were primarily due to increased headcount to support our 25 university partners, and their increased enrollment growth, tenure-based salary adjustments, an increase in benefit costs, the timing of the Acquisition and the increased number of off-campus classroom and laboratory sites open between years. Our technology and academic services expenses as a percentage of net revenue increased 2.1% to
13.7% for the year ended 51 Table of ContentsDecember 31, 2020 , from 11.6% for the year endedDecember 31, 2019 primarily due to our services agreements with university partners that provide for off-campus classroom and laboratory sites, which necessitate a higher level of technology and academic services than does our agreement with GCU and due to the revenue impacts caused by COVID-19 as we incur limited operating expenses to deliver those services. Additionally, for the year endedDecember 31, 2020 we incurred costs related to the opening of seven off-campus classroom and laboratory sites in the second half of 2020 and we are incurring costs for four more locations that will open in the first half of 2021. GCE has 30 off-campus classroom and laboratory sites open as ofDecember 31, 2020 as compared to the 23 sites that were open as ofDecember 31, 2019 . Counseling services and support. Our counseling services and support expenses for the year endedDecember 31, 2020 were$234.5 million , an increase of$10.9 million , or 4.9%, as compared to counseling services and support expenses of$223.6 million for the year endedDecember 31, 2019 . This increase was primarily attributable to increases in employee compensation and related expenses including share-based compensation and in depreciation, amortization and occupancy costs of$18.0 million and$1.2 million , respectively, partially offset by a decrease in other counseling services and support expenses of$8.3 million . The increases in employee compensation and related expenses were primarily due to increased headcount to support our 25 university partners, and their increased enrollment growth, tenure-based salary adjustments, and an increase in benefit costs, while the increase in depreciation, amortization and occupancy costs were primarily due to the timing of the Acquisition and the increased number of off-campus classroom and laboratory sites open year over year. The decrease in other counseling services and support expenses is primarily the result of decreased travel costs to service our 25 university partners. All non-essential travel ceased when the COVID-19 national emergency was announced in mid-March and only a small amount of travel has occurred subsequent to that date. Our counseling services and support expenses as a percentage of net revenue decreased by 0.9% to 27.8% for the year endedDecember 31, 2020 , from 28.7% for the year endedDecember 31, 2019 primarily due to the decrease in travel costs and our ability to leverage our other counseling services and support expenses across an increasing revenue base, partially offset by the revenue impacts caused by COVID-19 as we incur limited operating expenses to deliver those services. Marketing and communication. Our marketing and communication expenses for the year endedDecember 31, 2020 were$164.3 million , an increase of$21.4 million , or 15.0%, as compared to marketing and communication expenses of$142.9 million for the year endedDecember 31, 2019 . This increase was primarily attributable to the increased cost to market our university partners' programs and due to the marketing of new university partners and new off-campus classroom and laboratory sites which resulted in increased advertising of$21.4 million and increased employee compensation expenses and related expenses including share-based compensation of$0.2 million , partially offset by a slight decrease in other marketing supplies of$0.2 million . Our marketing and communication expenses as a percentage of net revenue increased by 1.1% to 19.5% for the year endedDecember 31, 2020 , from 18.4% for the year endedDecember 31, 2019 , primarily due to the increase in the number of new university partners and increased off-campus classroom and laboratory sites open between years and due to the revenue impacts caused by COVID-19 as we incur limited operating expenses to deliver those services. General and administrative. Our general and administrative expenses for the year endedDecember 31, 2020 were$43.4 million , a decrease of$0.9 million , or 2.2%, as compared to general and administrative expenses of$44.3 million for the year endedDecember 31, 2019 . This decrease was primarily due to decreases in professional fees of$1.8 million and in employee compensation and related expenses including share-based compensation of$1.3 million , partially offset by an increase in contributions in lieu of state income taxes to school sponsoring organizations of$1.0 million from$4.0 million in 2019 to$5.0 million in 2020, and increases in occupancy and depreciation of$0.8 million and in other general and administrative expenses of$0.4 million . In 2019, our professional fees were significantly higher due to a payment made to an outside provider that assisted us in obtaining a state tax refund with a favorable impact of$5.9 million in the first quarter of 2019. The decrease in employee compensation and related expenses is primarily related to lower headcount at our office inIndiana as we have transitioned a number of back office functions toArizona . Our increase in occupancy and depreciation are primarily related to the timing of the Acquisition and the increased lease expense for our office inIndiana . Our general and administrative expenses as a percentage of net revenue decreased by 0.6% to 5.1% for the year endedDecember 31, 2020 , from 5.7% for the year endedDecember 31, 2019 due to the lower professional fees and our ability to leverage our other general and administrative expenses across an increasing revenue 52
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base, partially offset by the revenue impacts caused by COVID-19 as we incur limited operating expenses to deliver those services.
Amortization of intangible assets. Amortization of intangible assets for the year endedDecember 31, 2020 was$8.4 million , an increase of$0.2 million , as compared to$8.2 million for the year endedDecember 31, 2019 . This increase is related to the timing of the Acquisition, which occurred onJanuary 22, 2019 . As a result of the Acquisition, certain identifiable intangible assets were created (primarily customer relationships) that will be amortized over their expected lives.
Loss on transaction. The loss on transaction for the year ended
Interest income on Secured Note. Interest income on the Secured Note for the year endedDecember 31, 2020 was$59.2 million , a decrease of$0.1 million , or 0.2%, as compared to$59.3 million for the year endedDecember 31, 2019 . GCE recognizes interest income on its Secured Note with GCU including borrowings made for capital expenditures, earning interest at 6%, with monthly interest payments. The decrease over the prior year was primarily due to a decrease in the average principal balance of the Secured Note between periods due to repayments made by GCU under the Secured Note during the past 12 months. Interest expense. Interest expense was$4.4 million for the year endedDecember 31, 2020 , a decrease of$6.9 million , as compared to interest expense of$11.3 million for the year endedDecember 31, 2019 . The decrease in interest expense is primarily due to a decline in the average credit facility outstanding balance between periods due to paydowns of the credit facility during the past 12 months and a decrease in the average borrowing rate between years of approximately 163 basis points. Investment interest and other. Investment interest and other for the year endedDecember 31, 2020 was$0.9 million , a decrease of$3.5 million , as compared to$4.4 million for the year endedDecember 31, 2019 . This decrease was primarily attributable to a decline in interest income on excess cash as the average investment balance declined year over year and significantly lower interest rates. Income tax expense. Income tax expense for the year endedDecember 31, 2020 was$75.9 million , an increase of$17.6 million , or 30.2%, as compared to income tax expense of$58.3 million for the year endedDecember 31, 2019 . This increase is the result of an increase in our taxable income between periods, and an increase in our effective tax rate. Our effective tax rate was 22.8% during the year endedDecember 31, 2020 as compared to 18.4% during the year endedDecember 31, 2019 . The 2019 effective tax rate was lower due to some large, one-time, favorable discreet items. In 2019, an agreement was reached with theArizona Department of Revenue regarding previously filed refund claims related to income tax obligations for prior calendar years, which resulted in a favorable tax impact of$5.9 million recorded as a discrete tax item in the first quarter of 2019. In addition, the effective tax rate in 2019 was favorably impacted by a law change with respect toArizona state taxes and higher excess tax benefits of$7.2 million compared to excess tax benefits of$1.4 million for the year endedDecember 31, 2020 . The inclusion of excess tax benefits and deficiencies as a component of our income tax expense increases the volatility within our provision for income taxes as the amount of excess tax benefits or deficiencies from share-based compensation awards are dependent on our stock price at the date the restricted awards vest, our stock price on the date an option is exercised, and the quantity of options exercised. Our restricted stock vests in March each year so the favorable benefit will primarily impact the first quarter each year.
Net income. Our net income for the year months ended
Seasonality
Our net revenue and operating results normally fluctuate as a result of seasonal variations in our business, principally due to changes in our university partners' enrollment. Our partners' enrollment varies as a result of new
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enrollments, graduations, and student attrition. Revenues in the summer months (May through August) are lower primarily due to the majority of GCU's traditional ground students not attending courses during the summer months, which affects our results for our second and third fiscal quarters. Since a significant amount of our costs are fixed, the lower revenue resulting from the decreased summer enrollment has historically contributed to lower operating margins during those periods. Partially offsetting this summer effect has been the sequential quarterly increase in enrollments that has occurred as a result of the traditional fall school start. This increase in enrollments also has occurred in the first quarter, corresponding to calendar year matriculation. Thus, we experience higher net revenue in the fourth quarter due to its overlap with the semester encompassing the traditional fall school start and in the first quarter due to its overlap with the first semester of the calendar year. A portion of our expenses do not vary proportionately with these fluctuations in net revenue, resulting in higher operating income in the first and fourth quarters relative to other quarters. We expect quarterly fluctuation in operating results to continue as a result of these seasonal patterns.
Liquidity, Capital Resources, and Financial Position
Liquidity. Our unrestricted cash and cash equivalents and investments were
During 2019, we financed our acquisition of Orbis Education for$361.2 million , net of cash acquired, from an increase in our credit facility of$190.1 million and the use of$171.1 million of operating cash on hand. Concurrent with the closing of the Acquisition, we entered into an amended and restated credit agreement datedJanuary 22, 2019 and two related amendments datedJanuary 31, 2019 andFebruary 1, 2019 , respectively, that together provided a credit facility of$325.0 million comprised of a term loan facility of$243.8 million and a revolving credit facility of$81.3 million , both with a five-year maturity date. The term facility is subject to quarterly amortization of principal, commencing with the fiscal quarter endedJune 30, 2019 , in equal installments of 5% of the principal amount of the term facility per quarter. The proceeds of the term loan, together with$6.3 million drawn under the revolver and cash on hand, were used to pay the purchase price in the Acquisition. Concurrent with the entry into the amended and restated credit agreement and the completion of the Acquisition, we repaid our existing term loan of$59.9 million and our cash collateral of$61.7 million was released. GCE entered into a further amendment to the credit facility onOctober 31, 2019 . This amendment increased the revolving commitment by$68.8 million to$150.0 million , while reducing the term loan by the same$68.8 million to$150.6 million . GCE elected to repay the$68.8 million revolver balance onNovember 1, 2019 . The amended facility is subject to quarterly amortization of principal, commencing with the fiscal quarter endedDecember 31, 2019 , in equal quarterly payments of$8.4 million with a maturity date ofJanuary 2025 . Both the term loan and revolver have monthly interest payments currently at 30-Day LIBOR plus an applicable margin of 2%. Based on our current level of operations and anticipated growth, we believe that our cash flow from operations and other sources of liquidity, including cash and cash equivalents and our revolving line of credit, will provide adequate funds for ongoing operations, planned capital expenditures, and working capital requirements for at least the next 24 months.
Arrangements with GCU
In conjunction with the Asset Purchase Agreement with GCU, we received a Secured Note as consideration for the transferred assets (the "Transferred Assets"). The Secured Note contains customary commercial credit terms, including affirmative and negative covenants applicable to GCU, and provides that the Secured Note bears interest at an annual rate of 6%, has a maturity date ofJune 30, 2025 , and is secured by all the assets of GCU. The Secured Note provides for GCU to make interest only payments during the term, with all principal and accrued and unpaid interest due at maturity, and also provides that we may loan additional amounts to GCU to fund approved capital expenditures during the first three years of the term. As ofDecember 31, 2020 , GCE had loaned an additional$99,815 to GCU, net of repayments. We believe that GCU's cash flows from operations are currently sufficient to fund all of its capital expenditures although it is possible that GCU may make requests to borrow additional amounts from us for short term cash flow needs. 54 Table of Contents Share Repurchase Program InJuly 2020 ,December 2020 andJanuary 2021 , our Board of Directors increased the authorization under our existing stock repurchase program by$50.0 million ,$100.0 million and$100.0 million , respectively, reflecting an aggregate authorization for share repurchases since the initiation of our program of$500.0 million . As ofDecember 31, 2020 , we had a total remaining authorization of$148.3 million (which authorization was increased to$248.3 million inJanuary 2021 ). Pursuant to this authorization, in our discretion, we can repurchase our common stock, from time to time, in open market or in privately negotiated transactions, depending on market conditions and other considerations. The amount and timing of future share repurchases, if any, will be made as market and business conditions warrant, and we may modify, suspend or discontinue repurchases at any time. The current expiration date on the repurchase authorization by our Board of Directors isDecember 31, 2021 . Since 2011, we have purchased 5.6 million shares of common stock at an aggregate cost of$251.7 million , which includes 1,601,788 shares of common stock at an aggregate cost of$129.0 million during the year endedDecember 31, 2020 .
Cash Flows
Operating Activities. Net cash provided by operating activities for the years endedDecember 31, 2020 and 2019 was$308.8 million and$306.3 million , respectively. The slight increase in cash generated from operating activities between the years endedDecember 31, 2019 and 2020 was primarily due to changes in other working capital balances. We define working capital as the assets and liabilities, other than cash, generated through GCE's primary operating activities. Changes in these balances are included in the changes in assets and liabilities presented in the statement of cash flows. Investing Activities. Net cash used in investing activities was$19.4 million and$405.9 million for the years endedDecember 31, 2020 and 2019, respectively. Our cash used in investing activities in 2020 was primarily related to capital expenditures of$29.4 million partially offset by proceeds from the sale of investments of$10.6 million . Funding to GCU for the year endedDecember 31, 2020 net of repayments totaled nil. Our cash used in investing activities in 2019 was primarily related to the Acquisition, the funding of capital expenditures to GCU, and the liquidation of short-term investments and capital expenditures. We paid$361.2 million , net of cash acquired, to acquire Orbis Education onJanuary 22, 2019 . Funding to GCU for capital expenditures during the year endedDecember 31, 2019 totaled$69.8 million , net of repayments made by GCU of$100.0 million in 2019. Proceeds from investments, net of purchases of short-term investments, was$47.8 million for the year endedDecember 31, 2019 . Capital expenditures were$22.4 million for the year endedDecember 31, 2019 . During the years endedDecember 31, 2020 and 2019, capital expenditures primarily consisted of leasehold improvements and equipment for new off-campus classroom and laboratory sites, internally developed software, as well as purchases of computer equipment, other internal use software projects and furniture and equipment to support our increasing employee headcount. The increase in capital expenditures year over year is due to the increase in off-campus classrooms and laboratory sites between years. As ofDecember 31, 2020 , 30 off-campus classroom and laboratory sites were opened compared to 23 as ofDecember 31, 2019 . Financing Activities. Net cash used in financing activities was$166.3 million for the year endedDecember 31, 2020 . During 2020,$129.0 million was used to purchase treasury stock in accordance with GCE's share repurchase program and$5.0 million was used to purchase common shares withheld in lieu of income taxes resulting from the vesting of restricted share awards. Principal payments on notes payable totaled$33.1 million , partially offset by proceeds from the exercise of stock options of$0.9 million . Net cash provided by financing activities was$40.1 million for the year endedDecember 31, 2019 . During 2019,$243.8 million of proceeds was drawn on the term loan, and$26.3 million was drawn and repaid on the revolver in 2019, and the term loan balance of the prior credit agreement of$59.9 million was repaid along with the repayment of$101.3 million of principal and revolver payments on the new credit facility. In addition,$2.4 million of debt issuance costs were incurred on the new credit facility and$8.1 million was used to purchase common shares withheld in lieu of income taxes resulting from the vesting of restricted share awards and$35.8 million was used to purchase treasury stock in accordance with GCE's share repurchase program. Proceeds from the exercise of stock options of$3.8 million were received for the year endedDecember 31, 2019 . 55 Table of Contents Contractual Obligations
The following table sets forth, as of
Payments Due by Period
Less than More than Total 1 Year 2-3 Years 4-5 Years 5 Years Notes payable(1)$ 107.8 $ 33.1 $ 66.3 $ 8.4 $ - Lease liabilities(2) 64.0 7.4 14.3 13.3 29.0 Purchase obligations(3) 18.0 7.4 10.6 - - Total contractual obligations$ 189.8 $ 47.9 $ 91.2 $ 21.7 $ 29.0
See Note 10, "Notes Payable and Other Noncurrent Liabilities," to our
(1) consolidated financial statements, included in Item 8, Consolidated Financial
Statements and Supplementary Data, for a discussion of our notes payable and
other obligations.
See Note 9, "Leases," to our consolidated financial statements, included in
(2) Item 8, Consolidated Financial Statements and Supplementary Data, for a
discussion of our leases.
(3) Represents unconditional purchase obligations and other obligations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have had or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.
Adjusted EBITDA (Non-GAAP Financial Measure)
In addition to our GAAP results, we use Adjusted EBITDA as a supplemental measure of our operating performance and as part of our compensation determinations. Adjusted EBITDA is not required by or presented in accordance with GAAP and should not be considered as an alternative to net income, operating income, or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities or as a measure of our liquidity. Adjusted EBITDA is defined as net income plus interest expense, less interest income and other gain (loss) recognized on investments, plus income tax expense, plus depreciation and amortization (EBITDA), as adjusted for (i) contributions to privateArizona school tuition organizations in lieu of the payment of state income taxes; (ii) loss on transaction; (iii) share-based compensation, and (iv) unusual charges or gains, such as litigation and regulatory reserves, impairment charges and asset write-offs, and exit or lease termination costs. We present Adjusted EBITDA, a non-GAAP financial measure, because we consider it to be an important supplemental measure of our operating performance. We also make certain compensation decisions based, in part, on our operating performance, as measured by Adjusted EBITDA, and our credit agreement requires us to comply with covenants that include performance metrics substantially similar to Adjusted EBITDA. All of the adjustments made in our calculation of Adjusted EBITDA are adjustments to items that management does not consider to be reflective of our core operating performance. Management considers our core operating performance to be that which can be affected by our managers in any particular period through their management of the resources that affect our underlying revenue and profit generating operations during that period and does not consider the items for which we make adjustments (as listed above) to be reflective of our core performance. We believe Adjusted EBITDA allows us to compare our current operating results with corresponding historical periods and with the operational performance of other companies in our industry because it does not give effect to potential differences caused by variations in capital structures (affecting relative interest expense, including the impact of write-offs of deferred financing costs when companies refinance their indebtedness), tax positions (such as the impact 56 Table of Contents
on periods or companies of changes in effective tax rates or net operating losses), the book amortization of intangibles (affecting relative amortization expense), and other items that we do not consider reflective of underlying operating performance. We also present Adjusted EBITDA because we believe it is frequently used by securities analysts, investors, and other interested parties as a measure of performance. In evaluating Adjusted EBITDA, investors should be aware that in the future we may incur expenses similar to the adjustments described above. Our presentation of Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by expenses that are unusual, non-routine, or non-recurring. Adjusted EBITDA has limitations as an analytical tool in that, among other things, it does not reflect: ? cash expenditures for capital expenditures or contractual commitments; ? changes in, or cash requirements for, our working capital requirements;
? interest expense, or the cash required to replace assets that are being
depreciated or amortized; and
the impact on our reported results of earnings or charges resulting from the
? items for which we make adjustments to our EBITDA, as described above and set
forth in the table below. In addition, other companies, including other companies in our industry, may calculate these measures differently than we do, limiting the usefulness of Adjusted EBITDA as a comparative measure. Because of these limitations, Adjusted EBITDA should not be considered as a substitute for net income, operating income, or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities or as a measure of our liquidity. We compensate for these limitations by relying primarily on our GAAP results and use Adjusted EBITDA only as a supplemental performance measure. For more information, see our consolidated financial statements and the notes to those consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The following table reconciles net income to Adjusted EBITDA for the periods indicated: Year Ended December 31, 2020 2019 Net income$ 257,196 $ 259,175 Plus: interest expense 4,402 11,311 Less: interest income on Secured Note (59,190)
(59,297)
Less: investment interest and other (915)
(4,385)
Plus: income tax expense 75,944
58,327
Plus: amortization of intangible assets 8,419
8,223
Plus: depreciation and amortization 21,233
18,696
EBITDA 307,089
292,050
Plus: contributions in lieu of state income taxes(a) 5,000
4,003
Plus: loss on transaction(b) -
3,966
Plus: share-based compensation(c) 10,663
10,300
Plus: estimated litigation and regulatory reserves(d) 1,078
1,023 Adjusted EBITDA$ 323,830 $ 311,342
Represents contributions to various private
organizations to assist with funding for education. In connection with such
contributions made, we received a dollar-for-dollar state income tax credit,
which resulted in a reduction in our effective income tax rate to 22.8% and
(a) 18.4% for the years ended
contributions not been made, our effective tax rate would have been 23.9% and
19.3% for 2020 and 2019, respectively. Such contributions are viewed by our
management to be made in lieu of payments of state income taxes and are
therefore excluded from evaluation of our core operating performance.
(b) Represents costs incurred related to the Acquisition, including legal and
other third-party costs.
(c) Reflects share-based compensation expense related to GCE employees.
Reflects primarily regulatory litigation as GCE retained responsibility for
(d) all liabilities of GCU arising prior to the closing date of the Transaction.
See Note 2 - The Transaction in our consolidated financial statements for a
full description of the Transaction. 57 Table of Contents
Recent Accounting Pronouncements
See Note 4 - Summary of Significant Accounting Policies, in Item 8, Consolidated Financial Statements and Supplementary Data.
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