Business Context and Reporting Period
Career Education Corporation (CEC) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. CEC operated more than 90 campuses in the U.S. and Europe, serving over 104,000 students; about 44% attended online campuses. Results are not necessarily indicative of full-year results.
CEC realigned schools into five reporting segments and revised prior-period segment results for comparison. It acquired International University of Monaco (IUM) in April for approximately $6.3 million, plus $4.3 million of assumed loans that were immediately repaid.
Financial Results and Key Metrics
Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue | $527.9 | $437.7 | $1,057.6 | $870.5 |
| Operating income | $95.4 | $37.1 | $183.5 | $88.3 |
| Operating margin | 18.1% | 8.5% | 17.3% | 10.1% |
| Income from continuing operations | $65.2 | $23.6 | $121.1 | $57.5 |
| Net income | $64.3 | $6.5 | $119.5 | $29.7 |
| Diluted earnings per share | $0.80 | $0.07 | $1.46 | $0.33 |
- Q2 revenue increased 20.6%; management attributed growth primarily to student population up 23% and new student starts up 18%. Six-month revenue rose 21.5%, with starts up 25%.
- Q2 operating margin expanded 9.6 percentage points. General and administrative costs rose 9.1%, slower than revenue, while educational services and facilities expense rose 6.4%.
- Bad debt expense was $19.5 million in Q2, up 30.4%; for the first half it was $45.9 million, up 84.3%. Culinary Arts had particularly high bad debt expense, equal to 10.4% of segment revenue in Q2 and 11.9% for the first half.
- First-half cash from operating activities was $47.9 million, versus $51.7 million a year earlier. Changes in operating assets and liabilities used $160.8 million of cash.
- Cash and short-term investments totaled $312.7 million at June 30, down from $484.9 million at year-end; this included $35.4 million restricted for certain European not-for-profit schools. Current assets were $475.1 million and current liabilities $367.7 million.
- CEC had no borrowings under its $185 million U.S. credit agreement; $176.2 million remained available after $8.8 million of letters of credit. Capital lease obligations totaled approximately $2.1 million.
- First-half capital expenditures were $43.2 million. CEC repurchased 5.4 million shares for approximately $155.0 million and had $290.5 million remaining under its repurchase authorization.
Material Changes Versus Prior Period
- Q2 net income increased sharply, reflecting higher continuing-operations earnings and a smaller discontinued-operations loss ($0.9 million versus $17.1 million). For the first half, the discontinued-operations loss was $1.6 million versus $27.7 million.
- Growth and operating leverage were broad-based. Q2 segment revenue increased 18.8% in University, 25.0% in Health Education, 25.0% in Culinary Arts, and 14.1% in International. Culinary Arts moved from an operating loss to $12.4 million of operating income.
- Student receivables, net, increased to $94.7 million across current and non-current balances from $79.3 million at year-end. The allowance for doubtful accounts rose to $68.7 million from $53.4 million.
- CEC repurchased shares and paid its 2009 annual incentive in Q1, contributing to the decline in cash. Treasury shares increased to 15.1 million from 9.6 million at year-end.
- The Q2 effective tax rate declined to 31.1% from 36.0%, partly due to a $4.2 million benefit from a recently closed federal tax audit related to curriculum-development credits.
Outlook, Commentary, Risks, and Unusual Items
- Management described growth initiatives focused on online education, bachelor’s and master’s programs, university brands, and expansion of Health Education. It expected AIU and CTU new-start growth for the rest of 2010 to be lower than Q2 as comparisons became tougher.
- CEC expected to open at least two additional Health Education schools in 2010. AIU–Los Angeles was expected to complete its teach-out by Q4 2010; CEC estimated approximately $9 million of future real-estate charges related to its closure.
- A new Schaumburg lease creates a $48.1 million real-estate obligation through 2022. CEC also planned approximately $52 million of capital improvements over two years, mostly in 2010; first-half results included $3.7 million of lease-termination costs.
- First-half results included an $8.1 million pretax increase in reserves for certain extended-payment-plan and terminated recourse-loan receivables. CEC reported approximately $87.7 million committed to extended payment plans as of June 30.
- Proposed U.S. Department of Education rules on incentive compensation, gainful employment, credit hours, and misrepresentation could materially affect operations and Title IV eligibility if adopted. CEC noted that approximately 82% of U.S. schools’ tuition cash receipts in the first half came from Title IV funding.
- AIU’s accreditor cited no accreditation violations or sanctions after its review, but approved a focused visit in 2011 or 2012 concerning AIU’s new undergraduate credit structure. A preliminary Education Department review identified six findings at AIU, including two systemic findings related to documenting online attendance; AIU planned to contest those findings. A CTU compliance audit was ongoing.
- CEC disclosed student class actions and a False Claims Act case involving AIU. The government declined to intervene in the latter; the court denied CEC’s motion to dismiss, and discovery was stayed pending further motions. CEC said outcomes were uncertain and could be materially adverse.
- Municipal auction-rate securities totaling $11.8 million remained illiquid; CEC recorded approximately $0.5 million of cumulative unrealized losses and considered the impairment temporary. Management provided no numerical full-year revenue or earnings guidance in the supplied filing text.
Most Important Facts for Investors to Verify
- Whether growth in enrollment and new student starts persists as comparisons tighten, and whether segment margins remain strong.
- Student receivables, extended-payment-plan performance, and the adequacy of bad-debt reserves, particularly in Culinary Arts.
- Final outcomes of proposed federal rules, AIU’s Education Department review, CTU’s audit, and related accreditation matters, given CEC’s reliance on Title IV funding.
- Cash generation after share repurchases, planned capital spending, lease commitments, and potential closure costs.
- Developments and potential financial exposure in the disclosed litigation; the filing does not provide a clear quantified estimate of potential losses.