Business Context and Reporting Period
Lincoln Educational Services Corporation provides career-oriented post-secondary education through 46 schools in 17 states, serving recent high school graduates and working adults across health sciences, automotive technology, skilled trades, business and information technology, and hospitality services. The unaudited Form 10-Q covers the three months ended March 31, 2012, with comparisons to the three months ended March 31, 2011. Enrollment at March 31, 2012 was 19,118 students; average quarterly student population was 19,572.
Financial Performance and Liquidity
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $104.9 million | $145.4 million | Down 27.9% |
| Operating income (loss) | $(4.1) million | $18.5 million | Down $22.6 million |
| Net income (loss) | $(3.1) million | $10.4 million | Down $13.4 million |
| Basic EPS | $(0.14) | $0.47 | Declined |
| Operating margin | (3.8%) | 12.7% | Down 16.5 points |
| Net margin | (2.9%) | 7.1% | Down 10.0 points |
| Cash flow from operations | $5.7 million | $15.0 million | Down $9.4 million |
| Capital expenditures | $2.7 million | $11.9 million | Down $9.1 million |
Educational services and facilities expense declined 12.2% to $51.8 million, while selling, general and administrative expense declined 15.8% to $57.2 million. Despite these reductions, expenses exceeded revenue because of the company’s relatively high fixed-cost structure. Expense ratios increased to 49.4% of revenue for educational services and facilities and 54.4% for SG&A, compared with 40.6% and 46.7%, respectively, in the prior-year quarter.
The company reported a $2.3 million income-tax benefit, equal to 43.4% of the pretax loss, compared with a $7.0 million tax provision in Q1 2011. Net interest expense increased to $1.3 million, partly because deferred financing costs associated with the expiring credit facility were accelerated.
Cash and cash equivalents were $27.6 million at March 31, 2012, versus $26.5 million at December 31, 2011. Total liabilities were $121.9 million and stockholders’ equity was $234.5 million. Total debt and lease obligations were $36.4 million, including $0.5 million of current maturities; no revolving credit borrowings were outstanding. The company had approximately $1.6 million of letters of credit.
Net cash used in investing activities was $2.7 million and net cash used in financing activities was $1.9 million. Financing cash uses included $1.6 million of dividends, including the quarterly dividend of $0.07 per share. Management stated that cash from operations, existing cash and availability under the new credit facility are expected to fund operations and planned capital expenditures through 2012. Capital expenditures are expected to equal approximately 4% to 5% of 2012 revenue.
Material Changes Versus the Prior Comparable Period
- Revenue fell $40.5 million, primarily because average student population declined 31.2%. Average revenue per student increased 4.9%, partly due to tuition increases averaging approximately 3% and changes to program offerings.
- Student starts declined 4.9%, while management attributed the broader enrollment decline to more selective admissions, program restructuring, lower financial-aid availability for certain programs, economic conditions and increased student reluctance to incur debt.
- Operating results shifted from $18.5 million of operating income to a $4.1 million operating loss. The operating loss includes the effect of costs that could not be reduced in proportion to enrollment.
- Bad debt expense declined, and bad debt expense as a percentage of revenue improved to 3.5% from 4.6%. However, student loan commitments increased to $28.8 million from $26.4 million at December 31, 2011, or $21.4 million net of interest compared with $20.2 million.
- Operating cash flow decreased 62.3%, although lower capital expenditures and lower financing cash uses allowed cash to increase modestly during the quarter.
Guidance, Outlook, Risks and Unusual Items
Management expects the rate of enrollment decline to improve in the second half of 2012, supported by three campuses opened in 2011, expanded offerings at the relocated Denver campus and more favorable year-over-year comparisons. Management cautioned that enrollment remains difficult to predict and that continued weakness could further reduce revenue and materially impair profitability.
On April 5, 2012, after the reporting date, the company replaced its $115 million secured revolving facility with an $85 million secured revolving credit facility maturing April 5, 2015. The facility includes a $5 million swing-line sublimit, a $25 million letter-of-credit sublimit and an option to increase commitments by up to $50 million subject to conditions. The facility is secured by substantially all tangible and intangible assets other than real estate and contains financial, regulatory and other customary covenants.
On April 18, 2012, the company acquired the assets of Florida Medical Training Institute for approximately $2.0 million net of cash acquired. The acquired business operates five Florida locations and offers emergency medical, nursing assistant, fire science and related programs.
Regulatory exposure is significant because approximately 84% of 2011 revenue-related cash receipts came from Title IV programs. The company must manage the 90/10 Rule, cohort default rates, gainful-employment requirements, student-aid eligibility and restrictions affecting ability-to-benefit students. The company reported that 2011 institutional 90/10 percentages ranged from 76.5% to 89.2%. Draft 2010 two-year cohort default rates ranged from 12.2% to 33.7%, and draft 2009 three-year rates ranged from 17.7% to 49.8%; the company planned to appeal all draft rates.
Approximately 7.2% of students were ability-to-benefit students at March 31, 2012. Legislative changes eliminating federal aid eligibility for new ability-to-benefit students enrolling after July 1, 2012 are expected to reduce this population and could adversely affect enrollment and revenue. The company also disclosed seasonal enrollment patterns, substantial operating lease obligations and total contractual cash obligations of $222.7 million.
Management stated that no pending legal proceedings were expected to have a material adverse effect. Goodwill was $97.4 million, or approximately 27.3% of total assets, with no impairment identified at December 31, 2011 and no subsequent events requiring a retest through March 31, 2012. Disclosure controls and procedures were assessed as adequate and effective, with no material changes to internal control over financial reporting.
Facts Investors Should Verify
- Whether student starts and average enrollment improve in the second half of 2012 as management expects.
- The final effect of the new admissions, program restructuring and student-financing policies on enrollment, revenue per student and loan commitments.
- Final Department of Education cohort default rates, appeals and any effect on Title IV eligibility or credit-facility covenants.
- Compliance with the 90/10 Rule after expiration of temporary statutory relief and the effect of increased institutional lending.
- The impact of gainful-employment regulations taking effect July 1, 2012 and the elimination of aid eligibility for new ability-to-benefit students.
- Liquidity, covenant compliance and borrowing availability under the $85 million 2012 Credit Facility.
- Integration, enrollment contribution and financial results of the Florida Medical Training Institute acquisition.
- The recoverability of the $97.4 million goodwill balance and the company’s ability to manage its fixed operating-cost base during enrollment weakness.