LINCOLN EDUCATIONAL SERVICES CORP quarterly report, Q3 FY2012

Business Context and Reporting Period

Lincoln Educational Services Corporation is a provider of career-oriented post-secondary education, operating 46 schools and five training sites in 17 states across health sciences, automotive technology, skilled trades, business and information technology, and hospitality services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2012, compared with the corresponding 2011 periods.

At September 30, 2012, the Company reported 19,028 diploma-and-above students and 536 short-certificate students. Average student population declined 19.7% in the quarter and 25.8% year to date, primarily due to more selective admissions, regulatory changes, reduced ATB enrollment, program restructuring, and economic conditions.

Key Financial Metrics

Metric	Three Months Ended September 30, 2012	Three Months Ended September 30, 2011	Nine Months Ended September 30, 2012	Nine Months Ended September 30, 2011
Revenue	$104.1 million	$123.5 million	$309.4 million	$397.1 million
Operating income (loss)	$(2.5) million	$(5.0) million	$(34.7) million	$22.8 million
Operating margin	(2.3%)	(4.1%)	(11.2%)	5.8%
Net income (loss)	$(1.5) million	$(3.9) million	$(25.2) million	$11.4 million
Diluted EPS	$(0.07)	$(0.18)	$(1.14)	$0.51
Net cash from operating activities	Not separately provided	Not separately provided	$8.1 million	$27.2 million

Quarterly revenue decreased 15.7%; year-to-date revenue decreased 22.1%. Average revenue per student increased 5.1% in the quarter and 4.9% year to date, primarily from tuition increases and program changes.
Quarterly educational services and facilities expense declined 10.2%, but increased to 49.5% of revenue from 46.5% because the cost base contains significant fixed components. Year-to-date expense declined 10.5%, while the margin increased to 49.5% of revenue from 43.1%.
Quarterly selling, general and administrative expense declined 12.3%, but increased to 51.1% of revenue from 49.2%. Year-to-date SG&A declined 14.2%, while increasing to 53.4% of revenue from 48.5%.
Bad debt expense was 6.3% of quarterly revenue and 5.2% year to date, compared with 7.8% and 6.0%, respectively, in the prior-year periods.
Cash and cash equivalents were $20.4 million at September 30, 2012, down from $26.5 million at December 31, 2011. Total current assets were $73.5 million versus $72.7 million at year-end.
Total debt and lease obligations were $36.1 million, including $35.7 million classified as long-term, compared with $36.5 million at December 31, 2011. The Company had no borrowings under its new revolving credit facility and $1.6 million of outstanding letters of credit.
Stockholders’ equity declined to $211.1 million from $239.0 million, primarily reflecting the year-to-date net loss and $4.8 million of dividends paid.

Cash Flow, Liquidity and Capital Resources

Operating cash flow declined to $8.1 million from $27.2 million, primarily because of the reduction in earnings and working-capital effects.
Investing cash outflow was $8.2 million, including $6.8 million of capital expenditures and $1.5 million for the acquisition of Florida Medical Training Institute. This compared with $30.1 million of investing outflow in 2011, when capital expenditures were $30.9 million.
Financing cash outflow was $6.0 million, including $4.8 million of dividends, $0.7 million of deferred finance fees, and $0.4 million of capital lease principal payments.
The April 2012 secured revolving credit facility provides commitments of up to $85 million, matures April 5, 2015, and permits an increase of up to $50 million subject to conditions. Reported net availability was approximately $83.4 million, including a $23.4 million letter-of-credit sublimit.
Management stated that cash, operating cash flow, and available credit are expected to fund operations and currently identified capital expenditures beyond the next twelve months, although access to additional capital on favorable terms is not assured.
2012 capital expenditures were expected to range from 4% to 5% of revenue, compared with 7.4% in 2011.

Material Changes Versus the Prior Comparable Period

Enrollment contraction drove significant revenue deterioration despite higher revenue per student. Third-quarter student starts declined 16.7% year over year.
The Company recorded a $23.7 million pre-tax, noncash impairment charge in the second quarter of 2012, consisting of $15.4 million of goodwill impairment and $8.3 million of long-lived-asset impairment. No impairment was recorded in the third quarter.
Goodwill declined to $83.9 million from $97.4 million at December 31, 2011. The filing attributes the impairment to lower-than-expected student populations at five reporting units.
The Company approved the closure of seven campuses and stopped enrolling new students at those locations. The campuses generated $9.1 million of revenue during the first nine months of 2012 and had operating expenses of $26.3 million, including impairments.
The Company acquired Florida Medical Training Institute on April 18, 2012 for approximately $1.7 million net of cash acquired. The acquired business operates five Florida locations.
On July 1, 2012, the Company stopped enrolling new ATB students because the Consolidated Appropriations Act, 2012 eliminated their eligibility for federal student aid. ATB students represented approximately 5.1% of enrollment at September 30, 2012.
The Company entered into a new $85 million secured revolving credit agreement in April 2012, replacing the former $115 million facility. No revolver borrowings were outstanding under either facility at the applicable reporting dates.

Guidance, Outlook, Risks and Unusual Items

Management expected the rate of enrollment decline to improve in subsequent quarters but at a slower pace, while noting that the economic environment and regulatory activity made enrollment difficult to predict.
Management expected the seven-campus closure program to require approximately $6.9 million of second-half 2012 charges, of which approximately $2.4 million had been incurred through September 30, including $0.6 million recorded as a reduction of revenue. The financial statements separately report $1.7 million of school closing costs as an expense.
Management expected the campus closures to be accretive to 2013 earnings by approximately $0.21 per share, but this is a forward-looking estimate and is not assured.
The Company is highly dependent on Title IV programs, which represented approximately 84% of cash receipts relating to revenue in 2011. Changes in Title IV eligibility, the 90/10 rule, cohort default rates, gainful-employment requirements, admissions policies, or federal funding could materially affect enrollment, receivables, liquidity, and operations.
For fiscal 2009, institutional two-year cohort default rates ranged from 8.1% to 33.7% after appeals. For fiscal 2009, final three-year rates ranged from 16.9% to 49.2%; 10 institutions had rates of at least 30%, although the institution above 40% was subsequently merged with another institution whose rate was below 30%.
The court vacated most gainful-employment regulations in June 2012. The Department of Education could appeal, issue new regulations, or take other action, and the ultimate impact was not determinable.
Outstanding student loan commitments were $33.7 million, or $25.4 million net of interest, at September 30, 2012. These commitments increased as the Company restructured programs to create financing gaps supporting 90/10 compliance.
The Company reported no material pending legal proceeding and stated that its disclosure controls were adequate and effective. Management also reported remediation of the previously disclosed material weakness concerning long-lived-asset impairment accounting.

Important Facts for Investors to Verify

Whether enrollment and student starts stabilize following the ATB restriction, selective admissions changes, and seven-campus closures.
The final cash costs, timing, and operating savings from the campus closures, including the effect of lease buyouts, severance, refunds, and potential subleasing.
Compliance with the 90/10 rule, cohort default-rate thresholds, Title IV eligibility requirements, and any successor gainful-employment rules.
Whether lower student populations produce additional goodwill or long-lived-asset impairments, particularly given the remaining $83.9 million goodwill balance.
The adequacy of cash flow and credit availability to fund student loan commitments, contractual obligations, capital expenditures, and lease obligations totaling $212.1 million.
The sustainability of dividends and the Company’s ability to maintain liquidity while reporting losses and reduced operating cash flow.