LINCOLN EDUCATIONAL SERVICES CORP quarterly report, Q3 FY2016

Lincoln Educational Services Corporation — Form 10-Q Summary

Business context and reporting period

Quarterly report for the three and nine months ended September 30, 2016. Lincoln operated 30 career-oriented post-secondary schools in 15 states, with programs primarily in transportation, skilled trades, healthcare, hospitality, business and information technology. The company was executing a strategic shift toward Transportation and Skilled Trades while divesting or teaching out other campuses and programs.

At September 30, 2016, the company reported 12,855 total students, including 7,863 students in continuing operations. The continuing operations segments were Transportation and Skilled Trades and Transitional; 17 healthcare campuses were reported as discontinued operations.

Financial performance and key metrics

Metric	Three months ended September 30	Change	Nine months ended September 30	Change
Revenue	$49.8 million	Down 7.8%	$138.4 million	Down 8.1%
Operating income (loss)	$1.0 million	Down from $5.9 million	$(8.2) million	Down from $(3.2) million
Income (loss) from continuing operations	$1.3 million	Down from $4.0 million	$(7.7) million	Comparable to $(7.6) million
Net income (loss)	$(0.5) million	Down from $2.6 million	$(9.7) million	Improved from $(11.9) million
Net loss per share	$(0.02)	Down from $0.11	$(0.41)	Improved from $(0.51)

Continuing-operations operating margin was 2.1% in the quarter versus 10.9% in the prior-year quarter, and negative 5.9% for the nine-month period versus negative 2.1%. Educational services and facilities expense represented 49.0% of quarterly revenue and 51.3% of nine-month revenue, while selling, general and administrative expense represented 48.9% and 55.0%, respectively.

Transportation and Skilled Trades revenue was $47.9 million in the quarter, down 3.5%, and $131.2 million for nine months, down 4.2%. Segment operating income declined to $6.1 million from $10.6 million in the quarter and to $11.9 million from $18.3 million for nine months.
Transitional revenue declined to $1.9 million in the quarter and $7.2 million for nine months, reflecting campus closures and teach-outs. The segment generated operating losses of $1.4 million and $5.6 million, respectively.
Discontinued operations generated revenue of $24.5 million for the quarter and $74.5 million for nine months, with net losses of $1.7 million and $2.0 million, respectively.
Average continuing-operations student population declined approximately 8.1% in the quarter and 10.2% for nine months. Total student starts declined 10.5% and 8.2%, respectively.

Cash flow, liquidity and capital structure

Cash and cash equivalents were $19.2 million at September 30, 2016, compared with $38.4 million at December 31, 2015. Total cash, including restricted cash, was $45.8 million, of which $26.6 million was restricted.
Operating cash flow was $(9.5) million for the nine months, compared with positive $2.5 million in the prior-year period. Investing cash flow was $(0.6) million, including $2.2 million of capital expenditures. Financing cash flow was $(9.0) million.
Accounts receivable increased to $13.7 million from $9.9 million, while the allowance for doubtful accounts was $8.4 million. Bad debt expense was 4.4% of quarterly revenue and 4.8% of nine-month revenue.
Total debt and lease obligations were $43.4 million, including $41.7 million of term-loan debt and $1.7 million of finance obligation, compared with $55.7 million at year-end 2015. The term loan carried an 11% interest rate at September 30, 2016, matures July 31, 2019 and is secured by substantially all company assets.
The company had $5.5 million of letters of credit outstanding under a facility with $9.5 million of maximum availability. Surety bonds totaled approximately $14.9 million.
Management stated that expected cash sources should fund operations for the next twelve months. Assets held for sale were $48.3 million, and management expected approximately $32.3 million of net proceeds from asset sales, with up to $10 million required for debt repayment.

Material changes versus the prior comparable period

Revenue and student population continued to decline, primarily because of lower beginning-of-year enrollment, campus teach-outs and weaker student starts.
Quarterly profitability deteriorated sharply as lower revenue and higher marketing, sales, facilities, laptop and West Palm Beach closing costs outweighed cost reductions.
Nine-month selling, general and administrative expense declined 6.1%, aided by lower salaries, benefits, bad debt and teach-out costs, but expense ratios increased because revenue declined faster.
Net interest expense decreased by approximately $0.6 million in both the quarter and nine-month period, partly due to lease modifications and lease terminations.
The company incurred approximately $8.5 million of campus closing costs, a $0.7 million loan-modification fee and $0.7 million of severance during the nine months.
The company entered into a planned $15.9 million West Palm Beach property sale agreement, but the buyer terminated the agreement on September 1, 2016.

Guidance, outlook, risks and unusual items

The filing provides no specific revenue, earnings or enrollment guidance. Management expects seasonal fluctuations to continue and stated that second-half performance depends significantly on high-school recruiting and enrollment execution. Management described industry enrollment trends as more stable but still challenged by regulatory changes, competition, low unemployment and students entering the workforce instead of pursuing post-secondary education.

The company intends to focus predominantly on Transportation and Skilled Trades, complete the Hartford teach-out by year-end 2016 and complete the West Palm Beach program teach-out in the first quarter of 2017.
On November 1, 2016, the board approved teach-outs of the Green Valley, Nevada and Center City, Philadelphia campuses. These operations were already classified as discontinued operations and held for sale at September 30, 2016.
Title IV funding represented approximately 80% of 2015 cash receipts relating to revenue. Changes to federal aid eligibility, gainful-employment rules, the 90/10 rule, cohort-default requirements or accreditation could materially affect enrollment, cash flow and campus operations.
One institution comprising 13 campuses was accredited by ACICS. The Department of Education had terminated ACICS recognition, subject to appeal. Loss of recognition could require new accreditation, affect Title IV eligibility and potentially trigger a credit-agreement default.
Five programs had draft failing gainful-employment rates, 13 were in the zone and 60 passed for the 2015 debt-measure year. Final results were expected in early 2017.
New borrower-defense regulations effective July 1, 2017 could increase administrative requirements and potentially require letters of credit or other financial protection.
The company maintained a valuation allowance against net deferred tax assets because realization was not considered more likely than not.
The Maryland Attorney General requested information concerning the Columbia, Maryland campus. Management stated that pending legal matters were not expected to have a material adverse effect, but the ultimate outcome of the investigation was not stated.

Important facts for investors to verify

Whether unrestricted liquidity and operating cash flow are sufficient to meet debt service, lease obligations, campus closing costs and required debt repayments.
The timing and proceeds of asset sales, including the consequences of the terminated West Palm Beach sale agreement and the requirement to use certain proceeds for debt repayment.
Compliance with the term-loan financial covenants and whether the company elects covenant resets requiring up to $4 million of repayment by January 15, 2017.
Final ACICS accreditation and Department of Education determinations, including any effect on Title IV eligibility or debt covenants.
Final gainful-employment rates and any required student warnings, program closures or financial protection.
Enrollment trends, student starts, accounts-receivable collections and bad-debt allowances in the Transportation and Skilled Trades segment.
Completion costs and remaining liabilities associated with Hartford, West Palm Beach, Green Valley and Center City teach-outs.