LINCOLN EDUCATIONAL SERVICES CORP quarterly report, Q3 FY2014

Business Context and Reporting Period

Lincoln Educational Services Corporation is a provider of career-oriented post-secondary education in automotive technology, health sciences, skilled trades, hospitality services, and business and information technology. As of September 30, 2014, it operated 31 campuses and five training sites in 15 states, enrolling 15,364 diploma and degree students and 181 short-program students. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.

Financial Performance and Position

Metric	Three Months Ended September 30	Nine Months Ended September 30
Revenue	$84.7 million, down 4.4%	$241.8 million, down 5.8%
Operating income (loss)	$(42.3) million	$(61.7) million
Net income (loss)	$(38.1) million	$(60.8) million
Net loss per share	$(1.67)	$(2.67)
Operating margin	(50.0)%	(25.5)%
Net margin	(45.0)%	(25.1)%
Cash provided by operating activities	Not separately reported	$1.3 million

• Revenue declines reflected lower average student populations: 14,361 in the quarter, down 4.0%, and 14,109 for the nine months, down 6.0%. Average revenue per student decreased 0.4% in the quarter but increased 0.3% year to date.
• Educational services and facilities expense represented 51.1% of quarterly revenue and 52.7% year to date, compared with 50.1% and 50.8%, respectively, in 2013. Selling, general and administrative expense represented 49.9% and 55.7%, compared with 48.8% and 54.1%.
• Goodwill and long-lived asset impairment charges totaled $41.4 million in the quarter and year to date, including a $39.0 million goodwill charge affecting 10 reporting units and approximately $2.4 million of long-lived asset and intangible impairments at six campuses. The charges were non-cash.
• Cash and cash equivalents were $12.7 million at September 30, 2014, compared with $12.9 million at December 31, 2013. Current assets were $43.5 million versus current liabilities of $68.5 million.
• Total debt and lease obligations were $42.8 million, including $7.5 million outstanding under the credit facility, $9.7 million of finance obligations, and $25.6 million of capital lease obligations. Current maturities totaled $8.0 million.
• The secured revolving credit facility had a $40 million commitment, matures April 5, 2015, and had $7.5 million outstanding at quarter-end. Outstanding letters of credit totaled $5.3 million. The company reported compliance with all financial covenants.
• Nine-month capital expenditures were $4.8 million. Total contractual cash obligations were $165.5 million, including operating leases of $106.3 million.

Material Changes Versus the Prior Comparable Period

• Quarterly revenue decreased $3.9 million and nine-month revenue decreased $14.8 million, primarily due to lower enrollment.
• Quarterly operating results deteriorated from $1.2 million of operating income in 2013 to a $42.3 million operating loss in 2014, primarily because of the impairment charges and lower revenue.
• Nine-month net loss increased to $60.8 million from $19.1 million. The 2013 results included $7.2 million of losses from discontinued operations; the company ceased operations at five Ohio and Kentucky campuses at December 31, 2013.
• Bad debt expense increased to 5.1% of quarterly revenue from 4.7% and to 4.9% year to date from 4.0%, reflecting somewhat weaker collections and changes in the timing of student account packaging.
• Operating cash flow improved to $1.3 million from $(9.3) million, primarily due to tax refunds and working-capital changes, but remained modest relative to the company’s losses and obligations.
• Debt declined substantially from $90.1 million at December 31, 2013 to $42.8 million at September 30, 2014, largely because $54.5 million of credit-facility borrowings were repaid in January using restricted cash. The company subsequently borrowed under the facility.
• Stockholders’ equity declined to $83.3 million from $145.2 million, primarily because of the nine-month net loss and a $3.8 million dividend.

Guidance, Outlook, Risks, Contingencies, and Unusual Items

• Management stated that student starts had stabilized in the first half of 2014 and that automotive and skilled-trade programs appeared more stable, while other programs continued to face challenges. Management subsequently expected the recovery in starts to be delayed by economic conditions, student and parent reluctance to incur debt, industry disruption, and competitor closures.
• Management expects 2014 capital expenditures to approximate 1% to 3% of revenue and believes cash from operations, existing cash, credit-facility borrowings, and potential leverage of owned real property should fund operations and obligations for at least the next twelve months. The company stated it may need to modify its business plans if it cannot improve operating performance or leverage properties.
• The company depends heavily on Title IV student aid; approximately 80% of 2013 cash receipts related to revenue came from Title IV programs. Regulatory changes, student loan availability, parental loan denials, the 90/10 rule, cohort default rates, and gainful-employment requirements could materially affect enrollment, receivables, liquidity, and operations.
• The Department of Education calculated the company’s 2013 financial responsibility composite score at 1.4 rather than the company’s calculation of 1.5. The company disputed the calculation and selected the Zone Alternative, requiring participation under Heightened Cash Monitoring 1 beginning October 22, 2014. Management reported no identified impact on the ability to disburse or receive Title IV funds as of the filing.
• A composite score below 1.0, or remaining between 1.0 and 1.4 for more than three consecutive years, could result in additional requirements, including a potential letter of credit and other restrictions.
• The company maintained a valuation allowance against net deferred tax assets because realization was not considered more likely than not. A $5.7 million quarterly and $4.8 million year-to-date tax benefit resulted partly from the reversal of a deferred tax liability following the goodwill impairment.
• The company faces ordinary-course lawsuits, investigations, and claims. A Massachusetts Attorney General civil investigative demand regarding consumer protection and finance laws remains outstanding; the company stated that it is cooperating and does not expect currently pending proceedings to have a material adverse effect.
• The company’s credit facility matures in April 2015, creating a refinancing or repayment consideration. The facility is secured by substantially all company and subsidiary assets and contains financial and regulatory covenants.

Investor Verification Priorities

1. Verify the company’s ability to refinance or repay the credit facility at its April 2015 maturity and its ability to leverage owned real estate.
2. Monitor enrollment, student starts, retention, average revenue per student, and bad debt trends, which are central to revenue and cash generation.
3. Assess the Department of Education’s final treatment of the 1.4 composite score and the operational and liquidity effects of Heightened Cash Monitoring 1.
4. Evaluate exposure to Title IV funding, gainful-employment rules, the 90/10 rule, cohort default rates, and other regulatory changes.
5. Determine whether additional goodwill, long-lived asset, or campus impairments may be required if losses and market capitalization declines continue.
6. Reconcile liquidity against $32.2 million of contractual cash obligations due within one year, including $7.5 million of credit-facility borrowings and $20.6 million of operating lease payments.
7. Review the sustainability of dividends and other cash uses in light of continuing losses, limited cash, and the company’s dependence on external financing.