Career Education Corporation (CEC) — Form 10-Q
Reporting period: Quarter ended September 30, 2016; filed November 3, 2016. The filing identifies the registrant as Career Education Corporation. Unless otherwise noted, amounts below are in U.S. dollars.
Business context and reporting period
CEC operated Colorado Technical University (CTU) and American InterContinental University (AIU), primarily online, alongside Culinary Arts and Transitional Group campuses being taught out. The two universities represented 88% of total enrollment at quarter-end; teach-out campuses no longer generally enrolled new students. Five Transitional Group campus teach-outs were completed during the quarter.
Financial results and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $167.6m | $203.5m | $549.1m | $647.3m |
| Operating income (loss) | $(0.7)m | $(44.0)m | $23.6m | $(88.2)m |
| Net income (loss) | $(0.7)m | $(45.2)m | $14.2m | $(90.8)m |
| Diluted EPS | $(0.01) | $(0.67) | $0.21 | $(1.34) |
| Operating margin | (0.4%) | (21.6%) | 4.3% | (13.6%) |
| Operating cash flow | Not presented quarterly | $15.7m | $(21.0)m | |
| Adjusted EBITDA (non-GAAP) | $4.8m | $2.7m | $43.6m | $(13.4)m |
At September 30, 2016, cash, cash equivalents, restricted cash and short-term investments totaled $217.8m, including $55.7m unrestricted cash and $11.0m restricted balances. There were no borrowings outstanding; the revolving facility was $95m, matures December 31, 2018, and requires 100% cash collateral for borrowings and letters of credit. Total assets were $551.5m, current liabilities $130.8m, and stockholders’ equity $355.0m. Nine-month capital expenditures were $3.4m.
Material changes versus prior comparable periods
- Q3 revenue fell 17.6%; nine-month revenue fell 15.2%, largely as Career Schools campuses were taught out. Total enrollment declined 20.3% year over year at quarter-end, while University Group enrollment increased 1.6%.
- University Group Q3 revenue rose 2.5% and operating income rose 7.2%. CTU revenue increased 6.4%; AIU revenue decreased 4.2%.
- Q3 operating loss improved substantially versus 2015, principally because the prior-year quarter included $33.4m of asset impairment charges, alongside lower teach-out and corporate costs. Nine-month 2016 operating results also benefited from $50.8m less impairment expense than the prior year.
- Bad debt expense increased to $8.5m in Q3 from $6.4m and to $23.3m year to date from $15.7m. Management cited higher reserve rates and delays in students completing financial-aid verification.
- Nine-month operating cash flow improved by $36.7m year over year. Cash and cash equivalents declined $11.3m from year-end 2015, while the company repaid its $38m revolving borrowing in Q1.
Outlook, management commentary, risks and unusual items
- Management raised its projected year-end 2016 cash, cash equivalents, restricted cash and short-term investments, net of borrowings, to $180m–$190m, from prior guidance of $160m–$170m. The comparable 2017 target is $160m–$170m. Management said it expects cash usage to moderate through 2016–17 and cash generation to begin in 2018.
- Management expected 2016 adjusted EBITDA to improve significantly versus 2015, positive adjusted EBITDA in 2017 but below 2016, and improvement in 2018 as teach-outs conclude. Assumptions include flat-to-modest University Group enrollment growth and no material adverse change in the legal or regulatory environment; actual results may differ.
- CEC expected teach-out operating losses to increase as declining student revenue fails to cover remaining fixed costs. Most remaining Culinary Arts and Transitional Group campuses were expected to complete teach-outs by the end of 2017, with the remainder through 2018. The company estimated $40m–$50m of additional future lease-exit charges upon campus closures, beyond approximately $34.6m already recorded for remaining obligations during 2015 through Q3 2016. Net contractual operating lease obligations were $233.4m.
- Regulatory exposure is significant. Approximately 77% of tuition cash receipts came from Title IV funding. All institutions were on Heightened Cash Monitoring 1 and held provisional participation agreements through December 31, 2016; continuing institutions had applied for recertification. The Department of Education (ED) could impose restrictions, delays, fines or enhanced financial protections, potentially affecting access to federal student aid.
- Draft gainful-employment metrics placed two continuing AIU programs and three continuing CTU programs in the “zone”; one program at each university failed, with both being placed into teach-out. Criminal Justice programs in the zone represented about 18% of University Group enrollment. Final rates were expected in January 2017.
- ED issued borrower-defense regulations on October 28, 2016, generally effective July 1, 2017. Potential loan-discharge reimbursement, letters of credit, disclosures, litigation costs and administrative obligations were uncertain; CEC said it was still evaluating the impact.
- CEC disclosed multiple unresolved legal and regulatory matters, including state attorneys general, FTC and SEC inquiries, and False Claims Act and student litigation. A $2.6m accrual covered estimated legal fees and settlements, but the company said it could not reasonably estimate potential losses in several major matters. The Powell False Claims Act case was set for trial in February 2017; the SEC inquiry concerned the 2014 classification and sale process for Le Cordon Bleu campuses.
- Tax results were affected by an $8.8m nine-month tax provision despite pretax income of $24.0m; this included a favorable $2.1m adjustment from completion of a federal tax audit. Management also noted valuation allowances on certain deferred tax assets.
Most important facts for investors to verify
- Whether University Group enrollment, retention, bad debt trends and CTU/AIU performance sustain the improvement reported in Q3.
- Whether the 2016–17 liquidity targets and adjusted EBITDA outlook are achieved, including the cash and cost effects of teach-outs and lease obligations.
- ED recertification and Title IV funding status, HCM1 developments, and final gainful-employment outcomes for the programs in the zone or failing.
- Potential financial and enrollment effects of borrower-defense regulations, government investigations, and pending litigation; several exposures were not estimable in the filing.
- Whether the estimated $40m–$50m of future lease-exit charges and the recorded lease obligations change as closures, subleases and lease buyouts progress.