PERDOCEO EDUCATION Corp quarterly report, Q2 FY2013

Business context and reporting period

This is Career Education Corporation’s unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The company operated career-focused postsecondary schools through online, on-ground and hybrid programs. The filing identifies the registrant as Career Education Corporation; it does not identify it as Perdoceo Education Corp.

Unless otherwise noted, financial amounts below are in millions of dollars. The company reported University Schools, Career Schools, International and Transitional Schools; Transitional Schools were being taught out and were no longer enrolling new students.

Financial results and liquidity

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Revenue	$294.8	$365.9	$635.1	$795.6
Operating loss	$(63.5)	$(105.3)	$(80.9)	$(57.0)
Operating margin	(21.5%)	(28.8%)	(12.7%)	(7.2%)
Net loss	$(31.4)	$(100.2)	$(46.6)	$(48.2)
Basic and diluted loss per share	$(0.47)	$(1.52)	$(0.70)	$(0.72)

• Revenue fell 19.4% in Q2 and 20.2% year to date. The Q2 operating loss narrowed year over year, while the six-month operating loss widened. The prior-year comparisons included $85.5 million of goodwill and asset impairments; the six-month 2012 results also benefited from a $19.0 million insurance recovery.
• Q2 2013 results included a $10.0 million probable New York settlement charge, $4.0 million of trade-name impairments and $2.5 million of restructuring costs. Q2 2012 included $85.4 million of goodwill and asset impairment charges.
• Operating cash flow was $(67.0) million for the six months, versus $16.6 million provided in the prior-year period. Investing cash flow was $(12.6) million and financing cash flow was $6.3 million. Capital expenditures were $10.0 million, down from $20.0 million.
• At June 30, cash, cash equivalents and short-term investments totaled $241.8 million, including $12.0 million of restricted cash. Unrestricted cash and cash equivalents were $165.9 million; $72.5 million of cash related to European not-for-profit schools was designated for their use. The company reported approximately $128.2 million of unrestricted cash and short-term investments held by U.S. operations.
• No borrowings were outstanding at quarter end. The $80.0 million revolver had been repaid in Q1 and was scheduled to mature January 31, 2014. It required at least $75.0 million of cash and cash equivalents in domestic accounts and was secured by 110% cash collateral.
• Total assets were $994.2 million and stockholders’ equity was $569.7 million at June 30. The company used a $6.6 million favorable tax adjustment in Q2, partly offset by tax effects associated with the AIU London sale.

Changes versus the prior comparable period

• Student starts fell 25% in Q2 overall and 26% year to date; excluding Transitional Schools, starts declined 19% and 18%, respectively. Management said readiness programs accounted for part of the decline; excluding those programs and Transitional Schools, Q2 starts were down 10%.
• University Schools revenue declined 14% in Q2, with operating income of $17.6 million. Career Schools revenue declined 22% and the segment reported a $51.7 million operating loss. International revenue grew 22%, although the segment recorded a Q2 operating loss of $3.7 million, which management attributed mainly to the summer break in classes.
• Student population was down 25% overall at June 30 year over year. Domestic revenue declines reflected lower enrollment, fewer starts and the continuing wind-down of Transitional Schools.
• Cash and cash equivalents plus short-term investments fell 40% from December 31, 2012, mainly reflecting repayment of the revolver and operating cash use. Other accrued expenses increased primarily due to litigation accruals; deferred tuition revenue declined with the student population.

Outlook, risks and unusual items

• Management expected Transitional Schools to incur $70–$80 million of operating losses for 2013, excluding remaining lease charges and other unusual items, and expected most teach-outs to be completed by Q2 2014.
• Management targeted operating-cost reductions of at least $25 million in 2013 and expected about 480 positions to be eliminated during the year. It anticipated up to $2.0 million of additional severance and related costs in the remainder of 2013.
• Management said it expected to meet cash requirements for at least the next 12 months using operating cash and existing balances, while noting continued pressure on domestic operating cash flow. It was evaluating extension or replacement of the credit line, potential asset sales, its real-estate footprint and its campus portfolio.
• Title IV funding was critical: approximately 78% of U.S. tuition cash receipts in the first half of 2013 came from Title IV programs. All institutions remained on Heightened Cash Monitoring 1 status. A move to reimbursement or HCM2 could delay federal cash receipts and require the company to fund operations from available cash.
• Regulatory and legal exposure remained significant. The company recorded a $10.0 million reserve for a probable New York Attorney General settlement, subject to final terms. Proposed securities and derivative settlements were expected to involve $32.5 million of company payments, which management expected to be offset by insurance recoveries; court approval and final agreements remained pending. Total accrued legal fees and settlements were $49.4 million, with a $32.5 million insurance receivable recorded.
• Other matters included state attorney general inquiries, an SEC inquiry and Department of Education matters. The company disclosed student, securities, False Claims Act and employment litigation; it said it could not reasonably estimate possible losses for several unresolved cases. It recorded a $0.8 million liability related to a Department of Education file review.
• New FCC consent rules for automated calls were scheduled to take effect October 16, 2013; management anticipated reduced marketing efficiency and possible adverse effects on prospective-student inquiries. Management also cited extended student decision cycles, competition, negative publicity and an uncertain regulatory environment.
• The sale of AIU London generated no consideration and resulted in a $6.9 million year-to-date loss, including cumulative currency translation losses. The company also reported $37.7 million of remaining lease obligations for discontinued operations, with lease expirations extending as late as 2019, and estimated about $77 million in gross lease obligations for campuses still in the teach-out process once closures are complete.

Important facts for investors to verify

1. Whether enrollment and revenue declines stabilize, particularly at the University and Career Schools, and whether management’s reported early application trends translate into starts.
2. Whether the company achieves its 2013 cost-reduction target and Transitional Schools loss outlook, including the timing and cost of campus closures and lease obligations.
3. Available domestic liquidity after considering cash designated for not-for-profit schools, operating cash burn, the $75 million domestic-cash covenant and the January 2014 revolver maturity.
4. Final terms, court approval and insurance recoveries for the New York, securities and derivative matters, and the potential exposure from other investigations and litigation.
5. Any Department of Education action affecting Title IV participation or payment timing, and the operational and cash-flow effects of the FCC consent rules.