LINCOLN EDUCATIONAL SERVICES CORP - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

---

Form 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2017

or

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

 

---

Commission File Number 000-51371

---

 

LINCOLN EDUCATIONAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)

(973) 736-9340

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

	Large accelerated filer ☐	Accelerated filer ☐
	Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☒
	Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☒

As of November 8, 2017, there were 24,719,055 shares of the registrant’s common stock outstanding.

 

---

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

 

 

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

(Continued)

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(In thousands)

(Unaudited)

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(In thousands, except share amounts)

(Unaudited)

 

		Common Stock								Additional Paid-in				Treasury				Retained Earnings (Accumulated				Accumulated Other Comprehensive
		Shares				Amount				Capital				Stock				Deficit)				Loss				Total
BALANCE - January 1, 2017			30,685,017			$	141,377			$	28,554			$	(82,860	)		$	(26,044	)		$	(6,101	)		$	54,926
Net loss			-				-				-				-				(19,190	)			-				(19,190	)
Employee pension plan adjustments			-				-				-				-				-				881				881
Stock-based compensation expense
Restricted stock			128,810				-				948				-				-				-				948
Net share settlement for equity-based compensation			(184,231	)			-				(429	)			-				-				-				(429	)
BALANCE - September 30, 2017			30,629,596			$	141,377			$	29,073			$	(82,860	)		$	(45,234	)		$	(5,220	)		$	37,136

		Common Stock								Additional Paid-in				Treasury				Retained Earnings (Accumulated				Accumulated Other Comprehensive
		Shares				Amount				Capital				Stock				Deficit)				Loss				Total
BALANCE - January 1, 2016			29,727,555			$	141,377			$	27,292			$	(82,860	)		$	2,260			$	(7,072	)		$	80,997
Net loss			-				-				-				-				(9,677	)			-				(9,677	)
Employee pension plan adjustments			-				-				-				-				-				666				666
Stock-based compensation expense
Restricted stock			1,079,267				-				1,086				-				-				-				1,086
Net share settlement for equity-based compensation			(38,389	)			-				(107	)			-				-				-				(107	)
BALANCE - September 30, 2016			30,768,433			$	141,377			$	28,271			$	(82,860	)		$	(7,417	)		$	(6,406	)		$	72,965

 

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

(Continued)

See notes to unaudited condensed consolidated financial statements.

 

LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016

(In thousands, except share and per share amounts and unless otherwise stated)

(Unaudited)

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activities— Lincoln Educational Services Corporation and its subsidiaries (collectively, the “Company”, “we”, “our” and “us”, as applicable) provide diversified career-oriented post-secondary education to recent high school graduates and working adults.  The Company, which currently operates 25 schools in 15 states, offers programs in automotive technology, skilled trades (which include HVAC, welding and computerized numerical control and electronic systems technology, among other programs), healthcare services (which include nursing, dental assistant, medical administrative assistant and pharmacy technician, among other programs), hospitality services (which include culinary, therapeutic massage, cosmetology and aesthetics) and business and information technology (which includes information technology and criminal justice programs).  The schools operate under Lincoln Technical Institute, Lincoln College of Technology, Lincoln College of New England, Lincoln Culinary Institute, and Euphoria Institute of Beauty Arts and Sciences and associated brand names.  Most of the campuses serve major metropolitan markets and each typically offers courses in multiple areas of study.  Five of the campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. The Company’s other campuses primarily attract students from their local communities and surrounding areas.  All of the campuses are nationally or regionally accredited and are eligible to participate in federal financial aid programs offered by the U.S. Department of Education (the “DOE”) and applicable state education agencies which allow students to apply for and access federal student loans as well as other forms of financial aid.

We operate in three reportable business segments:  (a) Transportation and Skilled Trades segment, (b) Healthcare and Other Professions (“HOPS”) segment, and (c) Transitional segment which refers to businesses that have been or are currently being taught out.  In November 2015, the Board of Directors approved a plan for the Company to divest the schools included in the HOPS segment due to a strategic shift in the Company’s business strategy.  The Company underwent an exhaustive process to divest the HOPS schools which proved successful in attracting various purchasers but, ultimately, did not result in a transaction that our Board believed would enhance shareholder value. When the decision was first made by the Board of Directors to divest HOPS, 18 campuses were operating in this segment.  By the end of 2017, we will have strategically closed seven underperforming campuses leaving a total of eleven campuses remaining under the HOPS segment.   The Company believes that the closures and planned closures of the aforementioned campuses has positioned this segment and the Company to be profitable going forward as well as maximizing returns for the Company’s shareholders.

The combination of several factors, including the inability of a prospective buyer of the HOPS segment to close on the purchase, the improvements the Company has implemented in the operations of the HOPS segment, the closure of seven underperforming campuses and the change in federal government administration, resulted in the Board reevaluating its divestiture plan and the determination that shareholder value would more likely be enhanced by continuing to operate our HOPS segment as revitalized.  Consequently, in the first quarter of 2017, the Board of Directors abandoned the plan to divest the HOPS segment and the Company intends to retain the HOPS segment.  The results of operations of the campuses included in the HOPS segment are reflected as continuing operations in the condensed consolidated financial statements.

In the fourth quarter of 2016, the Company completed the teach-out of its Hartford, Connecticut and Henderson (Green Valley), Nevada campuses which originally operated in the HOPS segment.  Also in 2017, the Company completed the teach-out of its Northeast Philadelphia, Pennsylvania; Center City Philadelphia, Pennsylvania; and West Palm Beach, Florida facilities which also originally operated in the HOPS segment.  In addition, in March 2017, the Board of Directors approved a plan to not renew the leases at our schools in Brockton, Massachusetts and Lowell, Massachusetts which also were originally in our HOPS segment and which are being taught out and expected to be closed in December 2017, and are now are included in the Transitional segment as of September 30, 2017.  In October 2017, the Company agreed to a $1.5 million lease termination with University City Science Center to terminate the lease for our recently closed school located in Center City Philadelphia, Pennsylvania which is included in our Transitional segment.

On August 14, 2017, New England Institute of Technology at Palm Beach, Inc., a wholly-owned subsidiary of the Company, consummated the anticipated sale of the real property located at 2400 and 2410 Metrocentre Boulevard East, West Palm Beach, Florida, including the improvements and other personal property located thereon (the “West Palm Beach Property”) to Tambone Companies, LLC (“Tambone”), pursuant to a previously disclosed purchase and sale agreement (the “West Palm Sale Agreement”) entered into on March 14, 2017. Pursuant to the terms of the West Palm Sale Agreement, as subsequently amended, the purchase price for the West Palm Beach Property was $15.8 million. As a result, the Company recorded a gain on the sale in the amount of $1.5 million. As previously disclosed, the West Palm Beach Property served as collateral for a short term loan in the principal amount of $8.0 million obtained by the Company from its lender, Sterling National Bank, on April 28, 2017, which loan matured upon the earlier of the sale of the West Palm Beach Property or October 1, 2017.  Accordingly, on August 14, 2017, concurrently with the consummation of the sale of the West Palm Beach Property, the Company repaid the term loan in an aggregate amount of $8.0 million, consisting of principal and accrued interest.

 

Liquidity—For the last several years, the Company and the proprietary school sector have faced deteriorating earnings. Government regulations have negatively impacted earnings by making it more difficult for potential students to obtain loans, which, when coupled with the overall economic environment, have discouraged potential students from enrolling in post-secondary schools. In light of these factors, the Company has incurred significant operating losses as a result of lower student population.  Despite these challenges, the Company believes that its likely sources of cash should be sufficient to fund operations for the next twelve months and thereafter for the foreseeable future.  At September 30, 2017, the Company’s sources of cash primarily included cash and cash equivalents of $14.5 million (of which $7.2 million is restricted) and $7.5 million of availability under the Company’s revolving loan facility discussed below. The Company is also continuing to take actions to improve cash flow by aligning its cost structure to its student population.

In addition to the current sources of capital discussed above that provide short term liquidity, the Company has been making efforts to sell its remaining West Palm Beach, Florida property and associated assets originally operated in the HOPS segment, which has been classified as held for sale and is expected to be sold within one year from the date of classification which was December 31, 2016.

Basis of Presentation – The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial statements.  Certain information and footnote disclosures normally included in annual financial statements have been omitted or condensed pursuant to such regulations.  These statements, which should be read in conjunction with the December 31, 2016 consolidated financial statements and related disclosures of the Company included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, reflect all adjustments, consisting of normal recurring adjustments and impairments necessary to present fairly the consolidated financial position, results of operations and cash flows for such periods.  The results of operations for the nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the full fiscal year ending December 31, 2017.

The unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries.  All significant intercompany accounts and transactions have been eliminated.

Use of Estimates in the Preparation of Financial Statements – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period.  On an ongoing basis, the Company evaluates the estimates and assumptions including those related to revenue recognition, bad debts, impairments, fixed assets, income taxes, benefit plans and certain accruals.  Actual results could materially differ from those estimates.

 

New Accounting Pronouncements – The Financial Accounting Standards Board (the “FASB”) has issued Accounting Standards Update (“ASU”) 2017-09, “Compensation—Stock Compensation (Topic 718) — Scope of Modification Accounting.” ASU 2017-09 applies to entities that change the terms or conditions of a share-based payment award. The FASB adopted ASU 2017-09 to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to the modification of the terms and conditions of a share-based payment award. The amendments provide guidance on determining which changes to the terms and conditions of share-based payment award require an entity to apply modification accounting under Topic 718. ASU 2017-09 is effective for all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for public business entities for reporting periods for which financial statements have not yet been issued. The Company does not expect the adoption of ASU 2017-09 will have a material impact on its condensed consolidated financial statements.

 

In March 2017, the FASB issued ASU 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost." ASU 2017-07 requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the statement of comprehensive income separately from the service cost component and outside a subtotal of operating income. The ASU is effective for annual periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect the adoption of ASU 2017-07 will have a material impact on its condensed consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment.”  ASU 2017-04 provides amendments to Accounting Standards Code (“ASC”) 350, “Intangibles - Goodwill and Other,” which eliminate Step 2 from the goodwill impairment test. Entities should perform their goodwill impairment tests by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. The amendments in this update are effective prospectively during interim and annual periods beginning after December 15, 2019, with early adoption permitted.  The Company adopted the provisions of ASU 2017-04 as of April 1, 2017.  As fair values for our operating units exceed their carrying values, there has been no impact on our condensed consolidated financial statements.

 

The FASB has recently issued several amendments to the new standard on revenue recognition, ASU 2014-09, “Revenue from Contracts with Customers.” The amendments include ASU 2016-08, “Revenue from Contracts with Customers (Topic 606)—Principal versus Agent Considerations,” issued in March 2016, which clarifies the implementation guidance for principal versus agent considerations in ASU 2014-09, and ASU 2016-10, “Revenue from Contracts with Customers (Topic 606)—Identifying Performance Obligations and Licensing,” issued in April 2016, which amends the guidance in ASU No. 2014-09 related to identifying performance obligations. The new standard permits adoption either by using (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures.

 

The new standard is effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted for annual reporting periods beginning after December 15, 2016. We have not adopted the new standard as yet but we will adopt the new standard effective January 1, 2018 using the modified retrospective approach. The Company’s assessment of the potential impact is substantially complete based on our review of current enrollment agreements and other revenue generating contracts. We believe the timing of recognizing revenue for tuition and student fees will not significantly change. The Company is closely reviewing its book revenue stream to determine whether the performance obligation of the Company is satisfied over time and revenue is recognized over the length of the student contract, which is the Company’s current practice with respect to revenue recognition, or whether the performance obligation of the Company is satisfied at the point in time and revenue is recognized when students’ books are delivered.  Additionally, we are currently assessing the impacts related to the accounting for contract assets separately from accounts receivable and are evaluating the point at which a student’s contract asset becomes a receivable.

 

We are in the process of updating our revenue accounting policy and implementing changes to our business processes and controls in response to the new standard, as necessary.  During the remainder of 2017, we are finalizing our revenue related documentation.  The Company expects to adopt the new standard on a modified retrospective basis with the cumulative effect of the change reflected in retained earnings as of January 1, 2018 but not restated for prior periods.

 

In November 2016, the FASB issued ASU 2016-18: “Statement of Cash Flows (Topic 230): Restricted Cash.” This guidance was issued to address the disparity that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The amendments will require that the statement of cash flows explain the change during the period in total cash, cash equivalents and restricted cash. The amendments are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments will be applied using a retrospective transition method to each period presented. The Company anticipates that the adoption will not have a material impact on the Company’s condensed consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments” to address eight specific cash flow issues with the objective of reducing the existing diversity in practice. The amendments are effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company anticipates that the adoption will not have a material impact on the Company’s condensed consolidated financial statements.

The Company prospectively applied ASU 2016-09, “Improvements to Employee Share Based Payment Accounting,” to the condensed consolidated statement of operations for the recognition of tax benefits within the provision for taxes, which previously would have been recorded to additional paid-in capital. The impact for the nine months ended September 30, 2017 was $0. In addition, the Company retrospectively recognized no tax benefits within operating activities within the condensed consolidated statements of cash flow for the nine months ended September 30, 2017 and 2016. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented in the condensed consolidated statements of cash flows, since such cash flows have historically been presented in financing activities. The treatment of forfeitures has not changed as the Company is electing to continue the current process of estimating the number of forfeitures. There was no cumulative effect adjustment required to retained earnings under the prospective method as of the beginning of the year because all tax benefits had been previously recognized when the tax deductions related to stock compensation were utilized to reduce tax payable. The Company is not recording deferred tax assets or tax losses as a result of the adoption of ASU 2016-09.

 

In February 2016, the FASB issued guidance requiring lessees to recognize a right-of-use asset and a lease liability on the balance sheet for substantially all leases, with the exception of short-term leases. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the statements of income. The guidance is effective for annual periods, including interim periods within those periods, beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the impact that the update will have on our results of operations, financial condition and financial statement disclosures.

Stock-Based Compensation – The Company measures the value of stock options on the grant date at fair value, using the Black-Scholes option valuation model.  The Company amortizes the fair value of stock options, net of estimated forfeitures, utilizing straight-line amortization of compensation expense over the requisite service period of the grant.

The Company measures the value of service and performance-based restricted stock on the fair value of a share of common stock on the date of the grant. The Company amortizes the fair value of service-based restricted stock utilizing straight-line amortization of compensation expense over the requisite service period of the grant.

The Company amortizes the fair value of the performance-based restricted stock based on the determination of the probable outcome of the performance condition.  If the performance condition is expected to be met, then the Company amortizes the fair value of the number of shares expected to vest utilizing straight-line basis over the requisite performance period of the grant.  However, if the associated performance condition is not expected to be met, then the Company does not recognize the stock-based compensation expense.

Income Taxes – The Company accounts for income taxes in accordance with FASB ASC Topic 740, “Income Taxes” (“ASC 740”). This statement requires an asset and liability approach for measuring deferred taxes based on temporary differences between the financial statement and tax basis of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which taxes are expected to be paid or recovered.

 

In accordance with ASC 740, the Company assesses its deferred tax asset to determine whether all or any portion of the asset is more likely than not unrealizable.  A valuation allowance is required to be established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. In accordance with ASC 740, the Company’s assessment considers whether there has been sufficient income in recent years and whether sufficient income is expected in future years in order to utilize the deferred tax asset. In evaluating the realizability of deferred income tax assets, the Company considered, among other things, historical levels of income, expected future income, the expected timing of the reversals of existing temporary reporting differences, and the expected impact of tax planning strategies that may be implemented to prevent the potential loss of future income tax benefits. Significant judgment is required in determining the future tax consequences of events that have been recognized in the Company’s consolidated financial statements and/or tax returns.  Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on the Company’s consolidated financial position or results of operations.  Changes in, among other things, income tax legislation, statutory income tax rates, or future income levels could materially impact the Company’s valuation of income tax assets and liabilities and could cause the Company’s income tax provision to vary significantly among financial reporting periods.

 

The Company recognizes accrued interest and penalties related to unrecognized tax benefits in income tax expense.  During the three and nine months ended September 30, 2017 and 2016, the Company did not recognize any interest and penalties expense associated with uncertain tax positions.

 

2.	WEIGHTED AVERAGE COMMON SHARES

The weighted average number of common shares used to compute basic and diluted loss per share for the three and nine months ended September 30, 2017 and 2016 was as follows:

 

For the three months ended September 30, 2017 and 2016, options to acquire 552,189 and 1,181,073 shares were excluded from the above table because the Company reported a net loss for each period and, therefore, their impact on reported loss per share would have been antidilutive.  For the nine months ended September 30, 2017 and 2016, options to acquire 572,428 and 668,307 shares were excluded from the above table because the Company reported a net loss for each quarter and, therefore, their impact on reported loss per share would have been antidilutive.  For the three and nine months ended September 30, 2017, options to acquire 170,667 shares were excluded from the above table because they have an exercise price that is greater than the average market price of the Company’s common stock and, therefore, their impact on reported income (loss) per share would have been antidilutive.

 

3.	GOODWILL AND LONG-LIVED ASSETS

The Company reviews long-lived assets for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.  There were no long-lived asset impairments during the nine months ended September 30, 2017 and 2016.

The Company reviews goodwill and intangible assets for impairment when indicators of impairment exist.  Annually, or more frequently if necessary, the Company evaluates goodwill and intangible assets with indefinite lives for impairment, with any resulting impairment reflected as an operating expense.  The Company concluded that, as of September 30, 2017 and 2016, there was no indicator of potential impairment and, accordingly, the Company did not test goodwill for impairment.

The carrying amount of goodwill at September 30, 2017 and 2016 is as follows:

 

As of September 30, 2017, the goodwill balance is related to the Transportation and Skilled Trades segment.  As of September 30, 2016, the goodwill balance consists of $14.5 million related to the Transportation and Skilled Trades segment and $8.8 million related to our HOPS segment.

 

Intangible assets, which are included in other assets in the accompanying condensed consolidated balance sheets, consist of the following:

 

Amortization of intangible assets was less than $0.1 million for each of the three and nine months ended September 30, 2017 and 2016.

The following table summarizes the estimated future amortization expense:

4.          LONG-TERM DEBT

Long-term debt consist of the following:

(a) On March 31, 2017, the Company entered into a secured revolving credit agreement (the “Credit Agreement”) with Sterling National Bank (the “Bank”) pursuant to which the Company obtained a credit facility in the aggregate principal amount of up to $55 million (the “Credit Facility”).  The Credit Facility consists of (a) a $30 million loan facility (“Facility 1”), which is comprised of a $25 million revolving loan designated as “Tranche A” and a $5 million non-revolving loan designated as “Tranche B,” which Tranche B was repaid during the quarter ended June 30, 2017, and (b) a $25 million revolving loan facility (“Facility 2”), which includes a sublimit amount for letters of credit of $10 million.  The Credit Facility replaces a term loan facility (the “Prior Credit Facility”) which was repaid and terminated concurrently with the effectiveness of the Credit Facility.  The term of the Credit Facility is 38 months, maturing on May 31, 2020.

 

The Credit Facility is secured by a first priority lien in favor of the Bank on substantially all of the personal property owned by the Company as well as mortgages on four parcels of real property owned by the Company in Connecticut, Colorado, Tennessee and Texas at which four of the Company’s schools are located.

 

At the closing of the Credit Facility, the Company drew $25 million under Tranche A of Facility 1, which, pursuant to the terms of the Credit Agreement, was used to repay the Prior Credit Facility and to pay transaction costs associated with closing the Credit Facility.  After the disbursement of such amounts, the Company retained approximately $1.8 million of the borrowed amount for working capital purposes.

 

Also, at closing, $5 million was drawn under Tranche B, which, pursuant to the terms of the Credit Agreement, was deposited into an interest-bearing pledged account (the “Pledged Account”) in the name of the Company maintained at the Bank in order to secure payment obligations of the Company with respect to the costs of remediation of any environmental contamination discovered at certain of the mortgaged properties based upon environmental studies undertaken at such properties.  During the quarter ended June 30, 2017, the environmental studies were completed and revealed no environmental issues existing at the properties and accordingly, pursuant to the terms of the Credit Agreement, the $5 million in the Pledged Account was released and used to repay the non-revolving loan outstanding under Tranche B.  Upon the repayment of Tranche B, the maximum principal amount of Facility 1 was permanently reduced to $25 million.

 

Pursuant to the terms of the Credit Agreement, all draws under Facility 2 for letters of credit or revolving loans are secured by cash collateral in an amount equal to 100% of the aggregate stated amount of the letters of credit issued and revolving loans outstanding through draws from Facility 1 or other available cash of the Company.

 

Accrued interest on each revolving loan is payable monthly in arrears.  Revolving loans under Tranche A of Facility 1 bear interest at a rate per annum equal to the greater of (x) the Bank’s prime rate plus 2.50% and (y) 6.00%.  The amount borrowed under Tranche B of Facility 1 and revolving loans under Facility 2 will bear interest at a rate per annum equal to the greater of (x) the Bank’s prime rate and (y) 3.50%.

 

Each issuance of a letter of credit under Facility 2 requires the payment of a letter of credit fee to the Bank equal to a rate per annum of 1.75% on the daily amount available to be drawn under the letter of credit, which fee is payable in quarterly installments in arrears.  Letters of credit totaling $7.2 million that were outstanding under a $9.5 million letter of credit facility previously provided to the Company by the Bank, which letter of credit facility was set to mature on April 1, 2017, are treated as letters of credit under Facility 2.

 

The terms of the Credit Agreement provide that the Bank be paid an unused facility fee on the average daily unused balance of Facility 1 at a rate per annum equal to 0.50%, which fee is payable quarterly in arrears.  In addition, the Company is required to maintain, on deposit in one or more non-interest bearing accounts, a minimum of $5 million in quarterly average aggregate balances.  If in any quarter the required average aggregate account balance is not maintained, the Company is required to pay the Bank a fee of $12,500 for that quarter and, in the event that the Company terminates the Credit Facility or refinances with another lender within 18 months of closing, the Company is required to pay the Bank a breakage fee of $500,000.

 

In addition to the foregoing, the Credit Agreement contains customary representations, warranties and affirmative and negative covenants, including financial covenants that restrict capital expenditures, prohibit the incurrence of a net loss commencing on December 31, 2018 and require a minimum adjusted EBITDA and a minimum tangible net worth which is an annual covenant, as well as events of default customary for facilities of this type.  As of September 30, 2017, the Company is in compliance with all covenants.

 

In connection with the Credit Agreement, the Company paid an origination fee in the amount of $250,000 and other fees and reimbursements that are customary for facilities of this type.

 

The Company incurred an early termination premium of approximately $1.8 million in connection with the termination of the Prior Credit Facility.

 

On April 28, 2017, the Company entered into an additional secured credit agreement with the Bank, pursuant to which the Company obtained a short term loan in the principal amount of $8 million, the proceeds of which were used for working capital and general corporate purposes.  The loan, which had an interest rate per annum equal to the greater of the Bank’s prime rate plus 2.50% or 6.00%, was secured by real property assets located in West Palm Beach, Florida at which schools operated by the Company were located and matured upon the earlier of October 1, 2017 and the date of the sale of the West Palm Beach, Florida property.  The Company sold two of three properties located in West Palm Beach, Florida in the third quarter of 2017 and concurrently repaid the $8 million.

 

As of September 30, 2017, the Company had $17.5 million outstanding under the Credit Facility which was offset by $0.8 million of deferred finance fees.  As of December 31, 2016, the Company had $44.3 million outstanding under the Prior Credit Facility which was offset by $2.3 million of deferred finance fees, which were written-off.  As of September 30, 2017 and December 31, 2016, there were letters of credit in the aggregate principal amount of $7.2 million and $6.2 million outstanding, respectively.  As of September 30, 2017, there are no revolving loans outstanding under Facility 2.

 

Scheduled maturities of long-term debt at September 30, 2017 are as follows:

5.	STOCKHOLDERS’ EQUITY

Restricted Stock

The Company has two stock incentive plans:  a Long-Term Incentive Plan (the “LTIP”) and a Non-Employee Directors Restricted Stock Plan (the “Non-Employee Directors Plan”).

Under the LTIP, certain employees receive awards of restricted shares of common stock based on service and performance.  The number of shares granted to each employee is based on the fair market value of a share of common stock on the date of grant.

On May 13, 2016 and January 16, 2017, performance-based restricted shares were granted to certain employees of the Company, which vest on March 15, 2017 and March 15, 2018 based upon the attainment of a financial responsibility ratio during each fiscal year ending December 31, 2016 and 2017.  There is no restriction on the right to vote or the right to receive dividends with respect to any of these restricted shares.

On June 2, 2014 and December 18, 2014, performance-based restricted shares were granted to certain employees of the Company, which vest over three years based upon the attainment of (i) a specified operating income margin during any one or more of the fiscal years in the period beginning January 1, 2015 and ending December 31, 2017 and (ii) the attainment of earnings before interest, taxes, depreciation and amortization targets during each of the fiscal years ended December 31, 2015 through 2017.  There is no restriction on the right to vote or the right to receive dividends with respect to any of these restricted shares.

Pursuant to the Non-Employee Directors Plan, each non-employee director of the Company receives an annual award of restricted shares of common stock on the date of the Company’s annual meeting of shareholders.  The number of shares granted to each non-employee director is based on the fair market value of a share of common stock on that date.  The restricted shares vest on the first anniversary of the grant date.  There is no restriction on the right to vote or the right to receive dividends with respect to any of these restricted shares.

For the nine months ended September 30, 2017 and 2016, the Company completed a net share settlement for 184,231 and 38,389 restricted shares, respectively, on behalf of certain employees that participate in the LTIP upon the vesting of the restricted shares pursuant to the terms of the LTIP.  The net share settlement was in connection with income taxes incurred on restricted shares that vested and were transferred to the employees during 2017 and/or 2016, creating taxable income for the employees.   At the employees’ request, the Company will pay these taxes on behalf of the employees in exchange for the employees returning an equivalent value of restricted shares to the Company.  These transactions resulted in a decrease of $0.4 million and $0.1 million for each of the nine months ended September 30, 2017 and 2016, respectively, to equity on the condensed consolidated balance sheets as the cash payment of the taxes effectively was a repurchase of the restricted shares granted in previous years.

 

The following is a summary of transactions pertaining to restricted stock:

The restricted stock expense for the three months ended September 30, 2017 and 2016 was $0.3 million and $0.4 million, respectively.  The restricted stock expense for the nine months ended September 30, 2017 and 2016 was $0.9 million and $1.1 million, respectively.  The unrecognized restricted stock expense as of September 30, 2017 and December 31, 2016 was $0.6 million and $1.5 million, respectively.  As of September 30, 2017, outstanding restricted shares under the LTIP had aggregate intrinsic value of $1.6 million.

Stock Options

The fair value of the stock options used to compute stock-based compensation is the estimated present value at the date of grant using the Black-Scholes option pricing model.  The following is a summary of transactions pertaining to stock options:

As of September 30, 2017, there was no unrecognized pre-tax compensation expense.

The following table presents a summary of stock options outstanding:

 

6.	INCOME TAXES

The Company assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to recover the existing deferred tax assets.  In this regard, a significant objective negative evidence was the cumulative losses incurred by the Company in recent years.  On the basis of this evaluation, the realization of the Company’s deferred tax assets was not deemed to be more likely than not and, thus, the Company maintained a full valuation allowance on its net deferred tax assets as of September 30, 2017.

7.	CONTINGENCIES

In the ordinary conduct of its business, the Company is subject to certain lawsuits, investigations and claims, including, but not limited to, claims involving students or graduates and routine employment matters. Although the Company cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against it, the Company does not believe that any currently pending legal proceedings to which it is a party will have a material adverse effect on the Company’s business, financial condition, and results of operations or cash flows.

8.

SEGMENTS

We currently operate in three reportable segments: (a) Transportation and Skilled Trades segment (b) Healthcare and Other Professions segment and (c) Transitional segment.  Our reportable segments represent a group of post-secondary education providers that offer a variety of degree and non-degree academic programs.  These segments are organized by key market segments to enhance operational alignment within each segment to more effectively execute our strategic plan.  Each of the Company’s schools is a reporting unit and an operating segment which have been determined based on a method by which we evaluate performance and allocate resources.  Our operating segments have been aggregated into three reportable segments because, in our judgment, the operating segments have similar services, types of customers, regulatory environment and economic characteristics.  Our reportable segments are described below.

Transportation and Skilled Trades – Transportation and Skilled Trades segment offers academic programs mainly in the career-oriented disciplines of transportation and skilled trades (e.g. automotive, diesel, HVAC, welding and manufacturing).

Healthcare and Other Professions – HOPS segment offers academic programs in the career-oriented disciplines of health sciences, hospitality and business and information technology (e.g. dental assistant, medical assistant, practical nursing, culinary arts and cosmetology).

Transitional – Transitional segment refers to operations that are being phased out or closed and our campuses that are currently being taught out.  These schools are employing a gradual teach-out process that enables the schools to continue to operate while current students complete their course of study.  These schools are no longer enrolling new students.  During the year ended December 31, 2016, the Company announced the closings of our Northeast Philadelphia, Pennsylvania; Center City Philadelphia, Pennsylvania; and West Palm Beach, Florida facilities which were fully taught out in 2017.  In the first quarter of 2016 we completed the teach-out of our Fern Park, Florida campus.  Also, in the fourth quarter of 2016, we completed the teach-out of our Hartford, Connecticut and Henderson (Green Valley), Nevada campuses.  In addition, in March 2017, the Board of Directors approved a plan to cease operations at our schools in Brockton, Massachusetts and Lowell, Massachusetts.  These schools are being taught out and expected to be closed in December 2017.

The Company continually evaluates all campuses for profitability, earning potential, and customer satisfaction.  This evaluation takes several factors into consideration, including the campus’s geographic location, the programs offered at the campus, as well as skillsets required of our students by their potential employers.  The purpose of this evaluation is to ensure that our programs provide our students with the best possible opportunity to succeed in the marketplace with the goals of attracting more students to our programs and, ultimately, to provide the shareholders with the maximum return on their investment.  Campuses in the Transitional segment have been subject to this process and have been strategically identified for closure.

We evaluate segment performance based on operating results.  Adjustments to reconcile segment results to consolidated results are included under the caption “Corporate,” which primarily includes unallocated corporate activity.

 

Summary financial information by reporting segment is as follows:

9.	FAIR VALUE

The carrying amount and estimated fair value of the Company’s financial instrument assets and liabilities, which are not measured at fair value on the Condensed Consolidated Balance Sheet, are listed in the table below:

 

The fair value of the revolving credit facility approximates the carrying amount at September 30, 2017 as the instrument had variable interest rates that reflected current market rates available to the Company.

The carrying amounts reported on the Consolidated Balance Sheets for Cash and cash equivalents, Restricted cash and Noncurrent restricted cash approximate fair value because they are highly liquid.

The carrying amounts reported on the Consolidated Balance Sheets for Prepaid expenses and other current assets, Accrued expenses and Other short term liabilities approximate fair value due to the short-term nature of these items.

10.	RELATED PARTY

The Company has an agreement with MATCO Tools whereby MATCO provides the Company, on an advance commission basis, credits in MATCO branded tools, tool storage, equipment, and diagnostics products. The chief executive officer of the parent Company of MATCO is considered an immediate family member of one of the Company’s board members.  The Company’s payable balances from this third party was immaterial at September 30, 2017 and 2016. Management believes that its agreement with MATCO is an arm’s length transaction and on similar terms as would have been obtained from unaffiliated third parties.

 

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion may contain forward-looking statements regarding the Company, our business, prospects and our results of operations that are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, those described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission (the “SEC”) and in our other filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.  We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise.  Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC that advise interested parties of the risks and factors that may affect our business.

The interim financial statements and related notes thereto filed in this Form 10-Q and the discussions contained herein should be read in conjunction with the annual financial statements and notes included in our Form 10-K for the year ended December 31, 2016, as filed with the SEC, which includes audited consolidated financial statements for our three fiscal years ended December 31, 2016.

General

Lincoln Educational Services Corporation and its subsidiaries (collectively, the “Company”, “we”, “our” and “us”, as applicable) provide diversified career-oriented post-secondary education to recent high school graduates and working adults.  The Company, which currently operates 25 schools in 15 states, offers programs in automotive technology, skilled trades (which include HVAC, welding and computerized numerical control and electronic systems technology, among other programs), healthcare services (which include nursing, dental assistant, medical administrative assistant and pharmacy technician, among other programs), hospitality services (which include culinary, therapeutic massage, cosmetology and aesthetics) and business and information technology (which includes information technology and criminal justice programs).  The schools operate under Lincoln Technical Institute, Lincoln College of Technology, Lincoln College of New England, Lincoln Culinary Institute, and Euphoria Institute of Beauty Arts and Sciences and associated brand names.  Most of the campuses serve major metropolitan markets and each typically offers courses in multiple areas of study.  Five of the campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. The Company’s other campuses primarily attract students from their local communities and surrounding areas.  All of the campuses are nationally or regionally accredited and are eligible to participate in federal financial aid programs by the U.S. Department of Education (the “DOE”) and applicable state education agencies and accrediting commissions which allow students to apply for and access federal student loans as well as other forms of financial aid.

In the first quarter of 2015, we reorganized our operations into three reportable business segments:  (a) Transportation and Skilled Trades segment, (b) Healthcare and Other Professions (“HOPS”) segment, and (c) Transitional segment, which refers to businesses that have been or are currently being taught out.  In November 2015, the Board of Directors approved a plan for the Company to divest the schools included in the HOPS segment due to a strategic shift in the Company’s business strategy.  The Company underwent an exhaustive process to divest the HOPS schools which proved successful in attracting various purchasers but, ultimately, did not result in a transaction that our Board believed would enhance shareholder value. When the decision was first made by the Board of Directors to divest HOPS, 18 campuses were operating in this segment.  By the end of 2017, we will have strategically closed seven underperforming campuses leaving a total of 11 campuses remaining under the HOPS segment.   The Company believes that the closures and planned closures of the aforementioned campuses has positioned this segment and the Company to be more profitable going forward as well as maximizing returns for the Company’s shareholders.

The combination of several factors, including the inability of a prospective buyer of the HOPS segment to close on the purchase, the improvements the Company has implemented in the HOPS segment operations, the closure of seven underperforming campuses and the change in Federal government administration, resulted in the Board reevaluating its divestiture plan and the determination that shareholder value would more likely be enhanced by continuing to operate our HOPS segment as revitalized.  Consequently, the Board of Directors has abandoned the plan to divest the HOPS segment and the Company now intends to retain the remaining campuses in the HOPS segment.  The results of operations of the campuses included in the HOPS segment are reflected as continuing operations in the condensed consolidated financial statements.

In the fourth quarter of 2016, the Company completed the teach-out of its Hartford, Connecticut and Henderson (Green Valley), Nevada campuses which originally operated in the HOPS segment.  Also in 2016, the Company announced the closing of its Northeast Philadelphia, Pennsylvania, Center City Philadelphia Pennsylvania and West Palm Beach, Florida facilities, which also were originally in our HOPS segment and which were fully taught out in 2017.  In addition, in March 2017, the Board of Directors approved a plan to not renew the leases at our schools located in Brockton, Massachusetts and Lowell, Massachusetts, which also were originally in our HOPS segment.  These schools are being taught out with expected closure in December 2017 and are included in the Transitional segment as of September 30, 2017.

 

On August 14, 2017, New England Institute of Technology at Palm Beach, Inc., a wholly-owned subsidiary of the Company, consummated the anticipated sale of the real property located at 2400 and 2410 Metrocentre Boulevard East, West Palm Beach, Florida, including the improvements and other personal property located thereon (the “West Palm Beach Property”) to Tambone Companies, LLC (“Tambone”), pursuant to a previously disclosed purchase and sale agreement (the “West Palm Sale Agreement”) entered into on March 14, 2017. Pursuant to the terms of the West Palm Sale Agreement, as subsequently amended, the purchase price for the West Palm Beach Property was $15.8 million. As a result, the Company recorded a gain on the sale in the amount of $1.5 million. As previously disclosed, the West Palm Beach Property served as collateral for a short term loan in the principal amount of $8.0 million obtained by the Company from its lender, Sterling National Bank, on April 28, 2017, which loan matured upon the earlier of the sale of the West Palm Beach Property or October 1, 2017. Accordingly, on August 14, 2017, concurrently with the consummation of the sale of the West Palm Beach Property, the Company repaid the term loan in an aggregate amount of $8.0 million, consisting of principal and accrued interest.

On March 31, 2017, the Company entered into a new revolving credit facility with Sterling National Bank in the aggregate principal amount of up to $55 million, which consists of up to $50 million of revolving loans, including a $10 million sublimit for letters of credit, and an additional $5 million non-revolving loan.  The new credit facility requires that revolving loans in excess of $25 million and all letters of credit issued thereunder be cash collateralized dollar for dollar.  The proceeds of the $5 million non-revolving loan were held in a pledged account at Sterling National Bank as required by the terms of the new credit facility pending the completion of environmental studies undertaken at certain properties owned by the Company and mortgaged to Sterling National Bank.  Upon the completion of environmental studies that revealed that no environmental issues existed at the properties, during the quarter ended June 30, 2017, the $5 million held in the pledged account at Sterling National Bank was released and used to repay the $5 million non-revolving loan.  The new revolving credit facility replaces a term loan facility which was repaid and terminated concurrently with the effectiveness of the new revolving credit facility.  The term of the new revolving credit facility is 38 months, maturing on May 31, 2020.  The new revolving credit facility is discussed in further detail under the heading “Liquidity and Capital Resources” below and in Note 4 to the condensed consolidated financial statements included in this report. 

As of September 30, 2017, we had 11,515 students enrolled at 25 campuses in our programs.

Critical Accounting Policies and Estimates

Our discussions of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the period.  On an ongoing basis, we evaluate our estimates and assumptions, including those related to revenue recognition, bad debts, impairments, income taxes, benefit plans and certain accruals.  Actual results could differ from those estimates.  The critical accounting policies discussed herein are not intended to be a comprehensive list of all of our accounting policies.  In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not result in significant management judgment in the application of such principles.  We believe that the following accounting policies are most critical to us in that they represent the primary areas where financial information is subject to the application of management’s estimates, assumptions and judgment in the preparation of our condensed consolidated financial statements.

Revenue Recognition.  Revenues are derived primarily from programs taught at our schools.  Tuition revenues, textbook sales and one-time fees, such as nonrefundable application fees and course material fees, are recognized on a straight-line basis over the length of the applicable program as the student proceeds through the program, which is the period of time from a student’s start date through his or her graduation date, including internships or externships that take place prior to graduation, and we complete the performance of teaching the student which entitles us to the revenue.  Other revenues, such as tool sales and contract training revenues are recognized as services are performed or goods are delivered. On an individual student basis, tuition earned in excess of cash received is recorded as accounts receivable, and cash received in excess of tuition earned is recorded as unearned tuition.

We evaluate whether collectability of revenue is reasonably assured prior to the student attending class and reassess collectability of tuition and fees when a student withdraws from a course.  We calculate the amount to be returned under Title IV and its stated refund policy to determine eligible charges and, if there is a balance due from the student after this calculation, we expect payment from the student and we have a process to pursue uncollected accounts whereby, based upon the student’s financial means and ability to pay, a payment plan is established with the student to ensure that collectability is reasonable.  We continuously monitor our historical collections to identify potential trends that may impact our determination that collectability of receivables for withdrawn students is realizable.  If a student withdraws from a program prior to a specified date, any paid but unearned tuition is refunded. Refunds are calculated and paid in accordance with federal, state and accrediting agency standards. Generally, the amount to be refunded to a student is calculated based upon the period of time the student has attended classes and the amount of tuition and fees paid by the student as of his or her withdrawal date. These refunds typically reduce deferred tuition revenue and cash on our consolidated balance sheets as we generally do not recognize tuition revenue in our consolidated statements of income (loss) until the related refund provisions have lapsed. Based on the application of our refund policies, we may be entitled to incremental revenue on the day the student withdraws from one of our schools. We record revenue for students who withdraw from one of our schools when payment is received because collectability on an individual student basis is not reasonably assured.

 

Allowance for uncollectible accounts.  Based upon our experience and judgment, we establish an allowance for uncollectible accounts with respect to tuition receivables.  We use an internal group of collectors, augmented by third-party collectors as deemed appropriate, in our collection efforts.  In addition, we periodically sell written-off receivables to third parties.  In establishing our allowance for uncollectible accounts, we consider, among other things, current and expected economic conditions, a student’s status (in-school or out-of-school), whether or not a student is currently making payments and overall collection history.  Changes in trends in any of these areas may impact the allowance for uncollectible accounts.  The receivables balances of withdrawn students with delinquent obligations are reserved based on our collection history.  Although we believe that our reserves are adequate, if the financial condition of our students deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be necessary, which will result in increased selling, general and administrative expenses in the period such determination is made.

Our bad debt expense as a percentage of revenue for the three months ended September 30, 2017 and 2016 was 4.7% and 4.8%, respectively.  Our bad debt expense as a percentage of revenue for the nine months ended September 30, 2017 and 2016 was 5.3% and 4.7%, respectively.  Our exposure to changes in our bad debt expense could impact our operations.  A 1% increase in our bad debt expense as a percentage of revenues for each of the three months ended September 30, 2017 and 2016 would have resulted in an increase in bad debt expense of $0.7 million and $0.7 million, respectively.  A 1% increase in our bad debt expense as a percentage of revenues for each of the nine months ended September 30, 2017 and 2016 would have resulted in an increase in bad debt expense of $1.9 million and $2.1 million, respectively.

We do not believe that there is any direct correlation between tuition increases, the credit we extend to students, and our loan commitments.  Our loan commitments to our students are made on a student-by-student basis and are predominantly a function of the specific student’s financial condition.   We only extend credit to the extent there is a financing gap between the tuition charged for the program and the amount of grants, student loans and parental loans that each student receives and the availability of family contributions.  Each student’s funding requirements are unique.  Factors that determine the amount of aid available to a student are student status (whether they are dependent or independent students), Pell Grants awarded, Plus Loans awarded or denied to parents, and family contributions. As a result, it is extremely difficult to predict the number of students that will need us to extend credit to them. Our tuition increases have ranged historically from 2% to 5% annually and have not meaningfully impacted overall funding requirements.

Because a substantial portion of our revenue is derived from Title IV programs, any legislative or regulatory action that significantly reduces the funding available under Title IV programs or the ability of our students or schools to participate in Title IV programs could have a material effect on the realizability of our receivables.

Goodwill.  We test our goodwill for impairment annually, or whenever events or changes in circumstances indicate an impairment may have occurred, by comparing its fair value to its carrying value. Impairment may result from, among other things, deterioration in the performance of the acquired business, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of the acquired business, and a variety of other circumstances. If we determine that impairment has occurred, we are required to record a write-down of the carrying value and charge the impairment as an operating expense in the period the determination is made. In evaluating the recoverability of the carrying value of goodwill and other indefinite-lived intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the acquired assets. Changes in strategy or market conditions could significantly impact these judgments in the future and require an adjustment to the recorded balances.

There was no goodwill impairment for the three and nine months ended September 30, 2017 and 2016.

Long-lived assets.  We review the carrying value of our long-lived assets and identifiable intangibles for possible impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. We evaluate long-lived assets for impairment by examining estimated future cash flows. These cash flows are evaluated by using weighted probability techniques as well as comparisons of past performance against projections. Assets may also be evaluated by identifying independent market values. If we determine that an asset’s carrying value is impaired, we will record a write-down of the carrying value of the asset and charge the impairment as an operating expense in the period in which the determination is made.

 

There was no long-lived asset impairment during the three and nine months ended September 30 2017 and 2016.

Bonus costs.  We accrue the estimated cost of our bonus programs using current financial information as compared to target financial achievements and key performance objectives.  Although our recorded liability for bonuses is based on our best estimate of the obligation, actual results could differ and require adjustment of the recorded balance.

Income taxes. We account for income taxes in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Code (“ASC”) Topic 740, “Income Taxes”. This statement requires an asset and liability approach for measuring deferred taxes based on temporary differences between the financial statement and tax basis of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which taxes are expected to be paid or recovered.

 

In accordance with ASC 740, we assess our deferred tax asset to determine whether all or any portion of the asset is more likely than not unrealizable.  A valuation allowance is required to be established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. In accordance with ASC 740, our assessment considers whether there has been sufficient income in recent years and whether sufficient income is expected in future years in order to utilize the deferred tax asset. In evaluating the realizability of deferred income tax assets, we considered, among other things, historical levels of income, expected future income, the expected timing of the reversals of existing temporary reporting differences, and the expected impact of tax planning strategies that may be implemented to prevent the potential loss of future income tax benefits. Significant judgment is required in determining the future tax consequences of events that have been recognized in our consolidated financial statements and/or tax returns.  Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated financial position or results of operations.  Changes in, among other things, income tax legislation, statutory income tax rates, or future income levels could materially impact our valuation of income tax assets and liabilities and could cause our income tax provision to vary significantly among financial reporting periods.  On the basis of this evaluation the realization of our deferred tax assets was not deemed to be more likely than not and thus we have provided a valuation allowance on our net deferred tax assets.

 

We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense.  During the three and nine months ended September 30, 2017 and 2016, there were no interest and penalties expense associated with uncertain tax positions.

Effect of Inflation

Inflation has not had a material effect on our operations.

Results of Continuing Operations

Certain reported amounts in our analysis have been rounded for presentation purposes.  The following table sets forth selected consolidated statements of continuing operations data as a percentage of revenues for each of the periods indicated:

 

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

Consolidated Results of Operations

Revenue.   Revenue decreased by $7.0 million, or 9.4%, to $67.3 million for the three months ended September 30, 2017 from $74.3 million in the prior year comparable period.  The decrease in revenue is mainly attributable to the suspension of new student starts at campuses in our Transitional segment which have closed or will be closed at year-end.  This segment accounted for approximately 95% of the total revenue decline.

Total student starts decreased by 10.9% to approximately 4,400 from 5,000 for the three months ended September 30, 2017 as compared to the prior year comparable period.  Approximately 82% of the overall decrease was due to the Transitional segment noted above.  The remaining decrease resulted from start underperformance at one campus in the Transportation and Skilled Trades segment and two campuses in the Healthcare and Other Professions segment.

For a general discussion of trends in our student enrollment, see “Seasonality and Outlook” below.

Educational services and facilities expense.   Our educational services and facilities expense decreased by $3.5 million, or 9.3%, to $34.1 million for the three months ended September 30, 2017 from $37.5 million in the prior year comparable quarter.  This decrease is mainly attributable to the Transitional segment which accounted for $3.2 million in cost reductions as three campuses in the segment have closed during the three months ended September 30, 2017 and the remaining two campuses are preparing to close by the end of the current calendar year.

Educational services and facilities expenses, as a percentage of revenue remained essentially flat at 50.6% for the three months ended September 30, 2017 and 2016.

Selling, general and administrative expense.    Our selling, general and administrative expense decreased by $1.9 million, or 5.1%, to $35.5 million for the three months ended September 30, 2017 from $37.4 million in the comparable quarter of 2016.  This decrease also was primarily due to the Transitional segment, which accounted for approximately $2.9 million in cost reductions.  Partially offsetting the cost reductions was $0.6 million of corporate and other costs related to the closure of the of the Hartford, Connecticut campus on December 31, 2016.

As a percentage of revenues, selling, general and administrative expense increased to 52.7% for the three months ended September 30, 2017 from 50.3% in the comparable prior year period.  Our selling, general and administrative expenses contain a high fixed cost component and are not as scalable as some of our other expenses.  As our student population decreases, we typically experience a reduction in average class size and, therefore, are not always able to align these expenses with the corresponding decrease in population.

Gain on Sale of Assets.  For the three months ended September 30, 2017, gain on sale of assets increased to $1.5 million from less than $0.1 million in the prior year comparable period.  The increase was due to the sale of two properties located in West Palm Beach, Florida.  

 

Net interest expense. For the three months ended September 30, 2017, net interest expense decreased by $0.7 million, or 50% to $0.7 million from $1.4 million in the prior year comparable period.  The expense reductions were attributable to lower debt outstanding in combination with more favorable terms under our new credit facility with Sterling National Bank effective March 31, 2017.

 

Other Income.  For the three months ended September 30, 2017, other income decreased by $1.7 million from the prior year comparable period.  The $1.7 million of other income in 2016 reflected the amortization of a one-time gain from the modification of a lease at three of the Company’s campuses which were previously accounted for as finance obligations in the prior year.

Income taxes.    Our provision for income taxes was $0.1 million, or 3.5% of pretax loss, for the three months ended September 30, 2017, compared to $0.1 million, or 11.9% of pretax loss, in the prior year comparable period. No federal or state income tax benefit was recognized for the current period loss due to the recognition of a full valuation allowance.  Income tax expense resulted from various minimal state tax expenses.

 

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016

Consolidated Results of Operations

Revenue.   Revenue decreased by $18.5 million, or 8.7%, to $194.5 million for the nine months ended September 30, 2017 from $213.0 million for the prior year comparable period.  The decrease in revenue is primarily attributable to the suspension of new student enrollments at campuses in our Transitional segment which have closed or will be closed by year end.  This segment accounted for approximately 90% of the total revenue decline.  The remaining decline was due to our HOPS segment which decreased by $1.8 million for the nine months ended September 30, 2017 due to average population down approximately 30 students.

Total student starts decreased by 12.5% to approximately 9,900 from 11,300 for the nine months ended September 30, 2017 as compared to the prior year comparable period.  The decrease was largely due to the suspension of new student starts for the Transitional segment which accounted for approximately 79% of the decline.   The Transportation and Skilled Trades segment starts were down 2.8% and the HOPS segment starts were down 3.4% for the nine months ended September 30, 2017 as compared to the prior year comparable period.

For a general discussion of trends in our student enrollment, see “Seasonality and Outlook” below.

Educational services and facilities expense.   Our educational services and facilities expense decreased by $11.1 million, or 10%, to $99.2 million for the nine months ended September 30, 2017 from $110.2 million in the prior year comparable period.  This decrease is mainly attributable to the Transitional segment which accounted for $10.4 million in cost reductions as three campuses in the segment have closed during the nine months ended September 30, 2017 and the remaining two campuses that are preparing to close by the end of the current calendar year.  The remainder of the decrease was due to a $1.4 million decrease in depreciation expense resulting from fully depreciated assets.

Educational services and facilities expenses, as a percentage of revenue decreased to 51.0% for the nine months ended September 30, 2017 from 51.8% in the prior year comparable period.

Selling, general and administrative expense.    Our selling, general and administrative expense decreased by $3.9 million, or 3.5%, to $109.4 million for the nine months ended September 30, 2017 from $113.3 million in the comparable period of 2016.  The decrease also was primarily due to the Transitional segment, which accounted for approximately $9.5 million in cost reductions.  Partially offsetting these costs reductions are $3.3 million in increased administrative expense; and $2.5 million in additional sales and marketing expense.

Administrative expense increased primarily due to a $1.8 million increase in bad debt expense as a result of higher past due student accounts, higher account write-offs, and timing of Title IV funds receipts and $1.1 million in additional closed school expenses which relates directly to the closure of the Hartford, Connecticut campus in December 31, 2016.  The additional expenses relating to the Hartford Connecticut campus will terminate with the apartment lease which ends in September 2019.

Sales and marketing expense increased by $2.5 million, or 6.6%, primarily as a result of $2.1 million in increased marketing expense.  Increased marketing spend was part of a strategic marketing initiatives intended to reach more students. These initiatives resulted in a slight improvement in starts in the adult demographic for the nine months ended September 30, 2017 as compared to the prior comparable period.

As a percentage of revenues, selling, general and administrative expense increased to 56.2% for the nine months ended September 30, 2017 from 53.1% in the comparable prior year period.

As of September 30, 2017, we had total outstanding loan commitments to our students of $46.9 million, as compared to $40.0 million at December 31, 2016.  Loan commitments, net of interest that would be due on the loans through maturity, were $34.9 million at September 30, 2017, as compared to $30.0 million at December 31, 2016.  The increase in loan commitments was due in part to the seasonality of the Company’s operations.

Gain on sale of assets.  For the nine months ended September 30, 2017, gain on sale of assets increased to $1.6 million from $0.4 million in the prior year comparable period.  The increase was due to the sale of two properties located in West Palm Beach, Florida.  

Net interest expense. For the nine months ended September 30, 2017 net interest expense increased by 2.1 million, or 46% to $6.6 million from $4.5 million in the prior year comparable period.  The increase was mainly attributable to a $2.2 million non-cash write-off of previously capitalized deferred financing fees.  These costs were incurred at March 31, 2017 when the Company entered into a new revolving credit facility with Sterling National Bank.  Partially offsetting these increases were reductions in interest expense resulting from lower debt outstanding in combination with more favorable terms under the current Credit Facility compared to our prior Term Loan.

 

Other Income.  For the nine months ended September 30, 2017 other income decreased by $5.1 million from the prior year comparable period.  The $5.1 million in 2016 reflected the amortization of a one-time gain from the modification of a lease at three of the Company’s campuses which were previously accounted for as finance obligations in the prior year.

Income taxes.    Our provision for income taxes was $0.2 million, or 0.8% of pretax loss, for the nine months ended September 30, 2017, compared to $0.2 million, or 1.6% of pretax loss, in the prior year comparable period. No federal or state income tax benefit was recognized for the current period loss due to the recognition of a full valuation allowance.  Income tax expense resulted from various minimal state tax expenses.

 

 

The for-profit education industry has been impacted by numerous regulatory changes, the changing economy and an onslaught of negative media attention. As a result of these challenges, student populations have declined and operating costs have increased.  Over the past few years, the Company has closed over ten locations and exited its online business.  In 2016, the Company ceased operations in Hartford, Connecticut; Fern Park, Florida; and Henderson (Green Valley), Nevada. In the fourth quarter of 2016, the Board of Directors approved plans to cease operations at our schools in Center City Philadelphia, Pennsylvania; Northeast Philadelphia, Pennsylvania; and West Palm Beach, Florida which were fully taught out in 2017.  In addition, in March 2017, the Board of Directors approved plans to cease operations at our schools in Brockton, Massachusetts and Lowell, Massachusetts, which are expected to close in the fourth quarter of 2017.  These schools, which were previously included in our HOPS segment, are now included in the Transitional segment.

In the past, we offered any combination of programs at any campus.  We have shifted our focus to program offerings that create greater differentiation among campuses and attain excellence to attract more students and gain market share.  Also, strategically, we began offering continuing education training to select employers who hire our students and this is best achieved at campuses focused on their profession.

As a result of the regulatory environment, market forces and strategic decisions, we now operate our business in three reportable segments: (a) Transportation and Skilled Trades segment; (b) Healthcare and Other Professions segment; and (c) Transitional segment.

Our reportable segments have been determined based on a method by which we now evaluate performance and allocate resources.  Each reportable segment represents a group of post-secondary education providers that offer a variety of degree and non-degree academic programs.  These segments are organized by key market segments to enhance operational alignment within each segment to more effectively execute our strategic plan.  Each of the Company’s schools is a reporting unit and an operating segment.  Our operating segments are segments described below.

Transportation and Skilled Trades – Transportation and Skilled Trades segment offers academic programs mainly in the career-oriented disciplines of transportation and skilled trades (e.g. automotive, diesel, HVAC, welding and manufacturing).

 

Healthcare and Other Professions – The Healthcare and Other Professions segment offers academic programs in the career-oriented disciplines of health sciences, hospitality and business and information technology (e.g. dental assistant, medical assistant, practical nursing, culinary arts and cosmetology).

 

Transitional – Transitional segment refers to operations that are being phased out or closed and consists of our campuses that are currently being taught out.  These schools are employing a gradual teach-out process that enables the schools to continue to operate while current students complete their course of study.  These schools are no longer enrolling new students.  In addition, in March 2017, the Board of Directors of the Company approved a plan to cease operations at our schools in Brockton, Massachusetts and Lowell, Massachusetts.  These schools are being taught out and are expected to be closed in December 2017.  During the year ended December 31, 2016, the Company announced the closing of our Northeast Philadelphia, Pennsylvania, Center City Philadelphia, Pennsylvania and West Palm Beach, Florida facilities which were fully taught out in 2017.  In the first quarter of 2016, we completed the teach-out of our Fern Park, Florida campus.   In addition, in the fourth quarter of 2016, we completed the teach-out of our Hartford, Connecticut and Henderson (Green Valley), Nevada campuses.

The Company continually evaluates each campus for profitability, earning potential, and customer satisfaction.  This evaluation takes several factors into consideration, including the campus’ geographic location and program offerings, as well as skillsets required of our students by their potential employers.  The purpose of this evaluation is to ensure that our programs provide our students with the best possible opportunity to succeed in the marketplace with the goals of attracting more students to our programs and, ultimately, to provide our shareholders with the maximum return on their investment.  Campuses in the Transitional segment have been subject to this process and have been strategically identified for closure.

 

We evaluate segment performance based on operating results.  Adjustments to reconcile segment results to consolidated results are included under the caption “Corporate,” which primarily includes unallocated corporate activity.

The following table present results for our three reportable segments for the three months ended September 30, 2017 and 2016:

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

Student starts for the quarter decreased by 74 students, or 2.4%, compared to the prior year comparable period.  The decline in student starts is mainly the result of the underperformance of one campus, which decreased by 98 students.  Excluding this campus, student starts for the quarter would have grown over the prior year comparable period.  In addition, as previously reported in the second quarter, there was a decline in starts as a result of a lower than expected high school start rate.  High school students make up approximately 30% of the segment’s population.  In an effort to increase high school enrollments, the Company made various changes to its processes and organizational structure. 

 

·

Revenue decreased by $0.2 million, or 0.5% to $47.7 million for the three months ended September 30, 2017 from $47.9 million in the prior year comparable period.  The decrease in revenue was primarily driven by a 2.1% decrease in average student population due to a decline in the number of student starts slightly offset by a 1.6% increase in average revenue per student compared to the prior year comparable period.

·

Educational services and facilities expense decreased by $0.4 million, or 1.9%, to $22.4 million for the three months ended September 30, 2017 from $22.8 million in the prior year comparable quarter.  This decrease was primarily due to reductions in facilities expense resulting from more favorable lease terms at one of our campuses and reductions in depreciation expense due to fully depreciated assets.

·

Selling, general and administrative expenses were essentially flat.  Our selling, general and administrative expenses contain a high fixed cost component and are not as scalable as some of our other expenses.  As our student population decreases, we typically experience a reduction in average class size and, therefore, are not always able to align these expenses with the corresponding decrease in population.

 

Student starts in the Healthcare and Other Professions segment decreased by 24 students, or 1.7%, for the three months ended September 30, 2017 as compared to the prior year comparable period.  This segment consists of 11 campuses and, despite the overall decrease in student starts, for the three months ended September 30, 2017, seven of the 11 campuses in this segment showed an increase in student starts.  Of the remaining four campuses, one remained flat, two demonstrated less starts as a result of underperformance, and the last campus had a shift in start dates lowering starts compared to the prior year comparable period.

 

Operating loss for the three months ended September 30, 2017 was $0.6 million compared to $0.1 million in the prior year comparable period.  The $0.5 million change was mainly driven by the following factors:

·

Revenue decreased to $18.4 million for the three months ended September 30, 2017, as compared to $18.6 million in the prior year comparable quarter.  The decrease in revenue is mainly attributable to a 2.0% decline in average revenue per student due to tuition decreases at certain campuses and shifts in program mix.

·

Educational services and facilities expense increased by $0.2 million, or 1.9%, to $10.2 million for the three months ended September 30, 2017 from $10.0 million in the prior year comparable quarter.

·

Selling, general and administrative expense increased by $0.2, or 2.4%, to $8.8 million for the three months ended September 30, 2017 from $8.6 million in the prior year comparable quarter due to increases in sales and marketing expense.

The following table lists the schools that are categorized in the Transitional segment and their status as of September 30, 2017:

**Revenue for the campuses in the above table have been classified in the Transitional segment for comparability for the three months ended September 30, 2017 and 2016.

Revenue was $1.2 million for the three months ended September 30, 2017 as compared to $7.8 million in the prior year comparable period mainly due to the campus closures.

Operating loss increased by $0.5 million to $2.5 million for the three months ended September 30, 2017 from $2.0 million in the prior year comparable period.  The decrease was due to campus closures.

 

This category includes unallocated expenses incurred on behalf of the entire Company.  Corporate and Other expenses decreased by $1.0 million, or 21.1%, to $3.7 million from $4.7 million, in the prior year comparable period.  The decrease was primarily driven by a $1.5 million gain resulting from the sale of two properties located in West Palm Beach, Florida on August 14, 2017 and a decrease in salaries expense of approximately $0.9 million.  Partially offsetting these reductions was a $0.9 million increase in benefits expense and $0.6 million of additional closed school costs.  The decrease in benefits was attributable to historically lower medical claims in 2016 and the additional closed school costs related to the closure of the Hartford, Connecticut campus on December 31, 2016.  The additional expenses relating to the Hartford Connecticut campus will terminate with the apartment lease which ends in September 2019.

The following table presents results for our three reportable segments for the nine months ended September 30, 2017 and 2016:

 

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016

Student start results decreased by 2.8% to 6,502 from 6,686 for the nine months ended September 30, 2017 as compared to the prior year comparable period.

Operating income decreased by $3.0 million, or 24.8%, to $9.0 million for the nine months ended September 30, 2017 from $11.9 million in the prior year comparable period mainly driven by the following factors:

·

Revenue remained essentially flat at $131.2 million for the nine months ended September 30, 2017 as compared to the prior year comparable period mainly due to a higher carry in population compared to the prior year quarter in addition to a slight increase in revenue per student.  Partially offsetting the increases was a decline in average population of approximately 30 students.

·

Educational services and facilities expense decreased by $0.6 million, or 0.9% primarily due to a $1.2 million decrease in facilities expense, partially offset by a $0.6 million increase in instructional and books and tools expense.  Reductions in facilities expense were primarily driven by reduced depreciation expense resulting from fully depreciated assets.  Increases in instructional expenses were due to the launch of a new program at one of our campuses in combination with increased materials costs; and increased expenses for books and tools were due to the timing of the distribution of materials for students starting classes in combination with implementing the use of laptop computers for more of our program curriculums during the quarter.

·

Selling, general and administrative expense increased by $3.6 million due to (a) $1.3 million of additional bad debt expense resulting from higher past due student accounts, higher account write-offs, and timing of Title IV fund receipts; and (b) $1.4 million increase in sales and marketing expenses.  The increased spending in sales and marketing was part of a strategic effort to attract student enrollments and increase brand awareness.

Student start results decreased by 3.4% to 3,272 from 3,386 for the nine months ended September 30, 2017 as compared to the prior year comparable period.

Operating loss for the nine months ended September 30, 2017 was $1.1 million compared to operating income of $2.6 million in the prior year comparable period.  The $3.7 million change was mainly driven by the following factors:

·

Revenue decreased to $55.2 million for the nine months ended September 30, 2017, as compared to $57.0 million in the prior year comparable quarter.  The decrease in revenue is mainly attributable to two main factors, a decline in average population of approximately 30 students in combination with a 2.4% decline in average revenue per student due tuition decreases at certain campuses and shifts in our program mix.

·

Educational services and facilities expense remained essentially flat at $29.9 million for the nine months ended September 30, 2017 as compared to the prior year comparable period.

·

Selling, general and administrative expense increased by $1.9 million primarily resulting from a $1.1 million increase in sales and marketing expense.  The increased marketing initiatives has resulted in a slight improvement in student starts in the adult demographic for the nine months ended September 30, 2017 as compared to the prior comparable period; and a $0.6 million increase in administrative expenses mainly the result of bad debt expense which increased due to higher past due student accounts, higher account write-offs, and timing of Title IV fund receipts.

Revenue was $8.1 million for the nine months ended September 30, 2017 as compared to $24.7 million in the prior year comparable period mainly attributable to the closing of campuses within this segment.

Operating loss decreased by $3.2 million to $3.9 million for the nine months ended September 30, 2017 from $7.1 million in the prior year comparable period.  The decrease is primarily attributable to the closing of campuses within this segment

 

This category includes unallocated expenses incurred on behalf of the entire Company.  Corporate and Other expense decreased by $1.1 million, or 6.0%, to $16.5 million from $17.6 million in the prior year comparable period.  The decrease in corporate expenses was primarily driven by a $1.5 million gain resulting from the sale of two properties located in West Palm Beach, Florida on August 14, 2017 and a decrease in salaries expense of approximately $2.7 million.  Partially offsetting these reductions was a $2.1 million increase in benefits expense and $1.2 million of additional closed school costs.  The increase in benefits was attributable to historically lower medical claims in 2016 and the additional closed school costs related to the closure of the Hartford, Connecticut campus on December 31, 2016.  The additional expenses relating to the Hartford Connecticut campus will terminate with the apartment lease which ends in September 2019.

 

Our primary capital requirements are for facilities expansion and maintenance and the development of new programs. Our principal sources of liquidity have been cash provided by borrowings under our credit facility.  The following chart summarizes the principal elements of our cash flow:

 

At September 30, 2017, the Company had $14.5 million of cash, cash equivalents and restricted cash (which includes $7.2 million of restricted cash) as compared to $47.7 million of cash, cash equivalents and restricted cash (which included $26.7 million of restricted cash) as of December 31, 2016.  This decrease is primarily the result of a net loss during the nine months ended September 30, 2017; repayment of $44.3 million under our previous term loan facility and seasonality of the business.

For the last several years, the Company and the proprietary school sector generally have faced deteriorating earnings growth. Government regulations have negatively impacted earnings by making it more difficult for prospective students to obtain loans, which when coupled with the overall economic environment have hindered prospective students from enrolling in our schools. In light of these factors, we have incurred significant operating losses as a result of lower student population.  Despite these events, we believe that our likely sources of cash should be sufficient to fund operations for the next twelve months and thereafter for the foreseeable future.

To fund our business plans, including any anticipated future losses, purchase commitments, capital expenditures and principal and interest payments on borrowings, we leveraged our owned real estate. We are also continuing to take actions to improve cash flow by aligning our cost structure to our student population.

Our primary source of cash is tuition collected from our students. The majority of students enrolled at our schools rely on funds received under various government-sponsored student financial aid programs to pay a substantial portion of their tuition and other education-related expenses. The most significant source of student financing is Title IV programs which represented approximately 79% of our cash receipts relating to revenues in 2016. Pursuant to applicable regulations, students must apply for a new loan for each academic period. Federal regulations dictate the timing of disbursements of funds under Title IV programs and loan funds are generally provided by lenders in two disbursements for each academic year. The first disbursement is usually received approximately 31 days after the start of a student’s academic year and the second disbursement is typically received at the beginning of the sixteenth week from the start of the student's academic year. Certain types of grants and other funding are not subject to a 31-day delay.  In certain instances, if a student withdraws from a program prior to a specified date, any paid but unearned tuition or prorated Title IV financial aid is refunded according to federal, state and accrediting agency standards.

As a result of the significant amount of Title IV funds received by our students, we are highly dependent on these funds to operate our business. Any reduction in the level of Title IV funds that our students are eligible to receive or any restriction on our eligibility to receive Title IV funds would have a significant impact on our operations and our financial condition.  See “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016.

Operating Activities

Net cash used in operating activities was $16.6 million for the nine months September 30, 2017 compared to $9.5 million for the comparable period of 2016.  The increase in cash used in operating activities in the nine months ended September 30, 2017 as compared to the nine months ended September 30, 2016 is primarily due to an increased net loss as well as changes in other working capital such as accounts receivable, accounts payable, accrued expenses and unearned tuition.

 

Investing Activities

Net cash provided by investing activities was $10.9 million for the nine months ended September 30, 2017 compared to cash used of $0.6 million in the prior year comparable period.   Our primary use of cash in investing activities was capital expenditures associated with investments in training technology, classroom furniture, and new program buildouts.

 

We currently lease a majority of our campuses. We own our schools in Grand Prairie, Texas; Nashville, Tennessee; and Denver, Colorado and our buildings in West Palm Beach, Florida; and Suffield, Connecticut.

On August 14, 2017, the Company completed the sale of two of three properties located in West Palm Beach Florida resulting in cash inflows of $15.5 million.

Capital expenditures are expected to approximate 2% of revenues in 2017.  We expect to fund future capital expenditures with cash generated from operating activities, borrowings under our revolving credit facility, and cash from our real estate monetization.

Financing Activities

 

Net cash used in financing activities was $8.1 million as compared to net cash used of $9.0 million for the nine months ended September 30, 2017 and 2016, respectively. The decrease of $0.9 million was primarily due to three main factors: (a) net payments on borrowing of $6.5 million; (b) $2.9 million in lease termination fees paid in the prior year; and (c) the reclassification of $5 million in restricted cash in the prior year.

 

Net borrowings consisted of: (a) total borrowing to date under our secured revolving credit facility of $38.0 million; (b) reclassification of payments of borrowing from restricted cash of $20.3 million; and (c) $64.8 million in total repayments made by the Company.

 

Credit Agreement

On March 31, 2017, the Company entered into a secured revolving credit agreement (the “Credit Agreement”) with Sterling National Bank (the “Bank”) pursuant to which the Company obtained a credit facility in the aggregate principal amount of up to $55 million (the “Credit Facility”).  The Credit Facility consists of (a) a $30 million loan facility (“Facility 1”), which is comprised of a $25 million revolving loan designated as “Tranche A” and a $5 million non-revolving loan designated as “Tranche B,” which Tranche B was repaid during the quarter ended June 30, 2017 and (b) a $25 million revolving loan facility (“Facility 2”), which includes a sublimit amount for letters of credit of $10 million.  The Credit Facility replaces a term loan facility (the “Prior Credit Facility”) which was repaid and terminated concurrently with the effectiveness of the Credit Facility.  The term of the Credit Facility is 38 months, maturing on May 31, 2020.

 

The Credit Facility is secured by a first priority lien in favor of the Bank on substantially all of the personal property owned by the Company as well as mortgages on four parcels of real property owned by the Company in Connecticut, Colorado, Tennessee and Texas at which four of the Company’s schools are located.

 

At the closing of the Credit Facility, the Company drew $25 million under Tranche A of Facility 1, which, pursuant to the terms of the Credit Agreement, was used to repay the Prior Credit Facility and to pay transaction costs associated with closing the Credit Facility.  After the disbursements of such amounts, the Company retained approximately $1.8 million of the borrowed amount for working capital purposes.

 

Also, at closing, $5 million was drawn under Tranche B and, pursuant to the terms of the Credit Agreement, was deposited into an interest-bearing pledged account (the “Pledged Account”) in the name of the Company maintained at the Bank in order to secure payment obligations of the Company with respect to the costs of remediation of any environmental contamination discovered at certain of the mortgaged properties based upon environmental studies undertaken at such properties. During the quarter ended June 30, 2017, the environmental studies were completed and revealed no environmental issues existing at the properties.  Accordingly, pursuant to the terms of the Credit Agreement, the $5 million in the Pledged Account was released and used to repay the non-revolving loan outstanding under Tranche B.  Upon the repayment of Tranche B, the maximum principal amount of Facility 1 was permanently reduced to $25 million.

 

Pursuant to the terms of the Credit Agreement, all draws under Facility 2 for letters of credit or revolving loans must be secured by cash collateral in an amount equal to 100% of the aggregate stated amount of the letters of credit issued and revolving loans outstanding through draws from Facility 1 or other available cash of the Company.

 

Accrued interest on each revolving loan will be payable monthly in arrears.  Revolving loans under Tranche A of Facility 1 will bear interest at a rate per annum equal to the greater of (x) the Bank’s prime rate plus 2.50% and (y) 6.00%.  The amount borrowed under Tranche B of Facility 1 and revolving loans under Facility 2 will bear interest at a rate per annum equal to the greater of (x) the Bank’s prime rate and (y) 3.50%.

 

Each issuance of a letter of credit under Facility 2 will require the payment of a letter of credit fee to the Bank equal to a rate per annum of 1.75% on the daily amount available to be drawn under the letter of credit, which fee shall be payable in quarterly installments in arrears.  Letters of credit totaling $7.2 million that were outstanding under a $9.5 million letter of credit facility previously provided to the Company by the Bank, which letter of credit facility was set to mature on April 1, 2017, are treated as letters of credit under Facility 2.

 

The terms of the Credit Agreement provide that the Bank be paid an unused facility fee on the average daily unused balance of Facility 1 at a rate per annum equal to 0.50%, which fee is payable quarterly in arrears.  In addition, the Company is required to maintain, on deposit in one or more non-interest bearing accounts, a minimum of $5 million in quarterly average aggregate balances.  If in any quarter the required average aggregate account balance is not maintained, the Company is required to pay the Bank a fee of $12,500 for that quarter and, in the event that the Company terminates the Credit Facility or refinances with another lender within 18 months of closing, the Company is required to pay the Bank a breakage fee of $500,000.

 

In addition to the foregoing, the Credit Agreement contains customary representations, warranties and affirmative and negative covenants, including financial covenants that restrict capital expenditures, prohibit the incurrence of a net loss commencing on December 31, 2018 and require a minimum adjusted EBITDA and a minimum tangible net worth, which is an annual covenant, as well as events of default customary for facilities of this type.  As of September 30, 2017, the Company is in compliance with all covenants.

 

In connection with the Credit Agreement, the Company paid the Bank an origination fee in the amount of $250,000 and other fees and reimbursements that are customary for facilities of this type.

 

The Company incurred an early termination premium of approximately $1.8 million in connection with the termination of the Prior Credit Facility.

 

On April 28, 2017, the Company entered into an additional secured credit agreement with the Bank, pursuant to which the Company obtained a short term loan in the principal amount of $8 million, the proceeds of which were used for working capital and general corporate purposes.  The loan, which had an interest rate equal to the greater of the Bank’s prime rate plus 2.50% or 6.00%, was secured by real property assets located in West Palm Beach, Florida at which schools operated by the Company were located and matured upon the earlier of October 1, 2017 and the date of the sale of the West Palm Beach, Florida property.  The Company sold two of three properties located in West Palm Beach, Florida to Tambone in the third quarter of 2017 and subsequently repaid the $8 million.

 

As of September 30, 2017, the Company had $17.5 million outstanding under the Credit Facility; offset by $0.8 million of deferred finance fees.  As of December 31, 2016, the Company had $44.3 million outstanding under the Prior Credit Facility; offset by $2.3 million of deferred finance fees, which were written-off.  As of September 30, 2017 and December 31, 2016, there were letters of credit in the aggregate outstanding principal amount of $7.2 million and $6.2 million, respectively.  As of September 30, 2017, there are no revolving loans outstanding under Facility 2.

 

As of September 30, 2017, we had outstanding loan commitments to our students of $46.9 million, as compared to $40.0 million at December 31, 2016.  Loan commitments, net of interest that would be due on the loans through maturity, were $34.9 million at September 30, 2017, as compared to $30.0 million at December 31, 2016.

 

Contractual Obligations

Long-term Debt.  As of September 30, 2017, our current portion of long-term debt and our long-term debt consisted of borrowings under our Credit Facility.

Lease Commitments.  We lease offices, educational facilities and equipment for varying periods through the year 2030 at base annual rentals (excluding taxes, insurance, and other expenses under certain leases).

The following table contains supplemental information regarding our total contractual obligations as of September 30, 2017 (in thousands):