ITEM 1.
BUSINESS
OVERVIEW
We are a leading and diversified for-profit provider of career-oriented post-secondary education as measured by total enrollment. We offer recent high school graduates and working adults degree and diploma programs in five areas of study: automotive technology, health sciences, skilled trades, business and information technology and hospitality services. For the year ended December 31, 2008, our automotive technology program, our health science program, our skilled trades program, our business and information technology program, and our hospitality services program accounted for approximately 35%, 32%, 14%, 9%, and 10%, respectively, of our average enrollment. We had 21,667 students enrolled as of December 31, 2008 and our average enrollment for the year ended December 31, 2008 was 20,006 students, an increase of 13.1% from our average enrollment of 17,687 for the year ended December 31, 2007. For the year ended December 31, 2008, our revenues were $376.9 million, which represents an increase of 15.0% from the year ended December 31, 2007. Excluding our acquisition of Briarwood College, or BRI, in December 2008, our revenues and average enrollment would have increased by 14.7% and 13.0%, respectively, compared to the year ended December 31, 2007. For the year ended December 31, 2007, our revenues were $327.8 million, which represented a 5.5% increase from the year ended December 31, 2006. Excluding our acquisition of New England Institute of Technology at Palm Beach, Inc., or FLA, in May 2006, our revenues and average enrollment in 2007 would have increased by 3.2% and decreased by 0.4%, respectively, compared to the year ended December 31, 2006.
As of December 31, 2008, we operated 36 campuses in 17 states. We operate our campuses under the following six brand names: Lincoln Technical Institute, Lincoln College of Technology, Nashville Auto-Diesel College (“NADC”), Southwestern College, Euphoria Institute of Beauty Arts and Sciences and Briarwood College. In February 2007, we completed a re-branding initiative to consolidate 26 of our schools under the Lincoln Technical Institute and Lincoln College of Technology brand names, with the remaining schools continuing to operate under their pre-existing names. Most of our campuses serve major metropolitan markets and each typically offers courses in multiple areas of study. Five of our campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. Our other campuses primarily attract students from their local communities and surrounding areas. All of our schools are nationally accredited and are eligible to participate in federal financial aid programs by the U.S. Department of Education, or 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 May 2007, we announced a realignment pursuant to which we created separate managerial oversight for two groups of educational programs:
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Lincoln Technical Group. The Lincoln Technical Group primarily focuses on our automotive technology and skilled trades programs.
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Lincoln Education Group. The Lincoln Education Group primarily focuses on our health sciences, hospitality services and business and information technology programs, as well as our online programs.
This realignment is intended to promote efficiencies across our operations and further enhance our ability to execute on our strategy.
On December 1, 2008, we acquired the rights, title and interest in the assets used in the conduct and operation of Briarwood College (“Briarwood”) for approximately $10.5 million in cash, net of cash acquired. Briarwood operates one campus in Southington, Connecticut, is regionally accredited by the New England Association of Schools and Colleges (“NEASC”), and currently offers two bachelor’s degree programs and 31 associate degree programs to approximately 550 students as of December 31, 2008 from Connecticut and surrounding states.
On January 20, 2009, we completed the acquisition of four of the five institutions comprising Baran Institute of Technology, or Baran, for approximately $24.9 million in cash, net of cash acquired, subject to contractual post closing adjustments. Baran consists of five distinct institutions serving approximately 1,900 students and offers associate and diploma programs in the fields of automotive, skilled trades, health sciences and culinary arts. The four institutions we acquired on January 20, 2009 are Baran Institute of Technology, or BIT, Connecticut Culinary Institute, or CCI, Americare School of Nursing, or ASN, and Engine City Technical Institute, or ECTI. We also acquired the membership interests of Hartford Urban Ventures, LLC and certain assets and assumed certain liabilities of Educational Properties, LLC, which provide support services to Baran. We expect to acquire the fifth Baran institution, Clemens College, for an additional $3.0 million in the second quarter of 2009.
We believe that we provide our students with the highest quality career-oriented training available for our areas of study in our markets. We offer programs in areas of study that we believe are typically underserved by traditional providers of post-secondary education and for which we believe there exists significant demand among students and employers. Furthermore, we believe our convenient class scheduling, career focused curricula and emphasis on job placement offer our students valuable advantages that have been neglected by the traditional academic sector. By combining substantial hands-on training with traditional classroom-based training led by experienced instructors, we believe we offer our students a unique opportunity to develop practical job skills in key areas of expected job demand. We believe these job skills enable our students to compete effectively for employment opportunities and to pursue on-going salary and career advancement.
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Our principal business is providing post-secondary education. Accordingly, our operations aggregate into one reporting segment.
DISCONTINUED OPERATIONS
On July 31, 2007, our Board of Directors approved a plan to cease operations at three of our campuses. As a result of that decision, we recognized a non-cash impairment charge related to goodwill at these three campuses of approximately $2.1 million as of June 30, 2007. Additionally, we determined that certain long-lived assets would not be recoverable at June 30, 2007 and recorded a non-cash charge of $0.9 million to reduce the carrying value of these assets to their estimated fair value.
As of September 30, 2007, all operations had ceased at these campuses, and accordingly, the results of operations of these campuses have been reflected in the accompanying statements of operations as “Discontinued Operations” for all periods presented.
The following amounts relate to discontinued operations at these three campuses (in thousands):
AVAILABLE INFORMATION
Our website is www.lincolnedu.com. We make available on this website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, annual proxy statement on Schedule 14A and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission. You can access this information on our website, free of charge, by clicking on “Investor Relations.” The information contained on or connected to our website is not a part of this annual report on Form 10-K.
BUSINESS STRATEGY
Our goal is to strengthen our position as a leading and diversified provider of career-oriented post-secondary education by continuing to pursue the following:
Maximize Utilization of Existing Facilities. We believe that by creating separate oversight for two groups of educational programs, we are able to improve the day-to-day management, operational efficiency and capacity utilization of our campuses. We are also focused on improving capacity utilization through increased enrollments, and we expect to continue investing in marketing resources to attract new students.
Expand Existing Areas of Study and Existing Facilities. We believe we can leverage our operations to expand our program offerings in existing areas of study and expand into new areas of study to capitalize on demand from students and employers in our target markets. For example, in 2007 we began offering courses in Licensed Practical Nursing at three of our New Jersey campuses, and we believe we will be able to similarly expand our program offerings at other campuses. We also expect to continue expanding some of our existing facilities and relocating other facilities to expand capacity. In 2008, we increased capacity at two of our Southwestern College campuses and moved into a new and larger campus in Brockton, Massachusetts.
Expand Geographic Presence. We believe that we can leverage our marketing and recruiting programs by opening additional campuses in selected markets and obtaining greater market penetration. For example, in March 2006, we established our presence in the New York metropolitan area with the opening of our Queens, New York automotive school in partnership with the Greater New York Area Automobile Dealers Association. In 2008, we expanded our presence in Las Vegas with the opening of our third Euphoria campus in the north end of Las Vegas which will enable us to better serve that market. We believe we can also increase our student enrollments by entering selected new geographic markets that we believe have significant growth potential and where we can leverage our reputation and operating expertise.
Opportunistically Pursue Strategic Acquisitions. We continue to evaluate attractive acquisition candidates. In evaluating potential acquisitions, we seek to identify schools that provide the potential for program replication at our existing campuses, expand our program and degree offerings, and extend our presence into markets with attractive growth opportunities.
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On December 1, 2008, we acquired Briarwood College which strengthened our position in Connecticut, by adding additional associate and bachelor’s degree programs and has regional accreditation which we believe will enable us to serve a new market and enhance our online programs.
Expand Online Programs. We have offered online programs since 2005 with a view towards capitalizing on the rapidly growing demand for, and flexibility provided by, online education alternatives. We launched our first 100% online program in June 2006 and our second in December 2006. In 2008, we launched two associate degree programs and three bachelor’s degree programs. We believe that our online programs are an attractive option for students without the geographic or financial flexibility to enroll in campus-based programs and will continue to broaden our addressable market.
PROGRAMS AND AREAS OF STUDY
We structure our program offerings to provide our students with a practical, career-oriented education and position them for attractive entry-level job opportunities in their chosen fields. Our programs are designed to be completed in 14 to 102 weeks. Tuition for programs ranges from $10,000 to $35,000, depending on the length of the program and the area of study. As of December 31, 2008, all of our schools offer diploma and certificate programs, 18 of our schools are currently approved to offer associate degree programs and two schools are approved to offer a bachelor’s degree program. In order to accommodate the schedules of our students and maximize classroom utilization, we typically offer courses four to five days a week in three shifts per day and start new classes every month. Also for those students who do not live near one of our campuses or whose schedules prevent them from attending school we offer several programs online. We update and expand our programs frequently to reflect the latest technological advances in the field, providing our students with the specific skills and knowledge required in the current marketplace. Classroom instruction combines lectures and demonstrations by our experienced faculty with comprehensive hands-on laboratory exercises in simulated workplace environments.
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The following table lists the programs offered as of December 31, 2008 with the average number of students enrolled in each area of study for the year ended December 31, 2008:
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Automotive Technology. Automotive technology represents our largest area of study, with 35% of our total average student enrollment for the year ended December 31, 2008. Our automotive technology programs are 24 to 92 weeks in length, with tuition rates of $10,000 to $35,000. We believe we are a leading provider of automotive technology education in each of our local markets. Graduates of our programs are qualified to obtain entry level employment ranging from positions as technicians and mechanics to various apprentice level positions. Our graduates are employed by a wide variety of employers, ranging from automotive and diesel dealers, independent auto body paint and repair shops, to trucking and construction companies.
We have an arrangement with BMW that offers our automotive technology students the opportunity to work for BMW through the Service Technician Education Program (“STEP”). The STEP program is a "graduate" school program for individuals who have successfully earned an automotive certification either at one of our schools or any of our competitor's schools. Students who are admitted to the STEP program have their tuition paid by BMW and upon successfully completing the program are typically employed as BMW mechanics. The BMW STEP program commenced at our Columbia, Maryland facility in 2004. Our arrangement with BMW signifies our high quality education capabilities and is an attractive marketing program.
As of December 31, 2008, each of our Lincoln Technical Institute schools, with the exception of our Allentown, Pennsylvania campus, offer programs in automotive technology in addition to other technical programs. Lincoln College of Technology (formerly Denver Automotive & Diesel College) (“Denver LCT”) and Nashville Auto-Diesel College currently offer programs exclusively in automotive technology. Denver LCT, Nashville Auto-Diesel College, and our Lincoln College of Technology schools in Grand Prairie, Texas and Indianapolis, Indiana are destination schools, attracting students throughout the United States and, in some cases, from abroad.
Health Sciences. For the year ended December 31, 2008, health sciences represented our second largest area of study, representing 32% of our total average student enrollment. Our health science programs are 30 to 92 weeks in length, with tuition rates of $10,000 to $30,000. Graduates of our programs are qualified to obtain positions such as licensed practical nurse, medical administrative assistant, EKG technician, claims examiner and pharmacy technician. Our graduates are employed by a wide variety of employers, including hospitals, laboratories, insurance companies, doctors' offices and pharmacies. Our medical assistant and medical administrative assistant programs are our largest health science programs.
As of December 31, 2008, we offered health science programs at 23 schools, including five Southwestern College schools, Briarwood College, and 17 Lincoln College of Technology and Lincoln Technical Institute schools.
Skilled Trades. For the year ended December 31, 2008, 14% of our total average student enrollment was in our skilled trades programs. Our skilled trades programs are 41 to 91 weeks in length, with tuition rates of $16,000 to $29,000. Our skilled trades programs include electrician, heating, ventilation and air conditioning repair, welding, drafting and computer-aided design and electronic system technician. Graduates of our programs are qualified to obtain entry level employment positions such as electrician, cable, wiring and HVAC installer and servicer and drafting technician. Our graduates are employed by a wide variety of employers, including residential and commercial construction, telecommunications installation companies and architectural firms.
In the first quarter of 2008 we launched our first welding program. This program was developed based on the National Center for Construction Education and Research (“NCCER”) curriculum. NCCER is a not-for-profit education foundation created to help address the critical workforce shortage facing the construction industry and to develop industry-driven standardized craft training programs with portable credentials.
As of December 31, 2008, we offered skilled trades programs at 13 of our 25 Lincoln Technical Institute and Lincoln College of Technology campuses.
Hospitality Services. For the year ended December 31, 2008, 10% of our total average student enrollment was in our hospitality services programs. Our hospitality services programs are 14 to 98 weeks in length, with tuition rates of $10,000 to $27,000. Our spa programs include therapeutic massage, cosmetology and aesthetics. Graduates work in salons, spas, cruise ships or are self-employed. We offer massage programs at 15 campuses and cosmetology programs at five campuses. Our culinary graduates are employed by restaurants, hotels, cruise ships and bakeries. As of December 31, 2008, we offered culinary programs at the Florida Culinary Institute and three Centers for Culinary Arts.
Business and Information Technology. For the year ended December 31, 2008, 9% of our total average student enrollment was in our business and information technology programs, which include our diploma and degree criminal justice programs. Our business and information technology programs are 30 to 102 weeks in length, with tuition rates of $11,000 to $27,000. We have focused our current IT program offerings on those that are most in demand, such as our PC systems technician, network systems administrator and business administration specialist programs. Our IT and business graduates work in entry level positions for both small and large corporations. Our criminal justice graduates work in the security industry and for various government agencies and departments. As of December 31, 2008, we offered these programs at 18 of our campuses.
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MARKETING AND STUDENT RECRUITMENT
We utilize a variety of marketing and recruiting methods to attract students and increase enrollment. Our marketing and recruiting efforts are targeted at potential students who are entering the workforce, or who are underemployed or unemployed and require additional training to enter or re-enter the workforce.
Marketing and Advertising. Our marketing program utilizes integrated advertising such as the Internet, television, and various print media, direct mail, and event marketing campaigns. These campaigns are enhanced by student and alumni referrals. Internet lead generation is our most successful medium, built upon successful search engine optimization and specific keywords. Our website leads incorporate integrated campaigns that drive prospects to the website for lead capture. Our internal systems enable us to closely monitor and track the effectiveness of each advertisement on a daily or weekly basis and make adjustments accordingly to enhance efficiency and limit our student acquisition costs.
Referrals. Referrals from current students, high school counselors and satisfied graduates and their employers have historically represented over 20% of our new enrollments. Our school administrators actively work with our current students to encourage them to recommend our programs to potential students. We continue to build strong relationships with high school guidance counselors and instructors by offering annual seminars at our training facilities to further educate these individuals on the strengths of our programs. Graduates who have gone on to enjoy success in the workforce frequently recommend our programs, as do local business owners who are pleased with the performance of our graduates whom they have hired.
Recruiting. Our recruiting efforts are conducted by a group of approximately 400 field-and campus-based representatives who meet directly with potential students during presentations conducted at high schools, in the potential student's home or during a visit to one of our campuses.
Field-Based Recruiting. Our field-based recruiting representatives make presentations at high schools to attract students to both our local and destination campuses. Our field-based representatives also visit directly with potential students in their homes. During 2008, we recruited approximately 21% of our students directly out of high school.
Campus-Recruiting. When a potential student is identified through our marketing and recruiting efforts, one of our representatives is paired with the potential student to follow up on an individual basis. Our media advertisements contain a unique toll-free number and our telephone system automatically directs the call to the campus nearest to the caller. At this point, a recruiting representative will respond to the inquiry, typically within 24 hours. The representatives are trained to explain in detail the opportunities available within each program and schedule an appointment for the potential student to visit the school and tour the school's facilities.
STUDENT ADMISSIONS, ENROLLMENT AND RETENTION
Admissions. In order to attend our schools, students must complete an application and pass an entry examination. While each of our programs has different admissions criteria, we screen all applications and counsel the students on the most appropriate program to increase the likelihood that our students complete the requisite coursework and obtain and sustain employment following graduation.
Enrollment. We enroll students continuously throughout the year, with our largest classes enrolling in late summer or early fall following high school graduation. We had 21,667 students enrolled as of December 31, 2008 and our average enrollment for the year ended December 31, 2008 was 20,006 students, an increase of 13.1% from December 31, 2007. Excluding our acquisition of BRI in December 2008, our average student enrollment would have increased by 13.0%. Our average student enrollment for the year ended December 31, 2007 was 17,687 students, an increase of 1.7% from December 31, 2006. Excluding our acquisition of FLA in May 2006, our average enrollment for the year ended December 31, 2007 would have decreased by 0.4%.
Retention. To maximize student retention, the staff at each school is trained to recognize the early warning signs of a potential drop and to assist and advise students on academic, financial, employment and personal matters. We monitor our retention rates by instructor, course, program and school. When we notice that a particular instructor or program is experiencing a higher than normal dropout rate, we quickly seek to determine the cause of the problem and attempt to correct it. When we notice that a student is having trouble academically, we offer tutoring.
JOB PLACEMENT
We believe that securing employment for our graduates is critical to our ability to attract high quality students. In addition, high job placement rates result in low student loan default rates, an important requirement for continued participation in Title IV Programs. See "Regulatory Environment-Regulation of Federal Student Financial Aid Programs." Accordingly, we dedicate significant resources to maintaining an effective graduate placement program. Our non-destination schools work closely with local employers to ensure that we are training students with skills that employers need. Each school has an advisory council made up of local employers who provide us with direct feedback on how well we are preparing our students to succeed in the workplace. This enables us to tailor our programs to the market. The placement staff in each of our destination schools maintains databases of potential employers throughout the country, allowing us to place students in their career field upon graduation. We also have internship programs that provide our students with opportunities to work with employers prior to graduation. For example, some of the students in our automotive programs have the opportunity to complete a portion of their hands-on training while working with a potential employer. In addition, some of our allied health students are required to participate in an internship program during which they work in the field as part of their career training. Students that participate in these programs often go on to work for the same business upon graduation. We also assist students with resume writing, interviewing and other job search skills.
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FACULTY AND EMPLOYEES
We hire our faculty in accordance with established criteria, including relevant work experience, educational background and accreditation and state regulatory standards. We require meaningful industry experience of our teaching staff in order to maintain the quality of instruction in all of our programs and to address current and industry-specific issues in our course content. In addition, we provide intensive instructional training and continuing education, including quarterly instructional development seminars, annual reviews, technical upgrade training, faculty development plans and weekly staff meetings.
The staff of each school typically includes a school director, a director of graduate placement, an education director, a director of student services, a financial-aid director, an accounting manager, a director of admissions and instructors, all of whom are industry professionals with experience in our areas of study.
As of December 31, 2008, we had approximately 3,206 employees, including 793 full-time faculty and 663 part-time instructors. At six of our campuses, the teaching professionals are represented by unions. These employees are covered by collective bargaining agreements that expire between 2009 through 2012. We believe that we generally have good relationships with these unions and our employees.
COMPETITION
The for-profit, post-secondary education industry is highly competitive and highly fragmented, with no one provider controlling significant market share. Direct competition between career-oriented schools and traditional four-year colleges or universities is limited. Thus, our main competitors are other for-profit, career-oriented schools, as well as public and private two-year junior and community colleges. Competition is generally based on location, the type of programs offered, the quality of instruction, placement rates, reputation, recruiting and tuition rates. Public institutions are generally able to charge lower tuition than our schools, due in part to government subsidies and other financial sources not available to for-profit schools. In addition, some of our private competitors have a more extended or dense network of schools and campuses than we do, which enables them to recruit students more efficiently from a wider geographic area. Nevertheless, we believe that we are able to compete effectively in our local markets because of the diversity of our program offerings, quality of instruction, the strength of our brands, our reputation and our success in placing students with employers.
We compete with other institutions that are eligible to receive Title IV funding. This includes four-year, not-for-profit public and private colleges and universities, community colleges and all for-profit institutions whether they are four years, two years or less. Our competition differs in each market depending on the curriculum that we offer. For example, a school offering automotive, allied health and skilled trades programs will have a different group of competitors than a school offering allied health, business/IT and skilled trades. Also, because schools can add new programs within six to twelve months, new competitors can emerge relatively quickly. Moreover, with the introduction of online learning, the number of competitors in each market has increased because students can now stay local but learn from a non-local institution.
Notwithstanding the above, we mainly compete with community colleges and other career schools, both for-profit and not-for-profit. We focus on programs that are in high demand. We compete against community colleges by seeking to offer more frequent start dates, more flexible hours, better instructional resources, more hands on training, shorter program length and greater assistance with job placement. We compete against the other career schools by seeking to offer a higher quality of education, higher quality instructional equipment and a better overall value. On average, each of our schools has at least three direct competitors and at least a dozen indirect competitors. As we continue to add courses and degree programs, our competitors within a given market increase and thus we face increased competition.
ENVIRONMENTAL MATTERS
We use hazardous materials at our training facilities and campuses, and generate small quantities of waste such as used oil, antifreeze, paint and car batteries. As a result, our facilities and operations are subject to a variety of environmental laws and regulations governing, among other things, the use, storage and disposal of solid and hazardous substances and waste, and the clean-up of contamination at our facilities or off-site locations to which we send or have sent waste for disposal. We are also required to obtain permits for our air emissions, and to meet operational and maintenance requirements. In the event we do not maintain compliance with any of these laws and regulations, or are responsible for a spill or release of hazardous materials, we could incur significant costs for clean-up, damages, and fines or penalties.
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REGULATORY ENVIRONMENT
Students attending our schools finance their education through a combination of family contributions, individual resources, private loans and federal financial aid programs. Each of our schools participates in the federal programs of student financial aid authorized under the Title IV Programs, which are administered by the DOE. For the year ended December 31, 2008, approximately 79% (calculated based on cash receipts) of our revenues were derived from the Title IV Programs. Students obtain access to federal student financial aid through a DOE prescribed application and eligibility certification process. Student financial aid funds are generally made available to students at prescribed intervals throughout their predetermined expected length of study. Students typically use the funds received from the federal financial aid programs to pay their tuition and fees. The transfer of funds from the financial aid programs are to the student, who then applies those funds to the cost of his or her education.
In connection with the students' receipt of federal financial aid, our schools are subject to extensive regulation by governmental agencies and licensing and accrediting bodies. In particular, the Title IV Programs, and the regulations issued thereafter by the DOE, subject us to significant regulatory scrutiny in the form of numerous standards that each of our schools must satisfy in order to participate in the various federal student financial aid programs. To participate in the Title IV Programs, a school must be authorized to offer its programs of instruction by the applicable state education agencies in the states in which it is physically located, be accredited by an accrediting commission recognized by the DOE and be certified as an eligible institution by the DOE. The DOE will certify an institution to participate in Title IV Programs only after the institution has demonstrated compliance with the Higher Education Act of 1965, as amended, or HEA, and the DOE's extensive regulations regarding institutional eligibility. The DOE defines an eligible institution to consist of both a main campus and its additional locations, if any. Each of our schools is either a main campus or an additional location of a main campus. Each of our schools is subject to extensive regulatory requirements imposed by state education agencies, accrediting commissions, and the DOE. Because the DOE periodically revises its regulations and changes its interpretations of existing laws and regulations, we cannot predict with certainty how Title IV Program requirements will be applied in all circumstances. Our schools also participate in other federal and state financial aid programs that assist students in paying the cost of their education.
State Authorization
Each of our schools must be authorized by the applicable education agencies in the states in which the school is physically located, and in some cases other states, in order to operate and to grant degrees, diplomas or certificates to its students. Some states have sought to assert jurisdiction over online educational institutions that offer educational services to residents in the state, notwithstanding the lack of a physical location in that state. State agency authorization is also required in each state in which a school is physically located in order for the school to become and remain eligible to participate in Title IV Programs. If we are found not to be in compliance with the applicable state regulation and a state seeks to restrict one or more of our business activities within its boundaries, we may not be able to recruit or enroll students in that state and may have to stop providing services in that state, which could have a material adverse effect on our business and results of operations. Currently, each of our schools is authorized by the applicable state education agencies in the states in which the school is physically located and in which it recruits students.
Our schools are subject to extensive, ongoing regulation by each of these states. State laws typically establish standards for instruction, curriculum, qualifications of faculty, location and nature of facilities and equipment, administrative procedures, marketing, recruiting, financial operations, student outcomes and other operational matters. State laws and regulations may limit our ability to offer educational programs and to award degrees, diplomas or certificates. Some states prescribe standards of financial responsibility that are different from, and in certain cases more stringent than, those prescribed by the DOE. Some states require schools to post a surety bond. We believe that we have posted surety bonds on behalf of our schools and education representatives with multiple states in a total amount of approximately $13.7 million. These bonds are backed by $2.4 million of letters of credit.
If any of our schools fail to comply with state licensing requirements, they are subject to the loss of state licensure or authorization. If any one of our schools lost its authorization from the education agency of the state in which the school is located, that school and its related main campus and/or additional locations would lose its eligibility to participate in Title IV Programs, be unable to offer its programs and we could be forced to close that school. If one of our schools lost its state authorization from a state other than the state in which the school is located, the school would not be able to recruit students in that state. We believe that each of our schools is in substantial compliance with the applicable education agency requirements in each state in which it is physically located.
Due to state budget constraints in certain states in which we operate, it is possible that those states may reduce the number of employees in, or curtail the operations of, the state education agencies that authorize our schools. A delay or refusal by any state education agency in approving any changes in our operations that require state approval could prevent us from making such changes or could delay our ability to make such changes.
Accreditation
Accreditation is a non-governmental process through which a school submits to ongoing qualitative and quantitative review by an organization of peer institutions. Accrediting commissions primarily examine the academic quality of the school's instructional programs, and a grant of accreditation is generally viewed as confirmation that the school's programs meet generally accepted academic standards. Accrediting commissions also review the administrative and financial operations of the schools they accredit to ensure that each school has the resources necessary to perform its educational mission.
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Accreditation by an accrediting commission recognized by the DOE is required for an institution to be certified to participate in Title IV Programs. In order to be recognized by the DOE, accrediting commissions must adopt specific standards for their review of educational institutions. As of December 31, 2008, fifteen of our campuses are accredited by the Accrediting Commission of Career Schools and Colleges of Technology or ACCSCT, nineteen of our campuses are accredited by the Accrediting Council for Independent Colleges and Schools or ACICS and one of our campuses is accredited by the New England Association of Schools and Colleges or NEASC. All of these accrediting commissions are recognized by the DOE. The following is a list of the dates on which each campus was accredited by its accrediting commission and the date by which its accreditation must be renewed.
Accrediting Commission of Career Schools and Colleges of Technology Reaccreditation Dates
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Branch campus of main campus in Union, NJ
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Branch campus of main campus in New Britain, CT
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Currently going through re-accreditation
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Accrediting Council for Independent Colleges and Schools Reaccreditation Dates
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Branch campus of main campus in Edison, NJ
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Branch campus of main campus in Somerville, MA
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Branch campus of main campus in Dayton, OH
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Branch campus of main campus in Lincoln, RI
New England Association of Schools and Colleges and Reaccreditation Dates
If one of our schools fails to comply with accrediting commission requirements, the institution and its main and/or branch campuses are subject to the loss of accreditation. If any one of our schools lost its accreditation, students attending that school would no longer be eligible to receive Title IV Program funding, and we could be forced to close that school. Any institution required to submit retention data to the ACICS is required to obtain prior permission from the ACICS for the initiation of any new program and new branch campus or learning site.
Nature of Federal and State Support for Post-Secondary Education
The federal government provides a substantial part of the support for post-secondary education through Title IV Programs, in the form of grants and loans to students who can use those funds at any institution that has been certified as eligible by the DOE. Most aid under Title IV Programs is awarded on the basis of financial need, generally defined as the difference between the cost of attending the institution and the expected amount a student and his or her family can reasonably contribute to that cost. All recipients of Title IV Program funds must maintain a satisfactory grade point average and progress in a timely manner toward completion of their program of study. In addition, each school must ensure that Title IV Program funds are properly accounted for and disbursed in the correct amounts to eligible students.
Students at our schools receive grants and loans to fund their education under the following Title IV Programs: (1) the Federal Family Education Loan program, (2) the Federal Pell Grant, or Pell, program, (3) the Federal Supplemental Educational Opportunity Grant program, and (4) the Federal Perkins Loan, or Perkins, program.
Federal Family Education Loan. Under the Federal Family Education Loan program, banks and other lending institutions make loans to students or their parents. If a student or parent defaults on a loan, payment is guaranteed by a federally recognized guaranty agency, which is then reimbursed by the DOE. Students with financial need qualify for interest subsidies while in school and during grace periods. For the year ended December 31, 2008, we derived approximately 62% of our Title IV revenues (calculated based on cash receipts) from the Federal Family Education Loan program.
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Pell. Under the Pell program, the DOE makes grants to students who demonstrate the greatest financial need. For the year ended December 31, 2008, we derived approximately 19% of our revenues (calculated based on cash receipts) from the Pell program.
Federal Supplemental Educational Opportunity Grant. Under the Federal Supplemental Educational Opportunity Grant program, the DOE issues grants which are designed to supplement Pell grants for students with the greatest financial needs. An institution is required to make a 25% matching contribution for all funds received from the DOE under this program. For the year ended December 31, 2008, we received less than 1% of our revenues (calculated based on cash receipts) from the Federal Supplemental Educational Opportunity Grant program.
Perkins. Perkins loans are made from a revolving institutional account, 75% of which is funded by the DOE and the remainder by the institution. Each institution is responsible for collecting payments on Perkins loans from its former students and lending those funds to currently enrolled students. Defaults by students on their Perkins loans reduce the amount of funds available in the applicable school's revolving account to make loans to additional students, but the school does not have any obligation to guarantee the loans or repay the defaulted amounts. For the year ended December 31, 2008, we derived less than 1% of our revenues (calculated based on cash receipts) from the Perkins program.
Other Financial Assistance Programs
Some of our students receive financial aid from federal sources other than Title IV Programs, such as the programs administered by the U.S. Department of Veterans Affairs and programs administered under the Workforce Investment Act. In addition, many states also provide financial aid to our students in the form of grants, loans or scholarships. The eligibility requirements for state financial aid and these other federal aid programs vary among the funding agencies and by program. Many states that provide financial aid to our students are facing significant budgetary constraints. We believe that the overall level of state financial aid for our students is likely to decrease in the near term, but we cannot predict how significant any such reductions will be or how long they will last.
In addition to Title IV and other government-administered programs, all of our schools participate in alternative loan programs for their students. Alternative loans fill the gap between what the student receives from all financial aid sources and what the student may need to cover the full cost of their education. Students or their parents can apply to a number of different lenders for this funding at current market interest rates.
Effective February 2008, Sallie Mae, Inc. (“SLM”) terminated its tiered discount loan agreement with us pursuant to which SLM provided private party loans to our students. As a result, we continue to search for alternative sub-prime loan providers but in the meantime we have decided to make financing available to students through our internal funding sources.
Reorganization
We were founded in 1946 as Lincoln Technical Institute, Inc. In February 2003, we reorganized our corporate structure to create a holding company, Lincoln Educational Services Corporation. The ownership of Lincoln Educational Services Corporation was identical to that of Lincoln Technical Institute, Inc. immediately prior to this reorganization. We subsequently began operating our entire organization under the Lincoln Educational Services Corporation name; however, before this reorganization, all of our interaction with the DOE, state and federal regulators and accrediting agencies was conducted by Lincoln Technical Institute, Inc.
Regulation of Federal Student Financial Aid Programs
To participate in Title IV Programs, an institution must be authorized to offer its programs by the relevant state education agencies in the state in which it is physically located, be accredited by an accrediting commission recognized by the DOE and be certified as eligible by the DOE. The DOE will certify an institution to participate in Title IV Programs only after the institution has demonstrated compliance with the Higher Education Act of 1965, as amended, HEA or Higher Education Act, and the DOE's extensive regulations regarding institutional eligibility. The DOE defines an institution to consist of both a main campus and its additional locations, if any. Under this definition, for DOE purposes, we had the following 16 institutions as of December 31, 2008, collectively consisting of 16 main campuses and 19 additional locations:
Index
*
This campus operates under the Lincoln College of Technology brand.
**
These campuses operate under the Euphoria Institute of Beauty Arts & Sciences brands.
All of our main campuses, including their additional locations, are currently certified by the DOE to participate in the Title IV Programs. In connection with our acquisitions of New England Technical Institute, and New England Institute of Technology at Palm Beach, we have received in each case an executed provisional program participation agreement from the DOE. In connection with our acquisition of Briarwood College, we have received a temporary provisional program participation agreement from the DOE which remains in effect on a month-to-month basis until the DOE completes its review and approval process for the change in ownership.
The DOE, accrediting commissions and state education agencies have responsibilities for overseeing compliance with Title IV Program requirements. As a result, each of our schools is subject to detailed oversight and review, and must comply with a complex framework of laws and regulations. Because the DOE periodically revises its regulations and changes its interpretation of existing laws and regulations, we cannot predict with certainty how the Title IV Program requirements will be applied in all circumstances.
Significant factors relating to Title IV Programs that could adversely affect us include the following:
Congressional Action. Political and budgetary concerns significantly affect Title IV Programs. On August 14, 2008, the Higher Education Opportunity Act, Public Law 110-315, reauthorized the Title IV HEA programs through at least September 30, 2014. The HEA reauthorization among other things revises the 90/10 Rule, as described below, revises the calculation of an institution's cohort default rate, requires additional disclosures and certifications with respect to non-Title IV alternative loans, prohibits certain activities or relations between lenders and schools to discourage preferential treatment of lenders based on factors not in students' best interests, and makes other changes.
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In addition, Congress reviews and determines federal appropriations for Title IV Programs on an annual basis. Congress can also make changes in the laws affecting Title IV Programs in the annual appropriations bills and in other laws it enacts between the Higher Education Act reauthorizations. Because a significant percentage of our revenues are derived from Title IV Programs, any action by Congress that significantly reduces Title IV Program funding or the ability of our schools or students to participate in Title IV Programs could reduce our student enrollment and our revenues. Congressional action may also increase our administrative costs and require us to modify our practices in order for our schools to comply fully with Title IV Program requirements. The College Cost Reduction & Access Act, which was signed into law in September 2007, cut approximately $22 billion in subsidies to federal student lenders and guarantors as an offset to increases to federal financial aid. This resulted in significant changes to the terms that alternative lending providers were willing to make and resulted in the tiered discount programs.
The College Cost Reduction & Access Act reduces payments to lenders and guaranty agencies participating in the Federal Family Education Loan (FFEL) Program. This, in turn, reduces the profitability of the FFEL Program and will make access to these loans, as well as, private loans more difficult. The widening sub-prime mortgage crisis has negatively impacted student loans. Lenders are experiencing difficulty in securing funding from the debt markets to make new student loans, however through the Ensuring Continued Access to Student Loans Act the Department of Education will provide liquidity support to FFEL lenders by purchasing loans and providing long term financing for FFEL loans. This program is designed to continue access to these funds for students and their parents.
On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act which further increased the maximum Pell grant to $4,860 for the July 1, 2009 through June 30, 2010 award year. When these funds are combined with the funding authorized and appropriated by the College Cost Reduction and Access Act - which increased the maximum award by $490 - the maximum Pell award will be $5,350 for the July 1, 2009 through June 30, 2010 award year.
The "90/10 Rule." Under the HEA reauthorization, a proprietary institution that derives more than 90% of its total revenue from the Title IV programs for two consecutive fiscal years becomes immediately ineligible to participate in the Title IV programs and may not reapply for eligibility until the end of two fiscal years. An institution with revenues exceeding 90% for a single fiscal year ending after August 14, 2008 will be placed on provisional certification and may be subject to other enforcement measures. Under prior law, an institution would immediately lose its eligibility to participate in Title IV Programs if it derived more than 90% of its revenue (calculated based on cash receipts) from those programs in any fiscal year as calculated in accordance with DOE regulation s and would be ineligible to apply to regain its eligibility until the following fiscal year. If one of our institutions violated the 90/10 Rule and became ineligible to participate in Title IV Programs but continue to disburse Title IV Program funds, the DOE would require the institution to repay all Title IV Program funds received by the institution after the effective date of the loss of eligibility. Effective July 1, 2008, the annual Stafford loans available for undergraduate students under the Federal Family Education Loan Program, or FFEL, increased. This loan limit increase, coupled with recent increases in grants from the Pell program and other Title IV loan limits, will result in some of our schools experiencing an increase in the revenues they receive from the Title IV programs. The HEA reauthorization provides some relief from this effect by excluding portions of the loan limit increase from the Title IV component of the 90/10 rule calculation.
We have calculated that, for each of our 2008, 2007 and 2006 fiscal years, none of our institutions derived more than 89.0% of its revenues from Title IV Programs. For our 2008 fiscal year, our institutions' 90/10 Rule percentages ranged from 69.7% to 89.0% except for Briarwood which was 45.5%. We regularly monitor compliance with this requirement to minimize the risk that any of our institutions would derive more than the maximum percentage of its revenues from Title IV Programs for any fiscal year.
Student Loan Defaults. An institution may lose its eligibility to participate in some or all Title IV Programs if the rates at which the institution's current and former students default on their federal student loans exceed specified percentages. The DOE calculates these rates based on the number of students who have defaulted, not the dollar amount of such defaults. The DOE calculates an institution's cohort default rate (as defined by the DOE regulations) on an annual basis as the rate at which borrowers scheduled to begin repayment on their loans in one year default on those loans by the end of the next year. An institution whose Federal Family Education Loan cohort default rate is 25% or greater for three consecutive federal fiscal years loses eligibility to participate in the Federal Family Education Loan and Pell programs for the remainder of the federal fiscal year in which the DOE determines that such institution has lost its eligibility and for the two subsequent federal fiscal years. An institution whose Federal Family Education Loan cohort default rate for any single federal fiscal year exceeds 40% may have its eligibility to participate in all Title IV Programs limited, suspended or terminated by the DOE. The HEA has been amended by the HEOA to calculate the institution’s cohort default rate using a three year period, effective for fiscal 2009 and beyond.
Under the HEA reauthorization, an institution's cohort default rate is redefined to be based on the rate at which its former students default on their FFEL loans over a period of time that is one year longer than the period of time over which rates currently are calculated. As a result, most institutions' respective cohort default rates are expected to increase under the new provision, which first would apply to cohort default rates calculated after October 1, 2011. The DOE will not impose sanctions based on rates calculated under the new provision until three consecutive years have been calculated under the new method. Until that time, the DOE will continue to calculate rates under the old method and impose sanctions based on those rates. The HEOA also increases the cohort default three-year threshold from 25% to 30% effective in fiscal year 2012. On September 15, 2008, the DOE published the cohort default rate for each of our schools which range from 5.6% to 19.3%.
Index
Federal Family Education Loan Program
As of December 31, 2008, none of our institutions has had a Federal Family Education Loan cohort default rate (as defined by the DOE) of 25% or greater for any of the federal fiscal years 2006, 2005 and 2004, the three most recent years for which the DOE has published such rates. The following table sets forth the Federal Family Education Loan cohort default rates for each of our 15 DOE institutions as of December 31, 2008 for those fiscal years:
An institution whose cohort default rate under the FFEL program is 25% or greater for any one of the three most recent federal fiscal years does not meet the DOE standards of administrative capability may be placed on provisional certification status by the DOE.
Perkins Loan Program
An institution whose Perkins cohort default rate is 50% or greater for three consecutive federal award years loses eligibility to participate in the Perkins program for the remainder of the federal award year in which DOE determines that the institution has lost its eligibility and for the two subsequent federal award years. None of our institutions has had a Perkins cohort default rate of 50% or greater for any of the last three federal award years. The DOE also will not provide any additional federal funds to an institution for Perkins loans in any federal award year in which the institution's Perkins cohort default rate is 25% or greater. Denver LCT and NETI are our only institutions participating in the Perkins program. Denver LCT’s cohort default rate was 35.7% for students scheduled to begin repayment in the 2007-2008 federal award year. The DOE did not provide any additional Federal Capital Contribution Funds for Perkins loans to Denver LCT. Denver LCT continues to make loans out of its existing Perkins loan fund. Lincoln Technical Institute (New Britain, CT) is provisionally certified by the DOE based on its change in ownership and on a finding by the DOE prior to the change in ownership that NETI had not transmitted certain data related to the Perkins program to the National Student Loan Data System during periods prior to the acquisition. Our New Britain, CT institution’s cohort default rate was 14.1% for students scheduled to begin repayment in the 2007-2008 federal award year.
Financial Responsibility Standards. All institutions participating in Title IV Programs must satisfy specific standards of financial responsibility. The DOE evaluates institutions for compliance with these standards each year, based on the institution's annual audited financial statements, as well as following a change in ownership resulting in a change of control of the institution.
The most significant financial responsibility measurement is the institution's composite score, which is calculated by the DOE based on three ratios:
·
The equity ratio, which measures the institution's capital resources, ability to borrow and financial viability;
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The primary reserve ratio, which measures the institution's ability to support current operations from expendable resources; and
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The net income ratio, which measures the institution's ability to operate at a profit.
The DOE assigns a strength factor to the results of each of these ratios on a scale from negative 1.0 to positive 3.0, with negative 1.0 reflecting financial weakness and positive 3.0 reflecting financial strength. The DOE then assigns a weighting percentage to each ratio and adds the weighted scores for the three ratios together to produce a composite score for the institution. The composite score must be at least 1.5 for the institution to be deemed financially responsible without the need for further oversight. If an institution's composite score is below 1.5, but is at least 1.0, it is in a category denominated by the DOE as "the zone." Under the DOE regulations, institutions that are in the zone are deemed to be financially responsible for a period of up to three years but are required to accept payment of Title IV Program funds under the cash monitoring or reimbursement method of payment and to provide to the DOE timely information regarding various oversight and financial events.
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If an institution's composite score is below 1.0, the institution is considered by the DOE to lack financial responsibility. If the DOE determines that an institution does not satisfy the DOE's financial responsibility standards, depending on its composite score and other factors, that institution may establish its financial responsibility on an alternative basis by, among other things:
·
Posting a letter of credit in an amount equal to at least 50% of the total Title IV Program funds received by the institution during the institution's most recently completed fiscal year;
·
Posting a letter of credit in an amount equal to at least 10% of such prior year's Title IV Program funds, accepting provisional certification, complying with additional DOE monitoring requirements and agreeing to receive Title IV Program funds under an arrangement other than the DOE's standard advance funding arrangement; and/or
·
Complying with additional DOE monitoring requirements and agreeing to receive Title IV Program funds under an arrangement other than the DOE's standard advance funding arrangement.
The DOE has evaluated the financial responsibility of our institutions on a consolidated basis. We have submitted to the DOE our audited financial statements for the 2006 and 2007 fiscal year reflecting a composite score of 1.7 and 1.8, respectively, based upon our calculations, and that our schools meet the DOE standards of financial responsibility. For the 2008 fiscal year, we have calculated our composite score to be 1.8.
Beginning December 30, 2004 and for a period of three years, all of our institutions were placed on "Heightened Cash Monitoring, Type 1 status." As a result, we were subject to a less favorable Title IV fund payment system that required us to credit student accounts before drawing down Title IV funds and also required us to timely notify the DOE with respect to certain enumerated oversight and financial events. The DOE has notified us that, as of December 31, 2007, we are no longer subject to Heightened Cash Monitoring, Type 1 status.
Return of Title IV Funds. An institution participating in Title IV Programs must calculate the amount of unearned Title IV Program funds that have been disbursed to students who withdraw from their educational programs before completing them, and must return those unearned funds to the DOE or the applicable lending institution in a timely manner, which is generally within 45 days from the date the institution determines that the student has withdrawn.
If an institution is cited in an audit or program review for returning Title IV Program funds late for 5% or more of the students in the audit or program review sample, the institution must post a letter of credit in favor of the DOE in an amount equal to 25% of the total amount of Title IV Program funds that should have been returned for students who withdrew in the institution's previous fiscal year.
School Acquisitions. When a company acquires a school that is eligible to participate in Title IV Programs, that school undergoes a change of ownership resulting in a change of control as defined by the DOE. Upon such a change of control, a school's eligibility to participate in Title IV Programs is generally suspended until it has applied for recertification by the DOE as an eligible school under its new ownership, which requires that the school also re-establish its state authorization and accreditation. The DOE may temporarily and provisionally certify an institution seeking approval of a change of control under certain circumstances while the DOE reviews the institution's application. The time required for the DOE to act on such an application may vary substantially. DOE recertification of an institution following a change of control will be on a provisional basis. Our expansion plans are based, in part, on our ability to acquire additional schools and have them certified by the DOE to participate in Title IV Programs. Our expansion plans take into account the approval requirements of the DOE and the relevant state education agencies and accrediting commissions.
Our recent acquisition of Briarwood College resulted in a change in ownership of said school requiring it to reapply for eligibility to participate in the Title IV programs and for approvals from their accrediting and state licensing agencies. Briarwood has received approval of the change in ownership from its accrediting agency and from its state licensing agency. Briarwood has also received a Temporary Provisional Program Participation Agreement, or Temporary PPPA, from the DOE, and we believe that we have provided the documentation necessary for the Temporary PPPA to remain in effect on a month-to-month basis pending completion of the DOE's review.
While it cannot be assured that the respective agencies will issue the required approvals described above, we believe that we will be able to meet the requirements necessary for obtaining these approvals.
Prior to our acquisition of Briarwood, the American Board of Funeral Service Education (“ABFSE”), the accrediting agency that accredits Briarwood’s Mortuary Sciences program, placed the program on “show cause”. Briarwood submitted a response on January 12, 2009 and hosted a follow-up visit from the agency on February 8-10, 2009. ABFSE has informed us that they intend to review Briarwood’s January response as well as the information obtained from the agency’s February visit at their April 2009 meeting.
Change of Control. In addition to school acquisitions, other types of transactions can also cause a change of control. The DOE, most state education agencies and our accrediting commissions have standards pertaining to the change of control of schools, but these standards are not uniform. DOE regulations describe some transactions that constitute a change of control, including the transfer of a controlling interest in the voting stock of an institution or the institution's parent corporation. For a publicly traded corporation, DOE regulations provide that a change of control occurs in one of two ways: (a) if a person acquires ownership and control of the corporation so that the corporation is required to file a Current Report on Form 8-K with the Securities and Exchange Commission disclosing the change of control or (b) if the corporation has a shareholder that owns at least 25% of the total outstanding voting stock of the corporation and is the largest shareholder of the corporation, and that shareholder ceases to own at least 25% of such stock or ceases to be the largest shareholder. These standards are subject to interpretation by the DOE.
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A significant purchase or disposition of our common stock could be determined by the DOE to be a change of control under this standard. Most of the states and our accrediting commissions include the sale of a controlling interest of common stock in the definition of a change of control although some agencies could determine that the sale or disposition of a smaller interest would result in a change of control. A change of control under the definition of one of these agencies would require the affected school to reaffirm its state authorization or accreditation. Some agencies would require approval prior to a sale or disposition that would result in a change of control in order to maintain authorization or accreditation. The requirements to obtain such reaffirmation from the states and our accrediting commissions vary widely.
A change of control could occur as a result of future transactions in which our company or schools are involved. Some corporate reorganizations and some changes in the board of directors are examples of such transactions. Moreover, the potential adverse effects of a change of control could influence future decisions by us and our stockholders regarding the sale, purchase, transfer, issuance or redemption of our stock. In addition, the adverse regulatory effect of a change of control also could discourage bids for your shares of common stock and could have an adverse effect on the market price of the Company’s shares.
Opening Additional Schools and Adding Educational Programs. For-profit educational institutions must be authorized by their state education agencies and be fully operational for two years before applying to the DOE to participate in Title IV Programs. However, an institution that is certified to participate in Title IV Programs may establish an additional location and apply to participate in Title IV Programs at that location without reference to the two-year requirement, if such additional location satisfies all other applicable DOE eligibility requirements. Our expansion plans are based, in part, on our ability to open new schools as additional locations of our existing institutions and take into account the DOE's approval requirements.
A student may use Title IV Program funds only to pay the costs associated with enrollment in an eligible educational program offered by an institution participating in Title IV Programs. Generally, an institution that is eligible to participate in Title IV Programs may add a new educational program without DOE approval if that new program leads to an associate level or higher degree and the institution already offers programs at that level, or if that program prepares students for gainful employment in the same or a related occupation as an educational program that has previously been designated as an eligible program at that institution and meets minimum length requirements. If an institution erroneously determines that an educational program is eligible for purposes of Title IV Programs, the institution would likely be liable for repayment of Title IV Program funds provided to students in that educational program. Our expansion plans are based, in part, on our ability to add new educational programs at our existing schools. We do not believe that current DOE regulations will create significant obstacles to our plans to add new programs.
Some of the state education agencies and our accrediting commission also have requirements that may affect our schools' ability to open a new campus, establish an additional location of an existing institution or begin offering a new educational program. Any institution required to submit retention data to the ACICS may be required to obtain prior permission from the ACICS for the initiation of any new program or new branch campus or learning site. We do not believe that these standards will create significant obstacles to our expansion plans.
Administrative Capability. The DOE assesses the administrative capability of each institution that participates in Title IV Programs under a series of separate standards. Failure to satisfy any of the standards may lead the DOE to find the institution ineligible to participate in Title IV Programs or to place the institution on provisional certification as a condition of its participation. These criteria require, among other things, that the institution:
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Complies with all applicable federal student financial aid regulations;
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Has capable and sufficient personnel to administer the federal student financial aid programs;
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Has adequate checks and balances in its system of internal controls;
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Divides the function of authorizing and disbursing or delivering Title IV Program Funds so that no office has the responsibility for both functions;
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Establishes and maintains records required under the Title IV regulations;
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Develops and applies an adequate system to identify and resolve discrepancies in information from sources regarding a student’s application for financial aid under Title IV;
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Has acceptable methods of defining and measuring the satisfactory academic progress of its students;
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Refers to the Office of the Inspector General any credible information indicating that any applicant, student, employee or agent of the school has been engaged in any fraud or other illegal conduct involving Title IV Programs;
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Provides financial aid counseling to its students; and
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Submits in a timely manner all reports and financial statements required by the regulations.
Index
Failure by an institution to satisfy any of these or other administrative capability criteria could cause the institution to lose its eligibility to participate in Title IV Programs, which would have a material adverse effect on our business and results of operations.
Other standards provide that an institution may be found to lack administrative capability and be placed on provisional certification if its student loan default rate under the Federal Family Education Loan program is 25% or greater for any of the three most recent federal fiscal years, or if its Perkins cohort default rate exceeds 15% for any federal award year. None of our institutions has a Federal Family Education Loan cohort default rate above 25% for any of the three most recent fiscal years for which the DOE has published rates. Denver LCT and NETI are our only institutions participating in the Perkins program. Denver LCT 's cohort default rate was 35.7% for students scheduled to begin repayment in the 2007-2008 federal award year. The DOE did not provide any additional Federal Capital Contribution Funds for Perkins loans to Denver LCT. Denver LCT continues to make loans out of its existing Perkins loan fund. As was the case prior to our acquisition NETI, the institution remains provisionally certified by the DOE based on its change in ownership and on a finding by the DOE prior to the change in ownership that NETI had not transmitted certain data related to the Perkins program to the National Student Loan Data System during periods prior to the acquisition. NETI 's cohort default rate was 14.1% for students scheduled to begin repayment in the 2007-2008 federal award year.
Ability to Benefit Regulations. Under certain circumstances, an institution may elect to admit non-high school graduates, or "ability to benefit," students, into certain of its programs of study. In order for ability to benefit students to be eligible for Title IV Program participation, the institution must comply with the ability to benefit requirements set forth in the Title IV Program requirements. The basic evaluation method to determine that a student has the ability to benefit from the program is the student's achievement of a minimum score on a test approved by the DOE and independently administered in accordance with DOE regulations. The HEOA provisions also permit students to demonstrate their ability to benefit and become eligible to receive Title IV funds upon satisfactory completion of six credit hours or the equivalent coursework. In addition to the testing requirements, the DOE regulations also prohibit ability to benefit student enrollments from constituting 50% or more of the total enrollment of the institution. In 2008, the following schools were authorized to enroll “ability to benefit” applicants: Southwestern College, New Britain, Cromwell, Shelton, Hamden, Union, Mahwah, Indianapolis, Melrose Park, Grand Prairie, Somerville, Denver, West Palm Beach, Center City Philadelphia, Northeast Philadelphia, Paramus, Mt. Laurel, Marietta, Lowell, Edison, Brockton, Allentown, and Summerlin.
Restrictions on Payment of Commissions, Bonuses and Other Incentive Payments. An institution participating in Title IV Programs may not provide any commission, bonus or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any person or entity engaged in any student recruiting or admission activities or in making decisions regarding the awarding of Title IV Program funds. In November 2002, the DOE published new regulations which attempt to clarify the "incentive compensation rule." Failure to comply with the incentive compensation rule could result in loss of ability to participate in Title IV Programs or in fines or liabilities. We believe that our current compensation plans are in compliance with the Higher Education Act and the DOE's new regulations, although we cannot assure you that the DOE will not find deficiencies in our compensation plans.
Eligibility and Certification Procedures. Each institution must periodically apply to the DOE for continued certification to participate in Title IV Programs. The institution must also apply for recertification when it undergoes a change in ownership resulting in a change of control. The institution also may come under DOE review when it undergoes a substantive change that requires the submission of an application, such as opening an additional location or raising the highest academic credential it offers.
The DOE may place an institution on provisional certification status if it determines that the institution does not fully satisfy certain administrative and financial standards or if the institution undergoes a change in ownership resulting in a change of control. The DOE may withdraw an institution's provisional certification with the institution having fewer due process protections than if it were fully certified. In addition, the DOE may more closely review an institution that is provisionally certified if it applies for approval to open a new location, add an educational program, acquire another school or make any other significant change. Provisional certification does not otherwise limit an institution's access to Title IV Program funds. In connection with our acquisitions of NETI, and New England Institute of Technology at Palm Beach, we received in each case an executed provisional program participation agreement from the DOE. In connection with our acquisition of Briarwood College, we received a temporary provisional program participation agreement from the DOE which remains in effect until the DOE completes its review and approval process for the change in ownership.
Index
All institutions are recertified on various dates for various amounts of time. The following table sets forth the expiration dates for each of our institutions' current program participation agreement as of December 31, 2008:
* Provisionally certified
** Currently going through re-certification
*** Temporary provisional certification extended on a month-to-month basis pending completion of DOE change in ownership review and approval process
Compliance with Regulatory Standards and Effect of Regulatory Violations. Our schools are subject to audits, program reviews, and site visits by various regulatory agencies, including the DOE, the DOE's Office of Inspector General, state education agencies, student loan guaranty agencies, the U.S. Department of Veterans Affairs and our accrediting commissions. In addition, each of our institutions must retain an independent certified public accountant to conduct an annual audit of the institution's administration of Title IV Program funds. The institution must submit the resulting audit report to the DOE for review.
The DOE conducted a program review at Southwestern College (“SWC”) and issued an initial program review report, dated February 6, 2008, in which it identified potential instances of noncompliance with certain DOE requirements. SWC responded to the DOE initial program review report on April 3, 2008. In a letter, dated May 29, 2008, the DOE issued a Final Program Review Determination and SWC refunded $0.2 million to the DOE.
In a letter received from the ACCSCT, dated July 7, 2008, we were informed of a “show cause” regarding our Lincoln Technical Institute institution in Philadelphia, Pennsylvania. An institution under “show cause” is required to satisfy its accrediting agency within a prescribed period, typically 18 months, that it has satisfactorily resolved the deficiency. We responded to ACCSCT’s “show cause” request in September 2008. In a letter dated December 5, 2008, ACCSCT informed us that the “show cause” order was vacated.
If one of our schools failed to comply with accrediting or state licensing requirements, such school and its main and/or branch campuses could be subject to the loss of state licensure or accreditation, which in turn could result in a loss of eligibility to participate in Title IV Programs. If the DOE determined that one of our institutions improperly disbursed Title IV Program funds or violated a provision of the Higher Education Act or DOE regulations, the institution could be required to repay such funds and related costs to the DOE and lenders, and could be assessed an administrative fine. The DOE could also place the institution on provisional certification and/or transfer the institution to the reimbursement or cash monitoring system of receiving Title IV Program funds, under which an institution must disburse its own funds to students and document the students' eligibility for Title IV Program funds before receiving such funds from the DOE. An institution that is operating under this "Heightened Cash Monitoring, Type 1 status," is required to credit student accounts before drawing down funds under Title IV Programs and to draw down funds in an amount no greater than the previous disbursement to students and parents. Additionally, the institution's compliance audit will be required to contain verification that this did occur throughout the year. In addition to the above, the DOE has required us to comply with certain requirements prescribed for institutions operating in "the zone," which is indicative of a composite score between 1.0 and 1.4. Those requirements include providing timely information regarding any of the following oversight and financial events:
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Any adverse action, including a probation or similar action, taken against the institution by its accrediting agency;
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Any event that causes the institution, or related entity to realize any liability that was noted as a contingent liability in the institution's or related entity's most recent audit financial statement;
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Any violation by the institution of any loan agreement;
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Any failure of the institution to make a payment in accordance with its debt obligations that results in a creditor filing suit to recover funds under those obligations;
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Any withdrawal of owner's equity from institution by any means, including declaring a dividend; or
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Any extraordinary losses, as defined in accordance with Accounting Principles Board Opinion No. 30.
Index
Operating under the zone requirements may also require the institution to submit its financial statement and compliance audits earlier than the date previously required and require the institution to provide information about its current operations and future plans. An institution that continues to fail to meet the financial responsibility standards set by the DOE or does not comply with the zone requirements may lose its eligibility to continue to participate in Title IV funding. If eligibility is lost, the institution may be required to post irrevocable letters of credit, for an amount determined by the DOE at a minimum of 50% of the Title IV Program funds received by the institution during its most recently completed fiscal year. The institution may also be required to post irrevocable letters of credit at a minimum of 10% of such funds and be provisionally certified and subject to other reporting and monitoring requirements.
Significant violations of Title IV Program requirements by us or any of our institutions could be the basis for a proceeding by the DOE to limit, suspend or terminate the participation of the affected institution in Title IV Programs or to civil or criminal penalties. Generally, such a termination extends for 18 months before the institution may apply for reinstatement of its participation. There is no DOE proceeding pending to fine any of our institutions or to limit, suspend or terminate any of our institutions' participation in Title IV Programs.
We and our schools are also subject to complaints and lawsuits relating to regulatory compliance brought not only by our regulatory agencies, but also by third parties, such as present or former students or employees and other members of the public. If we are unable to successfully resolve or defend against any such complaint or lawsuit, we may be required to pay money damages or be subject to fines, limitations, loss of federal funding, injunctions or other penalties. Moreover, even if we successfully resolve or defend against any such complaint or lawsuit, we may have to devote significant financial and management resources in order to reach such a result.
Lenders and Guaranty Agencies. In 2008, six lenders provided funding to more than 90% of the students at the schools we owned during that year: Sallie Mae Education Trust, AMS Trust, Regions Bank, PNC Bank, Student Funding Group, and Nelnet. While we believe that other lenders might be willing to make federally guaranteed student loans to our students if loans were no longer available from our current lenders, there can be no assurances in this regard. In addition, the Higher Education Act requires the establishment of lenders of last resort in every state to ensure that loans are available to students at any school that cannot otherwise identify lenders willing to make federally guaranteed loans to its students.
Our primary guarantors for Title IV loans are USA Group, a subsidiary of Sallie Mae, and New Jersey Higher Education Assistance Authority, an independent agency of the State of New Jersey. These two agencies currently guarantee a majority of the federally guaranteed student loans made to students enrolled at our schools. There are six other guaranty agencies that guarantee student loans made to students enrolled at our schools. We believe that other guaranty agencies would be willing to guarantee loans to our students if any of the guaranty agencies ceased guaranteeing those loans or reduced the volume of loans they guarantee, although there can be no assurances in this regard.
Subsequent Event. On January 20, 2009, we completed the acquisition of four of the five institutions comprising Baran Institute of Technology, or Baran, for approximately $24.9 million in cash, net of cash acquired, subject to contractual post closing adjustments. Baran consists of five distinct institutions serving approximately 1,900 students and offers associate and diploma programs in the fields of automotive, skilled trades, health sciences and culinary arts. The four institutions we acquired on January 20, 2009 are Baran Institute of Technology, or BIT, Connecticut Culinary Institute, or CCI, Americare School of Nursing, or ASN, and Engine City Technical Institute, or ECTI. We also acquired the membership interests of Hartford Urban Ventures, LLC and certain assets and assumed certain liabilities of Educational Properties, LLC, which provide support services to Baran. We expect to acquire the fifth Baran institution, Clemens College, for an additional $3.0 million in the second quarter of 2009.
Our recent acquisition of the four Baran schools resulted in a change in ownership of such schools requiring each of those schools and their campuses to reapply for eligibility to participate in the Title IV programs and for approvals from their accrediting and state licensing agencies. Each of the four Baran schools has received a Temporary Provisional PPA allowing each to resume its participation in the Title IV programs and we have provided the documentation necessary for each Temporary Provisional PPA to remain in effect on a month-to-month basis pending completion of the DOE's review and decision to issue a Provisional Program Participation Agreement.
Each of BIT, CCI and ECTI have received Part 1 approval of the change in ownership from their accrediting agency, the Accrediting Commission of Career Schools and Colleges of Technology, or ACCSCT, and have applied for Part 2 approval under a process that takes place after the change in ownership under applicable standards. Both BIT and CCI have received approval of the change in ownership from the State of Connecticut Board of Governors for Higher Education. ECTI has applied for approval of its change in ownership from the New Jersey Department of Labor and Workforce Development under a process that takes place after the change in ownership. ASN has received a provisional license from the Commission for Independent Education of the Florida Department of Education and is awaiting final approval of the change in ownership from that agency at its March 2009 meeting. ASN has applied for approval of the change in ownership with its accrediting agency, the Accrediting Bureau of Health Education Schools, or ABHES, under a process that also takes place after the change in ownership under applicable standards.
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While we cannot assure you that the respective agencies will issue the required approvals described above, we believe that we will be able to meet the requirements necessary for obtaining these approvals.
Prior to our acquisition of the four Baran schools, the DOE notified those schools that they did not meet DOE financial responsibility standards and, as a result, must submit letters of credit to the DOE in the amount of $2.0 million and be placed on heightened cash monitoring 1 status. The required letters of credit have been submitted to the DOE and have an expiration date of December 31, 2009. Prior to our acquisition of the ASN school, ABHES directed the school to show cause why its accreditation should not be withdrawn based upon a visit to the school's branch campus in St. Petersburg, Florida. The school is required to submit a response to ABHES by April 1, 2009 and will have a subsequent opportunity to appear before an ABHES panel. Subsequent to our acquisition of the school, we have engaged in a process to respond to the show cause order and to work closely with ABHES to resolve any potential issues.
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Item 1A.
Item 1A.
RISK FACTORS
The following risk factors and other information included in this Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe are not material may also adversely affect our business, financial condition, operating results, cash flows and prospects.
RISKS RELATED TO OUR INDUSTRY
Failure of our schools to comply with the extensive regulatory requirements for school operations could result in financial penalties, restrictions on our operations and loss of external financial aid funding, which could affect our revenues and impose significant operating restrictions on us.
Our schools are subject to extensive regulation by federal and state governmental agencies and by accrediting commissions. In particular, the Higher Education Act of 1965, as amended, and the regulations promulgated thereunder by the DOE, set forth numerous standards that our schools must satisfy to participate in various federal student financial assistance programs under Title IV Programs. In 2008, we derived approximately 79% of our revenues, calculated based on cash receipts, from Title IV Programs. To participate in Title IV Programs, each of our schools must receive and maintain authorization by the applicable education agencies in the state in which each school is physically located, be accredited by an accrediting commission recognized by the DOE and be certified as an eligible institution by the DOE. These regulatory requirements cover the vast majority of our operations, including our educational programs, facilities, instructional and administrative staff, administrative procedures, marketing, recruiting, student performances and outcomes, financial operations and financial condition. These regulatory requirements also affect our ability to acquire or open additional schools, add new educational programs, expand existing educational programs, and change our corporate structure and ownership.
If any of our schools fails to comply with applicable regulatory requirements, the school and its related main campus and/or additional locations could be subject to the loss of state licensure or accreditation, the loss of eligibility to participate in and receive funds under the Title IV Programs, the loss of the ability to grant degrees, diplomas and certificates, provisional certification, or the imposition of liabilities or monetary penalties, each of which could adversely affect our revenues and impose significant operating restrictions upon us. In addition, the loss by any of our schools of its accreditation, its state authorization or license, or its eligibility to participate in Title IV Programs constitutes an event of default under our credit agreement, which we and our subsidiaries entered into with a syndicate of banks on February 15, 2005. An event of default on our credit agreement could result in the acceleration of all amounts then outstanding under our credit agreement. The various regulatory agencies periodically revise their requirements and modify their interpretations of existing requirements and restrictions. We cannot predict with certainty how any of these regulatory requirements will be applied or whether each of our schools will be able to comply with these requirements or any additional requirements instituted in the future.
If we or our eligible institutions do not meet the financial responsibility standards prescribed by the DOE, as has occurred in the past, we may be required to post letters of credit or our eligibility to participate in Title IV Programs could be terminated or limited, which could significantly reduce our student population and revenues.
To participate in Title IV Programs, an eligible institution must satisfy specific measures of financial responsibility prescribed by the DOE or post a letter of credit in favor of the DOE and possibly accept other conditions on its participation in Title IV Programs. Any obligation to post one or more letters of credit would increase our costs of regulatory compliance. Our inability to obtain a required letter of credit or limitations on, or termination of, our participation in Title IV Programs could limit our students' access to various government-sponsored student financial aid programs, which could significantly reduce our student population and revenues.
Each year, based on the financial information submitted by an eligible institution that participates in Title IV Programs, the DOE calculates three financial ratios for the institution: an equity ratio, a primary reserve ratio and a net income ratio. Each of these ratios is scored separately and then combined into a composite score to measure the institution's financial responsibility. If the composite score for an institution falls below thresholds established by the DOE, the DOE could place the institution on provisional certification and/or transfer the institution to the reimbursement or cash monitoring system of receiving Title IV Program funds, under which an institution must disburse its own funds to students and document the student's eligibility for Title IV Program funds before receiving such funds from the DOE. If an institution has a composite score between 1.0 and 1.4, the institution will be required to operate under "Heightened Cash Monitoring, Type 1 status." If an institution's composite score is below 1.0, the institution is considered by the DOE to lack financial responsibility and, as a condition of Title IV Program participation, the institution may be required to, among other things, post a letter of credit in an amount of at least 10 to 50 percent of the institution's annual Title IV Program participation for its most recent fiscal year.
Based on our calculations, the 2008 and 2007 financial statements reflect a composite score of 1.8 for each year. However, because our composite scores for 2001 and 2002 were below 1.0 all of our institutions were placed on “Heightened Cash Monitoring, Type 1 status” from December 30, 2004 through December 30, 2007. If we revert to this status in the future or fail to comply with applicable DOE requirements, we may lose our eligibility for continued participation in Title IV Programs or may be required to post irrevocable letters of credit. In addition, a composite score under 1.0 in any future year could have an adverse effect on our operations and would result in a default under our credit agreement and could result in an acceleration of the debt under our credit agreement.
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If we fail to demonstrate "administrative capability" to the DOE, our business could suffer.
DOE regulations specify extensive criteria an institution must satisfy to establish that it has the requisite "administrative capability" to participate in Title IV Programs. These criteria require, among other things, that the institution:
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Comply with all applicable Title IV regulations;
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Have capable and sufficient personnel to administer Title IV Programs;
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Has adequate checks and balance in its system of internal controls;
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Divides the function of authorizing and disbursing or delivering Title IV Program Funds so that no office has the responsibility for both functions;
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Establishes and maintains records required under the Title IV regulations;
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Develops and applies an adequate system to identify and resolve discrepancies in information from sources regarding a student’s application for financial aid under Title IV;
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Have acceptable methods of defining and measuring the satisfactory academic progress of its students;
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Provide financial aid counseling to its students; and
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Submit in a timely manner all reports and financial statements required by the regulations.
If an institution fails to satisfy any of these criteria or any other DOE regulation, the DOE may:
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Require the repayment of Title IV funds;
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Impose a less favorable payment system for the institution's receipt of Title IV funds;
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Place the institution on provisional certification status; or
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Commence a proceeding to impose a fine or to limit, suspend or terminate the participation of the institution in Title IV Programs.
If we are found not to have satisfied the DOE's "administrative capability" requirements, one or more of our institutions, including its additional locations, could be limited in its access to, or lose, Title IV Program funding. A decrease in Title IV funding could adversely affect our revenues, as we received approximately 79% of our revenues (calculated based on cash receipts) from Title IV Programs in 2008.
We are subject to fines and other sanctions if we pay impermissible commissions, bonuses or other incentive payments to individuals involved in certain recruiting, admissions or financial aid activities, which could increase our cost of regulatory compliance and adversely affect our results of operations.
A school participating in Title IV Programs may not provide any commission, bonus or other incentive payment based on directly or indirectly on success in enrolling students or securing financial aid to any person involved in any student recruiting or admission activities or in making decisions regarding the awarding of Title IV Program funds. The law and regulations governing this requirement do not establish clear criteria for compliance in all circumstances. If we are found to have violated this law, we could be fined or otherwise sanctioned by the DOE or we could face litigation filed under the qui tam provisions of the Federal False Claims Act.
If we were involved in conflicts of interest with student loan lenders, we could be subject to penalties and otherwise suffer adverse impacts on our business.
In 2007, the New York Attorney General, several other attorneys-general, the United States Senate and House of Representatives Education Committees, and the DOE all launched investigations of potential conflicts of interest between university officials and various private lending organizations that provide student loans. Several universities and lending organizations have agreed to pay fines to settle claims in this regard. In addition, several financial aid officials at other universities have been suspended or placed on leaves of absence. While no allegations have been raised concerning our institutions, we received general requests for information from the offices of two state attorneys-general. We have no reason to believe that any of our employees have engaged in improper conduct in this regard. If any such impropriety were found, we could be subject to penalties and other adverse consequences.
If our schools do not maintain their state authorizations and their accreditation, they may not participate in Title IV Programs, which could adversely affect our student population and revenues.
An institution that grants degrees, diplomas or certificates must be authorized by the appropriate education agency of the state in which it is located and, in some cases, other states. Requirements for authorization vary substantially among states. The school must be authorized by each state in which it is physically located in order for its students to be eligible for funding under Title IV Programs. Loss of state authorization by any of our schools from the education agency of the state in which the school is located would end that school's eligibility to participate in Title IV Programs and could cause us to close the school.
A school must be accredited by an accrediting commission recognized by the DOE in order to participate in Title IV Programs. Accreditation is a non-governmental process through which an institution submits to qualitative review by an organization of peer institutions, based on the standards of the accrediting agency and the stated aims and purposes of the institution, including achieving and maintaining stringent retention, completion and placement outcomes. Certain states require institutions to maintain accreditation as a condition of continued authorization to grant degrees. The Higher Education Act requires accrediting commissions recognized by the DOE to review and monitor many aspects of an institution's operations and to take appropriate disciplinary action when the institution fails to comply with the accrediting agency's standards. Loss of accreditation by any of our main campuses would result in the termination of eligibility of that school and all of its branch campuses to participate in Title IV Programs and could cause us to close the school and its branches.
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Our institutions would lose eligibility to participate in Title IV Programs if the percentage of their revenues derived from those programs were too high, which could reduce our student population and revenues.
Under the HEA reauthorization, a proprietary institution that derives more than 90% of its total revenue from the Title IV programs for two consecutive fiscal years becomes immediately ineligible to participate in the Title IV programs and may not reapply for eligibility until the end of two fiscal years. An institution with revenues exceeding 90% for a single fiscal year ending after August 14, 2008, will be placed on provisional certification and may be subject to other enforcement measures. Under prior law, an institution would immediately lose its eligibility to participate in Title IV Programs if it derived more than 90% of its revenues (calculated based on cash receipts) from those programs in any fiscal year as calculated in accordance with DOE regulations and would be ineligible to apply to regain its eligibility until the following fiscal year. Based on our calculations, none of our institutions received more than 90% of its revenues in fiscal year 2008, and our institution with the highest percentage received approximately 89.0% of its revenues, from Title IV Programs. If one of our institutions violated the 90/10 Rule and became ineligible to participate in Title IV Programs but continued to disburse Title IV Program funds, the DOE would require the institution to repay all title IV Program funds received by the institution after the effective date of the loss of eligibility. If any of our institutions loses eligibility to participate in Title IV Programs, that loss would cause an event of default under our credit agreement, which could result in the acceleration of any indebtedness then outstanding under our credit agreement, and would also adversely affect our students' access to various government-sponsored student financial aid programs, which could reduce our student population and revenues. These calculations are required to be made based on cash receipts.
Our institutions would lose eligibility to participate in Title IV Programs if their former students defaulted on repayment of their federal student loans in excess of specified levels, which could reduce our student population and revenues.
An institution of higher education, such as each of our institutions, loses its eligibility to participate in some or all Title IV Programs if its former students default on the repayment of their federal student loans in excess of specified levels. If any of our institutions exceeds the official student loan default rates published by the DOE, it will lose eligibility to participate in Title IV Programs. That loss would adversely affect our students' access to various government-sponsored student financial aid programs, which could reduce our student population and revenues.
We are subject to sanctions if we fail to correctly calculate and timely return Title IV Program funds for students who withdraw before completing their educational program, which could increase our cost of regulatory compliance and decrease our profit margin.
An institution participating in Title IV Programs must correctly calculate the amount of unearned Title IV Program funds that have been credited to students who withdraw from their educational programs before completing them and must return those unearned funds in a timely manner, generally within 45 days of the date the institution determines that the student has withdrawn. If the unearned funds are not properly calculated and timely returned, we may have to post a letter of credit in favor of the DOE or may be otherwise sanctioned by the DOE, which could increase our cost of regulatory compliance and adversely affect our results of operations.
If regulators do not approve our acquisition of a school that participates in Title IV Programs, the acquired school would no longer be permitted to participate in Title IV Programs, which could impair our ability to operate the acquired school as planned or to realize the anticipated benefits from the acquisition of that school.
If we acquire a school that participates in Title IV Programs, we must obtain approval from the DOE and applicable state education agencies and accrediting commissions in order for the school to be able to continue operating and participating in Title IV Programs. An acquisition can result in the temporary suspension of the acquired school's participation in Title IV Programs unless we submit to the DOE a timely and materially complete application for recertification and the DOE issues a temporary provisional program participation agreement. If we were unable to timely re-establish the state authorization, accreditation or DOE certification of the acquired school, our ability to operate the acquired school as planned or to realize the anticipated benefits from the acquisition of that school could be impaired. In connection with our acquisitions of New England Technical Institute and, New England Institute of Technology at Palm Beach, we received in each case an executed provisional program participation agreement from the DOE. In connection with our acquisition of Briarwood College, we have received a temporary provisional program participation agreement from the DOE which remains in effect until the DOE completes its review and approval process for the change in ownership.
If regulators do not approve or delay their approval of transactions involving a change of control of our company or any of our schools, our ability to participate in Title IV Programs may be impaired.
If we or any of our schools experience a change of control under the standards of applicable state education agencies, our accrediting commissions or the DOE, we or the affected schools must seek the approval of the relevant regulatory agencies in order for us or the acquired school to maintain required state licensure and accreditation and to participate in Title IV Programs. Transactions or events that constitute a change of control of us include significant acquisitions or dispositions of our common stock (including, pursuant to DOE regulations, sales by a shareholder that owns at least 25% of our total outstanding voting stock and is our largest shareholder, as a result of which sales such shareholder ceases to own at least 25% of our outstanding voting stock or ceases to be our largest shareholder) or significant changes in the composition of our board of directors. Some of these transactions or events may be beyond our control. Our failure to obtain, or a delay in receiving, approval of any change of control from any state in which our schools are located or other states as the case may be, our accrediting commissions or the DOE could impair or result in the termination of our accreditation, state licensure or ability to participate in Title IV Programs. Our failure to obtain, or a delay in obtaining, approval of any change of control from any state in which we do not have a school but in which we recruit students could require us to suspend our recruitment of students in that state until we receive the required approval. The potential adverse effects of a change of control with respect to participation in Title IV Programs could influence future decisions by us and our stockholders regarding the sale, purchase, transfer, issuance or redemption of our stock. In addition, the adverse regulatory effect of a change of control also could discourage bids for shares of our common stock and could have an adverse effect on the market price of shares of our common stock.
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Congress may change the law or reduce funding for Title IV Programs, which could reduce our student population, revenues or profit margin.
Congress periodically revises the Higher Education Act and other laws governing Title IV HEA Programs and annually determines the funding level for each Title IV Program. On August 14, 2008, the Higher Education Opportunity Act, Public Law 110-315 was enacted. The HEA reauthorized the Title IV programs through at least September 30, 2014. Any action by Congress that significantly reduces funding for Title IV Programs or the ability of our schools or students to receive funding through those programs could result in increased administrative costs and decreased profit margin.
In addition, current requirements for student and school participation in Title IV Programs may change or one or more of the present Title IV Programs could be replaced by other programs with materially different student or school eligibility requirements. If we cannot comply with the provisions of the Higher Education Act, as they may be revised, or if the cost of such compliance is excessive, our revenues or profit margin could be adversely affected.
In February 2009, President Obama released a budget blueprint for federal fiscal year 2010 that proposes that all new loans be originated through the Federal Direct Loan Program rather than the FFEL Program. The Proposal has not been passed by Congress and is subject to further amendment. If this proposal were adopted, it could result in our institutions being required to certify loans through the Federal Direct Loan Program rather than through the Federal Family Education Loan Program. Our schools currently participate in the Federal Direct Loan Programs.
Regulatory agencies or third parties may conduct compliance reviews, bring claims or initiate litigation against us. If the results of these reviews or claims are unfavorable to us, our results of operations and financial condition could be adversely affected.
Because we operate in a highly regulated industry, we are subject to compliance reviews and claims of noncompliance and lawsuits by government agencies and third parties. If the results of these reviews or proceedings are unfavorable to us, or if we are unable to defend successfully against third-party lawsuits or claims, we may be required to pay money damages or be subject to fines, limitations on the operations of our business, loss of federal funding, injunctions or other penalties. Even if we adequately address issues raised by an agency review or successfully defend a third-party lawsuit or claim, we may have to divert significant financial and management resources from our ongoing business operations to address issues raised by those reviews or defend those lawsuits or claims. Prior to our acquisition of Briarwood, the American Board of Funeral Service Education (“ABFSE”), the accrediting agency that accredits Briarwood’s Mortuary Sciences program, placed the program on “show cause”. Briarwood submitted a response on January 12, 2009 and hosted a follow-up visit from the agency on February 8-10, 2009. ABFSE has informed us that they intend to review Briarwood’s January response as well as the information obtained from the agency’s February visit at their April 2009 meeting.
RISKS RELATED TO OUR BUSINESS
If we fail to effectively manage our growth, we may incur higher costs and expenses than we anticipate in connection with our growth.
We have experienced a period of significant growth since 1999. Our continued growth has strained and may in the future strain our management, operations, employees or other resources. We will need to continue to assess the adequacy of our staff, controls and procedures to meet the demands of our continued growth. We may not be able to maintain or accelerate our current growth rate, effectively manage our expanding operations or achieve planned growth on a timely or profitable basis. If we are unable to manage our growth effectively while maintaining appropriate internal controls, we may experience operating inefficiencies that likely will increase our expected costs.
We may not be able to successfully integrate acquisitions into our business, which may materially adversely affect our business, financial condition, results of operations and could cause the market value of our common stock to decline.
Since 1999, we have acquired a number of schools and we intend to continue to grow our business through acquisitions and internal expansion of our programs. The anticipated benefits of an acquisition may not be achieved unless we successfully integrate the acquired school or schools into our operations and are able to effectively manage, market and apply our business strategy to any acquired schools. Integration challenges include, among others, regulatory approvals, significant capital expenditures, assumption of known and unknown liabilities and our ability to control costs. The successful integration of future acquisitions may also require substantial attention from our senior management and the senior management of the acquired schools, which could decrease the time that they devote to the day-to-day management of our business. The difficulties of integration may initially be increased by the necessity of integrating personnel with disparate business backgrounds and corporate cultures. Management's focus on the integration of acquired schools and on the application of our business strategy to those schools could interrupt or cause loss of momentum in our other ongoing activities. Our inability to properly manage or support the growth may have a material adverse effect on our business, financial condition, and results of operations and could cause the market value of our common stock to decline.
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Failure on our part to establish and operate additional schools or campuses or effectively identify suitable expansion opportunities could reduce our ability to implement our growth strategy.
As part of our business strategy, we anticipate opening and operating new schools or campuses. Establishing new schools or campuses poses unique challenges and requires us to make investments in management and capital expenditures, incur marketing expenses and devote financial and other resources that are different, and in some cases greater than those required with respect to the operation of acquired schools.
To open a new school or campus, we would be required to obtain appropriate state and accrediting commission approvals, which may be conditioned or delayed in a manner that could significantly affect our growth plans. In addition, to be eligible for federal Title IV Program funding, a new school or campus would have to be certified by the DOE and would require federal authorization and approvals. In the case of entirely separate, freestanding U.S. schools, a minimum of two years' operating history is required to be eligible for Title IV Program funding. We cannot be sure that we will be able to identify suitable expansion opportunities to maintain or accelerate our current growth rate or that we will be able to successfully integrate or profitably operate any new schools or campuses. A failure by us to effectively identify suitable expansion opportunities and to establish and manage the operations of newly established schools or online offerings could slow our growth and make any newly established schools or our online programs unprofitable or more costly to operate than we had planned.
Our success depends in part on our ability to update and expand the content of existing programs and develop new programs in a cost-effective manner and on a timely basis.
Prospective employers of our graduates increasingly demand that their entry-level employees possess appropriate technological skills. These skills are becoming more sophisticated in line with technological advancements in the automotive, diesel, information technology, or IT, skilled trades, healthcare industries and hospitality services. Accordingly, educational programs at our schools must keep pace with those technological advancements. The expansion of our existing programs and the development of new programs may not be accepted by our students, prospective employers or the technical education market. Even if we are able to develop acceptable new programs, we may not be able to introduce these new programs as quickly as our competitors or as quickly as employers demand. If we are unable to adequately respond to changes in market requirements due to financial constraints, unusually rapid technological changes or other factors, our ability to attract and retain students could be impaired, our placement rates could suffer and our revenues could be adversely affected.
In addition, if we are unable to adequately anticipate the requirements of the employers we serve, we may offer programs that do not teach skills useful to prospective employers or students seeking a technical or career-oriented education which could affect our placement rates and our ability to attract and retain students, causing our revenues to be adversely affected.
Risks specific to our schools’ online campuses could have a material adverse effect on our business.
Our schools’ online campuses intend to increase student enrollment, and more resources will be required to support this growth, including additional faculty, admissions, academic, and financial aid personnel. This growth may place a strain on the operational resources of our schools’ online campuses. Our schools’ online campuses’ success depends, in part, on their ability to expand the content of their programs, develop new programs in a cost-effective manner, maintain good standings with their regulators and accreditors, and meet their students’ needs in a timely manner. The expansion of our schools’ online campuses’ existing programs and the development of new programs may not be accepted by their students or the online education market, and new programs could be delayed due to current and future unforeseen regulatory restrictions. The performance and reliability of the program infrastructure at our schools’ online campuses is critical to the reputation of these campuses and the campuses ability to attract and retain students. Any computer system error or failure, or a sudden and significant increase in traffic on our computer networks that host our schools’ online campuses, may result in the unavailability of our schools’ online campuses’ computer networks. Individual, sustained, or repeated occurrences could significantly damage the reputation of our schools’ online campuses and result in a loss of potential or existing students. Additionally, our schools’ online campuses’ computer systems and operations are vulnerable to interruption or malfunction due to events beyond our control, including natural disasters and network and telecommunications failures. Any interruption to our schools’ online campuses’ computer systems or operations could have a material adverse effect on the ability of our schools’ online campuses to attract and retain students.
Our computer networks-either administrative network or those supporting educational programs- may also be vulnerable to unauthorized access, computer hackers, computer viruses, and other security threats. A user who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in our operations. Due to the sensitive nature of the information contained on our networks, such as students’ grades, our networks may be targeted by hackers. As a result, we may be required to expend significant resources to protect against the threat of these security breaches or to alleviate problems caused by these breaches.
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We may not be able to retain our key personnel or hire and retain the personnel we need to sustain and grow our business.
Our success has depended, and will continue to depend, largely on the skills, efforts and motivation of our executive officers who generally have significant experience within the post-secondary education industry. Our success also depends in large part upon our ability to attract and retain highly qualified faculty, school directors, administrators and corporate management. Due to the nature of our business, we face significant competition in the attraction and retention of personnel who possess the skill sets that we seek. In addition, key personnel may leave us and subsequently compete against us. Furthermore, we do not currently carry "key man" life insurance on any of our employees. The loss of the services of any of our key personnel, or our failure to attract and retain other qualified and experienced personnel on acceptable terms, could have an adverse effect on our ability to operate our business efficiently and to execute our growth strategy.
If we are unable to hire, retain and continue to develop and train our employees responsible for student recruitment, the effectiveness of our student recruiting efforts would be adversely affected.
In order to support revenue growth, we need to hire new employees dedicated to student recruitment and retain and continue to develop and train our current student recruitment personnel. Our ability to develop a strong student recruiting team may be affected by a number of factors, including our ability to integrate and motivate our student recruiters; our ability to effectively train our student recruiters; the length of time it takes new student recruiters to become productive; regulatory restrictions on the method of compensating student recruiters; the competition in hiring and retaining student recruiters; and our ability to effectively manage a multi-location educational organization. If we are unable to hire, develop or retain our student recruiters, the effectiveness of our student recruiting efforts would be adversely affected.
Competition could decrease our market share and cause us to lower our tuition rates.
The post-secondary education market is highly competitive. Our schools compete for students and faculty with traditional public and private two-year and four-year colleges and universities and other proprietary schools, many of which have greater financial resources than we do. Some traditional public and private colleges and universities, as well as other private career-oriented schools, offer programs that may be perceived by students to be similar to ours. Most public institutions are able to charge lower tuition than our schools, due in part to government subsidies and other financial resources not available to for-profit schools. Some of our competitors also have substantially greater financial and other resources than we have which may, among other things, allow our competitors to secure strategic relationships with some or all of our existing strategic partners or develop other high profile strategic relationships, or devote more resources to expanding their programs and their school network, or provide greater financing alternatives to their students, all of which could affect the success of our marketing programs. In addition, some of our competitors have a larger network of schools and campuses than we do, enabling them to recruit students more effectively from a wider geographic area. If we are unable to compete effectively with these institutions for students, our student enrollment and revenues will be adversely affected.
We may be required to reduce tuition or increase spending in response to competition in order to retain or attract students or pursue new market opportunities. As a result, our market share, revenues and operating margin may be decreased. We cannot be sure that we will be able to compete successfully against current or future competitors or that the competitive pressures we face will not adversely affect our revenues and profitability.
We may experience business interruptions resulting from natural disasters, inclement weather, transit disruptions, or other events in one or more of the geographic areas in which we operate.
We may experience business interruptions resulting from natural disasters, inclement weather, transit disruptions, or other events in one or more of the geographic areas in which we operate. These events could cause us to close schools - temporarily or permanently - and could affect student recruiting opportunities in those locations, causing enrollment and revenues to decline.
Our financial performance depends in part on our ability to continue to develop awareness and acceptance of our programs among high school graduates and working adults looking to return to school.
The awareness of our programs among high school graduates and working adults looking to return to school is critical to the continued acceptance and growth of our programs. Our inability to continue to develop awareness of our programs could reduce our enrollments and impair our ability to increase our revenues or maintain profitability. The following are some of the factors that could prevent us from successfully marketing our programs:
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Student dissatisfaction with our programs and services;
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Diminished access to high school student populations;
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Our failure to maintain or expand our brand or other factors related to our marketing or advertising practices; and
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Our inability to maintain relationships with automotive, diesel, healthcare, skilled trades and IT, and hospitality services manufacturers and suppliers.
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If students fail to pay their outstanding balances, our profitability will be adversely affected.
We offer a variety of payment plans to help students pay the portion of their education expense not covered by financial aid programs. These balances are unsecured and not guaranteed. As a result of SLM’s tiered discount loan program termination, effective February 18, 2008, our internal gap financing between Title IV and tuition has increased. Although we have reserved for estimated losses related to unpaid student balances, losses in excess of the amounts we have reserved for bad debts will result in a reduction in our profitability.
An increase in interest rates could adversely affect our ability to attract and retain students.
Interest rates have reached historical lows in recent years, creating a favorable borrowing environment for our students. Much of the financing our students receive is tied to floating interest rates. Increases in interest rates result in a corresponding increase in the cost to our existing and prospective students of financing their education which could result in a reduction in the number of students attending our schools and could adversely affect our results of operations and revenues. Higher interest rates could also contribute to higher default rates with respect to our students' repayment of their education loans. Higher default rates may in turn adversely impact our eligibility for Title IV Program participation or the willingness of private lenders to make private loan programs available to students who attend our schools, which could result in a reduction in our student population.
Seasonal and other fluctuations in our results of operations could adversely affect the trading price of our common stock.
Our results of operations fluctuate as a result of seasonal variations in our business, principally due to changes in total student population. Student population varies as a result of new student enrollment, graduations and student attrition. Historically, our schools have had lower student populations in our first and second quarters and we have experienced large class starts in the third and fourth quarters and student attrition in the first half of the year. Our second half growth is largely dependent on a successful recruiting season. Our expenses, however, do not vary significantly over the course of the year with changes in our student population and net revenues. We expect quarterly fluctuations in results of operations to continue as a result of seasonal enrollment patterns. Such patterns may change, however, as a result of acquisitions, new school openings, new program introductions and increased enrollments of adult students. These fluctuations may result in volatility or have an adverse effect on the market price of our common stock.
Our total assets include substantial intangible assets. The write-off of a significant portion of unamortized intangible assets would negatively affect our results of operations.
Our total assets reflect substantial intangible assets. At December 31, 2008, goodwill and identified intangibles, net, represented approximately 35.9% of total assets. Intangible assets consist of goodwill and other identified intangible assets associated with our acquisitions. On at least an annual basis, we assess whether there has been an impairment in the value of goodwill and other intangible assets with indefinite lives. If the carrying value of the tested asset exceeds its estimated fair value, impairment is deemed to have occurred. In this event, the amount is written down to fair value. Under current accounting rules, this would result in a charge to operating earnings. Any determination requiring the write-off of a significant portion of goodwill or unamortized identified intangible assets would negatively affect our results of operations and total capitalization, which could be material. Our annual impairment analysis, performed as of December 31, 2008, did not result in an impairment charge.
We cannot predict our future capital needs, and if we are unable to secure additional financing when needed, our operations and revenues would be adversely affected.
We may need to raise additional capital in the future to fund acquisitions, working capital requirements, expand our markets and program offerings or respond to competitive pressures or perceived opportunities. We cannot be sure that additional financing will be available to us on favorable terms, or at all particularly during times of uncertainty in the financial markets similar to that which is currently being experienced. If adequate funds are not available when required or on acceptable terms, we may be forced to forego attractive acquisition opportunities, cease our operations and, even if we are able to continue our operations, our ability to increase student enrollment and revenues would be adversely affected.
Our schools' failure to comply with environmental laws and regulations governing our activities could result in financial penalties and other costs which could adversely impact our results of operations.
We use hazardous materials at some of our schools and generate small quantities of waste, such as used oil, antifreeze, paint and car batteries. As a result, our schools are subject to a variety of environmental laws and regulations governing, among other things, the use, storage and disposal of solid and hazardous substances and waste, and the clean-up of contamination at our facilities or off-site locations to which we send or have sent waste for disposal. In the event we do not maintain compliance with any of these laws and regulations, or are responsible for a spill or release of hazardous materials, we could incur significant costs for clean-up, damages, and fines or penalties which could adversely impact our results of operations.
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Approximately 25% of our schools are concentrated in the states of New Jersey and Pennsylvania and a change in the general economic or regulatory conditions in these states could increase our costs and have an adverse effect on our revenues.
As of December 31, 2008, we operated 36 campuses in 17 states. Nine of those schools are located in the states of New Jersey and Pennsylvania. As a result of this geographic concentration, any material change in general economic conditions in New Jersey or Pennsylvania could reduce our student enrollment in our schools located in these states and thereby reduce our revenues. In addition, the legislatures in the states of New Jersey and/or Pennsylvania could change the laws in those states or adopt regulations regarding private, for-profit post-secondary coeducation institutions which could place additional burdens on us. If we were unable to comply with any such new legislation, we could be prohibited from operating in those jurisdictions, which could reduce our revenues.
A substantial decrease in student financing options, or a significant increase in financing costs for our students, could have a material adverse affect on our student population, revenues and financial results.
The consumer credit markets in the United States have recently suffered from increases in default rates and foreclosures on mortgages. Adverse market conditions for consumer and federally guaranteed student loans could result in providers of alternative loans reducing the attractiveness and/or decreasing the availability of alternative loans to post-secondary students, including students with low credit scores who would not otherwise be eligible for credit-based alternative loans. Prospective students may find that these increased financing costs make borrowing prohibitively expensive and abandon or delay enrollment in post-secondary education programs. Private lenders could also require that we pay them new or increased fees in order to provide alternative loans to prospective students. If any of these scenarios were to occur, our students’ ability to finance their education could be adversely affected and our student population could decrease, which could have a material adverse effect on our financial condition, results of operations and cash flows.
In 2008, six lenders provided funding to more than 90% of the students at the schools we owned. In addition, the primary guarantors for the Title IV loans of our students are USA Group, a subsidiary of Sallie Mae, and New Jersey Higher Education Assistance Authority, an independent agency of the State of New Jersey. These two agencies currently guarantee a majority of the federally guaranteed student loans made to students enrolled at our schools. There are six other guaranty agencies that guarantee student loans made to students enrolled at our schools. While we believe that other lenders may be willing to make federally guaranteed student loans to our students if loans were no longer available from our current lenders, and that other guaranty agencies would be willing to guarantee loans to our students if any of the current guarantee agencies ceased guaranteeing those loans or reduced the volume of loans they guarantee, we cannot assure you that we would be successful in locating alternative lenders or guarantors. If such alternative lenders or guarantors were not forthcoming, our enrollment and our results of operations could be materially and adversely affected.
In February 2008, Sallie Mae terminated its tiered discount loan program with us. Students who obtained funding through Sallie Mae programs continue to have access to funding either through alternative lenders or through our own internal financing. However, if we opted to no longer provide financing to our students and/or were unable to obtain other alternative loan providers, our student population could decrease, which could have a material adverse effect on our financial condition, results of operations and cash flows.
In addition, any actions by the U.S. Congress that significantly reduce funding for Title IV Programs or the ability of our students to participate in these programs, or establish different or more stringent requirements for our schools to participate in Title IV Programs, could have a material adverse effect on our student population, results of operations and cash flows.
Anti-takeover provisions in our amended and restated certificate of incorporation, our amended and restated bylaws and New Jersey law could discourage a change of control that our stockholders may favor, which could negatively affect our stock price.
Provisions in our amended and restated certificate of incorporation and our amended and restated bylaws and applicable provisions of the New Jersey Business Corporation Act may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our stockholders. These provisions could discourage potential takeover attempts and could adversely affect the market price of our common stock. For example, applicable provisions of the New Jersey Business Corporation Act may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of five years after the person becomes an interested stockholder. Furthermore, our amended and restated certificate of incorporation and amended and restated bylaws:
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Authorize the issuance of blank check preferred stock that could be issued by our board of directors to thwart a takeover attempt;
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Prohibit cumulative voting in the election of directors, which would otherwise allow holders of less than a majority of stock to elect some directors;
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Require super-majority voting to effect amendments to certain provisions of our amended and restated certificate of incorporation;
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Limit who may call special meetings of both the board of directors and stockholders;
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Prohibit stockholder action by non-unanimous written consent and otherwise require all stockholder actions to be taken at a meeting of the stockholders;
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Establish advance notice requirements for nominating candidates for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholders' meetings; and
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Require that vacancies on the board of directors, including newly created directorships, be filled only by a majority vote of directors then in office.
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We can issue shares of preferred stock without shareholder approval, which could adversely affect the rights of common stockholders.
Our amended and restated certificate of incorporation permits us to establish the rights, privileges, preferences and restrictions, including voting rights, of future series of our preferred stock and to issue such stock without approval from our stockholders. The rights of holders of our common stock may suffer as a result of the rights granted to holders of preferred stock that may be issued in the future. In addition, we could issue preferred stock to prevent a change in control of our company, depriving common stockholders of an opportunity to sell their stock at a price in excess of the prevailing market price.
Our principal stockholder owns a large percentage of our voting stock which allows it to control substantially all matters requiring shareholder approval.
Stonington Partners Inc. II, or Stonington, our principal stockholder, directly or indirectly holds approximately 58% of our outstanding shares. Accordingly, it controls us through its ability to determine the outcome of the election of our directors, to amend our certificate of incorporation and bylaws and to take other actions requiring the vote or consent of stockholders, including mergers, going private transactions and other extraordinary transactions, and the terms of any of these transactions. The ownership positions of this stockholder may have the effect of delaying, deterring or preventing a change in control or a change in the composition of our board of directors. In addition, two members of our board of directors are partners of Stonington. As a result, Stonington has an added ability to influence certain matters, such as determining compensation of our executive officers.
A disposition by our principal stockholder of all or a significant portion of its shares of our outstanding stock could impact the market price of our shares and result in a change of control.
In light of the termination provisions of its fund agreement, Stonington, our largest stockholder, is currently considering its options with respect to its investment in us, including selling its shares of our outstanding common stock, in one or more transactions, over the next 12 to 24 months. A sale by Stonington of all or a significant portion of its shares of our outstanding common stock, whether to a single buyer, through open market sales or otherwise, could cause the price of our common stock to decline. Such a sale could also result in a change of control under the standards of the DOE and applicable state education agencies and accrediting commissions. See “Business - Change of Control” and “Risk Factors -- Risks Related to Our Industry.”
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
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ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 2008, we leased all of our facilities, except for our West Palm Beach, Florida campus, our Nashville, Tennessee campus, our Grand Prairie, Texas campus and our Cincinnati (Tri-County) campus, which we own. Four of our facilities (Union, New Jersey; Allentown, Pennsylvania; Philadelphia, Pennsylvania; and Grand Prairie, Texas) were also accounted for by us under a finance lease obligation. We continue to re-evaluate our facilities to maximize our facility utilization and efficiency and to allow us to introduce new programs and attract more students. As of December 31, 2008, all of our existing leases expire between June 2009 and August 2023.
The following table provides information relating to our facilities as of December 31, 2008, including our corporate office:
*Operations at this campus has ceased as of September 30, 2007.
We believe that our facilities are suitable for their present intended purposes.
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ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
In the ordinary conduct of our business, we are subject to periodic lawsuits, investigations and claims, including, but not limited to, claims involving students or graduates and routine employment matters. Although we cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against us, we do not believe that any currently pending legal proceeding to which we are a party will have a material adverse effect on our business, financial condition, results of operation or cash flows.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 2008.
PART II.
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for our Common Stock
Our common stock is quoted on the Nasdaq Global Market under the symbol “LINC”.
The following table sets forth the range of high and low sales prices per share for our common stock, as reported by the Nasdaq Global Market, for the periods indicated:
On March 11, 2009, the last reported sale price of our common stock on the Nasdaq Global Market was $16.79 per share. As of March 11, 2009, based on the information provided by Continental Stock Transfer & Trust Company, there were approximately 18 stockholders of record of our common stock.
Dividend Policy
We have never declared or paid dividends on our common stock and we do not anticipate declaring or paying dividends on our common stock in the foreseeable future. Instead, we currently anticipate that we will retain all of our future earnings, if any, to fund the operation and expansion of our business and to use as working capital and for other general corporate purposes. Our board of directors will determine whether to pay cash dividends in the future based on conditions then existing and the financial responsibility standards prescribed by the DOE, as well as any economic and other conditions that our board of directors may deem relevant. In addition, our ability to declare and pay dividends is subject to certain restrictions under our existing credit agreement.
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Issuer Purchases of Equity Securities
On April 1, 2008, our Board of Directors approved the repurchase of up to 1,000,000 shares of our common stock over the period of one year. The following table outlines repurchases of our common stock during the quarter ended December 31, 2008:
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Stock Performance Graph
This stock performance graph compares the Company’s total cumulative stockholder return on its common stock during the period from June 23, 2005 (the date on which our common stock first traded on the Nasdaq Global Market) through December 31, 2008 with the cumulative return on the Russell 2000 Index and a Peer Issuer Group Index. The peer issuer group consists of the companies identified below, which were selected on the basis of the similar nature of their business. The graph assumes that $100 was invested on June 23, 2005, and any dividends were reinvested on the date on which they were paid.
The information provided under the heading "Stock Performance Graph" shall not be considered "filed" for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent that the Company specifically incorporates it by reference into a filing.
Companies in the Peer Group include Apollo Group, Inc., Corinthian Colleges, Inc., Career Education Corp., DeVry, Inc., ITT Educational Services, Inc., Strayer Education, Inc. and Universal Technical Institute, Inc.
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Securities Authorized for Issuance under Equity Compensation Plans
The Company has various equity compensation plans under which equity securities are authorized for issuance. Information regarding these securities as of December 31, 2008 is as follows:
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ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
SELECTED FINANCIAL INFORMATION
The following table sets forth our selected historical consolidated financial and operating data as of the dates and for the periods indicated. You should read these data together with Item 7
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with the “Selected Financial Data,” “Forward Looking Statements” and the consolidated financial statements and the related notes thereto included elsewhere in this Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Risk Factors,” “Forward Looking Statements” and elsewhere in this Form 10-K.
GENERAL
We are a leading and diversified for-profit provider of career-oriented post-secondary education. We offer recent high school graduates and working adults degree and diploma programs in five areas of study: automotive technology, health sciences, skilled trades, business and information technology and hospitality services. Each area of study is specifically designed to appeal to and meet the educational objectives of our student population, while also satisfying the criteria established by industry and employers. The resulting diversification limits dependence on any one industry for enrollment growth or placement opportunities and broadens potential branches for introducing new programs. As of December 31, 2008, we enrolled 21,667 students at our 36 campuses across 17 states. Our campuses primarily attract students from their local communities and surrounding areas, although our five destination schools attract students from across the United States, and in some cases, from abroad.
From 1999 through December 31, 2008, we increased our geographic footprint and added 18 additional schools through our acquisitions of: Denver Automotive & Diesel College in 2000 (one school), Career Education Institute in 2001 (two schools), Nashville Auto-Diesel College in 2003 (one school), Southwestern College in 2004 (five schools), New England Technical Institute (four schools) in January 2005, Euphoria Institute of Beauty Arts and Sciences (two schools) in December 2005, New England Institute of Technology at Palm Beach, Inc. in May 2006 (two schools) and Briarwood College in December 2008 (one school). Our campuses, a majority of which serve major metropolitan markets, are located throughout the United States. Five of our campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. Our other campuses primarily attract students from their local communities and surrounding areas. All of our schools are nationally accredited and are eligible to participate in federal financial aid programs. In connection with each of our acquisitions of New England Technical Institute, New England Institute of Technology at Palm Beach and Briarwood College, we received an executed provisional program participation agreement in connection with the acquisition, from the DOE.
Our revenues consist primarily of student tuition and fees derived from the programs we offer. Our revenues are reduced by our scholarships granted to our students. We recognize revenues from tuition and one-time fees, such as application fees, ratably over the length of a program, including internships or externships that take place prior to graduation. We also earn revenues from our bookstores, dormitories, cafeterias and contract training services. These non-tuition revenues are recognized upon delivery of goods or as services are performed and represent less than 10% of our revenues.
Tuition varies by school and by program and on average we increase tuition once a year by 2% to 5%. Our ability to raise tuition is influenced by the demand for our programs and by the rate of tuition increase at other post-secondary schools. If historical trends continue, we expect to be able to continue to raise tuition annually at comparable rates.
We have historically enjoyed revenue growth as a result of strategic acquisitions coupled with organic growth. We have enjoyed organic growth every year except for 2006. Our revenues increased 15.0% in 2008 and 5.5% in 2007, over the prior years as we grew from 34 campuses at December 31, 2007 to 36 campuses at December 31, 2008. Our average student population increased from 17,687 for the year ended December 31, 2007 to 20,006 for the year ended December 31, 2008. While we expect to increase our revenues and enrollment in the foreseeable future as a result of both organic growth and strategic acquisitions, we can give no assurance as to our ability to continue to increase our revenues at historical rates and expect our rate of revenue increases to moderate over time as we become a larger and more mature company.
Our operating expenses, while also a function of our revenue growth, contain a high fixed cost component. Our educational services and facilities expenses as a percentage of revenues decreased to 40.7% in 2008 from 42.6% in 2007 and 41.6% in 2006, and selling, general and administrative expenses increased as a percentage of revenue to 49.9% in 2008 from 49.5% in 2007 and 48.7% in 2006. We expect that in the future these expenses will decline slightly as a percentage of revenues as we achieve better operating efficiencies and utilization at our schools.
Our revenues are directly dependent on our average number of students enrolled and the courses in which they are enrolled. Our enrollment is influenced by the number of new students starting, re-entering, graduating and withdrawing from our schools. In addition, our programs range from 14 to 102 weeks and students attend classes for different amounts of time per week depending on the school and program in which they are enrolled. Because we start new students every month, our total student population changes monthly. The number of students enrolling or re-entering our programs each month is driven by the demand for our programs, the effectiveness of our marketing and advertising, the availability of financial aid and other sources of funding, the number of recent high school graduates, the job market and seasonality. Our retention and graduation rates are influenced by the quality and commitment of our teachers and student services personnel, the effectiveness of our programs, the placement rate and success of our graduates and the availability of financial aid. Although similar courses have comparable tuition rates, the tuition rates vary among our numerous programs. As more of our schools receive approval to offer associate degree programs, which are longer than our diploma degree programs, we would expect our average enrollment and the average length of stay of our students to increase.
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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 largest of these programs are Title IV Programs which represented approximately 79% of our cash receipts relating to revenues in 2008.
We extend credit for tuition and fees to many of our students that are in attendance in our campuses. Our credit risk is mitigated through the student’s participation in federally funded financial aid programs unless students withdraw prior to the receipt by us of Title IV funds for those students. Under Title IV programs, the government funds a certain portion of a students’ tuition, with the remainder, referred to as “the gap,” financed by students themselves under private party loans, including credit extended by us. The gap amount has continued to increase over the last several years as we have raised tuition on average for the last several years by 2% to 5% per year, while funds received from Title IV programs have remained constant. Thus, a significant number of students are required to finance amounts that could be as much as $15,000 per year.
We entered into a tiered discount loan program agreement, effective September 1, 2007, with SLM Financial Corporation (“SLM”) to provide up to $16.0 million of private non-recourse loans to qualifying students. Under this agreement, we were required to pay SLM either 20% or 30% of all loans disbursed, depending on each student borrower’s credit score. We were billed at the beginning of each month based on loans disbursed during the prior month. For the year ended December 31, 2008, $0.5 million of loans were disbursed, resulting in a $0.1 million loss on sale of receivables. Loss on sale of receivables is included in selling, general and administrative expenses in our financial statements.
In February 2008, SLM terminated its tiered discount loan program with us. It is our understanding that SLM also terminated its tiered discount loan programs with our peer companies. The College Cost Reduction & Access Act, which was signed into law in September 2007, cut approximately $22 billion in subsidies to federal student lenders and guarantors as an offset to increases in federal financial aid. This resulted in significant changes to the terms that alternative lending providers including SLM were willing to make and resulted in the termination of the tiered discount loan programs described above. As a result of the costs associated with these programs and, in anticipation of additional changes, we concluded that the cost of using the tiered discount loan program was too high and would lead to significant margin erosion over time and that we would be better served by financing the gap between Title IV and tuition internally, while also examining other alternative loan sources.
We believe that SLM’s termination of its tiered discount loan program will continue to have a limited impact on our business. Our current expectations are that students who previously received funding through the program will continue to have access to funding either through alternative lenders or through our own internal financing.
The additional financing that we are providing to students may expose us to greater credit risk and can impact our liquidity. We believe that these risks are however somewhat mitigated due to:
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Annual federal Title IV loan limits, including grants have increased. Title IV funds represented 79% of our 2008 revenue on a cash basis;
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Our internal financing is provided to students only after all other funding resources have been exhausted; thus, by the time this funding is available, students have completed approximately two-thirds of their curriculum and are more likely to graduate;
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Funding for students who interrupt their education is typically covered by Title IV funds as long as they have been properly packaged for financial aid; and
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We have an excellent collection history with our graduates. Historically, 90% of all graduates have repaid their balances in full.
For the year ended December 31, 2008, approximately 79% of our revenue on a cash basis was derived from Title IV funds, approximately 13% was derived from state grants and cash payments made by students, and approximately 4% was funded under third-party private loan programs, which included SLM programs. For the year ended December 31, 2007, approximately 80% of our revenue on a cash basis was derived from Title IV funds approximately 13% was derived from state grants and cash payments made by students, and approximately 7% was funded under third-party private loan programs, which include SLM programs. Of the private loan programs funded during 2007, approximately 4.6% would be considered sub-prime loans. The credit crisis that has impacted the financial markets is expected to have a limited impact on our ability to continue to finance our credit worthy students. There are a number of lenders that will finance the Title IV funds or alternatively we may choose to finance Title IV funds directly with the government under the government’s Direct Loan Program. Additionally, we have several alternative lenders that will provide private party loans to credit worthy students. In addition, commencing in late 2007, we decided to assist students in financing the gap in student tuition for which students are unable to obtain third-party financing. As of December 31, 2008, we had outstanding loan commitments to our students of $24.0 million as compared to $15.7 million at December 31, 2007. Loan commitments, net of interest that would be due on the loans through maturity, were $16.5 million at December 31, 2008 as compared to $10.8 million at December 31, 2007. Assuming that our historical trends continue, we expect that in 2009 our net incremental investment in accounts receivable will not exceed $5.0 million.
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As a result of the above, during 2008 our bad debt expense as a percentage of revenues increased to 5.7% from 5.3% and 4.9%, respectively, in 2007 and 2006.
All institutions participating in Title IV Programs must satisfy specific standards of financial responsibility. The DOE evaluates institutions for compliance with these standards each year, based on the institution’s annual audited financial statements, as well as following a change in ownership resulting in a change of control of the institution.
Based on audited financial statements for the 2008, 2007 and 2006 fiscal years our calculations resulted in a composite score of 1.8, 1.8 and 1.7, respectively.
The operating expenses associated with an existing school do not increase proportionally as the number of students enrolled at the school increases. We categorize our operating expenses as (1) educational services and facilities and (2) selling, general and administrative.
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Major components of educational services and facilities expenses include faculty compensation and benefits, expenses of books and tools, facility rent, maintenance, utilities, depreciation and amortization of property and equipment used in the provision of education services and other costs directly associated with teaching our programs and providing educational services to our students.
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Selling, general and administrative expenses include compensation and benefits of employees who are not directly associated with the provision of educational services (such as executive management and school management, finance and central accounting, legal, human resources and business development), marketing and student enrollment expenses (including compensation and benefits of personnel employed in sales and marketing and student admissions), costs to develop curriculum, costs of professional services, bad debt expense, rent for our corporate headquarters, depreciation and amortization of property and equipment that is not used in the provision of educational services and other costs that are incidental to our operations. All marketing and student enrollment expenses are recognized in the period incurred.
We use advertising to attract a substantial portion of our yearly student enrollment. While we utilize a mix of different advertising mediums, including television, internet and direct mail, we rely heavily on television and internet advertising. The cost of television advertising has been increasing faster than the pace of student tuition increases and the cost of living index. Continued increases in the cost of television advertising may have a material impact on our operating margins.
During the third quarter of 2007, we completed the roll-out of our new student management and reporting system to all of our campuses. We believe that our student management and reporting system will improve services to students and our ability to integrate new schools into our operations, if and when new schools are opened or acquired. The costs associated with the implementation of this new system are included in selling, general and administrative expenses and were approximately $0.6 million and $0.4 million, respectively, for the two years ended December 31, 2007. No additional costs were incurred in 2008.
Costs related to developing and starting-up new facilities are expensed as incurred. Costs related to our start up facility in Queens, New York, which opened March 27, 2006, were approximately $0.9 million for 2006.
DISCONTINUED OPERATIONS
On July 31, 2007, our Board of Directors approved a plan to cease operations at our Plymouth Meeting, Pennsylvania, Norcross, Georgia and Henderson, Nevada campuses. As a result, we reviewed the related goodwill and long-lived assets for possible impairment in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
As of September 30, 2007, all operations had ceased at these campuses and, accordingly, the results of operations of these campuses have been reflected in the accompanying statements of operations as “Discontinued Operations” for all periods presented.
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The results of operations at these three campuses for each of the two year period ended December 31, 2007 were comprised of the following (in thousands):
ACQUISITIONS
Acquisitions have been, and will continue to be, a component of our growth strategy. We have a team of professionals who conduct financial, operational and regulatory due diligence as well as a team that integrates acquisitions with our policies, procedures and systems.
On January 20, 2009, we completed the acquisition of four of the five institutions comprising Baran Institute of Technology, or Baran, for approximately $24.9 million in cash, net of cash acquired, subject to contractual post closing adjustments. Baran consists of five distinct institutions serving approximately 1,900 students and offers associate and diploma programs in the fields of automotive, skilled trades, health sciences and culinary arts. The four institutions we acquired on January 20, 2009 are Baran Institute of Technology, or BIT, Connecticut Culinary Institute, or CCI, Americare School of Nursing, or ASN, and Engine City Technical Institute, or ECTI. We also acquired the membership interests of Hartford Urban Ventures, LLC and certain assets and assumed certain liabilities of Educational Properties, LLC, which provide support services to Baran. We expect to acquire the fifth Baran institution, Clemens College, for an additional $3.0 million in the second quarter of 2009.
On December 1, 2008, we acquired all of the rights, title and interest in the assets of Briarwood College (“BRI”) for approximately $10.5 million, net of cash acquired. Briarwood is regionally accredited by the New England Association of Schools and Colleges, and currently offers two bachelor’s degree programs to approximately 550 students as of December 31, 2008 from Connecticut and surrounding states.
On May 22, 2006, a wholly-owned subsidiary of the Company, acquired all of the outstanding common stock of New England Institute of Technology at Palm Beach, Inc., or FLA, for approximately $40.1 million. The purchase price was $32.9 million, net of cash acquired plus the assumption of a mortgage note for $7.2 million. The FLA purchase price has been allocated to identifiable net assets with the excess of the purchase price over the estimated fair value of the net assets acquired recorded as goodwill.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussions of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or 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 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, fixed assets, goodwill and other intangible assets, income taxes 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. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result from the result derived from the application of our critical accounting policies. 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 consolidated financial statements.
Revenue recognition. Revenues are derived primarily from programs taught at our schools. Tuition revenues 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, 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. 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. Other revenues, such as textbook sales, 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.
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Allowance for uncollectible accounts. Based upon 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 establishing our allowance for uncollectible accounts, we consider, among other things, a student's status (in-school or out-of-school), whether or not additional financial aid funding will be collected from Title IV Programs or other sources, 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 for 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 revenues for the years ended December 31, 2008, 2007 and 2006 was 5.7%, 5.3% and 4.9%, 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 the years ended December 31, 2008, 2007 and 2006 would have resulted in an increase in bad debt expense of $3.8 million, $3.3 million and $3.1 million, respectively.
Because a substantial portion of our revenues 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.
As discussed in “Discontinued Operations” above, as a result of a decision to close three of our campuses we conducted a review of our goodwill as of June 30, 2007. In connection with that review, we recognized a non-cash impairment charge of approximately $2.1 million as of June 30, 2007. Goodwill represents a significant portion of our total assets. As of December 31, 2008, goodwill was approximately $91.5 million, or 34.1%, of our total assets. As of December 31, 2008 and 2007, we tested our goodwill for impairment utilizing a market capitalization approach and determined that we did not have an impairment.
Stock-based compensation. We currently account for stock-based employee compensation arrangements in accordance with the provisions of SFAS No. 123R, “Share Based Payment.” Effective January 1, 2004, we elected to change our accounting policies from the use of the intrinsic value method of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock-Based Compensation" to the fair value-based method of accounting for options as prescribed by SFAS No. 123 “Accounting for Stock-Based Compensation”. As permitted under SFAS No. 148, "Accounting for Stock-Based Compensation-Transitions and Disclosure-an amendment to SFAS Statement No. 123," we elected to retroactively restate all periods presented. Because no market for our common stock existed prior to our initial public offering, our board of directors determined the fair value of our common stock based upon several factors, including our operating performance, forecasted future operating results, and our expected valuation in an initial public offering.
Prior to our initial public offering, we valued the exercise price of options issued to employees using a market based approach. This approach took into consideration the value ascribed to our competitors by the market. In determining the fair value of an option at the time of grant, we reviewed contemporaneous information about our peers, which included a variety of market multiples, including, but not limited to, revenue, EBITDA, net income, historical growth rates and market/industry focus. During 2004, the value we ascribed to stock options granted was based upon our anticipated initial public offering as well as discussions with our investment advisors. Due to the number of peer companies in our sector, we believed using public company comparisons provided a better indication of how the market values companies in the for-profit post secondary education sector.
During 2005, we adopted the provisions of SFAS No. 123R, “Share Based Payment”. The adoption of SFAS No. 123R did not have a material impact on our financial statements.
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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 weighted average fair values of options granted during 2008, 2007, and 2006 were $6.69, $6.78, and $9.68, respectively, using the following weighted average assumptions for grants:
The expected volatility considers the volatility of certain of our competitors’ common stock that has been traded for a period commensurate with the expected life. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate used is based on the published U.S. Treasury yield curve in effect at the time of grant for instruments with a similar life. The dividend yield is 0% as we have never declared or paid dividends on our common stock and we do not anticipate declaring or paying dividends on our common stock in the foreseeable future.
Results of Continuing Operations for the Three Years Ended December 31,
The following table sets forth selected consolidated statements of continuing operations data as a percentage of revenues for each of the periods indicated:
Year Ended December 31, 2008 Compared to Year Ended December 31,
Revenues. Revenues increased by $49.1 million, or 15.0%, to $376.9 million for 2008 from $327.8 million for 2007. Approximately $1.0 million of this increase was a result of our acquisition of Briarwood College (BRI), on December 1, 2008. Excluding BRI, the increase in revenues was primarily attributable to a 13.0% increase in average student population, which increased to 19,983 for the year ended December 31, 2008, from 17,687 for the year ended December 31, 2007. Revenues were also favorably impacted during the year by tuition increases, which averaged from 3.0% to 3.5%, and increases in book and tool sales and interest income collected on student loans, which increased by $0.7 million and $0.8 million, respectively, for the year ended December 2008. Average revenue per student increased 1.5% for the year ended December 31, 2008, from the year ended December 31, 2007, primarily due to tuition increases during the year, offset by a shift in our student population enrolled in lower tuition programs.
Historically, our schools have lower student populations in our first and second quarters and we have experienced large class starts in the third and fourth quarters. Our second half growth is largely dependent on a successful high school recruiting season. We recruit our high school students several months ahead of their scheduled start dates, and thus, while we have visibility on the number of students who have expressed interest in attending our schools, we cannot predict with certainty the actual number of new student starts and its related impact on revenue.
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Educational services and facilities expenses. Our educational services and facilities expenses increased by $14.0 million, or 10.1%, to $153.5 million for the year ended December 31, 2008 from $139.5 million for the year ended December 31, 2007. BRI accounted for $0.5 million or, 0.4%, of this increase. Excluding BRI, the increase in educational services and facilities expenses was primarily due to instructional expenses, and books and tools expenses, which increased by $6.1 million, or 8.4%, and $3.6 million, or 20.9%, respectively, over the prior year. This increase was attributable to a 12.4% increase in student starts for the year ended December 31, 2008 as compared to the prior year and the overall increase in student population and higher tool sales during 2008 compared to 2007. We began 2008 with approximately 1,400 more students than we had on January 1, 2007 and as of December 31, 2008 our population was approximately 3,600 higher than as of December 31, 2007. The remainder of the increase in educational services and facilities expenses was due to facilities expenses, which increased by $3.8 million for the year ended December 31, 2008 over the prior year. This increase was primarily due to an increase in depreciation expense of $2.7 million resulting from higher capital expenditures during 2008 and 2007. The remainder of the increase in facilities expenses was due to higher utilities, rent and repairs and maintenance expenses at our campuses. Capital expenditures in 2008 included the renovation and conversion of our former auto school in Grand Prairie, Texas to a skilled trades school, as well as the opening of our new campus, Aliante, in North Las Vegas, Nevada. Educational services and facilities expenses as a percentage of revenues decreased to 40.7% of revenues for the year ended December 31, 2008 from 42.6% for the year ended December 31, 2007.
Selling, general and administrative expenses. Our selling, general and administrative expenses for the year ended December 31, 2008 were $187.7 million, an increase of $25.3 million, or 15.6%, from $162.4 million for the year ended December 31, 2007. Approximately $0.3 million, or 1.2%, of this increase was attributable to BRI. Excluding BRI, the increase in our selling, general and administrative expenses for the year ended December 31, 2008 was primarily due to a $1.9 million, or 13.4%, increase in student services, a $4.8 million, or 7.4%, increase in sales and marketing and an $18.3 million, or 22.0%, increase in administrative expenses as compared to the prior year.
The increase in student services was primarily due to increases in compensation and benefit expenses attributed to additional financial aid and career services personnel as a result of a larger student population during the year ended December 31, 2008 as compared to the prior year. In addition, we expanded a pilot program, which we began in 2007, to centralize the back office administration of our financial aid department in an effort to improve the effectiveness of our financial aid processing. This resulted in the hiring of additional financial aid representatives during 2008.
The increase in sales and marketing expense was due to (a) annual compensation increases to sales representatives; (b) the hiring of additional sales representatives; and (c) increased call center support for the year ended December 31, 2008 as compared to the prior year. In addition, we increased our marketing investments in an effort to continue to grow our student population.
The increase in administrative expenses was primarily due to (a) a $9.8 million increase in compensation and benefits, resulting from annual compensation increases, including increases in employee bonuses, stock compensation expense and the cost of benefits provided to employees; (b) a $4.2 million increase in bad debt expense; (c) $0.2 million refunded to the U.S. Department of Education resulting from a program review at Southwestern College; (d) a $0.6 million increase in software maintenance expenses resulting from increased software licenses for our student management system; (e) $0.9 million of acquisition costs incurred in 2008 related to our acquisition of Baran in January 2009 in accordance with the transitional guidance to SFAS No. 141; and (f ) $0.9 million of expenses incurred in connection with two registration statements on Form S-3, filed with the SEC during 2008, and other related expenses.
For year ended December 31, 2008, our bad debt expense as a percentage of revenue was 5.7% as compared to 5.3% for the year ended December 31, 2007. This increase was primarily attributable to higher accounts receivable due to an increase of 13.0% in average student population for 2008 as compared to the same period in 2007. The number of days sales outstanding for 2008 decreased to 25.4 days compared to 27.7 days for 2007, primarily due to the timing of the collection of federal funds. Commencing in late 2007, we decided to assist students in financing the gap in student tuition for which students were unable to obtain third-party financing. As of December, 31, 2008, we had outstanding loan commitments to our students of $24.0 million as compared to $15.7 million at December 31, 2007. Loan commitments, net of interest that would be due on the loans through maturity, were $16.5 million at December 31, 2008 as compared to $10.8 million at December 31, 2007. Assuming that our historical trends continue, we expect that in 2009 our net incremental investment in accounts receivable will not exceed $5.0 million.
As a percentage of revenues, selling, general and administrative expenses increased to 49.9% of revenues for 2008 from 49.5% for 2007.
Net interest expense. Our net interest expense for the year ended December 31, 2008 decreased slightly to $2.0 million from $2.2 million for the same period in 2007 due to lower interest rates as well as lower average borrowings outstanding during the year.
Income taxes. Our provision for income taxes for the year ended December 31, 2008 was $13.3 million, or 39.8% of pretax income, compared to $9.9 million, or 41.8% of pretax income for the year ended December 31, 2007. The decrease in our effective tax rate for the year ended December 31, 2008 was primarily attributable to shifts in state taxable income among various states.
Year Ended December 31, 2007 Compared to Year Ended December 31,
Revenues. Revenues increased by $17.1 million, or 5.5%, to $327.8 million for 2007 from $310.6 million for 2006. Approximately $7.4 million of this increase was a result of our acquisition of New England Institute of Technology at Palm Beach, Inc. (FLA), on May 22, 2006. The remainder of the increase was due to tuition increases, which ranged between 2% and 5% annually depending on the program. For the year ended December 31, 2007, our average undergraduate full-time student enrollment increased 1.7% to 17,687 compared to 17,397 for the year ended December 31, 2006. Excluding our acquisition of FLA, our average undergraduate student enrollment decreased by 0.4% to 16,682 from 16,757 in 2006.
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Historically, our schools have lower student populations in our first and second quarters and we have experienced large class starts in the third and fourth quarters. Our second half growth is largely dependent on a successful high school recruiting season. We recruit our high school students several months ahead of their scheduled start dates, and thus, while we have visibility on the number of students who have expressed interest in attending our schools, we cannot predict with certainty the actual number of new student starts and its related impact on revenue.
During 2006, we experienced erosion between the number of students who expressed an interest in attending our schools and enrolled, and those that commenced classes. Many of these prospective students chose immediate employment, rather than pursuing education in the near term. Moreover, we believe the attractive job market further elevated sensitivity levels regarding the affordability of education. As a result of the above, our first half 2007 revenue was negatively impacted by lower student populations at our campuses. This was not offset until the third quarter of 2007 when we experienced a 10.3% increase in student starts due to improved retention of sales representatives, packaging our students for financial aid earlier in the process and by extending our student outreach program.
Educational services and facilities expenses. Our educational services and facilities expenses increased by $10.2 million, or 7.9%, to $139.5 million for 2007 from $129.3 million for 2006. Our acquisition of FLA accounted for $3.0 million or 29.4% of this increase. Excluding FLA, instructional expenses and books and tools expense increased by $1.1 million or 1.7% and $1.8 million or 11.9%, respectively, over the prior year primarily due to increased compensation and benefits expenses and due to higher volumes of sales for books and tools. The remainder of the increase in educational services and facilities expenses was primarily due to facilities expenses which increased $4.3 million over the prior year. Of this amount approximately $3.7 million represents increases in facility costs and $0.6 million represents additional depreciation expense during the year over prior year. The increase in facilities costs is primarily due to a $1.0 million increase in rent expense in 2007 due to our expanded campus facilities at our Rhode Island, Southwestern and Indianapolis campuses. We also experienced increased costs for insurance and real estate taxes, which increased approximately $0.5 million from the prior year, utilities which increased approximately $0.5 million over the prior year and from repairs and maintenance expenses, which increased approximately $1.4 million over the prior year. Approximately $0.8 million of the increase in repairs and maintenance was due to higher than normal repairs and maintenance expenses at one of our schools. Educational services and facilities expenses as a percentage of revenues increased to 42.6% of revenues for 2007 from 41.6% for 2006.
Selling, general and administrative expenses. Our selling, general and administrative expenses for the year ended December 31, 2007 were $162.4 million, an increase of $11.3 million, or 7.5%, from $151.1 million for 2006. Approximately $4.1 million of this increase were attributed to our acquisition of FLA. The remainder of the increase was primarily due to: (a) a $1.0 million or 3.3% increase in sales expense resulting mainly from yearly compensation increases; (b) a $0.6 million or 2.1%, increase in marketing costs as a result of increased advertising expenses associated with student leads and enrollment; and (c) a $5.2 million or 7.0% increase in administrative expenses, over the prior year.
The increase in marketing expenses during 2007 included a shift from television advertising to internet based initiatives and from the re-launching of our website during 2007. These initiatives increased student leads at a lower cost per lead. Included in administrative expenses during 2007 are an upfront one time non-cash charge of $0.5 million incurred in connection with the termination of certain lease agreements and a $0.6 million charge incurred in connection with severance payments related to the separation of employment of two executives. The remainder of the increase in administrative expenses was attributable to a higher provision for bad debts in 2007 as compared to 2006. Bad debt expense, excluding FLA in 2007 increased by $1.8 million from $14.9 million in 2006 to $16.7 million for the year ended December 31, 2007. This increase was due to higher accounts receivable balances throughout the year as compared to prior year, resulting from increased loans to our students. The remainder of the increase in administrative expenses is due to yearly compensation increases to existing personnel and higher benefit costs during the year.
As a percentage of revenue, selling, general and administrative expenses increased to 49.5% of revenues for 2007 from 48.7% for 2006.
Interest income. Interest income decreased to $0.2 million for the year ended December 31, 2007, a decrease of $0.8 million from interest income of $1.0 million for 2006. The decrease in interest income for the year was due to lower average cash balances during the year as compared to 2006.
Interest expense. Interest expense was essentially flat year over year at $2.3 million, respectively in 2007 and 2006 due to our average borrowings during 2007 remaining relatively flat with 2006.
Income taxes. Our provision for income taxes for the year ended December 31, 2007 was $9.9 million, or 41.8% of pretax income, compared to $12.1 million, or 41.4% of pretax income for the year ended December 31, 2006. The increase in effective tax rate for the year ended December 31, 2007 is attributable to higher state income taxes during the period.
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LIQUIDITY AND CAPITAL RESOURCES
Our primary capital requirements are for facilities expansion and maintenance, acquisitions and the development of new programs. Our principal sources of liquidity have been cash provided by operating activities and borrowings under our credit agreement. The following chart summarizes the principal elements of our cash flow for each of the three years in the period ended December 31, 2008:
As of December 31, 2008, we had cash and cash equivalents of $15.2 million, representing an increase of approximately $11.7 million as compared to $3.5 million as of December 31, 2007. Historically, we have financed our operating activities and organic growth primarily through cash generated from operations. We have financed acquisitions primarily through borrowings under our credit facility and cash generated from operations. During 2008, we borrowed an additional $23.0 million to finance our working capital needs during the first half of the year and repaid $28.0 million outstanding under our credit facility in the second half of the year. We currently anticipate that we will be able to meet both our short-term cash needs, as well as our need to fund operations and meet our obligations beyond the next twelve months with cash generated by operations, existing cash balances and, if necessary, borrowings under our credit facility. On February 18, 2009, we sold common stock in a public offering and received net proceeds of approximately $14.0 million. In addition, we may also consider accessing the financial markets again as a source of liquidity for capital requirements, acquisitions and general corporate purposes to the extent such requirements are not satisfied by cash on hand, borrowings under our credit facility or operating cash flows. However, we cannot assure you that we will be able to raise additional capital on favorable terms, if at all. At December 31, 2008, we had net borrowings available under our $100 million credit agreement of approximately $95.9 million, including a $15.9 million sub-limit on letters of credit. The line of credit matures February 15, 2010.
Our primary source of cash is tuition collected from the 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 largest of these programs are Title IV Programs which represented approximately 79% of our cash receipts relating to revenues in 2008. 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 30-day delay. Our programs range from 14 to 102 weeks. 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 state and federal regulations.
As a result of the significance of the 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 impact on our ability to be able to receive Title IV funds would have a significant impact on our operations and our financial condition.
Operating Activities
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007. Net cash provided by operating activities was $54.2 million for the year ended December 31, 2008 as compared to $15.7 million for the year ended December 31, 2007. The $38.5 million increase in net cash provided by operating activities was driven by an increase in net income of approximately $11.9 million coupled with better collection on accounts receivable as our days sales outstanding decreased from 27.7 to 25.4 due to, among other things, the successful centralization of the back office administration of our financial aid department. Additionally, during the year we were favorably impacted by the timing of cash collections from federal fund programs. The remainder of the increase was due to increases in cash provided by other working capital items.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006. Net cash provided by operating activities increased to $15.7 million for 2007 from $15.3 million for 2006. This increase of $0.4 million was primarily due to a reduction of approximately $5.7 million in cash paid for income taxes during 2007 as compared to 2006 offset by a $3.7 million increase in accounts receivable at December 31, 2007 from December 31, 2006. The remainder of the decrease was primarily due to decreases in cash used for working capital items during the year offset by a decrease in net income during the year. The increase in accounts receivable which represents 27.5 days revenues outstanding for 2007 as compared to 24.3 days revenue outstanding in 2006 is attributable to the increase in loans that we provided to our students. As the gap between the amount of funding provided by Title IV and tuition rates widens, students are finding it increasingly difficult to finance on a short term basis this portion of their tuition. This has resulted in an overall increase in the term of loan programs established to assist students in financing this gap. In an ongoing effort to help those students who are unable to obtain any additional sources of financing, we assist students in financing a portion of their tuition. Students that elect to participate in this financing option currently have up to seven years to repay this obligation, an increase of up to two years from the five year term that we previously offered our students in prior years.
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The increase in loans to our students adversely impacts our accounts receivable, our allowance for doubtful accounts and our cash flow from operations. Although we reserved for estimated losses related to unpaid student balances, losses in excess of the amounts we have reserved for bad debts will result in a reduction in our profitability and can have an adverse impact on the results of our operations.
Investing Activities
Our cash used in investing activities was primarily related to capital expenditures and the acquisition of BRI. Our capital expenditures included facility expansion, leasehold improvements, improvements of classroom, furniture and shop training equipment and student management operation systems. On December 1, 2008 we acquired all the rights, title and interest in the assets of BRI for $10.5 million in cash, net of cash acquired. On May 22, 2006 we acquired all of the outstanding common stock of FLA for $32.9 million in cash and the assumption of a mortgage.
We currently lease a majority of our campuses. We own the new Grand Prairie, Texas campus, the FLA campuses, the Nashville campus and certain buildings in the SWC campuses. As we execute our growth strategy, strategic acquisitions of campuses may be considered. In addition, although our current growth strategy is to continue our organic growth, strategic acquisitions of operations will be considered. To the extent that these potential strategic acquisitions are large enough to require financing beyond available cash from operations and borrowings under our credit facilities, we may incur additional debt or issue additional debt or equity securities.
Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007. Net cash used in investing activities increased $7.4 million to $31.2 million for the year ended December 31, 2008 from $23.8 million for the year ended December 31, 2007. This increase was primarily attributable to a $10.5 million increase in cash used in the acquisition of Briarwood offset by a $4.6 million decrease in capital expenditures due to the timing of payments for the year ended December 31, 2008 from the year ended December 31, 2007.
Year Ended December 31, Compared to the Year Ended December 31, 2006. Net cash used in investing activities decreased $28.4 million to $23.8 million for the year ended December 31, 2007 from $52.2 million for the year ended December 31, 2006. This decrease was primarily attributable to a $32.9 million decrease in cash used in acquisitions offset by a $5.4 million increase in capital expenditures for the year ended December 31, 2007 from the year ended December 31, 2006.
Capital expenditures are expected to increase in 2009 as we upgrade and expand current equipment and facilities and open or expand new facilities to meet increased student enrollment. We anticipate capital expenditures to range from 5% to 6% of revenues in 2009 and expect to fund these capital expenditures with cash generated from operating activities and, if necessary, with borrowings under our credit facility.
Financing Activities
Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007. Net cash used in financing activities was $11.2 million for the year ended December 31, 2008, as compared to net cash provided by financing activities of $5.1 million for the year ended December 31, 2007. This decrease of $16.4 million was attributable to the repayment of debt resulting in a decrease in net borrowings of $10.0 million as compared to 2007 and to repurchases of our common stock for $6.6 million during 2008.
On February 18, 2009, we sold common stock in a public offering and received net proceeds of approximately $14.0 million.
Year Ended December 31, Compared to the Year Ended December 31, 2006. Net cash provided by financing activities was $5.1 million for the year ended December 31, 2007, as compared to net cash used in financing activities of $6.9 million for the year ended December 31, 2006. This increase is due to increased borrowings under our credit facility during 2007 to fund our working capital needs.
On April 1, 2008, our Board of Directors approved the repurchase of up to 1,000,000 shares of our common stock over the period of one year. In 2008, we repurchased 615,000 shares of our common stock for approximately $6.6 million.
On February 15, 2005, we and our subsidiaries entered into a credit agreement with a syndicate of banks, which expires February 15, 2010. This credit agreement provides for a $100 million revolving credit facility with a term of five years under which any outstanding borrowings bear interest at the rate of adjusted LIBOR (as defined in the new credit agreement) plus a margin that may range from 1.00% to 1.75% or a base rate (as defined in the new credit agreement) plus a margin that may range from 0.00% to 0.25%. At December 31, 2008 we had no amounts outstanding under the credit facility. The credit agreement permits the issuance of letters of credit up to an aggregate amount of $20.0 million, the amount of which reduces the availability of permitted borrowings under the credit facility.
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Our obligations and our subsidiaries’ obligations under the credit agreement are secured by a lien on substantially all of our and our subsidiaries’ assets and any assets that we and our subsidiaries may acquire in the future, including a pledge of substantially all of the subsidiaries’ common stock. In addition to paying interest on outstanding principal under the credit agreement, we are required to pay a commitment fee to the lender with respect to the unused amounts available under the credit agreement at a rate equal to 0.25% to 0.40% per year, as defined.
The credit agreement contains various covenants, including a number of financial covenants. Furthermore, the credit agreement contains customary events of default as well as an event of default in the event of the suspension or termination of Title IV Program funding for our and our subsidiaries' schools aggregating 10 % or more of our EBITDA (as defined in the new credit agreement) or our and our subsidiaries' consolidated total assets and such suspension or termination is not cured within a specified period. The following table sets forth our long-term debt for the periods indicated:
We believe that our working capital, cash flow from operations, access to operating leases and borrowings available from our amended credit agreement will provide us with adequate resources for our ongoing operations through 2009 and our currently identified and planned capital expenditures.
Contractual Obligations
Long-Term Debt and Lease Commitments. As of December 31, 2008, our long-term debt consisted of the finance obligation in connection with our sale-leaseback transaction in 2001 and amounts due under capital lease obligations. We lease offices, educational facilities and various equipment for varying periods through the year 2023 at basic annual rentals (excluding taxes, insurance, and other expenses under certain leases).
The following table contains supplemental information regarding our total contractual obligations as of December 31, 2008:
Capital Expenditures. We have entered into commitments to expand or renovate campuses. These commitments are in the range of $3.0 to $5.0 million in the aggregate and are due within the next 12 months. We expect to fund these commitments from cash generated from operations.
OFF-BALANCE SHEET ARRANGEMENTS
We had no off-balance sheet arrangements as of December 31, 2008, except for our letters of credit of $4.1 million which are primarily comprised of letters of credit for the DOE and security deposits in connection with certain of our real estate leases. These off-balance sheet arrangements do not adversely impact our liquidity or capital resources.
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RELATED PARTY TRANSACTIONS
On May 12, 2008, we repurchased from Five Mile River Capital Partners and Steven W. Hart an aggregate 100,000 shares of our common stock for $11.25 per share for a total cost of $1.1 million. Hart Capital LLC is the managing member of Five Mile River Capital Partners LLC, our second largest stockholder. Steven W. Hart is the owner and president of Hart Capital LLC and is a former member of our board of directors. At the time of the transaction Hart Capital beneficially owned, through Five Mile River Capital LLC, 8.3% of our outstanding shares of common stock.
On October 15, 2007, we entered into a Separation and Release Agreement with Lawrence E. Brown, our former Vice Chairman. Under this agreement Mr. Brown’s employment terminated as of the close of business on October 31, 2007. For a period of 14 months following the date of separation of employment, Mr. Brown continued to provide transitional services to us, not to exceed ten hours per month. In consideration for a release of claims, we paid Mr. Brown a lump sum cash payment of $0.5 million and reimbursed Mr. Brown for the employer-portion of the premiums due for continuation of coverage under COBRA through December 31, 2008. Mr. Brown was entitled to the use of his automobile and reimbursement of associated costs by us through December 31, 2008. In addition, pursuant to the terms of the agreement, Mr. Brown agreed to be subject to certain restrictive covenants, which, among other things, prohibited him for the duration of 14 months following the date of separation of employment, from (i) competing against us and (ii) soliciting our or any of our affiliates’ or subsidiaries’ employees, consultants, clients or customers through December 31, 2008.
Pursuant to the Employment Agreement between Shaun E. McAlmont and us, we agreed to pay and reimburse Mr. McAlmont for the reasonable costs of his relocation from Denver, Colorado to West Orange, New Jersey in the year ended December 31, 2006. Such relocation assistance included our purchase of Mr. McAlmont’s home in Denver, Colorado. The $0.5 million price paid for Mr. McAlmont’s home equaled the average of the amount of two independent appraisers selected by us. This amount is reflected in property, equipment and facilities in the accompanying consolidated balance sheets.
SEASONALITY AND TRENDS
Our net revenues and operating results normally fluctuate as a result of seasonal variations in our business, principally due to changes in total student population. Student population varies as a result of new student enrollments, graduations and student attrition. Historically, our schools have had lower student populations in our first and second quarters and we have experienced large class starts in the third and fourth quarters and student attrition in the first half of the year. Our second half growth is largely dependent on a successful high school recruiting season. We recruit our high school students several months ahead of their scheduled start dates, and thus, while we have visibility on the number of students who have expressed interest in attending our schools, we cannot predict with certainty the actual number of new student enrollments and the related impact on revenue. Our expenses, however, do not vary significantly over the course of the year with changes in our student population and net revenues. During the first half of the year, we make significant investments in marketing, staff, programs and facilities to ensure that we meet our second half of the year targets and, as a result, such expenses do not fluctuate significantly on a quarterly basis. To the extent new student enrollments, and related revenues, in the second half of the year fall short of our estimates, our operating results could suffer. We expect quarterly fluctuations in operating results to continue as a result of seasonal enrollment patterns. Such patterns may change as a result of new school openings, new program introductions, and increased enrollments of adult students and/or acquisitions.
Similar to many other for-profit post secondary education companies, the increase in our average undergraduate enrollments in 2007 and 2006 did not meet our anticipated growth rates. As a result of the slowdown in 2005, we entered 2006 with fewer students enrolled than we had in January of 2005. This trend continued throughout 2006 and resulted in a shortfall in the enrollments we were expecting in the second half of 2006 and especially in the third quarter which has accounted for a majority of our yearly starts. As a result we also entered 2007 with fewer students enrolled than we had in January 2006. This trend continued during the first half of 2007 and reversed itself in the latter half of the year as we benefited from the 2007 high school recruiting season. The slowdown that has occurred in the for-profit post secondary education sector appears to have had a greater impact on companies, like ours, that are more dependent on their on-ground business as opposed to on-line students. We believe that this slowdown was attributed to many factors, including: (a) the economy; (b) the availability of student financing; (c) dependency on television to attract students to our school; (d) turnover of our sales representatives; and (e) increasing competition in the marketplace.
As a result of soft organic enrollment trends we experienced, we instituted numerous initiatives and took steps to address and optimize our internal operations. These initiatives coupled with the counter cyclicality of our programs have now produced nine consecutive quarters of positive student start growth and six consecutive quarters of enrollment growth. This has resulted in us entering 2009 with approximately 3,100 more students on a same school basis than we had on January 1, 2008. Because our revenue stream is closely related to our enrollments, we believe that this will result in revenue and net income growth in 2009.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 163, “Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60,” (“SFAS No. 163”). SFAS No. 163 requires that an insurance enterprise recognize a claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. SFAS No. 163 is effective for us as of January 1, 2009. The implementation of this standard had no effect on our consolidated financial statements.
Index
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS No. 162”). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. SFAS No. 162 was effective for us as of November 15, 2008. The implementation of this standard had no effect on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” (“SFAS No. 161”) - an amendment to FASB Statement No. 133. SFAS No. 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. The Statement is effective for us as of January 1, 2009. The adoption of the provision of SFAS No. 161 had no effect on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" (“SFAS No. 141R”). SFAS No. 141R establishes revised principles and requirements for how we will recognize and measure assets and liabilities acquired in a business combination. SFAS No. 141R requires, among other things, transaction costs incurred in a business combination to be expensed, establishes a new measurement date for valuing acquirer shares issued in consideration for a business combination, and requires the recognition of contingent consideration and pre-acquisition gain and loss contingencies. SFAS No. 141R was effective for our business combinations completed on or after January 1, 2009. In accordance with the transition guidance of SFAS No. 141 R, we elected to expense $0.9 million of costs incurred in 2008 related to an acquisition which was completed in 2009.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin (“ARB”) No. 51" (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for us as of January 1, 2009. The adoption of the provision of SFAS No. 160 had no effect on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), providing companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of our choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which they have chosen to use fair value on the face of the balance sheet. SFAS No. 159 became effective for us as of January 1, 2008; however, we did not elect to utilize the option to report selected assets and liabilities at fair value.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). Among other items, SFAS No. 158 requires recognition of the overfunded or underfunded status of an entity’s defined benefit postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit postretirement plan assets and obligations as of the end of the employer’s fiscal year, and requires recognition of the funded status of defined benefit postretirement plans in other comprehensive income. We adopted SFAS No. 158 on December 31, 2006. The incremental effects of applying SFAS No. 158 on our December 31, 2006 consolidated financial statements, on a line by line basis, are as follows:
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. The provisions of SFAS No. 157 were effective for us as of January 1, 2008. The adoption of the provision of SFAS No. 157 had no effect on our consolidated financial statements.
Index
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108 which provides interpretive guidance on how the effects of the carryover or reversal of prior year unrecorded misstatements should be considered in quantifying a current year misstatement. SAB No. 108 became effective for us as of January 1, 2007. The adoption of the provision of SAB No. 108 had no effect on our consolidated financial statements.
In June 2006, FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB SFAS No. 109, “Accounting for Income Taxes”, which was adopted by us on January 1, 2007. FIN No. 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The adoption of FIN No. 48 resulted in a negative cumulative effect adjustment to retained earnings as of January 1, 2007 of approximately $0.1 million.
In March 2006, FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“SFAS No. 156”). SFAS No. 156 provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities, and provides an approach to simplify efforts to obtain hedge accounting treatment. SFAS No. 156 was adopted on January 1, 2007. The adoption of the provision of SFAS No. 156 had no effect on our consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”). SFAS No. 155 is effective beginning January 1, 2007. The adoption of the provision of SFAS No. 155 had no effect on our consolidated financial statements.
Effect of Inflation
Inflation has not had and is not expected to have a significant effect on our operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks as part of our on-going business operations. We have a credit agreement with a syndicate of banks. Our obligations under the credit agreement are secured by a lien on substantially all of our assets and our subsidiaries and any assets that we or our subsidiaries may acquire in the future, including a pledge of substantially all of our subsidiaries’ common stock. Outstanding borrowings bear interest at the rate of adjusted LIBOR plus 1.0% to 1.75%, as defined, or a base rate (as defined in the credit agreement). As of December 31, 2008, we had no amounts outstanding under the credit agreement. We initially funded our acquisition of Baran with borrowings under our credit facility and may incur additional borrowings to fund capital expenditures in 2009.
Based on our outstanding debt balance as of December 31, 2008, a change of one percent in the interest rate would not have caused a change in our interest expense. Changes in interest rates could have an impact however on our operations, which are greatly dependent on students’ ability to obtain financing. Any increase in interest rates could greatly impact our ability to attract students and have an adverse impact on the results of our operations. The remainder of our interest rate risk is associated with miscellaneous capital equipment leases, which are not material.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See “Index to Consolidated Financial Statements” on page on this Form 10-K.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
DISCLOSURE CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Our Chief Executive Officer and Chief Financial Officer, after evaluating, together with management, the effectiveness of our disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)) as of December 31, 2008, have concluded that our disclosure controls and procedures are effective to reasonably ensure that material information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended is recorded, processed, summarized and reported within the time periods specified by Securities and Exchange Commissions’ Rules and Forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Index
Internal Control Over Financial Reporting
During the quarter ended December 31, 2008, there has been no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Annual Report on Internal Control over Financial Reporting
The management of Lincoln Educational Services Corporation (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, management believes that, as of December 31, 2008, the Company’s internal control over financial reporting is effective.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s independent auditors, Deloitte & Touche LLP, an independent registered public accounting firm, audited the Company’s internal control over financial reporting as of December 31, 2008, as stated in their report included in this Form 10-K that follows.
/s/ David F. Carney
David F. Carney
Chairman & Chief Executive Officer
March 12, 2009
/s/ Cesar Ribeiro
Cesar Ribeiro
Chief Financial Officer
March 12, 2009
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
Index
PART III.
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors and Executive Officers
The information required by this item is incorporated herein by reference to our definitive Proxy Statement to be filed in connection with our 2009 Annual Meeting of Shareholders.
Code of Ethics
We have adopted a Code of Conduct and Ethics applicable to our directors, officers and employees and certain other persons, including our Chief Executive Officer and Chief Financial Officer. A copy of our Code of Ethics is available on our website at www.lincolnedu.com. If any amendments to or waivers from the Code of Conduct are made, we will disclose such amendments or waivers on our website.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Information required by Item 11 of Part III is incorporated by reference to our definitive Proxy Statement to be filed in connection with our 2009 Annual Meeting of Shareholders.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information required by Item 12 of Part III is incorporated by reference to our definitive Proxy Statement to be filed in connection with our 2009 Annual Meeting of Shareholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information required by Item 13 of Part III is incorporated by reference to our definitive Proxy Statement to be filed in connection with our 2009 Annual Meeting of Shareholders.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by Item 14 of Part III is incorporated by reference to our definitive Proxy Statement to be filed in connection with our 2009 Annual Meeting of Shareholders.
Index
PART IV.
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
1.
Financial Statements
See “Index to Consolidated Financial Statements” on page of this Form 10-K.
2.
Financial Statement Schedule
See “Index to Consolidated Financial Statements” on page of this Form 10-K.
3.
Exhibits Required by Securities and Exchange Commission Regulation S-K
Index
________________________________________________
(1)
Incorporated by reference to the Company’s Registration Statement on Form S-1 (Registration No. 333-123664).
(2)
Incorporated by reference to the Company’s Form 8-K dated June 28, 2005.
(3)
Incorporated by reference to the Company’s Form 10-K for the year ended December 31, 2006.
(4)
Incorporated by reference to the Company’s Form 8-K dated October 15, 2007.
(5)
Incorporated by reference to the Company’s Form 10-Q for the quarterly period ended March 31, 2006.
(6)
Incorporated by reference to the Company’s Registration Statement on Form S-3 (Registration No. 333-148406).
(7)
Incorporated by reference to the Company’s Form 10-K for the year ended December 31, 2007.
*
Filed herewith.
Index
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 13, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ David F. Carney
Chief Executive Officer and Chairman of the Board
March 13, 2009
David F. Carney
/s/ Cesar Ribeiro
Senior Vice President, Chief Financial Officer and Treasurer (Principal Accounting and Financial Officer)
March 13, 2009
Cesar Ribeiro
/s/ Peter S. Burgess
Director
March 13, 2009
Peter S. Burgess
/s/ James J. Burke, Jr.
Director
March 13, 2009
James J. Burke, Jr.
/s/ Celia H. Currin
Director
March 13, 2009
Celia H. Currin
/s/ Paul E. Glaske
Director
March 13, 2009
Paul E. Glaske
/s/ Charles F. Kalmbach
Director
March 13, 2009
Charles F. Kalmbach
/s/ Alexis P. Michas
Director
March 13, 2009
Alexis P. Michas
/s/ J. Barry Morrow
Director
March 13, 2009
J. Barry Morrow
/s/ Jerry G. Rubenstein
Director
March 13, 2009
Jerry G. Rubenstein
Index
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Index
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Lincoln Educational Services Corporation
West Orange, New Jersey
We have audited the accompanying consolidated balance sheets of Lincoln Educational Services Corporation and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Lincoln Educational Services Corporation and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, the Company adopted the provisions of Financial Accounting Standards Board Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes- an Interpretation of FASB Statement No. 109” on January 1, 2007.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting.
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
March 12,
Index
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Lincoln Educational Services Corporation
West Orange, New Jersey
We have audited the internal control over financial reporting of Lincoln Educational Services Corporation and subsidiaries (the "Company") as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s consolidated balance sheet as of December 31, 2008 and the related consolidated statements of income, changes in stockholders’ equity and cash flow and financial statement schedule for the year ended December 31, 2008, and our report dated March 12, 2009 expressed an unqualified opinion on those financial statements and schedule and included an explanatory paragraph regarding the Company’s adoption of the provisions of Financial Accounting Standards Board Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109” on January 1, 2007.
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
March 12,
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LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
See notes to consolidated financial statements.
Index
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Continued)
See notes to consolidated financial statements.
Index
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
See notes to consolidated financial statements
Index
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands, except share amounts)
See notes to consolidated financial statements.
Index
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Index
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Continued)
See notes to consolidated financial statements.
Index
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2008
(In thousands, except share and per share amounts and unless otherwise stated)
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Activities-Lincoln Educational Services Corporation and Subsidiaries (the "Company") is a diversified provider of career-oriented post-secondary education. The Company offers recent high school graduates and working adults degree and diploma programs in five principal areas of study: Automotive Technology, Health Sciences (which includes programs for licensed practical nursing (LPN), medical administrative assistants, medical assistants, pharmacy technicians, medical coding and billing and dental assisting), Business and Information Technology, Hospitality Services and Skilled Trades. We currently have 36 schools in 17 states across the United States.
Principles of Consolidation-The accompanying consolidated financial statements include the accounts of Lincoln Educational Services Corporation and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.
Revenue Recognition-Revenue is derived primarily from programs taught at the schools. Tuition revenue 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. If a student withdraws from a program prior to a specified date, any paid but unearned tuition is refunded. Other revenues, such as textbook sales, 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. Refunds are calculated and paid in accordance with federal, state and accrediting agency standards.
Other Comprehensive Income- Other comprehensive income was as follows:
Cash and Cash Equivalents-Cash and cash equivalents include all cash balances and highly liquid short-term investments, which mature within three months of purchase.
Restricted Cash- Restricted cash represents amounts received from the federal and state governments under various student aid grant and loan programs. These funds are either received prior to the completion of the authorization and disbursement process for the benefit of the student or immediately prior to that authorization. Restricted funds are held in separate bank accounts. Once the authorization and disbursement process is completed and authorization obtained, the funds are transferred to unrestricted accounts, and these funds then become available for use in the Company’s current operations. As of December 31, 2006, the Company was subject to Heightened Cash Monitoring, Type 1 Status by the DOE, however as of December 30, 2007, the Company was no longer subject to this restriction. Therefore, the Company had no restrictions on cash at December 31, 2007. As of December 31, 2008, restricted cash related to Connecticut State Grants of $0.4 million.
Accounts Receivable-The Company reports accounts receivable at net realizable value, which is equal to the gross receivable less an estimated allowance for uncollectible accounts. Noncurrent accounts receivable represent amounts due from graduates in excess of 12 months from the balance sheet date.
Allowance for uncollectible accounts-Based upon 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 establishing our allowance for uncollectible accounts, we consider, among other things, current and expected econmic conditions, a student's status (in-school or out-of-school), whether or not additional financial aid funding will be collected from Title IV Programs or other sources, 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 for based on our collection history.
Index
Inventories-Inventories consist mainly of textbooks, tools and supplies. Inventories are valued at the lower of cost or market on a first-in, first-out basis.
Property, Equipment and Facilities-Depreciation and Amortization-Property, equipment and facilities are stated at cost. Major renewals and improvements are capitalized, while repairs and maintenance are expensed when incurred. Upon the retirement, sale or other disposition of assets, costs and related accumulated depreciation are eliminated from the accounts and any gain or loss is reflected in operating income. For financial statement purposes, depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the assets, and amortization of leasehold improvements is computed over the lesser of the term of the lease or its estimated useful life.
Rent Expense-Rent expense related to operating leases where scheduled rent increases exist, is determined by expensing the total amount of rent due over the life of the operating lease on a straight-line basis. The difference between the rent paid under the terms of the lease and the rent expensed on a straight-line basis is included in accrued expenses and other long-term liabilities on the accompanying consolidated balance sheets.
Deferred Finance Charges-These charges consist of $0.2 million and $0.3 million as of December 31, 2008 and 2007, respectively, related to the long-term debt and $0.4 million as of December 31, 2008 and 2007, related to the finance obligation. These amounts are being amortized as an increase in interest expense over the respective life of the debt or finance obligation.
Advertising Costs-Costs related to advertising are expensed as incurred and approximated $33.8 million, $31.1 million and $28.9 million for the years ended December 31, 2008, 2007 and 2006, respectively. These amounts are included in selling, general and administrative expenses in the consolidated statement of income.
Bonus costs-The Company accrues the estimated cost of our bonus programs using current financial and statistical information as compared to targeted financial achievements and individual performance objectives. Although we believe our estimated liability recorded for bonuses is reasonable, actual results could differ and require adjustment of the recorded balance.
Goodwill and Other Intangible Assets- The Company tests its 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 the Company determines that an impairment has occurred, it is 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, the Company 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.
As discussed in Note 19, as a result of a decision to close three of our campuses we conducted a review of our goodwill as of June 30, 2007. In connections with that review, we recognized a non-cash impairment charge of approximately $2.1 million as of June 30, 2007. At December 31, 2008 and 2007, the Company tested its goodwill for impairment utilizing a market capitalization approach and determined that it did not have an impairment.
Concentration of Credit Risk-Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and student receivables.
The Company places its cash and cash equivalents with high credit quality financial institutions. The Company's cash balances with financial institutions typically exceed the Federal Deposit Insurance limit of $100,000. The Emergency Economic Stabilization Act of 2008 that was enacted October 3, 2008 temporarily raised the FDIC insurance coverage to the first $250,000 of funds at member banks. This temporary increase is scheduled to expire January 1, 2010. The Company's cash balances on deposit at December 31, 2008, exceeded the balance insured by the FDIC by approximately $12.9 million. The Company has not experienced any losses to date on its invested cash.
The Company extends credit for tuition and fees to many of its students. The credit risk with respect to these accounts receivable is mitigated through the students' participation in federally funded financial aid programs unless students withdraw prior to the receipt of federal funds for those students. In addition, the remaining tuition receivables are primarily comprised of smaller individual amounts due from students.
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With respect to student receivables, the Company had no significant concentrations of credit risk as of December 31, 2008, and 2007.
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, fixed assets, income taxes, benefit plans and certain accruals. Actual results could differ from those estimates.
Stock Based Compensation Plans-The Company accounts for its stock-based compensation plans in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. 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, net of estimated forfeitures, utilizing straight-line amortization of compensation expense over the requisite service period of the grant.
Income Taxes-Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in income in the period that includes the enactment date.
Impairment of Long-Lived Assets-The Company reviews 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. The Company evaluates 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 the Company determines that an asset’s carrying value is impaired, it 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.
As discussed in Note 19, as a result of a decision to close three of our campuses we conducted a review of our long-lived assets as of June 30, 2007. In connections with that review, we recognized a non-cash impairment charge of approximately $0.9 million as of June 30, 2007.
Start-up Costs-Costs related to the start of new campuses are expensed as incurred.
2.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2008, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60,” (“SFAS No. 163”). SFAS No. 163 requires that an insurance enterprise recognize a claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. SFAS No. 163 is effective for the Company as of January 1, 2009. The implementation of this standard had no effect on the Company’s consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS No. 162”). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements. SFAS No. 162 was effective for the Company as of November 15, 2008. The implementation of this standard had no effect on the Company’s consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” (“SFAS No. 161”) - an amendment to FASB Statement No. 133. SFAS No. 161 is intended to improve financial standards for derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity's financial position, financial performance, and cash flows. Entities are required to provide enhanced disclosures about: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The Statement is effective for the Company as of January 1, 2009. The adoption of the provision of SFAS No. 161 had no effect on the Company’s consolidated financial statements.
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In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" (“SFAS No. 141R”). SFAS No. 141R establishes revised principles and requirements for how the Company will recognize and measure assets and liabilities acquired in a business combination. SFAS 141R requires, among other things, transaction costs incurred in a business combination to be expensed, establishes a new measurement date for valuing acquirer shares issued in consideration for a business combination, and requires the recognition of contingent consideration and pre-acquisition gain and loss contingencies. SFAS No. 141R was effective for business combinations completed on or after January 1, 2009. In accordance with the transition guidance of SFAS No. 141R, the Company elected to expense $0.9 million of costs incurred in 2008 related to an acquisition which was completed in 2009.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin (“ARB”) No. 51" (“SFAS No. 160”). SFAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 is effective for the Company as of January 1, 2009. The adoption of the provision of SFAS No. 160R had no effect on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159 “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), providing companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the Company’s choice to use fair value on its earnings. It also requires entities to display the fair value of those assets and liabilities for which they have chosen to use fair value on the face of the balance sheet. SFAS No. 159 became effective for the Company as of January 1, 2008; however, the Company did not elect to utilize the option to report selected assets and liabilities at fair value.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”). Among other items, SFAS No. 158 requires recognition of the overfunded or underfunded status of an entity’s defined benefit postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit postretirement plan assets and obligations as of the end of the employer’s fiscal year, and requires recognition of the funded status of defined benefit postretirement plans in other comprehensive income. The Company adopted SFAS No. 158 on December 31, 2006. The incremental effects of applying SFAS No. 158 on the Company’s December 31, 2006 consolidated financial statements, on a line by line basis, are as follows:
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. The provisions of SFAS No. 157 were effective for the Company as of January 1, 2008. The adoption of the provision of SFAS No. 157 had no effect on the Company’s consolidated financial statements.
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108 which provides interpretive guidance on how the effects of the carryover or reversal of prior year unrecorded misstatements should be considered in quantifying a current year misstatement. SAB No. 108 is effective for the Company as of January 1, 2007. The adoption of the provision of SAB No. 108 had no effect on the Company’s consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB SFAS No. 109, “Accounting for Income Taxes”, which was adopted by the Company on January 1, 2007. FIN No. 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. The adoption of FIN No. 48 resulted in a cumulative effect adjustment to retained earnings as of January 1, 2007 of $0.1 million.
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In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets” (“SFAS No. 156”). SFAS No. 156 provides guidance addressing the recognition and measurement of separately recognized servicing assets and liabilities, common with mortgage securitization activities, and provides an approach to simplify efforts to obtain hedge accounting treatment. SFAS No. 156 was adopted on January 1, 2007. The adoption of the provision of SFAS No. 156 had no effect on the Company’s consolidated financial statements.
In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”). SFAS No. 155 is effective beginning January 1, 2007. The adoption of the provision of SFAS No. 155 had no effect on the Company’s consolidated financial statements.
3. FINANCIAL AID AND REGULATORY COMPLIANCE
Financial Aid
The Company’s schools and students participate in a variety of government-sponsored financial aid programs that assist students in paying the cost of their education. The largest source of such support is the federal programs of student financial assistance under Title IV of the Higher Education Act of 1965, as amended, commonly referred to as the Title IV Programs, which are administered by the U.S. Department of Education (or "DOE"). During the years ended December 31, 2008, 2007 and 2006, approximately 79%, 80% and 80%, respectively, of net revenues were indirectly derived from funds distributed under Title IV Programs.
Regulatory Compliance
To participate in Title IV Programs, a school must be authorized to offer its programs of instruction by relevant state education agencies, be accredited by an accrediting commission recognized by the DOE and be certified as an eligible institution by the DOE. For this reason, the schools are subject to extensive regulatory requirements imposed by all of these entities. After the schools receive the required certifications by the appropriate entities, the schools must demonstrate their compliance with the DOE regulations of the Title IV Programs on an ongoing basis. Included in these regulations is the requirement that the Company must satisfy specific standards of financial responsibility. The DOE evaluates institutions for compliance with these standards each year, based upon the institution’s annual audited financial statements, as well as following a change in ownership of the institution. Under regulations which took effect July 1, 1998, the DOE calculates the institution's composite score for financial responsibility based on its (i) equity ratio, which measures the institution's capital resources, ability to borrow and financial viability; (ii) primary reserve ratio, which measures the institution's ability to support current operations from expendable resources; and (iii) net income ratio, which measures the institution's ability to operate at a profit. This composite score can range from -1 to +3.
An institution that does not meet the DOE's minimum composite score requirements of 1.5 may establish its financial responsibility by posting a letter of credit or complying with additional monitoring procedures as defined by the DOE. Based on audited financial statements for the 2008, 2007 and 2006 fiscal years our calculations result in a composite score of 1.8, 1.8 and 1.7, respectively. Beginning December 30, 2004 and for a period of three years, all of our institutions were placed on "Heightened Cash Monitoring, Type 1 status." As a result, we were subject to a less favorable Title IV fund payment system that required us to credit student accounts before drawing down Title IV funds and also required us to timely notify the DOE with respect to certain enumerated oversight and financial events. The DOE has notified us that, as of December 31, 2007, we are no longer subject to Heightened Cash Monitoring, Type 1 Status.
For the years ended December 31, 2008, 2007 and 2006 the Company was in compliance with the standards established by the DOE requiring that no individual DOE reporting entity can receive more than 90% of its revenue, determined on a cash basis, from Title IV, HEA Program Funds.
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4. WEIGHTED AVERAGE COMMON SHARES
The weighted average numbers of common shares used to compute basic and diluted income per share for the years ended December 31, 2008, 2007 and 2006, respectively, in thousands, were as follows:
For the years ended December 31, 2008, 2007 and 2006, options to acquire 546,708, 608,208 and 288,500 shares, respectively, were excluded from the above table as the result on reported earnings per share would have been antidilutive.
5.
BUSINESS ACQUISITIONS
On December 1, 2008, the Company acquired all of the rights, title and interest in the assets of Briarwood College (“BRI”) for approximately $10.5 million, net of cash acquired. Briarwood is regionally accredited by the New England Association of Schools and Colleges, and currently offers two bachelor’s degree programs to approximately 550 students as of December 31, 2008 from Connecticut and surrounding states. The BRI purchase price has been preliminarily allocated to identifiable net assets with the excess of the purchase price over the estimated fair value of the net assets acquired recorded as goodwill. Accordingly, the allocation may be subject to revisions when the Company receives final information including appraisals, valuations and other analyses.
On May 22, 2006, the Company acquired all of the outstanding common stock of New England Institute of Technology at Palm Beach, Inc. (“FLA”) for approximately $40.1 million. The purchase price was $32.9 million, net of cash acquired plus the assumption of a mortgage note for $7.2 million. The FLA purchase price has been allocated to identifiable net assets with the excess of the purchase price over the estimated fair value of the net assets acquired recorded as goodwill.
The consolidated financial statements include the results of operations from the respective acquisition dates. The purchase price has been allocated to identifiable net assets with the excess of the purchase price over the estimated fair value of the net assets acquired recorded as goodwill. None of the acquisitions were deemed material to the Company’s consolidated financial statements.
The following table summarizes the estimated fair value of assets acquired and liabilities assumed of BRI at the date of acquisition:
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6.
GOODWILL AND OTHER INTANGIBLES
Changes in the carrying amount of goodwill during the years ended December 31, 2008 and 2007 are as follows (in thousands):
As described further in Note 19, during the year ended December 31, 2007, the Company recorded a goodwill impairment charge as a result of its decision to cease operations at three of its campuses.
Identified intangible assets, which are included in other assets in the accompanying consolidated balance sheets, consisted of the following:
The increase in student contracts, accreditation and curriculum assets was due to the acquisition of BRI on December 1, 2008.
Amortization of intangible assets for the years ended December 31, 2008, 2007 and 2006 was approximately $0.1 million, $0.3 million and $0.5 million, respectively.
The following table summarizes the estimated future amortization expense:
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7.
PROPERTY, EQUIPMENT AND FACILITIES
Property, equipment and facilities consist of the following:
Included above in equipment, furniture and fixtures are assets acquired under capital leases as of December 31, 2008 and 2007 of $4.5 million and $6.6 million, respectively, net of accumulated depreciation of $4.1 million and $5.9 million, respectively.
Included above in buildings and improvements is capitalized interest as of December 31, 2008 and 2007 of $0.6 million and $0.5 million, respectively, net of accumulated depreciation of $0.2 million and $0.1 million, respectively.
Depreciation and amortization expense of property, equipment and facilities was $17.2 million, $14.5 million and $13.0 million for the years ended December 31, 2008, 2007 and 2006, respectively.
8.
ACCRUED EXPENSES
Accrued expenses consist of the following:
9. LONG-TERM DEBT AND LEASE OBLIGATIONS
Long-term debt and lease obligations consist of the following:
(a) The Company has a credit agreement with a syndicate of banks which expires February 15, 2010. Under the terms of the agreement, the syndicate provided the Company with a $100 million credit facility. The credit agreement permits the issuance of up to $20 million in letters of credit, the amount of which reduces the availability of permitted borrowings under the agreement. At December 31, 2008, the Company had outstanding letters of credit aggregating $4.1 million which is primarily comprised of letters of credit for the Department of Education and real estate leases.
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The obligations of the Company under the credit agreement are secured by a lien on substantially all of the assets of the Company and its subsidiaries and any assets that it or its subsidiaries may acquire in the future, including a pledge of substantially all of the subsidiaries’ common stock. Outstanding borrowings bear interest at the rate of adjusted LIBOR plus 1.0% to 1.75%, as defined, or a base rate (as defined in the credit agreement). In addition to paying interest on outstanding principal under the credit agreement, the Company and its subsidiaries are required to pay a commitment fee to the lender with respect to the unused amounts available under the credit agreement at a rate equal to 0.25% to 0.40% per year, as defined.
During 2008, the Company borrowed an additional $23.0 million under the credit agreement. During the third quarter of 2008, the Company repaid a total of $28.0 million, leaving no amounts outstanding as of December 31, 2008. Interest rates on the loans outstanding during the year ranged from 3.46% to 7.25%.
During 2007, the Company had borrowed a total of $26.5 million under the current credit agreement. Interest rates on the loans outstanding during the year ranged from 6.32% to 8.25%. During the third quarter of 2007, the Company had repaid a total of $21.5 million on the total debt incurred during the year, leaving $5.0 million outstanding under the credit agreement as of December 31, 2007. The interest rate on the $5.0 million was 7.25% at December 31, 2007.
The credit agreement contains various covenants which, among other things, restricts, subject to certain exceptions, the Company's ability to incur additional indebtedness, pay dividends and make certain acquisitions. Furthermore, the credit agreement contains customary events of default as well as an event of default in the event of the suspension or termination of Title IV Program funding for the Company’s and its subsidiaries' schools aggregating 10% or more of the Company’s EBITDA (as defined) or its consolidated total assets and such suspension or termination is not cured within a specified period. As of December 31, 2008, the Company was in compliance with the financial covenants contained in the credit agreement.
(b) The Company completed a sale and a leaseback of several facilities on December 28, 2001, as discussed further in Note 17. The Company retained a continuing involvement in the lease and as a result it is prohibited from utilizing sale-leaseback accounting. Accordingly, the Company has treated this transaction as a finance lease. Rent payments under this obligation for the three years in the period ended December 31, 2008 were $1.4 million, $1.3 million and $1.3 million, respectively. These payments have been reflected in the accompanying consolidated income statement as interest expense for all periods presented since the effective interest rate on the obligation is greater than the scheduled payments. The lease expiration date is January 25, 2017.
As of December 31, 2008, the Company was in compliance with the financial covenants contained in its borrowing agreements.
Scheduled maturities of long-term debt and lease obligations at December 31, 2008 are as follows:
10.
SLM FINANCIAL CORPORATION LOAN AGREEMENT
The Company entered into a Tiered Discount Loan Program agreement, effective September 1, 2007, with SLM Financial Corporation (“SLM”) to provide up to $16.0 million of private non-recourse loans to qualifying students. Under this agreement, the Company was required to pay SLM either 20% or 30% of all loans disbursed, depending on each student borrower’s credit score. The Company was billed at the beginning of each month based on loans disbursed during the prior month. For the year ended December 31, 2008, $0.5 million of loans were disbursed, resulting in a $0.1 million loss on sale of receivables. Loss on sale of receivables is included in selling, general and administrative expenses in the accompanying statements of income.
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In January 2008, SLM notified the Company that it was terminating its tiered discount loan program, effective February 18, 2008.
11. STOCKHOLDERS' EQUITY
On June 8, 2005, the Company adopted the Lincoln Educational Services Corporation 2005 Long-Term Incentive Plan (the “LTIP”). The LTIP permits the granting of stock options, restricted share units, performance share units, stock appreciation rights and other equity awards, as determined by the Company’s compensation committee. The compensation committee has the authority, among other things, to determine eligibility to receive awards, the type of awards to be granted, the number of shares of stock subject to, or cash amount payable in connection with, the awards and the terms and conditions of each award (including vesting, forfeiture, payment, exercisability and performance periods and targets). The maximum number of shares of our common stock that may be issued for all purposes under the LTIP is 1,000,000 shares plus any shares of common stock remaining available for issuance under the Lincoln Technical Institute Management Stock Option Plan (“2002 Plan”). Any shares of our common stock that (i) correspond to awards under the LTIP or the 2002 Plan that are forfeited or expire for any reason without having been exercised or settled or (ii) are tendered or withheld to pay the exercise price of an award or to satisfy a participant’s tax withholding obligations will be added back to the maximum number of shares available for issuance under the LTIP.
Under the Company’s LTIP, certain employees received restricted stock totaling 200,000 shares, valued at $2.9 million, on October 30, 2007; 80,000 shares, valued at $1.0 million, on February 29, 2008; 8,000 shares, valued at $0.1 million, on May 2, 2008; and 8,000 shares, valued at $0.1 million, on May 5, 2008. As of December 31, 2008, there were a total of 296,000 restricted shares awarded and 40,000 shares vested under the LTIP. The restricted shares vest ratably on the first through fifth anniversary of the grant date; however, there is no vesting period on the right to vote or the right to receive dividends on these restricted shares. The recognized restricted stock expense for the years ended December 31, 2008 and 2007 was $0.8 million and $0.1 million, respectively. The deferred compensation or unrecognized restricted stock expense under the LTIP as of December 31, 2008 and 2007 was $3.2 million and $2.8 million, respectively.
Pursuant to the Company’s 2005 Non-Employee Directors Restricted Stock Plan (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 ratably on the first through third anniversary of the grant date; however, there is no vesting period on the right to vote or the right to receive dividends on these restricted shares. As of December 31, 2008, there were a total of 84,954 shares awarded and 37,772 shares vested under the Non-Employee Directors Plan. The recognized restricted stock expense for the years ended December 31, 2008, 2007 and 2006 was $0.3 million, respectively. The deferred compensation or unrecognized restricted stock expense under the Non-Employee Directors Plan as of December 31, 2008 and 2007 was $0.4 million, respectively.
On April 1, 2008, the Company’s Board of Directors approved the repurchase of up to 1,000,000 shares of its common stock over the period of one year. The purchases may be made in the open market or in privately negotiated transactions from time to time as permitted by securities laws and other legal requirements. The timing, manner, price and amount of any repurchases will be determined by the Company in its discretion and will be subject to economic and market conditions, stock price, applicable legal requirements and other factors. The program may be suspended or discontinued at any time. During the year ended December 31, 2008, the Company repurchased 615,000 shares of its common stock for approximately $6.6 million at an average price of $10.70 per share.
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 weighted average fair values of options granted during 2008, 2007, and 2006 were $6.69, $6.78, and $9.68, respectively, using the following weighted average assumptions for grants:
The expected volatility considers the volatility of certain of our competitors' common stock that has been traded for a period commensurate with the expected life. The expected term of options granted represents the period of time that options granted are expected to be outstanding. The risk-free rate used is based on the published U.S. Treasury yield curve in effect at the time of grant for instruments with a similar life. The dividend yield is 0% as the Company has never declared or paid dividends on our common stock and we do not anticipate declaring or paying dividends on our common stock in the foreseeable future.
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The following is a summary of transactions pertaining to the option plans:
As of December 31, 2008, we estimate that unrecognized pre-tax compensation expense for all unvested stock option awards, in the amount of approximately $1.1 million which will be expensed over the weighted-average period of approximately 1.2 years. In 2009, 174,333 shares are expected to vest.
The following table presents a summary of options outstanding at December 31, 2008:
12.
PENSION PLAN
The Company sponsors a noncontributory defined benefit pension plan covering substantially all of the Company's union employees. Benefits are provided based on employees' years of service and earnings. This plan was frozen on December 31, 1994 for non-union employees.
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The following table sets forth the plan's funded status and amounts recognized in the consolidated financial statements:
Amounts recognized in the consolidated balance sheets consist of:
Amounts recognized in accumulated other comprehensive loss consist of:
The accumulated benefit obligation was $14.8 million and $13.9 million at December 31, 2008 and 2007, respectively.
The following table provides the components of net periodic cost/(income) for the plan:
The estimated net loss, transition obligation and prior service cost for the plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next year are ($0.8) million, $0 million and $0 million.
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Fair value of total plan assets by major asset category as of December 31:
Weighted-average assumptions used to determine benefit obligations as of December 31:
Weighted-average assumptions used to determine net periodic pension cost for years ended December 31:
As this plan was frozen to non-union employees on December 31, 1994, the difference between the benefit obligation and accumulated benefit obligation is not significant in any year.
The Company invests plan assets based on a total return on investment approach, pursuant to which the plan assets include a diversified blend of equity and fixed income investments toward a goal of maximizing the long-term rate of return without assuming an unreasonable level of investment risk. The Company determines the level of risk based on an analysis of plan liabilities, the extent to which the value of the plan assets satisfies the plan liabilities and the plan's financial condition. The investment policy includes target allocations ranging from 30% to 70% for equity investments, 20% to 60% for fixed income investments and 0% to 10% for cash equivalents. The equity portion of the plan assets represents growth and value stocks of small, medium and large companies. The Company measures and monitors the investment risk of the plan assets both on a quarterly basis and annually when the Company assesses plan liabilities.
The Company uses a building block approach to estimate the long-term rate of return on plan assets. This approach is based on the capital markets assumption that the greater the volatility, the greater the return over the long term. An analysis of the historical performance of equity and fixed income investments, together with current market factors such as the inflation and interest rates, are used to help make the assumptions necessary to estimate a long-term rate of return on plan assets. Once this estimate is made, the Company reviews the portfolio of plan assets and makes adjustments thereto that the Company believes are necessary to reflect a diversified blend of equity and fixed income investments that is capable of achieving the estimated long-term rate of return without assuming an unreasonable level of investment risk. The Company also compares the portfolio of plan assets to those of other pension plans to help assess the suitability and appropriateness of the plan's investments.
While the Company does not expect to make any contributions to the plan in 2009, after considering the funded status of the plan, movements in the discount rate, investment performance and related tax consequences, the Company may choose to make contributions to the plan in any given year.
The total amount of the Company’s contributions paid under its pension plan was $0 for each of the years ended December 31, 2008 and 2007, respectively. The net periodic benefit expense was $2 thousand for the year ended December 31, 2008. The net periodic benefit income was $64 thousand for the year ended December 31, 2007.
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Information about the expected benefit payments for the plan is as follows:
The Company has a 401(k) defined contribution plan for all eligible employees. Employees may contribute up to 15% of their compensation into the plan. The Company will contribute an additional 30% of the employee's contributed amount on the first 6% of compensation. For the years ended December 31, 2008, 2007 and 2006 the Company's expense for the 401(k) plan amounted to $1.4 million, $1.2 million and $0.9 million, respectively.
13.
INCOME TAXES
Components of the provision for income taxes from continuing operations were as follows:
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The components of the deferred tax assets are as follows:
The difference between the actual tax provision and the tax provision that would result from the use of the Federal statutory rate is as follows:
The Company adopted the FIN No. 48 in 2006. At that time the Company established a liability of $0.1 million. In 2007 and 2008 there have been no adjustments or settlements related to such uncertain tax positions. Accordingly, at December 31, 2008, the Company’s liability remained $0.1 million. The Company believes that it is reasonably possible that the $0.1 million of unrecognized tax benefits associated with FIN No. 48 will be resolved by December 31, 2009.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states. The Company is no longer subject to U.S. federal income tax examinations for years before 2004 and generally, is no longer subject to state and local income tax examinations by tax authorities for years before 2003.
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14. SEGMENT REPORTING
The Company's principal business is providing post-secondary education. Accordingly, the Company's operations aggregate into one reporting segment.
15.
RELATED PARTY TRANSACTIONS
On May 12, 2008, the Company repurchased from Five Mile River Capital Partners and Steven W. Hart an aggregate 100,000 shares of our common stock for $11.25 per share for a total cost of $1.1 million. Hart Capital LLC is the managing member of Five Mile River Capital Partners LLC, our second largest stockholder. Steven W. Hart is the owner and president of Hart Capital LLC and is a former member of our board of directors. At the time of the transaction Hart Capital beneficially owned, through Five Mile River Capital LLC, 8.3% of our outstanding shares of common stock.
On October 15, 2007, the Company entered into a Separation and Release Agreement with Lawrence E. Brown, our former Vice Chairman. Under this agreement Mr. Brown’s employment terminated as of the close of business on October 31, 2007. For a period of 14 months following the date of separation of employment, Mr. Brown continued to provide transitional services to the Company, not to exceed ten hours per month. In consideration for a release of claims, the Company paid Mr. Brown a lump sum cash payment of $0.5 million and reimbursed Mr. Brown for the employer-portion of the premiums due for continuation of coverage under COBRA through December 31, 2008. Mr. Brown was entitled to the use of his automobile and reimbursement of associated costs by us through December 31, 2008. In addition, pursuant to the terms of the agreement, Mr. Brown agreed to be subject to certain restrictive covenants, which, among other things, prohibited him for the duration of 14 months following the date of separation of employment, from (i) competing against the Company and (ii) soliciting the Company or any of our affiliates’ or subsidiaries’ employees, consultants, clients or customers through December 31, 2008.
Pursuant to the Employment Agreement between Shaun E. McAlmont and the Company, the Company agreed to pay and reimburse Mr. McAlmont the reasonable costs of his relocation from Denver, Colorado to West Orange, New Jersey in the year ended December 31, 2006. Such relocation assistance included the purchase by the Company of Mr. McAlmont’s home in Denver, Colorado. The $0.5 million price paid for Mr. McAlmont’s home equaled the average of the amount of two independent appraisers selected by the Company. This amount is reflected in property, equipment and facilities in the accompanying consolidated balance sheets.
16.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
On May 22, 2006, the Company assumed a mortgage note payable with an accompanying interest rate swap (the “SWAP”) as part of the acquisition of the New England Institute of Technology at Palm Beach, Inc. in the amount of $7.2 million. The Company accounted for the interest rate swap agreement in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. Under the swap agreement, the Company paid a fixed rate tied to the one month LIBOR rate until May 1, 2013 and received a variable rate of 6.48%. The SWAP was accounted for as an ineffective hedge as it did not meet the requirements set forth under SFAS No. 133. Accordingly, other income (loss) includes a loss of $0.2 million as of December 31, 2006. The Company repaid the mortgage note in November 2006. As a result the SWAP agreement was terminated in 2006 and the Company received $0.2 million for the fair market value.
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17. COMMITMENTS AND CONTINGENCIES
Lease Commitments-The Company leases office premises, educational facilities and various equipment for varying periods through the year 2023 at basic annual rentals (excluding taxes, insurance, and other expenses under certain leases) as follows:
On December 28, 2001, the Company completed a sale and a leaseback of four owned facilities to a third party for net proceeds of approximately $8.8 million. The initial term of the lease is 15 years with two ten-year extensions. The lease is an operating lease that starts at $1.2 million in the first year and increases annually by the consumer price index. The lease includes an option near the end of the initial lease term to purchase the facilities at fair value, as defined. This transaction is being accounted for as a lease obligation. The net proceeds received have been reflected in the consolidated balance sheet as a finance obligation. The lease payments are included as a component of interest expense.
Rent expense, included in operating expenses in the accompanying financial statements for the three years ended December 31, 2008 is $17.2 million, $16.7 million, and $15.7 million, respectively. Interest expense related to the financing obligation in the accompanying financial statements for the years ended December 31, 2008, 2007 and 2006 is $1.4 million, $1.3 million and $1.3 million, respectively.
Capital Expenditures-The Company has entered into commitments to expand or renovate campuses. These commitments are in the range of $3.0 to $5.0 million in the aggregate and are due within the next 12 months.
Litigation and Regulatory Matters-In the ordinary conduct of our business, we are subject to periodic lawsuits, investigations and claims, including, but not limited to, claims involving students or graduates and routine employment matters. Although we cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against us, we do not believe that any currently pending legal proceeding to which we are a party will have a material adverse effect on our business, financial condition, results of operation or cash flows.
Student Loans-At December 31, 2008, the Company had outstanding net loan commitments to its students to assist them in financing their education of approximately $16.5 million.
Vendor Relationship-On April 1, 2006, the Company entered into an agreement with Snap-on Industrial (“Snap-on”) which expires on March 31, 2011. The Company has agreed to grant Snap-on exclusive rights to our certain automotive campuses to display advertising and to train our students with the exception of one pre-existing vendor contract. The Company earns credits that are redeemable for tools and equipment based on the number of automotive graduates quarterly. In addition, credits are earned on our purchases as well as purchases made by students enrolled in our automotive programs. Snap-on receivable for credits not redeemed for the years ended December 31, 2008 and 2007 was $0.3 million and $0.5 million, respectively.
In October 1, 2005, the Company entered into an agreement with Snap-on exclusively for our Queens, NY campus opened March 27, 2006 which expires on November 30, 2011. We have agreed to grant Snap-on exclusive rights to in school advertising and supplying all student training tools and equipment, as well as our automotive equipment purchases. In exchange, Snap-on agreed to advance tools and equipment needed to build out the school, not to exceed $1.0 million at list price. The equipment advance is offset by credits earned through purchases by the Queens campus and their students. Snap-on liability resulting from advanced equipment received in excess of credits earned for the years ended December 31, 2008 and 2007, was $0.5 million and $0.6 million, respectively.
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Executive Employment Agreements-The Company entered into employment contracts with key executives that provide for continued salary payments if the executives are terminated for reasons other than cause, as defined in the agreements. The future employment contract commitments for such employees were approximately $4.0 million at December 31, 2008.
Change in Control Agreements-In the event of a change of control several key executives will receive continue salary payments based on their employment agreements.
Surety Bonds-Each of our campuses must be authorized by the applicable state education agency in which the campus is located to operate and to grant degrees, diplomas or certificates to its students. The campuses are subject to extensive, ongoing regulation by each of these states. In addition, our campuses are required to be authorized by the applicable state education agencies of certain other states in which our campuses recruit students. The Company is required to post surety bonds on behalf of our campuses and education representatives with multiple states to maintain authorization to conduct our business. At December 31, 2008, we have posted surety bonds in the total amount of approximately $13.7 million.
18. UNAUDITED QUARTERLY FINANCIAL INFORMATION
Quarterly financial information for 2008 and 2007 is as follows (in thousands except per share data):
19. DISCONTINUED OPERATIONS
On July 31, 2007 the Company’s Board of Directors approved a plan to cease operations at the Company’s Plymouth Meeting, Pennsylvania, Norcross, Georgia and Henderson, Nevada campuses. As a result of the above decision, the Company reviewed the related goodwill and long-lived assets for possible impairment in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” and SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
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As of September 30, 2007, all operations had ceased at these campuses and, accordingly, the results of operations of these campuses have been reflected in the accompanying statements of operations as “Discontinued Operations” for all periods presented.
The results of operations at these three campuses for each of the two year period ended December 31, 2007 were comprised of the following (in thousands):
20. SUBSEQUENT EVENTS
On January 20, 2009, the Company completed the acquisition of four of the five institutions comprising Baran Institute of Technology (“Baran”), for approximately $24.9 million in cash, net of cash acquired, subject to contractual post closing adjustments. Baran consists of five distinct institutions serving approximately 1,900 students and offers associate and diploma programs in the fields of automotive, skilled trades, health sciences and culinary arts. The four institutions the Company acquired on January 20, 2009 are Baran Institute of Technology (“BIT”), Connecticut Culinary Institute (“CCI”), Americare School of Nursing (“ASN”), and Engine City Technical Institute (“ECTI”). The Company also acquired the membership interests of Hartford Urban Ventures, LLC and certain assets and assumed certain liabilities of Educational Properties, LLC, which provide support services to Baran. In connection with these acquisitions, the Company recorded a charge of approximately $0.02 per share in the fourth quarter of 2008 and for the year ended December 31, 2008 and we expect to record a charge of approximately $0.01 per share in the first quarter of 2009 to reflect the expenses related to the acquisitions.
On February 18, 2009, we sold common stock in a public offering and received net proceeds of approximately $14.0 million.
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LINCOLN EDUCATIONAL SERVICES CORPORATION
Schedule II-Valuation and Qualifying Accounts
(in thousands)