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

 

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In addition to the current sources of capital discussed above that provide short term liquidity, the Company plans to sell three West Palm Beach, Florida properties and associated assets, which are currently classified as held for sale and are expected to be sold within one year from the date of classification.  On March 14, 2017, the Company entered into a purchase and sale agreement with Tambone Companies, LLC, pursuant to which the Company has agreed to sell two of the three properties (the “West Palm Beach Property”) for a cash purchase price of $15.7 million.  The purchase and sale agreement, as amended, is among other things, subject to customary closing conditions but the Company expects to close on the transaction in the third quarter of 2017.  On April 28, 2017, the Company obtained from its lender, Sterling National Bank, an $8 million bridge term loan secured by the West Palm Beach Property.  The bridge loan must be repaid upon the earlier of the sale of the West Palm Beach Property or October 1, 2017.

 

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The loan is secured by real property assets located in West Palm Beach, Florida at which schools operated by the Company are currently located.  The loan is payable interest only until its maturity, which will occur upon the earlier of October 1, 2017 and the date of the sale of the West Palm Beach, Florida property.  Pursuant to a purchase and sale agreement, as amended, the Company has agreed to sell two of three properties located in West Palm Beach, Florida to Tambone Companies, LLC for a cash purchase price of $15.7 million.  The Company expects this sale to be completed in the third quarter of 2017.

 

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

Our bad debt expense as a percentage of revenue for the three months ended June 30, 2017 and 2016 was 6.6% and 4.8%, respectively.  Our bad debt expense as a percentage of revenue for the six months ended June 30, 2017 and 2016 was 5.7% and 4.7%, respectively.  Our exposure to changes in our bad debt expense could impact our operations.  A 1% increase in our bad debt expense as a percentage of revenues for each of the three months ended June 30, 2017 and 2016 would have resulted in an increase in bad debt expense of $0.6 million and $0.7 million, respectively.  A 1% increase in our bad debt expense as a percentage of revenues for each of the six months ended June 30, 2017 and 2016 would have resulted in an increase in bad debt expense of $1.3 million and $1.4 million, respectively.

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

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

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

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

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

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

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

 

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

 

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

 

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

Effect of Inflation

Inflation has not had a material effect on our operations.

Results of Continuing Operations

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

 

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

Consolidated Results of Operations

Revenue.   Revenue decreased by $6.2 million, or 9.1%, to $61.9 million for the three months ended June 30, 2017 from $68.1 million for the prior year comparable period.  The decrease in revenue is mainly attributable to the suspension of new student starts at campuses in our Transitional segment, which accounted for approximately 93% of the total revenue decline; and a 3.4% decline in average revenue per student in the Healthcare and Other Professions segment due to shifts in program mix combined with tuition rate decreases in various programs.

 

Total student starts decreased by 16.1% to approximately 2,600 from 3,100 for the three months ended June 30, 2017 as compared to the prior year comparable period.  The decrease was largely due to the suspension of new student starts for the Transitional segment which is down 100% as compared to the prior year comparable quarter.   The Transportation and Skilled Trades segment starts were down 9.0% and the Healthcare and Other Professions segment starts were up 2.7% for the three months ended June 30, 2017 as compared to the prior year comparable period.

Starts in the Transportation and Skilled Trades segment were down for the three months ended June 30, 2017 as a result of lower than expected high school start rates.  The shortfall occurred primarily at three campuses and was directly attributable to affordability and sustainability of student engagement between enrollment and start date.  Sustaining student engagement following enrollment, especially when the enrollment occurs months in advance, requires constant contact.  In addition, in striving to find the optimum affordability balance, the Company experienced a start decline in markets where scholarships were scaled back.  Certain external factors that are also driving the softer than expected start rate include low unemployment rates and increased wages for both skilled and unskilled labor.  The Company believes such external factors have caused many potential students to postpone training and enter the workforce directly upon graduation from high school.  Further, contributing to the decline in high school student starts is the lead time between the initial recruitment efforts and the actual start date, which could be up to one year.  High school students comprise approximately 30% of the segment’s population.  In an effort to increase high school enrollments, the Company has made various changes to processes and organizational structure.  As a result, enrollments for the quarter remained essentially flat; however, as noted above starts declined.

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

Educational services and facilities expense.   Our educational services and facilities expense decreased by $3.2 million, or 8.9%, to $32.4 million for the three months ended June 30, 2017 from $35.6 million in the prior year comparable quarter.  This decrease is mainly attributable to the Transitional segment which accounted for $3.1 million in cost reductions as campuses in the segment prepare to close during this fiscal year.

Educational services and facilities expenses, as a percentage of revenue remained essentially flat at 52.4% for the three months ended June 30, 2017 from 52.2% in the prior year comparable period.

Selling, general and administrative expense.    Our selling, general and administrative expense decreased by $0.2 million, or 0.6%, to $35.6 million for the three months ended June 30, 2017 from $35.8 million in the comparable quarter of 2016.  The decrease was primarily due to the Transitional segment, which accounted for approximately $3.2 million in cost reductions as campuses in the segment prepare to close during this fiscal year.  Partially offsetting the cost reductions are $2.0 million in increased administrative costs and $1.3 million in additional sales and marketing expense.

Administrative expense increased primarily due to a $0.9 million increase in bad debt expense as a result of higher student accounts receivable, higher account write-offs, and timing of Title IV funds receipts; and a $1.0 million increase in medical costs as compared to the prior year.  In 2016, the Company had historically low medical claims as compared to medical claims in the current year, resulting in the significant increase quarter over quarter.

Sales and marketing expense increased by $1.3 million, or 10.8%, from strategic marketing initiatives intended to reach more students. These initiatives resulted in a slight improvement in starts in the adult demographic quarter over quarter.

As a percentage of revenues, selling, general and administrative expense increased to 57.5% for the three months ended June 30, 2017 from 52.5% in the comparable prior year period.

Net interest expense. For the three months ended June 30, 2017 net interest expense decreased by $0.8 million, or 55% to $0.7 million from $1.5 million in the prior year comparable period.  The cost reductions resulted from favorable terms under our new Credit Facility with Sterling National Bank effective on March 31, 2017.

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

Income taxes.    Our provision for income taxes was $0.1 million, or 0.7% of pretax loss, for the three months ended June 30, 2017, compared to $0.1 million, or 1.6% of pretax loss, in the prior year comparable period. No federal or state income tax benefit was recognized for the current period loss due to the recognition of a full valuation allowance.  Income tax expense resulted from various minimal state tax expenses.

 

Six Months Ended June 30, 2017 Compared to Six Months Ended June 30, 2016

Consolidated Results of Operations

 

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

Educational services and facilities expense.   Our educational services and facilities expense decreased by $7.6 million, or 10.4%, to $65.1 million for the six months ended June 30, 2017 from $72.7 million in the prior year comparable period.  This decrease is mainly attributable to the Transitional segment which accounted for $7.1 million in cost reductions as campuses in the segment prepare to close during this fiscal year.

Educational services and facilities expenses, as a percentage of revenue decreased to 51.2% for the six months ended June 30, 2017 from 52.4% in the prior year comparable period.

Selling, general and administrative expense.    Our selling, general and administrative expense decreased by $2.0 million, or 2.7%, to $73.9 million for the six months ended June 30, 2017 from $75.9 million in the comparable period of 2016.  The decrease was primarily due to the Transitional segment, which accounted for approximately $6.6 million in cost reductions as campuses in the segment prepare to close during this fiscal year.  Partially offsetting these costs reductions are $2.3 million in increased administrative expense; and $2.6 million in additional sales and marketing expense.

As of June 30, 2017, we had total outstanding loan commitments to our students of $42.2 million, as compared to $40.0 million at December 31, 2016.  Loan commitments, net of interest that would be due on the loans through maturity, were $31.4 million at June 30, 2017, as compared to $30.0 million at December 31, 2016.  The increase in loan commitments was due in part to the seasonality of the Company’s operations.  Students that miss the fall enrollments in the third and fourth quarter typically start in the first and second quarter of the new year.  Students requiring additional subsidy for tuition increased 6.1% to approximately 6,200 for the six months ended June 30, 2017 as compared to approximately 5,900 for the year ended December 31, 2016.

Gain on sale of assets.  Gain on sale of fixed assets decreased by $0.3 million for the six months ended June 30, 2017 primarily as a result of the sale of certain of the Company’s assets during the six months ended June 30, 2016.

Net interest expense. For the six months ended June 30, 2017 net interest expense increased by 2.8 million, or 91% to $5.8 million from $3.1 million in the prior year comparable period.  The increase was mainly attributable to a $2.2 million non-cash write-off of previously capitalized deferred financing fees; and $1.7 million of additional costs relating to the early retirement of our previous term loan.  These costs were incurred at March 31, 2017 when the Company entered into a new revolving credit facility with Sterling National Bank.

Other Income.  For the six months ended June 30, 2017 other income decreased by $3.4 million from the prior year comparable period.  The $3.4 million in 2016 reflected the amortization of a one-time gain from the modification of a lease at three of the Company’s campuses which were previously accounted for as finance obligations in the prior year.

Income taxes.    Our provision for income taxes was $0.1 million, or 0.6% of pretax loss, for the three months ended June 30, 2017, compared to $0.1 million, or 1.1% of pretax loss, in the prior year comparable period. No federal or state income tax benefit was recognized for the current period loss due to the recognition of a full valuation allowance.  Income tax expense resulted from various minimal state tax expenses.

 

 

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

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

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

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

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

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

 

Transitional – Transitional refers to operations that are being phased out or closed and consists of our campuses that are currently being taught out.  These schools are employing a gradual teach-out process that enables the schools to continue to operate while current students complete their course of study.  These schools are no longer enrolling new students.  In addition, in March 2017, the Board of Directors of the Company approved a plan to cease operations at our schools in Brockton, Massachusetts and Lowell, Massachusetts.  These schools are being taught out and expected to be closed in December 2017.  During the year ended December 31, 2016, the Company announced the closing of our Northeast Philadelphia, Pennsylvania, Center City Philadelphia, Pennsylvania and West Palm Beach, Florida facilities.  These schools are expected to be fully taught out on August 31, 2017, August 31, 2017, and September 30, 2017, respectively.  In the first quarter of 2016, we completed the teach-out of our Fern Park, Florida campus.   In addition, in the fourth quarter of 2016, we completed the teach-out of our Hartford, Connecticut and Henderson (Green Valley), Nevada campuses.

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

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

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

 

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

Student start results decreased by 9.0% to 1,762 from 1,936 for the three months ended June 30, 2017 as compared to the prior year comparable period.    This decrease was a result of lower than expected start rates for high school students.  The majority of the decline occurred at three campuses and was directly attributable to affordability and sustainability of student engagement between enrollment and start date.  In addition, in striving to find the optimum affordability balance the Company experienced a start decline in markets where scholarships were scaled back.  External factors including low unemployment rates and increased wages for both skilled and unskilled labor also contributed to the decline in student starts.

 

Operating income decreased by $1.6 million, or 65.0%, to $0.9 million from $2.4 million in the prior year comparable period mainly driven by the following factors:

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Revenue increased by $0.3 million, or 0.7% to $41.3 million for the three months ended June 30, 2017 from $41.0 million in the prior year comparable period.  The increase in revenue was primarily driven by higher carry in population compared to the prior year comparable period.

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Educational services and facilities expense remained essentially flat only increasing by $0.1 million quarter over quarter.  This increase is primarily attributable to increased costs associated with materials used for instructional purposes.

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Selling, general and administrative expenses increased by $1.8 million due to $0.9 million of additional bad debt expense primarily the result of higher student accounts receivable, higher account write-offs, and timing of Title IV fund receipts.    In addition, sales and marketing expense increased by $0.7 million resulting from strategic marketing initiatives intended to reach more students.  These initiatives resulted in a slight improvement in starts in the adult demographic quarter over quarter.

 

Student start results increased by 2.7% to 842 from 820 for the three months ended June 30, 2017 as compared to the prior year comparable period.

Operating loss for the three months ended June 30, 2017 was $0.6 million compared to operating income of $0.9 million in the prior year comparable period.  The $1.6 million change was mainly driven by the following factors:

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Revenue decreased to $17.9 million for the three months ended June 30, 2017, as compared to $18.7 million in the prior year comparable quarter.  The decrease in revenue is mainly attributable to a 3.4% decline in average revenue per student due to shifts in our program mix combined with tuition rate decreases in various programs.  Slightly offsetting the decline in revenue was a 2.7% increase in student starts for the quarter compared to the prior year comparable period.

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Educational services and facilities expense remained essentially flat for the three months ended June 30, 2017 as compared to the prior year comparable period.

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Selling general and administrative expenses increased by $1.0 million primarily resulting from a $0.6 million increase in sales and marketing expense, which has driven student starts up 2.7% quarter over quarter and a $0.3 million increase in administrative expenses mainly the result of increased bad debt primarily due to higher student accounts receivable, higher account write-offs, and timing of Title IV fund receipts.

 

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

 

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

Revenue was $2.6 million for the three months ended June 30, 2017 as compared to $8.4 million in the prior year comparable period mainly attributable to the closing of campuses within this segment.

Operating loss decreased by $0.6 million to $0.8 million for the three months ended June 30, 2017 from $1.5 million in the prior year comparable period.  The decrease is primarily attributable to a decrease in salaries and benefits as a result of the suspension of new student enrollments and a declining student population.

 

This category includes unallocated expenses incurred on behalf of the entire Company.  Corporate and Other costs increased by $0.3 million, or 5.7%, to $5.4 million from $5.1 million, for the prior year comparable period.

The increase in Corporate expenses was driven in part by a $1.0 million increase in medical expenses resulting from historically low claims in 2016 as compared to the three months ended June 30, 2017.  Partially offsetting this expense is a reduction in salaries and benefits of $0.7 million.

Included in Corporate and Other costs for the three months ended June 30, 2017 are approximately $0.3 million of additional dormitory costs directly relating to the closure of the Hartford, Connecticut campus on December 31, 2016.  

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

Six Months Ended June 30, 2017 Compared to Six Months Ended June 30, 2016

Student start results decreased by 3.1% to 3,486 from 3,596 for the six months ended June 30, 2017 as compared to the prior year comparable period.  This decrease was a result of lower than expected start rates for high school students.  The decline occurred primarily at three campuses and was directly attributable to affordability and sustainability of student engagement between enrollment and start date.  In addition, in striving to find the optimum affordability balance the Company experienced a start decline in markets where scholarships were scaled back.  External factors including low unemployment rates and increased wages for both skilled and unskilled labor also contributed to the decline in student starts.

 

 

Student start results decreased by 4.7% to 1,843 from 1,933 for the six months ended June 30, 2017 as compared to the prior year comparable period.

Operating loss for the six months ended June 30, 2017 was $0.5 million compared to operating income of $2.7 million in the prior year comparable period.  The $3.1 million change was mainly driven by the following factors:

 

 

Revenue was $6.9 million for the six months ended June 30, 2017 as compared to $17.0 million in the prior year comparable period mainly attributable to the closing of campuses within this segment.

Operating loss decreased by $3.7 million to $1.4 million for the six months ended June 30, 2017 from $5.1 million in the prior year comparable period.  The decrease is primarily attributable to a decrease in salaries and benefits as a result of the suspension of new student enrollments and a declining student population.

Included in Corporate and Other costs for the six months ended June 30, 2017 are approximately $0.6 million of additional dormitory costs directly relating to the closure of the Hartford, Connecticut campus on December 31, 2016. 

 

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

At June 30, 2017, the Company had $13.4 million of cash, cash equivalents and restricted cash (which includes $6.2 million of restricted cash) as compared to $47.7 million of cash, cash equivalents and restricted cash (which includes $26.7 million of restricted cash) as of December 31, 2016.  This decrease is primarily the result of a net loss during the six months ended June 30, 2017; repayment of $44.3 million under our previous term loan facility; and seasonality of the business.

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

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

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

As a result of the 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 restriction on our eligibility to receive Title IV funds would have a significant impact on our operations and our financial condition.  See “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016.

Operating Activities

Net cash used in operating activities was $19.5 million for the six months ended June 30, 2017 compared to $18.1 million for the comparable period of 2016.  For the six months ended June 30, 2017, changes in our operating assets and liabilities resulted in cash outflows of $15.3 million primarily attributable to decreases in deferred revenue, accounts receivable, accounts payable and accrued expenses.  The decrease in deferred revenue resulted in a cash outflow of $4.3 million primarily attributable to the timing of student starts, the number of students in school and the status of students in relation to the completion of their program at June 30, 2017 when compared to June 30, 2016.  The decrease in accounts receivable resulted in a cash outflow of $9.3 million primarily due to the timing of Title IV disbursements and other cash receipts on behalf of our students.  The net decrease in accounts payable and accrued expenses resulted in a cash outflow of $1.8 million and was attributable to the timing of invoices received during the quarter.

 

Investing Activities

Net cash used in investing activities was $1.8 million for the six months ended June 30, 2017 compared to $0.3 million for the prior year comparable period.   Our primary use of cash in investing activities was capital expenditures associated with investments in training technology, classroom furniture, and new program buildouts.

 

Capital expenditures are expected to approximate 2% of revenues in 2017.  We expect to fund future capital expenditures with cash generated from operating activities, borrowings under our revolving credit facility, and cash from our real estate monetization, including the pending sale of the Company’s West Palm Beach, Florida property.  On April 28, 2017, the Company obtained from its lender, Sterling National Bank, an $8 million short-term loan secured by the West Palm Beach, Florida property.  This loan must be repaid upon the earlier of the sale of the West Palm Beach, Florida property or October 1, 2017.

Financing Activities

Net cash provided by financing activities was $7.4 million as compared to net cash used of $9.0 million for the six months ended June 30, 2017 and 2016, respectively. The increase of $16.4 million was primarily due to three main factors: (a) net borrowing of $9.0 million; (b) $2.9 million in lease termination fees paid in the prior year; and (c) the reclassification of $5 million in restricted cash in the prior year.

Net borrowings consisted of: (a) total borrowing to date under our new secured revolving credit facility of $38.0 million; (b) reclassification of payments of borrowing from restricted cash of $20.3 million; and (c) $49.3 million in total repayments made by the Company.

Credit Agreement

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

 

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

 

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

 

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

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

Each issuance of a letter of credit under Facility 2 will require the payment of a letter of credit fee to the Bank equal to a rate per annum of 1.75% on the daily amount available to be drawn under the letter of credit, which fee shall be payable in quarterly installments in arrears.  Letters of credit totaling $6.2 million that were outstanding under a $9.5 million letter of credit facility previously provided to the Company by the Bank, which letter of credit facility was set to mature on April 1, 2017, are treated as letters of credit under Facility 2.

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

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

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

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

On April 28, 2017, the Company entered into an additional secured credit agreement with its existing lender, Sterling National Bank, pursuant to which the Company has obtained a short term loan in the principal amount of $8 million, the proceeds of which are to be used for working capital and general corporate purposes.  The loan bears interest at a rate per annum equal to the greater of the Bank’s prime rate plus 2.50% or 6.00%.

 

The loan is secured by property located in West Palm Beach, Florida at which schools operated by the Company are currently located.  The loan is payable interest only until its maturity, which will occur upon the earlier of October 1, 2017 and the date of the sale of the West Palm Beach, Florida property.  The Company has entered into a contract to sell two of three properties located in West Palm Beach, Florida to Tambone Companies, LLC for a cash purchase price of $15.7 million.  The Company expects this sale to be completed in the third quarter of 2017.

As of June 30, 2017, the Company had $33 million outstanding under the Credit Facility (which includes the short term loan of $8 million); offset by $1.0 million of deferred finance fees.  As of December 31, 2016, the Company had $44.3 million outstanding under the Prior Credit Facility; offset by $2.3 million of deferred finance fees which were written-off.  As of June 30, 2017 and December 31, 2016 there were letters of credit in the aggregate principal amount of $6.2 million outstanding, respectively.  As of June 30, 2017, there are no revolving loans outstanding under Facility 2.

 

The following table sets forth our long-term debt (in thousands):

As of June 30, 2017, we had outstanding loan commitments to our students of $42.2 million, as compared to $40.0 million at December 31, 2016.  Loan commitments, net of interest that would be due on the loans through maturity, were $31.4 million at June 30, 2017, as compared to $30.0 million at December 31, 2016.

Contractual Obligations

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

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

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

 

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of June 30, 2017, except for surety bonds.  As of June 30, 2017, we posted surety bonds in the total amount of approximately $14.3 million.  Cash collateralized letters of credit of $6.2 million 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.

Seasonality and Outlook

Seasonality

Our revenue 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 larger class starts in the third quarter and higher 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, typically do not vary significantly over the course of the year with changes in our student population and revenue. During the first half of the year, we make significant investments in marketing, staff, programs and facilities to 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 revenue, in the second half of the year fall short of our estimates, our operating results could be negatively impacted. 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.

 

Outlook

Similar to many companies in the proprietary education sector, we have experienced significant deterioration in student enrollments over the last several years. This can be attributed to many factors including the economic environment and numerous regulatory changes such as changes to admissions advisor compensation policies, elimination of “ability-to-benefit,” changes to the 90/10 Rule and cohort default rates, gainful employment and modifications to Title IV amounts and eligibility. While the industry has not returned to growth the trends are far more stable as declines have slowed.

As the economy continues to improve and the unemployment rate continues to decline our student enrollment is negatively impacted due to a portion of our potential student base entering the workforce prematurely without obtaining any post-secondary training. Offsetting this short term decline in available students is the fact that an increasing number of the “baby boom” generation are retiring from the workforce.  The retirement of baby boomers coupled with a growing economy has resulted in additional employers looking to us to help solve their workforce needs.  With schools in 15 states, we are a very attractive employment solution for large regional and national employers.

To fund our business plans, including any anticipated future losses, purchase commitments, capital expenditures, principal and interest payments on borrowings and to satisfy the DOE financial responsibility standards, we have entered into new credit facilities as described above and continue to have the ability to sell our assets that are classified as held for sale. We are also continuing to take actions to improve cash flow by aligning our cost structure to our student population.

Regulatory Update

On July 6, 2017, the DOE notified our Indianapolis, Indiana campus that an on-site Program Review is scheduled to begin on August 14, 2017. The Program Review will assess the institution’s administration of Title IV Programs in which the campus participated for the 2015-2016 and 2016-2017 award years.

On August 2, 2017, the DOE issued its Final Program Review Determination (“FPRD”) letter to the Columbia, MD, school that included the DOE’s review of our initial response and corrective actions for the five findings originally noted in the June 29, 2015, program review report.  The DOE concluded in its FPRD letter that the school had taken the corrective actions necessary to resolve and close the first four findings.  The DOE concluded in the fifth finding that there were violations of the Clery Act, but accepted the school’s response and stated that it now considers the finding closed for program review purposes.  However, the DOE reserved the right to impose an administrative action and/or require additional corrective actions by the school in connection with the Clery Act finding in the report.  The DOE did not impose any financial liabilities in any of the five findings in the FPRD letter. 

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to certain market risks as part of our on-going business operations.  On March 31, 2017, the Company repaid in full and terminated a previously existing term loan with the proceeds of a new revolving credit facility provided by Sterling National Bank in an aggregate principal amount of up to $50 million, which revolving credit facility is referred to in this report as the “Credit Facility.”  Our obligations under the Credit Facility are secured by a lien on substantially all of our assets and any assets that we or our subsidiaries may acquire in the future. Outstanding borrowings under the Credit Facility bear interest at the rate of 6.75% as of June 30, 2017.  As of June 30, 2017, we had $33 million outstanding under the Credit Facility (which includes the short term loan of $8 million).

Based on our outstanding debt balance as of June 30, 2017, a change of one percent in the interest rate would have caused a change in our interest expense of approximately $0.3 million, or $0.01 per basic share, on an annual basis.  Changes in interest rates could have an impact on our operations, which are greatly dependent on our 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 is not significant.

Item 4.

CONTROLS AND PROCEDURES

(a)   Evaluation of disclosure controls and procedures.  Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)) as of the end of the quarterly period covered by this report, have concluded that our disclosure controls and procedures are adequate and effective to reasonably ensure that material information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s 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.