10-Q 1 t10261_10q.txt FORM 10-Q U. S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------------------------------------------------------------- FORM 10-Q (MARK ONE) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 -------------------------------------------------------------------------------- COMMISSION FILE NUMBER 000-51371 -------------------------------------------------------------------------------- LINCOLN EDUCATIONAL SERVICES CORPORATION (Exact name of registrant as specified in its charter) NEW JERSEY 57-1150621 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 200 EXECUTIVE DRIVE, SUITE 340 WEST ORANGE, NJ 07052 (Address of principal executive offices) (973) 736-9340 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No |_| Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer|_| Accelerated filer|_| Non-accelerated filer|X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X| As of May 9, 2006, there were 25,211,521 shares of the registrant's common stock outstanding. --------------------------------------------------------------------------------
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES INDEX TO FORM 10-Q FOR THE QUARTER ENDING MARCH 31, 2006 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS 1 CONDENSED CONSOLIDATED BALANCE SHEETS AT MARCH 31, 2006 AND DECEMBER 31, 2005 (UNAUDITED) 1 CONDENSED CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (UNAUDITED) 3 CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE THREE MONTHS ENDED MARCH 31, 4 2006 (UNAUDITED) CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 5 (UNAUDITED) NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 19 ITEM 4. CONTROLS AND PROCEDURES 19 PART II. OTHER INFORMATION 19 ITEM 1. LEGAL PROCEEDINGS 19 ITEM 6. EXHIBITS 19
PART I - FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
MARCH 31 DECEMBER 31, 2006 2005 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 41,427 $ 50,257 Restricted cash 508 -- Accounts receivable, less allowance of $7,920 and $7,647 at March 31, 2006 and December 31, 2005, respectively 12,643 13,950 Inventories 1,997 1,764 Deferred income taxes 3,500 3,545 Prepaid expenses and other current assets 2,886 3,190 Prepaid income taxes 2,000 -- Other receivable 429 452 -------- -------- Total current assets 65,390 73,158 -------- -------- PROPERTY, EQUIPMENT AND FACILITIES - At cost, net of accumulated depreciation and amortization 69,390 68,932 -------- -------- OTHER ASSETS: Deferred finance charges 1,161 1,211 Prepaid pension cost 5,070 5,071 Deferred income taxes 3,312 2,790 Goodwill 59,476 59,467 Other assets 3,885 4,163 -------- -------- Total other assets 72,904 72,702 -------- -------- TOTAL $207,684 $214,792 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt and lease obligations $ 255 $ 283 Unearned tuition 31,196 34,930 Accounts payable 11,366 12,675 Accrued expenses 9,849 11,060 Advance payments of federal funds 302 840 Income taxes payable -- 4,085 -------- -------- Total current liabilities 52,968 63,873 NONCURRENT LIABILITIES: Long-term debt and lease obligations, net of current portion 10,434 10,485 Other long-term liabilities 4,897 4,444 -------- -------- Total liabilities 68,299 78,802 -------- --------
1
COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, no par value - 10,000,000 shares authorized, no shares issued and outstanding at March 31, 2006 and December 31, 2005 -- -- Common stock, no parvalue - authorized 100,000,000 shares at March 31, 2006 and December 31, 2005, issued and outstanding 25,197,971 shares at March 31, 2006 and 25,168,390 shares at December 31, 2005 119,681 119,453 Additional paid-in capital 6,106 5,665 Deferred compensation (396) (360) Retained earnings 13,994 11,232 --------- --------- Total stockholders' equity 139,385 135,990 --------- --------- TOTAL $ 207,684 $ 214,792 ========= =========
See notes to unaudited condensed consolidated financial statements. 2 LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2006 2005 -------- -------- REVENUES $ 75,513 $ 70,869 -------- -------- COSTS AND EXPENSES: Educational services and facilities 32,137 29,084 Selling, general and administrative 38,668 39,284 -------- -------- Total costs & expenses 70,805 68,368 -------- -------- OPERATING INCOME 4,708 2,501 OTHER: Interest income 471 8 Interest expense (474) (1,194) Other income 16 -- -------- -------- INCOME BEFORE INCOME TAXES 4,721 1,315 PROVISION FOR INCOME TAXES 1,959 543 -------- -------- NET INCOME $ 2,762 $ 772 ======== ======== Earnings per share - basic: $ 0.11 $ 0.04 ======== ======== Net income available to common shareholders Earnings per share - diluted: $ 0.11 $ 0.03 ======== ======== Net income available to common shareholders Weighted average number of common shares outstanding: Basic 25,186 21,699 Diluted 26,038 22,965 See notes to unaudited condensed consolidated financial statements. 3
LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (IN THOUSANDS) (UNAUDITED) ADDITIONAL COMMON STOCK PAID-IN DEFERRED RETAINED SHARES AMOUNT CAPITAL COMPENSATION EARNINGS TOTAL -------- -------- -------- ------------ -------- -------- BALANCE - December 31, 2005 25,168 $119,453 $ 5,665 $ (360) $ 11,232 $135,990 Net income -- -- -- -- 2,762 2,762 Reduction of issuance expenses associated with the initial public offering -- 150 -- -- -- 150 Issuance of restricted stock and amortization of deferred compensation 4 -- 60 (36) -- 24 Stock-based compensation expense -- -- 329 -- -- 329 Tax benefit of options exercised -- -- 52 -- -- 52 Exercise of stock options 26 78 -- -- -- 78 -------- -------- -------- ---------- -------- -------- BALANCE - March 31, 2006 25,198 $119,681 $ 6,106 $ (396) $ 13,994 $139,385 ======== ======== ======== ========== ======== ======== See notes to unaudited condensed consolidated financial statements.
4 LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2006 2005 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,762 $ 772 -------- -------- Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 3,463 3,082 Amortization of deferred finance charges 50 56 Write-off of deferred finance costs -- 365 Deferred income taxes (477) (111) Fixed asset donations (16) -- Provision for doubtful accounts 3,150 2,285 Stock-based compensation expense and issuance of restricted stock 353 399 Tax benefit associated with exercise of stock options 52 39 Deferred rent 274 392 (Increase) decrease in assets, net of acquisitions: Restricted cash (508) -- Accounts receivable (1,843) (1,561) Inventories (233) 90 Prepaid expenses and current assets 226 335 Other assets 44 277 Increase (decrease) in liabilities, net of acquisitions: Accounts payable (1,309) 1,159 Other liabilities (403) 356 Income taxes payable/prepaid (6,085) (2,334) Accrued expenses (1,128) (3,061) Unearned tuition (3,734) (5,599) -------- -------- Total adjustments (8,124) (3,831) -------- -------- Net cash used in operating activities (5,362) (3,059) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (3,467) (3,195) Acquisitions, net of cash acquired -- (19,691) -------- -------- Net cash used in investing activities (3,467) (22,886) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings -- 31,000 Payments on borrowings -- (35,750) Payments of deferred finance fees -- (833) Proceeds from exercise of stock options 78 24 Principal payments under capital lease obligations (79) (73) Repayment from shareholder loans -- 181 -------- -------- Net cash used in financing activities (1) (5,451) -------- -------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,830) (31,396) CASH AND CASH EQUIVALENTS--Beginning of period 50,257 41,445 -------- -------- CASH AND CASH EQUIVALENTS--End of period $ 41,427 $ 10,049 ======== ========
5
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 516 $ 687 ====== ======== Income taxes $8,469 $ 2,946 ====== ======== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Cash paid during the period for: Fair value of assets acquired $ -- $ 23,238 Net cash paid for the acquisitions -- (19,691) ------ -------- Liabilities assumed $ -- $ 3,547 ====== ========
See notes to unaudited condensed consolidated financial statements. 6 LINCOLN EDUCATIONAL SERVICES CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS ACTIVITIES - Lincoln Educational Services Corporation and its wholly owned subsidiaries ("LESC" or the "Company") operate career-oriented post-secondary schools in various locations, which offer technical programs of study in several different specialties. BASIS OF PRESENTATION - The accompanying unaudited condensed consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission and in accordance with accounting principles generally accepted in the United States of America ("GAAP"). Certain information and footnote disclosures normally included in annual financial statements have been omitted or condensed pursuant to such regulations. These statements, when read in conjunction with the December 31, 2005 consolidated financial statements of the Company reflect all adjustments, consisting solely of normal recurring adjustments, necessary to present fairly the consolidated financial position, results of operations, and cash flows for such periods. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2006. The unaudited condensed consolidated financial statements as of March 31, 2006 and the condensed consolidated financial statements as of December 31, 2005 and for the three months ended March 31, 2006 and 2005 include the accounts of the Company. All significant intercompany accounts and transactions have been eliminated. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. On an ongoing basis, the Company evaluates the estimates and assumptions, including those related to revenue recognition, bad debts, fixed assets, goodwill and other intangible assets, stock-based compensation, income taxes, benefit plans and certain accruals. Actual results could differ from those estimates. 2. RECENT ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS." SFAS No. 155 is effective beginning January 1, 2007. The adoption of the provision of SFAS No. 155 is not expected to have a material effect on the Company's consolidated financial statements. In June 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS, A REPLACEMENT OF APB OPINION NO. 20 AND FASB STATEMENT NO. 3. SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. Accounting Principles Boards ("APB") Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. APB Opinion No. 20 previously required that such a change be reported as a change in accounting principle. The Company adopted SFAS No. 154 on January 1, 2006. The adoption of the provisions of SFAS No. 154 had no effect on the Company's consolidated financial statements. In March 2005, the FASB issued FASB Interpretation No. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS ("FIN 47"). FIN 47 clarifies that a conditional asset retirement obligation, as used in SFAS 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of the settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. The Company adopted FIN 47 on January 1, 2006. The adoption of the provisions of FIN 47 had no effect on the Company's consolidated financial statements. 7 In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY ASSETS, AN AMENDMENT OF APB OPINION NO. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and requires that such exchanges be measured at fair value, with limited exceptions. SFAS No. 153 amends APB Opinion No. 29 ACCOUNTING FOR NONMONETARY TRANSACTIONS, by eliminating the exception that required nonmonetary exchanges of similar productive assets be recorded on a carryover basis. The Company adopted SFAS No. 153 on January 1, 2006. The adoption of the provisions of SFAS No. 153 had no effect on the Company's consolidated financial statements. 3. STOCK-BASED COMPENSATION In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), SHARE-BASED PAYMENT, ("FAS 123R"). This Statement requires companies to expense the estimated fair value of stock options and similar equity instruments issued to employees over the requisite service period. On December 1, 2005, the Company adopted FAS 123R in advance of the mandatory adoption date of the first quarter of 2006 to better reflect the full cost of employee compensation. The Company adopted FAS 123R using the modified prospective method, which requires it to record compensation expense for all awards granted after the date of adoption, and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Prior to the adoption of FAS 123R, the Company recognized stock-based compensation under FAS 123 "STOCK BASED Compensation" and as a result, the implementation of FAS 123R did not have a material impact on the Company's financial presentation. The compensation cost that has been charges against income under this plan was approximately $0.3 million and $0.4 million for the three months ended March 31, 2006 and 2005. The fair value concepts were not changed significantly under FAS 123R from those utilized under FAS No. 123; however, in adopting this Standard, companies must choose among alternative valuation models and amortization assumptions. After assessing these alternatives, the Company decided to continue using the Black-Scholes valuation model, however, we decided to utilize straight-line amortization of compensation expense over the requisite service period of the grant, rather than over the individual grant requisite period as chosen under FAS 123. Under FAS 123, the Company had recognized stock option forfeitures as they incurred. Commencing with the adoption of FAS 123R, the Company make estimates of expected forfeitures calculation upon grant issuance. 4. WEIGHTED AVERAGE COMMON SHARES The weighted average numbers of common shares used to compute basic and diluted income per share for the three months ended March 31, 2006 and 2005, respectively, were as follows: THREE MONTHS ENDING MARCH 31, ----------------------------- 2006 2005 ------------- ------------- Basic shares outstanding 25,186,000 21,699,000 Dilutive effect of stock options 852,000 1,266,000 ------------- ------------- Diluted shares outstanding 26,038,000 22,965,000 ============= ============= For the three months ended March 31, 2006 and 2005, options to acquire 159 and 71 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, 2005, a wholly-owned subsidiary of the Company acquired Euphoria Institute LLC ("EUP") for approximately $9.0 million, net of cash acquired. On January 11, 2005, a wholly-owned subsidiary of the Company acquired New England Technical Institute ("NETI") for approximately $18.8 million, net of cash acquired. The consolidated financial statements include the results of operations of NETI and EUP from their respective acquisition dates. The purchase prices have 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 financial statements. 8 The following unaudited pro forma results of operations for the three months ended March 31, 2005 assume that the acquisitions occurred at the beginning of the year of acquisition. The unaudited pro forma results of operations are based on historical results of operations, include adjustments for depreciation, amortization, interest, and taxes, but do not necessarily reflect the actual results that would have occurred.
PRO FORMA PRO FORMA IMPACT IMPACT HISTORICAL NETI EUP PRO FORMA 2005 2005 2005 2005 2005 ------------- --------- -------- -------- Revenues $ 70,869 $ 278 $ 1,368 $ 72,515 Net income $ 772 $ 6 $ (10) $ 768 Earnings per share - basic $ 0.04 $ 0.04 Earnings per share - diluted $ 0.03 $ 0.03
6. GOODWILL AND OTHER INTANGIBLES ASSETS The Company accounts for its intangible assets in accordance with SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS. The Company reviews intangible assets with an indefinite useful life for impairment when indicators of impairment exist, as defined by SFAS No. 144, ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Annually, or more frequently if necessary, the Company evaluates goodwill for impairment, with any resulting impairment reflected as an operating expense. Amortization of intangible assets was approximately $0.2 million for each of the three months ended March 31, 2006 and 2005. Changes in the carrying amount of goodwill from the year ended December 31, 2005 to the three months ended March 31, 2006 were as follows: Goodwill balance as of December 31, 2005 $59,467 Goodwill adjustments 9 ------- Goodwill balance as of March 31, 2006 $59,476 ======= Intangible assets, which are included in other assets in the accompanying consolidated balance sheet, consist of the following:
AT MARCH 31, 2006 AT DECEMBER 31, 2005 ----------------------------- --------------------------------- WEIGHTED AVERAGE GROSS GROSS AMORTIZATION CARRYING ACCUMULATED CARRYING ACCUMULATED PERIOD (YEARS) AMOUNT AMORTIZATION AMOUNT AMORTIZATION --------------- ---------- ---------------- ------------- ----------------- Student Contracts 1 $1,920 $1,783 $1,920 $1,569 Trade name Indefinite 1,410 -- 1,410 -- Curriculum 10 1,400 109 1,400 74 Non-compete 0 1 1 1 1 ------ ------ ------ ------ Total N/A $4,731 $1,893 $4,731 $1,644 ====== ====== ====== ======
7. LONG-TERM DEBT The Company has a credit agreement with a syndicate of banks. Under the terms of the agreement, the syndicate provided the Company with a $100 million credit facility. The credit agreement permits the issuance of letters of credit, up to $20 million, the amount of which reduces the availability of permitted borrowings under the agreement. As a result of this credit agreement, the Company wrote off approximately $0.4 million of unamortized deferred finance charges under the old credit agreement for the three months ended March 31, 2005. The Company incurred approximately $0.8 million of deferred finance charges under the agreement. At March 31, 2006, the Company had outstanding letters of credit aggregating $4.1 million. 9 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. In connection with the Company's initial public offering in 2005, the Company repaid the then outstanding loan balance of $31.0 million. 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 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. There were no borrowings outstanding under the credit agreement at March 31, 2006 and December 31, 2005. As of March 31, 2006, the Company was in compliance with the financial covenants contained in the credit agreement. 8. EQUITY Pursuant to the Company's 2005 Non-Employee Directors Restricted Stock Plan (the "Non-Employee Directors Plan"), two newly appointed non-employee directors received an award of restricted shares of common stock equal to $60 thousand on March 1, 2006. The number of shares granted to each non-employee director was based on the fair market value of a share of common stock on that date. These 7,250 restricted shares (3,625 for each non-employee director) vest ratably on the first, second and third anniversaries of the date of grant; however, there is no vesting period on the right to vote or the right to receive dividends on these restricted shares. As of March 31, 2006, there were a total of 25,664 shares awarded under the Non-Employee Directors Plan. None of these shares are vested. 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 2006 were $8.25 using the following weighted average assumptions for grants: MARCH 31, 2006 --------------- Expected volatility 55.10% Expected dividend yield 0% Expected life (term) 5-6 Years Risk-free interest rate 4.13-5.81% Weighted-average exercise price during the year $ 16.01 The following is a summary of transactions pertaining to the option plans: WEIGHTED-AVERAGE EXERCISE PRICE SHARES PER SHARE -------------- ---------------- Outstanding December 31, 2005 1,839,173 $ 7.26 Granted 3,000 14.70 Cancelled (23,500) 21.86 Exercised (25,400) 3.10 --------- Outstanding March 31, 2006 1,793,273 7.11 ========= ========== 10 The following table presents a summary of options outstanding at March 31, 2006:
----------------------------------------------------------------------------------------------- STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE ---------------------------------------------------------- --------------------------------- CONTRACTUAL WEIGHTED AVERAGE RANGE OF EXERCISE PRICES AVERAGE LIFE WEIGHTED WEIGHTEED PRICES SHARES (YEARS) AVERAGE PRICE SHARES EXERCISE PRICE ------------------------- ------------ ------------------ -------------------- ------------ ------------------ $1.55 50,898 3.23 $1.55 50,898 $1.55 $3.10 1,153,000 5.78 3.10 1,127,720 3.10 $4.00-$10.00 59,000 7.12 6.19 26,800 5.53 $14.00-$14.19 371,875 8.08 14.05 120,360 14.00 $20.00-$25.00 158,500 8.58 22.17 24,800 23.65 ----------- ----------- 1,793,273 6.48 7.11 1,350,578 4.44 =========== ===========
9. RECOURSE LOAN AGREEMENT During 2005, the Company entered into an agreement with Student Loan Marketing Association (Sallie Mae) to provide private recourse loans to qualifying students. The following table reflects selected information with respect to the recourse loan agreements, including cumulative loan disbursements and purchase activity under the agreement from inception through March 31, 2006:
LOANS LOANS LOANS WE MAY BE DISBURSED DISBURSED PURCHASED TO REQUIRED TO AGREEMENT EFFECTIVE DATE (1) LOANS LIMIT TO DATE DATE PURCHASE (2) ----------------------------------- ---------------- ------------------- -------------- --------------------- March 28, 2005 to June 30, 2006 $ 6,000 $ 3,265 $ - $ 980
(1) Either party may terminate the agreement by giving the other party 30 days written notice of such termination. (2) Represents the maximum amount of loans under the agreement that we may be required to purchase in the future based on cumulative loans disbursed and purchased through March 31, 2006. Under the recourse loan agreement, the Company is required to fund 30% of all loans disbursed into a Sallie Mae reserve account. The amount of our loan purchase obligation may not exceed 30% of this deposit. We record such amounts as a deposit in long-term assets on our balance sheet. Amounts on deposit may ultimately be utilized to purchase loans in default, in which case recoverability of such amounts would be in question. Accordingly, the Company has an allowance for the full amount of deposit. 10. INCOME TAXES The effective tax rate for the three months ended March 31, 2006 and 2005 was 41.5% and 41.3%, respectively. 11. RELATED PARTY TRANSACTIONS The Company had a consulting agreement with Hart Capital LLC, which terminated by its terms in June 2004, to advise the Company in identifying acquisition and merger targets and assisting with the due diligence reviews of and negotiations with these targets. Hart Capital is the managing member of Five Mile River Capital Partners LLC, which is the second largest stockholder of the Company. Steven Hart, the President of Hart Capital, is a member of the Company's board of directors. The Company paid Hart Capital a monthly retainer, reimbursement of expenses and an advisory fee for its work on successful acquisitions or mergers. In accordance with the agreement, the Company paid Hart Capital $0 and approximately $0.3 million for the three months ended March 31, 2006 and 2005, respectively. In connection with the consummation of the NETI acquisition, which closed on January 11, 2005, the Company paid Hart Capital $0.3 million for its services. 11 In 2003, the Company entered into a management service agreement with its major stockholder. In accordance with this agreement the Company paid Stonington Partners a management fee of $0.75 million per year for management consulting and financial and business advisory services. Such services included valuing acquisitions and structuring their financing and assisting with new loan agreements. The Company paid Stonington Partners $0 and $0.75 million for the three months ended March 31, 2006 and 2005, respectively. Fees paid to Stonington Partners were being amortized over a twelve month period. This agreement terminated by its terms upon the Company's completion of its initial public offering. Selling, general and administrative expenses for the three months ended March 31, 2005 include a $0.2 million charge resulting from the amortization of these fees. 12. COMMITMENTS AND CONTINGENCIES LITIGATION AND REGULATORY MATTERS - The Company has been named as a defendant in actions resulting from the normal course of operations. Based, in part, on the opinion of counsel, management believes that the resolution of these matters will not have a material effect on its financial position, results of operations and cash flows. STOCK PURCHASE AGREEMENT - On March 30, 2006, the Company entered into a definitive stock purchase agreement (the "Purchase Agreement") to acquire New England Institute of Technology at Palm Beach, Inc., a Florida corporation ("NET"), for approximately $35.3 million in cash plus the assumption of a $7.2 million mortgage. The transaction, which is currently expected to close in the second quarter of 2006, is subject to certain regulatory approvals, as well as other customary conditions to closing. 13. 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. While the Company does not expect to make any contributions to the plan in 2006, 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 net periodic benefit cost was $1,000 and $30,000 for the three months ended March 31, 2006 and 2005, respectively. 14. SUBSEQUENT EVENT The Massachusetts Department of Education has raised concerns regarding the status of certain instructor's Department approval to teach certain courses at the Company's Career Education Institute Brockton campus. The Brockton campus represented less than 1.5% of the Company's revenue in 2005. Based on the Company's discussions with the Department to date, the Company does not expect the resolution of this matter to have a material financial impact. The Company is working with the Massachusetts Department of Education to address their concerns. 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion may contain forward-looking statements regarding us, our business, prospects and our results of operations that are subject to certain risks and uncertainties posed by many factors and events that could cause our actual business, prospects and results of operations to differ materially from those that may be anticipated by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those described in the "Risk Factors" section of our Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission that advise interested parties of the risks and factors that may affect our business. The interim financial statements filed on this Form 10-Q and the discussions contained herein should be read in conjunction with the annual financial statements and notes included in our Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission, which includes audited consolidated financial statements for our three fiscal years ended December 31, 2005. GENERAL We are a leading and diversified for-profit provider of career-oriented post-secondary education. We offer recent high school graduates and adults degree and diploma programs in five areas of study: automotive technology, allied health, skilled trades, business and information technology and spa and culinary. As of March 31, 2006, we enrolled 17,374 students at our 35 campuses across 16 states. Our campuses primarily attract students from their local communities and surrounding areas, although our four destination schools attract students from across the United States, and in some cases, from abroad. We continue to expand our product offerings, and on March 23, 2006 we announced that our new automotive campus in Queens, New York will be opened on March 27, 2006. 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 policies 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, stock-based compensation, 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. 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 based on our collection history. Although we believe that our reserves are adequate, if the financial condition of our students 13 deteriorates, resulting in an impairment of their ability to make payments, or if we underestimate the allowances required, 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 March 31, 2006 and 2005 was 4.2% and 3.2%, respectively. Our exposure to changes in our bad debt expense could impact our operations. 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 an 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. STOCK-BASED COMPENSATION. We currently account for stock-based employee compensation arrangements in accordance with the provisions of Statement of Financial Accounting Standards ("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, 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 on June 22, 2005, 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. Prior to our initial public offering, 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. RECENT ACCOUNTING PRONOUNCEMENTS In February 2006, the Financial Accounting Standards Board ("FASB") issued SFAS No. 155, ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS." SFAS No. 155 is effective beginning January 1, 2007. The adoption of the provision of SFAS No. 155 is not expected to have a material effect on our consolidated financial statements. In June 2005, the FASB issued SFAS No. 154, ACCOUNTING CHANGES AND ERROR CORRECTIONS, A REPLACEMENT OF APB OPINION NO. 20 AND FASB STATEMENT NO. 3. SFAS No. 154 applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. Accounting Principles Board "APB" Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires that a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. APB Opinion No. 20 previously required that such a change be reported as a change in accounting principle. We adopted SFAS No. 154 on January 1, 2006. The adoption of the provisions of SFAS No. 154 had no effect on our consolidated financial statements. 14 In March 2005, the FASB issued FASB Interpretation No. 47, ACCOUNTING FOR CONDITIONAL ASSET RETIREMENT OBLIGATIONS ("FIN 47"). FIN 47 clarifies that a conditional asset retirement obligation, as used in SFAS 143, ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of the settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated. We adopted FIN 47 on January 1, 2006. The adoption of the provisions of FIN 47 had no effect on our consolidated financial statements. In December 2004, the FASB issued SFAS No. 153, EXCHANGES OF NONMONETARY ASSETS, AN AMENDMENT OF APB OPINION NO. 29, ACCOUNTING FOR NONMONETARY TRANSACTIONS. SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and requires that such exchanges be measured at fair value, with limited exceptions. SFAS No. 153 amends APB Opinion No. 29 ACCOUNTING FOR NONMONETARY TRANSACTIONS, by eliminating the exception that required nonmonetary exchanges of similar productive assets be recorded on a carryover basis. We adopted SFAS No. 153 on January 1, 2006. The adoption of the provisions of SFAS No. 153 had no effect on our consolidated financial statements. RESULTS OF OPERATIONS The following table sets forth selected consolidated statements of operations data as a percentage of revenues for each of the periods indicated: THREE MONTHS ENDED MARCH 31, --------------------------- 2006 2005 ------------ ----------- Revenues 100.0% 100.0% Costs and expenses: Educational services and facilities 42.6% 41.0% Selling, general and administrative 51.1% 55.4% ------------ ----------- Total costs and expenses 93.7% 96.4% ------------ ----------- Operating income 6.3% 3.6% Interest expense, net 0.0% (1.7)% Other Income 0.0% 0.0% ------------ ----------- Income before income taxes 6.3% 1.9% Provision for income taxes 2.6% 0.8% ------------ ----------- Net income 3.7% 1.1% ============ =========== THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005 REVENUES. Our revenues for the quarter ended March 31, 2006 were $75.5 million, representing an increase of $4.6 million, or 6.6%, as compared to $70.9 million for the quarter ended March 31, 2005. Approximately $1.4 million, or 2.1%, of this increase was as a result of our acquisition of Euphoria Institute LLC, or Euphoria, on December 1, 2005, while the remainder was primarily due to tuition increases. For the quarter ended March 31, 2006, our average undergraduate full-time student enrollment was 17,676 as compared to 17,692 for the quarter ended March 31, 2005. Excluding our acquisition of Euphoria, our average undergraduate student enrollment decreased by 1.6% to 17,409. For a discussion of trends in our student enrollment, see "Seasonality and Trends" below. EDUCATIONAL SERVICES AND FACILITIES EXPENSES. Our educational services and facilities expenses for the quarter ended March 31, 2006 were $32.1 million, representing an increase of $3.0 million, or 10.5%, as compared to $29.1 million for the quarter ended March 31, 2005. The acquisition of Euphoria resulted in $0.9 million, or 3.0%, of this increase. Instructional expenses increased by $0.8 million or 4.6% as compared to last year primarily due to increased compensation and benefit costs. Books and tools expenses increased $0.5 million or 20.0% over the prior year primarily due to timing of class starts in the first quarter of 2006 and from higher costs of books and tools. Additionally, facilities expenses increased by approximately $0.9 million due to rent expenses on our new Queens, New York facility for the full quarter in 2006 as compared to only two months in 2005, our expanded campus facilities at New England Technical Institute during the second half of 2005 and from additional depreciation expense which increased $0.3 million or 8.5% from prior period. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Our selling, general and administrative expenses for the quarter ended March 31, 2006 were $38.7 million, a decrease of $0.6 million, or 1.6%, as compared to $39.3 million for the quarter ended March 31, 2005. Approximately $0.4 million of the $38.7 million incurred for the quarter ended March 31, 2006 related to the acquisition of Euphoria. Excluding Euphoria, our selling, general and administrative expenses would have decreased 2.6% as compared to the same period in 2005. This decrease was primarily due to: (a) a $0.6 million, or 3.4%, decrease in sales and marketing expenses as a result of 15 efficiencies gained through the better utilization of technology and due to a shift in advertising from television to the Internet, which is more cost effective; and (b) a $0.4 million, or 1.9%, decrease in administrative costs primarily due to decreased expenses associated with the timing and efficiencies gained from rolling out of our new student software and management reporting system at some of our schools during the first quarter of 2006. NET INTEREST EXPENSE. Our net interest expense for the quarter ended March 31, 2006 was $0.0 million, representing a decrease of $1.2 million from the quarter ended March 31, 2005. This decrease was primarily due to an increase in interest income of $0.5 million due to higher cash balances during the period as well as a decrease of $0.7 million in interest expense due to paying off our debt outstanding under our credit facility with the proceeds from our initial public offering. INCOME TAXES. Our provision for income taxes for the quarter ended March 31, 2006 was $2.0 million, or 41.5% of pretax income, compared to $0.5 million, or 41.3% of pretax income, for the quarter ended March 31, 2005. The increase in our effective tax rate for the three months ended March 31, 2006 is primarily attributable to an allocation of income between states. LIQUIDITY AND CAPITAL RESOURCES Our primary capital requirements are for facility 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 the three months ended March 31, 2006 and 2005: CASH FLOW SUMMARY THREE MONTHS ENDED MARCH 31, ----------------------------- 2006 2005 -------- -------- (DOLLARS IN THOUSANDS) Net cash used in operating activities $ (3,656) $ (2,536) Net cash used in investing activities $ (3,476) $(22,886) Net cash used in financing activities $ (1) $ (5,451) As of March 31, 2006 we had cash and cash equivalents of $41.4 million, compared to $48.6 million as of December 31, 2005. 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 agreement and cash generated from operations. 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 agreement. As of March 31, 2006, we had borrowings available under our credit agreement of approximately $95.9 million, including a $4.1 million sub-limit on letters of credit. On March 30, 2006, we entered into a definitive stock purchase agreement to acquire New England Institute of Technology at Palm Beach, Inc., for approximately $35.3 million in cash plus the assumption of a $7.2 million mortgage. The transaction, which is currently expected to close in the second quarter of 2006, is subject to certain regulatory approvals, as well as other customary conditions to closing. If this acquisition is consummated, our cash and cash equivalents would be significantly reduced and we would expect to incur additional indebtedness. Notwithstanding this reduction in cash and cash equivalents, we believe we will continue to be able to meet both our short-term and long-term cash needs through the sources identified above. Our primary source of cash is tuition collected from our students. Our students fund their tuition payments from a variety of sources including Title IV Programs, federal and state grants, private loans and their personal resources. A significant majority of our students' tuition payments are derived from Title IV Programs. 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 30 days after the start of a student's academic year and the second disbursement is typically received at the beginning of the sixteenth week after 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 30 to 84 weeks and may cover one or two academic years. 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 and the amount of the refund varies by state. 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 is Title IV, which represented approximately 80% of our cash receipts relating to revenues in 2005. 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 receive Title IV funds would have a significant impact on our operations and our financial condition. 16 OPERATING ACTIVITIES Net cash used in operating activities was $3.7 million for the quarter ended March 31, 2006 compared to $2.5 million for the quarter ended March 31, 2005. The $1.2 million increase in cash used by operating activities was primarily due to $5.5 million of increased tax payments made during the first quarter of 2006 as compared to the comparable period in 2005, offset by increased net income as well as non-cash expenses as adjusted by bad debt expense over the comparable period in 2005 as well as reductions in unearned tuition. The remaining difference resulted from changes in other working capital items. INVESTING ACTIVITIES Our cash used in investing activities was primarily related to the purchase of property and equipment and in acquiring schools. Our capital expenditures primarily result from facility expansion, leasehold improvements, and investments in classroom and shop technology and in operating systems. On January 11, 2005, we acquired New England Technical Institute, or,NETI, for $18.8 million, net of cash acquired. We currently lease almost all of our campuses. In October 2005, we completed the purchase of our Grand Prairie, Texas facility and expect to open the facility in the second half of 2006. In addition, although our growth strategy is primarily focused on internal growth, including campus expansions, we may also consider strategic acquisitions. 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. Net cash used in investing activities decreased $19.4 million to $3.5 million for the quarter ended March 31, 2006 from $22.9 million for the quarter ended March 31, 2005. This decrease is entirely due to our acquisition of NETI. Capital expenditures are expected to increase as we upgrade and expand current equipment and facilities and open new facilities to meet increased student enrollments. Additionally, we are evaluating several other expansion opportunities. We anticipate capital expenditures to be approximately 12% to 15% of revenues in 2006. We expect to be able to fund these capital expenditures with cash generated from operating activities. FINANCING ACTIVITIES Net cash used in financing activities was $0.0 million for the quarter ended March 31, 2006 compared to $5.5 million for the quarter ended March 31, 2005. This decrease in 2006 is mainly attributable to the pay down of our debt in 2005 from the proceeds of our initial public offering. On February 15, 2005, we entered into a new credit agreement with a syndicate of banks led by our existing lender. Under the terms of this agreement, the syndicate provided us with a $100 million credit facility with a term of five years. The credit agreement permits the issuance of letters of credit of up to $20 million, the amount of which reduces the availability of permitted borrowings under the agreement. In connection with of this new credit agreement, we wrote off as a component of interest expense approximately $0.4 million of unamortized deferred finance costs under our old credit agreement in the quarter ended March 31, 2005. We incurred approximately $0.8 million of deferred finance costs under the new agreement. The following table sets forth our long-term debt at the dates indicated:
MARCH 31, DECEMBER 31, 2006 2005 -------- -------- (DOLLARS IN THOUSANDS) Credit agreement $ -- $ -- Automobile loans 73 81 Finance obligation 9,672 9,672 Capital leases-computers (with rates ranging from 6.7% to 10.7%) 944 1,015 -------- -------- Subtotal 10,689 10,768 Less current maturities (255) (283) -------- -------- $ 10,434 $ 10,485 ======== ========
17 CONTRACTUAL OBLIGATIONS LONG-TERM DEBT. As of March 31, 2006, our long-term debt consisted entirely of the finance obligation in connection with our sale-leaseback transaction in 2001 snd amounts due under capital lease obligations. LEASE COMMITMENTS. We lease offices, educational facilities and various equipment for varying periods through the year 2020 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 March 31, 2006, measured from the end of our fiscal year, December 31, 2005:
PAYMENTS DUE BY PERIOD ------------------------------------------------------------------------- LESS THAN TOTAL 1 YEAR 2-3 YEARS 4-5 YEARS AFTER 5 YEARS -------- --------- --------- --------- ------------- (DOLLARS IN THOUSANDS) Capital leases (including interest) $ 1,140 $ 291 $ 457 $ 309 $ 83 Operating leases 144,442 16,575 31,912 25,981 69,974 Finance obligation 13,949 1,259 2,517 2,517 7,656 Automobile loans (including interest) 75 36 39 -- -- -------- -------- -------- -------- -------- Total contractual cash obligations $159,606 $ 18,161 $ 34,925 $ 28,807 $ 77,713 ======== ======== ======== ======== ========
OFF-BALANCE SHEET ARRANGEMENTS We had no off-balance sheet arrangements as of March 31, 2006. RELATED PARTY TRANSACTIONS We had a consulting agreement with Hart Capital LLC, which terminated by its terms in June 2004, to advise us in identifying acquisition and merger targets and assisting with the due diligence reviews of and negotiations with these targets. Hart Capital is the managing member of Five Mile River Capital Partners LLC, which is the second largest stockholder of our Company. Steven Hart, the President of Hart Capital, is a member of our board of directors. We paid Hart Capital a monthly retainer, reimbursement of expenses and an advisory fee for its work on successful acquisitions or mergers. In accordance with the agreement, we paid Hart Capital $0 and approximately $0.3 million for the quarter ended March 31, 2006 and 2005, respectively. In connection with the consummation of the NETI acquisition, on January 11, 2005, we paid Hart Capital $0.3 million for its services. In 2003, we entered into a management service agreement with our majority stockholder, Stonington Partners. In accordance with this agreement, we paid Stonington Partners a management fee of $0.75 million per year for management consulting and financial and business advisory services. Such services include valuing acquisitions and structuring their financing and assisting with new loan agreements. We paid Stonington Partners $0 and $0.75 million for the quarter ended March 31, 2006 and 2005, respectively. Fees paid to Stonington Partners were being amortized over a twelve month period. This agreement terminated by its terms upon the completion of our initial public offering in June 2005. Selling, general and administrative expenses for the quarter ended March 31, 2005 include a $0.2 million charge resulting from the amortization of these fees. 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 expenses, however, do not vary significantly 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 have the proper staffing to meet our second half targets and, as a result, such expenses do not fluctuate significantly on a quarterly basis. We expect quarterly fluctuations in operating results to continue as a result of seasonal enrollment patterns. Such patterns may change, however, as a result of new school openings, new program introductions, 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 did not meet our historical or anticipated growth rates in 2005. As a result of this slow down, we entered 2006 with fewer students enrolled 18 than we had in January of 2005. The slow down 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 the slow down can be attributed to many factors, including: (a) the economy; (b) dependency on television to attract students to our school; (c) turnover of our sales representatives; and (d) increasing competition in the marketplace. Despite soft organic enrollment trends and increased volatility in the near term, we believe that our growth initiatives as well as the steps we have taken to address the challenging trends that our industry and we are currently facing will produce positive growth over the long-term. While our operating strategy, business model and infrastructure are well suited for the short-term and we have ample operating flexibility, we continue to be prudent and realistic and have taken the necessary steps to ensure that operations that have not grown as rapidly as expected are right sized. We also continue to make investments in areas that are demonstrating solid growth. Operating income is negatively impacted during the initial start-up phase of new campus expansions. We incur sales and marketing costs as well as campus personnel costs in advance of the opening of each campus. Typically we begin to incur such costs approximately 15 months in advance of the campus opening with the majority of such costs being incurred in the nine-month period prior to a campus opening. During the current year, we initiated expansion efforts for one new campus, located in Queens, New York, which opened on March 27, 2006. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our principal exposure to market risk relates to interest rate changes. However, as a result of completing our initial public offering, we have been able to repay in full our line of credit leaving only miscellaneous capital equipment leases, which are not material. 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 specific 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. (b) CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING. There were no changes made during our most recently completed fiscal quarter in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In the ordinary conduct of our business, we are periodically subject to 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 or financial condition. ITEM 6. EXHIBITS EXHIBIT INDEX The following exhibits are filed or incorporated by reference with this Form 10-Q.
Exhibit NUMBER DESCRIPTION 3.1 Amended and Restated Certificate of Incorporation of the Company (1). 3.2 Amended and Restated By-laws of the Company (2).
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4.1 Stockholders' Agreement, dated as of September 15, 1999, among Lincoln Technical Institute, Inc., Back to School Acquisition, L.L.C., and Five Mile River Capital Partners LLC. (1). 4.2 Letter agreement, dated August 9, 2000, by Back to School Acquisition, L.L.C., amending the Stockholders' Agreement (1). 4.3 Letter agreement, dated August 9, 2000, by Lincoln Technical Institute, Inc., amending the Stockholders' Agreement (1). 4.4 Management Stockholders Agreement, dated as of January 1, 2002, by and among Lincoln Technical Institute, Inc., Back to School Acquisition, L.L.C. and the Stockholders and other holders of options under the Management Stock Option Plan listed therein (1). 4.5 Registration Rights Agreement between the Company and Back to School Acquisition, L.L.C. (2). 4.6 Specimen Stock Certificate evidencing shares of common stock (1). 10.1 Credit Agreement, dated as of February 15, 2005, among the Company, the Guarantors from time to time parties thereto, the Lenders from time to time parties thereto and Harris Trust and Savings Bank, as Administrative Agent (1). 10.2 Employment Agreement, dated as of January 3, 2005, between the Company and David F. Carney (1). 10.3 Amended Employment Agreement, dated as of March 1, 2005, between the Company and David F. Carney (1). 10.4 Employment Agreement dated as of January 3, 2005, between the Company and Lawrence E. Brown (1). 10.5 Amended Employment Agreement, dated as of March 1, 2005, between the Company and Lawrence E. Brown (1). 10.6 Employment Agreement, dated as of January 3, 2005, between the Company and Scott M. Shaw (1). 10.7 Amended Employment Agreement, dated as of March 1, 2005, between the Company and Scott M. Shaw (1). 10.8 Employment Agreement, dated as of January 3, 2005, between the Company and Cesar Ribeiro (1). 10.9 Amended Employment Agreement, dated as of March 1, 2005, between the Company and Cesar Ribeiro (1). 10.10 Lincoln Educational Services Corporation 2005 Long Term Incentive Plan (1). 10.11 Lincoln Educational Services Corporation 2005 Non Employee Directors Restricted Stock Plan (1). 10.12 Lincoln Educational Services Corporation 2005 Deferred Compensation Plan (1). 10.13 Lincoln Technical Institute Management Stock Option Plan, effective January 1, 2002 (1). 10.14 Form of Stock Option Agreement, dated January 1, 2002, between Lincoln Technical Institute, Inc. and certain participants (1).
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10.15 Management Stock Subscription Agreement, dated January 1, 2002, among Lincoln Technical Institute, Inc. and certain management investors (1). 10.16 Stockholder's Agreement among Lincoln Educational Services Corporation, Back to School Acquisition L.L.C., Steven W. Hart and Steven W. Hart 2003 Grantor Retained Annuity Trust (2). 10.17 * Stock Purchase Agreement, dated as of March 30, 2006, among Lincoln Technical Institute, Inc., and Richard I. Gouse, Andrew T. Gouse, individually and as Trustee of the Carolyn Beth Gouse Irrevocable Trust, Seth A. Kurn and Steven L. Meltzer. 31.1 * Certification of Chairman & Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 * Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32 * Certification of Chairman & Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -----------------
* Filed herewith (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. 21 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Date: May 12, 2006 LINCOLN EDUCATIONAL SERVICES CORPORATION By: /S/ CESAR RIBEIRO --------------------------- Cesar Ribeiro Chief Financial Officer (Principal Accounting and Financial Officer)