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EDMC > SEC Filings for EDMC > Form 10-Q on 10-Feb-2014All Recent SEC Filings

Show all filings for EDUCATION MANAGEMENT CORPORATION

Form 10-Q for EDUCATION MANAGEMENT CORPORATION


10-Feb-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Key Trends, Developments and Challenges
We operate in a dynamic business environment. The following developments and trends present opportunities, challenges and risks to our business:
New regulations may have a significant impact on our business. Our business is highly regulated and there has been an increased focus on regulations designed to address the rising costs of post-secondary education in order to make higher education more affordable. President Obama announced a plan to measure performance by post-secondary institutions through a new rating system designed to provide students and their families with information to select schools that provide the best value. The President's plan would permit Congress to tie federal student aid to performance by post-secondary institutions to allow students to maximize their federal aid at institutions that provide the best value. The U.S. Department of Education announced new proposed rulemaking topics, including a negotiated rulemaking panel to address the appropriateness of adopting standards for measuring whether programs offered by proprietary institutions such as ours lead to "gainful employment" in a recognized occupation. Under the Higher Education Act of 1965, as amended ("HEA"), with the exception of certain liberal arts degree programs, proprietary schools are eligible to participate in Title IV programs only with respect to educational programs that prepare a student for "gainful employment in a recognized occupation." The U.S. Department of Education previously adopted regulations that were scheduled to become effective as of July 1, 2012 and that would have for the first time set forth standards for measuring whether programs lead to gainful employment in a recognized occupation. These regulations, which were vacated by a federal court decision, would have established three annual metrics related to student loan borrowing which would have imposed certain restrictions on programs up to and including the prohibition on participation in Title IV financial aid programs in the event that the metrics were not satisfied over a period of time. Draft regulatory language posted by the U. S. Department of Education on August 30, 2013 takes a similar approach to determining program eligibility as the vacated 2011 regulations except that one of the three program eligibility tests has been eliminated. The draft regulatory language includes a number of modifications to the provisions of the vacated regulation and some additional provisions, with many of these changes being more restrictive than the terms of the regulation proposed in 2011. Negotiated rulemaking sessions were held in November and December 2013, but the proposal distributed by the U. S. Department of Education for discussion at the last session did not reach consensus, and the Department is preparing to publish a notice of proposed rulemaking for public comment. If implemented as proposed as part of the negotiated rulemaking sessions, the regulatory language would have a material adverse impact on our business. On January 30, 2014, the Office of Information and Regulatory Affairs ("OIRA") at the Office of Management and Budget ("OMB") posted a notice that it had received a draft of the proposed gainful employment rule from the Department of Education. The draft regulation is reviewed by OIRA/OMB prior to a notice of proposed rulemaking being released for public comment.
In addition, the HEA is scheduled for reauthorization in 2014 and the reauthorization process may result in significant changes to the post-secondary education industry. Among other things, there have been proposals in Congress to amend the 90/10 rule in connection with the reauthorization of the HEA to prohibit proprietary institutions from receiving more than 85 percent of their revenues from federal funds, including veterans benefits and U.S. Department of Defense tuition assistance. Any revisions to the HEA, the regulations adopted by the U.S. Department of Education, or the 90/10 rule could have a material adverse impact on our business. An amendment to the U. S. Telephone Consumer Protection Act of 1991 became effective on October 16, 2013 which, among other things, requires specific prior written consent from consumers in order to place telemarketing calls to wireless phones using an automatic telephone dialing system. We use telephonic communications with prospective students and cannot estimate the impact of this new regulation, including compliance costs, on our business at this early stage of compliance. However, we believe that it contributed to lower than anticipated application production across our organization for future academic terms due to delays in contacting prospective students.
In January 2014, the U.S. Department of Education commenced negotiated rulemaking sessions to implement changes to the Clery Act required by the Violence Against Women Act which, among other items, requires institutions to compile statistics for certain crimes reported to campus security authorities or local police agencies, and include such information in its annual security report. Finally, another series of negotiated rulemaking sessions to address program integrity and improvement issues will be held in February, March, and April 2014, and will address cash management of Title IV funds including use of debit cards and handling of Title IV credit balances; state authorization for programs offered through distance or correspondence education; state authorization for non-U.S. locations of educational institutions; clock to credit hour conversion; the definition of "adverse credit" for borrowers under the Federal Direct PLUS Loan Program; and the application of repeat coursework provisions to graduate and undergraduate programs.


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We have increased our focus on student affordability, which can have a negative impact on our net revenues.
In the past, we and other providers of a post-secondary education were able to pass along the rising cost of providing quality education through increases in tuition charged to students. As a result, the cost of a post-secondary degree increased substantially while incomes earned by families stagnated due to a weak economy. In order to make our programs more attractive to prospective students, we have introduced a number of initiatives to limit or decrease the cost of obtaining a degree from our institutions, including freezing tuition at The Art Institutes through 2015 for students who enrolled by October 2013, decreasing the number of credit hours necessary to complete certain programs, reducing certain fees and other charges, and substantially increasing the availability of scholarships to students. We have awarded approximately $70 million of scholarships in the six months ended December 31, 2013, an increase of approximately 50 percent compared to the six months ended December 31, 2012, with the majority of scholarships awarded at The Art Institutes. We anticipate awarding approximately $140 million in scholarships in fiscal 2014, an increase of approximately 45 percent from fiscal 2013. Due to this focus on decreasing the cost of education at our schools, we estimate that the average debt incurred by students graduating from the Art Institutes has decreased by approximately 15 percent since 2010. We believe that our limited ability to increase tuition will continue for the foreseeable future.
We have adopted a number of initiatives to make our business more efficient and to respond to changing market conditions and will continue to do so in the future.
We have adopted a number of measures designed to make our business more efficient in order to decrease the cost of an education for our students and to respond to changing market conditions. Primarily through process efficiencies and productivity improvements, we are targeting cost savings of $100 million to $125 million during fiscal 2014 as compared to fiscal 2013. For example, during fiscal 2013, we created The Center, which provides support services to our four education systems through the centralization and automation of certain non-student facing activities, including financial aid packaging, the qualification and transfer of prospective students to school admissions teams, student billing services, certain registrar services, support call center services for our students and employees, and remote student advising services. Additionally, during fiscal 2014, we have taken measures to decrease our reliance on third party lead generators and we anticipate these efforts will increase in the second half of the fiscal year. Some of these projected savings will offset cost increases in other areas of our business that we have incurred and expect to incur during the remainder of fiscal 2014. We believe that these affordability efforts, some of which increase the risk associated with our future operating results, contribute significantly to our core mission of educating students.
Changes in the availability of PLUS program loans contributed to a reduction in student enrollment and net revenues at The Art Institutes during fiscal 2013 and are likely to adversely impact new students in fiscal 2014 and beyond. Approximately 50 percent of the campus-based students attending The Art Institutes education system are considered dependents for Title IV program purposes. These traditional-age students often receive financial support from their parents to help pay for their education. As part of this support, parents often participate in the PLUS program, which allows parents of a dependent student to borrow an amount not to exceed the difference between the total cost of that student's education and other aid to which that student is entitled. During fiscal 2012, the U.S. Department of Education implemented more stringent underwriting criteria for PLUS program loans, which resulted in a decrease in the percentage of our net revenues we received from PLUS loans from 12.4 percent in fiscal 2012 to 8.3 percent in fiscal 2013. Total new students at The Art Institutes decreased approximately 12.8 percent in fiscal 2013 as compared to fiscal 2012, which we believe was due in part to the decrease in PLUS loan availability.
We have undertaken a number of actions to address this issue including, among other measures, expanding our scholarship programs at The Art Institutes and extending greater amounts of credit to those Art Institute students who are denied PLUS program loans but who still enroll in school. Additionally, we increased the maximum length of payment plans we offer students from 36 months beyond graduation to 42 months beyond graduation effective in October 2012. Further, we commenced a new program under which we purchase loans awarded and disbursed to our students from a private lender during the fourth quarter of fiscal 2013. All of these initiatives have negatively impacted our liquidity. The changes we have made with respect to extension of credit to our students have resulted in higher gross long-term student receivable and purchased loan program balances, which were $67.2 million at December 31, 2013 and $43.0 million at December 31, 2012 and higher bad debt expense as a percentage of net revenues compared to prior periods. Bad debt expense was 7.2 percent and 7.1 percent of net revenues during the six months ended December 31, 2013 and 2012, respectively, and 6.9 percent and 5.9 percent during the fiscal years ended June 30, 2013 and 2012.
Investigations of proprietary education institutions, adverse publicity, and outstanding litigation have adversely impacted our operating results and student enrollment.
Although we believe that there are a number of factors that should contribute to long-term demand for post-secondary education, recently the industry as a whole has been challenged by a number of factors, including the overall negative impact of the current political and economic climate. We and other proprietary post-secondary education providers have been subject to


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increased regulatory scrutiny and litigation in recent years. On July 30, 2012, the majority staff of the US Senate Committee on Health, Education, Labor, & Pensions (the "HELP Committee") released a report, "For Profit Higher Education:
The Failure to Safeguard the Federal Investment and Ensure Student Success" which was drawn from hearings on the industry beginning in August 2010. While stating that proprietary colleges and universities have an important role to play in higher education and should be well-equipped to meet the needs of non-traditional students who now constitute the majority of the post-secondary educational population, the report was highly critical of these institutions. Additionally, a number of state Attorneys General have launched investigations into proprietary post-secondary institutions, including a number of our schools. We received subpoenas from the Attorneys General of Florida, Kentucky, New York, Colorado, and Massachusetts in October 2010, December 2010, August 2011, September 2012, and January 2013, respectively, and the San Francisco, California City Attorney in December 2011 in connection with investigations of our institutions and their business practices. As previously disclosed, on December 5, 2013, the Company entered into a Final Consent Judgment with the Colorado Attorney General's Office, and we accrued the $3.4 million settlement within general and administrative expense in the accompanying consolidated statement of operations in the three months ended December 31, 2013. We also received inquiries from 13 states in January 2014 regarding our business practices, which will be coordinated through the Attorney General of the Commonwealth of Pennsylvania.
In addition, we received subpoenas from the Division of Enforcement of the Securities and Exchange Commission in March 2013 and May 2013 requesting documents and information relating to our valuation of goodwill in fiscal 2012, bad debt allowance for student receivables, and letters of credit we posted with the U.S. Department of Education. We also received a subpoena from the Office of Inspector General of the U.S. Department of Education in May 2013 requesting policies and procedures related to Argosy University's attendance, withdrawal, and return to Title IV policies. These investigations, together with the Washington qui tam lawsuit in which the U.S. Department of Justice and Attorneys General from five states have intervened, have led to a significant amount of negative publicity for the proprietary education industry and our schools. The Consumer Financial Protection Bureau and state attorneys general are also investigating student-lending practices at proprietary education institutions, which actions are expected to continue and could expand in 2014. On January 30, 2014, the Federal Trade Commission (the "FTC") announced a new system to handle complaints from military veterans and service members regarding higher education institutions, providing online reporting forms to file complaints directly with the U.S. Department of Veterans Affairs and the U.S. Department of Defense regarding issues such as cost of attendance, marketing, graduation rates, program quality employment prospects, and course credit. Students may also email similar complaints to the U.S. Department of Education. These complaints will be forwarded to the FTC's Consumer Sentinel Network database. These initiatives could result in additional litigation and investigations regarding proprietary education.
Student concerns regarding the assumption of additional debt in light of the current economic climate have given rise to reluctance to pursue further education.
Due to the effects of the current economic climate many prospective students are unable to make cash payments towards their education. Recently, there has been a significant amount of negative publicity surrounding the incurrence of excessive debt to pay for a post-secondary education. On July 19, 2012, the Consumer Financial Protection Bureau ("CFPB") and the U.S. Department of Education issued a report describing what they characterized as risky practices in the private student loan market over the past ten years, among other things. According to the CFPB's estimates, outstanding student loan debt in the United States exceeded $1 trillion in 2011, consisting of $864 billion of federal student debt and $150 billion of private student loan debt. A number of media outlets have published stories linking student loan indebtedness to the recent mortgage loan crisis. We believe that the negative publicity surrounding student indebtedness, together with the inability of students to pay cash for their education and the effect of a stagnant economy and challenged employment prospects, have led to a reluctance in a number of prospective students to enroll in our schools. The education industry is rapidly evolving and highly competitive. The U.S. higher education industry, including the proprietary sector, is experiencing unprecedented, rapidly developing changes due to technological developments, evolving needs and objectives of students and employers, economic constraints affecting educational institutions and students, price competition, increased focus on affordability, and other factors that challenge many of the core principles underlying the industry. Related to this, a substantial proportion of traditional colleges and universities and community colleges now offer some form of distance learning or online education programs, including programs geared towards the needs of working learners. As a result, we face increased competition for students, including from colleges with well-established brand names. In addition, we face competition from various emerging nontraditional, credit-bearing and noncredit-bearing education programs, offered by both proprietary and not-for-profit providers. These include massive open online courses (MOOCs) offered worldwide without charge by traditional educational institutions and other direct-to-consumer education services, which some educational institutions are now accepting for credit. Further, according to information published by the National Student Clearinghouse, enrollment in post-secondary institutions decreased by 1.5 percent from the Fall of 2012 to the Fall of 2013, and enrollment in four-year proprietary institutions decreased by 9.7 percent during the same time period. We must adapt our business to meet these rapidly evolving developments. We are wo


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rking to accelerate the enhancement of our offerings to remain competitive and to more effectively deliver a quality student experience at an attractive price. Our business is highly leveraged, which requires us to use cash from operations to repay indebtedness and subjects us to market conditions to refinance debt. At December 31, 2013, we had $1.28 billion of indebtedness outstanding. The terms of our debt agreements restrict us from certain activities such as incurring additional indebtedness and require us to comply with several financial ratios, which has become more difficult to do as a result of our weaker financial results in recent periods. We refinanced and repaid $375.0 million of 8.75 percent senior notes due June 1, 2014 and issued $203.0 million of senior notes, which are due on July 1, 2018. We are also required to post a letter of credit with the U.S. Department of Education due to our failure to meet certain financial responsibility standards. As of January 2014, this letter of credit requirement is set at 15 percent of the Title IV program funds received by students at our institutions during fiscal 2013, which is $302.2 million. Our significant indebtedness requires us to use a substantial portion of cash flows from operations for the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flows to fund our operations and invest further in our business. The factors described above, which have adversely impacted our business, have also made it more difficult to refinance our indebtedness due to investor uncertainty about our results from operations. We also are subject to market factors in connection with our efforts to refinance our indebtedness, including our revolving credit facility which expires on June 1, 2015 and a portion of our term loan which is due in 2016. We may not be able to obtain additional financing on acceptable terms, if at all, particularly because of our high levels of debt and the debt incurrence restrictions imposed by the agreements governing our debt. To the extent that we do refinance any portion of our debt, that refinanced debt is likely to be subject to higher interest rates and fees than our existing debt. In addition, under its senior secured credit facilities, our subsidiary, Education Management LLC, is required to satisfy a maximum total leverage ratio, a minimum interest coverage ratio and other financial conditions tests. While Education Management LLC has continued to satisfy applicable financial covenant compliance ratios, due to declining operating performance, the margin between our results and the covenant requirements has decreased significantly over the past 12 months. Federal government shut down.
On October 1, 2013, the U.S. Departments of Education, Defense, and Veterans Affairs began operating on a limited basis due to the partial federal government shutdown. The contingency plans for the U.S. Department of Education provided that Pell Grant and Direct Student Loan programs under Title IV of the Higher Education Act, which are funded through mandatory and carryover appropriations, would continue to operate as normal for the foreseeable future, and that the U.S. Department of Veterans Affairs benefits would be paid until current funds were exhausted. In some cases the U.S. Department of Defense ceased to provide educational benefits to students. The government shutdown ceased on October 17, 2013 when President Obama signed legislation to fund federal government agencies until January 15, 2014, and to raise the federal debt ceiling through February 7, 2014, and the U.S. Departments of Education, Defense and Veterans Affairs resumed normal activity. However, the February 7, 2014 deadline has passed and the U.S. Department of Treasury currently estimates that it will exhaust its borrowing capacity to fund the government in late February if the debt ceiling is not raised or suspended prior to such time. We are unable to anticipate whether a subsequent shutdown will occur in the future, the nature and scope of any related contingency plan, or the likelihood of another agreement to raise the debt ceiling, the occurrence or non-occurrence of each of which could negatively impact our revenues and adversely affect our business, results of operations, financial condition, and cash flows.


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