LINCOLN EDUCATIONAL SERVICES CORP 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion together with the “Selected Financial Data,” “Forward-Looking Statements” and the consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Risk Factors” and “Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K. GENERAL Lincoln Educational Services Corporation and its subsidiaries (collectively, the “Company”, “we”, “our” and “us”, as applicable) provide diversified career-oriented post-secondary education to recent high school graduates and working adults. The Company, which currently operates 22 schools in 14 states, offers programs in automotive technology, skilled trades (which include HVAC, welding and computerized numerical control and electrical and electronic systems technology, among other programs), healthcare services (which include nursing, dental assistant and medical administrative assistant, among other programs), hospitality services (which include culinary, therapeutic massage, cosmetology and aesthetics) and information technology (which includes information technology). The schools operate under Lincoln Technical Institute, Lincoln College of Technology, Lincoln Culinary Institute, and Euphoria Institute of Beauty Arts and Sciences and associated brand names. Most of the campuses serve major metropolitan markets and each typically offers courses in multiple areas of study. Five of the campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. The Company’s other campuses primarily attract students from their local communities and surrounding areas. All of the campuses are nationally or regionally accredited and are eligible to participate in federal financial aid programs by the U.S. Department of Education (the “DOE”) and applicable state education agencies and accrediting commissions which allow students to apply for and access federal student loans as well as other forms of financial aid. Our business is organized into three reportable business segments: (a) Transportation and Skilled Trades, (b) Healthcare and Other Professions (“HOPS”), and (c) Transitional, which refers to our campus operations which have been closed. As of December 31, 2020, we had 12,217 students enrolled at 22 campuses which excludes 102 students on leave of absence due to COVID-19. Our campuses, a majority of which serve major metropolitan markets, are located throughout the United States. Five of our campuses are destination schools, which attract students from across the United States and, in some cases, from abroad. Our other campuses primarily attract students from their local communities and surrounding areas. All of our schools are either nationally or regionally accredited and are eligible to participate in federal financial aid programs. Our revenues consist primarily of student tuition and fees derived from the programs we offer. Our revenues are reduced by scholarships granted to our students. We recognize revenues from tuition and one-time fees, such as application fees, ratably over the length of a program, including internships or externships that take place prior to graduation. We also earn revenues from our bookstores, dormitories, cafeterias and contract training services. These non-tuition revenues are recognized upon delivery of goods or as services are performed and represent less than 10% of our revenues. Our revenues are directly dependent on the average number of students enrolled in our schools and the courses in which they are enrolled. Our average enrollment is impacted by the number of new students starting, re-entering, graduating and withdrawing from our schools. Our diploma/certificate programs range from 19 to 136 weeks, our associate’s degree programs range from 64 to 98 weeks, and students attend classes for different amounts of time per week depending on the school and program in which they are enrolled. Because we start new students every month, our total student population changes monthly. The number of students enrolling or re-entering our programs each month is driven by the demand for our programs, the effectiveness of our marketing and advertising, the availability of financial aid and other sources of funding, the number of recent high school graduates, the job market and seasonality. Our retention and graduation rates are influenced by the quality and commitment of our teachers and student services personnel, the effectiveness of our programs, the placement rate and success of our graduates and the availability of financial aid. Although similar courses have comparable tuition rates, the tuition rates vary among our numerous programs. The majority of students enrolled at our schools rely on funds received under various government-sponsored student financial aid programs to pay a substantial portion of their tuition and other education-related expenses. The largest of these programs are Title IV Programs which represented approximately 77% and 78% of our revenue on a cash basis while the remainder is primarily derived from state grants and cash payments made by students during 2020 and 2019, respectively. The Higher Education Act of 1965, as amended (the “HEA”) requires institutions to use the cash basis of accounting when determining its compliance with the 90/10 Rule. 36 Index We extend credit for tuition and fees to many of our students that attend our campuses. Our credit risk is mitigated through the students’ participation in federally funded financial aid programs unless students withdraw prior to the receipt by us of Title IV Program funds for those students. Under Title IV Programs, the government funds a certain portion of a student’s tuition, with the remainder, referred to as “the gap,” financed by the students themselves under private party loans and extended financing agreements offered by us. The gap amount has continued to increase over the last several years as we have raised tuition on average for the last several years by 2-3% per year and restructured certain programs to reduce the amount of financial aid available to students, while funds received from Title IV Programs increased at lower rates. The additional financing that we are providing to students may expose us to greater credit risk and can impact our liquidity. However, we believe that these risks are somewhat mitigated due to the following: • Our internal financing is provided to students only after all other funding resources have been exhausted; thus, by the time this funding is available, students have completed approximately two-thirds of their curriculum and are more likely to graduate; • Funding for students who interrupt their education is typically covered by Title IV Program funds as long as they have been properly packaged for financial aid; and • Creditworthy criteria to demonstrate a student’s ability to pay. The operating expenses associated with an existing school do not increase or decrease proportionally as the number of students enrolled at the school increases or decreases. We categorize our operating expenses as: • Educational services and facilities. Major components of educational services and facilities expenses include faculty compensation and benefits, expenses of books and tools, facility rent, maintenance, utilities, depreciation and amortization of property and equipment used in the provision of education services and other costs directly associated with teaching our programs excluding student services which is included in selling, general and administrative expenses. • Selling, general and administrative. Selling, general and administrative expenses include compensation and benefits of employees who are not directly associated with the provision of educational services (such as executive management and school management, finance and central accounting, legal, human resources and business development), marketing and student enrollment expenses (including compensation and benefits of personnel employed in sales and marketing and student admissions), costs to develop curriculum, costs of professional services, bad debt expense, rent for our corporate headquarters, depreciation and amortization of property and equipment that is not used in the provision of educational services and other costs that are incidental to our operations. Selling, general and administrative expenses also includes the cost of all student services including financial aid and career services. All marketing and student enrollment expenses are recognized in the period incurred. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussions of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. On an ongoing basis, we evaluate our estimates and assumptions, including those related to revenue recognition, bad debts, fixed assets, goodwill and other intangible assets, income taxes and certain accruals. Actual results could differ from those estimates. The critical accounting policies discussed herein are not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not result in significant management judgment in the application of such principles. 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. Substantially all of our revenues are considered to be revenues from contracts with students. The related accounts receivable balances are recorded in our balance sheets as student accounts receivable. We do not have significant revenue recognized from performance obligations that were satisfied in prior periods, and we do not have any transaction price allocated to unsatisfied performance obligations other than in our unearned tuition. We record revenue for students who withdraw from our schools only to the extent that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Unearned tuition represents contract liabilities primarily related to our tuition revenue. We have elected not to provide disclosure about transaction prices allocated to unsatisfied performance obligations if original contract durations are less than one-year, or if we have the right to consideration from a student in an amount that corresponds directly with the value provided to the student for performance obligations completed to date in accordance with Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contract with Customers . We have assessed the costs incurred to obtain a contract with a student and determined them to be immaterial. 37 Index 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 in our collection efforts. In establishing our allowance for uncollectible accounts, we consider, among other things, current and expected economic conditions, a student’s status (in-school or out-of-school), whether or not a student is currently making payments, and overall collection history. Changes in trends in any of these areas may impact the allowance for uncollectible accounts. The receivables balances of withdrawn students with delinquent obligations are reserved for based on our collection history. Although we believe that our reserves are adequate, if the financial condition of our students deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be necessary, which will result in increased selling, general and administrative expenses in the period such determination is made. Our bad debt expense as a percentage of revenues for the years ended December 31, 2020 and 2019 was 9.2% and 7.6%, respectively. A 1% increase in our bad debt expense as a percentage of revenues for the years ended December 31, 2020 and 2019 would have resulted in an increase in bad debt expense of $2.9 million and $2.7 million, respectively. We do not believe that there is any direct correlation between tuition increases, the credit we extend to students and our financing commitments. The extended financing plans we offer to our students are made on a student-by-student basis and are predominantly a function of the specific student’s financial condition. We only extend credit to the extent there is a financing gap between the tuition and fees charged for the program and the amount of grants, loans and parental loans each student receives. Each student’s funding requirements are unique. Factors that determine the amount of aid available to a student include whether they are dependent or independent students, Pell grants awarded, Federal Direct loans awarded, Plus loans awarded to parents and the student’s personal resources and family contributions. As a result, it is extremely difficult to predict the number of students that will need us to extend credit to them. Our tuition increases have averaged 2-3% annually and have not meaningfully impacted overall funding requirements, since the amount of financial aid funding available to students in recent years has increased at greater rates than our tuition increases. Because a substantial portion of our revenues are derived from Title IV Programs, any legislative or regulatory action that significantly reduces the funding available under Title IV Programs or the ability of our students or schools to participate in Title IV Programs could have a material effect on the realizability of our receivables. Goodwill. We test our goodwill for impairment annually, or whenever events or changes in circumstances indicate an impairment may have occurred, by comparing its fair value to its carrying value. Impairment may result from, among other things, deterioration in the performance of the acquired business, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of the acquired business, and a variety of other circumstances. If we determine that impairment has occurred, we are required to record a write-down of the carrying value and charge the impairment as an operating expense in the period the determination is made. In evaluating the recoverability of the carrying value of goodwill and other indefinite-lived intangible assets, we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the acquired assets. Changes in strategy or market conditions could significantly impact these judgments in the future and require an adjustment to the recorded balances. Goodwill represents a significant portion of our total assets. As of December 31, 2020, goodwill was approximately $14.5 million, or 5.9%, of our total assets, from approximately $14.5 million, or 7.5%, of our total assets at December 31, 2019. The goodwill is allocated among nine reporting units within the Transportation and Skilled Trades Segment. When we test goodwill balances for impairment, we determine the fair value of each of our reporting units using an equal weighting of the discounted cash flow model and the market approach. The determination of fair value using the discounted cash flow model requires significant estimates and assumptions related to forecasts of future revenues, which is driven by student start growth, EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) margins, the long-term growth rate used in the calculation of the terminal value, and the discount rate to apply against each reporting unit’s financial metrics. The determination of fair value using the market approach requires significant estimates and assumptions related to the selection of EBITDA multiples and the control premiums. Changes in these assumptions could have a significant impact on either the fair value, the amount of any goodwill impairment charge, or both. Although we believe our projected future operating results and cash flows and related estimates regarding fair values are based on reasonable assumptions, historically projected operating results and cash flows have not always been achieved. The failure of one of our reporting units to achieve projected operating results and cash flows in the near term or long term may reduce the estimated fair value of the reporting unit below its carrying value and result in the recognition of a goodwill impairment charge. Significant management judgment is necessary to evaluate the impact of operating and macroeconomic changes and to estimate future cash flows. Assumptions used in our impairment evaluations, such as forecasted growth rates and our cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. In addition to cash flow estimates, our valuations are sensitive to the rate used to discount cash flows and future growth assumptions. At December 31, 2020 and 2019, we conducted our annual test for goodwill impairment and determined we did not have an impairment. 38 Index Income taxes. We account for income taxes in accordance with ASC Topic 740, “ Income Taxes ” (“ASC 740”) which requires an asset and a liability approach for measuring deferred taxes based on temporary differences between the financial statement and tax bases of assets and liabilities existing at each balance sheet date using enacted tax rates for years in which taxes are expected to be paid or recovered. In accordance with ASC 740, we assess our deferred tax asset to determine whether all or any portion of the asset is more likely than not unrealizable. A valuation allowance is required to be established or maintained when, based on currently available information, it is more likely than not that all or a portion of a deferred tax asset will not be realized. In accordance with ASC 740, our assessment considers whether there has been sufficient income in recent years and whether sufficient income is expected in future years in order to utilize the deferred tax asset. In evaluating the realizability of deferred income tax assets we considered, among other things, historical levels of income, expected future income, the expected timing of the reversals of existing temporary reporting differences, and the expected impact of tax planning strategies that may be implemented to prevent the potential loss of future income tax benefits. Significant judgment is required in determining the future tax consequences of events that have been recognized in our consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated financial position or results of operations. Changes in, among other things, income tax legislation, statutory income tax rates, or future income levels could materially impact our valuation of income tax assets and liabilities and could cause our income tax provision to vary significantly among financial reporting periods. We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense. During the years ended December 31, 2020 and 2019, we did not record any interest and penalties expense associated with uncertain tax positions. Results of Operations for the Two Years Ended December 31, 2020 The following table sets forth selected consolidated statements of operations data as a percentage of revenues for each of the periods indicated: Year Ended Dec 31, 2020 2019 Revenue 100.0 % 100.0 % Costs and expenses: Educational services and facilities 41.7 % 45.2 % Selling, general and administrative 53.3 % 53.1 % Loss on sale of assets 0.0 % -0.2 % Total costs and expenses 95.0 % 98.1 % Operating income 5.0 % 1.9 % Interest expense, net -0.4 % -1.1 % Income from opeartions before income taxes 4.6 % 0.8 % (Benefit) provision for income taxes -12.0 % 0.1 % Net income 16.6 % 0.7 % Year Ended December 31, 2020 Compared to Year Ended December 31, 2019 Consolidated Results of Operations Revenue. Revenue increased $19.8 million, or 7.2% to $293.1 million for the year ended December 31, 2020 from $273.3 million in the prior year. The increase in revenue was a result of a 6.8% increase in average student population year over year, driven by a 10.7% increase in student starts. Student start growth of 10.7% benefitted from our ongoing investments in marketing as well as continuous evaluation and improvement of the admissions process. Increased efficiency is evidenced by a decline in the overall cost to obtain student starts while continuing growth. Lincoln has now experienced three years of consistent growth in student starts, with the only exception being the first quarter of 2020 which was impacted by COVID-19. The consistent student start growth has also increased the year over year ending population, which as of December 31, 2020 grew by approximately 1,000 students or 8.3% to 12,217 excluding 102 students classified as on a leave of absence. Students classified as on leave of absence resulted from the continuing impact of COVID-19, which restricted access to externship sites and classroom labs ultimately resulting in the extension of certain students’ graduation dates. Educational services and facilities expense. Our educational services and facilities expense decreased $1.3 million, or 1.1% to $122.2 million for the year ended December 31, 2020 from $123.5 million in the prior year comparable period. The reduction in costs were driven by facility closures during the first and second quarter as a result of the impact of COVID-19. Among the byproducts of the campus closures were reductions in utilities expenses, regular daily cleaning services and meal plan expenses. Further cost savings were realized from rent abatements at certain campuses resulting in lower rent expense while campuses were closed. Partially offsetting these savings were additional books and tools expense and instructional expense resulting from an increased student population. 39 Index Educational services and facilities expense, as a percentage of revenue, decreased to 41.7% from 45.2% for the year ended December 31, 2020 and 2019, respectively. Selling, general and administrative expense. Our selling general and administrative expense increased $11.0 million, or 7.6% to $156.2 million for the year ended December 31, 2020 from $145.2 million in the prior year period. The increase year over year was driven by several factors including increased administrative expense, additional bad debt expense and increases in our marketing investments year over year. Partially offsetting the increase were cost savings in sales and student services. Increased administrative expense was driven by actions taken in response to the impact of COVID-19 on our employees and students and an increase in incentive compensation accruals driven by improved financial performance. Bad debt expense increased as a result of a higher reserve amount for doubtful accounts due to greater reserve rates and higher accounts receivable mostly driven by student population growth and the effects from COVID-19. The COVID-19 pandemic presented challenges in our ability to reach students during campus closures and subsequently reduced on-site hours, resulting in delays in financial aid packaging and Title IV disbursements during the second and third quarters. However, as a result of the strong focus and efforts, the fourth quarter demonstrated significant improvement or reduction in the amount of delayed Title IV disbursements. Marketing investments increased year over year to continue to capitalize on more cost effective lead generating opportunities. We invested in higher converting channels while reducing our spend through less expensive, yet lower converting, third party affiliate channels. In 2020 we also experienced a year over year increase in production costs with the development of a series of new commercial ads to air on traditional TV as well as through digital media channels designed to drive greater brand awareness. Despite the increased investment in marketing, our cost per start for the full year decreased compared to the prior year, demonstrating that we are achieving a strong return on our investment as evidenced by a 10.7% increase in year over year starts. Reductions in sales expense were the result of travel restrictions imposed by the COVID-19 pandemic, while lower student services expense was the result of suspended busing and transportation services for students. Selling, general and administrative expense, as a percentage of revenue, increased to 53.3% from 53.1% for the year ended December 31, 2020 and 2019, respectively. Net interest expense. Net interest expense for the year ended December 31, 2020 decreased $1.7 million, or 56.9% to $1.3 million from $3.0 million in the prior year comparable period. The decrease year over year is due to the reduction in interest rates we obtained in our current credit facility in combination with a lower loan balance outstanding in the current year. Income taxes. Our income tax benefit for the fiscal year ended December 31, 2020 was $35.1 million compared to an income tax provision of $0.3 million in the prior fiscal year. The fiscal 2020 tax benefit primarily relates to a release of valuation allowance on deferred tax assets due to sufficient positive evidences obtained during fiscal year 2020. Segment Results of Operations We operate our business in three reportable segments: (a) the Transportation and Skilled Trades segment; (b) the Healthcare and Other Professions (“HOPS”) segment; and (c) the Transitional segment. Our reportable segments have been determined based on a method by which we now evaluate performance and allocate resources. Each reportable segment represents a group of post-secondary education providers that offer a variety of degree and non-degree academic programs. These segments are organized by key market segments to enhance operational alignment within each segment to more effectively execute our strategic plan. Each of the Company’s schools is a reporting unit and an operating segment. Our operating segments are described below. Transportation and Skilled Trades – The Transportation and Skilled Trades segment offers academic programs mainly in the career-oriented disciplines of transportation and skilled trades (e.g. automotive, diesel, HVAC, welding and manufacturing). Healthcare and Other Professions – The Healthcare and Other Professions segment offers academic programs in the career-oriented disciplines of health sciences, hospitality and business and information technology (e.g. dental assistant, medical assistant, practical nursing, culinary arts and cosmetology). 40 Index Transitional – The Transitional segment refers to our campus operations which have been closed. The schools in the Transitional segment employed a gradual teach-out process that enabled the schools to continue to operate to allow their current students to complete their course of study. The Company continually evaluates each campus for profitability, earning potential, and customer satisfaction. This evaluation takes several factors into consideration, including the campus’s geographic location and program offerings, as well as skillsets required of our students by their potential employers. The purpose of this evaluation is to ensure that our programs provide our students with the best possible opportunity to succeed in the marketplace with the goals of attracting more students to our programs and, ultimately, to provide our shareholders with the maximum return on their investment. Campuses classified in the Transitional segment have been subject to this process and have been strategically identified for closure. No campuses have been categorized in the Transitional segment since the year ended December 31, 2018. We evaluate segment performance based on operating results. Adjustments to reconcile segment results to consolidated results are included under the caption “Corporate,” which primarily includes unallocated corporate activity. 41 Index The following table present results for the activity for our reportable segments for the years ended December 31, 2020 and 2019: Twelve Months Ended December 31, 2020 2019 % Change Revenue: Transportation and Skilled Trades $ 207,434 $ 193,722 7.1 % Healthcare and Other Professions 85,661 79,620 7.6 % Total $ 293,095 $ 273,342 7.2 % Operating Income (Loss): Transportation and Skilled Trades $ 34,458 $ 21,979 56.8 % Healthcare and Other Professions 11,068 7,588 45.9 % Corporate (30,745 ) (24,329 ) -26.4 % Total $ 14,781 $ 5,238 182.2 % Starts: Transportation and Skilled Trades 9,442 8,548 10.5 % Healthcare and Other Professions 4,879 4,386 11.2 % Total 14,321 12,934 10.7 % Average Population: Transportation and Skilled Trades 7,872 7,319 7.6 % Leave of Absense - COVID-19 (219 ) - 100.0 % Transportation and Skilled Trades Excluding Leave of Absense - COVID-19 7,653 7,319 4.6 % Healthcare and Other Professions 4,232 3,666 15.4 % Leave of Absense - COVID-19 (156 ) - 100.0 % Healthcare and Other Professions Excluding Leave of Absense - COVID-19 4,076 3,666 11.2 % Total 12,104 10,985 10.2 % Total Excluding Leave of Absense - COVID-19 11,729 10,985 6.8 % End of Period Population: Transportation and Skilled Trades 7,917 7,349 7.7 % Leave of Absense - COVID-19 (22 ) - 100.0 % Transportation and Skilled Trades Excluding Leave of Absense - COVID-19 7,895 7,349 7.4 % Healthcare and Other Professions 4,402 3,936 11.8 % Leave of Absense - COVID-19 (80 ) - 100.0 % Healthcare and Other Professions Excluding Leave of Absense - COVID-19 4,322 3,936 9.8 % Total 12,319 11,285 9.2 % Total Excluding Leave of Absense - COVID-19 12,217 11,285 8.3 % 42 Index Year Ended December 31, 2020 Compared to Year Ended December 31, 2019 Transportation and Skilled Trades Student start results increased 10.5% to 9,442 for the fiscal year ended December 31, 2020 from 8,548 in the prior fiscal year. Operating income increased $12.5 million, or 56.8% to $34.5 million for the year ended December 31, 2020 from $22.0 million in the prior year comparable period. The increase year over year was mainly driven by the following factors: • Revenue increased $13.7 million, or 7.1% to $207.4 million for the year ended December 31, 2020 from $193.7 million in the prior year comparable period. The increase in revenue was primarily due to a 4.6% increase in average student population, driven by a 10.5% increase in student starts year over year. • Educational services and facilities expense decreased $2.3 million, or 2.7% to $83.4 million for the year ended December 31, 2020 from $85.7 million in the prior year comparable period. The reduced costs year over year were primarily driven by savings in facilities expense due to facility closures during the first and second quarter as a result of the COVID-19 pandemic, which drove down utilities expense, regular daily cleaning services and meal plan expense. Further cost savings were realized from rent abatements at certain campuses resulting in lower rent expense while campuses were closed. • Selling general and administrative expense increased $3.0 million, or 3.5% to $89.6 million for the year ended December 31, 2020 from $86.6 million in the prior year comparable period. The increase was primarily due to bad debt expense and additional investments in marketing. Partially offsetting the increase were cost savings in sales expense and student services expense all of which are discussed in detail above in the consolidated results of operations. Healthcare and Other Professions Student start results increased 11.2% to 4,879 for the year ended December 31, 2020 from 4,386 in the prior fiscal year. Operating income increased 45.9% to $11.1 million for the year ended December 31, 2020 from $7.6 million in the prior year comparable period. The $3.5 million increase was mainly driven by the following factors: • Revenue increased by $6.1 million, or 7.6% to $85.7 million for the year ended December 31, 2020 from $79.6 million in the prior year comparable period. The increase in revenue was primarily due to a 11.2% increase in average student population, driven by an 11.2% increase in student starts year over year. • Educational services and facilities expense increased $1.0 million, or 2.7% to $38.8 million for the year ended December 31, 2020 from $37.8 million in the prior year comparable period. The increase was primarily driven by increases in instructional expense and books and tools expense resulting from a larger student population year over year. Partially offsetting these costs were savings realized in facilities expense driven by facility closures during the first and second quarter as a result of the COVID-19 pandemic, which drove down utilities expense and regular daily cleaning services. Further cost savings were realized from rent abatements at certain campuses resulting in lower rent expense while campuses were closed. • Selling general and administrative expense increased $1.5 million, or 4.5% to $35.8 million for the year ended December 31, 2020 from $34.3 million in the prior year comparable period. The increase was primarily driven by bad debt expense, which is discussed in detail in the consolidated results of operations. Transitional No campuses have been classified in the Transitional segment for the year ended December 31, 2020 and 2019, respectively. Corporate and Other This category includes unallocated expenses incurred on behalf of the entire Company. Corporate and other expenses were $30.7 million and $24.3 million for each of the years ended December 31, 2020 and 2019, respectively. Increased expense was driven by actions taken in response to the impact of COVID-19 on our employees and students and an increase in incentive compensation accruals driven by improved financial performance. 43 Index LIQUIDITY AND CAPITAL RESOURCES Our primary capital requirements are for maintenance and expansion of our facilities and the development of new programs. Our principal sources of liquidity have been cash provided by operating activities and borrowings under our credit facility. The following chart summarizes the principal elements of our cash flow for each of the three fiscal years in the period ended December 31, 2020: Cash Flow Summary Year Ended December 31, 2020 2019 (In thousands) Net cash provided by operating activities $ 23,485 $ 988 Net cash used in investing activities $ (5,483 ) $ (4,810 ) Net cash used in financing activities $ (18,620 ) $ (3,480 ) As of December 31, 2020, the Company had a net cash balance of $20.8 million compared to $4.6 million in the prior year comparable period. The net cash balance is calculated as our cash, cash equivalents and both the short and long-term restricted cash less both short and long-term portion of the credit agreement. The increase in our net cash position is mainly attributed to net income generated by the Company during the year, partially offset by net repayments on borrowings of $17.0 million. As of December 31, 2020, the Company can borrow an additional $21.0 million under its credit facility. Our primary source of cash is tuition collected from our students. The majority of students enrolled at our schools rely on funds received under various government-sponsored student financial aid programs to pay a substantial portion of their tuition and other education-related expenses. The most significant source of student financing is Title IV Programs, which represented approximately 77% of our cash receipts relating to revenues in 2020. Pursuant to applicable regulations, students must apply for a new loan for each academic period. Federal regulations dictate the timing of disbursements of funds under Title IV Programs and loan funds are generally provided by lenders in two disbursements for each academic year. The first disbursement is usually received approximately 31 days after the start of a student’s academic year and the second disbursement is typically received at the beginning of the sixteenth week from the start of the student’s academic year. Certain types of grants and other funding are not subject to a 31-day delay. In certain instances, if a student withdraws from a program prior to a specified date, any paid but unearned tuition or prorated Title IV Program financial aid is refunded according to federal, state and accrediting agency standards. As a result of the significant amount of Title IV Program funds received by our students, we are highly dependent on these funds to operate our business. Any reduction in the level of Title IV Program funds that our students are eligible to receive or any restriction on our eligibility to receive Title IV Program funds would have a significant impact on our operations and our financial condition. For more information, see Part I, Item 1A. “Risk Factors - Risks Related to Our Industry”. Operating Activities Net cash provided by operating activities was $23.5 million and $1.0 million for each the years ended December 31, 2020 and 2019, respectively. For the year ended December 31, 2020, changes in our operating assets and liabilities resulted in cash outflows of $37.5 million primarily attributable to changes in deferred income taxes, provision for doubtful accounts, accounts receivable and accrued expenses. The decrease in deferred income taxes resulted in a cash outflow of $35.9 million and was the result of the reversal of a tax valuation allowance in the current year. The increase in the provision for doubtful accounts resulted in a cash inflow of $26.9 million and was driven by increased reserve rates coupled with a higher accounts receivable balance. Increases in accounts receivable resulted in a cash outflow of $37.4 million and was driven in part by a larger student population. Increases in the accrued expenses resulted in a cash inflow of $8.8 million and was driven by increases in compensation accruals resulting from an improved financial condition year over year. Investing Activities Net cash used in investing activities was $5.5 million for the fiscal year ended December 31, 2020 compared to $4.8 million in the prior fiscal year. The decrease of $0.7 million was primarily the result of proceeds received from an insurance settlement in the prior year. One of our primary uses of cash in investing activities was capital expenditures associated with investments in training technology, classroom furniture, and new program buildouts. We currently lease a majority of our campuses. We own our real property in Grand Prairie, Texas; Nashville, Tennessee; and Denver, Colorado and our former school property located in Suffield, Connecticut. Capital expenditures were 2% of revenues in 2020 and are expected to approximate 2% of revenues in 2021. We expect to fund future capital expenditures with cash generated from operating activities and borrowings under our credit facility. 44 Index Financing Activities Net cash used in financing activities was $18.6 million for the year ended December 31, 2020 compared to $3.5 million in the comparable prior year period. The increase of $15.1 million was due to several factors including the payment of $1.4 million in dividends in the current year; an increase in net payments on borrowings of $2.5 million year over year; and proceeds received in the prior year of approximately $12.0 million from the issuance of Series A Convertible Preferred Stock in November 2019. Net payments on borrowings consisted of: (a) total borrowings to date under our secured credit facility of $11.0 million; and (b) $28.0 million in total repayments made by the Company. Credit Facility with Sterling National Bank On November 14, 2019, the Company entered into a new senior secured credit agreement (the “Credit Agreement”) with its lender, Sterling National Bank (the “Lender”), providing for borrowing in the aggregate principal amount of up to $60 million (the “Credit Facility”). The Credit Facility is comprised of four facilities: (1) a $20 million senior secured term loan maturing on December 1, 2024 (the “Term Loan”), with monthly interest and principal payments based on 120-month amortization with the outstanding balance due on the maturity date; (2) a $10 million senior secured delayed draw term loan maturing on December 1, 2024 (the “Delayed Draw Term Loan”), with monthly interest payments for the first 18 months and thereafter monthly payments of interest and principal based on 120-month amortization and all balances due on the maturity date; (3) a $15 million senior secured committed revolving line of credit providing a sublimit of up to $10 million for standby letters of credit maturing on November 13, 2022 (the “Revolving Loan”), with monthly payments of interest only; and (4) a $15 million senior secured non-restoring line of credit maturing on January 31, 2021 (the “Line of Credit Loan”). The Credit Agreement gives the Company the right to permanently terminate, in its entirety, the Revolving Loan or the Line of Credit Loan or permanently reduce the amount available for borrowing under the Revolving Loan or the Line of Credit Loan. In April 2020, the Company terminated the Line of Credit Loan. On November 10, 2020, the Company entered into an amendment to its Credit Agreement to extend the Delayed Draw Availability Period by one year to May 31, 2022 and to increase the amount of permitted cash dividends that the Company can pay on its Series A Preferred Stock during the first twenty-four months of the Credit Agreement from $1.7 million to $2.3 million. The Credit Facility is secured by a first priority lien in favor of the Lender on substantially all of the personal property owned by the Company, as well as a pledge of the stock and other equity in the Company’s subsidiaries and mortgages on parcels of real property owned by the Company in Colorado, Tennessee and Texas, at which three of the Company’s schools are located, as well as a former school property owned by the Company located in Connecticut. At the closing of the Credit Facility, the Lender advanced the Term Loan to the Company, the net proceeds of which were $19.7 million after deduction of the Lender’s origination fee in the amount of $0.3 million and other Lender fees and reimbursements to the Lender that are customary for facilities of this type. The Company used the net proceeds of the Term Loan, together with cash on hand, to repay the existing credit facility and transaction expenses. Pursuant to the terms of the Credit Agreement, letters of credit issued under the Revolving Loan reduce dollar for dollar the availability of borrowings under the Revolving Loan. Borrowings under the Line of Credit Loan are to be secured by cash collateral. Under the Credit Agreement, borrowing under the Delayed Draw Term Loan was available through May 31, 2021 but an amendment to the Credit Agreement entered into on November 10, 2020 extended the period through May 31. 2022. Accrued interest on each loan under the Credit Facility will be payable monthly in arrears. The Term Loan and the Delayed Draw Term Loan bear interest at a floating interest rate based on the then one month London Interbank Offered Rate (“LIBOR”) plus 3.50%. At the closing of the Credit Facility, the Company entered into a swap transaction with the Lender for 100% of the principal balance of the Term Loan, which matures on the same date as the Term Loan. At the end of the borrowing availability period for the Delayed Draw Term Loan, the Company is required to enter into a swap transaction with the Lender for 100% of the principal balance of the Delayed Draw Term Loan, which will mature on the same date as the Delayed Draw Term Loan, pursuant to a swap agreement between the Company and the Lender or the Lender’s affiliate. The Term Loan and Delayed Draw Term Loan are subject to a LIBOR interest rate floor of .25% if there is no swap agreement. Revolving Loans bear interest at a floating interest rate based on the then LIBOR plus an indicative spread determined by the Company’s leverage as defined in the Credit Agreement or, if the borrowing of a Revolving Loan is to be repaid within 30 days of such borrowing, the Revolving Loan will accrue interest at the Lender’s prime rate plus .50% with a floor of 4.0%. Line of Credit Loans will bear interest at a floating interest rate based on the Lender’s prime rate of interest. Revolving Loans are subject to a LIBOR interest rate floor of .00%. 45 Index Letters of credit are charged an annual fee equal to (i) an applicable margin determined by the leverage ratio of the Company less (ii) .25%, paid quarterly in arrears, in addition to the Lender’s customary fees for issuance, amendment and other standard fees. Letters of credit totaling $4 million that were outstanding under the existing credit facility are treated as letters of credit under the Revolving Loan. Under the terms of the Credit Agreement, the Company may prepay the Term Loan and/or the Delayed Draw Term Loan in full or in part without penalty except for any amount required to compensate the Lender for any swap breakage or other costs incurred in connection with such prepayment. The Lender receives an unused facility fee of 0.50% per annum payable quarterly in arrears on the unused portions of the Revolving Loan and the Line of Credit Loan. In addition to the foregoing, the Credit Agreement contains customary representations, warranties and affirmative and negative covenants (including financial covenants that (i) restrict capital expenditures, (ii) restrict leverage, (iii) require maintaining minimum tangible net worth, (iv) require maintaining a minimum fixed charge coverage ratio and (v) require the maintenance of a minimum of $5 million in quarterly average aggregate balances on deposit with the Lender, which, if not maintained, will result in the assessment of a quarterly fee of $12,500), as well as events of default customary for facilities of this type. As of December 31, 2020, the Company was in compliance with all debt covenants. The Credit Agreement also limited the payment of cash dividends during the first twenty-four months of the agreement to $1.7 million but an amendment to the Credit Agreement entered into on November 10, 2020 raised the cash dividend limit to $2.3 million in such twenty-four-month period. As of December 31, 2020 and 2019, the Company had $17.8 million and $34.8 million, respectively, outstanding under the Credit Facility offset by $0.6 million and $0.8 million of deferred finance fees, respectively. In January 2020, the Company repaid the $15.0 million outstanding on the Line of Credit Loan. As of December 31, 2020 and 2019, letters of credit in the aggregate outstanding principal amount of $4.0 million and $4.0 million, respectively, were outstanding under the Credit Facility. Long-term debt and lease obligations consist of the following: As of December 31, 2020 2019 Credit agreement $ 17,833 $ 34,833 Deferred financing fees (621 ) (805 ) Subtotal 17,212 34,028 Less current maturities (2,000 ) (2,000 ) Total long-term debt $ 15,212 $ 32,028 We had outstanding financing principal commitments to our active students of $21.7 million and $23.3 million as of December 31, 2020 and 2019, respectively. These are extended financing plans and no cash is advanced to students. The full amount is not guaranteed unless the student completes the program. The extended financing plans are considered commitments because the students are packaged to fund their education using these funds and they are not reported on our financials. Climate Change Climate change has not had and is not expected to have a significant impact on our operations. Contractual Obligations Current portion of Long-Term Debt, Long-Term Debt and Lease Commitments. As of December 31, 2020, our current portion of long-term debt and long-term debt consisted of borrowings under our Credit Facility. We lease offices, educational facilities and various items of equipment for varying periods through the year 2031 at basic annual rentals (excluding taxes, insurance, and other expenses under certain leases). We had no off-balance sheet arrangements as of December 31, 2020, except for surety bonds. At December 31, 2020, we posted surety bonds in the total amount of approximately $12.4 million. We are required to post surety bonds on behalf of our campuses and education representatives with multiple states to maintain authorization to conduct our business. These off-balance sheet arrangements do not adversely impact our liquidity or capital resources. SEASONALITY AND OUTLOOK 46 Index Seasonality Our revenue and operating results normally fluctuate as a result of seasonal variations in our business, principally due to changes in total student population. Student population varies as a result of new student enrollments, graduations and student attrition. Historically, our schools have had lower student populations in our first and second quarters and we have experienced larger class starts in the third quarter and higher student attrition in the first half of the year. Our second half growth is largely dependent on a successful high school recruiting season. We recruit our high school students several months ahead of their scheduled start dates and, thus, while we have visibility on the number of students who have expressed interest in attending our schools, we cannot predict with certainty the actual number of new student enrollments and the related impact on revenue. Our expenses, however, typically do not vary significantly over the course of the year with changes in our student population and revenue. This year, due to COVID-19 and not a seasonality issue, it has not been a typical year and expenses have varied more significantly. In a typical year, during the first half of the year, we make significant investments in marketing, staff, programs and facilities to meet our targets for the second half of the year and, as a result, such expenses do not fluctuate significantly on a quarterly basis. To the extent new student enrollments, and related revenue, in the second half of the year fall short of our estimates, our operating results could be negatively impacted. We expect quarterly fluctuations in operating results to continue as a result of seasonal enrollment patterns. Such patterns may change as a result of new school openings, new program introductions, and increased enrollments of adult students and/or acquisitions. Effect of Inflation Inflation has not had and is not expected to have a significant impact on our operations.