Note: All new or revised material since the last report is highlighted.
Reason for Report: Initiation of coverage by one broker Previous Edition: June 8, 2007
Recent Events: Summary
July 11, 2007: Ariel Capital announces to cut CECO stake.
June 28, 2007: CECO announces to close 3 schools.
May 3, 2007: CECO reports 1Q07 results.
Overview
Illinois-based Career Education Corporation (CECO) is the world’s largest on-campus provider of private post-secondary education with over 80 campuses throughout the United States, Canada, France, the United Kingdom, and the United Arab Emirates.
Analysts have identified the following issues as critical for evaluating the investment merits of CECO:
Key Positive Arguments / Key Negative Arguments1. Quality and Diversity of Educational Programs: Career Education Corporation continues to impress analysts with robust growth, quality curricula and diverse program offerings. / Heightened Regulatory Risk: Rising legal costs, given the increased level of regulatory and legal scrutiny.
Highly Visible Robust Earnings Growth: Career Education is expected to continue to benefit from positive secular factors including high barriers to entry and strong earnings visibility. / Increasing Bad Debt: Rising bad debt expense may be an early indicator of deteriorating earnings quality.
Favorable Long-Term Secular Outlook: The company is poised for strong growth given the quality and diversity of its career-oriented educational programs, the predictability of earnings growth, and attractive secular dynamics. / Decelerating Enrollments: The company is faced with several concerns like deteriorating enrollment rates, high attrition and declining retention rates attributable to strict collection policies.
Attention Paid to the Business Side: The company’s move to close two unprofitable campuses is viewed as a long-term positive by most analysts. / Legal and regulatory issues: Analysts remain concerned about the legal and regulatory issues surrounding CECO.
Note: Career Education Corporation’s fiscal year ends on December 31.
The company’s online presence, American InterContinental University Online (AIU Online), is one of the fastest growing for-profit education centers in the world. The company’s schools, colleges, and universities offer educational opportunities across five high-growth fields of study: visual communication and design technologies, information technology, business studies, culinary arts, and healthcare to more than 95,000 students. The company has grown significantly through acquisition since it was established in 1994. Its website is www.careered.com.
Pursuant to Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information, as of September 30, 2006, CEC identified seven school reportable segments: the University segment, the Culinary Arts segment, the Colleges segment, the Health Education segment, the Gibbs segment, the Academy segment, and the INSEEC segment, and one non-school segment, the JDV Online segment. In November 2006, the company announced its decision to sell 13 of its schools and campuses, including the nine campuses that comprise the Gibbs division, McIntosh College, the two campuses of Brooks College (Long Beach and Sunnyvale), and Lehigh Valley College. The results of these 13 schools and campuses are noted in all presentations as discontinued operations. As a result, the company presently has six school reportable segments: the University segment, the Culinary Arts segment, the Colleges segment, the Health Education segment, the Academy segment, and the INSEEC segment, and one non-school segment, the JDV Online segment.
Recent Events: Details
On July 11, 2007, Ariel Capital Management Company said that it has reduced its stake sharply in Career Education Corp., a for-profit education company. As of June 30, Ariel owned 587,700 shares, or 0.6% of Career Education's shares outstanding, down from about 11 million shares, or 11.6% of the company's shares outstanding, as of February 28, according to SEC filings. It said that it felt CECO stock were fully valued and saw other education companies as more compelling opportunities.
On June 28, 2007, Career Education Corp. said it is closing three schools. CECO said that it does not believe the closures will materially affect second-quarter results. Two of the schools slated for closure, the Long Beach and Sunnyvale, California campuses of Brooks College, had been for sale.
On May 3, 2007, CECO reported 1Q07 results. Highlights are as follows:
· Revenue was $242.0 million versus $484.6 million in 1Q06.
· Net income from continuing operations was $34.6 million versus $65.5 million in 1Q06.
Revenue
According to the company, consolidated revenue from continuing operations (i.e. excluding the 13 campuses held for sale) in 1Q07 was $424.0 million, a 12.5% decrease from consolidated revenue of $484.6 million in 1Q06. This was in line with the Zacks Digest average. This decline in revenue was driven by lower average revenue per student and weak enrollment.
One firm (William Blair) believes that the main driver of the revenue decline was the degradation in revenue per student, which was driven by a mix shift towards the lower-priced associate degree programs at the company’s large AIU Online campus.
Segment detail of 1Q07 Revenue according to the Company
University: This segment includes American Intercontinental University (AIU) and Colorado Technical University (CTU) online and ground-based schools, and generates the largest portion of the company’s revenue and operating profit. Total segment revenue decreased 25.79% y/y from $243.58 million in 1Q06 to $180.76 million in 1Q07. AIU Online revenue decreased 38% y/y in 1Q07 and CTU Online revenue declined 5% y/y. The price decline at AIU Online had a significant impact on the segment’s revenue. Starts in the University segment dropped 15% y/y to 14,540 while starts at the fully online programs within University also declined to 30,600 from 31,500. In addition, the company noted that online enrollment increased sequentially from the January 2007 start to the April 2007 start versus a decline in sequential population in FY06 due to the news concerning the AIU prohibition.
Culinary Arts: This segment includes the Le Cordon Bleu Schools of North America and the Kitchen Academy schools, all ground-based programs. Revenue declined 2.13% y/y from $90.63 million in 1Q06 to $88.70 million in 1Q07. Management attributed the improvement in demand at Culinary and Health Education to better processing of leads rather than starting unpackaged students and the increase in bad debt allowances. Starts increased roughly 8.4% y/y to 2,720 in 1Q07.
Colleges: This segment includes a number of the company’s career-oriented schools. Results of this segment were adjusted to remove Brooks College, Lehigh Valley College and McIntosh College, which are being divested. Revenue declined 12.29% y/y from $51.84 million in 1Q06 to $45.47 million in 1Q07. Management stated that the Colleges segment has been affected by the declining enrollments at a number of schools, but was partly offset by an increase in average revenue per student of 4%. Starts decreased roughly 19.4% y/y in 1Q07 to 1,080.
Health Education: This segment primarily includes the Sanford-Brown Colleges and Institutes. Revenue improved 10.57% y/y from $40.58 million in 1Q06 to $44.87 million in 1Q07. Management cited extended payment plans as partly having contributed to the success of the segment. Starts increased roughly 8.9% y/y to 4,040 in 1Q07.
Academies: This segment includes International Academies of Design and Technology (IADT). Revenue decreased 1.53% y/y from $43.03 million in 1Q06 to $42.37 million in 1Q07. Starts decreased roughly 20.8% y/y to 1,220 in 1Q07. Management identified an admissions counselor attrition issue in 4Q06 as having impacted enrollments.
International: This segment consists of the company’s INSEEC schools in France and the newly acquired Istituto Marangoni, with campuses in Milan, London, and Paris. Revenue increased 47.18% y/y from $14.88 million in 1Q06 to $21.90 million 1Q07. Starts decreased roughly 13% y/y to 400 in 1Q07, in the seasonally light quarter.
JDV Online: This segment generated revenue to the tune of $0.1 million in 1Q07.
The company plans to open 3-5 new start up schools by early FY08, which should help to generate revenue growth in FY08.
Provided below is a summary of revenue as compiled by Zacks Research Digest:
Revenue($M) / 1Q06A / 1Q07A / 2Q07E / 3Q07E / 4Q07E / 2007E / 2008E / 2009EUniversity / $243.6 / $180.6 / $183.8 / $169.3 / $159.5 / $693.1 / $694.7 / $740.8
Culinary Arts / $90.6 / $88.7 / $84.2 / $101.4 / $98.2 / $372.5 / $397.7 / $415.6
College / $51.8 / $45.5 / $41.2 / $41.1 / $47.4 / $175.1 / $171.8 / $183.6
Health Education / $40.6 / $44.9 / $46.6 / $49.1 / $49.3 / $189.8 / $208.9 / $230.2
Academy / $43.0 / $42.4 / $39.4 / $38.1 / $43.1 / $162.9 / $163.9 / $168.1
INSEEC / $14.9 / $21.9 / $17.2 / $10.3 / $17.8 / $70.1 / $72.2 / $70.8
JDV Online / $0.1 / $0.1 / $0.4 / $0.5 / $0.6 / $0.9 / $3.1 / $4.5
Total Revenue / $484.6 / $424.0 / $413.6↑ / $408.4↓ / $426.6↓ / $1,671.2↓ / $1,745.8↓ / $1,834.3↑
Digest High / $484.6 / $424.0 / $433.2 / $432.8 / $450.7 / $1,740.7 / $1,829.9 / $1,979.1↑
Digest Low / $484.6 / $424.0 / $397.9 / $388.8↓ / $405.2↓ / $1,639.0 / $1,654.9 / $1,743.6↓
Y/Y Growth / -12.5% / -10.3% / -5.3% / -0.6% / -7.1% / 4.5% / 5.1%
Sequential Growth / -1.2% / -2.5% / -1.2% / 4.4%
Please refer to the Zacks Research Digest spreadsheet on CECO for detailed sales breakdown and future estimates.
Margins
According to the company, operating income from continuing operations declined 51.7% to $48.2 million in 1Q07 from $99.7 million in 1Q06. This was in line with the Zacks Digest. The operating margin was 11.4% in the quarter, down from 20.6% in 1Q06, reflecting the weakness in the University segment, the company's highest margin segment, continued pricing pressures online, and around 10% decline in the student starts across all the offerings. This was in line with Zacks Digest. EBITDA margin declined to 15.8% from 24.9% in 1Q06. EBITDA declined roughly 45% y/y to roughly $67.0 million from about $120.7 million in 1Q06. According to the Zacks Digest, EBITDA margin declined to 15.7% from 23.7% in 1Q06. EBITDA declined 41.4% y/y to $67.2million in 1Q07 from $114.7 million in 1Q06.
Management attributed the decrease in profitability to an unfavorable student population mix (larger revenue declines in its high-margin University segment), a decrease in the operating margin at the University segment caused by lower revenue, increased administrative expenses, and the disproportionate growth of low-margin CTU Online versus AIU Online, tuition fee decline in its AIU Online associate degree programs, and increased occupancy expense and other fixed costs as a percentage of revenue due to declines in revenue. The decrease in operating margin was partially offset by a decrease in bad debt expense as a percentage of revenue.
As per segment, University operating margin decreased to 18.7% in 1Q07 from 33.8% in 1Q06 due to revenue decline, higher administrative expenses and a mix shift towards lower margin CTU online revenues. Culinary Arts operating margin declined to 12.9% in 1Q07 from 15.5% in 1Q06 owing to the impact of five start-up campuses that had revenue of $179,000 and operating losses of $1.3 million. Colleges operating margin declined to 16.1% in 1Q07 from 21.7% in 1Q06. Health Education operating margin increased to 7.7% in 1Q07 from 3% in 1Q06. Academies operating margin decreased to 9.5% in 1Q07 from 10.9% in 1Q06 due to slight fall in population. International operating margin increased to 28.3% in 1Q07 from 25.9% in 1Q06.
Educational services and facilities expense increased 1.9% y/y to $141.6 million in 1Q07 from $139.0 million in 1Q06. This expense increased as a percentage of revenues to 33.4% from 28.7% in 1Q06, due to higher occupancy costs and the negative leverage from declining revenues.
General and administrative costs declined 5.6% y/y to $215.4 million in 1Q07 from $228.2 million in 1Q06, and increased as a percent of revenues to 50.8% from 47%. Marketing and advertising expenses also increased in 1Q07. Depreciation and amortization increased 5.7% y/y to $18.8 million in 1Q07 from $17.8 million in 1Q06. The weak enrollment makes it difficult for the company to leverage these fixed costs.
Management expects margins to continue to be negatively impacted by the University segment for the next several quarters.
One analyst (Citigroup) expects operating margin to grow in mid-teens, up from previously estimated low-teens. Another analyst (UnionBankSwitz.) expects operating margin to be 13.6% for FY07.However, it thinks that its operating margin estimate is too aggressive and there is downside risk.
Provided below is a summary of margins as compiled by Zacks Research Digest.
Margins / 1Q06A / 1Q07A / 2Q07E / 3Q07E / 4Q07E / 2007E / 2008E / 2009EGross / 71.3% / 66.6% / 65.8%↓ / 66.7%↑ / 67.7%↑ / 66.7%↑ / 67.3%↑ / 68.7%↑
Operating / 20.6% / 11.4% / 8.3% / 8.8% / 11.9%↓ / 10.1%↓ / 11.5% / 13.1%↓
Pretax / 21.6% / 12.9% / 9.6%↓ / 10.2% / 13.4%↓ / 11.6% / 13.0% / 14.8%↓
Net / 13.5% / 8.2% / 6.1% / 6.4%↓ / 8.5% / 7.3% / 8.2% / 9.4%↓
Please refer to the Zacks Research Digest spreadsheet of CECO for more details on margin estimates
Earnings per Share
According to the company, consolidated net income from continuing operations during 1Q07 was $34.6 million or $0.36 per diluted share, compared to consolidated net income from continuing operations of $65.5 million or $0.65 per diluted share in 1Q06. This was in line with the Zacks Digest.
One analyst (MorganStanley) has reduced FY07 EPS estimate from $1.36 to $1.26 to reflect the expectations of lower revenue.
Based on better than expected enrollment momentum, which is strengthened by the change in the mix, one analyst (Stifel Nicolaus) has raised FY07 and FY08 EPS estimates from $1.30 and $1.55 to $1.35 and $1.60, respectively.