10-Q 1 d224345d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

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 June 30, 2016

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 1-13144

 

 

ITT EDUCATIONAL SERVICES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   36-2061311

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

13000 North Meridian Street  
Carmel, Indiana   46032-1404
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (317) 706-9200

 

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

23,988,384

Number of shares of Common Stock, $.01 par value, outstanding at June 30, 2016

 

 

 


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ITT EDUCATIONAL SERVICES, INC.

Carmel, Indiana

Quarterly Report to Securities and Exchange Commission

June 30, 2016

PART I

FINANCIAL INFORMATION

 

Item 1. Financial Statements.

Index

 

Condensed Consolidated Balance Sheets (unaudited) as of June  30, 2016 and 2015 and December 31, 2015

     3   

Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2016 and 2015

     4   

Condensed Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended June 30, 2016 and 2015

     5   

Condensed Consolidated Statements of Cash Flows (unaudited) for the three and six months ended June 30, 2016 and 2015

     6   

Condensed Consolidated Statements of Shareholders’ Equity (unaudited) for the six months ended June 30, 2016 and 2015 and the year ended December 31, 2015

     7   

Notes to Condensed Consolidated Financial Statements

     8   


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ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

(unaudited)

 

     As of  
     June 30,
2016
    December 31,
2015
    June 30,
2015
 

Assets

      

Current assets:

      

Cash and cash equivalents

   $ 77,999      $ 130,897      $ 124,632   

Restricted cash

     5,408        6,015        6,936   

Accounts receivable, net

     49,242        48,837        45,204   

Private education loans

     7,807        8,480        9,379   

Deferred income taxes

     22,194        26,440        24,795   

Prepaid expenses and other current assets

     21,328        22,429        57,294   
  

 

 

   

 

 

   

 

 

 

Total current assets

     183,978        243,098        268,240   

Property and equipment, net

     134,402        142,164        150,095   

Private education loans, excluding current portion, net

     51,960        62,161        69,724   

Deferred income taxes

     68,496        71,817        67,125   

Collateral deposits

     91,230        91,168        97,873   

Other assets

     54,809        53,246        61,030   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 584,875      $ 663,654      $ 714,087   
  

 

 

   

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

      

Current liabilities:

      

Current portion of term loans

   $ 34,231      $ 68,161      $ 14,546   

Current portion of PEAKS Trust senior debt

     12,812        20,105        23,068   

Current portion of CUSO secured borrowing obligation

     17,706        23,591        19,750   

Accounts payable

     58,427        59,753        76,476   

Accrued compensation and benefits

     13,105        12,425        16,535   

Other current liabilities

     33,152        31,973        27,391   

Deferred revenue

     85,830        113,739        119,568   
  

 

 

   

 

 

   

 

 

 

Total current liabilities

     255,263        329,747        297,334   

Term loans, excluding current portion

     0        0        76,688   

PEAKS Trust senior debt, excluding current portion

     26,482        30,701        40,515   

CUSO secured borrowing obligation, excluding current portion

     88,229        91,728        93,218   

Other liabilities

     49,857        50,342        57,170   
  

 

 

   

 

 

   

 

 

 

Total liabilities

     419,831        502,518        564,925   
  

 

 

   

 

 

   

 

 

 

Commitments and contingencies (See Note 11)

      

Shareholders’ equity:

      

Preferred stock, $.01 par value, 5,000,000 shares authorized, none issued

     0        0        0   

Common stock, $.01 par value, 300,000,000 shares authorized, 37,068,904 issued

     371        371        371   

Capital surplus

     169,037        181,160        186,501   

Retained earnings

     981,566        987,223        974,900   

Accumulated other comprehensive (loss) income

     (2,172     (1,693     725   

Treasury stock, 13,080,520, 13,394,834 and 13,490,795 shares, at cost

     (983,758     (1,005,925     (1,013,335
  

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

     165,044        161,136        149,162   
  

 

 

   

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 584,875      $ 663,654      $ 714,087   
  

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


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ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share data)

(unaudited)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2016     2015     2016     2015  

Revenue

   $ 176,324      $ 214,231      $ 367,823      $ 444,206   

Costs and expenses:

        

Cost of educational services

     88,592        101,865        180,555        205,418   

Student services and administrative expenses

     71,705        91,408        149,604        181,660   

Asset impairment

     317        0        985        0   

Legal and professional fees related to certain lawsuits, investigations and accounting matters

     1,265        6,005        6,136        13,291   

Provision for private education loan losses

     1,169        3,313        3,047        4,557   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs and expenses

     163,048        202,591        340,327        404,926   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     13,276        11,640        27,496        39,280   

Interest income

     64        22        132        35   

Interest (expense)

     (6,136     (9,991     (13,235     (20,379
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

     7,204        1,671        14,393        18,936   

Provision for income taxes

     2,894        955        5,976        7,773   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 4,310      $ 716      $ 8,417      $ 11,163   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

   $ 0.18      $ 0.03      $ 0.35      $ 0.47   

Diluted

   $ 0.18      $ 0.03      $ 0.35      $ 0.47   

Weighted average shares outstanding:

        

Basic

     23,928        23,621        23,835        23,591   

Diluted

     24,122        24,086        24,181        23,953   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(unaudited)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2016     2015     2016     2015  

Net income

   $ 4,310      $ 716      $ 8,417      $ 11,163   

Other comprehensive income (loss), net of tax:

        

Net actuarial pension loss amortization, net of income taxes of $0, $0, $0 and $0

     0        0        0        1   

Prior service cost (credit) amortization, net of income taxes of $149, $151, $298 and $301

     (240     (238     (479     (477
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive (loss), net of tax

     (240     (238     (479     (476
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 4,070      $ 478      $ 7,938      $ 10,687   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(unaudited)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2016     2015     2016     2015  

Cash flows from operating activities:

        

Net income

   $ 4,310      $ 716      $ 8,417      $ 11,163   

Adjustments to reconcile net income to net cash flows from operating activities:

        

Depreciation and amortization

     4,397        6,061        8,912        12,042   

Asset impairment

     317        0        985        0   

Provision for doubtful accounts

     7,529        8,692        14,838        20,875   

Deferred income taxes

     803        2,554        3,906        12,423   

Stock-based compensation expense

     721        1,364        1,948        3,260   

Accretion of discount on private education loans

     (2,525     (2,948     (5,249     (6,029

Accretion of discount on term loans

     329        385        816        776   

Accretion of discount on PEAKS Trust senior debt

     516        1,365        1,236        3,020   

Accretion of discount on CUSO secured borrowing obligation

     30        214        75        433   

Provision for private education loan losses

     1,169        3,313        3,047        4,557   

Other

     (285     (148     (522     (415

Changes in operating assets and liabilities:

        

Restricted cash

     130        (608     607        (896

Accounts receivable

     (9,685     (7,696     (15,243     (19,696

Private education loans

     6,287        6,601        13,075        13,245   

Accounts payable

     1,409        848        (1,937     6,390   

Other operating assets and liabilities

     (2,033     (1,931     (1,415     (1,214

Deferred revenue

     (20,166     (20,288     (27,909     (27,907
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash flows from operating activities

     (6,747     (1,506     5,587        32,027   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

        

Capital expenditures

     (304     (1,640     (1,022     (2,509

Collateral and escrowed funds

     (1     59        (62     59   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash flows from investing activities

     (305     (1,581     (1,084     (2,450
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flows from financing activities:

        

Repayment of term loans

     (15,824     (2,500     (35,000     (5,000

Repayment of PEAKS Trust senior debt

     (5,772     (9,380     (12,748     (25,026

Repayment of CUSO secured borrowing obligation

     (1,855     (6,314     (9,459     (10,351

Common shares tendered for taxes

     (161     (38     (194     (505
  

 

 

   

 

 

   

 

 

   

 

 

 

Net cash flows from financing activities

     (23,612     (18,232     (57,401     (40,882
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in cash and cash equivalents

     (30,664     (21,319     (52,898     (11,305

Cash and cash equivalents at beginning of period

     108,663        145,951        130,897        135,937   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 77,999      $ 124,632      $ 77,999      $ 124,632   
  

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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ITT EDUCATIONAL SERVICES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars and shares in thousands)

(unaudited)

 

                            Accumulated                    
                            Other                    
    Common Stock     Capital     Retained     Comprehensive     Treasury Stock        
    Shares     Amount     Surplus     Earnings     Income (Loss)     Shares     Amount     Total  

Balance as of December 31, 2014

    37,069      $ 371      $ 198,883      $ 963,737      $ 1,201        (13,619   $ (1,022,120   $ 142,072   

For the six months ended June 30, 2015:

               

Net income

          11,163              11,163   

Other comprehensive (loss), net of income tax

            (476         (476

Equity award vesting

        (9,290         198        9,290        0   

Tax benefit from equity awards

        (6,352             (6,352

Stock-based compensation

        3,260                3,260   

Shares tendered for taxes

              (70     (505     (505
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2015

    37,069        371        186,501        974,900        725        (13,491     (1,013,335     149,162   

For the six months ended December 31, 2015:

               

Net income

          12,135              12,135   

Other comprehensive (loss), net of income tax

            (2,418         (2,418

Equity award vesting

        (7,519         136        7,519        0   

Tax benefit from equity awards

        (348             (348

Stock-based compensation

        2,526                2,526   

Shares tendered for taxes

              (42     (127     (127

Issuance of shares for Directors’ compensation

          188          2        18        206   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of December 31, 2015

    37,069        371        181,160        987,223        (1,693     (13,395     (1,005,925     161,136   

For the six months ended June 30, 2016:

               

Net income

          8,417              8,417   

Other comprehensive (loss), net of income tax

            (479         (479

Equity award vesting

        (8,287     (14,074       402        22,361        0   

Tax benefit from equity awards

        (5,784             (5,784

Stock-based compensation

        1,948                1,948   

Shares tendered for taxes

              (88     (194     (194
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2016

    37,069      $ 371      $ 169,037      $ 981,566      $ (2,172     (13,081   $ (983,758   $ 165,044   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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ITT EDUCATIONAL SERVICES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2016

(Dollars in thousands, except per share data and unless otherwise stated)

 

1. The Company and Basis of Presentation

ITT Educational Services, Inc. is a leading proprietary provider of postsecondary degree programs in the United States based on revenue and student enrollment. References in these Notes to “we,” “us” and “our” refer to ITT Educational Services, Inc., its wholly-owned subsidiaries and the variable interest entities (“VIEs”) that it consolidates, unless the context requires or indicates otherwise. As of June 30, 2016, we were offering:

 

    master, bachelor and associate degree programs to approximately 40,000 students at ITT Technical Institute and Daniel Webster College locations; and

 

    short-term information technology and business learning solutions for career advancers and other professionals.

As of June 30, 2016, we had 137 campus locations in 39 states. In addition, we offered one or more of our online degree programs to students who are located in all 50 states and the District of Columbia. We closed one campus location in the three months ended June 30, 2016 and expect to close one campus location in the six months ending December 31, 2016 based upon the expected date that the remaining students at that location are scheduled to complete their programs of study. All of our campus locations are authorized by the applicable education authorities of the states in which they operate and are accredited by an accrediting commission recognized by the U.S. Department of Education (“ED”). We have provided career-oriented education programs since 1969 under the “ITT Technical Institute” name and since 2009 under the “Daniel Webster College” name. Our corporate headquarters are located in Carmel, Indiana.

The accompanying unaudited condensed consolidated financial statements include the accounts of ITT Educational Services, Inc., its wholly-owned subsidiaries and, beginning on February 28, 2013 and September 30, 2014, two VIEs that we consolidate in our consolidated financial statements, and have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) for interim periods and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures, including significant accounting policies, normally included in a complete presentation of financial statements prepared in accordance with those principles, rules and regulations have been omitted. All significant intercompany balances and transactions are eliminated upon consolidation. The Condensed Consolidated Balance Sheet as of December 31, 2015 was derived from audited financial statements but, as presented in this report, may not include all disclosures required by GAAP.

We reclassified debt issuance costs that were previously reported in the line item Other assets on our Condensed Consolidated Balance Sheets as of December 31, 2015 and June 30, 2015 to the line items Current portion of term loans and Term loans, excluding current portion, upon adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs” (“ASU 2015-03”). These reclassifications had no impact on previously reported net income, total shareholders’ equity or cash flows. See Note 8 – Debt, for the amount of debt issuance costs that were reclassified.

In the three months ended March 31, 2016, we recorded a charge of $668 for the impairment of a building and other long-lived assets. We reclassified that amount to the separate line item Asset impairment in the Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows in this report to conform to the current period presentation. We previously reported that amount in Cost of educational services in our Condensed Consolidated Statements of Operations and in Depreciation and amortization in our Condensed Consolidated Statements of Cash Flows. This reclassification had no impact on previously reported net income, total shareholders’ equity or cash flows. See Note 3 – Fair Value and Credit Risk of Financial Instruments for further discussion of the charge for the impairment of the building. In the three months ended June 30, 2016, we recorded a charge of $317 for the impairment of long-lived assets at one facility.

We review the operations of our business on a regular basis to determine our reportable operating segments, as defined in Accounting Standards Codification (“ASC” or “Codification”) 280, “Segment Reporting.” As of June 30, 2016, December 31, 2015 and June 30, 2015, we reported our financial results under one reportable operating segment.

In the opinion of our management, the condensed consolidated financial statements reflect all adjustments that are normal, recurring and necessary for a fair presentation of our financial condition and results of operations. The interim financial information should be read in conjunction with the audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (“2015 Form 10-K”) as filed with the SEC.

 

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2. New Accounting Guidance and Adoption of New Accounting Guidance

New Accounting Guidance. In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which is included in the Codification under ASC 326, “Financial Instruments – Credit Losses” (“ASC 326”). This guidance amends how credit losses are measured and reported for certain financial instruments. This guidance will be effective for our interim and annual reporting periods beginning January 1, 2020, with early adoption permitted, but not earlier than our annual reporting period beginning January 1, 2019. A modified retrospective approach is to be used for certain parts of this guidance, while other parts of the guidance are to be applied using a prospective approach. We are assessing the impact that ASU 2016-13 may have on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, “Improvement to Employee Share-Based Payment Accounting” (“ASU 2016-09”), which is included in the Codification under ASC 718, “Compensation – Stock Compensation” (“ASC 718”). This guidance simplifies several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance will be effective for our interim and annual reporting periods beginning January 1, 2017, with early adoption permitted. A modified retrospective approach is to be used for certain parts of this guidance, while other parts of the guidance are to be applied using a retrospective or prospective approach. We are assessing the impact that ASU 2016-09 may have on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases” (“ASU 2016-02”), which is included in the Codification under ASC 840, “Leases” (“ASC 840”). This guidance introduces a new lessee model that brings substantially all leases on the balance sheet and represents a significant change to lease accounting. This guidance will be effective for our interim and annual reporting periods beginning January 1, 2019, with early adoption permitted. A modified retrospective approach is to be used for the adoption of this guidance. We are assessing the impact that ASU 2016-02 may have on our consolidated financial statements.

In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”), which is included in the Codification under ASC 740, “Income Taxes” (“ASC 740”). This guidance simplifies the presentation of deferred income taxes by requiring that deferred income tax liabilities and assets be classified as noncurrent in a classified statement of financial position. This guidance will be effective for our interim and annual reporting periods beginning January 1, 2017. Earlier adoption is permitted as of the beginning of an interim or annual reporting period. The amendments in ASU 2015-17 may be applied either prospectively to all deferred income tax liabilities and assets or retrospectively to all periods presented. We are assessing the impact that this guidance may have on our consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, “Simplifying the Measurement of Inventory” (“ASU 2015-11”), which is included in the Codification under ASC 330, “Inventory” (“ASC 330”). This guidance requires inventory to be measured at the lower of cost and net realizable value under certain circumstances. Current guidance requires inventory to be measured at the lower of cost or market value, where market value could be either replacement cost, net realizable value, or net realizable value less a normal profit margin. This guidance will be effective for our interim and annual reporting periods beginning January 1, 2017, with early adoption permitted. A prospective approach is to be used for the adoption of this guidance. We do not expect the adoption of ASU 2015-11 to have a material impact on our consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”), which is included in the Codification under ASC 205, “Presentation of Financial Statements” (“ASC 205”). This guidance was issued to define management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosure in certain circumstances. Under the new guidance, management is required to evaluate, at each annual and interim reporting period, whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued and to provide related disclosures. The guidance will be effective for our interim and annual reporting periods beginning January 1, 2017, with early adoption permitted. A prospective approach is to be used for the adoption of this guidance. We are assessing the impact that this guidance may have on our consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which is included in the Codification under ASC 606, “Revenue From Contracts With Customers” (“ASC 606”). This guidance requires the recognition of revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration expected in exchange for those goods or services. In May 2016, the FASB issued ASU No. 2016-12, “Narrow Scope Improvements and Practical Expedients” (“ASU 2016-12”), which provides for improvements to the guidance on collectability, noncash consideration and completed contracts, and provides a practical expedient for contract modifications upon adoption of the updated guidance under ASC 606. Originally, the updated guidance under ASC 606 was to become effective for our interim and annual reporting periods beginning January 1, 2017. In August 2015, the FASB issued ASU No. 2015-14, which defers the effective date of the updated guidance under ASC 606 by one year. Therefore, ASU 2014-09 and ASU 2016-12 will become effective for our interim and annual reporting periods beginning January 1, 2018. Early adoption is permitted, but not any earlier than the original effective date. A full retrospective or a modified retrospective approach may be used for the adoption of this guidance. We are assessing the impact that this guidance may have on our consolidated financial statements.

 

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Adoption of New Accounting Guidance. In September 2015, the FASB issued ASU No. 2015-16, “Simplifying the Accounting for Measurement Period Adjustments” (“ASU 2015-16”), which is included in the Codification under ASC 805, “Business Combinations” (“ASC 805”). This guidance simplifies the accounting for adjustments made to provisional amounts recognized in a business combination and requires that the acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer is also required to record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the provisional amounts. In addition, an entity is required to present separately on the face of its financial statements or disclose in the notes to its financial statements, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This guidance became effective for our interim and annual reporting periods beginning January 1, 2016 and was applied prospectively. The adoption of ASU 2015-16 did not have a material impact on our consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03 which is included in the Codification under ASC 835, “Interest” (“ASC 835”). This guidance requires that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that liability. This guidance became effective for our interim and annual reporting periods beginning January 1, 2016 and was applied retrospectively. The adoption of ASU 2015-03 did not have a material impact on our consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, “Amendments to the Consolidation Analysis” (“ASU 2015-02”), which is included in the Codification under ASC 810 “Consolidation” (“ASC 810”). This guidance changes the analysis that an entity must perform to determine whether it should consolidate certain types of legal entities. This guidance became effective for our interim and annual reporting periods beginning January 1, 2016 and was applied prospectively. The adoption of ASU 2015-02 did not have a material impact on our consolidated financial statements.

In January 2015, the FASB issued ASU No. 2015-01, “Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items” (“ASU 2015-01”), which is included in the Codification under ASC 225, “Income Statement” (“ASC 225”). This guidance eliminates the concept of extraordinary items from GAAP. This guidance became effective for our interim and annual reporting periods beginning January 1, 2016 and was applied prospectively. The adoption of ASU 2015-01 did not have a material impact on our consolidated financial statements.

 

3. Fair Value and Credit Risk of Financial Instruments

Fair value for financial reporting is defined as the price that would be received upon the sale of an asset or paid upon the transfer of a liability in an orderly transaction between market participants at the measurement date. The fair value measurement of our financial assets utilized assumptions categorized as observable inputs under the accounting guidance. Observable inputs are assumptions based on independent market data sources.

The following table sets forth information regarding the recurring fair value measurement of our financial assets as reflected on our Condensed Consolidated Balance Sheet as of June 30, 2016:

 

          Fair Value Measurements at Reporting Date Using  

Description

  As of June 30,
2016
    (Level 1)
Quoted Prices in
Active Markets for
Identical Assets
    (Level 2)
Significant Other
Observable Inputs
    (Level 3)
Significant Other
Unobservable
Inputs
 

Cash equivalents:

       

Money market funds

  $ 71,047      $ 71,047      $ 0      $ 0   

Restricted cash:

       

Money market funds

    768        768        0        0   

Collateral deposits:

       

Money market funds

    8,633        8,633        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 80,448      $ 80,448      $ 0      $ 0   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table sets forth information regarding the recurring fair value measurement of our financial assets as reflected on our Condensed Consolidated Balance Sheet as of December 31, 2015:

 

          Fair Value Measurements at Reporting Date Using  

Description

  As of
December 31,
2015
    (Level 1)
Quoted Prices in
Active Markets for
Identical Assets
    (Level 2)
Significant Other
Observable Inputs
    (Level 3)
Significant Other
Unobservable
Inputs
 

Cash equivalents:

       

Money market funds

  $ 130,821      $ 130,821      $ 0      $ 0   

Restricted cash:

       

Money market funds

    585        585        0        0   

Collateral deposits:

       

Money market funds

    8,631        8,631        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 140,037      $ 140,037      $ 0      $ 0   
 

 

 

   

 

 

   

 

 

   

 

 

 

The following table sets forth information regarding the recurring fair value measurement of our financial assets as reflected on our Condensed Consolidated Balance Sheet as of June 30, 2015:

 

          Fair Value Measurements at Reporting Date Using  

Description

  As of June 30,
2015
    (Level 1)
Quoted Prices in
Active Markets for
Identical Assets
    (Level 2)
Significant Other
Observable Inputs
    (Level 3)
Significant Other
Unobservable
Inputs
 

Cash equivalents:

       

Money market funds

  $ 124,564      $ 124,564      $ 0      $ 0   

Restricted cash:

       

Money market funds

    1,820        1,820        0        0   

Collateral deposits:

       

Money market funds

    8,629        8,629        0        0   
 

 

 

   

 

 

   

 

 

   

 

 

 
  $ 135,013      $ 135,013      $ 0      $ 0   
 

 

 

   

 

 

   

 

 

   

 

 

 

We used quoted prices in active markets for identical assets as of the measurement dates to value our financial assets that were categorized as Level 1.

The carrying value for cash and cash equivalents, restricted cash, accounts receivable, accounts payable and other current liabilities approximate fair value, because of the immediate or short-term maturity of these financial instruments. Except as described below, we did not have any financial assets or liabilities recorded at estimated fair value on a non-recurring basis on our Condensed Consolidated Balance Sheets as of June 30, 2016, December 31, 2015 or June 30, 2015. As of June 30, 2016 and December 31, 2015, the carrying value of a building that we considered held-for-sale was approximately $2,300, and was included in Prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets. The carrying value of that building as of those dates was approximately equal to its estimated fair value, less selling costs. In the six months ended June 30, 2016, we recorded an impairment charge of approximately $543 to reduce the carrying value of another building to its estimated fair value. The estimated fair value of that building was approximately $2,600 and was included in Property and equipment, net on our Condensed Consolidated Balance Sheet as of June 30, 2016. We considered the results of independent appraisals and other available market data, which are categorized as Level 3 measurements under the accounting guidance, to determine the estimated fair value of the buildings as of June 30, 2016.

In July 2016, we classified an additional building that we own as held-for-sale. The estimated fair value, less selling costs, of this building was approximately $6,500. Because the estimated fair value, less selling costs, exceeded the carrying value of this building, we do not expect to record an impairment charge in the three months ended September 30, 2016. The building’s carrying value of approximately $5,500 was included in Property and equipment, net on our Condensed Consolidated Balance Sheet as of June 30, 2016. We considered the results of independent appraisals and other available market data, which are categorized as Level 3 measurements under the accounting guidance, to determine the estimated fair value of the building.

As of June 30, 2016, the aggregate carrying value of the private education loans (“PEAKS Trust Student Loans”) owned by a trust (the “PEAKS Trust”) that purchased, owns and collects private education loans made under the PEAKS Private Student Loan Program (the “PEAKS Program”) and the private education loans (“CUSO Student Loans”) owned by an entity (the “CUSO”) that purchased, owns and collects private education loans made under a private education loan program for our students (the “CUSO Program”) was

 

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$59,767 and the estimated fair value was approximately $69,000. As of December 31, 2015, the aggregate carrying value of the PEAKS Trust Student Loans and the CUSO Student Loans (collectively, the “Private Education Loans”) was $70,641 and the estimated fair value was approximately $81,335. As of June 30, 2015, the aggregate carrying value of the Private Education Loans was $79,103 and the estimated fair value was approximately $89,138. The fair value of the Private Education Loans was estimated using the income approach with estimated discounted expected cash flows. We utilized inputs that were unobservable in determining the estimated fair value of the Private Education Loans. The significant inputs used in determining the estimated fair value included the default rate, repayment rate and discount rate. Fair value measurements that utilize significant unobservable inputs are categorized as Level 3 measurements under the accounting guidance.

As of June 30, 2016, the carrying value of our debt under our Financing Agreement (as defined in Note 8—Debt) was $34,231 and the estimated fair value was approximately $35,000. As of December 31, 2015, the carrying value of our debt under our Financing Agreement was $68,161 and the estimated fair value was approximately $70,000. As of June 30, 2015, the carrying value of our debt under our Financing Agreement was $91,234 and the estimated fair value was approximately $93,000. The fair value of our debt under our Financing Agreement was estimated by discounting the future cash flows using current rates for similar loans with similar characteristics and remaining maturities. We utilized inputs that were unobservable in determining the estimated fair value of our debt under the Financing Agreement. The significant input used in determining the estimated fair value was the discount rate utilized for credit and liquidity purposes. Fair value measurements that utilize significant unobservable inputs are categorized as Level 3 measurements under the accounting guidance.

As of June 30, 2016, the carrying value of the senior debt issued by the PEAKS Trust in the initial aggregate principal amount of $300,000 (the “PEAKS Senior Debt”) was $39,294 and the estimated fair value was approximately $37,000. As of December 31, 2015, the carrying value of the PEAKS Senior Debt was $50,806 and the estimated fair value was approximately $47,000. As of June 30, 2015, the carrying value of the PEAKS Senior Debt was $63,583 and the estimated fair value was approximately $62,313. The fair value of the PEAKS Senior Debt was estimated using the income approach with estimated discounted cash flows. We utilized inputs that were unobservable in determining the estimated fair value of the PEAKS Senior Debt. The significant input used in determining the estimated fair value was the discount rate utilized for both credit and liquidity purposes. Fair value measurements that utilize significant unobservable inputs are categorized as Level 3 measurements under the accounting guidance.

As of June 30, 2016, the carrying value of the liability that the CUSO was required to record (the “CUSO Secured Borrowing Obligation”) on its balance sheet for the cash received from the owners of the CUSO (the “CUSO Participants”), which liability we now consolidate, was $105,935 and the estimated fair value was approximately $87,000. As of December 31, 2015, the carrying value of the CUSO Secured Borrowing Obligation was $115,319 and the estimated fair value was approximately $87,000. As of June 30, 2015, the carrying value of the CUSO Secured Borrowing Obligation was $112,968 and the estimated fair value was approximately $105,147. The fair value of the CUSO Secured Borrowing Obligation was estimated using the income approach with estimated discounted cash flows. We utilized inputs that were unobservable in determining the estimated fair value of the CUSO Secured Borrowing Obligation. The significant input used in determining the estimated fair value was the discount rate utilized for both credit and liquidity purposes. Fair value measurements that utilize significant unobservable inputs are categorized as Level 3 measurements under the accounting guidance.

Financial instruments that potentially subject us to credit risk consist primarily of accounts receivable, cash equivalents and the Private Education Loans. Our accounts receivable are comprised of a large number of individual balances owed by students whose credit profiles vary and who are located throughout the United States. Our cash equivalents generally consist of money market funds which invest in high-quality securities issued by various entities. The Private Education Loans consist of a large number of individual loans owed by borrowers, whose credit profiles vary and who are located throughout the United States.

 

4. Equity Compensation

The amount of stock-based compensation expense and the line items in which those amounts are included in our Condensed Consolidated Statements of Operations and the related estimated income tax benefit recognized in the periods indicated were as follows:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Cost of educational services

   $ 476       $ 703       $ 1,184       $ 1,645   

Student services and administrative expenses

     245         661         764         1,615   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

   $ 721       $ 1,364       $ 1,948       $ 3,260   

Income tax (benefit)

   $ (278      (525      (750      (1,255

As of June 30, 2016, we estimated that pre-tax compensation expense for unvested stock-based compensation grants in the amount of approximately $2,900, net of estimated forfeitures, will be recognized in future periods. This expense will be recognized over the remaining service period applicable to the grantees which, on a weighted-average basis, is approximately 1.6 years.

 

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The stock options granted, forfeited, exercised and expired in the period indicated were as follows:

 

     Six Months Ended June 30, 2016  
     # of Shares     Weighted
Average
Exercise Price
     Aggregate
Exercise
Price
    Weighted Average
Remaining
Contractual Term
     Aggregate
Intrinsic
Value (1)
 

Outstanding at beginning of period

     1,088,208      $ 70.21       $ 76,406        

Granted

     159,000      $ 3.57       $ 568        

Forfeited

     (24,306   $ 4.24       $ (103     

Exercised

     0      $ 0       $ 0        

Expired

     (188,500   $ 121.56       $ (22,914     
  

 

 

      

 

 

      

Outstanding at end of period

     1,034,402      $ 52.16       $ 53,957        1.7       $ 0   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Exercisable at the end of period

     782,564      $ 66.21       $ 51,811        1.5       $ 0   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)  The aggregate intrinsic value of the stock options was calculated by identifying those stock options that had a lower exercise price than the closing market price of our common stock on June 30, 2016 and multiplying the difference between the closing market price of our common stock and the exercise price of each of those stock options by the number of shares subject to those stock options that were outstanding or exercisable, as applicable. Since the closing market price of our common stock on June 30, 2016 was lower than the exercise price of all outstanding stock options and exercisable stock options, the aggregate intrinsic value of the stock options was zero.

The following table sets forth information regarding the stock options granted and exercised in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Shares subject to stock options granted

     0         121,208         159,000         121,208   

Weighted average grant date fair value per share

   $ 0       $ 3.65       $ 2.09       $ 3.65   

Shares subject to stock options exercised

     0         0         0         0   

Intrinsic value of stock options exercised

   $ 0       $ 0       $ 0       $ 0   

Proceeds received from stock options exercised

   $ 0       $ 0       $ 0       $ 0   

Tax benefits realized from stock options exercised

   $ 0       $ 0       $ 0       $ 0   

The intrinsic value of a stock option is the difference between the fair market value of the stock and the option exercise price.

The fair value of each stock option grant was estimated on the date of grant using the following assumptions in the periods indicated:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2016      2015     2016     2015  

Risk-free interest rates

     Not applicable         1.55     1.30     1.55

Expected lives (in years)

     Not applicable         4.7        4.8        4.7   

Volatility

     Not applicable         107     75     107

Dividend yield

     Not applicable         None        None        None   

For the three months ended June 30, 2016, the assumptions listed above were not applicable because we did not grant any stock options in that period.

 

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The following table sets forth the number of restricted stock units (“RSUs”) that were granted, forfeited and vested in the period indicated:

 

     Six Months Ended June 30, 2016  
     # of RSUs      Weighted
Average Grant

Date Fair Value
 

Unvested at beginning of period

     793,019       $ 14.18   

Granted

     413,882       $ 3.55   

Forfeited

     (98,327    $ 9.92   

Vested

     (402,347    $ 14.50   
  

 

 

    

Unvested at the end of period

     706,227       $ 8.36   
  

 

 

    

 

 

 

The total fair market value of the RSUs that vested and were settled in shares of our common stock was:

 

    $787 in the three months ended June 30, 2016;

 

    $123 in the three months ended June 30, 2015;

 

    $886 in the six months ended June 30, 2016; and

 

    $1,383 in the six months ended June 30, 2015.

 

5. Variable Interest Entities

Under ASC 810, an entity that holds a variable interest in a VIE and meets certain requirements would be considered to be the primary beneficiary of the VIE and required to consolidate the VIE in its consolidated financial statements. In order to be considered the primary beneficiary of a VIE, an entity must hold a variable interest in the VIE and have both:

 

    the power to direct the activities that most significantly impact the economic performance of the VIE; and

 

    the right to receive benefits from, or the obligation to absorb losses of, the VIE that could be potentially significant to the VIE.

We hold variable interests in the PEAKS Trust as a result of:

 

    a subordinated note issued to us by the PEAKS Trust in exchange for the portion of each private education loan disbursed to us under the PEAKS Program that we transferred to the PEAKS Trust (“Subordinated Note”); and

 

    our guarantee of the payment of the principal and interest owed on the PEAKS Senior Debt, the administrative fees and expenses of the PEAKS Trust and a minimum required ratio of assets of the PEAKS Trust to outstanding PEAKS Senior Debt (“PEAKS Guarantee”).

We hold variable interests in the CUSO as a result of:

 

    a risk sharing agreement (the “CUSO RSA”) that we entered into with the CUSO in connection with the CUSO Program; and

 

    a revolving note owed to us by the CUSO (the “Revolving Note”).

Primary Beneficiary Analysis. The PEAKS Trust and the CUSO are VIEs as defined under ASC 810. To determine whether we are the primary beneficiary of the PEAKS Trust or the CUSO, we:

 

    assessed the risks that the VIE was designed to create and pass through to its variable interest holders;

 

    identified the variable interests in the VIE;

 

    identified the other variable interest holders and their involvement in the activities of the VIE;

 

    identified the activities that most significantly impact the VIE’s economic performance;

 

    determined whether we have the power to direct those activities; and

 

    determined whether we have the right to receive the benefits from, or the obligation to absorb the losses of, the VIE that could potentially be significant to the VIE.

We determined that the activities of the PEAKS Trust and the CUSO that most significantly impact the economic performance of the PEAKS Trust and the CUSO involve the servicing (which includes the collection) of the PEAKS Trust Student Loans and the CUSO Student Loans. To make that determination, we analyzed various possible scenarios of student loan portfolio performance to evaluate the potential economic impact on the PEAKS Trust and the CUSO. In our analysis, we made what we believe are reasonable assumptions based on historical data for the following key variables:

 

    the composition of the credit profiles of the borrowers;

 

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    the interest rates and fees charged on the loans;

 

    the default rates and the timing of defaults associated with similar types of loans; and

 

    the prepayment and the speed of repayment associated with similar types of loans.

Based on our analysis, we concluded that we became the primary beneficiary of the PEAKS Trust on February 28, 2013. This was the first date that we had the power to direct the activities of the PEAKS Trust that most significantly impact the economic performance of the PEAKS Trust, because we could have exercised our right to terminate the servicing agreement that governs the servicing activities of the PEAKS Trust Student Loans (the “PEAKS Servicing Agreement”), due to the failure of the entity that performs those servicing activities for the PEAKS Trust Student Loans on behalf of the PEAKS Trust to meet certain performance criteria specified in the PEAKS Servicing Agreement. We have not, however, exercised our right to terminate the PEAKS Servicing Agreement.

As a result of our primary beneficiary conclusion, we consolidated the PEAKS Trust in our consolidated financial statements beginning on February 28, 2013 (the “PEAKS Consolidation”). Prior to February 28, 2013, the PEAKS Trust was not required to be consolidated in our consolidated financial statements, because we concluded that we were not the primary beneficiary of the PEAKS Trust prior to that time. The PEAKS Trust is discussed in more detail below.

Our consolidated financial statements for periods as of and after February 28, 2013 include the PEAKS Trust, because we were considered to have control over the PEAKS Trust under ASC 810, as a result of our substantive unilateral right to terminate the PEAKS Servicing Agreement. We do not, however, actively manage the operations of the PEAKS Trust, and the assets of the consolidated PEAKS Trust can only be used to satisfy the obligations of the PEAKS Trust. Our obligations under the PEAKS Guarantee remain in effect, until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full. See Note 11 – Commitments and Contingencies, for a further discussion of the PEAKS Guarantee.

Based on our analysis, we concluded that we became the primary beneficiary of the CUSO on September 30, 2014. This was the first date that we determined we had the power to direct the activities of the CUSO that most significantly impact the economic performance of the CUSO, because the entity that performs the servicing activities on behalf of the CUSO (the “CUSO Program Servicer”) failed to meet certain performance criteria specified in the servicing agreement that governs the servicing activities of the CUSO Student Loans (the “CUSO Servicing Agreement”) on that date. The CUSO Servicing Agreement provides that in the event that the CUSO Program Servicer fails to meet certain performance criteria specified in the CUSO Servicing Agreement, and the CUSO Program Servicer does not affect a cure of that failure during a specified cure period, we would have the right to terminate the CUSO Servicing Agreement. We determined that it was not reasonably possible that the CUSO Program Servicer would be able to affect a cure during the specified cure period and, therefore, because the cure period was not substantive, we effectively had the right to terminate the CUSO Servicing Agreement as of the date that the CUSO Program Servicer failed to meet the performance criteria. We have provided notice of termination of the CUSO Servicing Agreement, however, the termination will not be effective until a successor servicer has been retained by the CUSO.

As a result of our primary beneficiary conclusion, we consolidated the CUSO in our consolidated financial statements beginning on September 30, 2014 (the “CUSO Consolidation”). Prior to September 30, 2014, the CUSO was not required to be consolidated in our consolidated financial statements, because we concluded that we were not the primary beneficiary of the CUSO prior to that time. The CUSO is discussed in more detail below.

Our consolidated financial statements for periods as of and after September 30, 2014 include the CUSO, because we were considered to have control over the CUSO under ASC 810, as a result of our substantive right to terminate the CUSO Servicing Agreement after a cure period that was not substantive. We do not, however, actively manage the operations of the CUSO, and the assets of the consolidated CUSO can only be used to satisfy the obligations of the CUSO. Our obligations under the CUSO RSA remain in effect, until all CUSO Student Loans are paid in full. See Note 11—Commitments and Contingencies, for a further discussion of the CUSO RSA.

PEAKS Program. On January 20, 2010, we entered into agreements with unrelated third parties to establish the PEAKS Program, which was a private education loan program for our students. We entered into the PEAKS Program to offer our students another source of private education loans that they could use to help pay their education costs owed to us and to supplement the limited amount of private education loans available to our students under other private education loan programs, including the CUSO Program. Under the PEAKS Program, our students had access to a greater amount of private education loans, which resulted in a reduction in the amount of internal financing that we provided to our students in 2010 and 2011. No new private education loans were or will be originated under the PEAKS Program after July 2011, but immaterial amounts related to loans originated prior to that date were disbursed by the lender through March 2012.

Under the PEAKS Program, an unrelated lender originated private education loans to our eligible students and, subsequently, sold those loans to the PEAKS Trust. The PEAKS Trust issued the PEAKS Senior Debt to investors. The lender disbursed the proceeds of the private education loans to us for application to the students’ account balances with us that represented their unpaid education costs. We transferred a portion of the amount of each private education loan disbursed to us under the PEAKS Program to the PEAKS Trust in exchange for the Subordinated Note.

 

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The Subordinated Note issued by the PEAKS Trust to us does not bear interest and matures in March 2026. Principal is due on the Subordinated Note following:

 

    the repayment of the PEAKS Senior Debt;

 

    the repayment of fees and expenses of the PEAKS Trust; and

 

    the reimbursement of the amounts of any payments made by us under the PEAKS Guarantee.

The carrying value of the Subordinated Note was eliminated from our consolidated balance sheet when we consolidated the PEAKS Trust in our consolidated financial statements beginning on February 28, 2013. In the three months ended December 31, 2012, we determined it was probable that we would not collect the carrying value of the Subordinated Note and, therefore, recorded an impairment charge for the total carrying value of the Subordinated Note.

The PEAKS Trust utilized the proceeds from the issuance of the PEAKS Senior Debt and the Subordinated Note to purchase the private education loans made by the lender to our students. The assets of the PEAKS Trust (which include, among other assets, the PEAKS Trust Student Loans) serve as collateral for, and are intended to be the principal source of, the repayment of the PEAKS Senior Debt and the Subordinated Note.

Assets and Liabilities of the PEAKS Trust. We concluded that we became the primary beneficiary of the PEAKS Trust on February 28, 2013 and, therefore, were required to consolidate the PEAKS Trust in our consolidated financial statements. The following table sets forth the carrying value of assets and liabilities of the PEAKS Trust that were included on our Condensed Consolidated Balance Sheets as of the dates indicated:

 

     As of  
     June 30,
2016
     December 31,
2015
     June 30,
2015
 

Assets

        

Restricted cash

   $ 1,517       $ 1,462       $ 1,629   

Current portion of PEAKS Trust student loans

     5,362         5,746         6,250   

PEAKS Trust student loans, excluding current portion, less allowance for loan losses of $13,892, $21,816 and $36,921

     38,944         45,987         50,937   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 45,823       $ 53,195       $ 58,816   
  

 

 

    

 

 

    

 

 

 

Liabilities

        

Current portion of PEAKS Trust senior debt

   $ 12,812       $ 20,105       $ 23,068   

Other current liabilities

     0         191         158   

PEAKS Trust senior debt, excluding current portion

     26,482         30,701         40,515   
  

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 39,294       $ 50,997       $ 63,741   
  

 

 

    

 

 

    

 

 

 

The assets of the PEAKS Trust can only be used to satisfy the obligations of the PEAKS Trust. Payment of the administrative fees and expenses of the PEAKS Trust and the principal and interest owed on the PEAKS Senior Debt are guaranteed by us under the PEAKS Guarantee.

Revenue and Expenses of the PEAKS Trust. The following table sets forth the revenue and expenses of the PEAKS Trust, which were included in our Condensed Consolidated Statements of Operations for the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Revenue

   $ 1,862       $ 2,246       $ 3,864       $ 4,659   

Student services and administrative expenses

     508         489         1,003         1,030   

Provision for private education loan losses

     1,063         4,615         2,546         5,418   

Interest expense

     1,422         2,826         3,180         6,085   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) before provision for income taxes

   $ (1,131    $ (5,684    $ (2,865    $ (7,874
  

 

 

    

 

 

    

 

 

    

 

 

 

The revenue of the PEAKS Trust consists of interest income on the PEAKS Trust Student Loans, which is the accretion of the accretable yield on the PEAKS Trust Student Loans. The servicing, administrative and other fees incurred by the PEAKS Trust are included in Student services and administrative expenses in our Condensed Consolidated Statements of Operations. The provision for

 

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private education loan losses represents the increase in the allowance for loan losses that occurred during the period. The allowance for loan losses related to the PEAKS Trust Student Loans represents the difference between the carrying value and the total present value of the expected principal and interest collections of each loan pool of the PEAKS Trust Student Loans, discounted by the loan pool’s effective interest rate as of the end of the reporting period. Interest expense of the PEAKS Trust represents interest expense on the PEAKS Senior Debt, which includes the contractual interest obligation and the accretion of the discount on the PEAKS Senior Debt.

PEAKS Guarantee. Under the PEAKS Guarantee, we guarantee payment of the principal and interest owed on the PEAKS Senior Debt, the administrative fees and expenses of the PEAKS Trust and a minimum required ratio of assets of the PEAKS Trust to outstanding PEAKS Senior Debt (the “Asset/Liability Ratio”). Our guarantee obligations under the PEAKS Program remain in effect until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full. At such time, we will be entitled to repayment of the amounts that we paid under the PEAKS Guarantee, to the extent of available funds remaining in the PEAKS Trust. See Note 11 – Commitments and Contingencies, for a further discussion of our obligations to make guarantee payments pursuant to the PEAKS Guarantee.

The following table sets forth the PEAKS Guarantee payments that were made in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

PEAKS Guarantee

   $ 2,659       $ 6,820       $ 7,193       $ 20,457   

CUSO Program. On February 20, 2009, we entered into agreements with the CUSO to create the CUSO Program. Under the CUSO Program, an unrelated lender originated private education loans to our eligible students and, subsequently, sold those loans to the CUSO. The CUSO purchased the private education loans from the lender utilizing funds received from its owners in exchange for participation interests in the private education loans acquired by the CUSO. The lender disbursed the proceeds of the private education loans to us for application to the students’ account balances with us that represented their unpaid education costs. No new private education loans were or will be originated under the CUSO Program after December 31, 2011, but immaterial amounts related to loans originated prior to that date were disbursed by the lender through June 2012.

Assets and Liabilities of the CUSO. We concluded that we became the primary beneficiary of the CUSO on September 30, 2014 and, therefore, were required to consolidate the CUSO in our consolidated financial statements. In accordance with ASC 810, the consolidation of the CUSO was treated as an acquisition of assets and liabilities and, therefore, the assets and liabilities of the CUSO were included in our consolidated financial statements at their fair value as of September 30, 2014.

We recorded the CUSO Secured Borrowing Obligation at the time of the CUSO Consolidation. The CUSO Secured Borrowing Obligation represents the estimated amount that the CUSO owes to the CUSO Participants related to their participation interests in the CUSO Student Loans, which amount is expected to be paid to the CUSO Participants by the CUSO from payments received by the CUSO related to the CUSO Student Loans, whether from the borrower or from us under the CUSO RSA.

In accordance with ASC 810, we included the CUSO Secured Borrowing Obligation on our consolidated balance sheet at its fair value as of September 30, 2014, the date of the CUSO Consolidation. The difference between the estimated fair value of the CUSO Secured Borrowing Obligation and the amount expected to be paid by the CUSO to the CUSO Participants was recorded as an accrued discount on our consolidated balance sheet at the date of the CUSO Consolidation. The accrued discount is being recognized in interest expense using the interest method based on the actual and projected cash flows, over the expected life of the CUSO Secured Borrowing Obligation.

The expected life of the CUSO Secured Borrowing Obligation is an estimate of the period of time over which payments are expected to be made by the CUSO to the CUSO Participants related to their participation interests in the CUSO Student Loans. The period of time over which payments are expected to be made by the CUSO to the CUSO Participants is based upon when the CUSO Student Loans enter a repayment status and the period of time they remain in a repayment status. Since all of the CUSO Student Loans have not entered repayment, and those loans that have entered a repayment status may be granted forbearances or deferments, the period of time over which payments are expected to be made to the CUSO Participants is an estimate. The assumptions used to estimate the expected life of the CUSO Secured Borrowing Obligation are reviewed periodically and updated accordingly, which may result in an adjustment to the expected life of the CUSO Secured Borrowing Obligation and the related recognized interest expense.

 

17


Table of Contents

The following table sets forth the carrying values of assets and liabilities of the CUSO that were included on our Condensed Consolidated Balance Sheets as of the dates indicated:

 

     As of  
     June 30,
2016
     December 31,
2015
     June 30,
2015
 

Assets

        

Restricted cash

   $ 3,123       $ 3,968       $ 3,487   

Current portion of CUSO student loans

     2,445         2,734         3,129   

CUSO student loans, excluding current portion, less allowance for loan losses of $2,741, $1,796 and $1,178

     13,016         16,174         18,787   

Other assets

     351         257         198   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 18,935       $ 23,133       $ 25,601   
  

 

 

    

 

 

    

 

 

 

Liabilities

        

Current portion of CUSO secured borrowing obligation

   $ 17,706       $ 23,591       $ 19,750   

Other current liabilities

     362         154         302   

CUSO secured borrowing obligation, excluding current portion

     88,229         91,728         93,218   
  

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 106,297       $ 115,473       $ 113,270   
  

 

 

    

 

 

    

 

 

 

The assets of the CUSO can only be used to satisfy the obligations of the CUSO. Other liabilities of the CUSO of $1,879 that were reported as of June 30, 2015 have been reclassified and included in the line item CUSO secured borrowing obligation, excluding current portion, to conform with the current year presentation.

Revenue and Expenses of the CUSO. The following table sets forth the revenue and expenses of the CUSO, which were included in our Condensed Consolidated Statements of Operations for the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Revenue

   $ 1,023       $ 1,185       $ 2,105       $ 2,249   

Student services and administrative expenses

     419         483         779         879   

Provision (benefit) for private education loan losses

     106         (1,302      501         (861

Interest expense

     3,049         3,573         6,216         7,214   
  

 

 

    

 

 

    

 

 

    

 

 

 

(Loss) before provision for income taxes

   $ (2,551    $ (1,569    $ (5,391    $ (4,983
  

 

 

    

 

 

    

 

 

    

 

 

 

The revenue of the CUSO consists of interest income on the CUSO Student Loans, which is the accretion of the accretable yield on the CUSO Student Loans, and an administrative fee paid by the CUSO Participants to the CUSO on a monthly basis. The servicing, administrative and other fees incurred by the CUSO are included in Student services and administrative expenses in our Condensed Consolidated Statements of Operations. The provision for private education loan losses represents the increase in the allowance for loan losses that occurred during the period, offset by recoveries received from private education loans that were charged off prior to the CUSO Consolidation. The allowance for loan losses represents the difference between the carrying value and the total present value of the expected principal and interest collections of each loan pool of the CUSO Student Loans, discounted by the loan pool’s effective interest rate as of the end of the reporting period. Interest expense of the CUSO represents interest expense on the CUSO Secured Borrowing Obligation, which includes the contractual interest obligation on the CUSO Student Loans and the accretion of the discount on the CUSO Secured Borrowing Obligation.

CUSO RSA. In connection with the CUSO Program, we entered into the CUSO RSA with the CUSO. Under the CUSO RSA, we guarantee the repayment of any private education loans that are charged off above a certain percentage of the private education loans made under the CUSO Program, based on the annual dollar volume. Under the CUSO RSA, we have an obligation to make the monthly payments due and unpaid on those private education loans that have been charged off above a certain percentage (“Regular Payments”). Instead of making Regular Payments, however, we may elect to discharge our obligations to make Regular Payments on specified charged-off private education loans by:

 

    paying the then outstanding balance (plus accrued and unpaid interest) of those private education loans that have been charged off above a certain percentage and, with respect to which, an amount equal to at least ten monthly payments has been paid; or

 

    paying the then outstanding balance (plus accrued and unpaid interest) of those private education loans that have been charged off above a certain percentage and, with respect to which, an amount equal to at least ten monthly payments has not been paid, plus any interest that would otherwise have been payable until ten monthly payments had been made, discounted at the rate of 10% per annum

 

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Table of Contents

(collectively, “Discharge Payments”). See Note 11 – Commitments and Contingencies, for a further discussion of our obligations to make guarantee payments pursuant to the CUSO RSA.

Pursuant to the CUSO RSA, we are entitled to all amounts that the CUSO recovers from loans in a particular loan pool made under the CUSO Program that have been charged off, until all payments that we made under the CUSO RSA with respect to that loan pool have been repaid to us by the CUSO. We have the right to offset payment amounts that we owe under the CUSO RSA by the amount of recoveries from charged-off loans made under the CUSO Program that are owed, but have not been paid, to us. We exercised this offset right in the three and six months ended June 30, 2016 and 2015.

In June 2015, we entered into an amendment to the CUSO RSA that, among other things, allowed us to defer the payments due in June 2015 through December 2015 under the CUSO RSA to January 2016 (the “Deferred Payment”). See Note 11 – Commitments and Contingencies for a discussion of this amendment. In accordance with the provisions of this amendment, we deferred the payments due in June 2015 through December 2015 under the CUSO RSA, and we utilized the amount of the recoveries of charged-off loans received by the CUSO between June 2015 and December 2015 that were due but were not paid to us to offset against amounts that we owed under the CUSO RSA in January 2016.

The following table sets forth the payments that we made to the CUSO related to our guarantee obligations under the CUSO RSA in the periods indicated:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2016     2015     2016     2015  

Regular payments

   $ 2,653 (1)    $ 1,560 (2)    $ 5,250 (3)    $ 3,840 (4) 

Deferred payment

     0        0        5,331 (5)      0   

Discharge payments

     0        6,544        0        9,253   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 2,653      $ 8,104      $ 10,581      $ 13,093   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) This amount is net of $351 of recoveries from charged-off loans owed to us that we offset against amounts we owed under the CUSO RSA.
(2) This amount is net of $231 of recoveries from charged-off loans owed to us that we offset against amounts we owed under the CUSO RSA.
(3) This amount is net of $645 of recoveries from charged-off loans owed to us that we offset against amounts we owed under the CUSO RSA.
(4) This amount is net of $521 of recoveries from charged-off loans owed to us that we offset against amounts we owed under the CUSO RSA.
(5) This amount is net of $761 of recoveries from charged-off loans received by the CUSO from June 8, 2015 through December 31, 2015 that were not paid to us that we offset against amounts owed by us under the CUSO RSA in January 2016.

We made advances to the CUSO under the Revolving Note in years prior to 2012. We made the advances so that the CUSO could use those funds primarily to purchase additional private education loans made under the CUSO Program. The period of time during which we could make additional advances under the Revolving Note ended on January 1, 2014. Certain of the assets of the CUSO serve as collateral for the Revolving Note. The Revolving Note bears interest, is subject to customary terms and conditions and is currently due and payable in full. In 2013, we also offset $8,472 owed by us under the CUSO RSA against amounts owed to us by the CUSO under the Revolving Note, instead of making additional payments in that amount. We did not offset any amounts owed by us under the CUSO RSA against amounts owed to us by the CUSO under the Revolving Note, instead of making additional payments in those amounts, in the three months ended June 30, 2016 or 2015. See Note 11 – Commitments and Contingencies, for a further discussion of the offsets and CUSO RSA.

The amount owed to us under the Revolving Note, excluding those offsets, was approximately $8,400 as of June 30, 2016, $8,300 as of December 31, 2015, and $8,200 as of June 30, 2015. The amount of the Revolving Note was eliminated from our financial statements as a result of the CUSO Consolidation.

 

6. Private Education Loans

We concluded that we were required to consolidate the PEAKS Trust in our consolidated financial statements beginning on February 28, 2013 and to consolidate the CUSO in our consolidated financial statements beginning on September 30, 2014. See Note 5 – Variable Interest Entities, for a further discussion of the consolidation of the PEAKS Trust and CUSO (the “Consolidated VIEs”). As a result, the assets and liabilities of the Consolidated VIEs were included on our Condensed Consolidated Balance Sheets as of June 30, 2016, December 31, 2015 and June 30, 2015.

The aggregate carrying amount of the Private Education Loans included under the Private education loan line items on our Condensed Consolidated Balance Sheets as of June 30, 2016 was $59,767, as of December 31, 2015 was $70,641 and as of June 30, 2015 was $79,103. The outstanding principal balance of the Private Education Loans, including accrued interest, was approximately $90,806 as of June 30, 2016, $114,346 as of December 31, 2015 and $144,588 as of June 30, 2015.

 

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Table of Contents

Initial Measurement. A significant number of the Private Education Loans were determined to be credit impaired upon consolidation. Loans determined to be credit impaired upon consolidation or acquisition (“Purchased Credit Impaired Loans” or “PCI Loans”), are initially measured at fair value in accordance with ASC 310-30, “Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). A loan is considered a PCI Loan if it has evidence of deteriorated credit quality following the loan’s origination date. As a result, at the date of consolidation or acquisition, it is probable that all contractually required payments under a PCI Loan will not be collected.

The Private Education Loans that did not individually have evidence of deteriorated credit quality at the time of consolidation were also initially measured at fair value and are accounted for in accordance with ASC 310-30. We believe that following the guidance of ASC 310-30 by analogy with respect to those loans provides the most reasonable presentation of the value of those loans, primarily due to:

 

    the evidence of deteriorated credit quality of a significant number of the Private Education Loans; and

 

    the probability that all contractually required payments with respect to those loans will not be collected.

All of the Private Education Loans are, therefore, considered to be, and reported as, PCI Loans.

This accounting treatment is consistent with the American Institute of Certified Public Accountants’ (the “AICPA”) December 18, 2009 confirmation letter (the “Confirmation Letter’), in which the AICPA summarized the SEC staff’s view regarding the accounting in subsequent periods for discount accretion associated with loan receivables acquired in a business combination or asset purchase. In this letter, the AICPA states that it understands that the SEC staff will not object to an accounting policy based on contractual or expected cash flow. We believe that following ASC 310-30 by analogy with respect to the Private Education Loans that did not individually have evidence of deteriorated credit quality at the time of consolidation is an appropriate application of the accounting guidance to determine the initial measurement of the value of those loans.

Aggregation of Loans. PCI Loans recognized upon consolidation or acquisition in the same fiscal quarter may be aggregated into one or more pools, provided that the PCI Loans in each pool have common risk characteristics. The Private Education Loans were considered to be PCI Loans upon consolidation. As of the date of the PEAKS Consolidation or the CUSO Consolidation, as applicable, we aggregated the PEAKS Trust Student Loans into 24 separate pools of loans and the CUSO Student Loans into 48 separate pools of loans, based on common risk characteristics of the loans, which included:

 

    the fiscal quarter in which the Private Education Loan was purchased by the PEAKS Trust or the CUSO; and

 

    the consumer credit score of the borrower.

PCI Loans that do not have evidence of deteriorated credit quality are not aggregated in the same pools with PCI Loans that have evidence of deteriorated credit quality. The same aggregation criteria, however, were used to determine those loan pools. Each loan pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.

Accretable Yield. The Private Education Loans were recorded at their estimated fair value upon consolidation. The estimated fair value of the PEAKS Trust Student Loans as of February 28, 2013, and the CUSO Student Loans as of September 30, 2014, was determined using an expected cash flow methodology. Projected default rates and forbearances were considered in applying the estimated cash flow methodology. Prepayments of loans were not considered when estimating the expected cash flows, because, historically, few Private Education Loans have been prepaid. No allowance for loan loss was established as of the date of consolidation of the PEAKS Trust and the CUSO, because all of the Private Education Loans were recorded at fair value and future credit losses are considered in the estimate of fair value.

The excess of any cash flows expected to be collected with respect to a loan pool of the Private Education Loans over the carrying value of the loan pool is referred to as the accretable yield. The accretable yield is not reported on our Condensed Consolidated Balance Sheets, but it is accreted and included as interest income using the effective interest method, which is at a level rate of return over the remaining estimated life of the loan pool.

 

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Table of Contents

The following tables set forth information regarding aggregate changes in accretable yield of the loan pools of the PEAKS Trust Student Loans, in total, and for those loans pursuant to which ASC 310-30 was applied by analogy, for the periods indicated:

 

     Three Months Ended      Three Months Ended  
     June 30, 2016      June 30, 2015  
     Total      ASC 310-30
Applied By
Analogy
     Total      ASC 310-30
Applied By
Analogy
 

Balance at beginning of period

   $ 31,652       $ 17,358       $ 47,898       $ 28,682   

Accretion

     (1,862      (942      (2,246      (1,276

Reclassification from nonaccretable difference and changes in expected cash flows

     (1,846      (1,239      (5,450      (3,173
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 27,944       $ 15,177       $ 40,202       $ 24,233   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Six Months Ended      Six Months Ended  
     June 30, 2016      June 30, 2015  
     Total      ASC 310-30
Applied By
Analogy
     Total      ASC 310-30
Applied By
Analogy
 

Balance at beginning of period

   $ 34,984       $ 19,313       $ 51,819       $ 32,654   

Accretion

     (3,864      (1,964      (4,659      (2,707

Reclassification from nonaccretable difference and changes in expected cash flows

     (3,176      (2,172      (6,958      (5,714
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 27,944       $ 15,177       $ 40,202       $ 24,233   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following tables set forth information regarding aggregate changes in accretable yield of the loan pools of the CUSO Student Loans, in total, and for those loans pursuant to which ASC 310-30 was applied by analogy, for the periods indicated:

 

     Three Months Ended      Three Months Ended  
     June 30, 2016      June 30, 2015  
     Total      ASC 310-30
Applied By
Analogy
     Total      ASC 310-30
Applied By
Analogy
 

Balance at beginning of period

   $ 11,646       $ 6,885       $ 11,120       $ 5,777   

Accretion

     (663      (398      (702      (394

Reclassification from nonaccretable difference and changes in expected cash flows

     (486      (360      3,348         2,832   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 10,497       $ 6,127       $ 13,766       $ 8,215   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Six Months Ended      Six Months Ended  
     June 30, 2016      June 30, 2015  
     Total      ASC 310-30
Applied By
Analogy
     Total      ASC 310-30
Applied By
Analogy
 

Balance at beginning of period

   $ 12,793       $ 7,611       $ 11,728       $ 5,857   

Accretion

     (1,385      (830      (1,370      (740

Reclassification from nonaccretable difference and changes in expected cash flows

     (911      (654      3,408         3,098   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 10,497       $ 6,127       $ 13,766       $ 8,215   
  

 

 

    

 

 

    

 

 

    

 

 

 

Allowance for Private Education Loan Losses. On a quarterly basis, subsequent to the PEAKS Consolidation and the CUSO Consolidation, as applicable, we estimate the principal and interest expected to be collected over the remaining life of each loan pool. These estimates include assumptions regarding default rates, forbearances and other factors that reflect then-current market conditions. Prepayments of loans were not considered when estimating the expected cash flows, because, historically, few Private Education Loans have been prepaid.

 

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If a decrease in the expected cash flows of a loan pool is probable and would cause the expected cash flows to be less than the expected cash flows at the end of the previous fiscal quarter, we would record the impairment as:

 

    a provision for private education loan losses in our Condensed Consolidated Statement of Operations; and

 

    an increase in the allowance for loan losses on our Condensed Consolidated Balance Sheets.

The provision for private education loan losses represents the increase in the allowance for loan losses that occurred during the period. The allowance for loan losses is the difference between the carrying value and the total present value of the expected principal and interest collections of each loan pool, discounted by the loan pool’s effective interest rate at the end of the previous fiscal quarter. If a significant increase in the expected cash flows of a loan pool is probable and would cause the expected cash flows to be greater than the expected cash flows at the end of the previous fiscal quarter, we would:

 

    first reverse any allowance for loan losses with respect to that loan pool that was previously recorded on our Condensed Consolidated Balance Sheets, up to the amount of that allowance; and

 

    record any remaining increase prospectively as a yield adjustment over the remaining estimated lives of the loans in the loan pool.

The following table sets forth information regarding changes in the allowance for loan losses of the loan pools of the PEAKS Trust Student Loans in the aggregate in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Balance at beginning of period

   $ 17,122       $ 39,596       $ 21,816       $ 42,353   

Loans charged off

     (5,059      (7,898      (11,966      (11,959

Recoveries from charged off loans

     766         608         1,496         1,109   

Provision for loan losses

     1,063         4,615         2,546         5,418   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 13,892       $ 36,921       $ 13,892       $ 36,921   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth information regarding changes in the allowance for loan losses of the loan pools of the CUSO Student Loans in the aggregate in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016     2015      2016     2015  

Balance at beginning of period

   $ 2,412      $ 2,480       $ 1,796      $ 2,039   

Loans charged off

     0        0         0        0   

Recoveries from charged off loans

     0        0         0        0   

Provision (benefit) for loan losses

     329 (1)      (1,302      945 (2)      (861
  

 

 

   

 

 

    

 

 

   

 

 

 

Balance at end of period

   $ 2,741      $ 1,178       $ 2,741      $ 1,178   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(1)  The provision for private education loan losses shown on our Condensed Consolidated Statements of Operations for the three months ended June 30, 2016 was reduced by $223 for recoveries from CUSO Student Loans that were not recognized on our consolidated balance sheet at the time of the CUSO Consolidation.
(2)  The provision for private education loan losses shown on our Condensed Consolidated Statements of Operations for the six months ended June 30, 2016 was reduced by $444 for recoveries from CUSO Student Loans that were not recognized on our consolidated balance sheet at the time of the CUSO Consolidation.

Adjustments to the interest income of a loan pool are recognized prospectively, if those adjustments are due to:

 

    changes in variable interest rates; or

 

    any other changes in the timing of the expected cash flows of the loan pools.

Loan Modifications and Charge Offs. Modifications were made to PCI Loans in the three and six months ended June 30, 2016 and 2015 and were primarily due to forbearances granted with respect to the payment of those loans. We consider the impact of any modifications made to PCI Loans as part of our quarterly assessment of whether:

 

    a probable and significant change in the expected cash flows of the PCI Loans has occurred; and

 

    the loans should continue to be accounted for and reported as PCI loans.

In evaluating the impact of modifications made to PCI Loans on the expected cash flows of those loans, we consider the effect of any foregone interest and the potential for future default. These default estimates are used to calculate expected credit losses with respect to each loan pool. In developing these probabilities of default estimates, we considered the relationship between the credit quality characteristics of the loans in the loan pool and certain assumptions based on the performance history of the Private Education Loans and industry data related to the severity and recovery lag of defaults applicable to private education loans.

 

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The charge off of a PCI Loan results in the removal of that loan from the underlying PCI Loan pool and reduces the loan pool discount. If the discount for principal losses for a particular PCI Loan pool has been fully depleted, the charge off of a PCI Loan will reduce the PCI Loan pool’s allowance for loan losses. Removal of a PCI Loan from the underlying PCI Loan Pool does not change the effective yield of the PCI Loan Pool.

 

7. Goodwill and Intangibles

We recognized goodwill and certain other intangible assets on our consolidated balance sheet as a result of the acquisition of:

 

    certain assets and liabilities of CompetenC Solutions, Inc. and Great Equalizer, Inc. on January 31, 2014;

 

    the membership interests of Cable Holdings, LLC on August 1, 2013; and

 

    substantially all the assets and certain liabilities of Daniel Webster College on June 10, 2009.

The acquired intangible assets consist of certain identifiable intangible assets that are amortized over the asset’s estimated life, and indefinite-lived intangible assets, including goodwill. Goodwill represents the excess of the consideration paid over the estimated fair value of identifiable net assets acquired.

The following tables set forth the carrying value of our acquired intangible assets that were included in Other assets on our Condensed Consolidated Balance Sheets as of the dates indicated:

 

     As of June 30, 2016         
     Gross
Carrying
Value
     Accumulated
Amortization
     Net Carrying
Value
     Weighted Average
Amortization
Period (months)
 

Amortizable intangibles assets:

           

Customer relationships

   $ 2,500       $ (1,328    $ 1,172         60   

Non-compete agreements

     1,120         (616      504         60   

Training materials

     440         (367      73         42   

Accreditation

     210         (210      0         84   
  

 

 

    

 

 

    

 

 

    
   $ 4,270       $ (2,521    $ 1,749      
  

 

 

    

 

 

    

 

 

    
     As of December 31, 2015         
     Gross
Carrying
Value
     Accumulated
Amortization
     Net Carrying
Value
     Weighted Average
Amortization
Period (months)
 

Amortizable intangibles assets:

           

Customer relationships

   $ 2,500       $ (1,078    $ 1,422         60   

Non-compete agreements

     1,120         (504      616         60   

Training materials

     440         (304      136         42   

Accreditation

     210         (195      15         84   
  

 

 

    

 

 

    

 

 

    
   $ 4,270       $ (2,081    $ 2,189      
  

 

 

    

 

 

    

 

 

    
     As of June 30, 2015         
     Gross
Carrying
Value
     Accumulated
Amortization
     Net Carrying
Value
     Weighted Average
Amortization
Period (months)
 

Amortizable intangibles assets:

           

Customer relationships

   $ 2,500       $ (828    $ 1,672         60   

Non-compete agreements

     1,120         (392      728         60   

Training materials

     440         (241      199         42   

Accreditation

     210         (180      30         84   
  

 

 

    

 

 

    

 

 

    
   $ 4,270       $ (1,641    $ 2,629      
  

 

 

    

 

 

    

 

 

    

 

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All amortizable intangible assets are being amortized on a straight-line basis. Amortization expense for amortized intangible assets was:

 

    $220 in the three months ended June 30, 2016;

 

    $219 in the three months ended June 30, 2015;

 

    $440 in the six months ended June 30, 2016; and

 

    $440 in the six months ended June 30, 2015.

The following table sets forth our estimate of the amortization expense for our amortizable intangible assets in each of the four years, 2016 through 2019:

 

Fiscal Year

Ending December 31,

   Estimated
Amortization
Expense
 

2016

   $ 865   

2017

     734   

2018

     562   

2019

     28   
  

 

 

 
   $ 2,189   
  

 

 

 

The following tables set forth the carrying value of our indefinite-lived intangible assets that were included in Other assets on our Condensed Consolidated Balance Sheets as of the dates indicated.

 

     As of June 30, 2016  
     Gross
Carrying
Value
     Accumulated
Impairment
Loss
     Net Carrying
Value
 

Indefinite-lived intangible assets:

        

Goodwill

   $ 7,247       $ (7,247    $ 0   

Trademark

     660         (410      250   
  

 

 

    

 

 

    

 

 

 
   $ 7,907       $ (7,657    $ 250   
  

 

 

    

 

 

    

 

 

 
     As of December 31, 2015  
     Gross
Carrying
Value
     Accumulated
Impairment
Loss
     Net Carrying
Value
 

Indefinite-lived intangible assets:

        

Goodwill

   $ 7,247       $ (7,247    $ 0   

Trademark

     660         (410      250   
  

 

 

    

 

 

    

 

 

 
   $ 7,907       $ (7,657    $ 250   
  

 

 

    

 

 

    

 

 

 
     As of June 30, 2015  
     Gross
Carrying
Value
     Accumulated
Impairment
Loss
     Net Carrying
Value
 

Indefinite-lived intangible assets:

        

Goodwill

   $ 7,290       $ (2,044    $ 5,246   

Trademark

     660         (410      250   
  

 

 

    

 

 

    

 

 

 
   $ 7,950       $ (2,454    $ 5,496   
  

 

 

    

 

 

    

 

 

 

Indefinite-lived intangible assets include trademarks and goodwill, which are not amortized, since there are no legal, regulatory, contractual, economic or other factors that limit the useful life of those intangible assets by us.

Intangible assets that are not subject to amortization are required to be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset may be impaired. We perform our impairment evaluation annually, during the fourth quarter, or more frequently if facts and circumstances warrant. All of our goodwill relates to one reporting unit, which is defined as one level below an operating segment.

 

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In addition to our annual impairment test, we consider certain triggering events when evaluating whether an interim impairment analysis is warranted. Among these is a significant long-term decrease in our market capitalization based on events specific to our operations. Deteriorating operating results and current period and projected future operating results that negatively differ from the operating plans used in the most recent impairment analysis are also triggering events that could be cause for an interim impairment review. In our analysis of triggering events we also consider changes in the accreditation, regulatory or legal environment; increased competition; innovation changes and changes in the market acceptance of our educational programs and the graduates of those programs, among other factors. We concluded that no triggering event had occurred during the three month period ended June 30, 2016 or June 30, 2015.

The assumptions and estimates underlying the fair value calculations used in our annual impairment test are uncertain by their nature and can vary significantly from actual results. Therefore, as circumstances and assumptions change, we may be required to recognize additional impairment charges for indefinite-lived intangible assets in future periods.

 

8. Debt

As of June 30, 2016, our Condensed Consolidated Balance Sheet included: (i) outstanding Term Loan (as defined below) borrowings under the Financing Agreement, as described further below under “—Term Loans,” (ii) the PEAKS Senior Debt issued by the PEAKS Trust, which was consolidated in our consolidated financial statements beginning February 28, 2013, as described further below under “—PEAKS Trust Senior Debt,” and (iii) the CUSO Secured Borrowing Obligation of the CUSO, which was consolidated in our consolidated financial statements beginning September 30, 2014, as described further in Note 5 – Variable Interest Entities.

Term Loans. On December 4, 2014, we and certain of our subsidiaries entered into a financing agreement (the “Original Financing Agreement”) with Cerberus Business Finance, LLC (“Cerberus”), as administrative agent and collateral agent, and the lenders party thereto. Under the Original Financing Agreement, we borrowed $100,000 aggregate principal amount of senior secured term loans (the “Term Loans”).

On December 23, 2014, we entered into Amendment No. 1 to Financing Agreement (“Amendment No. 1”), on March 17, 2015, we entered into Amendment No. 2 to Financing Agreement (“Amendment No. 2”), on May 26, 2015, we entered into a Limited Consent to Financing Agreement (the “FA Consent”), on September 18, 2015, we entered into Amendment No. 3 to Financing Agreement (“Amendment No. 3”), on December 31, 2015, we entered into Amendment No. 4 to Financing Agreement (“Amendment No. 4”) and on March 10, 2016, we entered into a Limited Waiver (the “Waiver”). The Original Financing Agreement, as amended by Amendment No. 1, Amendment No. 2, Amendment No. 3, Amendment No. 4 and including the FA Consent and the Waiver, is referred to herein as the “Financing Agreement.”

Pursuant to the Waiver, the agents and the lenders under the Financing Agreement agreed to waive any default or event of default that may have occurred and is continuing, or may occur, under the Financing Agreement or related loan documents as a result of the restatement of our condensed consolidated financial statements for each of the fiscal quarters ended March 31, 2014, June 30, 2014, September 30, 2014, March 31, 2015, June 30, 2015 and September 30, 2015, and our consolidated financial statements for the fiscal year ended December 31, 2014 (the “Restatements”), as long as we delivered to the agents and lenders our restated financial statements by March 31, 2016. We delivered our restated financial statements to the agents and lenders by March 31, 2016.

A portion of the proceeds of the Term Loans, as well as other funds, were used for payment of fees in connection with the Financing Agreement. We paid a one-time commitment fee of $3,000 in the fourth quarter of 2014 in connection with the Financing Agreement. The commitment fee and other costs paid to, or on behalf of, the lender were recorded as debt discount on our Consolidated Balance Sheets.

The following table sets forth the outstanding principal balance, debt issuance costs, debt discount and carrying value of the Financing Agreement as of the dates indicated:

 

     As of  
     June 30,
2016
     December 31,
2015
     June 30,
2015
 

Outstanding principal balance

   $ 34,681       $ 69,681       $ 95,000   

Debt issuance costs

     (106      (360      (891

Debt discount

     (344      (1,160      (2,875
  

 

 

    

 

 

    

 

 

 

Carrying value

   $ 34,231       $ 68,161       $ 91,234   
  

 

 

    

 

 

    

 

 

 

 

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The outstanding principal balance under the Financing Agreement is expected to be repaid by us as set forth in the following table:

 

Fiscal Quarter Ending

   Scheduled
Payments
 

September 30, 2016

   $ 15,500   

December 31, 2016

     19,181   
  

 

 

 

Total

   $ 34,681   
  

 

 

 

The Financing Agreement provides for mandatory prepayment of outstanding principal in an amount equal to 50% of Excess Cash Flow (as defined in the Financing Agreement) calculated based on our cash flows for the fiscal years ended December 31, 2015 and 2016 or, in the case of 2015, at least $9,000. Any mandatory prepayment amounts due under this provision are payable within 90 days of December 31. Because our Excess Cash Flow for the fiscal year ended December 31, 2015 was less than the minimum required payment pursuant to the Financing Agreement, we made a mandatory prepayment of $9,000 under the Excess Cash Flow provision in March 2016.

The Term Loans were scheduled to mature on December 4, 2017. Assuming the required principal payments are made in accordance with the repayment schedule for the remainder of 2016, however, the outstanding balance of the Term Loans is expected to be $0 as of December 31, 2016. Based on these repayment expectations, we have classified the entire carrying value of the Term Loans as a current liability on our June 30, 2016 Condensed Consolidated Balance Sheet.

The Financing Agreement provides that we must pay a premium on any prepayment of outstanding principal (“Premium Payment”) that we make during the first two years of the Financing Agreement that is not specifically required under the mandatory prepayment provision. We did not make any Premium Payments in 2015. The Premium Payment for any such prepayment of principal is 1.0% of the amount of any prepayment we make from December 5, 2015 through December 4, 2016. We do not expect to make any Premium Payments in 2016.

The Term Loans bear interest, at our option, at:

 

    the higher of (a) the London Interbank Offered Rate (“LIBOR”) and (b) 1.00%, plus a margin of 8.50%; or

 

    the highest of (a) 2.00%, (b) the federal funds rate plus 0.50%, (c) LIBOR plus 1.00% and (d) the U.S. Prime Rate, plus a margin of 8.00%.

The effective interest rate on our borrowings under the Financing Agreement was approximately:

 

    14.50% per annum in the three months ended June 30, 2016;

 

    9.91% per annum in the three months ended June 30, 2015;

 

    14.30 % per annum in the six months ended June 30, 2016; and

 

    9.91% per annum in the six months ended June 30, 2015.

The following table sets forth the total amount of interest expense and fees (including amortization of debt issuance costs and accretion of debt discount) that we recognized on our borrowings under the Financing Agreement in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Interest expense and fees

   $ 1,659       $ 3,472       $ 3,833       $ 6,839   

The Term Loans are guaranteed by certain of our subsidiaries (the “Guarantors” and together with us, the “Loan Parties”) and are secured, subject to certain agreed upon exceptions, by: (i) a first-priority lien on and perfected security interest in substantially all the Loan Parties’ assets, including a pledge of the equity of the Guarantors and our other subsidiaries, (ii) a mortgage on the Loan Parties’ owned real estate, and (iii) control agreements on certain of the Loan Parties’ deposit accounts.

The Financing Agreement contains certain affirmative and negative covenants, including restrictions on the Loan Parties’ ability to incur debt and liens, make investments, dispose of assets, pay dividends and make prepayments on existing indebtedness, in each case subject to customary exceptions.

The Financing Agreement requires us to maintain compliance with a Leverage Ratio (as defined in the Financing Agreement) and a Fixed Charge Coverage Ratio (as defined in the Financing Agreement), as well as with certain educational regulatory measurements. Compliance with the Leverage Ratio and the Fixed Charge Coverage Ratio is determined on a quarterly basis, covering certain prior periods as described in the Financing Agreement.

 

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The educational regulatory measurements are calculated over different time periods, based on statutory guidelines. The educational regulatory measurements are set forth in the Financing Agreement, and include the following tests:

 

    a minimum composite score of our equity, primary reserve and net income ratios;

 

    our institutions’ loan cohort default rates under the programs under Title IV (“Title IV Programs”) of the Higher Education Act of 1965, as amended (“HEA”);

 

    our institutions’ compliance with the 90/10 Rule of the HEA;

 

    our compliance with the ED’s gainful employment regulations; and

 

    our institutions’ student retention rate.

The Financing Agreement contains certain events of default, including:

 

    the failure by us to pay any amount owed under the Financing Agreement when due;

 

    an inaccuracy in any material respect of the representations or warranties that the Loan Parties made in the Financing Agreement;

 

    a violation of any covenant that the Loan Parties made in the Financing Agreement and the related loan documents;

 

    a default by us under any other material indebtedness owed by us, including, without limitation, our failure to pay any amounts due under the PEAKS Guarantee or the CUSO RSA;

 

    a change of control of us;

 

    the invalidity of certain liens or guarantees granted or made by the Loan Parties in the Financing Agreement;

 

    the occurrence of certain regulatory events; and

 

    certain bankruptcy or insolvency events affecting the Loan Parties.

If an event of default occurs under the Financing Agreement, the lenders may declare all Term Loans then outstanding to be immediately due and payable in full.

PEAKS Senior Debt. In January 2010, the PEAKS Trust issued the PEAKS Senior Debt in the aggregate principal amount of $300,000 to investors. Beginning on February 28, 2013, the PEAKS Trust was consolidated in our consolidated financial statements. See Note 5– Variable Interest Entities, for a further discussion of the PEAKS Consolidation. The PEAKS Senior Debt was recorded on our consolidated balance sheet as of February 28, 2013 at its estimated fair value on that date, which was approximately $226,096. The outstanding principal balance of the PEAKS Senior Debt as of February 28, 2013 was $257,533. The $31,437 difference between the estimated fair value and the outstanding principal balance of the PEAKS Senior Debt as of February 28, 2013 was recorded as a debt discount on our consolidated balance sheet and is being recognized as Interest expense in our consolidated statements of operations using the interest method, based on the actual and projected cash flows, over the expected life of the PEAKS Senior Debt.

The following table sets forth the outstanding principal balance, debt discount and carrying value of the PEAKS Senior Debt as of the dates indicated:

 

     As of  
     June 30,
2016
     December 31,
2015
     June 30,
2015
 

Outstanding principal balance

   $ 44,363       $ 57,111       $ 71,892   

Debt discount

     (5,069      (6,305      (8,309
  

 

 

    

 

 

    

 

 

 

Carrying value

   $ 39,294       $ 50,806       $ 63,583   
  

 

 

    

 

 

    

 

 

 

We recorded $12,812 as a current liability as of June 30, 2016, which represented our estimate of the amount of the carrying value of the PEAKS Senior Debt that we expect to be due in the 12 months immediately following June 30, 2016.

The PEAKS Senior Debt matures in January 2020. There are no scheduled principal repayment requirements for the PEAKS Senior Debt prior to the January 2020 maturity date. Under the terms of the PEAKS Program documents, however, amounts received on a monthly basis by the PEAKS Trust that exceed the fees and expenses of the PEAKS Trust then due and the interest then due on the PEAKS Senior Debt are to be paid to reduce the outstanding principal balance of the PEAKS Senior Debt. In the six months ended June 30, 2016, the aggregate amount of principal payments on the PEAKS Senior Debt was $12,748.

 

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The following table sets forth the estimated principal payments on the PEAKS Senior Debt in the periods indicated:

 

Fiscal Year Ending December 31,

   Amount  

2016

   $ 20,592   

2017

   $ 8,975   

2018

   $ 8,142   

2019

   $ 8,864   

2020

   $ 10,538   
  

 

 

 

Total

   $ 57,111   
  

 

 

 

The PEAKS Senior Debt bears interest at a variable rate based on the LIBOR, plus a 550 basis point margin. The minimum LIBOR rate applied to the PEAKS Senior Debt cannot be less than 2.00%. The effective interest rate on the PEAKS Senior Debt was approximately:

 

    13.4% per annum in the three months ended June 30, 2016;

 

    16.6% per annum in the three months ended June 30, 2015;

 

    14.0 % per annum in the six months ended June 30, 2016; and

 

    16.4% per annum in the six months ended June 30, 2015.

The following table sets forth the total amount of contractual interest expense and discount accretion that we recognized on the PEAKS Senior Debt in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Contractual interest expense

   $ 906       $ 1,461       $ 1,944       $ 3,065   

Discount accretion

     516         1,365         1,236         3,020   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

   $ 1,422       $ 2,826       $ 3,180       $ 6,085   
  

 

 

    

 

 

    

 

 

    

 

 

 

The assets of the PEAKS Trust (which include, among other assets, the PEAKS Trust Student Loans) serve as collateral for, and are intended to be the principal source of, the repayment of the PEAKS Senior Debt. Payment of the PEAKS Senior Debt may be accelerated by the indenture trustee of the PEAKS Trust or by the holders of the PEAKS Senior Debt in response to certain events of default under the indenture under the PEAKS Program (the “PEAKS Indenture”), including, among other things:

 

    a payment default by the PEAKS Trust;

 

    a default in the performance or observation of the PEAKS Trust’s covenants, agreements or conditions under the PEAKS Indenture;

 

    a breach of our obligations under the PEAKS Guarantee; and

 

    certain bankruptcy events with respect to the PEAKS Trust or us.

An acceleration of the payment of the PEAKS Senior Debt would result in an acceleration of our obligation to pay the full amount of the PEAKS Senior Debt pursuant to the terms of the PEAKS Guarantee, if the PEAKS Trust was not able to make that payment (and we believe that it is unlikely that the PEAKS Trust would be able to make that payment). The acceleration of our obligation to pay the full amount of the PEAKS Senior Debt, and/or our inability to make that payment, could also result in cross-defaults under the Financing Agreement.

Asset/Liability Ratio. The PEAKS Trust must maintain a minimum required Asset/Liability Ratio. The minimum required Asset/Liability Ratio is 1.05/1.00. The applicable required Asset/Liability Ratio as of each monthly measurement date, however, is based on our compliance, as of the prior quarterly measurement date, with certain metrics specified in the PEAKS Program documents, including maximum leverage ratios and minimum liquidity amounts. If we are not in compliance with those metrics as of the end of a fiscal quarter, the required Asset/Liability Ratio increases to 1.40/1.00, until the monthly measurement date following the end of a succeeding quarter at which we are in compliance with those metrics. We were not in compliance with those metrics as of June 30, 2016. For purposes of computing the Asset/Liability Ratio, as of June 30, 2016, the amount of the assets of the PEAKS Trust was $61,062 and the amount of the liabilities was $44,363. The amounts used to calculate the Asset/Liability Ratio include, for the assets, cash and the contractual balance of the PEAKS Trust Student Loans that have not defaulted, and, for the liabilities, the amount of the contractual balance of the PEAKS Senior Debt.

If the amount of the assets of the PEAKS Trust does not equal or exceed the outstanding PEAKS Senior Debt by the applicable required Asset/Liability Ratio on a monthly measurement date, we are required to make a payment under the PEAKS Guarantee in the following month in an amount that would reduce the outstanding principal balance of the PEAKS Senior Debt to the extent necessary to cause the ratio of the assets of the PEAKS Trust to the resulting outstanding PEAKS Senior Debt to equal or exceed the applicable required Asset/Liability Ratio.

 

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In order to cause the PEAKS Trust to maintain the applicable required Asset/Liability Ratio, we made payments of $7,193 in the six months ended June 30, 2016, and $30,090 in the year ended December 31, 2015 under the PEAKS Guarantee that were applied by the PEAKS Trust to reduce the amount of the PEAKS Senior Debt. See Note 11 – Commitments and Contingencies, for a discussion of our projected PEAKS Guarantee payments for 2016 through 2020.

As a consequence of the Restatements, the quarterly and annual reports for the affected periods that we were required to deliver to the indenture trustee of the PEAKS Trust under the PEAKS Guarantee were inaccurate. We delivered corrected reports to the indenture trustee on March 14, 2016, and we believe that if any breach of the PEAKS Guarantee or any event of default under the PEAKS Indenture had occurred as a result of the Restatements, that our delivery of the corrected reports has cured any such breach or event of default. We cannot predict, however, whether the holders of the PEAKS Senior Debt will assert other breaches of the PEAKS Guarantee by us or assert that any breach of the PEAKS Guarantee or event of default under the PEAKS Indenture was not properly cured.

 

9. Earnings Per Common Share

Earnings per common share for all periods have been calculated in conformity with ASC 260, “Earnings Per Share.” This data is based on historical net income and the weighted average number of shares of our common stock outstanding during each period as set forth in the following table:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2016      2015      2016      2015  

Shares:

           

Weighted average number of shares of common stock outstanding

     23,928         23,621         23,835         23,591   

Shares assumed issued (less shares assumed purchased for treasury) for stock-based compensation

     194         465         346         362   
  

 

 

    

 

 

    

 

 

    

 

 

 

Outstanding shares for diluted earnings per share calculation

     24,122         24,086         24,181         23,953   
  

 

 

    

 

 

    

 

 

    

 

 

 

A total of approximately 1.5 million shares in the three and six months ended June 30, 2016 and 1.3 million shares in the three and six months ended June 30, 2015 were excluded from the calculation of our diluted earnings per common share, because the effect was anti-dilutive.

 

10. Employee Pension Benefits

The following table sets forth the components of net periodic pension benefit of the ESI Pension Plan (a non-contributory defined benefit pension plan, commonly referred to as a cash balance plan) and ESI Excess Pension Plan (a nonqualified, unfunded retirement plan) in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Interest cost

   $ 387       $ 409       $ 790       $ 818   

Expected return on plan assets

     (1,199      (1,384      (2,424      (2,767

Recognized net actuarial loss

     0         0         0         1   

Amortization of prior service costs

     (389      (389      (777      (778
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic pension (benefit)

   $ (1,201    $ (1,364    $ (2,411    $ (2,726
  

 

 

    

 

 

    

 

 

    

 

 

 

The benefit accruals under the ESI Pension Plan and ESI Excess Pension Plan were frozen effective March 31, 2006. As a result, no service cost has been included in the net periodic pension benefit.

We did not make any contributions to the ESI Pension Plan or the ESI Excess Pension Plan in the three or six months ended June 30, 2016 or 2015. We do not expect to make any significant contributions to the ESI Pension Plan or the ESI Excess Pension Plan in 2016.

 

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The following table sets forth the changes in the components of Accumulated other comprehensive income (loss) on our Condensed Consolidated Balance Sheet in the six months ended June 30, 2016:

 

     Defined Benefit Pension Items  
     Accumulated
Other
Comprehensive
(Loss)
     Income Tax
Benefit
     Accumulated
Other
Comprehensive
(Loss) Net of
Income Tax
 

Balance at December 31, 2015

   $ (2,869    $ 1,176       $ (1,693

Amortization of:

        

Actuarial (gains) losses

     0         0         0   

Prior service costs (credits)

     (777      298         (479
  

 

 

    

 

 

    

 

 

 

Balance at June 30, 2016

   $ (3,646    $ 1,474       $ (2,172
  

 

 

    

 

 

    

 

 

 

The reclassification of prior service costs or credits from Accumulated other comprehensive (loss) are included in the computation of net periodic pension benefit. The following table sets forth the approximate amounts of net periodic pension benefit and the line items in which those amounts were included in our Condensed Consolidated Statements of Operations in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Cost of educational services

   $ 793       $ 877       $ 1,576       $ 1,762   

Student services and administrative expenses

     408         487         835         964   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net periodic pension benefit

   $ 1,201       $ 1,364       $ 2,411       $ 2,726   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

11. Commitments and Contingencies

As part of our normal operations, one of our insurers issues surety bonds for us that are required by various education authorities that regulate us. We are obligated to reimburse our insurer for any of those surety bonds that are paid by the insurer. As of June 30, 2016, the total face amount of those surety bonds was approximately $21,700. As of June 30, 2016, we also caused a letter of credit with a face amount of approximately $106 to be issued to one of our state regulatory agencies.

Our institutions’ failure to submit their 2013 audited consolidated financial statements and the 2013 compliance audits of their administration of the Title IV Programs in which they participate (“Compliance Audits”) to the ED by the due date resulted in sanctions imposed by the ED on our institutions that included, among other things, our institutions having to submit a letter of credit payable to the ED. We caused a letter of credit payable to the ED in the amount of $79,708 (the “ED Letter of Credit”) to be issued on October 31, 2014. On December 16, 2015, we and the ED entered into an agreement (the “ED Agreement”), which provides that we would provide funds to the ED for the ED to maintain in an escrow account (the “ED Escrowed Funds”) in lieu of the ED Letter of Credit. On December 17, 2015, we provided to the ED funds in the amount of $79,708, which amount is subject to further adjustment by the ED based upon changes in our annual Title IV Programs funding, and based on the ED’s determination of the percentage of our annual Title IV Programs funding that must be maintained. The ED Letter of Credit was cancelled effective December 22, 2015. As of June 30, 2016 and December 31, 2015 the amount of the ED Escrowed Funds held by the ED was $79,708 and was included in Collateral deposits on our Condensed Consolidated Balance Sheets on each of those dates.

The ED Agreement provides that the ED may draw on the ED Escrowed Funds upon certification by the ED that the drafted funds will be used for one or more of the following purposes:

 

    to pay refunds of institutional or non-institutional charges owed to or on behalf of current or former students of our institutions, whether our institutions remain open or have closed;

 

    to provide for the “teach-out” of students enrolled at the time of closure of our institutions; and

 

    to pay any liabilities owing to the ED arising from acts or omissions by our institutions, on or before November 4, 2019, in violation of requirements set forth in the HEA, including the violation of any agreement entered into by our institutions with the ED regarding the administration of Title IV Programs.

On June 6, 2016, we received a letter from the ED (the “June 2016 ED Letter”) stating that the ED believes that certain actions of the ITT Technical Institutes’ accrediting agency, the Accrediting Council for Independent Colleges and Schools (“ACICS”) (which actions are described in Note 12 – Risks and Uncertainties), represent an increased risk to the funds under the Title IV Programs that we administer on behalf of students. The June 2016 ED Letter indicates that due to this increased risk, the ED determined that the

 

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amount of surety provided by us must be increased from approximately $79,708 to approximately $123,646. The June 2016 ED Letter states that we can provide the additional amount required of approximately $43,938 (the “Additional ED Amount”) to be held as additional ED Escrowed Funds or that we may provide a new letter of credit payable to the ED in the Additional ED Amount. The June 2016 ED Letter also provides that we must continue to comply with the other requirements imposed on us by the ED currently in effect. These other requirements are described further in our 2015 Form 10-K.

On July 6, 2016, the ED informed us that the ED will permit us to provide the Additional ED Amount in three equal installments of approximately $14,646 on each of July 20, 2016, September 30, 2016 and November 30, 2016. The ED stated that prior to the third installment due on November 30, 2016, the ED will evaluate our Title IV Program funding level for the 2016 fiscal year to determine if an adjustment in the scheduled payment amount can be made while ensuring that the amount held in surety represents at least 20% of our annual student aid funding. The ED subsequently indicated that the analysis of our annual Title IV Program funding volume will not be the only factor that the ED considers in determining whether a change to the third installment is warranted, and it will also take into account the risk environment as it exists at that future time.

On July 20, 2016, we made the required first installment payment of $14,646 to the ED, which is being held as part of the ED Escrowed Funds under the ED Agreement. The Additional ED Amount will be included in Collateral deposits on our Condensed Consolidated Balance Sheets.

Claims and Contingencies. Claims and contingencies that we are subject to include those related to litigation, government investigations, business transactions, tax matters and employee-related matters, among others. We record a liability for those claims and contingencies, if it is probable that a loss will result and the amount of the loss can be reasonably estimated. Although we believe that our estimates related to any claims and contingencies are reasonable, we cannot make any assurances with regard to the accuracy of our estimates, and actual results could differ materially.

The following table sets forth the amounts of our recorded liability related to our claims and contingencies and where the amounts were included on our Condensed Consolidated Balance Sheets as of the dates indicated:

 

     As of  
     June 30,
2016
     December
31, 2015
     June 30,
2015
 

Other current liabilities

   $ 15,936       $ 16,330       $ 13,397   

Other liabilities

     588         588         598   
  

 

 

    

 

 

    

 

 

 

Total

   $ 16,524       $ 16,918       $ 13,995   
  

 

 

    

 

 

    

 

 

 

The following table sets forth the activity with respect to our recorded liability related to our claims and contingencies in the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2016      2015      2016      2015  

Balance at beginning of period

   $ 15,788       $ 15,006       $ 16,918       $ 15,574   

Increases (decreases) from:

           

Additional accruals, other (1)

     5,966         6,037         12,475         11,554   

Payments, other (2)

     (5,230      (7,048      (12,869      (13,133
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at end of period

   $ 16,524       $ 13,995       $ 16,524       $ 13,995   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Consists of accruals for legal fees.
(2) Consists of payments for legal and other contingencies.

In connection with estimating our recorded liability for claims and contingencies as of June 30, 2016, December 31, 2015 and June 30, 2015, we considered whether additional losses for claims and contingencies were reasonably possible, could be estimated and might be material to our financial condition, results of operations or cash flows. As with any estimate, as facts and circumstances change, the recorded liability and estimated range of reasonably possible losses could change significantly. With respect to legal proceedings, we determined that we cannot provide an estimate of the possible losses, or the range of possible losses, in excess of the amount, if any, accrued, for various reasons, including but not limited to some or all of the following:

 

    there are significant factual issues to be resolved;

 

    there are novel or unsettled legal issues presented;

 

    the proceedings are in the early stages;

 

    there is uncertainty as to the likelihood of a class being certified or decertified or the ultimate size and scope of the class;

 

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    there is uncertainty as to the outcome of pending appeals or motions; and

 

    in many cases, the plaintiffs have not specified damages in their complaint or in court filings.

We may resolve certain federal and state income tax matters presently under examination within the 12 months immediately following the date of this filing. As of June 30, 2016, we estimated that it was reasonably possible that unrecognized tax benefits, excluding interest and penalties, could decrease in an amount ranging from $0 to $11,100, and that we could pay approximately $4,200, in each case in the 12 months immediately following the date of this filing due to the resolution of those matters.

We have presented legal and professional fees related to certain lawsuits, investigations and accounting matters as a separate line item in our Condensed Consolidated Statements of Operations. A portion of the amounts included in this line item represent expenses for various lawsuits, investigations and accounting matters that we believe are not representative of those normally incurred in the ordinary course of business. Certain of those lawsuits and investigations are described in detail, below. The expenses for the accounting matters included in this line item related primarily to services relating to accounting for the Private Education Loans and, in the three and six months ended June 30, 2015, services relating to the accounting for the CUSO Consolidation.

Guarantees. PEAKS Guarantee and Purchase Obligation. Under the PEAKS Guarantee, we guarantee payment of the principal and interest owed on the PEAKS Senior Debt, the administrative fees and expenses of the PEAKS Trust and a minimum required Asset/Liability Ratio. The PEAKS Guarantee contains, among other things, representations and warranties and events of default that we believe are customary for guarantees of this type. In addition, under the PEAKS Program, some or all of the holders of the PEAKS Senior Debt could require us to purchase their PEAKS Senior Debt, if the law is changed to reduce the maximum allowable percentage of our annual revenue derived from Title IV Program funds from 90% to 75% or less. At this time, we believe that the likelihood of such a change in the law is remote. Our guarantee and purchase obligations under the PEAKS Program remain in effect until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full. At such time, we will be entitled to repayment of the amount of any payments we made under the PEAKS Guarantee to the extent that funds are remaining in the PEAKS Trust. The PEAKS Senior Debt matures in January 2020 and, therefore, we do not expect to begin receiving any repayment of amounts that we previously paid under the PEAKS Guarantee until February 2020.

We consolidated the PEAKS Trust in our consolidated financial statements beginning on February 28, 2013. See Note 5 – Variable Interest Entities, for a further discussion of the PEAKS Consolidation. As a result, the assets and liabilities of the PEAKS Trust have been included on, and all intercompany transactions have been eliminated from, our Condensed Consolidated Balance Sheets as of June 30, 2016, December 31, 2015 and June 30, 2015.

Projected PEAKS Guarantee Payments. We believe that it is probable that we will make additional payments under the PEAKS Guarantee and estimate that those payments may be approximately $3,600 from July 1, 2016 through December 31, 2016, $1,200 in 2017 and $10,500 in 2020. All of these payments are expected to reduce the outstanding principal balance of the PEAKS Senior Debt, which would result in an outstanding principal balance of the PEAKS Senior Debt of approximately $36,500 as of December 31, 2016, $27,500 as of December 31, 2017 and $0 as of January 31, 2020. See Note 8 – Debt, for a further discussion of the PEAKS Senior Debt. After the PEAKS Senior Debt matures in January 2020, the PEAKS Trust will continue to collect on PEAKS Trust Student Loans that remain in repayment and collect recoveries on PEAKS Trust Student Loans that have been charged off. The only obligation of the PEAKS Trust, at that time, will be the payment of the fees and expenses of the PEAKS Trust. As a result, we believe that, after that time, we may recover from the PEAKS Trust, in the aggregate, approximately $32,000 of the amount that we have paid or will pay under the PEAKS Guarantee. See below for information regarding the assumptions on which those estimates are based.

The estimated amount and timing of future payments and recoveries with respect to the PEAKS Guarantee discussed above and elsewhere in this report are only estimates, are based on numerous assumptions and are subject to change. As with any estimate, as facts and circumstances change, the estimated amounts and timing could change. We made a number of assumptions in preparing the estimates, which assumptions may not be correct. The assumptions included, among other things, the following:

 

    the repayment performance of the PEAKS Trust Student Loans, the proceeds from which will be used to repay the PEAKS Senior Debt and to pay the fees and expenses of the PEAKS Trust, and the performance of which also affects the Asset/Liability Ratio;

 

    the fact that those loans will consist of a large number of loans of individually immaterial amounts;

 

    the fact that the interest rate on the PEAKS Senior Debt is a variable rate based on the LIBOR plus a margin; and

 

    the amount of fees and expenses of the PEAKS Trust, much of which is based on the principal balance of the PEAKS Trust Student Loans.

See also “—PEAKS Guarantee and CUSO RSA Payments in Certain Periods,” for information regarding certain payments we have made related to the PEAKS Program.

CUSO RSA. On February 20, 2009 we entered into the CUSO RSA in connection with the CUSO Program. Under the CUSO RSA, we guarantee the repayment of the principal amount (including capitalized origination fees) and accrued interest payable on any

 

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private education loans made under the CUSO Program that are charged off above a certain percentage of the private education loans made under the CUSO Program, based on the annual dollar volume. The total initial principal amount of private education loans that the CUSO purchased under the CUSO Program was approximately $141,000. No new private education loans were or will be originated under the CUSO Program after December 31, 2011, but immaterial amounts related to loans originated prior to that date were disbursed by the lender through June 2012. Our obligations under the CUSO RSA will remain in effect, until all private education loans made under the CUSO Program are paid in full. The standard repayment term for a private education loan made under the CUSO Program is ten years, with repayment generally beginning six months after a student graduates or three months after a student withdraws or is terminated from his or her program of study.

Pursuant to the CUSO RSA, we are required to maintain collateral to secure our guarantee obligation in an amount equal to a percentage of the outstanding balance of the private education loans disbursed to our students under the CUSO Program. As of June 30, 2016, December 31, 2015 and June 30, 2015, the total collateral maintained in a restricted bank account was approximately $8,630. This amount was included in Collateral deposits on our Condensed Consolidated Balance Sheets as of each of those dates. The CUSO RSA also requires that we comply with certain covenants, including that we maintain certain financial ratios which are measured on a quarterly basis and that we deliver compliance certificates on a quarterly basis setting forth the status of our compliance with those financial ratios. If we are not in compliance with those covenants at the end of each fiscal quarter, we are required to increase the amount of collateral maintained in the restricted bank account to a predetermined amount, until the end of a succeeding quarter at which we are in compliance with those covenants. The predetermined amount is based on the percentage of the aggregate principal balance of the private education loans made under the CUSO Program that exceeds a certain percentage as of the end of each fiscal quarter.

We were not in compliance with certain covenants under the CUSO RSA as of June 30, 2016 and, as a result, will be required to deposit approximately $200 as additional collateral in August 2016. We do not expect to be in compliance with these covenants in the foreseeable future, however based on the estimated principal balance of the private education loans under the CUSO program, we do not believe that we will be required to deposit any additional collateral.

Under the CUSO RSA, we have the right to elect to make Discharge Payments with respect to private education loans made under the CUSO Program that have been charged off. The effect of a making a Discharge Payment related to a private education loan is to reduce the aggregate amount that we may have to pay under our guarantee obligations with respect to that loan. We have claimed as an offset against amounts owed to us under the Revolving Note amounts that would have the effect of discharging our obligations with respect to certain charged off loans under the CUSO RSA. In addition, in the three and six months ended June 30, 2015, we made Discharge Payments to the CUSO. We did not make any Discharge Payments in the three or six months ended June 30, 2016. Making Discharge Payments results in us paying amounts to the CUSO in advance of when a guarantee payment would be due, which would negatively impact our liquidity in a particular period, but results in us paying a lesser amount than we otherwise would have been required to pay under our guarantee obligation in future periods under the CUSO RSA. See Note 5 – Variable Interest Entities, for a further discussion of Discharge Payments.

We consolidated the CUSO in our consolidated financial statements beginning on September 30, 2014. See Note 5 – Variable Interest Entities, for a further discussion of the CUSO Consolidation. As a result, the assets and liabilities of the CUSO have been included on, and all intercompany transactions have been eliminated from, our Condensed Consolidated Balance Sheets as of June 30, 2016, December 31, 2015 and June 30, 2015.

CUSO RSA Amendment. On June 8, 2015, we entered into a Sixth Amendment to the CUSO RSA (the “Sixth Amendment to CUSO RSA”) with the CUSO. The Sixth Amendment to CUSO RSA provides that:

 

    the period of time during which we are not required to comply with the debt service ratio covenant under the CUSO RSA is extended through March 31, 2016;

 

    the period of time during which we are not required to comply with the current ratio covenant under the CUSO RSA is extended through March 31, 2016;

 

    we are not required to comply with the average persistence percentage covenant under the CUSO RSA as of the end of each fiscal quarter ending March 31, 2015 through March 31, 2016;

 

    we make a payment of $6,544 to the CUSO, which payment is considered a Discharge Payment under the CUSO RSA;

 

    at our option, we may defer the payment of any amounts otherwise becoming due by us under the CUSO RSA between June 8, 2015 and December 31, 2015, which payments must be made by us on or before January 4, 2016; and

 

    the payments deferred by us will not bear interest, unless we do not pay such amounts by January 4, 2016, in which case any portion of any deferred payments remaining unpaid as of that date will accrue interest at the rate of 12.5% per annum, from the date such deferred payment would otherwise have been due absent the deferral provided in the Sixth Amendment to CUSO RSA.

We made the $6,544 Discharge Payment on June 10, 2015, which had the effect of reducing the amount of Regular Payments that we otherwise would have had to make in 2015 by approximately $2,000. The reason for the provision in the Sixth Amendment to CUSO RSA that permitted us to defer to 2016 the payment of any amounts otherwise due between June 8, 2015 and December 31,

 

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2015 is because without such deferral, we believed that we would have exceeded the limitation under the Financing Agreement on amounts that we could pay in 2015 under the CUSO RSA and the PEAKS Guarantee. We deferred the full amount of the payments due in June 2015 through December 2015 under the CUSO RSA, which totaled $6,092. Recoveries of charged-off loans received by the CUSO from June 2015 through December 2015 and due to us were $761 and were not paid to us. We utilized those recovery amounts to offset against amounts that we owed under the CUSO RSA in January 2016, resulting in a payment of $5,331 related to this deferral.

Projected CUSO RSA Payments. We believe that it is probable that we will make additional payments under the CUSO RSA. We are entitled to all amounts that the CUSO recovers from loans in a particular loan pool made under the CUSO Program that have been charged-off, until all payments that we made under the CUSO RSA with respect to that loan pool have been repaid to us by the CUSO. Pursuant to the CUSO RSA, we have the right to offset amounts that we owe under the CUSO RSA by the amount of recoveries from charged-off loans made under the CUSO Program that are owed, but have not been paid, to us.

Based on various assumptions, including the historical and projected performance and collections of the CUSO Student Loans, we believe that we will make payments under the CUSO RSA as set forth in the following table:

 

Period

   Estimated
Regular
Payments
    Estimated
Recoveries (1)
     Estimated
Total
Payments,
Net
 

7/1/16 - 12/31/16

   $ 5,600      $ (500    $ 5,100   

2017

     12,000        (1,000      11,000   

2018

     14,000        (1,000      13,000   

2019 and later

     99,000 (2)      0         99,000 (2) 
  

 

 

   

 

 

    

 

 

 

Total

   $ 130,600      $ (2,500    $ 128,100   
  

 

 

   

 

 

    

 

 

 

 

(1)  We expect to offset Regular Payments due to the CUSO from us under the CUSO RSA by the recoveries from charged-off loans that are due to us from the CUSO.
(2)  We believe that this amount will be paid by us in approximately equal portions in each of 2019 through 2025.

Our estimates of the future payment amounts under the CUSO RSA and the timing of those payments assume, among other factors, that we do not make any Discharge Payments in 2016 and future years, based on the uncertainty related to the amount of future operating cash flows that will be available to us to make Discharge Payments. If we do make Discharge Payments in any future years, the effect of those Discharge Payments will be to reduce the total amount of our projected future payments under the CUSO RSA.

The estimated amount of future payments under the CUSO RSA assumes that an offset that we made in 2013 of certain payment obligations under the CUSO RSA against the CUSO’s obligations owed to us under the Revolving Note will not be determined to have been improper. See “—PEAKS Guarantee and CUSO RSA Payments in Certain Periods below for a further discussion of that offset. As of June 30, 2016, in the event that offset is determined to be improper, we may be required to pay the CUSO approximately $10,681, net of approximately $1,049 of recoveries from charged-off loans, which would be in addition to the estimated payment amounts set forth above.

The estimated amount and timing of future payments and recoveries with respect to the CUSO RSA discussed above are only estimates, are based on numerous assumptions and are subject to change. As with any estimate, as facts and circumstances change, the estimated amounts and timing could change. We made a number of assumptions in preparing the estimates, which assumptions may not be correct. The assumptions included, among other things, the following:

 

    the repayment performance of the private education loans made under the CUSO Program;

 

    the timing and rate at which those private education loans will be paid;

 

    the changes in the variable interest rates applicable to those private education loans;

 

    the amounts and timing of collections in the future on those private education loans that have been charged off; and

 

    our ability to utilize the available options for payment of our obligations under the CUSO RSA.

 

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PEAKS Guarantee and CUSO RSA Payments in Certain Periods. The following table sets forth the approximate aggregate amount of PEAKS Guarantee payments and CUSO RSA payments that were made in the periods indicated:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2016     2015     2016     2015  

PEAKS Guarantee Payments

   $ 2,659      $ 6,820      $ 7,193      $ 20,457   

CUSO RSA Regular Payments

     2,653 (1)      1,560 (2)      5,250 (3)      3,840 (4) 

CUSO RSA Discharge Payments

     0        6,544        0        9,253   

CUSO RSA Deferred Payment

     0        0        5,331 (5)      0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 5,312      $ 14,924      $ 17,774      $ 33,550   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)  This amount is net of $351 of recoveries from charged-off loans owed to us that we offset against amounts owed by us under the CUSO RSA.
(2)  This amount is net of $231 of recoveries from charged-off loans owed to us that we offset against amounts owed by us under the CUSO RSA.
(3)  This amount is net of $645 of recoveries from charged-off loans owed to us that we offset against amounts owed by us under the CUSO RSA.
(4)  This amount is net of $521 of recoveries from charged-off loans owed to us that we offset against amounts owed by us under the CUSO RSA.
(5)  This amount is net of $761 of recoveries from charged-off loans received by the CUSO from June 8, 2015 through December 31, 2015 that were not paid to us that we offset against amounts owed by us under the CUSO RSA in January 2016.

In the three and six months ended June 30, 2016 and 2015, we offset all recoveries from charged-off loans that were due to us from the CUSO against the amounts we owed to the CUSO under the CUSO RSA.

Since 2013, we have not offset any amounts owed by us under the CUSO RSA against amounts owed to us by the CUSO under the Revolving Note. In the first quarter of 2013, we notified the CUSO that we had determined that the CUSO was in default of its obligations to us under the agreement pursuant to which the Revolving Note was issued and, as a result of that default, all amounts under the Revolving Note were immediately due and payable. We also notified the CUSO that we would not make payments under the CUSO RSA until we received credit for the full amount due us under the Revolving Note, based on the provisions of the CUSO Program documents that allow us to set off amounts owed by us under the CUSO RSA against amounts owed to us by the CUSO under the Revolving Note. At that time, the outstanding amount of the Revolving Note due to us was approximately $8,200, representing principal and accrued interest.

In response to our notification, the CUSO denied that it was in default and refused our demand to immediately pay the Revolving Note in full. As a consequence, over the period from February 2013 through August 2013, we offset our then current payment obligations under the CUSO RSA and the amount of Discharge Payments we elected to make during that period against all of the CUSO’s obligations owed to us under the Revolving Note (the “Offset”).

We understand that the CUSO’s position is that the Offset was improper, because it has not defaulted and, even if it had defaulted, the assets of the CUSO against which we could offset or exercise our other remedies were limited. We further understand the CUSO’s position to be that, because the Offset was improper, we are in default under the CUSO RSA. In April 2013, the CUSO notified us that it had taken control of the restricted account containing the cash collateral that we deposited to secure our obligations under the CUSO RSA (the “Collateral”). To our knowledge, the CUSO has taken no further action related to the Collateral. We believe that our good faith exercise of our right of offset provided for in the CUSO Program documents does not constitute an event of default under the CUSO RSA, and that the CUSO’s seizure of control of the restricted account containing the Collateral constitutes an additional default by the CUSO. We cannot assure you, however, that the Offset will ultimately be determined to have been proper. As of June 30, 2016, in the event of a default by us under the CUSO RSA related to the Offset, we may be required to pay to the CUSO approximately $10,681, net of approximately $1,049 of recoveries from charged-off loans that are owed, but have not been paid, to us. If, instead, the CUSO was to withdraw Collateral in that amount from the restricted bank account, we would be required to deposit that amount of cash in the account to maintain the required level of Collateral.

Litigation. We are subject to various litigation. We cannot assure you of the ultimate outcome of any litigation involving us. Although we believe that our estimates related to any litigation are reasonable, deviations from our estimates could produce a materially different result. Any litigation alleging violations of education or consumer protection laws and/or regulations, misrepresentation, fraud or deceptive practices may also subject our affected campuses to additional regulatory scrutiny. The following is a description of pending litigation that falls outside the scope of litigation incidental to the ordinary course of our business.

On December 22, 2008, we were served with a qui tam action that was filed on July 3, 2007 in the United States District Court for the Southern District of Indiana by a former employee (“relator”) on behalf of herself and the federal government under the following caption: United States of America ex rel. Debra Leveski v. ITT Educational Services, Inc. (the “Leveski Litigation”). We were served with the Leveski Litigation after the U.S. Department of Justice declined to intervene in the litigation. On June 3, 2008, the relator

 

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filed an amended complaint in the Leveski Litigation. On September 23, 2009, the court dismissed the Leveski Litigation without prejudice and gave the relator an opportunity to replead her complaint. On October 8, 2009, the relator filed a second amended complaint. In the second amended complaint, the relator alleges that we violated the False Claims Act, 31 U.S.C. § 3729, et seq., and the HEA by compensating our sales representatives and financial aid administrators with commissions, bonuses or other incentive payments based directly or indirectly on success in securing enrollments or federal financial aid. The relator alleges that all of our revenue derived from the federal student financial aid programs from July 3, 2001 through July 3, 2007 was generated as a result of our violating the HEA. The relator seeks various forms of recovery on behalf of herself and the federal government, including:

 

    treble the amount of unspecified funds paid to us for federal student grants;

 

    treble the amount of unspecified default payments, special allowance payments and interest received by lenders with respect to federal student loans received by our students;

 

    all civil penalties allowed by law; and

 

    attorney’s fees and costs.

A qui tam action is a civil lawsuit brought by one or more individuals (a qui tam “relator”) on behalf of the federal or state government for an alleged submission to the government of a false claim for payment. A qui tam action is always filed under seal and remains under seal, until the government decides whether to intervene in the litigation. Whenever a relator files a qui tam action, the government typically initiates an investigation in order to determine whether to intervene in the litigation. If the government intervenes, it has primary control over the litigation. If the government declines to intervene, the relator may pursue the litigation on behalf of the government. If the government or the relator is successful in the litigation, the relator receives a portion of the government’s recovery.

On August 8, 2011, the district court granted our motion to dismiss all of the relator’s claims in the Leveski Litigation for lack of subject-matter jurisdiction and issued a judgment for us. On February 16, 2012, the relator in the Leveski Litigation filed a Notice of Appeal with the 7 th Circuit Court of Appeals regarding the final judgment entered by the district court dismissing all claims against us. On March 26, 2012, the district court in the Leveski Litigation awarded us approximately $395 in sanctions against the relator’s attorneys for filing a frivolous lawsuit. Relator’s attorneys also appealed this award to the 7 th Circuit Court of Appeals. On July 8, 2013, the 7 th Circuit Court of Appeals reversed the district court’s dismissal of the Leveski Litigation for lack of subject-matter jurisdiction and the award of sanctions against relator’s attorneys. In addition, the 7 th Circuit Court of Appeals remanded the Leveski Litigation back to the district court for further proceedings.

We have defended, and intend to continue to defend, ourselves vigorously against the allegations made in the complaint.

On March 11, 2013, a complaint in a securities class action lawsuit was filed against us, one of our current executive officers and one of our former executive officers in the United States District Court for the Southern District of New York under the following caption: William Koetsch, Individually and on Behalf of All Others Similarly Situated v. ITT Educational Services, Inc., et al. (the “Koetsch Litigation”). On April 17, 2013, a complaint in a securities class action lawsuit was filed against us, one of our current executive officers and one of our former executive officers in the United States District Court for the Southern District of New York under the following caption: Massachusetts Laborers’ Annuity Fund, Individually and on Behalf of All Others Similarly Situated v. ITT Educational Services, Inc., et al. (the “MLAF Litigation”). On July 25, 2013, the court consolidated the Koetsch Litigation and MLAF Litigation under the following caption: In re ITT Educational Services, Inc. Securities Litigation (the “New York Securities Litigation”), and named the Plumbers and Pipefitters National Pension Fund and Metropolitan Water Reclamation District Retirement Fund as the lead plaintiffs. On October 7, 2013, an amended complaint was filed in the New York Securities Litigation, and on January 15, 2014, a second amended complaint was filed in the New York Securities Litigation. The second amended complaint alleged, among other things, that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and Rule 10b-5 promulgated thereunder by:

 

    our failure to properly account for the 2007 RSA, CUSO RSA and PEAKS Program;

 

    employing devices, schemes and artifices to defraud;

 

    making untrue statements of material facts, or omitting material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading;

 

    making the above statements intentionally or with reckless disregard for the truth;

 

    engaging in acts, practices, and a course of business that operated as a fraud or deceit upon lead plaintiffs and others similarly situated in connection with their purchases of our common stock;

 

    deceiving the investing public, including lead plaintiffs and the purported class, regarding, among other things, our artificially inflated statements of financial strength and understated liabilities; and

 

    causing our common stock to trade at artificially inflated prices and causing the plaintiff and other putative class members to purchase our common stock at inflated prices.

The putative class period in this action was from April 24, 2008 through February 25, 2013. The plaintiffs sought, among other things, the designation of this action as a class action, an award of unspecified compensatory damages, interest, costs and expenses, including counsel fees and expert fees, and such equitable/injunctive and other relief as the court deems appropriate. On July 22, 2014,

 

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the district court denied most of our motion to dismiss all of the plaintiffs’ claims for failure to state a claim for which relief can be granted. On August 5, 2014, we filed our answer to the second amended complaint denying all of the plaintiffs’ claims. Plaintiffs filed their motion for class certification on March 27, 2015.

Following a mediation which began in the third quarter of 2015, the parties came to an agreement in principle to settle the New York Securities Litigation. On November 2, 2015, the parties in the New York Securities Litigation entered into a Stipulation and Agreement of Settlement (the “New York Settlement”) to resolve the action in its entirety. Under the terms of the New York Settlement, we and/or our insurers made a payment of $16,962 in exchange for the release of claims against the defendants and other released parties, by the plaintiffs and all settlement class members, and for the dismissal of the action with prejudice. On November 2, 2015, the plaintiffs in the New York Securities Litigation filed the New York Settlement and related exhibits with the court and moved, among other things, for the court to preliminarily approve the New York Settlement, to approve the contents and procedures for notice to potential settlement class members, to certify the New York Securities Litigation as a class action for settlement purposes only, and to schedule a hearing for the court to consider final approval of the New York Settlement. On November 23, 2015, the court entered an order preliminarily approving the New York Settlement and scheduled a hearing for March 8, 2016 to consider final approval of the New York Settlement. Prior to the March 8, 2016 hearing, potential settlement class members (all persons and entities who purchased or otherwise acquired our common stock between April 24, 2008 and February 25, 2013, both dates inclusive (with limited exclusions)) had an opportunity to exclude themselves from participating in the New York Settlement or to raise objections with the court regarding the New York Settlement or any part thereof. On March 8, 2016, the court granted final approval of the New York Settlement and entered an order dismissing the New York Securities Litigation with prejudice.

The New York Settlement contains no admission of liability, and all of the defendants in the New York Securities Litigation have expressly denied, and continue to deny, all allegations of wrongdoing or improper conduct. Our insurance carriers funded a combined $25,000 collectively towards the settlement payments for the New York Settlement and the Indiana Settlement (defined below).

On September 30, 2014, a complaint in a securities class action lawsuit was filed against us, one of our current executive officers and one of our former executive officers in the United States District Court for the Southern District of Indiana under the following caption: David Banes, on Behalf of Himself and All Others Similarly Situated v. Kevin M. Modany, et al. (the “Banes Litigation”). On October 3, 2014, October 9, 2014 and November 25, 2014, three similar complaints were filed against us, one of our current executive officers and one of our former executive officers in the United States District Court for the Southern District of Indiana under the following captions: Babulal Tarapara, Individually and on Behalf of All Others Similarly Situated v. ITT Educational Services, Inc. et al. (the “Tarapara Litigation”), Kumud Jindal, Individually and on Behalf of All Others Similarly Situated v. Kevin Modany, et al. (the “Jindal Litigation”) and Kristopher Hennen, Individually and on Behalf of All Others Similarly Situated v. ITT Educational Services, Inc. et al. (the “Hennen Litigation”). On November 17, 2014, the Tarapara Litigation and the Jindal Litigation were consolidated into the Banes Litigation. On January 21, 2015, the Hennen Litigation was consolidated into that consolidated action (the “Indiana Securities Litigation”). On December 1, 2014, motions were filed in the Indiana Securities Litigation for the appointment of lead plaintiff and lead counsel. On March 16, 2015, the court appointed a lead plaintiff and lead counsel. Subsequently, the caption for the Indiana Securities Litigation was changed to the following: In re ITT Educational Services, Inc. Securities Litigation (Indiana).

On May 26, 2015, an amended complaint was filed in the Indiana Securities Litigation. The amended complaint alleged, among other things, that the defendants violated Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder by knowingly or recklessly making false and/or misleading statements and failing to disclose material adverse facts about our business, operations, prospects and financial results. Plaintiffs asserted that the defendants engaged in a fraudulent scheme and course of business and that alleged misstatements and/or omissions by the defendants caused members of the putative class to purchase our securities at artificially inflated prices. The amended complaint included allegations relating to:

 

    the performance of the PEAKS Program and the CUSO Program;

 

    our guarantee obligations under the PEAKS Program and the CUSO Program;

 

    our accounting treatment of the PEAKS Program and the CUSO Program;

 

    consolidation of the PEAKS Trust in our consolidated financial statements;

 

    the impact of the PEAKS Program and the CUSO Program on our liquidity and overall financial condition;

 

    our compliance with Department of Education financial responsibility standards; and

 

    our internal controls over financial reporting.

        The putative class period in the Indiana Securities Litigation was from February 26, 2013 through May 12, 2015. The plaintiffs in the Indiana Securities Litigation sought, among other things, the designation of the action as a proper class action, an award of unspecified compensatory damages against all defendants, interest, costs, expenses, counsel fees and expert fees, and such other relief as the court deems proper.

Following a mediation that began in the third quarter of 2015, the parties came to an agreement in principle to settle the Indiana Securities Litigation. On November 2, 2015, the parties in the Indiana Securities Litigation entered into a Stipulation and Agreement of Settlement (the “Indiana Settlement”) to resolve the action in its entirety. Under the terms of the Indiana Settlement, we and/or our

 

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insurers made a payment of $12,538 in exchange for the release of claims against the defendants and other released parties, by the plaintiffs and all settlement class members, and for the dismissal of the action with prejudice. On November 2, 2015, the plaintiffs in the Indiana Securities Litigation filed the Indiana Settlement and related exhibits with the court and moved, among other things, for the court to preliminarily approve the Indiana Settlement, to approve the contents and procedures for notice to potential settlement class members, to certify the Indiana Securities Litigation as a class action for settlement purposes only, and to schedule a hearing for the court to consider final approval of the Indiana Settlement. On November 4, 2015, the court entered an order preliminarily approving the Indiana Settlement and scheduled a hearing for March 10, 2016 to consider final approval of the Indiana Settlement. Prior to the March 10, 2016 hearing, potential settlement class members (all persons and entities who purchased or otherwise acquired our common stock, purchased or otherwise acquired call options on our common stock, or wrote put options on our common stock, between February 26, 2013 and May 12, 2015, both dates inclusive (with limited exclusions)) had an opportunity to exclude themselves from participating in the Indiana Settlement or to raise objections with the court regarding the Indiana Settlement or any part thereof. On March 10, 2016, the court entered an order finding that the Indiana Settlement is fair and reasonable and was entered into in good faith, and the court stated that a separate order regarding the Indiana Settlement would follow. On March 24, 2016, the court entered a final judgment and order approving the Indiana Settlement and dismissing the Indiana Securities Litigation with prejudice.

The Indiana Settlement contains no admission of liability, and all of the defendants in the Indiana Securities Litigation have expressly denied, and continue to deny, all allegations of wrongdoing or improper conduct. Our insurance carriers funded a combined $25,000 collectively towards the settlement payments for the Indiana Settlement and the New York Settlement.

On May 8, 2013, a complaint in a shareholder derivative lawsuit was filed against two of our current executive officers, one of our former executive officers, all but two of our current Directors, and three former Directors in the United States District Court for the Southern District of New York under the following caption: Sasha Wilfred, Derivatively on Behalf of Nominal Defendant ITT Educational Services, Inc. v. Kevin M. Modany, et al. (the “Wilfred Litigation”). On May 27, 2014, a complaint in a similar shareholder derivative lawsuit was filed against two of our current executive officers, one of our former executive officers, all but two of our current Directors, and four former Directors in the United States District Court for the district of Delaware under the following caption: Janice Nottenkamper, Derivatively on Behalf of Nominal Defendant ITT Educational Services, Inc. v Kevin M. Modany, et al. (the “Nottenkamper Litigation”).

On April 29, 2015, the Nottenkamper Litigation was transferred to the United States District Court for the Southern District of New York. On July 28, 2015, the court also consolidated the Wilfred Litigation and the Nottenkamper Litigation, appointing plaintiff Sasha Wilfred as lead plaintiff in the consolidated action.

On August 21, 2015, lead plaintiff filed a consolidated amended complaint. On September 16, 2015, plaintiff Nottenkamper was appointed as co-lead plaintiff in the Wilfred Litigation. The consolidated amended complaint alleged, among other things, that the defendants violated state law, including breaching their fiduciary duties to us, grossly mismanaging us, abusing their control of us, wasting our corporate assets and being unjustly enriched, by:

 

    causing or allowing us to disseminate to our shareholders materially misleading and inaccurate information relating to a series of risk-sharing agreements through SEC filings, press releases, conference calls, and other public statements and disclosures;

 

    willfully ignoring obvious and pervasive problems with our internal controls and practices and procedures, and failing to make a good faith effort to correct these problems or prevent their recurrence;

 

    violating and breaching fiduciary duties of care, loyalty, reasonable inquiry, oversight, good faith and supervision;

 

    causing or allowing us to misrepresent material facts regarding our financial position and business prospects; and

 

    abandoning their responsibilities and duties with regard to prudently managing our businesses in a manner imposed upon them by law.

The consolidated amended complaint also referred to certain issues and events that arose subsequent to the commencement of the Wilfred Litigation, including among other things, the agreements that we entered into with Mr. Modany and Mr. Fitzpatrick, dated August 4, 2014 and April 29, 2015, respectively, setting forth the terms of their resignations (the “Resignation Agreements”), the CFPB complaint against us, our submission of a letter of credit to the ED, our restatement of certain financial results, our receipt of a Wells Notice from the SEC, and the SEC complaint against us.

The consolidated amended complaint sought:

 

    unspecified damages;

 

    restitution;

 

    disgorgement of all profits, benefits and other compensation obtained by the individual defendants;

 

    an order directing us to take all necessary actions to reform and improve our corporate governance and internal procedures; and

 

    costs and disbursements, including attorneys’, accountants’ and experts’ fees, costs and expenses.

 

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On December 23, 2014, a complaint in a shareholder derivative lawsuit was filed against two of our current executive officers, one of our former executive officers, all but four of our current Directors, and three former Directors in the United States District Court for the Southern District of Indiana under the following caption: Michelle Lawrence, Derivatively on Behalf of Nominal Defendant ITT Educational Services, Inc. v. Kevin M. Modany, et al. (the “Lawrence Litigation”). The complaint alleges, among other things, that the individual defendants breached their fiduciary duties to us, abused their control, grossly mismanaged us and were unjustly enriched by:

 

    participating in misrepresentation of our business operations;

 

    failing to correct our public statements;

 

    failing to oversee our business and internal controls;

 

    causing us to issue false and misleading statements of material fact in our consolidated financial statements in our quarterly reports;

 

    subjecting us to multiple federal securities fraud class action lawsuits;

 

    causing us to restate our consolidated financial statements in our quarterly reports; and

 

    causing us to receive a Wells Notice from the SEC.

The complaint sought:

 

    unspecified damages;

 

    restitution;

 

    disgorgement of all profits, benefits and other compensation obtained by the individual defendants;

 

    an order directing us to take all necessary actions to reform and improve our corporate governance and internal procedure, including taking action to strengthen the Board’s supervision of operations, procedures for greater shareholder input and for effective oversight of compliance; and

 

    costs and disbursements, including attorneys’ and experts’ fees, costs and expenses.

On July 1, 2015, a complaint in a shareholder derivative lawsuit was filed against two of our current executive officers, one of our former executive officers, all but two of our current Directors, and three former Directors in the Marion Superior Court, Indianapolis, Indiana under the following caption: William McKee, Derivatively on behalf of ITT Educational Services, Inc. v. Kevin Modany, et al. (the “McKee Litigation”). The complaint alleged, among other things, that the individual defendants breached their fiduciary duties to us by:

 

    causing us to engage in unlawful conduct with respect to risky student loan financing programs;

 

    causing us to fail to disclose material information to shareholders regarding our business, financial condition, and accounting procedures;

 

    preparing and disseminating inaccurate press releases and SEC filings;

 

    failing to ensure the existence of appropriate and adequate internal financial controls;

 

    exposing us to substantial investigation costs, huge liability to stock purchasers, regulatory penalties, and the cost of defending the SEC proceeding and the securities litigations; and

 

    damaging our reputation and goodwill in the securities markets.

The complaint sought:

 

    a declaratory judgment;

 

    restitution;

 

    equitable and/or injunctive relief;

 

    an order directing us to reform and improve corporate governance and internal procedures; and

 

    costs and disbursements, including attorneys’, accountants’ and experts’ fees, costs and expenses.

On January 21, 2016, the parties in the Wilfred Litigation, Lawrence Litigation, and McKee Litigation all entered into a Stipulation and Agreement of Settlement (the “Derivative Settlement”), subject to court approval, to settle the three shareholder derivative actions discussed above: (1) the Wilfred Litigation, including the Nottenkamper Litigation consolidated thereunder; (2) the Lawrence Litigation; and (3) the McKee Litigation. The Derivative Settlement is intended by the settling parties to fully, finally and forever resolve the Wilfred Litigation, the Lawrence Litigation, and the McKee Litigation and to result in the dismissal of those actions with prejudice. Under the terms of the Derivative Settlement, we will implement certain agreed upon corporate governance reforms, to be administered by us and the Board of Directors. Additionally, pursuant to the terms of the Derivative Settlement, we paid half of $1,100 in attorneys’ fees and expenses (the “Derivative Fee Award”) to the plaintiffs’ counsel. One of our insurers funded the other half of the Derivative Fee Award, on behalf of the individual defendants in the Wilfred Litigation, the Lawrence Litigation, and the McKee Litigation.

On January 22, 2016, the Derivative Settlement and related exhibits were filed in the Wilfred Litigation, and the plaintiffs in the Wilfred Litigation moved, among other things, for the court to preliminarily approve the Derivative Settlement and to approve the form and manner of notice to be provided to our shareholders. On January 29, 2016, the court in the Wilfred Litigation entered an

 

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order preliminarily approving the Derivative Settlement, and scheduled a hearing for April 6, 2016 to consider final approval of the Derivative Settlement. Prior to the April 6, 2016 hearing, current shareholders had an opportunity to raise objections, or otherwise be heard, regarding the terms of the Derivative Settlement and the Derivative Fee Award. On April 6, 2016, the court in the Wilfred Litigation granted final approval of the Derivative Settlement and entered a final order and judgment dismissing the Wilfred Litigation with prejudice.

On May 12, 2016, the plaintiff in the Lawrence Litigation filed a motion to dismiss that action with prejudice. On May 13, 2016, the plaintiff in the McKee Litigation filed a motion to dismiss that action with prejudice. On May 16, 2016, the respective courts for the Lawrence Litigation and the McKee Litigation granted those motions to dismiss and ordered that the actions be dismissed with prejudice.

The Derivative Settlement did not include any admission of the validity of any of the claims the plaintiffs had asserted in the Wilfred Litigation, the Lawrence Litigation, or the McKee Litigation, or of any liability with respect thereto. We determined that the Derivative Settlement was in our company’s best interests, and it was intended to eliminate the uncertainty, distraction, disruption, burden, and expense of further litigation of the Wilfred Litigation, the Lawrence Litigation, and the McKee Litigation.

On December 21, 2015, a complaint in a shareholder derivative lawsuit was filed against two of our current executive officers, one of our former executive officers, all but two of our current Directors, and four former Directors in the United States District Court for the Southern District of Indiana under the following caption: Donnald Canfield, Derivatively on Behalf of Nominal Defendant ITT Educational Services, Inc. v. Kevin M. Modany, et al. (the “Canfield Litigation”). The complaint alleges, among other things, that the individual defendants breached their fiduciary duties to us, and abused their control by:

 

    failing to properly oversee our business;

 

    allowing us to mischaracterize our financial position and business prospects;

 

    causing us to issue false and misleading statements of material fact in SEC filings regarding a series of risk-sharing agreements related to student loan programs;

 

    failing to take sufficient steps to reduce risks associated with student loan default rates;

 

    subjecting us to securities class action lawsuits, government investigations, government enforcement actions, and their associated costs; and

 

    damaging our reputation and goodwill.

The complaint also alleged that the defendants violated Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder by misrepresenting or omitting material information in the Company’s proxy statement filed with the SEC on March 13, 2012.

The complaint sought:

 

    a declaratory judgment;

 

    unspecified compensatory and exemplary damages;

 

    restitution;

 

    equitable relief;

 

    an order directing us to reform and improve corporate governance and internal procedures; and

 

    costs and disbursements, including attorneys’ and experts’ fees, costs and expenses.

On January 22, 2016, the defendants in the Canfield Litigation filed a motion to stay the Canfield Litigation pending the approval of the Derivative Settlement for the settlement of the Wilfred Litigation, the Lawrence Litigation, and the McKee Litigation. On February 23, 2016, the court entered an order that no responsive pleading would be due in the Canfield Litigation until after the court’s ruling on the stay motion. On April 7, 2016, the defendants filed a notice of final approval of the Derivative Settlement in further support of defendants’ motion to stay the Canfield Litigation and requested that the parties report to the court following the effective date of the Derivative Settlement, unless and until the Derivative Settlement was canceled or terminated. On June 24, 2016, the plaintiff in the Canfield Litigation filed a motion to dismiss without prejudice. On June 27, 2016, the court entered an order of dismissal of the Canfield Litigation without prejudice.

Although the Wilfred Litigation, Lawrence Litigation, McKee Litigation, and Canfield Litigation were each brought nominally on behalf of us, we have incurred defense costs and other expenses in connection with those actions.

        On May 18, 2012, we received a Civil Investigative Demand (the “Original CID”) from the U.S. Consumer Financial Protection Bureau (the “CFPB”). In September 2013, the CFPB withdrew the Original CID, and we received a new Civil Investigative Demand (the “New CID”) from the CFPB. Both the Original CID and the New CID provided that the purpose of the CFPB’s investigation was, in part, “to determine whether for-profit post-secondary companies, student loan origination and servicing providers, or other unnamed persons have engaged or are engaging in unlawful acts or practices relating to the advertising, marketing, or origination of private student loans.” Both the Original CID and the New CID contained broad requests for oral testimony, production of documents and written reports related to private education loans made to our students, internal financing provided to our students and certain other aspects of our business. We provided documentation and other information to the CFPB, while preserving our rights to object to its inquiry.

 

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On February 26, 2014, the CFPB filed a complaint against us in the United States District Court for the Southern District of Indiana under the following caption: Consumer Financial Protection Bureau v. ITT Educational Services, Inc. (the “CFPB Litigation”). The complaint claimed, among other things, that we violated:

 

    Section 1036(a)(1) of the Consumer Financial Protection Act of 2010 (the “CFPA”), 12 U.S.C. § 5536(a)(1), which prohibits unfair, deceptive and abusive acts and practices, from July 21, 2011 through December 2011, by:

 

    subjecting consumers to undue influence or coercing them into taking out private education loans through a variety of unfair acts and practices designed to interfere with the consumers’ ability to make informed, uncoerced choices;

 

    taking unreasonable advantage of consumers’ inability to protect their interest in selecting or using the private education loans; and

 

    taking unreasonable advantage of consumers’ reasonable reliance on us to act in the consumers’ interests; and

 

    the Truth in Lending Act, 15 U.S.C. §§ 1601 et seq., and Regulation Z thereunder, 12 C.F.R. Part 1026, which require certain disclosures to be made in writing to consumers in connection with the extension of consumer credit, since March 2009, by failing to disclose a discount that constituted a finance charge.

We filed a motion to dismiss the CFPB Litigation on several grounds. On March 6, 2015, the court issued an order denying our motion in part and granting it in part, including by dismissing the CFPB’s claim under the Truth in Lending Act. On April 8, 2015, we filed a notice of appeal to the United States Court for the Seventh Circuit from the order on the motion to dismiss. On April 20, 2016, the court dismissed our appeal for lack of jurisdiction. We have defended, and intend to continue to defend, ourselves vigorously against the remaining allegations made in the complaint.

On February 27, 2014, the New Mexico Attorney General filed a complaint against us in the District Court of New Mexico under the following caption: State of New Mexico, ex rel. Gary K King, Attorney General v. ITT Educational Services, Inc., et al. (the “New Mexico Litigation”). On April 4, 2014, we removed the New Mexico Litigation to the U.S. District Court for the District of New Mexico. In April 2014, the Attorney General filed a motion to remand the New Mexico Litigation to the District Court of New Mexico. On June 30, 2015, the U.S. District Court remanded the New Mexico Litigation back to the state District Court. The complaint alleges, among other things, that we engaged in a pattern and practice of exploiting New Mexico consumers by using deceptive, unfair, unconscionable and unlawful business practices in the marketing, sale, provision and financing of education goods and services in violation of New Mexico’s Unfair Practices Act. In particular, the complaint contains allegations that:

 

    we misrepresented matters related to our nursing education program, including, without limitation, its programmatic accreditation status, the transferability of credits earned in the program and the curriculum of the program;

 

    we misrepresented the terms of the financial aid available to students and the cost of our programs;

 

    we engaged in unfair or deceptive trade practices;

 

    we failed to issue refunds; and

 

    our form enrollment agreement contained unenforceable and unconscionable provisions.

The complaint seeks:

 

    an order declaring portions of our enrollment agreement illusory, unconscionable and unenforceable;

 

    preliminary and permanent injunctive relief;

 

    disgorgement of unjust enrichment amounts;

 

    unspecified civil penalty amounts;

 

    restitution; and

 

    reasonable costs, including investigative costs.

On July 30, 2015, we filed a motion to dismiss the New Mexico Litigation on several grounds and a motion to compel arbitration. On December 8, 2015, the court denied the motion to dismiss and the motion to compel arbitration. On December 11, 2015, we filed a notice of appeal challenging the denial of our motion to compel arbitration. That appeal is pending in the court of appeals. On January 6, 2016, the State District Court issued an order providing for a stay of the case pending resolution of our appeal. The Attorney General disputes that a stay is in effect and has filed a motion asking the State District Court to proceed with the nonarbitrable claims. We opposed the Attorney General’s motion to proceed. On March 24, 2016, the court granted the Attorney General’s motion to proceed on nonarbitrable claims. On July 11, 2016, we filed our appellate brief in the court of appeals.

We have defended, and intend to continue to defend, ourselves vigorously against the allegations made in the complaint.

On December 17, 2013, a complaint was filed against us in a purported class action in the Superior Court of the State of California for the County of Los Angeles under the following caption: La Sondra Gallien, an individual, James Rayonez, an individual, Giovanni Chilin, an individual, on behalf of themselves and on behalf of all persons similarly situated v. ITT Educational

 

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Services, Inc., et al. (the “Gallien Litigation”). The plaintiffs filed an amended complaint on February 13, 2014. The amended complaint alleges, among other things, that under California law, we:

 

    failed to pay wages owed;

 

    failed to pay overtime compensation;

 

    failed to provide meal and rest periods;

 

    failed to provide itemized employee wage statements;

 

    engaged in unlawful business practices; and

 

    are liable for civil penalties under the California Private Attorney General Act.

The purported class includes recruiting representatives employed by us during the period of December 17, 2009 through December 17, 2013. The amended complaint seeks:

 

    compensatory damages, including lost wages and other losses;

 

    general damages;

 

    pay for missed meal and rest periods;

 

    restitution;

 

    liquidated damages;

 

    statutory penalties;

 

    interest;

 

    attorneys’ fees, cost and expenses;

 

    civil and statutory penalties;

 

    injunctive relief; and

 

    such other and further relief as the court may deem equitable and appropriate.

Following a mediation that began in the third quarter of 2015, the parties came to an agreement in principle to settle the Gallien Litigation on a class-wide basis for $400. On October 28, 2015, the parties executed a Stipulation of Class Action Settlement (the “Gallien Settlement”) to document the terms and conditions of the settlement. In connection with the Gallien Settlement and subject to court approval, the settlement is based on claims made with a specific reversion of funds paid back to us, depending on the number of claims made by settlement class members for individual settlement payments. Under the terms specified in the Gallien Settlement, 55% of a net settlement amount of approximately $204 must be paid to settlement class members in the form of individual settlement payments. In the event the settlement is not approved by the court or otherwise does not become effective, we intend to continue to defend ourselves vigorously against the allegations made in the amended complaint. On March 11, 2016, the court entered an order preliminarily approving the Gallien Settlement and scheduled a hearing for June 23, 2016 to consider final approval of the Gallien Settlement. On June 30, 2016, the court entered a final judgment and order approving the Gallien Settlement, which required a payment of $350 from us. On July 8, 2016, we made a payment of $350 in accordance with the terms of the Gallien Settlement.

On May 12, 2015, the SEC filed a civil enforcement action against us, our Chief Executive Officer, Kevin M. Modany, and our former Chief Financial Officer, Daniel M. Fitzpatrick, in the United States District Court for the Southern District of Indiana under the following caption: United States Securities and Exchange Commission v. ITT Educational Services, Inc., Kevin M. Modany and Daniel M. Fitzpatrick (the “SEC Litigation”). As we previously disclosed, we received several SEC subpoenas beginning on February 8, 2013. The SEC’s subpoenas requested the production of documents and communications that, among other things, relate to our actions, disclosures, and accounting associated with the CUSO Program and the PEAKS Program. We provided the information requested, including testimony of senior employees. On August 7, 2014, we received a “Wells Notice” from the Staff of the SEC notifying us that the Staff had made a preliminary determination to recommend that the SEC file an enforcement action against us. According to the Staff, the enforcement action would allege violations of Sections 10(b), 13(a) and 13(b)(2) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11, 13a-13 and 13a-15 under the Exchange Act. Under the SEC’s procedures, a recipient of a Wells Notice has an opportunity to respond in the form of a Wells submission that seeks to persuade the SEC that such an action should not be brought. We made submissions to the Staff in response to the Wells Notice we received that set forth why the factual record does not support the enforcement action recommended by the Staff and explained that any of our perceived shortcomings were acts taken in good faith. Our Chief Executive Officer and former Chief Financial Officer each made similar submissions.

The SEC Litigation relates to the matters addressed in the Wells Notice that we received, and the complaint alleges violations of Sections 10(b), 13(a) and 13(b)(2) of the Exchange Act; Rules 10b-5, 12b-20, 13a-1, 13a-11 and 13a-13 under the Exchange Act; and Section 17(a) of the Securities Act. Among other assertions, the complaint alleges that we engaged in a fraudulent scheme and course of business and made various false and misleading statements to our investors relating to the CUSO Program and the PEAKS Program. The remedies sought by the SEC in the complaint include:

 

    a finding that each of the defendants committed the alleged violations;

 

    an injunction permanently restraining and enjoining each of the defendants from violating, directly or indirectly, the laws and rules alleged in the complaint;

 

    an order that Messrs. Modany and Fitzpatrick be permanently prohibited from acting as an officer or director of any public company;

 

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    disgorgement of any and all ill-gotten gains, together with pre- and post-judgment interest, derived from the improper conduct alleged in the complaint;

 

    civil money penalties pursuant to Section 20(d) of the Securities Act and Section 21(d) of the Exchange Act in an amount to be determined by the court, plus post-judgment interest;

 

    an order that Messrs. Modany and Fitzpatrick reimburse us for all bonuses, incentive-based and equity-based compensation, and/or profits realized from their sale of our stock pursuant to Section 304 of the Sarbanes-Oxley Act of 2002; and

 

    such other relief as the court may deem just or appropriate.

On July 17, 2015, we filed our answer in the SEC Litigation in which we denied all of the SEC’s claims.

We intend to defend ourselves vigorously against the claims in the SEC Litigation. Nevertheless, we cannot predict the outcome of any legal action or whether the matter will result in any settlement. We cannot assure you that the ultimate outcome of the SEC Litigation or any settlement will not have a material adverse effect on our financial condition, results of operations and/or cash flows.

In September 2015, we received a Civil Investigative Demand (“CID”) from the U.S. Department of Justice (“DOJ”). The CID provides that the purpose of the investigation is to determine whether there is or has been a violation of the False Claims Act and whether we knowingly submitted false statements in violation of the ED’s Program Participation Agreement regulations. The CID contained requests for production of documents and answers to interrogatories that we believe are principally related to our compliance with the ED’s compensation regulations and was related to a sealed qui tam action. We believe that our practices with respect to compensation matters are in compliance with applicable laws and regulations, and we cooperated with the DOJ in responding to the CID. On January 15, 2016, the United States District Court for the Middle District of Florida issued an order unsealing the underlying qui tam case, revealing that the DOJ has declined to intervene in the qui tam action. Accordingly, the DOJ has closed its investigation. The court also ordered that the qui tam False Claims Act complaint, which was filed by a former disgruntled employee, be served on defendants ITT Educational Services, Inc. and ITT Technical Institute. The qui tam action was filed on April 8, 2015 in the United States District Court for the Middle District of Florida under the following caption: United States of America ex rel. Rodney Lipscomb v. ITT Educational Services, Inc. (the “Lipscomb Litigation”). On May 16, 2016, the relator filed an amended complaint. The relator alleges in the amended complaint, among other things, that we received Title IV federal financial aid in violation of various Title IV condition of payment rules and regulations and thereby violated the False Claims Act, 31 U.S.C. §3729, et. seq., by:

 

    enrolling students who lacked the ability to benefit from our educational experience, contrary to ACICS’s accreditation standards;

 

    misrepresenting course offerings to students;

 

    misrepresenting the cost of attending ITT Technical Institute and the terms of our Opportunity Scholarship;

 

    misrepresenting our credit transfer policies and transferability of our credits to other institutions; and

 

    instructing students to submit false information to the ED about their income on the Free Application for Federal Student Aid.

The relator also alleges that we retaliated against him and violated the False Claims Act by terminating his employment after he reported illegal and unethical practices to our management. The relator also alleges that in violation of Title VII of the Civil Rights Act of 1964, 42 U.S.C. §2000e, et. seq., we terminated his employment because of his race or because he reported and opposed alleged discriminatory behavior by us.

The relator seeks various forms of recovery on behalf of himself and the federal government, including treble damages and civil penalties; the maximum amount pursuant to 31 U.S.C. §3730(d); the maximum amount pursuant to 31 U.S.C. §3730(h), including two times back pay; interest; expenses; attorney’s fees; and costs. On April 11, 2016, the complaint was served on us. On July 14, 2016, we filed a motion to dismiss the Lipscomb Litigation. We vehemently deny the allegations in the action and intend to vigorously defend ourself against these claims.

On October 30, 2012, we received a CID from the Massachusetts Office of the Attorney General (“MAG”). The MAG’s CID provides that the MAG is investigating allegations that we may have violated Massachusetts General Laws, Chapter 93A, Section 2(a), by “engaging in unfair or deceptive practices in connection with marketing and advertising job placement and student outcomes, the recruitment of students, and the financing of education.” The MAG has since requested additional information from us, including through two follow up CIDs. The MAG’s CID contains broad requests for production of documents related to our students in Massachusetts, including the financial aid available to those students, our recruitment of those students, the career services that we offer to those students, our marketing and advertising, the retention and graduation rates of those students and many other aspects of our business. We have cooperated with the MAG in its investigation, and we have provided documentation, communications and other information to the MAG in response to the CID.

 

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On March 31, 2016, the MAG filed a civil complaint against us in the Norfolk County (Massachusetts) Superior Court (the “Massachusetts Litigation”). On April 6, 2016, the MAG served that complaint on us. The complaint alleges that we violated the Massachusetts Consumer Protection Act, M.G.L. c.93A §2 with respect to our Computer Network Systems program, by, among other things and without limitation:

 

    engaging in unfair and harassing sales tactics, including placing undue pressure on Massachusetts consumers and prospective students to enroll;

 

    making false and/or misleading representations to prospective students concerning placement rates, wages and salaries, and the nature, character and quality of the program and instruction; and

 

    unfairly steering Massachusetts student borrowers to expensive private loans.

The complaint seeks:

 

    permanent injunctive relief;

 

    restitution;

 

    civil penalties of $5 per violation; and

 

    costs, including reasonable attorneys’ fees.

On May 31, 2016, we filed a motion to dismiss the Massachusetts Litigation. We intend to defend ourselves vigorously against the allegations made in the complaint.

On May 8, 2014, a former employee filed a complaint against us in the Superior Court of Alameda County, California under the following caption: Hung Duong v. ITT Educational Services, Inc., Sam Russell and Allison Hawkins (the “Duong Litigation”). The complaint alleges, among other things, that we discriminated and retaliated against the plaintiff based upon his race, national origin, and age. In particular, the complaint contains allegations that:

 

    we violated the California Fair Employment and Housing Act (“FEHA”) by terminating the plaintiff in retaliation for him opposing conduct that he believed constituted unlawful discrimination and harassment;

 

    we violated FEHA by failing to promote and terminating the Plaintiff due to his national origin, his age and his race; and

 

    we and two of our employees defamed the plaintiff by making false and defamatory publications and declarations that directly injured plaintiff’s professional, personal, and business reputation causing injury.

The complaint sought:

 

    past and future economic damages, including but not limited to lost wages, benefits, costs of seeking alternative employment and lost earning capacity;

 

    past and future non-economic damages including, but not limited to, emotional distress, pain, suffering shame, humiliation, embarrassment and injury to reputation;

 

    punitive damages, pre-judgment interest, injunctive relief in the form of court ordered training and modification of policies;

 

    injunctive relief in the form of court-ordered training and/or modification of policies concerning harassment, discrimination and retaliation;

 

    declaratory relief that we acted unlawfully; and

 

    reasonable attorneys’ fees and costs.

On February 19, 2016, we filed a motion for summary judgment and/or summary adjudication seeking to dismiss all claims. On May 9, 2016, the court granted us summary adjudication with regard to the plaintiff’s claims for failure to promote and termination based upon national origin, race, and/or age. The court denied our motion with regard to the plaintiff’s claims for retaliation and defamation. Trial on the matter was held in June 2016, and on June 30, 2016, the jury returned a verdict in favor of the plaintiff and awarded damages in the amount of $414. On July 1, 2016, the jury further awarded the plaintiff $500 in punitive damages.

The court has indicated that it will not enter judgment until it determines whether the damages award should be reduced by the amount applicable to plaintiff’s defamation claim against one of the individual defendants based upon the affirmative defense of the common interest privilege. The court set a briefing schedule on that matter, with the hearing scheduled to take place on August 10, 2016. After the court resolves that issue, the court will enter judgment. After entry of judgment, we will have the opportunity to file a notice of appeal, a motion for judgment notwithstanding the verdict and/or a motion for a new trial. Plaintiff will have the opportunity to file a notice of motion to claim attorneys’ fees and a memorandum of costs.

We have defended, and intend to continue to defend, ourselves vigorously against the allegations made in the complaint.

 

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On July 20, 2016, a complaint was filed against us in a purported class action in the Superior Court for the State of California County of Alameda under the following caption: Sean Miner, David Heumann, and Shawna Admire, individually and on behalf of all others similarly situated v. ITT Educational Services, Inc. (the “Miner Litigation”). The complaint alleges, among other things, that under California law, we:

 

    failed to pay wages for all hours worked;

 

    failed to provide paid rest periods and failed to pay missed rest break premiums;

 

    failed to pay compensation due upon discharge from employment;

 

    failed to issue accurate wage statements;

 

    failed to reimburse for business-related cellphone usage;

 

    engaged in unfair, unlawful, or fraudulent business practices; and

 

    are liable for civil penalties under the California Labor Code Private Attorney General Act.

The purported class includes adjunct instructors employed by us during the period of January 12, 2012 through the trial date. The complaint seeks:

 

    an order that the action may proceed and be maintained as a class action;

 

    declaratory judgments;

 

    compensatory damages, including lost wages and other losses;

 

    pay for missed meal and rest periods;

 

    restitution;

 

    liquidated damages;

 

    interest;

 

    attorneys’ fees, cost and expenses;

 

    civil and statutory penalties;

 

    injunctive relief; and

 

    all other relief as the court deems proper.

We intend to defend ourselves vigorously against the allegations made in the complaint.

Kevin M. Modany and Daniel M. Fitzpatrick were named in the New York Securities Litigation, Indiana Securities Litigation, Wilfred Litigation, Lawrence Litigation, McKee Litigation and Canfield Litigation and are named in the SEC Litigation. John E. Dean was also named in the Wilfred Litigation, Lawrence Litigation, McKee Litigation, and Canfield Litigation.

There can be no assurance that the ultimate outcome of the Leveski Litigation, CFPB Litigation, New Mexico Litigation, Gallien Litigation, SEC Litigation, Lipscomb Litigation, Massachusetts Litigation, Duong Litigation, Miner Litigation or other actions (including other actions under federal or state securities laws) will not have a material adverse effect on our financial condition, results of operations or cash flows.

Certain of our current and former officers and Directors are or may become a party in the actions described above and/or are or may become subject to government investigations. Our By-laws and Restated Certificate of Incorporation obligate us to indemnify our officers and Directors to the fullest extent permitted by Delaware law, provided that their conduct complied with certain requirements. We are obligated to advance defense costs to our officers and Directors, subject to the individual’s obligation to repay such amount if it is ultimately determined that the individual was not entitled to indemnification. In addition, our indemnity obligation can, under certain circumstances, include indemnifiable judgments, penalties, fines and amounts paid in settlement in connection with those actions and investigations.

Government Investigations. We are subject to investigations and claims of non-compliance with regulatory standards and other actions brought by regulatory agencies. The more significant pending investigations, claims and actions are described below. If the results of any investigations, claims and/or actions are unfavorable to us, we may be required to pay money damages or be subject to fines, penalties, injunctions, operational limitations, loss of eligibility to participate in federal or state financial aid programs, debarments, additional oversight and reporting, or other civil and criminal sanctions. Those sanctions could have a material adverse effect on our financial condition, results of operations and cash flows.

In January, February, April and May 2014, in February, March and June 2015, and in July 2016, we received subpoenas and/or CIDs from the Attorneys General of Arkansas, Arizona, Colorado, Connecticut, District of Columbia, Hawaii, Idaho, Iowa, Kentucky, Maryland, Minnesota, Missouri, Nebraska, North Carolina, Oregon, Pennsylvania, Tennessee and Washington under the authority of each state’s consumer protection statutes. The Attorney General of the Commonwealth of Kentucky has informed us that it will serve as the point of contact for the multistate group to respond to questions relating to the subpoenas and CIDs. The subpoenas and CIDs

 

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contain broad requests for information and the production of documents related to our students and practices, including marketing and advertising, recruitment, financial aid, academic advising, career services, admissions, programs, licensure exam pass rates, accreditation, student retention, graduation rates and job placement rates, as well as many other aspects of our business. We believe that several other companies in the proprietary postsecondary education sector have received similar subpoenas and CIDs. We are cooperating with the Attorneys General of the states involved. The ultimate outcome of the state Attorneys General investigation, however, could have a material adverse effect on our financial condition, results of operations and/or cash flows.

On April 1, 2016, we received a letter from the SEC requesting that we supply information voluntarily to the SEC. In the letter, the SEC states that it is conducting an inquiry of trading in our securities to determine if violations of the federal securities laws have occurred. The SEC’s letter requests the voluntary production of communications and other documents that relate to, among other things, our October 16, 2014 filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, and our May 29, 2015 filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014. We are cooperating with the SEC in its inquiry, and we have provided documents and other information to the SEC in response to its requests, including our insider trading policies and information regarding individuals who were aware in advance of our filing of our 2013 Form 10-K and our 2014 Form 10-K. There can be no assurance, however, that the ultimate outcome of the SEC inquiry will not have a material adverse effect on our financial condition, results of operations and/or cash flows.

 

12. Risks and Uncertainties

Many of the amounts of assets, liabilities, revenue and expenses reported in our consolidated financial statements are based on estimates and assumptions that affect the amounts reported. We are subject to risks and uncertainties that could affect amounts reported in our consolidated financial statements in future periods. Our future performance, results of operations, financial condition, cash flows, liquidity, capital resources, ability to meet our obligations and ability to comply with covenants, metrics and regulatory requirements are subject to significant risks and uncertainties that could cause actual results to be materially different from our estimated results. Those significant risks and uncertainties include, but are not limited to, the following:

 

    The PEAKS Consolidation and CUSO Consolidation, which have and could negatively impact our compliance with:

 

    the ED’s financial responsibility measurements, primarily our institutions’ composite score;

 

    the financial requirements of certain state education and professional licensing authorities (“SAs”); and

 

    the financial metrics to which we are subject under the PEAKS Program and the CUSO RSA.

See Note 5 – Variable Interest Entities, Note 8 – Debt and Note 11 – Commitments and Contingencies, for additional information.

 

    Our institutions’ failure to submit their 2013 audited consolidated financial statements and 2013 Compliance Audits to the ED by the due date resulted in sanctions imposed by the ED on our institutions that include, among other things, our institutions having to submit a letter of credit, being placed on heightened cash monitoring (“HCM”) and being provisionally certified. We caused the ED Letter of Credit to be issued on October 31, 2014, but it has subsequently been replaced by the ED Agreement. The term of the ED Agreement ends on November 4, 2019. Pursuant to the ED Agreement, $79,708 was held in an escrow account by the ED as of June 30, 2016. The funds held are not available for use by us, and could be used by the ED if certain conditions are met. See Note 11 – Commitments and Contingencies for additional information. An institution that is provisionally certified by the ED must apply for and receive approval from the ED for any substantial change, before the institution can award, disburse or distribute Title IV Program funds based on the substantial change. Substantial changes generally include, but are not limited to:

 

    the establishment of an additional location;

 

    an increase in the level of academic offering beyond those listed in the institution’s Eligibility and Certification Approval Report with the ED;

 

    an addition of any non-degree program or short-term training program; or

 

    an addition of a degree program by a proprietary institution.

 

    On October 19, 2015, we received a letter from the ED identifying additional procedures that we are required to implement as a result of the identification of certain past deficiencies. These additional procedures have resulted in the delay of our receipt of Title IV Program funds. While these additional procedures have affected the timing of our receipt of Title IV Program funds and have imposed an administrative burden on us, we do not expect them to have a significant negative effect on our overall cash flow or operations, but we cannot assure you that there will not be future delays in our institutions’ receipt of Title IV Program funds. The letter also states that we are required to provide certain additional information and reporting to the ED on a regular basis. We have implemented, and are in the process of implementing, measures to comply with the ED’s requirements. We have been submitting the additional information to the ED, and intend to continue submitting information to the ED according to the schedule specified by the ED.

 

   

On June 6, 2016, we received the June 2016 ED Letter stating that the ED believes that certain actions of the ACICS (which actions are described below), represent an increased risk to the funds under the Title IV Programs that we administer on behalf of students. The June 2016 ED Letter indicates that due to this increased risk, the ED determined that the amount of

 

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surety provided by us must be increased from approximately $79,708 to approximately $123,646. The June 2016 ED Letter states that we can provide the Additional ED Amount required to be held as additional ED Escrowed Funds or that we may provide a new letter of credit payable to the ED in the Additional ED Amount. The June 2016 ED Letter also provides that we must continue to comply with the other requirements imposed on us by the ED currently in effect. These other requirements are described further in our 2015 Form 10-K.

On July 6, 2016, the ED informed us that the ED will permit us to provide the Additional ED Amount in three equal installments of approximately $14,646 on each of July 20, 2016, September 30, 2016 and November 30, 2016. The ED stated that prior to the third installment due on November 30, 2016, the ED will evaluate our Title IV Program funding level for the 2016 fiscal year to determine if an adjustment in the scheduled payment amount can be made while ensuring that the amount held in surety represents at least 20% of our annual student aid funding. The ED subsequently indicated that the analysis of our annual student aid funding volume will not be the only factor that the ED considers in determining whether a change to the third installment is warranted, and it will also take into account the risk environment as it exists at that future time.

On July 20, 2016, we made the required first installment payment of $14,646 to the ED, which is being held as part of the ED Escrowed Funds under the ED Agreement.

 

    We are subject to various claims and contingencies, including those related to litigation, government investigations, business transactions, tax matters and employee-related matters, among others. See Note 11 – Commitments and Contingencies, for a further discussion of certain litigation and government investigations to which we are subject.

 

    We have significant guarantee obligations under the PEAKS Guarantee and the CUSO RSA (collectively, the “RSAs”). In 2015, we made payments of $30,090 under the PEAKS Guarantee, and $13,093, net of $521 of recoveries owed to us that we offset against amounts that we owed to the CUSO, related to the CUSO RSA. Based on various assumptions, including the historical and projected performance and collection of the PEAKS Trust Student Loans, we believe that we will make payments under the PEAKS Guarantee of approximately $10,800 in 2016 and approximately $1,200 in 2017. In addition, based upon various assumptions, including the historical and projected performance and collections of the private education loans under the CUSO Program, we believe that we will make payments under the CUSO RSA, net of recoveries, of approximately $15,700 in 2016 and $11,000 in 2017. See Note 8 – Debt and Note 11 – Commitments and Contingencies for a further discussion of the RSAs and estimated payment amounts.

 

    We have principal payments due under the Financing Agreement of $34,681 during the period July 1, 2016 through December 31, 2016.

 

    We had negative working capital as of June 30, 2016, December 31, 2015 and June 30, 2015.

 

    On April 20, 2016, the accrediting agency which accredits our ITT Technical Institute institutions informed us that, based on its review, the ITT Technical Institutes have not demonstrated compliance with certain accreditation standards. As a result, we must show cause why the ITT Technical Institutes’ accreditation should not be withdrawn by suspension or otherwise conditioned. We believe that the ITT Technical Institutes are in compliance with all accreditation standards, however, if the ITT Technical Institutes ultimately were to lose their accreditation, they would lose their eligibility to participate in Title IV Programs, in which case we likely would not be able to continue to operate our business.

 

    On June 16, 2016, the ED released a staff report which recommended that ACICS’s petition for renewal of recognition be denied and that ACICS’s recognition be withdrawn. This recommendation represents one step in the overall process of reviewing an accrediting agency’s recognition. On June 24, 2016, the National Advisory Committee on Institutional Quality and Integrity (“NACIQI”) voted that ACICS no longer be recognized as an accrediting agency. Both the ED staff report and NACIQI recommendations were provided to the Senior ED official (“SDO”) for the actual decision. The SDO has 90 days from the date of the NACIQI meeting to make a final decision regarding ACICS.

If the ED does not renew its recognition of the ACICS, all ITT Technical Institutes would no longer be accredited by a recognized accrediting agency. In such a case, the ED’s regulations provide that the ED may continue the eligibility of those institutions to participate in Title IV Programs, putting them on provisional certification status, for a period of up to 18 months, during which time the institutions could seek to obtain accreditation by another accrediting agency that is recognized by the ED. If the ACICS were to lose its recognition by the ED, we cannot assure you that all, or any, of our campuses comprising our institutions could obtain accreditation by another recognized accrediting agency within any specified timeframe. In addition, if our campuses remained on show cause status with the ACICS at the time the ED withdrew its recognition of the ACICS, we cannot predict what effect the show cause status would have on our campuses’ ability to become accredited by another recognized accrediting agency. If any of our campuses could not obtain accreditation by another recognized accrediting agency within the time period given to our institutions by the ED, those campuses would lose their eligibility to participate in Title IV Programs and we would likely be forced to close those campuses. Closing multiple campuses would have a material adverse effect on our financial condition, results of operations and cash flows. If all or substantially all of our campuses lost their eligibility to participate in Title IV Programs, we likely would not be able to continue to operate our business.

 

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In addition to the ED, the approval status and in some cases funding provided by other agencies would be adversely affected by the institutions’ loss of accreditation by a recognized accrediting agency, effective at the time the accreditation is lost, even during any period that the ED’s provisional certification of the institutions continues. For example:

 

    some state authorizing agencies require institutions to be accredited by a recognized accrediting agency in order to operate or for students at those institutions to receive state funding;

 

    the Department of Defense requires institutions to be accredited by a recognized accrediting agency in order for military personnel attending those institutions to participate in DOD tuition assistance programs; and

 

    the Department of Veterans Affairs subjects programs at institutions that are not accredited by a recognized accrediting agency to a more stringent review process.

We cannot assure you what impact the ED’s withdrawal of recognition of ACICS as a recognized accrediting agency would have on our campuses’ approval status by other agencies or on our funding that those agencies provide to our campuses and their students.

Based on our current projections, we believe that cash generated from operations will be sufficient for us to satisfy our payment obligations for the Additional ED Escrowed Funds, payment obligations under the RSAs, working capital, loan repayment and capital expenditure requirements over the 12-month period following the date that this Quarterly Report on Form 10-Q was filed with the SEC.

In order to generate additional cash from operations to provide the Additional ED Amount, in July 2016 we implemented certain modifications to our marketing and recruitment strategy which we expect will result in a significant decrease in our advertising expenditures for the six months ending December 31, 2016 compared to the same period in the prior year. The modifications also included a significant reduction in the number of recruiting representatives employed at local campus locations in favor of greater utilization of our centralized recruitment center. We believe that the reduction in advertising expenditures will contribute to a further decline in new student enrollments beginning with the September 2016 academic quarter as compared to prior periods. While we expect these modifications to result in an increase to our operating income and cash flow in the short-term, continued enrollment declines would have a negative long-term impact on our revenue, cash flows and financial condition.

We also believe that any reduction in cash and cash equivalents that may result from their use for the Additional ED Escrowed Funds, to make payments under the RSAs or repay loans will not have a material adverse effect on our planned capital expenditures, ability to meet any applicable regulatory financial responsibility standards, ability to satisfy the financial covenants under the Financing Agreement or ability to conduct normal operations over the 12-month period following the date that this Quarterly Report on Form 10-Q was filed with the SEC. Accordingly, our consolidated financial statements contained in this Quarterly Report on Form 10-Q were prepared on the basis that we will continue to operate as a going concern. There can be no assurance, however, that the ultimate outcome of those events, whether individually or in the aggregate, will not have a material adverse effect on our financial condition, results of operations or cash flows. Additionally, our projections are estimates, which are based upon numerous assumptions, and therefore, may not prove to be accurate or reliable and involve a number of risks and uncertainties.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

All statements, trend analyses and other information contained in this report that are not historical facts are forward-looking statements within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 and as defined in Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Exchange Act. Forward-looking statements are made based on our management’s current expectations and beliefs concerning future developments and their potential effects on us. You can identify those statements by the use of words such as “could,” “should,” “would,” “may,” “will,” “project,” “believe,” “anticipate,” “expect,” “plan,” “estimate,” “forecast,” “potential,” “intend,” “continue” and “contemplate,” as well as similar words and expressions. Forward-looking statements involve risks and uncertainties and do not guarantee future performance. We cannot assure you that future developments affecting us will be those anticipated by our management. Among the factors that could cause actual results to differ materially from those expressed in our forward-looking statements are the following:

 

    the impact of adverse actions by the ED related to certain deficiencies, ACICS actions, lawsuits against us and our failure to submit our 2013 audited financial statements and 2013 compliance audits to it by the due date;

 

    the impact of our consolidation of variable interest entities on us and the regulations, requirements and obligations that we are subject to;

 

    our inability to obtain any required amendments or waivers of noncompliance with covenants under the Financing Agreement;

 

    our failure to maintain or renew required federal or state authorizations or accreditations of our campuses or programs of study;

 

    the risk that the ED does not renew its recognition of ACICS;

 

    the impact of any adverse actions taken against us due to our failure to comply with the extensive education laws and regulations and accreditation standards that we are subject to;

 

    our inability to remediate material weaknesses, or the discovery of additional material weaknesses, in our internal control over financial reporting;

 

    our exposure under our guarantees related to private education loan programs;

 

    the outcome of litigation, investigations and claims against us;

 

    issues related to the restatement of our financial statements for the first three quarters of each of 2014 and 2015, and for the 2014 fiscal year;

 

    the effects of the cross-default provisions in the Financing Agreement;

 

    changes in federal and state governmental laws and regulations with respect to education and accreditation standards, or the interpretation or enforcement of those laws and regulations, including, but not limited to, the level of government funding for, and our eligibility to participate in, student financial aid programs utilized by our students;

 

    business conditions in the postsecondary education industry and in the general economy;

 

    effects of any change in our ownership resulting in a change in control, including, but not limited to, the consequences of such changes on the accreditation and federal and state regulation of our campuses;

 

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    our ability to implement our growth strategies;

 

    our ability to retain or attract qualified employees to execute our business and growth strategies;

 

    receptivity of students and employers to our existing program offerings and new curricula;

 

    our ability to repay moneys we have borrowed; and

 

    our ability to collect internally funded financing from our students.

Readers are also directed to other risks and uncertainties discussed in other documents we file with the SEC, including, without limitation, those discussed in Item 1A. “Risk Factors.” of our 2015 Form 10-K and in Part II, Item 1A.“Risk Factors” of our Quarterly Report on Form 10-Q for the three months ended March 31, 2016 and of this report. We undertake no obligation to update or revise any forward-looking information, whether as a result of new information, future developments or otherwise.

Overview

You should keep in mind the following points as you read this report:

 

    References in this document to “we”, “us”, “our”, and “ITT/ESI” relate to ITT Educational Services, Inc. and its subsidiaries and any VIE that is consolidated into its consolidated financial statements, unless context requires or indicates otherwise.

 

    The terms “ITT Technical Institute” or “Daniel Webster College” (in singular or plural form) refer to an individual school or campus owned and operated by ITT/ESI, including its learning sites, if any. The term “institution” (in singular or plural form) means a main campus and its additional locations, branch campuses and/or learning sites, if any.

 

    References in this document to “education programs” refer to degree or diploma programs of study that have been, or may be, offered by an ITT Technical Institute or by Daniel Webster College; and references in this document to “training programs” refer to the non-degree, short-term programs that have been, or may be, offered through the Center for Professional Development @ ITT Technical Institute (the “CPD”).

This management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the same titled section contained in our 2015 Form 10-K filed with the SEC for a discussion of, among other matters, the following items:

 

    cash receipts from financial aid programs;

 

    nature of capital additions;

 

    debt;

 

    private education loan programs;

 

    variable interest entities; and

 

    federal regulations regarding:

 

    timing of receipt of funds from the Title IV Programs;

 

    percentage of applicable revenue that may be derived from the Title IV Programs;

 

    return of Title IV Program funds for withdrawn students; and

 

    Title IV Program loan cohort default rates.

This management’s discussion and analysis of financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in conformity with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue, expenses, and contingent assets and liabilities. Actual results may differ from those estimates and judgments under different assumptions or conditions.

In this management’s discussion and analysis of financial condition and results of operations, when we discuss factors that contributed to a change in our financial condition or results of operations, we disclose the primary factors that materially contributed to that change in the order of significance.

Executive Summary

In 2015, a number of events and factors impacted our results of operations, financial position, cash flows and liquidity, the most significant of which included the following:

 

    new and total student enrollment in education programs decreased, in each case, compared to the prior year;

 

    we ceased new student enrollment at ten campus locations effective with the academic period that began in December 2015;

 

    we closed six campus locations;

 

    total operating expenses decreased $115.6 million, as compared to the prior year;

 

    we made payments aggregating $43.2 million under the PEAKS Guarantee and the CUSO RSA;

 

    we made principal, interest and fee payments aggregating $39.5 million under the Financing Agreement;

 

    we received a refund of federal income taxes of $18.2 million; and

 

    we reduced the amount of cash held as collateral or escrowed funds from $97.9 million to $91.2 million.

 

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These events and factors are described further in the management’s discussion and analysis of financial condition and results of operations section and in the Notes to Consolidated Financial Statements contained in the 2015 Form 10-K.

In the six months ended June 30, 2016:

 

    our new and total student enrollment in education programs decreased, in each case, compared to the prior year;

 

    we ceased new student enrollment at five campus locations effective with the academic period that began in June 2016;

 

    we closed one campus location in June 2016;

 

    total operating expenses decreased $64.6 million, as compared to the same prior year period;

 

    we made payments aggregating $17.8 million under the PEAKS Guarantee and the CUSO RSA; and

 

    we made principal, interest and fee payments aggregating $38.1 million under the Financing Agreement.

We continue to be subject to a number of payment obligations and risks and uncertainties, as described in this report. We believe that during the six months ending December 31, 2016, we will be required to make the following payments:

 

    $43.9 million to the ED as additional surety for the ED to maintain in an escrow account;

 

    $8.7 million under the PEAKS Guarantee and the CUSO RSA as described below; and

 

    $36.4 million as principal, interest and fee payments under the Financing Agreement as described below.

Further, we believe that during that time period:

 

    our new student enrollment may decline by 45% to 60%, as compared to the same period in 2015;

 

    ACICS will make a decision as to whether the ITT Technical Institutes’ accreditation should be withdrawn by suspension or otherwise conditioned; and

 

    the ED will decide whether to renew or condition its recognition of ACICS.

See Note 11 – Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements for additional information regarding the additional surety for the ED and Note 12 – Risks and Uncertainties of the Notes to Condensed Consolidated Financial Statement for additional information regarding the accreditation of the ITT Technical Institutes by ACICS and the recognition of ACICS by the ED.

We continue to have significant cash payment obligations in connection with the PEAKS Program and the CUSO Program. Our current estimate of the amount of future payments that we believe we will be required to make under the PEAKS Guarantee and the CUSO RSA are set forth in the table below under the column captioned “Estimated Payments from ITT/ESI.” The PEAKS Trust is obligated, among other things, to repay the PEAKS Senior Debt, and the CUSO is obligated, among other things, to repay the CUSO Secured Borrowing Obligation. The amounts in the table below under the column captioned “Total Estimated Payments” represent (i) the estimated amount of the total PEAKS Senior Debt interest and principal payments to be made by the PEAKS Trust in the periods indicated; and (ii) the estimated amount of the payments to be made to the CUSO Participants by the CUSO in the periods indicated, less amounts that may be payable related to the Offset.

The amounts in the table below under the column captioned “Estimated Payments from Private Education Loans” constitute the difference between the amounts in the “Total Estimated Payments” column and the “Estimated Payments from ITT/ESI” column, and represent an estimate of the amount of payments that would be paid by borrowers or others, pursuant to the terms of the private education loans made under the PEAKS Program and the CUSO Program, and utilized by the PEAKS Trust to pay interest and principal on the PEAKS Senior Debt and by the CUSO to pay the CUSO Participants, as applicable. The amounts in the “Estimated Payments from Private Education Loans” do not include other amounts that may be paid by borrowers or others pursuant to the terms of the private education loans that are used by the PEAKS Trust or the CUSO, as applicable, to make other payments related to other obligations of those entities, such as administrative fees and expenses.

 

     Estimated Payments from ITT/ESI      Estimated Payments from Private
Education Loans
     Total Estimated Payments  
     PEAKS
Program
    CUSO
Program (1)
    Total      PEAKS
Program
    CUSO
Program
     Total      PEAKS
Program
     CUSO
Program
     Total  
     (In millions)  

7/1 - 12/31/16

   $ 3.6      $ 5.1      $ 8.7       $ 5.8      $ 3.4       $ 9.2       $ 9.4       $ 8.5       $ 17.9   

2017

     1.2        11.0        12.2         10.2        5.5         15.7         11.4         16.5         27.9   

2018

     0.0        13.0        13.0         10.0        4.9         14.9         10.0         17.9         27.9   

2019 and later

     10.5 (2)      99.0 (3)      109.5         10.1 (4)      16.1         26.2         20.6         115.1         135.7   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15.3      $ 128.1      $ 143.4       $ 36.1      $ 29.9       $ 66.0       $ 51.4       $ 158.0       $ 209.4   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)  Amounts in this column are net of the amount of recoveries from charged-off loans that we estimate will be owed to us, and that we will use to offset payments owed by us to the CUSO, in the periods indicated. See Note 11 – Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements for the estimated amounts of those recoveries.

 

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(2)  We believe that this amount will be paid by us in January 2020.
(3)  We believe that this amount will be paid by us in approximately equal portions in each of 2019 through 2025.
(4)  We believe that this amount will be paid in 2019 and in January 2020. After January 2020 (the maturity date for the PEAKS Trust Senior Debt), the PEAKS Trust will continue to collect on PEAKS Trust Student Loans that remain in repayment and collect recoveries on PEAKS Trust Student Loans that have been charged off, and those future collections are not reflected in this amount. The only obligation of the PEAKS Trust, at that time, will be the payment of the fees and expenses of the PEAKS Trust.

The estimated amounts and timing of future payments set forth in the table above are only estimates, are based on numerous assumptions and are subject to change. As with any estimate, as facts and circumstances change, the estimated amounts and timing could change. We made a number of assumptions in preparing the estimates, which assumptions may not be correct. See Note 11 – Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements and “– Contractual Obligations and Other Commitments” for additional information regarding the assumptions and estimates.

In addition, our estimates of the future payment amounts under the CUSO RSA and the timing of those payments assume, among other factors, that we do not make any Discharge Payments in 2016 or future years, based on the uncertainty related to the amount of future operating cash flows that will be available to us to make Discharge Payments. If we do make Discharge Payments in any future years, the effect of those Discharge Payments will be to reduce the total amount of our projected future payments under the CUSO RSA.

Further, the estimated amount of future payments under the CUSO RSA assumes that an offset that we made in 2013 of certain payment obligations under the CUSO RSA against the CUSO’s obligations owed to us under the Revolving Note will not be determined to have been improper. See Note 11 – Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements for a further discussion of that Offset. As of June 30, 2016, in the event that Offset is determined to be improper, we may be required to pay the CUSO approximately $10.7 million, net of approximately $1.0 million of recoveries from charged-off loans, which would be in addition to the estimated payment amounts set forth above. In the event that the Offset is determined to be improper and assuming it remained outstanding and accruing interest through 2027, we may be required to pay the CUSO up to approximately $33.0 million. If the Offset is determined to be improper, we would pursue collections from CUSO of amounts we believe are owed to us under the Revolving Note. See Note 5 – Variable Interest Entities of the Notes to Condensed Consolidated Financial Statements for additional information regarding the Revolving Note.

We also have debt service and principal repayment obligations under the Financing Agreement. We estimate that in 2016, the amount of those cash payment obligations will be approximately $74.5 million, of which $38.1 million was paid in the first six months of 2016. In the event of a default by us under the Financing Agreement, the lenders could declare the full amount of the Term Loans then outstanding to be immediately due and payable in full. Our obligations under the Financing Agreement are secured by a security interest in substantially all of our and our subsidiaries’ assets, including a mortgage on all of our and our subsidiaries’ owned real estate. The covenants under the Financing Agreement could have a material adverse effect on our business by limiting our ability to take advantage of financing, merger and acquisition or other corporate opportunities and/or to make certain payments under the RSAs.

In order to generate additional cash from operations to provide the Additional ED Amount, in July 2016 we implemented certain modifications to our marketing and recruitment strategy which we expect will result in a significant decrease in our advertising expenditures for the six months ending December 31, 2016 compared to the same period in the prior year. The modifications also included a significant reduction in the number of recruiting representatives employed at local campus locations in favor of greater utilization of our centralized recruitment center. We believe that the reduction in advertising expenditures will contribute to a further decline in new student enrollments beginning with the September 2016 academic quarter as compared to prior periods. While we expect these modifications to result in an increase to our operating income and cash flow in the short-term, continued enrollment declines would have a negative long-term impact on our revenue, cash flows and financial condition.

Based on our current projections, we believe that cash generated from operations will be sufficient for us to satisfy our payment obligations for the Additional ED Escrowed Funds, our CUSO RSA and PEAKS Guarantee payments, working capital, loan repayment and capital expenditure requirements over the 12-month period following the date that this Quarterly Report on Form 10-Q was filed with the SEC. We also believe that any reduction in cash and cash equivalents that may result from their use for the Additional ED Escrowed Funds, to make payments under the CUSO RSA and PEAKS Guarantee or repay loans will not have a material adverse effect on our planned capital expenditures, ability to meet any applicable regulatory financial responsibility standards, ability to satisfy the financial covenants under the Financing Agreement or ability to conduct normal operations over the 12-month period following the date that this Quarterly Report on Form 10-Q was filed with the SEC. Our projections, however, are estimates, which are based on numerous assumptions and, therefore, may not prove to be accurate or reliable and involve a number of risks and uncertainties. See Note 12 – Risks and Uncertainties of the Notes to Condensed Consolidated Financial Statements, Part I, Item 1A, “Risk Factors” in the 2015 Form 10-K and Part II, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2016 and in this report for a further discussion of those risks and uncertainties.

 

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Consolidations and Core Operations

Our consolidated financial statements as of and for the three and six months ended June 30, 2016 include the results of operations, financial condition and cash flows of the CUSO and the PEAKS Trust, two variable interest entities that we were required to consolidate in our consolidated financial statements. Beginning on September 30, 2014, our consolidated financial statements include the CUSO, and beginning on February 28, 2013, our consolidated financial statements include the PEAKS Trust.

We included the CUSO in our consolidated financial statements beginning on September 30, 2014, because we were considered to have the power to direct the activities that most significantly impact the economic performance of the CUSO under ASC 810 on that date. In accordance with ASC 810, we included the PEAKS Trust in our consolidated financial statements beginning on February 28, 2013, because we determined that was the first date that we had the power to direct the activities of the PEAKS Trust that most significantly impact the economic performance of the PEAKS Trust. See Note 5 – Variable Interest Entities of the Notes to Condensed Consolidated Financial Statements. We do not, however, actively manage the operations of the CUSO or the PEAKS Trust, and the assets of the consolidated CUSO and the consolidated PEAKS Trust can only be used to satisfy the obligations of the CUSO and the PEAKS Trust, respectively. Our obligations under the CUSO RSA remain in effect, until all CUSO Student Loans are paid in full. Our obligations under the PEAKS Guarantee remain in effect, until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full. See Note 8 – Debt and Note 11 – Commitments and Contingencies of the Notes to Condensed Consolidated Financial Statements.

Unless otherwise noted, the information in this management’s discussion and analysis of financial condition and results of operations is presented and discussed on a consolidated basis, including the CUSO and the PEAKS Trust as of and following the applicable consolidation dates. Certain information is also provided, however, regarding our results of operations on a basis that excludes the impact of the CUSO and the PEAKS Trust. We identify and describe our education programs and education-related services on this basis as our core operations (“Core Operations”). The presentation of the Core Operations financial measures differs from the presentation of our condensed consolidated financial measures determined in accordance with GAAP. Our management believes that the Core Operations information provides useful information to investors, because it:

 

    allows more meaningful information about our ongoing operating results;

 

    helps in performing trend analyses and identifying trends that may otherwise be masked or distorted by items that are not part of the Core Operations; and

 

    provides a higher degree of transparency of our core results of operations.

The following tables set forth selected data from our Statements of Operations for the three and six months ended June 30, 2016 and 2015 for:

 

    the Core Operations on a stand-alone basis;

 

    the PEAKS Trust on a stand-alone basis;

 

    the CUSO on a stand-alone basis; and

 

    the Core Operations, the CUSO and the PEAKS Trust consolidated in accordance with GAAP.

 

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The information presented also constitutes the reconciliation of our non-GAAP Core Operations, PEAKS Trust and CUSO data to the related consolidated GAAP financial measures. Following the tables, we describe the effect of the PEAKS Consolidation and the CUSO Consolidation, as applicable, on the financial statement information presented, including the components attributable to the Core Operations, the PEAKS Trust and the CUSO.

 

     Three Months Ended June 30, 2016  
     Core
Operations
     PEAKS Trust      CUSO      GAAP
Consolidated
 
     (in Thousands)  

Statement of Operations Data:

        

Revenue

   $ 173,439       $ 1,862       $ 1,023       $ 176,324   

Costs and expenses:

        

Cost of educational services

     88,592         0         0         88,592   

Student services and administrative expenses

     70,778         508         419         71,705   

Asset impairment

     317         0         0         317   

Legal and professional fees related to certain lawsuits, investigations and accounting matters

     1,265         0         0         1,265   

Provision for private education loan losses

     0         1,063         106         1,169   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total costs and expenses

     160,952         1,571         525         163,048   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income

     12,487         291         498         13,276   

Interest income

     64         0         0         64   

Interest (expense)

     (1,665      (1,422      (3,049      (6,136
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before provision for income taxes

   $ 10,886       $ (1,131    $ (2,551    $ 7,204   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Three Months Ended June 30, 2015  
     Core
Operations
     PEAKS Trust      CUSO      GAAP
Consolidated
 
     (in Thousands)  

Statement of Operations Data:

           

Revenue

   $  210,800       $ 2,246       $ 1,185       $  214,231   

Costs and expenses:

           

Cost of educational services

     101,865         0         0         101,865   

Student services and administrative expenses

     90,436         489         483         91,408   

Legal and professional fees related to certain lawsuits, investigations and accounting matters

     6,005         0         0         6,005   

Provision (benefit) for private education loan losses

     0         4,615         (1,302      3,313   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total costs and expenses

     198,306         5,104         (819      202,591   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income (loss)

     12,494         (2,858      2,004         11,640   

Interest income

     22         0         0         22   

Interest (expense)

     (3,592      (2,826      (3,573      (9,991
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before provision for income taxes

   $ 8,924       $ (5,684    $ (1,569    $ 1,671   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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     Six Months Ended June 30, 2016  
     Core
Operations
     PEAKS Trust      CUSO      GAAP
Consolidated
 
     (in Thousands)  

Statement of Operations Data:

           

Revenue

   $ 361,854       $ 3,864       $ 2,105       $ 367,823   

Costs and expenses:

           

Cost of educational services

     180,555         0         0         180,555   

Student services and administrative expenses

     147,822         1,003         779         149,604   

Asset impairment

     985         0         0         985   

Legal and professional fees related to certain lawsuits, investigations and accounting matters

     6,136         0         0         6,136   

Provision for private education loan losses

     0         2,546         501         3,047   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total costs and expenses

     335,498         3,549         1,280         340,327   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income

     26,356         315         825         27,496   

Interest income

     132         0         0         132   

Interest (expense)

     (3,839      (3,180      (6,216      (13,235
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before provision for income taxes

   $ 22,649       $ (2,865    $ (5,391    $ 14,393   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Six Months Ended June 30, 2015  
     Core
Operations
     PEAKS Trust      CUSO      GAAP
Consolidated
 
     (in Thousands)  

Statement of Operations Data:

           

Revenue

   $ 437,298       $ 4,659       $ 2,249       $ 444,206   

Costs and expenses:

           

Cost of educational services

     205,418         0         0         205,418   

Student services and administrative expenses

     179,751         1,030         879         181,660   

Legal and professional fees related to certain lawsuits, investigations and accounting matters

     13,291         0         0         13,291   

Provision (benefit) for private education loan losses

     0         5,418         (861      4,557   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total costs and expenses

     398,460         6,448         18         404,926   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income (loss)

     38,838         (1,789      2,231         39,280   

Interest income

     35         0         0         35   

Interest (expense)

     (7,080      (6,085      (7,214      (20,379
  

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before provision for income taxes

   $ 31,793       $ (7,874    $ (4,983    $ 18,936   
  

 

 

    

 

 

    

 

 

    

 

 

 

Following the applicable Consolidation, our revenue consists of:

 

    revenue from the Core Operations, primarily from tuition, tool kit sales and student fees;

 

    student loan interest income on the Private Education Loans, which is the accretion of the accretable yield on the Private Education Loans; and

 

    administrative fees earned by the CUSO.

Following the applicable Consolidation, our student services and administrative expenses are comprised of:

 

    expenses related to the Core Operations, including marketing expenses, an expense for uncollectible accounts and administrative expenses incurred primarily at our corporate headquarters; and

 

    expenses incurred by the PEAKS Trust and the CUSO, primarily related to fees for servicing the Private Education Loans and various other administrative fees and expenses of the PEAKS Trust and the CUSO.

Following the applicable Consolidation, our provision for private education loan losses in a reporting period represents the increase in the allowance for loan losses that occurred during that period, offset by recoveries from Private Education Loans that were charged off prior to the applicable Consolidation. The allowance for loan losses is the difference between the carrying value and the total present value of the expected principal and interest collections of each loan pool of the Private Education Loans, discounted by the loan pool’s effective interest rate as of June 30, 2016 or 2015, as applicable.

 

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Following the applicable Consolidation, our interest expense includes:

 

    interest expense from matters related to the Core Operations, primarily the interest expense on the outstanding balance under the Financing Agreement;

 

    interest expense on the PEAKS Senior Debt, which includes the contractual interest obligation and the accretion of the discount on the PEAKS Senior Debt; and

 

    interest expense on the CUSO Secured Borrowing Obligation, which includes the amount of interest expense on the CUSO Student Loans that is accrued for payment to the owners of the CUSO and the accretion of the discount of the adjustment associated with accounting for the CUSO Secured Borrowing Obligation at fair value upon the CUSO Consolidation.

Since the inception of the PEAKS Program, we have guaranteed, and continue to guarantee, the payment of the principal and interest owed on the PEAKS Senior Debt, the administrative fees and expenses of the PEAKS Trust and the minimum required Asset/Liability Ratio, pursuant to the terms of the PEAKS Guarantee. Our obligations under the PEAKS Guarantee remain in effect, until the PEAKS Senior Debt and the PEAKS Trust’s fees and expenses are paid in full.

Since the inception of the CUSO Program, under the CUSO RSA, we have guaranteed, and continue to guarantee, the repayment of any CUSO Student Loans that are charged off above a certain percentage of the CUSO Student Loans made under the CUSO Program, based on the annual dollar volume. Our obligations under the CUSO RSA remain in effect until all CUSO Student Loans are paid in full. Under the CUSO RSA, we have an obligation to make the monthly payments due and unpaid on those private education loans that have been charged off above a certain percentage. Instead of making those Regular Payments, however, we may elect to discharge our obligations to make Regular Payments on specified charged-off private education loans by making Discharge Payments.

The revenue and expenses of the PEAKS Trust and CUSO are presented in our Consolidated Statements of Operations following the applicable Consolidation. The cash received by the PEAKS Trust, which is derived from its revenue, however, is considered restricted and can only be used to satisfy the obligations of the PEAKS Trust. The cash received by the CUSO, which is derived from its revenue, however, is considered restricted and can only be used to satisfy the obligations of the CUSO.

Background

We are a leading proprietary provider of postsecondary degree programs in the United States based on revenue and student enrollment. As of June 30, 2016, we were offering:

 

    master, bachelor and associate degree programs to approximately 40,000 students at ITT Technical Institute and Daniel Webster College locations; and

 

    short-term information technology and business learning solutions for career advancers and other professionals.

As of June 30, 2016, we had 137 campus locations in 39 states. In addition, we offered one or more of our online programs to students who are located in all 50 states and the District of Columbia. We regularly review the efficiency of our campus locations. We closed one campus location in the three months ended June 30, 2016 and we expect to close one campus location in the six months ending December 31, 2016 based upon the expected date that the remaining students at that location are scheduled to complete their programs of study. As previously reported, in 2015 we closed six campus locations.

In addition, as previously reported, we ceased accepting new student enrollment at 10 campus locations, effective with the academic quarter that began in December 2015, and are in the process of evaluating the local demands for those markets. As a result of a recent internal operational review, we ceased accepting new student enrollment at an additional five campus locations, effective with the academic quarter that began in June 2016, and will not be accepting new student enrollment at one campus location effective with the academic quarter that begins in September 2016. These six campus locations represented approximately 1.8% of our new student enrollments, based on our new student enrollment results in the first quarter of 2016. During the next 12 to 18 months, we will be evaluating the local demands for these markets. During this evaluation period, we do not believe there will be any disruption to ongoing course work for continuously enrolled students, as we will continue to teach classes for those students.

As used in this document, the term “Affected Campus Locations,” includes the following:

 

    the four campus locations that we closed in 2014;

 

    the six campus locations that we closed in 2015;

 

    the 10 campus locations at which we ceased accepting new student enrollment, effective with the academic quarter that began in December 2015;

 

    the one campus location that we closed in the three months ended June 30, 2016; and

 

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    the five campus locations at which we ceased accepting new student enrollment, effective with the academic quarter that began in June 2016.

All of our campus locations are authorized by the applicable education authorities of the states in which they operate, and are accredited by an accrediting commission recognized by the ED. We design our education programs, after consultation with employers and other constituents, to help graduates prepare for careers in various fields involving their areas of study. We have provided career-oriented education programs since 1969 under the “ITT Technical Institute” name and since 2009 under the “Daniel Webster College” name. In addition, through the CPD, we offer training programs to career advancers and other professionals.

While our long-term strategy continues to be the pursuit of multiple opportunities for growth, our ability to execute on this strategy is subject to extensive regulations and restrictions, as discussed further in our 2015 Form 10-K and has been impacted by declining enrollments; payments for guarantee obligations, loan repayments and surety requirements; and other factors.

Critical Accounting Policies and Estimates

The preparation of our condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue, expenses, and contingent assets and liabilities. Actual results may differ from those estimates and judgments under different assumptions or conditions. We have discussed the critical accounting policies that we believe affect our more significant estimates and judgments used in the preparation of our consolidated financial statements in the “Management’s Discussion and Analysis of Financial Condition and Results of the Operations – Critical Accounting Policies and Estimates” section of our 2015 Form 10-K, filed with the SEC.

New Accounting Guidance

For a discussion of applicable new accounting guidance, see Note 2 – New Accounting Guidance and Adoption of New Accounting Guidance of the Notes to Condensed Consolidated Financial Statements.

Results of Operations

The following table sets forth the percentage relationship of certain statement of operations data to revenue for the periods indicated:

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2016     2015     2016     2015  

Revenue

    100.0     100.0     100.0     100.0

Costs and expenses:

       

Cost of educational services

    50.2     47.5     49.1     46.2

Student services and administrative expenses

    40.7     42.7     40.7     40.9

Asset impairment

    0.2     0.0     0.3     0.0

Legal and professional fees related to certain lawsuits, investigations and accounting matters

    0.7     2.8     1.7     3.0

Provision for private education loan losses

    0.7     1.5     0.8     1.0
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

    7.5     5.4     7.5     8.8

Interest (expense), net

    (3.4 %)      (4.7 %)      (3.6 %)      (4.6 %) 
 

 

 

   

 

 

   

 

 

   

 

 

 

Income before provision for income taxes

    4.1     0.8     3.9     4.3
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table sets forth our total student enrollment in education programs as of the dates indicated:

 

     2016     2015  

Total Student

Enrollment in Education

Programs as of:

   Total Student
Enrollment In
Education
Programs
    (Decrease)
from Prior
Year
    Total Student
Enrollment In
Education
Programs
    (Decrease)
from Prior
Year
 

March 31

     43,293 (1)      (15.4 %)      51,201        (10.4 %) 

June 30

     40,015 (1)      (16.4 %)      47,874        (13.7 %) 

September 30

     Not Applicable        Not Applicable        48,231 (1)      (15.5 %) 

December 31

     Not Applicable        Not Applicable        44,922 (1)      (16.3 %) 

 

(1)  Amount reflects the revised definition of a new student that was effective beginning in the quarter ended September 30, 2015, as described below. The number of students that were not included as a result of using the revised definition of a new student was approximately 1% or less of the total student enrollment as of each of these dates.

The following table sets forth our total student enrollment in education programs as of the dates indicated, excluding the Affected Campus Locations:

 

     2016     2015  

Total Student

Enrollment in Education

Programs as of:

   Total Student
Enrollment In
Education
Programs
    (Decrease)
from Prior
Year
    Total Student
Enrollment In
Education
Programs
    (Decrease)
from Prior
Year
 

March 31

     41,906 (1)      (13.3 %)      48,360        (9.1 %) 

June 30

     38,993 (1)      (14.1 %)      45,391        (12.6 %) 

September 30

     Not Applicable        Not Applicable        46,113 (1)      (14.0 %) 

December 31

     Not Applicable        Not Applicable        43,275 (1)      (14.3 %) 

 

(1)  Amount reflects the revised definition of a new student that was effective beginning in the quarter ended September 30, 2015, as described below.

Total student enrollment in education programs includes all new and continuing students. A continuing student is any student who, in the academic term being measured, is enrolled in an education program at one of our campuses and was enrolled in the same program at any of our campuses at the end of the immediately preceding academic term. A new student is any student who, in the academic term being measured, enrolls in and begins attending any education program at one of our campuses:

 

    for the first time at that campus;

 

    after graduating in a prior academic term from a different education program at that campus; or

 

    after having withdrawn or been terminated from an education program at that campus.

Beginning in the three months ended September 30, 2015, we revised our definition of a new student to include any student who (1) met the previous criteria for a new student, and (2) if the student was a first-time student and was enrolled in an online degree program, continued to attend their program of study beyond the first 15 days of the program’s term (or 30 days, if the student was only enrolled in courses that are taught over a 12-week period). Our accounting policies for revenue recognition are not based on the definition of a new student and, therefore, our revenue recognition is not impacted by this revised definition. The impact of this revised definition of new student is to:

 

    exclude those students in our reported new student enrollment for the quarter in which they began attending class, but had not yet continued to attend beyond the applicable time described above;

 

    exclude those same students from our reported total student enrollment for that same quarter; and

 

    if those students continued to attend beyond the applicable time described above, include those same students in our reported new and total student enrollment for the subsequent quarter.

 

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The following table sets forth our new student enrollment in education programs in the periods indicated:

 

     2016     2015  

New Student Enrollment

in Education Programs

in the Three Months

Ended (1):

   New Student
Enrollment In
Education
Programs
     (Decrease)
from Prior
Year
    New Student
Enrollment In
Education
Programs
     (Decrease)
from Prior
Year
 

March 31

     11,788         (16.4 %)      14,104         (15.8 %) 

June 30

     9,910         (21.6 %)      12,638         (18.6 %) 

September 30

     Not Applicable         Not Applicable        14,943         (18.4 %) 

December 31

     Not Applicable         Not Applicable        10,478         (17.1 %) 
  

 

 

      

 

 

    

Total for the year

     Not Applicable         Not Applicable        52,163         (17.5 %) 
  

 

 

      

 

 

    

 

(1)  New student enrollment for periods prior to September 30, 2015 do not reflect the revised definition of a new student that became effective in the three months ended September 30, 2015, as described above.

We believe that the 21.6% decrease in new student enrollment in education programs in the three months ended June 30, 2016 compared to the three months ended June 30, 2015 and the 16.4% decrease in new student enrollment in the three months ended March 31, 2016 compared to the three months ended March 31, 2015 were primarily due to:

 

    the reduction in the number of campus locations that were accepting new students (see the table below for information related to new student enrollment excluding the Affected Campus Locations);

 

    the revised definition of a new student;

 

    a decrease in the rate at which prospective students who inquired about our education programs actually applied for enrollment in the three months ended June 30, 2016 and March 31, 2016 compared to the same prior year periods;

 

    a decrease in the rate at which prospective students who applied for enrollment actually began attending classes in their education programs in the three months ended June 30, 2016 and March 31, 2016 compared to the same prior year periods;

 

    greater sensitivity to the cost of postsecondary education;

 

    uncertainty about the value of a postsecondary education due to the prolonged economic and labor market disruptions; and

 

    the current political environment and continued negative media related to our industry.

The following table sets forth our new student enrollment in education programs in the periods indicated, excluding the Affected Campus Locations:

 

     2016     2015  

New Student Enrollment

in Education Programs

in the Three Months

Ended (1):

   New Student
Enrollment In
Education
Programs
     (Decrease)
from Prior
Year
    New Student
Enrollment In
Education
Programs
     (Decrease)
from Prior
Year
 

March 31

     11,549         (13.7 %)      13,378         (15.2 %) 

June 30

     9,846         (18.3 %)      12,048         (17.5 %) 

September 30

     Not Applicable         Not Applicable        14,198         (17.7 %) 

December 31

     Not Applicable         Not Applicable        10,262         (14.0 %) 
  

 

 

      

 

 

    

Total for the year

     Not Applicable         Not Applicable        49,886         (16.2 %) 
  

 

 

      

 

 

    

 

(1)  New student enrollment for periods prior to September 30, 2015 do not reflect the revised definition of a new student that became effective in the three months ended September 30, 2015, as described above.

In order to generate additional cash from operations to provide the Additional ED Amount, in July 2016 we implemented certain modifications to our marketing and recruitment strategy which we expect will result in a significant decrease in our advertising expenditures for the six months ending December 31, 2016 compared to the same period in the prior year. The modifications also included a significant reduction in the number of recruiting representatives employed at local campus locations in favor of greater utilization of our centralized recruitment center. We believe that the reduction in advertising expenditures will contribute to a further decline in new student enrollments beginning with the September 2016 academic quarter as compared to prior periods. While we expect these modifications to result in an increase to our operating income and cash flow in the short-term, continued enrollment declines would have a negative long-term impact on our revenue, cash flows and financial condition.

At the vast majority of our campuses, we generally organize the academic schedule for education programs offered on the basis of four 12-week academic quarters in a calendar year. The academic quarters typically begin in early March, mid-June, early September and late November or early December. To measure the persistence of our students, the number of continuing students in any academic term is divided by the total student enrollment in education programs in the immediately preceding academic term.

 

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The following table sets forth the rates of our students’ persistence as of the dates indicated:

 

     Student Persistence as of:

Year

   March 31   June 30   September 30   December 31

2016

   70.1%   69.5%   Not Applicable   Not Applicable

2015

   69.2%   68.8%   69.5%   71.4%</