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Fitch Affirms Calibre Academy fka Carden Traditional Schools (AZ) Revs at 'B'; Outlook Negative
[January 07, 2015]

Fitch Affirms Calibre Academy fka Carden Traditional Schools (AZ) Revs at 'B'; Outlook Negative


Fitch Ratings has affirmed the 'B' rating on $16.1 million Industrial Development Authority of the County of Pima's education revenue refunding bonds (Carden Traditional Schools project) series 2012.

The Rating Outlook is Negative.

SECURITY

Absolute and unconditional obligation of the borrower (Calibre, or CTS (News - Alert)) and the guarantor (E-Institute Charter School, Inc. or EICS), payable from all legally available revenues, and secured by a first lien on facilities owned by the borrower. There is additionally a debt service reserve cash-funded to maximum annual debt service (MADS). Gross revenues of both the borrower and guarantor will flow directly from the state treasurer to the trustee for debt service.

KEY RATING DRIVERS

NEGATIVE OUTLOOK: The Outlook reflects Calibre's weak financial position and failure to resolve its going concern status. Resolution is expected as a result of improved financial performance due to the entity's reorganization. Despite operating margin improvement, challenges remain in meeting escalating debt service (DS). After receiving charter renewals in mid-2014, academic performance standards were not met in fiscal 2015 making charter revocation a concern.

SPECULATIVE-GRADE CHARACTERISTICS: The 'B' rating reflects Calibre's improved but still tenuous financial position which includes a high debt burden, expense growth historically outpacing revenues, lower than anticipated enrollment levels and historical coverage of DS only with substantial, albeit planned, EICS support.

ENROLLMENT SHORTFALL: Actual enrollment at Calibre and EICS' campuses is significantly below the school's base case projections. Fitch notes that initial headcount projections were aggressive; however, Calibre's ability to adjust expenditures for a lower headcount could alleviate operating pressure and possibly stabilize performance.

MANAGEMENT RESPONSIVENESS IMPROVES: Calibre's last two CFOs left the institution, with the most recent CFO replaced by an outside consulting firm with charter school experience in spring of 2014. Fitch expects Calibre's future responsiveness levels to improve.

RATING SENSITIVITIES

FAILURE OF FY2015 COVERAGE TEST: The inability to meet the transaction maximum annual debt service (TMADS) coverage test of 1x for the combined entity (Calibre and EICS) in fiscal 2015 may constitute an event of default. Fitch may downgrade the bonds in this case to reflect the increased volatility due to remedies that include an accelerated timeline for bond redemption.

PROTRACTED FISCAL IMBALANCE: In Fitch's view, a persistent negative trend in Calibre's operating margins resulting in the continuance of a going concern note from the auditor in fiscal 2015, indicates an intrinsic lack of fiscal stability and would likely result in ratings pressure. Also, balance sheet resources are very limited, providing virtually no offset in the event of continued financial volatility.

RELIANCE ON (News - Alert) EICS PERFORMANCE: Improvement in EICS operations is essential to the current rating, assuming Calibre's continued weak margins.

STANDARD CHARTER RENEWAL RISK: Like all Fitch-rated charter schools, Calibre and EICS are subject to charter renewal risk, which Fitch views as a substantial credit concern. Despite renewal in mid-2014 for both schools, Calibre's academic performance failed to meet standards in fall 2014, which put the school in jeopardy of charter revocation if progress is not demonstrated.

CREDIT PROFILE

TRANSACTION PARTICIPANT OVERVIEW

Calibre serves grades K-8 and includes one school in Surprise, AZ. Calibre's second physical campus in Glendale and its virtual campus were both voluntarily closed in 2014. EICS, the financial guarantor for the rated debt of Calibre, maintains six physical campuses and a virtual campus. The financial statements and charter agreements for both schools each include a fully online campus managed by the schools' education management organization (EMO), Learning Matters Educational Group, Inc. (LMEG).

Both Calibre and EICS are authorized by Arizona State Board for Charter Schools (ASBCS, the authorizer) with 15-year terms that expire in 2015 and both were recently renewed for additional 20-year terms. LMEG serves as EMO for both schools and maintains a working relationship with the ASBCS.

NEGATIVE OUTLOOK REFLECTS UNCERTAINTY

The schools posted transaction MADS (TMADS) coverage of over 1x for the second consecutive yer in fiscal 2014 (based on unaudited results) complying with a DS coverage covenant requiring at least 1x coverage of DS. The Negative Outlook reflects Fitch's longer term concern that the consolidated entity continues to post weak results and could encounter problems in achieving legal DS coverage, especially considering the escalating debt service.



The covenant compares combined net income available for debt service of Calibre and EICS to MADS, excluding the final year of maturity TMADS. Coverage below 1x could be declared an event of default under terms of the loan agreement by the trustee. The trustee's remedies for events of default include acceleration, receivership, foreclosure, or a suit for judgment. While the declaration is subject to certain loan agreement provisions allowing Calibre and EICS to develop a remedy plan within specified timeframes, in the event of acceleration Fitch views Calibre and EICS as highly unlikely to be able to meet full and immediate payment on the bonds without defaulting.

ENROLLMENT BELOW PROJECTIONS; INCREMENTAL GROWTH


Calibre and EICS enrolled fewer students in fall of 2014 than originally projected when the bonds were issued. However, after closing the Glendale campus, Calibre's total average daily membership (ADM) improved 9.5% to 726 in fall 2014 when compared to the prior year for Calibre Surprise campus only. Fall 2013 ADM for the Surprise campus surpassed revised projections provided to Fitch. Further, ADM for EICS grew 7.7% to 855 for fall 2014. However, this is lower than revised projects presented during the last review and the original fall 2013 expectations. EICS does not have a waitlist due to its open enrollment policy while Calibre Surprise has a waitlist of about 330 according to LMEG.

Calibre and EICS were noted as generally meeting academic requirements by the ASBCS at the point of charter renewal. However, post-renewal there was a drop in Calibre's academic results in fall 2014. Failure to improve academic performance next fall could put the charter in jeopardy of revocation. Calibre was required to submit a Performance Management Plan by Nov. 14, 2014, indicating expectations set forth in the Board's Academic Performance Framework.

Additionally, EICS was able to re-classify all of its campuses as alternative, thereby altering the benchmarks used to evaluate performance and more accurately reflect its at-risk population.

MARGINS IMPROVE; GOING CONCERN CONTINUES

Requirements for a single audit provided the extension of audited fiscal 2014 financials until March 31, 2015. Unaudited consolidated fiscal 2014 margins are strongly positive and improved to 16.5% from 6.3% in fiscal 2013. Calibre's individual performance also improved markedly, from negative 24.8% to negative 4.6%, while EICS's margin weakened slightly to 13.3% from 15.3% in fiscal 2013. Fitch notes that Calibre's ability to increase revenues and curb expense growth should improve debt service coverage over time and lessens the need to depend substantially on EICS for the long term. LMEG implemented several measures to align expenses with revenues.

Nonetheless, Calibre failed to remedy the going concern situation and meet the financial performance framework standard based on unaudited fiscal 2014 results with respect to growth in net income.

Several structural changes have been implemented for fiscal 2015 to mitigate the auditor's going concern note, including closing Calibre's Glendale campus, renting out vacant space, and also realigning student/teacher ratios at the Surprise campus. Combined these modifications are expected to generate net income improvement for fiscal 2015. Fitch will continue to monitor Calibre's progress in meeting the financial performance framework in fiscal 2015 as presented in Calibre's framework response. Failure to do so could negatively impact the rating.

LIQUIDITY AND DEBT SERVICE COVERAGE IMPROVE

Available funds for Calibre and EICS, on a consolidated basis, covered just 13.7% and 8.3% of operating expenses and debt, respectively. While improved from fiscal 2013, these levels remain very light, which is typical of most charter schools rated by Fitch.

Combined TMADS coverage (EICS and Calibre) continues to improve from a weak 0.9x to 1.5x in fiscal 2014. Adjusting for management fees which are subordinate to DS payment, coverage improved to 2.8x in fiscal 2014, up from 1.8x in 2013. Notwithstanding this improvement, Calibre, on its own, is unable to support required TMADS. Fitch notes positively, though, that EICS, as the guarantor of the bonds, will continue to support Calibre's operations.

Additional information is available at 'www.fitchratings.com'.

In addition to the sources of information identified in the 'Revenue-Supported Rating Criteria' and 'Charter School Rating Criteria', this action was informed by information from the Arizona Department of Education website (http://www.azed.gov/).

Applicable Criteria and Related Research:

--'Revenue Supported Rating Criteria', dated June 2014;

--'Charter School Rating Criteria', dated Sept. 19, 2012;

--'Fitch Affirms Calibre Academy FKA Carden Traditional Schools (Arizona) Revs at 'B'; Outlook Negative', dated Jan. 21, 2014.

Applicable Criteria and Related Research:

Charter School Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=688957

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=964955

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.


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