Fitch Affirms The Academy's (CO) Revenue Bonds at 'B-'; Outlook Revised to Positive

NEW YORK--()--Fitch Ratings affirms the 'B-' on approximately $34.7 million in outstanding charter school revenue bonds for the Colorado Educational and Cultural Facilities Authority. The bonds are issued on behalf of The Academy.

The Rating Outlook is revised to Positive from Stable.

SECURITY

The bonds are essentially a general obligation of the school, with each series secured by first liens on their respectively financed facilities. Each series of bonds is further secured by a debt service reserve fund.

KEY RATING DRIVERS

IMPROVED OPERATIONS UNDERPIN POSITIVE OUTLOOK: The Academy registered positive GAAP-based operating performance in fiscal 2013, which marks a departure from historical performance and was reportedly sustained in fiscal 2014, although unaudited financials (June 30 fiscal year) were unavailable for review. Management continues to work toward fully resolving the various reserve violations and deficiencies in internal controls that are documented in the annual audit.

DEBT MANAGEABILITY CONCERNS: Fitch considers the Academy's considerable debt burden, limited track-record of generating at least 1 times (x) current and maximum annual debt service (MADS) coverage from net operating income, and elevated pro-forma debt to net income available for debt service metric to be negative rating factors. Management obtained a waiver related to a covenant breach under the 2004 Indenture and 2008 Supplemental Indenture. There are no near-term debt plans.

SOUND DEMAND AND ENROLLMENT TRENDS: The Academy's demand profile is sound and remains a fundamental credit strength. Steady and growing enrollment trends are supported by healthy school-wide retention rates, favorable academic performance relative to district- and state-wide averages, and an established reputation given its 20-year operating history.

RATING SENSITIVITIES

SUSTAINED FINANCIAL IMPROVEMENT: Evidence of steady, sustained improvement in audited financial results coupled with the full resolution of various inadequacies in internal controls cited in the audit would likely support upward rating movement. Further, Fitch expects management to continue to show evidence of progress toward achieving full compliance with the school's various reserve violations.

STANDARD SECTOR CONCERNS: The Academy's modest financial cushion, substantial reliance on enrollment-driven per pupil funding, and charter renewal risk are credit concerns common among all charter school transactions. If pressured, these issues could negatively impact the rating over time.

TIMELY INFORMATION: Maintenance of the rating is contingent upon receipt of timely and relevant information sufficient to maintain an accurate rating.

CREDIT PROFILE

Located in Westminster, Colorado, The Academy has been in operation since 1994, one year after the state enacted its initial charter authorization law. Since inception, the Academy's charter authorizer was Adams County School District 12 (the district), from which the school received a total of three charter renewals, with the most recent five-year contract in effect until June 30, 2014.

Since Fitch's last review, The Academy applied to and was approved by the Charter School Institute (CSI), an independent agency of the Colorado Department of Education, to be authorized by CSI at the expiration of its current contract with the district. The term of the new contract is in effect for five-years (June 30, 2019), which matches the previous charter term and represents maximum allowable in the state. Management reported that the switch to CSI would better position the school to improve its financial position through more continuous monitoring, support, and resources. The school received transfer consent from the district in order to move forward with the authorizer change.

Importantly, CSI conducted its own due diligence prior to becoming The Academy's authorizer, which included hiring a financial services firm to complete a review of The Academy's internal financial controls, budgeting procedures, and accuracy of financial reporting. The resulting assessment and recommendations were presented to The Academy's administration and Board of Directors. Management reported to Fitch that it has already initiated every recommendation, which is expected to help The Academy resolve the various weaknesses in internal financial controls cited in the audit. The charter with CSI does have a clause that allows for an early renewal evaluation of the charter if The Academy fails to maintain a positive fund balance that includes meeting the TABOR reserve requirement at the end of any fiscal year ($16,132 in fiscal year-end 2013) or otherwise materially fails to meet generally accepted standards of fiscal management.

IMPROVED OPERATIONS UNDERPIN POSITIVE OUTLOOK

The Academy registered a 1.6% GAAP-based operating margin in fiscal 2013, the first positive margin recorded since at least fiscal 2009. Total revenues grew by approximately 5.6%, aided by enrollment growth of 4%, to 1,752. Per pupil revenues (PPR) constituted 84.2% of fiscal 2013 operating revenues, which underscores the school's limited revenue diversity and financial flexibility, although both characteristics are not atypical for the sector. The absence of salary increases in fiscal 2013 helped to keep operating expenses virtually flat year-over-year.

While unaudited financial statements were not available for Fitch to review, management reported that fiscal year-end 2014 financial performance yielded a similar outcome to fiscal 2013, supported by an enrollment gain of 3.1%, to 1,806, a 2.8% increase in PPR, and continued cost restraint, although additional monies were allocated to support teacher retention. The school did experience an unanticipated facilities-related issue (flooding) that was not covered by insurance and resulted in a draw of $176,000 from the repair and replacement fund associated with the series 2004 bonds. Management plans to replenish the fund over a three-year period and has since upgraded its insurance coverage to cover floods.

The state funding environment improved significantly in fiscal 2015, with management anticipating a PPR increase of 5.25%. Additionally, the state legislature passed an increase in the Charter School Capital Construction fund, which provides monies to charter schools that are available for debt repayments. Importantly, starting in fiscal 2015, PPR will flow through CSI as a result of the authorizer change.

Revenue gains in fiscal 2015 will be somewhat offset by planned pay increases, although Fitch notes that management continues to set aside funds in the budget to achieve full compliance with various reserve requirements. Fitch notes that the school is in the process of repaying the district for certain bills paid by the latter on behalf of the former. Management reported that the remaining repayment balance is $280,000, which will be paid in monthly installments by the end of the 2014 calendar year.

SOUND DEMAND AND ENROLLMENT TRENDS

The Academy's demand profile is sound and remains a fundamental credit strength. Management expects total headcount enrollment to continue to increase over the next one to two years before reaching the school's maximum headcount capacity of around 1,900. Headcount growth is supported by healthy school-wide retention rates, which was 93.5% in academic year 2013-2014, above the 92% achieved in the prior year. Student demand benefits from the school's favorable academic performance, evidenced by results on the state of Colorado's annual Transitional Colorado Assessment Program (TCAP) exam that continue to exceed to district- and state-wide averages. TCAP results for academic year 2013-14 will be released Mid-August 2014.

It is anticipated that the Partnerships for Assessment of Readiness for College and Careers (PARCC) ELA and mathematics assessments will replace TCAP reading, writing, and math assessments in Spring 2015 (and will incorporate the 'Common Core'). Additionally, Colorado will also administer the Colorado Measures of Academic Success (CMAS) exams in social studies and sciences in Spring 2015 (the former has never been a content area on state examinations). Management indicated that academic instruction has been modified to ensure alignment with new state standards.

DEBT MANAGEABILITY CONCERNS

The Academy's leverage profile remains an area of concern. Current debt service of around $2.6 million represented a very high 20% of fiscal 2013 revenues. Improved operating performance allowed the school to generate adequate coverage from net operating income of 1.13x; however, Fitch notes that the school's track-record of generating at or above 1x coverage is limited, which is viewed as a credit weakness. Transactional maximum annual debt service (T-MADS), which incorporates the debt service reserve funds when calculating the final maturity payments on each series of bonds, was approximately $3 million (fiscal 2034) and represented 23.5% of fiscal 2013 operating revenues. T-MADS debt service coverage from fiscal 2013 net operating income was 0.96x. The Academy has no near-term debt plans.

As reported in Fitch's last credit review, The Academy successfully attained a waiver for an unrestricted working capital balance covenant breach. Under the waiver, The Academy has until fiscal year-end 2016 to achieve full compliance with the covenant. Management is required to demonstrate progress on an annual cycle toward re-establishing covenant compliance. Failure to demonstrate annual progress results in a modest monetary fine rather than in a waiver invalidation. Management believes the timeframe set forth in the waiver provides sufficient flexibility to achieve covenant compliance. Fitch will continue to monitor management's progress in future credit reviews.

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

Applicable Criteria and Related Research:

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

--'Fitch Removes Academy of Charter Schools, Co's Rev Bonds from Rating Watch Negative' (Aug. 22, 2013);

--'Fitch Downgrades Academy of Charter Schools (CO) to 'B-'; Still on Watch Negative' (March 8, 2013).

Applicable Criteria and Related Research:

Charter School Rating Criteria

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=850794

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Contacts

Fitch Ratings
Primary Analyst
Alexander Vaisman
Associate Director
+1-212-908-0721
Fitch Ratings, Inc.,
33 Whitehall Street Plaza
New York, NY 10004
or
Secondary Analyst
Colin Walsh
Director
+1-212-908-0767
or
Committee Chairperson
Joanne Ferrigan
Senior Director
+1-212-908-0723
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Alexander Vaisman
Associate Director
+1-212-908-0721
Fitch Ratings, Inc.,
33 Whitehall Street Plaza
New York, NY 10004
or
Secondary Analyst
Colin Walsh
Director
+1-212-908-0767
or
Committee Chairperson
Joanne Ferrigan
Senior Director
+1-212-908-0723
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com