OREANDA-NEWS. December 23, 2015. Fitch Ratings has affirmed the 'BB-' rating on the \\$7.2 million outstanding charter school revenue bonds, series 2010, issued by the Industrial Development Authority of the County of Pima, Arizona on behalf of Cambridge Academy East (CAE).

The Rating Outlook is Stable.

SECURITY

The bonds are a general obligation of CAE, secured by a first mortgage on the financed facilities and a cash-funded debt service reserve sized to transaction maximum annual debt service (TMADS). There is an intercept mechanism in place directing state funding disbursements to the trustee to cover debt service on the bonds before monies are released to the school for operations. The Fitch rating does not incorporate the intercept mechanism.

KEY RATING DRIVERS

ADEQUATE FINANCIAL PERFORMANCE: CAE's operating margin weakened in fiscal 2015, following two consecutive years of improvement. While the margin was negative 2.2% on a GAAP basis, annual coverage was sufficient at 1.0x. The decline was attributable to lower state per pupil funding due to a decline in average daily membership and a one-time loss on investment property. CAE's very thin balance sheet and high debt burden remain rating concerns.

ENROLLMENT VOLATILITY BUT STRONG ACADEMIC PERFORMANCE: CAE's Queen Creek campus continues to experience enrollment declines resulting in part from increased competition from neighboring charter and district schools. Student academic performance improved at both campuses in 2014, with both campuses receiving higher scores and overall ratings of 'A' by the Arizona State Board for Charter Schools (ASBCS or the board).

WEAK FINANCIAL CUSHION: Characteristic of most charter schools rated by Fitch, CAE's balance sheet resources remain limited on both a nominal and ratio basis, providing minimal cushion relative to operating expenses and debt.

HIGH DEBT BURDEN: CAE's debt burden remains high; TMADS was 20.8% of fiscal 2015 operating revenue. The debt to net income ratio, measuring the number of years of cash flow needed to repay outstanding principal was also high, at 10.7 years, an increase from 7.3 in fiscal 2014. The school was able to cover TMADS from operations for the past three fiscal years (1.0x in 2015, weaker than 1.6x in fiscal 2014), although debt manageability could be stressed going forward if enrollment declines persist.

RATING SENSITIVITIES

ABILITY TO STABILIZE ENROLLMENT: Given Cambridge Academy East's high reliance on per pupil funding for operating support, its inability to stabilize enrollment and improve operating margins would stress operations and cause negative rating pressure.

CHARTER RELATED CONCERNS: A limited financial cushion; substantial reliance on enrollment-driven per pupil funding; and charter renewal risk are credit concerns common among all charter schools that, if pressured, could negatively impact the rating.

CREDIT PROFILE

Founded by a family of educators, CAE is a charter school serving grades K-8. Originally chartered in 2002, CAE is in year 13 of its initial 15-year charter. CAE has submitted their intent to renew under their charter to the ASBCS, the charter authorizer. ASBCS notes that CAE currently remains in compliance with all requirements under its charter. The school began operations in 1999 and currently operates two campuses, Mesa currently serving grades K-6 and Queen Creek currently serving grades K-8, both situated in Maricopa County, AZ. Fitch continues to view CAE's highly interconnected board and administrative structure as less than ideal. Close ties maintained between the board, senior management, and the founding family constitutes a governance structure inconsistent with the independence typically expected by Fitch. However, CAE's management team remains committed and effective, despite it and the board maintaining multiple inter-related business and family ties.

VOLITILE OPERATING RESULTS

Operating results remain volatile. Margins weakened in fiscal 2015 to negative 2.2%, following marked improvement to positive 5.7% in fiscal 2014 from negative 5.3% in fiscal 2013. Management reports that weak fiscal 2015 results were attributable to a one-time loss on investment property and lower state per pupil funding resulting from lower than projected average daily membership.

CAE has a small revenue base, contributing to operating volatility, with just \\$3.2 million in operating revenue for fiscal 2015. Typical of most charter schools, revenue flexibility is very limited with about 90% of CAE's operating revenues derived from state funding. Favorably, the funding environment improved slightly in Arizona over the past two years. The fiscal 2015 base level was \\$3,373 per student with additional assistance of \\$1,708 for K-8, a 1.4% increase over the prior year. For fiscal 2016, the base level improved slightly (1.6%) to \\$3,427 with additional assistance of \\$1,735. Management estimates that state funding should increase by a minimum of 2% annually over the next few years.

The school's fiscal 2016 budget shows a slight increase in revenues and expenditures of approximately 2% over the 2015 budget. As of the end of fiscal 2016 first quarter (Sept. 30), CAE recorded net income of \\$82,000 and management expects to end the fiscal year with slightly positive operations.

INCREASED COMPETITION; ENROLLMENT VOLATILITY

The Queens Creek campus is facing increased competition - three new charters opened this past year. Additionally, the campus has been plagued by administrative issues leading to several teacher resignations which has negatively impacted enrollment. Concerns, however, are partially offset by strong academic performance and management's success to date to manage expenses accordingly. For 2014, the Mesa campus retained its state accountability grade of 'A', with an overall score of 78 (up from 70 in 2013). The Queen Creek campus was upgraded to 'A' from 'B' following implementation of a turnaround plan, with its score improving to 87.5 from 68.8 in 2013. Both campuses met their annual measurable objectives, which are used to measure school performance. State academic performance measures are being revised so grades will be on hiatus for 2015 and 2016 and when available will not be comparable to 2014.

Due to the competitive environment, CAE has experienced ongoing enrollment pressure in recent years. Average daily membership (ADM), which determines state per pupil funding, fell in fiscal 2016 to 426 as of the 40-day count compared to 438 and 544 in fiscal 2015 and 2014, respectively. For the 2015-2016 school year, 458 students are presently enrolled at CAE's two campuses; 220 at Mesa and 238 at Queen Creek compared to 463 for the 2014-2015 school year. While the Mesa campus gained 22 students, Queens Creek enrollment declined by 27 students.

CAE's high state rating as measured by academic performance should help the campuses to maintain and/or restore some level of demand despite a competitive environment. Fitch will continue to monitor CAE's enrollment and demand trends, noting that further enrollment declines could stress operating performance and lead to negative rating action.

WEAK LIQUIDITY AND HIGH DEBT BURDEN

CAE's balance sheet liquidity remains limited and provides a very thin financial cushion relative to operating expense and debt. Available funds, or cash and cash equivalents not permanently restricted, decreased to \\$394,000 as of June 30, 2015 from \\$502,000 as of June 30, 2014, and only covered fiscal 2015 operating expenses (\\$3.2 million) and outstanding debt (\\$8.0 million) by a low 12.2% and 5.3%, respectively.

The series 2010 bonds and a small capital lease (approximately \\$19,000) are the school's only debt outstanding. Its debt burden remains high and increased in fiscal 2015 with TMADS of about \\$660,000 representing 20.8% of fiscal 2015 operating revenues. Coverage of TMADS of 1.0x from 2015 operations was lower than the past two years - 1.1x and 1.6x in fiscal years 2013 and 2014, respectively - but still better than previous years (2011 and 2012 had below 1x coverage).

Pro forma debt to net available income was high at 10.7x in fiscal 2015 and worse than in prior years as fiscal 2015 operating results were lower. CAE has no material capital needs or additional borrowing plans for either campus, which is viewed positively as Fitch does not believe CAE has any additional debt capacity.

Rating stability will depend on CAE's ability to maintain breakeven to positive operating results, while stabilizing enrollment and controlling expenses.