Arlington Higher Education

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1 Ratings Series 2014A Stable Outlook Contacts Humberto Patiño Senior Associate José Luis Cano Executive Director / ABS Joseluis.cano@hrratings.com HR Ratings ratified the LT rating of 1 with Stable Outlook for the A of Trinity Basin Preparatory 2. The ratification of the rating is the result of a positive trend observed on our main rating metrics, with an estimated debt service coverage ratio (DSCR) of 2.0x and years of payment in 5 for FY18. The rating is also based on the likelihood that TBP will maintain the observed level of the rating metrics in the years to come, taking also into consideration the recently opened Ledbetter campus and the students and revenues it will add; helping TBP to achieve the projected cash generation, which in our base scenario is used to early amortize the Ledbetter bonds. The observed financial results are a consequence of the School s capacity to continue with its expansion plan, in terms of enrollment, through acquisitions, construction and revamps of its buildings, along with more efficient spending and investments focused on the preservation of academic quality and motivating and retaining teachers. Also, TBP reduced the pressure on its liquidity by assuming the existing bonds of Ledbetter campus ($8.8m) with null debt service and accrued interests for two years coupled with the option to amortize it at a discounted amount. In the preliminary 3 results for FY18, DSCR and DSCR with cash reached 2.1x and 4.1x, higher 0.9x and 1.4x than our previous projections. For FY19 and FY20 we estimate that these metrics will reach an average of 1.2x and 4.3x, respectively, with amortization payments related to the revolving credit line and the long-term debt of new buildings including Ledbetter bond. We expect years of payment to temporary increase from 5.0 in FY18 to 8.1 in FY19 due to Ledbetter bonds. Our rating contemplates: growing student demand with 66.7% growth in enrollment capacity, TBP will continue with its cost control strategy, campus improvement in 2020 and compliance with accountability performance rating. Hence, HR Ratings does not expect a risk of charter revocation. Definition The issuer or issue with this rating provides moderate safety for timely payment of debt obligations. Maintains moderate credit risk on a global scale, with weakness in the ability to pay in adverse economic scenarios. The rating is based on the following credit rating drivers: DSCR and Years of Payment. Despite a projected temporary increase in years of payment, due to Ledbetter bonds, HR Ratings base scenario DSCR is expected to range between 0.6x and 1.8x over the five-years forecast period ( ), while DSCR with cash would range from between 1.9x and 6.6x. Years of payment would decline after the Ledbetter bonds amortization from 8.4 in FY19 to 5.5 in FY21. Enrollment Progress. TBP continued with its expansion plans in its current campuses with a growth rate of 12.9% in FY18 compared to 18.9% in FY17 and 9.6% projected in our previous base scenario. After the acquisition of the Ledbetter campus, enrollment is expected to accelerate in the forthcoming years, particularly in Dallas area, with an increase of 22.3% in FY19 and 6.6% in FY20. Additionally, the FY19 growth will be enhanced by a new building in Panola campus, in the Fort Worth area. Revenues and EBITDA. Our base scenario contemplates that the observed increase in revenue per student will continue at an average annual rate of 0.8% based on the assumption that the School achieves the required attendance average and accountability performance rating, which are the key elements to receive federal and state funds. However, EBITDA is expected to evolve at a slower pace due to the expected investment of the school in its teachers and academic programs. Long term debt structure. Our base scenario considers that the School will continue with its strategy of financing its expansion through long-term debt, reducing TBP liquidity pressures. Bond Covenants. TBP must comply with DSCR and days cash on hand levels as specified in the master indenture. Our scenarios assume that this will be the case. 1 The G indicates that the rating is based on a global scale. The rating is based on TBP s credit risk. 2 Finance Corporation, (TBP or the School). 3 FY18 results are based on preliminary audited results. Final results are not expected to show any relevant changes. Page 1 of 29

2 Main Factors Considered This report focuses on the qualitative and quantitative events related to TBP that took place within the last twelve months. Additionally, it incorporates revised projections of the School s financial statements. All of this resulted in the assigned rating and outlook. Due to the nature and the legal framework of the Series 2014 bonds, their credit rating is based on the general obligation rating of TBP. The analysis presented here corresponds to the fourth annual review of the credit rating of the bonds. (the School or TBP) is a non-profit organization that operates open-enrollment schools at six locations within Dallas and Fort Worth, Texas; operating under the laws of the State pursuant to a charter that became effective on October 1, 1998 and has been renewed through July 31, The School has been in operation for around 19 years, offering education to predominantly lower income students from pre-kindergarten 3 (PK3) through 8 th grade; reaching approximately 3,162 students combined within its five campuses for FY18 4. For more detail of the credit rating and its evolution, we recommend reading this and the previous reports available at our website Relevant Events The observed financial results for fiscal years 2015 through 2017 and preliminary numbers for FY18, reflect the capacity of TBP management to control the School s expenses, despite the growth in its operations. Furthermore, its debt strategy and loan structure have allowed TBP to continue with its expansion plans without putting its liquidity at risk. TBP closed its FY17 results above our last year s base scenario due to a higher ADA 5 than expected, which directly resulted in higher federal funds for the School, complemented with lower overheads or fixed expenses, as a consequence of a higher absorption of costs due to TBP s enrollment and operations growth, resulting on an EBITDA of $5.8m in FY17 (30.9% above our base scenario and 113.1% higher than FY16). The estimated results for FY18 also show that this positive trend continued with an expected EBITDA of $7.0m (21.1% above FY17 and 57.9% larger than last year s base scenario) and FCF of $7.1m (+51.8% vs. FY17). As a reference, the ADA closed FY18 at a level similar to FY17, 95.3%. TBP s ADA has never been under 95.0% of enrollment since The School continues to enhance the diverse strategies that it has implemented to maintain the observed ADA level; hence, our projected scenarios were estimated on the base of stable attendance ratios. The School complied with the covenants defined in the trust indenture with a DSCR of 1.7x in FY17 and 2.1x in the preliminary FY18 financial results. As a reference, the indenture establishes that this metric must be above 1.1x. For its part, an index of days of cash on hand of 98 in FY17 and 143 in FY18 compared to the 30 days that is required. HR Ratings is not projecting that the 143 days, observed in FY18, will be 4 FY18 = period between September 2017 and August 2018, which is aligned with the School year. 5 ADA = Average Daily Attendance. Is the most important variable to determine most of the funding that the School receives. Page 2 of 29

3 maintained due to the School s expansion and investments projects. However, based on TBP guidelines, we expect that the cash on hand will be maintained at similar levels of FY17. In May 2018, TBP incorporated the Ledbetter campus into its operations, the location of a previous charter school that surrendered its charter at the beginning of 2017 before the state could revoke it, as the TEA had placed it under scrutiny for falling below academic standards for three consecutive years. TBP purchased the campus for an estimated $8.9m by assuming the existing debt of the school. The acquired indebtedness consists of a long-term bond with no interest payments for two years and principal payments of $0.5m during that period. At the end of these two years, TBP will have the option of fully amortizing the bond at a discount to face value of 32.7%, transferring the debt to the trustee, or assuming debt service for the outstanding balance. Based on the estimated enrollment that the Ledbetter campus will add to TBP operations (around 500 students) coupled with the observed performance of the School, the received federal funds level and the required debt service, we estimate that the liquidity of TBP will not be impacted due to this transaction, maintaining its Debt Coverage Ratio (DSCR 6 ) close to 2.0x and reaching an average days of cash on hand 7 of 116 for FYs 2019 and In order to continue with its expansion plans, TBP started in FY18 the construction of a new building adjacent to the current Panola campus. The new investment will allow TBP to maintain a positive growth trend at this campus with an annual growth rate of 19.2% between 2018 and 2023, and almost triple its enrollment for the years to come, reaching an estimated 944 students in FY23 (vs. 329 observed in FY18). The School calculates that the new building will be ready for the beginning of next school year which starts in August 2019, increasing by 22.3% the number of students in all the campuses in FY19 and 6.6% in FY20. TBP estimates that the total required investment for the new building will be $5.3m. Thus far, the School has already spent $3.9m in FY18 and which was financed through a long-term loan obtained in the same period. TBP reduced its operating leases by exercising its purchase option on the Panola campus for a total amount of $2.8m in October Since the Panola campus was one of TBP s largest lease contracts, after the transaction the School decreased its rentals and operating leases to $0.9m in FY18 (25.3% lower than FY17). As estimated in our prior year analysis, TBP used its own cash balance to source the acquisition of the campus. With the additional facilities that TBP is incorporating, it is expecting to enroll around 442 additional students in their Dallas campuses and 263 more in its Fort Worth District for a total of 705 more students enrolled in the school year (22.3% higher than ). If the assumed enrollment level 8 of 3,867 students in all the campuses is reached by the end of FY19, it would represent 76.9% of TBP capacity (5,026 students considering that the current ratio of students per classroom is kept). 6 DSCR calculated according the indenture is EBITDA divided by Debt Service, considering in Debt Service all long-term obligations. 7 Days of cash on hand is Cash and cash equivalents over Total Operating Expenses plus Net Interest Payments per 365 days. 8 Based on the guideline of the School. Page 3 of 29

4 The defined enrolled target for is considered achievable based on the 3,537 returning/complete registration students (91.5% of the defined target) observed a month before the beginning of school year , with a waitlist of 752 students (184 in Dallas and 568 in Fort Worth). As expected, TBP obtained Met Standard in and Accountability Ratings 9 of the TEA, achieving the target of each of the four indexes. Is important to highlight that the School has never been at a substandard performance level and we believe that the risk of the School losing its charter s license is minimal, since the Texas Education system requires three years below academic standards to revoke a charter's license. Based on TBP's Academic Program and the information provided by the School, it is probable that TBP will continue achieving Met Standard in its Accountability Rating for the years to come. HR Ratings will continue monitoring the official publication of the rating. The 2014 Series Bonds, which represented 62.2% of TBP s total debt in FY18, have the guarantee of the Permanent School Fund (PSF). This guarantee reduced the interest rate of the bonds and secures all payments of principal or interest. If the School uses the guarantee, it has the obligation to refund PSF the disposed amount. It is important to mention that the existence of this guarantee is not incorporated in this credit rating. The rating is subject to changes based on the following credit risks: o o o o o o o TBP inability to continue meeting its enrollment and ADA targets for the school years to come. The Ledbetter campus does not achieve its academic and enrollment objectives. Inability to meet any required payments on the revolving credit line. Changes in state funding levels, or statutory changes in state open-enrollment charter School funding. Deterioration on the School s FCF generation that could result on the impossibility to maintain days operating cash above 30 days through the life of the bonds, or adequate DSCR levels as required by the master trust indenture. Financial deterioration due to unforeseen circumstances. Revocation or non-renewal of the academy s charter s license. New Projects and Enrollment In the past three years, TBP has almost doubled its student capacity through the construction and expansion of its facilities coupled with acquisitions of new campuses. Consequently, the School has increased its enrollment by 71.6% in just four years (from 1,843 students in FY15 to 3,162 in FY18), without modifying its strategy of maintaining an average of 22 students per classroom as the school believes its academic quality can be sustained through this number of students in each class. As a reference, the average of students per classroom is 30 in traditional public and other charter schools. Among the main factors that have contributed to this growth are the opening of new campuses in Dallas (Jefferson campus and the acquisition of the Ledbetter campus from other Charter 9 The state accountability system assigns one of three academic ratings to each district and campus: Met Standard, Met Alternative Standard, and Improvement Required. The performance index framework combines results from STAAR assessments, graduation rates, rates of students completing the various graduation plans, and other indicators. Page 4 of 29

5 school) and in Fort Worth (Panola campus). Additionally, they have expanded the existing capacity of their Pafford campus in Fort Worth. Therefore, they have been able to exceed their growth expectations and our enrollment projections. Two years ago, the School focused its expansion plans in the Fort Worth area, mainly by new investments in the Panola campus and the opening of new grades in both campuses, growing at an average annual rate of 38.3% from 2015 to Additionally, they are still expecting an increase in the Pafford building in 2019 (7.2%). However, with the acquisition of the Ledbetter campus TBP has recovered its growth trend in the Dallas area, allowing it to expand with newly available classroom space. In conjunction with the Ledbetter growth, the School is planning to continue the development of its Dallas campuses through the increase of enrollment at the Jefferson campus (5 th to 8 th grades), at an average growth of 3.2% in FY19 y FY20. Table 1 below presents the observed and projected enrollment breakdown by campus. In FY2018 the Fort Worth campuses and the Jefferson campus in Dallas had a double-digit growth in enrollment. Although the other campuses in Dallas only increased 1.0% this area is still the most relevant for the School as it accounted for 62.4% of the total enrollment of TBP in FY18. Although the growth plans will continue in the Fort Worth area, it is not expected that the geographical distribution of enrollment will change as result of the addition of Ledbetter campus in Dallas, with this area ending having 60.7% of the total enrollment by FY23. In terms of distribution per school grade, TBP had 27.4% of the total enrollment from Pre- K3 to Kinder, around 37.9% from 1st through 4th grade and around 34.8% from 5th through 8th grade in This means that 55.5% of total enrollment is below 4th grade compared to the 60.1% in This trend, combined with the observed enrollment growth, is considered an indicator of a good retention rate as it suggests that enrolled students in entrance grades (Pre-K3 to 3th grade) are continuing their studies in TBP s campuses. We consider that this trend is consistent with the School s strategy of first opening the lower grades to have a solid base of students to source the next school levels. As a reference, for the school year the average retention rate for students above grade 4 was 7.6% compared to a 2.2% average retention rate of the schoolchildren below grade 4. Hence, we estimate that the retention rate will continue improving in line with the opening of higher grades in the different campuses. Page 5 of 29

6 TBP total capacity of its current locations is 5,026, assuming the number of students per classroom is not higher than 20 for PK3 and PK4 grades, 22 for the segment of K-4th, and 24 for 5 th 8 th grades. During FY18 the School has reached 62.9% of its capacity and, as we can see in the below graph, our base scenario assumes that the School will reach 85.5% of its total enrollment capacity in FY23. Also, TBP guidance considers that the 95.0% of the current capacity will be achieved until FY23. Therefore, we do not consider there is any restriction for the enrollment growth assumed in our scenarios. Additionally, in Graph 1 shows the historical and projected enrollment trend, where we can see that student enrollment has increased from FY12 to FY18 at an Annual Average Growth Rate (AAGR) of 15.8%, with the highest increase shown in due to the opening of the Jefferson and Panola campuses. In our base scenario forecast we are assuming an AAGR of 6.3%, compared to the 8.6% of TBP guidance, while in our stress scenario we are projecting 5.3%. Our base scenario considers that higher growth will be observed during the period as consequence of the integration of the Ledbetter campus, which is estimated that will represent around 10% of the total enrollment. Is important to highlight that our analysis and rating is partially based on the assumption that the estimated enrollment in the Ledbetter campus will be reached, contributing to the projected increase on revenues for the years to come, coupled with the hypothesis that TBP will continue with its observed operational efficiency and cost controls, resulting on a higher cash generation. Page 6 of 29

7 Qualitative Analysis Academic Performance In 2018, TBP obtained the Met Standard Accountability Rating by the Texas Education Agency (TEA) evaluating students performance and achievements, school s growth, closing performance gaps, and postsecondary readiness. For the last ten consecutive years the School has earned this rating by meeting the standards required. It is important to mention that if for three consecutive years a school is given a substandard rating (i.e., an Improvement Required Accountability Rating), the state of Texas revokes the charter s operating license. In our last review of the credit rating we mentioned that the School was expecting an increase in the number of teachers and employees coupled with further incentives for its educators based on performance as a part of its strategy to elevate the quality of education. Therefore, based on the observed academic results, we have concluded that the School s strategy is working in a positive way since its students presented an average growth of 3.5% in their grades in FY18 (vs. previous year). In order to improve the quality of the educational experience it provides, TBP has expended resources on providing incentives to its teachers increasing the account named accrued wages in the balance sheet by 60.1%. These range from an additional bonus for teachers who reach the requested performance level and a permanence bonus for talent retention for teachers who continue working for TBP beyond a defined date This strategy has resulted in an increase in teacher tenure increasing to 4.8 years in FY18 vs. 4.7 in the previous year. Furthermore, class size remains relatively small vs. peers at around 20 students per classroom for PK3 and PK4 grades, 22 for the segment of K-4th, and 24 for 5th 8th grades. This compares to a 30-student average for traditional public schools and other charters 10. The school continued with its mentoring program where more experienced teachers help less experienced teachers to improve their skills. We expect that measured academic performance will continue improving since TBP recently integrated into its management team an experienced Chief Academic Officer who will oversee the development and retention of the academic staff and standardization of best practices throughout the campuses. Additionally, TBP continues with its Literacy for Life strategy, launched in Additional Information on Texas Charter Schools For the school year, total enrollment in all Texas Public Schools increased by approximately 0.8% reaching 5,399,682 students, vs. 5,359,127 for the previous year. In % or 296,323 were enrolled in charter schools up from 272,835 in the 2017 academic year. It is important to mention that for this school year the number of openenrollment Charter School campuses reached a total of 707 (vs. 676 campuses in ), which suggests the strength of the demand for charter schools; as well as the political support given by the state of Texas, reducing future risks for TBP. 10 Numbers provided by TBP. Page 7 of 29

8 Quantitative Analysis In accordance with our rating methodology for charter schools credit risk evaluation, HR Ratings has elaborated a quantitative and qualitative analysis of the historic and forecast information of TBP; under both, base and stress scenarios. This evaluation considers an emphasis our main financial metrics related to the cash generation to meet the debt obligations. The document can be found at Audited results for FY18 On the basis of the preliminary audited results, our calculation of TBP s main rating metrics for FY18 ended higher than our projections last year. This improvement is due mainly due to a higher enrollment than expected at the Fort Worth area and in the 10 th Street campus in Dallas; coupled with a 4.8% increase in revenues per student. The stronger revenue per student was the result of a combination of good academic scores and the achieved attendance rate which are the relevant elements to receive state and federal funds. Also, the higher than expected results were positively impacted by an efficient use of instruction expenses by standardizing them across the campuses. Hence, the School only keeps the most efficient program for each school subject, coupled with lower maintenance and supporting services expenses per student due to the implemented cost control program and well-organized use of TBP facilities through a strategy of gradual growth. For example, higher grade classrooms are not opened until the enrollment target is achieved in the lower grades. Because of the aforementioned actions, the School finished FY18 with an EBITDA of $6.9m, 55.2% higher than our projected base scenario and with an EBITDA margin 6.8 basis points above our expectations, reaching for a second year in a row a margin over 20% and an increase of 94.1% on Free Cash Flow (FCF), as observed in the below table. As a result of this, our main metrics also closed superior to what we expected, with an observed DSCR of 2.0x vs 1.1x projected on the base scenario, and a DSCR with cash 3.9x vs 2.9x Page 8 of 29

9 Although net debt ended 31.9% higher than our earlier projections, the strong operating performance resulted in a lower years of payment metric, reaching 5.0 years versus our forecast of 7.4 years. The higher debt was the result of the expansion program including the assumption of debt from the Ledbetter campus. We are not expecting that this metric will be sustained in the years to come due to the expected investments and expenses that the School will have to incur to maintain academic quality and fully integrate the Ledbetter campus. As a consequence, we expect that years of payment will surpass 8 in FY19, a level that we expect will gradually decrease after the amortization of the Ledbetter bond in FY20. The financial results of TBP have gradually improved over the last three years, as we can see in the following table. As previously noted, the main factor behind the improvement in FCF generation was the growth of EBITDA, which was mainly the consequence of an important increase in enrollment, as well as taking advantage of economies of scale and a more efficient spending policy. All these factors have resulted in substantial reductions in per student expenditures. Is important to highlight that FCF was also impacted by the extraordinary effects in , mainly due to advanced payments related to the new building under construction adjacent to the Panola campus, which positively affected the working capital of the Page 9 of 29

10 School by $1.1m, recorded in the balance sheet under the account named accounts payable. We estimate that this amount will be partially reversed in the school year as soon as the construction of the new building is concluded. Additionally, the Balance Sheet and Cash Flow were positively impacted due to the accrued wages account, which increased by $0.6m in , due to earned performance incentives tied to teacher-retention which will be paid during the next School year to the teachers that remain with TBP. These positive effects on the working capital helped to more than compensate the increase in maintenance Capex considered on the equation for the FCF calculation. The debt service in FY18 included the voluntary accelerated amortization of the promissory note agreement acquired during FY17 for an amount of $1.4m (made to minimize interest expenses), debt expenses related to the 2014 bonds and the corresponding amortization of capital leases. In contrast, in FY17 the School paid $550,000 of capital from 2014 bonds and $600,000 of the revolving credit line, plus capital leases. Thanks to a lower growth than the FCF of the debt service (it moved from $2.8m in FY17 to $3.3m in FY18) the increase in FCF for FY18 resulted in an improvement in the DSCR metrics. Although in FY18 net debt increased 46.9%, due to the assumption of the Ledbetter bonds for $8.8m and the promissory notes contracted to source the construction of the new Panola building of $5.9m, the years of payment metric maintained a similar level than the prior year due to the larger amount of FCF generated. Additional to the just acquired debt TBP maintained $1.2m debt related to the revolving credit line and the corresponding outstanding balance of the capital leases. Base Scenario Forecasts In accordance with our methodology, HR Ratings elaborates projections that go from FY19 to FY23 for the balance sheet, statement of activities as well as cash flow statement. Projections are made taking into consideration guidance given by TBP. Regarding the recently concluded FY18, it is considered to be very similar as the information provided by TBP already considers its almost final fiscal year figures. Revenues and Student Enrollment The most important income for TBP is state revenues; which represented 88.2% of the total revenue in FY18 and they are distributed by the government based on enrollment as well as Average Daily Attendance. Average state revenue per student for our forecast period (FY19-FY23) is $8,634 vs $8,420 in our previous report (for FY18- FY22), with an increasing trend over the years, going from $8,579 in FY19 to $8,688 in FY23 The other important component of revenues is federal income which represents around 11.1% of total revenues. For FY18 the federal revenue per student reached $1,075 compared with $1,011 in FY17. TBP is still carrying out its expansion plan in terms of enrollment but at a more moderated pace. In FY19 the growth rate is expected to be near 10.7% from an observed growth rate of 12.9 in FY18. This increase represents around 318 more students between FY18 and FY19 to close with around 3,480 students in our base Page 10 of 29

11 scenario. Compared with our expectations in the first annual review in 2015, we were forecasting for FY19 enrollment of 2,943 and in our last review we were expecting 3,294, therefore, we can conclude that the School has been successful in their expansion plans. For FY20 we are expecting a growth rate of 6.6%, through the incorporation of the Griggs building and the consolidation of the Ledbetter campus. Expenses On the expenses side, TBP has been able to take advantage of economies of scale and reduce their overall expenses per student in the past years. For example, total cash operating expenses per student have gone down from $8,185 in FY14 to $7,541 in FY18. Instructional costs represent the largest item constituting 49.4% of the total expenses in FY18. This concept also been decreasing on a per student basis, especially in FY17 with a decrease of 5.2% continuing with this trend in FY18 with a reduction of 1.5%. Nonetheless, we think these two years may have been atypical since the Schools strategy is focus on investing its generated cash in this line. Therefore, in FY19 we are expecting it to return to levels observed in FY16 ($4,520). According to information provided by TBP depreciation is primarily accounted for as Instructional Expense. Another important concept are the General Administration and Facilities Maintenance and operations. These variables account for 10% and 11% respectively of the total expenses, as they are semi-fixed in nature they present opportunities for reductions on a per student basis as enrollment rises significantly. For example, General Administration has seen, for a second year in a row, reductions of 11.5% in FY16 and 21.4% in FY17, in absolute terms, and 33.9% per student in FY17. However, these reductions were temporary since this account showed an increase of 11.2% per student in FY18, we consider that this advance on General Administrative expenses is a consequence of the recently observed expansion with the integration of Ledbetter campus and classrooms growth in other campuses. We are expecting that this account will continue with a growing trend per student due to the expansion plans of TBP but at a more moderate rhythm based on the assumption that the School has already in site its required administrative staff and the implemented strategies to control fixed expenses. Maintaining the same trend of increase in concepts like Instruction, Instructional leadership and guidance, among others, we are expecting total cash operating expenses per student to rise on average 2.2% from 2019 to 2023 in our base scenario. It is important to highlight that the expenditures accounts that has seen a rise on a per student basis are: Instructional leadership; guidance, counseling, evaluation, health services, security and community services. All of these are related to the quality of education provided by TBP. EBITDA EBITDA Margin levels would remain very similar, on average, to our previous projection, nevertheless, this year we are expecting higher figures in the short term and lower in the medium term. On average, comparing projection periods, the margin would be 17.6% for FY18 in this review vs 15.7% last year. We are expecting, in FY19, a margin of 17.9% from a preliminary figure of 22.5% in FY18. Starting in 2019 the margin would have a decreasing trend until reaching 17.2% in The decreasing trend is a result of an outstanding year in FY18 that, based on historic performance, we think it may be difficult Page 11 of 29

12 to sustain. Graph 2 shows the EBITDA and EBITDA Margin levels projected this year vs our projections in the last rating review. Our current expectations for EBITDA are the result of the following forecast evolution for revenues and cash operating expenses. Free Cash Flow A major concept in HR Rating s Charter School methodology is that of free cash flow (FCF). By definition, FCF is used for the calculation of DSCR and years of payment. FCF is basically cash generated by operations (cash operating income less working capital requirements) less maintenance capital expenditures. On a default basis we generally use depreciation as a proxy for maintenance Capex. We assume that FCF will reach $3.8m in FY19 (net of $1.6m in non-cash maintenance cap. ex.). This level of cash was mainly pushed by the good financial result of the School. In the forthcoming years, we expect levels of cash rounding $8.1m which provide with sufficient liquidity to pay the financial obligations. Furthermore, TBP is supported by a revolving credit line of $2.6m to comply with financial covenants in the bonds or any liquidity problem that the School has. It is also important to highlight that the strong investments related to the expansion plans are expected to be financed through a longterm loan. As said before, this year we incorporated into our base projections $1.7m on average of maintenance capex. Additionally, our base scenario considers the investment of $5.0m in FY21 for corporate offices (based on TBP guideline) and $1.8m for possible renovation of some buildings at the Panola campus. We do not consider that any of the projected investments would imply a higher risk on the liquidity of the company since we consider they are not critical Capex for the operation of the School, hence, in case of a stress scenario we assume that TBP will not need to incur on this Capex. Page 12 of 29

13 Debt 2014 Bonds One of the most significant changes in the cost of debt of the 2014 Series bonds came from the PSF guarantee obtained by TBP in August of 2014, shortly after the issuance was made. In our original model, we considered an average interest rate of 6.6%. After the PSF guarantee, the interest rate for the Series A would be around 4.0%. It is important to mention that on August 15 th, 2017 the Series B was fully amortized for an amount of $550,000. Another relevant event related to the 2014 bonds was the Escrow Agreement. The agreement was established with Wilmington Trust, National Association as escrow agent and the main purpose was the deposit by TBP of $2.6m into an irrevocable escrow to be pledged to the payment of principal, redemption premium, and interest of the defeased bonds. The escrow will cover all the capital payments from 2018 to 2020 and 75% of the capital payment of 2021, and approximately 6.0% of interest payments from 2018 to According to information provided by TBP, this instrument was created to maintain the tax exemption of the bonds and as a result of the sale of the Monroe building which was part of the allocation of the bond proceeds. The amount is maintained out of the balance of the School; hence, it is not impacting the debt service in our rating metrics. The Permanent School Fund was created with a $2.0m appropriation by the Texas Legislature in 1854 expressly for the benefit of the public Schools of Texas. The revenues of the PSF come mainly from the increase in the fair value of their investments, interest, dividends and land endowment. As of August 2017, their total assets worth $44.5 billion (versus $38.8 billion in 2016) and $74.3 billion were guaranteed in school and charter district bond issues 12 ($72.9 billion for school district guarantees and $1.4 billion is for charter district guarantees). It is important to mention that the existence of this guarantee is not incorporated in this credit rating. Revolving Credit Line In FY16 TBP had a revolving credit line with Frost Bank for an amount of $600,000, which closed FY16 with an outstanding amount equal to the value of the line. In FY17, TBP fully paid this line with the proceeds obtained from another revolving credit line contracted with Liberty Capital Bank for an amount of $2.6m, TBP only used $1.2m which were used to pay the line with Frost Bank and another working capital purposes, additional to allowing TBP to comply more comfortably with bond financial covenants. The outstanding balance of the line at the end of FY18 was $1.2m and the full payment would be on FY21. The line is secured by a first and prior lien upon certain real property located in Dallas County, Texas. Interest is calculated on the basis of the prime rate published by the Wall Street Journal (WSJ) plus a spread of 2.0%. The rate shall not be at any time less than 5.5% per annum. According to HR Ratings methodology, these lines are included in debt and debt service in case they have an outstanding balance at the end of the fiscal year. 11 Calculated considering the whole outstanding 2014 bonds debt. 12 Texas Permanent School Fund, Comprehensive Annual Financial Report for the Fiscal Year ending August 31, Page 13 of 29

14 Lease Obligations In FY16 the school closed with capital lease obligations of $719,191, which represented an increase of 40% with respect to FY15. New leases were used mainly to furnish and equip the new buildings and classrooms. In FY18 the outstanding balance of capital lease obligations closed at $0.7m (52.2% decrease vs FY17). The observed decrement was mostly explained by the cash generated during FY18 which TBP used to source the buildings and classrooms requirements and voluntary early payment of capital leases. Trinity Basin Preparatory s largest operating lease contract was the Panola campus, in which TBP exercised its purchase option in FY18 and acquired the property. Starting in 2019 the School does not expect to acquire any new capital leases. Therefore, in line with the amortization calendar, capital leases will be fully paid in According to HR Ratings methodology, capital lease obligations are included in our measures of debt while the repayments are included in our measure of debt service. Additional debt In May 2018, TBP purchased the Ledbetter campus. The transaction included assumption of previously issued Series 2011 Education Revenue bonds by an outstanding balance of $8.8m. For the next 24 months, ending May 2020, the School will pay $0.5m of principal but no interests. At the expiration of this period TBP has three options: i) transfer the title and possession of the collateral and debt obligations to the Trustee, ii) make a liquidation payment to the Trustee for a discounted amount of $6.0m or ii) assume new debt to cover the outstanding balance. If TBP elects to make the liquidation payment hence the School will obtain a potential gain of $2.4m, hence, our base scenario assumes the School opts for this alternative reducing its indebtedness level. Moreover, the School in FY18 entered into a promissory note agreement with a bank to advance up to $5.0m, with an annual interest rate of prime rate plus 1.5%. Starting in December 2018 is contemplated a monthly payment of $0.3m until the maturity date in November The note has as a real estate collateral and its proceeds were mainly used for the construction of the new building adjacent to the Panola campus. Also, based on TBP guidance, they are expecting to contract a $5.0m long-term loan to be acquired in FY21. The interest rate assumption is of 6.5%. All financial conditions are assumptions given by TBP and would be adjusted at the moment of the signature of the loan agreement. The proceeds of this loan will be used to purchase a new Corporate building. Debt analysis Fiscal year 2018 ended up with a higher level of net debt from what we had expected (debt less the sum of cash and cash restricted for debt service and construction), despite a much higher level of cash due to the assumption of the Ledbetter debt in FY18 as part of the purchase included assumption of previously issued Series 2011 Education Revenue bonds with an outstanding balance of principal of $8.8m. Additionally, the debt is integrated by the outstanding balance of the revolving credit line which doubles the one reported in FY16. Page 14 of 29

15 Total net debt in FY18 was $33.1m while our previous expectation was $28.0m. The difference is due to the $8.8m Ledbetter bond and the new credit contract of $5.6m in FY18 for the new building in Panola campus. Net debt is also expected to be lower each year compared to our previous projections. According to TBP guideline, the revolving credit line will be accessed again in FY20 and repaid in FY21. Graph 3 presents the amortization schedule over the whole legal period of the long-term debt of TBP as well as the interest payments over the entirety of the debt (including the revolving credit line). Is assumed that the $1.2m outstanding of the revolving credit line would be fully paid in FY21. While the capital payments from 2019 through 2021 would correspond entirely to the new $5.6m loan and the early amortization of the Ledbetter bond at a discount amount. According to the master indenture, TBP has to comply with financial covenants. The DSCR, as calculated in the indenture, has to be above 1.1x; if not, the School has to hire an independent consultant. If the DSCR is below 1.0x a default event could be triggered. Additionally, unrestricted cash reserves shall be maintained in amount equal to 30 DCOH 13. If the School fails to maintain this level, they would also have to hire a Management Consultant to make recommendations with respect to revenues or other financial matters. In our base scenario, these covenants will be met during the forecast period. Our projections of three of the most relevant metrics calculated by HR Ratings to obtain the credit rating are shown in graph 4. We expect FCF to be on average $5.1m in the forecast period (FY19-FY23) vs $2.9m in last year s report (FY18-FY22). For its part, 13 Days Cash on Hand Page 15 of 29

16 Debt Service is expected to be on average $4.2m vs $2.4m previously. Despite the escrow agreement, the increase in debt service is due to the increase in the revolving credit line, as well as the new two loans. During FY18 DSCR closed around 2.0x. Adding cash and cash equivalents, we obtain the DSCR with cash which is estimated to close around 3.9x. The expected decrease in FY20 is a result of an expected amortization of $6.0m of the Ledbetter Series 2011 Education Revenue Bond assumed in FY18. Calculated as per Master Trust Indenture 14 DSCR closed FY18 at 2.1x. The average from FY19 through FY23 would be 2.0x, being the lowest 0.8x in 2020, due to reasons above mentioned. As shown in Graph 5, years of payment would increase to 8.5 in 2019, because of the increase in net debt due to the $5.9m contract that will work to keep-up with expansion plans in Panola, $8.8m of the Ledbetter bonds and to the use of $1.2m in FY20 of the revolving credit line. Finally, the expected drop in FY20 is due to the Ledbetter bonds amortization and in FY22 is because it will be the first year where TBP will have to pay entirely the amortization of 2014 bonds. 14 EBITDA / Debt Service Page 16 of 29

17 Stress Scenario Forecasts Our methodology considers the projections of the financial statements in a stress scenario over the same period as the base scenario (FY19-FY23). Our stress scenario assumes lower enrollment, lower revenue per student, as well as higher expenses per student than our base scenario 15. This results in lower EBITDA margins, lower Free Cash Flow levels and therefore, a deterioration of the key metrics used by HR Ratings for the credit rating (DSCR, DSCR with cash, Years of Payment and MALC). For FY18 HR Ratings does not consider stress in the variables mentioned because guidance given by the School is close to the end of the fiscal year. 15 It is important to point out that or base scenario represents our estimate of the set of most likely outcomes. Page 17 of 29

18 Starting with enrollment, our stress scenario considers 1,065 fewer students in the period. By the end of FY23 enrollment would be 5.0% below our base scenario. This scenario captures a possible poor performance of the School in their expansion plans, mainly in the Dallas area in the recently added Ledbetter campus and Fort Worth District (Panola and Pafford) 16. The two main adjustments made in revenues are state and federal income. State revenues per student would be 1.8% lower than the base scenario for the period This means that in FY23 state revenue per student would be $8,516 vs $8,845 in our base scenario. As for the reduction in federal revenues per student, these would be 1.1% vs. our base scenario, federal revenue per student in FY23 would be $1,158 vs. our base scenario assumption of $1,176 which has already been lowered from guidance given by the School. On the expenses side, two main adjustments are considered, the first on Instructional Expenses and the second on General Administration. In the forecast period, Instructional Expenses per student would be 3.2% higher in our stress scenario vs. our base, while General Administration would be 16.7% higher. These assumptions result in cash expenses per student 3.0% higher than our base scenario. As a result of the assumptions on revenue and expenses, EBITDA per student levels would be 25.8% lower in our stress scenario. EBITDA Margin is projected in a base scenario to be 17.2% in FY23, while in stress scenario it is projected to be 11.6%. In Table 4 we show the projections of the four-key metrics used by HR Ratings in the quantitative analysis in both scenarios. Total Debt and debt service would be the same in both scenarios, thus, stress on DSCR metrics come from the reduction in the FCF, and stress on years of payment come from the reduction in the FCF and therefore higher levels of Net Debt. Marketable Assets (MALC) is reduced by considering a lower percentage on the value of the MALC. 16 For more detail on the enrollment projections in stress scenario, see Graph 5. Page 18 of 29

19 Legal Covenants Security The bonds are secured by and payable from: 1) loan payments made by TBP to the trustee under the loan agreement and, 2) amounts payable by TBP under the issuer master notes. Pursuant to the loan agreement, the academy agrees to make loan payments to the issuer sufficient to meet required debt service payments. Additional Bonds Test Additional bonds may be issued if: 1) net revenues for either the preceding fiscal year or any consecutive 12 months out of the most recent 18 months before the issuance of debt equal at least 1.10x maximum annual debt service (MADS) and 2) projected net revenues equal at least 1.20x MADS, including the additional debt, the fiscal year following the completion of the project being financed. An endorsement of the title insurance policy issued in connection with the debt increasing the coverage by an amount equal to the aggregate principal amount of the additional debt is also required. DSCR & Cash Reserves The DSCR must be at least 1.1x for any fiscal year beginning in fiscal If the School does not maintain DSCR levels above 1.1x, they would have to employ a Management Consultant to review and analyze the operations and administration of the School. A DSCR below 1.0x constitutes an event of default and if a default occurs and is continuing, it could lead to an acceleration of the maturity of the bonds. Furthermore, unrestricted cash reserves shall be maintained in amount equal to 30 DCOH. If the School fails to maintain this level, they would also have to hire a Management Consultant in order to make recommendations with respect to revenues or other financial matters It is important to mention that this covenant was changed after the bonds obtained the PSF guaranty. Page 19 of 29

20 Appendix 1 (Base Scenario) Page 20 of 29

21 Page 21 of 29

22 Page 22 of 29

23 Page 23 of 29

24 Appendix 2 (Stress Scenario) Page 24 of 29

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27 Page 27 of 29

28 HR Ratings Management Contacts Management Chairman of the Board Vice President Alberto I. Ramos Aníbal Habeica Chief Executive Officer Fernando Montes de Oca Analysis Chief Credit Officer Deputy Chief Credit Officer Felix Boni Pedro Latapí Public Finance / Infrastructure Financial Institutions / ABS Ricardo Gallegos Fernando Sandoval ricardo.gallegos@hrratings.com fernando.sandoval@hrratings.com Roberto Ballinez roberto.ballinez@hrratings.com / ABS Methodologies José Luis Cano Alfonso Sales joseluis.cano@hrratings.com alfonso.sales@hrratings.com Regulation Chief Risk Officer Head Compliance Officer Rogelio Argüelles Rafael Colado rogelio.arguelles@hrratings.com rafael.colado@hrratings.com Business Development Business Development Francisco Valle francisco.valle@hrratings.com Page 28 of 29

29 Mexico: Avenida Prolongación Paseo de la Reforma #1015 torre A, piso 3, Col. Santa Fe, México, D.F., CP 01210, Tel 52 (55) United States: One World Trade Center, Suite 8500, New York, New York, ZIP Code 10007, Tel +1 (212) The rating assigned by HR Ratings LLC to the entity, issuer and/or issue is based upon the analysis performed under a base case and stress case scenario, in accordance with the following methodology(ies) established by the rating agency: Rating Methodology for Charter Schools Credit Risk Evaluation, February 13, Form 17-g (7): For more information with respect to this (these) methodology(ies), please consult the website: Complementary information Previous Rating., Stable Outlook Date of the last Rating Action. August 9, 2017 Period of the financial information used by HR Ratings for the assignment of the current rating. Main sources of information used, including third parties. Ratings assigned by other rating agencies that were used by HR Ratings (if so). HR Ratings considered at the moment of assigning or reviewing the rating, the existence of mechanisms designed to align the incentives between the originator, servicer and guarantor and the possible buyers of the rated instrument (where it applies). Audited data from FY2009 through FY17. Preliminary information for and projections through Information provided by Trinity Basin Preparatory, the National Alliance for Public Charter Schools and Texas Education Agency. N.A. N.A. *HR Ratings, LLC (HR Ratings), is a Credit Rating Agency registered by the Securities and Exchange Commission (SEC) as a Nationally Recognized Statistical Rating Organization (NRSRO) for the assets of public finance, corporates and financial institutions as described in section 3 (a) (62) (A) and (B) subsection (i), (iii) and (v) of the US Securities Exchange Act of The rating was solicited by the entity or issuer, or on its behalf, and therefore, HR Ratings has received the corresponding fees for the rating services provided. The following information can be found on our website at (i) The internal procedures for the monitoring and surveillance of our ratings and the periodicity with which they are formally updated, (ii) the criteria used by HR Ratings for the withdrawal or suspension of the maintenance of a rating, and (iii) the procedure and process of voting on our Analysis Committee. HR Ratings ratings and/or opinions are opinions of credit quality and/or regarding the ability of management to administer assets; or opinions regarding the efficacy of activities to meet the nature or purpose of the business on the part of issuers, other entities or sectors, and are based exclusively on the characteristics of the entity, issuer or operation, independent of any activity or business that exists between HR Ratings and the entity or issuer. The ratings and/or opinions assigned are issued on behalf of HR Ratings, not of its management or technical staff, and do not constitute an investment recommendation to buy, sell, or hold any instrument nor to perform any business, investment or other operation. The assigned ratings and/or opinions issued may be subject to updates at any time, in accordance with HR Ratings methodologies. HR Ratings bases its ratings and/or opinions on information obtained from sources that are believed to be accurate and reliable. HR Ratings, however, does not validate, guarantee or certify the accuracy, correctness or completeness of any information and is not responsible for any errors or omissions or for results obtained from the use of such information. Most issuers of debt securities rated by HR Ratings have paid a fee for the credit rating based on the amount and type of debt issued. The degree of creditworthiness of an issue or issuer, opinions regarding asset manager quality or ratings related to an entity s performance of its business purpose are subject to change, which can produce a rating upgrade or downgrade, without implying any responsibility for HR Ratings. The ratings issued by HR Ratings are assigned in an ethical manner, in accordance with healthy market practices and in compliance with applicable regulations found on the rating agency webpage. There Code of Conduct, HR Ratings rating methodologies, rating criteria and current ratings can also be found on the website. Ratings and/or opinions assigned by HR Ratings are based on an analysis of the creditworthiness of an entity, issue or issuer, and do not necessarily imply a statistical likelihood of default, HR Ratings defines as the inability or unwillingness to satisfy the contractually stipulated payment terms of an obligation, such that creditors and/or bondholders are forced to take action in order to recover their investment or to restructure the debt due to a situation of stress faced by the debtor. Without disregard to the aforementioned point, in order to validate our ratings, our methodologies consider stress scenarios as a complement to the analysis derived from a base case scenario. The rating fee that HR Ratings receives from issuers generally ranges from US$1,000 to US$1,000,000 (or the foreign currency equivalent) per issue. In some instances, HR Ratings will rate all or some of the issues of a particular issuer for an annual fee. It is estimated that the annual fees range from US$5,000 to US$2,000,00 (or the foreign currency equivalent). Page 29 of 29