Lincoln Educational Services Corporation (LINC) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Quarter 2 2012 Lincoln Educational Services Earnings Conference Call. My name is Marianna and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And now I would like to turn the call over to Shaun McAlmont, President and Chief Executive Officer of Lincoln Educational Services. Please proceed, sir.

Thank you, Marianna, and good morning, everyone. Joining me today is Cesar Ribeiro, our Chief Financial Officer. Let me begin this morning by reading the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Statements in this presentation concerning Lincoln Educational Services Corporation's future prospects are forward-looking statements that involve risks and uncertainties. There can be no assurance that future results will be achieved and actual results may differ materially from forecasts, estimates and summary information contained in this earnings release. Important factors that could cause actual results to differ materially are included, but not limited to, those listed in Lincoln's annual report on Form 10-K for the year ended December 31, 2011, and other periodic reports filed with the SEC. All forward-looking statements are qualified in their entirety by this cautionary statement. This morning, I'll provide an overview of our company's operations and environment, and Cesar will review our second quarter financial results and provide our outlook for the third quarter and full year 2012 and we'll then take your questions. As an overview of the environment, I felt it important for me to address the final industry report issued by the Senate Health Committee this week, which was essentially a one-sided attack on our sector of education. It failed to share any positive elements of vocational training, especially the types of training Lincoln has offered to hundreds of thousands of people over a 66-year period and the report also reflected outdated information. Furthermore, the report did not focus on the many changes we've made to our operating model over the past 2 years to ensure our students achieve success according to the efforts they put into their education. We've carefully outlined as a part of this public forum over the past 2 years the many…

Thank you, Shaun. Good morning, everyone. As we disclosed in our press release earlier this morning, on July 31, 2012, the company's Board of Directors approved a plan to cease operations at 7 of our campuses. The adjustments we made to our business model to better align with the Department of Education's increased emphasis on student outcomes and our efforts to comply with the 90/10 rule and cohort default rates greatly impacted student population at these campuses. In addition, the current economic environment and regulatory changes on the Consolidated Appropriations Act of 2012, signed into law on December 23, 2011, which eliminated the ability to enroll -- ability to benefit students have made these campuses no longer viable. Accordingly, the company has decided to cease operations at these campuses and have stopped enrolling new students. For 2012, these campuses were expected to contribute approximately $14.5 million in revenue. These campuses were expected to contribute approximately 570 students to second half of 2012 student starts. We anticipate that the company will incur additional pretax expenses during the second quarter of the year of approximately $11.4 million to shut down these facilities. Once all operations have ceased at these campuses, the results of operations will be reflected as discontinued operations in our financial statements. We anticipate that the impact of this decision will be accretive to earnings in 2013 by approximately $0.21 per share. For the second quarter, student starts increased by 18.4% as compared to the second quarter of 2011. Student starts for the second quarter include some students who are originally scheduled to start in July 2012, but started in late June of 2012. Excluding these students, starts for the second quarter were up approximately 13% versus the second quarter of 2011. The deteriorating start numbers we experienced during 2011…

[Operator Instructions] And the first question is from the line of Gary Bisbee from Barclays.

It's Zach Fadem for Gary. Can you give us some color on what drove the starts performance this quarter? And whether the lower starts guidance for the year from 6.8 -- or 6% to 8% to flat is primarily due to ATBs and starts from the closed campuses?

Zach, this is Shaun. I'll start and then Cesar can jump in if necessary. But I'll just say that in the second quarter, despite fewer reps and a lighter inquiry flow, we saw stabilization in the reps performance and they were able to convert the inquiries that came in at a higher rate than we've seen over the last year or so. And that conversion improvement was not only on the inquiries, but it was also on the enrollment to start category as well. So that primarily drove the starts in the second quarter. In addition, as both Cesar, myself mentioned, there were some students that started early that moved from Q3 to Q2, which also impacted those second quarter starts. In terms of the year forecast for flat starts, that does account for slight down starts in the third quarter driven by ATB, but also the closed schools and really, those are the only contributing factors. I will also say though that ever since the first quarter, we have not enrolled online students and so there's a small factor there as well. But in summary, I'll just say that flat starts for the year, considering the closed schools, no online this year and ATB does show us good stability in our admissions processing.

Okay. And another question, can you walk us through the timing of the school closures and how we should think about costs in the second half of the year and the first half of next year?

We anticipate that we will close all the schools by December 31. We are projecting, obviously, subject to accreditation and other that most of the costs will be incurred during the third quarter of the year, with just a few costs incurred in the fourth quarter. Our intention, I think, we said we expect about $11.4 million of costs to shut down these facilities. We hope to mitigate some of those costs by transferring some students to other institutions as well as subleasing some of our properties to the extent that that's possible. But for now, we are projecting approximately $11.4 million of costs, most of which will be incurred in the third quarter.

Okay. And just one last question, you're now breaking out the enrollment for your new shorter duration programs, the cash programs. Can you give us a sense of just the revenue impact of these programs, I mean, is there any impact at all there?

Yes, I mean, for the year, we believe SMTI will produce about $2.5 million of revenue and so yes, there is revenue impact in those programs. Obviously, the reason we break them out is that while our average revenue per student is in the $20,000 range, average revenue per student for these short programs are a lot smaller than that, and so we did not want to mix that into the equation and that's why we've shown separately, so you can provide your own analysis.

The next question is from the line of Jeff Silber from BMO Capital Markets.

Just wanted to focus again a little bit on these campus closings. You mentioned that capacity utilization was down about 36%. Is it safe to assume that the 7 campuses you're closing have a lower utilization or would it be higher or about the same?

It's safer to say that they would have a lower utilization.

Okay. And have you released the names of the campuses that you're closing yet?

No, Jeff, we have not. Obviously, we are in the process of notifying the campuses as well as the accrediting bodies. So until we have all that done and make sure that there's no -- waiting for their approvals, we will not release the name of the campuses to the public.

I understand. It's a very sensitive issue, I do understand that. And just a little bit more color on the guidance side, just trying to model out the different expense line items. If you can give us some color on that, that will be great.

Well, obviously, most of the shutdown expenses are going to come through SG&A.

And then, I guess, forgetting the shutdown just in terms of just the go forward, the continuing operations, what should we expect on the expense line items?

We would expect that those line items will remain relatively stable to second quarter x charges.

Okay. And also just in terms of the tax rate and share count we should be using for the rest of the year?

We're projecting tax rate for the rest of the year to be about 35% and the share count should be somewhere around 22.2 million to 22.3 million.

The next question is from the line of Jeff Meuler from Baird.

Just wanted to start with a follow-up on Zach's question. So what are you assuming in terms of your Q3 EPS guidance in terms of the closure costs? I know you said the majority, but is it like $9 million in Q3? Is it like $7 million in Q3?

No, we are assuming -- again, these cost can change from one period to the other. Our estimates are that we'll have about $10 million to $10.5 million of those costs incurred in Q3. Again, these costs can change. I mean, that's what we predict the timing to be. If it gets pushed out into the fourth quarter, then obviously, there could be a change in what period the costs are recorded in.

Understood. That's why I want to know what was factored into the guidance. And then on the -- just trying to get between what you're calling out as the EPS impact versus looking at the pretax impact, so it looks like it implies something like a 15% tax rate on the impairment charges and the closures. How should we think about that?

Obviously, the EPS impacts include not only the impairment of long-lived asset charges as well as the shutdown costs, as well as the decreased revenue that's going to be coming from these campuses, and I believe we utilized about a 32% tax rate.

Okay. So you're assuming the decreased revenue on that figure as well. How -- I know that you said that you expected $14.5 million of revenue for the year. How much revenue did you have in the first half and then what's the timing of the closures, what are you assuming for revenue in the second half...

We are not prepared to disclose that information. We -- obviously, the campuses, we're not meeting their stated objectives. That is one of the reasons that we decided to shut them down in addition to the regulatory changes and the inability to enroll ATB students. We believe in our opinion that these campuses are no longer viable and therefore, we decided to shut them down. But these campuses, as we said, were projected to produce about $14.5 million of revenue and they were producing at less than that.

Okay. And then with the closure, should we kind of view this as one fell swoop, where anything that was kind of close you're deciding to close all at the same time? Or is there another group that you're kind of monitoring and could potentially be closing in the next 12 to 18 months?

Well, I mean, I would say that we're continuing to review our reporting units. There are other reporting units that have operating losses, but we think that those are easily turned around and that we have new programs going into those schools and they're not in the same category as the one that we're shutting down. So for now, these are the ones that we feel we don't have a way forward with. But again, we continuously monitor our reporting units and their performance and what we believe their eventual outcome will be, and so I can't tell you for sure that there will not be more forthcoming. But as of now, we're comfortable with the 7 that we chose.

Okay. And this maybe too soon to answer this, but thus far, how is the receptivity among prospective students been for the GED program?

Well, this is Shaun. I'll just say that today, the GED program has a longer span to it than our prior ATB testing and so today, we're sitting at about 150 students in the GED queue compared to last year, we had maybe 380 or so ATB students and so you can see it's probably half the volume. Now there are a number students that went in and went out of that GED queue. These are the ones that are still in and we feel will be successful. We think that, that number will continue to grow and that there's potential upside in the fourth quarter just because of the length of time the students will be in that program and when they finish.

The next question is from the line of David Chu from Bank of America Merrill Lynch.

So of the 500 new starts expected in the second half of the year to these campuses, can you break that out between 3 and 4Q?

Yes, I think it was roughly 320 to 350 in the third quarter and the rest in the fourth quarter.

Okay. And so just if you can repeat what you're saying about like the ATB population in the second half of last year, so are you saying that there were 380 ATB students, I guess, in total in the second half?

Starts, David, yes, 380 ATB starts in the third quarter last year.

380 in the third, how about in the fourth?

I don't have that number, but I can give it to you at some other point.

Okay, no problem. And let's see, just -- I think, Cesar, I talked to you offline last -- post the call last quarter that this impact of larger graduating classes on persistence should end soon. Is that the correct way to think about it just because we model to include graduations?

Correct. So, I mean, and obviously, I think what you're seeing as part of the decline in average population is that we have more students coming out of the system, which is a good thing because they're actually succeeding. And so we probably will lap that, I would say, probably within the next quarter or 2.

Okay. Now that's helpful. And just -- sorry, just give me 1 second. In terms of, I guess, campus closures and capacity utilization, I mean, should we expect that to kind of ramp somewhat significantly going forward, I mean, due to the campus closures?

We -- to be quite honest, I have not worked out what the new capacity utilization would be with the campus closure. But on a same school basis, we expect that to -- I mean, we're predicting flat starts for the year. So I would not necessarily expect that utilization would ramp up significantly until next year.

The next question is from the line of Scott Schneeberger from Oppenheimer.

How should we expect to see the ATB students wind down through the coming quarters? What was the percentage of overall at June 30 and then what do you anticipate that percent being over the next 2 quarters and when will it be at 0?

At June 30, they were 8% of the population and that number is going to ramp down. I mean, the majority of our students are in average, 12 months programs. With nobody starting in July, that number will ramp down, we feel, pretty significantly over the next 3 quarters.

So Shaun, it's fair to say that by maybe end of first quarter next year, we -- in the second quarter of next year, it would be down to 0?

Exactly.

Okay. Then a lot of talk about campus closures. Could you speak to some of the more recent opened campuses and or built-out campuses and anything interesting you're seeing at those?

Yes, I'll just -- let me focus on the Denver campuses for a second. We essentially added programs to that school. We built out an additional 100,000 or so square feet and it has proven to be a successful addition for us. There are a number of incremental starts to those new programs in addition to increases in their high school enrollment. And so that school is performing according to plan over the last year especially and we expect it to do good things moving forward. I would say that our Cleveland expansion is also performing well and according to plan. There are a couple of other of the expansion schools that are not and so we're working with them accordingly. But at this point in time, I would say that we have incremental starts in Q2 and Q3 from the growth actions that you described.

And so could you address the pricing revenue per student, use of scholarship, just to ask that broadly and let you take it from there?

Certainly. So obviously, I think you saw this morning that revenue per student actually increased during the quarter. It was about $5,417 as compared to $5,189 in the prior-year quarter. So basically, that includes the 3% pricing as well as don't forget that we told you that last year, we've accelerated some programs to limit the amount of financial aid available to students, so that also contributes to that 4.4%.

And any considerations on scholarships? Is that something that's being discussed?

Yes, we've continuously given scholarships out. I mean, we don't make a big mention of it, but our students are -- we give scholarships anywhere, depending on their need, up to $3,000, plus there's other scholarships that we give. That could be a full scholarship, a half scholarship. So that's something that we continuously do. We increased it at the beginning of the year to try to bridge the affordability gap that some of our students have, especially since we have a lot of destination students, whose parents are being denied plus loans and that gap becomes pretty big when they have to pay for not only housing, but a meal plan. So we are offering more scholarships to those students to help them bridge the affordability gap.

Two more if I can sneak them in. They're separate, but I'll ask them both upfront. Could you compare and contrast what you're seeing with high school entering students as opposed to adult entering students. And then just Cesar's thoughts on dividend going forward?

All right, Scott. Let me just handle high school very quickly. For the high school students who have already started and those expected to start within the third quarter, we see flat performance against last year.

Yes, as far as the dividend is concerned, our continuation is to -- our expectation is to be a dividend-paying company and as long as our cash flow and our performance supports that, we expect to continue to be. Obviously, the Board of Directors will have the ultimate say, but our expectation will be to continue to pay dividends.

And the next question will be from the line of Trace Urdan from Wells Fargo.

Shaun, I wondered if you could you talk about the difference in the consideration process between teach-out versus closure versus sale and how you made the decision you made?

Well, Trace, I think as you've seen and most have seen as a reality of this sector, I mean, sale is a difficult prospect at this point in time for a myriad of reasons. One of the things that we wanted to do, I mean, if you look at the schools that we are closing, they all sit in territories where we have additional campuses. We're closing schools in Connecticut, Florida and Ohio where we have groups of schools, large groups of schools. And so these schools, when taken out, we remain a presence in the state and we have students which will have the opportunity to attend other Lincoln schools in most cases. So that was a large factor in our decision-making process.

Okay. That's exactly what I was looking to understand. And then I wonder if you could talk about -- a little bit about the -- how disruptive the turning on and off ATB is and if, for some reason, congress were to change its mind and reinstitute ATB, how would you respond to that? Obviously, you're not going to open up those campuses that you're closing, but what -- are there costs associated with turning ATB on and off from your perspective? And is it worth the trouble if it comes back and how do you think about that?

I would say that the way we look at ATB, I mean, you're always going to have those students inquiring as to attendance in those programs. So we still have ATB students contacting us today. Instead of enrolling them through the ATB process, we talk to them about the GED program and those who are interested in going that route, we will enroll in the GED program and then they can enroll in the school once successfully completed. Our advertising will have tags on it at times that used to say, "If you didn't have a high school diploma, we might be able to help you." In many cases, those ads have been changed. Those tags have come off, yet we still have those students inquiring. I would say that, as you know, I mean, about a year ago, we made the conscious decision to reduce the number of ATB students in our schools and so our ATB percentage dropped dramatically. If ATB was to come back as an option for students without a high school diploma, I think we'd have to look at it in a very select way and we might only open it up in schools that were successful with those students in terms of outcomes in the past. Any school that struggled with those types of students in terms of outcomes, we might not open it up in those cases. But one other point, remember, when we kept ATB students on board, we also added our early orientation and our early student engagement program to help with those types of high-risk students. So although we wouldn't open it up dramatically again, we are much better prepared to deal with those types of students and we're seeing great success from a lot of those efforts as we talked about earlier in our Lincoln Edge program. So it's a long way of saying that we will probably not go back fully that direction, but in schools that have succeeded in the past, we would open it up to them.

Okay, fair enough and then just a quick question for Cesar. The effect of the accelerated programs on the revenue per student, when would you -- when should we expect that to normalize and would you expect to see then a decline in the rate of growth in that metric?

Yes, I mean, obviously, that probably accounted for about 1% or so. It was only certain programs at select schools and I would expect we open -- we did that in starting in June of 2011 through December of 2011. So I would expect that by the second quarter of 2012, most of that will be gone.

Okay. So basically into 2013? And then, I'm sorry, in the Q3 numbers, that aspect will be gone?

Correct.

[Operator Instructions] There are no further questions.

Okay. With that said, let me just give you some quick closing comments. As you can see, we're focused and have been very busy executing on initiatives, which really continue to better position us in a time of uncertainty. We're very confident in the steps we've taken. And I think it's evident, as you can see, the stability that we've gained as a company in our performance metrics. We're managing our 90/10 and cohort default risk factors. We've sharpened the strategies that really will allow us to compete in the unique segment of education and training and we have a long-term strategy to position Lincoln as a market leader. We believe strongly in vocational training and in the viability of the skill trades careers and we feel that our Careers that Build America campaign will drive our company strategy for the long term. Thank you to all for joining us and we look forward to updating you on our third quarter results in October. Thanks, everybody.

Thank you for your participation, ladies and gentlemen. This concludes the presentation. You may now disconnect. Have a good day.