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Lincoln Educational Services Corporation (NASDAQ:LINC)

Q1 2009 Earnings Call

May 6, 2009 10:00 am ET

Executives

David F. Carney – Executive Chairman

Shaun E. McAlmont – President and Chief Executive Officer

Cesar Ribeiro – Senior Vice President and Chief Financial Officer

Analysts

Kelly Flynn - Credit Suisse

Gary Bisbee - Barclays Capital

Jeffrey Silber - BMO Capital Markets

Kevin Doherty - Banc of America-Merrill Lynch

[Amy Younker] – Robert W. Baird

Trace Urdan - Signal Hill Group, LLC

Operator

Good morning, ladies and gentlemen, and welcome to the first quarter 2009 Lincoln Educational Services earnings conference call. (Operator Instructions) This conference call is being webcast and an audio version of the call will be available on the company’s website for 90 days. As a reminder, this conference is being recorded for replay purposes.

Before we begin today’s call, the company would like to remind everyone that this conference call may contain certain forward-looking statements relating to future events, future financial performance, strategies, expectations, competitive environment, regulations and availability of resources. Such forward-looking statements are based upon current expectations that involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statements based on a number of factors and other risks which are more specifically identified in Lincoln’s filings with the SEC.

And now I would like to turn the call over to Mr. David Carney, Executive Chairman of Lincoln Educational Services. Please go ahead David.

David F. Carney

Thank you. Good morning everyone and welcome to our first quarter earnings conference call. Joining me today is Shaun McAlmont our President and Chief Executive Officer, as well as Cesar Ribeiro our Senior Vice President and Chief Financial Officer. Following my remarks Shaun will provide an update on our operations including our 2009 priorities, and Cesar will provide an overview of our first quarter results. We’ll then open the call for the question-and-answer session.

Now turning to our results from continuing operations. During the first quarter our revenues, net income and operating margin all grew meaningfully as we once again generated strong new student starts and enrollment growth while demonstrating the benefits of the operating leverage in our business model. Revenue from continuing operations rose 41.1% to $118.6 million in the first quarter and on a same school basis revenue increased by 27.3% to $107 million. Net income from operations was $5.8 million and diluted earnings per share was $0.22 versus $0.02 in the first quarter of last year.

Now let me turn to our starts and enrollment metrics. We generated new student start growth for the tenth consecutive quarter and experienced growth across all five of our verticals. New student start growth was 42.4% for the quarter and 35.1% on a same school basis, which illustrates the success we have had in strengthening our operations and expanding [audio impairment]. Student enrollments on a same school basis at March 31, 2009 were 23,144, an increase of 24.4% while average enrollment for the quarter was 22,597, up from 18,459 for the same quarter a year ago.

The year-over-year increase in end of quarter enrollment and average enrollment occurred across all five verticals. The average enrollment of 22,597 as of March 31, 2009 is divided between Health Sciences 36%, Automotive 31%, Skilled Trades 14%, our Business and IT tempered Hospitality Services 9%. We’re very pleased with our operating and financial results which were driven by the hard work and dedication of our employees across our schools as well as our ability to provide our students with high quality education programs aimed at preparing them to secure careers in high demand career fields, a formidable value proposition in today’s market.

We believe the successful execution of our strategic plan has resulted in a significant improvement in both the operating and financial fundamentals of our business, as well as our long term growth profile. We have continuously diversified our program mix and expanded the breadth of our offerings in verticals which possess attractive employment prospects. We have also worked to expand the depth of our degree offerings through internal program development as well as strategic acquisitions. Together these efforts have allowed us to grow our addressable market considerably while also extending the student lifecycle.

At the same time, we have significantly improved efficiencies across our operations, fostering an environment characterized by enhanced productivity and accountability. During the past three years we have strengthened virtually every aspect of our organization with an eye on making our programs more valuable to prospective students while also improving our ability to generate returns from our business. We believe these efforts have put us in a position to maximize the current macro environment which is driving more students to seek quality education and training to better compete in today’s more competitive job market.

Our mission going forward which Shaun will discuss in detail is centered on continuing to execute against our strategic plan, principally strengthening and rolling out high value program offerings with an emphasis on increasing our degree options and regionally accredited online offerings, replicating fast growing programs such as LPN, Licensed Practical Nursing, across our campus footprint and further branding our schools under the Lincoln umbrella. At the same time we will further strengthen our career development and placement resources given the highly competitive job market and we will continue to operate with intense focus on regulatory compliance, an area where we have an outstanding track record.

As we grow our business and maintain the focus on operating efficiently, we remain well positioned to grow our margins over time. We also believe our efforts to expand our addressable market and extend the student lifecycle, principally through degree programs, will support our growth profile as the economy begins to recover and the overall volume of students entering training moderates.

In summary, our objective is to provide our students an attractive value proposition and the opportunity to go from diploma to degree while remaining in the Lincoln schools and colleges.

Now I would like to take a moment and update you on the new student, on the student lending environment and the effect on Lincoln. First the credit crunch that has impacted the credit markets continues to have little impact on our ability to enroll and finance our students. The legislation passed last year has helped to greatly reduce the gap between tuition and the amount the students receive from financial aid. Therefore the students are benefiting in their ability to finance their education and the amount remaining or the gap has been reduced to a very manageable level.

Also President Obama and the new administration have already demonstrated their commitment to education and the benefits it’ll provide our students and the industry as a whole. The President’s stimulus package has provided an additional $500 in Pell which will further assist our students in financing their education as well as reduce the level of need for the internal funding. As many of you know, provisions exist in the President’s budget aimed at terminating the FFEL Program effective July 1, 2010. We currently have a direct loan program in place at all of our campuses and we will keep a close eye on the situation as it develops and will be fully prepared to seamlessly transition to our direct loan program at the appropriate time.

With that said, our students are not having difficulty securing loans from FFELPs lenders at this time. FFELP loans continue to be an accessible source of financing for our students and we expect that that will continue moving forward. And Cesar will comment further on our internal financing programs in his prepared remarks.

Now let me turn to our second quarter and 2009 financial outlook and guidance. The outlook for the second quarter and full year is very promising fueled by the strong carry in population on April 1, the benefit of strong high growth programs across all of our verticals, the current macro environment and improved execution resulting from our operational initiatives that we have been working on for the past three years. Accordingly we are updating our full year and second quarter guidance. For the full year we now expect annual revenue of $505 to $515 million, representing an increase of approximately 34 to 37% over 2008 with student starts increasing 15 to 17% over 2008. We expect diluted earnings per share of $1.25 to $1.30 or an increase of approximately 60 to 67%.

For the second quarter of 2009 we expect starts to increase 19 to 22% over the second quarter of 2008 and we expect revenue of $120 to $122 million and diluted earnings per share of $0.18 to $0.20. With that said we are encouraged by our starts in April and enrollment trends for the balance of the quarter. Based on these trends we expect to end the second quarter on a same school basis approximately 4,500 students ahead of prior year.

And with that said, let me turn the call over to Shaun who will summarize our results for the quarter and discuss our strategic focus for the remainder of the year. Shaun?

Shaun E. McAlmont

Thanks, Dave, and good morning everyone. Our first quarter results demonstrate our ability to execute our 2009 operational plan and build on the momentum we experienced in 2008. We beat our own expectations in the second half of the quarter as our Automotive programs rebounded to show impressive growth. We continue to see the benefits of our expanded focus between vocational and career related associate degree programs, and our more diversified program mix has helped increase our average student population by 22% on a same school basis. We’ve brought on expertise in key areas and we’re realizing our potential in all functional areas of the business.

Taking a closer look at our first quarter 2009 operational performance, new student starts increased dramatically on a same school basis for the period, which we believe illustrates our improved ability to meet the demand driven by the economy. Furthermore we’ve built an operational platform that will provide sustained growth opportunities based on improved operations and diversification into high demand program areas.

In addition, over the past several years we’ve worked diligently to improve the hiring and training in our admissions area. We’ve increased admissions exposure to technology, educated them in presenting diploma and degree options and most importantly we’ve dramatically reduced the company wide turnover rate of these representatives. During the first quarter we saw our lowest turnover in years and addressed our market with a more experienced and tenured admissions representative force that achieved improved new student starts for the tenth consecutive quarter.

Our high school recruitment and admissions efforts during the quarter focused on maximizing our recruitment visits around the country and recruiting and continuing to build relationships with key high school personnel. We’re tracking ahead of our prior year progress in high school enrollments and we expect these new student starts to improve between 5 to 7% for the year. High school recruitment remains a significant portion of our annual enrollment picture as well as a long term organic opportunity for all of our campuses.

New student starts in this category are less volatile than media and are dependent on recruitment efforts of each high school representative, and amount to approximately 20% of the starts for the full year and 40% of the starts for the third quarter. Our future high school growth will be positively impacted by the addition of approximately 40 Baran high school admissions representatives working in ten states and we’ll integrate these representatives into our national recruitment framework over the next year.

Moving to our marketing efforts, during the first quarter we produced total new student inquiry growth of 36% compared to the first quarter last year. One major initiative contributing to this increase was the performance of our main website which had 45% more visitors to the [audio impairment] than the same period last year, 58% more inquiries and great responses where we implemented enhancements for optimizing search results. As the website outperforms other lead sources it also continues to produce overall cost efficiencies as our advertising costs per new student decreased by 37% for the same period year-over-year.

Additional first quarter progress related to our marketing activities include the advancement of our national brand strategy through co-branding and specifically moving all remaining non-Lincoln brands under the Lincoln group of schools umbrella. Also the continued addition of Automotive Service Industry statistics marketing efforts which has offset negative OEM coverage and is having a positive effect as we’ve seen an uptick in Automotive interest.

And lastly the launch of our purely online website in March which has begun attracting students outside of our current demographic while also providing unique online user experience. The design was pursued with the mindset of distancing it from our more hands on vocational website. We remain on track to complete all phases of the new site in late 2009, in concert with our regionally accredited online program launch in early 2010. Overall, we’re very pleased with our marketing initiatives which are positioning Lincoln [audio impairment] of vocational and career degree educational options for students around the country.

In regards to our educational efforts, we’re committed to fostering strong academic performance among our students, providing them learning resources and other student resources and continually striving to maintain strong student retention rates. In late 2008, 94% of our students responded to our most recent institutional survey as satisfied with almost 70% showing very high satisfaction which reflects the success of our dedicated service improvements.

Our move to new programs and increased degrees has given us the opportunity to add impressive and highly qualified faculty and educational staff across our system who have added value to instruction, curriculum review and program development. In addition, our overall institutional student interrupt rate continues to [audio impairment], indicating continued progress in this important student services metric. Overall we are very pleased with our ability to educate our students, provide career skills and also prepare them for the workforce.

As students graduate we continue to provide job placement assistance, and as you can imagine we’ve dedicated increased attention to these services for our graduates, alumni and also in school students, during this current economic environment especially. Our 85 local career services professionals are aggressively working to ready students for their job search and also developing new job opportunities in our local markets.

As we discussed on our last conference call we’re seeing some timelines lengthen for students trying to find jobs given the prolonged economic downturn. However, our two largest verticals, Automotive and Health Sciences are still tracking close to prior year. The healthcare worker shortage in this country has continued to result in strong employment opportunities for our allied health graduates. And on the auto side we continue to see increased service opportunities which are helping to offset the impact of dealership closings.

With the current pressure on the job market we expect our placement rate to decrease from our 83% in 2007 to the mid-70% range for 2008. We’ll report the full year average in July.

Looking ahead, our plan for the remainder of 2009 consists of driving additional incremental improvements in all operational areas and also focusing on the smooth integration of our two recent acquisitions. As you know, strategic acquisitions have served as a growth driver over the past several years for our company. We’ve used such acquisitions to strengthen current programs, add new program verticals, expand into new geographies and add degree options and also higher accreditation. With each acquisition we demonstrated the ability to smoothly integrate the acquired schools and their programs under the Lincoln system. We believe the integration of Baran and Briarwood will be no different and we’re already aggressively moving forward with our efforts to leverage our corporate team and our systems across all functional areas to insure that we integrate for long term efficiency.

Looking further out, our strategy involves focusing on developing and rationalizing our programs to further strengthen and diversify our verticals, expanding the depth and validity of our degreed offerings, and further building our online platform and shift toward regionally accredited programs. We believe this long term strategy will position Lincoln for sustained growth and profitability as we strengthen the value proposition we offer to our students and further increase our addressable market across our verticals and across higher degree levels.

For years our strength has been focused in vocational career training. We will continue to build on this foundational strength and we also intend to build degrees that are natural extensions of this vocational base. Strengthening and diversifying our product offerings will also through internal development and replication will allow us to continue offering high demand programs that best meet our current student demand in each of our markets. By continuing to build a stronger foundation in each of our verticals, we will also be a better positioned company to withstand a potential downturn in any one of those specific product areas.

A key area of attention for us is our LPN program as Dave mentioned, which continues to exhibit strong growth in its current market. Looking ahead we anticipate receiving approval for and launching LPN programs in Ohio and Pennsylvania in 2009 and in four additional states in 2010. Overall we believe in continually optimizing our entire program portfolio to insure we’re in a strong position to continue generating healthy results when the macroeconomic environment improves.

Our plans for increasing the degree options we offer are moving forward, along with the additional goal of further building our online platform. As of March 31, 2009 our degree mix included 21% of our students enrolled in Associate degrees, while approximately 1% were enrolled in Bachelors programs. This 21% represents 5,300 students compared to the prior year number of 3,900 degree seeking students. We anticipate this percentage of our population to increase at a reasonable rate for 2009 and 2010 and to accelerate with the addition of regionally accredited Associate and Bachelors programs thereafter. The acquisitions of Briarwood and Baran will greatly accelerate our efforts over the next three years.

Baran and Briarwood also offer Associate degree programs across four of our verticals and our recent closing on the acquisition of Clemens College, the final piece of the Baran group, marks our second regionally accredited institution and will provide us with a platform to launch higher end hospitality programs.

Our long term online plans include accelerating the growth of our online platform via Briarwood’s regional accreditation status. We anticipate that fully online regionally accredited programs will be delivered from this school in a 12 to 15 month timeframe.

Overall, increasing our degree options will serve to expand our potential pool of students as well as extend our average student lifecycle. It provides us with several growth avenues including multiple degree entry points, migration opportunities from diploma to degree for our students, degree completer options and also credit transfer opportunities for prospective students. So as Dave mentioned in his opening remarks we are intensely focused on executing our plan and continuing to improve our long term growth profile so that we can deliver the highest quality programs and generate successful outcomes to our students while insuring that we have the right platform in place to grow our top line, provide a quality education for our students, and improve our margins over time.

Given our progress to date and looking at our company’s rallying around our mission and vision and the very clear strategic roadmap that we have in place, I remain very optimistic about our outlook.

Now I would like to turn the call over to Cesar for the financial review.

Cesar Ribeiro

Thank you Shaun. Good morning everyone. As we disclosed in our press release earlier this morning and as Dave stated in his prepared remarks we are very pleased with our first quarter results. Some key highlights of the first quarter include revenues increased 41.1% to $118.6 million for the first quarter of 2009. The increase in revenues were driven by an increase in average population of 33.7% with an increase of average revenue per student of 5.5%.

Our operating margin improved 750 basis points to 9% for the three months ended March 31, 2009 from 1.5% in the first quarter of 2008. We benefited from the increased capacity utilization and the leverage inherent in our business model. Educational services facilities decreased to 40.7% of revenue for the first quarter of 2009 from 43.4% for the first quarter of 2008, and selling, general and administrative expenses decreased to 50.3% for the first quarter of 2009 from 54.9% for the first quarter of 2008.

Cost per student start decreased 16.9% for the first quarter of 2009 to $2,609 from $3,135 in the first quarter of 2008 as we benefited from reduced turnover in our sales force which produced improved conversion rates and efficiencies in our marketing spend. Capacity utilization was essentially flat with capacity utilization during the fourth quarter of 2008. Bad debt for the quarter was 6.1% of revenue as compared to 4.8% for the first quarter of 2008 and 5.4% for the fourth quarter of 2008.

Earnings per diluted share grew to $0.22 for the three months ended March 31, 2009 from $0.02 per share for the first quarter of 2008. We generated [audio impairment] from operations of $2.3 million compared to $7.5 million from the first quarter of 2008. The decrease in cash flows from operations during the period were due to timing and receipt of federal funds in 2009 as compared to 2008.

We finished the year with $15.2 million in cash and cash equivalents, $10 million in borrowings outstanding under our credit agreement. Net accounts receivable at March 31, 2009 were $28.6 million as compared to $26.2 million at December 31, 2008. Net property and equipment grew to $142.1 million on March 31, 2009, as compared to $108.6 million at December 31, 2008.

Now turning to our loan program as of March 31, 2009 we had granted loan commitments to our students net of interest that would be due on the loan’s maturity of $16.2 million down from $17 million at December 30, 2008. As of March 31, 2009 we had capital lease obligations of $27.4 million which were assumed in connection with our acquisition of the Baran group of schools.

In conclusion, the company is in a very solid position. We finished the first quarter with $15.2 million of cash on hand and minimal debt even after paying down approximately $25 million in connection with our acquisition of the Baran schools during the period. As we look out in 2009 we expect that our financial position will only get stronger as we continue to benefit from improved margins and cash flow generated from operations.

With that I’d like to turn the call back to the Operator to begin the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Kelly Flynn - Credit Suisse.

Kelly Flynn - Credit Suisse

A question for Cesar. Just can you drill down a little bit more into the operating cash flow and also the free cash flow? I know you said the operating cash flow was down year-over-year due to the timing of federal receipts but what did the, your internal lending program do to weigh on cash flow? And then the CapEx, I know you touched on it. Can you just revisit sort of why the investing activity was such a drain and then finish up with where do you think your operating and free cash flow will fall for the year? Thanks.

Cesar Ribeiro

Certainly. Well obviously the timing is, if you remember back in December ’07 we had about $6 million that was due from the federal government. That cash was received in January of 2008 so impacted the 2008 cash flows. That was not there in 2007. That accounted for most of the impact on the decrease in cash flow from operations. As far as our lending activity it really had nothing, no impact at all on our cash flows. If anything our commitments, our net commitments were down from December and that really had absolutely no impact. Capital expenditures during the period were roughly $2.5 million. I think we previously guided for the year that they would be $2.5 to, I’m sorry 5 to 6% of revenue. And the net cash used in investment activities included $25 million of cash that went out the door in connection with the Baran acquisition.

As far as cash flow for the year, we do not provide guidance on cash flow generated from operations but I would expect it to significantly exceed 2008 cash flows.

Kelly Flynn - Credit Suisse

And then just a follow up on the operating cash flows. What was the deferred revenue change and the impact that had on cash flow? Was that a drag on cash flow or a benefit?

Cesar Ribeiro

No. The deferred revenue went from $38 million, $38.8 million at 12/31/08 to $43.3 million.

Operator

Your next question comes from Gary Bisbee - Barclays Capital.

Gary Bisbee - Barclays Capital

I guess just if I could ask sort of a bigger picture strategic question, you’ve done a couple of acquisitions, over the last two years you’ve gone through re-branding a lot of the schools under the Lincoln name. Are you going to do that with all of the acquisitions and have you given some thought to, I don’t know, maintaining Briarwood or having a different name for your what will eventually be your regionally accredited online school? Or are you comfortable branding it all as Lincoln?

David F. Carney

Gary, pretty much branding all of it as Lincoln over time. Some of it, you know, we have to phase some of it in but the ultimate goal for the regionally accredited would be the Lincoln College of Arts and Sciences.

Gary Bisbee - Barclays Capital

The SG&A dropped quite a bit giving huge leverage there. Can you give us any sense as to how much of that would actually be, you know, like lower television spot rates versus what you’d said is, you know, a big benefit from rising tenure of your reps? And is there anything on the G&A side there that’s also moving the needle quite a bit?

Shaun E. McAlmont

I’ll take the first part, Gary. On the marketing side we have seen great leverage in our marketing dollar. We’ve moved 81% of our advertising under what would be considered web resources, which has dramatically impacted our costs per metrics. We’ll continue to see that kind of leverage moving forward for the year. TV spot costs have gone down. However, I’ll say that most of the leverage has come from the actual shift to web sources. The TV spot costs going down has given us an actual opportunity to brand a little more than we have in the past and so not much leverage I think has come from TV in that regard. But we feel great about where we sit today and also looking forward for the remainder of the year on the marketing side.

I’ll turn it over to Cesar to talk about other leverage.

Cesar Ribeiro

Yes, Gary, a lot of the leverage that was obtained was in selling and marketing expenses. I think both the stability of the sales force produced leverage. They were able to produce more without increasing the sales force as well as marketing spend. So a great deal of that leverage has come from that line item. There was some leverage that came from administrative expenses. Obviously with increased revenues we do have fixed cost platform. But I would continue to expect to see leverage come from sales and marketing and that’s where that leverage came from during the quarter.

Gary Bisbee - Barclays Capital

It looks like as you predicted it would be the acquisitions were, you know, $1 million, $1.5 million dilutive to operating profit. How much of that is the amortization expense from these acquisitions? And can you give me a ballpark sense as to when that amortization runs off or how quickly it runs off? Thanks a lot.

Cesar Ribeiro

Certainly. Amortization was part of it but don’t forget we also assumed capital leases in connection with the acquisition of about $27.5 million. But the amortization during the quarter was roughly about $350,000 for the acquisition. The run off, most of it will run off in 12 months but it does go out to about 18 months.

Operator

Your next question comes from Jeffrey Silber - BMO Capital Markets.

Jeffrey Silber - BMO Capital Markets

If I’m looking at the guidance you had given initially for the first quarter I think was $0.05 to $0.07 in earnings and that was done in early March, and you had this gigantic upside surprise. I’m not complaining. But what was the real key drivers? You know, what happened over that last month that sort of changed compared to where your guidance had been?

Shaun E. McAlmont

Well, Jeff, I think one of the things that we’re very pleased with and I’d say over the last month but certainly over the quarter was the strength in Auto, the build up in Auto starts. If you recall last year it was more or less flat. In the first quarter of 2009 I will just say that we were in the double digit figure and in excess of 20% of our start growth in the first quarter. And that, you know, created a tremendous amount of market expansion and operating leverage that quite frankly we hadn’t, you know, fully anticipated in the guidance.

Jeffrey Silber - BMO Capital Markets

Also just comparing to some of your historical metrics, I know the business is typically back end loaded and with the guidance you’re giving we’re still seeing some of that back end loading, but compared to prior years you seem to be generating at least this year a lot more in earnings in the first half of the year. Has the business changed? Is it because of recent acquisitions? If you could just give us some color on that that would great.

David F. Carney

Well, I think what we’ve always said, Jeff, is that once we achieve a certain population everything else drives to the bottom line. In the past the business was very back ended because we didn’t achieve those scales and efficiencies until the third quarter start. As the population has grown I think we said it was going to be 4,500 a head, we’ve now achieved that leverage. So while the earnings will continue to be somewhat back ended, I think we’ve guided we have $0.22 for this quarter, we guide $0.18 to $0.20 from $1.25 to $1.30, I think you’ll see some of that seasonality starting to disappear as we attain higher populations.

Jeffrey Silber - BMO Capital Markets

Fourth quarter would still be the peak in earnings?

David F. Carney

That is correct.

Shaun E. McAlmont

That’s right.

Jeffrey Silber - BMO Capital Markets

What share count and tax rate are you assuming for both the second quarter and the full year?

Cesar Ribeiro

We’re assuming 40% for the full year as far as the tax, effective tax rate. And the share count is somewhere around 27 million, 27.250 on a fully diluted basis. I’m sorry, 27.5 million.

Jeffrey Silber - BMO Capital Markets

27.5 million for the year?

Cesar Ribeiro

That’s correct.

Jeffrey Silber - BMO Capital Markets

And for the second quarter?

Cesar Ribeiro

About 27 million.

Operator

Your next question comes from Kevin Doherty - Banc of America-Merrill Lynch.

Kevin Doherty - Banc of America-Merrill Lynch

I guess just given all the changes to the portfolio, how are you thinking about the longer term growth prospects? And maybe specifically too if you can just touch on the margin potential going forward.

Shaun E. McAlmont

Kevin, I think looking forward we’re, first of all poised extremely well today to maximize all of our performance metrics as you’re seeing in this quarter’s results. That clearly is a foundation for us as we move forward. We are looking at three very specific ways to drive the business forward and sustain our growth and one is as both Dave and I mentioned in our prepared remarks relates to expanding our programs. You should expect that we’ll stay within the verticals that we currently operate but we’ll de-rationalize our programs to make sure we’ve got the best lineup in each one of them.

Secondly, as far as our degree mix we will be adding Associate and Bachelors degrees. And I want to make sure that I mention that, you know, our first phase in that regard is to stay within our area of expertise. And so you’ll start seeing Associate and Bachelors degrees that link to our current vocational base and allow students to extend their training within their area of expertise, and also attracting students who are looking for higher level degrees in our five verticals. Past that we’ll look at some other areas.

And thirdly, online. You know we are poised today with our platform, a great faculty and staff and electronic services that are second to none. We are, we just launched our new online website that is particular to online. And then we are also looking at regional accreditation in the next 12 to 15 months to support the full online picture moving forward.

So we feel that with those three particular initiatives in addition to also looking at strategic acquisitions down the road we’ve really poised ourselves for some great long term growth potential.

Kevin Doherty - Banc of America-Merrill Lynch

And is there a particular target range you’re thinking about on the margin side as you do move into more online programs and you do move a little bit more upstream in terms of the degree offerings?

Shaun E. McAlmont

I would say just quickly no, not in the next two to three years. We really expect the online growth to accelerate after we start launching our regionally accredited programs and so for the foreseeable future we haven’t moved off of the guidance of the margin expansion range that we’ve given prior.

Kevin Doherty - Banc of America-Merrill Lynch

If I can just go back to some of the comments on Automotive. Maybe if you could just touch a little more about what drove that rebound, how sustainable you think it is? And then just where some of those grads are finding jobs primarily.

David F. Carney

Well, I’ll kick it off. Certainly the rebound if you will I think ties to a couple of things. One, which we’ve talked a little bit about but specifically the improved or I should say the stabilization of our admissions teams across the country, particularly in the Lincoln Tech group schools in this case, has made a big difference. You couple that with the improved messaging if you will over the last several months, and we saw some of this in the latter part of the fourth quarter and the benefit is accelerating in the first quarter. And I’d take that a step further and say that the trends for certainly for the second quarter in terms of adult starts is also looking very promising.

As far as where these students are going to school and just talking a little bit about placement for Auto Tech grads in particular, and I’ll let Shaun jump in as well, but overall we actually haven’t seen much of a decline versus last year. What we have seen is a switch or a change in where some of these grads are going to work and more independents versus the dealerships as they have downsized. Shaun, do you want to add anything to that?

Shaun E. McAlmont

I agree. I think that we feel very good about where Automotive is today. Our marketing efforts as I mentioned earlier we have changed our messaging a little bit in that we’ve added the Automotive Service statistics into a lot of our marketing efforts to really offset some of the negative news out of Detroit. And we feel that that’s been helpful. Dave mentioned our stabilized rep force and I would agree with that.

We feel good about Quarter 2 in Automotive, and Quarter 3 for Automotive is heavily based in high school starts. High school starts are not as [inaudible] as media and they’re very predictable if all things go well according to our leading indicators today they are. We expect probably 5 to 7% improvement over prior year in our high school numbers. And so we’re feeling good about where Automotive is today and for the year just based on those facts.

And just on the placement side, we met with the Greater New York Auto Dealers Association not long ago. They provided some of their statistics on dealerships across the country. Although dealerships have been closing to some degree those that are remaining open have extended their service areas and we’re finding that our graduates are still able to find service related jobs. In some cases we’ve got to reroute our efforts to go to independent shops where we were going to a particular dealership in the past, but that’s happening very aggressively on a local basis. And as Dave mentioned we feel very strong about the continued placement opportunities for Auto graduates.

Operator

Your next question comes from [Amy Younker] – Robert W. Baird.

[Amy Younker] – Robert W. Baird

Can you talk just a little bit about the guidance? I want to make sure, I guess, that I understand. You know following the 35% same school start growth you saw in the first quarter, guidance for 19 to 22% in the second quarter to kind of get to your full year same school start growth guidance of 15 to 17% we would have to see a meaningfully deceleration in growth. And I’m just trying to understand is that just conservatism on your part because you don’t have the visibility? Or are you actually starting to see evidence of the slowdown in those starts?

David F. Carney

Amy, I can see the math that you’ve done and I, let me just come back to number one we haven’t seen a deceleration in our outlook as relates to the adult students. What I guess I’d come back to is as we look at the third quarter and Shaun has touched on the fact that, you know, there’s a large high school component in that, and that sort of range, you know, the likelihood of that being significantly over the 5 to 7% that we’re talking about is extremely unlikely. So we’ve taken that into consideration.

Where we may be a little conservative and we hope we are is really on the adult start component that’ll flow through in the third quarter and if that continues at the rate we’ve enjoyed or we’re seeing in the first and now into the second quarters, maybe it’ll turn out that we’re being conservative. But on the high school side, you know, it’s roughly 40% of that number in the third quarter. So you take that into consideration and that leads you to the conclusion that, you know, the overall guidance for the year 15 to 17% is.

[Amy Younker] – Robert W. Baird

If I could just ask a clarification question, Cesar, you said that capacity utilization was flat in the quarter. I’m wondering how that could be given the exceptional enrollment trends that you’ve seen. You know, have you been adding capacity during this time period as well? And if you could also just touch on what your plans are maybe for the remainder of the year in terms of expansions that would be helpful.

David F. Carney

Well, Amy, and Cesar may want to comment on this as well but as far as the overall capacity it hasn’t changed a whole lot from fourth quarter to first quarter. We do, you know, of course continue to add capacity. The net effect is about the same. We will be adding in capacity. We already have in the case of, you know, opening the Toledo school in April which is not of course in the first quarter. And there’ll be some other, you know, minor expansions if you will during the balance of the year.

And as far as the capacity itself as it relates to non-Auto schools where we have the, you know, the Health Sciences programs those schools have been, the enrollments been building very nicely. What I will tell you is that at the moment we’re selectively, you know, we’re looking at some of those campuses. And where we have the opportunity for third shifts which are not built into our capacity calculations that we shared with you in the past, so and we can do that with a minimal investment because it’s just basically [resold] improvements and so on. And we’ve done that over time. So right now the capacity is close to where it was in the fourth quarter. It’s certainly going to increase, capacity utilization will increase throughout the balance of the year as we continue to grow our population.

Operator

Your next question comes from Trace Urdan - Signal Hill Group, LLC.

Trace Urdan - Signal Hill Group, LLC

I’m wondering, you guys had a pretty significant pop in Automotive. We saw something similar from UTI last night. I’m wondering whether you think that some of this may have to do with the stories we’re hearing about community colleges sort of reaching capacity and students being unable to get into classes. I mean, do you see any of that spillover just anecdotally or is this just about kind of a shift in sentiment overall and not really related to that issue?

David F. Carney

Trace, in the case of the Auto students although there are some community colleges across the country that have Automotive programs they generally have not, you know, they have not represented competition for us. So I don’t think that’s what we’re seeing. I think it’s more a case of, you know, certainly the change in the economy. You know, the unemployment. As you know in the past we’ve talked about competing with, you know, construction jobs and so on. They’re not there.

And, you know, these are still, you know, great careers for young people and I think through some of the improved messaging that we’ve talked about we’ve been able to get across to these folks that these are not, you know, we’re not training people to work on the assembly line at Detroit. And the fact that, you know, cars still have to be repaired, the average age of the vehicles. We’ve talked about all those things and it’s an attractive value proposition for the students. And the good news and I assume for our competitors at this point is there are still plentiful jobs and I think we’ve gotten our message across that overall we’re very pleased with where we came out in the first quarter and the trends again on the adult side going forward. Certainly with our visibility being as far as May and June at this point for the Auto Techs.

Trace Urdan - Signal Hill Group, LLC

Given that there’s this real surge in demand that you guys are seeing, what can you tell us about how you’re working internally to make sure that your standards in terms of accepting students that are really qualified and successful isn’t being pressured in any way?

Shaun E. McAlmont

I think that’s a good question. We’ve spent the last three years as Dave mentioned focused squarely on our admissions representatives’ tenure, quality, training, on boarding, you name it. We are, we’ve been known for a long time as a very regulatory compliant company and that doesn’t change when it comes to what happens on the front end of our process.

I’ll also tell you that we take it so seriously that we shop our own schools in a number of ways, but we also shop ourselves against competitors. We leave nothing for granted in that regard. And so there has been an increase in overall inquiry rate or lead flow and I’ll say that the number of representatives that we have, since we’ve retained them at a better rate, we haven’t had the typical seasonal drop off that required higher levels of rehire and training. And because of that I think our capacity to handle the additional lead flow has been good.

In the past, you know, a particular rep in a downturn for our rev number overall in the company could have been overwhelmed by the additional lead flow. Today, I think each representative has been at a reasonable capacity. The additional leads have upped that capacity per representative but it hasn’t stressed them. So I think we’re managing quite well. We have a full team of regionals and sales admissions managers at corporate that look at all of those components. And we also have a regulatory compliance team of regionals that also goes out and looks at all those metrics, sometimes file by file, in addition to the shopping process I mentioned earlier. So with all that I just said I hope you get the picture that we take it extremely seriously.

Operator

Your next question comes from Kelly Flynn - Credit Suisse.

Kelly Flynn - Credit Suisse

I have a couple of follow up questions. Like Amy I’m trying to make sense of your guidance. Given your revenue guidance I’m having a hard time getting to your earnings numbers, but I’m assuming some year-over-year margin declines in the second half. First of all, can you tell me what’s the interest expense that you’re assuming, you know, in each quarter from here? And maybe that’s the disconnect. And then just to take it further, where are the incremental expenses layering in and kind of what am I missing with respect to my comments? Or are you being conservative?

Cesar Ribeiro

I’m not sure exactly what your model is. I mean my model is showing that we are benefiting at the margin level versus prior year every single quarter. Maybe you’re missing the interest component of capital leases, on 27.5 of capital leases as well as the depreciation and amortization of intangibles associated with the acquisitions. But I think if you model out the year, I think you’ll see even including the fact that we have Baran which we said will be $0.10 to $0.12 by [audio impairment] we’re seeing better margins for the rest of the year.

Kelly Flynn - Credit Suisse

And can you explain what incremental D&A interest expense you’re starting to see second quarter and in the third as well, just to make sure we have it right?

Cesar Ribeiro

Well, I think interest expense is going to run $1 million plus a year just because of all the capital leases that are out there. And then I think D&A I stated before just on the Briarwood acquisitions on intangibles we should have about $2 million of additional depreciation and amortization of intangibles.

Kelly Flynn - Credit Suisse

The interest expense was $1 million in the first quarter, right?

Cesar Ribeiro

That’s correct.

Kelly Flynn - Credit Suisse

So you think it’ll be over $1 million per quarter or did you say annually?

Cesar Ribeiro

No, over $1 million per quarter. I mean the interest expense in the first quarter only had two of the Baran acquisitions, so.

Kelly Flynn - Credit Suisse

Can you give a little more detail? I mean, it seems like it would be significantly above $1 million per quarter. And where?

Cesar Ribeiro

No, but I’ll be happy to speak to you afterwards but we’re modeling roughly at just slightly over $1 million a quarter. Not much more than that.

Operator

At this time we have no further questions in the queue and I would like to turn the call back over to Mr. David Carney for any closing remarks. Sir?

David F. Carney

Thank you. Well thanks everyone for joining us today. We’re very pleased with our performance in the first quarter and we’re excited about the outlook for the balance of the year. And with that we’ll look forward to updating you on our progress on our next earnings call which will be in early August. Thanks very much and have a great day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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Source: Lincoln Educational Services Corporation Q1 2009 Earnings Call Transcript
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