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Lincoln Educational Services Corporation (NASDAQ:LINC)

Q4 2013 Results Earnings Conference Call

March 5, 2014 10:00 AM ET

Executives

Shaun McAlmont - CEO

Scott Shaw - President and COO

Cesar Ribeiro - CFO

Analysts

Jeff Silber - BMO

David Chu - BofA Merrill Lynch

Trace Urdan - Wells Fargo

Alex Paris - Barrington Research

Douglas Ruth - Lenox Financial Services

Operator

Good day, ladies and gentlemen. And welcome to the Fourth Quarter 2013 Lincoln Educational Services Earnings Conference Call. My name is Denise, and I'll be the operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Shaun McAlmont, Chief Executive Officer. Please proceed.

Shaun McAlmont

Thanks, Denise, and good morning, everyone. Joining me in the room today is Scott Shaw, our President and Chief Operating Officer; and 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, 2012 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 introductory comments, Scott will then provide an overview of our company’s operations and then Cesar will review our 2013 and also provide our financial outlook for 2014 and we'll then take your questions.

Let me start by saying, many Americans most vital industries have found themselves in recent years at an interesting and challenging crossroads. The dynamics of their workplaces are changing as new technology drives innovation forward in their field and leads to increased productivity, improved efficiency and enhanced quality of the final product, that product can be a tangible one like say for automobile or new heating or cooling or maybe a service like patient care, culinary or cosmetic treatments.

The challenge of course lies in identifying qualified candidates with the skills necessary to succeed in the technologically advanced environment no matter what the field. Lincoln's approach to career training began in 1946.

And as we've grown throughout the years, the scope of our programs expanded from the original HVAC program to not only include other skill trades but also automotive technology, health sciences, business, information technology and hospitality services.

With each new program we have launched, the first step after identifying the projected need and opportunities for graduates was then to connect with employers and highlight the benefits of hiring our graduates. This approach continues today, focused on a segment of training which remains viable long-term opportunity for our company.

Over the past few years, we’ve honed our approach and our programs to address this market. We’ve made significant improvements in our student success measures and our related outcomes. I also believe we found ways to operate in a very challenged external regulatory and economic environment.

Our goal is to continue to make incremental progress and student outcomes remain regulatory sound and to grow our institutions organically, while also seeking strategic opportunities for overall company growth. 2013 marked an important point in our company’s history as we completed a series of initiatives which repositioned the company following a long period of retrenchment.

Our three-year focus on student outcomes and regulatory compliance has yielded improved results in key metrics. Notably, student persistence and graduation rates have steadily improved, while our three-year Cohort Default Rates have improved and are also in compliance with federal regulations.

In addition, our 90/10 ratio was the lowest it’s been in years and we’ve closed campuses that were no longer viable, reduced our ATB population and taught out fully online degree programs to focus on our programmatic strengths, which is certificate training in skilled fields. Improvements to these areas were crucial given that many of our students are economically and academically challenged.

Effective performance in these regulatory areas enables us now to turn our full attention to growing our student population. We’ve reduced expenses in some areas and reallocated resources to once again drive new student start growth. Moreover we’ve launched a series of initiatives which should contribute to this growth throughout the year, including scholarships, technology, increasing the number of admissions and Financial Aid Representatives and so on.

In 2013, approximately 80% of our campuses were either profitable, or close to break even, while 20% did not come close to our profitability expectations. Thus our initiatives are focused clearly on increasing new student starts, rebuilding our population and improving our profitability throughout our organization.

As of December 31, 2013, we’ve completed the aforementioned retrenchment efforts, which included campus closures, OPEID mergers and the implementation of processes and systems to manage effectively in this new environment. We feel confident that we’ve positioned the company with a stronger foundation.

The company is now organized in seven OPEIDs or federal institutions which comprise 33 campuses. Each of these seven federal reporting units reflects strong regulatory compliance and student success. Moreover all seven have three-year Cohort Default Rates and 90/10 ratios which fall within the federal guidelines.

In 2014, we can look forward to continued advancement in the development and delivery of our educational programs especially those through cooperation with the employers who hire our graduates. We can also take pride in the innovations arising in our delivery methods.

This year Lincoln Technical Institute in Allentown, Pennsylvania will introduce our first adaptive learning curriculum, a program that evolves and changes for each individual student as he or she advances in certain areas whether they face challenges in others and ultimately they learn on a system uniquely tailored to their needs.

Allied Health students in Massachusetts are utilizing our fully functioning online platforms in a blended delivery system and now attends the physical campus only two or three days versus four or five in the past. In addition, students in Indianapolis and Grand Prairie will train on CNC manufacturing equipment specific to our sponsoring employer partners, Hurco Technologies and Haas Automation.

And in Mahwah, New Jersey, automotive technology students can now challenge themselves to be accepted into Chryslers highly competitive apprentice program. In addition, in order to put these opportunities in reach for more students than ever before, we probably increased the number of scholarships available to students.

We know that across the country there are large numbers of upcoming high school graduates, career changers and those who face economic difficulty in job markets that’s still recovering. Now in terms of our new student starts, which are a leading indicator of our future growth and profitability.

For the fourth quarter of 2013, new student starts from continuing operations declined 7.2%. To date, for the first quarter of 2014 and despite numerous weather-related impediments to our admissions, we’re slightly ahead of prior year starts between the January and February start months with 3% ahead of the same time last year.

We expect the month of March to hold steady in terms of enrollment doubles and star grades, given this confidence that we will see a 1% to 3% improvement in the student starts for the quarter over prior year. This will be our first quarter one increase and our best year-over-year quarter one performance since 2010.

Now, we will describe our growth initiatives in more detail. But let me just mentioned that, we’ve implemented a series of tactical initiatives, which are intended to mature over the year and contributed to start growth in different ways. The addition of admissions representatives related to enrollment volume, the addition of financial labor representatives affect the rate at which enrollments start school, automation allows for processing efficiency and compliance and our scholarships will help affordability.

I reported on our last earnings call that the third quarter of 2013, on 10 of our 33 campuses had quarter-over-quarter new start improvements. In the fourth quarter of 2013, there were 15 campuses that improved over prior year. And now looking ahead to the first quarter of 2014, we expect that 23 of our 33 campuses will be prior year numbers. This consisted progress and performance shows the positive results we have been working towards at bodes well for attaining our 2014 goals.

Before I turn the time over to Scott, I think it’s also important that I mention that we’ve been operating under a burdensome regulatory framework that at times contradicts itself. This reality forced us to put together a regulatory compliance program that has been at the forefront of our efforts while we also saw growth.

In our estimation, we found that we had to balance these objectives, and we’ve realized meaningful improvement across a number of key measures under these top circumstances. Our expectation for slight quarter one start growth comes with significant effort. We also feel that our trend is encouraging when compared to the broader sector performance.

Scott Shaw, our President and Chief Operating Officer has been focused on ensuring that our infrastructure is capable of fulfilling our mission, that we are tracking against our initiatives and our long-range goals keep us in line with continued strong student outcomes, regulatory compliance and growth and profitability across our operating units.

I will now turn the time over to Scott for more details of our operations. Scott?

Scott Shaw

Thank you, Shaun and good morning everyone. Let me start off reviewing our general business model and market approach, and then follow that with a review of what we accomplished in 2013. I'll then conclude by discussing our 2014 strategy. All of my comments will be focused on our continuing operations, and thus exclude the shutdown of our five campuses in Ohio and Kentucky as well as our online operations.

As Shaun mentioned in his remarks, we made great progress in 2013 in strengthening our company for the long-term. We entered 2013 with three clear strategic goals. First, solidify our regulatory outcomes. Second, continue to improve our student outcomes and third, return to growth and profitability. We clearly achieved the first two goals, but fell short on the third. However, as I will share with you later in my remarks, we feel very confident that we are on our way to achieving the third goal of returning to growth.

Our focus remains on creating the leading Middle Schools career training company in the country by concentrating on certificate and associated degree programs that delivered in a shorter time as possible. We are able to provide our students with a quick entry into the workforce and a good return on their educational investment. Furthermore, we select programs that lead to non-exportable jobs in order to maximize long-term demand for Lincoln and our graduates.

On top of this, we add our expertise in delivering hands-on education in facilities that are well-equipped to provide real on-the-job training. Delivering this type of education is definitely more expensive than offering non-technical programs. But we believe our experience and commitment to these offerings differentiate us from non-profit and for-profit competitors.

Furthermore, our education provides more than just entry-level job training. We strive to instill confidence, commitment and professionalism in all our students. As a result, many Lincoln graduates move up within their companies, or even go out on their own to start their own businesses. Our graduates range from the individual who draws blood at your local doctor to the owner of an Indy racing team, to the CEO of a $5 billion internationally publicly traded software company. Where students go with their Lincoln education is up to them.

We just know that we played an important role in jumpstarting their careers, or helping them acquire skills to follow their passion. As we continue to speak to employers and industry experts, we are reassured that the demand for what we offer is expected to increase. As our economy and society become more complex and technologically driven, the need for post-secondary education and training increases at all levels.

Furthermore, as more and more baby boomers reach retirement, the need for skilled workers increases. This worker deficit is exacerbated, especially in the middle skills area, by societies almost sole focused on promoting the need for 4-year degree in order to achieve success and fulfillment. Both of these circumstances create opportunities for Lincoln.

As for our 2013 results, we made excellent progress with continuing to improve our outcomes. With regard to student outcomes for the third year in a row, we increased both our retention rate and our placement rates. We view both of these metrics as critical measures of the quality of our education and of our students.

To strengthen graduation rate, we continue to expand and refine our Lincoln Edge program, which forms the foundation for how each campuses organized and operates. With Lincoln Edge, we provide students the support and encouragement throughout their time at Lincoln, starting from the day of enrollment to the time they accept the job offer.

In 2013, we rolled out our new Career Edge program, which is a blended learning professional development tool designed to help students enhance their professionalism and soft skills, which are attributes that employers increasingly tell us they seek in all new hires. We expect to achieve in greater improvement of our placement rates in 2014, as we benefit from a full year of this program.

Furthermore, our enhanced metric driven process of managing our career services professionals will continue to strengthen this important area. We know that the number one reason why students come to Lincoln is to obtain a job, which makes our placement rate, the ultimate measure of our success in delivering a strong return on each student’s investment.

We also achieved success with our government outcomes of 90-10 and 3-year Cohort Default Rates. Lincoln’s overall 90-10 rate was approximately 80%. With 7 OPE ID numbers, our lowest ratio was 67% and highest was 85%. Similarly, we recently received the draft of our 2011 3-year Cohort Default Rates and all of our remaining OPE ID numbers were below 30%, with the lowest rate being 17% and the highest 27%.

We continue to educate our students on the responsibilities to manage and repay their debt. We expect that these efforts, along with improving retention rates and greater focus on default rates, will result in lower rates going forward. While we strengthen our outcomes, we’re less successful on achieving growth in starts.

Overall, starts declined by 11.4% or 2,095 starts for the year. On the positive side, almost 75% of this decline occurred in the first half of 2013, with the decline in starts lessening in each quarter of the year, which bodes well for 2014. Our declining starts were surprising since our total enrollments for the year were greater than the prior year. Unfortunately, we experienced a decline in our start rate, which led to the decline in starts.

When I review our 2014 plan, I will discuss how we’re addressing this issue, since improving our start rate is one of the major initiatives in 2014.

We entered 2013 with 2,200 or 12.3% fewer students. Throughout the year, we continually removed cost in order to rightsize our business, everything from lowering headcount to renegotiating leases, to changing business practices, all with the goal of lowering our fixed cost. Unfortunately, our business has significant fixed cost, and since we never want to lessen the quality of our students’ experience, it’s difficult to cut cost dollar for dollar to offset declines in revenue.

Lincoln’s operations are diverse from a geographic perspective and from a program perspective. However, all of our campuses are organized, staffed and managed on a similar basis. We add programs and remove programs in response to local market demand. All campuses utilize referrals, TV, internet and high school admission representatives to recruit.

When one looks across all of our campuses, one can identify certain trends from year-to-year. In 2013, we experienced fewer declines in our high school population than in our adult population. Amongst our five verticals, the greatest strength came from our skilled trades vertical, which increased slightly in starts as demand for wielders and electricians grew.

Our second best performing vertical was automotive, which declined in population starts less than each of our remaining three verticals. As a result, our population mix has shifted. Our share of students in automotive and skilled trades increased, while the percent in health sciences, hospitality services, and business and IT decreased as reflected in our earnings release.

Increasing our population and revenues are the keys to returning to profitability. Throughout 2013, we adjusted our marketing and sales processes, which resulted in the second half of the year performing much better than the first half. Throughout the fall, we continue to refine these processes and identify additional areas for improvement. We expect to return to start growth in 2014 by focusing on three key areas. First, improving the media start rate, second, improving the high school start rate and third, launching new programs.

To immediately increase media start rate in the first quarter of 2014 we have introduced additional scholarships which could total up to $4 million. Affordability remains a major obstacle for many families who are still reluctant or unable to borrow for their education. We believe that by selectively offering scholarships in the programs that appear most challenged we will attract and enable more students to enroll with Lincoln.

Secondly, we have added additional sales staff at the -- at those campuses that showing the greatest volume of inquiries.

Third and most importantly we are continuing to improve our sales process by providing additional training, tools and practices and by decreasing the volume of low converting web initiatives inquiries.

As a result of these activities, we are seeing increased performance and satisfaction among our admissions representatives by lessening our dependence of high volume low converting web initiatives. Our admissions teams are able to spend more time with prospective students to more fully educate them on Lincoln’s value proposition.

Also by making the interview process more engaging by utilizing videos and other multimedia tools, students develop a much better understanding of our programs and services. The end result has been positive for Lincoln and for the students.

To improve our high school start rate, we all -- we are also focused on affordability and better training but in a slightly different way. The high school sales process is much longer than the media sales process and thus requires a different approach. The critical component here is providing students with timely answers to their financial aid questions so that students truly know in advance how they will pay for college.

To better serve our students, we have expanded our centralized financial aid call centre operation so that we can more timely package and address prospective student financial aid questions. This eliminates uncertainty and enables us to better determine the level of commitment by the prospective student.

We have dramatically shorten the time between when our high school representative meets with the student and that students knows or has an estimate of how much financial aid he or she may be entitled to.

Based of a similar approach that was used last year at one our campuses, we believe these efforts will result in significant improvement in our high school start rate all the other things being equal.

Thirdly, we will be replicating and launching six programs in over a dozen campuses. Two programs serve our health sciences vertical, three serve the skilled trades and one for automotive.

New programs allow us to further penetrate existing markets and thus increase our population and subsequently our profitability. These programs will be launched in the third and fourth quarter of this year.

In addition to these specific initiatives, we continue to remain focused on building the Lincoln brand with our students, employers and industries served. In 2013, we started providing training to General Motor’s technicians through a partnership with Raytheon. We launched in our Mahwah campus, Chrysler’s highly competitive MOPAR X-Press apprentice program and we continue to work with BMW while we seek additional automotive OEM partnerships for future programs.

We successfully launched a new CNC machining program by working very closely with two industry participants, Haas and Hurco, who not only provide us with CNC machines but also work closely with us to find additional opportunities to expand this much needed program.

In health sciences, we set the stage for expansion into RN and our first RN-BSM program. Furthermore, we successfully launched blended and adapted delivery for some of our health sciences programs and given the positive feedback from students and faculty, we will expand these initiatives beyond the pilot stage in 2014.

These delivery approaches provide students with more one-on-one training and give them greater flexibility in their schedules both of which should help differentiate us more in the marketplace. All in all, we continue to invest in our program in campuses to meet or exceed our student’s needs.

Despite the economic and political uncertainty, Lincoln is strong at its core and ready to move forward. Lincoln’s heritage is one of compliance and regulatory strength and this heritage was further strengthened in 2013.

We had numerous federal state and [inaudible] visits with all resulting in no material findings or penalties. We continue to successfully manage our 90/10 ratio and set the course for further lowering our three-year cohort default rates.

We are very mindful of the concerns by our customers and the government to make sure that we are providing a strong return on our student’s educational dollar. With that said, we are continually impressed and satisfied by the stories we hear of the success of our graduates especially when they combine their passion and drive with the skills and training that we have imparted on them.

Our focus in 2014 is simple and clear. We need to grow Lincoln’s population and that growth will eventually lead to profitability. Our management and staff know the goal and by executing on these initiatives mentioned above plus others, we’re confident about our future. I look forward to sharing our progress with you during our next call.

With that, I’ll turn the call over to Cesar.

Cesar Ribeiro

Thank you, Scott. Good morning everyone. Our fourth quarter operational results reflect the seasonality inherent in our business and reflects the ceasing of operations at five of our campuses, which have been reflected as discontinued operations in the [accounting] [ph] schedules.

My prepared remarks will thus focus only in continuing operations. As we disclosed in our press release earlier this morning, revenue from continuing operations for the fourth quarter of 2013 decreased 8.8% to $88.5 million. This decrease was primarily due to an 11.6% decrease in average student population which was impacted by current economic conditions which have resulted in a number of potential students being hesitant to incur debt and thus not enroll in our schools.

Other key highlights for the fourth quarter include during the fourth quarter of 2013 the company recorded a $24.5 million valuation allowance against the deferred tax assets. This non-cash charge reducing the benefit from income taxes from continuing operations as a result of the company's assessment of the realizability of the deferred tax assets over a certain period of time.

A primary factor in the assessment is that the company is in a cumulative loss position over three-year period ending December 31, 2013. This valuation allowance can be reduced or reversed in the future as the company returns to profitability.

Loss per diluted share from continuing operations was $0.97 for the fourth quarter of 2013, compared to a loss per share of $0.24 per common share for the fourth quarter of 2012. Excluding the impact of the non-cash valuation allowance, earnings per diluted share for the fourth quarter of 2013 would've been $0.14 per common share. Our operating margin increased to a 7.4% for the fourth quarter of 2013 from a negative 4.3% in the fourth quarter of 2012.

Fourth quarter of 2012, operating margin was impacted from approximately $14.3 million impairment of goodwill and long-lived asset charges. The overall decrease in operating margin as a result of a decrease in our average population for the fourth quarter was approximately 11.6%.

This decrease in average population resulted in our capacity utilization decreasing to 37% for the fourth quarter of 2013 from 42% in the fourth quarter of 2012. With generated free cash flow of $9.6 million for the fourth quarter of 2013, an increase from the $3.8 million generated during the fourth quarter of 2012 and we paid a $0.07 quarterly dividend on December 31, 2013.

Now turning to our full year results. Revenues from continuing operations decreased by $37.7 million or 12.3% to $345 million for 2013 from $382.8 million in 2012. Revenues were negatively impacted during the year by as entering the year was approximately 2200 less students than we had in January of 2012 and continued declines in student starts throughout the year.

This resulted in a 12.3% decrease in our average population for 2013 as compared to 2012. Average revenue per student was essentially flat in 2013 as compared to 2012 as any increase in tuition was offset by additional scholarships given to students.

Operating loss from continuing operations was $9.6 million for 2013, compared to loss from continuing operations in 2012 of $14 million. Operating loss from 2013 includes $3.9 million impairment of goodwill and long-lived assets, compared to $25.2 million in 2012.

Net loss per share from continuing operations was $1.50 for the year as compared to loss of $0.71 for 2012. Losses for 2013 and 2012 include the impact of goodwill and long-lived assets impairment of $3.9 and $25.2 million respectively. Additionally, for 2013, the company established the valuation allowance against the deferred tax assets of approximately $24.5 million.

This non-cash charge reducing the benefit from income taxes from continuing operations as a result of the company's assessment and the realizability of deferred tax assets over a certain period of time, and the primary factor of the assessment of the company is in a cumulative loss position over three-year period ending December 31, 2013. The decrease in average population during 2013 resulted in reduced capacity utilization of 37% at December 31, 2013 versus 42% at December -- for the year ended December 31, 2012.

Cost per start increased 8.5% for 2013 to $4,000 from $3,687 in 2012. Cost per start was negatively impacted during the year by higher head rates, as well as lower conversion rates from enrollment to start than in prior years. Bad debt expense for the year decreased to 4.1% for 2013 from 5.1% of revenue in 2012. The decrease is attributable to improve collections in 2013.

All of the above factors resulted in the diluted loss per share from continuing operations for 2013 of $1.50 from a loss from continuing operations of $0.71 in 2012. Excluding the non-cash impairment charges and the impact of the valuation allowance loss per diluted share for 2013 would have been $0.28 per common share as compared to earnings per diluted share of $0.18 for 2012.

For the year ended, we generating cash flow from operations of $3.2 million for 2013, down from $60 million in 2012. However, free cash flow decreased to a negative $3.3 million in 2013 from free cash flow of $7.1 million in 2012. We finished the year with $67.4 million in cash and cash equivalents and restricted cash, and $54.5 million borrowings outstanding under our credit agreement.

Net accounts receivable at December 31, 2013 were $23 million as compared to $23.5 million at December 31, 2012. Net property and equipment decreased to $127.3 million at December 31, 2013, as compared to $154.1 million at December 31, 2012. Capital expenditures for 2014 are expected to be about 3% and 4% of revenue.

Now turning to our loan program, as of December 31, 2013 loan commitments to our students, net of interest that would be due on the loans to maturity were $26.5 million, as compared to loan commitments of $25 million at December 31, 2012. For 2013 -- ‘14 we expect that this loan commitments will increase by approximately $2 million to $5 million.

We finished the year with shareholders equity of $145.2 million, down from $198.5 million at December 31, 2012. Shareholders equity at December 31, 2013 reflects $6.7 million of dividends paid as compared to $6.4 million for the year ended December 31, 2012.

I will finish my prepared remarks by providing our current outlook for 2014, as well as our outlook for the first quarter. Our guidance is based on our current expectations. Our guiding also excludes any benefit for income tax for both the quarter and the year as we are expected to be in loss position. For comparison purposes our historical tax rate is approximately 40%.

For the year ended December 31, 2014, we expect revenue of $340 million to $350 million, essentially flat with 2013. Loss per share of $0.62 to $0.74, compared to a loss per share from continuing operations of $1.50 for 2013. Loss per share for 2014 and 2013, exclude any benefit for income taxes. As any deferred tax assets are expected to be offset by a full valuation allowance.

Student starts and continuing operations in 2014 are expected to be up in the mid-to high single digits as compared to starts from continuing operations in 2013.

For the first quarter of 2014 -- for the first quarter 2014, we expect revenues of $77 million to $79 million, representing a decrease of approximately 10.9% over the first quarter of 2013 and a loss per share a $0.57 to $0.60.

Loss per share for the first quarter of 2014 exclude any benefit for income taxes as any deferred taxes are expected to be offset by a full valuation allowance. We expect student starts from continuing operations for the first quarter of 2014 to be up 1% to 3% from the first quarter of 2013.

And finally, the Board of Directors has set the record and payment dates for the dividend for the first quarter of 2014. The Board approved a cash dividend of $0.07 per share, which will be payable on March 31, 2014 to shareholders of record on March 14, 2014.

In conclusion, 2013 is behind us and in 2014, our focus is to return to growth. We expect to start to gain traction in momentum in the second half of 2014. And with that, we’ll open your call to questions.

I'll turn the call back over to the operator. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jeff Silber with BMO. Please proceed.

Jeff Silber - BMO

Thanks so much and thank you so much for the color and the guidance in terms of where the company is going. I’m just curious. So in looking at your portfolio of campuses and programs, do you think you are going to be sticking with these 33 campuses or do you think there may be some parse then going forward?

Shaun McAlmont

Hi Jeff. This is Shaun. I’ll start and then I’ll turn it over to Scott and Cesar for more color. But we -- over the last two years, as you know, we’ve closed 12 campuses and we have closed those campuses that we thought were not viable for the long term for this company and the 33 schools that we operate today, we anticipate we will operate moving forward.

The only opportunity to parse would come if a school was [thought had a lease and could] [ph] be merged with another school. So it would essentially not reduce the student population, we’d just lose the site but that only comes opportunistically. At this point in time though we’re running with the 33.

Jeff Silber - BMO

Okay. Great. I also appreciated the color on all the regulatory issues. One you did not mention was gainful employment. I know there is still a tremendous amount of uncertainty out there. But based on what you know right now, do you think the program that you have in place will comply with the proposed regulations.

Shaun McAlmont

If you recall, over the last three years, as we’ve been talking about gainful employment, whether we look at the repayment metrics or debt to income we felt that the shifts that we’ve made to position ourselves in a certificate program -- group of programs, we would essentially make our way through that gainful employment regulation quite well.

The assessment we’re doing today relates to a programmatic look versus a look by OPEID number and even still, I think as we look at the types of programs that we offer, the cost and the length of programs, we feel pretty confident where we sit today. I think as the rule is better defined and we can do a full analysis, we would essentially share what our full impact is but as of today, I think that’s how we look at it.

Jeff Silber - BMO

Okay. Great. And just a modeling question for Cesar, in trying to get to your net loss per share which is pretty sizable I’m still a little bit confused on the tax rate. Does that mean if you have a pretax loss that we should be expecting no income tax benefit but actually an income tax expense and that’s how we get to such a loss per share?

Cesar Ribeiro

That is correct. So there will be no benefit. The benefits will have to be -- will be zero, will be fully offset by valuation allowance. So historically if you had a, let’s say, $0.50 loss per quarter, you would expect that your EPS loss would be $0.30. Now that loss, you would take that benefit and you would have to set up the valuation allowance, your taxes will be zero and you still would have a loss per share of $0.50. So when you're comparing -- when you're comparing, you need to take into consideration what historical 40% benefit would've been on those losses.

Jeff Silber - BMO

Okay. Great. And in terms of just specific line items, and just looking between your educational services and facilities in the SG&A, do we expect to see any leverage on those line items?

Cesar Ribeiro

Not for 2014, I think as you know Jeff we’re entering ‘14 will less students than we entered 2013. So as I said in the past, we’re seasonal business. But I think we've demonstrated over the years, we do return in the second half of the year and you’d have a very strong fourth quarter. And we expect to see the same type of momentum. But as where we sit today, I think our structure is pretty much fixed. And so what we expect to see is a return back to student start which would drive our revenues.

Jeff Silber - BMO

Okay. Great. I’ll somebody else on. Thanks so much.

Shaun McAlmont

Sure Jeff.

Operator

Our next question comes from David Chu with Merrill Lynch. Please proceed.

David Chu - BofA Merrill Lynch

Thank you. So, can you speak to what you are seeing in terms of lead flow and conversion rate so far in the first quarter and what you saw in the fourth quarter?

Shaun McAlmont

Yeah. Again, I will start, David. Our lead flow really hasn’t varied significantly. Our start rates are improving but they are not back to historical highs. And so as far as demand, we see good demand on the front end. When Scott talked about our initiatives, our initiatives are clearly focused on start rates. So, it’s taking more of those inquiries, more of the enrollments and getting them to a start status.

And so we feel good about the front-end demand, we feel better about the initiatives that are improving start rate. And I think that, in the first quarter, we are seeing a combination of the two. And so we are seeing ourselves return to flat to up growth and it’s coming on the start rate side. Scott?

Scott Shaw

Yeah. Just to add, I mean, we did make some adjustments in our marketing. As you know, we had inquires in through TV, through the web, and through web-based initiatives and referrals. And we did scale back the web-based initiatives, which are very plentiful and easy to get but very low converting type of inquiry and it consumes people time. And we thought it would be much more productive to scale that back to give our reps more time to work with the other students that are coming in.

And as we do that, we see that our conversion rates are improving and so it seems to be a good swap out of assets, reduce the number of inquiries coming in to get more starts at the end of the day. And that's really kicked-in in the second half of last year and we are continuing that process. And given the other initiatives that we have underway that Shaun touched on and I touched on for improving start rates, that's what seems to be helping us certainly in the first two months of this year.

David Chu - BofA Merrill Lynch

Okay. So it sounds like you are seeing some improvements to conversion rates at least so far in 1Q. It sounds largely based on, I guess higher quality leads?

Scott Shaw

Correct.

David Chu - BofA Merrill Lynch

Okay. And so based on guidance, when do you expect average enrollments to turn positive?

Cesar Ribeiro

Well, as you know, there's probably a good six to nine months before that would happen. It won’t be for a while because obviously, you would need - must have very strong starts, it would take at least six to nine months before we see average enrollment turning positive.

David Chu - BofA Merrill Lynch

So the six to nine months post-start growth?

Cesar Ribeiro

Correct. As it is based on – based on the guidance we provided you. Obviously, if the starts come in much higher than that, it could be sooner than that.

David Chu - BofA Merrill Lynch

Got it. Got it. Okay. And just to, I guess, continuing Jeff’s question, so how should we think about SG&A cost given higher admission advisor headcount in 2014? I mean, can you just help us think of it in terms of an absolute dollar basis?

Cesar Ribeiro

I think what you should expect for ’14, based on our guidance is you should see pretty much flat operations for 2014 as you saw in 2013. The big difference that’s going to happen is, we expect that we'll finish 2014 with a much higher population than we did in 2013, which will lend well for 2015.

Scott Shaw

And to the extent, we made investments in new admissions people we took out matching cost in another area.

David Chu - BofA Merrill Lynch

So, SG&A being largely flat, is that what you are speaking to?

Cesar Ribeiro

That’s correct. I mean, I think what we guided to is revenue to be essentially flat and I think we are guiding to EPS on a pro forma basis to be essentially flat as well.

David Chu - BofA Merrill Lynch

Okay. And so last question, if you guys do generate pre-tax income on any given quarter, we should be kind of utilizing a 40% tax rate, correct? It's only when you guys have losses that you zero that out?

Cesar Ribeiro

No, we will be reducing valuation allowance.

David Chu - BofA Merrill Lynch

So, on a GAAP basis….

Cesar Ribeiro

On a GAAP basis, it would still be -- you will be reducing some of your valuation allowance that you set upward reserves for.

David Chu - BofA Merrill Lynch

Okay. Thank you.

Operator

Our next question comes from Trace Urdan with Wells Fargo. Please proceed.

Trace Urdan - Wells Fargo

Thanks. So, Cesar, I’m just going to say this outright. I've no idea what you're talking about when you are describing the valuation allowance or what to do with taxes. So, I can get that from you offline. But my question is -- and I think you started to hit this before. But if we are looking at this on a non-GAAP basis, are you guys saying that your revenues are going to be flat and your operating expenses are going to be flat in 2014?

Cesar Ribeiro

That’s pretty much what we’re saying.

Trace Urdan - Wells Fargo

Okay, great. Thank you. That’s very helpful. And then, I just wondered if you might be able to give us a little bit of color on what your placement folks are telling you about the tone of the market in the larger degree areas that you’re offering? Are you seeing -- is hiring improving, is demand improving? Is it -- can you just speak in a little bit more detail by program offering if you don’t mind?

Scott Shaw

Sure. I mean, I will jump in Trace, it’s Scott. I mean, obviously, overall, for the whole company, our placement rates are up and we’re seeing improvements frankly across the board.

Trace Urdan - Wells Fargo

Okay. Let me quantify the question for a second, Scott. So that's great of course, but it's also the case that your populations are way down, right. So, that doesn't necessarily speak to what we might be seeing in the market overall. That's why I was kind of hoping for little bit of qualitative feedback, maybe just from what folks are suggesting, because the fact that you're pumping up your graduates and their replacement is going up is great. But, it doesn't necessarily speak to a better environment out there.

Scott Shaw

Sure. Well, I guess, there hasn’t been any feedback from any of the campuses saying that they’re experiencing any kind of troubles that you feel about their way of approaching the marketplace and reaching out and finding more potential employers is serving their needs. And frankly, I haven't heard any kind of comment back that they have any challenges facing them and getting students placed. So that’s the only I can base it all for Trace.

Trace Urdan - Wells Fargo

Okay. I don’t want to put words in your mouth, are you suggesting that the -- I mean, what I just heard you say was that they're doing more and be more creative in finding more spots for students, but that's not the same thing as saying that the overall employment environment is firming.

Scott Shaw

That maybe true, but I guess I don’t have any other insight beyond that.

Trace Urdan - Wells Fargo

Okay. All right. Thank you very much.

Operator

Our next question comes from Alex Paris with Barrington Research. Please proceed.

Alex Paris - Barrington Research

I just have a follow-up on taxes again. So Cesar, if I hear you right, we’re bottling zero for income tax expense throughout 2014, whether we model in a pre-tax loss or a pre-tax profit.

Cesar Ribeiro

That’s correct.

Alex Paris - Barrington Research

Then based on the valuation allowance and based on a return to profitability in 2015, a reasonable expectation of return to profits in 2015, do we continue to model zero for a while?

Cesar Ribeiro

No, the expectation is that after four quarters of profitability, we will reverse the valuation allowance, so whatever is left of it.

Alex Paris - Barrington Research

Okay. So I if had a profit in the fourth quarter say and I haven’t done my model yet, there were still -- and then those profits continued into the first three quarters of 2015, I am zero, zero, zero, zero, and then I have to access in the fourth quarter of the next year?

Cesar Ribeiro

Well, then you have gain because you reversed the full valuation allowance. We could talk about that outside. So you’re reversing the valuation allowance. And once that done, then you take whatever is left and you put it back in your balance sheet in order to -- and you recognized the benefit for income taxes.

Alex Paris - Barrington Research

Okay. That's good. Then with regard to the guidance for the first quarter, it obviously in March already sort of assumes what it assumes, but it also takes into account weather, what impact has weather had on your operations in the first quarter.

Shaun McAlmont

I would say Alex that we essentially lost a number of sales days and also days that students would complete their hours in class. What we ended up doing was replacing those days with weekend their longer hours. Now some of those replacement days were not as ideal as the regular work week that we typically engage. So I would say that there is some loss there. I can’t quantify it for you, specifically at this point in time, but we’ve been -- I guess the way we looked at it was to take it up and I think we’ve done a pretty good job of that.

Now there always are sort of backlog of enrollments that we’re able to get finance for their start or other increase that we aren’t able to get enroll because they might have missed an appointment, etcetera. We essentially tried to get those students in for the next schedule start, and so some of those starts might occur in the second quarter.

So what was we quantify what the loss was from Q1 on weather? We will have some amount of that that flows into starts for Q2.

Alex Paris - Barrington Research

Okay. That's helps. Then with regard to the absolute number of enrolment counselors, when did you start adding them? What did you finish the year at and what percentage will they increase in 2014 based on what you have in place now?

Scott Shaw

Well, I think the simplest way to look at is, we added about 10 reps and we added them starting in January and so those individuals on average could generate anywhere between 30 to 60 starts in the year.

Alex Paris - Barrington Research

And then of what base was that?

Scott Shaw

For total percent?

Alex Paris - Barrington Research

Yeah. What if you have an ECS at 12/31?

Shaun McAlmont

It’s about 10% for the adult reps, a 10% increase in reps for the adult media representatives.

Alex Paris - Barrington Research

Okay. Good. There are no change to the high school number reps?

Shaun McAlmont

No, the high school number reps stay the same. But along with that, we also increased the Financial Aid team, that Financial Aid team that is doing remote packaging, et cetera and that might have been about 15 bodies that represents kind of the same increase as well.

Cesar Ribeiro

Probably, 20% or 30% increase in that level.

Alex Paris - Barrington Research

Great. And then, the President’s budget proposal scheme out yesterday and one of the things that he proposed that you will know how this goes is restoring financial aid to people who haven’t graduated from college. Those who passed the ability to benefit test, that’s something they took away from us over the last couple of years. I don’t know if that applies only to community colleges or everyone. Have you seen that and if that does come to pass, would you dive back into those waters or would you avoid it?

Shaun McAlmont

Let me start with that one. We started ramping down our ATB population. Before the rule came, the ATB students didn’t qualify for aid. When we started ramping down that population, we added barriers to entry for the ATB students. And so when we saw our final ATB students moving through our system, they were performing at much higher rates than historically speaking. I think that we found a way to manage those students effectively and if they were able to qualify for aid again, I think that we would take a similarly conservative approach with them.

I don’t think, we would have opened it up in the ways that we have done before and I think it would be at schools that had programs that showed us, work well for ATB students. We would want to make sure that any of those students that came into our program would not detract from the outcomes that we work so hard to achieve to this point in time. There are quite a few proposals in the President’s budget that relate to education, and I am not sure how many of them are going to come to fruition. But we are looking at all of them if they pass and what we would do, et cetera and we’d probably have more color on that as time goes on.

Alex Paris - Barrington Research

Fair enough. Thanks very much for the color, guys.

Shaun McAlmont

Thank you.

Operator

(Operator Instructions) Our next question comes from Douglas Ruth with Lenox Financial Service. Please proceed.

Douglas Ruth - Lenox Financial Services

Hi. Thank you for hosting the conference call. Is the absolute advertising budget going to be up in 2014?

Cesar Ribeiro

It’s going to be essentially flat.

Douglas Ruth - Lenox Financial Services

Okay. Are we spending more on -- we are spending on TV and less on the internet, is that essentially what I heard?

Shaun McAlmont

I think you can look in a couple of ways, Doug. The overall marketing budget will be approximately flat. However, the way we spend will be different by quarter and I think that earlier on, we don’t see the high school starts coming until the third quarter. So, for the first two quarter, as Scott said earlier, much of our spending has shifted to different sources. But I will tell you that the most successful channel that we have is our own website.

And so the more we can drive students to our own website, the more that we find students, are able to target the geography in a program that fits for them and they can go into the school, they find programs that meet their needs and services through the website, et cetera, so to do that we found different ways. We go to TV to ultimately drive people to our website.

We buy such terms that will drive people to our website etcetera. I think what Scott was referring to are the large volume non-differentiated sort of aggregator leads that take a lot of time to contact a prospective student etcetera. So those will go away and the expense that we attributed to that channel in particular will be shifted to TV and other channels that can send students to our website. So it is a reallocation of resources under the overall marketing spend but that spend will remain the same.

Douglas Ruth - Lenox Financial Services

Okay. Could you comment some about the Florida schools and how they’re performing?

Shaun McAlmont

Are you referring to the FMTIs or we have other operations in Florida?

Douglas Ruth - Lenox Financial Services

Yeah, the FMTI schools.

Shaun McAlmont

Yeah. Right now, there are a bit challenged overall and populations are increasing at those campuses, but they're not in a position where we want them to be for the long term.

Cesar Ribeiro

And Doug, if you recall, we acquire those Florida schools because there were cash programs, there were short programs in paramedics and EMT training that fit our vertical but also contributed to our company’s cash there by reducing our need for Title IV. I think that when we attributed those schools through accreditation to have Title IV be able to be reduced, it required additional staffing in those schools that weren’t there pre-acquisition. And so Scott is probably really reflecting change in dynamic at those schools that we need to manage through. And ultimately, our goal is to grow them at the same rates that we grow our other schools, but they are a little different in nature of operation.

Douglas Ruth - Lenox Financial Services

Okay. Well, thank you for answering my questions. We look forward to future calls.

Cesar Ribeiro

Thank you.

Operator

We have no further questions. I would now like to turn the call back over to management for closing remarks. Please proceed.

Shaun McAlmont

Thanks, Denise. Thank you everyone for joining us on the call today. As you can see, we’ve taken important steps to improve the long-term strength of our institutions and our company. We’re working within the evolving regulatory metrics that we have to position Lincoln to be the leader in diversified skill training. We look forward to updating you on our first quarter results on our next call. Thank you. And have a good day, everybody.

Operator

This concludes today's conference. You may now disconnect. Have a great day.

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