ITT Educational Services, Inc. (NYSE:ESI)
Q1 2014 Earnings Conference Call
May 22, 2014 11:00 AM ET
Kevin Modany - CEO and Chairman
Dan Fitzpatrick - EVP and CFO
Corey Greendale - First Analysis Securities Corporation
Sara Gubins - Bank of America Merrill Lynch
Trace Urdan - Wells Fargo Securities, LLC
Tim Connor - William Blair
Jerry Herman - Stifel, Nicolaus & Co.
Susie Stein - Morgan Stanley
Jeff Volshteyn - JPMorgan
John Trevor - Piper Jaffray
Paul Ginocchio - Deutsche Bank
Greetings, ladies and gentlemen and welcome to the ITT Educational Services Incorporate Preliminary First Quarter 2014 Results Conference Call. (Operator Instructions) As a reminder this conference is being recorded.
Joining us today from the management of ITT Educational Services, we have Kevin Modany, Chief Executive Officer and Chairman and Dan Fitzpatrick, Executive Vice President and Chief Financial Officer.
Before we begin, ITT Educational Services, Inc. wishes to remind you that this conference call may include forward-looking information. Actual results may differ from the information presented during this call. For additional information, please review the section on forward-looking information contained in today's news release or in the company's public filings with the Securities and Exchange Commission. Thank you. Mr. Modany, you may begin.
Thank you. Good morning, ladies and gentlemen, thank you for joining us on our conference call to review our 2014 first quarter operating results and to provide you with an update on other corporate matters.
On the call with me this morning is our Executive VP and Chief Financial Officer, Dan Fitzpatrick. I’d like to begin today’s call with a brief overview of the topics that we’ll discuss this morning in our prepared remarks. First we will review the key operating metrics including new student enrollment, persistence in total student enrollment for the first quarter of ‘14 compared to the same period in the prior year.
Next, we will provide color on our ongoing programmatic expansion efforts to increase the depth and breadth of our educational program offerings, broad our students with increased opportunities to develop skills and knowledge that employees are looking for in today’s workforce. We’ll then turn to review with our results of our efforts to assist our graduates and obtaining employment in the fields of study, starting salaries to position and to obtain a solid return on their educational investment.
After review of our career services metrics, we will provide an update on regulatory and legal topics including the state attorneys general, CFPB and SEC matters. I'll then turn the call over to Dan, who will speak to the status of our efforts to finalize our full year 2013 and first quarter 2014 financial statements.
In conjunctions with our discussion he will provide an update on the status of our inquiry to the Office of the Chief Accountant or OCA of the Securities and Exchange Commission regarding the accounting treatment of the variable interest entity in the PEAKS program.
Additionally, Dan will comment on our recently announced sale leaseback agreement, another capital allocation considerations including our RSA obligations. Following Dan's comments, we'll open up the line for your questions and comments.
With the overview of today’s call out of the way let’s begin by reviewing the new student enrollment results. As we reported in the release this morning, new student enrollment for the first quarter of 2014 declined 3.8% compared to the same period in the prior year. We believe the severe weather during the quarter at several of our locations impacted new student enrollment results, as we lost 148 individual location recruitment days during the period of various ITT Technical Institute locations. We believe that the primary driver, the decline in new student enrollment in the first quarter however was a decrease in a number of increase from perspective students in the first quarter of 2014, compared to the same prior year period.
Looking a bit deeper to the results of ITT Technical Institute School of study in the first quarter of 2014, compared to the first quarter of '13, total new student enrollment increased 12.8% in the school of business. Increased 7.7% in the School of Information Technology, increased 3.0% in the Breckinridge School of Nursing & Health Sciences. Decreased 0.4% in the School of Electronics Technology, decreased 15.6% in the School of Drafting and Design and decreased 49.3% in the School of Criminal Justice.
As previously discussed this is part of our efforts to maximize the efficiency and effectiveness of our national network of campuses. In the 12 months ended December 31, 2013; we relocated five of our campuses into existing facilities of other ITT Technical Institute campuses and suspended the enrollment of new students at two of our campuses.
None other seven affected campuses enrolled any new students in the first quarter of 2014. Additionally, we’d like to remind everyone that our ongoing strategy continues to focus on offering programs with study, that offer graduates with solid potential for an attractive return on their educational investment and as a result we suspended enrollment of new students in the School of Criminal Justice and various graphic design related programs at certain campuses across our national network beginning in late 2012.
Excluding the negative year-over-year impact of the seven campuses that did not enroll new students in the first quarter of 2014, and the year-over-year declines in total new student enrollment in the School of Criminal Justice and graphics design-related programs. Total new student enrollment in the first quarter of 2014 was 4.8% higher than in the first quarter of 2013.
Turning our focus for perspective student applications for the academic period that begins in June 2014, we are continuing to experience a year-over-year decline in perspective student inquiries compared to the same prior year period. As a result total new student applications, net of cancellations were 13% lower as of May 18, 2014 and at that same date in the prior year for the June 2013 academic period.
Noting that as of May 18, 2014, we had three more weeks of recruiting activity before the start of the June 2014 academic period. We currently project that new student enrollment in the second quarter of 2014 maybe 10% to 15% lower than in the second quarter of 2013.
We recently reviewed our advertising plan for the remainder of 2014, and have made some adjustments to the plan and effort to generate an increased volume of student inquiries and reverse the year-over-year declines.
In the last two weeks, the number of inquiries from perspective students have increased, but we can now predict when or if the year-over-year decline in new student enrollment will reverse as a result of our actions.
Shifting now to a discussion of student persistence. Student persistence declined 130 basis points as of March 31, 2014 compared to the same date in the prior year. The decrease in the student persistence was primarily due to a decrease in student retention in the three months ended March 31, 2014 compared to the same prior year period. But we have implemented several student retention remediation initiatives to address what we believe is a decline in our early quarter retention rate in a select group of courses, we have yet to see a material year-over-year improvement in the student success rates or retention rates in those courses.
We’re disappointed with these results and we will continue to focus our efforts on improving the student outcomes in those early quarter courses. To that end we expect implement new adaptive learning tools in several of those early quarter courses in the second half of 2014. These adaptive learning tools provide an opportunity to further improve the students’ learning experience. However, we’re in the early phases of implementing these new tools so we’ll be several quarters before we able to determine that the tools have a positive impact on our retention rate. At this time we believe the student retention rate in the second quarter of 2014 will be flat or slightly down from the same prior year period.
However, we believe that student persistence in the second quarter of 2014 will improve over the same prior year period primarily due to a reduction in the total number of graduates in the second quarter of 2014 compared to the second quarter of ’13. You may recall that in the second quarter of 2013, we had what we refer to at the time as a double graduating class due to the reduction of the length of our associate degree programs from eight academic quarters to seven academic quarters that we made in 2011. We anniversary this double graduation impact in the second quarter of 2014 and as a result believe that there will be a reduction in the year-over-year graduate totals which should have a positive impact on the second quarter 2014 persistent rates compared to the second quarter of 2013. As a result of the new student enrolment results in the first quarter of 2014 and the year-over-year decline in the student persistence rates, total student enrollment declined 6.4% as of March 31, 2014 compared to the same date in 2013.
The change in total student enrollment in the various ITT tactical institute schools of study as of March 31, 2014 compared to March 31, 2013 and the percentage of total student enrolment that the school study represented as of March 31, 2014 were as follow; total student enrollment increased 19.0% in the School of Business and represented 10% of the total; total student enrollment increased 5.3% in the Breckinridge School of Nursing and Health Sciences and represented 11% of the total; total student enrollment declined 1.1% in the school of electronics technology and represented 22% of the total; total student enrollment declined 2.1% in the School of information Technology and represented 38% of the total; total student enrollment declined 15.0% in the School of Drafting and Design and represented 12% of the total; and total student enrollment declined 46.4% in the School of Criminal Justice and represented 7% of the total.
Shifting out to our programmatic expansion efforts, part of our growth strategy involves introducing new programs and studies throughout our locations as part of our efforts to offer our students an array of programs and disciplines that are in demand by employers. We added 61 and eliminated 80 degree offerings across our colleges in the 2014 first quarter. The principle focus of our programmatic efforts continues to be in the technology and health sciences areas. We believe our 45 year focus on helping students prepare for entry level, technician related positions and technical and now health science disciplines for job growth is projected to exceed the national average is a primary differentiator for our institutions.
We also added 858 non-credit short term programs in the first quarter of 2014. These short term programs are being offered by the Center for Professional Development and ITT Technical Institute and emphasize post degree continuing education in business and technology. Moving on we’d like to provide with an brief update on our graduate employment metrics the period for measuring the employment results of our 2013 graduates ended on April 30, 2014. Approximately 70% of our 2013 ITT Technical Institute employable graduates obtained employment and positions using skills thought and their programs and studies as of April 30, 2014. As of April 30, 2014, the average annual salary reported by our 2013 ITT Technical Institute employee graduates increased 2.4% compared to the average annual salary reported by our 2012 ITT Technical Institute employee graduates as of the same date in 2013.
While we’re seeing some signs of improvement employer engagement and the total number of job orders that we received from employers in our network we’re not yet experiencing a material improvement in the employment market dynamics for our graduates that would indicate a significant improvement in national employment trends. That said we continue to work diligently to provide great services assistance and support to our graduates at every one of our campuses and recognize that this student service is one of the most impactful institutional activities to position our graduates with a strong return on their educational investment.
I would like to now turn our attention to an update on legal and regulatory matters. We do not have any material updates to provide today regarding the subpoenas and/or civil investigative demands which I will refer to together as CIDs and we received from the Attorneys General a 15 states. We continue to cooperate the AGs. With regard to the lawsuit filed against the company by the U.S. Consumer Financial Protection Bureau on April 30, 2014. We filed a motion to dismiss the complaint, pointing out numerous flaws in the CFPB’s claims. We do not expect the ruling on our motion to dismiss before late 2014. Moving onto the SEC investigation, we have continued to dialogue with the SEC and provide them with requested information including participating in interviews with our CC staff but we have no updates to provide us to the nature of timing of the outcome of the investigation.
Before I turn it over to Dan and in response to a few questions that we have received, I would like to note that it is our understanding that the SEC investigation and OCA request form separate tracks and that the resolution of one of these matters without necessarily impact the outcome or timing of the other. At this point, I would like to turn the call over to Dan, who will provide an update on various financial related matters. Dan?
Thanks, Kevin. I would like to begin my prepared comments by updating you on our enquiry to the OCA. As we previously reported, we asked the OCA for its determination of the appropriate accounting treatment of the PEAKS Trust which is the variable interest entity in the PEAKS program. We have not yet received a final determination from OCA however we are continuing to communicate with the OCA on how that we will receive their guidance soon. As a reminder, we submitted our request to the OCA over nine weeks ago on March 18, 2014. We believe that the length of the review process speaks impart to the complexity of accounting issues under review by the OCA. Due to the uncertainties related to the accounting treatment of the PEAKS Trust, all previously issued financial guidance and internal goals provided by the company should not longer be relied upon and should be ignored. New guidance for 2014 may be provided subsequent to the following of our 2013 Form 10K with the SEC.
With that in mind, I would like to turn the discussion to the sale-leaseback agreement that we recently announced and a few other financial matters. As we reported in a recent Form 8K filing on May 8, 2014, we entered into a sale-leaseback agreement with the third-party to sale and subsequently fact up to 24 of our campus facilities. A this point in time, we cannot assure you that this transaction will close, if the transaction does close; however, we anticipate the gross proceeds to the company to be in the range of approximately $95 million to approximately $119 million. In that event the dissociated leases would be from expected 15 year term and contain a 2% annual escalation clause resulting in a first year annual rental expense of approximately 9.5 million. The terms are subject to change depending on the completion of the buyers’ due diligence and the closing of the transaction.
Annual depreciation on all 24 properties is approximately $2.4 million loss if the transaction closes and all 24 properties are sold and leaseback the transaction would be diluted to net income. Based upon our preliminary review of the potential accounting treatment of the leases, we believe that the leases would qualify for classification as operating leases on the company’s financial statements if the sale-leaseback transaction is consummated on the term specified in the agreement. This preliminary assessment however is subject to change until we are able to analyze the final terms of the potential transaction until that time there can be no assurance that the leases subject to the sale-leaseback transaction if consummated would not be classified as capital leases. If the sale-leaseback transaction closes, we expect to use the proceeds for general corporate purposes which include among things funding our RSA guarantee obligations.
We will announce the closing of the sale-leaseback transaction if it occurs and we want to note again that the negotiations on the terms continue and are not finalized. If the sale-leaseback transaction does close however we do not believe that the closing will occur before the audit of our 2013 financial statements is completed and we file our 2013 Form 10K with the SEC. Turning now to an update of risk share agreements and the anticipated payments under our guarantee obligations in the remainder of 2014 and beyond. First I will start with the PEAKS RSA and our review of the current projections of the guarantee payments and receipts over the remaining life of the PEAKS Trust. In the first quarter of 2014, we paid approximately 43 million to the PEAKS Trust related to our guarantee obligations.
Based upon the current projections including estimated default rates, student loan recoveries and the asset liability ratio requirements, we expect to pay approximately 116 million to the PEAKS Trust in the second to fourth quarters of 2014 related to our guarantee obligations. We believe that in 2014, the company’s leverage ratio will require that the PEAKS Trust maintain a higher asset liability ratio. In order to increase the PEAKS Trust asset-liability ratio in the required levels, we will need to pay additional amounts under the guarantee. These additional amount as well as potential payments related to the guarantee of the interest of senior debt and the fees and expenses in PEAKS Trust are the basis for the estimate that we will pay approximately $116 million in the second to fourth quarters of 2014. These projected levels of guaranteed payments will reduce the principal balance of the senior debt resulting in an estimated net balance of approximately $96 million as of December 31, 2014. We believe this lower outstanding principal balance would have the effective in reducing amount of interest payable on the senior notes that the senior debt and producing some of the fees of the PEAKS Trust and as a result we will reduce the amount of payment, that we would be required to make to the Trust.
Based upon our current projections we also estimate that we will not have to make additional guarantee payments to increase the asset liability ratio of the PEAKS Trust after 2014. As a result we project that we will not be required to make any payments to the PEAKS Trust in 2015 to 2019 related to our guarantee obligations. We project that we will pay approximately $28 million to the PEAKS Trust in early 2020 related to our guarantee obligations primarily to pay off the balance of the PEAKS senior debt on the maturity date. Based upon the current estimates and after the projected payments that I just reviewed, the balance of the PEAKS senior debt will be zero on January 27, 2020.
Lastly, as it relates to the PEAKS RSA, we currently estimate that we will collect approximately $60 million from the PEAKS Trust as reimbursement for our prior guarantee payments to the PEAKS Trust. These estimated recoveries in the PEAKS Trust are projected to be received in the years following the retirement of PEAKS senior debt on January 27, 2020 with the majority of the recoveries collected from 2020 to 2023.
Moving on to our guarantee obligations related to the 2009 RSA. Starting with a continued liability related to this guarantee, that was recorded in our preliminary unaudited balance sheet as of December 31, 2013, we expect increase that contingent liability amount. We expect that this adjustment together with any potential adjustments related to the PEAKS Trust would be initially reflected in the December 31, 2013 audited financial statement. It will be included in our form 10-K filing. The expected increase in the reserves of the 2009 guarantee obligations as of December 31, 2013 would be based upon a reassessment of various assumptions and estimates utilized in calculating the contingent liability. In the first quarter of 2014 we paid approximately 1 million under our guarantee obligation related to that 2009 RSA.
Turning now to review of the projected cash flows impact of that 2009 RSA. We projected that we will be approximately $6 million under the guarantee obligation related to the 2000 RSA, and the second through fourth quarters of 2014 based upon our current expectation that we will not choose to exercise our option to make larger discharge payments with respect to the defaulted loans during this period.
Looking forward to 2015 and beyond, if we choose to discharge loans associated with the 2009 RSA that had defaulted and defaulted in the future we should eliminate any future obligations with respect to those loans, we estimate that we would pay approximately $78 million under our guarantee obligation related to the 2000 RSA . We believe that approximately $75 million of the $78 million would be paid in 2015 and the remaining approximately $3 million would be paid in 2016.
Based upon the current default assumption and assuming that we begin making the optional loans discharge payments in 2015, we project that we would not be required to make any payments under our guarantee obligation related to the 2009 RSA after 2016. If we choose not to make the optional loan discharge payments, we estimate that we would be approximately $123 million under our guarantee obligation related to the 2009 RSA. Of this amount approximately $6 million would be paid in the second to fourth quarter 2014, approximately $12 million to $14 million would be paid annually in each 2015 to 2022 and approximately $17 million would be paid in 2023 to 2027.
Stating the obvious, the opportunity to satisfy the 2009 RSA guarantee obligations without making the optional discharge payments provides us with some flexibility in the timing of our guarantee payments. But that flexibility comes at additional cost as I just summarized. As it relates to the 2009 RSA, we currently estimate that we will collect approximately $6 million on recoveries from defaulted loans. The majority of these estimated recoveries are projected to be received from 2017 to 2019.
We included a schedule in this morning’s press release that summarizes our current projections, our future cash payments associated with the guarantee obligations related to the 2009 RSA and the PEAKS Program. That schedule does not reflect the approximately $60 million reimbursements projected to be received by the company from the PEAKS Trust or the recoveries projected to be received by the company related to 2009 RSA. That schedule assumes that we will not make optional loan discharge payments associated with the 2009 RSA in 2014, but that we will make those payments in 2015 in later years.
We would like to note that based upon our current estimates, we believe that we have sufficient cash and cash equivalents to fund our projected 2014 guarantee payments under the PEAKS Program and the 2009 RSA in working capital needs without having to borrow any additional amounts under our credit agreement even if the proposal sale lease back transaction does not close. Of course were prepared to answer any additional questions related to the 2009 RSA and future cash payments that you may have in the Q&A session.
While all projections and other forward-looking formation that we have provided are subject to material risks and uncertainties and actual results may of course differ from the projections. We would like to emphasize that our current projections for future payments under the guarantee obligations associated with the RSAs are based on numerous assumptions and estimates and could differ materially from the actual payments that we make in the future.
Moving on to a brief look at the preliminary unaudited balance sheet as of March 31, 2014, the preliminary unaudited cash, cash equivalents and restricted cash as of March 31, 2014, was $207.7 million compared to $210.7 million as of the same date in 2013. The outstanding balance on the line of credit at the end of 2014 first quarter was $50 million resulting in a net cash balance of $157.7 million.
Lastly, our current analysis of the impact of the potential consolidation of the PEAKS Trust into our financial statements and/or the impact of the sale leaseback transaction if it closes on the currently proposed terms suggest that we will continue to in compliance with the 90/10 rules and the financial responsibility ratios for all applicable periods. That said, there can be no assurance they’ll be in compliance with the 90/10 rule with the financial responsibility ratios and so until such time as our audited financial statements is complete.
At this point I’d like to turn the call back over to Kevin.
Thanks Dan. We’ll open up the lines to entertain your questions. I’d like to close our prepared remarks by stating the obvious the company has been dealing with a lot of noise and scrutiny around the 2009 in PEAKS RSA transaction that we first entered into more than five years ago. The 2009 RSA and PEAKS program involve (ph) must become the entire story as it relates to our business and while we understand why that has occurred we believe that these RSA transactions are not represented of what ITT Educational Services is or does as we sit here almost halfway through 2014.
As time has passed since we first entered into these RSA transactions, we’ve been able to gather more information and insight on the trajectory of the economic impact of these transactions such that as of today we believe that we have a much better sense of the future cash effect of these transactions may have on the company. In other words, we believe we’re getting close to knowing what the ultimate cash impact on the business that these transactions will cost. To further emphasize the point as of today based on our analysis of the available reports we believe that 99% of the borrowers under the PEAKS in 2009 RSA programs have entered into repayment giving us much more clarity on projected repayment performance certainly much more so than we’ve previously had.
One of the things that we have clarity on the precise impact of the RSA transactions we’ll have on our future cash flows because there are many assumptions and estimates that go into our projections. What we are saying is that we believe that we have much better clarity on what the potential impact will be than we’ve ever had before and with the disclosures included in today’s press release we’re attempting to resolve a lot of misunderstanding and misperceptions that exist in the investment community about the future impact of these few transactions on the corporation.
I’d like to emphasize that entering in risk share agreements associated with third party private education loan programs offer to our students is a thing in the past for this organization entering into risk share agreements are not part of our recent past and not part of our current operating model and are not anticipated to be part of our future operations. As those of you who follow us already now we’ve replaced our students’ need for third party private education loans with institutional scholarships. Since our students no longer need third party private education loans to help pay the cost of their education, there were no longer any private education loans that we need to guarantee.
With the disclosures in today’s press release we’re trying to put our current estimates of the projected cash impact of these two RSA transactions on the table for all to see so that we can begin the process of eliminating these transactions from our current and future operations. I want the investment community to focus on our current operating model instead of continuing to describe the company based on risk share agreements that we no longer do.
And with that being said we’d like the operator to open line to entertain your questions.
Ladies and gentlemen, at this time, we’ll begin the question-and-answer session. (Operator Instructions) And our first question comes from Corey Greendale from First Analysis. Please go ahead with your question.
Corey Greendale - First Analysis Securities Corporation
To your point about focusing on the fundamentals, I'd like to do that and talk a little about the trends you're seeing in inquiry flow. Can you give us a little bit more background on what you spent on marketing, what you think the drivers of the decline in inquiry flow might be and also what you're seeing in conversion rates once you have those inquiries?
Sure. So going back, probably, early first quarter, we made a couple of changes in our advertising plan where we thought we had some opportunities to generate some efficiencies in the spend. Principally, looking at some new lead scoring models, we implemented two or three different, I'll say methodology for lead scoring to try to help us filter out inquiry that we were generating that really weren't converting, didn't look like perspective inquiries that what were putting in through the system and allocating costs through from a recruitment perspective. We implemented that model after a lot of diligence from a data analysis perspective only to find that certainly we saw a decline in the inquiries which we anticipated, but we did not see the corresponding increase in the conversion rate. So we kind of let the models, the lead tiering models settle a bit. Obviously that impacted us for the first quarter enrollment being down 3.8. Keeping in mind that when you exclude the Criminal Justice and the graphics program and the schools that we discontinued enrollment, we were up 4.8. It still had an impact on that enrollment. And so we kind of went back and revisited what we were doing as we were heading into the second quarter and the June recruitment period and just recently kind of came up with a revised advertising model. We've implemented that, I'll say we've implemented about 75% of those changes, about two weeks ago, we still have some more changes to the make and it's really reallocating dollars, kind of revisiting those lead scoring models and in the last two weeks we've seen nice increase in the inquiry flow. All this time we've not -- whether pre-lead scoring methodology implementation, post changes that I'm recently talking about, the conversion rates have held pretty steady and those would be consistent with prior year which were up on the previous year most notably as a result of the scholarship implementation. So conversion rates don't seem to be the problem. Just some of our self sort of inflicted changes on the advertising plan that we put in early first quarter seem to be the culprit. That being said, obviously impacted first quarter, will impact second quarter, and then these changes we recently made seem to show some signs of life for us. Probably not in enough time to affect the June start because we only have a couple of weeks left, but we're hopeful, although we can't guarantee, we're hopeful that it will result in some positive opportunities for our September intake.
Corey Greendale - First Analysis Securities Corporation
Okay. And if you're starting to see a little bit of improvement maybe this somewhat answers this question, but could you provide some perspective on your thinking about scholarship and net tuition price. In light of the fact that it sounds like whatever benefit you got to demand atleast tapered off and maybe whether you think you might need to reduce net tuition above what you've done already in order to stimulate demand.
At this point based on the data we have it doesn’t appear if there is a need to further adjust scholarships as it relates to increasing demand and it truly does appear as if the enquiry adjustments that we saw were really as a result of changes we made in our advertising plan and the allocation of dollars and trying to be more efficient. So no plans for any increased scholarships as it relates to demand. I will tell you and I have mentioned this before. I do think it’s appropriate for us to sort of pilot different pricing models to try to understand the price demand elasticity ratio to see if in fact that by decreasing pricing somewhat we could see a corresponding increase in demand that would more than offset the investment and the price decrease. So we’re trying to be more intelligent and get smarter if you will about the pricing where we should be and we have a couple of tests going on right now.
We’ll test these pilots that we’re running, we’ll test them through the end of this year and they are not going to have an impact on overall results, because they are only in a handful of schools with a handful of programs. But testing will continue on pricing but no plans for any kind of large scale scholarship increased or pricing change to try to spur demand, we don’t think that’s necessary. And I’ll just remind everyone I mean on scholarship level we’re substantial at this point noting last year we were north of $170 million in institutional scholarships. So we’re very proud of that but I think that’s a rate that probably continues without any need for material increase at this point.
Our next question comes from Sara Gubins from Bank of America Merrill Lynch. Please go ahead with your question.
Sara Gubins - Bank of America Merrill Lynch
A question on 2009 RSAs, is it reasonable to think that you’re assuming about 68% right off rate for the third party loans? Has that rate off rate changed?
The performance on the loans in terms of deferrals really haven’t changed that much Sara. I think I would look at and Dan can add some color if he likes. I would look at more so any kind of change in the reserve that we’re expecting in the sort of 2013 financials for the 2009 RSA to be methodology based, kind of revisiting methodologies or finding methodologies more so than performance degradation, that really hasn’t been the material driver. Dan is correct?
That is, and when you think about the fact that so many of the students are already in repayment, the likelihood that’s going to change dramatically recently or going forward is remote at this point in time. I mean there is such a small number of students who have not yet entered repayment and really what you find is defaults can happen early. They don’t tend to happen down the road, it’s lot of time just first payment delinquency enrolls into default.
Yeah there hasn’t been a major shift recently nor is one anticipated going forward.
Sara Gubins - Bank of America Merrill Lynch
And then on fundamentals and following up on your comments about the advertising model changes. I understand that a change in the advertising model can certainly impact demand. But I guess I am surprised to see the magnitude of the fall off into this upcoming term. Your comparisons are much difficult more difficult to perhaps it’s that but do you think that you’re seeing any real change in underlying demand that you’re able to track or is this simply kind of an executional issue around the advertising model?
So right now I would say probably more the later as much as it pains me to say that but if you look at some of the things we did in the early part of the year entering the year under the guide of gaining some efficiencies we had an expectation that we take out about 10% of our inquiry flow even upwards to 15% to 18% of inquiry flow without having a corresponding impact in our application volume. So that gives you a sense of the degree of inquiry change that we were expecting. We in fact did see that we were able to sort of affect that type of a change with this lead scoring methodology but the corresponding improvement in the conversion rate did not occur when we kind of switch -- I won’t say we switched back we have another version of a model we’ve been running before and went back that model not on its entirety but closer to the previous model we’re seeing that lead flow start to come back and conversion rates are holding.
So again it’s a little bit early right now. It does not appear to be some sort of material shift in the demand that doesn’t seem to the case we’ll need some more time to know for sure. It appears based on our data and our analysis and the results of changes that we made in the advertising model that it appears to be more executional than it is sort of demand.
Our next question comes from Trace A. Urdan from Wells Fargo Securities. Please go ahead with your question.
Trace Urdan - Wells Fargo Securities, LLC
Thanks. Kevin I wonder this may not be possible but I am wondering if you can characterize the second quarter weakness in the context of the variety of demand that you’re seeing across the different programs? In other words is it something that’s going to pull down everybody equally? Are you seeing it disproportionately in some of your programs versus others? Do you have a sense of what we’re looking at as compared to that sort of 4.8% number that excludes criminal justice and design and the seven altered campuses? Is that number going to turn negative? Is that number going to be negative in the double digits? Or any color as far as that aspect if it goes.
I would say this one stretch the trends that we’ve been seeing from a programmatic perspective or the impact on the programmatic new student results appear to be continuing. We haven’t gotten to the point where as an example, School of Criminal Justice is kind of flattening we’re going to see a based on applications right now net applications we’re going to see another pretty substantial decline in new student enrollment in the School of Criminal Justice. Likewise the graphics design programs which are admittedly down in the low single digits percentage of total enrollment at this point we’ll still see a large decline there.
If we take those two sort of programmatic areas that we’re deemphasizing factoring in the schools where we suspended enrollment to say that we’ll be up over prior year, I don’t think that will be the case setting in and there is some opportunity for change there in the last couple of weeks given what’s going on with the lead flow model now. But we’re probably slightly down closer to be in flat in that regards. But generally speaking programmatic trends will continue into the second quarter based on what we’re seeing on the application front.
Trace A. Urdan - Wells Fargo Securities, LLC
Okay. And then with respect to the PEAKS and 2009 RSA obligations, this additional clarity that you now feel that you have with all the students in repayment. Does it aid your efforts to reach a settlement with the investors in those groups or does it may be have the opposite effect and make that seem less urgent or a less meaning goal for your guys?
Sure, I think I would say the later and let me just add some color to it. I think it’s probably less economically viable at this point if you take a look at PEAKS the payments there have been -- the change in our expectation on payments mostly relate to sort of acceleration of the payments and the acceleration as it relates to some of the covenants there is parity ratio that we have to maintain and because of some of the things we’re anticipating with potentially the results from the OCA and some of the adjustments in reserves and things of that nature that’s going to cost those PEAKS payments to be accelerated. And as we talked about there is a fairly substantial payment to them through the remainder of 2014 to bring that balance down to about $96 million let’s say a $100 million.
And so if you look at the way it plays out over the remaining period based on our current projections, the loans are sufficient in terms of repayment and cash collections that are coming in and projected to continue to come in kind of carry that and cover that. And then there is a sort of lump-sum payment at the end the maturity date being January 27, 2020 there is about $28 million that’s still there we pay that in 2020 and then beyond that monies (ph) keep coming in and we’re projecting another $60 million we collect. You kind of look at that all and see kind of where this is going to play out and it makes it tough to see an economic scenario where it would make sense of us for us to go back to the ambassadors and try to get a full blown settlement at this point that’s just based on the way its playing out I don’t see that economically make sense of us or for them. We have had that conversation and we will probably have another conversation but I am just saying, laying it out there I don’t feel that happens quite frankly. Same being true for the RSA, 2009 RSA I mean we have the option to make up fairly substantial payment and $78 million I think or $75 million in 2015 and then another $3 million after that that pretty much takes those defaulted loans off the meter for us and kind of eliminates the obligation going forward and then there’s this money that comes back to us. So, again just based on opportunities here and/or the requirements, requirements more so being relative to the PEAKS, opportunity or options being available on the 2009 RSA. It doesn’t seem like the economics would make sense for a settlement at this point. I hope that make sense and understand it’s complex but that’s kind of what it’s look like right now.
Our next question comes from Tim Connor from William Blair. Please go ahead with your question.
Tim Connor - William Blair
Thanks. I wanted to dig-in on the 7 campuses that you closed I guess, what are sort of the early results of those closures and with the impact that estimated on enrollment and cost structure did it really reach what you are looking for?
Let me try to answer that and if I miss it, you certainly give me a follow-up but in terms of expectations on cost, expectations on impact on enrollment, several of the locations were relocated into other locations and we had a model for anticipated impact of sort of loss as we migrated those students from one location to another. All of that’s coming out as expected, none of it to have any kind of unexpected material impact on the financials or on the enrollment results. Obviously we are calling those out as it relates to new student enrollment results in addition to the criminal justice and graphics programs, just to get folks kind of going forward looking sort of view of the trends. But to your question nothing unusual or unexpected in those seven campuses.
Tim Connor - William Blair
Okay, thanks. And then final one from me, where is capacity utilization right now across the entire campus network just in broad term versus PEAKS and where do you see that going?
Anytime we speak the campus utilization, we typically focus specifically on the evenings and we are probably using 70% of our capacity as it is defined by the number of classrooms in use that are available on a weekly basis in that evening segment. The afternoon segment and the morning segment continue to have a substantial amount of capacity. Obviously the morning segment with their capacity, we are looking to fill with our CPD initiatives but plenty of opportunity in the morning and the afternoon, evening about 70%.
Our next question comes from Jerry Herman from Stifel. Please go ahead with your question.
Jerry Herman - Stifel, Nicolaus & Co.
I was hoping you could talk a little bit about gainful employment and maybe more generally value proposition. You guys are making good moves with regard to price reductions and programmatic repositioning or the portfolio changes in the programs that you are offering but how you are thinking about gainful employment now the way it’s currently configured, how much will you have to change if it goes through as proposed relative to what’s already happened?
I think your comments are appropriate and we think of it the same way. We made a lot of changes since the G1.0 came out. We have substantially reduced the cost for students through the implementation of substantial amounts of institutional scholarships. We have reduced tuition just on its face as it relates to changing our programs, associate to programs anyways, from eight quarters to seven quarters. And so, we think we are kind of putting ourselves in a right place. The programmatic focus of course, if we weren’t seeing the salaries and the employment rates even and also that’s necessarily impact for GE but certainly impactful for our goals and missions. If we didn’t see the right salary and employment rates then we voluntarily discontinued enrollment there. And any programmatic expansion efforts are focused as they have always been in areas where we see job growth in excess of national averages. So, I think we are very well positioned programmatically and I think fair all the data is available.
Some of the gainful employment, we think some of the challenges with it not the least of which but one of them is the retroactive nature of it, makes it a little bit tough. But needless to say the changes we made position us well going forward. We are just going to have to see where the data is and other problem is we don’t have the data, we don’t have the salary information, so that’s a challenge. But I think we are doing everything we can do with all the information that’s available to position us well or we are just going to have to see where the final rule comes out and go from there. But any additional major changes aren’t anticipated but again we will reserve the right to comment differently once we see what the final rule is.
Jerry Herman - Stifel, Nicolaus & Co.
Great, thanks, and the follow-up’s just on the opportunity, scholarship, sort of the penetration area or the percentage of students that are now using that scholarship, especially in the context of the comments you guys made about 90-10 because it was a thorough understanding you had a fair amount of headroom under 90-10 that allowed you to reduce price, can you talk about that.
Yes, I think we still have some headroom there, so we didn’t mean to imply that we do not and we have headroom if we wanted to move price around. At this point I think we had a previous question on demand and whether we thought we needed to move price for demand and I don’t think that’s the issue at this particular point. The scholarships right now, we’re probably in the mid 70% in terms of utilization rate and that kind of makes sense, it’s a little north of the rate of folks who would have been using private lending and that’s because it’s applicable to more than just folks who would had a GAAP need but that’s probably where we settle in and about 75% of the students receiving some form of scholarship and scholarship levels again on a revenue basis, a 170 million last year. That probably continues, so but to your point if we need to, if we need to make more price adjustments as it relates to 90-10, we certainly have room to do that, I just don’t see that right now, but we’re continuing to run pricing tests and models that I mentioned before to see if fresh demand elasticity ratio price elasticity ratio can be favorable if we move the dial over more. But again nothing planned right now.
Our next question comes from Susie Stein from Morgan Stanley; please go ahead with your question.
Susie Stein - Morgan Stanley
Hi, thanks, first could you clarify the issue with the parity ratio, why does the asset liability ratio need to be raised based on the company’s estimated leverage ratio, I guess I thought the leverage ratio was coming down and the how does the sale leaseback transaction play into this.
Well we start off with this parity ratio, there’s certain requirements we have to meet a parity ratio based upon the metrics for the company itself, so as Kevin mentioned earlier some of the things that have taken place, increasing the reserves and potentially some of the outcome with respect to an OCA answer had an impact on one figure, our leverage ratio, so that would require an asset liability ratio, higher than what we’ve had to maintain up to this point in time.
And just to be clear through the, you know everything we’re talking about here in terms of cash payments here in the parity ratio for PEAKS and acceleration of those acceleration of those payments, it’s contemplating what we anticipate the outcome of OCA to be, we don’t know what it’ll be, we don’t have any clarity on that. We’re making estimates and assumptions on that. but if, let’s say for example if we have to consolidate, we’re going to have bring the senior note liabilities of PEAKS on to the balance sheet and so that’ll will be on the balance sheet that isn’t there today and that’ll have an impact on some of the other ratios that could impact or require an increase in the parity ratio within PEAKS. So that’s how they kind of all tie in, the sales leaseback in and of itself at this point would necessarily have an impact on that parity ratio if is in fact as we expect an operating lease. If it’s a capital lease it may have an impact and we’re factoring that into it as well. Right now we think it’s an operating lease but still kind of playing around with terms so that could change, but we to factor all that in when we think about what are these cash implications and while we can’t speak to the accounting right now because we don’t have an audit. We’re trying to speak over that and say well at least we think we can talk to about cash, should the accounting comes out the way we expect it to and that’s the goal of today, just lay out that cash out there so you can see what it looks like.
Our next question comes from Jeff Volshteyn from JP Morgan, please go ahead with your question.
Jeff Volshteyn - JPMorgan
Thank you for taking my question. I just want to get an updated number on the outstanding principle under PEAKS and under the 2009 RSA.
Well under the PEAKS program the settlement payment, payment we just made recently it’s 215, it was 255 prior to that, it’s 215. The outstanding balance under the RSA, really that’s not applicable because in that program you’re guaranteeing the student loan balances so you that’s why we try to give some clarity as far as the payment but one other thing just want to mention on, and Kevin touched upon this earlier and maybe it was in my comments that the expectation with these payments that we’re going to be making this year for PEAKs. That the outstanding balance under the senior notes at the end of the year would be $96 million, so I think that’s something, so there’s a significant move there and the other thing just to reiterate was mentioned before, at that level based upon the performing loans the expectation is, performing loans will be able to meet the current obligation to the trust and have some impact as far as releasing some of the principal balance of the senior notes.
And our next question comes from Peter Appert from Piper Jaffray, please go ahead with your question.
John Trevor - Piper Jaffray
Ah yes, you got John Trevor on for Peter, just real quickly on the sale leaseback, why don’t just comment about the proposed terms compared to maybe prior investment from that investor or investments in that space and then maybe talk about the utilization profile of both potential campuses just so we understand given the 15-year lease terms going forward.
Sure. So the terms on the lease, I think you're asking a market comparison, so-to-speak, we think they're comparable or favorable to transactions in the space. The folks we're working with from a brokerage perspective have dealt with other transactions in the space and we've got homework to do, the market comparison and feel good about the terms at this particular point. In terms of utilization of the properties, it wouldn't be any different than what we're seeing at the averages. Nothing sticks out in any of those properties. Obviously there's due diligence on each of those properties being conducted but I wouldn't look at any of those and say that anything sticks out in terms of higher or lower utilization rates at this point.
And our next question comes from Paul Ginocchio from Deutsche Bank, please go ahead with your question.
Paul Ginocchio - Deutsche Bank
Thanks, just, Kevin back to your last comment about the remaining student loans in the PEAKS program being sufficient to pay down or to pay the interest on the 96 million of senior notes, what are the key assumptions, what is the repayment rate you’re assuming. My follow-up’s around the cost, not talking about revenue but can you just talk about the key cost trends, the cost of sales excluding bad debt, advertizing cost and G&A cost.
Sure, let me take the last first. From a cost perspective in terms of trending, obviously we’re doing everything we can to be efficient and still in somewhat of a cost cutting, we don’t expect total cost reduction similar to 2013 but we’re still cutting that cost, I would say, without giving any guidance or goals which was kind of staying away from that until we get our financial statements completed for 2013. You know I would say if you’re modeling sort of consistent cost you’re going to be safe in that regard but again cost containment is certainly a part of what we’re doing. Can’t give any targeted goals right now, maybe in our follow up call, after the audit’s complete we can give a little more color on that. And then your first question.
Paul Ginocchio - Deutsche Bank
So we haven’t really made any changes in terms of the previously disclosed performance on the loans as Dan mentioned and I think I mentioned as well. You know we got 99% plus students who have, they’ve gone into repayment, so we’ve got most of these folks in a status where we have good history on what the roll rates are, they’re not anything near where we anticipated, they’re a lot worse than we anticipated, anyone involved in this ever anticipated but it is what it is. Again they haven’t changed that much, and we’re assuming any improvements at all, we’re just taking the very disappointing performance that we’ve seen just far and just rolling it forward. And as Dan mentioned, and I think I mentioned, the $96 million projected outstanding balances of senior PEAKS notes at 12/31/14 will be mostly carried by the student loan performance as well as the expenses there. We're not anticipating making any payments. That is until the maturity date. There will be a balance outstanding of about $28 million or so that we'll have to make that payment. But then again, there's still loans there. They're still paying based on the projections and we'll collect another $60 million throughout the terms that we mentioned in our prepared comments.
And ladies and gentlemen, we’ve reached the end of today’s allotted time for the question and answer session; I would like to turn the conference call back over to management for any closing remarks.
Thank you, operator. Thanks everyone for your participation today, hopefully today’s additional disclosures provide you with some additional clarity, again we appreciate everybody’s understanding for our inability to speak to any of the accounting issues. We’re working extremely diligently to try to close the 2013 financials, complete the audit and get our 10-K filed and as soon we do we hope to provide some additional clarity around the accounting and also then provide potentially some internal goals and some guidance for you. Again thanks for your time today, and look forward to talking to you soon, thank you.
Ladies and gentlemen that does conclude today’s conference call. We do thank you for attending, you may now disconnect your telephone lines.
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