ITT Educational Services' (ESI) CEO Kevin Modany Q1 2016 Results - Earnings Call Transcript

| About: ITT Educational (ESI)

ITT Educational Services Inc. (NYSE:ESI)

Q1 2016 Earnings Conference Call

April 29, 2016 11:00 AM ET

Executives

Nicole Elam – Investor Relations

Kevin Modany – Chief Executive Officer

Rocco Tarasi – Chief Financial Officer, Executive Vice President

Operator

Good morning, and welcome to the ITT Educational Services, Inc. 2016 First Quarter Earnings Conference call. I would now like to turn the conference over to Nicole Elam. Please go ahead.

Nicole Elam

Greetings, ladies and gentlemen. At this time, all participants are in a listen-only mode. 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 Rocco Tarasi, Executive Vice President and Chief Financial Officer.

Before we begin, ITT Educational Services 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 the news release dated April 26, 2016 or in the company's public filings with the US Securities and Exchange Commission.

Thank you, Mr. Modany. You may begin.

Kevin Modany

Thank you, Nicole. And good morning everyone, and thank you for joining us on this conference call to review our 2016 first quarter financial and operating results. Joining me on the call this morning as usual, is Executive Vice President and Chief Financial Officer, Rocco Tarasi.

On the call this morning, I’ll start things off by providing comments regarding our first quarter operating results. Following my comments Rocco will provide an overview of our financial results reported in this morning's release. After Rocco’s comments I will then provide a very brief legal and regulatory update, as well as a few thoughts on various influential factors impacting our current operating environment. Consistent with our recent practice we will not be taking any analyst questions following our prepared remarks.

Let’s get started by reviewing the enrollment results that we reported in today's release. New student enrollment in three months ended March 31, 2016 decreased 16.4% compared to the three months ended March 31, 2015. Our advertising efforts in the first quarter generated prospective student inquiries in line with our expectations and our marketing plans; however we continue to experience a decline in the conversion rate of those perspective student inquiries to new student enrollments.

We continue to believe the decrease in the perspective new student conversion rates for the first quarter of 2016 compared to the first quarter of 2015 in recent prior periods were a result of perspective students, greater sensitivity to the cost of postsecondary education, and uncertainty about value of the postsecondary secondary education due to the prolonged economic and labor market disruptions. In addition, we believe that the current media and political environment is also negatively impacting our new student enrollment results. I’ll speak to this point a little later in the call.

Further we believe our new student enrollment results for the three months ended March 31, 2016 compared to the same period in 2015 were impacted by a reduction in a number of campus locations that were recruiting new students in the three months ended March 31, 2016 as compared to the same prior year period.

As of March 31, 2016, we had a 138 campus locations, which included 126 campuses that were actively recruiting new students for academic periods that began in the three months ended June 30, 2016. As we’ve previously reported, beginning in the three months ended September 2015, we revised our definition of a new student to exclude any student who was a first time student and was enrolled in an online degree program who did continue to attend classes in his or her program of study beyond the first 15 days of the programs time or 30 days if the student was only enrolled in courses that are taught over a 12 week period.

Taking into account these factors, if we exclude the impact from the campuses that did not recruit new students in the first quarter of 2016, but did recruit new students in the same prior year period, most of the result of our decision to evaluate the viability of these markets, and the result of the change in the definition of a new student.

New student enrollment would have declined by 11.8% in the first quarter of 2016, compared to the same period in the prior year. As you could see there are several moving parts for the new student enrollment result that we reported this morning. However, we wanted to share the impact of some of these operational changes to help provide color on the new student enrollment results for the first quarter of 2016 compared to the same prior year period.

Looking ahead to the second quarter of 2016, we expect the headwinds to continue to negatively impact our new student enrollment. The persistent for the difficult enrollment environment along with the impact of our efforts to right size our campus network in line with current market conditions are expected to continue to negatively impact new student enrollment for the remainder of 2016. While we continue to generate prospective student inquiries in line with our marketing plan, we have not experienced a conversion of those prospective student inquiries to student applications for the academic periods that are scheduled to begin in the second quarter of 2016 that are in line with our expectations.

To give you a sense of the current new student application trends, as of April 25, 2016, new student application for academic periods that are scheduled to begin in the second quarter of 2016 net of cancellations were 20% less than at the same date in the prior year. Suggesting [ph] that the trend of year-over-year declines in new student enrollment will continue as we head towards the middle of the year and possibly throughout the remainder of 2016; as a resulting result we are adjusting our current expectations for new student enrollment for the full year of 2016 from our original estimate for a decline between 12% and 15% compared to full-year 2015 to revive estimate of a decline between 15% to 20% for the full-year of 2016 compared to 2015.

Turning now to a quick discussion of student persistence rates. Just as a reminder, the student persistence rate measures the number of continuing students’ in any academic term to [indiscernible] about a total student enrollment in education programs in immediately preceding academic term. On March 31, 2016 student persistence rate increased by 90 basis points to 70.1% compared to 69.2% as of the same date in the prior year, principally as a result of an increase in student retention and certain programs aside, to a lesser degree a decrease in graduates in the three months ended March 31, 2016.

Moving on to a quick look at our graduate employment metrics. As of April 23, 2016, the graduate employment rate for our 2015 ITT Technical Institute employable graduates was 270 basis points lower than the graduate employment rate of our 2014 ITT Technical Institute employable graduates as of the same date in 2015. As of April 23, 2016, the average annual salary reported by our 2015 ITT Technical Institute employed graduates increased 5.6% compared to the average annual salary reported by our 2014 ITT Technical Institute employee graduates as of the same date in 2015.

At this point, I’d like to hand the call over to Rocco for a review of the financial results included in this morning's release.

Rocco Tarasi

Thanks Kevin. I will begin my comments by noting that while the new student enrollment challenges discontinued in the first quarter of 2016 we also continued to be good stewards of our resources and maintained our focus on cost containment and rightsizing our operations, in line with the changes in our total student enrollment.

I’d like to provide a more detailed look at a few of the financial metrics for the first quarter of 2016 compared to the first quarter of 2015. Starting first with the income statement; revenue decreased $38.5 million or 16.7% to $191.5 million in the three months ended March 31, 2016 compared to $230.0 million in the three months ended March 31, 2015. The primary factor that contributed to this decrease was the 16.3% decrease in total student enrollment as of December 31, 2015 compared to December 31, 2014.

Cost of educational services decreased $10.9 million or 10.5% to $92.6 million in the three months ended March 31, 2016 compared to $103.6 million in the three months ended March 31, 2015. The primary factors that contributed to this decrease were decrease in compensation of benefit costs, resulting from fewer employees and decreases in campus operating and occupancy cost as a result of fewer physical locations and reduced square footage.

Student services and administrative expenses decreased $12.4 million or 13.7% to $77.9 million in the three months ended March 31, 2016, compared to $90.3 million in the three months ended March 31, 2015. The principal causes of this decrease were decreases in debt expense, compensation of benefits cost, and media advertising expenses. Bad debt expense as a percentage of revenue decreased to 3.8% in the three months ended March 31, 2016 compared to 5.3% in the three months ended March 31, 2015, primarily as a result of a reduction in internal student financing from utilization of the opportunity scholarship and other institutional scholarships and awards.

The legal and professional fees related to certain lawsuits, investigations and accounting matters decreased $2.4 million or 33.1% to $4.9 million in the three months ended March 31, 2016 compared to $7.3 million in the three months ended March 31, 2015. In the three months ended March 31, 2016, these expenses related primarily to legal and professional fees associated with the SEC litigation, the Massachusetts Attorney General Litigations, the CFPB litigation and the New Mexico Attorney General Litigation.

Operating income decreased $13.4 million or 48.6% to $14.2 million in the three months ended March 31, 2016 compared to $27.6 million in the three months ended March 31, 2015, primarily as a result of the impact of the factors previously discussed.

Interest income was less than $0.1 million in the three months ended March 31, 2016 and March 31, 2015. Interest expense decreased $3.3 million or 31.7% to $7.1 million in the three months ended March 31, 2016 compared to $10.4 million in the three months ended March 31, 2015.

Our combined federal and state effective income tax rate was 42.9% in the three months ended March 31, 2016, compared to 39.5% in the three months ended March 31, 2015. The effective income tax rate was higher in the three months ended March 31, 2016, primarily due to lower pretax income compared to the three months ended March 31, 2015, while the amount of interest recorded for unrecognized tax benefits remained approximately the same between the two periods.

Moving on now to a quick review of the balance sheet and cash flow metrics. Cash and cash equivalents were $108.7 million as of March 31, 2016, compared to $130.9 million as of December 31, 2015 and $146.0 million as of March 31, 2015. The $22.2 million decrease in cash and cash equivalents as of March 31, 2016 compared to December 31, 2015 was primarily due to repayments of principal totaling approximately $7.0 million related to the peak senior debts, $7.6 million related to the CUSO secured borrowing obligations, and $19.2 million under the financing agreement. The decrease in cash and cash equivalent as of March 31, 2016 compared to December 31, 2015 was partially offset by net cash flows generated from operating activities of $12.3 million.

Accounts receivable less allowance for doubtful accounts was $47.1 million as of March 31, 2016 compared to $46.2 million as of March 31, 2015. Days sales outstanding increased 4.3 days to 22.4 days at March 31, 2016 compared to 18.1 days at March 31, 2015. Our accounts receivable balance increased as of March 31, 2016, primarily due to the delay in the receipt of title IV funds following our implementation of additional procedures required by the Ed in October 2015.

Capital expenditures including expenditures for facility renovation, expansion and construction totaled $0.7 million in the three months ended March 31, 2016 compared to $0.9 million in the three months ended March 31, 2015. These expenditures consisted primarily of classroom and laboratory equipment, such as computers and electronic equipment, classroom and office furniture, software and leasehold improvements.

Moving on now to a review of our projected payments related to our guarantee and financing obligations. Based on various assumptions, including the historical and projected performance and collection of the student loans held by the PEAKS Trust and the CUSO, our current estimate of the payments we may have to make under the PEAKS guarantee and the CUSO risk sharing agreement for CUSO RSA, in the aggregate, we believe are approximately $27.4 million in 2016, $12.6 million in 2017, $13.0 million in 2018, and $105.3 million in 2019 and later. These estimated payment amounts are net of an estimated aggregate recoveries of approximately $3.8 million under the CUSO RSA, which the company expects to offset against the amounts due by it under the CUSO RSA over these periods.

Lastly, we currently estimate that we will make principal payments of approximately $50.5 million under the service financing agreement in the nine months ended December 31, 2016, after which point we expect the full balance of the financing agreement to be repaid.

Based on our current projections, we believe the cash generated from operations will be sufficient for us to satisfy our payments under the RSA's, working capital, loan repayment and capital expenditure requirements over the next 12 months.

And now, before I turn it over – back over to Kevin, I’d like to close my comments by noting that assuming our new student enrollment estimates that Kevin provided earlier are realized and there are no material changes in our student retention metrics for the remainder of 2016 as compared to 2015 and assuming that we maintain our focus on cost containment efforts as anticipated, we are increasing our internal goal for earnings before interest, taxes, depreciation and amortization or EBITDA for the 12 months ended December 31, 2016 from the previous range of $50 million to $70 million to a revised range of $55 million to $75 million. Please note the projected EBITDA for the non-GAAP financial measure and the reconciliation to projected net income is provided on our website at www.ittesi.com.

Our internal EBITDA goal includes an estimated $15 million in expenses for the full year of 2016 for various lawsuits, investigations and accounting matters that we believe are not representative of those normally incurred in the ordinary course of business, including charges related to the SEC, CFPB, Attorney’s General and DOJ matters.

Kevin, back to you.

Kevin Modany

Thanks, Rocco. Before we conclude our comments on today’s call, I’d like to provide a brief update on few legal and regulatory matters, and a few thoughts regarding ongoing and unsubstantiated media and political attacks that have become somewhat of a routine for the tax paying postsecondary education sectors.

First a quick review of few of the pending regulatory and legal matters. While there no material updates to report on the multi-state AG or CFPB matters at this time, we should note that we are engaged in fairly regular discussions with both the AG group and the CFPB with regard to the prospects or mutual acceptable resolution to these matters. That said, we are in no position to provide any assurances that our discussions will result in a favorable or otherwise resolution of these matters any time soon or at all. We should point out that it is not unusual for these types of conversations to occur at this stage of the process.

Again, we should emphasize as the conversations are ongoing, we do not and cannot suggest I believe a favorable resolution as eminent or even attainable. As regard to the SEC matter than company vehemently disagrees with the SECs position and continues to diligently prepare for the next stops in the litigation process. As we have said before we are confident that the evidence does not support the SEC's claims, and we are eager to have the court clear our reputation.

At this point, I’d like to shift gears and take this opportunity to provide a few thoughts and comments regarding the ongoing media and political environment, and we believe continues to impact our ability to execute on our mission of helping students, improve their lives to the pursuit of high quality career based education.

Over the past several years, ITT Technical Institute has been the target of various allegations, many of them concerned private education loans a third-party lenders issued the ITT Tech students, when the private loan market dried up in the financial crisis of 2008 and 2009. The accusations are persistent despite the fact these loans have not been originated for approximately five years. Unfortunately the claims against ITT elevate ideology over evidence and ignore ITT’s long and exemplary record of helping students to better their lives. We categorically deny any allegation ongoing.

Many of ITT’s critics are Washington insiders and the media and political allies, who have an ideological bias against the for-profit higher education sector. These individuals ignore the fact that for-profit colleges and universities are tax paying institutions that achieve better outcomes for non-traditional students than many non-for-profit schools and community colleges. Most of these individuals have never set foot in one of our schools, who haven’t spoken with our administrators, faculty staff or employer partners. First of all, these individuals are determined of a barred ITT and the sector as a whole, with one sided attacks, even in the absence of any proof of our ongoing.

The single minded objective of individuals behind these baseless attacks is simply this; to eliminate for-profit education in America. While America is going through a period of political change, we still firmly believe that the overwhelming majority of our society respects due process as a fundamental American principal. Due process requires four depriving a citizen of life, liberty or property that government must follow fair procedures. IT means that the government may not dispense its owned freewheeling brand of justice according to the political passions, but follow the law. It means the accusations are not proven with ideology and work, but with facts and evidence.

Unfortunately due process is woefully lacking in the political witch-hunt that is unfairly targeted ITT. Last week our creditor, ACICS issued ITT what is known as a show cause direct letter. The letter requires us to explain why our accreditation should not be suspended or otherwise conditioned. The letter sites a grab bag of unproven accusations against our organizations including a local news report about a small number of disgruntled former students. In that respect, the request channels the same guilty until proven innocent mindset that has been shown by opponents of the for-profit sector. Having said that, we are sympathetic to ACICS given the enormous ideological pressure they are under as an accreditor of ITT, and others in the sector.

Make no mistake, we take ACICSs request for information very seriously. We intend to submit a comprehensive and timely response, demonstrating that ITT has been and continues to be in full compliance with ACICS standards of accreditation. We at ITT Technical Institute are proud of our 50 year history as postsecondary institutions. We’ve worked hard to help hundreds of thousands of students, improve their lives through high quality career based education, while staying true to our core principles of quality, compliance and customer satisfaction. We are confident that if we receive fair treatment in due process, the cornerstones of this great country’s legal systems, ITT’s history of service and success will continue.

With all of that said, we’ve concluded our prepared comments for today's call. We want to thank everyone for your time today and your interest in our institution. And we look forward to talking with you all very soon.

Operator you may disconnect the line.

Operator

Thank you. The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

Question-and-Answer Session

Q -

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