Lincoln Educational Services Corp (LINC) 2005 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2005 Lincoln Educational Services earnings conference call. At this time all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. And now I would like to turn the presentation over to your host for today's call, Mr. Scott Shaw, Senior Vice President of strategic planning and Investor Relations. Please proceed, sir.

Good morning, everyone and thank you for joining us today for Lincoln Educational Services first quarterly conference call. With me this morning are Larry Brown, our President and COO, and Cesar Ribeiro our Vice President and CFO. Unfortunately Dave Carney, our Chairman and CEO cannot join us this morning. Dave was not feeling well and went to the hospital for some tests and as a precaution they kept him in for the weekend. Our latest information is that he expects to be released this week, and we look forward to seeing him back in the office. In his absence Larry Brown will read his prepared remarks.

During this call we will review our second-quarter results followed by a question-and-answer session. During the Q&A we ask that you please limit your questions to no more than one and one follow-up. This conference call is being webcast, and an audio version of the call will be available on our website for ninety days. Before we begin, we would like to remind everyone that this conference call may contain certain forward-looking statements relating to future events, future financial performance, strategies, expectations, competitive environment, regulations and availability of resources. Such forward-looking statements are based upon current expectations that involve risks and uncertainties. Actual results may differ materially from those stated in any forward-looking statements based on a number of factors and other risks, which are more specifically identified in our filings with the SEC. And now Larry will read from Dave's prepared remarks.

Good morning, everyone, and thank you for joining us today to review our second-quarter results. I hope that you had an opportunity to review the press release that we issued this morning. We are extremely pleased with our performance for the second quarter, highlighted by a 15.3% increase in revenue over the prior period. Our total revenues for the second quarter were 68.2 million. If you exclude the revenues attributable to New England Technical Institute which we acquired in January of this year, our revenues increased by a 8.9%.

Average student enrollment for the quarter was 16,909, an increase of 10.9% year-over-year and excluding the acquisition of New England Technical Institute, our average student enrollment increased 3.6%. Net income of 42,000 for the second quarter exceeded our internal expectations driven by better-than-expected operating efficiencies. During the quarter we have continued to make progress in executing our growth strategy. Let me take a moment to highlight a few of those initiatives.

One of our growth strategies is to increase our associate degree offerings. Associate degrees provide additional advantages for our students in the form of opportunities for promotion, as well as higher earnings potential. Associate degrees extend the length of time students remain on our campuses, which results in additional revenue and improved margins. During the quarter the percentage of our students who were enrolled in associate degree programs increased from 8% to 11% of our overall student population. We expect this to have a meaningful contribution to our growth in 2006 and beyond.

Our focus on developing new programs as well as replicating existing programs resulted in the launching of our first dental assistant program in one campus and our medical coding and billing program in five campuses. And over the next four months we expect to introduce medical billing and coding into six more of our campuses. In addition we are developing two new associate degree programs, health information technology and criminal justice which we will be introducing in 2006.

Now with regard to program diversification in addition to those discussed earlier, we are currently evaluating new locations to expand the culinary and electrician programs that we obtained with the acquisition of New England Technical Institute. Both of these programs have experienced strong demand from students and employers. Additionally, in consultation with our local advisory boards we have enhanced our electronic systems technology program to better prepare our students for the workplace. These enhancements will increase the length of the program by 50%.

We are very pleased with the success of our recently expanded Indianapolis campus. With its expansion not only increased our capacity for existing programs, but also provides us with additional opportunities for growth by adding additional curricula such as collision repair and electronic systems technology. Which is our low voltage electronics program focused on careers such as security systems and home theater installation repair. Due to the high demand for our collision repair program our Indianapolis campus is expected to add a third shift during the second half of the year. We view these facility expansion opportunities as low-risk growth initiatives since we are leveraging our existing trained management and we build upon our strong brand recognition in those markets.

We will be replicating our Indianapolis success with two other campuses, Philadelphia, Lincoln Tech and Grand Prairie, Texas since they are at or near capacity. Each is expected to open in the first quarter of 2006. Startup schools are another part of our growth strategy. We have begun sending out our new Queens, New York automotive school and for those of you who are not familiar with this project, we were selected by the Greater New York Automobile Dealers Association in a competitive process to operate an automotive training school for the benefit of the dealer organization at the newly created Center for Automotive Education and Training at Whitestone, Queens.

This association represents more than 500 dealers in the New York City region. And the facility was designed to meet the growing demand for skilled technicians in the Greater New York metropolitan area. Our Queens school will have a capacity of 800 to 1000 students, and our first class will begin in the first quarter of 2006. The Queens school and our new additions in Philadelphia and Grand Prairie will add 230,000 square feet of capacity, which can accommodate approximately 3500 students.

During the quarter we continue to make progress in building our online initiative. And as a result we expect to offer an online degree completion program in allied health by the end of this year. A degree completion program enables current students as well as our prior graduates, the ability to take online general education classes in order to earn additional credits toward obtaining their associate degree. Moreover, by this time next year we intend to offer our first 100% online course which will enable us to reach an entirely new market.

We continue our disciplined approach of looking for small, strategic acquisitions that will add new programs, new markets, new degrees and also where we can quickly add value. In all cases we expect that any acquisition should be at least earnings neutral in the first year. And to that end, we executed a second nonbinding letter of intent. These letters of intent are subject to the completion of due diligence and the negotiation and execution of definitive purchase agreements. And we cannot assure you that the acquisitions will ultimately be consummated.

Now at this time I want to focus my remarks on the operational aspects of the business. We believe one of our core strengths is our diversification. Not only in our schools, but in our curriculum. This diversification enables us to obtain greater penetration into the local markets we serve; it provides opportunities for growth and it minimizes risk to our company. As highlighted earlier, one area of growth for our company is our initiative to increase our degree offering. This provides us with the ability to increase our addressable market and to this end, during the first half of the year our Las Vegas school and our two Atlanta schools were approved to offer associate degrees. This brings the number of degree granting campuses to 16 out of 32.

Further, we are in the application process for associate degree programs in several more campuses, as well as our first bachelor's degree granting school. As degree granting is favorably viewed by high school students, their parents and guidance counselors, we expect that this initiative will produce favorable results beginning with this fall's high school recruitment effort. As discussed in our prospectus, the first quarter of 2005 proved to be a challenge, primarily due to a difficult TV advertising environment. And during the first quarter we experienced negative starts as compared to the prior year. As we stated before, our business is seasonal in nature, and the second quarter has historically been our slowest quarter for new student starts.

During the second quarter in spite of the negative trend in our first quarter, and the seasonality that is inherent in our business model, we saw a reversal from the first quarter's trends and we experienced positive starts on a quarter-over-quarter basis. These positive trends led to an increase in our average population of 10.9%, 3.6% exclusive of New England Technical Institute for the second quarter of 2005 as compared to the second quarter of 2004. We achieved this in the face of a continuing difficult television advertising environment.

In particular, a significant rate increase in some of our markets as well as a decrease in responses to our ads. We are able to mitigate this through improved conversion rates, which increased 300 basis points over the prior year on our television leads. We also shifted more of our media budget to Internet advertising. We will continue to manage our advertising mix to optimize the results. This produced favorable results for us quarter-over-quarter.

In an effort to address the challenging television market we face, we have taken the following initiatives. We have developed and rolled out new television creative across several of our disciplines. We have developed a 30 minute infomercial that is now running in two of our markets. We have rolled out advertising that is targeted to the Hispanic community. We have commenced a national table test for our automotive schools. We've enhanced our admissions representative training to help capture more of our rapidly growing Internet lead flow. We have commenced late-night television advertising to support our third shift in collision repair in our Indianapolis school and our fourth shift in our Grand Prairie, Texas school. And we are establishing a warm transfer program to a telemarketing company engaged to screen and transfer our Web leads to work our unconverted high school leads and in one case, to prequalify our television leads.

While none of us can predict when the advertising markets will improve, we are optimistic that these new initiatives will have a positive impact on our future results. I will now turn the call over to Caesar to discuss our financial results.

Thank you, Larry. I've outlined in our press release for the three months ended June 30, 2005 our revenues grew 15.3% to 68.2 million. This represents an increase of 9 million as compared to revenues of 59.2 million for the three months ended June 30, 2004. Of this increase approximately 3.8 million or 6.4% is due to our acquisition in New England Technical Institute in January. The remainder of the increase was primarily due to a 3.6% increase in our average undergraduate full-time student enrollment, which increased to 15,789 exclusive of New England Technical Institute for the three months ended June 30, 2005 as compared to 15,247 for the three months ended June 30, 2004. As well as from tuition increases, which averaged between 2 to 5% annually depending on the program.

Our operating income for the three months ended June 30, 2005 was 800,000 as compared to 1.4 million for the prior quarter. This led to a decrease in our operating margin for the quarter from 3.6 to 1.2%. As Larry stated our business is seasonal in nature and historically approximately 43 to 45% of our revenues and 47 to 49% of our yearly expenses occur in the first half of the year. The decreases in our operating income and operating margin for the quarter were less than our internal expectations, and were driven primarily by the acquisition of New England Technical Institute as well as planned increases in the first half of the year geared towards driving our second half growth.

In order to fuel this growth we have and continue to invest in extending our facilities. Accordingly our facility costs increased 15% on a same school basis over prior year due to rent on our new Queens, New York facility; our expanded campus facilities in Lincoln, Rhode Island and Marietta, Georgia, and as a result of our expanded corporate facilities. This also led to an increase in the second quarter of our selling, general and administrative expenses from the prior quarter by 50 basis points. SG&A for the three months ended June 30, 2005 represented 55.5% of revenues as compared to 55% from the prior quarter.

This represented an increase of 5.3 million or 16.4%. Approximately 1.4 million or 4.4% of this increase was due to the acquisition of New England Technical Institute while the remainder was due to a 29.1% increase in marketing costs as previously outlined by Larry. Our interest expense for the second quarter was 800,000, representing an increase of 100,000 or 7.5% from 700,000 for the second quarter last year. This was primarily due to an increase in the average debt balance outstanding under our previous credit agreement as a result of our acquisition from the New England Technical Institute.

Our provision for income taxes for the second quarter was 30,000 or 41.3% of pre-tax income compared to 600,000 or 39.9% of pre-tax income for the second quarter of 2004. The higher effective tax rate for this quarter is primarily attributable to our (indiscernible) taxes based upon our expected effective tax rate for the year ended December 31, 2005. Net income for the quarter of 42,000 or zero cents per share was less the net income of 860,000 or $0.04 per share in prior year but exceed our internal expectations which were for the company to lose money during the quarter. As previously stated, this was due to better-than-expected operating efficiencies.

During the quarter we received 53.1 million in net cash proceeds from our IPO. We utilized 31 million of these proceeds to repay all amounts outstanding under our credit facility. Subsequent to June 30, we received an additional 3.3 million resulting from the partial exercise of the underwriters over allotment option. As a result, our balance sheet as of June 30, 2005 remains very strong with cash and cash equivalents of 30.2 million and no amounts outstanding under our credit facility.

We also continue to experience favorable trends in our day's sales outstanding. As of June 30, 2005 our day's sales outstanding were 16.6 compared to 17.3 as of June 30, 2004. Our bad debt expense remained relatively flat, and as a percentage of revenues was 3.6% for the quarter ended June 30, 2005 as compared to 3.5% in the prior quarter. For the six months ended June 30, 2005 our bad debt expense as a percentage of revenue was 3.4% compared to 3.3% for the first half of prior year.

Our capital expenditures for the six months ended June 30, 2005 were 6.6 million as compared to 12.8 million in the same period in the prior year. In the coming quarters we expect our capital expenditures to increase significantly as we have begun to build out our Queens campus and look to extend both our Philadelphia Lincoln Tech campus as well as our Grand Prairie Texas campus. For economic reasons we anticipate purchasing these two new facilities and as a result expect capital expenditures for the year to be between 15 to 18% of revenue.

Finally, with respect to guidance we will only be providing guidance on revenues, net income and earnings per share for the next fiscal quarter as well as the fiscal year. Our guidance is based on current expectations. It is forward-looking, and actual results may differ materially and as a result the factors outlined in our prospectus. As we outlined in our press release earlier this morning, our guidance for the third quarter and for the year is as follows.

For the three months ended December 30, 2005 revenues of $78,082,000, net income of $4.5 to $5.5 million, basic earnings per share of $0.18 to $0.20 fully diluted earnings per share of $0.17 to $0.21. For the year ended December 31, 2005 revenues of $305 to $315 million, net income of $18 to $20 million, basic earnings per share of $0.77 to $0.85 and fully diluted earnings per share of $0.73 to $0.81. Earnings per fully diluted share for the year ended December 31, 2005 includes a $0.05 charge for stock-based compensation resulting from our accounting for stock-based competition in accordance with state financial accounting standard number 123. Now let me turn it back to Larry.

Our business is all about people. And we know the ultimate success is predicated on the hard work and dedication of our employees who day in and day out provide opportunities for our students to change their lives in a meaningful way. Without these hard-working people our company would not have achieved this level of success, and we truly do appreciate their efforts. We would now like to begin the question-and-answer portion of the call. So operator, would you please put the first call through?

(OPERATOR INSTRUCTIONS) Sarah Givens (ph), Merrill Lynch.

My first question is about the enrollment environment. It seems like it is still somewhat difficult and I am wondering if you are seeing weaknesses or strengths by particular type of programs or particular geographies. And any sense that you can give us on why TV advertising may be more challenging than in the past would be helpful.

Sarah, we have found the television advertising to be a challenged environment. We don't necessarily think it is program specific in terms of a discipline. We believe that the television environment is more difficult because of competitive pressures on television. The rates have gone up significantly. We mitigate the rate issues because by virtue of moving to other TV stations. We narrow our rotators and basically we move around the TV stations to the extent that we are able to given market conditions. In some cases we have opportunities to move to other stations and in other cases we do not. I think the good news though, Sarah, is that this year in the third quarter we are seeing some opening up of inventories? We see in fact some corrections in TV rates. This is not widespread. It is in certain markets, and we see lead flow increasing now that the third quarter has arrived.

In terms of the cause, I do think there's some pressure in terms of other schools. But you will see attorneys on the television stations in day parts that we are in and you will see companies like Verizon and all, all of whom put pressure into the same places on the television stations that we are.

Okay, thank you, and for my follow-up question I guess a longer-term question, has anything changed in your long-term outlook for enrollment growth and margin expansion over the next couple of years? And can you review what you would expect?

No, in the long-term we have not changed our outlook for what we expect our margin improvements to be. Or enrollment growth. Obviously, as you are aware, we derive 60% of our business from television advertising. So we are somewhat reliant on that media to drive our starts. Where we stand today we have not seen, as Larry pointed out, we see some openings in our market. And we still remain confident.

Okay, so in terms of top line growth over the next couple of years, are you still thinking -- (multiple speakers)

Well, at this time we are only providing guidance as far as our third quarter and our fiscal year 2005 guidance. During our first quarter of -- as we talk about our year end numbers will be providing guidance on 2006.

Gary Bisbee, Lehman Brothers.

Hi, guys, and I guess use the opportunity to give you an official congratulations on getting the deal done in being a public company. I guess my first question, just looking at the third quarter and fiscal four-year guidance and if you sort of back into what that implies for the fourth quarter, it seems to imply both the potential for a material acceleration in enrollment growth that you're looking for, and also a reversal in margins and pretty substantial margin expansion. Can you give me a sense as to how comfortable you are with that and maybe what specifically the drivers are that could lead margins to be a lot higher year-over-year in the fourth quarter?

First of all we expect that -- while we are still facing a challenging TV market, Gary, we -- our guidance has baked in our expectations in terms of where were going to grow from an enrollment and start standpoint. And 60% of our starts are in the second half. We are a second half company. 40% specifically occur in the third quarter of the year. We have a very strong high school program, and we expect nice growth in that program on a year-over-year basis. And while it represents 28% of our second half starts, it still is pretty significant in terms of the growth that we expect to have. We are still dependent on television. We still want to make that point clear but some of the initiatives I pointed out are beginning to bear fruit, at least from an opportunity standpoint if not from a real volume standpoint.

Okay, and in terms of the margin?

We expect to have the margin acceleration in the second half based upon the input of students that are moving into the system in the third quarter and the fourth quarter.

Okay, and I guess just my follow-up would be -- I guess you mentioned having signed a nonbinding letter of intent, and I think you said it was the second one. Is that the second one meaning after New England Tech earlier this year?

No, we had disclosed in our prospectus that we had a signed a nonbinding letter of intent, so we had one out there. We have signed a second nonbinding letter of intent. As we stand here today we have two letters of intent, and we are in the due diligence stage of those acquisitions.

I want to point out that while we really can't speak because of the nondisclosure issues, one or both of these programs have nice decree granting. They will serve to increase our geographic footprint. They have programs that are complementary to what we currently offer, and we feel can help fill out our margins with program replications back into the system.

Great. Thanks a lot.

Richard Close, Jefferies.

Just wanted a little housekeeping. You had mentioned something on the Philly and Grand Prairie in terms of square footage. Could you repeat that?

Yes, with Queens and Philly and Grand Prairie in '06 it will provide 230,000 square feet of capacity equating to probably a 35, roughly 3500 student capacity for the Company.

Great. Thank you there, and then with respect to I guess a follow-up on Sarah's question and a little bit on the question on the fourth quarter margins, in terms of a long-term, let's look at three to five years type of metric, what do you think top line growth is? I know you are not given numbers for 2006, but on a long-term basis what are you comfortable with top line growth? And then what do you think peak margins are with respect to the overall business?

Let me first address the revenue growth. While we're not providing margins for 2006 and beyond we do not see any reason why we cannot continue to increase revenue in the 15 to 20% range over the long-term. We also have a goal internally -- and I will speak to EBITDA margin of increasing our EBITDA margin 100 to 200 basis points per year for the next several years. We do not see any reason why we could not get into the low 20s before we start to flatten out.

Okay. Thank you very much. That is helpful.

Trace Urdan, Robert W. Baird.

I want to go back to Sarah's question, as well because I'm not sure that you addressed one aspect of her question, which was in terms of the 3.6% same-school growth, can you give us some sense of where the relative strengths and weaknesses are in that number? Automotive, non-automotive, some part of one geography versus another maybe related to recent acquisitions, versus schools you have held for a while?

Sure. Again, we've not found it to be tagged to any discipline, whether it is automotive or skilled trades or allied health or whatever. In the first quarter it was a very market specific issue. You could extract schools for one market, for instance, and you would see material contains in the growth in starts on a year-over-year basis. So to the extent that we can focus on -- and we are focusing on these markets -- we will increase the margin substantially and the growth substantially. So again, it is not a discipline specific issue.

I'm sorry, I beg your pardon, it is just -- are you suggesting, then, that the issue has more to do with converting leads? Because that would be in my mind the implication if there is no geographic or discipline related reason for the weak organic growth, then it would tend to imply that the issue was solely this aspect of converting the advertising leads that you described.

No, it is geographic. What I was saying was that if you take one market out of the whole, in fact both our auto schools we have -- our non-auto schools -- and you extract the one market out of it you would see significant growth on a year-over-year basis in new student starts. So to the extent we focus on those markets and we do everyday, we will overcome that particular issue. And as a matter-of-fact, if we talk about some of the initiatives we have going such as our Hispanic marketing effort, our infomercials and all that, we are actually seeing some very favorable results coming from those initiatives, which we hope will provide opportunities to again expand our growth in starts on a year-over-year basis.

Okay. Thank you.

Jeff Silber, Harris Nesbitt.

Just wanted a little bit more color on your expectations for operating margin guidance this year. You keep on talking about this leverage, and yet you refer to the difficult sales and marketing environment. Should we expect most of or any of the operating margin expansion to really come on the educational services line? And if so, how are you getting there?

Good morning, Jeff. No I think the operating margin is coming from all aspects of the business. Both the educational services, as well as the SG&A part of the house. I think what we said is we expect to continue to increase 100 to 200 basis points in EBITDA margin for the next several years. The guidance we gave you is in line with that. And how we are getting there is by gaining operating efficiencies, by maximizing our class sizes as well as I think when we have built a corporate structure that is very leverageable. And as we increase and grow, we do not necessarily need to increase that structure. And we are also leveraging our facilities expense. We are building -- we plan on purchasing the two new facilities we talked about Grand Prairie, and Philly. That will provide additional leverage to the Company.

If I remember correctly there were some issues with -- I do not know whether it was a phone installation or a new line earlier this year that may have contributed to the disappointing starts in the first quarter. Can you elaborate on that, and is that an issue anymore?

We installed a voice over Internet phone system throughout the Company; it rolled out on a school by school basis. The good news is as of roughly mid April all those issues have gone away. As a result of that I think you saw a resurgence of the second quarter from our April results. We had an excellent May and June turned out to be, while it was right where we expected it to be in terms of starts, we did see the telco system issue go away.

And just to clarify do you know or can you tell us what the impact was on the starts in the first quarter if you had not had the phone system issues would starts have been up year-over-year?

We do not know; we do not know what we lost, but I can tell you this. The impact in the second quarter lead flow, cost per lead was worse than the first quarter, yet we had growth in starts on a year-to-year basis. So once the telephone issue went away our ability to put students in the school increased dramatically. So I do not know what we lost in many cases, so I can't answer the question specifically. But I can tell you this that the second quarter saw a nice effect from the rebounding off of the television issue. Again that ended in mid April.

Howard Block, Banc of America Securities.

Good morning, and let me add my congratulations to joining the ranks of the public companies. In the press release there you wrote that you expect approximately 40% of all new students to enroll during the third quarter. I was wondering we are I guess a month or so into that quarter, how -- what does it look like? Is it a hockey stick, what is the visible on that 40% right now? Any color would be appreciated.

Well, the July start is coming in flat to prior year, but we are looking for a nice double-digit growth in our August and September starts. The high school prime, which again is 28% starts principally in August and then in September. And so we are very favorably inclined because of both of those. I would like to remind you also that the TV situations, while we are seeing increased lead flow in the third quarter, we are seeing actually some rate corrections. We are seeing clearance that we didn't see in the second quarter of the year. We're still heavily dependent on television. So it is an issue in the third quarter because it is something that this Company relies on very heavily.

So I'm sorry, you said the July starts are flat with the prior year?

July starts will be flat with the prior year but August will have double-digit growth on a year-over-year basis.

Okay, so I guess it would be fair to say that right now visibility certainly for the fourth quarter would be pretty limited in that you probably need to be good starts in August and September to serve as the revenue base for the fourth quarter?

That's exactly right, Howard. I would like to point out, though, that as we talked about the new TV creative in our presentation, we are seeing collision repair, for instance, from when we built our own TV commercial. We offer the program in two markets and we are showing a 23% favorable cross per lead versus the old creative. So we see that working.

Additionally our automotive new creative is working nicely on across all of our automotive markets we are seeing a 21% favorable cost per lead. Granted, we are only one month into the third quarter, but we are seeing some nice turnaround. So there is a 21% improvement, and it is working in all markets but one. And we are refining that final market.

That was television -- those creatives that you are talking about?

That was a television creative that we spoke. We put new creative into our markets. We are seeing a 21% across all nine automotive schools improvement in our cost per lead versus the cost per lead we were experiencing with the old creative. In fact, one market showed a 57% improvement in cost per lead. So we are very optimistic about it.

The infomercial that we built in both markets that it's in, we are beating our cost per lead by roughly 15% against the cost per lead -- in the end market cost per lead. So the kinds of things we are -- the initiatives we're putting into place are working.

One more example of that would be late-night TV. As we had mentioned, we have a third shift going into our Indianapolis market. That program will be at capacity on the first two shifts later on this quarter, and our late-night TV to begin to build our third shift there is working well.

In our Grand Prairie school we have a fourth shift we're putting in. So it is beating the cost per lead by roughly 30%. So the initiatives we're putting in place, and while we are reluctant to say that this is going to turn everything around, the initiatives we are putting in place are working well. Our infomercial in one of our markets in fact, in both markets is averaging roughly a 15% cost per lead improvement versus existing cost per lead. So these areas are working. We're very positive about them. We feel that this will be the solution in good part to the third quarter, along with the benefits that will be coming which the rate corrections and a couple of markets along with the improved clearance on TV along with the improving lead flow in the third quarter of the year. So our conversion has gone up 300 basis points in the second quarter over the prior second quarter. So we are seeing improvement, and we believe that this will have a material impact on the third quarter and beyond.

This cost per lead information you're sharing here is this the month of July or is this trailing --.

This is the month of July. So you are seeing real-time improvements coming in. And we have no reason to believe that these would change.

You mentioned that you said the facility expense grew 50% on a same school basis?

15, 15%.

And that was a second quarter over second quarter?

That's correct, and that is mainly because in the second quarter of this year we've had both rent in our Queens facility which is expected to open late in '05, start classes in '06. So we once we started the build out this month, we have rents six quarter before that far as well as our expansion facilities that we did during late '04 to both Lincoln, Rhode Island as well as Marietta, Georgia and the new space that we consolidated space downstairs in our corporate facilities. So we have some new space in our corporate headquarters. So all those four expansions basically created additional rent expense that increased our facility cost.

Some of my contusion may have been that it seemed like when you were offering sort of a litany of reasons for the growth you included I guess areas that I would have considered not part of same school, certainly. It seems like the new locations and corporate and things like that is, am I losing something in the definition of same school?

We define same school as the only thing we are excluding from same school is New England Technical Institute. So what we're saying is facility costs increased by 15% over the prior quarter basically due to additional rent, (multiple speakers) Existing facilities plus the new Queens startup.

With all the -- and then I will jump back into the queue, my apologies, but with all the capacity additions that you are discussing it sounds like it will be part of the business model for a long period of time. Dou you have sort of a target revenue per square foot or facility margin or anything guiding the rate of investment in capacity?

Whenever we look to make an investment we look to obtain a 35% IRR on that investment over time. So these expansions that we're doing, we expect to generate the same type of IRR.

Great. Thank you.

Sarah Givens with Merrill Lynch.

The SG&A line decreased sequentially between Q1 and Q2. And I am wondering I guess if there is anything unusual in that and if it is reasonable to assume that you should be able to maintain that level of spending through the rest of the year if there is any seasonality to it?

The SG&A line should be fairly straightforward for the rest of the year. We do experience sales and marketing should be relatively flat, and as well as administrative costs. So yes, we expect to be able to maintain that level.

Okay, and can you talk a bit about where your capacity utilization rates are currently, both overall and can you give us any breakdown between the technical auto schools, and the other types of schools?

As a company we are currently at 59% of capacity. Our more mature schools are at about 71% utilization. Our less mature schools are at about 50% utilization.

Okay. Thank you. I will get back in the queue.

Gary Bisbee with Lehman Brothers.

I'm wondering how you're doing versus say a year ago in terms of high school recruiting for the non auto schools? I know that has been a focus that historically you did not do as much there. But how is that going and how is that looking for this fall and is there still room to improve that going forward?

That's a good question because initially those schools when we began to ramp them up in 2001 they had little or no high school effort in that recruiting effort. Basically we were building them through a media base. This last year that is the '04 '05 recruiting year, roughly six schools went online in the high school programs, and we're going to see some nice starts coming from those schools. We have roughly six more going online this coming year in terms of building the '05 '06 high school recruiting year.

Gary, to the extent that we have an improving degree situation, this really will be a benefit to us because parents and guidance counselors and students view degree granting more favorably. As a matter of fact just on that note within our current student body we're seeing increasing interest in degree granting and in a number of cases our graduates want to come back to complete their degrees in our current schools. So and as we had mentioned, later on we will even have the online degree granting capability. So all of these things we think are going to be more attractive in the high school recruiting year in this next period.

So for this August September period, then that would be the sixth that started last year and six more, so 12 in the non auto?

No. In this year we will see the results of six additional non auto schools and in the '05 '06 recruiting year, six more, six additional ones will come online and join that effort.

Okay, so this fall would not be the '05 '06 year?

It would be. (multiple speakers) students won't start until they graduate high school in 2006.

Okay. Thanks.

Larry, I was wondering if you could comment a little bit on what you expect in the second half on the market in an advertising front. I guess the question specifically is what is baked into your guidance? Is it that there is an improvement in marketing and advertising costs? Or things are staying the same like with the first and second quarter, maybe a little additional detail?

We baked in the same difficulties that we have had in the past are baked into our guidance. We are optimistic, though, obviously because of the initiatives that we have spoken about and quite frankly Web results and Internet results have exceeded our expectations. Our Web leads grew in the second quarter of the year, 63% on a year-over-year basis. And a good proportion of that came down to the enrollment level.

None of the improvement you have seen so far in July is baked into the second half guidance?

Very little of the improved TV situation is baked into second half guidance Richard so from that standpoint I think to the extent that we do improve our TV issues with the initiatives that we have, I think it is upside. Again, July was a flat year-over-year, that gave us some flaws; we did have a higher expectation of that. But again, TV markets are very distinct in terms of their quarterly results. The second quarter is the most difficult quarter of the year, I think nationwide. And it always is a challenge and ergo the seasonality of the business. So we do expect some improvement in July in third quarter in terms of lead flow. We were not able to reap the benefit of that we believe until August and beyond. And that is what we expect. However, our guidance is not overly optimistic I would say in terms of a marked improvement in where we have been.

Thank you.

Jeff Silber with Harris Nesbitt.

I just want to clarify something Cesar that you had said in answer to Sarah's question, you said that SG&A should be pretty straightforward for the rest of the year. Are you implying, then in terms of SG&A dollars that roughly what you incurred in the second quarter we should be modeling roughly the same amount for the third quarter and fourth quarter, is that what you were saying?

Yes, I'm saying that the expenses we don't see expenses increasing significantly or decreasing significantly for the rest of the year. As far as SG&A is concerned.

I just wanted to clarify that. And in comparing to the third quarter and fourth quarter of last year where there any onetime items either in the educational services line item or in SG&A that we should be aware of again when modeling the back half of this year?

Yes, there were. Obviously you're talking about the second quarter onetime items, or you're speaking about the last half of the year?

Tell me any onetime items we should be aware of.

Well during the second quarter of this year we wrote off approximately $400,000 of the unamortized management fees that we add to our principal stockholder. That was a onetime item that happened in '05. Likewise, there was a similar onetime item in '04 which was, if you will recall, back in September of '04 we wrote off about $2.1 million of deferred IPO costs. Those costs were flowed through the quarter so there was obviously some onetime items in '04. But '05 particular onetime items we had in the first quarter we had the write-off of deferred financing fee as the result of the our new credit facility. We wrote off the old costs. And then in this quarter we had the approximately $400,000 as a write-off of the management fees.

In the write-off of the management fee, was that in the other income line item or is that in the SG&A?

That is in SG&A.

I just wanted to doublecheck that. Thanks.

Howard Block with Banc of America Securities.

I just wanted to clarify a couple things on the SG&A. In the press release it said marketing expenses increased 37.2%. And then in your comments -- I thought I heard a 29% something --

Yes, it is 37.2% for the company as a whole, 29% without New England.

Okay, great. And then the only other follow-up would be maybe to Jeff's question so if we look -- I think you gave us enough information for us to sort of figure a drive what the G&A grew year-over-year. It seems to be pretty modest even if we control for the onetime charges last year. And I would have thought with Sarbanes and public company costs and things that growth in G&A would have been greater. Is it fair to say that maybe in '04 you had already incorporated the overhead and the other spending that would be necessary to be a public company?

We had a lot of that built-in. There is still some to go. But yes, in the latter part of '04 we started to gear up the company to be a public company. So a lot of that infrastructure were in the numbers in the second half of '04. That infrastructure did not exist in the first half of '04.

Thank you very much.

Sarah Givens with Merrill Lynch.

Just a quick question. Can you tell us about how Southwestern is trending now that it is has been integrated after having been open for about a year?

Southwestern is doing extremely well. As we have spoken about in the past, typically when we make an acquisition its certainly neutral in its first-year. And we have started this group in the early part of '04. This year it will have a significant contribution profit wise to the company. So it is everything we expected it to be and more.

And from an enrollment perspective we you seeing any of the weakness that you were seeing in some of the other markets hitting Southwestern, or has that been pending I guess as well as or ahead of expectations?

Cincinnati is a difficult TV market, as well, but quite frankly we have been able to grow this school, this group of five schools significantly in that they were very unsophisticated in terms of their television marketing, and we installed -- we installed our advertising systems. We installed our admissions procedures, our Lincoln academy training and quite frankly they are exceeding our expectations in virtually every way.

At this time we have no further questions in the queue. I would like to turn the call back over to you for closing remarks.

Thanks, everybody. We appreciate your being on our very first earnings call, and we look forward to speaking to you next quarter.

Thank you for your participation in today's conference. This concludes your presentation, and you may now disconnect. Everyone, have a wonderful day, and thank you.