Lincoln Educational Services Corp (LINC) 2005 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2005 Lincoln Educational Services earnings conference call.

(Operator instructions)

I would now like to turn the presentation over to Mr. John Buckley. Please proceed, sir.

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

And now, I'd like to turn the call over to Dave Carney, Chairman and CEO of Lincoln Educational Services. Please go ahead, Dave.

Thank you, John. Good morning, everyone, and welcome to the Lincoln Educational Services third quarter earnings conference call. I'm joined here by Larry Brown, our president and chief operating officer, as well as Cesar Ribeiro, our chief financial officer.

For our call today, I will provide a brief overview of our results, as well as update you on our strategic progress in key areas. Larry will then provide an update on recent enrollment trends and marketing. And then Cesar will provide a more detailed review of our financial results as well as provide our updated guidance for the full year.

Turning to our results, we are pleased to report that the third quarter revenue, net income and earnings per share are all within the guidance we provided on our second quarter call. Revenues for the third quarter of 2005 grew 13.3% to 78.4 million.

Net income for the quarter was 5.5 million or 21 cents per diluted share. This represents quarterly earnings per share growth of 10.5%. Average undergraduate full-time student enrollment increased 8.6% to 18,029. On an organic basis, which excludes New England Technical Institute, the acquisition that we made in January of this year, average student enrollment increased 2.2%.

During the third quarter, we continued to make notable progress in improving our operations, taking steps to adjust our business model to address near-term challenges and strengthening our foundation for long-term growth.

At this point, I'd like to focus on the operational aspects of the business and our ongoing growth initiatives. First, we continue to focus on prudently expanding capacity in areas where there is strong demand. We recently announced the acquisition of an approximate 100,000 square foot facility, which will triple the size of our campus in Grand Prairie, Texas.

The new facility is expected to open by mid-2006, and combined with the existing school, will be able to serve approximately 2,500 students. The new facility is well-suited to our needs, as it was previously a regional service and repair center for automation dealers in the Dallas-Fort Worth area. The facility will enable us to expand our automotive and diesel programs and add new programs such as collision repair and skill trades.

We are pleased with the results of our Indianapolis campus expansion, which was completed in June of 2004. As I mentioned on our second quarter call, the third shift we added for collision repair has been a success and our second class is expected to start in Q4.

With regard to Philadelphia, we continue to work with the city in obtaining zoning approvals and expect the new facility to be open for next fall's important enrollment period.

Overall, we few our facility expansion opportunities as low-risk growth initiatives that enable us to leverage our existing trained management and build upon our strong brand recognition in these markets. Looking to 2006 and beyond, we anticipate expanding several additional campuses.

Now, turning to startups, we are very excited about the progress we're making in our Queens facility. As a reminder, we were selected by the Greater New York Automotive Dealers Association in a competitive process to operate an automotive training school for the benefit of the dealers organization at the newly created Center for Automotive Education and Training as Whitestone, Queens. This association represents more than 650 dealers in the New York City region, which will provide our students with direct access to a large pool of potential employers. This center formally opened this week and we expect our first class to begin at our campus midway through the first quarter of 2006.

Queens will have a capacity of approximately 800 students and the dealer participation in the early startup activities is very promising. Looking at the bigger picture, we believe the Queens facility highlights our focus on achieving profitable growth and reducing our risk profile.

For example, by partnering with the Greater New York Automotive Dealers Association, we were able to take advantage of the marketing the association brings to the site in newspapers, public relations and the New York Auto Show, which is held each spring at the Jacob Javits Center.

Further, for this facility, we have an agreement with Snap-On Tools to be sole provider of tools for the facilities, providing our students with high-quality tools and giving us a CapEx savings advantage. Further, Queens is a market that has a high demand and limited supply. There is limited competition in the market and we know from our research and marketing efforts that there is pent-up demand in the area. Lincoln Technical Institute is very strong in the region and this is a great way for us to extend our brand in an attractive market.

Finally, this is also a great template for us to use in future startups. We also continue to make progress in expanding our associate degree offerings, which certainly increases our addressable market. These programs provide advantages for our students in the form of opportunities for promotion as well as higher earnings potential. Associate degrees also extend the length of time students remain on our campuses, which results in additional revenue and improved margins.

We recently received approval to offer associate degrees in our Melrose Park, Illinois campus, which now brings the total to 17 out of our 32 campuses. During the third quarter, the percentage of our students who were enrolled in associate degree programs increased from 10.7% to 15% of our overall student population. We continue to expect our degree programs to have a meaningful contribution to our growth in 2006 and beyond.

Now, let me turn to acquisitions. We continue to look at transactions that will add new programs, new markets, degree granting and also where we can clearly add value. In all cases, we expect that any acquisition should be at least earnings neutral in the first year. In regard to the two signed LOIs that we've mentioned on the second quarter call, we continue to conduct our due diligence. We are proceeding carefully, adhering to our strategy and making sure that we go about these transactions in a disciplined manner that will benefit our shareholders. Having said that, we expect to be able to update you on both of these very shortly.

I should also note that during the quarter, we continue to make progress in improving our operations at New England Technical Institute, which we acquired in January of this year. We just expanded two of the facilities by 20,000 square feet and we expect to add another 10,000 square feet in the next 12 months. This expanded capacity will allow us to increase our enrollment and add new programs.

Now, let me turn to our exciting on-line strategy. We are on track to offer our online degree completion program in health sciences by the end of this year and we're currently running a pilot program at our Norcross, Georgia campus. Moreover, we are moving forward on our 100% online offerings and expect to launch in the second quarter of 2006 using the brand, Lincoln College Online. Initial programs will include criminal justice and health information technology.

Finally, we continue to study potential new programs that offer opportunities for growth as well as program replications where we believe there will be a strong demand and we have available capacity. For instance, we have narrowed the list of markets where we intend to replicate three of the programs we acquired with the acquisition of New England Technical Institute, including culinary, licensed practical nursing and electrical.

I'd now like to turn the call over to Larry who will provide more color on our enrollment growth during the quarter as well as our marketing initiatives.

Larry?

Thanks, Dave. Good morning, everyone. As Dave noted, we experienced organic average enrollment growth of 2.2% during the quarter, which was below our expectations. While July was flat and August experienced double-digit enrollment growth, September was down. This was primarily the result of weaker-than-expected enrollment in certain of our markets as we continue to be challenged in a very difficult television environment. We implemented several initiatives that we shared with you during our second quarter call and while we are starting to see some momentum from these initiatives, it is still too early to predict whether they will ultimately be successful.

We are continuing to address these issues head-on. First, we're taking a number of steps to improve the effectiveness of our TV advertising. During the quarter, we changed advertising agencies at certain schools. We also installed new TV Creative and changed our message, which is generating favorable results thus far. In addition, 15 of our 32 schools are on warm transfer and we expect all schools to be added to the program by year-end.

Second, we're implementing a number of Internet initiatives to improve upon our effectiveness in utilizing the Web to drive enrollments. We have incorporate Internet training into our Lincoln Academy and have recently completed our fifth web-training program for our admissions staff. We are also test piloting an Internet warm transfer program at one of our schools and the results have been very good. In addition, we have hired an agency to represent us with all of our Internet initiatives.

Specifically, we've hired CUnet to handle our Internet lead generations. CUnet specializes in propriety education lead management and offers a backend, web-based software tracking system. We are migrating to CUnet's Vendor Lead Management system to better track, monitor and manage our lead flow. The system offers a number of advantages, including in reduced lead costs through more effective vendor management and a centralized system for managing all activities and detailed access to performance trends, all of which will allow us to better analyze the effectiveness of these initiatives.

Our Internet leads were up 52% in the third quarter as compared to last year's third quarter without the CUnet effect. Given the current environment, we are being very prudent about our advertising expenditures. As we reduce our exposure to television in select markets, we are increasing the use of Internet market where it makes sense. We believe this will help to reduce our cost per start. Over the long-term, we believe our organic enrollment will rebound. We've been through periods of enrollment softness and volatility in the past and in the meantime, we're making adjustments to out cost structure and focusing on improving our marketing approach and resources.

I should note that we were able to increase our overall enrollment despite weak trends in several markets because we are seeing solid results in other regions, highlighting the benefits of our diverse asset base. And finally, I'd like to point out that one of our most important marketing resources comes from the referrals we receive from graduates and employees. And on this score, it is worth highlighting that demand for our graduates in automotive and health sciences remains exceptional. Our job placement record has actually strengthened in both of these fields for the first nine months of the year compared to 2004.

We believe this is notable, especially in our auto, diesel and collision repair programs, considering that we've exceeded 90% placement in these areas for the last five years. This attests to the quality of our programs and the demand for our graduates.

I would now like to turn the call over to Cesar.

Thank you, Larry. As announced in our press release earlier this morning, revenues for the third quarter of 2005 grew 13.3% or 9.2 million to 78.4 million from 69.2 million in the year-ago period. Net income for the quarter was 5.5 million, an increase of 24.8% over last year's net income of 4.4 million. Diluted earnings per share of 21 cents increased 10.5% over last year's third quarter earnings per share of 19 cents.

Earnings per share includes a charge of one cent and one cent respectively for the third quarter of 2005 and 2004 of stock-based compensation in accordance with SFAS No. 123, Accounting for Stock-Based Compensation. Revenue growth in the third quarter of 2005 can be attributable to the following. Approximately 4.6 million or 6.7% of the 13.3% growth is due to our acquisition of New England Technical Institute in January. Average undergraduate full-time student enrollment increased 2.2% to 16,975, exclusive of New England Technical Institute for the quarter as compared to 16,607 for the year-ago period. Including New England Technical Institute, average undergraduate full-time student enrollment increased 8.6%.

In addition, tuition increases continue to average between 2-5% annually, depending on the program. For the third quarter of 2005, we reported operating income of 7.9 million compared to operating income of 8.3 million for the prior quarters. This led to a decrease in our operating margin for the quarter from 11.9% to 10.1%. The decreases in our operating income and operating margin for the quarter were driven primarily by the acquisition of New England Technical Institute as well as due to 17.5% and 14.2% increases respectively in educational services and facilities expenses and selling, general and administrative expenses.

SG&A for the third quarter of 2005 increased 4.7 million or 14.2%. Approximately 1.8 million or 5.4% of this increase was due to the acquisition of New England Technical Institute while the remainder was due to a 25.5% increase in marketing costs. SG&A represented 48.4% of revenues as compared to 48.1% from prior quarter. Our facilities costs increased 18.3% on a same-school basis over prior year, due to rents on our Queens, New York facility and our expanded campus facilities in Lincoln, Rhode Island and Marietta, Georgia. During the quarter, we also recorded a charge of approximately 200,000 of catch-up depreciation, due to the accounting reclassification of our property in Indianapolis to property and equipment and facilities. This property had previously been classified as held for sale.

Our net interest expense for the third quarter was $192,000, representing a decrease of 547,000 or 74% from 739,000 for the third quarter last year. This was primarily due to an increase in interest income due to higher cash balances as well as a result of paying down our credit facility from the proceeds of the IPO. For the third quarter of 2005, we reported other income of $243,000, representing an increase of $207,000 from $36,000 for the three months ended September 30, 2004.

Other income relates primarily to equipment donations received by our technical school during the period. We periodically receive donations from vendors, which we value at fair market value based upon third party appraisals. Our provision for income taxes in the third quarter of 2005 was 2.5 million or 31% of pretax income, compared to 3.2 million or 41.8% of pretax income for the third quarter of 2004. The reduction in our effective tax rate for the quarter is attributable to a favorable resolution of a tax contingency. We continue to experience favorable trends in our day sales outstanding. As of September 30, 2005, our day sales outstanding were 17.86 as compared to 18.74 as of September 30, 2004.

Additionally, our bad debt expense increased by 10 basis points from the third quarter of 2004 and as a percentage of revenues was 4.2% for the third quarter of 2005 as compared to 4.1% in prior quarter. For the nine months ended September 30, 2005, our bad debt expense as a percentage of revenue was 3.7% compared to 3.6% for the first nine months of last year. Our capital expenditures for the nine months ended September 30, 2005 were 11.5 million as compared to 19.6 million in the same period last year. We expect our capital expenditures to increase significantly as we have begun to build out our Queens campus and we will be commencing the build-out of our Grand Prairie facility and look to expand our Philadelphia Lincoln Tech campus.

Guidance - finally, with respect to guidance, we will continue to provide guidance on revenues and earnings per share. Our guidance is based on current expectations. It is forward-looking and actual results may differ materially as a result of factors outlined in our latest 10-Q. As we outlined in our press release earlier this morning, our guidance for the full year is as follows. For the year ended December 31, 2005, we expect revenues to increase approximately 15% over 2004.

We are reaffirming the earnings per share guidance we provided during our second quarter call, which was earnings per fully diluted share of 73-81 cents. Earnings per fully diluted share for the year includes a five-cent charge for stock-based compensation resulting from our accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123. Our current earnings per share guidance is within the range of the guidance we provided in our last earnings call.

However, based on lower-than-expected enrollment trends, we have updated our revenue expectations for the year. While we are disappointed with the enrollment growth, we believe our ability to maintain our income and earnings per share guidance highlights the flexibility of our business model and our focus on prudently managing our business for profitable growth.

In general, we realize costs in advance of revenues. And while there is, obviously a large fixed cost component to our business, our business model provides us with the flexibility to right size our cost structure, depending on attendance trends. As a result, management has acted accordingly and has right sized the company to support the reduced growth for the remainder of the year. The cost savings we will realize in the fourth quarter relate primarily to variable costs that would have supported the attendance that did not materialize as well as the related expenses.

More importantly, we can do this without impacting the long-term growth potential of our company. Our annual goal of 15% revenue growth remains as does our goal of expending our margins by 100-200 basis points.

Now, let me turn the call the over to Dave. Dave?

Yes, thanks, Cesar. When you look at the growth initiatives we have underway and the steps we are taking to address the challenging trends that our industry is currently facing, I believe you can see how our operating strategy, our business model and infrastructure are ideally suited to deliver profitable growth over the long-term. Our results and our guidance underscore this fact. Despite recent soft organic enrollment trends and increased volatility in the near-term, Lincoln remains on track to deliver enhanced margins and net income growth.

Saying it another way, we're operating smarter and adapting to the market as appropriate. We have ample operating flexibility, but are being prudent and realistic. We are investing in the future, but we are not chasing growth that isn't profitable. We have been at this a long time, so we have a long-term approach to building value.

In the near-term, we are right-sizing operations that have not grown as rapidly as expected this year, while investing in areas that are demonstrating solid growth. Adding a third shift of night courses in Indianapolis and expanding our facility in Grand Prairie, Texas are examples of our approach. We are also pursuing expansion at the new high-growth markets, but more importantly, we have the infrastructure already in place to support these initiatives in a profitable manner.

We're also benefiting from a diverse portfolio with a solid mix of startups, developing immature properties spread across several geographic regions. Our Queens campus, our online initiative and our acquisition pipeline all represent future revenue and earnings growth drivers. At the end of the day, we have been both disciplines and innovative in our approach to growth. We have to leverage our brand and resources to secure additional growth channels with limited risk exposure for our shareholders. Margin improvement is a priority for us.

While Lincoln may be new to the public markets, we're certainly not new to this business. Lincoln's been a leading name in education for nearly 60 years. We have through periods of both rapid and moderate growth. We will continue to prudently execute our strategy with a focus on the long-term growth and we look forward to updating you on our progress in translating our operational success into financial results. And at this point, we'd be happy to take your questions.

Operator?

(Operator instructions)

And your first question comes from the line of Sara Gubbins of Merrill Lynch. Please proceed.

Hi. Good morning. Thank you. The first question that I had is can you give us an update on how October starts trended and then do you have a significant number of starts coming in November or even December. Just trying to get a sense of that for the fourth quarter.

Well, let me start with that, Sara. The October starts at this point are just about flat with the same period last year. And the balance of the quarter - hello?

Yes, I'm here. Sorry.

Yes, I'm sorry. And the balance of the quarter is - it tails off in November and December, so October is the larger of the three months.

Okay. So, when you're looking at the fourth quarter, what you're expecting in terms of revenue, is it fair to say that you have a pretty good sense of it, given that the bulk of the starts have, for the quarter, are already there?

We have a pretty sense of our revenue for the fourth quarter, given the third quarter results and the carryover. Yes.

Okay. Great. And then, my second question, when I look at the guidance for the rest of the year, it looks to me like you're talking about cutting about $7 million in operating costs sequentially, if I'm thinking about it the right way. And I know that Cesar mentioned that you're most focused on variable costs. But I guess first I wanted to make sure that seven million in cost cutting sounds about right. And then, second, if you can give us any more detail as to where that's coming from. Is that in salary costs or have you had to cut back on marketing as well?

Well, let me - I'll start with the response on that and Cesar may want to jump in, Sara. Basically, as we said before, in terms of our forecast, we assumed a much higher enrollment level for the second half of the year and, in particular, the fourth quarter. And unfortunately, that didn't materialize. As a result, a good deal of the cut, if you will, in the fourth quarter, of the reduced expense levels, are more a function of cutting back to the realistic levels. They don't necessarily represent actual people cuts as much as they recognize not filling certain positions.

Additionally, there are a number of - there's a good deal of consumable costs that are in the - in our cost structure in the fourth quarter that relate to starts that did not or will not materialize. There is some other redemption in actual people cuts and, in some cases, we've actually reassigned some of our corporate people out to the field. These are our strong talented people who were promoted up from the field in the past and are now focusing on particular campuses.

Additionally, there's some reduction, just as you would, and any time you right size a company in unnecessary, if you will, expense levels and additional travel and so on for the fourth quarter. Finally, your question as it relates to marketing. There is some reduction in marketing anticipated in that number - particularly around the holiday period. And also, to some extent, and we'll talk more about this later, perhaps - it also reflects a shift in TV spending to more Internet initiatives, which have a much higher degree of success for us as we move forward.

Yes, just so, I guess, everyone's on the same page, I think we have told you in the past that our expenses run ahead of our revenue. So, basically, we staff up for the growth that we expect for it to come in the second half. And our forecast includes both that revenue and those expenses. To the extent that the revenue is not there, likewise, those expenses drop off.

So, for example, books and tools, for example, if we were forecasting much higher growth starts and those starts aren't there, we would not necessarily have the books and tools expenses. So, while we're saying the word right-sizing because these are not necessarily cut, these are just reductions of our expense forecast, which, obviously, were a lot higher than we are now anticipating.

I'd like to just add one more point there. I think it's important to note that, again, we're running this business, this company for the long-term. And while we've cut back on certain variable costs in the fourth quarter, we're still continuing ahead on some real initiatives, which include, for example, rolling out our campus management across all the campuses. In fact, we're pleased to report that we've - we're now up to 12 of our 32 campuses. And just came - the additional ones that just came up October 1. So, in no way have we cut back in the compliance area, the regulatory area or on the initiatives that are going to support the long-term growth of this company.

Sara Gubbins. Great. Thank you. I'll jump back in the queue.

Thanks, Sara.

And your next question comes from the line of Trace Urdan of Robert W. Baird. Please proceed.

Hi, guys. Thank you. I don't mean to beat this horse to death. It's just that the numbers that you have suggested really imply a sequential decline from the spending level in this current quarter. If you finish the year with revenues up 15%, that implies total year revenues above $300-and-a-half million. That puts the December quarter somewhere like 83.1 million. In order to get to that, even the bottom end of your range, the expense numbers in the fourth quarter have to be sequentially far below where they were in the September quarter, which implies something more than just moving people from corporate to the field. I guess, I'm going to come back at this question one more time and see if you can help us really understand how it is that the expenses can come down so drastically, sequentially, in the fourth quarter.

Sure, Trace.

Sure, Trace. I'll take that one. First of all, our expenses always go down sequentially in the fourth quarter. So, the extent that there is a drop in the fourth quarter, that is correct. Advertising is always less in the fourth quarter as well as our other costs. So, just on a historical basis, our expenses - books and tools, et cetera - are always a lot less in the fourth quarter than they are in the third quarter. And then, as a result of the right-sizing that we talked about, the - we are, obviously, forecasting that the fourth quarter expenses will be a lot less than the third quarter expenses. But it is not - I guess what I'm saying, it is not all representative of cuts. Our model, even before we right size a company has a sequential reduction in expenses in the fourth quarter.

Okay. So, the sequential increase in the fourth quarter of '04, was that related to an acquisition?

Well, it was related to - Southwestern College was in there.

Okay. So, if you took Southwestern out of the December quarter, we would have seen a sequential decline in expenses?

That is correct.

Okay. Great. I'll let you move on. Thank you.

Okay, Trace.

And your next question comes from the line of Howard Block of Banc of America Securities. Please proceed.

Good morning, guys. If I could just get back to Trace's horse there for a second before it is beaten to death, in the fourth quarter of '03, there was also a sequential increase. Was that attributable, too?

Probably the acquisition of Nashville, Howard.

Okay.

We acquired Nashville in February of '03 and so that was in for a good part of the year.

So, the level of sequential decline in spending that you are guiding to is consistent with the two prior years if we were privy to the details of the contributions from acquisitions.

No, I don't think we're saying that at all. I think what we're saying is that, sequentially, our fourth quarter will go down. The level that it's going to go down this year has the effect of the right sizing of the operations that we have done.

Okay. Let me just try to revisit the starts discussion. So, just to summarize, what we're - what you're saying is that July and October were flat. August was up double digits. September was down, presumably single digits. And November and December are somewhat immaterial anyway.

We're comfortable with the 15% growth numbers that we've given. As you know, I mean, our revenue is based on the carry-in population that we carry in as well as the other initiatives that we have put on place that are starting to bear fruit, including, I think, Dave mentioned the associate degree offerings, which is up to 15% of our population. All those initiatives contribute to our top line.

And you're reasonably on target, Howard.

Okay. And then, when you said earlier on the call that the Philadelphia initiative was started - slated for the fall of '06. Is that right?

Yes, we're now saying it'll launch in the third quarter, Howard. We're still in the process of going through some zoning approval, which has caused that to be delayed by a quarter. I think, in our last call, we talked about a ramp-up, probably in the late second quarter.

Okay. So, can you just maybe catalog for us the significant initiatives that will be in the first quarter? I know we have Queens. We have Grand Prairie. Those are two big ones.

Are you talking about - did you say the first quarter, Howard?

Yes.

Oh, okay. Let me just walk you through the year quickly here. In the first quarter, in February of '06, we'll have our first class start in Queens. In the second quarter, which we really haven't talked about in any great detail, but we expect to launch our 100% online programs. In the third quarter, we will benefit from the launch of the Grand Prairie campus as well as later in the third quarter, the startup of the Philadelphia facility.

Okay. So, actually both Philly and Grand Prairie were pushed back from the first quarter.

Grand Prairie may be a late second quarter event, Howard, or early third, but ...

Yes, the second half ...

Okay, but just - it wasn't intentional - I'm sorry - originally intended to be open in the first quarter of '06?

It was.

Yes, it was.

As we went through environmental issues in the acquisition of the property, it took more time than we thought. We cleared all those hurdles and we've purchased the property and we're moving right along on it. So, it's probably set us back maybe two, three months, maybe.

Okay. Okay. I'll jump into the queue.

Okay.

And your next question comes from the line of Richard Close of Jefferies & Co. Please proceed.

Yes, good morning everyone. I guess, point of clarification on everyone's questions so far, with respect to the expenses, which I don't understand. When you're talking about the acquisitions being in there, if we're talking about sequential - a drop-off from third to fourth quarter, if I look at the company's history, Nashville was acquired in February of '03, Southwestern was acquired in January of '04. Thus, both those units, in their respective years, are in the third quarter expense numbers. So, I guess, just a point of clarification there that, I guess, the response doesn't quite make sense to me.

I can speak to it operationally. In the case of Nashville, we ramped up in terms of our advertising and marketing efforts and our staffing for our media business, which ramped up over the course of that year. And then, Nashville, in particular, staffs up late third, principally the fourth, for their high school efforts. So, the addition of any admissions people who may have not been there or may have left over the course of the year, would be - would take place in the third quarter, with its most impact in the fourth.

In the case of Southwestern, once again, we just began to ramp up that effort and as the schools matured and we got our arms around the opportunities, we increased our advertising in that operation as well as the year took place in '04.

Okay. Good enough there. With respect to the three months in the third quarter, July, August in double digits, September down, October is flat, how many graduations do you have in the fourth quarter?

Oh, boy. We'll have to get that number for you. We don't have that here.

So, are we looking at - and when we look at those months and the fact that November and December are sort of throwaway months, I guess, from bringing new students in, are we looking at the potential of average student population actually being down sequentially from third quarter to fourth quarter?

We're looking at the average population at the end of the year, basically, being equal to the beginning of the year.

That the end of the year is ...

The end of the - without the benefit of the New England Tech acquisition, the average enrollment, year over year, will be about 4%.

But on whole numbers, I mean, if I look at the end of the year last year, I think it was - the average population for '04 was 16,267.

Yes.

Okay. So, we're flat year over year.

And that'll - yes, it'll be up about 3-4% over that figure at the end of '05.

Okay. And that excludes NETC.

That's correct.

Okay. Now, final question and then I'll jump back in. I guess I'm looking for a little bit more than just general industry conditions in terms of explanation in the softness. Let's call it on your same school basis. Everyone's mentioned - everyone to date seems to have mentioned softer show rates and it leaves us scratching our heads here. As an industry, have we reached a saturation point with respect to for profit education? Maybe if you could just quantify a little bit why growth was only 2.2% at existing facilities other than just general industry conditions. I mean, why are people coming to school?

Well, people are coming - well, the programs that we offer, I mean, we're convinced are in high demand as evidenced by graduation rates and placement rates. I think what we're experiencing and perhaps others are experiencing as well, really, is a change in how people look at our - how they find our schools and, in particular, their response to the media, putting aside the high school recruiting for the moment. We've seen a shift, certainly between TV and Internet and we are experiencing a much better response from Internet and now the key for us, really, is to improve the show rates. There's no question that people are doing more comparison shopping than they were in the past.

Let me just add a little bit to that. As you - we talked about the cost for acquiring the TV lead going up. There are some responsiveness issues as well, that is, the leads per spot has gone down. And I attribute that, principally, to the economy. We have an improving economy and there are more jobs available and that has made our job more difficult. That said, there are elements within our processes that we can work on. We can work on improving the transition and we are working on improving the transition between the handoff, if you will, once the student enrolls, between admissions to financial aid and then back again to ensure that affordability is clearly acknowledged. We work on the quality of the enrollment to ensure that the student knows the value of a career versus simply a job meeting their immediate short-term expectations.

And that's what we do in terms of turning our attention to it. But clearly, I believe the economy has an effect on your start rate, your show rate, if you will. The economy has affect on your responsiveness on television. And certainly, the Internet has an effect on your responsiveness on television as well. And they, all the while, are increasing their costs with - wherein they aren't delivering, necessarily, what they did in the past. So, as Dave mentioned, selectively, market by market, as we go forth and look at places where we can reduce our TV expenditure and our dependence on TV and increase our Internet activities, which we're working on very diligently, we will do that. And we think, overall, that will impact our margin and our success in growing the company.

Well, let me just add one other point there. In terms of 2% - 2.2% growth in average population and looking at tying that into some of our initiatives, in particular, where we're - where we experience competition. There are pockets of competition in other markets, particularly as it impacts our health sciences programs. And we're really doing two things there. One, we mentioned earlier, the extent to which we're adding additional degree-granting programs. More of our schools now have degree granting. That's a differentiating factor.

Secondly, we intend to enhance certain program offerings that we have in many of those schools. An example of that would be a rollout or replication of the licensed practical nursing program. So that the effectiveness, if it's TV or Internet, we think that'll benefit us in terms of our conversion rates and getting folks' attention as they shop the Internet and look for options.

I guess, both of you guys have been there for a long time. Have we seen - is 2.2% the lowest amount of growth - like sort of same school that you've seen? I mean, going back to the beginning of time?

In my case, not going back to the beginning of time.

No.

We've been - I think, I don't want to speak for Larry, but I've certainly seen periods before that have been slower than this or flat or below. And I think, use the example of IT. I was involved in a lot of IT schools. I've watched periods that were a lot worse than what we're experiencing right now and I think one of the things that we kind of pride ourselves on here is the diversity of our program offerings. We've talked, in the past, about IT and what we - how we addressed that in the past with additional, moving from IT programs to allied health or health sciences programs. I think the diversity we have - the diversification at the schools, the addition of degree-granting programs, is really going to help us increase our enrollments, same school, year over year, going forward.

I think what we've experienced this year is really kind of a - it's almost like a rollercoaster. I mean, we started the year coming off several years of high growth and the we started to run into situations with very, very challenged TV environment and we kept spending more and really benefiting less. And then, as year progressed, we moved more toward Internet and that is clearly the direction that we're heading in. And what I think you see, Richard, really is a company in transition. We've got all these initiatives in place, we're rolling them out. We're diversifying our schools and we feel very comfortable about the years ahead of us and, in particular, the quarters ahead of us.

But I think right now, we have made a conscious decision as it relates to TV, in particular, to pull back. We're looking at profitable - we want to have profitable growth, profitable starts. We don't want small classes. So, we're actually going to forego business, if necessary, to improve our margins. And some of that you see reflected in even the cost reductions in the fourth quarter. Go ahead.

Go ahead. Let me piggyback on that. Even during those IT - those years when IT was very strong and other programs around the country paled by comparison. We didn't have the Internet to lean on at this point and I'm very encouraged by what that's providing us. I mean, while our leads have grown 52%, our starts, quarter over quarter, have more than doubled. Our start percentage has gone up. So, we are finding the key to unlock this opportunity and with the addition of CUnet, I'm very optimistic that we will be able to supplant what may be damaging to our company from a TV standpoint going forward.

And your next question comes from the line of Jeff Silber of Harris Nesbitt. Please proceed.

Thanks. Dave, you alluded to this a little bit in your question. I was wondering if we could get a little bit more color. When we talk about the weaker markets out there, are there specific verticals or specific geographies that are better or worse than others?

I think - Jeff, I think, in terms of - let's talk about TV responsiveness, I think we've been impacted across the country. There are some that are - have impacted us more negatively than others. It think what I was talking about earlier, I think, is really the key to it - whether it be TV or Internet, but more specifically Internet going forward - the ability to be able to differentiate ourselves from our competitors, namely adding those degree programs, adding additional programs, for example, in LPN and skilled trades and continuing to diversify.

We have - we've made a conscious effort, as I said, to - or a conscious decision - to move away from TV, where it's just not cost effective and put more emphasis on Internet. And so, that may have had some impact on our numbers or will have some effect on our numbers in the fourth quarter. But certainly, in terms of our margin improvement and how we run our business and how we position ourselves for 2006, I think, is really key. We don't want to begin the year and run halfway through the year with class sizes of four, five, six students for the sake of achieving some enrollment figure.

Okay. I understand. Again, I'm just trying to see where are there pockets of weakness. You mentioned in terms of the TV advertisements all across the country. Again, auto tech versus health, skill trades again, any general comments on the specific verticals?

No, I would say we don't see any weakness in demand for any of our program offerings. I - the only comment I would make is the extent to which some of the health sciences programs, where the barriers to entry are lower, there's more competition in some of the markets. And as a result, I think we've been - I think we've been impacted this year by that. And our response to that, our reaction to that is, number one, adding degree-granting programs where we can. Secondly, as I've mentioned earlier, enhancing our program offerings. That's a strategy or an initiative of the company.

And I think it's going to help us going forward. And finally, the ability for our students who were attending diploma programs, in states where we don't have degree granting, the opportunity to be able to complete their degree online. And that's an initiative that I mentioned earlier in the prepared comments regarding the pilot program we're currently offering or running in our Norcross, Georgia school, where the students - for example, in New Jersey, where we don't have degree granting, they can transfer the credits to another campus within the company and get their degree.

Okay. I just have a few numbers questions. In terms of the right sizing you're talking about, are we going to see it more on the educational services line item, the SG&A line item or will it be kind of spread between the two?

It's spread between the two.

All right. And how about in terms of the quarter? Can you give an ending enrollment and also starts for the quarter that just ended?

Well, the only number we provided is average enrollment data and I believe we provided that number in our press release. So, we ended the quarter at 18,029 students.

Okay. And from a tax rate perspective, what should we be looking for on a normalized basis for the rest of the year and next year?

We have several tax initiatives underway for the rest of the year. I would say, probably, we're in the process of updating it. They're probably 41.25-41.5%.

Okay. And then, finally, stock-based compensation, which line item is that recorded in?

That's in SG&A.

And roughly, what was that on a gross basis? You mentioned the EPS effect.

That was about $1.1 million.

Okay. 1.1. And last one, in terms of your capital expenditure budget, you said it's going to be going up. What should we be looking for, for this year and next?

I think the guidance we had previously provided is - while, obviously, some of these things have taken longer than we anticipated, especially the Grand Prairie and the Lincoln. However, we will be incurring additional monies the rest of this year as we finish the fit out of Queens. We will start building out Grand Prairie this year. So, I guess, on average, this year, we'll probably end up coming in at about 10% or so. Next year, it will probably be somewhere in the 12-14% range.

And you're talking percentage of revenues?

Yes, I am.

Great. Thanks a lot.

(Operator instructions) And your next question comes form the line of Gary Bisbee of Lehman Brothers. Please proceed.

Hi, guys. I'll ask a couple. I'll try to keep myself to two. But since everyone else has asked about eight, I might not be able to control myself. First question, on the enrollment trends that you've talked about, I know that August and September are big months for the high school students. Are you seeing some weakness there or is a lot more of it the older, non-traditional student who you attract much more than the media advertising.

Gary, our high school effort came in pretty much on target with what our expectations were, numerically, for the year.

Okay. And within that did you see any programs that were especially strong or not strong in the quarter? I mean, is that still mostly focused on the auto business at this point?

The bulk of it is auto and we have a growing high school effort in the remainder of the schools.

Okay. I guess I'm trying to understand the TV media cost. When I look at the broadcasting companies, they're saying they can't get much pricing and that industry doesn't seem to do very well. Is there something about the types of advertising you're buying or if somehow you can help me explain why the pricing has become so challenging there. Is it that the spot rates are much more expensive than buying them on the advance or what - any sense of what's going on?

Well, I can't speak to what's going on in the rest of the world, but I can certainly speak to direct response advertising that we do because we have numerous markets and we, to varying degrees, the same thing happening. We buy broad rotators, which, basically, we purchase unsold inventory and they put us in the rotator to fill a spot. With additional schools, with other advertisers who go on flights and have found those - principally, those day parts, we have found some pressure, as we've heard from other schools, to - it depends on the market and sometimes you pay to play and sometimes you back away.

And we chose, at this point, to be much more judicious in our selecting the markets we want to invest in. And then, we want to facilitate the growth of our schools where we have a lot of momentum. In the other schools, we're going to be moving towards the Internet and relying more heavily on that because we think we have some keys to success in that arena.

Historically, you've talked about some other areas, like newspaper advertising, direct mail, are seeing similar things there where the efficiency or effectiveness in those program has dropped somewhat over the last year?

Newspaper, I mean, if you look 30 years ago, newspaper was a predominate source of business. Over the years, newspaper has diminished, in our schools. And it's not as if we haven't periodically tested it over those years. It is a minor source of business for us.

I agree.

Direct mail - depending on the type of school. We have destination schools where we do significant amounts of direct mail. And it's a very reliable resource for us and it fits nicely into our portfolio of advertising opportunities. But for the most part, schools will use it on and off, but it's, again, a minor player. For all intentioned purposes, 90% of our lead flow, in the media side, comes from Internet and television. And so, the extent to which Internet takes over that lead pool, we believe with the cost involved and the cost per start involved, that that will really provide a great opportunity. So, we're jumping on that.

Much more cost effective.

Okay. Great. And then just one quick wrap-up for Cesar. When we look at the fourth quarter numbers, is there any reason to expect that the interest in common interest expense and/or share count would be materially different from what you just reported in the third quarter? Or is that like (inaudible).

Well, the share counts for the quarter alone should be the same. Obviously, for the year, it will not. Interest income and interest expense, I don't know the answer to that question as we stand in here. As you know, we have two LOIs that are process. We also have a lot of CapEx that we plan to go out the door. So, while the interest expense is fixed number, the interest income, obviously, is based on our cash balances. So, to the extent that we do lay out a lot of cash in the quarter, that would have an impact on our interest income numbers.

Okay. Got you. Is there a big chunk of capital leases that you have? Curious with what I think is a pretty, at least at the end of last quarter and this one, a pretty big net cash balance - why you would have net interest expense as opposed to income ...

While we have interest expense - I think if you recall, while we have zero debt, if you will, however, we do have a finance lease obligation out there for properties that we own. The payments on that lease are recorded as interest expense. And that's - so, what you see there is really the payments on the facilities that we lease on those four properties.

Okay. Great. Thanks a lot.

And your next question comes from the line of Tre Cohen (ph) of the Stanford (ph) Group. Please proceed.

Hi. Good morning guys. Whenever we're looking out to next year and your online initiative - 100% online programs, can you give us some sense of insight there as to the initiatives you're taking to actually develop your brand and image in the online arena?

I mentioned earlier the fact that we're going to brand it Lincoln College Online. We're tying that in with our overall thinking in terms of some consolidation of our brands going forward, Tre.

Okay.

But initially, just to kind of recap our approach, I mean, we're going through both ACCSET and ACICS for our 100% online programs so that we can, depending on where we get the approval first, we'll be able to launch that. So, we're very confident, given that strategy, that we'll be able to launch it in the second quarter. And we'll be tying that in with the first program offerings of criminal justice as well as health information technology, which are going to be offered at - on ground, as well, at the other campuses, which have similar branding.

Okay. I guess, the question - the approach I'm trying to look at is you're coming into this and you have several competitors that have done this over the last two or three years. And I was just wondering, are there any best practices that you're seeing there that you're probably going to incorporate into your initiatives, to get off to a cleaner start than probably they did?

Yes, I guess the way I would respond to that at this point, we were very successful earlier this year - about six months ago - in bringing on what we call our champion of online, who has an excellent track record with two other postsecondary education companies. And we're sort of taking the lead from him because he's done extremely well. So, I think we could probably give you a much better update on that in the - early next year when we have a lot more of it developed.

Okay. All right. Well, thank you, guys.

You're welcome.

Ladies and gentlemen, this concludes today's question-and-answer session. I would now like to turn it back over to management for closing remarks.

Well, thanks, everyone, for participating in today's call. We've discussed a number of our initiatives. We're really feeling we're very well positioned for long-term growth. We've got a number of initiatives that we're rolling out over the next several months and quarters. And we look forward to updating you on those programs and our progress in future calls. Thank you.

Ladies and gentlemen, thank you again for your participation in today's event. This concludes the presentation. You may now disconnect. Have a good day.