Universal Technical Institute Inc (UTI) 2011 Q2 法說會逐字稿

Good afternoon and welcome to the Universal Technical Institute, Inc. second quarter 2011 conference call. All participants will be in a listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions.

As a reminder, today's conference call is being recorded. A replay of this call will be available for 60 days at www.uti.edu or, alternatively, the call will be available through May 11th, 2011 by dialing 877-344-7529 or 412-317-0088 and entering passcode 450066.

At this time, I would like to turn the conference over to Ms. Jenny Bruso, Director of Investor Relations of Universal Technical Institute. Please go ahead.

Hello and thank you for joining us today for Universal Technical Institute's quarterly conference call. During the call, we will discuss the results of our second quarter ended March 31, 2011, and then open the call up for your questions. The Company's earnings release was issued after the market closed today and is available on UTI's website at www.uti.edu.

Before we begin, we would like to remind everyone that, except for historical information presented, the matters discussed today may contain forward-looking statements under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. I'll refer you to today's news release for UTI's comments on that topic. The Safe Harbor Statement in this release, which I will not repeat here in the interest of time, also applies to all statements made during this conference call.

Information in this conference call, including the initial statements by Management, as well as answers to questions related in any way to any projection or forward-looking statement, are subject to this Safe Harbor Statement.

In the prepared remarks you'll hear today, we will make reference to EBITDA. EBITDA for all periods discussed during our remarks is a non-GAAP measure representing net income exclusive of interest, income taxes, depreciation and amortization. The schedule provided in the earnings release reconciles EBITDA to the nearest corresponding GAAP-measure net income.

At this time, I would like to turn the call over to Kim McWaters, Chief Executive Officer. Kim?

Thank you, Jenny.

Good afternoon, ladies and gentlemen, and thank you for joining us. On today's call, we are going to change the flow of it slightly given Eugene Putnam's recent promotion to President and CFO. As usual, I'll give a high-level overview of the quarter with a focus primarily on marketing and advertising, student recruitment and new student metrics. Then, in addition to providing a more detailed review of our financial results, Eugene will also comment on key operating trends, the regulatory environment and our outlook for the remainder of the year.

The headlines for our second quarter are our average student population increased 3.3% to 18,800 students, despite a 12.4% decline in new student starts and a 23.5% increase in the number of graduates. Specific to second quarter comparisons historically, the average student population this quarter is a record high for the Company.

The increase in the average student population, combined with the 4.6% increase in average revenue per student, resulted in an 8.1% increase in net revenues to $114.2 million. Net income was 15.7% for a total of $7 million, or $0.28 per diluted share. This compares to $6 million or $0.25 per diluted share last year for the same period.

Now, let's take a closer look at what is behind the second quarter results, beginning with advertising and marketing. Our advertising expense during the second quarter was 7.7% of revenues, compared to 8.5% in the prior year's second quarter. For the quarter, advertising costs in total decreased $285,000 or 3.2% year over year.

The number of student inquiries were up 4% year over year and the cost on a per inquiry basis decreased 7% for the same period. The decrease in expense year over year is a reflection of the volatile advertising environment and our decision mid-quarter to eliminate inquiry sources that do not provide an acceptable cost per new student start, such as all third-party lead aggregators and certain national cable television advertising.

During the beginning of the quarter, just as we did in the previous quarter, we invested in lower-cost media sources as television rates continued to climb and availability tightened. Although the quantity of student inquiries continued to increase, the quality of the inquiries continued to decrease. Therefore, during the latter half of the quarter, we redirected our advertising investment towards higher-quality sources, recognizing that it would result in fewer, but higher-quality inquiries.

The good news is that, while television rates continued to increase and clearance rates at our cost threshold became even more challenging, we fortunately have been able to expand our efforts with certain higher-quality sources. With a clear shift in strategy to focus on higher-quality inquiries, we do expect fewer inquiries at a higher cost per inquiry, but a lower cost per new student start.

As we look forward to the second half of the year, I anticipate our marketing and advertising costs will increase year-over-year by a couple of percentage points due to higher advertising costs overall, our continued investment in critical local markets, and an overall shift in strategy to higher-quality inquiries. I expect advertising costs to be approximately 8% to 9% of revenues for the remainder of the year, and approximately 7.5% to 8.5% for the full year.

Student applications received during the quarter decreased 9.4% year over year, the majority of which is attributed to our adult student segment which declined 16.5%. Our high school segment was down approximately 4.2%, while military was up 38%.

We believe the decline in student applications is primarily the result of sustained economic pressure, disruption in the advertising and lead generation markets, as well as complicating regulatory factors, such as pending changes in compensation and performance management plans.

The depth and duration of the recession has certainly impacted our students and their families. We are clearly sensing some pricing sensitivity and reluctance to borrow. Some students have depleted financial resources and simply are unwilling to take on any more debt. Others lack the motivation and willingness to do what is necessary to overcome some of the financial challenges they face to physically relocate and attend school.

Adult students, those who are independent and do not have parental financial support, including PLUS loans, have been more negatively impacted than traditional age students. Given these factors, advertising and marketing has been less effective overall, which has impacted the growth in applications; again, more specifically with the adult student.

And there has been regulatory distraction for our admissions teams as new compensation and performance management plans are developed and implemented. We have now communicated all of the changes in our compensation plans, which were very well received. We acknowledge that these changes will make it more challenging to manage the performance of our admissions teams in the short term as new plans mature.

Last, while we know that there are certain headwinds we face, we also know that there is always opportunity to improve execution, especially during significant times of change, and we will work hard to do so.

During the quarter we started 3,600 new students compared to 4,100 a year ago. Although we did experience a slight decline in show rate of 180 basis points year over year, it was off a pretty tough comparison. But the decline in new student starts of approximately 12% is largely attributed to having an insufficient number of student applications who were scheduled to begin in the quarter. Although we have been working hard to close the gap for new students scheduled to start in both the second and third quarters, we have been unable to do so given the continued decline in adult student applications for the reasons I just mentioned.

At the end of the second quarter we had approximately 20% fewer students scheduled to start in the third quarter than a year ago at this time. Traditionally, our third quarter new student starts are largely dependent upon the adult student population. Given the challenges we face this quarter and through April with that particular segment, we confirm our previous guidance that we expect starts to decline year over year in the next quarter.

Further, if the trend continues, we may not see the growth we expected to see inside of the fourth quarter. It is still possible, but becoming more challenging.

Now, I'd like to turn the call over to Eugene. Eugene?

Thanks, Kim.

While new student growth continues to be challenging for the reasons that Kim just mentioned, our performance once a student starts school remains very strong. During the quarter our persistence rates were essentially flat as compared to the prior year second quarter. We graduated 2,800 students, an increase of 23.5% year-over-year. And over the past 12 months we have graduated a total of 11,500 students with either degrees or certificates in their chosen field of study.

And while employment remains very challenging for the motorcycle, collision and marine segments specifically, we are seeing some very good progress in both the auto and diesel segments. Now, I'll remind you this has been an area of heavy investment and focus on our part and it's rewarding to see improved performance, even in the face of continued unemployment headwinds.

For the second quarter three out of our nine auto campuses have placement rates at or above 90%, and an additional three are at 85% or better. So, we continue to see really nice progress. On a consolidated basis, our employment rates improved 530 basis points through the second quarter compared to last year's second quarter.

Turning now to our financial results, revenue for the second quarter was $114.2 million, up approximately 8% versus last year. The improvement over the period was primarily driven by an increase in average students in school of approximately 600, or about a 3% increase.

During the quarter we had $1.5 million in tuition revenue from our loan program that was not recognized. That amounts to 1.3% of revenue. And average revenue per student for the quarter increased 4.6% to approximately $6,060.

Operating income for the second quarter was $11.4 million, up 15.2%, compared to $9.9 million in the same period last year. The operating margin for the second quarter was 10%, compared to 9.4% last year and, year-to-date, our operating margin is 12.2%, which is up from 11.9% from the first six months of last year.

Compensation and benefit costs increased $3.5 million from last year's second quarter to $55.8 million. The increase is primarily attributable to an increase in the number of instructors, as well as an increase in IT staff to support the development and rollout of our new blended learning curriculum. This increase was partially offset by a decrease related to modifications we are making to our compensation plans in response to the final regulations. The modifications resulted in a decrease in compensation and benefits of $2.3 million during the three months ended March 31st.

Regarding the specific changes to our admissions plans, we eliminated future retention and graduate bonuses and increased the reps base salaries. If the number of admissions representatives remains the same as it is right now, we anticipate compensation and related expenses for this group will decrease approximately $6 million this year as compared to last year, and increase by the same amount in 2012. Said another way, 2012's numbers will look similar to 2010's.

Additionally, we modified our bonus plans for all other employees, which we anticipate will result -- will reduce total compensation and related expenses by approximately $2 million this year as compared to last.

Depreciation expense increased during the quarter $1.7 million to $6.4 million. Year-to-date, depreciation expense is $12.6 million, which is up from $9.3 million during the first six months of last year. The increase is primarily due to the addition of assets related to our blended learning curriculum project.

Bad debt expense for the second quarter was flat as compared to the prior year at $1.5 million. And as a percentage of revenue, it actually decreased from 1.4% to 1.3%.

We continued to be very pleased with the results of our Dallas-Fort Worth Campus that opened at the end of June last year. As of March of this -- 31st of this year, we had 453 students in school and, at the end of April, we had about 510 students in school at that campus, which is in line with our expectations.

Additionally, the development of our curriculum there continues to be on track and is scheduled to be completed by the end of this fiscal year. At this point, we would expect to begin rolling the blended line curriculum to a legacy campus as early as the second quarter of next year.

During the three months ended March 31st, the Dallas campus recognized $2.5 million in revenues and incurred $3.7 million in expense, which includes $1.6 million in corporate allocations. So, the campus actually had an operating profit of $400,000 for the quarter prior to allocations. As mentioned before, we have anticipated this campus would become profitable on a quarterly basis 9 to 15 months after its opening, and we actually achieved that milestone during the second quarter, less than 9 months after last June's opening.

EBITDA for the quarter was $17.9 million as compared to $14.7 million for this quarter last year. And net income for the quarter was $7 million compared to $6 million last year, and our earnings per share were $0.28, up 12% from the $0.25 per share for the second quarter of last year.

Return on equity for the trailing four quarters was 26.2%, up from 25.6% for the trailing four quarters ended September 30th.

Moving to the balance sheet, it continues to be extremely strong and liquid. We had cash, cash equivalents and investments of roughly $92 million at March 31st, compared with $86 million at December 31st and $81 million at September 30th.

We generated $17.1 million in cash flow from operations during the quarter, compared with $7.8 million during the three months ended March 31st of last year. And we also continue to have no debt on our balance sheet, and during the quarter we did not repurchase any shares of our stock.

During the quarter we did invest $11.7 million in fixed assets, which was up from $9.2 million in the same period last year. That is primarily related to our investment in new curriculum, as well as equipment to begin teaching our diesel curriculum at our Ranch campus.

Our private loan program continues to help students who don't have sufficient access to traditional credit-based loan products, and who are otherwise fully qualified to attend UTI. As of March 31st we have committed approximately $27.4 million under this program, and have $22.6 million in loans outstanding. The average loan per student is now about $4,800. And since inception of the program, we have not recognized tuition and interest revenue, which totals $25 million at March 31st.

As more and more participants enter repayment, our cash collections continue to improve. During the second quarter, we recorded $210,000 in revenue and interest from cash payments that were received, which was up from $142,000 in the previous quarter and, to date, that number is $663,000.

Moving to the regulatory front, as you might expect, senior management has been consumed working with regulatory counsel trying to interpret and adapt to the host of new regulatory oversight rules and preambles put forth by the Department.

As Kim mentioned, reception of the new comp structure has been very favorable and we feel that this is a significant hurdle that we can put behind us as this has been an area of uncertainty for our employees and very time consuming for our leadership. Yet, while this major distraction has been resolved, I believe it will be a few quarters before we can accurately describe what, if any, impact the changes will have on our ability to manage our employees effectively and efficiently.

Another regulation with the potential to impact our business model is the clock-to-credit hour conversion. As most of you probably know, the Department issued a Dear Colleague letter in March that we believe created more questions, and opened questions and interpretive issues with respect to the final regulations related to determining what will constitute a credit hour. In short, we may not be able to obtain sufficient guidance from either Ed or our creditor prior to July 1st to understand and implement the definition of a credit hour as required by the new regulations.

The potential impact is that students attending credit hour programs of study that are unable to meet the new measurements will likely receive less funds from Title IV programs to pay the costs of their education with respect to their chosen programs of study. These students may have to use other non-Title IV program funding to fill the gap created by reduced federal assistance. And that funding could be more expensive or even unavailable and may potentially increase usage of our proprietary loan program or result in students choosing not to pursue their education.

Unfortunately, due to a lack of clarity and guidance, we are at this time unable to estimate what, if any, impact these regulations may have on enrollments, on graduation rates, on proprietary loan usage, or on default rates.

The two other regulatory items that are worth noting are the cuts to the Cal Grant programs and the elimination of year-around Pell funding. In terms of the Cal Grants, in addition to lowering income eligibility requirements, the new law makes schools with three-year cohort default rates above about 24.5% ineligible to participate in the program. Given our relatively low CDRs, we would not expect any impact from this change going forward.

The decision to eliminate year-around Pell, returns the Pell award process to the model used prior to July of 2009. This change will result in delayed funding for some students while others may experience a reduction in Pell funds. AS in 2009, however, students have a number of funding options available to absorb that Pell shortfall should it occur, which would include increased PLUS loans for dependent students, private alternative loans, as well as our proprietary loan program.

As we look to the remainder of the year, the economic, regulatory and legislative and political environments are creating headwinds which are clearly driving lower revenue growth rates than we had previously planned for.

At this point of the year, while we are aggressively working to close the application shortfall and improve closure and show rates, we do believe that new student starts for the year will be below the levels of 2010. And while it remains critical for us to continue to invest in our business to generate quality growth and student outcomes, we must ensure that our cost structure is balanced with the level of student population that we are forecasting.

As mentioned in the press release, we are currently evaluating meaningful cost structure changes during the second half of the year. While these plans are not final, I do believe that, even with lower than planned revenue, we will be able to deliver on our previously announced guidance of full-year operating margins in the range of 11% to 13%.

While these margins will be on lower than previously anticipated revenue, the fact remains our Company is strong and in excellent shape, with plenty of capital and liquidity. And while we haven't seen the final data or regulations, we believe we are well positioned regarding any potential regulatory risk from potential gainful employment metrics.

Our market share of graduating students continues to be extremely strong. Our employment statistics improved again this quarter. Our new Dallas campus is surpassing our expectations, both in terms of financial results and, importantly, in terms of student feedback.

And while I certainly don't want to underestimate the challenges that we face, I'm confident that we can manage the Company to balance both the educational needs of our students with the hiring demands of our industry partners and, at the same time, producing improved operating margin goals that we set forth for the year.

And finally, before we go to questions, I would like to announce an organizational change in Investor Relations. Many of you know Jenny Bruso, our current Director. Jenny will be moving within the Company to pursue some additional career interests and opportunities. We very much appreciate her role and dedicated service over the past year.

Effective immediately, John Jenson, our Vice President and Corporate Controller, will assume day-to-day investor relations duties. I want to thank Jenny for the value she brought to the function and hope that she will meet or speak with John in the near future. And he can be reached directly at area code 623-445-0821.

And now, operator, I think we're ready to open the lines for questions.

Thank you. (Operator instructions.) David Chu, Bank of America Merrill Lynch.

Thanks, guys. I know it's a little bit early, but can you tell me what you're seeing from the high school market and how that compares to last year, for the September quarter.

For the September quarter?

The September start date, yes.

I'd say that it's -- I don't have that right in front of me. Hold on one second. It would be on the projected high school starts. I mean, if you look in terms of the business for the high school market overall through April, it is up 5%, but it's not significantly higher for the fourth quarter enough to offset some of the challenges that Eugene mentioned that we face, given the challenges in the adult market.

So, I will look for that statistic while we're on the phone here, but suffice it to say that it's not increasing enough to offset the challenges we're facing with the adult market in Q4. That said, it has been building momentum the latter part of this quarter and so -- in April -- and hopefully will continue to do that. But, our confidence is not such that we could say it would surpass last year.

Got it. Got it. And also, last quarter you guys discussed kind of hiring a new advertising agency. How has your marketing efforts changed due to this new relationship?

I think we're well into that transition and we've been very pleased with the transition and the efforts with this marketing agency. The changes that we have made, which I mentioned in the prepared remarks, is largely moving away from some of the lead aggregators, in fact all of them, and moving more towards pay-per-click or search engine optimization.

If you look at, on a year-over-year basis, our spend on transactional versus the Internet, that continues to migrate more towards the Internet. And that's something that's not specific to the agency. That's been our strategy all along, to balance our overall advertising spend with higher-cost television and lower-cost digital media.

So, if you looked at it last year, about 80% -- I'm sorry. If you looked at it last year, about 76% of all of the student inquiries were coming from the Internet. That's up to about 80% this year. If you looked at it in terms of spend, we were spending about 60% on television advertising and 40% on Internet. And this year, it is pretty balanced at 50/50.

Okay.

Does that answer your question?

Yes. No, that was great. And so the last question. So, what percentage of inquiries come from TV now?

It's hard to identify whether or not television is the source of origination because 80% of them are coming through the Internet. But, I think the fact that we continue to spend 50% of our advertising budget on television suggests that it is a large driver of traffic to our website and other sort of digital spaces, social media sites, etc. So, it is still a very key media vehicle for us.

Okay.

But, when you think about the Internet, think about it in terms of it being not only a student inquiry source, but also it's replaced the telephone in terms of how they interact with the Company and that's why it's very difficult for me to pinpoint how many are truly originating from television.

Understood. Thank you very much.

Corey Greendale, First Analysis.

Hi. Good afternoon. Actually, I want to pick up where that leaves off. I think, Kim, you just said that about 80% of inquiries are coming from the Internet. Is there any way you could break that out between aggregators and organic?

If you looked at all of our lead sources, I'd say a third of them were coming from lead aggregators. So, that would be a third of 100% of all inquiries.

Okay.

And we have cut those out at this point in time and have basically been able to redirect the spend to, again, some search engine vehicles, pay-per-click, etc., as well as some other quality lead sources that have backfilled some of that gap; not fully in terms of volume, but certainly in terms of quality.

And just if you could on the fly do a little back-of-the-envelop math, my question is, if your -- if the advertising conversion rates on the higher-quality sources are higher, if there's a third of the inquiries that aren't going to be there anymore, can the shift toward the higher-quality sources offset that sufficiently that you could grow the total number of contracts over the next year?

That is our intention. Again, we -- as we mentioned in the last quarter and the fourth quarter, we were trying to test some lower-cost media vehicles. Some worked very well and we're continuing to invest in those. Some are a little more costly, but they return a good investment a student start basis.

And so, our intention is that we will be able to backfill those leads from a quality standpoint and, at the same time, have a structure in place from a staffing model that makes more sense, so that our representatives are not having to waste time on inquiries that may have absolutely no interest in our programs, even though they may have stated that from the lead aggregator company and -- or do not have the means or desire to attend UTI.

So, we think overall it's more efficient and effective and that is our intention. But, it honestly is a little early to tell given that we just made the shift mid-quarter.

Okay. And Eugene, if I could shift to the cost side. I realize you're probably not ready to announce anything on the cost saving initiatives, but I was hoping you might be able to elaborate on that a little bit. Given that we're in May, I assume for the full year the dollar amount from those cost savings isn't going to be enormous. So, I assume some of the margin -- the offset on the cost side is from the change in incentive comp that you talked about already, but is there anything you can say in terms of just generally magnitude of what you're expecting, things you're looking at, anything like that?

Well, I think in terms of what we're looking at, we're looking at everything across the board, from student-facing employees that fluctuate basically with population levels of enrollments. And as those go up, we build up staff and, as they go down, obviously we don't need as much staff there. But, that's dependent upon the number of students in school. We manage that pretty well.

I think as we look to make whatever changes we decide to make going into the rest of this year and, more importantly, into 2012, we just have to understand that these headwinds don't seem to be subsiding anytime soon. And while there are clearly areas that we previously did not invest in as heavily as we are now, we feel those are important to do, such as employment, such as the regulatory front that we're spending a not insignificant amount of money on. Those things are going to continue. And as such, we have to find ways to eliminate other areas that are not as productive as some of the things that we are doing.

So, those are the things that we're looking at. I would not expect there to be significant savings, as you pointed out, for the remainder of this year just because of the timing, but I would expect us to do a fairly significant realignment of our cost structure to prepare for a year in 2012 that, at this point, still looks to be challenging based on those economic headwinds. So, I would clearly expect us to have significantly fewer employees at the end of this year than we have currently. And other than that, that's about as far as we're ready to go at this point.

That's helpful. If I could just throw in a congratulations to Jenny. And I've enjoyed working with you and hope to see you around at some point.

Thank you.

Thanks, Corey.

Peter Appert, Piper Jaffray.

Hi. This is George Tong for Peter Appert. Could you give us some color on how much of the expected start declines for 2011 are attributed to the new incentive comp plan versus the disruption in lead gens versus the economic pressures, etc.?

I think that's a difficult question to answer, but I would say I think that that the compensation distraction is not a significant contributor to new student starts. It is by far more a reflection of not having a sufficient quantity of applications written in previous quarters to begin in this quarter.

When you look at the headwinds that we've talked about, certainly the regulatory overhand is there and has been a distraction for our team. We've seen the disruption in the lead gen markets. All of these factors are colliding and making it more challenging, especially when you look at the macro environment and the duration of this recession and how it's impacted certain of our student segments.

So, I wish I could give you a solid answer and say what is the key driver, but it is the combination of all of them that is weighing heavy on our admissions teams, and our students in the ability to make certain that they apply and begin school as originally planned.

Thanks. And do you have any -- I know it's early, but any idea of where margins can go on a more long-term basis?

Well, we had -- and I'm not sure if it was in the last call, but we have recently talked about kind of an equilibrium goal for the Company of a 15% margin. That seems challenging right now where we are, even if we get to the 11% to 13%. I think it's an appropriate goal. We certainly won't -- I don't expect to get there next year. But, I think that is a good stretch goal; achievable, but not easily. So, that's what at least internally we're attempting to get to.

I appreciate it.

Jeff Silber, BMO Capital Markets. Please go ahead, Mr. Silber.

I'm sorry. Can you hear me?

Now we can. Hi, Jeff.

Okay, great. I wanted to focus on the employment market a little bit. You mentioned that the placement rates were up. Can you talk about the trends in salaries? And I'm just also wondering in terms of the hiring of your auto grad. Are you still seeing the same kind of mix shift between dealerships, aftermarket franchises, etc.? Thanks.

The raises have been relatively stable when you look just at automotive, where we've continued to see increased wages, starting wages, and continued improvement over their initial hiring timeframe and the length of their careers if they have diesel. And so, diesel end players are hiring at higher wages, which is a better opportunity for our students. They are rivaling some of the wages we saw on a historical basis in the auto dealers. And we're also seeing aftermarket companies be very competitive in their salaries, starting salaries and long-term offerings for the students that we've not seen before. Well, let's say before 2009.

So, I think the trends that we've talked to on the previous calls continue. Where I'd say there's pressure has been on the motorcycle and marine side, although that's kind of seasonal from an employment standpoint, and we hope to see that improve and pick up. So, bright signs on diesel and we're encouraging our students to pursue the combination programs of auto and diesel because it opens the doors for them in terms of their employment options as well as earning potential.

And roughly how many students are pursuing that right now?

At a campus you'll see anywhere from 30% to 50% in auto, and sometimes more take the diesel program. So, there's very few that take just diesel, but there are a large number of them that will take both.

Alright. That's helpful. I'm just also wondering about the competitive environment in some of the elective programs you have with some of the OEMs. Has it gotten more competitive? Less competitive? Who have you seen in the market these days?

Are you talking from a student demand standpoint?

I'm actually -- I'm sorry, from the corporations themselves in terms of other schools going after that market.

We have not really seen anything from a competition standpoint for well over a decade where we've seen manufacturers pursuing other direct competitors or vice versa. So, when you think about the manufacturer programs that UTI offers, again, with the exception of a handful at community colleges, we continue to be the primary sole provider of these types of programs for the students. So, it remains a key competitive strength and differentiator for us.

Alright. That's great to hear. And Eugene, just a quick numbers question for you. What should we be modeling for capital spending for the year?

For this year?

Yes, please.

This year will be around $30 million, give or take a couple million.

Okay, great. Thanks so much.

Gary Bisbee, Barclays Capital.

Hi. Good afternoon. It was interesting in the release and then, Eugene, in your comment saying that compensation expense actually dropped as a result of the new incentive comp plan. I feel like a lot of other companies have talked about it rising as they raise base salary -- or increase base salaries to offset I guess less bonus money, potentially. Is this decrease just because you're no longer offering those graduation and retention bonuses? And then the second part of the question, I think you said the costs would be down this year, but then up next year. I guess I'm wondering why.

Yes, let -- it kind of all runs together and I'm going to try to do this without too much accounting speak. But, you're correct, Gary, in that the decline here is because we obviously can no longer pay graduation or retention bonuses beyond July 1st.

And if you think of the mechanics of how we do that from an accounting standpoint, we start accruing for those bonuses when a student starts school. So, there is an amount that's built up on the balance sheet that would in essence reverse because it's not going to be paid anymore. So, that was kind of the one-time benefit this year, or this quarter.

And then, as we raise up -- and we did raise people's salaries, or the majority of people's salaries to compensate them for no longer having a bonus program, that will be a negative drag starting late in the third quarter and for the full fourth quarter of this year and into 2012.

So, the impact with the same number of reps, so taking numbers out of the variable, is -- will be, all in, down about $6 million from 2010 levels in 2011, and then back up about $6 million in 2012 due to the higher salaries. So, 2012 will roughly look the same as 2010.

That wasn't too --

Yes. No, that makes a lot of sense. Thanks. And then, I just wanted to confirm. The move to the hopefully higher-quality but also somewhat more expensive marketing channels, is that some of the Internet things, Kim, that you mentioned, like the search optimization, etc., or is that somewhat of a shift back to TV?

No, it is on the Internet. It is just more about the pay-per-click search engine optimization and those efforts. And I would say that, as we've said in previous quarters, we continue to invest in television and other advertising vehicles in local markets, because we do believe that is one way to kind of battle the headwinds with the students who live within close proximity to the campuses, being able to continue to pursue this despite economic hurdles that remote students might face.

So, we are continuing to invest in television. But, when I talked about moving away from lead aggregators, it was being replaced on other forms of Internet advertising.

Got you. Okay. And then just one last question. As you think about the cost structure and the scale of some of your campuses relative to what the local market demand might be in the near term, is there any thought process or would it even be feasible given the set up of the campuses, to maybe sublease some of the square footage to someone, or is that -- is that the kind of thing you're thinking about as well as the headcount potential?

Well, yes, we're thinking about it, but that's not going to be the driver. There -- that's one -- difficult to do, if not impossible. We've done it in a few instances in terms of subleasing. I think more appropriate, along the lines of what you're talking about is, as leases come up, to reconfigure some of the space. And in some cases that might be more space; in some cases that might be less space. But, in terms of the fairly short-term, being the remainder of this year, most of what I was talking about would be discretionary spend and headcount.

Okay. Thanks a lot.

Jason Anderson, Stifel Nicolaus.

Good evening, guys. How you doing? Just wanted to talk a little bit more on the front end for the third quarter. I know you mentioned volumes looking to be down 20% heading into the quarter. Have you seen -- beyond that, how has the activity been or any color you can provide beyond that?

Can you clarify what you mean by after this --

Well, just either your -- either application activity, inquiry, beyond the start, heading into the quarter, how do we seem so far progressing through?

Well, as far as inquiries, we were up 4% for the quarter. And when you translate that into the next several quarters, given that those are primarily the adult students, that's a positive trend, especially given the fact that we believe we're improving quality given some of the changes that we've made.

Applications, we continue to see building momentum with military and slight increases year-over-year for the field high schools. Btu from an adult application standpoint, that has been down on a year-over-year basis and we're not seeing a reversal in trend. When you look at the month of April, the trends continued and slightly worsened for the adult segment, while high school improved and military improved. So, we haven't seen the reversal of trend with that population yet, even though I think our teams and people are working very hard to do so. It's just there are some headwinds that we cannot change given what these adult students who have responsibilities and don't live close to a campus have to face at this time.

Thanks for that color. And I guess when it comes to the adults, I know even in last quarter and as you're commenting here this quarter, I believe you talked about more -- being more potential scheduled starts delayed out into 4Q. I mean, I guess it seems kind of obvious that maybe the risk of the show of those in 4Q being -- I guess being more at risk, would that be an accurate assessment, or do you feel pretty comfortable? Or any color you could provide there.

Well, in the first two quarters we've seen slight deterioration on our student show rates against, obviously, some tough comps last year. The challenge with Q4 always is that it's the high school student primarily. And so, the longer those students have from the time they make application to the time they show to school, there's greater risk there.

With that said, we're continuing to stay in touch with them and make certain that we're doing what we need to do so that they have the greatest likelihood of showing to school and hope that the adult population reverses trend so that we can start some additional students from that segment inside of that quarter.

But, the high school students, although they're building, they're still under 10% improvement year-over-year for that quarter. And we do need the adult students to pick up momentum so that we have growth on a start basis for the quarter.

Okay, thanks. Understood. One last one here. I know Pell, the second -- the year-around Pell, that second Pell is not a huge impact. But, is there any way you could quantify the dollars you're looking at from that, that second Pell?

Not really, not at this point in time.

Okay. Thanks for -- that's all I had. Thank you.

Alright.

(Operator instructions.) Okay, there is nothing else at the present time. I'd like to turn the call back over to Management for any closing comments.

We would just like to thank everyone for participating on the call today and hope that you will join us on our next call that is scheduled for July 28th, which is a Thursday. And wish you all a great evening. Thank you very much.

Thank you. That concludes today's teleconference. You may now disconnect your lines. Thank you for participating.