Element Solutions Inc
Q2 2008 Earnings Call Transcript

Published: 24 Jul 2008

[Operator:]

Good evening, ladies and gentlemen. And welcome to the ITT Educational Services Second Quarter 2008 Earnings Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. Joining us today from the management team of ITT Educational Services we have Kevin Modany, President and Chief Executive Officer, and Dan Fitzpatrick, Senior Vice President and Chief Financial Officer. Before we begin, ITT Educational Services, Inc. wishes to remind you that this conference call may include forward-looking information. Actual results may differ from the information presented during this call. For additional information please review the section on forward-looking information contained in today's news release or in the company’s public filings with the Securities and Exchange Commission. Thank you. Mr. Modany, you may begin.

[Kevin Modany:]

Thank you. Good morning, ladies and gentlemen, and thank you for joining us on this conference call to review our operating and financial results for the second quarter and first six months of 2008. With me on the call as usual is our Senior Vice President, Chief Financial Officer, Dan Fitzpatrick. Let me begin by providing a summary of what we will review with you on today’ call. We'll start by expanding on the extremely strong second quarter operating results, and we reported to you on our press release earlier this morning. We’ll then provide an update regarding the progress made during the quarter and some of the growth initiatives. We'll touch briefly on the current student lending environment and provide an update on our efforts to address the disruptions in the financing market. At that point, I will hand things over to Dan who will provide some additional detail regarding the outstanding second quarter financial results. Following the conclusion of his prepared remarks and a few summarizing remarks by me, we'll open up the phone lines for Q&A. With the agenda for the call out of the way, let's get started. As you have already read in this morning’s press release we reported tremendous results for the second quarter of 2008. Our results exceeded our internal expectations and further demonstrate the commitment and resolve of our faculty, staff, and management to focus on student success as their top priority. Those excellent results coupled with the strong outlook that we have for our business as we enter the second half of the year, have caused us increase our internal 2008 EPS goal from the range of $4.10 to $4.60 to the revised range of $4.65 to $4.75. As we reported in our press release this morning, we believe that we are incredibly well-positioned to achieve our operating and financial goals for fiscal 2008. In our April 2008 conference call we provided you with historical trending for several of our key performance measures and suggested that a consistent and strong performance of our prolonged period with an indication of the ability of our faculty, staff, and management team to effectively execute our business plan in a variety of operating environment in a phase of various disruptions in the market, be it student financing or otherwise. We believe the second quarter 2008 results further validate and reaffirm that view. Let me reiterate some of the key performance trends for our organization updated to reflect our second quarter results. The 2008 second quarter increase in new student enrolment compared to the same period in 2007 marks our 24th consecutive quarter in which we reported a year-over-year increase in new students enrolling at the ITT Technical Institute. The year-over-year increase in total student enrolment in the second quarter of 2008 represents the 50th consecutive quarter that we have posted a year-over-year increase in our total student census. And EPS increase in the three months ended June 30, 2008 compared to the same period in the prior year represents a 32nd consecutive quarter that we have reported a year-over-year increase in quarterly EPS. These are impressive and consistent results delivered by a talented group of employees who represent the very best of what the ITT Technical Institutes have to offer to our over 54,000 students attending one of our 111 facilities located in 35 states across our nation. To our 7000 plus employees, we would like to take this opportunity to thank each and every one of you for your contributions to our institution, your daily commitment and dedication to your students and to the employers who hired. With that, I'll turn now to a review of our second quarter operating results. New student enrolment increased a very impressive 22.5% to 14,751 during the three months ended June 30, 2008 compared to 12,043 during the same period in the prior year. Demand for our program offerings was extremely strong in the second quarter, and as a result, we experienced a year-over-year increase in new student enrolment in all six schools of study. That strong level of interest in our program offerings continued as we began the third quarter of 2008. The robust level of interest in our program offerings in the second quarter was generated by the efficient and effective execution of our marketing and advertising plans throughout the second quarter. Advertising expenditures during the second quarter increased at a less than planned rate of 2% over the same period in 2007, as we were able to take advantage of softness in general advertising market resulting from the disruptions in the overall economy. We believe that advertising expenditures in the remainder of 2008 will be equal to or slightly below our originally planned year-over-year quarterly increases of between 10 and 15% as we look to continue to take advantage of the favorable advertising environment. We intend to continue our growth strategy by allocating incremental marketing expenditures at a sufficient level to support the opening of new colleges, and the introduction of new programs of study throughout the remainder of the year. Following our planned ramp up and recruiters during the first six months of 2008, we believe that we entered the third quarter of the year armed with an adequate number of recruiting professionals to handle what we expect will be an increased level of student interest for our program (inaudible). At this point I'd like to give a quick update on student persistence. As we reported in this morning’s earnings release, our student persistence rate in the second quarter of 2008 declined 80 basis points to 73.9% compared to 74.7% in the second quarter of 2007. A decrease in student persistence was due to an increase in the number of graduates in the second quarter of '08 compared to the second quarter of '07. The increase in graduates was primarily due to improved student retention and we experienced and reported to you during fiscal 2007. Excluding the increase in graduates, the student persistence rate in the second quarter of 2008 was consistent with the student persistence rate in the same period in the prior year. As you may recall, the student persistence rate in the second quarter of '07 increased 100 basis points compared to the second quarter of '06 as a result of improved year-over-year student retention. Given that the second quarter of '08 student persistence rate was compared against the 100 basis point improvement we were very pleased with the consistent year-over-year student retention rate for the current quarter. We continue to have several retention initiatives in various stages of planning, development and/or implementation that is effective could improve student retention which could lead to higher student persistence rate in the future. That said, as we look forward to the second half of fiscal 2008 we believe the student persistence will remain consistent with prior year rate excluding any increases in the number of graduates. Primarily, as a result of the 22.5% year-over-year increase in new student enrolment and the consistency in the year-over-year student retention rate posted in the second quarter of 2008, total student enrolment increased a very impressive 12.1% to 54,793 as of June 30, 2008 compared to 48,873 at the same point in 2007. As of June 30, 2008, total student enrolment was higher in all six schools of study compared to the same point in the prior year. At this point, I'd like to turn your attention to our graduate employment metrics. Each fiscal year we measure the employment success of our students in graduates and obtain employment and position using skills taught in the program of study by April 30 of the year following the year of graduation. Therefore, the point for measuring the employment success of our 2007 graduates was April 30, 2008. I am very pleased to reiterate what we disclosed in this morning’s earnings release that 82% of our 2007 employable graduates obtained employment and positions using skills taught in their programs of study by April 30, 2008. This compares to 81% of our 2006 employable graduates who obtained employment by April 30, 2007. Our 2007 employed graduates reported an average annual salary of $32,400 which represents an increase of 5% compared to the average annual salary reported by a 2006 employed graduates. Notwithstanding the year-over-year increase in the number of graduates in the first half of 2008 as of June 30, 2008, the graduate employment rate for 2008 employable graduates was consistent with the rates of 2007 employable graduates at the same point in 2007. However, the average annual salary reported by our 2008 employed graduates at the end of the second quarter was approximately 5% higher that reported by our 2007 employed graduates at the same point last year. Moving into the third quarter of '08 employer interest in the graduates of our programs of study remain solid despite public reports about volatility in the general labor market as a result of the economic disruption in the marketplace. We remain optimistic about the job opportunities for our 2008 graduates. We continue to believe that stable job market for skilled labor and increases in average annual salaries for our employed graduates are positive indicators that we can continue to increase the value proposition for graduates of our programs of study. At this point I'd like to provide an overview of our progress with a few of our key growth initiatives. We began operations at our 101st college in Phoenix, Arizona and our 102nd college in Columbus, Ohio during the second quarter of 2008. These two new locations represent our second location in each market. We began operations at five new locations in the first six months of 2008 and are very well-positioned to meet or exceed our previously stated goal for geographic expansion of six to eight new locations in 2008. Combined with our nine learning sites, the two new locations opened in the second quarter bring to 111, the total number of ITT Technical Institutes locations operating throughout the United States. As an update on our program (inaudible) expansion efforts, we added 109 programs of study at our colleges during the six months ended June 30, 2008, positioning us very well with respect to our internal goal of introducing approximately 125 programs at new and/or existing ITT Technical Institutes in fiscal 2008. As we begin the second half of the year, we had several additional programs of studies and in various stages of research or development. These potential new program offerings are in both technology and non-technology areas of study that could be delivered both in residence and online. We plan to introduce several of these new programs at one or more of our ITT Technical Institutes in the second half of 2008. At this point I'd like to provide an update on the student financing environment. Of the first three or four months of 2008 represented a period of extreme volatility for the education lending sector as well as for the general financial markets, recent actions by Congress and the White House to provide stability to the student financing market, particularly the Title IV Loan Programs appear to be generating the desired effect. Additionally, the increases in federal student loan limits have substantially reduced our students need for private education. And we once again applaud Congress and the White House for their proactive and aggressive efforts to increase access the post secondary education for all qualified Americans. For our institutions, the new legislation materially reduces the funding gap for our students between the cost of their education and the amount of federal financial aid that is available to them. As a result, we believe that the funding gap for our students in 2008 will now be roughly 12 to 13% of our annual revenue, which is half of our original estimate. We have not returned to previous levels of liquidity in the overall student financing markets while there continues to be uncertainty with respect to the availability of private education financing for our students the federal loan program appears to have returned to a more normal level of stability. During the second quarter of 2008, we were approached by several lenders who expressed an interest in providing federal education loans to our students. We obviously view these recent developments to the very favorable sign and at this point do not have any major concerns with regard to the ability of our students to access the federal loan programs without disruption. We note however that the series of changes that we made to our systems to facilitate the processing of federal loans with new lenders did temporarily impact our ability to efficiently process federal loan disbursements during the second quarter. Although system changes did not impact our ability to package students the delay in receiving cash disbursements from these new federal lenders is most evident in the change in our deferred revenue as of June 30, 2008 compared to the same point in the prior year. We believe that the delay that we experienced in the second quarter and the processing of disbursements for students federal loans is a temporary byproduct of the introduction of these new federal lenders to our student lending systems, and we plan to eliminate those delays during the third quarter of 2008. Having described the positive impact on the federal loan programs in the recent legislation let's turn our attention to an update on the private lending front. During the second quarter of 2008 we continued our discussions with several new third-party lenders about the possibility of them providing private loans to our current and perspective students. Those conversations are continuing as we head to the third quarter. Separately, several financial institutions are currently providing private education loans to our students. The limited data that we have received today regarding the utilization of private education loans by our students does not suggest that there were any material changes in the underwriting criteria of those loans during the second quarter of 2008 compared to the first quarter of 2008. Furthermore at this point we have not been notified of any material changes to the underwriting criteria that are expected to occur during the third quarter of 2008. We cannot assure you that the lenders won't change their underwriting criteria in the future. As a result of the novelty and limited nature of the data that we have collected to-date regarding private lenders underwriting criteria we are unable to provide you with an accurate estimate of the amount of the revenue that we will derive from third-party private student loans during fiscal 2008. As our conversations progress with certain financial organizations and we obtain more data and experience with respect to underwriting criteria of current and or any new lenders that may begin offering private loans to our students in the future, we believe that by early 2009 we will be in a better position to provide estimates of our projected annual revenue from private education loans made to our students. To the extent we obtain any additional clarity sooner, we will certainly provide an update at that time. So while we are seeing some signs of stability in the private education loan environment and are having positive discussions with additional lenders about providing private education loans to our students we have not yet completely resolved the private student loans challenge to our satisfaction. Moving on now to an update of our internal financing program, during the second quarter of 2008 we continue to offer internal education financing to eligible students who did not qualify for private education loans as a result of the tighter underwriting criteria currently used by private lenders. The criteria that we use to determine the students eligibility for our internal financing are similar to the criteria used by the lender that made private education loans to our students before 2008. Student response to our internal financing program has been overwhelmingly positive and we do not anticipate making any changes to our student enrolment practices in the future as a result of the continued utilization of our internal financing program. Based on my earlier comments regarding the lack of data and experience to accurately estimate the amount of revenue derived from private education loans we are therefore unable to accurately estimate the annual model of internal (inaudible) that will be utilized by our students until we obtain a better perspective on the anticipated level of private education loans. What we can say is that we currently estimate the total funding gap for our students between 12% to 13% of our annual revenue. And at some portion of that amount is currently being funded by third-party private education loans to our students and the remainder is being funded by our internal financing program. As stated in this morning's earnings release our internal financing could result in days sales outstanding that exceed 10.8 days and bad debt expense higher than 3.9%. While we're not providing specific guidance on these metrics at this time we want to once again emphasize that any anticipated effect on our results that maybe caused by increases in internally funded student financing has been fully reflected in our revised 2008 EPS goal to the range of $4.65 to $4.75. Close out the student financing portion of our prepared remarks, let me just say that we continue to believe that the financial way that is currently available to our students including our internal student financing program will provide them with sufficient funding options to pay the cost of their ITT Technical Institutes education. Further, we believe that the financial aid options that are currently available to our students will allow us to achieve our 2008 goals. Now, before I turn it over to Dan for his prepared comments regarding the financial results, I want to reiterate our very optimistic view of the business and our confidence in our ability to continue executing our growth strategy to achieve our internal 2008 goals. Dan, let me toss it over to you for a review of the fantastic financial results.

[Dan Fitzpatrick:]

Thanks, Kevin. I'd like to begin as usual by reviewing the key financial highlights for the quarter. In the three months ended June30, 2008, revenue increased 13.6% to 246.4 million compared to 217 million in the same period in 2007. Revenue increase was primarily due to a 9.9% increase in total student enrolment as of March 31, 2008 compared to the same period in 2007, and the 5% increase in tuition that became effective with the academic quarter that began in March 2008. Revenue increase was partially offset by an 80 basis point decline student persistence in the second quarter 2008 compared to the same prior year period as a result of the increased number of graduates during the quarter as Kevin previously mentioned. Revenue per student increased 3.3% in the three months ended June 30, 2008 compared to the same prior year period. Cost of educational services increased 4.6 million or 5.1% to 95.2 million in the three months ended June 30, 2008 compared to 90.6 million in the three months ended June 30, 2007 primarily due to higher costs to support our increased number of students and operate our new colleges. The increase in the cost of educational services was partially offset by greater efficiencies in operating our colleges. As reported previously, the improved efficiency of our operating model was due to a more effective utilization of our existing staffing and facility and was supported by current and previous investments in the technological infrastructure. As a result, the cost of educational services as a percentage of revenue decreased 310 basis points to 38.6% in the second quarter of 2008. This compares to 41.7% in the three months ended June 30, 2007. Student services and administrative expenses increased 6.2 million or 9% to 74.9 million in the second quarter of 2008 compared to 68.7 million in the three months ended June 30, 2007. This increase was primarily due to the increase in bad debt expense to 3.9% of revenue in the second quarter of 2008 compared to 2.5% in the same prior year period. The increase in student services and administrative expenses was partially offset by the efficient executive of our advertising plan during the second quarter of 2008 which resulted in only a 2% increase in advertising expenditures compared to the same quarter in 2007. The increased in bad debt was a result of the increased utilization of internal financing by our students as Kevin noted in his comments. Despite the increase in bad debt expense student services and administrative expenses as a percentage of revenue decreased 130 basis points to 30.4% in the three months ended June 30, 2008 compared to 31.7 in the three months ended June 30, 2007. As we noted previously, we plan to continue providing internally funded student financing in future periods due to the disruption in the private student loan market. As a result we believe that bad debt expense as a percentage of revenue could increase in future periods, however, we're not providing specific bad debt guidance at this time. As Kevin has already reported, a revised 2008 EPS goal fully incorporate any anticipated impact of the possible increase in bad debt expense as a result of any planned increases in our internally funded student financing. Operating income increased 18.6 million or 32.3% to 76.3 million in the second quarter of 2008 compared to 57.7 million in the second quarter of 2007. The operating margin increased to 31% in the three months ended June 30, 2008 or 440 basis points compared to 26.6% in the three months ended June 30, 2007. As we reported in this morning's earnings release diluted earnings per share in the second quarter 2008 increased 37.9% to $1.20 compared to $0.87 in the same quarter of 2007. Cash and cash equivalents were 78.7 million as of June 30, 2008 compared to 10.1 million as of June 30, 2007. We also had short-term investments of 170.5 million as of June 30, 2008 compared to 290.3 million as of June 30, 2007. The change in the total line of cash, cash equivalents and investment balances reflect the delay and cash receipts from FFELP loan disbursements as Kevin previously noted as well as a decrease in funds received from private student loans. As we continue to refine the technology interfaces utilized with our new lenders we expect the rate at which they process FFELP loans for students to return to a more normalized level in the third quarter of 2008. We also anticipate that the additional FFELP cash receipts associated with the $2,000 per student increase in academic year loan limit which is effective as of July 1, 2008 will in future periods partially offset the impact on deferred revenue from the increased use of our internal financing program. To summarize the anticipated impact of all these funding changes on our cash flow for the year we believe that we will generate in excess of 150 million of free cash flow for the 12 months ended December 31, 2008. This compares to free cash flow of 168 million generated during the 12 months ended December 31, 2007. Reconciliation of these non-GAAP free cash flow measures to our comparable GAAP operating cash flow measures are posted on our Web site at www.ittesi.com Days sales outstanding increased 6.6 days to 10.8 days as of June 30, 2008 compared to 4.2 days as of the same date in the prior period. This increase primarily relates to the increase in internal student financing and the delays in receipt of FFELP lone disbursements. Once again, we anticipate that we will continue to provide internal financing to students in the future quarters, thus the possibility (inaudible) our DSO could increase in future periods in 2008 compared to the same prior year period. We did not repurchase any of our common stock in the second quarter of 2008. We have approximately 4.2 million shares under the share repurchase program authorized by our Board of Directors and we intend to resume repurchasing shares during the second half of 2008 if the market conditions are appropriate. I also want to echo Kevin's comments and note that our business fundamentals are very solid. The outlook for our business remains strong in the remainder of the year and we have a great deal of confidence in our ability to achieve our internal operating and financial goals for 2008. With that I'll turn the call back to Kevin.

[Kevin Modany:]

Thanks, Dan. I believe that you can tell by our comments today that the management team is very upbeat and then we like we're seeing in terms of the overall operating environment right now for high quality post secondary education institutions like ITT Technical Institutes. We of course will continue to work on the student financing challenges, but we believe that we've made substantial progress on this front over the past six months. We have more work to do, we believe that we are well-positioned to achieve our near-term goals as well as operating and financial performance over the long haul that is in line with our historical results. We remain committed to delivering a high quality education to our students and increasing the value proposition for ITT Technical Institutes graduates across the country. We strongly believe that shareholder value will be created and delivered over the long-term through our efficient execution of the business model and our singular focus on increasing student success. At this point I'd like to ask the operator to open up the lines and we'd be pleased to entertain any questions you may have.

[Operator:]

Ladies and gentlemen, we will be conducting a question-and-answer session. (Operator instructions) Our first question comes from Jerry Herman with Stifel Nicolaus. Please state your question.

[Jerry Herman:]

Thanks. Good morning, everybody. Nice quarter, guys. I just wanted to pursue the advertising spend again and maybe in the context of the very strong start numbers that existed. Can you talk about placement versus price on advertising spend? Meaning the volume of advertising you did relative to the pricing that you were paying for that advertising.

[Kevin Modany:]

I will just say I think you're hitting on it exactly. Really what we're talking about here is that we did not make any material changes to the volume of placements necessary to support any of the growth initiatives, whether they're new programs, new locations or whatever, really what we're seeing here is we’re taking advantage of some of the price differential there and probably a supply and demand thing relative to changes in the marketplace.

[Jerry Herman:]

Okay. Great. And with regard to the strong starts, can you talk about what (inaudible) matriculation you had on that number as –

[Kevin Modany:]

Sure.

[Jerry Herman:]

Go ahead.

[Dan Fitzpatrick:]

Nothing more than normal quite frankly. We’re seeing strong intake on the front end of the process and strong demand. So, there was really nothing unusual on either front.

[Jerry Herman:]

And then one question for Dan if I may, the accounts receivable, this is looking at some of these issues little differently, but accounts receivable number, can you maybe talk about the increase there year-over-year and what part of that was contributed by delays in FFELP and what part by your own internal funding?

[Dan Fitzpatrick:]

Well, Jerry, we're not going to break out that level of detail, but what I will say the other thing you need to keep in mind is some of the benefits that we'll get as we receive the proceeds of the additional 2000 and sub monies for the students in July and going forward, some of that will in fact offset – now again, the vast majority will offset the deferred revenue going forward, but they are admittedly. Both of those things contributed, we really don't break it out at that level of detail.

[Jerry Herman:]

Great. Thanks. I'll turn it over.

[Kevin Modany:]

Okay. Thank you.

[Operator:]

Our next question comes from Gary Bisbee with Lehman Brothers. Please state your question.

[Gary Bisbee:]

Hi, guys. My congratulations on the quarter.

[Kevin Modany:]

Thank you.

[Gary Bisbee:]

Can you tell us what percent of revenue in the quarter was private loans? Is that 12 to 13 – is it right to think of it sort of a blended number once you get past the loan amount increase in July it will go down and it was above that?

[Kevin Modany:]

The 12 to 13% really is kind of a forward-looking number. So you are that more factoring in the Title IV activity. The additional $2,000 on the Title IV as a result of recent legislation. So that’s encompassed in the 12 to 13. We really haven't seen that yet and we won't see it until we get past the July 1 date which from this point forward of course we will.

[Gary Bisbee:]

So what was it in the quarter? And can you tell us the exact number of loans that you underwrote for your students in the quarter?

[Kevin Modany:]

Yeah, we're not breaking out that level of detail, Jerry in terms of the amount of temp credit or internal financing that we’re utilizing and we're trying to give you a more macro view of it. The best way to think about this from our perspective is just trying to have you look at the cash flow and give you a forward-looking view of the free cash flow. I think if you look at where we're at to-date on free cash flow year-over-year you kind of look at the second half of the year you can see what we're projecting in terms of cash flow coming from Title IV and private loans and we think that gives you a pretty good look at it without us breaking out all the different pieces of the (inaudible).

[Gary Bisbee:]

I will try one more. Can you tell us roughly where you're reserving against the loans that you’re making?

[Kevin Modany:]

Again, we're not breaking out the reserve detail. That’s the best [ph].

[Gary Bisbee:]

I will give you a – my $0.02 on it which is that there is going to be fear in the marketplace that you're under reserving unless you can give people at some point some sense of how you're thinking about it that. My advice is to rethink that when you have future opportunities to talk to us. I will ask one more question though. The SG&A you've obviously done a terrific job and the advertising expense sounds like that really helped. When I go back and look at the last five years, it looks to me like just a seasonal pattern for your business like SG&A happens to fall quite a bit in the second half of a calendar year versus the first half. Is it right to think that should happen again? And maybe the second part of the question is do you have a better handle and you’re willing to comment on what amount of incremental costs you're going to have just to do the lending, like I think you said you might outsource servicing and some other things like that? Thanks.

[Kevin Modany:]

Yeah, I think in terms of the pattern of the expensing current, nothing materially different there. We will expect to see some upside on the marketing spend as we talked about related to some general softness in the market there is that opportunity and we talked a little bit about that. Our expected spending below the 10 to 15% increase that we originally planned. So that's the only difference in the timing issue there. Go ahead.

[Gary Bisbee:]

Just any sense what it's going to cause to actually do the loans yourself? You just that report I think maybe a couple million dollars I wanted to make sure it wasn't, just ballpark if you'd give a sense.

[Kevin Modany:]

I don’t think we gave that kind of detail, but I can tell you that we're not anticipating a significant amount of external costs relative to the internal financing program at this point.

[Gary Bisbee:]

Okay. Thanks for the color.

[Kevin Modany:]

Thank you.

[Operator:]

Our next question comes from Brandon Dobell with William Blair. Please state your question.

[Brandon Dobell:]

Thanks. One more kind of beat the dead horse (inaudible) on deferred revenue. I'm assuming that your comments would imply that year-over-year declines were really unrelated to disbursement timing issues and there was nothing in the way they were having to do account for using your own balance sheet that would change how that revenue is accounted for in deferred revenue which is relates to timing issue, is that fair?

[Dan Fitzpatrick:]

Yeah, there is a timing issue, but the other thing is still I mean there's no doubt that there is less private loan dollars coming in, but that coupled with the delay in the FFELP disbursements is really what you're seeing there. Relative to how we would recognize revenue on internal financing or otherwise, no impact there. You're not going to see anything from that perspective.

[Brandon Dobell:]

From a different point of view here, if you look at your physical locations and compare maybe recent school openings in the last year or so to what you guys saw three or four years ago and then look across the network now versus three or four years ago, how we think about the level or the number of people per location or the amount of FFELP service work that students can do, just trying to get a sense for from a personnel perspective what head count growth looks like now as you open new schools versus where it was before if you're getting a lot more efficiency because you just go on adding or don’t need to add as many people as you open new schools?

[Kevin Modany:]

Really, nothing made very materially different there, quite frankly. We're seeing efficiencies in the new school model as we talked about before.

[Brandon Dobell:]

Yes.

[Kevin Modany:]

That's more so probably because we're ramping up on the enrolment a little more quickly and then being more efficient in terms of the way we're executing on the delivery of the educational service. But when you’re talking about a start-up there's a certain number of people you need to have there, certain number of positions that need to be filled, and that really hasn't changed very much over the years.

[Brandon Dobell:]

Okay. And then you also mentioned a little bit about enrolment counselors or recruiters. How do we think about the relative magnitude of the productivity you're seeing from new hires versus the existing stock of people. Just trying and (inaudible) trying to get a sense of what kind of assumptions you built into your thought process going forward for how much more productive they get or when you’re making changes there if you look at what the enrollment growth should be?

[Kevin Modany:]

We talked a lot in the past about how new enrollment counselors are certainly not as productive as experienced and that seems the reason. We've seen a little bit of an uptick there, but I don't think anything that moves the dial. When we look forward we're not making any kind of material changes to our expectations and we think that if we can maintain these current rates of efficiency and maybe we would stay conversion rates, we should be in great shape.

[Brandon Dobell:]

Okay. And then one final question. Anyway that kind of frame out the relative magnitude or the relative size of the graduations this quarter versus last and if you think about the next two or three quarters going forward, any changes there in the size of what those graduating classes might look like, just given how good the retention was back in '07?

[Kevin Modany:]

Sure. No, the graduate increases are expected to continue in the second half and probably at about the same level we saw during the current quarter.

[Brandon Dobell:]

Okay. Thanks, guys.

[Operator:]

Our next question comes from Trace Urdan with Signal Hill. Please state your question.

[Trace Urdan:]

Thanks. I'm wondering given the strong new student start whether you believe or you have any anecdotal evidence for the ideas that the blended program offerings that you have and the ability to take classes online is a material factor in light of where gas prices are right now and if it makes you more competitive relative to other options that students might be looking at?

[Dan Fitzpatrick:]

Good question, Trace. And quite frankly, we're not seeing that. I mean, we're still seeing the majority of our enrolments on the resident side, and almost a great majority of them purely resident. So we're not seeing any impact from the gas prices. We heard that anecdotally and read about it, but we're not seeing it in the numbers.

[Trace Urdan:]

Okay. And then I wondered, Dan, maybe you could, obviously, you're hearing the deferred revenue kind of – you've explained it well, but it kind of bagged the question about what are we likely to see in the balance sheet as your lending ramps up. And I wondered if you – I get that you don't want to sort of reveal too many specifics. But maybe you could just talk about what the mechanism is as a private loan comes in. Do you guys – will you put all that money for the loan into the deferred revenue as though it were coming from a third-party source or will it not work that way? How are we likely to see those loans kind of come through your balance sheet?

[Dan Fitzpatrick:]

What we're trying to do is give some color on that when we try to give some guidance as to where we think we're going to be on free cash flow for the year. And as you can see that it's not going to change dramatically (inaudible). That’s going to impact both the AR side of things and deferred revenue, but nonetheless trying to shed some light if you will, going forward where we think free cash flow would be, and we feel – again, the number we put out there was we think we can exceed that number. So that how we’re trying to address that point. We can’t give you a little color.

[Kevin Modany:]

I may – Trace, just to add a little bit to it, as you look at the current quarter and you’re trying to think about looking at the current quarter results and what does that mean to the forward-looking. I mean, you really have to factor in these three kind of moving variables that were going on during the quarter. First and foremost is that we changed FFELP lenders, we brought on new FFELP lenders and that processing was different and as a result it delayed some of the cash receipts. So we have an impact there from that. Of course, we have an impact from the increased use of internal financing and AK [ph] the decrease use to private lending. But thirdly, we’re going to have an offset of that amount as a result of the receipt for the additional $2,000 of Title IV loans. So that comes July 1. That offsets that private differential. We’re not seeing that yet. So if you just purely look at the shift in deferred revenue right now, (inaudible) overstate the expected impact looking forward. So the simplest way for us to try to summarize that for everybody instead of breaking out all these moving parts was to say okay, looking forward we're going to take a 12-month view of this thing, we think we can exceed $150 million in free cash flow. You take a look at where we are today you can see what that means for the second half and it looks pretty good. So, that's the best way we can kind of take a macro view this and try to give you some sense of it without trying to break out all this specific detail on each moving part if that makes sense.

[Trace Urdan:]

Okay. Thanks.

[Operator:]

Our next question comes from Corey Greendale with First Analysis. Please state your question.

[Corey Greendale:]

Hi, Good morning.

[Kevin Modany:]

Good morning.

[Corey Greendale:]

First question again on the same issue. The first of the three items that you broke out, Kevin, is – it already kind of more in line with what you – are the systems more running as you expected? In other words, have you already received the disbursements that were delayed from June or is this more of an expectation as the quarter goes down?

[Kevin Modany:]

That's a good point. No, we actually have – already made the corrections necessary, and we're seeing more normalized disbursements.

[Corey Greendale:]

So you have evidence just…?

[Kevin Modany:]

Yes, exactly.

[Corey Greendale:]

Okay. Understood. Then second question, how many – real time how many lenders are you working with now and where do they stand in terms of being up and running into system?

[Kevin Modany:]

From a private lending side, we're getting the majority of the disbursements from three to four lenders although there are others involved as well.

[Corey Greendale:]

And those three to four are all up and running?

[Kevin Modany:]

Yes.

[Corey Greendale:]

Okay. Next question I had was the revenue for student growth was a little bit below the 5% price increase and I’d expected that to be more in line with the 5% given that retention was stable, what’s driving that below the 5%?

[Dan Fitzpatrick:]

Corey, the one thing, we're talking about retention be still in the persistence impact overall so that is going to drive it down some.

[Corey Greendale:]

Okay. So you'd expect it to stay around this level of growth, that kind of 3% growth going forward?

[Dan Fitzpatrick:]

In that neighborhood. Yes.

[Corey Greendale:]

Okay. Then next question I had was on the – I think Kevin you said that overall enrollment was positive in each of the six schools, is that true of new student growth as well?

[Kevin Modany:]

Yes, it was. New student and total.

[Corey Greendale:]

Okay. And last quick one, on the ad expense, was it primarily television that you’re talking about that was cheaper than expected or is that across all forms of media?

[Kevin Modany:]

Across all media.

[Corey Greendale:]

Okay. Great. Thanks very much.

[Kevin Modany:]

Thank you.

[Operator:]

Our next question comes from Mark Marostica with Piper Jaffray. Please state your question.

[Mark Marostica:]

Thank you. Just want to follow on that last question and ask whether or not you changed or alter your media mix in the quarter in addition to taking advantage of some lower pricing?

[Kevin Modany:]

We do that fairly regularly, Mark, but we didn't do anything materially different. We're still seeing the majority of the dollars going to television.

[Mark Marostica:]

Got it. I want to ask more macro question here. If we look back to the last economic downturn, did you see any pressure on starts or enrolments, any of your schools of study that you would attribute to a slowing economy, and perhaps if you could comment on that relative to the situation we're faced with no economically?

[Kevin Modany:]

Nothing in general. I mean whenever we see disruption in the technology markets, we see some downward pressure there. So and we've talked before about being more specifically tied to what will be happening in the technology market. But I would say as a general sense, no, we don't see anything other than that.

[Mark Marostica:]

And then relative to that point, Kevin, is there typically a lag that you see that certainly may not happen right away or materialize on your starts right away, but is there some sort of metric you can give us as far as what type of lag you might see relative to the effect on certain movements?

[Kevin Modany:]

It's pretty quick, Mark, quite frankly. If we were going to see something, we would have already seen it. And we’re just not seeing any of that right now and as we look forward in terms of our demand going into the second half of the year, it's really strong right now.

[Mark Marostica:]

Got it. And then there was a comment made in the prepared remarks around number of student retention initiatives that might be in play here. I'm just wondering if you could help give us a little bit of color if you would on some of those and whether or not you think they will have a near-term impact or whether there more longer term in nature?

[Kevin Modany:]

Let me take the second half, first. They're probably more longer term in nature. I don’t want to (inaudible) we’re recreating the wheel here, but there are basic things you can do in terms of student retention and you’re focusing on the basics so that making sure students are attending classes, making sure the quality of instruction is there, analyzing all the data course by course, section by section, putting initiatives then where you see some gaps in terms of your expected performance. So it's nothing that we haven't done before. Some things that we've had success with in the past we’re reinvigorating some of those program, but we're – when we're thinking about the guidance or talking to you about your model, we're really talking about trying to maintain the improvements we had last year. If you look in the second half of last year, probably third and fourth quarter we were north of 100 basis points on the persistence which results driven by retention. If we can hold that in the second half, we're going to be pleased with that.

[Mark Marostica:]

Great, and then one last item. And I just want a point of clarification. I think in your remarks you talked about not changing your enrolment discipline. Would I assume then that the same type of student you would have enrolled under the prior lender you will continue to enroll going forward?

[Kevin Modany:]

That's correct.

[Mark Marostica:]

Okay. Thank you.

[Kevin Modany:]

Thank you.

[Operator:]

Our next question comes from Kevin Doherty with Banc of America Securities. Please state your question.

[Kevin Doherty:]

Thanks. I know there's some items you obviously have some sensitivity around, but could you just help us understand, maybe we are in the process, you’re of understanding some of the default rate assumptions that you might have to use going forward for internal financing. And then separately, when you might begin to start to charge interest on some of that funding?

[Kevin Modany:]

Yeah. I think to your first question, there's no lack of clarity in terms of what the default rate assumptions are. We're absolutely clear on what default rate assumptions which we’re using because we have a significant amount of history there. So, no lack of clarity there. No confusion as to what the reserve should be. Extremely comfortable in that regard. The question really is what type of student will make it through the underwriting criteria. First and foremost, the question that was out there was, are the underwriting standards moving? And they were. And so what we’re seeing now is we’re seeing some stability on those underwriting standards. Again, the liquidity has been tightened, but we're seeing some stability in terms of what the underwriting standards are. The second piece that we had talked about before is still outstanding is some of these other lenders that we're talking to and trying to bring them on. And by bringing them on how does that change with the expectations are in terms of throughput. So, it's not a question on what the reserve should be. That’s not a question – I mean there is no question. The question is what is the profile of students that will come through? And then therefore what will be left behind? And what will we have to fund with internal financing. So that’s the only question that’s outstanding.

[Kevin Doherty:]

Could you just talk about maybe did any of that reserving occur in the quarter? I guess some still just a little confused how you have been accounting for the lending that you have been doing so far. Particularly, as we try to think about your earnings guidance and how you’re going to account for some of those items really I think it's a little tougher to get comfortable with that range if we don't know where you’re ad for some of those reserve assumptions or maybe how much of that 12 to 13% you think is going to be funded internally.

[Kevin Modany:]

Sure.

[Kevin Doherty:]

I'm just trying to think about – right some of the sensitivities around that earnings range.

[Kevin Modany:]

Sure. Let me take some of the initial part of your question where you were asking about. Did we reserve anything in the quarter? Yes, we did. I mean we reported some internal financing, we reported appropriate reserve against that. So that is in the results right now. In terms of looking forward until we're exactly sure what ultimately will go through to private lending, it's hard for us to know what we're going to end up carrying. And while may seem simple to you both that we could have an exact number, you just can't until those variables solidify. So we're going to be conservative in terms of the way we reserve right now as much as the accounting regulations will allow us, but there should be no question in terms of what we reserve at this point.

[Kevin Doherty:]

Okay. Thank you.

[Operator:]

Our next question comes from Corey Greendale with First Analysis. Please state your question.

[Corey Greendale:]

Hi, (inaudible) to get back in that quickly. I had two follow-up questions. Kevin, on the 12 to 13% of revenue from private loans, just to clarify that, would that incorporate a 5% price increase for next year that you (inaudible) of the 13% after that?

[Kevin Modany:]

Yeah, we think that will probably be the range. I don't want to get too ahead of ourselves there, but we'll see increases in FFELP brands and that will offset some of the price increase that we will see soon. Probably in the same range, again although we have not gone that far out in terms of that percentage from a guidance perspective.

[Corey Greendale:]

Okay. And second follow-up question I had is on the internal private lending, do you have a processor that you're currently working with? And when do you think you’re going to have the approvals that you're looking forward to start charging interest on those loans?

[Kevin Modany:]

We're working with the processor right now. In terms of charging interest, it's probably the fourth quarter, maybe in the beginning of 2009.

[Corey Greendale:]

Okay. Thanks.

[Operator:]

Our next question comes from Kelly Flynn with Credit Suisse. Please state your question.

[Kelly Flynn:]

Thanks. Just on the free cash flow, could you just specify how you're defining that? Is that just the operating cash flow on the cash flow statement minus CapEx?

[Dan Fitzpatrick:]

That's exactly it.

[Kelly Flynn:]

Okay. And then I know you've been asked many questions on this, but could you give us a sense of your 150 million target there? And what's the drag from deferred revenue change in '08? What's the assumed drag?

[Kevin Modany:]

I'm trying to follow you here.

[Kelly Flynn:]

How much should we assume is negative impact of deferred revenue change in '08 to get you the 150 million? You’re saying it was weaker than it will be going forward, but that would be helpful.

[Kevin Modany:]

I think actually we’re going [ph], Kelly. We're not breaking out the individual pieces there to be honest with you. We're trying to just again give you a macro color until we get some more of the details around how much is private, how much is that, because there's differences in the way those loans are disbursed and could have an impact on some of that. So it's hard for us to give – we think the conservative number is 150. There could be some upside on that if in fact we see some positive changes on the private lending side. So, again, trying to stop short of saying that we know (inaudible) where it all falls out. We think on a conservative side it's at least 150 million.

[Kelly Flynn:]

Okay, and then a simple question probably for you guys to answer. Could you just give us the exact definition of deferred revenue on your balance sheet? (inaudible) up from payments just from Title IV and private loans or what else there?

[Kevin Modany:]

Sure. Deferred revenue is cash received not yet earned.

[Kelly Flynn:]

And then can you tell us how much historically has been Title IV cash receipt versus private loans?

[Kevin Modany:]

It would be relatively close to the percentages received. So, you know, it's probably stock on 60, 70% Title IV, and somewhere around 25%, probably private. Some more in those ranges.

[Kelly Flynn:]

Okay. Thanks a lot.

[Kevin Modany:]

Sure.

[Operator:]

Our next question comes from Suzi Stein with Morgan Stanley. Please state your question.

[Suzi Stein:]

Hi, just a question on when students are accessing the ESI internal loan program, is there any difference in the out of pocket costs that they have versus when they access the third-party loans?

[Dan Fitzpatrick:]

It's actually a little bit less. There's some origination costs that students pay whenever they’re accessing a third party loan, but it wouldn't be material to them. They wouldn’t notice at this point in time, but it's a little bit less.

[Suzi Stein:]

Okay. And also are you doing anything to try to increase cash payments from students?

[Kevin Modany:]

You know, that's a good question, but we really kind of maxed out on that in terms of doing that previously. We’ve always we’re trying to push for cash payments when students could afford to do it, so we're still doing that, but I wouldn’t anticipate any upsell.

[Suzi Stein:]

Okay. Thank you.

[Kevin Modany:]

You're welcome.

[Operator:]

Thank you. Our next question comes from Andrew Simon with JP Morgan Chase. Please state your question.

[Andrew Simon:]

Hi, Kevin and Dan. Could you talk about the operational efficiencies as to on the hedge services line, you gave some color on where it was coming from and the magnitude being 300, 310 basis points year-over-year, do you feel right that level of efficiency year-over-year will continue into the second half of the year?

[Kevin Modany:]

Let me take the first part of your question. These operating efficiencies that we start similar to what we reported previously, really relative to the delivery, the educational services been efficient with our class room and facility space and talk about some technology we had implemented (inaudible) in doing that so, those are the things we're talking about. In terms of maintaining that level of expenditure in the second half of the year that certainly are our expectation, we will start anniversary as we get closer and closer to the point of implementation which we really already done and we even picked up some more efficiencies even that we anniversary, so you will start to see the year-over-year change kind of narrowing, but we anticipate continuing those. Those are one-time efficiency as I’ve said.

[Andrew Simon:]

It sounds like as you anniversary those I think going into next year you hold them but not increase from those high levels.

[Kevin Modany:]

We are not projecting any additional increases over the efficiencies we have obtained. There are opportunities for us to get efficiencies, but we are not projecting those in any kind of guidance right now.

[Andrew Simon:]

Okay. When do you think that anniversaring starts to happen? Well, it's already happened. It was third quarter of ’06, fourth quarter of ’06 when we really start to putting those out there. We kind of ramp our anniversaried that already, but what happened was some of the technologies we put in we actually saw additional efficiencies as the field management team gaining more experience with the utilization. So, that kind of slows down as well. And so, you start to see again the gap on the year-over-year narrow.

[Andrew Simon:]

Okay. Sounds good. Thank you very much.

[Operator:]

Our next question comes from Gary Bisbee with Lehman Brothers. Please state your question.

[Gary Bisbee:]

Hey, guys, one thing that hasn’t got a lot of commentary in the Q&A is actually to start which were pretty terrific. You said all six schools were up, can you give us any more color, is there any regional things you can talk about or any of those areas particularly strong – I know it's a smaller – seasonally a smaller quarter, so the numbers can jump around, but any more color you can give us as to why that number came in the way it did?

[Kevin Modany:]

While we did see good strength on the technology side, we had been seeing that, but we saw in another little spike there (inaudible) and then in the other areas criminal justice and visits, CJ was strong, and business were just in kind of flat, we have been talking about that. We saw a little bit of a spike there as well. But I would say sort of technology and the CJ leading, FFELP [ph] sciences is too small to make a difference, Gary, but it will be the first two.

[Gary Bisbee:]

Okay. And actually I heard a radio commercial the other day for a health sciences program, I guess, where are you with that in terms of adding that more campuses? Is that happened lot in '08 or that really going to be more something for next year? Thanks a lot.

[Kevin Modany:]

It's more something for next year. We got a baseline number of colleges out there offering one or more of the health sciences program; we have been measured in our extension on that, more so than we or in other areas of our programs of study. And just that because it's new laws, we're trying to get our arms around it. So I'd say if we're going to see some list there it's ’09, also nursing is one of the programs there, and that's just something that takes a lot of time to work through some of the state regulation. So, that's a little bit of a slower sort of roll out on what we typically used to we don't have to deal with the state by state regulation

[Gary Bisbee:]

Okay. Thanks a lot.

[Kevin Modany:]

Thank you.

[Operator:]

Our final question comes from Jerry Herman with Stifel Nicolaus. Please state your question.

[Jerry Herman:]

Hi, thanks, guys. (inaudible) a philosophical question for you that maybe would work into some numbers, you guys have said that you wouldn't change your enrolment criteria based on the funding issues, in light of the really strong start numbers, and what seems to be really strong demand for the product, how do you think about balancing that volume versus the incremental risk in this environment, i.e. the margin on the incremental students versus the risk associated with the students?

[Kevin Modany:]

We are always thinking about sort of the profile of our student where we want to set that enrolment standard and how that might impact some of the academic aspects of what we do, and we set an enrolment standard for a profile of student, a minimum enrolment standard that we think works really well for us. We don't think about it in terms of the financial per se, we're thinking about where that level needs to be, that profile needs to be to establish the appropriate academic environment, that you can really have some negative impact here, if you go too low, quite frankly, that's certainly our belief, anyway. So, we feel comfortable with our level works very well, we've seen strong demand at that level, there's really no need for us to go beyond that. So, right now, what it works for us is working operationally and it's working financially. So, thinking philosophically or looking forward we really don't think we need to make changes to that model that is work so effectively for us, we're probably 10 or 15 years.

[Jerry Herman:]

Yes, interior [ph] willing you take on more risk because the funding environment?

[Kevin Modany:]

Well, again, we think we got a lot of information about the funding aspects of it and so we feel very comfortable with that. I mean the history we have is makes us comfortable and the risks we are taking there and at the end of the day we feel like it's the right investment to make and we want to continue to provide that, student profile that we know can succeed from an academic process, we want to provide them access to education. So there is a disruption in the marketplace that ahs limited their access. We feel it’s more than appropriate and very consistent with our mission to provide that access for them, and we can do so within the confines of our model as we look long-term we can achieve our long-term historical performance doing so. So, when you put all that together you really come to know other conclusion and this is the right thing to do for the business.

[Jerry Herman:]

Okay, thanks.

[Kevin Modany:]

Thank you.

[Operator:]

Thank you. I'll now turn the conference back over to management for closing comments.

[Kevin Modany:]

Thank you very much. I want to thank everyone for participating on the call, and we look forward to talking with you again during our third quarter conference call. Thank you very much.

[Operator:]

Thank you. This concludes today’s conference. Thank you all for your participation. All parties may disconnect now.