Greetings, ladies and gentlemen, and welcome to the ITT Educational Services 2012 Second Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. Joining us today from the management of ITT Educational Services, we have Kevin Modany, Chief Executive Officer and Chairman; and Dan Fitzpatrick, Executive 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.

Thank you, operator. Good morning, ladies and gentlemen, and thank you for joining us on our conference call to review our 2012 second quarter results. As usual, Dan Fitzpatrick, our Executive Vice President and Chief Financial Officer, is on the call with me this morning. For our prepared remarks today, we'll follow our standard format and limit our comments so as to allow more time for your questions during the Q&A session. We'll begin the call with a brief review of our marketing and advertising efforts in the quarter. We'll then provide some additional color on the new student enrollment results for the academic period that began in June 2012. Additionally, we'll speak to the leading indicators related to new student enrollment for the academic period that will begin in September 2012. Next, we'll provide an overview of student retention and the number of graduates in the second quarter of 2012 compared to the same period in the prior year, as well as the resulting impact on our student persistence rate in the quarter. At that point, we'll provide the graduate employment metrics for our 2011 graduates compared to the same metrics for our 2010 graduates. We'll also provide an update on the year-to-date graduate employment metrics of our 2012 graduates in comparison to the 2011 graduate metrics at the same point in the prior year. I will then provide an update on our progress related to various elements of our strategic plan. And lastly, before I turn it over to Dan, I'll provide a few comments regarding our efforts to facilitate additional private education loan options for our students. Dan will then conclude the prepared comments portion of our call by providing additional color on the financial results reported in this morning's press release. At that point, we'll open…

Thanks, Kevin. I have just a few brief comments on the financial results that were released this morning. Revenue per student was up 0.5% in the 3 months ended June 30, 2012, compared to the same period in the prior year, primarily because of the continued impact of the rollout of the new programs at a portion of our schools, as Kevin mentioned earlier. The impact of the new program rollout on revenue per student for the second quarter of 2012 was offset by the timing of the start of the academic period that began in June 2012 compared to the start of the June 2011 academic term. The June 2012 academic term began 1 week later than the June 2011 term. And as a result, a portion of our students did not attend some of the classes until after the June 30, 2012, cut off for the revenue recognition for the second quarter of 2012. We expect that the year-over-year timing difference in the start of the June 2012 academic period will result in the recognition of the related revenue for these classes in the third quarter of 2012. And likewise, we anticipate that the revenue per student for the third quarter of 2012 will be approximately 4% to 5% higher than the same period in the prior year. As noted in our April 2012 earnings call, we continue to expect the revenue per student for the full year 2012 to be approximately 3% higher than revenue per student for the full year 2011. Moving on to scholarship, grant and award activity for the quarter. In the 3 months ended June 30, 2012, our students received approximately $16.9 million in scholarships and awards compared to approximately $22.6 million in the second quarter of 2011. This decrease was primarily the result of the year-over-year decline in total student enrollment as of March 31, 2012, compared to March 31, 2011. Days sales outstanding increased 9.3 days to 20.3 days as of June 30, 2012, compared to 11 days as of the same date in 2011. Bad debt expense as a percentage of revenue increased 130 basis points to 5.8% in the 3 months ended June 30, 2012, compared to 4.5% in the same period in 2011. The year-over-year increases in DSO and bad debt expense were primarily due to the decrease in the amount of funds received in private education loan programs available to our students in the second quarter of 2012 compared to the second quarter of 2011 and resulting an increased use of internal financing by our students. As of June 30, 2012, the outstanding balance under our $325 million revolving credit facility was $150 million. I'll now turn the call back over to Kevin.

Thanks, Dan. Operator, would you please open the line for questions.

[Operator Instructions] The first question comes from Kelly Flynn of Crédit Suisse.

A couple of questions -- sorry to violate the rule on the first question -- but the -- just with respect to the student lending preliminary agreement you referenced, when you say it's a preliminary understanding, but basically, you can't be sure it would happen, so -- I mean, my question really is how is this different than not having it at all? And kind of what can investors assume about the impact, if any, this has on your free cash flow for the year? And then the second one, given the negative free cash flow and other balance sheet dynamics, where do you stand on the financial responsibility ratios, and what are your expectations for that as we progress into next year?

Sure. Thanks, Kelly. With regard to the loan program, basically, what we have is we've executed a term sheet. The term sheet includes a number of, if not all of, the material provisions of an agreement. So we've spent a lot of time on this, negotiating all of the details of the transaction that, previously, we would not have documented and, again, executed on our term sheets. So I think we made substantial progress there. In terms of the impact on free cash flow, we really haven't given any guidance on the free cash flow at all. I think if you look at the numbers, it's pretty clear where we may be coming out, I think, if you follow the trends and whatnot and just kind of back into the full year guidance. But we're probably looking at somewhere between $50 million and $75 million of free cash flow for the year, absent anything with regard to the private lending program. So if we have $100 million program, if we think we can put that in play in the fourth quarter, we would basically have some portion of that $100 million added to that. And at this point, it's probably too difficult to speak to exactly what that would be. Obviously, when we speak to free cash flow, again, we haven't given guidance there, and that's a non-GAAP metric. So we'll provide some reconciliation of that -- of those numbers on our website for those folks that are interested in seeing that reconciliation. With regard to the financial responsibility ratios, I think that was the second part of your question, well in line with those. We don't see any issue whatsoever with the financial responsibility ratios based upon our projections for the year. So we see no issue there.

The next question comes from Suzi Stein of Morgan Stanley.

Just as far as your confidence that starts can go positive in the second half potentially, how much of that is simply just lapping the weakness in Criminal Justice versus any big change in conversion rates? I guess, if everything stayed the same, would the elimination of the comp from Criminal Justice just put you solidly to -- in a positive territory at this point?

Well, as we talked about with regard to the shift in the Criminal Justice programs, it made up about 85% of the difference, if you just look at the decline in those -- in the new student enrollment in those programs versus the decline overall. So it's not yet 100% of it. And I think deductively reasoning and backing into your question, at least for the second quarter, the answer would be no. Obviously, we start getting into the third and fourth quarter, we're going to start anniversary-ing that and see much less of an impact on a year-over-year rate. I would say just based on trending, what we're seeing, the comps, some of the impact to the advertising and marketing adjustments that we're making, but again, it appears as if there's the possibility for the second half, 1 of the 2 enrollment periods, September to December. And again, the transparency is a little bit tough right now. But 1 of those 2 periods, we've got the opportunity for improvement. I wouldn't say it's solely on the basis of CJ, but that certainly is a big chunk of it.

The next question comes from Jeff Volshteyn of JPMorgan.

Just following up on one of the questions. What -- is there any limitation on the share repurchase because of fiscal responsibility this quarter that you may have?

Well, yes, definitely. I mean, if you look at there for our calculation, one of the big components there is the equity. And so we really have been, over the past several years, kind of limited in terms of our net income or our contribution to our retained earnings or our equity as far as what we can buy back. So I would say that continues to be a limiting factor. It's really not availability in cash, it's the FRR [ph] and it's our ability to stay positive on the retained earnings and equity portion of that calculation.

[Operator Instructions] The next question comes from Paul Ginocchio of Deutsche Bank.

Just a question on your branch openings. I think you were previously at 8 to 10. You've taken that down to 6. Can you just talk about, I guess, what that was or why that was?

Sure. Really just obtaining the necessary approvals on the facilities and, really, kind of real estate limitations more than anything else. I think you'll see us probably pick up a little bit of that as we go into '13. That's why we want to give a little bit of guidance on that. But it wasn't anything that was predetermined on our part or we hadn't made any kind of adjustments in terms of reducing the number of new locations. So there's been no changes in our perspective there. And again, that's why we try to give a little bit of forward-looking information on that as it relates to 2013 openings.

The next question comes from Bob Craig of Stifel, Nicolaus.

Just a question on marketing and recruiting. I wonder if you could comment on ad response rates and the spending outlook to the extent you're comfortable for the balance of the year, and also rep staffing levels, if you could.

Sure. With regard to the marketing and recruiting response rates, we saw a little bit of a falloff earlier in the year as -- and I think we talked about that in previous calls, and we pretty much are staying consistent with those levels. So we're not seeing additional falloff. In our prepared comments, we talked about the fact that we actually generated more student inquiries this year than last year. So response rates remained strong. The challenge on the conversion rate, as we talked about in the prepared comments, is really from inquiry to new student enrollments, so that conversion rate process in various points along that path. So I think we feel pretty good about the marketing and advertising. Looking forward to the second half of the year, we're not looking at huge increases in the marketing spend. Probably somewhere between 0% and 5% over the prior year is probably a reasonable guess on what we expect, although we're going to stay very close to that and tweak it as necessary. If we need to make adjustments as we go along, we will. As far as rep staffing, right now, we've been flat. We haven't really made any changes on that and I would say, at this particular point, anticipate that the staffing levels will remain flat with the prior year in the second half of 2012.

The next question comes from Sara Gubins of Bank of America Merrill Lynch.

Two questions. The first is, you mentioned that net applications are down about 7%, so I'm wondering, is it reasonable to think that the fall start would be down below that given continued declines in conversion rates? And then also, the comment about some revenues shifting into 3Q versus 2Q because of the timing of the last start, could you just quantify what the impact of that was in the second quarter?

Sure. With regard to where we stand for the September enrollment, the net applications, down 7%. And just to clarify, basically, we take student applications as students come in into our facilities and express an interest in pursuing their program of study with us. And then throughout the 12-week period of recruitment, we're staying in touch with our students. But certain students may cancel. So when I refer to the net applications, it's net of cancellations. Anytime you're looking at applications net of cancellation, you're sort of factoring in some of those adjustments in terms of conversion, particularly the application, the start rate. So some of that's reflected here, Sara, in terms of the change in conversion rate. So probably one of the best leading indicators in terms of enrollment is the net application, and that's why we speak to that number. Certainly, the lack of transparency in trending would lead us to be a little less confident in terms of that as an absolute leading indicator. And I would tell you, our trending in terms of weekly applications, what we're taking in week by week at this particular point, have been more closely aligned with prior year levels. So there's an opportunity to kind of bring that in a little bit just based on weekly trending. But again, the transparency isn't great right now, and I don't think that's an ITT Technical Institute issue. It's pretty much across the sector, from the information we're gathering. So at the end of the day, I think it's the best leading indicator, and trending weekly is a little better than that. So we'll see. Again, we continue to follow the trends and feel fairly optimistic about our opportunity to be positive at some point in the second half of the year.

As far as the revenue per student, if you really take a look and see if they've grown, it had grown at the same pace that you saw in the first quarter, 3%. And if you just back into it, you'd be looking at something in the neighborhood of $8 million versus the 0.5% increase we saw in the quarter.

And then to just add to Dan's comments, I think if you go ahead and take a look at the third quarter, and we talked about in our prepared comments that we're expecting that to be in the 4% to 5% range versus, again, that annual rate of 3% or being up somewhere between 100 bps to 200 bps, and you factor that into the enrollment coming into that third quarter, it pretty much offsets that number. So it truly is a timing difference for us just on the basis of where the start landed on the calendar.

The next question comes from Peter Appert of Piper Jaffray.

This is George Tong for Peter Appert. One of your competitors pre-announced during this week that suggested scholarships and higher-than-expected inquiry generation and instructional costs basically weighed on second quarter results. Could you give us some insight as to why these factors would not be headwinds for ITT?

Well, it's difficult to compare the various companies in this sector, so I'm hesitant to do that. We all use different types of advertising vehicles in different levels, so the mix is extremely different. And the impact on shifts in each one of those sources of inquiries has a more or less material impact on different entities, again, depending upon their mix. So we can only speak to what we see. And right now, we've been, just to kind of rehash history, rebalancing our spend, moving a little bit away from television, moving more into certain types of Internet sources. And so our balance has been decent. The total spend was down on a year-over-year basis. The inquiries were up. We've got opportunities to do a better job communicating the value proposition to our students because we do strongly feel like we have a terrific value proposition. So that's where our opportunity lies. It's not necessarily in generating additional inquiries. We feel pretty confident about our methodology and our mix right now in terms of the advertising front. With regard to scholarships -- scholarships, grants and awards, we increased our levels a couple of years ago. I think if you go back about 3 years, we were doing about -- on an equivalent revenue base, a fairly equivalent revenue base, about $35 million. And we bumped that up to about $50 million and then, once again, bumped it up to about $90 million. We're on an equivalent per-student run rate, but this year probably takes us to about $80 million in revenue. We were down about $4 million for the quarter, but that's totally indicative of shifts in enrollments. It's not indicative of any change in our perspective on the utilization of scholarships, grants and awards. So we don't see it as a headwind, we don't see it as a challenge, and I think it's going to be status quo for us. And we're building that type of assumption relative to scholarships and awards into our analysis and projections from an enrollment perspective.

The next question comes from James Samford of Citigroup.

Just wanted to touch again on the sort of demand versus sort of marketing issue that you're facing. And I'm curious if the inquiries or at least are students potentially taking longer to actually fill out their applications or at least convert because of their cautious nature of the consumer at this point and their fear of incremental debt as well.

Well, it's hard to say what the reasons are for it, and so I'll leave that up to others. We've talked a lot about our analysis of the student enrollment process, whether it be an analysis of timing or analysis of conversion from one step in the process to the next and looking at all the various data elements and looking for correlations through our statistical analysis with those data points, so we really haven't been able to uncover anything specifically relative to the data points that we collect. So again, reasoning put aside, I will tell you that, certainly, the timing has been extended. And I think you'll see even in third-party data metrics that are reported by some of the advertising generators that the time that it takes a student from interest level to enrollment has increased. And I'm talking over the last couple of years, we haven't seen anything substantial in the last couple of quarters, but definitely, timing has increased. It takes a little longer for somebody to work through the funnel. But that's something we've adjusted to, and it's built into our expectations at this point. So specific to your question about the specific quarter, not -- we haven't seen a material change there.

The next question comes from Gary Bisbee of Barclays.

Two questions. I guess, first of all, can you give us a sense for how many of the starts or what percentage of starts are at schools open in the last 2 or 3 years? And I guess, I'm trying to get a handle on if -- when you think you might have some positive start growth. Are we likely to see continued declines at the older, more mature campuses? And then the second question, now that we're getting closer to getting to 2013, do you have a better handle on what the impact may be from this double graduation concept of the kids starting in second half of last year in the longer program graduating at the same time as some of the student who began first half of this year in the new shorter program?

Sure. Well, we really don't break out new-store same-store kind of metrics, Gary. Let's see if I can give you a little bit of color to give you a sense of that. I mean, as we look at our new locations and compare it to what we're seeing in all of our locations in terms of new student enrollment, we're not seeing a material difference there. We're down in new student enrollment at new locations in a similar fashion as to what we're down in our existing locations. And so I think that gives you a little bit of color there in terms of the impact from new locations. Nonetheless, still a very positive return on investment for those locations, and we're not seeing any indications that we need to be thinking about changing locations or closing locations or anything like that. Definitely, off at new locations like we are off at existing locations in terms of new student enrollment. To your second question about getting our arms around the double graduate pool, I can tell you that it -- the implementation of the new programs was extended out over a longer duration than maybe initially anticipated. Where we started to offer some of those programs in June 2011 at a handful of schools, and then we did more yet in September, and then it kind of slowly trickled out December, March and, now again, in June. We're at about 95% right now. So likewise, as we extended the duration of implementation of the new programs, we're going to see that impact of double graduates spread out over an extended period. There isn't going to be one particular quarter where you see a big bang impact from the double grads, which might have been anticipated for, say, June of 2013. Instead, you'll see some impact on June '13. You'll see some impact on September '13. You'll see some impact on December '13. And I would say over a 4-quarter period, you're going to kind of see that run itself out almost in a normal distribution curve, if you will. It'll kind of get started, it'll accelerate, it'll reach a peak, and then it'll kind of tail off at the end. So, again, not a lot of specifics for you there but give you a little bit of color on how you might see that play itself out in the 2013 fiscal year in terms of graduates from those new programs and all programs happening at the same time.

The next question comes from Corey Greendale of First Analysis.

I'm going to squeeze in 2 questions. The first, I just want to clarify, I think your Q2 share repurchases were very early in the quarter before you announced last quarter. So I just want to verify, the $8 to $9 guidance does not assume any more share repurchases than it did last quarter. And the other question is just when you reported last quarter, you talked about applications for Q2 getting close to flat year-over-year. And now for Q2, they're down 7% from last year. So I hear you talk about week-by-week trends being positive, but given that perspective, can you just give us a little bit more detail on what is trending positively and where you get the confidence that you could see positive starts at some point in the back half of the year?

Sure. Thanks, Corey. You are right. In terms of the guidance of $8 to $9, that does not assume any additional share repurchases at this particular point. As far as applications and kind of what's giving us some confidence there, we're looking at it on a programmatic basis, on a location basis, I'm looking school by school and trending in apps. At this particular point, as we've said on the net applications, it's down 7%. There's some confidence in the fact that, on a weekly basis, we're seeing improvements there. And as we get closer to the start, applications that are written closer to the date of start actually have a higher show [ph] rate than those that are written earlier in the start. So trending becomes more and more important as you get closer to the start. So that's also an indicator. So I would say it's trending on a weekly basis, it's programmatic specifics, and that coupled with kind of where we sit on the net apps and where those net apps are, and what particular programs gives us a little more confidence in terms of the possibility for some positive enrollment. Again, I don't want to get anyone to think that we're guiding specifically for positive year-over-year enrollment in September. We're saying that we still feel confident, based on trending, there's a second half opportunity for that, but we can't say with certainty whether that will be September or December. But again, trending gives us some reason to be optimistic.

[Operator Instructions] The next question comes from Jeff Meuler of Baird.

I was wondering if you guys could talk about how you're thinking about, I guess, your third-party private lending programs and any potential liability if private student loans would become dischargeable in bankruptcy again.

Sure. We really don't see that as a material impact. If you just look at recoveries and the percentage of students in bankruptcy and relative recoveries there, it really doesn't move the needle at all in terms of the financial analysis of a portfolio of private loan products, from our perspective. So I don't see that as a material item, from our perspective, as it relates to third-party loan programs that providers have brought to the table for our students.

The next question comes from Trace Urdan of Wells Fargo Securities.

Kevin, I wonder if you'd describe what the status is of the conversations that you have been having with the Consumer Financial Protection Bureau. And in terms of your negotiations with the third party in setting up the new loan program, is that sort of the CFPB's interest in the private loans and proprietary loans? Was that a risk factor for them? Is that something that your potential partner is concerned about?

Sure, Trace. It's difficult for us to speak in any kind of detail with regard to any activities with CFPB, except I can tell you that we are absolutely cooperating sharing information, and the communications there are ongoing. I will say relative to third parties that are stepping to the table, they're certainly aware of that. And people that come to the table are experienced in lending and experienced in the legalities around putting together a program. And if you look at the CFPB's CID, it was specifically geared towards determining whether there's unlawful activity in student lending arena. So the due diligence is performed by these individuals. They get their confidence level relative to their experience and the counsel that they receive and seem to be getting comfortable with what's happening there. Again, I can't speak to the details of our discussions with them, but we're certainly being cooperative. And at this point, again, I'll reiterate what we had said previously, that we don't have a big concern relative to our involvement in third-party private lending programs, what it is we do and the part that we play, which is extremely minimal. But again, third-party players are coming to the table. As we announced, we've got a term sheet in place. And other discussions are ongoing. So there's still a lot of activity on that front.

The next question comes from Tim Connor of William Blair.

Just a follow-up on the accelerated programs. Does the gainful employment data change your view in any way on how you might want to apply the use of accelerated programs? And then also, what kind of persistence are you seeing in the accelerated program so far, excluding what the graduation impact might be?

Sure. Thank you. The GE data does not impact our considerations relative to the new programs at all, and so there's no impact there. We've kind of moved forward with offering these new programs. We're excited about them. It gives students an opportunity to get in the marketplace and get a return on their investments sooner. And also for the associate degree students, it basically lowers their cost of tuition. So we see all positives there. And again, the GE data doesn't change that one way or the other. In terms of persistence in those programs, at this point, it's fairly early on. Keep it in mind, as I was talking earlier about the graduate impact, we've seen the rollout kind of extend beyond that initial quarter to 3 or even 4 more additional quarters. So the -- so it's early relative to retention. But that being said, we're not seeing any material differences. Anytime you roll out a new program, you'll see a little bit of a degradation in retention. But as we reported earlier this morning, our retention for this -- for the second quarter actually improved slightly over the prior period, and that would, obviously, be inclusive of those new programs. So right now, it's all thumbs up, and everything looks fairly positive on that front.

The next question is a follow-up from Paul Ginocchio of Deutsche Bank.

Kevin, just a couple of questions on the potential new loan facility for students. One, is it going to have the similar terms or at least you'll be on -- you'll guarantee performance of the underlying student repayments. And then second, would you have to disclose this loan if you get it as a related-party transaction?

The terms of the transaction are very, very similar to what is known as the PEAKS transaction. So structure of the transaction, very, very similar; in fact, probably somewhat similar parties involved in the transaction. So again, I think once details are disclosed, you'll see some familiar type structuring there. As far as the related-party transaction, no, it's not a related-party transaction. There will be no disclosure of any such arrangement. It's a program being sponsored and provided by a third party.

The next question comes from Tim Connor, William Blair.

One more follow-up on the loan program. I think you said it's $100 million?

Yes.

How did you model that? And how long do you expect that to last, if it does go into place in 2013? And then also, what does that do to bad debt expense projections?

Well, as we mentioned in the prepared comments, we're hopeful that the program actually will go into place in 2012, not 2013. Obviously, there's work to be done to dot a few Is and cross a few Ts, but we have had a substantial amount of work that has gone into identifying all the material terms of the arrangement, so again, hopeful that we'll see that happen in 2012. In terms of volume of that $100 million in funding, how much of that might come through in the cash flow, it truly will be dependent upon when we actually put that program in place because of the way that it's utilized by our students. We have new and continuing students coming through the funnel. Only continuing students are eligible for these programs. As I think many of you know, students need to be moving into their second academic year before they're eligible. But those students that are going through that process are getting repackaged at various points of that 12-week period. And so depending upon when we get that program in place in the fourth quarter, so when we do, the timing of that will be very important and will very much dictate how much of that $100 million in funding actually comes through in 2012. So I don't mean to skirt the question, but it truly is important to know when it gets in place and how that relates to the what we refer to as the repackaging cycle for those continuing students. So as soon as we get a little more detail on that, we'll certainly let you know, kind of gave some indication on cash flow impacts for the year. And there's some upside for that if we get this in place. And as soon as we have better color on it based on timing, we'll certainly let everyone know.

To the impact on bad debt, previously, we talked about a range that's obviously impacted by the availability of third-party private loans for students. So we would go to the lower end of that range, and we've talked about that range being in the 4% to 6% range.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Kevin Modany for any closing remarks.

Thanks, Andrew. I appreciate that. I just want to thank everybody for their time today and look forward to talking to them in October, when we do our third quarter call. Thanks again.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your line.