Greetings, ladies and gentlemen, and welcome to the ITT Educational Services 2013 First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, today's 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 conference. 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. Mr. Modany, you may begin.

Thank you. Good morning, ladies and gentlemen, and thank you for joining us on our conference call to review our 2013 first quarter results. Let me -- on the call with me this morning, as usual, is our Executive Vice President and Chief Financial Officer, Dan Fitzpatrick. In our prepared remarks, we plan to provide an update on several key focus areas for the organization. We will also discuss a few miscellaneous items, including an update on the renewal of the ITT Technical Institute's accreditation. At that point, I will turn the call over to Dan, who will provide some additional color in the financial results reported earlier this morning. With the agenda out of the way, let's get started. We continue to allocate a great deal of our energies towards stabilizing new student enrollment trends. We believe that new student enrollment results over the past several years have been negatively impacted by prospective students' increased sensitivity to the cost of postsecondary education. We also believe that the uncertainty of the value of additional education has increased recently, and prospective students' lack of confidence with respect to the value of a higher education has led some to put off a decision to pursue additional education. This uncertainty exists despite the overwhelming data that suggest that there is a growing skills gap in our country in particular disciplines, including health sciences, technology and engineering, at entry-level positions, such as technicians. While we continue to see strong demand for our programs of study, which were supported in the first quarter of 2013 by a 10% increase in advertising expenditures compared to the same period in the prior year, the conversion of prospective student inquiries to new student enrollments continues to lag historical trends. Based on our belief that prospective students are increasingly…

Thanks, Kevin. Revenue decreased 51 -- $54.1 million or 15.8% to $287.7 million in the 3 months ended March 31, 2013, compared to $341.8 million in the 3 months ended March 31, 2012. The primary factors contributing to this decrease included a 16.6% decrease in total student enrollment as of December 31, 2012, compared to December 31, 2011, and a 14.2% decrease in total student enrollment as of March 31, 2013, compared to March 31, 2012. Cost of educational services decreased $9.7 million or 7.2% to $125.2 million in the 3 months ended March 31, 2013, compared to $134.9 million in the 3 months ended March 31, 2012. The primary factors that contributed to this decrease were lower compensation and benefit costs resulting from fewer employees and a decrease in course supplies expenses due to lower student enrollment. Cost of educational services as a percentage of revenue increased 400 basis points to 43.5% in the 3 months ended March 31, 2013, compared to 39.5% in the first quarter of 2012. This is primarily attributable to the decline in revenue, which was partially offset by decreases in compensation and benefit costs and course supply expenses. Student services and administrative expenses were $106.3 million in both the 3 months ended March 31, 2013 and 2012. Student services and administrative expense increased to 36.9% of revenue in the 3 months ended March 31, 2013, compared to 31.1% in the same period in 2012. The principal causes of this increase were the decline in revenue and increases in bad debt and media advertising expenses, which were partially offset by a decrease in compensation and benefit costs and certain scholarship-related expenses. Bad debt expense as a percentage of revenue increased to 6.9% in the 3 months ended March 31, 2013, compared to 4.6% in the…

Thanks, Dan. At this point, we've concluded our prepared remarks. Operator, if you would, please open the line for questions.

[Operator Instructions] And our first question comes from Sara Gubins from Bank of America Merrill Lynch.

Could you talk about your expectations for new student starts in the second quarter and maybe the rest of the year? Do you think that now that you're rolling out the scholarships more broadly that, that might actually suggest that we would see starts flat or even up by the second quarter?

Thanks, Sara. Right now, our internal goals are for new student enrollment for the full year to be between minus 5% and 5%. Obviously, that's suggesting that there's an opportunity for us to see some positive start growth. I would say, without giving any kind of specifics on what our expectations are for the second quarter, we continue to be optimistic, cautiously optimistic, with what we're seeing in terms of the application volume right now. The net apps right now are pretty much flat for the June academic period as we sit here today so that gives us a good opportunity, again, to potentially see continual improvement. I caution everybody on that just to say that there is still continual volatility here so the transparency isn't as good as we'd like. But again, as we sit here today, the net applications are flat with prior year, and we continue to be cautiously optimistic as we roll the opportunity scholarship out to additional schools and continue to enhance the training and communication of that scholarship to our prospective students.

Great. And then as a follow-up, can you help us think through the negative impact that we should see on revenue per student in the second quarter and beyond as you do roll out more scholarships?

Sure. We're going to see -- we have the offsetting impact. We've got the fact that we're still seeing more of our total students in the 4.5 credit hour courses, which would, in the near term, increase revenue per student, offset by the timing of the impact of rolling out the opportunity scholarship, which would decrease it. So again, as we progress throughout the year, you're going to see it move more towards the guidance that we talked about on an annual basis, which will be minus 6% to minus 4% so we should move in that direction for the rest of the year.

Our next question comes from Corey Greendale from First Analysis.

A couple of questions about the opportunity scholarship. So first of all, I know it's early, but do you have any early returns on whether it's having an effect on persistence? And secondly, if students are becoming more price-sensitive, what gives you confidence that this is going to be enough and that additional reductions or more scholarships might not be necessary some point?

With regard to persistence, Corey, we haven't seen any indication of a positive impact as of yet. I would say it's probably still a little bit too early for that. So we'll monitor that, and if we see some sort of indication there of a correlation between the scholarship and retention levels, we'll certainly, certainly let you know. In terms of whether or not this will have the desired impact, I guess I would say, right now, we're pleased. We're -- again, we're cautiously optimistic. However, the intent is to continue to evaluate the elasticity here and to see what type of demand or conversion improvements we see with this level of scholarship-ing. And we will evaluate that on a going-forward basis, and if adjustments are appropriate, that would suggest that we can have a more favorable ratio or favorable outcome with an adjustment of the ratio, then we'll certainly do that. But right now, we're seeing positive impact. The show rate is improving second quarter in a row. We saw it in the test schools, now we're seeing it overall. And so that's a positive, and then we'll just continue to evaluate it. If there's an opportunity to optimize that ratio as far as scholarship level and conversion rate, then we'll do it. But right now, we don't have any indication that we should do that just yet.

Okay, appreciate it. And then just could you speak to your advertising expense plans for Q2 and the rest of the year? And Dan, in talking about the guidance, I didn't hear you mention free cash flow. Are you reiterating free cash flow guidance as well?

I'll take that, Corey, in terms of the advertising expense for the rest of the year, I would say slightly above the prior year for the remainder of the year, single digits. With regard to the free cash flow, and I'll remind everybody as we speak to free cash flow, it's a non-GAAP metric, so reconciliation is on the website. But we had talked about $50 million to $75 million, and that's still the internal goal for the full year at this point.

Our next question comes from Peter Appert from Piper Jaffray.

This is George Tong for Peter Appert. Just wanted to get some additional color on your scholarship for B.A. students. What's the conversion rate now? And what are your expectations for where it could go to after the scholarship? And then as a follow-up, what are your expectations for rollout timing of the scholarship to your campuses?

Sure, George. When we spoke in the prepared comments about a conversion rate, we were speaking specifically about our calculation of the associate degree graduates from an ITT Technical Institute, what percentage of those students continue on to a bachelor's degree program of study, if there is a bachelor option for them at that particular campus. We have historically seen that, that -- we'll refer to that as matriculation rate, has historically been -- or recently been in the range of about 40%. More recently, as we've seen that decline, the most recent quarter in March, it was about 32%, so we've seen about 800-basis-point decline there. So it's definitely an opportunity. And in terms of the rollout of the bachelor portion of that, we're rolling that out in June, so students who are applying for a bachelor's degree program of study that would begin in the June 2013 academic period, pending certain eligibility requirements, would receive the opportunity scholarship. In terms of other schools at this point, we have a handful of schools, principally our Pennsylvania schools that had not yet been approved for the scholarship. However, we have received that approval. And so all schools will be offering the scholarship program to all incoming students with the June 2013 academic period.

Our next question comes from Paul Ginocchio from Deutsche Bank Securities.

To follow up on that free cash flow question, your AR spiked to almost 33 days. Is the government slowing down payments to you? Can you just talk about how it's -- at 33 days, it's the highest it's ever been and how you're still going to achieve the $50 million to $75 million with your AR that high?

Sure. So with regard to any sort of slowdown in disbursements initiated by any governmental entity, the answer is no to that. With regard to the DSO spike, we're seeing a couple of things impacting that. We had a delayed disbursement in some of our funding correlated to some systems changes we're making. So we're making changes in our financial aid processes, which ultimately will lead to some efficiencies, and some of this is correlated to some of the savings initiatives we have. But as we rolled that out and put some new systems in place, it caused some delays in disbursements of Title IV funds, which have subsequently been received in the second fiscal quarter. So that had a little bit of an impact. And then also, as we roll out the opportunity scholarship, we basically eliminated all third-party private funding sources, and the opportunity scholarship has been rolled out and reintroduced to a larger number of new students. But when you think about those students generating tuition revenue for the first quarter, there are only 5% to 6% of those students who received the opportunity scholarship, so the remaining portion of those students for their gap financing is basically trade credits, so it's AR. And so you're seeing that increase there and then, therefore, the corresponding increase in the bad debt. Over time, as the rollout expands, you'll see the DSO, over the next couple of quarters, begin to come down, probably not yet for the second quarter and maybe even for the third quarter. But probably in the fourth quarter, we'll still start to see that come down. The DSO will come down, and then you'll start to see the corresponding impact that Dan referenced earlier with regard to revenue per student, where that number starts to come down as well. So it just plays itself out as the opportunity scholarship is rolled out throughout the campus footprint and should be mostly completed and fully evident in the financial results by the time that we get to the end of the year.

Can I ask a follow-up?

Sure.

Just persistence was down 100 basis points, I think, on a decline a year ago. What's going on there?

It's principally as a result of the graduate level increases in excess of the beginning census variance on a year-over-year basis. So graduates are impacting that, and we're probably going to see that for the next 2 quarters as a well, as we see sort of those larger enrollment increases from 2 years back kind of working their way through the system, in addition to the curriculum changes, where we shortened the duration of the program of study. So we've got sort of what some people refer to as a double graduation impact, and we'll see that in June and September. So it's a graduate thing more so than it is a retention rate. Retention of students is slightly down, not materially down but slightly down, but not a material impact on that overall persistence number.

If I could just sneak one more. Any change to your payments on contingent liabilities for this year and next?

No expected change. The information that we provided in the January call with regard to projected payments is still our current estimate.

Our next question comes from Gary Bisbee from Barclays.

Just wanted to follow up on that. Can you be any more specific on what we might think about for the double graduation impact. I think in the past, you've downplayed it to the extent that it was like a huge thing in any given quarter, but then it would bleed in over several quarters and have a negative impact. But since we're getting on top of that, is this -- should we think of this is as a significant impact to persistence and total enrollment growth?

Well, you're right, Gary, in that it's not going to all be in one quarter. As we initially rolled out some of those changes, we thought we would see a larger impact in the upcoming quarter because that was the timing when the students in a 7-quarter associate degree program would also be graduating with those students that were still in the 8-quarter associate degree program. So we will see an impact in this June quarter in the second quarter results that we report. But it's not going to be as substantial as originally thought because it will bleed a little bit into the September quarter as well. So you're going to see it over the next 2 quarters. By the time we get to the fourth quarter, it should have worked itself through, and that's probably the best way to look at it at this particular point.

And I mean, order of magnitude, could this be a couple of hundred basis points to persistence?

It's probably in the neighborhood of about 100 to 150.

Okay, great. And then on the -- thanks for the color on how the different areas performed in terms of starts this quarter. Did I hear the numbers right, the Criminal Justice was really the only one that was down sharply, couple of the IT ones were down a touch?

Correct.

Are you comfortable with the 12% of the mix now or are you deliberately trying to shrink that area further in terms of number of students?

Well, we've talked in previous calls about the fact that we're sort of self-policing that, as we typically do. We just haven't had this level of self-policing that was required. But we've looked at all of the schools in the system, and we really don't see the type of salaries and/or the employment rates that we expect. We've cut off the new student enrollment there. So we've not added a significant number of schools to that mix in the most recent quarter. But I would say that we're managing that very closely. We may see another couple of percentage points decline in that overall census over the next couple of quarters. And I think if you go back maybe a year or 2 on the script, I think I was asked this question a while back, and we had estimated that we thought that the census could come down to around 10% of the total, so we're at 12% now. There's probably a couple more points that we could see decline there, and a reasonable guess at this point is it settles in at around 10%.

And then just on the business, which was up so much, can you remind us what you're actually doing, what programs are in business and roughly how much of the mix that is these days?

Sure. Business right now is probably around 7% or 8% of the total census, and about half of that is project management. So one could argue that, that might have a little more of an IT focus than business. However, it is a program that is included in our School of Business and that program saw nice growth mid- to high-single digit growth in new student enrollment in the March quarter, so it was a solid contributor. But it represents about half of that 7.5% to 8% of total census. So we're really comfortable with that program of study based on the outcomes in employment and salaries.

And our next question comes from Jeff Volshteyn from JP Morgan.

Could you just give us a sense on the increase in receivables, how much of it roughly came from the systems issue versus the on-balance-sheet lending?

Yes, I think, roughly it would probably be somewhere in the neighborhood of about 5 days. And again, we've -- as Kevin mentioned before, some of those delays we pretty much caught out for that here in the second quarter.

Okay. As a follow-up, I'm glad that you got the accreditation for another 5 years. Looking back at your 10-K, there was some findings from the ACICS that had to do with improving the retention rates, I think, to 52% and placement rates to 47% and the number of campuses and programs. Where do you stand in the effort to improve those metrics? And how should we think about those numbers, let's say, for this year?

Sure, I appreciate that question. The large percentage of those programs that were identified in the 10-K, and here I'm speaking of somewhere in the 70% to 80% range of those programs of study, actually I think a little bit higher than that, north of 80%, closer to 90% of those programs are being taught out. So those programs -- really, there's not an effort or remediation effort that is underway for those programs of study, again, because they're being taught out. So -- and that's probably a point of clarification that was important to make, and I appreciate the question on that front.

Our next question comes from Jeff Lee from Wells Fargo.

I just wanted to get more color on the June starts. Was the improvement in new student starts versus Q4 more of a function of increased leads in student demand or is it more leads to increased conversion rates?

Let me try to see if I can answer that question in this way. We saw an increase in year-over-year lead flow. It's kind of a hard with the seasonality to compare it on a quarter-over-quarter basis. But on the year-over-year basis, we saw an increase in lead flow. We also saw an increase in the conversion rate. So there is -- I would say I would lean more towards conversion rate improvement than lead flow improvement. If I had to really try to break that down on a quarter-over-quarter basis, and again, we're correlating that conversion rate improvement to the continued rollout of the opportunity scholarship.

And our next question comes from Jerry Herman from Stifel.

Kevin, I wonder if you could talk about retention of students that are actually in the scholarship program? Is it -- can you measure that at this point? Is it incentivizing stay?

At this point, it's a little early to measure that. I had mentioned a little bit earlier, we haven't seen any sort of improvement that we can correlate to the opportunity scholarship. But again, I would just say, it's really early to do that. Probably sometime in the third quarter we'll have a sufficient amount of data where you can go back and take a look at it and get some statistically valid comparisons to see if there is a correlation. We're hopeful. We're not building that into any models at this point. We're not expecting that. But certainly, there's a reason to think that we could see some improved retention as a result of it. But it's too early to see it just yet.

And then a question about the loss related to the private student loan programs, the additional $3.5 million. I guess in timing, it seems to be in close proximity to the last time the analysis was done. And from a mechanical point of view, should we expect a truing up of those estimates every quarter? Is that how we should think about it? And then part b of that question is, any progress on the other loan providers in terms of coming to some, perhaps, settlement with them so that you don't have to worry about those liabilities?

Sure. Appreciate the questions. With regard to the adjustment for the quarter and sort of the methodology that goes into that, the answer to your question is yes, that is a quarterly analysis that occurs. A little more color on it or just to emphasize what we had in our prepared remarks. Principally relates to one of, let's say, 4 pools that exist or 3 pools of loans in the 2009 risk share agreement and then you have the PEAKS program, which I'll just call a separate pool. One of those 4 programs showed a degradation in performance, and it was the oldest of the group of loans -- the pool of loans, the 4 pools. And also, it was most impacted by servicing issues. So there's some reason for, I think, what's happening there versus all of the other pools being much more consistent with expectations. But yes, every quarter, we have to take a look at that, and we'll look at performance of enroll rates and make adjustments accordingly. Whether or not we'll see this level of adjustment going forward, hard to say. It's just very difficult. But whatever -- there's a methodology in place. You collect the data, you evaluate it and then you follow the methodology and make the adjustments accordingly. So this quarter, we had to make one, and we'll see what happens with the next quarter.

He also asked about settlement.

I'm sorry, on the settlement front, yes, nothing to report on that front at this point. We're certainly interested in having conversations, but there's nothing to report as of today.

And our final question in queue comes from Timo Connor from William Blair.

You said 5% to 6% of the total population has received the opportunity scholarships. What about new students in the quarter given that they're generally packaged upfront, I think?

Sure. So when we were referring to that number, we're trying to give a little bit of a sense of how it impacted revenues versus those students that actually were offered it in terms of impacting enrollment. And I think you're getting more to the latter point, if I understand correctly, than the former. To the latter point of how many people were offered the scholarship that could have potentially impacted the enrollment decision, we had all but probably 7 to 10 -- I think it's 7. It was in the prepared remarks, 7 schools that were offering the scholarship to their new students. Now that being said, out of that group of roughly 141 locations or 139 locations that were offering it, 115 of those began offering at about 8 weeks before the start. And so that's 8 out of 12 weeks of the recruitment period so its a substantial portion of that. But I will note that as we saw with our test group of 24 schools that began offering it in December, there is a ramp-up period here. It would take some time for the schools to get their arms around effective communication, and I think in our prepared comments, you'll note that we referenced that we do believe there's an opportunity to improve our communications. Certainly, with the 24 schools that have been offering it to new students for 2 quarters and most certainly with the group of 115, now it will be 122 that will be offering it for the June academic period, 115 for the second time and then the 7 that we obtained approval for offering it for the first time for June students. So we've got some opportunity there. But at this point, as we head into June, all schools will have it, and they'll be offering it to all new incoming students.

Okay. And then one follow-up on the individual loan loss accrual. So you said the 2009 cohort, that's the one that you took the additional accrual loan, but the 2010 and '11 you didn't, I think. What were the differences there? And then what are some of the indicators you're looking for potential losses?

I think principally, we believe, based on the evaluation of the data, that the major difference in that pool is servicing. There was material disruptions in servicing at the initiation of the program just that go toward the poor performance that we're seeing in that pool, and that is the worst performing pool of all 4 pools, by far. And again, it was impacted by poor servicing and poor management of the program, if I could say it specifically. And as far as what goes into evaluating it, really, it's -- not professing to be a credit expert here, but really it goes into looking at loan performance, students in repayment, students in default, rule rates on defaults. If you missed the first payment, what percentage of those people are likely to default. All of these different projections are part of the historical performance and also taking a look at even recoveries on defaults, all of that goes into the analysis. And again, the methodology is constant. It's consistent, you get actual data, and you plug it into the model and you go from there. I don't want to oversimplify it, but it's a pretty consistent process that we utilize.

And ladies and gentlemen, I'm showing no additional questions. I'd like to turn the conference call back over to Mr. Modany for any closing remarks.

Thank you very much. I just want to thank everybody for participating in the call today, and we look forward to talking to you again on our next conference call to review our second quarter results in July 2013. Thank you, everyone, and have a great day.

Ladies and gentlemen, today's conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your telephone lines.