ESI reported 1Q10 results this morning that topped PAA Research and consensus expectations. You can read the full release here.   Here are the quick highlights:

• Revenues and EPS of $384.0 million and $2.46 beat consensus expectations of $372.6 million and $2.28
• Bad-debt expense declined 100 bps sequentially to 5.9%, which was below our expectation of 6.5%
• SS&A expense EXCLUDING bad-debt, declined 314 bps YOY as a percentage of revenue and only increased 16.6% nominally YOY, which was below our expectation of 20%+
• Revenue per student increased 2.3% to $4,754
• For the spring term new student starts increased 21.8% YOY vs. our expectation of 12.5%
• Total enrollments increased 28.9% YOY to 84,555 students

Interesting Observations:

Here are a few interesting observations we had after evaluating the company’s earnings release:

• The revenue-per-student gain in light of the strong increase in student persistence (up 80 bps YOY to 76.1%) is surprisingly low. We know that ESI increased its list tuition pricing per credit hour by approximately 5% in the Spring.  This combined with an increase in student persistence should have led to a mid-single digit YOY increase in revenue-per-student. The smaller than expected increase suggests that ESI is discounting more of its programs and offering more scholarships than it has in the past.  ESI’s programs are some of the most expensive in the for-profit education sector and as we have argued for sometime, the return on educational investment for the company’s students is increasingly questionable.  We think revenue-per-student gains will continue to slow and eventually become an impediment to the company’s earnings growth.  It seems like the company has little room to increase tuition unless outcomes improve MATERIALLY.
• Deferred revenue increased 44% YOY, which represents the fastest rate of growth for the company EVER.  For almost a three year period, ESI’s deferred revenue growth has lagged its revenue growth.  We can only assume that distributions under the PEAKs loan program have enabled the company to receive a greater amount of tuition upfront. This will be an area to focus on for the conference call.
• For the first time since since the second quarter of 2006, the cost of educational services spend per student actually increased on a YOY basis, but only 2.6%.  One of the major arguments against ESI and the value proposition it offers students is that the company’s revenue per student increased from $11,117 in 1997 to $19,123 in 2009, while the cost of educational services spend per student DECREASED from $7,064 to $6,740 over the same time period.  Yes, the proliferation of online delivery options has increased operating efficiency for ESI, but there is little evidence to suggest that ESI has been reinvesting in its education on behalf of its students.

Questions Heading into the Earnings Conference Call

ESI will host a conference call today at 11AM EST.  We are almost certain that the vast majority of focus on the conference call will be the company’s views on gainful employment and how it could impact ESI’s earnings going forward.  We’re equally confident ESI management will do everything in their power to dodge these questions.  Here are some of the questions we would like answered on the conference call:

• How much was originated during the quarter under the PEAKS loan program?
• How much of the reduction in bad-debt expense can be attributed directly to PEAKS?
• Will the company provide separate disclosure on the amount of subordinated notes issued by the PEAKS loan trust?
• Will the company disclose reserve levels on the subordinated notes?
• How much did the company fund from its internal lending program in the first quarter and what are the company’s expectations for the remainder of 2010?
• What percentage of ESI’s current student population is enrolled in bachelor’s degree programs (this will become an increasingly important issue)?
• What were the final job placement rates and starting salaries for the company’s 2009 graduates?
• Has the company started to witness any lead cost inflation?
• How much is the company investing in cohort default rate management and what are management’s expectations for the magnitude of improvement?
• How has the PEAKS loan program impacted the company’s deferred revenue balances, if at all?
• Is the company in discussion with any other private lenders currently?
• How would the proposal to allow private student loans to be discharged in bankruptcy impact the PEAKS loan program (is this a MAC), the company’s own internal lending program, and the company’s ability to secure private loans on behalf of its students?

We recognize that ESI shares are likely to trade higher today based on the strong results, but in the context of the bigger picture, not much has changed.  ”Cracks” in ESI’s earnings growth story continue to emerge as a result of the company’s tuition pricing policies, which offer students a questionable return on their educational investment.

As always, please act accordingly….