Foolish Forecast: ITT's Time

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School's out for the summer, but a for-profit educator's work is never done. ITT Educational Services (NYSE: ESI) reports its Q2 2006 earnings tomorrow morning.

What analysts say:

• Buy, sell, or waffle? Ten analysts follow ITT. Seven like it; two say hold; one wants you to sell the stock.
• Revenues. On average, they expect to see 11% sales growth to $186.7 million tomorrow.
• Earnings. And 8% profits growth to $0.52 per share.

What management says:
Reviewing ITT's progress in the first quarter, CEO Rene Champagne pronounced himself "pleased" with the firm's growth and sounded optimistic about prospects in both the short and long term. COO Kevin Modany echoed the sentiment and credited the firm's "marketing and recruiting efforts, coupled with our geographic and programmatic expansion" with helping to increase new student enrollments. He noted that a 13.9% increase in advertising expenditures resulted in a 14.7% increase in new enrollments during the quarter. Total enrollment, however, rose just 5.6%.

What management does:
More students are good; more profits would be better. But as you can see from the analyst estimates above, they're not expecting ITT's profits to keep pace with its sales growth. Let's see why:

Margins %	12/04	3/05	6/05	9/05	12/05	3/06
Gross	51.6	52.5	53.2	53.6	52.3	51.9
Op.	23.4	23.8	24.3	24.6	24.2	23.5
Net	12.2	12.8	13.7	15.7	15.9	16.4

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
At first glance, the above table looks pretty good for ITT -- rolling gross, operating, and net margins today are all higher than they were 18 months ago. But a closer examination shows that although the net margin has risen steadily throughout the period shown, rolling gross and operating profitability has been on a slide over the past three quarters.

Part of the reason is that the cost of the services ITT provides (COGS) is rising faster than the revenues it's taking in for providing them. In the last six-month period, for example, we see sales rising 9%, and COGS rising 17% -- not a good trend. On the plus side, operating costs are being kept under control; they've risen just 5% year-over-year in the past six months.

Presumably, the rise in COGS is tied to the firm's well-publicized efforts to broaden its curriculum and expand its offerings of non-technical course offerings to attract new and retain existing students. In that case, we should probably expect gross margins to remain under pressure, as Modany called this one of the firm's "key growth initiatives" -- suggesting it will continue in the future. If that's true, then ITT's success in controlling operating costs will become even more essential to maintaining bottom-line profitability.

Competitors:

• Apollo Group (Nasdaq: APOL)
• Career Education (Nasdaq: CECO)
• Corinthian Colleges (Nasdaq: COCO)
• DeVry (NYSE: DV)
• Laureate (Nasdaq: LAUR)
• Strayer (Nasdaq: STRA)

Need further educational reading material? Try any of our investing newsletters free for 30 days or the following links:

• Foolish Forecast: Laureate Reports
• Foolish Forecast: ITT's Q4 Report Card
• Foolish Forecast: Apollo Group's Q3 Report Card

Fool contributor Rich Smith does not own shares of any company named above.