Grand Canyon Education Inc (LOPE) 2009 Q3 法說會逐字稿

Good afternoon. My name is Christina and I will be your conference operator today. At this time I would like to welcome everyone to the 2009 Third Quarter Earnings Call for Grand Canyon Education. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

(Operator Instructions)

I would now like to turn the call over to the General Counsel for Grand Canyon Education, Chris Richardson. Please go ahead, sir.

Thank you, operator. Good afternoon, and thank you for joining us today on this conference call to discuss Grand Canyon Education's 2009 third quarter results. Speaking on today's call are Brian Mueller, CEO, and Dan Bachus, our CFO. Additionally, Brent Richardson, our Executive Chairman; Stan Meyer, our Executive Vice President; Dr. Kathy Player, our President; and myself will be available during the Q&A period.

The call is scheduled to last one hour. During the Q&A we will try to answer all questions, but we apologize in advance for any question that we are unable to address due to time constraints. I would like to remind you that many of our comments today will contain forward-looking statements with respect to the future performance of the Grand Canyon Education that involves risks and uncertainties.

Various factors could cause the actual results of the Company to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the Company's SEC filings including the 10-K report for its fiscal year ended December 31, 2008, its subsequent 10-Q reports including the 10-Q for its fiscal third quarter ended September 30, 2009 and its current reports on Form 8-K filed with the Securities and Exchange Commission.

The Company does not undertake any obligation to update anyone with regard to the forward-looking statements made during this conference call and we recommend that all investors thoroughly review our annual and quarterly filings with the SEC and current reports on Form 8-K before taking a financial position in our company.

And with that, I'll turn the call over to Brian.

Good afternoon. Thank you for joining Grand Canyon Education's third quarter conference call. This is our fourth reporting period and we are pleased to again exceed expectations. Our results continue to validate the core components of our strategy. Because we are finishing our first year as a public company, I want to briefly review our strategic direction.

The first, and most important aspect of this strategy, is to build the brand of the university around the increasing strength and growing reputation of our traditional campus; we are doing that in five ways. One, our plan is to grow our traditional campus to 5,000 students in the next three years. Our incoming class in the Fall of 2009 was approximately 900 students and our projected 1,700 new students in the Fall of 2010 puts us on track to accomplish that goal by the Fall of 2012.

Two, continue to raise the academic qualifications of the new traditional students. Our Fall 2009 students brought incoming average GPAs that were 21% higher than the 2008 class. Three, continue to build the strength of the traditional faculty and use only approved faculty in the traditional campus classrooms, maintaining an average classroom size of 20 to one. We don't utilize large lecture halls filled with 500-plus students studying under teaching assistants. This raises the value proposition for our students, versus the large state universities we compete against for traditional students.

Four, surround a vibrant academic community on the traditional campus with strong performance in extracurricular activities. This creates high levels of interest in the university and contributes positively to awareness levels, brand recognition and lead generation. Music, theater and dance programs are starting in the Fall of 2010, which will add to our 20 NCAA Division II athletic programs.

Five, control costs. Our traditional campus tuition, room, board and fees are approaching half of the typical private university and becoming competitive with some state university rates, making a private university experience possible for many American families who in the past believed it was beyond their reach.

The second part of our strategy is built around the three unique characteristics of our online campus. One, 47% of our online students are graduate students; this brings academic prestige to the institution as well as supports high graduation rates, low default rates and financial stability. We are supporting this strategy by adding Master's and Doctoral programs and shifting enrollment counselors out of the Bachelor's divisions and into the Graduate divisions.

Two, continue to build online programs in the high job growth verticals of healthcare and education; these are the highest job growth areas in the country and support high graduation rates and low default rates.

Three, offer high quality and relevant academic programs at a price point that is close to the lowest in the industry and well below our largest competitors.

The Obama administration has been clear about five points regarding their expectations for higher education. Grand Canyon University is well positioned to support all five points.

One, the United States should have the highest percent of its developed population graduate from college of any modern industrial country; two, students should be studying in areas leading to jobs; three, students should be in programs with reasonable times to completion; four, costs should be controlled so that debt rates of students are reasonable; and five, graduation rates should grow and default rates should be low.

The most important thing we have learned in our first year at Grand Canyon is that leveraging the core infrastructure of our institution across two business strategies has created a greater amount of efficiency than we initially thought possible. This is important because it will allow us to accomplish our revenue and EPS goals, while making both traditional and online education affordable for thousands of Americans.

Turning to the results of operations for the third quarter of 2009, we are pleased to report another quarter of outstanding growth. Net revenues were $66.1 million as of September 30, 2009, an increase of $26.8 million or 67.9% from the $39.3 million in the prior period. Student enrollment at the end of quarter three 2009 are approximately 34,200, an increase of 55.8% from approximately 22,000 at September 30, 2008.

Operating margins for Q3 2009 was 10.1% compared to 6.8% for the same period in 2008 and net income was $3.5 million for the third quarter of 2009, compared to $1.3 million in the prior year. Excluding the estimated litigation loss recorded in the third quarter of 2009 related to the proposed settlement of the qui tam lawsuit of $5.2 million or $3.5 million net of taxes which we will discuss later in the call, operating margin for Q3 2009 was $11.9 million or 18%.

There are three areas contributing to the strong enrollment and revenue growth. One, we continue to make strides from an advertising perspective. Our traditional media and Internet advertising strategies are increasingly targeting leads that fall within our core program verticals, and are at the upper end of the market from a quality perspective; conversion rates are improving as a result.

Two, enrollment counselor productivity in the third quarter of '09 was higher on a per counselor basis than it was in third quarter '08. The large number of enrollment counselors hired one year ago are maturing and the overall attrition rate of counselors is down.

Three, the cross functional operations teams continue to work at better preparing students for class, both academically and from a financial perspective. The retention levels of students in their first three classes is improving as a result.

Turning to expenses, operational improvements and improved student retention have led to an operating margin increase of 11.2% quarter-over-quarter, excluding the estimated litigation cost loss. Instructional costs and services grew from $13 million in the third quarter of 2008 to $23.5 million in the third quarter of 2009. As a percent of revenue, IC&S increased from 33% to 35.5%.

Employee compensation and related expenses increased 344 basis points. Over one year ago, we began making an investment in enrollment counselors which is paying off nicely for us currently. We continue to add enrollment counselors in a number consistent with our enrollment goals. We are now focused on making investments in improving student academic success levels and therefore retention.

During the fourth quarter of 2008 and continuing into the first half of 2009, we have invested in academic counselors, financial counselors, technical support specialists and student academic support personnel as well as systems. Academic and financial counselors go through the same maturation process as enrollment counselors. We expect this line to stay at its current level and start to decline in 2010.

The increase in the wage and salary line was somewhat offset by an improvement in faculty pay by a 172 basis points because average class size went from 18.4 in Q3 of '08 to 19.8 in Q3 of '09.

Selling and promotional expense increased from $18.5 million in the third quarter of 2008 to $22.1 million in the third quarter of 2009. As a percent of revenue, that was a significant improvement of 13.8%, from 47.2% to 33.4%. This improvement reflects the return on our investment in enrollment counselors hired in 2008, as these employees have become more productive. Selling and promotional salaries and related expenses as a percentage of revenue decreased 642 basis points between periods.

Advertising and revenue share as a percent of net revenue decreased 761 basis points in the third quarter of '09 versus the same period of 2008, primarily as a result of continued improvement in the acquisition and distribution of leads. General and administrative costs increased from $5 million in the third quarter of 2008 to $8.6 million in the third quarter of 2009, and as percentage of revenue, remained relatively stable from 12.8% in Q3 2008 to 12.9% in Q3 2009.

Bad debt expense increased by 189 basis points between the third quarter of '08 and the third quarter of '09, primarily due to a refinement made in 2009 to our methodology for estimating bad debt expense to better reflect the pattern and timing of the aging of our receivables, as well as to incorporate our most recent collections experience. On a sequential basis, bad debt expense as a percent of revenue of 5.1% for the third quarter of 2009 is down from the 5.5% in the second quarter of 2009, and 5.2% for the year ended December 31, 2008.

Employee compensation was flat period-over-period since many of our key employees were hired and in place for all of Q3 2008. We realized net decreases as a percentage of revenue between periods in other expenses, including legal, audit and corporate insurance expenses, occupancy costs and consulting, due to our ability to leverage these costs over a higher revenue base.

The estimated litigation loss expense of $5.2 million or $3.5 million net of tax represents an accrual for anticipated settlement of the pending qui tam lawsuit. In October of 2009, we made substantial progress in discussions regarding the settlement of this matter. The Company is negotiating for a comprehensive settlement that would include, among other things, the resolution by the OIG of its investigation. The Company reached a settlement-in-principle, with the [relator] pursuant to which the Company has agreed to pay $5.2 million to resolve the qui tam case and thereby the costs and distraction of a potentially protracted trial. This settlement is conditioned upon obtaining the approval of the US Department of Justice, which has authority to approve settlements of false claim act matters, and the Department of Education with respect to the resolution of the OIG investigation and finalizing settlement terms that would release the Company from other false claims act cases based upon the conduct covered by the settlement. Pursuant to a joint request by the Company, the relator and the Department of Justice at September 28, 2009, the court granted a stay of all litigation proceedings for 120 days while parties attempt to negotiate a final settlement. Negotiations are underway.

Excluding this litigation claim, operating income for Q3 2009 would have been $11.9 million with an operating margin of 18% and net income would have been $7 million. We are looking forward to the finalization of the settlement and resolution of this contingent matter.

As a result of the above, net income grew from $1.3 million in the third quarter of 2008 to $3.5 million in the third quarter of 2009, a 179% increase.

I want to make a comment about CapEx expense. In the third quarter of 2009 CapEx was 11.8% of revenue; this was due primarily to the implementation of CampusView.

In fiscal year of 2010 CapEx will run at approximately 10% of revenues which, again, is above normalized levels, but is a reflection of the investments we are making in technology to support our online students, faculty and staff. It also reflects investments in campus infrastructure to support our growing number of traditional students. As we look to fiscal year 2011 and beyond, CapEx will begin to return to normalized levels.

Our enrollment and financial guidance is as follows. For the fourth quarter fiscal year 2009 we expect enrollment growth of approximately 46% equating to roughly 36,000 students at December 31, 2009. We expect net revenue growth of approximately 53% to roughly $79 million. We expect diluted net income per share will be $0.26 per share.

For fiscal year 2010 we expect enrollment to be between 47,000 and 49,000 students at December 31, 2010. We expect net revenues to be between $390 million and $400 million. We expect diluted net income per share will be in the range of $1.15 to $1.23 per share.

Our guidance for fiscal 2010 is positive, but is grounded in business fundamentals that we have analyzed carefully. I would like to briefly mention seven items; one, advertising improvements made during fiscal year '09 are sustainable through the next fiscal year; two, enrollment counselor productivity gains made during fiscal year '09 will be maintained at their current levels; three, retention levels of online students will go up slightly; four, online tuition increases will average 4%

Five, revenue per student for our traditional campus students will remain at its current high level and the student body will grow at 2,800; the high retention level and low acquisition cost of these students will also be maintained.

Six, the restructuring of some of our academic programs which will include some four credit courses, as well as our current three and five credit courses will improve the retention levels of some students. Seven, all of our curriculum will be delivered electronically via Canyon Connect by the third quarter of 2010. Electronic-delivered curriculum represents a savings for students, but is more profitable for the Company than through traditional textbooks.

With that, I'd like to turn it over to Dan Bachus, our CFO, to talk about the balance sheet and changes in the lending and regulatory environment.

Thanks, Brian. Our cash, cash equivalents and investments balances, unrestricted and restricted, totaled $77.9 million at September 30, 2009. Our accounts receivable net of allowance for doubtful accounts is $15.6 million, which represents 24.1 days sales outstanding compared to 26.2 at the end of the third quarter 2008. Unearned revenue and student deposits increased 66.5% between September 30, 2009 and 2008, with unearned revenue increasing 79.1% and student deposits increasing 20.2%.

In terms of the lending and regulatory environment, we recommended that all of our graduate financial aid students use the direct lending program for their Title IV needs beginning with our Fall-1 term and everything went smoothly. Thus, we are recommending that all of our undergraduate financial aid students use direct lending no later than our Spring-1 term.

We've received a number of questions from investors during the past week about revenue recognition and return to Title IV. It is worth noting that in connection with our initial public offering, which closed less than one year ago, we underwent a complete re-audit of our financial statements from 2006 forward as well as a full SEC review of our financial statements and related disclosures, which included a review of our critical accounting policies.

During the comment letter process, the SEC did ask for an explanation of our revenue recognition policy. That question and our answer are publicly available on EDGAR. As disclosed in our annual report and in our Form 10-Q, net revenues consist primarily of tuition and fees derived from courses taught by us online and our traditional campus and Phoenix, Arizona and onsite facilities of employers, as well as from related educational resources such as access to online materials.

Tuition revenue and most fees and related educational resources are recognized pro rata over the applicable period of instruction, net of scholarships provided by us. If a student withdraws during a refund period, we will refund all or a portion of tuition already paid pursuant to our institutional refund policy, or if applicable, a refund policy mandated by the state in which the student resides.

Based on our refund policy and the fact that we recognize revenue pro rata over the course, we do not recognize revenue prior to amounts that could be potentially refunded to a student.

We did make one change at the beginning of the third quarter of 2009 to refine our revenue recognition process. Historically, the university had recognized revenue on a monthly basis beginning in the month of the term generally started and pro rata over the remaining four months of the term. Effective July 1, 2009 we began recognizing revenue using a days approach, such that the revenue is recognized pro rata beginning on the day the course starts and ending on the day the course ends. This change had an immaterial effect on our financial results.

Returns to Title IV calculations are evaluated separately from our institutional refund process, and could result in us returning funds to the lender in excess of the funds we retain to cover institutional charges or recognize this revenue. In these instances, we book a receivable and attempt to collect this amount from the student. In a term-based environment, which we currently operate in, the return to Title IV is calculated based on completed days in the term as a percentage of the total days in the term.

The exception to this rule is that if courses are offered in a modular setting, if a student has completed the first module, no R2T4 calculation needs to be done. Our terms consist primarily of two eight-week courses. So, if a student completes the first eight-week course, no R2T4 calculation is required.

One other comment about this; we are a non-attendance taking university as are most traditional universities. Non-attendance taking universities are required by Title IV regulations to have an unofficial withdrawal policy for students that do not formally withdraw, but stop actively participating in class.

We have an unofficial withdrawal policy that requires the instructor to notify our registrar's office when a student is no longer actively participating and, in this case, we are required to do an R2T4 for 50% of the aid dispersed.

As we have discussed previously, we're moving from a term-based environment to a borrower-based non-term environment this Spring. In a non-term environment, return to Title IV is generally based on a 24-credit academic year and a 12-credit payment period. The calculation is based on the percentage of the payment period attended in comparison to the payment period. The entire aid is earned once a student attends greater than 60% of the payment period. There is no module concept.

While we will have to do R2T4 calculations on students in the non-term environment that we currently do not, we are able to help manage the student's aid better as we're able to hold 12 credits of aid on account, and the student must complete 12 credits before they qualify for the next disbursement. Thus, we believe the move to the non-term borrower-based environment is a positive for us and for our students.

I will not turn the call over to the moderator, so that we can answer questions.

(Operator Instructions)

Your first question comes from the line of Kelly Flynn with Credit Suisse.

Thanks. I have a bunch of questions. First, on the default rate -- the cohort default rate -- I know your default rate is quite low. Can you talk about where you expect it may go next year and going forward? It's my understanding that it might be kind of, for lack of a better term, artificially low because of the on-ground history. Is that fair, and is there any other color you want to provide around that? Thanks.

That's true. We expect and we have told people that over the next couple of years our default rate will be somewhere between 4% and 6%, which we think, given the makeup of our student body, is reasonable. And, Kelly, I don't think it was artificially low because of the ground campus; it was low because of the processes that we had currently previously in place around financially clearing students.

And so, now that we're financially clearing students before they start, that allowed the financial aid to come in a little sooner than what was being done before. So, you will have slightly higher default rates, but we think that 4% to 6% in the next few years is where we're tracking.

Okay. Great. And then, a second question on bad debt, can you give us some help on where that's going in the fourth quarter? There was a lot of seasonality or fluctuation in Q4 versus Q3 last year that makes it difficult to model.

Yes. I think we smoothed out a lot of that in the last year. You can expect it to be around 5%. One of the things Brian mentioned was the change in our methodology that we put in place in '09. That was really designed to smooth out that quarterly fluctuations.

As you remember last year, we had quarters that was over 6% and quarters within the 3% to 4% range. That's why we want you to focus on the sequential quarter because we made some tweaks to try to smooth out that quarter-over-quarter fluctuations.

Okay. A couple more, what's the right share count for the fourth quarter?

The one I would use is using the number of shares outstanding as your basic number, and then, adding a 0.5 million shares prior to your dilution factor. So, if you look at our financial outstanding at September 30th was 45,613,794, so somewhere in the 46.1 to maybe 46.5 at the most from dilution of stock options.

Okay. Great. And then, lastly, on the CapEx, did you say in the last call that you expected it to be -- think you said 8% to 9% of revenue in the second half of the year, but it was close to 12% this quarter. You may have said for Q4, but are you, in fact, saying you think it will be higher than the 8% to 9% for the whole of second half? Kind of what happened to the increase in estimates?

We accelerated the implementation of the CampusView.

Okay.

And so, that acceleration caused us to make a greater investment in the third and fourth quarter than maybe we initially thought possible -- or thought probable. But that's really basically it.

A lot of hardware for the CampusView because we're running both systems concurrently, both Datatel and CampusView. And so, we had to buy, in effect, duplicate servers for CampusView and other hardware like that. That's duplicative but necessary so we can run concurrent servers or concurrent applications for the first few months once we implement.

Okay. And just to follow up, so for the fourth quarter you think it's going to be what as a percentage of sales?

Probably 10% or slightly less. I think a lot of that IT spending happened in the third quarter, where some we thought would happen in the fourth quarter. That will be offset slightly by some of the traditional campus infrastructure projects that will be ramping up in the fourth quarter.

Okay. Great. And then, finally, I appreciate all the detail you gave about the revenue recognition-related issues. There's a lot there. So, that said, I'm wondering if you can tell us your thoughts on the negotiated rule-making topics of -- well, one topic is module versus term-based kind of Title IV funding, if you will.

And the other one is talking about taking attendance in class for purposes of calculating return of Title IV funds. (Inaudible) of all the detail you provided, can you tell us -- do you think that the changes being contemplated to those regulations could impact your cash flow significantly?

No, especially because we're moving to borrower-base this Spring. Had we not moved to borrower-base, I don't think it would have had much impact on us because, as I explained before, we do do the modules that -- there are two eight-week modules.

And so, there's -- as is kind of described in the comments from the Department of Ed, we're not playing any games with two week first module, and 14 weeks second module. So, I don't think any of the discussions that they're having will have any material impact on our financial condition.

Okay. Thanks a lot.

The next question comes from the line of Kevin Doherty with Merrill Lynch.

Great. Thanks, guys. I guess, just first of all, could you just provide maybe some more comments on the underlying drivers of the 2010 guidance? And I know you gave these seven factors but I guess, specifically, when we look at the revenue per student based on the guidance, it's quite a bit more healthy than what we were expecting.

So, maybe if you can just talk about some of the puts and takes that would impact revenue per student. I think you gave some comments on the on-ground campus, but anything that might shift that on the online?

Yes, it's really a combination of a lot of things that are coming together at the right time for us. The advertising improvements are having an impact, but we don't expect -- we're not modeling in that they will get better than they are currently.

Enrollment counts or productivity and increased conversion rates are impacting this positively. And so, we're going to get a whole year of that versus a half a year of that. That's going to help significantly.

Retention rates are going up. We have experienced retention rate improvement in the last six months. We're not modeling in more of them; we've already improved, but, again, we'll experience that over a complete year versus only three to six months.

The traditional students are more profitable than we thought, and you have to remember that a year ago, we were losing about $8 million a year on our traditional campus. By next Fall, our student body will be quite a bit above our breakeven mark and those students are turning out to be more profitable than we thought. They take an average of 30 credit hours compressed into an eight-month period of time, and because they pay tuition on a semester basis, they actually pay a slightly higher tuition rate per credit than our traditional students -- than our online students.

The next thing is that we get a high percentage of students returning year after year and there's no acquisition cost. So, in essence, you're getting a new student who's going to take 30-credit hours in a compressed period of time without any acquisition cost. And so, the traditional students, what we thought at one time were going to be a big minus are turning out to be a fairly positive plus which is why we're wanting to build that traditional campus to 5,000 students.

In addition to that, in about mid-year, we will have completely moved to electronic delivery of curriculum. And even though that represents a significant savings for students, it's very profitable for the Company. And so, once that happens, that is also going to contribute fairly significantly to our overall revenues.

In addition to that, we are doing some tweaking of some of our academic programs from a standpoint of length of time of classes, credit hours earned, et cetera. We're pretty strategic about that with regards to who the students are, what the curriculum is, and what the outcomes necessary to achieve are and that's also going to help. So, it's really a combination of those things that gives us the potential to have a very successful year next year.

Okay. And I know you gave some comments on the bad debt outlook for the fourth quarter, but could you just talk about what's implied in that 2010 guidance?

I think we have 5% modeled in 2010. We're hoping to do better than that but we think that's a conservative assumption.

Okay. And then, given just some of the discussions today around Neg Reg, could you just review for us your enrollment advisor policy? And what would be your thoughts if some of the existing Safe Harbors were to be eliminated?

We are very confident that we've moved into an era where the enrollment counselor compensation or evaluation in compensation really can be not attributed to new student starts at all, and not have a negative impact upon our growth. The Company moved approximately two years ago to a plan that compensated enrollment counselors for students who successfully achieve a 24-hour credit limits and then graduation.

That has proved to be a very effective way to motivate counselors to recruit students, to recruit good students, and to stay with them so they accomplish 24-credit hours and they eventually graduate.

So, that's where our focus is now. We've moved into that very successfully this year. And so, if there would be some significant change in the Safe Harbor rules around evaluating performance based upon new student starts, we don't believe we would be negatively impacted; we will be able to accomplish the goal that we've set.

Okay. Thanks for the color. I'll turn it over.

Thank you.

Your next question comes from the line of Mark Marostica with Piper Jaffray.

First, I was hoping to get a little bit more color around your electronic delivery curriculum. And I think -- did you mention Q3 '09 you would start to roll it out or did I get that wrong?

No, we've been rolling it out gradually during '09 and we will finish rolling it out across all programs and courses as we move into the second half of 2010.

Got it. And how do you charge for this?

By the course. There's a certain amount charged by the course, and it's just part of the student's payment if they pay course by course.

And how much is that per course?

It depends on the college. It varies a little. It's somewhere between $60 and $80 depending upon the college and the course.

Okay. So, I imagine it's mandatory then that the student gets charged that amount per course regardless?

Yes, it's mandatory, and so, it prohibits students from buying used textbooks or not buying the book, which we like. But it represents a significant savings over what the students would pay if they were buying new books.

How much is that savings on average per student?

Typically, textbooks for classes are running somewhere between a $100 and $200. So, it's a significant savings for students.

Okay. And then, looking at that $60 to $80, is that essentially just drop to the bottom-line for you or is there --?

No, there's cost to acquire the content from publishers and we negotiate individually with each publisher depending upon the content that we are needing to get to meet the outcomes of the course. So, some of the content -- if varies just depending upon what content is selected.

Okay. Can you give us any sense of the average margin on that $60 to $80?

Probably not. It's kind of -- because everybody's negotiating differently with the publishers it's kind of confidential or competitive information that we probably shouldn't give out.

Okay. Just moving on to another area and that's your move to non-term based institution. I recall you mentioned that you're planning to effect that move in February of 2010. Is that still on schedule -- still on track?

It's pretty much on track. It will probably be a little bit later than February. It probably will be towards the end of March or early in April. There's no rush. There's no need to rush it at all. We're taking our time making sure the campus new system is up and running and is capable of handling it, make sure that all the hardware's in place, that all the people have been trained.

We have a lot of experience, obviously. We've operated more out of that environment than we have the term-based environment, so we've got a lot of experience in doing that. But, there's no need to rush.

And then, finalized your modular implementation of CampusView at this point, and can you walk us through how you're going to roll that out?

Yes, it's just -- we're only using three modules. We're using the accounting module, the student records module, and the financial aid module. We are, in terms of -- there are customer relationship management systems which drives the front-end in terms of recruiting students and retaining students. We're staying with our current system which is CRM, which is running fine.

Mark, they'll all roll out at the same exact time, all three of them because Datatel, which is our current system, Datatel is all three systems. So, when we're ready to cut over, we'll cut over from Datatel to CampusView all modules -- all three.

Okay. But you're running them parallel right now?

Yes, correct.

Yes. We're running Datatel as our main system and we're doing testing and prep work on CampusView. And when we get into Spring, we will be running them both concurrently until we're ready to fully cut over to borrower-based non-term.

Got it. Okay. Thanks. I'll turn it over.

The next question comes from the line of Jeff Silber with BMO Capital Markets.

Thanks. Just wanted to shift back to some of the enrollment data. It looked like on both the Master's side and the Bachelor's side we saw accelerating enrollment growth, but a bigger shift towards Bachelor's. Can you talk about that, why it happened with the seasonality, and where do you see that going over time?

Yes. If you look at the last year and a half, 18 months ago there was a rapid hiring of enrollment counselors. It doubled in that time period, went from 250 to 500 approximately. Most of those people at that point were hired to sell business programs which is largely undergraduate students. What we've done is we started to reverse that, and we've got a lot of runway with Doctoral programs and with additional Master's degree programs.

So, the fact that we're currently at 47% graduate and 53% undergraduate is still very positive from our standpoint. If that slips a little bit in the next couple of quarters, we're fine with that because the majority of the slip would be with military students because we are ramping up our military department.

And we're okay with that because even though military students will be 80% or so, undergraduate students from a retention and from a financial standpoint will look a lot like graduate students. The retention rates are high,, their acquisition costs are low, and their retention is high. So, if it slips some more and it's primarily with military students, we're fine with that.

In terms of the military, what type of discounts do you provide?

We're about where most other people are in that. I think our published tuition rate for military is $250 a credit hour, which is obviously a reduction from where we're at. But typically, advertising costs for us run about 10% of revenues and those advertising costs are virtually nil. For military students it's very much a viral market.

In addition to that, because they have basically a 100% tuition reimbursement, there's virtually no bad debt expense and, again, the retention rates are high. So, it's worth it for us to give that discount because those students -- the other characteristics of those students are very positive.

Great. You talked a little bit about the enrollment counselor productivity. I'm just wondering -- can you comment on cost per start trends beyond the advantages you got from them?

Yes. That's -- it's competitive information so we don't give the detail on that. You obviously saw a big reduction in terms of S&P as a percent of revenue in this quarter. 33% is really still a little bit high in terms of what our eventual goal is, but it's not the result of our advertising or enrollment strategy; it's really the result of our very low tuition as compared to other players in the industry.

What we'd like to be able to do is keep making improvements in advertising and enrollment counselor productivity and retention levels, and in-step 33% down to closer to 30% but maintain our significant advantage from a pricing standpoint.

Are you seeing any change in terms of the lead buying market? Any softness, any change going forward?

Not really. What's interesting for us is that there are a lot of new players and those new players are very anxious to work with us in the specific areas that we recruit students. And so, we don't have, as general approach as maybe we had in the past, we are really looking to build our student body around Doctoral students, around Master's students, especially Master's students and Doctoral students in education and healthcare, and then around baccalaureate students.

So, no, we have not -- we see only slight gains there. We haven't seen any deterioration, and we really don't expect to in the next year.

Okay. Great. Thanks so much.

Thank you.

Your next question comes from the line of Ariel Sokol with Wedbush Securities.

Hi, guys. Just a couple of questions. The first one -- thanks for the 2010 guidance, but just to make sure that we're on the same page. Will 2010 revenue enrollment seasonality be the same as 2009, or will there be a pronounced seasonality in any given quarter given that enrollment and revenue are both decelerating?

I think the trends will be pretty much the same trends that you saw in 2009. And so, second and third quarter will be lower revenue and enrollment quarters, primarily because our ground traditional students are out of attendance for almost a four-month period, and some of our online students take time off in the summer.

One of the things we're hoping, although we haven't modeled in, is with the move to the borrower-based environment that we won't see as much of our online students taking long period of time off like we've had historically. If they were financial aid students, they had to take 16 weeks off. We're hoping that they don't take 16 weeks off now that -- once we got to borrower-based that they take two or three weeks off. But we haven't modeled that into our model that we provided for our guidance.

I guess the natural question would be let's assume that it does happen. What would the potential upside be?

We just don't know how to model that.

What we've got is we've got our experience, obviously, at the University of Phoenix. We talked about retention both in terms of the retention of students, but also the persistence rates. And the persistence rates at Grand Canyon are significantly lower. By persistence, I mean students staying from one course to the next.

And so, what you've got at Grand Canyon is a lot of temporary outs, and the reason they're temporarily out is that they have to be out for a longer period of time. When you start students every week, you can also re-enter students every week. And so, when students have to be out for some life circumstance for two or three weeks, in our situation, frequently, they have to be out for a total of 16 weeks which really hinders your persistence rate.

And so, there is going to be an upside for us there; we know how to manage that once we go to a borrower-based environment, but we haven't modeled that in because we just don't have history yet.

Great. And then, one last question, regarding the return to (inaudible) calculation, how does an instructor determine when a student is no longer participating? Are there certain milestones that an instructor has to note?

Yes. If a student hasn't posted in the classroom or submitted assignments for a two-week period of time, we're assuming there's something significantly wrong there and we're notifying our counselors, and we're making contact with the student and trying to find out what's going on. Frequently, if the student has dropped, we get on top of it and we do the calculation.

What percent of student drops are there of your total student body or alternatively, what's the revenue kind of impact typically?

We don't give that out. We don't give that information out. It's proprietary and competitive so we don't do that. But, obviously, we track it closely.

Thank you.

Your next question comes from the line of Bob Wettenhall with Royal Bank of Canada.

Hi. Good afternoon.

Hi, Bob.

Thanks for taking the question. Just wanted to see on your 2010 guidance without asking for a specific number, what's the implied operating margin under guidance of 115 to 123? Just a range, not a point estimate.

I don't know. Bob, let me -- I have to look at that. It's not something I prepared for, so we'll get back to you. Actually, Rick has handed me something. Let me look at it. We'll tell you preliminarily it's around -- it's in the vicinity of 24%.

24% for 2010. Okay. And just because you ran through it. I didn't fully get it. Can you give me your CapEx as a percentage of revenues? You said it goes up in '10 and then you're going to kind of revert to a more normalized level in 2011?

It wont actually go up, but it will stay at around 10% for 2010.

Yes. And then '11?

We'll see. Historically, we think more around 6% -- 6.5%, and so, I think as 2011 goes on we'll start to move in that direction.

Got it. Got it. Building up like a lot of cash, terrific quarter and continuation of momentum, what do you guys intend to do with the current cash on the balance sheet?

Good question. We'll consider the options that have always been in the space. Buyback of stock is an option. We're not talking about a dividend at this point because we're still in a strong growth mode. And so, we'll look for places either to buy back stock or make investments that will further the strategy especially around the development of the ground campus because we think that gives us some leverage from a marketing perspective.

Any thoughts to acquisitions, or is that not in the program?

We look, but at this point we aren't considering anything seriously.

Okay. That's great. And one final question, just in the regional market with ASU having a cap on enrollment, do you feel like you're getting an overflow which is helping give you a better enrollment expectation of that 46,000 or 47,000 to 49,000 range for next year?

Yes. The cap at ASU and the rising costs are really having a positive impact, especially on our traditional campus. Students are now in Arizona finding that they can get a private school education with all the advantages that exist there for pretty close to what it will cost them to attend a major state university.

And so, we're gaining a lot of momentum from that standpoint which is good because, like what we said before, one of the pleasant surprises that we have learned about this year is that those traditional students can be very profitable.

So, just to put that into context from a pricing scheme, what is tuition at ASU versus Grand Canyon for the on-ground program for a year on a --?

Well, they're somewhere between $7,000 and $8,000 for tuition. They're somewhere between $8,000 and $10,000 for room and board, there's another $1,000 or $1,500 for fees. So, when we say $16,500 and $6,500 for room and board with virtually no fees, we get to be very competitive with them. The advantage we have is that we've got this huge infrastructure to support higher education, but we're leveraging it across both the online campus and the traditional campus, which makes our ability to do that and make it profitable a pleasant surprise.

So, you're at like $16,000 plus another $6,000; so, $22,000 which is a price compared with ASU. They don't have capacity lap because of a budget constraint and you're just picking up that incremental demand in the marketplace. Correct?

Well, we're picking up the incremental demand, but we'd like to say we're picking up the incremental demand at the high end.

Okay. Great. But that's driving your better enrollment forecast for the strong enrollment next year.

That's definitely helping. Yes.

Once students -- Brian's talking about this all the time, but once students realize that they could go to a private school education with class size of 20 to one and the Christian side of that, that's a pretty positive thing with pricing that's pretty close to being the same.

I'm just trying to more directly just figure out is this a one-time thing or they're not -- it doesn't seem like ASU will add capacity sufficient to meet the demand and you should be a longer-term beneficiary in the next two or three years as a result of that. Is that fair?

Yes, that's fair. But in addition to that, I should point out that we also recruit pretty heavily for traditional students in the Southern California area, in Colorado, and in some places in the mid-West. And if you think about our tuition rate at $16,500 before scholarships, the average private university tuition rate is about $26,000.

And so, if you add on $8,000 to $10,000 for room and board, where we're $6,500 for room and board, it's not hard for us to recruit traditional students; they're looking for a private school education in other states as well.

Good. That's very helpful. Thanks a lot. Nice work.

Thank you.

(Operator Instructions)

Your next question comes from the line of Brandon Dobell with William Blair.

Snuck in here. How are you guys doing? Quick ones. With the uptick in the quality of the ground students and the bigger numbers, how should we think about scholarships looking into the fourth quarter, but more importantly, into 2010 as a percentage of revenue?

They'll be about the same as they have been.

Okay. So, you're getting an uptick in quality students without having to extend more of your own capital. Is that right?

Yes. One of the reasons is, especially on the ground campus, with athletes, a lot of the athletes are getting 100% scholarships or 50% scholarships. And so, these other students are coming in and they might qualify for an academic scholarship or a different scholarship, but it's not nearly at the 50% or 100% range. And so, from a ground campus perspective, it's actually staying the same or going down.

Great. I may have missed it, but did you guys talk about the split between ground and online students at the end of the third quarter?

Yes, it's obviously in the filing. The only piece probably to clarify is obviously ground in our filings include both ground traditional students that we talked a lot about and then our professional studies students, who are attending classes most likely in the hospital or in the school district that they teach in.

Yes.

Where we're at from a ground perspective, as Brian mentioned, is 1,700 students for ground traditional, so the remaining number is the professional studies number.

Got it. Perfect. How should I think about D&A next year, given the uptick and acceleration in CapEx this year? I mean, it's a question actually for 2010 and '11, is there a decent number that we can start to model for D&A?

Yes, I think as a percentage of revenue, it will stay pretty flat. It's going up obviously with our spending, but our revenue's going up as well. And none of the campus infrastructure projects will be placed into service until the tail-end of 2010, so you won't see any of that in depreciation until the fourth quarter at the earliest.

Okay. And then, final question before I let you guys go. On the IPO you talked a lot about the opportunity to partner with local hospitals, healthcare organizations, even perhaps not in Arizona but in surrounding states, I don't know if you guys have talked about too much recently but wonder if there's an update or if that strategy is still the same or has it changed, or still the opportunity you thought it was. Thanks.

Yes. The hospital arrangements, contracts, partnerships in Arizona are going very well; those are increasingly just added a couple. In surrounding states, we have potential; we're still working on it. We haven't finalized anything yet, but we still -- that's still part of our strategy.

Okay. Thanks, guys.

There are no further questions. I would now like to turn the call back to Brian Mueller for closing remarks.

Yes, thank you very much for your attendance and your questions. We appreciate your support, and we'll talk to you next quarter.

This concludes today's conference call. You may now disconnect.