Grand Canyon Education Inc (LOPE) 2010 Q2 法說會逐字稿

Good afternoon. My name is Bonnie and I will be your conference operator today. At this time I would like to welcome everyone to the second quarter Grand Canyon Education earnings call. (Operator Instructions). I would like to turn the call over to Mr. Chris Richardson.

Thank you, operator. Good afternoon and thank you for joining us today on this conference call to discuss Grand Canyon Education's 2010 second quarter results. Speaking on today's call are Brian Mueller, our CEO and Dan Bachus our CFO. This call is scheduled to last one hour. During the Q&A period we will try to answer all questions. We apologize in advance for any questions 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 Grand Canyon Education that involve risks and uncertainties.

Various factors could cause the actual results 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 a 10-K report for it fiscal year ended December 31, 2009 filed on February 18th, 2010. The quarter report on form 10-Q for the second quarter of 2010 filed today. Subsequent 10-Q reports 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 will recommend all investors thoroughly review our annual report on form 10-K, our quarterly reports on form 10-Q and our current reports on form 8-K filed with the SEC before taking a financial position in the Company. With that I will turn the call over to our CEO, Brian Mueller.

Good afternoon and thank you for joining our second quarter fiscal year 2010 conference call. We are pleased with the financial results of the quarter, but before I review them, I want to cover three areas that are important concerns for investors.

First- Steps the University has taken over the last two years to ensure the highest levels of compliance in academic and student financial aide areas. Second- The steps we continue to take to place a priority on building the academic brand of the University. Third-- Impact the gainful employment regulation would have on our operations. The University has taken 11 very important steps in the last two years to ensure the highest levels of compliance in regard to evaluating and improving student academic progress, implementing financial aide, controlling student costs and reducing student debt levels.

First- Refund policy. Before April 2010, University operated in a term base environment and followed the appropriate term base refund schedule. To better serve working adult students, the majority of whom take one class at a time. In 2009 University introduced a course by course policy that provides significant benefits to students.

Second- Student academic progress. In 2009 the University made changes to continue to strengthen it's academic progress policy. We continue to place an emphasis on tracking student progression and creating tools that will allow us to do it with greater position.

Third- Responsible borrowing. The main reason we transitioned to a borrower based academic year was to promote responsible borrowing for students. Using a term based method, students found that aggregate loan limits could be reached prior to degree completion. Moving to a borrower based format, ensures that borrowing is spread more appropriately across their entire program and that students have the funds necessary to complete their degree.

Four- Admissions. Grand Canyon has clearly defined admissions requirements. There are distinct admission requirements similar to other for doctoral, masters and undergraduate students. Although students may be provisionally accepted the University did increase the admissions GPA requirements for undergraduate students from 2.25 to 2.75 in the spring of 2009.

Five- Tuition costs. The University maintains one of the lowest tuition rates for students as compared to private institutional and private non traditional institutions. GCU's ground based tuition rate is roughly half that of other traditional private institutions. In fact, for traditional students living on campus, the University froze tuition for a period of two years as well as lowered room and board 20% starting with the fall 2009 semester, demonstrating a further commitment to keeping cost and debt levels reasonable for traditional students.

This move has made room, board, tuition and fees at Grand Canyon University very competitive, if not less expensive, than the cost at some state universities. This fact is true even though Grand Canyon University does not receive benefits of significant tax subsidies enjoyed by those same state universities. Our tuition rates for working adult online students are close to being the lowest in the industry and our tuition increases have been very modest helping ensure that these students don't take on exorbitant amounts of debt in order to complete their degrees.

Six- Academic scholarships. University continues to make a significant investment in academic scholarship programs to attract and retain high quality students, both students who attend our traditional campus and non traditional students who attend on-line. This further reduces the investment students must make to earn their degrees.

Seven- Electronic materials. In 2008-2009 the University introduced Canyon Connect which is the electronic delivery of text books and other classroom materials. This not only helps us in being more precise at tying content to the specific learning outcomes that are identified for each course, but it significantly reduces the cost of the materials to students. Historically, students have paid over $200 for their materials in a given class. Canyon Connect allows them to pay only $65 to $75 per class. This for bachelor students can represent over $4,000 in savings over the entire course of the program.

Eight- Capital expenditures. University continues to emphasize reinvestment of financial resources into upgraded facilities; technology; improved curriculum; instruction; and other support services such as library resources, tutoring and faculty.

Nine- Academic pillars. University student population continues to have a high percentage of students choosing to enter education and nursing or health care which are projected to be the fastest job growth areas in the next 10 years. We are confident these students will continue to benefit from their investment in education at Grand Canyon.

Ten- Institutional growth. The University's strategic plan includes moderating levels of growth to ensure high levels of quality. In 2009, University grew 50% over 2008. In 2010 the University is limiting its growth to 30% over 2009. Our long-term plan is to grow approximately 20 to 25% on an annual basis.

Eleven- Quality assurance. We have a quality assurance department at Grand Canyon University whose role is to monitor hundreds of phone calls on a daily basis for two purposes. One, it improves our training which increases our capabilities in communicating clearly to students as they navigate their way through the completion of their degree program. Second, to make sure that there is no false or misleading information ever communicated to either prospective or current students.

Next I would like to review and update on the strategies we are employing to build the academic brand of University. The quality of the student body on our traditional campus continues to increase. In the fall of 2009 our incoming class of students caused our total traditional student body to nearly double and the average incoming GPA's of those students went up over 25%.

We will start this fall with approximately 1750 new students which will cause our traditional student body to increase to just less than 3,000. The average incoming GPA's of these students will likely increase over last year's class. In addition, the reputation of the University continues to grow in the performance areas. We will compete for a number of NCAA division 2 national championships this year. And our fine arts, especially in the areas of music and theater, will be very active in putting on performances throughout the southwest. Second, the caliber of our on-line student body continues to grow. Approximately 44% of our on-line students are studying at the graduate level. The vast majority of those students are earning degrees in education and healthcare.

The third component of our strategy involves continuously improving faculty, curriculum and instruction. In the last two years we have nearly doubled the number of full time faculty on our traditional campus and are beginning to add full time faculty to our on-line campus. Fourth, the fourth component of our strategy involves continued investment in our infrastructure. CapEx as a percent of revenue, will run approximately 11% the next 15 months and eventually return to a normalized rate of 5% to 7%.We are adding three new buildings for the 2010 school year including a new classroom building, a new dormitory and a new recreation center. We have recently broken ground on a 5,000-seat event center to be completed in the fall of 2011. We also continue to invest heavily in the technology infrastructure necessary to continue to improve the quality of our on-line academic delivery and service.

The fifth component of our strategy is building on the Christian heritage of the University. Our partnership with Young Life, a powerful international Christian organization is going well. We are currently negotiating potential partnerships with three other Christian organizations which will help us further define our mission and differentiate us from other major players in the industry.

As it relates to the proposed rules on gainful employment, until there is more clarity around the calculation of the metrics and greater access to the data, we cannot give assurance regarding whether all of our programs qualify for continued participation. However, due to our low tuition pricing, program mix, historically low cohort to fault rate and the data we have been able to accumulate from the department of education, we believe that most, if not all of our programs will be above the 45% active repayment percentage. Because over 90% of our students are working adults, we have historically not tracked actual first year income. We do know in our largest program, graduate education, our students typically earn a significant annual increase upon graduation.

In connection with it's administration of the Title Four federal student aide programs, the department of education periodically conducts program reviews at selected schools that receive Title Four funds. In July 2010, the department of education initiated a program review of Grand Canyon University covering the 2008, 2009 and the 2009 2010 award years. As part of this program review, the department of education program review team conducted a site visit on our campus and reviewed, and in some cases requested, further information regarding our records, practices and policies relating to, among other things, financial aide, enrollment, enrollment counselor compensation, program eligibility and other Title Four compliance matters. Upon the conclusion of the site visit, we were informed by the program review team that it would, one, conduct further review of our documents and records off site. Two, upon completion of such review, schedule a formal exit interview to be followed by a preliminary program review report in which any preliminary findings of non compliance would be presented. And three, conclude the review by issuance of a final program review determination letter. Accordingly at this point, the program review remains open and we intend to continue to cooperate with the review team until the program review is completed. We have not yet received notification of the timing of our exit interview or the department of education's preliminary program review report.

As a result of concerns first raised by a member of the program review team at the conclusion of the site visit and subsequently stated in an affidavit by such member filed in connection with our qui tam case, we are aware the program review team has two preliminary findings of concern. The first issue is whether a compensation policy in use during part of the period under review improperly rewarded some enrollment counselors based on success in enrolling students in violation of applicable law. As we have previously disclosed in the context of our qui tam action while we believe that our compensation policies and practices are not based on success in enrolling students in violation of the applicable law, the department of education's regulations and interpretations of incentive compensation law do not establish clear criteria for compliance in all circumstances. In some of our practices in prior years were not within the scope of any specific safe harbor provided in the compensation regulations.

The second issue is whether certain programs offered within our college of liberal arts provided students with training to prepare them for gainful employment in a recognized occupation. This gainful employment standard has been a requirement for Title Four eligibility for programs offered at proprietary institutions of higher education such as Grand Canyon University. Although under legislation passed in 2008 and effective as of July 1, 2010 it no longer applies to designated liberal art programs offered by us and certain other institutions that have held accreditation by a regional accrediting agencies since the date on or before October 1st, 2007. We have held regional accreditation since 1968. Subsequent to the filing of the affidavit by the program review team member expressing this preliminary finding, the program review team requested additional information from us that would help them determine whether our liberal arts degree program were eligible under Title Four because they did not provide training to prepare students for gainful employment in a recognized occupation.

While we have not been informed at this time which of our liberal arts programs the program review team believes may be ineligible we are in the process of gathering the information for delivery to the department of education by its requested deadline that we believe will demonstrate that each of our liberal arts programs met this requirement. Our policies and procedures are planned and implemented to comply with the applicable standards and regulation under Title Four. If and to the extent the department of educations final program review determination letter identifies any compliance issues, we are committed to resolving such issues and assuring that Grand Canyon University operates in compliance with all of the department of education requirements. Program reviews may remain unresolved for months or years with little or no communication from the department of education.

It may involve multiple exchanges of information following the site visit. We cannot presently predict whether or if further information requests will be made, when the exit interview will take place, when the review report or final determination letter will be issued or when the program review will be closed. If the department of education were to make significant findings of non compliance in the final program review determination letter including any finding related to the two issues discussed above then after exhausting any administrative appeals available to us we would be required to pay a fine, return title form monies previously received or be subjected to other administrative sanctions. Any of which outcomes could damage our reputation in the industry and have material adverse affect on our business, results of operation, cash flows and financial position.

I would like to take a minute to thank the program review team for the professionalism they displayed during their visit and the kind things they had to say about the University and our people. I would also like to thank our employees who participated in the program review for all their efforts to ensure the site team received timely responses to all of their requests and answers to all of their questions.

Now, turning to the results of operations for the second quarter of 2010, we are pleased to report another solid quarter of outstanding growth. Net revenues were $97.5 million in second quarter 2010, an increase of $34.6 million or 55% from $62.9 million in the same period prior year. Student enrollment at the end of second quarter 2010 are approximately 36,300, an increase of 31.5% from approximately 27,600 at June 30th 2009. Operating margins for quarter two, 2010 was 21% compared to 20.7% for the same period in 2009, and net income was $12.4 million for the second quarter 2010 compared to $7.6 million in the prior year period. After tax margin was 12.7% compared to 12.2% for the same period in 2009.

I would like to make two comments about student and revenue growth. First, the make up of our student body is going as planned. Graduate students are still approximately 44% of our on-line students. Graduate students bring academic credibility to the institution as well as provide high retention and graduation rates, low default rates and low bad debt expense. We continue to see higher than expected growth rates at the undergraduate level in the healthcare and nursing area. We see this as a positive development given the high retention in graduation rates and low default rates.

Second, revenue growth continues to be significantly ahead of enrollment growth primarily because of the increase in the number of students taking four credit courses. This allows our traditional students on campus and our non traditional students attending on-line to complete their baccalaureate degrees in about four and a half years which is fairly standard. I would like to make a number of comments about margin expansion and expenses. Operational improvements have lead to an operating margin increase quarter over quarter.

Instructional costs and services grew from $20.4 million in the second quarter of 2009 to $36.2 million in the second quarter of 2010. As a percent of revenue, instructional costs and services increased from 32.4% to 37.1% in quarter two 2010. Primarily as a result of our continued investment in faculty, academic and financial advisors, technical support specialists and personnel related to curriculum improvement, instructional performance improvement and student learning assessment. Additionally we incurred non capitalizable system conversion costs during the second quarter of 2010 due to our transition to campus view. We expect this line to decrease as a percent of revenue for the duration of the fiscal year, although we intend to invest more in this area than originally planned.

Selling and promotional expense increased from $20.7 million in the second quarter of 2009 to $29 million in the second quarter of 2010. As a percent of net revenue, we had significant improvement of 3.2% from 32.9% in quarter two of 2009 to 29.7% in quarter two of 2010. This improvement reflects the maturation of our enrollment counselor workforce as well as improvements made to our advertising strategy. Selling and promotional salaries and related expenses as a percent of revenue decreased 211 basis points between periods. Advertising and revenue share as a percent of net revenue decreased 138 basis points in the second quarter 2010 over the same period of 2009 primarily as a result of continued improvement in the acquisition and distribution of student inquires. Other selling and promotional expense increased 25 basis points primarily due to promotional incentives.

General and administrative costs increased from $8.7 million in the second quarter of 2009 to $11.7 million in the second quarter of 2010 and as a percentage of revenue declined significantly from 13.8% in Q2 2009 to 12% in Q2 in 2010. This improvement was primarily the result of the decline by 41 basis points in employee compensation and shared base compensation. That debt expense is a percentage of revenue increased by 41 basis points between the second quarter of 2009 and the second quarter of 2010 primarily to a slightly higher amount of receivables becoming uncollectible. We realize net decreases of 184 basis points as a percentage of revenue between periods in other expenses including legal, audit, corporate insurance expenses, occupancy costs, consulting and other administrative expenses due to our ability to leverage these costs over a higher revenue base.

As a result of the above, net income grew from $7.6 million in the second quarter of 2009 to $12.4 million in the second quarter of 2010, a 62.2% increase.

Our enrollment and financial guidance is as follows- For the third quarter fiscal year 2010, we expect enrollment growth of approximately 29% to 32% equating to between 44,000 and 45,000 students at September 30th 2010.

We expect net revenue growth of approximately 53% to 56% to between $101 million and $103 million. We expect diluted net income per share will be between 28 cents and 30 cents.

For fiscal year 2010, our guidance is as follows- We expect enrollment to be between 47,000 and 49,000 students at December 31st, 2010. We expect net revenues to be between $403 million and $408 million. We expect diluted net income per share will be in the range of $1.22 to $1.28 per share.

With that I would like to turn it over to Dan Bachus, our CFO to give a little more color on our 2010 second quarter and talk about changes in the balance sheet.

Thanks, Brian. Positive revenue results in the second quarter 2010 was primarily the result of us exceeding our expectations in June 2010 related to the number of students that are taking four credit hour courses. We have not adjusted our initial expectations for the number of students taking four credit hour courses for July 2010 through the end of the year as we believe those expectations are still appropriate. Our effective tax rate for the second quarter of 2010 was 39.2% which is slightly below our expected full year affected tax rate of 40.6%. This is due to the positive impact of the resolution of our 2005 and 2006 IRS audit. As a result of our financial and operational performance we estimate the total amount of federal and state taxes we will pay during 2010 will exceed the total cost to the government consisting of our students, student loan default and federal and state grants including Pell grants.

Turning to the balance sheet, there are a number of significant changes in our balance sheet between March 31st, 2010 and June 30th, 2010, most of which have been caused by our conversion from a term-base financial aid institution to BBAY. First I thought it would be helpful to remind investors of the significant differences between term and BBAY and then I will discuss the changes.

In a term based environment which we historically operated in for all of our students, students began programs and were eligible to receive financial aide at periodic start dates pursuant to a calendar based term system. An academic year's worth of funds were dispersed regardless of the number of terms that would be attended during an academic year. Financial aid regulation allowed the University to hold an amount equal to the student's institutional charges for the term, and the rest had to be returned to the student for living expenses. As long as the student was not suspended from the University, he or she was eligible for the next financial aid disbursement at the start of the next term.

In BBAY, which all of our on-line and professional study students are now in, a student may begin a program and be eligible to receive financial aide at any time throughout the year. A borrower based non term system is generally based on a 24 credit academic year and a 12 credit payment period. A student is eligible to receive financial aid for the payment period. The University is allowed to hold an amount equal to the student's institutional charges for that payment period and the rest must be returned to the student for living expenses. To receive the next disbursement, the student must complete the payment period successfully and start attending in the next payment period.

Thus if the student fails or withdraws from a course in the payment period, they are not eligible for the next disbursement until they retake that course or pass another one. In conjunction with this move, the University revised its unofficial withdrawal policy such that the student is withdrawn from the University if they are inactive greater than 29 days. The change to BBAY allows us to manage our nontraditional students with greater ease and flexibility by providing for rolling and flexible start dates. We believe it also helps to ensure responsible buying by the student. We communicated this change to our students in a number of different forums and the majority of our students understand and welcome this change.

However, some have expressed challenges with this change. Thus we have enhanced our student services to assist those who have experienced challenges during this transition period. The transition to BBAY has required us to change the method in which we count enrollments. Prior to our transition to BBAY, enrollment was defined as an individual student that attended a course in the term that was in session as of the end of the quarter. Now that our non traditional students are not in terms we can no longer use this method.

Thus we are now defining enrollments as individual students who attended a course during the last two months of the calendar quarter. We believe this is a reasonable methodology as the majority of our non traditional students take courses that are eight weeks in length. We performed an analysis of previously reported enrollment counts in comparison to the new count method, and although we did not require all students to post into our angel classroom historically, we believe this new method generally would have resulted in a decrease in the number of disclosed enrollments by between 2% and 5%.

This transition has also caused some changes in our balance sheet. Total cash, unrestricted and restricted grew to $74.1 million at June 30th 2010 from $66 million at December 31, 2009. However, unrestricted cash decreased and restricted cash increased. Under BBAY we treat financial aid received for courses that have begun as unrestricted cash and deferred revenue, and for courses that have not yet begun, we are required to treat the financial aid as restricted cash and a student deposit liability whereas under the term base financial aid system, the majority of the financial aid received for the term was considered unrestricted cash and deferred revenue.

Additionally, historically we only had six starts per year. Typically in the first week of a month. We have recently increased the number of student starts and we had starts in the last two weeks of June in which we did not bring in financial aid until July. This causes significant increase in accounts receivable between December 31st, 2009 and June 30th 2010. Therefore our accounts receivable net of allowance for doubtful accounts is $42.6 million which represents 47.1 day sales outstanding compared to 18.5 at the end of the second quarter of 2009.

Unearned revenue and student deposits increased 123% between June 30th, 2010 and June 30th 2009 with unearned revenue increasing 11% and student deposits increasing 321%. CapEx in the second quarter of 2010 was approximately $11.2 million or 11.5% of net revenue. CapEx in the second quarter was primarily internal use software development, ground campus building projects and furniture and computer equipment to support our additional head count.

In terms of the legal environment in connection with our on going efforts to sell our qui tam case, a final hearing on approval, modification or rejection of the contested provisions will be held on August 13th, 2010. If the court determines it cannot approve the contested provisions, then the parties may agree to strike those provisions and the court June 10th, 2010 ruling will approve a settlement consisting of the remaining proposed provisions which as previously disclosed include A- a $5.2 million settlement amount that would be payable by us on the earlier of September 1, 2011 or the issuance by the department of education to us of our Title Four program participation agreement and B- a release of future false claim acts, i.e qui tam action with respect to all contact which is the same subject matter as the conduct at issue in the current qui tam litigation.

Alternatively, the Company would have the option to abandon the proposed settlement and continue with its defense of a litigation. In either such event, the DOE would retain the power it currently possesses to continue with the OIG investigation and/or to initiate other administrative actions including a program review against the Company based on the covered or any other conduct. Should the parties fail to conclude the settlement on the proposed or other terms, the Company intends to vigorously defend the lawsuit. I will now turn the call back over to Brian.

On August 6, 2010 we received a request for information from the health, education, labor and pensions committee of the U.S. senate. The request seeks information to more accurately understand how we use federal resources including how we recruit and enroll students, set program price for tuition, determine financial aide including private or institutional loans, track attendance, handle withdrawals of students and return of Title Four dollars and manage compliance with the requirements that no more than 90% of revenues come from Title Four dollars.

The request also seeks an understanding of the number of students who complete or graduate from programs we offer, how many of those students find new work in their educational area, to debt levels of students enrolling and completing programs and how we track and manage the number of students who risk default within the cohort default rate window. In furtherance of this, the help committee has requested we provide information about a broad spectrum of our business.

Including detailed information relating to financial results, management of operations, personnel, recruiting, enrollment graduation, student withdrawals, receipt of Title Four funds, institutional accreditation, regulatory compliance and other matters. The help committee requested we produce a portion of the specified information by August 26, 2010 and the remainder of the information by September 16, 2010. We are in the process of evaluating this request. Before we turn it over for questions, I have one other comment.

A special comment I would like to make on behalf of our staff. Just this morning we were named by the Arizona Business Magazine of our recognition as the inaugural winner of Arizona's most admired companies, one of the most comprehensive and prestigious award programs in the state. This award is based on leadership contribution, employee surveys, customer service and community opinions. I would like to thank all of our staff for helping us win that award. With that, I would like to turn it over for further questions.

(Operator Instructions). Our first question comes from the line of Peter Appert of Piper Jaffray.

Thanks. Brian, in terms of further details on the program review, I know the history of the current management is relatively short at the Company, but is there any history of prior program reviews that you can share with us and any insight in terms of the resolution of those prior program reviews?

Yes, there was a program review five years ago when just shortly after the Richardsons had bought the University and changed the status of the University to a for profit status. That program review went very well. There were some items listed, but they were all fixed. Yes, that would be the most recent history five years ago and that program review went very well.

And specifically in terms of the focus on the incentives and the compliance incentives, any specifics you can share with us further on that in terms of addressing incentive programs that are still in place or incentive programs that have changed since the review?

We did change our program a number of months ago. The problem they had was with the previous compensation program we had. There was some concern about the way the evaluation was calculated. We worked through that with them. I think there is still some concern there. Grand Canyon took a very conservative approach, in my opinion, to that evaluation. The safe harbor language clearly says you can evaluate enrollment counselor based upon the number of students they recruited. It just can't solely be based upon that, and this was not even close to be solely based upon that. It was pretty conservative in my opinion. And so we feel good about that program, and we feel positive that we can work through that problem. But it does remain a problem at this time.

And then last thing, what's the numbers or percentage of enrollment that is liberal arts related?

Today it would be less than 20% of our students pretty easily. But that's not -- that doesn't really help you. We don't know which program, but they are not identifying all programs under liberal arts as programs they think would be problematic. There's a few, and we don't know which ones yet. We are just going to have to wait until they get back to us on that. Obviously we have an attorney team here, and they have looked very carefully at those programs and we have looked carefully at the occupations that we believe those programs lead to, and we've done some surveying of our graduates to ensure they are in fact getting jobs. And so it is still an area of disagreement that we have and we are continuing to work through it with them.

Okay. thanks, Brian.

Thank you. Our next question comes from the line of Sara Gubins of Bank of America.

Hi, thanks. A couple questions. First, just to make sure I understand the discussion around the settlement of the false claims lawsuit, so no matter what happens in mid-August, GOIG is not part of that settlement, is that correct?

Actually the hearing is the judge asking for discussion on whether that would be a part of it or not. If the judge rules in favor of the government, then the OIG part of it would not be part of the settlement. If he rules in favor of the University, it will be.

Got it, okay. And then second, when you talked about changing the enrollment definition, so you think it lowers your enrollment numbers about 2% to 5%. Have you incorporated that into the guidance for the second quarter you previously provided of 32% to 36% growth?

Part of it, but probably not all of it. We had when we looked at the full year guidance, but looking at historical numbers by quarters, there was slight differences based on quarter. Another thing when you look at our enrollment numbers you will notice was we were slightly below where we expected to be for ground students. We had a higher percentage of our ground traditional students and our professional study students take some time off this summer. Some cohorts decided to be put on hold until the fall from a nursing stand point, and then we just didn't have as many summer school ground traditional students as we expected. Generally from an on-line perspective, we were pretty much in line with where we had guided.

For the fall, can you talk about what you are expecting in ground?

Yeah, as Brian talked about, from a ground traditional stand point we expect to be just short of 3,000. As we talked about before, our goal was to be at somewhere between 2700 and 3,000 from a ground traditional standpoint. So we are very, very pleased with where registrations are for schools that start in a couple weeks. From a professional study standpoint we expect it to be generally what it has in the past, maybe slightly higher based on again the cohorts are all scheduled to come back.

Okay. And was there anything surprising in your on-line growth or demand trends in the quarter?

No, not really. Things went pretty much as planned with the exception of we continue to see stronger than anticipated growth at the undergraduate level in nursing and health care so that would be the only thing I would say would be under than expected.

Thank you. Okay.

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

Thanks so much. Just a follow-up on the enrollment counts. Are you going to be providing us historical, I guess, restated enrollment's under the current method?

Yeah, Jeff, it was something that we contemplated and talked to our accountants about. The problem that we have is getting an exact number. As I said in my prepared remarks we did not require everyone to post our angel system. We didn't require our ground students. We didn't require all professional students to post through our on-line classroom. And so our assumption when I look at our historical numbers was that our ground students, both professional studies and ground, did not post into it. And so that's how I came up with those historical numbers for my own purposes. But that might be the right assumption. It might not be. Some professional study cohorts might have been required to post through the angel system and some of our ground traditional students might have. So getting an exact number is impossible, and that's why we haven't officially restated, but giving you the kind of general guidance of 2% to 5% under is the best we can do.

But just so I understand, the June 30, 2010 numbers are under the new system and going forward you will be consistently following that system?

That's exactly right.

Okay, great. Shifting back to the talk about incentive compensation, with everything going on with Neg-Reg, assuming it goes through as proposed what changes if any do you have to make to your compensation policies?

We have made the changes already. We made them a couple months ago assuming the safe harbors would go away. We made the major change which is really new student starts are not part of the calculation at all. Now, we still have one of the safe harbors which is an important part of what we do. We pay annuities which is compensation to enrollment counselors based upon students they recruit who successfully compete 24 credits. We made a significant -- we went to that from enrollment counselor stand point, also from an academic and financial counselor perspective. That we will have to change, if that goes away. We have ideas on how we would do that. Obviously we have a certain amount of money budgeted for those, and we would have to make some adjustments. But it is not something very honestly we want to do because we think it is the right thing. We believe in safe harbor but if we have to, we will make the change.

And I know it has only been a couple months, but have you seen any type of change either in turnover or morale based on those changes?

No, haven't seen it. It really was a moral booster to make the change. I think what we have now is even more clear to people. They know even better what they are expected to do. I think if anything it was positive.

Just a couple quick numbers, I think you mentioned you expected instructional costs and services to be down as a percentage in the back half of the year. Are you saying down from second quarter levels or down from year over year?

Down from second quarter levels.

Great. And then in terms of -- when will the Company be anniversaried in the shift to the four credit courses? When will we see that in terms of revenue per student?

You'll still see it probably through the third quarter of 2011. If you recall our guidance was roughly 25% of our students would be on it at the end of the first quarter 2010, 50% by the end of the second quarter, 75% by the end of the third quarter, 100% by the end of 2010. So when you are talking about year over year comparisons, you still have the first three quarters at least 2011 increased revenue per student.

But all else being equal, the impact will be lessened as we go over that period?

That's correct.

Okay, great, thanks so much.

Our next question comes from the line of Kelly Flynn of Credit Suisse.

Thanks. Just a follow-up on Jeff's margin question about the gross margin. First of all, the campus view impact on the gross margin, could you just quantify that and also let us know is that something that recur somewhat as we progress through the year?

Yes it was about $4 million in the second quarter. Part of it won't recur for the rest of the year. Part of it potentially will recur. And so we are anticipating, obviously, the instructional cost percentage of revenue to come down from where it was at the second quarter, but we are anticipating spending slightly more than we originally budgeted.

Okay. But $4 million is a lot on a percentage basis. How much of that are you assuming in your guidance if carried forward?

On a quarterly basis?

Yeah. $4 million in the second, I mean, what are you assuming it will be in the third?

Probably related to that, less than a million.

It will go down from four to less than a million?

Correct.

And then, I mean, you may have just answered this, but I want to go into it anyways. Your margins on an operating margin basis it fell in the second quarter year over year, but your guidance implies pretty nice margin expansion year over year. Can you just talk us through that in a little more detail? Some of it has to do with I think this campus view thing you just mentioned. You expect gross margins to fall year over year, but by less in the second half, is that fair? And then where are you getting the better leverage in the second half year over year? What is the line item?

First, margin did expand. It didn't expand at the level we expanded previously. But it did expand Q2, 2010 versus Q2, 2009. And then a lot of the costs that we've incurred already and continue to incur are generally fixed costs. They were associated with increasing head count, especially academic finance counselors. More recently technical support specialists.

So they were fixed costs and the margin expansion will happen in the second half of the year as revenue grows primarily caused by ground traditional campus growing and being out of session during two months of the second quarter and two months of the third quarter. And so that's really where the margin expansions go to. The investments we made will continue, but a lot of them have been made. As the revenue grows that's where you will get your expansion.

Thanks. And then finally on pricing can you talk about what price increases you are planning for the future just to help us better model revenue per student?

Average 3% to 4% on an annual basis is probably right. It is not probably, it is right.

So this year that just started, our school year that just started, the increases were anywhere from 0% to 5% depending on program, but blended rate on average was about three and a half.

Okay, great. Sorry I said last one, but just one more. The campus connect -- rather canyon connect, that technology thing you mentioned, remind us how long has that been in place, and has it changed much over that time period as far as the cost?

No, it has been in effect for almost a year now although we are not even fully -- we don't have it fully rolled out. We still have a few more courses we need to implement. But it is close now.

We rolled it out program by program starting with our masters of education. There has been no price increases in that since we rolled it out back -- I think it was the end of 2008 -- oh March of 2009, sorry. So there has been no price increases since we rolled it out. The margins -- Well, I think we talked about this before, but we generate very little margin from that. As Brian talked about, the costs are $65 for bachelor students, $75 for master students. Our costs are close to what we charge the students so there is very little margin in that product.

And what does this product include? Is your technology fee embedded in this or is that something separate?

We don't have a technology fee. It's simply this, the materials we get from publishers or other sources for a particular class. And so it could be a textbook or a number of books. It could be a simulation. It could be any content we insert in the class that typically would have got it in hard copy from the publisher and now we are delivering it electronically.

Right. So you don't have a technology fee to access the on-line environment?

No.

Okay. Thank you, appreciate it.

Our next question comes from the line of Amy [Yonker] Robert W. Baird.

Hi, Good afternoon. Thanks. Brian, can you just -- can you talk a little about the request from the health committee? I know you are just starting to look through it, but at first blush is there anything they are requesting that you wouldn't feel comfortable sharing either from a competitive reason or any other reason that might give you pause?

Let me just say this, it is very comprehensive. They are asking for a lot of things. I guess there is nothing in here that we would feel bad about trying to get them. There would be things in there that would be probably competitive. My expectation is they are not going to share those things. So this is just -- we got it, what, yesterday or the day before on Friday? And so we are just now in the process of going through it and assigning responsibilities, and we'll be moving forward with it. Let me put it this way, we have put aside some money. This is going to be a big task. This is going to be a real big task. And I think we will get a lot of it. But I don't know that we can get absolutely everything.

And I assume that whatever costs are associated with digging this up are built into your guidance at this point?

Yes, we did do that. We withheld some in terms of our overall guidance for EPS knowing that this will cost us some and anticipating that there might be something else. And so we thought it was the prudent thing to do to make sure we have flexibility to respond to this and other things.

Great. And then along those same lines, with respect to the notice of proposed rule making, exclusive of gainful employment, to what extent do you expect the new rules to result potentially in incremental investments on your part? You talked about incentive compensation, but any other topics you think will require more investment on your part to comply with those?

I think there are going to be costs associated with the tracking of information and responding. So I think that is going to have to occur. You know, our first blush was we probably have to add somewhere between three and five full time people just to track the information that would be required. A lot of the information in the proposed rule making is information that may be vocational or technical schools we are always required to track. But schools of higher education have not had to. I think there will be additional incremental costs associated with it. I don't think there will be huge numbers, but there will be costs.

Great, and then last question I will pass it over, Dan, can you just talk a little about expectations for cash flow from operations in 2010 if you talked about that, I missed it. I apologize.

No, we haven't talked about it. Generally we expect cash flow from operations to run very equivalent to net income. Unfortunately with the move to borrow base, it caused significant changes in our balance sheet primarily around restricted cash versus cash, unrestricted cash classification. And so this year we will look kind of funny in comparison to previous years. But once we get through a year being on borrow base, it will get back to normal trends. The only other thing obviously is as we have talked about a lot our CapEx is percentage of revenue will be in the 9% to 11% range as we move through these building projects and do the I.T. project that we've been talking about. And so that's been an investment that our board and management thinks is a very, very good use of our capital at this point. And so that's slightly decreasing our cash flow as well.

Great. That's helpful. Thank you.

Our next question comes from the line of Bob Wetenhall with RBC.

It seems like there is a lot more investment phone through on IC&S. I want to clarify, are the additional costs you are absorbing one off in nature? So should we expect better operating leverage in 2011?

I think yes, but I think it will be primarily the result of increased revenues. You know, we are putting a lot of investment into full time on-line faculty, into academic financial advisors and tech support specialists, academic coaching roles and so I don't think the actual spending will go down, but I believe as a percent of revenue it will go down some.

Fair enough. What kind of normalized operating margin then are you expecting for the business inclusive of the new compliance costs do you have to shake everything out?

Well, initially we talked about between 20% to 25% and then we have been talking recently more about 25% to 26% and we still feel confident that's where it will be. And I want to make a special note there, That's pre tax. And so for a lot of people who are interested in the margins that this industry is producing, they sometimes forget that 25% or 26%, 25% to 27% is pre tax. Post tax is significantly less than that.

Totally understand that. That's a great clarification. In terms of if you had a handicap as a percentage of total enrollment and percentage of revenues, just on the preliminary basis of the work you have done with gainful employment, what do you think potential exposure could be?

Bob, we just -- it is hard to know given the fact that we are working as hard as we can to get data from the department of education, and what we have been told by the department of education is they will be providing all of that information to us shortly. So when we have that, I think it will be easier to talk it through. I think as we talked before, where I think we had exposure historically was in students that attended Grand Canyon University with very low credits. We don't have associate programs here, and although our bachelors tuition rate is significantly below most of our peers, when you look at a full four years we may be slightly more expensive than them. We have been doing things for about the last six to nine months around scholar shipping low credit students in those first 24 to 36 credits to bring that down. I think we have reduced our risk in that area already. And then as it relates to the 45% rule and the 8% until we have more data it is just impossible to know.

Is the on boarding of scholarship students having a -- what kind of impact is that having on student persistence?

Well, the scholarship involves monies that we award based on incoming GPA's for students who bring some credit. But it also involves us scholar shipping students who do well here from an academic perspective. So we are really pushing hard for students not only to start the program, but do well right away with regards to their performance in the class room. The better they do, the higher their grade point average is, we believe the longer they will retain more and the more likely they are to graduate. So we see some evidence that it is helping at this point.

Got it. Thank you very much. Thank you.

At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone key pad. Our next question comes from the line of Brandon Dobell with William Blair.

Hi, thanks, guys. In the context of the MPR of (inaudible) of compensation, have you thought differently about the marketing strategy, and I guess kind of within that any color on what that selling and promotion line, how that will break out into major categories these days, personnel, add, spend, marketing dollars, that kind of thing?

Interesting from an advertising stand point, we were less than 10% this quarter, and so the weakness we have had in the past has been on the enrollment counselor's side. And that really has gone down significantly if you look over the last year. But advertising has gone down as well. We are building a number of net works slowly. They give us access to a flow of students that aren't the result of having to drive inquiries through the internet, and as we continue to build those networks, we think that 32% we are at today will come down -- or came down to 29%, but we are hoping that it will continue to go down gradually. I can't give you a number, but both trends on the counselor's side and advertising side are positive right now.

Okay. And I know you guys aren't a big military school, but given the focus on this issue, maybe an update on where that stand as a percentage of enrollment or revenue, what your strategy has been there, and in particular relative to military tuition reimbursement levels, how you guys price out those programs either with or without extras like books and things like that. That would be great. Thanks.

Yeah, in terms of the percent of our student body, it is quite a bit less than 10%. It is something that we are doing. It is not something a huge part of our strategy is based on. And there is a significant tuition discount we give those students. But it is from -- number one, it is the right thing to do because it is those people obviously and their service. But also from a business stand point it is. It is a very viral market. The advertising amount of money is very low. And really your success there depends on your level of service to those students.

If you are really good from a service stand point and you are really good from an academic delivery stand point, then the word spreads and that becomes a viral market. We are not putting a lot of dollars into it. We are putting a lot of time, energy and effort into service levels of what we do for them from an academic standpoint. If we continue to do well there, that will grow. It is not something that we are pouring large amount of money into or purposefully targeting. It is something we are doing a good job of and from a viral perspective we think because of that it will continue to grow.

You talked about CapEx turning back down to the 5%, 6%, 7% range after call it four or five quarters from now, at that level of spend, how much of your CapEx will be dedicated to expanding the ground facility or adding new billing to things like that or just maintaining the existing facility?

We still have some more building to do in the next 18 months or so and then most of it will be maintenance. We are in a very positive spot here to be honest with you. If we grow that to between 5,000 and 7,000 students, within 12 to 18 months we will be pretty much done from a building standpoint. But we do have available land, and the market is so strong. The synergy between our on-line program and the traditional ground base program is stronger than we thought. And so our average student now in our ground campus is paying less than $8,000 for tuition where tuition levels at most private universities are upwards of $35,000. Many of our students for room, board, tuition and fees are paying less than they would pay at a state University.

And so the model is working really well for both our on-line students and traditional students. If we would decide at some point to go further with our traditional campus, it would be for the reason of it is paying off. Any investment we would make would be covered by the increased tuition levels. It is something we are playing by ear right now. I know we talked to people about initially 4,000 or 5,000 students and then 5,000 to 7,000 students and that's where we are now, but honestly we are going to watch it. We really think it helps us from a branding perspective to be able to offer this kind of opportunity to middle class and lower middle class students who in the past would have thought private education was beyond their means.

Very good. Thanks a lot.

I think with that we are over the hour that we usually manage for these calls. If you have any further questions, please either contact myself, Dan Bachus or if you are media, Bill Jenkins. We appreciate your time and we'll talk to you soon.

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