Grand Canyon Education Inc (LOPE) 2010 Q3 法說會逐字稿

Good afternoon, my name is Courtney and I'll be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2010 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session.

(Operator Instructions)

Thank you. I would now like to turn today's call over to Mr. Chris Richardson, General Counsel for Grand Canyon Education. You may begin your conference.

Thank you, operator. Good afternoon and thank you for joining us today, on this conference call to discuss Grand Canyon Education's 2010 third 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. But we apologize in advance for any questions 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 Grand Canyon Education, that involve 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 our 10-K report for our fiscal year ended December 31, 2009, filed on February 18, 2010. Our quarterly reports on Form 10-Q, including our quarterly report for the third quarter of 2010 filed today, our subsequent 10-Q reports, and our 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 report, our Form 10-K, our quarterly reports on Form 10-Q, and our current reports on 8-K filed with the SEC before taking a financial position in our Company. And with that, I'll turn the call over to Brian.

Thank you. Good afternoon. Thank you for joining our third quarter fiscal year 2010 conference call. I want to accomplish three things in the first part of the call. First, I want to give our perspective on the macro environment of higher education. Especially as it relates to the private sector, and explain how we are responding strategically. Second, give you an update on the regulatory environment. Third, review the results of operations for the third quarter. We have been very consistent in our message to investors that we believe the space has benefited from a countercyclical environment. As unemployment and underemployment grew, a higher percentage of Americans were returning to school. This is especially true compared to the recession of 2000, 2001 because of the availability, and acceptability of online delivered programs. During the last three years many working adults experienced success as students.

However, some found the academic work too difficult, given their busy lives, or given their level of academic and financial preparation. A core component of our strategy has been to build the academic brand of Grand Canyon, by building a high quality student body. At a time when we could have grown at higher rates we focused instead on growing with the right students. Last quarter we reviewed the steps that we took. They included changing the refund policy, strengthening student academic progress policies, and raising admission standards. We also restricted growth by pulling back on advertising certain bachelor's programs, and focusing on our core verticals of education and healthcare, which are predicted to be the fastest job growth areas. In addition, we invested heavily in academic infrastructure, both on our traditional and online campuses. We also lowered costs for students by limiting tuition increases, delivering content electronically, and raising scholarships levels to attract good students. The most important move was transitioning from a traditional term-based financial aid environment, into a borrower based non-term for working adult students, attending online. This is by far the most effective way to administer a program for working adult students. Operating in a traditional term based environment, when teaching working adults, most of whom take one class at a time, is certainly within the Department of Education regulations, but can be inefficient in distributing funds evenly, over the course of a student's program. A term environment, allows students to reach aggregate loan limits early in their programs, and not have sufficient funds to complete their programs. The change to a borrower-based non-term financial aid environment impacted our growth negatively in the short run, but moved the quality of our student body in a positive direction. The change from a traditional term-based, to a borrower-based non-term financial aid environment also caused us to have to change out our student information system. The borrower-based change, in addition to the information system changes, was a great deal more problematic than we expected. There simply isn't a system in the marketplace designed to do this effectively.

These changes definitely restricted us operationally, and have had a negative impact on our growth. We estimate based on our loss of mainly bachelor students, in the area of business and liberal arts, that our enrollment is approximately 2,500 students less than we anticipated. We have additional software, including a student scheduling system, we need to build to operate at maximum efficiency. There will be investments in many manual processes over the next nine months that we originally believed would be automated through Campus View. Our goal is to be more fully operated by the beginning of the third quarter in 2011. Let me give you three specific examples of how the changes implemented have had a positive impact on the makeup of the student body. First, in the second quarter of 2010, our online undergraduate population was 55.9% of our total students, with graduates being 44.1%. In the third quarter of 2010, online undergraduates were 54.5%, while graduates were 45.5%.

Second, programs that typically attract students who persist at lower rates, saw a decline in their percentage of the whole. As a percentage of our total online student body our College of Liberal Arts and our College of Business decreased as a percentage of our online student body, from 37.1% at September 30, 2009, to 32.4% at September 30 of 2010. Third, the programs that produce the highest persistence percentages, nursing, healthcare, and education, went from 62.9% at September 30, 2009 to 67.6% at September 30 of 2010. These shifts set us up to be successful as an institution for the long-term. One last comment about our student body, a core component of our strategy is the building of a vibrant traditional campus. This September we started 1,700 new students, which brought our total number to just less than 3,000. And we again raised the average incoming GPA's over the prior-year's class.

By September of 2011, we expect our traditional campus to have approximately 4,200 students. We currently have received over 4,500 applications for our traditional campus next year. We are benefiting from a significant declining tax base in Arizona, and from proposed changes being made in scholarship awards for Arizona residents, considering attending the state university. Our awards to Arizona High School graduates are very competitive with the awards offered by our state universities. In addition, the building out of our traditional campus is going well. A new student dormitory was opened in August, and the athletic performance center was opened in October. A new classroom building will open in December. And our event center will be opened in October of 2011.

At the same time we were making changes to upgrade our student body, we invested heavily in academic infrastructure. We built an advanced online activity-monitoring system. Put in place a qualifying center, a transcript evaluation center, and made further upgrades to our quality assurance center. Most importantly, about 12 months ago, we invested in a company called LoudCloud Systems, to build a new online learning system. We will begin putting students on this system in January of 2011. This system will have advanced capabilities, with regard to content delivery, building learning and social communities, evaluating student and faculty performance, supporting mobile devices, using sophisticated analytics to assess students' learning needs, preferences, and learning outcomes. We will share more about this system in the next conference call.

I would like to make a number of comments on the regulatory environment, first, with regard to the proposed rule on gainful employment. Since there is really no new information at this point, our situation is basically the same. Due to our low tuition pricing, program mix, historically low cohort default rates, and the data we have been able to accumulate in the Department of Education. We believe 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, earned income. However, based on our program mix and job growth in the areas of our core verticals, we continue to believe that graduates are getting high value and good return on their investments.

Second, with regard to enrollment counselor evaluation, we have implemented a new plan which has been reviewed by our legal team, and that we believe is compliant with the incentive compensation rule. We feel very good about the major components of the plan, but will make some adjustments prior to July of 2011. Third, the regulation regarding state oversight of online programs is very broad, and thus, is difficult to comment on fully at this time. It is difficult to predict how the states will react in light of the new regulations as each state has different rules in this area. And some states regulate distance learning more actively than others. However, over the last two years, we have invested a significant amount of time and resources into state compliance, to evaluate each state and its requirements. And we routinely work with state agencies to determine appropriate steps. If a state makes changes to requirements, we have an established process, by which we can make the required changes to ensure that we are meeting the state's new requirements.

The status of the Department of Education's program review is basically the same as reported last quarter. There were two preliminary findings, one concerned an older enrollment counselor compensation plan. And the other, finding a concern whether certain programs offered within our College of Liberal Arts provided students with training to prepare them for gainful employment in a recognized occupation. We have responded to both in great detail. We are currently waiting for an exit interview to be followed by a preliminary program review report. In which any preliminary findings of non-compliance would be presented. The review would conclude by issuance of a final program review determination letter.

Turning to the results of operations for the third quarter of 2010, we are pleased to report another solid quarter. Net revenues were $98.9 million in the third quarter of 2010, an increase of $32.8 million or 49.7% from $66.1 million in the prior-year period. Student enrollment, at the end of quarter three 2010, are approximately 42,300, an increase of 23.6% from approximately 34,200 at September 30, 2009. Excluding the impact of the $5.2 million litigation reserve, recorded in the third quarter of 2009, operating margin for third quarter 2010 was 22.4%, compared to 18% for the same period in 2009, net income was $12.9 million for the third quarter of 2010, compared to $7 million in the prior-year period, and after tax margin was 13.1% compared to 10.6% for the same period in 2009.

I would like it make two comments about student and revenue growth. First, the makeup of our student body has improved this quarter. Graduate students are approximately 46% of our online 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 expenses. 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 their higher retention and 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 nontraditional students attending online, to complete their bachelor's 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. Overall, operational improvements have led to an operating margin increase quarter-over-quarter. Instructional costs and services grew from $23.5 million in the third quarter of 2009, to $35.9 million in the third quarter of 2010. As a percent of revenue, instructional costs and services increase from 35.5% to 36.3% in quarter three 2010, primarily due to an increase in faculty compensation as a percentage of revenue. This increase was the result of committing to hiring more full-time faculty on ground and online, and to teach difficult courses with lower class size ratios.

Selling and promotional expense increased from $22.1 million in the third quarter of 2009, to $28.1 million in the third quarter of 2010. As a percent of net revenue, we had significant improvement of 5 percentage points from 33.4% in quarter two '09 to 28.4% in quarter three of 2010. This improvement reflects the maturation of our enrollment counselor work-force. Enrollment advising and promotional salaries, and related expenses as a percentage of revenues, decreased 500 basis points between periods. Advertising and revenue share, as a percent of net revenue decreased 80 basis points in the third quarter of 2010 versus the same period of 2009, primarily as a result of continued focus on attracting students in the right academic programs. Our Internet advertising has remained stable. Cost per inquiry has gone up slightly because of our desire to generate more graduate level students. Conversion rates of Internet generated inquiries have not materially changed. We have seen a decline in the productivity of our outside representatives. We have made an adjustment in the process and are anticipating improvements as a result.

General and administrative costs increase from $8.6 million in the third quarter of 2009 to $12.7 million in the third quarter of 2010, but, as a percentage of revenue declined from 12.9% in quarter three 2009 to 12.8% in quarter three of 2010. This improvement was primarily the result of a decline by 120 basis points in employee compensation and share based compensation. Bad debt expense as a percentage of revenue increased by 110 basis points, between the third quarter of 2009 and the third quarter of 2010, primarily due to a slightly higher amount of receivables becoming uncollectible, principally due to delays in financial aid processing as a result of our conversion from term-based financial aid to borrower-based. We anticipate bad debt expense as a percentage of revenue will remain slightly higher than we initially forecasted until the second quarter of 2011. As expected, we incurred higher legal costs in the third quarter of 2010. As a result of us incurring significant costs related to responding to the health committee's request for information. But this was offset by a decrease as a percentage of revenue of 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 $3.5 million in the third quarter of 2009 to $12.9 million in the third quarter of 2010, a 270% increase.

Our enrollment and financial guidance is as follows. For the fourth quarter fiscal year 2010, we expect enrollment to be between 43,000 and 45,000 students at December 31, 2010. We expect net revenue growth of approximately 34% to 37% to between $104 million and $106 million. We expect diluted net income per share will be between $0.31 and $0.33 per share. For the fiscal year 2011 our guidance is as follows. We expect enrollment to be between 51,600 and 54,000 students at December 31, 2011. We expect net revenues to be between $500 million and $510 million. We expect diluted net income per share will be in the range of $1.30 to $1.50 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 third quarter, talk about changes in the balance sheet, and fourth quarter and full-year 2011 guidance.

Thanks, Brian, our transition for certain students from three credit hour courses to four credit hour courses remains as planned. We have not adjusted our initial expectations for the number of students taking four credit hour courses for October 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 40.4%, which approximates our expected full-year effective tax rate of 40.6%. As a result of our financial and operational performance, we estimate that the total amount of federal and state taxes we will pay during 2010 will exceed the total costs of the government consisting of our student, student loan defaults and federal and state grants, including Pell Grants.

Turning to the balance sheet, total cash unrestricted and restricted grew to $106.3 million at September 30, 2010, from $74.1 million at June 30, 2010. Accounts receivable net of allowance for doubtful accounts is $32.7 million, which represents 32.9 days sales outstanding. Compared to $42.6 million, or 47.1 day sales outstanding at the end of the second quarter of 2010. CapEx in the third quarter of 2010 was approximately $17.2 million or 17.4% of net revenue. CapEx in the third quarter of 2010 was higher than we anticipated, as we spent more on computer equipment and internally used software than we had expected. CapEx in the third quarter for the ground-campus building projects met our expectations. These projects remained at or under budget. We anticipate CapEx as a percentage of revenue in the fourth quarter 2010 to be between 10% and 13% of revenue.

In terms of the legal environment, as has been previously disclosed, the United States has appealed the August 17, 2010, decision of the United States District Court for the State of Arizona, approving a settlement agreement between the University and the relator, in our qui tam suit. And the August 20, 2010, decision of the court to dismiss the matter with prejudice. The United States notice of appeal indicates that it intends to appeal, in its entirety, the court's overruling of the United States settlement objection, including provisions concerning the timing and method of the settlement payment, and the length of the release periods, as well as the inclusion of the administrative release. If the ninth circuit court rules in favor of the United States in respect of one or more of its objections, then the parties may agree to strike those provisions and amend the settlement agreement to satisfy such objections. Alternatively, we would have the option to abandon the proposed settlement and continue with our defense of the litigation.

On August 31, 2010, we received a comment letter from the Securities and Exchange Commission, related to various issues with respect to our 2010 public filing. The SEC letter included comments seeking explanations of some of our regulatory related disclosures. As well as questions regarding, for example, our institutional refund policy, our 2009 move to the day's approach of revenue recognition from our prior month's approach, and our Spring 2010 transition to BBAY. We responded to the SEC on September 13, 2010. Subsequently on October 4, 2010, we received a second comment letter, containing several follow-up questions, to which we responded on October 18, 2010. By letter dated October 21, 2010, the SEC informed us that it had completed its review of our filings and had no further comments. Based on this comment letter process the 10-Q that we filed today contains -- and future filings will contain, as appropriate, more detailed disclosure regarding some of the topics that the SEC commented upon. Including, for example, a more detailed explanation of the meaning of transitioning from a term based system to a BBAY which we believe will be helpful to investors. We are very pleased to have completed this comment-letter process without needing to amend any prior filings. These comment-letters and our responses will be publicly available in accordance with the SEC's normal comment-letter release process.

As it relates to our enrollment guidance for the fourth quarter of 2010, we have brought down our previously provided fourth quarter enrollment estimates as a result of higher numbers of students leaving the university during our transition from term-based financial aid to BBAY, than anticipated.

However, as a reminder the transition to BBAY, required us to change the method in which we count enrollments. As we discussed on the second quarter earnings call, 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 that this new method, generally, would have resulted in a decrease in the number of disclosed enrollments by between 2% and 5%. Using the mid-point of our enrollment guidance for the fourth quarter, our year-over-year enrollment growth under the new account methodology would be 20% to 24%. Our estimated revenue for the fourth quarter of 2010 will also be negatively impacted by increased scholarships as a percentage of revenue. As a higher percentage of our students qualified for academic scholarships than what we had forecasted. On the expense side as a result of our new student information system requiring us to do a lot more tasks manually, than what was thought, we have had to add additional head count. These additional costs are included in both our fourth quarter and 2011 guidance. We are working diligently with the maker of our new student information system to enhance their system, such that these additional heads can eventually be eliminated.

As it relates to 2011 guidance we have provided you our current estimates based on the information that is currently known to us. These estimates could change if information such as repayment rates by programs, entry level salaries, or average debt levels are significantly different than our expectations. These estimates do take into account additional costs we anticipate will be incurred during 2011, related to the new regulations that have recently been published. These additional costs include the following. As a result of the elimination of the Safe Harbors, we are currently in the process of revising our agreement with Mind Streams which currently calls for us to make payments of a percentage of the revenue received by us for students that they recruited on our behalf, to a cost per lead arrangement.

Although we believe that the new agreement will ultimately reduce the amount that we pay Mind Streams for leads that they generate for us, the costs will now be incurred up-front rather than over the period the student is enrolled. We also anticipate that prior to the effective date of the new regulations, it is likely that we will be required to buy-out the estimated remaining payments due under the existing agreement and will be charged to expense in future periods. We also have budgeted additional administrative costs associated with the compliance with the new requirements, contained in the regulations. As a result, we anticipate IC&S and G&A as a percentage of revenue to be flat to slightly up year-over-year. While we are anticipating S&P could be up as much as 150 basis points. Depending on the agreement with Mind Streams, and accounting for such. I will now turn the call over to the moderator, so that we can answer questions.

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

So Brian, I'm trying to understand better the strategy, to drive enrollment growth in the ground based campus. It sounds like a fairly heavy capital burden associated with building out the campus. And some pressure on revenue per student in the context of the scholarship program. So, why the focus on growing the ground campus, given that the returns there would seem to be less attractive than you can get elsewhere?

Yes the -- well first, the ground campus has always been the marketing engine that we intend will drive in the future, our online business. At 2,000 or 3,000 students, and being a small Christian college, you can't have much of an impact. But, if you have 6,000 to 7,000 students and you have a growing academic reputation in the Southwest, eventually, nationally. If you are able to go division one in athletics, and those kind of things, that creates for you an opportunity. Working adult students would still prefer to be attached to a traditional, strong, academic, ground campus than to be in a university that is for working adults only. So, that's been part of our core strategy from the beginning.

Secondly, the ground students are a great deal more profitable than we initially thought when we came here. The pressure -- we are not going to lower or significantly increase the amount of scholarships next year for our ground students. By offering the same amount, we are just being more competitive, because what the states can offer is not nearly as much as what they could offer in the past. The buildings we are building are easily being covered with the revenues that we are generating from the student body. Now, if our margin is 22% or 23%, that means we are probably making 27% or at 28% on our online students, and less than that on our ground students. But we think the benefits far outweigh the negatives.

In addition to that, when you are dealing with traditional students, when we eventually get to 6,000 or 7000, those are very helpful. Because they don't get as much up-front monies through title four, which means they have got to come out-of-pocket, which helps from the 90/10 standpoint. Number two, their retention levels are high and their graduation rates are high, their bad debt on -- or default rate on student loans are low and bad debt is low. And so, there is a real strong reasons both financially and from a market standpoint to have that strong ground campus.

Helpful. Thank you. And just one other thing. The 2,500 enrollment less than anticipated you cited due to the shift in the lending program. Was that meant to imply in the current quarter you were 2,500 below your current expectations?

Yes. They were mainly students that were students baccalaureate students in either business, or liberal arts. Who are the most at-risk students. Once they understood they were going to be in a borrower-based environment, and that the implications for their award from a financial aid standpoint was -- was clear to them, they decided to choose a different university. Which is okay for us, because those students weren't going to graduate eventually any way.

Thank you.

Yes.

Your next question comes from the line of James Stanford with Citigroup.

Thank you, guys. I wanted to dig in a little bit more in some of the operational changes you are making in the admissions-counselor side. It sounded like from the 10-Q you are looking at some inefficiencies at this point and it should take time for them to ramp up. Is that sort of what's going on here? Or any other issues related to regulatory changes you are preparing yourself for? Thank you.

Yes, no. It really -- right now, maybe 7% to 8% of our enrollment counselors are what we call outside enrollment counselors. Those are people who are working in states where we are approved, to be on the ground. And they are recruiting teachers into our masters's degrees programs. They are recruiting business professionals into our business programs. They are recruiting nurses into our nursing programs at the Master's level, and baccalaureate level. And we were seeing a decline in their productivity. And so, we made some tweaks in regards to the process, and we expect that we'll get improvement in that area. But no, that had nothing to do with the regulatory environment at all.

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

Good afternoon. A couple of questions the information regarding the 2011 estimates reflects company-specific operational challenges. Some of your competitors have described sector wide challenges, reputational advantage, the economy, lower demand specifically for educational programs. Are you seeing any of these three drivers for those companies? I guess, the first part of the question.

You know, no, we have been following that very closely and anticipated that question, and we've checked on that. We are not seeing -- it's certainly a more competitive environment than it was for example, five years ago. So, we would never discount that. We aren't seeing any real change from the standpoint of demand for teachers. To go back and earn their Master's degree and I know that was pointed out by another company. And we did some research into that, and we just haven't seen that, to this point. But we'll continue to monitor that. And obviously, that would be important for us to report, because that is a significant program for us. From a reputational damage standpoint, we really haven't seen that and I'm not discounting it. That has existed for others, and we are asking our people -- we meet with all our managers on a weekly basis and we are, that is one of the questions we are asking, if that is what they are hearing from students. But we really have not heard that to this point.

I guess the second, is to what extent have you baked in the potential this could occur, lets say that you'll see it in Q1 or Q2? I guess the question is, how conservative is the guidance, and does it reflect kind of potential challenges in the end market?

Well, it certainly -- what's baked in there is certainly the challenges that we expect to face, with the transition that we've made from term-base to borrower-base. Which there will be some challenges yet in the first two quarters, and his we've baked those in. So, it's conservative from that standpoint. We have baked in the changes that we have seen from the productivity of our outside sales representatives. Although we expect to get some improvement there. We have not really baked in anything from the standpoint of change with regards to reputation al damage, because we just haven't seen that yet. I think -- us being very close with the school districts where we recruit from and the hospitals we recruit nurses from, I think has helped us to some degree from incurring that problem.

And then the last question is, at this point in time, can you speak to the adjustments you made to your incentive compensation plan? Or what you are moving toward? And when you are implement it?

Yes, at a very high level, we can. We don't give the -- some of the specifics. But the -- our enrollment counselors will be on an evaluation plan that evaluates them on an annual basis. It will be the same kind -- it will be exactly the same form that is used by everyone of the other of our employees. And they get a salary adjustment. On an annual basis that has nothing to do with the number of students that they recruit. And so, I mean -- it's -- we've run it past our legal team and outside legal team. And feel confident that it contains what is necessary to be in compliance. And so, we feel good about it at this point.

Great. Thank you.

Your next question comes from the line of Sara Gubins with Merrill Lynch.

Thank you. Dan, in your last comment was around IC&S and SG&A to be flat to slightly up for a percentage of revenue. I'm just wondering, was that for the fourth quarter or for 2011?

That's our 2011 guidance.

Okay. You have in the past, given longer term guidance of 20% to 25% enrollment growth, and 25% to 27% operating margins. It doesn't look like that's in the cards for next year necessarily. But -- but I'm wondering if you think those are reasonable longer term targets?

Yes, absolutely. I think the challenge we are going to face from a margin perspective in 2011 is just the effect of the new, regulatory changes. Especially around -- as I talked about earlier, the Mind Stream buy-out. In effect, we'll be taking through our -- we are assuming, I mean it is early on. But, there is a possibility that we'll be taking expenses through our P&L, both for the new students that were -- that they are generating leads for. And then additionally, the students that they've recruited in past years. And so, that double hit will be reflected in 2011 and maybe potentially a little bit in 2012.

Any way to quantify how much that would be in 2011?

It's really early, because we haven't finalized the agreement. But, I would tell you it's most likely going to be somewhere between $0.10 and $0.15 a share.

Okay. In 2011, it looks like revenue per student will grow or you're expecting it to grow still probably above your tuition increases. And I'm wondering if you are going to continue to get a benefit from the shift toward the higher credit hour structure in 2011?

Yes, especially in the first half of the year. Not as much in the second half of the year. If you recall, roughly 25% of our students that were going to make the move had made the move by the end of the first quarter. 50% by the end of the second quarter and a little over 75% by the end of the third quarter. So, definitely in the first half of the year, and lesser in the second half.

Okay and then just last question, you have talked a bit about how the market's become more competitive over time. And I'm wondering how you really see that play out. Particularly if conversion rates haven't materially changed and it doesn't sound like lead costs were skyrocketing. So how do you see that playing out?

I can only speak to how it is going to play out for us. You know, every single move that we've made and we've made many, is focused on targeting good students and increasing retention rates. So you know, as we move forward, the fact that we haven't seen a decline from a lead and conversion standpoint is good news. Especially given that we have set ourselves up for next year to significantly increase the retention rates of our students. So, I think one, we didn't capitalize hugely on the counter cyclicality. Which is why I made that comment at the beginning, we kept our numbers relatively small. Given we want to make the 20% enrollment growth for three, four, five years out here.

Great thanks. And sorry, if I could sneak in one last one. Student start trends. I know you don't give the numbers. But could you just give us any update on how those trended last quarter and what you are expecting going forward?

They are within our expectations. They are going as about planned, especially in relationship to the way the programs we are starting them in.

I think the exception is as Brian said with the inside-outside. Productivity.

Okay. So you are anticipating growth clearly?

Yes.

Oh yes.

Okay. Thanks a lot.

Your next question come from the line of Jeff Silber with BMO Capital Market.

Thanks so much. I just wanted to clarify something, and forgive me, if you've mentioned this already. When you talked about the roughly 2,500 about student short-fall in the quarter, would that be attributable to the shift of the borrowing-base here? Did it have anything to do with the SIS snap-through? I'm just a little bit confused here.

They are related, but it had mostly to do with -- the shift to the borrower base. The SIS implementation was more difficult than we planned. But we don't think we lost a lot of students as a result of that. Maybe some. The biggest part of it was simply students who in the term-based environment, their financial aid was distributed in a certain way. When we transitioned to the borrower-based environment, things tighten up a lot more -- things tighten up significantly for students. There is not as much out-of-pocket or out of living expense money distributed.

And some students decided to go elsewhere as a result. And I don't want to get into a lot of detail with this. But, the problem with the term-based environment is that if you start at the end of a year, you can get awarded for an entire year and yet take very few classes. And that's legal in the, within the regulations. But, probably not the smartest thing from the standpoint of the students to do. Because there is an aggregate loan limit they will eventually reach and therefore not be able to complete their program. And so, this move, for us, we felt was extremely responsible from the standpoint of making sure that we're recruiting students who have access to funds, so that they can complete their programs.

So, was this more of an impact on enrolling new students? Or was this an impact on existing students that for whatever reason misunderstood what the impact would be?

It was both. But mainly existing students. It will curtail your new growth a little bit. But, we don't think for more than a couple months. This was mainly students already in the system.

Okay that's helpful. Shifting back to the regulatory environment. One of the issues in the program integrity report had to do with credit hour definition. Are there going to be any issues in terms of your move from a three to four credit hour courses? Is that within the definition under the new regs?

No, not at all. The shift that's from three to four credit was done in a very methodical way. It was done with HLC's oversight. No programmatic outcomes were removed at all. That were simply -- a simple way to explain it is rather than there be 43 credit hour courses to complete, 120-degree program -- 120 credit our hour program, there were 40 -- 34 credit hour courses.

The other thing Jeff, and I think you know this. But, our eight week for credit model is still slower, from a completion standpoint, than just about everybody else in the industry. Who primarily operate in five-week three credit format. So, our program still takes the students slightly longer than those other programs. But it's at least now in the ballpark, where it wasn't before.

Okay great. And just one final question. It's more of a shareholder issue. I know you have a share buyback in place it looked like you dipped your toe in the water last quarter. Some companies were a little bit more aggressive. We have some companies that have instituted dividends. I'm just wondering your thought processes around those two issues?

Yes, I think if it makes sense we'll buyback. What happened to us this quarter was we started buying back. And then, as you might recall. We got the good news from the Arizona courts. And so, being prudent, we stopped our buyback at that point until the market had fully digested that information. You know, I think our board is interested in buying back stock when it makes sense.

On a -- from a dividend standpoint, I don't think there are any current plans to issue dividends. I think that they believe that there are better uses of our cash right now, primarily the CapEx things that we have been talking about. And just investing in the business.

Okay great. And in CapEx, what are you looking for, for next year?

I think as we've talked about before, I think -- we'll remain kind of in that 10% to 13% level. At least through the first nine months of the year. And then, when we get to our fourth quarter, it will probably slow a little bit. The one -- additional item is that, given the fact that our dorms are now at 98% occupancy. And, the fact that we would like to add an additional 1,700 ground students for next year. I think we're going to have to look at adding an additional dorm for the following academic year. And so, I think -- that 10% to 13% is still a probably very good number.

Okay. Great, thanks so much.

Your next question comes from the line of Amy Junker with Robert W. Baird.

Hi, thanks. Just a follow-up on Jeff's question with cash flow. Can you talk a little bit about kind of your expectations for cash flow from operations in 2011? Should that grow roughly in line with net income or is there something that would impact that to make that grow faster or slower?

I think generally we think it should grow in line with net income. I think, as you've seen for the last two quarters, given our change to the borrower-based method, and the fact that restricted cash is obviously not treated in operating cash from a cash flow standpoint. You've got some year-over-year comparison issues. But that will work itself out over the first six months, or so. Of the year. And the after that, I think you will see it grow in line with net income.

And then just a quick follow-up on your comment on bad debt. You said that you expect it to remain kind of above your expectations through the first half. Can you just give us a little more color on where you think that willing be and what a more normalized level should be? Should we expect it to get back down towards kind of 5%? Or eventually -- or what are you thinking there?

Yes, I think, for probably the next six months, or so, you'll see it remain in the 5.5% to 6% level. And then, I think you should see it start trailing down. I think once we get out of this transition period, there's no reason to think that long-term our borrower based -- with the borrower based system that our bad debt you know can't be 4% or lower. So you know, those are our targets. And we absolutely think they are achievable. But I don't think you should expect to see them, at least until at the earliest the second half of 2011.

Perfect, thanks guys.

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

How are you guys doing?

Hey Bob.

Wanted to ask, it sounds like in the transition to the borrower based. You are getting rid of a lot of students who would leave on their own accord, based on what Brian was saying. So, are you expecting to get much better retention levels, going forward?

Yes, the answer is yes to a lot of things. Once you get into that environment, it becomes very clear to students right from the beginning that, number one, they are not going to get much more financial aid than is required to their tuition amounts. And so, that becomes clear. But the other thing that becomes clear is, that they have got to perform academically, real quickly or that they've got to come out of pocket for a class that they either withdraw from or fail. Because they have to finish 12 credit hours before they can get their second disbursement.

So, it should not only -- allow us to recruit better students, it should improve retention. It should decrease, like Dan said, over time, bad debt expense. It should help control cohort default rates, it should help with active repayment percentages. That move, even though it's been painful in the short run, should help with all those key metrics going forward.

So is this a shift or a change in the business model on how we should think about retention for you guys?

Yes. And I think it was partially reflected in the third quarter in this way. If we are successful, and this will be over the long run. Then what you should see, is not more growth than we are seeing. Which is low 20% from an inch enrollment standpoint. And tuition increases of 3% to 5%, so revenues of 24% to 25%. But, the impact should be on a decline in S&P, as a percent of revenue. Because we are not going to need as many new students. And you saw a little bit of that this quarter. Now it's going to go up a little bit at the beginning of this year because of our Mind Streams contract. But that would be a way for you to see that reflected in our, in our financials.

All right. That's really helpful. And I think this is directed more towards Dan. So your guidance is $1.30 to $1.50. But on the Mind share buyout, it sounds like that's for $0.10 to $0.15 per share. So, are you really saying your guidance range is really more than $1.40 to $1.65? When you take out the non-recurring?

No the $1.50 to $1.30 takes into account the Mind Stream. Oh well, I guess based on the way you said it, yes. We believe that, depending on how significant the Mind Stream buyout is will be -- that is why that range is pretty wide. So, I don't think I would say it is really $1.65 to $1.45. I think it's more about how significant ,and we just don't know, because the agreement hasn't even been finalized, how significant it is -- is it $0.10 a share? Is it $0.15 a share? Et cetera.

Okay, but it's going to be in the ballpark. So realistically, that is a nonrecurring item. So, your guidance which includes the impact of that buyout is probably higher on a recurring basis than it would otherwise be is that a fair statement?

Yes, that is correct.

And with that, I'm just curious. Why are you expensing the cost to buyout Mind share? Why don't you capitalize it?

You know again, I don't want to get too much into this. Because we haven't even written an accounting memo on it. But I wanted to -- we wanted to give you guys a first look at 2011 guidance. But, my preliminary thoughts on how the accounting would be is you would to set it -- similar to what we did with the institute buyout, if you remember that. We would set up at least a portion of the buyout as a prepaid expense and have to amortize that prepaid expense into earnings over a period of time.

So, to go back to our institute buyout, the same exact thing occurred. We'll carve it out for you. In our -- probably in our adjusted EBITDA. So, you see what that effect of that buyout is on our earnings. But it still will go through our income statement. That is why we had to put it into our EPS guidance.

That's really helpful and it's obviously a material amount. Are there any other non-reoccurring one time charges that are reflected in your $1.30 to $1.50 guidance that will go away, once you transition to BBAY?

I don't think that there is any I would say non-recurring. The significant costs, are obviously, that one. And the second one is higher administrative costs that we believe we will have to occur to follow the new regulations. Those are legal, those are accounting, those are financial aid, et cetera. I would not call those non-recurring. Those will most likely be recurring. But I do think that -- we'll have to staff-up significantly in the near term. And then those costs might decrease in the long-term.

So essentially the quality of your earnings will go up because the quality and retention of your students are getting better. And the guidance you gave the street is probably distorted to the downside a little bit because of this large nonrecurring charge, fair assessment?

I guess so.

Alright, thanks a lot.

Thank you Bob.

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

Thanks. Can you talk in a little bit more detail about these kind of IT execution issues that you've experienced as a result of this borrower-based transition? What exactly has gone on there? And I know, you implemented this campus view thing last year, are you going to have to scrap that? Are you going to have incremental investments to do this? Kind of a little more color on that would be great.

No, we're not going to scrap it. That is our back-end student record keeping system now. And for the way that we are going to use it, in time, it will be fine. But we are going to have to build additional software. Which allows our front-end academic and financial counselors to do their work, in a system outside of that one. And then we'll transport data from that system into Campus View.

That is something it is basically the same thing we did at Apollo. We built some student scheduling systems, and some systems outside, that made it really easy for our counselors to do work with students. And then transported that data into the back-end system. So, it's probably going to take us about six months to build that scheduling system, which is most important. But, no we are not scrapping the system we are staying with the system. And anybody, by the way, that buys or purchases of that system in the future is going to benefit hugely from this work we've gone through. Because we are basically making it possible now to be able to use that system in a borrower-based environment.

I think it's a lot of what Brian and I said. I mean I think we had to do a lot of manual processes outside of the system to make it work under the borrower-based non-term financial aid regulation. That we assumed we were going to be able to do within the system. And so, I think that's the biggest effect, in terms of focus of our counselors. And being forced to hire additional head count was just a lot greater than what we anticipated.

Okay. And how much is it going to cost to make these changes? To your system?

From a CapEx standpoint?

Yes.

I mean -- I think we've always said -- and I don't think this is changing, that we expect to spend 5%, roughly, of our revenues on internal use software enhancement projects. I don't think that that's changed.

Okay great. And then, did -- is it fair to say this part of, I guess, your execution issued this quarter impacted starts? I mean the technology problem had a bigger impacts on starts than it did on retention?

No. No. It didn't have a huge impact on starts at all. Any impact on starts would be -- and it was minimal, would be the borrower-based environment. Because students just realized that this is a different -- era now. And that so, it would -- may have a small, borrower base had a small impact on starts. The technology problem had hardly any impact, although it did have some impact on retention.

Okay. And then, as far as the borrower based impact, I think you pretty much said this. But I want to make sure I'm paraphrasing accurately. Is it fair to say what's going on here is that previously certain students were liking the fact that they could borrow a lot of living expenses money? And now, that's not possible, so those that were only there for that reason aren't coming any more? Or are dropping out?

Yes -- it -- we -- our first six motive at Grand Canyon, having come from Apollo in a borrower-based environment, we saw students doing some things we didn't understand. There were some strange behaviors. And so, when we looked into it, it was directly associated with being in a term-based environment from financial aid standpoint. We figured out what it was, but it takes awhile. You have to -- transitioning to that environment, causes you to have to completely redo, really everything associated with bringing a student in for the first time. And then you've got to go through the complete technology change. So -- but your assessment of why those students dropped is correct.

Yes, one thing that Brian mentioned. One of the components of the difference between term-based and borrower-based I think he briefly mentioned this is that students have to complete with passing grades their three courses, 12 credits before they can get their next disbursement. In a term-based environment, a student could flunk a course or withdraw from a course, and move onto the next semester. And borrow money in effect to retake that same course or to take other courses. In a borrower-based environment if the student withdraws from a course or fails a course, they have to come out of pocket to retake that course before they can get their next disbursement. That way, they have enough funding for all 120 credits. Because, if you flunk a course and you use financial, additional financial aid dollars to pay for that course again, you are going to run out of financial aid before you get to 120 credits.

Okay. That makes sense. Thanks for taking those.

Your final question comes from the line of Tom Dillon with William Blair & Co.

Hey guys, couple of quick ones. Have you made any changes to the types of key words you are buying or the legend companies you are using?

Not really. We have expanded significantly our faith-based marketing department with partnerships. But, no we haven't changed things significantly.

Okay. And, are you still can't if I dent you can keep master's mix of 40% over the next say two years, given all the competition in your sector?

Given the numbers we need yes. But I would qualify that in one way. We are working hard in our tweaks in faculty model to get higher level of retention of baccalaureate students. So, if over the course of the next two years, some of that is successful, then it would tweak a little bit. But that would be a tweak that would be a good tweak. We won't worry about that. So, we don't -- we are not worried about reaching right now a ceiling in terms of those graduate students. But we are working hard at higher persistence rates of baccalaureate students and if that happens, then it's good.

Okay. That's helpful, thank you.

Alright. Thank you. We have reached the end of our third quarter conference call, we appreciate your time and interest in Grand Canyon Education. If you still have questions contacted Dan Bachus or Bill Jenkins. Thank you again.

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