Grand Canyon Education Inc (LOPE) 2011 Q3 法說會逐字稿

Good afternoon. My name is Christina and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter 2011 Grand Canyon Education earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) I would now like to turn the call over to Christopher Richardson, Director and General Counsel for Grand Canyon Education. You may begin, sir.

Thank you, operator. Good afternoon and thank you for joining us today on this conference call to discuss Grand Canyon Education's 2011 third quarter results. Speaking on today's call are Brian Mueller, our Chief Executive Officer, and Dan Bachus, our Chief Financial Officer. 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 its 10-K report for its fiscal year ended December 31, 2010, its subsequent 10-Q reports and its current reports on Form 8-K each as amended 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 on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K, each as amended, filed with the SEC before taking a financial position in our Company. And with that, I will turn the call over to Dan Bachus, our CFO.

Thanks, Chris. Today, in addition to announcing our results for the third quarter of 2011, we announced in our 8-K that we have restated certain previously issued financial statements. The restatement resulted from a decision we made in connection with the review of our third-quarter 2011 results to change our methodology relating to the manner in which we estimate our allowance for doubtful accounts. We record an allowance for doubtful accounts for estimated losses resulting from the inability, failure or refusal of our students to make required payments. We determine the adequacy of our allowance for doubtful accounts based on analysis of our historical bad debt experience, current economic trends and the aging of the accounts receivable. We apply reserves to our receivables based upon an estimate of the risks presented by the age of the receivables.

We believe that this policy is the best way to predict the ultimate outcome of our receivables that will go uncollected as our receivable balances are made up of a large number of small balances and we also believe that this policy conforms to industry practice. We have historically written off accounts receivable at the earlier of the time the balance is being deemed uncollectible or one year after the revenue is generated.

We monitor our collections and write-off experience to assess whether adjustments are necessary. While we continually refine our estimation process in the ordinary course, our general approach to estimating the allowance for doubtful accounts has remained the same since we went public in November 2008. As part of our process of analyzing our reserve balance at September 30, 2011, management for the first time determined it was appropriate to disaggregate our accounts receivable balances based on each student's school status as of September 30, 2011 each of the prior quarter ends between June 30, 2010, the quarter we transitioned to a borrower-based, non-term, or a BBAY financial aid system and June 30, 2011.

In initiating this review, we had noted that there had been an increase in the more mature receivables over the past few quarters. Once we have disaggregated our accounts receivable balances, we noted a significant change in the composition of our receivable balances since our transition to BBAY in which the receivables due from former students had grown as a percentage of the total amount outstanding during this period. We believe that this is a result of several factors. First, under BBAY, the student must generally complete 2 of the courses in a payment period to earn the full financial award, as opposed to just a single course under the term-based module approach, and as a result, we have experienced an increase in the Title IV program funds that need to be returned to lenders or the Department of Ed. Second, we have historically been successful in collecting receivables, including those due from former students as a result of the return to Title IV requirement, because the amount owed by a particular student that is in excess of the amount of financial aid that the student earned and that we are entitled to retain is often quite small. Due primarily to the ongoing economic conditions, we believe that the level of motivation that former students have to pay off their balances due to us, based on such factors as being able to receive their transcripts or protecting their credit, has lessened over time.

On the other hand, we have implemented a number of operational changes during the past twelve months that have resulted in more timely collections of balances due from active students. As our collection history over the past year demonstrated that receivables due from former students are now becoming much more likely to go uncollected, we concluded that our allowance for doubtful accounts needed to be adjusted. Thus, we have changed our allowance calculation methodology such that receivables due from former students are treated as a separate pool and are fully reserved for and written off in a much more accelerated timeframe. The methodology for reserving for receivables due from current students remains similar to our prior methodology given that we have not seen a change in the payment patterns for this pool of students. We continue to reflect accounts receivable with an offsetting allowance as long as management believes there is a reasonable possibility of collection. Bad debt expense is recorded as an instructional costs and services expense in the income statement.

Because our former students did not previously exhibit this collection behavior, the historical reserve process that we had implemented and followed in prior periods, do not include taking the additional steps that are necessary to disaggregate our receivable balances by students based on the enrollment status. As a result of our new analysis however, it now appears that this disaggregated information is particularly relevant in determining the probability of loss, and if it had been more readily available to us, could have been used to detect the change in the behavior of our former students that manifested in the latter half of 2010 and in 2011. So even though we had been following an accepted methodology for estimating our allowance for doubtful accounts since our IPO three years ago, it was nevertheless determined that viewed in hindsight, this change in methodology required a restatement.

Accordingly, the audit committee of the Board of Directors of the Company, together with management and in consultation with Ernst & Young LLP, the Company's independent registered public accounting firm, determined on November 3, 2011, that because we could have taken the additional steps necessary to develop and disaggregate the information for use in the analysis of our reserve requirements, and resulting allowances for 2010, 2011, the financial statements for the fiscal year ended December 31, 2010, and the fiscal quarters ended March 31, 2011, and June 30, 2011, should not be relied upon and should be restated to reflect the new allowance calculation methodology.

The Company expects to file its amended annual report on Form 10-K for the year ended December 31, 2010, its amended quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2011 and its amended quarterly report on Form 10-Q for the fiscal quarter ended June 30, 2011, each of which will include the applicable restated financial statements and related disclosures, shortly before and concurrently with the filing of its quarterly report on Form 10-Q for the quarter ended September 30, 2011. We expect to file our quarterly report on Form 10-Q for the fiscal quarter that ended September 30, 2011, on a timely basis on or prior to Wednesday, November 9, 2011. The Company is still working with its auditors to evaluate the level of internal control deficiency and any other issues that the restatement raised and expects to report on its conclusion in its quarterly report on Form 10-Q for the fiscal quarter ended September 30, 2011, and in the amended filings referenced above as applicable.

We believe that addressing this change in methodology as a restatement will be helpful to our investors in a number of ways. First, the new methodology reflects a more conservative approach to estimating our allowance for doubtful accounts which is the only significant estimate on our balance sheet with minimal effect on current and future earnings. Second, it provides much better clarity regarding the trend of our collections experience. By pushing back the methodology change to the second quarter 2010, readers of our financial statements can analyze our financial statements using the methodology developed in the third quarter 2011 on a consistent basis to prior periods. The amounts that will be discussed by both Brian and I in this earnings call will be the as restated numbers. With that, I will turn the call over to Brian.

Thank you Dan. Good afternoon. Thank you for joining Grand Canyon University's third quarter fiscal year 2011 conference call. We are excited about the academic enrollment and financial results of the quarter and the positive direction the university is headed. Our online working adult new student starts for third quarter of 2011 are up year-over-year in the mid-single digits and we expect this trend to continue. Our total enrollment count is up 5.2%, although this is somewhat misleading in that it was impacted significantly by the timing of graduates between years. Our unique students attending class in September 2011 was up 8.8%. Revenue grew by 10% and EPS grew by 26.1%. As we have said previously, it is our intent to compete in this industry as a traditional university with a vibrant and fast-growing ground traditional campus. It also has working adult students attending online.

Our traditional ground campus started this fall semester with approximately 4,000 students whose average incoming GPAs are about 3.4. Our goal is to start 4,000 new ground students each year for the next three years which would bring our total enrollment on ground to approximately 12,000 students. It is important to note, that the average annual revenue produced by a ground student is about the same as the average annual revenue of a working adult student attending online. However, our traditional ground students pay approximately 60% less than traditional students at most private universities and pay approximately the same amount as a heavily tax-subsidized state university student.

With 12,000 ground students on our campus by 2015, we would be in the same size of student body category as Baylor University in Texas, Marquette University in Wisconsin, or Villanova University in Pennsylvania. This is very important from a brand perspective. It is also important from a financial perspective because traditional ground students have extremely high retention rates and very low acquisition costs. We currently have 3,737 applications for the fall of 2012 and we believe we are currently on pace based on several metrics to reach 4,000 new student goal for 2012. Our new on-campus arena was completed in September and has really helped raise the visibility and image of the University. We have had 4 major concerts, a major speaking event and will have 3 additional concerts, and a nationally televised ice show before the end of the year.

Our men's basketball team opened the season by playing the highly regarded University of Oregon team to a 7-point game in Eugene. Our men opened at our arena this past Saturday to a sold-out game against across-town rival Arizona State University. The team was very competitive and within 6 points with eight minutes to go. This is important because it helps us position the University at a higher level as an institution, especially in the Southwest part of the country. An outside study calculated the PR impact of the arena media coverage to this point to be worth $2.5 million in equivalent advertising dollars.

The composition of our online working adult student body is important to our strategy. Our masters and doctoral students, as a percentage of the total, went down from 45.8% in the third quarter of last year to 43% this year, and our College of Education students went down from 48.7% to 44.6%. This was offset by our College of Nursing, our highest retaining students, going from 19.1% last year to 24.8% this year, and our traditional ground students going from approximately 2,700 total students last year to approximately 4,000 total students this year. Our College of Business online students, who have our lowest retention percentages and highest default rates, continued to decline going from 17.7% to 15.3%. Our new online student numbers have been flat or down for awhile. As said previous, this trend is now going in a positive direction. Our total student growth has been the result of recruiting students into higher retention programs and increasing our overall retention numbers as a result.

Our student acquisition costs have remained flat. Our conversion rate on inquiries outside Arizona and the Southwest has gone down. This has been offset by the conversion rate of inquiries being 3 times the rate inside Arizona and nearly 2 times the rate in other cities in the Southwest. We believe this reflects the growing strength of our traditional campus brand. I would like to mention 4 things that continue to boost the growing academic brand of University. First, the average incoming GPAs of our ground students continues to go up. Second, we are now rolling out our LoudCloud Learning Management System to our online students. We believe this system has functionality and analytics that make it the best system in the industry today. This system has already been sold into a large K-12 school district and we are working on other K-12 districts as well. When the system is implemented into a K-12 district, it will be branded as Grand Canyon University System, increasing our exposure to high school students and K-12 teachers and administrators. Third, we continue to hire full-time online faculty so that in most of our online programs, the first 3 courses are taught by full-time faculty members instead of an adjunct. The increased faculty costs have, to this point, been offset by increased retention percentages. Fourth, the pass rate of our pre-licensure nurses on the NCLEX Exam which is a post-graduate national exam nurses must pass to get their license, is a 100% pass rate so far this year for the August graduates. The FNP, which is a national certification that is necessary to practice at an advanced level, is also at 100% pass rate. Anything about 80% is acceptable but 100% is exceptional in both exams.

Turning to the results of operations for the third quarter of 2011, net revenues were $108.9 million in the third quarter of 2011, an increase of $10 million for 10.1%, from $98.9 million in the prior-year period. Operating margin for Q3 2011 was 19% compared to 18.7% for the same period in 2010. Net income was $12.9 million for the third quarter of 2011, compared to $10.7 million in the prior year period, and after-tax margin was 11.8% compared to 10.9% for the same period in 2010. Instructional costs and services grew from $45.7 million in the third quarter of 2010 to $48.9 million in the third quarter of 2011. As a percent of revenue, IC&S decreased from 46.2% to 44.9%. Bad debt expense, as a percent of revenue, decreased 100 basis points between years, while employee compensation and related expenses increased 80 basis points and faculty compensation decreased 70 basis points between the third quarter of 2010 and the third quarter of 2011. We anticipate debt expense as a percentage of revenue will decrease in the fourth quarter of 2011 and for fiscal year 2012.

Selling and promotional expense increased from $28.1 million in the third quarter of 2010 to $31.2 million in the third quarter of 2011. Selling and promotional expense, as a percent of net revenue, increased 29 basis points from 28.4% in Q3 2010 to 28.7% in Q3 2011. Enrollment advising and promotional salaries and related expenses, as a percentage of revenue, increased 210 basis points between periods, because we used the second and third quarters to increase our enrollment staff to the appropriate levels. Advertising, as a percent of net revenue, decreased 50 basis points between the third quarter of 2010 and the third quarter of 2011, primarily due to the termination of the revenue share arrangement with Mind Streams. Overall, our advertising costs have remained stable. General and administrative costs increased from $6.6 million in the third quarter of 2010 to $7.1 million in the third quarter of 2011 and as a percentage of revenue, decreased from 6.7% in Q3 2010 to 6.6% in Q3 2011. As a result of the above, net income increased from $10.7 million in the third quarter of 2010 to $12.9 million in the third quarter of 2011.

Our guidance for the fourth quarter of 2011 is the following. Revenue will be between $112 million and $116 million. Our targeted operating margin is 18.5% and our targeted adjusted EBITDA margin is 25% for the fourth quarter of 2011. As it relates to 2012, we have not completed our budgeting process for 2012 so we are not in a position to release guidance. However, we anticipate our guidance will be within our three-year goals of 8% to 12% enrollment growth, 11% to 15% revenue growth, and margin expansion on an annual basis of 100 basis points to 200 basis points. With that, I would like to turn it over to Dan Bachus, our CFO, to give you a little more color on our 2011 quarter, talk about changes in the income statement, balance sheet and other items.

Thanks Brian. Scholarships, as a percentage of revenue, increased from 12.8% in Q3 2010 to 13.5% in Q3 2011, primarily due to the growth in the ground traditional campus. Our effective tax rate for the third quarter of 2011 was 37.2%, excluding certain non-recurring tax items that had the effect of decreasing our effective tax rate during the quarter, our effective tax rate would have been 40.3%. Other than a very small purchase made at the beginning of the quarter, as part of the 10b5-1 plan, we did not repurchase any shares of our common stock during the quarter. Thus, we still have $26.8 million available under our authorizations.

Turning to the balance sheet and cash flows, total cash, unrestricted and restricted at September 30, 2011, was $66.7 million. We have a revolving line of credit for $50 million; no amounts have been drawn as of September 30, 2011. Accounts receivable net of the allowance for doubtful accounts is $16.3 million at September 30, 2011, which represents 14.4 days sales outstanding compared to $19.6 million or 19.7 days sales outstanding at the end of the third quarter 2010. CapEx in the third quarter of 2011 was approximately $23.2 million, or 21.3% of net revenue. The 2010/2011 ground campus building projects were completed at or under budget other than some unanticipated costs incurred for site work at the arena. We anticipate CapEx, as a percentage of revenue, in 2011 to be between 15% and 17%.

In late 2011 we will begin construction on a fifth residence hall and a new Arts & Health Sciences classroom building to meet the demand for our Health Sciences programs. Last month, our Board approved plans to build our first parking garage on campus. This cost of this garage will be approximately $14 million. We have the option to sell this garage and rights to all other parking on campus to an outside investor and we would enter into a master lease with that investor. We're currently analyzing this option. We anticipate total CapEx, as a percentage of revenue, will be between 12% and 15% in 2012, including the parking garage. I will now turn the call over to the moderator so that we can answer questions.

(Operator Instructions) Peter Appert with Piper Jaffray.

Thanks. So because you don't report the exact starts and persistence, a little bit harder to judge the flow-through of the starts numbers you guys were referencing into enrollment. So can you give us some color on how you see the enrollment numbers trending over the next couple of quarters? Brian, [absence] in the context through your comment on the positive start numbers you are expecting.

Yes, I think you can anticipate that total enrollment will be somewhere between 7% and 9% and revenues will be approximately 2% to 4% higher than that.

Got it. So that would imply, therefore, I think, that the third quarter or fourth quarter of '11 is probably the trough in terms of the year-to-year enrollment comps? Is that fair?

Well, two things are happening. One, we have been flat or down in terms of new enrollments for awhile. And so this does represent a trough from the new enrollment perspective. The second thing that is happening is as we move our student body and have less undergraduate business students and more nursing students and more traditional ground students, retention is picking up a little bit. So those two things combined would suggest that there is somewhat of a trough there, yes.

And the only other thing I would add, is that one challenge from an enrollment standpoint that we obviously have is with such a high percentage of our students in masters programs, masters students are really at the University between 15 months and 18 months. And so, unlike others in the sector, even those that have very large graduate populations, our graduate populations of students is with us only 15 months to 18 months.

And then, Dan, just to be clear on the restatement around the bad debt expense. I haven't been able to get through the whole release. Basically, no cash charge associated with this; correct?

That's correct. Just a change in methodology on how we calculate our allowance for doubtful accounts. As I mentioned before, the general concept before was we reserve for our accounts over a one-year period, fairly ratably. Now that we have disaggregated our receivables, we are reserving for those inactive receivables over a much shorter period than a year. And then the, obviously, the active receivables, it remains generally over a year period.

But it would be fair to expect then the, well, not so much bad debt expense, but specific charges against bad debt, presumably are at somewhat higher levels over the next several quarters then they have been historically, pre-the restatement.

Pre-the restatement, that is correct. But what you should see is because of all the operational changes that we have made, what you are seeing, if you look at the restated numbers, is our bad debt expense actually trend down. And that frankly, was one of the reasons we started digging really deep into our allowance is that, we have made just some really good strides on the collection side here, over the last 12 months, but as you know, our bad debt has been trending up. And so this quarter, we really, really pulled apart all components of what makes up our accounts receivables. And that is where we found the challenges that really just started around the time we went to borrower-based.

Okay. Thanks Dan.

Sara Gubins with Bank of America Merrill Lynch.

Hi thank you. Could you talk a bit more about what you are seeing in the education segment? It sounds like that's down.

Yes, that is down some. And I know that there is a lot of concern about that, because of two things. One, there's a lot of competition for those students, because they are good students. And secondly, there is some doubt in some areas as to whether a master's degree will mean the same thing that it used to be. So we have been saying for a couple quarters, that it's possible that those master students in education could be down some and they are. Although that is still a very strong part of our student body. What's fortunate for us, is that ground students operate even in a superior way from a retention standpoint. We've got a lot of runway with that over the next three years as well as a tremendous amount of runway with our nursing programs, especially the RN to BSN program. So, if we experienced somewhat of a downward trend with the education students, we believe we can replace them with the other students.

Okay, great. Thank you.

James Samford with Citigroup.

Thank you. Just wanted to touch on, it sounds like the arena is finished now. You're starting to get some feedback as to how that might impact the new enrollment. What's -- how should we think about student acquisition costs over time, once this starts to have a larger impact? Are you still going to have to reach the online community in a more traditional online marketing way?

To this point, yes, although we are gradually moving in a direction of more traditional media. You can see a big difference between the way we [acquire] inquiries outside of the Southwest versus the way we acquire inquiries in Arizona. In Arizona, about 50% of our inquiries come as a result of Internet lead-generating activities and the rest comes from people attending our campus, coming onto our campus or attendance at a concert in arena or referrals, that thing. So we are going to continue to move gradually our marketing to the Southwest, with the exception of a couple of key areas where we have got our brand has been built up over time. So I would not expect that we can make significant progress in 2012. I would expect that it is still going to be 28% or 29%. However, we do have some potential for it to go under that, I think in 2013 and beyond.

Great, thanks. I will hop back in queue.

Kelly Flynn with Credit Suisse.

Thanks. A couple questions. Just starting with the bad debt. I just want to make sure these numbers are right. Is it right that the bad debt ratio is 8.8% in the third quarter and it was 9.8% here in the third quarter?

That's correct.

Okay. And then what about for the second quarter? I think you guys had reported, what, 7.2% maybe last quarter and what is the restated level for that?

Actually, Kelly, all of the numbers are in the 8-K filing. (multiple speakers)

Yes, I know but I just -- you reported it at 4.30 PM. So I just want to make sure.

Yes, yes, I'm sorry. There was a little glitch on that getting out but I can calculate it for you. Maybe ask your other question and I'll get you that as you asked.

Just is related to that, I know that it is down year-over-year. What should we expect going forward? I know you are not giving fiscal '12 guidance. But should we expect it to be somewhere between 8% and 9% going forward or is there an opportunity to reduce it further?

No, we actually believe it should be long-term in the 5% to 7% range. And we think we can get into that range over the next 12 months. Doing the restatement as we did, it will help us do that. It put all of those receivables that were created around the time we went to borrower-based and for the six months or so after going to borrower-based behind us. We are obviously using a much more aggressive reserving methodology going forward as well. But what we are seeing from a trend standpoint is that receivables are much less than they were before. So if you look at our inactive receivables that are 30 days, 60 days, 90 days from today, they're almost one-half of what they were six months and up to a year prior.

So I think the University went through this transition when we borrower based from term-based. And obviously, there were a lot of negative ramifications from a financial standpoint from that but clearly, we all believe it is the right decision for the long-term of the University. And I think now the students we're recruiting understand what stipend they're going to get and what their requirements are to stay enrolled in a borrower-based institution and they are doing a much better job of that. So I -- no, I still think 5% to 7% is the right percent.

Now again, the question I get a lot from investors is why are our -- is our bad debt higher than the other institutions that are borrower-based? And one of the disadvantages we have is that we have low tuition rates and so students get a stipend check here at all levels, or living expense check at all levels. And when they drop out, we have to do a return to lender and that return to lender is not just for the tuition, but that is also -- we have to return a portion of the money that the student got for living expenses, and then we have to go after the student to collect that. And that has proven to be harder given the economy today than it has been in the past.

Okay, great. And second question (technical difficulty) I just want to make sure that what you said about starts as far as mid-single-digit growth, is that on the same basis as what you said last quarter when you said [they sell]? I mean, you called out today online working adults. I mean, are we talking about the same pool of starts here? The same pool that [stalls] year-over-year in the second quarter?

Yes. And that's why I said it that way. I didn't want to confuse the hyper growth that is going to take place on the ground campus with what we are doing online. And so, when I said mid-single digits, that was for online working adult students.

Okay. And then it looks like --

Kelly, real quick -- back to your first question. It was 8%.

Okay, thanks. Sorry I asked that.

No.

Just on the starts, obviously, you -- it said you showed a positive turning point in the online working adult starts [to settle] in the second quarter and now they're up this quarter. Can you talk about, Brian, what are the things that are changing for the better in the marketplace? I mean, is it things that you are seeing out there broadly, or are there some Company-specific things? Thanks.

Well, I think the first thing is us, like other companies, us not as much, was hit by a little bit of counter-cyclicality. So the comps have become easier, starting in this third quarter so obviously, that helps us. I think the second thing is that our brand is absolutely having an impact in Arizona. That is a big part of our most recent success. We went from a little under 10% of our online students being from Arizona now to over 20% of our online students being from Arizona. And if you think about the number of working adult students that are going to school in Arizona and the Southwest, we still have a very small share of that marketplace. And so we believe that, that will continue for us far while.

Okay, great. Thanks a lot guys.

Amy Junker with Robert W. Baird.

Hi, thanks. If we can just dig in a little bit to the operating margins. There's a couple of pieces here, let me lay them out and then I will let you talk, Dan. But I guess the margins came in a bit higher than what you were looking for. And at least the guidance, compared to what we were maybe looking for, is maybe a little bit light for 4Q. I'm wondering if you can talk through the trends that you are seeing there. If any expenses were pushed out from third quarter to fourth quarter. And then also, just the impact of the restatement, what that has on 4Q.

Great questions, Amy. The trend, well, yes, the answer to your question is yes. As we talked about in last quarter, we have started aggressively hiring enrollment counselors, primarily on the -- for the ground campus. Not all of those were hired at the beginning of the third quarter. Some of them came in to the middle of the third quarter and so that is one piece. The other piece, and maybe this is just me being a little conservative, but we opened our arena at the end of the third quarter and there's operating costs, depreciation expense, and others associated with that. And so there is also revenue that will be generated because of it. But I think until we have some experience under our belt for running the arena and the operating costs associated with it, I thought it was better to be conservative on the margin side.

Great, that's helpful. Thanks.

Paul Condra with BMO Capital Markets.

Hi, thank you. I just wanted to return to the bad debt again. Just the improvement that you mentioned you're expecting over the next year or so, are you looking at that to come mostly from burning through those older balances? Or is that is just focused on more your current students? Thanks.

No, it's more on the current students. As I said, with this restatement, we have done a really good job of burning through the historical balances. It is just more about what we are seeing in current trends, both on the inactive student balances and also the active student balances. And so, if the trend holds where they are right now, there is no reason to think that we won't be in the more like 7% or even high 6% level in 2012. And then one other piece to throw in there, when we talk about going out. The difference between our online student body bad debt expense, as a percentage of revenue and our ground, is significant. And the bigger the ground campus becomes, that alone will drive down our bad debt expense as a percentage of revenue.

And then just one follow-up on the ground campus. How do you think about capacity there? And is there a minimum student body you need there to make that profitable? Thanks.

Well, it's profitable now and becoming increasingly so. You have to think about it this way. It costs us less to acquire a ground student than it does an online student. Our best online students stay for between 30 credits and 39 credits. And we have very high retention rates of our ground students. And so if you think of 4,000 new, three consecutive years, and what they will be as a percent of the overall student body, think of their high retention rates, same average revenues, low bad debt expense, low acquisition cost, and those will, over time, become our most profitable students. And so that is one of the reasons we are so interested in growing that student body in addition to the branding impact that it will have. At 12,000 students, we've got enough land for 12,000 students. We have got the CapEx already built in to build the additional classrooms and dorms. And so, we are comfortable with the 12,000 number.

Now what typically happens to a University with 12,000 undergraduate traditional students, is that you start to build a sizable graduate traditional -- student body. If you look at Villanovas and the Marquettes and the DePauls, typically you're going to have another 3,000 graduate students or 4,000 graduate students, people who leave their undergraduate program and go right into a graduate program and stay with you. Most of those students will live off campus; we haven't put those really in our budget at this point but that would be [gravy] if it happens. And we think we have enough room for that additional 3,000 students as well, because most of those won't live on campus.

Thank you.

Brandon Dobell with William Blair.

Thanks. Guys, I want to go back to your longer-term comments for a second in the context of Dan, what you just talked about with the bad debt opportunities. If you guys are talking 100 basis points to 200 basis points, as a three-year plan, and yet, Dan, it sounded like you're talking a couple of hundred basis points, just in bad debt improvement over the next 12 months? So I'm trying to get at what assumptions we could should making about, I guess, let's call it, margin leverage in the core business, excluding bad debt. It sounds like you're not expecting an awful lot of leverage outside of just improvements in bad debt as you think about the 2012, 2013 timeframe. Or how am I thinking about that the wrong way?

No, I think you are thinking about it the right way, but -- and we have had long discussions about this. We are trying to be conservative from this standpoint. Things are obviously changing in this industry from the standpoint of acquiring students. If you look back a couple of quarters ago, we were at 30% of revenues to acquire students and now we're at 28.5%. So the assumption would be, if we keep getting better that would stay the same or maybe go down a little but that's just not what is happening everywhere else except with our particular business model. And so we haven't really factored in that improvement, which could very well happen.

And Brandon, I think you caught this, but we are talking 100 basis points to 200 basis points each year.

Right, right.

I just wanted to make sure you --

Got you. Okay. And then I think last quarter you guys talked about in context a different programmatic, I guess, issues with growth. Are you still seeing the same or are you being somewhat proactive in trying to drive down certain types of programs, just because the nature of the students? Or have you started, I guess, to not be, or to focus your attention really on only specific parts of the degree mix to grow programs? I guess what I'm trying to get at whether or not you are really shying away from a couple of specific programs or if you think you have got them down to a spot in the enrollment mix that you'd be okay with, like business, liberal arts and those things.

Well, we're definitely doing that by design and we have been for over a year. If you think back a year, even 18 months ago, we had doubled the number of enrollment counselors who were recruiting undergraduate business and liberal arts students. That has now been cut in half. So could we have had more total students now than we have had in the past? Yes, we could, but we just were cutting back that, because in spite of improvements we're making, they are not going to get better than a 35% or 40% graduation rate with those students. Now, that is double what community colleges get and we can be profitable. But we prefer where we can to get those students in the other areas. And we really think that in the next three years, because of the tailwind we have with regards to our ground students, and because we are still not even close to being maxed out with nursing students, that, that is the most important thing for us to do. It just possibly impacts all the other measures.

All right. And then final question for me. As you think about the enrollment advisors you have hired over the past, let's call it, six months or nine months, as part of that process, and then certainly past the end of June when the rules changed, how should we think about productivity there or the metrics that you guys pay attention to, to judge whether or not your internal processes are making a difference?

Well, the most important one is we've nearly doubled the number of enrollment counselors that we have out in high schools recruiting ground students. That has gone from 50 to slightly over 90. And so that is the biggest part of the addition. And you don't get -- it's another reason that we are conservative on the margin. You don't get revenue until next September. So they are at -- we're paying them, they are actively busy recruiting students, but we won't get that impact until those 4,000 new students come. And then the secondary is nursing. We continue to hire in nursing because of the rules around that most states are putting in place with regards to -- or not states but hospitals are putting in place with regards to the percent of their nurses that they want to be BSN-trained and MN-trained. That is still a very strong area for us and one that we will continue to expand on as long as that runway continues.

All right, thanks guys.

Trace Urdan with Wunderlich.

Thank you. I wonder if you guys -- and I apologize if you have spoken about this in the past. But when you made this change to borrower-based, did you see -- I mean, obviously the number of students dropped out at that point, did you see any significant number of those students that initially dropped out come back into the program at some later point?

No, thank goodness.

Okay, good riddance?

Yes, yes.

Okay, all right. That's an easy answer. And then I guess maybe related to that question, we had this report from OIG about the fraud rings. This is obviously something that you guys saw may be at some level and we're talking about a lot earlier than other folks. And I wonder what your take is on the report and some of the conclusions that were made by OIG in terms of recommendations, such as verifying student identity. Have you thought about that? Have you thought about what it might take to spend more energy verifying student identity for your online students?

We have done some thinking about that. We have got a CIO who is doing some work and he's very experienced in that area. But I will tell you, the most important thing that we are doing a thing that we will continue to focus on, is just continuing to build marketing strategies and enrollment strategies around the programs where you don't get those students. And so, as the number of undergrad and very honestly, we know exactly where they are. They are students that are 32 years old, 30 years old; they didn't go to college right out of high school. And they are not in a good situation socioeconomically and they're looking to back to school thinking that may be the answer. But they are also thinking it's the answer from the standpoint of some temporary relief from their financial burdens.

And so, we are doing some things internally to more closely identify that if, in fact, it is happening. For instance, if you start in our program today, and you fail or withdraw from your first course, we take you out of your second course immediately and we put you back into that first course. And if you can't pass it successfully the second time, you're out of the program totally. So there's not nearly the incentive to keep going when you're not being successful as there used to be. So we got -- we are doing some things on that end of it, but the most important thing is to continue to change our marketing strategy so that we are going after students that we know we won't have that problem with when they're going into programs that we are focusing on.

Yes and the only thing I would add is that we read the report and I think there were some good ideas in there and others that I think would have very little impact. And I think, from our perspective we were always very vigilant to look for that. Our enrollment counselors were always on the lookout for it. Our QA department was always on the lookout for it. The amount of suspected fraud that we have seen in the University has dramatically, dramatically decreased since we moved to borrower-based. I just think that it is very viral. And if people find out that you are in a term-based environment with very low tuition rates, i.e., you can get very large living expense checks, that is who they target. And so, online community colleges are probably big places that the target and those that have low tuition rates. But it has gotten out there that we are not the place to come try it out anymore because our living expense checks on a borrower-based environment are much lower than what they used to be.

Has there been any evidence anecdotally that by professors that the quality of the online classroom has improved as a result?

Yes. There are certain programmatic areas where we never had a problem and so we stayed strong in those areas. And the faculty are very appreciative of the fact that we are getting less of the at-risk students and more of the students that are likely to graduate and go into professions that where they are going to get a job. And we continue to monitor that. The thing that gives us an advantage that way, is that those courses now are all taught by full-time online faculty at Grand Canyon University, which is a big change. I mean we've built this industry to some extent on the backs of adjunct faculty, which there are some good adjunct faculty out there. But when you can meet with these people and they work for you and only you, and they're loyal to you, the communication that can happen around [trends] with regards to students and their academic success and the achievement of learning outcomes, is just a lot better. That really has helped us monitor this thing as well.

Trace, one of the most exciting things that we have seen in the last probably 6 months to 9 months, is the successful completion rate of the first course for undergraduate students. So that is a passing grade in that first course. It is a substantially -- now, it always was fairly good. But so it has increased substantially. I think, as Brian said, part of that is just the full-time faculty but part of it is better students.

Great. Okay, thanks guys.

There are no further questions.

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 please contact either myself, Dan Bachus or Bill Jenkins. Thank you very much.

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