Perdoceo Education Corp (PRDO) 2002 Q3 法說會逐字稿

Good morning. My name is Kristy, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Career Education Corporation Third Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during that time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key.

Statements made by CEC or its representatives on this conference call that are not historical facts are forward-looking statements that are subject to a variety of risks and uncertainties that could CEC's actual results in 2002 and beyond to differ materially from those expressed in any forward-looking statements made by or on behalf of CEC. Such risks and uncertainties are more fully described in CEC's filings with the Securities and Exchange Commission. CEC assumes no obligation to update its forward-looking statements.

I would now like to turn today's conference over to Mr. Jack Larson, Chairman, President and Chief Executive Officer. Thank you, sir. You may begin your conference.

Good morning. I'm pleased to report on the third quarter results: net revenue, up 42 percent; net income, up 81 percent; fall starts-up, 19 percent; and October population, up 23 percent.

Let me share with you some of the key reasons we had such a great quarter. Our student population was at an all-time high. Currently, we have over 50,000 students at the end of October. Our margins were up. Our starts were at an all-time high. Internet, TV, direct mail, high school and referrals gave us the most growth. Our [shore] rate was up, 2 to 3 percent on enrollment to starts for the fall quarter. Students are taking longer programs on average. Also, re-enters came back in record numbers, 67 percent up as compared to the third quarter of last year. All of our divisions – Culinary, University, College, Academy, Gibbs, AIU Online – had very positive growth. The fundamentals of our business are excellent. Lead flow continued at rapid pace in the third quarter, up dramatically over last year by 75 percent. I just want to remind everyone that's up from 69 percent on the second quarter. September hit an all-time high for numbers of leads. The cost per lead was below last year, a very positive sign that people are responsive to our message. Our programs apply to people of all ages, men and women. People can choose from diploma, associate, bachelor and masters degree. And, of course, many of our students travel from out of the area to go to school. This certainly gives us a excellent method to grow.

Graduate placement is up over last year, an all-time high of 93 percent. There are abundant career opportunities for people who have the right skills. We improved our placement assistant capabilities as part of our strategies for 2002, and it has paid off. For our graduates, we increased the number of career placement counselors and put in new Internet capabilities for employers and graduates to connect.

Our new start-ups this year in Orlando and San Jose, California are ahead of our projections. We are very pleased with the results. Start-ups give us a very positive way to grow in the future. We have had great success in 2001 with two new starts-up – two new start-ups; now, in 2002, with two new start-ups. In 2003, we will increase our start-ups to four colleges.

Our new transplanted programs this year had a very positive effect, also. Next year, we will increase our scheduled number of new transplanted programs from 15 this year to over 30 next year in such areas as criminal justice, visual communication, business, hospitality, fashion design and medical.

AIU Online continues to increase its market share in dramatic ways. It has beat our expectations in all key areas. This growth shows the strength of 100-percent online education in the programs that we offer. Online is well positioned to do even better in 2003 as they build momentum by adding market share and new programs. Students are attracted to the full online capabilities of getting their degree – an associate, a bachelor or master's. The unique technology of our system and its interactive learning capabilities is what attracts and retains students.

AIU Online has seven program offerings, from MBAs, BITs, MITs, BA in Visual Communication, Fine Arts. Our new Masters of Education, which we are currently enrolling students for and will start in February of 2003, has been received by the market with overwhelming interest.

Let me share some of our strategies for 2003.

Our momentum has never been stronger. Our 30-plus – next year, we'll do 30-plus new transplant programs. That's double what we did in 2002. We'll do five – five schools will have bachelor degree programs, four new school start-ups, three satellite campuses for high-growth ed markets. Our online division will continue to dramatically accelerate the number of students. Two to three acquisitions are planned. We are strategic in our methods. There are many opportunities. New automated enrollment sites will allow us to enroll students 24/7 on a more timely basis with greater efficiency. Also, our new Health Education division will begin to grow.

Another area of opportunity is we're looking for a new – or that we're using new third-party funding sources from Sallie Mae [Educate] to help students finance their education. There's also abundant student loans and grants available. Granting partners are being sought where it makes sense, such as in our Health Education division. We've been very successful with [indiscernible] with Le Cordon Bleu. New and improved lead-generation methods based on areas we know work will be implemented. I also want to share with you that the booked futures as of 9/30, so at the end of September, were up 33 percent over last year at the same time. This shows the strength and future momentum of our business. Booked futures are people who have enrolled but are waiting to start school at some point in the future. Again, as a reminder, on June 30, our booked futures were up 27 percent. So, again, very strong momentum and growth in this area.

At this time, I'd like to turn it over to Pat Pesch, our Executive Vice President and CFO.

As Jack's indicated, we had an outstanding third quarter financial performance with significant revenue growth and strong margin improvement. We continue to aggressively make investments in new campuses, our online learning initiative, and infrastructure improvements, all of which should continue to contribute to healthy growth in the future quarters and future years. Revenue growth, as Jack mentioned, was 42 percent. That matched the first- and second-quarter growth rates and includes same-school revenue growth of more than 30 percent. Operating margins increased in excess of 180 basis points from last year's reported third quarter. Adjusting for the impact of the required change in accounting for goodwill, the increase was a strong 110 basis points, which exceed third-quarter guidance of a 50-basis-point improvement.

The G&A was up on a year-over-year basis, offsetting the total margin improvements. This was consistent with the trends in the first two quarters, and as I indicated, it was reflective of – in prior quarters, I indicated it was reflective of our investments in our online business, some increased infrastructure at our corporate level, as well as the implementation of a new student management system. We have been converting schools into that system throughout the year and will complete that in the fourth quarter of this year. Despite the fact that the G&A line is up, that is up in spite of the fact that our marketing and admissions costs are actually down as a percentage of revenue year over year. That was true in the first two quarters and continues to be true in the third quarter, as well. The combination of strong revenue growth, improved margins and a lower effective tax rate for 2002 have generated net income growth for the quarter of 66 percent and EPS growth of 60 percent after taking into account the accounting change for goodwill.

Accounts receivable day sales outstanding of 38 days compares favorably to last year's DSOs of 40 days. This two-day year-over-year reduction continues to trend from last quarter. Bad debt expense as a percentage of revenue increased 30 basis points to 3.9 percent. I've previously indicated in response to questions on previous earnings calls that no one should be surprised to see this move up 10 or 20 basis points. We're similarly comfortable that this 30-basis-point increase is acceptable.

Net cash generated from operations for the quarter was approximately $25 million before the $40 million cash payment associated with the Le Cordon Bleu royalty reduction transaction. That payment will be treated as prepaid royalty expense for accounting purposes.

Also in the quarter, cap ex – cap ex during the quarter was approximately $14 million. Cap ex remains consistent with our previously issued guidance and for the full year should approximate 60 to $65 million.

Our fourth quarter earning guidance that we provided in the press release was only slightly revised from our prior guidance. Previously, we indicated an EPS range of 57 to 59 cents. We have modified that guidance by removing the low end of the range and projecting 58 to 59 cents. As we've indicated consistently in the past, we will maintain a conservative slant to our earnings guidance, and that is the case with our fourth quarter guidance. We are maintaining more modest margin improvement guidance of 50 points, reflective of our planned growth investments in the fourth quarter, including an increased level of activity in our AIU Online business.

We will now take questions at this time.

At this time, I would like to remind everyone in order to ask a question, please press star, then the number one on your telephone keypad.

Your first question is from Howard Block of Banc of America Securities.

And let me congratulate you, perhaps alone here on this, but on a very solid quarter, particularly financially.

Thank you.

First question, actually, is with regard to the booked futures. When you say they're up 33 percent, can you help us understand what may imply, perspectively, for starts maybe in the next quarter or two quarters from now, just giving us a sense as to when those booked futures will become starts and what the correlation may be?

Sure. Many students will enroll anywhere from six to nine months in advance of starting school. I mean there's some that will enroll a year in advance, but, I mean, the average is probably around – you know, around six months. And so this tells us that business is healthy, you know, as it's coming up here for, you know, our major starts that will occur in the first quarter, and, you know, that the people have a huge interest in the programs that we offer and that they're enrolling in school and they're waiting to start at school at some point in the future. Now, some of those would be this fall, and then many of them would come in the first and second quarter. But a lot of our high school students right now are also enrolling for, you know, July and the fall start next year. So I mean it's a good sign and you always want to be up, and we're very pleased that we're up 33 percent over last year.

So would it be perhaps unfair to think that the modest acceleration in booked futures may suggest in one of the subsequent quarters a modest acceleration in starts?

I mean it certainly could. I mean when you look at it with our leads being up as dramatic, I mean that tells us that, you know, that part of it's working well. People are translating or they're enrolling in school in record numbers, and, you know, now it's a matter of getting them to start school at some point in the future.

Okay.

So it's a very positive sign.

And with regards to the placement rate of 93 percent, do you recall [indiscernible] what it was last year same quarter?

It was the 92 percent.

Thank you. And how much of the ability to maintain that level would you attribute to your investment, I guess, in the placement infrastructure? And do you require additional investments next year to sort of maintain that level?

Well, I mean we certainly want to do the right things for our students. We kind of look at it as our moral report card. But, I mean, I would tell you we added more, you know, career counselors or placement counselors. We also put in a kind of a –a, you know, a worldwide web, where students can connect with employers, and that has been very, very positive. You know, many of our students, of course, come from out of the area, and so a lot of times we transplant, you know, placement back to where they came from, or they may choose other locations throughout the U.S. And, you know, I think that we've got a good system. I think every year we upgrade, you know, different things. You know, because we'd have more graduates next year, it would absolutely follow that we'd have more career counselors. And we'll probably do even more in the Internet-based placement area because that has been very successful this year.

Howard, we don't expect a disproportionate investment or level of spending next year relative to this year.

Okay. And then in this 30 transplants that you mentioned for '03, how many of those are related to the Allied Medical acquisition?

There'll probably be a number in there that – well, I mean it's probably only in the four or five range, so it won't be the majority by any means. You know, we probably have about six really solid areas that I had read off that we will be transplanting from, so it gives us a real strong basis where -- you know, where it makes sense.

Okay, and then just lastly, and then I'll jump back into the queue, any update in terms of the specific school locations [or] new schools that have three satellites?

Sure. I mean the satellites that we're looking at would be in the New York area, we'll look in the L.A. area, and here at the Chicago area. And then in terms of the new school, you know, start-ups – I guess that was the other part of your question – it'd be, you know, right now, Las Vegas, Detroit, San Diego and Atlanta.

Great. Again, congratulations.

Thank you.

Your next question is from Greg Capelli of Credit Suisse First Boston.

Good morning Jack and Pat, Howard. [Indiscernible] congratulating you on the quarter.

Hey, thank you.

You know, Jack, I wondered if you could just quickly follow-up on your comment about Sallie Mae and [Educated] and kind of how important this relationship will be going forward, and if you think of the others as well that come into the picture. I know that you mentioned there's a lot of financial aid out there, but could you talk about the mix and potentially how that could shift and how important that will be going forward?

Sure. I mean we certainly have used [Educated] and Sallie Mae in the past as a third-party provider, but, you know, with students having, you know, greater funding needs out there, we have kind of redoubled our efforts, you know, in this area. And, you know, there's lots of financial aid out there in terms of student loans. You know, those are guaranteed by third-party banks. There's certainly, you know, grants available for our students that have a – you know, a financial need, but, you know, I think what we find is that we want to be prepared to help kind of those students that, you know, can almost make it but can't quite make it. They've got some – you know, a little bit more funding methods that they need. And we have found this to be a very successful part of being able to – to enroll, you know, in other, let's say, three or four percent of our student body to be able to help them out. You know, a lot of our students come from out of the area, so they have a little bit maybe greater financial need there. And we have been very pleased with what these programs have done in the past, and we expect more – you know, even – or we expect even better things in the future.

It sounds, Jack, like you're not, you know, concerned at all with funding going forward, that you really haven't met any, you know, resistance or challenges there at this point.

Well, I mean it's an area of opportunity. I mean we certainly work hard to help students with the funding. I think any college or university does, especially that's of a private nature. But we find that there's lots of different resources out there to help students. I think a lot of times the students are looking at private schools, like our student colleges and universities, that they come into it with a mindset that there's got to be a certain amount of cash that has to come forward to in monthly payments. So, you know, we've been very pleased with that relationship there. That's about a 60/40 split there, so I do think it shows people find value in what we teach and also that they do have the methods available to be able to fund their education.

Oh, okay. And then I just wanted to follow-up with you on the – you know, I know you guys are excited about Missouri College. Could you just talk about the, you know, maybe the potential timing of rolling those programs out to some other schools and then potentially when you might, you know, target branding that with, you know, like you said, a third party?

Sure, yeah. We – you know, we – we, of course, have been very successful with the branding of Le Cordon Bleu, and one of our strategies has been to perhaps find a partner in the healthcare area with our medical schools, and, you know, that's kind of underway currently. There's nothing to report at this time, but there might be something in the future to report. And we're excited about that. I think it does – it would distinguish us from the whole market, frankly, so I think there's a tremendous opportunity there. And, you know, as we start rolling out, you know, medical programs at our schools, you know, existing schools, I mean we'll probably start that here in the first, second, third and fourth quarter of next year. You know, I've read off about seven, you know, different programs that are areas of opportunity for us that we'll be, you know, transplanting, anywhere from, you know, criminal justice to some of our hot biz-com areas, you know, some of our business study areas, you know, hospitality and our culinary area, fashion design, and, of course, the medical area we just discussed.

Okay. I'm just assuming that that – it's pretty – not easy, but you certainly can't drop those types of programs into some of your existing – or a lot of your existing schools, right?

Yeah, there's a lot of them. When you look at our Katharine Gibbs schools, of which there's nine of, when you look at our colleges, which there's 10 of, I mean all those are prime candidates to be able to drop that – that program into.

Okay, great opportunity. One final question for Pat. The 25 million in net cash sounds like a great number. Is that somewhat due to seasonality? And shall we expect it to be at that level, you know, perhaps in the fourth quarter?

Well, there's always a little bit of seasonality to the working capital components, you know, but we would expect, as is normally the case in the fourth quarter, a drop in our DSOs, which will generate some cash. Plus, it is our most profitable quarter traditionally, and that – certainly, the guidance reflects that. So we expect – we do expect strong cash generation in the fourth quarter.

Okay. Thanks, guys. Congratulations again.

All right, Greg. Thanks.

Your next question is from Mark Marostica of Piper Jaffray.

Hey, guys. Congratulations again on the quarter.

Thank you.

First question, you mentioned, Jack, lead flow is up dramatically. I’m wondering about conversion rates, how they've been faring?

You know, it really depends on the lead source. On, you know, some of the mix has leads that we convert at a little bit higher rate, some at a little bit lower rate, and, you know, I think that's a tremendous area of opportunity. As an example on the Internet, we've received, you know, many, many more of those leads than we ever thought that we would. And we're now putting in some really great systems and procedures. You know, we're automating the way we handle leads in terms of actually having people go to an automated site. And we think this is going to, you know, dramatically raise the lead conversion rate. So, you know, certain lead sources have a higher conversion [certain] -- and they'll have a lower conversion rate. I think the main thing is we feel – I'm very pleased that we have just substantial amounts of leads to be able to work with. And that's enough – a really nice up-side opportunity, frankly, is always to get a higher conversion rate.

If you were looking at collectively, are conversion rates up year over year or [indiscernible]?

Collectively – collectively, just running the math, the conversion rates are down, but as Jack mentioned, you've got a significant mix change with the large growth in the Internet leads, which convert at a lower rate than most of our other lead sources, although the student acquisition cost associated within Internet leads is still favorable. And that's why, on balance, we're still looking at – our advertising admissions costs are down as a percentage of revenue this year.

I got it.

When you also consider that just record-breaking numbers of students leaving high school right now, and of course, we generated record-breaking numbers of leads of students that are coming right out of high school, and those are always converted at a little bit lower rate, but there's lots of them out there, and we're very pleased with that because just as it were, we're following the demographic trends out there.

Okay, great. Question on new student – excuse me, same-school population growth, 19 percent year over year. I'm wondering, from a seasonal perspective, we typically have seen, you know, Q3 very strong, and I’m wondering sequentially if you perceive that down to get that seasonality in play or if you could give us a little bit more color on that trend?

Well, there is some seasonality in play here, and it's probably not seasonality throughout the year as opposed to probably the July 31 population number has traditionally – the summer population increase has traditionally been the strongest. If I just – even kind of going back in our history as a public company, 1998 was 26 percent, '99 was 27 percent, 2000 was 25 percent, 2001 was 23 percent, and this year was 24 percent. And one of the reasons that number – that period tends to be stronger, there's two things going. You've got, one, just the general increase in our start activity or the growth in the schools, plus, as we've acquired schools with more of a traditional academic calendar, where a good number of the students take the summer off, we have –we have emphasized year-round attendance for our students, so we've had growth from just an overall level, plus keeping students in school over the summer has added to the summer population. So in virtually every year of our existence, that's been a stronger growth quarter than the others. When you look at all the other quarters, our history as a public company, we've basically been between high teens and low 20s in all of the –all the other quarters. Last year, for instance, we were at 18 percent for – for the October – for the October quarter. So we're very comfortable with the 19-percent growth this year as being consistent with our – with our track record.

And your guidance going forward on that metric?

You know, we've not provided specific guidance with respect to any individual quarters. Our overall long-term guidance has been for 20-percent-plus internal revenue growth, and we've separated that into kind of a mid-teens population growth, with the remainder being price increase. We've done better than that historically. We – you know, there's nothing in our plans or our operating model where we – we're planning for that to fall off. But we have maintained a conservative slant to the guidance on a go-forward basis.

Okay, one last question, and I'll pop out. And that is on the bad debt expense, the percentage of revenue. Where does it go from here, and where does it level out, do you think?

Well, in terms of where it goes from here, I mean we think it's in a stable range right now. I mean historically, our bad debt numbers have been, you know, on individual quarters, you know, some – as low as in the kind of the, you know, the mid-2-percent range to as high as, you know, 5.5 percent. The range that we're in right now is one that we're comfortable with. I don't expect it to move significantly up or down in the near term. I don't know how to provide any more detail than that. I think from a projection standpoint and implicit in our guidance is, you know, a fairly stable number in that range.

Fair enough. Thanks, I'll hop out.

Thank you.

Your next question is from Bob Craig of Legg Mason.

Good morning, everybody. Actually, it's Jerry Herman. A couple of questions. Number one is, Jack, are there – were there any factors in the quarter that you had described as sort of gaining factors to growth, i.e., enrollment counselors? Obviously, the conversion rates were down a little bit. But anything that served as a constraint to growth in the quarter that you would cite?

No, we had lots of leads to work with. You know, we – our enrollment staff was at an all-time high. We were where we needed to be in terms of the budgeted numbers of people here, you know, recently, and, you know, from that side, it was very positive. I mean the IT enrollments, which I know a lot of times people have a number of questions on, I mean certainly was in the double-digit growth. We felt very, very good about that. And just a lot of positive factors out there.

Okay, great. And with regard to the lead flow – and, obviously, you guys got great aspirations on the online program -- how much of an influence has online leads, meaning students interested in online programs, how much of an impact has that had on the lead flow, if at all at this juncture? I would suspect it would go up, but what about now?

Well, that's been a very dramatic part. I mean our brick and mortar was the most dramatic, frankly, but the online stuff, because, you know, we were starting from a small basis, was up very significantly. So, you know, that's positive. It was very much, you know, expected. We have a lot of hot programs out there. The demand for 100-percent online degree programs is very strong. And, you know, we offer anything from, you know, an MBA to a masters of IT, there's Fine Arts and things like that. So, you know, I think that, you know, people responded very well to the numbers of things that we have out there. But I will tell you, there was just a tremendous strength in our brick and mortar, and I wouldn't separate one or the other and say, you know, one had a distinct advantage over the other. You know, just lots of ways to generate leads right now at very reasonable costs.

Were those leads enough to tip the needle up to the 75 percent from the 69 percent last quarter?

Well, we have always had very high numbers of leads that have come in in that third quarter. People are getting ready for the fall. Your high schools are back in session. You know, people are looking towards, you know, next year. So this is a kind of a typical time of year. I mean I guess I would just say that, you know, you spend more dollars, you have more initiatives, and, you know, we were at full throttle, I guess, in terms of our program offerings, both online, brick and mortar, and just about everything else that you could possibly think of. So, I mean, it's not one thing. I mean it was just a variety of things that we did, and we had stuff at full throttle. I think it really paid out in just every single way that we could look at our business in terms of the ability to be able to generate leads.

And, Jerry, I mean our brick-and-mortar lead flow growth did not fall off.

Okay, great. And I do have a question for you with regard to the guidance and your comment about margin. Just by way of clarification, I thought you said there would be about a 50-basis negative influence from your positive investment in AIU Online. But in that regard, wouldn't that be more than offset by the benefit from the royalty adjustment at Le Cordon Bleu?

Now, let's – two things. One, I didn't say there would be a 50-basis point negative. I said that our improvement for the fourth quarter year over year would be approximately 50 basis points.

Okay, great.

And that's – that's on an apples-to-apples basis, meaning, you know, if you pro forma it last year for the change in accounting for goodwill –

Um-hmm.

-- so it's a true year-over-year operating improvement of approximately 50 basis points. And what I indicated is the reason that was at a lesser level than what we've previously enjoyed does have to do with, you know, continued investment in the online business, okay?

Now, with respect to the Le Cordon Bleu arrangement, maybe I could kind of speak to that a little bit. With respect to the – clearly, in our mind, this is a very long-term positive arrangement. And while it was immediately accretive, the immediately part, it's very modest initially, and there's a couple reasons for that, and I'll actually walk through a few numbers with you. At this point in time, not 100 percent of our culinary students are subject to the Le Cordon Bleu royalty. We've got a couple campuses – our California Culinary Academy and the Pennsylvania Culinary Institute – which have begun Le Cordon Bleu classes and, therefore, have begun programs with higher tuition and revenue that's subject to the royalty. But there are a good portion of those student bodies that are still – that are completing programs under the non-Le Cordon Bleu curriculum, and they are not subject to that royalty yet. So what that means for us is as those students roll off and are replaced by full Le Cordon Bleu students and as our revenue in culinary grows, the benefit of that increases. Now, let me just share a couple numbers for you. You know, estimate for the fourth quarter would be that on a pre-tax basis, net of – we get the reduction in the royalty, but then we have amortization of the prepaid royalty that we've made.

Right.

And we're doing that on a straight-line basis over the remaining term of the agreement, and obviously the benefit will increase as the revenue grows. But net of that amortization of the prepaid and then net of some interest expense on the $40 million that we paid there, we're expecting probably 200,000 of pretax benefit in the fourth quarter.

Okay.

So, you know, tax affected, you're talking roughly about $100,000.

Okay.

When we look at this now in terms of why this transaction makes sense for us, when we roll this forward into 2003, in 2003, this is just, you know, some reasonably conservative numbers here. We would expect the savings on the royalty or the reduced payment to be approximately $12 million, okay?

Does that assume no growth?

That does not assume no growth. It's not an aggressive growth assumption. It does assume the remaining students that aren't subject to that royalty become subject to it, which will happen.

Okay.

And then if you look at the amortization expense for a full year associated with that will be approximately, you know, $6.8 million, interest expense – and, again, part of this, you can net this out depending on what our future cash generation is – but if you had interest expense assumed at about a 5-percent rate, you know, on $40 million, is about $2 million. If you kind of add that all up and tax-effect it, you get about a four-cent benefit, four cents-per-share benefit in '03.

After tax?

After – yes, after tax.

Great. Thanks, guys. Appreciate it.

Great. Thank you.

Your next question is from Richard Close of SunTrust.

Congratulations on a great quarter, guys. I want to hit on the new student starts real quick. A couple questions surrounding that where there seems to be some confusion or concern here. Last year, you reported a 31-percent growth in new student starts in the third quarter. You know, can you give us some sort of feel of what that would've been without AIU that was in there for the first time?

Yeah, I mean certainly the start growth is something that we provided gross numbers for versus same school, so it is very largely influenced by acquisition activity. So when you look at the revenue base that we picked up with the AIU acquisition last year, you know, in round numbers, you're talking about a 15-percent revenue increase compared to where the company was without it. And, you know, when the basic assumption of start activity being directly correlated with revenue levels, you know, you would look at about a 15-percent impact of that acquisition. So, again, it's not perfect math. The numbers don't work exactly that way. But that's the general – the general impact of acquisitions is all of that – all of the starts associated with an acquisition add to the growth over the prior year. So absent that large acquisition, that growth number year over year should go down dramatically.

Okay, and then a follow-up with the second quarter of this year, I guess, you were at 32-percent start growth, you know, as compared to 19 percent in the third quarter here. Was, you know, there anything with respect to that, that 32 percent, that maybe is, you know, not necessarily, you know, the same as the 19 percent? I mean like the Pennsylvania acquisition or anything there seasonality-wise?

Yeah, here's the – two things. One, the second quarter is a much lower start quarter overall, okay? So you kind of have a – call it a lower numerator to deal with. When you add in Pennsylvania Culinary, some of the largest starts – and that was the one acquisition – some of their largest starts, they have a very large June start. Most of our culinary schools that we have are fairly evenly loaded in terms of their start over the course of the year. Pennsylvania Culinary's a little bit of an exception, and they had a very large June start activity, which did have, you know, a significant influence on that quarter.

Okay. And I know you don't give guidance, you know, really on the start, but is it safe to assume or plausible to assume similar growth, you know, in the fourth quarter of this, like 19 percent?

Well, you pretty much have most of the fourth quarter information because in the press release we gave you third quarter, you know, of July through September, and we also gave you the full kind of summer/fall season of July through October, and those were both 19 percent. So you basically had October, you know, equal to the – essentially equal to the fall – or to the – I'm sorry, to the third quarter. And that we do have some starts in November, but they're – they're a much more modest part of the fourth quarter. October has the bulk of it.

I mean right now we're enrolling for the first quarter starts and then on into, you know, the second, third and fourth quarter of next year.

Okay. Two quick questions and then I'll jump off. You talked about the new student management system. If you can just give us an update on that and how that, you know, helps you out in the future, as well as, Jack, you mentioned the show rate increasing 2 to 3 percent. Is there anything you guys are doing there to really drive that specifically?

Sure, let me talk just a minute about the student management system. Our new system will be fully, you know, implemented and operational for all of our schools by the – by December. This has been an ongoing process throughout this year. The majority of our schools have been fully integrated, they're up and running, it gives the schools dramatically more capabilities to be able to, you know, understand their business and to be able to track things and work with things, and, you know, it's a really great system. So we feel, you know, very, very good about that.

And in terms of the show rates, I mean that's an ongoing thing that we do. As soon as a student enrolls, we've got a process that we put them through to make sure that we take care of their needs, that, you know, we answer any of their questions that they might have, we help them with their finances, if they're coming from out of town, certainly, you know, housing. We stay in touch with them. You know, this is an ongoing process. We have a 21-step program. We've got specialized people in each one of our locations that, frankly, deals with the student as soon as that enrollment comes in. And I think that's been probably the biggest part of that success. We did implement this a little over a year ago, and I think we're getting a very positive effect right now by having that in all of our schools here for the past year. So I mean that's something that's just going to help us as we go forward here in the future.

Okay. Thanks, guys. Congratulations again.

Thank you.

Your next question is from Matt Litfin of William Blair and Company.

Good morning. Wouldn't be a Career Ed conference call if someone didn't ask about the acquisition landscape -- what you're seeing generally and then, specifically, what the near-term plans are?

Well, certainly, we – we're, you know, aggressive in the acquisition area. We've got a number of plans. I can't disclose them on this call, but, you know, we have a full-time staff that sorts through things. Of course, we've always been very judicious, and, you know, it's got to make sense for us. But we've got a lot of confidence in our ability to, you know, acquire things, and, you know, over time, I think we certainly have proved that. We probably have done more, you know, acquisitions than anybody else, and so that's very much out there and part of what we will do as we go forward here in the future. So there's a lot in the pipeline.

Great. Wondered if you could talk about your line of credit currently. Where does that stand? And do you have any share repurchase authorized currently? Does that interest you at all as a potential use of the cash that you're generating here?

You know, let me address the second question first in terms of share repurchase. We do not have any current plans or authorization for a share repurchase program. Obviously, when we look at our cash position and look at, you know, our continued interest in acquisition activity, you know, generally, we've looked at that as a, you know, kind of a better use of our capital than share repurchase. Obviously, in the future, circumstances change, cash-generating capabilities at higher levels, and dependent on where the share price would be at some point of the future, we would always stay open to that possibility, but no current – absolutely no current plans.

Secondly, with respect to our bank line, we have – we currently have a $90 million bank line. Our usage on that facility, we have – you know, this is disclosed in our SEC filings – about $10 million used of that facility related to letters of credit. The bulk of those dollars are associated with deposits on lease arrangements, insurance and things of that nature.

In terms of our usage on it, we did draw down about $40 million at the time that we closed the LCB transaction and the Missouri – the Missouri College acquisition. We paid back approximately half of that by the end of – by the end of the quarter and early into the – early into the fourth quarter. And on a go-forward basis, we are pursuing right now the possibility of increasing the size of that line. Primary reason for looking at an increased line is to make sure that we, you know, have adequate bank lines available to support our acquisition activity.

Great. Just one more. I believe, Jack, you said IT enrollment at double-digit year-over-year enrollment growth. What are the factors that are leading to that success where so many other companies are performing poorly in that area, seeing less interest?

Sure. Well, I mean I think a big part of it is, you know, we've got programs that we feel that kind of match up with the needs of the local market, as well as giving people a large variety of things that they, you know, want to take. And, you know, I mean I think a big part of this is anywhere from diploma programs to associate to the bachelor and master's degree areas, and I think there's lots of jobs out there. I think we're – you know, we've been able to make that clear to people when they call in from one of our ads or they respond in some way.

Great. Thank you, and congratulations.

Thank you.

Your next question is from Tracy Urdan of ThinkEquity.

Question is about the margin line. Pat, your guidance for next quarter in terms of margin improvement was very similar to what you had guided for for the third quarter, and yet you clearly beat that pretty substantially. I wonder if you could subscribe what's driving the improvement on the educational services line and whether you see that gain continuing into the fourth quarter?

In terms of what's driving that improvement, I mean it's primarily just really a leveraging of our fixed cost structure there, including facilities. And, also, you know, with kind of larger student populations in the schools, you have a little more efficiency in classroom scheduling, so a little more efficient use of, you know, of faculty.

I don't expect that to really change in the fourth quarter. It's much more of a question of as we've continued to grow some – you know, to invest in some of our initiatives, including online, aggressively, frankly, we want to make sure that, you know, we can continue to spend the dollars as we find – as we see appropriate in growing the online business. We really – that is doing extremely well, and we don't want to pull back from – from our efforts there. If anything, we may look at doing a little bit more. And while that may have the effect of putting a little damper on the margin improvement, we think from a long-term perspective that that's probably the right thing to be doing. Having said that, as has been the case in the past, you know, there is – there is up-side opportunity to our guidance.

Sure, fair enough. The second question I wanted to ask is with respect to the revenue per student metric. I know this is something that bounces around, and it's not a very precise measure, but it looks like, based on the total student enrollment you've got this quarter and the revenues you're projecting for next quarter, it looks like that metric might be accelerating into the fourth quarter, and I’m wondering what might some of the qualitative factors be that could drive that --?

I would tell you it is not accelerating into the fourth quarter, and implicit in that guidance is really not an increase in that level. I would really associate it with kind of the imperfection of using kind of points-in-time estimates with the population versus what kind of an average earning population is.

Fair enough. Let me ask a similar question then. Can you speak to the retention rate that you're seeing and what your expectations might be for the fourth quarter relative to the prior year?

Retention – you know, retention is down a couple points, you know, versus the prior year. You know, that's not kind of a new phenomena for us. As our campuses have grown, you know, retention has been, you know, on a mild downward trend the last couple years. We don't think it's at a level that – or we don't expect any significant deterioration from where we're at now, but it is down now year over year a couple points.

Yeah, one of the brighter things to keep in mind, too, is that, you know, our re-enter programs, the ability to get people that perhaps like to drop out of school for a period of time to come back, has been very, very successful. As I quoted, in the third quarter we were up about 67 percent over the prior year. And, you know, we have many more programs to kind of, I guess, deal with issues that students have with their education. So, you know, that should be a very positive sign for the future.

Okay, great. And one last question. Just a detail on the royalty payments to Le Cordon Bleu. Where do you see that reflected in the income statement? Is that netted against revenues? Or is that in the educational services line?

No, it's on the ed services line. The royalty payments have historically been on that line and will continue to be. The way we're treating this is that [indiscernible] the payment is a prepaid royalty amount, and so the expensing over time of that prepayment will be on the exact same line. So there'll be no shift – no shift in the income statement lines for that.

Thank you.

Your next question is from Gary Bisbee of Lehman Brothers.

Thanks a lot, guys, and my congratulations on a good quarter.

Thank you.

I guess I'd like to start with online. In the press release --first of all, the growth there was pretty exceptional quarter over quarter, and the press release said that it might even accelerate, I believe? I wondered if you'd give us any guidance, you know, if not for the fourth quarter, maybe a general outlook as to what you see for 2003 just in terms of absolute growth of the online business.

Well, let me just give you just a little bit of flavor for what we're doing here. I mean, you know, this is a division we started up about a year-and-a-half ago, and it really is coming into its own now and just a lot of capabilities. We did a lot of research on that that – you know, this is a very strong market, and there's many, many people out there that want this 100-percent online anytime/anyplace, you know, degree. When we started, we started the program maybe a year ago, we only had two or three products or programs to be able to offer. You know, today we have seven, and we're also adding a course in the eighth program, the Masters of Education, and it will get kicked off in the first quarter. And I think a combination of these things have really, you know, given us the ability to, you know, generate lots of leads, have a lot of students be able to fulfill kind of their educational goals. And, you know, we always knew that this would be a very, you know, large program. It's turning out to probably be a bit larger than we thought it is, and, in fact, we've kind of accelerated, you know, the various activities in it so – and I do think the demand is tremendous out there, and we're – we're working with that demand.

Okay. How about an update on the profitability? Last quarter, if I remember correctly, you mentioned that it was like a mid- to high-single-digit-million operating loss that you expected this year. Any outlook as to whether that has changed, or is that still reasonable? And if you could give us any sense as to when you think it, you know, potentially could reach profitability?

Yeah, really no change from what we talked about last quarter in terms of the kind of full-year expectations. When we look at next year – you know, we're probably expecting something approximating breakeven for next year, perhaps a modest investment in terms of P&L dollars, particularly earlier in the year. But when we – but that's also a function of the growth curve as well. We believe if we – if we slow down the growth level – keep in mind, you know, in our business we recognize all of our expenses associated with new student acquisition up front, so, you know, in advance of generating any revenue, and if we were to flatten the growth rate there to a level that, say, matched the brick-and-mortar business, we believe it would be profitable next year. That's not our intention because we don't -- again, that's more of an accounting exercise than it is kind of the true economics. We believe keeping that heavy growth rate through next year makes sense and that we would look at profitability in the following year.

You know, keep in mind, one of the things we've also stated publicly at various, you know, events is that the revenue is expected to be between two and three hundred million by '05, and certainly, you know, we just feel very strongly that that's very, very realistic. In fact, I would tell you it's probably on the conservative side, so there's just lots and lots of opportunities in this area.

Yeah, I guess I was thinking about it from another obvious angle, which is that you haven't yet given any preliminary guidance on 2003. If it would to breakeven or even, you know, lose a little bit of money, that still could be a 60- to 80-basis-point jump in your operating margin given cutting off the losses from this year. So, you know, if that's the case, it looks to me like the '03 guidance should be viewed as somewhat – excuse me, the consensus right now should be viewed as somewhat conservative. Do you have any --?

Yeah, Gary, the one thing – the one thing I would say, kind of run a few numbers, in terms of the margin guidance with the – while the dollars may actually improve, you know, from a bottom-line perspective with significantly more top-line dollars at – at, you know, breakeven or slight loss margins –

Yeah.

-- that could – numerically, that could hold the margin improvement down even though it wouldn't – it wouldn't be bad in terms of earnings growth.

Yeah, and that's a fair point. I guess the next question is just then are you willing to comment on the consensus for next year? Or is that something that you want to wait till next quarter?

You know, we have – I would rather wait till next quarter. We've not historically provided, you know, definitive guidance until we've released earnings for the year in terms of guidance on the following year. I would just probably reiterate some of the long-term guidance that we've provided in our various conference presentations, and where we've indicated that we expect on a long-term basis to continue a 20-percent-plus internal revenue growth, as well as, you know, at least a half a point margin improvement for the next several years. And I would say that would be without regard to the improvement we'll get next year relative to the Le Cordon Bleu transaction, and I outlined some estimates for that benefit for next year earlier in the call.

Great, thanks. And I just have two real quick clean-ups. I didn't – I missed what you said for cash flow from operations.

Cash flow provided by operations before the Le Cordon Bleu payment –

Right.

-- was approximately 25 million. And we did have a $40 million payment --

Right, right.

-- okay, related to that, and, of course, the benefits of that transaction are not – they're not really third-quarter benefits. So, excluding that payment, it's $25 million provided from operations.

Yup. Okay, great. Thanks a lot, guys.

Thank you.

Your next question is from Mark Farano of First Analysis.

Good morning.

Morning.

Morning.

On the online, just when you think about how you invest in size in the business for 2003, the – are the investments you're talking about more P&L investments, as opposed to capital expenditures? I mean it's not really a very capital-intensive business, is it?

Yes, I mean your – it is. When we're talking about the investment there, we are talking more of a P&L investment. The cap ex needs that we see there are not – are not extraordinary. They're not assimilar to the capital investments for the brick-and-mortar business. It's a little different mix because you have less of a – less of a focus on facilities and more of a focus on kind of the technical infrastructure – servers, etcetera. It's a server-growing population.

Right. And I – one of the other points is – I know your model is still evolving for online, but, you know, if you look at [Apollo] and then the margins on online versus the margin on the ground schools, the online margins are a fair amount higher. I mean do you see your business model evolving that way over time as well?

Yes, definitely. We feel that online over time has, you know, a vast greater potential to achieve higher margins.

There's two major areas there that we see the opportunity in. One is certainly in the occupancy cost, and we think kind of the lower occupancy cost associated with not having to put students in the classroom kind of more than offsets the extra technology investment, if you will.

Yup.

And then, also, you know, the marketing costs, with it being kind of dominated by Internet-type activity is more efficient than the brick-and-mortar overall costs.

Yup. Okay, and then last question, just back on the acquisition front. You know, some of the larger companies in the education industry are still willing to do small acquisitions or still want to do small acquisitions, while others really don't seem to want to do – do things that don't move the needle in terms of their own size any longer. Can – could you just give us a sense of where – you know, what your own thinking is about that, if you're still interested in the smaller deals?

Sure. I mean – well, look, we've always been opportunistic. I mean there's – you know, some of our best schools today were deals that started out very, very small. Some of the things we've been able to really leverage. So, you know, we [got it down] to look at something just because it's of a certain size as being necessarily a negative thing. We find if we take the time to really understand it and does it fit in with our strategy, that's probably the biggest thing to us. I mean certainly, you know, if something is a bit larger, you know, that, from a standpoint of moving the business, can be a little bit easier to deal with, but I guess that we're certainly willing to look at both.

Okay, thank you.

Thank you.

Your next question is from [Eric Woodworth] of [BSM Capital].

I was wondering if you have finished teaching out students at the AIU DC campus? And about how many students did that represent in 2002? Thank you.

We did finish, you know, teaching out that program. It was a pretty modest number of students. And I mean that was – that was basically a continuation of prior management's plan of teaching out that campus. There was no revenue, you know, in our numbers associated that teach-out.

Okay, thank you.

Okay.

Your next question is from [Stephan Mixnik] of [Price Place Capital].

Good morning.

Morning.

A couple of things. Maybe you guys mentioned this but – and I missed it, but could you guys give us what same-store revenue and same-store EBITDA increases were?

I did mention that the same-school revenue was in excess of 30 percent. We've typically not put out the EBITDA numbers until, you know, kind of a full-year basis.

Okay, okay. And then –

I would say, Stephan, that, you know, our trend of growing the same-school EBITDA at a more rapid rate than the revenue is continuing.

Okay. I mean is it – to the extent – in the past you've been doing, you know, a greater than 30-percent same-store revenue growth and same-store EBITDA, you know, approaching 40 or 50 percent; is it still of that kind of magnitude?

It's similar.

Okay. And then in terms of just – I missed an earlier question. Are you – is the online spending this year something approaching $10 million? Are you confirming that?

No, actually – well, I mean total spending – I mean our expenses are clearly, you know, above that.

But I meant the net net –

The net – you know, we indicated, you know, we were somewhere between, you know, a million and 10 million. I mean we put out that broad a range before and said we weren't really that close to 10.

Okay. And can you give us a sense year-over-year how that that in the quarter and what you think the fourth quarter will be? In other words, how much have you increased the – has the net loss from the online changed year over year?

You know, the net investment has increased, you know, in terms of – as a percentage of revenue, it's obviously down because we had pretty modest revenue last year. In terms of absolute dollars, you know, we're investing more this year than last.

Okay. I mean – okay. Fair enough. And then, Jack, on the – in terms of the medical – you know, the medical curriculums, how big do you think that could be over time for the business?

Sure. I mean, you know, in each one of our divisions – we've got seven of them – we really feel that they're capable, after kind of doing a strategic planning, of certainly reaching revenues of $500 million. So there's lots of opportunities in the medical area. I mean just based on our economy, people spend $1.4 trillion. And just some of the other things that, you know, that you can add to medical schools that should be very, you know – I mean very productive.

Okay, thanks. Nice job.

Thank you.

Your next question is from [Chris Greenberg] of [Barron Capital].

Hi, guys. Great going. The satellite campuses you're talking about opening next year, are those just, in essence, additional space to run all your programs? And, therefore, are those profitable coming out of the blocks? Or is there some kind of ramp on that?

And then, also, the four schools you're planning to open next year, can you give us a little more detail on what curricula they're going to teach, when they're going to open, and your experience in two years of openings – how long does it take for profitability of these schools now since they're ramping so rapidly?

Yeah, you know, on the satellite campuses, we started a few of those, and those have done very well for us, you know, where we have the high-growth markets and you have a, you know, population that perhaps is a little bit sensitive about traveling certain distances. We have found that this can be very, very beneficial. Certainly, if you look at the Los Angeles, the Chicago and the New York area, there's some really great opportunities out there. So, you know, it's kind of a, you know, modest investment, and, you know, you're already paying for everything. By and large anyway, you've got to get some space and you've got to move some teachers over there. But, you know, you've already generated the leads. You already have the ability to enroll those students. You've got the curriculum. You've got the programs. And it's just a matter of outfitting the facilities. We expect that that'll do very, very well.

But when you look at, you know, start-ups, I mean this is something that we've done really well on. We kicked this off in 2001, of course, with the school in Orlando and then Philadelphia, and this year, of course, we did another – we did a culinary school in Orlando and at Brooks College in San Jose, California, which both those got off to just roaring starts. And, of course, the schools we started in 2001 have really progressed above expectations. We are super pleased with that. We're at the point now that we want to add -- put in four new start-ups next year, and I think this will accelerate over time. You know, we certainly have the ability to do that. We've got the brand names. And it kind of gives us the ability to go into the market and kind of put schools where we want to put them. At the same time, certainly, if there's, you know, good opposition, we would consider that, also.

You asked about the curriculum as well. Atlanta and Las Vegas, that Jack mentioned, would be culinary programs. He mentioned the Detroit area, which would be a international academy, which would probably start with Visual Communication and Technology programs. And then he mentioned San Diego, which would be a Brooks College, which is mostly a Visual Communication curriculum but some IT.

The Las Vegas entity would start in July, and the other ones would be in the fall.

Is there way, Pat, you could give some information concerning how quickly [inaudible] are ramping up as far as when you're actually getting to profitability?

Yeah, they're moving similar to slightly better than – to somewhat better than our original plans in terms of reaching profitability. Originally, what we had laid out for people is that we would have, you know, kind of a six- to nine-month period prior to the first start, where we would be basically ramping up and kind of getting our house in order and beginning our initial marketing, etcetera. And that we would certainly be investing or spending money in that period of time. And then from the date of the first actual start until breakeven would be, you know, a nine- to twelve-month period. And we're absolutely been on track with that model.

Great. Thank you.

There are no further questions at this time.

Very good. I just want to make one final comment. We're very pleased with our third-quarter results. We have a lot of confidence in the future as we go forward based on what we know students want and also with the addition of our exciting new initiatives that have a potential – or a huge potential and already have demonstrated their soundness. Please remember that we have, you know, many ways to grow and dramatic ways when you consider our various divisions, our college divisions, our culinary, our Gibbs, our Academy, University Online, our new Health Education division. Our global education system is ready for the future. Thank you.

Thank you for participating in today's Career Education Corporation Third Quarter Earnings Call. This call will be available for replay beginning at 1:30 PM Eastern Time today through 11:59 PM Eastern Time on Tuesday, October 29, 2002. The conference ID number for the replay is 6116760. Again, the conference ID number for the replay is 6116760. The number to dial for the replay is 706-645-9291. This concludes today's conference. You may now disconnect.