Perdoceo Education Corp (PRDO) 2003 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2003 Career Education earnings conference call. My name is David, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. If at any time during the call you require assistance, please key star zero, and a coordinator will be happy to assist you. As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to the host for today's call, Mr. Jack Larson, Chairman, President, and CEO. Please proceed, sir.

Good morning. We had a great third quarter, and I'm here today to report on our results. With me today are Pat Pesch, Chief Financial Officer, Jake Gruver, President of Colleges, Schools and Universities Group, also Nick Fluge, President of Online Education Group. This is our 23rd consecutive quarter of record results. Revenues up 60%, net income up 90%, summer and fall starts up 63%. Third quarter starts up 73%. And our October population up 58%. We also had significantly improving margins. Our student population is at an all-time high, some 79,500 students. This demonstrates the credibility in students' minds of attending a private postsecondary education institution that offers specialized programs. This credibility has never been higher, whether for on campus or online.

Let me highlight some recent positive trends. Our student population for on-campus and online were at an all-time high. The online group has approximately 9300 students. Last year at this time, only 1700. On campus had over 70,000 students. Some 95% of all of our students are full time, which generates more revenue and provides a more serious student. Colorado Technical University online had their first start of approximately 70 students. They're off to just a great start. This will be an exciting platform to grow our online business and it offers a less accelerated program than those offered by American Intercontinental University. So it shows that we can serve a number of online markets.

Our organic growth for our on campus operations for the quarter was very strong. The Whitman Education Group which became part of our system at the beginning of July has responded well to many of our enhancements and marketing operations. This has resulted in more leads and translated into higher starts. Colorado Technical University, Sanford-Brown, and UDS schools have successfully merged into our systems and are using systems to enhance their performance. INSEEC, our French group of schools had an excellent fall start in September and exceeded our expectations. Those students taking bachelors and masters degrees are the best of the best. The retention level of these students is the best in our system. Online had better than expected revenues and profit margins were excellent.

We continue to enhance our online technological capabilities and to offer programs students find attractive. This combination has proven to be very successful. The online group has scaled up all parts of their operation to meet the huge future demand for online education. The third quarter lead flow was very strong, up 76%, which shows potential students are responsive to our marketing message. The conversion rate for our onsite and online group was up in the quarter. Each has a record number of admissions personnel and to meet with students when it's convenient for the students. New programs had a very positive impact.

Our goal for 2003 was 50 transplant programs in our on-campus group. Many of these programs have started in the past six months of this year and also in the third quarter. More will follow in October. Other exciting factors that have recently occurred are the strong startup of our new campuses in Las Vegas, Atlanta, Detroit, and Houston. The new starts were ahead of plans in all locations. Book futures as of September 30th are up 40%. Last year at the same time they were up 33%. Book futures are students who have enrolled and are waiting to start school at some future date. This shows the strength and momentum of our business. Our acquisition pipeline is full. We continue to review deals that strategically fit in with our strategies. Placement is doing very well and we expect 2003 to be a very excellent year. We have done between 94 and 95% placement for on-campus and 98% for online. The thing we have learned is there are lots of career opportunities for those graduates who have the right skills. At this time I'd like to turn it over to Pat Pesch, our CFO.

Thanks, Jack. As Jack has indicated we had a outstanding third quarter financial performance with significant population and revenue growth and strong market improvements. As I indicated last quarter, I'd like to remind you that that performance comes as we still continue to aggressively make investments in new campuses, new program introductions and infrastructure improvements, all of which contribute to healthy growth in future quarters in future years. Revenue growth of 60% was up from 44% in the third quarter and includes same-school revenue growth of approximately 40%. Revenue for the online business was approximately $44 million for the quarter, up from approximately $32 million in the second quarter.

Operating margins increased 210 basis points from last year's third quarter. This improvement was up considerably from management guidance due to stronger-than-expected online revenue and the resulting improvement of online margins. The Online Education Group now has higher margins than any of our campus-based business units. The combination of strong revenue growth and improved margins generated net income growth of 90% and earnings per share growth of 73%.

Turning to the balance sheet. Accounts receivable day sales outstanding, or DSOs, of 33 days compares very favorable to last year's September 30th DSO of 38 days. Bad debt as a percentage of revenue was 4.8 versus 3.9% last year, and 3.9% in the second quarter. I'll discuss some of the reasons for that in just a few minutes. Deferred tuition revenue increased over 100% from last year's third quarter to approximately $106 million. With respect to DSOs and bad debt, we did make some changes in our cash collection practices and adjusted some of our credit standards during the quarter, which resulted in a significant improvement in our cash collection, as demonstrated by our year-over-year DSO performance and the growth in our deferred tuition revenue balances.

Those more aggressive collection practices were instituted in an effort to improve our working capital management and also to improve on a long-term basis our bad debt performance. In the short term, these more aggressive practices did have some impact on our bad debt. A portion of the increase in the bad debt was attributable to higher attrition. Some of that higher attrition resulted from these more aggressive cash collection practices. A portion of the increase was also due to higher average balances for dropped students, higher average receivable balances for dropped students. As we indicated before, we have had a steady decrease in the proportion of our funding that is provided by title 4, and that has put upward pressure on our bad debt levels.

Included in our changes in practices during the quarter, we also -- we instituted new training methodologies for our financial aid and cash collection professionals to ensure consistency and better performance over time. And I would also like to point out, in terms of our views of bad debt, this is not new, but consistent with our approach in the past, we have never shied away from looking at aggressive price increases or offering high-priced programs because of the potential for bad debt related to those changes. We have always viewed bad debt as one of the operating costs, and if we can get better bottom-line performance with more aggressive prices and higher-priced programs, those things can serve to improve the overall performance of the Company, even at a higher bad debt level. So we look at this metric as one that is just part of the overall business process. Having said that, we did institute some of these changes in an effort to improve our performance in this area, and we do think, over the long haul, that we will improve our performance in the bad debt area.

I would like to kind of shift over to discussion of our guidance for the rest of this year, specifically we expect full-year [2003] revenues to be approximately $1,170 million. We expect full-year 2003 earnings per share of approximately $1.14. With respect to online, we expect full-year revenue of more than $140 million. Third quarter revenue should be $354 million and $356 million with earnings per share of approximately 47 cents. I will note that that 47 cents is up about 2 cents from previously issued guidance. We expect fourth quarter operating profit margin improvement to be less than the first three quarters. We've guided between 30 and 50 basis points year-over-year improvement versus the fourth quarter of 2002. This reflects in large part the impact of the INSEEC, Western, and Whitman acquisitions and increased investment in startup campuses.

We expect 2003 capital expenditures to be approximately 88 to $93 million. That CAPEX estimate is up approximately $8 million from that which we issued last quarter. The cause for the increase is twofold. About a million dollars of that is associated with our acquisition of Western. The bulk of the remaining change is due to some opportunistic purchases of property and related capital spending for expansion. We have normally leased all of our facilities. In a couple of instances we found it more advantageous to look at acquiring real estate directly and have gone ahead and done so. I just wanted to point that out to you because it was a significant change from last quarter. I would also like to provide a little specific commentary again on online revenue guidance. We did talk about this at our last quarterly earnings announcement.

I would like to kind of reiterate that for our online business, there is a significant reduction in the number of earning days from the fourth quarter -- I'm sorry, from the third quarter to the fourth quarter. The third quarter had 82 earnings days in the quarter; the fourth quarter will only have 72 days. So basically, there's a 15% decline in the earning days. So that would put some downward pressure on the revenue growth. So I just wanted to make sure people understand that and have that in context as we talk about our full-year guidance for the online business. With that, I will turn it back over to Jack.

We'll take questions at this time, David, and I would tell you that we're going to try to finish this call today in one hour. So we will take approximately 40 minutes of questions.

Before we begin our question-and-answer session, statements made by CEC or its representatives which are not historical facts are subject to risks and uncertainties that could cause CEC's results to differ materially from those expressed in any forward-looking statements made for or on behalf of CEC. CEC assumes no obligation to update such forward-looking statements. Now we'll begin the question-and-answer session. If you have a question or comment, please key star one on your touch tone phone. If your question has been answered, please key star 2. As a reminder, please limit it to one question at a time. We will pause one moment for the first question, please. Our first question comes from Greg Cappelli from CSFB.

Hi, guys. Congrats on another fine quarter. I guess my one question, and I don't even have 15 sub sets to the one question, it is just a follow-up on the bad debt. I guess my question is, was there any reason why you kind of took the steps this quarter? Could you explain the timing of getting a little bit tighter on the credit? And do you -- you know, did you kind of get into the quarter and realize that there might have been an issue or a change in anything? And then, Pat, did you change any of the policy for reserves or anything like that? I'm guessing no, but it would be terrific if you could just address those.

Let me start kind of with the back end first. In terms of policies, accounting policy, there's absolutely no change in any of our accounting policies, in any of the reserve methodology or the methods for calculating bad debt expense or write-offs. All of that was maintained 100% consistently with past practices.

Okay.

In terms of the basic timing, you know, bad debt has been the subject of kind of intense focus and scrutiny throughout the industry for a period of time, and, you know, we've always looked at our collection experience and our results there as being an important aspect to the operations. You know, as I indicated before, bad debt -- you know, it's not that straightforward of a metric because there are a lot of things that can influence bad debt positively or negatively that have other impacts essentially in the operations. We really decided at this point in time to make a change, something we've looked at, we've studied for a long period of time, and, you know, we decided to make some changes there.

We absolutely recognize that some of the changes could have some short-term implications, although moving into those changes, it was, you know, not a very easy process to precisely quantify what the short-term impact of those things would be. We have indicated in past conferences that there continues to be upward pressure on bad debt due to title 4 limitations, and we've indicated that we're comfortable in making changes in our business in terms of price increases and the like, and that that's just -- I mean, that's just a cost of business.

Okay. It sounds like it was taken into your guidance anyways, the higher level that, you know, perhaps you're going to be dealing with for a little while here.

We knew that there could be that impact, yes.

Greg, just another comment too. It's Jack. We've got a very sound business model. We have an extremely healthy business organization. We try and serve a lot of different markets, a lot of different student elements out there. I think we've shown that we've been able to be successful, and having all the necessary quality and bringing in large groups of students, being able to graduate large groups of students and being able to help them as they proceed along with their education.

Okay, great. Thanks a lot and keep up the great job.

Thank you.

Thank you. And our next question comes from Matthew Litfin with William Blair & Company. Please go ahead, sir.

Yes, good morning, and let me add my own congratulations. Let me ask a question of Pat, if I might. You talked about the deferred tuition being up over 100%. Why was that so much stronger than revenue growth? Are you dealing with timing issues only, or what is different about the student mix giving you that additional visibility?

Well, what's going on there -- I mean, the same thing in terms of cash collection efforts, you know, broadly has a positive impact on deferred revenue. So there is -- you know, with the financing that's available to students, there is the opportunity to drive collections in some instances in advance of the time at which you earn revenue on them. And so any general effort that you make to improve your collection on receivables is going to have a positive impact on deferred revenue as well.

Okay. Thanks. That's helpful. One follow-up, if I might, for Jack. You mentioned, Jack, that your acquisition pipeline is full. I think we all know what your appetite is for acquisitions within post secondary, but I'm interested in your thoughts on activity, acquisition-wise, outside the postsecondary area, if any?

You know, from time to time we have looked at other types of acquisitions, you know, different types of fields, and obviously we haven't done anything in that area. There are certainly things out there that are certainly close cousins, I guess, to postsecondary education, but we certainly haven't done anything in that area.

Okay. Thanks so much, everyone.

All right. Very good.

Thank you. Our next question comes from Howard Block.

Jack, you opened up by saying that Whitman, I think you said, quote, has responded well to your marketing practices which apparently is a dramatic understatement. I was wondering, is the immediacy of Whitman's response, was that expected? Is that normal? I mean, should we expect a similar level of response on this, in other words growth, in the next few quarters on Whitman until your ownership anniversaries? And just a follow-up on that, were there any transplants or new programs that served as a catalyst for that dramatic growth as well?

Yeah, no, we didn't offer up any new programs. We felt they had enough on their plate. They certainly had some very good products on their own. Of course we stated this as we were going to do the acquisition, but we felt we could bring to the party immediately with more resources, more marketing know how, such things as making sure they had a full television schedule, direct mail, web page, any print media that might be available in their markets. The very attractive thing about Whitman is a lot of their schools either had tremendous markets or they were in very attractive markets.

I think by stepping in there and doing, frankly, what we did as we did AIU or done other acquisitions, this has certainly provided a very strong base itself. Just very responsive. We took the schools over July 1st. There probably wasn't much impact that we had in July so much, but certainly it came through and very dramatically in August and September. I think it's only going to get better because now we've had time to work with them, and some of the things that we're able to do have probably only been in the last 30 to 45 days. It's going to get better in the future and next year they're poised to have a very, very excellent year.

If I may cheat one more question in here. Just on the on-site same-school growth, it decelerated a bit down to about 11%. Is there a target range for on-site same-school growth for fiscal 2003, and should we expect to perhaps to stabilize around this level and then obviously pick up next year when some of these acquisitions move into same-store?

Some of it is seasonal, of course. There's a year-over-year comparison to some extent, but we've had a very strong summer and fall enrollment intake, the book futures are tremendous, they're way up over what we've ever done in the future. But let me ask Pat Pesch to talk about some of the historical levels and what some of our businesses look like over the last three or four years.

The seasonality of our same-school growth has been brought up in the past at this same time of year, you know, last year, and our historical patterns are for same-school numbers to drop 3, 4, 5 percentage points from the July 31 disclosure information to October 31. This year, you know, we were off about 4 points from 30 to 26 percent. You asked specifically with respect to on-campus operations. You know, in terms of a target for this year, you mention about a target for 2003, you know, we've always looked at kind of a mid-teen type range as being where we'd like to be on an overall basis, and I guess I would point out that does fluctuate from quarter to quarter.

We were around the 11.5% range this quarter and that was down kind of on a seasonally adjusted level from the middle of the year. We're not, you know, we're always looking for great results, we're not unhappy with that, and I think you can see from our financial performance in the third quarter as well as our increase in guidance for the fourth quarter is well in line with what our expectations were.

Great. Again, thank you, and congratulations.

Thank you.

And our next question comes from Richard Close from Jeffery's.

Really quick. Jack, you mentioned retention at the French schools as being the best in the system. Can you maybe elaborate a little bit on that and tell us whether you could take what they're doing over there and bring it here domestically to improve retention?

Sure, yeah. Look, in all of our system, we have different things that are out there that are best practices. One of the things we've discovered is these are very unique schools. We've got over 4,000 students in these schools. What we find is that students have to qualify to get in, there's a lot of tests that they take prior to entrance. France, of course, is a different setting. But once students get on a government list, if you will, and they're accepted at a school, they're expected to go to that school, they're expected to start there. And there's not just an easy transfer -- in France, if you don't like something or something frustrates you, you have a change or mind or whatever, that you just move on. There you're expected to start at that school, stay at that school, and graduate.

So the drop rates are just very, very small. They might equal 3 or 4% a year. And that's just unheard of when you look at kind of the, you know, American system. So, yeah, I mean, I guess there are some best practices that we're kind of studying now. I don't know if you could fully implement all of them, but there's probably more that we could do to transplant some of those things from over there.

And then just a follow-up, maybe on Howard's question, what is the utilization, I guess, at existing campuses for career education -- Career Education and maybe the Whitman schools in terms of maybe plans for expansions?

Sure. I mean, almost all the Whitman schools were very compact. You know, certainly the CTU group had, I guess I would say, a lot more space. You know, many of the Sanford-Brown schools were well-laid-out and very nice facilities. Some of the UDS schools were also. Some of the UDS schools were cramped on space, they were efficient operations, but to us that's an easy fix. You go out and you rent other space, you know, very near in the existing facility. And we have found that in every single case that we've had to plan on that or either do that, that we have been successful in putting that through. So that's one of those variable costs that you're glad to pay for because it means you're going to have more population and greater revenue and greater profitability.

Okay. Thank you.

All right. Thank you.

Thank you. And our next question comes from Mark Marostica from U.S. Bancorp Piper Jaffray. Please go ahead, sir.

Hi, guys. Great job on the quarter.

Thank you.

Pat, with your comments regarding online margins being higher than any campus-based unit, it appears that those margins could be as high as 30%, and I'm wondering, with the reduction in earnings days this quarter, if you expect those margins to kind of level out or moderate or stay around the same levels this quarter, and just ultimately, where do you think margins can go from here for online?

In terms of the impact on the fourth quarter, you know, we don't expect, you know, a fall-off in our operating performance related to less days outstanding where some of our costs are moderated as well in terms of educational delivery, etc. I think in terms of fourth quarter margin performance for the online group overall, it will be influenced by our ramping up of our Colorado Tech platform, but with respect to the AIU activities, you know, as a separate unit, you know, that won't be significantly affected by the number of days. It will obviously affect the revenue growth in the quarter, but profitability should hold up well.

Great. Then a question regarding your common and same-school revenue growth up 40%, same-school population up, I believe, 26%. Pretty big difference there. I wonder if you would care to comment on what's driving that big a gap?

Well, you clearly have some mixed change elements in there. It's not all kind of a higher price kind of per student basis, it really does have to do with where some of the growth is coming. Obviously a good portion of the revenue growth is coming from the online business which, with AIU Online's accelerated programs, the revenue per student is very high, so that's contributing to part of that mix change.

Great. Last question, Jack, you mentioned 50 program transplants for this year, some yet to come in the balance of the quarter. I'm wondering for next year, for fiscal '04, as you look out, do you expect the number of program transplants to be well north of 50, and if you would kind of care to comment on where you think that will end up?

Yeah, I think our early indication is, as we review budgets, that it should be equal to or greater than. We have a lot on the drawing board, there's a lot that we've -- that we have planned on doing, and I think it certainly would be, you know, well within the range of what we typically have done this year, I mean, but it could be larger.

All right, great. I'll turn it over.

All right.

Thank you. And our next question comes from Gary Bisbee with Lehman Brothers. Please go ahead, sir.

Hi, congratulations on another great quarter.

Thank you.

You know, I realize you're not providing any '04 guidance at this point, but I just wondered more big picture, given the online growth and profitability, the 50 basis points that we've talked about historically is obsolete at this point and specifically I wondered if you'd be willing to endorse a higher level of margin growth the next couple of years, or maybe next year, more like 100 to 150 basis points?

Gary, this is Pat. At this point in time we're not prepared to make that change, and let me talk a little bit about why I would say that at this point. We are absolutely expecting to increase our level of startup activity in terms of campus-based operations. You know, our start-ups to date have been -- we've been very, very pleased with and think the return prospects for that activity is extremely strong. But certainly it puts a pressure on earnings and margin improvement as we do more of those in the short term, and, you know, we will be kind of kicking that activity up a level starting next year. So that is one factor to take into account. We absolutely understand the question and will take that into consideration when we look at guidance for '04 when we provide that next quarter.

Okay, thanks. One just quick follow-up. You know, you've talked about the AIU and the accelerated format and CTU now giving you a more -- more normal format online. Can you talk about how you think about allocating resources between the two, and specifically, you know, where you, you know, expect to roll out new programs, you know, to one or the other, and I guess, ultimately, do you think one or the other has a bigger market potential? Just curious about how you think about this too.

Sure. This is Jack, I'll turn it over to Nick Fluge, who is the president of that group. We certainly want to serve all markets, we think that's been a big part of our success. When we first did our study and set up the online group, there was a tremendous market in the accelerated program. There certainly is a market out there that probably is looking for more of a normal paced program but still a full-time student, they pay a lot of money, we have high earnings on them, but somebody with a few different goals and how they want to proceed with their education. We feel great that we have this model, that we can frankly do both areas, because I do think it gives us an added advantage that very, very few other institutions have. Let me ask Nick Fluge to make a comment on that.

Sure. Just a couple of things. I would say that, as Jack said, we're very excited about this. AIU online has done great, great work. As we look at Colorado Tech, we have a really good regional brand. We'll turn that into a national and international brand. Right now we have four masters level programs. That was our [first] start. In January we moved to bachelor level programs in both business and IT. Students can begin at the freshman, sophomore, or junior. Programs are a little longer, 15 months, so it gives people a little more time to move through the programs. There is a market for that. And I guess I would say the earnings potential is every bit as vibrant. As you know, our students are earning in excess of $20,000 in a calendar year. That will continue.

So I think we can offer programs that are slightly different than what we might see at AIU. We can have a lot of success. And I will also say that we're able to scale effectively. We actually look to the OEG group now, which of course drove the AIU program, so the online educational group of CEC. We can basically take many of those things we built in house, or platform, or virtual campus, our course development, etc., and we can turn those into a different look and feel with regard to CTU. It's been very successful in the early going.

Great. Thank you.

And our next question comes from Jeff Silber with Harris Nesbitt Gerard. Please go ahead, sir.

Good morning. Pat, you mentioned a few times about how the Company is comfortable installing aggressive price increases. I was wondering, were there any price increases installed either on the ground and/or online over the past few months? What are the plans over the next few months? And then related to that, the roughly 12.5% sequential increase you're looking for in revenues between the third and fourth quarter, will that be price related or enrollment related? Thanks.

With respect to price increases, we've absolutely put in some price increases and will continue to do so. The one thing I think you need to bear in mind, our campuses are very distinct with respect to the timing of our price increases, so we do not put in price increases kind of in lock-step across our system. So it is a campus-based decision and execution, and it's program by program. So there have been price increases, there will continue to be. We tend to have them spread throughout the course of the year. Jeff, if you could repeat again the part of the question, I'm not sure I followed.

I'm sorry. It looked like you were projecting sequentially about a 12.5% increase in revenues between the fourth quarter and the third quarter. So again, I'm just, you know, going from third quarter to fourth quarter, is it more enrollment related or more price related?

It is more enrollment related. If you look at our historical trends, you know, we have a large concentration of new starts in September and October. So if you look -- you know, even kind of stripping away acquisition noise in our path, there's always been kind of a strong increase in revenue between third and fourth quarter, related to the up tick in the population.

Okay. Thanks for clarifying that.

And our next question comes from Corey Greendale with First Analysis. Please go ahead.

Good morning, guys, and congratulations.

Thank you.

A question about lead flow. Sort of on an absolute basis, you already generate an impressive number of leads. Do you think at some point you start bumping up against a lot of large numbers in terms of the growth in that metric? I don't know if you can give a same-school lead flow growth number, but sort of qualitatively, how much do you think Whitman contributed to that growth?

Well, you know, there's a lot of, you know, moving parts there. We spend a tremendous amount of dollars on that area. We do, you know, a lot of market research. We're very directly response oriented. We build budgets for the lead flow, we are very aware, you know, where the leads are going to come from, whether it be television or direct mail or Internet, etc. I mean, probably the lion's share of our lead success came from, you know, I guess I would call it our core group of schools that have been out there on site and certainly the online group. You know, Whitman tended to see a pretty dramatic increase just because of the, you know, added dollars that were spent there, but, you know, our lead flow this year certainly will be in the millions.

In terms of the law of big numbers, there are a lot of people who are looking for postsecondary education, both for on-site and online, and I mean we could spend a lot more dollars, we could generate a lot more leads, you know, in our approach. I guess it's very planned-out, I guess if you will, we look at history and we look at what we need to kind of give us the numbers that we need in the future. I will tell you this, there's almost no bumping up against each other when it comes to the on-site and online, they're two totally different markets, we run them as separate units, and they just do exceedingly well in generating their needed leads that they need out there.

And just quickly following up on that. Could you just talk for a second about the high school market, particularly how the start was there, and also lead flow coming out of the high school market?

Sure. I mean, there's lots of high school students out there. Our leads were up dramatically over last year. Part of that is demographics. You have more students graduating from high school than at any other time in the history of the country. You know, frankly this is a world-wide phenomenon. Here in the U.S., where we measure it in great detail, certainly we also do the same thing in Canada. But we find that there's lots of demand for these types of programs. We go in, we do presentations, we have special high school web sites that students find, and the lead flow this year and last year was up very dramatically. Probably overall between our various methods of attracting high school students, those probably will be up pretty significantly over last year.

So it is a market that we aggressively pursue because if you kind of look at our breakdown when it comes to age groups, in about 35% of our students, I guess they're probably coming right out of high school. The next biggest group would be young adults, that's probably in the 40% range somewhere, and then after that is the older students. So all those markets are very much alive and kicking.

Thank you. Our next question comes from Cliff Greenberg of Baron Capital.

You mentioned before - your online business margins are strongest in the company. Just a little sense of where the margins can potentially go in that business. You have your OPX is up showing their operating margins. Is it more probable that our margins will equal or exceed that in time as we get over the startup expenses from our rolling out the two programs?

Well, let me -- Cliff, this is Pat Pesch. Last quarter we were kind of asked the question about, you know, did we see being able to kind of get to University of Phoenix online level margins in the next few years? At that time I indicated that, you know, we absolutely didn't expect to take years to get to that level. And as has been indicated before, you know, our campus operations, our most profitable campus operations, are in the 30% range, and we're above those levels now.

In terms of where it can get to, we really don't see any reason that we can't ultimately be talking about 50% type margins, you know, just because of some of the leverage points in terms of delivery of, you know, an automated delivery of services, efficiencies there; limited investment in terms of occupancy costs, because you don't have the classrooms, etc.; efficient marketing delivery. So all those are leverage points, versus our strongest campus-based operation. So we really do foresee something in the 50% range --

That's after overhead of that division?

That is a fully absorbed margin.

Okay, great. And-- that's terrific. If Nick or somebody can comment on what's going well as far as the programs that you've rolled out so far in AIU, and what new offerings that you plan to continue to add to what you're teaching and what kind of starts you have planned for either later this year or next year, how many starts?

Sure, you bet. I mean, I'll just say across the board, we've seen really a lot of success in all of our programs. I can't say that one has not done as well as another. Most of our students -- under 50% that are coming in the business discipline, about 35% in IT, 11% in education. It's done very well. Rollout from earlier this year. Visual communications is doing very well at about 7%. We see a nice mix across the board with about 50% of our students coming from the bachelor level programs. We also have a very nice 25% in masters level program. CTU got a real nice kickoff.

So really across the board, I think students are coming to us from many different areas of interest. When Pat talks about margins, I'll give you a sense of where some of those are coming from. We do really good -- you know, why are we successful? Plenty of low-cost leads that are high quality and convert well. I think that's number one. Number two, great technology. As you know, Cliff, we do our own technology -- we put our hearts and souls into it. That means we customize around our students. That's number two. That leads to many things. I won't get into them unless you have a follow-up question on it. But that leads to point number 3, great customer service. So those three things drive our success online, and the customer service and technology lead to automated processes that lead to those high margins.

Great. And, Nick, so how many starts do you have the rest of this year and what's the plans for next year, and are there a lot more offerings that you're rolling out under AIU or CTU?

Sure. We have a start in November at AIU and also CTU. CTU is still the master's level. We have our next start in January, I think it will be really, really a sound start. I won't talk about the specific numbers, but I think it will be an outstanding January start. We hope to bring Criminal Justice into our AIU mix in January, so that would be a whole new discipline that would do great things. In terms of CTU, we now have masters level. We will bring bachelors level students in January.

Great. Next year do you have any idea how many starts you're going to have between either one of the two?

That's probably a number I don't know that we'd quote at this time, but it's going to be good.

Right. Congratulations.

Thank you.

Our next question comes from Brad Safalow of JP Morgan.

Okay. Just wanted to make sure you could hear me. Just on this issue of, you know, less reliance on title 4 as a source of revenue growth. Can you talk a little bit about the third party loan sources you have maybe as a percentage of revenues, the arrangements I know you have in place, how those have been trending as well as any traction or progress you've made in getting corporate tuition reimbursement either in AIU or CTU?

Let's start with the basic program that, you know, we have available. Beyond title 4, there's really kind of a category of alternative financing that's available from a number of sources to students, all of which is on a non recourse basis to us. Then we do have a recourse loan program and some financing that we do on our own balance sheet for students. To give you -- I can't give it to you as a percentage of revenue but I could give you a general feel for it on an overall basis. We have a recourse loan program with Sally Mae, and in that program we basically provide a 20% loss subsidy to Sally Mae, so our losses or recourse is limited to 20 percent on loans. That is basically a fill-in program to fill in the gap between what tuition levels are and what title 4 programs cannot fully pay for.

To give you an idea of the size of that program, our arrangement with Sally Mae is basically a $40 million program over three years so the kind of annual fundings available under that are relatively limited. And then kind of the lowest rung would be where we would take on the balance sheet risk, and again we do that in a -- at a controlled level in kind of similar proportions. So, you know, the great majority of our students are -- getting the bulk of their funding either through title 4 or alternative loan sources, and then we do have a level, you know, in-school payment collections for a number of students.

The really good news is we have the resources to pretty much work with any and all groups. I mean, a lot of our students are independent, meaning that they no longer depend on parents or things like that. Many of our students, the majority of them are probably dependent, which means they do depend on parents for some type of help, etc. And so, you know, we have a lot of different products that we can truly help any and all groups, from the online side, they certainly have a little bit different market because 94% of their students are working full-time, plus they're getting corporate sponsorship in many cases, and so I think that's something that's a little bit easier. But on our on-site campuses, there's also -- there's very little groups we cannot work with, and I think that's a real positive aspect of the capabilities that our overall Company has.

Our next question comes from Kelly Flynn with UBS. Please go ahead.

Thanks. Questions on attrition. I'd like to pose it to maybe Jake and Jack. You did say that only part of the attrition, you know, was because of the tighter credit standards. Could you just elaborate on what else you might be seeing there, kind of qualitatively and, you know, if it's one thing more than the other? And then secondly, sort of along the lines of an earlier question, I'm trying to get an idea of what the start are [inaudible] look like in the new schools? Could you give us what the starts were? Thanks.

Let me comment on the attrition. That's something that we work on -- I'm going to let Jake speak to it in a second because he'll go into greater detail. There are a lot of different things we do to help students while they're in our campuses. You know, we do a lot of surveys, we do a lot of quality control stuff, focus groups, etc. Probably some of the biggest reason students leave school overall is it does come down to student financing. And not just in terms of being able to afford school but to kind of being able to afford the cost of living and transportation and, you know, etc. So we'll help students with part-time jobs, we'll do whatever it takes, really, to work with them, as long as the student is willing to work with us. You know, I'd say that's probably been a little bit bigger factor here maybe over the past quarter or so with helping students with their financial resources. Jake, let me ask you to comment on that also.

Sure, sure. We're always addressing our retention efforts at all the campuses, whether it's from student advising, student coaching perspective. You know, as well as just making sure that, as we ramp up the population, so they don't get lost in the numbers and they feel like there's a sense of community within their discipline, within their school of choice; but also to let them know that there's a support structure there for them when needed, when things come up -- as they will come up. So we are getting a lot more proactive, and rather than waiting for a student to say they have a need or a concern is making sure all students are contacted and worked with and advised on a regular basis, especially from day one. So, again, we are looking at very different or a lot of different initiatives constantly at each of the campuses just so they know there's a lot of support out there. Not that they need it today but maybe tomorrow.

Kind of the flipside of retention is reenters. We've been very successful this year in getting students to come back to school. So sometimes over the course of a student's life, they may need to drop out for a quarter or two, they still see the value of education. But that number certainly has exceeded the budget in terms of what we thought, and we do have separate kind of marketing campaigns to let me people, come on back to school when the time in your life is right. That's at an all-time high. We feel very positive about that.

Kelly, with respect to the last question, I mean, we have not historically, you know, broken down our start data, you know, in terms of same-school and separate school. I think we feel we've provided strong information in terms of the breakdown of the population changes to kind of help you understand how the different activities are working and kind of where the core schools have been at with the same-school data.

Okay. Thanks a lot. That's good color.

Thank you.

And our next question comes from Robert Craig with Legg Mason Wood Walker. Please go ahead.

Can you hear me?

Yes.

Congratulations by the way. A follow-up on a previously asked question. Any thoughts on what average tuition price increases may be for '04?

Let me ask Pat Pesch to comment on that.

Sure.

Yeah. I mean, we'll look at a consistent range with what we've done in the past. I mean, generally we're looking at somewhere between 4 and 7, probably more typically averaging 5, although we will, you know, selectively we will look at more aggressive changes in a particular school for a particular program it's warranted.

With Whitman generally fall within that range?

Generally it would although we will look at some of those specific programs as to whether or not other adjustments would be appropriate.

Just a quick follow-up. You mentioned earlier about buying some real estate in advance. Are you also considering buying back any existing facilities?

You know, at this time we are, you know, kind of evaluated where -- you know, in a couple situations, where we're coming up for lease renewals and things like that, we're evaluating the options available to us, and that really kind of comes down to market-by-market what the opportunities are and what our needs are. We just had a situation there where this past quarter the difference between leasing and owning was -- it was just a very clear financial choice, and we went ahead and made that choice.

Okay, terrific. Thanks a lot, guys.

Maybe about one to two more questions here, if we could, please?

Thank you. Our next question comes from Mark Hughes from SunTrust. Please go ahead, sir.

Thank you very much. You had talked last quarter about Whitman going from dilution to accretion, I think about 6 cents worth during the third and fourth quarter. Should we still think about that kind of magnitude now?

What I would tell you is that -- we talked about kind of a two and a half cent dilution, three and a half cent -- two and a half cent dilution in the third quarter, three and a half cents accretion in the fourth quarter. With respect to expectations for the fourth quarter, we haven't changed them. We did do a little bit better -- a little bit better in the third quarter than we guided to.

Gotcha. As I recall you had three online enrollment starts in the May-through-July period and two this quarter. Does it make sense to look at sequential population gains on a per-start basis?

Let me ask Nick Fluge to take that.

Perhaps -- I don't know if I know the question exactly. I'll just say, every start has exceeded our previous start and every quarter has exceeded our previous quarter. We've been very successful with that. I know a number of people say, gosh, don't you have more graduations every quarter? How does your population increase? Well, clearly we go out, we get more leads, we get more enrollments, we get more starts. And as you've seen since our inception and as I see going forward, we're very confident that our total student population will continue to grow over time.

Yes, that answers the question. Thank you.

Thank you. Our next question comes from Trace Urdan from ThinkEquity Partners. Please go ahead.

Ooh, just under the line there. My question is whether the 50% margin guidance from Pat includes the key man insurance you're going to need to have on Nick at that point in time.

It does, it does.

My real question is whether or not you all are thinking about additional brands besides the online and CTU, you know, maybe looking at Katharine Gibbs or other brands in your stable as potential online programs?

Yeah. Let me just make an overall comment and I may ask Nick and Jake to comment on that because I think that's something we definitely have. We have some tremendous brand names out there that teach a variety of subjects. A lot of schools have been out there for, you know, many years, over a hundred years old. Certainly well-recognized names, some of the best in the business, whether it's Le Cordon Bleu or Katharine Gibbs International Academies, and we really have looked at the future, that perhaps we could do something like that as we move forward. Let me ask Nick to comment on that and see if Jake has any comment.

Sure. I guess I'll just say that we are, in fact, you know, in our strategies, we always consider new programs. We think that's big. And new platforms. And I think by the time we get to the end of next year, we'll be working on our third new platform. I remember the days when I looked at the Beatles and their songs were in the top 5, they had four out of five in the top 5. We hope to have four out of five of the top online universities by then.

I'm sure you will.

This is Jake, Trace. In the meantime what we are doing because I agree with Jack and Nick is we will be going that direction, is using some of their Gen Ed courses, they provided some of their technology, we rolled out our c-core, which are some gen eds online that that we are offering to our Brick and Mortar students. That is a whole separate section of what online has done that we're branding in that different segments or divisions that we have, Katharine Gibbs or the international academy, they are offering some of the classes online that we have an articulation or consortium agreement that those students take it that their home school although the backbone is being provided by our online group.

Sort of flex that is out there. I would emphasize none of those numbers are included in the online numbers. Our numbers are all separate. We simply act as a service center to our great brick and mortar sister schools.

We'll take one more call then.

Thank you. Our final question comes from Jennifer Childs from Bear Stearns. Please go ahead, ma'am.

Thanks. I'll keep it quick. What is the average online class size, and would you consider a spin-off of the online segment?

Let me ask Nick to comment on the class size. I'll ask Pat to speak to the spin-off.

Sure. Our class sizes are generally in the low 20s. I know other groups range from 10s, and if you go to the University of Michigan or Syracuse law school, you see numbers in the 100 range, we think we can do the 20s in student-teacher ratios, we think that can give us really good profitability. More important, the students and our faculty enjoy those numbers and can work with them. Part of the reason we have dynamic multimedia courseware, we have academic advisors and virtual learning labs for all our students, and we have terminally degreed instructors, meaning at the master and doctorate level, we have great rates which mean we have quality education, multimedia course ware. We're proud of those numbers. Some look at quality when they look at student ratio. We look at it by great student services. If you have those, you can ramp those numbers up a bit. We feel comfortable in the 20s with our faculty, our students, our accrediting bodies, department of education - they all say we're doing a good job,

One of the important things to realize -- this is Jack -- we do a lot of customer surveys, and we get very, very positive feedback from students in terms of responsiveness and our ability to interface with them. They love the product, they love the technology, and they're just very motivated student body.

And this is Pat. With respect to the question on spin-off. We have no current plans to spin off the online business or to set up a tracking stock or anything like that. Obviously, you know, we will always kind of look at opportunities and, you know, if a transaction like that turned out to be, you know, kind of in the best interests of shareholders, you know, we would have to look at it. But I say that merely as a theoretical. You know, we have to be open to the possibility. Absolutely no intentions at that time to do anything.

Okay, Pat, maybe one quick follow-up. If the max for the online is in the 20s, wouldn't that limit your ability to get to 50% margins?

If the max, you mean in terms of --

Class size.

-- the student/faculty ratio?

Yeah.

No, I don't think so. Because I think you've got -- if you just look at kind of the cost structure that we have, you know, throughout our system, one major leverage point, for instance, I mention our top-performing campuses are close to 30% in operating margins, online has an advantage versus them in occupancy. Occupancy costs alone generally would be in the 9 to 10% range for our brick and mortar schools as a percentage of revenue, and we're at a, you know, very modest levels on the online business. Nick also mentioned some of the efficiencies in terms of customer service of, you know, automated processes in terms of financial aid and other services, and all of those things really provide additional leverage points. And also, as you see, not only from us but others in the industry, you know, efficiencies in terms of student acquisition costs. I think all of those things, you know, are major leverage points, even without improvement in the academic delivery portion.

Very good. Thank you. At this time I would just like to make a final comment, and that is, that we have the confidence and the strategies in place to achieve our goals now and in the future, whether it be acquisitions, new start-ups, satellites, program transplants, advance degrees, seeking regional degrees in the markets it makes sense, international curricula and expansion. Our internal growth is extremely strong and we have a lot of confidence as we move forward to finish this year in a very strong fashion and on into next year. Thank you very much.

Thank you, gentlemen. Thank you today, ladies and gentlemen, for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.