Perdoceo Education Corp (PRDO) 2008 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the second quarter 2008 Career Education earnings conference call. My name is Jasmine and I'll be your operator for today. At this time, all attendees will be in a listen-only mode. We will conduct a question and answer session towards the end of the conference. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call Mr. Mike Graham, Chief Financial Officer. You may proceed sir.

Thank you. Good morning everyone, and thank you for joining us today for our second quarter earnings call. Joining me today on the call are Gary McCullough, our President and Chief Executive Officer and John Springer, our new Vice President of Investor Relations. John joined us on Monday. His background includes leading the investor relations and the financial planning and analysis functions at Telabs and Serva, two publicly companies here in Chicago area. John can be reached via the main investor relations line and we look forward to having John work with you, our investors and analysts, closely as we go forward. I will now turn it over to John.

Thank you, Mike, it is good to be here and I look forward to meeting all of you on the call today over the coming weeks. Now in terms of format for today's call, I will start by quickly addressing a couple introductory items, after which I will the call over to Gary McCullough. Gary and Mike will discuss the second quarter results and we will then open the call for analyst and investor questions. First, this conference call is being webcast live on the investor relations section of our website at careered.com. The replay will also be available on our site. If we are unavailable to answer the question during the call, please call our investor relations department at 847-585-3899.

Second, let me remind you that yesterday's press release and the presentations made by our executives may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on information currently available to us and involve risks and uncertainties that could cause our actual results, performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements. These risks and uncertainties include, but are not limited to, those factors identified in our second quarter earning release and in our annual report on form 10-K for the year ended December 31, 2007 and from time to time, in other filings with the Securities and Exchange Commission. Except as expressly required by securities laws, we undertake no obligation to update such factors or to publicly announce the results of any of these forward-looking statements to reflect future events, developments or changed circumstances or for any other reason. Now, let me turn the call over to Gary McCullough.

Thanks, John and welcome aboard. We are pleased to have you with us. Good morning. Once again, thank you all for joining us today on our second quarter 2008 earnings call. As John indicated, Mike Graham and I will provide details of our operating results for the quarter. We will also provide an update on progress we have made in addressing certain challenges we outlined in our March investor meeting and during our first quarter call in May.

I will begin by briefly recapping the quarter. Overall, I was pleased at our operating income in the quarter met our internal expectations. But I'm not pleased with our new start performance, particularly in our university online businesses. On a consolidated basis, second quarter 2008 revenue was down 2.2% from the second quarter of 2007. Excluding the transitional school segment, revenue was up roughly 1%. Again, excluding transitional schools, student population was up 3%. With the exception of our health SBU which continues to experience strong growth, starts for the quarter were down 3%, excluding the transitional school segment. During the first half of 2008 , we communicated detailed information on our challenges, opportunities and milestones over the next three years within our strategic plan. We also acknowledge significant structural and operational issues that needed to be addressed. Accordingly, our focus has been on reducing costs and improving a number of internal processes.

We have asked our organization to do a lot and over the first half of this year, we have done a number of things, including eliminating organizational redundancies, reducing our relatively high and inefficient cost structure, working to improve or eliminate underperforming campuses and better understanding the strength and equities of our brands to either better differentiate them or determine their long-term fit in our portfolio. Against this background, we also took steps to mitigate challenges presented by the credit crisis and we provided funding opportunities to many qualified students. We said in our February and May calls and at our analyst day that we were confident our actions would turn around the performance of the organization. We also said there would be bumps along the way. The second quarter was a challenge on a number of fronts, but we remain confident that we were taking the right steps to lay a strong foundation for long-term success. We remain on track to deliver the milestones we established for 2010. In the first quarter, we met our internal milestones and developed starts and operating income consistent with the plan we communicated to you in March. In the second quarter, we again met our internal operating income targets as the initiatives I described and structural changes we have made generated cost savings. However, new student start performance was below our plan. This was due in part to the lending environment, but it was also due in part to temporary internal issues in our online businesses that are being corrected.

Now I will speak more specifically to some of the challenges we faced this quarter and how we are addressing them. First I'll start with student lending. We expected second quarter starts in our culinary and art and design SBUs to be below 2007 levels due to the credit crisis and reduced third party financing alternatives for students with sub prime credit profiles. However, the impact of these issues was greater than we estimated and as a result, the culinary and arts and design delivered starts at the lower end of our expectations. Another factor impacting the business was the credit standards that we adhere to within our own student funding programs versus standards previously set by former recourse product providers. We're providing student financing programs from our balance sheet and the process is working smoothly. As we previously communicated and committed to, our objective is to provide financing to those students without access of third party private loans who will be able to complete their program of study and meet their financial commitments. We continue to refine the program based on our experience to date, and we expect more students to take advantage of it in the coming quarters. Like others in the industry, we are pleased that the higher education act was passed by Congress last week and we are optimistic that the President will act on it quickly. This is a positive move for our students and for the industry as a whole.

Now onto university. During the second quarter, we accelerated the roll out of the peer qualifier model in the university SBU. As a reminder, the peer model is a two step process where a representative screens and qualifies leads who are contacted using a predictive dialer technology. And then passes the highest potential leads to a more experienced admissions representative. We rolled this model out at CTU in the fourth quarter of 2007 and during the first quarter of 2008. The model worked well and CTU's results benefited from using this approach. In the second quarter, we expanded the peer model across AIU. Using the peer model in the university segment, we continue to see positive results. In the first half of 2008, we achieved a 12% reduction in cost per start while at the same time delivering 3% start growth. In the second quarter, the peer model also enabled us to reduce admissions costs by 11% versus 2007, and we handled the same level of lead volume with approximately 400 fewer representatives on staff versus 2007. At the same time, conversions have been solid and admissions representative turnover has improved. Despite these positive gains in efficiency, we encountered executional issues in our expansion of peer during the second quarter and our teams worked very hard to determine the causes of the issues and they are being remedied. As a result, -- pardon me, as we expanded and shifted personnel into the new model, we learned that our staffing levels were not in line with the predictive dialer programming. Put simply, there is a peak time that prospective students are available and want to be contacted. However, too often the peak time coincided with shift changes and maintenance downtime. We have adjusted staffing levels and altered the maintenance schedule as a result.

Was also learned that the pace of the outbound dialer was misaligined with our phone capacity and again, the availability of admission representatives. As a consequence, we did not contact leads in as timely a fashion as we have historically. As a result of that, we failed to capitalize on student interests in our programs. The issue wasn't immediately apparent, and a cumulative effect which led to some leads not being contacted at all. Since we identified the issues, we have made changes that have resulted in meaningful improvements. The peer model is a significant change for the company, both in culture and process, so I'm not surprised that we have had to address bugs in our system. Starts performance was directly impacted and available leads were not converted. Again, key issues were identified and the most significant ones have been reinvolved. But because third quarter starts are highly correlated with the late second quarter and early third quarter leads, we believe there still be might be a lagging negative impact on the third quarter. Despite these challenges, we believe the peer model will continue to help us reduce costs per start while improving productivity. We have seen it work. As I have said, excluding the international and transitional segments, our second quarter advertising admissions cost was reduced by approximately $3 million or 3%, while lead volume did not suffer. This gain in efficiency is meaningful as we seek to improve our margins and having identified the issues, we believe we will get starts back on track.

Continuing with our university business, we completed our AIU brand renewal campaign spending $9 million of our $12 million budget in the first half of 2008. The goal of the media spending was to increase awareness of AIU in key markets. Preliminary data for the brand campaign indicates awareness for AIU ground schools increased from 42% to 55% and awareness for AIU online increased from 30% to 41%. We are encouraged by this trend and continue to work hard at rebuilding AIU. However, it's clear we still have work to do, particularly at our ground campuses where we have got to overcome the negative press that dogs AIU during its probation for two years. As we expected, we are seeing positive movement at CTU with associate degree students matriculating into bachelors degree programs. While still early, approximately 1,800 students have already enrolled for the second part of a two plus two program as of June 30, 2008. This compares favorably with the historical conversion levels at AIU. The CTU online program recently became one of the few select -- one of the select few institutions in the world offering bachelors and masters project management that our credit the project management institute.

Moving on now to health. We are pleased with the performance of our health SBU as it continues to grow. Starts in the quarter were up 13%, revenue was up 11% and operating profit dollars and margin both improved on a year-over-year basis. We are also pleased that three of our health campuses were named ACICS honor roll schools while six schools received perfect (inaudible) accommodations from their accreditor, ABHAS. This recognition is important, as the health SBU has worked to continuously improve their programs and student outcomes. Health assumed responsibility for, and began integrating the Vienna, Virginia and Melville, New York Gibbs campuses. The schools are being conformed to the health SBU staffing, expense and academic delivery models including the phase out of most non-health programs. Those schools will benefit from a more focused health curriculum and they show significant financial progress in the second quarter. Collectively, the campuses are meeting planned income targets for the year and year to date, their starts are up 12% versus 2007.

We are also pleased to have renewed our agreement with Le Cordon Bleu International for an additional five years. The LCB renewal included no up front cash or other consideration by CEC and the economics are slightly better than our previous arrangement. Development and approval of a 21 month program that we previously discussed is under way and we are on track to offer this option to students in early 2009. We are also making good progress winding down our transitional schools. We were extremely pleased to have been able to sell the IDT Toronto campus to a respected buyer at the end of the second quarter. The sale was a 6% improvement versus the cost of teach out. We completed the teach out at Brooks Long Beach -- Brooks College in Long Beach, California in June and then the teach outs at IDT Toronto -- excuse me, IDT Pittsburgh and Gibbs Piscataway are on track with both institutions scheduled to close in December of this year. I will mention here that Gibbs Piscataway closing in December will be ahead of the schedule we originally expected, as we thought it was going to close before in 2009. Finally, I'm pleased that we continue to make good end roads in increasing employee engagement and reducing turn over. Our turn over rates have improved with overall turnover reduced by 19% versus last year and admissions representatives turn over down by 29%. This is an important find on the progress we have made on changing our culture to support the company's long-term goals. With that overview, I will turn it over to Mike for more details on the quarter.

Thanks, Gary. I'd like to start by providing some information regarding non-comparable items during the second quarter and the treatment of discontinued operations. Following that, I'll discuss our quarterly results including financial highlights and provide and update on a somewhat improving student lending situation.

As you review our second quarter results, please note there are two items impacting year-over-year compatibility: discontinued operations in 2008 and legal settlement costs in 2007. Regarding discontinued operations, upon the sale of the school or the completion of a teach out, all prior period financial results are reclassified into discontinued operations in the section within our income statement. As Gary mentioned, in June 2008, we completed the sale of our IDT Toronto school. That -- just to clarify, that was a $6 million cash benefit to the company versus our teach out. In addition, our Brooks College campus located in Sunnyvale completed its teach out activities in June. The results of these operations for the two campuses for all periods reported including the prior year have been reclassified and reported within discontinued operations.

Looking forward through the end of 2008 -- fiscal 2008, we expect to complete teach outs at three additional schools that are currently classified in our transitional school segments, our art and design IEDT Pittsburgh location, our Gibbs Piscataway location and Brooks College Long Beach campus. For these three schools, within the transitional segment results, the forecasted 2008 revenue is estimated to be approximately $5.7 million and 2008 operating loss is estimated to be $13.1 million. The results will be moved into discontinued operation in Q4 2008. As Gary mentioned, we were able to accelerate the completion of the teach out at Gibbs Piscataway into the fourth quarter of 2008 versus 2009. Upon ceasing operations at this school, we expect to record an additional pretax charge of approximately $5.6 million in the fourth quarter, which represents the remaining real estate operating lease obligation of the school. This charge was part of the estimate that we provided you as a one time 2009 charge in our March investor day presentation. So it's an acceleration of $5.6 million of the charge. A second non-comparable item is the $13.1 million accrual in the second quarter of 2007 for expenses related to the settlement of certain legal matters. Additionally, the district court approved a settlement of our shareholder lawsuit. In this case, the district court ruled in the company's favor. However, rather than spend money to continue the litigation once the plaintiff's chose to appeal, the company chose to settle. Approximately $4.5 million of the $4.9 million settlement was covered by insurance. The remaining amount was previously reserved by the company. Let me provide you some more detail on the second quarter. Second quarter revenue was $418.8 million, down 2.2% from the second quarter revenue of 2007 of $428.2 million. Excluding transitional schools, second quarter revenue of $398.3 million was roughly up 1% from second quarter 2007 revenue of $395 million. The increase was driven primarily by health and international SBUs and these SBUs continue to deliver solid student start and population growth and remain our strongest performers. Second quarter 2008 revenue for the university segment was $175.3 million, down 1.8% from the second quarter 2007 revenue.. Revenue for CTU was up 10.4% from second quarter 2007 while AIU was down 8.6%. During the first half of the year, both AIU and CTU have experienced slight improvements to start totals as compared to a year ago. But Gary spoke to the challenges on our conversion to the university SBU peer model and we continue to experience mix shift in the more associates degree based programs. In addition, as we discussed in the first quarter, our AIU ground business realigned its teaching calendar to be identical to the online calendar allowing students to freely move between the schools. AIU ground earned approximately $2 million less revenue in the second quarter 2008 versus the prior year due to this calendar alignment as the equivalent to eight fewer days moved into Q1, 2008. Again, with that alignment in Q3 2008, AIU online will see a benefit of the equivalent of six days moving from the first quarter 2008 to the third quarter 2008. AIU ground starts were 34% higher in the first quarter 2008 and 78% lower in the second quarter of 2008, both versus prior year. So for the six months of this year, AIU ground starts were down about 200 students. In total, excluding transitional schools and AIU ground, starts were flat versus last year's second quarter.

While we experience challenges on new starts during the quarter given the lending environment and peer model, we continue to work hard on reducing overhead costs and improving margins. Gary outlined efficiencies in our advertising, including the renewal of the AIU brand. During the second quarter, we continued to optimize advertising expenditures by ceasing any campaigns where the anticipated cost per start would exceed our investment criteria. This included elimination of certain third party aggregator campaigns via the internet as well as scrutiny of all off line media spending. In addition to the advertising media savings, we have also taken steps in other areas leading to better efficiencies. We executed several important programs in the second quarter in addition to our already tight cost controls. We continue to reduce head count in line with decreased revenue expectations. During the quarter, we recorded approximately $1 million in severance expense related to the elimination of over 275 positions with an annualized savings of approximately $13 million, and these were primarily in the culinary arts segment. These actions and future savings are incremental to the actions discussed in the first quarter and taken in the university and corporate segments.

We also continue to renegotiate more cost efficient service and outsourcing arrangements, many of which are outdated. For example, we signed a renewal and expansion of our IT infrastructure outsourcing arrangement with Axiom. Over the five-year life, we anticipate saving over $8 million versus our current contract. Regarding real estate efforts, we again continue to work hard. To date in 2008, we have released or backfilled approximately 90,000 square feet of excess real estate with an annualized savings of roughly $2 million. As we discussed at investor day, we will continue to seek opportunities to exit unfavorable leases and transitional segment real estate. We hope to be able to execute several more real estate deals in the second half of 2008 to remove the excess and transitional school operating leases. If we do find opportunities to exit real estate in 2008, this will again result in a portion of the charges forecasted in 2009 to move into 2008. Finally, we improved our overall margin performance, even with the higher number of new school startups, which experienced an operating loss of approximately $1 million higher than the previous year second quarter.

Let me turn to lending, Gary discussed the lending environment and the impact on starts. Let me give you a little more clarity on the impacts of the quarter. Given our decreased number of starts in culinary and in certain portions of the art and design segment, our student financing levels using our balance sheet were well below our anticipated levels. We also help students take advantage of the remaining available Sallie Mae recourse funding through March 31, 2008, which moved to anticipate student financing volume out of the second quarter and that to our balance sheet. Additionally, remember for financing agreements with students in the quarter they have not generated a full academic term yet of earned accounts receivable as they just began school. As a result of June 30, we held approximately $14.5 million of new student financing agreements on our balance sheet. This includes new originations since April 1 as well as carry over balances from programs we had in place before the credit crisis. This amount excludes the balances remaining under the previous Stillwater agreements.

Let me make sure everyone is clear on our accounting per student financing programs. We recognize interest income on a cash basis for this program. Interest becomes payable once a student is out of school. Interest received is recorded as a component of revenue on our income statements. Bad debt expense will be recorded with bad debt expense on the income statement and is being calculated in a similar fashion to the other receivable balances. As we explained earlier this year, we are applying an approximate 44% bad debt expense rate to balances outstanding in our new program, and we will adjust that rate once we gain the experience of the fall history of these cohorts. Also recall that expense related to our previous recourse fees with Sallie Mae ware recorded within educational expenses in our income statement and that expense will dissipate as those students end their terms under the recourse program. At our first quarter earnings call, I provided a forecast of balances outstanding as of December 31, 2008 to be in the range of $45 million to $65 million. With lower than expected Q2 starts, increased (inaudible) levels and increased staff levels, we believe we will no longer reach the low end that have range. Given the fluid nature of the lending environment and the calculations to be done for PELL and staff for the students join the institutions, we are not providing a new estimate at this time. Again, we are encouraged by the new higher education act provisions that will remove institutional loans and increase staffer loans from the 10% portion of 9010, and we continue to believe that 9010 will not be an issue at our schools.

As Gary mentioned, we commend this year's action taken by Congress and the White House regarding increased levels of Stafford and full year PELL grants. The increases in Stafford and PELL have relieved some of the tuition and fee costs that would otherwise have been shifted into private loans. This is a very positive development and has reduced our forecasted annual domestic cash revenues from private loans. Our 2007 10-K noted that the portion of cash receipts for the year and ended December 31, 2007 was 16.1% and our current forecast indicates this could be as low as 14% by the end of this year. In general, we anticipate that these changes will increase the number of students interested in our programs who will be able to meet their financial obligations with decreased borrowing and lower monthly payments on a per student basis. For schools with relatively larger gaps and private lendings such as culinary and art design, the changes will shift the need for private funding from those of our internal programs and third party programs into federal loan sources and the additional PELL grants will reduce the needs for loans. For other segments, the changes will reduce the overall amount of their federal loans taken by their students and make the programs more affordable.

Let me wrap up with highlights of our balance sheet and an update on our share repurchase program. As of June 30, we had $421 million in cash and investments and the quality of the investment portfolio remains strong. At the end of the quarter, we only had $13.3 million invested in auction rate securities reduced from $148 million as of December 31, 2007. Capital expenditures for the quarter were $7.7 million, or under 2% of revenues and our annualized DSO was 14 days consistent with that at the end of the year. The company did not purchase any of its shares during the quarter at the direction of the board of directors. For equity grants under our 1998 plan, if any entity owned 20% or more of the combined voting power of our common stock, a change in control provision would be triggered. If triggered, as of June 30, 2008 we would have recognized additional share based compensation expense of approximately $38 million during the second quarter of 2008. Approximately $30 million of this expense relates to the acceleration of compensation expense that would be recognized in the future for gap, but triggered earlier by the change in control. Under our 2008 plan which was recently approved by our stockholders, the change in control provision was significantly altered and ownership levels were increased to 35%.

In light of the current change in control provisions in the plans at 20%, the company opted not to buy back shares in the second quarter as that may have triggered a change in control provisions. As we have one shareholder a at approximately 19% ownership, the company could buy back up to 4 million shares without triggering the 20% change in control assuming no other purchases by a larger shareholder. The board determined it was not in the company's best interest to potentially trigger the change in control provisions through further buy backs in the second quarter. Two date, we have repurchased $604 million and still intend to execute the remainder of our $195 million authority once the board reinvolves the issue. With that, we will open up the line for questions.

Ladies and gentlemen, if you wish to ask a question, press star followed by a 1 on a touch tone phone. If your question has been answered or you wish to withdraw your question, press star followed by 2 q-and-a. Your first question comes from the line of Amy Junker. You may proceed.

Hi, thanks. Gary, can you talk a little bit about -- I'm trying to understand the reps that you cut or laid off, what -- can you help us, give us the confidence that this isn't what is impacting starts, that perhaps you cut too deeply there, just to make us feel a little better about that?

Amy, that is a good question. In fact, as we have gone through a lot of the data that's been presented to us and digging into the issues, I have asked that very same question. The fact is as we looked across the organization, we had quite a number of reps that aren't as productive as we thought they should be. ne of the things that's happened culturally is, given some of the challenges we have had in the past, there has not been, in some cases, the proactivity or the aggressiveness that doesn't cross the line with our representative force. We had representatives that frankly, were unproductive, and the reality is with what we -- the remaining representatives we have, with the changes we have made, they have become much more productive. We've seen across the board increases in their productivities, but it is a question that I have asked. It is a question that we are evaluating, but we don't believe, given what we are seeing, that that's the case at this point in time. I wouldn't hesitate to add back if we felt that was the right thing to do for the business. You can't cut your way to glory, that's not what we're trying to do here. We're trying to make sure that we have processes that are smart processes, that are efficient processes and will build back from those. And again, if it is necessary, we would add back, but we don't see the need today.

One other question, Mike, on the bad debt. That was a good level this quarter. Are you anticipating that that's going to go up? I know you are going to be internally funding less than you had originally anticipated, but should we expect that level will probably drift back up through the remainder of the year?

I would think so, because the balances for the students, both the serial loans and the originated loans in the second quarter, students will continue to build a receivable balance on their ledgers as they take more courses and as we add those loans and they grow, we will be applying that 44%. So the rate will tick up as we go forward.

Great, thank you.

Thank you, Amy.

Your next question comes from the line of Jeff Silber. You may proceed.

Thanks so much. Wanted to get back to the discussion about the peer model that you were talking about. Just so I understand, is that something that you have only installed in the university segment? Is that something you are thinking of installing in the other segments throughout the company as well?

Thank you, Jeff. The answer is we have only expanded this in the university segment. As I said, we began in the fall of 2007, experienced tremendous positive results at CTU. We continued that expansion of CTU in early 2008, recognizing the strong performance there, we extend the model onto AIU, which was always the plan. Again, we -- in some of those issues that I described, we worked to fix them and at this point, our plan is to expand it and make sure it is fully operational at university before doing anything beyond that.

Okay, great. Then just a couple of quick numbers questions. Your corporate and other costs were a little bit higher than what we thought. Was there any specific reason and where do you think that is going over time?

Specific reasons, at this time last year, the company was well out of its target for bonus, and for this year, since our operating plan metrics are on plan, we have got full bonus accrued. That's probably worth about $3 million of the $5 million lift. I think the remainder is related to certain allocations, because revenues are down, less the corporate expenses are allocated to the other segments. Again, the corporate numbers we've got and good savings year-over-year from a head count standpoint kind of masked with not only those two factors, but also, we have taken in more shared services. So our loan processing, our IT organizations also more centralized, shifting some costs outside of the business unit and into corporate. So we really don't give guidance going forward on specific segment data.

Okay, but just so I understand, should it be going down from here based on what you said?

Let me follow up with you. I'm not sure I want -- the details available.

You mentioned the real estate savings, what divisions were those in?

That real estate savings, it is across the board. The 90,000 of space we that took out was not one parcel, it was several parcels across the business unit.

Great, I'll drop back in the queue, thanks.

Your next question comes from the line of Gary Bisbee. You may proceed.

Good morning. I guess the first question, is there anything that can be done between now and next winter when you launch the longer duration culinary programs to sort of try to maintain revenue based profitability? Or are the declines we saw this quarter likely to continue and accelerate in the second half? I guess specifically one thing I'm wondering, is will the year end PELL grant sort of aide your recruitment a bit relative to the second quarter as we get into the second half? Thanks.

Sure. A couple of thoughts for you there. We have looked closely at the under writing criteria that we use for the culinary students and our focus has always been about completion and retention. We are looking at a lot of internal programs right now that stitch in the student better and keep the student through the process. As we get systems in place and we work with our team in the culinary group, we have some very good experience from low drops from the loans we have given, and if we continue to see positive results with keeping students in school with things such as credit counseling and other things that we can do to help the student complete, we may loosen up our FICO score bands and let more students in. The year long PELL will benefit the students a lot. It will move money off of their loans into federal funding in terms of their program, it will move money off of their loans into federal funding. It will also help retention, because the students will be able to make their payments better. Also, remember as you look at the press release, we have been dormant in our start up,s and right now, we have four start ups going. LCB Dallas, LCB Boston and two Kitchen Academy schools. Those schools collectively were a $2.5 million operating loss in the quarter which hurts the profitability of the business. Without that, we have about a 5% margin. And those schools, as those ramp up, should turn towards more profitability.

Thanks, and then the second question was on the CTU online starts. I understand your explanations for AIU, but CTU decelerated quite a bit. Was there some lingering impact there, or is there something else going on this quarter that caused that?

Remember, CTU and AIU are connected in terms of the peer model. So the dialer issues that we had in the peer roll out issues affected AIU hurt the entire university group, because those systems are commingled. So just like AIU, CTU had the same issues.

And then just one clean up one. CapEx was a lot lower. Is that likely a good trend number, or will that move back up as you continue to open some new campuses. Thanks a lot.

We still look at CapEx to be someplace between a 3% to 3.5% of revenue. It was just abnormally low this quarter.

Thank you.

Thank you.

Your next question comes from the line of Kelly Flynn. You may proceed.

Thanks, a couple questions. First, just revisiting the art and design and culinary starts. I know you mentioned the credit crisis as one of the issues there. Can you drill down on that a little bit more? Are you saying that students couldn't get private loans and that hurt or that they didn't want to take on debt, as it relates to the broader credit crisis and its impact on consumers credit profile and then maybe tie that in why you didn't lend as much off your balance sheet? Was it that the students didn't want the loans or you decided not to do it because you didn't like the credit profile.

Thanks. I think it is more driven on the first part of the questions than the latter. Which is, it was more about access. We don't think it was about affordability. It was more about access. Again, for those businesses we did get as much volume as we could into the Sallie Mae program as of March 31, so we did that. We have tighter (inaudible) standards than the recourse providers have previously done. As we stated, our goal was to take the higher level bands of the Sallie Mae resource funding and lend off our balance sheet, and the private lender market has contracted a little bit more in the quarter, making it go harder for students to get access. We thought our standards were fair because they're centered around outcomes and about graduating the students. They are centered around outcomes and graduating the students. As I said, in culinary, we're looking at expanding and going a little bit lower in FICO scores, because some of the programs we've put in place from retention, credit counseling, other things,and as we go forward, we'll look at art and design, about putting those programs in place there as well.

Mike, that 14% you mentioned, you were talking about the private loan, you thought it could be as low as 14%, is that comparable to the prior 18%? You think that could go down to 14%? Does that include your own lending program, or can you kind of explain that number a little bit more?

Sure. In our 10-Q and 10-K we have a disclosure table that shows the sources from federal money, the sources from private loans and the sources from cash and other. Our loans themselves are in cash and other. So, we are just saying that with the shift -- the higher PELL, the higher Stafford and the reduced access to some private loans and use of our balance sheet, we are forecasting right now that we think we can be as low as 14% from private loan sources versus 16% at the end of last year. You can see in this quarter's Q that we released last night, that our total blend is 14% right now, but obviously, as you go through a larger season and mix changes, it could tick up in the third quarter. But right now, we're looking at potentially being as low as 14%. Pretty fluid, though, to forecast what the balances are going to be at the end of the year.

And then relative to the $2,000 loan limit increase, I know last quarter -- I know you didn't say this, but it was inferred that you had said you were only getting $300 to $400 of that $2,000. Seems from what you're saying today on private loans that that is going up. Can you give a little more detail on how much of that $2000 you think you can now benefit from, given the change in 9010?

Well, 9010 has never been an issue for the company. The only place -- as we said last quarter, the only place 9010 was an issue was in certain of our healthcare schools, which has now gone away with a new legislation. In terms of the inferred $300 to $400, that was not our number. What we did was we went profile by profile of students segment by segment and tried to estimate how much of the $2,000 would help them, based on where their gap was and we came up with a reduction of our balance sheet that we disclosed in our first quarter press release. Given the different portfolio we have, the different gaps and the different students, I don't have a number that would say, is it X number or is it Y of the $2,000 that benefits us, because you have to go SBU by SBU, and we are not prepared to disclose that.

But it's safe to say that the 9010 change doesn't change that figure, is that right?

Correct.

The change in 9010 doesn't impact that at all.

Okay, thank you very much.

Thank you, Kelly.

Your next question comes from the line of Kevin Doherty. You may proceed.

Thanks. Just a follow-up on some of those questions. Could you talk about the outlook in starts, more in the context of the lending. How much of the lending headwind you saw in 2Q essentially goes away because of the higher loan limits or some of the other changes you are making and how much of that headwind might still linger?

Difficult question to answer. Again, we don't give guidance. We have given some forecast through 2010, our milestones, our cumulative growth of 6% to 8%. We have given you some cautionary terms here on university that will take some time to come back from the issues that we experienced in the second quarter. I'm not, again, prepared to talk about where we are segment by segment. Our health business is doing very well. The international business, as you know, is a very seasonal business because in Europe, the students do not attend a summer session. We will have starts in the third quarter for the international business, which we feel very strong about, it's performing very well and culinary art and design continue to have issues as we've talked about. We hope that the PELL grants and the Stafford levels will help us. The PELL grants, as you look at a calendar, the benefit of that with a full year, given that a lot of students do start in September, the full year impact on revenue would be next year, but it could impact starts in the fourth quarter as students look at their packaging levels and their affordability levels, but it's hard for me to give any more clarity to some of the details on the question than that.

One of the things -- I'll reiterate what Mike just mentioned is that third quarter starts are under way, and that really is comprised of what we saw in the second quarter, beginning of the third quarter. While these changes will be beneficial, we expect they'll take effect later in the year and benefit us more in 2009.

That's fair. Could you talk about exactly when you put in some of those fixes for the peer qualifier model?

Sure.The fixes have been under way throughout the month of July. They continue as we speak to you this morning. We expect that they will be up and running and we will begin to see benefit from those, and we're seeing benefit from them right now, but again, we will work our way through them over the next of couple weeks. It has been something that as the second quarter unfolded, we began to penetrate. It took a while to get to the root causes of the issues. Obviously, it takes a while once you diagnose them to put the fixes in place and those fixes are underway.

Could you maybe just drill down, why it was so successful initially at CTU, and then when it became a broader roll out, you ran into issues?

I think when we rolled it out with CTU, it was a small segment of the population. As we then rolled it out to AIU with the total reps in terms of the organization, it gets more complicated on the call arrival patterns and as the calls come in to maximize and optimize your staff profiles. Also, as we added more volume into the system and the dialers needed more phone capacity, we had to align the phone capacity technology with that. I think organizationally, as we ramped up quickly from a smaller test that was very successful, we were very bullish on the test and what we were doing, and just executionally, as Gary said, we expected bugs in the system. These bugs were tougher than we thought and we have taken a lot of actions to fix it.

I'll also add that AIU and CTU are different schools, and while behind the scenes we are backing them with systems that are consistent, a roll out in one place doesn't necessarily mean it is going to be a one-to-one correlation in the other place. They are in different institutions with different governing boards with different cultures and that is something we have had to account for as we move forward.

And if I could just sneak one more in real quick, I know in the past, you have mentioned becoming more productive with our internet lead buys and shifting away from TV, and you touched on that a little more in this call, but could you update us on those efforts? Was there any disruption on the start side this quarter or when might you start seeing some benefits on the cost side there?

I think we stated that we saw a $3 million benefit in the cost side this quarter in our starts per cost -- cost per start for the year down 12%. So we have seen a lot into that. We have done our shifting from aggregators into different advertising buys. Our team, led by Len Mariani who joined us in October are doing a really great job of understanding the system and understanding opportunities and I think we have more to come on that in the second quarter, consistent with Len's presentation that he shared in March.

One of the things I will say is that while we did go after what were clearly non-productive or unproductive leads, our total lead volume remained high, and so we feel good that the trade offs we have made from a quality point of view and from a cost point of view, the trade off was a good trade off. Ultimately, we mishandled some of those leads that came to us. We have to do a better job of that. It was clear in doing the analysis that we had lead sources that were not as productive as others, and we took those out. We will still look at what is the right mix of lead sources, what is the right mix of media. Those are changes we are making. There is no one size fits all answer, because of the differences that we see in the business. Some of them being online, and some of them being more local, so we're working through some of those things. But that is continuous improvement.

Thanks, guys.

Thank you Kevin.

As a reminder, please limit your questions to one. Your next question comes from the line of Bob Craig. You may proceed

Given the one question rule, I will try this one again. I was wondering if there is any way you can quantify or indicate the magnitude of the carry over impact on the starts in the university division in the third quarter? Is it reasonable to assume that we could be back to slight positive start growth year-over-year in 3Q?

The factors that are out there, you have the second quarter that you saw. You know we do have shifting on calendars. The AIU calendar shift is done. The online calendar brings in more earnings days into the quarter. We have to work through these systems, we have to work through the problems, which is on the negative side. On the positive side, we do have some improved packaging and affordability from a business standpoint.

Again, as you look at the businesses, I think they are in slightly different places. CTU has been on a roll. While it was impacted in this quarter by the issues as we expanded, we expect CTU to continue its strong performance. AIU, as we indicated, has more issues and we are working at delivering those. So there will be some balance in there.

Okay. Thank you.

Your next question comes from the line of Tracy Urdan. You may proceed.

Performance in the Sanford-Brown business has been so consistently strong. I'm wondering i-- this may seem a little bit out there and l I apologize for that. But is there was a potential for any kind of capacity constraints as you look at that particular line of business going forward?

Define capacity constraint for me, Trace.

Are going to fill up those skills and need to expand their physical plant or start to open up new schools in order to accommodate demand?

Sure. I will start by saying that we are obviously very pleased with what we are seeing in our health business. We think it is a growth business and as we look at how to grow the business, there are a couple things. First of all, new programs and George Grayeb, who's been that leading that business, has done a terrific job, and his team are identifying new programs and other programs we can expand to that are within their capability where there is strong demand. He and the team there have done a good job of making sure we grow in a controlled fashion. The other piece is graphic expansion. As we look at the geographies we are currently in, we think there are more opportunities in those geographies and we have identified several other geographies that we would like to expand to. You should expect us to be pursuing both those lines for growth.

Okay thanks.

Your next question comes from the line of Sarah Gubins. You may proceed.

Thanks, good morning.

Good morning, Sarah.

Could you talk about how you view underlying student demand in the art and design and culinary program? Maybe gauged by lead flow or other metrics? And then also if you can discuss the reasons for the attrition in the art and design business unit during the quarter.

Sure. In terms of lead flow, we feel pretty good about the underlying demand. When you look at the sheer number of leads that we had in the second quarter of 2008 versus last year, our lead flow was up 13%. We think that there is demand for the programs. Our program are quality programs. We are continuing to work on those programs. So, no underlying issue with regard to the lead flow. I will let Mike talk about the underlying other pieces.

I think retention standpoint in art and design specific to our question, I think some of the retention issues, we had slightly lower retention during the quarter than we did the previous year in the first quarter. Some of that, again, relates to packaging and to financing for students, affordability in terms of serial loans that for some reason, were not renewed or just affordability with the tightened loan environment. I think the other thing that is helping our businesses and will help our businesses going forward in terms of the underlying model is our shift to more local markets, as we've talked about, that our culinary schools were built on a national footprint, and drew a lot of students nationally, which comes with it tuition and housing costs.. There is some of that also for art and design, because we have ceratin institutions like Harrington and like Brooks that are great institutions with top quality programs that draw national students. And part of the challenge on art and design is to continue, especially with the academy schools, to stay more local than national, to make the affordability better on a tuition standpoint. But the demand for art and design was very strong. We ramped up our online program, as you know. n the early parts of our online program, some of the same phenomenon happened with packaging, that certain students get into the online program and they do drop early on because of some of the packaging and cost needs which, as we rolled it out in the first half of the year, we've had a little bit higher attrition issues than we like in the online portion of the arts and design business.

Sara, there is only one thing I would add. I looked at the attrition issues as well and one of the things that came to light, that I pushed on was about 40% of the attrition we saw in the quarter was due to academic issues. We saw -- we are going to continue to hold a high standard, but about 40% were academic issues, a lack of satisfactory academic process and other issues that we drove and drove some of that attrition. At the end of the day, we want to make sure our programs are quality programs and that we have students that should be there so that they can interface with other students. So while there were funding issues, we drove some of that attrition as well.

Okay, thanks very much.

Your next question comes from the line of Corey Greendale. You may proceed.

Good morning.

Good morning.

Just waned to go back to the impact of lending for a minute. When you talk about the changes impacting more than you were anticipating, did you tighten your own internal credit standards more than you anticipated, or are you saying that you were figuring there would be lenders who would be willing to provide that gap financing for people who were not meeting you credit standards and that has dried up?

I would say on the latter part of your question, we did anticipate a little more access in the private markets, especially some of the higher previous recourse FICO scores, I think that market, Wachovia and other people have left that market, so that has an impact. I don't think we -- I know we haven't tightened up our credit scores. What we have done, as you recall, we have required in school payment of students between $50 to $150. We have also required co-borrower arrangements. We have pushed our students heavily on co-borrower requirements. In the past, we weren't as diligent as we could have been getting co-borrower. When you asked a student for a co-borrower, you naturally will have the potential of losing some starts. In the end, it is better to have a co- borrower. Much better student success when they have a co-borrower. We may be his able to loosen that up over time, our co-borrower requirements. But those factors probably drove us, again, towards the lower end of our range. We weren't surprised by the decrease. It was just the lower end of our internal model.

Corey, one of the things I'll say is that as we were rolling out what is, frankly, for us a new process as we are doing some new things, our tack was to be a bit more conservative up front. Because if you do that and you learn, you can go back and loosen the reins some if it is wanted to do that. It is more difficult to do that the other way. So we learned things early on in the quarter that will help us make some changes as we go along. But we are not going to lend our money lightly, and we will hold a high standard.

Thank you.

Your next question comes from the line of Brandon Dobell. You may proceed.

Thanks. Guys, how should we think about where we see the impact of the CTU students going onto the second part of the two plus two program? Is it going to be in starts, continuing students, how should it play out from a reporting perspective?

Let me defer that question. I will check again when you matriculate out of the two plus two program whether we consider that a new start or not. Obviously, you are going to see the benefit. The population will not change, but you will see an up tick in the revenue per student for those institutions as the students go into the second part of their program, which we've had a lot of success with 1,800 students to date. You will also see a reduced cost per start so to speak, a reduced marketing cost, because these students are matriculating out versus new student acquisitions.

kay. And in line with that, as you think about the next two years, compound growth for the university division from an enrollment perspective, what kinds of assumptions are you making for the sustainability of that CTU matriculation into the bachelors programs? Is it a significant part of that enrollment growth from a support perspective, or is it just a moderate contributor and it's really about generating organic bachelors students?

We have assumed that in our long-term models, that CTU will resemble AIU. AIU has had a historical 50% success rate of the associate to repopulation on their two plus two program matriculating up to bachelors. So we have used that consistent in our model for CTU.

Anything within the university this quarter from a retention perspective that was notable, either good or bad, as you think about both CTU and AIU, either online or off line, for that matter?

Again, nothing specific stands out. Across the company, the attrition levels have ticked up versus where we have been. Some of that due to financing, some of it due to academic progress and standards we've had internally, but nothing stands out from anything different on the university group.

Thanks.

Thank you, Brandon.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Mark Marostika. You may proceed.

Thank you. Gary, I know you are not giving specific start growth guidance for AIU and CTU online, but I'm curious, for the month of July, can you give us a sense of the relative performance for both units CTU online and AIU online in terms of start growth, relative to the second quarter? Was it up or down?

Mark, I won't give you specifics, but we are pleased with the progress we are seeing.

Just to be clear, in our business, given calendar shifts and start dates and the amount of acquisition time for a student between starts, monthly starts could be pretty misleading versus looking at it quarterly, which has a more comparable basis than before. So month numbers by themselves are not all that informative at times.

Just trying to gauge the speed of improvement. But -- go ahead.

I know you are looking for something that you can hang your hat on. Candidly, we are early in this. We can tell you that at AIU, we have seen improving show rates. We have seen improving conversion rates, we've seen improving referral rates. So all the things that we would look for to demonstrate that we should expect improvement are beginning to line up, so sequentially, kind of start-over-start, we are seeing those, and July was a continuation of those things based upon the changes we have made. It is a start when it is start. What we have is we have enrollments, we have people that we're working to package. We've got to get them to the front door, but we are seeing positives this is all those things, but we have got to make it happen for our starts throughout the balance of the fall. All the underlying things, we are seeing improvement.

Thanks for the color on that, Gary. Switching gears, outside of culinary where you have obviously been able to trim a good deal of head count, are there other areas you would point to where you think the cost structure is maybe more bloated or you see opportunities to trim costs significantly?

Again, from our standpoint, we have done a very good job on margins. We have done structural head count reduction programs at corporate university and culinary based on population. We continue to look at costs across the board. I wouldn't say any of our organizations are necessarily bloated. I believe as you look at some of the historical investments the company has made, be it in real estate or be it in administration areas or other areas, it is time for us to just look at every cost carefully and make sure it is a necessary cost to educate the student. As we look at outdated contracts, we have got contracts -- our (inaudible) contract was five years old. We went back to market with that and saved $8 million. It is more of that than a bloated organization. It is more of just being smart about our money and continuing the tight cost controls we have.

The only thing I would add as well as that, one of the things we've done is we have begun to ramp up accountability in the organization. Where we find that we have people who, for whatever reason aren't performing their jobs well, but want to do a better job of helping them to do a great job that they have been hired for or we'll counsel them out of the organization. So, we have asked the organization to do a lot with regard to new processes. We did take out what we saw as head count that was unnecessary, but as I said earlier in the call, we don't believe you can cut your way to glory. At the end of the day, we need to grow. But the changes we have made were changes that were aimed at, ultimately allowed us to grow, but grow in a way that was responsible and that will deliver results over time. That's what our focus has been, we will continue to examine the organization where we think either the process -- the structure was not right, we will go in and deal with those. We will also take unnecessary costs out of the organization, but we will begin to shift out of that mode into how to grow.

Great, thank you.

You have a follow-up question from the line of Kelly Flynn. You may proceed.

Thanks. Sorry to beat a dead horse on this balance sheet lending thing. But the comments you have made, I'm still having trouble with. I don't understand why you would lend less off of your balance sheet if your credit standards haven't changed A, and if B, the students that have gotten rejected from private loans, I guess at a greater pace than expected, weren't students that you would have lent to in the first place. Meaning, if they hadn't got a private loan, they wouldn't have been on your balance sheet. So, is there another demand issue that you mentioned that is contributing to this? I don't know if there is any more color you can give on that? Thanks.

We gave a lot of color on the script that we went through. I'm not sure I can add much more. Again, we did package up students under Sallie Mae. The co-borrower issue, that w're asking for co-borrowers did turn into a potentially slower process as the student goes and attains a co- borrower, versus in the past, they did not need to have a co-borrower. That may have slowed things down moving into the next quarter. Just a couple thoughts for you in addition to what we've said.

As Mike said in his script, we said that we would lend at the high end of the range that some of the lenders, the recourse lenders departed, and we have stuck by that. We have gone to a FICO level that was higher than previous, and so there were a number of students that might have qualified previously that would no longer qualify, and again, as we have gotten a history with some of those students, we have run the data and it suggests that we might be able to be a little bit looser going forward, we'restill working that one through. But we aim to fill a void without extending credit to students who it was clear in our data, would likely not graduate and would likely not repay the loans.

I think just to close that point, a little bit, also as we said, it was more based on our estimate than necessarily any results, so we made our estimate last quarter and in March as we went through a lot of the crisis and lenders moving out, and all the shifts that we had to do, we made some broad estimates, and without a lot of data , because Sallie Mae has a lot of data obviously, as the largest lender in the industry. So we had made an estimate. We are at the low end of our estimate range, but we have seen anything from a model standpoint that concerns us from a change in the lending standards. It is more driven by what our estimate was.

Okay, I got you. Thanks a lot.

Thank you.

You have a follow-up question from the line of Brandon Dobell. You may proceed.

Sorry about that. You talked a little bit about credit standards in general in the Stafford and PELL impact, is it fair to assume that within culinary that the kind of that long-term guidance you gave for the revenue impact in that division will be less than that 50 or 65 or so that you talked about historically, or is that still a good number to think about, it's just more about the timing or the trajectory, how to get to that number, or maybe it was off to a slower start towards that number than we may have expected.

I think it's more towards the latter. Again, with four start ups right now in the pipeline, we are changing the model from to 21 -- from 16 or 15 months to 21 months. One quarter, as we just started the lending process, I don't think it necessarily takes us off of our model. It is a slower start in the trajectory and we will continue to update our model through every year strategic plan cycle to tune it down. I don't think one quarter puts us off of our three-year plan.

In that same vein, should we expect you guys to change credit standards outside of culinary, or is that really just one business where the gap was sufficient enough that the standards can move around a little bit? Should we expect you guys to make that same move over at university or health or art and design and things like that?

We have credit standards that are built on each organization. I think what we were saying was that where are an organization like culinary is taking extra steps to put in place better retention tools than what we have had, better help to get the students through the the process, we are willing to take some more risk on a FICO score basis, because we have confidence that that student will be more likely to graduate. I don't think it is changing FICO scores by division. On culinary, it's simply a matter of, we've put resources in a place that we are seeing some very good progress with.

Thanks.

Thank you.

There are no further questions at this time. I would like to turn the call back to Mr. Gary McCullough for closing remarks. You may proceed.

One thing I want to thank you all for joining us on the call. As I noted, the turn around of this organization won't be easy and it won't be fast, but we are confident that it will happen. We have both operational issues and cultural issues that we're addressing here at the organization. We are on task, we're focused on what we are doing and we're meeting our plan. We have made progress in making a number of the changes that need to happen for the long-term, and we are confident that ultimately, those changes will result in strong financial results down the line. For the last two quarters of this year, we'll continue to reinvest in our core businesses, we'll continue to execute on the items that we've talked about and we're working to build a foundation for long-term, sustainable growth. So again, thank you for your interest,, thank you for your questions and we look forward to talking with you again soon. Thank you.

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