Perdoceo Education Corp (PRDO) 2009 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the third quarter 2009 earnings conference call. At this time, all participants are in a listen only mode. Later we will conduct a question and answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. John Springer. Mr. Springer, you may begin.

Thank you. Good morning, everyone, and thank you for joining us on our third quarter 2009 earnings call. With me on the call this morning are Gary McCullough our President and Chief Executive Officer and Mike Graham our Chief Financial Officer. Following remarks made by management, the call will be open for analysts and investor questions. This conference call is being web cast live on the investor relations section of our website at careered.com. Replay will be available on our site. If we do not get to your question during the call call our investor relations department at 847-585-3899.

Please note that our financial and operating results for the third quarter 2009, and 2008 include operating losses associated with schools currently being taught out as well as other significant items that impact year-over-year comparability. Unless otherwise noted, the operations and financial measures discussed on this call will be on a non-GAAP basis which exclude these items. A reconciliation of the non-GAAP discussion to our announced GAAP results can be found as exhibit in last night's news release which is available on our website under the Investor Relations tab. Before I turn the call over to Gary, let me remind you that yesterday's press release and remarks 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 future 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 quarterly earnings releases, our annual report on Form 10-K for the year ended on December 31, 2008 and our quarterly and other filings with the Securities and Exchange Commission. Except as expressly required by Securities laws, we undertake no obligation to update the risk factors or to publicly announce the results of any of these forward-looking statements to reflect future events, developments or change circumstances or for any other reasons. Now let me turn the call over to Gary McCullough.

Thanks, John. Good morning, everyone. Thank you for joining us on this morning's call. I'm going to start with a brief overview of our third quarter 2009 results. When my remarks are concluded, I will turn the call over to Mike Graham, Executive Vice President and Chief Financial Officer will provide more detail.

As a reminder the financial results I will discuss exclude the impact of our transitional segment and certain other significant items as detailed in last night's earnings release. Across the board we were very pleased with our third quarter results and our continued progress. Once again we improved operational and financial performance in our core segments. In fact, the third quarter represented the first time since 2005 that all of our segments delivered a year-over-year increase in revenue. I'm proud of the effort of our teams for their strong execution and delivering on key elements of our turnaround plan which was aimed at repositioning our core institutions for sustainable growth. In the third quarter, we generated strong results on a number of key financial and nonfinancial metrics.

During the quarter, we welcome 37,670 new student. The highest quarterly new student start total in the company's history. Importantly, we graduated 13,000 students in the third quarter bringing the cumulative total number of graduates across our institutions to over 444,000. As of October 31, our total student population of almost 114,000 is also the highest in the company's history. The third quarter was also the tenth consecutive quarter that we experienced year-over-year improvement in employee turnover. Our performance reflection of both the value students derive from our schools and the commitment of our employees.

As I just mentioned, total student population grew to almost 114,000 by the end of October 2009. This was an 18% year-over-year improvement. The higher rates of student population growth drove a 17% increase in revenue and led to another significant improvement in operating margins. In the third quarter, operating margins expanded by over 860 basis points resulting in operating income of $61 million or over 200% growth versus the third quarter of 2008.

As a result of the improvements in revenue, student population and margin ,we are now on pace to significantly outperform our 2009 internal plan for operating income. I want to put our operating income improvement and performance into perspective. For the 12 month ended September 2009, we reported normalized operating income of $218 million. And based on our current revenue trends we were on track to deliver operating income in 2009 within the low end of the range of our 2010 milestones. This would put us one year ahead of schedule on delivering our previously communicated objectives.

Our 2010 operating income milestones were set during my first year of CEO during a period of great uncertainty including the collapse of the student private lending market. Since then we navigated significant challenges and we made a number of changes to improve company operations. While we had some benefit from a strong market this year, the actions we took enabled the company to better capitalize on market conditions. Further and more important, they will help us continue to perform well as the market continues to evolve.

Now let me comment on the highlights from our third quarter. We talked a lot about health education segment this year. And they have been on a terrific run in the third quarter was no exception. Health continued strong performance delivering over 30% growth in both student population and revenue. Importantly, we also continued to invest in career services personnel at a faster pace than student population growth that continued to enable strong outcomes for our students as the institution grow.

In the third quarter, we also converted another transitional school Gibbs Farmington to help. Including Farmington, we opened three new health campuses so far in 2009. And we are on track to open four or five more by the end of the year. As a result by the end of 2009 we will have grown the health campus footprint by one-third if solid platform for future growth.

The university segment also delivers strong financial performance in the third quarter with 20% revenue growth in the sixth consecutive quarter of operating margin improvement. More importantly, our admissions functions have continued to improve. As I'm sure you recall, while we have strong lead flow in student demand in the first half of the year, we were unable to translate that demand in the new student start growth while overcoming efficiencies within our admissions operations. We made several organization and process changes which aided our third quarter results and which we believe will continue to aid AIU and CTU going forward.

In CTU, the improvement accelerated new student start growth to 20% in the third quarter. In AIU, the improvements begin to take effect later in the quarter. So I don't believe AIU's 7% new student start growth in the quarter fully reflects the progress the team has made. Lead flow in university remains strong as we exited the third quarter. Accordingly, we will maintain higher rates advertisement investment to take advantage of the demand and expect this to result in further improvements in new student start growth in the fourth quarter.

Now let me take a minute to update you on the status of AIU new program initiatives. On our last call I mentioned we had (indiscernible) AIU to introduce new programs in early 2010. At this point it appears new program introductions will take longer than I expected.

In terms of background, in May 2008, the higher learning commission made certain recommendations to AIU as part of its initial grant of accreditation. They indicated then that they will schedule a focused visit at a later point in time to assess progress versus their recommendations. After submitting new programs for approval, HLC advised AIU in October that the granting of new program approvals will be subject to satisfying certain recommendations that were associated with the initial grant of accreditation including the completion of the focus visit. As a result the introduction of new programs at AIU will be delayed beyond our previous estimate.

While I'm disappointed the progress was taking longer than we initially anticipated, the team at AIU is moving quickly to address the recommendations. I expect to see continued improvement in AIU's performance as we close 2009.

Culinary continues its impressive progress in the third quarter, as student population growth accelerated to 21% from 6% in the second quarter. Thanks to two consecutive quarters of 50% plus student start growth, culinary now has the highest student population in its history. Demand remains strong across the 15 and 21 month programs in a third quarter, we generated our first new student starts in culinary's on-line bachelor's program in new growth area for us. During the quarter, we also completed the purchase of the LeCordon Bleu branding rights in North America which gives us the ability to brand or schools more consistently under the Cordon Bleu name. The rebranding initiative is underway and we expect to complete it in early 2010. With that, I will stop and turn the call over to Mike who will provide more detail on our financial results.

Thanks, Gary. Let me begin by providing the financial details on the third quarter results, our progress against the previously stated against the previously stated 2010 milestones and our share repurchase activity. As you review our results for the third quarter there are a number of items impacting the year-over-year comparability which are detailed on the table in last night's press release and exhibits and available on our website, careered.com under the Investor Relations tab.

For the third quarter 2009 operating included first transitional school operating losses of $7.4 million or $0.06 per diluted share. Second, we recorded $18.8 million or $0.14 per diluted share for performance based compensation expense in the quarter to reflect the significant over achievement of our 2009 operating earnings relative to our internal bonus plan. From a segment perspective, $4 million of that adjustment is in university split evenly between AIU and CTU, $3.5 million in health education, $2 million in culinary arts, and $2 million in art and design, and $7.3 million in corporate and other. Also included this year incorporate and other is a non-cash charge of $2.5 million or $0.02 per diluted share (indiscernible) reduction of asset carrying value at a company owned dormitory.

In a third quarter of last year, there were first transitional operating losses of $8 million or $0.06 a share. Second, $9.7 million or $0.07 per diluted share in lease termination charges in culinary. And finally $6.8 million or $0.05 per diluted share associated with eight asset impairment charges. $4.8 million of which were in culinary and $2 million in health.

Otherwise noted during the remainder of this call my discussion on the earnings and results will exclude these items.

Now to the results. All key metrics will improve for the quarter. Our new student starts and student population were record levels and our retention and show rates continue to improve over the prior year. In a third quarter, revenue was $457.5 million, an increase of 17% over the prior year quarter. As Gary mentioned, the acceleration in revenue growth drove significant operating leverage in both educational services and G&A expense in the quarter resulting in operating income of $61 million in the quarter up over 200% from the third quarter of 2008. Operating margins reached 13.3% in the quarter,representing 860 basis point improvement over the 4.7% margins in last year's quarter. For the 12 months ended September 30, 2009, operating income excluding the transitional segment and excluding the significant items totaled $218 million.

So as you can see we are already approaching the low end of the previously communicated 2010 milestone objectives of $225 to $270 million. As a reminder, this range does not include the $15 to $20 million of additional benefit from the LeCordon Bleu transaction. On the same non-GAAP basis revenue for the 12 months is $1.75 billion resulting in operating margins of approximately 12%.

As of the third quarter, each of our core institutions is at or above our 2010 operating margin objectives, enabling us to reach the milestones on a lower revenue base. This improved level of margin performance coupled with the student population of 18% higher than last year as of October 31, 2009 put us in an exceptional position as we enter 2010.

With that as a backdrop, let me now review the third quarter results by segment. In university, third quarter 2009 revenue is $206.8 million, 20% higher than last year, reflecting the accelerated student population growth also up 20%. University operating income is $44.9 million, 6% higher than last year and operating margins were 21.7%. 590 basis points higher than last year and sixth quarter of improvement. Revenue for AIU was $107.2 million, up 13% from 2008's third quarter reflecting 14% increase in student population. AIU's operating profit in the quarter was $25.5 million as compared to $16.2 million in last year's third quarter. Operating margins increased 670 basis points to 23.8%. The fourth consecutive quarter of operating margins of 20% or more for AIU. CTU had a very strong quarter with revenue of $92.8 million. Up 30% from the third quarter of 2008 reflecting a 27% increase in student population. CTU's operating profit was $18.9 million in the third quarter, up 63% versus last year.

Operating margin was 20.4%. Up 410 basis points over the prior year.

In culinary arts third quarter revenue of $91.6 million was 7% higher than last year's quarter. And a 21% increase in student population was partially offset by declining revenue per student as a result of the mix shift towards the 21-month program. Culinary arts operating income was $9.4 million, as operating margins reached 10.3% of revenue as compared to 4.7% in last year's quarter. Since the close LeCordon Bleu transaction on August 21, we recorded one last month of royalty payments increasing this quarter's earnings by $1.5 million or 1.6 margin points of operating margin benefit in the quarter. From a modeling perspective, remember in the fourth quarter we get the full quarter of benefits which will result in 450 to 500 total basis points of margin improvement if culinary.

In the third quarter, health education continued its excellent performance with revenue for the segment of $78 million, up 31% from third quarter 2008 driven by a 32% increase in student population. Operating income was $16.4 million in the quarter. And operating margins were 21.1%.

Start up operating losses totaled $2.3 million in the quarter. Excluding startups, operating margins were 24.2% in the third quarter.

As we look forward, we expect the operating losses associated with the start ups to be approximately $7 million in the fourth quarter and $12.5 million for the full year of 2009. Art and design operating income was $9.7 million in the third quarter, up from $3.8 million in last year's quarter. The increase in operating income was primarily driven by the calendar and curriculum alignment efforts within IADT which resulted in higher levels of student population and timing related benefits and bad debt expense during the quarter.

Finally, 2009 third quarter revenue for international segment was $15.3 million. Up 22% from the third quarter last year. Internationals operating losses is $4.5 million in the third quarter versus a loss of $5.2 million in last year's quarter. This reduction in operating loss is driven by currency benefits which was approximately $1 million in the quarter. Operating loss was annual experienced in this segment for the third quarter as our academic calendar is traditional nature with few summer sessions. Corporate costs of $15 million in the third quarter. Down from $16.9 million last year. The decrease in operating expenses is compared to the prior year quarter's driven primarily by higher absorption of corporate cost into the segments due to the increased level of revenues.

Now let me update on our financial position. Overall we continue to have modest use of our internal student payment programs through the third quarter. With total balances as of September 30, 2009 of approximately $34 million, only slightly higher than the $31 million outstanding at the end of the second quarter. As a result, total bad debt expense as a percentage of revenue was 3.1% up only 30 basis points from last year's third quarter. Even after adjusting for the favorable timing benefits we saw at in Art and Design, bad debt expense would have been 3.4%. Overall student receivable collection efforts remain effective with the annualizes DSO of 14 days in line with 13 days from September 30th of last year.

Our operating cash flow remains strong. For the nine month ended September 30, 2009, our operating cash flow was $217.4 million, $58 million higher than the nine month ended September 30, 2008. Capital expenditures were $50.3 million or 3.7% of revenue. And free cash flow to defined as cash flow from operations less Cap Ex was $215 million for the nine months ended STEPT 2009 compared to $119 million in the previous year's nine month period. Turning to our share repurchase program, during the third quarter of 2009 the company repurchased 1.7 million shares for approximately $40 million in an average price of $24.15 per share.

During the nine month ended September 30, 2009, we repurchased 8.2 million of our shares for approximately $180 million, and average price of $21.84.

Before we turn the call to your questions let me touch on a couple of items to keep in mind for modeling perspective as we close out 2009. First, we anticipate all but one of the six remaining transitional schools will complete their teach outs in 2009. And we expect to record charges of approximately $40 million to $50 million for real estate associated with these schools in the fourth quarter. We may also have the opportunity to convert yet another transitional school into a health school in which case we only cease operations if four schools by the year end with one school remaining in transitional in 2010. Second, in the fourth quarter we will continue to accrue performance based compensation expense related to our planned out performance. By segment, we expect the magnitude of the additional accruals in Q4 to be half the amount we accrued in the third quarter and noted in our press release. I would like to announce we will hold an analyst day on February 18th 2010 in New York City. We will broadcast the event live via webcast for those who can't attend in person and we'll have presentation materials available in our investor relations section of our website of the day's events. We will release our fourth quarter 2009 earnings results after market close on February 17th. And now operator we would like to open up the call for your questions.

Thank you. (Operators Instructions) Our first question comes from Jeff Silber with BMO Capital Markets

Thank you so much. There was one disclosure on your 10Q, I wanted to focus on. It's about the program review at AIU. Give you give us more color on that?

Sure Jeff, this is Gary McCullough. We do announce we have a department of of education program review at AIU. And from our point of view this is routine and happens periodically at institutions. The last program review at AIU was conducted in 2006. So the Department of Education informed us they were going to come and focused primarily on financial A compliance and those types of things. We review our own compliance with the things that the Department of Education will typically focus on. We feel confident in what is happening in our capability there. Again, we look at this as routine. And will announce any time we have a program at any of the institutions which happen periodically.

This has nothing to do with the HLC issues?

No, this is completely separate. It's just the Department of Education notifying us on a routine basis they were going to do the review. First one they have done in three years.

Great. Just wanted to clarify that. And a quick follow up on the performance basis compensation. Thank you for giving us color by segment and letting us know what will happen in the fourth quarter. And this is an all cash charge?

Yes. The annual bonus plan for employees is a cash based program. And we anticipate because we were so far ahead of plan, we're paying above target. And we lay that out for everyone because as we go into 2010 and set up new budget targets, we don't anticipate that will recur to pay over target as mention in the year.

Ok, great. That was my question, in terms of what the next basis for the year.

Just to be clear. It's the cash charge, from a balance sheet stand point the cash is paid in the first quarter after close.

Ok, great. I will jump back in the queue.

Thanks, Jeff.

Our next question comes from Herman from Stifel Nicolaus. Please go ahead.

Good morning, everybody. Let me get the question of the week out of the way here and that's the revenue recognition question. And as part A, B and C of that, can you review that revenue recognition policy and also the refund policy? And specifically how you true up the timing of a drop relative to what you guys believe is a drop versus what a student believes is a drop? Then finally review the third quarter adjustment you made to revenue recognition and what drove that?

Everybody is expecting the call. Our 10K gives out the policy clearly. I think you take a look at that. We bill at the beginning of the term.

Recognizing a deferred tuition liability. We recognize the pro ratta across the term. Withdrawals and refunds are process in compliance with state, federal and crediting bodies. If you drop that period, we give a full refund. And any refunds after that are given according with the catalog. We follow all the title 4 rules. We stop recognizing revenue on withdrawal. Which means if the student notifies us of withdraw and withdrawal date we stop recognizing revenue. If the student does not notify us we look at our last day of attendance programs. We track attendance online and on ground through our campus view system.

We go back and look at the last day of attendance. And after a certain period of time if the student has not attended and not notified we cancel the student out. And go back to the last day of attendance to do the refund and the withdrawal work. We think our policies are consistent with GAAP and industry practices and have no issues with that. The Q3 adjustment was a small adjustment just because of the nature of it we disclosed it in the Q. What happened was in 2006 there was a program change made within the university group and as that program change was made and the deferred revenue was accounted for as student (indiscernible) at the end of the program in 2009 and we trued up our deferred revenue, that program changed and was not accounted for and it was leftover -- deferred tuition revenue on the books which was wrote off. So, it was outside of the normal system process and manual process that we caught. Out of of period as we take than small amount of income in 2009 that probably should have been recognized in 2006.

Thanks. One quick follow-up. Congratulations on hitting the targets early. You guys at this point have good visibility. There's not many starts beyond October. Will you update guidance for 2010? Is that something you will do in conjunction with the analyst day or sooner?

Not sooner. I think Gary gave you color about university starts for the quarter. I think we are in a good position. We said we will continue to be plan based on accrual. We will give guidelines and milestones. We were formulating what we will tell you in terms of the amount of granularity. We think we did a good job as Gary said back in 2008 as we laid these out and we tried to explain in a great process and are happy we beat those. Not only just beat those but a year ahead of time.

Great. Thanks, guys.

Thank you, Jerry.

Our next question comes from Brandon Dobell from William Blair.

Hi, guys. Wonder if I could follow up on the revenue recognition stuff. Anything historically from a change in the refund policy as we look back in the last couple of quarters that's worth mentioning from you guys. From the course catalog or just internally as you make a slight modification there?

No modification at all. The refund policies are typically done by catalogs. Catalogs updated on a regular basis. More driven by the accreditor and the state laws in each state and those haven't changed much and those haven't changed much in catalogs. There's been no systematic change and no change of accounting on our side in 2009 or 2008.

Okay. And within the Art and Design, I know it's a small segment for you, but any color there on kind of a new program, student behavior type of students you are seeing? Still confident that business has the same opportunity as you thought it would back when you did the analyst day in 2008?

This is Gary. First of all I say we still believe the business has opportunity. One of the things we have done since I got here was we move what we could move or some programs into an on-line basis. And we like that the business there will continue to do that as we move forward. We've looked at the programs across our Art and Design segment. And we recently I think we told you on a previous call that we created an organization look across to create programs in our institutions. And in doing that we identified some programs that we don't think are as robust as we like in the process of teaching some of those out.

At the same time we identified opportunities. And some of the opportunities are of no surprise. One of the things I'm pushing for at IADT for instance, we do a lot of design but not enough technology. We were working to drive more technology curriculum into the business. But we do think there is upside and maybe not as much upside from explosive growth point of view as we see in some of the other parts of the business but we continue to like that business.

I think the other thing, Brandon, as we talked about in other quarters they are design segment comprises the IADT business, the national business and then forced among colleges which historically had. We worked hard on curriculum design and worked hard on calendar alignment and payment plans with the IADT. And they have been successful as you can see with the numbers of the last couple quarters. We are struggling on the colleges to roll out the programs across the colleges to help them perform better.

And then final question. Within the culinary business, maybe a little more color around the inner play now that you own the LeCordon Bleu brand the interplay between the brand and new school opening strategy and does the brand fit with the smaller footprint.

How can you best utilize the control of that brand either ground or on-line going forward?

We said on a number of previous calls as we look at the size of the boxes that were previously built that we felt the need to reduce those and for anything we do in the future we would reduce them. And as I indicated in my remarks we are in the process right now of standardizing the naming convention for LeCordon Bleu and we will be doing that through the first part of the first quarter of next year. That work is underway and really takes along so state approvals and other things we have to get done to make it happen.

And so we do think that the name is consistent with the size of the spaces that we would want to move to. At the end of the day this is really less about size of space and more about quality of program and the promise of LeCordon Bleu brings. So this fits very, very nicely with that. We think there are a lot of marketing and other ensynergies associated with doing that. And we will move down that path. You will look forward to the January, February time frame when everything will be renamed LeCordon Bleu.

Great. Thanks, guys.

Our next question comes from Gary Bisbee from Barclays Capital.

Hi, guys, congratulations on a strong quarter.

Thank you.

I guess the first question, I can appreciate how this performance based comp is unlike to recur in a similar rate. I struggle with how you talk about non-GAAP earnings at $0.47. Because ultimately, you did well. You're paying yourselves cash for it and, I mean, that's not a one time item. I'm struggling to understand that. Can you tell me how you think being sort of referencing that as a one time item?

I think one thing is that we pride ourselves on giving very extensive disclosures and I think we continue to lay everything out there for you. I think we laid it out pretty accurately. The one time items to think about, one, we have caught up that accrual in the third quarter because we have gotten more visibility to our trajectory from the beginning of the year. There is somewhat of it that is probably goes back to the previous quarters on an estimate basis than the current quarter.

Second is we don't intend that to recur. I think if you look back historically at the company 2005 through 2008 we have not paid anywhere near over plan. As we enter into 2010 given new trajectory and milestones over layout, we again don't intend to pay over plan. We just in a great position based on our execution being a year ahead given the amount that we needed to accrue based on the design of the plan and success of the company and the employees had, we thought it was important to lay it out there for you. I think it's a very important component to look at as you look at trajectory toward 2010.

I wanted to give that guidance to make sure as you build your models through 2010 you thought that through. I think it's less important as you look at the 2009 performance because it's part of the cash component and operating earnings this year. I think it's important for trend.

I can appreciate that. Ultimately you basically overlearned a bit in the first half and catching up this quarter. That's what's happening. Right?

Part of that adjustment. If you had full visible to the year, you would spread the $18 million and let's say I targeted about half of that to $27 million you spread it over the four quarters of the year if you have perfect visibility at the beginning of the year.

Moving on, the share count was a bit lower than I would have thought. Can you tell us how much of the $3 million LeCordon Bleu shares on average were in the diluted number? Is it about $1 million? Was there as much as 2 million?

I don't have the calculation in front of me but the shares were issued out on September 1. $3 million shares are in the full count for the month of September. For the month of July and August those $3 million are in treasury. They are inside the company.

So $1 million on average.

Should be $1 million on an average basis.

I guess the next question, you commented that both the 15 and 20 month programs at culinary were seeing good growth and the revenue per student didn't drop as much as I would have thought if the 21 month program was driving all the growth. Has something changed from a financing perspective or would you attribute that maybe more to better execution on your part in terms of getting people packaged and marketing and what not. It seems to be trending different than we would have thought when we first announced that. I assume you are doing something better. Maybe the financing markets are helping, too. Any color on that? Thanks.

Sure. I think A, fantastic job of the culinary team to react on everything they had to do. Put new programs in place. They rolled out 21 month program in all but two schools. It will be in the other two schools at the beginning of the year. Kuddos to them. They've done a great job getting that rolled out. Second is remember you do have the teach out so to speak of the old 15 month program. Students are still in the 15 month program. New student entering the 21 you have a modal that flow.

Still have a good deal of students in the 15 month program completing their degrees and their certificates. So you got that rolling through the program. From a financing standpoint the markets have not opened up much. We are still using that balance sheet. We're being prudent. Our underwriting criteria solidly anchored and the student success criteria as we talked about before. So we're using it on a prudent basis. We are using grants for the students as well as different loan strategies which does influence RPS up a bit.

And just last question. When you think over the next couple of years and think about adding capacity with these new start ups that you are doing. Have you given any thought to the fact that maybe the health care business has about as much momentum as it will ever have today given the economy and maybe it will be prudent to be adding capacity? Some of the program areas that may be less counter cyclical? There is a risk to adding capacity what is potentially near the peak? Or are you pretty confident this business can continue to grow in much stronger economy? Thanks a lot.

Thank you. We looked very hard at the healthcare market in particular to understand the likely demand it will be over the course of the next three, five, seven years. And we remain comfortable that there is going to be significant demand. Our challenge right now is to make sure that we can clearly articulate or clearly understand what areas within the health care space there will be demands so we will move our programs into the areas and discontinue where we begin to see saturation.

If you look at our health care business, we continue to have a great deal of geography that we aren't occupying. Our geographic footprint is largely east coast. It's down to the south and extends out to Texas. We opened up recently a health care school in the Phoenix area. And we have done as we open things up in year in particular I think we were smart how we have done it seeking to use existing real estate where we are under utilizing the real estate. We think there is demand. There is a graphic play that we can get to and we have excess real estate capacity that we can utilize in doing it.

Thank you.

Our next question comes from Sarah Gubins from Merrill Lynch.

Thanks. Good morning. Could you talk a bit about outcomes and the kinds of things that I'm thinking about are job placement trends, starting salaries either in the absolute or interims of trends and maybe some discussion around graduation rates?

Yes. And I will probably as we have over the past talk about this from a macro point of view than a specificity you will look for. One of our concerns as we come into this marketplace is will we continue to see demand employer demand and we really have worked hard to increase the resources we have available from both a corporate and SVU basis to aid or graduates and finding jobs. We have not seen and I have been asking this question a lot internally.

We have not seen any significant degradation in demand for our students. We, through the course of this year have helped and placed 9000 graduates into jobs and we did not see that abate during the third quarter. We continue to see strong placement trends in outcomes in our culinary business. We are able to track these things we feel very, very good abut what we see and the continued demand.

If something we are concerned about as I mentioned in my remarks in health care as we continue to grow because of the strong population growth we have seen, we added career services people. We added career services people at corporate level to begin to cultivate and do a better job from a national employer point of view and make sure we coordinate across the SPUs there could be opportunities with large employers. We are concerned. But the concern seems to be at least at this point in time misplaced based upon the results that we are seeing.

Okay. And any chance you could provide us starting salaries, the ranges for the different program areas?

No.

If that's something you think about sharing with us on your investor day, that would be great.

We will note that, Sarah. I'm not trying to be flip. I understand your desire to have greater visibility.

Thank you. I'm hoping you could talk about the margin potential and on-line. Made some nice progress there over the course of this year and it looks like it will trend above 30% in terms of operating margins. I'm wondering what the potential for that is over time?

A long term question is better answered on investor day, but we have done a good job gaining operating leverage. We have issues in the past with some of the admissions side. We corrected those a lot of those issues. We were adding reps as we need to. The Rep growth is less than start growth as conversion rates have gone up. As the rest has become more seasoned, great training, lower turnover. As we go into the fourth quarter we talked about accelerating starts and continue to gain leverage. I would rather answer that in February when we give you more grounding about our long term plans and strategies.

OK. Fair enough and just one last question. Can you give us any update on what you are expecting in terms of upcoming (indiscernible)default rate trends.

We have looked at some of the trends. We had good trends last year. We had below industry level data. I think right now we were looking at some place between maybe 50 to 100 basis point tick up this year from the data we are seeing. Small increase. No school's anywhere near the 25% hurdle. That's helpful. Thanks a lot. I appreciate it.

Thank you, Sarah.

Our next question comes from Amy Junker from Robert Baird. Please go ahead.

Thanks. Can you talk a little bit about AIU's margins. Those were obviously up quite a bit in the quarter. And was just wondering if that reflects any of the pressure you talked about on the last call for adding reps and media mix? Or Is some of that spending changed or delayed?

I think you combination of things. If you look back to last year's third quarter we were coming out of the peer issues so we had a dampened margin as we were coming out. Second is our margins are improving not only from the start growth you saw at 6% but also the population growth with high retention rates. We have not added reps quite as high as you may have modeled.

Additionally no longer having deceleration on the RPS. In the past we had RPS falls because of price cuts and shifting to associates degrees. We now seen with the price increase that we took in tuition of January 1 moderating and now increasing RPS trends. I think all that builds and improves margin.

We aren't expecting pushout and spend going forward? There wasn't anything that was delayed?

I think the only thing would be nothing delayed. As Gary said, we are seeing high demand for our programs. We are seeing great leap flows. As we go through the fourth quarter to continue to spend behind that and continue to spend behind the leads that are out there in the marketplace.

Great. I have one on culinary and I'll pass it over. Last quarter you had talked about the low to mid-single digit operating margin in that business in the fourth quarter. I'm wondering if that's reasonable and along with that if you can talk about the level of investments that will be required for the LeCordon Bleu branding efforts. Thanks.

Let me start with the margins and I'll let Gary talk about the rebranding effort. On the margin basis, remember as I said earlier I think the margins in culinary were 4 1/2% for the quarter.

But we also had the incentive comps. I think the margins on a normalized basis we disclosed were closer to 10%. You'll also get the big pick up from LCB in the fourth quarter. We said last quarter we feel confident the culinary will be 10% margin in the fourth quarter. I believe it still will be in terms of the investment in the brand.

We don't anticipate any significant incremental investment in the brand. We spent moneys for signage and other things like that. The things we are doing are how we show up in the marketplace. We got all of the internal resources necessary to make those things happen. We spend capital for signage and things like that. But no incremental significant spending necessary to rebrand the schools.

Having the brand over the last ten years we backed as an owner as well. We have been investing in the brand and positioning of the brand. I think the base amount of costs is simply the change over costs.

Perfect. Thank you.

Our next question comes from Trace Urban from Signal Hill. Please go ahead.

Hey, good morning. I wonder if you can elaborate more on the comments that you made regarding sort of opportunistic increase in the sales and marketing spend? I didn't quite get it. And if you can provide color maybe by program if there was sort of any nuances there based on the different schools? And maybe just to be perfectly explicit about it, maybe you can explain to us why this shouldn't be read as some kind of a trend that points towards deleveraging in that expense line?

Trace, we were here looking at each other. I'm not sure what you are talking about. I spoke in my comments to continuing to spend in the fourth quarter at the university business reflecting the fact that we got strong lead volumes. So we will continue to take advantage of that. Beyond that I don't recall anything that we said explicitly.

I guess maybe rephrase it. It looks like the advertising of the DNA spend is higher year-over-year as a percentage of revenue. I took from your comments Gary, about the ad spend that you were intensifying your level of spend there relative to where it had been. I didn't quite get the point what you made about why lead flow would drive spending. I thought that spending drove lead flow. That's what I'm asking about.

Sure. Mike will start and I will clean up if I need to.

If you look at P&L from a pure GAAP standpoint in the 10Q, advertising last year's 64, this year 76, $12 million growth in advertising spend on a revenue growth of $57 million. So that from a common size stand-point that's a traditional normal spend level. G&A is up from $95 million to $114 million. Remember, in the normalization we spoke to the $18 million or $19 million of compensation expense. Take the $95 million from last year and plus the $18 million and get to a relatively small growth in administrative creating the operating leverage I spoke to in my script.

Fair enough. That's my mistake.

That answer your question, Trace?

Maybe I could still ask you to talk about the lead flow comment. I didn't quite get that.

I don't want you to misinterpret it. There is a phenomenon that our company has experienced over some period of time where as we entered the fourth quarter there is a belief that we shouldn't spend and we couldn't spend as we were bringing the year to a close. It's our intention to continue to drive the business. The fact is that it's a good market. We want to take advantage of the good market so we will continue to spend through the year to make sure we end the year strongly and we start the year strong as well.

Thanks very much.

Our next question comes from Kelly Flynn from Credit Suisse. Please go ahead.

Thank you.I have a couple of follow-up questions to those earlier questions. First one following up what trace was talking about with expenses. The Ed services expense is down. Year-over-year where you are growing enrollments nicely. I wonder, what are you reducing there. I guess it's surprising to see it actually down. I can understand the leverage but for it to decrease when your enrollments are increasing. And then maybe a little color on whether or not you expect that to continue to occur meaning (indiscernible)

You broke up when you started your comment you broke up. Which line?

Sorry. Educational services expense.

Remember, educational services you have facilities costs. So in facilities costs year-over-year we have charges last year that you have to normalize out. As you normalize out the facilities charge, I think educational services expenses is pretty much flat. So I think what you are seeing is from a class size standpoint and leverage standpoint the educational size, we are investing in the faculty members and the class sizes we need. Facility costs are going down. We are taking real estate out of the system. We took real estate out on a run rate basis the facilities cost are not increasing. I think the combination of lower facility costs faculty costs in line with inflation and in line with the class size is just driven moderating trend in that line and getting operating leverage from the higher populations.

Ok. That makes sense. Thanks. Second question about the return of title 4 funds. Can you confirm for AIU and CTU what you're required to do there? Are you term based or nonterm based? Meaning do you do the 60% attendance? That means they've earned it all? Or is another way you are required to do it.

We are on the 60% basis.

Okay. Related to that, there is some talk about certain states requiring schools to take attendance and others not. Can you clarify for AIU and CTU first of all, are the rules dictated by the state that it's based in or the state where the student is? And whether or not there are any specific attendance taking requirements or not for those particular schools, AIU and CTU?

I can't comment on the state government side. That's a question for council. We will try to follow up with you on that. From a attendance standpoint, because of the campus view system, we have attendance taken is basically automatic. We know exactly when the student is in the classroom or on the working session. And so the system records when the student is logged into the attendance. We have an attendance record for every student in online programs.

Ok, great. Very helpful. And then finally the last question on the incentive compensation issue that Gary asked about. Just to clarify there. I mean, I would think that your business will perform better next year and therefore you are likely to pay your executives more. And therefore you might have less bonus for outperformance per se but the overall executive compensation will likely be more. Is that the right way to think about it? Or is something I'm missing there?

I think what will happen is every year we go and set a target. And the team has paid at 100% of target and 100% of bonus. We're tracking well above that. Next year based on our trajectory and guidance and our milestones that we lay out, we fully expect to have a higher number next year. And when we get a higher number plan and expect to make that plan, not beat the plan. Next year we won't have this over performance.

All we laid out in the normalization tables has been the over performance. The amount over 100% level because we have done a significantly better job this year anticipated and being a year ahead we accrued more than anticipated. Next year both the target will be set and the spend level on bonuses will go down to 100% of target and this will not recur. If we are fortunate enough based on setting a target and to out perform the target as well as we have this year, again next year, it will recur and that's a fantastic result for our share holders and company.

Thank you very much. Appreciate it.

Thank you.

Our next question comes from Mark Marostica from Piper Jaffray.

Thank you. First I wanted to ask about Gary your comment I believe that you expect a better growth trends with AIU as you head into the fourth quarter here. I'm curious without the benefit of introductions of new programs there, what is really driving the growth?

I will come at it a couple of different ways. We are executing better. Very simply from admissions point of view we were doing a better job of converting potential students into students. We have invested pretty significantly in people, in communication processes internally to make sure that we have the appropriate number of people staffing at the right time. We went through situations where as we discussed earlier in the year where we weren't staffing at the times of day or times of week where we had demand for enrollment counselors. All of those things are about admissions execution which led to tick up.

I want to talk about our programs at AIU. We have talked about wanting to update or introduce new programs because we think they are incremental places that we could be offering programs. The fact is, we have very strong programs at AIU. We teach courses that we taught historically. We got professors that were with us for quite a long time and our program continue to be very good. We would like to be able to operate in the clear in terms of introducing even new programs into the business. Or where it makes sense to tweak the programs where we have. We were not operating in my judgement a programmatic deficit. We have not able to update or add new ones or accelerate where we were at. We have strong programs where it feels like people tend to discount that as we have these conversations.

Gary, given your comment on the increasing effectiveness of the reps at AIU, I'm curious that coupled with the increasing spend at university marketing spend advertising spend in the fourth quarter targeted AIU as well. How should we marry those two things together in terms of cost per start trends at AIU and perhaps CTU separately as we look at Q4 and head into Q1.

Couple things to consider.The fourth quarter, I cost per start this year is relatively flat for the third quarter year-over-year. The timing and the timing of the marketing spend difference a little bit. Can't give you guidance on the fourth quarter. I will make sure you remember as you go into the first quarter modeling our cost for start last year was relatively high because of the inefficiency that we talked about in our first quarter call of buying additional leads, not having the necessary staffing there and not getting the conversions we missed. Hard to give you fourth quarter number but as you model the first quarter last year where our trend was.

And then last question I will turn it over. Gary your initial remarks you talked about the HLC deferring consideration of AIU's application for new programs until quote-unquote certain recommendations tied to the initial grant of accreditation are satisfied. Can you give more color on what the specific recommendations are other than you mentioned completion of the focused visit?

Sure. When AIU was granted accreditation. There were a couple of things particularly around programs that the master's degree level from a credit hour point of view.

So, there was some issues around a non credit hour course that they wanted us to address and we are on track to address that by January of this year coming up. They gave us two years initially to do it. We are on track to do it in a year from when the initial grant was given. In addition, there were some things around principles for designing curriculum and some things around learning outcomes primarily the masters degree level. These were things that were typical academic types of things that they are looking at as an accreditor.

Those are the general things they were talking about. And so our teams are off. Our academic folks are off working against making sure that those things are clear in terms of the questions that were asked. I expect that when they come through for the focus visit, we will satisfy those issues and we will move forward. For me the HLC coming back you indicating that they wanted to wait, given the fact that the move of AIU was a bit atypical because we went from one regional creditor to another. I think they are being cautious and the way that they do this and that's appropriate.

Great. Will there be any announcement coming out of the company regarding the outcome of the visit? Or how will the information flow to the street be relayed around the outcome?

We really haven't thought that far forward and that we don't have the focus visit schedule. I know there is a great deal of interest in this. It's my assumption just as Mike indicated we worked hard to be pretty transparent around things that are going on. My expectation is that when we note things that are relevant, we will make them known to you all.

Very good. Thank you.

Thank you, Mark.

Our next question comes from Cory Greendale from First Analysis Securities.

Good morning.

Good morning, Cory.

Just wanted to ask about the internal student financing program which sounds like it wasn't used all that much in the quarter. Can you talk a little bit about first of all what your expectation for the for the full year. And secondly what's driving the lower , I you mentioned different student financing strategies and scholarships, but what is

Expectations for the year I would think will grow about another $10 million, maybe $15 million for the balance may be between $40 million, $45 million, maybe up to $50 million by the end of December. In terms of what's driving the low growth, a few things. One, the shift between the 15 month and 21 month culinary and the redesign of the calendars in IADT has enabled the students greater assess to PAL, greater assess to Stafford loans which is reduced the need for our balance sheet. Second, we have used grants selectively where it's in the best interest of the student versus the loan to have a grant program put out in the culinary group as used grants. Third we are seeing the normal flow of the cash paying students that have other sources.

We have third party private loan sources that you see in the 10Q from our disclosure in terms of flow. We have third party levels. Then fourth, it's very difficult thing to estimate for us. Do we know what's packaged and earned receivables. And students that continue the program drop. Our first time doing this in terms of the program so our estimates are difficult to give. As we laid out levels, it's been a little bit hard to estimate. This quarter again we think it will be between $40 million and $50 million at the end of the year.

And also on the financing front I see from the queue that title 4 was 80% for the entire company. Within that, are there any schools that could be bumping up against 90-10 and what are you doing to counteract that?

We don't have a significant issue with title 4. We do have some schools that are approaching the level. Obviously the new basis with the $2000 Stafford helps that issue. We do a lot of different things from 90-10 standpoint where we need to help the students out. But there is nothing that we need to do in the short term for 90-10 purposes especially this year.

And want to go back to the question that Sarah asked about placement and starting salaries which I know you talked about that qualitatively in the past. I was wondering from the student's perspective. Do you disclose that information to perspective students or under what circumstances do you disclose it? How do you disclose it?

Where it's required by state, we disclose what we do on the campuses. But as a general rule we don't talk about those things publicly.

I would vote for more information there just seems like the world whether regulatory driven or just market driven seems like it's moving toward more transparency so that would be helpful.

We agree with you. Our issue is not about transparency. It's making sure we give you the data on a basis comparable to competitors and comparable (indiscernible) data, and comparable across our company. With a number of creditors and number of states we give it to you in the best basis that you can make the best conclusions from it versus just putting data out.

Understand. Thank you.

Leave it at that.

Our next question comes from Trace Urban from Signal Hill.

I wanted to follow up on something that I thought I heard you say but I want to really understand this. For attendance taking at the local level, is it the case that the students who are attending ground schools are logging themselves in for each class?

No. The instructor uses our system. A campus-used system. The instructor uses the system to log attendance on the ground campuses.

My question is relevant. What controls do you have in place to ensure that that is happening accurately at the sort of school level?

We have several different controls. Every school has a local registrar and the registrar is responsible for making sure the controls exist. We have compliance staff that reports the corporate team that does institutional self-assessments, so that they can go back and test the different compliance. We also have OnBug Man and Whistle blowers so we know there are issues in terms of course attendance or a student brings up an issue, that it comes back to the corporate office and it's followed up very quickly.

OK. Thanks.

Thank you, Trace.

At this moment we show no further questions. Do you have any closing remarks?

Yes, I do. I want to say a couple things. First of all, we think there is a lot to be proud of in our third quarter results especially in light of the historical challenges we face as an organization. I am delighted about the progress that we made towards the goals that we communicated for 2010 to you as early as 2008. We knew at that point in time there would be a lot of moving parts. That there would be executive risks as we move through 2008 and 2009.

As we approached 2009, we feel as though we done good job of doing the things that we said we were going to do and laying a foundation for a terrific 2010 and years to come. I want to say publicly thank you to our employees, who have done such a great, good job. Mike and I are the public face of about 12,000 people who come to work every day and do a fantastic job and they're the ones who have enabled the results that we were seeing and ones that will continue to deliver as we continue to go forward. I want to say that publicly. And then finally, I want to thank you all for the time you spent with us this morning. We appreciate it and we look forward to talking with you in February at our investor analyst day.

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect.