Perdoceo Education Corp (PRDO) 2010 Q3 法說會逐字稿

Welcome to the third quarter 2010 earnings conference call. My name is Sandra, and I will be your operator for today's call.

(Operator Instructions)

Later we will conduct a question and answer session. Please note that this conference is being recorded. We'll turn the call over to Mr. Jason Friesen. Mr. Friesen, you may begin, sir.

Thank you, Sandra. Good morning, everyone. Thank you for joining us on our third quarter 2010 earnings conference call. With me on the call are Gary McCullough, our President and Chief Executive Officer, and Mike Graham, our Executive Vice President and Cheif Financial Officer. Following the remarks made by management, the call will be open for analyst and invester questions.

This conference call is being webcast live on the investor relations section of our website, at careered.com. The replay will be available on our site. If we don't get to your question during the call, please call our investor relations department at 847-585-3899.

Now, before I turn the call over to Gary, let me remind you that yesterday's press release and remarks made today 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 release, our annual report on Form 10-K for the year ended December 31, 2009, and our quarterly and other filings with the Securities and Exchange Commission. Except as expressly required by the securities laws, we undertake no obligation to update those risk 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, Jason. Good morning, everyone. Thank you for joining us on this morning's call. I'll begin by summarizing some of our third quarter highlights and then turn the call over to Mike Graham, our Chief Financial Officer, who will provide more details on our financial performance.

As a reminder, the financial results I'll discuss exclude the accounting impact of a legal settlement related to California Culinary Academy. They also exclude the incremental bonus expense incurred in 2009 as a result of the Company's performance last year

Results for the third quarter were in line with our expectations, and continued our year-over-year improvement. The quarter represented not only a period of more challenging comparables for CEC, but also a time of unprecedented media coverage of our sector. During the quarter I continued to impress upon our teams that we cannot control external events. Our most important priority is to maintain a clear and intentional focus on our purpose of changing lives through education.

We can best accomplish this by focusing effort in three areas -- we are maintaining and improving upon the compliance culture we developed over the past few years. This includes ensuring students had clear information including the demands of our programs, the range of potential outcomes, and their financial obligations. We're focused on continuing to enhance the educational quality and ensuring that our programs prepare students for success in their chosen field or career, and we continue to engage in activitities that help identify students who are more likely to persist and graduate, thereby improving student outcomes.

Obviously a significant amount of leadership attention during the quarter was spent on the rules proposed by the Department of Education, various request for information and discussions that occurred in Washington, D.C. As we stated from the beginning of the negotiated rule-making process, we support what's in the best interest of students. Our goal is to help ensure that the final rules are grounded in fact, that they do the right thing for students and that they limit unintended consequences.

During the quarter, in response to the Department's proposals, our team submitted nearly 200 pages of comments during the respective comments periods, and I spent time in Washington, D.C. discussing our concerns. In the months ahead, we intend to continue to engage with the Department and members of Congress to advocate for final rules that balance the best interest of students with the Department's desire to regulate so-called bad actors. While we are still discussing the rules published last week we are focused on following areas--gainful employment, incentive compensation and the online state authorization requirements.

We're pleased the Department elected to take time to further consider the gainful employment rules based on comments it received, and we remain hopeful that the Department will make constructive changes to proposed rules. We continue to believe the proposed gainful employment rules are not good policy. Our view is that certain proposed rules conflict with rules that exist today and that the proposed rules, if enacted, will limit student choice, will result in unintended consequences, particularly for minority students and will eliminate good programs in areas of employment demand.

During the past months, in anticipation of new gainful employment rules, we've spent a great deal of time looking closely at the business models in each of our segments, particularly our culinary and art and design businesses, and we developed preliminary action plans for each of our segments pending final rules. However, because the publication of these rules has been delayed, we are not in a position to share specifics of our plans or to quantify any potential impact to our business at this time.

We indicated previously and continue to believe that the elimination of incentive compensation in Safe Harbors is a mistake. Nevertheless, we'll work to ensure our practices are fully compliant. We're also evaluating the actions necessary to comply with the Department's rules related to state authorization for online institutions. These requirements were not articulated in the NPRM, so it will take further analysis to understand their ramifications.

During the quarter we continue to take actions aimed at enhancing quality and student outcomes across our institutions. For example, we increased the number of career services personnel by 15%, and our academic team by 25% compared with the third quarter of 2009. In university, we completed the realignment of student advisor resources to provide students more support during their first six terms of study when attrition is highest. CTU completed the implementation of faculty performance management and development program to ensure the best teachers are teaching the most classes. We believe this focus on academic quality will further improve the student experience, improve graduation rates and increase student satisfaction. AIU is in the process of implementing the same program.

We prepared for the rollout of additional financial literacy training modules and customizable tools that can be used throughout the student's tenue. Now, as a reminder, we've engaged in certain actions for some time now. We continue to require the completion of orientation courses within AIU and CTU. As I indicated in last quarter's call, these courses typically result in 10% to 13% of perspective students realizing they may not be well-suited for the program. Students who do not continue after orientation, do not incur financial obligation and are not counted in any of our reported new student start or student population metrics.

We continue to require students in our online programs who have never attended college to complete a college prep course as their first class. This course helps in the early identification of students who are less likely to persist and results in an additional 5% to 10% first-term drop rate.

Now let me turn to our third quarter results. As I indicated our performance in the third quarter was in line with our expectations and consistent with the objectives we established at our 2010 analyst and investor day. As we shared last quarter, we're seeing the signs of slowing enrollment trends, particularly within our university segment. For the third quarter 2010, total Company revenue increased by more than 14% versus the same quarter in 2009. New student starts for the quarter were up 6% versus a year ago. We also achieved a 16% increase in student population, finishing the quarter with over 118,000 students.

Excluding the items I spoke of earlier, this growth resulted in a 38% increase in operating income versus the third quarter of 2009 to $78.3 million. Operating margins of 14.9% were a 250 basis point improvement, and a 40% increase in earnings per share from continuing operations to $0.66 from $0.47 in the third quarter of 2009.

Health education continued its growth in margin expansion. Revenue increased 22% and student population increased 24%. During the third quarter we opened our fifth health start-up school this year in Skokie, Illinois. We also opened a health start-up school in Portland, Oregon in mid-October.

Sanford-Brown also continued its effort to further prepare students for better career outcomes by entering into a relationship with Pegasus Lectures, which specializes in instruction and exam preparation techniques. On October 20, over 3300 Sanford-Brown's employees and students participated in a nationwide Give Back day. This event allows students, faculty and staff to demonstrate the positive impact they can and are having in their local communities. The Sanford-Brown team has participated in off campus and volunteer events at nursing homes, shelters, food banks and clinics. This event reinforced the service learning enhancement to the Sanford-Brown curriculum launched in the third quarter to provide students with a combination of experiential learning and community service.

Culinary continued to perform well in the third quarter, growing new student starts and student population by 4% and 20% respectively and expanding margins by 530 basis points over the 2009 third quarter prior to the charge of the settlement of a legal dispute related to California Culinary Academy. We believe the institution has been operated appropriately, but given the inherent risks of litigation in California and the potential cost to defend the suit, we elected to enter into a settlement agreement. This will allow the school to focus solely on serving students as we move forward.

The university segment's performance for the quarter was in line with our expectations. Revenue increased 12% on an increase in the student population, which was up 13%. Mike will provide more financial details during his comments. I want to cover a couple of items related to our university segment.

It's been nearly three years since we made significant changes to our Company's structure. In that time we've made substantial progress in our strategic business units and the functions that support them. As both external forces and internal capabilities change and evolve, good organizations evaluate their structures and needs from time to time to identify how they can become even more effective. In doing such an evaluation, I concluded that, while progress has been made in the past few years, we could do more to leverage our size and to optimize functional expertise in support of our businesses. As such, we will move to bring greater focus and structure to certain functions by creating a shared services group that will be expected to further leverage resources across the organization and to drive greater consistency and common services. This group will report to Mike Graham.

This led to my decision to reorganize the university SBU structure, because many of the services centralized under the university SBU which support AIU, CTU, and the Art and Design institutions, can be delivered by a broader enterprise-wide shared services group in accordance with existing service agreements, reducing the need for the university SBU layer of management as it was originally conceived. This means the leaders of AIU, CTU, and Art and Design will report to me while other university SBU functions will report to Mike or other leaders within our Company. This also means that Deb Lenart, who has helped us make great progress in the past three years will leave the Company. This has been a difficult decision for me, but one I believe is right for our organization at this time.

While contemplating this or any other significant structural move, I consider a number of factors--our individual and collective organization capabilities, the ability to create and leverage scale to control costs and the ability to simplify our structure for clearer and faster communication. This realignment will help in these areas. While discussing our organization let me say a few words about several key hires we recently made. Over the past 60 days hired Diane Auer Jones, as Vice President of External and Regulatory Affiars; Walter Pryor, as Vice President of Government Affairs and Certified Master Chef Ferdinand Metz as Executive Dean to also serve as Chairman of the Cordon Bleu National Advisory Board.

Diane began her career as a community college biology professor. She worked for the National Science Foundation, the White House Office of Science and Technology policy, served as Princeton University's Director of Governmental Affairs and as Assistant Secretary of Postsecondary Education in 2007 and 2008. Her diverse postsecondary education includes a master's degree in applied molecular biology as well as professional massage training at a career college.

Walter is an attorney with extensive experience in Washington, D.C. He most recently served as principal and General Counsel of the Podesta Group. He also served as Legislative Director for Senator Mark Pryor, Deputy Director and Managing Attorney for the National Association of Attorneys General, and as a member of the Justice Department during the administration of President Bill Clinton.

Chef Metz will assist in the design and implementation of innovative new programs for the Cordon Bleu. Over the years he's honed his skills in several great restaurants and through service at the Heinz Company, and as President of the Culinary Institute of America for more than 21 years. Now let me touch briefly on a couple of other points.

We have nothing further to report on the two reviews we discussed in our second quarter call. You may recall we discussed that in late 2009, AIU underwent a program review by the Department of Education and that the Office of Inspector General of the Department of Education Audit Services Division was in the process of conducting a Title IV compliance audit of Colorado Technical University. When we learn anything more of substance, we'll report it immediately.

AIU continued to work with the Higher Learning Commission and appropriate state agencies to obtain approvals for new programs. For the first time since 2003, AIU has submitted two new programs for approval. Both were in accounting. We view these program submissions as another positive step in AIU's working relationship with the HLC. Important components of student body -- of the student bodies of both AIU and CTU are military veterans and active duty personnel. Both AIU and CTU were once again recognized in the quarter by GI Jobs magazine as top military friendly schools. This puts AIU and CTU in the top 15% of colleges, university, and trade schools that are doing the most to support military students.

Also, this month, CTU will award another 50 scholarships under its Wounded Warrior program which recognizes the significant sacrifices these individuals have made and which underscores our commitment to military service men and women. 25 of those 50 scholarships will be awarded to the spouses of Wounded Warriors, who in many cases must assume the role of primary providers in their families.

These scholarships will provide their recipients with the full cost of tuition, course materials, fees, a laptop computer and the significant support services to aid them in completing their programs as they cope with the physical, mental and emotional consequences of their injuries. The selection committee for the Wounded Warriors was chaired by Tammy Duckworth, currently Assistant Secretary for Public and Inter-Governmental Affairs at the US Department of Veterans Affairs. She is also a Wounded Warrior and an Army spouse. The Spouses Committee was Chaired by Marie Tillman, widow of Army Ranger Pat Tillman and Board Chair of the Pat Tillman Foundation and a Gold Star Army spouse. Now let me turn things over to Mike Graham to provide you more detail on our financial results.

Thanks, Gary. Let me share with you an overview of the third quarter highlights. As you review our results for the third quarter, let me again remind you that there are items that affected year-over-year comparability. For the third quarter 2010, operating income included the estabilishment of the reserve for the preliminary settlement of student litigation case related to the California Culinary Academy for about $40 million. This charge is reflected in the G&A costs within our culinary business. It's anticipated that this cash charge for 2010 will be paid in early 2011 upon court approval.

As a reminder, in the third quarter of 2009, our results included recording a $19 million charge for performance based incentive compensation expense reflecting the significant overachievement in our operating earnings relative to our internal plan in 2009. We do not anticipate such overachievement will occur in 2010. Unless otherwise noted by a discussion of our earnings and results during the remainder of this call we will exclude these items.

Now to the third quarter, during the quarter we generated $524 million of revenue, which is an increase of 14% over last year. Our operating margin increased to 14.9% in the quarter, representing a 250 basis point improvement over last year's third quarter. New student starts increased 6% over last year, and our student population grew 16% over the third quarter, 2009. In our university segment, third quarter revenue grew by 12% over last year, to $291 million. This is primarily attributable to our 13% increase in student population and a 4% growth in new student starts.

Operating income for the quarter was $65 million, up 26% from last year's third quarter. Operating margin increased 260 basis points to 22.3%. Revenue for AIU was $113 million, an increase of 6% from the third quarter 2009, reflecting an 8% increase in student population and a 4% increase in new student starts. Operating margins for the third quarter at AIU were 20.6%, and operating profit in the quarter was $23 million.

In the normal course of operations, the Company assesses ongoing litigation and settles certain legal matters. During the third quarter these settlements included reaching agreement on a number of individual matters in AIU which were in an aggregate amount of approximately $7 million. While we have not normalized the Company's results in a manner similar to the California Culinary Academy charge as these individual settlements were each immaterial in nature and in amount it is important for you to note the amount as you assess the year over year improvement in both the university and AIU operating performance.

While AIU starts were up 4% for the period, advertising spend was also down versus the prior-year third quarter, reflecting slowing enrollment trends. We have also seen some pressure on our retention rate and revenue per student, which were both down versus last year's third quarter. We responded to our lower retention rates by adjusting our student advisory ratio in the first academic year when attrition is the highest. The modifications to this advisory ratio were fully implemented at the end of the third quarter. The small decline in revenue per student is largely attributable to the increased flexibility in moving from an accelerated to more traditional full-time basis study related to our undergraduate degree program credit structure as we discussed in previous calls.

CTU's revenue grew by 25% from the third quarter 2009 to $116 million. This performance reflected a 22% increase in student population and a 5% increase in new student starts. CTU's operating profit was $32 million in the third quarter, up 85% from last year. Operating margin was 27.9%, an increase of 900 basis points over the prior year. CTU also experienced a softening in enrollment trends and lead flow during the quarter. As a result, our advertising spend was at levels roughly in line with last year's third quarter. This represents a reduction for the percentage growth and advertising expense that CTU experienced in the second of 2010 versus 2009 levels.

Our third quarter starts for CTU were also significantly lower than the past two quarters because of three factors--more difficult comparable data in this year's third quarter, the slowing enrollment trend that we and we believe others in the industry are experiencing and a shift in the program mix in one of our relatively larger areas of study. As part of our ongoing assessment of specific programs and our commitment to helping students achieve quality outcomes, during the quarter our CTU team implemented a curriculum change, aimed at further optimizing potential employment opportunities for graduates.

In the quarter we stopped enrolling new students in our medical coding and billing program. Instead, students interested in a similar associate degree at CTU can now enroll in our Associate of Science in Health Administrative Services program, which provides a broader education in the healthcare delivery system. It also prepares graduates interested in further obtaining a bachelor's degree in health administration by meeting the requirements of entering the bachelor's degree program. We believe this change reduced new students' interest as we modified marketing efforts and started up the new sessions, and we believe our new program will enhance and broaden potential longer-term outcomes for our graduates.

Finally, for the university, revenue for the Art and Design schools was up $61 million, about 2% from last year's third quarter. In the third quarter, the new student starts for Art and Design were up 2%. Art and Design operating profit was $9 million in the quarter, up 14% from last year with operating margin of 15% up 160 basis points over prior year.

In culinary arts revenue increased 18% to $108 million on a 20% increase in student population and a 4% growth in new student starts for the third quarter. Culinary arts operating income for the quarter was $16 million excluding the legal settlement for CCA. This compares to $9 million in the third quarter of 2009. Operating margin in the third quarter was 14.9%, a 530 basis point increase over last years third quarter.

Bad debt expense increased on a year over year basis similar to the last two quarters. As we shared in our first quarter 2010 earnings call, with additional amounts of performance data for student payment plans,h in Q1 we began analyzing the data in two distinct categories, students who have dropped out of school and students who have graduated. As you recall, in the first quarter, we increased our estimate for uncollectable accounts primarily related to those students who drop out of school prior to completing their program of study. During the first quarter of 2010 we shared that our bad debt expense as a percentage of revenue could approach 13% for the year.

Consistent with these comments, during the course of 2010 as we've gained additional data now on our graduate performance as well as we've seen some repayment performance decline likely due to the difficult economic environment, we determined it was appropriate to increase our overall estimate for uncollectable accounts for student payment plans for graduates of the program. This change represented a $7 million increase in bad debt expense in this quarter. The balance of the increase relates to population growth and the overall increase in our student receivable balances.

So, in the third quarter 2010, bad debt expense for culinary as a percentage of revenue was 17.6%. The most significant portion of this increase relates to the adjustment I spoke of for the $7 milion for prior period receivables, and we anticipate the culinary bad debt expense for the full year 2010 as a percentage of revenue will likely be between 13% and 14%.

Turning to health education, the student population grew by 24% over the third quarter last year and new student starts increased 18%. Revenue is 22% higher than last year. Operating income was $13 million in the third quarter, and operating margin was 11.6%, which included $5.8 million in operating losses from the startup campuses. Operating losses for startup campuses in the third quarter 2009 were only $2.4 million. If you exclude start-up losses in both years, operating margin for health education would have been 18.3%.

As Gary mentioned with the addition of Skokie and Portland, Oregon openings we now have opened six new six new health start-ups in 2010. We do not anticipate any additional openings this year in the fourth quarter, but expect to open at least three additional health schools next year. As of September 30, we are operating 38 health schools, 10 of which are classified as start-up schools. This does not include the Portland location, which opened in October.

Finally, for international, our revenue decreased by 2% on a 4% increase in student population. Operating income was down from last year's third quarter largely due to higher administrative expense, related spending on student programs and unfavorable impacts of foreign currency. As a result of the changes in these change rate versus the prior year, revenues impacted by about $2.9 million and operating income by about $300,000.

Part of the traditional European fall start was in October of 2010 versus September in 2009. As of the end of October, our student population in the international segment was 12,200 students, 12% higher than last year.

Let me update you on our financial position. As of September 30, 2010, we had cash, cash equivalents and short-term investments of $443 million. Cash flow from operations for the nine months ended September 30, was $218 million. On a year to date basis, our cash from operations is roughly flat with 2009 despite much higher net income.

This is primarily attributable to change in operating assets and liabilities. The most notable of these changes include three items, first the payment this year in 2010 of approximately $25 million in the overachievement bonus from the 2009 performance. Approximately $20 million of leasehold payments associated with discontinued operations for our [Techow] locations as we continue to meet the long-term obligation of those closed schools. And finally, the impact of our accounts receivable growth as business has grown and the performance of our student payment plans which accounts for approximately $40 million.

Capital expenditures in the first nine months of this year increased to $82 million or 5.2% of revenue from $50 million in the previous -- in the nine months of last year partially due to the incremental $5 million investment in our start-up schools in 2010 as well as spending on our new campus support center. Our DSO this year was 15 days versus 16 days last year.

As of September 30, 2010, total gross balances of our student extended payment plans were up $4 million sequentially from last quarter to now approximately $60 million. We expect approximately $2 million to $3 million of growth in our internal payment program receivable in the fourth quarter of 2010.

We continue to focus on the best use of our cash balance. We intend to hold cash as required by the Department of Education's financial responsibility ratio for working capital needs, for maintenence capital expenditures and on high return projects such as our start-ups; and for 2010, the investment in the build-out of the new campus support center. During the fourth quarter of 2010, as we finalize the build-out and begin our transition to the new building from the five existing buildings we expect capital expenditures of approximately $25 million to $30 million consistent with our prior communications of $40 million in capital to build out the facility.

We continue to monitor our DOE financial responsibility ratios. As you know, these calculations are very sensitive to changes in equity. As a result based on our share activity earlier in the year we did not repurchase any shares in the third quarter of 2010. As of September 30, 2010, we have remaining authorization to repurchase $290.5 million of shares.

So, in closing before we take questions, we believe we will achieve the revenue growth of 15% versus 2009 and operating income of $350 million to $370 million before the legal settlement for CCA that we discussed earlier, and these numbers are the same numbers we shared with you earlier this year at the analyst investor day. As a reminder please also note that in the fourth quarter of 2010 we expect our AIU Los Angeles location to complete its teach-out. As a result, we anticipated roughly a $9 million charge to be incurred in the fourth quarter related to our main lease obligation. The 2010 revenue for AIU LA of approximately $500,000, and the operating loss of approximately $13.7 million through December 31, 2010, which is inclusive of the $9 million charge will then be reclassified in the fourth quarter of 2010 to discontinued operations.

In the fourth quarter, we will continue to face more challenging comparable data points from 2009 and the softening enrollment trends while we're also preparing for any potential business model changes. As a result we anticipate the fourth quarter to be more challenging than recent quarters in terms of new student start growth. While we anticipate overall new student start growth for the fourth quarter to be flat to low single digits, we do expect AIU and CTU to show new student start decline in the high single digit to low teens range for the fourth quarter of 2010. We've also said in the past that we would adjust student facing costs with levels of population, and hold all other costs to the rate of inflation.

With these moderating start trends, we intend to aggressively manage cost to hold the operating leverage we've gained over the past two years. As you know, as a matter of policy, we do not provide annual guidance. We have provided longer term milestones through 2014 at the analyst investor day related to annual revenue and margin growth. Additionally, we have provided milestones for 2010. All these milestones are based on the regulatory environment that existed late in 2009.

With the recent regulatory changes, the potential for additional rules early next year, and the slowdown in new student starts across the industry, we've begun the process of reevaluating our longer-term milestones. We believe 2011 will be a challenging year as we evolve our institutions and experience lower carry-in student population than we had modeled in those milestones. While too early to provide more specific milestones, we do not believe we will be able to meet the trend of the longer-term milestones for the calandar year 2011. But as the regulatory environment becomes more clear, we continue to believe in the value proposition for our students which will enable us to again experience growth over the longer term in revenue and operating leverage for the business. With that, we would like to open up the call for your questions.

Thank you. We will now begin the question and answer session.

(Operator Instructions)

The first question is from Bob Craig from Stifel Nicolaus. Please go ahead.

Thank you. Good morning, everybody.

Good morning, Bob.

I was wondering if I could explore the fourth quarter starts in greater detail. We heard a number of causal different factors cited by other companies reported so far. I was wondering if you can embellish on why you think things are deteriorating to the extent they are.

I don't know if we have much to add from what everybody said in the last quarter. We did reduce our advertising spend with the declining student interest. I talked about CTU and some of the trends we have in CTU as well as the comparables. We're just seeing a softening across our businesses as you saw in other businesses. Like culinary, we've gone from high growth levels to single-digit growth levels. I don't think we have anything further to add besides the speculation people have said and the lead trends we're seeing.

Mike, I was wondering if you could give us some idea on where you stand in on [90-10] by year end and also relative to the sunsetting of the low to mid increases in institutional lending and are you contemplating and pricing changes to offset any problems there?

Yes. As we said in the past, 90-10, it's a significant issue for the industry, not as big an issue for us a as some of the other countries may be experiencing. We do not believe right now at the end of 2010 that any of our institutions will exceed 90%. As we look at 2011 and the change that happens in July, we're looking at different techniques and different changes in pricing and program mix to make sure that we do comply again for the half year of 2011.

You do have the benefit of the $2,000. So, it will be more likely to be a 2012 issue. Most affected will be our health business. Least affected will be our culinary business as we said before. So we don't see an issue in 2010. 2011, with the change mid-year, will be less of an issue. We're hoping that as we move to 2012 that we get some legislative help that will benefit us and our students.

You mentioned aggressively managing costs. Relative to advertising that was down 200 basis points this quarter. Will that trend likely continue in the fourth quarter?

I don't think that's a good comparison point, Bob, because we're given the $40 million of cost in the G&A line. That skews the revenues as a percentage. So we said last quarter and the second revenue was up only 3% and this quarter is flat. So I wouldn't look so much as a percentage of revenue in this quarter because of the $40 million charge in G&A.

Okay. Looking at it year over year in dollars in the fourth quarter?

We won't give specific guidance on the fourth quarter spend.

Okay, great. Thanks.

Thank you. The next question is from Jeff Silber from BMO Capital Markets. Please go ahead.

Thanks so much. Just a couple of numbers questions. In terms of the shared services announcement that you made, what do you think the financial impact of that will be?

I don't it's going to be significant financial impact. As we said, what we're doing is moving thing from the university group to an overall corporate share services, so the services that had been provided by university will be provided by the corporate segment. So this was not necessarily a cost reduction exercise. More of an alignment exercise to benefit the scale of the company.

I will add one thing. One of the things we try to do is not have the duplication of effort. As I looked at the structures, as I look at the services were providing, there are places where we have duplication. So, there may be some small things that we will do to adjust the organization. What I don't want to have us do is have things that are done multiple times in multiple ways, because I think ever time we have the variations on a theme, you put yourself at risk. And that's what we're trying to avoid.

Fair enough. Moving on to bad debt, Mike you gave us a lot of color what was going on in culinary. Is that a one-time [true-up]? Should we see bad debt of these levels going forward. I'm wondering if you can comment about the debt levels in some of the other verticals as well.

Sure. I remember we had a true-up earlier in the year for the students that had dropped, and this is true-up for the students who are graduating. Going forward, we're looking at 13% to 14%. I think, as you look into next year, given just the trends -- the economic trends, the percentage would not be materially different than where we have been tracking. Across other businesses, we have not had a very significant increase in the bad debt trends. Much of it is due to the timing of different cash payments. We have not seen a decline in any of the bad debt trends across the remaining institutions.

Great. One final question. Gary, at the beginning of the call you talked about some of the things you're doing on the military side. Can you remind us what your military exposure is, either as a percentage of population or a percentage of revenue? Any data you have will be great.

Sure. AIU and CTU at any given point in time is somewhere between 25% and 30% of our student population are either active duty, military or veterans.

And some of the other segments?

You know what? Very little to the point that we don't track them much. Mike has actually has more pertinent information.

Just remember, the other is less significant because the remaining segments are ground based.

Okay, great. Thanks so much.

Thank you. The next question is from Amy Junker are Robert W. Baird. Please go ahead.

Hi. Thank you. Thanks for all the color on the call. It's always helpful. Mike, I just wanted to clarify the share repurchase comment. So you think the share repurchases in the third quarter is specifically due to the department of financial responsibility ratio? Just want to confirm that's what you meant. And on a go-forward basis, I mean, is that going to still be an issue you think for another couple of quarters and how are you thinking about that? Is it better to sit on some cash at this point until there's more clarity in the macro environment?

Sure. The ratio obviously you need to be between 1.5 and 3.0. Traditionally we have been somewhere between 2.0 and 3.0. This year, especially given the regulatory environment, we would never violate the ratio, but want to stay in good standing or have a solid ratio. Given the charge of $40 million and given the net income, the ratio is highly sensitive to equity. So, as your net income--and as you buy back shares, it actually hurts the ratio.

So with the repurchasing we've done during the year, which are approximately below net income and [approximate] income, we're running a ratio somewhere around 2. We don't believe we want to have the ratio below 2 in the regulatory environment we're in, so we have stopped buying back the shares at the current point.

As you enter into 2011, you obviously reset your numbers, reset your income, reset all your metrics, and we continue to generate strong free cash flow and net income, and we wouldn't need a position to repurchase shares in 2011. We think the shares are attractive to repurchase. And we could always use the cash to repurchase shares over the last few years, but given the financial responsibility ratio, and barring other high-return opportunities for our cash, we would intend to repurchase shares back in 2011.

Great. Helpful. Thank you. Then just one other one on gainful employment, and then I'll pass it over. I certainly appreciate an unwillingness to talk about the details at this point, but given some of the efforts that it sounds like you were starting to implement, how confident are you that you will be in a position if the rule passes as is sometime next year, that you will be able to be in compliance across the majority if not all of your programs by 2012 to -- given some of the changes you're making or do you foresee significant changes that need to be make some time next year if that rule passes?

Sure. Ones we get a rule, hopefully it's not as complex and complicated and in conflict with other rules, we'll be able to react better. Culinary and art and design are more impacted. We worked really hard. I'm looking at our degree levels, the tenure of our programs, the price of our programs and we've identified preliminary action steps to address those.

University and health are less impacted. That said, we have to look, because everyone has to look at what the new growth restrictions will be depending on how the department lands on those. So, we feel good that we made a lot of progress. As we said in the past as we were hit with the student loan crisis we made great changes to our model, as we've been hit with issues of CEC from long ago, we changes to our model. As these government regulations change, we'll make changes to our model, but much too early to share the details.

Perfect. Thank you, guys.

You're welcome, thank you, Amy.

Thank you the next question is from Trace Urdan from Signal Hill. Please go ahead.

Thanks. I'm sorry. I want to go back to Bob's question about the slowdown in the university business, and I'm not sure I really understood your answer if you're referring to the answers you gave in the second call regarding the slowdown or whether you were addressing comments that other companies have made about what they're seeing in terms of slowdown in the quarter, because I think we've gotten a very varied range of explanations as to what the slowdown is all about. So, I respectfully ask if maybe you can just go back and articulate maybe a little bit more clearly what exactly you see as the principal causes of the slowdown and demand in those degree programs.

We'll do the best we can. We have said last quarter that we saw a reduced demand in our associate degree programs. 65% to 75% of all of our students are in the 2 + 2 program or in associate degree. We saw a significant increase in lead flow.

Second, as you look at advertising spend, this quarter, third quarter's advertising spend will generate fourth quarter student interest. In the third quarter of 2010, we spent a flat level versus last year, a much higher level. So, the comparables and the lead spend drive lower lead volume. We've also moved away from our medical coding department at CTU, one of our larger programs in a new program in a start-up mode. So we stopped enrolling students.

That will cause pressure on that and just the general lead flow we're seeing which will lead to what others in the industry are saying, we're seeing a lower lead flow. Our conversion rates have not changed dramatically, but we're seeing lower lead flow. Those are the facts we see. Speculation of whether it's negative publicity or anything else is simply speculation.

Are you seeing any kind of distinction between associate, bachelor's and master's program?

Not in our university group, because most of our enrollees are in a 2 +2 program, which enter into associate's degrees and move up to bachelor's. So we don't have as much direct enroll into bachelor's. Our master's mix has stayed steady at about 8% - 10% of our population.

Okay. And Gary, could you speak to -- or maybe this is a Mike question. Why the shared services just for the university SBU? If this is a good idea, why is it not a good idea for the other units?

I think you may have misunderstood what I was trying to say. The shared services we are creating are for the Company. What I saw was similar services only being performed for the university group and in order to gain the leverage and scale I think we should have as a Company we are not doing it only at the university group, but bringing it up to the corporate level. So that's what we're doing. We're doing exactly what your instinct tells you should be doing.

Is there no concern at all about a [timing] between the differently accredited schools? I know this was an issue for [CC] prior to your arrival where there was, you know, some concern about how the individual schools were being managed? Is that not a concern in this case?

The university SBU has service level agreement on certain services they provide the institutions. We're not getting into the running of the institutions, but there are certain things we do, whether purchasing leads or other things like that you can do on a more holistic basis. We're bringing those up, certain HR services that we provide as an organization, those types of things can be done on a more macro basis than a university or institutional basis.

So we are not getting into trying to run the institution. That is, in fact, what the heads of the institutions do. We are simply providing services. We'll work in accordance with the agreements. I think by doing that, we won't run a foul of the rules.

And in the past, we've had these service-level agreements. The creditors, [HLC], have looked at these agreements, and we have had no issues with the agreements as we provide administrative services non-academic services, administrative services to institution. This is simply removing a layer of the service and consolidating the layer within the great service organization that we have. Nothing more than that.

Okay. Thank you.

Thank you the next question is from Sara Gubins from Bank of America. Please go ahead.

Hi, thank you. Can you talk about your expectations of any impact to changes in incentive compensation or rather, I should call it overall enrollment compensation going forward?

Sure, Sarah. At the end of the day, we expected what has happened to have happened. The Safe Harbors have gone away. We anticipated that. One of the things I said is that our compensation practices relatively speaking were conservative any way. And so we'll make sure that we make the appropriate changes to our compensation practices and move forward. I don't anticipate a significant change in what we are doing.

Okay. And then, could you talk a bit more if you've got an answer about why you think retention is going to down at AIU?

Yes. Retention across the Company was down somewhere below a 100 basis points. AIU was just higher. No specific answers beyond just the academic rigor of the programs and trying to make sure we align the advisors where they can help the students. So a combination of student interest and a combination of the academic rule or progress where the students are not making the progress they need to. They're dropping the institution.

Okay. So it's voluntary and involuntary.

Correct.

And then just lastly, could you talk about the fixed variable nature of the cost structure? I'm wondering, as you start to see it start to declining, which should lead to enrollment declines where you can cut costs and how long that really takes?

Sure. If you look across the P and L, obviously bad debt expense, admissions reps and advertising costs are all highly variable and those can be moved. Obviously bad debt expense with the economy, but those will all move with revenue and with student population. If you then look at the educational cost, the great majority of our faculty are adjunct versus full-time faculty. The ability to adjust faculty levels to class size and enrollment is also a pretty good lever to keep the variable cost nature.

As Gary said, with the shared services organizations that we're enhancing and with our approach, we try to keep all other costs level. We'll look very hard as we enter 2011 and our budgets that we set in November and December with our board of directors to determine other fixed costs that need to be adjusted or come out of the organization if the population does drop.

Thank you.

Thank you. The next question is from Gary Bisbee from Barclays Capital. Please go ahead.

Good morning. I guess, you know, just wanted to ask a little bit about the advertising expense. If you're seeing that demand is falling somewhat in ad expense across a good portion of the inquiry flow, you know, why would you actually shrink that expense at AIU at [CT]? It seems like it may be exacerbating the slowdown that you're seeing, and I guess I wanted to probe your thoughts on that, and two, are there things going on, like after that GAO report if you clamped down on the reps to be more conservative or other steps here that may be driving that slow down?

Sure. As we said last quarter, we're taking the student interest that is coming into the system. We're not chasing student interest if you want to call it that. As we've seen the demand softening, there are leads that will be a lower converting lead and they will probably not be as interested in long-term education within our institution, and those are leads that we're not going to pursue. Clamping down interrupts in terms of quotes we've changed nothing in our admissions practices and our rep practices as related to the GAO report. We've got solid practices we've done in the past, good education of our reps, dos and don't and the regulations that we do internally and externally to follow us. There was nothing done in the model related to GAO reports.

The only thing I would give on the clamping down versus anything else, we've made a lot of changes over the last couple of years to make sure our admissions practices are sound, that people understand right from wrong. Rather than clamping down, we did go back and reiterate the right and wrongs and dos and don't in our admissions organizations. I think we take some of those issues very, very seriously. So we did do that. I will say that in talking with some of our admissions leadership, they noted that as this was going on, there was I guess a gun-shy nature that went into probably a week after things that were happening. But, in fact,, you know, we saw the performance continue to move forward. So we didn't clamp down. We simply reiterated right from wrong.

And I guess just going back to the advertising spend, so am I right to think that what you're basically saying is incremental ad dollars spent at this time are a lot less efficient than what they've been in the past or there's been some change there, so it's just you're making a decision on the ROI on incremental purchases is poor even though that clearly could have a negative impact on operating leverage for the non-advertising expense?

That's exactly right. You know, every day, every week, every month we've got our marketing teams and our business heads looking at the efficacy of the spending, and they got to a point where they decided that incremental spending beyond a certain point wasn't paying out or efficient. So we've elected to draw that down if they didn't think they were going to get incrementally more for the spending.

And one last question, can you tell us how many states in which you have online students you do not have the state authorization at this point?

Yes. As of today, our schools have the appropriate state authorization that are required under Title IV. The new rules that have been proposed are fairly complex as to what constitutes state authorization, and so we're in the process of reviewing those new rules along with all of the relevant state laws and regulations that apply to what we do. So we believe, at this point in time that we may need to seek additional state authorizations. But honestly sitting here now, we still don't understand the differences between some of the laws, some of the regulation, and what constitutes authorizations. So we'll know relatively shortly but we're not in a position to say which ones at this point. Because they all vary.

Thank you.

You're welcome.

Thank you. The next is from Corey Greendale from First Analysis. Please go ahead.

Good morning. One more question on the advertising side. Can you just help us, given that media rates have been up, can you just help us to aggregate the various moving pieces between changes in media rates, changes in impressions and how significantly the number of impressions may be down?

Sure. And historically our lead spend has been somewhere around 70% Internet, 15% traditional media, TV, print and the rest other sources including referrals, so from an Internet standpoint or referral standpoint we see nothing. From a TV standpoint, we've seen some pressure on the cost side. But given the lead mix, TV is probably only 10%, 12% of our lead mix. We haven't seen anything dramatic in terms of cost structure or changes for us because of our use of the Internet.

Okay. And then following up on Sarah's question from earlier, from your response, the conclusion I'm drawing is just to take the university segment, if you see revenue declines in the university segment that the margin on that revenue decline won't be as high, in other words, fall from the bottom line as you saw on the way up, is that accurate?

I'm not going to give you specific guidance. I think what we are saying is we're going to work hard to make sure not only variable costs but also fixed costs do come out if the population does for some reason drop dramatically, not that we're seeing that, but if it does. So, we don't have specifics on what the operating leverage gain or loss would be on a variable basis. I tried to give you as much color as I could on the different areas you could model to come up with estimates.

And also on the university segment, the change in the program CTU that you mentioned. If I missed this I apologize. Can you quantify how many students were in the program, and are you looking at similar changes to the mix at CTU or elsewhere?

We haven't quantified that. We did say it's one of the relatively larger programs. We continue to look -- this is a CTU decision, not a Company decision. CTU and the other institutions like AIU continue to look at their programs and mixes and look at outcomes. They are looking at those currently, they are looking at those in gainful employment. And they'll make decisions accordingly as they see fit. We don't see anything material right now for the fourth quarter in terms of dramatic changes within the programs by our institutions.

And AIU with the shift in the credit hour structure, would you say that's stable in terms of students deciding to slow down and the revenue decline in Q3 is reflective of what we'll see going forward, or can you still decline further?

You could still decline further. The change happened in March, at the beginning February for online and March for the ground students. You're working through the different students that started in that period and looking at their pace of studies. So, I think it would not be unrealistic to see flat to slightly declining RPS as we go forward.

So a similar decline, not an accelerated decline?

Not likely.

Thank you.

The next question is from James Samford from Citigroup. Please go ahead.

Thank you. Two quick questions. I just want to dig in to the military side of your business. I'm wondering whether you've seen any change since the buildup in Afghanistan and any other troop movement affecting demand on that side. And secondly, on the -- in your conversations in DC, any thoughts on the impact of the elections yesterday?

Let me take the first one first. We have not seen a significant change in our military population or demand. The majority of our students, while we have a number of active duty personnel, the majority are veterans. You know, either newly returned or out of the military using the benefits. So we have not seen a significant change on that front. I don't want to prognosticate on what I think all the stuff in Washington means to us at this time. It's early on. My hope, based on my conversations and what I've seen happen over the last several months in Washington is that the changes bring more balance to the conversation around the issues related to higher education in our Company. You know, as things have played out, the discussions have been fairly weighted towards the for-profit industry, debt that has been taken on by students, and so on and so forth. And my take on this is that the issues that the Department indicates they want to address, you know, are issues of higher education, not just the for-profit sector. So, I'm hopeful that some balance comes to the conversation so we get to the right place for our students.

Thank you. The next question is from Bob Wetenhall from RBC. Please go ahead.

Good morning. I'm just trying to get a little clarity. Are you revoking your long-term objectives that you laid out earlier in the year or are you just postponing them?

What we were saying was as we set the goals early in the year was a different regulatory environment. As we look at the trajectory rate and our population, the fourth quarter starts we gave you, we're saying that to grow 8% to 10% plus 100 basis point margin improvement in 2011 does not look likely. We're not recalling our guidance, we're not changing our guidance. They are milestones, not guidance. As we get more on the regulatory environment we're hopeful that the Company and industry can restore itself to good growth trends because we do a good job for students. We're giving you thoughts on 2011 based on data we shared with you earlier this year.

That's really helpful, and we appreciate it. Let me ask you the question a different way. If there was no gainful employment and no impact from the regulatory front, would what you're telling us today be a function of negative enrollment growth in the fourth quarter and the continuation of that trend into next year?

I don't think you can model it that way because you don't know what the impacts of gainful employment are.

Put that aside for a second a pretend that doesn't happen, because we're not speculating on gainful employment. Putting aside gainful employment would you still be delaying or postponing your goals based on the enrollment trends that you're experiencing? In terms of your long-term milestones?

Don't know the answer, because I haven't modeled it that way. I modeled it using gainful employment because that's what the regulatory environment appears to be. I'm giving you an update based on what I know between gainful employment and the trends of what '11 may look like because I have not tried to model without gainful employment.

Okay. Great. With that -- I'm just trying to understand a bigger picture and consolidated basis and not in any one particular score or segment. Do you expect negative sales leverage to affect the model next year or expect margin stability going forward?

We don't give guidance on a specific year. We give guidance only on '10 because we were in the year and went to the investor day and I don't have specific guidance for '11. We do have the thought that we shared with you about how to alter your models as we go into '11 based on the current trajectory and gainful employment.

Do you think it's possible you can scale down your cost structure? If your revenue base starts to decline, do you think you can cut your base faster than your revenue base drops.

I don't know. I'm not in a position to answer that. But I think you know in the online business and the business models that most of this industry have, there is a significant operating leverage in the business, and as populating leverage does grow, you do gain operating leverage. If the business was to retract itself, you have to take steps to remove your cost structure appropriately. Variable costs come first. Student facing costs come last, and make sure your overheads are aligned. I'm not in a position to give you your model, but I think we have to work hard as everyone has to work hard on a deceleration of the growth.

Thank you very much. I appreciate the candor.

Thank you, Bob.

Thank you. The next question is from Kelly Flynn from Credit Suisse. Please go ahead.

Thanks. Could you update on the size of your internal lending program and then reserve rates, charge-off rates and any recent changes to those? And I guess also confirm as you do that is the culinary bad debt issue largely related to that internal program or does it go beyond that?

Kelly, I think we'll take it off line a little bit. We'll have Jason and Casey talk to you about what we had said through the script and the program. Basically $60 million in the balance sheet. If you look at the balance sheet in 10-Q, you can see the reserve rate, our allowance is somewhere around 50% of all receivables. We said in the past three quarters we were reserving at a 48% rate for our graduates and non-graduates when we started the program, because we had only (inaudible) data. We've taken that rate higher for both graduates in the third quarter and the drops in the first quarter of the year. So the rate is above 50%, and we have $60 million of gross balances for reserve on our books for culinary.

And the whole program relates to culinary?

If you look at the balance sheet, there's about $60 million in culinary and another $60 million for all other receivables we have on our balance sheet. Some for small lending programs, payment programs and maybe one to three years in duration that we've always done historically as well as open account student balances from the ledger cards for students who had balances owed to us for the current programs of study. So our receivables, culinary is about $60 million, and the total receivable balance is just about double that.

Okay. Thanks.

Thank you. The next question is from Arvind Bhatia, from Sterne Agee. Please go ahead.

Thank you, just a question for Mike. I'm wondering if you can refresh on your thinking for your free cash flow now. I think you said it's about $160 million if I recall correctly for the year. Is that still the target for the year, and as you look at next year, is there anything major in terms of CAPEX that might be significant one time in nature?

I don't think we gave any specific cash flow guidance. What we did tell people is we thought our operating income would be between $350 million and $375 million. Our tax rate would traditionally be somewhere around 35%. We had some benefit in our tax rate in the last couple of quarters based on discrete items. Capital expenditures would typically run about 4% of revenues; but in this year we'd have $40 million in [our] headquarters. So that would nod out our free cash flow. Next year two significant things to hit the cash flow next year to think about, one will be the that the headquarter spending will not be done, so in the spend we may have an additional $10 million to $15 million in the first quarter of carryover spending. Additionally, as you look at next year's first quarter you will have the $40 million payment of the culinary settlement if approved by the courts.

Just wanted go back to the buyback question. Given the free cash flow and given the improvements you expect in your cash situation, how long should we be thinking you're going to be suspending your buyback before you feel comfortable with your ratios and you resume your buy back?

We haven't suspended our buyback. We have $290 million of authorization, and we frontloaded our buyback this year with $155 million in the first two quarters. That said, the deal ratio resets at the every year. It only applies to the last day of the fiscal year. As we look forward to December 31, we know the ratio and didn't buy back shares in the third quarter to make sure we (inaudible) that ratio. As we go into next year with the new net income target, we have to look at gainful employment, look at trajectory and everything else. We'll look at our net income target, look at our free cash flow, capital expenditures, and if the best use of cash is for that next year we'll do so within the timing we believe best.

Thank you.

Thank you. The next question is from Peter Appert from Piper Jaffray. Go ahead.

Was hoping you could remind me when you created the orientation program in the online intro course. In the context, I'm trying to understand if these efforts have a meaningful impact on persistence in 2011.

The orientation programs that I referred to were created a couple of years ago. I don't remember the exact timing, but it was two to three years we began to do those things.

You mentioned specifically, Gary, the change in number of student counselors. Are there any other proactive steps underway to try to drive improvement in persistence?

You know, beyond the things that I've talked about in the prepared portion in my comments, no. We moved counselors to aline with students during the first part of the program. So we find that's we find that's where most of the retention issues happened, in that first six terms. So we've worked hard, hard to move the appropriate resources. We worked hard to identify our best teachers to insure that those instructors are aline and have the opportunity to teach the most classes. Most of them are higher education, education in general that, you know, a terrific teacher is the key to both making sure students get what you teach them and retention. Those are the predominant things we have done at least over the last six to 12 months.

I guess the issue is it seems like the decline persistence is dramatic given all the efforts you're making. Relative at least to internal expectations was this a surprise in the current quarter?

I can't say it was a surprise. I don't think we saw a dramatic uptick. When you step back and think about all the factors that happened to our students, you know, across the board and in our schools, first of all, I think what we're seeing is not inconsistent with what's happened more broadly in the industry.

There are a number of things that impact when you've got high unemployment, you've got issues, just family issues, other things like that, there are a number of things that can impact retention. I can't say we're surprised, but we're doing all those things we can control to ensure the students are getting the experience and teaching that they need to have while they're with us. But there are a lot of things that impact retention. Not just what happens in our institutions.

If you look across our institutions, attrition trends were less than a 100 basis point change. It was just more pronounced the day [we] took actions on. So I don't think we're seeing broad-based issues. 100 basis point change is not significant given all the trends of the last several years.

Thank you.

There are no further questions at this time. I'll turn the call over to Mr. McCullough for final remarks.

First of all, I want to thank you all very much for your attention and your questions. As we indicated on the call, we continue to be on track to finish the year in line with the goals that we laid out early in the fiscal year. Obviously we're looking forward to 2011. As Mike indicated in his prepared remarks, we expect 2011 to be a challenging year. But we're taking all the actions that we think are necessary to ensure we improve the educational quality of our institutions, improve the student outcomes we have and to make sure we are compliant with any changes in the new regulations that come out.

So, we'll continue to manage the Company in a manner that's responsible and that's measured so we can deliver value over the long term. Again, it will be a challenging year. We tried to be open as we continue to see changes that come out of Washington or any place else, we'll work those into our business assumptions and we will be as open as we can on the impact to the Company. So with that I thank you very much for your time and attention. Thank you very much. Take care.

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