Strategic Education Inc (STRA) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Strayer Education Inc. third quarter 2004 earnings conference call. At this time all lines are in a listen-only mode. Later we will announce the opportunity for questions and instructions will be given at the time. (OPERATOR INSTRUCTIONS). At this time, I'd like to turn the conference call over to Sonya Udler, Vice President of Corporate Communications for Strayer Education. Please go ahead, ma'am.

Thank you, operator. Good morning. With us today to discuss the results are Robert Silberman, Chairman and Chief Executive Officer for Strayer Education, and Mark Brown, Senior Vice President and Chief Financial Officer.

For those of you that wish to listen to the conference via the Internet, please go to www.StrayerEducation.com where the call the archived for 90 days. If you are unable to listen to the call in real-time, a replay will be available beginning today at 3 PM Eastern Time through Friday, November 5th. The number for the replay is 888-203-1112, passcode 197271.

Following Strayer's remarks, we will open the call for questions and answers. Please note that today's press release contains statements that are forward-looking and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act. The statements and based on the Company's current expectations and are subject to a number of uncertainties and risks that the Company has identified in the press release, and that could cause the Company's actual results to differ materially. Further information about these and other relevant uncertainties may be found in the Company's annual report on Form 10-K and its other filings with the Securities and Exchange Commission.

And now, I'd like to turn the call over to Rob. Rob, please go ahead.

Thank you, Sonya, and good morning ladies and gentlemen. As is our custom, I'd like to begin this morning with a brief overview of our company and our business model for any listeners who are new to Strayer. I'll then ask Mark to report on the detailed financial results for the third quarter. After which I'll comment on our enrollment results for the fall term, provide an update on our growth strategies, and finally end up with the Company's outlook for Q4 and the full year, as well as describing our model for 2005.

Strayer Education Inc. is a for-profit education service company, who's primary asset is Strayer University. An over 23,000 students, 30 campus, postsecondary education institution, which offers associates, bachelors and masters degrees in business administration, accounting, information technology, public administration and education. Strayer students are working adults who are returning to school to further their careers.

Our revenue comes from tuition payments and associated fees. Approximately 55% of our revenue comes from federally-insured Title 4 loans to our students. Our expenses include the cost of our professors, our admissions and administrative staff, marketing expenses, and facilities and supplies costs. We currently operate campuses in eight states in the eastern United States, as well as throughout the world over the Internet through Strayer University Online. We serve students in all 50 states and in over 40 foreign countries through Strayer University Online. Strayer University accredited by the Middle States Association of Colleges and Schools. Mark?

Revenues for the three months ended September 30th, 2004 increased 27% to 38 million compared to 30 million for the same period in 2003, due primarily to increased enrollment and a 5% tuition increase which commenced in January 2004.

Income from operations increased 7% to 7.8 million from 7.3 million for the same period in 2003. As most of you are aware, income from operations in 2003 included a 1.8 million gain from the sale of the Washington, D.C. campus building. Excluding the 2003 gain from the sale of this building, income from operations rose 41%. Management believes that excluding this asset sale provides a useful indicator of the Company's underlying operating performance.

Net income rose 5% to 5.1 million compared 4.9 million for the same period in 2003. Excluding the 2003 gain from the sale of the Washington, D.C. campus building, net income rose 34%.

Earnings per diluted share rose 6% to $0.34 compared to $0.32 for the same period in 2003. Excluding the 2003 asset sale, earnings per diluted share rose 36%. Diluted weighted average shares outstanding increased to 15,021,000 from 14,969,000 for the same period in 2003.

Revenues for the nine months ended September 30th 2004 increased 26% to 130.9 million compared to 103.7 million for the same period in 2003, due primarily to increased enrollment and a 5% tuition increase effective for 2004.

Income from operations rose 26% to 44.7 million from 35.5 million for the same period in 2003. Excluding the 2003 asset sale, income from operations rose 33%.

Net income rose 24% to 28 million compared to 22.6 million for the same period in 2003. Excluding the 2003 asset sale, net income rose 30%.

Earnings per diluted share rose 21% to $1.85 compared to $1.53 for the same period in 2003. Excluding the 2003 asset sale, earnings per diluted share rose 28%. Diluted weighted average shares outstanding increased to 15,092,000 from 14,796,000 for the same period in 2003.

At September 30th, 2004 the Company had cash, cash equivalents and marketable securities of 111.7 million and no debt. The Company generated 40.2 million from operating activities in the first nine months of 2004. Capital expenditures were 8 million for the same period.

During the three months ended September 30th, 2004, the Company's spent 15.6 million for the repurchase of 165,900 shares of common stock at an average price of $94 per share, as part of a previously-announced common stock repurchase authorization. During the nine months ended September 30th, 2004 the Company's spent 36.8 million for the repurchase a 346,500 shares of common stock at an average price of $106 per share.

In the third quarter of 2004 bad debt expense, as a percentage of revenue, was 2.5% compared to 1.7% for the same period in 2003. Day sales outstanding, adjusted to exclude tuition receivable related to future quarters, was nine days at the end of the third quarter 2004 compared to seven days for the same period in 2003. Rob?

Thank you, Mark. Just a few comments on the financial. Since Mark had to trip over excluding the asset sale a number of times, I will not do that. But understand that that's how we are looking at the quarter.

Our revenue growth of 27% for the quarter was consistent with our model. It was actually a little better than our model, as we had announced a 22% enrollment growth of the summer term and the 5% price increase. As Mark mentioned at our Investor Day last May, we no longer have interest income on Strayer-owned student loans running through our revenue line. But that was partly made up by increased fee income on our application fees and some other fees including textbook sales. Our seats per student ratio, which I think is sort of the most important moving target with regards to going from enrollment to actual revenue, came in about where we predicted.

We reported a 200 basis point increase in operating margin in the quarter. Again, however, if you back out the effect of our accounting reclassification this year, which Mark has talked about previously, our revenue growth for the quarter would have actually increased to 28.5%, and the operating margin increase would have only been 70 basis point versus the 200. That's 70 basis points -- that's the real increased operating leverage in the business -- was accomplished even with opening the five new campuses on a base of 25 in the first nine months of this year.

Now, one expense items which was significantly higher than we would have liked was our bad debt expense at 2.5% of revenue. This is our second quarter in a row above 2%, which as Mark and I have mentioned before, we feel that's an important target. We actually saw this metric, which is really a derivative -- it is actually the inverse of our collection rate, which is what we track. We saw that trending up in late August and early September at four or five of our campuses, as well as our out-of-area online unit. In response to that we tightened down our credit standards after those units for the fall enrollment cycle, which was ongoing at the time. That doesn't help our collections for the summer, but it will hopefully help us going forward. And Mark and I and our operations team are going to continue to monitor and manage this line item closely.

Our free cash flow, which again we define as our cash from operations minus all necessary CapEx, was up 440% in the quarter, which is obviously well above our 35% increase in net income. However, a lot of that was a cash tax benefit associated with stock option exercises. When you back out that benefit, our free cash flow in the quarter was still up about 125% year-over-year. So, we did real well on that metric.

Finally, the 36% EPS growth on 27% revenue growth, just reflects that real operating leverage that we've had, that 70 basis point that we discussed already.

Turning to the fall term enrollment results. Total enrollment increased 17% on a year-over-year basis. New student enrollment was up a little bit less, about 16%. And continuing student enrollment was around 18%. Our out-of-area online enrollment was up 53% over the previous year in the quarter.

Now this quarter we continue to see high demand from our campus-based students for online classes. However, I would point out that the rate of that mix shift is continuing to slow, and that ultimately, as we reach an equilibrium -- what I mean by an equilibrium is reach a steady-state in terms of the desire of our campus-based students to take classes online. We expect the growth of our 100% online course takers will be the mean between the rate of growth between our campus population and the rate of growth of our out-of-area online population. And we're starting to see that happen as, over the last couple of quarters, the rate of growth of our out-of-area online population has been significantly higher than our total 100% online course takers.

With regard to the student mix, business administration and accounting degree seekers account for slightly over 60% of our students for the fall term. That's fairly consistent with the last couple of terms. Computer information science degree candidates made up about 30% of our total population. Interestingly, our new graduate programs now account for about 2.5% of our student population this fall. That's those three new programs -- the Masters in Education, Masters in Health Services Administration, and Masters in Public Administration. Yes, exactly. Our overall graduate population remains about 24% of our student mix in the quarter, up from about 21% a year ago.

Turning to an update on our growth strategy. Many of you will remember that our strategy is based on five objectives. First is to maintain enrollment in the Company's mature markets. Second, open new campuses, particularly in new states. Third, invest in and build up our online offerings. Fourth, increase our corporate and institutional alliances. And the final objective is to look selectively at potential acquisitions and the reallocation of capital back to our shareholders.

On our first objective for the fall term, we had a solid quarter at our mature campuses, showing 3% growth, while mature campus students continued to exhibit a preference to take online courses in their later terms. With regard to new campus activity, we opened one new campus for the fall term, our third campus in the Philadelphia market. This successfully completed our planned five campus openings scheduled for 2004. I'd also note that all five of the campuses we open in 2003 are now operating profitably this quarter. That was a partial source of our margin expansion in the third quarter as we moved towards profitability a little bit ahead of our ramp rate. And in our out-of-area online campus, our growth for the fall term was 53%, ahead of our 50% target.

In the area of capital redeployment, we were able to repurchase about 170,000 shares in the quarter, or about another 1.2% of our outstanding shares. As I mentioned last quarter, we roughly doubled the annual dividends to $0.50 per share. And the first payment at that new annual rate will be made December 10th to shareholders of record as of November 26th. This increase in the common dividend will not have any meaningful impact on our cash generation for the year, as it is almost fully funded by the cash portion of our preferred dividend, which we no longer have to pay having converted all of that stock back to common.

In my letter to shareholders this year, I did discuss the fact that the Board and I are convinced that our business model allows us the luxury of fully funding a strong organic growth strategy and still making a periodic return of capital to our shareholders. We as the management team and the Board will continue to weigh all uses of cash every quarter to determine the most value enhancing, after-tax return on our owners' capital.

On our business outlook for the fourth quarter and the full year, due to the university's strong enrollment growth for the fall term, offset partly by increased expenses associated with the new campus openings, we estimate our fourth-quarter EPS will be in the $0.84 to $0.86 range. And knowing our full-year enrollment now and our first three quarter results, we believe our full-year 2004 results will be in the $2.69 to $2.71 range.

Finally, with regard to next year, we're pleased to announce today that once again we intend to open five new campuses in 2005. Our success over the last two years gives us increased confidence in our human capital development programs, such that we feel we can sustain this rate of expansion and continue to maintain and improve our academic quality. Indeed with this plan, doing five campuses next year, by the end of 2005 we will have almost tripled the number of our campuses in the five years under our present management.

Two of the five planned campus openings next year will be in the Tampa, Florida market we were just recently approved in a few weeks ago, and which we announced today. Our notional model suggests that with opening five new campuses and continuing to invest in and support academic quality and growth at our existing campuses and our out-of-area online unit, we should be able to sustain stable operating margins in 2005 and at least 15 to 18% enrollment growth.

One adjustment Mark and I have made to our model reflects slightly lower revenue per student growth next year than our tuition increase. We are modeling that revenue per student growth at about 4% versus the 5% tuition increase. This reflects the mix shift to graduate students, which we have experienced and we've discussed earlier.

And with that operator, I'd be pleased to answer any questions. Let me just emphasize also, though, that I think on the last call there may have been some people that wanted to ask a second or third question and just didn't get into the queue in time. We will be here as long as there's questions, so please let the operator know if you have them. And we'll be pleased to answer them. Sheila, with that, we are ready to go.

(OPERATOR INSTRUCTIONS). Mark Marostica, Piper Jaffray.

I wanted to first ask about your comments around bad debt expense, particularly if you'll comment on your rate of attrition in the quarter versus last quarter or the year-over-year period. And any trends that should be noteworthy there.

There really wasn't much change in the rate of attrition. We look at our continuation rate, which is the rate at which our students who complete one quarter sign up for the next quarter. That was down slightly, less than a percent. It has been up significantly over the last couple of years. So I would say we're pretty strong in that area. I think our bad debt expense, as I said, we saw it isolated at really just a couple of campuses, and a little bit higher in our out-of-area online unit. And I think it had more to do with credit decisions that we were making at the campuses with regard to students who are neither Title 4 our corporate sponsored. We want to give that flexibility at our campuses, but we obviously monitor it quite closely in those circumstances where collection rates don't match what we think they need to be; we just tighten it down a little bit.

Next question, new student enrollment growth came in modestly below our estimate and the result for summer '04 and the year-ago period. I'm just wondering is there anything to point out there that might account for that?

It's a variable business. We don't know exactly what it's going to be in any given quarter, and we're not really trying to manage to a particular number. We think our notional model is that our total enrollment growth, given the investments we are making in the campuses and the online business, ought to run sort of 15 to 18%. It was higher than that in several quarters earlier this year, and it may be higher in the future, it may be lower. I really don't have anything specific beyond the fact that, as I mentioned, we tightened down our credit standards at a couple of campuses. Other than that, we were quite pleased with it.

And then last question and I'll turn it over, I'm wondering what your total online enrollment growth is implied in your fiscal '05 guidance?

You mean 100%, those students taking 10 % classes online?

Correct.

I think it's actually slightly less than 50%. Because, as I said, we're expecting that mix shift to slow.

Bradley Safalow, J.P. Morgan.

Good job on the quarter. A quick clean-up oppression. The only schools that drop into the mature campus space this quarter was the Newport News campus? Is that right, Mark?

Yes, that's the only new one this quarter, but then we also still have the impact of re-classing Chesapeake and Owings Mills from last quarter.

I just wanted to make sure that was the case. And then, just in terms of the out-of-area online, can you talk a little bit about your current marketing plans for that division? You did hit the 50% benchmark you established, you just referenced that. Now you expect the mix of total online to be below 50% for the year. Are you changing any of the marketing strategy? Do you see a difference in the competitive landscape for that? Do you see higher lead costs, things like that?

Let me take it in reverse order. We actually had a lower lead cost. I think our marketing program, such as it is -- I would be the first to admit we don't have the most aggressive one, specifically with regard to the out-of-area online -- has been quite effective. That is an area of the business that we've made a lot of investment in. Most of that investment is accounted for as expense, because it's additional people, additional professors, additional admissions officers. And specifically, given what we were talking about before, we've invested in additional student finance officers. I think that business continues, or that unit of the business, continues to grow quite nicely. And we've been real pleased, particularly with the student learning outcomes, which is really the thing that we're most focused on in the long-term.

I think it is a competitive area; it's always been a competitive area. I'm not sure I would say it's become more competitive in the last quarter or the last six months or last year. We had a slightly higher cost per student acquired, or per student start, because notwithstanding a pretty healthy lead flow, we were pretty strict on them, more so than we had been in the past, with regard to some of the enrollment requirements to deal with a slightly lower collection rate than we were prepared to accept.

So with new credit standards you've implemented for out-of-area online, you still think 50% is a good benchmark for next year?

That's what we're investing towards. Yes, I would hope that we'd be at or above that number. It could be a little bit below, it could be a little bit above. But I think about it in a general sense, we are going to hire a lot of professors and we're going to hire a lot of admissions staff, and we've got a good team there and we are certainly buying enough leads. So yes, I'd hope we'd be in that ballpark.

Greg Cappelli, CS First Boston.

Can you talk about, Rob, you mentioned the bad debt expense, where you'd like to target that. Is it 2.5? Is it back down to 2? What's your goal there?

We've said, in the past, we think it ought to be around 2. Let me also say, there's nothing illegal or immoral about bad debt expense. You can run a business at 5%, there's nothing wrong with that. And indeed, in some business you might argue that makes sense because you're getting your appropriate revenue and earnings growth associated with that. In our case, it's somewhat modified by the fact that we are a university and the culture that we're trying to create -- we don't want to have students in who are not paying, because they don't graduate. By definition, they can't get their degree if they have not cleared their account. And it ties up our professors and the rest of our organization. So we arbitrarily said we want to keep that at a very low number. And overall, we're so excited about the prospects for building out a nationwide university and what the value creation, which is inherent in that, and we're prepared to do it in a very deliberate way to make sure that the student quality and the learning outcomes, and ultimately the financial quality of the expansion, is reflected in that.

Do the schools have some say in that, as well as, obviously, corporate?

No. That's a decision we make here. What we try and do is give as much flexibility as we can to the individual campuses, but the standards are set by Mark and myself here.

In the past, you've talked about average number of courses per student. Is that still just below 2?

Yes.

And that's what you are referring to when you had mentioned the shift toward graduates, because they're probably taking less credit hours?

Correct. Exactly right. You know, the average graduate student takes about 1.5, and the average undergraduate student takes a little over 2. So as more of your population becomes graduate students, your average class counts per student trends down slightly. What are we down to, Mark, about 1.9 something?

Yes, just about 1.9.

Got it. And then the last question on the ramp-up of the new schools you talked about -- seeing some good results there. Is that now coming in -- when you originally talked about the rollout of the new schools, would you do say it's as much as a quarter or two -- breakeven is coming in a quarter or two prior to what you had maybe originally thought?

Yes, at least actually. Some of them it's been more than that, and none of them have been slower than that. We've now opened 16 campuses that have reached profitability. I'm sorry, 11 campuses that have reached profitability since we started. And all of the achieved that milestone at least a quarter ahead of what our notional models said. That's correct.

Gary Bisbee, Lehman Brothers.

My congratulations as well on a very strong quarter. A couple of questions about looking forward to next year. And I know that you refer to this not as typical guidance, but just sort of your business plan. But it seemed to me that the margin guidance you are giving was actually down year-over-year versus what this year will likely be. Is there anything specifically behind that? Are you expecting the bad debts to stay higher or anything else? Or is that just conservatism at this point.

I'm not sure I'd make a quantitative statement about it. Basically, our model suggests that if you keep the same number of campus openings year-over-year, you should basically have stable margins, maybe some slight improvement. And so we do have a number of investments scheduled next year in the online area, and we are refurbishing a number of our mature campuses. But I would hope we would have stable margins, Gary, that's what we're shooting for.

Do you want to comment, maybe this quarter versus a year ago, in terms of what the profitability of the online business, either the out-of-market or online in total is? Is it still above your most profitable campuses? Or does it come in at all?

No, it still is. It's a good question, because it is the way we look at it both in terms of out-of-area and total. But the problem with looking at it in total is, it is a purely arbitrary decision as to where do you account for the margin inherent in a student who is recruited through a campus and then takes classes online. We take a arbitrary view internally and assign a certain amount of the instructional and education costs associated with the student taking the class online. But we give some of the margin back to the operating campus that recruits the student and that services the student. That's where their faculty adviser is, that's where they use the library facilities, things of that nature. We could really make that, on a segment basis, whatever we wanted. We think the right way to think about it is to split it. And even with that, you still end up with the online as a unit at or above our most mature campus, our most profitable campus.

Does it makes sense, given that -- think about some actions to try to grow that out-of-market somewhat more quickly than the 50% bogey you've put out there? Or are you still comfortable that that's the right number in terms of keeping the quality?

It makes sense as a business to grow that as fast as you can. It'll only be good as a business as long as we can maintain the academic quality. So that becomes the limitation on our investments there. We think that on a long-term sustainable basis, that is about the right number right now, that 50%.

And then just to clean-up questions. It looked like in the press release, unless I had it wrong in my model, that the year-over-year out-of-market online was a different number than you gave us. Would that be, if you had students in Atlanta, for instance, and now that you've moved there, would those be reclassified into the new market online enrollments?

That is exactly right, Gary. Just as we do with our new campuses going to mature, we've talked about that in the past, over time, eventually, I guess we'll not have any true out-of-area online. But, it's a long time from now, at least in the continental United States -- let's not exclude Alaska and Hawaii. But yes, that's exactly right.

And then just one last one. You know, as you look over the next couple of years -- I know you've got Florida and you expect to get other state approvals, but which of your existing states do you think there's opportunity for a lot more? And are you progressing towards moving to Pittsburgh or any other market within Pennsylvania?

I would say that all of our states, with the exception of Maryland, DC, and Virginia, have room for significant campus expansion.

(OPERATOR INSTRUCTIONS). Howard Block, Bank of America.

It's Derek here. The first one, the mature campus enrollment declining 6%, what's the variant across the 17 campuses? Is that a fairly indicative decline for across the network?

Again, Derek, I think that's a misstatement. The mature campus enrollment actually increased 3%. The number of students who were taking classes in physical classrooms in those campuses declined by 6%. Yes, I would guess it's fairly -- to be honest, I don't have the specifics right in front of me. Nothing jumps out in my memory as it being out of the ordinary in any one campus over the other. What we find is, is that in the last five years that we've made the online available to our campus-based students, there is a percentage of our students who, particularly in their later terms, once they become comfortable with the University and with taking classes here, will prefer to take some of their classes online just for convenience sake. And as I say, that mix shift is slowing, but it is still there, it's still significant. We want to serve those students in whatever way they want to take the classes. We're not trying to move it in one direction or the other. What we want to do is make sure that our asset base, our fixed asset base, reflects how our students want to take classes. And so part of our campus refurbishments, as we are upgrading our physical plant, some of our more mature campuses, is to both shrink the square footage slightly to take into account this phenomenon, as well as making the internal square footage fit more of a student who wants to take at least some of their classes online. So more of the square footage is associated with library resources, computer facilities, counseling centers, advising centers, things of that nature.

Great. And a follow-up on that -- the average enrollment, the mature classroom campus students, that has declined at an accelerating rate the last five quarters. I think it's about a 590 student’s school. Is that something that you're managing to an optimum level? Or is this just a reflection of that mix shift?

It's a reflection of the mix shift, but at least for the 10 or so campuses that were mature when we took over the company, it's actually been a beneficial mix shift, or a beneficial byproduct. Because we had some physical classrooms that were just, frankly, too crowd. And so we were able to -- we're bringing that number down to, I think, a better student per teacher ratio in some of those classrooms, as this goes forward. In some of our newer campuses that are moving into the mature market, into the mature category, what we've done is just tried to build those campuses, taking into account the fact that somewhere between 20 and 40-ish percent of our students will, at some point in their career, will want to take 100% of their classes in a given term online as opposed to in the classroom.

And that rate of decline, is that something that we should see, the rate of decline lessening?

I don't know. As a say, I think we are moving towards equilibrium, but once we hit there won't be any decline at all. As the campus population grows, both that portion of it, which is taking classes online and the ones taking in the classroom, will grow at the same rate. At least notionally; it's never going to be exactly the same. I don't know when that's going to happen, to tell you the truth.

Corey Greendale, First Analysis.

Actually, just quickly following up on what you were just saying, Rob. You're talking about the shift to online approaching equilibrium. If you look at it on a sequential basis, the percent of students taking classes online relative to on-ground for both the mature and the new campuses, actually declined for online, that's sequentially I'm talking about. Is there some seasonality to that? Or do you think we may have actually hit equilibrium here?

I'm not sure I understood the question, Corey, say that again.

I apologize. If you look at this term versus the last term you just reported --

Yes. All of our -- our entire campus is small in the summer. Our entire university system is smaller in the summer because of that seasonality.

So, looking at last term, a smaller percentage of students were taking their classes in on-ground campuses than are this term. It looks like the mix sequentially actually shifted towards the on-ground and away from online.

I had not actually looked at it that way. I don't know that that's correct. Mark is shaking his head.

I don't know.

But clearly -- what I look at, Corey, is I look at the rate of growth of our out-of-area online, and the rate of growth of our 100% online course takers. And for a while, the 100% course takers was quite a bit higher than our out-of-area online growth rate. And that told me that our use of online was being significantly fueled by campus-based students wanting to take online. Now it's the other way around; now our out-of-area online growth rate is higher than our 100% course takers. And that's what I mean by it reaching equilibrium or that mix shift slowing.

Moving on to one other follow-up, hopefully won't be as confusing. You mentioned in answer to Mark's question about retention. You said that the students signing up for the next term was down less than a percent. Was that referring to from the year-ago term or from the previous term?

The previous term is what I was thinking of. It's probably consistent with a year ago as well. Our continuation rates are around 78, 79, 80%. It's a little bit higher from summer into fall because our base is smaller in the summer going into the fall. But I forget, it's maybe 50 basis points or something, was both relative to the previous quarter, last spring quarter, and also to a year ago.

That's actually what I was getting at. And then lastly on the timing, do you know the timing of any campus openings for next year?

We don't yet. We have not announced that yet. I would expect the Tampa, Florida ones to be, hopefully, the first half of the year. And the other ones basically on the basis of when we can get our internal calendar together, get the management teams set up and trained and get the real estate done.

Any sense of whether the remaining three are more likely to be new markets versus new campuses in existing markets?

I think they are actually likely to be new markets in existing states.

Jerry Herman, Legg Mason.

Rob, the (indiscernible) ramp at the schools, as you indicated, was quicker than expected. Is that because of the combination of more students and cost structure? Or more heavily weighted to one or the other?

More heavily weighted to more students.

More students?

Yes, because our adjustment of the cost structure does not have anywhere near the impact that the student growth does.

And you mentioned that there was a higher cost per students start this quarter. Clarification -- was that on both sides of the business, on-ground and online? And if so, how much? Could you quantify that in any way?

Yes. It was within the margin of error. It was a couple, maybe a percentage point or two. And I think it was fairly evenly spread between campuses and online. As was the lower cost per lead evenly spread between campuses and online. But again, that was also within the margin of error on the positive side. We're slightly better on cost per lead than we had been historically, slightly worse on cost per students start than we had been historically.

Are you guys doing any promotions, incentive programs, that kind of stuff, at this juncture? I don't know if you have historically, but certainly some of your peer group does.

Right. We do a couple things, one is we have the corporate institutional alliances, where in those cases, some of them have a 5% tuition discount. Our military discount is significant. I think it's like 30% at this point, so that's a big promotion. We have always had that. We will occasionally, particularly in the summer, enrollment cycle, as we are moving into the fall, do open houses where we waive application fees. I think we did that a couple of times this summer; we usually do. And then we'll also, occasionally in conjunction with those open houses, offer a specific corporate alliance that we're trying to have a big impact with. We'll waive textbook fees or give some kind of textbook voucher occasionally as well. There's nothing going on right now beyond the normal contractual discounts, but we do that occasionally. And usually it is in the August and early September timeframe as we're doing our fall enrollment.

Is there any way to quantify just how much tightening of credit policies impacted student flow, either at the front end or --

Yes, it was several hundred students. I would say that's a good guess.

And just one last final question -- your employee development program, you've often talked about that being a major constraint to growth. Could you maybe just spend a minute updating us on that?

Well, we're actually really pleased with that, Jerry. I'm glad you asked that because that's why we feel comfortable doing five campuses again next year. We also, I should note, added a new region as well, so we now have four geographic regions. The fourth one is Georgia, Tennessee and Florida, it's our SEC region. (laughter) But you have to scale the infrastructure, we think, at that level as well in order to effectively oversee the educational product and make sure that we're delivering learning outcomes.

Five campuses on a base of -- well, in the first year it was a base of 20. That is a significant rate of unit growth rate. To be able to do that three years in a row, we feel pretty good about. We could not have done that had we not built-up and accelerated this internal development program. Because we definitely feel as if grooming people from within is a lower risk strategy than hiring from the outside. We will hire from the outside occasionally, and we've had some good luck from that. But over time we want to build our models and our budgets on the constraint that we don't open any more campuses than we feel pretty confident that we can staff with people from within.

Richard Close, Jefferies.

Just a follow-up, maybe on the tightening of the credit standards. Was that more in a mature market or maybe a newer market that you saw those individual campuses? I know you did mention online as well.

There were five of them and they were all in the mature category.

And then you talked a little bit about right-sizing some of the mature campuses or older campuses. Maybe if you could give us some details, in how many of those did you do in the current fiscal year? What do you expect next year in terms of number of campuses? And what kind of margin improvement have you been able to see by right-sizing those?

Well, I'll answer the first two and I'll let Mark take a crack at the last, because I really don't know the answer to that. We did Annapolis, Alexandria, D.C. -- we did four this year. And we have, I think, three scheduled for next year. I think we're actually adding expense, frankly, even with the right-sizing, because we are increasing the quality of the facilities. We are upgrading, literally, things as simple as the furniture and the whiteboards and some of the LCD or electronic equipment, which over time, we are pretty comfortable, frankly, with the operating margins that we operate at. Our view has always been that this is a great opportunity to grow our topline and build out a significant nation-wide presence, and if we can maintain these margins, that is a very healthy and hefty financial return for our owners.

We really haven't looked at the right-sizing from the standpoint of improving the margins; it's been more associated with the fact that we needed to upgrade those campuses anyway. And we shouldn't waste our owners' assets by building facilities that are bigger than we think we actually need. And also, more importantly, within those square footage, make sure that the mix of classroom space, counseling space, advising space, and the library facilities, things of that nature more closely tracks the way our students want you to us the campus. Did I?

That's right. Just looking at Anne Arundel, the margin did not change significantly, slightly down, but marginally small.

So then if you're -- to follow up with Gary's question maybe on the margins for next year maybe being conservative. If you're opening the same amount of campuses and the ones that you are opening are reaching profitability faster, wouldn't that have a less drag on your overall margins, and be able to see some expansion going forward?

One would hope. Our model is to have stable to slightly improving margins with the same number of campuses being opened. And we'll certainly shoot for that. We try and lay out for our investor base how we are looking at this, and let everybody draw their own conclusions.

And at this time, we have one question remaining in the queue. (OPERATOR INSTRUCTIONS). Howard Block, Bank of America.

What would be the probability of opening six campuses next year? Or what time would consideration of the incremental school be considered final?

I would say the probability is low for doing six campuses next year. And we will look at that issue again next summer and next early fall, as we go through our budgeting process. And most importantly, looking at our human capital development and see where we are on that. It would be an out-of-the-ordinary circumstance for us to increase that in the middle of the year. We have done it once, under circumstances that I thought really required it, just because the opportunity was so high. I can't preclude it 100%, but I'd say the probability is low.

Could you provide us an update on the UVA program alliance? I think that's been marketed pretty heavily.

Sure. Yes, we're actually quite pleased with that. This is our first term. We worked very closely with the University of Virginia in some of the outreach efforts. I don't have an exact number of students, and most of them that are involved are actually starting at UVA in their certificate program first. We've got a pretty strong handful, and most importantly, I think on the academics side, the interaction between the two faculties has been quite strong.

And one last -- I may have missed this -- on the marketing, last quarter you said you constrained marketing spending a little bit because you didn't have the capacity to handle the lead flow. Any update on that this quarter?

We spent the full amount this quarter, and we did quite well. We generated slightly more leads than we thought we were going to. Our team did a great job in terms of pre-buying a lot of the media, particularly in some of the heavily-contested political states, so that we really didn't have much of an impact in the third quarter with regard to the election, either.

Jeff Marsh, Matador Capital.

Rob, hopefully this is a fair question. Might the tightening of the credit standards and the higher bad debt expense be explained by change in marketing practices? Because I just read between the lines, if the lead flow is adequate and the cost per lead is still favorable, it might suggest that you are attracting a little bit less quality lead at the margin. I would think that might stem from how the leads are being sourced. Maybe you can just talk about the marketing and how that is being performed.

It's a very fair question. The answer is really no, no change to that. And I actually would not say that, just based on anecdotally my review of the data, that we are getting a less-qualified lead. I think that, as I said, there's a certain number of students who do not have, for whatever reason, access to Title 4. They are not part of a corporate sponsorship of some kind, for which we do try to make some accommodation in terms of getting them into the program. I think that, at the campus level, we trust the judgment of our student finance officers and our campus managers to do that appropriately. I think that, in a few cases, we may have been a little bit too aggressive over the last quarter or two. This is something that builds up over time because what happens is, the way our bad debt expense works, we're looking back two full quarters in terms of what those collection rates are. And we wanted to nip it in the bud right away. It was off of a very low base anyway, and we are quite sensitive to it.

I have actually been quite pleased with the quality of the leads that we have and our ability to get them without spending as much, in some cases, as we thought we were going to have to, particularly in new markets. And so I really think it's much more of a variability of execution, and we are going to get on top of it. I think it's fair to say though, Jeff, there's no question that we would trade off enrollment growth for financial and academic quality. We've said that publicly before, and nobody should be surprised by that.

Mark Marostica, Piper Jaffray.

Could you comment on when your last DOE program review was? And when the next one is scheduled if there is one scheduled? Lastly, anything to highlight specifically on the regulatory front that would be material? Thanks.

I think the last program review would have been as part of the change of control when I came in. So that's what? Four years ago. We don't have anything scheduled, nor have we heard of anything. Nothing out of the ordinary with regard to the regulatory front. We stay very close to Middle States. We have a very proactive relationship with them and draw them in quite a bit in our discussions on discussing expansion and growth. So there's an ongoing and active discussion there, but nothing specific or out of the ordinary.

Rob, on that point, is there an accreditation visit scheduled coming up? Or could you give us some timing perspective on your relationship with the accrediting body?

Sure. Our accreditation is for ten years. It was reaccredited in 2000, so it would be 2010. But we don't stand on that. And we have an active, as I said, an ongoing relationship with them. We probably talk to them once a quarter on various things. We are constantly involved what institutional self-assessment, and we have a whole staff of learning outcome research professionals and things of that nature. And the data we share with Middle States on an ongoing basis. But the next regularly scheduled review, the 10-year review, would be 2010.

Gary Bisbee, Lehman Brothers.

Over the last year or whatever, you haven't really reported the institutional alliances like you used to. Is that any change in your strategy or is it just some other reason? And can you give us an update on how that's going in new markets? Do you have people actively out soliciting relationships as you are entering these new states and markets?

Well, let me take it in reverse order. Yes, we do have people, as a matter-of-fact, in each metropolitan market. We usually have at least one person who's sole responsibility is to focus on that. We also have three people at a national level that do it. And we have added a position on the corporate staff to support that processes as well. We generally don't announce them unless, as a matter of marketing efficiency, the company wants us to do it as a means of reaching their employees. I think the last time we did that was AT&T several quarters ago. And Gary, I guess that's the one area where we are probably a little bit sensitive on a competitive basis. We want to be there to serve those students; we don't want to highlight that activity in other ways.

That's fair. I guess two last ones. How broadly have you currently rolled out these three Masters programs? It sounds like you've got good initial response to those. And secondly, in terms of the military, any update as to what percent of the overall student population right now would be related in one way or the other? And I wonder if you could break that out, online versus campus, if you have a sense what those numbers are.

Mark is shaking his head. I don't know it, Gary. I think it's less than 2 or 3% at this point. It's gone down somewhat as we have moved out of the D.C. area. There are some online, clearly. As a matter-of-fact, our head of online, Pam Bell, who teaches a class, brought me, at one point earlier in the term, her list of students. And we logged into her credit (ph) discussion groups to see where they were all from, and there was at least one that was overseas with the military. So I know they exist. And then, Gary, I lost the first question?

Just in terms of how broadly have you now rolled out the three new Masters programs?

The programs graduate programs, yes. Well, they've really only been offered in the Maryland, D.C. and Virginia areas. And there was a couple of the Maryland campuses that we did not offer all of them at, because we were doing some test marketing -- or test rollout, and we wanted to see what the control was. We have, in the last quarter, been approved in North Carolina. Our initial approval in Georgia included it -- I think that's correct. And we should be approved in Tennessee by the end this year. And so, it's been on a small portion of our campus base at this point, as well as online.

(OPERATOR INSTRUCTIONS). At this time, it appears we have no further questions. I'd like to turn the conference back over to the speakers for any additional our closing remarks.

Thank you, Sheila. Well, I appreciate everybody's participation. We look forward to talking to you again next quarter. Thank you.

And that does include today's presentation. We thank you for your participation, and you may disconnect at this time.