Strategic Education Inc (STRA) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to Strayer Education Inc.'s third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS]. At this time, I would like to turn the conference over to Sonya Udler, Vice President of Corporate Communications for Strayer Education. Please go ahead.

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 who wish to listen to the conference via the internet, please go to www.strayereducation.com, where the call will be archived for 90 days. If you are unable to listen to the call in real time, a replay will be available beginning today at 1:00 PM eastern time, through Tuesday, October 31. The replay is available at 888.203.1112; pass code 8642933. 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 are 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.

Now, I'd like to turn the call over to Rob.

Good morning, ladies and gentlemen. As is our customer, I'd like to begin this morning with a brief overview of both 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 of 2006, after which, I will comment on our enrollment results for the fall academic term, provide an update on our growth strategies, and, finally, end up with the Company's earnings outlook for Q4 and for the full year of 2006.

Strayer Education Inc. is a for-profit education service company, whose primary asset is Strayer University, a 31,000-student, 43-campus post-secondary education institution, which offers associates, bachelors and masters degrees in business administration, accounting, computer science, 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 students are receiving federally insured Title 4 loans. 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 ten states in the eastern half of the United States, as well as throughout the world over the internet through Strayer University online. We serve students in all 50 states and over 30 foreign countries through Strayer University online. Strayer University is accredited by the Middle States Association of Colleges and Schools.

Mark, do you want to run them through the financials?

Sure. Revenues for the three months ended September 30, 2006 increased 20% to $56.7 million compared to $47.1 million for the same period in '05, due to increased enrollment and a 5% tuition increase, which commenced in January of '06. Income from operations was $9 million compared to $9.6 million for the same period in '05, a decrease of 6%.

In '06, the Company began recording stock-based compensation expense, which amounted to $2.2 million, before tax, for the three months ended September 30, 2006. Excluding stock-based compensation expense, income from operations was $11.2 million, an increase of 17% compared to '05. Net income was $6.3 million compared to $6.4 million for the same period in '05. Net income for the three months ended September 30, '06, includes the effect of a $1.4 million after-tax expense related to stock-based compensation. Excluding stock-based compensation expense, net income was $7.7 million, an increase of 20% compared to '05.

Diluted earnings per share was $0.44, the same as for the comparable period in '05. This diluted earnings per share for the three months ended September 30, '06 includes the effect of $0.09 per share, after tax, related to stock-based compensation expense. Excluding that expense, diluted earnings per share was $0.53, an increase of 20% compared to '05. Diluted weighted average shares outstanding decreased to 14.462 million to 14.637 million for the same period in '05.

Revenues for the nine months ended September 30, of '06 increased 19% to $189.3 million compared to $158.5 million for the same period in '05, due to increased enrollment and a 5% tuition increase, which commenced in January of '06. Income from operations was $55.5 million compared to $51.6 million for the same period in '05, an increase of 8%.

In '06, stock-based compensation expense amounted to $5.5 million, before tax, for the nine months ended September 30, '06. Excluding stock-based compensation expense, income from operations was $61 million, an increase of 18% compared to '05. Net income was $36.3 million compared to $33.1 million for the same period in '05, an increase of 10%. Net income for the nine months ended September 30, '06, includes $3.4 million after-tax expense related to stock-based compensation. Excluding stock-based compensation expense, net income was $39.7 million, an increase of 20% compared to '05.

Diluted earnings per share was $2.50 compared to $2.23 for the same period in '05, an increase of 12%. Diluted earnings per share for the nine months ended September 30, '06 includes the effect of $0.24 per share, after tax, related to stock-based compensation expense. Excluding this expense, diluted earnings per share was $2.74, an increase of 23% compared to '05. Diluted weighted average shares outstanding decreased to 14.506 million to 14.792 million for the same period in '05.

At September 30, '06, the Company had cash, cash equivalents and marketable securities of $123 million and no debt. The Company generated $39 million from operating activities in the first nine months of '06. Capital expenditures were $9 million for the same period. During the three months ended September 30 of '06, the Company repurchased 52,514 shares of common stock at an average price of $103.05 per share and a cost of $5.4 million as part of a previously announced common stock repurchase authorization. For the third quarter of '06, bad debt expense as a percentage of revenue was 3.2% compared to 2.5% for the same period in '05. Day sales outstanding, adjusted to exclude tuition receivable related to future quarters, was ten days at the end of the third quarter of '06 compared to eight days at the end of the same period in '05.

The financials will get a lot shorter next April when we no longer have to go through the FAS-123 comparisons on each line. But, we'll just have one more quarter of that.

Just a couple of comments from me on the financials. The revenue growth of 20% was slightly ahead of our model. With a 15% enrollment growth for the summer term, we were expecting 18% to 19% revenue growth. The increase to 20% is the result of the leveling off of the student mix shift we had been experiencing towards graduate students, who take less classes per term. So, we're effectively receiving more of our 5% tuition increase as the percentage of graduate students and undergraduate students remains stable.

On expenses, we were basically right on our budget, with the exception of bad debt expense, which Mark mentioned, ticking up to 3.2%. That ran through our G&A line. On operating margin, based on the expenses we are incurring in opening the eight new campuses during the year, we had expected approximately 100 basis points of margin compression, before FAS-123. However, with the outperformance on revenue, we ended up with only about 60 basis point decrease in operating margins; and that different is responsible for roughly have of the $0.04 upside versus our guidance for the third quarter. The other half was slightly lower FAS-123 expense and a slightly lower tax rate.

Our growth in distributable free cash for the first nine months of the year was 21% on 20% growth in net income, again, slightly ahead of our model; so that looked healthy from our perspective.

Turning to the fall term enrollment results, we had a solid quarter, the University total enrollment increasing 15% on a year-over-year basis. The highlight was the continuing student enrollment, which was up 17% compared to the same quarter last year. We're particularly pleased with the investments that we've made on retention over the last couple of years. We're starting to see some meaningful results on that. This quarter, the retention rate increased over 140 basis points, and it's actually the fourth quarter in a row where we've had an increase in the retention rate over the same quarter in the prior year.

Our new student growth rate of 10% was a little lighter than we would have liked. We generally prefer to see a balance between new and continuing student growth. The new student growth may have been somewhat negatively affected by the uptick in the bad debt expense that Mark and I mentioned. The reason they're related is because, as Mark and I saw collections during the quarter at a couple of campuses suffering, we tightened credit authorities at those campuses. That can have an effect on new student enrollment. But, as we've shown in the past, we're prepared to make that tradeoff when it's necessary, and we think it makes sense in the long run.

With regard to student mix, business administration and accounting and economics degree-seekers continue to account for about 65% of our students for the fall term, with our computer science degree candidates at just below 25%. Our new graduate programs increased to 7% of our student population; that's fairly stable with the last quarter or two. And our overall graduate population is at 27% of our student mix in the quarter, which is pretty close to the 26% we had a year ago.

Turning to an update on the growth strategy, many of you will remember that it's based on five objectives. The first is to maintain enrollment in the Company's mature markets. Second, accelerate the rate of growth of new campuses, particularly in the 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 ultimate redeployment of capital to our owners.

On our first objective-- Let me just run through each of these briefly. On the first objective for the fall term, we are ahead of target at our mature campuses, showing 5% growth, while mature campus students continue to exhibit a preference to take online courses in their later terms.

With regard to new campus activity, the fall term, we opened one campus each in two new markets, Charleston, South Carolina and Birmingham, Alabama. These campuses completed our planned eight new campus openings in 2006, and we had strong starts in both locations. So, we were pleased with those.

In the out-of-area online unit, our growth rate of around 21% remains above the rate of growth of the overall University, so that's still helping us in the overall scheme of our growth.

On capital redeployment, we announced this morning that we've been able to repurchase approximately $5.5 million worth of our common stock during the third quarter.

Now, the business outlook for the fourth quarter, based on the University's 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 $1.17 to $1.19 range, before the impact of FAS-123R; and we expect approximately $0.11 of after-tax, stock-based compensation expense in the fourth quarter. In the fourth quarter, we expect about 240 to 260 basis points of operating margin compression compared to Q4'05, as we bear the full cost of our investments in all eight new campus openings of 2006.

With our enrollment now known for the fall term, we are in a position to give actual guidance as to the full year 2006 results as well. We expect EPS to be in the range of $3.56 to $3.58, including the impact of FAS-123R, or $3.90 to $3.92, excluding that impact.

Now, if you compare that full-year 2006 guidance to our internal investment model, which we had provided to you last October, the one thing which I think will stand out is that, with the student enrollment growth of 15% which we achieved this year, we would have expected EPS of around $3.75 versus the $3.90-plus we think we're going to earn this year. Now, that extra $0.15 of EPS is basically the result of higher revenue per student than we originally modeled last October. And that extra revenue per student is also going to put us at or above the high end of the 32.5% to 33% operating margin range, which we had modeled for 2006. Again, that's that issue of the graduate student population leveling off compared to the undergraduate and getting more of that tuition price increase through on all our class seats.

Now, turning to our 2007 investment model, I'm very pleased to announce that we are once again planning to open eight new campuses next year. We expect to do so fairly evenly throughout the year. The first two, which are planned for a winter term start classes, are in the markets of Louisville and Lexington, Kentucky, which is a new state for us. In 2007, we are also implementing a 5% tuition increase, effective January 1; and we are rolling into our revenue model the higher revenue per student growth which we experienced in 2006. So, we'll have that-- that's in what we provided in the press release.

So, if we achieve 15% enrollment growth in 2007 with the eight campuses, we would expect roughly stable operating margins versus this year. Obviously, if our enrollment growth is higher than 15%, we would expect some margin expansion. Conversely, if it's lower, our model would predict some margin contraction. We try to give you the point at which we're at the midpoint for operating margin. As usual, we'll tell you as soon as we know each quarter what the enrollment growth is. You ought to be able to track that fairly closely in terms of future operating margins and EPS.

Finally, looking at our increase in both net income and distributable cash flow in 2006, the board and I have concluded that, even with this aggressive expansion plan that I've just outlined, it's appropriate to increase our annual common dividend by 25% to $1.25 per share and increase our authorization for share repurchases by an additional $35 million to $40 million. I want to reiterate; the board and I remain convinced that our business model allows us the luxury of fully funding a strong, organic growth strategy and still make a period return of capital to our shareholders. We as a management team and a board continue to weigh all uses of cash every quarter to determine the most value-enhancing, after-tax return on our owners' capital.

With that, operator, we'd be pleased to answer any questions.

Thank you. [OPERATOR INSTRUCTIONS]. Our first question comes from Mark Marostica; Piper Jaffray.

Good morning, and congratulations on the quarter. The first question is related to bad debt. With this uptick in the quarter, I was wondering if you could comment as to whether or not the uptick is isolated to a certain number of campuses or if it's more widespread and, then, tied to that, if you expect going forward a pattern of continuation in the tightening of credit. Thanks.

Sure, Mark. It was not fully widespread. It was concentrated in a few campuses. And, no; I don't expect a continued tightening. It's the kind of thing that we manage as it happens, sort of quarter to quarter. We have a lot of confidence in the operating staff we have out in the field. And, every once in a while, we'll get a little off balance in one or two locations. Then we tend to take action as we've described. But this has happened once or twice before over the last five years, and it tends to work itself out.

Just one other question. Obviously, you're doing a great job on student retention with the metrics that you shared with us. Perhaps you could comment on what you think you've been doing differently or uniquely on that front to continue that trend and, perhaps, if you think there's still more room to improve retention going forward.

We've got it up to a pretty high rate right now. Our retention numbers are net of both graduations and academic failures. In an open-access university, we expect to have some number of academic failures. Otherwise, you really don't have any rigor in your classroom. I don't know if it can get much higher than it is now, but we certainly want to keep it where it is. Really, Mark, all we've done in that area-- A couple of years ago, we put in place the organizational change that put an administrative focus at the campus on retention. We've now had that for a couple of years. I think the real focus is-- or the real benefit is a focus on what's going on in the classrooms. We find that for working adult students that, if they are pleased with what they're receiving in the classroom and are both benefiting and enjoying the educational process, they'll tend to reenroll. That's really where we try and keep the most focus.

Thank you.

Our next question comes from Howard Block; Banc of America Securities.

Good job on the quarter, guys. I did have a question, though, on the bad debt. What you're saying is that students were being allowed into school that maybe weren't properly packaged in terms of financial aid, and then you're sort of forced to reserve for those students who are ultimately either asked to leave school or drop out because they don't get the financial aid they need?

That's part of it, Howard. The way it works exactly is our bad debt expense is basically a corollary of our collections. So, we have a reserve for doubtful accounts, and our expense is what we put into that reserve to make sure the reserve is equal to an algorithm that we've had for several years now, which says that you're going to-- it needs to be equal to 50%-- I'm sorry-- 25% of your uncollected amounts in the current quarter, plus 50% of your uncollected amounts from the previous quarter. Then you write off 100% of any debt that's more than 180 days old. So, what Mark and I do is track during the quarter what the collections are. With your Title 4 funds, obviously, you're going to pull those down right at the beginning of the quarter. You can have a problem with, as you put it, packaging or paperwork, which can have an effect.

The other thing that can have an effect is not all of our students are Title 4 students. So, we allow our campus administrative staff to extend credit through the quarter, in some circumstances, through what we call a promissory note. Those sometimes don't work, as well. They're fairly small numbers of students and small amounts of revenue. But, as we've said in the past, my bigger concern with regard to bad debt is not a financial concern; it's do you have the right atmosphere at the campus? Are you bringing in more than a normal share of students who basically aren't going to benefit from the education? We use it as kind of a contra indicator to make sure we've got our arms around the quality.

Okay. Then just, again, on that same line, can you just--? I think this is the third time where we're seen, as you noted earlier, a pretty high correlation between a little bit of a disappointment or deceleration in new student growth and a significant uptick, at least in terms of basis points in bad debt. So, it may be a little redundant, but if you could just, again, explain why those two should be correlated so tightly.

The reason that they're correlated is because when you're running a campus you've got a lot of different competing imperatives that you're trying to meet. We make it quite clear in our organization that they all have equivalent importance. So, when we actually reduce credit authorities at a campus, it's more difficult to enroll some students who might be on the margin. More importantly, you're sending the message that-- make absolutely certain that the students that you're bringing in are capable of both benefiting from the education and are going to be paying their tuition bills. So, it's both a specific tool as well as an atmospheric message that goes out.

Okay. And then, if I could, another question. I hesitate greatly to question you about returns on capital. Obviously, it would be like asking Warren Buffet and questioning him on value investing. But, it does appear that returns on capital are deteriorating a little bit. Maybe it's my slide rule, and I'm using it improperly. But, is that not true? And, if it is true, when do you think it might reverse?

I think we'll send you a calculator, if you're using a slide rule. There's two things. One is if it's total capital, it would include our burgeoning cash balances.

It's not.

Okay. So, if it's invested capital, then it will start to improve, frankly, as we slow the opening of campuses and the average age of our campuses increases and the individual returns on those campuses start to go up. It's the same issue as your operating margin. The more campuses that you have that you have-- you've got the capital invested up front, but you're not getting the full value of those campuses-- or you're getting more and more as they reach maturity. So, right now, we've got-- out of 43 campuses, probably, Mark, 15 or 20 that are less than 4 years old?

Yes.

So, if we stopped opening campuses, our return on capital would go up for a while until it got to kind of that steady state. Our long term return on capital, we think, is benefited by putting our owners' capital to work as quickly as possible and getting as many of these campuses open as we can.

Okay. Great. Thank you.

Our next question comes from Jerry Herman; Stifel Nicolaus.

Rob, a question about new student growth. Could you address any geographic pockets of weakness or [programmic] pockets of weakness, perhaps?

There's nothing that really jumps out at me. Over the last three or four years, computer science has been less of a growth engine for us than business and accounting, but that hasn't really changed quarter to quarter. The corollary-- our new graduate programs have been quite successful. But, no; there's nothing I would draw geographically or programmatically from that.

How about attrition levels in the recruiting-- in the recruiters?

You're talking about our employees?

Yes. Employees.

There's no real change there. It's fairly low.

If you look at the start number, which, in our estimation, may represent as much as half or a third of your total population for the fall term, that up 10%-- Obviously, you're persistence numbers and continuing students was very strong. You guys are still expecting 15% enrollment growth for the full year. That seems to imply that you expect improvement out of that new student metric.

Let me walk you back on that one, Jerry, because there's a couple of concepts there that probably require clarification. First off, we know we've done 15% for '06. It's not a question of expecting; that's what we've done already. We don't talk about what we expect for '07. What we provide in our investment model is mathematical calculations that you guys can then use to inform your models. We'll tell you exactly what we're going to-- what we achieve in enrollment growth when we do it. I'm constantly trying to clarify that we're not providing guidance for '07. We want you to understand what we know right now, which is what we're going to invest and what that's going to cost us and, then, what a fairly predictable impact of enrollment growth is on revenue and then operating margin.

Over the long term-- What we've said in the past is we would hope and expect that your enrollment growth will track, broadly, your rate of capital investment because each of these campuses tends to, at least they have so far, operate very similarly. So, it's fairly easy to project that on a notional basis. We've been fairly close over the last six years to that. So, I don't want there to be any confusion with regard to that 15% number.

I'm sorry; what was the first part of what you asked, Jerry? I know what it was. The other thing that you mentioned was the 10%. The new students as a percentage of our total students are not quite that high for fall term. We tend to bring in students that stay about eight quarters on average. The percentage of your total students who are new students in the fall are higher than normal, but it's not up to 30% or 33% of your total students.

Okay. Finally-- I know we can't plug this into our model either, but with regard to your bench strength in the ability to open eight campuses, how are you feeling about that bench strength at this point?

Well, I feel very confident about it with regard to '07. Otherwise, I wouldn't have asked the board for approval to do eight nor announced it. Beyond that, we hope that it will continue to stay strong, and we've got a lot of focus and effort on that. I think it's really the ultimate key to our success over the next five to ten years. But, we'll let you know a year from now with regard to '08 whether it has remained that strong.

Great. Thanks, guys.

Our next question comes from [Amy Yonker]; Robert W. Baird.

Just a quick question on the number of new campuses you're expecting to open in '07. You said the first two will be in Kentucky, a new state. Of the remaining six, do you have any anticipation how many of those will be in new versus existing markets at this point?

Yes. We've got a pretty good idea. I think it will probably be close to half and half, maybe slightly more towards new markets. It's always a tough strategic decision each year because you've got competing priorities. We have markets that we're already in that we know we're under serving, and the people in those markets are saying, please, give us the people and the capital to open additional units. But, we only feel comfortable with doing eight next year. So, we also have these new markets we've been improved in. We do have a preference towards spreading the flag quicker, anyway. So, I think it will be a slight prejudice towards new, but we'll certainly be doing some investment in existing markets.

Then, finally, in your due diligence in studying prospective states or new markets to enter, have you come across any states that you've really determined are just not attractive enough to enter?-- I would guess New York would probably be one of those; but any other states that you've come across and what those might be.

No. And I wouldn't characterize New York that way either.

Okay. Thank you.

We'll go next to Greg Cappelli; Credit Suisse.

I just wanted to follow up on the-- Given the investment in capital and in human capital you talked about and you're continuing to make, it sounds like you do remain confident, obviously, despite not giving us specific guidance here-- that you remain confident that this can continue to be a mid-teens enrollment grower. The question that I have is if you take that apart a little bit, for that to happen, does that imply that the online growth rate needs to kind of be at or around the 20% level, just given the rate of growth in online and how it differs?

We haven't looked at it that way, Greg. I don't think that's necessary because, particularly given the increase in campus openings that we did last year-- We're going to do eight this year. We had done five for three years before that. So, at the end of this year, we'll have 51 campuses, [31] of which will be kind of in the meat of their growth stage. So, I don't think mathematically that's necessary. We certainly want the out-of-area online to grow as fast it can. But, I wouldn't have said that; no.

Okay. You touched on the new schools. A little bit more color there, maybe, on the ramp. Were there any schools that didn't meet your expectation? It sounds like most of them are ramping according to or better than expected.

Certainly the ones that we opened in '06, we feel that way. The ones we opened in '05-- we've already commented-- are all at or above the level of profitability already.

Right. Okay. Then, finally, just to follow up on the return on capital question, understanding the base of capital that's been going into this, I've got to understand-- Is there anything changed in your thinking in terms of return on incremental invested capital, just for the model as you think about the investment you're making going forward?

No. Each of these individual campuses look every bit as attractive to me as they did five years ago; frankly, more attractive because I think we de-risked significantly the concept that the brand wouldn't travel to new markets.

Got it. Thanks a lot, guys.

We'll go next to Gary Bisbee; Lehman Brothers.

Congratulations on the quarter. A couple of questions. In the 2007 plan, the amount you're expecting for option expense would indicate fairly big growth year over year. I guess, I'm not really asking about that number as much as, when you think out over the next couple years, given the fact that we are now expensing options, what's your strategy in terms of issuing options? What would the rate of change you'd expect, if you think forward over the next couple of years, in terms of the number actually issued?

Well, a couple of points on that, Gary. First, I can speak from my own vantage point and viewpoint, but it really is a board issue and one which is, trust me, quite capably overseen by the board. I'm really giving you one person's opinion on that. The other point I would make is that the increase that you're describing with regard to '07 really isn't an increase in rate. What happened was we waited to issue much of our '06 stock options until after our annual meeting in May because they required shareholder approval. So, what you're seeing in '07 is the annualization of '06's expense, plus any new grants that may be put in place. But, the bellwether question, which I am comfortable answering from my own perspective is, we think that, given our business model, that restricted stock grants are a more appropriate means of incentivizing management than large sporadic grants of stock options - a more stable-- assuming we perform the way we hope to perform, a more stable and even annual grant of restricted shares, which would be somewhat similar to the amount of expense that you're seeing in '07. I've said publicly that the plan that we approved by our board is less than-- it's certainly less than 0.05% of shares dilution. It's closer to, like, 0.02% of shares dilution each year. That's what is currently approved by our board. Obviously, any change to that would have to come from the board. I can say that atmospherically, we're pretty comfortable that that's a plan that works for the next several years.

Okay. And, can you just remind me how far down the organization, either the options historically or restricted stock, maybe in the future grants are made? The new campus directors, for example-- does it go to that level?

No; it does not. We don't have any kind of incentive compensation for campus directors or deans. It's at basically what we call our operating committee level, which is my direct reports' direct reports.

Okay. Great. I guess, moving on, can you give us an update on the trend in the enrollment ramp at some of these new campuses? I know a few quarters ago, part of the reason for the higher enrollment growth and earnings upside you'd cited was some of the schools ahead of plan, turning profitable more quickly. Is that still happening? Has it been happening to the extent that you'd consider at some point revising the plan slightly upward? Any color there would be great.

The '05 campuses have done quite well. I would say the '06 campuses have been around that same level. Earlier in the year, the combination of the '05 and the early campus openings in '06 did have an impact, keeping operating margins higher than we would have expected. As you get to the end of '06, you now have a full-- you have all eight campuses in place that are losing money. So, it becomes a bit more of a drag. I think I can answer the question better sort of the midpoint of next year as to how the '06 campuses are behaving and whether or not that roughly stable operating margin we would think we would have at 15% enrollment growth. If we have 15% enrollment growth and we're doing better than stable margins, then that will be your evidence that '06 campuses are really ramping at a higher rate.

In general, we think that the campuses have performed basically, as I said, at or above our plan. But, the number of campuses that we open isn't really constrained by our concern with regard to their individual returns. So, changing our investment model doesn't make much difference to us. We're still-- What we're constrained by is management strength and our commitment to making sure that in expanding this brand, we're really not doing anything that can hurt the academic quality. So whether they get profitable in three quarters or six quarters is not really going to change the speed with which we do this.

Okay. Then, just one last one. It's probably a question that's been asked too much in the last year, but I'll ask it anyway. Given increased spending by several of your competitors, particularly in the internet, any update on the trends in selling and promotional? It seems like you're able to grow the business taking that cost modestly higher year to date. Do you expect any change in that over the near term, meaning the next two or three quarters, given what some of your peers have said they're planning to spend?

I don't expect any change, Gary. Our plan is not that tactically proficient or susceptible to those kinds of events. We really have a plan that's based on a patient, deliberate employment of capital in these new markets. It seems to have worked for us so far, and we've kept real strong brand recognition in our existing markets. I really think that probably the biggest impact on the number that you're seeing may not be what other people call the effectiveness of marketing spending but really is how effective is your academic product. If you're doing a good job for the students you have in the classroom, that building of reputation and brand recognition is going to swamp anything that you're spending on advertising. So, I don't expect to see any change over the next year.

Great. Thanks a lot.

Our next question comes from [Trace Erden]; Signal Hill.

My first question is I'm wondering if-- you're mentioned a few times that management constraints are the biggest factor preventing a more aggressive expansion of campuses. I'm wondering if there's anything changing on the recruiting landscape in terms of talented managers from other companies that might be more actively looking to make a change and whether that might impact your approach to managing talent in your company.

I haven't seen a measurable change in that area. But, even if I had, Trace, it doesn't really change our view. We've made the decision that one of the ways that you limit risk to quality in this plan is recognizing that a university and university campuses are basically cultural organizations. The best way to ensure that as you expand you maintain that sense of culture is by promoting from within. So, the thing that allows you to expand faster is getting better at your internal training and promotion and identification of personnel. That's what we're really focused on. We will hire from the outside sporadically. We're sort of an acquirer of talent. But, it doesn't-- we base our plan on our ability to grow from within. Anything that we can hire from the outside really is gravy for us.

Okay. Fair enough. Rob, you guys are continuing, I think, to see a migration of students at your very mature campuses into an online mode versus an on-ground mode. I'm wondering if-- At one point--? Of, if there is a point where you need to take a look at some of your older ground facilities and maybe think about relocations or any kind of significant changes on that front?

That trend has actually slowed quite a bit in the last year or two. It's sort of leveled off at around a 50/50 ratio. I don't know if there's any science to that, but that's just about what it's felt like. None of our physical plants are affected by that. As a matter of fact, over the last three years, we've had a major investment plan in renovating most of our existing older facilities in the Washington, D.C. area, which is where you would see these more mature campuses. As we did that over the last three years, we took into account the fact that more of our students, even though they'd be using the campus for a number of activities, might not be using it as much for classrooms. So, in those renovations, we both took less leased space as well as shifted our use of space internally to more library space, computer labs, advising and tutoring centers and things of that nature. So, I think we've managed that process as it's happened. We're really at the tail end of that now, and I feel pretty good about that.

Okay. Good. One last question. Is there anything--? There's a lot of stuff that's changing in the marketplace, kind of broadly speaking, outside of what you guys do perhaps. I'm wondering if there's-- if you look at the outside trends-- if there's any point at which you might re-examine your approach to program offerings and if there's any notion that you might at some point want to expand more significantly the range of programs you're offering or whether you're happy with what you've got.

We're certainly happy with what we've got. But, I have to tell you, we're very pleased with the performance of the three new graduate programs. I would be dishonest if I didn't say that there are people on the internal staff that would like to see more of that. My basic focus on that is making sure that we don't stray into academic areas where we don't know we have a real capability to teach it and teach it well. So, academic areas that are closer to what we already do, closer to business administration, general management and things of that nature, are ones we're more likely to do. Things that get very far afield of that, I think, is very unlikely. But, we could see some additional programs, similar to moving as we did into public administration from business administration or health services administration, which is really just an MBA in the health services vertical. I'm not opposed to that.

Okay. Great. I'll let you move on. Thank you.

We'll go next to Corey Greendale; First Analysis.

Congratulations. First of all, I guess, a little bit of a dead horse, but the bad debt enrollment question. If you-- I think you referred to it as a slight disappointment in the new students; was that tied entirely to the campuses where you tightened credit standards? Is there anything that you were seeing outside those campuses?

I'm not sure that I am granular enough to tell you exactly what an increase or a decrease of a couple hundred students is caused by. I can tell you that I think that had an effect. But this is a variable business, Corey. We try not to get too excited one way or the other when we're up 25% or up 10%. Over time, we expect it to track, in general, our rate of capital investment. And when that capital investment slows-- when we've fully penetrated the United States, we would expect it to slow as well at that point. But we're a long ways off from that.

And, the tighter credit standards that you discussed; is that kind of a temporary tightening as things get back under control, and then you'd expect the growth to reaccelerate at those campuses? Or, is this more of a permanent tightening?

No. With regard to the first part of the question, we want to give as much authority as we can at the lowest possible level. So, we try and do that. So, any tightening tends to be temporary until we see things under control. And, we don't comment on what's going to happen to enrollment in the future.

Okay. You sort of answered this in Gary's question. But, I think you said last quarter cost per lead was actually down a bit. Was that still the case this quarter?

No; it was actually up slightly. It was up a couple percentage points, which was more consistent with what we would have expected, given the number of new markets that we entered into. In the third quarter, we were actually spending marketing across all of the new markets that we'd opened in 2006. So, it was pretty much consistent with plan.

Okay. And last [real quick] question, maybe for Mark. At the beginning of the year, in the K, it said the CapEx expectation was $13 to $15 million. You're below that run rate. Do you actually expect to bump that up in Q4, or do you think you'll come in below for the full year?

Corey, I think our best guess at this point is in the $13 to $14 million range.

Okay. Thanks very much.

Our next question comes from [Mike Marburg]; Ramsey Assets.

I'm just trying to get a little smarter in terms of thinking about the right way to think about capacity. If capacity is growing by 50% and enrollees are growing by 20%, that's not good - that type of concept. People have suggested that you think about it in terms of marketing spend and/or in terms of campus growth as a percentage of the total number of campuses. How do you guys think about it?

Well, what I'd refer you to is if you look on our website-- We did an investor day two years ago, and I think it was Mark that gave the presentation that had the notional campus model.

Right.

So, you look under the CFO's presentation. We lay out for you how we believe these campuses are going to behave. We've got a long historical record that we've looked at. So, the way we think about is you make the investment in the campus, and it will grow over a period of time, about seven to ten years, from zero students to, say, a thousand students on average. You reach a point in that process where you pass breakeven, where your operating costs are more than covered by the tuition revenue that you have. And then, this tends to be a pretty high margin expansion business because the additional students that you bring in-- about the only real costs you have are the additional professors as you add new classes. So, that's how we think about it. As a campus grows, it's going to get more and more profitable. The overall business is going to be made up of each of these discrete units. That's going to lead to the profitability and the returns to the business as a whole.

With regard to capacity, we don't really think of it as a physical capacity constrained kind of business. Number one, our lease costs are not all that high relative to our cost base. Number two, they're pretty easy to expand. If we have a market which is behaving significantly different than all our other ones and we end up with a thousand students more than we'd normally have, you just lease more space. It's not difficult to do. It's not like a power plant or a paper mill or something, where so much of the cost is tied up in the physical plant. So, that's how we think about it.

Thank you.

We'll go next to Mike Lillywhite; American Education Corporation.

Hello, and, also, congratulations on your great quarter. My question centers around your strong growth and retention that you've had with your enrollment. Really, I'd like to get your perspective. With traditional schools experiencing about 40% of the incoming first-time requiring or needing some type of remediation and how that can obviously be a great retention tool as well. Just curious as to what you might be experiencing with your first-time enrollment from remediation standpoint and also what your thoughts on how to address it.

It's a big issue for us. We don't have that many students who are truly first-time students. Most of our students come in with some college credit. But those that are working adults who have only a high school degree and haven't been in school for a long time clearly require, on average, a fair amount of remediation and tutoring and remedial education. That's a fairly large expense for us, but we think it's a good investment because there's no way those students are going to be successful at the college level if you don't help them get across that bridge.

Thanks.

We'll go next to Matt Litfin; William Blair.

Given the increased preference for online courses by your students, how does that affect the size and structure of the campuses that you're building these days and also that you plan to build next year? And, maybe a corollary to that is-- are there any other big CapEx needs next year?

Well, I'll let Mark talk about CapEx for next year. But, we think our current campus size, which we've evolved over the last five years, takes into account the preference of a fair number of our students to want to take some of the classes online. We think we have that baked into our plans. Mark, do you want to talk--?

Yes; sure. Matt, our view is that CapEx, as we look at '07, will continue to be in the range of 5% to 5.5% of revenue.

Okay. Also, what does the 2007 business model that you shared in the press release assume in the way of share repurchases?

None. That's not to say they're not going to happen. We just don't know what they are, so we just leave that out.

That's what I was hoping for. Thanks very much.

And, we'll now take a follow-up question from Howard Block.

Rob, you may have answered this already. When you said the mix was leveling off between grad and undergrad, what does that imply about that seat per student statistic that you occasionally give us?

It goes up. That's the extra revenue per student.

Did you give the statistic, though?

I don't think we gave it, but, Mark, do you have it? It was like 1.9 or something.

Okay. Remind me; is the out-of-area online-- I forget; is that the tail or the dog of market expansion?

It's the tail. As the markets expand, it gets smaller.

I know it's getting smaller. But, I mean, does it draw you to markets?

No. Our strategy is really based on contiguous expansion. You look at our map and you look where we started from and where we are now. We try and get to the next metropolitan area and keep those interior lines of communication short, which allows us to more easily execute and maintain oversight and quality over a disparate campus system. So, we have some markets that are much farther afield that we do real well in the out-of-area online. But, we'll get to those when we get to them. Actually, Howard, I would say-- When I say we have some markets where we do real well with out-of-area online, it's really-- I'm saying that with regard to the number of people that we-- students that we have enrolled from those markets. But, as a percentage of those markets' population, there's nothing that really stands out. In other words, we have a lot of out-of-area online students in California and Texas and Chicago and places that have high population. But, there's nothing that really geographically describes to me a more fertile ground for Strayer brand than anyplace else.

Okay. A couple more quick ones. The mature student that they've always talked about who is increasingly online versus on ground-- how do you define mature?

Mature campus?

No; mature student, the maturing student that has been--

All of our students, I would say, are maturing because they're all working adults. I think what I was saying in my comments was that at our mature campuses, more of our students who have been there are taking-- have been there for a year or so are taking online courses.

That's what I mean. So, it's that year or so a point where they begin to migrate more heavily to online?

It can be earlier. It depends on the student, and it depends on the course schedule at the campus. But, in general, we find students come in and, particularly at a mature campus, will take at least a quarter or two of campus-based classes and then start to dabble in the online. Some like it very much and will take almost all their classes online, and others will revert back to taking classroom-based.

I guess what I want to clarify is-- the distinction, though, is the student's maturity or the campus' maturity in terms of any differentiation in online versus off, on ground.

The campus maturity. The reason is we have a higher percentage in new campuses because we have less of the course catalog available in the physical classroom at a brand new campus.

Okay. So, in that regard, if you took two-- let's call them early students-- mature people, but early students. Do you see any difference in persistence rates for students who are on ground versus online?

We don't see much of a difference with regard to students who are enrolled at a campus between whether they take classes in the classroom or classes online. We do see a bit of a difference with regard to out-of-area online students, which I've always said is a more difficult student to serve. We have a slightly lower persistence rate for that student.

Okay. Then, last question, again, back to my abacus and slide rule. The returns on incremental invested capital also seem to be deteriorating a bit. Again, it could just be our math. I don't think it is. How do you reconcile that with what appears to be so much outperformance in your notional model?

The only way I'd reconcile that is I'd say the math's wrong.

Okay. We can talk about it offline. Thanks.

And we have a follow-up question from Matt Litfin; William Blair.

I wondered-- Can you update us on what you're doing to groom the next layer of corporate leadership or the next generation of corporate leadership? And, also, give us a sense of Karl McDonnell's uptake and what he's contributing so far and how that's going.

We're quite pleased with our senior corporate staff, and Karl's been a great addition. Across the board at each of our senior corporate leaders, one of their requirements is to be working within their own organizations as to who's a potential replacement. But, in general, I think we've got a very strong team and one which is committed to being around here for a reasonable period of time. I don't think that this management team needs to be supplemented significantly to manage a much larger organization. We have to grow intermediary managers at the campus and region level to be able to effectively execute over a much larger geography. But, the senior team, I think, is probably about the size that it needs to be. Notwithstanding that, each of us has an obligation to really be focusing on who would replace us if something happened. That's a big part of the management responsibility.

Okay. Thanks.

At this time, we have no further questions in our queue. I'd like to turn the conference back over for any additional or closing remarks.

Thank you, Jennifer, and thanks, everybody, for participating. We'll look forward to talking to you in February. Thank you.

Once again, ladies and gentlemen, that does conclude today's conference. You may now disconnect.