Strategic Education Inc (STRA) 2011 Q2 法說會逐字稿

Good morning, everyone, and welcome to Strayer Education Incorporated's second quarter 2011 earnings results conference call. This call is being recorded. Following today's call we will offer the opportunity for questions and answers.

At this time for opening remarks and introductions, I would like to turn the call over to Strayer Education's Senior Vice President of Corporate Communications Ms. Sonya Udler. Ms. Udler, please go ahead.

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

For those of you that wish to listen to the conference via the Internet, please go to 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 Thursday, August 4. The replay is available at 800-642-1687, conference ID 78833654.

Following Strayer's remarks, we will open the call for questions and answers. I would like to remind everyone that today's Press Release contains, and certain information on this call, may contain statements that are forward-looking and are made pursuant to the Safe Harbor Provision 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 paragraph on forward-looking statements at the end of its 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.

Copies of these filings and the full Press Release are available online and upon request from the Company's Corporate Communications Department. Now I would 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 both our Company and our business model for any listeners who are new to Strayer. I'll then ask Mark to report on our second quarter financial results, and Karl to comment on our second quarter operational results as well as our enrollment statistics for the summer academic term.

Finally I liked provide an update on our growth strategy, the Company's earnings outlook for Q3 2011 and some thoughts on the Department of Education's recently finalized Gainful Employment rulemaking.

Strayer Education is an education service company whose primary asset is Strayer University, a 55,000 student, 92 campus, postsecondary education institution founded in 1892, which offers Bachelor's, Master's and Associate Degrees in Business Administration, Accounting, Computer Science, Public Administration and Education.

Unlike traditional universities, Strayer University students are working adults who are returning to college and graduate school to improve their lives. Our revenue comes from tuition payments and associated fees. Approximately 75% of that revenue comes to us from federal Title IV loans issued to our students.

Our expenses at Strayer Education include the cost of our professors, our admissions and administrative staff, marketing expenses, and facilities and supplies cost. We serve students in 20 states through physical campuses as well as in all 50 states and over 30 foreign countries through our online courses. Strayer University is accredited by the Middle States Commission on Higher Education. Mark, will you run through the financials?

Sure. Revenues for the three months ended June 30, 2011, increased 3% to $163.8 million compared to $159.3 million for the same period in 2010, due to level enrollment and a tuition increase which commenced in January of this year.

Income from Operations was $50.1 million compared to $58.7 million for the same period in 2010, a decrease of 15%. Operating income margin was 30.6% compared to 36.8% for the same period in 2010. Net income was $29.6 million compared to $35.7 million for the same period in 2010, a decrease of 17%.

Diluted earnings per share was $2.53 compared to $2.60 for the same period in 2010, a decrease of 3%, reflecting a lower share count due to share repurchases. Diluted weighted average shares outstanding decreased to $11.737 million from $13.704 million for the same period in 2010. Revenues for the six months ended June 30, 2011, increased 6% to $335.7 million compared to $317.2 million for the same period in 2010, due to increased enrollment and a tuition increase which commenced in January of this year.

Income from Operations was $109.4 million compared to $118.6 million for the same period in 2010, a decrease of 8%. Operating income margin was 32.6% compared to 37.4% for the same period in 2010. Net income was $65.4 million compared to $72 million for the same period in 2010, a decrease of 9%.

Diluted earnings per share was $5.34 compared to $5.25 for the same period in 2010, an increase of 2% reflecting a lower share count due to share repurchases. Diluted weighted average shares outstanding decreased to $12.263 million from $13.716 for the same period in 2010.

At June 30, 2011, the Company had cash and cash equivalents of $50.6 million. Become a generated $87.4 million from Operating activities in the first six months of 2011, compared to $87.9 million during the same period in 2010. Capital expenditures were $18.1 million for the six months ended June 30, 2011, compared to $22.6 million for the same period in 2010.

As previously announced, the Company entered into an amended and restated revolving credit and term loan agreement on April 4, 2011. This credit facility, which is secured by the assets of the Company, provides $100 million revolving credit facility and $100 million term loan facility with a maturity date of March 31, 2014.

Proceeds from the term loan were used to pay off the $80 million outstanding at March 31, 2011, under the original revolving credit facility. At June 30, 2011, the Company had $100 million outstanding under its term loan and $15 million outstanding under its rolling credit facility.

During the three months ended June 30, 2011, the Company used $55.5 million to repurchase approximately 434,000 shares of stock at an average price of $127.73 per share as part of a previously announced stock repurchase authorization.

During the six months ended June 30, 2011, the Company used $182.7 million to repurchase approximately 1.370 million shares of stock at an average of $133.32 per share. The Company's remaining authorization for stock repurchases was $25 million at June 30, 2011. During the six months ended June 30, 2011, the Company paid regular quarterly dividends of $25.2 million or $1 per share for each of the quarterly dividends.

For the second quarter 2011 bad debt expense as a percentage of revenues was 4.1% compared to 3.6% for the same period in 2010. Day Sales Outstanding was 12 days at the end of the second quarter of 2011, compared to 11 days at the end of the second quarter of 2010. Rob?

Thanks, Mark. Karl, you want hit the operational results and comment on the summer enrollment as well?

Sure. Total enrollment for the summer academic term was 47,790 students a decrease of 8% versus the prior year. New student enrollments decreased 21% and continuing enrollments decreased 5%. Our continuation rate in the quarter declined 390 basis points.

Enrollment at mature campuses decreased 9%, declined 3% at new campuses and global online students increased 12%. Enrollments from corporate and institutional alliances grew 8%. And as a result, students from corporate and institutional alliances have increased from 20% to 25% of our total student body.

In addition we added four new agreements during the quarter including agreements with CISCO Corporation, a nationwide through distribution company, as well as the BIC Corporation.

Also today we announced that we have opened three new campuses for the fall academic term, including two in Chicago, which is both a new state and a new market, as well as one in Dallas, Texas, which is our fourth in that market. With these three campuses, we have completed our planned eight new campuses for 2011. And in October we will announce our new campus plans for 2012.

Lastly in terms of student mix, approximately 70% of our students are enrolled in undergraduate degree programs with Business and Accounting representing roughly two-thirds of that population. Graduate programs continue to comprise one-third of our overall student mix. Rob?

Thanks, Karl. Just a couple of comments on the Q2 financials from my perspective going back to Mark's comments.

First, at $2.53 we did learn $0.16, $0.17 more than our forecast of 90 days ago; however, that large positive variance was caused entirely by lower share count from share repurchases that we executed during the quarter. Our actual revenue and expense lines were right on Mark's and my target. So that explains the large variance.

Using the share count that we had reported at the end of the first quarter, we would've earned $2.38, which was right where we said we would be in second quarter.

Second, while net income was down 17% in the quarter, distributable cash flow in the quarter was actually flat of last year at about $14 million. And that's as a result of Mark and Karl and their teams doing both a great job at working capital management slightly lower CapEx.

Turning to a brief update on the gross strategy. Many of you will remember that our strategy is based on five objectives. The first is to maintain enrollment in the Company's mature markets. The second is to invest our human and financial capital in opening new campuses particularly in new states and markets.

Third is to continue to build our online offerings. Fourth, increase our corporate and institutional alliances; and the fifth and final objective is to effectively redeploy our owners capital. Karl's already covered the update on the first four objectives.

On the capital redeployment as Mark mentioned, we did announce our regular quarterly dividend of $1 per share and also that we had repurchased approximately $55 million worth of our common stock during the second quarter and that was at an average price of around $128 per share. That brings our share repurchases during calendar year 2011 to approximately 10% of the outstanding shares of the Company at the start of the year.

On the earnings outlook for the third quarter of 2011, based on the 8% decrease in the University's enrollment for the summer term, we expect earnings per share between $1.04 and $1.06 in the third quarter. And that's again using the share count at the end of Q2. And approximately 1,000 basis points of Operating margin decrease versus the prior year.

You'll remember summer term is seasonally lower for us; and so the incremental margin impact of both increases or decreases in enrollment have always been larger in the summer term.

Finally, on the Department of Education's recently published Gainful Employment Regulation, while we are still reviewing all 450-some pages and waiting both clarifications and data from the Department in certain areas, which they have said they are going to provide, based on what we have seen, we remain comfortable that all of our academic programs will meet the requirements of this rule. And we currently contemplate no major changes to either our academic offerings or our business model on the basis of this rule.

And with that, Operator, we'd be pleased to answer any questions.

Thank you. (Operator Instructions) Our first question comes from the line of Sara Gubins with Bank of America, please go ahead.

Sara, are you there?

I'm here. Sorry about that. I know it is early, but do you have any sense on how new student enrollment is going for the upcoming term? Is there any reason to think that there's an improvement in the overall marketplace?

Well, we never comment on future enrollment, Sara. And it is early in the process. We think that over time, our new student enrollment should match the rate at which our capital expansion expands the University. In the shorter term, there's obviously a great deal of volatility and variability that we've been comfortable with.

So I think that the new student enrollment -- the most interesting part of this data to date is that we now have essentially 3 quarters in a row of minus 20%. So that's a fact and something that we are dealing with. But we don't have any comment with regard to the fall term enrollment at this point.

Okay. I guess maybe another way to ask about it is -- are you seeing any change in your operations in terms of enrollment adviser productivity, or are any of the questions that incoming students are asking any different? I know at some point you said that they were asking about whether or not Strayer was a for-profit. Is that changing at all?

No, I don't -- I will have Karl comment because he's closer, but again, our view is, the whole concept of the enrollment adviser, and we have admissions officers' productivity, is a bit of a misnomer. These students are not factors of production. It is not things that we are trying to move through or convince or manage in some way. We've built a university. We've got admissions officers at the campuses and our Global Center. They are dealing with incoming inquiries. And I think the demand is clearly lower at this point for a variety of reasons. But we don't spend a whole lot of time worrying about how that's going to get adjusted in the short term. I think in the long term, demand for Education is quite high; and if you're doing a good job in the classroom, then you're going to have a very successful enterprise.

But Karl, do you have anything on their questions?

The only thing I would add is -- students continue to raise concerns and questions; and I wouldn't say that there's any new questions we're hearing, or certainly on a trend basis, but there's also no difference over about the last year now, really.

Okay. Thanks. And then, I don't know if you've been in any contact with the Department of Education about this, but is there any concern that federal financial aid might stop flowing depending on what happens over the course of the next week or so?

I have been in contact with the Department of Education on a number of issues. I haven't raised that question, and nobody that I've talked to on the Department side has suggested that that is a concern. I don't know that that's (inaudible) because we weren't really talking about it.

Karl, has our FSA Group had anything on that?

No, we've not heard anything around a disruption.

Okay, thank you.

Our next question comes from Suzi Stein with Morgan Stanley. Please go ahead with your question.

Hi. Your peers have been talking about more competition for higher quality students. I'm just curious, given kind of where you are, are you seeing this from either your peers or from traditional schools, specifically?

Again, the whole term -- higher quality student -- I find somewhat puzzling. Our University, for over 100 years, has been built to serve working adults. We've always served students who generally have some college credit when they enroll. And we find that students that have some college credit tend to perform better in our academic surroundings.

We have some students who come in with no college credit who actually do fine, it is just a lower percentage. The idea that a student is either higher or lower quality is just not the way we think about this. What we want is that our prospective students know what it is that they are signing up for, that they're adequately briefed and counseled by our admissions staff and our academic staff, and that the ones who enroll have self-selected to be the ones that are most likely to be successful. But there are some who are not successful.

The competition for those students has always been high. In other words, students have a number of opportunities to go back to school. What we found is that the nature of our offerings, both in terms of academic content, and where and when they are offered, have been attractive. And I continue to see that going forward.

So we really don't try and think about whether it is a higher or lower quality student. We want the prospective student to be interested in attending Strayer University, and have both the commitment and the wherewithal to succeed, and that's really just part of our process to make sure that that's been communicated.

Okay, and then maybe I can just ask a question on buybacks. Are there any issues with respect to the financial responsibility ratio that would limit buybacks? And also, what are your thoughts as far as raising the dividend in Q4?

Let me take it in reverse order. Our Board and I always talk about the next calendar year's dividend in our October meeting. But what we said fairly consistently in the past is that we expect our dividend policy to rise generally in concert with net income. And I don't know of any sort of major change to that as an overarching concept. But we will talk about it in October, and let you all know.

With regard to the Financial Composite Score, it is 1 way in which the Department regulates the industry, and it certainly goes into the question of either, both how much debt you have and how many shares that you buy back. The Financial Composite Score is affected by share repurchases.

Okay, so you think that could limit the ability to continue to make repurchases at the rate at which you have?

We don't really comment on future repurchases, but it is a factor that goes into that decision.

Okay. Thank you.

Our next question comes from Bob Craig with Stifel Nicolaus, please go ahead with your question.

Thanks, operator. Good morning, everybody. Rob, I know you mentioned you will discuss school openings in October, but any directional thinking on those plans, given the elimination of regulatory uncertainty, which, correct me if I'm wrong, I think was behind the reduction this year. I know it has always been driven by human capital, but I would suspect you have the human capital to support well more than 8. So maybe some thoughts on what's going to drive that decision?

Sure. It is generally always limited by human capital, and you're correct in saying that last year we limited below that -- opened probably half the number that we could have because of that regulatory uncertainty. I wouldn't say that it's completely eliminated at this point. There's still a fair amount of implementation and interpretation risk that, over the next, I think, 18 months will be clarified. And we also have somewhat of a timing issue, as well, in that we are fairly late in the year to do a significantly larger number, because it would back in so many openings into the same quarter.

But you're also correct in saying that having slowed down last year, I think our bench actually is stronger than it has ever been. And so, when we sit down with our Board in October, and our Board of Trustees will go through all those issues, and share that with the investment community in October. We are firmly committed to our expansion plan. And I expect we will be opening new campuses next year; I don't know exactly how many.

Karl, do you want to comment on the human capital bench? Anything you want to add to that?

No, the only thing I would say, Bob, is we just completed -- my senior management team, we just completed a review of it. And as we've said in the past, there's many dozens of people who are at various stages of writing us; and we will make our final recommendation to the Board in October and what that number should be next year.

Helpful. Over and above the normal quarterly fluctuation, Rob, any real changes here in marketing strategy and spending levels, especially on the brand building side? Seemingly, from some of the sites we've been visiting, your ubiquity of banner ads has increased here recently.

Karl?

We always take a look at the way that we invest our marketing dollars. And within every channel that we advertise, be it traditional broadcast media or over the Internet, we are always working with our team to tweak things based on what we think is going to be the most effective in just getting the Strayer brand out. And what you're seeing is just probably a reflection of those ongoing changes.

Okay. Last one for me -- any cost adjustments you can talk about, given the lower volume looking at a same-school basis on admission staffing and adjunct faculty, for example?

Certainly adjunct faculty. Admission staffing hasn't really been affected. We don't have that many admissions officers anyway. We generally have 3 or 4 per campus, and a few dozen at Global Online. I don't see that changing significantly, and that's part of -- almost what we think of as a fixed cost to build the University.

In the same context, we think of full-time faculty and the academic infrastructure necessary to support all the courses that we do teach, adjunct faculty clearly are truly variable, and expand or contract on the basis of the number of classes that we offer. A fair amount that we are seeing and projecting with regard to our Q3 results is -- first off, your summer term enrollment is always lower anyway, so your margin goes down. There's less of a revenue base to offset all these costs.

But really, for the whole year what we've seen is -- we're going to run a certain number of courses. And we need to run those courses regardless of how many students are in the class because you have to have the courses available for students to progress through to get to their degrees. So our average student per class is down significantly, and that increases our instructional and educational expenses as a percent of revenue. And you will see that quite a bit with regard to the summer, the Q3 financial results in the summer academic term.

That's helpful, Rob, thanks.

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

Thanks. Rob, just a question on underlying retention. Given starts have been lower for several quarters, not surprising to see a decrease in the overall number of continuing students, but can you just help us understand the trends of what's happening in underlying retention, if you adjust for graduation and adjust for the lower starts? Are you seeing any difference in trends there? Are more people dropping out, or maybe even bad retention is better, I'm not sure.

That's a great question, Amy. If you think about it, our continuation rates, our retention rates, were basically as high as they could be going into last year. We talked about that, going back several years. So when you have down 20% on new students, you've got a bunch of cohorts going through -- there's just less continuing students to enroll. So on a year-over-year basis, that continuation rate is clearly going to go down.

The other way to think about it just mathematically is, our average student stays mark 7 or 8 quarters, like 7.5 quarters. So if you've got 3 or 4 quarters of down 20%, then that continuation rate ought to be down 10%, roughly. That's just the way the math works. It is not that complicated. And that's essentially what we are seeing right now.

We also get a little more granular, and look at what we call our cohort retention rate, which is the individual retention rate of each new class of new students that come in. That was also down slightly, Karl, but there was something on our remedial classes, our developmental classes, wasn't there?

We did, we made a change in the quarter to the failure policy for our developmental educational courses, both English and math, and we capped the number of times that a student can fail that at 2. So, if any student fails 1 of the developmental courses twice, they're automatically disenrolled from the University.

But you've got noise like that in almost every quarter, don't you?

We do. We make those kind of changes every quarter, and this 1 was at the request of our senior academic leadership team who had been looking at it for a while, and we decided to implement that in the spring term.

I think sort of the broader way to look at this, Amy, is that eventually our growth in continuing students is going to match, on an average basis over the last 8 quarters, the growth rate or shrinkage rate of new students, as long as our retention rate stays high.

That's exactly the color I was looking for. Thank you.

And just a follow-up to Bob's comment on opening up new campuses. Any impact, or maybe you can comment on, I know there's been some challenges in the upper Midwest with those campuses perhaps not ramping as quickly as some others, given what's happening in the macro environment. Does that play in at all in your decision of how many campuses to open, or is it more dependent on, or maybe that just plays a role in where you open the campuses, not necessarily how many?

It really doesn't affect either of those, for 2 reasons. One is, even the ones that are growing at a slower-than-recent rate, they are still at or above our investment model, and they are still great investments. So there's none of those markets that we're going to shy away from.

It happens that the upper Midwest is sort of that next area of the country that's contiguous to where we are going. So there's been, over the last 2 years, Ohio, Indiana, your hometown, Milwaukee, Illinois, it's just an area of fertile investment for us.

The number of campuses is really only affected by 2 issues, primarily human capital, and in the last 12 months, some prudence or caution associated with regulatory uncertainty. And then also at this point, now you have a little bit of a time lag, too. It takes about 6 to 12 months to get a particular site up and running. So my guess is, most of the campuses that we open in 2012 will be back-end loaded from that standpoint.

Great, thanks for the color.

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

Thanks. A couple questions, first related to the admissions advisory expense. That was down 10%-odd consequentially. It has been increasing pretty consistently, I guess since last year, so that's a change in the trajectory. Can you talk to why that fell in light of your comment that you don't anticipate making any cuts there?

And then I guess specifically address the question as to whether or not you did make any changes at all to your compensation policies, in reaction to the regulatory change?

Let me take those in reverse order, Kelly. We did not make any changes to our compensation policy, at least that would flow through -- actually, we didn't make any change to our compensation policy, period. The quarter-over-quarter comparison I think is a little bit affected by timing markets -- (multiple speakers).

It is.

-- (multiple speaker) dollars that shifted from second quarter to first quarter.

Q1 was a little bit higher than normal. And Q2 was a little bit lower.

-- a little bit lower.

Then the final issue is, is that -- I think we talked about this last quarter. As we dived into it last quarter -- because we just switched to this new expense line detail that some of that admissions advisory costs are truly variable, because it's fulfillment costs for students who do enroll, we send them catalogs, view books, information that's necessary to enroll in the University. We don't send it unless they do enroll, so as new student enrollment goes down on a year-over-year basis, you are going to see that number move around a little bit. But I think from Q2 to Q1, it is really just a question of timing of some expenses that got pushed into Q1 from Q2.

Great. I have a second technical question about the share count. I think it said in the Press Release that you ended the quarter at 12 million shares. But the average, both basic and diluted numbers, were in the 11s, which just seems like it doesn't work mathematically. What was going on there?

Kelly, the 12 million consists of about 11.6 million in common shares and about 400,000 in restricted shares. So when you do the DSO on the restricted shares, it is actually -- the impact is much lower than the 400,000. So that's why the diluted share count is lower than the actual absolute share count.

Okay, great. And then one last one. Rob, the color you gave on the adjunct faculty flexibility is very helpful. Can you give us a sense of what portion of the instructional and ed support line item is made up of adjunct faculty expense?

I would be guessing, but we have about half the classes are taught by adjuncts. The adjunct costs are lower, so I would say it is much less than half. Do you have a comment on that? (multiple speakers).

I agree, it is less than half.

Less than half of faculty, but faculty is obviously not the full line item. Do you know what portion of that line item is faculty?

The only other thing in there are lease costs, academic infrastructure, our President's office, our Senior Vice [Presidents], things of that nature. Again, Mark, do you have a sense as to --? We can get back to you, Kelly.

Why don't we get back to you, Kelly?

Okay, that's helpful; thanks a lot, appreciate it.

In general, Kelly, most of our costs are human capital costs, so I would guess that well over half of that line item is some kind of faculty cost. We will get back to you exactly.

Okay, thank you.

Our next question comes from Ariel Sokol with UBS. Please go ahead with your question.

Hi, good morning. I had a couple questions regarding the 2011 business model that was provided in the beginning of the year. The first question is -- can we still rely upon the 2011 business model in thinking about forecasts for 2011, given some of the trends that you've experienced?

Absolutely, Ariel. I'm glad you asked because it is something that Mark and I do each quarter, and go back and look at it. We are right on, or slightly ahead of, that model. You'll remember in that model we said if we were down 5% on enrollment growth, we would be flat to down 1% on revenue growth. The operating margin would be down roughly 750 basis points. And that, at the share count at the time, that would lead to $7.50 to $7.70 of earnings per share. If you take out the effect of the lower share count, we are just slightly above that.

And of course, a lot of it will depend on what our enrollment is for the fall term, but mathematically it is going to be hard to not be down on students, average students, for the full year. It is just not our nature to blow out enrollment by such a large number that it would reverse that. So my guess is -- you're going to end up somewhere between the 0% enrollment growth and minus 5% enrollment growth, and in which case that forecast -- that's why we put it out there, to show you how the business model works. And everyone should frankly be very close to that in terms of thinking about what we are going to achieve in earnings adjusting for the share count for the full year.

That's very helpful. And I just want to make sure -- to revisit the point that the December quarter, or the fall term, alternatively, that's your seasonally strong quarter with respect to new starts. Is it around 40% of your new starts for the full year? I vaguely recall that.

That sounds about right, Karl? It is more than a quarter. It may not be quite 40%; it might be 35%, generally.

It's -- I would say, between 35% and 40%.

Yes.

Okay, so basically as we are building out our forecast, depending upon Q4 alternately the fall term, that's really going to dictate where exactly it will be with respect to this business model?

For the full year, correct.

Perfect, thank you.

Our next question comes from Peter Appert with Piper Jaffray; please go ahead with your question.

Thanks. So Rob, you've been very consistent in saying that you're comfortable with lower margins in the context of the cyclicality of the business. I guess I was just wondering if, in the context of the weakness in starts that you and others are seeing, and the persistence in this weakness, if you've given any further thought to the need to adjust cost structure or think about cost structure?

We think about cost structure every day, Peter. We want to be good stewards of our owners' capital. But from my perspective, the way to be the best steward of that is to invest it in what I perceive to be a very high, inherently very high return enterprise, which is providing postsecondary education to working adults. That requires a cost structure, which we've invested in, and we are going to continue to invest in.

And either the seasonality, the short-term cyclicality, even the medium-term cyclicality of enrollment, is going to affect those margins, and it is not going to affect our view as to what's necessary to provide a great education. You can be certain that any cost that's not necessary, that is truly variable, that we are addressing, and costs that we feel are necessary to provide the kind of education and the kind of institution we want to have, is going to be there without regard to the cyclicality of the enrollment.

Fair enough. And then Rob, you've been very consistent I think also in terms of the pricing strategy somewhere around 5% a year; and some in the industry have been dialing back I think how aggressive they are in pricing. How are you thinking about that longer term?

There's 2 parts to that. One is what I perceive to be the inherent pricing power, the real value creation that you have for the users of your enterprise. And in our case, our students. And we've always felt that that is relatively high, but that the best way to deal with that is on a stable, predictable 5% increase, which is what we've done over the last 11 years. Clearly in the last year, there is a fair amount of public policy attention and discussion; and so I'm certainly sympathetic or understanding of universities looking at that pricing structure within that context.

I don't think -- we are quite comfortable with where our tuition is, and our costs do increase, and we need to have some of that pass on to our students. So, I suspect that we will be in the range of 5%. It's been a little bit higher -- in some respects, Mark and I like to round it to a manageable number, 10s or something like that. So it has been a little bit higher than 5%. It's, I think, conceivable it could be a little bit lower, but it is going to be in the mid-single digits.

Great, thanks, Rob.

Our next question comes from Bob Wetenhall with RBC Capital. Please go ahead with your question.

Good morning, this is Steven Bachman in for Bob. How are you?

Good, Steven, go ahead.

You mentioned the 1,000 basis point impact in operating margin during the third quarter. But given where the enrollment level is, it seems to imply that revenue per student will also need to come down a little bit. Are you anticipating any higher scholarship activity, or is there anything going on in revenue per student that you guys could elaborate on?

There's a couple of things. One is -- and if you look back at our history over the last 10 years, you will see this. In those periods where our mix shift of students moves towards graduates, it has a depressing effect on revenue per student. Even though graduate tuition is higher, our graduate students tend to take 1 course, and our undergraduate students tend to take 2, roughly. So that will affect it.

We do have, as Karl mentioned, an increased percentage of our students that are coming to us from corporate institutional alliances. And in those cases, routinely we have about a 5% price discount, which really is part of having a relationship with the organization. They bill us -- or we will bill them directly. They send us tuition directly, so we save some costs as well.

And other than that, Mark, is there anything else that's affecting revenue per student?

We have seen our failure rate up a little bit.

Academic failure.

Yes.

Got it. That make sense.

So, more drops.

More drops, yes, so higher -- (multiple speakers).

Higher drops, which affects your revenue per student.

Got it. That makes sense. Getting back to operating margin, where do you expect to see the largest declines in that 1,000, in terms of line items? I don't know if it is possible to break out some color there?

As I mentioned earlier, you're going to see most of that in the instructional and education line, because you're going to have less students per professor and per classroom. I would guess out of 1,000, probably 600 or 700 of that is instructional education.

I think that is right.

That's great, thank you.

Our next question comes from Gary Bisbee with Barclays Capital. Please go ahead with your question.

Good afternoon. I guess first question, and I know you're not going to like it, but I'm going to ask it anyway. Rob, you continue to state comfort with enrollment volatility. At what level would the volatility lead to you being uncomfortable with the trend, or are there anything else we could look at that would drive much different behavior from the way you've managed the Company over the last decade?

I mean, I believe, Gary, that there's inherent constraints in terms of how you market, how you approach prospective students if you want to have a long-lived, sustainable educational institution. So there's not a lot. We've been around for over 100 years. And we've had a great deal of success in attracting working-adult students. So I just don't -- there's nothing that's being talked about or that we are seeing right now that's likely to affect that.

I guess from the standpoint of investing our owners' capital, if we couldn't invest it properly based on a lack of enrollment, then we certainly would stop opening new campuses, stop putting capital to work if it wasn't achieving a commensurate return. But the fluctuations in enrollment that we are talking about now -- bear in mind, Gary, we've talked for 10 years about a notional model that adds about 100 students per campus pre year. What you're seeing in terms of enrollment comparisons versus last year is off of a period of years where we were so far above that, '07, '08, '09, most of 2010, that you could have quite a bit less enrollment and still be such a powerful and profitable enterprise that it is unlikely to change our view of what our strategy is and how to invest our owners' capital.

Okay. And then just in terms of you guys doing your jobs on a day-to-day basis, what are you doing differently today than maybe you've done most days or weeks or months or quarters over the time you've been running the Company?

I'm glad you amplified the question, because I thought you were saying, what are you doing? (laughter).

You sound so nonchalant, and this is just the way goes. I guess I'm trying to ask differently than others have, sort of how are you guys reacting? I totally understand the long-term plan to invest towards your target of a national university. I guess I'm trying to understand if there are things behind the scenes that you are all doing very different that might help us understand how you are approaching this.

We are not doing anything particularly differently. If I appear or sound nonchalant, that must be a great deal of training, because there's obviously quite a bit to do to running the Company, and an enterprise of this nature.

The last year has been incredibly busy, because of -- really, the intrusion in the business model of a much increased regulatory, public policy, public affairs kind of requirement to deal with. But that's part of the game. We get 70%-plus of our revenue from students who are financed by the federal government, so they have a legitimate purpose in looking and reviewing what the nature of education is. Besides the fact that we are involved in a public good, and so you are going to be part of the public policy debate.

So I would say that over the last year, a lot more of my time has been taken up in that. Certainly a lot more of Karl and Mark's and their senior time has been. We would like to get back to a more balanced application of that time, and focus in a little bit more closely on a lot of the academic improvements that we've always been focused on, and executing our strategy.

But as I said, that's the situation that we are dealt, and we deal with it. It hasn't changed in any meaningful way how Karl or Mark or I think about our responsibilities and what we have to do. It's just that it has increased in importance, that part of it, particularly for me.

Okay, and then just one last one. The decline in new students over the last 9 months or 3 terms has been incredibly consistent in terms of the year-to-year change. I think we all probably at this point assume there will be a similar fourth quarter number. Is there any reason to believe that that pace of change would change dramatically? And I'm not asking you if you'll grow starts in 2 terms or anything, but are any of the leading indicators pointing to further deterioration that would lead to another big down year or rebound? Is there anything you can say as you look out at that?

We just don't comment on future enrollment, Gary, mainly because we don't know. The kinds of leading indicators that you're describing don't lead us past a quarter, for the most part. So I can't really help you with that.

My view has been, and continues to be, that over time our rate of new student growth is going to roughly match our rate of capital investment and expansion of the University. And at the period at which we fully invest it in building the University, then what we would hope is we would have relatively stable new student enrollment and relatively stable total enrollment. But that's a long ways off. We've got a lot of states and a lot of cities to get to before we even think about that as a long-term operating model.

Okay, thank you.

Our next question comes from Maria Karahalis from Goldman Sachs. Please go ahead with your question.

Good morning. The question I wanted to ask is to follow up on the enrollment trends, and it seemed that the online enrollment was decelerating at a faster rate when you look at the total enrollment, either at the mature campuses or at Global Online. Could can give us a little bit of commentary on what you are seeing?

Sure. Let me focus on Global because that's really a discrete market, if you will. The choice that our students make, who are enrolled at a campus to take either an online or a classroom-based class, really is based on their desire and the way in which they want to access the education. So we don't really spend a whole lot of time worrying about that, besides making sure that we have adequate professors in the classroom and online.

But the Global is a discrete unit, if you will. And that's always been, in my judgment, the most challenging from an academic standpoint. The students are farther away. You don't have the ability for the face-to-face interaction, which helps in an educational enterprise.

So that is decelerating at a slightly faster rate than the University as a whole. I don't really have much explanatory input from that, beyond the fact that we've recognized it. The actual enrollment acceleration or deceleration has been less of a concern to us than thinking about -- how do you manage that part of the academic enterprise to get the same learning outcomes. And over years, I've said I think it is more difficult. We found it more difficult.

We may not be as good at it as other online providers, but it takes more cost per student, both in terms of academic and administrative staff, in order to serve that student. And I would also describe it, Karl, as maybe -- it is not a surprise to us that the impact in overall demand would be felt more there because it is just a student that we have less interaction with, coherence with.

I agree. Every part of that operation, be it on the administrative side or the academic side, is tougher, for what Rob just said -- you never see the student. It is unsurprising to us that it's declined at a little bit of a faster rate, and something we obviously are aware of and monitoring. But it is not unsurprising.

The other point we make is that as we grow the campus network, it is by definition going to decline because eventually when we have campuses everywhere, that facility, those people will be repurposed other ways to serve the University. It is really a means of administratively serving inquiries that we get that are currently outside of our campus-based footprint.

So, if I can follow up then -- understood. If I can follow up then on the mature campuses, and the trend between classroom students and online students. You're saying that -- or maybe I should ask it as a question. On the online students, that's more a function of perhaps shifting a student from online to classroom, as opposed to more online students -- online students not retaining as well?

No. It is really important you understand, Maria, those aren't discrete students.

Understood.

Those are choices that the student makes in any given quarter. What's happening there is, some number, some higher number of those students versus the prior year have decided to take classes in the classroom versus online. So we just break that out as a facility utilization data, so that you can see the same thing that we see.

If you think about students who enroll at our campuses -- Karl, correct me if I'm wrong -- but roughly 30% will never take a class online. 20%-ish will take all their classes online, even though they live right near the campus; it is just how they want to access. And then the 50% in the middle are going to take some of their classes online. In any quarter in which they've decided to take all their classes online, they show up in that category.

But it is not a business unit or a discrete academic unit that would allow you to sort of granularly look at, see, trends with regard to whether online or on campus is growing faster or slower. Because those students are all associated with the physical campus, and we really don't want to try and push, even subconsciously, those students in the one side or the other. We want to have enough investment available so that the student can decide in any given quarter, without any implication to them, whether they want to take a class online or in the classroom.

Okay. Thank you.

Our next question comes from Andrew Steinerman with JPMorgan. Please go ahead with your question.

You mentioned the demand is clearly lower for a variety of reasons, and I obviously realize Strayer doesn't [stimulate] demand. But can you just go over what specific reasons are affecting demand, in the target market that Strayer is going after?

Karl, you want to take a shot at what you're hearing from your staff?

I think it is a combination of factors, Andrew. We've noticed that for some students, they are taking a longer time versus what we've seen in the past, to ultimately decide whether or not any particular quarter is the right one in which to enroll. As we've said, some of these students have concerns just around the general perceptions of for-profit education, and we do get those questions throughout our campuses.

It is hard to pinpoint 1 thing because we hear these broad macro sort of themes running through our various campuses. And we don't necessarily focus group or survey these students, and so it is just our anecdotal sense of what's happening.

Andrew, I'd say there's probably 4 or 5 things. There is the compounding effect of economic downturn over time. As to the question of whether we are countercyclical -- we've never felt that we were countercyclical. We've always felt that we were relatively acyclical, but at some level you have to have -- for a working-adult student, particularly at the undergraduate level, making about $25,000 or $30,000 a year, making the decision to commit, not so much the dollars, but the time necessary to get an undergraduate degree, it's certainly helped by economic uncertainty, but it has to be balanced by a sense of faith that there's value at the other end of that. So there's some amount of that.

Clearly there's a lot of the discussion around the nature of investor-funded universities. Partly you've got a regression to a mean. And as I said with regard to Gary and new students, you had 3 years of growth in new students that was well above what we've always said is our investment model. And it's some combination of all of those things.

We don't have an ability to, in my judgment, granularly pinpoint what percent is associated with what. As a matter of fact, it's only in the last quarter that I've come to believe that these are semi-impactful trends. As I said, the first quarter or so, we'll say -- let's see what happens. We've had 3 quarters in a row of this. It is clearly a diminution in demand. We will see what happens going forward.

Right. Rob, when you think about all those factors together, does it feel like we are moving through the bottom of that?

I don't have any idea, Andrew. I don't try and call that.

Okay, thanks so much. Appreciate it.

Our next question comes from Jeff Silber with BMO Capital Markets. Please go ahead with your question.

I wanted to focus on the students in your newer campuses. In terms of the trend declining, it was a pretty significant change in trend. Is it only because we have fewer new campuses, or are you seeing issues at the cohort of campuses that you opened in the 2 years before this?

Both. We have fewer new campuses as a percent of the total by going to 8 this year. And some of the new campuses that we opened in 2009 and 2010, particularly up in the upper Midwest, have not enrolled as many students as the cohort that we opened in '08 and '09. So you are seeing both of those.

Is there any specific reason for that, the latter part of that, in terms of some of the newer ones you opened over the past couple of years, or is it just general trends that you've discussed? I'm just curious if there's anything going on differently there?

I don't think there's anything going on differently. I think it is part and parcel of the general trends.

Okay, great. Just a couple numbers questions regarding your business outlook. What tax rate and share count is embedded in that for the third quarter?

Mark?

Yes, the tax rate, Jeff, continues to hover around 39.5%.

He's just asking what do we use?

39.5% is what we're providing at.

And the share count?

That would be quarter end, right?

Our guidance is based on effectively the quarter-end share count.

Quarter-end share count; okay, great. Thanks.

Our next question comes from Brandon Dobell with William Blair. Please go ahead.

As you guys continue to broaden the geographic footprint, as well as Global Online, does that give you any reason to rethink the kinds of programs that would fit with the University? Or do the geographies not really make a difference from what you think may serve those local students better?

The geography is not going to make a difference. Although with our 2 new Chicago campuses -- I'd like to see you stop by, and then come back and tell us if you think that we need to be offering some other types of programs, Brandon.

I could be up for maybe an accounting course that would be good for me, I think; if you can get that set up, that would be great.

We were hoping that we could get you in one of those. (laughter).

Perfect. I will sign up tomorrow.

And then a question relative to what Karl had mentioned about students taking longer to decide around which quarter. How much visibility do you have in to students that start the application process or start the enrollment process in the very beginning, and end up deciding not to attend Strayer? Do you have any idea if they are going someplace else, are they not going anywhere? I'm just trying to get a feel for what the alternatives that people are seeing now or taking advantage of now versus what they were looking at maybe a year ago or 2 years ago?

Brandon, we don't really know if they go anywhere else. As I said, we don't survey these students. The comment I made is in reference to, essentially what you're saying. Students who complete an application and then ultimately enroll, we could just see that that has taken longer than it has in some quarters in the past. And it is a combination of all the factors that we've just discussed as to why that's happening.

But we don't have a good sense for what's happening if they ultimately elect not to attend. I can say, however, that periodically I look at transcripts that are leaving the University, and we've not seen any trends in the absolute number of percentages of students leaving Strayer to go to another institution where we would be sending that transcript.

For an existing student.

For an existing student, correct.

Brandon, on the issue of -- are they going someplace else? I think I said this in the last quarter -- you've got a fairly consistent and broad-based reduction in enrollment across the entire sector. There are some entities that are still adding students, but they are adding them at much lower rates than they were before. So, it is hard not to draw from that, that there's just less overall students enrolling. If they are going someplace else, it would have to be to traditional universities, and we know they are not expanding their capacity. So I think the logical conclusion is, they are not enrolling, period. But, as Karl said, we don't have a lot of data on that.

Final question for me. If you look at this term's student behavior compared to the previous couple of terms, as the students move from that application to actually starting class process, I guess, call it a show rate or call it whatever you want to call it, have you seen any change in let's call it the last mile of the enrollment process? Are students showing up at a higher or a lower rate than you had seen previously? And I guess, or is that rate markedly different from what your expectations would be?

We haven't really seen any big changes in our start rate. As Mark said, in the last quarter, our academic failure rate was up a bit, and so we have seen an increase in students that dropped as a result of that, and some other number of reasons during the quarter. But to answer your specific question around start rate, that's relatively flat.

The failure rate was up about 100 basis points.

Went from like 9.5 to 10.5?

Yes.

Thanks, appreciate it.

Our next question comes from Peter Wahlstrom with Morningstar.

You mentioned the corporate and institutional alliances were up to about 25% of the student body. Can you remind us if there's a target mix that you're looking at as you look out a couple of years, and is this another variable that you think about as you look at potential new campus locations?

We don't have a specific target. When we embarked on this expansion strategy 10 years ago, we were at about 20% here in the DC area; and we wanted to keep it at about that. We are pleased with that.

Corporate-sponsored students tend to do well with us. They've got the preparation. They've got the commitment, plus we like the affirmation from the corporation that academically we are serving the mission. So we will continue to work on that without a specific target.

It doesn't really have a lot to do with our campus citing or which markets we decide to go to. Our plan is to expand across the United States, and over time, get basically every community that's got sufficient population to support a campus. And having the corporate-sponsored students is helpful in all those places.

Thanks, and then as a quick follow up. If this trend were to tick up, let's just say, over time, would you view this as a positive or negative factor in terms of your overall retention rate?

I'm sorry, Mark was handing me a note.

What was the question, Karl?

I think what you are asking is, do these students continue at a more favorable rate?

Yes, exactly.

Yes, they do. (multiple speakers). They do continue at a higher rate.

And just a quick broad-based question about cost and trend of faculty. Looking ahead, are you finding the quality of candidates, faculty with well credentialed, et cetera, to get them in the right place at the right price when you are looking at expanding programs, whether it is in the online channel or the physical campus channel? Thank you.

We are not really expanding programs, but we are expanding locations. And yes, we are pleased with the availability of faculty. That's one of the things that makes the business model I think quite powerful is there's a lot of qualified teaching faculty who are underutilized, particularly in research universities, and who want to be at an institution like ours. That's a positive part about that.

Mark had a clarification.

I just wanted to clarify my response to Jeff's question on what share count we used for our Q3 guidance. We actually used the Q2 diluted share count of 11.7 million, so I just wanted to clarify that. As opposed to the Q2 ending.

Got you.

Our next question comes from Arvind Bhatia with Sterne Agee. Please go ahead.

Thank you. Also wanted to talk about corporate relationships a little bit. There's been a positive trend for you for some time. I wonder if you can speak to what you are doing maybe differently. Is that continuing to be a bigger focus for you, and what's the pipeline looking like? And also, as you look at the new relationships versus what you already have, is a lot of the growth coming from new, or existing relationships are also yielding pretty positive results?

We are not really doing anything differently. And I would say that all the real growth in it comes from the way we serve our current corporate partners, ie, a corporation who is thinking about bringing us in, is going to talk to somebody else. There's a network of HR and benefits professionals who look at this sort of thing. It is like everything else in terms of building the brand of a university; it is an intangible, so the success you have with your existing students and existing partners is going to feed your ability and propel your ability to gain new ones.

I mean, I think a good example is -- we were asked by the NFL union to go down and provide some financial management training to the NFL rookies when the owners locked out the teams; and that came out of the fact that we had a program for the Washington Redskins that the union President knew about. So, and Karl and Mark got to go down and lecture to a bunch of NFL rookies, accounting and finance.

So all of that, it is going to feed on itself. And it is, can either be a self-perpetuating virtuous cycle, or if you do a bad job, it can be quite detrimental to the enterprise, which is why we always come back to -- it's how well you teach in the classroom that, over time, is going to actually determine the success of the institution.

Got it. And another question I have is on new campuses. As you open these new campuses in new markets, you obviously have the initial start-up cost, et cetera. Are you doing anything to your cost structure, the initial start-up costs, in light of the trends that you are seeing in enrollment? Is there any flexibility there, whether it is in the support staff or faculty or any other cost?

No. We open a new campus with the facility and the staff necessary to run the facility, even if you have 1 student. Then the operating losses you incur over a year or 2 is the fact that you need to get to 200, 250 students in order for that to break even. And if it takes a little bit longer, that just affects your ultimate return, but there's no way in my judgment to make it smaller or less expensive, and have a real university.

Got it. Final question on bad debt expenses. Mark, can you talk about what you are thinking for the third quarter?

You can see from our second-quarter results where bad debt nudged up to 4.1% versus the same period in the prior year. There are a couple of factors there to keep in mind. One is that, as our revenue has declined a bit, we have a sort of negative comparison because you have essentially -- you're reserving or aging receivables from prior quarters, and you're measuring it against a lower revenue base.

We are also seeing fewer recoveries coming from receivables that we've written off subsequently. We collect a certain percentage of those. We are seeing those slow down. But in terms of the balance of the year, I'm not sure we are going to see a material change from what we've experienced in the current quarter.

Appreciate it, guys.

I'm not showing any other questions in the queue. I'd like to turn it back over to Mr. Silberman for closing comments.

Thank you, Shawn. I appreciate everybody listening. We look forward to talking to you in October. Thanks very much.

Thank you for your participation in today's conference. This does conclude the conference. You may now disconnect.