Strategic Education Inc (STRA) 2011 Q3 法說會逐字稿

Good morning everyone and welcome to Strayer Education, Incorporated's third-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 Rob 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're unable to listen to the call in real-time, a replay will be available beginning today at 1 PM Eastern time through Thursday, November 10. The replay is available at 855-859-2056, conference ID 94195606.

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 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 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. And 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 would 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. Mark will then report on our third quarter financial results followed by Karl commenting on our third quarter operational results including our student enrollment for the fall academic term. Finally I'd like to provide an update on our growth strategy, discuss the Company's earnings outlook for both Q4 and full-year 2011 and share our thoughts on Strayer's investment plans and resulting business model for 2012.

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's degrees in business administration, accounting, computer science, public administration and education.

Unlike traditional universities, Strayer students are working adults who are returning to school to further their careers. Our revenue comes from tuition payments and associated fees. Approximately 75% of that revenue comes to us from federally insured Title IV loans. Our expenses include the cost of our professors, our admissions and administrative staff, marketing expenses, and facilities and supplies costs. Strayer University is accredited by the Middle States Commission on Higher Education. Mark, you want to run through the financials?

Sure. Revenues for the 3 months ended September 30, 2011, decreased 8% to $135.9 million compared to $147.6 million for the same period in 2010 due to lower enrollment, partly offset by a 5% tuition increase, which commenced in January of this year. Income from operations was $24.4 million compared to $38.2 million for the same period in 2010, a decrease of 36%. Operating income margin was 18%, compared to 25.9% for the same period in 2010. Net income was $13.9 million, compared to $23.3 million for the same period in 2010, a decrease of 40%.

Diluted earnings per share was $1.20 compared to $1.72 for the same period in 2010, a decrease of 30%. Diluted weighted average shares outstanding decreased 14% to $11.647 million from $13.557 million for the same period in 2010. Revenues for the 9 months ended September 30, 2011, increased 1% to $471.6 million compared to $464.8 million for the same period in 2010 due to a 5% tuition increase which commenced in January of this year, offset by lower average enrollments.

Income from operations was $133.8 million compared to $156.9 million for the same period in 2010, a decrease of 15%. Operating income margin was 28.4% compared to 33.8% for the same period in 2010. Net income was $79.4 million compared to $95.4 million for the same period in 2010, a decrease of 17%.

Diluted earnings per share was $6.58 compared to $6.98 for the same period in 2010, a decrease of 6%. Diluted weighted average shares outstanding decreased 12% to 12.055 million shares from 13.663 million shares for the same period in 2010.

At September 30, 2011, the Company had cash and cash equivalents of $57.1 million. The Company generated $122.7 million from operating activities in the first 9 months of 2011, compared to $141.4 million during the same period in 2010. Capital expenditures were $24.9 million for the 9 months ended September 30, 2011, compared to $32.1 million for the same period in 2010.

As previously announced the Company entered into a revolving credit and term loan agreement in April of this year. This credit facility, which is secured by the assets of the Company, provides a $100 million revolving credit facility and a $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 September 30, 2011, the Company had $100 million outstanding under its term loan and $5 million outstanding under its revolving credit facility.

During the 9 months ended September 30, 2011, the Company invested $182.7 million to repurchase approximately 1.370 million shares of stock at an average price of $133.32 per share as part of a previously announced stock repurchase authorization. During the same 9 month period, the Company paid regular quarterly dividends of $37.2 million or $1.00 per share for each quarterly dividend.

For the third quarter 2011 bad debt expense as a percentage of revenues was 3.8% compared to 4.2% for the same period in 2010. Days sales outstanding was 14 days at the end of the third quarter of 2011 compared to 13 days at the end of the third quarter of 2010. Rob?

Thank you, Mark. Karl, do you want to run through the operational results and also hit on the fall term enrollment?

Sure. Total enrollment for the fall academic term was 54,233 students, a decrease of 11% versus the prior year. Continuing student enrollment declined 9% and our continuation rate declined 60 basis points. New student enrollment decreased 15%. Enrollment at our mature campuses decreased 13%, while enrollment at new campuses grew 21%. Global online students decreased 15%.

During the quarter we added a new statewide community college articulation agreement with the state of Wisconsin which has 11 community colleges in its system. And presently we have 195 articulation agreements including 9 statewide agreements. Together these agreements cover more than 430 colleges nationally. And in total, students from these colleges represent approximately one-third of our total undergraduate student population.

We also signed 4 new national accounts during the quarter, including agreements with Volkswagen America, McGraw-Hill and Eli Lilly. New students from national accounts grew 4% versus the prior year and total student population increased 6%.

During the quarter, we also successfully opened our final 3 campuses for 2011. These included our fourth campus in the Dallas, Texas market and our first campuses in the state of Illinois with 2 campuses in the Chicago market.

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

Thanks, Karl. Just going back to the financials for a second, a couple of comments on the third quarter from my perspective. Our operating margin was about 200 basis points better than our forecast and that was caused by both I would say fairly effective cost control efforts as well as much lower bad debt expense than we were forecasting. On distributable cash flow for the first 9 months of the year, we're down 11% on a 17% decrease in net income reflecting what I believe is fairly effective working capital management by Mark and his team.

On our business outlook for the fourth quarter of 2011, based on the University's enrollment for the fall term, which as you know, we have already started so we know exactly what that is, we estimate our fourth-quarter EPS will be in the $2.24 to $2.26 range with approximately 500 basis points of lower operating margin versus the prior year.

Now turning to a brief update on our strategy, many of you will remember that it's based on five objectives. First, maintain enrollment in the Company's mature markets. Second, open new campuses, particularly in new states. Third, invest in our online curricula. Fourth, increase our corporate and institutional alliances. And the final objective is to effectively manage our owners' financial capital.

In terms of a third quarter update on those objectives, Karl really already the covered the first four and Mark covered the fifth. So I don't feel I need to add anything here. However since we now have visibility into our fourth-quarter earnings, I would like to take this opportunity as we do each year at this time to give a full year 2011 forecast and then compare that forecast to our 2011 business model, which we first provided last October and which Mark and I updated for you last January. And then finally describe our investment plans and the resulting business model for 2012.

Now in January, Mark and I said that if the University experienced a 5% decrease in student enrollment in 2011, we would expect about a 1% decrease in the Company's revenues, operating margins of roughly 26.5% and earnings per share in the $7.50 to $7.70 range. We now know that we experienced approximately a 4% decrease in student enrollment for full-year 2011, which we project will lead to slightly less than a 1% decrease in revenues. So pretty much on target there.

However, we expect our full-year 2011 operating margin to be about 200 basis points better than our model or approximately 28.5% and full-year 2011 earnings per share to be in the $8.82 to $8.84 range. The better operating margins, combined more importantly with our extensive share repurchases during the year, explain the higher EPS than our business model indicated 10 months ago for this same level of enrollment.

Now turning to our 2012 investment plan and business model, we announced today that Strayer University intends to open 8 new campuses, again next year, which will bring our total to 100 by the end of the year, and that we will implement a tuition price increase of approximately 3% effective January 1, 2012. In addition, Mark and I decided that in this release, it would be helpful to provide you not just with how our financial model in 2012 would be affected by these investments and by different total student enrollment results as we have in the past, but also give you expanded visibility into how our total student enrollment is affected by different rates of new student enrollment throughout the year.

With our high student continuation rates, and they've consistently been quite high for the last 4 or 5 years, the variable which has the most impact on our total student enrollment is the rate of growth of new students. But since our average student enrolls in the University for approximately 8 quarters, the impact of new student enrollment on total student enrollment has about a one-year lag. This is why in 2011, even though new student enrollment was down 19% for the whole year, our total student enrollment was down only 4% versus 2010.

Now by the same token, our 19% decrease in new students in 2011 will have an adverse impact on 2012. Even after new student growth rates turn positive, the shortfall in new students from 2011 will have a limiting effect on both our continuing student enrollment and our total student enrollment in 2012. It's a trough that works its way through the system.

In this press release, Mark and I provided an illustration of that effect to give our owners more transparency into our operating and financial model. Now we of course do not know what our new student enrollment will be in any upcoming quarter, nor do we ever comment on it in the future. The enrollment of new students will be variable and we are comfortable with that variability. We are obviously pleased that our new student enrollment in the fall term was better, or at least, less worse, than our winter, spring and summer terms.

One last point on revenue for 2012. Our tuition increase of 3% in 2012 is less than our standard 5%. This is because in the teeth of I think what can only be described as a prolonged, real recession for our target student market and with the obvious evidence of our lower new student enrollment through the whole year, it seemed prudent to be a little more judicious with our tuition increase in 2012.

In addition, when you work through our illustrative model in the press release you'll see that even with the 3% tuition increase, Mark and I are expecting very little revenue per student growth in 2012. This is because of two other factors, both of which we have experienced before over the last 10 years so some of you may be familiar with them.

First, our student mix in 2011 shifted towards more graduate students. While our graduate students pay higher tuition per class than our undergraduates, they also take fewer classes per term on average. Undergraduates tend to take 2 and graduates tend to take 1. And therefore they generate lower revenue per student per term.

And then second as Karl mentioned, students from our corporate and institutional alliance partners have grown to a larger percentage of our total student population in 2011. As a matter of fact, we had real growth in that area compared to shrinkage in the rest of the University. And many of those relationships involve 5% to 10% tuition discounts or scholarships. So again, on a revenue per student basis, that will have an impact.

Finally, I would like to turn back to the fifth leg of our value creation strategy, the financial capital management. When the Board of Directors and I looked at where our cash balances are likely to end up this year and where, more importantly, these cash balances are likely to grow in 2012, we decided that we would take the following actions. First, we are maintaining our annual common dividend at $4.00 per share in 2012. And second, we have increased our share repurchase authority to $100 million.

Now the Board and I remain convinced that our business model allows us to fully fund an organic growth strategy of patiently and deliberately building a nationwide university to serve working adults and still make periodic returns of capital to our shareholders. Of course we as a management team and a Board will continue to weigh every quarter all uses of cash to determine the most value enhancing after-tax return on our owners' capital. And with that, Shawn, we'd be pleased to answer any questions.

Thank you. (Operator Instructions) Amy Junker, Robert W. Baird.

Rob, the decision to open up 8 new campuses, again is that still predicated on the regulatory uncertainty and demand concerns? Or does that really reflect your bench strength at this point?

No. For a second year in a row we have got deeper bench strength than we are using. And it certainly doesn't reflect demand. Our new student enrollment is down on a year-over-year basis. But the new campuses that we opened in 2011 are performing according to plan.

So it really is a continued comment on the fact that the regulatory situation, while clearer than last year, still requires a fair amount of effort and additional clarity in terms of implementation to really feel comfortable to have the full impact of our bench strength and our financial capital.

So again, it was just a decision to be a little more prudent than otherwise while we wait until next spring and watch how the Department continues to illuminate and illustrate how they intend to execute these regulations.

That's great. Then just a quick follow-up on that, because my next question -- I know I've asked about this in the past, but you have had some more challenges at some of the campuses in the upper Midwest here in Milwaukee, Cleveland you cited in the past. Has that started to improve yet? Or are you still struggling in some of those geographic pockets?

I wouldn't say we were struggling. What I would say is that both in terms of geography and cohort time, they didn't enroll as many new students as quickly as some of the campuses that we had opened in the South in '07 and '08. But they have all been at least according to our plan, and we were delighted to open the 2 campuses in Chicago.

The one thing that we see is in, particularly as you mentioned in Cleveland, Akron, Milwaukee, I don't know about Chicago, Karl you will have to correct me on this or illuminate. But there was a higher percentage of new students who were unemployed and were trying to be students full-time, which in our model is a difficult thing to do. Do you know about Chicago whether that was the case?

I would say it was less so in Chicago.

Okay. But that still has been the case. And we are obviously trying to create an academic home and a method by which that student can be served but it is clearly more difficult.

Great. Thanks for the color.

Andrew Steinerman, JPMorgan.

Could you go over your course management initiative? Obviously happy to see the operating margins come in better than expected. But are we holding back on any branding or other investments that, if we were in a different environment, maybe we would be making?

No. We spent everything that we intended to spend in terms of brand building and campus openings and marketing. We have kept our -- the lineup of courses exactly as we would have hoped it to be, managing class count, seats per classes to an appropriate level.

What we have basically been able to do and I don't know any other specific way to describe this, but then just to describe the outcome, which is over a prolonged period of less revenue than you were expecting, you just get better at finding discretionary items that don't need to be spent on.

So there wasn't any one particular thing I would point to, but you know, as a culture, and as an organization we try and be as efficient as possible. And we did a better job than I was expecting over the last 3 months and found areas where expenses didn't need to be incurred. But without really -- there was nothing related to our academic model or any of our rollout plans that were affected by that.

Right. Since you just described them as discretionary, when enrollments do start to grow, you don't think of this as kind of a deferred headwind on margins, do you?

No, I don't. I used to work for a guy who said it's never a bad time to cut costs and to look hard at it. We're building a University. We are growing a University. We know that there are additional costs that are necessary. And frankly I've always felt limited economies of scale as you grow a University.

But as I said before, it is never a bad time to take a really hard look at certain things. None of this was dictated from the top; the whole organization just did a better job of sort of managing expenses.

That sounds right. Thank you.

Bob Craig, Stifel Nicholas.

Actually I'm going to impersonate Jerry. (laughter) Questions about the 2012 model, and in particular the relationship between total and new. If you guys run 10% new student start declines for the next 4 quarters on top of the 19% declines that you have had for the last 4 quarters, I'm wondering how you can get to the negative 9 in total for '11? Is there something happening with retention or re-entries or something that is impacting that relationship?

No. Jerry, the reason we decided put this model in here is to really try and provide visibility for you all in the same way that we see it. The best way to think about this, as I said, is that the average student stays for 8 or 9 quarters. I mean, it varies year-to-year.

Obviously, that is not every student. We have some students who drop out after 1 quarter and we have some students that'll take 16 or 20 quarters to finish a program.

But for modeling purposes, if you think of it that way, you have got a stock and flow concept. You have got really 8 different cohorts that are in existence in the University at a given time. And our retention rate has remained quite high, our cohort retention rate. With each individual starting class, the percentage that goes on to the next level, net of graduations and academic failures.

So when you model that through, we know how many students we have in 2011 who haven't graduated yet. We have a high level of confidence how many of them will continue through 2012. We know that there is a trough of new students in 2011. It was down roughly 20% versus the prior year. When you model all that through, if in 2012 our new students are down 10% over 2011, that creates the -- was it minus 9%, Mark? That we modeled?

The purpose of providing this visibility is so you all can see the relative impact of different rates of new student growth. It is not intended to bound anything either. If we are plus 20% on new students -- well, interestingly enough, plus 20% with that 8-quarter life is basically going to bring us back to stable revenue and stable operating margin versus this year. Because the plus 20 will offset the minus 20 in the prior-year.

By the same token, if you were minus 20, you're going to double down on that trough for a couple of years. So it's really just an attempt to try and give you a sense of the stock and flow.

I see; okay. And just a follow-up to Andrew's question with regard to cost, can you identify any big buckets of cost savings?

It really went across the board. It was just a tighter and more efficient management of everything that we do. If I could point to it, I would. I was obviously pleasantly surprised through the quarter, and also cognizant of the fact that you don't want to cut back on things that are important. So Mark and Karl and I have a fairly steady hand on this to make sure that nothing is being cut that we think is necessary.

One thing that you end up with, particularly in a summer term, is more of your costs are variable. You have an ability to -- because all your classes are essentially taught by adjuncts in the summer, the full-time get the summer off. You do get a slightly higher amount of variable impact that Mark and I did, frankly, miss when we were modeling 3 months ago.

Great. Thanks, guys; turn it over.

Corey Greendale, First Analysis.

Also a question on the cost side. Can you just talk a little bit more about what you attribute the lower bad debt to? And then what you are assuming bad debt does in 2012 in the model you provided?

Bad debt went down, because more people paid their receivables to us and we actually collected more on the previously written off receivables than we had the quarter before. We have felt that bad debt in the 3.5% to 4% range is an acceptable level, given the credit authority that we give our campus Directors and Deans. I don't know exactly what we have modeled, but it is going to be consistent with that.

Okay, and a second question also on the margin. Rob, I think you said you expect operating margin to be down about 500 basis points in Q4. Obviously that would be a less negative result than you just had in Q3. Is that entirely because you are opening 3 campuses versus 4 last quarter? Or what else would you ascribe the lower, the lesser decline to?

No, it is more mathematical. We have less revenue in a summer term, in a Q3, and so the impact -- we have less revenue anyway and more expenses. Because you are spending most of your marketing -- not most, but a greater amount of your marketing dollars for the fall term start. And so, incremental decreases in student revenue has a bigger impact than it does in the fourth quarter. Then also, we are a little bit better on enrollment on a year-over-year basis as well.

Okay. If I could just throw in one more on a totally unrelated topic. Looking through the information on the Strayer University website now for the required gainful employment metric, it talks about, as required, typical debt of graduates. The number I saw for the programs it has posted is in the $31,000 range.

In the past, I think when gainful employment was first discussed, you had talked about typical debt loads in the low $20,000s. Can you just talk about the reason for the differential and what the actual number we should think of is?

Yes, absolutely. The reason for the differential is that the debt information that was required to be posted on November 1, or whenever that was, is calculated in a different way than the median debt level for the debt-to-income rate ratio in the gainful employment regulation. I think it has to do with previous costs or --

Total debt as opposed to the lower of your --

Yes. So it is living expenses and things like that, that gets rolled into that. Whereas the debt-to-income ratio in the gainful employment is the lower of full tuition or total debt so as to basically focus in on what the cost of the actual education is. In that case, I think all of our numbers are in the $20,000 to $25,000 range if I remember correctly.

Great. Thanks, and welcome to Chicago.

Gary Bisbee, Barclays Capital.

I guess I'll continue to beat on this cost thing, because it seemed like such a stark change. I understand that some of the costs are variable and revenue began to decline. But instructional costs -- and I guess I also understand that you are opening fewer campuses than the year before, but you did open a net 10% more campuses and the instructional cost flowed from 15% growth to less than 4%. And at the same time, marketing cost actually declined year-over-year and admissions advisory also declined.

I guess I'm struggling to understand how, when you're adding new campuses at a rate of almost 10% versus the prior year, how those 2 cost items could actually fall slightly and how you could have such a rapid deceleration in the growth rate of instructional costs.

I'm not sure I understand your point on rapid deceleration in -- our instructional costs went up about almost $4 million year-over-year.

Which is, which is 4%.

We had less students. Instructional costs are going to be related to the number of students that you have. The reason it didn't go down even more is that we have more campuses.

How much of that -- I guess maybe asked a different way. How much of that cost should we think of being, on the instructional cost side, being variable in direct proportion to the number of students? I got your point earlier about more adjuncts in the summer so maybe you can flex that more than you could in other terms potentially.

Correct.

But I've always thought you had somewhat higher maybe than some of your peers full-time faculty. And there is some cost obviously for adding the new campuses. Should we think of that as there is just much more ability to flex this quarter than others? Or is there quite a bit of variable cost in that line item when we go forward?

Well, let me try and illuminate the question. Our academic costs consist of our full-time faculty and full-time academic staff, the physical classrooms, the instructional technology for online, and then adjunct professors.

The full-time faculty essentially don't teach in the summer, so there is more flexibility in Q3 to match costs with actual student enrollment. Because as I said earlier, we're building a university for the long term and

we're quite comfortable with the fact that both our physical classrooms and our full-time faculty members will be amortized over a lower number of students if we have a reduction in enrollment. So there's clearly a advantage in Q3.

In Q4, what you end up with is now you have all your full-time faculty back teaching. You've still got all of the fixed costs of your facilities and the instructional technology for the online classrooms. And then, you also have more students. So, it just flows from one to the other.

You're at a level of granularity, Gary, that I'm not sure is frankly helpful. Certainly not the way we look at it. From our standpoint, the one thing that Mark and I probably were a little conservative on in looking at our model 3 months ago was the impact of the full amount of faculty being. Even full-time faculty who teach in the summer are paid at adjunct rates.

Okay. So let me take one more cut at this. In the middle case under the 2012 business plan where you have a mid-single-digit decline in enrollment, presumably somewhat lesser decline in revenue. Would it be reasonable, opening 8 new campuses, to think that instructional and education support costs could actually fall in that scenario? Or would it likely continue to grow based on opening the new campuses and presumably some full-time faculty at those new campuses?

For the full year I think it is unlikely that it would fall. I expect it to go up. In a third quarter it might fall. But for the full year, we tend to think of this on an annual basis as opposed to a quarterly basis.

Okay. Then just one last one on the marketing and admissions advisory, where the cost in dollar terms did fall year-over-year slightly. I realize there's seasonality, but on a year-over-year basis they were both down. I guess that struck me as a little surprising given that you are opening a net 10% new campuses this year.

Is that just these cost efforts you talked to earlier? Can you tell us if there is -- like were there headcount reductions or anything?

No. There's no headcount reduction. I think what's going on there is, number one, we had more new markets last year at this time than we have at this time. And it is less new campuses versus new markets. Then also last year we had a significant amount of costs in developing some new media that we rolled out this year, which we didn't have this time.

Okay. Thanks a lot.

Jeff Silber, BMO Capital Markets.

I just wanted to expand on Gary's question a big. Again, just looking at the mid case of your 2012 business model, it does imply some sizable operating margin contraction. Which other line items do you think that we'll see most of that on?

Instructional and education. We're building more campuses, and if we have zero new student growth, we will be amortizing those campuses and the ones we have and our faculty over less students. I'm not sure you could deep dive any more than Gary's question. I thought we covered that.

I was looking at the other line items, how's that?

Okay.

And also just a clarification. The total student enrollment change, you are talking an average for the entire year, not necessarily the year-end number. Correct?

Yes. There is no year-end number. We do it by quarter so it's the average for the full year is what we report at year-end.

Okay, great. Then there's a couple other number questions. What are your capital spending plans for 2012?

We expect them to be in the range of $25 million to $30 million for 2012.

Okay. Then in terms of the business outlook for the fourth quarter, what tax rate and share count are you assuming?

For the fourth quarter, we are assuming a 39.6% tax rate for Q4. And in terms of share count, I think it is probably safest to use our Q3 diluted share count of 11.650 million.

All right, fantastic. Thanks so much.

Kelly Flynn, Credit Suisse.

A couple similar questions to those that were just asked. For the guidance for the fourth quarter, I guess I was having a little trouble getting to the EPS number. Can you be a little more specific about the revenue per pupil expectation? I guess what growth or decline you would expect year-over-year based on the dynamics you laid out?

I'm not sure I can, Kelly. Mark, do you have anything that you want to add to that?

No, I think it is similar to what you described. We're not expecting to get a lot of incremental revenue per student.

Right.

It grew 0.6% year-over-year I think in the quarter you just reported. So do you think it would be prudent to assume something similar or to assume flat?

I think you should assume 0.575, Kelly.

Okay. (laughter) All right, different question. You probably won't answer this one either, but I will try. For marketing for the fourth quarter, this relates to Gary's question, but I suspect you know the answer. Last quarter -- last year you had a similar marketing spend in the third quarter to what you did this year, so roughly $23 million, and then it declined to about $18 million in the fourth quarter. Should we expect something similar? Your guidance seems to imply actually even lower. So can you maybe help with that?

Our third quarter is always our biggest quarter in terms of marketing spend, because our largest student start is always in the fall. So Karl and his organization takes the annual budget that we give them to spend on marketing and spreads them through the year consistent with when the highest likelihood of students are going to enroll.

So it will go down, I don't know exactly what it is going to go down to. But it is probably similar in scale to last year.

Okay. I guess maybe another way to state that question is, you said you expect a 500 basis point margin decline year-over-year for the fourth quarter, right?

Right.

But your revenue is likely to decline more than it did in the third quarter. Normally I would expect worse negative operating leverage as your revenue growth or -- your revenue decline widens, but you are saying the opposite is going on here. I know that relates to the cost savings.

But can you just help with why that is happening? Where should we assume the savings really show up? I know you said it is across the board, but you pretty much only have marketing and instructional. Where should we put the cost savings?

Let me try it the other way. I think the 500 basis points, most of that is going to come in instructional and education. Isn't that correct, Mark?

Yes, I mean that is the largest line item.

So if you take last year and you take the lion's share of that diminution in margin it's going to be in instructional and educational. You're right, we have more revenue -- we have a higher -- what's the right way to say this? A greater decline, relatively, in the fall than we did in the summer. But you also -- I think it might be helpful to look at it the way we do in that a lot of the incremental margin impact has to do with levels or bands of enrollment.

So you have a certain amount of capacity with the faculty that you have, that are laid out. As you add students above that, you get a very positive impact on operating margin because there's very little additional cost, until you get to a certain level and then you actually incur some additional variable costs. And then the incremental amount of margin declines.

It's the same thing on the downside. As you lose students and as you lose revenue relative to a plan, you have for the first tranche a larger amount of diminution, and then after that every 20 or so students you actually eliminate a class. And so it kind of works its way going down as well.

So it's just -- it's not quite as -- we don't manage it as granularly as you all seem to be asking the question about it. We tend to think about it more along the lines of what is going to take to build this University, what is the appropriate cost structure for that, and then the revenue flows in based on how many students we enroll.

Okay, that makes sense. Thanks so much.

Peter Appert, Piper Jaffray.

I was hoping you could just give us a little bit of color on what you're seeing in terms of competitive dynamic in the marketplace. Do you have a sense from your recruitment advisors that maybe students are looking at more options before they choose to enroll? And just a sense of competitive intensity, whether it is perhaps at a higher level than you have seen historically?

Karl you are closer to the admissions officers.

Sure. I would say we have not seen any real change in terms of the number of other schools that people are looking at. We know that most of our students consider many schools from which to attend. As we said on our last call, and I would say is still the case, we have seen maybe a lengthening in the students' decision cycle about whether or not to attend school. But nothing really in the way of increased competition.

The other thing I would add to that is there is just sort of a prisming effect I've always found on this question in that you all are necessarily focused on an increased number of opportunities for education in the area that you cover. I.e. investor-funded, publicly traded entities. And there was a relatively small number of those and that number has gotten bigger.

That is really not the competitive set that our students are looking at. It is hard for the addition of 1 or 2 of those to actually make that competitive set that much more difficult. Because if you think about the markets that we operate in, they are saturated with traditional universities that have night and extension programs. That doesn't get much bigger or smaller over time, at least it hasn't in the markets that we've operated with. But it has always been quite competitive.

So it's just something that for last 10 years that we have lived with, we have planned around, and that we are comfortable with.

How about specifics in terms of conversion rates or show rates? Can you give us any color on that?

Again, conversion rates for me, it is somewhat of a unhelpful metric. And let me explain why. You can always buy leads.

It's really quite amusing to me the way this discussion has gone over the last year. Where there has clearly been a diminution in demand that has I think probably been caused by the economy. And yet these people who sell leads can always sell you the same number of leads.

And then, if you think about that student as a factor of production in some manufacturing concept, and so therefore the admissions officer has a conversion rate and it goes up or down and that's going to explain or help illuminate the efficiency of the organization, I really don't see it that way. What we have seen is that, as Karl said, over the last year students have had a more difficult time dealing with a number of issues that caused them to either want to enroll or to enroll.

I think the increased unemployment rate at the target band of students that we are looking at clearly has hurt us. Also, the consistency of that over the last 4 years on a compounding basis limits by some -- I don't know -- 10%, 20% the market that was available to us 3 or 4 years ago. But it is not something that from our standpoint we look at in terms of we're going to adjust the conversion rate or shift to adjust the conversion rate.

The real problem with that is I've always felt that if you're having to convince the student to enroll, you have a much less likely successful student. The students who are successful are the ones who have convinced themselves and their conversion rate is going to be 100% unless you really do something bad with them in the process.

Right. Just one last thing, Rob, then. How about time to profitability or time to maturity on new campuses? Is that changing?

Well, it is. On the ones that we have opened in the last 2 years, it will be slower than the ones that we opened 2 years before. But it is actually more analogous to the investment model that we originally used 10 years ago, which is about 2 years. Some of the campuses that we opened in '06, '07, '08 frankly reached profitability in a couple quarters.

But again, we tend to look at this across broad averages and it affects our decision as a return on capital as opposed to an IRR. So that the speed of it, while it has a big impact on short-term profitability, does not affect our decision very much in terms of how many we do.

And that you are attributing again more to the macro environment as opposed to some evolution in competitive dynamic in these newer markets?

Well, yes. Because we have opened additional campuses in existing markets in the last 2 years that have also slowed. Also, if you look at our existing campuses in those markets, they are not enrolling students as fast in the last 12 months than they did the previous 24 months before that.

Got it. Thanks, Rob.

Peter Wahlstrom, Morningstar.

As you do look to open the 8 campuses this year, could you help us think about the marketing strategy and how you go to market in a new market versus an existing market? Particularly given some of the general softness that we have seen.

I know this kind of an a tack-on to some of the other questions that have already been asked, but maybe do you become a little bit more aggressive in terms of how you are marketing the institution?

We really don't. We've got a set play-book which has worked quite well for us. In the early couple of terms, it's really just name identification. We are obviously trying to piggyback on any institutional or corporate alliances that we have that happen to be in the new market. Quite often we will have existing online students in a brand-new market and they are a key early beachhead for us in terms of communicating.

But we spend about the same amount, adjusted for cost of media, in each of our markets in the first, say, 4 quarters. Then our marketing team tends to adjust based on what they've learned, what they've seen, which channels tend to be most effective in brand building. But we are really quite patient.

We feel that the best way to build the University is to just get a handful of students that first term and do a great job with them and have them talk about it. That is going to drive the kinds of success that we have seen over time. Whether we get 30 students are 60 students that first term, we are not going to spend dollars differently to try and make 30 60. It is not, in my judgment, the right way to build a University for the long term.

Very good. Then with the decision to implement the 3% tuition increase, could you talk a little bit more about what you think you'd need to see in order to -- from maybe from a macro perspective, to get back to a 5% target tuition increase? And maybe how tuition changes at the traditional colleges and universities has impacted your decision?

I think traditional colleges and universities have much more than 3% this year. We are always cognizant of that. But honestly we try and think of it from the standpoint of what we are providing and what our students need.

Honestly there was less analytics that went into this than I would like to be able to portray. We went a full year with significantly less new students than we had the year before. And that has never happened to us.

We are operating in a social and political environment now where I think everybody realizes that the country's going through a pretty tough patch. And it is particularly tough for the students in our target market.

Our costs are increasing. I do believe that we have pricing power because I think education is increasing in importance over time. But when we weighed all that together, Mark and I decided that this would be the year in which rather than stick with the straight 5% we would ratchet that down and then we will see what happens.

Very good. And one final last one. As you look into the 2012 business model, what do you have in terms of assumptions for corporate partners? Are you concerned that given the economic outlook is relatively fuzzy, are you finding it more difficult to convert some of those corporate and institutional partners? What is the outlook there?

No, as Karl mentioned, that has really been the strength over the last year and that's starting to be a bigger part of our overall student population. I think it speaks to the fact that for the individual student making a decision, there is an approbation that comes from your employer saying this is a place that we like. So it helps deal with some of the other insecurities or uncertainties that a student goes through in what is making such an important decision.

We always budget based on recent trends or current conditions. And that is one of the reasons Mark and I are budgeting for very little revenue per student growth. Because we expect that that is going to continue into next year.

Very good. Thank you.

Suzanne Stein, Morgan Stanley.

It's Thomas Allen filling in for Suzi. Can you help us think about your liquidity a little more? How low are you willing to go in cash? And then on the other side, how high would you go up on leverage?

And then in terms of dividends versus share buybacks, would you ever consider cutting the dividend if the stock price is at a level where you would be buying back stock as a more attractive use of capital?

Let me take that in reverse order. The answer to the last question is yes. Your dividend and share buyback decision always has to be affected by the view of the price of the stock and the value of the stock.

On the other hand, for the last 7 years, we have felt that our model, even with slightly shrinking revenue, is very cash-generative. And since when you are buying back shares, all you're really doing is providing an in-kind dividend to the shareholders who stay, because they own more of the Company at that point, we are really taking their decision away.

So some portion of that excess cash we felt it makes sense to allow the shareholder themselves to make that decision. That would also weigh into a decision based on whatever the stock price was, as to whether to pay a dividend or buy back shares.

And then in terms of liquidity, we obviously need a certain amount of cash on hand to run the University. We have generally kept more cash than that, significantly more than that on hand, because it helps you with a number of regulatory and educational entity views of you as an institution. And then further, on the regulatory side, you're obviously further constrained beyond what a normal debt-to-equity ratio would be in a different type of company based on the financial composite score requirements of the Department of Education.

Okay, thanks. And then you have had a full year with starts down over 15%. And I know you don't what to give any one-quarter guidance, but was there anything that happened a year ago that you maybe anniversaried this past quarter that could see starts get easier this next quarter or going forward?

Well, there was a lot that happened a year ago. And by the nature of the calendar you do anniversary that. I tend not to think about comparisons getting easier or harder. It is a raw number of students that you bring in based on the size of the University that you are building. But you are correct to point out that there was an awful lot that happened last fall in terms of regulatory and media coverage of institutions of our type.

And you have an extended period of economic downturn, all of which has had an impact over the last year and at this point, we are anniversarying that.

And just to confirm, you never paid incentive comp, so you don't think that really had an impact right?

No. We have never paid any incentive compensation to admissions officers. It has always been straight salary, so there's nothing to anniversary there. There is no Company management changes that are anniversarying. That is accurate.

Okay. Great. Thanks for answering my questions.

Sara Gubins, Merrill Lynch.

Can you talk about use of scholarships? I'm sorry if I missed that if you talked about it already.

Rob Silberman. Sure. Go ahead, Karl.

We have always used scholarships, just as we use various tuition discounts for our corporate and institutional alliance partners. That is something that we have done for quite some time.

Okay. That is not increasing much at the moment?

Only as much as the corporate and institutional partners are increasing. And some of those have built-in tuitions and scholarships. So if they get to be a bigger portion of our total student population, there's an incremental increase in that.

Okay. Thank you.

Brandon Dobell, William Blair.

A couple quick ones. Leveraging on Peter's questions around conversion rates, maybe from a different perspective, I would imagine you guys track application flow and then actual enrollments. You get people showing up in classes. Any change the past couple of quarters in terms of how that algorithm has looked for you?

You mean what percentage of the students who actually apply enroll?

Correct.

I think we have just had less applications, so the percentage has been about the same. Is that right Karl?

Yes, yes.

All right, fair enough. Then it sounds like you spent a little bit of time thinking about the right pricing structure for the coming year. Was there any discussion about either not raising price or lowering price or maybe offering bigger discounts to the corporate or alliance channel?

Yes.

Well, if it didn't happen, then what was the reasoning behind not going that direction if, to get to your point, Rob, we are in a pretty deep prolonged recession? What is the reasoning behind not making maybe a bigger move to make the program more affordable?

Because we think that this is the right price, that it fairly balances the value that is being created and the cost to create it with the value that the student and graduate receives. And that is what we came up with.

All right, fair enough. Then final one for me. Looking at the growth from new locations, which was actually pretty solid, I guess especially considering the year-on-year comparison of schools added is relatively flat. Are the schools -- and I don't think they are -- but are the schools ramping at a different pace than the ones you opened last year for example? Or are they still both for 2010 and '11, still well off the pace of ramping schools back in '07 and '08? I'm just trying to get at the underlying cause for the low 20s growth in the new campuses.

You will remember, Brandon, back in '07 and '08, those numbers were like 100%. So they are clearly lower than '07 and '08.

The impact -- diminution of demand or whatever you want to describe it -- has been pretty uniform across both the new and the mature markets. The difference is, the mature markets we're growing -- we were surprised and delighted they were growing at mid-single digits. We have always expected them to be flat.

So they came down quite a bit, and then the newer markets, some of them were doubling in size, from small numbers obviously, but on a quarter-to-quarter basis. Now they're down in the 20% to 50% range. So really it is consistent across both classes that it's slower now than it was 2 years ago.

All right, fair enough. Thanks a lot.

(Operator Instructions) Trace Urdan, Wunderlich.

My question, I'd like to take you back to Peter Appert's question, Rob. It has certainly always been the case that you have competed with traditional universities' night school programs. But there seems to be a greater availability and interest and level of marketing by traditional schools in an online environment. So I'm wondering if you see that as something new and potentially threatening from a competitive standpoint.

We certainly don't see it as new, mainly because where we have come from. I mean our heritage is here in the Washington, DC, area and the University of Maryland has always had the strongest working adult-focused extension university, if you will, of any traditional. About the same time that I took over here, they were rolling out very significant advances in online.

Over the last 10 years, every year there is the new traditional university who has got the new online application. It clearly increases the amount of available educational opportunities to prospective students. I don't see it as increasing it significantly above what was there already. So that's, from my judgment, what allows us to say that from our standpoint we don't see that as a major competitive impact.

The other thing, as I have said in the past, everybody's student enrollment has been going down. Some are still growing slightly versus tripling in size. Others -- and I think a lot of that depends on the attitude and the marketing focus of the particular institution. Others that were growing at some stable rate have shrunk and some have shrunk a lot more.

It is hard for me to suggest that anything that is happening with regard to our enrollment is more affected by competitive dynamics, except inasmuch as when you have less demand the players that are involved have a larger impact. There is less of a margin for error. But I don't think it is the traditional universities rolling out online programs that is actually the dispositive fact there.

Okay, thanks, Rob.

I'm not showing any further questions. I'd like to turn the conference back over to Rob for closing comments.

Thank you, Shawn. I appreciate everybody's participation and we'll look forward to talking to you again in February. Thank you.

Thank you ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.