Strategic Education Inc (STRA) 2012 Q2 法說會逐字稿

Good morning, everyone and welcome to Strayer Education Incorporated's second quarter 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, Miss Sonya Udler. Miss 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 PM Eastern through Thursday, August 2. The replay is available at 855-859-2056, conference ID 39822252.

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 10K 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 it 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.

I am going to ask Mark to report on our second quarter financial results and ask Karl to comment on our second quarter operational results including our enrollment statistics for the summer academic term. Finally I would like to provide an update on our growth strategy, our business model and our earnings outlook for the third quarter of 2012.

Strayer Education is an education service company whose primary asset is Strayer University, a 50,000 student, 100 campus post-secondary education institution founded in 1892 which offers bachelors, masters and associates degree 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 Four loans issued to our students.

Our expenses at Strayer Education include the cost of our professors, our admissions and administrative staff, marketing expansions, and facilities and supplies costs. We serve students in 23 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. Now Mark, will you run them through the financials?

Sure. Revenues for the three months ended June 30, 2012, decreased 11% to $146.3 million compared to $163.8 million for the same period in 2011 principally due to lower enrollment. Income from operations was $36.2 million compared to $50.1 million for the same period in 2011, a decrease of 28%. Operating income margin was 24.7% compared to 30.6% for the same period in 2011. Net income was $21.2 million compared to $29.6 million for the same period in 2011, a decrease of 28%. Diluted earnings per share was $1.85 compared to $2.53 for the same period in 2011, a decrease of 27%.

Diluted weighted average shares outstanding decreased 2% to 11,483,000 from 11,737,000 for the same period in 2011. Revenues for the six months ended June 30, 2012, decreased 12% to $295.8 million compared to $335.7 million for the same period in 2011, principally due to lower average enrollment. Income from operations was $77 million compared to $109.4 million for the same period in 2011, a decrease of 30%. Operating income margin was 26% compared to 32.6% for the same period in 2011. Net income was $45.2 million compared to $65.4 million for the same period in 2011, a decrease of 31%.

Diluted earnings per share was $3.94 compared to $5.34 for the same period in 2011, a decrease of 26%. Diluted weighted average shares outstanding decreased 6% to 11,480,000 from 12,263,000 for the same period in 2011. At June 30, 2012, the Company had cash and cash equivalents of $48.7 million. The Company generated $42.7 million from operating activities in the first six months of 2012 compared to $87.4 million during the same period in 2011. Capital expenditures were $9.9 million for the six months ended June 30, 2012, compared to $18.1 million for the same period in 2011.

During the six months ended June 30, 2012, the Company paid regular quarterly dividends of $23.7 million or $1 per share for each of the quarterly dividends. At June 30, 2012, the Company had $85 million outstanding under its term loan facility and $15 million outstanding under its revolving credit facility. The $15 million was subsequently repaid earlier this month leaving us $100 million available under this revolving credit facility.

For the second quarter 2012, bad debt expense as a percentage of revenues was 4.4% compared to 4.1% for the same period in 2011. Days sales outstanding was 15 days at the end of the second quarter of 2012 compared to 12 days at the end of the second quarter of 2011. Rob?

Thanks, Mark. Karl?

Total enrollment for the summer academic term was 44,236 students which is a decrease of 7% versus the prior year. Our continuing student enrollment decreased 11% and our continuation rate decreased approximately 150 basis points. The decline in our continuation rate is due to small variations in graduations, drops and our academic failure rate. Our newer student enrollment increased 9%. Enrollment at mature campuses decreased 12% while our new campuses grew 31%. Global online students increased 8%.

We also announced today the opening of two new campuses in the Chicago market, bringing the total number of campuses in that market to four. These two campuses along with our two Minneapolis campuses comprise four of the previously announced eight for 2012. We expect the remaining four campuses to open in the latter half of the year. Lastly in terms of student mix, total graduate students now represent 33% of all students and undergraduate students comprise 67% of students with business and accounting representing roughly two-thirds of that population. Rob?

Thanks, Karl. As Mark reported, our Q2 financials were right on our forecast so I don't believe any additional comments are necessary there. However, did I want to briefly update our 2012 business model, will which Mark and I had put out last October. When Mark and I presented that model, we announced that our Board of Trustees had set only a 3% tuition increase for Strayer University for 2012, versus our historical 5%.

But more importantly, we reported then that based on the student mix shift we were experiencing towards more graduate and corporate sponsored students, as well as selected use of targeted scholarships, we didn't expect to realize any of that tuition increase and indeed forecast that our revenue per student would be flat to slightly down in 2012.

With our first and second quarters now in the books, and with visibility into our summer term enrollment, we can now more specifically forecast that our revenue per student will be down about 1% to 2% for 2012. That lower revenue per student will flow through our business model and cause slightly lower revenue and earnings for each of the indicated enrollment ranges in the model we had provided.

The other point that I wanted to make with regard to that is that we tried in that model to give you all a look as to the effect of new student enrollment growth on our total student enrollment growth, mainly to point out that given the short fall in new students in 2011 which would flow through our university system throughout 2012, that increases in new students would not necessarily translate into increase in total students right away. The thing that we've seen now to date is as Karl mentioned we have slightly lower continuation rates but more importantly, our new student growth in 2012 is geared towards the back half of the year.

We were actually down 8% on new students I believe, is that right, Karl, 8% for the winter term? And I think the better way to think about that as Mark and have I looked at it is that the entering argument for that model for new students should be really on a weighted average.

New students at the beginning of the year have more of an impact than they have later in the year because of the impact that they have on continuation rate. And so I suspect that with -- assuming for the sake of argument that you that you had new student growth that was mid single digits in the fall term, or even consistent with what we had in the last two terms, say 9% or 10%, you're going to be at an average of new student growth that's probably somewhere around 5%, 0% to 5%, but you're still going to be at total student enrollment which is going to be down closer to 7% to 9% towards the low end of that model. And that's the timing, seasonality, of when the new students came in.

Turning to a brief update on our growth 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. Second, invest our human and financial capital in opening new campuses. Particularly in new states and markets. Third, continue to build our online offerings. Fourth, increase our corporate and institutional alliances.

And the 5th and final objective is to effectively redeploy our owner's capital. Karl's already covered the update on our first four objectives. On capital redeployment we announced this morning our regular quarterly dividend of $1 per share. On our earnings outlook for the third quarter of 2012 based on the announced 7% decrease in Strayer University's enrollment for the summer term and most importantly increased expenses associated with again the back loaded calendar of our new campus openings in 2012, relative to the previous year, we expect earnings per share of $0.30 to $0.32 in the third quarter with operating margin in the 5% to 6% range for the quarter.

And with that, then, we would be pleased to answer any questions.

(Operator Instructions). Our first question comes from the line of Jeff [Bolsteen] from JPMorgan. Your line is open. Please go ahead..

Good morning, thank you for taking my question. Could you give us a little more color on the performance of these new campuses as far as students and the associated investments and not only the four that are open now but also the ones that have been opened over the last 12 months or so.

Sure. Well, the four that were opened for 2012, we have very few students in right now. They're actually the two downtown -- or the downtown and the Aurora won't even take students until the fall. Minneapolis we've got I think a handful of students. Those were open for the spring term. And then there will be four more that we open during the fall term which will probably not take students prior to the winter term of 2013. The four campuses that we opened in 2011 are running I would say at or slightly below our notional model. It's a little variable by geography. The couple of our Texas campuses I think are probably doing a little bit better and some of the north central or upper Midwest campuses are a little bit worse. And actually going back to the 2010 openings which we've done, again you're -- for a while we were running quite a bit above that notional model. We were adding on average 140, 150 students per year. With the downturn in new students that we experienced in 2011, the campuses that opened in that -- during that time frame, that cohort of campuses were much closer to the notional model and we'll watch that over the next year or so to see what their break even point is. But I would expect that the 2011 campuses would be breaking even towards the end of this year or early 2013.

(Inaudible - technical difficulty) investments that go into these campuses, are they generally on target or are they changing compared to the last couple of years?

No, they're precisely where they've been over time. That's sort of a set model for us. If you open the campus at the beginning of the year, there's about a $1.5 million or so of expense and then if you open them towards the back end of the year, it's obviously less in that current year. Not a lot less actually because there's a lot of pre-opening expenses. But you certainly have a higher operating income loss because you have less revenue.

Thank you very much.

You bet you.

Thank you. And our next question comes from the line of Gary Bisbee Barclay's. Your line is open. Please go ahead.

Hi, guys, good morning.

Good morning, Gary.

I guess, Rob, I asked you a couple quarters go about the debt covenants and in light of the third quarter guidance, I guess I'll ask it again. It looks to me like you're going to fall somewhat short of the $60 million two quarter EBITDA covenant and could fall short of the liquidity covenant depending on how that's defined. How are you thinking about that?

We're obviously going to maintain compliance with all our covenants. I don't see any issue at all with regard to liquidity compliance because that's -- the revolver itself is part of the liquidity. And our debt -- the trailing EBITDA covenant we'll take a look at as we get closer to it.

I mean, can't you say anything more than that? By your guidance, what the EBITDA should be, it looks to me like you fall short of it. Is that something you're talking to the bank or anything else you can say?

I think that's wrong, Gary. By our guidance, we won't fall short of it.

Okay. All right. I'll take another look at that. How about can you give any color on the mature campus enrollment trends? Obviously we can see it from the data you reported but how are those trending? A quarter ago you talked about some stability in bachelors, and is that still going on? Are you likely to see any improvement there in the mature campus, or mature geographies I should say specifically?

I would say in the last quarter call the mature campuses have -- they've certainly come down from where they were in 2010. And the upturn in growth on new students, we certainly have seen some of that in the mature markets as well although it's been geared I would say more heavily towards the graduate students. We continue to -- we have benefits in our mature markets in that those are the markets in which we tend to have the most and the longest standing corporate alliances and those programs have actually done quite well. And so it continues to be the unaffiliated, no transfer credit bachelor student that I think has been most -- demand has been most diminished by the economic circumstances and that's certainly the case in our mature markets as well.

Okay. And then just one last one. Can you give any color on exactly how the scholarship activity has changed or what's driving the change in that revenue per enrollment? I think the mix shift is certainly part of it but it seems like you must be doing a lot more there? Are you seeing -- I guess maybe the bigger question is are you seeing any retention benefit from those scholarships such that the lifetime value would be similar or do you think it's sort of a loss at the end of the student's term of stay from a revenue and a profit perspective? Thank you.

Yes, you bet, Gary. We wouldn't do it if we didn't think that it was an increase in lifetime value per student. Not the least of which is, these scholarships are geared towards those students who we think are going to academically perform the best. So if you put aside, focus, if you will, on -- even on a midterm sort of revenue per student or financial value per student over its lifetime, and think about the institution as a whole, we've constantly run this enterprise with the view that the most sustainable and best increase in value for our owners is increases in the performance of Strayer University academically. And so we clearly -- that's a driving force for us as we look at these -- putting these scholarships in place. I do think as a matter of fact that -- as an ancillary benefit that the financial value per student over the lifetime is improved or increased based on what we expect to be higher continuation rates, because students who perform better academically continue at a higher rate. It's as simple as that. The other thing though is that as we described last quarter, we've always had scholarships and we actually eliminated some scholarships and some other types of marketing benefits in 2012 as we put these in place. So the net effect is nowhere near as large as the impact of the mix shift towards students that tend to generate less revenue per student, i.e graduates and corporate alliance students.

Thank you.

You bet, Gary.

Thank you. And our next question comes from the line of Peter Appert from Piper Jaffrey. Your line is open. Please go ahead. Peter Appert: Thanks. So Rob, I was hoping you might able to give us some incremental color on cost dynamics here in the third quarter, even more broadly in the back half of the year. Are there any issues around timing or specific spending decisions you're making that might account for the pretty significant margin contraction you're anticipating beyond just the deleveraging associated with slower revenue growth?

Sure. Peter, first off, that deleveraging is always most apparent in our summer term because we have lower revenue anyway, less students as our students take the -- some of them take the summer off. But the simplest and largest impact is we have essentially got the full cost associated with eight brand new campuses in the back half of the year. And so that's probably a good $10 million to $12 million of expense that we didn't have in the first half of the year.

I guess the bigger question might be just in terms as you think about -- and we've discussed this in the past I think -- but as you think about the longer term margin implications and the changes in the market dynamic, can you give us any thoughts in terms of what the appropriate level of margin is for the business going forward?

I honestly don't really think about it that way, Peter, because it is a high margin business if it's done properly and you're getting good academic outcomes. We have always believed that. It's certainly going to be affected by your rate of capital expansion because new units are -- they lose operating income for a couple of years. But if you think about it in a purely steady state, i.e we've completed our nationwide expansion. We're not -- and you just think about that part of our business because your might be doing other things at that point that would affect the overall corporate margins. But at that point, obviously the margins will go up. And probably the biggest single impact on where they go up to relative to where they were, when we took over, when we started the nationwide expansion, is that I do think that at least over the midterm that the public policy implications of the cost of education are quite apparent right now. And that the idea that you're going to have significant increases in tuition revenue per student compounding on an ongoing basis, it's not part of our plan right now. We're thinking about building this university and assuming that you're not going to get much revenue per student increase over that time frame. And so that will obviously diminish margins and frankly by about, if you were thinking that it was -- previously it was 5% a year, and you're not going to get that 5% a year, it's not going to come down not by that full amount because there's some things you can do on the cost side as well, but it has a dilatory impact. Or deleterious impact.

Got if. Thank you.

Our next question comes from the line of Sara Gubins from Bank of America. Your line is open. Please go ahead.

Hi, thank you. On recent calls you've been giving us some detail about growth in new students coming via the national accounts and relationships with community colleges. Could you update us on that this past quarter or in the summer term?

Yes, Karl can. The one that sort of stuck out to me was the Central Intelligence Agency.

Yes, just in terms of national accounts, we had 11% growth in new students in our national account. I believe there were six new agreements in the quarter overall. And on community colleges, we added four articulation agreements in the quarter, bringing our total now to 200.

And the growth in new students from what are referred to as unaffiliated students, I think that had turned slightly positive if I remember correctly last term. Can you tell us how that did this past term?

It was up sort of mid single digits.

Great. Okay. And then just last, you mentioned weakness in the continuation rate and gave a couple of reasons why. Could you go into some more detail on that?

Yes, I mean I think clearly you've got some economic distress. We certainly focus group our students who had left, had dis-enrolled and we did hear quite a bit of that. We had a slightly higher drop rate in the quarter. And the students who drop are unlikely -- who didn't finish the current quarter are unlikely to sign up for the next quarter. And then we've got a smattering of academic policies that we're constantly updating and we were a little tighter on a couple of those and we put those in place at the beginning of the quarter. But Sara, we do that all the time and there's a variability to that, that is extant always, so I wouldn't put too much in that. I do think that the economic distress hurts us and it's hurt us in new students and it's hurt us in those students particularly that have academic difficulty, it makes it more difficult to continue to make that commitment. But it was up slightly the quarter before. Down slightly this quarter. There's variability and variation to that and so far I'm comfortable it's within the normal range of variability.

Thank you.

You bet.

Thank you. Our next question comes from the line of Suzanne Stein from Morgan Stanley. Your line is open. Please go ahead.

Hi, thank you. I just want to follow up on the question of expenses in the back half of the year, particularly in Q3 and I understand in that Q3 is kind of a high number for marketing. But has it changed sort of seasonally this year? Will that number accelerate to try to generate enrollment growth? Or how should we think about that? Because I guess I'm just having trouble sort of getting to the guidance number without really boosting some of these numbers up.

Let me make it simpler for you, Suzie. On the revenue side, we're going to have about 3,500 less students. Which is about roughly $10 million of less revenue than we had the year before. And then you're probably going to have another $ million less of revenue associated with lower revenue per student and we have about $6 million more of expenses. Almost all of that $6 million is associated with the additional campuses. It's actually higher than $6 million but it's offset by some lower variable costs. We don't really think about our marketing spend as a direct means of generating larger amounts of enrollment right off the bat. We have a strategy to build brand over time in markets and that marketing line is going to be most affected by the fact that we've probably got four or five new markets in the quarter based on our campus expansion strategy. But the whole idea behind the model is you're spending a modest and relatively fixed amount of brand building advertising in those markets. You don't get very many students to start with because they don't know you very well and then over time, you get a few and as those students do well and they talk and you've got a few corporate alliances and things like that, it tends to build slowly and then there's not additional costs for those markets except for the variable costs of educating those students. So that's what generates the guidance, if you will, and it's -- we try to make it as straight forward as possible.

Okay. Very helpful. Just one more question. Just given sort of your cash position and the outlook for the second half of the year, what are your thoughts going forward in terms of your dividend policy?

Well, we will a take a look at that in the third quarter. We always do with our board. And our view is even in these diminished financial conditions, we are a still a very profitable business, generate excess free cash and mine and the board's responsibility is to determine each year what's the most value-enhancing way to redeploy that cash. We always want to put as much of it as we can back in the business in high value, high return investments but given the constraints, the practical constraints on growth if you're trying to generate or produce a first-rate academic product, we've always had more cash than we could invest. So we'll look at that and figure out given our view of conditions outside, things that we don't control, tax policy, things of that nature. What we feel is an appropriate balance of returning capital to owners either through share repurchases or dividends.

Okay. And just quickly, the $15 million draw-down, was that just compliance with financial responsibility temporarily?

No, it was just we used the revolver to match our cash position when we need it. So it was just a normal draw of cash. It's payroll.

It's what we use to manage the working capital, yes.

Okay. All right. Got it. Great, thank you.

You bet.

Thank you. Our next question comes from the line of Corey Greendale from First Analysis. Your line is open. Please go ahead. Corey Greendale: Hi, good morning.

Hi, Corey. We made your list, huh?

When stocks act certain ways it can change plans.

Yes, okay. Fair enough.

A couple questions. So first of all, maybe not much to this but ordinarily in your press releases you give a sense of where your new campus openings are going to be for the following term and you didn't do that this time. So I was just wondering if there's more uncertainty about regulatory approvals or why you didn't do that.

I think we've already announced it. We already said it's Kansas City, St. Louis, San Antonio and Houston.

Oh, okay, sorry if I missed that. And secondly on the revenue per student, given that you still are seeing one would imagine will continue to see better growth among graduate students and the institutional alliances than it did in the broader markets, I mean is it fair -- I guess the question is when does this bottom effect continues? It was down 2% now, could it be down in the back half of the year 3%?

No, the update to the forecast I gave was intended to give you our visibility into the back half of the year. So the 1% to 2% includes a continuation of the current trend to our Q4, our fall term enrollment. As to the future, first off, I don't know that graduate students will grow at a faster rate indefinitely. They haven't always done that. I think that the current economic conditions are creating a situation where you have very high levels of unemployment, much higher than normal and particularly among students -- among individuals who don't have a college degree. And so those obviously affect our undergraduate enrollments. And the most important point about that is the sense that it's not a counter cyclical business. I've never felt that. I've never suggested that. It's too much of a financial and time commitment for a working adult to really effectively address themselves if they're unemployed. So as long as you've got very high levels of unemployment among individuals without a college degree, I think our undergraduate -- particularly our unaffiliated undergraduate students will be affected by that. I have a lot of confidence in the American economy over time. Notwithstanding -- without regard to the political leadership. So I wouldn't say that's a permanent condition. And we're building this asset for a very long period of time. So I would expect that at some point that rate of growth among graduates and undergraduates would revert back to a more equal or normal but as to when, I don't have any idea.

Okay. Maybe I'll ask it in a broader way. The question I think is on a lot of people's minds about the sector generally which is there seems to be more use of scholarships and I understand you change that all the time and you've done it in the past. Do you think generally that students are more price sensitive in a meaningful way and that we're going to see more significant erosion in tuition prices via scholarships or some other vehicle?

Well, our students are always somewhat price sensitive. So I wouldn't suggest that that's not the case. I think that in general, the cost of education has clearly been highlighted as something which has increased significantly and so has generated a lot of public policy attention which makes it a more topical and more real subject. And that's a stakeholder venue that we have to be concerned about as well as the individual students. And then you've got a very severe economic downturn. I mean there's just no other way to describe that. And particularly among the types of students that we're trying to attract, who by definition have been undereducated. That's why they're coming back to school.

So I do think that pricing is much more of an issue over the next ten years than it was over the previous ten years. The use of scholarships in many cases as I said, really its primary purpose -- because you could take those same dollars, it's really just a discounted tuition. You could take them, leave tuition where it is, use more marketing if you thought that was a way in which you could affect shaping the student class that you wanted or there's a variety of ways in which you can take that capital and use it to generate your student population in the way that you want to do that. And so I can't really speak for other management teams, but it's a tool for us which has been effective in the past and we would expect to continue to use it.

Okay. Thank you.

You bet.

Thank you. Our next question comes from the line of Jerry Silber from BMO Capital. Your line is open. Please go ahead.

Thanks so much. It's Jeff Silber, close enough. I know you're not talking about next year yet but given everything that's going on, I'm just wondering, are you potentially rethinking in terms of your new campus opening strategy, either changes in the number or maybe locations, maybe staying a little bit closer to home so maybe you don't have to invest as much in marketing going forward? Thanks.

Well, the staying closer to home, I assume by that you mean putting more of your new campuses in existing markets?

Or close to, yes.

Because we have markets now that are quite a way the away from Washington D.C, where we have a lot of brand recognition. And but no, actually, having clarified that, the answer to that is no. We haven't really started our look at next year yet. And we'll be doing that over the next couple of months. But in general, we'll take a look at what's the best use of our owners' capital. We continue to believe that opening new campuses, building a nationwide university is a very, very high return use of our owners' capital. We have done 100 campuses over the last ten years or I guess 88 since we inherited 12. We've slowed down in the last two years based on a sense of regulatory and legislative uncertainty. A lot of that again will clarify itself over the next couple of months. And we'll take all that into account. So we really don't -- we don't update at this point because we really haven't done all the thinking.

Okay. That's fair enough. In terms of capital spending plans for this year, if I remember correctly you had guided somewhere in the range of $25 million to $30 million. Is that still accurate for this year?

Yes, Jeff, we'll probably be at the lower end of that range but it's still accurate.

Okay. Great. Thanks so much.

Thank you, Jeff. Thank you. Our next question comes from the line of Jerry Herman from Stifel Nicolaus. Your line is open. Please go ahead.

I'll be Jeff Herman, just to switch it up. Good morning, guys. I just want to get clarification on this RPS situation and just to be clear, Rob, you indicated that that 1% to 2% decline is predominantly mix as opposed to scholarship, is that correct?

Yes. Well, the overall -- you've got a 3% tuition increase. And so on a net basis, you're really down 4% or 5% after the tuition increase. And that is predominantly mix shift both towards graduate students that have lower revenue per student and corporate alliance partners who are growing at a significant rate and that for which there is a 5% to 10%, in some cases a little bit higher than 10% discount.

And what are the current course loads, graduate versus undergraduate?

I think the average course load for an under -- well, average becomes sort of meaningless. Undergraduates tend to take two and graduates take one and the price differential [Karl] on a class it's, like, $1,700 versus $2,200 or something like that? So you get two times $1,700 versus one times $2,200.

And then on the scholarship side, you guys imply that there are targeted scholarships yet when you look at the website, it really doesn't look like they're targeted. It looks like they're basically available to anybody that applies.

Well, that has those conditions, that has either transfer credits or other things that we're trying to facilitate.

And the reason I ask that question is the notion that there's this large bubble of students on scholarship matriculating through the system, what prevents RPS from declining into the forward quarters and years?

Well, we'll manage the process. Nothing prevents it beyond our own decisions. On a steady state, RPS will decline if we continue to have a mix shift towards graduate students and corporate alliance students or the other way to say that is if our unaffiliated students continue to stay flat or shrink slightly. But the scholarship decision and the tuition, the setting of tuition levels is something which is under our control. Tuition levels are set by the board of trustees. But the amount of scholarships that we offer essentially becomes -- it's a contra-revenue item, and is something that we decide.

And just one last quick one. You helped with the updating of the outlook based on what you said, it looks like the scenario most likely to happen is scenario one, revenue declines of high single digits? And margin in the low 20%, very low 20% range?

Let me put it this way. If we performed in the -- if our fall term enrollment was exactly analogous to our summer term enrollment, that is correct.

Great. Thanks, guys.

You bet, Jerry.

Thank you. Our next question comes from the line of Jeff Meuler from Baird. Your line is open. Please go ahead.

Yes, thank you. Just wanted to ask a follow-up on that last question. Based on the -9% student enrollment, if that scenario would unfold, should we haircut that $570 million revenue number by 1% to 2% and then have that I guess $5.7 million to $11.4 million drop straight down in terms of a decline in operating income as well relative to the prior notional model? Given the change if RPS expectations?

I understand the question. It's a little bit blunt but it's directionally accurate.

Okay. And then Rob, how did you think about the, I guess underlying expense base inflation net of efficiency gains just given your updated commentary on pricing expectations? Just do you think that it's 1% or 2% underlying increases or you talked about being able to do some gaining productivity to offset some of that. How do you think about that?

Well, I mean most of our expenses are human capital. And we've got a lot of first rate faculty and staff and they're going to get a salary increase next year. So there's some increase there. We have to use technology effectively. We have to constantly look for ways to lower non-human costs. And that's an ongoing exercise. Whether your revenue is going up or down, it's something that you ought to be focused on. And then the other really important thing with regard to 2013 is you have an annualization of cost. In other words, the new investments that we put in place in 2012, the eight new campuses, and then we added some personnel as well, the Jack Welch Management Institute. We've got a few things going on in the corporate headquarters. Those are added during the year. Those anniversary the next year. So you've got some inherent increase in costs that are based on that. You've got an increase in salary at some level. And then you've got -- you have to look at everything else and think about productivity and scale and make the adjustments that are most efficient for providing the type of academics that you want to provide.

Okay. And I guess as you look over a three to five-year period of time and assume constant mix, do you think that the tuition ex-scholarships, increase will be an in excess of this underlying rate of inflation?

I don't know the answer to that, Jeff, that's a little early. I would say in the near term, that it's incumbent upon all of us in education to focus on how you lower the cost of education to the student which is a tuition issue. And we're going to spend a lot of time thinking about that and figuring out how to be both proactive and hopefully leaders in that area. Now a lot of that, you hope can be offset with cost but you take a look at it. You still have to run a university. And again, we expect this asset to be around for another hundred years so we're not going to do anything that threatens its viability or its value over that time frame abruptly. So that will all go into the mix.

Fair enough. Thanks, Rob.

You bet.

Thank you. Our next question, comes from the line of Brandon Dobell from William Blair. Your line is open. Please go ahead.

Good morning, guys.

How are you?

Good, not too bad. Quick question on scholarships I guess. The uptake from potential students, or interest from potential students, has it been in line with your expectations and I guess to a certain extent are the local school presidents and school employees pushing back on more the students given what could be lower transfer credits or not being as qualified as you would like them to be? Or is it the opposite where you're finding a lot more students picking this up so the utility or the usage of it is above expectations?

First off, we only have one university president.

I meant school director, sorry.

The campus directors, and I would say that the use of the scholarships have been consistent with what we would have hoped. What has occurred over that same time frame is that we continue to be quite limited in our no transfer credit unaffiliated types of students who are enrolling at the bachelors level. So as a mix, it's probably a little bit higher than we might have anticipated. But we really didn't think too much about that to be honest. Ultimately, I forget somebody else's question, where does it stop? The answer is, it depends on what happens to these other types of students. And over time, my expectation is education is still a very valuable, very necessary asset to have for an individual. Even -- I mean the kind of sad irony is even more so in a down economy. Because it's the differentiator between very high levels of unemployment and still high but significantly lower. The problem is that the access to it, the availability -- the ability for an individual to commit themselves both financially and from a time standpoint just is below what people can do given the stress that they're under. And so I would say that the general mix, the usage has been about what we expected and that the individuals who don't qualify for it have done slightly worse than we would have hoped but better than last year and no longer declining. It's certainly not at the rate it was in 2011.

Okay. And then early this week one of your peers, Capella, talked about the rising popularity or at least their broadening profile or course catalog, of certificate programs, post baccalaureate certificate programs for students who are not quite sure about a masters degree, want something more, want a more specialized skill but aren't ready to commit to a two or three-year educational program. Have you guys thought about those kind of shorter term certificate programs in light of let's call it consumer price sensitivity but also the need for a little more upscaling in some of your students?

We do have some post graduate certificate programs but frankly our growth in graduate students has been very healthy. That's not really been where the issue is. I think our graduate school and the programs that it offers are fairly well situated right now and we're pleased with that.

All right. Final one for me, any -- in the last several quarters, any change in the matriculation of bachelor students into graduate programs within Strayer University?

I don't know the answer to that. Do you know that, Karl?

There's been no real change in terms of the rate year-over-year.

So the percentage of undergraduate graduates who then go into the --

It's about flat.

Right. Okay. Great. Thank you.

Thank you, Brandon.

Thank you. Our next question comes from the name of Trace Urdan from Wells Fargo Securities. Your line is open, please go ahead.

Hi, good morning, guys.

Good morning, Trace

I didn't really want to be the guy to ask this question but I fall here in the queue so I'm going to. Rob, we had the opportunity to see some more detail on the gainful employment data recently and I know that the issue of gainful employment is not germane the way that it was. But the data -- we had additional data, right, so it confirmed that your graduates make a good living and those numbers seem to be quite strong but there was still a range between the different program offerings and repayment and I wondered if you had any other observations based on having looked at that data. Did it tell you anything about your business? Do you think that there's still issues with the data? Can you speak to that?

Sure. I mean, we were pleased with the confirmation of what we had determined by survey, our own alumni surveys on the debt to income. But it was somewhat of a relief to see that the process of extracting that data from the social security administration confirmed the very extensive surveys we did. So that part we were pleased with. On the repayment rate, I don't really have any additional insight because again we were not provided with the underlying student records. And I think that's always been one of the frustrations that I've had with regard to repayment rate calculation because you've taken an additional test beyond the cohort default rate which is absolutely measurable and it confirmed by student record. There's a whole process for doing that.

And then frankly just pulling from the NSLDF and the department's data system, you can tell exactly which students that you have either in forbearance and deferment. If you grant the department a reasonable concern, a public policy concern as to a large number of deferments or forbearances. Again, that's identifiable. You can add those numbers to your cohort default rate and know exactly where you are. Introducing this new sort of vague concept of reduction of $1 in principle and in a manner in which we have no way of confirming whether students are up-to-date on their loans and meeting the terms of their loans has always been a real frustration for me. We communicated that to the department. They did what they wanted to do. And then now you've got a federal court saying that that particular test is arbitrary and capricious. I guess you're back to square one. I think there's certainly been some salutary impact of the whole regulatory process because I think in general all institutions are more focused on academic student outcomes, which a good thing, and we'll just have to see what the department does in terms of going back to address the district court's concerns on the repayment rate. And then I'll have a better answer for you, Trace. At this point, we really have nothing more than what you have and our attempts to get more underlying data that explains by program the variations in repayment rate relative to our cohort default rate and the rate at which if you add in forbearance and deferment have been unsuccessful so far.

Fair enough. And then just this one question. Are you guys anticipating any kind of variance related to advertising spending in the fourth quarter relative to the elections?

Not particularly. I mean we've known there's going to be an election for a long time. So I'm sure Karl's team has put that into their thinking.

Okay. Great. Thank you.

Thank you, Trace.

Thank you. Our next question comes from the line of Brian Karimzad from Goldman Sachs. Your line is open, please go ahead.

Hi, good morning. Just to help understand a little bit more on why the corporate alliance impact on revenue per student surprised you a bit versus your initial plan. Was there a change in the mix of what came in say on new agreements versus existing or the source of the students? And then I have a follow-up.

I wouldn't say that we were surprised. We've had more students who have enrolled through our corporate alliances relative to students who didn't. And we're quite comfortable, Brian, with variability in our student mix and in our revenue lines. I mean it's a profitable business and we don't try and forecast it down to a gnat's eyelash. And so I think surprise is the wrong term. What we try and do is when we have additional clarifying data we try and share it with you all as soon as we get it.

Okay. And then just generally among your working student population, I don't know if you have this granularity, but do you have a sense of what percentage of them are employed by government institutions or private sector firms that you kind of classify as fairly dependent on the government as contractors?

I mean we certainly know how many work for directly for the government. And if you add in active duty military, what do you think that, Karl, 5%, 7%?

Yes, sounds about right.

That's gone down over time as we've moved outside of the Washington, D.C. area. But we have a number of federal government agencies that are direct partners with us. In terms of contractors who are dependent on the government, that I really don't have a good view for. It's obviously we would be more significant in the D.C. area than elsewhere but I don't have any data on that.

Okay. Thank you.

You bet.

You bet. Thank you. Our next question comes from the line of Kelly Flynn from Credit Suisse. Your line is open. Please go ahead.

Thanks. Got in under the wire here. Hi. I've got a couple of quick ones. Just going back to a question someone else asked, I just want to kind of simplify. On the business model update you gave, you didn't give the EPS update associated with kind of the revenue update. What is the EPS range associated now with that high end -- high single-digit enrollment decline if you could give that?

Well, if you extrapolate out, 1% of revenue is what, $6 million, Mark?

Yes.

Because I think we had $600 and some million last year. Every dollar of operating income is about $0.04 or $0.05 of EPS.

So it's basically the low end of the scenario minus about a nickel?

I think if it would minus -- it we were at $5 million or $6 million below the low end, and a point of operating margin, it would be more than a nickel.

Sorry, I misstated that. I understand what you are talking about. Just a couple of other quick ones. This model, I think the business model does imply that the fourth quarter margin should improve significantly versus the third quarter. Am I correct in inferring that that margin based or your model should be at least mid teens? Operating?

Yes, absolutely, Kelly. Our operating margins are always much lower in the summer term because we essentially have all of our fixed costs but we have a lot less students.

Okay. Got it. And then Jack Welsh, can you tell us how many starts and enrollments that had for the quarter?

I mean the whole institution now is a couple of hundred students.

Oh, okay, only a couple hundred. Okay. I think I'm good then. Thanks a lot. I appreciate it.

You bet, Kelly.

Thank you. And that does conclude our question and answer period. And I would like to turn the conference back over to Mr. Rob Silberman for any closing remarks.

Thanks, Ben. Thanks everybody for listening. We'll look forward to talking to you again in November.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of the day.