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ITT Educational Services (NYSE:ESI)

Q4 2012 Earnings Call

January 24, 2013 11:00 am ET

Executives

Kevin M. Modany - Chairman and Chief Executive Officer

Daniel M. Fitzpatrick - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Kelly A. Flynn - Crédit Suisse AG, Research Division

Sara Gubins - BofA Merrill Lynch, Research Division

James Samford - Citigroup Inc, Research Division

Gary E. Bisbee - Barclays Capital, Research Division

Jerry R. Herman - Stifel, Nicolaus & Co., Inc., Research Division

Peter P. Appert - Piper Jaffray Companies, Research Division

Jeffrey Lee - Wells Fargo Securities, LLC, Research Division

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Corey Greendale - First Analysis Securities Corporation, Research Division

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

Paul Ginocchio - Deutsche Bank AG, Research Division

Operator

Greetings, ladies and gentlemen, and welcome to the ITT Educational Services 2012 Fourth Quarter and Full Year Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

Joining us today from the management of ITT Educational Services, we have Kevin Modany, Chief Executive Officer and Chairman; and Dan Fitzpatrick, Executive Vice President and Chief Financial Officer.

Before we begin, ITT Educational Services, Inc. wishes to remind you that this conference call may include forward-looking information. Actual results may differ from the information presented during this call. For additional information, please review the section on forward-looking information contained in today's news releases or in the company's public filings with the Securities and Exchange Commission.

Thank you. Mr. Modany, you may begin

Kevin M. Modany

Thank you. Good morning, ladies and gentlemen, and thank you for joining us on our conference call to review our 2012 fourth quarter results. On the call with me this morning, as usual, is our Executive Vice President and Chief Financial Officer, Dan Fitzpatrick. In our prepared comments today, we plan to discuss the key focus areas of the organization. At the conclusion of our prepared remarks, we will open up the lines for your questions. We will attempt to be efficient with our remarks so as to provide ample time for your questions during the Q&A session.

With that said, we will begin by reviewing a few of the organizational's -- organization's current areas of focus. Protecting and enhancing our student value proposition and effectively communicating it to prospective students is a key focus area of our organization. We believe that this is especially important today given the current state of the postsecondary education environment. Our internal research suggests that prospective students are more sensitive of the cost of postsecondary education and are making educational decisions based on their perceived opportunity to derive value from their educational investment.

Our analysis of our prospective student behaviors led us to conclude that sensitivity to price and value are more prevalent today than in any time in our recent history. We believe this is a positive development that creates an opportunity for us to highlight the value of our career-based education offerings in disciplines where job growth is projected to exceed the national average. Specifically, we believe we are well positioned with our technology and health care-related programs for the career-changer demographic.

We further believe that our 40-plus-year history of focusing on student outcomes, coupled with our national network of technology and health care-related employers, makes us an attractive choice for students interested in obtaining an education to pursue entry-level careers in these growing fields. With more than 80% of our current students pursuing an associate's degree, we also believe that we are well positioned to offer the appropriate credential to this career-changer demographic.

The value of an associate's degree in today's employment market is demonstrated in a January 4, 2013, report by the U.S. Bureau of Labor Statistics. This report states that the average unemployment rate for individuals 25 years or older with an associate's degree is 5.5% or 260 basis points less than the average 8.1% unemployment rate for individuals whose highest educational credential is a high school diploma.

We continue to believe that we have the right programmatic focus and are appropriately incorporating employer needs into our curriculum. If we continue to focus on student outcomes and employer needs, we believe that our students can realize a good value on their investment in an education at ITT Technical Institute. That said, while we believe we have the right programs, we also think that we can improve the way in which we market our programs.

By highlighting to prospective students the attributes of our programs that we believe are paramount in their decision-making process, including cost and value, we think that we can improve our student enrollment trend. With that in mind, in the 2012 fourth quarter, in an effort to address prospective student sensitivity to the cost and value of a postsecondary education, we introduced the opportunity scholarship at 24 of our resident campuses that I will refer to as the pilot group.

The opportunity scholarship is an institutional scholarship intended to help reduce the cost of an ITT Technical Institute education and to increase access to our high-quality, career-based technology and health care-related programs of study. We should note that the pilot group only began offering the opportunity scholarship in the last 4 weeks of the recruitment period for the academic quarter that began in December 2012, so we have a limited amount of data to analyze to determine the effectiveness of the scholarship.

However, based on our review of this small data set, the rate at which prospective students who applied for admissions converted to new student enrollments in the academic quarter that began in December 2012 was 250 basis points higher for the pilot group compared to the non-pilot group. Further, new student enrollment for the pilot group declined 6.3% year-over-year in the 2012 fourth quarter compared to a 12.7% year-over-year decline for the non-pilot group.

I want to, once again, remind everyone that we have a limited amount of data with respect to the impact of the opportunity scholarship on our new student enrollments. As such, we want to be cautious not to come to any conclusions about the effectiveness of the opportunity scholarship in assisting our efforts to improve the conversion rate of prospective students to new student enrollments. However, the preliminary results, thus far, are positive and heading in the right direction.

Based on the pilot group results in the first quarter of 2013, we began offering the opportunity scholarship at an additional 101 campuses for the academic period that begins in March 2013. Additionally, we hope to begin offering the opportunity scholarship at the remaining campuses before the end of 2013. We will continue to monitor the impact of the opportunity scholarship and our enhanced communications regarding the student value proposition to our prospective students, and we will report on our progress with this key initiative in future conference calls with the investment community.

Taking into consideration the changes that we are implementing and the projected impact of those changes on our student enrollment, our internal goal for new student enrollment for the full year 2013 is in the range of a 5% decrease to a 5% increase compared to the full year 2012. This internal new student enrollment goal is reflected in the $3.50 to $4 range of internal EPS goal for 2013.

In addition to working to increase our student value proposition through the opportunity scholarship and improving our communication of that value proposition during our recruiting, the organization is focused on increasing the efficiency of our operation and improving our student services. Our intent is to reduce the cost of our operations in a way that provides more effective student services and results in better students experience and more attractive candidates for employers who hire our graduates.

In our October 2012 conference call, we said that our goal was to reduce our annual operating expenses by approximately $50 million through various operational efficiency initiatives. Based on the actions that we took through the end of the fourth quarter of 2012, which are not reflected in our 2012 operating results, we believe that we are well on our way towards achieving, and quite possibly, exceeding that savings target for the full year 2013.

Some of our efforts that we believe will help us realize those savings include increasing the use of technology to support and enhance our student services, rebalancing our advertising expenditures and optimizing the use of our facilities. While improving the value proposition and containing costs are at the top of our list of priorities, so too is our desire to reduce our students' reliance on private loans to help finance their cost of education.

As we noted on our October 2012 conference call, we believe that with the introduction of the opportunity scholarship, our students' need for private student loans could be significantly reduced. The preliminary information that we have gathered in the fourth quarter of 2012 from the experience of our opportunity scholarship pilot group has confirmed our belief that our students' needs for private loans has been drastically reduced, if not eliminated, in most cases at the pilot group campuses.

As a result of the information we gathered from the pilot group, combined with the first quarter 2013 expansion of the number of campuses offering the opportunity scholarship, we believe that the vast majority of our students will no longer require private student loans to help finance the cost of their education at ITT Technical Institute, and we, therefore, discontinued efforts to secure additional private student loan programs for our students to access. We view this as a very positive development for our students and one that further positions us as an institution of choice for individuals looking to pursue a career-based education in technology and/or health care-related fields.

We're also directing our efforts towards another key objective, which is to manage our obligations under the 2007, 2009 and PEAKS risk share agreements that we entered into in connection with the private student loan programs made available to our students. As was previously reported on December 28, 2012, we agreed to pay Sallie Mae $46 million to resolve all of our guaranty obligations under the related RSA that we entered into in 2007.

The total principal amount of the private education loans made under the 2007 RSA, net of refunds, was approximately $180 million. As such, the $46 million settlement amount represents approximately 25.6% of the net amount of the private education loans made under the 2007 RSA. To be clear, we did not make any other payments to Sallie Mae or take any discounts on the loan proceeds with respect to the 2007 RSA.

As a result of the settlement, all of the company's guaranty obligations associated with the 2007 RSA have been eliminated. We are pleased to have the litigation and contingent liability related to the 2007 RSA resolved. We will now focus our energies towards managing the contingent liabilities associated with our 2 remaining risk share agreements: the one we entered into in 2009 and the PEAKS Program.

As a reminder, let's talk briefly about each of these 2 remaining RSA. Under the 2009 RSA, we guaranteed the repayment of principal amounts, including capitalized origination fees and accrued interest payable on any private education loans originated under the program that are charged off above a certain percentage based on the annual dollar volume. The total initial principal amount of loans made under that private student loan program was approximately $141 million. The current agreement stipulates that our obligations under the 2009 RSA will remain in effect until all private student loans made under that loan program are paid in full or charged off.

Under the PEAKS Program, we guaranteed payment of the principal and interest owed on the PEAKS senior debt, the administrative fees and expenses of the PEAKS trust and the required ratio of assets the PEAKS trust to outstanding PEAKS senior debt. Our guaranty obligations under the PEAKS Program remain in effect until the PEAKS senior debt and the PEAKS trust fees and expenses are paid in full. The outstanding principal balance of the PEAKS senior debt is approximately $260 million.

And lastly, before I turn it over to Dan, I'd like to provide the current macro snapshot of the cash flow to date with respect to the 3 RSA programs, as well as the projected impact on the net cash flows resulting from future projected RSA guaranty obligations. To recap, the total proceeds from the 3 RSA programs were approximately $600 million. Through the end of 2012, we had paid approximately $15 million in RSA-related guaranty obligations. We expect to pay the $46 million Sallie Mae settlement before the end of January 2013.

We are currently projecting approximately $80 million of future RSA guaranty payments. This is represented by the contingent liability reserved at December 31, 2012, of approximately $78 million, net of the Sallie Mae settlement. Thus, our current projected net total proceeds from the 3 RSA programs is approximately $460 million or approximately 77% of the original gross proceeds of approximately $600 million.

At this point, I'd like to turn the call over to Dan, who will provide additional color on the charges related to the private student loan programs that were recorded in the fourth quarter of 2012. Dan?

Daniel M. Fitzpatrick

Thanks, Kevin. At the end of each reporting period, we assess whether we should record a contingent liability related to our guaranties under the RSAs and if so, in what amount. We received additional information in the fourth quarter of 2012 from the servicer of the private student loan portfolios associated with the 2009 RSA and the PEAKS Program that aided our most recent assessment of our contingent liabilities related to those RSA guaranty obligations.

This information provided greater clarity on the loan repayment status of a group of borrowers whose loans were previously in forbearance. Also affecting our contingent liability assessment was an additional cohort of borrowers, who were in repayment for a period greater than 30 days, which is past the date when the first loan payment is due, during the 3 months that ended December 31, 2012. Lastly, we also received preliminary results from the enhanced servicing activities associated with the RSA loan portfolios.

This information -- from this information, we determined that the repayment performance for these loans were significantly worse than we previously estimated, and as a result, the assessment of our contingent liabilities associated with the 2009 RSA and the PEAKS Program increased substantially. The contingent liability reserve of approximately $78 million as of December 31, 2012, projects an approximate 60% default rate on the combined loan portfolios associated with the 2009 RSA and the PEAKS Program.

We believe that this default rate projection is almost 2x the historical default rate experienced in private loans made to our students. We believe that the material increase in the rate of default is primarily due to the loan servicing disruptions and the poor economy during 2007 to 2010, when the majority of the loans were originated. Our analysis, regarding the effects of the poor economy on the performance of the private loans originated under the 2009 RSA and the PEAKS Program was supported by our review of publicly available data released by some of the largest private loans student servicers to the loan servicers, including Sallie Mae and First Marblehead. Each of these servicers have reported spikes in default rates of private student loans originated in 2007 through 2010, which suggests to us that the increased default rates on private student loans is more correlated to the economic disruption during this period than to any one institution or class of borrowers.

And lastly, with regard to the RSA programs, the December 31, 2012, contingent liability reserve of approximately $78 million, net of the Sallie Mae settlement, represents our current estimate of all future obligations related to the 2009 RSA and PEAKS Program. This estimate was based upon all of the available information that we have to date with respect to the loans made under these programs incurring the -- including the current default trend, which we believe is almost twice the historical default rate of our private loans made to our students and the analysis and the input from several third-party experts that we retain, including consumer lending specialists. And to be clear, while we cannot assure you that our actual RSA-related obligations will not differ from this estimate, we believe that the estimate is the best projection of our total future guaranty obligations related to the 2009 RSA and PEAKS Program.

At this point, I'd like to talk about our financial goals for 2013. As was reported in our earnings release this morning, our internal financial goals for 2013 are: revenue per student, 2013 versus 2012, in the range of down 6% to down 4%; EBITDA in the range of $165 million to $190 million; earnings per share in the range of $3.50 to $4. As of December 31, 2012, we had approximately $430 million in cash, cash equivalents and available borrowings. We expect to pay the 2007 RSA settlement of $46 million by the end of this month. We believe that the payments associated with our guaranty obligations related to the 2009 RSA and PEAKS Program will be in the range of $15 million to $20 million in 2013. We should note that the terms of the 2009 RSA and PEAKS Program contemplate long repayment scenarios that permit us to spread any future obligations over the next 7 to 10 years.

Turning now to a discussion of available borrowings. The term of our current $325 million line of credit lines runs through March 2015. At this time, based upon our current operating and financial projections, we do not believe that we will violate any covenants under the line of credit or any regulatory financial metrics.

Before I turn it over to Kevin, I'd like to provide a quick update on our default management efforts related to our federal cohort default rates. In February 2013, the Department of Education is expected to release the preliminary 2-year and 3-year cohort rates for the 2011 and 2010 federal fiscal years. Based upon our review of the related information in our possession, we believe that the consolidated 2-year CDR for the 2011 federal fiscal year will be approximately 15% and the consolidated 3-year CDR for the 2010 fiscal year will be approximately 28%. These rates compare to the 2-year CDR for the 2010 federal fiscal year of 16.4% and the 3-year CDR for the 2009 federal fiscal year of 33.6%. As such, we are pleased with the results of our default management efforts thus far, and we believe that our federal cohort default rates are trending in a positive direction.

Lastly, I will be happy to entertain any questions you might have regarding any of the financial metrics in our press release this morning that we did not touch upon in the prepared remarks. With that, I'll turn the call back over to Kevin.

Kevin M. Modany

Thanks, Dan. Before we open up the lines for your questions, I'd like to briefly touch on a governance matter. We are very pleased to welcome back Tom Morgan to our Board of Directors. Tom previously served as an ITT Educational Services, Inc. Director from May 2006 to June 2008. Tom stepped down from the board when he assumed the role of Chairman and Chief Executive Officer at the Baker & Taylor. Baker & Taylor is a distributor of books, entertainment products and value-added services to libraries, institutions and retailers.

Tom was elected to serve on the ITT Educational Services, Inc. Board of Directors on January 21, 2013, and will also serve on the audit committee of the Board of Directors. Once again, we are very pleased to welcome Tom back to the board.

At this point, we have concluded our prepared remarks. And I'd like to ask the operator to open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Jeff Meuler of Baird.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

First, I just wanted to ask about the 2013 starts guidance, as well as what you saw in terms of the pilot program. I guess just the variance between the minus 6.3% in Q4 and the 12.7% outside of the pilot group seems pretty significant considering that you only had it in place for 4 weeks. So I guess, first, I just wanted to confirm that, that pilot group, the trends entering Q4 were similar to what they were at the other campuses, and then anything that you could say that would maybe make it a little bit more clear about how having that pilot in place for only 4 weeks drove that magnitude of difference.

Kevin M. Modany

Sure, Jeff. Yes, I think in terms of the pilot group, it was a fairly representative sample of our overall population. So I would say, looking at that directionally in terms of the 250-basis-point improvement, I think that's accurate and appropriate, and we set up the test group in that manner. And yes, we're cautiously optimistic about it. Again, 4 weeks worth of recruitment activity in the field at those 24 schools drove a nice result. Again, we want to be cautious. It's a small set of data. It's a small complement of data. But we -- we're optimistic about it, and we like, again, the preliminary information that we have obtained thus far. And that led to the rollout at the other campuses, so we have another 101 schools that are now onboard recruiting for our March intake -- our March 2013 intake. Early results on that are also favorable. Again, limited data set but we are seeing the trending that we would like to see as a result of this change. And I think the folks in the field are embracing the communication of the value proposition to our students. So again, very early, limited data, but all is going as planned and we're pleased thus far.

Operator

The next question comes from Kelly Flynn of Crédit Suisse.

Kelly A. Flynn - Crédit Suisse AG, Research Division

Thank you for providing all that color on the RSAs. I just had a follow-up question on that topic. I think, Kevin, you talked about the $260 million in principal related to PEAKS. But you also, I think, talked about other potential -- other fees and factors that could increase the liability. So I just want to understand what's the total potential liability on PEAKS? I don't think it's the principal amount. So what is it?

Kevin M. Modany

Well, we haven't disclosed kind of the projections going forward. I assume what you're talking about, Kelly, is just kind of accrued interest on the notes and any of the charges and whatnot of the trust and expenses there. We haven't really kind of run off the model, if you will. But trying to give investors a kind of snapshot view of what those senior notes are at this particular point in time and the balance as of 12/31, being 200 -- well, actually, today's balance, not 12/31. Today's balance is roughly $260 million.

Operator

The next question comes from Sara Gubins of Bank of America Merrill Lynch.

Sara Gubins - BofA Merrill Lynch, Research Division

Two questions. The first is there are a lot of moving parts impacting revenue per student. Can you talk through what's included in there? And in particular, I'm wondering if you're assuming the rollout of the scholarships across the company. And then second, could you help us think about your conversion of net income to cash flow from operations in 2013, areas that you're expecting might be similar or different to 2012? Just trying to get to your cash flow from ops expectations.

Daniel M. Fitzpatrick

Sure. As far as the expect -- and I think what you're asking as far as revenue per student looking forward. The guidance really is based upon the ultimate timing of rolling out of the opportunity scholarship. As Kevin mentioned, right now, we're in basically 120-some schools. But then you've got the reenters and so forth, so the rollout for the remaining part of the year, there's a little bit of an uncertainty, if you will, relative to the ultimate timing. So that's why you have a range there. And ultimately, two, don't forget we're coming off a higher revenue per student this past year that had to do with rolling off the new programs. And the second question I think had to do with cash flows relative to net income next year. The one real variable we'll have is the timing of risk share payments next year. As we've already guided, you're looking at somewhere between $50 million and $60 million of -- or no, $60 million and $70 million, I'm doing the math right there, as far as payments next year. That would be the only real significant variance relative to cash flow from operations next year versus this year.

Kevin M. Modany

And just to clarify those payments on the RSA, that does include that Sallie Mae settlement. So we've got about $46 million in payments for the Sallie Mae settlement, and then non-Sallie Mae settlement is about $15 million to $20 million. So I think that will help you reconcile when you look at kind of that net income range to cash flow from operations, not looking for any other kind of material changes in working capital per se over and above trends. So I think that will get you there. If not, feel free to call Dan. He'll walk you through it after the call. But those are the principal differences between the 2.

Operator

The next question comes from James Samford of Citigroup.

James Samford - Citigroup Inc, Research Division

Just wondering from a -- on the future payments, I think you said 7 to 10 years of potential future payments on the RSAs. Is that -- so are we talking about $10 million to $15 million essentially of potential cash payments for those RSAs?

Daniel M. Fitzpatrick

Yes, thanks for that question. I'll provide a little bit of clarity there. We don't have exact clarity on this, but if you kind of run it out over the next couple of years, it's not an exact straight line. The 2013 obligation, we're projecting around $15 million to $20 million. The very, very early estimate on 2014 is probably somewhere in the $30 million range, and that appears to be the high watermark. Then, it goes down from there, and you wouldn't be materially off if you kind of straight-lined the remaining portion from there out. We're somewhere between 7 and 10 years, so it'll give you probably the best color we can at this point on the cash obligations relative to that estimated liability.

Operator

The next question comes from Gary Bisbee of Barclays.

Gary E. Bisbee - Barclays Capital, Research Division

You said, Dan, I think that the contingent liability assumes a 60% default rate or you've seen that thus far. Can you help us just think how impactful it is if that number changes? I mean, if the 60% goes to 65%, is there like a rule of thumb we could use, every 5% incremental is x amount of incremental cost or any color to help us think about how that could change in the future?

Kevin M. Modany

Gary, this is Kevin. Let me just talk a little about the 60%. Obviously, that is a substantial number and well off any kind of historical trends. So I think we don't have any rose-colored glasses on here and we disclosed that today to give you that particular sense, quite frankly. In terms of kind of modeling the scenarios plus and minus, we're not at a point where we kind of want to disclose that, but I can tell you that, that is reflective of the current trends. We don't -- we're seeing some improvement in trends, and that may be hard to understand, given the fact that we're estimating this as high as 60% default rate. But we factored that in to what we're seeing going forward and exclusive of that, we're just taking what the actual is and assuming things play out where it is. And that kind of lands us in a probable range of estimates in terms of the obligations. We do think there's a lot that could be done here. I think most importantly, we're trying to lobby on behalf of the student borrowers for some borrower modifications. These aren't our programs. I mean, these are third-party programs. We don't service them. We're not in control of the servicing. But we lobby on behalf of the borrowers, and we're getting some receptivity to some borrower modifications that could help a lot. Right now, there isn't a lot of that in these programs. So if we get that, we're cautiously optimistic there might be some upside improvement. But again, we're not quantifying that yet. But just to give you more color again, we've kind of estimated this at the probable level based on current defaults and just kind of running those out and just again, not putting on any rose-colored glasses relative to where it lands. And as you can see, we took a big charge as a result. The focus here is to try to get a fence around this thing and see how much we can put it behind us.

Operator

The next question comes from Jerry Herman of Stifel, Nicolaus.

Jerry R. Herman - Stifel, Nicolaus & Co., Inc., Research Division

Just some questions on the regulatory ratio, let's call them. What does the scholarship program do to your 90/10? And then, you did indicate that you expect it to comply with the financial regulatory metrics. But do you expect dialogue with the department based on the interpretation of the balance sheet, let's say, as the department seems to be interpreting charges and other adjustments with some of the other players?

Daniel M. Fitzpatrick

Well, first off. As far as the scholarship impact on 90/10, 90/10 is a cash ratio, so really that should not have much of an impact. And our projection this year, we're going to be somewhere right around 80% as far as that measure, and we don't see that changing going forward. We don't see any of external financial sources changing with respect to that, so that really shouldn't have much of an impact. As far as dialogue with the Department of Education, as far as financial metrics, we don't anticipate any of that. In fact, when you think about our composite score this year, we expect it to be well above 1.5, and we expect it to improve going forward, too. So there's not any concerns that I would expect to see from the department.

Kevin M. Modany

Jerry, this is Kevin. I'll just add, really nothing unusual about these charges per se, in the sense that they're included in operating expenses at this point. So from a -- the department's perspective and interpretation of the financial statements, these charges are included in the operating expenses and reflected in any of the calculations of the financial metrics. They flow through. They impact them. But even after impact of these charges, we're still well in compliance with all of the regulatory metrics and specifically, the financial metrics.

Operator

The next question comes from Peter Appert of Piper Jaffray.

Peter P. Appert - Piper Jaffray Companies, Research Division

So a lot of moving parts in the financial model, so I have a couple of questions. One is I'm just wondering if you have a longer-term view, over the next several years, what you think sort of the financial models should evolve to for ESI in terms of the level of enrollment growth you'd feel comfortable getting back to and the level of margin you think might be sustainable for the business. And then second question, maybe for Dan, just in terms of capital allocation, just any thoughts of buybacks or are buybacks a reasonable possibility on the near term basis, or do the other cash uses take priority? And then any thoughts on new campuses in 2013?

Kevin M. Modany

Sure. Let me see if I can maybe hit 1 or 2 of those, and we'll bounce around here between Dan and I. We're going to hesitate to really give a much longer-term view of the financial model beyond what we've given for 2013. I will add a little bit of color in that clearly, at this particular point as we see enrollment increases, as we sort of work our way through kind of this transition period that we've been in over the last couple of years, readjusting the value proposition, with the opportunity scholarship going out and kind of hoping to see some improvements on the conversion, we still have strong demand. So hopefully, this new messaging and communication will help us convert that strong demand. With incremental enrollment, we see a substantial, and I can't emphasize that enough, fall-through of any incremental revenue at this point in the model. So if we're able to generate some enrollment growth, we're seeing the vast, vast, vast majority of those incremental revenues fall to the bottom line. So we think there's improvement and opportunities for improvements in margin, all of course predicated on what happens on the enrollment side. And I understand everybody gets that and everybody is aware of that. But we're very well positioned at this point, if we see a transition in the enrollment trends, to see that model change and improve and margins expand. But again, I'm going to stop short of quantifying any of that at this point. Just because we're not going to go out beyond 2013 in terms of enrollment trends and/or margin of the model. As far as capital allocation, let me just touch on that. No plans at this particular point for repurchases. No plans for 2013 new campuses at this point. We're pretty much -- we've got those on hold. They would have been at the back end of the year regardless, but I don't see us adding new campuses at this point for 2013. And I think we'll do a good job managing our CapEx, in terms of managing it probably below that 3% of revenue that has historically been the number. We're probably looking at 2% or even below 2% going forward on the CapEx side. We'll maintain facilities and whatnot, but I think we're going to be able to manage that fairly effectively as well. And then I think did you ask about programmatic...

Peter P. Appert - Piper Jaffray Companies, Research Division

No, just as far as expansion.

Kevin M. Modany

Yes, we will use capital to expand programmatically, so that's one of the focus areas for us. And part of what I mentioned when I talked about optimization of the network, a way to do that, of course, is to put more product or programs through our network, and we are formulating plans of that front and expect to have some new program roll-outs in 2013, and hopefully, that will aid on the enrollment side as well. Long answer but hopefully we touched on a few of the things you talked of.

Operator

The next question comes from Jeff Lee of Wells Fargo.

Jeffrey Lee - Wells Fargo Securities, LLC, Research Division

Are the lower price points and new financial aid scripts part of the changes that you made in opportunity scholarship pilot groups? And then, if so, how much of an impact do you believe those changes made versus the opportunity scholarship?

Kevin M. Modany

I'm sorry, could you ask that again? I missed the first part of it.

Jeffrey Lee - Wells Fargo Securities, LLC, Research Division

Sure. You talked about lower price points and new financial aid scripts last quarter. Are those part of the changes that you've made at the opportunity scholarship pilot groups? And if so, how much of an impact do you believe the new scripts among the enrollment counts and lower price points have made?

Kevin M. Modany

Well, it's all sort of part of the same initiative. So we've rolled off the scholarship, and when we talk about the new financial aid scripts, if you will, if you want to use that term, I would say our communication campaign is better emphasizing the value proposition, providing more clarity and transparency towards cost and also the components of financing, which include the opportunity scholarship. So somebody gets a very clear picture of the net cost of the total programs. So we've communicated these things in the past but really not in a very concentrated effort and probably not as proactively as we are today because it wasn't, in years past, a principal variable in the decision-making. It was a variable, but it wasn't as important. Today, you don't get over the first hurdle if we don't discuss these metrics. So we kind of move them forward, we clarified them, we provided some additional language around the value propositions, so people are clear on that. And certainly, I think it's an impactful part of what we're seeing here. I can't quantify it. I don't have any data to segregate the impact, positive impact on some of the trends that we talked about and the difference between just the change in the scholarship level and the net cost versus the activities of the financial aid professionals out there. But again, it's all part of the same program, and I think all of it is having a positive impact, again, based on the limited data that we've collected thus far.

Operator

The next question comes from Brandon Dobell of William Blair.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

I want to focus on the new enrollment guidance for '13. Maybe some levels of confidence around those different numbers. And is there particular things that you have identified that would be more likely to push it towards one end of that spectrum or another? And also wanted to touch on the SG&A for a second. Is that fourth quarter number a decent run rate for how we should think about going forward or is there some things in that result that were kind of onetime-ish or nonrecurring, I guess?

Kevin M. Modany

Sure. In terms of the enrollment, again, we're -- we'll be cautious not to sort of refine our estimates anymore than we already have. But we're seeing positive trending and principally, I think, driven by some of the things we've done on the communications front and the opportunity scholarship front. So just current trending heading into the March intake, again, positive results there, seeing things improving. We look at our full year, we look at the comps, we look at our planned advertising spend and the response rates we're getting there, what our historical conversions have been, what they could be if we see positive impact from opportunity scholarship expand over a larger set of data over a larger period of time. And we're feeling good about our opportunity to transition out of the last couple of years of downward trends. But again, to give more clarity than that, we're going to hesitate. Maybe, Brandon, as we get more data on this opportunity scholarship when we get into the March start, that will obviously give us a little more clarity. Maybe we can narrow that band. But right now, we're going to hesitate to do that.

Daniel M. Fitzpatrick

Brandon, as far as the SS&A, yes, I would say that you would expect to see that trend continuing. But I would caution you just a little bit. There is some seasonality to that line. If you go back and look historically, you'll see that sometimes the costs are lower in the fourth quarter than they are in the other quarters of the year. But Kevin mentioned earlier, too, that the cost reductions we've put into play, we'll see more of those next year rolling out. So when you think it on an annual basis, you definitely would expect to see that line moving down.

Operator

The next question comes from Corey Greendale of First Analysis.

Corey Greendale - First Analysis Securities Corporation, Research Division

Actually, a related question, if -- on the guidance, if you take kind of the top line numbers you're talking about, I would have expected a higher bottom line number. So I just want to clarify, was there any of the $50 million savings already in Q4? Is that all still to come? And could you possibly give us just a little bit more in terms of what is assumed on total enrollment, bad debt and marketing expense within the 2013 guidance?

Kevin M. Modany

We could touch on a couple of the variables. Again, we don't want to narrow the enrollment guidance or goals any more than we already have. Bad debt for the year probably somewhere in the 4% to 6% range, maybe a little towards the higher end of that range than not. Advertising expenditures probably up about 10%, in that range, although we've got some opportunities there, as I mentioned in the prepared comments. And we're focused on a little bit of rebalancing there that may give us a little bit of upside. But right now, the model would suggest about a 10% increase in advertising expenditures. So we can kind of give you some clarity on that. In the fourth quarter, not a lot of the savings initiatives that we've been talking about showed up in the fourth quarter. There wasn't a significant amount there, probably some drips and drabs, but nothing material. And I think you see that reflected in the cost, if you look at them on a year-over-year basis. One point I can clarify in Q4, we actually had -- our advertising expenditures in Q4 were down pretty substantially, down 25%. So that's a big savings area that we saw in Q4. And once you kind of adjust the expenditure rate in Q4 for that particular variable, I think it gives you a better picture that we really haven't seen a lot of these savings initiatives play themselves out in Q4. But we're optimistic that we're extremely well positioned for that to play itself out throughout 2013.

Operator

The next question comes from Jeff Volshteyn of JP Morgan.

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

Just to clarify, Dan, how much more will you be putting on the balance sheet as far as tuition and what's not funded by federal sources of funding before the scholarship programs are fully rolled out? And as a quick follow-up, I know you mentioned you're not opening new campuses in '13 as of the current plan. Is there an opportunity to scale back some of the campus footprint right now?

Daniel M. Fitzpatrick

Well, as far as your first question, I assume you're asking just as far as lending off the balance sheet. The goal is to phase that out, and that basically has to do with the timing of the rollout of the opportunity scholarship. So all of the new students coming into these campuses that we talked about already were offered this but also those that are being repackaged. So it really comes down to the timing of that rollout, but the goal is that the lending off the balance sheet will go basically to 0 over some point in time.

Kevin M. Modany

And yes, let me take the second part of the question. I think you were asking about is there an opportunity to scale back campuses. At this particular point, we don't have anything to announce there. I will say that we are diligently reviewing our cost structure across the board. And of course, given the amount of expenses represented by facility costs, we're certainly taking a hard look at that. We don't see anything that suggests immediate action there. Again, we're monitoring it very closely. I can give you a little bit of color on some of the stuff that might be helpful for everyone out there. We have about 25 or 30 campuses right now that are generating operating losses. But if you think about our model and our new campus model, the way we start them up and the volume that we've started up, that wouldn't surprise you because we've had probably close to 25 or 30 campuses open over the last 2, 2.5 years. We've talked about the new startup model taking a little longer to get to breakeven. It was historically about 24 months, it's taken a little bit longer than that, probably another 6 to 12 months added to that. Again, that probably then allows the 25 to 30 campuses with operating losses to make a little more sense to you. That total operating loss was, for 2012, somewhere in the neighborhood of $25 million to $30 million, in the middle of that range. So there are dollars there that we're watching. But as long as the schools continue to trend albeit behind the historical curves, if they continue to trend where they're trending, they get to an operating profit, again, albeit in a longer duration. So right now, again, as much clarity as we can give you, there's nothing on the radar screen but we're looking at ways to be as efficient as we possibly can in delivering our educational programs. And if there's an opportunity, we'll take advantage of it. But again, nothing to report on that front today. Hopefully, the color was a little bit helpful.

Operator

The next question comes from Paul Ginocchio of Deutsche Bank.

Paul Ginocchio - Deutsche Bank AG, Research Division

If I could just sneak a few in. First, around the $15 million to $20 million of payments that you're looking for in 2013 for PEAKS and the 2009 RSA, is that pretty much what the number's going to be? Or is there a wider range on that? And sort of what -- and then second, what is -- now with the scholarships, what's the all-in cost of an associate's program, roughly within the $1,000 or so just to give us an idea? I think before it was around $38,000. Correct me if I'm wrong. And then finally, the assumptions on your recovery, I think it's $6.5 million, $6.7 million in the fourth quarter. Is that an assumption and why is the recovery rate so high on the payment? Or is that what you've actually seen recovered already?

Kevin M. Modany

Sure. There's a lot of questions there. We're going to do our best to try to knock a couple of these out. I think you were asking about, at least in one point, the opportunity scholarship and tuition. Gross tuition level right now is about $44,000 for an associate degree, I assume that's what you were asking about, given the predominance of our students pursuing associate degrees. After the opportunity scholarship, the net out-of-pocket cost for them, we estimate at around $27,000 based on the mix. And the average of -- that average mix continues to stay the same once we roll it out. So that's kind of the net out-of-pocket costs that we're looking at. In terms of the RSA obligations, the $15 million to $20 million, I think you were asking how solid is that estimate. I'll just say that the closer the proximity of the payment, the more clarity. So we've got pretty decent clarity around 2013 and even 2014. You start getting out beyond '15 -- I think probably the first 3 years we've got pretty good clarity. You get beyond that, you're starting to rely a little more on some of the estimates. So I would just say 2013, very good clarity around that.

Daniel M. Fitzpatrick

And your last question having to do with the recovery and the accounting of that. There were some payments made in the fourth quarter, some of which remain on the balance sheet. As Kevin described before, as far as the PEAKS Program, some the issues you have there is timing. There is a sufficient number of students in repayment now and payments coming in to cover the obligations of the trust, which is basically the senior notes and its expenses. So if you look at the scenarios and you run it out and you look at the timing perspective, you will make these payments, some of which are going to be coming back in the future. So no, we will not get those funds back until the senior notes are fully retired. But there's pretty good estimates as to the fact some of the moneys that are going in will come back in a later date and then you take a present value haircut to that.

Operator

The next question comes from Kelly Flynn of Crédit Suisse.

Kelly A. Flynn - Crédit Suisse AG, Research Division

Just a quick one, and you may have kind of covered this indirectly but just to clarify. The earnings goal for this year, does that include any additional charges related to the '09 RSA or PEAKS?

Kevin M. Modany

It does not.

Operator

The next question comes from James Samford of Citigroup.

James Samford - Citigroup Inc, Research Division

Just a quick one. Can you just comment on how placement rates and salary trends have been? I think typically you provide some sort of -- how your students are -- how the outcomes are trending right now.

Kevin M. Modany

Sure. As of middle of the month, approximately January 14, January 15, the average employment rate was approximately 240 basis points below the prior year. On the flip side, starting salaries of the reporting grads -- and here, we're talking about the 2012 and 2011 graduates, those that graduated in '12 and '11. On the salary side, it was up about 2%. The average reported starting salary, up about 2%. So down 240 basis points on the employment rate, up 2% on the salary.

Operator

The next question comes from Jeff Meuler of Baird.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

I guess a follow-up on Kelly's first question. Any additional sensitivity analysis that you can provide so that we as analysts and investors, can do our own sensitivity around what potential liabilities could be to the third-party lending programs? And I guess on the 60%, are you just saying that the default rate has been trending at 60% or are you saying that you're incorporating a 60% default rate into kind of the reserve estimate on a go-forward basis? And then, finally, not sure if you're willing to provide this, but -- and I understand this is an unrealistic assumption but just so we could get an upper bound on what the liability could be. If no student ever repaid any of their loans related to the 2009 RSA and PEAKS, what would -- what's your maximum potential liability?

Kevin M. Modany

Okay. So on that last one, we're not going to sort of address hypotheticals that are based on fiction. So I'm going to go ahead and pass on that one. It doesn't make any sense to try to provide an answer to that. With regard to the default rate, I think you were asking is that our assumption in the estimate and/or is that what we've been trending, is that what we've seen in the trending. The answer is yes and yes. Yes, the trending and yes, that's what we've been seeing. So we're just saying we think there's an opportunity for these default rates to get better. There are so many other things that could be done. And we've got, again, third parties helping us kind of look at that and also then lobbying the servicers and the owners of these programs to try to make these modifications. So we're at the very rudimentary levels in terms of what we're doing to try to improve these rates. However, in terms of calculating our reserve, we're not assuming that there's any upside there in terms of the servicing changes that we can make and the loan borrower modifications that can be made. So it's just like we're not pleased with this. These default rates are much higher than we've ever seen. We see the same thing in other private lending programs. You can go out to publicly available sites and look at all types of private lending, regardless of the profile of the individual, regardless of the institution, and you're seeing the same types of relative change in historical performance. That's what our analysis of the data suggested to us. And we're just saying, "Look, let's just assume that, that continues on through the duration of the program." And when you run that out and calculate it and calculate the probable result, that's the methodology utilized here to calculate this reserve. So we're providing that. We're providing clarity on this. We're giving you a really good look behind the curtain. We are limited in terms of some of the things we can say. We have nondisclosure agreements on some of these stuff with some of the players. But we've looked through those agreements to try to give you some additional clarity on what we're doing and what we're projecting and what we're seeing. And again, hopefully we've done that for you today and everybody has a better snapshot. And once again, our focus here is to try to put a fence around this and record, as this liability, what we see for the overall obligations for these programs through to their duration.

Operator

The next question comes from Corey Greendale of First Analysis.

Corey Greendale - First Analysis Securities Corporation, Research Division

Just 2 quick clarifiers. Could you just remind us the terms of the 2009 RSA and PEAKS in terms of were those only available to students who already completed their first year of school? In that category, is that a 60% default rate or what that rate is? And secondly, I thought with the changes where you were not going to have to be using your balance sheet for the third-party private lending, that, that would have trended back toward kind of the historical 2% range and why you think it would still be upwards of 6% this year.

Kevin M. Modany

Yes, sure, Corey. Let me take the last one real quick, and Dan can add some color as well. We will see the scholarship kind of roll itself out. So right now, that bad debt number that we talked about at 4% to 6% contemplates sort of the rollout. So you'll have people who still have some, I'll call it, internal credit that will be on our balance sheet. But that will wind itself down. And as it winds itself down, you will see that bad debt number go down back towards that historical level of 2%. We're just reflecting the timing of the rollout of the scholarship in that number.

Daniel M. Fitzpatrick

And Corey, as to your question as far as the -- basically, the underwriting criteria for these 2 programs, yes, you are correct. To be eligible for the 2 remaining risk share arrangements that are out there, it was available to students who had completed their first academic year essentially to be able to get into those programs, and that is an important distinction.

Operator

And that second question will come from Jeff Volshteyn from JPMorgan.

Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division

Quick housekeeping questions. What is the income tax that's assumed in 2013? And there is a large outflow in taxes in the fourth quarter, in deferred taxes. Can you just provide a little more color on that?

Daniel M. Fitzpatrick

Sure. 2013, using basically what we've seen as far as effective rate, pretty much in the low 39% range. Be careful, in the fourth quarter of 2012, just because of the anomaly of taking these charges and how it played out having a -- reporting a net loss, and as far as deferred tax asset, yes, there's a significant climb. And again, it comes back to these charges. The actual deductability of the payments we're going to be making this year will happen this year. So if you think about it, you took -- you've taken an expense for payments that are going to be made this year of, let's say, $60 million. So you can't deduct it to this year. So that's why particularly, the current deferred tax assets has climbed so significantly. But even overall, the long-term asset climbed as well because of these reserves. It's primarily related to these reserves.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Kevin Modany for any closing remarks.

Kevin M. Modany

Thank you very much. I just want to thank everybody for their time today. We hope that some of the additional information we provided today gave you some of the clarity that, I believe, you were seeking and hopefully that answers some of your questions. We look forward to providing you with an update on some of the key focus areas and initiatives of the organization that we talked about today in our April call. So we'll look forward to talking to you -- all of you at that time. Once again, thank you for your participation in the call today. Have a great day.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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