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Executives

Jim Sober - Vice President, Finance

Todd Nelson - Chairman

Ed West - President and Chief Executive Officer

Randy Killeen - Acting Chief Financial Officer

Analysts

Reza Vahabzadeh - Barclays

Jeff Silber - BMO Capital Markets

Corey Greendale - First Analysis

Kelly Flynn - Credit Suisse

Bob Craig - Stifel Nicolaus

Gary Bisbee - Barclays

Jeff Meuler - Baird

Jeff Volshteyn - JPMorgan

David Chu - Bank of America

Trace Urdan - Wells Fargo Securities

Brandon Dobell - William Blair

Yaying Chen - MetLife

Kelly Flynn - Credit Suisse

Todd Morgan - Oppenheimer

Education Management Corporation (EDMC) F2Q 2013 Earnings Conference Call January 31, 2013 9:00 AM ET

Operator

Good morning and welcome to the Education Management Corporation’s Fiscal 2013 Second Quarter Conference Call. All participants will be in a listen-only mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Jim Sober, Vice President of Finance. Please go ahead.

Jim Sober - Vice President, Finance

Thanks Emily. Welcome to Education Management’s fiscal 2013 second quarter earnings call. With me on the call today are Todd Nelson, Chairman; Ed West, President and Chief Executive Officer; and Randy Killeen, Acting Chief Financial Officer.

Following our opening remarks, we will begin a question-and-answer session. During this session, we ask would you please limit yourself to one question and no more than one follow-up question, so that we can respond to all participants on the call today.

Before turning the call over to Ed for his opening comments, I’d like to remind everyone that information presented on this call contains forward-looking statements. These forward-looking statements include, but are not limited to statements about our future plans, our future financial and operating performance. Actual results might differ materially from those contained in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially are set forth in the cautionary statement included in the earnings release. Ed?

Ed West - President and Chief Executive Officer

Thanks Jim. Welcome to our fiscal 2013 second quarter earnings call. On today’s call, we will cover several operational topics, review our financial results, provide guidance, and discuss our priorities in quality measures. Of the many things we will discuss today, what I would likely to takeaway are these. First, we are making progress on our key priorities that I outlined last quarter, in particular our focus on positive student retention. Second, we are seeing new student demand for campus-based programs turning positive across several of our education systems, with the total campus-based new student growth trend improving sequentially despite the previously mentioned challenges at The Art Institutes. And third, we are making investments in our students to help them achieve their educational goals by increasing our scholarship programs.

For the second quarter of fiscal 2013, we reported net revenues of $655 million, down 11% from the prior year with EBITDA of $123 million and EPS of $0.25. Our financial results were better than expected as a result of expense management and improved collections efforts, which had a favorable impact on bad debt expense. While new students for the three-month period ended December 31st decreased approximately 22% versus the prior year period. Our second quarter average enrolled student body and the recent January start both benefited from the year-over-year improvement in student retention that we experienced during the quarter.

Regarding the decline in new students, nearly 80% of the decline was due to fewer fully online students with South University representing the majority of this reduction. As we discussed last quarter, we have implemented changes to our marketing efforts for South University’s fully online programs in order to more effectively attract students who we believe will be the most academically successful.

While the operating environment remains challenging, we continue to see encouraging signs and improving demand as several of our education systems, particularly for the campus-based programs. For total campus-based programs, new student growth trends improved sequentially during the second quarter and we expect these trends to continue through the remainder of the fiscal year despite the previously mentioned challenges for The Art Institutes campus-based programs. In fact, when looking at the combined campus-based new student enrollment at Argosy University, Brown Mackie Colleges, and South University, we had positive new student growth during the quarter and we expect that trend to continue into the fiscal third quarter. Historically, the Art Institutes have been a very predictable segment providing consistent reliable enrollment growth. However, over the last six-month period the Art Institutes have been heavily impacted by the continued macroeconomic conditions compounded by the reduced availability of PLUS loans.

Recently, we have taken a number of actions to help offset these factors, especially in support of The Art Institutes core demographic the traditionally aged student. These work streams include working with prospective students and their families earlier in the enrollment process to establish financial aid plans well before the plan’s start date in order to provide clarity on funding availability. We have been increasing the number of campus-based event activities. And as a result of new technology, we are now able to have dedicated high school admissions teams.

Traditionally, age students represent more than half of our campus-based Art Institutes enrollment and have historically been more successful in persisting, graduating, and repaying their financial obligations. Through these efforts, we are taking at The Art Institutes, we are beginning to see some stabilizing trends for the prospective high school graduate population, including an improving trend in application growth for the July, August and October class starts, which will win more than two-thirds of these students typically enroll. In support of these efforts, we have also recently expanded our scholarship programs at the Art Institutes. While it’s too early to assess the full impact that these scholarships will have on student demand, our admissions teams are excited by the offering and believe will help in the recruitment process.

As a result of the various actions that we have taken, we believe the Art Institutes will see new student growth trends are less negative during the second half of the fiscal 2013 when compared to the first half of the fiscal year. Campus based programs for our other education systems have already demonstrated solid recovery signs. At Argosy University demand trends are favorable with application volume for both campus-based and fully online programs are up versus the prior year. Further for the campus-based programs, new student year-over-year growth turned positive during the second fiscal quarter for the first time in two years.

At Brown Mackie Colleges, new student growth has recently turned positive, up year-over-year for both the December and January class starts, benefiting from various programs implemented over the past year. In addition, retention rates have improved significantly at Brown Mackie Colleges with 180-day new student cohort retention rate improving several hundred basis points versus the prior year period.

South University continued to experience strong demand for its campus-based programs, which again saw application volume growth as well as double-digit growth in new students during the fiscal second quarter. While South University’s fully online enrollment has declined sharply over the last nine months, largely due to the change in the marketing strategy that I have previously mentioned, we are pleased by the significant improvement we have seen in the financial performance of South University’s fully online programs versus the prior year period.

For the third and fourth quarters of fiscal 2013, we expect continued improvement in the year-over-year new student growth trend for the campus-based programs. Now for the first six months of fiscal 2013, we rolled out over 135 programs across our colleges and universities, where they were not currently offered covering a wide range of programmatic areas and degree levels. For example, we rolled out 40 Bachelors, and 57 Associates degree programs. We have also developed a new diploma level of health sciences program at Brown Mackie College and launched a new fully online program at Argosy University and Master’s in Science in Human Services.

Our cash flow from operations for the six months ended December 31st was roughly flat to the prior year period. As I’ve mentioned previously, our plan related to our capital structure is to first stabilize enrollment and EBITDA. Second, evaluate opportunities to free up cash. And third, address our near-term maturities by either repayments, refinancing or both. As we continue to execute on this plan, I would like to provide a few updates on actions taken to help further strengthen our liquidity. As I mentioned on last quarter’s earnings call, we have been exploring the opportunity to monetize several of the facilities that we own through sale, leaseback transactions. As of today, we have completed transactions for four school facilities and one housing facility that we owned, with the net cash proceeds from these transactions totaling approximately $65 million.

During December, the U.S. Department of Education notified us that our letter of credit of $414.5 million could be reduced to $348.6 million or 15% of the lower Title IV funds we have received during fiscal 2012. We completed this reduction in January.

Further, through purchasing efficiencies, reprioritizing certain projects and the elimination of others, we continued to project our capital spending during fiscal 2013 to be between 3% and 3.5% of net revenues. This range includes the anticipated opening of only one additional new school during the remainder of this fiscal year depending on the timing of regulatory approvals. Beyond this location, we currently do not anticipate any additional new locations through this calendar year.

Now, we’ll now your turn the call over to Randy Killeen, our Acting Chief Financial Officer for an update on our financials and our fiscal 2013 guidance. Randy?

Randy Killeen - Acting Chief Financial Officer

Thanks Ed. In my comments today, I will review EDMC’s financial results for the second quarter of fiscal 2013, discuss our segment results and provide guidance. For the three months ended December 31, 2012, the company reported net income of $31.1 million or $0.25 per diluted share, on net revenues of $654.9 million, down 11.2% versus the prior year quarter. EBITDA was $123.3 million, which exceeded our previous expectations. The 2013 second quarter revenue decrease of 11.2% was primarily driven by the year-over-year decrease in our average quarterly enrolled student body of 12.7%. Overall revenue per student was up 1.8% due to a greater mix of campus-based students. Average tuition levels across the system were up a little over 1% year-over-year. Total operating expenses for the first quarter were down 6% to $570.8 million versus the prior year quarter.

Looking at expenses in more detail, Educational Services costs were $360.4 million, down 4.1% or approximately $15 million versus the prior year quarter. This decrease was primarily due to lower staff levels related to lower enrollments, partially offset by slightly higher rent from our sale leaseback transactions. As a percentage of net revenues, Educational Services expenses increased by 405 basis points versus the prior year quarter, primarily due to the decline in net revenues.

As Ed mentioned, we have completed five sale leaseback transactions with unrelated third-parties for net proceeds of $65 million. In connection with these transactions, during the second quarter, we recorded a net loss of $3.5 million within Educational Services related to one of the properties. The remaining properties have a deferred gain of $17.8 million that will be recognized over the lives of the new leases, which range from 3 to 15 years. Within Educational Services, instruction costs were up 53 basis points as a percent of revenues primarily due to the drop in average class size. Bad debt expense as a percent of revenue was 6.2% for the quarter, up 63 basis points from the prior year. Compared to prior year quarter, bad debt expense was flat as improved collections were offset by higher AR balances.

General and administrative expenses were down 10.9% to $171.2 million versus the prior year quarter, roughly flat to last year on a percentage of net revenues basis. Within G&A, marketing and admissions costs were down 13.2% year-over-year and represented 21.3% of net revenues, an improvement of 49 basis points versus the prior year period. However, marketing admissions costs for new students start were up approximately 11% due to lower start rates and lower application volume.

Depreciation and amortization was essentially flat year-over-year at $39.3 million. As a percentage of net revenues, D&A expenses increased 68 basis points versus the prior year quarter. EBITDA decreased 27.2% to $123.3 million for the second quarter. EBITDA margin was 18.8%. EBITDA, which we used to measure operating performance, is a non-GAAP financial measure and reconciliation reported net income is included in the quarterly press release. Net interest expense was $31 million in the current quarter, an increase of $4.2 million from the prior year quarter due to higher rates on the portion of the term loan that matures in 2018.

I’d now like to cover the results for The Art Institutes. Average enrolled student body for the three-month period ended December 31, 2012 was 69,500, down 12.1% year-over-year with approximately one-third of the decline from fully online students and the remainder from campus-based students. Revenue declined 12.4% from the prior year quarter to $411.5 million driven by the 12.1% year-over-year decline in average enrolled student body.

Operating expenses, excluding depreciation and amortization, decreased 6% year-over-year. The decline was driven by staffing adjustments made in the first quarter to align costs with enrollment levels and the lower advertising costs. EBITDA decreased 26% year-over-year to $112.3 million with a segment EBITDA margin of 27.3%.

Turning to South University, I would like to highlight the significant year-over-year improvement in EBITDA which during fiscal 2012 was negatively impacted by the performance of South’s fully online programs. For the three months ended December 31, 2012, EBITDA has improved 185% year-over-year to $8.9 million. This improvement is a direct result of continued demand you are seeing for campus-based programs and the success of the marketing strategy changes we have implemented related to fully online programs.

Looking at selected details from our statement of cash flow, cash flow provided by operations for the six months ended December 31, 2012 was $93.2 million compared to $97 million in fiscal 2012, despite a decrease in the EBITDA of approximately $100 million between the two six-month periods. Cash flow from operations was relatively flat versus the prior year primarily because of lower cash tax payments and lower working capital usage in the current year, and annualizing the conversion to non-term academic structures with students attending fully online programs at Argosy University and South University, which resulted in a lower impact from restricted cash in the current period versus the prior year. For the second of half fiscal 2013, we continue to believe that we will generate positive free cash flow.

Cash paid for capital expenditures was $39.5 million or 3.1% of net revenues for the six months ended December 31, 2012 compared to $36.1 million or 2.5% of net revenues in the same period last year. We expect CapEx to be between 3% and 3.5% of revenues for fiscal 2013.

Looking at the company’s balance sheet as of December 31, 2012, the cash and cash equivalents balance was $189 million. Net student receivables including the long-term portion increased $5.8 million from the prior year period to $175.2 million as increases in internal payment plan balances were partly offset by improved collections. We had no borrowings outstanding under our revolving credit facility. Long-term debt was $1.46 billion.

For our guidance, our third quarter and annual guidance for fiscal 2013 reflects our recent January start, continued higher bad debt expense from increased usage of our internal payment plans related to the plus program eligibility changes. Cost savings from prior restructurings rents from the sale leaseback transactions, and excludes restructuring charges, employee severance, lease termination, and other expenses, which have or have been or maybe incurred.

For the three months ending March 31, 2013, we are expecting EBITDA to be between $113 million and $117 million, net income to be between $25 million to $27 million and earnings per share to be between $0.20 and $0.22 per diluted share. For the 12 months ending June 30, 2013, we are expecting EBITDA to be between $365 million and $375 million, net income to be between $48 to $55 million, earnings per share to be between $.038 and $0.44 per diluted share, and CapEx to be between 3%, 3.5% of net revenues.

Ed, back to you.

Ed West - President and Chief Executive Officer

Great, thanks Randy. In the last quarter, we launched a new goal of achieving $1 million graduates by the year of 2020, which will be supported by five key priorities. First, increasing student retention and the number of graduating students with successful outcomes, second, improving access and affordability for all students, third, developing education related products and services that are not dependent upon government funding, fourth, positively reinforcing our image and finally fifth, foresting a culture of engaged and motivated faculty and staff.

And in support of these long-term priorities I’d like to cover several of the quality measures that we utilize student retention, scholarships awarded, the number of graduates and the graduate employment statistics. Student retention remains a crucial focus and the programs that we have initiated over the past year are beginning to show benefits. We believe one of the key measures for retention is to look at a cohort of students 180 days after their initial start.

We are extremely proud to report that for new students that enrolled during the quarter ended June 30, 2012, the 180 day cohort retention rate as of the quarter ended December 31st showed an improvement of roughly 400 basis points from the prior year period. This is a true testament to the dedication and passion of our faculty and staff across the country. We are also proud of our graduates and what they had achieved in both their academic and working careers and are excited about their future opportunities.

During the first six months of fiscal 2013, we had approximately 15,000 graduates, up slightly versus the prior year. Of our graduate students who graduated during the – of our undergraduate students who graduated during the quarter ended June 30, 2012 from all of our colleges and universities and were available for employment are approximately 74% became employed in their fields or related fields of study within six months of graduation with an average starting salary of approximately $30,000.

As a demonstration of the talent and the success of our graduates, just this past week four of our alumni from the Art Institutes of Pittsburgh won top honors at the Sundance Film Festival receiving the 2013 Sundance U.S. Documentary Grand Prize and the 2013 Audience Award for a U.S. documentary. Again, we are very proud of the successes of our graduates and want to congratulate them on their recent recognition.

Now, I would now like to turn the call over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) And, our first question will come from Reza Vahabzadeh of Barclays. Please go ahead.

Reza Vahabzadeh - Barclays

Good morning.

Ed West

Good morning, Reza.

Reza Vahabzadeh – Barclays

Can you talk about the drivers behind the improved bad debt expense ratio that you saw in this quarter and whether is that sustainable from this standpoint of your better collection ratio and collection efforts? And then if you can just also touch on the cash flow use in the second quarter which was far less than the prior year, if that is sustainable or if that is a, or if that is related to the timing factor? Thank you.

Ed West

Let me touch on the later, on the second, on the cash flow and then I’ll have Randy elaborate more on the bad debt and the new collections that we did experience. As Randy mentioned obviously cash flow came in better than expectations on the performance largely a lot of the due to the collection activities that I will speak to more in a minute. As well as on a year-over-year basis, we had less growth in restricted cash because when we are rolling into the non-term programs for our fully online students, obviously there is a fair amount of growth in restricted cash, which at normally pulled down cash flow from operations a year ago. So we had more favorable comparisons this year. And this year would have been more normalized from that standpoint. And also there is a benefit to this quarter with lower tax payments in the life, but we’re pleased with how cash flow came in during the period. Ran, do you want to talk more on the bad debt?

Randy Killeen

Sure. Over the past two quarters Reza, we had a significant focus on receivables and collections of receivables. We’re in the process of centralizing our collection function, we have seen some significant improvements in collection. I think going into Q3, we would expect to see a strong performance in collection that’s typically a good collection quarter with tax refunds coming out. So we’re certainly goaling that and shooting to continue our strong performance that we had in Q2.

Reza Vahabzadeh – Barclays

Got it. Thank you.

Ed West

Thank you.

Operator

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

Jeff Silber - BMO Capital Markets

Thanks so much. Just wanted to step back, your 2Q results were better than expected, yet it appears that you lowered guidance for EBITDA for the back half of the year. Can you explain what happened in 2Q and why you think that may not continue for the rest of the year? Thanks.

Ed West

Sure, thanks Jeff. So in the second quarter obviously coming in better than expectations, slightly better on revenue, but really better on the expense side on cost that where we came in as well as bad debt that we just touched on in a minute, we expect some of that to continue. On – from a guidance standpoint, the drivers for the reduction really is more revenue related, and that’s a combination of lower unit revenue from mix. So if we look at the mix of students, probably less than we had anticipated from an Art Institute and higher from some of our other education systems between Argosy and South and Brown Mackie, which have a lower unit revenue. So that impacts it from a mix standpoint. In addition to as I mentioned on the call, we’ve increased various merit-based and need-based scholarship programs particularly at the Art Institutes, enrolled that out and have increased that, which will have a negative impact for the back half in the year, our guidance reflects that. We’re really excited to make that investment. And as I mentioned on the call, a lot of enthusiasm around that, and look forward to having that fully utilize, and then going into ‘14, obviously we would expect benefit from that.

Jeff Silber - BMO Capital Markets

Great. That’s helpful. Thank you. And just switching gears in terms of the campuses that you own, if you could just remind us how many of them are left? And are you evaluating anymore sales leasebacks for those?

Ed West

Yeah, we have three additional locations. As we mentioned before, we’ve monetized, sold five of those into a sale leaseback. We have three, really of those three remaining, is only one of the substance which is the Art Institute here in Pittsburg. The other two are much smaller locations. We have to evaluate that, we continue to, and there’s always the opportunity for that, but nothing is definitive right now.

Jeff Silber - BMO Capital Markets

Okay, great. Thanks so much.

Operator

Our next question comes from Corey Greendale of First Analysis. Please go ahead.

Corey Greendale - First Analysis

Hi. Good morning.

Ed West

Good morning.

Corey Greendale - First Analysis

Following up on Jeff’s first question, can you just help give us a little sense of what you think the impacts will be of the scholarships in terms of what we should be modeling on revenue per student in the back half of the year?

Ed West

From revenue per student we would still expect to see that being up slightly on a year-over-year basis for as compared to last year. Some of that is just mix driven, just from more campus-based students versus online students which tend to have a higher load. So, it would still be up slightly. Thinking about from a dollar standpoint, if you recall from our last call, our total scholarships last year were approximately 82 million, I think it’s in the low-80 millions from an investment standpoint, scholarships for last fiscal year. We would expect that to approach $100 million this year in investment in scholarships across our education systems with the lion share that with the Art Institutes.

And that’s where really the big increase is, is with the Art Institutes to really to help the students working without, really going back to some of the changes that we – the impact that we experienced, that we talked about in the last quarter. Ongoing macroeconomic conditions with the economy, families from figuring out how to finance this important investment in education and that compounded by the changes in the PLUS loan program really, really impacted us. Frankly, we believe that the total impact for the Art Institutes just from the changes in PLUS become near close to 7,000 students on a year-over-year basis, when you look at the students who enroll today versus a year ago, who had PLUS loans.

Corey Greendale - First Analysis

Okay, that is helpful. And a follow-up question, I think, I asked this last quarter, but I’ll ask again now that you have some more data under your belt. What do you think the performance is sort of different between online and on-ground and at some point do you think, you might make sense to consider different pricing for the online programs to drive demand there?

Ed West

Well, I mean obviously, two different students here for those near the campus and one in the campus-based environment and those who are working mostly more adults on a – on nights, weekends, off time, better flexibility for them, and also students who are doing both. It’s very important, but we want to make sure so we have integrated and unified opportunities for them. But I ask students whether they want to do it at a campus or online, and better tailoring it for them and their needs, and we’re doing a lot more to make sure that in fact Argosy is rolling out a lot more programs ahead of that more unified and a better student experience.

Clearly on online, competition continues to increase, and awareness, and but we feel like that’s a good thing, more awareness, more interest on it, better validation and the like, and we feel strongly about that. But we have made the changes that I mentioned in particular with South, going back a little more than a quarter, in this past summer with changes in the marketing programs. We’re really focusing on the students where we saw strong academic progression from where were those students when they came, what the programs are, the degree, the region within the country, what were the sources, and really focusing on that making sure we’re leveraging our best ranks.

Corey Greendale - First Analysis

Right, thank you.

Operator

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

Kelly Flynn - Credit Suisse

Thanks. Similar question to Corey’s, but just about starts in persistence. Can you clarify that you’re confirmed that you think that starts decline for the total company will narrow in the back half, and also maybe give us a little bit help or guidance on persistence in the back half? It looked like you did increase a lot in this quarter. Do you expect that to continue? Thank you.

Ed West

Sure. Thanks, Kelly. Yes, we do expect that starts would show improvements in the back half of the year. And more specifically, looking at the campus-based enrollment, as I mentioned on my earlier remarks, is very encouraging and very solid data point and sign seeing now where Argosy University campus-based programs turned positive in during the second quarter first time in two years that’s happened and now going into the third quarter that trend is continuing and even building. So that’s a very good sign.

Obviously South University’s campus-based programs have grown double-digit during this whole downturn in the industry and its just again very strong programs, very strong basis of differentiation, and we expect that to continue. Also another very encouraging sign is Brown Mackie. Brown Mackie turned positive from a new student standpoint during the month of December and even more so in January. We see that continuing on and that for Brown Mackie turning positive in December was the first time in 23 months. And then that’s all compounded with the several hundred basis point improvement in retention across the system, which is a very, very encouraging sign. And we do, just from all the plans and the efforts and work across the system we would hope that that would continue to see ongoing improvement there.

Kelly Flynn - Credit Suisse

Okay. Thank you very much.

Operator

Our next question comes from Bob Craig of Stifel Nicolaus. Please go ahead.

Bob Craig - Stifel Nicolaus

Thanks, operator. Good morning everybody.

Ed West

Good morning.

Bob Craig - Stifel Nicolaus

I was wondering if you could indicate what percentage of your students are eligible or receiving scholarships and what is the average amount, I’m just trying to gauge what the reduction in net price is to those students?

Ed West

Sure. Thanks Bob. Almost half of our students receive some form of a benefit or a scholarship was merit-based, need-based and then really I mean those are just focusing on AI with that. And that historically if you look the last year, I think across the system was about 3% of total revenue, little bit higher to AI about 3.5% to 4%, we see that going up year-over-year, so that will be increasing going into fiscal ‘13 as a result of these increases.

Bob Craig - Stifel Nicolaus

Okay. And also to – could you indicate what your progress has been on your cost saving target, I thought you had earlier articulated $100 million with potentially $70 million being the amount you would realize this year?

Ed West

Yes, very good progress on it. In fact, we continue on that, that’s where we came in a little bit better than expectations this past quarter. I mean, obviously a lot of effort, great effort doing across the system and across the country. People are really focusing on that and continue to make investments back with the student with these scholarships.

Bob Craig - Stifel Nicolaus

Great. Thanks Ed.

Ed West

Thank you, Bob.

Operator

Our net question comes from Gary Bisbee of Barclays. Please go ahead.

Gary Bisbee - Barclays

Hey, guys. Good morning. I guess the question, I appreciate the positive commentary on the three smaller brands, but can you dig in a little more on the Art Institute, which remains the vast majority of profits. I guess, you said you expect the trends to get better and I think by that you probably meant less negative in the back half of the year. But how – could, is that like not down 20, down 15 such that, that this is going to continue to see the revenue and profit base decline for a long time or is there the potential for a more significant inflection?

Ed West

Good morning. So, on that, you’re right. Obviously AI is a significant portion. And as we talked about before, AI had held up extremely well, very steady through the downturn, even showing new student growth last year not substantial but it was positive, and we were actually feeling very good going into the summer. And then that’s when we learned about the impact around the PLUS loans. So, once we realized that, unfortunately we were too late for the high school start. When you think about the Art Institutes, which is more than half of our students who are traditional aged students and a lot of those coming from high school, that class that had already gone through and we had a big impact from that going into July, August and October and because that’s when the majority, vast majority of those students start. So, this year, obviously we are aware of that.

We are aware of the changes in our PLUS loans, it did have a significant impact, but that’s now in the base. We understand the criteria now, we will work with that. And as I outlined earlier, we are very focused working with the students, the families earlier on in the process going through the packaging process and actually receive very positive signs of that building into this next summer’s high school graduating class start, which will happen in July, August, and October and have good trends there even turning positive that, obviously it’s been choppy during this period. And we monitor it very closely with whatever efforts we can. In addition to that that’s why rolled out these scholarships this past month going into for the enrollment and help further support that and support the students, which we believe we would see the benefit on both retention as well as the ability to finance the education.

Gary Bisbee - Barclays

Okay, great. That’s helpful. And then just a follow-up on online, you have now lapped the change to non-term, you have talked about the change in marketing and yet we are still seeing pretty, pretty devastatingly weak results there is I guess, the upside is the comps start to get easier from here, but how do we think about online? What are you really doing, in a marketing sense, to differentiate your brands in the marketplace? And is the price point a hindrance or is there something else going on? I guess, what I am really getting at is how much of this is self-inflicted changes you are making versus having difficulty in the market like a lot of the industry is?

Ed West

Yeah, it’s a great point. And it really goes back to also in your first point in some of the earlier discussions. And it’s around the new student side here. In new students, yes, we are down 22%, almost 80% of that was due to fully online programs. And we were seeing growth on some of the campuses, the non-AI institutions or Argosy, Brown Mackie, and South. And yes, the new student enrollment for online was down year-over-year, but the majority of that was self-inflicted by changes that we made in South University. Those were proactive, fully intentional. We changed the infrastructure, the size, the marketing effort to the students in which we were focused on recruiting, where we see better academic progress. So, the majority of that was self-inflicted. Separately, Argosy applications have actually turned positive. So, we are actually very encouraged. So, on the application growth turning positive this past quarter and now going into the third quarter, we feel like we will see some very good signs there that where we look forward to reporting at the next quarter for Argosy’s performance, both online and on ground there. So, you really have to go back into the mix on that.

Now, back to each of the brands, that’s one of the reason why we feel so strongly about our education systems, that through the offering, but whether it’s The Art Institutes, Argosy, South or Brown Mackie are very unique have a very strong basis of differentiation in the marketplace, for their particular programs, whether those are the healthcare programs at South or the behavioral health education business at Argosy. And obviously, the Applied Arts programs at The Art Institutes, they are very strong and is further buttressed by our strong campus presence. Having that combined offering out there and to the unique demographic, programmatic and degree mix, we believe is a clear differentiator and where we are optimistic about the future there.

Gary Bisbee - Barclays

Great, thank you.

Randy Killeen

And I would add – hey Gary, I would just add one thing on that, Ed was talking about the infrastructure that was to support what we felt was the right students to pursue. There was a significant amount of rightsizing. And so obviously that being a direct result some of the self-inflicted changes.

Gary Bisbee - Barclays

Yeah, great, thanks.

Operator

Our next question comes from Jeff Meuler of Baird. Please go ahead.

Jeff Meuler - Baird

Yeah, thank you. Could you recap any sort of initiatives that Art Institute beyond kind of facilitating the PLUS loan issue and the scholarships, any other initiatives of note whether it be around the high score recruiting or programmatic changes, I guess to try to drive starts growth or in your view is it almost all isolated to this PLUS loan issue?

Randy Killeen

No. It’s comprehensive, broad-based on all fronts and all efforts and it’s not just on the front end, it’s also in the classroom and the experience on retention and working with students, because we were ongoing of helping support them on their investment retaining and staying in school and pursuing their education. And you mentioned on high school, absolutely, so the high school recruitment, the inquiries we have going there now being able to make some investments on technology, now able to have dedicated high school admissions representatives having inquiries and individuals who are interested of being able to channel directly and instantly to those admissions representatives, having more events at the campuses bringing the families in on a more proactive interfaced basis, obviously, curriculum that we are doing in terms of their early parts of the program all in effort trying to work on retention there as well. So, it’s very broad-based. In addition, we have talked about before, we are going back over the last year, the utilization of facilities, enrollment ability with rolling out additional programs with multifunction use and on that shorter degree programs, in the culinary programs to help support that and better utilization of having a fourth shift at many cinches.

And finally and most importantly with as we talked about our priorities is also the change in terms of the cost of education of having that being lower. We have removed and eliminated a lot of different fees, the costs we have held tuition flat like on the West Coast in California, we are now on our third year with zero tuition increase at The Art Institutes, zero increase. And then frankly the cost of an Associates or Bachelors degree is down almost 9% over the last three years just because of the changes in credit loads, changes in other fees, other costs and utilization of e-books and the like have helped lower the cost of education. And we are frankly enthusiastic about continuing to try to do more of that in addition to the scholarship. So, it’s broad-based, comprehensive, lot of different fronts.

Jeff Meuler - Baird

Thanks. That was a helpful recap. And then on the, I guess, extension of the maturity date for the credit facility, any sort of change in terms or covenants of note that went along with that?

Ed West

You are talking about on the extension for the Letter of Credit facility.

Jeff Meuler - Baird

Yeah, from the 8-K you put out like two or three days ago.

Ed West

Yeah, yeah, nothing of significance here.

Jeff Meuler - Baird

Great, thank you.

Ed West

Just extend the time-out.

Jeff Meuler - Baird

Thank you.

Ed West

Thank you. Any further questions here, operator?

Operator

Our next question comes from Jeff Volshteyn of JPMorgan. Please go ahead.

Jeff Volshteyn - JPMorgan

Good morning, thank you. Just following up on the previous question, could you give us a little more color on the debt level for the remainder of the year and probably debt ratios, by my calculation of debt to EBITDA is about three times now, how do you think that’s trending for the remainder of the year? And also as a follow-up, what is your bad debt expense guidance in 2013?

Ed West

So, on the latter part, the bad debt, I think our previous guidance was 7% to 7.5% and still we think a bit lower end of that probably near 7%. The leverage obviously is a net debt as you pointed out closed to three times that fluctuates based on liquidity, cash balances, obviously, December is a low period in terms of liquidity just because of the timing, when the starts are, the use of working capital, and cash would build during this next quarter, which would benefit and then lower the other net debt leverage that’s there.

Todd Nelson

Okay. Operator, next question?

Operator

Our next question is from David Chu of Bank of America. Please go ahead.

David Chu - Bank of America

All right, good morning. So in regards to total enrollment it was off the trough this past quarter and just thinking about your guidance do you expect enrollment trends to improve from here on now in terms of total enrollment or should it get worse before it gets better?

Ed West

Yeah, you’re talking about our starting student body that we had in January coming in it was down 11.1 versus the October start of 12.7 well, within that. As I mentioned, we would expect our new students particularly our campus-based programs continue to show progress and on that on year-over-year basis and obviously we are very focused on continuing to see improved retention. So, I think it very well could improve from here on for the rest of year and obviously that is our – all of our efforts to do so.

David Chu - Bank of America

And just a couple of questions on your upcoming debt repayment so, based on the lower Letter of Credit, how much should we expect in restricted cash on a go forward basis?

Ed West

Well, right now, the restricted cash is comprised of a couple of different elements, the largest of which is about $210 million is utilized to back the Letter of Credit facility. So that will continue to stay on there and then the other fluctuates as restricted cash, in particular for our non-term academic programs and that goes up and down. So that varies the reduction that we had with the department from the letter that we received from the Department of Education lowered the utilization of our revolving credit facility, which we used to offset the issue of Letters of Credit.

David Chu - Bank of America

Okay, and last question, can you use any of the cash to reify your debt?

Ed West

Which cash?

David Chu - Bank of America

Any form of restricted cash?

Ed West

Yeah, then the restricted is it would be restricted unless we can do other things that we talked about before as one of our strategies to free up some of that and to the extent we can free up that and no longer having that restricted, they never become available to use and for reducing debt or other activities.

David Chu - Bank of America

Okay, thank you.

Ed West

Thank you.

Operator

Our next question comes from Trace Urdan of Wells Fargo Securities. Please go ahead.

Trace Urdan - Wells Fargo Securities

Thanks, hey Ed, you threw out a 7,000 number in connection with the PLUS loan usage. Can – could you just describe exactly what that number represents?

Ed West

Yeah, its a few different things, well, good morning Trace.

Trace Urdan - Wells Fargo Securities

Good morning.

Ed West

It’s a few different things, it goes back to – it’s impacting from PLUS continuing students. So that drops during the period, also new students who we believe didn’t enroll because of just the conversations where parents could not get that financing and weren’t comfortable entering into a payment plan. And third it’s also impacting students who actually – who were continuing, who stayed enrolled, but no longer have a – parents have a PLUS loan, but now have entered in to a payment plan, which then we’ve supported on our balance sheet and between those three components that’s where rose into the 7,000.

Trace Urdan - Wells Fargo Securities

So, that’s sort of a number of students impacted, is that the way to think about that?

Ed West

Yes. Yes. And then we look at total year-over-year in terms of total students who received or whose families received a PLUS loan is also down close to that 7,000 figure mark.

Trace Urdan - Wells Fargo Securities

Okay. And then, there were some talk last quarter of the department maybe revisiting applications and you had sent out letters and did anything come of that are we still waiting to see if something might come of that?

Ed West

Well, what…

Trace Urdan - Wells Fargo Securities

With respect to the PLUS loans?

Ed West

Sure. Sure. So, what happens is if as an individual is denied of a PLUS loan, they also have the opportunity to reapply, and being able to then show whatever support for documentation because there could have been in air or something on their file for which they were denied from that adverse credit to win in there is a better probability for them being approved on the backside, obviously we’ve sent out literally thousands of letters to families, having them sort of reapply for that. And we have seen some approvals, but not of any significance going back through that. So – and we’re also not aware of any other changes that have been made to the program for the underwriting. It’s just – I’d say what’s different today than going into last summer we have – we’re fully aware of the changes, and have implemented action plans accordingly.

Operator

And our next question comes from Brandon Dobell of William Blair. Please go ahead.

Brandon Dobell - William Blair

Thanks. Hey, guys in the Art Institute business, do you feel like you’ve got a handle on kind of how the students are reacting to different price points? I guess I’m looking at your initial level of confidence around elasticity in particular within the Art Institutes, but I guess, even broadly, do you feel like you’ve got enough information to where you feel like you’ve got the right price points or know how to understand what the right price points are or is it still early to say?

Ed West

We always love more information, nothing is better than time and data and be able to do other things, I mean as I mentioned earlier it’s too early to tell, just the impact on the scholarships that we have were rolling out the increase, we’ve historically had a significant amount of scholarships, and we’re just increasing that going forward. So, it’s too early to tell. We’ll continue to work on the pricing points, that’s why it’s also one of our top priorities. As an organization, we’re committed to do different things to lower the cost of education. So, we’re going to continue to look for ways to do that.

Brandon Dobell - William Blair

And earlier you talked about CapEx plans and school plans, what should we look for as kind of benchmarks or beacons out there that would change how we think about the opportunity if you guys to open new locations, and I guess as there are different things if you see a couple of quarters of positive new enrollment growth in particular brand, does that change how you think about new school opportunities or is it going to take a longer particularly in the Art Institute given the impact of online. Just trying to figure out what we should look for to start to gaze how you guys think about CapEx and school openings?

Ed West

Yeah. We would like to – where we are we’re starting to see now is that showing positive signs for the campuses that I mentioned earlier of Argosy, South and Brown Mackie, so that’s very encouraging. We’d like to see that turning to a trend versus just a couple of quarters. So, having that being sustained, I would tell you right now sitting here looking at those systems with applications that we have going forward into this next quarter, frankly next couple of quarters looks very, very encouraging. So, we would like to see progress there, clearly we’d like to see going into the summer for the Art Institutes and having as the high school class that we are so focused on right now. And on the changes that we’ve had in online, those are coming around where Argosy, we believe with the integration and unification on with the on-ground campuses, the positive signs we’re seeing there, the improvements on applications and then also South with the financial performance, those are encouraging. So I think it’s just having a few more quarters of seeing that having overall enrollment stabilized, better understanding of the macro environment in which we are operating than we give us the confidence to begin those investments.

Brandon Dobell - William Blair

Okay, thanks a lot.

Operator

Our next question comes from the Yaying Chen of MetLife. Please go ahead.

Yaying Chen - MetLife

Hi, I know, excuse me, in the past, you had talked about potentially repurchasing some of your bonds in the open market and I was curious if you have done any of this?

Ed West

We have not repurchased any new bonds, what we have obviously historically and extinguish our sub notes, but not on the seniors.

Yaying Chen - MetLife

Okay. And then last question, do you have a sense yet of when your EBITDA is going to turn positive on a year-over-year basis?

Ed West

We worked on that every day as from function of enrollment where we see new students stabilizing and then obviously our on-going enrollments would trail that probably by several quarters once that we move solidly positive there and then EBITDA should track along with our overall enrollment. So, we are – those are obviously as front center of focus across the organization and then obviously we also benefit by the improvements that we are seeing in retention.

Yaying Chen - MetLife

Okay, thank you very much.

Ed West

Thank you.

Operator

Our next question is a follow up from Kelly Flynn of Credit Suisse. Please go ahead.

Kelly Flynn - Credit Suisse

Thanks. I had a question about the debt covenants, you made a number of comments on the call that I think can get me through this answer. But I just want to give you the chance to address it directly. How do you expect to be positioned relative to your covenants and what gets you there of all the things you mentioned, you talked about the timing change on the credit facility, the letter of credit change , some of the other things you were doing, you could just kind of walk us through that, that will be great. Thank you.

Ed West

Sure. Just speaking to December where we were obviously that’s one of our lower points from a liquidity stand point in December. But based on where we came in from liquidity cash flow our levels of EBITDA, we were absolutely fine on our covenants with cushion, where the actual ratio was 2.9 on the leverage test and fine with plenty of cushion and on the interest. So, it’s just ongoing and making sure from our liquidity stand point on that we have, the company in a net debt and our visibility through the rest of the fiscal year based on our outlook and the guidance that we have the liquidity that we have sufficient cushion to be in compliance with our governance.

Kelly Flynn - Credit Suisse

Okay thanks for that appreciate it.

Ed West

Thank you.

Operator

And our final question for today will come from Todd Morgan of Oppenheimer. Please go ahead.

Todd Morgan - Oppenheimer

Thank you. Quick things, cash taxes, you talked about them being lower year-to-date. Can you give us any sense of wide application and how you might expect that to evolve for the rest of year and just kind of the follow up I think an earlier question was asked about bad debt drivers, I don’t know if you had spoken to it directly other than say you are working very hard on trying to collections. Is there any further color you can provide? Thanks.

Ed West

On the cash taxes where the benefit of that obviously lower earnings year-over-year on the cash tax and can you come back to your repeat your second part of question please?

Todd Morgan - Oppenheimer

Sure. You made the comment about bad debt improving, and I think it also spoken to the fact that you were working hard on collections and making sure that the working capital bring, making those collections is going to perform. And I think one of the first questioners sort of asked if you could talk to sort of the process going on behind that and how expect that to evolve for the rest of the year?

Ed West

Well as Randy had mentioned a lot of the effort of on some of the activities around that having a dedicated group focusing on that which has multiple benefits, you have a team now who are really focusing on collections having the metrics around that, the performance working with students and alike. But also frees up individuals out of campus to really focus more on the relationship there in the campus the students and ongoing in education that are allowing more and more focused. So, with those activities, we are seeing some of the benefit. I’d just say it’s all about focus and on that, and we expect that to maintain for the rest of this year. I don’t think you’ll see significant ongoing improvements, but we are comfortable with the guidance that we had out there on bad debt.

Todd Morgan - Oppenheimer

Okay. And just to be clear on the cash tax front, should we expect this kind of run rate to be the norm at this earnings level or is there just sort of your timing differences its creating the reduction in cash taxes paid year-to-date?

Ed West

Yeah, I think that was more timing and Randy, I want you to have overall from a cash tax rate?

Randy Killeen

Yeah, I think that this quarter was a little bit unusual just because the way the timing of the payments works with the IRS and those have to be remaining. So, I wouldn’t expect that to continue.

Todd Morgan - Oppenheimer

Okay, good luck and thank you.

Randy Killeen

Thanks.

Ed West

Great, thank you.

Operator

This concludes our question-and-answer session. I’d like to turn the conference back over to management for any closing remarks.

Ed West - President and Chief Executive Officer

Great. Well, thank you. Thank you again for your time today. And again, we would like to reiterate that while the operating environment remains difficult, we’re seeing some positive demand trends. We are making progress on our long-term priorities, and we’re continuing to build on our commitment to students. And with that, we thank you very much for your time and have a great day.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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