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Career Education Corp. (NASDAQ:CECO)

Q4 2008 Earnings Call

February 20, 2009 10:00 am ET

Executives

John Springer – Senior Vice President Finance & Investor Relations

Gary E. McCullough – President, Chief Executive Officer & Director

Michael J. Graham – Chief Financial Officer & Executive Vice President

Analysts

Jerry Herman – Stifel Nicolaus & Company, LLC

Sara Gubins – Bank of America Merrill Lynch

Brandon Dobell – William Blair & Company, LLC

Gary E. Bisbee – Barclays Capital

Jeff M. Silber – BMO Capital Markets-US

Gordon [Lasik] – Robert W. Baird & Co.

Trace Urdan – Signal Hill Group, LLC

Analyst for Mark A. Marostica – Piper Jaffray

Analyst for Kelly Flynn – Credit Suisse

Operator

Welcome to the Career Education fourth quarter 2008 earnings conference call. My name is Mary and I will be your coordinator for today. At this time all participants are in listen only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call Mr. John Springer, Senior Vice President Finance and Investor Relations.

John Springer

Thank you for joining us on our fourth quarter 2008 earnings call. With me on the call this morning are Gary McCullough, our President and Chief Executive Officer and Mike Graham, our Chief Financial Officer. Following a brief presentation by management, the call will be opened for analyst and investor questions.

This conference call is being webcast live on the investor relations section of our website at www.CareerEd.com. The replay will also be available on our site. If we are unable to answer the question during your call please call our investor relations department at 847-585-3899.

Please note that there are a number of items impacting year-over-year comparability for both the fourth quarter and full year 2008 which were detailed in a table within last night’s press release. Unless otherwise noted, the financial measures discussed today will excluded these items. In addition, to facilitate comparisons against our previously communicated 2010 milestones, in some cases we will be referring to our performance excluding the transitional segment which is comprised of nine schools currently in teach out. The results of the transitional segment can also be found in last night’s press release.

Now, before I turn the call over to Gary, let me remind you that yesterday’s press release and the presentations made by our executives may included forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on information currently available to us and involve risks and uncertainties that could cause our actual results, performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements.

These risks and uncertainties include but are not limited to those factors identified in our quarterly earnings release, our annual report on Form 10K for the year ended December 31, 2007 and our quarterly and other filings with the Securities & Excha43nge Commission. Except as expressly required by the securities laws we undertake no obligation to update those risk factors or to publically announce the results of any of these forward-looking statements to reflect future events, developments or changed circumstances or for any other reason.

Now, let me turn the call over to Gary McCullough.

Gary E. McCullough

Once again thank you for joining us on this call as we discuss our fourth quarter and fiscal 2008 results. I want to star this morning by providing my perspective on the 2008 fiscal year and then discuss some of the areas of focus for 2009. I’ll then turn the call over to Mike Graham who will provide more detail on the fourth quarter results.

Overall, I’m pleased with our performance in 2008 as an organization. We knew 2008 would be a challenge as the year began. As was well documented, the company was in the midst of ongoing deterioration in operational and financial performance brought on by significant legal, regulatory and accreditation issues as well as a highly decentralized and inefficient organization structure.

As a result businesses representing over 60% of our enrollment base were not growing and were in a multiyear decline. In 2008 we took decisive action to arrest those declines. Our leadership team built a multiyear business plan designed to address fundamental operational issues that will position the organization for improved growth in 2010.

Despite the significant challenge we faced because of the impact of a rapidly changing student lending market, I believe our team responded well and we’ve been executing against our plan. Our plan is focused on increasing organizationally effectiveness and efficiency by simplifying and gaining scale through shared services to drive common processes across the company. We have also proactively addressed high costs areas and profit drains.

During 2008 we took a number of significant steps. We restructured and reorganized to eliminate redundancy and we realigned our incentive compensation programs to encourage collaboration in the attainment of important companywide goals. We began the process of teaching out 14 schools. These schools represented our most unprofitable operations accounting for over $70 million in run rate operating losses. With five teach outs already completed, we are progressing ahead of plan and at least eight of the nine remaining teach outs are expected to be completed by the end of 2009.

We also attacked our largest fixed cost component by exiting more than half a million square feet of excess real estate. We worked at all levels of the organization to align around a shared vision, values and performance principles. We believe our efforts increased employee engagement. Importantly, we reduced turnover in admissions by 20% and overall company turnover by 15% in 2008.

In a response to reductions in private lending alternative we implemented an internal student lending plan. We took a measured approach as we implemented the program to ensure we learn and could make refinements as we moved in to 2009. In short, 2008 was a foundational year and we took great strides towards achieving the 2010 goals we communicated last March. At that time we said in 2010 we would deliver operating income of between $225 and $270 million. we said we’d increase operating margins to the low to mid teens, that we’d generate free cash flow of $195 to $225 million and that we’d grow our population by 6% to 8% per year.

To judge our progress against those milestones it’s important to look at 2008 performance excluding the transitional segment and one-time items as these will no longer be reported with the results of continuing operations in 2010. On that basis, in 2008 we delivered $144 million of operating income, 9% operating margins, $158 million of free cash flow and 7% population growth. By these measures we’re well on our way towards achieving the milestones we set out for 2010.

Importantly, in 2008 we exceeded our internal operating plan for the first time in several years. Setting a plan, executing that plan and then delivering on it as a team is important as it shows the organization that collectively we can accomplish what we set out to do. But, despite our progress, I’m not satisfied with our ability to generate meaningful growth consistently across our entire portfolio.

Several institutions or segments in our portfolio, namely international, CTU and health were performing well coming in to 2008. The continued their strong performances during the year. In 2007, those segments represented about 40% of our student population. Combined, in 2008 international, CTU and health grew student population by 15%. They grew operating income by $34 million or almost 50% higher than 2007. Collectively, they expanding operating margins by 370 basis points. They now represent half of our student population.

In international, strong local teams have continued to strengthen and differentiate both INSEEC and Instituto Marangoni. CTU benefitted from continued growth of the military channel in the two plus two program. In fact, in 2008 CTU was once again selected by the Council of College and Military Educators as one of the best providers of education to US military personnel.

Our health education SVU has been a real success story. Its progress is instructive of what we are working to do in other parts of our organization. health has centralized its operating model and has consistently developed new programs to meet changing market demands. In 2008 the health SVU accelerated population and revenue growth for the third consecutive year. It ended the year with 10% operating margins which is a 300 basis point improvement over 2007 and an 860 basis point improvement since 2005. Importantly that growth has been achieved without the benefit of new locations, demonstrating the value proposition of the curriculum.

As we move forward, our first priority is to ensure that we continue to resource each of these growing businesses. In 2009 we’ve committed to an accelerated start up plan as well targeting seven to 10 new start ups by the end of the year. As I indicated, health, international and CTU educate about half of our students. Culinary, art & design, AIU and Briarcliffe College education the other 50% of our students and continuing to improve their results is a clear priority in 2009.

In 2008 the biggest negative impact to our profit was in our culinary and art & design segments where tightening lending markets added an additional challenge to businesses that were already under pressure. In culinary our response was rapid. We reduced excess real estate capacity and headcount where we had the opportunity. We implemented our internal student payment program and coupled it with additional on campus resources to ensure success student progress. Our actions have helped stabilize the population in the latter part of 2008.

In January we began operating a new extended 21 month culinary program which allows student access to an additional academic year of Title IV funds thereby reducing their reliance on private loans. This decelerated program also allows students to work during their course of study to offset expenses. The 21 month program combined with the experience we’ve gained dealing with students of varying credit profiles and the selective use of grants has given us new insights in to changes necessary to regrow the population in 2009. Our results in culinary are increasingly positive and in the first quarter we expect culinary to deliver strong year-over-year start growth.

Art & design which faced similar issues as culinary in 2008 is not as far along in their response but they’re making good progress. Our internal student payment program has helped them mitigate the declines in student population. However, variations in curriculum and calendars that trace to a more diverse mix of institutions have made crafting a broad consistent response more challenging.

To address this variation, in 2008 we began a curriculum alignment initiative which we expect to be implemented in the second half of 2009. By aligning curriculums, we can enable centralized program development, facilitate transfer of credit across institutions and allow for greater blended learning opportunities positioning the business for more sustainable population growth in 2010.

Finally, we talked a lot about AIU throughout the year and I think the best way to characterize 2008 for AIU was it was a year of stabilization. The year brought a number of successes and insights. External research conducted in the first half of confirmed that AIU student satisfaction is among the highest in the industry. The team transitioned to a new admissions model that is delivering higher levels of admission productivity and it’s also resulted in lower employee turnover.

AIU’s population grew by 6% and while modest, it’s the first year-over-year growth at AIU since 2005. As a result, in the fourth quarter of 2008 AIU nearly tripled operating income as compared to year ago levels. In 2008 AIU also expanded its operating margins. While I believe AIU is back on a solid foundation its growth rates lagged the market in 2008 so returning AIU to more competitive growth rates is one of our primary focus areas in 2009.

While I believe AIU will continue to improve, there’s still more work to be done. New programs will be important to the ongoing turnaround of the university and to some degree AIU has been caught in new program limbo. During its two year FACTS probation AIU was unable to launch or significantly modify its academic programs.

As you know AIU with the approval of its governing board has applied for accreditation with the Higher Learning Commission of the North Central Association. While that process is underway, AIU is once again unable to introduce new programs or significantly modify current ones. I believe the results are admirable in light of this ongoing disadvantage.

Again, let me say that I’m proud of what we’ve accomplished as an organization in 2008. We exceeded our own internal 2008 earnings goals and we’ve begun to position our organization for future success. From a business point of view half of our business is performing well and growing and we’re taking the necessary actions to stabilize the operating and financial performance of AIU, culinary and art & design. Our focus in 2009 is to make sure we turn these three businesses to sustainable growth while continuing to invest in the areas of our business that are working well.

We came a long way during the last year and I’m excited about where we are and the opportunities that lay in front of us. With that, I’ll turn the call over to Mike who will provide more detail on the financial results for the fourth quarter.

Michael J. Graham

Let me begin with a more detailed overview of the fourth quarter results and then spend some more time commenting no our student payment programs and our strong cash flows. As you review our results for the fourth quarter and for the full year, please take note of the following items. First, there are a number of items impacting year-over-year comparability for both the fourth quarter and for the full year which are detailed in a table within last night’s press release and are available on our website www.CareerEd.com under the investor relations tab.

Unless otherwise noted, my discussion on earnings and results during the remainder of this call will excluding the following significant items: first, for the fourth quarter 2008 within operating income there were $1.6 million in severance charges for headcount reduction actions in the art & design and corporate segments; here were $1.9 million in non-cash charges related to excess space and reduction in space requirements. Those were primarily in the art & design and culinary arts segments; and, there’s $3.6 million in legal settlements within the culinary arts segment for a settlement of an ongoing contract dispute.

In total, this is $7.1 million of significant items in the 2008 quarter which represents $0.05 per diluted share. Second, in the fourth quarter 2007 there were $6.5 million in legal settlements in the health education settlements and $28.2 million in non-cash impairment charges of which $1.7 million was in health and the remainder in the transitional segment. The total impact of these 2007 significant items was $34.7 million or $0.24 per diluted share.

Additionally, in the fourth quarter of 2008 we completed the teach outs in three schools: IADT Pittsburgh; Gibbs Piscataway; and Brooks College Long Beach. All of which have been classified in our transitional segment during the first three quarters of 2008. The financial results of these schools including a $4.6 million non-cash charge for remaining lease obligations are now reflected within discontinued operations.

Our press release issued last night included quarterly statements of operations for 2008 and for 2007 on this basis so you can adjust your models accordingly for this move to discontinued operations. Now, on to the fourth quarter results, total GAAP revenue was $431.8 million in the fourth quarter down 5% from fourth quarter of last year. Excluding our schools within transitional segment which are currently being taught out, total revenue decreased about 1% primarily related to schools most heavily impacted by the destructions in the student lending markets.

We reported fourth quarter earnings per share from continuing operations of $0.38 in the fourth quarter including the $0.05 of non-comparable items in the quarter. The progress we made in 2008 may not be readily apparent from our comparative statements of operations due to the number of significant charges we have taken during the year as we restructure the company and taught out the unprofitable schools.

Let me highlight several important points. First, we’ve reduced our cost per start from $5,300 in 2006 down to $4,400 in 2008 a 17% reduction. Despite the challenges in student lending we’ve increased overall population across the company by 7% in the last year. We improved our retention, our show rates and our conversion rates of new student interest in the fourth quarter versus prior year and we now have experienced three consecutive quarters of operating margin improvement in AIU online and six consecutive quarters of operating margin growth for CTU online.

Let’s turn to the operating segments. For the university segment fourth quarter 2008 revenue was $177 million, 2% higher than last year. Operating income was $43.1 million which is 63% higher than last year’s fourth quarter. Operating margin was 24.4% in the quarter up 900 basis points from last year’s fourth quarter driven by expense reductions.

Revenue for AIU was $87.4 million flat with the fourth quarter 2007. A 7% increase for population was offset by a decline in revenue per student driven by changes in degree mix. AIU operating profit in the quarter was $18.5 million as compared to $6.6 million in last year’s fourth quarter. Total operating expenses were 15% lower, again driven by lower academics and admission expenses resulting in operating margin of 21.2%.

Revenue for CTU was $79.6 million up 9% from the fourth quarter of 2007 as a 16% growth in our population more than offset a slight decline in revenue per student again, related to shifts in degrees. Fourth quarter starts growth of 21% and the population growth of 16% shows the benefit from the two plus two program and the starts as the students have now matriculated in to the bachelor degree programs.

As we enter 2009, remember we have anniversaried the two plus two shift and our starts will be more in line with population growth. We also believe the fourth quarter starts may have pulled forward some of the potential Q1 2009 starts as a tuition increase went in to effect on January 1, 2009 for CTU. CTU operating profit was $23 million in the fourth quarter up 25% versus last year with an increase in operating margin from lower admission expenses and fixed cost leverage.

Also in university, revenue for Briarcliffe College was $10 million down 18% from the fourth quarter 2007 reducing the overall reported university segment growth. Operating income of $1.7 million was almost unchanged from the year before. Fourth quarter 2008 revenue for culinary was $77.3 million down 18% from the fourth quarter 2007 reflecting a 12% reduction in population.

As a reminder, the year-over-year starts comparison for culinary arts is impacted by the timing shift of our traditional fall start which occurred in the third quarter 2008 compared to the fourth quarter 2007. This timing impacted resulted in 1,100 fewer starts in the 2008 fourth quarter and excluding this timing impact starts were down 12%. Excluding the significant items I mentioned in my opening remarks, culinary operating income would have been $3.7 million with an operating margin of 4.8%.

As Gary mentioned our health education segment had a strong finish to the year with fourth quarter 2008 revenue for the segment of $64.4 million up 19% from the fourth quarter 2007 driven by a 20% increase in population and a 21% increase in starts. Operating income was $10.4 million in the fourth quarter almost double the $5.4 million in operating income in the fourth quarter 2007 excluding the significant charges. Strong revenue growth drove fixed cost leverage resulting in a 600 basis point increase in operating margin to a record 16.1%.

Art & design revenue was $67.5 million in the fourth quarter down 8% from the fourth quarter of 2007 reflecting a 5% reduction in population and 9% lower starts in line with the rates of decline experienced in the third quarter. Operating income was $11 million, after adjusting for the significant items mentioned earlier down 21% from the fourth quarter 2007 as the lower revenue more than offset a 4% reduction in total operating expenses year-over-year.

Our fourth quarter 2008 revenue in the international segment was $35.7 million up 10% from the fourth quarter last year. Impacting the year-over-year comparability in international revenue in the quarter was unfavorable foreign currency impact of approximately $1.9 million versus the prior year. Starts were up 8% contributing to a 10% increase in population versus the fourth quarter of 2007.

The international segments operating income was $8.1 million in the fourth quarter versus $9.4 million in last year’s fourth quarter reflecting the timing of certain administration expenses which we do not expect to recur in the first quarter 2009 and also slightly unfavorable currency impacts. Most importantly, full year operating income was up 45% from 2007 and operating margin expanded by 160 basis points.

Now, let me update you again on our internal student payment programs. The total balances outstanding on our internal payment program as of December 31, 2008 were approximately $20 million. In 2009 we expect an increase in originating volume related to a modest expansion of our underwriting criteria beginning in the early part of 2009. This along with annualizing the impact of our existing payment programs results in an estimated additional balance sheet use in 2009 within a range of $30 to $50 million. All these amounts are before the allowance for doubtful accounts.

In general we are pleased with our internal lending programs and internal payment programs as we are experiencing strong levels of retention and success for students who have utilized our plans. We’ve gained important experience in the past year and we’re finding ways to continue to expand our payment programs when paired with institutional activities that better help students succeed in completing their education programs.

Our overall student receivable collection efforts remain strong. Our annualized DSO was 15 days, up slightly from 14 days at the end of 2007. While they are still being finalized our initial or preliminary 2007 cohort default rates do not reflect a material change or material increase over 2006. Excluding our transitional schools our final cohort default rate for 2006 was 8.2% and our preliminary 2007 rate is 9.1%.

Our operating cash flow remains very strong despite the reduced revenue due to the student loan market contraction, operating losses experienced in our teach out schools and the cash portion of charges associated with the organizational reductions and the real estate rationalization. Additionally, our balance sheet remains solid with $509 million in cash and investments and no outstanding debt as we paid down all remaining borrowing under our revolver in the fourth quarter.

For the year we produced $186.7 million of operating cash flow. Capital expenditures for the year were $53.9 million or 3.2% of revenue. Free cash flow which we define as cash flows from operations less capital expenditures were $132.9 million for the year. Gary noted that we are on plan through 2008 against our previously communicated 2010 goals. Again, in judging our progress against those milestones for 2010 we need to exclude the one-time items as well as the transitional segment and discontinued operations.

On that basis, we delivered $145 million in operating income and slightly higher free cash flows than that in 2008. We are well on our way to our 2010 milestone objectives of $225 to $270 million in operating income and $195 to $235 million in free cash flow. After the internal investments of capital expenditures, student payment plans and the new campus startups, it remains our intention to return cash to shareholders within our share repurchase program.

In the past three quarters we have not repurchased shares due to concerns by the company’s board of directors regarding change in control provisions in the company’s charge based compensation plans. We expect the change of control concern will be resolved in the first quarter 2009. With our largest shareholder owning 17.7% of our shares outstanding as of 12/31/2008, we can repurchase up to 10 million shares without increasing the shareholders ownership to 20%.

With that, we’ll now open up the lines to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jerry Herman – Stifel Nicolaus & Company, LLC.

Jerry Herman – Stifel Nicolaus & Company, LLC

Mike, I’m wondering if you can maybe help us with regard to the restructuring charges, how they hit each of the individual line items in P&L, educational services, G&A and so on and so forth just to get some guidance with regard to ’09 modeling?

Michael J. Graham

If you look at the $7.1 million of charges this year, for the most those are all within the general and administrative line.

Jerry Herman – Stifel Nicolaus & Company, LLC

How about the full year numbers Mike?

Michael J. Graham

We’ll talk later. I’ll give you some information later. I don’t have the full year detail in front of me in terms of each line item by each segment because I would image you’d need it by segment as well?

Jerry Herman – Stifel Nicolaus & Company, LLC

That would be helpful. Then maybe directionally can you talk a little bit more specifically about the segments. You guys did a good job in the investor day talking about where your goals will be for 2010. Gary, could your reference directionally where those trends are for ’09? I guess you enter ’09 with some pretty good momentum in online and healthcare. I guess one question would be how bad should it get in culinary and how much deterioration might there be in art & design?

Gary E. McCullough

I’ll probably answer this more broadly than you are looking for. I would tell you that our focus continues to be on driving revenue growth and start growth in our online business. We clearly think that’s an area of focus as we move forward in the company we’ve got to make that happen. When you look at health we intend to continue to expand in our healthcare business. Our start up efforts are primarily focused in our healthcare business based upon our geographic presence and the opportunities we see available in the marketplace.

When you look at what’s happening in our culinary business, we continue to like culinary, it’s been a good business over the course of the years. As we said early in the year when the student lending issues began to happen, it affords us the opportunity to look at our student base, make the appropriate changes to grow the business in the future. We’re executing against that right now.

As I said in my opening remarks, we expect that we’ll see strong start growth year-over-year in our culinary business here in the first quarter and that’s important because we’re actually going up against a period of time a year ago where we had ample lending available to students. So, I think what we have done in our culinary business is more than just admirable, it’s been heroic in moving the business forward and we believe that business will grow as we move through 2009.

I also said our art & design business has been more of a challenge because we start with a much more diverse mix of schools. We are working much more forcibly going forward to align those school to go forward but, I think that will continue to be an area of challenge for us in 2009 as we move forward. International will just continue to push forward, we’ve got a solid plan.

So, when we laid out things back in March we talked about those segments of the business have been much more of a challenge based upon some of the things that happened beginning around the time we had our investor day. In culinary and art & design I think culinary has made progress and we’ll begin to see a turn but we’ve got more work to do in art & design.

Michael J. Graham

It’s not our intention obviously to give ’09 guidance so we do stand behind the 2010 milestones. I think as you look through the P&L from a trajectory standpoint we’re at the lower end of our range on the revenue side based on some of the issues we’ve experienced in art & design. If you look at our cost per start and our advertising we’re well on the way and probably ahead of the numbers we gave you there.

Our bad debt has probably ramped up slower because of the use of the lending programs and our default ratios on CDRs and other things are less than we thought. And, we’re ramping up our startup activity. We’ve committed to ramp up start ups in 2009. We think it’s the right thing to do with our cash because the paybacks are great. That will hurt 2009 a bit obviously as we open up more start ups but that will help benefit 2010.

Jerry Herman – Stifel Nicolaus & Company, LLC

Just a last one if I can, as we look at 2009 the biggest restructuring charges will really be the lease exits. I guess what I’m trying to determine is, is there any material restructuring action that are going to happen in ’09 that will in fact result in meaningful charges above and beyond the lease exit write downs that you guys had mentioned?

Michael J. Graham

As you look at the charges that we traditionally have talked about, the three buckets are severance, legal settlements and real estate. Real estate we will have a significant charge, we’ve talked about it being $80 to $100 million in the past at the end of ’09. It will come in different quarters as we teach out the schools obviously. We’re still being aggressive in the real estate market exit of the real estate.

It’s a very difficult market for sublet however, landlords are very eager with our ability to use cash to buyout obligations, cash today for landlords versus a 10 year flow in the future can be very appealing from a discount standpoint. So, on a disciplined basis if we see opportunities to remove real estate we will do so.

Legal settlements we never comment on legal activities. Settlements do occur if it is in the best interest of the company to put things behind us so I can’t give you any guidance there. From a severance standpoint we have no large severance plans for 2009. We have a great team of people here, we’ve done a good job getting our cost down and we’ve right sized our business to the revenue stream and our focus now has turned on growing the business versus taken even more additional costs out.

Operator

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

Sara Gubins – Bank of America Merrill Lynch

AIU online really had a significant rebound in profitability on a year-over-year basis, could you give some more details around this? And also, do you view the fourth quarter rate as a stable rate or is that more seasonal?

Michael J. Graham

I would definitely point you to a seasonal impact in the fourth quarter on AIU as we always have advertising expenditures given the holidays tend to be reduced in the fourth quarter so we do have a seasonal pattern that does expand some of the margins in the fourth quarter. The university has done a phenomenal job in its cost structure. In terms of admissions expenses we continue to experience our peer model being successful, going to the qualifier model with the initial call and then the experienced rep on the back end of the call. That has resulted across the board in about a 20% reduction in reps on the university businesses including AIU.

Our academic expenses has been aligned to the population which is a very good trend. There’s a little bit improvement in some of the occupancy expense but not much more. So, hopefully that gives a little bit of color but there is seasonality to it. But, as we now have better visibility on the revenue and as the population starts to pick up we’re trying to stabilize out that margin and we’ve had three quarters in a row of margin improvement which we’re proud of.

Sara Gubins – Bank of America Merrill Lynch

Could you give an update on the size of enrollment rep force? How productivity has been trending there? And, is that organization now at the right size or do you need to return to growing it to deal with increased lead flow?

Michael J. Graham

I think we have now stabilized our admissions reps somewhere around 2,000 for the last three quarters. That is down about 18% to 20% from this period last year. The peer model started last year in the fourth quarter so we have now anniversaried it so I don’t anticipate in the first quarter 2009 we’ll see any more reduction from the peer model. That said, our lead flow is very good now and we are in the position of adding reps.

We did the conversion of peer second, third quarter. We learned a lot, we staffed up to do the peer and now as we see the lead flow, in the first quarter we were adding reps to handle the lead flow and help the university performance.

Gary E. McCullough

I want to reiterate what Mike said. Last year over a couple of calls we were asked whether we thought we might have cut too far. The fact of the matter is that we weren’t as efficient and as effective as we needed to be so we felt like it was appropriate to make those changes. We stabilized the model, we understand what we’re doing now, we’ve realigned jobs and expectation and based upon that we feel comfortable beginning to add back because we want to make sure those adds are all productive for us moving forward.

Sara Gubins – Bank of America Merrill Lynch

Just last question can you give us an update on job placement trends for your graduates?

Gary E. McCullough

We obviously think that this is an issue that we’ve got to be concerned about as an industry and not just here at Career Education given what’s going on in the macro environment. To date, we haven’t seen significant changes in demand for our graduates but it’s something we’re keeping an eye on. We continue to experience our strongest placements in our culinary business where job placements are in excess of 90% in most cases but again, it’s a challenge that we foresee that might be out there and we’ll stay attuned to it.

We have across most of our schools begun invest in personnel to help from a placement and student success point of view and we’ll continue to make that investment because we think it is necessary going forward.

Operator

Your next question comes from Brandon Dobell – William Blair & Company, LLC.

Brandon Dobell – William Blair & Company, LLC

First, on the numbers side the quarter’s G&A expenses on a dollar basis is that a decent run rate or kind of a starting point to think about how we should look at the quarters in 2009? Or, is there anything from a king of extraordinary seasonally perspective like you talked about AIU profitability but from overall G&A are those dollars about how we should think about the business right now?

Michael J. Graham

In terms of the model I would look at taking the one-time items out that we disclosed to you. I would also to Sara’s point make sure from a seasonality standpoint of advertising that that’s thought through. Again, we’re seeing more lead volume and we’re seeing more advertising dollars put to work and more reps as we go in to the beginning of next year so that will have an impact.

You have the normal inflation. We’ve annualized out our bonus so we do have an increase in our expense 2008 versus 2007 because the company made their numbers for the first time since 2005 and we paid our bonuses so that is normalized out and we expect that full bonus accrual to be there in 2009. So, I would think about those as you do some modeling.

Brandon Dobell – William Blair & Company, LLC

Over in AIU from a new program perspective, any sense of kind of timing wise when you guys are going to get back to normal operations rolling out new programs [inaudible] the spits and starts with opportunities to do so. Should we think about a big wave of new opportunities this year or is it going to be a 2010 timeframe for you, really get a chance to spread your wings?

Gary E. McCullough

I’d like to be able to say I know the exact timing on when AIU will receive its accreditation but we don’t know that. Again, we’re moving through the process, there’s a visit that’s scheduled in early March and the Higher Learning Commission is meeting I believe in June and beyond that. But, we have not guarantees as to what the timing might be so as I said earlier, we’re caught in limbo.

But, from a macro point of view, across the company we introduced about 70 or so new programs in 2008. As I look at our pipeline today we have about 90 or so in the pipeline and AIU has its fair share or more than its fair share of the things that are in the pipeline. So, we do expect that when we finalize are in the clear from an accreditation point of view we’ll make those applications so we’re prepared to go. But, that’s the best I can tell you because there’s no guarantees on timing.

Ideally, we’ll see this happen in 2009, we’re certainly doing everything we can to make that happen. The team is working pretty dramatically to make sure that they have everything that the commission is looking for to go forward.

Brandon Dobell – William Blair & Company, LLC

Kind of in line with that, as you think about growth in AIU online, it’s been relatively slow compared to the overall peer group maybe. Is part of the issue there the inability to open new programs or are you guys kind of taking it easy there to kind of make sure the business is operating efficiently before you kind of let the growth accelerator? I’m just trying to get a feel for what the trajectory there should look like relative to what else we’re seeing in the overall economy and from your peers in the online space.

Gary E. McCullough

AUI online as part of AIU as a more macro institution, they are not separate so the same issues we have with regard to new programs exist there as they do on the on ground space. So, we believe we have been hampered by our inability to create new programs and introduce new programs. When you think about what goes on in the marketplace, students search, things change over time and AIU has be in effect hindered for about three years in introducing new things.

So, we’ve got a situation where the programs frankly are not as robust as we want them to be. We don’t have any governors on growth except for some of those that have been imposed based upon the situation and we’ll ramp it up as quickly as we can. Again, I’d step back and say given the handcuffs the university has been operating under, I think they’ve done a pretty terrific job.

Brandon Dobell – William Blair & Company, LLC

Final question for you on cohort default rates, I’m assuming you guys have the draft data in hand. Any color on where you’re coming out? I guess a larger question, if they’re already significant movements in the different schools CDRs. Does that impact how you guys think about running those businesses either from a bad debt reserve perspective or a retention perspective? What do you do if you see a cohort default rate move dramatically one way or another? But, in particularly I want to get a sense of kind of where you’re coming out on those CDRs?

Michael J. Graham

From our standpoint we’ve had three years in a row of declining CDRs and improving CDRs, so we’re really pleased with that. A lot of that was the efforts made here to centralize collections and also the lending criteria that we used on our own work. As I disclosed on the call we had a 90 basis points worsening in the CDRs from about 8.2% to 9.1% excluding transitional. Honestly, I’m pretty pleased with that given the economy and given the environment.

It shows well for what we have done. I do have in hand a range, our range has not materially changed from last year. We have nothing anywhere near 25% consistent with last year. It reinforced our need that as we lend off our balance sheet, if you want to call it lending, as we do payment plans that as we continue to focus on student success and couple it up with those students who really want their education and are really graduating and are getting placed. We’ve done it well. We’re having really good cohort default experience. 90 basis points in this economy, we’re very pleased with that.

Operator

Your next question comes from Gary E. Bisbee – Barclays Capital.

Gary E. Bisbee – Barclays Capital

Let me ask my first question on costs, I understand the reps down year-over-year and the improving efficiency as well. Can you give us a sense for what other things are benefitting university segment on a cost item? I was sort of amazed that basically with $4 million sequential from the third quarter revenue growth you had $15 or $16 million improvement in profits so clearly cost dropped a lot just in the quarter not just year-over-year. Was a lot the marketing and the lower reps or what else is going on?

Michael J. Graham

I think you have a combination of a lot things, you have the lower reps, you’ve done a good job on faculty and academic costs. We no longer have recourse in that number, it’s gone to bad debt but our recourse use in that business was not significant. We are experiencing as most other people are experiencing from a lead cost standpoint for media a reduction, our aggregated costs are also slightly softer but not as material as we [inaudible], we’re more indexed towards aggregators so that’s not going to have as big of an impact.

We’ve just done a great job as institutions as CTU and AIU, as institutions. They’ve just done a wonderful job acknowledging where they are in population, acknowledging where they are in costs and making sure that the organization cost structure is aligned to the revenue stream. I can’t point to anything more but just give credit to those institution for doing a really good job this year.

Gary E. Bisbee – Barclays Capital

Then understanding this is usually the seasonal high point for margins how should we think about the ability to get margin improvement in this business over the next couple of quarters? I assume it probably wouldn’t be as large in basis points and absolute increases but are you very confident that there is the potential for substantial margin gain in university in ’09?

Michael J. Graham

I think for university what the focus is now is shifting back to a growth platform. As Gary said, we’ve talked about ramping up the reps coming in to the first quarter. We have the new programs that are going to go through CTU and hopefully through the AIU process. The model is wonderful on a fixed cost basis as you add population. So again, I think it’s less about focusing on cost reductions and cost containment as it is making smart investments in advertising and in reps and getting the population back.

Now, CTU population year-over-year, a huge increase and AIU population up so the starts don’t tell you the whole story, the population tells you the whole story which includes retention and it includes starts and the populations are growing.

Gary E. Bisbee – Barclays Capital

Then just on the healthcare business, you said most of those new startups would be in that. Can you give us any sense for what type of cost you’d expect? Are we still $1 million a campus type of thing? How much should we think about maybe cap ex rising based on those and any sense when in the year you’ll have those new schools opened?

Michael J. Graham

We’ve done startups in the past so within our cap ex number of 3.2% of revenue, startups have been accounted for on a capital basis, the ramp up that we’re adding would not bring cap ex over 4% of revenues so within that 3% to 4% of revenues, cap ex you’re there. In terms of quarters, it will be more measured we’ve had startups in the pipeline, we’re accelerating startups.

If you want to try to model some of the hit next year as we go through take a look at the press release where we give a schedule of the existing startups and you can see the average drain on profitability the startups have to model out what a large number would be.

Gary E. Bisbee – Barclays Capital

So evenly spread throughout the year, is that a reasonable assumption to use at this point?

Michael J. Graham

In terms of evenly spread I would say the openings will be more back half loaded because the openings will be more back half loaded. The revenue stream will not be until 2010 so you’ll see the cost impact in ’09. From a build out stand point you have the occupancy but the real cost comes from when you staff up the admission size, the advertising side right before opening.

Operator

Your next question comes from Jeff M. Silber – BMO Capital Markets-US.

Jeff M. Silber – BMO Capital Markets-US

Just a quick follow up on the startups for this year, are these all in new locations? Are you doing any co-locations with existing campuses maybe in some of your other segments, is that something you’re thinking about?

Gary E. McCullough

For the most part I’d say we’re looking at new locations in health. There are some areas where we have underutilized space and we’ve accessed those markets to determine whether it makes sense to locate in to them and where it does make sense we’ll take advantage of the space as long as the locations are based upon the marketplace.

Jeff M. Silber – BMO Capital Markets-US

This is more of a modeling question, do you see in 2009 on a quarterly basis any difference in terms of starts by some of the different schools that are in existence like we just saw with culinary in this past quarter, anything we should be aware of?

Michael J. Graham

Obviously you need to be aware of Sally Mae recourse going away at the end of March 31st. In 2007 we still had access to recourse funds and we anniversaried that out starting the first of April. I would look at that I would also look at the summertime dip we experienced last year in our university business because of our peer model so we did have a short fall in starts in the second quarter and in to the beginning of the third because of the conversion of peer so that will anniversary out.

Jeff M. Silber – BMO Capital Markets-US

Sorry, I was just referring to the calendar issue in culinary how last year the fall start was in 3Q as opposed to 4Q last year, anything like that coming up in ‘09

Gary E. McCullough

I believe the culinary will go back to the ’07 calendar so you’ll see the same kind of reversing shift here in 2009.

Jeff M. Silber – BMO Capital Markets-US

Anything else in the other segments that we need to be aware about?

Gary E. McCullough

Nothing specific that I can think of, no.

Jeff M. Silber – BMO Capital Markets-US

I’m starting to go back to the cohort default rate question but since you have the detail in front of you are there any schools that we need to know about that broke the 10% threshold in ’07 that were not there in ’06?

Gary E. McCullough

I’m not prepared to talk about that right now because you’re still in a challenge standpoint so we still have challenges to go back to the department on what they are. There were no big shifts in our model from a school basis, there was no change in trend or any dramatic shifts but I’m not prepared to go OPID by OPID.

Jeff M. Silber – BMO Capital Markets-US

Just one other numbers question, you mention in terms of the one-time charges the severance charge is broken out between art & design and corporate and the lease exit charges was between art & design and culinary if I remember correct, can you just give us the number of how those fell out by segment?

Gary E. McCullough

On the real estate charge about three quarters of it was art & design and a quarter of it was culinary. From the severance standpoint the bulk of the severance was in art & design.

Operator

Our next question comes from Gordon [Lasik] – Robert W. Baird & Co.

Gordon [Lasik] – Robert W. Baird & Co.

Can you just give a quick update on the private lending environment if you see any changes there over the last couple of months? Then, kind of an extension of that is I think I heard you say that you’re expanding your underwriting criteria for your internal loans. What gives you the confidence to do that going forward? Are you seeing any changes within the student base that you’re lending to currently?

Michael J. Graham

The lending environment remains difficult for our students as you know. We have not had a change in any of our lending pools either in the FELP or the private loans standpoint since first quarter 2008 so our lending base for our students and the options remain steady. I’m not sure we’ve seen a lot of help to the lending community from [inaudible] or any of the other programs, we haven’t seen any changes that way.

From our standpoint we’ve learned a lot. We’ve learned a lot in eight months or nine months of underwriting. We’ve learned of putting student success coordinators in the school and pairing those up to make sure the student is doing well, that their academic progress is on, that they’re working, that their living arrangements are well taken care of. We’ve done a great job of pairing that up and because of that we’ve always said that we would use our balance sheet around student success, it wasn’t strictly about economics.

As these people become seasoned in the schools, as we roll out student success to places like art & design from where it started in culinary, as we roll out the program in 21 months versus 15 months it helps us in culinary to have more confidence about student success. Also, just from a trend standpoint we’ve looked at other thing like using more grants to a student or looking to make sure that from a calendar standpoint and other institutions that we’re maximizing the use of Title IV.

We’re just becoming much better internally with our systems and our people about finding better answers that work with the students. It was a pretty big shock to the system as you can imagine nine months ago losing all of Sally Mae recourse lending which cost us we think, as we said before, somewhere between $75 and $90 million of revenue. That said, our revenue year-over-year was flat so we’ve done a good job recovering but, it took us sometime to be very careful not to go backwards on CDRs and everything that we’ve done from a payment plan standpoint.

Gary E. McCullough

I just want to reiterate what Mike said what we’ve worked to do is to pair up our lending with the ability in the school to support the students so they can stay and graduate and move on and get a job. What we’re not doing is panicking at this point in time and opening up the bank here to anybody that comes in the door. We were very measured in the way we got going in this.

We stepped back, thought about what we’ve levered we’ve shared that learning across the business so people really understand what’s going on and we want to replicate those things that are working in other parts of our business so we will continue to be measured in our approach but based upon what we’ve learned we believe that we can open up just a bit more and that will give us more learning and we’ll make the adjustments sometimes in 2009 if it’s warranted to do that.

Operator

Your next question comes from Trace Urdan – Signal Hill Group, LLC.

Trace Urdan – Signal Hill Group, LLC

Gary, I’d like to kind of go back and maybe push back a little bit on this question of the university business really being held up by new program introductions. I’m not sure that intuitively that I really get that. You guys have a pretty wide range of program offerings between AIU and CTU and there are plenty of competitors that are putting up stronger growth off of a more narrow base of programs so maybe you could address that a little bit and then speak to whether there’s anything else that needs to be tackled in order to accelerate the growth in university?

Gary E. McCullough

Trace I’d like to draw the distinction between university and AIU and CTU because when you step back if you take a look at CTU which have been consistently introducing new programs, making the changes that they need to make, that business has grown I think quite nicely and in line with what you see in the broader market.

In fact, if you take a look at the numbers, I think we’re in significant double digit growth 16% to 17% in online and we’re growing at 15% on ground at CTU. Conversely, AIU has been hindered both from a reputational point of view and from a programmatic point of view and we have done a lot to change things in the business and they’ve had to absorb a number of shocks as we look at the business.

So, AIU we believe based on the data has been hindered and this is both quantitative and qualitative data that we speak from. So, rather than talk about university I’d ask that you think about it as AIU and CTU. CTU we want to keep driving the heck out of, they’re doing a great job. AIU has pent up programmatic demand that we can’t get approved at this point in time. We believe that will help drive things.

Having been in a number of businesses, when my product go stale it was more difficult to have people make the buy, the purchase when they had other alternatives that seemed better in the marketplace and I believe that’s where we are.

Trace Urdan – Signal Hill Group, LLC

Anything more specific that you can point to in terms of what – I just don’t really intuitively understand what that means. I get conceptually this idea that the product could be stale but I’m just not sure at looking at your list of program offerings where you feel like there’s something that you don’t have in the marketplace that other people have. That’s the place where I’m just not getting it.

Gary E. McCullough

Personally, I don’t think this is a question of do we have a certain program of study across the board, I think the question becomes underneath that are the classes as up to date and as robust as we would like them to be reflecting new learnings and changes in the marketplace. I would say that information that we’re getting back from our teams internally that they believe as we shop, as we look at other competitors as we get feedback from perspective students that our programs in some cases are not as up to date or don’t appear to be up to date as some of the competitive offerings that are out there.

I’m not going to give much more color than that except that we’ve been pretty attuned to our mission folks who talk to us about objectives they see in the marketplace and what we see in the overall marketplace. Again, all I’d ask you to do is think about this not as university but think about it as two very large institutions that are starting from different places.

Trace Urdan – Signal Hill Group, LLC

Well, it’s probably a larger discussion, I don’t want to have it here on the call. The other thing I wanted to ask about was Gary, you did a pretty great job when you came in at really taking a hard look at all of your assets and the schools that you had and obviously we’re in a different place now and I’m wondering if you have some sort of an ongoing program of examining schools, specific campuses, schools if you can tell us sort of looking at these things annually or quarterly to determine whether you need to pull any bigger levers here as you look forward.

I guess I don’t want to be coy, I guess I’m thinking in terms of art & design. How much more do you invest in art & design before you feel like you need to make a bigger change there?

Gary E. McCullough

Let me talk about it from a macro point of view then I’ll come back without probably giving you all the nurturing you want on the question on art & design. We look at our businesses both in the whole and by individual campus. One of the things we did this year for the first time is that we said to our campus presidents that we would on a quarterly basis rank them on a number of different dimensions. It’s revenue with starts, it’s retention, it’s a number of different things that we would rank them top to bottom and that we would help them understand how they are doing and that we would reward them top to bottom based upon their rankings at the end of the year.

So, for the first time ever we’ve done that. We’ve been very overt with our campus presidents about where their campuses rank, why they are where they are and how that will impact them from a compensation point of view, from a bonus point of view. So, we’ve done that and we’ll continue to do that. That is also instructive to help say there are some that are lagging and we’ve got to focus on them to help make them better and there are some that are really working well, what’s working there that we can reapply across the board to the ones that are lagging.

So, it’s an ongoing review. I will tell you that at this point in time our focus is not on taking more out from a teach out point of view but more helping the ones that are struggling become better because in most cases when you look at where they are they’re struggling and they’re on the margins and we think we can improve them.

When I think about art & design, clearly there are challenges in that business so we’re not asleep at the switch here in terms of looking at what’s happening in the macro marketplace, understanding what’s happening. Art & design consists of colleges, the old colleges division that we have which is a variety of schools that very [quadramatically] at AIDT which is a bit more homogenous.

So, we tend to like homogeneity because you can drive things across the system and get more system wide answers to things. So, as we look at them just like I talked about university being bifurcated between AIU and CTU and some degree Briarcliffe, I think about colleges and I think about our AIDT business and where we can drive scale we are tending to have a better outcome in our business so we’re looking to drive scale.

We’re looking to move some of those colleges towards our academy model so we can improve across the board. Again, I won’t give you all the nurturing you’re looking for. I will tell you that as we’ve come through the end of the year we’ve looked at the business and we do have points of view about the things we need to do to continue to shape our business going forward.

Trace Urdan – Signal Hill Group, LLC

Could that striving for scale actually lead you in to making acquisitions potentially?

Gary E. McCullough

Potentially.

Operator

Your next question comes from Analyst for Mark A. Marostica – Piper Jaffray.

Analyst for Mark A. Marostica – Piper Jaffray

A follow up to Trace’s question there may be looking at AIU from a different perspective. If you look sort of [inaudible] programs and we’re looking at growth at AIU can you sustain the last quarter’s run rate on a start growth basis for ’09? And also can you just mention how retention is trending at AIU?

Michael J. Graham

From retention the retention trend has been positive at AIU. The matriculation rate of the students from the associates degree to the bachelors degree has stayed stable at AIU. We have seen no material shift. The starts, we’re not here to give guidance for 2009, we’ve been doing starts someplace below 105. I think to Gary’s point about the programs the institution is working hard and it’s not just about programs it’s about the brand and the history and everything that we’ve gone through with the business that just makes it a little more uphill.

Again, pleased with 7% population growth and I think going forward in the year it is our intent to grow the business even further but not ready to say what we think a range of starts might be.

Analyst for Mark A. Marostica – Piper Jaffray

Then Q4 saw some stabilization on cost of ed services on a year-over-year basis and it looks like for the first time in several quarters. I’m just curious why that was and is that sustainable in ’09?

Michael J. Graham

On a comparable basis if you look at ed services from the P&L remember you do have the transitional schools in from the previous year. So, on a company basis our education services and facilities went from about $166 million down to $158. Remember, you are teaching out schools so within there we have about half of that improvement is probably related to transitional.

Also remember historically educational services facilities has taken the recourse fee and the recourse fee at 25% of the loan volume at Sally Mea in the past is no longer there from a quarterly standpoint year-over-year. So, I would argue that we’ve had inflation in educational services, we’ve had efficiencies driven from class size and from organizations. The biggest year-over-year change in the quarter were the combination of recourse and transitional.

Analyst for Mark A. Marostica – Piper Jaffray

How much would you say recourse would have been in the quarter? You said about half was transitional and roughly speaking on the recourse?

Michael J. Graham

I believe if you look at our recourse fees in the last year they ranged someplace between $15 to $20 million for Sally Mae. If you go back to our 10K from 12/31/07 and find the exact number. There’s no seasonality to that so I would go back and look at the disclosure we made last year and divided it by four.

Analyst for Mark A. Marostica – Piper Jaffray

Then just one last quick one, regarding your 2010 op income guidance, is there an implied leave of bad debt expense as a percent of revenue that you can share?

Michael J. Graham

If you remember from our investor day back in March we had implied a 4% bad debt rate across the country in 2010 based on our lending programs. In the fourth quarter our bad debt expense was 2.6% across the company so we have 140 basis points room as we go in to 2010.

Operator

Your next question comes from Analyst for Kelly Flynn – Credit Suisse.

Analyst for Kelly Flynn – Credit Suisse

One quick clarification, is the $30 to $50 million of internal lending, is that incremental to the current $20 million balance or is that the whole?

Michael J. Graham

That would be incremental.

Analyst for Kelly Flynn – Credit Suisse

Secondly, can you give big picture color on the company’s approach to balancing margins and at the same time ensuring the quality of the various programs and that the needs of students continue to be met? Some commentary there would be helpful.

Gary E. McCullough

When I think about some of the issues that led to my arrival here in the company, there were places where it wasn’t clear that people saw the value in what we were doing. So, that’s an issue for us. The communication that we have taken and the approach we’ve taken with our organization is to make sure that they understand that quality must come first, that we must deliver to students what we promised them when they sign up for courses.

So, we have worked to balance our approach while we are taking costs out we have reinvested back in the campuses or we’ve allowed that investment to happen. We’ve worked to ensure that we have people on campus who are working on student success and so ultimately I think if we don’t deliver on our value proposition, on what’s expected of us, we won’t have good calls in the future. Our goal is to take out the inefficiencies in the organization so we can spend back against our institutions to deliver quality and value to the students who sign up for our courses.

Michael J. Graham

Another thing I would note is year-over-year our total faculty time between full-time and adjunct is unchanged from the end of ’07 to the end of ’08 as we’ve gone through and done structuring moves and right sizing the organization the number of faculty who deliver the quality of the front line is unchanged.

Operator

I would now like to turn the call over to Gary McCullough for closing remarks.

Gary E. McCullough

I just want to reiterate that we’re pleased with the progress that we made in 2008. With that said, we recognize that we still have work that we’ve got to do. We’ll continue to invest in those areas of our business that represent strength and we’ll continue to redouble our efforts to address those areas of the business that are currently underperforming to bring them up to an area that both financial and from an outcomes point of view we can be proud of. With that said I just want to thank you all for joining us on our call. We appreciate your interest in our company and we look forward to talking to you soon.

Operator

Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. Have a great day.

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