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Education Management (NASDAQ:EDMC)

Q3 2012 Earnings Call

May 03, 2012 9:00 am ET

Executives

James Sober - Vice President of Investor Relations

Todd S. Nelson - Chief Executive Officer and Director

Edward H. West - President and Chief Financial Officer

Analysts

Sara Gubins - BofA Merrill Lynch, Research Division

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

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

Reza Vahabzadeh - Barclays Capital, Research Division

Nick Gibbons - Gradient Analytics, Inc.

Gary E. Bisbee - Barclays Capital, Research Division

Suzanne E. Stein - Morgan Stanley, Research Division

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

Andrew C. Steinerman - JP Morgan Chase & Co, Research Division

Corey Greendale - First Analysis Securities Corporation, Research Division

Kelly A. Flynn - Crédit Suisse AG, Research Division

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

Jeffrey M. Silber - BMO Capital Markets U.S.

George K. Tong - Piper Jaffray Companies, Research Division

Operator

Good day, everyone and welcome to the Education Management Corporation's Fiscal Year 2012 Third Quarter Results Conference Call. [Operator Instructions] Please also note that today's event is being recorded. I would now like to turn the conference call over to Mr. Jim Sober, Vice President of Finance. Mr. Sober, please go ahead.

James Sober

Thanks, Jamie. Welcome to Education Management's fiscal 2012 third quarter earnings call. With me on the call today are Todd Nelson, Chief Executive Officer; and Ed West, President and Chief Financial Officer.

Following our opening remarks, we will begin our question-and-answer session. Before turning the call over to Todd for his opening comments, I'd like to remind everyone that the information presented on this call contains forward-looking statements. These forward-looking statements include, but are not limited to, statements about our future plans and our future financial and operating performance.

Actual results might differ materially from those contained in the forward-looking statements. Additional information containing the factors that could cause actual results to differ materially are set forth in the cautionary statement included in the earnings release. Todd?

Todd S. Nelson

Thanks, Jim. Welcome to our fiscal 2012 third quarter earnings call. On today's call, I'll provide an update of our business operations, and then Ed will review our third quarter results, cover several operational topics and provide our guidance.

While the operating environment continues to be challenging, our financial and operational results for our fiscal third quarter were generally in line with our expectations. There remains no doubt of the long-term need and benefits of higher education. However, given the weak economic recovery and uncertain employment landscape and the new regulatory changes, the operating environment continues to be challenging. We remain focused on 4 main priorities: enhancing student success, which we measure through retention and persistence; graduation rates and graduate employment outcomes; improving performance for our fully online students; implementing initiatives to help mitigate risks from the new regulations; and enhancing the support for our operations through productivity and centralization initiatives.

While business trends may not be improving, we are beginning to see stability in various metrics, particularly at our on-ground schools. Application flow for our on-ground schools, while still down slightly year-over-year, has begun to see some stabilization over the past 9 months. In addition, new student cohort retention rates for our on-ground students, while still negative as compared to our prior-year period, are not declining as much as recent quarters.

Although we have not seen the stability in our online programs that we are seeing on our on-ground programs, we do see some positives. The transition to non-term academic structure for our fully online programs at South University and Argosy University are complete. And we're beginning to see some of the benefits of the transition materialize, as continuing students are earning more credits and persistence by students attending fully online programs offered by South University has increased year-over-year.

Furthermore, the year-over-year application declines that we have experienced have remained in the same general range since the beginning of the calendar year with some stabilization in volume over the last quarter. And while overall persistence remains down compared to the year-over-year to the prior-year period, we believe these underlying trends could begin to show up in the overall metrics over the remainder of the calendar year 2012.

For our recent April start, we had enrollment of approximately 134,900 students, a decrease of 9.3% over the prior-year period. Excluding the 6 locations that are less than a year old, same-school enrollment declined approximately 10%. Students taking their classes in a fully online modality decreased 16.6% from last year to 34,200 students, representing about 25% of the total student population. Further, new students for the 3-month period ended March 31, 2012 decreased by approximately 21% over the prior-year period, in line with our comments on our earnings call last quarter that this decline should be at or near the low watermark.

We continue to believe new student year-over-year enrollment trends will remain choppy in the near term, but should improve in the latter half of calendar year 2012.

On a positive note, benefiting from over 140 new diploma and certificate programs we introduced last year, we did see slightly positive new student growth and shorter-term programs during the third quarter. Furthermore, our on-ground schools experienced sequential new student growth at certain degree levels and disciplines, in particular, at both the doctoral and the master's degree levels as well as in behavioral sciences, business and health sciences programs.

During the third quarter of fiscal 2012, we rolled out over 60 programs across schools not currently offering them, bringing the total programs rolled out during the first 9 months of -- to over 210.

Argosy University developed a new education specials degree in advanced educational administration, while Brown Mackie College launched 2 new diploma programs, including bioscience laboratory technician.

During the month of April, we launched 2 new schools. Brown Mackie started its second Texas location in Dallas, while The Art Institute opened its first location in the state of Missouri in St. Louis.

Of our undergraduate students, excluding Argosy University available for employment that graduated during the first quarter -- excuse me, during the quarter ended this past September, approximately 75% were employed in their fields or related fields within 6 months of graduation.

And the average starting salaries for these graduates from our undergraduate programs for the quarter ended this past September.

Bachelor's degree students obtained an average salary of approximately $32,000, while graduates from our associates and diploma programs earned approximately $26,000.

At South University, new on-ground student's enrollment continues to go well with continued strong interest in health science programs and graduate employment statistics continue to show increases over the prior year.

The Art Institutes have launched new student support services, including virtual advisors, who contact students at the earliest possible point of persistent issues, and the early results have been positive.

Argosy University recently received accreditation by the accreditation commission of senior college and universities of the Western Association of Colleges and Schools, secured approval for launched associates programs in business and psychology at 17 campuses and completed a centralization effort that will enhance operational efficiencies and improved services to all students.

Brown Mackie College has begun to introduce programs that provide visual tutoring and supplemental academic resources for student learning with the roll out across all campuses expected to be completed by September.

With that, I'll turn the time over to Ed.

Edward H. West

Thank you, Tom. For my comments today, I will review our financial results for the third quarter of fiscal '12, cover several operational topics and update our guidance.

For the third quarter ended March 31, 2012, net revenues were $702.5 million, down 6.9% versus the prior-year quarter. Driven by a goodwill impairment charge of $495.4 million, we recorded a net loss of $417.1 million, or $3.31 loss per share, and EBITDA was a loss of $366.8 million.

Excluding the goodwill impairment and restructuring and other expenses that I will detail later, EBITDA for the quarter was $134.5 million, slightly ahead of our previous expectations.

Now, we had a lag going on this past quarter from a financial perspective. Let me cover a number of the items that had a significant impact. The most significant of which was the goodwill impairment charge.

The 2006 going-private transaction resulted in our recording approximately $3 billion of goodwill and indefinite-lived intangible assets. On April 1 of this year, we evaluated our goodwill and indefinite-lived intangible assets for impairment.

During the third quarter, as a result of current and projected future enrollment trends, we determined that there were indicators of impairment. And therefore, as required by GAAP, we conducted an interim impairment review.

We completed our step 1 and step 2 impairment valuation processes and determined that 3 of our education systems had goodwill impairment. $254.6 million at Brown Mackie College, $155.9 million at Argosy University and $84.9 million at South University.

The Art Institutes were not impacted and neither were the indefinite-lived intangible assets.

Of the total goodwill charge of $495.4 million, $379 million is non-deductible for tax purposes. The goodwill impairment was recorded in a discrete item for tax purposes in the quarter. Therefore, the $116.4 million of deductible goodwill resulted in a tax benefit of 5.7% for the quarter. However, because most of the goodwill impairment was not tax-deductible, we still recorded a tax expense for the 9-month period, resulting in an effective tax rate of 10.9% for the 9 months.

Excluding the impact of goodwill impairment, the effective tax rate would have been 38% for the 3 months and 38.7% for the 9-month period.

In addition to the goodwill impairment charge, we also had a restructuring charges of $4.9 million at 2 of our education systems and our corporate office that is mentioned in the last earnings call, affected approximately 2% of our work force. We had a $1 million charge related to the lease termination of 1 of our schools, and we recognized a $9.5 million loss on debt extinguishment associated with the refinancing of $349 million of our $1.1 billion term loan.

In summary, the expenses I just detailed, which total $510.8 million, are also listed in our earnings press release. Including the tax effect of these items and the reversal of an uncertain tax position liability of $700,000, the total impact to net income was $458.7 million, or $3.64 per diluted share.

Now, please note that the following comments on the third quarter's income statement will exclude those items that I just mentioned. When comparing current results to the year -- to the prior year, my comments also exclude the effects of the fair market value loss of $13.2 million we recorded last year related to the April 2011 sale of our EFL loan portfolio.

In summary, revenue was $702.5 million, EBITDA was $134.5 million, operating income was $93.8 million. Net income was $41.6 million and diluted EPS was $0.33. The 6.9% revenue decrease was primarily driven by the year-over-year decrease in January enrollment of 9.3%.

Overall, revenue per student was up 2.7% due to a greater mix of on-ground students. Average tuition levels were up less than 1% on a year-over-year basis.

Total operating expenses for the third quarter were up 2.1% to $608.7 million, versus the prior-year quarter.

Looking at expense categories in more detail. Educational services were up 3% to $379.3 million. As a percentage of net revenues, educational services expenses increased by 515 basis points versus the prior-year quarter. The increase, as a percentage of revenue, was primarily due to declining net revenues, a drop in the average class size and higher bad debt expense. Within educational services, instruction costs, as a percentage of revenue, were up 121 basis points, primarily from the drop in the average class size.

Bad debt expense represented 5.9% of net revenues for the quarter, up 160 basis points from the prior-year quarter due to higher receivable balances from active and out-of-school students as we continue to assist students with their cost of education through the use of payment plans as well as timing differences related to the frequency of starts for our online students.

General and administrative expenses were down 1% to $188.7 million versus the prior-year quarter, but increased 160 basis points on a percentage of net revenue basis. Within G&A expense, marketing and admissions costs were down 1.9% year-over-year and represented 23.1% of net revenues, an increase of 116 basis points from the prior-year quarter due to the 6.9% decline in net revenues.

Growth in cost per start was primarily driven by lower conversion rates and slightly lower start rates as compared to the prior-year period.

Depreciation and amortization increased 9.3% year-over-year to $40.6 million. As a percentage of net revenues, D&A expense increased 86 basis points versus the prior-year quarter.

EBITDA decreased 31.2% to $134.5 million for the fiscal third quarter. EBITDA margin was 19.1% and the EBITDA, which we use to measure our operating performance, is a non-GAAP financial measure and a reconciliation to reported net income is included in the earnings press release.

Net interest expense was $25.4 million in the current quarter, a decrease of $6 million from the prior-year quarter due to our lower fixed-rate swap rates and the repayment of our senior subordinated notes in June 2011, offset by higher rates on the term loan.

Looking at slide to [indiscernible] cash flow and balance sheet detail, cash flow from operations for the 9 months ended March 31 was $152.7 million compared to $513.8 million in fiscal 2011. The decrease in operating cash flows was largely the result of a one-time transfer in March of 2012 of $210 million to restricted cash in order to utilize the company's cash-secured letter-of-credit facilities, as I mentioned in the last -- which I have mentioned in the last quarter's earnings call.

The use of these facilities which are being used to help satisfy the previously disclosed letter of credit with the U.S. Department of Education which now stands at approximately $450 million and will result in reduced letter-of-credit fees due to our lower rates on these facilities versus the revolver.

In addition, the reduced operating performance also negatively impacted cash flow from operations as compared to the prior-year period. Cash paid for CapEx was $64.7 million or 3% of net revenues for the 9 months ended March 31, 2012, down from 4.9% of net revenues during the same period last year. We expect the CapEx for 2012 to be approximately 4% of net revenues.

During the fiscal third quarter, we repurchased 1 million shares of common stock, totaling 21.5 million. Since the inception of our share repurchase program in June 2010 through March 31 2012, we have repurchased 17.8 million shares, or 78% of the 23 million shares of common stock, issued in our initial public offering at an average price of $17.83.

At March 31, 2012, approximately $57 million remains on the $375 million share repurchase program that we originally announced in June 2010.

Looking at the balance sheet, as of March 31, cash and cash equivalents balance was $287.5 million. We had no borrowings outstanding under our revolving credit facility, and long-term debt was $1.47 billion.

Regarding investments in new locations, during the quarter, we incurred approximately $2.7 million in losses from startups and operations less than 24 months. And as Todd mentioned, with the recent opening of the Brown Mackie College in Dallas and The Art Institute of St. Louis, we have completed our plan for new locations in 2012.

And during the third quarter, we completed a refinancing of $348.6 million of our $1.1 billion term loan that was set to mature in June of 2013 by replacing the maturing debt with $350 million of new term debt under the same credit agreement. The new term loan, which was issued with the OID at 97%, matures in March of 2018, accrues interest at a rate equal to the higher of LIBOR or 1.25% plus a margin of 7%.

As I mentioned previously, we recorded a loss on extinguishment of debt of $9.5 million as a result of the refinancing. We estimate that the refinancing will increase interest expense by approximately $22 million per year.

And as Todd mentioned, while we have seen several signs of stability at our on-ground schools, we continue to anticipate that the new student growth will remain choppy in the near-term, but believe that the decrease in new students that we experienced in the third quarter of fiscal 2012 was at or near our low watermark from a new student growth perspective on a year-over-year change basis.

Our guidance for the fourth quarter of fiscal 2012 reflects our recent April start, near-term negative variability in new student enrollment and excludes the impact of potential restructuring and lease termination expenses which may be incurred during the quarter.

For the fourth quarter, we are expecting the EBITDA to be between $85 million and $90 million, net income to be between $8 million and $11 million and the EPS to be between $0.06 and $0.08 per diluted share.

Our expectations for EBITDA for the 12 months ended June 30, 2012 remained consistent with the high-end of the guidance we provided on our last quarter's earnings call and as detailed in the earnings press release along with the reconciliation to net income.

Todd, back to you.

Todd S. Nelson

Thanks, Ed. Operator, we'll go ahead and open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Sara Gubins from Bank of America Merrill Lynch.

Sara Gubins - BofA Merrill Lynch, Research Division

I'm hoping to get some more color on what you're seeing in the online enrollment there. The declines improved a little bit from the winter term but are still weaker than the on-ground. And I'm wondering if you're seeing any sense of improvement there or the things still remain pretty tough?

Todd S. Nelson

Well, I think you've got several factors that are still difficult. Obviously, just the change in the compensation plan if that is annualized, some of the -- obviously, competition is a little bit tougher through our online versus on-ground. But what we're starting to see is some stability in the production levels of the enrollment counselors, which is -- that's very encouraging. We knew that, that would take some time to get there. Lead flow continues to be good. And so -- again, as Ed said, we feel we are starting to see -- hopefully, we are hitting that low watermark from a new student perspective. And overall, online is just in a little bit more challenging environment but as I say, we're starting to see the stability in the production level of enrollment counselors.

Sara Gubins - BofA Merrill Lynch, Research Division

And then in terms of total enrollment given the drop-off in starts that you saw this past quarter, is it reasonable to assume that total enrollment should get worse for a quarter or 2 in terms of the declines before it gets better?

Edward H. West

Yes. I think you don't want to draw too much conclusion over that, but you probably assume that there would be -- yes, some of that.

Todd S. Nelson

There is likely a lag effect.

Edward H. West

Yes.

Sara Gubins - BofA Merrill Lynch, Research Division

By about a quarter or 2, is that the right way to think about it?

Edward H. West

Obviously, it depends on based on how other productions are going and how new students change from period to period. But obviously, enrollment will lag the new students as well as the financial performance.

Sara Gubins - BofA Merrill Lynch, Research Division

And then just last question, the start decline in the quarter, you had talked about it. It is getting more negative. It dropped off quite a bit, and I'm hoping to get some more color about where you were seeing that drop-off across your education group or by program area?

Todd S. Nelson

As we said last quarter, we felt like this quarter would be down from the prior quarter in new students and that's, as we said, about what we expected. And then what was your second question?

Sara Gubins - BofA Merrill Lynch, Research Division

Just where -- if there were any particular areas that were weaker than others in terms of program area?

Todd S. Nelson

You hit on it earlier. The good news is, from an on-ground perspective, what we started to see is the growth rates, although, yes, still down year-over-year, were some of the best we've seen during the past year. Earlier in the year, earlier quarters around 8%, 10% negative and then this quarter about 5%. So that is actually very -- again, we feel very encouraged by that. And obviously, online was in a more challenging environment. But we're hopeful with the production levels we're seeing there, that will also -- several quarters will start to see that change as well.

Operator

Our next question comes from Bob Craig from Stifel, Nicolaus.

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

Todd, I just want to clarify your last remark. You said ground start is down 5% in the quarter overall?

Todd S. Nelson

Year-over-year, they were down 5% versus, say, in Q3 which was about 10% and Q2 about 8% -- excuse me, second quarter was about 10% and Q1 was about 8%.

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

When you -- looking at your ground schools overall, and you mentioned stability you're seeing in applications and everything else, is there any one of your divisions where that's more true than others?

Todd S. Nelson

Yes. In particular, you are seeing where the programs where you would expect that to be in health sciences business and some of the other areas that we've been very encouraged. The Art Institute continues to, as we have said in the past -- but it's very stable there. And those programs across the board are continuing to be very stable.

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

When you said starts to remain choppy, but improved in the second half of calendar '12, did you mean turn positive or the rate of decline improving?

Edward H. West

No, we really have not given guidance on that. But I would say that the rate of the negative year-over-year would become less. But we're not saying yet when we would see that go positive.

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

Last one for me. I know you haven't commented yet on fiscal '13, but is it fair to say that overall gross spending is likely to accelerate in fiscal '13?

Edward H. West

Yes, we had not [indiscernible] gross spending in terms of total expenses?

Robert L. Craig - Stifel, Nicolaus & Co., Inc., Research Division

Yes, I'm trying to ascertain whether or not you guys are going to accelerate school openings and program rollout, et cetera, next year?

Todd S. Nelson

I'd say from a program rollout, we're obviously going to continue to accelerate that as demand is there. And from a new campus location?

Edward H. West

Yes, we've -- Bob, what we've talked is 4 to 6 campuses this year. We did the 4 somewhere in the level maybe an additional overall.

Todd S. Nelson

I mean -- this question in the last couple -- as far as new students, we are encouraged by -- we're encouraged by increased flow continues to be strong. We -- as we've said, with the new compensation plan, we wanted to see a stabilization of benchmark of production. We're starting to see that. We're starting to see, as we've said, on-ground come back. And we're not ready to say yet that we're seeing online come back, but we are seeing some very positive signs over there. So again, we -- as we've said, we think there's some real opportunity to see that trend change.

Operator

Our next question comes from Brandon Dobell from William Blair.

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

If you look at the schools that have opened up in the past couple of years, how wide is the variance of performance there? And I guess, I'm trying to get a feel for in the ground business. Are you seeing other, bigger weakness or strength at new locations, which may be in new markets where you don't have the same kind of brand equity or coverage that you had in the immature markets. So are you seeing better opportunities with some locations that you've been at for a while? Or is rolling in new programs in a new area working out better these days?

Todd S. Nelson

We are seeing solid performance at our existing locations and, to our expectations, with our new locations. Obviously, certain of our education systems in this labor market tend to do better. And in particular, South University is a great example that have big business and health sciences programs, and those are 2 areas that are doing well. And obviously, because of the regulatory changes that are out there, we have had to modify, to some degree, some of our startups, for example, Brown Mackie. We look at those programs. And although there's still less clarity around which programs would be eligible and -- our view is to be very conservative. And as we roll out that -- those new locations, we have modified their program offerings. And so -- but across the board, we continue to be, from a new campus as well existing campus, pretty close to our expectations.

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

And then to point on new programs, the one that you rolled out in the past -- let's call it 2 quarters, you expect to roll out in the next several quarters, are those modifications of existing ones where there's a duration change or they just fall in new areas where you haven't had an offering before that you're planning on layering on to the existing network?

Todd S. Nelson

Well, again, there's a lot of variables that come into play there. It depends on the size of the market. It does depend on, in particular, what is going on in the job market. But as we've said, we've been very careful to, as we roll out these new programs, to be -- look at the regulatory impact, look at what competition is doing and then just given the overall demographics. But -- and as we've said earlier, health sciences business -- some of the behavioral sciences are the ones doing well and then you see just good consistent performance across the board with the applied arts at The Art Institutes.

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

And then final one for me. For the couple of weeks, a lot of companies have commented in the online space about different drivers for weakness or continued weakness in new enrollments, economy, competition and enrollment counselor issues. Maybe some thoughts from you guys on what you think the bigger drivers are for the weakness in new enrollments? And if there's anything beside enrollment counselor issues going on, does that normalize or get better? Or is that a structural issue for a while?

Todd S. Nelson

I think you hit on them, I think every one of the education companies is a little bit different in their offerings and how they approach things. But from our perspective, our view is that the change in incentive compensation plan for enrollment counselors -- it is a different type of training that goes on with these folks. There are, obviously, the rules being different. But our view is that, as we've said several quarters now, that the ability to plan in your adding of enrollment counselors and having some sort of benchmark as far as the level of productivity there is something that takes some time to fine tune. There's also -- our view is that there's a transition. It is a different type of person over time that your enrollment counselors, the type of person that you're looking for and those that get to reap the cyclic reward that they're looking for in their job. And so as a result, our view is that, from an EDMC perspective, that's probably the one that has had the most impact. As we've said before, we have also -- just to our own reluctance to roll out certain programs and have as many startups has had an impact as well because of the lack of clarity around the regulatory environment going forward. But I think competition has always been very stable for us, in particular, on-ground. But yes, online, there is more competition obviously. You having more nonprofits who have gotten into the online space. But in addition to that, there has been a migration towards those programs and the demographic that probably, from a regulatory environment, is seems to be the type of student that we're all pursuing. But our view of that is, going back to the strength of the EDMC, is the diversity of program, the programmatic offerings and educational systems that we have online really does give us the ability to devote our resources to the area where the demand is the greatest and where, again, we feel that the return is good for the students. And so our view is that is, although it takes time to get some, again, a good feel for the type of person who is an enrollment counselor and what level they can produce that going forward. We feel there is good opportunity for us.

Edward H. West

Brandon, one other item there might -- is probably more specific to us on an online standpoint, where you're comparing year-over-year on the new students is the advent of non-term in rolling that out across our platform between the South and Argosy and maybe just less appealing to attend our programs where versus someone who may have found it more attractive historically.

Operator

Our next question comes from Reza Vahabzadeh from Barclays.

Reza Vahabzadeh - Barclays Capital, Research Division

As far as the revenue mix that you're getting and the benefit to revenues of roughly 2.7%, would you anticipate that to continue in the next 3 or 4 quarters? Is there any offset to that, just given the better performance of the on-ground schools?

Edward H. West

Reza, it's Ed. So the mix there -- what drove that is the mix of our greater percentage for our on-ground students. And so we would expect that to stay in there probably not as much from a difference as you saw this past quarter. So that will probably dampen some, but we would expect overall revenue to track a little bit higher than just enrollment.

Nick Gibbons - Gradient Analytics, Inc.

And then shifting gears to expenses, the cost of instruction, you mentioned it was up 130 basis points in this quarter. Is that a reasonable run rate to use, at least, in the near-term next quarter or 2, just given where total enrollments are trending? Or do you have any cost savings or other offsets that can mitigate that?

Edward H. West

Well, we are always instituting various cost-savings and operational initiatives, cost of system. I think what you have here on the basis points, which you're referring to, was the direct instructional cost, where that was up 121 basis points and just relative to the quarter and as you recall, in January, where the enrollment came in a little worst than we had originally anticipated and then what we saw in the new students throughout the quarter ultimately drove that loss of leverage and the higher student structure ratios. We would expect that probably to be a little bit better this quarter and not quite as increased as a percentage of revenue that we experienced this past quarter, but it won't be significantly different.

Reza Vahabzadeh - Barclays Capital, Research Division

And then as far as use of free cash flow on a go-forward basis as it relates to whether you want to build cash, delever the balance sheet versus share buybacks or other uses, any thoughts as to the application of free cash flow?

Edward H. West

So going forward, as you know, you pointed out there, we have repurchased on the debt, we've [indiscernible] stock repurchase program to date and have been doing both as well as well as the investing CapEx is down a little bit this year and roughly at the 4% level. So obviously, we're still generating free cash flow. Just when you look at the stock repurchases, just the amount that we've done so far and then the amount of shares that are just left out publicly, obviously, that's come down as you saw from the amount of repurchases has abated fair amount going this past quarter and so there's not a whole lot more to repurchase on just that regular day-to-day basis. So I think you'll see that to be a little bit more limited.

Operator

[Operator Instructions] Our next question comes from Gary Bisbee from Barclays.

Gary E. Bisbee - Barclays Capital, Research Division

Can you give any more color on progress with some of the efficiency and process reengineering efforts you've talked about over the last 6 months or so? And could you be specific on savings number's grade period if you are not there yet, maybe just some color on what you're working on and how it's going?

Edward H. West

Yes, different areas across the system whether it's been from technology enhancements and in continuing to automate, in particular, for our online team, we still are rolling out various systems. We still have more to go on the centralization of activities whether that's been financial aid, human resources, IT, some of the desktop activities across the system than more centralized within that, procurement in terms of strategic sourcing in various areas, alignment of technology spend as well as on wireless and data activities. Those are the benefits that have been built into the results and also the guidance going forward. And that's out there. There's still more, we believe, ahead of that from an efficiency standpoint as we consolidate across the system, in particular, on support and administrative functions in the company that, we believe, there's still a fair amount we will continue to achieve over time. The frustrating thing, obviously, is there's been a lot of wins and a lot of achievement on that front by a lot of people across the system. It's offset by the decline in revenues and decline in enrollment, where you -- we've had the loss student instructor ratios and plus a double-digit increase on the cost per new student and cost per start. So you are not seeing -- and we don't see those directly because of the offsets and the inefficiencies. But as enrollment stabilizes, going forward, we believe we'll benefit from all of these achievements.

Gary E. Bisbee - Barclays Capital, Research Division

And then a follow-up. It sounds like you're making some progress in the ground-based schools. If at some point in the future, if and when that continues, how should we think about the ability to generate incremental margins if you were to get back to just modest revenue growth in those schools? Is -- are there incremental investments that are still being made around programs, around regulatory compliance and other factors? Or if we got to a modest revenue growth environment in the campuses, would you likely see very high incremental margins based on just utilization rising?

Todd S. Nelson

Yes, I mean, I think this has been a good year to make those investments that you've been talking about to enhance the student experience and also the regulatory and compliance environment. And we have done that. And our view is that we'll continue to make those investments, but we will start to see the leverage of that going forward. So we felt that it was a good time to be making those investments.

Edward H. West

That will continue going forward. In terms of those additional investments and student experience, I think probably one of the bigger benefits going forward as you see the economy stabilizing and enrollment stabilizing likely would be through retention and persistence and higher -- at some point in time, getting back to higher earned credits. Although some of this will also be offset because of the changes that we have been implementing as a result of the regulatory changes to shorten the degree programs as students who may be pursuing a shorter degree. Obviously, we will increase the cost of the acquisition cost.

Operator

Our next question comes from Suzi Stein from Morgan Stanley.

Suzanne E. Stein - Morgan Stanley, Research Division

Can you give us a sense of where you are in terms of your marketing mix and how that's changed?

Todd S. Nelson

You mean as far as our -- how we're...

Suzanne E. Stein - Morgan Stanley, Research Division

Just where your starts are coming from.

Todd S. Nelson

Sure. We still continue to, obviously, have a larger percentage of our advertising dollars spent on interactive, and we continue to see good return on that. One other data point that's, again, a very good positive early indicator. As you know, we are a little different than some of the other education companies that we also have a high school -- the folks who [indiscernible] as high school representatives and help generate interest there. Increase during the quarter were up about 10.9% from the prior year levels. That's a good indicator for us. One, it's more obviously inquiries but it also shows the interest level and the demand level that's out there that -- within the high schools. And again, we -- next to again our interactive inquiries, high school inquiries are our second largest source. So it's good to see that increase year-over-year.

Suzanne E. Stein - Morgan Stanley, Research Division

And then you mentioned the recent refinancing, can you just give us a sense of how negotiations with creditors were? What were they pushing back on that drove the interest rate up? Is it just kind of lack of visibility? Or is there something specifically that they were pushing back on?

Todd S. Nelson

Yes, I mean, just looking at the current environment that we're all operating in right now. The regulatory -- there's continued regulatory uncertainty out there in the environment. That's what we've all been living with. The new student enrollment has been declining. We're looking to see stabilization. So these consistent things we're all acutely aware of. I mean, obviously, we are pleased to be getting the refinancing done, having that extended out to 2018. There's a lot of product available too at that time.

Operator

Our next question comes from Andrew Steinerman from JPMorgan.

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

This is Jeff for Andrew. Could you give us a little more color on the size of your graduating classes over the next few quarters?

Edward H. West

We don't necessarily see a spike. We see pretty much the graduation levels being pretty consistent with prior years. So that what we have built in, in the forecast is that we -- that's a stable number.

Todd S. Nelson

A pretty consistent year.

Andrew C. Steinerman - JP Morgan Chase & Co, Research Division

And can you quantify what that number is?

Edward H. West

Running roughly overall about 5% to 7% when you think about on a trended basis.

Operator

Our next question comes from Corey Greendale from First Analysis.

Corey Greendale - First Analysis Securities Corporation, Research Division

Ed, so you've discussed the class side a couple of different ways but I just want to approach it slightly differently. So the guidance, I think, implied even at the low-end less of a EBITDA margin decline in Q4 than you saw in Q3? So if you could just maybe -- and given you have a similar enrollment decline, could you just talk about maybe on the cost side what would drive less of a margin decline?

Edward H. West

Well, I think we took a restructuring charge this past quarter, unfortunate changes there throughout the system and also we had, in the previous quarters, some other changes that have been implemented across the system. And you see the cumulative effect of those beginning to appear in the fourth quarter.

Corey Greendale - First Analysis Securities Corporation, Research Division

I meant even backing up the restructuring charge, it's, I think -- or maybe I'm misunderstanding what you're saying?

Edward H. West

Just the -- we will have lower expenses on some of the salary expenses and some of the lease expenses and other things that have been restructured throughout the -- in the last few quarters and you're seeing the compounding of that in Q4 to where -- to the extent that there is an implied basis. It's not significant. But on a quarter-over-quarter period, it is a little bit better.

Corey Greendale - First Analysis Securities Corporation, Research Division

And then the follow-up question is, can you just remind us in terms of -- if the changes in incentive comp is one of the biggest issues you think impacting enrollment trends, when did you implement that? And what should we expect at sort of on the 1-year anniversary if that, that something should turn positive or could there be a longer tail on declines for other reasons?

Edward H. West

Well, just one of the other things that, Corey, we talked about last quarter where the majority of our admissions representatives were operating under the new admissions compensation plan in the first -- third quarter of last year. So now, as we sit here today, the vast majority of our admissions representatives have annualized their comp plans. So I think we are working with a team, and our managers are more familiar with it and operating under that, in that like and we both see that as a positive.

Todd S. Nelson

Two other quick things that we've noticed I didn't mention earlier and that is, as we have seen a transition in the enrollment counselor staff, is that a couple of pilots where, again, not only the type of folks who are being recruited for these roles, but also the level of training and the type of training to compare their production versus those that didn't have that is quite impressive. And so obviously going forward, as we implement that further, we also hope to see further levels of productivity improvement.

Operator

Our next question comes from Kelly Flynn from Crédit Suisse.

Kelly A. Flynn - Crédit Suisse AG, Research Division

Question is about starts expectations. I think you said a couple of times in your remarks that you thought this quarter you just reported that start's decline would be at or near the low watermark. But is there something -- maybe you could manage the expectations a little better for this upcoming quarter? Do you expect it will be sort of similar to what it just was? It sounded from your remarks like maybe that was the case or do you think, given the annualization of the comp changes, that you actually might see an improvement in the near term?

Todd S. Nelson

Well, as you know, Kelly, we don't give guidance on that. But our view is there's a lot of positive things going on, obviously, more positive results you're seeing on-ground than online. And so obviously, there's still a lot of things happening. But certainly there's the potential for that. But I think Ed's way of describing it being choppy, we don't want to be too aggressive out there in what we're saying but at the same time, as we've said, we really do feel that we're at or near that low watermark. As we've said last quarter, we felt we would see that continued trend through this -- through the third quarter and it pretty darn close to what we had expected.

Kelly A. Flynn - Crédit Suisse AG, Research Division

And then can you give a quick update on the stipend chasers, if you will, kind of where you are and the efforts to address that issue? And, kind of, what impact should we expect that to have on bad debt over time?

Todd S. Nelson

Let me just comment on the percentage of those who are may have been enrolling for the stipend. I looked at some data yesterday from LHE [ph]. And really has -- you see a decline at both South University Online and Argosy University Online. And I think it's encouraging because, again, we don't want students in there that's why they're attending. And so that has been a nice transition. As far as bad debt, that I don't know. If you want to comment on that?

Edward H. West

I mean, obviously, to the extent that the student profile is improving because of the reduction of that, there is improvement. But Obviously, our bad debt is -- it is up year-over-year as we've supported more students on their payment plans as well as we've had retention with the drops that we've experienced through the transition has increased bad debt. And finally, there are receivables balances that were higher also because of the increased frequency in the number of starts, where we may not have had that receivable balance at the end of the quarter a year ago. So that's offset any of the other benefits that we're seeing. If you remember, a year ago, we also had the EFL program when you look at that on a prior-year basis, where we had received the cash upfront until now that we've been supporting students on the payment plan.

Todd S. Nelson

And the other thing is, yesterday, it was interesting to look at the data on the GPA level of the students. You are seeing that go up as well in both South and Argosy Online which is again another indication that you've got, again, the non-term impact is having on that which again as you would expect that there are more students in there that are really serious about their education.

Operator

Our next question is from Jeff Meuler from Baird.

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

Just trying to get my math work, how much were the online starts down and then -- just, I guess, as a follow-up to that, has the impact from South and Argosy, kind of, run its course and started to stabilize in terms of the impact on starts from the transition to non-term? And then just finally, you talked about seeing some good things in terms of lead flow and things like that, I was just wondering if you could comment specifically to the online part of the business on what you're seeing around those metrics?

Todd S. Nelson

Well, again, as we've said, what we're seeing is some stabilization in the productivity which is, again, one of the early indicators that you'll start to see -- hopefully again, provided you don't have other things that come into play, you'll start to see that level of performance go up. And as I also said some of the pilots that we've had thus far is trying to enhance, not just stabilize the productivity but actually improve the productivity. Also from a retention perspective, we've been focused on some coaching pilots as well as some initiatives with faculty. And again all of these things we're starting to see again as a sign of stability as far as when we see that trend improving, I think -- again, I'll just have to refer back to Ed's comment about being choppy. It's very difficult at this point to feel comfortable enough to say this is what it's going to be.

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

I guess I just wanted to clarify how much were the starts down in the online business, if you're willing to give it? And are you seeing those same signs of improvement and stabilization and productivity in the online business? Or is that more specific to on-ground and you're still seeing incremental softening in those metrics for the online business?

Edward H. West

Yes. We have -- we don't really break it out that way. So that's not -- as far as the exact percentage of new students, that they were down. As far as the stabilization though, as I've said, for on-ground, you do have to look at, again, the new students' growth rates that have -- the trend that we're seeing over these last couple of quarters. And we're not seeing, again, that level of increase in the growth rate as far as new students at online yet. We have -- as I've said, there are different variables that they're facing with different things in the external variables that they're facing. But in addition to that, we recently had a reduction in force there that obviously you'd expect and some decline now because we just don't have the number of folks that are recruiting students. Based on inquiry flow and what we're seeing though, we are feeling like that is, we do want to start hiring again there and I think that, that will also help in the level of the new student improvement year-over-year.

Operator

Our next question comes from Jeff Silber from BMO Capital Markets.

Jeffrey M. Silber - BMO Capital Markets U.S.

I'll try to be quick. I think you mentioned in your prepared remarks that your marketing and advertising expense went down year-over-year, do you expect that to continue, especially given that we're coming up to the election period and the Olympics, et cetera where rates might go up?

Todd S. Nelson

Well, to just comment, obviously, with the amount of the political advertising, in particular, you may expect the time that you're buying to go up, you don't see as much on the interactive side as you do your traditional media outlets. We don't really have any expectation to increase the amount of dollars being spent there. Again, it seems to continue to be an area that we are very optimistic about, as I mentioned, with the high school representatives which are not really impacted by the amount of advertising going on politically or with the Olympics. But our view right now is I don't -- Ed, why don't you -- I don't know of anything that we don't have built in the forecast from an expense area that we would see any big changes.

Edward H. West

Where would you not -- from a standpoint, also as we've talked about before on a traditional media which obviously, I believe, is the most significantly impacted from the election spending is that's a small portion of our dollars over most of its own interactive side. And frankly, we have seen continued efficiencies on that front on mostly different fronts and are pleased with the direction there.

Jeffrey M. Silber - BMO Capital Markets U.S.

And then in terms of your guidance, what share count should we be using for the fourth quarter?

Todd S. Nelson

Well, we ended last quarter at -- let's see, we were at 125.6 million shares and if my memory serves me correct right here, yes, about 125.6 million. But the problem now, in diluted and obviously because it was negative, there was no anti-dilution so I would say 125.6 plus 1 million shares so adding about 126 to 127 million.

Operator

And our final question comes from Peter Appert from Piper Jaffray.

George K. Tong - Piper Jaffray Companies, Research Division

This is George Tong for Peter Appert. You had mentioned the productivity levels are driving for the most part of starts performance, could you give us specifics in terms of what you're seeing in inquiries and conversions that would help give you confidence this quarter with the low watermark for starts decline?

Todd S. Nelson

Well, let me just comment on what we do to disclose -- which is the level of productivity on an enrollment counselor basis, we tried everything. And in particular, seeing your app production that was, as we've said, we're seeing some stabilization there. We're also seeing at the start rate which is, we had had some declines there. We're also seeing stabilization there. So those are both leading indicators that we feel good about.

George K. Tong - Piper Jaffray Companies, Research Division

And then from a competitive perspective, I know you had mentioned you are seeing the most challenges from your online enrollments, could you tell us what EDMC is doing to differentiate itself so that they can improve its competitive positioning?

Todd S. Nelson

Sure. We just commented that overall general competition is stiffer, but I think that is again really plays some strength of EDMC. How you differentiate yourself is: One, is the quality of the actual programs and the schools which we believe in the area of the post-secondary education market, where each of our 4 education systems are positioned. They are viewed as one of the real high-quality providers and that's why this had allowed us to not have as early decline in enrollment that some of the other education companies face and our view is that obviously at this point, it doesn't look like we've had the level of decline either, which is very encouraging. The second is that the broad array of programs that we offer as you know we offer everything from a law degree and doctoral programs in pharmacy and psychology and so on all the way down to and including associates and diploma and certificate programs. So and ranging, obviously -- I don't want to go through all the disciplines but again, the company was really constructed in a way for us to provide programmatically and from a degree level across a very large percentage of the post-secondary education market. That distinction, as well as continuing to focus on the quality of education, is why we feel optimistic about the future. We think, obviously, the regulatory environment has been challenging. We think that we have been as ahead of that as possible and obviously made the changes that are necessary to help us to continue to navigate through that. So going forward, we feel the differentiation is there. And I think again that's what has helped us in the past and makes us feel optimistic about the future.

Operator

And that concludes today's question-and-answer session. I'd like to turn the conference call back over to management for any closing remarks.

Todd S. Nelson

Well, again, we thank you very much for joining us this morning, and we do look forward to speaking with you again next quarter. Thank you.

Edward H. West

Thank you.

Operator

Ladies and gentlemen, today's conference has now concluded. We do thank you for attending today's presentation. You may disconnect your telephone lines.

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