Corinthian Colleges, Inc. F3Q08 (Qtr End 03/31/08) Earnings Call Transcript

| About: Corinthian Colleges, (COCO)

Corinthian Colleges, Inc. (NASDAQ:COCO)

F3Q08 Earnings Call

April 30, 2008 12:00 pm ET


Anna Marie Dunlap – Senior Vice President Investor Relations & Corporate Communications

Jack Massimino – Chief Executive Officer, Executive Director

Peter Waller – President, Chief Operating Officer

Ken Ord – Chief Financial Officer, Executive Vice President


Sara Gubins – Merrill Lynch

Trace Urdan – Signal Hill Group, LLC

Jeff Silber – BMO Capital Market

Kevin Doherty – Banc of America Securities

Bob Craig – Stifel Nicolaus & Company

[Gary Bisbee – Lehmann Brothers]

Amy Junker – Robert W. Baird & Company

Mark Marostica – Piper Jaffray


Welcome to the third quarter 2008 Corinthian Colleges earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Anna Marie Dunlap, Senior Vice President Investor Relations and Corporate Communications please proceed.

Anna Marie Dunlap

I am here today with Jack Massimino, Chief Executive Officer, Peter Waller, President and Chief Operating Officer and Ken Ord our Chief Financial Officer.

This call is being webcast and an audio version of the call on transcript will be available on Corinthian’s website for 30 days. In addition, a telephonic replay of this call will be available until Wednesday, May 7. The details for accessing the replay are included in the press release we issued this morning.

Before reviewing the Safe Harbor Statement, I would like to remind everyone that we are hosting an event on May 29 on Long Beach and hope that you will be able to join us. If you have not already registered, please call Krissy Teneger, our Investor Relations administrator here at Corinthian’s corporate office at 714.427.3000.

Please note that during this conference call we may make projections or other forward-looking statements regarding a variety of issues. These statements are based up current information and expectation. Actual results may differ materially based on a number of risks, which are identified in our filings with the Securities and Exchange Commission.

Following our prepared remarks, we will open the call for a question and answer session.

With that I will turn the time over to you Jack.

Jack Massimino

Today we will start with the review of student lending and other regulatory issues, followed by Peter’s comments about our operational progress. After which Ken will review the financials and then we will open it up for questions.

On balance, we were satisfied with out third quarter performance especially in light of the operational challenges posed by the credit market and the impact of the student-lending environment.

We reported earnings per share from continued operations of $0.16 in the third quarter versus $0.15 in the same quarter last year. Revenue from continuing our operations was 281.5 million in the third quarter up 16.8%. The revenue increase was primarily driven by new student starts, which grew by 13.3% in the third quarter compared with the same quarter last year. The total student population at March 31 was 72,241 students and increase of 11.8% over the prior year. Our third quarter results exceeded our previous guidance range for starts and were within our guidance range for revenue and earnings per share.

Our National Everest and Linotech advertising campaigns continued to be the primary impetus for growth in the quarter. In addition, we believe that our ongoing efforts to reduce employee turnover, invest in employee training, standardize and upgrade key business processes and improve service to students contributed to higher growth.

Today we also announced that we had named a new non-employee Director to our Board, John Dionisio. John is currently the Chief Executive Office of AECOM Technology Group, a $4 billion NYSE-listed Company that provides professional, technical and management services for its clients around the globe. John has been with AECOM or its predecessor Companies for six years. He previously served as Executive Vice President and Chief Operating Officer for AECOM, which has approximately 35,000 employee’s service clients in more than 60 countries.

His many years as senior level operations experience at such a large and diverse public company will add dept to our Board. Now that John has been appointed to the Board, we have nine members eight of whom are non-employee Directors. Expanding the number of non-employee Directors is part of our ongoing effort to improve corporate governance.

I will turn now to discussion of student lending.

As previously discussed, in late January, Sallie Mae notified us that as of March 1, they would no longer provide private loans for students with subprime credit profiles. We had just five weeks to develop and roll out the Company wide changes required to offset the loss of those loans and we are very pleased to report that we were successful.

Under Peter Waller’s leadership, we developed and implemented a modification of operation Ignite, our standardized system for admissions and student finance. Playing off the Ignite metaphor, we named this new initiative operation FIRE, which stands for Funding Ignited Retained Enrollees.

Under operation FIRE, we now require all but the neediest of students to make monthly cash payments while in school and we are focused on increasing the number of plus loans.

In addition, we have established a new internal student lending program with tighter underwriting guidelines than those we previously employed. We are also working with third party lenders to secure additional funds for our students. Peter will provide more detail on operation FIRE, in a few minutes.

Thus far, we have been able to arrange financing for the vast majority of perspective students through Title IV, our internal lending program, cash and other resources. That said we have experienced some disruption associated with the transfer of students from one loan provider to another as lender exited either the subprime private loan and/or FFELP business.

This disruption has primarily occurred on our online learning division. At this time, Federal Title IV student loans continue to be available to our students through Sallie Mae and other lenders; but as you are undoubtedly aware, a number of lenders have exited the Title IV business over the past several months due to the lack of equity in the credit markets.

To insure the continue availability of loans for our students, we are pursuing the conservative course of comparing all of our U.S. School to participate in the Federal Direct Student Loan Program.

We conducted a pilot program with three of our schools in March and have since accelerated our efforts to prepare all of our schools to transition to this program. As of today, 26 of our schools can offer loans to the Federal Direct Student Loan Program. By the end of May, that figure will increase to 54 schools and we expect to have all of our schools prepared to participate in direct lending by the end of June.

Keep in mind that school participating in direct lending can also offer Title IV loans to students through the Federal Family Education Loan Program, know as FFELP to students. For example, Everest University in Tampa will offer students Federal Direct loans in addition to (inaudible) loans through lenders such as Sallie Mae, Wells Fargo and others.

In essence, preparing our schools to participate in direct lending expands the options available to our students and provides protection against the loss of additional PPELP lenders leaving the business.

Congress has recognized the need to insure that the flow of Title IV funds is not disrupted as well as the need to help ease the burden of higher education costs for American families.

Toward that end, on April 17, the House passed HB 5715 by an overwhelming majority. The bill increase unsubsidized Stafford loan limits by $2000 per academic year and allows the Federal Government to create liquidity for Title IV lenders by establishing a secondary market for student loans.

The bill sponsored by Rep. George Miller, Chairman of the House, Education and Labor Committee. Sen. Kennedy is sponsoring similar legislation in the Senate. We applaud these efforts, which would go a long way toward eliminating the funding gap for many of our students.

For our Everest student, the average non-Title IV subprime student loan is $2500. An increase in Stafford loans of $2000 can help cover that amount while providing a lower cost source of funds for our students.

There is a challenge associated with the proposed increase of student loan limits and that is the 90/10 rule. This rule requires that at least 10% of our funding be derived from non-Title IV sources. If Title IV loan limits are increased by $2000, it would cause many of our campuses to exceed the 90% threshold. 90/10 rules calculated by OPE ID Number, which is the Department of Education system for designating a main campus and its branches.

We have 42 OPE ID Numbers in the Company. Even if the Company as a whole meets the 90/10 requirement, we could still have certain OPE ID Numbers that don’t. So what do we do about 90/10? Among other strategies, we are pursuing legislative remedies and devoting substantial sustained efforts to achieving a positive outcome. We will continue to work with the Coalition of Colleges and the Career College Association to represent the interest of our students with congressional leaders and will keep you informed as to significant developments.

If we do not receive a legislative remedy for 90/10, one of the few solutions available is to raise tuition to create a gap, which we would then have to fund through non-Title IV sources. We believe Congressional Leaders understand that this is no a desirable solution. I want to emphasis; however, that we are not relying solely on legislative remedies to provide adequate funding for our students.

As our response to Sallie Mae’s departure from the subprime market indicates, we are relying on our own capabilities to manage through the ongoing turbulence in the student financing environment.

Before turning the time over to Peter, I will provide a brief update on a few other issues starting with accreditation compliance.

Since our last investor call, two campuses have been placed on accreditation show-cause by ACCSCT. Both show-cause orders were issued because of management turnover at these campuses. We now have stabilized management at both locations. With the addition of these two show-cause orders, we have a total of three schools on show-cause, excluding the Atlanta campus, which is being taught out.

We remain committed to being a full regulatory compliance and will continue to strive for meeting accreditation standards.

Turning to the investigation of our Ft. Lauderdale campus by the Office of the Inspector General, we met with the OIG and reviewed the findings of our own internal investigation. That investigation, which identified questionable conduct by three employees at the campus, whose employment has since been terminated, did not identify any systemic compliance problems at the campus.

We are continuing to cooperate with the OIG’s investigation. The OIG did not give us any information about their findings or how long it might take to complete their investigation.

Moving now to our recent divestitures, as reported in December, we entered into an asset purchase agreement to sell our 12 Canadian schools outside the Ontario province. These schools were sold to a wholly owned subsidiary of the Eminata Group in a cash transaction valued at C$7.4 million. The sale price is consistent with the book value of these assets at the time they were transferred to discontinued operation. The transaction closed on February 29.

We have also entered into an agreement to sell the WyoTech Boston Aviation Campus, which we expect to complete in fourth quarter. These divestitures are part of our ongoing effort to rationalize our facility footprint and improve operating margins.

I will turn the time over to Peter, who will provide a few highlights of our operational performance. After his comments, Ken will review the financials and provide guidance for the fourth quarter and fiscal year end.

Peter Waller

I will begin with the recent results of our employee survey, which indicated a remarkable improvement over the prior year.

Building people capability is at the top of our list of operational priorities; we were gratified by the improvement in this year’s employee survey results. 75% of employees responded to the survey, which showed a full nine percentage point improvement in overall employee satisfaction compared with the prior year.

The Hay Group, which administered the survey, said a one year improvement of that magnitude is extraordinary. We share all of the survey results with you in an upcoming

Invest today.

Higher employee satisfaction is translating into lower employee turn over. Fiscal year to date, turnover is running at 28% that is nine points better than last year. We believe having a more stable, satisfied and productive workforce is essential to our continue progress as a Company.

Moving now to the stock growth, marketing and admissions, for the fourth consecutive quarter, we posted strong growth in new student starts. In the third quarter starts in continuing operations totaled 26,546 an increase of 13.3% compared with the third quarter of the prior year.

Once again, this quarter, we are encouraged that our growth was broad based. All U.S. continuing operations, that’s both grant schools and online, reported an increase in starts. In particular, our exclusively online business poses a robust increase passing the 10,000 student mark in the third quarter.

WyoTech posted a solid increase in starts up 7.4% in the third quarter. The increase was primarily driven by more productive admissions team and the WyoTech Guide customer Service Program. The guide program has now been in place for one year. During that time, WyoTech show rate, that’s the percentage of enrolled students who then show up for class, has increased significantly. We believe the Guide Program has helped us achieve this improvement.

Although, we remain confident that WyoTech’s turn around is progressing as planned and we continue to expect positive stock growth from the division for the current fiscal year and beyond.

For the Company as a whole, we now expect total stock growth of approximately 11% for fiscal 2008 and stock growth of 6-7% in the fourth quarter.

As we discussed previously, we did expect fourth quarter growth to slow as we transition from Sallie Mae private subprime loans to alternative sources.

Our new advertising campaigns for the Everest and WyoTech brands continues to be a major source of new leads and starts. The National ads help generate over 618,000 leads in the third quarter. That is a 32% increase over the same quarter last year and an all time record for the Company.

The media cost of start continues its positive trend declining 7.7% in the third quarter compared with the same period last year. This improvement reflects higher stock growth and increased efficiencies associated with brand consolidation and National advertising, more strategic media buys and more effective internet lead management.

The mix of media channels have generated our stock growth in the third quarter was fairly consistent with the past several quarters. Of total starts, we derived 26% from the referrals, 24% from television and newspaper advertising, 35% from the internet and 15% from all other sources.

The total cost per start that is including all marketing and admission expenses, increased 3.5% in the third quarter of fiscal 2008 compared with the third quarter last year. The increase reflects higher admission starting to accommodate the increased lead flow, which helped with (inaudible) higher starts.

Thus far this fiscal year, we’ve added approximately 300 reps, a 27% increase. These reps take about six months to become productive as experienced reps.

We continue to focus on reducing rep turnover and increasing the productivity of entire rep force. We do not expect to increase the size of the rep force for the balance of this fiscal year.

Total marketing and admission expenses as a percentage of revenue increased by 10 bases points in the third quarter compared with the same quarter last year. Assuming continued start growth and marketing efficiencies, reduce admission rep turnover and high rep productivity, we expect marketing admission expenses as a percentage of revenue to decrease slightly this fiscal year versus the prior year.

During the third quarter, we continue to make progress on consolidating brands a key part of leveraging our marketing expenditures.

As anticipated, we converted four additional schools to the Everest Brand in the third quarter. We now have 100 Everest Schools up from 96 schools at the end of December and five schools at the end of the first quarter.

Grant consolidation is now essentially complete; we just have one school awaiting regulatory approval for the Everest name change.

Turning now to the topic of operation FIRE, as Jack explained, we had a few weeks to respond to Sallie Mae’s announcement that they would no longer provide private loans to students in the subprime credit category. We quickly would amend operation FIRE in response to that challenge because of the standardization associated with operation Ignite that is our front end system for admissions of student finance.

As you may recall, Ignite was developed and rolled out in fiscal 2006 and 2007. Our success with Operation FIRE would not have been possible without the extensive groundwork laid by Ignite. To develop and implement FIRE, we didn’t have to create the entirely new system; we modified existing Ignite procedures and training processes.

Shortly after receiving the new from Sallie Mae, we had a FIRE summit of key corporate and campus personnel from marketing, admissions and finance. We determined that FIRE should have three main objectives that are to increase cash payments with students, increase the number of plus loans to dependent students and fund qualified students through our new access loan program.

In addition, we wanted to implement FIRE in a way that would maximize starts, minimize drops and bad debt and help us maintain the 90/10 rule.

So, what has our experience with FIRE been this far? With just eight weeks under our belt, we can say the following.

Firstly, our cash commitments from incoming students have increased significantly and are higher than our internal targets. The majority of students are willing to make monthly cash payments while in school.

Secondly, the number of plus loans for dependent students are essentially flat, which we expected. Plus loans mainly apply to our WyoTech students and we do not expect to have an impact on the increased number of plus loans until WyoTech’s next major start date, which is July.

Thirdly, the majority of students who require gap financing have been able to qualify for loans through our new internal lending program, which we call Access.

Fourthly, as I anticipated, stricter underwriting screens and cash payment requirements have slowed growth somewhat.

As I mentioned previously, we are now anticipating start growth of 6 to 7% in the fourth quarter, this is approximately 11% for the fiscal year.

We will caution you that eight weeks of experience with FIRE doesn’t give us sufficient information to establish a trend. We need several more months of experience to determine the full impact of FIRE on our level of funding mix, start growth and bad debt.

Speaking of bad debt, I’ll turn to that topic next. On a sequential basis, bad debt improved from 6.3% in the first quarter of this fiscal year to 6% in the second quarter and 5.9% in the third quarter, in line with out previous guidance.

In the third quarter of last fiscal year, bad debt was 4.9%, which included unusually high cash collections.

Before I turn the time over to Ken, I want to reiterate that we are encouraged by our operational progress. Our work force is becoming more stable and productive and our student population is growing. Over time, we expect our growth to leverage our investments in employees, marketing, admissions and facilities and result in improved bottom line.

As our experience in Operation FIRE indicates, we have built a front end infrastructure that will help us respond quickly to the ongoing changes in student financing.

With that I will turn the time over to Ken for review of the financials and fourth quarter and fiscal guidance.

Ken Ord

As a reminder, all the data I am about to review pertains to continuing operations.

I will begin with student population statistics. The total student population at March 31 was 72,241 students an increase of 11.8% compared with 64,637 students at March 31, 2007. The average student population increased 10.8% in the third quarter of fiscal 2008 compared with the same period last year.

Our online division continues to perform very well. Exclusively online student population grew to 10,738 students at March 31 up 47% from 7,319 students at the end of March last year. Online course registration, which includes both hybrid and exclusively online students, grew by 44% to 38,770 registrations in the third quarter of 2008.

Turning to facilities data, occupied square footage for continued operations was 4.3 million square feet at March 31 flat with March 31 of last year. Occupied square footage per student was 70 square feet at the end of March 2008 a decrease from 76 square feet per student at the end of March last year. Excluding WyoTech from the calculation, occupied square footage per student was 55 square feet at the end of March compared with 59 square feet at the end of March last year.

As these figures indicate, our recent increase in student population is beginning to have a positive impact on facility utilization.

Turning to income statement and again the result we are about to review are based upon continuing operation. Revenues for the third quarter of fiscal 2008 were $281.5 million versus 241.1 million an increase of 16.8% compared with the same period of the prior year. Average tuition revenue per student increased by approximately 5.4% in the third quarter compared with the same quarter last year.

In the third quarter of fiscal 2008, operating income was 18.5 million compared with 19.4 million in the third quarter of fiscal 2007.

Effective tax rate in the quarter was 30.2%. As you recall, we adopted FIN 48 in the first quarter of this fiscal year. In the third quarter, we recorded a tax credit of approximately $2 million as a result of the finalization of the fiscal year 2006 and prior IRS audit.

Income from continuing operations, in the third quarter of fiscal 2008, was 13.5 million compared with income of 12.5 million in the same quarter of the prior year. The net loss from discontinued operation was 1.7 million in the third quarter of this year versus the net loss of five-tenths of a million in the third quarter of last year.

Diluted earnings per share from continuing operations were $0.16 in the third quarter of fiscal 2008 versus earnings per share of $0.15 for the same quarter last year. The diluted loss per share from discontinued operations was $0.02 in the third quarter of fiscal 2008 versus $0.01 in the third quarter of the prior fiscal year.

The weighted average number of diluted shares outstanding for the third quarter 2008 was 85.7 million compared with the 87.5 million for the same quarter of the prior year. The decrease reflects the repurchase of 2.3 million shares during fiscal 2007.

Turning to the cash flow statement and balance sheet, cash flow from operations was 61.7 million in the first nine months of fiscal 2008 compared with approximately 41.9 million in the same period last year.

Turning to the balance sheet, at March 31, 2008, we had approximately 59.2 million in cash and marketable securities.

Long term debt, including the current portion, as of March 31, was approximately 42.5 million, which includes capitalized leased obligations approximately 15.2 million.

Net accounts receivable and student notes receivable, as of March 31, were approximately 106.6 million compared with 85.2 million at June 30, 2007. The increase is the result of first, underwriting more Company sponsored student loans; second, a delay in packaging that resulted from replacing college loan corporation’s student loans with loans from other lenders as a result of CLC’s departure from the student loan business; third, higher receivable balances as a result of the increased student population.

Net gain sales outstanding for the third quarter of fiscal 2008 were 29 days versus 25 days in the same quarter last year.

Turning now to guidance, our guidance is based on the current expectations and is forward looking. Actual results may differ materially as a result of the factors described in our public filing. In addition, the guidance I am about to give pertains to continuing operations.

As Peter said, we expect start growth of approximately 11% for the year. We expect fiscal 2008 revenue to be in the range of 1,075,000,000 to 1,080,000,000. We are giving this guidance with the caveat to give accounting treatment for loan losses. We will be consistent with our prior history. We are currently discussing the accounting treatment with our independent auditors to determine whether certain potential changes in loan loss allowances will be recorded as a reduction in revenue or as increased bad debt reserves.

Regardless of the accounting treatment, we continue to expect diluted earnings per share to be in the range of $0.40 to $0.45 and expect to be at the low end of that range.

Our fiscal year 2008 guidance excludes any onetime charges that may occur.

As we get into fourth quarter guidance, again for continuing operations, we expect year over year start growth of 6 to 7% for the fourth quarter. We expect revenue in the fourth quarter to range from 275 to $280 million.

Again, we are giving this guidance with the caveat that the accounting treatment for loan losses will be consistent without prior history. Again, we are currently discussing the accounting treatment with our independent auditors to determine whether certain potential changes in loan loss allowances will be reported as a reduction in revenue or an increase in bad debt reserves.

Given the ongoing changes in the student lending environment, our bad debt target for fiscal 2009 and beyond remain under review.

We expect fourth quarter diluted earnings per share to be approximately $0.08 to $0.10.

As we discussed last quarter, we expect our fourth quarter earnings to include approximately $0.03 to $0.04 in costs associated with changes to student lending.

For purposes of fourth quarter guidance, we assumed 85.8 million diluted shares outstanding. The tax rate is anticipated to be approximately 40% in the fourth quarter.

We plan to provide fiscal 2009 guidance during our regularly scheduled fourth quarter and fiscal year end conference call in late August 2008.

With that I will turn the time back to Jack for closing remarks and question-and-answer.

Jack Massimino

To sum up in the third quarter, we continue to grow and improve operations while making the transition to new funding sources for our students.

March was our 14 consecutive month of positive start growth driven by more effective marketing, lower employee turnover, better service to students and other operational improvements. Over time, we expect the higher student population and to help expand margins as we leverage our scale in investments we made in building a sustainable business model.

Although Congress may increase student loan limits, which would be a positive development for our students and to the Company, we are not relying on the uncertainty of legislative fixes. Instead, as Operation FIRE indicates, we are relying on our own capabilities to manage through the ongoing changes to the student financing environment.

Operator, I will turn it back to you.

Question-and-Answer Session


(Operator Instructions) Your first call comes from Sara Gubins of Merrill Lynch.

Sara Gubins - Merrill Lynch

Can you talk about what is involved in getting the schools up and running on the Direct Loan Program?

Jack Massimino

The Direct Loan Program is not that difficult a process. You have to go through a little of administrative procedure just to get them coded appropriately. The biggest issue for us wasn’t in dealing with the Department of Education, it was dealing with our third party processor that we use that packages our loans and then submits them to the Department of Education.

We had to make a few changes to their software package so that it would be able to flow just as if we were dealing with Sallie Mae or any other third party private lender.

We have now done that; we have a fix in place and, as we mentioned earlier, we have now 26 schools that have the ability to do direct lending. In addition, Global, our outside third party processor had to staff up during that period. We had a combination of a little bit of training, some software development that we had to do; but, dealing with the Department of Education hasn’t been complicated at all.

Peter Waller

I will just add, the operation at the School level, it is pretty straight forward because it works with a third party and once the third party got the software packaging in place from the school’s point of view, this is fairly seamless.

Sara Gubins - Merrill Lynch

If you did have to move to direct lending for all of your schools, what would be the incremental cost?

Jack Massimino

There is a processing cost associated with it; it is around 10 to $11 per file that we push through. There is a little incremental cost that would be included.


Your next call comes from Trace Urdan - Signal Hill Group.

Trace Urdan - Signal Hill Group

One of you mentioned that the reason for the more sober dark guidance heading into the fourth quarter has to do with the transition from Sallie Mae to the new lending regime and that you didn’t really have enough experience to get a good fix on that, given the very strong student starts in the quarter, I am wondering what that maybe supposes for the trend from January, February and March. I was wondering if you could talk to us about how this start played out during the quarter as you made that transition and whether maybe the March starts are significantly lower than where the January starts were.

Peter Waller

First of all, as we have said in the last call, we do anticipate that due to our strict underwriting guidelines that it will take a little of the cream off the low end of the less qualified students. We do expect to see somewhat of a lower start rate going forward.

I have to say, as I said in my (inaudible), it is very early days and we do have, as the quarter progresses, see early in our business through the quarter. We have linear stocks; the beginning of the quarter seems it is always higher that the back end of the quarter. We understanding what those trends are, it is difficult for us to really be certain at this stage. We are just at the end of April, but we have May and June to go.

This is a reasonable call based on the trending that we’ve seen and the best that we can interpret where our linear stocks are and where our diploma stocks are.

Jack Massimino

Trace, as you recall from last quarter, we initially came out at 5 to 6% start growth in the fourth quarter; we have moved that up a little to 6 to 7%; but the truth of the matter is that March didn’t really give a lot of guidance. We are still playing this on a forecast basis. It is not based on a whole lot of experience as yet.

Ken Ord

Trace, finally, the underwriting that we have introduced was really introduced through the course of March, so you really won’t see the full impact of those underwriting procedures until we get into the fourth quarter.

Trace Urdan - Signal Hill Group

Fair enough, Jack, I do have to point out that between the 5-6 and 7-8, there was also an 8-9 in the middle there. That is the nature of the question. You guys obviously versus where you were at the earnings call last quarter. You are seeing things a little differently that you were at that point in time.

Jack Massimino

I don’t think so, Trace. I think last quarter what we came out with, our forecast for the quarter was 5-6 and we moved that up to 6-7. The 8-9, I am not sure what that was.

Peter Waller

That was the full year.

Trace Urdan - Signal Hill Group

Yes, it might have been the full year.

Jack Massimino

It might have been early on; but I think we are pretty consistent in coming out 5-6 early on and then increasing the point in the range this cycle. We are looking a little more optimistically at it.

Trace Urdan - Signal Hill Group

Fair enough and then if I could also ask, it looked like we would have negative leverage in each of the line items in the income statement; but, the guidance for the fourth quarter, at least by my read against the revenue numbers that you put up, suggests that you are anticipating some positive leverage as you head into the June quarter. I wondered if you could speak to that, why was there negative leverage in this quarter and why you are anticipating positive year over year leverage heading into the June quarter.

Jack Massimino

I will turn that over to Ken; what I will tell you is that there are a number of one-time events in the quarter. Ken will outline those for you; we see those, obviously, not continuing into the fourth quarter and that is where we begin to get the leverage we have been talking about.

Ken Ord

Trace, let me just take each of those line items, one by one.

At services, in the third quarter that was up 1.6 percentage points; a full percentage of that was the bad debt year over year. About 4 points of that was increase in compensation expense for four tenths of a point, so 400 bases points was incremental benefit costs as a result of (inaudible) and Claims experience in our self insured medical program.

We also had, we are going through a bookstore conversion and had some onetime inventory write-offs in this quarter, which was worth about 300 bases points. As we move into the fourth quarter for educational services, again we don’t have the negative comp year over year for bad dept that we would have had in the third quarter, we won’t have the on time bookstore cost and we don’t think the flair up in claims experience will continue into the fourth quarter.

In terms of marketing and admissions cost, we were negative a tenth in this quarter or 100 bases points. We expect that to improve; we don’t expect, as Peter mentioned, any increase in marketing reps in the fourth quarter.

Both of those line items will be favorable year over year in the fourth quarter, which would help us in terms of that year over year outlook.


Your next call comes from Jeff Silber - BMO Capital Markets.

Jeff Silber - BMO Capital Markets

Your guidance for the current quarter of $0.08 to $0.10 in EPS that includes or excludes the $0.03 to $0.04 in lending related charges?

Ken Ord

That includes it.

Jeff Silber - BMO Capital Markets

In terms of your access program, I was wondering if you could give us a little more colour; I am not sure you are willing to do this, but if you could that would be great. In terms of how large the program is; I believe you have sets some goals in terms of where you want to get and I just wanted to monitor that progress. Talk about some of the lending criteria, the underwriting criteria that you are using to qualify students.

Ken Ord

As we have indicated and to take you back to the numbers we have given you. Obviously, when Sallie Mae exited the market, we have indicated that in ’07 that was about $100 million worth of subprime lending. The Access program will cover that gap. We expect to sell off part of that to third parties and we are negotiating it. We have talked about with certain of those third parties. The Access program covers the whole space part of which we would have to keep on our balance sheet, another part we would expect to sell off.

In terms of the underlying criteria for underwriting, potentially we go through a process which would mirror much of the questions that would be entered into on a FAFSA so that we want essentially to be underwriting students, which would have the benefit of Title IV loans coming with them. Then we do other screens, which we won’t go in on this call; but, essentially to help us feel secure in the ability of those students to repay going forward.

Jack Massimino

Jeff, we set up loan limits for our students based on certain criteria, so there are maximum loan amounts that we will put together for our students. One of the reasons we have talked about this slight reduction in start growth compared to the full year, comes from that process. The number of students who might otherwise have gotten through the process historically won’t meet our screen; we know they won’t meet our screens and that is where we are getting roughly 1% to 3% change that we are looking at.

Jeff Silber - BMO Capital Markets

Okay and for those loans that you are keeping on your balance sheet, how much are you reserving for bad debt?

Ken Ord

Again, there will be three tiers based on FICO’s score and we’ve indicated previously that given that this is consistent with what we did with the Sallie Mae and again, we have talked about the fact that in our ending negotiations with Sallie Mae there was about a 45% discount they were willing to take. Our own view, at this point, on a forecast basis is that that will be roughly at 50% discount on the loans that we would keep on our balance sheet. It will depend on the mix of FICO scores that we bring on, but that is our rough guess at this point.

Jeff Silber - BMO Capital Markets

What was stock based compensation in the quarter?

Ken Ord

Let me get that for you.


Your next call comes from Kevin Doherty - Banc of America Securities.

Kevin Doherty - Banc of America Securities

I just want to see if you quantify some of the new monthly cash payments you are talking about from your new students. I may guess, how much were really do you think those folks are going to be willing to pay out of pocket?

Jack Massimino

I think, as we have said previously, historically, we have been able to get about 10% of our total revenue in cash collections from our students. That number dropped down to around 5% recently, within the last couple of years as a result of the easy availability of Sallie Mae funding for the students. We set an expectation of collecting around 30 to 35 million for our organization in increased cash payments over our historical low that is what we have been talking about. As we sit here today, the commitments, we are just starting to collect the cash, but the commitments that we saw in that March time period, March and April time period, actually exceed our own internal targets that we put for ourselves.

It is a question of commitment versus cash collection; we will know a lot more in the next couple of months. Cash commitments were up fairly, significantly.

Peter Waller

I’d like to reinforce, Kevin, this is Peter, that our intents and expectations to be able to increase our monthly cash receipts wasn’t a wish, in an empty environment. We hired experienced operators who have now been with us and in the school business for many years and this is really just tapping into that experience and we moved away from it in the last couple of years because of the ease in getting the Sallie Mae. There was a high degree of confidence in the admissions, finance and management teams, in the schools and in the campus support center that we would be able to increase it and that is why we laid out some of those expectations to you.

As I indicated in my words and Jack just reinforced, at least at the commitment level, ahead of those internal targets.

Kevin Doherty - Banc of America Securities

Does that expected to have any push back; I am just trying to think when you rolled this out, a little more longer term, will that have any impact on your starts or your retention rates?

Ken Ord

We have incorporated that in the guidance we are giving you in the fourth quarter. All of that is part of what we think is going to have an impact on us.

Kevin Doherty - Banc of America Securities

No indications going forward that it is going to be in incremental drag?

Ken Ord

No, I don’t think so, certainly, not at this stage.

Peter Waller

Just operationally, what we do is when a student comes in and they meet with admissions and they get moved across to financial planning, they really establishing with that financial planner their individual budget. Initially starting off with their outgoing expense and we help them go through an estimator of their own lifestyle and how they are going to pay for their education. From that is derived reasonable number that the student then says, yes I can do this. It is not a number picked out and prescribed, it is coming out of the individual situation from the student. The student who has ownership to it; they will then take it back in consideration after that meeting with either the parents or friends, obviously, thinking about it in a rather short period of time and then be motivated to come back to be educated knowing that they can afford it.

Jack Massimino

I think I would add one other to that Kevin, as you listen to others in our industry; you are going to hear a variety of comments around cash collection. The issue for us is pretty straight forward. Our students don’t have 10 or $12,000 gap. Our students have a $2000 to $2500 gap. Any cash they can pay reduces their need for an extra loan. The way we work it out and here is the bit of information you probably don’t have, which we are willing to share.

When a student pays cash during school, we charge them no origination fees and no interest on that amount of money. They actually get an interest free loan from us while they are making these cash payments. There is a real advantage to them to go ahead and put cash upfront.

We are not talking about thousands of dollars a month. We are talking about 30, $50 per month up to $100 per month. It is a much less amount of money because our gap is that much smaller than a number of our competitors.

Ken Ord

When you wind it back to lifestyle, we talk it with the students in terms of weekly. You are down to $10 per week. For a lot of people, banking $10 a week is meaningful and I am not diminishing that and it becomes sizable. You can size it in your own lifestyle and education becomes important to you and they understand the value of that education and graduating in a year or two. They find a way to find that $10.


Your next call comes from Bob Craig - Stifel Nicolaus.

Bob Craig - Stifel Nicolaus

There have been a lot of changes on the lending side; could you run down who your active lenders are now for both FFELP and private?

Jack Massimino

Bob, we have heard from the lenders every time we give you a list of names, you run out and contact them. We have about 30 different FFLEP lenders that we use. Fundamentally, Sallie Mae is still our largest FFLEP lender. I suspect quickly here Direct Lending will be our second largest FFLEP lender as we move forward. We are using a number of the brand names that are still in business out there. No different than everybody else.

Frankly, some of it is on a school by school basis. We do have a couple National contracts; we have given you those names in the past. As you well know, Citibanc, Bank of America, a number of these have dropped out, J.P. Morgan. They were not a big part of our business. Fundamentally, Sallie Mae was the biggest part of our business and that is where we stand today.

Bob Craig - Stifel Nicolaus

On the private side, Jack.

Jack Massimino

On the private side, we are in negotiations currently; I would just as soon not give you information about who we are dealing with because there are a limited number of people out there who are making these kinds of loans and this is almost every man for himself, Bob.

Bob Craig - Stifel Nicolaus

Why were the disruptions centered on the online side and could you gauge that impact?

Peter Waller

From the medley of long distance, it so happened that we mostly packaged certain lenders in the online business. Those lenders went away in sequential order. A couple of them actually, one dropped and then six weeks later, another one dropped.

Re-packaging at distance is harder, obviously, than re-package when people are in a school where you can ask them to come from the classroom and ask them to complete the new paperwork, so long distance. Then you get sheer scale, when you have this number of students, we have just described that we are over the 10,000 mark now, in terms of population and a significant portion of those needed to be re-packaged. No sooner than we decide to repackage them and then one lender then another lender came along and dropped.

Headline, long distance critical mass.

Jack Massimino

It is fair to say also, Bob that you can imagine now that we are not using any other lender than going direct with our online students.


Your next call comes from Gary Bisbee of Lehman Brothers.

Gary Bisbee - Lehman Brothers

Through the eight weeks that you have been using the new operation FIRE way of going about business, can you give us any sense of what percent of the revenue you funded yourself through the Access Program, what percent was cash pay, any other details on how that looks so far.

Ken Ord

Gary, it is really early on all of that because we said earlier, cash commitments are up and we really haven’t funded a whole lot of loans. We were making loans in that March time period and funding is just now beginning as these students begin to come to school. We will have a much better fix on how much.

One thing that affects that, you come in with a gross number on a funding basis then you have refunds because students drop and we are not at any way, level, shape or form to be able to give you any detail around it, yet.

Gary Bisbee - Lehman Brothers

Let me take another crack at a similar question. You talked about the 30 to 35 million that you targeted in total cash commitment and once you annualize all the new students in the system, does the math work to take a hundred million of loans from last year, grow it 8 or 10% then subtract 30 to 35 to in other words total private loans that you might be on the hook for would be something like 70 to 80.

Jack Massimino

That is pretty good; that is a pretty good way to take a look at it and then you’ve got to deal with whatever we do on Direct and whatever we do on Plus and swallow that we will roll through there as well.

Ken Ord

What we can say is that what we are seeing doesn’t look different than what we were anticipating. Although we can’t give you those specific breakdowns, what we are seeing is in line with the indications we have given you previously on total loan volume and the percentage of that loan volume we take.

Gary Bisbee - Lehman Brothers

Trying to get an understand of what’s holding back the ability to translate this pretty rapidly accelerating revenue growth into gross margin expansion. I think if I heard you right, the square foot per student metrics getting better, but we are not yet seeing the margin. How confident are you that that comes next quarter or the next few quarter?

Jack Massimino

Pretty confident, we’ve got in the quarter we have about eight tenths of a percent pick up just on the cost of the facility utilization. We expect that to continue forward into this next quarter; we think you will start to see that in our next announcement.

Peter Waller

On the marketing and admissions line, said the advertising line, we are getting gains on the advertising side of it and admissions being somewhat offset as we ramped up; but, we said that we are not adding anymore and we are going to have extra revenue there, which coming into the fourth quarter.

As Ken outlined, you will see that leverage taking place within the fourth quarter. The key variables there, in our fixed cost on compensation management in the schools, are going to pick up leverage. It is coming through. You aren’t just seeing it because of some of the lumps that came through in the third quarter in education experiences and services.


Your next call comes from Amy Junker - Robert W. Baird.

Amy Junker - Robert W. Baird

I would expect an increase versus fourth quarter of last year because it was so depressed and if you look back two years ago, at least given the guidance it looks like we are not really seeing that margin improvement. Maybe, if we can look beyond the fourth quarter because that is not really a great comp. Again maybe give us the confidence that we are really going to start to see this margin improvement. I think when I look back a couple of quarter ago, you talked about being able to achieve upper single digits margins by the end of this fiscal year and we certainly are not seeing that.

Jack Massimino

A couple of thing going on there, Amy, first, the upper single digit was prior to anything with this credit impact. You’ve got a number of pennies in the fourth quarter that we had no idea about at the time.

The other thing that you have to figure out when you go back two years, we had no incentive comp two years ago in our performance for the Company. We have a significant amount of incentive comp built into this fourth quarter as we told you early on in the year; we had over $12 million worth of additional incentive comp built into the run rate this year that hasn’t been in the run rate for the last several years. All of those things are beginning to come through or picking up all that and we are going to see increases in the fourth quarter.

Amy Junker - Robert W. Baird

If you were to think about start growth, excluding what is happening in this student lending, would you normally expect the strong growth you saw in this quarter would continue into the next quarter. My question is the slow down due entirely to the student lending?

Peter Waller

We do think there is momentum in our business around start growth; it is true, if you go back to a year ago, you will see that we were flat through the first three quarter and then by the fourth quarter we started to see significant gains. Obviously, as we started to get the impact of national advertising, some of the re-branding taking place and our media efficiencies, our advertising started to kick in well in the fourth quarter a year ago. We have had part of the double digit growth for the first three quarters this year with add that roll over. But, even with the roll over, we are feeling pretty good about the underlying health of the stock growth that we are going to see, so a combination of student credit and roll over, a combination of the two.

Jack Massimino

I think clearly, had we not had this credit circumstance hit us. We would have had a pretty good enrollment growth in the fourth quarter. It may not have been at that 13% level, we have seen in the first and third quarters, but it would have been pretty good.

Ken Ord

Doing the math, clearly, coming up 13, we wouldn’t have taken you all of the way down to our guidance had it not been for the student loan situation. But, we would have taken it down slightly.


Your next call comes from Mark Marostica - Piper Jaffray.

Mark Marostica - Piper Jaffray

With regards to your third party lender that you are planning to sell off certain of the loans, I am curious whether that lender is willing to entertain risk-share?

Jack Massimino

They are, Mark. Now that is actually what we are negotiating.

Mark Marostica - Piper Jaffray

We have seen some lenders get more selective on the Title IV side, particularly with high default rate schools and I am curious if you could help us screen the risk with regards to the Sallie Mae potentially taking a more conservative posture there. From your standpoint, what is that risk, can you help us assess that?

Jack Massimino

I think, Mark, that is a fair question and the reason we are making such a strong move to Direct lending is to mitigate that risk. I have no idea what Sallie Mae is going to do or not do and given the experience that we have had with them over the last 4 or 5 months, my expectation is that they are going to do what I don’t think they are going to do. We are taking every precaution we can, which clearly gets us lined up to move our stuff across direct lending and that is why we are doing it. We will be in that position with all of our school by the end of this fiscal year, by June 30. I think we will mitigate the risk, we are already mitigating the risk because the schools that we are moving over first, first 26, were our highest total for default schools. The next up to 54 will be our second highest group of co-work default schools. It is our best risk schools will be the last schools we are transitioning across over the next 60 days.

Mark Marostica - Piper Jaffray

With your work in Washington, I am trying to get a handle on the 90/10 issues, could you handicap for us the likelihood of the legislative remedy.

Jack Massimino

There are a couple of things on the legislative side that I feel pretty good about. I think we will get institutional loan capability so that we can take our own loans and count those against the 90/10 just as we use to be able to count Sallie Mae loans. I have a pretty good feeling for that piece of it. I can’t tell you there is going to be much more than that.

I do know that instead of having as we sit today, the house bill includes a piece; the HEA piece included a piece that would extend us from a one year period to a two year period. It doesn’t come, sudden death. You get a year to fix it an additional year to fix it. Those are two positive outcomes. We are still working with a lot of our support groups in Washington to make it even better to complicate a deal for us as I said in my initial comments.

If we don’t get the other fixes that we are trying to arrange, it would mean that we would have to re-create a gap in the number of our locations and that would mean an increase in pricing for us.


Your next call comes from Kelly Flynn - Credit Suisse.

Kelly Flynn - Credit Suisse

A follow up to the last one relative to the loan limit increases that looks like they are going to go through. They provided some detail but to clarify, do you think that these increases will enable you to basically eliminate your reliance on private loans as well as reliance on your own lending program? Then, in that answer, can you talk in more detail about what you said about 90/10? Are you willing to raise your prices as much as you need to avoid violating that and are you comfortable being right on the edge of violating it?

Jack Massimino

Yes, if we get a $2000 increase because of our student mix and because of our accounts that we have, other than for our WyoTech business, we will see a pretty good improvement for our students in the amount of money they have to finance to then directly relate to reducing the amount of Access loans we have to take.

We would still have a portfolio of loans that we would take on our balance sheet dealing without WyoTech business, but as we have mentioned a number of times, that business is a better risk for us so students default at a much lower level and as a result, we feel pretty good about that book of business and that’s roughly between 17 to 20% of our total of that $100 million, we talked about in 2007.

I think that as we go forward, if we don’t get any additional fixes other than what is already in there, there are a number of other things we can do internally to help mitigate 90/10 ourselves. We have a number of schools that are sitting at 50/50. We have some flexibility around combining what I was talking about previously these OPE ID Numbers. There are some ways you can get at this. It is not easy but you have to go through a regulatory process to do it. The question is would we raise rates. Yes, we would have to raise rates. We are willing to do that to accommodate what we need to do to mitigate this 90/10 impact.

Having an additional year to fix things, gives us some runway to do a number of other things. One of the things that we are focused on is bringing in other third party revenue from payers than Title IV.

If you have a two year run rate to make that happen, remember your 90/10 calculations at the end of your year, so you get to run through this year, run through the next year. You would have that period of time to fix the problems.

There are a number of things we can do to deal with it. I am willing to play it somewhat close to the vest but not that close to the vest.


Your final question comes from Jeff Silber - BMO Capital Markets.

Jack Massimino

Jeff before you ask your question Ken will give you the answer on that stock base comp.

Jeff Silber – BMO Capital Markets

I appreciate that; I also just wanted to know in terms of retention if you can give us any colour on how the quarter went.

Jack Massimino

The retention in the quarter is pretty flat with historical experience, Jeff. Ken will give you the stock (inaudible).

Ken Ord

Stock based compensation in the quarter was $2.8 million and that compares to 1.8 million a year ago.

Jeff Silber – BMO Capital Markets

Should we expect about the same amount in the fourth quarter?

Ken Ord

Yes, approximately the same amount in the fourth quarter.

Jack Massimino

I would like to thank you for participating on the call with us today and we look forward to providing you with an update of our progress at our investor day on May 20 in Long Beach. If you haven’t signed up, you have the phone number. Get hold of Anna Marie and her assistant will be glad to put you on the list. Thanks for your time and consideration this morning.

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