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Career Education Corp. (NASDAQ:CECO)

Q1 2008 Earnings Call

May 6, 2008 10:00 am ET

Executives

Karen King – Vice President Investor Relations

Gary McCullough – President, Chief Executive Officer

Mike Graham – Executive Vice President, Chief Financial Officer

Analysts

Gary Bisbee – Lehman Brothers

Kelly Flynn – Credit Suisse

Amy Junker – Robert W. Baird

Sara Gubins – Merrill Lynch

Suzanne Stein – Morgan Stanley

Jeff Silber – BMO Capital Markets

Mark Marostica – Piper Jaffray

Jerry Herman – Stifel Nicolaus

Chris [Shetler] – William Blair & Co.

Kevin Doherty – Banc of America Securities

Trace Urdan – Signal Hill Group

Corey Greendale – First Analysis Securities

Operator

Good day ladies and gentlemen and welcome to the first quarter 2008 Career Education earnings conference call. (Operator instructions) I would now like to turn the call over to Ms. Karen King, Vice President of Investor Relations. Please proceed ma’am.

Karen King

Thank you. Good morning everyone and thank you for joining us on our first quarter 2008 earnings call today. I’m Karen King, Vice President Investor Relations and with me today are Gary McCullough, our President and Chief Executive Officer and Mike Graham, our Chief Financial Officer.

Following a brief presentation by management the call will be opened for analyst and investor questions. This conference call is being webcast live on the investor relations section of our website at www.careered.com. The replay will also be available on our site. If we are unable to answer your questions during the call, please call our investor relations department at 847-585-3899.

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

These risks and uncertainties include but are not limited to those factors identified in our first quarter earnings release and in our annual report on form 10-K for the year ended December 31, 2007 and from time to time in our other filings with the Securities & Exchange Commission.

Except as expressly required by securities laws, we undertake no obligation to update such factors or to publically announce the results of any of these forward-looking statements to reflect future events, developments or changed circumstances or for any other reason. Now, let me turn the call over to Gary McCullough.

Gary McCullough

Thanks Karen. Good morning and thank you for joining us today for our first quarter 2008 earnings call. As Karen indicated, I’m joined on this call by Mike Graham, Executive Vice President and Chief Financial Officer. During today’s call, we’ll provide details of our operating results, we’ll discuss how we are addressing changes and uncertainty in the student lending environment and we’ll discuss progress we’ve made on a number of corporate initiatives.

Our consolidated first quarter revenue of $460 million was in line with our expectations and was flat versus the first quarter of 2007. Excluding our transitional schools division, first quarter 2008 revenue was up 2.5% from first quarter 2007 revenue of $415.6 million. In addition, excluding the transitional schools division, population increased 6% and starts were up 10% year over year.

On our last call I told you that we had restructured our organization into five strategic business units: university, art and design, culinary, health and international. In the first quarter we had strong starts in all of our SBUs with the exception of culinary. The university SBU showed improvements in the first quarter with starts up 8% year over year.

As you may recall, last quarter we indicated we would synchronize AIUs ground and online calendars in order to provide seamless offerings to our students and we’ve done so. We are encouraged by the 10% year over year increase in starts at AIU. In the first quarter, AIU experienced the highest number of quarterly starts since the second quarter of 2006.

During the investment analyst day we hosted in March, Len Mariani shared some of the work our teams are doing to become more effective in our admissions and marketing efforts. We have continued to improve our focus on the most productive internet vendors and we have shifted away from ineffective television buys to more productive lead sources.

In addition, we’ve made progress with our peer qualifier admissions model. For those unfamiliar with peer, it is our outbound calling operation that allows us to qualify internet leads and then transfer interested student prospects directly to a school admissions representative.

By grouping leads in this fashion, our admissions representatives are able to focus primarily on admissions advising and enrolling. This model has been successfully used at CTU online. During the quarter, CTU continued to show strong results with revenue, starts, population, income and margins all up year over year.

While starts increased, our cost per start decreased primarily as a result of more efficient and targeted internet marketing and the peer model. We plan to continue to expand this best practice across the rest of the university SBU and into other SBUs during the balance of 2008 and into 2009.

I want to mention here that we’re extremely pleased that we brought an accomplished professional to lead our university SBU. Deb Lenart, our new Senior Vice President for the University SBU has successfully led multi-billion-dollar divisions of Ameritech and EDS. She has also led key legislative and regulatory policies within state and Federal commissions, law makers and with Congress. Deb has immersed herself in understanding the education business and is moving quickly to get to know her schools.

In our art and design SBU, starts were up 27% during the quarter, reflecting the positive impact of IDT online and our successful academy startups in Sacramento and San Antonio.

During the quarter we also added a strong leader to art and design. Ty Roberts, Senior Vice President for the art and design SBU previously led operations for DeVry’s online division and helped lead the turnaround of DeVry’s professional education division. Ty and his team are working with all the schools within the new SBU to allow him key short and long term goals and to implement consistent and effective practices.

The health education SBU continued to achieve strong results. Starts in health were up 17% year over year. The SBU rolled out four completely new programs at various campuses this quarter, including a bachelor of science and nursing at our Sanford-Brown St. Peters campus.

Four health education schools are now offering blended learning programs in which students can take general education and theory based core courses online. The SBU plans to roll out blended learning to five additional campuses in 2008 and to the rest of the health education campuses by 2009.

In the international SBU starts were up 40% year over year in both our France based INSEEC schools and Italy based Istituto Marangoni continued to perform well. Our transitional schools are winding down effectively with a strong and experienced leadership team in place to ensure that all current students can complete their programs and graduate. The decision to teach out these schools, while difficult, was the right one and we remain committed to the students, staff and faculty at those schools.

Finally, we’ll move to culinary. Starts in the culinary SBU were down 8% in Q1. This decrease primarily reflected the decision made last year to reduce culinary use of the extended payment plan program. We also carefully decreased staffing in the culinary schools this quarter reflecting the anticipated smaller student population as we work to reshape the business.

We are on track to begin to offer our 21 month culinary program by Q1 2009, assuming we receive the appropriate regulatory approvals within the expected timeframe. The combination of the longer program, increasing use of our new payment program, a more creditworthy student base, adjustments in staffing and a smaller footprint in startup culinary schools should put the SBU in position to return to growth over the long term.

Now I’d like to address student lending which has been top of mind for most of us during the past several months. The credit markets are in an extraordinary period that wasn’t predicted. Since we initially provided detail on our February earnings call, and even since March when we provided and update at our investor and analyst day, the student loan market has worsened and the situation has continued to evolve.

We continue to believe that our company can emerge from this period, stronger and better positioned for the future. As you know, since we last spoke, additional lenders have pulled out of the student loan market, both in private lending and in Federally backed student loans.

We are pleased at the speed with which Congress has passed important legislation to increase Federal funding for students and we look forward to the President signing it as he’s indicated he will. Our students like those across the country will benefit from these changes.

While we continue to be able to provide our students with an array of options for FFELP loans, we are prepared to participate in the Federal Direct lending program should that become necessary. We have a pilot program in place through which Collins College in Arizona will allow students access to direct lending this month.

All CET schools are approved within the government’s direct lending program and we have the systems and resources in place to transition schools with no material incremental expense. Our student finance team has an experienced leader with institutional experience in direct lending and the IT conversion necessary for direct lending will be operational by the end of next week.

All that said, we do not intend that this will be the student’s main conduit to Federally backed loans as we believe the third party FFELP program will continue to be viable. Even with the challenges in the private lending market, we continue to have multiple lenders who offer private loans to our students. We previously indicated that we believe certain lenders would step in to fund the most credit worthy students who were impacted when Sallie Mae exited the recourse product.

Given the increased market contraction in the last few months, this hasn’t occurred. I want to reiterate what we said in our last call. We do not see ourselves as a long term lender. However, we have a strong balance sheet and that will allow us to provide transitional financial assistance when we believe it’s in the best long term interest of our students and the company.

Accordingly, we will use our balance sheet to provide funding to the small group of students to ensure that those students who previously utilized lenders that exited the market will not be left behind. Because we will replace the lost third party originations with our balance sheet, we do not anticipate a material change in the revenue estimates we previously provided.

In the beginning of April, we moved from our previous extended payment program to a program we outlined on our last call. As we noted, the new payment program requires higher FICO scores than our previous extended payment program. In addition, before students are approved for funding through the new program, they are first required to seek out a co-borrower.

While early, we’ve seen an increase in the number of students utilizing co-borrowers which in many instances resulted in them having access to third party funding. This allows us to reserve our balance sheet for those students without other options. We remain committed to successful outcomes for our students and will work with each of our continuing students to ensure that they will receive adequate funding through our new payment program and we’ve already processed loans for several hundred students under the new program.

In light of the consistent changes in the credit markets, we expect to increase the use of our balance sheet beyond our previous estimate. Mike will provide more details but I want to make clear once again that these students will still be in higher FICO bands than those who traditionally received loans through the recourse program.

As Mike noted in our last call, it’s in everyone’s best interest to focus on students that have both the desire, the financial capability and who are prepared to be successful with their academic pursuits. We continue to believe that it’s in the best long term interest of all of our stakeholders to work to build a population of students with stronger credit scores and ability to pay.

We continue to meet with a variety of third party lenders to develop products for students who are unable to qualify for more traditional loan products. While early conversations are encouraging, we are carefully assessing the long term sustainability and infrastructure of each potential partner to ensure that we do not jeopardize our three year trend in lowering cohort default rates.

In summary I’ve given you a number of reasons we are confident we can mitigate the impact of the volatile market. First, the increased levels of funding that have been approved in recent legislation will be helpful to students in several of our programs. Nonetheless, we have everything in place to implement direct lending if needed.

Second, we have a strong balance sheet from which we’re able to fund much of the gap for our current and new students.

Finally, as outlined in our last call, we are making the operational changes necessary to address expected lower starts in our culinary SBU. These changes include adjustments in staffing, reduced real estate footprints and a more local focus. Before turning things over to Mike I have one more update from the quarter.

We were extremely pleased to have added two new members to CECs Board of Directors this quarter. Ted Snyder, Dean of the University of Chicago Graduate School of Business, overseeing the academic programs in Chicago, London and Singapore. Ted’s career has included positions with some of the nation’s top universities, including the University of Virginia, the University of Michigan as well as various roles at the University of Chicago.

Dave Devonshire played a significant role in the turnaround at Motorola during his tenure as CFO of the company, driving 20 straight quarters of positive operating cash flow before his retirement. Ted and Dave bring tremendous experience, expertise and new perspectives to our Board and to our Company and we’re pleased to have added professionals of their stature to our Board.

In addition, Steve Lesnik moved into the role of Chairman of the Board this quarter. Steve’s experience as former Chair of the Illinois Board of Higher Education, his business experience and expertise in communication strategy continue to be a great value to me and to the Board as a whole.

Steve took on the Chairman role from Bob Dowdell, who stepped down as Chairman and is not standing for reelection to the Board. Bob has been a Director since the company’s inception in 1994, has chaired our Board since 2006. As most of you know, he was interim CEO for a period of time during 2006 and early 2007. Bob’s leadership and commitment have been invaluable to the organization over the years.

On a personal note, I deeply appreciate Bob’s support and insight as he assisted me in transitioning to this industry and into my role as CEO. I’d like to thank him on behalf of the organization and myself. Now I’ll turn it over to Mike.

Mike Graham

Thanks Gary. I’d like to provide an update on our restructuring efforts and the transitional schools and add some financial clarity with respect to student lending before I end with some highlights of the first quarter.

During the first quarter we announced a companywide restructuring as part of our long term growth strategy and we indicated that the estimated savings from workforce reduction during 2008 will be approximately $18-$20 million net of severance costs. In the first quarter, the net savings was negligible and we recorded all the severance expense associated with this reduction.

We expect approximately $4-$6 million of savings per quarter for the remainder of the year. These reductions and related savings are exclusive of reductions made in the transitional schools division. We also restructured into five strategic business units as Gary discussed and the separate transitional schools division.

14 schools that we identified as teach outs moved into the transitional schools division. In the first quarter, we recognized $15.2 million of charges related to the onset of transitional activities. We recorded $8.6 million of severance and stay bonus expense associated with these schools.

We also recorded a $4.6 million non-cash goodwill impairment charge in the first quarter of 2008 as the projected cash flows for the transitional division could not support the goodwill that was assigned to it. In addition, we recorded a $2 million non-cash asset impairment charge in the division related to the reduction in the asset carrying value for AIU ground campus in Los Angeles.

As Gary mentioned, the transitional schools division is on track to wind down these schools as efficiently as possible. These charges were materially consistent with our estimates for the annual cost of winding down these operations that we provided to you in our investor and analyst day. However, the amounts in the first quarter were slightly higher than we had anticipated as we expected some of these charges would be recognized either in the late half of 2008 or at the close out of the activities in 2009.

With the creation of our strategic business units, we eliminated our college and academy divisions and moved the respective schools to either the university or the art and design SBU based on the primary program offerings. Upon approval by various regulatory bodies, we are expecting to convert Gibbs College in Vienna, Virginia and Katherine Gibbs School in Melville, New York to Sanford-Brown campuses, focusing on allied health programs.

The results of both of these schools are currently being recorded in the health education SBU. Now let me turn to some financial details on lending. Again in our last earnings call in February we discussed in great detail how we anticipated the changes from Sallie Mae and the contraction of the US credit markets would affect our business. We updated that information in March at our investor and analyst day presentation which is available on our website.

We provided a 2008 and a 2009 view of the revenue loss we projected that we would incur and we outline the balance sheet impact of assuming certain student financing. We believe as a company we have been very open and transparent on the issues and in our response and we intend to continue this approach with you and share as much data as we can.

We have provided an exhibit accompanying our press release with our latest estimates of the use of the balance sheet to make some of the comments in this call clear to you. Please note that the data is for the use of our balance sheet solely and is not the full impact of the new government legislation.

We previously communicated our anticipated annual originations form the new payment plan from our balance sheet to be about $25-$35 million in 2008. Since that communication, other lenders have exited the market, but the new government legislation will reduce the need of the use of our balance sheet.

With the reduction of other available lenders, we now estimate an incremental $30-$50 million in 2008 financing for both continuing and new students which will be an incremental $35-$55 million in 2009. The increased Stafford levels that are currently proposed in legislation will provide an approximately $10-$20 million reduction of the use of private loans and of our balance sheet in 2008 and reduce $15-$25 million of that use in 2009.

This is a very preliminary estimate and we’re currently in the process of fully analyzing the impact of the use of our balance sheet. We have previously stated that our original estimate of bad debt expense for outstanding balances under our new payment plan will be 44%, the rate of Sallie Mae’s last recourse program with the company.

We will consider applying this same initial rate or lower to these additional originations as we believe the ultimate rate of default will be lower as these are much higher FICO score students than the historical recourse level with a higher number of loans utilizing co-borrowers.

We also believe that as markets improve and securitizations are again available our portfolio of student loans will be of a much stronger credit quality than the company had previously held and thus will be more readily marketable.

Now let me provide some detail on our first quarter results. Excluding the timing of certain charges related to transitional schools division, we met our financial goals and internal expectations for the quarter and these goals were imbedded in the estimates we provided to you in Atlanta as a milepost to measure our progress.

On our last quarterly call, we communicated that we had a significant amount of change in our quarterly earnings pattern in this first quarter of 2008 with the investment in AIU marketing, the change in AIU earnings days and the severance and stay bonus expenses.

As Gary said, revenue for the first quarter was approximately $460 million, relatively unchanged from the first quarter of 2007. Excluding the transitional schools, first quarter revenue would have been $426 million, up 2.5% from first quarter 2007 revenue of $415.6 million.

This increase was driven by strong starts in the fourth quarter 2007 and this year’s first quarter starts in all SBUs with the exception of culinary arts. Our health education and international businesses continue to be the strongest performers in the quarter. First quarter 2008 revenue for our university SBU was $177.2 million, down 4.7% from first quarter 2007 university revenue of $185.8 million.

Revenue for CTU was up 16% for the first quarter, offset by a decline of 16% in AIU revenue. Starting January 1, 2008, AUI aligned its on-ground and online academic calendars resulting in a shift of earnings days between quarters. Approximately $6 million in AUI online revenue shifted from this first quarter to the third quarter of 2008.

This was offset by approximately $2 million of AIU on-ground revenue that shifted from the second quarter of 2008 to the first quarter of 2008 for a net impact in this quarter of a $4 million decrease. Excluding the impact of the shift in these earnings days, the overall year over year decline in AIU revenue would have been 13%.

Consolidated operating profit of $17.5 million was impacted by several non-comparable items as we’ve discussed. The first quarter had the severance and stay bonuses, $11.4 million related to the transitional school teach outs as well as our organizational restructuring.

Correspondingly, last year in the first quarter severance expense was only $1.7 million. The transitional schools division incurred a $6.6 million goodwill and asset impairment charge. AIU’s new media campaign was launched in the first quarter with expense of $5.7 million versus prior year and the shift in the academic calendar just discussed accounted for a $4 million decrease.

Reporting operating and profit margin for the quarter was 3.8% versus 8.9% last year. If you exclude the four non-comparable items just listed, the operating profit would have been closer to 10% in this year’s first quarter versus 9.3% last year. The transitional schools division now reported as a separate reportable segment provides you transparency to the loses of this unit, separate from ongoing businesses.

Excluding the results of transitional schools in both years, operating profit this year would have been 9.5% versus 11.8% last year. For the university SBU, first quarter 2008 operating profit margin was 14.1%, down 4.2% from last year’s 18.3%. The operating profit margin at CTU was 23.4% and the operating profit at AIU was 7.4%.

Our AU Dubai agreement was terminated as of January 1, 2008 and our first quarter results include other income of $4.7 million which is recognized on the income statement in share of affiliated earnings related to this termination.

Let me turn quickly to our balance sheet. As of March 31, 2008, we held approximately $32 million of municipal bond auction rate securities, all of which are rated triple A after the insurance component. We expect to be able to further reduce this amount in the near future. To date, we’ve experienced no loss in principle while liquidating our portfolio that stood $228 million as of September 30, 2007.

Turning to our share repurchase program, during the quarter of 2008 we repurchased 1 million shares for approximately $14 million at an average price of $13.84. From the inception of the buyback program in July 2005 to the end of the quarter, we have repurchased 19.2 million shares for approximately $605 million and we have remaining authorization of $196 million.

As of the balance sheet date of March 31, 2008, we had cash and cash equivalents and investments of $417 million. Our priorities remain unchanged for the use of cash. The first priority continues to be to maintain adequate liquidity to meet financial responsibility requirements and fund selective loans to students.

We have sufficient financial resources to meet the obligations of students under the programs committed to date. Next we will invest in high growth opportunities, such as startups, technology and new programs and from there we’ll continue to look to return cash to shareholders as we use cash for its highest return.

For our balance sheet our DSOs were 14 days at the end of March 31, consistent with that of year end December 31. Our capital expenditures were $18.8 million or 4.1% of total revenue, up slightly from the first quarter of 2007. Most of the capital expenditures in the first quarter were improvements of existing facilities and startup campuses. With that, we’ll take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Gary Bisbee – Lehman Brothers.

Gary Bisbee – Lehman Brothers

A question on the increased disclosure around student lending in your press release, it appears that the benefit you’re expecting on average for each of your students from the Stafford loan limit increase would only be on an annualized basis something like $400.00 or substantially less than the $2,000.00 increase.

I guess I wondered if you could give some more color on that, is that just a mix issue? Some programs are cheap enough that the kids just won’t need that extra amount and only a smaller portion actually will? Why would the benefit not be more?

Gary McCullough

What we did to come up with that number and obviously the legislation is new, we went division by division, SBU by SBU and took as much data as we had on our serial students, continuing students, as well as new starts and the new start impact. And we looked at our relative gap, the relative amount of Pell and the relative amount of Stafford and then division by division we calculated out how that up to $2,000.00 limit would benefit moving money from our balance sheet, using our balance sheet to the Federal balance sheet.

And so it is mostly driven by mix. Our health business unit has the least need for financing, our culinary has the most need for financing. And it’s been calculated out that way and again that is simply the Stafford of impact only on our use of balance sheet, it does not impact any improvement in our business from additional private loans or additional volume that may come from students who now have more affordable educations.

Gary Bisbee – Lehman Brothers

I wondered if you could give us any color on the starts growth at CTU, it appears to slow down a bit verse the recent trend, is that more of a one quarter data point or was there some slowing there that we should expect going forward?

Gary McCullough

I don’t think there’s any slowing, if you look at the CTU starts fourth quarter to first quarter, the number of actual starts themselves are very consistent with over 5,000 starts at the university. As you remember back to the two plus two program and things we had last year, we were coming off a relatively easier comp basis and last year’s first quarter was a high start number. So I think it’s just more math of the percentage but the start number fourth quarter to first quarter was very consistent.

Operator

Your next question comes from Kelly Flynn – Credit Suisse.

Kelly Flynn – Credit Suisse

I wanted you to revisit the schedule change at AIU and clarify, did that impact enrollments or just revenue per student and then can you talk about both revenue per student and margin there with and without the schedule change? I thought it would have improved by now but I’m trying to figure out if it was because of the schedule change or something else.

Mike Graham

From an enrollment standpoint there’s not a material change necessarily across all of AIU from the schedule change. Again we’re moving, we changed the days so that the start of the online programs and the on-ground programs in January was the same allowing the student to go between the two programs on a blended basis seamlessly.

What happened was basically you started the online program later in the quarter, moving $6 million of revenue and profit from this year’s first quarter to this year’s third quarter. At the same time we moved up the calendar slightly on the ground business so you’ve lost $2 million of revenue in this upcoming second quarter, right now that we’re in, and you gain $2 million.

So you have a net $4 million shift in the calendar which is revenue and profit because there’s no cost changes to that calendar movement. I don’t have in front of me the relative RPSs, on the businesses. We can get that to you later. But again the RPSs on the business son the AIU business, which we’ve talked about before, you do have the impact of the calendar, you do have some shifts in the population between bachelors and associates which we’ve discussed in previous calls.

And in this quarter we did see an increase in our starts slightly on students on a bit of a decelerated program, taking on class during an academic term then two, which also dropped our RPS slightly.

Kelly Flynn – Credit Suisse

As we look forward through the remainder of the year, can you give some insights on what RPS should do given all the moving parts, just maybe for 08 on average versus 07, just for AIU.

Gary McCullough

During the quarter RPS on-ground went up about $700.00 per student and was slightly down, call it another $700.00 in the online business. Obviously we’ll work to address the RPS business issue on the online business as we go forward. I would expect that they’ll remain in the area they are, although we’re going to push for the online business. We don’t expect to take a price increase.

One of the things we did do, if you recall in the first quarter is we began to address costs that had creeped into the AIU business as we took headcount reductions that were necessary in the organization. What we expect they’ll continue to be reflected in the business as we go forward. But we did that move in February along with the other reductions in force that we took.

Operator

Your next question comes from Amy Junker – Robert W. Baird.

Amy Junker – Robert W. Baird

First just a clarification question, do you still have starts in your transitional schools? And I guess I’m curious why that is and how long should we expect that to continue for those schools?

Mike Graham

As you recall we announced our teach out within the first quarter, so we did have January starts because we had not concluded the sales process right at January 1. So you do have residual starts in the first quarter. You should have very little if any starts from the second quarter forward.

Amy Junker – Robert W. Baird

Gary, you mentioned pricing a little bit, can you just talk about your plans to increase prices by segment? I know you allow your individual segment leaders to determine what’s appropriate, but what are your thoughts at this point and I’d be particularly interested in the culinary program.

Gary McCullough

As we said before and you reiterated, we don’t from the corporate center here determine price increases. We don’t have planned price increases in the business. We’re looking SBU by SBU to ensure that we’re competitive across the board on a by market basis. And so at this point we don’t have price increases planned into the business.

Operator

Your next question comes from Sara Gubins – Merrill Lynch.

Sara Gubins – Merrill Lynch

Could you talk about your plans for advertising spend for the rest of the year.

Gary McCullough

As you noted we’re making progress in terms of cost per start. Len Mariani and that team along with the SBU heads have done a good job of beginning to take unnecessary costs out of our spend.

We spent incrementally on AIU in particular in the first quarter and we think that was justified coming off of probation in December and I think when you see the positive starts that we experienced, we feel good about that and feel like the spend that we made was appropriate. We do not intend to spend at that level going forward, we’ll continue to look for opportunities to take spending out of our mix.

Mike Graham

And we did talk about in the first quarter that some of the AIU spending made in the first quarter would be offset later in the year with some reductions of spending. So in general we anticipate that our advertising spending as a percentage of revenue would be consistent or below last year’s level.

Sara Gubins – Merrill Lynch

Then the tax rate for the rest of the year, I saw that you guys had a benefit in this quarter, is 39% more of a reasonable run rate?

Mike Graham

I wouldn’t think so, I think that we had a $2 million discrete item that comes out, I don’t think the tax rate will be that high. Our tax rate, our statutory tax rate is 35% and then our state tax rate is 2% so you’re at 37% and then the tax exempt securities drives that rate down. I don’t think our rate for each quarter going forward will be much different than the 35% maybe up to 36%, I think it’ll be pretty constant right around where it is.

Sara Gubins – Merrill Lynch

For the Stonecliffe program, the associate degree program at CTU, I don’t know if it’s too early but any indications on those student’s interest in finishing up their bachelors degree with you?

Gary McCullough

Sure, we made certain assumptions around the sheer percentage that would move on to our bachelor’s degree programs and at this point we’re seeing the matriculation rate higher than we had anticipated.

Sara Gubins – Merrill Lynch

Could you share the matriculation rate with us?

Gary McCullough

Sara I’d rather not because we’re still moving into that, we’re seeing the interest that is higher and we’ll know more probably mid to late summer.

Operator

Your next question comes from Suzanne Stein – Morgan Stanley.

Suzanne Stein – Morgan Stanley

Can you just give us a little more color on what’s going on in the international division and just what we can expect as far as seasonality, the pattern for this year.

Gary McCullough

I’ll start by saying the international business is a bit different than our domestic business in that they enroll primarily in September for the academic year, so you would expect to see the larger or at least the starts increase in September unlike the balance of the business.

Those businesses continue to perform well as I said in my opening comments. I actually spent time with them about two weeks ago to understand the business in each of the cities in which we operate. And so you could expect from a seasonality point of view the big start, September or in the fall as the traditional school year.

Mike Graham

On a seasonal basis your first quarter and your fourth quarter, because you have full student attendance are your highest and the third quarter is a trough because you’ll have the schools basically dark for July and August. So you can anticipate that the third quarter will be half the normal volume of the business.

The business enjoys great trends as Gary said in our call, starts around 40%, we disclosed in our 10-Q that we do benefit slightly from the Euro, but only $4 million of our top line increase in that business was driven by Euro favorability, so most of it was driven by starts and organic growth.

Suzanne Stein – Morgan Stanley

Your share of affiliate earnings, going forward given the termination of the Dubai arraignment, what should we expect there, is that all that was in that line item?

Mike Graham

Yes, there’ll be zero in there going forward.

Operator

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

Jeff Silber – BMO Capital Markets

In your prepared remarks you talked about the private lending environment or the lending environment getting a little bit tougher since the analyst meeting in March, can you just review with us who your preferred lenders are, both on the private and the Title IV side and if that’s changed in recent months?

Mike Graham

As you know we’ve never given out the different names. We’ve gone through RFP processes and we’re talking to different people. We have had a reduction in both the Federal and the private side. We do have several lenders that are providing loans to our students on the private loan side and we have a list of lenders that are still active in the [self volume].

Jeff Silber – BMO Capital Markets

And continuing on lending, some of the other companies in this space expressed some concerns with while the potential addition in Stafford loan is positive, having to monitor a little more closely against breaking the 90-10 threshold, can you talk about what your company is doing along those lines?

Mike Graham

Given our revenue per student and the relative Federal levels, 90-10 has not been a material issue for the company. Our lowest priced products are in the health business, and if you look across the reports that we’ve given out before on the OPIDs, we don’t have a lot of severe 90-10 issues. We tend to have in our health program somewhat higher degrees and higher programs and so we don’t butt up against those.

Our plan would be first we would be hopeful that legislation does pass that would relieve any 90-10 issues from the industry, we’ll start there. Second, we’ll continue to manage the hire in programs and make sure that we look carefully at 90-10 levels. I know other people have potentially talked about different things like price increases.

At the current time because it’s early and we have very few schools in our health division that are affected by 90-10, we haven’t contemplated price increases right now. We’ll see more when legislation comes out and gets finalized, whether we need to do that on a selective basis, but right now we feel good about 90-10.

Jeff Silber – BMO Capital Markets

And if you could just give us a little bit of color on retention by the different business units that’ll be great.

Gary McCullough

When we looked at retention frankly we weren’t pleased with what we saw, we saw each of the units flat or slightly down from a retention point of view versus where they were year over year. And when I say that I mean a half a point or a point in each case and so that’s work we have to do that’s fundamental blocking and tackling which we’ll get after.

Mike Graham

We did have sequentially from our fourth quarter last year to our first quarter this year, we saw retention rates improve by just under 100 basis points.

Operator

Your next question comes from Mark Marostica – Piper Jaffray.

Mark Marostica – Piper Jaffray

I wanted to follow up on Gary’s comments regarding the idea of no price increases at any SBUs going forward at this point. Relative to the culinary division and given the relatively high cost of tuition in that division, I’m curious whether you’re considering or not considering price decreases or additional scholarships to combat the decline in start growth. How do you balance those two things?

Gary McCullough

Again, I’d never say never on either taking price up or down, but I think it’s one of those things that we just have to be aware of and make sure that we remain competitive on a market by market and program by program basis. And so that’s work that we can consistently do and we will do going forward.

I guess with regard to scholarship and grants, obviously that is something we are contemplating across the company and by SBU. I would mention here that we do have a non-profit associate with the company that provides scholarships and we’re about to release $1.2 million in funds across the company for deserving students. And so we look forward to doing that for those deserving students where we can.

Mike Graham

I think the other thing that we’re looking at is, as you know, we’ve spent a lot of time on the changes in the programs and the changes in programs won’t be effective until the beginning of 2009. The business again has the lowest cohort default rates in the company, is market priced with its competitive set and has very high placement rates.

So we think that the price is not necessarily out of line with the value the student is getting and I think we’ll need more time to see how the length in program, the reduced footprint, reduced headcount and the staffing of the model works before we go quickly to a price decrease.

Mark Marostica – Piper Jaffray

As a follow up to that point I’m curious how much of your decline in starts in the culinary business this quarter was attributable to your tightening of credit standards?

Gary McCullough

The culinary starts this quarter were minus 8%. Talking to our business units, it’s hard to quantify that but they thought that they would probably have been in the low single digits on starts versus the negative 8% that they had.

Mark Marostica – Piper Jaffray

When do you think you’ll report a quarter without charges? Are we done with all the charges this quarter or should we expect more charges in the coming quarters?

Mike Graham

I would say a couple things, one we did outline for you in our investor meeting in Atlanta that we would have a lot of different charges from a real estate standpoint, from a restructuring standpoint, so we’ve been pretty clear there. And we did lay out for you a pattern of the charges over the years. Second is we do work heavily on our cost models and we have taken severance charges and other charges as we’ve reduced staff.

As we look at our model going forward and we’ve talked about culinary that we reduced some staff in culinary, we will potentially have severance charges related to different staffing as we [treated] our employees with the right programs as we reduce our staff levels. It’s hard to say when we wouldn’t have charges but I will tell you that when we do have charges we’ll clearly lay them out for you, tell you if they’re cash or non-cash and be as descriptive as we can.

Mark Marostica – Piper Jaffray

Is there anything specific you can comment on if there are any charges for Q2?

Mike Graham

I think Gary did speak to that we did reduce headcount in the culinary division. As you know the change in lending happens April 1. So Sallie Mae no longer gives us recourse loans so a lot of the revenue decline that we had told you about in the first quarter that would hit begins to hit here April 1. And so we have adjusted and right sized our culinary organization to our anticipated levels of population and starts so there will be some kind of a cost for severance in the second quarter for culinary.

Also as you know, we talked about the AIU ground earnings days moving. So those two days that are moving from the second quarter to the first quarter will impact our second quarter results here which is not a charge, but it is an unusual item, it’s a $2 million item that I disclosed to you earlier.

Operator

Your next question comes from Jerry Herman – Stifel Nicolaus.

Jerry Herman – Stifel Nicolaus

I’m wondering if you guys would give us sort of where you are in the break out between bachelors and associates programs for both of the online programs, AIU and CTU and how close are we to normalizing there?

Gary McCullough

I can give you some rough numbers on the online programs, AIU mix is about 60% associate, 30% bachelors, 10% masters. The CTU program, the associate is slightly higher in associate, slightly lower on bachelors and about 10% on masters. CTU obviously we anticipate that that associate population will go up a little bit through September when we start matriculating the students in the two plus two and then we expect that to come down.

So I think that we could look at 50-60% associate population over the near term for both these businesses. We have seen as most in the industry have seen an interest in our associate degree populations, we’ve seen a growth there. And we’ve also seen some growth in our part time or decelerated programs based on student needs. So I think right now 60-65% and it’ll stay there for a while.

Jerry Herman – Stifel Nicolaus

So given that the RPS should stabilize or maybe even get a little bit better, correct?

Gary McCullough

I think the RPS will. It’s hard to say, you’ve got to take out the noise of AIU as we modeled that out. So you take that out and then the RPS in CTU, depending on the shift of the associates degree could increase late in the year into 2009 as those students move from associates to bachelors.

Jerry Herman – Stifel Nicolaus

And another one regarding the operating profits in online and specifically AIU. Is a fair way to reconcile that operating profit by looking at the $4 million net revenue shift and then the $5.7 million incremental media spend if we affectively adjust for those, that might be a reasonable representation of what the operating margin would have been ex these timing issues? Speaking of online only.

Gary McCullough

I’m not sure that we have attributed all that advertising to the online business. It obviously affects the ground business as well. The majority of it may be going to the online business. There’s a split between those based on certain models we have internally. But I think you would halve it from there.

Jerry Herman – Stifel Nicolaus

With regard to that media spend, the online starts were up 7% and that’s a bit lower than what it’s been the last couple of quarters, I know AIU was pretty strong, maybe you could just talk to the start growth and any influence that you’re seeing of the new media spend.

Gary McCullough

It’s always difficult to attribute results to media spend. I would tell you that a portion of the media spend was actually spent in markets where we have on ground campuses. And so it was good to see the on ground starts up over 30% which is the first time we’ve seen any number like that in some time.

But we did outdoor and buses and things like that that weren’t typical of the spending. We did that primarily to remind people that the university existed in their locales. And so again I was pleased to see that we had start growth both at online and on ground. It was in line with what we expected but it’s hard to say it’s because of this, that or that that we saw things.

We’ll continue to work at honing our message, we’ll continue to work at making sure that our media shows up where our students consume media, so to speak, which is largely on the internet and some television.

Mike Graham

As you know the online starts are eight times higher than the on ground starts so just on that small number, that percentage on that small number, we probably did benefit slightly form that calendar shift on the ground basis just from moving a little bit more of the curriculum in and starting it a bit earlier.

Jerry Herman – Stifel Nicolaus

Were all the severance related payments actually paid during the course of the quarter, in other words does the cash balance reflect all payments?

Mike Graham

No they do not. The severance payments for employees who left the company for the most part, those have been paid. The stay bonuses related to the transitional schools will be paid out at the end of the transitional period.

Operator

Your next question comes from Chris [Shetler] – William Blair & Co.

Chris [Shetler] – William Blair & Co.

I wanted to touch on the trends in faculty turnover and enrollment rep turnover if you could give us a little bit of color on that for the voluntary employees as opposed to the ones that have been terminated.

Mike Graham

From a rep standpoint, we have about 2,200 reps on hand in the company as of the end of the first quarter, that’s down about 26% from the year before. That is again driven by our peer qualifier model and the great work that Len and his team have done on changing the way we do the admissions process.

From a faculty standpoint, our turnover is better year over year by about between 400-600 basis points of the company. But our turnover statistics across the company are better and our headcount of faculty is lower than the previous year at this time.

Chris [Shetler] – William Blair & Co.

And sequentially you’re seeing some slight improvement as well?

Mike Graham

Yes there was some sequential improvement from fourth quarter forward.

Chris [Shetler] – William Blair & Co.

Also I wanted to touch on the art and design segment, obviously growth there was pretty strong this quarter and I know some of it was due to the startup campuses that you have and the online. But those would seem to have also positively impacted the previous couple of quarters. And this was really the first quarter where you saw some pretty significant growth and I’m just wondering if we could model that going forward or how we should think about that.

Gary McCullough

I’ll start by telling you that we began our online business August-September of last year and so we’ve seen it continue to grow in line with our expectations. With regard to the new campuses that have been started up, we carry those in a separate startup group until they have been up and running for a year. And so this reflects those moving in to the group.

Mike Graham

And again, it’s hard to say on the online business how much of that is being cannibalized from the ground businesses, those schools, or how much is incremental. We did disclose in the 10-Q in the MD&A that our revenues for art and design exclusive of the startups and of online were down slightly for the quarter.

Chris [Shetler] – William Blair & Co.

The detailed breakout that you provided this quarter on the university division, all the different operating metrics, will that be included in the press release going forward?

Mike Graham

Yes.

Operator

Your next question comes from Kevin Doherty – Banc of America Securities.

Kevin Doherty – Banc of America Securities

Just to follow up on the enrollment reps, I guess from the reduction do you think those reps are properly aligned with your lead flow right now and I guess would you expect any more changes going forward either way and maybe on the upside if some of your media efforts result in an increase in your lead flow.

Gary McCullough

At this point I would say that we do think that we’re properly aligned. We’re seeing better productivity out of our reps at this point in time. That said, as I said, we’ve been experimenting with our peer qualifier model. We think there are opportunities to continue to expand that in the balance of the business and so actually do that, we’ll continue to make the appropriate reductions and or add depending on what our needs are in each of the businesses.

Kevin Doherty – Banc of America Securities

And you touched a bit on the on-ground population at AIU and CTU, how would you characterize the utilization there right now and I know it’s a much smaller population but how do you guys think about building back some of that population in order to drive leverage in that SBU.

Gary McCullough

We think obviously our goal would be to get back to where we had been historically and beyond that and so this is the first steps in us doing that. We will continue to drive start growth and population and work on the fundamentals of retention in each of those businesses as well.

So we think there’s significant upside assuming we’re able to do that. But we’ve made reductions as necessary we we’ve talked about doing in the culinary business, we made the reductions that we think are necessary to support the student populations that we have and are prepared to continue to add back at the appropriate time when we have the population to warrant to.

Mike Graham

Remember that as we made the decision to teach at AIU LA, that was half of the ground school loss of the AIU business. So we’ve addressed the capacity issue there. Second, we talked a lot about this calendar alignment but the important thing is that gets the ground campus and the online campus fully aligned so the student can go back and forth.

So from the utilization of that campus, that makes that on-ground campus even more important so some of that cost and that loss may be benefitting or subsidizing the online business as part of the student experience.

Kevin Doherty – Banc of America Securities

On the higher Stafford loan limits, I know we don’t have a lot of visibility right now but when do you expect some of those increases to start taking affect?

Gary McCullough

Depends on legislation and what the President signs and what goes into effect.

Kevin Doherty – Banc of America Securities

But at least based on the range that you gave right now, I imagine it’s in the very near future?

Gary McCullough

Yeah we were basically expecting something and the range we gave we were basically expecting it would be in place by July 1. We would anticipate given the academic years at traditional schools it will be in place well in advance of that. So as we’ve made a very broad estimate for you, we took a July 1 start date.

Operator

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

Trace Urdan – Signal Hill Group

I was hoping to get a sense of, obviously a lot of moving parts around private lending in the quarter and I’m wondering if you could help us understand what the, how that relates to the starts that you experienced in the quarter, what was the experience of the students as you went through time with respect to the lenders dropping out, with respect to you guys stepping up.

And I was interested specifically around the comments where you’re asking for co-borrowers, when did that kick in, was it only for new students or is it for existing students as well? If you could relate the experience of the student to the comments around lending that would be helpful I think.

Gary McCullough

We talked to various admissions reps and we have not seen a material change in the students’ behavior. Obviously the students read the paper, they see what’s going on, they understand it. Remember what’s happened in the quarter we’re speaking of, it was pretty dynamic. Sallie Mae did not go away until the April 1.

And so from a student experience, during that quarter, we still had a long list of FFELP volume, you still had several if not more private lenders available and you still had the Sallie Mae recourse program. We were not packaging up students with our balance sheet to any great extent. We had curtailed most of our use of our extended payment plan by then and so most of it to the student through March 31, end of the quarter, was transparent and didn’t have a big impact on them.

We worked hard obviously with knowing Sallie Mae was terminated as of March 31 to make sure every student had as much access as possible to the Sallie Mae product and helped every student get in that could get in.

Trace Urdan – Signal Hill Group

So all these students that we see enrolled here are all packaged?

Mike Graham

That’s correct.

Trace Urdan – Signal Hill Group

And effectively you haven’t really started this process of asking the students for co-borrowed funds at this point?

Mike Graham

We rolled out our program April 1, correct.

Trace Urdan – Signal Hill Group

But you’re not anticipating that’s going to be a problem in terms of getting them to commit to programs if you’re sort of throwing that up as you go?

Gary McCullough

We’re not just throwing it out as we go, we actually had planned for this and we put the process in place where we’ve asked our admissions representatives to require an attempted co-borrower and we’re in fact seeing a more than 10 point increase in co-borrowers.

Again I think as Mike said if you look at what’s happening from a macro point of view, the students and in some cases parents were in affect or other people who were sponsoring them understand that the situation has changed. And so they are working with us to take part in our programs. We’re not asking or requiring them to do things that are different than I think most of the other folks who are out there.

Trace Urdan – Signal Hill Group

So you were asking for co-borrowers in the first quarter?

Gary McCullough

We put the training into place and the expectations into place in anticipation of recourse funding going away and us starting a new program on April 1.

Mike Graham

Remember, as we communicated our revenue decline of $75-$90 million in our previous communications, we had built into that a loss of volume from lending capabilities, the use of our balance sheet, requiring more stringent co-borrower requirements, adding an in school payment component for every student to make sure that in school they’re making payments to get financially responsible.

So all that was factored into our revenue loss estimate that we gave you which basically began on April 1 with the change of the programs. The data we’ve told you about co-borrowers was since April 1 our call it five weeks of experience where we are now stepping up the requirement for co-borrowers where we may have in the past asked for a waiver of co-borrowers, now we’re asking for more, but denial of a co-borrower. So we’re making sure the co-borrower process is much more rigorously enforced.

Trace Urdan – Signal Hill Group

So basically your experience in April so far has been positive with respect to looking for co-borrowers?

Mike Graham

Yes.

Trace Urdan – Signal Hill Group

And then have you also been asking students to put up more cash as they enroll?

Gary McCullough

No we have not, we are asking them to make in school payments so we can monitor them as we go along. So that in fact is happening in each of the programs where we’re lending money.

Trace Urdan – Signal Hill Group

I just want to understand the experience of the numbers that we’re seeing in the first quarter, were you asking students to make in school payments in the first quarter to a greater degree than you had in the prior year?

Gary McCullough

Remember what we had in place in the first quarter. In the first quarter all we had was our extended payments program which was given to students below that recourse level of Sallie Mae. So that was a totally different program than we have starting April 1. And we weren’t using our balance sheet to subsidize or take over the asset of any lenders because they hadn’t disappeared in the first quarter.

Trace Urdan – Signal Hill Group

I’m just trying to get a sense of whether you’ve seen, had experience with any of this new activity so far. So just basically starting April 1 you’ve been asking for some cash or in school payments?

Mike Graham

No, we have in the past asked for in school payments, we had the extended payments plan as we talked about. We’ve also always had in school payment plans where people make certain contributions to their education while they’re in school. We’ve had that, we’ve collected that, we’ve processed that.

As we’ve talked about before, the amount of volume we were generating under the existing EPP program, the amount of balance sheet we’ve been using before theses new lenders was the same volume. So systems wise, people wise, process wise, consistent with what we’ve done. But we haven’t materially changed in the first quarter any needs for payments in school or co-borrowers that would give you evidence of what the second quarter looks like.

Trace Urdan – Signal Hill Group

So no change in the first quarter but you do anticipate asking for more in school payments starting in the second quarter?

Mike Graham

As we’ve communicated, our new program, we require in school payments. So if you are in our new payment program we’re requiring you to make some kind of in school payment.

Trace Urdan – Signal Hill Group

Alright and just as you gave us some feedback around the co-borrower experience in the first part of April, have you had any experience with that piece where you’re asking or requiring in school payments? Has there been any kind of a problem so far in the second quarter is what I’m asking.

Gary McCullough

After five weeks it’s too early at this point Trace. But we’ll stay abreast of it. Our experience suggest though that when students make their in school payments faithfully, they are much more committed to their education and they tend to pay over time.

Mike Graham

The other thing, just remember how the paperwork process may work. If you’re starting early in April, you were probably packaged in March or before. So you could have been packaged under Sallie Mae or one of those existing lenders. Most lenders that have left the market have said that if you’re in the system and you’re approved that they’ll honor those commitments. So you’re not going to get on April 1 this total void for the starts that people are already planning on coming in that quickly.

Operator

Your final question comes from Corey Greendale – First Analyst Securities.

Corey Greendale – First Analysis Securities

Following up on Trace’s questions, as you ramp up this co-borrower requirement, is there an opportunity to access the Plus loan program more and would any benefit of that be factored into that table you provided at the back of the press release?

Mike Graham

Yes. Again, it’s really early to tell but when we did our analysis we looked at the different Stafford levels and the Plus levels and how the Stafford loan limits work with the Plus loan limits.

Corey Greendale – First Analysis Securities

And looking at that $45-$65 million number at the bottom of that table, I just want to make sure I’m understanding, so there was no impact of that in Q1 so that $45-$65 million in Q2 through Q4 combined is that correct?

Mike Graham

No that is the amount of receivables we will have on our balance sheet as of 12/31/08 for originations of loans.

Corey Greendale – First Analysis Securities

And it’s fair to assume that it’s going to be a lesser impact on Q2 and then grow with each quarter as the bigger portion of the student population gets new loans?

Mike Graham

Every time we underwrite a new loan that balance will grow and it will grow to $45-$65 by the end of the year on the balance sheet.

Corey Greendale – First Analysis Securities

Is it also fair to assume that the share repurchases will probably slow given that you’re having to use your balance sheet more for liquidity right now?

Mike Graham

I’m not sure about the pace of the share repurchases. We still have the authorization, we still as we talked about want to return our cash to shareholders as we can but let’s be prudent right now based on the lending environment. We did purchase 1 million shares in the first quarter based on our free cash flow and where we knew the lending markets were at.

Operator

At this time I would now like to turn the call back over to Mr. Gary McCullough for the final remarks.

Gary McCullough

Thank you. Career Education is no stranger to adversity as you’ve seen. Over the past four years, as I shared with you when we were at our investor analyst day, our company has faced significant challenges and we’ve resolved many of those challenges. We’ve successfully addresses significant legal, regulatory compliance and accreditation challenges from almost every angle and we’re making positive progress to put checks and balances in place to make sure that we won’t face those issues again.

Today I believe we’re better positioned to withstand the current changes in the market and will emerge from these challenges as an organization positioned for sustainable long term growth. I appreciate your participation on the call this morning. Because the environment that we’re operating in is constantly changing I want you to know that we’ll keep you, as Mike said, we’ll make every effort to keep you informed and to be as transparent as possible if any changes happen that you ought to be made aware of. And with that, thanks again for your support and for your interest in Career Education.

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Source: Career Education Corp. Q1 2008 Earnings Call Transcript

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