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Career Education Corporation (NASDAQ:CECO)

Q2 2012 Earnings Call

August 1, 2012 11:00 AM ET

Executives

Mike Graham – EVP and CFO

Steve Lesnik – President and CEO

Analysts

Jeff Silber – BMO Markets

Sara Gubins – Bank of America

Jerry Herman – Stifel Nicolaus

Brandon Dobell – William Blair

Thomas Allen – Morgan Stanley

Jeff Meuler – Baird & Company

Corey Greendale – First Analysis

James Samford – Citigroup

Operator

Welcome to the Career Education Corporation’s Second Quarter 2012 Earnings Conference Call. My name is Christine and I will be your operator for today’s conference. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note today’s conference is being recorded.

I will now turn the call over to Mike Graham, Executive Vice President and Chief Financial Officer. Sir, you may begin.

Mike Graham

Thank you, Christine. Good morning, everyone, and thank you for joining us on our second quarter 2012 earnings call. Also with me on the call this morning is Steve Lesnik, our President and Chief Executive Officer.

Following the remarks made by Steve and I, the call will be opened for analysts and investor questions. This conference call is being webcast live within our Investor Relations section of our website at careered.com. A replay of this call will also be available on our site. If we don’t get to your question during the call, please call our Investor Relations department at 847-585-3899.

As part of recently announced changes in leadership, John Springer, formerly Vice President of Strategy and Investor Relations has joined our Senior Leadership Team at AIU, American Intercontinental University. He serves as Vice President of Finance, Strategy, and University Operations for AIU reporting to the University President, Dr. George Miller. I’m pleased to announce that Matthew Tschanz, our Director of Corporate Finance has worked with John and I in Investor Relations over the past year will now partner directly with me in leading our IR efforts.

Now, before I turn the call over to Steve, let me remind you that yesterday’s press release and remarks made today by Steve and I may include forward-looking statements as defined in Section 21E of the Securities Exchange Act. These statements are based on information currently available to us and involve risks and uncertainties that could cause our actual results – our actual future 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 annual report on Form 10-K for the year ended December 31, 2011 and subsequent filings with the Securities and Exchange Commission.

Except as expressly required by securities laws, we undertake no obligation to update those risk factors or to publicly announce the results of any of these forward-looking statements to reflect future events, developments or changed circumstances or for any other reason.

With that now, now let me turn the call over to Steve.

Steve Lesnik

Thanks, Mike. Good morning, everyone. Thank you very much for joining the discussion this morning of our second quarter year-to-date financial results. Last February, during our call with you, I said that 2012 would be a year of transition. I also suggested that it would be a year of results erosion. Both of those predictions have certainly turned out to be true.

It’s a year of transition as we and others in the private sector education deal with public criticism, as well as regulatory initiatives aimed at limiting the sector’s growth in providing post-secondary education in America. Those and a number of other factors including the weak economy, uncertainty about employment, negative publicity regarding student loans, and in our case, some missteps last year have meant an erosion in student enrollment in our schools leading to declining revenues to extent greater than costs can be correspondingly controlled.

I also said at that time the long range prospects for our universities and career schools were strong, as we had and continue to have, an array of advantages from technology to academics that benefits our students and enables them to realize aspirations and improve their lives.

I remain optimistic about the long-term. Why? It’s simple. Our nation needs more people with post-secondary education. As the former chairman of one of the nation’s largest publicly education agencies overseeing all the colleges and universities here in Illinois, I know our public institutions across the nation are terribly starved for funding and will remain that way for the foreseeable future.

I also believe these institutions consume more public funds than their private sector counterparts do. So the private sector must be part of the solution to produce better educated, more career ready citizens.

Now, let me tell you what we are doing currently at Career Ed through the second quarter. As you know, when I assumed this role last November, Career Ed was being buffeted by regulatory and accreditor issues. Many have been resolved and as a result of efforts throughout the company, much progress has been made. Yet, challenges remain stemming from those same issues. On the whole, however, I am satisfied with the progress we have made in dealing with the challenges we faced at that time.

I’m satisfied from the standpoint of changes we have made internally to be a consistently compliant company with the goal of zero defects, if you will, and also from the standpoint of getting on a fresh more trusting and transparent footing with our many regulators and accreditors. I hope everyone, both inside and outside this company knows that we are committed to putting our best foot forward to make the right decisions on behalf of our students and to communicate openly and thoroughly about our policies and procedures, the impact of those on our students and about our students academic progress and employment prospects. But this progress, much of it being led by new leaders in the company, is coming amid a trying economic period and as I’ve said, considerable external headwinds.

Specifically, these external factors have dramatically lowered our overall prospective student inquiries, starts and enrollments; lowered revenue projections well below our expectations at the beginning of the fiscal year, particularly among our career institutions and underscored the need to improve significantly our methods and channels for identifying and attracting qualified prospective students. In short, we stand with all higher education institutions amidst a difficult economic environment and resulting declining trends across many key metrics.

Not surprisingly, the slow growth economy and related factors I mentioned have had a deleterious impact on student’s ability to find jobs upon graduation. Despite the progress, we at Career Ed have made in enhancing our student placement policies and practices and our increased investment in career services personnel and resources, we know that reaping the benefit of these changes will not be as evident in the near term.

Meeting multiple accreditor placement standards will remain a challenge in this academic year. More on that later.

The difficulty graduates are encountering in finding employment however is not limited to just the private sector. As some of you may have seen an article by economist and Bloomberg columnist, Gary Shilling, that appeared just last week, highlighted some striking statistics for graduates across all higher education institutions. Specifically, the report noted only 49% of graduates from the classes of 2009 to 2011 found jobs within their first year out of school, compared with 73% of those who graduated three years earlier.

And only about 54% of Bachelor degrees holders under 25, or about 1.5 million people, were jobless or unemployed last year. While our Bachelor graduates tend to be older and more at risk, and many already hold jobs, these stark statistics point to the difficulty facing student placements across all higher education institutions well beyond just our sector.

The difficulty graduates are having in finding employment is among the factors prompting students to think twice about committing to higher education, and we believe has slowed their decision-making cycles noticeably. Against this backdrop in post-secondary education, I have indicated that our company will continue to focus on three strategic areas that I have outlined to you in our prior calls. First, addressing and resolving our legal and accreditation challenges, second, establishing a well-defined strategic path, and third, augmenting our company leadership.

Let’s talk about regulatory and legal affairs first. As evidence of our progress with regulators, it’s worth noting that during the second quarter, American Intercontinental University received the Department of Education’s final report from its program review launched in 2009. The final program review determination closed all previous findings without any further requirements based on AIU’s response to the exploration. We are very pleased with that long-awaited positive outcome from the United States Department of Education.

I’m also pleased that our processes and progress have resulted in several important instances in which CEC institutions have, following extensive accreditor reviews and within a period of heightened scrutiny and political pressures been either reaccredited or completed the regulatory process with a zero finding. Notably, Briarcliffe College received reaccreditation from its regional accreditor, the Middle States Commission on Higher Education.

We have also achieved reaccreditations, renewals, and positive program reviews at several of our career institutions, including among others, International Academy of Design and Technology campuses in Detroit and Nashville, Le Cordon Bleu institutions in Dallas and Austin, and programmatic approvals at various health schools.

As you all know, the Accrediting Commission of Career Schools and Colleges, or ACCSC, recently issued a show cause directive on ten of our institutions stemming from the well-known placement determination issues dating back to the 2010, 2011 time period.

Since those issues have already been comprehensively reviewed and addressed by another of our accreditors, ACICS, a few months ago, we are hopeful that this new look by ACCSC will be as careful, thorough and declarative. To that end, we are in ongoing dialogue with ACCSC to make sure we provide everything it requests and requires. Our formal response to ACSC is due September 7, and we remain on course to meet that deadline.

While we cannot predict the outcome of the show cause action, we remain confident that the extensive and substantial steps we have taken with respect to placements, including the independent investigation commissioned by our board of directors, hiring more than 75 additional careers services personnel, terminating individuals who compromised our placement standards, producing a more definitive policy manual and submitting placements reported to accreditors for independent third-party reverification make a compelling case for continued accreditation of these ten institutions.

Despite our clear progress, we do have new challenges regarding placement rates. As you know, placement rates in the past that did not meet accreditor requirements resulted in four of our career institutions being placed on probation by ACICS. This fall, we’ll report our school placement rates for the July 1, 2011 to June 30, 2012 period. Because ACICS reporting requirements for placement rates are based not on a calendar year, but on the July to June timetable, we know that placement rates we will report in September will not reflect the full impact of our process and personnel enhancements implemented at the outset of the current calendar year.

However, we are seeing very substantial progress in our graduate placement trend since January, and we expect over the next full reporting period to realize the full benefit of these efforts. Another vestige of the past we are dealing with involved the OPID consolidation we initiated early last year and for which we applied to the Department of Education, shortly after we received all the required accreditor approvals.

After consultation with the Department, we are now in the process of reversing that decision. The rationale for the consolidation made sense at the time, as the company sought to simplifies its maze of overlapping and sometimes conflicting regulatory requirements based on 26 different OPIDs under multiple accreditors. However, while the stagnant application remained in place, we were impeded in our ability to seek new program approvals. We believe that introducing new programs is critical to better serving our students and our ongoing focused efforts to align our course offerings with current employment demands. As a result, we are actively engaged in the regulatory steps to withdraw the consolidation application, which will free us to seek the program approvals that are essential to student service and outcome into the company’s growth.

While the withdrawal of the application slows regulatory simplification. As we implement our strategy to streamline the company operationally, we will seek whatever OPID consolidations naturally fall from that reorganization. The OPID consolidation also had the benefit of combining campuses for 90/10 impact.

We are addressing 90/10 throughout the year by utilizing external scholarships and grants, putting increased emphasis on programs supported under the Workforce Investment Act, increasing the level of accredited non-Title IV Programs, making pricing adjustments and delaying the disbursement and receipt of Title IV Funds. With these actions, we are optimistic that the OPIDs that failed in 2011 will succeed in 2012.

Now let’s turn briefly to our imperatives on leadership and strategy, which of course, are intertwined. We’ve made significant strides in our commitment to augmenting the company’s leadership. During the quarter, we announced a number of executive moves to bolster the company’s management team, realign and simplify the organization structure and help Career Ed navigate its regulatory, legal, and political environment, consistent with the strategies outlined to you and others earlier in the year.

I believe you all have had access to the statement we issued two weeks ago detailing the executive changes we have made. So, I will not repeat them all here. The configuration of our leadership team and the organization will be essential to embarking upon the strategic transformation of the company. As part of this transformation, the company will reorganize its more than 90 campuses into University, Career and International Education groups. The previously enables plan to establish these three education segments versus the current six will concentrate and enhance academic focus, consolidate and align similar institutions, and better position the company in a competitive marketplace through fewer, stronger institutional brands.

To this end, we have internal studies underway by our new education group leaders to determine which brands are best position to serve student and employers. Those that are not well-positioned will either be folded into those that are, possibly sold to other entities, or where appropriate be taught out.

Perhaps a word here about cost controls in view of declining revenues. Longer term, our simplification of institutions and brands will, of course, bring about permanent material institutional cost reduction. Meantime, we have a sharp focus on removing redundancies, eliminating excess cost and creating greater efficiencies across the company as student population declines while not hindering our ability to turn the corner and return to growth.

Now, let’s turn to some additional strategy initiatives. Clearly, simplification and consolidation lie at the core of where we are headed. We intend to continue our efforts to turn around the business by becoming a leaner, stronger organization making us a more competitive player in the adult post-secondary education marketplace with limited brands offering the differentiated value propositions.

As part of our strategy, we recognize that the company must also improve its current model for identifying, attracting and enrolling prospective students.

We have a definitive focus on revamping our approach to this foundational activity. As a key step in that progress, management has engaged Price Waterhouse Coopers to come in and review our model and approach from prospective student recruitment of more qualified candidates and student inquiry, all the way through to enrollment starts and persistence.

Further, we like others in the industry, are making progress in having students query and contact us through channels other than the current disproportionate reliance on lead aggregators, including improving our ability to identify prospective students, who can succeed directly through our institutions’ websites.

We want to accelerate that migration and are focusing heavily on this effort. That’s why we launched branding initiatives at AIU and CTU, both initiatives are having strong impact in the areas of improving brand awareness and brand equity, although with all the headwinds and volatility, we are being cautious about concluding too much about direct impact on inquiry conversion rates and enrollment.

Improving our ability to identify students who are likely to be interested in and qualified for our programs and to increase subsequent enrollments of these students is at the heart of our ability to reverse current trends.

Moving to another key strategic front. We continue to leverage and build upon our core technology and academic strengths. The company has long been at the vanguard of leveraging technology and innovation to enhance student learning experience and outcomes. We have invested in and deployed our award-winning virtual campuses, introduced state-of-the-art experiential learning tools, like Simpro Virtual trainer, enhanced our E-books platform and library, and launched our leading flexible learning tool M.U.S.E. or My Student User Experience MUSE. allows our students to receive content in a manner that best suits their learning style, whether they be visual or auditory learners or desire course work delivered in a synchronous or asynchronous fashion.

We’ve observed with some intensity the wide array of interests, who have begun work in what are commonly called adaptive learning models. Education innovators, private equity players, technology entrepreneurs, and others are currently claiming advancements in this area with some regularity.

We too have been purposely at work on this front. We expect consistent with our past technological successes in leadership to begin testing a proprietary, adaptive learning system by the end of the year. We’ll have more to report on this project when the efficacy of our new system is further tested and proven. As I have said consistently, we will continue to invest in this area to further our technological leadership.

Finally, despite the substantial challenges facing our industry and this company, I believe that we are putting in place the people and the plans to advance our business against the challenges in the higher education environment. We know today that this turnaround, however accelerated we can make it, will not be measured in terms of a period of weeks or the span of my short tenure, now spanning nine months, but we will make steady measured progress over time to become a leaner, stronger and more competitive enterprise built for the long haul. Thank you for this opportunity to review our current position, progress and prospects.

I will now turn it over to Mike to discuss our second quarter financial results. And I look forward to addressing your questions and comments at the conclusion of Mike’s remarks.

Mike Graham

Thanks, Steve, let me just begin by sharing with you some details of the financial performance for the quarter. During the quarter, we generated $369 million of revenue which is a decrease of 24% versus the second quarter of 2011. The operating loss was $108 million for the quarter. The second quarter results as we outlined in yesterday’s press release and in the form 10-Q filed with the SEC include non-cash goodwill and impairment charges of $85.6 million. The $85.6 million has three elements, $83.4 million of goodwill impairment, $41.9 million on Health, $41.5 million on Art & Design; $1.2 million of other asset impairment, $1.1 million in Health and $100,000 in AIU, and $1 million of trade name impairment for Health Education.

To arrive at a more comparable basis versus last year, please remember that the operating income for the second quarter of 2011 included a non-cash charge of $2.7 million for goodwill and other intangible asset impairment. If you exclude the impact of these charges, the operating loss for the second quarter of 2012 was $23 million.

All the comments on the remainder of the call will be on this non-GAAP basis, which excludes the charges I just discussed in both these years.

As Steve discussed in his remarks, 2012 will be a year of transition, and we’re taking the steps necessary to reposition the company for the future. Simplification and consolidation are an important part of the strategy. Consistent with this approach for the company, during the quarter, our operational teams made the decision to teach-out three of our Health campuses, SBI Landover, Maryland, SBC Milwaukee, Wisconsin, and SBC Collinsville, Illinois.

Further, a similar decision to no longer enroll new students was made by the AIU team for its South Florida campus in Westin, Florida. These decisions, which are very difficult, came after evaluating a number of other factors. The overall performance of the campus including operating results, new student starts, placement opportunities in the local market, degree and market competition from both private sector and public institutions, and the existing lease obligations of the campus.

For the most part, the lease expirations are concurrent with the expected last day of attendance for current students based on their matriculation paths. Along with the asset impairment charge of $1.2 million I discussed, our second quarter results also include $1.5 million for severance and employee retention awards related to these actions. Of these charges, the $2.7 million of charges, $2.3 million is in Health and $400,000 is in AIU.

During the teach-out periods, which have ending dates varying from June of 2013 to August of 2015, we again remain focused on fulfilling our educational and our post-educational commitments to our students consistent with our student-first philosophy and practices of the teach-outs of other schools over the past several years.

Additionally, throughout the first half of 2012, we continued to use our SOAR program for online students in AIU and CTU, and our pre-enrollment testing for our ground students. Again using our student-first mandate to enroll students with the highest propensity to persist and to graduate. During the first half of this year, approximately 4,700 new students did not join CEC institutions due to these programs, which in the short-term has a very, very significant impact on our revenue.

Now, let me briefly turn to financial results by segment. First, for University group, which is AIU and CTU. In the second quarter, new student starts declined 29% and 24% in AIU and CTU respectively.

Excluding the impact of the Student Orientation and Readiness Program, SOAR, new student starts were down 15% and 17% respectively. Again, as we mentioned on previous calls, the goal of SOAR has been to identify students who are not prepared for the rigor of academic studies. Additionally, those students who withdraw or fail this five-week course are not charged tuition. We continue to enroll about a third of the new undergraduate starts into SOAR with about 50% to 60% of the students receiving a passing grade and moving on.

For the second quarter, AIU’s revenue was $79 million, down 20% from the second quarter of 2011. Revenue was impacted not only by lower student population, but also due to a slight reduction in the average credit load per student. Again, given the macroeconomic trends including which we believe are the increased intensity of the competitive environment, lengthening decision cycles and aversion to taking on debt, it’s challenging to provide more perspective on start growth going forward for AIU and CTU in the near term.

Operating margins were 8.9% for AIU in the second quarter versus 26.9% in the second quarter last year. As mentioned earlier, AIU’s South Florida campus will enter teach-out, and is expected to remain open until August 1 of 2015. For the first six months of 2012, the Westin campus contributed $6 million of revenue and experienced an operating loss of $1 million.

Revenue for CTU was $95 million in the quarter which is down 15% versus the second quarter of 2011.as a 16% reduction in student population offset modest increases in revenue per student.

Operating profit for AIU was $12 million in the quarter with operating margin declining to 12.1%.

While CTU’s short term margin has been negatively impacted by the National Advertising Campaign, we remain committed to the initiative. And as Steve stated, it has had several, very, very promising end results. In particular, we have been pleased to see an increase in brand awareness among prospective students and growth in the quantity of internally developed leads and inquiries.

Now, moving to the Career Schools. As Steve said in his remarks, we have a lot of opportunity in front of us to simplify the career focused operations. Over the past year, our Culinary, Health and Art Design teams have spent considerable effort examining and modifying where necessary their business models. With the recent hiring of Dan Hurdle as Chief Career Education Officer, it’s our expectation that these activities will quickly evolve from brand and institutional centric undertakings to one comprehensive strategy, designed to optimize the schools – the ground school, distinct brands, and their operating scale, lowering cost and complexity while improving marketing effectiveness.

Turning to Culinary Arts, revenue decreased 30% to $58 million on a 35% decrease in new student starts and an 8% reduction in student population. This reduction in revenue is primarily attributable to a business shift to certificate programs and a corresponding reduction in tuition per credit hour. Let me remind you as we noted in the press release that the year-over-year start comparison is impacted by one less start in this quarter versus the previous year. So, on a comparable basis new student starts would have been down 21%. In addition, the pre-enrollment testing that I spoke of, also contributed to 410 basis points of decline.

As you look forward, please note that for the third quarter 2012, our start comparable with the September 2011 start will occur in October; so another timing shift for the third quarter.

As discussed last quarter, Culinary’s model to change to shorter certificate programs has resulted in significantly more graduates and thus lower student population levels versus the prior year. The operating loss for the quarter was $4 million. We continue to be committed to Culinary Arts and believe Le Cordon Bleu’s high-quality kitchen curriculum is the gold standard in U.S. Culinary Education.

Based on feedback from prospective students and our insight into various local markets, the team is assessing the redesign and the re-launch of its Associate’s degree program beyond the current Chicago and Los Angeles locations.

Now onto Health which continues to be our biggest challenge, one of which requires significant changes, which we have discussed in previous calls, and that continues to pressure our operating results.

Revenue for the quarter was $76 million down 31% from the second quarter of 2011. Health new student starts decreased 69% over the second quarter last year while student population decreased 41%. Similar to Culinary, Health year-over-year start comparison is impacted by a calendar shift this year that results in 2,540 fewer starts in 2012’s second quarter.

Excluding this timing impact, starts would have been down 53%. In last quarter’s call, Steve discussed the introduction of pre-enrollment testing for Health as a means to better ensure the student have the skills to be successful. Again, this resulted in 738 fewer starts, fewer new student starting, a 950 basis point impact on new student starts for the quarter.

For the second quarter 2012, Health’s operating loss is $23 million and that’s exclusive of the non-cash goodwill and impairment charges. The institution continues its efforts to realign the cost structure by driving standardization throughout the school based operations. As I mentioned, the teach-out at Landover, Milwaukee and Collinsville further demonstrates this organization’s commitment to simplify the company’s operations and reduce complexity. Two of the campuses Landover and Milwaukee are amongst the four campuses on ACICS probation status due to the placement rates at or below 40% for the period July 1, 2010, through June 30, 2011. These three campuses now in teach-out for the first six months of 2012, achieved $11 million of revenue, while experiencing a $4 million operating loss.

Now, into Art & Design, second quarter revenue for Art & Design was $40 million, down 29% from the prior year reflecting a 31% decrease in new student starts, and a 24% decrease in student population. The operating loss was $5 million excluding the impairment and goodwill charges.

Finally, the International Segment continues to perform well. Year-to-date revenue increased 3% from the prior year, as a result of higher revenue per student due to annual tuition increases implemented in the fourth quarter 2011. Revenue was negatively impacted by $5 million in unfavorable foreign exchange rates with the euro. Excluding the impact of unfavorable foreign exchange rate, revenue would have increased approximately $7 million or 12% versus the prior year. New student starts for the first six months increased 14%.

And as we discussed in last quarter’s call, the international institutions experienced higher than normal graduations due to the timing of program completions, resulting in a 25% decline in year-over-year student population. Our expectation is that new student starts for the remainder of the year will continue to grow due to the high-quality education and the strong business model. And this year’s ending student population will exceed and should exceed 2011’s levels.

Year-to-date operating income was $11 million, down 9% for the prior year. Operating income was negatively impacted by about $1 million of foreign exchange rates. Further, the International Group incurred additional academic costs for the INSEEC group as it prepares to seek internationally recognized programmatic accreditation, and we launched our first ever blended learning Executive MBA program at the International University of Monaco.

Turning to an outlook, as you know as a matter of policy, we do not provide annual guidance. As you can see from the difficult marketing conditions we’ve faced, evidenced by our level of new student starts, and the commentary of many other comparable for-profit education firms in the last 10 days, inflection points we have assumed continue to move back causing our anticipated 2012 results, as Steve said, excluding the non-cash impairment charges, now to move into an operating loss level.

While visibility if the inflection point remains unclear, we do not right now anticipate a material improvement in our trend of new student starts as compared to the prior year adjusted for the timing of calendar changes in the third quarter of 2012. Our financial results versus our previously communicated range of 2012 ground school operating losses will also be impacted by the lower level of new student starts. Accordingly, our expectations for the ground schools versus last quarter’s earnings release and conference call have fallen as well. Given the current market conditions, we will not provide any further milestones at this time.

Before we open the call for questions, let me quickly update you on the financial position as of June 30, 2012, the company had cash, cash equivalents, and short-term investments of $370 million. Our cash flow for operations for the three months ended June 30, 2012, was approximately a $1 million cash outflow. And capital expenditures were $8 million or 2.1% of revenues.

With that, operator, let’s open up the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question comes from the Jeff Silber from BMO Markets. Please go ahead.

Jeff Silber – BMO Markets

Thank you so much. I know you’re not giving any specific guidance, but I wanted to look a little bit more longer term, specifically focused on the Health Education, Culinary Arts, and Art & Design segments, what kind of revenue levels on an annual basis do you think you need before those segments become profitable again?

Mike Graham

Again, Jeff, this is Mike, I can’t give you guidance, you can – you have to do the models, as Steve said, looking closely at how to take out metrically driven costs which we’ve done throughout the year, looking at the fixed cost levels and looking for Dan Hurdle, as he joins the organization to streamline the three organizations.

As you know, as we go into 2013, the level of Harrington student population leaving this year will dictate a good deal of the first half of next year. That will give you some idea about how to model next year’s out, but a longer-term basis, it’s not our goal to become profitable in these organizations, it’s our goal to become profitable and meet different cost of capital, investor returns, well above just becoming profitable.

Jeff Silber – BMO Markets

Okay. Let me ask the question in another way then, from an incremental basis every time you lose a student, what’s the impact on the bottom line roughly in terms of incremental operating margins?

Mike Graham

Again it’s hard to tell because of the step function of the class sizes, but traditionally some of the flow through, when you look at the models has been around 50% to 60% on less students.

Jeff Silber – BMO Markets

Okay. And that hasn’t changed dramatically based on some of the changes you’ve made?

Mike Graham

Hard to tell because the changes have been taking place and the changes are so numerous across the institution as we talked about last quarter, especially in Health, the visibility right now is very, very difficult, the moving parts and a lot of the teach-outs, all the additional investments in career services, the different models on 90/10, the pre-enrollment testing, you can imagine as we talked about last quarter with the different steps – different steps, the 19 step plan Jason Friesen put in place. It is very difficult to model each of the impacts but we know they are all in the right place in terms of student-first and they’re in the best interests of the company long term.

Jeff Silber – BMO Markets

All right. I understand. Just a quick numbers question, what are you budgeting for capital spending for the remainder of the year?

Mike Graham

Traditionally it would run around 3% of revenues. So I don’t think the level would change dramatically from this quarter’s $8 million level so probably – hard to say on a revenue basis because revenue is changing but let’s say $8 million to $10 million a quarter going forward.

Jeff Silber – BMO Markets

Okay. Great. I’ll jump back in the queue. Thanks so much.

Mike Graham

Thanks, Jeff.

Operator

The next question comes from Sara Gubins from Bank of America. Please go ahead.

Sara Gubins – Bank of America

Thank you, good morning. Given that you’re not looking to consolidate the OPIDs, how should we think about where you’ll fall out on 90/10 and also your 10-Q mentioned that some schools might delay some federal financial aid until early 2013 to meet 90/10. I’m just wondering if that’s something that’s done as a standard.

Steve Lesnik

This is Steve. Thank you for the question. I’ll answer it in two parts. One as I said in my prepared remarks, we remain optimistic that the OPIDs that failed in the past will pass in 2012 based upon all of the steps that we have taken throughout the year in order to address 90/10 requirements. That’s the first part of your question. The second part of your question with respect to withholding funds, yes that is something that is commonly done in the industry has been done by a number of companies. In our particular case, we have also done it occasionally in the past but we have a system for doing it whereby the stipend – the living stipend that the student receives is not affected in any way. So, I know that has recently been pointed out that withholding funds would in some cases affect student living expenses or stipends and that is not the case with Career Ed.

Sara Gubins – Bank of America

Okay. And then, could you give us updated thoughts on share repurchase. Are you holding off on this point given the fundamentals or for any regulatory reasons?

Mike Graham

I think you can see in the quarter with the operating loss we’re experiencing and the decrease in operating cash flow, we still have authorization available. We obviously look to the Department of Ed financial responsibility ratio at the end of the year. Historically, we’ve bought back shares right around the level of net earnings because of the way the calculation works and with an operating loss to be experienced this year share repurchases would become difficult under the calculation.

Sara Gubins – Bank of America

Okay. Thank you.

Operator

The next question comes from Gary Bisbee from Barclays. Please go ahead.

Unidentified Analyst

Hi, it’s (inaudible) for Gary. Can you give us some color around how to think about new enrollment trends at AIU and CTU next quarter after you’ve lapped the SOAR impact?

Mike Graham

Sure. I think the SOAR lapses in the quarter so we should look to the level that I quoted in my prepared remarks of the 15% to 19% decline after the adjustment for SOAR so we’ll anniversary out – call it roughly 500 to 1,000 basis point adjustment. Our trend right now as I stated doesn’t show a material change in our trajectories as we go into third quarter starts. So the modeling would be consistent with the adjusted basis after SOAR in the second quarter.

Unidentified Analyst

Okay. And just on your teach-outs, what incremental cost do you see going forward as a result of those and when further down the line, do you see those costs starting to come out?

Mike Graham

From the teach-out model and because of the way we have done teach-outs before in our discontinued operations, if you look to the past year, as you can see the trend of cost early on in the teach-out, there is a slight increase in the profitability of the school because you no longer have admissions or marketing efforts around the school. Then over time as the class sizes decline, but we keep career services people, we keep academic people, everyone else on the campus to serve the student till the last student graduates, we tend to run into operating losses.

For the most part the only obligation after the closure of the teach-out is any lease obligation and for three of the four teach-outs that we spoke of, the teach-out is commensurate with the end of the lease. Only one of the leases will continue on in discontinued operations after the close of the teach-out in August of 2015.

Unidentified Analyst

Okay, and just a last question on your calendar shift. You mentioned, I think you’ve got another calendar shift next quarter in Culinary. So the start period will be in October and what about for any other segments, is that the only calendar shift for next quarter?

Mike Graham

That’s the only calendar shift, obviously Health, because we had a calendar shift in the second quarter, that starts now in the third quarter which I spoke to in the remarks, and Culinary’s just missing one start, which just trickles over from September to October; those are the only non-comparables.

Unidentified Analyst

Got it, thanks a lot.

Operator

The next question comes from Jerry Herman from Stifel Nicolaus. Please go ahead.

Jerry Herman – Stifel Nicolaus

Thanks, good morning, everybody. Guys given your commentary about simplification and consolidation in light of the deteriorating situation, would you suspect the need for a more radical action plan, i.e., cost reduction or other in some way with again particular focus on the Career Schools.

Steve Lesnik

Well, I would say what we said in the past about reducing the number of institutions and brands we have from what is now the high-teens to the mid-to-low single-digits. If we can do that, we would consider that a reasonably radical transformation plan. The question is how fast we can achieve it. So, we do think that that’s a rather aggressive plan for changing the way we conduct business. And as I said in my prepared remarks, we fully expect that it will have the impact financially of reducing the cost of complexity and inefficiency that we now incur.

Jerry Herman – Stifel Nicolaus

And, Steve, just a follow-up. Is there internally, an expedited effort to do so again in light of the deterioration?

Steve Lesnik

We are not oblivious to the impact and implications of the numbers that we have experienced in the last two to five months. We are very, very much aware of the implication of those numbers and we recognize that the strategic plan while everybody recognizes that it’s a sound logical, reasonable. And as you put it radical plan that we have to accelerate the implementation of it as much as we can.

Jerry Herman – Stifel Nicolaus

Thank you. And just question for Mike. I mean, obviously, we’re looking at your balance sheet and it certainly shows a healthy amount of cash. But I guess, if you could just add some additional color on some qualitative statements on what you deem to be the most significant, say calls on that cash, i.e., operating losses, lease obligations, the position of international cash and the like?

Mike Graham

Sorry, Jerry, in terms of the cash requirements, if you look at the split, $370 million of cash, $250 million of which is domestic, $120 million of which is international. There are – as described in the 10-K, there is within the non-profit entities of international about $63 million of cash that’s based in those entities, so that’s the first call on cash. The second call on cash is obviously to make sure from a working capital standpoint, a balance sheet standpoint in funding operations in terms of having an operating loss that we’re there, and that we again meet everything, the requirements of the DOE, and we’re going to make sure that on a capital expenditure basis, as we go forward we continue to invest into the different facilities and campuses for the students. Obviously in terms of our operating cash flow and our balance sheet in terms of material acquisitions at this time or other things, we’re not putting that as a high priority. And as you know the business traditionally runs a negative working capital level, so as the business deleverages, some of that negative working capital spins back out.

Jerry Herman – Stifel Nicolaus

Great. Thanks, guys. I’ll turn it over.

Operator

The next question comes from Brandon Dobell from William Blair. Please go ahead.

Brandon Dobell – William Blair

Thanks. Guys, what kind of timeframe should we expect to hear back from you on some of these major or larger initiatives like the Price Waterhouse and kind of look at the business, sort of the processes, some of the decisions around the brand consolidation or maybe a little more visibility on 90/10, are those a Q3 call kind of prospect or are we talking the fourth quarter call in early 2013?

Steve Lesnik

This is Steve, thanks for the question.

Brandon Dobell – William Blair

Hi, Steve.

Steve Lesnik

Obviously as I said, we’re going to do on as much of an accelerated basis as we possibly can. I mean the only way I can really prospectively answer that question, however, is to say that as material things occur, we will release them publically in a filing and that as we have quarterly calls to the thing – to the extent that things have taken place in the quarter, we’re happy to talk to you about them as fully as we can. But, we’re not going to be predictive in what we say.

Brandon Dobell – William Blair

All right, fair enough. And then maybe remind us of what the process is with the schools that are on show cause with ACCSC, is there like there was with ACICS a particular time around the meeting of their board that we should use as kind of, I guess a milepost for when there should be some more information about those schools.

Steve Lesnik

I believe that they are planning to meet. They don’t meet every month, but my understanding is that, there is a meeting in both September and October. The key date is that we are required to get our formal response to ACCSC by September 7. Obviously, they need it in time for their reviewers and those that’ll be making, adjudicating and judging the material, time to think about it and look at it.

So, I don’t know whether they will get to it in their September meeting or their October meeting, but we hope that they would look at it rather sooner rather than later. As I said in my prepared remarks, I do expect that they’re going to be as thoughtful and careful in their examination as ACICS was, as you know there’s a lot of interest in how the accreditors do these sorts of things. I can only tell you that we have sent much of the same material that we sent to ACICS, it’s voluminous, it’s transparent and I would hopeful – I would hope that eventually we would get the same outcome.

Brandon Dobell – William Blair

Okay. And final one from me, you mentioned being kind of held back on new programs given the application process for the OPID consolidation. Where should we expect or where are you guys planning on rolling out new programs and is there – are we talking a backlog of a handful of programs or is it a much bigger kind of pool of new opportunities for you guys to roll out.

Steve Lesnik

While we’ve been in the penalty box now for some time on these things...

Brandon Dobell – William Blair

Yeah.

Steve Lesnik

Due to the fact that we’ve had the consolidation application pending. So, there has been – there is a backlog, and it is very important that we get programs that today enable us to place our students reliably. So, we are dealing with that backlog now. Obviously, we have to go through all of our accreditation processes and we’re trying to do that in a way that we can apply for new programs on an orderly basis and we’re prioritizing the ones that we think ought to go first and we’re sort of queuing them up in that way with the strongest criteria being needs of employers and employment needs in the marketplace.

Mike Graham

And then Brandon, just to be clear, because of the consolidation was the national schools, ground schools only.

Brandon Dobell – William Blair

Right.

Mike Graham

There were not constraints on AIU, CTU International, so new program launches continue in those schools which are over half the company?

Brandon Dobell – William Blair

Yes, okay. Thanks, guys.

Operator

The next question comes from Suzie Stein from Morgan Stanley. Please go ahead.

Thomas Allen – Morgan Stanley

Hi, guys. It’s Thomas Allen filling in for Suzie. Now that gainful employment appears to be off the table at least for the time being, are you operating and planning as if the rule comes back or not? Thank you.

Steve Lesnik

That’s a very interesting question that is being asked repeatedly. I don’t think that we can predict with certainty whether or not it will come back. I don’t think anybody can. It will depend upon a great many factors including political factors. What we are doing is assuming that we should look at what we think is in the best interest of our students, it gives us the opportunity to place them, to place them in a way that they are able to repay their loans whether gainful employment exists or doesn’t exist. That’s the guiding principle that we’ve adopted at the school, at our institutions.

Can a student complete, can we place the student and can we place the student in a way that they can repay the loans that they incur? And that’s the policy we will use whether the Department Of Education does or doesn’t look to reinstitute gainful employment. And as everybody knows, if the Department Of Education does seek to do that, it’s likely not to happen between – before 2014 or 2015 because of the processes that need to be gone through.

Thomas Allen – Morgan Stanley

Okay. Thank you. And then other schools that have similar orientation programs have discussed modifying them, so that because their programs were turning away some prepared potential students. You said that 4,700 potential starts have turned away year-to-date. Any thoughts on modifying SOAR and the other programs to get some of these students? Thanks.

Steve Lesnik

Yes. As I mentioned in our last call, and I think Mike talked about it as well. We are looking at our SOAR program and alternatives to the SOAR program to make sure that on the one hand, we are putting our students through the right paces to give them the highest probability of persisting and completing the courses, and at the same time, not leaving on the editing room floor so to be speak, students who do – may not test well or may not seem at first blush to be able to do it, but would have a chance to persist and complete. So we’re trying to address both parts of the equation. There is no question that some qualified students not only at Career Ed, but at other schools have been denied admission, despite the fact that they could possibly make it, but not probably make it.

Thomas Allen – Morgan Stanley

And quickly just the sizing or the timeframe of those changes, the size of potential students.

Steve Lesnik

Mike, could speak to the numbers, but in terms of making changes, we are looking at SOAR program and if we do make changes in the SOAR program, modifications or changes, it will probably come before the end of the year with the impact primarily falling in 2013.

Mike Graham

I think from a sizing standpoint if you look at the 4,700 starts, I spoke of, about half of those are in university, half of those are in ground. It’s too early to tell, I think as Steve said there’s various methods to allow a student access to the school and to assess a student over a broader period of time than just a test, whether they have the propensity to persist and graduate and we continue to look at that. And so, it’s too early to give you numbers on what any adjustments may be, but that will give you an idea about the current split.

Thomas Allen – Morgan Stanley

Okay. Thank you.

Operator

The next question comes from Jeff Meuler from Baird & Company. Please go ahead.

Jeff Meuler – Baird & Company

Thank you. Just wanted to ask about AIU and CTU inquiries, I caught the data point that the internal generated leads at CTU are up, but are total leads at those institutions still declining and if so, I understand it’s a tough market, but what would you attribute the continued declines to? Just the timing of when you kind of rolled out the CTU branding campaign or are there other factors that I guess would potentially concern you about their competitive position or what – I guess turned – what gives you confidence that they remained in a good competitive position?

Steve Lesnik

Well, we believe that the University side our business, looked at together remains a strong franchise, so let me say that first. Secondly, I think we and everybody has reported some resistance recently in getting applications, leads, inquiries, whatever term you want to use. And I think I discussed in my prepared remarks what we perceive to be some of the reasons that queries of the company and leads through any channel are reduced, it is the negative publicity – it’s all things that I mentioned.

Also, students are being more cautious and therefore, it’s taking more time for them to make a decision and we’re hearing more and more deferrals from people who seem to be deciding, I’m going to put this off for awhile and because of that, because of the falling interest, you’re finding the environment to be far more competitive than it has been in the past for qualified students. Don’t forget also it’s a smaller pool of candidates when you’re focusing more on those that can persist and complete, which is, of course, what we’re doing and I suspect others are doing as well.

So, the franchises themselves remain very strong and are improving their ability to both reach out to and be receptive to new student applications, but the competition is fierce and the pool is shrinking somewhat; is that responsive?

Jeff Meuler – Baird & Company

It is but, so I guess the question is, in your view are the declines either in starts or in inquires due to that environment or in this more competitive environment, is it your view that you may also be losing share or I guess if you think it’s just the environment, the question is, I’m just trying to figure out the competitive positioning versus the environment and how much of it is a tough environment versus potential share loss, if you can say anything to that.

Steve Lesnik

Yeah. Well, I can understand... I think we’d all like to be able to quantify if we could how much is due to the shrinking pool so to speak for the various reasons that I’ve mentioned and how much is due to the more intense competition. I don’t think I can quantify which of those is the greater factor or which among those is the greatest factor. What I have said is that we recognize, we think, what is going on out there in the marketplace, we’re sensitive to the changes that are taking place in the marketplace. And, we have internally and with the help of a new external consultant are beginning to re-examine everything we do to make sure that we can be as competitive as anybody and maintain or expand our market share in the new environment.

Jeff Meuler – Baird & Company

Okay. And then just a follow-up on the balance sheet, any update on the credit facility, Mike?

Mike Graham

The credit facility matures on the October 31 in the fourth quarter. We’re in negotiations with our banks. We’ve great bank partners that have helped us all along. They have expressed a willingness to discuss a facility. Obviously the facility we have, which was entered in 2010 in a much different business environment and a much different credit environment, and it will be nowhere near the favorable terms we have there.

There is no assurance we’ll have a facility given the operating losses we’re working hard with the banks. Too early to give you more details but in the next quarter call we’ll be able to share more.

Jeff Meuler – Baird & Company

Thanks, Mike.

Operator

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

Corey Greendale – First Analysis

Hi, good morning. Just following up on the question about the competitive and the economic environment, given your responses, Steve, how are you thinking about tuition pricing and I know you are potentially raising price some places because of 90/10, but are you considering either discounting tuition, giving more scholarships to help yourselves competitively?

Steve Lesnik

Well, look, pricing has to be the part of the equation I think we all know that. And you’re correct in that for 90/10 purposes, pricing has to move in a particular direction. But, the most compelling criteria is whether the prospective students, whether the consumers will pay the price for the service that you’re offering, and also whether they will be able to repay any indebtedness they incur in wherever they are placed subsequent to the education. We are looking at trying to adjust our pricing for the programs that we have in place, to be both competitive and to enable the student to repay, and at the same time, be responsive to the 90/10 imperatives. It’s sort of a simultaneous equation that we are dealing with.

Corey Greendale – First Analysis

Okay, and then I had a couple of regulatory questions. There was I think some new language in the Q about the Department of Education doing an inquiry about potential violations or misrepresentation. I know they’ve requested information before. Can you just clarify is there something new or different in their communication to you about what they’re doing?

Mike Graham

Corey, that’s just a continuing disclosure. There is no news to report on that. The Department of Ed, as part of the consolidation process, as part of other things that are going on in the company has asked over time for various parts of information and we participate very frequently and fully with them and give them anything they ask for and any dialogues we have are continuing and open.

Corey Greendale – First Analysis

Okay, and then there is also some language in the Q about some ongoing information requests from HLC in connection with the CTU reaccreditation, can you just put that in context, how common is it to have continuing information requests after a focus visit and some sense of what they might be looking for?

Steve Lesnik

It is not, I don’t know whether it’s common, but it is not uncommon to have what are called subsequent visits and it often happens. And so I would say it’s somewhere between not uncommon and routine. It is not anything that is that out of the ordinary in our judgment and we believe that the revisits by the peer review team are going to be handled over the coming period with some facility.

Corey Greendale – First Analysis

Okay. And just one last one, the one piece of good news, it sounds like is you’re making some progress on the placement front. Can you give just comment on the kinds of feedback you’re getting from employers and what I’m curious about is, whether there’s any impact of the negative publicity on employers’ willingness to hire graduates of your institutions?

Steve Lesnik

I’m happy to answer to that question, the answer is no. There are – we are seeing on the intake side as I’ve said several times in the call already with the reluctance of students to make the decision to attend post-secondary education, which I consider to be very unfortunate for them because they’re going to need that education to get jobs in the long-term, but we’re not seeing any impact on the outgo side, that is on the outcome side with employers.

I think that they are still doing what employers do, which is to evaluate the strength and qualifications of the individual candidates and they are still accepting our graduates both on the University side and the Career side. Our marked improvement in placements is a testimony to that. I think you know that we have redoubled our efforts to place our graduates and we’re having really good results. So I would say that is evidence, that we’re not seeing a resistance on the employer side.

Corey Greendale – First Analysis

Great. Thank you.

Operator

There’s time for one final question. The final question comes from James Samford from Citigroup. Please go ahead.

James Samford – Citigroup

Great, thank you. I just wanted to touch on the placement issue as well. It sounds like you’re still hiring more, where are you in terms of your staffing levels on your placement staff at this point?

Steve Lesnik

Well, we have, as I said in my prepared remarks we’ve hired at least 75 new people this year, you do have normal attrition during the year, so we’re not 75 over where we are. But we watch very closely our ratio of placement advisors, guidance counselors to students and our ratios are greatly improved over the past.

Mike Graham

James, we have about 14% more career service advisors right now than we had this time last year.

James Samford – Citigroup

And I guess it sounds like a lot of the OPID consolidation efforts et cetera is really a function of trying to offer new programs. How do you feel the programs that you have today are potentially oversaturated in some of your markets given the macro factors that are taking place right now.

Steve Lesnik

Yeah, I’m not sure that it’s so much that the programs are oversaturated, I think it’s the fact that we offer some programs, where there’s not great demand by employers right now. Employment needs do change from time-to-time and you have to stay alert to the changes. So what we’re more concerned about is particularly in our ground schools is the demand locally for jobs that’s changing. We have to be alert and stay up-to-date on that to make sure that what we’re offering is what the employers want in that general locality.

James Samford – Citigroup

Any regional differences that you’ve seen that you can talk about on a local basis?

Steve Lesnik

Well, again, if we had some of local people in here, they could probably answer the question better than I. But, what we do here at our level is that on a regional basis there are different employment needs and we know that as we study MSIs that in some MSIs there is a demand for X and in another MSI there is a demand for Y but not X.

For example, we’re in Sioux Falls, South Dakota – Sioux Falls, South Dakota is both a regional medical center and it’s also a credit card services processing center. So they have certain kinds of needs there. And in another location in Pittsburgh, the needs are entirely different. And we have to be sensitive to that and we are working very hard to make sure that we adapt as quickly as possible to the needs of the MSIs in which our schools are located.

James Samford – Citigroup

Okay. Thank you.

Operator

Gentlemen that was the last question for today. Please go ahead with any final remarks.

Steve Lesnik

Thank you everybody for being on for various parts of – I know you’re in various parts of the country. We appreciate your continued interest in our company and we will see you all down the line, and if there’s anything that we didn’t answer completely today, I know that Mike is always at your disposal and Matt will be, too. Thanks again.

Operator

Thank you for participating in the Career Education Corporation’s Second Quarter 2012 Earnings Conference Call. This concludes the conference for today. You may all disconnect at this time.

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