Education Management Corporation's CEO Discusses F4Q12 Results - Earnings Call Transcript

Aug. 9.12 | About: Education Management (EDMC)

Education Management Corporation (NASDAQ:EDMC)

F4Q12 Earnings Call

August 09, 2012 09:00 am ET

Executives

Jim Sober - VP Finance

Todd Nelson - CEO

Ed West - President & CFO

Analysts

Gary Bisbee - Barclays

Reza Vahabzadeh - Barclays

Jeff Volshteyn - JPMorgan

Bob Craig - Stifel Nicolaus

Suzi Stein - Morgan Stanley

Brandon Dobell - William Blair

Corey Greendale - First Analysis

Kelly Flynn - Credit Suisse

Jeff Silber - BMO Capital Markets

Trace Urdan - Wunderlich Securities

Sara Gubins - Bank of America Merrill Lynch

Jeff Meuler - Robert W Baird

Operator

Good day and welcome to the Education Management Corporation's fiscal 2012 fourth quarter earnings call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation there will be an opportunity to ask questions. (Operator Instructions) Please also note this event is being recorded. I would now like to turn the conference over to Jim Sober, Vice President of Finance. Please go ahead sir.

Jim Sober

Thank you, operator. Welcome to Education Management's fiscal 2012 fourth quarter earnings call. With me on the call today are Todd Nelson, Chief Executive Officer; who will succeed Jock McKernan as Chairman of the Board of Directors effective August 15, 2012, and Ed West, currently President and Chief Financial Officer, who will become the company’s new Chief Executive Officer. Following our opening remarks, we will begin the question-and-answer session.

During the session we ask that you please limit yourself to one question and not more than one follow-up question to ensure that we can respond to the many participants on today’s call.

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

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

Todd Nelson

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

Having worked in the post secondary education industry for close to 25 years, I can say that the current environment is unprecedented in the numerous challenges in place, but at the same time offers many positive opportunities.

For the past three years, we’ve seen net employment levels that this country not experience since early 1980s. The pervasive high employment while initially a tailwind has become a significant barrier to higher education as individuals find it more challenging to fund their education given the difficult job market.

The drop off in enrollments is not confined to the proprietary sector alone, but also includes the nonprofit sector as well. The primary reasons for the decline in enrollment are tuitions and concerns about debt according to the American Association of Collegiate Registrars and Admissions Officers and other higher education officials.

That said there is still a critical need for higher education in this country to meet the skilled demand for the marketplace. According to Georgetown University Center on Education and the Workforce, by 2018 the number of jobs requiring an associates or higher degree are expected to grow by 17 million, while those not requiring higher education are expected to decrease by several million jobs.

Furthermore the United States which is number 16 out of the 36 countries measured by the organization for Economic Co-operation and Development in the number of adults aged 25 to 34 with at least an associate’s degree needs to significantly grow its post secondary education workforce in order to stay competitive with the global marketplace.

So going forward, although post secondary education faces many significant challenges, we see significant opportunities for education providers to deliver quality education for their students. Despite these challenges, we are pleased with the success our graduates have in the job market for graduation.

Based on the Gainful Employment Program data provided by the Department of Education for completers, from fiscal years 2007 and 2008, the graduates from our programs in calendar year 2010 are an approximately 5% more on average than the graduates from all other institutions measured that offer the same programs.

We believe this illustrates the value we bring to our students and graduates to help them succeed in their chosen careers. With approximately 325,000 alumni and nearly 125,000 students currently enrolled, we are proud of the difference we make in the lives of our students.

While the operating environment continues to be challenging, our financial and operational results with our fiscal fourth quarter were generally in line with expectations. As you noticed from our earnings release, we have modified our student enrollment as well as new student enrollment disclosures to include our four reportable segments. The Art Institutes, Argosy University, Brown Mackie College, and South University which Ed will touch on later.

For our recent July start, we had enrollment of approximately 124,600 students, a decrease of 10.8% over the prior-year period. Students enrolled at fully online programs at The Art Institutes of Pittsburgh online division, Argosy University and South University decreased 19.4% from last year to 31,000 students representing about 25% of the total student population.

Further new students for the three-months period ended June 30, 2012 which is typically our smallest enrollment period decreased by approximately 20% over the prior-year period to 21,400 students. During the fourth quarter of fiscal 2012, we rolled out over 40 programs across schools, not currently offering them, bringing the total programs rolled out during fiscal 2012 to over 250.

We are very pleased to announce that a few weeks ago, 92% of the graduates of Western State College of Law at Argosy University taking the State Bar of California’s Committee of Bar Examiners Exam in February for the first time past compared to just 62% at all other California Bar Association accredited law school, placing the school first in the rankings of all California law schools.

This is another example of the quality education and outstanding support we provide that helps our student succeed in their chosen field.

While experiencing some slight improvements in average starting salaries, our graduate employment statistics continued to be impacted by the struggling economy, high unemployment and anemic job growth. Our undergraduates students excluding Argosy University available for employment and graduated during the quarter ended this past December, approximately 75% were employed in our field or related fields within six months of graduation.

And the average starting salaries for these graduates from undergraduate programs for the quarter ended this past December, that saw our students obtain an average starting salary of $33,000 while graduates from associates and diploma programs earned approximately $27,000.

In addition, for our undergraduate students, excluding Argosy University, available for employment graduated during the calendar year 2011, approximately 77% were employed in their fields or related fields within six months of graduation with an average starting salary nearly $31,000.

Lastly, I just wanted to mention the leadership announcement we made a couple of week ago. I wanted to again personally thank John for his years of excellent leadership as Chairman of the Board of EDMC and I am very grateful to have his continued insight and expertise going forward as a member of our board.

I also wanted to mention how excited I am to have Ed West as our new CEO. As you know, Ed has a tremendous amount of experience and expertise in our industry and in managing large organizations. I've worked closely with Ed for over five years.

He is well respected in the education sector and within our company and with the exciting opportunities and challenges in our industry going forward, we're very fortunate to have someone of Ed’s caliber as Chief Executive Officer of our company.

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

Ed West

Todd, first I would like to thank you for your leadership over the last five and half years and I look forward to working with you in our roles. This quarter in order to provide additional insights into our operations and financial results. We have enhanced the information included in both our earnings press release and comments, included as part of this call.

In my comments today, I will review our financial results for the fourth quarter of fiscal 2012, discuss our reportable segments, cover several operational topics and provide our guidance for 2013.

So for the fourth quarter ended June 30 of 2012, net revenues were $639.2 million down 8.1% versus the prior year quarter. It's driven by non-cash goodwill and indefinite-lived intangible asset impairment charges of $1.25 billion; we recorded a net loss of $1.19 billion and EBITDA loss of $1.16 billion.

Excluding the non-cash impairment charges and $1.6 million restructuring charge EBITDA for the quarter was $89.6 million in line with our previous expectations. For the fiscal year 2012, we had revenue of $2.8 billion and EBITDA of $509.9 million when excluding the non-cash impairment charges, restructuring expenses, termination of lease agreements and a loss on extinguishment of debt.

Last quarter, we recorded goodwill impairments at three of our education systems Argosy University, Brown Mackie Colleges and South University. While The Art institutes based on our preliminary plan in applications on-hand at that time showed no signs of impairment. As a result of lower enrollment projections since April at The Art institutes due to the continued weak labor market, the general reluctance by consumers to take on debt and a significant reduction in the number of depended students using plus loans to finance their education, it became evident that there were now signs or now indicators of impairment at The Art institutes.

Similar to last quarter, we completed step one and step two impairment valuation processes in all of our reporting units and determined that we had non-cash goodwill impairment of $1.12 billion at The Art institutes and non-cash investment indefinite-lived intangible assets by impairment of $128.3 million.

The non-cash impairment charges of $1.25 billion are non-deductible for tax purposes. But the resulting tax benefit, this all resulted in tax benefit of 3.7% for the quarter and 0.9% for the fiscal year ended June 30 of 2012.

Excluding the impact of the impairments and other one-time items, the effective tax rate would have been 30.9% for the quarter and 38.4% for the fiscal year. We also had restructuring charges of [$1.26 million] on our corporate office and two of our education systems, including the tax effect of both these items the total impact of net income was $1 million or approximately $0.01 per share.

Please note that the following comments on the fourth quarter's net income statement will exclude these items I just mentioned when comparing current results to the prior year, my comments also exclude the following items in fiscal 2011. The $3 million in expenses we incurred in connection with our repurchase of the remaining $47.7 million of senior subordinated notes, $600,000 restructuring charge and $700,000 related to the write off of capitalized assets at one of our institutions due to a lease termination.

The 8.1% revenue decrease for the quarter was primarily driven by the year-over-year decrease in the April enrollment of 9.3%.

Overall, revenue per student was up 1.4% due to a greater mix of on-ground students. Average tuition levels across the system were up less than 1% year-over-year. Total operating expenses for the fourth quarter were down 1.7% to $589.6 million versus the prior year quarter.

Looking at the expense categories in more details, educational services were $369.8 million essentially flat to the prior year. As a percentage of net revenues, educational services expenses increased by 502 basis points versus the prior year quarter. The increase as a percentage of revenue was primarily due to decline in net revenues, higher bad debt expense and drop in the average class size.

Within educational services, instruction cost as a percent of revenue were up 89 basis points primarily from the drop in the average class size. Bad debt expense represented 7.2% of net revenues for the quarter, up 309 basis points from the prior year quarter. This increase was largely due to higher accounts receivable balances at The Art institutes as a result of active students, to utilize payment plans to finance their education.

This increase in accounts receivable was largely driven by lower plus on approvals which I will speak more to later. General and administrative expenses were down 7.4% to $179.9 million versus the prior year quarter, but increased 22 basis points on a percentage of net revenues basis.

Within G&A expense, marketing and admissions costs were down 8.4% year-over-year and represented 23.6% of net revenues, roughly flat with the prior year period. Marketing and admissions costs per start were up 14.8% due to lower startup rates particularly for students enrolling in fully online programs.

EBITDA decreased 33.1% to $89.6 million for the fiscal fourth quarter. EBITDA margin was 14%. EBITDA which we used to measure operating performance is a non-GAAP financial measure and reconciliation to report a net income is included in the quarterly earnings press release.

The net interest expense was $31.2 million in the current quarter, a decrease of $2 million from the prior year quarter due to lower fixed rate, swap rates and the repayment of our senior subordinated notes in June of 2011, partially offset by higher rates on the term loans.

Regarding the segment reported in the quarter ended June 30, 2012, we will report results for each of our forward reportable segments, The Art institutes, Argosy University, Brown Mackie Colleges and South University.

We evaluate segment performance based on EBITDA excluding certain expenses with adjustments to reconcile segment results to consolidated results included under the caption corporate and other which primarily excludes the unallocated corporate activity.

Please note that the following comments for the fourth quarter of fiscal 2012 financial performance for each segment will exclude as appropriate the impact of the items I mentioned earlier in my remarks.

At The Art Institutes, enrollment for the July 2012 start was 65,400 students down 11% year-over-year. New students for the three months ended June 30, decreased 18.3% versus the prior year period. Lower new student enrollment and fully online programs represented 92% of the year-over-year decline in new students.

We continue to see improving application flow for our campus based The Art institute programs where year-over-year growth has recently turn positive and are the best results we have seen in more than a year. Application flow for our fully online programs at The Art Institute of Pittsburg remained down on a year-over-year basis.

Despite the improvement in a number of applications received from perspective students start rates remain below prior year levels. The improving start rate trend, we experienced through the third fiscal quarter was reversed in the fourth quarter.

Revenue declined 7.5% from the prior year quarter to $397.4 million driven by 8.7% year-over-year decline in the April enrollment partially offset by an approximate 1.4% increase in the average revenue per student.

The increase was largely driven by the mix of campus based versus fully online students. Operating costs excluding depreciation and amortization decreased 2.9% year-over-year

driven by reductions in staffing levels and advertising reflecting our recent restructurings and a soft operating environment partially offset by an increase in bad debt associated with the students in school payment plans.

EBITDA decreased 20% year-over-year to $92 million with the segment margin up $23.1%. In Argosy University, enrollment for July 2012 start was 23,200 students down 14.5% year-over-year. These students for the three months ended June 30 decreased 26.7% versus the prior year period.

Lower new student enrollment in fully online programs represented 93% of the year-over-year decline in new students. Application flow of Argosy's campus based programs remain consistent with recent quarters, however, we continue to see weaker application flow for our fully online programs at Argosy University.

Revenue declined 14.6% from prior year quarter to $88.4 million driven by 14.3% year-over-year decline in April enrollment. Operating expenses excluding depreciation and amortization decreased 5.4% primarily due to the lower staffing related expenses. EBITDA decreased 61% year-over-year to $6.6 million with the segment EBITDA margin of 7.5%.

At Brown Mackie Colleges enrollment for the July 2012 start was 17,200 students down 12.7% year-over-year. However, we are beginning to see several signs of encouragement at Brown Mackie. Student persistence was up over a 100 basis points for the year and application flow is beginning to improve. New students for the three months ended June 30 decreased 15.9% versus the prior year period. Revenue declined 10.8% from the prior year quarter to $74 million driven by 12.7% year-over-year decline in April enrollment partially offset by a 3% tuition increase. Operating expenses excluding depreciation and amortization were roughly flat year-over-year. EBITDA decreased 43.8% year-over-year to $11.4 million with segment EBITDA margin up 15.3%.

And finally at South University, enrollment for the July 2012 start was 18,800 students down 3.3% year-over-year. We are beginning to see signs of improvement in student persistence rates for students enrolled in fully online programs at South. We believe this is our early indication that the shift to a non-term academic structure which began in January of 2011 is beginning to have a positive impact on our education system.

New students for the three months ended June 30, 2012 decreased 21% versus the prior year period. Although, we experienced positive increases in both new students and total enrollment at South University’s campus based programs, these increases were more than offset by new student and enrollment decline of their fully online programs. Application flow for campus based South University programs remained relatively consistent with previous levels, but we continue to see lower application flow for our fully online programs at South.

Revenue was flat versus the prior year quarter at $79.3 million with a slight tuition increase offsetting lower April enrollment. Operating expenses excluding depreciation and amortization were kept flat year-over-year consistent with revenue. EBITDA increased 4.3% year-over-year to $4.5 million with the segment margin of 5.7%.

Looking at the company's selected cash flow detail; cash flow use in operations for 12 months ended June 30, 2012 was $10.9 million compared to cash flow generation of almost $400 million in fiscal 2011. This decrease in operating cash flow was largely the result of one-time transfer in March of 2012 of $210 million to restricted cash in order to utilize the company’s cash secured letter of credit facilities as I mentioned on our last several earnings call.

The use of these facilities which are being utilized to help satisfy the previous disclosed letter of credit, for the program of education now stands at approximately $415 million, and will result in reduced letter of credit fees due to lower rates on these facilities versus a revolver. In addition, reduced operating performance and growth in accounts receivables resulting from the fall off in PLUS Loans also negatively impacted cash flow from operations as compared to the prior year period. Looking ahead to fiscal 2013, we believe we will generate positive free cash flow for the year.

Cash paid for CapEx was $93.5 million, or 3.4% of net revenues for the 12-months ended June 30th, down from 4.8% of net revenues during the same period a year ago. We expect the CapEx for fiscal 2013 to be between 3% and 4% percent of net revenues.

Looking at the company’s balance sheet as of June 30, 2012, the cash and cash equivalents balance was $191 million, net student receivables including the long-term portion increased $49 million to $218.6 million. We had a $111.3 million in borrowings outstanding on our revolving credit facility, which we repaid in total on July 1st. Long-term debt was $1.47 billion.

Regarding investments in new locations, during the fourth quarter, we incurred approximately $5.9 million in losses from startups in operations less than 24 months, as we mentioned last quarter, we have completed our planned four new locations in fiscal 2012. For fiscal 2013, we anticipate opening three to four new schools with the majority occurring later in the fiscal year depending on the timing of regulatory approvals.

Regarding PLUS Loans; at The Art Institutes more than half of our students are considered dependents. These traditional age students often receive financial support from their parents to help pay for their education. As part of this support, parents often participate in the Federal Parent Loan for undergraduate students or PLUS program that lets parents borrow money to cover any costs not already covered by the students financial aid package up to the full cost of attendance; since July 1, 2010, all new PLUS Loans like the Stafford Loans have been made through the direct loan program.

Earlier this year, we began to hear from our schools that a number of parents of dependent students who had previously been eligible for PLUS were now denied eligibility. It came to our attention that the Department of Education change their credit criteria to now include accounts as adverse credit that a creditor seeks collection or charged off because it was deemed uncollectible.

This change in PLUS eligibility along with the continued macroeconomic challenges and a reluctance by parents to take on additional debt likely led to the sharp reduction in the number of students using the PLUS to finance their education. The change impacts both current and prospective dependent students at all institutions, whether they be public, private or proprietary.

The percentage of campus based dependent students at The Art Institutes using the PLUS program dropped sharply during the fourth quarter to approximately 33% back to the levels seen in fiscal 2010. As a result of the drop in the PLUS program usage, we are seeing larger number of students using our internal payment plans since fee alternative funding sources are available for most students. The increased use of internal payment plans is leading to higher accounts receivable levels and additional bad debt reserves. We are also seeing a number of applicants who are interested in attending The Art Institutes who we believe are having difficulty funding their education and thus enrolling, because of these issues with financing their education without the PLUS program.

Now regarding Gainful Employment; on June 26th the Department of Education released to the public the fiscal 2011 informational rates. Over the following several weeks we downloaded nearly 1,500 supporting files containing program and student level data to help us analyze and understand the published rates. Of the 415 programs reflected for EDMC institutions in the publicly released data, 94% of the programs representing more than 95% of our enrollment either passed at least one of the three metrics or passed because of an insufficient data was available to calculate the measures.

In the detailed files, we identified an additional 150 programs that were not included in the publicly released data, because of the insufficient number of students that were available to calculate at least one of the metrics. Of the 23 programs that did not pass, at least one in the three GE metrics as reported by the Department of Education, four are no longer offered and 13 would pass the debt income ratio based on our calculations if the Bureau of Labor Statistics data were used for annual earnings. Thus leaving only six programs that failed all three metrics.

That said, as we reported, when the Department of Education first released the 2011 informational rates, we have identified several inaccuracies with the reported measures including the debt amounts of certain groups of students which do not appear to be included at all debt incurred to students while attending the program of study. We have not yet received clarification from the Department of Education that corrected data will or can be obtained. As a result, we are unable to confirm if these effects in programs which we believe represent approximately 25 programs out of the 415 programs reported by the Department will fail all three measures.

Regarding guidance; our first quarter and annual guidance for fiscal 2013 reflects our recent July start it continue near-term negative variability and new student enrollment and excludes the impact of potential restructuring and lease termination expenses which maybe incurred. For fiscal 2013 first quarter, we’re expecting EBITDA to be around $55 million, a net loss of $10 million and EPS to be a loss of $0.08 per diluted share. For the 12-months ended June 30, of 2013, we’re expecting EBITDA to be approximately $400 million, net income to be approximately $68 million and EPS to be around $0.54 per diluted share.

Fiscal 2012 was a challenging year. We saw and continue to see a struggling economy, a very poor job growth and weak consumer confidence all of which are impacting enrollment across secondary education industry. Because of these decline in enrollments we have had to make some tough decisions to streamline our company by looking for efficiencies, reducing discretionary spending and adjusting staffing levels to the student population that we serve.

At the same time, we continue to make additional investments in the student experience in an effort to support retention and lowering the overall cost of education. The core focus of our faculty, administrators and staff is the education of in support for our students which has been unwavering despite all the uncertainty and negative press. We're very proud of all the efforts and achievements made by our employees and we would like to personally thank them for continuing to espouse EDMC’s values of doing the right things for our students.

Despite the current challenges, I am optimistic and confident that we will navigate successfully through this difficult time and we will establish a more focused confidence centered or student achievement. And with that Todd, back to you.

Todd Nelson

Thanks, Ed. Operator, we will go ahead and open it up for a few questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Gary Bisbee of Barclays. Please go ahead.

Gary Bisbee - Barclays

I guess the first question looking at the guidance, it seems to imply that costs will increase quite a bit quarter -- or at least several percent quarter-over-quarter June to September and I think over the last year or two, it has been a more moderate increase. I just wondered what's going on there and as part of that for the fiscal year guidance, it would seem to imply I guess more aggressive cost cutting or cost reduction later in the fiscal year. I guess number one, is that right and number two any color you can give.

Todd Nelson

So in the guidance, what you are implying there from a cost standpoint, our current forecast and outlook that we have for Q1 sequential from Q4 would suggest a very slight uptick in expenses going into the first quarter. You know that's driven by a couple of different categories. Honestly, the increase in bad debt that we talked about a minute ago that we had in Q4. We anticipate that continues going into Q1. Separately just some timing differences really on some of the marketing front.

We anticipate having a little bit higher expenditures in the first quarter versus the fourth, that's really the timing. And then some other initiatives that we have going on that are rolling out or frankly as we speak during the first quarter, but that's really a one quarter rollout of that initiative.

Then from there, we would anticipate seeing going back to a trend of reducing costs on a sequential basis quarter-to-quarter and this is all reflected in that long-term guidance that we outlined.

Gary Bisbee - Barclays

And then the follow-up question. I appreciate the extra, the incremental data by school group, that's helpful. But given that there's only one quarter there, can you help us understand what the trend has been like over the last couple of quarters at the Art Institute, I guess the Q4 versus the fiscal year seems to imply that it's gotten quite a bit worse, is that right? And based on what you know would it be reasonable to think that continues to trend I guess deteriorate in the next quarter or two.

Todd Nelson

Obviously from a standpoint of what we experienced right now on particular there on the bad debt side and some of the enrollments for July, that that would on a year-over-year basis. But we do also anticipate. I would say we will continue to do efforts to help maintain the cost structure there and I think our current outlook reflects all that.

Ed West

And then the other thing I would add Gary is we are seeing some improved application flow at the on ground Art Institute and so some year-over-year growth has recently turned positive. So I mean there are some positive there as well.

Todd Nelson

And Ed (inaudible) as regular point, which I noted in the comments there, the underlying demand application, the number of applications that we are seeing has been positive into the flow and frankly it's more positive than we are seeing for some time. What we saw was that fall off in start rate where those applications cancelled out before the student elected to start, we anticipate some more of that. But that will flow through the system throughout the year.

Ed West

And it is hard to note as Ed pointed out, plus loan changes is something that was relatively unexpected on our part and you know, obviously now we just need to make adjustments for that and our view of that is it will be interesting to see if that helps the start rate go back in the right direction.

Operator

Our next question comes from Reza Vahabzadeh of Barclays. Please go ahead.

Reza Vahabzadeh - Barclays

I guess one question as far as On Ground starts for this quarter, do you have the data and then if you can also talk about are applications now in aggregate flat year-over-year, and I have a separate question regarding your free cash flow in 2013. What would you expect net free cash flow to be after everything CapEx, cash taxes, working capital?

Ed West

So, first on the color that we provided on the call (inaudible) provided there. We have seen an improvement on the application flow of our campus-based programs across the system, which has been an encouraging trend. As I mentioned, the Art Institutes are actually seeing an increase there.

So, an improving trend at Brown Mackie not positive yet, but it's been less negative and obviously headed in the right direction. South University campus-based programs have trended steadily throughout the year and frankly have experienced new students and enrollment growth year-over-year offset by the declines for the fully online programs.

When you look at the new students, we did report this was down year-over-year of about 20% for the quarter. Over 90% of that was a result of the fully online programs as I touched on each of those systems.

So that was a big driver. Going forward from a cash flow perspective, based on everything that we know sitting here today and the outlook and our guidance on this, we expect to have positive free cash flow after CapEx, get that range of 3% to 4%.

Obviously that goes up with a lower CapEx levels but uncomfortable with that. And we have also factored in ongoing impact of the plus loans as more students come up for renewal and factored in the experience that we had to the best system possible that we saw this past quarter and try to reflect in working capital going forward.

Todd Nelson

And the only thing I would add is that said, we are seeing some positive signs in the On Ground enrollment online. There are some things that have happened as we have talked about in the past, there has been a reduction in force. As well as – not the ad spend that we have been making in the past as we have rightsized what we feel was our online division. So that's why again you see the majority of the shortfall in new students coming from online which by the way is also consistent with some of the other larger online providers in the sector.

Going forward again with these changes, we feel that it puts them in a better position to take advantage of the market where there is demand for online programs, but again the On Ground is not the fall off that online has.

Ed West

I think one last it’s important to note that as I said earlier in the call like what we are seeing for the fully online students itself where positive progress from a retention standpoint which was a very positive sign and also positive academic progress as well.

And that now that we have a full year-over-year behind us after the conversion to the non-term academic structure and we look forward to seeing some of the same trends for (inaudible) and we believe we are starting to see some of that on the academic side as well.

It is also important to put all this in perspective from a scale standpoint of the company between the campus based and the fully online students. If you look at from a new student perspective what we had during the fiscal 2012, roughly 38% of our students came from the fully online programs.

Our enrollments for the year was roughly a quarter, about 26% of our enrollment were enrolled in fully online programs. The revenue associated with that was about 18% of and the EBITDA contribution from the fully online programs was about 5%. So I think it is important to put that into perspective and on interestingly, obviously the stability that we see across the campus-based programs and then as we start seeing some signs of stabilization improvement for online.

Operator

(Operator Instructions) Our next question and partner [pronunciation] comes from Jeff Volshteyn of JPMorgan. Please go ahead

Jeff Volshteyn - JPMorgan

I wanted to ask about levels of persistence that you have implied in 2013 guidance, is it fair to assume that Art Institutes will continue to be challenged and persistent and then South and Argosy are sort of stabilizing?

Ed West

It is fair to say that we do anticipate strategic challenges for The Art institutes in particular from the financing and on the debt size we mentioned on the plus one. We have seen the improvement on South University’s fully online programs. There we've continued improvements I mentioned earlier at Brown Mackie, year-over-year, on a year-over-year persistence result in excess of 100 basis points. So some of that as we anticipated is based on what we've been seeing on recent trends.

Jeff Volshteyn - JPMorgan

And what level of bad debt expense do you anticipate in 2013?

Ed West

Well, this past quarter was slightly over 7% and for the year we are just right around 6% so we anticipate to be in between 6% and 7% and probably closer in the midpoint of that.

Operator

Our next question comes from Bob Craig of Stifel Nicolaus.

Bob Craig - Stifel Nicolaus

Ed, I was wondering if you could share some of the assumptions behind your guidance in terms of OEM revenue per student and marketing spend, and I understand you might have reluctance in doing that but your numbers forecast return deposits starts at any point over the next four quarters?

Ed West

Well, let's talk about some more on the macro side that as we suggested on the revenue per student, we expect a slight increase but less than 2% and kind of what we've been trending here recently and that's really driven by mix and we have a very nominal tuition increases only on certain programs across the system for the year. So that revenue per student is really from a mixed standpoint between the campus base and fully online from an expenditures in your second point there on marketing admissions cost, as I mentioned earlier, we would see a little bit of an uptick in that in Q1 but then we anticipate for the year to be roughly equivalent of where we are this past year as a percentage of revenue.

Bob Craig - Stifel Nicolaus

Okay and anything on volume start assumptions?

Ed West

You know, we continue to work across the system obviously taking application flow with what I mentioned earlier from what we have expansion team to work that as aggressively as possible. You know, you see where we’ve been for the last couple of quarters, and we had expect overtime to see improvement there from the new student standpoint.

Todd Nelson

We see inquiry flow continues to be encouraging, but again given this change to start, we just, we don’t want to be too aggressive on that, we are still working through that, especially the impact of what we perceive to be a change in how the plus ones are ---

Bob Craig - Stifel Nicolaus

Okay, as my follow-up, what are you guys doing to jazz up demand and improve affordability we see other based, you are heavily utilizing scholarship and discounting to not only attract students but retain them, having really noticed a lot of that with you folks but maybe just haven't see what I should be seeing?

Todd Nelson

I think that’s a good work jazz up. I think from our point of view, you really look to the students and why are they choosing to again enquire about our schools and it really comes down to the quality of the education and are they again getting the education with a reputation that will allow them to get jobs and/or get promotion or raise or whatever that is and that really has been our focus that's going to continue to be our focus and that’s what helps the students a lot.

And our view of that is that is the only real long-term way to continue to sustain enrollment and produce positive outcomes other than that its in [cases] or some short-term things you can do to look at to increase exposure but the bottom line is and we will continue to focus on the quality education and again we point to some of the success of our law school and those who passed the Bar there in California means that's the type of effort that we were trying to make across the board with our programs in each of the segments of the market that we have that our schools are positioned and that really is going to be a focus going forward and our view of that is that is the best way to ensure success and return to growth.

Operator

Our next question is from Suzi Stein of Morgan Stanley. Please go ahead.

Suzi Stein - Morgan Stanley

Given your outlook is there any concern that you could trip any debt covenants next year and can you also just address the financial responsibility ratios, are there any concerns on the equity measurement just given the recent right downs?

Ed West

On our debt covenants with our term loans as we look here selectable file our statements of today we have to test as the operating leverage and also interest coverage. On the leverage test, we have an excess of $100 million of [tuition fee] here today as of June 30, that kept us step down and going into this next year in terms of the multiple of coverage and basically (inaudible) it does get tired what we know today is sitting here today and we believe they are sufficient cushion and therefore to satisfy those tests based on what we know right now. From a DOE test as you know today we do not pass those tests today based on the goodwill and the equity test and the goodwill is counted against us today. It will be tomorrow and so we will still be insufficient on that measure which is why we posted a letter for that which we do not see that changing.

Suzi Stein - Morgan Stanley

Is there any expectation that you will have to post anymore in terms of cash or letter of credit?

Ed West

So right now we have, we utilized both our revolving credit facility as well as the stand by letter of credit facility, for both of those but based on the company's performance where we are and the coverage we do not anticipate any changes to that.

Operator

Our next question comes from Brandon Dobell of William Blair.

Brandon Dobell - William Blair

I wonder if you could touch on your expectations for let's call it student facing headcount, enrolling advisors, academic counsel and those types of things within Argosy and The Art institutes to look out the next three or four quarters.

Ed West

Well, as we said they have some reductions of course over the last several quarters and we felt like based on some of the uncertainty around the regulatory environment and what programs wouldn't be eligible on where we are seeing demand. We did some right sizing there that we felt with appropriate credit company. Going forward and some of our education systems they actually are now doing optimistic and up to the adding enrolment but that's something that we really do want to continue to monitor very closely on a quarter-by-quarter basis and again see where the demand is coming and in those places to make sure we are meeting the students, demands of the students needs that we are adding those but again over the year you just vary depending on the education system demand but as I said there are some of the education systems who are having enrollment staff as we speak.

Brandon Dobell - William Blair

And as a follow-up you mentioned a pretty healthy number on your programs that you rolled out, I guess, any impact from those new programs thus far in terms of what the enrollment impact has been and how should we think about the balance of the year in terms of new programs and is there any concentration within The Art institute or Argosy or it is across the systems? Thanks.

Todd Nelson

There are two factors that drive program rollout. One is obviously demand and interest and then the second is what do you see happening which is relatively new development over the last couple of years, has been the regulatory environment, and so as a result, we really back that off in new program roll out there is some of lack of clarity and that has become more fair to us.

We obviously stepped up the amount of rollout of new programs back to really where we have been in the past. Our view that is although, initially as you roll them out the impact on the total enrollment is relatively small because again you are starting and as you are roll them out for a very small backlog from nothing and then starting to build the base. But going forward that is one of the, what we feel is one of the strongest components of Education Management is that we do have this different education systems with opportunity to roll out many programs as the demand there warrants it.

So our view going forward is that you would see consistent number based on what we had this past year going forward.

Operator

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

Corey Greendale - First Analysis

Several times you talked about the difference in demand in trends in on-ground versus strong online, something about (inaudible) just a little more, in terms of what do you think are the causes of the differential in demand, how much of competition playing a factor in, are there any implications for differences in trends how are you managing the business?

Ed West

Well again, I think you know as I you said earlier there is certain amount of regulatory impact on some of our program growth on ground as well as online. We think one of the strengths of the company has been again our network of schools out there on ground programs and to appeal within the communities that they reside and depending on again what we see going forward also our interest in continuing to roll out new campuses although again obviously as we have in the past to be vary careful about how we do that.

We do know based on what we are hearing and statement there is demand for that, but again given the regulatory environment as you know again we are just very careful how we do that. Online faces some unique challenges as you know online was growing very rapidly to keep up with the demand you need to add resources to do that and as that demand started to slow again, we found our self with that capacity and again that was one of the things that we needed to look at carefully as we reduced that force. So again right sizing will be needed to take place based on what we were seeing as far as growth opportunities.

So going forward again we think that as Ed pointed out, most of our programs and most (inaudible) are still on ground and going forward we see that there is a demand for both, but right now we are seeing, probably we are seeing more stability in our on ground versus online. But having said that, again we still see a great opportunity for our online programs you know as things continue to stabilize.

Corey Greendale - First Analysis

And my follow-up going back to part of the question that Craig asked about demand and on the pricing side, it sounds like pretty clearly part of what current demand is, is price sensitivity or diverging, so can you just -- and I heard that you said that you was expecting a modest increase in revenue for students next year, but can you just talk a little bit about how you are thinking about the price elasticity of demand and what maybe likely to make sense to provide more scholarships to you impact that issue?

Todd Nelson

Well, I mean there's a couple of things in your question, one is that its really not that we feel our programs are not priced out of who they compete against, the problem is just access the funding for students and the expense of education in general. And again, as whenever you see a change for example this change we've talked about in the PLUS approval rate levels that does affect the ability of the student who is an application to start, but our view of that is its just again a function of what's going on in the economy in general and the job market and the ability for people to get the access to the funding to pay for their programs.

So our view of that is that's really affecting our own strategy to try and keep, eliminate some of our programs, any tuition increase and keep to a minimum and other programs and again that's driven by trying to help make it easier on our students. Bottomline, its obviously a little more price sensitive there just because the fact that you don't have the barriers that you have in an on ground environment, there's much more of an opportunity for students to look at different opportunities.

But having said that, again even though our programs if they are competitively priced what happens is the students will and eventually do get to the program that produces the outcome that they want and that's why although we saw fall off in a norm, we are still continuing to see demand in our view with the opportunity for that to increase going forward. But the strategy to keep prices down is less so about the competition, it’s more so about trying to help our students, manage just the cost of education.

Operator

Our next question comes from Kelly Flynn of Credit Suisse.

Kelly Flynn - Credit Suisse

Actually I wanted to go back to one of Bob’s questions as well just related to starts. Given that you’re giving annual guidance, I imagine you are putting concrete assumptions about worst starts will be. So shall we could give a little more help. Two questions really, will the starts decline narrow in Q1 do you think and then by year-end, fiscal 13-year end, do you expect to be achieving something like mid-single digit starts growth, are those numbers ballpark?

Ed West

Well, this is Ed, and good morning Kelly. Just going back to what we mentioned earlier, we would anticipate a more remodel as an improvement on in start trend to occur during this year. Now, speaking well about a specific quarter versus that quarter there are also timing differences that occurred for example, there will be fewer number of starts in the first quarter versus the fourth quarter, so you have some underlying variability that occurs during on a quarter-to-quarter basis. But in general, for the year, we would anticipate some improvement in the trend.

Kelly Flynn - Credit Suisse

And then just second question, can you talk about the cash flow drag if you will that we might see this year from the accounts receivable funding that you referenced related to the PLUS Loan issue; what impact does that have on cash flow?

Ed West

We're modeling based on what we saw this past quarter for the fiscal year ahead of us to be an impact of in the neighborhood of around $65 million.

Kelly Flynn - Credit Suisse

And then if I get this thorough and one last one, you talked about I think what you referred to as a step-down in the debt covenants. Can you just explain what's going on there and if it’s possible and what’s the changes are?

Todd Nelson

As I mentioned, we have two tests; one is a leverage test and other is interest coverage. In the leverage test, we have to have a coverage of our net debt divided by the adjusted EBITDA four times that steps down to 3.5 times beginning next quarter. So when you are just looking net debt and EBITDA there is just a little bit higher hurdle to cover on that standpoint, but based on liquidity that we have the cash flow that we anticipate and EBITDA we believe that there was a sufficient amount of cushion there. To cover that obviously our low points are June 30th and December 30th which is when those covenant test will be tighter.

Operator

Our next question is from Jeff Silber of BMO Capital Markets. Please go ahead.

Jeff Silber - BMO Capital Markets

Ed, I was hoping if you can just go back to this whole thing about the PLUS Loan changes; I don’t think we have heard this from any other companies in the space and if you can give us a little bit more color that would be great?

Ed West

Sure, so as mentioned probably obviously we saw the impact particularly here in this past quarter, but became aware of it a little bit earlier based on changes as we understand it that the department implemented with their systems in terms of what they are describing as the adverse credits. And what happened as we have students who are coming up for renewal who started last fall, who are coming up to renew their financing and PLUS Loans and then we saw the denial rates going into this July to be a lot higher than what was previously anticipated.

This impacts us and also traditional college and universities because of our large size number of dependent age students, some of the other colleges who do not have a large age population of traditional age students maybe less impacted, but obviously a lot of parents supporting their children and students into the programs, it did have that impact. And so we now assume that going forward and clearly you know when you look at the economy right now, the difficulty in the economy that just exacerbates the issue and we see the number of students receiving at The Art Institutes PLUS Loans going back to levels that we saw back in 2010.

Jeff Silber - BMO Capital Markets

And just shifting gears a bit, in your commentary you talked about the move to the non term base programs starting to bear some fruits. Can you remind us, did you make those similar room like that in any other schools systems and when that was done? Thanks.

Todd Nelson

Sure. We initiated a South University’s fully online programs back in January of 2011 and then in Ernst really Argosy University full online programs there in July. So obviously it s a little bit of a lag there between the two and we did see higher number of drops as you recall at Argosy University once we started implementing to the non-term programs than what we have experienced at South, but it’s very encouraging sign to seeing the level of academic progress and improvement itself as well as the improvements on retention.

Operator

Our next question comes from the line of Trace Urdan of Wells Fargo Securities [Wunderlich Securities]. Please go ahead.

Trace Urdan - Wunderlich Securities

I hate to take you back to this place, but it is one of the things that market is obsessed with right. Now can you speak to just more broadly what experience you had with scholarships across the brands and you know how you tested it and how you used it in the past, how effective is it with each of the school systems or not and just generally what your attitude is towards using that as a device in the marketing mix?

Todd Nelson

Sure, we haven't really had much change at all rates. We have had a minimal amount within the organization and we continue to keep it at that level. I think going forward it is one of the things that we will need to look at further but at this point in time we haven't used it to the extent that some of the others have and I guess the best way to say is its been very consistent with not just the new regulatory environment but consistent for several years.

Trace Urdan - Wunderlich Securities

Okay, and then on the plus loan issue, it strikes me that we are all familiar with the different proprietary loan products that schools have used but it did sounds like something different and I am wondering if you think there might be an opportunity for a private third party who is interested in parent cosigned loans as, basically having a different character from just independent student loans and whether you think there might be some solution out there that could fill in that gap that has been created with the different credit standards at the department.

Todd Nelson

That's a very good point and I obviously we will and all are working in earnest to we work with students, work with families and parents to help, seek good solutions for this. And we do that today, we will do that tomorrow and similar like we did a couple of years ago, few years ago when the financial markets went south back in the 2009 and came up with some solutions there. So we will be working on that. We just wanted to provide what we know today to the extent we are continuing to experience about this last quarter what that would look like over the next few quarters.

Operator

Our next question comes from Sara Gubins of Bank of America Merrill Lynch. Please go ahead.

Sara Gubins - Bank of America Merrill Lynch

Could you give us an update on the media cost environment and I am wondering if you’re seeing any, or if you are making any changes, to whether you are trying to drive these students and if you are seeing changes in enquiry costs?

Todd Nelson

You know, again our mix largely web based inquiries versus the traditional media outlets and obviously given the election right now what's going on, you know, we don’t have any plans to increase the amount of traditional media buys and those cost will be unusually high enough because of the cost of inquiry but just simply there is just not a fine available so here from now we are going to see very consistent with our strategies as far as again the majority that being web-based spend versus traditional media but as far as the inquiry cost it remains relatively stable and if we’re seeing changes it really is a long the lines of just crowded it is because of the (inaudible).

Operator

Our final question for today comes from Jeff Meuler of Robert W Baird. Please go ahead.

Jeff Meuler - Robert W Baird

Just wondering how you guys are thinking about guidance since you gave our point estimates instead of a range and I guess what feels like a pretty low visibility in environment, are you thinking as guidance or something that think you at least will do, as more of a goal. How should we view it?

Ed West

We just view it, this is based on what we know today, sitting here today, an outlook that we’re comfortable with to achieve and little based on newer information we see at that time. But as we sit here today, that we’re comfortable with achieving these results.

Todd Nelson

I just want to echo with it. I mean to say it's just a goal that's not have we operate the company. Obviously as you go in to the year, there things have changed. So obviously that may change but with that said this is based on a lot of work and effort.

Jeff Meuler - Robert W Baird

And then a conceptual question on offense versus defense; you obviously lay out a number of areas where you are still investing, still rolling up programs, still opening some new locations, I was just hoping you guys could talk about how you think about internal hurdle rates and what growth investments you are making versus which growth investments maybe you are foregoing right now given either the environment or given the balance sheet?

Todd Nelson

Well, I think you have to manage all of those factors together, but the one thing that continues to provide us encouragement is the demand for our programs and the outcomes that are providing success for our students continuing to be strong. And if you look at the entire post secondary education industry, the majority of the degree programs are still provided by the non-profit sector and those who are following that realize that they face significant funding challenges.

The value of an education continues to be extremely high and somebody needs to provide that, again the quality education and our view of that is that we have excellent programs and we are going to do that, and obviously we are navigating that at the beginning for a very challenging, financial and regulatory environment. But we feel like we have the team that is assembled to be able to do that going forward. So we do see again in the midst of these challenges some incredible opportunities and that’s our goal to execute on those.

Jeff Meuler - Robert W Baird

And may be just one more last one, how is the restricted cash treated in the net debt calculation for the covenant?

Ed West

That’s excluded.

Operator

This concludes our question and answer session. I would like to turn the conference back over to management for any closing remarks they may have.

Todd Nelson

Again, we just want to thank you all for joining this morning and we look forward to speaking with you next quarter. Thank you.

Operator

The conference is now concluded and we thank you for attending today’s presentation. You may now disconnect your lines and have a wonderful day.

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