Perdoceo Education Corporation
Q4 2012 Earnings Call Transcript

Published: 28 Feb 2013

[Operator:]

Welcome to the Career Education Corporation's Fourth Quarter 2012 Earnings Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the call over to Mr. Matthew Tschanz. Mr. Tschanz, you may begin.

[Matthew Tschanz:]

Thank you, John. Good morning, everyone, and thank you for joining us on our fourth quarter 2012 earnings call. With me on the call this morning are Steve Lesnik, our President and Chief Executive Officer; and Colleen O'Sullivan, our Senior Vice President and Chief Financial Officer. Following remarks made by management, the call will be open for analysts and investor questions. This conference call is being webcast live within the Investor Relations section of our website at careered.com. A replay of this call will be available on our site. You can also contact our Investor Relations department at [phone]. Before I turn the call over to Steve, let me remind you that yesterday's press release and remarks made today by our executives 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 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, 2012, which will be filed later today, and our other filings with the Securities and Exchange Commission. Except as expressly required by the 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. In addition, the remarks today may refer to non-GAAP financial measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. Our press release, which contains financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures, is available with the Investor Relations section of our website at careered.com. Now let me turn over the call to Steve Lesnik.

[Steven H. Lesnik:]

Thank you, Matt, and good morning, everyone. And thank you all for joining us this morning. During today's call, we will cover 4 areas. We'll review some of the 2012 accomplishments, update you on our strategic plan, discuss the fourth quarter and year-end financials and, finally, provide you with perspective on our 2013 expectations. First, 2012. It was notably a year of challenges for the postsecondary education industry. We saw a domestic economy characterized by slow economic growth and sustained high unemployment levels, especially at below bachelor degree levels; reduced postsecondary market demand reflecting longer decision cycles by prospective students and a hesitancy by students to take on debt; increased competition for new student leads, especially within digital marketing channels; and finally, a regulatory environment which resulted in curtailing growth in the entire postsecondary sector. In addition to these sector trends, Career Education faced, in 2012, its own immediate priorities to address. You'll recall in prior earnings calls I discussed the need to first, resolve our accreditation, regulatory and legal issues; second, reinforce and reorganize the leadership of the company; and third, establish a well-defined strategic path. I'm encouraged by the progress of our management team and what we have accomplished against each of these foundational necessities. I'd like to highlight just a few pivotal achievements that occurred during the year. We achieved marked improvements in our placement policies and practices, which culminated in the removal of the ACICS show cause this midyear. Later last year, ACCSC also vacated their accreditation holds on our institutions. Our regulatory and compliance teams restarted our relationship with the Department of Education. You may recall that, among other things, we had a consolidation application pending throughout 2011. That issue was resolved to both parties' satisfaction in 2012, and we began to receive approval for new programs, something that had not happened for almost a year. During 2012, we resolved our outstanding issues with the Veterans Administration. Also, several of our institutions earned significant programmatic and regional accreditations and successfully completed program reviews with no findings, an important validation of the strength of our education institutions currently. One result for which we are particularly pleased is that the Higher Learning Commission acted to continue the accreditation of CTU, with the next reaffirmation scheduled for 2022, 2023. I would commend to your attention details on interim reporting requirements that are outlined in an earlier 8-K and in our press release. I believe you are all aware that this was completed during a time when accreditors have held organizations like ours to very high standards. All our OPEIDs passed the 90-10 Title IV eligibility requirement. And finally, Career Ed met or exceeded the Department of Education's financial responsibility ratio during the fiscal year ending 2012. I'm encouraged by these accomplishments of our management team. However, it came at a cost. Our financial performance continued to lag the industry, as it has for several years. We know more is required to stabilize the company and reestablish it for long-term sustainable success. I define success to include all our stakeholders; students; employees, including our faculty; and shareholders. We are continuously working to enhance our educational offerings so that they advance career paths, earnings and job opportunities for our graduates. Our company aims to provide its own employees with engaging work and career development while supporting our organization's broader educational mission. I strongly believe that doing well by our students and employees is critical and will ultimately translate into sustainable financial performance for our shareholders. Essential to our ability to achieve success is a well-defined strategy. As you know, in 2012, we adopted a progressive strategic plan, as well as a set of milestones to track our progress over the next 12 to 36 months. While I provided an overview of our strategies during the third quarter call, I'd like to give an update on the work begun late last year and share more specific details on activities that will continue through 2013. As you well know, Career Education's diversified group of institutions and global footprint is a result of numerous M&A transactions. While this staccato growth over a decade enabled the organization to quickly gain scale, it also resulted in ever-increasing levels of complexity over that same period. As I have described to you, we possess 25 OPEIDs across multiple institutions, innumerable accreditors and, up to now, largely independent operating processes, approaches and institutional variety. In order to be successful in the future, we must transform the organization, and that begins with simplifying operations. We began to tackle this difficult task during 2012 by consolidating our existing 6 strategic business units into 3, with 1 leader over each. For the next 18 months, we have also established a unit to ensure an orderly transition for the student at our teach-out institutions. It's our belief that this structure, for the long term, will standardize business models across institutions, increase efficiencies in student support and eliminate redundancies across the company. With an eye towards simplification, we also made the difficult but necessary decision in the fourth quarter to teach out 23 additional ground campuses. These institutions were identified after careful analysis of a number of factors, including program offerings, market-by-market placement outlook, operating performance, student outcomes and strategic fit. By concentrating our efforts on a smaller ground-based footprint, we were able to focus our intention on those assets most likely to succeed in the marketplace. At the same time we announced closures, we also announced the elimination of 900 positions. A smaller educational footprint requires a smaller, simpler support apparatus. Of course, our financial performance in 2012 is not sustainable. We know the company must continue to act swiftly to adapt to the radically different postsecondary education marketplace. The private sector postsecondary market grew rapidly for a sustained period of time. But for 2 years now, it has exhibited year-over-year population declines. Moreover, we've seen the new expected student inflection point, which we all thought would take place in 2012, pushed out once again into the future. The resulting trend reversal has left many organizations, ourselves included, saddled with cost structures designed to support a significantly larger student base. We recognize that, and as a result, have determined that we need to further reengineer Career Ed to accommodate the student population we now expect to serve over the next few years. As a result, we have recently engaged AlixPartners to assist our organization in a broad-based reengineering effort focused on

[Colleen M. O'Sullivan:]

Thanks, Steve. As I review our results for the fourth quarter and full year 2012, there are a number of items impacting year-over-year comparability. Let me first start out by reminding you that in the fourth quarter, we completed the teach-out of LCB Pittsburgh, which had been reported in our Culinary segment. The results of operations for LCB Pittsburgh, including $4 million of full year operating losses, are now reported in discontinued operations. Additionally, our segment level financial reporting has expanded to include a separate reporting unit entitled Transitional Schools. This reporting unit includes the results of our 28 campuses engaged in a gradual teach-out process. During this period, the campuses will continue to operate and serve their existing student base, but are no longer enrolling new students. I will provide more details on our 2013 Transitional Schools' expectations in a few minutes. Our fourth quarter results, as outlined in yesterday's press release, includes severance and asset impairment charges totaling $55 million. Those charges consist of 3 elements

[Steven H. Lesnik:]

Thank you, Colleen. Before we get to the Q&A, I would just like to say 2 quick things. First, I would like to congratulate the new secretary -- Defense Secretary, Chuck Hagel, who is a Brown College alumnus and former United States Senator. He graduated from Brown College, which is one of our institutions, with a degree in broadcasting in 1966. Perhaps, in terms at least of pop culture, more importantly, just last night on the Bravo Network, Kristen Kish, a 2006 graduate of Le Cordon Bleu in Chicago, won Season 10 Top Chef of the year. And she is actually the third graduate of Le Cordon Bleu to win Top Chef of the year. So congratulations to both Kristen and to Secretary Hagel. Needless to say, we are very proud of all of our alumni. And with that, I will open up the call to questions.

[Operator:]

[Operator Instructions] Our first question comes from Jerry Herman from Stifel.

[Jerry R. Herman:]

I just wanted to make sure I understood some of the directional discussion on 2013 and, in particular, the student population. I think, Colleen, you said it'd be down 2%. Is that an average number? And if you could just give some color in terms of what sort of start growth that would require in order to generate sort of that level of improvement in total versus now?

[Colleen M. O'Sullivan:]

Sure. Jerry, the reference to student population being down 2% is an end-of-year, year-over-year comparable comparison point. And at this point, I don't think we're in a position to provide a specific data point on start growth.

[Jerry R. Herman:]

Okay, very helpful in terms of the operating losses on the Transitional Schools. I imagine you could probably convert those operating losses to cash flow absorption as well. Can you help us with that?

[Colleen M. O'Sullivan:]

Sure. I mean, the $70 million to $80 million, obviously, we're not putting any additional capital expenditures into those institutions. We're in the process of ensuring that they are orderly finishing out the education of the existing student body. From a cash flow perspective, I think you could estimate maybe $5 million to $6 million of depreciation expense in that base as it pertains to 2013.

[Jerry R. Herman:]

Okay, great. And then when we think about 2013, understanding your substantial cost reduction efforts, reengineering, so an and so forth, how do you think about the incremental margin? How do you think about what $1 of revenue does to the operating income line at this point?

[Steven H. Lesnik:]

We think that it contributes to the operating income line substantially. It's highly leveraged, de-leveraging is you suffer, very steep, percentage-wise, a decline to operating income. And as revenue goes in the opposite direction, you have an equally steep contribution to operating income.

[Jerry R. Herman:]

Okay, great. And just one final question, if I might. With regard to starts in the University segment, they seem to be sequentially lower. And I'm just wondering if you can help quantify the effect of the new readiness program and if there's a way to disaggregate what sort of impact that had versus, let's call it, normal flow -- student flow.

[Steven H. Lesnik:]

Well, I don't think there's a way to disaggregate it from a quantitative standpoint. But embedded in your question is the answer. It's 2 factors. One is all of the general conditions that we've all discussed, all the companies that I've discussed and you're well aware of. And the other is the fact that we introduced a 21-day guarantee in the middle of the fourth quarter, which we think did have an effect on starts on the University side. But I would also point out that we have had 2 cohorts now, and we are seeing evidence that we are having a positive effect on retention.

[Operator:]

Our next question comes from Corey Greendale from First Analysis.

[Corey Greendale:]

I also wanted to ask about that suggestion that population would be down 2% at the end of the year. Does that include the teach-out segment? Or is that in the ongoing schools?

[Colleen M. O'Sullivan:]

That's excluding Transitional at this point.

[Corey Greendale:]

Okay, excluding Transitional. And then I think last quarter you had said that the target from -- in cost savings from the headcount reductions was $45 million to $55 million. Is that still a good number to use? And I'm wondering how much of that benefit was already in the Q4 results?

[Colleen M. O'Sullivan:]

So, Corey, we still feel comfortable with that range of benefit from the actions we took in the fourth quarter. But I would remind everyone that we announced both the closures and the reductions in force late in the fourth quarter. The individuals impacted were not out of the organization until the end of the year for the majority of the actions that we took. Some did actually stay with us into January. So there's very little impact in Q4.

[Corey Greendale:]

Okay. And Colleen, can you give us a sense how much of that dollar amount is in the Transitional segment?

[Colleen M. O'Sullivan:]

How much of the savings?

[Corey Greendale:]

Correct.

[Colleen M. O'Sullivan:]

I don't have that figure for you, Corey. You can follow up with Matt after the call on that.

[Corey Greendale:]

Okay. And then I just wanted to ask about AIU. Steven, in your presentation, you mentioned changes in their pricing structure. I imagine you're still thinking that through, but any color on that?

[Steven H. Lesnik:]

No. We are still thinking it through. We've got some research going on. We've got some consultants working with us. Obviously, we have to provide a definition to the offering and what kinds of cost structure is going to be needed to support -- new cost structures are going to be needed to support the offering, and then that will lead us to pricing. But we are working assiduously to get to that point as quickly as we can, as early as we can in 2013.

[Corey Greendale:]

And just one last one. Philosophically, I think you said in kind of looking at your overall cost structure, one of the things that you're considering is reducing support infrastructure for students. Just how are you thinking about that, kind of balancing that against the fact that you're also trying to improve quality and student engagement?

[Steven H. Lesnik:]

No. What I said was -- when I referred to reducing corporate support, it's corporate support to the institutions, not to student-facing services. It is back-office kinds of stuff. We don't anticipate having any reduction in student-facing services, unless they are enabled by technology or other efficiency -- operational efficiencies that we can identify. It's basically fewer schools, fewer students in the schools, requiring smaller functional units at the corporate level.

[Operator:]

Our next question comes from Trace Urdan from Wells Fargo Securities.

[Trace A. Urdan:]

I wanted to ask about the 21-day Readiness Opportunity. I think, if I caught that right, you described that as something that would apply to both AIU and CTU. Is that correct?

[Steven H. Lesnik:]

Correct.

[Trace A. Urdan:]

And do you have the expectation that it will have the effect of pushing back starts overall? Is there going to be sort of a cost associated with it as you roll it out?

[Steven H. Lesnik:]

What do you mean by pushing back?

[Trace A. Urdan:]

Well, if you are not formally enrolling the students for 21 days, then presumably, some percentage of the students coming in, instead of starting class and generating revenue, will be engaged in this readiness exercise.

[Colleen M. O'Sullivan:]

Corey, we are enrolling the students, and this is Colleen, to the institutions as normal. Think of it similar to the 21-day in that, I think as we shared when we put that program into place, we are not counting those students as starts. We will remove them from the start figure once they complete their readiness program. It will be a cancel in effect.

[Trace A. Urdan:]

I'm sorry, I didn't understand what you just said. You're going to enroll them and generate revenue but you're not going to count them in the start figures?

[Steven H. Lesnik:]

They will not -- they do not incur any indebtedness or any cost until they pass the 21-day milestone. There is no revenue, there is no cost, and there's no incurring any expense until they pass the 21 days. So they are subtracted out, if you will, from numbers, and there's no cost -- revenue implication at all.

[Trace A. Urdan:]

Okay. But that then that 21 days is counted as credit towards an actual course?

[Steven H. Lesnik:]

If they pass the 21 days, they are in the course, yes. Once they've passed the 21 days -- you've had the car for 21 days and drove it, and we do charge you for those 21 days, but only if you make the decision to remain in the course and complete the course.

[Trace A. Urdan:]

I see. So is there specialty -- is what they're studying during that 21 days just the normal course material? Or is there some special curriculum that's associated with that period?

[Steven H. Lesnik:]

It's the normal course. I would say this, the normal course with close monitoring by faculty.

[Trace A. Urdan:]

Okay. I wanted to ask another question about the financial responsibility ratio. Colleen, you mentioned that it was sound. I presume that's at December 31, 2012?

[Colleen M. O'Sullivan:]

Yes.

[Trace A. Urdan:]

Do you expect that, that ratio might be put under some pressure as you go through the process of the teach-outs and the cash outlays that are associated with that?

[Colleen M. O'Sullivan:]

The question related to 2013? Is that what you're...

[Trace A. Urdan:]

Yes, basically, or as you can look through 2013 and even 2014 in terms of what you're expecting to incur with respect to the teach-outs.

[Colleen M. O'Sullivan:]

Sure, Trace. As you can -- as you, I'm sure, are well aware, the calculation is at a point in time, as of December 31 in each respective year. And as we've laid out, as Steve laid out in his remarks and mine, we have a number of initiatives going on in 2013. So at this point, it's too early for us, and I don't think it would be prudent to forecast out what we believe the ratios will be in future years.

[Trace A. Urdan:]

Okay. And then the last question, you mentioned in your discussion of what you expected in 2013, that you thought that the start growth in the first quarter would be consistent with industry projections. I'm just curious as to what you believe that those projections are.

[Steven H. Lesnik:]

We kind of anticipated that question. There's lots of stuff published out there as to what various people are anticipating, and I'm not going to characterize that. It's out there in the literature. There's a range, obviously, of projections, and what we're suggesting is that we're well within the range of projections that a number of you have made.

[Colleen M. O'Sullivan:]

And Trace, I would just add to that, just for everyone to keep in mind, that, that excludes Traditional Schools [indiscernible] those students. We're not enrolling students there.

[Operator:]

Our next question comes from Peter Appert from Piper Jaffray.

[Peter P. Appert:]

Colleen, can you give us any sense of what the Transition School loss in 2014 might look like?

[Colleen M. O'Sullivan:]

At this point, I would not give that kind of guidance that far out.

[Peter P. Appert:]

Okay. How about -- I mean, the fundamental challenge, Steve, as you understand from an investor standpoint, is you've got a business that's in significant transition and it's very hard to get a beat on what the financial model is going to evolve into. So can you give us any help in that regard? Can you talk about sort of what you have in mind in terms to the targets you would like to achieve in the next few years in terms of maybe margin benchmarks, levels of enrollment growth you think the business can get back to, things along those lines?

[Steven H. Lesnik:]

I cannot.

[Peter P. Appert:]

Can you speak to when you think the business can be profitable again?

[Steven H. Lesnik:]

I can tell you that I have said repeatedly, since almost the first call that I did with you, that the margins in this company have been at the lower end of the spectrum of the publicly held companies in this sector, and that is unacceptable. And everything that we're doing, that I described and Colleen described, is designed to get our margins to be at least in the second quartile, if not the first quartile, of publicly traded -- those companies whose numbers we can see. And that is the ultimate goal of everything that you hear us talk about, to get into one of those 2 quartiles in terms of margin. So that's one. As far as timing is concerned, when are we going to get there? We've got, as I've indicated, a strategic plan, but I don't want to -- so our board probably could answer that question, but I don't want to get on to the slippery slope of -- particularly as a public company, in trying to give you specific guidance on what period of time we expect to get into the black. We do think that we are on an improvement slope that will get us there. I know you would like more specificity than that, but I -- unfortunately, I've got our General Counsel sitting here, and that's about as far as he'll let me go.

[Peter P. Appert:]

Well, you could send him out of the room, of course. And then -- just last thing. Obviously, you've done a ton of research to identify the schools that you wanted to teach out. Is there any continuing -- I assume there's continuing analysis looking at all the campuses. But should we assume that the teach-out process or the -- there's not going to be additional schools in the teach-out process?

[Steven H. Lesnik:]

I want to be careful about leaving that last phrase, the implication of the last phrase. Look, we are continuing to monitor all of the remaining schools on a very close basis against the criteria that I mentioned generally in my remarks today, and which we've discussed previously and which we touched on when we announced the teach-out. All of the schools are continuing on high monitoring, and we will reevaluate these schools on a periodic basis during the year. As we sit here today, the schools that we have chosen to teach out are it. As we move forward, time will tell.

[Operator:]

[Operator Instructions] We have no further questions at this time. Do you have any closing remarks?

[Steven H. Lesnik:]

I do. I want to thank everybody that is on the call this morning for following the company. I'm sure all of you who are on the call know that this is an interesting company, to say the least. And I also would like to again acknowledge the tremendous work of our employees during a very compelling year in 2012. My hats go off to all of you. Thanks, everybody, for being on the call. Again, if you have any further questions that you think of after the call, Matt Tschanz is available to talk to you. And with that, thanks a lot, and we'll see you down the road.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.