Strategic Education, Inc.
Q2 2009 Earnings Call Transcript

Published: 30 Jul 2009

[Operator:]

Welcome to the Strayer Education Inc. Second Quarter earnings results conference call. (Operator Instructions). I would now like to turn the call over to Sonya Udler, Senior Vice President, Corporate Communications

[Sonya Udler:]

Good morning, with us today to discuss the results are Robert Silberman, Chairman and Chief Executive Officer for Strayer Education, and Mark Brown, Executive Vice President and Chief Financial Officer. For those of you that wish to listen to the conference via the Internet, please go to strayereducation.com, where the call will be archived for 90 days. If you are unable to listen to the call in real time, a replay will be available beginning today at 1

[Rob Silberman:]

Thank you, Sonya. And good morning, ladies and gentlemen. I hope you all enjoyed that musical interlude as much as Mark and I did. As is our custom, I'd like to begin this morning with a brief overview of both our company and our business model for any listeners who are new to Strayer. I'll then ask Mark to report on the detailed financial results for the second quarter, after which I'll comment on our enrollment results for the summer academic term, provide an update on our growth strategies, and finally end up with the company's earnings outlook for Q3 2009. Strayer Education, Inc. is an education service company whose primary asset is Strayer University, a 46,000 student, 67 campus post-secondary education institution, which offers undergraduate and graduate degrees in business administration, accounting, computer science, public administration and education. Strayer students are working adults who are returning to school to further their careers. Our revenue comes from tuition payments and associated fees. Approximately 70% of our revenue comes to us from federally insured Title 4 loans issued to our students. Our expenses at Strayer Education include the cost of our professors, our admissions and administrative staff, marketing expenses, and facilities and supplies costs. We serve students in 16 states through physical campuses, as well as in all 50 states and over 30 foreign countries through our online courses. Strayer University is accredited by the Middle States Association of Colleges and Schools. Mark, do you want to run through the financials?

[Mark Brown:]

Sure. Revenues for the three months ended June 30, 2009 increased 29% to $125.9 million, compared to $97.9 million for the same period in 2008, due to increased enrollment and a 5% tuition increase which commenced in January of this year. Income from operations was $45.1 million, compared to $33.6 million for the same period in '08, an increase of 34%. Operating income margin was 35.8%, compared to 34.3% for the same period in '08. Net income was $27.5 million, compared to $21.3 million for the same period in '08, an increase of 29%. Diluted earnings per share was $2.00, compared to $1.50 for the same period in '08, an increase of 33%. Diluted weighted average shares outstanding decreased to $13,771,000 from $14,248,000 for the same period in '08. Revenues for the six months ended June 30, 2009 increased 28% to $250.4 million, compared to $195 million for the same period in '08, due to increased enrollment and a 5% tuition increase which commenced in January of this year. Income from operations was $92.7 million, compared to $69.2 million for the same period in 2008, an increase of 34%. Operating income margin was 37%, compared to 35.5% for the same period in '08. Net income was $56.6 million, compared to $44.8 million for the same period in '08, an increase of 26%.Diluted earnings per share was $4.07, compared to $3.14 for the same period in '08, an increase of 30%.Diluted weighted average shares outstanding decreased to $13,886,000 from $14,294,000 for the same period in '08. At June 30, 2009, the company had cash, cash equivalents and marketable securities of $90.4 million and no debt. The company generated $72 million from operating activities in the first six months of '09, compared to $43.5 million during the same period in '08. Capital expenditures were $13 million for the six months ended June 30, 2009, compared to $10 million for the same period in '08. During the three months ended June 30, 2009, the company invested $5.1 million to repurchase 27,800 shares of stock at an average price of $181.95, as part of a previously announced stock repurchase authorization. The company's remaining authorization for stock repurchases was $5 million at June 30, 2009, having invested approximately $65.1 million during the six months ended June 30, 2009 for this purpose. During the six months ended June 30, 2009, the company paid regular quarterly dividends of $14.1 million. For the second quarter 2009, that debt expense as a percentage of revenues was 4.2%, compared to 2.8% for the same period in '08. Days sales outstanding adjusted to exclude tuition receivable related to future quarters was 15 days at the end of the second quarter '09, compared to 12 days at the end of the second quarter of '08. Rob?

[Rob Silberman:]

Thanks, Mark. Just a couple of amplifying comments on the financials from my perspective, for the second quarter we earned $0.04 more than the midpoint of the forecast that we gave you 90 days ago. That positive variance was caused by approximately $0.06 of higher-than-expected revenue offset by roughly $0.02 of higher bad debt expense. And just to go through that in a little more detail, on the revenue side we continue to experience increasing revenue per student growth mostly caused by lower student withdrawals during the quarter. Our Q2 revenue growth of 29% was a full 700 basis points higher than our 22% enrollment growth for the spring term, and that's with only a 5% tuition price increase. Now after Q1's revenue outperformance, Mark and I had ratcheted up our Q2 revenue forecast to try and take into account this trend. But even after that we were only expecting around 27% revenue growth. The extra 2% revenue growth was worth about $0.06 of earnings per share. On the expenses, everything was right about on target with the exception of bad debt, which came in around 40 basis points higher than our internal forecasts. Our 2009 spring term tuition collections actually improved versus last year. But as I mentioned on our last earnings call, during this economic downturn, we're experiencing lower collection rates on tuition receivables related to prior quarters. To put this in simpler terms, a higher percentage of our currently enrolled students are paying their tuition bills, but it's getting harder to collect the tuition which is owed to us from those students who have previously dropped out of the university. So we're adjusting our reserve calculations accordingly. The additional 40 basis points of bad debt expense above what we had forecast shaved about $0.02 from that Q2 EPS forecast, so that's net the positive $0.04 plus six minus two. Moving to cash, our owner's distributable cash flow increased really well over 100% for the quarter and roughly 75% year-to-date. This compares to an increase in net income of 30% for the quarter and 27% year-to-date. Even after funding our major campus and online expansion in the first half of 2009, we generated $59 million of owners' distributable cash flow in the first six months of the year, which exceeds our $57 million of reported net income for the same period. So we continue to be a fairly healthy generator of cash, which is the metric that Mark and I probably pay the most attention to anyway on the financial side. Turning to the summer term enrollment results, total university enrollment increased 24% on a year-over-year basis. New students increased 28%. And continuing student enrollment increased a little over 23%. Student retention was up almost 100 basis points on our continuing students in the quarter. With regard to student mix, business administration, accounting, and economics degree seekers continue to make up about 70% of our student body for our summer academic term. Computer science degree candidates are below 20% of the total student population mix. The graduate population is just under 30% of the student mix for the summer term, so fairly stable across all of those. These would be last quarter and last year. We did successfully start instruction in our new criminal justice Bachelor's degree at several campuses during the spring term, the one we just completed, and we're expanding that program for the summer term. Turning to an update on the growth strategy, many of you will remember that our strategy is based on five objectives. The first is to maintain enrollment in the company's mature markets. Second, accelerate the rate of growth of new campuses, particularly into new states. Third, invest in and build up our online offerings. Fourth, increase our corporate and institutional alliances. And the final objective is to effectively redeploy our owners' capital. On our first objective for the summer term, we were fairly well ahead of target at our mature campuses. We showed 12% growth which I believe, Mark, is the highest that we've had in the eight years. And just [baying] the question which I know one of you is going to ask, if you just strip out the campuses that are actually over 10 years old, so they are the most mature, the rate of growth at those campuses was actually 7%. So all across the age groups of these campuses, we saw pretty healthy growth in the student population for the summer term. With regard to new campus activity for the summer term, we opened one campus each in two new markets for us, Cincinnati and Columbus, Ohio. We also announced this morning our intention to complete our planned 2009 campus opening schedule with four campuses for the fall term. They'll actually open during Q3 to enroll students for the fall academic term. These include a second campus in the Cincinnati market. One each, a new campus each in the Cleveland and Akron, Ohio markets, and a new campus in Miami, Florida, which will be our first in that market. Actually Cleveland, Akron, and Miami will all be new markets for us in the fall term. In the global online unit, our growth rate for the spring term was 43%. We were helped by a pretty healthy start at our second global online operations center out in Salt Lake City, Utah. On institutional alliances, during the quarter, we added articulation agreements with three community college systems in Ohio and one in upstate New York. As I've mentioned in the past, we consider community colleges important partners in our educational mission, we really don't view them as competitors, and so we're delighted by President Obama's intention to increase funding and support for the community college systems in this country. We think that's a net benefit for everybody. We also added, during the quarter, one additional corporate partner, that's Gulfstream Aerospace Corporation. Our total student enrollment from corporate alliance partners increased by 29% for the summer term. On capital re-deployment, we announced this morning our regular quarterly dividend of $0.50 per share and, as Mark mentioned, that we had taken advantage of market conditions to repurchase roughly $5 million of our common stock during the second quarter of 2009. On our business outlook for the third quarter, the higher revenue associated with the university's 22% enrollment growth for the summer term will clearly more than offset the increased expenses from the openings of our new campuses and our second online center. So we do expect 125 to 150 basis points of operating margin expansion in the quarter, which should drive third quarter EPS to the $1.14 to $1.16 range. And with that, Dana, we'd be pleased to answer any questions.

[Operator:]

(Operator Instructions). Our first question comes from Suzanne Stein – Morgan Stanley.

[Christina Colone:]

My question relates to bad debt expense and you'd mentioned before that it comes out relating to decisions that are made at the campus level whether to enroll students that aren't fully packaged yet and you were previously comfortable with that structure, but given that you just came in a little bit above target in terms of that expense, I'm wondering if you're considering any changes internally to how those decisions are made?

[Rob Silberman:]

Yes. Actually, before I answer that, Christina, I just wanted to clarify one thing. Mark pointed out to me that I said there was 22% enrollment growth for the summer term; it was actually 24%, which would have caused revenue growth to be even farther above enrollment growth. On the bad debt expense, no, we're actually not considering, at this point, operational changes. I mean we always try and be as careful as we can in terms of the decisions that are made at the campus level to enroll students. But as I mentioned, the nature of this increase in bad debt expense really has less to do with the students that we're enrolling. In other words, the percent of our students who are paying their tuition in this quarter was actually better than it was in the previous year. The problem has been collecting tuition from students who have dropped out, which is getting increasingly difficult over the last 9 to 12 months. And again, since the financial impact of the bad debt expense really isn't as significant or as important to us – I mean you could run this business with a much higher level of bad debt expense and have higher revenue and net income growth. It's been more of concern to us as a proxy for good decision making at the campus and as long as the percentage of our students who are enrolled, who do pay their full tuition, is not increasing, then I'm less concerned about the academic and operational impacts of this.

[Operator:]

Our next question comes from Andrew Steinerman – JP Morgan.

[Andrew Steinerman:]

Could you talk about, just in general, investments in the second half of the year versus investments in the first half of the year?

[Rob Silberman:]

Well, most of our campus and the extension of the online center would have been, I think, Mark, done in the first half of the year. I guess the other four campuses will be in the third quarter, right.

[Mark Brown:]

Third quarter.

[Rob Silberman:]

And then we have maintenance activities at existing campuses. I don't know, do you have a sense as to the CapEx flow during the year; are we sort of half way through it?

[Mark Brown:]

I think we'll probably see a pick up towards the end of the year just in terms of timing.

[Rob Silberman:]

And also, it will depend on what our campus plan is for 2010 because the ones that we opened for the winter term of 2010, Andrew, will be funding in the fourth quarter of 2009.

[Andrew Steinerman:]

And could you just review the total investment in your second online campus, was as expected, lower than expected, how did it look relative to budget on the spend side?

[Rob Silberman:]

Well, on the capital side, it was probably a little bit lower than expected. I mean we got pretty good pricing on construction materials, things of that nature. On the impact on operating income, it will certainly be at least as what we had modeled, if not a little better just because we had a pretty strong start there. I know that our operating staff would like to increase the headcount at that facility maybe even a little bit faster because of the success and so we might balance that out a little bit. A lot of it will depend on our confidence in the ability of the people that we can hire. But I would say it's probably going to be pretty close to, if not slightly better than what Mark and I had laid out which would be roughly a $5 million drag on operating income through the year.

[Operator:]

Our next question comes from Kevin Doherty – Bank of America Merrill Lynch.

[Kevin Doherty:]

Just a follow-up on the earlier questions on bad debt expense, how long might we expect some of that elevated bad debt to persist until some of those older receivables are charged off? I guess, or are these the type of year-over-year increases we can expect, at least over the next few quarters?

[Rob Silberman:]

I'm not so sure about the year-over-year increase as it more the absolute amount. I would expect, over the next couple of quarters that the absolute amount would be in this range. It will have less of a year-over-year increase in the latter half of the year, because I think our bad debt was elevated in the second half of '08 versus the first half of '08. And it also is not just the issue of charging off already delinquent tuition receivables, it's going forward in the future. If we keep our same operational standards with regard to enrolling students, will the impact of the economy cause, in the future, a lower collection of previously written off or unpaid tuition receivables for dropped out students as we go forward, and that we don't have a whole lot of visibility into. But, again, it's not, that's a financial metric we can manage, it's not the core metric which is important to us, which is bad debt as a potential proxy for bad decision making, frankly just trying a little too hard to put students in a seat.

[Kevin Doherty:]

And then you showed some good leverage this quarter and some on promotional; could you talk a little more about what drove that? I know there's just some timing around the new campuses. We were expecting probably a little more of an incremental bump up from the online center.

[Rob Silberman:]

Well, I mean it's what it always is. We end up spending approximately what we expect to spend with regard to brand building and advertising. I don't think we under spent what our forecast was, but we ended up with more revenue and, so additional revenue on the same amount of expense causes more leverage.

[Kevin Doherty:]

And then as we think about next quarter, when you bring those new four campuses online, could we expect any leverage in that line item year-over-year?

[Rob Silberman:]

Well, the more new markets that we bring on, the more advertising expense that we have with relatively little revenue associated with it. I don't know what it will do for the company as a whole. The start of those four campuses has a negative impact. That may be overwhelmed by positive impacts elsewhere in the system. I don't really have a good feel for that right now.

[Kevin Doherty:]

In the release you mentioned talking about your plans for campus expansion next quarter, but could you just give any indication on maybe the mix of going into new geographies versus existing markets?

[Rob Silberman:]

Well, as I mentioned, for the last half of this year, it's all new markets. The two that we did for the summer term in Cincinnati and Columbus was a brand new market – actually, I take that back, we have one additional Cincinnati campus out of the remaining four. The other three will be in brand new markets, Akron, Cleveland and Miami, FL, and we really haven't made decisions about 2010 yet. We'll let you know that on the October release.

[Operator:]

Our next question comes from Ariel Sokol – Wedbush Morgan Securities.

[Ariel Sokol:]

Hi, just a quick question with respect to the post 9/11 GI Bill that goes live next week, are you in to seceding material benefit from this new, kind of, veterans program? And just out of curiosity what percent of your students either come from the military or military veterans?

[Rob Silberman:]

Well let me take that in reverse order Ariel. The actual active duty military is probably about 3%, maybe a little bit less right now. I'm not 100% sure on veterans; I suspect it's clearly more than 3%. It's additive, we have a lot of students who I think have served in the military. I mean it's kind of a core demographic for us; it's a working adult that's interested in self-improvement and in education. I do think the GI Bill will be helpful to us. I mean we're happy to have support, financial support, in serving a demographic that we think is very important to our University.

[Operator:]

Our next question is from Trace Urdan – Signal Hill Group.

[Trace Urdan:]

Hey Rob, just to finish up on that point, are you guys devoting special marketing resources against the GI Bill in the upcoming quarter?

[Rob Silberman:]

No, I don't believe we are Trace. I mean we don't – we have a small part of our marketing budget that goes to specific military media but I don't anticipate that that's – it's so small anyway relative to our overall mix that it's not really material and I don't think it's gone up very much.

[Traci Urdan:]

Okay. And then, the next thing I wanted to ask about and I apologize because I think I always gravitate back to this area. But in thinking about the global online center, you guys talk about it like it's sort of a mega-campus but in reality it's really a very deep pool of opportunity that you could presumably devote more resources to, if you chose to, and grow maybe at an even faster rate than the rate you're growing. So I wonder if you can just sort of address how you'd, thinking about the global online business strategically, you made some reference here to the fact that maybe enrollment counselors and adding enrollment counselors was a constraining factor. Is that the right way to think about that? Or how do you think about how fast to grow global online?

[Rob Silberman:]

Well it's not really different from how we think about expanding the University as a whole, Trace. The issue in any, I believe, in any sort of human services business is the individual provision of that service. In our case, a relationship between a professor and a student, a teaching relationship, is made more difficult to keep at a high level quality the faster the rate of expansion. It's just the nature of managing a business like this. So we try and control the rate of growth, whether it's in terms of campus expansions or the global online, to a rate at which we're comfortable with that we can maintain that level of quality. We have the same opportunity frankly in terms of expanding our campus network faster, that you described, in terms of expanding the global online. In both cases what we're doing is trying to manage the process around a high level of confidence with regard to our expansion of human capital, our hiring and training and mentoring of both administrative staff and faculty so as to be able to serve a larger and larger population base. And we really don't think of the online any differently from the campuses with regard to that constraint. The online provides certain complications so we believe it's a little harder to serve that purely online student well. We're quite confident we can do it but it takes a little more effort. But in terms of our focus on what the right rate of growth is, we don't see the two academic methods as being different.

[Operator:]

And we'll go next to Kelly Flynn – Credit Suisse.

[Kelly Flynn:]

Thanks. Back to the bad debt issue I just want to understand a little more clearly. When you talk about the drop-outs, am I correct to assume there's really no bad debt associated normally with graduates, it's mostly someone drops out and there's kind of a timing issue with Title Four? Is that the right way to think about it and therefore asking you about debt, bad debt experience for graduates isn't relevant? Is that --

[Rob Silberman:]

Correct. A student will not – we won't graduate a student that hasn't paid their tuition bill. So that is correct Kelly.

[Kelly Flynn:]

Okay. And then as you think about the ramifications of this bad debt issue, can we extrapolate at all that you're default rates when we think about the graduates? I mean is there – I know they're likely to go up overall because of the weak economy but can you tell us anything new there? Are you incrementally more concerned that the default rate may go up more than you previously expected? Or how do you think about that?

[Rob Silberman:]

Well the – it will have an impact on current default rates but you can't have a cohort default which is associated with the graduate students. So there's two different issues there. A student who graduates and has – we've been paid in entirety through the Title Four program, they then – they have to repay the loan in order to not fall into a Cohort Default. The fact that they've graduated is certainly helpful, I would believe, in terms of their ability to pay the loan but it's not dis-positive. In the same way that bad debt expense with regard to our own balance sheet is purely associated with students who haven't graduated. I mean, the other way to say this Kelly is we don't lend to our students, we're not in the student lending business, so it is purely a timing issue with regard to, as you put it, packaging of Title Four loans. Although in some cases, these are students who are not Title Four payers, they're self-payers and we've entered into some sort of promissory note over a 30-90 day period to get them enrolled. Which is why we tend to think about it as a proxy for, if the number of those students that were enrolling for whom payment in full is not received at the end of the first term, is rising at a significant rate, than we're concerned about that cultural implication. On the Cohort Default rate, it'll clearly be effected by a downturn in the economy. My focus on that, and we've talked about this with our Board of Trustees and our Board of Directors, is really more along the lines of, how are we doing as University relative to other Universities? We are – have been among the lowest Cohort Default rates of any Universities in the country and I would expect to stay in that ratio even if overall Cohort Default rates are going up. I don't think that an increase in Cohort Default rate associated with a downturn in the economy really changes the value proposition to the students. Even in a shrinking economy or a downturn in the economy it's pretty empirically clear that you're better off with a college degree than without one. And so all in, it's really just a question of managing this relative to your position beats the other universities. And to make sure that your students are graduating with the learning outcome and the academic achievement necessary to advance their own careers and be in a position to pay back loans.

[Kelly Flynn:]

Okay, great. And then finally with respect to state grants, are you seeing any move there? I've heard from some other players that some states, including Ohio, fold back on that. Is that a needle mover for you?

[Rob Silberman:]

I don't think we have a lot of revenue that comes in state grants. Mark, do you know?

[Mark Brown:]

Most of it would be in, for example, the state of Pennsylvania. And we're so new in Ohio that I don't think any negative impacts from that have…

[Rob Silberman:]

And is Pennsylvania [inaudible] down?

[Mark Brown:]

No.

[Rob Silberman:]

No. I think the answer's no Kelly.

[Operator:]

And we'll go next to Gary Bisbee – Barclays Capital.

[Gary Bisbee:]

I guess just following up on Trace's question on the online center, you made a comment like that is driving growth and maybe this is just semantics but I understand that it essentially allows you to handle more leads. So if you've stepped up marketing out your – the markets re-up campuses and is that what's happening there or is it just something about the environment today that you're getting better response rates to the marketing that you've got out in the market and so that new facility is handling an overflow of leads that maybe you weren't handling in the past?

[Rob Silberman:]

I think it's – actually a better way to think about it is because we set our brand building budget around supporting, for the most part, our brand building specific to geographic areas associated with our campuses. And when you're on the Internet you're going to get a lot of interest from places where you don't have campuses anyway. I think a better way to think about is, we probably last year and the year before had inquiries that came from areas where we didn't have campuses that we weren't serving and so we needed to increase that administrative staff as I mentioned I think, you know, in a couple of quarters ago when we talked about this we could have easily just added those personnel at our Washington D.C. location. But we decided for the purpose of diversifying and redundancy and also some time zone management because more and more of these inquiries were coming from the West Coast of the U.S. to build a separate center which involved its own costs, but gave us a little more redundancy, gave us access to a different hiring market and gave us a location where, you know, we could be talking to people in the union when they wanted to be talked to and it wasn't, you know, midnight here on the East Coast time.

[Gary Bisbee:]

Yes – no that all makes sense but I, so I guess then the question is are increasing the amount of marketing that you're doing either on the web or in markets who don't have campuses to take advantage of that or was that just sort of the natural outgrowth of demand overall growing for the business?

[Rob Silberman:]

It's mainly the natural outgrowth, Gary. I mean we're increasing our marketing budget but we would have done that anyway to support the additional locations that we operate in. And we get a lot of – we do a lot of advertising on the Internet to support the markets that we open that we operate campuses in as well. So it is more the latter.

[Gary Bisbee:]

Okay and then can you give us – a couple of years ago you launched a couple of new sort of specialized graduate programs. Can you just give us an update since you launched those? How large a percentage of enrollment have they become and some sense of what the growth path there looks like?

[Rob Silberman:]

They grew to – they're 5%, I think 5%, 10%.

[Mark Brown:]

Yes, yes.

[Rob Silberman:]

They're fairly large now. The Education Master's, the Public Administration Master's has done quite well. Our Health Service Administration in isolated areas has done better than others but I would say in total those three are at least 5% of our student population if not more. And that growth rate is over about a four-year period so I mean I don't have it mathematically in front of me. It's obviously quite high when you start because it's going from a base of zero but we're pretty excited about Criminal Justice. It's had as strong a start in its first quarter as those graduate programs had in there's as well so we think we can do a good job with that.

[Gary Bisbee:]

Is there any, obviously that is what I was trying to get at, is there any sense that undergraduate program relative to graduate would react differently or given how you're thinking about rolling this out across your campus network would that be a reasonable couple of year target for this program too?

[Rob Silberman:]

Yes. I don't have a reason to think it would react differently or the same. We just don't have the data on that. I mean the one thing about Bachelor programs is students tend to take more classes at the Bachelor level than they do at the graduate level so we may end up with higher seat count per student associated with those then we did the graduate programs. But the rate of growth I don't – we're really not in the business of trying to project that. I mean it's – we think that like our business in economics and computer science and accounting that we've got the right faculty if we're doing a good job on the curricula, you know, if we're teaching well. There's a high demand for education and it's probably going to do pretty well.

[Operator:]

And we'll go next to Jeff Silber – BMO Capital Markets.

[Jeff Silber:]

Thanks so much. In your prepared remarks you talked about your persistence going up I think it was 100 basis points year-over-year. That's a pretty strong increase. If we can get a little bit more color on what drove that and what you expect going forward? Thanks.

[Rob Silberman:]

Well our retention rate is very high. I mean our continuation rate, the rate at which students who neither academically fail or have graduated enroll for the next quarter is, you know, it's about as high as I think it's going to get with a working adult population. But you do have things happen to adults and we actually had a relatively high academic failure rate this quarter as well. One of the higher ones that we'd had. So at the plus 80%, you know, we don't expect it to get a whole lot higher than that Jeff. As a matter of fact the, you know, the last couple of quarters it sort of stabilized out. This was a big jump. Partly that's seasonal. I think we continue to make progress in getting adults to go to school in the summer and so we can get a little bit of uptick on that. But on an annual basis, you know, we would like to maintain these continuation rates at their high level and hopefully have that translate into higher and higher graduation rates. And then ultimately if the university is running the way it's supposed to we'll get a rate of incoming students as new students and then with a stable continuation rate that increase in student population will just run through over the two to three-year average life of a student here at Strayer and result in that percentage increase in graduation rates as well.

[Jeff Silber:]

All right thanks. You just mentioned the higher failure rate this past quarter. Did you see that across the landscape? Did you see more at your new campuses as opposed to your mature campuses? Any insight would be great.

[Rob Silberman:]

I really don't. Do you know Mark?

[Mark Brown:]

No.

[Rob Silberman:]

I honestly saw it as an aggregated number. I'll have to dive into that Jeff and we can get back to you.

[Jeff Silber:]

All right just curious on that. And then just one more follow-up, in terms if you look over the past year or so in terms of the new campuses that you've been opening up have you seen any major difference between your first time campuses at a new location or your add on at existing locations in some of the acceptance in the market place?

[Rob Silberman:]

It's always easier with an add on. I mean you're just, you know, you've got some brand identity which is very important I think in a academic setting. So I don't know of a circumstance where it hasn't been slightly easier with the second and third or fourth campus in a market then the first one.

[Jeff Silber:]

But in terms of the reception of new locations any insights or any issues?

[Rob Silberman:]

Well, you know, it's been fairly strong so far. I mean we have single campus markets that obviously was brand new when we opened that campus there and they've grown as fast a rate as any of our third or fourth campuses in a existing market. But I mean in answering your first question empirically or logically it's a little easier in brand building with a second or third campus in a market then it is in the first one.

[Operator:]

Our next question comes from Amy Junker – Robert W. Baird & Co.

[Amy Junker:]

Rob, can you just give us an update on how you think enrollment and retention has been impacted by your decision to require underprepared students to take, I guess, their time in kind of developmental courses. I suspect it's helping retention but I'm wondering if it's having any negative effect on enrollment. Obviously the growth is very good but wondering if it could have potentially been better?

[Rob Silberman:]

Amy I really don't know how to answer that. I mean logically you would say that there are some students that if you require them to take a high school level course that they may go someplace else. But on the other hand, as you correctly point out, I mean our rate of new student growth over the last 18 months has been well above our expectations and higher than it's ever been in the past. So I, if it's a negative impact we're happy to suffer it because it's clearly, it's – I can't tie it directly to the increase in retention, although logically it has an impact but it's clearly helping the academic atmosphere, the quality of the classroom experience. I hear that from my faculty all the time. It's the single thing that we've done that has been most well received and supported by our faculty. And ultimately that's a consistency that we have to be quite concerned about.

[Amy Junker:]

And Mark just a follow up on CapEx spending. I know you said it was going to ramp up in the back half of the year. I think previously you'd said 8% of revenues but given revenues are coming in higher than expected is that still a good number or would you expect it to be maybe closer to 7% or something more?

[Mark Brown:]

Yes, yes. I think what we had said is somewhere between 7 and 8%. I would guess it would be at the lower end of that range.

[Operator:]

And we'll go next to [Bob Whittenhom] – World Bank of Canada.

[[Bob Whittenhom]:]

In the 125 to 150 basis points in operating margin expansion is that generally going to be evenly split between in a decline in instructional and educational support in some of them promotion.

[Mark Brown:]

It was this quarter but I'm not sure we'd expect that on a go forward basis. We'd actually have to get some leverage on G&A on a go forward basis. We didn't this quarter because of bad debt expense.

[Rob Silberman:]

Well on reason it's a little difficult to answer, Bob, is if it Mark might actually look at a much more detailed chart of accounts and I don't really see it in the format that you see it until we look at the close, you know, and put the press release together. We don't really think about those three categories as important determiners. And so it for us those dollars can shift between the categories that you see based on decisions that we're making that we probably wouldn't see until the end of the quarter to be honest.

[[Bob Whittenhom]:]

Understood. Is your bad debt expense running through G&A or –

[Rob Silberman:]

Yes.

[Mark Brown:]

Yes, yes. That you clearly can count on. I mean, it's generally logical. I mean G&A is those overhead expenses and we run bad debts through that. It's Mark's and my and the headquarter's costs and then some overhead costs at the campuses. And instructional and educational is the cost of the professors, and the curriculum development and the lease cost of buildings. And marketing and admissions is that side, so.

[[Bob Whittenhom]:]

On your bad debt expense are you reserving about 20% because just on Robert's earlier comments about bridging students from a funding standpoint; i.e., you're not in the business of student lending but you will provide funds if the student needs to go in for a quarter and comes up short of tuition? Is the reserve you're setting aside for collectability around 20%?

[Rob Silberman:]

Well let me clarify that question because we aren't funding students for a quarter. What we allow students to do is, because we only have four starts per year, is if the campus dean has established that this is going to be a good student, serious student, and the campus director has not, through their staff, been able to finalize the payment mechanism, we will allow the student to enroll. But we expect the student to finalize that payment mechanism whether it's paying themselves, a corporate alliance partner or a Title IV loan immediately. The point that I was making is that at the end of the quarter if for some reason that hasn't happened, they won't be allowed to enroll for the next quarter. So we never have this receivable going past that point. The amount that we reserve, it's seasonal, it depends, because it's based on what we perceive our collection rates are going to be. It was over 20% for this last quarter.

[[Bob Whittenhom]:]

I'm just referencing the fact that DSOs went up to 15 days on that basis because I understand you have to strip out your expected payments from corporate alliance partners. But it is above 20%, is that close?

[Rob Silberman:]

Yes, it generally runs between 20% and 25%. It's been as low as the high teens in the past. We cranked it up in this last quarter, it's over 20%.

[[Bob Whittenhom]:]

And one final question any expectation of increasing the authorization for incremental share repurchases during the back half of the year?

[Rob Silberman:]

Well we always do that as part of our budget process with our board of directors in October. So I would expect to see an increase would take place in October.

[[Bob Whittenhom]:]

You're likely to reset the basket to $50 million, $100 million, any guess?

[Rob Silberman:]

We're likely to reset to whatever amount the board of directors and I feel is truly extra to our needs over the next year. And that gives Mark and I an ability to either use it when the market gives us the opportunity or if the market didn't because the stock price was trending toward our view of intrinsic value we'd figure out other ways to return it to owners.

[Operator:]

Our next question comes from Todd Young – Morningstar.

[Todd Young:]

I wanted to ask about your comment, you mentioned that the campuses that are over 10 years have seen 7% growth. I was wondering how you think about those that typically cap out around the 1,000 mark. Are you increasing the size, is there any extra expenditures or costs to expand those facilities? And on that note is there may be a potential growth opportunities in areas that you thought you were capped out in the past?

[Rob Silberman:]

Several of our campuses are well above 1,000 students. I mean that's more than average particularly in denser population areas. We have campuses that are quite a bit above that. The interesting thing for us in this quarter is that we had higher than normal rates of growth at a number of those campuses that are over 10 years that have generally been flat in the past. And most of the growth of the mature campus group has come from the younger, sort of year four to eight. I think that we're delighted by that. It doesn't really require a whole lot of additional expenditure. It's pretty easy to get more classroom space if we need it. Many of these students are actually taking classes online so you might not need physical space. And [President Sollard] and our academic deans keep a fairly ready supply of faculty that can be called up and asked to teach a course if they weren't scheduled to teach, particularly for a summer term. So it's certainly manageable. It terms of growth opportunity it hasn't been core to how we think about expanding the university. We have sensed that there's a stable equilibrium. When you get to a certain size you're enrolling a lot of new students but you're graduating a lot of students and that tends to balance out. Obviously over the last couple of years maybe partially impacted by some of these new programs we've put in place, we're doing a little bit better than that. But long-term our strategy is to focus on building out the university geographically, getting to a nationwide footprint, continuing to invest in the online and we'd be delighted to have these campuses get to that mature level and just stay healthy, stable educators of adults in those markets. Anything above that is frankly gravy.

[Todd Young:]

And one last quick one, with the new corporate partnership that you added how does that number compare to the past quarters in the number of new corporate partnerships that you've added?

[Ron Silberman:]

It's kind of sporadic I mean sometimes we'll have none for several quarters. Sometimes we'll have two or three in a quarter. There's no real pace to that. Those go at their own kind of organic development and as we get bigger and more well-known I will have to say it's a little bit easier. But there's no real pattern quarter-to-quarter.

[Operator:]

Your next question comes from Brandon Dobell – William Blair & Co.

[Brandon Dobell:]

Going back to the mature campus line of questioning, if you look at that group of schools let's say the ones that are four to eight and the ones that are over 10, what is the breadth of performance look like. You referenced 7% is that an average of two in 20 or an average of more like five in eight? I'm just trying to get a sense how broad it is.

[Ron Silberman:]

It's more the latter, Brandon, because they're already pretty big. I mean we're not going to get 20% enrollment growth in a campus that has 1,600 students. I mean it just, we wouldn't allow that because we wouldn't, it's not the kind of thing you could do and have a high level of confidence in your ability to execute.

[Brandon Dobell:]

Even with the potential for enrolling online students? I guess I'm trying to get that dynamic between true capacity growth versus just adding on additional faculty. How much, let's call it extra online growth stress on mature campus versus extra ground growth?

[Ron Silberman:]

Well a student who is enrolling is going to take all their classes their entire career online there is clearly less stress on the academic side of the campus. But you still have, even for those students who are enrolled on campus who take all their classes online still have faculty advising, tutoring as necessary, academic advising functions that are physically available at the campus. So we have to scale those as well.

[Brandon Dobell:]

Let's say you're faced with a quarter or two where there's just a lot of extra people showed up unexpectedly and you felt that you were really starting to stress the organization. How do you manage that, I wouldn't call it turning away students, but there's a structural level at which you probably are uncomfortable with the number of students. How do you manage that with the students that really want to start school?

[Ron Silberman:]

You do that through your regional campus leadership teams and you let them know that if the individual intake of students is above what their academic partner, their campus dean, their regional dean is expecting and capable of handling, then you do, I mean turn away is a harsh term, but you just make it clear that the circumstance is such that you don't want to try that hard to get that next student.

[Brandon Dobell:]

And then turning a little bit to new state expansions, any change in I guess the politics of applying for entrance into a new state? Or do you see new states taking a different view of the for-profit companies just from a broader policy perspective of it? I just want to get your sense of what the level of acceptance might be going forward?

[Ron Silberman:]

We really haven't run into any state where the concept of being for-profit was automatically a negative. I mean it raises a level of healthy skepticism and we have to establish that we're a real university and that we'll fund this university for the purpose of insuring high academic outcomes. But we've never had a situation where a state just said, "Because you a for-profit entity, we're not interested." In our own case it's getting easier because we're more well-known and so we go to a state now and that state's licensing body, that board of education whatever it is, has got a dozen or so other states they can call and get some feedback. And so it's a little easier than the first few times that we did this where we were basically a very small local player and there wasn't a lot of track record for incremental states that we were talking to, to go back to talk to our state licensers now. There's much more of that it lubricates that process and makes it a little bit easier. As long as we're doing a good job, obviously, that's why we tend to focus on the academic achievement and the reputational value of what we are doing because it makes it easier to achieve our operational objective of getting a nationwide footprint.

[Brandon Dobell:]

Okay, and another question relates to that. Would you expect any changes in terms of how your crediting body looks at other new programs, new locations, new concentrations? Is there any sense that the current environment is causing them to change how they look at the schools within their peripheral?

[Rob Silberman:]

Well ours is middle states and we are very actively engaged with them at all times. It's a very important relationship. It couldn't get any more intense than it is, so, no I don't anticipate any big change with that.

[Operator:]

Our next question comes from Jerry Herman – Stifel Nicolaus & Company.

[Jerry Herman:]

Thanks, good morning everybody. Rob, a question about the community colleges or the feeder system. Could you maybe quantify the number of articulation agreements you have right now. What percentage of students might be coming from that system as a feeder and maybe even compare it to what it might have been when you first go there?

[Rob Silberman:]

Well, it's over a hundred now. And I am sure it was just a couple when I first got here, because we really only operated in Maryland and Virginia. And it's a significant percentage of our student population, I would say 25%. It's probably a quarter of our students come to us with an associate's degree from one of these community colleges so, it may even be more actually. I have to get the exact data and get it to you, Jerry, but it's a very important part of our educational mission. We don't really do a lot of associate's degrees. We tend to focus on degree completion and we very much like the idea that in an open access working adult focused university, one way in which you can limit the number of unprepared learners is to get a lot of them having already graduated from a community college. Where they've established both the intellectual capacity and the perseverance to go back to school and be successful.

[Jerry Herman:]

And then the topic of the day of course, bad debt, is there anything in the students that are dropping are not paying the A/R that gives you any ability to reasonably manage that process, i.e. is there something in their profile or their geography? Have you asked the campus management to change the behavior? And then as a general question, have you raised your level of acceptability on back that. I mean it's running at historic highs, have you rethought that and now willing to accept a higher level?

[Rob Silberman:]

Well, let me take those in order. There's not a lot we have to ask, frankly of the campuses. They know we've been through this drill probably three times in the last eight years. They know exactly how we feel about it and so I am quite certain that they are being more careful than ever, given the visibility of this. I've never had a fixed level of acceptability for bad debt for financial purposes. And I have tried to make that clear. For me, the issue of bad debt and where it's got my attention is where it's associated with enrollment practices that my concern is that are not in tune with how we want to operate the university, trying too hard to put unprepared students in the seats. What I try to make clear on this call is that my comfort level, if that's the word, with the financial impact of this bad debt is such, is there because academically, none of the data that I've looked at is suggesting that we are making bad decision or worse decisions than we were making in the past, with regard to the enrollment of students. That's the area where for me it can be uncomfortable and where we in the past have cracked down. We'll manage the financial cost of lower collections on existing receivables as long as the number of those students who are creating those receivables are not increasing significant as we percentage of our total student population.

[Operator:]

And we will go next to Mark Marostica – Piper Jaffray.

[[Mark Skitovich]:]

Hi, It's actually Mark Skitovich from Rosica, just to fall into that last question, I think you mentioned that just collection trends in general over the last 9 to 12 months have been for and just given a change in the bad debt, I'm assuming that you saw an acceleration in that this quarter. Just curious if that is the case and can you kind of talk about how drop rates trended through the quarter and how you see that heading into Q3?

[Rob Silberman:]

Yes, again let me clarify because there's a misconception in your question. The performance of our existing students in the classroom is higher. We had higher collections of our spring term receivables than we did the year before. What has deteriorated are the aids receivables for those students would have dropped out in either the winter or the fall. And we have seen that over the last nine months or so those that have trended down, which is why we increased our reserve allocation from that standpoint. So our drops were actually better in the quarter, and that, again, was a source of the higher revenue performance and I suspect helped to the higher retention rate and higher continuation rate. So there's – it's a little bit complicated. There's a lot of moving parts here. It's hard to keep track of them accurately in terms of seeing what the impact on the organization as a whole is.

[[Mark Skitovich]:]

Great and I'm assuming just given the magnitude of the increase. And you're correct, I was speaking to the aids receivables. Is it safe to assume that you have a good handle on just how significant the acceleration is or could be? And related to that what is the top end of bad debt that you are comfortable managing the business at in this environment?

[Rob Silberman:]

Well, it can't be worse than 100%, right? I mean in other words, you know exactly at the end of the quarter who hasn't paid you and what that receivable amount is. So if you get nothing else going forward, it can't get worse than that. And again, we are comfortable managing financially deterioration in receivable collections, as long it doesn't impact the quality of the classroom experience and it's not related to the problem I've tried to characterize before, which we have suffered in the past once or twice, where we found that individual campuses or regions were just enrolling students that shouldn't have been enrolled. That was not the case this time and so it's not of particular concern to me. And I practically, as long as we continue to improve on our current quarter collections, it would be hard for it to get much above 5%.

[Operator:]

Now we'll take our next question from Andrew Fones – UBS.

[Andrew Fones:]

I want to ask if you could give me the approximate sense of the number of students that are in your new global center now, please?

[Rob Silberman:]

Well, we don't really comment on the individual units or campuses, but it's just a handful. I mean we just started with only a few people on the administrative side, so it's far less than our current unit in D.C., but it was a strong start and we would expect that over a five to eight-year period it would certainly get as large as our D.C. unit which is 3,000 to 4,000 students, 4,000 students.

[Andrew Fones:]

Okay, and in terms of how you think about managing the two centers, are you going to look to put new students enrolling maybe on the West Coast and maybe the Midwest into the new center and new students on the East Coast into the old center? How would you think about that?

[Rob Silberman:]

Well, our operational staff will look at what's the right way to optimize that. I don't really have an answer right now, Andrew. But the other point is that these are service centers and it's not really that relevant. In other words, we're going to serve up the student where ever it's easiest for them. We don't think of these as separate business units that we have to measure their performance and make sure that one is growing, or both are growing. I mean overall, whatever works best for the student is how we are going to serve them. And we'll add the headcount either in D.C. or in Salt Lake City based on wherever those operational decisions come out.

[Andrew Fones:]

Okay, just one final on one other topic. As you are now able to offer a greater number of hours where you are servicing the students on the West Coast, do you see that giving you an advantage in that market in attracting students, and have you thought about potential impacts on growth there?

[Rob Silberman:]

Well, it certainly is an advantage in servicing the students. We were already attracting them. We already had the inquiries, but in terms of the ability of servicing them and having it be a great academic experience, more importantly a great administrative experience, which can lead to or certainly can detract from an academic experience if it doesn't go well, I think it will be an improvement for us. I mean, we wouldn't have done it if we didn't think it was going to help us grow. So yes, I think it is an advantage.

[Andrew Fones:]

Okay. Then just on the topic of the day, the bad debt expense – I think 4.2 in Q2. You've said it shouldn't go or it's unlikely to go above 5 as far as you can tell, but what are you assuming in terms of the guidance you gave in Q3 for where that could reach, thanks?

[Rob Silberman:]

Well, we've been pretty conservative and assumed that it would be between 4% and 5%.

[Operator:]

We have no further questions in the queue. I will turn the conference back over to Mr. Rob Silberman for any additional or closing remarks.

[Rob Silberman:]

Thank you Dana, and thank all of you for participating. I look forward to talking to you in the weeks to come and we'll be back in October with our next year's plan as well. Thank you.

[Operator:]

That does complete today's presentation. We thank you for your participation.