Grand Canyon Education, Inc. (LOPE) Q2 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Hope, and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2012 earnings conference call. [Operator Instructions] I would now like to turn the call over to Mr. Brian Roberts, General Counsel for Grand Canyon Education.

Thank you, operator. Good afternoon, and thank you for joining us today on this conference call to discuss Grand Canyon's 2012 second quarter results. Speaking on today's call is GCU's President and CEO, Brian Mueller; and GCU's CFO, Dan Bachus. This call is scheduled to last 1 hour. During the Q&A period, we will try to answer all of your questions and we apologize in advance if there are questions that we're unable to address due to time constraints. I would like to remind you that many of our comments today will contain forward-looking statements with respect to GCU's future performance that involve risks and uncertainties. Various factors could cause GCU's actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in GCU's SEC filings, including our annual report on Form 10-K for the fiscal year ended December 31, 2011, our subsequent quarterly reports on Form 10-Q and our current reports on Form 8-K filed with the SEC. We recommend that all investors thoroughly review these reports before taking a financial position in GCU, and we do not undertake any obligation to update anyone with regard to the forward-looking statements made during this conference call. With that, I will turn the call over to Brian.

Good afternoon. Thank you for joining Grand Canyon University's second quarter fiscal year 2012 conference call. We are pleased with the academic enrollment and financial results of the quarter. The very positive results continue to validate that GCU has created a differentiated model within the higher education landscape that is producing a win-win scenario for all stakeholders. Students are getting high-quality, low-cost education. The programs we offer are focused in employment areas where there is good job growth. Hundreds of jobs are being created in higher education, technology and construction, which is healthy for the economy in the southwest. The model places a minimum burden on taxpayers. In addition, as an investment supported institution, we continue to pay taxes at high levels. If we continue in this positive direction, and our shareholders get a good return on their investment, everybody will continue to win. There are 5 main reasons this is happening, and all 5 offer insights as to why we believe this is likely to continue. The first is the growing strength of the traditional ground campus and its impact on the overall brand of the institution. We will start the fall semester with approximately 6,500 students on our campus in Phoenix. This is down slightly from the number we anticipated 3 months ago. We turned away over 500 ground traditional students that weren't as strong academically as we would've liked or were not in a strong position from a financial perspective. Even with the pullback, we have an historic traditional class from a numbers perspective but also a very strong class from an academic perspective. Approximately 71% of our new traditional students are from Arizona. Arizona has a number of important needs that this class will help satisfy. Healthcare is a huge driver of the economy here. Our new class of freshmen will have 326 pre-med students, 42 pre-pharmacy students, 88 new pre-physical therapy students, 514 new pre-physician assistant students and 148 new pre-licensure nurses. In the nursing program, the NCLEX examination pass rate is still running above 96% for the year. This is a quality metric very important to building the university's academic brand. Arizona also has an aging group of K-12 educators and has been identified as a state in need of a new group of young teachers. We will help support this challenge with 212 new elementary ed majors and 139 new secondary ed majors. We also have 621 new business students in this class as well as many new students spread across a variety of additional majors. Very high retention levels are helping support the overall growth of the traditional campus. We have an 84% retention rate between the spring semester of last year and the fall semester of this year. This is an extremely high retention rate even when compared to some of the best branded institutions in the country. Both new and continuing students will experience the approximately $200 million investment in new classrooms, dorms, eating facilities and performance centers, as well as the approximately $80 million investment in technology we have made in the last 3.5 years. We look forward to record-setting performances in music, theater, dance and athletics this year. Last year, our athletic teams won the Learfield Directors' Cup at the Division II level, which measures performance across all 21 athletic teams. Our athletic teams also won the award for having the highest average GPA in our conference. We expect to repeat this year in both categories, which should make us a strong candidate to move to the Division I level. Our Fine Arts department won many music, theater and dance awards in Arizona, and we expect that to continue as well. As a result of the many accomplishments of our ground campus, and the increased visibility that these accomplishments bring to the institution, the brand of GCU is really growing in the southwest. Our total enrollment growth rate overall is 12.4%, but our growth rate in Arizona is 25%; in California, 21%; and in New Mexico, 22%. The second reason for this success is the high-quality composition of the online student body, which supports high retention and graduation rates. Of all online students who started our program between August and November of 2011, 70% completed their first 12 credits by July 2012. The long-term implications of this trend are very significant. In our working adult student body, 42% are studying at the graduate level, while 58% of our students are studying at the undergrad level. As many of you know, it is our goal to keep graduate students at greater than 40% of the total. The College of Liberal Arts and Sciences stayed relatively flat as a percentage of the total students going from 15.1% last year to 15.5% this year. The College of Business students went from 15.6% of the total to 14.2% of the total. In our high retention colleges, the College of Education students went from 45.7% last year to 43.2% this year, but the raw number of education students actually went up. The College of Nursing and Health Sciences students went from 23.6% of the student body last year to 27.1% of the student body this year. The increased retention levels of our student body is caused partly by increased selectivity. This is true on both the ground and online campuses. However, the retention level of students is also supported by our increasing use of full-time faculty. On our traditional campus approximately 50% of core sections are taught by a full-time faculty and 50% by adjuncts. We are working towards making those numbers 70% full-time and 30% adjunct. Online students, which are taught almost entirely by adjuncts at many institutions, are increasingly being taught by full-time faculty members at Grand Canyon. The first 3 courses of most of our programs delivered online are taught by full-time faculty. It's important to note that the retention percentages reported by the Harkin report were based on students recruited between July 1, 2008 and June 30, 2009. The current management team did not take over running the University until spring of 2009. There were many, many changes made academically and operationally during 2009 and 2010 that have put us in the very strong position that we are in today. The third reason for the success is our very competitive pricing model. On our traditional campus, our published tuition rate is $16,500 per year. We have not raised that for 3 years. After scholarships, our average student pays approximately $7,800 per year. Most private universities have published rates between $35,000 and $50,000 per year, and our state universities in Arizona are about $11,000 per year in addition to the tax subsidies that support each in-state student. Those institutions also offer scholarships. But our after-scholarship averages are now very competitive with the tax-supported state institutions and as much as 2/3 under many private institutions. In addition, our room and board rate for those students living on campus are extremely low. Most students on our campus are paying about $6,500 for room and board for the entire year. Most universities have rights -- rates much higher than that; in fact, some are almost double that amount. Our online students have close to the lowest tuition rates in the industry. Our long-term growth targets are to grow enrollments by 8% to 10% each year, revenues from 12% to 15% per year and increase our margin levels by 1% per year. We believe that we will be able to accomplish that margin improvement with very modest tuition increases in some programs, but our plan is to actually lower tuition levels in others. We have recently lowered tuition levels significantly in our theology programs and have seen a spike in enrollment as a result. We have also lowered tuition levels in our education programs delivered in a cohort ground model and kept our undergraduate online education tuition level the same for 3 years. We remain committed to increasing student retention levels, lowering acquisition costs and seeking other efficiencies that will allow us to continue to decrease tuition levels over time, but continue to increase earnings so our investors will get good returns. The fourth reason for this success is a flat organizational model with very advanced dashboard technology that gives us the ability to manage the progress of our students on a daily basis. Our academic counseling staff can monitor the attendance and participation trends of students as well as track closely their academic progress. This allows them to work cooperatively with faculty to provide any intervention necessary to keep students moving in a positive direction. We are also working hard on the advanced analytics component of our LoudCloud learning management system, which will provide another large amount of data on the academic work of both our students and faculty. The fifth reason for our success is the growing experience levels of our faculty, management and staff. Our employee turnover rate has improved 8 basis points year-over-year, decreasing to 12% in 2012. During that same period, our operations management turnover rate has dropped to under 4% and our full-time faculty turnover rate has dropped to under 2%. The instruction and service our students get as a result is reaching very high levels. Many of you know that Grand Canyon University has become a finalist to receive the gift of the Northfield Mount Hermon campus located in Northfield, Massachusetts. The Green family, who owns Hobby Lobby, wants to give this property to an organization that would run it as a private Christian university. The original purpose of the Northfield Mount Hermon school was to provide private Christian high school education to students that came from the lower socioeconomic strata of that area. A number of years ago, Northfield Mount Hermon merged with another private boarding school leaving the property vacant. The Green family has been impressed with our model of providing very high quality, low-cost higher education that is made available to all classes of Americans at very little cost to the taxpayer. If we are ultimately offered this opportunity, it would tie us closer to our online students in the 12 northeast states. It would provide high quality, low-cost higher education to traditional age students. Because of the more than $100 million investment we would make on the campus and because of the hundreds of jobs we would create in the area for local residents, it would provide an economic stimulus to the poorest county in Massachusetts. We have had meetings with local residents, the State Department of Education, the Department of Economic Security and we'll be meeting with the Higher Learning Commission later this month to discuss this opportunity. If this becomes a reality, we would probably start new students on the campus in the fall of 2014. Turning to the results of operations for the second quarter of 2012. Net revenues were $119.3 million in the second quarter of 2012, an increase of $16.2 million or 15.7% from the $103.1 million in the prior year period. Operating margin for quarter 2 2012 was 21.3% compared to 21.4% for the same period in 2011. Net income was $15.6 million for the second quarter of 2012 compared to $12.9 million in the prior year period. After-tax margin was 13.1% compared to 12.5% for the same period in 2011. It should be noted that the difference between a 21.3% margin and the after-tax margin of 13.1% is money that we pay in taxes that goes back to the taxpayers. Given our relatively low default rates, our low Pell usage and the high tax amounts we pay, our net cost to the taxpayer is extremely low. Instructional costs and services grew from $46.4 million in the second quarter of 2011 to $53.4 million in the second quarter of 2012. As a percent of revenue, IC&S remained relatively flat going from 45% to 44.8%. Bad debt expense as a percent of revenue decreased 490 basis points between years to 3.1%. This major improvement is a result of 4 things: one, the increasing quality of our online students; two, the growth of our traditional ground student body; three, the flat organizational structure and the innovative dashboard that allows us to manage the progress of each student to a greater extent than we ever have before; four, the increased experience level of our staff. Faculty compensation as a percent of revenue stayed flat between years. Employee compensation and related expenses increased to 60 basis points; instructional supplies increased 90 basis points. Arena costs increased 40 basis points and depreciation increased 40 basis points. Additionally, in connection with the University's review of student files for the period from July 1, 2008 to June 30, 2010, in accordance with the pending program review with the Department of Education, the University determined that Pell grants received by the University for students that later unofficially withdrew primarily from -- during 2008-2009 school year should have been returned. The current management system fixed this problem shortly after we arrived. Although the student is obligated to repay the university for these amounts, the University has decided that it will not seek reimbursement from the students once the returns are made. The University estimates the total amount to be returned is approximately $3 million and accordingly has reserved this amount during the second quarter of 2012 resulting in a 250 basis point increase as compared to the second quarter of 2011. Selling and promotional expense increased from $27.7 million in the second quarter of 2011 to $32.8 million in the second quarter of '12. Selling and promotional expense as a percent of net revenue increased 60 basis points from 26.9% in Q2 2011 to 27.5% in Q2 2012. Enrollment advising and promotional salaries and related expenses as a percent of revenue increased 160 basis points between periods, while advertising as a percentage of net revenue decreased 80 basis points between the second quarter of '11 and the second quarter of '12. As a reminder, during the second quarter of '11, the University reversed $2.2 million of amounts accrued in previous periods that were to be paid to employees for students they previously recruited and for which retention bonuses were to be paid when those students completed 24 credits. Due to the compensation rule changes effective July 1, 2011, those amounts could no longer be paid. $1.5 million of the accrual reversal last year was recorded in selling and promotional expense and $700,000 was recorded in instructional costs and services. General and administrative costs increased from $7 million in the second quarter of 2011 to $7.7 million in the second quarter of '12 and as a percentage of revenue decreased from 6.8% in quarter 2 to 6.5% in quarter 2 2012. As a result of the above, net income increased from $12.9 million in the second quarter of 2011 to $15.6 million in the second quarter of '12. With that, I would like to turn it over to Dan Bachus, our CFO, to give a little more color on our second -- on our 2012 second quarter, talk about changes in the income statement, balance sheet and other items.

Thanks, Brian. Scholarships as a percentage of revenue increased from 12.8% in Q2 2011 to 14.5% in Q2 2012, primarily to -- due to the growth in the ground traditional campus. Bad debt expense as a percentage of revenue decreased to 3.1% in the third -- in the second quarter of 2012. We are extremely pleased that the trends that we began to see in late 2011 have continued, and again want to thank our operational staff for their efforts. We estimate that approximately 100 basis points of this improvement was the result of increased collections of previously written-off receivables and do not believe that collection efforts for previously written-off receivables in that magnitude will continue. Our effective tax rate for the second quarter of 2012 was 38.5% as compared to 41.5% in the second quarter of 2011. The lower-than-anticipated rate is primarily due to certain nonrecurring tax items, which had the effect of decreasing our effective tax rate in the second quarter of 2012. We still anticipate our effective tax rate for the second half of 2012 will be 40.5%. We purchased 120,000 shares of our common stock during the second quarter of 2012 at a cost of $2 million and have repurchased another 177,000 to date in the third quarter of 2012 under 10b5-1 plans that had been put in place. We have also extended the term of our stock repurchase program through September 2013. Turning to the balance sheet and cash flows. Total cash unrestricted and restricted at June 30, 2012, was $105.6 million. We have a revolving line of credit for $50 million. No amounts have been drawn as of June 30, 2012. Accounts receivable net of the allowance for doubtful accounts is $8.4 million at June 30, 2012, which represents 6.7 days sales outstanding compared to $13.1 million or 11.8 days sales outstanding at the end of the second quarter of 2011. CapEx in the second quarter of 2012 was approximately $33.6 million or 28.2% of net revenue. This month, we will be completing construction of our fifth residence hall and sixth residence hall, a new arts and health sciences classroom building to meet the demand for our health sciences programs and our first parking garage. These buildings are on schedule and on budget. CapEx as a percentage of revenue was higher in the second quarter of 2011 than what we had anticipated due to timing of payments and seasonality. We still anticipate CapEx in 2012 as a percentage of revenue to be similar to 2011. As we have mentioned previously, we continue to have discussions with outside investors about selling and leasing back certain aspects of the university. We are also having discussions with our bank about increasing our mortgage on the campus. Given the extremely low interest rate environment, both are attractive options. Last, in case you missed last quarter's conference call, I would like to provide similar color on the guidance we have provided for 2012. We have provided a range of estimates for each quarter of 2012. Although this is something we might or might not do in the future, we did it this year for a couple of reasons. First, our business is becoming more seasonal due to the significant growth of our ground traditional campus. A large percentage of these students only attend classes between the end of August and the first week of May. However, a large percentage of the ground traditional campus costs are fixed. In addition, we have hired additional support staff to service the increasing traditional campus student body in the spring of this year so that they were trained and could start working with the soon-to-be students when these students were ready to be registered for the fall semester. We have significantly increased our estimates for Q3 2012, primarily due to an increase in our projected enrollments and projected revenue per student to do better-than-anticipated retention rates and have increased our margin -- anticipated margins by 100 basis points due to lower-than-expected bad debt expense. We remain comfortable with our previously provided guidance for the fourth quarter of 2012. Our guidance assumes an effective tax rate of 40.5% for the remainder of the year. We have also provided our estimates of diluted weighted average shares outstanding by quarter. Although we might repurchase shares during 2012, these estimates do not assume material repurchases. They do assume increased dilution from stock options granted in previous years and from a 2012 stock grant. I will now turn the call over to the moderator so that we can answer questions.

[Operator Instructions] Your first question comes in the line of Sara Gubins, Bank of America.

I'm sorry if I missed it, but could you talk about how new student start trends looked in the quarter?

Yes, thank you. They were in the mid-double digits. So significantly up from -- and we expect that to continue.

Okay, great. And then you increased the third quarter guidance but not the fourth. I'm wondering is that a question of visibility or is there something -- or are there more conservative assumptions in the fourth?

No, I think we have good visibility and things, as we've said, are going really well. I think we had some pretty aggressive expectations for the fourth quarter when the year began and things seem to be trending in the way we felt they would. And so we felt at this time it was -- is best to keep those expectations where they were previously set.

Okay, great. And then just last one. Brian, you laid out the longer-term targets and I think that those are somewhat lower than your previous targets. Before you'd talked about 8% to 12% enrollment, 11% to 15% revenue and 100 to 200 basis points of margin expansion. And now it looks like you did 10% enrollment but 12% to 15% revenue and 100 basis points of margin expansion. Could you help us better understand what's driving those changes? Is it really more the strategy around lower tuition pricing over time or is it some combination of that and something else?

No, I think the expectations are pretty much in line with what we've given in the past, especially last quarter. When we talked about 100 to 200 basis point margin expansion, we were -- our expectation on bad debt was to see a slight decrease in bad debt expense on an annual basis. There was never an assumption that we would see such huge improvement in bad debt all within this year. And so given that this year's margins are going to be significantly higher than we anticipated at the beginning of the year, to increase our margins 100 basis points a year on a go-forward basis, I think would be very reasonable. Brian has always talked about target margins for the University and that gets us into the -- those target margins.

I guess, the only thing I'd add is that the enrollment number is -- obviously we're exceeding that by a lot right now. And we have no reason to believe that there's going to be a slowdown there. It's -- we're just taking a conservative approach, that's all.

Your next question comes from the line of Adrienne Colby, Deutsche Bank.

I was hoping you could comment on the trends you're seeing in conversion rates, if you've seen any changes in the trends you're seeing in Arizona and also in the southwest?

They're staying very, very strong in Arizona. We -- 25% year-over-year growth in Arizona even exceeded what we thought we would get. New Mexico is very strong. Nevada is pretty strong. Where we were really surprised is California is gaining a lot of strength. And that's true for both traditional students and nontraditional students. It's a reflection of the difficult time people are having out there finding a place in local universities. And so we're going to put additional efforts out there as a result.

Great. And if I can just ask one more. I think in the past few years, your average tuition increase in the online program has been about 3.5%. In your prepared comments, you mentioned that there'd be some selective increases and some decreases. Is it fair to think about that as sort of staying in that 3.5% average range going forward?

It will probably be lower than that. We're not focused on that as nearly -- nearly as much as what's historical in this space. We want earnings to be strong. We want the returns to investors to be strong, but we want to get there through enrollment increases and operational efficiencies so that we continue in our very competitive mode from a pricing perspective. There'll be some programs competitively selected that will be 3% or 4%, but there'll be others who will actually go down. And so right now, we're in the kind of the middle of that process and it couldn't be going better from an enrollment standpoint or from an earnings standpoint. And I think if people are under the -- living under the impression that this is going to go back to what it was from a pricing standpoint, that's not going to happen. This thing is just going to get more and more competitive, and we feel like we're in a really, really strong position.

One other data point for you. This year, and I think it was April, where tuition prices went into effect, our average across all programs was 2.1%. So we think that that's probably a pretty good assumption of where they'll be or maybe even a little under that on a go-forward basis. But we haven't raised tuition prices on average in the 3.5% level in a couple of years.

Your next question comes from the line of Jeff Volshteyn, JPMorgan.

I know it's probably a little too early to talk about the northeastern opportunity, but can you generally tell us sort of the demographics of the area? How is it -- how does it compare to Phoenix area in general?

Well, the interesting thing about the northeast is that if you -- aside from the southwest, we are -- that's the best place for us from an online enrollment standpoint. Our growth rates there are already better than they are in other areas of the world and it's because of our competitive pricing advantage for our online students and also we've got a decent brand in some school districts and hospitals in the northeast. The 4x conversion rates that we get in Arizona because of the presence of our ground student body here, we just take a look at what we'd get in the northeast if our conversion rates were double there, and it's obviously a very good number. So we're already doing well from an online student body perspective and we think we could do considerably better. For traditional students, people say, "Well, the northeast has a lot of tradition. There's been universities there for a long period of time." We, in fact, have visited many of those. They're $40,000, $50,000, $60,000 a year, for tuition, room and board. We would -- the same play that works here is the play that would made out there. High-quality, low-cost tuition levels for all classes of Americans. So we would still put a focus on good students. We're not a community college, we're not remediation. But we believe based upon what we've -- our investigations to the current point that if we were -- the average student here pays about $7,800 a year. The average student there would probably pay $11,000 or $12,000 a year. But that would be so much under what they're going to have to pay in other universities that we think that we can be very successful there.

Okay. And I have a couple of housekeeping questions. On new enrollments, you said middle double-digits, did you mean mid-teen kind of level?

Yes.

Yes.

Okay. And the charge of $3 million, what line would it be in the income statement?

Instructional costs and services.

Your next question comes from the line of Bob Craig, Stifel, Nicolaus.

First question, following up on Jeff's question on the northeast opportunity. When do you expect a decision there? And I take it by your comments that it would be branded under Grand Canyon, is that accurate?

Yes. We have worked through some issues with the name and that not fitting in the northeast and we'll work through that kind of stuff and figure out how to do it. The decision is probably going to be -- there's 2 finalists. The decision will be made by the Greens, we think, in the next couple of weeks and probably announced towards the end of September.

Okay. You mentioned, Brian, I think in your earlier comments that the ground school enrollment, 6,500, is a little bit less than what you had earlier planned for. Was that simply due to the rejection rate?

Yes, absolutely. We just -- it's the same strategy that's working online with us being more selective by virtue of where we put our marketing dollars and enrollment count. So it's in really working hard to recruit the students in the high retention programs. On the ground, it's just basically grade point average, and we don't follow up and don't encourage and don't accept the students that don't fit and we're in a -- fortunately, we're in a strong position to be able to do that. So...

Any early thoughts, Brian, on what your objective would be for next year in terms of ground enrollment?

Yes, somewhere -- new starts would be somewhere between 3,500 and 4,000 students. And that would take our total ground enrollment to about 9,500, between 9,000 -- around 9,000.

Okay. One last one and I'll turn it over. Where does that program review stand? Have you provided all necessary information now and are just waiting for the final determination letter?

Bob, if you recall, there's 3 -- there were 3 significant findings they had. One was on enrollment counts or compensation. They asked for a lot of documents. We've been providing rolling document requests to them. And so we continue to do that and we assume they're looking through the documents that we've provided. The second was on the interdisciplinary studies program and whether that really led to gainful employment. We've provided them the information that they've requested on that. We feel very good that, that program did lead to gainful employments, especially given the fact that it was a program requested by some of our employer partners. The third and the one that's cause the most amount of work was this issue around the unofficial withdrawal of students. Clearly, the Department of Ed has taken a position as it relates to unofficial withdrawals for students in a term-based rule on all universities that they've been going on and doing program reviews, so we are clearly not the only one. Both for-profits and not-for-profits have gotten a similar finding to us. We've been going through the file review that they've requested of us. We -- early on in that file review, we found this Pell issue so we really spent the last few months going through, the whole 2 years, and looking at Pell refunds for students that unofficially withdrew, and that's where we've come up with this reserve. We are also going through the Title IV calculations for students that unofficially withdrew as well and we're early on in the process around that piece.

Your next question comes from the line of James Samford, Citigroup.

I wanted to touch on the accreditation side of things and it sort of appears that the accreditors are taking a fresh look at the online model, particularly adjunct faculty and of course -- and part-time faculty side. Brian, have you been getting a lot of feedback, are you working with HLC to make sure that the online model is not under particular stress or risk? And is that part of the decision to shift a little bit more to full-time faculty at this point?

Absolutely not. We are not -- we started making this shift from an online standpoint 2 years ago. And so this is not in a response to any of that. This is simply in a way to -- our online students are making a big investment and they're making a big commitment from a time perspective and they're very sensitive to how quickly they get feedback and how much feedback they get and how -- and so the first couple courses are really important. Our online full-time faculty work between 12 noon and 8:00 in the evening so they're right there on-site and ready to respond to assignment submission and to questions and to discussion posts. And it's the ability to increase retention rates, increase student learning, increase student satisfaction rates that overcome the added investment that we're making in salary and benefits. That's why we did it and we'll continue to do it that way. The characteristics that make you an effective teacher online versus in a ground -- in a classroom, sometimes they'll do the same but many times they're different. And people that are experienced online instructors and very good at it have a way of working, it comes -- they learn over time and so that's why we're doing it.

I guess a follow-up on the competition side. A lot of your competitors are pointing to deteriorating consumer confidence is a big factor for declining enrollment that they're seeing. Clearly, price is one thing that's working in your favor. I was wondering, are you getting any feedback or any hints that, that consumers are delaying their signing up to go back to school or any other dynamics that we should know about?

No. We're not getting that, but there's a lot of things that we're doing that combat that problem because this clearly is a problem. It is not for us. I can tell you that, for example, the online students who expressed interest in Grand Canyon that live in the southwest, many of them we are actually sending a plane ticket to and we're flying them in to spend time on our campus before they even start our program. The confidence that we are building as a result of that is huge. And so, yes, there is some loss of confidence and there is some skepticism, but we're doing a lot of things to fight that. When we bring people in from the southwest who, for example, may be thinking about doing a doctoral program and they meet the Dean and they meet the President and they sit down and get all their paperwork done in person and they spend time on our ground campus, they go back and they tell people in their school district and they go back and tell people in their hospitals that, that's the place to go. You have to see their campus, you have to meet with their Deans, you got to see the confidence they have in what they're doing and in their future. And so you can't do that nationwide but you can certainly do it in the southwest where we're putting a focus on growth, which that's, very honestly, why we're thinking about the northeast. Because when you can connect those people to your ground campus, the sense of confidence they have in your permanence and what you're doing just goes up.

Your next question comes from the line of Kelly Flynn, Credit Suisse.

I have a bunch of short questions. Just on the new student growth, do you expect to maintain the mid-teens growth in the back half?

Yes, probably. I mean that is higher than we anticipated and very honestly things are going better than even we thought. So at this point, as we look into the second half, yes.

Okay, great. And then just back to James' question about the Higher Learning Commission. I understand you did not make any of those faculty mix changes in response to any criticism from HLC. But can you just talk about the current environment on the heels of some of that news we've seen in the sector. Are there any other areas besides for adjunct faculty mix that you expect you'll need to make changes in? And are you, in fact, getting any new feedback from HLC on anything on the heels of some of the news that's hit the sector recently?

No, we're not. And certainly, we pay close attention to where higher education is going and what the thoughts on higher education from the Higher Learning Commission would be. But honestly, we're focused on number one, the learning outcomes that our students are achieving; and number two, the retention levels of our students. And so being selective on the front end, providing good programs and instruction that lead to high retention and high learning outcomes is what we're focused on. Full-time online faculty just produce better learning, and they produce better retention levels early on in the program as students are gaining confidence in their ability to do this. On ground, online -- full-time online -- our full-time ground faculty, if they are teaching a load that's significant can be hugely impactful both to student learning and from a financial perspective. But they have to teach. And so the average faculty member on our campus teaches 4 classes a semester. And what we are experiencing as a result of that is number one, financially it works really well in terms of keeping tuition levels low; number two, they're full-time engaged with our students and it's producing good learning outcomes and high retention. Those are the things we're focused on.

Okay, great. And then just lastly, can we go back to CapEx? I think I might have asked a similar question last quarter, but you said you expected CapEx to be close to what it was last year and last year it was close to $80 million. But I thought on the last call you said it was going to be $90 million for the year. So I guess the question is, is it $80 million or $90 million? And then, how should we think about it going forward? I think you said you'd spend $100 million on the Massachusetts campus if you got that. I mean can we expect CapEx to kind of come down over time in the next 2 to 3 years?

To answer your question, yes. As a percentage of revenue is what I said, it'd stay flat year-over-year so -- yet, we do believe it will be up a little bit on a raw dollar amount over last year, maybe not to the level that maybe we thought a quarter ago because things are coming in under -- on budget or slightly under budget. But we are going to spend on CapEx because we believe it's the best return on investment that we can do. We -- in terms of -- or in terms of the ground campus here, next year should be down a little bit over this year. We are not going to be building a classroom building next year like we did this year so the focus next year will be on dorms and a parking garage. In terms of Northfield, if we were to take on that project, you would not see any significant CapEx there until kind of that 2014 time period. We would have some CapEx that we would spend that very first year to get the campus up to our requirements, especially around fixing up the existing dorms and food service and that sort of thing. We would not build our first dorm there until that probably 2014 year.

Right. That's probably at second half of 2014. We won't start students there to -- till fall of 2014 if we're gifted this. We would put about $10 million into that campus in the second half of 2013 to get the campus ready and then 2014, 2015 is when we would start building dorms. There's probably enough classrooms there. There's 40 buildings on that campus. I mean it's 220 acres. And so we are really further ahead there than we were even here when we started this.

Your next question comes from the line of Peter Appert, Piper Jaffray.

So Brian, do you have a sense of what the decision criteria in Northfield are for the Greens?

Yes, they want somebody that's fiscally strong enough and -- to carry the project off and they -- secondly, they want somebody who can, as much as possible, guarantee them that the private Christian mission of the institution will stay in effect, long term. In fact, that second one is equally as important as the first one. And so we think we're in a pretty good spot. The final decision hasn't been made, but we think we're in a pretty strong spot.

It seems -- if they -- are they specifically looking for a post secondary institution, though, is that correct or not?

Yes, yes, they are. The reason that they -- I have selected a second finalist was just that they really didn't feel like they found an institution that could carry it out -- that could pull it off. And so that's why the second one is not. So...

Right. The second one is not a post secondary institution, correct?

Right. It's a Southern Baptist Church. They would build a training center for. So they really didn't find another one that they thought, from a fiscal standpoint, could pull it off.

Got it. Which is why you think the odds are reasonably good that you could win?

I mean -- yes, I do think they're pretty good.

Okay. So I'm doing these calculations right, it looks like the online persistence maybe -- is down a little bit on a year-to-year basis. Can you talk to that?

Actually, it's up. It's up about 100 basis points, yes. Obviously, you have to look at the ground -- the ground campus effect really makes our June numbers look strange. But if you look on a year-over-year basis, no, our retention rates, our persistence rates are up about 100 basis points.

Okay, great. And then I think, Dan, you said something about trimming ad spending in the current quarter. Can you give us any more color on the strategy there?

No, I don't think we talked about trimming ad spending. We are actually down year-over-year in advertising as a percentage of revenue, but I think that had more to do with the growth in our revenue per student than it really did in any of our spending.

We're actually down from 10.9% to 9.6% and that is -- most of that is the additional revenue.

Got it. Okay. And then last thing, bad debt, you mentioned also, Dan, that you've got some particular benefit from things that won't recur. What should we think about as a reasonable sustainable level of bad debt expense as a percent of revenues?

I would say the way we're trending in the month, the second and third quarters probably low 4s and in the first and fourth, something more in the 3s. Although clearly, we were better than that this quarter and we're hopeful that, that will continue.

Your next question comes from the line of Jeff Meuler, Baird.

Questions on the quarter. Just -- did you guys give the starts number for the fall campus or for the ground campus this fall?

I don't think Brian did, but it's roughly 3,500.

Okay. So you're not going to require a significant investment in terms of recruiting resources on campus to kind of hit that 3,500 to 4,000 type number for next fall, correct?

That's a very important point. We've made the investments on the enrollment side and on the academic and financial counseling side. So we're ready to go for the next year.

Great. And then in terms of the -- if you would receive Northfield Mount Hermon and accept it, what would that do to your intermediate term margin guidance? Would you still expect to achieve margin expansion or should we think about margins being more flattish with faster enrollment and revenue growth in that scenario?

We've talked about this a little bit, but I think that the expectation is for Northfield Mount Hermon is for in the first year or so we would probably lose $1 million or so. And then that second year, leading up to the fall of 2014 start, that loss would be higher than that as we hire employees. At this point, we're not quite prepared to state what that is because there's a lot of work still to be done. But the carrying cost of the property alone is about $1 million a year, so not real material.

Your next question comes from the line of Paul Condra, BMO.

You've given some previous guidance, I think, for the ground enrollments in -- by fall of 2015 that it was like 12,000 on the ground and 2,000 to 3,000 graduate students. Any -- I mean, is that still a ballparking where you expect to be?

Very close. We might be a little under that. We've been a little bit more selective this year and maybe a little more selective next year, but we'll be close to that 12,000 and 3,000 number.

Okay. And then I just wanted to ask, you gave a little detail about the percent of ground students from the southwest, I think you said 71%. How does that compare to your online students?

Well, online students are more -- with about 25% of our online students are from Arizona, about 70% of our ground students are from Arizona. But the ground students are as a percent from Arizona is going down. Online students from Arizona as a percent is going up, so they're moving in opposite directions.

And I suppose the remaining 75%, is that -- how is that dispersed just in terms of the online students?

It's -- southeast and northeast are pretty good areas for us. And so it's pretty evenly distributed between the southeast and the northeast. We're not -- we don't do quite as well in the Midwest.

But big in the southwest. So -- as Brian talked about, California through Texas, really strong.

And then -- has your marketing strategy changed at all? I mean, are you still focused primarily on the southwest or are you just geographically, I'm wondering?

No, increasingly it's in the southwest and it's increasingly with branded advertising that focuses on our traditional campus. It's interesting that 32- and 34-year old working adults absolutely love the ad campaign that is directed around our ground campus. They want to be able to say that's where they go to school. They want to be able to tell people that's what they're attached to.

Your next question comes from the line of Brandon Dobell, William Blair.

One thing about the program review, any sense of timing on when you might get a prelim exit interview or the final data -- determination?

No, we have no idea. Our commitment to the Department of Ed is part of this was to give them a monthly update as we progress through the file review and that's what we've been doing. So at this point, it's us providing information to them. We have not heard much in response.

Okay. And how should we think about second half of the year in terms of scholarships? Should that kind of current trend continue or should it be an outsized bump in the third quarter given the ground start?

Yes -- no, it will go up as a percentage of revenue as the ground campus goes. As Brian kind of laid out the numbers, greater than 50% of our ground campus revenue as a percentage of revenue is scholarship, given that the average student pays about $7,800 and our rack rate is $16,500. So the bigger the ground campus gets, the bigger that scholarship as a percentage of revenue will be.

Okay. And final one for me, as mentioned, a number of stats or anecdotes around conversion rates and things like that. I guess, I'm trying to get a sense of -- the conversion rates, are those being driven more by just the -- let's call it the incoming quality of a -- like somebody has already kind of decided they're going to go so it's more just a question of how fast you can service that interest or are you seeing a significant uptick in productivity from the enrollment reps? And if so, is that within a particular program or do you think you've got the right mix of people in the right programs now?

Yes, we do think we have the right mix of people and in the right programs. The uptick is that the students that always were the most difficult for us from a retention standpoint, and where we keep putting fewer and fewer dollars from a marketing and enrollment standpoint, are actually now their retention rates are going up. And so that's having a positive impact on our advertising as a percent of revenue. So our student body online, we are happy with where they -- with the composition of it and we'll keep reinforcing that with our marketing mix. But the real outlier is in increased retention levels. That's the thing that's driving it more than everything.

Before we take the last question, one thing about the program review I should have mentioned for those investors that are new to Grand Canyon is the issues around this unofficial withdrawal issue that was raised by the Department of Ed had to do with when the University operated under a term-based environment. Since the summer of 2010, the University has operated in a borrower-based environment so the issues raised in that program review are not issues that are a concern with the way the University operates today. This was an issue related to the way the University operated prior to the summer of 2010.

Your final question comes from the line of Trace Urdan, Wells Fargo Securities.

Dan, I understand the comment about scholarships as a percentage of revenue in total. But I'm wondering about scholarships on average for your ground campus students. Is that number up, down, flat?

It's probably up a little bit. As we talked in the past, our scholarships as a percentage of revenue for our online campus is run about 10% a year, 10% as a percentage of revenue. It's been pretty consistent. The biggest scholarship in that is the discount that we give to our military students. We discount that down as a lot of universities do to $250 a credit hour for undergraduate students and a little higher rate than that but pretty close to that for graduate students. And so that is by far the largest discount we do for online students. The other discounts are pretty minimal given our very low tuition rates.

Okay. So if it's going up a little bit, is that because military is becoming a bigger piece of the total or...

Yes, military has gone up a little bit, not hugely, but it has gone up a little bit over the last couple of years, primarily again driven by 2 things: one, retention rate improvements; and then secondarily, we believe word-of-mouth. When you do a good job of educating military students, you tend to -- there tends to be a viral affect. And so I think we have seen our new starts of our military students go up a little bit.

And just so I understand the dynamic -- I mean, obviously, there's more demand for the ground campus this year than there was last year and perhaps next year versus this year and you guys -- it sounds like from your prepared remarks that you're actively making the choice to use GPA as a way to sort of refine who comes and who doesn't come. In other words, that you're using that extra demand to bring up your average GPA rather than using that extra demand to peel back the amount of scholarships that you're awarding, is that a fair statement?

I'm not sure. As you know, we have academic scholarships for our ground students based on GPA, so the higher the GPA the higher the scholarship. I think one of the things that happened this fall and this is probably normal, but the ground campus is a new thing for us in some respects. But students that had registered based on their, let's say, junior GPA came in with their final transcripts after their senior year and their GPA might have gone down a little bit. And thus, their scholarship would've gone down a little bit. And for some students, that caused them to say, "I don't know if this works." And in some respects caused us to say, "We don't think Grand Canyon is the right school for you." And so I'm not sure what you said is exactly correct. It has a lot to do with the GPA and thus the scholarship that they are entitled to at Grand Canyon.

All right. And then the -- if you mentioned this already, I apologize. But can you speak to the -- can you give a little bit more color on the strength in graduate degrees this quarter? I'm curious whether there were specific strength by program offering and then whether you're seeing any kind of acceleration in your ability to enroll grad students in the on-ground campus.

The -- well, the most competitive areas in education and we did a little bit better than we thought we were going to do there in terms of Masters Degrees in education. But the biggest gain for us was in the doctoral area. We put a lot of resources there, and we got a good return for that. So the biggest thing is the doctoral students. Our ground student graduate program got off to a little bit slower start than we thought, but we're going to put quite a bit of an effort into it this year.

And Brian, where are the doctoral students? What program area are they focused in?

Still a lot in education, but also in business. And the one that's really growing is the PhD program in psychology.

We have reached the end of our second quarter conference call. We appreciate your time and interest in Grand Canyon. If you still have questions, please contact either myself, Dan Bachus or Bill Jenkins. Thank you very much.

This concludes today's conference call. You may now disconnect.