American Public Education, Inc. (APEI) Q3 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter 2014 American Public Education Earnings Conference Call. My name is Lacey, and I'll be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Chris Symanoskie, Vice President of Investor Relations. Please proceed.

Great. Thank you, operator. Good evening, and welcome to American Public Education conference call to discuss financial and operating results for the third quarter of 2014. Presentation materials for today's call are available in the webcast section of our Investor Relations website and are included as an exhibit to our current report on Form 8-K filed earlier today. Please note that statements made in this conference call regarding American Public Education or its subsidiaries that are not historical facts are forward-looking statements based on current expectations, assumptions, estimates and projections about American Public Education and the industry. These forward-looking statements are subject to risks and uncertainties that could cause actual future events or results to differ materially from such statements. Forward-looking statements can be identified by words such as anticipate, believe, seek, could, estimate, expect, intend, may, should, will and would. These forward-looking statements include, without limitation, statements regarding expected growth, expected registration and enrollment, expected revenue, expected earnings and plans with respect to recent and future investments and partnerships. Actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described in the Risk Factors section and elsewhere in the company's annual report on Form 10-K filed with the SEC and the company's other SEC filings. The company undertakes no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. This evening, it's my pleasure to introduce Dr. Wallace Boston, our President and CEO; and Rick Sunderland, our Executive Vice President and Chief Financial Officer. Also available for questions today is Harry Wilkins, Executive Vice President, Chief Development Officer and CEO of Hondros College of Nursing. Now at this time, I'll turn the call over to Dr. Boston. Wally?

Thank you, Chris. Good evening, everyone. I will begin today's call with a summary of our third quarter results on Slide 3 and provide a brief commentary on the progress we are making with respect to our strategic goals. Then our CFO, Rick Sunderland, will discuss our financial results and provide perspective on our outlook for the fourth quarter of 2014. At American Public University System, overall net course registrations declined 5% in the third quarter of 2014 compared to the prior year period. This was driven by an 11% decline in net course registrations by new students. As expected, net course registrations by students using Department of Defense voluntary Tuition Assistance programs, also called TA, declined 11% year-over-year, driven by a 16% decline in net course registrations by new students using TA. We believe ongoing confusion over TA eligibility and changes in administration of the TA program may have adversely impacted enrollment of military students at AMU during the quarter. That said, we continue to believe that American Military University enjoys a strong leadership position in the military community and that the fundamental needs for higher education within the U.S. Military community remain largely intact, including the use of education benefits as a recruitment tool, requirements for educational attainment to advance within the military and the need for well-educated fighting force. We believe net course registrations by students using Federal Student Aid were adversely impacted by the challenging competitive environment in higher education, as well as by our efforts to transition advertising away from traditional mass media while increasing our focus on strategic relationships in other channels in order to improve our quality mix of students. In the third quarter of 2014, net course registrations by students using Federal Student Aid decreased 6% year-over-year, driven by a 14% decline in net course registrations by new students using Federal Student Aid. These declines were partially offset by growth in net course registrations by students using veterans benefits and by students using cash or other sources. Net course registrations by students using veterans benefits or VA increased 8% year-over-year, and net course registrations by students using cash or other sources increased 3% compared to the prior year period. We believe AMU's reputation in military-affiliated communities help drive a 17% year-over-year increase in net course registrations by new students using VA benefits. Net course registrations by new students using cash or other sources increased 14% year-over-year. This growth may have been aided by TA students shifting to self-financing and VA benefits to fund their education, as well as by our efforts to attract students through corporate and strategic relationships at APUS. During the third quarter, our strategic outreach team expanded existing partnerships and built several new relationships with corporations, associations and public service organizations. We're now proud that APUS now serves more than 200 corporations, associations and other organizations through a corporate the strategic outreach in addition to maintaining over 350 relationships with community colleges. At Hondros College of Nursing, student enrollment increased 8% in the third quarter of 2014 compared to the prior year period. This increase was driven by a 6% increase in new student enrollment. This growth was largely the result of strong demand for nursing education and our ongoing efforts to improve the success of our outreach through their expanded use of social media and by building strategic relationships. I am pleased that Hondros recorded its largest-ever fall starting class all while relocating the Cleveland campus and preparing to transition their LMS to Sakai next year. In the third quarter, we met or exceeded our expectations for launching evening and weekend classes at the Columbus and Cleveland campuses, thereby advancing our plan to expand capacity and improve utilization. We believe the team at Hondros is setting the stage for a great future while making valuable contributions to our efforts to build a successful nursing and health care education enterprise. Moving on to Slide #4, academic quality and innovation. APUS continues to focus on providing a tremendous value to students through affordability and academic quality. We continue to be recognized for these efforts. Recently, several of our faculty and staff members were the recipients of an effective practice award from the online learning consortium, formally the Sloan Consortium, for their project to help students develop academic research skills and online courses utilizing our online library. This is the fourth of such award earned by members of our faculty and staff, the most awarded to any member institution. Our students continue to be recognized by peers and professional organizations. For example, in August of 2014, the AMU and APU chapter of Golden Key International Honour Society was awarded their key chapter award, which is the highest honored granted to chapters exemplifying outstanding achievement in academics, leadership and service. The AMU, APU chapter was 1 of 23 honorary out of Golden Keys 400 national and international chapters. Our focus on matters related to persistence is an all-hands effort, spanning nearly all university functions. We are developing and deploying new approaches to not only ensure that new students are capable of earning a degree, but to support college-ready students with strong academic intent through greater engagement, active interventions and new student support services. We continue to see progress on the high-enrollment courses where we are implementing these initiatives, and we will continue to evaluate alternatives to improve persistence and our quality mix of students. We have palleted the use of a learning relationship management or LRM system called ClearPath to improve student engagement, persistence and graduation rates. This is a product of Fidelis, a company in which we have a minority investment. We are the first university to deploy ClearPath, and we have recently expanded the pilot to include more than 3,000 students who voluntarily elected to participate. In this population, we have seen that ClearPath users complete the enrollment and transfer credit process at a higher rate at lower withdrawals and drops, exhibit a higher GPA in their initial courses and register for subsequent classes earlier than those in the larger student population. Based on the results of the pilot, we plan to open ClearPath to all new students and eventually all students. During the third quarter, we also expanded our efforts to improve student engagement and activity through the use of new rich media, interactive content, simulation and game application. Our new dual master's degree in Homeland Security and Emergency & Disaster Management is being added to our December course catalog and will be available for registration in January 2015. In addition, we are looking forward to the launch of our second MOOC, massive open online course, a course in American Government, POLS210, in the first quarter of 2015. We also pleased by our minority investment in New Horizons Worldwide, Inc. and their recent profit and growth. We are excited about working with New Horizons to potentially expand our new product offerings, as well as to advance our outreach to international students during the franchisees and other initiatives currently in development. This is just one part of our long-term strategic plan to expand, further diversify our program offerings and enter new market segments. In closing, we are happy to report that the third quarter results were largely in line with or above our stated outlook for the third quarter of 2014. Despite the income fronted with several challenges and particular softness in the TA market and increasing competition, we are optimistic about our future because of the unique characteristics that differentiate APUS from other institutions. We provide a tremendous value proposition to working adult students. We have amazing faculty, innovative and affordable programs and great platforms for expansion. Our fourth quarter outlook calls for a slight sequential improvement in student volume, which we believe reflects the success of our efforts in this very challenging and volatile environment. To achieve our long-term goals, we will continue to develop new approaches to optimize our operations. We will seek to diversify into new growth fields, and we will continue investing in education technology as yet another key differentiator all while remaining passionate about and focused on student success and affordability. At this time, I will turn the call over to our CFO, Rick Sunderland, to discuss our financial results and outlook in greater detail. Rick?

Thank you, Wally. Onto Slide 5. American Public Education third quarter 2014 consolidated financial results include a 4% increase in revenue to $84.7 million compared to $81.8 million in the prior year period. The increase in revenue was due to the inclusion of Hondros College of Nursing, or our Hondros segment, which was acquired on November 1, 2013, and therefore not included in the prior year period. Hondros earned revenue of $7.5 million in the third quarter of 2014. In the third quarter, our APEI segment revenue declined to $77.2 million from $81.8 million, a decrease of 6% compared to the prior year period. This decline in revenue was the result of a year-over-year decrease in net course registrations at APUS. As previously discussed, we believe that the volatility and softness in our Military/TA enrollment is, in part, related to marketplace confusion over changes to TA eligibility, as well as to other administrative changes in the Military/TA program. In addition, we believe the weakness we are experiencing in FSA enrollment is largely related to increased competition and by our effort to transition advertising away from traditional mass media while increasing our focus on strategic relationships and other channels in order to improve our quality mix of students. In the quarter, on a consolidated basis, our cost and expenses increased 9% to $70.1 million compared to $64.3 million in the prior year period. The increase was due to the inclusion of the results of our Hondros segment, which was partially offset by a decrease in expenses in our APEI segment as a result of lower net course registrations and lower payroll cost. Overall, our margins were impacted by a decline in our APEI segment operating margin and the inclusion of our Hondros segment in the 2014 period. Our Hondros segment has a lower operating margin than our APEI segment, largely because Hondros offers the majority of its courses at physical campuses, which have a higher cost structure than courses delivered fully online. In the third quarter, our Hondros segment operating margins decreased sequentially from the second quarter due to additional investment in capacity, outcome assessment tools and other expansion-related expenditures. Next year, we expect to realize recurring annual savings by transitioning the current Hondros LMS to Sakai, plus additional savings from ongoing optimization initiatives. For the quarter, consolidated instructional cost and services expenses, as a percent of revenue, increased to 36.2% compared to 34.4% in the prior year period. This increase was primarily the result of the inclusion of the results of the Hondros segment, which was partially offset by decreases in instructional costs and services expenses in our APEI segment due to lower net course registrations and lower course material costs. The cost of course materials incurred by APUS declined year-over-year to approximately $29 per net course registration in the third quarter of 2014 from $41 in the third quarter of 2013. Selling and promotional expense as a percent of revenue increased to 21.2% of revenue compared to 19.6% in the prior year period. The increase as a percent of revenue was due to the revenue decline in our APEI segment, as well as to an increase in spending on advertising at APUS. General and administrative expenses increased as a percentage of revenue to 20.6% from 20.4% in the prior year period. The increase is primarily due to an increase in bad debt expense at APUS. The increase in consolidated general and administrative costs, as a percent of revenue, was partially offset by the inclusion of the Hondros segment, which has lower general and administrative costs as a percentage of revenue. In the third quarter of 2014, consolidated bad debt expense was approximately $4.3 million or 5.1% of revenue. This compares to $3.4 million or 4.1% of revenue in the prior year period and $4.9 million or 5.7% of revenue in the second quarter of 2014. For additional detail regarding expenses as a percent of revenue for our reporting segments, please see the financial table that is included as an Appendix to our presentation. This presentation is available on our website and was filed with the SEC as part of an 8-K. Our effective tax rate increased to 39.9% in the third quarter of 2014 compared to 37.6% in the prior year period. This increase is primarily due to an increase in our effective state tax rates. In the third quarter of 2014, net income was $8.8 million, or $0.51 per diluted share compared to $10.9 million or $0.61 per diluted share in the prior year period. Total cash and cash equivalent as of September 30, 2014, were $108.6 million, with no long-term debt. Capital expenditures were $15.3 million for the 9 months ended September 30, 2014, compared to $15.1 million in the prior year period. Depreciation and amortization was $11.9 million for the 9 months ended September 30, 2014, compared to $9.9 million in the same period of 2013. On to Slide 6. Our outlook for the fourth quarter of 2014 is as follows: APUS net course registrations by new students in the fourth quarter of 2014 are expected to increase between 0% and 2% year-over-year. Total net course registrations are expected to increase between 6% and 8% year-over-year compared to the prior year period, which was adversely impacted by the partial government shutdown in October. During that time, active-duty military students were temporarily unable to access Tuition Assistance funds and therefore, unable to enroll for courses using TA. Hondros College of Nursing fourth quarter new student enrollment is expected to increase by approximately 16% year-over-year. We anticipate consolidated revenues for the fourth quarter of 2014 to increase between 7% and 9% year-over-year, compared to the prior year period of 2013. In the fourth quarter of 2014, we anticipate total consolidated earnings per share to be between $0.50 and $0.54 per diluted share. In closing, the third quarter of 2014 was marked by decreases in net course registrations by students using TA benefits and FSA funding. These declines were partially offset by increases in net course registrations by students using veterans benefits and cash or other sources. While there is still uncertainty and softness in the student enrollments by students using TA and FSA, we are pleased to be guiding to a slight sequential improvement in net course registration levels in the fourth quarter of 2014 compared to the third quarter of 2014. In closing, we continue to focus on improving our operational processes and enhancing our offerings to further differentiate our programs. At the same time, we are pleased by the initial results of the pilots put in place at APUS to improve persistence. Finally, the growth that we are seeing in Hondros is exciting as it underscores the importance of our strategy to build a larger healthcare education platform. Overall, we believe that the unique characteristics of our institutions and our long-term strategy position us well to face the challenges that confront APUS and our industry. Now we would like to take questions from the audience. Operator, please open the line for questions.

[Operator Instructions] And our first question comes from the line of Corey Greendale with First Analysis.

So I want to dig into the guidance a little bit. So the fact that you're guiding to a better new student outcome in Q4 than in Q3, which market -- which of your end markets, is that tied to and do you expect an improvement in either FSA or TA?

Well, I think year-over-year, we are expecting a slight improvement in TA because we lost TA registrations in October a year ago. So if you take that into account, I'd say that removing -- just ballparking the TA students that we lost in October, we're actually guiding to a slight negative for the quarter.

That's right. I agree.

That is helpful. And then the fact that -- I know historically you had sort of drawn a line in the sand and said you were committing to sales and promotion not being more than 20% of revenue. I think this was the first time it had a 21% handle. Can you just comment on that and whether you think given the competitive environment, you think it makes sense to be raising that number in order to generate more enrollment?

Actually, no, we're trying to stick with 20%. We did have some creative ideas in our marketing team for targeted spend for quality students. And so we decided to spend that money and that put us a little bit over. But we're still trying to hold fast to roughly 20%.

Right, I would add to that, that as we came through the first and second quarter, we were talking about increased levels of spending in S&P. And we didn't and quite hit those numbers, which caused some outperformance in those earlier quarters. So there was a bit of catch-up happening in the third quarter. It wasn't the majority of the change sequentially, but it was a piece of it.

Okay. And then in the FSA space, when you talk about increased competition, I think everybody that follows the space and follows you is aware that the competitive environment has been getting more competitive. Is that -- are you seeing something different now than you were a couple quarters ago? And where do you think the increased competition is coming from, specifically?

Well, I think as we continue to try to target a higher quality mix of new students based on demographics, I think we're seeing our primary competition being the increased availability of fully online programs offered by public institutions. That's really the differential. I mean, that's our price point. We're really not priced with most of the other folks in this sector.

No, I understand. And the last one I have for you is on Hondros with the changes in year-over-year growth in the new students growth rate. How should we think about the sustainable growth rate, the long-term sustainable growth rate in that business in terms of new students and total enrollment?

Harry?

Well, again, we'd shy away from giving guidance beyond the next quarter, especially in today's environment. But what really key to growth of the fourth quarter is we rolled out evening programs at our 2 campuses, 2 of our 4 campuses, the ones in Cleveland and the 1 in Columbus. And we were -- we had really good results. So we plan to roll out evening classes at the remaining campuses throughout next year, and right now we're only offering the LPN program in the evenings. We hope to roll out APN programs in the evenings next year also at all 4 campuses. So I think that's going to be a key to growth. And then we expanded our -- we got a really good opportunity in Cleveland. The University of Phoenix closed down a Cleveland campus, which was right down the street from our old campus that we had outgrown, and we were able to double the size of our space in Cleveland. I think that's going to -- I think Cleveland is going to be a real opportunity for us at Hondros. We were a little bit limited by our facilities prior to July 1. We incurred a little bit more cost with the new lease, but we really like that facility. I think it's going to be a good spot for us. So I'm really -- we're really encouraged with the opportunity in Hondros. Nursing is a really great career. We think there's a tremendous shortage of nurses right now and projected to be for the next 5 years to 10 years. And we think we can fill a need and educate nurses. And we're very optimistic about the ability to grow Hondros long term and short term.

And our next question comes from the line of Jason Anderson with Stifel. Jason P. Anderson - Stifel, Nicolaus & Company, Incorporated, Research Division: On the -- I just want to touch off on the guidance on total, up pretty good there in 4Q in your guidance. But you -- and you obviously allude to the prior year comp. Is there anything other going into that? Or is there any benefit of persistence or retention help there?

I think if you look at our third quarter numbers, you can see some improvements in persistence, particularly when you look at the difference between where the total net is versus the new net. And we, as I stated, we continue to have all hands on deck initiative related to improving retention from the staff to the faculty, and so there's some of that in there. But I also think that we don't anticipate a TA stoppage like we had a year ago. Jason P. Anderson - Stifel, Nicolaus & Company, Incorporated, Research Division: Okay. And then should -- would it make sense to think that's going to continue your -- kind of the gap there between -- some of the gap difference between your start trends and your total in the persistence improvement there?

I think it's difficult to predict, particularly when you're an open enrollment school. It's just -- it's much more likely predicting persistence when you have a minimum GPA and a minimum SAT score and open enrollment does -- it could vary by quarter. So it's tough. Jason P. Anderson - Stifel, Nicolaus & Company, Incorporated, Research Division: Great. And then on the Hondros start guidance, how much of that is from the evening -- the introduction evening classes? Does that make up a good portion of that growth?

Yes, it was about half and half. And I really don't want to get into -- again, that's projection for the fourth quarter. I don't want to start a press thing where we're going to start giving guidance by specific campus or by specific programs going forward. But it was about half and half.

And our next question comes from the line of Adrienne Colby with Deutsche Bank.

Your guidance for the fourth quarter points to sequentially weaker operating margins, which is a little surprising, given that fourth quarter is typically seasonally strong. I'm just wondering if there's anything else we should be thinking about other than the higher instructional costs at Hondros?

I think what you're seeing is there could be some higher expenditures in technology in the fourth quarter, which would drive the line on the P&L G&A.

Great. And I know that in June, I think you added a second collection agency with some thoughts that, that would help on the bad debt expense line. Have we started to see some benefits there? Or is that something that's going to be more visible in 2015?

I think it's too early to tell. It just started up in kind of the June time frame. It's too early to predict the impact that's going -- obviously, the expectation is it would provide benefit.

Okay. And then I guess in regards to Tuition Assistance. I know that you commented last quarter that expectations were that the budgets will be stable next year. Just wondering if you could comment if most of the branches finished the year with budget surplus for education benefits, and any color you have around the new budget amounts that are coming in, and maybe October registration trends?

We won't know how the branches did, whether they had surpluses or deficits until the -- it's usually the February CCME meeting that the service heads reveal that data. I would just tell you that our gut thinking is that September was slower than what we expected, and we think that, that was probably due to budgetary issues, but there were no announcements. And with the sequester, there's less transparency than we've had in the past with information from DoD.

Our next question comes from the line of Jeff Silber with BMO Capital Markets.

Just a couple questions on Hondros. What is the likelihood and maybe you can give us some indication of when do you think you'll be providing those programs outside the state of Ohio?

Well, first of all, we have to get approval for our change of ownership in the Department of Ed which we have not yet to receive, even though it's been close to a year. We certainly expect to receive that. The case management team in Chicago is a little burdened right now with other change of ownership applications because of the turmoil that's taking place with some of our competition selling a lot of campuses. But once they get around to approving our application, then we can consider expansion. Until then, we really can't expand.

Are you having discussions in any states? I know you can't officially do it, but I'm assuming you're looking at least?

We always look at opportunities in other states, but I really don't want to talk about it on the call right now.

Okay, I understand. I'm sorry about that. And then just a couple numbers questions. Is it possible just for a modeling perspective, can we look at 4Q '13 Hondros new student enrollment and total student enrollment? Is that something you can provide for us?

Yes, I mean, we only owned the company for half of that period. So we -- I guess we can comparatively do that. I don't have the numbers right now. But [indiscernible]...

All right. I'll try to get that...

You'll definitely get it next quarter when we announce the actual results.

Right, because you'll have the year-over-year growth, so you'll know what the part of it was.

Okay, I'll try to get that offline.

Yes, and I was going to say we announced it last -- I mean, the fourth quarter of '13 was announced. So you should have that data from a year ago, roughly a year ago. But again, we didn't own the company while they were doing the recruiting and the admissions for that period.

And our next question comes from the line of Jeff Volshteyn with JPMorgan. Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division: Following the Republican win in Congress, what are your thoughts around the impact for budgets for DoD and VA going forward?

I would say that I don't consider myself a political expert. I think there's a lot of problems funding our budget, particularly if Republicans would like to cut taxes. So I would tell you that I'm not looking for anything to change anytime soon. I'm thinking that things will stay as they are. Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division: Okay, that's helpful. I might have missed it in your prepared remarks. Did you give color on persistence for -- in the third quarter for civilian students and military students and how they compare?

We didn't. But if you look at where we're down on new students versus where we are on total, we've improved somewhat in retention more than you would have predicted. And we can't attribute it to any 1 thing because we have about 4 different initiatives going on from faculty initiatives to staff and advising initiatives, and it's really a -- to actually marketing which is trying to recruit a better quality mix. So we're trying to do a lot of things. We did talk about the pilot population using our Fidelis ClearPath product. And our intention is to expand that because those students who, admittedly, are volunteers and not all asked to go into that product. But the students who are using that product are getting better grades or signing up for courses in advance and appear to be getting good counseling. So we're optimistic that, that and other initiatives are going to help us continue to improve retention going forward. Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division: Right, but are you able to break it out between civilian and military in any way?

No. I mean, we could probably, if we went back a year, so we don't have that data prepared. And we'll consider it for the next call. But the difficulty with the military are they always -- forget sequester, they've always taken much -- far fewer classes per year than our FSA students, at least the good FSA students, primarily because the military will fund 1 class a year. And we actually recommend that our new TA students take 1 class the first time so they can determine whether online is going to work for them or not. FSA students, unless they're grad students, if they're undergrads, have to do more than 1 class just to be half time. And so it's a difficult calculation to make. But we'll see if we can provide some color on our next call. Jeffrey Y. Volshteyn - JP Morgan Chase & Co, Research Division: That's helpful. Last question for me. Tax rate, that is implied in the fourth quarter guidance and perhaps further on in 2015?

Rick, you want to talk about the tax rate?

Right. So we saw a spike in the state rates -- states, several states changed how they calculate apportionment, or require us to calculate apportionment. In terms of the go-forward rate, I would keep it very close to about the same as what we're seeing -- what we reported in the third quarter.

And our next question comes from the line of Peter Appert with Piper Jaffray.

Yes, you have John Crowther on for Peter. Just 1 quick question here. As you're talking about a little bit more competitive in the FSA channel, but you also talked about part of that is advertising and trying to get a higher quality mix of students in there. Just wondering if you can kind of, as you pointed out, the price point doesn't make you that much comparable to some of the other for-profit peers. But if you could talk a little bit about your marketing campaigns to increase that mix and if you're sort of changing the marketing message at all here recently?

Well, I would like to change the marketing message and just be pretty blunt on cost, except every time we do focus groups, that doesn't resonate so well. This is -- higher ed is one of those odd-ball markets where sometimes cost is perceived as a negative and reversing that statement that the higher priced you are, the more -- the higher quality someone thinks you are. So we will continue to try to look at ways to position our affordability because we're passionately committed to it. Meanwhile, as far as our targeting goes, we're looking, without giving away the secret sauce, so to speak, we're looking for areas with higher income and the right demographic mix and specifically, targeting that not just on our TV and radio ads, which aren't a huge part of our business. But certainly, a piece of it and coordinating that with our Internet ads, which can be coordinated by zip code as well.

[Operator Instructions] And at this time, I show that we have no questions in queue. I will turn the call back over to Chris Symanoskie for any closing comments.

Thank you, operator. That will conclude our call for today. We wish to thank all of today's callers for participating and for your interest in American Public Education. Thank you, and have a great evening.

Thank you for your participation in today's conference. This concludes the presentation. You may all disconnect. Good day, everyone.