American Public Education, Inc. (APEI) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the American Public Education First Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to turn the conference over to Chris Symanoskie. Please go ahead.

Thank you, Operator. Good evening, and welcome to the American Public Education conference call to discuss financial and operating results for the first quarter of 2016. 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 registrations and enrollment, expected revenue, expected earnings and plans with respect to recent and future initiatives, 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 Factor section and elsewhere in the Company’s annual report on Form 10-K filed with the SEC, quarterly report on Form 10-Q filed with the SEC and the Company’s other SEC filing. The Company undertakes no obligation to update publicly any forward-looking for any reason unless required by law, even if new information becomes available or 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. Now at this time, I’ll turn the call over to Dr. Boston.

Thank you, Chris. Good evening, everyone. I would like to start today’s call with a summary of our recent results and review our progress with respect to our long-term goals. Then Rick Sunderland, our CFO, will discuss our first quarter financial results and provide perspective on the Company’s outlook for the second quarter of 2016. In the first quarter of 2016, net course registrations at APUS declined 4% compared to the prior year period. Although net course registrations by new students declined 15% year-over-year, net course registrations by returning students increased only 1 9% compared to the prior year period. We believe that the difference in the rate of decline of course registrations by new students and that of returning students relates at least in part to improvements in our quality mix of students. For example, for the three months ended February 29, 2016, the first course pass and completion rates of undergraduate students at APUS increased 29% year-over-year, a possible indicator that our efforts to attract and retain students with greater college readiness are working. The overall decline in net course registrations by new students at APUS is primarily driven by a 34% year-over-year decrease in net course registrations by new students using Federal Student Aid. We believe this decline was principally the result of our efforts to improve our quality mix of students through a new admissions process and a change to multiple financial aid disbursements to first time APUS undergraduate students as well as to an increase in competition, especially among online programs. Net course registrations by new students using military tuition assistance or TA decreased year-over-year by 3% compared to the prior year period. We believe this decline is primarily the result of changes in how the TA program is being administered by the Department of Defense. Additional changes to TA program administration and other possible factors including troop reductions, deployment and access to military bases could adversely impact net course registrations in the future. Net course registrations by new students using cash and other sources declined 3% year-over-year and net course registrations by new students using veterans benefits increased 6% compared to the prior year period. I’m pleased that APUS continues to develop new strategic relationships, including most recently with partners such as BenefitHub, a corporate benefit platform used by more than 5,000 companies and large corporate employers like Sodexo and Time Warner Cable. We are also pleased that various efforts aimed at improving our quality mix of students and the decision to change the method by which we disburse Federal Student Aid to a multiple disbursement method for first time APUS undergraduate students appears to have helped reduce bad debt expense to 2.5% of revenue in the first quarter of 2016, compared to 4.8% of revenue in same period of 2015. In the first quarter of 2016, enrollment at Hondros College of Nursing declined 20% and new student enrollment declined 17% compared to the prior year period. We believe that Hondros’ enrollment has been adversely impacted by strengthened completion requirements in its diploma in practical nursing program, which is the primary source of students for its associate degree in nursing program, and the transition to offering night and weekend courses, which has resulted in students taking fewer total courses each academic term as some students that would otherwise have studied on a full-time basis are now pursuing courses on a part time basis. Also, in January of 2016, Hondros implemented curriculum changes designed to conform its associates degree in practical nursing programs more closely to the programmatic accreditation standards. We believe the transition of these changes resulted in fewer students choosing to pursue their PN and ADN studies at Hondros. We are unable to predict how long this trend may continue. Moving on to slide number 4, APUS institutional goals, as a part of our long-term strategic plan, we continue to focus on several important initiatives to achieve two critical goals; one, increase student persistence, and two, stabilize enrollment at APUS. Although we must continue to improve student persistency at higher levels, we are pleased with our initial results. We believe student persistence is improving in part due to our changing quality mix of students, the release of new tools for students and many other initiatives aimed at increasing student engagement and classroom interactivity. We continue to experience a year-over-year increase in the usage of APUS Mobile, our native classroom app. Usage of APUS Mobile has increased 24% and the number of users has increased 14% on a year-to-date basis. We also continue to expand our use of Civitas, a predictive analytics tool to help improve student persistence through increased faculty and advisor engagement with at risk students. In the long run, we expect that higher student persistence rates will lead to a better online learning experience, higher graduation rates, increased referral rates and ultimately, improved overall operational and financial performance. In addition to persistence, we have also set a goal of stabilizing enrollment through initiatives aimed at attracting students with greater college readiness. In the first quarter of 2016, we continued with our targeted advertising and work to further improve the application and assessment processes to improve conversion rates. In light of difficult market conditions, we continue our attempts to enhance our marketing enrollment effectiveness, including with improved marketing analytics to drive resource allocations to target higher quality students and improved enrollment processes such as our streamlined mobile-friendly application form launched at the end of 2015. In the first quarter of 2016, we realized a double-digit year-over-year increase in the percent o applications completed by prospective students who start the application. We are pleased with the higher application completion rates and will continue to explore ways to further improve the enrollment experience and the quality of our prospective students. We also continue our efforts to optimize our new student assessment designed to screen for student’s ability to complete college with a focus on admitting higher quality, better persisting students. College assessment was originally launched in mid-April of 2015, which primarily impacted enrollments in the latter half of 205. While additional modifications may be required to achieve the desired result, we are seeing an improvement in new students’ academic performance. In addition to attracting college-ready students through an integrated approach to marketing, we intend to increase our emphasis on programs in which we have competitive strengths and on enhancing our brand positioning. This year, we expect APUS to evaluate repositioning select degree programs by implementing differentiated pricing primarily to better align the tuition of certain programs with higher market demand. In closing, APEI primarily serves working adult students through academic institutions that are built on solid foundations; quality, value and growing reputation. We continue to be pleased with the enhancements that we are making to advance the online learning experience and further improve student success while managing certain costs. At the same time, APEI intends to continue pursuing its long-term goals through additional investments in education technology and by diversifying into new degree fields and other areas of study. Our long-term objective is to further advance our institutions by positioning them to overcome tough marketplace challenges, provide students a rich and engaging learning experience and to enable alumni to advance their careers and improve their lives. At this time, I will turn the call over to our CFO, Rick Sunderland. Rick?

Thank you, Wally. American Public Education’s first quarter 2016 consolidated financial results include 1.6% decline in revenue to $84.0 million compared to $85.4 million in the prior year period. Both our APEI segment and our Hondros segment reported declines in revenue when compared to the prior year. In the first quarter, our APEI segment revenue decreased 1.5% to $76.3 million compared to $77.5 million in the prior year period. Decline in APEI segment revenue is a result of a 3.8% decrease in net course registrations, partially offset by increased revenue from the 2015 tuition increase. Hondros segment revenue decreased 3.8% to $7.7 million in the first quarter of 2016 compared to $8.0 million in the same period of 2015. The decline in Hondros segment revenue was due to decreased enrollment in Hondros. On a consolidated basis, costs and expenses decreased 4.2% to $68.0 million compared to $71.0 million in the prior year period. The decrease is primarily due to a decrease in bad debt expense, which is reported in general and administrative expense as well as lower selling and promotional expenses and lower instructional costs and services expenses in our APEI segment. On a consolidated basis, operating margins increased to 19.0% in the first quarter of 2016 as compared to 16.9% in the prior year period. The year-over-year improvement in operating margins is due to expenses decreasing at a rate greater than the decrease in revenue, primarily as a result of a decrease in bad debt expense. For the first quarter, consolidated instructional costs and services expense as a percentage of revenue was 35.4% compared to 35.5% in the prior year period. Selling and promotional expense or S&P as a percentage of revenue decreased to 19.6% of revenue compared to 19.9% in the prior year period. Year-over-year S&P costs decreased 2.9% to $16.5 million compared to $17.0 million in the prior year. Accordingly, the year-over-year decrease as a percentage of revenue is due to S&P costs declining at a rate greater than the decline in revenue. General and administrative expense or G&A as a percentage of revenue decreased to 20.2% from 22.4% in the prior year period. Our G&A expenses decreased 11.5% to $16.9 million compared to $19.1 million in the prior year. The decrease in G&A expense was largely the result of a decrease in bad debt expense in the first quarter of 2016. For the three months ended March 31, 2016, bad debt expense decreased to $2.1 million or 2.5% of revenue compared to $4.1 million or 4.8% of revenue in the first quarter of 2015. We believe the improvement of bad debt expense is a result of our ongoing efforts to attract students with greater college readiness, the change in our quality mix of students and the launch of the multiple disbursement method of disbursing Federal Student Aid to first time APUS undergraduate students. Income from operations before interest income and income taxes increased 10% to $16.0 million compared to $14.5 million in the prior year period. In the first quarter of 2016, net income was $10.3 million or $0.64 per diluted share compared to $8.8 million or $0.51 per diluted share in the prior year. Our earnings per share was approximately $0.12 per diluted share above the top of our previously issued guidance range of between $0.47 and $0.52 per share. The primary factors contributing to the higher than anticipated earnings per share included higher than expected revenue, lower than expected bad debt expense and federal student aid processing costs and New Horizons’ favorable adjustment to its deferred tax asset valuation allowance. Total cash and cash equivalents as of March 31, 2016 were approximately $120.0 million with no long-term debt. Capital expenditures were approximately $3.1 million for the three months ended March 31, 2016, compared to $5.3 million in the prior year period. Depreciation and amortization was $4.9 million for the three months ended March 31, 2016, compared to $4.6 million for the same period of 2015. Going on to Slide 6, our outlook for the second quarter 2016 is as follows; APUS net course registrations by new students in the second quarter of 2016 are expected to decrease between 24% and 19% year-over-year. Total net course registrations are expected to decrease between 10% and 7% year-over-year. We believe these declines are primarily a result of the various measures we have put in place to improve our quality mix of students, a transition to more targeted advertising and increased competition for students. Moreover, net course registrations by students using TA may be adversely impacted by continued volatility in the military, changes in how the TA program is being administered by the Department of Defense and other possible factors. In the second quarter of 2016, total enrollment that Hondros is expected to decrease by approximately 10% year-over-year and new student enrollment is expected to decrease by approximately 12% year-over-year. We believe that enrollment in the second quarter may continue to be adversely impacted by the January 2016 curriculum changes that resulted in marketing challenges. These changes were made with the goal of further improving student outcomes, academic quality and operational efficiency. For the second quarter of 2016, we anticipate consolidated revenue to decrease between 7% and 4% year-over-year. Net income for the second quarter of 2016 is expected to be in the range of $0.36 to $0.41 per fully diluted share. Although our focus on student persistence has contributed to a decline in net course registrations by new students and a decline in revenue, we believe that it has also led to lower bad debt expense and operating margins that are higher than would have been achieved absent such results. In addition to improved financial performance, the benefits from improved student persistence may include improved student success and satisfaction and could lead to higher referral rates, making us a stronger institution in the long-run. Today, we are cautiously optimistic about future enrollment stabilization as we begin to anniversary the implementation of the new assessment processes and benefit from our efforts to optimize our enrollment application. In addition, we will continue to optimize our targeted marketing efforts and take steps to enhance our brand positioning, while simultaneously executing on our student persistence initiatives. Now, we would like to take questions from the audience. Operator, please open the line for questions.

Thank you. [Operator Instructions] And our first question comes from the line of Corey Greendale of First Analysis. Your line is now open.

Hey, good afternoon everyone.

Hey, Corey.

So, my first question, just sort of a [indiscernible] so when you reported [indiscernible] you had given us the Hondros enrollment results [indiscernible] total enrollment was down 6% and now you’re reporting it’s down 17%. Can you just explain why that change relative to what you’d said last quarter?

Corey, it’s Rick. I’m not sure I’m following. What was the number you are referring to last quarter?

Stop me if I am getting something wrong. I think when you report each quarter you already know what Hondros’ enrollment is. So in other words, like this quarter, you just gave us that Hondros’ total enrollment is down approximately 10% in Q2. Last quarter, you had said that total enrollment at Hondros was down 6% in Q1. Now you just reported it was down 17%. But I’m wondering why it changed from down 6% to down 17%.

Corey, I think the difference is, one is sort of a point in time and the other is the earning enrollment that’s driving revenue.

Okay. So in other words, we shouldn’t necessarily model down 10% in Q2 because it could change for that?

No, I think – so the ending enrollment…

We gave two different metrics.

Yes, there are two different metrics. That’s what I am getting it, but for purposes of modeling, we get the model of the earning number, which is in the guidance.

Right. I can follow up offline but I thought you told us in Q1 that Hondros’ number would be down 6%.

Okay. That’s correct, but it’s a different metric. Yes, we could follow-up on that.

Next question I had is, on the bad debt, could you give us some sense of – so, is it sustainable this level and have you factored in 2.5% bad debt into the Q2 guidance?

Yes, I think we tend to be a little conservative, because we would like to see that trend continue for several quarters, Corey, before we fully accept that. But we’re definitely – we’re modeling right in that range. We’re not materially different than that for the second quarter guidance.

Okay. And then, on the APU enrollment results, so I think the change in the admissions process that happened kind of mid-April of 2015, so I thought kind of thinking that through, with that starting to anniversary maybe things would get better plus the comps gets a little easier but it sounds like new registration has actually been more negative in Q2 and there is a lot of different things in the environment, but can you give us a little more specificity around maybe why you think it’s getting more negative now?

We implemented that April 15 or I might be off by a couple of days, but around the middle of April last year. Typically, there is a 45-day cycle between when somebody applies and when they actually register for a class. So we don’t expect to see the masterful difference until the third and fourth quarters.

Okay. So, all else equal, what that anniversarying and comps get easier, you would expect things would at least get somewhat less negative just conceptually in Q3 and Q4?

I think conceptually there may always be something different that could happen, but conceptually, the assessment shouldn’t have the impact beginning in Q3 and Q4 that it has for the previous four quarters.

Okay, good. I’ll turn it over and I’ll follow-up on that other point offline.

Yes. Okay.

Thank you. And our next question comes from the line of Jeff Silber of BMO. Your line is now open.

Hey, good afternoon. It’s Henry Chen calling for Jeff. I just had a question on the start trends that you noted in the beginning of the call. So, it looks like the military and VA, it looks like trends are improving. I was just wondering if you could add a little color on if that’s the case and may be touch upon what other trend that you’re seeing in terms of starts for this coming quarter?

Rick, you want to take that one?

So, starting with military TA, we see continued volatility there, some challenges at the end of last year, which we think carried over into the first quarter, but when we look at our guidance into the second quarter, I think we’re seeing some softness in the military TA market, to be quite honest. So if you think about it strengthening a little bit in the first quarter and then perhaps getting a little softer in the second quarter, that speaks to the volatility. The VA, we’re working off a much smaller number. Such smaller movements in registrations have a more noticeable impact as a percentage of the total, but I would say if you look at VA back over several quarters, that trend has been favorable certainly compared to TA. So I think we’ll expect that to continue at some level on the VA side.

Got it. Okay.

I think also the drawdown in the army in particular, off course. Those people are leaving and unusing their VA benefits since they no longer have access to tuition assistance.

Got it. Okay. And just a follow-up on TA, just curious of your thoughts on the outlook in terms of the funding environment for TA for the rest of the year?

I wish I would share the funding environment. It’s volatile and I would say not disclosed till after the fact. So we have some basis that say they don’t have any issues with funding and another one said allocated quarter by quarter and it continues to be volatile overall. Automated systems require access by annual forms being signed, which to me is a method that’s done deliberately to slowdown enrollments. Obviously, times are tight budget wise. The Department of Defense had to take a hit with sequestration and I think that the bill that Congress passed to restore TA funding almost two years ago to its previous levels only applied for that year and didn’t apply for funding going forward and this administration has kept that number secret. So I think the situation is volatile. There are fewer people enrolled and we just hope to continue to do a good job and keep our returning students enrolled towards the degree and pick up our share of new students.

Got it, okay. Fair enough. And just last one from me. I know in the past you mentioned of some new degree offerings that you are developing. Is there any update you can give us on some of the programmatic changes if any that you’re looking out for the rest of the year?

I don’t. I can’t recall after top of my head when we – we usually use a press release for announcing new degrees when they are approved, but I certainly don’t have any stats in front of me as far as what the current enrollments are for anything that we introduced in the first six months or the last six months rather so. Perhaps we could follow that up next quarter when we talk about our numbers.

Sure. All right. Thanks so much.

Thank you. And our next question comes from the line of Peter Appert of Piper Jaffray. Your line is now open.

Thanks. I think maybe it was Rick, you said you were more confident, I think you said, more confident in the start outlook at this point, which seems to be a little bit of, I guess, a disconnect with the expectations for the quarter. I’m wondering if there are specific metrics you’re seeing that you could share with us that give you that confidence.

Rick, did you say that?

So I think we’re…

Well, I think, Peter, I don’t remember saying it. First of all, the second quarter is typically, always from a seasonality perspective, a little less than the first quarter, our first quarter is a little more robust. But I would say, if you go out beyond – we’re not giving any outlook beyond the second quarter, but we believe that with the admissions assessment, the year-over-year comparison for the reductions in enrollment related to that should look better come third and fourth quarter. But I think at least in my script, we talked about there is increased competition, there is volatility to TA market and we’re trying to do the best that we can to market with creative means to keep the budget, we’ve always had this figure of 20% of revenues that we try to keep our marketing budget under and respond to all the outside competition and then another noise in a manner that’s prudent bringing in quality students. But I would say that – I wouldn’t say it’s very predictive at this point.

Sure. Would the – so I know that the bad debt expense helped a lot in the current quarter, the selling and promotional expense and marketing expense, is that down on a year-to-year basis [indiscernible] that’s not in there anyway, but selling and promotion being down year-to-year, I’m wondering if that has some bearing in terms of the weaker current start trends?

Well, actually, typically the marketing spend is more in – starts from more influenced by marketing spend in the previous quarter. So this year versus last year, I would tell you that we’ve been experimenting since I believe it was August of 2014, but Rick is going to correct me if I’m wrong, in much more targeted ways of trying to find quality students. So it could – a simple explanation for the first quarter a year ago versus the first quarter of this year in marketing difference could be that we tried something and it didn’t work, so we decided we’re not going spend money on it this year.

All right. I guess – well, I just keep back to the fact that you’re cutting the spend, you’re getting the margin benefit, but it’s seems like it’s at the expense of revenue, right. So, it seems like –

Well, I would – I mean, I would disagree. If you look at our returning students in FSA versus our new students, here the new students are down, but I would say that most of that differential is students, so we didn’t believe met our quality standards for continued persistence. So we – Peter, if I could find the perfect formula to find 100% quality students who would persist and graduate, I would spend a lot more money. But it’s, we’re totally online. We have a brand that’s only 20 some years old and it’s – when you’re competing in the non-traditional marketplace and there’s a lot of people – lot more people competing online than before, we continue to experiment how to do it in an affordable manner. But at the same time, you also have to be very conscious and cognizant that if you increase your spending in Google, which is a bid process, you may increase the cost per student in the seat far more overall than you wanted to. So there is a sort of – your search engine optimization folks are experts in saying we really can’t push these key words or these key adds anymore because it’s going to take us to a number that we don’t an acceptable ROI on.

Okay, understood. And then on Hondros, in terms of the curriculum changes that you outlined to be more in line with the accreditor requirements, was that something that – were you out of line with competitors, are you ahead of the game in terms of tightening standards relative to your competitors.

I think we’re ahead of the game. The handwriting is on the wall that I can’t remember whether it was a proposal by the Department or a proposal in Congress, but a proposal that institutions that offered programs that had programmatic accreditation should obtain that programmatic accreditation. So while we had institutional accreditation, we only had programmatic accreditation for one of the programs there. So we said, let’s get ahead of this. Let’s not wait till they legislate it. Let’s go for programmatic accreditation and we decided the sooner the better.

And then last thing, anything due on geographic expansion for Hondros?

Not at this point in time. The good news is we received our final change in ownership approval. So at this point, that option is there legally. So we would have to submit an application to the Department and they have so many days or months, I forgot the exact number. I think it’s 60 days to review the application and let us know.

Thanks, Wally.

Sure.

Thank you. [Operator Instructions] And I’m showing no further questions at this time. I’d now like to turn the conference over to Chris Symanoskie for closing remarks.

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

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.