American Public Education, Inc. (APEI) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for your patience. You’ve joined the American Public Education Q2 2016 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 be given at that time. [Operator Instructions] I would now like to turn the conference over to host Vice President of Investor Relations Mr. Chris Symanoskie. Sir you may begin.

Thank you, Operator. Good evening, and welcome to the American Public Education conference call to discuss financial and operating results for the second 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 statements for any reason unless required by law, 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. Now at this time, I’ll turn the call over to Dr. Boston. Mr. Boston?

Thank you, Chris. Good evening, everyone. I would like to begin today’s call with a summary of our recent results and a review of the progress we’ve made with respect to our long-term goals. Then our Chief Financial Officer Rick Sunderland, will discuss our second quarter financial results and provide perspective on the Company’s outlook for the third quarter of 2016. Moving to slide number 3, in the second quarter of 2016, net course registrations at APUS declined 8% compared to the prior year. Although net course registrations by new students declined 22% year-over-year, net course registrations by returning students decreased only 5% compared to the prior year period. We believe that the difference in the rate of decline in net course registrations by new students and that of returning students relates at least in part to improvements in our quality mix of students. For the three months ended May 31, 2016, the first course pass and completion rates of undergraduate students using Federal Student Aid at APUS increased 28% year-over-year, this is the highest such rate since October of 2010. We believe the continued improvement in this and other metrics is a possible indicator that our efforts to attract and retain students with greater college readiness are working. The overall all decline in net course registrations by new students at APUS was primarily driven by a 38% year-over-year decrease in net course registrations, our new students using Federal Student Aid or FSA. We believe this decline was the result of our efforts to improve our quality mix of students through our admissions processes, marketing and multiple financial aid disbursements to first time APUS undergraduate students as well as to an increase in competition for new online students. Net course registrations by new students using military tuition assistance or TA decreased year-over-year by 17% compared to the prior year period. We believe this decline is the result of changes in how the TA program is being administered by the Department of Defense as well as other possible factors. Additional changes to TA program administration, troop reductions, deployments and access to military bases could adversely impact net course registrations in the future. Net course registrations by new students using veterans benefits decreased 1% year-over-year and net course registrations by new students using cash and other sources decreased 7% compared to the prior year period. We believe that the various efforts aimed at improving our quality mix of students has helped reduce bad debt expense which has decreased to 2.3% of revenue in the second quarter of 2016, compared to 4.9% of revenue in the same period of 2015. In the second quarter of 2016, enrollment at Hondros College of Nursing declined 8% and new student enrollment declined 13% compared to the prior year period. We believe Hondros’ enrollment has been adversely impacted by strengthened completion requirements in its diploma in practical nursing program or PN program, which is the primary source of students for its associate degree in nursing program or ADN program. And curriculum changes implemented in January of 2016 designed to conform the associates degree in practical nursing programs to programmatic accreditation standards. We believe the transition of these changes resulted in fewer students choosing to pursue their PN studies at Hondros. We are unable to predict how long this trend may continue. In 2016, Hondros was notified that is PN and ADN programs have been granted pre-accreditation candidacy status by the National League for Nursing Commission, for nursing education and accreditation effective through June 23 of 2019. Hondros’ locations and programs are approved by the Ohio State Board of Career Colleges and Schools and the RN-to-BSN Program is approved by the Ohio Department of Education accredited by the Commission on Collegiate Nursing through June of 2018. In addition, to PN and ADN programs are approved by the Ohio Board of Nursing or OBN, in July of 2016, the OBN voted to extend full approval for Hondros’ PN and ADN programs to November 2017 and May 2018 respectively. It has been widely reported that the Department of Education may no longer recognize Accrediting Council of Independent Colleges and Schools, or ACICS, as an institutional accreditor that can provide schools with accreditation that makes them eligible for participation in the Federal Student Aid program. We believe that the risk of a change in status of ACICS, has had a negative impact on enrollment and revenue at Hondros. This risk has also led the team at Hondros to initiate a process to evaluate and seek alternative institutional accreditation. We continue to evaluate our options with respect to institutional accreditation for Hondros and contemporaneously with that evaluation have begun the process for pursuing accreditation with another national, institutional accrediting agency. The team at Hondros has been working diligently to overcome various challenges. We believe their efforts have lead to initial signs of improvement and persistence. Furthermore I'm pleased to announce that Hondros has received approval from the Department of Education to open a new campus in suburban Plato which we expect, we’ll welcome the first class of students in early 2017. Hondros colleges committed to remaining at the forefront of job preparedness, by teaching practical skills using simulations, real world instruction and inaccessible concept-based curriculum. We believe the new campus and the recent changes we have made support Hondros College’s efforts to advance the careers of professionals in the nursing and allied healthcares. Moving on to slide number 4, as previously noted our long-term plan for APUS includes several important initiatives aimed at achieving two critical near-term goals, one to increase student persistence and two to stabilize enrollment at APUS. We will continue to focus on improving persistence and student satisfaction to get higher levels through use of our new classroom tools, additional enhancements to APUS Mobile and the expansion of our use of CIVITAS. Predictive analytics tool that helps increase 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 and increasing referral rates and ultimately improved overall operational and financial performance. In addition to improved persistence, we've also set a goal of stabilizing enrollment through initiatives aimed at attracting students with greater college readiness. In the second quarter of 2016, we’ve continued with our targeted advertising and work to further improve the application and the assessment processes to improve conversion rates. For example, I'm pleased to report in the second quarter of 2016, the application completion rate for prospective students who accessed our application for enrollment more than doubled compared to the prior year period. Improving the application process was one of our stated goals for the year. Such efforts to improve the enrollment process are also aided by the strength of the relationships, we have with the communities we serve. In the military for example AMU was recently highlighted in Military Times magazine annual ranking of top schools most frequently selected by military and veteran students. In addition I am pleased that APUS continues to develop new strategic relationships including with several public service organizations, associations incorporations during the second quarter of 2016. In this 25th year since our founding I think it's important to take stock of the many accomplishments that have made APUS a University of National Significance. Since our founding we have served the military and veteran communities with distinction. We have honored our commitment to students by keeping tuition affordable. We received the recognition of others including the online learning consortium and other third-party stakeholders. We have implemented innovative solutions to improve student outcomes and improve the online learning experience. And our 20th annual commencement in June, we recognize the accomplishments of nearly 11,000 AMU and APU graduate at ceremonies in National Harbor, Maryland and via live webcast. We are pleased that the class of 2016 will join the APUS global online network of more than 60,000 runs worldwide. Going forward we intend to pursue APUS’s long-term goals with the same passion and creativity that drove our initial success. We will fulfill our purpose in part through investments in education technology and entering new degree fields in areas of study. In addition we plan to advance both APUS and Hondros by positioning them to overcome tough marketplace challenges and addressing the growing workforce development requirements of our nation while providing student’s a rich and engaging learning experience, advancing their careers and improving their lives. At this time I will turn the call over to our CFO, Rick Sunderland. Rick?

Thank you, Wally. American Public Education’s second quarter 2016 consolidated financial results include a 4.5% decline in revenue to $76.7 million compared to $80.3 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 second quarter, our APEI segment revenue decreased 4.2% to $69.5 million compared to $72.6 million in the prior year period. The decline in APEI segment revenue is the result of the decrease in net course registrations, partially offset by increased revenue from the July, 2015 tuition increase. Hondros segment revenue decreased 6.1% to $7. 2 million in the second quarter of 2016 compared to $7.7 million in the same period of 2015. The decline in Hondros segment revenue is due to a decreased enrollment at Hondros. On a consolidated basis, costs and expenses decreased 3.8% to $66.1 million compared to $68.7 million in the prior year period. The decrease is primarily due to a decrease in our API segment, bad debt expense and advertising expenses. On a consolidated basis, operating margins decreased to 13.9% in the second quarter of 2016 as compared to 14.4% in the prior year period. The decrease in operating margin was primarily due to a lower operating margin at Hondros, the year-over-year decrease in operating margins is due to expenses decreasing at a rate less than the decrease in revenue. For the second quarter, consolidated instructional costs and services expense or ICS as a percentage of revenue was 38% compared to 37% in the prior year period. The year-over-year increase as a percentage of revenue is due to revenue decreasing at a rate greater than a decrease in ICS costs. Selling and promotional expense or S&P as a percentage of revenue decreased to 19.5% of revenue compared to 20.1% in the prior year period. Year-over-year S&P cost decreased 7.2% to $15 million compared to $16.2 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 22.3% from 22.6% in the prior year period. Our G&A expenses decreased 5.8% to $17.1 million compared to $18.1 million in the prior year. The decrease in G&A expense was largely the result of a decrease in our API segment bad debt expense partially offset by an increase in compensation costs. For the three months ended June 30, 2016, bad debt expense decreased to $1.8 million or 2.3% of revenue compared to $3.9 million or 4.9% of revenue in the second quarter of 2015. We believe the improvement in 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 decreased 7.9% to $10.7 million compared to $11.6 million in the prior year period. In the second quarter, net income was $6.6 million or $0.41 per diluted share compared to $7.1 million or $0.42 per diluted share in the prior year. Total cash and cash equivalents as of June 30, 2016 increased by approximately $18.4 million to $124.1 million with no long-term debt. Capital expenditures were approximately $6.9 million for the six months ended June 30, 2016 compared to $12.8 million in the prior year period. The decline in capital expenditures is a result of a decrease in building costs related to our IT center in Charles Town and a reduction in software development costs. Depreciation and amortization was $9.7 million for the six months ended June 30, 2016, compared to $9.3 million in the same period of 2015. Going on to Slide 6, third quarter outlook, our outlook for the third quarter of 2016 is as follows; APUS net course registrations by new students in the third quarter of 2016 are expected to decrease between 27% and 23% year-over-year. Total net course registrations are expected to decrease between 13% and 10% year-over-year. We believe these declines will primarily result from increased competition for students as well as the admissions process initiated last year. In addition, we expect net course registrations by students using TA may be adversely impacted by ongoing challenges related to base access and impacts related to the new enrollment management tool implemented by the army in December 2015. In the third quarter of 2016, total student enrollment at Hondros is expected to decrease approximately 11% year-over-year and new student enrollment is expected to decrease by approximately 20% year-over-year. We believe that enrollment in the third quarter may continue to be adversely impacted by the January 2016 curriculum change, which we believe resulted in fewer students choosing to pursue their studies at Hondros particularly in the RN-to-BSN Program as well as strengthened completion requirements in the PN program, which is a primary source of students for the ADN program. These and other changes were made with the long-term goal of further improving student outcomes, academic quality and operational efficiency. For the third quarter of 2016, we anticipate consolidated revenue to decrease between 6% and 3% year-over-year. Net income for the third quarter of 2016 is expected to be in the range of $0.26 to $0.31 per fully diluted share. Although efforts to improve our quality mix of students may have in part contributed to the decline in net course registrations in revenue, we believe that such efforts have had a positive effect of lowering bad debt expense, increasing persistence and improving the learning experience for our students. Furthermore, we believe that our focus on quality and on attracting and retaining students with greater academic readiness will ultimately lead to even greater stability and improved financial performance in the long run. Now, we'd like to take questions from the audience. Operator, please open the line for questions.

Thank you, sir. [Operator Instructions] Our first question comes from the line of Peter Appert of Piper Jaffray. Your line is open.

Thanks, good afternoon. So Wally, I think the student enrollment declines that you're projecting suggests that revenue growth is going to continue to decelerate. So my question is how much more flexibility do you think there is on the cost side of the equation. Do you have comfort that you can maintain margins somewhere near the mid-teens levels they're running at currently?

Good question, Peter. I think that we have not a highly fixed model. We do have some fixed costs. So at certain stages, we may need to make adjustments for that, but for the most part, we're flexible on things like comp – equity compensation and direct student costs such as textbooks follow with revenue declines pretty directly. So I think we've done a good job of monitoring those and managing those over the past with a periodic look back to where the enrollment is.

Okay. And then on Hondros, I hear what you're saying about the changes curriculum, these other initiatives you've made to improve outcomes, but the changes in curriculum in particular, is this basically just to put you in line with industry peers. Do you feel your – you are now at a more rigorous, offering more rigorous program than peers. I’m just wondering how it changes your competitive positioning.

Sure. We had seen a number of proposals that, that have not been put into place yet that institutions offering career programs would have to pursue specialty accreditation. So we made a decision that because specialty accreditation academically is perceived as a higher level of accreditation that we would pursue specialty accreditation in all the degree programs that we’re capable of doing that for at Hondros. And so I don't believe that all of our competitors have the specialty accreditation that we're pursuing. I think some do, but we made the decision that we rather be ahead of the curve and force the regulation to do it afterwards.

Got it. And any specific implications associated with a new campus in Toledo, are there significant costs that might move the needle over the next couple quarters associated with that.

I'll let Rick answer that question. We're actually pleased that we finally got the approval for it. But I’ll let Rick answer the question of that cost. Rick?

Yes. I don't think its material. I think at the top end it's probably $0.01 to $0.02 in each of those quarters. We do think that given our modeling we look at that campus to breakeven sometime in kind of 18 months timeframe from when we open which will be right now is expected to be early 2017.

Got it. And any thoughts in terms of additional campuses beyond Toledo then.

I think we’ll take them one at a time, but our plan when we originally purchased Hondros was to take a small organization that had the overhead and capability to expand and where we saw opportunities, we would try to expand. So I think, we continue to look for that level of expansion.

Got it. Thank you.

Thank you. Our next question comes from Jeff Silber of BMO Capital Markets. Your question please.

Thanks so much. Just wanted to get a little bit more color on your guidance. I'm specifically starting at the top, what is embedded on a revenue per student basis for both of APUS and Hondros.

Jeff, I’ll let Rick answer that.

Yes. So Jeff at APUS it’s about 810 to 815 per student. On the Hondros side, I don't know that I have that metric or that we've given that out before I’m going to pass on that one.

Okay. I'm sorry, you said 10 to 815 was that a range of.

At somewhere Jeff around 810 or 815 on the APUS side.

I just missed the beginning of that. Thank you so much.

Okay, sorry. My fault.

No problem. And then again just going down a little bit further down the income statement, are there any specific expense line items you'd like to call out in order for us to try to get to the $0.26 to $0.31 in earnings.

I think Peter's question about managing costs, Jeff, we – in addition to the direct cost of teaching we’ll also make sure that we keep our marketing costs in line as well. So we try not to exceed 20% in the past. Rick, are there any others.

Yes, I would highlight. I would look at S&P costs which vary within the corridor, but if you look back to the third quarter of last year, it's probably a good proxy for where we think we'll be this year. We’ve been calling out bad debt expense. We see significant year-over-year improvements, but sequentially I think we've sort of gotten to a place where we're not going to see material improvements there. So you'll probably see some consistency. I think those are the ones I would call out.

Okay, great. That's helpful. And in generally I know folks would ask this question every quarter but I'll ask it. From a competitive perspective I know you talked about – only we didn’t talk about this, but maybe we can talk about it for both APUS and Hondros.

I’m not sure specifically what you mean Jeff.

I'm sorry, are you seeing any more competition in your markets.

Well, I think we're seeing more competition everywhere in online. The prices of search terms, the more common search terms have gone up 20% a year for the last two years if not three years. So we're trying to be creative and find ways to generate more organic content as well as continuing to improve our level of student services to keep our referral rate as high as it has been.

And it has a – has that competitive level gotten any worse or better over the past six months or so.

Well, I don't know about specifically six months. I think there have been some issues particularly as it relates to the military, whether it's budget related, whether it's base access related, whether it’s just the sequester, whether it's the pullback in forces with lowering the number of service members or active duty. I think we've seen a number of challenges there over the last six months that hopefully will stabilize in the near future.

Okay, thanks so much.

Thank you. Our next question comes from Corey Greendale of First Analysis. Your question please.

Hey, good afternoon.

Good afternoon.

Hey so, Jeff and I are under contractual obligation to follow-up on each other's question. I want to go back to the first question about the revenue per student and it is so I got the number that you're talking about Rick, but that's a huge year-over-year increase it's up like kind of 11% year-over-year. I'm talking about the revenue per registration at 8 is what. Can you talk a little about what would drive that?

Sure. So there was an 8% tuition increase in July of last year, right. So that didn't – that was registrations made after July 1. So as you know our students can register non-military up to five months in advance. So that didn't fully bake-in in the third quarter. So it’s a small effect associated with that. But Corey I think we've talked in the past about our normalized registrations. And so it will vary quarter-to-quarter based upon when Monday start is, so a start on a Monday that's the first of the month has a greater impact on the quarterly revenue than one that happens at the very end, which would be the eighth day of the month. So I believe there's also some effect associated with that. So that's – it's the combination of those two that are going to drive what you're observing.

Okay. And is there any mix impacts when you look at kind of relative strength to weakness FSA versus active duty.

In terms of the revenue per student?

Yes, just – I think you had a price increase for civilians and not for military.

Right. So what we've been disclosing as the pricing impact. The price increase impacted about 25% of our registrations. So there is a modest, I wouldn’t say its material impact due to the mix change with the FSA of course on our percentage or relative basis going down year-over-year.

Okay, right. That helps. And I just want to come back to the kind of I understand kind of what's been happening over the course of the year. It sounds directionally I think that actually may be getting a little weaker in Q3 and I'm coming from the point of view that I think you anniversaried some of the changes you made in your application process of all people I was expecting the new student decline to kind of narrow somewhat in Q3. So maybe you can just address that a little bit.

Wally, you want to talk…

Yes, I’ll start off. I think we certainly expected in Q3 some of that to come down, but part of the Q3 is actually being driven by TA, seasonally this quarter has been all over the map over the years with the services that they have extra money in their budget. We’ll have good registrations if they don't have extra money in their budget. We’ll have virtually no registrations for September, which is the last month. That's harder to predict now though than ever before because now they are due to budgetary constraints they haven't been allowing registrations more than 30 days in advance. So our Q3 has typically been our lowest performing quarter of the year from a seasonality perspective. But in the case of our projections here more of it is driven by TA than it’s typical. And so I wouldn’t say that while those other things have improved and should be settling down. They're not as big as a driver in this quarters as institutional systems.

Okay. And Wally, do you think going into the beginning of the next federal fiscal year. Is there reason to think to that should get better or does the factor we are in an election year impact that at all?

Yes. Then in the last time we had a presidential election, we didn't get our budget approved till January. So yes, I’m hopeful that doesn't happen, but this may be the most unique year for American politics that I've ever experienced. So I'm not going to try to predict anything Corey – other than we'll try to do business as usual and hope that there's no drastic impact by impasses in Congress.

Understood. All right, thank you.

Thank you. [Operator Instructions] The next question comes from the line of Alex Paris of Barrington Research. Your line is open.

Good afternoon. This is Chris Howe sitting in for Alex Paris. I just had a question around the Toledo campus for Hondros. Just kind of general overview what you saw in the Toledo marketplace that made it so attractive, understanding that it was up for approval with DOE. I just wanted to see how this may compare to some other opportunities that you have in your pipeline or that you are considering.

Sure. This is Wally. I’ll start out and then if Rick has any extra points to add. The state of Ohio is pretty good about projecting shortages in nurses and by major areas Toledo was one of those areas. We had also one or two competitors close locations in the state. One of those locations were that close was, it was in Toledo. And I think it was for regulatory reasons, not because of poor market conditions. And the other thing about Toledo it's actually pretty close to Michigan. In fact a lot of people who fly in and out of Toledo, fly in and out of Detroit's airport. So we like the location. We like the fact that people in that area are familiar with the Hondros brand because it’s been around in the state of Ohio for a while. So we're pretty optimistic that Toledo is a good choice for our next market. Rick, I don’t know if you have anything else.

I’ve just got to mention, Wally, that’s where Manor Care is headquartered, I don’t that any synergy associated with that relationship but possibly, yes.

Thank you very much.

Thank you. At this time, I'd like to turn the call back over to Mr. Symanoskie for any closing remarks. Sir?

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

Thank you, sir. Ladies and gentlemen, that does conclude your program. You may disconnect your lines at this time. Have a wonderful day.