American Public Education, Inc. (APEI) Q2 2019 Earnings Report, Transcript and Summary

Good afternoon. My name is Chavez and I'll be your conference operator today. At this time, I would like to welcome everyone to the American Public Education Second Quarter 2019 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session [Operator Instructions]. Thank you. I would now like to turn the call over to Chris Symanoskie, Vice President of Investor Relations.

Thank you, operator. Good evening and welcome to American Public Education's discussion of financial and operating results for the second quarter of 2019. Materials that accompany today's conference call are available in the events and presentation section of our website and are included as an exhibit to our current report on Form 8-K furnished with the SEC earlier today. Please note that statements made in this conference call and in accompanying presentation materials regarding American Public Education or its subsidiaries that are not historical facts may be 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, statements regarding expected growth, expected registration and enrollments, Navy tuition assistance funds, expected revenues, expected earnings and plans with respect to recent, current and future initiatives, including information technology replacements and upgrades and 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 most recent 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 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, I'll turn the call over to Dr. Boston.

Thanks, Chris. Good evening, everyone. As we begin today, I'd like to comment on the quarter at a high level. While the quarter met our expectations, we were by no means satisfied with the results and remain focused on aggressively pursuing our improvement initiatives. Today you'll hear about the challenges we faced, but even more about how we're addressing each in a way that we believe will pave the way for improvement and sustained success. We remain focused on strengthening the core business at APUS and repairing the business at Hondros, while maximizing the inherent value on our existing assets. We will continue to be results focused both in the near and long term. I will also discuss possible future investment in our information technology infrastructure and the second quarter's operating results at a high level before our CFO, Rick Sunderland will walk you through APEI's recent financial results and our outlook for the third quarter of 2019. With that, let's proceed with our discussion of Hondros. Hondros College of Nursing, or HCN, is facing two primary operational challenges. One, achieving satisfactory enrollment in new and returning students. And two, meeting the applicable standards of our regulatory and accrediting bodies. To overcome these challenges, we have opened additional pathways to degree attainment as well as work to identify the appropriate balance of academic achievement requirements, admissions requirements and attracting appropriate students. One new pathway to degree obtainment is our new direct entry associates degree in nursing or ADN option which we will launch this fall. HCN's direct entry ADN option provides an additional way for successful college ready students to enroll, complete a degree and enter the nursing profession in as few as 15 months when attending full time. Acceptance in the program requires a prospective student to take an entrance exam, transfer at least 32 semester credits and possess a 2.5 GPA or higher from prior college experience. We believe the program is ideal for students with no prior nursing experience or with some college experience or non-nursing degree, who are seeking the opportunity to change careers and begin a nursing program. We think this new option will help HCN reach its enrollment goals of achieving sequential increases in new student enrollment, strengthen total student enrollment and improve retention rates in first time NCLEX pass rates by attracting working adults from non-nursing professions who have already demonstrated successful academic performance. Since appointing Harry Wilkins as Interim CEO at HCN in May. I am pleased with his team's progress in performing a thorough analysis of the college and its operations. They are already making important changes to improve the financial and operating performance of the institution. These changes include but are not limited to upgrading HCN's enrollment management processes with new sales force and Enrollment RX software, fine tuning the staffing model by adjusting customer service staff hours to include week evenings and weekends, optimizing marketing with enhanced geo targeting and new referral based marketing campaigns, and enhancing financial services by launching new scholarships and payment plans for approval -- to recruitment and retention, as well as to lower bad debt expense. In addition, the team performed a comprehensive course by course analysis, made changes to optimize teaching and better align curriculum with NCLEX exam content and created a more personalized academic experience, especially for at rest students. HCN continues to prepare for the opening of a new campus location. We signed a lease and are building out a new campus location in Indianapolis, Indiana. The economics of opening a new campus are attractive given the relatively low capital investment required. Properly located and managed, the new campus can reach cash flow break even within 18 to 24 months. Our discussion of new campus locations merit some discussion, given the work that Harry and the team are doing at HCN to improve the health of the institution. While we believe there is great opportunity for new campus locations beginning with Indianapolis, we will monitor our existing programs and locations before carefully considering the timing of future investments. I'm optimistic about a timely turnaround of HCN because of the quick and smart actions of the current team at HCN as well as because of the continuing strong demand for nursing education. In the third quarter of 2019, APUS escalated plans to evaluate possible replacements or upgrades to its information technology and learning management systems. The initiative is expected to lead to an information technology transformation program intended to increase the enterprise's agility and enhance the university experience for students. In addition, if we proceed, the goals of the longer term effort will include enabling our systems to better accommodate flexible learning modalities such as dual degrees, competency based education and custom programs for partnerships. The initial evaluation phase of this initiative will determine the final scope, duration and estimated cost of the project. Moving onto operational results for the second quarter of 2019, APUS reported a year-over-year decrease at new and total net course registrations of 2% and 1% respectively. The decreases were driven by year-over-year decline of 9.7% in net course registrations by new students utilizing Federal Student Aid, or FSA. A decline of 8.4% in net course registrations by new students utilizing veterans' benefits or VA. And a decline of 5.7% in net course registrations by new students utilizing cash and other sources. These declines were partially offset by 5.7% increase in net course registrations by new students utilizing DoD tuition assistance or TA. As of May of 2019, The Navy reported that its Tuition Assistance program funds had been exhausted for the balance of its fiscal year ending September 30, 2019. The Navy is the only branch of service to have suspended its TA program funds and we expect the funds to be reinstated at the start of their next fiscal year. Although some Navy students may be Pell eligible, we anticipate this event will have a negative impact on our third quarter results and to a lesser extent, our fourth quarter results. For context, Navy TA registrations at APUS represented approximately 6.5% of total registrations for the three months ended September 30, 2018. I'm pleased to report that according to data provided by the Department of Defense, AMU maintains its number one position in the TA market. Having provided approximately 17% of all TA courses in FY 2018 the year, the latest data is available for a leadership position comparable to the prior year. At HCN for the three months ended June 30th of 2019, total student enrollment declined by 24% year-over-year and new student enrollment decreased by approximately 35% year-over-year. As mentioned earlier, I believe the team at HCN has an effective plan in place, to improve the overall health and reputation of our nursing platform. As a result of their confidence in the plan. We have decided to increase HCN's advertising spend in the third quarter in support of our goal to achieve a sequential increase in new student enrollment and a strengthening of total student enrollment in the fourth quarter of 2019. A strong fall start would position HCN for improved operational performance in 2020. In conclusion, in APUS, we have built a respected higher education enterprise based on our core belief that higher education should be flexible and affordable. Approximately 70% of our APUS alums graduate with no student loan debt incurred at APUS. Few title for institutions can say this. In 2002, we celebrated the success of a 107 graduates. And in May of 2019, I presided over the graduation of over 11,000 students, bringing the total number of AMU and APUS alums to more than 90,000. We achieved this success during a time of rapid transformation in higher ed, as well as during a period of unprecedented regulatory change and economic volatility. We recognize the strengthening in the core business at APUS and repairing the business at HCN is a mere step, but a critically important step toward maximizing the inherent value in our enterprise and building a higher education institution that serves the needs of working professionals as job skills and nature of work itself rapidly evolve. Now, I will turn the call over to our CFO, Rick Sunderland. Rick?

Thank you, Wally. Going on to Page 3 in the PowerPoint, American Public Education's consolidated revenue for the three months ended June 30, 2019 decreased 3.1% to $70.6 million, compared to $72.8 million in the prior year period. The revenue decrease was primarily due to a $2 million or 21.6% revenue decrease of Hondros. For the quarter, APUS revenue declined $0.2 million or 0.4%. Total cost and expenses were $64.9 million for the three months ended June 30, 2019, compared to $64.8 million in the prior year, an increase of $0.1 million or 0.2%. Consolidated instructional costs and services expenses decreased approximately $0.3 million to $28.7 million and as a percentage of revenue increased to 40.7% compared to 39.8% in the prior year period. The decrease in instructional costs and services expenses was primarily driven by a decrease in employee compensation costs and instructional materials costs in both our APEI and HCN segments. Selling and promotional expenses increased approximately $0.8 million to $14.1 million, and as a percentage of revenue increased to 20% of our revenue compared to 18.2% in the prior year period. The increase in selling and promotional expenses was primarily driven by an increase in advertising costs in our APEI segment. General and administrative expenses increased approximately $0.5 million to $18.1 million and as a percentage of revenue increased to 25.7% from 24.2% in the prior period. The increase in general and administrative expenses was primarily related to increased information technology cost in our API segment and employee separation costs in our HCN segment, partially offset by a decrease in professional fees in our API segment. Consolidated bad debt expense was $0.9 million in both quarterly periods and as a percent of revenue, 1.3% of revenue in 2019 compared to 1.2% of revenue in 2018. Depreciation and amortization expenses decreased approximately $0.4 million to $3.9 million and as a percentage of revenue decreased to 5.6% of revenue from 6% in the prior year period. The $2.4 million or 29% decline in consolidated income from operations before interest income and income taxes was driven by a decrease in income from operations before interest income and income taxes at Hondros. For the quarter, the loss from operations before interest income and income taxes in Hondros was $0.9 million, compared to income from operations before interest income and income taxes of $0.9 million in the prior period, a year-over-year decrease of $1.8 million. In our API segment, income from operations before interest income and income taxes decreased $0.6 million or 8.1% primarily due to higher advertising and information technology costs in the current year period. API segment operating income margin declined to 10.4% in the current year period, compared to 11.3% in the prior year. Driven by the operating loss at Hondros, consolidated operating income margin declined to 8% in the current year period, compared to 11.1% in the prior year. Consolidated net income for the quarter was $4.9 million or $0.30 per diluted share compared to net income of $6.5 million or $0.39 per diluted share in the prior year period. Cash flow from operations increased 21.2% to $23.7 million, compared to $19.6 million in the prior year. Accounts receivable decreased by $7.6 million compared to December 31, 2018, driven by improved payment processing in both TA and VA. Total cash and cash equivalents as of June 30, 2019, were approximately $220.8 million compared to $212.1 million as of December 31, 2018. During the quarter, the Company repurchased 327,467 shares of its common stock for $9.6 million under the previously authorized $35 million stock repurchase plan. At June 30, 2019, 25.7 million remains under our share repurchase authorization. Capital expenditures for the quarter were approximately $3 million, compared to $3.6 million in the prior year period. Going on to Page 4, third quarter 2019 outlook, our outlook for the third quarter of 2019 is as follows. In the third quarter of 2019, we expect consolidated revenue to decline between 11% and 7% year-over-year. The Company expects diluted earnings per share between a loss of $0.02 and income of $0.03 per deluded share in the third quarter of 2019. The EPS range indicated by our third quarter guidance is impacted in part by the enrollment decline at Hondros that has a significant impact on that unit's operating income. We anticipate a year-over-year decline in HCN segment operating income of approximately $2.4 million in the third quarter of 2019 compared to the third quarter of 2018, driven in part by the higher advertising spend mentioned by Wally. In addition, the following will impact operating income and operating income margin in our API segment in the third quarter of 2019. Number one, APUS estimates that the temporary suspension of Navy's TA program funds, will result in a loss of approximately 4300 net course registrations in the quarter. The revenue impact of this disruption in Navy TA funding is expected to be approximately $2.9 million. Number two, we anticipate the evaluation of technology upgrades and possible replacements will cost $1.2 million pretax. And number three, APUS plan to increase its advertising spend by approximately an additional $1.8 million pre-tax as compared to the prior year period. In APUS, total net course registrations are expected to decline between 10% and 5% year over year, and net course registrations by new students are expected to decline between 17% and 12% year over year, both impacted, of course, by the reduction in Navy TA registrations. Excluding the anticipated loss of net course registrations, resulting from the disruption in Navy TA funding, new and total net course registrations would have been approximately 6 percentage points higher for new and 5 percentage points higher for total than third quarter guidance year over year. At Hondros, both new and total student enrollment will decrease by 29% year over year in the third quarter of 2019. As Wally noted earlier, enrollments at Hondros were adversely impacted by changes in admissions processes, academic achievement policies and market perceptions. However, as noted, Hondros has launched several initiatives to improve the overall performance of the institution and importantly, has set a goal to achieve a sequential increase in new student enrollment and a strengthening of total student enrollment in the fourth quarter of 2019. 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 Corey Greendale with First Analysis.

Hey, good afternoon.

Hi Corey.

Two questions, so first. Hey, how're you doing? First question is easy and apologies, this is repetition. But I just missed the number, Wally, that you provided for the change in new student registrations from FSA, if you could just repeat that one.

Are you talking about guidance or for the second quarter?

For the second quarter.

Yeah, second quarter, Corey, new was down 5.7%.

5.7%, thank you.

I'm sorry. It's 9.7%, Corey.

9.7%, thank you.

For FSA.

Got it. So few questions, maybe first on Hondros. The -- in terms of -- there's some language in the Q and you somewhat alluded to it about market perceptions and something about perceptions on the ground, there. I was just hoping, if you could elaborate on that -- what that is and what you're doing to improve that.

Sure, we have basically been -- we flat-lined at a NCLEX pass rate for first time test takers for our ADN program, our RN program at a number that was below the level that the State of Ohio wanted us to be at, which is 95% of the national average. We -- the Board and I were not happy with that. So we wanted to look at -- we asked our academic team to look at ways in which we can improve the rate. And so a number of things that they put in place were practices followed by other schools, including administering an additional admissions test up front, a test called the ACCUPLACER , which is not uncommon. We were using the HESI and instead, we added the ACCUPLACER as well as putting in different standards for minimum passing grades on lab courses. And so when those changes went in and the last one went in and starting in the first quarter in January, it was very negative reaction across the board with prospective students. And some of that was caused by returning students who weren't happy with the changed passing requirements for the lab courses, which are very helpful toward passing the NCLEX exam. And so, that was our first quarter decline, which we obviously reported on. And we began looking at ways in which we can improvement -- and prove it. And when some of those ways, which, by the way, changes in test results and passing standards and other requirements may have to get approved by the Ohio Board. And so typically, if you're going to make a change, you've got to do, you've got to notify them a quarter in advance of when you're going to make a change. So you can't make these changes overnight. And so when our teams' recommended solution didn't work, starting in the second quarter in April, I decided in May to make a leadership change and we brought Harry Wilkins back. And so Harry -- been working with the team, many of whom he knew from his previous three years as the CEO and, put a number of changes in place, including evaluating the entire curriculum, where some of the speed bumps were in courses for students that was causing some of the negative reaction and basically spending a lot more time with students at the campus locations, listening to them and trying to alleviate some of those perceptions that were out in the community. So it's not cured yet, but I believe that he and his team with this, deliberate measured pace of analyzing and then visiting all of the campuses, including making a campus director change at one campus, I think are progressing and, it's sad that this occurred, particularly when the impetus for the changes was to get a higher pass rate, by the way, the pass rates are improving. But at the same time, its impacted enrollment much more negatively than we wanted. So we're working to build a balance between what the right curriculum is -- what the right evaluations are and how to make sure that our students succeed.

Very helpful, thank you. And just sort of in light of those. It sounds like there are steps in place that should lead to improvements, obviously in terms of the enrollment, it hasn't happened yet. So as you think about geographic expansion, I guess are you committed to Indianapolis and are you seeing enough in the data to suggest, it is bottoming that it makes sense to start expanding geographically before you have more confidence that the model stabilizes or just can you -- just kind of elaborate on your thinking?

No. It's a great question. In fact, we don't have a specific start date, but we did have a date. Our application had been with the state of Indiana for quite a while. I think about 18 or -- 18 months to 24 months and there was a lag because you may recall the previous administration changed out ACIC. It made all schools move over from ACICS to another accreditor and while we were in that process, we couldn't add locations, so we'd already put our application in place, we had the delay. The state understood that. Once we got a new accreditor in place, we had six months roughly to make a go, no go decision on it. We like the location, we like the state, we like all the demographics. So we signed a lease, and part of the state's process is you actually have to have your campus build up before they'll give you your license and authorization to open up a class. So our goal is to have that campus build up done by November, at the same time, our current plans don't have a starting and opening up term until the second quarter of next year. And if we're not feeling good about how we're progressing elsewhere, Corey, we can always delay that. We could push it back. But we did have to sign our lease in order to keep the authorization from expiring.

Yeah understood. I have some additional questions but I'll go back in queue and ask if no one else ask them. Thank you.

Okay.

[Operator Instructions] And we have another question from Corey Greendale with First Analysis.

All right. Well.

All right.

So I will just keep going then.

Sure.

So the next question I had was on the -- the APUS segment and understand the effect of the Navy, and I know this kind of thing has come up, this general sort of thing has come up before. If you back out the impact of the Navy, it sounds like the new course registration trend is still a little bit more negative than it was in Q2. So what else are you seeing that is softer in Q3 versus Q2?

Well, one thing we're seeing, we made a choice this year to really focus on putting our marketing dollars, given the increased competition everywhere with online. Where we could achieve a student enrollment for $2000 or less. And so that meant that we were spending more money on our military segment than our civilian segment. And so one of the things that did to us was it lowered our average number of registrations per student overall because the military students take fewer registrations per year than the civilian students. So that number in terms of net registrations through June 30th is approximately 2000. Right, Rick. And so we're seeing that. Cory, I can't quite fine tune it for what it will be in the third quarter because we don't exactly project our registrations by payer source. We look at them in the aggregate but we just don't fine tune them that much. But if you know that it was 2000 down on the net simply due to the ratio difference, TA was up for the first six months. But by virtue of TA being up, it's a lower number of net registrations per student on average. It's been that way. Historically, FSA students have to be at least half time TA Students are allowed to take one course only. And because of that differential it was 2000 down in the first. And it's going to be a similar negative number down just simply because of the mix in the third quarter.

It is very helpful, thank you. And as the decision to increase selling promotional expense for APUS. Does that mean that you're willing to accept a higher cost per student registration or does it mean you're focusing kind of on different areas?

No. It does mean we're willing to accept something slightly higher. And part of the issue is that when you have monthly starts, where you're bringing in students every month, where we have this temporary suspension of TA funding by the Navy. If we don't bring in students to replace them, then we're not going to have returning students in subsequent quarters. So it's just prudent to spend that extra money. We looked at the ROIs and the pluses and minuses and where to spend it. So we're more than likely and that incremental spend is going to be spending more than the $2000 . But it's because we want to bring in some new students to try and replace the new student lost by the Navy.

Got it, obviously, one more and then we can follow-up offline. In terms of the potential scope of the technology transformation plan, it sounds like it at least could relate to the LMS. What can the scope be, could it hit your ERP system, your CRM or what pieces of technology you're looking at?

Yeah, I would say just from a big picture perspective. We're looking at the LMS, we're looking at the SIS, which are SIS pad is homegrown and we're also looking at the CRM. So those three systems are pretty large, pretty transformative and very few people engage in a project. But we think, it's about time when you look at -- we're probably the largest user of SECIA that's our existing LMS out there. It's open source, it served us well. But there's a number of advances, particularly as it relates to accommodating some of the alternative modalities of instruction like CBE, that the newer LMSes can handle quite capably. And then CRM is really dependent on what we do with the SIS.

Okay, great. Very helpful. Thank you.

And our next question comes from Greg Pendy with Sidoti.

Hey, guys, thanks for taking my question. Can you just help us understand. I guess, just on Hondros, just with the requirement now to take that, I guess, ACCUPLACER exam. How many nursing schools, I guess in the area probably don't require that. I am assuming that, in a competitive environment, some students may just choose another nursing school. So how common is that requirement?

Actually, the ACCUPLACER requirement that we put in place in January was a pre-test requirement and not something that was normally done by the for profit schools. And so when we did that, we had students who were just test averse, because it's a three or four hour exam. They didn't want to do it and they went elsewhere where people were not administering it. We've changed that, we actually changed that requirement and we're still administering as a baseline. But we've built it into the first term courses, and so that way we can have the baseline so we can diagnose how well the students are performing and learning. But not making a pre-admission requirement. And so that's working, but it's still going to take a while to get the word out in the community that were no longer requiring that as a pre-test.

Got it. That's helpful. Thanks.

And there are no further questions at this time. I'll turn the conference back over to Chris Symanoskie.

Thank you, operator, that will conclude our call for today. We wish to thank you for listening and for your continued interest in American Public Education. Good evening.