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American Public Education, Inc. (NASDAQ:APEI)

Q1 2014 Results Earnings Conference Call

May 8, 2014 5:00 PM ET

Executives

Christopher Symanoskie - Vice President, Investor Relations

Dr. Wallace Boston - President and CEO

Rick Sunderland - Executive Vice President and CFO

Harry Wilkins - EVP and Chief Development Officer and CEO, Honduras College of Nursing

Analysts

Adrienne Colby - Deutsche Bank

Jason Anderson - Stifel

Jeff Goldstein - JPMorgan

Corey Greendale - First Analysis

Jeff Silber - BMO Capital Markets

Trace Urdan - Wells Fargo Securities

Tim Connor - William Blair

John Crowther - Piper Jaffray

Operator

Good day, ladies and gentlemen. And welcome to the Q1 2014 American Public Education Inc. Earnings Conference Call. My name is Jasmine, and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Christopher Symanoskie, Vice President of Investor Relations. Please proceed.

Christopher Symanoskie

Great. 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 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 future growth, expected registration and enrollments, expected revenues, expected earnings and plans with respect to our investment and in potential partnership with a gain based learning company.

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 filings with the SEC.

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 Chief Executive Officer; and Rick Sunderland, our Executive Vice President and Chief Financial Officer. Also available for questions today is Harry Wilkins, Executive Vice President and Chief Development Officer and CEO of Honduras College of Nursing.

Now at this time, I'd like to turn the call over to Dr. Boston.

Dr. Wallace Boston

Thank you, Chris. Good evening, everyone. Thank you for joining us today. I will start off with an overview of our first quarter results and provide a brief update on the environment and our strategy. Then Rick Sunderland, our Chief Financial Officer, will discuss our financial results and provide perspective on our outlook for the second quarter of 2014.

While the higher education environment remains challenging with continued uncertainty surrounding access, cost, student borrowing, regulatory changes and increase in competition.

We continue to move forward with plans to advance our academic quality, utilize education technology to further improve student outcomes and increase and improve our quality mix of students.

In addition, we continue to make progress on our plans to establish Hondros College of Nursing as a healthcare platform and operate U.S. degree programs to additional international students.

In the first quarter of 2014, APUS net course registrations decline, primarily as a result of continued volatility and softness in enrollment by students using tuition assistance programs administered by the Department of Defense which we refer to as TA.

Net course registrations by new students in the first quarter of 2014 decreased approximately 8% year-over-year, driven by a 21% decrease in net course registrations by new students using TA.

Total net course registrations in the first quarter of 2014 decreased approximately 4% year-over-year, driven by a 10% decrease in net course registrations by students using TA.

The first quarter decline in net course registrations by students using TA was less than the 39% and 35% decline in new and total net course registrations that occurred in fourth quarter of 2013, but reflects continued instability in predicting enrollments from active daily students.

Since our year end earnings call, there were few changes to TA eligible requirements by the services. That said, in late March the army launched a course planner that is required to be use by soldiers to document the courses they plan to take.

We believe that this new requirement is impacting the timeliness of army soldiers enrolling in courses in the second quarter and creating some confusion as soldiers education service officers and voluntary education staff members learn the new processes.

Naturally we would like to see more stabilization in the TA program, but there are no assurances that the program will return to the stability it had prior to 2013. Well, the future net course registrations will not be adversely impacted by continued changes to TA, funding and administration. However, we believe that AMU continues to enjoy the strong reputation for serving the military, despite the challenges we continue to experience with regards to TA funding.

For the quarter ended March 31, 2014, net course registrations by nonmilitary students increased by approximately 3% and 1% in new and total, respectively. More specifically net course registrations by new students using Title IV and VA education benefits increased year-over-year by 3% and 9%, respectively. Net course registrations by new students using cash and other sources decreased 2%.

Total net course registrations by students using VA education benefits increase 14% year-over-year, while net course registrations by students using Title IV in cash and other sources decreased by 4% and 3%, respectively.

The 4% year-over-year decrease in total net course registrations by students using Title IV indicates that persistent for students utilizing FSA as a primary payment source decline at APUS during the past year.

The dropout rates of some of these students also trigger an increase in bad debt expense. This underscores the importance of the various methods we currently employ to validate the qualification and intent of new students.

Improving student retention is important on many fronts, increasing the number of newly enrolled academically prepared students, not only improves the student persistence rates but it enhances the student classroom experience as well. It is also important from business model perspective as it enables us to continue our affordable pricing structure as greater numbers of students that we enroll.

At the same time, our efforts to improve retention by seeking students with greater academic intent and college readiness could temporarily impact new student enrollment growth. We believe our plans to develop and deploy new learning technologies and measures to further increase academic engagement in classroom will also help in this effort.

In the first quarter of 2014, we outperformed our guidance due in part to the timing of marketing expenses, but also as a result of obtaining cost savings and efficiencies. We have always strived to create both cost efficiencies and improved services through automation and process improvement.

For example, our electronic books and course materials initiative, transfer credit evaluation system and other processes continue to be effective by improving services to our students while reducing overall cost. That said, the recent decline in net course registrations at APUS has caused this look more critically at all of our spending including payroll costs.

In the first quarter of 2014, we reduced some nonessential spending and better align our workforce needs with our strategic plan. We expect to continue evaluating ways to optimizer our spending and better align our cost with our strategic direction and overall enrollments.

Recently our Community College and military outreach teams were merged to better leverage overlapping responsibilities creating greater operating efficiency. For example the integration of these teams should help us to more effectively focus on meeting the continuing education needs of veterans and active duty military students after they graduate from Community Colleges.

As of March 31, 2014, we have nearly 330 relationships with Community Colleges across the country. Going forward we will focus more on serving and expanding the value of existing military and Community College partnerships.

Corporate and other strategic relationships are also a key focus of our approach to attracting new students with greater college readiness. In the first quarter of 2014, our strategic outreach team developed partnerships with the Hartford, a property and casualty insurance company, Waste Management Corporation, a leading environmental services company, VTEC, a computer software solutions company and the Arizona Association of Chiefs of Police. Overtime, we believe corporate and other strategic relationships may grow to a scale that could be a meaningful contributor to our overall growth.

During the first quarter of 2014, we launched several initiatives to update more than 250 courses with new rich media, simulations, blended learning models and MOOCs. For example in June we will offer an eight week MOOCs in international relations that was developed in partnership with the Policy Studies Organization, a publish, excuse me, a publisher of academic journals for those making and evaluating public and private policy.

In addition, we plan on offer our MOOCs in American government that starts in September. While on each eight-week course, MOOCs participants will have the option to earn academic credit equivalent to three semester hours to an examination for which we will charge a fee.

Through these courses we hope to continue learning about MOOCs delivery, as well as to make more perspective students and key influencers aware of APUS. We believe MOOCs have the potential to expand access, drive greater brand awareness and create competitive and cost advantages for APUS.

We continue to make substantial investments in technology, internally and externally, including in the development of interactive learning activities in simulation resources that are being added to our courses.

On April 2, 2014 APEI invested $1.5 million to acquire approximate 25% of the gain based learning company that develops education software. Both APUS and Hondros College of Nursing plan to partner with this gain based learning company to jointly develop courses and further enhance existing courses with interactive, personalized and adaptive learning environment.

In some cases, we believe that it can be less expensive to invest in technology rather than developing it internally and investing can potentially reduce the risk of development. Moreover, by investing our university benefit academically from such technologies and at the same time, we made potentially benefit economically from revenues and/or the increasing the value of our investment.

We continue to be pleased by the results of Hondros College of Nursing. In the first quarter of 2014, enrollment at Hondros College of Nursing increased 14% year-over-year, driven by 43% increase in new students.

In light of strong expected job growth in the healthcare sector, we believe that expanding our healthcare focus and success with Hondros College of Nursing will eventually enable us to create a highly respected healthcare educational enterprise.

We received the Temporary Provisional Program Participation Agreement from the U.S. Department of Education allowing Hondros College of Nursing to continue to participate in Title IV program turning the Department action on the change in ownership application. We hope to receive notice of this action from the Department in the near future.

Our strategy to expand access to international students has recently made another step forward with the development of a plan to launch a pilot program with a few selected international franchisees of New Horizons in the second half of 2014.

APUS expects to offer students alemania New Horizons, as well as other international students access to APU academic programs through relationships cultivated by local franchisees.

In our pilot program, we expect to evaluate how best to support these international students for success and persistence in the online environment. If this plan is successful, we will offer similar programs to other New Horizons franchises in 2015.

Our continuing efforts to enhance academic quality continue with the advancement of two very important collaborative initiatives, the Foundations of Excellence and the Gateways to Completion program.

As the first fully online institution to participate in the Foundations of Excellence program of the John N. Gardner Institute, APUS carefully examined the practices that support first year and transform students.

Throughout 2014 the retention committee of APUS will be implementing the recommended initiatives identified in the study to improve retention and student success with a focus on at risk students.

In addition, APUS began work on the Gateways to Completion or G2C project, a three-year project in which we will partner with 11 other founding institutions to explore ways to improve student learning and success in high-risk high enrollment gateway course with historically with high failure withdrawal in complete way.

The first set of committee reports will be delivered to the G2C steering committee in July and the strategy implementation phase is set to begin in August. Through the Foundations of Excellence and G2C initiatives we hope to expand and build on our efforts to improve student success and retention.

APUS’ academic leadership continues to produce faith with the Degree Qualifications Profile or DQP initiative moving from mapping all of our degree programs using the first version of DQP standards to working with the more recently developed DQP2 standards and the identification and evaluation of signature assessments.

The DQP initiative with close to 500 participating colleges and universities has resulted in substantial review and analysis of the academic rigor of degrees, as well as identifying the critical learning necessary for progress of major milestones of completion at each of our 3 degree levels, associates, bachelors and masters.

Our academic and assessment teams have produced several helpful tools that are used by the greater higher education community. This work helps to ensure that our students are equipped with proficiencies needed for success and work citizenship, global participation and life in general.

Moving to slide number four advancing strategic goals, in short our key priorities are to retain, engage, innovate and diversify the sources of students that we educate. We believe we can accomplish several significant goals by focusing on retention and pursuing an optimal quality mix of students. These goals include improve student outcomes, enhance learning experiences and reductions in certain costs associated with students who dropout.

We believe we can more effectively and affordably enhance our reputation, grow brand awareness and expand enrollment by engaging with our corporate partners and by fostering new strategic relationships.

In additions, we believe students who enroll as a result of some of our corporate and other partnerships exhibit greater college readiness and academic intent average those student who hears about APUS through traditional media sources.

Our efforts to drive innovation and invest in education technology have great potential to improve persistence, enhance the student experience, increase student success and reduce costs.

We believe that new interactive learning technologies we deploy may afford our institution’s long-term competitive advantages over schools that have failed to invest in advanced classroom technology.

Diversifying the sources of our higher education student’s through additional degrees, new corporate partners and Hondros, is important to our long-term success, as our intention is to stand out in terms of breadth of offerings and quality in an increasingly competitive higher educational market.

In the second quarter of 2014, we continued to implement elements of our plan while taking a more critical look at ways to reduce and better manage our expenses. We are making significant progress to expand our strategic relationships, invest in education technology and execute a plan to reach international students. Most of all, we are moving forward with the greatest aspects of our mission and strengths fully intact, our academic quality, unique programs and affordability for students.

In the interest of making sure, we're positioned to serve a greater number of students with stronger academic content and college readiness, we are analyzing our methods of recruiting and enrolling new civilian students. In preparation for late 2014, we will spend the next two quarters further analyzing persistence state and piloting any new processes, not only to increase persistence but to make sure we address student needs with an optimized academic and business model.

At this time, I would like to turn the call over to Rick Sunderland, our CFO to provide more detail on recent results and outlook for the second quarter of 2014? Rick?

Rick Sunderland

Thank you, Wally. Going on to Slide 5 financial results, summary, American Public Education’s first quarter 2014 financial results included 6% increase in revenue to $88.6 million compared to $83.8 million in the prior year period. The increase in revenue was due to the inclusion of Hondros College of Nursing or Hondros segment, which earned revenue of $7.2 million in the first quarter of 2014.

Our APEI segment revenue declined to $81.3 million from $83.8 million, a decrease of 3% compared to the prior year period. This decline in revenue was primarily the result of a decrease in net course registrations by students using TA benefits. As discussed last quarter, we believe that the volatility and softness in military enrollment is in part related to marketplace confusion over changes to TA eligibility as well as through administrative changes in the military TA Program.

Our cost and expenses increased 9% to $71.8 million, compared to $65.6 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, resulting from lower net course registrations and lower payroll costs.

Our Hondros segment has the lower operating margin than our APEI segment largely because Hondros offers majority of its courses at physical campuses, which have a higher cost structure than courses delivered fully online. However, next year, we expect to realize recurring annual savings by transitioning the current Hondros (indiscernible), plus additional savings from other classroom enhancements and optimization initiatives.

For the quarter, instructional costs and services as a percent of revenue increased to 35.4%, compared to 33.9% in the prior year period. The increase was primarily the result of the inclusion of the results of Hondros, which was partially offset by a decrease in instructional costs and services expenses in our APEI segment, as the result of lower net course registrations and lower course material costs.

The cost of course materials for net course registration at APUS declined year-over-year from $44 to $31 in the first quarter of 2014. Selling & promotional expense as a percent of revenue decreased to 19.3% of revenue, compared to 19.7% in the prior year period. The decrease was due to the inclusion of the results of Hondros, which has substantially lower selling and promotional expenses as a percent of revenue than our APEI segment and due to the timing of certain expenses in our APEI segment in the quarter.

General and administrative expenses increased as a percentage of revenue to 22.0% from 20.9% in the prior year period. The increase was due to an increase in technology-related expenditures and higher bad debt expense in our APEI segment, due to a decrease in student persistence among students participating in Title IV programs.

For the three months ended March 31, 2014, consolidated bad debt expense increased to $5.1 million or 5.7% of revenue, compared to $3.6 million or 4.3% of revenue in the prior year period. We continued to focus on the various matters related to student persistence and academic preparedness as well as initiatives to improve our collections.

We've engaged a second collections agency starting in June and we plan to implement several new internal collections processes starting in the fourth quarter. These new processes will automate certain administrative steps to enhance the vigor and speed of communications with students, enable us to engage with them more frequently about the campuses do and facilitate better coordination of these efforts with our collections agencies.

We’ve began to take a more critical look at our cost to make sure we are right sized, or continuing to allocate sufficient resources to support growth initiatives with fewer redundancies. Going forward, we will continue to evaluate and implement additional cost savings initiatives as appropriate.

In the first quarter of 2014, net income was approximately $10.4 million or $0.59 per diluted share compared to $0.63 per diluted share in the prior year period. Compared to our previously issued guidance, the earning’s outperformance was attributable to a combination of factors, including our ongoing efforts to create efficiencies through innovation, the timing of certain marketing expenses and our efforts to reduce unnecessary costs to workforce realignment and elimination of redundancies where possible among other efforts.

For example, selling, promotion expenses at APUS during the first quarter of 2014 benefited from approximately $600,000 in cost savings initiatives that focused on optimizing our advertising spend and workforce adjustments to eliminate redundancies. Additionally, the timing of approximately $900,000 of previously planned expenses that are now expected to be incurred over the next three quarters.

Total cash and cash equivalents as of March 31, 2014 were approximately $99.7 million and we have no long-term debt. Cash from operations for the three months ended March 31, 2014 was approximately $12.4 million, compared to $20.6 million in the same period of 2013. The decrease was the result of the timing of the vendor payment and other payment obligations and increase in accounts receivable and lower net income.

Moving on to Slide 6, second quarter 2014 outlook, our outlook for the second quarter of 2014 is as follows. APUS net course registrations by new students in the second quarter of 2014 are expected to decline between 7% and 4% year-over-year and total net course registrations are expected to decline between 5% and 2% year-over-year, compared to the prior year period.

At Hondros College of Nursing, second quarter new student enrollment is expected to decrease by 10% year-over-year. The decline is partially the result of adjustments in marketing spend, as we seek to optimize advertising and attempt to better align outreach efforts with the institution’s strategic focus.

These adjustments included reduced advertising in certain channels, resulting in lower new student enrollment. That said, Hondros’ earning enrollment increased by 1% sequentially for April starts, despite graduating a significant number of students during the prior quarter.

Earning enrollment includes active returning students, returning just enrolled students and new students. We anticipate consolidated revenue for the second quarter of 2014 to increase between 3% and 5% compared to the prior year period. Second quarter 2014 total consolidated earnings per share are expected to be between $0.43 and $0.50 per diluted share.

In closing, the first quarter of 2014 continued to be impacted by volatility and softness, particularly with respect to the military enrollment. While persistence among civilian students using Title IV appears to have declined, we're addressing matters related to retention and college readiness from several perspectives, including marketing, academics and operations.

The highlights for the quarter continued to be growth in net course registrations by veterans at APUS and the enrollment growth of students at Hondros. Our ongoing efforts to create efficiencies through innovation and efforts to manage our costs and better align them with our strategic focus have produced positive initial results.

Going forward, our goals are to grow our base of college ready students at APUS and Hondros through a continued focus on relationship marketing and strategic relationships and to enter new markets by launching new programs such as engineering and cyber security.

In addition, our goal is to enter new segments and advanced our technology through investments, partnerships and acquisitions such as the acquisition of Hondros, our investment and relationship with new horizons and our most recent investment in the gaming company.

At the same time, we will move forward with our unyielding focus on academic quality, industry-leading affordability and our passion to advance higher learning through the development and utilization of leading-edge education technology.

Now we would like to take questions from the audience. Operator, please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Adrienne Colby with Deutsche Bank. Please proceed.

Adrienne Colby - Deutsche Bank

Hi. Thanks for taking my question. I was wondering if you could talk a little bit about the persistent issues. I’m just wondering why you think that all of a sudden software should change and what you are seeing from your Title IV students?

Dr. Wallace Boston

Sure. I don't know that it's all of a sudden, by the way, we’ve had some issues with Title IV students really going back for a number of years and we’ve talked about it, but for the first time it became a difference that actually resulted in year-over-year declines in FSA students. And essentially, what we’re finding is that most of those students come through traditional media sources instead of referral sources. And the quality of their ability to complete their first few courses is not as good as referral students or military students. We've been working with them, finding ways to remediate them. In some cases, they have no interest in doing that.

So we’re trying to find ways, as we said, to see if we can better ascertain intent. We’re moving some of our assessments from the first course that the student takes if they have no background in higher Ed to the orientation process that they actually take the assessment before they go into a course. And hopefully, we will do a better job of assessing intent as well as people's ability to complete those courses because once we get them through the first few courses, we are doing a very good job of retaining just that initial group of new students and our ability to retain them.

Adrienne Colby - Deutsche Bank

So is that something you’ve implemented, then there is change in the assessment period or is that something that’s second quarter or third quarter or…

Dr. Wallace Boston

I just had a call on that this morning, it’s technology-related, so we're going to begin some pilots because you don't want to implement a new technology across the board with as many students as we have and disrupt the whole group. So we will be doing some pilots in the summer with a goal of beginning it in late September according to the latest IT timeframe.

Adrienne Colby - Deutsche Bank

Okay. And at the beginning, I missed but you said the new course registrations were from Title IV students, could you repeat that?

Dr. Wallace Boston

Sure. In the quarter, we grew at 3%.

Adrienne Colby - Deutsche Bank

Okay. And just as a final question, could you just talk about what the getting factors are on the range of guidance? What would be the deciding factor between you coming in at the lower end of the range that you’ve given for ETS versus the higher end? So what are the factors that play in the margin guidance you’ve given?

Dr. Wallace Boston

Well, I think the guidance we feel we know what our April registrations are as of today, but we don't know what May is because even though registrations are closed, students are in a free drop week and they have the ability to draw drop classes or we drop them for non-attendance at the end of the week. So that volatility used to be more much predictable for month, but unfortunately with the DA situation, we are dropping in from nonpayment as well.

So we’re not exactly correct about the -- we're not confident that so we’ve given ourselves some range for May and June as we said on previous calls, ever since the financial issues with the military instead of people registering as much as five months out like we allow. Now most branches are improving TA more than 30 days out and some of them are improving TA more than 10 days out. So we've got a lot of volatility on the revenue side. We’ve got some volatility on the bedside. And I would say those are the two biggest issues.

Rick Sunderland

Yes, I was going to point out the bad debts with the changing persistence tunnel fees where that’s going to land going forward, so that create some volatility in terms of where we will land inside the range?

Adrienne Colby - Deutsche Bank

Thank you.

Operator

Thank you. And your next question comes from the line of Jason Anderson with Stifel. Please proceed.

Jason Anderson - Stifel

Good evening, guys. I guess a little more on the persistence, is there anyway you could frame for us maybe how that come down over the years, to what degree, and then maybe how much of an opportunity is there on the upside to improve it? I mean, obviously not going to persist to 100%, but to a practical level there, is there -- I’m just trying to get an idea of how much fluctuation has been and could be?

Dr. Wallace Boston

Well, it’s kind of complicated, Jason. We actually -- and in fact, I am usually a coauthor on these publications. My colleagues, Phil Ice and myself along with other folks on the academic side presented a bunch of research papers on predicting -- measuring and predicting online student persistence and the variation can be tremendous because of the risk factors with serving working adult students. I mean the big thing and the most common way to describe what can happen is that life gets in the way, so you have people who drop out simply because something happened to them on their job or with their family, there is marriage student risk factors or risk factors if you have dependence. There is risk factor if the student happens to get in the class and doesn’t like the online format. I would say that’s actually one of our largest reasons when we survey the students who drop out is one of the major reasons is online format just didn’t suite me.

But we also still have issues not with tall runners, but we do have issues with students who I believe are moving from online school to online school because they know how to gain the system and they are doing an up work academically to stay in the classroom until they receive their loan refund check and then they what I call one is none. They register for term with us. They have gotten their loan refund check and then because they have got an act in the course, they are not able to continue to persist with us. So they go to another school and never report that they have been at our school and they got crappy grade, so the other school accepts them and this is circular group of this. Last time I checked, it’s not against the law unfortunately and there is no national database so at times this can cycle in and periods we can get higher percentage of those types of students.

Other times it lowers with really no -- our ability to predict it. So that’s a complex way of telling you that it’s very difficult to predict that. At the same time I believe that some of the technology measures and some of the processes that we are putting in place for example moving assessments out of the first class into orientation. If the student can’t get through those assessments orientation, then we’re basically got to recommend that they are go into remediation and now allow them into a regular course.

As I mentioned on the call, I can’t predict what that might do to overall enrolments, but I can predict that it will give -- it will leave us with the higher quality student. At the end of the day, this is a process that’s going to take months and years to fine tune because we don’t want to put a hammer on everything, but we have become I would say observant students of the risk factors and practices of working it help students and we continue to try to find ways to both make more students successful as well as to provide better outcomes for the institution as a whole.

Jason Anderson - Stifel

Great, thanks for the color on that. When it comes to the bad debt, how should we think about, as what could it get to, I mean is there I don’t know if you guys could even provide a split of bad debt percentage by T4 side or the civilian side versus the military and as obviously the T4 becomes heavier percentage for civilian and general?

Dr. Wallace Boston

Well, I will start and let Rick add to my comment. One of the issues that we have is that when we provide categories, those are primary payer types. So for example, somewhere between 25% and 30% of our tuition and systems students are also using FSA. So we don’t track bad debt by payer type, but we believe that most of it is more oriented towards the FSA students, but the FSA students aren’t all in the FSA category, so you know.

Harry Wilkins

I agree, so we don't have a breakout by paired sites, I can't provide a split. We do know that when we see a decline in persistent in an FSA student population it results in a higher volume of return of funds to Title IV, which results in a balance due from that student and that's really where we've had to step up our collection efforts and to the extent that's difficult population to collect from. That is what is negatively impacting our bad debt expense.

Jason Anderson - Stifel

All right, thank you for that.

Operator

And your next question comes from the line of Jeff Goldstein with JPMorgan. Please proceed.

Jeff Goldstein - JPMorgan

Thank you for taking my question. Just following up on the bad debt expense dynamics, where do you think you are in the process of improving your collections processes? Meaning in 2014 do you expect bad debt to be up as a percentage of revenue?

Rick Sunderland

I don't know, where it's going to end up in 2014, I know that we are very focused on how we collect and how we can improve our collections and I think I alluded to some of those initiatives in my comments. So we are very focused on what the underlying issues are and very focused on implementing solutions that will address those.

Dr. Wallace Boston

And I think the other point to note is that when you look at the average debt balance of our students, they're really small amounts because, as I mentioned, on the persistence side, if we can get our students through the first few courses, we retain a much higher percentage and our tuition is much lower.

So it's really, this churn of students that were coming through and dropping out for various reasons, that where we have the highest exposure and highest risk, but once we keep them there's really very little risk.

Jeff Goldstein - JPMorgan

Yeah. That's helpful. In your second quarter guidance, could you help us separate Hondros from the core operations, so as revenues and when, I kind of back into the number it seems that revenue per registration at American Public University System could turn negative, is that what is implied in your guidance?

Rick Sunderland

Revenue per registration turn to negative? I don't believe that will be the case.

Dr. Wallace Boston

Yeah. I don't think that's the case.

Jeff Goldstein - JPMorgan

So what is the contribution of Hondros to revenues approximately?

Rick Sunderland

Well, in the quarter it was $7.2 million of consolidated revenue.

Jeff Goldstein - JPMorgan

And in the second quarter?

Rick Sunderland

I don't think we're providing guidance at that level of details but it gives you some sense of the mix between the two segments.

Jeff Goldstein - JPMorgan

Okay. Last question from me, would you be able to give us a run rate of expenses, now given the new cost base for Hondros, at least the one that’s implied in your guidance?

Rick Sunderland

A run rate of expenses, we’ve never given guidance.

Dr. Wallace Boston

Yeah. I think you'd have to look at everything relative on what we reported for the first quarter, just because we never tried to breakout our guidance by expenses and revenues.

Jeff Goldstein - JPMorgan

So would the first quarter expenses be -- got for the remainder of the year or at least for the second quarter?

Rick Sunderland

You mean the relative percentage? Because I don't, yeah, I don't know why we’ve given very materially.

Jeff Goldstein - JPMorgan

Okay.

Rick Sunderland

We're going to file the 10-Q tomorrow, which will have the segment level reporting of revenues and operating income for the first quarter.

Jeff Goldstein - JPMorgan

Thank you very much. Thank you.

Rick Sunderland

Thank you.

Operator

And your next question comes from the line of Corey Greendale with First Analysis. Please proceed.

Corey Greendale - First Analysis

Hi. Good afternoon.

Dr. Wallace Boston

Hi, Corey.

Corey Greendale - First Analysis

By the way, Rick, that information is actually in the press release the breakout by segment, the revenue and income from operations? I had a few questions, going to back to one of Jeff's questions, just a slightly different angle on it. Is the revenue per student number for Hondros in Q1 a good run rate to use in Q2?

Rick Sunderland

I think so.

Corey Greendale - First Analysis

Okay. And then within the guidance the decline in new student registrations, do you expect the drivers there between TA and civilians will be similar, or do you think you're going to see narrowing or decline in TA and then more of a fall-off in civilians?

Dr. Wallace Boston

Let me think about that, I think that TA is still rather in a more unpredictable state for example, we only have one month down in Q2 with April and we still haven't gone through our pre-trough week in May.

But I would say that year-over-year the TA number should come down because a year ago we had the April situation where they stopped TA and so we really only had two good months to comp on and the FSA number should be relatively the same, so it will get closer.

Corey Greendale - First Analysis

Okay. And just for the benchmark, looks like on the underlying market, you mentioned that new army course planner, do you expect that -- are you seeing material impact from that, if you look at the other branches in military, anything better -- better performance in Q2?

Dr. Wallace Boston

I don't have really good data for Q2 because we've only got one month down. But if we looked at Q1, you got really the bulk of -- or the substantial majority of TA registrations for just about anybody that provides services, or in the army and the air force. And both of those and I'm not counting overseas because overseas is a separate contract. So there was a substantial decline in overseas versus the first quarter from a year ago.

Most of that was because of a new policy change that we talked about where new students are obligated to register with schools that have the overseas contract and then after that they can transfer. So that's down in the first quarter about 22%, the overseas contracts and I'm assuming that schools like us that don't have -- they're not part of the overseas contract as the same issue.

And the army and the air force, were down approximately 10% in the first quarter, the navy was down approximately 19%, which is probably why the navy came out and said they had funding for the full year for whatever reason, people in the navy just aren't registering and then the marine corps was down pretty substantially, but part of that, if you recall when we talked about in our last call, the marine corps suspended all registrations for the month of February.

So the good news is the marine corps is a not a big percentage. But nonetheless, if you have a big drop like 40% in the quarter, that what's impacted schools other than us as well, with February being shut out with these quarterly allocation is pending. So overall that's the color, those are our numbers on my branch of service.

I think this new form is slowing down the army folks in the second quarter until everyone gets adjusted, we're actually tracking it manually because Army had this grade system, GoArmyEd, which was totally automated and large schools like us spent a lot of money to interface our systems with them and they've now essentially put in a manual system, to authorize people to go into the electronic system.

So if anything it sounds like a way to slow down registrations to me, even though that's not what they said it was. So, we'll see how it goes for the second quarter but it's just too unpredictable right now.

Corey Greendale - First Analysis

I appreciate that and one question on the civilian side then, it sounds like you're thinking of potentially doing something differently to target students who are likely to succeed and maybe changing some of the marketing channels? I have the sense that you over the past year or some period of time had already been thinking about the changes and pulling back on some of the mass media? Can you just give us an historical perspective on what you're already done to try to target students likely to succeed in and what else do you think you can do to improve that further?

Dr. Wallace Boston

Yeah. I mean we changed our commercials and tried to make them oriented more towards -- this is on the mass media side towards students who had either completed some college already or who were potential graduate students. Because we found that most of the students who weren't succeeding or students who were reporting to us, that they had never attended college before, whether or not that was true, because there's no a national data base, we couldn't figure that out.

And in addition we were matching up. We had changed the markets that we were advertising in. And so when we were using traditional media, we were matching that traditional media with very specific interact -- the search keyword purchases in zip codes that combine the profile the student we wanted to seek along with a higher demographic in terms of income, which theoretically hopefully that helps find a working adult, as well as increased activity in our social media.

So, we -- the reason we continued although at a lower number our traditional media in radio and TV, we thought that being more targeted, we could drive the conversation rates of the keywords higher, which we did in certain markets. But at the same time, some times when you do purchases particularly on cable, you still get spread over, they use your ads and slots and markets you're not paying for, so you don't get charged for it, but it brings in students who really didn't want to bring in.

And so, I think over time if we can't bear out successful traditional media we'll get pretty close to I would say interactive media with the keyword purchases and the online ads, because we can target that so well and be very minimal on the traditional media. It's just the fact that we're passionate about our affordability, our affordability doesn't play well for an ad in certain areas of the country and unfortunately it also leads to the word of mouth that people's who find out they can get higher refund checks by attending institutions with lower tuition.

So it's complicated, we have been working on it for more than a year. But in the first quarter it's just -- the results didn’t the way we wanted them to go in the FSA and so we're ratcheting up our methods for trying to change that quality mix.

Corey Greendale - First Analysis

Okay. Thank you for answering my questions.

Operator

And your next question comes from the line of Jeff Silber with BMO Capital Markets. Please proceed.

Jeff Silber - BMO Capital Markets

Thanks so much. You discussed the retention trends for new students they get Title IV funding. I'm just wondering are you seeing different retention trends from students from other payment sources?

Dr. Wallace Boston

No. In fact it's interesting, I think, this is my 12th year with APUS, I'm looking at Harry, because he was here as a consultant before I started and our military retention numbers have been spot on.

Now and to the uninformed you might say, well how can that be? But the military actually has it's screening process, so they have an exam, I think it's called the ASVAB and they make people take that exam, they have to have a minimum cut off point, as well as they look for other aspects of high school GPA.

So in effect they're doing a screening process that really isn't coming into play with our general approach to being in an open enrollment institution for the other students. But the cash paying students are pretty much coming from corporate contracts and relationships and there's probably a natural selection process there, so…

Harry Wilkins

Plus they acquire national support community.

Dr. Wallace Boston

Correct.

Harry Wilkins

The military and the corporate communities that…

Dr. Wallace Boston

Correct.

Harry Wilkins

… an individual FSA student does have.

Rick Sunderland

And then they tries to take one course with that.

Dr. Wallace Boston

Right. Yeah. There is another factor which is, and I've talked about this at conferences, it's ironic if you look at the power project that we participated in with a number of other institutions funded by Gates.

One of the findings was that students were more successful when they only took one course, their first time taking an online course. But the problem with that is that one course at the undergraduate level doesn't qualify you for FSA. So the FSA students take more and like I said if we can get them through their first enrollments, we're actually -- they're persisting pretty well, it's just the high dropout rate in the first enrollments.

Jeff Silber - BMO Capital Markets

Okay, interesting. And just a couple of numbers questions? Can you tell us what's implied in your guidance for taxes, share count and depreciation and amortization?

Rick Sunderland

One second, taxes are about 30% which is consistent with the first quarter and shares is 17,800,000.

Jeff Silber - BMO Capital Markets

And depreciation and amortization?

Rick Sunderland

Again it's going to be consistent quarter-over-quarter.

Jeff Silber - BMO Capital Markets

Consistent with the quarter. Okay. Great. And then just one last question, I'm sorry, you're capital expenditure budget for this year?

Rick Sunderland

I don't think we've even given that number out.

Dr. Wallace Boston

Yeah.

Rick Sunderland

We haven't given it out. But we, I'd say most of our projects in the first half of the year are IT related and we have a lot of technology projects that we're working on.

Jeff Silber - BMO Capital Markets

Okay. Fair enough. Thanks so much.

Operator

And your next question comes from the line of Trace Urdan with Wells Fargo Securities. Please proceed.

Trace Urdan - Wells Fargo Securities

Thank you. Hey, Wally, given the conversations you’ve been having about the students that are drawn to the larger refund check and I apologize for not even knowing the answer to this but why isn’t borrower-based lending a potential solution for that problem?

Dr. Wallace Boston

It maybe, now that we have regions that I’ve been told and Rick can add some color that the region system is much more flexible related to that than our previous system, Trace. But as you recall, we had some issues with our region conversion. So the last thing we wanted to do you was to go to borrower-based lending, while we were trying to clean up some of that.

Rick Sunderland

That’s right.

Dr. Wallace Boston

So, I would say that that is under consideration and we’re looking at a number of measures and so that could theoretically help us address the issue of the people who are looking for greater refund check. But that’s not all of the persistence issues.

Trace Urdan - Wells Fargo Securities

No, I understand that. I understand that perfectly. I just -- that seems to be a bigger issue for you guys and certainly I think when you were going to those region issues, one of the things that was instructive was seeing how fixated a lot of your students were on getting their refund check, right. You’ve got the sense of how important that was to them so.

Dr. Wallace Boston

Yeah.

Trace Urdan - Wells Fargo Securities

Other thing I wanted to ask about was, you’ve been talking about the efforts to sort of work on the quality of enrollment in the different things you’ve been doing in the marketing mix. But I'm not sure that you’ve really sort of addressed your view on why in aggregate things, the start should be down year-over-year. And I'm wondering to what extent, is it fair to attribute some of that to those efforts that you’ve been making to try to inch quality up or is that overstating? I’m speaking just on the FSA side. I understand the situation of the military.

Dr. Wallace Boston

Right. Right. But, Trace, there is a difference between the total FSA enrollments and the new students. The new students for the first quarter were actually up 3%.

Trace Urdan - Wells Fargo Securities

Okay.

Dr. Wallace Boston

So while that’s not a huge number in this environment, that’s not a bad number considering that’s a year-over-year, quarter-to-quarter comparison. It’s really what we're trying -- as I went to a great explanation on the persistence side, it’s taking those that come in the door on those starts and making sure there are students who can continue to complete with us beyond the initial registrations.

Trace Urdan - Wells Fargo Securities

Right. Okay. And then I kind of just missed what Rick said about the Hondros new student enrollment. I know that you gave an explanation for why that was expected to be down in the second quarter, but can you just go through that a little bit more slowly for me?

Harry Wilkins

Yeah. I can. It’s Harry, the CEO of Hondros to answer that.

Trace Urdan - Wells Fargo Securities

Yeah. Fair enough.

Harry Wilkins

Prior year, Hondros, it was a privately-owned company and they were very consistent with their marketing prices. They enrollment was all over the place and they had 280 new students in the first quarter. They had 424 new students in the second quarter. We really are trying to make a little bit more stable. We’re changing the marketing mix to align more relationship marketing, Internet-based marketing. We’re finding new student persist better than more so than the mass media, radio advertising or hip-hop stations like they have been doing.

So, we’re really changing the marketing mix and we’re getting more consistent. What’s looking like is volatility is because of the volatility of the previous, the school under the previous ownership. It’s really not so much hard. We probably own this school for six months now. So it’s going to take a while for things to level off. But overall, total enrollments are up and the revenues are up for the year. And we’re saving our pace for a strong, a strong second half of year we believe.

So we’re really trying to gear students more towards the BSN degree and attract more bachelors. Wally had the students from the beginning because we think that’s where the nursing professionals headed. And Hondros has the CCNE accredited bachelors program where most of our core profit competitors at Ohio do not. So we have a competitive advantage there and the cost of it is very affordable. So, I just think -- while it looks volatile, it’s really in comparison with last year which was volatile and our enrollments are really not.

Trace Urdan - Wells Fargo Securities

Okay. So fair enough, so despite our obsession with year-over-year comparisons, we should really be looking at Hondros more on the sequential basis, at least for the first four quarters?

Dr. Wallace Boston

If you could, I would appreciate it.

Trace Urdan - Wells Fargo Securities

All right. Thank you.

Operator

And your next question comes from the line of Tim Connor with William Blair. Please proceed.

Tim Connor - William Blair

Thanks. I’ll ask one more about Hondros. Were there any weather impacts in the second quarter, second quarter starts number?

Dr. Wallace Boston

That is a really good question and I'm certain that they were, because we had several Hondros, the way they do it at the campus space level. It is one thing if you are recruiting online. Weather is not as much of a factor. When you’re recruiting in person, it’s a hell of a factor. And how many students didn’t show up for their interviews because Hondros was closed seven days during the winter. So you don't know how much of that. I don’t want to use that as an excuse but that’s a very good point and I started to thinking it has some sort of an impact although I have no idea what it might be. But you can’t recruit students on the days we are closed. That’s for sure.

Tim Connor - William Blair

Okay. And then now that you’ve got couple of quarters to look at Hondros other than optimizing marketing and few other little things. I guess, is there anything that you’re saying that new connect would constrain you from broadening the campus network outside of Ohio into other states?

Dr. Wallace Boston

Right now, we’re been constrained by the fact that as part of education, it still has to formally approve the change of ownership. Until that happens, we’re actually prohibited from new programs, new campuses. So we’re going to just make sure we get that done first. That should happen any day. It really -- we think is more of a formality than anything else. So we have to wait till the department approves, as we have to give them all the information they need. It’s up to them.

Dr. Wallace Boston

And then I think it’s also dependent upon the state. So some states are easier to get approvals. Some states require tremendously complicated needs assessments and only allowed student -- only allowed school to apply every so often based on their need calculations.

Tim Connor - William Blair

Let me ask it a different way. Is Hondros scalable platform from a brand encouragement standpoint now you had a couple of quarters to look at it?

Dr. Wallace Boston

Yes. We think Tim.

Tim Connor - William Blair

Okay. And then just more broadly that cost of acquisition for sort of civilian channels sounds like it’s gone up and it’s continuing to go up. I guess, how are you thinking about marketing spend as a percentage of revenue longer-term? And then, would you consider passing through additional fees, whether it’s technology or otherwise to the civilian channel?

Dr. Wallace Boston

Good question. I would say that well I’m thinking about this big picture, I don’t mind spending more for civilians if they’re quality civilians. So if I can get through this, what I find is an unacceptable percentage for initial FSA students who can't make it through, then it’s more than worthwhile spending additional money. We still have a pretty low spend overall compared to others, but that's because we really work on trying to get those relationships and referrals, because our data shows that those are generally students who are going to succeed.

And so we never like to take the foot off the pedal here. We like to continue to put stress that we want to try to keep our marketing cost under 20% of revenues. And I think that's a good rule of thumb to follow. But if we could find a successful channel that we had to spend a little bit more money but we got a much higher quality student, they’d be worthwhile.

Tim Connor - William Blair

Okay. And then what about it's reflecting on the tax fee increase and a little bit of a diversions on the price if it’s the military and Title IV, is that a strategy that you might pursue at some point in future again?

Dr. Wallace Boston

Yes. So I think we have a lot of flexibility right now when you take tuition fees and books, we’re about 20% less than national average in-state tuition at the bachelors level. We’re close to 38% less. I think the numbers on the graduate-level. So we certainly have some flexibility there. Some of it though is limited to our current system that was really designed to price one way and not. I mean, we can put additional fees and things, but it’s more complicated than it needs to be and that's one of our big IT project this year as to put in flexible pricing. But I would say that we’ll continue to examine that and we’ll look for potential opportunity there.

Tim Connor - William Blair

Okay. Thank you very much, guys.

Operator

And your next question comes from the line of Peter Appert with Piper Jaffray. Please proceed.

John Crowther - Piper Jaffray

Yes, you’ve got John Crowther on for Peter here. Lot of questions already and I hate to beat a dead horse here. But just on the expense side, cost savings in the first quarter, how much was actually reflected in the expenses there versus what was sort of taken out and will be reflected in subsequent quarters? And then if you just look at the guidance, it seems to reflect a modest increase in year-over-year expenses, total expenses in terms of year-over-year growth. Just wondering, obviously, we’ve color a couple of things, bad debt expense, marketing, if there’s anything else be that might sort of be behind that modest year-over-year increase?

Dr. Wallace Boston

Well, we also talked about the fact that Hondros has a higher expense ratio than we do. One of the things that we will be doing at the end of this year is replacing the LMS which will reduce some of the G&A cost for Hondros and improve the margin. But we’re a-- lso once again we’re paying for increased technology. We talked about some of those enhancements and you can’t capitalize a 100% of your programming cost for the systems at use. So we have increased our IT expenses. So while we’re saving in one area, we think it's pretty important to continue to invest on the technology side.

We’re not what I would call a leading-edge, but if you’re not leading-edge, you really don’t have a product that differentiates yourself from a lot of competitors. So we periodically assess particularly in the summer. We look at what we want to do for capital spending next year. So we’ll look at the projects that we've done and make a determination whether we’re going to come back a little better or keep the accelerator going with IT projects for next year.

John Crowther - Piper Jaffray

Okay. And then just kind of going back to the first part of that. In terms of cost savings, were most of the cost saving were reflected in the Q1 expenses or is there some incremental that might sort of lead into Q2?

Dr. Wallace Boston

I think you’ll see the plans, the larger effect about in the second half of the year. We mentioned and understand in selling the promotion specifically. A portion of that is recurring and a very large portion of that simply is a timing issue between the various quarters. So I would say, the things we’re doing today will have a greater impact later in the year.

Rick Sunderland

And then we also mentioned that we had some overlapping expenses that we adjusted both travel expenditures, conference expenditures, some payroll costs. And we’ve mentioned the merger of our two with our community college and our military outlets teams to make them more efficient and less overlapping. And so that will really show up in quarter three and four.

John Crowther - Piper Jaffray

Great. Thank you.

Dr. Wallace Boston

Thank you.

Operator

At this time, there are no further questions. I would like to turn the call over to Mr. Chris Symanoskie for closing comments.

Chris Symanoskie

Great. Thank you, Operator. That will conclude our call for today. I 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.

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Source: American Public Education's (APEI) CEO Dr. Wallace Boston on Q1 2014 Results - Earnings Call Transcript

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