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American Public Tops, Dull 2Q Ahead

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American Public Education (APEI - Free Report) recorded first quarter 2012 earnings of 50 cents per share, beating the Zacks Consensus Estimate by 2 cents and the prior-year quarter earnings by 7 cents. Earnings were also above the guidance of 45 cents to 49 cents due to top-line growth in the quarter.

Total revenue of $75.7 million was up 29% from the prior-year quarter, slightly above management’s expectation of a growth of approximately 27% for the said quarter. Revenues also edged past the Zacks Consensus Estimate of $75.0 million. The top-line growth was driven by brisk student enrollments in the quarter, particularly from civilian, military, and veteran students.

Revenue and Costs in Detail

Total net course registration increased 24% to approximately 101,000, beating the company expectations of recording growth in the region of 20-22%. Net course registrations from new students grew 15% to approximately 20,500, slightly better than the company’s guidance of growth of approximately 14%. American Public stated that about 119,200 students were enrolled in the American Public University System as of March 31, 2012, reflecting an increase of 32% year over year. Operating income for the quarter rose 14% to $14.9 million.

The students enrolled in American Public Education courses primarily serve the military and public service communities. They can finance their education through tuition assistance programs of the US Armed Forces (DoD tuition assistance programs), education benefits administered by the Department of Veterans Affairs, private loans, corporate reimbursement programs, and federal student financial programs referred to as Title IV programs. In the first quarter of 2012, net course registrations by students using Title IV increased approximately 42% year over year. Title IV now represents approximately 34% of total net course registrations versus 30% in the prior-year period. Net course registrations by students using DoD tuition assistance programs increased 7% year over year, and net course registrations by students using veterans benefits were up 83% year over year.

General and administrative expenses were 21.2% of revenue in the quarter, up from 17.9% of revenue in the prior-year period. The increase was driven by higher bad debt costs (as the company shifted focus to civilian students), investments in Title IV processing automation (to reduce abuse of these funds) and ePress initiative development, and increased expenses to adapt to regulatory changes. Instructional costs and services were 36.7% of revenue in the first quarter of 2012, compared with 37.7% of revenue during the first quarter of 2011.

Second-Quarter 2012 Outlook

Like always, American Public Education introduced its financial guidance for the next quarter of 2012. The company is expecting revenue growth in the range of approximately 14% to 22% for the second quarter of 2012. Management now expects second quarter 2012 net course registrations to rise between12% and 18% over the prior-year period. Net course registrations from new students are expected to rise in the range of 2% to 4% year over year. Management further projects second quarter 2012 earnings between 41 cents and 47 cents a share.

Though American Public Education beat expectations in the first quarter, the overall outlook for the second quarter of 2012 is weak. Both revenue and enrollment growth projections represent a sharp decline from first quarter results. Management commented that steps taken to reduce student abuse of Title IV funds could result in lower new student enrollments in the second quarter. Particularly, new fraud prevention software implemented in March this year will significantly impact new enrollments in the second quarter. The educational institutions are under the scanner due to higher abuse of funds, mostly by civilian students who use the balance fund (fund is usually more than American Public Education’s tuition costs) to meet living expenses. American Public Education is taking steps to reduce student abuse of Title IV Funds and thereby improve student outcomes. However, such efforts increase costs and hurt margins.

In fact, the enrollment growth rates have been consistently declining for this online higher education provider despite numbering among the very few education companies that have booked positive enrollment growth.

American Education derives a significant portion of its revenue from DoD tuition assistance programs and the Title IV federal aid programs which are administered by the Department of Education. The DoD is expected to announce cuts to its tuition assistance benefits, which will however be implemented only after a comprehensive benefit review. Management believes that military enrollment will continue to be volatile and possibly decline going forward due to possible reductions in US army, marine and sales force personnel due to budgetary constraints and potential changes to the DoD tuition assistance programs.

Changing regulatory requirements are taking a beating on enrollment growth for most education companies. Recently, a provider of post-secondary degree programs,ITT Educational Services Inc. , announced a 15.4% decline in total enrollment in the first quarter 2012 which resulted in a top-line decrease of 10.8%. DeVry Inc. also reported a 3.9% decline in revenues due to a 3.7% reduction in total post-secondary enrollments across all its programs.

In March, Apollo Group Inc. reported a 12.2% decline in total second-quarter enrollments at the University of Phoenix, the company’s wholly owned subsidiary, which pulled down its total revenues by 7.5%.

Our Recommendation

We currently have a Neutral recommendation on American Public Education. The stock carries a Zacks #3 Rank in the near term (‘Hold’ rating).

We believe the American Public Education’s affordable tuition costs and its shifting of student focus to the civilian market bode well for long-term growth. However, the focus on civilian growth as well as initiatives to curb fund abuse will be a headwind for margins. Moreover, uncertain military enrollment growth due to possible changes to the DoD tuition assistance programs also concerns us. We therefore prefer to remain on the sidelines and maintain a Neutral rating.

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