Weak Profits Hurt American Public Q2 Earnings; Q3 View Soft

Despite beating expectations in the second quarter of 2014, American Public Education, Inc.'s APEI share price went down 1.4% as profits declined and the post secondary education provider issued a soft outlook for the next quarter.

American Public's second-quarter earnings of 56 cents per share beat the Zacks Consensus Estimate of 50 cents by 12%. Earnings also beat management's expected range of 43 to 50 cents.

American Public is the parent company of online learning provider American Public University System (APUS) and campus-based Hondros College, Nursing Programs which was acquired in November last year.

The company beat expectations only because of expense savings at APUS and lower share count due to share buybacks. Earnings declined 8.2% year over year due to continued military enrollment hurdles and higher costs associated with Hondros.

Revenues and Enrollment Details

Total revenue increased 6% year on year to $85.5 million, slightly beating the Zacks Consensus Estimate of $85.0 million. The top-line growth was better than management's expectation of an increase in the range of 3–5%.

However, like the first quarter, we believe the top-line beat was only due to the inclusion of $7.2 million sales from Hondros against the absence of any such revenues last year.

Revenues continued to decline at APUS, down 3.2% this quarter to $78.3 million, due to weak enrollment trends.

Total enrollment at APUS declined 3% year over year to 96,100 in line with the company's expectation of 2% to 5% shortfall. New student enrollments (student starts) at APUS declined approximately 7% to 16,700, at the higher end of management's expectation of 4% to 7% decline.

Like the past three quarters, APUS enrollments in the reported quarter were adversely impacted by continued volatility and softness in military enrollments. Moreover, this quarter as significant slowdown in enrollments of students using federal student aid FSA also hurt APUS enrollments.

In the second quarter, total enrollments of students using Department of Defense (DoD) Tuition Assistance or TA benefits decreased 1% year over year. New enrollments of students using TA remained flat in the quarter.

Enrollments by students using TA were significantly affected by the recent administrative changes by the military. Management believes that marketplace confusion over recent changes to TA eligibility also played a role in lowering TA enrollments.

However, the total and new enrollments of students using TA showed a sequential improvement from the first quarter. Nevertheless, management is unsure of when the TA program will return to stability.

Net enrollments of students using FSA (also called Title IV funds) decreased 8% year over year which slowed down from the past few quarters. Difficult year-ago comparisons, measures taken to improve the quality mix of students and the overall challenging environment for higher education hurt FSA enrollments in the quarter. APUS is facing challenges regarding student recruitment, persistence and retention. Therefore, the company has implemented a number of initiatives to improve the quality of student enrollments and thereby student success and persistence.

Total enrollments of students using cash or other source decreased 10% in the quarter while that of students using veterans benefits were up 6% year over year.

Total enrollments at the newly acquired Hondros rose 17% in the quarter to 1,410 students, while starts declined 12%.

Profits Decline

Operating income for the quarter declined 8.1% year over year to $15.8 million due to higher costs related to Hondros which offset lower expenses at APUS. In fact, the company's operating margins are suffering due to the inclusion of the lower-margin Hondros segment. Hondros' physical campus based model requires higher costs than APUS' online courses.

Selling and promotional (S&P) expenses as a percentage of revenues increased 10 basis points (bps) to 19.9% of revenues due to poor operating leverage at APUS. Instructional costs and services increased 170 bps to 35.3% of revenues due to higher costs at Hondros.

Further, bad debt ratio increased 180 bps in the quarter to 5.7% due to a change in student mix to a higher percentage of civilian students.

Third-Quarter 2014 Outlook Soft

Management expects third-quarter 2014 total enrollments to decline in the range of 6% to 9%, while student starts are expected to go down in the range of 8% to 12%. American Public expects revenues to remain flat year over year. Management further projects third-quarter 2014 earnings between 44 to 51 cents, which fell far short of the Zacks Consensus Estimate of 59 cents.

Management also stated that new student enrollments at Hondros increased approximately 5% in third-quarter 2014.

Other Stocks to Consider

American Public carries a Zacks Rank #3 (Hold). Other better-ranked stocks in the education industry include DeVry Education Group, Inc. DV, Capella Education Company CPLA and Grand Canyon Education Inc. LOPE. All the three companies have a Zacks Rank #2 (Buy).