American Public Education Inc (APEI) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2009 American Public Education, Inc. Earnings Conference Call. My name is Erica and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Mr. Chris Symanoskie, Director of Investor Relations. Please proceed, sir.

Thank you, Operator. Good evening, everyone, and welcome to American Public Education's Second Quarter 2009 Earnings Release Conference Call. The presentation materials that accompany 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.

Also, 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," "could," "estimate," "expect," "intend," "may," "would," "should," "will" and "would." These forward-looking statements include, without limitation, statements about the third quarter and full-year 2009 outlook and statements regarding expected growth.

Actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described in the Risk Factor section and elsewhere in the Company's annual report on Form 10-K filed with the SEC.

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. Today, our speakers are Wally Boston, the Chief Executive Officer of American Public Education, and Harry Wilkins, the Chief Financial Officer. Now at this time, I'd like to turn the call over to Wally Boston. Mr. Boston?

Thanks, Chris. We are pleased to report another quarter of strong results driven by our growing ability to attract and retain civilian students, as well as by our continued success at addressing the needs of the military community. American Military University's continuing lead among Service members is illustrated by our No. 2 ranking in Military Time's Edge Magazine Top 50 schools chosen by Service members in 2008; and on the slide on page 3 we had listed the Top 20 there. This list points out the fact that the Top 5 institutions enjoy a huge size advantage over many lower ranking schools, and that the number of Service members served by the leading institutions varies dramatically beyond the top five or six schools. Many of the top schools like AMU have served the military community for many years.

Our top standing within the military community, in addition to our deep relationships with the military's key influencers, gives us great visibility and a unique advantage over other institutions as a number of military students enrolled at AMU continues to expand faster than the overall number of military students using tuition assistance.

Moving on to slide 4 -- since our IPO in November 2007, we have consistently stated that our intent is to continue addressing the needs of military students while expanding outreach to public service and other civilian communities. In the second quarter of 2009, our growth of net course registrations from Title IV students, our reasonable proxy for civilian growth, increased approximately 100%. This represents a slight acceleration from the first quarter of 2009 when net course registrations from students using Title IV grew approximately 87%. Furthermore, strong growth in Title IV net course registrations, which now represents 18% of total net course registrations, illustrates that our mix shift to a larger civilian population is well underway. Our efforts expand awareness of our APU brand and effectively advertise and select civilian markets continue to produce positive results.

Civilian student application growth accelerated slightly in the second quarter as well. While our conversion rates in the civilian market are lower than those among military students, we believe there is an opportunity for us to improve our registration processes and shorten the duration between application and registration to improve conversion rates.

As you know, we have a robust new product pipeline that enables us to bring new programs to market quickly and efficiently. In the second quarter, we submitted two new Masters' programs to HLC for approval. As these and other new products are approved and launched we will be able to provide you with more details regarding these programs. The key message here is that we are successful moving forward with the launch of new programs that will continue to contribute to our long-term growth.

Our expansion strategy also includes investing for future growth by entering new markets and launching new initiatives. This quarter we are pleased to announced that American Public University System has partnered with Connections Academy, a leading operator of K through 12 virtual public schools, to provide an accelerated path to earning a college degree. The partnership offers high school students the opportunity to earn a high school diploma through Connections Academy's national private school, National Connections Academy, and an Associate's Degree through APUS in four years. Additionally, participating students may also earn a Bachelor's Degree from APUS in just two additional years.

We believe that younger students with the remarkable embrace of technology represent enormous opportunities for online universities. This partnership places APUS at the forefront of this emerging market and places us in the best position to serve young students. Our affordable programs and high-quality academic offerings will be attractive options to Connections Academy students, who already have the desire for and experience with online learning.

To support a rapidly-increasing student population, we make regular investments in systems, processes and management talent as we grow. I am pleased to announce that Sharon van Wyk has joined us as our new Chief Operations Officer. Sharon recently served as Vice President of Process Excellence infrastructure and online customer support at Intuit, a leading international provider of business and financial management solutions with $3.1 billion in revenue. Prior to her role at Intuit, she served as Vice President of Process Excellence in new market development for the Employee Benefits Group of GE Financial, as well as other leadership positions within GE Capital. Sharon was a founding member of the Change Management Group at Accenture, the first and largest of the Big 6 Change Management Practices.

I will continue to focus on corporate and university strategic leadership, as well as academics, marketing and finance. Sharon van Wyk will have primary responsibility for Student Services, IT and Human Resources. Sharon van Wyk has a consistent track record for generating impressive results at organizations that are much larger than APUS is today. We know she shares our vision for the future of APUS and she has the knowledge, credentials and talent to effectively contribute to our rapid expansion.

Moving on to slide number 5 -- our track record for generating growth is reinforced by our second quarter enrollment results. Overall, total student enrollment increased 49% year over year to 53,600 students in the second quarter of 2009. Net course registrations increased 44% in the quarter. This was slightly higher than expected due to stronger than expected growth from civilian students as well as improved retention. Net course registrations from new students increased 27% to 11,200. While this is about 150 registrations shy of our projected outlook due to the variability of forecasting, a changing mix of military and civilian students, we view this result as being in line with our expectations.

We move on to slide number 6 -- I'd like to talk about the benefits to our growing mix of civilian students. First of all, our civilian students take more classes per year than our military sector students. On average it's about 50% to 60% more courses per year generating more annual revenue per student. Secondly, our civilian students have a higher retention rate, which also leads to more lifetime revenue per student. Therefore, we believe that strong net course registration growth and revenue growth can be achieved with lower growth and net course registrations from new students, while our mix is shifting towards civilian students.

We continue to pursue civilian growth with our focus on niche markets and student referrals. These segments of the civilian market rely heavily on the opinions of others when making a higher education purchase; therefore, allowing us to streamline our marketing efforts. While the referral rate among our civilian students is lower than that of the military, it is still very high at approximately 40%. Our overall referral rate continues to be above 50%.

In short, we see great opportunities for APUS in civilian markets as we continue to achieve excellent results at much lower student acquisition costs than many other for-profit institutions. We believe it is more cost effective to pursue our targeted, relationship-oriented approach to marketing with industry-leading referral rates, than to change business model.

Moving on to slide number 7 -- investors who have followed our American Public Education story since the IPO know that we've really not changed the story today. I'm pleased by how our management team and employees have worked to execute on our long-term strategy that focuses on quality and affordability with high margins and strong growth rates. Our outcome assessments, the results of which we publish on the Internet, illustrate that our students perform above the national norms in most assessment, exam and survey categories. Moreover, the fact that 25% of our alumni return for a second degree, and more than 50% of new students are referred by others, speaks volumes about our quality and customer service.

While public and private universities have increased prices by an average of 6% annually, APUS has chosen to keep tuition affordable with no undergraduate tuition increases since 2001. We've been able to enjoy rapid growth and margin expansion while holding prices steady. Our marketing model is an example of growth at a reasonable price. We do not rely on expensive lead aggregators to generate growth, but instead use multiple channels that are more targeted and more cost effective. Although the cost of advertising in civilian markets has increased our overall marketing costs as expected, our student acquisition cost certainly remains among the lowest of the peer group.

While the cost to acquire civilian students is higher than military students, we realize more economic value from the civilian students. As a result of the return on investment, we may accelerate our advertising spend from time to time, but in a way that does not sacrifice overall margins. Over time we should be able to gain additional leverage from General and Administrative expenses, and to some extent instructional cost and service expense.

In closing, we are a university that happens also to be a growth company. The opportunity is available to us in the civilian market and continued expansion within the military community will enable us to be a high growth, high margin business for the foreseeable future. Our goal is to maintain growth rates above the industry average without sacrificing affordability, margins or quality. The characteristics that made us so successful with Service members should also allow us to grow in selected civilian markets.

Now, for additional details regarding our most recent quarter, I'd like to turn the call over to our CFO, Harry Wilkins. Harry?

Thanks, Wally. I'm please that API reported yet another quarter of strong results. Revenues grew 43% to $35.7 million -- I'm looking slide 8 now on the presentation -- and the growth was due to growth in net course registrations. EBIT increased 52% to $8.8 million and this represents a strong improvement in our operating margins year over year.

While our net income increased 35% to $5.3 million, it's important to note that in the prior year's tax rate was unusually low at 34% compared with our 40% tax rate the second quarter of 2009. It's also important to recognize that our growing cash balance is earning a lower interest rate because of our conservative estimate and, therefore, it's a bit of a drag on net income. Our second quarter 2009 earnings were $0.28 per share. That was about a penny above our expectations.

Our balance sheet is very strong with no long-term debt and increasing cash balances. We also plan to build a new facility in Charlestown in the year 2009 or 2010. This quarter we also introduced our third quarter guidance with a slight refinement to full-year guidance, which calls for a 54% to 58% year over year growth in EBIT.

On slide 9, you can see that API became more efficient in the second quarter of 2009. Our operating margins expanded from 23% to approximately 24.7% as a result of strong revenue growth and leverage of G&A expenses, as well as some improvements in instructional costs and services.

Instructional costs and services decreased as a percent of revenue and this decrease was, in part, the result of full-time faculty teaching more classes in the first half of the year; a trend which will likely reverse itself in the second half of the year. We also saw some leverage from fixed costs associated with our Transcript Evaluation Department, Student Services and Academic Advising.

Selling and Promotion increased as a percent of revenue as we had expected. Selling and Promotion increased to 14.4% of revenue and is basically in line with the expectations that we outlined in the first quarter of this year. Remember, the prior year's period of Selling and Promotion expense was still impacted by the delay of our Master's Of Education Program and the associated marketing initiatives with that, and that led to an unusually low Selling and Promotion expense in the first half of 2008.

A better-than-expected acceleration of civilian applications and our strong enrollment growth from civilian students, combined with the high economic value of civilian students, makes us willing to spend a little higher percentage of revenue on Selling and Promotion to civilians, especially as we continue to build out that APU brand in the civilian marketplace. We will be willing to do this as long as we see the good return and as along as we continue to gain leverage from G&A to offset the increased Selling and Promotion costs.

We do not need to sacrifice quality or margins to manage the top line growth rate in the mid-30s to 40%, a rate which we are currently exceeding without increasing tuition and without spending a higher percentage of revenue on marketing.

G&A expenses decreased as a percentage of revenue from 20.3% to 16.9%, and this decrease is due to leveraging our fixed cost as we expected; and this is where we expect to get most of our operating leverage going forward.

Interest income decreased as a percentage of revenue despite a higher cash balance. We're being more conservative on how our cash is invested and, thus, we're seeing a lower interest rate. Our Board of Directors requests that we invest cash in very conservative investments as is prudent in response to the risk associated with this recession.

We currently plan to continue accumulating cash. Our effective tax rate in the second quarter of 2009 was approximately 40%, and our bad debt remains less than 1% of revenue.

On slide 10 -- as of June 30, 2009, cash and cash equivalents grew to $57.1 million with no long-term debt. Depreciation and amortization expense grew roughly in line with revenues to $1.4 million during the second quarter, and CapEx expenditures increased moderately to $2.6 million.

There's a strong possibility that we have an opportunity to either purchase and/or build facilities in Charlestown in the next 18 to 24 months. This could add up to $10 million of CapEx we need to expand our operations about 10,000 to 12,000 square feet of space each year. The space that we're contemplating building would be about 44,000 square feet.

We are now more than halfway through the year -- if you would turn to slide 11 -- and we're able to refine our guidance for the full-year outlook with the greater visibility into the year. We have adjusted our net course registration from new students to 49,000 students or more, an increase of 33% or more, as we believe that we will continue to outperform our original expectations for civilian growth as our military student growth matures.

Due to the mix shift to more civilian students and to greater visibility, we're raising our net course registration guidance slightly to 205,200 or more, which is an increase of 40% over the full-year 2008.

We're adjusting our full-year revenue expectations to between $147 million and $150 million, which represents a growth of 37% to 40% over the full-year 2008.

EBIT is expected to be between $39.5 million and $40.5 million, a growth of between 54% and 58%. Included in our EBIT outlook is the expectation of Selling and Promotion expense of approximately 14% of revenue. We continue to gain confidence in our ability to attract civilian students, as well as our understanding of the financial implications of the changing mix and the impact of that on growth margins.

We are raising the bottom end of our full-year guidance range for net income from between $23 million to $23.9 million, or earnings between $1.20 and $1.26 per diluted share.

On slide 12, we expect net course registrations from new students to increase 31% during the third quarter of 2009. Yet, the net course registrations are expected to 38% to about 53,800 registrations.

Revenues for the third quarter 2009 are expected to be between $35 million and $36 million, which is a growth rate of between 28% to 31%. Our growth rates in the third quarter are being adversely impacted by the timing of our classes' starts in September. This trend should reverse itself in the fourth quarter and I'll go into that in greater detail in a moment.

Our net income is expected to be between $4.8 million and $5.2 million, a growth rate of approximately 26% to 37%. We anticipate EPS of between $0.25 and $0.27 per diluted share on weighted average shares outstanding that were approximately $19 million.

On slide 13, the reason why our third quarter revenue is lower than analysts may have expected is due to the timing of the starts in September, which is our seasonally strongest month. In September 2009, classes will start on the 7th, whereas in 2008 classes started on the 1st. This means that we'll expect to recognize less revenue this September than we did in the September of the previous year. Stated differently, we recognized 56% of the 2008 September cohorts revenue in September, where we expect to only recognize about 44% of the 2009 September cohorts revenue in 2009. You need to know that this phenomenon will also occur in December of this year.

On slide 14, in closing, APEI is in a solid financial position for continued growth. We provide an affordable, high-quality product delivered efficiently. We have strong top-line growth in the mid-30s to 40%, and expanding margins that should lead to a bottom-line growth rate of 40% to 50%. Despite changes to our seasonality and our student mix, we are achieving our long-term growth goals and improving our efficiency while planning for the future by investing in new programs and entry into new markets.

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

(Operator Instructions) Our first question comes from the line of Arvind Bhatia with Sterne, Agee. Please proceed.

Thank you. Good afternoon, gentlemen.

Good afternoon.

Good afternoon.

My first question is on competition, which seems to be the foremost question in investors' minds. Can you comment on the competitive environment and how that might have changed? And then my second question is the impact of the new GI Bill, both short term and long term, I'd like to get some perspective from you guys.

Well, we'll give you a couple of different things. As far as competition goes, there are a number of companies that have stated their objective to pursue the military market because of the 90/10 issue they have. While they appear to be growing in market share, we're still growing in market share. So, there's more competition in the market, but we believe that we're still achieving a significant number of new military students each month. And this illustrative slide, while it's 2008 numbers, we actually believe that we've moved into the No. 1 position over UMUC.

As far as the VA goes and the new GI Bill, we really thinks it's too soon to tell on that. If you look at a number of the releases, I think the VA said this morning that they have about 5,000 applications so far for that and I think we've roughly got about several hundred. I'm not sure of the exact number, but there are a number of students who have stated that they're waiting to see how it shakes out specifically on the housing allowance. Which there is a technical proposal in the House from the chairman of that committee to make that change; we think that change will get made. We also think, as we've stated for the past year since the Bill was passed, that we think a significant number of military folks will use tuition assistance and will save that benefit for their spouses and dependents.

And my last question is on the September quarter guidance. You mentioned the timing differences. How much do you think the impact is on your EPS or top line? I know you gave some color, but had everything been normal how much of an EPS impact would that be in your mind?

Well, that one week of revenue is about $2 million that gets pushed back into a different quarter.

Okay, and then December quarter you mentioned is going to have the same impact, so as we look at our models we should take that into account. And to be clear, the June quarter didn't have that impact?

That's correct.

That's correct. And December it's generally a fairly light enrollment month in comparison with fall.

Great. Thank you and congratulations.

Thank you.

Our next question comes from the line of Ariel Sokol with Wedbush. Please proceed.

Hi, guys, a question with respect to the sales and marketing spend. You said that you would be willing to spend more money to attract civilian students. I'm just curious, so is the 12% to 14% kind of range that you provided in the past still hold, or are you willing to go above that?

Well, Ariel, I think that it's -- our objective is to stay within that range. One of the things that we're finding is that as we spend more money we get more leads, but we believe that the prudent thing to do rather than just trying to generate pure leads is to try to focus on the niches and the markets related to our degrees on those leads. And so I would say, conservatively spend rather than putting a shotgun approach to it. So for right now, while we're spending money in the civilian areas and it is costing us more in acquisition costs, as we noted the revenues per civilian student are higher. The other thing that we're doing is we are spending money on branding where you have roughly -- while we have approximately 20% civilian students, we have roughly only 7% of our students overall are enrolled in American Public University, because as you may recall a lot of our civilian students are in law enforcement and they're quite comfortable with the AMU brand.

Great, and could you quantify the average cost per civilian student and maybe talk about it on a year-over-year basis? And can you also speak to the referral rates, both what they were in Q2, but as well as how you think they could trend potentially, or how it is in your internal model with assuming guidance for the rest of the year?

I think we've done that on an annual basis. I don't think we've done that on a quarterly basis. But the cost of acquisition per civilian student is higher. We've said that on previous calls and the referral rate is lower. So, while our average referral rate is in excess of 50%, we stated on this call that our civilian rate is currently running about 40%, which we believe is due to the niche markets that we're pursuing in law enforcement, emergency management and with teachers. I believe that if you do the math, I think that implies that our military referral rate is about 63%. So, if you use referral rates as an indication there, you might be able to back into what the cost per acquisition for a civilian student is.

Thank you.

Our next question comes from the line of Jerry Herman with Stifel Nicolaus. Please proceed.

Thanks. Good afternoon, everybody. Guys, just a couple of questions about growth. I know that you've been public for some time and heretofore you've talked about 40% growth. You mentioned mid-30s to 40% growth on the call for the top line. Is that -- are you maturing guidance let's say in the process of growth here?

I don't know that we're maturing guidance.

Yes, I think that's what we say, Jerry. To go back to the first quarter when we were giving guidance for the full year, we said that as we got into the fourth quarter we were expecting growth in the high 30s. But yes, I mean as long as our growth rate is in excess of 35% we're happy. If it's gets much above 45%, we start to worry about ability to continue to improve the quality of our product with that many students going through the system. So, we're happy in that 35% to 45% range, and certainly we're very happy with the growth that we're anticipating right now, which is about 40% for the year.

And the other thing that I would add, even though our civilian students that we're actively seeking have cost us more to acquire, you note that our margins are actually outstripping on our growth percentage the revenue growth.

Okay and then with regard to guidance, the net new course registrations, you gave third quarter guidance. It implies an acceleration in the fourth quarter. I know you guys have talked about timing shifts, but is there something else going on there or maybe the question is, what's your confidence in the predictability in that out quarter?

I think our confidence is pretty good. Typically, the fourth quarter is our best quarter. When we talked about seasonality last quarter, we showed a graph and showed how everything goes. September is our first boost month of the third quarter, or first booth month of really what's a seasonal thing that happens in the fall, but we only get one month's revenues in there. And then when we go into the fourth quarter, October and November are traditionally very strong with December being a little light due to the holidays.

Okay and --

We're very comfortable with the forecast that we've given.

I have just one last one. I know you haven't talked about this too much, but just the composition of selling and promotion, i.e. maybe some guidance in terms of the percentage of that line item that's for enrollment reps, branding, lead generation; any rough guidance you can give us with regard to that line item.

I think most of our increased spend, Jerry, is lead generation with spend in branding. But if you're familiar with how the online lead generation works, you can spend your money on very specific key words that relate to degrees and other strategies, and then you can also spend your key words on your brand itself. So, there is some that goes into both, but most of the increased spend is in Internet marketing.

Great. Thanks very much guys. I'll turn it over.

Our next question comes from the line of Kelly Flynn with Credit Suisse. Please proceed.

Thanks. I guess a couple of questions. First, on the 49,000 new student growth figure, that was lower than what you said last quarter which I think was 50,200. Can you drill down more into that? Were you disappointed by military growth and, if so, why? And then I have a couple more, thanks.

No, but we're finding that the civilians are actually good for us, as you can see. As we shift more towards civilian students our margins are increasing and we don't need as many new students as our percentage shift towards civilian students as we do military students, because civilian students take more courses. I mean our goal is to try to manage that top line and high of 30% to 40%, and with civilian students you just don't need quite as many new students to do that.

Okay, so yes. I guess that was the next part of the question. I mean you're basically managing your growth to around 40% and you think that's the right way to look at it?

We think that's prudent for now. We continue to look at the regulatory environment with some uncertainty about either accrediting bodies or the Department of Education. And we are comfortable that with all the new degrees that we add, which in some cases means that an accrediting body comes to visit us that we can continue to manage to a number of under 50%. You may recall that the Higher Education Opportunity Act last summer put a provision in there that accrediting bodies are supposed to investigate institutions that have a growth rate of higher than 50% in a year. So, we like the 40% number. Our deans and faculty are comfortable that we can manage the growth and maintain or improve our academic quality and we think it's prudent to be able to manage this Company as a long-term growth Company.

Yes, and we want to keep our margin. We put that chart in there for a reason. Our goal is to maintain high margins, above-average margins for the industry, and above-average growth for the industry. We like that. At that same time we have 74 programs currently, going up to 77 once we get approval for the three new programs in the next quarter or so, so that's more programs than anybody else has. We also haven't increased our price. We're the only school that I know of that hasn't had a price increase. So keeping our prices affordable, having a wide variety of programs, and I would put the quality of our programs up against anybody. By any measure of student outcomes you want to use, our programs measure up against anybody. So we're not sacrificing anything to achieve higher growth rates. We're comfortable that we can maintain or improve the quality of our programs; keep our prices relatively where they are, stable; have a very profitable business, and our profitability is growing as you see; and maintain 35% to 40% growth. All that results in us having an EBIT growth of about 50% or more this year and what's wrong with that?

Right, okay. That 35% growth, or 35% to 40% rather, following up on Jerry's question, what timeframe does that apply to? How long do you think you can do that?

We haven't given any guidance for next year yet, but we obviously want to maintain growth over a long period of time. Wally and I are long-term shareholders just like hopefully all of our other shareholders are. So our goal is to grow this Company, have healthy growth for a long period of time. Certainly, we think we can do 35% or better, more than beyond this quarter.

Okay, but just again to clarify, I mean you don't see that as a change versus the prior 40% that I think you had talked about?

Well, I think our guidance for this year, Kelly, was 38% top-line growth, so we actually started out the year at 38%. So we've increased our guidance at 40% for the year and I think we're just throwing in a range of 35% to 40%. Because as you know management teams like to achieve their forecasts and 35% to 40% is a comfortable range.

Okay, got it, a couple more. The new student growth for the third quarter I think implies about 31%, which is better than the second quarter, but not as fast as what you're expecting for the fourth quarter. You mentioned last quarter there was a tough comp in the second quarter. Is there anything else holding back that growth in the third quarter that would explain why it would accelerate so much in the fourth quarter but not the third?

Well, we had strong military growth last year. We had about 60% growth in the third quarter last year, which we're comping against. But no, mean we're managing the growth to where we think it needs to be to keep our goal of improving margins and keeping 35% to 40% top-line growth.

We also had -- last July there were two divisions that returned from the Army from Iraq and we don't -- we're not aware of any divisions that are returning in the third quarter this year, and so, that is a particularly specific -- I think our July -- well, I think our numbers for military enrollments were 60% roughly in the third quarter of last year, and while we're predicting growth we're not predicting that kind of growth because we don't see those divisions coming back at this time.

Okay, great, and the last one. On the marketing expense line, if you will that 14% you spoke to, I notice no one else touched on this but is that -- are you intending to increase that versus what you said previously? Because I thought I had in my notes that you had said 12% last time and, if so, is that part of the reason the guidance is a little lower than consensus for Q4 earnings, or is that meant to be the same range?

I think if you listened to the call last time we said 12% to 14% was the range that we were comfortable in. But as we improve our margins, as we get economies to scale in other areas, we have a large portion of fixed costs like our G&A cost, we may decide to spend some of that money on marketing. But our goal is to have margins that either remain the same or go up, and we're not going to hurt our margins for the expected growth, but we're not going to not grow with expected margin. We're going to continue to have margin increase and grow the Company.

Okay, sorry, one last one on the regulatory stuff. I wasn't going to ask you about this on this call, but you since you mentioned it. I mean when you say part of the reason you want to control your growth is because of that, were you just talking about that accreditation issue highlighted, or is there something else you're observing that gives you pause on that front?

Well, as you may know, we did something rather unique prior to our IPO, which was we contacted all 50 states and gave them the particular facts that while we were an online university we had faculty members in their state and students in their state. And we were licensed in West Virginia and the State of Virginia because of physical presence, but we wanted to see whether those facts may or may not have deemed that we needed to be licensed in their state. And I think that the net of that was we're currently licensed in about 12 states and we think we've gotten ahead of that.

Nonetheless, we continue to focus on regulatory changes in all of the states. We see some states that are tightening up on standards and, quite frankly, if you're not regionally accredited which we are, they may some standards that are tightening in some of the states that we're staying in touch with. But if you look at some of the rules and regulations that were put out there through the HEOA, the accrediting bodies are being forced to examine on a tighter basis growth. Our particular accrediting body, the Higher Learning Commission, actually put in some provisions on change and control that we think only really applies to for-profits. Whether they're for-profit institutions or private equity firms that are buying non-profits, but nonetheless we see that as a sign that people want institutions whether they're for-profit or not to be very accountable.

And so in discussions internally with our faculty and our deans, we believe that 40% growth rate meets the clean standard of coming in under 50%, as well as a comfortable growth rate that we can back all of our growth with the fact that we're maintaining standards in the classroom and we're maintaining good outcomes for our students.

Okay, thank you very much.

Sure.

Our next question comes from the line of Mark Marostic from Piper Jaffray. Please proceed.

Thank you. I wanted to touch on your point, Harry, on instructional costs and services. I think you mentioned that the full-time faculty was teaching more in the second quarter that boosted or helped you leverage ICS more effectively, and in the back half of the year you expect that trend to reverse. Can you quantify that for us as you look at Q3 and Q4?

Yes. You know, it may be a percentage point. What happens is that our full-time faculty are paid a salary and their contracts depicts a certain number of students a year. But a lot of them like to take off in July and August for vacation, so they will teach more students than they normally would in the first half of the year because they're taking off two months in the summer. So when they take off, we still have students taking classes. We have to fill those positions with adjuncts which we pay per student per class. So usually in the third quarter our instructional costs go up a point or two because of that factor, just the fact that our full-time faculty take vacations and we have to pay somebody to finish their class.

Got it, and as you look as December?

Yes, the first quarter shouldn't be too bad. That should be more normal type -- the faculty should teach about what we contracted them to teach.

Okay, great. And then you could comment on the mix of graduate students in the quarter, how that's been trending.

We haven't given that information out, but it's been trending fine. I mean the graduate population continues to increase. The civilian students actually now make up more than half of our total graduate students are civilians, so we've had quite good growth there. But the mix is still predominately undergraduate.

Right, and then touching on that point, you talked about pricing and your ability to maintain pricing. I'll just ask the question I think we always ask on this call, at the graduate level are you looking more seriously at price increases here or what are you thinking about there?

Well, we've always stated that we thought that there was some room in our Masters Degrees, basically of the fact that years ago we set our Masters Degrees' tuition at the military reimbursement which did not differentiate between undergraduate and Masters.

Some of you may have attended the DoD Worldwide Conference last week in Atlanta, and on Friday they announced that they had done a review of undergraduate and graduate tuition and that their conclusion on undergraduate tuition was that there was not a need to increase that for now; mainly because of the fact that still a substantial portion of their students go to community colleges which are priced well below $250.00 a credit hour. At the same time, they said they had done an analysis and that the graduate tuition may need to be moved to as high as $350.00 per credit hour. So, there's no firm date on that.

I'm sure some people can get the transcripts of that. At some point maybe there'll be a DoD press release, but we're watching very attentively for the date. Our guess is that it would probably be around October 1, 2010, since it's really too late to make that impact in October 1st of this fiscal year; beginning October 1, 2009. So, that falls into line with our strategy of looking at doing something some time in 2010. So as we get closer to a decision on that, we'll inform everyone at the same time.

Okay, great, and then one last question and I'll turn it over. Regarding the timing of start periods, as you look to the quarters in 2010, are there any nuances that we should be aware of.

Maybe you can figure it out as well as we can as our classes start the first Monday of every month and that's when we start recognizing the revenue. So, look at the first Monday of each month and you'll be able to tell as well -- I don't have a calendar in front of me right now but.

Fair enough.

Yes, we haven't put together our budget model, which is actually where we get into the greater detail on monthly starts.

Thank you.

Sure.

Our next question comes from the line of Trace Urdan with Signal Hill. Please proceed.

Hey, guys. Last year you started the Masters of Education program, I believe, sort of midway through the summer into the fall. It didn't really hit the teachers in their prime season and I'm wondering if you could sort of speak to how that program faired this summer in what I would think of as being the peak season for teachers to enroll in that program. Maybe just in a case study of your, you know sort of an offering in the civilian market, can you give us any color on what happened with that program; what kind of growth you saw; where the strength came from; where the leads came from, something to that nature?

Sure. I think we commented a little bit on this on the last quarter's call as well. The summer has seen continued growth in the program, Trace, and while it's grown at a rate that's actually higher than our new student rate for the quarter it -- there's a particular issue on the Masters of Education in Teaching that we're finding. We're finding that in some states if you don't have the [MK] accreditation, we're not allowed to accept students from those states. That's something that we didn't realize when we set the degreed program up and we certainly don't want to get in trouble on a state licensing perspective. So, that particular degree is going a little slower.

On the other hand, we're really pleased with the other two degrees in Counseling and in Administration and Supervision, which allow people to be either principals or counselors. We're really pleased with that. They have different accreditation versus the MK accreditation. One of them the counseling is called [K Crup] and that accreditation, you know, we believe we can get all the accreditations, but it's a quicker process than the MK accreditation.

One of the other things that's happening, too, is in some of our Masters Degrees, like History, we're seeing strong enrollments of teachers who are already licensed. So while they don't go into our education degrees, we're actually pleased with the results from the conferences of the influx of teachers into the Liberal Arts Masters and the Humanities that we have, like History. So, we're probably going to try to do a summary on this when we can collect more combined information from our data warehouse on applications and source of employment, since not all the teachers enroll directly in the Education degrees.

And have you gotten any kind of qualitative feedback in terms of who they're comparing you to, how important price is in their decision process, anything like that?

We are. I think we had a student in New Jersey who was quoted by one of the regional newspapers that he said he selected our Education degree because of cost. We also recently had, not in Education degrees, but the San Francisco Chronicle which is located out near where you are, quoted one of our students who selected one of our Masters Degrees because of cost. So, we're pleased with the civilian growth in general and we're pleased with civilian growth in particular in our Masters Degree program. As Harry said, we now have more than 50% of our Masters Degree students are civilian and that wasn't the case a year ago.

Sure. I think both UTI and Capella had spoken about the IRS coming in and looking at the treatment of adjunct faculty, requiring or asking the schools to recognize them as employees versus contractors. Does that potentially impact you guys at all?

That's what we've been saying all along, Trace. You may recall that before we went public we made the decision to treat all of our adjunct faculty as employees, as they are under law. If you control when somebody works for you and what they make, then they are an employee of yours. They're not an independent contractor. We made that move way back in 2006-2007. That does, however, open up a whole can of worms when you do that, especially if you have adjuncts all over. Because what happens is, when they become employees, then you get taxes in the state where they work and you've got to file tax returns in those states.

Got it.

The year that we did that we went from filing in 12 states to filing in 38 states, but we did that before we went public, not after we went public. And that's a big undertaking and I'm glad that we did it when we did.

Yes, me too. Last question, I just want to ask you guys if you could maybe elaborate a little bit. I think, Wally, you were speaking to this. You made reference to some changes in the regulatory practices in certain states that you're aware of. I think that's going to maybe be some news tomorrow and I wonder if I could just ask you to elaborate on that a little bit further?

Well, I don't want to -- I don't want to be quoted about a specific state, but I think the one state that's made the news has been California who sunsetted their regulation, their regulatory body and are in the process of trying to bring that back. And there was a case recently where a student tried to sue, I believe it was DeVry, and the court threw it out because they said that California has no process to regulate institutions whether they're for-profit or non-profit.

But, we are -- we actually have two people full time engaged with state regulations and, as I said, we're now licensed in 12 states even though we only have a physical presence in two. The other states we either have waiver letters, or in some cases -- well, we have waiver letters. We have situations such as we begin our student teaching, the practicums, because of that practicum we'll actually designate physical presence. We'll have to be licensed in some of the states that we have waivers.

So, we're very close to some of the proposed state changes, and what I stated was that we're seeing some tightening up of regulations on licensing of distance education institutions, and particularly there seems to be a state or two that are making some waves on differentiating between regional and national accreditation. The good news is we made the decision to pursue our regional accreditation a number of years ago and achieved it in 2006, but I would tell you that as states go through a budget crisis and start losing their students to out-of-state institutions, there may be some political ramifications for that.

Okay, so your comments were really primarily directed at the changes going on in California right now?

No, my comments were directed at the fact that we're seeing some rumblings in some states, but fortunately right now because of our status we're not being impacted.

Okay. All right, thanks guys,

Sure.

Our next question comes from the line of Suzi Stein with Morgan Stanley. Please proceed.

Hi. Can you give us some more detail on the relationship with Connections Academy? You know, how are you going to market this? How are you going to price it? When is it going to start? Any clarification on that relationship would be helpful, thanks.

Sure. We're located in Charlestown, West Virginia, which is really a D.C. or Baltimore suburb depending on how you look at it. Harry and I both live outside of Baltimore and, anyway, we've know the senior management team at Connections for quite a while. We like their story. We like what they do and we had a meeting with them a few months ago where we talked about what we saw as changing dynamics with more online students in high school, whether they're home schooled or in some of the public programs like the ones that they run, and we said what are students and their parents looking for?

They're looking for access and affordability and they're also looking for a way to jumpstart an education. And so, we put together this program which you could either call a 3 plus 3, or a 2 plus 2 plus 2 program, and we aligned their curriculum with ours. We have a very specific regimen. We have an agreement to do that and we think that it's a win-win for both of us. It's not an exclusive, so Connections could choose to do it with other online institutions and we could choose to do it with other online high schools. But what we wanted to demonstrate from this is that it's very reasonable and possible to do this as accredited institutions and we want to recognized the changes in technology and not just provide access to students who may take six years to get a college degree, but also provide access to high school students who would actually like to get through high school and earn a Bachelor's Degree in about six years.

And we're very excited about the growth in online high schools and we think that's going to lead to a big growth in traditional 18 to 22 year old students opting for more online education. So we'd like to be an early entrance into that market and this is a good opportunity.

How is that going to be marketed to their students, though?

We have an agreement that we'll collaborate on marketing jointly, and as you might imagine we want to kick-start that and we're going to both spend some money on it and put up some landing pages on each of our websites. So, we'll put the proper partnership direction in and we'll evaluate the agreement over time to see if it's working for both of us.

So the Advanced Placement courses the students take with them will count toward credit toward our degree if they enroll with us.

Okay. All right, thank you.

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

Thanks so much. I'm sorry, just following up with the Connections Academy partnership, did you talk about in terms of the economics do you get paid only the last two years if somebody is going to be getting a high school diploma and the Associate's Degree?

I think the way it works, Jeff, is that we get paid for the last three years. So, they get three years' worth of revenue. We get three years' worth of revenue. Whatever they charge for their three years is what they get. Whatever we charge for our three years is what we get.

What if somebody is only going to be going for four years and getting their high school diploma and the Associates Degree, is it two and two?

No, it's three and 1, but that's okay with us. We happen to think that their students are much more achievement oriented than just wanting an Associates Degree. So, we think we'll get the three years.

Okay, great. Thanks for that color. In your slide presentation you give the breakdown in terms of total net course registrations between the civilian or the Title IV market and the non-Title IV. Can you give us a similar breakdown in terms of your net -- your new course registrations?

We haven't historically given that and we don't plan to give it at this point. We may -- we usually give something at the end of the year.

Is it safe to assume, though, it has skewed a little bit more towards the civilian market based on your comments?

Yes, as we anticipated that it would. But as our military number gets bigger and bigger, it's harder to continue to grow. At 40% we were growing the military in the fourth quarter of last year. It's hard to continue that when you're the number one school in the military.

Right. Is that something, though, in terms of that breakdown you might give at the end of the year on an annual basis again?

I think we're comfortable doing it annually.

Okay. All right, that's fair. And then just one more numbers' question? What kind of tax rate should we be using for the rest of the year?

40%.

40% for the year. Okay, thanks so much.

Thank you.

Our next question comes from the line of Bob Wetenhall with Royal Bank of Canada. Please proceed.

Hey, would it be fair to say that by year-end the civilian component of your total enrollment would be around 25% or 30%?

You know, Bob, that's something that's actually dependent upon what happens with the military enrollment. While our civilian enrollment grew 100% based on Title IV in the second quarter year over year, because our military enrollment is so huge and it is still growing in double digits, we didn't change as a percent of the total pool all that much. So as to say, I guess I'm just thinking off the top of my head, I'd say a range probably it isn't too bad to look at somewhere between 22% and 25%.

22% and 25%, okay.

Yes, somewhere in that range.

It's all dependent on how the military grows for the quarter.

And your current market share in terms of courses other than military would be about 12%?

We haven't seen -- they always release their data one year behind, so I believe we thought we were somewhere between 10% and 12%, basically because when they report the data sometimes they only do TA that is outside of contracts they have in Europe and the Far East. And then sometimes they aggregate it, for example, the CCME conference data in January that showed us as No. 1 in terms of enrollment didn't have Europe and the Far East. And this latest report that we put in there includes Europe and the Far East that shows us just right on the heels of UMUC. So, I think it depends on the data, but I'd say 12% is kind of a comfortable number to use. But depending on your source it might be skewed a little bit one way or the other.

But, I'm just trying to understand mechanically, by any stretch in 2010 you have enough headroom where at a comparable and existing growth rate for military enrollment, you're not going to be more than 15% to 18% next year. Would that be fair?

We haven't given guidance on 2010 yet. We still think we can continue to grow at what's considered a good number for just about anybody's book of business in the military market. We just haven't tried to give that guidance yet.

Okay, understood. You got a nice pickup in your operating margin of 150 basis points, and I think your guidance implies that. How much additional leverage through the business model do you anticipate looking out in the next 6 months to 12 months?

Well, what we say is we try to have some margin improvement every year. But we're -- if we can have healthy growth rates, we're happy with our margins where they are. We're one of the most profitable companies in the industry right now. We're certainly above the peer average in profitability and we're focused on growth. So, we can get some margin improvement, I mean without a price increase at some point that would be difficult. But certainly we can improve margins and we have.

And if you did a price increase, it sounds like it would be Masters and not in your Bachelors program, correct?

Right. We've pretty much consistently stated all along that we'll keep our undergraduate prices pegged to the military tuition reimbursement and they just announced at the same time they announced this increase for Masters that they were going to keep the undergraduate the same.

Okay, and there's no chance you would tier pricing between the civilian and military market?

Well, there could be, but we've also stated that our niche markets that we focused on are really public servants between law enforcement, fire and emergency management and teachers. We think that the people who we serve are servants themselves and income is an issue, so trying to tier it particularly when the other point about our competition, we look at our competition as the public four-year institutions predominantly and many of them offer the in-state lower rates for law enforcement and firemen just as they do for military.

As long as we can accomplish our goal of 35%-plus growth with margins that maybe slightly improve, if we can do that without a price increase we're going to do it. If it takes a price increase to do it, we would consider it.

Fair enough. Thanks a lot

Thank you.

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

Hi. Good afternoon.

Hi, Corey.

I just had a couple of questions about growth. All else equal, you would expect new student registrations to be a pretty good leading indicator of total registrations. If you have a continuing shift outside of the military toward Title IV, just thinking through the math if you could help me for a second, do you think you could over an extended period of time have new registration growth below 35%, yet maintain total registration growth above 35% because of the mix shift?

Yes, for probably 18 to 24 months.

Okay, so the fact that you're looking at a couple of quarters here of 30% or maybe in that range of new student registrations doesn't suggest that you think that total registrations are at risk of dropping to that level?

That's correct.

Okay, and the second question also about growth. Obviously, there's a lot of benefits to your model and to the referral marketing method. The only real drawback is that it's not the larges funnel compared to other ways of attracting students. So as the base that you're growing off of is growing relatively rapidly and as that base grows, obviously it gets tougher to maintain the 35% growth, just how do you think about that balance. As you want to maintain the 35% growth presumably that gets a little harder to do with just -- with referrals as such a big part of your mix as the base gets larger.

Well, as I think as the base gets larger what we've said is we'll continue to spend a lot more in dollars to attract new students on the civilian but will also generate more revenues. I really think that what's nice about our model is with our large percentage of military students we give them 10 years to earn a Bachelors Degree and I think the average is running about 7 years. And as you may or may not remember from previous calls, we have disenrollments because of deployments and then we have re-enrollments that come back in and we don't count those re-enrollments as new students. And so while it looks like our overall number is good, once in a while it'll look like our new students are down, but actually we have new students coming back in the form of returning students who've been gone for more than 12 months.

So, we continue to like the way we're trying to manage this in the sense that we're trying to hover around the 40% number for this year in terms of top-line growth and we're trying to do it by spending on a targeted basis and not doing what I call the shotgun approach. We've talked on previous calls about using led aggregators, and when we've done that we've found that our experience is we generate a ton of leads but the net cost per student in the classroom runs about $3,000.00, which is what many of the online competitors do. And we just don't view that as a judicious expenditure of funds particularly if we can focus on the niche markets, do our own lead generation and bring the net cost per civilian student in for a lot less than that.

Okay, if I can just throw one quick last one? Are you still looking to aggregate the lab courses at some point with the main courses?

We are.

We are. We have not done that yet, and just to give you an idea of the impact, in the second quarter of '08 we had about 1,180-some lab courses, as one-credit courses. In the second quarter of '09, we had about 1,700. So there's about a 47% increase, but it's still a relatively small number.

Okay, thank you.

Our next question comes from the line of Brandon Dobell with William Blair. Please proceed.

I wonder if you could focus on the civilian students for a second. Any color outside of the Masters Education program as to where you're seeing strength in terms of programmatic mix, and do you see any major differences if you look past the last two or three quarters of where those students are coming in?

Brandon, we love you, but every time we give specific information about where our strength in students is coming from some of our competitors show up in that field.

Good point.

So we -- I mean one of the things we did talk about in this call is our civilian mix in the graduate programs has actually gone over 50%. I think it was roughly 40% about a year ago. I don't have the exact number in front of me, but I think it was about 40%. So we're seeing success with the pricing and affordability of those Masters' programs as well as the targeted niche marketing for them in the sectors we focus on. We're pretty pleased with that and, I guess, that's about I'll tell you so I don't see some of my competitors moving into my fields.

Fair enough. If you look at the civilian students that are coming in, we will recognize them as very similar to other institutions, i.e. either transferring in with like [bulk] transcripts, maybe 50-60 credits to transfer in, or are they looking a lot different, i.e. they're younger or have fewer credits to transfer in?

I think you saw that they're pretty similar to other institutions, although we're getting a lot more lead flow from younger students. Which it hasn't to this point been a real target market for us, but they're finding us and it's dramatically increased. The lead flow from younger students has dramatically increased.

In the context of that answer, Harry, when you talked here on the call about the civilian students having better retention, that kind of says a little bit of about with the younger online students I think we've seen at our other campuses. And as a broader, I guess in context to that question, how should we think about either the potential bad debt impact from the growth in civilian students, if there is one, or are you managing those younger students differently from a process perspective around financial aid or handholding, those kinds of things?

No, I mean most of them would be interested in financial aid. Our bad debt is less than one half of 1%. Also, there's -- you know with the increase in the Pell Grant that's proposed for next year, I'm sure a lot of those students won't even be needing loans. Remember, our tuition is low enough that with that new Pell Grant that's been outlined for next year, where you can get a Pell Grant every academic year and it's going over $5,000.00 a year for Pell Grants, you're pretty close to getting almost a free education just with Pell.

Right.

So, the needs for loans will be less for those students. But no, we're very comfortable we can control our default risk and that bad debt expense is something we control very well.

Okay, and then finally from a systems and let's call it process or headcount perspective, are you guys still comfortable with where you stand with financial aid administrators, enrollment counselors, those kinds of people for both the civilian and military markets, or should we expect a change in spending trajectory around what you think your growth expectations are?

You know, we sort of have our ratio of counselors to students, so as we increase the number of students on financial aid we add financial aid counselors, but it's sort of a linear thing not a geometric thing. So, our ratios work for us and the good news is being a suburb of D.C. or Baltimore, depending on how you look at it, we're able to find qualified people for those roles.

Okay, great. Thanks, guys.

There are no further questions at this time. I will now turn the call back over to Chris Symanoskie for closing remarks.

Thank you, Operator. Before we adjourn we'd like to thank you all for your participation, your questions and your interest in American Public Education. Thank you and have a great evening.

Thank you for your participation in today's conference. This concludes the presentation. Everyone have a great day.