American Public Education Inc (APEI) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2013 American Public Education, Incorporated, earnings conference call. My name is Crystal, and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Mr. Chris Symanoskie, Vice President of Investor Relations. Please proceed, sir.

Thank you, operator. Good evening, and welcome to American Public Education conference call to discuss the financial and operating results for the quarter ended September 30, 2013. 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, could, estimate, expect, intend, may, should, will, and would. These forward-looking statements include, without limitation, statements about the fourth quarter and full year 2013 as well as other statements regarding expected future growth.

Actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various risk 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, the Company's quarterly report on Form 10-Q filed with the SEC, and the Company's other SEC filings.

The Company undertakes no obligation to update publicly any forward-looking statements for any reason 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 CEO, and Harry Wilkins, our Executive Vice President and Chief Financial Officer. At this time, I'll turn the call over to Dr. Boston.

Good evening, everyone. I will begin today's call with an overview of our third quarter operating results and provide a brief update on our long-term strategy.

Then Harry Wilkins, our Chief Financial Officer, will discuss our financial results in more detail and provide perspective on our outlook for the fourth quarter of 2013.

As noted in our last earnings call, we believe net course registrations in the third quarter 2013 have been adversely impacted by the delays we experienced in processing certain Federal Student Aid, FSA, applications. For the three months ended September 30, 2013, net course registrations increased 6% compared to the prior-year period, and net course registrations by new students declined 8% year-over-year.

In the third quarter of 2013, net course registrations by students using FSA and GI Bill benefits, or VA, increased approximately 2% and 22%, respectively, while net course registrations by students using tuition assistance, or TA, and by students using cash and other sources decreased approximately 1% and 10%, respectively, compared to the prior-year period. Net course registrations by new students declined across all tuition categories.

At the beginning of July we brought our financial aid processing in-house, and we experienced unexpected delays in processing. We believe the initial delays were the result of various record conversion issues with new software. Though identified software defects continue to cause processing delays for affected students, the large majority of our financial aid requests are now being processed within our standard time frame.

Processing delays impact the customer satisfaction of affected students. We continue to work with the software vendor to fix ongoing issues and defects. We believe that the initiative to automate and bring FSA processing in-house will eventually result in cost savings and improve customer service once these remaining matters are fully resolved.

During the third quarter of 2013, we expanded our corporate and strategic outreach by building new agreements and relationships including with the World Alliance for Retail Excellence & Standards, an international trade association for manufacturers and retailers, and the Positive Coaching Alliance, a national nonprofit that works with youth athletes. In addition, we expanded our existing relationships with several corporate and police chiefs associations.

Since the beginning of the year, our community college outreach team has signed new agreements and developed relationships with approximately 90 community colleges. APUS now has more than 340 relationships or agreements with community colleges around the country.

We have created a new strategic account management team within our corporate and strategic outreach department to further our success at growing existing partnerships by increasing levels of customer service through a greater onsite presence and interaction with key stakeholders. We believe that customer service is a key differentiator for APUS. A high level of service is expected by key stakeholders and the various departments of our corporate partners.

We recently realigned our enrollment advisors into new functional teams to more capably focus on advising the students of our strategic partners -- students from community colleges and international students as well as students from veteran and military communities.

As we continue to cultivate relationships, we optimize our operations and improve student success through innovation. For example, our ePress online library solution initiative continues to be tremendously successful at lowering textbook and course material costs to nearly $41 per net course registration while, at the same time, supporting student success and satisfaction.

In addition, we recently completed our mobile classroom project, which now enables student access to all classroom features through just about every mobile device, smart phone, or tablet. This new level of accessibility enables our students and faculty to interact and study using whatever device they have in hand.

On a financial note, I am pleased that bad debt expense remains relatively low at 4.1% of revenue as of the third quarter compared to 4.4% in the prior-year period. We believe this is attributable, in part, to the success of our ongoing efforts to limit FSA fraud and abuse.

We believe that many military students impacted by the temporary suspension of tuition assistance will resume their efforts to pursue higher education. However, military students take three courses per year, on average, and there is no certainty that they will modify their original plans or adjust their schedules as a result of the temporary suspension of TA in October.

This event may amount to a permanent deferral of registrations by certain military students. Thus, the financial and operating results for the fourth quarter of 2013 will be adversely impacted by these and other possible events.

Despite the volatility we see in certain tuition financing programs, possible regulatory changes, and growing competition, the unique and fundamental characteristics of our institution remain very healthy. Our academic quality continues to improve, we continue to be recognized by the academic community for many of our online initiatives, we continue to innovate, and our affordability continues to expand compared to the broader industry.

The College Board recently released its annual report, Trends in College Pricing, which indicated that the average published price of college tuition for in-state tuition at public schools increased 3% year-over-year despite major efforts to reign in the high cost of education.

Today APUS undergraduate program costs are approximately 20% lower than the average published cost for in-state tuition, fees, and books at public universities. Recently, APUS was recognized by the Association for Continuing Higher Education, ACHE, with the 2013 Creative Use of Technology Award for a project that creates greater student engagement through textbook innovation. Once again, APEI was honored by Forbes.com in its October 2013 edition, ranking us number 12 in Forbes.com's America's Best Small Public Companies.

This, along with our recent academic recognition, illustrates the strength of our commitment to excellence and the soundness of our long-term approach.

Moving over to slide 4, Academic Quality Initiatives. Our success is, in part, attributable to a focus on increasing the level of student engagement achieved through increasingly interactive course content. Recently, our curriculum and instructional technology and design office began building additional interactive course elements with the goal to increase student engagement and retention.

Leveraging internal resources, the academic media team, instructional designers and faculty developed interactive case studies, interactive videos, a virtual lab, and a virtual literary museum. The interactive case studies debuted in October, and the team is currently collecting data on student success and satisfaction. The remaining elements will deploy in courses between November and January.

These interactive assets combine elements of simulation design and gaming technology and are built to support specific learning objectives. Each piece is designed for access on computers and mobile devices as well as for accessibility requirements of the Americans with Disability Act. APUS is dedicated to increasing the level of student interactivity through simulation and gaming technology among other recognized online classroom tools.

In the third quarter of 2013, APUS began offering three new degrees. Our new BA and MA in entrepreneurship offer students who want to direct their own career path by starting businesses or nonprofit organizations. These two programs were offered in response to strong student interest and were developed from the university's existing entrepreneurship concentrations within its business administration programs. Student feedback and continued growth in small businesses nationwide suggest that this is an increasingly popular career field.

Our new BS in mathematics will prepare graduates to use their skills in almost every sector of the job market. This is the first of several planned degrees that advance our strategic focus on the science, technology, engineering, and mathematics, or STEM, area. APUS plans to submit for accrediting body approval to offer additional STEM degrees in the future.

In September we launched an undergraduate certificate program in restaurant operations, and a graduate certificate in business essentials for the security executive. APUS also earned approval to offer four new certificates, a graduate and undergraduate certificate focused on law enforcement leadership, an undergraduate certificate in strategic leadership, and a graduate certificate in human capital leadership. All four will be offered in the December course catalog.

APUS recently became the first fully online institution to participate in the Foundations of Excellence program of the John M. Gardner Institute for Excellence in Undergraduate Education. The self-study examined our practices and support for our first year and transfer students with the goal to enhance student learning, student success, and increase retention. We are now moving into the implementation phase in which our university retention committee will begin executing the resulting recommendations.

We will also soon begin another three-year project with the Gardner Institute called Gateways to Completion, G2C, in which APUS will partner with 11 other founding institutions to explore ways to improve student learning and student success in high-risk, high-enrollment gateway courses with historically high failure, withdrawal, and incomplete rates.

This project is especially interesting because of the Institute's predictive analytics tools they share with the institutions involved in the project. Between the FoE and G2C initiatives, we hope to build on our success in improving student success and retention.

In addition, APUS was chosen to be in one of the first cohorts to participate in the inaugural offering of the Higher Learning Commission's, HLC, Academy for Student Persistence and Completion. The primary focus of the Academy will be on identifying critical issues, potentially useful approaches, and institutional cultural and demographic concerns that have an effect on retention in order to help students stay in school and graduate.

Our focus on teaching excellence is also an important point of differentiation, and we have successfully invested substantial resources into these efforts over the last several years. We have built and recently launched a new and innovative social media collaboration tool for our faculty to connect and interact with one another. We believe this new proprietary tool called Faculty Connect will further strengthen our academic community, increase collaboration, and ultimately enhance the student experience. This is yet another example of how our institution innovates to become a highly differentiated and respected institution in higher education.

Moving on to slide number 5, APEI's 2013 Strategic Goals. Academic quality, affordability, and program diversity have been the major hallmarks of our differentiated position. In light of the economic challenges impacting supply and demand in higher education overall, we believe our enterprise is further strengthened by diversification and focus on high-demand career fields such as nursing and engineering. As such, I am pleased to announce the completion of the transaction to acquire Hondros College, Nursing Programs, effective November 1, 2013.

We believe this well run, growing, and financially sound institution will continue to address the increasing demand for and shortages of nurses in the communities they serve. At the same time, we look forward to working with their experienced management team to evaluate blended educational delivery systems to further improve student retention. The closing of this transaction represents an early milestone in the execution of our long-term strategy.

In recent days, like many companies and individuals, APUS and our students have been adversely impacted by the government shutdown and subsequent temporary suspension of tuition assistance in October and, to a lesser extent, November. The federal budgetary pressures, our conversion to an in-house financial aid system, and marketing adjustments to improve our quality mix of students pose some challenges for us in the near term.

However, we continue to successfully build on our existing strengths and reinforce our differentiated positioning through quality, affordability, and innovation. We have made good progress on our long-term strategy with our continued programmatic diversification and the completed accretive acquisition of Hondros Nursing Programs.

Now I'll turn the call over to our CFO, Harry Wilkins, for a review of our financial results in more detail. Harry?

Thanks, Wally. Turning to slide 6, the third quarter financial summary, American Public Education's third quarter 2013 financial results include a 6% increase in revenues to $81.8 million compared to $77.1 million in the prior year. The revenue increase was primarily driven by an increase in the number of net course registrations.

Operating income for the third quarter 2013 was approximately $17.5 million compared to $17.5 million in the same period of 2012. Instructional costs and services increased to 34.4% of revenue in the third quarter compared to 34.2% in the prior-year period. This increase was primarily related to a greater use of adjunct faculty.

Selling and promotional expense as a percentage of revenue increased slightly to 19.6% of revenue compared to 18.7% of revenue in the prior-year period. This increase is primarily related to higher costs associated with online advertising and an increased staff focused on strategic relationships.

General and administrative expenses decreased as a percentage of revenue to 20.4% from 20.8% in the prior-year period due to headcount growing slower than revenue and a slight improvement in bad debt expense as a percentage of revenue. Bad debt expense as a percentage of revenue was approximately 4.1% in the third quarter of 2013 compared to 4.4% of revenue in the third quarter of 2012, a clear indication that we continue to be successful at limiting financial aid fraud and abuse.

In the third quarter 2013 net income was approximately $10.9 million, or $0.61 per diluted share, which was ahead of guidance. This compares to $10.8 million in the prior-year period.

Our cash balance as of September 30, 2013, was approximately $143.8 million, and we have no long-term debt.

On November 1 we closed the Hondros transaction. We believe this acquisition represents an attractive use of capital, and estimated expected returns in excess of the estimated calculated returns of other investment options we evaluated including the repurchase of our common stock.

At certain prices we believe repurchasing our common stock is an appropriate use of cash. During the third quarter we repurchased approximately 10,000 shares of common stock. However, between September 30, 2013, and November 1, 2013, the company repurchased approximately 168,000 shares of its common stock for approximately $6.2 million. There remains approximately $9.8 million of authorized availability under our authorized stock repurchase programs as of November 1, 2013.

Moving to slide 7, which is our fourth quarter outlook, APEI believes net course registrations in the fourth quarter will be adversely impacted by the temporary suspension of TA programs as a result of the US government partial shutdown that occurred in October 2013.

The company announced in an 8-K last month that approximately 13,100 net course registrations were dropped in the month of October. We believe this is largely the result of events related to the government shutdown and suspension of the TA program. Because the services did not move quickly to re-authorize tuition assistance, we believe the smaller impact incurred in November 2013 due to a shorter registration window for TA students.

A more precise estimate cannot be made because we don't know whether an October student dropped who did not re-register did so because of an inconvenient work schedule or the inability to re-register and receive approval on a timely basis. Thus the company expects the fourth quarter net course registrations, revenue, and operating margins to be impacted by these events.

As a result of these and other possible factors, American Public Education expects net course registrations by new students in the fourth quarter of 2013 to decline between 9% and 5% year-over-year and net course registrations to decline between 7% and 3% year-over-year compared to the prior-year period.

The company anticipates fourth quarter revenue 2013 to decline between 9% and 5% compared to the prior-year period. Fourth quarter earnings per share are expected to be between $0.50 and $0.54 per diluted share.

Fourth quarter revenues are expected to decline more than the net course registration growth year-over-year because of the timing of net course registrations within the three-month period ending December 31, 2013. Monthly starts for the weak October/November and relatively stronger starts for December year-over-year effectively pushed some of that expected revenue from eight- and 16-week courses into the first quarter of 2014.

Selling and promotional expenses as a percentage of revenue for the fourth quarter 2013 are anticipated to be above our longstanding goal of 20% of revenue as a result of lower-than-expected revenues in October and November. We did not think it was prudent to adjust our marketing budget for what we believed was a short-term disruption in volume, particularly during the month of October and April that we experienced when TA funding was temporarily disrupted.

Lastly, we anticipate a year-over-year increase in net course registrations by new students using Federal Student Aid in the fourth quarter of 2013.

In closing, we are pleased that the underpinnings of our innovative enterprise and our differentiated positioning remain very strong. We continue to earn awards and recognition for academic quality and best practices. We enjoy industry-leading affordability. We continue to innovate while launching new degree programs in high-demand fields.

At the same time, we are building on our long-term strategy and making the right choices for long-term success. Our strategy includes increasing our presence within the military and civilian communities through an even greater focus on relationships and referrals and by focusing on high-demand fields to further drive growth in a difficult overall market.

We plan to expand our efforts to develop relationships with corporations, associations, community colleges, and government agencies. Going forward, we hope to grow our base business, help Hondros College, Nursing Programs, address existing demand and enter new segments each year through acquisition and partnerships. We believe our plans to diversify and develop new lines of business are an important part of creating a long-term value and stability -- an approach that we think will prove to be effective.

At this time, we'd like to open up questions from the audience. Operator, can you please open the line for questions?

Corey Greendale, First Analysis.

First question, can you clarify the Q4 guidance? Is Hondros included in the registration guidance?

No, not at all.

Okay, so this is purely APUS?

Correct.

Okay, can you help -- now that Hondros has closed, can you help us with modeling Hondros? You've given us what 2012 revenue was, but can you give us a sense what 2013 revenue is; how we should be thinking about revenue per student and margin in that business?

Not at this time. The fourth quarter is going to be kind of clouded by transaction costs. We plan, going forward, next year to give enrollment guidance.

They're on a quarter system, so we'll give quarterly guidance and actual results for the quarter for Hondros. But we don't think it's going to have a significant impact this year. But we obviously believe it's going to be an accretive investment, and we will give student guidance, going forward.

The other thing to look to is that we historically have given net student registrations as our enrollment guidance. With Hondros, we'll probably give student guidance. That course registration is a little bit different there. It's mostly full-time programs, and the number of students is more significant.

Okay. Does the $0.50 to $0.54 guidance, then, does that include meaningful transaction costs?

Yes. It does not include any significant impact from Hondros.

Okay. And then if I could just ask about the TA. So it sounds like students didn't fully come back in November, but just to orient this, so when you put out the 8-K indicating what the impact of the shutdown would be, it sounded like the enrollment fundamentals were quite positive before the shutdown.

So one could read through to that to once you're past the shutdown you would expect those kind of trajectories to continue. Do you still expect that, what you saw going into Q4 before the shutdown, that you see that exiting Q4?

Yes, there was a lot of noise around, especially around the military enrollment. We really feel that the third quarter military enrollment was impacted by the fact that a lot of the branches of the military were running out of TA funding in the last fiscal year, which ended September 30. And we really thought we were going to see, and we did actually see an increase in registration as a result of that for October, but it never came to fruition because of the government shutdown. And the government -- the different branches of the service were a little delayed in reopening and approving TA to the point that it also impacted November registrations a little bit.

So -- there's a lot of noise in the fourth quarter. We do think that the TA registrations were going to be strong in October, and those students, many of whom will hopefully come back. We certainly don't think we've done anything to drive them away, and we think their interest in our programs remains strong, but it's difficult to give an exact number.

And, also, our military students conform to the average overall, which is about three courses a year. So it may be that once we miss the October window, that they don't come back till January. That's just totally unpredictable. It's really based upon their work schedule and personal issues. So it's very tough to quantify that, Corey.

But as we alluded to in our commentary, I really think these numbers mask what I think is a very positive trend of return to mid single-digit growth in FSA. New FSA student registrations is in our guidance for the fourth quarter.

Okay, just following up on that, maybe asking it slightly a different way -- the 8-K, I think said, that in October registrations were up 17% before you had the shutdown issue.

Correct.

It wasn't clear how much of that might have been because you had sort of pent-up demand because you had the financial aid processing issues before that. So do you think that 17% -- that's an attainable growth rate going into Q1, or was there some benefit from pent-up demand from the FSA issue?

I think that we're not going to get into giving first quarter guidance at this point, but we think that the -- we really think that there were some -- that some military personnel delayed registering in the third quarter and registered in October, and then they cut the funding in October. So that's kind of muddying the waters a little bit.

We think a lot of those students will return to us. We think that we are growing mid single-digits in FSA growth, overall. So that's where we are right now.

Thank you.

Jeff Volshteyn, JPMorgan.

Let me ask you a high-level question as far as what is going on with funding levels and conversations in the various military branches. We've heard reports about tougher eligibility criteria for some of the military students around the October time frame. So can you update us on what's going on there?

Sure. Some of the branches -- and, by the way, I'm not aware that the finals have been issued by every branch yet, but some of the branches put in some tighter criteria on pre-screening, that students would have to not just have their degree program but have a formal counseling center to avoid these one-off students where they just simply take a single course and that's it.

Another screening method is that they'd have to be in their second term of enlistment versus their first term. I don't think that's as significant because most of our students are not in their first term. That's primarily a training term, and very few of them go to college.

And we'll wait and see. There are always rumors. I don't believe we've seen the final Army regulations yet. We have seen the Air Force regulations, which are tighter screening policies. Those two branches are the largest component.

And the other unknown here, just to be candid, is that they need to resolve this sequester thing by the middle of January. And who knows, we're hopeful that maybe our Congress with both parties will come to a successful resolution, but that's totally unpredictable by us.

Thank you, that's helpful. Let me follow up on Corey's question around Hondros. I recall that there was a division of names or branding. Will you be using the same name for the college, or how would that branding be managed?

Yes, the founders, John and Linda Hondros, also operate a real estate school, and we've agreed that we are going to use the nursing restriction. So whenever we say Hondros College, it will be Hondros -- eventually we want to call it Hondros College of Nursing. Right now, we're calling it Hondros College, Nursing Programs. That was what the department approved. We're going to change the name to Hondros College of Nursing.

And everything else is completely differentiated. Their real estate school was quite small in comparison with the nursing school.

Okay. Thank you very much.

Adrienne Colby, Deutsche Bank.

I was wondering if you could count -- you could provide some color on what typical seasonality looks like in the fourth quarter. The month of October versus November versus December -- if you typically see declining total registrations or if December tends to be stronger than November.

Actually, the way our seasonality works, you have to look at October/November combined, and it really relates to the significant influence of tuition assistance students and whether or not the new budgets have been -- the budget amounts have been flowed down to the individual basis in time for October registrations.

If that doesn't happen, then typically we'll see a November for TA that's better than October. If it has happened, October is usually slightly better than November.

Obviously, we had a crazy October this year when the whole program was suspended. But December is typically our slowest month of the quarter just because of the holidays. Many students don't want to begin their courses and have to deal with midterms or papers over the Christmas holiday. So, at the same time, it doesn't fall down to a really, really low number, it's just going to be lower than, let's say, the average of October and November.

And the other part that I would note, and we've reiterated this many times, is that our fourth quarter is almost always our best quarter of the year from a seasonality perspective.

Great. And I didn't know if you could comment if there are any changes in the calendar coming up in the first quarter that we should be aware of as we're forecasting out.

Well, we start our semesters on the first Monday of every month, so I don't have the calendar in front of me but whatever that ends up being for the first quarter and you could compare that to the first quarter from a year ago to see if we have a particular month that has five fewer days or five more days, depending on where the first day of the month shapes up.

And I would say the only thing that's a little bit different about this is because of the disruption in TA in October and November, our December is going to be a little stronger than we anticipated, and half of that revenue will go into next year, which is a little unusual because it's 8- and 16-week courses, so a lot of that revenue will go in the next year.

Thank you.

Peter Appert, Piper Jaffray.

So, Wally, could you take a minute and just walk us through the strategy -- how you're thinking about building up the Hondros Nursing College?

Sure. The idea was that we've long felt that building out healthcare degrees totally online was really not possible due to the practicum requirement of some of the more career-oriented degrees, like an RN for example. So about a year and a half ago we began looking for on-ground nursing programs that met our criteria of quality in academics and decent outcomes for the students.

We found that in Hondros College, we thought that John and Linda Hondros and their management team had done a good job of building that out. It's exclusively nursing, which, from our perspective, we can measure that demand. Most states actually track it with their licensing bodies as far as how many seats are available in the schools, and they are very specific in tracking pass rates and placement rates. So it's very measurable. It allows us entry in there.

There was a very small program of -- newly started program of an online RN to BSN that Hondros started, and we happen to have one of those ourselves, so, over time, we'll look at whether having two or one is reasonable. But the bottom line is that we're putting ourselves into this field, which I think is very specific. It's healthcare oriented. It's nursing.

I think there are opportunities to add additional locations. We'll work with the management team to be more specific on that, and once we make decisions on that, we'll give you all what we see as the specific outlook for future additional locations and whether we're going to strictly stay in the state of Ohio or whether we'll add other states.

I would add that they currently don't have any evening or weekend classes. They're a full-time day program, and certainly their facilities are not at capacity, and there's a nursing shortage in Ohio. So we really like the opportunity that we have there to help answer some of that nursing shortage.

What are they licensed to -- how many students could they potentially have?

The restriction is mostly right now in clinical sites. So that's more of a limiting factor than any licensing. Ohio doesn't currently limit them in terms of the number of nurse graduates they can have. But they have to have clinical placements for the people they have and, right now, that's the gating factor for some of the campuses.

Got it. And so does the economics of this transaction work if you don't expand the physical presence of this operation to not just within Ohio but other states?

Yes, it does, and obviously it becomes a little pricier if we don't do that. But we looked at it both ways, but whether it's this business or our existing business, obviously, we want to look at our ability to continue to grow whether it's at a slower rate on a bigger number such as our existing business or with a smaller business like Hondros, the ability to make a difference by adding a couple of locations to four existing ones.

We stated in our commentary that we expected to have a better return on investment than we would have gotten from buying back shares, so we paid $45 million for it. You can probably do the math.

Right. I guess my question is motivated by the fact that Wally sounded sort of reticent in terms of committing to expanding this beyond the four locations beyond Ohio, which just doesn't really --

No, no, I didn't sound reticent. I just said that we don't have a specific plan that we can give you right now. So once we formulate those plans, we'll be glad to declare the plan.

But, remember, it's much more complicated to receive licensure approval whether it's in the state of Ohio or in other states for nursing programs. So we have to go one by one and get all those approvals versus, you know, if you're totally online there's very little approval if you're already licensed that you have to receive.

And we haven't announced any plans to our accrediting bodies or licensing bodies, and certainly it would be prudent to do that first before we make any public announcement.

Got it. And one last thing -- so they currently offer an online nurse to BS nursing, I think I recall. Can you indicate how big a part of the program that is?

It's tiny. I think it's less than 2% of revenues.

Got it. Great. Thank you.

Jerry Herman, Stifel.

Guys, it's sort of a two-part question regarding course takers and stipend chasers on the FSA side. We know that the Department has been placing greater emphasis here. I guess part A is, is there any new news on the demonstration project that was being contemplated, and you guys potentially part of that?

And part B is, are you seeing any increase or evidence in the number or percentage of applicants getting flagged in some way by the Department because of some unusual parameters, prior enrollment activity, or otherwise?

Well, I don't know if it's unusual. We have a fairly large number of students who are flagged each month as what we call red-flag students, and basically they do not get through our process or the Department's process for financial aid processing. And we discussed at an extensive point many of the detection algorithms and just flags that we put into place to try to avoid having those students register.

The Department itself has gotten very sophisticated, and they put flags in, particularly one of the newer flags are for students who have a pattern of registering at institutions and doing enough academic work until they qualify for their refund check, and then they drop their courses. The good news is that the Department is very helpful on that now. They've got a flag and, because we aren't able to get that information because there's no such thing as a national database, they are now flagging students and informing us that a student like that is probably at risk to drop.

So there are significant initiatives that we continue to do as well as, I'd say, increased initiatives by the Department. And this problem isn't just an online and for-profit problem, but it continues as long as, I would say, we have an economy that has not recovered. It's still stagnant.

I think they're doing a good job, Jerry, of selecting students for verification with more criteria that we have to verify discrepant information. I think the Department is doing a better job of that than they used to in the old days.

Great. Harry, I've got one for you, too, with regard to RPS in the fourth quarter guidance. Your revenue is down 5% to 9%. Your net course is down 3% to 7%. You get two months of Hondros, what am I missing there? It seems like a pretty big gap.

We really have not included any impact of Hondros in our guidance at this point because of the fact that we're -- they are a quarter system. The acquisition theoretically -- even though we've closed, it hasn't really gotten the final approval, which will be subject to the -- we got Department of Ed approval, but they still have to go back now to the nursing board, since we got Department of Ed approval, to get their final approval.

We don't anticipate any problems, but we have been conservative in our guidance, and not included any impact of that. It does include in our guidance, our fourth quarter cost that we have to expense related to the transaction. So I wouldn't (multiple speakers) that.

So really no help on the revenue side?

No help on the revenue side at this point with Hondros.

Great. Thanks, guys, appreciate it.

In our guidance. That doesn't mean that when we finalize the transaction it won't be included in year-end numbers.

Got it. Appreciate it.

Jeff Silber, BMO Capital Markets.

I wanted to talk about gainful employment. I know historically this really has not been an issue for your company, and I'm just wondering, based on what you've seen in the new regulations, if you don't think it's going to be an issue this time. And also if you could give us a little bit more color on how you think Hondros might comply with gainful employment. Thanks.

I think Hondros is doing quite well. I mean, I think they are competitively priced tuition. They have about a 70% placement rate and very good completion rates, well above the regulatory limits. They're doing okay.

Historically, we've done well, but historically they included all students including military students in gainful employment numbers. Now, if they break out FSA students, of course, that will be a higher threshold for us, because if they're just looking at FSA students, there will be, obviously, a higher percentage of those students borrowing money. And most of our military students are in the workforce, so we have pretty good numbers.

So we don't know, of course, what the final rules are going to be, but if they exclude our military students, our numbers won't be as good as they were historically. But I still think, because of our low tuition and the relatively low borrowing of our students, we'll be fine.

The other thing, Jeff, the last time around, they started with the same proposal they have now, where they did not allow institutions to substitute tuition and fees for the total debt. That was put in after the hearings and the appeals.

We still intend to submit a written document and testify, once we're allowed to do that, that because, as an institution, we're not allowed to deny a student's request for additional funds, and yet, at the same time, we haven't increased our undergraduate tuition in 12 years, it seems to us unjust and unfair that we've been measured against debt that our preference is that the student not borrow it.

Okay, great, I understand that. And you're not giving guidance for next year, and I know you have not included the impact of Hondros, but is there any impact on the seasonality of your business once Hondros is included?

That's a good question. They're on a quarter system, so we haven't tried to look at that, but I'll tell you what, we will consider that when we get through the end of the year and talk about next year.

And that will be on your fourth quarter earnings call?

Yes, we'll certainly give guidance in the first quarter. We'll know what their enrollment numbers are for the first quarter by then.

Okay. That will be helpful. Thanks so much.

(Operator Instructions) Trace Urdan, Wells Fargo Securities.

Thank you. I want to start with a little bit of cleanup here. So I guess what you're saying is that the Hondros deal costs are included in your guidance but any revenues that you might get from Hondros are not included in the guidance, is that correct?

Correct.

Why not break out the Hondros costs so that we can see what the operating business looks like, exclusive of non-operating costs?

The transaction costs, you mean?

Yes.

Yes, we did that in the previous two quarters, but we have this debate internally whether it's material enough or not to include.

If you recall, we did give some guidance prior to closing the transaction of those costs. Most of those costs were incurred prior to the fourth quarter, anyway.

But all the guidance has this cost in. All the guidance we've given throughout the year, and we expect to continue to do further transactions. So the conclusion that we've reached internally is it's really a recurring cost. It's not something that we want to exclusively say it's just Hondros-related because we expect to look to pursue other acquisitions, and there will be a cost associated with them.

So it has really become a cost of operations at this point. However, in the future, we'll have the revenue offset it from Hondros.

Got it, all right. And then kind of the flip side -- you sort of answered half of Jerry's question about the revenue and not the other half. So the implication from your guidance is that there is some kind of -- there's a little bit of a thumb on the scale in terms of the revenue per registration, and I wonder if you could just address that specifically. (multiple speakers) the revenues are declining --

I think what we're saying is that December, because of the TA situation in October and November of this year, we're having a little bit back-weighted quarter in terms of enrollment. December is a little bit higher than we would have anticipated otherwise, and not all of that revenue is going to be reflected in the fourth quarter. So -- that's what we've said at this point.

All right; fair enough. I'm sorry if I missed that earlier.

On your slide presentation, when you talk about the growth by segment, you've talked about optimism in terms of getting the FSA back to a mid single-digit growth area. I wonder if you could address the other pieces of the pie there in terms of what you think those markets look like over -- you don't have to even specify the period of time, but just what the trend line looks for from your perspective for growth in military and then growth in the veterans -- in the GI Bill dollars?

There's a little too much noise right now for TA to have a meaningful comparison. But I think one of the things that is significant is that our VA, which we're growing off some tough comps with VA students, and that continues to do quite well. You can see on the slide we gave you that our year-to-date growth in VA is about 29%, and that's on top of some pretty good growth last year. So we're getting some pretty significant numbers there now.

Cash and other sources of revenue continues to be an area we would like to see -- had to do better, but we do think, because of the economy, a lot of the businesses are cutting back. And we talk about TA and the interruption of the government. We have a lot of federal students who work for the FBI or other federal agencies, and they lost their funding, too, during the government shutdown. So it's not just the impact of TA on enrollments, it's the impact of other third party sponsors also in the fourth quarter.

I think we're going to have to wait till that -- we get out of this fourth quarter and see where the real impact on enrollment (multiple speakers)

And also how the budget gets reset with the hopeful agreement to resolve the second phase of the sequester.

I understand all that, and I guess maybe the point of my question is a little bit missed, which is that I get that there's a ton of noise. That's exactly why I'm asking is it possible for you guys to step out, away from the noise, and give us a view on those markets, I don't know, three- to five-year time frame? I mean, something in terms of as you think about the business longer term, what do you think the opportunities look like in each of those segments for you, longer term?

Well, I would tell you, Trace, we have no clue in the sense that all you have to do is read anything that Clayton Christensen's put out. We truly are -- higher ed itself is in a period of mass disruption.

We continue to innovate. We're proud of our innovation. We're proud of our focus on both quality and affordability. So at the end of the day, we want to be one of the ones who are standing because of that focus on innovation, quality, and affordability.

But, you know, there certainly are going to be ebbs and flows and disruption, particularly if the economy doesn't recover. I think that you look at the TA component, it's really subject to a lot of these federal budget issues. The VA is not, so far, and so that's been pretty healthy. FSA has not been, so far, but, at the same time, FSA, there's this proposal by the president to put in matrices by institutions and, to me, the devil is in the details.

But we'll continue to focus on doing what we aspire to, which is improving quality, keeping our costs down, and innovating. And, at the end of the day, in three to five years, we hope to still continue to be a leader.

I guess I'm encouraged by our -- we think we still have a continued strong position in the military. We think these new programs, as we roll them out, we can get traction in the military with the new programs. We think the blended model is very interesting now that it enables us to get into the healthcare curriculum. We think healthcare is a huge industry where we can really add value to a quality, affordable product. Hondros is our first foray into that. They are mostly campus-based. There's a great opportunity to build that online phase of the business.

We haven't even touched our international relationships, which we hope to continue to build it out through our relationships with New Horizon, an investment we made in the fall of last year. So we were quite optimistic that we are in the right -- we have the right product in the right place at the right time.

We would like to become less reliant on federal funding, and we hope to continue to move in that direction. But right now we are subject to the whim of Congress in terms of the budget crisis, and that adds a little noise to the business. But the underlying fundamentals are strong.

Okay, last question. A bunch of new certificate programs this quarter. Could you talk about that market and what is driving you to introduce those certificates? And specifically who benefits from these certificates and how?

Sure. We actually have industry advisory councils for our career-oriented degrees, which are much more professional versus academic. And just to take an example of one -- in hospitality, we have people from both the hotel and restaurant end in hospitality, and they tell us what new trends are, what we should do.

So -- the certificate program in restaurant operations was recommended by our hospitality advisory group working in conjunction with the faculty. The faculty developed the degree.

We think it's because they're -- at least using that one specific example, and we have similar thinking with other ones, that it takes a long time to earn a degree when you're in a full-time working position and you're taking courses part time. But that the way the restaurant operations certificate was designed, we believe that it offers promotion opportunities for students at a much shorter stopover point. It's six courses versus an entire associate's degree, which will be 20 courses, or a bachelor's degree, which would be 40.

So it's just launched. We don't know about the outcome of that, but the thinking is that we might find a more attractive market in that area for the six-course certificate and that, obviously, if a person successfully completes it, receives a promotion, chooses to continue a career there, those courses flow right nicely into our hospitality management degree.

We have a history of having about 50% of our graduates go and get follow-on degrees with us. So we think these certificate programs can capture additional share of the marketplace and then a lot of those students will matriculate and get their degrees once they've become accustomed to taking online courses with us. So we think it's a good idea.

Okay, thank you.

And with no other questions on the queue, I would now like to turn the call back over to Mr. Chris Symanoskie for closing remarks.

Thank you, operator. That will conclude our call for today. We wish to thank you for participating and for your interest in American Public Education. Have a great evening.