Good day, ladies and gentlemen, welcome to the second quarter 2018 American Public Education Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star and then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Chris Symanoskie, Vice President, Investor Relations. Sir, you may begin.
Good evening, welcome to American Public Education's discussion of financial and operating results for the second quarter of 2018. Presentation materials for today's conference call are available via the webcast section of our website and are included as an exhibit to our current report on Form 8-K furnished with the SEC earlier today. Please note that statements made in this conference call and in the accompanying presentation materials regarding American Public Education or its subsidiaries that are not historical facts may be forward-looking statements based upon current expectations, assumptions, estimates, and projections about American Public Education and the industry. These forward-looking statements are subject to risks and uncertainties that could cause actual future events or results to differ materially from such statements.
Forward-looking statements can be identified by words such as "anticipate," "believe," "seek," "could," "estimate," "expect," "intend," "may," "should," "will," and "would." These forward-looking statements include, without limitation, statements regarding expected growth, expected registrations and enrollments, investments, and partnerships. Actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described in the Risk Factors section and elsewhere in the company's most recent annual report on Form 10-K and subsequent quarterly reports 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, unless required by law, 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, Rick Sunderland, our Executive Vice President and Chief Financial Officer. I'll turn the call over to Dr. Boston.
Thanks, Chris. Good evening, everyone. I will begin our call today by discussing our recent operating performance, starting with page two of our slide deck. Our CFO, Rick Sunderland, will report on our second quarter financial results and outlook for the third quarter of 2018. In the second quarter of 2018, net course registrations by new students using Federal Student Aid, or FSA, at APUS declined 13.4% compared to the prior year period. However, net course registrations by new students, excluding those utilizing FSA, increased 3.5% compared to the prior year period. This increase was driven by a 9.5% year-over-year increase in net course registrations by new students utilizing cash and other sources, a 6.1% year-over-year increase in net course registrations by new students utilizing veterans benefits, and a 0.6% year-over-year increase in net course registrations by new students utilizing Military Tuition Assistance, or TA.
Overall, net course registrations by new students at APUS declined by approximately 1% in the second quarter of 2018, while total net course registrations and net course registrations by returning students were both approximately flat year-over-year. Although future volatility in net course registrations can be expected, I'm particularly pleased by our progress in stabilizing enrollment at APUS. We believe this goal was achieved in part by the continued improvement in student persistence and recent increases in conversion rates that resulted from re-engineering student onboarding processes and expanding student service hours. We believe the initiatives that we have launched over the last several years aimed at improving student success and the overall quality of our offerings also contributed to our success.
For the three months ended June 30, 2018, or the spring term of 2018, total enrollment at Hondros College of Nursing, or HCN, increased approximately 17% year-over-year, and new student enrollment increased 5% compared to the prior year. HCN recently announced plans to launch a medical laboratory technician program at its Cincinnati campus in late 2018. As of June 11th of 2018, HCN earned national accreditation by the Accrediting Bureau of Health Education Schools, or ABHES, and continues to be nationally accredited by the Accrediting Council for Independent Colleges and Schools, or ACICS. We remain excited about HCN's long-term prospects, as well as the opportunity for nursing and healthcare education more broadly, and we are pleased by the progress the team at HCN is making to further strengthen the institution for a bright future.
The Air Force recently experienced delays in processing Military Tuition Assistance as a result of an enrollment portal outage that began on July 14th and ended on August 2nd. We anticipate that net course registrations at APUS will be lower in the third quarter of 2018 compared to the prior year period as a result of recent softness in registrations by students utilizing TA, as well as a result of increased competition for quality civilian students. In light of both increased competition and our belief that APUS is now attracting better quality students with improved persistence and conversion rates, we plan to increase our advertising spend compared to the second quarter as we enter into the all-important fall season, a peak decision period for prospective students.
Turning to legal matters for a moment, last year the company received from the Attorney General of the Commonwealth of Massachusetts a civil investigative demand, or CID, relating to an investigation of alleged unfair or deceptive acts or practices by AMU. On August 6, 2018, APUS chose to enter into an assurance of discontinuance agreement, or AOD, to resolve the inquiry. Pursuant to the terms of the AOD, and without any finding or admission of wrongdoing on APUS's part, we agreed to make a payment of $270,000 to the attorney general and to otherwise comply with applicable Massachusetts regulations. We are pleased that this matter has been resolved. Moving on to page three. Over the last several years, we have remained steadfast in our commitment to affordability while working to stabilize enrollment and prepare our institution for the future.
Our work is not done, it is worth noting that our efforts have yielded positive results. For example, despite growing competition, our low tuition remains an important point of differentiation in the marketplace. APUS undergraduate costs are 23% below the average published tuition and fee price paid by full-time in-state students at public four-year institutions, according to the College Board's Trends in College Pricing 2018. Affordable tuition is just the beginning of our commitment to provide valuable educational programs to working adults. Since 2002, APUS has awarded more than $134 million in textbook and course material grants to undergraduate students. Since 2010, APUS has awarded more than 2 million transfer credit hours to students who have graduated eventually, representing approximately $500 million in applied value to our graduates.
Undergraduates who apply for transfer credit receive an average of 44 credits towards their degree at APUS, an average of approximately $11,000 in savings to students who complete their degrees with us. These and other attributes have helped AMU to become a leader in serving military and veteran communities. We believe they are also necessary to serve public service professionals and strategic partners. In short, we believe affordable tuition and high academic quality provides differentiation and serves national interest by helping working adults succeed in their professions. These attributes, combined with efforts to expand strategic partnerships and address growing demand for healthcare education, should help us to reach our institutional goals in support of our collective interest in advancing America's workforce. At this time, I will turn the call over to our CFO, Rick Sunderland. Rick?
Thank you, Wally. Going on to slide four. American Public Education's second quarter 2018 consolidated revenue increased 1% to $72.8 million, compared to $72.2 million in the prior year period. The revenue increase was due to a $1.2 million, or 15.4% revenue increase in our Hondros segment, which was partially offset by $0.6 million, or 1% revenue decrease in our APEI segment. The Hondros segment revenue increase was primarily due to an increase in student enrollment, whereas the APEI segment revenue decrease was primarily due to a decrease in APUS net course registrations. Costs and expenses for the three months ended June 30, 2018, were $64.8 million, a decrease of $1.1 million or 1.7%, compared to $65.9 million for the three months ended June 30, 2017.
The decrease in costs and expenses was primarily due to decreases in instructional materials costs, employee compensation costs, and advertising costs in our APEI segment, partially offset by increases in professional fees and additional stock-based compensation expense related to certain employees reaching retirement eligibility in our APEI segment, and increased employee compensation costs in our Hondros segment. Consolidated instructional costs and services expense as a percentage of revenue decreased to 39.8%, compared to 41.3% in the prior period. Selling and promotional expense as a percentage of revenue decreased to 18.2% of revenue from 19.4% in the prior year. General and administrative expense as a percentage of revenue increased to 24.2%, compared to 23.1%. Bad debt expense for the three months ended June 30, 2018, was 1.2% of revenue, compared to 1.3% of revenue in the prior period.
Depreciation and amortization was $8.9 million for the six months ended June 30, 2018, compared to $9.5 million in the prior period. Our effective tax rate during the second quarter of 2018 was approximately 26.2%, compared to 39.9% in the prior year. Our net income was $6.5 million, or $0.39 per diluted share for the three months ended June 30, 2018, compared to net income of $3.8 million or $0.23 per diluted share in the prior period. We exceeded our second quarter 2018 outlook for earnings per share because of lower than expected employee compensation costs and bad debt expense. Cost savings from the previously announced voluntary reduction in force completed April 1st are tracking towards the top end of the 2018 savings range. Total cash and cash equivalents as of June 30, 2018, were approximately $193.6 million, compared to $179.2 million as of December 31, 2017.
Cash flow from operations for the six months ended June 30 was $19.6 million, representing a 20.3% improvement over the prior year period due primarily to higher net income and lower estimated tax payments resulting from the 2017 Tax Act. Capital expenditures were approximately $3 million for the six months ended June 30, 2018, compared to $3.8 million in the prior year period. Going on to slide five. Third quarter 2018 outlook. Our outlook for the third quarter of 2018 is as follows. APUS net course registrations by new students are expected to decrease between 13% and 8% year-over-year. Total net course registrations are expected to decrease between 6% and 2% year-over-year. For its summer term, which is the three months ending September 30, 2018, total student enrollment at Hondros increased approximately 11% year-over-year, while new student enrollment decreased by 3% year-over-year.
The prior period included a second ADN cohort start at our Toledo campus. Absent this factor, new student enrollment at Hondros would have increased 5% year-over-year. In the third quarter of 2018, we expect consolidated revenue to decrease between 3% and 0% year-over-year. Net income for the third quarter of 2018 is expected to be in the range of $0.28 to $0.33 per fully diluted share. Consolidated net income per share includes approximately $0.7 million, that's $700,000, in professional fees associated with an acquisition that the company is no longer pursuing. As Wally commented earlier, selling and promotional expense is expected to increase by approximately $1.3 million in the third quarter of 2018 compared to the second quarter of 2018. In closing, we are pleased with the second quarter results, the continued growth in total student enrollment at Hondros, and our ongoing efforts to stabilize enrollment at APUS.
Now we'd like to take questions from the audience. Operator, please open the line for questions.
Absolutely. Ladies and gentlemen, if you have a question at this time, please press the star and the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Corey Greendale of First Analysis. Your line is open.
Hey, good afternoon.
Hi, Corey.
A couple of clarifications. Rick, you said Q3 will include $700,000 in costs associated with an acquisition you decided not to pursue. Did I hear that right?
Yes, that's correct, Corey.
Sorry, did you say that that is included in the EPS guidance or excluded?
Included in the EPS guidance.
I missed the first number given at the beginning of the script. What was new FSA students down in Q2?
New FSA was down 13.4%.
13.4%. Thank you. It sounds like there was a temporary issue that's impacting Q3 with the Air Force. Is there any way of estimating what the impact of that was and what you'd expect new students to be doing in Q3 if it weren't for that Air Force glitch?
We didn't try to do that for this call, Corey. Typically, the Air Force is about 40% of our military TA enrollment. Maybe we could get back to you, but we don't have that number, Rick, do you?
No. Well, it certainly impacted August registrations, right? How many of those then come back and register in September? I can't tell you if there's going to be an offset and if there is, what it's going to be. To Wally's point, it is 40% of our total TA registrations.
Okay. It's still ongoing, or it was resolved now?
It was resolved on August 2nd. It was about a two-week period that it was down, right?
Yeah, it was just a little over two weeks.
All right.
Okay. I had a question on pricing generally. Maybe start with Hondros. I scanned the Form 10-Q and saw that Hondros is now offering institutional loan program, which as opposed to just offering scholarships, which would seem more in keeping with kind of a philosophy of low cost. Why the decision to offer an institutional loan program?
I think we tend to be overly conservative on compliance. We wanted to make sure that we dotted our I's and crossed our T's for people who might have temporary needs. Long-term, Corey, I think we just have to see what the market is.
Okay. Rick, in terms of the accounting for that, I don't know if there's a question about collectability. Does that impact revenue per student at Hondros?
We're not anticipating it's going to, Corey, obviously we've got to build a record there, looking at the payment experience. We'll be watching that very closely.
Okay. On the APUS side, obviously all the things you say are true in terms of the differentiation with the lower tuition point, obviously there's a pretty wide gulf between where you're at and where most of the market is, if you raised a little bit, that would give more to invest in student services and sales and marketing and stuff. Maybe just philosophically, I know this comes up repeatedly, why not raise tuition prices somewhat in the civilian market so you have that access to it to invest?
I would say, Corey, that we look at this not monthly, but a couple of times a year. One of the reasons why we have not done much over time is that we would still keep our tuition at the same rate for military or military-affiliated, which includes veterans and spouses. When you put all those numbers together, they're 70%, 71% of our total student population. We continue to look at it. It's a very good point. We're not oblivious to it. We just have to make sure that
You know, it's worthwhile going through the initiative.
Okay. Great. I'll turn it over. Thank you.
Thanks, Corey.
Thank you. Our next question comes from the line of Peter Appert of Piper Jaffray. Your line is open.
Hey, guys. This is Kevin Estock. I'm in for Peter Appert.
Hi, Kevin.
Hi. My first question has to do with corporate partnerships. I just wanted to know how you were developing those to drive enrollment growth, and maybe if you could give a little color on the % of total enrollments that currently come through that corporate channel. Also where that % could go, going forward, would be helpful. Thank you.
Yeah. I think it's about half of our current cash and other that comes through corporate partnerships. We're pretty optimistic that area will continue to grow. As I've said on this call before, though, it's really tough sledding, because it's very difficult to be the unique sole provider to any corporation. We try to focus on corporations where if we're just one of two, three, or four, that we can get a substantial number of prospective students. Currently, it's about half of that cash in other category.
Okay. All right. Thank you. My second question has to do with margins. They've obviously improved quite a bit this quarter, which is very encouraging, and I guess I was wondering what your views were on driving margin leverage going forward.
I think we're always looking at ways at improving efficiencies and driving that leverage, with the one exception being that in the first quarter, we'll have higher benefit costs for payroll. In quarters like the third quarter, which is typically a seasonal dip in enrollment versus other quarters, we want to spend into the fourth quarter, which is usually our best quarter from an enrollment perspective.
I think the VRF, as I said in my comments, it is tracking towards the high end of the range that we discussed earlier in the year. I think that's having an effect on the current quarter, second quarter versus the prior year. The longer-term trends have remained positive for both, we call it instructional materials, it's really book costs, as well as bad debts. Although, our bad debts are getting to a point where it would be tough to see meaningful additional improvement.
Okay, great. Thank you very much.
Thank you. As a reminder, if you have a question at this time, please press the star and the number one key on your touch-tone telephone. Our next question comes from the line of Alex Paris of Barrington Research. Your line is open.
Hi, this is Chris Howe sitting in for Alex Paris. Good afternoon.
Hi, Chris.
I just had a question. As we think about student persistence and student retention moving forward, some of the operational things that are going on behind the scenes and what type of successes are you seeing or different types of challenges that are presenting themselves either in this past quarter or moving forward?
Well, the good news is that while the new students using FSA are down, the returning student number is a much, much lower decline, closer to even. What we're finding with the returning FSA students is we're getting some signs that we're getting an improved lifetime value in those students. I think our strategy to really, really focus on students who are capable of completing college for our FSA student recruitment is paying off.
I think there's multiple levers here. You've got conversion rates where you convert applications to students, and then you've got student success metrics once they become a student. We've reported over many quarters at this point, the latter of the two, which is the first-course pass rate for first-time FSA students. I mean, non-FSA No, FSA students.
Yeah
excuse me. We've made great strides there. The re-engineering of the enrollment process, which is multifaceted and ongoing, has resulted in improved conversion rates. The marketing function is identifying students that are on average more college-ready. The re-engineering of the enrollment process is delivering higher conversion rates. The quality of the students that we're enrolling is delivering better student success. It's a combination of those two that's, in my opinion, driving the overall, I'll say, getting to basically even on total net course registrations.
Okay, that's very helpful. Thank you. Do you quantify this metric on an internal basis to see how retention is improving year-over-year? I don't know. I guess just on a comparable basis, how is retention moving versus the prior year, and can we expect further improvement next year?
Retention continues to improve. It's a complicated calculation, and different institutions calculate it differently. I would tell you that across the board, we're seeing improvements in retention, how we measure it. I think you can see the difference between the new student numbers in FSA and the returning student numbers in FSA as a specific category. We didn't provide numbers in other payer categories. We use our own metrics in our data warehouse. We use a program from Civitas. We participate in our accrediting body, the HLC's Persistence Academy. We have multiple initiatives going on in which we analyze and implement processes to mentor, monitor, and to recruit students who are going to persist.
Okay. Thank you for taking my questions.
Thank you. At this time, I'm showing no further questions. I'd like to turn the conference back over to Mr. Chris Symanoskie for any closing remarks.
Thank you. That will conclude our call for today. Thank you for listening and for your interest in American Public Education. Have a great evening.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.