Filed Pursuant to Rule 424(b)(4)
Registration Statement 333-148851

PROSPECTUS

 

3,744,500 Shares

 

Common Stock

 

We are offering 25,000 shares of our common stock and the selling stockholders identified in this prospectus are offering 3,719,500 shares of our common stock. We will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders.

 

The common stock is listed on The NASDAQ Global Market under the symbol “APEI.” The last reported sale price of the common stock on February 13, 2008 was $36.17 per share.

 

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 10 of this prospectus.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

Certain of the selling stockholders have granted the underwriters an option for a period of 30 days from the date of this prospectus to purchase up to 500,175 additional shares of common stock on the same terms and conditions set forth above to cover over-allotments, if any.

 

The underwriters expect to deliver the shares to purchasers on or about February 19, 2008.

 

 

            Stifel Nicolaus

 

 

 

 

The date of this prospectus is February 13, 2008

 

Table of Contents

 

 

 

You should rely only on the information contained in this document or to which we have referred you. We have not authorized anyone to provide you with information that is different. This document may only be used where it is legal to sell these securities. The information in this document may only be accurate on the date of this document.

 

PROSPECTUS SUMMARY

Common stock offered by us		25,000 Shares

Common stock offered by the selling stockholders		3,719,500 Shares

Common stock outstanding after the offering		17,812,025 Shares
NASDAQ Global Market symbol		“APEI”

Use of proceeds		The proceeds to us from this offering will be approximately $839,000 after deducting the underwriting discount. We will use the proceeds primarily to pay the offering expenses payable by us. Any remaining proceeds will be used for working capital and other general corporate purposes.

		We will not receive any proceeds from the shares sold by the selling stockholders.
Risk factors		See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding whether to invest in shares of our common stock

	•	1,537,835 shares of our common stock issuable upon exercise of options outstanding as of December 31, 2007 at a weighted average exercise price of $6.13;
	•	744,810 shares of common stock reserved under our 2007 Omnibus Incentive Plan; and
	•	100,000 shares of common stock reserved under our Employee Stock Purchase Plan;

	•	72,573 shares of restricted stock that are subject to forfeiture; and
	•	26,500 shares of our common stock that are being sold in this offering by employees and that are to be issued upon the exercise of employee stock options in connection with the consummation of this offering.

														Nine Months Ended
		Year Ended December 31,												September 30,
		2004				2005				2006				2006				2007
														(Unaudited)
		(In thousands)
STATEMENT OF OPERATIONS DATA:
Revenues		$	23,119			$	28,178			$	40,045			$	27,149			$	47,873
Costs and expenses:
Instructional costs and services			10,944				13,247				17,959				12,558				20,697
Selling and promotional			2,206				4,043				4,895				3,533				4,834
General and administrative			5,737				7,364				9,150				6,461				10,769
Write-off of software development project(1)			—				—				3,148				—				—
Depreciation and amortization			674				1,300				1,953				1,244				2,007
Total costs and expenses			19,561				25,954				37,105				23,796				38,307
Income from continuing operations before interest income and income taxes			3,558				2,224				2,940				3,353				9,566
Interest income, net			56				225				289				211				595
Income from continuing operations before income taxes			3,614				2,449				3,229				3,564				10,161
Income tax expense			1,327				1,061				771				1,153				4,368
Income from continuing operations			2,287				1,388				2,458				2,411				5,793
Preferred stock accretion, including a $12,300 charge in 2005 attributable to the exchange of preferred stock			(1,085	)			(12,985	)			—				—				—
Income (loss) from continuing operations attributable to common stockholders			1,202				(11,597	)			2,458				2,411				5,793
Loss from discontinued operations, net of income tax benefit			—				(303	)			(660	)			(633	)			—
Net income (loss) attributable to common stockholders		$	1,202			$	(11,900	)		$	1,798			$	1,778			$	5,793

														Nine Months Ended
		Year Ended December 31,												September 30,
		2004				2005				2006				2006				2007
														(Unaudited)
STATEMENT OF OPERATIONS DATA:
Income (loss) from continuing operations per common share:
Basic		$	0.22			$	(1.44	)		$	0.21			$	0.21			$	0.48
Diluted		$	0.22			$	(1.44	)		$	0.20			$	0.20			$	0.46
Net income (loss) attributable to common stockholders per common share:
Basic		$	0.22			$	(1.48	)		$	0.15			$	0.15			$	0.48
Diluted		$	0.22			$	(1.48	)		$	0.15			$	0.15			$	0.46
Weighted average number of shares outstanding:
Basic			5,386,392				8,055,300				11,741,191				11,723,458				11,990,375
Diluted			5,407,050				8,055,300				12,177,693				12,159,350				12,530,269

														Nine Months Ended
		Year Ended December 31,												September 30,
		2004				2005				2006				2006				2007
		(Dollars in thousands)
OTHER DATA (Unaudited):
Net cash provided by operating activities from continuing operations		$	4,546			$	3,971			$	9,011			$	5,903			$	14,467
Capital expenditures		$	2,613			$	4,613			$	4,475			$	3,574			$	3,489
Stock-based compensation expense(2)			—			$	1,198			$	284			$	239			$	754
EBITDA from continuing operations(3)		$	4,232			$	3,524			$	4,893			$	4,597			$	11,573
Net course registrations(4)			32,558				37,506				54,828				37,756				67,011

		As of September 30, 2007
		Actual				As Adjusted(6)
		(In thousands)
CONSOLIDATED BALANCE SHEET DATA (Unaudited):
Cash and cash equivalents		$	20,261			$	24,984
Working capital(5)		$	13,835			$	18,558
Total assets		$	39,219			$	43,942
Stockholders’ equity		$	24,192			$	28,915

(1)		During 2006, $3.1 million of capitalized software development costs were written off when management determined that the asset related to these costs was impaired because we are no longer pursuing the related project.
(2)		Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R)-Share-Based Payment, or SFAS 123R, which requires companies to expense share-based compensation based on fair value. Prior to January 1, 2006, we accounted for share-based payment in accordance with Accounting Principles Board Opinion No. 25-Accounting for Stock Issued to Employees, and provided the disclosure required in SFAS 123-Accounting for Stock-Based Compensation, as amended by SFAS No. 148-Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment of FASB

		Statement No. 123. Stock-based compensation expense for the year ended December 31, 2005 resulted from the repurchase of shares of common stock acquired upon exercise of employee stock options.
(3)		EBITDA from continuing operations consists of income from continuing operations minus interest income, net, plus income tax expense and depreciation and amortization. Interest income, net consists primarily of interest income earned on cash and cash equivalents, net of any interest expense for notes payable. We use EBITDA from continuing operations as a measure of operating performance.
		However, EBITDA from continuing operations is not a recognized measurement under U.S. generally accepted accounting principles, or GAAP, and when analyzing our operating performance, investors should use EBITDA from continuing operations in addition to, and not as an alternative for, income from continuing operations as determined in accordance with GAAP. Because not all companies use identical calculations, our presentation of EBITDA from continuing operations may not be comparable to similarly titled measures of other companies and is therefore limited as a comparative measure. Furthermore, as an analytical tool, EBITDA from continuing operations has additional limitations, including that (a) it is not intended to be a measure of free cash flow, as it does not consider certain cash requirements such as tax payments, (b) it does not reflect changes in, or cash requirements for, our working capital needs; and (c) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized often will have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements, or future requirements for capital expenditures or contractual commitments. To compensate for these limitations, we evaluate our profitability by considering the economic effect of the excluded expense items independently as well as in connection with our analysis of cash flows from operations and through the use of other financial measures.
		We believe EBITDA from continuing operations is useful to an investor in evaluating our operating performance and liquidity because it is widely used to measure a company’s operating performance without regard to certain non-cash expenses (such as depreciation and amortization) and expenses that are not reflective of our core operating results over time. We believe EBITDA from continuing operations presents a meaningful measure of corporate performance exclusive of our capital structure, the method by which assets were acquired and non-cash charges, and provides us with additional useful information to measure our performance on a consistent basis, particularly with respect to changes in performance from period to period.
		Our management uses EBITDA from continuing operations:
		• In developing our internal budgets and strategic plan;
		• As a measurement of operating performance, because it assists us in comparing our performance on a consistent basis, as it removes depreciation, amortization, interest and taxes;
		• As a factor in evaluating the performance of our management for purposes of compensation purposes; and
		• In presentations to members of our board of directors to enable our board to have the same measurement basis of operating performance as is used by management to compare our current operating results with corresponding prior periods and with the results of other companies in our industry.

		The following table provides a reconciliation of income from continuing operations to EBITDA from continuing operations:

														Nine Months Ended
		Year Ended December 31,												September 30,
		2004				2005				2006				2006				2007
		(In thousands)
Income from continuing operations		$	2,287			$	1,388			$	2,458			$	2,411			$	5,793
Interest income, net			(56	)			(225	)			(289	)			(211	)			(595	)
Income tax expense			1,327				1,061				771				1,153				4,368
Depreciation and amortization			674				1,300				1,953				1,244				2,007
EBITDA from continuing operations		$	4,232			$	3,524			$	4,893			$	4,597			$	11,573

		EBITDA from continuing operations for the year ended December 31, 2006 is reduced by a write-off of $3.1 million of capitalized software development costs. EBITDA from continuing operations is also reduced by stock-based compensation expense of $1.2 million, $284,000, $239,000 and $754,000 for the year ended December 31, 2005, the year ended December 31, 2006, the nine months ended September 30, 2006 and the nine months ended September 30, 2007, respectively.
(4)		Net course registrations represent the total number of course registrations for students that have attended a portion of a course.
(5)		Working capital is calculated by subtracting total current liabilities from total current assets.

(6)		As adjusted to give effect to (i) our sale of common stock in our initial public offering at an offering price of $20.00 per share on November 8, 2007 and the receipt and application of the net proceeds thereof primarily to pay a special distribution to our stockholders of record immediately prior to the closing of our initial public offering and (ii) our sale of common stock in this offering at an offering price of $35.50 per share after deducting the underwriting discount and the estimated offering expenses.

 

Investing in our common stock has a high degree of risk. Before making an investment in our common stock, you should carefully consider the following risks, as well as the other information contained in this prospectus, including our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The risks described below are those that we believe are the material risks we face. Any of the risk factors described below could significantly and adversely affect our business, prospects, financial condition and results of operations. As a result, the trading price of our common stock could decline and you may lose all or part of your investment.

 

Risks Related to Our Business

 

If we are unable to continue our recent revenue and earnings growth, our stock price may decline and we may not have adequate financial resources to execute our business plan.

 

Our revenue increased 73% from $23.1 million in 2004 to $40.0 million in 2006, and it increased 76% from $27.1 million in the first nine months of 2006 to $47.9 million in the first nine months of 2007, primarily due to strong referrals from current students, new student marketing, and the receipt of regional accreditation in May 2006. These same factors also contributed to our net income attributable to common stockholders improving to $5.8 million for the first nine months of 2007 from $1.8 million in the corresponding period in 2006. We may not be able to achieve similar growth rates in future periods. You should not rely on the results of any prior periods as an indication of our future operating performance. If we are unable to maintain adequate revenue and earnings growth, our stock price may decline, and we may not have adequate financial resources to execute our business plan.

 

Our growth may place a strain on our resources that could adversely affect our systems, controls and operating efficiency.

 

The growth that we have experienced in the past, as well as any future growth that we experience, may place a significant strain on our resources and increase demands on our management information and reporting systems and financial management controls. We do not have experience scheduling courses and administering programs for more students than our current enrollment, and if growth negatively impacts our ability to do so, the learning experience for our students could be adversely affected, resulting in a higher rate of student attrition and fewer student referrals. We also have limited experience adding to our courses, programs and operations through acquisitions. Future growth will also require continued improvement of our internal controls and systems, particularly those related to complying with federal regulations under the Higher Education Act of 1965, or the Higher Education Act, as administered by the U.S. Department of Education, including as a result of our participation in federal student financial aid programs under Title IV of the Higher Education Act, which we refer to in this prospectus as Title IV programs. We have described some of the most significant regulatory risks that apply to us, including those related to Title IV programs, under the heading “Risks Related to the Regulation of our Industry” below. If we are unable to manage our growth or successfully carry out and integrate acquisitions, we may also experience operating inefficiencies that could increase our costs and adversely affect our profitability and results of operations.

 

Tuition assistance programs offered to United States Armed Forces personnel constituted 67% of our revenues for 2006, and our revenues and number of students would decrease if we are no longer able to receive funds under these tuition assistance programs or tuition assistance is reduced or eliminated.

 

Service members of the United States Armed Forces are eligible to receive tuition assistance from their branch of the armed forces that they may use to pursue postsecondary degrees. Service members of the United States Armed Forces can use tuition assistance at postsecondary schools that are accredited by accrediting agencies recognized by the U.S. Secretary of Education. Our tuition is currently structured so that tuition assistance payments for service members fully cover the service member’s per course tuition cost of our undergraduate courses and cover more than 90% of the per course tuition cost of our graduate courses. For 2006 and the nine months ended September 30, 2007, tuition assistance payments represented approximately 67% and 66% of our revenues, respectively. If we are no longer able to receive tuition assistance payments or the tuition assistance program is reduced or eliminated, our enrollments and revenues would be significantly reduced resulting in a material adverse effect on our results of operations and financial condition.

Strong competition in the postsecondary education market, especially in the online education market, could decrease our market share and increase our cost of acquiring students.

 

Postsecondary education is highly fragmented and competitive. We compete with traditional public and private two-year and four-year colleges as well as other for-profit schools, particularly those that offer online learning programs. Public and private colleges and universities, as well as other for-profit schools, offer programs similar to those we offer. Public institutions receive substantial government subsidies, and public and private institutions have access to government and foundation grants, tax-deductible contributions and other financial resources generally not available to for-profit schools. Accordingly, public and private institutions may have instructional and support resources that are superior to those in the for-profit sector. In addition, some of our competitors, including both traditional colleges and universities and other for-profit schools, have substantially greater name recognition and financial and other resources than we have, which may enable them to compete more effectively for potential students, particularly in the non-military sector of the market. We also expect to face increased competition as a result of new entrants to the online education market, including established colleges and universities that have not previously offered online education programs.

 

We may not be able to compete successfully against current or future competitors and may face competitive pressures that could adversely affect our business or results of operations. We may also face increased competition if our competitors pursue relationships with the military and governmental educational programs with which we already have relationships. These competitive factors could cause our enrollments, revenues and profitability to decrease significantly.

 

If we are unable to update and expand the content of existing programs and develop new programs and specializations on a timely basis and in a cost-effective manner, our future growth may be impaired.

 

The updates and expansions of our existing programs and the development of new programs and specializations may not be accepted by existing or prospective students or employers. If we cannot respond to changes in market requirements, our business may be adversely affected. Even if we are able to develop acceptable new programs, we may not be able to introduce these new programs as quickly as students require or as quickly as our competitors introduce competing programs. To offer a new academic program, we may be required to obtain appropriate federal, state and accrediting agency approvals, which may be conditioned or delayed in a manner that could significantly affect our growth plans. In addition, we have been advised by the Department of Education that because we are provisionally certified due to being a new Title IV program participant, we may not add new degree or non-degree programs for Title IV program purposes, except under limited circumstances and only if the Department of Education so approves, until the Department of Education reviews a compliance audit that covers one complete fiscal year of Title IV program participation. Even after our initial certification period ends, to be eligible for Title IV programs, a new academic program may need to be approved by the Department of Education. If we are unable to respond adequately to changes in market requirements due to financial constraints, regulatory limitations or other factors, our ability to attract and retain students could be impaired and our financial results could suffer.

 

Establishing new academic programs or modifying existing programs requires us to make investments in management, incur marketing expenses and reallocate other resources. We may have limited experience with the courses in new areas and may need to modify our systems and strategy or enter into arrangements with other institutions to provide new programs effectively and profitably. If we are unable to increase the number of students, or offer new programs in a cost-effective manner, or are otherwise unable to manage effectively the operations of newly established academic programs, our results of operations and financial condition could be adversely affected.

 

If we do not have adequate continued personal referrals and marketing and advertising programs that are effective in developing awareness among, attracting and retaining new students, our financial performance in the future would suffer.

 

Building awareness of AMU and APU and the programs we offer among potential students is critical to our ability to attract new students. In order to maintain and increase our revenues and profits, we must continue to attract new students in a cost-effective manner and these students must remain active in our

programs. During 2007 and 2008, we have increased the amounts spent on marketing and advertising, and we anticipate this trend to continue, particularly as a result of our attempts to attract and retain students from non-military market sectors. We use marketing tools such as the Internet, exhibits at conferences, and print media advertising to promote our schools and programs. Additionally, we rely on the general reputation of AMU and APU and referrals from current students, alumni and educational service officers in the United States Armed Forces as a source of new students. Some of the factors that could prevent us from successfully advertising and marketing our programs and from successfully enrolling and retaining students in our programs include:

 

 

If we are unable to continue to develop awareness of AMU and APU and the programs we offer, and to enroll and retain students in both military and non-military market sectors, our enrollments would suffer and our ability to increase revenues and maintain profitability would be significantly impaired.

 

System disruptions and security breaches to our online computer networks could negatively impact our ability to generate revenue and damage our reputation, limiting our ability to attract and retain students.

 

The performance and reliability of our technology infrastructure is critical to our reputation and ability to attract and retain students. Any system error or failure, or a sudden and significant increase in bandwidth usage, could result in the unavailability of our online classroom, damaging our ability to generate revenue. Our technology infrastructure could be vulnerable to interruption or malfunction due to events beyond our control, including natural disasters, terrorist activities and telecommunications failures.

 

Our systems, particularly those related to our Partnership-At-a-Distance, or PAD, system, have been predominantly developed in-house, with limited support from outside vendors. We are continuously working on upgrades to the PAD system, and our employees continue to devote substantial time to its development. To the extent that we face problems with the PAD system, we may not have the capacity to address the problems with our internal capability, and we may not be able to identify outside contractors with expertise relevant to our custom system.

 

Any failure of our online classroom system could also prevent students from accessing their courses. Any interruption to our technology infrastructure could have a material adverse effect on our ability to attract and retain students and could require us to incur additional expenses to correct or mitigate the interruption.

 

Our computer networks may also be vulnerable to unauthorized access, computer hackers, computer viruses and other security problems. A user who circumvents security measures could misappropriate proprietary information, personal information about our students or cause interruptions or malfunctions in operations. As a result, we may be required to expend significant resources to protect against the threat of these security breaches or to alleviate problems caused by these breaches. We engage multiple security assessment providers on a periodic basis to review and assess our security. We utilize this information to audit ourselves to ensure that we are continually monitoring the security of our technology infrastructure. However,

we cannot assure you that these security assessments and audits will protect our computer networks against the threat of security breaches.

 

We use third party software for our online classroom, and if the provider of that software were to cease to do business or was acquired by a competitor, we may have difficulty maintaining the software required for our online classroom or updating it for future technological changes, which could adversely affect our performance.

 

Our online classroom employs the Educator^tm learning management system pursuant to a license from Ucompass.com, Inc. The Educator system is a web-based portal that stores and delivers course content, provides interactive communication between students and faculty, and supplies online evaluation tools. We rely on Ucompass for ongoing support and customization and integration of the Educator system with the rest of our technology infrastructure. If Ucompass ceased to operate or was unable or unwilling to continue to provide us with service, we may have difficulty maintaining the software required for our online classroom or updating it for future technological changes. Any failure to maintain our online classroom would have an adverse impact on our operations, damage our reputation and limit our ability to attract and retain students.

 

Future growth or increased technology demands will require continued investment of capital, time and resources to develop and update our technology and if we are unable to increase the capacity of our resources appropriately, our ability to handle growth, our ability to attract or retain students and our financial condition and results of operations could be adversely affected.

 

We believe that continued growth will require us to increase the capacity and capabilities of our technology infrastructure, including our PAD system. Increasing the capacity and capabilities of our technology infrastructure will require us to invest capital, time and resources, and there is no assurance that even with sufficient investment our systems will be scalable to accommodate future growth. We may also need to invest capital, time and resources to update our technology in response to competitive pressures in the marketplace. If we are unable to increase the capacity of our resources or update our resources appropriately, our ability to handle growth, our ability to attract or retain students, and our financial condition and results of operations could be adversely affected.

 

The loss of any key member of our management team may impair our ability to operate effectively and may harm our business.

 

Our success depends largely upon the continued services of our executive officers and other key management and technical personnel. The loss of one or more members of our management team could harm our business. Except for the employment agreements we have with Mr. Boston, Dr. McCluskey, Mr. Wilkins and Mr. Herhusky, we do not have employment agreements with any of our other executive officers or key personnel. We do not maintain key person life insurance policies on any of our employees.

 

If we are unable to attract and retain faculty, administrators, management and skilled personnel, our business and growth prospects could be severely harmed.

 

To execute our growth strategy, we must attract and retain highly qualified faculty, administrators, management and skilled personnel. Competition for hiring these individuals is intense, especially with regard to faculty in specialized areas. If we fail to attract new skilled personnel or faculty or fail to retain and motivate our existing faculty, administrators, management and skilled personnel, our business and growth prospects could be severely harmed.

 

The protection of our operations through exclusive proprietary rights and intellectual property is limited, and we encounter disputes from time to time relating to our use of intellectual property of third parties, any of which could harm our operations and prospects.

 

In the ordinary course of our business, we develop intellectual property of many kinds that is or will be the subject of copyright, trademark, service mark, patent, trade secret or other protections. This intellectual property includes but is not limited to courseware materials and business know-how and internal processes and procedures developed to respond to the requirements of operating and various education regulatory agencies. We rely on a combination of copyrights, trademarks, service marks, trade secrets, domain names, agreements

and registrations to protect our intellectual property. We rely on service mark and trademark protection in the United States and select foreign jurisdictions to protect our rights to the marks “AMERICAN MILITARY UNIVERSITY,” “AMERICAN PUBLIC UNIVERSITY,” “AMERICAN PUBLIC UNIVERSITY SYSTEM” and “EDUCATING THOSE WHO SERVE,” as well as distinctive logos and other marks associated with our services. We rely on agreements under which we obtain rights to use course content developed by faculty members and other third party content experts. We cannot assure you that the measures that we take will be adequate or that we have secured, or will be able to secure, appropriate protections for all of our proprietary rights in the United States or select foreign jurisdictions, or that third parties will not infringe upon or violate our proprietary rights. Despite our efforts to protect these rights, unauthorized third parties may attempt to duplicate or copy the proprietary aspects of our curricula, online resource material and other content, and offer competing programs to ours.

 

In particular, third parties may attempt to develop competing programs or duplicate or copy aspects of our curriculum, online resource material, quality management and other proprietary content. Any such attempt, if successful, could adversely affect our business. Protecting these types of intellectual property rights can be difficult, particularly as it relates to the development by our competitors of competing courses and programs.

 

We may encounter disputes from time to time over rights and obligations concerning intellectual property, and we may not prevail in these disputes. Third parties may raise a claim against us alleging an infringement or violation of the intellectual property of that third party. In July 2006, we settled a dispute with another institution regarding the use of certain marks that allowed us to continue to use the marks at issue, but we may not be able to favorably resolve future disputes. Some third party intellectual property rights may be extremely broad, and it may not be possible for us to conduct our operations in such a way as to avoid those intellectual property rights. Any such intellectual property claim could subject us to costly litigation and impose a significant strain on our financial resources and management personnel regardless of whether such claim has merit. Our general liability and cyber liability insurance may not cover potential claims of this type adequately or at all, and we may be required to alter the content of our classes or pay monetary damages, which may be significant.

 

We may incur liability for the unauthorized duplication or distribution of class materials posted online for class discussions.

 

In some instances, our faculty members or our students may post various articles or other third party content on class discussion boards. We may incur liability for the unauthorized duplication or distribution of this material posted online for class discussions. Third parties may raise claims against us for the unauthorized duplication of this material. Any such claims could subject us to costly litigation and impose a significant strain on our financial resources and management personnel regardless of whether the claims have merit. Our faculty members or students could also post classified material on class discussion boards, which could expose us to civil and criminal liability and harm our reputation and relationships with members of the military and government. Our general liability insurance may not cover potential claims of this type adequately or at all, and we may be required to alter the content of our courses or pay monetary damages.

 

Because we are an exclusively online provider of education, we are entirely dependent on continued growth and acceptance of exclusively online education and, if the recognition by students and employers of the value of online education does not continue to grow, our ability to grow our business could be adversely impacted.

 

We believe that continued growth in online education will be largely dependent on additional students and employers recognizing the value of degrees from online institutions. If students and employers are not convinced that online schools are an acceptable alternative to traditional schools or that an online education provides value, or if growth in the market penetration of exclusively online education slows, growth in the industry and our business could be adversely affected. Because our business model is based on online education, if the acceptance of online education does not grow, our ability to continue to grow our business and our financial condition and results of operations could be materially adversely affected.

If we do not maintain continued strong relationships with various military bases and educational service officers, and if we are unable to expand our use of articulation agreements, our future growth may be impaired.

 

We have non-exclusive articulation agreements or memoranda of understanding with various educational institutions of the United States Armed Forces and other governmental education programs. Articulation agreements and memoranda of understanding are agreements pursuant to which we agree to award academic credits toward our degrees for learning in educational programs offered by others. Additionally, we rely on relationships with educational service offices on military bases and base education counselors to distribute our information to interested service members. If our relationships with educational service offices or base education counselors deteriorate or end, our efforts to recruit students from that base will be impaired. If our articulation agreements and memoranda of understanding are eliminated, or if our relationships with educational service offices or base education counselors deteriorate, this could materially and adversely affect our revenues and results of operations.

 

The United States Armed Forces has in the past and may in the future approve programs and initiatives to provide additional educational opportunities to service members, and these programs and initiatives may not include participation by us. We cannot predict the impact of these announcements, programs or initiatives on us, but given our dependence on students from the armed forces, our net course registrations and results of operations could be materially adversely affected by such announcements, programs and initiatives.

 

Government regulations relating to the Internet could increase our cost of doing business, affect our ability to grow or otherwise have a material adverse effect on our business.

 

The increasing popularity and use of the Internet and other online services have led and may lead to the adoption of new laws and regulatory practices in the United States or foreign countries and to new interpretations of existing laws and regulations. These new laws and interpretations may relate to issues such as online privacy, copyrights, trademarks and service marks, sales taxes, fair business practices and the requirement that online education institutions qualify to do business as foreign corporations or be licensed in one or more jurisdictions where they have no physical location or other presence. New laws, regulations or interpretations related to doing business over the Internet could increase our costs and materially and adversely affect our enrollments, revenues and results of operations.

 

Risks Related to the Regulation of Our Industry

 

If we fail to comply with the extensive regulatory requirements for our business, we could face penalties and significant restrictions on our operations, including loss of access to federal tuition assistance programs for members of the United States Armed Forces and federal loans and grants for our students.

 

We are subject to extensive regulation by (1) the federal government through the U.S. Department of Education and under the Higher Education Act, (2) state regulatory bodies and (3) accrediting agencies recognized by the U.S. Secretary of Education. The regulations, standards and policies of these agencies cover the vast majority of our operations, including our educational programs, facilities, instructional and administrative staff, administrative procedures, marketing, recruiting, financial operations and financial condition. These regulatory requirements can also affect our ability to add new or expand existing educational programs and to change our corporate structure and ownership.

 

Institutions of higher education that grant degrees, diplomas or certificates must be authorized by an appropriate state education agency or agencies. In addition, in certain states as a condition of continued authorization to grant degrees and in order to participate in various federal programs, including tuition assistance programs of the United States Armed Forces, a school must be accredited by an accrediting agency recognized by the Secretary of Education. Accreditation is a non-governmental process through which an institution submits to qualitative review by an organization of peer institutions, based on the standards of the accrediting agency and the stated aims and purposes of the institution. The Higher Education Act requires accrediting agencies recognized by the Department of Education to review and monitor many aspects of an institution’s operations and to take appropriate action when the institution fails to comply with the accrediting agency’s standards.

Our operations are also subject to regulation due to our participation in Title IV programs. Title IV programs, which are administered by the Department of Education, include educational loans with below-market interest rates that are guaranteed by the federal government in the event of default. Title IV programs also include several grant programs for students with economic need as determined in accordance with the Higher Education Act and Department of Education regulations. To participate in Title IV programs, a school must receive and maintain authorization by the appropriate state education agencies, be accredited by an accrediting agency recognized by the Secretary of Education and be certified as an eligible institution by the Department of Education. Following our implementation of Title IV programs for classes beginning in November 2006, for the nine months ended September 30, 2007, 10% of our net course registrations were from students using financial aid under Title IV programs. Our growth strategy is partly dependent on enrolling more students who are attracted to us because of our continued participation in these programs.

 

The regulations, standards and policies of the Department of Education, state education agencies and our accrediting agencies change frequently, and changes in, or new interpretations of, applicable laws, regulations, standards or policies, or our noncompliance with any applicable laws, regulations, standards or policies, could have a material adverse effect on our accreditation, authorization to operate in various states, activities, receipt of funds under tuition assistance programs of the United States Armed Forces, our ability to participate in Title IV programs, or costs of doing business. Furthermore, findings of noncompliance with these laws, regulations, standards and policies also could result in our being required to pay monetary damages, or being subjected to fines, penalties, injunctions, limitations on our operations, termination of our ability to grant degrees, revocation of our accreditation, restrictions on our access to Title IV program funds or other censure that could have a material adverse effect on our business.

 

If we fail to maintain our institutional accreditation, we would lose our ability to participate in the tuition assistance programs of the United States Armed Forces and also to participate in Title IV programs.

 

American Public University System is accredited by The Higher Learning Commission of the North Central Association of Colleges and Schools, one of six regional accrediting agencies recognized by the Secretary of Education, and by the Accrediting Commission of the Distance Education and Training Council, or DETC, which is a national accrediting agency recognized by the Secretary of Education. Accreditation by an accrediting agency that is recognized by the Secretary of Education is required for participation in the tuition assistance programs of the United States Armed Forces. In 2006, we derived approximately 67% of our revenues from these tuition assistance programs. Accreditation by an accrediting agency that is recognized by the Secretary of Education for Title IV purposes is also required for an institution to become and remain eligible to participate in Title IV programs. American Public University System recently achieved regional accreditation from The Higher Learning Commission in 2006 and has had national accreditation from the Distance Education and Training Council since 1995. We have identified the Higher Learning Commission as our primary accreditor for Title IV purposes. Either The Higher Learning Commission or DETC may impose restrictions on accreditation or may terminate accreditation. To remain accredited American Public University System must continuously meet certain criteria and standards relating to, among other things, performance, governance, institutional integrity, educational quality, faculty, administrative capability, resources and financial stability. Failure to meet any of these criteria or standards could result in the loss of accreditation at the discretion of the accrediting agencies. Furthermore, many prospective students may view accreditation by a regional accrediting agency to be more prestigious than accreditation by a national accrediting agency, and we believe that loss of regional accreditation may reduce the marketability of American Public University System even if national accreditation were maintained. The complete loss of accreditation would, among other things, render our students and us ineligible to participate in the tuition assistance programs of the United States Armed Forces or Title IV programs and have a material adverse effect on our enrollments, revenues and results of operations.

We have only recently begun to participate in Title IV programs, and our failure to comply with the complex regulations associated with Title IV programs would have a significant adverse effect on our operations and prospects for growth.

 

We first became certified to participate in Title IV programs for classes beginning in November 2006. For the nine months ended September 30, 2007, 10% of our total net course registrations were attributable to students utilizing Title IV programs. We expect a significant portion of our growth in enrollments and revenues to come from students who are utilizing funds from Title IV programs. However, compliance with the requirements of the Higher Education Act and Title IV programs is highly complex and imposes significant additional regulatory requirements on our operations, which require additional staff, contractual arrangements, systems and regulatory costs. We have limited to no demonstrated history of compliance with these additional regulatory requirements. If we fail to comply with any of these additional regulatory requirements, the Department of Education could, among other things, impose monetary penalties, place limitations on our operations, and/or condition or terminate our eligibility to receive Title IV program funds, which would limit our potential for growth outside the military sector and adversely affect our enrollment, revenues and results of operations.

 

If American Public University System does not maintain its authorization in West Virginia, our operations would be curtailed and we may not grant degrees.

 

A school that grants degrees, diplomas or certificates must be authorized by the relevant education agency of the state or states in which it is located. State authorization is also required for an institution to be eligible to participate in Title IV programs. American Public University System is headquartered in the State of West Virginia and is authorized by the West Virginia Higher Education Policy Commission. If we maintain our regional accreditation, we will likely remain in good standing with the West Virginia Higher Education Policy Commission. However, the West Virginia Higher Education Policy Commission may also take disciplinary action or revoke authorization if an institution’s bond is cancelled, if the institution fails to take corrective action to bring it into compliance with West Virginia Higher Education Policy Commission policies, or if the owner is convicted for a felony or crime involving institution administration of Title IV programs. If we do not maintain regional accreditation, our state authorization may be continued based on our national accrediting agency, DETC, if the West Virginia Higher Education Policy Commission finds that it is an acceptable alternative accrediting agency. If we lose accreditation from both accrediting agencies, or accreditation by DETC is not an acceptable alternative accrediting agency in case of loss of Higher Learning Commission accreditation, the West Virginia Higher Education Policy Commission may suspend, withdraw, or revoke our authorization. In addition, in order to maintain our eligibility for accreditation by The Higher Learning Commission, we must remain headquartered in one of the states in its region, which includes West Virginia. If we were to lose our authorization from the West Virginia Higher Education Policy Commission we would be unable to provide educational services, and we would lose our regional accreditation.

 

Our failure to comply with regulations of various states could have a material adverse effect on our enrollments, revenues and results of operations.

 

Various states impose regulatory requirements on educational institutions operating within their boundaries. Several states have sought to assert jurisdiction over online educational institutions that have no physical location or other presence in the state but offer educational services to students who reside in the state, or that advertise to or recruit prospective students in the state. State regulatory requirements for online education are inconsistent among states and not well developed in many jurisdictions. As such, these requirements change frequently and, in some instances, are not clear or are left to the discretion of state regulators. Our changing business and the constantly changing regulatory environment require us to evaluate continually our state regulatory compliance activities. In the event we are found not to be in compliance, and a state seeks to restrict one or more of our business activities within its boundaries, we may not be able to recruit students from that state and may have to cease providing service to students in that state.

 

American Public University System has a physical presence in the Commonwealth of Virginia based on administrative offices in that state, and it is authorized by the State Council of Higher Education for Virginia. We are currently reviewing the licensure requirements of other states to determine whether our activities in

these states constitute a presence or otherwise require licensure or authorization by the respective state educational agencies, and we have, and are in the process of seeking, licensure or authorization in additional states. State laws typically establish standards for instruction, qualifications of faculty, administrative procedures, marketing, recruiting, financial operations and other operational matters. To the extent that we have obtained, or obtain in the future, additional authorizations or licensure, state laws and regulations may limit our ability to offer educational programs and award degrees. Some states may also prescribe financial regulations that are different from those of the Department of Education, the West Virginia Higher Education Policy Commission, The Higher Learning Commission or DETC. If we fail to comply with state licensing or authorization requirements, we may be subject to the loss of state licensure or authorization. If we fail to comply with state requirements to obtain licensure or authorization, we may be the subject of injunctive actions or penalties. Although we believe that the only state licensure or authorization that is necessary for American Public University System to participate in the tuition assistance programs for the United States Armed Forces and in Title IV programs is our authorization from the West Virginia Higher Education Policy Commission, loss of licensure or authorization in other states or the failure to obtain required licensures or authorizations could prohibit us from recruiting or enrolling students in those states, reduce significantly our enrollments and revenues and have a material adverse effect on our results of operations.

 

We must periodically seek recertification to participate in Title IV programs, and may, in certain circumstances, be subject to review by the Department of Education prior to seeking recertification, and our future success may be adversely affected if we are unable to successfully maintain certification or obtain recertification.

 

An institution that applies to participate in Title IV programs for the first time, if approved, will be certified for no more than one complete award year. In addition, it will be provisionally, not fully, certified. A provisionally certified institution must apply for and receive Department of Education approval of substantial changes and must comply with any additional conditions included in its program participation agreement. If the Department of Education determines that a provisionally certified institution is unable to meet its responsibilities under its program participation agreement, it may seek to revoke the institution’s certification to participate in Title IV programs with fewer due process protections for the institution than if it were fully certified. In 2006 we applied to participate in Title IV programs for the first time and were provisionally certified for a period through June 30, 2007. We timely submitted our application for recertification, and the Department of Education granted us provisional certification through June 30, 2008. The Department of Education considers us to be in our initial period of certification, which requires us to remain provisionally certified, because we have not yet submitted, and it has not yet reviewed, a compliance audit that covers one complete fiscal year of Title IV program participation. The Department of Education has advised us that we may not add new degree or non-degree programs for Title IV program purposes, except under limited circumstances and only if the Department of Education approves, until the Department of Education reviews a compliance audit that covers one complete fiscal year of Title IV program participation and determines to remove such limitation. After an initial certification period, an institution that is certified to participate in Title IV programs must seek recertification from the Department of Education at least every six years and possibly more frequently depending on various factors, such as whether it is provisionally certified for reasons other than initial certification. The Department of Education may also review our continued eligibility and certification to participate in Title IV programs, or scope of eligibility and certification, in the event we undergo a change in ownership resulting in a change of control or expand our activities in certain ways, such as the addition of certain types of new programs, or, in certain cases, if we modify the academic credentials that we offer. If the ownership percentage of the funds affiliated with ABS Capital Partners goes below 25% of our outstanding common stock, as a result of future sales by those funds, due to an increase in our outstanding stock or otherwise, we could be deemed to have undergone a change of control. We expect that in the future the ownership percentage of funds affiliated with ABS Capital Partners will go below 25% of our outstanding common stock. In addition, the Department of Education may withdraw our certification if it determines that we are not fulfilling material requirements for continued participation in Title IV programs. If the Department of Education does not renew or withdraws our certification to participate in Title IV programs, our students would no longer be able to receive Title IV program funds, which would have a material adverse effect on our enrollments, revenues and results of operations. In addition, regulatory restraints related to the addition of new programs could impair our ability to attract and retain students and could negatively affect our financial results.

If regulators do not approve or delay their approval of transactions involving a change of control of our company, our ability to operate could be impaired.

 

If we or American Public University System experience a change of control under the standards of applicable state education agencies, the Department of Education, DETC, The Higher Learning Commission, or other regulators, we must notify or seek the approval of each relevant regulatory agency. Transactions or events that constitute a change of control include significant acquisitions or dispositions of an institution’s common stock and significant changes in the composition of an institution’s board of directors. Some of these transactions or events may be beyond our control. We have sought confirmation from applicable regulators, including state educational agencies that authorize or license American Public University System, the Department of Education, DETC and The Higher Learning Commission, that this offering will not require us to notify them or obtain their approval under their respective standards, and we understand that the Department of Education, DETC, The Higher Learning Commission, the West Virginia Higher Education Policy Commission and the State Council for Higher Education for Virginia will not require us to notify them or obtain their approval. Our failure to obtain, or a delay in receiving, approval of any change of control from the West Virginia Higher Education Policy Commission, the Department of Education, DETC or The Higher Learning Commission could have a material adverse effect on our business and financial condition. Our failure to obtain, or a delay in receiving, approval of any change of control from other states in which we are currently licensed or authorized could require us to suspend our activities in that state or otherwise impair our operations. The potential adverse effects of a change of control could influence future decisions by us and our stockholders regarding the sale, purchase, transfer, issuance or redemption of our stock. In addition, the regulatory burdens and risks associated with a change of control also could have an adverse effect on the market price of your shares.

 

Government and regulatory agencies and third parties may conduct compliance reviews, bring claims or initiate litigation against us, any of which could disrupt our operations and adversely affect our performance.

 

Because we operate in a highly regulated industry, we are subject to compliance reviews and claims of non-compliance and lawsuits by government agencies, regulatory agencies and third parties, including claims brought by third parties on behalf of the federal government. For example, the Department of Education regularly conducts program reviews of educational institutions that are participating in the Title IV programs and the Office of Inspector General of the Department of Education regularly conducts audits and investigations of such institutions. If the results of compliance reviews or other proceedings are unfavorable to us, or if we are unable to defend successfully against lawsuits or claims, we may be required to pay monetary damages or be subject to fines, limitations, loss of Title IV funding, injunctions or other penalties, including the requirement to make refunds. Even if we adequately address issues raised by an agency review or successfully defend a lawsuit or claim, we may have to divert significant financial and management resources from our ongoing business operations to address issues raised by those reviews or to defend against those lawsuits or claims. Claims and lawsuits brought against us may damage our reputation, even if such claims and lawsuits are without merit.

 

Our regulatory environment and our reputation may be negatively influenced by the actions of other for-profit institutions.

 

We are one of a number of for-profit institutions serving the postsecondary education market. In recent years, regulatory investigations and civil litigation have been commenced against several companies that own for-profit educational institutions. These investigations and lawsuits have alleged, among other things, deceptive trade practices and non-compliance with Department of Education regulations. These allegations have attracted adverse media coverage and have been the subject of federal and state legislative hearings. Although the media, regulatory and legislative focus has been primarily on the allegations made against these specific companies, broader allegations against the overall for-profit school sector may negatively affect public perceptions of other for-profit educational institutions, including American Public University System. In addition, recent reports on student lending practices of various lending institutions and schools, including for-profit schools, and investigations by a number of state attorneys general, Congress and governmental agencies have led to adverse media coverage of

postsecondary education. Adverse media coverage regarding other companies in the for-profit school sector or regarding us directly could damage our reputation, could result in lower enrollments, revenues and operating profit, and could have a negative impact on our stock price. Such allegations could also result in increased scrutiny and regulation by the Department of Education, Congress, accrediting bodies, state legislatures or other governmental authorities with respect to all for-profit institutions, including us.

 

Congress may change the law or reduce funding for Title IV programs, which could reduce our student population, revenues and profit margin.

 

The Higher Education Act comes up for reauthorization by Congress approximately every five to six years. However, when Congress does not act on complete reauthorization, there are typically amendments and extensions of authorization. The last reauthorization of the Higher Education Act was completed in 1998, and since that time there have been a number of amendments and extensions. Additionally, Congress reviews and determines appropriations for Title IV programs on an annual basis through the budget and appropriations process. There is no assurance that reauthorization of the Higher Education Act will happen, or that Congress will not enact changes that decrease Title IV program funds available to students, including students who attend our institution. A failure by Congress to reauthorize or otherwise extend the provisions of the Higher Education Act, or any action by Congress that significantly reduces funding for Title IV programs or the ability of our school or students to participate in these programs, would require us to arrange for other sources of financial aid and would materially decrease our enrollment. Such a decrease in enrollment would have a material adverse effect on our revenues and results of operations. Congressional action may also require us to modify our practices in ways that could result in increased administrative and regulatory costs and decreased profit margin. Further, Congress recently passed, and President Bush signed into law, legislation that, among other measures, reduces interest rates on certain federal student loans and reduces government subsidies to lenders that participate in federal student loan programs. We are not in position to predict with certainty whether any legislation will be passed by Congress or signed into law. The reallocation of funding among Title IV programs, material changes in the requirements for participation in such programs, or the substitution of materially different Title IV programs could reduce the ability of certain students to finance their education at our institution and adversely affect our revenues and results of operations.

 

Investigations by state attorneys general, Congress and governmental agencies regarding relationships between loan providers and educational institutions and their financial aid officers may result in increased regulatory burdens and costs.

 

The student lending practices of postsecondary educational institutions, financial aid officers and student loan providers are currently subject to several investigations being conducted by state attorneys general, Congress and governmental agencies. These investigations concern, among other things, possible deceptive practices in the marketing of private student loans and loans provided by lenders pursuant to Title IV programs. Congress may enact new requirements pertinent to relationships between lenders and institutions. In addition, the Department of Education recently published regulations, generally effective July 1, 2008, that in part address institutions’ student loan activity. In particular, the Department of Education’s regulations clarify and expand rules pertinent to relationships between institutions and lenders and establish new rules applicable to institutions that make available a list of recommended or suggested lenders for use by potential borrowers. State legislators have also passed or are considering legislation related to relationships between lenders and institutions. Because of the evolving nature of these legislative efforts and various inquiries and developments, we can neither know nor predict with certainty their outcome, or the potential remedial actions that might result from these or other potential inquiries. Governmental action may impose increased administrative and regulatory costs and decreased profit margins.

 

We are subject to sanctions that could be material to our results and damage our reputation if we fail to calculate correctly and return timely Title IV program funds for students who withdraw before completing their educational program.

 

A school participating in Title IV programs must correctly calculate the amount of unearned Title IV program funds that have been disbursed to students who withdraw from their educational programs before completion and must return those unearned funds in a timely manner, generally within 45 days after the date

the school determines that the student has withdrawn. Because we only began to participate in Title IV programs in 2006, we have limited experience complying with these provisions. Under Department of Education regulations, late returns of Title IV program funds for 5% or more of students sampled in connection with the institution’s annual compliance audit constitutes material non-compliance. If unearned funds are not properly calculated and timely returned, we may have to repay Title IV funds, post a letter of credit in favor of the Department of Education or otherwise be sanctioned by the Department of Education, which could increase our cost of regulatory compliance and adversely affect our results of operations.

 

A failure to demonstrate “financial responsibility” may result in the loss of eligibility by American Public University System to participate in Title IV programs or require the posting of a letter of credit in order to maintain eligibility to participate in Title IV programs.

 

To participate in Title IV programs, an eligible institution must satisfy specific measures of financial responsibility prescribed by the Department of Education, or post a letter of credit in favor of the Department of Education and possibly accept other conditions, such as provisional certification, additional reporting requirements or regulatory oversight, on its participation in Title IV programs. The Department of Education may also apply such measures of financial responsibility to the operating company and ownership entities of an eligible institution and, if such measures are not satisfied by the operating company or ownership entities, require the institution to post a letter of credit in favor of the Department of Education and possibly accept other conditions on its participation in Title IV programs. Any obligation to post a letter of credit could increase our costs of regulatory compliance. If we were unable to secure a letter of credit, we would lose our eligibility to participate in Title IV programs. In addition to the obligation to post a letter of credit under certain circumstances, an institution that is determined by the Department of Education not to be financially responsible may be transferred from the “advance” system of payment of Title IV funds, which allows the institution to obtain Title IV program funds from the Department of Education prior to making disbursements to students, to cash monitoring status or to the “reimbursement” system of payment, which requires the institution to make Title IV disbursements to students and seek reimbursement from the Department of Education. A change in our system of payment could increase our costs of regulatory compliance. If we fail to demonstrate financial responsibility and thus lose our eligibility to participate in Title IV programs, our students would lose access to Title IV program funds for use in our institution, which would limit our potential for growth outside the military community and adversely affect our enrollment, revenues and results of operations.

 

A failure to demonstrate “administrative capability” may result in the loss of American Public University System’s eligibility to participate in Title IV programs.

 

Department of Education regulations specify extensive criteria an institution must satisfy to establish that it has the requisite “administrative capability” to participate in Title IV programs. See “Regulation of our Business” in this prospectus for more information on the Department of Education’s regulations on administrative capability.

 

If an institution fails to satisfy any of these criteria or comply with any other Department of Education regulations, the Department of Education may require the repayment of Title IV funds, transfer the institution from the “advance” system of payment of Title IV funds to cash monitoring status or to the “reimbursement” system of payment, place the institution on provisional certification status, or commence a proceeding to impose a fine or to limit, suspend or terminate the participation of the institution in Title IV programs. If we are found not to have satisfied the Department of Education’s “administrative capability” requirements we could be limited in our access to, or lose, Title IV program funding, which would limit our potential for growth outside the military sector and adversely affect our enrollment, revenues and results of operations.

 

We rely on a third party to administer our participation in Title IV programs and its failure to comply with applicable regulations could cause us to lose our eligibility to participate in Title IV programs.

 

We only recently became eligible to participate in Title IV programs, and we have not developed the internal capacity to handle without third-party assistance the complex administration of participation in Title IV programs. Global Financial Aid Services, Inc. assists us with administration of our participation in Title IV programs, and if it does not comply with applicable regulations, we may be liable for its actions and we could

lose our eligibility to participate in Title IV programs. In addition, if it is no longer able to provide the services to us, we may not be able to replace it in a timely or cost-efficient manner, or at all, and we could lose our ability to comply with the requirements of Title IV programs, which would limit our potential for growth and adversely affect our enrollment, revenues and results of operation.

 

We are subject to sanctions if we pay impermissible commissions, bonuses or other incentive payments to individuals involved in recruiting, admissions or financial aid activities.

 

A school participating in Title IV programs may not provide any commission, bonus or other incentive payment based directly or indirectly on success in enrolling students or securing financial aid to any person involved in student recruiting or admission activities or in making decisions regarding the awarding of Title IV program funds. The law and regulations governing this requirement do not establish clear criteria for compliance in all circumstances. If we violate this law, we could be fined or otherwise sanctioned by the Department of Education, or we could face litigation brought under the whistleblower provisions of the Federal False Claims Act. Any such fines or sanctions could harm our reputation, impose significant costs on us, and have a material adverse effect on our results of operations.

 

We may lose eligibility to participate in Title IV programs if our student loan default rates are too high, and if we lose that eligibility our future growth could be impaired.

 

An educational institution may lose its eligibility to participate in some or all Title IV programs if, for three consecutive federal fiscal years, 25% or more of its students who were required to begin repaying their student loans in the relevant fiscal year default on their payment by the end of the next federal fiscal year. In addition, an institution may lose its eligibility to participate in some or all Title IV programs if its default rate exceeds 40% in the most recent federal fiscal year for which default rates have been calculated by the Department of Education. Because we have just begun to enroll students who are participating in these programs, we have no historical cohort default rates. Relatively few students are expected to enter the repayment phase in the near term, which could result in defaults by a few students having a relatively large impact on our cohort default rate. If American Public University System loses its eligibility to participate in Title IV programs because of high student loan default rates, our students would no longer be eligible to use Title IV program funds in our institution, which would significantly reduce our enrollments and revenues and have a material adverse effect on our results of operations.

 

Risks Related to this Offering

 

A significant portion of our outstanding common stock will soon be released from restrictions on resale and may be sold in the public market in the near future. Future sales of shares by existing stockholders, including sales pursuant to this offering, could cause our stock price to decline.

 

If following this offering our existing stockholders, particularly our directors, funds affiliated with ABS Capital Partners and funds affiliated with Camden Partners and our executive officers, sell substantial amounts of our common stock in the public market, or are perceived by the public market as intending to sell, the trading price of our common stock could decline significantly. Based on shares outstanding as of December 31, 2007, upon completion of this offering we will have 17,812,025 shares of common stock outstanding, which includes 72,573 shares of restricted stock that were subject to forfeiture as of that date. Of these shares, 8,004,152 shares, or approximately 45.0% of our outstanding shares after this offering, assuming the underwriters do not exercise their over-allotment option, are subject to lock-up agreements entered into by our stockholders with the underwriters in connection with our initial public offering. The shares subject to lockup agreements will become freely tradeable in the public market beginning May 6, 2008, subject to extension as described in this prospectus under the heading “Underwriting,” except for shares of common stock held by directors, executive officers and our other affiliates that will be subject to volume limitations under Rule 144 of the Securities Act and, in certain cases, various vesting arrangements.

 

Some of our existing stockholders, including funds affiliated with ABS Capital Partners and funds affiliated with Camden Partners, have contractual demand or piggyback rights to require us to register with the SEC up to 6,085,311 shares of our common stock, after taking into account the shares being sold in this

offering and assuming the underwriters do not exercise their over-allotment option. If we register these shares of common stock in connection with this offering or otherwise, the stockholders would be able to sell those shares freely in the public market, which sales could cause the trading price of our common stock to decline.

 

The price of our common stock may be volatile, and as a result returns on an investment in our common stock may be volatile.

 

We completed our initial public offering in November 2007. Given the relatively limited public float since that time, trading in our common stock has also been limited and, at times, volatile. An active trading market for our common stock may not be sustained, and the trading price of our common stock may fluctuate substantially.

 

The price of the common stock may fluctuate as a result of:

 

 

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been brought against that company. Because of the potential volatility of our stock price, we may become the target of securities litigation in the future. Securities litigation could result in substantial costs and divert management’s attention and resources from our business.

 

We are incurring significant costs as a result of operating as a public company that we have not previously incurred, and our management and key employees are, and will continue to be, required to devote substantial time to compliance initiatives.

 

We have operated as a public company only since November 8, 2007. As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002 and rules subsequently implemented by the SEC and The NASDAQ Stock Market have imposed various new requirements on public companies, including with respect to public disclosure, internal control, corporate governance practices and other matters. Our management and other personnel are devoting substantial amounts of time to these new compliance initiatives. Moreover, these rules and regulations have significantly increased our legal and financial compliance costs and have made some activities more time-consuming and costly. In addition, we have and will continue to incur additional costs associated with our public company reporting requirements. We will incur significant costs to remediate any material weaknesses we identify through these efforts. These rules and regulations have made it more difficult and more expensive for us to obtain director and officer liability insurance. We currently are evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs. If our profitability is adversely affected because of these additional costs, it could have a negative effect on the trading price of our common stock.

 

Our principal stockholders may be able to exercise significant influence over matters requiring stockholder approval.

 

After completion of this offering, funds affiliated with ABS Capital Partners will beneficially own approximately 26% of our outstanding common stock. As a result, ABS Capital Partners may be able to exercise significant influence over matters requiring stockholder approval, including the election of directors, equity compensation plans and significant corporate transactions. For example, ABS Capital Partners may vote

against a transaction involving an actual or potential change of control of our company or other transaction that you may deem to be in the stockholders’ best interests. In addition, prior to our initial public offering ABS Capital Partners was entitled to designate three of our directors for appointment to our board of directors, two of whom are general partners of ABS Capital Partners. Following our initial public offering, ABS Capital Partners was no longer entitled to designate new directors to our board but their representatives continue to serve on our board and can exercise substantial influence over us.

 

Seasonal and other fluctuations in our results of operations could adversely affect the trading price of our common stock.

 

Our results in any quarter may not indicate the results we may achieve in any subsequent quarter or for the full year. Our revenues and operating results normally fluctuate as a result of seasonal variations in our business, principally due to changes in enrollment. Student population varies as a result of new enrollments, graduations and student attrition. While our number of enrolled students has grown in each sequential quarter over the past three years, the number of enrolled students has been proportionally greatest in the fourth quarter of each respective year. A significant portion of our general and administrative expenses do not vary proportionately with fluctuations in revenues. We expect quarterly fluctuations in operating results to continue as a result of seasonal enrollment patterns. Such patterns may change, however, as a result of new program introductions and increased enrollments of students. These fluctuations may result in volatility in our results of operations and/or have an adverse effect on the market price of our common stock.

 

If we fail to maintain proper and effective disclosure controls and procedures and internal controls over financial reporting, our ability to produce accurate financial statements could be impaired, which could adversely affect our stock price, our ability to operate our business and investors’ views of us.

 

Ensuring that we have adequate disclosure controls and procedures, including internal controls over financial reporting, in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We are continuing the process of documenting, reviewing and, if appropriate, improving our internal controls and procedures following our becoming a public company and eventually being subject to the requirements of Section 404 of the Sarbanes-Oxley Act, which will require annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. We will be required to comply with the internal controls evaluation and certification requirements of Section 404 of the Sarbanes-Oxley Act by no later than the end of our 2008 fiscal year.

 

If securities analysts do not publish research or reports about our business or if they downgrade their evaluations of our stock, the price of our stock could decline.

 

The trading market for our common stock depends in part on the research and reports that industry or financial analysts publish about us or our business. If one or more of the analysts covering us downgrade their estimates or evaluations of our stock, the price of our stock could decline. If one or more of these analysts cease coverage of our company, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.

 

Provisions in our organizational documents and in the Delaware General Corporation Law may prevent takeover attempts that could be beneficial to our stockholders.

 

Provisions in our charter and bylaws and in the Delaware General Corporation Law may make it difficult and expensive for a third party to pursue a takeover attempt we oppose even if a change in control of our company would be beneficial to the interests of our stockholders. These provisions include:

 

 

 

An individual has made claims that he is entitled to shares that we do not treat as being outstanding, and this could result in our outstanding shares being understated and subject us to claims for damages.

 

An individual has recently presented a stock certificate of our predecessor company that he asserts represents his ownership of 57,965 outstanding shares of our common stock. Our records and other evidence available to us indicate that these shares were repurchased from him before 2003, notwithstanding the fact that the stock certificate he has presented was not marked canceled. If he is successful in asserting that these shares are in fact outstanding, then our outstanding capital stock as presented in this prospectus is understated by 57,965 shares of common stock, which represents less than half of one percent of our outstanding common stock before this offering and for which the amount of the special distribution made in connection our initial public offering would have been $442,273. In addition, if he successfully asserts ownership to these shares, we may be subject to claims from stockholders who have purchased stock from us prior to our initial public offering in respect of the representations and warranties related to our outstanding capitalization that were made at the time those stockholders invested in our company. We are not able to predict with certainty the amount of any liability we may ultimately have with respect to this matter.

 

This prospectus, including the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business,” contains forward-looking statements. We may, in some cases, use words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “potentially,” “will,” or “may,” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this prospectus include statements about:

 

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. There are a number of important factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements, which apply only as of the date of this prospectus. These important factors include those that we discuss in this prospectus under the caption “Risk Factors” and elsewhere. You should read these factors and the other cautionary statements made in this prospectus as being applicable to all related forward-looking statements wherever they appear in this prospectus. If one or more of these factors materialize, or if any underlying assumptions prove incorrect, our actual results, performance or achievements may vary materially from any future results, performance or achievements expressed or implied by these forward-looking statements. We undertake no obligation to publicly update any forward-looking statements after the date of this prospectus, whether as a result of new information, future events or otherwise, except as required by law.

 

Our proceeds from our sale of shares of common stock in this offering will be approximately $839,000, after deducting the underwriting discount. We will use the proceeds primarily to pay the offering expenses payable by us. Any remaining proceeds will be used for working capital and other general corporate purposes.

 

We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

 

Our common stock has traded on The NASDAQ Global Market under the symbol “APEI” since it began trading on November 9, 2007. Our initial public offering was priced at $20.00 per share on November 8, 2007. The following table sets forth, for the time periods indicated, the high and low sales prices of our common stock as reported on The NASDAQ Global Market.

 

 

On February 13, 2008 the last reported sale price of our common stock on The NASDAQ Global Market was $36.17. As of January 23, 2008, there were approximately 433 holders of record of our common stock.

 

Upon the closing of our initial public offering, we paid a special distribution to our stockholders who owned shares immediately prior to the consummation of that offering in the amount of $7.63 per share, or $93.8 million in the aggregate. See “Certain Relationships and Related Person Transactions — Special Distribution” below for information on the special distribution.

 

We do not anticipate declaring or paying any cash dividends on our common stock in the foreseeable future. The payment of any dividends in the future will be at the discretion of our board of directors and will depend upon our financial condition, results of operations, earnings, capital requirements, contractual restrictions, outstanding indebtedness and other factors deemed relevant by our board. As a result, you will likely need to sell your shares of common stock to realize a return on your investment, and you may not be able to sell your shares at or above the price you paid for them.

 

The following table shows our capitalization as of September 30, 2007:

 

 

 

You should read this table together with the sections of this prospectus entitled “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as our financial statements and related notes and the other financial information appearing elsewhere in this prospectus.

 

 

The outstanding share information as of September 30, 2007 shown in the table above excludes 917,774 shares of common stock issuable upon the exercise of stock options and 155,815 shares of Class A common stock issuable upon the exercise of a warrant outstanding as of September 30, 2007, which was subsequently exercised in October 2007. The number also excludes 1,100,000 shares of our common stock reserved for issuance under our 2007 Omnibus Incentive Plan and 100,000 shares of our common stock reserved for issuance under our Employee Stock Purchase Plan. The number of shares of common stock issued and outstanding on an as adjusted and an as further adjusted basis exclude 72,573 shares of restricted stock that are subject to forfeiture.

 

The following table shows our consolidated statements of operations, balance sheet and other financial and operating data as of the dates and for each of the periods indicated. The selected consolidated statements of operations and the other financial data for the years ended December 31, 2004, 2005 and 2006 and the selected balance sheet data as of December 31, 2005 and 2006 are derived from our audited consolidated financial statements prepared in accordance with GAAP, which appear elsewhere in this prospectus. The selected consolidated statements of operations and the other financial data for the years ended December 31, 2002 and 2003 and the selected consolidated balance sheet data as of December 31, 2002, 2003 and 2004 are derived from our audited consolidated financial statements prepared in accordance with GAAP, which are not included in this prospectus. Our historical results are not necessarily indicative of our results for any future period.

 

The selected consolidated statement of operations data for the nine months ended September 30, 2006 and 2007 and the selected consolidated balance sheet data as of September 30, 2007 have been derived from our unaudited consolidated financial statements which are included elsewhere in this prospectus. In our opinion, the unaudited consolidated financial statements have been prepared on the same basis as our audited consolidated financial statements, except we adopted FAS 123(R) as of January 1, 2006, and include all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of our financial position and operating results for the unaudited periods. The selected consolidated financial and operating data as of and for the nine months ended September 30, 2007 are not necessarily indicative of the results that may be obtained for a full year.

You should read this data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes appearing elsewhere in this prospectus.

 

 

 

 

 

 

 

 

 

 

 

You should read the following discussion together with the financial statements and the related notes included elsewhere in the prospectus. This discussion contains forward-looking statements that are based on management’s current expectations, estimates and projections about our business and operations, and involves risks and uncertainties. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of a number of factors, including those we discuss under “Risk Factors,” “Special Note Regarding Forward-Looking Statements” and elsewhere in this prospectus.

 

Overview

 

American Public Education, Inc. is a provider of exclusively online postsecondary education directed at the needs of the military and public service communities. We operate through two universities, American Military University, or AMU, and American Public University, or APU, which together constitute the American Public University System.

 

In recent years, we have experienced substantial growth. In the first nine months of 2007, revenues increased 76% over the same period in 2006 resulting from a 77.5% increase in net course registrations over the same period and a 10% increase in graduate student tuition in 2007 that we announced in the summer of 2006. Net income for the first nine months of 2007 was $5.8 million, an increase of 225.8% over the same period in 2006. Diluted earnings per share were $0.46 for the first nine months of 2007 compared to $0.15 for the same period in 2006. We believe achieving regional accreditation in May 2006 and gaining access to Title IV programs beginning with classes that started in November 2006 have been additional factors driving our recent acceleration in growth. While we have experienced substantial growth in recent periods, you should not rely on the results of any prior periods as an indication of our future growth in net course registrations or revenue as our historical growth rates may not be sustainable. Similarly, you should not rely on our operating margins in any prior periods as an indication of our future operating margins. Our difficulty in forecasting future growth rates and operating margins is in part due to our inability to fully estimate the actual impact of gaining access to Title IV programs. Following our implementation of Title IV programs for classes beginning in November 2006, for the nine months ended September 30, 2007, 10% of our net course registrations were from students using financial aid under Title IV programs. Because of our limited history with Title IV programs and because we cannot estimate the growth of new students that may result from our participation in Title IV programs, we cannot estimate the costs and expenses associated with administering Title IV programs and complying with the associated regulations.

 

We were founded as American Military University, Inc. in 1991 and began offering graduate courses in January 1993. Following initial national accreditation by the Accrediting Commission of the Distance Education and Training Council, or DETC, in 1995, American Military University began offering undergraduate programs primarily directed to members of the armed forces. Over time, American Military University diversified its educational offerings in response to demand by military students for post-military career preparation. With its expanded program offerings, American Military University extended its outreach to the greater public service community, primarily police, fire, emergency management personnel and national security professionals. In 2002, we reorganized into a holding company structure, with American Public Education, Inc. serving as the holding company of American Public University System, Inc., which operates our two universities, AMU and APU. Our university system achieved regional accreditation in May 2006 with the Higher Learning Commission of the North Central Association of Colleges and Schools and became eligible for federal student aid programs under Title IV for classes beginning in November 2006. In September 2007, we received approval from the Higher Learning Commission to offer seven new degree programs in Education and Information Technology.

 

On August 7, 2007 we filed a Registration Statement on Form S-1 (Registration No. 333-145185) for our initial public offering, which we completed on November 14, 2007. In the initial public offering, we sold 5,390,625 shares of our common stock at a price to the public of $20.00 per share, before underwriting discounts and commissions. The sale of the shares included the exercise in full of the underwriters’ option to

purchase up to an additional 703,125 shares at the initial public offering price to cover over-allotments. Net proceeds to us were approximately $100.3 million, after deducting the underwriting discount and before offering expenses. In connection with the closing of the initial public offering, all of our Class A Common Stock was converted into shares of common stock.

 

Our key financial results metrics:

 

Revenues

 

In reviewing our revenues we consider the following components: net course registrations; tuition we charge; tuition net of scholarships; and other fees.

 

Net course registrations.  For financial reporting and analysis purposes, we measure our student body in terms of aggregate course enrollments, or net course registrations. Net course registrations represent the aggregate number of classes in which students remain enrolled after the date by which they may drop the course without financial penalty. Because we recognize revenues over the length of a course, net course registrations in a period do not correlate directly with revenues for that period because revenues recognized from courses are not necessarily recognized in the period in which the course registrations occur. For example, revenues in a quarter reflect a portion of the revenue from courses that began in a prior period and continued into the quarter, all revenue from courses that began and ended in the quarter, and a portion of the revenue from courses that began but did not end in the quarter.

 

We believe our curriculum is directly relevant to federal, state and local law enforcement and other first responders, but historically this market was limited to us because, outside the federal government, only a few agencies or departments have the tuition reimbursement plans critical to fund continuing adult education. Now that our students can obtain low cost student loans or grants through Title IV programs, we have begun to increase our focus on these markets. Title IV programs require participating students to take more courses per semester than students participating in DoD tuition assistance programs. As a result, we expect that our increased focus on markets that utilize Title IV programs may cause the average number of courses per student to increase.

 

Tuition.  Providing affordable programs is an important element of our strategy for growth. Other than a modest increase in 2007 for graduate tuition, we have not raised tuition since 2000. We set our tuition costs so that our undergraduate military students may take courses without incurring out-of-pocket costs because our tuition is within the Department of Defense, or DoD, tuition ceilings. Using the DoD tuition ceiling as a benchmark keeps our tuition in line with four-year public university, in-state rates.

 

Net tuition.  Tuition revenues vary from period to period based on the aggregate number of students attending classes and the number of classes they are attending during the period. Tuition revenue is reduced to reflect amounts refunded to students who withdraw from a course in the month the withdrawal occurs. We also provide scholarships to certain students to assist them financially and to promote their registration. The cost of these scholarships is netted against tuition revenue in the period incurred for purposes of establishing net tuition revenue and typically represents less than 1% of revenues.

 

Other fees.  Other fees include charges for transcript credit evaluation, which includes assistance in securing official transcripts on behalf of the student in addition to evaluating transcripts for transfer credit. Students also are charged withdrawal, graduation, late registration, transcript request and comprehensive examination fees, when applicable. In accordance with Emerging Issues Tasks Force Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor (EITF 02-16), other fees also includes book purchase commissions we receive for graduate student book purchases and ancillary supply purchases students make directly from our preferred book vendor.

 

Costs and Expenses

 

We categorize our costs and expenses as (i) instructional costs and services, (ii) selling and promotional, (iii) general and administrative, (iv) depreciation and amortization, and (v) stock-based compensation.

Instructional costs and services.  Instructional costs and services are expenses directly attributable to the educational services we provide our students. This expense category includes salaries and benefits for full-time faculty, administrators and academic advisors, and costs associated with adjunct faculty. Instructional pay for adjunct faculty is primarily dependent on the number of students taught. Instructional costs and services expenses also include costs for educational supplies such as books, costs associated with academic records and graduation, and other university services such as evaluating transcripts.

 

Substantially all undergraduate students receive their textbooks through our book grant program. Over the course of a complete bachelor’s degree program, this represents a potential average student savings of approximately $3,600 when compared to a 2005 estimate by the General Accounting Office of average textbook costs for a first-time, full-time student at four-year public universities for the 2003-2004 academic year. In connection with our book grant program, we have been working to reduce the overall cost of books per course. Graduate students may order and pay for their books through the contracted vendor from which we purchase the undergraduate book grant program books or they can purchase books from a vendor of their choice.

 

Selling and promotional.  Selling and promotional expenses include salaries and benefits of personnel engaged in recruitment and promotion, as well as costs associated with advertising and the production of marketing materials related to new enrollments and current students. Our selling and promotional expenses are generally affected by the cost of advertising media, the efficiency of our selling efforts, salaries and benefits for our selling and admissions personnel, and the number of advertising initiatives for new and existing academic programs. We believe that the availability of federal student aid programs to our students should increase our marketability in non-military markets, but we anticipate that the more competitive nature of these markets may cause our student acquisition costs to increase in the future.

 

General and administrative.  General and administrative expenses include salaries and benefits of employees engaged in corporate management, finance, information technology, human resources, facilities, compliance and other corporate functions. In addition, the cost of renting and maintaining our facilities, technology expenses and costs for professional services are included in general and administrative costs. General and administrative expenses also include bad debt expense.

 

Depreciation and amortization.  We incur depreciation and amortization expenses for costs related to the capitalization of property, equipment, software and program development on a straight-line basis over the estimated useful lives of the assets.

 

Stock-based compensation.  On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), Share-based Payment (FAS 123(R)), which requires the measurement and recognition of compensation expense for stock-based payment awards made to employees and directors, including employee stock options. FAS 123(R) eliminates the ability to account for stock-based compensation transactions using the footnote disclosure-only provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and instead requires that such transactions be recognized and reflected in our financial statements using a fair-value-based method. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107), relating to FAS 123(R). We have applied the provisions of SAB 107 in our adoption of FAS 123(R).

 

We have adopted FAS 123(R) using the modified prospective method, which requires the application of the accounting standard as of January 1, 2006. Our financial statements for the year ended December 31, 2006 reflect the impact of FAS 123(R). In accordance with the modified prospective transition method, our consolidated financial statements for the years ended December 31, 2005 and 2004 have not been restated to reflect, and do not include, the impact of FAS 123(R).

 

Prior to the adoption of FAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (FAS 123). Under the intrinsic value method, no stock-based compensation expense had been recognized in our consolidated statement of income because the exercise price of stock options granted to employees and directors equaled the fair market

value of the underlying stock at the date of grant. See Note 9 to our consolidated financial statements included elsewhere in this prospectus for pro forma information had compensation expense been determined based on the fair value of options at grant dates computed in accordance with FAS 123.

 

As a result of adopting FAS 123(R) on January 1, 2006, our income before income taxes and net income for the year ended December 31, 2006 was approximately $284,000 and $227,000 lower, respectively, than if we had continued to account for stock-based compensation under APB 25.

 

For stock option awards subsequent to our adoption of FAS 123(R), we have selected the Black-Scholes option pricing model to estimate the fair value of the stock option awards on the date of grant. Our determination of the fair value of these stock option awards was affected by the estimated fair value of our common stock on the date of grant, which we discuss in detail below, as well as assumptions regarding a number of highly complex and subjective variables. We calculate the expected term of stock option awards using the “simplified method” as defined by Staff Accounting Bulleting No. 107 because we lack historical data and are unable to make reasonable expectations regarding the future. We also estimate forfeitures of share-based awards at the time of grant and revise such estimates in subsequent periods if actual forfeitures differ from original projections. We make assumptions with respect to expected stock price volatility based on the average historical volatility of peers with similar attributes. In addition, we determine the risk free interest rate by selecting the U.S. Treasury five-year constant maturity, quoted on an investment basis in effect at the time of grant for that business day. Estimates of fair value are subjective and are not intended to predict actual future events, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made under FAS 123(R).

 

The table below reflects our stock-based compensation expense recognized in the consolidated statements of income for the year ended December 31, 2006 and the nine months ended September 30, 2007 (in thousands):

 

 

Prior to the adoption of FAS 123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in our consolidated statement of cash flows. FAS 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those stock options (excess tax benefits) to be classified as financing cash flows.

 

We grant our employees options to purchase our common stock at exercise prices at least equal to the fair market value of the underlying common stock at the date of each grant, as determined by our board of directors at the time. Determining the fair market value of our common stock prior to our initial public offering required making complex and subjective judgments because there was no public trading market for our common stock. While we have obtained contemporaneous valuations by an independent valuation specialist in connection with option grants on several occasions, we have not done so at all times because our board of directors, which includes representatives of the third-party investors in our equity financings, determined that it had the relevant expertise to reasonably estimate the fair market value of our common stock with the information available to it. These estimates were based on several factors, including the fair market value of preferred stock we issued from time to time with superior rights and preferences to our common stock, sales of our Class A common stock, repurchases of our common stock, current market conditions, and our financial and operating performance.

 

Based on this analysis, our board of directors estimated that the per share fair market value of the common stock underlying stock options granted throughout 2006 was $4.55 per share. In 2006, our board of

directors considered numerous objective and subjective factors to determine the fair market value at each option grant date during this period, including the following:

 

 

In particular, we considered that with the exception of one stock option grant for 33,000 shares in July 2006, all of the stock options were granted prior to our receipt of regional accreditation from The Higher Learning Commission in May 2006, and the grant in July 2006 was before we had revised our projections as a result of the receipt of that accreditation. We also considered that all grants in 2006 were made prior to our eligibility to participate in Title IV programs, which occurred for classes beginning in November 2006. We believe that regional accreditation, and the more recent eligibility for Title IV program participation, have contributed to our recent acceleration in growth and were the most significant factors in an increase in value of our common stock.

 

In light of our receipt of regional accreditation, our eligibility to participate in Title IV programs, our growth, and the passage of time since a third-party transaction involving our capital stock, in January 2007 we engaged The Baker-Meekins Company, Inc., an independent valuation specialist that had provided us with several valuations in prior years, to prepare a valuation of our common stock as of November 30, 2006. The valuation specialist considered several methodologies in its analysis, including an analysis of guideline public companies and a discounted cash flow analysis. The results of the public company analysis vary not only with factors such as our revenue, EBITDA, and income levels, but also with the performance of the public market valuation of the companies at the time. The final valuation conclusion was more heavily weighted toward the results of the market-based analysis. The discounted cash flow analysis, an income-based approach, involves applying appropriate discount rates to estimated future free cash flows, which were based on management’s forecasts of revenue and costs at the time. As with any valuation based on the discounted cash flow method, the underlying assumptions involve a significant degree of complexity and judgment. Once our enterprise value was determined, the result was reconciled to equity value after the consideration of interest-bearing debt, excess cash and cash to be received upon the exercise of stock options. To determine the market value of a share of common stock, the independent valuation specialist divided the equity value by the number of common stock equivalents. The independent valuation specialist then applied a discount of 20% for the lack of marketability. The analysis resulted in an estimated fair market value of our common stock on a nonmarketable minority basis as of November 30, 2006 of $4.92 per share. We believe that this valuation supports our determination of value for the grants made in 2006 prior to the receipt of the report, and we have subsequently determined that no reassessment of this estimate is appropriate.

 

The valuation report was used as an aid to the board of directors in determining the fair market value of the common stock underlying options granted in February 2007. Our board of directors considered our improving operating performance, results and projections at the time of the grants in February 2007 and determined that an increase to the price provided in the valuation report was appropriate. The board of directors determined at that time that the fair market value per share of our common stock was $5.45 per share during that period. As described below, this determination was subsequently reassessed.

 

In May 2007, the same independent valuation specialist was engaged to perform a valuation of our common stock as of May 4, 2007. The valuation specialist used substantially the same analysis and methodologies as it had for the previous valuation, except that the independent valuation specialist also took into account the prospect of our initial public offering, which had become more likely after management met

with representatives of the underwriters in the spring of 2007. The valuation specialist also observed that the discount rate that it applied in the May valuation for the discounted cash flow analysis differed from the November valuation as a result of increases to interest rates on government bonds and an increase in the calculation of business risk, which was calculated as the median of the guideline companies’ beta using a regression of those companies’ stock returns against the S&P 500. In May 2007, the valuation specialist reduced the discount to 15% for lack of marketability that it applied to our per share valuation because it determined that it was likely that we would pursue an initial public offering in less than 12 months. The valuation specialist selected 15% in part because in its estimation this approximates the median discount for illiquidity in studies of restricted stock of publicly traded corporations that have a one-year holding period. The valuation specialist determined that the fair market value of our common stock was $9.66 per share on a non-marketable minority interest basis as of May 4, 2007.

 

As a result of reviews of our stock option grants, we determined that a reassessment of the fair market value estimate for grants made during the six months ended June 30, 2007 was appropriate. As an initial matter, we concluded that, because (i) our business had demonstrated continued growth and improvement during the six months ended June 30, 2007; (ii) our internal projections of our results were increasing during the period; and (iii) the fair market value of our common stock was in a period of sequential increases, a valuation report that estimated the fair market value of our common stock nearer to the end of the period, rather than the beginning of the period, would provide a more reliable and conservative estimate of the fair market value of our common stock. In conducting the reassessment we also took into account that the likelihood that we would conduct an initial public offering in 2007 continued to increase throughout 2007, from an initial expectation in the first quarter of the year that it would not occur in 2007, and that in May 2007 we had received initial indications of values from the representatives of several underwriters that were conditioned on an initial public offering in the fourth quarter of 2007 and continued growth in our business. As a result of this reassessment, we have retrospectively estimated that the fair market value of our common stock for purposes of determining the appropriate compensation expense for our options granted in the six months ended June 30, 2007 was $8.00 per share for options granted in February 2007 and $11.20 for options granted in May 2007, which is a blended rate between the results of the valuation report from the independent valuation expert and the estimates provided by the representatives of potential underwriters with whom we met in May 2007.

 

As a result of the reassessment of the fair market value of our common stock underlying stock option grants to employees discussed above, we have recorded additional stock-based compensation for each stock option granted during the six months ended June 30, 2007 based upon the difference between the retrospectively determined fair market value of our common stock at the relevant measurement date of the stock option grant and the exercise price of the stock option. We amortize the unearned stock-based compensation and record stock-based compensation expense ratably over the vesting periods of these stock options. For the nine months ended September 30, 2007, we recorded $754,000 of stock-based compensation expense.

The table below is a summary of the intrinsic value of options outstanding at September 30, 2007, using the offering price to the public in our initial public offering, which was $20.00 per share:

 

 

Interest Income, Net

 

Interest income, net consists primarily of interest income earned on cash and cash equivalents, net of any interest expense.

 

Changes in Connection with Becoming a Public Company

 

As a public company, we have begun and will continue to incur significant additional costs and expenses such as increased legal and audit fees, professional fees, directors’ and officers’ insurance costs and expenses related to compliance with Sarbanes-Oxley Act regulations and other annual costs of doing business as a public company including hiring additional personnel and expanding our administrative functions. We expect these additional expenses to range from $1.5 million to $2.0 million per year and anticipate funding costs relating to being a public company with cash provided by operating activities and cash on hand.

 

Critical Accounting Policies and Use of Estimates

 

The discussion of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. During the preparation of these financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions, including those related to revenue recognition, accounts receivable and allowance for doubtful accounts, valuation of long-lived assets, contingencies, income taxes and stock-based compensation expense. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated financial statements.

 

A summary of our critical accounting policies follows:

 

Revenue recognition.  We record all tuition as deferred revenue when students begin a class. At the beginning of each class, revenue is recognized on a pro rata basis over the period of each class, which is either eight or sixteen weeks. This results in our balance sheet including future revenues that have not yet been earned as deferred revenue for courses that are in progress.

 

Accounts receivable.  Course registrations are recorded as deferred revenue and accounts receivable at the time students begin a course. Students may remit tuition payments through the online registration process

at any time or they may elect various payment options, which can delay the receipt of payment up until the class starts or longer. These other payment options include payments by sponsors, alternative loans, financial aid, or a tuition assistance program that remits payments directly to us. When a student remits payment after a class has begun, accounts receivable is reduced. If payment is made prior to the start of class, the payment is recorded as a student deposit and the student is provided access to the classroom when classes start. If one of the various other payment options are confirmed as secured, the student is provided access to the classroom. If no receipt is confirmed or payment option secured, the student will be dropped from the class. Therefore, billed amounts represent invoices that have been prepared and sent to students or their sponsor, lender, financial aid, or tuition assistance program according to the billing terms agreed upon in advance. The DoD tuition assistance program is billed on a course-by-course basis when a student starts class, whereas federal financial aid programs are billed based on the classes included in a student’s semester. Billed accounts receivable are considered past due if the invoice has been outstanding more than 30 days. The provision for doubtful accounts is based on management’s evaluation of the status of existing accounts receivable. Recoveries of receivables previously written off are recorded when received.

 

Property and equipment.  Property and equipment are carried at cost less accumulated depreciation. Assets acquired under capital leases are recorded at the lesser of the present value of the minimum lease payments or the fair market value of the leased asset at the inception of the lease. Depreciation and amortization are calculated on a straight-line basis over the estimated useful lives of the assets. In 2004, we placed in operation our Partnership At a Distance, or PAD, system, which is a customized student information and services system, that manages admissions, online orientation, course registrations, tuition payments, grade reporting, progress toward degrees, and various other functions. Costs associated with the project have been capitalized in accordance with Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, and classified as property and equipment. These costs are amortized over the estimated useful life of five years.

 

Valuation of long-lived assets.  We account for the valuation of long-lived assets under Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 requires that long-lived assets and certain identifiable intangible assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the long-lived asset is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Assets to be disposed of are reportable at the lower of the carrying amount or fair value, less costs to sell.

 

Income taxes.  Deferred taxes are determined using the liability method, whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. As those differences reverse, they will enter into the determination of future taxable income. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

 

Stock-based compensation.  Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R)-Share-Based Payment which requires companies to expense share-based compensation based on fair value. Prior to January 1, 2006, we accounted for share-based payment in accordance with Accounting Principles Board Opinion No. 25-Accounting for Stock Issued to Employees, and provided the disclosure required in SFAS 123-Accounting for Stock-Based Compensation, as amended by SFAS No. 148-Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment of FASB Statement No. 123.

 

Goodwill.  We record as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired. Statements of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets,

prescribes a two-step process for the impairment testing of goodwill, which is performed annually, as well as when an event triggering impairment may have occurred. The first step tests for impairment, while the second step, if necessary, measures the impairment. As of August 31, 2006, goodwill was fully impaired and written off in the amount of $735,000 upon the decision to discontinue operations of our subsidiary Rockwell Education, Inc., or Rockwell. We had formed Rockwell for the February 2005 acquisition of all of the assets of Pinnacle Software Solutions, Inc., a school that provided various software and programming training sessions to students and companies. As a result of our determination in the Spring of 2006 to discontinue the operations of Rockwell after completing a teach-out of existing students in August 2006, the activities of Rockwell are included in our financial statements as discontinued operations.

 

Recent Accounting Pronouncements

 

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (SFAS 154). This statement replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. For us, SFAS 154 was effective at the beginning of fiscal year 2007. The adoption of SFAS 154 did not have a material impact on our consolidated financial statements.

 

In June 2006, the Financial Accounting Standards Board Issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes. This interpretation applies to all tax positions accounted for in accordance with SFAS No. 109 by defining the criteria that an individual tax position must meet in order for the position to be recognized within the financial statements and provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition for tax positions. This interpretation is effective for fiscal years beginning after December 15, 2006, with earlier adoption permitted. We adopted FIN 48 effective January 1, 2007. There was no material financial impact to us as a result of adopting this standard.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines and establishes a framework for measuring fair value. In addition, SFAS 157 expands disclosures about fair value measurements. SFAS 157 will be effective for us beginning in fiscal year 2009. We do not expect that the adoption of SFAS 157 will have a material impact on our consolidated financial statements.

Results of Operations

 

The following table sets forth statements of operations data as a percentage of revenues for each of the periods indicated:

 

 

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

 

Revenues

 

Our revenues for the nine months ended September 30, 2007 were $47.9 million, an increase of $20.8 million, or 76.3%, compared to $27.1 million for the nine months ended September 30, 2006. The increase was a result of an increase in the number of net course registrations, which were primarily attributable to increased student referrals, the receipt of regional accreditation in May 2006, and our participation in the Title IV program starting in October 2006, as well as a 10% increase in graduate tuition in 2007.

 

Costs and Expenses

 

Costs and expenses were $38.3 million for the nine months ended September 30, 2007; an increase of $14.5 million, or 61.0% compared to $23.8 million for the nine months ended September 30, 2006. Costs and expenses as a percentage of revenues decreased to 80.0% for the nine months ended September 30, 2007 from 87.7% for the nine months ended September 30, 2006. This decrease resulted from the factors described below.

 

Instructional costs and services.  Our instructional costs and services expenses for the nine months ended September 30, 2007 were $20.7 million, representing an increase of 64.8% from $12.6 million for the

nine months ended September 30, 2006. This increase was directly related to an increase in the number of classes offered due to the increase in net course registrations. Instructional costs and services expense as a percentage of revenues decreased to 43.2% for the nine months ended September 30, 2007 from 46.3% for the nine months ended September 30, 2006. This decrease was primarily due to an increase in the average class size, which provided for a more efficient use of our full-time faculty. Full-time faculty increased from approximately 37 at September 30, 2006 to 98 at September 30, 2007.

 

Selling and promotional.  Our selling and promotional expenses for the nine months ended September 30, 2007 were $4.8 million, representing an increase of 36.8% from $3.5 million for the nine months ended September 30, 2006. This increase was primarily due to an increase in the number of personnel in our admissions department required to support higher student enrollments. Selling and promotional expenses as a percentage of revenues decreased to 10.1% for the nine months ended September 30, 2007 from 13.0% for the nine months ended September 30, 2006. This decrease was primarily due to our ability to realize advertising efficiencies as a result of strong lead generations from personal referrals.

 

General and administrative.  Our general and administrative expenses for the nine months ended September 30, 2007 were $10.8 million, representing an increase of 66.7% from $6.5 million for the nine months ended September 30, 2006. The increase in expense was a result of the need for additional technology, financial positions, recruiting, professional services, management and administrative facilities required to support a larger student body, participation in federal student aid, preparations for going public, and an increase in stock based compensation expense. General and administrative expenses as a percentage of revenues decreased to 22.5% for the nine months ended September 30, 2007, from 23.8% for the nine months ended September 30, 2006. The decrease was primarily due to efficiencies realized through a higher volume of students and the number of staff and expenses increasing at a slower rate than revenue.

 

Depreciation and amortization.  Depreciation and amortization expenses were $2.0 million for the nine months ended September 30, 2007, compared with $1.2 million for the nine months ended September 30, 2006. This represents an increase of 61.3%. This increase resulted from additional capital expenditures and higher depreciation and amortization on a larger fixed asset base.

 

Stock-based compensation.  Stock-based compensation included in instructional costs and services, selling and promotional, and general and administrative expense for the nine months ended September 30, 2007 was $754,000 in the aggregate, representing an increase of 215.5% from $239,000 for the nine months ended September 30, 2006. The increase in stock-based compensation is primarily attributable to an increase in new stock option grants at a higher value.

 

The table below reflects our stock-based compensation expense recognized in the consolidated statements of income for the nine months ended September 30, 2007 and 2006 (in thousands):

 

 

Interest Income, Net

 

Our interest income, net increased by $384,000 for the nine months ended September 30, 2007 to $595,000, representing an increase of 182.0%. This is attributable to increased cash flow from operations resulting in investment income on higher cash balances.

 

Income Tax Expense

 

We recognized income tax expense from continuing operations for the nine months ended September 30, 2007 and 2006 of $4.4 million and $1.2 million, respectively, or effective tax rates of 43.0% and 32.4%,

respectively. The increase in income tax expense was directly attributable to higher pre-tax profits and a reduction in the historic tax credit we were eligible for in 2006.

 

Net Income

 

Our net income was $5.8 million for the nine months ended September 30, 2007, compared to net income of $1.8 million for the nine months ended September 30, 2006, an increase of $4.0 million. This increase was related to the factors discussed above and a reduction in our loss from discontinued operations. Income from continuing operations was $5.8 million for the nine months ended September 30, 2007, compared to income from continuing operations of $2.4 million for the nine months ended September 30, 2006. We incurred a net loss of $633,000 for the nine months ended September 30, 2006 related to our discontinued Rockwell operations compared to $0 for the nine months ended September 30, 2007.

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Revenues

 

Revenues for 2006 were $40.0 million, representing an increase of 42% from revenues of $28.2 million for 2005. The increase was a result of an increase in the number of net course registrations. Tuition did not increase in 2006 from the 2005 rates. Net course registrations increased 46% to 54,828 for 2006 from 37,506 for 2005. The increase in net course registrations resulted primarily from strong student referrals and the achievement of regional accreditation in May 2006.

 

Costs and Expenses

 

Costs and expenses were $37.1 million for 2006, an increase of $11.1 million, or 43%, compared to $26.0 million for 2005. This increase was due to the specific factors discussed below. Costs and expenses as a percentage of revenues increased slightly to 92.7% for 2006 from 92.1% for 2005. This increase resulted from the factors described below.

 

Instructional costs and services.  Instructional costs and services expense for 2006 was $18.0 million, representing an increase of 36% from $13.2 million for 2005. This increase was directly related to an increase in the number of classes offered due to the increase in enrollment. Instructional costs and services expense as a percentage of revenue declined to 44.9% in 2006 from 47.0% in 2005. This decrease was primarily due to an increase in the average class size, which provided for a more efficient use of our full-time faculty.

 

Selling and promotional.  Selling and promotional expenses for 2006 were $4.9 million, representing an increase of 21% from $4.0 million for 2005. The increase in expense was primarily due to an increase in the number of personnel in our admissions department required to support the increase in student enrollment. Selling and promotional expenses as a percentage of revenue declined to 12.2% in 2006 from 14.4% in 2005. This decrease primarily resulted from gaining regional accreditation, which led to increased enrollment of new students without significantly increasing marketing costs.

 

General and administrative.  General and administrative expenses for 2006 were $9.2 million representing an increase of 24% from $7.4 million for 2005. General and administrative expenses in 2006 increased due to the need for technology and finance positions and additional administrative facilities to support a larger student body and expenses in connection with Title IV administration. General and administrative expenses as a percentage of revenue decreased to 22.9% in 2006 from 26.1% in 2005.

 

Write-off of software development project.  We recognized an expense of $3.1 million in 2006 for a discontinued software development project not related to the discontinuation of Rockwell. In the summer of 2005, we initiated a project to integrate our PAD system with a third-party system to accommodate the addition of federal student aid programs. Over time we determined that given the complexity of joining the two systems and our expertise we would be better served by developing a different system to accommodate federal student aid programs. Capitalized software development costs for the portion of the project not involving the PAD system were written off when management determined that the asset related to these costs was impaired. We did not record any comparable expense in 2005.

Depreciation and amortization.  Depreciation and amortization expenses were $2.0 million for 2006, which represents an increase of 50% from $1.3 million for 2005. This increase resulted from greater capital expenditures and higher depreciation and amortization on a larger fixed asset base.

 

Stock-based compensation.  Stock-based compensation included in instructional costs and services, selling and promotional and general and administrative expense for 2006 was $284,000 in the aggregate, representing a decrease of 76% from $1.2 million for 2005. The decrease in stock-based compensation expense is primarily attributable to the $1.2 million payment made to a former employee and major stockholder to settle stock option rights.

 

The table below reflects our stock-based compensation expense recognized in the consolidated statements of income for the years ended December 31, 2006 and 2005 (in thousands):

 

 

Interest Income, Net

 

Interest income, net increased by $64,000, or 28%, to $289,000 for 2006 from $225,000 for 2005. The increase in other income, net is attributable to increased cash flow from operations, which resulted in increased investment income on higher cash balances.

 

Income Tax Expense

 

We recognized tax expense from continuing operations for 2006 of $771,000, or an effective tax rate of approximately 24%, compared to tax expense of $1.1 million, or an effective tax rate of approximately 43.4%, for 2005. The lower effective tax rate in 2006 was primarily due to a tax credit related to the historical renovation of one of our office buildings.

 

Net Income (Loss)

 

Net income was $1.8 million for 2006, compared to a net loss of $11.9 million for 2005. The increase in net income was the result of factors previously mentioned, a reduction of $681,000 in preferred stock accretion and a $12.3 million charge in 2005 to record the excess of the fair value of Class A common stock over the carrying value of the Series A Convertible Preferred Stock, or Series A preferred stock, for which it was exchanged. This amount was offset by an increase in the loss from discontinued operations to $660,000 in 2006 from $303,000 in 2005.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

Revenues

 

Revenues for 2005 were $28.2 million, representing an increase of 22% from $23.1 million for 2004. The increase was a result of an increase in the number of net course registrations, an increase in fees collected and revenue for net course registrations being recognized on a faster basis due to course scheduling. Tuition did not increase in 2005 from the 2004 rates. Net course registrations increased 15% to 37,506 in 2005 from 32,558 in 2004. The increase in net course registrations resulted primarily from strong student referrals and increased marketing to promote our programs. In addition to timing differences, the increase in revenue in excess of the growth in net course registrations was due to the decision to begin charging students a $75 transcript evaluation fee to obtain their transcripts from previously attended schools (in 2004 the students were responsible for obtaining their own transcripts), and the shift to begin offering more 8-week rather than 16-

week courses, which had the effect of shortening the period during which we recognized tuition revenue for those courses.

 

Costs and Expenses

 

Costs and expenses were $26.0 million for 2005, an increase of $6.4 million, or 33%, compared to $19.6 million for 2004. This increase was due to the specific factors discussed below. Costs and expenses as a percentage of revenues increased to 92.1% for 2005 from 84.6% for 2004. This increase is due to the factors described below.

 

Instructional costs and services.  Instructional costs and services expense for 2005 was $13.2 million, representing an increase of 21% from $10.9 million for 2004. This increase resulted from higher faculty costs directly related to an increase in the number of classes offered due to the increase in enrollment and an increase in student services personnel. Instructional and education support expenses as a percentage of revenue were roughly comparable in 2005 and 2004.

 

Selling and promotional.  Selling and promotional expenses for 2005 were $4.0 million, representing an increase of 83% from $2.2 million for 2004. The increase in expense was primarily due to an increase in the number of personnel in our admissions department required to support the increase in student enrollment and an increase in marketing costs to promote our programs. Selling and promotional expense increased as a percentage of revenue to 14.3% in 2005 from 9.5% in 2004. The increase was primarily attributable to an increase in marketing costs to promote our programs.

 

General and administrative.  General and administrative expenses for 2005 were $7.4 million representing an increase of 30% from $5.7 million for 2004. General and administrative expenses increased due to the need for additional administrative facilities and technology and finance positions to support a larger student body as well as a result of $1.2 million in stock-based compensation expense related to the purchase of shares held by a former major stockholder. General and administrative expenses increased as a percentage of revenue to 26.1% in 2005 from 24.8% in 2004. This decrease resulted from operating efficiencies.

 

Depreciation and amortization.  Depreciation and amortization expenses were $1.3 million for 2005. This represents an increase of 93% from $674,000 for 2004. This increase resulted from greater capital expenditures and higher depreciation and amortization on a larger fixed asset base.

 

Interest Income, Net

 

Interest income, net increased 302%, to $225,000 for 2005 from $56,000 for 2004. This increase in other income, net is attributable to increased cash flow from operations, which resulted in increased investment income on higher cash balances.

 

Income Tax Expense

 

We recognized tax expense from continuing operations for 2005 of $1.1 million, or an effective tax rate of approximately 43.4%. For 2004, we recognized tax expense of $1.3 million, or an effective tax rate of approximately 36.7%. The increase in the effective tax rate and corresponding increase in income tax expense resulted from the decrease in the size of research and development tax credits relating to the development of our PAD system used in 2004 compared to 2005.

 

Net Income (Loss)

 

Net loss was $11.9 million for 2005, compared to net income of $1.2 million for 2004. The decrease in net income was the result of the factors mentioned above and a $12.3 million charge to record the excess of the fair value of the Class A common stock over the carrying value of the Series A preferred stock for which it was exchanged, offset by a decrease of $404,000 of preferred stock accretion. For 2005, we sustained a net loss from discontinued operations of $303,000 compared to $0 in 2004.

Quarterly Results

 

The following table presents our unaudited quarterly results of operations for each of our eleven last quarters ended September 30, 2007. You should read the following table in conjunction with the consolidated financial statements and related notes contained elsewhere in this prospectus. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Results of operations for any quarter are not necessarily indicative of results for any future quarters or for a full year.