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APOL > SEC Filings for APOL > Form 10-K on 22-Oct-2012All Recent SEC Filings

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Annual Report

Item 7 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help investors understand our results of operations, financial condition and present business environment. The MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and related notes included in Item 8, Financial Statements and Supplementary Data. The MD&A is organized as follows:
• Overview: From management's point of view, we discuss the following:

• An overview of our business and the sectors of the education industry in which we operate;

• Key trends, developments and challenges; and

• Significant events from the current period.

• Critical Accounting Policies and Estimates: A discussion of our accounting policies that require critical judgments and estimates.

• Recent Accounting Pronouncements: A discussion of recently issued accounting pronouncements.

• Results of Operations: An analysis of our results of operations as reflected on our consolidated financial statements.

• Liquidity, Capital Resources, and Financial Position: An analysis of our cash flows and contractual obligations and other commercial commitments.

Apollo is one of the world's largest private education providers and has been a provider of education services for approximately 40 years. We offer innovative and distinctive educational programs and services at the undergraduate, master's and doctoral levels at our various campuses and learning centers, and online throughout the world. Our principal wholly-owned subsidiaries and subsidiaries that we control include the following:
• The University of Phoenix, Inc. ("University of Phoenix");

• Apollo Global, Inc. ("Apollo Global"):

• BPP Holdings Limited ("BPP");

• Western International University, Inc. ("Western International University");

• Universidad Latinoamericana ("ULA"); and

• Universidad de Artes, Ciencias y Comunicaciσn ("UNIACC");

• Institute for Professional Development ("IPD"); and

• The College for Financial Planning Institutes Corporation ("CFFP").

On September 12, 2011, we acquired all of the outstanding stock of Carnegie Learning, Inc. ("Carnegie Learning"), a publisher of research-based math curricula and adaptive learning software. Refer to Fiscal Year 2012 Significant Events - Carnegie Learning, Inc. Acquisition in this MD&A for additional information. In addition, we are developing a business, Apollo Education Services, through which we intend to begin providing a variety of educational delivery services to other higher education institutions.
Substantially all of our net revenue is composed of tuition and fees for educational services. In fiscal year 2012, University of Phoenix generated 91% of our total consolidated net revenue and more than 100% of our operating income, and 84% of its cash basis revenue for eligible tuition and fees was derived from U.S. federal financial aid programs established by Title IV of the Higher Education Act and regulations promulgated thereunder ("Title IV"), as calculated under the 90/10 Rule.
We believe that a critical element of generating successful long-term growth and attractive returns for our stakeholders is to provide high quality educational products and services to increase the value proposition for students and maximize the benefits of their educational experience. Accordingly, we are actively focused on further aligning our educational offerings with the learning outcomes students need to succeed in today's and tomorrow's workplace. We are continuously enhancing and expanding our current service offerings and investing in academic quality. We have developed customized systems for academic quality management, faculty recruitment and training, student tracking, and marketing to help us more effectively manage toward this objective. We believe we utilize one of the most comprehensive postsecondary learning assessment programs in the U.S. We seek to improve student retention by building a strong connection between our education and careers, promoting instructional innovation and enhancing student services. All of these efforts are designed to help our students stay in school and succeed.

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Key Trends, Developments and Challenges
The following developments and trends present opportunities, challenges and risks as we work toward our goal of providing attractive returns for all of our stakeholders:
• Focus on Education to Careers. We recognize the critical importance to our students of improved employment or advancement prospects. We believe that this has been a core value proposition in our offering to students over the years. However, we believe that we must enhance this value proposition for our students and do so in a manner that is clearly demonstrable. Specifically, we believe that we must be able to demonstrate a clearly compelling relationship between our degree programs and improvements in our graduates' prospects for employment in their relevant field of choice or advancement within their existing careers. Accordingly, we are actively focused on enhancing this element of our educational offerings through various initiatives, including the incorporation of career resources such as career planning tools and faculty support directly into the learning experience.

• Student Experience. We remain focused on more effectively identifying students who can succeed in our educational programs, ensuring they are adequately prepared, and improving the overall student experience. In furtherance of this, along with enhancing the connection of education to careers as discussed above:

•            we are actively working on major enhancements to our learning and
             student service platforms, and we are in the process of
             incorporating adaptive learning into our curricula to offer an
             individualized approach to learning;

•            we require substantially all incoming students with less than 24
             credits to attend our free three-week University Orientation
             Program, which is designed to help inexperienced prospective
             students better understand the time commitments and rigors of higher
             education prior to enrollment;

•            we have modified our marketing content and channels to better
             identify potential students that we believe are more likely to
             succeed at University of Phoenix; and

•            we have eliminated all enrollment factors in evaluating the
             performance of our admissions personnel in order to better align our
             admissions personnel with our students' success.

We believe that some of these changes significantly contributed to the reduction in aggregate New Degreed Enrollment in fiscal years 2011 and 2012; however, we believe these changes, together with other initiatives, have improved the student experience and will enhance student outcomes. Furthermore, we believe that over the long-term these initiatives will reduce the risks to our business associated with the regulatory environment.
• Business Process Reengineering. During fiscal year 2011, we began initiating a series of activities to reengineer business processes and refine our educational delivery structure. These activities are designed to increase operating efficiencies and effectiveness, and enhance our students' educational experience and outcomes. We have incurred $61.6 million of cumulative restructuring and other charges associated with these activities during fiscal years 2011 and 2012.

Pursuant to this initiative, in fiscal years 2012 and 2011 we implemented the following strategic reductions in workforce:

•            During the fourth quarter of fiscal year 2012, we eliminated
             approximately 350 positions at University of Phoenix, Apollo Global
             and certain Corporate functions;

•            During the third quarter of fiscal year 2012, we eliminated
             approximately 150 positions at UNIACC principally representing
             non-direct student servicing personnel; and

•            During the first quarter of fiscal year 2011, we eliminated
             approximately 700 full-time positions at University of Phoenix
             principally representing admissions personnel.

Subsequent to August 31, 2012, we continued our initiative to reengineer business processes and refine our educational delivery structure. These activities, including the actions discussed below, are expected to favorably impact annual operating expenses by at least $300 million by fiscal year 2014, when compared to fiscal year 2012. We expect to realize more than half of these cumulative cost savings in fiscal year 2013, with the remainder in fiscal year 2014.

•         University of Phoenix is realigning its ground locations throughout the
          U.S., which will directly impact approximately 4% of Degreed
          Enrollment, or around 13,000 students. These students will be offered
          support to continue their education at University of Phoenix either
          online, through alternative on-ground arrangements or, in limited
          cases, at existing University of Phoenix locations. This plan includes
          closing 115 locations, consisting of 90 learning and student resource
          centers, which are generally smaller satellite locations, and 25
          campuses. University of Phoenix will preserve a national coast-to-coast
          network of 112 locations and plans to retain a

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presence in 36 states, the District of Columbia and the Commonwealth of Puerto Rico. Subject to regulatory approvals, the realignment is expected to be substantially complete in fiscal year 2013. We expect to incur approximately $175 million of restructuring and other charges, principally for lease exit and other related costs, with most of these costs incurred in fiscal year 2013. We plan to continue investing in our ground locations to create state-of-the art, technologically-integrated facilities offering academic and career support and increased mobile connectivity, while also continuing to advance our leading-edge online learning platform.

•         We also have begun implementing a workforce reduction and expect to
          decrease total headcount, excluding faculty, by approximately 800
          employees during fiscal year 2013. We anticipate incurring
          approximately $25 million of restructuring and other charges in fiscal
          year 2013 related to workforce reductions.

Refer to Results of Operations in this MD&A and Part I, Item 1A, Risk Factors - Risks Related to Our Business - The on-going reengineering of our business processes, including a substantial reduction in our on-ground locations and a reduction in workforce, could negatively impact our enrollment and operating results, for further discussion.
• Regulatory Environment. Our domestic postsecondary institutions are subject to extensive federal and state regulations. In particular, the federal Higher Education Act, as reauthorized, and related U.S. Department of Education regulations, prescribe detailed requirements affecting substantially all activities of University of Phoenix and Western International University as a condition to participating in Title IV programs. We have summarized below certain significant regulatory developments and trends applicable to our business. For a more detailed discussion of the regulatory environment and related risks, refer to Part I, Item 1, Business, and Item 1A, Risk Factors.

•         Higher Learning Commission. In August 2010, University of Phoenix
          received a letter from its principal accreditor, the Higher Learning
          Commission ("HLC"), requiring University of Phoenix to provide certain
          information and evidence of compliance with HLC accreditation
          standards. This followed the August 2010 report published by the
          Government Accountability Office of its undercover investigation into
          the enrollment and recruiting practices of a number of proprietary
          institutions of higher education, including University of Phoenix. In
          July 2011, the Special Committee formed to review this matter completed
          its work, concluding that based on its limited review, it found no
          apparent evidence of systematic misrepresentations to students or that
          University of Phoenix's procedures in the areas of recruiting,
          financial aid and admissions were significantly inadequate or
          inappropriate. HLC also stated that there remained significant
          questions and areas that University of Phoenix should work on
          improving. HLC is reviewing these areas of concern as part of its
          previously scheduled comprehensive reaffirmation evaluation visit,
          which began in March 2012.

In September 2012, HLC required University of Phoenix to provide a response to data submitted on the University of Phoenix's 2012 Institutional Annual Report. HLC reviews data from all of its accredited and candidate for accreditation member institutions. HLC identified three non-financial indicators for which it sought additional information:

•               Increase or decrease in full-time faculty of 25% or more from the
                prior year's report;

•               Ratio of undergraduate full-time equivalent students to
                undergraduate full-time equivalent faculty of greater than 35 in
                the period reported; and

• Three-year student loan default rate of 25% or more.

University of Phoenix expects to respond to HLC in late October 2012. HLC has indicated that it will assign several members of the current team reviewing University of Phoenix's reaffirmation to evaluate University of Phoenix's response to the report, and that their evaluation will become an appendix to the review team's report on University of Phoenix's reaffirmation.
Refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - If we fail to maintain our institutional accreditation or if our institutional accrediting body loses recognition by the U.S. Department of Education, we could lose our ability to participate in Title IV programs, which would materially and adversely affect our business.
• U.S. Congressional Hearings and Financial Aid Funding. In recent years, there has been increased focus by members of the U.S. Congress on the role that proprietary educational institutions play in higher education. Congressional hearings and roundtable discussions have been held, beginning in June 2010, by the U.S. Senate Committee on Health, Education, Labor and Pensions ("HELP Committee"), regarding various aspects of the education industry that may result in regulatory changes that affect our business. We have voluntarily provided substantial amounts of information about our business at the request of various Congressional committees, and we intend to continue being responsive to Congress in this regard. In July 2012, the HELP Committee issued their final report which was unfavorable to proprietary institutions. In addition, other Congressional hearings or roundtable discussions are expected to be held regarding various aspects of the education industry that may affect

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our business. We cannot predict what legislation, if any, may emanate from these Congressional committee hearings or what impact any such legislation might have on the proprietary education sector and our business in particular. As Congress addresses the historic U.S. budget deficit, financial aid programs are a potential target for reduction. Any action by Congress that significantly reduces Title IV program funding, whether through across-the-board funding reductions, sequestration or otherwise, or materially impacts the eligibility of our institutions or students to participate in Title IV programs would have a material adverse effect on our enrollment, financial condition, results of operations and cash flows. Congressional action could also require us to modify our practices in ways that could increase our administrative costs and reduce our operating income, which could have a material adverse effect on our financial condition, results of operations and cash flows. Refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - Action by the U.S. Congress to revise the laws governing the federal student financial aid programs or reduce funding for those programs, including changes applicable only to proprietary educational institutions, could reduce our enrollment and increase our costs of operation. In addition to possible reductions in federal student financial aid, state-funded student financial aid also may be reduced as many states grapple with their own historic budget shortfalls, including California, as described below.

•         California Grant Program ("Cal Grants"). In California, the state in
          which we conduct the most business by revenue, University of Phoenix
          students received approximately $21 million of Cal Grants in fiscal
          year 2012. Effective July 1, 2012, only schools with a graduation rate
          of at least 30% and a three-year federal student loan cohort default
          rate below 15.5% are eligible to participate in the Cal Grant program.
          As a result, new University of Phoenix students are no longer eligible
          for Cal Grants and continuing students will be eligible for only one
          additional year, and the maximum award for these students has been
          reduced by 20%. This change and other changes in state-funded student
          financial aid could result in increased student borrowing, decreased
          enrollment and adverse impacts on our 90/10 Rule percentage.

•         Increased Attention to Issues Surrounding Marketing. At both the state
          and federal level, there are a growing number of efforts to evaluate
          and restrict the manner in which educational institutions market their
          services to potential students. For example, several state Attorneys
          General recently reached a settlement with a third-party lead
          generation provider relating to alleged misleading marketing
          practices. In addition, various members of Congress have commented
          publicly about allegedly deceptive marketing practices by some
          for-profit educational institutions based on review of the materials
          released by Senator Tom Harkin, and on September 21, 2012, a group of
          Senators and Representatives sent a letter to the Federal Trade
          Commission encouraging the Commission to evaluate these practices.
          Other members of Congress have introduced legislation to limit the use
          of federal funds for marketing purposes. Action by Congress or the
          Department of Education to address these marketing issues could
          limit and potentially constrain our choices of marketing plans and
          limit their effectiveness.

•         Office of the Inspector General of the U.S. Department of Education
          ("OIG"). In October 2011, the OIG notified us that it was conducting a
          nationwide audit of the Department's program requirements, guidance,
          and monitoring of institutions of higher education offering distance
          education. In connection with the OIG's audit of the Department, the
          OIG examined a sample of University of Phoenix students who enrolled
          during the period from July 1, 2010 to June 30, 2011. The OIG
          subsequently notified University of Phoenix that in the course of this
          review it identified certain conditions that the OIG believes are Title
          IV compliance exceptions at University of Phoenix. Although University
          of Phoenix is not the direct subject of the OIG's audit of the
          Department, the OIG has asked University of Phoenix to respond so that
          it may consider University of Phoenix's views in formulating its audit
          report of the Department. These exceptions relate principally to the
          calculation of the amount of Title IV funds returned after student
          withdrawals and the process for confirming student eligibility prior to
          disbursement of Title IV funds.

•         90/10 Rule. University of Phoenix and all other proprietary
          institutions of higher education, are subject to the so-called "90/10
          Rule" under the Higher Education Act, as reauthorized. Under this rule,
          a proprietary institution will be ineligible to participate in Title IV
          programs if for any two consecutive fiscal years it derives more than
          90% of its cash basis revenue, as defined in the rule, from Title IV
          programs. An institution that derives more than 90% of its cash basis
          revenue from Title IV programs for any single fiscal year will be
          automatically placed on provisional certification for two fiscal years
          and will be subject to possible additional sanctions determined to be
          appropriate under the circumstances by the U.S. Department of
          Education. An institution that derives more than 90% of its cash-basis
          revenue from Title IV programs for two consecutive fiscal years will be
          ineligible to participate in Title IV programs for at least two fiscal

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The 90/10 Rule percentages for University of Phoenix for fiscal years 2012, 2011 and 2010 were as follows:

90/10 Rule Percentages for Fiscal Years Ended August 31,
2012 2011(1) 2010(1)
University of Phoenix 84% 86% 88%

(1) Calculated excluding the temporary relief from the impact of loan limit increases, which was allowable for amounts received and applied to eligible charges between July 1, 2008 and June 30, 2011 that were attributable to the increased annual loan limits. Although the University of Phoenix 90/10 Rule percentage for fiscal year 2012 has decreased from fiscal years 2011 and 2010, the 90/10 Rule percentage for University of Phoenix has increased materially over the years prior to fiscal year 2010. This prior increase was primarily attributable to the increase in student loan limits affected by the Ensuring Continued Access to Student Loans Act of 2008 and expanded eligibility for and increases in the maximum amount of Pell Grants. We believe the decrease in the University of Phoenix 90/10 Rule percentage in fiscal year 2012 compared to fiscal years 2011 and 2010 is primarily attributable to the reduction in the proportion of our students who are enrolled in our associate's degree programs, which historically have had a higher percentage of Title IV funds applied to eligible tuition and fees, and emphasizing employer-paid and other direct-pay education programs. Based on recent trends, we do not expect the 90/10 Rule percentage for University of Phoenix to exceed 90% for fiscal year 2013. However, the 90/10 Rule percentage for University of Phoenix remains near 90% and could exceed 90% in the future depending on the degree to which our various initiatives are effective, the impact of future changes in our enrollment mix, and regulatory and other factors outside our control, including any reduction in military benefit programs or changes in the treatment of such funding for purposes of the 90/10 Rule calculation. In addition, the ineligibility of University of Phoenix students for Cal Grants in California as discussed above, and reductions in other state-funded student financial aid programs could adversely impact our compliance with the 90/10 rule, because tuition revenue derived from such programs is included in the 10% portion of the rule calculation. Any necessary further efforts to reduce the 90/10 Rule percentage for University of Phoenix, especially if the percentage exceeds 90% for a fiscal year, may involve taking measures which reduce our revenue, increase our operating expenses, or both, in each case perhaps significantly. In addition, we may be required to make structural changes to our business in the future in order to remain in compliance, which changes may materially alter the manner in which we conduct our business and materially and adversely impact our business, financial condition, results of operations and cash flows. Furthermore, these required changes could make it more difficult to comply with other important regulatory requirements, such as the cohort default rate regulations, which are discussed below.
Refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - Our schools and programs would lose their eligibility to participate in federal student financial aid programs if the percentage of our revenues derived from those programs is too high, in which event we could not conduct our business as it is currently conducted.
• Student Loan Cohort Default Rates. To remain eligible to participate in Title IV programs, educational institutions must maintain student loan cohort default rates below specified levels. Each cohort is the group of students who first enter into student loan repayment during a federal fiscal year (ending September 30). Under current regulations, an educational institution will lose its eligibility to participate in Title IV programs if its two-year measuring period student loan cohort default rate equals or exceeds 25% for three consecutive cohort years, or 40% for any given year. If our student loan default rates approach these limits, we may be required to increase efforts and resources dedicated to improving these default rates. In addition, because there is a lag between the funding of a student loan and a default thereunder, many of the borrowers who are in default or at risk of default are former students with whom we may have only limited contact. Accordingly, there can be no assurance that we would be able to effectively improve our default rates or improve them in a timely manner to meet the requirements for continued participation in Title IV funding if we experience a substantial increase in our student loan default rates.

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The two-year cohort default rates for University of Phoenix and for all proprietary postsecondary institutions for the federal fiscal years 2010, 2009 and 2008 were as follows:

                                                Two-Year Cohort Default Rates for
                                                 Cohort Years Ended September 30,
                                                 2010          2009          2008
University of Phoenix(1)                        17.9%         18.8%         12.9%
All proprietary postsecondary institutions(1)   12.9%         15.0%         11.6%

(1) Based on information published by the U.S. Department of Education. . . .

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