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APOL > SEC Filings for APOL > Form 10-Q on 26-Mar-2012All Recent SEC Filings

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Quarterly Report

Item 2. 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 unaudited condensed consolidated financial statements and related notes included elsewhere in this report. 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 in our condensed consolidated financial statements.

• Liquidity, Capital Resources, and Financial Position: An analysis of 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 more than 35 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 educational institutions and educational institutions that we control include the following:
• The University of Phoenix, Inc. ("University of Phoenix");

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

• BPP Holdings, plc ("BPP");

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

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

• Universidad Latinoamericana ("ULA");

• 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 to Date - Carnegie Learning, Inc. Acquisition in this MD&A for additional information.
Substantially all of our net revenue is composed of tuition and fees for educational services. In fiscal year 2011, University of Phoenix generated 91% of our total consolidated net revenue and more than 100% of our operating income, and 86% 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 for our students in order for them to maximize the benefits of their educational experience. Accordingly, we are intensely focused on student success and more effectively identifying and enrolling students who have a greater likelihood to succeed in our educational programs. 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 enhancing student services, including academic support, and promoting instructional innovation. 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:
• University of Phoenix Enrollment and Certain Operating Trends. We are intensely focused on enhancing student experiences and outcomes. In furtherance of this, we have implemented a number of important changes and initiatives in recent years to transition our business to more effectively support our students and enhance their educational outcomes. The decrease in University of Phoenix enrollment during fiscal year 2011 compared to fiscal year 2010 was principally the result of some of these changes and initiatives. Although University of Phoenix New Degreed Enrollment increased 12.7% and 1.0% during the first and second quarters of fiscal year 2012, respectively, University of Phoenix net revenue decreased 10.1% during the first six months of fiscal year 2012 compared to the first six months of fiscal year 2011. We expect that the effects of our initiatives during fiscal year 2011 will continue to reduce University of Phoenix net revenue, operating income and cash flow for the remainder of fiscal year 2012. Furthermore, the reduced rate of New Degreed Enrollment in fiscal year 2011 is expected to continue to have an impact beyond fiscal year 2012. However, we believe that many of the initiatives we have implemented are in the best interests of our students and, over the long-term, will improve student retention and completion rates, reduce the risks to our business associated with our regulatory environment, and position us for more stable long-term growth.

We also believe University of Phoenix New Degreed Enrollment has been impacted by the following additional factors:

•         changes in marketing content and channels to better identify potential
          students more likely to succeed at University of Phoenix;

•         changes in economic conditions and, in particular, an improving U.S.

labor market. Refer to Our business may be adversely affected by changes in the U.S. economy in Item 1A, Risk Factors, in our 2011 Annual Report on Form 10-K; and

• a robust competitive environment. Refer to We face intense competition

          in the postsecondary education market from both public and private
          educational institutions, which could adversely affect our business in
          Part II, Item 1A, Risk Factors.

We are pursuing opportunities to improve our operating efficiency and optimize our cost structure. We believe successful implementation of related initiatives can strengthen our position as we continue to invest in initiatives that differentiate our educational products and services and enhance student experiences and outcomes.
• 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 the various federal student financial aid 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 Item 1, Business, and Item 1A, Risk Factors, in our 2011 Annual Report on Form 10-K.

•         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, and more are expected to be held in the future, 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.

As Congress addresses the historic U.S. budget deficit, financial aid programs are a potential target for reduction. In February 2012, President Obama submitted his fiscal year 2013 federal budget request. If enacted, the President's budget request would, among other things:

•                maintain the 3.4% interest rate on undergraduate subsidized
                 student loans for one additional year, which is currently
                 scheduled to revert to 6.8% in July 2012,

•                fund a maximum Pell Grant of $5,635 for the 2013-2014 award
                 year, an $85 increase over the prior year, and

•                make permanent the American Opportunity Tax Credit, which is a
                 refundable tax credit for undergraduate education expenses.

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Congress will consider the President's budget request in its formulation of tax and spending legislation later this year, including the fiscal year 2013 appropriations bills that will set specific funding levels for federal education programs. 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. In addition to possible reductions in federal student financial aid, state-funded student financial aid also may be reduced as many states grapple with historic budget shortfalls. For example, in California, the state in which we conduct the most business by revenue, the governor has proposed changes to both the eligibility for and maximum awards under the principal state-funded grant program. If adopted, these changes could end our students' eligibility to participate in this grant program, at least temporarily, which provided approximately $20 million of grants to our students in fiscal year 2011. These and similar changes in other states could result in increased student borrowing, decreased enrollment and adverse impacts on our 90/10 Rule percentage discussed below.

•         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. The letter related to 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, HLC informed University of Phoenix that the Special
          Committee formed to review this matter had 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 are significantly inadequate or
          inappropriate. HLC also stated that there remain 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 evaluation visit, which began in March 2012.

•         Rulemaking Initiative. In October 2010 and June 2011, the U.S.
          Department of Education promulgated new rules related to Title IV
          program integrity issues and foreign school issues. The most
          significant of these rules for our business are the following:

•                Modification of the standards relating to the payment of
                 incentive compensation to employees involved in student
                 recruitment and enrollment;

•                Implementation of standards for state authorization of
                 institutions of higher education;

•                Adoption of a definition of "gainful employment" for purposes of
                 the requirement of Title IV student financial aid that a program
                 of study offered by a proprietary institution prepare students
                 for gainful employment in a recognized occupation; and

•                Expansion of the definition of misrepresentation, relating to
                 the Department's authority to suspend or terminate an
                 institution's participation in Title IV programs if the
                 institution engages in substantial misrepresentation about the
                 nature of its educational program, its financial charges, or the
                 employability of its graduates, and expansion of the sanctions
                 that the Department may impose for engaging in a substantial

Most of the rules were effective in July 2011. The rules regarding the metrics for determining whether an academic program prepares students for gainful employment are effective on July 1, 2012. We believe substantially all of our academic programs currently prepare students for gainful employment measured in the manner set forth in the final gainful employment regulations for purposes of continued eligibility to participate in federal student financial aid programs. In May 2011, the Department announced its intention to establish additional negotiated rulemaking committees to prepare proposed regulations under the Higher Education Act. In January 2012, two negotiation teams began their work on regulations relating to teacher preparation and student loan issues. These negotiations are expected to conclude in April 2012. More information can be found at

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•         90/10 Rule. One requirement of the Higher Education Act, as
          reauthorized, commonly referred to as the "90/10 Rule," provides that 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. The University of Phoenix 90/10 Rule percentage for fiscal
          year 2011 was 86%. Based on our most recent trends, we do not expect
          the 90/10 Rule percentage for University of Phoenix to exceed 90% for
          fiscal year 2012. However, the 90/10 Rule percentage for University of
          Phoenix remains near 90% and could exceed 90% in the future.

Various legislative proposals have been introduced in Congress that would heighten the requirements of the 90/10 Rule. For example, in January 2012, the Protecting Our Students and Taxpayers Act was introduced in the U.S. Senate and, if adopted, would reduce the 90% maximum under the rule to the pre-1998 level of 85%, cause tuition derived from Title IV programs for military personnel to be included in the 85% portion under the rule instead of the 10% portion as is the case today, and impose Title IV ineligibility after one year of noncompliance rather than two. If this or other proposals are adopted as proposed, University of Phoenix would have to make material changes to its business to remain eligible to participate in Title IV programs, which could materially and adversely affect our business. In addition, reductions in state-funded student financial aid programs also could adversely impact our compliance with the 90/10 rule, because tuition revenue derived from such funding sources is included in the 10% portion of the rule calculation.

•         Student Loan Cohort Default Rates. To remain eligible to participate in
          Title IV programs, an educational institution's student loan cohort
          default rates must remain below certain specified levels. 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. For University of
          Phoenix and Western International University, the 2009 cohort default
          rates were 18.8% and 9.3%, respectively, and the draft 2010 cohort
          default rates, which will be finalized in September 2012, were 18.0%
          and 8.0%, respectively.

The cohort default rate requirements were modified by the Higher Education Opportunity Act enacted in August 2008 to increase by one year the measuring period for each cohort. Starting in September 2012, the U.S. Department of Education will publish the official three-year cohort default rates in addition to the two-year rates, beginning with the 2009 cohort. If an institution's three-year cohort default rate exceeds 30% for any given year (compared to 25% under the current two-year standard), it must establish a default prevention task force and develop a default prevention plan with measurable objectives for improving the cohort default rate. We believe that our current repayment management efforts meet these requirements. If an institution's three-year cohort default rates for the 2009 and 2010 cohorts exceed 30%, the institution may be subject to provisional certification imposing various additional requirements for participation in Title IV programs. Beginning with the three-year cohort default rate for the 2011 cohort published in September 2014, the three-year rates will be applied for purposes of measuring compliance with the requirements. If the three-year cohort default rate for the 2011 cohort exceeds 40%, the institution will cease to be eligible to participate in Title IV programs, and if the institution's three-year cohort default rate exceeds 30% for three consecutive years, beginning with the 2009 cohort, the institution will cease to be eligible to participate in Title IV programs. The Department has published, for informational purposes, "trial rates" to assist institutions in understanding the impact of the new three-year cohort default rate calculation. For University of Phoenix and Western International University, the trial three-year cohort default rates for the 2008 cohort were 21.1% and 16.3%, respectively. The University of Phoenix and Western International University draft three-year cohort default rates for the 2009 cohort, which will be finalized in September 2012, were 26.7% and 14.7%, respectively.
• Expand into New Markets. We intend to continue to pursue opportunities to utilize our core expertise and organizational capabilities, both domestically and internationally. In particular, Apollo Global is actively evaluating opportunities to partner with or acquire existing institutions of higher learning outside of the U.S. to address the growing international demand for postsecondary education services. To date, Apollo Global has acquired educational institutions in the United Kingdom, Mexico and Chile, and has also established a joint venture to develop and provide educational services and programs in India. The integration and operation of acquired businesses in foreign jurisdictions entails substantial regulatory, market and execution risks and such acquisitions may not be accretive for an extended period of time, if at all, depending on the circumstances.

For a more detailed discussion of trends, risks and uncertainties, and our strategic plan, refer to our 2011 Annual Report on Form 10-K and Part II, Item 1A, Risk Factors, included in this report.

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Fiscal Year 2012 Significant Events to Date In addition to the items mentioned above, we experienced the following significant events during fiscal year 2012:
1. Carnegie Learning, Inc. Acquisition. During the first quarter of fiscal year 2012, we acquired all of the stock of Carnegie Learning, Inc., a publisher of research-based math curricula and adaptive learning software for $75.0 million. In a separate transaction, we acquired related technology from Carnegie Mellon University for $21.5 million, payable over a 10-year period. The acquisitions allow us to accelerate our efforts to incorporate adaptive learning into our academic platform and to provide tools to help raise student achievement in mathematics, which we believe will support improved retention and graduation rates. Refer to Note 5, Acquisitions, in Item 1, Financial Statements.

2. UNIACC Accreditation. On November 17, 2011, UNIACC was advised by the National Accreditation Commission of Chile that its institutional accreditation would not be renewed and therefore had lapsed. UNIACC expects to appeal the decision. The loss of accreditation from the National Accreditation Commission does not impact UNIACC's ability to operate or confer degrees and does not directly affect UNIACC's programmatic accreditations. However, this institutional accreditation is necessary for new UNIACC students to participate in government loan programs and for existing students to begin to participate in such programs for the first time. The loss of accreditation has reduced new enrollment in UNIACC's degree programs due to the unavailability of the government loan programs and, if this action is not reversed, we expect new enrollment will continue to be adversely impacted. We cannot predict the magnitude of any further reduction at this time and if the loss of institutional accreditation is not reversed and continues to decrease demand among students who seek government loans or otherwise reduces demand for potential students, the university's viability could be materially and adversely affected. Based principally on these developments, we recorded goodwill and other intangibles impairment charges of $16.8 million during the first quarter of fiscal year 2012. Refer to Critical Accounting Policies and Estimates in this MD&A.

3. Joint Venture to Provide Educational Services in India. On December 3, 2011, Apollo Global entered into an agreement with HT Media Limited, an Indian media company, to participate in a start-up, 50:50 joint venture intended to develop and provide educational services and programs in India. HT Media Limited, which is based in New Delhi, India, publishes the Hindustan Times, Hindustan and Mint newspapers, among other business activities.

4. Securities Class Action (Policeman's Annuity and Benefit Fund of Chicago). During the first quarter of fiscal year 2012, we entered into an agreement in principle with the plaintiffs to settle a securities class action lawsuit entitled In re Apollo Group, Inc. Securities Litigation, Case No. CV04-2147-PHX-JAT, filed in the U.S. District Court for the District of Arizona, for $145.0 million, which was preliminarily approved by the Court on November 28, 2011. Based on the terms of the Court's preliminary approval, we placed $145.0 million into a common fund account on December 5, 2011, which is presented as restricted funds held for legal matter on our Condensed Consolidated Balance Sheets as of February 29, 2012. Our remaining accrual of $160.7 million as of February 29, 2012 represents the $145.0 million settlement, an estimate of the disputed amount we may be required to reimburse our insurance carriers for defense costs advanced to us, and estimated future legal costs. The settlement agreement is subject to final approval by the Court, and the Court has scheduled a Final Approval Hearing for April 16, 2012. Refer to Note 15, Commitments and Contingencies, in Item 1, Financial Statements.

5. Changes in Directors and Executive Officers. The following changes in directors and executive officers have occurred during fiscal year 2012:

•               During the first quarter of fiscal year 2012, Samuel A. DiPiazza,
                Jr. resigned from the Board of Directors;

•               Dino J. DeConcini chose not to stand for reelection at the annual
                meeting of the holders of Class B common stock and therefore his
                term of service ended January 9, 2012;

•               During the second quarter of fiscal year 2012, Richard H. Dozer
                was appointed to our Board of Directors;

•               During the second quarter of fiscal year 2012, Charles B.
                Edelstein announced that he will retire as co-CEO and director as
                of August 26, 2012; and

• In March 2012, Allen R. Weiss was appointed to our Board of Directors.

6. University of Phoenix Academic Annual Report. In February 2012, University of Phoenix published its fourth Academic Annual Report, which we believe provides a transparent assessment of how well University of Phoenix

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is serving its students' needs which guides its continuous improvement.
7. Securities and Exchange Commission Informal Inquiry. In March 2012, the staff of the Securities and Exchange Commission notified us that its informal inquiry into our revenue recognition practices had been completed and that the staff did not intend to recommend any enforcement action by the Commission. Refer to Note 15, Commitments and Contingencies, in Item 1, Financial Statements.

Critical Accounting Policies and Estimates For a detailed discussion of our critical accounting policies and estimates, refer to our 2011 Annual Report on Form 10-K. Included below is an update for certain of our Critical Accounting Policies and Estimates as of February 29, 2012.
Goodwill and Intangible Assets
Refer to Fiscal Year 2012 Significant Events to Date - UNIACC Accreditation in this MD&A for additional information on the uncertainty associated with UNIACC's accreditation. Based on these factors and related uncertainty, we revised our cash flow estimates and performed an interim goodwill impairment analysis for UNIACC in the first quarter of fiscal year 2012.
To determine the fair value of the UNIACC reporting unit in our interim step one analysis, we used a discounted cash flow valuation method using assumptions that we believe would be a reasonable market participant's view of the impact of the loss of accreditation status and the increased uncertainty impacting UNIACC. We used significant unobservable inputs (Level 3) in our discounted cash flow valuation. For further discussion of the valuation methods we employ, refer to our 2011 Annual Report on Form 10-K.
Our interim step one goodwill impairment analysis resulted in a lower estimated fair value for the UNIACC reporting unit as compared to its carrying value. Based on the estimated fair value of the UNIACC reporting unit and a . . .

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