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APOL > SEC Filings for APOL > Form 10-Q on 8-Jan-2013All 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 on our condensed 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 nearly 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 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")

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

• Institute for Professional Development ("IPD")

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

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 University of Phoenix's 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 our success depends on providing high quality educational products and services to students to maximize the benefits of their educational experience.
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:
• Changing Education Industry. The U.S. higher education industry, including the proprietary sector, is experiencing unprecedented, rapidly developing changes due to technological developments, evolving needs and objectives of students and employers, economic constraints affecting educational institutions and students, and other factors that challenge many of the core principles underlying the industry. Additionally, an increasing number of traditional colleges and universities and community colleges are offering distance learning and other online education programs, including programs that are geared towards the needs of working learners. As the proportion of traditional colleges providing alternative learning modalities increases, we will face increasing competition for students from traditional colleges, including colleges with well-established brand names. We must adapt our business to meet these rapidly evolving developments, and many of the initiatives described below are driven by our focus on this imperative.

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• Education to Careers. We believe it is critical that we demonstrate a clear connection between our students' education goals and career goals. Accordingly, we are focused on providing a compelling relationship between our degree programs and improvements in our graduates' prospects for employment in their field of choice or advancement within their existing careers. We are enhancing this element of our value proposition through various initiatives, including connecting our educational offerings directly with employers, providing an interactive online portal that allows employers to directly recruit our students, and incorporating career resources such as career planning tools 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:

•         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

•         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 New Degreed Enrollment beginning in fiscal year 2011. 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. Beginning in fiscal year 2011 and continuing through the first quarter of fiscal year 2013, we initiated 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 $85.7 million of cumulative restructuring and other charges associated with these activities since we initiated these activities in fiscal year 2011. In connection with these activities, in the first quarter of fiscal year 2013 we initiated the following:

•         A plan to realign University of Phoenix's ground locations throughout
          the U.S. This plan includes closing 115 locations and students directly
          impacted by the plan 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. We incurred $10.1 million of expense associated with
          this plan during the first quarter of fiscal year 2013, the substantial
          majority of which is accelerated depreciation for fixed assets at the
          designated facilities we have not yet closed. Subject to regulatory
          approvals, we expect to substantially complete this realignment in
          fiscal year 2013. We expect to incur approximately $165 million of
          additional charges, principally for lease exit and other related costs,
          with most of these costs incurred in fiscal year 2013. We also plan to
          continue investing in our remaining ground locations to create
          state-of-the art, technologically-integrated facilities offering
          academic and career support and increased mobile connectivity, while
          continuing to advance our leading-edge online learning platform.

•         A workforce reduction consisting of approximately 800 positions due in
          part to University of Phoenix's ground location realignment. We
          eliminated a portion of these positions during the first quarter of
          fiscal year 2013 and incurred $10.9 million of severance and other
          employee separation costs. We expect to incur approximately $15 million
          of additional charges associated with this reduction as the remaining
          positions are eliminated.

Our activities to reengineer business processes and refine our educational delivery structure are expected to favorably impact annual operating expenses by at least $300 million when compared to fiscal year 2012. Although we expect to realize at least $200 million of these annual savings in fiscal year 2013, we do not expect to realize the full $300 million in annual savings until fiscal year 2014.
• Regulatory Environment. Our domestic postsecondary institutions are subject to extensive federal and state regulations and to the requirements of our academic accrediting bodies.

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 U.S. federal financial aid programs established under Title IV of the Higher Education Act ("Title IV"). We have summarized below certain significant regulatory matters applicable to our business. For a more detailed discussion of the regulatory environment and related risks, refer to Part I, Item 1,

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Business, and Item 1A, Risk Factors, in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission on October 22, 2012.
• Higher Learning Commission. University of Phoenix is undergoing the scheduled comprehensive reaffirmation evaluation by its principal accreditor, the Higher Learning Commission ("HLC"), which began in March 2012. The HLC accreditation of University of Phoenix was last reaffirmed by HLC in 2002. Prior to this reaffirmation evaluation, in August 2010, HLC requested supplemental evidence of compliance with the HLC accreditation standards following an August 2010 report by the Government Accountability Office of its undercover investigation into the enrollment and recruiting practices of a number of proprietary institutions, including University of Phoenix. In July 2011, the Special Committee formed by HLC to review this matter reported 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. However, HLC also stated that there remained significant questions and areas that University of Phoenix should work on improving, and HLC is reviewing these areas of concern as part of its current reaffirmation evaluation. In addition, HLC has requested that University of Phoenix provide an explanation, to be reviewed in connection with the reaffirmation evaluation, of three non-financial indicators identified by HLC that warrant further inquiry, namely:

•            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.

•         U.S. Congressional Activity 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
          and we expect this focus to continue. Various 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") and other Congressional members and committees
          regarding various aspects of the education industry. 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 majority staff issued their final report which
          was unfavorable to proprietary institutions. We expect that other
          Congressional hearings and roundtable discussions will be held
          regarding various aspects of the education industry. In addition, over
          the past two years, a number of proposed bills and amendments have been
          introduced in the Senate and House of Representatives that if adopted,
          would affect our business. We cannot predict what legislation, if any,
          will result from these hearings and legislative proposals 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.

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.

•         Program Participation Agreement. University of Phoenix's Title IV
          Program Participation Agreement expired December 31, 2012. University
          of Phoenix has submitted necessary documentation for re-certification.
          University of Phoenix's eligibility continues on a month-to-month basis
          until the Department issues its decision on the application. We have no
          reason to believe that our application will not be renewed in due
          course, and it is not unusual to be continued on a month-to-month basis
          until the Department completes its review.

•         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

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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.
• 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 2012 was 84%. 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 2013. However, the 90/10 Rule percentage for University of Phoenix remains high 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 military benefit programs 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 these or similar proposals are adopted, University of Phoenix may have to make material changes to its business to remain eligible to participate in Title IV programs, including measures which may reduce our revenue, increase our operating expenses, or both, in each case perhaps significantly.
• 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. An educational institution will lose its eligibility to participate in Title IV programs if its two-year student loan cohort default rates exceed 25% for three consecutive cohort years, or 40% for any given cohort year. The 2010 and 2009 two-year cohort default rates for University of Phoenix were 17.9% and 18.8%, 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. 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 requirements for participation in Title IV programs. Beginning with the three-year cohort default rate for the 2011 cohort published in September 2014, only 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 rates exceed 30% for three consecutive years, beginning with the 2009 cohort, the institution will cease to be eligible to participate in Title IV programs. The 2009 and 2008 three-year cohort default rates for University of Phoenix were 26.4% and 21.1%, respectively. If our student loan default rates approach the applicable limits, we may be required to increase efforts and resources dedicated to improving these default rates. This is challenging because most borrowers who are in default or at risk of default are no longer students, and we may have only limited contact with them. Furthermore, recently there has been increased attention by members of Congress and others on default aversion activities of proprietary education institutions. If such attention leads to congressional or regulatory action restricting the types of default aversion assistance that educational institutions are permitted to provide, the default rates of our former students may be negatively impacted. Accordingly, there is 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.
• Information Technology. We are upgrading a substantial portion of our key IT systems, including our student learning system, student services platform and corporate applications, and retiring the related legacy systems. We believe that these new systems will improve the productivity, scalability, reliability and sustainability of our IT infrastructure. However, the transition from our legacy systems entails risk of unanticipated disruption, including disruptions in our core business functions that could adversely impact our business.

• Expansion into New Markets. We intend to continue pursuing opportunities to utilize our core expertise and organizational capabilities, both domestically and internationally. In particular, we are actively pursuing quality opportunities to acquire or develop institutions of higher learning through Apollo Global and to provide educational services to other higher education institutions through our Apollo Education Services business. 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.

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For a more detailed discussion of trends, risks and uncertainties, and our strategic plan, refer to our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission on October 22, 2012. Fiscal Year 2013 Significant Events
In addition to the items mentioned above, we experienced the following significant events during fiscal year 2013 to date:
1. Purchase of Noncontrolling Interest. During the first quarter of fiscal year 2013, we purchased the 14.4% noncontrolling ownership interest in Apollo Global from The Carlyle Group. We paid $42.5 million cash, plus a contingent payment based on a portion of Apollo Global's operating results through the fiscal years ending August 31, 2017. As a result of the transaction, Apollo Group owns 100% of Apollo Global. Refer to Note 10, Shareholders' Equity in Item 8, Financial Statements and Supplementary Data.

2. Changes in Directors and Executive Officers. We have experienced the following changes in directors and executive officers:

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