Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Allyson Pooley - Vice President, Investor Relations

Charles B. Edelstein  - Co-Chief Executive Officer, Director

Brian L. Swartz - Chief Financial Officer, Senior Vice President, Treasurer

Gregory W. Cappelli - Co-Chief Executive Officer, Director

Joseph L. D'Amico - President, Chief Operating Officer

Analysts

Sara Gubens - Banc of America Merrill Lynch

Mark Marostica - Piper Jaffray

Susan Stine - Morgan Stanley

Andrew Steinerman - J.P. Morgan

Gary Bisbee - Barclays Capital

Bob Craig - Stifel Nicolaus

Amy Yunker - Robert Baird

Brandon Dobell - William Blair

Kelly Flynn - Credit Suisse

Trace Urdan - Signal Hill

Jeff Silber - BMO Capital Markets

Andrew Fones - UBS

Corey Greendale - First Analysis Securities

Paul Ginocchio - Deutsche Bank

Analyst for Scott Schneeberger - Oppenheimer

Apollo Group Inc. (APOL) F3Q09 Earnings Call June 29, 2009 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen and welcome to Apollo Group Incorporated’s fiscal 2009 third quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Allyson Pooley, Vice President, Investor Relations of Apollo Group. Ms. Pooley, go ahead, please.

Allyson Pooley

Thanks, Sean. Thank you, everyone for joining us today. Speaking on our call will be Charles Edelstein, Co-Chief Executive Officer; Greg Cappelli, Co-Chief Executive Officer and Chairman of Apollo Global; and Brian Swartz, our Senior Vice President, Chief Financial Officer, and Treasurer. Joe D'Amico, our President and Chief Operating Officer, is also here with us and will be available during the Q&A period.

Before we begin, we’d like to remind you that as we discuss our results, we note that unless otherwise stated, we will be comparing our third quarter of fiscal 2009, which ended May 31, 2009, to the third quarter of fiscal 2008.

I would also like to remind you that this conference call may contain forward-looking statements with respect to the future performance and financial conditions of Apollo Group that involve risks and uncertainties. Various factors could cause actual results of the company to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in item 1A and elsewhere in the company’s most recent 10-K report and in subsequent 10-Q reports filed with the Securities and Exchange Commission. The company does not undertake any obligation to update anyone with regard to the forward-looking statements made during the conference call.

With that, I’d like to turn the call over to Chaz.

Charles B. Edelstein 

Good afternoon, everyone. Thanks for joining us today to discuss our third quarter results. We reported another record quarter and are particularly pleased to have surpassed the $1 billion quarterly revenue mark for the first time.

Today I will provide you with some highlights from the quarter and Brian will then review our financial results in more detail. Lastly, Greg will touch on certain regulatory items and provide an update on some of the important operational aspects of the business.

We continue to enjoy the benefits from the investments we’ve been making in key academic and operating areas which drove 26% revenue growth and a 48% EPS growth in the third quarter. The primary drivers of the revenue growth were higher enrolment and the benefits of the 2008 increased tuition rates at University of Phoenix. Degreed enrolment at University of Phoenix contributed about 22 points of that total 26% revenue growth and higher tuition rates accounted for the balance.

Total enrolment growth at University of Phoenix was driven by continued strong new degreed enrolment growth of approximately 23%. Additionally, given our focus on the student experience we are very pleased to report continued year-over-year improvement in retention at each degree level.

Going forward, we are going to continue to focus on the big things -- number one, access to high quality education. We are providing access to high quality education for greater numbers of students. Number two, quality people -- we are hiring and retaining high caliber faculty members and staff and giving them the tools necessary to execute and succeed. And number three, best-in-class systems -- we’re focusing on building and maintaining best-in-class systems and processes to support the delivery of our educational products, compliance, and risk management.

We believe these are the critical elements necessary to generate successful long-term growth and attractive returns for all of our stakeholders and our results this quarter are testimony to our continued progress therein.

With that, let me turn the call over to Brian to discuss our financial results in more detail.

Brian L. Swartz

Thanks, Chaz. Our strong results this quarter were driven by an increase in revenue of nearly 26% to just over $1 billion compared to $835 million for the same period a year ago. Again, the components of this increase were primarily University of Phoenix’s 22% enrolment growth and increased tuition rates. Net income for the third quarter excluding the securities litigation charge a year ago increased 44% to $201 million, resulting in diluted earnings per share of $1.26. About $0.02 of our earnings this quarter came from a lower share count due to stock repurchases, which I’ll discuss in a moment.

Operating income excluding the securities litigation charge a year ago increased almost 51% to $336 million, and our operating margin expanded a healthy 520 basis points to 31.9% from 26.7% a year ago. This increase as a percentage of revenue was driven by a 350 basis point improvement in instructional cost and services, or ICS, a 120 basis point improvement in selling and promotional expenses, and a 50 basis point improvement in general and administrative expenses, or G&A.

I will spend a minute on the drivers of improvement in each of these expense categories.

First, ICS, which increased about 15% year over year, but declined 350 basis points as a percentage of revenue to 38.1% from 41.6% a year ago. The significant improvement here was driven primarily by economies of scale associated with our 26% increase in revenue, as well as continued savings from lower negotiated contract costs with third-party vendors, particularly in the area of financial aid processing, where costs declined significantly year over year despite an increase in volume.

Offsetting some of the improvement in ICS were two factors -- first, start-up costs at Apollo Global and second, higher bad debt expense. Bad debt expense increased 100 basis points to 3.4% of revenue compared to 2.4% a year ago. The year-over-year increase was primarily due to the increased ageing of receivables and the related risk of collecting them, coupled with lower collection rates of older receivables. Consistent with past quarters, our total allowance for doubtful accounts continues to exceed all receivables greater than 90 days old. It is important to note that over time, we have the ability to exercise significant control over our receivables and bad debt levels.

For example, we control the timing of when a student begins class relative to our loan certification process. We periodically review this type of item and make judgments balancing the business opportunity and receivables risk. We are comfortable with our current bad debt levels.

Moving to selling and promotional expense, which increased approximately 20% year over year but as a percentage of revenue, declined 120 basis points to 23.2% from 24.4%. This is the second quarter in a row we have seen a decline as a result of more effective marketing spend, as well as continued improvement in enrolment counselor effectiveness.

Finally, G&A -- G&A expenses increased just over 17% to $71.5 million, yet as a percentage of revenue declined 50 basis points to 6.8%. The improvement, as a percentage of revenue, is primarily due to the continued leveraging of relatively fixed employee compensation costs over higher revenue.

As we look forward, we want to remind you that in the fourth quarter of 2008, we had abnormally low G&A costs due to executive management departures, which led to lower-than-expected compensation expense, including share-based compensation.

On the subject of share-based compensation, during the third quarter we recorded approximately $18 million. We now expect to record approximately $70 million for the full year. This is slightly below our prior estimate.

With respect to income taxes, during the third quarter our effective tax rate was 40.9% due to higher state taxes and an increase in certain non-deductible losses, we now expect our tax rate for the full year to be approximately 41%, slightly above what we had previously forecasted.

Now let me turn to the balance sheet and cash flows -- we continue to maintain a well-capitalized balance sheet with cash and marketable securities excluding restricted cash at the end of the quarter totaling $819 million versus $511 million at August 31, 2008.

We generated approximately $312 million of adjusted free cash flow during the third quarter, a 34% increase year over year.

As a reminder, we define adjusted free cash flow as cash flow from operations less CapEx and changes in restricted cash.

I would like to note that last week, we funded an escrow account for $550 million related to Apollo Global’s previously announced proposed purchase of BPP which lowers our currently available cash and liquidity. We expect a portion of these escrow funds to be released shortly after the closing of the deal.

During the third quarter, we repurchased approximately 7.2 million shares of Apollo stock at a weighted average price of approximately $62 per share, for a total expenditure of $444 million out of our prior $500 million authorization. Our board recently brought that authorization for share repurchases back to $500 million and we will continue to evaluate future share buy-backs in addition to other investment opportunities.

With that, I will turn the call over to Greg.

Gregory W. Cappelli

Thanks, Brian. I would like to address several key topics and touch on some of the questions we now are on your mind. First I will discuss certain government regulatory issues; second, provide an update on a couple of our investment areas; and third, discuss recent tuition changes and give you our thoughts on the business as we finish the year.

I’ll start with addressing government regulation. There’s three topics here I want to touch on. First, the current administration; second, the 90-10 rule; and third, our focused program review.

Since the Obama administration took office in January, there’s been a heightened concern in the investment community about regulatory issues. This administration is very focused on education reform and has set many positive objectives, many of which align with our vision of providing access to high quality, affordable education to as many students as can benefit.

In recent years, University of Phoenix has taken a leadership role in providing a very transparent view into the learning outcomes of our students. We are in the process of preparing our second academic annual report and that should be available in September. It will provide more data on student performance, student satisfaction, completion rates, and how we are faring in achieving our mission of accessibility, diversity, and occlusion in under-represented populations.

Apollo Group has over 30 years of experience working with many different administrations, accrediting bodies and departments of education in numerous states. We therefore have a high degree of confidence in our ability to meet our students’ needs in changing regulatory environments going forward.

Now let me discuss 90-10. As you know, this is a rule that applies only to proprietary schools, due in large part to the loan limit increases put in over place -- put in place over the last couple of years, University of Phoenix’s percentage of revenue that has come from title four continues to trend up.

We’ve been carefully monitoring the impact of the increased loan limits on the University of Phoenix’s 90-10 calculation and continue to take action, including emphasizing employer paid and military programs, encouraging students to carefully evaluate the amount of title four loans they are taking and increasing our focus on professional development and continuing education.

We are required to report our 90-10 calculation annually and while we can’t perfect predict at this point where this calculation will come out, based on our most current information we do expect the rate for the University of Phoenix to approach but not exceed 90% for fiscal 2009. Again, it’s an area we continue to monitor closely and of course we’ll update you when we report next quarter as to exactly where the rate comes out after the completion of our fiscal year.

Next I’d like to give you an update on our focused program review which you’ll remember took place in February this year. We’ve been very responsive to the Department of Education’s requests and we believe they are making progress in finalizing the report. We hope the review will be completed in the next few months.

I’d now like to touch on a couple of our investment areas, specifically marketing and Apollo Global.

As a reminder, we evaluate all potential investments in a pyramid type priority structure. The University of Phoenix is on the top because of its superior returns and therefore we continue to reinvest first and foremost in the numerous growth and quality initiatives within the University of Phoenix. But we are also planting the seeds for future growth by investing additional resources in our other businesses, such as Apollo Global and Western International, to name a few.

We also look to invest in Apollo Group stock through share repurchases in which, as discussed earlier, we were very active during the quarter.

On the marketing front, we acquired Aptimus almost two years ago to bring our marketing capabilities in-house. We had two key objectives when we made the purchase. First, more effectively target students who would retain at a higher rate and acquire them at a lower cost; and second, to take back control of our brand. Just a quick update on both.

During the quarter, we experienced very strong new and total enrolment growth. We believe the strategic marketing initiatives that we are implementing, including the continued move to more direct advertising, are producing better quality student inquiries and resulting in higher conversion rates. We also continue to see growth in transfers from our associates program to our bachelors program while the pool of associate grads and thus potential transfer students continues to grow.

During the third quarter, we continued to increase our marketing spend on brand building. We rolled out our I am a Phoenix campaign nationally in part to instill a sense of pride within our student body and to leverage our large alumni base.

Additionally, we continue to expand advertising in local communities to drive long-term brand and reputation awareness. We believe these efforts are very important and key to our future succession, establishing our company in the consumer’s mind as the premier provider of accessible, high-quality education.

Another area we think improves our position and advances our mission is to more deeply partner with large Fortune 500 type companies. We are also enjoying some good progress in our strategic accounts group. This group partners with our target companies by customizing solutions to address a company’s specific academic needs. Our efforts are in the early stages but we are quite pleased with the results thus far.

Now an update on Apollo Global. As a reminder, Apollo Global is a $1 billion joint venture formed in 2007 between Apollo Group and private equity firm The Carlyle Group. Apollo Global’s mission is to advance access to quality global education by investing in institutions respected in their academic communities, led by visionary leaders and driven by innovation.

In early June, Apollo Global announced its intent to acquire BPP Holdings for 620 pence per share in cash. That represents an enterprise value of about $540 million at the time of the announcement. Now, since then we’ve entered into a hedge agreement to limit our currency risk. The transaction is structured as a court sanctioned acquisition arrangement under U.K. laws and it is subject to court, shareholder, and regulatory approval.

Assuming receipt of the necessary approvals, we expect to close around August 1st. BPP is a leading provider of education and training to professionals in the legal and finance industries and is the first private sector institution to have been granted degreed awarding powers in the U.K.

The acquisition will provide Apollo Global with access to lifelong learning, programs in the U.K.’s professional education sector, establish a significant U.K. and pan-European platform, and expand the range of advanced degrees and cross-border educational opportunities available to its students.

We are excited at the prospect of joining forces with this outstanding company.

Now let me just touch on recent tuition rate changes -- we recently announced University of Phoenix’s 2009 tuition and fee changes, which will be effective in a few days on July 1st. In aggregate, the tuition and fee changes average about 4%. This includes higher discounts to our military and veteran students as well.

The rate at the associate degree level increased approximately 6% and the rates at our bachelors and graduate levels prior to the discounts I just mentioned increased about 3% to 5%.

As a reminder, discounts in the fourth quarter generally are higher than the rest of the year because we allow students to prepay for courses at the old rate. We record the prepay as a discount.

Additionally, the increase in military and veteran discounts could lead to higher levels of discounts going forward.

So in conclusion, the third quarter was a continuation of the strong performance we have seen this past year. We’ve been making investments over the last couple of years and we are experiencing the benefits. We continue to see opportunities in front of us that cause us to be very excited about the future of the company. We are committed to balancing our growth with our mission to provide access to a quality education and experience for students.

As we move forward, the primary operating metrics for the fourth quarter continue to look strong on a year-over-year basis and we continue to manage the business for solid growth and cash flows for 2010 and beyond.

As always, we want to thank our thousands of employees and faculty who work so hard to deliver high quality education to all of our students every day.

With that, I will turn the call over to the Operator so we can take your questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Sara [Gubens] from Banc of America Merrill Lynch. Your line is open.

Sara Gubens - Banc of America Merrill Lynch

Good afternoon. Last quarter you mentioned that if growth continued at the current rate, that you would probably need to increase the hiring of academic counselors, enrolment advisors, and financial aid advisors. I’m wondering if you had begun to do this and what your plans are.

Charles B. Edelstein 

We are always looking at the rate at which we need to add ECs, ACs, and financial counselors and we’ve been adding them appropriately. As far as increasing them at a greater rate, I don’t think that’s something that we are doing right now, Sara. I think that we feel comfortable at the levels they have been at and while we do continue to add to them, it’s not at an outpaced rate of growth at this point.

Sara Gubens - Banc of America Merrill Lynch

Okay, and then were there any costs that you expected to incur in the third quarter that were deferred to the fourth?

Charles B. Edelstein 

No, not that I can think of.

Sara Gubens - Banc of America Merrill Lynch

Okay, and then last question, you had given some broad guidance about your longer term growth expectations a couple of years ago and I’m wondering if you could provide any update to that.

Charles B. Edelstein 

Yeah, we do plan to actually update you after our fiscal year ends on those growth goals. We know we’ve been outperforming those metrics at a considerable pace and so we’d like to complete the fiscal year-end. We’re getting through the budgeting process, obviously, and we’ll have an update for you on the conference call next quarter.

Sara Gubens - Banc of America Merrill Lynch

Okay. Thanks very much.

Operator

Your next question comes from the line of Mark Marostica from Piper Jaffray.

Mark Marostica - Piper Jaffray

Thank you. My first question relates back to Sara’s point on hiring plans and I’m curious -- I know you are not giving specific guidance or anything along those lines on enrolments but if you could frame for us how you think about controlling or looking at start growth over the coming quarters now that you are coming up against I guess the first tough comp on starts in the upcoming August quarter, and also looking at certain hiring targets. Any color there on how you frame that?

Joseph L. D'Amico

Yes, we look at managing the new enrolment growth and trying to maintain consistent growth. Also, we look at obviously our advertising spend in that light as well. We’ve been managing to make sure our spend is commensurate with expected start growth. We realize that as comps get more difficult that it may be a little tougher to get the levels that we are looking for but so far we’ve been doing very well and all indications today anyway are that we expect our growth to continue at levels consistent with where we’ve been.

Mark Marostica - Piper Jaffray

Fair enough, and then one follow-up on Greg’s remarks concerning 90-10 -- I understand you are approaching that 90% level. Are you planning to alter your selection criteria in any way, shape, or form as you look at incoming students?

Gregory W. Cappelli

You know, Mark, we’re doing a number of things that I mentioned in my remarks, including focusing on and building more of our corporate business and our military business and just educating some of our students on whether they need as much financial aid as they currently take out.

As far as the selection criteria, we are continuing to work on some pilots, looking at certain criteria. I would not tell you that it would be something that would be, you know, that would have a meaningful impact any time soon. We’re looking at some different initiatives there now. But not just as it relates to 90-10; as it relates to making sure that we are accepting the students that we think can really benefit from the University of Phoenix into our system going forward.

Mark Marostica - Piper Jaffray

Okay, thank you. I’ll turn it over.

Operator

Your next question comes from the line of Susan Stine from Morgan Stanley.

Susan Stine - Morgan Stanley

Thank you. You seem to be doing very well in the bachelor degree area in terms of enrolment growth. Can you just address this a little more? I know you mentioned that some of this was coming from the associate programs but can you maybe break that down a little and just talk about any targeted efforts that you have along those lines?

Charles B. Edelstein 

Sure, Susie. We are really pleased with what we are seeing from our associates to bachelors levels. I think that is paying dividends for us and we are trying to encourage those students to go on to get their bachelors programs.

We’ll tell you that the majority of the increase in bachelors enrolment growth still is outside of that transfer from the associates to the bachelors level, and we are pleased with that as well.

You know, we haven’t yet started to see the benefits, I don’t think, of a targeted campaign just at bachelors or even masters students just yet. We are refining that now. We do plan on doing more of that and in the future quarters ahead and you will hear us talk more about that going forward.

That’s about as much detail as I can give to you right now on the subject of bachelors enrolment growth.

Susan Stine - Morgan Stanley

Okay, and can you give us any update on your thoughts as far as transitioning to direct lending, you know, any expenses on what you are putting in place now?

Brian L. Swartz

We are on track to certainly comply as necessary if the government goes in that direction in July of 2010. We’ll be rolling it out here as an option for certain loan programs on July 1, 2009, so we have no concerns about meeting any deadlines the government might put in place.

Susan Stine - Morgan Stanley

What about any costs though associated with that? Do you expect -- how significant do you expect that to be?

Brian L. Swartz

Not significant based on our current plans.

Charles B. Edelstein 

We’ve been doing -- you know, as you can imagine, research in this area, making sure the software is in place, looking at costs, checking with other institutions that have already been through it and that’s why we feel comfortable giving you the answers that we have.

Susan Stine - Morgan Stanley

Okay. Thank you.

Operator

Your next question comes from the line of Andrew Steinerman from J.P. Morgan.

Andrew Steinerman - J.P. Morgan

In the quarter, the margin was 32% and I know this was just an individual quarter but it is one of the highest margins the company has seen in a good period of time. Could you just talk kind of big picture over the intermediate term? Do you feel like there’s margin expansion over the intermediate term from these levels?

Charles B. Edelstein 

Andrew, I think that in the fourth quarter, we are comfortable telling you that there is going to be -- you know, there should be significant margin expansion. Again, can we pinpoint the exact level for you? No, but we are comfortable with the direction we are seeing. Obviously some of that is going to depend on when you look out longer term into how successful we are with Aptimus, how successful we are in our cost initiatives at the University of Phoenix as well as Apollo Global in general. How aggressively we invest in some of the other businesses that we are talking about, including Global but we are trying to balance that now and do think that our margin will see some expansion in the fourth quarter as well.

Andrew Steinerman - J.P. Morgan

My question was more intermediate term.

Charles B. Edelstein 

Let me add one more thing, too -- I know we’ve said this before. It really is not how we manage the business. We’re not managing to a certain target. We are managing for operating and cash flow growth going forward and the margin will be what it is.

Andrew Steinerman - J.P. Morgan

Right. Let me just slip out one part to the question -- costs per starts been coming down for a while year over year for two quarters, sequentially for longer. Do you think costs per start is at a level that could be sustained, improved, or does it have a bias to upwards?

Charles B. Edelstein 

Well, our goal is to continue to try and see improvements there. We have seen significant improvements in the cost to acquire a student. Again, some of those are initiatives that we announced we were taking over a year ago that are paying dividends. That’s going more direct than through the third-party affiliate channels and that’s having an impact. There’s other initiatives as well that we hope will continue to drive that at least to the current levels and maybe lower. Some of that is going to depend on the, as you know, on the overall advertising environment as a whole.

Andrew Steinerman - J.P. Morgan

Okay, sounds good. Thank you.

Charles B. Edelstein 

I’ll add one other thing as well, and that is when you look at our advertising spend or just the cost in general, the majority of it this quarter is coming from our long-term brand-building initiatives that we are focused on right now. Sorry, the majority of the increase, I apologize.

Andrew Steinerman - J.P. Morgan

Okay.

Operator

Your next question comes from the line of Gary Bisbee from Barclays Capital.

Gary Bisbee - Barclays Capital

Good afternoon and congratulations on the quarter. You know, a couple of questions -- you haven’t said a whole lot to date about sort of strategic rational and how excited you are about this BPP transaction. Can you give us some sense what are sort of the highlights that you see and how big this opportunity may be?

Charles B. Edelstein 

You know, Gary, part of the reason for that is because legally, there’s only so much we can say before a transaction hopefully closes like this. We are very excited about it. You know, as I mentioned in my comments, this is an opportunity for us to establish a significant U.K. presence with a tremendous brand in the U.K. They have the right as a for-profit to grant degrees, which is very important to us as well. And potentially will be an opportunity for us to go into the rest of Europe.

So we’re looking -- I won’t discuss the strategy for BPP on this call but I can tell you that there’s a terrific management that we’ve known for a while running the business and we see a lot of opportunity for us to take things that we’ve learned here over the past 30-plus years and help this organization to be a much more significant player, not only in the U.K. but in other parts of the world.

Gary Bisbee - Barclays Capital

And any sense how much you would likely look to increase investment in the business? I mean, it seems to me you could spend a whole lot relative to what they’ve been spending of incremental growth investments and it wouldn’t be a huge deal for you. Should we expect a big --

Charles B. Edelstein 

I think that we will look to invest in the business, absolutely, to do some of the things that we just talked about but I think you are also right that as a consequence to Apollo Group, that it will not -- you will not look at that investment as having a material impact to Apollo as a whole.

Gary Bisbee - Barclays Capital

Okay, and then just the comment around setting aside the $550 million in escrow -- is the minority owner here, Carlyle, are they going to chip in money or might you borrow money? Any sense on how you are thinking about financing?

Brian L. Swartz

The escrow that we set up was basically required under U.K. takeover rules so we would expect upon closing, and Carlyle has agreed they are absolutely going to fund their share of it to fund it at closing and as a result of that, we would expect some of those escrow proceeds to come back to us at closing, as I mentioned. So yes, Carlyle is absolutely participating. We’re excited about that and the escrow was just for purposes, to comply with U.K. takeover rules.

Gary Bisbee - Barclays Capital

And then just one last question -- can you give us any update at all on some of the less talked about growth initiatives where we know you are investing money? Like any update on what is going on at insight? How you might be positioned looking into this start of this fall’s school year, or maybe anything on the Canadian business that you started a couple of quarters ago? Thanks.

Joseph L. D'Amico

Both of those are still in the start-up mode, where we are investing and growing. And we are also doing that on a -- in a deliberate way, so we want to do it right. So we’re not really commenting much further than that at this point.

Gregory W. Cappelli

Yeah, same thing with -- Gary, you’ve heard us talk about WIU. Very excited about the potential opportunities there are -- some of the new management that we’ve put in place are already off to a terrific start and we do expect that to have an impact going forward, so we’ll be excited to tell you more about that in future quarters as it ramps up.

Gary Bisbee - Barclays Capital

Okay, thanks a lot.

Operator

Your next question comes from the line of Bob Craig from Stifel Nicolaus. Your line is open.

Bob Craig - Stifel Nicolaus

Good evening, everybody. I know you want to get away from this but can you give us any idea as to the magnitude of increase in percentage terms and ad spend in the quarter? And was there any meaningful change in the composition of ad spend? I know last quarter you referred to more offline spending.

Charles B. Edelstein 

Yeah, that’s a good question and we are -- the reason why we haven’t classified it the exact same way is as the company grows and we do things outside of just the University of Phoenix and Global and what not, those will certainly have impacts but what I would say as a percentage of revenue, it was fairly close to what it was last quarter and from a growth perspective, although it grew faster than last quarter, and I’m talking about advertising now, even though it grew faster as I mentioned in my comments, the majority of that was from the long-term branding campaign, so we’re still getting leverage on the average cost to start a student.

Bob Craig - Stifel Nicolaus

Okay, that’s helpful. And thinking back to some of the conversation at the end of last quarter about what to expect in margins in the second half and you were pretty emphatic that you wouldn’t see the 550 basis point increase you had year-to-year in the first half and I guess to be fair, you didn’t quite get there in this quarter but certainly got a lot closer than we thought you would. I mean, is it basically just the business surprised you positively from a standpoint of enrolment persistence, the leverage that that creates or were there some other factors there?

Charles B. Edelstein 

Yeah, I think that’s right. I mean, when you achieve greater revenues in this business than you project, you get a lot of leverage and it can go the other way as well, as you know. So we continue to benefit from that.

We’re also -- you know, we’ve been refining our forecasting and investing in our forecasting abilities and that’s continuing to improve now as well. And we’ll talk more about that next quarter as we give out some of our revised thinking in terms of long-term growth targets and what not but those are some of the things that -- you know, we’re very pleased to see it. We certainly at the time, we’re not trying to be confusing on the margin but just realistic and it came in better than we had expected.

Bob Craig - Stifel Nicolaus

That’s helpful. Last one and I’ll turn it over -- can you comment on the program development pipeline? You know, quantify it or what are some of the areas of focus there?

Charles B. Edelstein 

Sure. Assuming you mean the academic programs?

Bob Craig - Stifel Nicolaus

Yes.

Charles B. Edelstein 

We continue to invest in many different areas. One of them, for example, is on the sustainability because it’s totally consistent with our objectives. We think it’s an area that will be, especially under the Obama administration, will be a hotter area going forward. So we are investing in that area as an example, and we are investing really at all degree levels, including our doctoral degree programs and our master degree programs.

We’re also looking at actually our entry programs to address those programs and create a better student experience, for example. So we’re investing throughout the curriculum and have been for a while.

Bob Craig - Stifel Nicolaus

Okay, great. Thanks, guys.

Operator

Your next question comes from the line of Amy Yunker from Robert Baird.

Amy Yunker - Robert Baird

Thanks. Can you talk just a little bit about given the current administration’s focus on affordability for programs and desire to limit student debt what your thoughts are on tuition increases going forward? I know you talked about what’s going on this year but does that change your thought at all on how you increase tuition going forward?

Charles B. Edelstein 

I think that as you saw this year, we are not inclined to be overly aggressive in tuition price increases and that’s -- I mean, I guess it’s responsive to the administration. It’s largely responsive to our students and their needs and that’s how we think about it. So we look at what’s going on in the markets and so our tuition increases vary between modality and region and degree type but it keeps in mind the fact that we’re trying to be responsive to our student needs and our mindset is not to be overly aggressive.

Amy Yunker - Robert Baird

Great. And then Greg, last quarter you talked about increased investments in the learning management system. Can you just talk a little bit about timing and size of those investments?

Gregory W. Cappelli

Yeah, sure, and Joe has been leading that so I’ll ask him to make some direct comments.

Joseph L. D'Amico

Sure. We’re looking at this first from a people perspective and we have made some investments, if you will, in top caliber people to help us guide our direction there and to keep us on, if you will, the leading edge of -- on the software development side. Most importantly thinking about how that affects the student experience and making the student experience the very, very best you can get in this industry. So that’s sort of the approach.

We’re not anticipating a major investment that would be sort of in the stair step way, and we expect this to occur over -- not the course of six months or a period like that but over a longer term period of time.

Charles B. Edelstein 

The things that we’ve seen to this point are to us very exciting because we think it’s going to really help reach additional people and help them learn, hopefully at greater levels.

Amy Yunker - Robert Baird

Great. Thank you.

Operator

Your next question comes from the line of Brandon Dobell from William Blair.

Brandon Dobell - William Blair

Thanks. Brian, a quick one for you -- in your prepared remarks, you talked about bad debt. I just wanted to understand how to kind of put in context your comments about how comfortable you guys are looking at this quarter’s number or talking about the historical range of bad debt. I want to get a better idea of what you mean by comfortable and how we should think about it on a go-forward basis.

Brian L. Swartz

It really comes down to one, we control the metrics, so there are things that we could do to drive bad debts down and there are things that we do that potentially could increase it. If you look at bad debt instead of sequentially but more kind of on a last 12 month, an LTM basis, over the last three years, we’ve been at the low point of about 3% and a high point of 4.5% each quarter sequentially, if you look on it on an LTM basis. And generally obviously we prefer 11% over 4.5 but we are constantly focused on managing that number, doing the right thing to -- I’m sorry?

Charles B. Edelstein 

You said 11%.

Brian L. Swartz

Strike that from the record, Brandon.

Brandon Dobell - William Blair

It’s stricken. Thank you.

Brian L. Swartz

Obviously we prefer 3% over the 4.5 but it is in our control and we monitor it and over time, we will do what’s necessary to make sure it stays in the range that we are comfortable with.

Brandon Dobell - William Blair

Okay, and as a related question there, in the press release you talked about little more efficiencies or just a better process in terms of financial aid processing times. As you guys get better there, or perhaps even if it changes up a little bit in your favor as you move to direct lending, how do you balance that or how does that feed into the bad debt calculation?

Brian L. Swartz

Yeah, you noticed that in the day sales outstanding. That impact receivables but generally current receivables so the reason why the bad debt is going up is we have more aged receivables now than we did a year ago and we are seeing collection rates on those older receivables come down. So if you want to look at it as current receivables versus older receivables, the current receivables are down because of better processing times and the older receivables, we’re seeing lower collections and more of those dollars and that’s why it is up.

Brandon Dobell - William Blair

Okay, got it. And then a broader question -- you know, one of the perceived or I guess the perception among investors that we talk to focuses on instructional costs and services as some sort of proxy for educational quality or just the amount of dollars you are investing in in the product for student outcomes. Was this -- this being the first quarter below 40% and obviously great margin leverage there, if someone came to you and said look, that number is just too low. We don’t think you are putting enough back in the classroom, you know, those kind of general comments that we hear from people. How would you guys as a management team address that perspective or what kind of data can you offer up relative to your traditional peers that would help refute that kind of an argument?

Joseph L. D'Amico

Boy, that’s a great question. First of all, the main part of the reduction in cost was strictly a reduced price from -- getting reduced pricing from an outsourced -- the group that outsources, that we outsource too on title four processing. So that in and of itself had zero impact on quality. It was only the price part.

Secondly, we’re investing in increased salaries to faculty members. You know, we have 24,000 faculty. We’re reviewing them all the time. We’re attracting new people, new faculty to the program always. There’s a big backlog. We’ve invested in training. We invest in the curriculum. There are substantial dollars that go in that line that do relate to -- you know, directly to the quality of the education that our students are getting. But I would also offer to you that a lot of the other things we do that don’t necessarily get included in that category are also creating and contributing to the quality of the education, whether that be in the software that’s used, in some of the support functions, like for example, counseling that’s done. There are a lot of factors that enter into the student experience that we think is really important that are also adding to the quality of the educational product.

So most of the gain bottom line has been through price reductions that have had nothing to do to deal with the quality.

Charles B. Edelstein 

In aggregate, you would have seen greater but those are being offset by significant investments we are making into the quality of the student experience.

Brandon Dobell - William Blair

Okay, and then final question for you -- if you look at the other revenue this quarter, so non-degree granting revenue being flat year over year right around the $44 million, $45 million number, I would think with the investments historically and insight and the schools in Latin America that we’d see some revenue growth there. Is there something else going on that is skewing seasonality or is it currency? How do we think about that being flat year-on-year?

Brian L. Swartz

Well, let me clarify -- there’s actually two lines there, Brandon. There’s one that says non-degree seeking revenues and then there’s an other row. The other row is principally those other businesses and Apollo Global. The non-degree seeking revenue, you can call them single course as well, they are courses, many of which are offered at the University of Phoenix that we haven’t historically actively marketed, so it’s just ongoing business. There is a lot of seasonality there as you see generally a tick-up in Q4, so it’s just not degree seeking revenue at the University of Phoenix that we actively and historically marketed.

Brandon Dobell - William Blair

Okay.

Operator

Your next question comes from the line of Kelly Flynn from Credit Suisse. Your line is open.

Kelly Flynn - Credit Suisse

Thanks. I have a couple of questions -- first of all, I wanted to clarify if I’m inferring from your comments correctly, both Joe and Greg in talking about Q4, it seems like you are saying you are hopeful you can maintain same start growth levels and margin expansion levels as you saw in Q3. And I know you didn’t give guidance but is that broadly what you think the current trends are indicating?

Gregory W. Cappelli

Well, we think we did not say that we think they will be at the exact same levels of the third quarter but we did say we are expecting a strong fourth quarter.

Kelly Flynn - Credit Suisse

Okay. All right, and then on the title four certification, I saw in the Q that I think WIU certification expires I guess tomorrow. Could you let us know if that’s going to go month-to-month or if there’s been anything new there? And also, any color you could provide on the month-to-month at UOP would be helpful too. Thanks.

Brian L. Swartz

Yeah, Kelly, on WIU, we did submit our application I believe in March, a couple of months ago, on time as required, so we would expect that it would go month-to-month similar to the University of Phoenix. There’s no specific update on the University of Phoenix PPA or program participation agreement month-to-month but we would expect that at the appropriate time it will be renewed by the Department of Ed.

Kelly Flynn - Credit Suisse

Okay, thanks. And then finally as it relates to the [inaudible] related to incentive comp, I noticed there’s been a lot of activity, if you will, on the lawsuit. A lot of things have been filed recently. I think that’s because the trial is upcoming but could you help us understand A, why there’s been a pick-up there and then also specifically, I know the plaintiffs have been seeking to extend the timeframe from which they can draw, give evidence, if you will. Could you update us on that specific point, if there’s anything to add? Thanks.

Joseph L. D'Amico

Sure, Kelly. With respect to the [key tam], the period for which witnesses could be deposed, not the experts but let’s say fact witnesses, came to an end or was coming to an end and the plaintiffs asked for some additional time for -- to allow a few witnesses to -- who could not be deposed to be deposed. And the judge on his own extended the timeframe for all of fact witnesses to a later time because he believed that there was, at least this is my understanding, there was enough time in the schedule to actually extend the fact witness time for deposition. So that’s what happened in that regard.

In terms of the activity, I think the activity came about because -- probably because we are coming to the end of the period in which fact witness depositions could be taken.

Kelly Flynn - Credit Suisse

Okay, and then on -- as far as the years are concerned, that was actually one of the things I was referencing. I thought originally it was only allowed to cover through a certain period in ’04 but the plaintiffs are trying to extend that period even to the current period. Where does that stand?

Joseph L. D'Amico

Well, I believe -- I’m not as familiar with that point as -- you know, it’s not really directly in operations. But I will give you my understanding, which is that obviously we want to limit the time to -- back to as close to the period in which the program review took place, because we believe obviously beyond that, things had changed and it’s no longer relevant. So we obviously would like to limit the time frame; the other side would obviously like to extend the time frame. We just don’t think it’s relevant.

Kelly Flynn - Credit Suisse

Okay. Thanks for taking those. I appreciate it.

Charles B. Edelstein 

And I just want to clear one thing up on the margin -- I know that Andrew brought up earlier when I made the comment that we expect margin expansion, I didn’t mean to infer that sequentially off of this quarter. What I met was year-over-year as we look to the fourth quarter, we expect that -- we do expect to see margin expansion again in the fourth quarter. Hopefully that was clear.

Kelly Flynn - Credit Suisse

Thanks.

Operator

Your next question comes from the line of Trace Urdan from Signal Hill.

Trace Urdan - Signal Hill

So to drag you back a little bit to Mark’s question, I know that you are not prepared to update the long-term guidance but I wondered if you could speak to what data points you all can see that we can’t that point forward more than a quarter or two. So as you are looking at 2010 and putting your budget together, can you just sort of speak qualitatively to what metrics or what evidence you are able to draw from the environment that you will use to sort of put together your plan for next year?

Gregory W. Cappelli

Sure, Trace. It’s a fair question. We’re working on that now as we go through our budgeting process and you know, some of the things we rely on are how past investments have -- you know, the results that they’ve driven, how we think that they will continue to drive results going forward, investments that we are making in areas of academics and technology and also in a number of other areas in the University of Phoenix and outside the University of Phoenix, so there’s a lot of things to put together there. And we are in the process of doing that, which is why we are more comfortable giving you a flavor for what that looks like after our fourth quarter earnings.

That being said, you can see that from our current results that we’ve had some success here with some of these things already and we have confidence going into the quarter and also going forward that barring a sea change in the environment that our business is going to be pretty good.

Trace Urdan - Signal Hill

Okay, thanks, Greg.

Operator

Your next question comes from the line of Jeff Silber from BMO.

Jeff Silber - BMO Capital Markets

Thanks so much. Last quarter you disclosed, and I think you were told informally, that there would be an annual program review, or maybe a more frequent program review. Can you give us an update on that?

Charles B. Edelstein 

Yes, unfortunately or fortunately, there is no update but as I indicated in the last call and certainly in calls after we had the conference call, we actually look at that very positively in the sense of we have nothing to hide. We are very transparent. We believe we are doing all the right things and we welcome the opportunity to demonstrate that to our regulators who we certainly feel accountable to. But first we are accountable to ourselves and the students and want to do the right thing. So having them in here every year certainly limits our exposure going forward. If there is any, we can make corrections. Just a better working relationship in my view than waiting three or four years before you have these.

Jeff Silber - BMO Capital Markets

Okay, just to shift gears a bit, Greg, I think in your remarks you were talking about your greater focus of some of the strategic accounts, the Fortune 500 companies you deal with. Can you just tell us generally what the corporate tuition reimbursement environment is like right now? Has it been shrinking or under pressure because of the economy?

Gregory W. Cappelli

You know, we’ve seen -- as we said last quarter, our business there remains on target and we are building our business in that area, so for us to be able to tell you a lot differently this quarter, you know, things remain on target for us. Are there -- you know, can there be an account or two where something changes? Yes but in general, has there been a wholesale change that is showing up and driving results? No, I don’t think so. Joe, I don’t know if you want to add anything to that.

Joseph L. D'Amico

No, I think that’s spot-on. There are some industries that we don’t really partake in a big way that I am sure are affected but the top companies we are dealing with still want to retain their best people and providing educational opportunities to them and paying for that is one of the benefits that they provide to their employees.

Jeff Silber - BMO Capital Markets

Okay, great and just switching back to the BPP transaction, have you disclosed any financial metrics around that besides what’s been out there publicly? And also I’m just curious how you are going to be accounting for that -- is that going to be a separate entity? Are you going to be disclosing enrolments separately? Any color you can give would be great. Thanks.

Gregory W. Cappelli

Yeah, first of all, it will be consolidated in our financial results, so it will be owned by Apollo Global, Apollo Global is consolidated in our financial results so you will see it in there. We are not commenting at this point on the financial results until the deal closes, so we’ll talk more about that after the closing. In terms of any operating metrics we might provide on that business, we are still considering that and if we decide to do that, we’ll talk more in the future.

Jeff Silber - BMO Capital Markets

All right, great. And just one quick follow-up -- can you tell us what your CapEx budget is for the current quarter and maybe looking out to 2010, some general direction would be great. Thanks.

Brian L. Swartz

I think on a year-to-date basis, CapEx was in the mid $90 millions. There was nothing unusual that we would expect here in the near-term in Q4 or even longer term, so it’s kind of status quo.

Operator

Your next question comes from the line of Andrew Fones from UBS.

Andrew Fones - UBS

Thanks. I guess we’ll get the official [inaudible] with the [inaudible] numbers release before you probably next report earnings? I was wondering if you could give us any update on where you think that your [inaudible] rates could come in for WIU and for University of Phoenix? Thanks.

Gregory W. Cappelli

Andrew, we actually did publish the draft rates that were released I believe in April of this past year. For University of Phoenix, it came in at 9.3% and for WIU, it came in at 18.5%. So those are the draft rates from the Department of Ed. When they are finalized, we’ll talk about it next quarter.

Andrew Fones - UBS

Okay, and then obviously we’ve been seeing a nice improvement in kind of retention rates. Understandably I would imagine the placement rates may be under pressure in a rising unemployment environment but can you give us any thoughts as to how these rates may trend as we look out perhaps to next year? Do you think you can hold on to these rates? Might we see a little increase or how should we think about that? Thanks.

Charles B. Edelstein 

I think we still have some running room in the existing programs that we have that we are working on retention. You know, some of the things that we talked about before, our resource centers and the training that we are doing. And I think really the thing that is having that impact is we talk about retention everywhere we go, so we are building this into the culture of the organization and we get ideas bubbling up back at us from the campuses, which we don’t know what they will be. But we still see some room there and I think we’ve said before there’s a limit to this retention improvement because we have a high quality rigorous program. So at some point, we reach a limit on that but we still see some running room with what we’ve got going on.

Andrew Fones - UBS

Okay. Thank you.

Operator

Your next question comes from the line of Corey Greendale from First Analysis.

Corey Greendale - First Analysis Securities

Good afternoon. A couple of questions about your regulatory comments, Greg -- on the 90-10s, if it turns out that you are above the 90%, I believe the implication is you’d go on provisional certification. Is that right and do you expect any impact on the business that we would be able to see?

Gregory W. Cappelli

Well, that’s true, that if we were to go over 90-10, we would get put on provisional status. As I said, we don’t expect to be over 90-10 and there are various things that the department can look at to -- they can look at to regulate your business, basically, going forward.

So could it have an impact on our business? It’s possible, yes. But again, we don’t expect it to be over 90 and again, we’re managing that process aggressively.

Corey Greendale - First Analysis Securities

Okay, and then I wanted to ask about topics raised in the [neg reg] -- the potential change in the incentive comp. I think you mentioned in public forums about things you’ve piloted that give you comfort that if you do need to change the way you compensate the admissions reps, that it wouldn’t have a material impact. Could you just give a little bit more detail about that and what does give you that comfort?

Joseph L. D'Amico

Well, first of all obviously we are complying with the regulations as we speak, so we -- that’s point one. Point two is that we are really focused on retention as an organization, as we talked about. So I think changing comp structures, if in fact that happened where retention was a larger part of the determination of comp to us is very consistent with our culture and consistent with what we are trying to achieve in terms of the student experience anyway.

So I don’t think it will have a big impact if there were changes but obviously we don’t know what those changes are but we managed through them in the past and we’ll manage through it now.

Corey Greendale - First Analysis Securities

Okay, and on another topic they raised, I know it’s still early days and who knows what this ends up looking like, but one of the other topics was about putting more teeth into the gainful employment and given that University of Phoenix doesn’t do placements, do you have any early thoughts on how that could affect you, whether you end up having to do placements or anything like that?

Joseph L. D'Amico

Well, I think the placement really relates more to the vocational schools rather than to us. You know, we’re a degree-granting university and not a vocational university, so I don’t think that really applies to us. And that’s one of the things that we sort of have traditionally had to manage, is even though we are for profit, we are really -- we’re not a vocational school which many of the regulations are attempting to get at.

I think from our perspective really the key is clarity -- tell us what the ground rules are. We know we can comply or we are pretty certain we can comply and we’ve been doing this for a long time. We’ve have a lot of success so just make sure -- we want to make sure we know the ground rules and we’ll be leaders then once we know that.

Charles B. Edelstein 

As our founder reminds us from time to time, there’s been a lot of change over the past 30 or 40 years and University of Phoenix and Apollo Group has managed to comply successfully through changes, different administrations, and different regulatory environments and our intent is to continue doing that going forward.

Corey Greendale - First Analysis Securities

Great. Thank you.

Operator

Your next question comes from the line of Paul Ginocchio from Deutsche Bank.

Paul Ginocchio - Deutsche Bank

Thanks for taking my question. Just a question on [persistence], it’s going up -- is that one of the reasons -- is one of the reasons because you are being a little more selective in the leads that you pursue or the leads that you pass on to your ECs? Thanks.

Joseph L. D'Amico

It’s really as a result I think of our better marketing and qualifying the student, if you will. I guess in some ways that’s what it is but we haven’t -- you know, we’re still open access and so we’re looking at all those leads and those opportunities for students who get in and placed in the right program, whether it be an associate degree or bachelor degree program.

Paul Ginocchio - Deutsche Bank

Maybe just a follow-up -- it sounded like last quarter you talked about somewhat about managing your growth and making sure you could be consistent in your academic delivery. Is that still something that we should think about, that you are somewhat limiting your growth to make sure you maintain consistency?

Charles B. Edelstein 

It is, Paul. I mean, that’s -- we have said that I think more than one quarter that we believe there’s value in managing this business for consistency and so we proactively would like to have more consistency in our growth.

Paul Ginocchio - Deutsche Bank

Great. Thank you very much.

Operator

Your last question comes from the line of Scott Schneeberger from Oppenheimer.

Analyst for Scott Schneeberger - Oppenheimer

Yes, thank you. This is Jim for Scott. You mentioned we should expect a seasonal increase in discounts due to prepayment activity but can you comment on how this year’s prepayment activity compares to past years, particularly relative to past July price increases? As I guess I’d envision people would be more price sensitive in this environment. Thank you.

Charles B. Edelstein 

We don’t expect any massive change from prior years for this quarter. I mean, the prepayment opportunity is there for students that have the ability to make those payments and take advantage of it.

Analyst for Scott Schneeberger - Oppenheimer

Okay. Thank you.

Operator

Ladies and gentlemen, this concludes the Q&A session and signals the end of today’s conference call. We thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Apollo Group F3Q09 (Qtr End 5/31/09) Earnings Call Transcript
This Transcript
All Transcripts