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Executives

Allyson Pooley – Vice President, Investor Relations

Charles B. Edelstein – Co-Chief Executive Officer

Gregory W. Cappelli – Co-Chief Executive Officer and Chairman of Apollo Global

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

Joseph L. D’Amico – President and Chief Operating Officer

Analysts

Gary Bisbee - Barclays Capital

Andrew Steinerman - J.P. Morgan

Sara Gubins - BofA Merrill Lynch

Trace Urdan - Signal Hill Group, LLC

Suzanne Stein - Morgan Stanley

Robert Craig - Stifel Nicolaus & Company, Inc.

Andrew Fones - UBS

Mark Marostica - Piper Jaffray

Kelly Flynn - Credit Suisse

Brandon Dobell - William Blair & Company, LLC

Paul Ginocchio - Deutsche Bank

Amy Junker - Robert W. Baird & Co., Inc.

Jeffrey Silber - BMO Capital Markets

Scott Schneeberger - Oppenheimer & Co.

Ariel Sokol - Wedbush Morgan Securities Inc.

Corey Greendale - First Analysis Corp.

Apollo Group, Inc. (APOL) F1Q10 Earnings Call January 7, 2010 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to Apollo Group, Incorporated fiscal 2010 first quarter earnings conference call. (Operator Instructions)

This conference call is being recorded today, January 7, 2010 and may not be reproduced in whole or in part without permission from the company. There will be a replay of this call available through January 15 beginning approximately two hours after we conclude today. Additionally, this call will be broadcast over the Internet and can be accessed via the company’s website.

I would now like to turn the call over to Allyson Pooley, Vice President, Investor Relations, of Apollo Group. Miss Pooley, go ahead please.

Allyson Pooley

Thank you and thank you all for joining us today. Speaking on the call will be Chas Edelstein, our Co-Chief Executive Officer; Greg Cappelli, our 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 and will be available during the Q&A period.

Before we begin, I would like to remind you that as we discuss our results, unless we note otherwise, we will be comparing our first quarter of fiscal 2010 which ended November 30, 2009 to the first quarter of fiscal 2009. I’d also like to remind you that this conference call may contain forward-looking statements with respect to the future performance and financial condition 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 and subsequent 10-Q reports filed with the SEC.

The company does not undertake any obligation to update anyone with regard to the forward-looking statements made during the call. Additionally, during the call we may refer to non-GAAP financial measures which are intended to supplement but not substitute the most directly comparable GAAP measures. A reconciliation of these GAAP to non-GAAP metrics is included in our press release issued today and available on our website.

On today’s call Greg will provide highlights of the quarter and an update on our primary investment areas. Brian will review our financial results and Chas will finish with an overview of recent milestones achieved, including the Program Review Report which we received from the Department of Education. And I’ll now turn the call over to Greg.

Gregory W. Cappelli

All right. Thank you, Allyson, and thanks for joining us today everyone to discuss our first quarter results.

We’re pleased to report that we had a solid start to fiscal 2010. In the first quarter including our recent acquisition of BPP, revenue grew approximately 31% to $1.3 billion and net income excluding special items grew 27% to $229 million, $1.47 per diluted share. Our flagship institution, University of Phoenix, enrolled 98,100 new students during the first quarter for total degree enrollment of 455,600 students. That’s an 18% increase versus a year ago.

And importantly, we are now experiencing stronger growth in our core Bachelor programs, which has been a key focus and important goal of ours over the last couple of years. Overall, we’re very focused on our long term strategic plan, our balance sheet remains strong which puts us in a good position to execute on our key areas of investment, and our focus remains steadfast with respect to delivering a high quality student experience.

Now, I want to quickly focus on a couple of key areas today with respect to the University of Phoenix and our strategy, and then just give you a brief update on Apollo Global. As you know, the University of Phoenix is our top priority for investment within the Apollo Group. We’ve been extremely focused on delivering high quality college level programs to all those who think they can benefit. I’m sure it comes as no surprise to any of you that there are a tremendous number of working adults that know they need to get a college education to better prepare them for the incredible changes we’ve seen in our economy and job base in just the last few years.

And we want to educate as many of these people that we believe have a reasonable chance of succeeding in our rigorous programs. However, as we’ve indicated before, more students are coming to us under prepared for college and we need to respond, which we continue to do on a number of fronts. First, through an important new initiative, we call University Orientation, which I’ll discuss more in a moment; second, implementing student protection such as our responsible borrowing calculator and new withdrawal process; third, significant technological advances around our learning platform; fourth, marketing focused on attracting better prepared students to the Bachelor and advanced degree levels.

Here’s what we can expect in the near term; a continued student mix shift to higher level programs; some pressure on bad debts which should level off and ultimately improve and Brian’s going to go into more detail on this; fewer students who have incurred debt and fewer students leaving us before they can benefit from our programs. Over time, it’s our objective to achieve improved retention and graduation rates, lower bad debt and default rates, and make continued gains in marketing efficiencies.

Here’s the bottom line. We’re committed to providing access to high quality education while balancing this against our responsibility to insure that only students who have a reasonable chance to succeed enroll in our universities. In order to better identify who these students are, we’re refining some of our marketing efforts and Chas will discuss more of this in just a minute, and we have introduced as we mentioned during our last quarter conference call a pilot assessment before a student starts class.

This initiative is called University Orientation. It combines stronger commitment of time and energy from students up front, with more help and assistance from us prior to their formal enrollment and receipt of Title IV loans. In its current format the program requires prospective students at selected campuses who have less than 24 credit hours to take a free, three week orientation program prior to enrolling. Now we’re still in the test and evaluation phase of the program. However, as expected it is having some impact on our new enrollment growth.

For the first quarter we reported new enrollment growth of about 14%. Had we included students who entered our orientation program rather than starting class right away, new enrollment growth would have been a few hundred basis points higher. Also expected the impact on new enrollment was greatest at the Associate level. Importantly, we think this is the right thing to do for the student, and if we are successful we also believe the financial impact should ultimately be positive for us, as students that enroll and retain have a far greater impact on our profitability.

Now I’d like to quickly address student persistence. We did see a decline in persistence for the first time in many quarters. This is an area we’re very sensitive to and while persistence isn’t the same as retention, we certainly don’t want to see this continue to trend in the wrong direction, particularly after the significant strides we’ve made over the last year. This is despite the continued mix shift Associate students which makes it more difficult to maintain our overall persistence levels to begin with.

In addition, there are a few specific factors which adversely impacted Associate persistence this quarter including the extra Associate new enrollment date in the fourth quarter and the larger percentage of Associate graduates in the first quarter of fiscal 2010 compared to a year ago.

Retention, which is what we focus on internally and which takes into account our graduates, isn’t as weak as the persistence numbers would suggest. We have achieved significant retention improvement over the last year and as a result further gains are more difficult to attain. In the first quarter we saw some pullback in retention at the Associate level. However, we generally maintained or improved retention at the Bachelor and graduate levels. Retention continues to be one of our primary areas of focus at the company and we hope the initiatives we’re taking such as University Orientation will help drive further improvement over time, particularly with Associate students.

I’d also like to touch on some of the marketing efforts we’ve put in place and the investment we’re making in our brand equity. As you know, we acquired Aptimus over two years ago with two primary goals in mind, to lower the cost of acquiring a student and to take back control of our brand. Now over the last couple of years we’ve learned much through our market research. Today we are better at directing our marketing spend to reach the right students. One of the positive results of our efforts is the quality shift we’re seeing through the growth in Bachelor students. In the first quarter new Bachelor enrollments grew 23%, which was faster than Associates, something that hasn’t happened in over three years here.

Some of this growth was the result of a greater number of students matriculating from our Associates program. In fact, well over half of all Associate students who graduate now continue on to get a Bachelors degree. That being said, the vast majority of the growth in our Bachelors programs continues to be from students new to the University of Phoenix. We believe this is the result of many factors including our branding efforts, increased focus on local marketing and the improvements we’ve made to our website among other things.

Now just a brief update on Apollo Global. Since its inception over two years ago now, Global has been building a strong management and operations team. During the first quarter, John Baule joined us from K12 and will serve as the CLO and CFO of Apollo Global. We’re very excited to have him on board as John’s education, international operational experience will benefit us as we continue to grow Global’s existing three institutions, as well as further expand our global education network.

Our first quarter was the first full quarter with BPP operations and in total we’ve been working with BPP for over five months and we’re pleased with the integration process. The key areas of focus are marketing, technology and human resources, and our teams are working together to share best practices and streamline operations, particularly for BPP’s recently launched business school. We’re starting to see the benefits of our global education network and representatives from all of our schools are sharing knowledge in many areas including academics and marketing, and we remain excited about the many opportunities that exist in the international marketplace.

Before I turn the call over to Brian, let me just quickly address share repurchases. We continue to have $500 million authorized for share repurchases. We didn’t repurchase any shares during the first quarter. Unfortunately there are many restrictions placed on us when it comes to buybacks. We have internal rules around blackout dates and we always consult our legal counsel. However, we have bought our stock back in the past and share repurchases are a part of our capital allocation plans for the future.

With that, I’ll turn the call over to Brian.

Brian L. Swartz

Thanks, Greg, and good afternoon everyone. Our strong first quarter results were driven by revenue increasing nearly 31% compared to the same period a year ago. Excluding the impact of $89 million in revenue from our recent acquisition of BPP, [inaudible] growth was 22%. The components of this increase were primarily University of Phoenix’s 18% enrollment growth combined with increased tuition rates.

While I’m talking about enrollment I want to remind you that during the second quarter of fiscal 2010 there will be one less Monday as compared to a year ago, which will have an adverse impact on our Associates enrollments for that quarter.

As expected, revenue growth was impacted by the higher discounts we are now offering our active duty military students and our participation to the fullest extent possible in the Department of Veteran Affairs Yellow Ribbon Program. Our net income for the first quarter was $240 million, or $1.54 per share, as compared to $180 million or $1.12 per share in the first quarter a year ago. Excluding the $11.4 million tax benefit resulting from our recent settlement with the IRS, our net income increased 27% to $229 million resulting in EPS of $1.47 per share. BPP’s operations added $0.04 per share in the first quarter.

Operating income increased 28% to $393 million. However, we saw a 70 basis point decline in operating margins, primarily due to BPP’s cost structure and increase in our bad debt expense. Excluding the impact of BPP’s operations, our operating margin would have been 100 basis points higher than reported. The change in operating margin was driven by a 280 basis point increase as a percentage of revenue and instructional costs and services or ICS, offset by 180 basis point decrease in selling and promotional expenses, a 30 basis point decrease in general and administrative expenses or G&A.

Before I discuss each individual cost category, I’d like to spend a few minutes discussing BPP’s business model in more detail. As we indicate last quarter, BPP experienced lower new student enrollment in the fall of 2009 versus 2008, primarily due to economic conditions in the UK. As a result, we do not expect to see much growth at BPP this year. Additionally, BPP has significantly more seasonality than our other businesses due to its student intake being driven by a more traditional fall school year start, as well as the timing of the various certification exams, which together tend to drive stronger revenues in our first and third quarters. Furthermore, we intend to make significant investments in BPP and BPP’s cost structure is fairly fixed, which results in large swings in margin and will result in BPP contributing fairly significant losses in our fiscal second and fourth quarters. In fact, we expect the loss in the second quarter to more than offset the contribution this quarter, and the loss in the fourth quarter to be greater than the second.

Now I’ll spend a minute on the variances in each of our expense categories. First, ICS. The significant increase in ICS was primarily driven by BPP’s expenses as well as an increase in bad debt expense. Offsetting some of the increase was continued leverage of certain operating expenses such as space and employee costs. Bad debt expense increased 130 basis points to 4.9% of revenue compared to 3.6% a year ago. BPP’s operations favorably impacted overall bad debt expense as a percentage of revenue by 40 basis points in the first quarter of fiscal 2010.

The year-over-year increase in bad debt expense is a result of the same factors we experienced last quarter, namely lower collection rates on older receivables, in part to a difficult economy, and the shift to a larger portion of Associate students at the University of Phoenix. Additionally, some of the operational changes we implemented during the fourth quarter of 2009, including the 30 day disbursement delay for certain students who receive Title IV funds, as well as the evaluation of transfer credits prior to loan certification, have had a permanent impact on bad debt expense. Consistent with past quarters, our allowance for doubtful accounts continues to exceed all receivables greater than 90 days old.

We monitor bad debt expense trends as a percentage of revenue on a last 12 month basis due to seasonal fluctuations. We expect recent LTM trends in bad debt expense to continue in the near term and therefore we are evaluating some of the operational measures available to us which we believe can eventually help reverse this trend. We believe that over time our operational actions, improvements in economic conditions and a mix shift towards more Bachelor and graduate degree students should lead to lower bad debt expense as a percentage of revenue.

Selling and promotional expense as a percentage of revenue improved versus a year ago for the fourth quarter in a row, primarily due to continued improvement in enrollment counselor effectiveness. On the marketing side, consistent with the past couple of quarters the majority of the dollar increase was due to non-Internet marketing, which is primarily focused on long term branding initiatives. I want to point out that in the first quarter BPP’s operations benefited us in selling and promotional expense by about 120 basis points as a percentage of revenue due to their seasonally strong revenue and generally lower selling and marketing costs as compared to our other businesses.

Finally, G&A, which was down slightly year-over-year as a percentage of revenue, primarily due to lower share based compensation. In the first quarter share based compensation totaled about $14 million. We continue to believe share based compensation for the fiscal year will be approximately $65 to $70 million.

Our effective tax rate in the first quarter was 38.4% which includes a tax benefit of $11.4 million associated with the settlement of an IRS audit related to stock option compensation. Excluding any additional unusual items, we expect our effective tax rate for the remainder of the year to be consistent with our prior estimate of 41%. However, this rate could vary depending on the outcome of our state tax initiatives and the results of our foreign operations.

Now let me turn to the balance sheet and cash flows. We continue to maintain a well capitalized balance sheet as of November 30, 2009 with unrestricted cash and cash equivalents as well as marketable securities of about $925 million. Furthermore, during the quarter we paid down the majority of our revolving credit facility, leaving total debt outstanding at November 30, 2009 of $193 million versus $589 million at August 31, 2009.

During the first quarter we generated approximately $330 million in adjusted free cash flow, a 13% increase versus the first quarter a year ago. Adjusted free cash flow growth was lower than earnings growth, due primarily to the increase in accounts receivable partially offset by lower income taxes paid due to the timing of tax payments. As a reminder, we define adjusted free cash flow as cash flow from operations less CapEx and changes in restricted cash.

Excluding Apollo Global, our day sales outstanding for the first quarter was 32 days, consistent with the amount at August 31, 2009 but higher than the 26 days a year ago. This year-over-year increase is primarily due to operational changes at the University of Phoenix which I mentioned when discussing bad debt expense, as well as increases in gross accounts receivable due to lower collection rates on aged receivables.

Before I turn the call over to Chas, I want to address the SEC informal inquiry which we announced in October. First, we continue to fully cooperate with the SEC to insure they have all the information they need to complete their inquiry. And second, we continue to believe that our accounting policies are appropriate and in accordance with GAAP. We will not be commenting any further about the inquiry at this time.

And with that, I’ll turn the call over to Chas.

Charles B. Edelstein

Thanks Brian. Today I’d like to highlight a few key milestones which we have accomplished over the last several months and touch on a few initiatives which will give you a feel for our priorities.

Our management team is actively focused on lowering our risk profile as part of our efforts to create long term value. We understand this includes both how we operate our business as well as removing uncertainties to the extent we can. Over the last several months we’ve made significant progress in this area. First, as we announced a few weeks ago, we resolved our Qui Tam lawsuit. This settlement brings closure to a long running dispute and enables us to avoid the uncertainty and further expense associated with protracted litigation. Importantly we admitted no liability or wrongdoing as a result of this settlement.

Second, University of Phoenix recently received recertification of its Program Participation Agreement, thus providing University of Phoenix students’ access to Title IV for the next three years.

And third, as Brian discussed we recorded a reduction in our income tax expense during the first quarter associated with our settling an IRS audit.

Fourth, we’ve received our Program Review Report from the Department of Education. I’d like to provide a little more detail on this recent event. As you know in February of ’09 the Department performed a focused Program Review of University of Phoenix’s policies and procedures involving Title IV programs. We received this report last week. The report contains six findings and one concern. Three of the findings generally relate to our procedures for determining the date of student withdrawals, which is relevant for calculating the date on which we must return unearned Title IV funds. No errors were identified in our calculation of the amount of Title IV funds to be returned. Another finding relates to isolated clerical errors in verifying student supplied information. The two remaining findings were self reported by University of Phoenix and involve our calculation of student financial need in certain cases without taking into account tuition and fee waivers and discounts, as well as the use of Title IV funds for non-program purposes like transcript, application and late fees.

In addition, the Department expressed a concern that some students enroll and begin attending classes before completely understanding the implications of enrollment including their eligibility for student financial aid. We believe our liability resulting from the findings will be approximately $1.5 million, which has been accrued in our financial statements. In addition, the Department’s regulations require certain institutions to post a letter of credit when a preliminary program review cites untimely return of unearned Title IV funds for more than 10% of sampled students which applies in our case. Absent relief from this requirement, we will be required to post by January 30 a letter of credit in the amount of approximately $125 million.

We’re reviewing the report in detail and expect to submit a response within the 90 day timeframe as required. The process was constructed and we have taken or expect to take actions to address each finding and concern. Until the final report with our response has been issued, we won’t be discussing the contents of the Program Review Report in any further detail.

Also on the topic of risk management, we continue to closely monitor the current negotiated rule making process and other developments in Washington. Since our beginnings over 35 years ago, Apollo’s been through many of these processes and we’re confident we will once again manage through the outcome.

Additionally, in order to further enhance corporate governance we strengthened our Board of Directors with the addition of Sam DiPiazza, former Global CEO of PricewaterhouseCoopers International. Sam has joined the audit committee and we look forward to the benefit of his vast experience in leading a large global organization.

Finally, as we strive to lead the industry in delivering greater accountability and transparency in higher education, we published University of Phoenix second Academic Annual Report. In it we have again reported a variety of metrics which provide a transparent look at issues such as academic qualities, including student performance and satisfaction as well as completion rates, which are notable given the risk factors associated with the non-traditional students that we serve.

Before we close I’d like to elaborate on an important priority for us. This is our commitment to do the right thing for our students including implementing certain student protections. For example, we’ve recently made a responsible borrowing calculator available to students who are considering enrolling at University of Phoenix. This tool enables the student to determine the exact amount of borrowing required for his or her needs, as well as motivates students to identify and eliminate excessive borrowing.

Second, our pilot University Orientation Program helps identify prospective students who are not yet prepared for the rigors of college before they incur tuition fees or debt. You can expect to see us doing more work in this area.

As Greg mentioned earlier, we’re also trying to use our marketing intelligence to better identify students who have a greater chance of succeeding in our rigorous programs. As a result, we’ve been making some adjustments to our marketing efforts which we hope will resonate with more prepared students looking to return to college. As with University Orientation, our changes in marketing may initially result in lower new enrollments, but our hope is that if successful we trade lower new enrollments for higher completion rates.

We also strive to be one of the most responsible corporations through the environmental work we do, through our focus on employee wellness and our efforts to give back to the communities through support of employee volunteerism and corporate giving.

In summary, we believe we have a responsibility to be leaders in education for the working learner, and we are committed to being a role model within our industry. We will maintain the position as leader and role model through our initiatives aimed at responsible growth, our student protection measures and through continued elimination of those uncertainties over which we have control. We believe we can accomplish these goals for the benefit of our students while achieving the long term internal growth targets which we have previously outlined.

Before we take your questions, we’d like to thank our dedicated employees and faculty who work hard every day to deliver the service I just mentioned. Their passion and talent drive our positive results.

With that, I’ll turn the call back over to the operator so we can take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Gary Bisbee - Barclays Capital.

Gary Bisbee - Barclays Capital

Can you clarify for us, I appreciate the comment on buybacks and not wanting to get more into the SEC but does that inquiry preclude you from share buybacks in the near term or have you got, you know, the legal okay to do that if you chose to next week?

Gregory W. Cappelli

You know, Gary, what we’ve said about it is that they’re definitely part of our capital program and it is something that we’ll consider, you know, going forward. We do have the buyback in place. We consult with legal, you know, continuously as you would expect and we would expect to have buybacks as a part of our capital allocation program going forward.

Gary Bisbee - Barclays Capital

Can you give us any more color on the Orientation Program highlighted? How extensively have you rolled that out, you know, to date? When and over what timing will you do the rest of that? And you may not be able to answer this but the last one there it would seem like that might be something that would be helpful in this one concern that the Program Review brought up. Is that something that was considered during that review?

Gregory W. Cappelli

Actually university orientation is something that we’ve been thinking about for a long time. Its’ taken time to design it, to implement it, to start testing and piloting it. We’re excited about it. I mean we’ve told you the last couple of quarters the direction we want to go in with the University. Maybe what I’ll do is just ask Joe to comment a little bit further and try to answer your question.

Joseph L. D’Amico

Yes. We are making queries evaluating it every month and every quarter to see how much further we want to roll out the pilot and the benefits its’ bringing. So we’re going to continue to work on that and roll that out as, you know, we deem appropriate.

Gary Bisbee - Barclays Capital

Would it be reasonable to expect that the impact to starts that you mentioned for this quarter might increase from that level? Or is that maybe, you know, a reasonable number to think about using for the rest of the year?

Gregory W. Cappelli

It’s possible, Gary. We haven’t really looked at it that way. You know we are truly in the evaluation stage in different regions and at different campuses and at different areas of online. And you know we’re going to try to do it responsibly as we roll it out. You know we’re not looking to try and kill all of our enrollment growth. We were very pleased to see, you know, the increase in our Bachelors degree programs which we’ve been again working on here for some time. And ultimately what we want is to do the right thing for the student and for the University. So that’s how we’re thinking about it in terms of rolling it out.

I think it was important that Chas highlighted that while doing that we still think we can achieve our long term internal goals which we highlighted last quarter.

Operator

Your next question comes from Andrew Steinerman - J.P. Morgan.

Andrew Steinerman - J.P. Morgan

I’d like you to just repeat and maybe emphasize some of the points in the Program Review. I think either this was in part or in full that there is not a question of the amount of Title IV to be refunded but it’s just the timing of Title IV to be refunded. And is the $125 million letter of credit help resolve that issue and how much does $125 million letter of credit cost?

Brian L. Swartz

Hi Andrew. Let me try to answer all of those questions. First of all to confirm yes, you’re correct, there’s a finding in the Program Review deals with the timely return of Title IV funds, not the amount. As Chas mentioned there were no determinations that the amount that we returned were incorrect. So it deals with the timing and it really deals with the determination of when a student has withdrawn and at that point you have a certain amount of time to return funds to the programs. And in our case, you know, we were late in the sample that the Department of Ed looked at.

With respect to the letter of credit the Department of Ed as a rule that if there’s a sample with more than a 10% error rate, which there was in this case on the number of samples, that you have to put a letter of credit in place which represents 25% of your prior year total return to lender dollars. And in our case that’s approximately $125 million. So we’ve disclosed that and that’s what the letter of credit will require. We’ll talk to the Department to see if there’s any opportunities from relief in terms of how much that letter of credit has to be.

Andrew Steinerman - J.P. Morgan

And the last part, $125 million letter of credit is not that expensive.

Brian L. Swartz

Yes, I know. We have the ability to issue it out under our credit facility and obviously some interest costs with doing that, but yes, we have the ability to do that. There’s plenty of liquidity in our balance sheet.

Andrew Steinerman - J.P. Morgan

So this is a pretty low amount of money to kind of get the issue behind you.

Gregory W. Cappelli

You know all things considered, I have to say that we were pretty pleased with the entire process of the Program Review. Again I don’t know if Joe you’d like to comment on it, because I know you were directly involved, but?

Joseph L. D’Amico

Yes, I would just add that the process was very constructive and we continue to have I think good dialogs with the Department just as you know the regulator should have with the largest handler of Title IV funds.

Operator

Your next question comes from Sara Gubins - BofA Merrill Lynch.

Sara Gubins - BofA Merrill Lynch

Could you talk a bit about the decline in persistence in Associate degree students? Just any sense of what you think might have driven that.

Gregory W. Cappelli

Well, I mean, one thing right off the bat is we just had a much harder comp. It was about a year ago that we saw you know some real improvement in that, but the reality is that you know as that pool gets larger, those are tougher students to retain. And we want to make sure that if there is a trend there we stop it immediately.

There was also just in the persistence, the way you calculate it for models, that extra start date just technically last quarter versus this quarter drives part of the difference as well. But all that being said, I guess so that would have smoothed last quarter and this quarter to be a little bit more consistent and a lower level drop in persistence rate, quarter-to-quarter. That being said, there’s some drop there and we’re all over it. We want persistence and we want retention which is what we focus on internally, to be stable to improving. We knew that it would be a little harder, you know, at this point with the levels and the gains we’ve made, you know, to keep going up at the rate we were, but the reason why we’re putting the programs in place is the reasons why we’re doing things for the University that we are.

Charles B. Edelstein

And there were also a higher number of graduates versus a year ago, and so that as you look at the persistence number in Associates that’s part of it as well.

Sara Gubins - BofA Merrill Lynch

And then you mentioned some changes in your marketing to try to go after more prepared students. Could you give some more details about how the marketing campaign is changing?

Gregory W. Cappelli

Sure. Well, in terms of marketing it’s really in gathering data to identify what are the characteristics of students most likely to succeed. So for example, we’re trying to understand more about the characteristics of individual marketing partners and affiliates as we think about those marketing channels. Also other characteristics like number of credit hours that students come to us with. So if we can understand these characteristics better by gathering data and target our marketing efforts more toward the characteristics that are likely to result in more prepared students that give us a better base.

Charles B. Edelstein

One of the things we watch closely is, you know, does it cost more money to get the same type of a student or additional students into the University? And I think as was previously said in the script that is not the case. You know we are moving around our targeting in these areas to some extent, but we’re pleased with the cost to acquire a student at this point.

Sara Gubins - BofA Merrill Lynch

Is there any chance that you might slow down the rate of growth in your marketing spend in that you’re going after a more targeted focus and so start growth might be lower but sales and marketing expense might also be commensurately lower?

Gregory W. Cappelli

That is possible. What I would say about that is there’s more likely to be a shift in it, so if you look at the rate of growth and I realize you have a number that’s consolidated, but we’re able to look at that and say well, where is the growth in that number? And there is much more significant growth in our long term branding and awareness campaign than there is perhaps in what you would look at it in terms of traditional ways of getting students. So that’s possible, but again the composition of that number has changed some and may continue to do that over the next couple of quarters.

Sara Gubins - BofA Merrill Lynch

Are you actually changing your enrollment policies in terms of who can be admitted into programs or just more of a targeting approach?

Joseph L. D’Amico

This is Joe. It’s more of a targeting approach, but if a student comes in with less than 24 credits we are looking at them participating in University Orientation, at least in selected markets at this point.

Gregory W. Cappelli

It’s important for us that they understand that it’s a rigorous program, it’s going to take time and effort, and we want them to realize that and to get some flavor and experience of what it’s going to be like to be in college prior to taking on debt.

Operator

Your next question comes from Trace Urdan - Signal Hill Group, LLC.

Trace Urdan - Signal Hill Group, LLC

I want to go to and see if you might be able to comment on the issue regarding the determination of when a student has withdrawn. Was there sort of a difference in understanding between you and the Department of Ed over that issue? Was it simply an error on your part? Is there any change? You know, was it something systematic there or was it they just kind of found some errors?

Joseph L. D’Amico

Trace, it’s Joe. We had a process in place to insure that any student who withdrew from the University or let’s say did not attend was automatically withdrawn from the University and payments for those who withdrew were made timely. The discussion really was around exactly when does the student initially indicate that they want to withdraw. Of course we have a lot of documentation in systems and files with the discussions that take place with students. And many times a student will call and say they’re thinking about withdrawing and the like. So there are notes around that, notes and files, that then became a dialog around well did the student at that point intend to withdraw and shouldn’t that be the date on which the withdrawal is determined.

So there is some element of systematic impact here. It only related to one year and I think Greg mentioned the new withdrawal process that we’ve put in place. Well that in part was really an idea that came from those discussions because we felt that we could eliminate that issue totally by putting in a better process in place, one that first of all provided self service capabilities which is totally consistent with what we want to do. It brought efficiencies for us. It created clarity for the student, clarity around the whole issue, consistency, communication and addressed a matter that we knew was going to be a part of the Program Review. So bottom line is it resulted in a better student experience. And finally I want to be sure everybody understands it’s totally unrelated to the recognition of revenue. So we think it was a good result and in fact when we talk about the process with the Department of Education being constructive, this is one area where I felt it was very constructive. And by the way the average number of days late for the sample for this one year was around six days, and we have 45 days generally to return from the initial time a student intends to withdraw.

Trace Urdan - Signal Hill Group, LLC

So given all that, how long does the letter of credit need to stay in place?

Joseph L. D’Amico

Well, that is something we’re going to talk to the Department on, but I believe it’s a two year requirement or up to two years. It could be more, I suppose, than two years. But if you think about the amount that we’re talking about, $125 million to cover this is really a huge amount and I don’t think the rules were written for our situation, quite frankly. So at least we’ll talk to the Department around that requirement and see if in fact this totally applies and how we might discuss it and view it.

Brian L. Swartz

Just to be clear, too, how long the LC needs to be in place we’re still looking at. We believe its September of 2011. And more importantly what Joe mentioned we have over $1 billion of liquidity just to reiterate that, so you know the LC mechanically we can do under the credit agreement and overall it’s not going to impact our capital.

Trace Urdan - Signal Hill Group, LLC

On a different topic, I wondered if you have seen any kind of movement in terms of demand in the military market as a result of your pricing change there. Has it worked?

Joseph L. D’Amico

Yes, it is working.

Trace Urdan - Signal Hill Group, LLC

Any more elaboration?

Joseph L. D’Amico

No.

Trace Urdan - Signal Hill Group, LLC

I was hoping that you might just offer a little bit of commentary on the criticism that the OIG has levied against some of the creditors including HLC around the recognition of credit hours. You worked with HLC for a long time. What’s at the heart of that in your opinion and do you see any changes likely resulting at the accreditation level as a result of this kind of wave of activity by OIG?

Charles B. Edelstein

We don’t really have any way to forecast that. You know I can tell you from our perspective we have a very constructive relationship with HLC and you know our approach has been so long as we do the right thing by our students from an academic perspective, then we expect to retain a good relationship with HLC and all of our creditors.

Operator

Your next question comes from Suzanne Stein - Morgan Stanley.

Suzanne Stein - Morgan Stanley

Can you just delve a little deeper into the bad debt issue? I mean do you think that this will get worse before it gets better? I mean I know you have plans to put procedures in place to mitigate it, but how quickly can this happen? Just wondering if it makes sense to build in an incrementally higher number for the next few quarters.

Brian L. Swartz

Yes, Suzy, the way that we monitor the trends in bad debts as I mentioned is on a last 12 month basis, kind of an LTM basis, and we’ve seen that increase as you can see in the last few quarters. And we do expect that trend to continue in the near term. You know over time there are things that we can do to help control this. You know the principle on targeting students that retain longer. As we said before our receivables and our bad debt occur when students drop out of a class. And so you know tying into all of the discussion that Greg mentioned in terms of targeting more Bachelors and graduate degree students is an obvious one that we’re doing and going to do more of. And then there are also other things that we can do just operationally to help manage it over time.

Gregory W. Cappelli

I think it’s a prudent thing to do, though, you know, we don’t know but it certainly could go up you know over the next couple of quarters. We are going to anniversary eventually what Brian talked about before in terms of the change that was made with one of the issues affecting bad debt and that could help and provide some relief as well. But ultimately it’s the things that we’re talking about strategically that we’re doing that we expect to play the biggest role here.

Suzanne Stein - Morgan Stanley

And I know you don’t want to comment on the SEC inquiry but could you maybe just address how it’s being handled internally? Have you hired experts beyond your auditors to look at the revenue recognition policies? Just any commentary you can address, you know, you can give us about that would be helpful.

Brian L. Swartz

Yes, Suzy, I mean unfortunately we’re not getting into a lot of detail there. I’m sure you can appreciate why given the sensitivity. But I think it’s important for everyone to know that we’re fully cooperating with the SEC and that you know we believe all of our accounting policies are appropriate in accordance with GAAP.

Suzanne Stein - Morgan Stanley

Can you just address the increase in corporate overhead expense year-over-year?

Brian L. Swartz

Are you referring to the segment cable you’re referring to?

Suzanne Stein - Morgan Stanley

Yes.

Brian L. Swartz

Yes, it’s principally due actually to just some adjustments year-over-year and the allocation of costs to the segments. There were some minor differences just in terms of how we allocate costs from corporate to segments so it shows that it’s going up. Obviously when our cost structure is up our revenue is up. That’s part of it as well, but it’s just an allocation issue and timing issue.

Joseph L. D’Amico

I’d just add to Brian’s point. We obviously pay very close attention to our cost structure, especially with the things that we’ve spoken about earlier so cost management is definitely something top of mind.

Operator

Your next question comes from Robert Craig - Stifel Nicolaus & Company, Inc.

Robert Craig - Stifel Nicolaus & Company, Inc.

I just want to make sure I understand the shifts, I was going to call it a strategic shift but that might not be accurate, to emphasizing the higher end programs. And that’s especially in light of some of the success you’ve had in terms of increasing that migration rate. Is that a temporary phenomenon do you believe until the University Orientation program is completely rolled out? Or is this something that will continue for a while?

Gregory W. Cappelli

No, we don’t think that the increase in that is temporary by any means. In fact that’s been trending nicely for a long period of time now and as you mentioned it’s significantly over 50% at this point. So that’s something that we’re really happy about.

Charles B. Edelstein

Bob, are you asking about the actions that we’re taking to focus more on higher level degrees? That really stems from I think what we’re learning, which is as we move forward we’re seeing more students come to us who are less prepared, particularly at the Associate level. And so we’re doing things to try to attract more prepared students. And that will logically mean probably more higher level students on a relative basis than previous.

Joseph L. D’Amico

It’s also where you focus your efforts, where you point your marketing efforts, what you choose to focus on internally, where you roll out your programs of study, at what level. We were very focused on the Associate level for a long period of time. And as you know from the last several calls we’ve had where our focus is going forward.

Robert Craig - Stifel Nicolaus & Company, Inc.

Is part of that, Greg, is an emphasis in terms of program development, too, on higher end programs?

Gregory W. Cappelli

Yes.

Robert Craig - Stifel Nicolaus & Company, Inc.

Can you quantify that in any way?

Gregory W. Cappelli

How many programs?

Robert Craig - Stifel Nicolaus & Company, Inc.

Yes, how many programs.

Gregory W. Cappelli

I really don’t want to do that at this point, Bob, but we will keep you updated there, as well as on the technology front which is going to play a role in that as well. You know as we mentioned we’re doing some very exciting things on that front and we’ll have more to say about that on future calls.

Robert Craig - Stifel Nicolaus & Company, Inc.

I know there’s a long tale to this, but any measure of the ROI of the brand spending you’re doing and any change overall in receptivity to your marketing message?

Gregory W. Cappelli

There’s absolutely a measure to the ROI. We look at that closely all the time.

Joseph L. D’Amico

There’s been very good receptivity to the marketing message, the branding message, and we actually monitor that very closely and adjust accordingly. And you’ll see there’s some new ads out, maybe it’s in the last 60 days or so that they’re helping our thought leaders understand University of Phoenix in a very clear way, understanding our accreditation and understanding who we are. And what we find is that the more someone understands what the University of Phoenix is all about, what we’re trying to do and the good that we get done, the perceptions of who we are are changing. And our objective is to get that message out, because we of course internally understand it very clearly. That’s why we’re here. But we want everybody to understand it and that will change the perception of our brand.

Robert Craig - Stifel Nicolaus & Company, Inc.

Is the magnitude of that spend going to remain fairly constant here?

Joseph L. D’Amico

I think in the near term it probably will, so.

Gregory W. Cappelli

We’ve actually budgeted for a certain amount of spend in this fiscal year and right now we’re on that plan.

Operator

Your next question comes from Andrew Fones – UBS.

Andrew Fones - UBS

I just wanted to follow up and clarify on the buyback. I was just wondering if you can tell us when the blackout period ends, you know, related to this earnings release, whether or not at the moment you’re expecting to be in a position to potentially buyback stack if you wish or whether this inquiry would still currently impede that.

Brian L. Swartz

Andrew, the blackout ends a couple of days after today, after we release earnings. The only thing we’re going to say about buyback is they’ve been a part of our capital allocation plan in the past and they are going to be part of it going forward. It’s part of our assessment always in terms of how we use our capital.

Gregory W. Cappelli

So Andrew even in periods where our policies have the windows open we still have to review with counsel at that time to see what the deal is.

Andrew Fones – UBS

Going back to one of Gary’s questions, I was a bit unclear on kind of how you answered it but can you give us the exact kind of timing in terms of when you implemented the new onboarding and marketing strategy? I’d just like to kind of understand whether that impacted Q1 results at all or whether that’s something that will be incremental going forward.

Joseph L. D’Amico

The University Orientation is what you’re referring to, Andrew?

Andrew Fones - UBS

Yes.

Joseph L. D’Amico

That started a couple of quarters ago anyway. I don’t remember the exact start date for the pilot and the pilot has been growing, which is why now it’s something we’re speaking about because it’s now, you know, having impact. So now we’re beginning to discuss it as it continues to grow.

Andrew Fones – UBS

In terms of kind of the shift on marketing, that has also just been sort of a gradual change or was there a real start date there?

Gregory W. Cappelli

Marketing, and I think we’ve said this all along, you know, the more control we’ve had now over the brand and the data, and we see what’s happening we’re constantly making changes to our marketing and our focus, and taking and relating data in ways that we’ve never done before. So we’ve gotten let’s say more sophisticated about it. And we’re really tying the performance of our partners to new enrollments that retain. That’s what’s key. Not new enrollments, not the cheapness of it, new enrollments that retain. That’s what we’re focused on.

Brian L. Swartz

And in fact that’s what we use to measure the ROI’s that was brought up in a prior question. That’s a big part of the calculation.

Andrew Fones – UBS

In terms of the 45 days that you have to return the funds and I guess 10% of the sample students being over that timeframe, I was wondering how that can occur, you know, for instance for a program where you have a five week period to the program so that’s only 35 days for the entire program and yet the kind of return of the funds because you were unsure whether the student dropped out was longer than that period.

Joseph L. D’Amico

The rules, Andrew, are when you make a determination that a student has withdrawn from the University, at that date you have 45 days to return the funds to the program. It doesn’t deal with the timeline of the course but more around the determination of when someone withdraws from the University. And at the point the clock starts to return the funds within the 45 days.

Operator

Your next question comes from Mark Marostica - Piper Jaffray.

Mark Marostica - Piper Jaffray

First is your Masters stark growth was flattish and I’m curious what you’re doing there to drive additional movement there? You talked about attempting to get people to move to the higher level programs. And then tied to that, you did mention the matriculation from Associates to Bachelors. Can you talk about the same sort of matriculation from Bachelors to Masters?

Gregory W. Cappelli

You know, Mark, I don’t have enough data for you right now to update you on matriculation from Bachelors to Masters. You know we were talking about this you know earlier in the quarter and again so much of it gets down to focus. You know Bachelors is a large area in this industry and we put a focus in place to begin to grow that again after many quarters of not growing. And we need to do the same thing in Masters. We need to focus on it. We’re starting to do that and I believe that you know we have as much opportunity as anybody to grow Masters. But you know we initially put our focus outside of Associates into Bachelors. That’s what we’ve done and now we’re moving from there.

Mark Marostica - Piper Jaffray

And perhaps tied to that, I know you don’t disclose ground versus online enrollments, but I’m curious if you’re seeing and I think you mentioned this in the past some sort of resurgence of ground enrollment and how prevalent that is across the system? And perhaps you can talk about, you’ve talked about the enrollment counselor effectiveness, how is that looking ground versus online?

Gregory W. Cappelli

Well we can tell you unequivocally that we care about our ground operations. We want them to be stable and growing and in fact they did grow in the quarter.

Mark Marostica - Piper Jaffray

And would you say it’s fairly prevalent across the system or is still more isolated in select geographies?

Gregory W. Cappelli

I don’t have that level of detail for you right now on this call and perhaps we can follow up with you.

Mark Marostica - Piper Jaffray

Fair enough.

Gregory W. Cappelli

But again it gets down to some of the things that we’re directly doing and part of that is the local marketing that you may have seen, you know, in certain markets, Mark.

Mark Marostica - Piper Jaffray

And then one point of clarification, you mentioned six findings and one point of concern with the Program Review and then you walked through a number of items and I just want to make sure that I understand what was the exact concern of the list that you gave us?

Charles B. Edelstein

A finding is something that we need to specifically respond to and have an action with regard to it and a concern is a broader comment. But we expect to address you know both findings and concerns. So the concern that was specifically addressed here is that some students who enroll and begin attending the classes before they completely understand the implications of the enrollment, like their eligibility for financial aid and all the implications of what it means to enroll. So it’s not a specific finding but it’s rather a concern and we’re going to be thoughtful about it.

I would say that we learned something from this process and you know we’re going to be thoughtful in responding.

Mark Marostica - Piper Jaffray

So the concern really hits at what you’re trying to do with the boarding process.

Gregory W. Cappelli

It certainly does.

Operator

Your next question comes from Kelly Flynn - Credit Suisse.

Kelly Flynn - Credit Suisse

I know you don’t want to give guidance but I was wondering for the starts for the second quarter, I mean, could you help us out just in the interest of avoiding, you know, completely wrong estimates? There’s a lot of moving parts. You’ve got one less Monday, you’ve got the pilot among other things. What type of deceleration should we be thinking about? I mean what can you tell us there to help us out?

Gregory W. Cappelli

Well, Kelly, maybe one way to think about at least the calendar item we talked last quarter in Q4, if you recall, we had one extra Monday in Q4 of ’09. And I think we reported around 22%, 23% enrollment growth and we said that it would have been in the high teens, you know, without that extra day or extra start. So I think you could use that as a benchmark for what it would mean for Q2, so hopefully that helps you a little bit.

Kelly Flynn - Credit Suisse

And then I guess one way to come at this is the Orientation pilot, to what extent is it rolled out or what percentage of whatever’s relevant is it currently covering and how much is there to go?

Joseph L. D’Amico

Yes, Kelly, we have it rolled out in a number of areas. We don’t have percentages for you right now that we’re going to share. We do consider it, you know, a pilot, but it’s got meaningful numbers of students in it and it will have more in it by the time we speak next quarter. One of the things that’s difficult is just on a forecasting perspective right now, even internally on that front, is we are going to be getting people out of that program that are going to be coming to enroll in the University. Not everybody is excluded. They go through the program, we hope that it screens out the appropriate numbers of people that are not as prepared as they need to be and then some are going to enroll back in the program.

So it is growing, it is meaningful at this point in terms of how it’s impacting University but we’re going to monitor it closely and we’re going to try to be careful how quickly we continue to broaden the program.

Kelly Flynn - Credit Suisse

And then a related question on margins, also looking for a little help there, given what you said about BPP I mean should we expect the year-over-year margin decline?

Brian L. Swartz

Kelly, we’re not giving exact numbers but you know I did in my part of the script talk qualitatively about the BPP seasonality and hopefully provided you some guidance on ways to think about it, you know, the seasonality more directly. And I also made some qualitative comments about bad debts as well.

Kelly Flynn - Credit Suisse

And then you reiterated the longer term targets that you gave out on the last call. Would you give us a little help with that in terms of do you feel like, you know, you slow below that in the near term and that ends up being kind of a reacceleration goal? Or how should we think about that in the context of what you’re implying about the second quarter?

Gregory W. Cappelli

We didn’t imply that. It’s certainly possible that that could happen. The thing we’re going to do without question is we are going to get this right, you know, from the standpoint of how we want to run the University, what we want the make up of the University to be, the quality we expect out of the entire University including all the processes around what we’re doing. That’s what we’re totally focused on. Now, we also are modeling things out, we’re forecasting and we know the size of the industry, we know the numbers of people that are in the industry both domestically and internationally and our goal is consistent with what we talked about last quarter in terms of our long term targets.

You know what happens every quarter on the way to that, can’t tell you for sure, and you can tell we’re going through a bit of a shift right now in terms of what we’re driving at. But overall we feel about the fact that if we do the right things, we have the capability to meet our internal targets over time. And we will certainly update you on that if that changes.

Kelly Flynn - Credit Suisse

I was watching The Bachelor the other night. I saw a new ad, the one that detailed what University has 400,000 plus graduates, etc. I was wondering what that new ad campaign is and where does the I Am a Phoenix campaign stand? Is it no longer going on or kind of what’s the new message, etc.? Thanks.

Brian L. Swartz

Both campaigns are still going on. You maybe have heard us refer to it as our Thought Leadership Campaign. Those are the advertisements or the actual PR around that campaign that initially was rolled out in a certain location and now we’re doing it more broadly.

Gregory W. Cappelli

It’s interesting because a number of people have called over the quarter and we’ll get questions like you know from an industry perspective given the economy, maybe jobs aren’t as difficult at this point, is there some big shift that you’re seeing in terms of how difficult it is to attract students? And I think the answer to that is unequivocally no, it’s not, but it depends on who you want to be and what area you want to go after and that, you know, there’s a different answer to that but there’s no question in my mind that if you want to put a certain amount of capital towards marketing, you can achieve certain enrollment goals if you want to in this industry at this point.

Kelly Flynn - Credit Suisse

What’s your current view on counter cyclicality and do your comments about mix shift relate at all to the expectation that Associates may slow more than Bachelors for that reason? Are you seeing any of that now?

Gregory W. Cappelli

No, that counter cyclicality wasn’t the reason for that comment. I mean mix shift gets back to where we want to put our focus so that’s an important distinction. I think our views on counter cyclicality haven’t changed. You know I rely on my research from years past, which absolutely in certain areas I found some counter cyclicality in this industry and in other areas. Not as much, not as much to the University level but it’s certainly absolutely something that occurs and to what level in any one year, we don’t have an exact estimate for you.

What we talk about a lot internally is we’re not going to sit around and wait for the economy to do certain things and worry that the economy is going to do certain things. We believe that there’s going to be an increasing need here, you know, to educate students, both domestically and internationally. That it’s something that’s going to be hugely important for our economy, you know, going forward and regardless of the economy at any one point in time we’re putting in the strategy and the plans to do that, you know, over the next five years and the long term.

Operator

Your next question comes from Brandon Dobell - William Blair & Company, LLC.

Brandon Dobell - William Blair & Company, LLC

I guess asked a different way on a continuum of rolling out the Orientation Program or being more selective in terms of financial aid disbursements, how connected are those two things? Are they connected with the Student Resource Center effort that you had going on, you know, kind of in earnest last year? I’m trying to get an idea how connected all these things are or if they’re just kind of individual efforts that are not really tied together. I guess the larger question is, if we go back a year-and-a-half or so, you guys had talked about I think 15 or 20 different pilot programs put in place, a lot of them looked at retention and program development, you know, were these some of them? How many have dropped off? How do you feel about the success rate of those pilots?

Joseph L. D’Amico

I’ll try to answer that, Brandon. They are all connected. They’re connected to a philosophy. The philosophy is to create the right student experience, to deliver our education to students who have a reasonable chance to succeed in our program, try to not put people into debt that, you know, just want to try it out and don’t understand what they’re getting into. It’s about quality of the institution and it’s about doing the right thing. This is all connected and I think all of these would fall into that category. We are making investments to be the best we can possibly be as an educator and that’s where some of the technology discussion comes in. We believe some of those investments will also contribute to retention. So all of this is really connected and there is a theme here which I think Greg laid out at the very beginning of his talk.

Brandon Dobell - William Blair & Company, LLC

If you look at the impact of delayed disbursements or I guess you’re choosing to make delayed disbursements, you know, how big of either a quarter on quarter or year on year impact was that to bad debt? Or was it mostly just that the difficult collections on older receivables drove that year on year increase?

Joseph L. D’Amico

Yes, Brandon, I mean I think it’s a combination of the two as I mentioned. I mean there’s no doubt the 30 day delay that we get in the fourth quarter as well as implementing, you know, a full evaluation of transfer credits prior to certification, those are impacting the level of accounts receivables and ultimately bad debts. You know how much of it is that versus how much of it is the economy, you know, is difficult to even tell. And you know you combine that with the student mix issues, there’s a lot of moving parts in there and so they’re all impacting it and at the end of the day, you know, we think it’s all the right thing to do for the students, you know, in the long term and that’s why we did them.

Gregory W. Cappelli

Just to add on to what Joe said, if we do those things and we’re successful, we’ll be successful financially. It’s okay to have, you know, from what we had in the past lower levels of enrollment growth and better financial returns. That’s okay. And you can do the right thing for the student and achieve your financial objectives which is what I was trying to say earlier.

Brandon Dobell - William Blair & Company, LLC

Chas you mentioned the academic report as part of the ongoing effort to kind of manage the risks, I guess, or look at from that perspective. The sample sizes that you guys got on the different tests like sales and MAP seemed real small compared to the number of graduates or number of students, so the utility of that information I think some people could call into question just because you guys are such a big organization. How do you reconcile the utility of that information with the size of the organization or do you have the opportunity or the ability to make people when they graduate take the MAP test so you’ve got a broader sample size that I think the average investor and maybe politician would view with a little more robustness or utility.

Charles B. Edelstein

We don’t require it. It is voluntary and so we really haven’t discussed it if we would want to require students to do that. I guess it’s something to think about. It’s really been on a voluntary basis and it’s been conducted by an outside party, you know, so we know we’re getting good data. But it’s not every student so that’s a fair point.

Operator

Your next question comes from Paul Ginocchio - Deutsche Bank.

Paul Ginocchio - Deutsche Bank

Back to the University Orientation, could you just looking back at your’09 new enrollment could you give us an idea of what percentage of your Associates and what percentage of your Bachelors would under this new program go through University Orientation? And what was the impact? I think you said a couple hundred basis points on overall new enrollment growth. Could you break that out into or would you talk about what was the impact on Associates?

Gregory W. Cappelli

I’m sorry, can you just clarify your question? Are you saying go back historically and see how it would have compared to a year ago? Just clarify for us what you’re after.

Paul Ginocchio - Deutsche Bank

What percentage of your new enrollment would be subject to new orientation less than 24 credits? To the University Orientation Program.

Gregory W. Cappelli

You’re saying if it was rolled out to?

Paul Ginocchio - Deutsche Bank

Yes, if it was rolled out. I’m just trying to understand what kind of impact that has or what percentage of students.

Joseph L. D’Amico

We don’t have the percentage for you, we don’t have the data with the exact number of students that have less than 24 credit hours right now. We don’t give that out.

Paul Ginocchio - Deutsche Bank

You track it?

Joseph L. D’Amico

We absolutely know how many credit hours students come in with.

Paul Ginocchio - Deutsche Bank

Obviously there’s a bigger impact on Associates, the deceleration on Associate new enrollment growth this quarter?

Joseph L. D’Amico

Yes.

Paul Ginocchio - Deutsche Bank

You won’t size that for us?

Joseph L. D’Amico

Yes, most of the students that come in with a modest number of credit hours are Associate students. Yes, that’s true.

Paul Ginocchio - Deutsche Bank

Again a question about second quarter new enrollment growth, should we just assume one less start week for Associates and we should just use that as the metric to factor in the deceleration or the impact?

Joseph L. D’Amico

Yes, Paul, as I mentioned to Kelly the way to think about it to use the data from Q4 of ’09, where we had the opposite effect, we had one extra Monday in the fourth quarter of ’09. We have one less Monday year-over-year in Q2 2010 so we gave some qualitative analysis about what the impact was on Q4 and you could draw a similar conclusion to Q2 of 2010.

Operator

Your next question comes from Amy Junker - Robert W. Baird & Co., Inc.

Amy Junker - Robert W. Baird & Co., Inc.

Brian, I was hoping you could just help us understand, I appreciate the color with BPP and the seasonality there. I’m just wondering, you know, my understanding is the majority of the hit to the gross margin exclusive of bad debt came from BPP. Should we expect that same level of you know impact? I guess I’m wondering should we think about gross margin being down, you know, 300 basis points going forward at each quarter or does the seasonality change that going forward?

Brian L. Swartz

Yes, with respect to BPP, Amy, and obviously I gave a lot of qualitative discussion in my comments, but their seasonality is much more pronounced than our other businesses I think is the way to think about it. So the financial performance that they had for Q1 2010 and the operating income they generated we said would be, you know, more than offset in the second quarter because that’s one of their seasonally weak quarters. They just have a fixed cost structure. It’s the nature of their business. So you know you could certainly think about it that way. I mean look at the numbers relative to all the other non-BPP businesses within Apollo and the general seasonality amongst those, specifically the University of Phoenix.

Amy Junker - Robert W. Baird & Co., Inc.

If you could tell me roughly what percentage of their revenues fall in each of the four quarters?

Brian L. Swartz

I don’t know those numbers off the top of my head.

Gregory W. Cappelli

Okay, we’ll get you that.

Amy Junker - Robert W. Baird & Co., Inc.

Certainly appreciate not wanting to comment on the SEC inquiry and I’m not going to ask a specific, but last quarter you know when you announced it you said you didn’t really know what they were looking at specifically, and I’m wondering if today you have more clarity on that, if you’ve had enough conversations with the SEC to understand exactly what they’re looking for. And again I’m not even asking what that is. I’m just wondering if you feel comfortable with what they’re looking at.

Brian L. Swartz

Yes, and believe me, I appreciate the question and again given the sensitivity of this, Amy, I’m sure you can appreciate we’re just not elaborating on the details. But I think, you know, one of the comments I did say which I think kind of will somewhat answer your question is that today we absolutely are comfortable with our accounting policies and believe they’re in accordance with GAAP. So I mentioned that. We still stand by that as a management team and as a company.

Operator

Your next question comes from Jeffrey Silber - BMO Capital Markets.

Jeffrey Silber - BMO Capital Markets

I’m going to go back to the Program Review. In the press release in the Q you talk about these findings from the February, 2009 Program Review. If I remember correctly the Department had told you they were going to do an annual Program Review. Has there been a new Program Review that’s started since then? If you could tell us anything about that. Thanks.

Joseph L. D’Amico

There has not been a new one.

Operator

Your next question comes from Scott Schneeberger - Oppenheimer & Co.

Scott Schneeberger - Oppenheimer & Co.

Following up on the Program Review. It was a single year assessed. Is that correct?

Joseph L. D’Amico

I’m sorry, no it covered more than one year.

Scott Schneeberger - Oppenheimer & Co.

Okay, but I think one of you had mentioned it was a single year that concern arose. Is that?

Joseph L. D’Amico

With the amount or the timing of withdrawals and the payment on a timely basis, that related to only one year. They did not find that issue in prior years or in all the years they examined. Just in one.

Scott Schneeberger - Oppenheimer & Co.

And on another topic, just some discussion earlier on use of cash and share repurchase and restriction there. What is the outlook now with regard to acquisitions with a few months under the belt of BPP? Where and how robust is the pipeline and how active do you expect to be going forward?

Joseph L. D’Amico

You know, there’s a very good pipeline in place. There are very good people in place now at Global. We are continuing to have discussions with organizations really around the globe in different areas where we’re building, you know, long term relationships. And I think that you’ll continue to see Apollo Global grow from the capital that we’re putting into it. So the opportunity is there and we’re certainly excited about those opportunities and when the time is right, we’ll certainly continue to build out the network.

Operator

Your next question comes from Ariel Sokol - Wedbush Morgan Securities Inc.

Ariel Sokol - Wedbush Morgan Securities Inc.

One, you mentioned the University of Phoenix academic reporting and thanks for calling it out. You list that with the average student salary increases for Bachelors and Masters students but I didn’t see anything about Associates degree program students who now represent close to 50% of the total student body. Could you provide those numbers?

Joseph L. D’Amico

I don’t have that report right in front of me. I’m sorry. There certainly would be no reason for us to omit something versus one of the other categories.

Ariel Sokol - Wedbush Morgan Securities Inc.

Can you parse out what the three year default rate was for the Axia students as separate from the University of Phoenix since I’m just trying to get a sense of what the default rate is for an Associate student.

Gregory W. Cappelli

We don’t have that data. I mean we know what the three year default rates were for the institution but we don’t have it broken down by degree type.

Joseph L. D’Amico

I just want to point out that Axia isn’t a separate university. It’s part of the University of Phoenix and that’s the way the government tracks it as well.

Ariel Sokol - Wedbush Morgan Securities Inc.

I’m just trying to assess the conversation with the Associates degree. I guess here’s the question I have. You guys are talking about a reasonable chance of success for these students but you haven’t defined what the measure of success is and the report says there’s a 31% completion rate for the 2004 cohort after three years. What’s the completion rate that you guys are targeting?

Gregory W. Cappelli

You’re right. We didn’t say it has to be a magic number or it has to be a certain completion rate. What we said is we’re not happy with how many students we’re finding want to go to school and don’t realize how hard it is and that they’re actually not prepared to do so at this point in time. So we know that that’s an issue for us and we’re dealing with it. And we outlined the things that we’re doing to deal with it. What’s the absolute number that completion rates would have to get to? Higher.

Joseph L. D’Amico

Think of it this way. If we can identify up front maybe even before we paid for the lead, but in any event before they’re incurring debt and start our program, if we can identify students who are going to come and in a couple of months figure out that this is way too hard for them before they start all that, it’s better for us because we don’t spend the money to bring them in and it’s better for them because they don’t incur debt. And that’s the way to think about it.

Gregory W. Cappelli

One of the ways you can get completion rates higher is to make the courses easier and we’re not going to do that.

Ariel Sokol - Wedbush Morgan Securities Inc.

Last question, regarding getting students to retain longer and of a better quality, it sounds simple but presumably there are other schools out there, competitors who are also targeting the same quality leads, so what would give you the confidence that you can implement this program without increase in the cost of a quality lead? And would you potentially anticipate that those costs could increase over the next year or two?

Joseph L. D’Amico

Well, Ariel, I mean historically speaking yes, higher level students you know in the higher level programs are a more expensive lead. It’s an allocation of where you put your focus and your dollars and your investment. However you traditionally get higher returns off those areas as well. So there’s a trade-off. And even if there aren’t technically the same exact numbers of those students, if the returns are higher than financially it can be just as rewarding for the company. So you know there’s a lot that goes into it. There’s a history here of growing Bachelors and Masters programs successfully for years. Our focus changed some during the journey and we’ve outlined clearly where we’re going with it.

Operator

Your next question comes from Corey Greendale - First Analysis Corp.

Corey Greendale - First Analysis Corp.

Can you speak to if you just look at the students who have gone through the orientation, what the retention of those students is like once they enroll in a standard class versus people who didn’t go through the orientation?

Joseph L. D’Amico

Don’t have that data available for you right now. That is something that potentially we’ll look to give out in the future but again, I can understand you wanting it but when you’re in the pilot phase and you’re rolling things out, that’s not something that we want to share at this point.

Corey Greendale - First Analysis Corp.

I understand that. It’s not entirely intuitive that overall retention of Associates would be down at a time when you’re rolling out a program to improve retention.

Joseph L. D’Amico

Exactly. Remember there is a lag effect here. It doesn’t happen magically right away. And we knew that was going to be the case. There needs to be a catch up.

Corey Greendale - First Analysis Corp.

Brian, if you look at the instructional costs and services line and exclude BPP, the rate of growth in that line and the costs accelerated from last quarter, even after you can look at bad debt and bad debt actually the rate of growth actually decelerated slightly, and the rate of revenue growth decelerated, so what is driving the rate of accelerated growth in instructional costs and services at BPP? And will that continue to accelerate?

Brian L. Swartz

I’d have to look at some of the data a little more closely. I mean we did get leverage in some of the other costs that are in there as I mentioned around our employees and service students are in that category. We did see leverage in those other categories including our space and elsewhere. There are some variable costs in there around you know [inaudible] of the costs and other costs that are more variable like textbooks and publishing fees. But on a high level those are the main things driving numbers.

Joseph L. D’Amico

Technology as well.

Corey Greendale - First Analysis Corp.

I apologize if you think you’ve answered this already but I’m still not entirely clear so I’ll ask it again. Looking at the question raised in [inaudible] the department on the withdrawal date, I’m still not entirely clear why it wouldn’t effect the dollar amount since I would think you have to return dollars as of the withdrawal date that’s identified? And if there’s a discrepancy in the date why the dollars wouldn’t be different.

Joseph L. D’Amico

The point of that was the finding was not that we didn’t return the right dollar amount or we didn’t calculate the right dollar amount to return. The finding was that in some cases we have 45 days from the date that the student withdraws and in some cases there was a question about what was the date that the student actually withdrew and therefore did we meet that 45 day mark when we sent the money.

Brian L. Swartz

There is an amount that we said we would be likely paying as a result of the Program Review. I think its $1.5 million. Included in that is a factor of some amount related to the timing of the return of money. So there is an impact. But the dollar amount we returned, the principal amount so to speak was correct.

Joseph L. D’Amico

So basically it’s an interest charge for returning.

Corey Greendale - First Analysis Corp.

What I’m asking is if you have identified that the student has withdrawn a week later than the Department thinks you should have, why you shouldn’t be returning an extra week of funds that you otherwise wouldn’t have gotten for that student.

Joseph L. D’Amico

Because we go back to the date the student last attended for these determinations, regardless of when they withdrew.

Gregory W. Cappelli

That calculation is not in question.

Joseph L. D’Amico

That’s not in question. That’s exactly the point.

Gregory W. Cappelli

That’s a very good point actually that you made.

Brian L. Swartz

You calculate it as of the last date of attendance but it’s a determination of withdrawal when the 45 day clock starts and we have to return the money.

Corey Greendale - First Analysis Corp.

That makes sense. I appreciate it. Thank you for clarifying that.

Brian L. Swartz

Corey, it’s Brian again. I think to answer your earlier question around the ICS or instructional costs you might recall this was the fourth quarter was the last quarter where we anniversaried year-over-year our savings, or at least we have other contractual savings with vendors but we had a very large contractual savings if you recall in our outsourced financial aid servicing. So I think that’s why you see the growth rate go up significantly from Q4 to Q1 as a result of that we’ve anniversaried the savings.

Operator

We are out of time. I would like to turn the call back to the management team for closing comments.

Gregory W. Cappelli

Thank you everybody for joining us and we’ll look forward to following up with you throughout the quarter. Take care everyone.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Apollo Group, Inc. F1Q10 (Qtr End 11/30/09) Earnings Call Transcript
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