Apollo Group F4Q06 (Qtr End 8/31/06) Earnings Call Transcript

Apollo Group Inc. (APOL)
F4Q06 Earnings Call
October 18, 2006 11:00 am ET

Executives

Brian Mueller - President
Kenda Gonzales - CFO

Analysts

Mark Marostica - Piper Jaffray
Matthew Litfin - William Blair
Kirsten Edwards - ThinkEquity Partners
Sara Gubins - Merrill Lynch
Paul Beland - Citigroup
Gregory Cappelli - Credit Suisse
Howard Block - Banc of America Securities
Gary Bisbee - Lehman Brothers
Kelly Flynn - UBS
Robert Craig - Stifel Nicolaus
Chris Gutek - Morgan Stanley
Jeff Silber - BMO Capital Markets
Corey Greendale - First Analysis
Trey Cowan - Stanford Financial
Jennifer Childe - Bear Stearns
Mark Hughes - Numis Securities

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the Apollo Group Incorporated fourth quarter fiscal year-end 2006 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. Please refrain from entering into the queue until those instructions are given.

(Operator Instructions)

As a reminder, ladies and gentlemen, this conference is being recorded today, October 18, 2006, 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 October 31, 2006, beginning approximately two hours after we conclude today. The replay number is 800-642-1687, or 706-645-9291 internationally. The conference ID for the replay is 8999037.

Additionally, this call will be broadcast over the Internet and can be accessed via the company's website at www.apollogrp.edu.

I would also like to remind you that this conference call contains certain forward-looking statements with respect to the future performance of Apollo Group that involve risks and uncertainties. Various factors could cause the 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 the company's 10-K report filed with the Securities and Exchange Commission.

I would now like to turn the call over to Mr. Brian Mueller, President of Apollo Group. Mr. Mueller, go ahead, please.

Brian Mueller

Good morning. Thanks for your attendance. I am going to turn it over to Kenda to briefly review the financial performance of the fourth quarter and then I will spend considerable time commenting on it, and then we will take your questions. Kenda, it is yours.

Kenda Gonzales

Thanks, Brian.

Revenue related to students enrolled in degree programs increased 4.3% for the fourth quarter of fiscal 2006 to $574.4 million, compared to $550.7 million for the fourth quarter of fiscal 2005.

Discounts for the quarter were $27.5 million, or 4.2% of gross revenue.

Instructional costs and services increased as a percentage of revenue in the quarter ended August 31, 2006, primarily as a result of an increase in bad debt expense and employee-related expenses.

Selling and promotional costs increased as a percentage of revenue in the quarter ended August 31, 2006, primarily as a result of an increase in the number of enrollment counselors and increased advertising.

University of Phoenix currently has 74 local campus locations, of which 38 are less than five years old.

General and administrative expenses decreased during the fourth quarter of fiscal 2006 as a percentage of revenue, due to a $19.8 million stock-based compensation charge related to the conversion of University of Phoenix online recorded in the fourth quarter of fiscal 2005, offset by an increase in employee compensation and related expenses.

As a result of the above, our operating margin, excluding stock-based compensation expense, decreased to 24.1% for the fourth quarter of fiscal 2006, compared to 31.9% for the fourth quarter of fiscal 2005.

Turning to the balance sheet, cash and marketable securities, excluding restricted cash, were $416.7 million at August 31, 2006.

Net receivables were $204.6 million, which equates to 30 days sales outstanding.

At August 31, 2006, we have reserved $23.6 million against our receivable balance, and during the fourth quarter of fiscal 2006, we wrote off $29.6 million of student receivables.

Between August 31, 2005 and August 31, 2006, the current portion of deferred tuition revenue increased 5.8% to $139.5 million, and student deposits increased 1.8% to $254.1 million.

Cash flow from operations was roughly $550 million, compared to $565.7 million for fiscal 2005.

Capital expenditures, net of the land and building transactions for fiscal 2006, were $45.8 million, compared to $103.8 million for fiscal 2005. Brian.

Brian Mueller

Thanks, Kenda. At the last two conferences, I indicated that we were trying to reverse a two-and-a-half year trend of declining performance. As I stated, I believe there are changes taking place in the economy and within higher education that are affecting our performance. Most importantly, we are now trying to grow against a very large number.

Our major focus in the fourth quarter was to continue to implement our plan in order to get back to acceptable growth rate. I want to spend some time this morning updating you on the most important elements of that plan.

We feel good about the front-end of the process. The demand for higher education in this country is very high. Our September leads are way up over our January leads. The cost per lead is down 36%. Conversion rates are slightly down, but we expect them to improve.

We continue to increase the percent of leads we get off the ad.com network, which has a positive impact on lead quality and increases the value of the contract to both entities. Our Monster contract is approaching 100,000 leads a month and we are getting closer to a contract with another major partner. This gives us greater control over the process and makes us less dependent on ineffective vendors.

Our national branding campaign is on track and will begin in January. It will consist primarily of national television, and we believe it will have a positive impact on lead generation and conversion rates.

The Stadium Naming Rights Project was added as a component to our branding campaign. As you probably have read, it is a $154 million deal over 20 years. It starts at $5.75 million a year, which is less than 2% in sales and promotion per year.

An independent marketing analyst group estimated the contract would be worth $30 million a year based upon the impressions it would generate. It is a state-of-the-art facility that will host over 100 events in the first year, including the NFL, the Super Bowl next year, the Fiesta Bowl, the National Championship football game, the NCAA Men's Regional Finals, and eventually a final four.

In the two days following the press conference, we generated 66,000 leads, which was an all-time high for a two-day period.

On the sales front, we hired 515 enrollment counselors between March and August. That was a huge investment we made, primarily in the fourth quarter, for the next two years.

Our average EA performance for EAs over one year of experience is 30% higher than EAs under six months. We had 3500 EAs in January and now have 4300. We believe our lead flow will support that number.

We have 95% of all ground-based recruiters trained to sell our ground, online and Axia products. A higher percentage of all enrollment counselors will continue to be placed in the field. Early evidence indicates the productivity of these recruiters will eventually go up because of the flexibility they will be able to provide students.

We feel good about our progress from a marketing and sales perspective. Ultimately, our success will be dependent upon our ability to create greater levels of student academic success and increase retention rates.

Our success rates with students entering higher education for the first time has been 7% over the last number of years. Our first objective with the Axia College program was to improve the graduation rate of those students and secondarily, to open up the 18- to 23-year-old marketplace.

To date, we are still focused primarily on the first objective. The average age of an Axia college student is 30 years old, just three years under the average age of our UoP students.

Based on the Axia students that started in fiscal year '05 first quarter, our graduation rates are tracking at 32%, and 43% of those who are graduating are transferring to UoP. The students who are transferring to UoP are persisting at a 93% rate and their average grade point average is slightly higher than the overall UoP undergraduate GPA. This is obviously an important part of our plan going forward.

We continue to work hard at the academic part of the Axia program. Improving curriculum and experimenting with alternative delivery options are ongoing. We are transitioning towards faculty members who are not practitioners so they are available to students on a very consistent basis.

We are studying closely the impact of faculty response rates, the quantity and quality of feedback, the overall impact of faculty presence, especially in the online classroom, to determine the impact of student academic achievement and persistence.

We are piloting the impact of 24/7 online tutorial services, campus-based tutorial services, and a student mentor process to improve student success rates.

We are transitioning our academic counselors into academic coaching roles. Our improved scheduling systems have freed up time and is allowing them to take on a coaching role. The type of person we hire, how we train them, how we evaluate and compensate them will be different in the future.

We are considering a national pricing strategy that would get all students within Title IV loan limits. The strategy would increase conversion rates, increase retention rates, decrease bad debt expense and operational costs, and decrease default rates.

From an international perspective, we have over 6500 international students attending our online program. We have converted our MBA program into Spanish and have 250 students in the program currently, and that demand is growing. We are beginning work on an undergraduate business program in Spanish.

We are on track to open an online Canadian University through the province of New Brunswick in August.

We have 800 students in our WIU program in India, and are planning to open more campuses.

We continue to look for acquisitions in both Latin America and China.

We have opened the following programs in the last six months:

• An AA program in IP visual communication;
• An AA program in paraprofessional education;
• A Bachelor of Science in communication;
• A Bachelor of Science in psychology;
• A Bachelor of Science in information technology information security;
• Bachelor of Science in information technology with a concentration in information systems security;
• An MAED in early childhood;
• A Bachelor of Science in health administration long-term care;
• A Bachelor of Science in health administration health information systems; and
• A post-master certificate for family nurse practitioners.

In the next six months, we plan to open the following programs:

• An AA in IT networking;
• An AA in psychology;
• An AA in communication;
• An AA in healthcare administration;
• An AA in human services management;
• A Bachelor of Science in liberal studies;
• A Bachelor of Science in business organizational innovation;
• A Master of Science in psychology;
• A Master of Science in accounting;
• A Baccalaureate of Science in nursing;
• A Master of health administration in education;
• A Master of health administration in gerontology;
• A Master of health administration in informatics; and
• A school nurse certificate program.

Returning to the fourth quarter for a minute, we failed to meet our own expectations with regard to student and revenue growth. We are pushing change in the organization very rapidly. A lot of our online campus managers are participating in the training that is happening all over the country. The short-term distraction is certainly an issue.

There were two things happening in the fourth quarter that had a negative impact.

First, the online campus re-entered over 10,000 less students in the second-half of the year than they did in the previous year. That had a major impact on the fourth quarter.

Second, many ground enrollment counselors are struggling with the intricacies of properly preparing online students for their first class. In the fourth quarter, there was a 40% non-start rate for new student applicants.

Both of those issues are improving. We exceeded our own expectations in September from a total growth standpoint. The online campus actually re-entered 3,000 more students this September than last, and the percent of applicants who are actually starting is improving on the ground campuses.

I know that is a lot of information, but there are a lot of things going on. At this point, we will open it up and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

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

Mark Marostica - Piper Jaffray

Good morning, everyone. My question first relates to Brian's comment on the national pricing strategy. I was wondering if you could give us some more specifics around that and whether or not you are actually planning to lower prices as part of that.

Brian Mueller

It is something that we are considering. I have talked about it the last couple of conferences we have attended. We have a very unique opportunity in July. Loan limits go up for first and second level students, which is fairly long overdue.

By the time we get to July, I am estimating that upwards of 70% of all students who are studying at the University of Phoenix at the level one and level two, at those levels will be at Axia College at Axia College tuition rates, so there will be some room for us to raise tuition there, from maybe 265 to 295 and from 285 to maybe 310, without putting a burden on students from the standpoint of out-of-pocket expense.

At the graduate level, there is a lot of room. We are actually quite a bit under the competition in our graduate programs, and there is a lot of room from a Title IV standpoint, so that again, we would not put a burden on students from an out-of-pocket expense.

It is in the middle group that we would have the challenge. About half of our campuses are below a price point of say $395 at level three and four. Those students would come up and then the students that primarily are at online or studying in our West Coast campuses, where the tuition rate is higher, would come down. At this point, we are estimating maybe 60% would have to come down and 40% would have to come up, but we are still studying that.

It is an opportunity to get into a position where all students, regardless of the modality that they selected, would be paying the same tuition rate across the country. It would get students in a situation where their burden in terms of out-of-pocket expense would be lessened.

We have a lot of evidence to indicate that our retention rate would go up. Our conversion rate would go up. There would be a decrease in bad debt expense. We would lower the operational costs, because there is an inordinate amount of time that is spent managing that gap and, maybe most importantly, it would stabilize our default rates on loans, which are still not bad, but we are cognizant of wanting to make sure that does not get out of control.

There are a lot of very positive reasons to do it and because of loan limits going up at level one and two, we could do it in a fairly revenue-neutral way.

That is our thinking as far as that goes, and we are continuing to study it and would not do anything before the end of the first-half, most likely.

Mark Marostica - Piper Jaffray

Great, thanks for the additional clarity there. Regarding selling and promotion spend, and your comment concerning the national branding campaign beginning in January, could you talk about any incremental spend that might be tied to that? Any thoughts around the spend on marketing.

Brian Mueller

It will not be incremental, and obviously you saw the sales and promotion as a percent of revenue go up. We knew it would go up. We are investing in this year. We are very honestly tired of playing from behind by lowering advertising expenditures at the end of quarters.

The majority of that increase was not in advertising. The majority of the increase was in sales salaries. You are not going to get a return on that in the first six months that you make that investment. You are investing for the future.

Because of the decrease in cost per lead, we will be spending around 10% of our dollars in this next year in that national branding campaign, without any measurable impact from an increase standpoint on overall advertising. It will be within the limits that you are used to from an advertising standpoint. Obviously, from a sales standpoint, if those enrollment counselors and when those enrollment counselors become productive and the revenue line goes up, then that sales as a percent of revenue will start to go down.

Mark Marostica - Piper Jaffray

Great, thanks. I will turn it over.

Operator

Your next question comes from the line of Matt Litfin with William Blair and Company.

Matthew Litfin - William Blair

Yes, good morning. Wondering, how can you improve that 43% conversion rate that you mentioned of Axia to UoP? What is your current numerical goal there?

Brian Mueller

There are a number of ways. Right now, there is some sticker shock when students who are studying at Axia College transition to University of Phoenix, with regard to the online tuition rate. Part of it is sticker shock, part of it is the recognition that they are going to have considerable out-of-pocket expense. If we went to a national pricing strategy so that that condition did not exist for a level three and four students, that would help I think considerably.

Secondly, and I think that is the most important thing in terms of a transfer rate. I think the thing that is even more on our minds is increasing that 32% graduation rate. If we can start inching that 32% graduation rate up to closer to 50%, and then we go to some kind of national pricing strategy, I think that transfer rate will go up, which would have a major impact on our business, because if a student does transfer, we have prepared them really well from an Axia College standpoint to be successful at UoP. Their grades are good and their persistence rates are very good.

Matthew Litfin - William Blair

Are you prepared to share any kind of numerical goal that is updated? I know when you first rolled out the program, we talked about maybe a rate that was higher. Have you updated your thinking there, or just kind of want to send that upward?

Brian Mueller

Yes, we are working so hard from an Axia College standpoint with regard to who our instructors are, how we hire them, how we train them, what their expectations are in terms of their contact with the students, their response rates, their presence in the classroom -- all of that.

We are working hard from a curriculum standpoint to understand which parts of courses students struggle with and how we can improve that curriculum. We are working hard from an instructional support standpoint with our counselors.

If we could inch that up to closer to 40%, we would be very happy. Then, if we could inch that transfer rate up above 50%, we would be very happy. Obviously we are already ahead, because 32% is a heck of a lot better than the 7% that we had previously.

We are going to work hard to inch that thing up, and we are in it for the long-term, not the short-term. How good we can get at that, I do not know but it is, I would have to say, without question our major priority.

Matthew Litfin - William Blair

Last question for Kenda -- is this still a 30-something operating margin business in your opinion? Or are we permanently now in the range reported in the fourth quarter?

Kenda Gonzales

We, as you know, Matt, do not have guidance out there right now. For us right now, we are investing for the future, so once those investments take hold, we will be able to better project the guidance.

Matthew Litfin - William Blair

Thank you.

Operator

Your next question comes from the line of Kirsten Edwards with ThinkEquity.

Kirsten Edwards – ThinkEquity

Good morning. You guys gave the show rate, or the non-start rate for student applicants this quarter. I think you said 40%. Can you share what that is on a more normalized basis, or what has been historically, for a point of comparison?

Brian Mueller

Yes, it is in the 80% rate. What we mean by that is when students decide to apply to our program, what percent of them actually then go through the entire process and start the program? That is usually in the vicinity of 80%.

There has not been a drop-off with our enrollment counselors at online, and there is not really a drop-off with our ground-based counselors when they put them into the ground programs. The huge drop-out is when the ground campus enrollment counselors are putting students into an online program. We have worked hard at that from a training perspective but it just takes time.

Preparing a student to go to class online in a way that gives them the confidence that they can be successful means you have to walk them into the classroom and show them how everything works, including the messaging part of it, how to access the content, the library, the writing lab, the math lab -- helping them with how all of that works so they have confidence they can be successful. It is an important part of the recruitment process with students up-front. The ground-based counselors are just not used -- they are not used to working in that amount of detail with students, and so that is the part where we can make a big improvement.

Kirsten Edwards – ThinkEquity

You also talked about changes in your faculty. Does that mean that there will be more full-time faculty versus part-time?

Brian Mueller

There will be more faculty who are full-time teachers. Now, we will not be hiring them on a full-time basis, for the most part, and then paying them fringe benefits and those kind of things.

We are in the process of actually changing this, and pretty rapidly. Faculty members who have masters degrees in the area they teach, and some of them will have doctoral degrees, but they are not working. They are not practitioners. They are teaching in the liberal arts general education areas and they teach primarily in an online environment, which means they are teaching, for most of the day, from the comfort of their home, and could have as many as 100 students, five groups of 20.

But they are available to students on a very, very consistent and very pervasive basis, as compared to what our practitioner faculty members are at the baccalaureate and masters degree level.

Our practitioner model is still the right one at the baccalaureate and masters degree model, because students do not need as much consistent attention. They want the practical application benefit a practitioner faculty member can give them.

But with our entering students in the liberal arts general education areas, where so many universities are really, really struggling getting students prepared to be successful baccalaureate students, we are trying to move to a model that is very, very service-oriented, and ensures that we can instruct students at a level that exceeds how they are getting instructed in other universities, and create a buzz around that.

Again, that is our biggest priority.

Kirsten Edwards – ThinkEquity

Just to double-check a number you gave earlier, you said that online campus enrollments were 10,000 less in the second half of '06 than they were the second-half of '05, is that correct?

Kenda Gonzales

No, that is not what he said.

Kirsten Edwards – ThinkEquity

Thank you.

Brian Mueller

Thank you for giving me a chance to clarify that. The campus actually re-entered 10,000 fewer students, with actually a bigger pool to work with, than they did in the second-half of the previous fiscal year. That was unfortunate and it was honestly, not good management.

When I left online in January, I took a number of critical managers with me to Apollo Group. Vince Grell, who took over for me online, and is a very capable person, got very, very ill and was in the hospital for a period of almost four months. During that time, there was a focus on starting new students. There was a focus on retaining those new students, because we had put some new processes and expectations in place around all of that.

But there is a lot of flexibility with an online program, in terms of students moving in and out, and what you have to be able to do is, in prime time -- which is August, July and August especially, when people have finished their vacations and are thinking about re-entering college and continuing on with their program -- you have to have a plan to work that on a very consistent daily basis to take full advantage of that opportunity.

It exists primarily in that online environment. There simply was not the attention or focus to that that there was in the previous year, and that cost us tremendously in the fourth quarter.

I reinserted myself and some other managers in that process in the last four weeks, and in September, we actually re-entered 3,000 students more than we re-entered in the prior September, so it is there. There is a tremendous opportunity there. There just has to be consistent attention paid to it and specific goals outlined, so that huge opportunity does not elude us.

Kirsten Edwards – ThinkEquity

That is a lot more clear. Thank you.

Operator

Your next question comes from the line of Sara Gubins with Merrill Lynch.

Sara Gubins - Merrill Lynch

Good morning, thank you. First question, regarding the NASDAQ hearing related to the delayed 10-Q filing. Have you heard back from NASDAQ yet?

Kenda Gonzales

We continue to be listed on NASDAQ and continue to work with them, yes.

Sara Gubins - Merrill Lynch

Can you make any comment about your confidence around remaining listed?

Kenda Gonzales

You know, I really cannot. I mean, we continue to work with them on it and I do not think I can project that. There are no issues at the current time and they have given us time to get through the process.

Sara Gubins - Merrill Lynch

Okay. Then, for Axia, you mentioned that the majority of your students, or the average age is around 30. Can you talk about the trends in terms of recent high school graduates in Axia? I know that you had just started to market to them in June.

Brian Mueller

We spent some money in June and July locating websites and putting advertising out on websites where younger students would tend to frequent, and we are getting a response.

We also have a program with Monster called Making It Count, in which we are establishing relationship with 2,500 high schools and making presentations to them between January and April. They are junior and senior classes, to talk to them about making smart choices about career and school. Axia College and the University of Phoenix are the major partners with Monster from an educational standpoint.

They have employment partners that are on the employment side, people like Price Waterhouse and Microsoft, and so it is giving us some exposure in the high schools. It is giving us exposure with academic counselors.

We have a number of enrollment counselors who have been trained to work with graduating high school seniors and enter them into our program. We are moving on that, but we are moving slowly. We are not putting a lot of resources into it.

Our biggest priority is to work with the 30-year old students that we have always been getting and working hard to make them successful at a higher rate. We will slowly over the next couple of years gain more information and develop a more specific strategy around how to transfer high school graduates into our program.

We still think that is a good market. We think we can be very successful in that market, but in terms of prioritizing what is most important right now, it is working with our current students and moving at that a little bit slower.

Sara Gubins - Merrill Lynch

I know that you are not giving guidance, but would it be fair to say that we should expect growth rates in Axia to slow pretty significantly over the next year, given that a lot of the enrollment growth is coming from students who had been interested in University of Phoenix, and who are being directed to Axia over the past year?

Brian Mueller

I am not sure I understand the question.

Kenda Gonzales

Sara, the enrollment growth obviously for Axia, or for our associates program, is very, very large at this point in time. If you are just looking at a percentage, then I think it would probably be fair to say that there is the potential for that number to slow.

Sara Gubins - Merrill Lynch

The incremental growth over the next year is going to come from that older student, as opposed to the recent high school grads?

Brian Mueller

Yes, it will be -- the growth that we will get over the next couple of years will be primarily with students that we have always serviced, but we expect to be -- and hope to be -- a lot more successful from a success and persistence rate standpoint with those inexperienced students.

How much is going to come from those 18-, 19- and 20-year old students, we have them and we continue to work with them. What percent will come from that is difficult for me to predict at this time.

Sara Gubins - Merrill Lynch

Okay then, last quick question and I will turn it over. Bad debt levels remain pretty high in the fourth quarter. When would you expect those to come down, or would you expect those to come down?

Kenda Gonzales

We are currently working on it and at this point, that is something that has a great deal of focus within our organization.

Brian Mueller

I am glad you asked that question. I will comment on that, too.

It will come down, but it is important in terms of the overall strategy, because there is an inordinate amount of resources that are required to manage the gap that exists and the burden that students have in terms of that out-of-pocket expense which, very honestly for the most part, they just do not have the money.

Sara Gubins - Merrill Lynch

Thanks very much.

Operator

Your next question comes from the line of Paul Beland with Citigroup.

Paul Beland - Citigroup

Good morning, thanks. Could you talk a little bit more about student starts in September? You alluded that they were way up over last year.

Brian Mueller

The leads are way up over last year and yes, starts are. We are not giving that number, obviously, but starts are up considerably over last year as well.

Paul Beland - Citigroup

Did you see a deviation in Q4? It looked like student starts started the quarter pretty well up in the upper teens, but enrollment trends did not suggest that was the case by the end of the quarter. Is that correct?

Brian Mueller

Yes, we were disappointed. We had momentum. There was momentum picking up and we were disappointed in how August new enrollments turned out, primarily with regard to productivity of ground-based enrollment counselors who were putting students into online.

That goes back to not the number of people that were interested and applied, but the number of people who were interested, applied, and then did not start because they just were not prepared well enough to start. The fact that some of them did not start in August, but got better prepared and then started in September did help our September numbers.

The total enrollment growth, in terms of how we finished out the quarter, was hurt by the fact that a lot of those students who we had generated interest in and they were leads and we were getting them into the program and we anticipated them to count towards our total student growth number in the quarter, actually did not start. Again, that is a problem that is the result of how much change is going on and we are trying to affect this change over now almost 2,000 enrollment counselors out in the field, who are extremely dispersed, and we are getting better at it. In the future, it should really help us.

Paul Beland - Citigroup

Thanks a lot.

Operator

Your next question comes from the line of Greg Cappelli with Credit Suisse.

Greg Cappelli - Credit Suisse

I guess on the online versus off-line front, first question is, what percentage of your new students now are coming online versus off-line? Brian, you talked several quarters ago about how you were not going to be directing students as much to one area or the other, you were going to let that flow happen more naturally. I am wondering where that is coming out right now.

Brian Mueller

It is north of 60% that are going online, and probably inching closer to 65% as we go through this third quarter, and that is a good thing. It is also something that does not come without adjustments that have to be made in how we operate our business. Those students can be very profitable but there is a lot of flexibility in terms of coming in and out of class, and so you have to be really good in terms of managing them managing their goals and keeping them in class and keeping them on track. That will be a major priority for us.

Greg Cappelli - Credit Suisse

On that note, can you just talk a little bit historically, generally, how much higher attrition has been for online students versus off-line?

Brian Mueller

Yes, and there are two ways to talk about attrition. The first way is how many students actually persist all the way through graduation? From an online standpoint, traditionally that has been a little bit lower than ground, but we are talking two or three, maybe four percentage points.

The biggest difference is that students who are in an online model, because they can start any class any time, any class any week, if they decide they need a break or to sit out for any reason on ground, they might not be able to come back and rejoin their group for a period of five or six weeks, whereas an online student can come back the very next week or two or three weeks later. There is a lot of flexibility there.

If you were dealing with an online student body, for example, of -- just pick a number, 150,000 students. You do not have 150,000 students. You really have closer to 290,000 students, of which 150,000 of them are in class and 140,000 of them are temporarily not in class.

Your ability to keep them, to get them scheduled to come back and to stay in touch with them, maintain contact and make sure they come back when they have agreed to, is an important part of the overall success rate in any given quarter. The numbers are so big now that if you miss or lose focus on that at all for a period of a couple months, it has a dramatic impact upon your student enrollment and your financials, to the point where you could swing 10,000 or 11,000 or 12,000 students in a short period of time.

The fact that more people are choosing online has really positive ramifications. We just need to understand what the potential pitfalls are and make sure that we are organized to manage against that very well.

Greg Cappelli - Credit Suisse

Okay, I got it. Attrition is clearly running above where you want it to be. Have you identified the primary reason for either online or off-line students? It sounds like it is going to be more important because more and more of your students are going to come online going forward.

Then, what is the primary plan to stop it? I think you had talked a little bit more about a couple of initiatives, but is there one thing you can put your hand on that perhaps you are going to be starting this year to help make attrition better?

Brian Mueller

Well, there are things. There are two major things, lots of minor things, two major things. One, it is pricing. It is out-of-pocket expense. It is the burden students have if they do not have the money to cover the cost of tuition. There is not a lot that you can do about that, unless you go to some kind of national pricing strategy and take that burden away. I think we are in a good position to do that at some point, so that is one.

Secondly, the students just are not prepared from an academic standpoint at those lower levels. I do not want to get into what is going on in secondary schools and all of that, but Axia College was the first attempt and again, that is the primary focus, is providing students academic support from the faculty member, from the curriculum, from the student, from the academic coaches -- improving the amount of support that we give those entry-level students so that we can increase their persistence rates.

When they drop out, it is either because there is a financial reason or the classroom, and what we are asking them to do in the classroom is just too difficult. They cannot do the work, and --

Greg Cappelli - Credit Suisse

They are not having a good classroom experience, basically.

Brian Mueller

Well, they are not having a good classroom experience because they cannot do the work. They are not prepared. Not because they do not like what is going on in the classroom or -- they cannot do the work.

We are not going to get them all. There is no way we can get them all, but we need to get those that are capable, we need to get a higher percentage of those confident in their first couple of courses.

Greg Cappelli - Credit Suisse

Okay, because it sounds like these are average age, 31-year old students, so it is not like these are 18-year olds coming in, for the most part. Do you need to change that model more aggressively perhaps, over the next six or nine months, to make that experience better for them?

Brian Mueller

The Axia model?

Greg Cappelli - Credit Suisse

Well, just the model in general, because it sounds like -- I think there was some perception that all your new students were 18- to 24-years old. It sounds like now, you are saying the average age is 31, and they are still -- they are not getting it. That is not far off the average age you had, 35-years old, for the last decade.

Where is that breakdown coming in? Do you need to change the model some so they are getting what they need earlier on?

Brian Mueller

Absolutely. We feel really good about where that is tracking. Moving them from the UoP model, which was five- and six-week courses, very practical in applications, very ambitious in terms of time to completion, very little faculty support that the students were wanting to be on their own and directing their own education.

We changed it from that to the Axia model, which are nine-week courses, heavy involvement from a faculty member, faculty office hours, lots of contact with the faculty, increased library resources, and that took us from a 7% graduation rate to a 32% graduation rate. Now, to continue to work on that model, to inch that 32% graduation rate up to 40%, is what our goal is.

In the short time that we have been doing this, we do feel good about 32%, in the short time we have been doing it, because that is better than the less than 25% that community colleges are getting, and I do not know that they will put the amount of resources, thought, et cetera into that whole thing that we are putting into it. To inch it up to 40%, we think is possible.

Greg Cappelli - Credit Suisse

Thank you. One last quick one -- was your start growth into positive territory this quarter?

Brian Mueller

Yes.

Greg Cappelli - Credit Suisse

Thank you.

Operator

Your next question comes from the line of Howard Block with Banc of America Securities.

Howard Block - Banc of America Securities

Thank you, Operator. Hi, Brian and Kenda. First question is for Brian. The acceptable growth rate, which is to quote you from your earlier comment, what would that be?

Brian Mueller

North of what it was at the end of the third quarter.

Howard Block - Banc of America Securities

Okay, and why that number? Why is that acceptable?

Brian Mueller

Because it is something we think that we can achieve in the course of the next year.

Howard Block - Banc of America Securities

Okay.

Brian Mueller

The amount of uncertainty that exists out there, from the standpoint of growing on top of 300,000 students, and in order to do that, having to work with a higher percentage of students that come to us with less college preparation, the uncertainty of how good we can get at that is why we cannot be as predictable as we would like to be in terms of what the growth rate would be. We just have to be honest about that.

As we get students who transfer in 60 credits, we are fairly certain about our success rate with them. As we get graduate students, we are pretty certain about what our success rate will be with them.

What we know on the front-end of it is that the demand is huge. There are so many people in that age bracket of 23 or 24 to 32 that want to go to college and do not have very much college experience.

The reason we cannot be more predictive in terms of exactly what an acceptable growth rate would be is that we just do not know ultimately what our success rate with those students is going to be.

Howard Block - Banc of America Securities

Okay, and how do you define a "start"?

Brian Mueller

It is a student who posts attendance in the first week of their first course.

Howard Block - Banc of America Securities

Can you explain the rationale behind the -- I guess you can say footnote -- about degree enrollments that was in the press release that talked about a restatement?

Kenda Gonzales

Yes. What we were able to do in the fourth quarter was we were able to automate enrollment count. As Brian was indicating earlier, especially at online, students are in and out all of the time, so we came up with a specific definition, which we provided in the fourth quarter. We were able to automate that across all of our UoP and Axia locations. We were not able to, at this time, automate that for the other subsidiaries, which is why we did not provide the information.

But it is an automated count, and year over year, we are able to give that, and that is what results in the numbers that we put out there.

Howard Block - Banc of America Securities

Are you eventually going to disclose the other subsidiaries?

Kenda Gonzales

The other subsidiaries, I am not sure, Howard, that we are going to be able to automate them, but I will tell you from, you know, to that definition but really, they have not been growing much. As you have known from the historical numbers, they are in that 27,000 to 29,000 range. The bulk of it is IPD. We have not added any new IPD contracts recently, so those numbers would be fairly consistent with what you have seen historically.

Howard Block - Banc of America Securities

So in that vein, Brian, when you were explaining, I think to Greg about the -- I think you said 150,000 students in the classes versus sort of 290 out there, are those proportions real? Is that usually the number that are sort of out there but not enrolled at any one time?

Brian Mueller

Yes. Of all the students that have not graduated or have not permanently moved away from us because it is not working for them, at any given time, we will have 55% or a little bit more that will be in the classroom.

Now, of the 45% that are not, they may only be out for a week or two weeks, but the plus side of online education, because of the scale, is the ability to have flexibility with regard to your schedule. That is attractive to students and gets more of them in.

The downside is that flexibility does create the opportunity to be a little bit less conscientious in terms of your graduation goal and be willing to take a little bit more time off, which we have to encourage and coach and work with them and remind them of what their original goal was, and keep them moving.

Howard Block - Banc of America Securities

You said of the Axia starts from 1Q05, 32% graduated, is that right?

Brian Mueller

Correct.

Howard Block - Banc of America Securities

Of the Axia starts, let’s say from 1Q06, what is their persistence rate at this point in time?

Brian Mueller

It would be certainly north of that. I do not have that number in front of me right now, so --

Howard Block - Banc of America Securities

If you were to extrapolate from the numbers that you do not have in front of you, would you believe the graduation rate would be higher than 32%, or the same?

Kenda Gonzales

Those students, if they just started in the first quarter of last year, Howard, they would not be to the point where they would be graduating yet.

Howard Block - Banc of America Securities

That is why I said extrapolate, if you were to extrapolate.

Kenda Gonzales

Well, I do not think we should, you know --

Brian Mueller

I understand the question that you are asking. Would our expectation of ourselves be that we get better at this so that it is better than 32% in the future? Absolutely and we are doing everything we possibly can to move that in that direction. That is the biggest priority that we have.

Howard Block - Banc of America Securities

With the fiscal year having concluded, how many students graduated from UoP during fiscal '06? Sort of your best estimate.

Brian Mueller

Dan is throwing a number out.

Kenda Gonzales

I do not have the exact number and I do not think we should just guess at it.

Howard Block - Banc of America Securities

Jan does not want to throw a number out?

Brian Mueller

It was Dan Bachus.

Howard Block - Banc of America Securities

Dan, I am sorry. Then, I will wrap up quickly, but you had said on many calls prior that you are somewhat certain that you that can hold to this 21% selling and promotion expense margin in '07. Do you still hold to that?

Brian Mueller

I have been pretty consistently saying it may move a percentage point or two, but not more than that. It moved obviously more than three, and I do not believe it will stay at that level. We will bring it back down again. I do not know that it will be 21, but I believe it will be in the 22, 23 range.

In the first and second quarters of this year, that will be predicated primarily on accounts where those enrollment counselors are, so that we are out run on the top line when it is costing us to hire them on the bottom line.

Howard Block - Banc of America Securities

You said September leads versus January leads were way up, and then you said conversion rates are way down again. Is that comparing September versus January?

Brian Mueller

Yes, it was down. I did not say way down. What I said was they were slightly down.

Howard Block - Banc of America Securities

Okay, slightly down. Why would that be the case if you have been right pricing and using advertising.com to clean up the leads flow?

Brian Mueller

Because when the leads go up as dramatically as they did, we were willing to let that happen without being asked specifics about right pricing, as eventually we will be, because the cost per lead was going down so drastically. In the short run, we were willing to accept all those leads in order to do both the learning that we need to do, as well as provide our enrollment counselors an opportunity, even if they are with slightly less quality leads. I want to say it is slightly less than a conversion rate standpoint. Then, as we are moving into a new phase now where we will start driving the number of leads down, understanding where the highest quality leads are.

But in saying that, we will not drive them down dramatically, because I think unlike a lot of our competitors, we are interested for the most part in all leads. Because we have a national qualifying center, we will take 1% converting leads as long as we pay $3 or $4 or $5 for them. That puts us in a position to start students. It puts us in a position not to have to overburden our enrollment counselors, because they do not get them until they have been through the qualifying center.

Howard Block - Banc of America Securities

Kenda, on the bad debt expense, Brian said that obviously it is a great deal of focus within our organization, and somebody said that requires an inordinate number of resources. I would think that if the out-of-pocket expense is declining with the growth in the students that are so highly covered by Title IV, that the bad debt, you would think it would actually decline as well. Wouldn't that be the secular trend you would expect?

Kenda Gonzales

That certainly ties in with the right pricing, or the pricing strategy that Brian articulated.

Howard Block - Banc of America Securities

In what way?

Kenda Gonzales

In that therefore, all of the level three, four students would then be within the Title IV loan limits.

Howard Block - Banc of America Securities

So the driver of the bad debt increase is the level three and four student?

Kenda Gonzales

Not exactly. The driver of the bad debt expense right now is a result of continuing from earlier on a year ago, which we have talked about, the Axia students and the process where they were not required to sell off their Title IV financial aid form before they began their first night of class, which put us at risk for the money coming in.

We always accept the risk for students that have completed their financial aid forms, and this would be Axia and all other students, and allow them to start class. If they have completed their forms, we accept the risk. But if they do not continue in, and we are not able to therefore drive down the Title IV money, we would have a bad debt expense.

But the bulk of what we have right now is the result of the Axia students from a year ago or so not completing the financial aid forms prior to starting classes.

Howard Block - Banc of America Securities

Thanks for your patience.

Kenda Gonzales

Operator, just as a -- and for everybody out there, we have about ten additional questions in the queue, so hopefully we can move this along a little faster with questions.

Operator

Your next question comes from the line of Gary Bisbee with Lehman Brothers.

Gary Bisbee - Lehman Brothers

Good morning, I will try to be quick, but try to ask a couple quickly, if I can. I know the numbers are not apples and apples, given that you changed the definition of the enrollments a bit, but can you give us a sense as to what was the bigger driver of the University of Phoenix and Axia slowdown from the 11% year-over-year growth last quarter to the 5.5% this quarter? Was it more due to the starts performance being weak or an increase in attrition, or something else?

Brian Mueller

It had to do with the two things I indicated. One, after the number of applicants necessary to get the new start goals that we had were there, but we had 40% of them who did not actually go in office. That really hurt us. That was primarily again the result of new people putting students into the online program.

In terms of the demand and in terms of the number that we could have got to from a new start standpoint we were tracking, we did not make it because 40% of them who applied did not actually start because they were not prepared.

The second thing that hurt us was the re-entry part of it on the online campus side, and that hurt us. That was a bigger factor in that 5.5% growth than even the first one was, and we are working hard on that.

Gary Bisbee - Lehman Brothers

Are you willing to comment on those, the University of Phoenix versus Axia? Was there a big difference between the two?

Brian Mueller

No. If a student attends Axia College, obviously they are online. If they attend the online part of University of Phoenix, they are online. The applicant-to-not-start percentage was equitable across, whether you were an online, whether a UoP student or an Axia student.

Gary Bisbee - Lehman Brothers

The core bachelors and masters degree enrollments continue to deteriorate, particularly the bachelors. I wonder if you have any comment on that. I know a couple of quarters ago, it sounded like a lot of that was just artificially people going to Axia who would have historically, with the same level of credits, gone to UoP, but it seems like it is more than that now.

Brian Mueller

The number of baccalaureate students studying at the University of Phoenix is increasing. What you have to do with those numbers is you have to understand that before Axia College, when we put a student into the University of Phoenix who had no credits, they were entered into a baccalaureate program.

Ninety-plus percent of the students that are coming to us now in Axia have that same intent, to do a bachelors program. They are using the associate degree program to get there. You have to combine those two numbers today and compare that against what it was in the prior year in order to get the true indication of the percent increase at the baccalaureate level.

Gary Bisbee - Lehman Brothers

Then I just want to make sure I understand the different definition for the enrollments. When I look at the 293,000, it is not much different from the 295.6 last quarter. Were you historically also in counting, counting students who were not enrolled at the end of the quarter but had been enrolled shortly before that? How is this number different?

Kenda Gonzales

The count method -- it is more of a -- it is probably a coincidence that it is close to the same number, in all honesty. The count number was not consistent across all of our locations, and so by automating it, we have been able to make it consistent across all of our locations. The percentage increase, we restated the prior year so that you have the appropriate percentage increase.

Gary Bisbee - Lehman Brothers

Okay, and then just one last one. In answering a question a couple of minutes ago, you commented more about that you thought for the next year, the third quarter level of growth might be the better one to use than this recent quarter. How confident are you in that being able to bounce back in the next quarter, given that you are now a month and a half into it? Or is that more as we look out over the course of the year, you think you will be able to alleviate the situation?

Brian Mueller

More over the course of a year. We have made significant investments now, and we still are in this period where we are putting a lot of strain on people because of the changes going on. We are going to continue down that road and are really pointing in a lot of ways to third and fourth quarter.

Gary Bisbee - Lehman Brothers

Okay, great. Thanks for all the color.

Operator

Your next question comes from the line of Kelly Flynn with UBS.

Kelly Flynn - UBS

Thanks, a couple questions. Brian, I need you to clarify something from the last question, from Gary's question. You had previously said that one of the disappointing factors was the 40% start rate, if you will -- that 40% of the people that signed up actually showed up, but then --

Brian Mueller

60%.

Kelly Flynn - UBS

So it is 60%?

Brian Mueller

40% did not.

Kelly Flynn - UBS

Okay, that was my question, and that you said compares with 80% historically?

Brian Mueller

Right.

Kelly Flynn - UBS

Okay, all right. I got that. The second issue is talking about re-entry. That basically means someone dropped out and you were unable to get them back in. Is that correct?

Brian Mueller

Well, no. This is exactly how it works. You have adult students. You move into that period of time, the summer period of time, the student will call and say I am going to take a family vacation in the month of June, I cannot be in class, let me do it in July. They may do it in May when their kids first get out of school. So a schedule change is made, the course is dropped, the student is not in during that time.

Somebody who is very conscientious and very good will continue to work with that student to make sure that they come back when they first agreed to come back. If you are not in contact with that student, and if you are not really persistent with that student, they will not just not come back in June -- they will not come back in July, they will not come back in August. They may decide to come back in September.

What you lose is -- and when you lose three or four or five people like that across 1200 academic counselors, you lose a lot of potential students. It is just a little bit of attention and a little bit of improvement across a lot of academic counselors just to stay in touch with students to make sure that when they temporarily sit out, they come back when they first agreed to come back.

If you let it slip, it turns into thousands of students very quickly.

Kelly Flynn - UBS

Okay, because it sounds to me like that is just a drop-out issue that could very well be tied-in with the lower graduation rates at Axia. I do not understand why you are talking about an execution issue when it seems like in fact it is probably just a structural issue related to the student’s profile at Axia. Can you help me understand that?

Brian Mueller

Yes, well, no, it is not. Those are two separate issues. The Axia College student and the dropout rate is absolutely an issue, because as we have stated, in the students, in the [program] that we evaluated, 32% graduated. Obviously, 68% did not. They dropped and they are not going to graduate.

But that is as compared to those same students previously in our company where we only graduated them at the rate of 7%, so drop-out rate is a huge issue for us and everybody else with inexperienced students. But we have improved that in the last number of months, because of the things that we are doing at Axia College.

But there is a separate issue, and that separate issue is your current students who are on track to graduate but who are kind of in and out of class at a greater rate, because of the flexibility of online, than they would be if they were in a ground campus. That is a little bit of a threat to the business model but it can be managed.

The upside of the flexibility of online and people's willingness to do it, you just have to offset that with making sure that you are managing that temporary out strategy the best that you can, because it can be managed and you can make significant progress on that.

Kelly Flynn - UBS

Are those students that you are talking about, that 10,000, are those basically bachelors and above? Is that safe to say?

Brian Mueller

Some of them are masters, some of them are bachelors, some of them our associates. It is across the board.

Kelly Flynn - UBS

All right, and then, a related question -- can you talk about what is going on in the masters category, why that is deteriorating so much? With that, what is going on with competition? You mentioned the law of large numbers in your initial comments, but is competition an incremental negative here? If so, where is it coming from?

Brian Mueller

We are watching the masters degrees numbers. We have opportunities to improve that, and it lies primarily in those programs that are very popular that we are not able to offer in all of the states because of regulatory issues.

The MBA program and all the programs related to the MBA programs, that is a stagnant thing from our standpoint. We are evaluating that in terms of what are we offering in our curriculum and in our program that may or not be helpful to improving that? That is how we are looking at those programs.

The MAED program is a very good example of a program where we would have the potential to get the growth going again at the masters degree level. That is a regulatory problem that we are working on, because there are some states who just do not allow us to offer that program in those states in an online delivery format.

We are looking at it program by program, and I think some programs that are at the masters degree level that are stagnant, it is the result of the fact that there is competition out there and that our program might not differentiate itself the way it did in the past. We need to address that. The other part though is that there are programs that we have that are very marketable, being held back from a regulatory perspective, and we are working on that as well.

Kelly Flynn - UBS

Okay, so to say it another way, why is the masters headcount down? Is it competition? The issue of regulatory approvals could sort of explain why it is not growing, but --

Brian Mueller

I would say it is competition from an MBA standpoint, from a management standpoint, those graduate programs, and we need to address that. I think that is competition. We could offset that if we make some improvements on the regulatory side.

Kelly Flynn - UBS

Where is the competition coming from? What types of schools?

Brian Mueller

Overall, if you look at both from a baccalaureate standpoint and a masters degree standpoint, the biggest competition that we have is the accumulated effect of the traditional universities doing a little bit in online education.

Five, six years ago, seven years ago, 90% of the students who were interested in doing a program online, either at the baccalaureate or masters level, did it through the University of Phoenix. Over time, traditional universities have gotten involved in online education and they do a little bit. That accumulative effect has had an impact on us to some extent. I cannot quantify it, but it has had an impact.

We have always been in a position where we have had to be better than those state universities in terms of the services that we offer to students. We are just going to have to continue to get better.

Kelly Flynn - UBS

One last one. On the bad debt, Kenda, you referenced this Axia financial aid forms issue as the lingering issue. I thought from previous quarters' comments that issue is under control, but now the bad debt has spiked back up, so what is the deal?

Kenda Gonzales

I think in the previous quarters, we had indicated that would be an issue through the fourth quarter. I think that was an issue through the fourth quarter. It is just at this point in time, with the gap and some of the other things that we are looking at, I am not sure I am prepared to give guidance as to what it would be going forward.

Kelly Flynn - UBS

Right, but it spiked up a lot, so it does not imply that it is still an issue -- it implies that something got worse between last quarter and this quarter, so what got worse?

Kenda Gonzales

The dollar amounts that were written off. It was just timing as to when the students came in and when they would get written off.

Kelly Flynn - UBS

Thank you so much.

Operator

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

Robert Craig - Stifel Nicolaus

Good morning, everybody. Brian, I know you made a lot of changes, but what on average should be the time period it takes for a recruiter to reach full productivity?

Brian Mueller

Six months.

Robert Craig - Stifel Nicolaus

Six months?

Brian Mueller

Yes. There is a big difference between those that are six months and over and those that are a year and over, but yes, it gets significantly better at six months for most people.

Robert Craig - Stifel Nicolaus

What is a reasonable expectation for the number of students each rep should bring in, given the changes that again you have made to the system?

Brian Mueller

We do not know that.

Robert Craig - Stifel Nicolaus

Once they reach full productivity?

Brian Mueller

It is not information that we have shared traditionally. We know what it is. We know what we can kind of expect.

Very honestly, where we are hoping to get a bump over where we have been in the past is with a greater percentage of all of our enrollment counselors being able to offer all three options to students. We have some evidence that is the case, that a person who becomes very good at that and having all those options will increase their productivity on a monthly basis.

Very honestly, if we find out that is true, we will be pushing more of the sales force out to the field, because an online enrollment counselor in Phoenix can certainly put the student in Axia College or University of Phoenix online. For that person to put the student on ground in Miami, Florida is very difficult, because they do not understand Miami. Where are the learning centers? What are the traffic patterns, what are the specific ways they enroll students, et cetera. That kind of limits what you can do with the person back in Phoenix.

Robert Craig - Stifel Nicolaus

One follow-up to a question that Greg asked. Despite some of the student preference studies that you have mentioned, certainly we have seen the economic return is very favorable on an online student, but from an academic success standpoint, might it make sense to direct more younger or less experienced students to on-ground programs, as opposed to online?

Brian Mueller

Possibly, and I will tell you one thing that we are experimenting with right now that I have high hopes for, and that is a student that goes to our ground campus, and when they start their ground campus program, that group that they are in is put on our online learning system.

They attend class let's say on Tuesday night but, between Tuesdays, they will be in the online classroom interacting with their learning team and with their cohort of students and with their faculty member, therefore, being able to submit assignments exactly when they are done, getting them returned in a period of time that is very acceptable and allows them to use that feedback to go on to their next week of work, being able to have their questions answered by the instructor within a 24-hour timeframe versus waiting until next Tuesday.

I think that is the next kind of blended model. There are two blended models that we are working on, that we are thinking about, but that is one that we are experimenting with right now. Class attendance and what you can get out of that could be very, very important for some people.

But to combine that with being able to consistently interact with your faculty member in that online learning system between class sessions, I think will improve the success rate of students even more.

That is something that we will hopefully be moving to across the board.

Robert Craig - Stifel Nicolaus

Do you envision, Brian, the offering of a fully on-ground Axia program at some point? Might that be a big percentage of the total, or a decent percentage of the total at some point?

Brian Mueller

Possibly. Possibly, but I would say that if we do take the program and put it in an on-ground delivery format, we would combine that class attendance with a component of -- because we would never want to take those entry-level students who have little college experience, put them in class on Tuesday, and then not have them touch base with an instructor again until the next Tuesday. That just does not work.

We want our students to be able to work with their faculty members every day, if necessary, especially in those first three, four, or five courses.

Robert Craig - Stifel Nicolaus

Okay, that is helpful. A couple quick ones -- you mentioned the pricing adjustments possibly on level three, level four, was 60%, maybe down 40%. I take it that would equate to an overall reduction system wide, and if I think --

Brian Mueller

It would at that three and four level, but we are hoping, with the analysis that we are doing, that gets offset by the fact that everybody, a 70% that are one and two are going to go up, and then 100% that are five and six would go up.

Robert Craig - Stifel Nicolaus

Any idea of the percentage decline that would represent in level three, level four?

Brian Mueller

No, we are still working on it.

Robert Craig - Stifel Nicolaus

Last one, and sorry to be so long -- Kenda, does the definitional change of enrollment substantially affect prior period numbers?

Kenda Gonzales

It did not obviously in the fourth quarter, and I have not really done the analysis for the go-forward quarters, but again, the percentage growth, we will restate the prior years to make sure that they are consistent with the current definition that we are using.

Robert Craig - Stifel Nicolaus

That is helpful. Thanks.

Operator

Your next question comes from the line of Chris Gutek with Morgan Stanley.

Chris Gutek - Morgan Stanley

A couple questions, I will make it quick. The company is spending a lot of money here in the short-term on sales and marketing, and direct educational costs as well, and you partially responded to the issue with Howard's questions, but I am curious. Looking at not just the sales and marketing costs going forward, but overall operating profitability, recognizing you are not getting full benefit for some of this incremental spending in the short-term, how do you guys think about that short-term versus long-term trade-off? Specifically, how much further margin erosion would you guys find acceptable to be a better top line performance?

Brian Mueller

We would not consider any margin erosion acceptable. Our goal is to not allow that to happen.

I will tell you that there are a lot of factors that impact that, but really there is only one that has a significant impact, and it is retention. If we are able to keep students around longer and get them to persist to graduation, everything else changes. You need less advertising, you need less salespeople because you need less new starts.

For four or five years, no more than that, or maybe a ten-year period of time in our company's history, we did not have to be as good as we could have been at educating students and at servicing students. I think we were better than most or maybe everybody, but we were not as good as we could have been. We always were able to offset that with sales. When you get to Apollo Group having 300,000 students, you cannot offset those lower retention numbers. You cannot outrun them with marketing and sales.

If we can move that retention needle three, four, five, six, seven percentage points, it takes the pressure off of marketing and sales, reduces costs, and allows us to maintain our historical margins.

Chris Gutek - Morgan Stanley

As a related follow-up, recognizing you are not giving guidance, is your confidence increasing or decreasing on the company's prospects, given this latest performance? If it is increasing, what do you see that we might be missing?

Brian Mueller

In terms of my own thinking about our company's prospect, it has not changed.

The things that happened, the two things I mentioned that happened in the fourth quarter that were disappointing, those things are certainly disappointing but those things we can fix. Nothing that happened in the fourth quarter changes my thinking with regard to what the company's prospects are.

Chris Gutek - Morgan Stanley

Finally, with the stock down significantly, what about the thinking on share repurchases? Has that changed?

Brian Mueller

It does not change because we are in the process, or have been in the process over the last number of months, of planning to get very active with regard to that. You can expect us to do that as soon as we get the backdating issue resolved and can be legally back in the market.

Chris Gutek - Morgan Stanley

Great, thanks.

Operator

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

Jeff Silber - BMO Capital Markets

Thanks for your patience, appreciate it. In prior quarters, you have given us some growth rates in terms of your online enrollments. Can we get a gauge of that, how it did last quarter?

Kenda Gonzales

You know, we are going to be moving away from providing that, just because for us right now, having the on-ground enrollment counselors enrolling into the online programs, et cetera, that is not how we are running the business anymore.

We are looking at if there is other data that we could give that would talk about online students within certain ZIP codes around our on-ground campuses, et cetera, but at this point, I do not have that information developed to be able to provide that.

Jeff Silber - BMO Capital Markets

Okay, that's fair. Brian, you had given out a number, about a 93% persistent rate for those Axia students that have transferred into UoP. How do you define that? Over what period are we talking about?

Brian Mueller

Those students who graduated and entered University of Phoenix, if they finished the first 15 credit hours, we counted them as persisting.

Jeff Silber - BMO Capital Markets

How many credit hours would they need to complete their degree at University of Phoenix in total?

Brian Mueller

120, so most of them are going to be doing in the vicinity of 60 credits.

Jeff Silber - BMO Capital Markets

Finally, one more, in drilling down into one expense line item in terms of instructional cost and services, the employee compensation and related expenses went up fairly dramatically. I know that does not include faculty. What type of folks are we talking about? Why did that line item go up so much?

Brian Mueller

It is a variety, but it is mainly IT.

One of the things that we are looking at is what percentage of wages and salaries we are spending on our IT workforce, because it has grown really, really significantly. In saying that, all the projects that they have on their table to improve the online learning system, the student scheduling system, what we call the other operating systems, IS3, et cetera -- there is just a lot of software that we are in the process of developing that could improve the operations of our business.

We know right now, for a company our size, the amount of wage and salary that we have invested in technology is more than the average. At this point, we believe it is justified because of the amount of operational improvement we could experience by continuing to develop software products that we can give our people. Over time, will we have a chance to bring that down? Possibly, but that is where the majority of that is.

Jeff Silber - BMO Capital Markets

Okay, thanks. That is helpful, appreciate it.

Operator

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

Corey Greendale - First Analysis

Good morning. Brian, on the retention, the things you talked about specifically sound like they relate more to online, and if I missed this, I apologize, but can you comment on the retention in the on-ground campuses?

Brian Mueller

It is slightly better than online, and the reason I focused on online is because so many students that are going to Axia College, at this point it is just online.

But the retention rate of students at our ground campuses, being a couple percentage points in front of online, it could get significantly better. It could get better in our opinion, and I think especially at the lower levels, it has most to do with how much support we can give students and consistent support we can give students from a faculty standpoint.

That is why the baccalaureate students on-ground, we are starting to experiment with things like putting them on the online learning system so that they can maintain contact with their faculty and fellow students between class sessions. We have a mentor program in place where we use a senior level student and assign them to an entry-level student as a student mentor, and they work with that student throughout the first couple of courses to help them with how to become an effective student at the University of Phoenix.

We are doing things like that in order to increase the retention rate on the ground campuses.

Corey Greendale - First Analysis

Was on-ground retention down year over year?

Brian Mueller

No, it is about the same.

Corey Greendale - First Analysis

With that in mind, it sounds like there are some operational things that contributed to the retention decline online. I am just wondering why you think that a price decrease makes sense as part of the retention program.

Brian Mueller

Well, it is not going to be just a price decrease. It would be a price increase at level one and two, which is going to impact a huge percentage of our students. It will be a price increase at five and six, and it would be a price increase for about 40% at level three and four, and a price decrease about 60%. At the point we are done with the analysis, we hope that we are in a situation where it is very revenue neutral, so it is not a price decrease.

Corey Greendale - First Analysis

I just mean on that portion of it, given that the price was not up that much year over year, I am just wondering what makes you think that pricing is part of the retention issue for those 60%.

Brian Mueller

Oh, well, because you can do an analysis, which we have, which points to it just very directly. It is unbelievably correlated. You can select students from Southern California, for example, which is a very high tuition rate. You can watch them go through their first course. You can watch them go through their second course, and then when they get to their third course, where there is out-of-pocket expense, the retention rate goes down 10%.

You can go to another campus that is a little bit less expensive, and you can watch them go through it from course one to two to three, and then they get to course four where there is an out-of-pocket expense, and it is 10% down.

You can do the same thing at online. Online is pretty much like Southern California at the baccalaureate level. You go one, two, and at number three, you are going to have out-of-pocket, you go down 10%.

There is an unbelievable correlation between when the student first experiences their out-of-pocket expense and their retention percentage.

Corey Greendale - First Analysis

The second question is, obviously I would imagine you are pretty focused on the existing business. I was wondering if the fact that you are below the acceptable growth rate that you are looking for changes your thinking on international acquisitions or the potential timing.

Brian Mueller

No, it does not. If we do something in Latin America -- if we do something, it would be potentially and probably in Latin America and it would be something that we believe that we could apply the appropriate management resources to that would not detract from what we are doing from a domestic standpoint.

If we think that any acquisition internationally will detract from our focus on what we are doing domestically, I can guarantee you that we would not do that, because we have too much to gain here.

Corey Greendale - First Analysis

So you are ready, willing and able, it is just a question of getting the deal done essentially?

Brian Mueller

Getting the right deal done.

Kenda Gonzales

Finding the right property.

Brian Mueller

At the right price, with the management need that we think we can fill without detracting from our domestic operations.

Corey Greendale - First Analysis

Okay, and then Brian, at the beginning of your comments, you said something about changes in the economy and in the higher ed space that is affecting your performance. You do not need to repeat what you said in answer to Kelly's question about competition, but anymore you could add to the economy and the higher ed space that you were referring to?

Brian Mueller

Yes, the economy is just -- if you think back 10 years ago, our students were, their average household income and the percentage that had tuition reimbursement support from their employer, those things were much higher. We are still getting those students, but we are getting a lot of students who are at more entry-level positions in the economy.

It is just the squeezing of the middle-class and the fact that more and more of the population is lower middle-class or lower class, and we are working and dealing with those students. That is a different student to deal with because of their economic conditions than when we dealt with 100% of those other students.

Corey Greendale - First Analysis

Last quick one for Kenda, I know you are not giving guidance, but can you share any thoughts on what you think cap-ex and tax rate might come in for next year?

Kenda Gonzales

I would say the tax rate would be in the range where it has been for the last couple of years, and cap-ex, I really do not have any guidance to give on that at this point.

Corey Greendale - First Analysis

Thanks very much.

Kenda Gonzales

Operator, I think we are going to take two more questions here. I do not think we have time to do any more than two more.

Operator

Your next question comes from the line of Jennifer Childe with Bear Stearns.

Jennifer Childe - Bear Stearns

What percentage of your leads are level three and above?

Brian Mueller

I have not looked at that in a couple of months. The percentage of leads that are level one and two leads would be about 55% -- 45% of all other leads then are either baccalaureate or masters degree leads, and I do not have that information, that breakdown in front of me right now.

Jennifer Childe - Bear Stearns

That is fine. That is what I was looking for. Are your conversion rates with your mature counselors up?

Brian Mueller

No, I would say they are stable at this point, but as we get better at right pricing leads, I believe that they will go up.

Jennifer Childe - Bear Stearns

Are there different conversion rates, or drastically different conversion rates, according to the level of the student? Are you seeing any changes?

Brian Mueller

There used to be. We used to convert leads that were in that level one, two category at significantly lower rates than we did students that were in those three, four, five, six categories. We are still do not have an equal conversion rate with those one and two students but it is getting closer to -- the one, two students are starting to convert at a rate closer to the three, four, fives and sixes.

Jennifer Childe - Bear Stearns

Are you back to an 80% start rate, or are you just better than a 60% start rate?

Brian Mueller

Now, you are talking about from application to start?

Jennifer Childe - Bear Stearns

Yes.

Brian Mueller

Let's see, we were at around 60%. I do not know. I will know that when our September numbers are complete and I will know better when our October numbers are complete. We are above 60. We are not to 80.

Jennifer Childe - Bear Stearns

Your example with the student who tells you he will sit out June but does not come back in July or August, would he be included as an enrollee?

Brian Mueller

No.

Jennifer Childe - Bear Stearns

Last question, will the national branding include Axia?

Brian Mueller

Not initially.

Jennifer Childe - Bear Stearns

Okay, thank you.

Operator

Our final question comes from the line of Mark Hughes with Numis Securities.

Mark Hughes - Numis Securities

Thank you very much. That mix of leads between one and two and three and four, have you shifted your marketing strategy in order to tailor that lead volume? Or is the marketing strategy fairly similar, and that is just the way they have been coming in lately?

Brian Mueller

Yes, the important thing to note about that is not that we -- if you look at our promotional literature, if you look at the words that we use, if you look at how we are explaining and describing ourselves, it has not changed at all.

The thing that has changed is that we are still getting an increase in the number of leads that we got in that old student category 34-, 35-years old, 45 or 50 credits to transfer, or a masters degree student. We are increasing the number of leads that we get in that category. We just cannot increase it enough to get northwards of 10% enrollment growth with just those students. That is one part of it.

The second part of it is that the 21-, 23-, 25-, 26-year old student, there is just a huge demand in the country right now because those people are experiencing the fact that they are not going to get to middle-class status like their parents did without a college education.

They are working at Wal-Mart, they are working at entry-level jobs, and it is not working out and they have been doing it for four or five years. They see our ads out there and they are raising their hands saying “I have to do it -- maybe this will be the way it will work”.

It is just a big explosion with that group of people. It is really responding, but it is responding to our traditional advertising in the traditional places that we have advertised.

Mark Hughes - Numis Securities

So essentially, the net is the same, you are obviously committing more resources to it. The leads that you are pulling in, you have more of a mix of younger students recently. Is that fair?

Kenda Gonzales

Slightly younger.

Brian Mueller

Slightly younger, but the biggest thing is they are less experienced from a college standpoint, and then less predictable in terms of how successful they might be.

Mark Hughes - Numis Securities

Thank you very much.

Brian Mueller

We really appreciate you staying with us for the full hour-and-a-half, or more, and appreciate your questions. Thanks again for your attendance and we will see you again in a couple months.

Operator

This concludes today's conference call. Thank you for your participation.

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