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Apollo Group, Inc. (NASDAQ:APOL)

F2Q10 Earnings Call

March 29, 2010 8:00 am ET

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

Andrew Steinerman - J.P. Morgan

Gary Bisbee - Barclays Capital

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

Andrew Fones - UBS

Arvin Bhatia – Sterne, Agee & Leach

Ariel Sokol - Wedbush Morgan Securities Inc.

Corey Greendale - First Analysis Corp.

Jerry Herman – Stifel Nicolaus

Kelly Flynn - Credit Suisse

Analyst for Mark Marostica - Piper Jaffray

Paul Ginocchio - Deutsche Bank

Sara Gubins - BofA Merrill Lynch

Suzanne Stein - Morgan Stanley

Trace Urdan - Signal Hill Group, LLC

Scott Schneeberger - Oppenheimer & Co.

Paul Condra – BMO Capital

Bob Wetenhall - RBC Capital Markets

Brandon Dobell - William Blair & Company, LLC

Operator

Welcome to the Apollo Group, Incorporated fiscal 2010 second quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to Allyson Pooley, Vice President, Investor Relations of Apollo Group. Miss Pooley, go ahead please.

Allyson Pooley

Thank you and good morning everyone, particularly those on the West coast where it is very early. We appreciate you joining us. Participating with me on the call today are 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. 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 second quarter of fiscal 2010 which ended February 28, 2010 to the second quarter of fiscal 2009. I would 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 Chas will provide highlights of the quarter and discuss our view with respect to the current events in Washington. Greg will give you an update on our primary investment areas and an update on University Orientation. Brian will then review our financial results and provide you with our outlook for the third quarter.

I will now turn the call over to Chas.

Charles Edelstein

Thanks Allyson and thank you for joining us today to discuss our second quarter results. We are pleased to report solid results and importantly to share the progress we are making in our efforts to shift our student mix to higher degree levels.

In the second quarter including our acquisition of BPP, revenue grew approximately 23% to $1.1 billion and net income from continuing operations excluding special items was $130 million or $0.84 per diluted share. Consistent with our expectations, University of Phoenix experienced greater Bachelor due to enrollment growth but slower growth in the Associate level. In total, we enrolled 87,500 new students during the second quarter for a total degree development of 458,600 students. That is a 15% increase in total degreed enrollment versus a year ago.

During the second quarter there was one less Monday than in the second quarter last year which adversely impacted new enrollment by about 500 basis points and of course the impact was even greater at the Associates level. As a reminder, there will be one extra Monday in the third quarter which will positively impact our reported new enrollment at that time.

Now let me spend a minute on our primary objectives for the business and our views on the recent events in Washington. Our management team continues to focus on lowering our risk profile as part of our effort 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. To that end, we continue to actively monitor the rule making process and other developments in Washington. It is important to support the Department’s efforts to enhance accountability within higher education and we strive to play a leadership role in that regard.

In general we encourage education policy which supports congressional intent and we advocate for consensus building rule making in order to achieve responsible education policy nationwide. Importantly we caution against policy development with the potential for unintended consequences that could restrict educational access, limit career choice or unfairly disadvantage historically under-served student populations. Because of that we are engaged in constructive dialogue with the Department of Education and legislators regarding the pending gainful employment provision in order to help by providing our perspective on what the consequences of that provision in its current format could be.

At the same time, we are in the process of analyzing our University’s more than 100 degree programs to determine debt to earnings ratios, median loan balances and loan repayment status by program of study. Given the number and range of disciplines offered by our universities as well as the uncertainty regarding the implementation process of the draft proposal, our analysis is both extensive and complex.

The rule making process is ongoing and as such we can’t predict what the final outcome of gainful employment will be but we are hopeful that together we will arrive at a position which addresses the underlying goal; that of providing students with quality education while not over-burdening them with debt and do so without having unintended consequences which could be detrimental to both students and society as a whole.

At Apollo we remain committed to doing the right thing for students. We have several initiatives in place which are allowing us to transform and improve the student experience across our universities to ensure optimal student outcome and greater administrative oversight. Inherent in this process is a commitment to high quality, practical and accessible educational offerings which combined with a positive student experience should result in sustainable long-term growth. We promote responsible borrowing practices and are committed to enhancing financial literacy. To this end we have introduced a series of tools to assist students in better understanding the direct and indirect costs of their education, enabling them to make informed decisions.

In summary, we take our responsibility as a leader in education for the working learner very seriously and are committed to being a role model within our industry. Now I will turn the call over to Greg to he can provide an update on some of the initiatives we are taking as an industry leader.

Gregory Cappelli

Thanks Chas. Good morning everyone. Today I would like to focus on a couple of key areas with respect to the University of Phoenix and our strategy and then give you a brief update on Apollo Global as well.

As you know, the University of Phoenix is our top priority for investment within the Apollo Group and we remain steadfast in our goal of delivering high quality college level programs to all of those who are willing to put in the effort and believe they can benefit from a college education. We want to deliver the best student experience we can to those enrolled in our universities which means high quality academics and outstanding service all tailored to the student needs. To that end we continue to invest in our curriculum and technology and in fact we have begun rolling out our components of our new learning platform and data platform this quarter.

Every month our talented team brings new and innovative ideas to the table, all of which help us in our quest to reinvent education again, not only in this country but globally as well. However, the University of Phoenix is not for everyone. While there is tremendous demand for a college education today there are also more students that are under-prepared for the challenges and rigor of our programs. Last quarter we shared with you some of the ways we are addressing this issue including University Orientation, student protection, enhancements to our learning platform and refinements to our marketing efforts.

We continue with each of these initiatives and are pleased with the progress we are making. We also talked about the fact that University Orientation carries with it some near-term impacts including reduced new associate enrollment growth. Most importantly we strongly believe the steps we are taking are the right thing to do for our students and despite any near-term volatility in our enrollment or financial metrics, if we are successful they should result in significant value creation for all of our stakeholders. This is because we expect University orientation to improve overall retention, lead to better graduation rates and lower bad debt and that means better long-term profitability and cash flow growth.

Let me just take another minute on this important, relatively new program. University Orientation is a free, 3-week program designed to help our new students with limited college experience better sample and understand the requirements necessary to be successful prior to starting their degree program. Importantly, prior to taking on any college debt students must complete the program before they can attend our University. We are still in our test and evaluation phase of the Orientation program, however, similar to the first quarter it had a fairly significant impact on new enrollment growth.

For the second quarter we reported new enrollment growth of 9.4%. Now adjusting for the number of days in University Orientation, new enrollment growth would have been about 19% and the impact on new enrollment at the Associate level was even greater. We are monitoring the results of this pilot very carefully and while our sample size is still relatively small it has grown and we are very encouraged by the early results particularly the retention rates of the students that complete the program which are significantly higher.

Additionally, feedback from our students regarding the program is very positive. It is still early but it is looking like the program is effective and we plan to continue with the pilot. Because of this we anticipate associate new enrollment growth could actually decline in the third quarter. That said, we have been working hard to reinvigorate our Bachelor’s level programs which has been paying dividends. Because our Bachelor’s students have better retention relative to Associate students this should positively impact incremental profitability. While there is still much to do we are really excited about the initial results of this important program.

Let me just quickly address student persistence. In the second quarter we again saw a decline in the persistence rate at the Associates level. However, persistence turned around this quarter at the Bachelor level. Helping students succeed continues to be one of our primary areas of focus at the company and we hope that the initiatives we are taking such as University Orientation will help drive improvement over time particularly at the Associate level students.

I would also like to touch on some of the branding and marketing efforts we have been investing in over the past couple of years. As our capabilities continue to get better in the areas of data mining and analytics we are now better able to direct our marketing spending to reach students we think will have a better chance of success at the University of Phoenix. In the second quarter we again enjoyed solid growth in our new Bachelor enrolments which we think are a direct result of our efforts in this area including the many improvements we have made to the University of Phoenix website.

We also continue to see greater matriculation into the Bachelor’s program from the Associate’s program and if University Orientation is successful we hope to see more potential transfers over the long-term. With our Bachelor enrollments now moving in the right direction we are turning our efforts towards Master and Doctoral programs and we hope to eventually have a similar impact there.

Just a brief update on Apollo Global. First, our schools in Chile were affected by the earthquake last month. However, we were relieved that none of our employees nor their family members were injured in the quake. The earthquake occurred while school was out for the summer so thankfully no students were there. We did have some damage to our campus, however in the grand scheme of things it was relatively minor and we were able to begin classes on schedule. We take our hats off to the Chileans for their high level of preparedness and the resilience they have demonstrated throughout this crisis. It is this strength of character that makes Chile such a compelling strategic market for Apollo and Apollo Global.

As a point of interest, we have a first mover advantage in the online education market in Chile. In less than a year we have been able to enroll more than 1,400 students into our online program there. We are very excited about the prospects for the future in Chile.

Regarding BPP, revenues are suffering a bit from the lingering effects of the economic crisis. However, we are beginning to see some evidence of stabilization. Despite the challenging economic environment we continue to invest in BPP. Not only is it a critical part of our global education network but it provides a global platform in its own right. The British education system is respected around the globe and we believe our ability to award accredited degrees worldwide represents a tremendous opportunity.

Before I turn the call over to Brian I want to touch on our share repurchase program. During the second quarter we repurchased 3.4 million shares at an average price of just under $60 per share. Additionally, in mid-February our board increased our authorization by $500 million. As of today we have $800 million available under the current repurchase authorization. As you know we have a disciplined capital allocation process and share repurchases are part of that plan and we will continue to use our capital to repurchase shares when we believe it appropriate.

In summary, we have a lot going on at the Apollo Group and the University of Phoenix. We are investing in all areas of the business and we understand the new direction we are taking with our most important asset, the University of Phoenix will require great care, sound judgment and constant monitoring. These are bold steps we are taking, but we believe are the right steps for an organization that is intent on reinventing education again on a global scale.

So with that I will turn the call over to Brian.

Brian Swartz

Thanks Greg. Good morning everyone. I would like to start by providing you a summary of our second quarter financial results. Revenue increased 23% compared to the same period a year ago. Excluding $53 million in revenue from BPP revenue growth was 17%. The components of this increase were primarily University of Phoenix’s 15% total enrolment growth combined with increased tuition rates.

As expected, revenue growth was impacted by higher discounts to our military students which we expect to continue. Net income from continuing operations was $103 million or $0.67 per share compared to $129 million or $0.79 per share in the second quarter a year ago. During the second quarter we entered into settlement talks in regard to a securities class action lawsuit. As you may remember the case was ruled in our favor by the court back in August of 2008 and the plaintiff’s appealed that ruling. A ruling has not been made on the appeal.

As a result of settlement discussions which did not result in a settlement we accrued $44.5 million for this liability during the second quarter. If we exclude this charge net income from continuing operations was essentially flat versus a year ago at about $130 million and EPS increased 6% to $0.84 per share versus $0.79 per share a year ago.

BPP’s operations reduced our EPS by $0.06 per share principally due to their seasonally soft second quarter revenue. Operating income declined in the quarter to $173 million. Excluding the litigation reserve operating income increased 3% to $217 million. However, we saw a nearly 400 basis point decline in operating margin primarily due to BPP’s cost structure and increase in bad debt expense. Excluding the impact of BPP’s operations margin contraction would have been about 180 basis points.

Now I will spend a minute discussing each of the expense categories, starting with instructional costs and services (NYSE:ICS). The significant increase in ICS was primarily driven by BPP’s expenses as well as a 280 basis point increase in bad debt expense. Bad debt expense as a percentage of revenue was 6.9% compared to 4.1% a year ago. BPP’s operations positively impacted bad debt expense as a percentage of revenue by 40 basis points in the second quarter of fiscal 2010. As we indicated in February, the year-over-year increase in bad debt expense is the result of lower collection rates on older receivables due in part to the difficult economy and a larger portion of Associate students at the University of Phoenix as well as operational changes made during the fourth quarter of fiscal 2009.

We believe the bad debt expense in the third quarter on an absolute dollar basis will be slightly less than the second quarter level which should result in a fairly significant decline as a percentage of revenue due to our seasonally higher revenue in the third quarter. We are seeing some signs of stabilization in bad debt expense in the quarter but it is too early to tell if that trend will be sustained into the fourth quarter. We are taking steps to lower our bad debt expense. However, we believe the biggest improvement will come over time as we shift our student mix towards Bachelors and Graduate degree level students and improve retention particularly at the Associate level.

Selling and promotional expense as a percentage of revenue was at 120 basis points. However, BPP’s operations accounted for the majority of that improvement. We also continued to see 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.

Finally, G&A. G&A was down 130 basis points as compared to a year ago primarily due to the unusual expense in the year-ago quarter resulting from our review of our satisfactory academic progress calculations as well as lower share based compensation as a percentage of revenue in the second quarter of fiscal 2010. In the second quarter share based compensation totaled about $15 million. We believe share based compensation for the fiscal year will be about $65 million. Our effective tax rate in the second quarter was 40.6%. We expect our effective tax rate in the third quarter to be about 41% and in the fourth quarter to be about 40%. The reduction in the fourth quarter rate is a result of a discrete item we expect to report in that quarter related to the release of an uncertain tax position. These rates 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 flow. We continue to maintain a well capitalized balance sheet as of February 28, 2010 with unrestricted cash and cash equivalents of $661 million. Our outstanding debt was $176 million at February 28th versus $589 million at the prior year-end. During the second quarter our adjusted free cash flow remained strong excluding the impact of two one-time payments. The first was an approximate $80 million payment in connection with the settlement of our Qui Tam lawsuit and second was an approximate $23 million payment to the IRS related to our taxes due. 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 quarter declined to 30 days from 32 days at August 31, 2009 but was slightly higher than the 25 days a year ago. The year-over-year increase is primarily due to the previously discussed operational changes at the University of Phoenix as well as increases in accounts receivable due to lower collection rates.

Now I would like to provide a brief update on the SEC’s informal inquiry which we originally announced in October. We have and will continue to fully cooperate with the SEC. Since the inquiry began we and our auditors have provided information and documents to the SEC at their request. These requests have been for information related to revenue recognition practices and other matters including policies and practices related to student refunds, the return of Title IV funds to lenders and bad debt reserves. We continue to believe that our accounting policies are appropriate and in accordance with GAAP.

Finally, before we take your questions I would like to share with you our current business outlook for the third quarter. This outlook is based on our current business trends. Of course many things can, and will change. We talked earlier about our plans with marketing and the University Orientation and the impact they might have on new enrollment. Given the student mix transition we are undertaking, we want to help you understand how we expect that to translate into our operating performance in the near-term.

It is important to note we are intensely focused on long-term value creation which means we make investments where we believe we can create long-term value even if they cost us near-term margin dollars. However, we also recognize our near-term operating performance is important to our stakeholders. Based on our current business trends which as I mentioned earlier could change, third quarter revenue should be approximately $1.3 billion which includes $75-80 million in revenue from BPP. Absent any additional share repurchases and thus assuming approximately 153 million diluted shares outstanding as well as a tax rate consistent with my previous comments this results in earnings per share of approximately $1.55.

This includes a contribution from BPP based on current exchange rates of approximately $0.03 per share. Additionally, based on current trends for the full-year 2010 we should achieve our long-term operating income growth target of mid-teen’s growth excluding the impact of special items and discontinued operations. We also want to remind you that BPP’s business has significant seasonality with the fourth quarter being its weakest. Barring further economic weakness in the U.K. we would expect BPP’s revenues at current exchange rates to be approximately $35 million in the fourth quarter and for them to generate a loss per share of approximately $0.13.

With that I will turn the call over to the operator so we can take your questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Andrew Steinerman - J.P. Morgan.

Andrew Steinerman - J.P. Morgan

My question is about the difference in operating margin between Axia degrees and Bachelor degrees? I think it was mentioned starts might go negative on Axia and I guess that means it is possible that at some point revenues might go negative on Axia and so my question is will the mix shift to Bachelors given the great Bachelor starts be a lot more meaningful than any negative operating leverage that might happen if Axia revenues go negative?

Gregory Cappelli

That is a good question and obviously the profitability at our Bachelor level is significantly higher than that in the Axia area. What we haven’t discussed exactly is the mix shift and how it would impact profitability. Your intuition is correct that there should be an offsetting effect there regardless of revenue on the profitability from the mix shift.

Brian Swartz

The only thing I would add is many of our Associates students today aren’t with us for very long as you can tell from our operating statistics we provide. Although we are generating some revenue from them there are many of them we don’t generate a lot of revenue from and a lot them that we lose money on. So do some implied math to get to some of those numbers based on the data we provide.

Andrew Steinerman - J.P. Morgan

Do you have any preliminary sense for the students that enroll in the Orientation? What percentage actually go on to enroll in degree classes?

Joseph D'Amico

We do. We have that data and we are continuing to analyze that in terms of the pilot program.

Andrew Steinerman - J.P. Morgan

Is it as you would have planned?

Joseph D'Amico

Yes, consistent with our expectations.

Operator

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

Gary Bisbee - Barclays Capital

Given the prospects for negative starts at Axia it seems to me that has to be the big thing behind the bad debt going up. Is it reasonable to think we could actually see bad debt on an absolute basis start to come down as we move forward over the next year? Or is there some reason maybe that might be a little bit aggressive a statement at this point?

Gregory Cappelli

I would expect over time as we execute on the mix shift that the bad debt would come down. When exactly that happens and what quarter would depend on how successful we are at that mix shift change. The majority of our bad debt expense is related to Associates so as we change that mix you would expect the expense to come down over time.

Gary Bisbee - Barclays Capital

Can you give us any more color on what you have done differently to drive the better Bachelors? I know you have talked about getting more sophisticated in your marketing. Anything else you can tell to help us understand that? What I am trying to get at is how confident are you that you can continue to have a good teens or in the teens somewhere or better growth from starts in the Bachelors?

Gregory Cappelli

It is our goal. We are working very hard to do that. It is a combination of things. It is operational. We have talked about in the past putting the right sources in the right areas. That can stem from how you advertise and market and put the University of Phoenix out there, getting back into the local markets in a myriad of different ways. There are a lot of things that go together to drive Bachelor growth and we are working hard to do that. Hopefully those trends will continue.

Gary Bisbee - Barclays Capital

I know the long-term plan for BPP is to really get the college and degree granting part of the business going. What is a reasonable expectation as to how quickly that really ramps? Is there an awful lot of investment you have to make over the next year or two before you really start turning it on in terms of enrollment growth or is that something you can get fairly quick return on?

Gregory Cappelli

We have planned and continue to make the investments in BPP. We are very excited about their future. How quickly those enrollments come at the degree granting level we are anxious to see. We have high expectations for BPP. We have got a tremendous management team in place and a good plan in place to do that. It would be nice to see a little stability in their business outside of that in the U.K. That will come. We think their market position is healthy and good. Again, we are excited about the potential prospects for the degree granting business as well. Sorry I can’t provide more specifics there. We are very engaged in that and I mentioned in my prepared remarks that BPP is an important asset and piece of our goal going forward.

Operator

The next question comes from the line of Amy Junker - Robert W. Baird & Co., Inc.

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

Can we touch for a minute on some of the margins and the expectations for that going forward? You saw more leverage out of the selling and promotional than I would have expected. Is that something…was there something in the quarter that was specific or should we expect that trend to continue going forward?

Brian Swartz

Most of that improvement in the consolidated numbers was from BPP. In the supplemental schedule we have provided you can actually see the selling and promo with and without BPP. It is more or less flat. It is down just slightly excluding the BPP operations.

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

Seasonality on BPP…is there anything that would change that going forward on that line item specifically?

Brian Swartz

I think as we invest in BPP over time it will include more marketing, selling and promotional type expenses to grow the business.

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

If we can touch on the strategy shift to go after more Bachelors, I am curious I know you have talked a lot about this but are you primarily accomplishing that through a change in marketing strategy? I am assuming you are not turning away Axia students who are coming in so you are still getting a fair amount of starts there but how are you really accomplishing that? Is it just a change in message or change in how you are targeting your new students?

Gregory Cappelli

No as I said before it is a number of different things including where you put your focus and your resources and we are putting more of them into that area. There are other things that come into play. There are corporate alliances that are paying more dividends now that we are more focused on. There is just a lot more focus and effort from the whole organization being put in that area. It is a priority for us.

Operator

The next question comes from the line of Andrew Fones – UBS.

Andrew Fones - UBS

First, over the last three quarters we have seen much higher growth in deferred revenue, around 40% or more than we were seeing previously and we are currently seeing in overall revenue growth. Is that due to BPP or is there anything else we should be aware of?

Brian Swartz

At the end of the year there was very little deferred revenue in the balance sheet related to BPP that were mostly student deposits. So since the end of the year just given their seasonality, operations and their student intake a big chunk of the deferred revenue increase came from the BPP operations since year-end.

Andrew Fones - UBS

Our understanding regarding an SEC inquiry is within the same period of time the SEC has to make a determination internally whether or not to make an inquiry an investigation and that time period would have already passed. It appears as though the SEC inquiry remains as such. Can you just kind of discern as to your understanding whether that actually occurred that there was a decision made internally there at the SEC to keep this as an inquiry rather than expand the scope?

Charles Edelstein

We don’t have any indication there is any change there. We can’t predict the timing or the scope of the inquiry so we have disclosed to you what we know in that regard.

Gregory Cappelli

As far as we know though it remains an informal inquiry.

Andrew Fones - UBS

Could you tell us what you expect bad debt expense to be as a percentage of revenue in Q3 and [perhaps] what is implied by your guidance?

Brian Swartz

I am sorry, can you say that again? I didn’t get your question.

Andrew Fones - UBS

Looking for some guidance in bad debt expense for the third quarter if you don’t mind.

Brian Swartz

We expect it to be, as I mentioned, slightly down from Q2 levels.

Operator

The next question comes from the line of Arvin Bhatia – Sterne, Agee & Leach.

Arvin Bhatia – Sterne, Agee & Leach

I wanted to go back to BPP real quick. By my calculation the guidance you have given suggests about $0.17 per share loss this year. Obviously you have some plans down the road for growth in that business. Is there anything else you can do say in 2011 that can bring down those losses? Anything on the cost side or any other efficiency that you see as you continue to integrate and move forward with this acquisition?

Gregory Cappelli

Our team is working hard on those things including looking at new revenue opportunities and again some stabilization in the base business would be helpful. I think they are doing a good job overall controlling their expenses in this environment. We will continue to make investments for the long-term here. We were interested in BPP joining the Apollo Group family for obvious reasons that we have gone over extensively in the past and we are excited about those opportunities. We are looking at making investments for the long-term there but again we are not oblivious to the fact we want to try and make sure we are controlling the expenses to the extent we can while still making the investments that are important to the growth and future of BP.

Brian Swartz

The only thing I would add is obviously it is the first year of the acquisition. We went through purchase accounting so there is quite a bit of amortization of intangibles in that $0.12 to $0.13 loss number you mentioned.

Arvin Bhatia – Sterne, Agee & Leach

Are you suggesting then that goes down significantly? Could we be looking at a break-even number next year?

Brian Swartz

I am not commenting on 2011. I am just suggesting there is a lot of amortization expense that yes will go down over time and you can see that in our 10-K filing for last year and the level of amortization that goes down over time for the whole company.

Arvin Bhatia – Sterne, Agee & Leach

On the military student growth could you provide us some color on whether you are seeing acceleration or similar growth rates you have seen recently? Any changes in the trajectory there?

Charles Edelstein

There is some improvement in military activity especially because of the spouses program which has taken off. We played a fairly sizeable role there. The trends in military are still good for us and strong.

Operator

The next question comes from the line of Ariel Sokol - Wedbush Morgan Securities Inc.

Ariel Sokol - Wedbush Morgan Securities Inc.

How did costs for enrolling Bachelor student’s trend in the quarter? Are costs for these students stable or are they rising?

Gregory Cappelli

We don’t comment on the costs intra-quarter for acquisition costs of students. As we have said in the past it is more expensive to acquire and enroll a Bachelor student and an upper level Master’s and Doctoral student than it is an Associate student. Obviously the economics of that student to us are different so we are more than willing to pay that difference.

Ariel Sokol - Wedbush Morgan Securities Inc.

With respect to the conversion rate of Associate students who become Bachelor students, how does it compare to the prior year and also what percent of Bachelor new starts came from Associate students who matriculated to be a Bachelor student?

Gregory Cappelli

The matriculation rate continues to improve year-over-year so it was again better this quarter versus the prior year. As for the specific number, we don’t give that out but it was less than half of the growth, well less than half of the growth in the growth rate above the Bachelor students.

[Joseph D'Amico]

Over half of our Associate graduates, well over half of our Associate graduates do matriculate to Bachelor.

Ariel Sokol - Wedbush Morgan Securities Inc.

So is it fair to say given the large numbers of Associate students who have enrolled in the program the last several years we should start to see a real lift for Bachelor students given nothing more than just the Associates students who are finally graduating and taking Bachelor classes?

Gregory Cappelli

The majority of our growth, as I said before from Bachelors is organic. It is not coming from the Associates pool. Given the thing about our graduation rates which are published in our Annual Academic Report and the numbers of people actually going into the Bachelor program even at the higher rate, so it is the math involved there but again the majority of our growth in Bachelor is coming outside of that.

Operator

The next question comes from the line of Corey Greendale - First Analysis Corp.

Corey Greendale - First Analysis Corp.

I want to first start with a question that came up last quarter and then I don’t know if you are going to say anything more this quarter. Can you say anything about how widely the Orientation program has been rolled out?

Gregory Cappelli

We are not commenting. It is in the pilot phase. It has grown in size every quarter for us but as I said in my prepared remarks it is still relatively small compared to the total enrolment of the overall organization but it has been growing in size and it is a significant enough sample size for us to get the kind of data we were looking for from it from a retention standpoint. As I mentioned we are really pleased with the outcomes there.

Corey Greendale - First Analysis Corp.

In terms of the strategic shift more to the Bachelor from the Associates, just to set some parameters, are you still thinking in the long-run the Associates will be growing mid to high single digits? Or could the emphasis be more severe than that such that you would start to see over time Associates actually shrinking by design?

Gregory Cappelli

What we have said in the past and continue to believe is the Associate level program for us continues to be an important program for us. We are trying hard to make refinements to that to really improve the program and the outcomes for the University of Phoenix. While I can’t comment on exactly where growth in any degree granting is going to come out, what we can say is that we are comfortable that with our position within that large market and the direction where we are taking the associate program, I don’t know if you want to comment Brian on growth in general?

Brian Swartz

That covers it.

Charles Edelstein

One thing I would say there, you asked about our intention on the Associate program. I don’t want to leave the impression that it is our intention to shrink the size. It is our intention to admit as many people as we can who can get through the program. That is the way we think about it.

Corey Greendale - First Analysis Corp.

I have one mechanical question about that. Are students started into degree levels based on how many credits they have or could someone theoretically come in with zero credits and be identified as a Bachelor student based on their intention to enroll in a Bachelor program?

Gregory Cappelli

No, they can go wherever they want. We will counsel them and provide some guidance but whatever path they choose they are free to go down.

Corey Greendale - First Analysis Corp.

Brian, the G&A looking back over the past couple of years there is no consistent pattern in terms of what it does through the year. All things equal should we model G&A staying roughly flat in dollar amount in each quarter that is remaining in the year?

Brian Swartz

I think we have gotten some recent leverage in that and some of the benefit in the current quarter year-over-year because we had some unusual expenses in the prior year but for the most part, the legal costs which are included in G&A can fluctuate and quite frankly they do vary from quarter to quarter but we are not expecting any stair step change in G&A that we are aware of.

Operator

The next question comes from the line of Jerry Herman – Stifel Nicolaus.

Jerry Herman – Stifel Nicolaus

A question with regard to bad debt and the operational changes and in particular is there any way to disaggregate the influence of those on bad debt? Ultimately what I am getting to is when those items might be lapsed from a comparative point of view?

Brian Swartz

The operational changes I referenced that were really principally two that occurred in the fourth quarter of 2009. The first one was the implementation of the 30 day delay, first year and first time borrowers. We had initially stated our CDR would be above 10% with this coming year the release of the CDR is in September. The second one is we fully evaluate transfer credits for students that transfer in credits prior to certifying their loans. So both of those basically have the effect of Apollo or University of Phoenix acting as the bank for a lack of a better word and we carry the receivables longer. That is why our AR’s increased pretty dramatically in the last few quarters. Those were the two operational changes. Again they were in Q4 of 2009. I think that was your question.

Jerry Herman – Stifel Nicolaus

The issue is what influence can you disaggregate or help quantify the influence of those relative to Associates?

Brian Swartz

I provided some commentary on where we expect bad debt to be in Q3 and longer term we like what we are seeing thus far in terms of a pattern and we think a lot of it is the bad debt given we are two quarters beyond the implementation of those operational changes.

Jerry Herman – Stifel Nicolaus

Will they be lapped in a year effectively then?

Brian Swartz

I think it is better now and I would certainly hope by the end of the year we would see the majority of the one-time impact from those things by the end of the year.

Jerry Herman – Stifel Nicolaus

A question about the SEC inquiry. Your language changed a little bit in the Q. It seems to at least on the surface resemble or maybe get a little bit closer to some of the things that were referenced in the program review. You know what I am getting at here. Is there enough similarity between those two issues to make you feel there is in fact some relationship between the two?

Charles Edelstein

I don’t think we were signaling any sort of similarity. Our intent there was we have had a number of questions about what is the nature of the process so far. We were just attempting to clear up the process. It is our understanding in an informal inquiry the SEC asks a broad range of questions and we were just trying to convey that was what was happening.

Jerry Herman – Stifel Nicolaus

You are scheduled to respond to the program review in the next couple of days. That is still true? That is still on track?

Gregory Cappelli

We expect to file it within at least the next 30 days. We have spoken to the Department of Education. We have requested an extension of time to file by the end of April. We believe will be granted. That is the preliminary indication anyway. We will file it when we need to and on time.

Operator

The next question comes from the line of Kelly Flynn - Credit Suisse.

Kelly Flynn - Credit Suisse

Back to the Bachelors growth, can you talk about how you perceive the weak economy to be helping the new student and total enrollment growth there? Then related to that, what are you seeing as kind of as sustainable long-term enrollment growth target for that business?

Gregory Cappelli

As we have said in the past on the economy it could be helping all enrollment to some extent. Who knows exactly how much that has moderated over the past year as the economy has gotten a little bit better, or a little less worse I guess you could say. Where we may see more of an impact from that is in employee retention where we have been [inaudible] some of the numbers we have been seeing in that area.

As far as the long-term growth in Bachelors programs, we are sticking to in terms of conveying our long-term growth targets to what we said before on the revenue and the operating profit side of things. Exactly how that plays out in degree and mix shift is yet to be seen. We can tell you we are putting more of our focus on the area of degree granting programs for all of the reasons we talked about earlier. We certainly hope and are planning for that to continue to grow.

Kelly Flynn - Credit Suisse

Brian I think you addressed this or a related item but if you could go back to the impact on basis points from the orientation at Axia, did you give out the impact on the new student growth for Associates?

Brian Swartz

The new student growth was about 9.5% for the quarter. I think we said it was about 500 basis points higher give or take excluding the impact of the days year-over-year and a similar amount if we didn’t have the University Orientation going on. So if you combine all of those together the growth would have been about 19%.

Kelly Flynn - Credit Suisse

Was that total or just for associates?

Brian Swartz

That is total and the University Orientation program is principally at the Associate level.

Gregory Cappelli

Just to be clear that is new enrollment growth.

Kelly Flynn - Credit Suisse

Sorry to go back to this but on the SEC inquiry we saw in the Q someone else refer to a change in the language. I want to clarify, when you initially indicated there was an informal inquiry it was discussed as one related to revenue recognition and now there are other items listed. Is it your understanding the scope has broadened relative to what you initially thought it was or is it all just kind of under the same umbrella at this point?

Charles Edelstein

We haven’t received any notification it is anything other than the informal inquiry. That is what we believe. We are trying to give you a feel for the nature of the process. In the spirit of an open dialogue, we don’t have any reason to believe anything has changed in the scope but we can’t predict what the scope and the outcome is going to be.

Brian Swartz

As Chas mentioned earlier it is also our understanding when you go for an informal inquiry the SEC does ask a broad range of questions.

Operator

The next question comes from the line of Analyst for Mark Marostica - Piper Jaffray.

Analyst for Mark Marostica - Piper Jaffray

What are the inhibitors to your Masters start growth? Can you talk about what you will be doing to reignite growth here and whether any new Master’s programs will be part of any new initiatives here?

Charles Edelstein

I think the biggest focus again is where you put your resources and we have decided to put more focus on Bachelors and now we are starting to get more of that focus and attention on Masters. Exactly when that growth and how quickly it will pick up we can’t tell you exactly. You are going to see more of our time and attention put on that area. Again it is people, process and resources you put in place. It is the way you advertise and market the programs. There are a lot of things that go into it just like the Bachelors area. Hopefully we will have some better results for you there.

Gregory Cappelli

It is also which programs we put forth. So we talk about what programs we are going to offer as well.

Analyst for Mark Marostica - Piper Jaffray

In terms of timing and in terms of when we will see that improvement can you give us some color on that?

Charles Edelstein

I can’t actually. All I can tell you is we are investing in that area and putting resources on it and we expect to see results.

Analyst for Mark Marostica - Piper Jaffray

On the instructional cost line if you strip out BPP what would have growth looked like there? Just trying to get at are you foreseeing any leverage on the ICS Line excluding BPP?

Brian Swartz

The ICS line is about half of the increase on a basis point change related to BPP. The balance really is bad debt year-over-year. Bad debt expense and as you know that amount is up year-over-year. Those are really the two principle items impacting ICS.

Analyst for Mark Marostica - Piper Jaffray

On enrollment counselor productivity can you comment on what levels you are seeing today and where we are at today versus historical levels and can we expect to see any further productivity gains from here?

Gregory Cappelli

We don’t provide exact comments on that but we are pleased with the productivity we are seeing over the prior year in that area.

Operator

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

Paul Ginocchio - Deutsche Bank

Can you talk about the timeline of when the Orientation program would be fully implemented so that all students with less than 24 credits would go through the program? Is your threshold, that less than 24 credits, have your thoughts about that threshold changed at all with the data you have gotten so far?

Charles Edelstein

It really depends on the results and the continuation of the results we see and we will think carefully about any rollout and the timing of that.

Gregory Cappelli

One of the things I want to make clear is we will do that consistent with our remarks about the total value proposition at not only the University of Phoenix but to our stakeholders as well. Obviously if we do that in a more aggressive manner then we expect to see enhanced results as a result from a profitability perspective over time in that area.

Paul Ginocchio - Deutsche Bank

So to follow-up on that timeline is it in the next few quarters you think you will be fully implemented or the next few years? Any way to sort of size that for us?

Gregory Cappelli

We haven’t decided that yet. As Joe said we are looking at the results we are getting in every week from that important program. We are pleased with the data we are getting back and we will keep you up to speed in terms of the pace of the rollout.

Paul Ginocchio - Deutsche Bank

On 90/10, any update on where you are in 90/10? It sounds like the military enrollment is strong. Have you been able to move that down a bit?

Gregory Cappelli

With regard to 90/10 we have seen some increases in that as you know. We do expect to stay below 90% for this year including the temporary relief. So want to make sure you understand that.

Operator

The next question comes from the line of Sara Gubins - BofA Merrill Lynch.

Sara Gubins - BofA Merrill Lynch

Following up on that can you give us an update on the percent of your revenue that is coming from corporate tuition reimbursement and if that has been increasing significantly?

Charles Edelstein

We don’t provide that information but we are pleased with the changes that have been made and the investment we have made. We feel we are improving and enhancing and expanding the relationships with various significant corporations across the country.

Sara Gubins - BofA Merrill Lynch

There was an earlier question that asked about where you are placing students in terms of Axia or Bachelor’s degrees and my understanding had been before that if a student had less than 24 credits they would go into Axia and if it was more than that they would go into the Bachelors degree program. Is that still the case or could a student with very few credits go into a Bachelors degree program? I am wondering if that is both a strategy change also because it makes it more difficult for us to be able to compare historical growth at Axia and the Bachelor’s degree programs versus currently?

Charles Edelstein

The Axia degree is an online degree to students who may have fewer than 24 credits who want to attend on campus would attend in a Bachelor’s program. So there are choices for students.

Gregory Cappelli

You may be thinking some of our previous comments we have talked about many students who have lesser amounts of credit do go online and start the Axia program. Part of that is a price consideration. There is a pricing differential as well.

Sara Gubins - BofA Merrill Lynch

If they were going online and have fewer than 24 credits would they still go into Axia or could they go into a Bachelor’s degree program?

Charles Edelstein

We would be counseling those students probably to go through the Associates program but if the student is intent on getting a Bachelor degree and they seem to have the wherewithal to achieve that we could also put them into a Bachelor program.

Sara Gubins - BofA Merrill Lynch

Do you plan to continue to give quarter ahead guidance from now on?

Brian Swartz

I think as we are going through this transition obviously in the student mix we want to help our investors understand how we are thinking about that. I think at least through the current transition we would expect to provide some commentary.

Gregory Cappelli

Again that is an extrapolation of the trends we are seeing. We are trying to provide help with and we are not actually thinking of it as guidance internally. We have an idea of what the trends are right now in the quarter and that is what we are trying to help you understand.

Operator

The next question comes from the line of Suzanne Stein - Morgan Stanley.

Suzanne Stein - Morgan Stanley

I wanted to follow-up on the 90/10 question and how will the shift away from the Associate students impact this? Can you talk a little about how Bachelors are paying for their education? What percentage is non-Title IV? On a relative basis how that compares to Associate degree students.

Gregory Cappelli

We don’t give details on that but as you might appreciate the higher level students have a higher cash pay or a company pay support which obviously helps on the 90/10 front. The Associate degree students many of them, most of them or the majority of them certainly are paying through Title IV.

Suzanne Stein - Morgan Stanley

I can’t remember if you have given us any numbers on this but have you talked in the past about your direct CDRs for the coming year?

Gregory Cappelli

We have not yet.

Suzanne Stein - Morgan Stanley

Can you provide any color on that? Or are you not doing that at this point?

Gregory Cappelli

We are not doing that right now.

Brian Swartz

We did say last year we expected it to be above 10% for the 2008 cohort rate.

Operator

The next question comes from the line of Trace Urdan - Signal Hill Group, LLC.

Trace Urdan - Signal Hill Group, LLC

I heard you loud and clear about turning your attention to the Master starts but I wonder if you could comment on what you saw in the quarter to what extent the weakness appeared to be coming from fewer leads or possibly an issue with conversions or some combination of the two? Can you comment on that?

Gregory Cappelli

Not really at this point. I don’t have the data to tell you whether it was from lead flow, conversion or what not. Let me just say this, I appreciate the question but it is where you put your focus. I don’t think there is anything structural in why our Master’s programs can’t grow. We have great people in our Master’s division. We are continuing to make improvements there and we are going to put more focus there going forward.

Trace Urdan - Signal Hill Group, LLC

I don’t mean for this to be a leading question at all but I am curious as to whether nor not you think the Orientation program might begin to give you information that will allow you to target either your messaging or where you are sourcing your leads from differently for the Associate program and whether you maybe have even seen some of that already?

Charles Edelstein

Absolutely we expect that to happen.

Operator

The next question comes from the line of Scott Schneeberger - Oppenheimer & Co.

Scott Schneeberger - Oppenheimer & Co.

With regard to the targeting focus to Bachelors how much consideration is being given to pricing among the degree levels and perhaps discounting?

Gregory Cappelli

What we said and continue to believe is there will be some pricing increases going forward but we haven’t elaborated on exactly where this will be. It is an evaluation process every year and we look at that carefully.

Scott Schneeberger - Oppenheimer & Co.

No actual put into practice until early next year?

Gregory Cappelli

Can you say that one more time?

Scott Schneeberger - Oppenheimer & Co.

You probably wouldn’t put any pricing changes into practice until early next year is how I infer the response.

Gregory Cappelli

We generally, if we increase prices it is generally over the summer months. Usually around July 1 but again we haven’t made any final decisions for this year.

Scott Schneeberger - Oppenheimer & Co.

Along those lines you mentioned not only advertising but corporate partnerships as a way for you to control that shift. Could you take us a little deeper on some of the things you are doing there?

[Joseph D'Amico]

We have a group of our people who are focused on academic alliances. Those vary company to company based upon the company needs. We are very focused on extending and expanding that program and have been successful at doing that.

Scott Schneeberger - Oppenheimer & Co.

More broadly, any comment on rate trends for advertising and cost inputs?

Brian Swartz

Nothing that would stand out at this point in the quarter from prior quarters.

Scott Schneeberger - Oppenheimer & Co.

Now $800 million in authorization for share repurchase. Would you view that as the main priority for use of cash right now or if you could just give us a priority hit list?

Brian Swartz

As we have discussed in the past we use a framework where we evaluate all of our capital needs and the returns with respect to every capital decision that is a major one. University of Phoenix given its return on incremental invested capital gets the top attention followed by other assets in the organization including those of Apollo Global. Share repurchases is definitely part of the capital allocation process. We returned cash in the past and it is part of our plan going forward.

Operator

The next question comes from the line of Paul Condra – BMO Capital.

Paul Condra – BMO Capital

I wanted to clarify one thing regarding the days, 500 basis points that was a shift in days. Was that for total new starts or just for Associate level?

Brian Swartz

There was one extra Monday in the second quarter this year versus last year and our Associate programs online start on Mondays. Our non-Associates, Bachelors and other degrees start on Tuesday so with one extra Monday that change did come from the Associate level this quarter.

Gregory Cappelli

But that was 500 basis points was the effect of that change in total on all.

Paul Condra – BMO Capital

Did you disclose how much impact that had on Associate level?

Brian Swartz

No.

Paul Condra – BMO Capital

I apologize if you have answered this in the past but how many incoming Associates actually have less than 24 credits?

Gregory Cappelli

We don’t give out that specific information. We have it obviously. We manage it and monitor it but we don’t provide that data.

Paul Condra – BMO Capital

Related to the interest expense, it came down substantially…

Gregory Cappelli

Your line is cutting out. Could you move closer to the speaker?

Paul Condra – BMO Capital

Regarding interest expense now that your debt has come down considerably I am wondering if you could give us any sense of how that will trend going forward?

Brian Swartz

We are not giving specifics. We have given a lot of data points in terms of our business outlook for Q3 based on trends but we are not giving out specifics on interest expense.

Paul Condra – BMO Capital

Are you going to be providing any financials regarding Insight or related historicals excluding Insight?

Gregory Cappelli

Any financials on our Insight subsidiary?

Paul Condra – BMO Capital

Yes. Insight schools.

Brian Swartz

Well previously Insight Schools was a separate segment in our financial statement so you can actually see their revenue and operating income in our previous 10-Q’s and 10-K’s. This quarter we are presenting them as a discontinued operation. So in the income statement they have been carved out and are shown below the line as a discontinued operation. Then there is a footnote in our 10-K that we filed this morning to add some more details as well.

Operator

The next question comes from the line of Bob Wetenhall - RBC Capital Markets.

Bob Wetenhall - RBC Capital Markets

In new degree enrollment for the Bachelor’s you had a 25% move which is pretty impressive. Do you think that kind of growth rate for the Bachelor’s program for new degreed enrollment is sustainable?

Gregory Cappelli

No. Not at that kind of level. We have said in the past not for any of our degreed programs over time are we going to be growing or do we think the growth will remain in something like the mid 20’s. Part of the reason for that again is we went through a long period of time when we didn’t see growth at the Bachelor’s level and you are seeing the impact of year-over-year against those comparisons. That being said do we look for that to fall off a cliff or something? No we don’t. We are making investments there. We are obviously mindful. We want quality growth. Obviously the mix shift is extremely important here but to the degree each program grows we are not giving out our perspective or guidance on exactly where that is going to come out. Again we are focused there. We are investing there and we do expect to see growth there going forward.

Charles Edelstein

To give you a sense of more sustainable growth levels one of the reasons why we put forth our 3-5 year targets are so you can look at those sources of revenue and operating targets that gives you a feel for what kind of sustainable growth rates we would expect.

Bob Wetenhall - RBC Capital Markets

With the mix shift and the long-term goals where would you like to see the Bachelor’s program as a percentage of total degreed enrolment within like the next three years? Is there a target you have?

Gregory Cappelli

No. What we have done is we have made important decisions internally about the direction we want to point the University and we are making the investments to do that. Ultimately we expect to see the growth and the percentages fall out in those directions. To the exact extent and the exact percentage we are not providing guidance on that at this point.

Bob Wetenhall - RBC Capital Markets

Is it likely you will expect to see kind of a decline in the Associates as a percentage of enrollment starting in 2011?

Gregory Cappelli

That is a fair assumption. Again we are not running the business to pinpoint a certain percentage where it needs to be. Yes, that would be a fair assumption to make.

Operator

The next question comes from the line of Brandon Dobell - William Blair & Company, LLC.

Brandon Dobell - William Blair & Company, LLC

The last couple of quarters it seems I have seen a lot more in the way of new location openings of physical campuses or learning centers. Maybe an update on where the physical capacity stands now and how you think about that aspect of the growth strategy over the next year or two?

Charles Edelstein

We look at all of our locations across the country in a strategic way and have identified where there are opportunities of where we should be that we are not and we continue to see success with our learning centers and they have been well received and it is great for the student experience. We will continue to expand those in a normal way. Nothing extraordinary going on there.

Gregory Cappelli

I think the message is that our ground operations are extremely important to us. We want to have a meaningful presence on the ground in the U.S. and we would like to see our ground locations grow as well in terms of student population.

Brandon Dobell - William Blair & Company, LLC

So in terms of ground locations do those all come with some sort of a student resource center opportunity for the online students or how are you using the ground capacity to either increase retention of the online students or use it as a way to generate [inaudible]?

Charles Edelstein

I think we have freshened, if you will, our campuses and the new ones are certainly a different look and feel and are more consistent with what the students need and want these days. For example, more computer locations. More computer space. More accessibility to computers and the like.

Brandon Dobell - William Blair & Company, LLC

Given the ongoing [inaudible] discussions around all these topics, I guess mostly in…

Gregory Cappelli

You are breaking up a little bit. Could you get a little closer to the mic?

Brandon Dobell - William Blair & Company, LLC

How do you think about the direction you want to take enrollment compensation? Have you made any specific changes or real structural changes or do you have a much different policy going on? I am trying to figure out what might be the right structure for incenting those advisors.

Charles Edelstein

The way we think about that is we are trying to make sure we evaluate our counselors based on the relationships they build with the students. Those are the trials we have going on in thinking and understanding and learning more about the relationships.

Operator

I would like to turn the call back to Charles Edelstein for closing remarks.

Charles Edelstein

We appreciate you being with us on this early morning. We look forward to keeping in touch with all of the things we are doing. Take care now.

Operator

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

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