Apollo Group F1Q08 (Qtr End 11/30/07) Earnings Call Transcript

| About: Apollo Education (APOL)

Apollo Group, Inc. (NASDAQ:APOL)

F1Q08 Earnings Call

January 8, 2008 5:00 pm ET


Dr. John G. Sperling - Acting Executive Chairman of theBoard

Gregory W. Cappelli - Executive Vice President - GlobalStrategy, Assistant to Executive Chairman, Director

Joseph L. D'Amico - Chief Financial Officer, Executive VicePresident

Brian E. Mueller - President, Director


Jeff Silber - BMO Capital Markets

Sarah Gubins - Merrill Lynch

Amy Junker - Robert W. Baird

Jerry Herman - Stifel Nicolaus

Gary Bisbee - Lehman Brothers

Kevin Doherty - Bank of America Securities

Brandon Dobell - William Blair & Company

Corey Greendale - First Analysis

Jeff Lee - Signal Hill

Scott Schneeberger - CIBC World Markets

Mark Marostica - Piper Jaffray

Susan Stein - Morgan Stanley

Edward Yruma - JPMorgan


Good afternoon, ladies and gentlemen, and welcome to ApolloGroup Incorporated first quarter fiscal 2008 earnings conference call.(Operator Instructions) There will be a replay of this call available throughJanuary 18, 2008 beginning approximately two hours after we conclude today. Thereplay number is 800-642-1687 or 706-645-9291 internationally. The conferenceID number for the replay is 27318003.

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

I’d also like to remind you that this conference call maycontain forward-looking statements with respect to future performance of ApolloGroup that involve risk and uncertainties. Various factors could cause theactual results of the company to be materially different from any futureresults expressed or implied by such forward-looking statements. These factorsare discussed in the company’s 10-K report and subsequent 10-Q reports filedwith the Securities and Exchange Commission. The company does not undertake anyobligations to update anyone with regard to forward-looking statements made duringthis conference call.

I would now like to turn the call over to Dr. John Sperling,Acting Executive Chairman of the Apollo Group. Dr. Sperling, go ahead, lease.

Dr. John G. Sperling

Thank you. Good afternoon and thank youfor joining us today to discuss Apollo Group’s first quarter results. We areoff to a strong start in fiscal 2008 as the momentum we experienced last yearcontinues.

Before we discuss the quarter, I wouldlike to update you on a few of the recent board changes that we’ve made as wecontinue to fine-tune our leadership team.

First, Peter Sperling has been nameVice-Chairman. Peter has been with Apollo since 1983 and served an operationalrole as a member of the board of directors. We believe his understanding of thebusiness and his experience and interest in the company will continue to serveshareholders well and we have confidence in his leadership role as boardVice-Chairman.

Additionally, Dino DeConcini hasformally been named Lead Independent Director, a role he’s been performing forsome time. Dino has served as a director of Apollo since 1981 and his valuesand leadership have been invaluable.

Finally, Ann Kirshner, who was appointedto the board last October, has become a member of the compensation committee.

We believe we now have a top-notch groupof board members to guide Apollo's management as we continue to growdomestically and expand internationally.

I’d like to turn the call over to GregCappelli now who will update you on Apollo Global. Joe D'Amico will then reviewthe highlights of the first quarter and Brian Mueller will update you onoperational progress and long-term strategy. And finally, we will open the callto your questions. Greg.

Gregory W. Cappelli

Thanks, John and first, just along with Brian, I’d like toofficially welcome Allyson Pooley as the head of ourinvestor relations to Apollo Group. Many of you have probably spoken or met herover the past couple of months but we’re thrilled to have her on board.

Since announcing Apollo Global in lateOctober, we’ve been busy building the necessary infrastructure for the JV aswell as identifying and evaluating a wide range of opportunities. We arepleased with our decision to work with The Carlyle Group in creating ApolloGlobal and the relationship continues to build. Together, we’ve implemented adisciplined evaluation and due diligence process as we’ve identified potentialpartners and acquisition targets.

In addition to acquisitions, Apollo'sexisting international offerings continue to perform well and other organicgrowth initiatives in foreign markets are also well under way.

We also continued to assemble a strongApollo Global management team which now includes an interim president, CFO, andCOO, and we continued to build out our global team, which compromises employeesin China, India, Europe, and Canada.

Our focus has resulted in a growingpipeline of opportunities that validates the factors which drove our decisionto create Apollo Global, including the attractive demographics and economicgrowth in certain targeted international markets, the strong foreign demand forquality educational services at all levels, and the increasing use oftechnology to deliver such services, which we think provides us with a uniquecompetitive advantage.

Before I turn the call to Joe, let mejust touch on our capital structure for a moment. We’ve been stressing for thelast several quarters that we continue to evaluate our capital structure toachieve our goals, including the utilization of leverage as appropriate. Tothis end, we announced today a new $500 million unsecured revolving creditfacility, which is available to us for acquisitions and other needs we may havegoing forward.

The revolving facility provides amulti-currency sub-limit for borrowing in certain foreign currencies up to $300million. We also have the ability to increase the facility by another $250million. We think this facility gives us additional financial flexibility anddeeper financial relationships to help us capitalize on the globalopportunities that exist.

During the first quarter, we didn’trepurchase any of our Class A stock. As I just discussed, with the creation ofApollo Global, our potentially deep pipeline has grown significantly and we arebusy evaluating the best use of our capital to create long-term value for ourshareholders. That said, we will continue to evaluate all of our capital needscarefully going forward, including the potential for additional sharerepurchases.

In summary, we are excited about the outlookfor both Apollo Group and Apollo Global. We continue to be disciplined in ourapproach to investing in both areas and we’ll keep you updated on our progressgoing forward.

With that, I’ll turn the call over toJoe.

Joseph L. D'Amico

Thank you, Greg. Financially, we’ve had a strong start tothe year with total consolidated revenues for Apollo Group of $781 million, a16.9% increase over the first quarter of fiscal 2007. Additionally, wegenerated an operating margin of 28.1%, a full point improvement when comparedto the first quarter a year ago.

Excluding share-based compensation expense of $15 millionand share-based compensation expense and special items of $12 million in thefirst quarters of fiscal 2008 and 2007 respectively, our adjusted operatingmargin was 30% versus 28.8% respectively.

Net income for the first quarter increased 22.8% to $140million, or $0.83 per diluted share as compared to net income of $114 million,or $0.65 per diluted share a year ago. Excluding share-based compensation, weearned $0.88 per diluted share in the first quarter of fiscal 2008 as comparedto $0.69 in the prior year.

Turning to the balance sheet and our cash flow, our cash andmarketable securities excluding restricted cash totaled $590 million at November30, 2007, as compared to $393 million at August 31, 2007.

During the quarter, we generated $208 million of cash flowfrom operations, which was reduced by $24 million of CapEx and $47 million forthe purchase of Aptimus. Of the capital expenditures, approximately $5 millionwere one-time in nature and represent the continued build-out of our newcorporate headquarters building in Phoenix.

As a reminder, we have an option to execute a sale andleaseback transaction to monetize our investment in this new building when itis completed in the second half of fiscal 2008. At that time, we expect toexercise the sale and leaseback and will receive approximately $170 million inproceeds.

Gross student receivables were $276 million at November 30,2007, compared to $282 million at August 31, 2007, and net receivables were$188 million at November 30, 2007 compared to $191 million at August 31.

Our allowance for doubtful accounts increased slightly to$105 million at November 30, 2007, from $100 million at August 31, 2007.

Our day sales outstanding remain consistent with the prioryear at 35 days and declined from 38 days as of August 31, 2007. Theimprovement in DSOs since year-end is due to a reduction in the percentage ofaccounts receivable under 90 days, which we attribute to the improvements inour front-end collection process. Our total allowance continues to exceed allreceivables greater than 90 days.

Bad debt expense for the first quarter of 2008 as apercentage of revenue was 4.2% compared to 3.5% a year ago. During the quarter,we performed a review of the components of bad debt expense and identifiedcertain items that should have been reported or should have been classified asdiscounts or refunds, that is, as a reduction of revenue, as opposed to acharge to bad debt expense in prior quarters.

We have not adjusted the prior year’s bad debt expense orrevenues for such items since the reclassifications are not material and wouldhave no affect on reported net income. However, since the bad debt trend is notcomparable, we have disclosed the impacts on revenue and bad debt expense inour press release and Form 10-Q.

Taking into account the affect of the reclassification onprior periods, bad debt expense as a percent of revenue would have been 2.9% ayear ago and 4.4% last quarter, versus 4.2% in the current quarter.

Bad debt expense as a percentage of revenue increased overthe prior year comparable quarter primarily due to the continuing shift in ourenrolment mix to a higher percentage of associate degree students when comparedto prior periods. As we have said previously, bad debt is a cost of ourbusiness due to the relatively open enrolment policy that we maintain at theassociate level.

Importantly, our bad debt expense as a percent of revenuedeclined from the fourth quarter on a comparable basis by 20 basis points,which is the first time in several quarters that this percentage has declined.We are hopeful that our efforts to manage the bad debt levels will continue topay off as we execute our plan of improving student retention in our associatedegree programs.

Deferred revenue declined $7 million from the year-end to$160 million and student deposits were essentially flat at $333 million as ofNovember 30, 2007. When compared to November 30, 2006, deferred revenueincreased by $28 million and student deposits increased by $73 million. Thesechanges are seasonal in nature and consistent with our enrolment growth.

Finally, you should note that good will increased $37million and other assets increased $7.4 million versus August 31, 2007. Theseincreases relate to our acquisition of Aptimus. We have one year from theacquisition date to finalize our allocation of the assets and liabilitiesacquired.

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

Brian E. Mueller

Thanks, Joe. The first quarter was a strong one, withdouble-digit revenue and enrolment growth. We continue to outperform ourlong-term goals of mid to high single digit growth in annual domestic revenueand low double-digit annual growth in domestic operating profit and free cashflow.

In fact, revenue grew almost 17% year over year, andexcluding stock-based compensation and special items, operating income growthwas almost 22%, resulting in a 30% operating margin which validates the heavyinvestments we made over the last couple of years.

Before I drill down into the results, I’d like to step backand review the overall environment.

The demographic and economic trends contributing to the riseof adult education over the past three decades continue. One of the primarydrivers is under employment and by this I’m referring to the growing numbers ofworking people whose wages are not high enough to provide them with acomfortable middle class lifestyle. Many of these individuals will seek highereducation as an answer.

Statistically, the U.S. Department of Education’s nationalcenter for education statistics estimated that based on its most recent datafrom 2005, more than 6.8 million, or 39% of higher education students are over24 years old, placing a large percentage outside the consideration oftraditional universities and colleges. And the number is expected to increaseby 21% from 2005 through 2016.

During this same period, the 18 to 24 year old segment makingup the generation of eco-boomers is anticipated to increase 15%. The studentsin both of these age groups are candidates for our associates program at AxiaCollege, which provides solid preparation for completing a four-year degree.

These eco-boomers also have a different attitude abouteducation and work and provide an example of how Apollo Group organizationsrapidly adapt to changing market forces. University of Phoenix commissioned amarket research study that provided some interesting insights about eco-boomerstudents, including the fact that 70% of them must work while attendingcollege.

A large majority of the eco-boomers are single women, mostdependent heavily on the Internet for socializing, entertainment, andeducation, and they believe education is about earning power. They arepragmatic about their futures and don’t necessarily want to leave home toattend college. At the same time, they are the most education focusedgeneration in history. Most of them understand the value of and express thedesire to achieve a bachelor’s degree.

These trends are important to our business and continue todrive our enrolment growth.

Now let me review our results, specifically focusing onrevenue, enrolment, and margin growth and update you on some of the initiativeswe have in place to achieve our long-term objectives.

As I mentioned, our revenue for the quarter grew almost 17%to $781 million compared to the first quarter of the prior year. We are verypleased with this number and the continued positive trend we have experiencedover the last several quarters.

Importantly, revenue growth surpassed enrolment growth forthe second consecutive quarter. This increase in revenue was driven by threefactors, which I’ll discuss in more detail, namely tuition price increases,improved retention, and an overall increase in total enrolment.

Tuition increases were particularly a factor in ourassociates programs as we continued to benefit from the increase which tookplace in May of 2007. We also benefited in the first quarter from selectivetuition increases in our other programs which went into effect July of 2007.

As we anticipated, these tuition increases, along with theimprovement in retention levels, are offsetting the mix shift of the studentbody into lower tuition rate associates programs.

Also positively impacting revenue growth is improvedretention. Retention continues to be the number one focus at Apollo as itimpacts so many aspects of our results, including enrolment, revenue, profitlevels, bad debt, and student default rates.

The third factor positively impacting revenue growth istotal enrolment. Total enrolment in the first quarter increased 11.4% year overyear, reaching a total of 325,000 students. Associate student enrolmentcontinues to be our fastest growing segment, increasing 37.7% year over year.

Associate students now represent 35% of our student base.Enrolment in bachelor’s degree programs remained relatively flat year overyear, decreasing by only 1.5%.

Let me now discuss student starts. During the first quarter,we started approximately 67,400 students, a 7.8% increase over the prior year.Like last quarter, we faced a difficult comparable in starts due to the highdrop rates we experienced a year ago, and I’m speaking mainly about high droprates of new student starts.

As we said last quarter, a year ago we started many studentswho dropped quickly, thus the start numbers from a year ago are artificiallyhigh. As you know, a little over a year ago, we hired hundreds of new enrolmentcounselors who began training our campus-based counselors to recruit studentsinto the online programs.

As our counselors gain experience and training, the studentsthey enroll, particularly in the online programs, are better prepared for theircollege experience and are persisting at higher rates.

The flip side of this is that the growth in our revenue perstudent, particularly at the associates level, is off of an artificially lowbase and the growth rate is not expected to be maintained at the current level.

I’d also like to address the continuing trend of greaterstart growth at the associates level relative to the bachelors level. Duringthe first quarter, starts at the associates level increased 23% year over year,while bachelor’s degree starts declined at 8.4%. Together, associates andbachelor starts, or undergraduate starts as a group, grew approximately 9% yearover year and we believe that had we not started Axia three years ago, thisnumber would be lower.

As a reminder, we started Axia in 2004 due to the fact thatmore and more of our leads involved students with fewer credit hours andtherefore they needed better preparation for the rigorous academic programs acollege student experiences.

Enrolling these students directly into our bachelor’s degreeprograms wasn’t the answer as they were dropping at high rates. Axia Collegeaddresses the needs of these less prepared students. Specifically, classes arelonger, the cost per credit hour is less, and tutoring and counseling servicesare more comprehensive.

The demand for education from students that have fewercredit hours continues to be very strong and as I mentioned earlier, thisdemographic is large and projected to grow rapidly. Additionally, as counselortraining increases, particularly our cross-training of campus counselors torecruit students into our online programs, the number of students beingreferred to and starting at Axia continues to increase.

A year ago, students with less than 42 credits in certainparts of the country would have enrolled directly in our bachelor’s program.Today, the vast majority are counseled to being their programs at Axia Collegewhere they are more likely to succeed.

Another factor is the unavailability of our online programsin certain geographies. During October, Axia became authorized in the state ofFlorida for the first time, which contributed to the mix shift in studentstarts in the first quarter.

We are now sure when the mix shift will level off. What wedo know is that the pool of Axia students available to potentially transfer toour bachelor’s programs continues to grow rapidly. Eventually, we expect thistrend to lead to improved growth within our bachelor’s programs.

Before I move to operating costs, let me touch on InsightSchools. As a reminder, we acquired Insight a little over a year ago and at thetime, Insight was approved in one state. In the last year, we have expanded andare now approved in five states, including Washington, Wisconsin, California,Oregon, and Minnesota. We are currently operating in three of these states andwe’ll be opening in Oregon this month and in Minnesota in the fall.

We have several other target states and believe we are ontrack to have a total of 10 by the beginning of the next school year, namelythis fall.

Now let me discuss our operating costs. In the firstquarter, we achieved an operating margin excluding share-based compensation andspecial items of 30% up about 120 basis points from a year ago. Several factorsled to this improvement.

First, instructional costs and services declined 140 basispoints to 42.7% of revenues from 44.1% in the first quarter a year ago. Theimprovement was primarily due to centralizing much of our financial andacademic counseling, which provides further leverage as our enrolment andrevenue continue to grow.

Second, we continue to benefit from space utilization as ouronline student body grows. As we’ve said previously, we are not necessarilyreducing space but we are able to grow our student body without adding space asmore students choose to study online. These improvements were offset somewhatby an increase in bad debt, which Joe discussed earlier.

Selling and promotional expense as a percent of revenuedeclined 70 basis points to 22.6% from 23.3% in the first quarter a year ago.Effectiveness in advertising productivity continues to improve.

In the quarter, advertising spend increased approximately9%, resulting in a 70 basis points improvement as a percent of revenue versusthe first quarter a year ago, despite incurring Aptimus expenses in the monthof November.

Additionally, we again hired incremental enrolmentcounselors in geographies where we continue to believe there is additionalopportunity, particularly the Midwest and the Northeast.

Based on the positive returns we are seeing on our ad spend,we increased the amount of dollars spent starting in December and we expectthis to continue throughout the quarter.

Although our advertising as a percent of revenue increasedin the first quarter, we did experience an increase in the cost per new startversus a year ago. This is also related to the high drop rate we experience ayear ago. We have significantly decreased the number of early drops from theprior year, which had an effect of spreading our marketing and sales expensesover a relatively larger number of new starts in the prior year.

We continue to believe the persistence of the current newstudents will be improved over the prior year, which should positively impactour operating profit going forward. As a reminder, we launched our nationalbranding campaign in January of ’07, we continued to invest to support ourimage, which will also adversely impact cost per start in the short term. Butwe are pleased with the progress we are making and believe the long-termeffects will be very positive.

G&A expenses increased this quarter to 6.6% of revenuesversus 5.6% in the first quarter of fiscal ’07. The increase is due toinvestments we made over the last year in our finance and legal teams, as wellas continued investment in IT areas to support our enrolment growth.

Additionally, we experienced higher legal costs inconnection with some of our outstanding legal matters.

Let me now update you on two of our most important strategicinitiatives that contribute to the above results and which will continue todrive our success; the first is retention and the second is reducing studentacquisition costs.

As I mentioned earlier, retention continues to be the numberone priority at Apollo Group. We continue to target four key areas forimproving retention. First, building new programs which relate specifically todrive growth areas in the country; second, analyzing and improving curriculumin places where students have specific difficulties; third, evaluatinginstructional best practices and providing training to instructors throughoutthe system. In fact, we currently provide over 60 faculty development workshopssuch as grades and feedback, assisting the academically at risk student, anddissertation mentor training; fourth, increasing support services, which I’veincluded additional tutoring and student workshops.

Additionally, we have instituted a pilot program to providescholarships to Axia students who graduate and transfer to a University ofPhoenix bachelor’s program. We are evaluating the impact of this program onstudent transfers and retention and have been very pleased with the initialresults.

As a result, we expect our discounts to increase. However,we believe this will improve retention, which will drive revenue andprofitability growth.

The second key initiative is our focus on marketing, leadgeneration, and the costs associated with acquiring a student. At the end ofOctober, we closed the acquisition of Aptimus and our marketing teams have beenworking over the past couple of months to transition to the new platform. Weare pleased to report that as the transition begins in earnest, we have begunto successfully manage our online marketing investments in-house.

Over the next several weeks, we will complete the transitionof all affiliates, as well as management of all search and display advertising.Over time, we will be implementing innovative marketing plans to moreeffectively communicate with prospective students and other constituentsonline, ultimately with the goal of lowering our cost of acquiring and startinga student.

I’d like to address just a few other items before we takeyour questions. First, the current situation with the credit markets continuesto be front-page news and we’ve received many questions about it from you.Recent legislative changes made by the federal government have lowered themargins earned by student loan lenders for administering and managing the titlefour government loan programs. According to news reports, this has pushed manystudent lenders to look elsewhere for improved profitability and some of youwould like to know whether this has affected or will impact Apollo.

Let me try to put this in perspective. A few years ago,Apollo made some decisions with regard to pricing that in light of the currentcredit situation have turned out to be particularly important. These decisionshave allowed us to run our business without a heavy dependence on privateloans. As a result, approximately 4% of our revenues are derived from privateloans.

Second, other than a small pool of loans, primarily forinternational students, we do not have any material risk sharing agreement withprivate loan providers. In total, our exposure is very small and we don’texpect this to change.

Finally, we know there are concerns in the market regardingthe availability and accessibility of title four loans. We have not seen anyimpact to date on our students obtaining financial aid. We have a strong anddiverse selection of unaffiliated student loan providers that are reviewedquarterly to include lenders that offer competitive borrower benefits, haveexceptional operating standards, possess technical wherewithal, and arecommitted to providing outstanding service and expedited processing by meetingor exceeding established performance standards.

In our opinion, the student loan market remains competitiveand our students have quality choices to meet their educational financingneeds.

With that, I’ll turn the call over to the Operator so we cantake your questions.



(Operator Instructions) Our first question is from the lineof Jeff Silber. Please go ahead.

Jeff Silber - BMOCapital Markets

Thanks so much. I appreciate all the color, Brian. I justwanted to delve a little bit further into this private lending issue. I thinkyou said that you -- I think the words you used were review the lendersagreements quarterly. I know you haven’t seen any as of yet, but as you dothese reviews, are lenders coming to you and asking for more risk sharing? Areyou hearing that in the market at all?

Brian E. Mueller

Joe, you had some meetings just recently. What are youhearing?

Joseph L. D'Amico

Right. Well, the lenders surely would like us to participatebut we’ve declined. And we haven’t seen any fall-off in terms of our ability toenroll students or have any serious impact on our abilities to -- for ourstudents to get loans. The level of private loans is down but there is stillsignificant, or at least to the 4% level for us.


Our next question is from the line of Sarah Gubins.

Sarah Gubins -Merrill Lynch

Thank you. Good afternoon. I’m hoping to understand a bitmore about the pattern of Axia graduates transferring into University ofPhoenix or finishing up their bachelor’s degree program at Phoenix,particularly in light of the decline in bachelor starts. Can you give us anupdate on what you are seeing for Axia graduation rates and the transfer rate forthe bachelor’s program? And then maybe talk a bit about the level of discountsor scholarships that you are expecting for those people who are transferringin.

Brian E. Mueller

Okay, there’s a number of points there. One, the -- we’renot giving any color on the number or the percent of students that aretransferring from Axia to the University of Phoenix and completing atUniversity of Phoenix. We gave some initial information about that but weconsider it proprietary and very competitive and we don’t want to release that.

The second point though is that it’s easy for you toprobably do some modeling around the number of students. The volume of studentsthat are graduating, that are going to Axia therefore the volume of studentsthat are graduating is getting bigger, so that pool of people who canpotentially transfer into our bachelor’s program is growing month over month,which is a very good thing from our standpoint.

The bachelors growth or lack of it as compared to theassociates growth has to be understood from the standpoint of we now have morethan half of our enrolment counselors out on the ground campuses and if youlook at a year ago, a student that would come with 42 credit hours or less --let’s say 30 college credits, would likely have been put by one of thosecounselors into a bachelor’s program.

Today, those people are putting them into the associatesprogram, into the Axia College program and so that number is being artificiallymanipulated by what’s going on from a new student standpoint.

And then the last question was about discounts. We don’tknow for sure what’s going to happen to that discount line. It will probably goup some but it will only go up in relationship to our increased retention andtherefore increased revenues, so anything that we invest from a scholarshipstandpoint into an Axia College graduate that would go to University of Phoenixbaccalaureate program would only be done because what we know is we willbenefit from the standpoint of increased student retention and thereforeincreased revenues, and that will result in increased profit.

So those discounts are done very strategically in order toincrease retention and revenues and we are experiencing that as part of oursuccess this quarter.


Our next question is from the line of Amy Junker. Please goahead.

Amy Junker - RobertW. Baird

Thanks. If I could actually just follow-up on that question,and I appreciate that you don’t want to give us specifics on the numbers, butcan you just at least tell us directionally if you are seeing improvement inthe percentage of students that are continuing? I assume you are seeing betterretention numbers you talked about, but are you seeing a greater interest inthose students wanting to go on to get a bachelor’s or are most of themsatisfied at this point with associates?

And then, as I think again a follow-up, when should --should we expect the bachelor’s to reaccelerate, you know, for all of this tocome through before the end of fiscal ’08 or is this going to be a fiscal ’09phenomenon where we should start to really see an acceleration in thebachelor’s portion of it?

Brian E. Mueller

We don’t know for sure about that because the numbers areimpacted by what new students are doing and in any given quarter, new studentsare 20% of our total student body. So it’s a difficult question to answer.There’s a lot of moving parts there.

What I will tell you is that from a business modelperspective -- I’ll say two things. Number one, as compared to what studentsare experiencing in community college programs, our graduation and transferrates are very good, very strong, so we think we are doing a very good job fromthe standpoint of servicing the needs of those students as they relate towhat’s going on in the rest of the industry.

Secondly, from a business model standpoint, it’s very, very-- it’s working very well. Our revenues are increasing, our margins areincreasing, and so what the results -- and we’ll continue to work at it. We’llwork at that as hard as anything that we’re working at but in terms of itsimpact on our business results, they are very good.


Our next question is from the line of Jerry Herman. Please go ahead.

Jerry Herman - StifelNicolaus

Thanks. Good afternoon, everybody. A question with regard tonew programs; you guys have talked about an expansion in the program offeringand I’m wondering, Brian, if you can give some indication as to what sort ofinfluence that’s having at this stage of the game -- is it material or not? Andhow is it potentially changing the student acquisition process from a leadgeneration point of view and what sort of impact is it having on retention,especially in the more specialized programs?

Brian E. Mueller

I think it’s a very, very good question and it’s somethingthat we have a great deal of interest in understanding more thoroughly. We’verolled out so many new programs in the last six to 12 months that we don’t havedefinitive data yet on both the increased conversion rates, so its impact onstudent starting or its impact on retention rates.

But what we do know is the Department of Education in arecent survey to college students, when they ask the college students to rankthings that were most important to them as they considered a college choice,number one was program availability. And we know that the programs that wecurrently have as a percent of all programs that are available in highereducation at all the four levels that we teach at are very small.

And so we are monitoring the conversion rates. We continueto specialize with regard to our enrolment counselors, making them responsiblefor fewer and fewer programs, therefore being able to be more expert at theprograms they represent. And we’ll watch closely the retention rates ofstudents, especially in those niche programs. Initial evidence is that they arehigher and we hope that they continue to go higher.


Our next question is from the line of Gary Bisbee. Please goahead.

Gary Bisbee - LehmanBrothers

Congratulations on the nice quarter. I guess the question istwo parts, but when do you expect you are going to lap this period ofartificially high new student starts last year that related to all the new repsyou hired and as that’s going to relate to starts performance, I guess over thelast few quarters you’ve said you are cautiously optimistic that in thenear-term, you may be above that medium term guidance you’ve given. Is itrealistic to assume that the starts growth can continue to do that once you’velapped this more difficult period? Thanks.

Brian E. Mueller

Well, we are seeing high single digit revenue growth, lowerdouble-digit operating profit growth and we currently are exceeding those, andso what we said was in the short run, we would exceed those and we are.

And the first question, the first question was -- oh, whenwas the last -- let me -- I left a little bit out of that story. One of the-- a year ago, when all those enrolmentcounselors were trained to put students in online programs, they put a lot inthat didn’t stay and so that partially impacted that 25% increase number.

But that was doubly impacted by the fact if you go back ayear before that, it was the low point. Fourth quarter two years ago and firstquarter two years ago, we reached our low point with regard to oureffectiveness as an organization, and so there was a double impact there.

I think what you will see is gradually over the next threequarters, things will level out and by first quarter of next year, we will becomparing an apples and apples scenario.

Gregory W. Cappelli

Gary, just one follow-up; when you think about -- I know youasked about the near term but we remain comfortable with our long-term internalobjective which we have given out quite a few times over the past couple ofquarters for mid to high single digit long-term revenue growth and double-digitoperating profit growth. And to get there, you do have to make certainassumptions in terms of a total enrolment growth and we have not changed ourinternal goals or view on that.


Our next question is from the line of Kevin Doherty. Pleasego ahead.

Kevin Doherty - Bankof America Securities

Thank you. I just wanted to follow-up on that last question.You talk about the strong demographic background, kind of the lack of thecredit crunch here. What scenario would really need to happen in your businessto level off to some of those longer term growth rates, particularly given howstrong things have been recently?

Brian E. Mueller

We evaluate those things all the time. I guess we -- youknow, we’re like Intel and we’re very, very paranoid, so we are looking out forthings that might impact us negatively. There’s lots of things out there thatcould but we have a lot of confidence in what we are doing at each level ofeducation that we service students at and we’ll continue to work very hard atit. And our progress in relationship to who our major competitor is, which arethe traditional universities and the community colleges, we believe that our progressin providing increasing levels of quality is improving versus theirs. We’reconfident about our future.


Our next question is from the line of Brandon Dobell. Pleasego ahead.

Brandon Dobell -William Blair & Company

I wonder if I could circle back, coming from a differentangle on the Axia matriculation question or idea here. Maybe it would behelpful to get a better sense, at least I know it would be helpful for me toget a better sense of what the Axia students actually look like relative to UoPstudents. Are they just the same students, less credit hours? Are they takingthe same kind of programs? Do they have the same kind of jobs and the same kindof positions? I’m just trying to gauge the likelihood of matriculation, thelikelihood of going on to a higher degree. I guess it would be helpful for usto understand if this is just really the same person with less credit hours orif there is even a decent difference in what those students might look like.Thanks.

Brian E. Mueller

From a demographic standpoint, our University of Phoenixstudents are 33 to 34 years old. They are about 60% male and about 40% female.Our Axia College students are 28 to 29 years old. They are 70% to 72% female,28% to 30% male. Their average household income, the Axia College students, isless. They are at more entry level jobs in the economy than our University ofPhoenix students.

So from an age perspective, there’s not that great adifference. They have the same bent towards females versus males. They are atmore entry level positions in the economy but we believe that their need forhigher education is as great or greater than our traditional University ofPhoenix student.

Anything else I can share, ethnically and from a racialstandpoint, it’s pretty close in terms of how they break down between ourUniversity of Phoenix students and our Axia College students.

I think one more thing that’s important to note, that we dovery little Axia College advertising. We do very little advertising of our associateprograms. The students that come to us and we put in Axia are students 99% ofthem who have a goal of achieving a baccalaureate degree. We think this is justa good way to get them started and get them well-prepared for pursuing that.

Gregory W. Cappelli

Brian, would you say in terms of the demographics, I mean,is there any reason why those Axia students would not at some point in time intheir growth, not want to get a bachelor’s degree?

Brian E. Mueller

No, I don’t think so because if you look at -- if you lookat the Axia College programs that we have, you will notice that there are a fewwhere there is some direct benefit from having an associates degree. There issome increased capability from an income standpoint but there is still a much greaterdifferentiator at the baccalaureate level, and so there’s not -- it’s not ascenario where an associates degree will give you an opportunity close to orequivalent to a baccalaureate degree so that people would be tempted to stopthere. We are not seeing that happen.


(Operator Instructions) Our next question is from the lineof Corey Greendale. Please go ahead.

Corey Greendale -First Analysis

Good afternoon. I have a question on the margins. Is thereanything that you would highlight as being kind of unusual or unsustainable,positive or negative, that affected those or if the revenue picture lookssimilar to this over the next couple of quarters, is this a pretty goodindication of what the margins should do as well?

Brian E. Mueller

Well, the thing that will impact it is the seasonality. Thesecond quarter, the revenue is going to be a little bit less. I mean, revenuesare depressed a little bit because of the students taking off time in theholidays and so that’s going to impact the margin.

But other than that, there is not -- you know, the gainsthat I think that we’ve made on the space side will continue that. They won’tcontinue to increase but we’ll maintain that. From an instructional cost andservices standpoint, those are gains we’ve made from an academic counselor andfinancial advisor standpoint. We expect to maintain those.

Bad debt has come down a little bit from the previousquarter, and so we gained a little bit there and obviously the hope is thatwe’ll maintain that, so I don’t think there’s anything outstanding other thanwe are going to spend, and I mentioned it in the script, we are going to spenda little bit more in December and January in advertising. We are gaining -- wecontinue to gain knowledge. We don’t know where the upper limit is in terms ofwhen we will start to get a decline in the return, positive return on thatadvertising dollar spend, so we’ll spend a little bit more. If we get a goodreturn, then we’ll continue that.

So that will go up a little bit as a percent of revenue, butother than that there is nothing outstanding there that would say it’s going tobe significantly different, other than the seasonality, which I know you guysknow about and take into account.


Our next question is from the line of Jeff Lee. Please goahead.

Jeff Lee - SignalHill

Good afternoon. What have you seen so far with theintegration of Aptimus? And has it made any impact on the organization in thetwo months you’ve owned it so far?

Brian E. Mueller

No, you know -- well, I will say that our goal is to makesure that we make this transition smoothly and we keep operating at our currentlevel of effectiveness and I believe that we are doing that. We are watchingthat very carefully. Those guys are working really, really hard to make surethere is no steps backwards.

Going forward, there is a lot of talent there. There is alot of talent around some significant areas that impact Internet advertisingthat over time we hope to leverage and see improvements.


Our next question is from the line of Scott Schneeberger.Please go ahead.

Scott Schneeberger -CIBC World Markets

Thank you. For Apollo Global, could you speak to a littlebit about where you are looking geographically, what types of business modelsyou are reviewing, what the environment is out there -- just any color you canadd since it appears that you are stockpiling cash there.

Gregory W. Cappelli

Sure. As we’ve said previously, we are initially focused onChina and Asia in general -- that’s including India -- part of Latin America,including Brazil and also Europe, where we’ve deployed resources now and havepeople on the ground.

The environment is mixed. In certain parts of the worldbecause of successful IPOs, we’ve seen prices that have been bit up and inthose cases, we are scouring the landscape, we’re trying to make sure weunderstand everything that’s out there. We are going to be disciplined with ourpartner, Carlyle, in our evaluation processes to these businesses. And we arein the stage right now of putting a nice pipeline together of opportunitiesthat we want to follow up on going forward.

So I’d say overall, we’ve been working hard the past coupleof quarters to get the right people in place, to get the discipline in place,and we’re pleased with where we are at this point.


Our next question is from the line of Mark Marostica. Pleasego ahead, sir.

Mark Marostica -Piper Jaffray

Thank you. Brian, I want to revisit a comment you made inyour remarks concerning the federal loan environment. In particular, a fewweeks ago Sallie Mae in a filing noted that it plans to be somewhat moreselective in pursuing origination activity on the federal side and on theprivate side, but on the federal side I’m wondering if you could help usunderstand your exposure to Sallie Mae. And secondly, what do you think thismeans, you know, the statement in their filing means relative to your business?Does it slow down your enrolment process? Does it force you to look at otherlenders? Can you give us a sense of how you think that plays out over the nextfew quarters?

Joseph L. D'Amico

With respect to Sallie Mae, they are one of our preferredlenders. We have four and Sallie Mae continues to process new loans for us onthe federal side without a hitch -- no cut backs, no changes, no delays. So wehaven’t felt the effect on the federal side at all relating to Sallie Mae.

And we continually look at our preferred lender list and gothrough a process of deciding whether to add or to change lenders who areparticipating with us. There is significant interest by a substantial number oflenders to become preferred lenders for the University of Phoenix.


Our next question is from the line of Susan Stein. Please goahead, Madam.

Susan Stein - MorganStanley

Thank you. First, a follow-up to the last question; can youjust mention who the other three preferred lenders are?

And also, is there any evidence in the market thatprospective students are price shopping more than they have in the past becauseof the lack of available private loans? And are you directing your marketingefforts at that? I mean, can you envision a scenario maybe where you wouldactually benefit from what’s happening in the private loan market?

Joseph L. D'Amico

I’ll answer the first question with respect to who are theother preferred lenders -- it’s Citibank, Wachovia, and Wells Fargo.

Brian E. Mueller

The answer to the second question is yes, we absolutely canenvision a point in time where we will benefit from the fact that we’ve beenable to build a business that is profitable at a level that is at a price thatis quite a bit less than most of our competition. I think we are in the rightplace at the right time from that standpoint and as we expand outprogrammatically, I think that will put some pressure on people.


Our next question is from the line of Edward Yruma. Pleasego ahead, sir.

Edward Yruma -JPMorgan

More of a housekeeping question; I noticed that otherreceivables ticked up significantly sequentially. What goes into that and whatdrove that increase? Thank you.

Joseph L. D'Amico

Nothing unusual occurred there. It’s just timing or --


And we do have a follow-up question from the line of GaryBisbee. Please go ahead.

Gary Bisbee - LehmanBrothers

Just a question around this line of credit here and thedecision not to buy back any stock this quarter; I think you’ve got $600million of cash, restricted cash and now you’ve got borrowing capacity for $0.5billion. Should we read anything into this in terms of how much you arethinking about potentially investing in international acquisitions and in termsof doing something quickly because of the stockpile in cash? How are you goingto think about buy-backs? It seems to me with your cash flow what it is, yourbalance sheet what it is and now that borrowing power, there still would belots of room for buy-backs as well. Thanks.

Gregory W. Cappelli

Why did I know you were going to ask me that question, Gary?No, you shouldn’t read anything into it but let’s step back for one second -- aquarter ago we were able to get off over $430 million in repurchases, which wewere pleased with. We did take a step back this quarter just to take a look atall of our capital needs going forward and we’ve been evaluating thosecomprehensively.

Think about our businesses now -- it’s not just theUniversity of Phoenix and the capital needs two or three years ago of buildingthat business. We’ve got Aptimus and there are opportunities to put capital towork in that industry. Insight Schools, there are opportunities there and we’reexcited about the growth potential in that part of our business.

There is the University of Phoenix and all the initiativesthat Brian has talked about, from retention on to new programs. And now thereis Apollo Global, where -- and I know I failed to mention this on the earlierquestion from the last caller but we are looking at K-12, post-secondary,vocational and corporate training outside the U.S.

So the good news is we’ve got no shortage of opportunitiesto actually deploy and put capital to work. What we are doing is we are tryingto evaluate where we will get the highest returns for all the projects that weare lining up in the pipeline.

And just to finish with your question, we are not adverse toopportunistically buying back stock as well, so that’s something that we arecontinuously evaluating going forward. Hopefully that answers your question.


Our next question is from the line of Sarah Gubins. Pleasego ahead.

Sarah Gubins -Merrill Lynch

Thanks. Just a quick follow-up; Brian, you mentioned that ayear ago, reps were still putting students with less than a certain number ofcredit hours in some cases into the University of Phoenix program as opposed toAxia College. At what point did reps really entirely start putting studentswith fewer credit hours into Axia?

Brian E. Mueller

It varies. It really depends upon the comfort level of thatperson and so it varies. The other thing that it varies around is the size ofthe campus. If you are in a very small campus, a very small marketplace whereit is difficult to get class size and group size in ground-based programs, thenyou are going to have more people gravitating towards the online program wherestudents can start every single week, whenever it’s most convenient for them.

So I guess the answer is it varies.

Thank you very much. I’m sorry, there is one more.


We do have a question from the line of Jeff Silber. Pleasego ahead, sir.

Jeff Silber - BMOCapital Markets

Thanks for letting me sneak in. Just looking quickly at therevenue per student, you had mentioned some selective price increases. Can youtell us what programs they were in? Was it bachelor’s, master’s, et cetera? Doyou have plans to continue that going forward? And can you also review, I knowhistorically you talked about a national pricing model -- what are yourthoughts on that?

Brian E. Mueller

The price increases were around both bachelor’s, master’s,and doctoral programs. And going forward, as we talked about before, we havesignificant room for price increases at the doctoral level. We have significantroom under title four loan limits at the master’s level. We have some room atthe associates level and at the baccalaureate level, we have some students whoare under title four loan limits because they are at campuses in the Midwest.We have other students who are above title four loan limits and so it’s a mixedbag only at the bachelor’s level.

Right now, we really like how the business is going. We likewhat we are getting in terms of conversion rates and retention rates and welike how the revenue per student is going at all levels, and so we have noinclination to do anything currently. We’ll just continue to watch it. We’llcontinue to evaluate it and at some point if we do it, it would only be donebecause it would increase revenues -- increase revenues per student because ofits impact on retention. We would not do it if we weren’t sure that it would dothat.

But again, thank you all for attending. We appreciate yourattendance and have a good evening.


This concludes today’s conference call. Thank you foryour participation.

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