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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

     
xbox   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
             For the quarterly period ended May 31, 2002

OR

     
box   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-25232

APOLLO GROUP, INC.

(Exact name of registrant as specified in its charter)
     
ARIZONA
(State or other jurisdiction of
incorporation or organization)		   86-0419443
(I.R.S. Employer
Identification No.)

4615 EAST ELWOOD STREET, PHOENIX, ARIZONA 85040
(Address of principal executive offices, including zip code)

(480) 966-5394
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.

xbox  Yes           box  No

AT JULY 9, 2002, THE FOLLOWING SHARES OF STOCK WERE OUTSTANDING:

     
Apollo Education Group Class A common stock, no par value   173,020,000 Shares
Apollo Education Group Class B common stock, no par value   484,000 Shares
University of Phoenix Online common stock, no par value   14,099,000 Shares

 

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
Item 1 – Financial Statements — Apollo Group, Inc.
PART I – FINANCIAL INFORMATION
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of Apollo Group, Inc.
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EX-15.1
Exhibit 99

Table of Contents

APOLLO GROUP, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX

         
    PAGE
PART I – FINANCIAL INFORMATION
        
 
        
Item 1. Financial Statements
     1  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
     13  
Item 3. Quantitative and Qualitative Disclosures about Market Risk
     18  
 
        
PART II – OTHER INFORMATION
        
 
        
Item 1. Legal Proceedings
     19  
Item 2. Changes in Securities and Use of Proceeds
     19  
Item 3. Defaults Upon Senior Securities
     19  
Item 4. Submission of Matters to a Vote of Security Holders
     19  
Item 5. Other Information
     19  
Item 6. Exhibits and Reports on Form 8-K
     19  
 
        
SIGNATURES
     20  
 
        
EXHIBIT INDEX
     21  

EXHIBIT 15.1 – Letter on Unaudited Interim Financial Information
 
EXHIBIT 99 – University of Phoenix Online Financial Statements and Management’s Discussion and Analysis of Financial
Condition and Results of Operations

 

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements — Apollo Group, Inc.

APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

                   
      May 31,   August 31,
      2002   2001
     
 
      (Unaudited)        
(Dollars in thousands)                
Assets:
                
Current assets
                
 
Cash and cash equivalents
   $ 238,655     $ 145,933  
 
Restricted cash
     88,755       57,896  
 
Marketable securities
     207,238       170,866  
 
Receivables, net
     94,543       92,179  
 
Deferred tax assets, net
     10,863       7,822  
 
Other current assets
     12,630       12,355  
 
    
     
 
Total current assets
     652,684       487,051  
Property and equipment, net
     104,383       102,624  
Marketable securities
     64,197       27,239  
Cost in excess of fair value of assets purchased, net
     37,096       37,096  
Deferred tax assets, net
     4,655       3,180  
Other assets
     23,310       23,153  
 
    
     
 
Total assets
   $ 886,325     $ 680,343  
 
    
     
 
Liabilities and Shareholders’ Equity:
                
Current liabilities
                
 
Current portion of long-term liabilities
   $ 3,003     $ 408  
 
Accounts payable
     15,401       16,846  
 
Accrued liabilities
     37,470       30,524  
 
Income taxes payable
     14,168       7,096  
 
Student deposits and current portion of deferred revenue
     164,777       127,326  
 
    
     
 
Total current liabilities
     234,819       182,200  
Deferred tuition revenue, less current portion
     1,157       1,409  
Long-term liabilities, less current portion
     20,216       14,849  
 
    
     
 
Total liabilities
     256,192       198,458  
 
    
     
 
Commitments and contingencies
                
Shareholders’ equity
                
Preferred stock, no par value, 1,000,000 shares authorized; none issued Apollo Education Group Class A nonvoting common stock, no par value, 400,000,000 shares authorized; 172,843,000 and 171,597,000 issued and outstanding at May 31, 2002 and August 31, 2001, respectively
     103       103  
Apollo Education Group Class B voting common stock, no par value, 3,000,000 shares authorized; 484,000 issued and outstanding at May 31, 2002 and August 31, 2001
     1       1  
University of Phoenix Online nonvoting common stock, no par value, 400,000,000 shares authorized; 13,550,000 and 12,596,000 issued and outstanding at May 31, 2002 and August 31, 2001, respectively
                
Additional paid-in capital
     210,037       185,424  
Apollo Education Group Class A treasury stock, at cost, 4,540,000 and 5,789,000 shares at May 31, 2002 and August 31, 2001, respectively
     (48,878 )     (60,761 )
University of Phoenix Online treasury stock, at cost, 3,000 shares at May 31, 2002
     (50 )        
Retained earnings
     468,887       357,036  
Accumulated other comprehensive income
     33       82  
 
    
     
 
Total shareholders’ equity
     630,133       481,885  
 
    
     
 
Total liabilities and shareholders’ equity
   $ 886,325     $ 680,343  
 
    
     
 

The accompanying notes are an integral part of these consolidated financial statements.

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APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS

                                   
      For the Three Months Ended   For the Nine Months Ended
      May 31,   May 31,
      2002   2001   2002   2001
     
 
 
 
              (Unaudited)        
(In thousands, except per share amounts)                                
Revenues:
                                
 
Tuition and other, net
   $ 276,349     $ 214,305     $ 727,146     $ 554,358  
 
    
     
     
     
 
Costs and expenses:
                                
 
Instructional costs and services
     129,764       107,871       365,302       297,343  
 
Selling and promotional
     50,546       40,127       142,851       104,126  
 
General and administrative
     15,260       13,600       43,247       37,309  
 
    
     
     
     
 
 
     195,570       161,598       551,400       438,778  
 
    
     
     
     
 
Income from operations
     80,779       52,707       175,746       115,580  
Interest income, net
     3,068       3,755       8,847       10,584  
 
    
     
     
     
 
Income before income taxes
     83,847       56,462       184,593       126,164  
Provision for income taxes
     33,048       21,074       72,742       49,598  
 
    
     
     
     
 
Net income
   $ 50,799     $ 35,388     $ 111,851     $ 76,566  
 
    
     
     
     
 
Net income attributed to:
                                
 
Apollo Education Group common stock
   $ 48,369     $ 34,224     $ 106,599     $ 74,358  
 
    
     
     
     
 
 
University of Phoenix Online common stock
   $ 2,430     $ 1,164     $ 5,252     $ 2,208  
 
    
     
     
     
 
Earnings per share attributed to:
                                
Apollo Education Group common stock:
                                
 
Basic net income per share
   $ 0.28     $ 0.20     $ 0.62     $ 0.43  
 
    
     
     
     
 
 
Diluted net income per share
   $ 0.27     $ 0.20     $ 0.61     $ 0.43  
 
    
     
     
     
 
 
Basic weighted average shares outstanding
     173,112       171,758       172,635       171,224  
 
    
     
     
     
 
 
Diluted weighted average shares outstanding
     176,040       174,366       175,462       173,731  
 
    
     
     
     
 
University of Phoenix Online common stock:
                                
 
Basic net income per share
   $ 0.18     $ 0.10     $ 0.40     $ 0.19  
 
    
     
     
     
 
 
Diluted net income per share
   $ 0.16     $ 0.09     $ 0.35     $ 0.16  
 
    
     
     
     
 
 
Basic weighted average shares outstanding
     13,283       11,664       12,974       11,572  
 
    
     
     
     
 
 
Diluted weighted average shares outstanding
     15,291       13,586       14,928       13,391  
 
    
     
     
     
 

The accompanying notes are an integral part of these consolidated financial statements.

2

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APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

                                   
      For the Three Months Ended   For the Nine Months Ended
      May 31,   May 31,
      2002   2001   2002   2001
     
 
 
 
              (Unaudited)        
(In thousands)                                
Net income
   $ 50,799     $ 35,388     $ 111,851     $ 76,566  
Other comprehensive income, net of income taxes:
                                
 
Currency translation gain (loss)
     (152 )     10       (49 )     96  
 
    
     
     
     
 
Comprehensive income
   $ 50,647     $ 35,398     $ 111,802     $ 76,662  
 
    
     
     
     
 

The accompanying notes are an integral part of these consolidated financial statements.

3

Table of Contents

APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS

                         
            For the Nine Months Ended
            May 31,
            2002   2001
           
 
            (Unaudited)  
(In thousands)                
Cash flows provided by (used for) operating activities:
                
   
Net income
   $ 111,851     $ 76,566  
   
Adjustments to reconcile net income to net cash provided by operating activities:
                
     
Depreciation and amortization
     26,341       24,034  
     
Amortization of investment premiums (discounts)
     2,208       (1,147 )
     
Provision for uncollectible accounts
     11,495       8,802  
     
Deferred income taxes
     (4,516 )     (1,237 )
     
Tax benefits of stock options exercised
     20,537       10,489  
     
Decrease (increase) in assets:
                
       
Restricted cash
     (30,859 )     (14,885 )
       
Receivables
     (13,859 )     (15,663 )
       
Other assets
     (204 )     1,620  
     
Increase in liabilities:
                
       
Accounts payable and accrued liabilities
     12,573       11,732  
       
Student deposits and deferred revenue
     37,199       16,960  
       
Other liabilities
     8,576       1,569  
   
 
    
     
 
Net cash provided by operating activities
     181,342       118,840  
   
 
    
     
 
Cash flows provided by (used for) investing activities:
                
   
Net additions to property and equipment
     (27,713 )     (31,178 )
   
Cost of facility subject to sale-leaseback
             (3,447 )
   
Purchase of marketable securities
     (225,568 )     (176,464 )
   
Maturities of marketable securities
     150,030       80,153  
   
Purchase of other assets
     (1,129 )     (743 )
   
Proceeds from sale of land
             879  
   
 
    
     
 
Net cash used for investing activities
     (104,380 )     (130,800 )
   
 
    
     
 
Cash flows provided by (used for) financing activities:
                
   
Purchase of Apollo Education Group Class A common stock
     (2,438 )     (1,593 )
   
Issuance of Apollo Education Group Class A common stock
     14,368       13,165  
   
Purchase of University of Phoenix Online common stock
     (6,833 )        
   
Issuance of University of Phoenix Online common stock
     10,812       76,244  
   
Payments on long-term debt
     (100 )     (100 )
   
 
    
     
 
Net cash provided by financing activities
     15,809       87,716  
   
 
    
     
 
Currency translation gain (loss)
     (49 )     96  
   
 
    
     
 
Net increase in cash and cash equivalents
     92,722       75,852  
Cash and cash equivalents at beginning of period
     145,933       59,912  
   
 
    
     
 
Cash and cash equivalents at end of period
   $ 238,655     $ 135,764  
 
    
     
 

The accompanying notes are an integral part of these consolidated financial statements.

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APOLLO GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

1.     The interim consolidated financial statements include the accounts of Apollo Group, Inc. (“Apollo” or the “Company”) and its wholly-owned subsidiaries, which include The University of Phoenix, Inc. (“University of Phoenix”), Institute for Professional Development (“IPD”), Western International University, Inc. (“WIU”), and The College for Financial Planning Institutes Corporation (the “College”). This financial information reflects all adjustments, consisting only of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Unless otherwise noted, references to 2002 and 2001 refer to the periods ended May 31, 2002 and 2001, respectively.

On March 24, 2000, the Board of Directors of Apollo authorized the issuance of a new class of stock called University of Phoenix Online common stock, that is intended to reflect the separate performance of University of Phoenix Online, a division of University of Phoenix. Apollo’s other businesses and its retained interest in University of Phoenix Online are referred to as “Apollo Education Group.” On October 3, 2000, an offering of 5,750,000 shares of University of Phoenix Online common stock was completed at a price of $14.00 per share. At the time of the offering this stock represented a 10.8% interest in that business with Apollo Education Group retaining an 89.2% interest in University of Phoenix Online.

2.     The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the fiscal year ended August 31, 2001 included in the Company’s Form 10-K as filed with the Securities and Exchange Commission. The results of operations for the three-month and nine-month periods ended May 31, 2002 are not necessarily indicative of the results to be expected for the entire fiscal year or any future period.

3.     The Company’s operations are aggregated into a single reportable segment based upon their similar economic and operating characteristics. The Company’s educational operations are conducted in similar markets and produce similar economic results. These operations provide higher education programs for working adults. The Company’s operations are also subject to a similar regulatory environment, which include licensing and accreditation.

4.     On April 4, 2002, the Board of Directors of Apollo authorized a 3-for-2 stock split of its Apollo Education Group Class A and Class B common stock to be affected in the form of a stock dividend. All Apollo Education Group common stock amounts and earnings per share figures for periods prior to the stock split have been restated to reflect the effect of the stock split.

On June 29, 2001, the Board of Directors of Apollo authorized a 3-for-2 stock split of its University of Phoenix Online common stock to be affected in the form of a stock dividend. On April 4, 2002, the Board of Directors of Apollo authorized a 4-for-3 stock split of its University of Phoenix Online common stock to be affected in the form of a stock dividend. All University of Phoenix Online common stock amounts and earnings per share figures for periods prior to the stock splits have been restated to reflect the effect of the stock splits.

5.     Earnings attributable to different classes of the Company’s common stock are as follows:

                                 
    For the Three Months Ended   For the Nine Months Ended
    May 31,   May 31,
    2002   2001   2002   2001
   
 
 
 
    (Unaudited)
(In thousands)                                
Apollo Education Group
   $ 48,369     $ 34,224     $ 106,599     $ 74,358  
University of Phoenix Online
     2,430       1,164       5,252       2,208  
 
    
     
     
     
 
Net income
   $ 50,799     $ 35,388     $ 111,851     $ 76,566  
 
    
     
     
     
 

The earnings attributable to University of Phoenix Online common stock represent the portion of the earnings of University of Phoenix Online attributed to the shares of University of Phoenix Online common stock outstanding excluding Apollo Education Group’s retained interest in the University of Phoenix Online. At the date of the issuance of the University of Phoenix Online common stock, Apollo Education Group retained an 89.2% interest in University of Phoenix Online. This percentage has decreased to 87.5% at May 31, 2002 due to the issuance of shares related to the exercise of University of Phoenix Online stock options and the issuance of shares of University of Phoenix Online common stock as part of the Apollo Group, Inc. Employee Stock Purchase Plan partially offset by the repurchase of shares of University of Phoenix Online common stock.

5

Table of Contents

A reconciliation of the basic and diluted earnings per share computations for Apollo Education Group Class A and Class B common stock is as follows:

                                                   
      For the Three Months Ended May 31,
      2002   2001
     
 
              Weighted                   Weighted        
              Average   Per Share           Average   Per Share
      Income   Shares   Amount   Income   Shares   Amount
     
 
      (Unaudited)
(In thousands, except per share amounts)                                                
Basic net income per share
   $ 48,369       173,112     $ 0.28     $ 34,224       171,758     $ 0.20  
Effect of dilutive securities:
                                                
 
Stock options
             2,928                       2,608          
     
 
Diluted net income per share
   $ 48,369       176,040     $ 0.27     $ 34,224       174,366     $ 0.20  
     
 

          

                                                   
      For the Nine Months Ended May 31,
      2002   2001
     
 
              Weighted                   Weighted        
              Average   Per Share           Average   Per Share
      Income   Shares   Amount   Income   Shares   Amount
     
 
      (Unaudited)
(In thousands, except per share amounts)                                                
Basic net income per share
   $ 106,599       172,635     $ 0.62     $ 74,358       171,224     $ 0.43  
Effect of dilutive securities:
                                                
 
Stock options
             2,827                       2,507          
     
 
Diluted net income per share
   $ 106,599       175,462     $ 0.61     $ 74,358       173,731     $ 0.43  
     
 

Basic earnings per share for Apollo Education Group common stock for the three and nine months ended May 31, 2002 and 2001 were computed by dividing Apollo Education Group earnings (including its retained interest in University of Phoenix Online earnings) by the weighted average number of Apollo Education Group common stock shares outstanding during the respective periods. Diluted earnings per share was calculated similarly, except that the dilutive effect of the assumed exercise of options issued under Apollo Group, Inc. incentive plans, exclusive of options granted and shares issued with respect to University of Phoenix Online common stock, is included.

A reconciliation of the basic and diluted earnings per share computations for University of Phoenix Online common stock is as follows:

                                                   
      For the Three Months Ended May 31,
      2002 2001
     
 
              Weighted                   Weighted        
              Average   Per Share           Average   Per Share
      Income   Shares   Amount   Income   Shares   Amount
     
 
    (Unaudited)
(In thousands, except per share amounts)                                        
Basic net income per share
   $ 2,430       13,283     $ 0.18     $ 1,164       11,664     $ 0.10  
Effect of dilutive securities:
                                                
 
Stock options
             2,008                       1,922          
     
 
Diluted net income per share
   $ 2,430       15,291     $ 0.16     $ 1,164       13,586     $ 0.09  
     
 

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                              For the Period From the Date of the
      For the Nine Months Ended May 31,   Offering Through May 31,
      2002   2001
     
 
              Weighted                   Weighted        
              Average   Per Share           Average   Per Share
      Income   Shares   Amount   Income   Shares   Amount
     
 
      (Unaudited)
(In thousands, except per share amounts)                                                
Basic net income per share
   $ 5,252       12,974     $ 0.40     $ 2,208       11,572     $ 0.19  
Effect of dilutive securities:
                                                
 
Stock options
             1,954                       1,819          
     
 
Diluted net income per share
   $ 5,252       14,928     $ 0.35     $ 2,208       13,391     $ 0.16  
     
 

Basic earnings per share of University of Phoenix Online common stock for the three months ended May 31, 2002 and 2001 and the nine months ended May 31, 2002 and for the period from the date of the offering through May 31, 2001 were computed by dividing University of Phoenix Online earnings (excluding Apollo Education Group’s retained interest in University of Phoenix Online earnings) by the number of shares of University of Phoenix Online common stock outstanding during the respective periods. Diluted earnings per share was calculated similarly, except that the dilutive effect of the assumed exercise of options issued under Apollo Group, Inc. incentive plans with respect to University of Phoenix Online common stock is included.

6.     The following schedules present statement of operations data of Apollo Education Group, University of Phoenix Online, and Apollo Group, Inc. We have presented this information to illustrate the respective operating results of Apollo Education Group and University of Phoenix Online, including the impact of the inter-group license fee and inter-group allocated expenses, and how the operating results of those groups relate to the consolidated operating results of Apollo Group, Inc.

Since its inception, the Company has financed University of Phoenix Online’s operations internally and has not incurred any related third-party debt. All of its cash receipts and disbursements were processed by the Company on University of Phoenix Online’s behalf. All amounts were settled through the funds allocated to/from Apollo Education Group component of University of Phoenix Online’s divisional net worth. Whenever University of Phoenix Online generated cash from operations, that cash was deemed to be transferred to Apollo Education Group and was accounted for as a return of capital. Whenever University of Phoenix Online had a cash need, that cash was deemed to be transferred from Apollo Education Group and was accounted for as a capital contribution. As a result of this policy, no inter-group interest income or expense was reflected in the consolidating statement of operations for the periods prior to the offering.

Upon the completion of the offering, the net proceeds of the offering of $72.8 million were transferred to University of Phoenix Online and accounted for as a capital contribution. Subsequently, the difference between cash receipts and cash outlays attributable to University of Phoenix Online have been accounted for as a revolving credit advance from University of Phoenix Online to Apollo Education Group (to the extent this difference was not transferred to University of Phoenix Online) requiring the reflection of interest expense by Apollo Education Group and interest income by the University of Phoenix Online at the rate of interest determined by the Board of Directors.

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      Three Months Ended May 31,
      2002   2001
     
 
      Apollo   University of                   Apollo   University of                
      Education   Phoenix           Apollo   Education   Phoenix           Apollo
      Group   Online   Eliminations   Group, Inc.   Group   Online   Eliminations   Group, Inc.
     
 
      (Unaudited)
(In thousands)                                                                
Revenues:
                                                                
Tuition and other, net(1)
   $ 185,301     $ 91,048     $ —     $ 276,349     $ 160,234     $ 54,071     $ —     $ 214,305  
Inter-group license fee revenue(2)
     3,642               (3,642 )     —       2,163               (2,163 )     —  
     
 
 
     188,943       91,048       (3,642 )     276,349       162,397       54,071       (2,163 )     214,305  
     
 
Costs and expenses:
                                                                
Instructional costs and services
                                                                
 
External expenses(3)
     102,965       26,799               129,764       92,753       15,118               107,871  
 
Inter-group allocated expenses(4)
     (4,907 )     4,907               —       (3,502 )     3,502               —  
 
Inter-group license fee expense(2)
             3,642       (3,642 )     —               2,163       (2,163 )     —  
Selling and promotional
                                                                
 
External expenses(3)
     31,598       18,948               50,546       27,015       13,112               40,127  
 
Inter-group allocated expenses(4)
     (185 )     185               —       (337 )     337               —  
General and administrative
                                                                
 
External expenses(3)
     15,260                       15,260       13,600                       13,600  
 
Inter-group allocated expenses(4)
     (4,675 )     4,675               —       (3,200 )     3,200               —  
     
 
 
     140,056       59,156       (3,642 )     195,570       126,329       37,432       (2,163 )     161,598  
     
 
Income from operations
     48,887       31,892       —       80,779       36,068       16,639       —       52,707  
Interest income, net
     2,316       752               3,068       2,747       1,008               3,755  
     
 
Income before income taxes
     51,203       32,644       —       83,847       38,815       17,647       —       56,462  
Provision for income taxes(5)
     20,072       12,976               33,048       14,075       6,999               21,074  
     
 
Net income
   $ 31,131     $ 19,668     $ —     $ 50,799     $ 24,740     $ 10,648     $ —     $ 35,388  
     
 
                                                                   
      Nine Months Ended May 31,
      2002   2001
     
 
      Apollo   University of                   Apollo   University of                
      Education   Phoenix           Apollo   Education   Phoenix           Apollo
      Group   Online   Eliminations   Group, Inc.   Group   Online   Eliminations   Group, Inc.
     
 
      (Unaudited)
(In thousands)                                                                
Revenues:
                                                                
Tuition and other, net(1)
   $ 499,601     $ 227,545     $ —     $ 727,146     $ 430,075     $ 124,283     $ —     $ 554,358  
Inter-group license fee revenue(2)
     9,102               (9,102 )     —       4,971               (4,971 )     —  
     
 
 
     508,703       227,545       (9,102 )     727,146       435,046       124,283       (4,971 )     554,358  
     
 
Costs and expenses:
                                                                
Instructional costs and services
                                                                
 
External expenses(3)
     294,092       71,210               365,302       258,800       38,543               297,343  
 
Inter-group allocated expenses(4)
     (13,154 )     13,154               —       (8,602 )     8,602               —  
 
Inter-group license fee expense(2)
             9,102       (9,102 )     —               4,971       (4,971 )     —  
Selling and promotional
                                                                
 
External expenses(3)
     91,595       51,256               142,851       75,108       29,018               104,126  
 
Inter-group allocated expenses(4)
     (508 )     508               —       (752 )     752               —  
General and administrative
                                                                
 
External expenses(3)
     43,247                       43,247       37,309                       37,309  
 
Inter-group allocated expenses(4)
     (12,712 )     12,712               —       (7,873 )     7,873               —  
     
 
 
     402,560       157,942       (9,102 )     551,400       353,990       89,759       (4,971 )     438,778  
     
 
Income from operations
     106,143       69,603       —       175,746       81,056       34,524       —       115,580  
Interest income, net
     6,534       2,313               8,847       7,872       2,712               10,584  
     
 
Income before income taxes
     112,677       71,916       —       184,593       88,928       37,236       —       126,164  
Provision for income taxes(5)
     44,155       28,587               72,742       34,626       14,972               49,598  
     
 
Net income
   $ 68,522     $ 43,329     $ —     $ 111,851     $ 54,302     $ 22,264     $ —     $ 76,566  
     
 

(1)   Tuition and other revenues are shown net of discounts from a variety of promotional programs and represent amounts earned from students of Apollo Education Group and University of Phoenix Online, respectively. There are no tuition or other net revenues that have been allocated between Apollo Education Group and University of Phoenix Online.

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(2)   Apollo Group, Inc. charges University of Phoenix Online a license fee equal to 4% of University of Phoenix Online’s net revenues for the use of curriculum, trademarks, and copyrights owned by Apollo Group, Inc. and its subsidiaries. The license fee, which is included in University of Phoenix Online’s instructional costs and services, totaled $3.6 million and $2.2 million for the three months ended May 31, 2002 and 2001, respectively, and $9.1 million and $5.0 million for the nine months ended May 31, 2002 and 2001, respectively. The inter-group license fee revenue of Apollo Education Group eliminates against the inter-group license fee expense of University of Phoenix Online in consolidation at the Apollo Group, Inc. level.
(3)   External expenses represent costs incurred directly by Apollo Education Group and University of Phoenix Online and do not include any inter-group allocations.
(4)   Certain costs incurred by Apollo Group, Inc. and The University of Phoenix, Inc. including legal, accounting, corporate office, and centralized student services costs, have been allocated to University of Phoenix Online on the basis of its revenues in relation to those of Apollo Group, Inc. and The University of Phoenix, Inc. The allocation of such expenses to University of Phoenix Online was as follows:

                                                
    Three Months Ended   Nine Months Ended
    May 31,   May 31,
    2002   2001   2002   2001
   
 
 
 
    (Unaudited)
(In thousands)                                
Instructional costs and services
   $ 4,907     $ 3,502     $ 13,154     $ 8,602  
Selling and promotional
     185       337       508       752  
General and administrative
     4,675       3,200       12,712       7,873  
 
    
     
     
     
 
 
   $ 9,767     $ 7,039     $ 26,374     $ 17,227  
 
    
     
     
     
 

(5)   University of Phoenix Online’s results, along with other divisions of The University of Phoenix, Inc., are included in the Apollo Group, Inc. consolidated federal income tax return. State taxes are paid based upon apportioned taxable income or loss of Apollo Group, Inc., with the exception of certain state taxes that are based upon an apportionment of The University of Phoenix, Inc. taxable income or loss. The provision for income taxes included in the accompanying consolidating statement of operations data has been calculated on a separate company basis.

7.     The U.S. Department of Education Office of the Inspector General (“OIG”) is currently auditing the administration of the federal student financial assistance programs in connection with educational programs provided pursuant to contractual arrangements between IPD and certain of its client institutions. In audit reports issued to five client institutions, the OIG asserted that the client institutions violated the statutory prohibition on the use of incentive payments for recruiting by paying IPD a percentage of tuition revenue. The reports further suggest that IPD paid its employees in a manner that included incentive-based compensation even though IPD based its compensation plans for recruiters on factors or qualities that were not solely related to the success in securing enrollments. Additionally, the audit reports question the client institutions’ interpretation of the “12-hour rule.” Although both IPD and the client institutions believe that the matters in question do not relate to student program or institutional eligibility and, therefore, believe a repayment of federal funds is not appropriate, the OIG has recommended to the U.S. Department of Education that the client institutions be required to return to lenders all loan funds disbursed. The institutions, with IPD’s assistance, will work with the U.S. Department of Education to eliminate or settle the issues raised in the audit reports.

During 2001, IPD recorded a charge of $5.1 million (including $4.1 million recorded in the first nine months of 2001), to provide for its share of the estimated settlement obligation relating to all of its client institutions under audit. Our calculation of the estimated settlement obligation, which is reflected in instructional costs and services in the accompanying consolidated statement of operations, was based on information available to us and our previous experience with respect to such settlements.

Although we believe that the OIG’s audits of IPD’s client institutions will be resolved without any material effect on our financial position, results of operations, or cash flows, and without any material change in IPD’s business strategy, as with any program review or audit, no assurance can be given as to the final outcome as the matters are not yet resolved.

On approximately December 19, 2001, a class action complaint was filed in the Superior Court of the State of California for the County of Solano, captioned Davis et. al. v. Apollo Group, Inc. et. al., Case No. FCS018663. Plaintiffs, one current and two former enrollment counselors with The University of Phoenix, Inc., filed this class action on behalf of themselves and current and former enrollment counselors employed by the Company in the State of California and seek certification as a class, monetary damages in unspecified amounts, and injunctive relief. Plaintiffs allege that during their employment, they and other enrollment counselors worked in excess of 8 hours per day or 40 hours per week, and contend that the Company failed to pay overtime. An initial status conference has been held, but no trial date has been set. While the outcome of this legal proceeding is currently not determinable, management does not expect the results of this action to have a material adverse effect on the Company’s business, financial position, results of operations, or cash flows.

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8.     The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS No. 141”), and No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 141 eliminates the use of the pooling-of-interests method of accounting for business combinations and requires all acquisitions to be accounted for using the purchase method. SFAS No. 142, among other things, discontinues the requirement that goodwill resulting from purchase business combinations be amortized to expense over the related estimated useful life. Under the new guidance, goodwill balances are subjected to an impairment analysis on an annual basis or whenever events or circumstances indicate that the estimated fair value is less than the related carrying value. As of May 31, 2002, the Company had approximately $37.1 million in unamortized cost in excess of fair value of assets purchased (i.e. goodwill) resulting from our acquisitions of WIU and the College.

The Company adopted SFAS No. 142 effective September 1, 2001. Under the Standard’s transitional rules, the Company was required to complete the first step of a two-step impairment test by February 28, 2002 using carrying and fair value information as of September 1, 2001. If an impairment was indicated by that test, the Company would have been required to complete the second test by August 31, 2002. The Company has completed its first step test and determined that the estimated fair value of our goodwill exceeded the related carrying value as of September 1, 2001 and, therefore, a related impairment charge was not required. The Company will continue to monitor its goodwill balances for impairments on an annual basis or whenever circumstances indicate that the estimated fair value is less than the carrying value. The Company recognized goodwill amortization expense of $0.3 million and $1.0 million during the three and nine month periods ended May 31, 2001; such amortization expense is no longer required under SFAS No. 142.

9.     In August 1998, the Company together with Hughes Network Systems and Hermes Onetouch, L.L.C. (“Hermes”) formed Interactive Distance Learning, Inc. (“IDL”), a new corporation, to acquire One Touch Systems, a leading provider of interactive distance learning solutions. The Company contributed $10.7 million in October 1999 and $1.2 million in December 1999, in exchange for a 19% interest in the newly formed corporation. The Company accounted for its investment in IDL, which was included in other assets in the consolidated balance sheet as of August 31, 2001, under the cost method. Hermes, which owned a 30% interest in IDL as of August 31, 2001, is currently owned by Dr. John G. Sperling, the Chairman of Apollo.

On December 14, 2001, Hermes acquired the Company’s investment in IDL in exchange for a promissory note in the principal amount of $11.9 million, which represented the related carrying value and approximated the related fair value as of that date. The promissory note accrues interest at an annual rate of six percent and is due at the earlier of December 14, 2021 or nine months after Dr. Sperling’s death. The promissory note is included in other assets in the consolidated balance sheet as of May 31, 2002.

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Review by Independent Accountants

         The financial information as of May 31, 2002, and for the three-month and nine-month periods then ended, included in Part I pursuant to Rule 10-01 of Regulation S-X, has been reviewed by PricewaterhouseCoopers LLP (“PricewaterhouseCoopers”), our independent accountants, in accordance with standards established by the American Institute of Certified Public Accountants. PricewaterhouseCoopers’ report is included in this quarterly report.

         PricewaterhouseCoopers does not carry out any significant or additional audit tests beyond those that would have been necessary if its report had not been included in this quarterly report. Accordingly, such report is not a “report” or “part of a registration statement” within the meaning of Sections 7 and 11 of the Securities Act of 1933 and the liability provisions of Section 11 of such Act do not apply.

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Report of Independent Accountants

The Board of Directors and
Shareholders of Apollo Group, Inc.:

We have reviewed the accompanying consolidated balance sheet of Apollo Group, Inc. and its subsidiaries as of May 31, 2002, and the related consolidated statements of operations and of comprehensive income for each of the three-month and nine-month periods ended May 31, 2002 and May 31, 2001 and the consolidated statement of cash flows for the nine-month periods ended May 31, 2002 and May 31, 2001. These financial statements are the responsibility of Apollo Group, Inc.’s management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We previously audited in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet as of August 31, 2001, and the related consolidated statements of operations, of comprehensive income, of changes in shareholders’ equity and of cash flows for the year then ended (not presented herein), and in our report dated September 28, 2001 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of August 31, 2001, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.

/s/ PricewaterhouseCoopers LLP
Phoenix, Arizona
June 24, 2002

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PART I – FINANCIAL INFORMATION

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of Apollo Group, Inc.

         The following information should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations of Apollo Group, Inc. and the consolidated financial statements and related notes of Apollo Group, Inc. for the fiscal year ended August 31, 2001 included in our Form 10-K as filed with the Securities and Exchange Commission, as well as in conjunction with the consolidated financial statements and related notes of Apollo Group, Inc. for the three-month and nine-month periods ended May 31, 2002 included in Item 1.

         This Form 10-Q, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Apollo Group, Inc.” contains forward-looking statements. Forward-looking statements are inherently uncertain and subject to risks. Such statements should be viewed with caution. Forward-looking statements in this Form 10-Q and “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Apollo Group, Inc.” include, but are not limited to, statements such as: 1) total purchases of property and equipment for us for the year ended August 31, 2002, are expected to range from $40.0 to $45.0 million; 2) we anticipate the seasonal trends in the second and fourth quarters will continue in the future; 3) although we believe the OIG’s audits of Institute for Professional Development’s client institutions will be resolved without any material effect on our financial position, results of operations, or cash flows, and without any material change in Institute for Professional Development’s business strategy, as with any program review or audit, no assurance can be given as to the final outcome as the matters are not yet resolved; and 4) while the outcome of this legal proceeding is currently not determinable, management does not expect the results of this action to have a material adverse effect on the Company’s business, financial position, results of operations, or cash flows.

         Future events and actual results could differ materially from those set forth in the forward-looking statements as a result of many factors. Statements in this Form 10-Q, including “Notes to Consolidated Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Apollo Group, Inc.,” describe factors, among others, that could contribute to or cause such differences. Additional factors that could cause actual results to differ materially from those expressed in such forward-looking statements include, without limitation: 1) new or revised interpretations of regulatory requirements; 2) changes in or new interpretations of other applicable laws, rules, and regulations; 3) failure to maintain or renew required regulatory approvals, accreditation, or state authorizations by University of Phoenix or certain Institute for Professional Development client institutions; 4) failure to obtain authorizations from states in which University of Phoenix does not currently provide degree programs; 5) failure to obtain approval from The Higher Learning Commission for University of Phoenix to operate in new states; 6) changes in student enrollment; and 7) other factors set forth in this Form 10-Q. These forward-looking statements are based on our estimates, projections, beliefs, and assumptions and speak only as of the date made and are not guarantees of future performance. We undertake no obligation to publicly update or revise any forward-looking statements, or any facts, events, or circumstances after the date hereof that may bear upon forward-looking statements. You are advised, however, to consult any further disclosures we make in our reports filed with the Securities and Exchange Commission.

SIGNIFICANT ACCOUNTING POLICIES

         Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 2 of the Notes to Consolidated Financial Statements of Apollo Group, Inc. for the fiscal year ended August 31, 2001 included in our Form 10-K as filed with the Securities and Exchange Commission includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The following is a brief discussion of the more significant accounting policies and methods used by us.

Revenues, receivables, and related liabilities

         95.8% of our tuition and other net revenues during the first nine months of 2002 consist of tuition revenues. Tuition revenue is recognized on a weekly basis, pro rata over the period of instruction. Our tuition and other net revenues also include sales of textbooks and other education-related products, application fees, other student fees, and other income. Our tuition and other net revenues vary from period to period based on several factors that include: 1) the aggregate number of students attending classes; 2) the number of classes held during the period; and 3) the weighted average tuition price per credit hour (weighted by program and location). University of Phoenix tuition revenues currently represent 92.8% of consolidated tuition revenues. Institute for Professional Development tuition revenues consist of the contractual share of tuition revenues from students enrolled in related programs at its client institutions. Institute for Professional Development’s contracts with its respective client institutions generally have terms of five to ten years with provisions for renewal.

         Our educational programs range in length from one-day seminars to degree programs lasting up to four years. Students in our degree programs generally enroll in a program of study that encompasses a series of five to six week courses that are taken consecutively over the length of the program. Students are billed on a course-by-course basis when the student first attends a session, resulting in the recording of a receivable from the student and deferred tuition revenue in the amount of the billing. The related

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revenue for each course, including that portion of tuition revenues to which we are entitled under the terms of our revenue-sharing contracts with Institute for Professional Development client institutions, is recognized on a pro rata basis over the period of instruction for each course. Application fee revenue and related costs are deferred and recognized on a pro rata basis over the period of the program. Seminars, continuing education programs, and many of the College for Financial Planning’s non-degree programs are usually billed in one installment with the related revenue also recognized on a pro rata basis over the period of instruction.

         Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. Estimates are used in determining our allowance for bad debts and are based on our historical collection experience, current trends, and a percentage of our accounts receivable by aging category. In determining these percentages, we look at historical write-offs of our receivables. A significant change in the aging of our accounts receivable balances would have an effect on the allowance for doubtful accounts balance.

         Many of our students participate in government sponsored financial aid programs under Title IV of the Higher Education Act of 1965. These financial aid programs generally consist of guaranteed student loans and direct grants to students. Guaranteed student loans are issued directly to the student by external financial institutions, to whom the student is obligated, and are non-recourse to us.

         Student deposits consist of payments made in advance of billings. As the student is billed, the student deposit is applied against the resulting student receivable.

Expenses

         We categorize our expenses as instructional costs and services, selling and promotional, and general and administrative. Instructional costs and services at University of Phoenix, Western International University, and College for Financial Planning consist primarily of costs related to the delivery and administration of our educational programs that include faculty compensation, administrative salaries for departments that provide service directly to the students, financial aid processing costs, the costs of educational materials sold, facility leases and other occupancy costs, bad debt expense, and depreciation and amortization of property and equipment. University of Phoenix and Western International University faculty members are contracted for one course offering at a time. All classroom facilities are leased or, in some cases, are provided by the students’ employers at no charge to us. Instructional costs and services at Institute for Professional Development consist primarily of program administration, student services, and classroom lease expense. Most of the other instructional costs for Institute for Professional Development-assisted programs, including faculty, financial aid processing, and other administrative salaries, are the responsibility of its client institutions. Costs related to the start-up of new campuses and learning centers are expensed as incurred.

         Selling and promotional costs consist primarily of compensation for enrollment counselors and corporate marketing, advertising costs, production of marketing materials, and other costs related to selling and promotional functions. We expense selling and promotional costs as incurred.

         General and administrative costs consist primarily of administrative salaries, occupancy costs, depreciation and amortization, and other related costs for departments such as executive management, information systems, corporate accounting, human resources, and other departments that do not provide direct services to our students. To the extent possible, we centralize these services to avoid duplication of effort.

Impairment of intangible assets

         Our intangible assets primarily consist of approximately $37.1 million in unamortized cost in excess of fair value of assets purchased (i.e. goodwill) resulting from our acquisitions of Western International University and the College for Financial Planning. Intangible assets, including cost in excess of fair value of assets purchased, are reviewed for impairment on an annual basis or whenever events or circumstances indicate that the estimated fair value is less than the related carrying value. The carrying value of cost in excess of fair value of assets purchased is assessed for any permanent impairment by evaluating the operating performance and using valuation techniques such as future discounted cash flows of the underlying businesses. In assessing the recoverability of our goodwill and other intangibles we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these estimates or their related assumptions change in the future, we may be required to record non-cash impairment charges for these assets not previously recorded.

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RESULTS OF OPERATIONS

         The following table sets forth our consolidated statement of operations data expressed as a percentage of tuition and other net revenues for the periods indicated:

                                   
      Three Months Ended   Nine Months Ended
      May 31,   May 31,
      2002   2001   2002   2001
     
 
 
 
      (Unaudited)
Revenues:
                                
 
Tuition and other, net
     100.0 %     100.0 %     100.0 %     100.0 %
 
    
     
     
     
 
Costs and expenses:
                                
 
Instructional costs and services
     47.0       50.3       50.2       53.7  
 
Selling and promotional
     18.3       18.7       19.6       18.8  
 
General and administrative
     5.5       6.4       6.0       6.7  
 
    
     
     
     
 
 
     70.8       75.4       75.8       79.2  
 
    
     
     
     
 
Income from operations
     29.2       24.6       24.2       20.8  
Interest income, net
     1.1       1.7       1.2       2.0  
 
    
     
     
     
 
Income before income taxes
     30.3       26.3       25.4       22.8  
Provision for income taxes
     11.9       9.8       10.0       9.0  
 
    
     
     
     
 
Net income
     18.4 %     16.5 %     15.4 %     13.8 %
 
    
     
     
     
 

THREE MONTHS ENDED MAY 31, 2002 COMPARED WITH THREE MONTHS ENDED MAY 31, 2001

         Tuition and other net revenues increased by 29.0% to $276.3 million in the three months ended May 31, 2002 from $214.3 million in the three months ended May 31, 2001 due primarily to a 24.7% increase in average full-time equivalent degree student enrollments and tuition price increases averaging four to six percent (depending on the geographic area and program) at University of Phoenix. Most of our University of Phoenix campuses, which include their respective learning centers, had increases in net revenues and average full-time equivalent degree student enrollments from the three months ended May 31, 2001 to the three months ended May 31, 2002.

         Tuition and other net revenues for the three months ended May 31, 2002 and 2001 consist primarily of $261.7 million and $198.4 million, respectively, of net tuition revenues from students enrolled in degree programs and $3.0 million and $3.6 million, respectively, of net tuition revenues from students enrolled in non-degree programs.

         Instructional costs and services increased by 20.3% to $129.8 million in the three months ended May 31, 2002 from $107.9 million in the three months ended May 31, 2001 due primarily to the direct costs necessary to support the increase in degree student enrollments partially offset by the $2.7 million reserve taken in the third quarter of 2001 related to the IPD client institutions audit by the OIG. Direct costs consist primarily of faculty compensation, related staff salaries at each respective location, classroom lease expenses, and financial aid processing costs. These costs as a percentage of tuition and other net revenues decreased to 47.0% in the three months ended May 31, 2002 from 50.3% in the three months ended May 31, 2001 due primarily to greater tuition and other net revenues being spread over the fixed costs related to centralized student services and the $2.7 million reserve taken in the third quarter of 2001 related to the IPD client institutions audit by the OIG. We may not be able to leverage our recurring costs to the same extent as we face increased costs related to the expansion into new geographic markets.

         Selling and promotional expenses increased by 26.0% to $50.5 million in the three months ended May 31, 2002 from $40.1 million in the three months ended May 31, 2001 due primarily to additional advertising and marketing expenditures and additional enrollment counselors. These expenses as a percentage of tuition and other net revenues decreased to 18.3% in the three months ended May 31, 2002 from 18.7% in the three months ended May 31, 2001 due to greater tuition and other net revenues being spread over a proportionately lower increase in advertising and marketing expenditures partially offset by additional enrollment counselors for University of Phoenix Online and new University of Phoenix campuses.

         General and administrative expenses increased by 12.2% to $15.3 million in the three months ended May 31, 2002 from $13.6 million in the three months ended May 31, 2001 due primarily to increased employee compensation and related expenses. General and administrative expenses as a percentage of tuition and other net revenues decreased to 5.5% in the three months ended May 31, 2002 from 6.4% in the three months ended May 31, 2001 due primarily to greater tuition and other net revenues being spread over the fixed costs related to various centralized functions such as information services, corporate accounting, and human resources.

         Net interest income was $3.1 million and $3.8 million in the three months ended May 31, 2002 and 2001, respectively. Interest expense was $113,000 for the three months ended May 31, 2002 and 2001.

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         Our effective tax rate increased to 39.4% in the three months ended May 31, 2002 from 37.3% in the three months ended May 31, 2001. This change is primarily the result of the impact of tax-exempt interest income.

         Net income increased to $50.8 million in the three months ended May 31, 2002 from $35.4 million in the three months ended May 31, 2001 due primarily to increased enrollments, increased tuition rates, improved utilization of instructional costs and services, selling and promotional expenses, and general and administrative expenses, partially offset by an increase in our effective tax rate.

NINE MONTHS ENDED MAY 31, 2002 COMPARED WITH NINE MONTHS ENDED MAY 31, 2001

         Tuition and other net revenues increased by 31.2% to $727.1 million in the nine months ended May 31, 2002 from $554.4 million in the nine months ended May 31, 2001 due primarily to a 27.8% increase in average full-time equivalent degree student enrollments and tuition price increases averaging four to six percent (depending on the geographic area and program) at University of Phoenix. Most of our University of Phoenix campuses, which include their respective learning centers, had increases in net revenues and average full-time equivalent degree student enrollments from the nine months ended May 31, 2001 to the nine months ended May 31, 2002.

         Tuition and other net revenues for the nine months ended May 31, 2002 and 2001 consist primarily of $688.0 million and $509.4 million, respectively, of net tuition revenues from students enrolled in degree programs and $8.6 million and $11.0 million, respectively, of net tuition revenues from students enrolled in non-degree programs.

         Instructional costs and services increased by 22.9% to $365.3 million in the nine months ended May 31, 2002 from $297.3 million in the nine months ended May 31, 2001 due primarily to the direct costs necessary to support the increase in degree student enrollments partially offset by the $4.1 million reserve taken in the first nine months of 2001 related to the IPD client institutions audit by the OIG. Direct costs consist primarily of faculty compensation, related staff salaries at each respective location, classroom lease expenses, and financial aid processing costs. These costs as a percentage of tuition and other net revenues decreased to 50.2% in the nine months ended May 31, 2002 from 53.7% in the nine months ended May 31, 2001 due primarily to greater tuition and other net revenues being spread over the fixed costs related to centralized student services and the $4.1 million reserve taken in the first nine months of 2001 related to the IPD client institutions audit by the OIG. We may not be able to leverage our recurring costs to the same extent as we face increased costs related to the expansion into new geographic markets.

         Selling and promotional expenses increased by 37.2% to $142.9 million in the nine months ended May 31, 2002 from $104.1 million in the nine months ended May 31, 2001 due primarily to additional advertising and marketing expenditures and additional enrollment counselors. These expenses as a percentage of tuition and other net revenues increased to 19.6% in the nine months ended May 31, 2002 from 18.8% in the nine months ended May 31, 2001 due to additional enrollment counselors for University of Phoenix Online and new University of Phoenix campuses.

         General and administrative expenses increased by 15.9% to $43.2 million in the nine months ended May 31, 2002 from $37.3 million in the nine months ended May 31, 2001 due primarily to increased employee compensation and related expenses. General and administrative expenses as a percentage of tuition and other net revenues decreased to 6.0% in the nine months ended May 31, 2002 from 6.7% in the nine months ended May 31, 2001 due primarily to greater tuition and other net revenues being spread over the fixed costs related to various centralized functions such as information services, corporate accounting, and human resources.

         Net interest income decreased to $8.8 million in the nine months ended May 31, 2002 from $10.6 million in the nine months ended May 31, 2001 due to reduced investment yields partially offset by increased investment balances. Interest expense was $338,000 and $335,000 for the nine months ended May 31, 2002 and 2001, respectively.

         Our effective tax rate remained relatively constant at 39.4% in the nine months ended May 31, 2002 from 39.3% in the nine months ended May 31, 2001.

         Net income increased to $111.9 million in the nine months ended May 31, 2002 from $76.6 million in the nine months ended May 31, 2001 due primarily to increased enrollments, increased tuition rates, and improved utilization of instructional costs and services and general and administrative expenses.

SEASONALITY IN RESULTS OF OPERATIONS

         We experience seasonality in our results of operations primarily as a result of changes in the level of student enrollments. While we enroll students throughout the year, second quarter (December through February) average full-time equivalent degree student enrollments and related revenues generally are lower than other quarters due to seasonal breaks in December and January. Second quarter costs and expenses historically increase as a percentage of tuition and other net revenues as a result of certain fixed costs not significantly affected by the seasonal second quarter declines in net revenues.

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         We experience a seasonal increase in new enrollments in August of each year when most other colleges and universities begin their fall semesters. As a result, instructional costs and services and selling and promotional expenses historically increase as a percentage of tuition and other net revenues in the fourth quarter due to increased costs in preparation for the August peak enrollments.

         We anticipate that these seasonal trends in the second and fourth quarters will continue in the future.

LIQUIDITY AND CAPITAL RESOURCES

         Net cash provided by operating activities increased to $181.3 million in the nine months ended May 31, 2002 from $118.8 million in the nine months ended May 31, 2001. The increase resulted primarily from increased net income and a larger increase in student deposits and deferred revenue partially offset by a larger increase in restricted cash.

         Capital expenditures decreased to $27.7 million during the nine months ended May 31, 2002 compared to $34.6 million in the nine months ended May 31, 2001 primarily due to costs associated with building an additional facility for University of Phoenix Online in 2001. Total purchases of property and equipment for the year ended August 31, 2002 are expected to range from $40.0 to $45.0 million. These expenditures will primarily be related to new campuses and learning centers and increases in normal recurring capital expenditures due to the overall increase in student and employee levels resulting from the growth in the business.

         At May 31, 2002, we had no outstanding borrowings on our $10.0 million line of credit. Borrowings under the line of credit bear interest at LIBOR plus .75% or prime at our election. At May 31, 2002, availability under the line of credit was reduced by an outstanding letter of credit of $8.8 million. The line of credit is renewable annually, and any amounts borrowed under the line are payable upon its termination in February 2004.

         Our Board of Directors authorized a program allocating up to $150.0 million of our funds to repurchase shares of Apollo Education Group Class A common stock and University of Phoenix Online common stock. As of May 31, 2002, we had repurchased approximately 10,058,000 shares of Apollo Education Group Class A common stock at a total cost of approximately $107.2 million and approximately 367,000 shares of University of Phoenix Online common stock at a total cost of approximately $6.8 million.

         On March 24, 2000, our Board of Directors authorized the issuance of a new class of stock called University of Phoenix Online common stock, that is intended to reflect the separate performance of University of Phoenix Online, a division of University of Phoenix. Our other businesses and our retained interest in University of Phoenix Online are referred to as “Apollo Education Group.” On October 3, 2000, an offering of 5,750,000 shares of University of Phoenix Online common stock was completed at a price of $14.00 per share. At the time of the offering this stock represented a 10.8% interest in that business with Apollo Education Group retaining 89.2% interest in University of Phoenix Online.

         The U.S. Department of Education requires that Title IV Program funds collected in advance of student billings be kept in a separate cash or cash equivalent account until the students are billed for that portion of their program. In addition, all Title IV Program funds received by us through electronic funds transfer are subject to certain holding period restrictions. These funds generally remain in these separate accounts for an average of 60 to 75 days from receipt. As of May 31, 2002, we had approximately $88.8 million in these separate accounts, which are reflected in the Consolidated Balance Sheet as restricted cash, to comply with these requirements. These restrictions on cash have not affected our ability to fund daily operations.

         The U.S. Department of Education Office of the Inspector General (“OIG”) is currently auditing the administration of the federal student financial assistance programs in connection with educational programs provided pursuant to contractual arrangements between Institute for Professional Development and certain of its client institutions. In audit reports issued to five client institutions, the OIG asserted that the client institutions violated the statutory prohibition on the use of incentive payments for recruiting by paying Institute for Professional Development a percentage of tuition revenue. The reports further suggest that Institute for Professional Development paid its employees in a manner that included incentive-based compensation even though Institute for Professional Development based its compensation plans for recruiters on factors or qualities that were not solely related to the success in securing enrollments. Additionally, the audit reports question the client institutions’ interpretation of the “12-hour rule.” Although both Institute for Professional Development and the client institutions believe that the matters in question do not relate to student program or institutional eligibility and, therefore, believe a repayment of federal funds is not appropriate, the OIG has recommended to the U.S. Department of Education that the client institutions be required to return to lenders all loan funds disbursed. The institutions, with Institute for Professional Development’s assistance, will work with the U.S. Department of Education to eliminate or settle the issues raised in the audit reports.

         During 2001, Institute for Professional Development recorded a charge of $5.1 million (including $4.1 million recorded in the first nine months of 2001), to provide for its share of the estimated settlement obligation relating to all of its client institutions under audit. Our calculation of the estimated settlement obligation, which is reflected in instructional costs and services in the

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accompanying consolidated statement of operations, was based on information available to us and our previous experience with respect to such settlements.

         Although we believe that the OIG’s audits of Institute for Professional Development’s client institutions will be resolved without any material effect on our financial position, results of operations, or cash flows, and without any material change in Institute for Professional Development’s business strategy, as with any program review or audit, no assurance can be given as to the final outcome as the matters are not yet resolved.

NEW ACCOUNTING PRONOUNCEMENTS

         The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS No. 141”), and No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 141 eliminates the use of the pooling-of-interests method of accounting for business combinations and requires all acquisitions to be accounted for using the purchase method. SFAS No. 142, among other things, discontinues the requirement that goodwill resulting from purchase business combinations be amortized to expense over the related estimated useful life. Under the new guidance, goodwill balances are subjected to an impairment analysis on an annual basis or whenever events or circumstances indicate that the estimated fair value is less than the related carrying value. As of May 31, 2002, we had approximately $37.1 million in unamortized cost in excess of fair value of assets purchased (i.e. goodwill) resulting from our acquisitions of Western International University and the College for Financial Planning.

         We adopted SFAS No. 142 effective September 1, 2001. Under the Standard’s transitional rules, we were required to complete the first step of a two-step impairment test by February 28, 2002 using carrying and fair value information as of September 1, 2001. If an impairment was indicated by that test, we would have been required to complete the second test by August 31, 2002. We have completed our first step test and determined that the estimated fair value of our goodwill exceeded the related carrying value as of September 1, 2001 and, therefore, a related impairment charge was not required. We will continue to monitor our goodwill balances for impairments on an annual basis or whenever circumstances indicate that the estimated fair value is less than the carrying value. We recognized goodwill amortization expense of $0.3 million and $1.0 million during the three and nine month periods ended May 31, 2001; such amortization expense is no longer required under SFAS No. 142.

IMPACT OF INFLATION

         Inflation has not had a significant impact on our historical operations.

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

         Our portfolio of marketable securities includes numerous issuers, varying types of securities and maturities. We intend to hold these securities to maturity. The fair value of our portfolio of marketable securities would not be significantly impacted by either a 100 basis point increase or decrease in interest rates due primarily to the short-term nature of the portfolio. We do not hold or issue derivative financial instruments.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

         On approximately December 19, 2001, a class action complaint was filed in the Superior Court of the State of California for the County of Solano, captioned Davis et. al. v. Apollo Group, Inc. et. al., Case No. FCS018663. Plaintiffs, one current and two former enrollment counselors with The University of Phoenix, Inc., filed this class action on behalf of themselves and current and former enrollment counselors employed by the Company in the State of California and seek certification as a class, monetary damages in unspecified amounts, and injunctive relief. Plaintiffs allege that during their employment, they and other enrollment counselors worked in excess of 8 hours per day or 40 hours per week, and contend that the Company failed to pay overtime. An initial status conference has been held, but no trial date has been set. While the outcome of this legal proceeding is currently not determinable, management does not expect the results of this action to have a material adverse effect on the Company's business, financial position, results of operations, or cash flows.

     
Item 2. Changes in Securities and Use of Proceeds   Not Applicable
Item 3. Defaults Upon Senior Securities   Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders   Not Applicable
Item 5. Other Information   Not Applicable

Item 6. Exhibits and Reports on Form 8-K

(a)   Exhibits:

  Exhibit 15.1   Letter on Unaudited Interim Financial Information
 
  Exhibit 99   University of Phoenix Online Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations

(b)   Reports on Form 8-K
 
    No reports on Form 8-K were filed during the three months ended May 31, 2002.

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SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

     
    APOLLO GROUP, INC.
(Registrant)
     
Date: July 11, 2002    
     
    By: /s/ Kenda B. Gonzales
   
    Kenda B. Gonzales
Chief Financial Officer
     
    By: /s/ Daniel E. Bachus
   
    Daniel E. Bachus
Chief Accounting Officer and Controller
     
    By: /s/ Todd S. Nelson
   
    Todd S. Nelson
President and Chief Executive Officer

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APOLLO GROUP, INC. AND SUBSIDIARIES
EXHIBIT INDEX

         
        PAGE
15.1   Letter on Unaudited Interim Financial Information   Filed herewith
99   University of Phoenix Online Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations   Filed herewith

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