UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number: 0-25232

 

APOLLO GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

4025 S. RIVERPOINT PARKWAY, PHOENIX, ARIZONA 85040

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code:

(480) 966-5394

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES þ    NO o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  YES o    NO þ

 

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.  YES þ     NO o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES þ     NO o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES o     NO þ

 

No shares of Apollo Group, Inc. Class B common stock, its voting stock, are held by non-affiliates. The holders of Apollo Group, Inc. Class A common stock are not entitled to any voting rights. The aggregate market value of Apollo Group Class A common stock held by non-affiliates as of February 28, 2010 (last day of the registrant’s most recently completed second fiscal quarter), was approximately $7.7 billion.

 

The number of shares outstanding for each of the registrant’s classes of common stock as of October 12, 2010 is as follows:

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Information Statement for the 2011 Annual Meeting of Class B Shareholders (Part III)

 

 

APOLLO GROUP, INC. AND SUBSIDIARIES

 

FORM 10-K

 

INDEX

 

 

This Annual Report on Form 10-K, including Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact may be forward-looking statements. Such forward-looking statements include, among others, those statements regarding future events and future results of Apollo Group, Inc. (the “Company,” “Apollo Group,” “Apollo,” “APOL,” “we,” “us” or “our”) that are based on current expectations, estimates, forecasts, and the beliefs and assumptions of us and our management, and speak only as of the date made and are not guarantees of future performance or results. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “could,” “believe,” “expect,” “anticipate,” “estimate,” “plan,” “predict,” “target,” “potential,” “continue,” “objectives,” or the negative of these terms or other comparable terminology. Such forward-looking statements are necessarily estimates based upon current information and involve a number of risks and uncertainties. Such statements should be viewed with caution. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include but are not limited to:

 

 

The cautionary statements referred to above also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no obligation to publicly update or revise any forward-looking statements, for any facts, events, or circumstances after the date hereof that may bear upon forward-looking statements. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.

 

 

Overview

 

Apollo Group, Inc. is one of the world’s largest private education providers and has been in the education business for more than 35 years. We offer innovative and distinctive educational programs and services both online and on-campus at the undergraduate, master’s and doctoral levels through our wholly-owned subsidiaries:

 

 

In addition to these wholly-owned subsidiaries, in October 2007, we formed a joint venture with The Carlyle Group (“Carlyle”), called Apollo Global, Inc. (“Apollo Global”), to pursue investments primarily in the international education services industry. Apollo Group currently owns 85.6% of Apollo Global, with Carlyle owning the remaining 14.4%. As of August 31, 2010, total contributions made to Apollo Global were approximately $555.3 million, of which $475.3 million was funded by us. Apollo Global is consolidated in our financial statements. Apollo Global currently operates the following educational institutions:

 

 

University of Phoenix.  University of Phoenix has been accredited by The Higher Learning Commission of the North Central Association of Colleges and Schools since 1978 and holds other programmatic accreditations. University of Phoenix offers associate’s, bachelor’s, master’s and doctoral degrees in a variety of program areas. University of Phoenix offers its educational programs worldwide through its online education delivery system and at its campus locations and learning centers in 39 states, the District of Columbia and Puerto Rico. University of Phoenix’s online programs are designed to provide uniformity with University of Phoenix’s on-campus programs, which enhances University of Phoenix’s ability to expand into new markets while maintaining academic quality. University of Phoenix has customized systems for academic quality management, faculty recruitment and training, student tracking and marketing, which we believe provides us with a competitive advantage. University of Phoenix’s net revenue represented approximately 91% of our consolidated net revenue for the fiscal year ended August 31, 2010.

 

IPD.  IPD provides program development, administration and management consulting services to private colleges and universities (“Client Institutions”) to establish or expand their programs for working learners. These services typically include degree program design, curriculum development, market research, student recruitment, accounting, and administrative services.

 

CFFP.  CFFP has been accredited by The Higher Learning Commission of the North Central Association of Colleges and Schools since 1994. CFFP provides financial services education programs, including a Master of Science in three majors, and certification programs in retirement, asset management, and other financial planning areas. CFFP offers these programs online.

 

Meritus.  Meritus was designated by the Government of New Brunswick to grant degrees in May 2008. Meritus offers degree programs online to working learners throughout Canada and abroad and launched its first three programs in the fall of 2008.

 

BPP.  BPP University College is the first proprietary institution to have been granted degree awarding powers in the United Kingdom and in July 2010 became the first private institution to be awarded the title of “University College” by the U.K. since 1976. BPP, acquired by Apollo Global in July 2009 and

headquartered in London, England, is a provider of education and training to professionals in the legal and finance industries. BPP provides these services through schools located in the United Kingdom, a European network of BPP offices, and the sale of books and other publications globally.

 

Western International University.  Western International University has been accredited by The Higher Learning Commission of the North Central Association of Colleges and Schools since 1984. Western International University offers associate’s, bachelor’s and master’s degrees in a variety of program areas as well as certificate programs. Western International University offers its undergraduate program courses at its Arizona campus locations and online at Western International University Interactive Online. Western International University was previously a wholly-owned subsidiary of Apollo. During fiscal year 2010, we contributed all of the common stock of Western International University to Apollo Global. See Note 4, Acquisitions, in Item 8, Financial Statements and Supplementary Data, for further discussion.

 

UNIACC.  UNIACC is accredited by the Chilean Council of Higher Education (Consejo Superior de Educación). UNIACC is an arts and communications university which offers bachelor’s and master’s degree programs on campuses in Chile and online. UNIACC was acquired by Apollo Global in March 2008.

 

ULA.  ULA carries authorization from Mexico’s Ministry of Public Education (Secretaría de Educación Publica), from the National Autonomous University of Mexico (Universidad Nacional Autónoma de México) for its high school and undergraduate psychology and law programs and by the Ministry of Education of the State of Morelos (Secretaría de Educación del Estado de Morelos) for its medicine and nutrition programs. ULA offers degree programs at its four campuses throughout Mexico. Apollo Global purchased a 65% ownership interest in ULA in August 2008 and purchased the remaining ownership interest in July 2009.

 

Our schools described above are managed in the following four reportable segments:

 

1. University of Phoenix;

Apollo Global:

2. BPP;

3. Other; and

4. Other Schools.

 

The Apollo Global — Other segment includes Western International University, UNIACC, ULA and Apollo Global corporate operations. The Other Schools segment includes IPD, CFFP and Meritus. The Corporate caption, as detailed in the table below, includes adjustments to reconcile segment results to consolidated results, which primarily consist of net revenue and corporate charges that are not allocated to our reportable segments. The following table presents the net revenue for fiscal years 2010, 2009 and 2008 for each of our reportable segments:

 

 

 

 

See Note 20, Segment Reporting, in Item 8, Financial Statements and Supplementary Data, for the segment and related geographic information required by Items 101(b) and 101(d) of Regulation S-K, which information is incorporated by this reference.

 

We also continue to operate online high school programs through our Insight Schools, Inc. (“Insight Schools”) wholly-owned subsidiary. In the second quarter of fiscal year 2010, we initiated a formal plan to sell Insight Schools, engaged an investment bank and also began the process of actively marketing Insight Schools as we determined that the business was no longer consistent with our long-term strategic objectives. Accordingly, we have presented Insight Schools as held for sale and as discontinued operations. See Note 3, Discontinued Operations, in Item 8, Financial Statements and Supplementary Data, for further discussion.

 

Our operations are generally subject to seasonal trends. We experience, and expect to continue to experience, fluctuations in our results of operations, principally as a result of seasonal variations in the level of University of Phoenix enrollments. Although University of Phoenix enrolls students throughout the year, its net revenue is generally lower in our second fiscal quarter (December through February) than the other quarters due to holiday breaks in December and January.

 

University of Phoenix degreed enrollment (“Degreed Enrollment”) for the quarter ended August 31, 2010 was 470,800. Degreed Enrollment for a quarter is composed of:

 

 

University of Phoenix aggregate new degreed enrollment (“New Degreed Enrollment”) for the four quarters in fiscal year 2010 was 371,700. New Degreed Enrollment for each quarter is composed of:

 

 

Students enrolled in or serviced by Apollo Global’s institutions (BPP, Western International University, UNIACC and ULA), Other Schools (IPD, CFFP, and Meritus) and Insight Schools are not included in Degreed Enrollment or New Degreed Enrollment.

We incorporated in Arizona in 1981 and maintain our principal executive offices at 4025 S. Riverpoint Parkway, Phoenix, Arizona 85040. Our telephone number is (480) 966-5394. Our website addresses are as follows:

 

 

Our fiscal year is from September 1 to August 31. Unless otherwise stated, references to the years 2010, 2009, 2008, 2007 and 2006 relate to fiscal years 2010, 2009, 2008, 2007 and 2006, respectively.

 

Strategy

 

Our goal is to strengthen our position as a leading provider of high quality, accessible education for individuals around the world by affording strong returns for all of our stakeholders: students, faculty, employees and investors. Our principal focus is to provide high quality educational products and services to our students in order for them to maximize the benefit of their educational experience. Our students receive an innovative, energizing and compelling learning experience and a quality academic outcome that provides the opportunity to improve their lives. We believe that a superior student experience, achieved through building a culture of always doing the right thing for the student, is key to building value for our shareholders. We intend to pursue our goal in a manner that is consistent with our core organizational values: operate with integrity and social responsibility; change lives through education; be the employer of choice and build long-term value. These values provide the foundation for everything we do as a business.

 

The key themes of our strategic plan are as follows:

 

 

We intend to use our expertise to enhance the quality, delivery and student outcomes associated with the respective curricula across our entire group of owned and operated institutions and companies. We believe we can utilize our organizational capabilities to offer innovative products, create new growth opportunities and optimize our cost structure. To enable this strategy, we continue to invest in our people, systems and organization, as they are the foundation for our future success.

To execute against our strategic vision, in fiscal year 2010 we began to implement a number of important changes and initiatives to transition our business to more effectively support our students and improve their educational outcomes, which efforts will continue into fiscal year 2011. These initiatives include the following:

 

 

We believe that the changes in our marketing approaches and the University Orientation pilot program implemented during fiscal year 2010 contributed to the 9.8% reduction in University of Phoenix New Degreed Enrollment in the fourth quarter of fiscal year 2010 compared to the fourth quarter of fiscal year 2009. We expect that the continuing changes in our marketing approaches and the implementation of the additional initiatives described above will significantly reduce fiscal year 2011 University of Phoenix New Degreed Enrollment and will adversely impact our net revenue, operating income and cash flow. However, we believe that these efforts are in the best interests of our students and, over the long-term, will improve student persistence and completion rates, reduce bad debt expense, reduce the risks to our business associated with our regulatory environment, and position us for more stable long-term growth in the future.

 

Industry Background

 

Domestic Postsecondary Education

 

The domestic non-traditional education sector is a significant and growing component of the postsecondary degree-granting education industry, which was estimated to be a $432 billion industry in 2008, according to the Digest of Education Statistics published in 2010 by the U.S. Department of Education’s National Center for Education Statistics (the “NCES”). According to the National Postsecondary Student Aid Study published in 2000 by the NCES, 73% of undergraduates in 1999-2000 were in some way non-traditional (defined as a student who delays enrollment, attends part time, works full time, is financially independent for purposes of financial aid eligibility, has dependents other than a spouse, is a single parent, or does not have a high school diploma). The non-traditional students typically are looking to improve their skills and enhance their earnings potential within the context of their careers. We believe that the demand for non-traditional education will continue to increase, reflecting the knowledge-based economy in the U.S.

 

Many non-traditional students, who we refer to as working learners, seek accredited degree programs that provide flexibility to accommodate the fixed schedules and time commitments associated with their professional and personal obligations. The education formats offered by our institutions enable working learners to attend classes and complete coursework on a more flexible schedule than many traditional universities offer.

Although more colleges and universities are beginning to address some of the needs of working learners, many universities and institutions do not effectively address their needs for the following reasons:

 

 

 

International Education

 

There were approximately 153 million students enrolled in postsecondary education worldwide in 2007 according to the Global Education Digest 2009 published in 2009 by the United Nations Educational, Scientific and Cultural Organization Institute for Statistics.

 

We believe that private education is playing an important role in advancing the development of education, specifically higher education and lifelong learning, in many countries around the world. While primary and secondary education outside the U.S. are still funded mainly through government expenditures, we believe that postsecondary education outside of the U.S. is experiencing governmental funding constraints that create opportunities for a broader private sector role.

 

We believe that the following key trends are driving the growth in private education worldwide:

 

 

Our Programs

 

Our more than 35 years as a provider of education enables us to provide students with quality education and responsive customer service at the undergraduate, master’s and doctoral levels. Our institutions have gained expertise in designing curriculum, recruiting and training faculty, monitoring academic quality, and providing a high level of support services to students. Our institutions offer the following:

 

 

 

 

 

 

Teaching Model and Degree Programs and Services

 

Domestic Postsecondary

 

Teaching Model

 

While 73% of undergraduates in 1999-2000 were in some way non-traditional, the primary mission of most accredited four-year colleges and universities is to serve traditional students and in many cases, conduct research. The teaching/learning models used by University of Phoenix were designed specifically to meet the educational needs of working learners, who seek accessibility, curriculum consistency, time and cost-effectiveness, and learning that has immediate application to the workplace. The models are structured to enable students who are employed full-time or have other commitments to earn their degrees and still meet their personal and professional responsibilities. Our focus on working, non-traditional, non-residential students minimizes the need for capital-intensive facilities and services like dormitories, student unions, food service, personal and employment counseling, health care, sports and entertainment.

 

University of Phoenix has campus locations and learning centers in 39 states, the District of Columbia and Puerto Rico and offers many students the flexibility to attend both on-campus and online classes. University of Phoenix online classes employ a proprietary online learning system. Online classes are small and have mandatory participation requirements for both the faculty and the students. Each class is instructionally designed so that students have learning outcomes that are consistent with the outcomes of their on-campus counterparts. All class materials are delivered electronically.

 

Components of our teaching/learning models at University of Phoenix for both online and on-campus classes include:

 

 

 

 

Degree Programs

 

University of Phoenix offers degrees in the following program areas:

 

 

Academic Annual Report

 

In December 2009, University of Phoenix published its second Academic Annual Report which contains a variety of comparative performance measures related to student outcomes and university initiatives related to quality and accountability. The Academic Annual Report is available on the University of Phoenix website at www.phoenix.edu. University of Phoenix expects to publish its third Academic Annual Report in fiscal year 2011.

 

International

 

Teaching Model

 

Our international operations include full-time, part-time and distance learning courses for professional examination preparation, professional development training and various degree/certificate/diploma programs. Our international operations faculty members consist of both full-time and part-time professors. Instructional models include face-to-face and online (simultaneous and non-simultaneous) methodologies.

 

Degree Programs and Services

 

Our international operations offer bachelor’s, master’s and doctoral degrees, which include a variety of degree programs and related areas of specialization. Additionally, we offer training and published materials for qualifications in specific markets for accountancy (including tax), financial services, actuarial science, insolvency, human resources, marketing, management and law. We also provide professional development through continuing education training and supplemental skills courses primarily in the legal and finance industries.

 

Admissions Standards

 

Domestic Postsecondary

 

Undergraduate.  To gain admission to undergraduate programs at University of Phoenix, students must have a high school diploma or a Certificate of General Educational Development, commonly referred to as GED, and satisfy employment requirements, if applicable, for their field of study. Applicants whose native language is not English must take and pass the Test of English as a Foreign Language, Test of English for International Communication or the Berlitz^® Online English Proficiency Exam. Non-U.S. citizens attending a campus located in the U.S. are required to hold an approved visa or to have been granted permanent residency. Additional requirements may apply to individual programs or to students who are attending a specific campus. Students already in undergraduate programs at other schools may petition to be admitted to University of

Phoenix on a provisional status if they do not meet certain criteria. Some programs have work requirements (e.g. nursing) such that students must have a certain amount of experience in given areas in order to be admitted. These vary by program, and not all programs have them.

 

In addition to the above requirements, we intend to require all prospective University of Phoenix students with less than 24 incoming credits to participate in University Orientation, beginning in November 2010. This program is a free, three-week orientation designed to help inexperienced prospective students understand the rigors of higher education prior to enrollment. Students practice using the University of Phoenix Learning System, learn techniques to be successful in college, and identify useful university services and resources.

 

Master’s.  To gain admission to master’s programs at University of Phoenix, students must have an undergraduate degree from a regionally or nationally accredited college or university, satisfy the minimum grade point average requirement, and have relevant work and employment experience, if applicable for their field of study. Applicants whose native language is not English must take and pass the Test of English as a Foreign Language, Test of English for International Communication or the Berlitz^® Online English Proficiency Exam. Non-U.S. citizens attending a campus located in the U.S. are required to hold an approved visa or have been granted permanent residency. Additional requirements may apply to individual programs or to students who are attending a specific campus.

 

Doctoral.  To gain admission to doctoral programs at University of Phoenix, students must generally have a master’s degree from a regionally accredited college or university, satisfy the minimum grade point average requirement, satisfy employment requirements as appropriate to the program applied for, have a laptop computer and have membership in a research library. Applicants whose native language is not English must take and pass the Test of English as a Foreign Language, Test of English for International Communication or the Berlitz^® Online English Proficiency Exam.

 

The admission requirements for our other domestic institutions are similar to those detailed above and may vary depending on the respective program.

 

International

 

In general, postsecondary students in our international institutions must have obtained a high school or equivalent diploma from an approved school. Other requirements apply for graduate and other programs. Admissions requirements for our international institutions are appropriate for the respective markets in which we operate.

 

Students

 

University of Phoenix Degreed Enrollment

 

University of Phoenix Degreed Enrollment for the quarter ended August 31, 2010 was 470,800. See Overview above for a description of the manner in which we calculate Degreed Enrollment. The following table details Degreed Enrollment for the respective periods:

 

The following chart details quarterly Degreed Enrollment by degree type for the respective periods:

 

 

University of Phoenix New Degreed Enrollment

 

University of Phoenix aggregate New Degreed Enrollment for fiscal year 2010 was 371,700. See Overview above for a description of the manner in which we calculate New Degreed Enrollment. The following table details University of Phoenix aggregate New Degreed Enrollment for the respective fiscal years:

 

The following chart details quarterly New Degreed Enrollment by degree type for the respective periods:

 

 

We believe growth in University of Phoenix Degreed Enrollment in recent years is primarily attributable to the following:

 

 

Partially offsetting the factors above are our efforts to better identify and enroll students who have the ability to succeed in our educational programs. Contributing to this effort are refinements in our marketing strategy, including leveraging our marketing analytics to identify and enroll those prospective students and our University Orientation pilot program.

 

Although University of Phoenix aggregate New Degreed Enrollment in fiscal year 2010 increased compared to fiscal year 2009, New Degreed Enrollment for the fourth quarter of fiscal year 2010 decreased 9.8% compared to the fourth quarter of fiscal year 2009. Additionally, we have recently experienced an increase in the percentage of bachelor’s degree students with fewer than 24 incoming credits in our Degreed Enrollment. We believe that the changes in our marketing approaches and the University Orientation pilot program noted above, as well as other initiatives to enhance the student experience contributed to these changes. Refer to “Strategy” above for further discussion.

 

University of Phoenix Student Demographics

 

We have a diverse student population. The following tables show the relative demographic characteristics of the students attending University of Phoenix courses in our fiscal years 2010 and 2009:

 

 

 

 

 

 

 

Marketing

 

While there is intense demand by working learners for a quality education, not everyone realizes that there is an option to get a degree while maintaining a job, a family, and other life responsibilities. We engage in a broad range of advertising and marketing activities to educate potential students about our teaching/learning model and programs, including but not limited to online, broadcast, outdoor, print, and direct mail. We are focused on improving our perception and more precisely utilizing our different communication channels to attract students who are more likely to persist in our programs. Our marketing informs and educates students of the options they have in higher learning.

 

Brand

 

Brand advertising is intended to increase potential students’ understanding of our academic quality, innovations in 21st century post-secondary education, commitment to service, academic outcomes and achievements of our academic community. Our brand is advertised primarily through national and regional broadcast, radio and print media. Brand advertising also serves to expand the addressable market and establish brand recognition and familiarity with our schools, colleges and programs on both a national and a local basis.

 

Internet

 

Prospective students are identifying their education opportunities online through search engines, information and social network sites, various education portals on the Internet and school-specific sites such as our own phoenix.edu. We advertise on the Internet using search engine keywords, banners, and custom advertising placements on targeted sites, such as education portals, career sites, and industry-specific websites. Our focused and selective Internet and non-Internet advertising activities have improved our identification of students who have the ability to succeed in our educational programs. Our owned and operated website, phoenix.edu, provides prospective students with relevant information about University of Phoenix.

 

We intend to continue to leverage the unique qualities of the Internet and its emerging technologies to enhance our brand awareness among prospective students, and to improve our ability to deliver relevant messages to satisfy prospective students’ specific needs and requirements. New media technologies that we

have begun to use to communicate with our current and prospective students include online social networks, search engine marketing and emerging video advertising.

 

Sponsorships and Other

 

University of Phoenix operates both nationally and locally. We foster community and advocacy selectively through sponsorships, advertising and event marketing to support specific activities, including local and national career events, academic lecture series, workshops focused on trends in the 21st century economy and symposiums regarding the future of education in America. In addition, we utilize direct mail to expand our local presence by targeting individuals in specific career fields in which we offer programs and degrees.

 

In 2006, we obtained naming and sponsorship rights on a stadium in Glendale, Arizona, which is home to the Arizona Cardinals team in the National Football League. These naming and sponsorship rights are in effect until 2026 with options to extend and include opportunities for signage, advertising, and other promotional rights and benefits to enhance the University of Phoenix brand awareness.

 

Relationships with Employers

 

We work closely with many businesses and governmental agencies to meet their specific educational and training needs either by modifying existing programs or, in some cases, by developing customized programs. These programs are often held at the employers’ offices or on site at select military bases. University of Phoenix has formed educational partnerships with various corporations to provide programs specifically designed for their employees. BPP enrolls the majority of its students through relationships with employers. We consider the employers that provide tuition assistance to their employees through tuition reimbursement plans or direct bill arrangements to be our secondary customers.

 

Competition

 

Domestic Postsecondary

 

The higher education industry is highly fragmented with no single private or public institution enjoying a significant market share. We compete primarily with traditional four and two-year degree-granting public and private regionally accredited colleges and universities. While 73% of undergraduates in 1999-2000 were in some way non-traditional, the primary mission of most accredited four-year colleges and universities is to serve traditional students and conduct research. University of Phoenix acknowledges the differences in educational needs between working learners and traditional students and provides programs and services that allow students to earn their degrees without major disruption to their personal and professional lives.

 

An increasing number of colleges and universities enroll working learners in addition to the traditional 18 to 24-year-old students, and we expect that these colleges and universities will continue to modify their existing programs to serve working learners more effectively, including by offering more distance learning programs. We believe that the primary factors on which we compete are the following:

 

 

In our offerings of non-degree programs, we compete with a variety of business and information technology providers, primarily those in the proprietary training sector. Many of these competitors have

significantly more market share in given geographical regions and longer-term relationships with key employers of potential students.

 

International

 

Competitive factors for our international schools vary by country and generally include the following:

 

 

In addition, BPP competes with other training providers, public and private colleges, and universities primarily in the United Kingdom. The primary factors on which BPP competes with these institutions include the following:

 

 

Employees

 

We believe that our employee relations are satisfactory. As of August 31, 2010, we had the following employees:

 

 

 

 

Accreditation and Jurisdictional Authorizations

 

Domestic Postsecondary

 

Accreditation

 

University of Phoenix is covered by regional accreditation, which provides the following:

 

 

Regional accreditation is accepted nationally as the basis for the recognition of earned credit and degrees for academic purposes, employment, professional licensure and, in some states, authorization to operate as a degree-granting institution. Under the terms of a reciprocity agreement among the six regional accrediting associations, including the Higher Learning Commission (“HLC”) of the North Central Association of Colleges and Schools, which is the primary accrediting association of University of Phoenix, representatives of each region in which a regionally accredited institution operates may participate in the evaluations for reaffirmation of accreditation of that institution by its accrediting association.

 

In August 2010, University of Phoenix received a letter from HLC requiring University of Phoenix to provide certain information and evidence of compliance with HLC accreditation standards. The letter related to the August 2010 report published by the U.S. Government Accountability Office (“GAO”) of its undercover investigation into the enrollment and recruiting practices of a number of proprietary institutions of higher education, including University of Phoenix. The letter required that University of Phoenix submit a report to HLC addressing the specific GAO allegations regarding University of Phoenix and any remedial measures being undertaken in response to the GAO report. In addition, the report was required to include (i) evidence demonstrating that University of Phoenix, on a university-wide basis, currently is meeting and in the future will meet the HLC Criteria for Accreditation relating to operating with integrity and compliance with all state and federal laws, (ii) evidence that University of Phoenix has adequate systems in place which currently and in the future will assure appropriate control of all employees engaged in the recruiting, marketing or admissions process, (iii) evidence demonstrating that Apollo Group is not encouraging inappropriate behavior on the part of recruiters and is taking steps to encourage appropriate behavior, and (iv) detailed information about University of Phoenix policies, procedures and practices relating to marketing, recruiting, admissions and other related matters. We submitted the response to HLC on September 10, 2010 and subsequently received a request for additional information. We have been informed that our response will be evaluated by a special committee in early 2011, and that the committee will make recommendations, if any, to the HLC board. If, after review, HLC determines that our response is unsatisfactory, HLC has informed us that it may impose additional unspecified monitoring or sanctions. In addition, HLC has recently imposed additional requirements on University of Phoenix with respect to approval of new or relocated campuses and additional locations. These requirements may lengthen or make more challenging the approval process for these sites. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate.

Accreditation information for University of Phoenix and applicable programs is described in the chart below:

 

 

Our other domestic institutions maintain the requisite accreditations for their respective operations.

 

Jurisdictional Authorizations

 

In addition to accreditation by independent accrediting bodies, our schools must be authorized to operate by the appropriate regulatory authorities in many of the jurisdictions in which they operate.

 

In the U.S., institutions that participate in Title IV programs must be authorized to operate by the appropriate postsecondary regulatory authority in each state where the institution has a physical presence, or

be exempt from such regulatory authorization, usually based on recognized accreditation. As of August 31, 2010, University of Phoenix is authorized to operate or has confirmed an exemption to operate based upon its accreditation and has a physical presence in 39 states, Puerto Rico and the District of Columbia. University of Phoenix has held these authorizations or has confirmed an exemption for specific authority to operate based upon its accreditation for periods ranging from less than three years to over 25 years. As of August 31, 2010, University of Phoenix has also been approved to operate or has confirmed an exemption to operate based upon its accreditation in Alaska, Mississippi, Montana and South Dakota, but does not yet have a physical presence in these states. In five states, including California, University of Phoenix is qualified to operate without specific state regulatory approval due to available state exemptions that permit such operation if certain programmatic or other accreditation criteria are met. Under new rules proposed by the U.S. Department of Education, we may be required to seek and obtain specific regulatory approval to operate in these states and would not be entitled to rely on available exemptions based on accreditation. If we experience a delay in obtaining or cannot obtain these approvals, our business could be adversely impacted. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business for further discussion regarding jurisdictional authorizations, which discussion is incorporated by this reference.

 

All regionally accredited institutions, including University of Phoenix, are required to be evaluated separately for authorization to operate in Puerto Rico. University of Phoenix has obtained authorization from the Puerto Rico Commission on Higher Education, and that authorization remains in effect.

 

Some states assert authority to regulate all degree-granting institutions if their educational programs are available to their residents, whether or not the institutions maintain a physical presence within those states. University of Phoenix and Western International University have obtained licensure in states which require such licensure and where students are enrolled.

 

Our other domestic institutions maintain the requisite authorizations in the jurisdictions in which they operate.

International

 

Our international schools must be authorized by the relevant regulatory authorities under applicable local law, which in some cases requires accreditation, as described in the chart below:

 

 

Financial Aid Programs

 

Domestic Postsecondary

 

The Higher Education Act of 1965 and the related regulations govern all higher education institutions participating in U.S. Title IV federal financial aid programs. In August 2008, the Higher Education Act was reauthorized through September 30, 2013 by the Higher Education Opportunity Act. Financial aid under Title IV of the Higher Education Act, as reauthorized (which we refer to generally as Title IV), is awarded every academic year to eligible students. Certain types of U.S. federal student aid are awarded on the basis of financial need, generally defined as the difference between the cost of attending an educational institution and the amount the student and/or the student’s family, as the case may be, can reasonably be expected to contribute to that cost. The amount of financial aid awarded to a student per academic year is based on many factors, including, but not limited to, program of study, grade level, Title IV annual loan limits, and financial need. We have substantially no control over the amount of Title IV student loans or grants sought by or awarded to our students. All recipients of Title IV program funds must maintain satisfactory academic progress within the guidelines published by the U.S. Department of Education.

 

We collected the substantial majority of our fiscal year 2010 total consolidated net revenue from receipt of Title IV financial aid program funds, principally from federal student loans and Pell Grants. University of Phoenix represented 91% of our fiscal year 2010 total consolidated net revenue and University of Phoenix

generated 88% of its cash basis revenue for eligible tuition and fees during fiscal year 2010 from the receipt of Title IV financial aid program funds, as calculated under the 90/10 Rule described below, excluding the benefit from the temporary relief for loan limit increases described below.

 

During fiscal year 2010, the Health Care and Education Reconciliation Act was enacted and signed into law. This legislation, among other things, eliminated the Federal Family Education Loan Program (FFELP) and requires all Title IV federal student loans to be administered through the Federal Direct Loan Program (FDLP) commencing July 1, 2010. We completed the transition of loan origination and related servicing from the FFELP to the FDLP during the third quarter of fiscal year 2010.

 

Student loans are currently the most significant source of U.S. federal student aid and are administered through the FDLP. Previously, these loans also were available under the FFELP. Annual and aggregate loan limits apply based on the student’s grade level. There are two types of federal student loans: subsidized loans, which are based on the U.S. federal statutory calculation of student need, and unsubsidized loans, which are not need-based. Neither type of student loan is based on creditworthiness. Students are not responsible for interest on subsidized loans while the student is enrolled in school. Students are responsible for the interest on unsubsidized loans while enrolled in school, but have the option to defer payment while enrolled. Repayment on federal student loans begins six months after the date the student ceases to be enrolled. The loans are repayable over the course of 10 years and, in some cases, longer. Both graduate and undergraduate students are eligible for loans. During fiscal year 2010, federal student loans (both subsidized and unsubsidized) represented approximately 79% of the gross Title IV funds received by University of Phoenix.

 

Federal Pell Grants are awarded based on need and only to undergraduate students who have not earned a bachelor’s or professional degree. Unlike loans, Pell Grants do not have to be repaid. During fiscal year 2010, Pell Grants represented approximately 20% of the gross Title IV funds received by University of Phoenix. The eligibility for and maximum amount of Pell Grants have increased in each of the past three years.

 

Funding from student loans not provided by the federal government represented approximately 1% of cash basis revenue for eligible tuition and fees for University of Phoenix, as calculated under the 90/10 Rule, during fiscal year 2010. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate.

 

International

 

Government financial aid funding for students enrolled in our international institutions historically has not been widely available.

 

Regulatory Environment

 

Domestic Postsecondary

 

Our domestic postsecondary operations are subject to significant regulations. Changes in or new interpretations of applicable laws, rules, or regulations could have a material adverse effect on our eligibility to participate in Title IV programs, accreditation, authorization to operate in various states, permissible activities, and operating costs. The failure to maintain or renew any required regulatory approvals, accreditation, or state authorizations could have a material adverse effect on us. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate.

 

The Higher Education Act, as reauthorized, and the related regulations govern all higher education institutions participating in Title IV financial aid programs, and provide for a regulatory triad by mandating specific regulatory responsibilities for each of the following:

 

 

To be eligible to participate in Title IV programs, a postsecondary institution must be accredited by an accrediting body recognized by the U.S. Department of Education and must comply with the Higher Education Act, as reauthorized, and all applicable regulations thereunder. We have summarized below recent material

activity in the regulatory environment and the most significant regulatory requirements applicable to our domestic postsecondary operations.

 

New Rulemaking Initiative.  In November 2009, the U.S. Department of Education convened two new negotiated rulemaking teams related to Title IV program integrity issues and foreign school issues. The team addressing program integrity issues, which included representatives of the various higher education constituencies, was unable to reach consensus on all of the rules addressed by that team. Accordingly, under the negotiated rulemaking protocol, the Department was free to propose rules without regard to the tentative agreement reached regarding certain of the rules. The proposed program integrity rulemaking addresses numerous topics. The most significant proposals for our business are the following:

 

 

On June 18, 2010, the Department issued a Notice of Proposed Rulemaking (“NPRM”) in respect of the program integrity issues, other than the metrics for determining compliance with the gainful employment requirement. On July 26, 2010, the Department published a separate NPRM in respect of the gainful employment metrics. The Department has stated that its goal is to publish final rules by November 1, 2010, excluding significant sections related to gainful employment which the Department expects to publish in early 2011. The final rules, including some reporting and disclosure rules related to gainful employment described below, are expected to be effective July 1, 2011. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business for further discussion regarding the proposed rules, which discussion is incorporated by this reference.

 

Incentive Compensation.  A school participating in Title IV programs may not pay any commission, bonus or other incentive payments to any person involved in student recruitment or admissions or awarding of Title IV program funds, if such payments are based directly or indirectly on success in enrolling students or obtaining student financial aid. The law and regulations governing this requirement do not establish clear criteria for compliance in all circumstances, but there currently are twelve safe harbors that define specific types of compensation that are deemed to constitute permissible incentive compensation. Currently, we rely on several of these safe harbors to ensure that our compensation and recruitment practices comply with the applicable requirements.

 

In the rules proposed by the Department, these twelve safe harbors would be eliminated and, in lieu of the safe harbors, some of the relevant concepts relating to the incentive compensation limitations would be defined. These changes would increase the uncertainty about what constitutes incentive compensation and which employees are covered by the regulation.

 

In response to the Department’s concern about the impact of compensation structures that rely on the current safe harbors (reflected in the proposed rulemaking), and in order to enhance the admissions process for our students, we began considering an alternative compensation structure for our admissions personnel in early 2009. We have been developing this new structure, which complies with the Department’s proposed rule, over the past twelve months and expect to implement it on a broad scale during the first quarter of fiscal year 2011. In connection with this, we eliminated enrollment results as a component of compensation for our admissions personnel effective September 1, 2010.

 

State Authorization.  In the U.S., institutions that participate in Title IV programs must be authorized to operate by the appropriate postsecondary regulatory authority in each state where the institution has a physical presence, or be exempt from such regulatory authorization, usually based on recognized accreditation. As of August 31, 2010, University of Phoenix is authorized to operate or has confirmed an exemption to operate based upon its accreditation and has a physical presence in 39 states, Puerto Rico and the District of

Columbia. University of Phoenix has held these authorizations or has confirmed an exemption for specific authority to operate based upon its accreditation for periods ranging from less than three years to over 25 years. As of August 31, 2010, University of Phoenix has also been approved to operate or has confirmed an exemption to operate based upon its accreditation in Alaska, Mississippi, Montana and South Dakota, but does not yet have a physical presence in these states. In five states, including California, University of Phoenix is qualified to operate without specific state regulatory approval due to available state exemptions that permit such operation if certain programmatic or other accreditation criteria are met. Under new rules proposed by the U.S. Department of Education, we may be required to seek and obtain specific regulatory approval to operate in these states and would not be entitled to rely on available exemptions based on accreditation. If we experience a delay in obtaining or cannot obtain these approvals, our business could be adversely impacted.

 

Gainful Employment.  Under the Higher Education Act, as reauthorized, proprietary schools are eligible to participate in Title IV programs only in respect of educational programs that lead to “gainful employment in a recognized occupation.” Historically, this concept has not been defined in detail. In its July 26, 2010 NPRM, the U.S. Department of Education published proposed rules that would for the first time define gainful employment, which would apply on a program-by-program basis.

 

Under the proposed rules, gainful employment in respect of a particular program would be defined by reference to two debt-related tests: one based on student debt service-to-income ratios for program graduates, and the other based on student loan repayment rates for program enrollees. Based on the application of these tests, a program may be eligible to participate in Title IV programs without restriction, may be eligible to participate with disclosure requirements, may be on restricted status and only able to participate with material restrictions (including enrollment limitations), or may be ineligible to participate.

 

The proposed debt service-to-income test measures the median annual student loan debt service of graduates of a program, as a percentage of their average annual earnings and/or their “discretionary income” (as defined), in each case measured over the preceding three years or, in some cases, the three years prior to the preceding three years. The proposed loan repayment test measures the loan repayment rate for former enrollees in (and not just graduates of) a program. The repayment rate is calculated as a percentage of all program enrollee Title IV loans that entered into repayment during the preceding four federal fiscal years that are in current repayment status, determined on a dollar weighted basis by reference to the original principal amount of such loans. A loan would be considered to be in current status if it has been fully repaid or debt service has been paid such that the outstanding principal balance was reduced during the most recent federal fiscal year.

 

The proposed rules provide for a two-year phase-in. For the award year beginning July 1, 2012, only the lowest-performing programs accounting for 5% of all graduates during the prior year would be subject to losing eligibility. The full application of the eligibility rules would commence with the award year beginning July 1, 2013.

 

The Department has stated that it intends to publish final rules by November 1, 2010 covering a portion of the proposed gainful employment rules. These rules would require proprietary institutions of higher education and postsecondary vocational institutions to provide prospective students with each eligible program’s graduation and job placement rates, and require colleges to provide the Department with information that will allow determination of student debt levels and incomes after program completion. Additionally, the rules would require institutions to provide certain information to the Department before new programs would be eligible to participate in Title IV programs.

 

The above descriptions of the proposed gainful employment rules are qualified in their entirety by the text of the proposed rules, available at http://www2.ed.gov/legislation/FedRegister/proprule/2010-3/072610a.pdf.  These proposed rules are complex and their application involves many interpretive and other issues, not all of which may be addressed in any final rulemaking.

 

If these rules are adopted in the form proposed, many of our programs may be ineligible for Title IV funding or restricted because they do not meet at least one of the specified tests. In addition, the continuing eligibility of our educational programs for Title IV funding would be at risk due to factors beyond our control,

such as changes in the income level of our graduates, increases in interest rates, changes in the federal poverty income level relevant for calculating discretionary income, changes in the percentage of our former students who are current in repayment of their student loans, and other factors. The exposure to these external factors would hinder our ability to effectively manage our business. If a particular program ceased to be eligible for Title IV funding, in most cases it would not be practical to continue offering that program under our current business model. Adoption of the regulations in the form proposed could result in a significant realignment of the types of educational programs that are offered by us and by other proprietary institutions, in order to comply with the rules or, most prominently, to avoid the uncertainty associated with compliance over time. This realignment could reduce our enrollment, perhaps materially.

 

The Department has not provided access to the income and debt service information sufficient to determine the impact of these proposed gainful employment rules on our programs.

 

We cannot predict the form of the final rules regarding program integrity that may be adopted by the Department. Compliance with these rules in the form proposed could reduce our enrollment, increase our cost of doing business, and have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

U.S. Congressional Hearings.  In recent months, there has been increased focus by the U.S. Congress on the role that proprietary educational institutions play in higher education. On June 24, 2010, the U.S. Senate Committee on Health, Education, Labor and Pensions (“HELP Committee”) held the first in a series of hearings to examine the proprietary education sector. The August 4, 2010 hearing included the presentation of results from a Government Accountability Office (“GAO”) review of various aspects of the proprietary sector, including recruitment practices, educational quality, student outcomes, the sufficiency of integrity safeguards against waste, fraud and abuse in federal student aid programs and the degree to which for-profit institutions’ revenue is composed of Title IV and other federal funding sources. Following the August 4, 2010 hearing, Sen. Harkin requested a broad range of detailed information from 30 proprietary institutions, including Apollo Group. We have been and intend to continue being responsive to the requests of the HELP Committee. Sen. Harkin has stated that another in this series of hearings will be held in December 2010.

 

We cannot predict what legislation, if any, will emanate from these Congressional committee hearings or what impact any such legislation might have on the proprietary education sector and our business in particular. Any action by Congress that significantly reduces Title IV program funding or the ability of our institutions or students to participate in Title IV programs would have a material adverse effect on our business, financial condition, results of operations and cash flows. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — Action by the U.S. Congress to revise the laws governing the federal student financial aid programs or reduce funding for those programs could reduce our student population and increase our costs of operation for further discussion regarding the HELP Committee hearings, which discussion is incorporated by this reference.

 

The “90/10 Rule.” A requirement of the Higher Education Act, as reauthorized by the Higher Education Opportunity Act, commonly referred to as the “90/10 Rule,” applies only to proprietary institutions of higher education, which includes University of Phoenix and Western International University. Under this rule, a proprietary institution will be ineligible to participate in Title IV programs if for any two consecutive fiscal years it derives more than 90% of its cash basis revenue, as defined in the rule, from Title IV programs. An institution that derives more than 90% of its revenue from Title IV programs for any single fiscal year will be automatically placed on provisional certification for two fiscal years and will be subject to possible additional sanctions determined to be appropriate under the circumstances by the U.S. Department of Education in the exercise of its broad discretion. While the Department has broad discretion to impose additional sanctions on such an institution, there is only limited precedent available to predict what those sanctions might be, particularly in the current regulatory environment. The Department could specify any additional conditions as a part of the provisional certification and the institution’s continued participation in Title IV programs. These conditions may include, among other things, restrictions on the total amount of Title IV program funds that may be distributed to students attending the institution; restrictions on programmatic and geographic expansion; requirements to obtain and post letters of credit; additional reporting requirements to include

additional interim financial reporting; or any other conditions imposed by the Department. Should an institution be subject to a provisional certification at the time that its current program participation agreement expired, the effect on recertification of the institution or continued eligibility in Title IV programs pending recertification is uncertain. An institution that derives more than 90% of its revenue from Title IV programs for two consecutive fiscal years will be ineligible to participate in Title IV programs for at least two fiscal years. University of Phoenix and Western International University are required to calculate this percentage at the end of each fiscal year. If an institution is determined to be ineligible to participate in Title IV programs due to the 90/10 Rule, any disbursements of Title IV program funds while ineligible must be repaid to the Department. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — Our schools and programs would lose their eligibility to participate in federal student financial aid programs if the percentage of our revenues derived from those programs is too high, in which event we could not conduct our business as it is currently conducted for further discussion regarding the 90/10 Rule, which discussion is incorporated by this reference.

 

The 90/10 Rule percentage for University of Phoenix has increased materially over the past several fiscal years and we expect further increases in the near term. These increases are primarily attributable to the increase in student loan limits enacted by the Ensuring Continued Access to Student Loans Act of 2008 and expanded eligibility for and increases in the maximum amount of Pell Grants.

 

The Higher Education Opportunity Act provides temporary relief from the impact of the loan limit increases by excluding from the 90/10 Rule calculation any amounts received between July 1, 2008 and June 30, 2011 that are attributable to the increased annual loan limits. We refer to this as the “LLI relief.” The following table details the 90/10 Rule percentages for University of Phoenix and Western International University, as well as the percentages for University of Phoenix with the LLI relief, for fiscal years 2010 and 2009:

 

 

 

 

Based on currently available information, we expect that the 90/10 Rule percentage for University of Phoenix, net of the LLI relief, will approach 90% for fiscal year 2011, principally because of the expanded eligibility for and increases in the amount of Pell Grants. We have implemented various measures intended to reduce the percentage of University of Phoenix’s cash basis revenue attributable to Title IV funds, including emphasizing employer-paid and other direct-pay education programs, encouraging students to carefully evaluate the amount of necessary Title IV borrowing, and continued focus on professional development and continuing education programs. Although we believe these measures will favorably impact the 90/10 Rule calculation, they have had only limited impact to date and there is no assurance that they will be adequate to prevent the 90/10 Rule calculation from exceeding 90% in the future. We are considering other measures to favorably impact the 90/10 Rule calculation for University of Phoenix, including tuition price increases; however, we have substantially no control over the amount of Title IV student loans and grants sought by or awarded to our students.

 

Based on currently available information, we do not expect the 90/10 Rule percentage for University of Phoenix, net of the LLI relief, to exceed 90% for fiscal year 2011. However, we believe that, absent a change in recent trends or the implementation of additional effective measures to reduce the percentage, the 90/10 Rule percentage for University of Phoenix is likely to exceed 90% in fiscal year 2012 due to the expiration of the LLI relief in July 2011.

We believe that the most effective long-term solution to address the increasing 90/10 Rule percentage is a change in the 90/10 Rule itself. Because of the increases in Title IV student loan limits and grants in recent years, we believe that many proprietary institutions are experiencing pressure on their 90/10 Rule compliance. One potential unintended consequence of this pressure is higher tuition rates. This is because one of the more effective methods of reducing the 90/10 Rule percentage is to increase tuition prices above the applicable maximums for Title IV student loans and grants, requiring other sources of funding to resolve the remaining tuition balance, in order to reduce the percentage of revenue from Title IV sources. However, this consequence directly undermines the Department of Education’s interest in promoting affordable postsecondary education. Although modification of the rule could limit this undesirable impact on tuition, there is no assurance that the Department, or Congress, will address this problem by modifying the rule or will address it in a manner that timely and favorably impacts compliance by University of Phoenix.

 

Our efforts to reduce the 90/10 Rule percentage for University of Phoenix, especially if the percentage exceeds 90% for a fiscal year, may involve taking measures which reduce our revenue, increase our operating expenses, or both, in each case perhaps significantly. If the 90/10 Rule is not changed to provide relief for proprietary institutions, we may be required to make structural changes to our business in order to remain in compliance, which changes may materially alter the manner in which we conduct our business and materially and adversely impact our business, financial condition, results of operations and cash flows. Furthermore, these required changes could make more difficult our ability to comply with other important regulatory requirements, such as the cohort default rate regulations discussed below under “Student Loan Defaults” and Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — An increase in student loan default rates could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business, as well as the proposed gainful employment regulations discussed above under “New Rulemaking Initiative” and Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business.

 

Student Loan Defaults.  To remain eligible to participate in Title IV programs, educational institutions must maintain student loan cohort default rates below specified levels. Each cohort is the group of students who first enter into student loan repayment during a federal fiscal year (ending September 30). Under the Higher Education Act, as reauthorized, the currently applicable cohort default rate for each cohort is the percentage of the students in the cohort who default on their student loans prior to the end of the following federal fiscal year, which represents a two-year measuring period. An educational institution will lose its eligibility to participate in some or all Title IV programs if its student loan cohort default rate equals or exceeds 25% for three consecutive years or 40% for any given year. If our student loan default rates approach these limits, we may be required to increase efforts and resources dedicated to improving these default rates. In addition, because there is a lag between the funding of a student loan and a default thereunder, many of the borrowers who are in default or at risk of default are former students with whom we may have only limited contact. Accordingly, there can be no assurance that we would be able to effectively improve our default rates or improve them in a timely manner to meet the requirements for continued participation in Title IV funding if we experience a substantial increase in our student loan default rates. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — An increase in student loan default rates could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business for further discussion regarding student loan cohort default rates, which discussion is incorporated by this reference.

 

If an educational institution’s two-year cohort default rate exceeds 10% for any one of the three preceding years, it must delay for 30 days the release of the first disbursement of U.S. federal student loan proceeds to first time borrowers enrolled in the first year of an undergraduate program. Western International University implemented a 30-day delay for such disbursements in fiscal year 2007 and University of Phoenix proactively implemented a 30-day delay in fiscal year 2009.

The cohort default rates for University of Phoenix, Western International University and for all proprietary postsecondary institutions for the federal fiscal years 2008, 2007 and 2006 were as follows:

 

 

 

 

The University of Phoenix cohort default rates have been increasing over the past several years, largely due to the transitioning of our associate’s degree students from Western International University to University of Phoenix beginning in April 2006 and the general expansion of the University of Phoenix associate’s degree program. Student loan default rates tend to be higher in our associate’s degree student population compared to our bachelor’s and our graduate degree student populations. We expect this upward trend to intensify due to the current challenging economic climate and the continuing effect of the historical growth in our associate’s degree student population. Consistent with this, the available preliminary data for the University of Phoenix 2009 cohort reflect a substantially higher default rate than the 2008 cohort, although we do not expect the rate to exceed 25%.

 

The cohort default rate requirements were modified by the Higher Education Opportunity Act enacted in August 2008 to increase by one year the measuring period for each cohort. Starting with the 2009 cohort, the U.S. Department of Education will calculate both the current two-year and the new three-year cohort default rates. Beginning with the 2011 three-year cohort default rate published in September 2014, the three-year rates will be applied for purposes of measuring compliance with the requirements.

 

 

Eligibility and Certification Procedures.  The Higher Education Act, as reauthorized, specifies the manner in which the U.S. Department of Education reviews institutions for eligibility and certification to participate in Title IV programs. Every educational institution involved in Title IV programs must be certified to participate and is required to periodically renew this certification. University of Phoenix was recertified in November 2009 and entered into a new Title IV Program Participation Agreement which expires on December 31, 2012. Western International University was recertified in May 2010 and entered into a new Title IV Program Participation Agreement which expires on September 30, 2014.

 

U.S. Department of Education Audits.  The U.S. Department of Education periodically reviews institutions participating in Title IV programs for compliance with applicable standards and regulations. In February 2009, the U.S. Department of Education performed an ordinary course, focused program review of University of Phoenix’s policies and procedures involving Title IV programs. On December 31, 2009, University of Phoenix received the Department’s Program Review Report, which was a preliminary report of the Department’s findings. We responded to the preliminary report in the third quarter of fiscal year 2010. In June 2010, we posted a letter of credit in the amount of approximately $126 million as required by the Department’s regulations when a program review report cites untimely return of unearned Title IV funds for more than 10% of the sampled students in a period covered by the review. The Department issued its Final Program Review Determination Letter on June 16, 2010, which confirmed we had completed the corrective actions and satisfied the obligations arising from the review.

Of the six findings contained in the Final Program Review Determination Letter, three related to University of Phoenix’s procedures for determining student withdrawal dates and associated timing of the return of unearned Title IV funds, which averaged no more than six days outside the required timeframe in the affected sample files. There were no findings that indicated incorrect amounts of Title IV funds had been returned. In the second quarter of fiscal year 2010, we made payments totaling $0.7 million to reimburse the Department for the cost of Title IV funds associated with these findings. The remaining findings involved isolated clerical errors verifying student-supplied information and, as self-reported by University of Phoenix in 2008, the calculation of student financial need where students were eligible for tuition and fee waivers and discounts, and the use of Title IV funds for non-program purposes such as transcripts, applications and late fees.

 

Administrative Capability.  The Higher Education Act, as reauthorized, directs the U.S. Department of Education to assess the administrative capability of each institution to participate in Title IV programs. The failure of an institution to satisfy any of the criteria used to assess administrative capability may cause the Department to determine that the institution lacks administrative capability and, therefore, subject the institution to additional scrutiny or deny eligibility for Title IV programs.

 

Standards of Financial Responsibility.  Pursuant to the Title IV regulations, each eligible higher education institution must satisfy a measure of financial responsibility that is based on a weighted average of three annual tests which assess the financial condition of the institution. The three tests measure primary reserve, equity, and net income ratios. The Primary Reserve Ratio is a measure of an institution’s financial viability and liquidity. The Equity Ratio is a measure of an institution’s capital resources and its ability to borrow. The Net Income Ratio is a measure of an institution’s profitability. These tests provide three individual scores which are converted into a single composite score. The maximum composite score is 3.0. If the institution achieves a composite score of at least 1.5, it is considered financially responsible. A composite score from 1.0 to 1.4 is considered financially responsible, and the institution may continue to participate as a financially responsible institution for up to three years, subject to additional monitoring and other consequences. If an institution does not achieve a composite score of at least 1.0, it can be transferred from the “advance” system of payment of Title IV funds to cash monitoring status or to the “reimbursement” system of payment, under which the institution must disburse its own funds to students and document the students’ eligibility for Title IV program funds before receiving such funds from the U.S. Department of Education. The composite scores for Apollo Group, University of Phoenix and Western International University exceed 1.5.

 

Limits on Title IV Program Funds.  The Title IV regulations place restrictions on the types of programs offered and the amount of Title IV program funds that a student is eligible to receive in any one academic year. Only certain types of educational programs offered by an institution qualify for Title IV program funds. For students enrolled in qualified programs, the Title IV regulations place limits on the amount of Title IV program funds that a student is eligible to receive in any one academic year, as defined by the U.S. Department of Education. An academic year must consist of at least 30 weeks of instructional time and a minimum of 24 credits. Most of University of Phoenix’s and Western International University’s degree programs meet the academic year minimum definition of 30 weeks of instructional time and 24 credits. Substantially all of University of Phoenix’s degree programs qualify for Title IV program funds. The programs that do not qualify for Title IV program funds consist primarily of corporate training programs and certain certificate and continuing professional education programs. The tuition for these programs is often paid by employers.

 

Restricted Cash.  The U.S. Department of Education places restrictions on excess Title IV program funds collected for unbilled tuition and fees transferred to University of Phoenix, Western International University or IPD Client Institutions. If an institution holds excess Title IV program funds with student authorization, the institution must maintain, at all times, cash in an amount at least equal to the amount of funds the institution holds for students. These funds are included in restricted cash and cash equivalents in our Consolidated Balance Sheets in Item 8, Financial Statements and Supplementary Data.

 

Authorizations for New Locations and Programs.  University of Phoenix, Western International University and CFFP are required to have authorization to operate as degree-granting institutions in each state where they physically provide educational programs. Certain states accept accreditation as evidence of meeting

minimum state standards for authorization or for exempting the institution entirely from formal state licensure or approval. Other states require separate evaluations for authorization. Depending on the state, the addition of a degree program not offered previously or the addition of a new location must be included in the institution’s accreditation and be approved by the appropriate state authorization agency. University of Phoenix, Western International University and CFFP are currently authorized to operate or have confirmed an exemption to operate based upon their accreditation in all states in which they have physical locations and in all states in which they operate and in which separate licensure is required for their distance education programs.

 

Under new rules proposed by the U.S. Department of Education, we may be required to seek and obtain specific regulatory approval to operate in states in which University of Phoenix is qualified to operate without specific state regulatory approval, and would not be entitled to rely on available exemptions based on accreditation. If we experience a delay in obtaining or cannot obtain these approvals, our business could be adversely impacted. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business for further discussion regarding authorizations for new locations and programs, which discussion is incorporated by this reference.

 

University of Phoenix, Western International University and CFFP also must obtain the prior approval of The Higher Learning Commission before expanding into new locations to conduct instructional activities. In addition, The Higher Learning Commission has recently imposed additional requirements on University of Phoenix with respect to approval of new or relocated campuses and additional locations. These requirements may lengthen or make more challenging the approval process for these sites. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — If we fail to maintain our institutional accreditation or if our institutional accrediting body loses recognition by the U.S. Department of Education, we could lose our ability to participate in Title IV programs, which would materially and adversely affect our business for further discussion regarding The Higher Learning Commission.

 

Branching and Classroom Locations.  The Title IV regulations contain specific requirements governing the establishment of new main campuses, branch campuses and classroom locations at which the eligible institution offers, or could offer, 50% or more of an educational program. In addition to classrooms at campuses and learning centers, locations affected by these requirements include the business facilities of client companies, military bases and conference facilities used by University of Phoenix and Western International University. The U.S. Department of Education requires that the institution notify the U.S. Department of Education of each location offering 50% or more of an educational program prior to disbursing Title IV program funds to students at that location. University of Phoenix and Western International University have procedures in place to ensure timely notification and acquisition of all necessary location approvals prior to disbursing Title IV funds to students attending any new location. In addition, The Higher Learning Commission requires that each new campus or learning center of University of Phoenix or Western International University be approved before offering instruction. States in which the two universities operate have varying requirements for approval of branch and classroom locations.

 

Change of Ownership or Control.  A change of ownership or control, depending on the type of change, may have significant regulatory consequences for University of Phoenix, Western International University and CFFP. Such a change of ownership or control could trigger recertification by the U.S. Department of Education, reauthorization by state licensing agencies, or the reevaluation of the accreditation by The Higher Learning Commission.

 

The Department has adopted the change of ownership and control standards used by the U.S. federal securities laws for institutions owned by publicly-held corporations. If a change of ownership and control occurs that requires us to file a Form 8-K with the Securities and Exchange Commission, or there is a change in the identity of a controlling shareholder of Apollo Group, University of Phoenix and/or Western International University may become ineligible to participate in Title IV programs until recertified by the Department. Under some circumstances, the Department may continue an institution’s participation in Title IV programs on a temporary provisional basis pending completion of the change in ownership approval process. In addition, some states where University of Phoenix, Western International University or CFFP are presently

licensed have requirements governing change of ownership or control that require approval of the change to remain authorized to operate in those states. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate — If regulators do not approve or delay their approval of transactions involving a change of control of our company, our state licenses, accreditation, and ability to participate in Title IV programs and state grant payments may be impaired. Moreover, University of Phoenix, Western International University and CFFP are required to report any material change in stock ownership to The Higher Learning Commission. In the event of a material change in stock ownership, The Higher Learning Commission may seek to evaluate the effect of such a change on the continuing operations of University of Phoenix, Western International University and CFFP.

 

New U.S. Department of Education Reporting and Disclosure Requirements.  The Higher Education Opportunity Act includes various provisions aimed at the rising cost of postsecondary education and other efforts for more transparency. Beginning July 1, 2011, the U.S. Department of Education will publish national lists disclosing the top five percent in each of nine institutional categories with the highest college costs and largest percentage cost increases. In addition, all Title IV eligible institutions will be required to disclose their plans for academic program improvement, institutional policies and sanctions related to the unauthorized distribution of copyrighted material, retention rates, placement information, completion and graduation rates and campus/student safety awareness provisions.

 

International

 

Governmental regulations in foreign countries significantly affect our international operations. New or revised interpretations of regulatory requirements could have a material adverse effect on us. Changes in existing or new interpretations of applicable laws, rules, or regulations in the foreign jurisdictions in which we operate could have a material adverse effect on our accreditation, authorization to operate, permissible activities, and costs of doing business outside of the U.S. The failure to maintain or renew any required regulatory approvals, accreditation, or state authorizations could have a material adverse effect on our international operations. See Item 1A, Risk Factors — Risks Related to the Highly Regulated Industry in Which We Operate.

 

Other Matters

 

We file annual, quarterly and current reports with the Securities and Exchange Commission. You may read and copy any document we file at the Securities and Exchange Commission’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for information on the Public Reference Room. The Securities and Exchange Commission maintains a website that contains annual, quarterly and current reports that issuers file electronically with the Securities and Exchange Commission. The Securities and Exchange Commission’s website is http://www.sec.gov.

 

Our website address is www.apollogrp.edu. We make available free of charge on our website our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Information Statements on Schedule 14C, Forms 3, 4, and 5 filed on behalf of directors and executive officers, and all amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission.

 

You should carefully consider the risks and uncertainties described below and all other information contained in this Annual Report on Form 10-K. In order to help assess the major risks in our business, we have identified many, but not all, of these risks. Due to the scope of our operations, a wide range of factors could materially affect future developments and performance.

 

If any of the following risks are realized, our business, financial condition, cash flow or results of operations could be materially and adversely affected, and as a result, the trading price of our Class A

common stock could be materially and adversely impacted. These risk factors should be read in conjunction with other information set forth in this Annual Report, including Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data, including the related Notes to Consolidated Financial Statements.

 

Risks Related to the Control Over Our Voting Stock

 

Our Class A common stock has no voting rights. Our Executive Chairman and Vice Chairman of the Board control 100% of our voting stock and control substantially all actions requiring the vote or consent of our shareholders, which may have an adverse effect on the trading price of our Class A common stock and may discourage a takeover.

 

Dr. John G. Sperling, our Executive Chairman of the Board and Founder, controls approximately 51% of our only class of voting securities, the Apollo Group Class B common stock. Dr. Sperling’s son, Mr. Peter Sperling, the Vice Chairman of our board of directors, controls the remainder of our Class B common stock. Dr. Sperling and Mr. Sperling together control the election of all members of our Board of Directors and substantially all other actions requiring a vote of our shareholders, except in certain limited circumstances. Holders of our outstanding Apollo Group Class A common stock do not have the right to vote for the election of directors or for substantially any other action requiring a vote of shareholders. In the event of Dr. Sperling’s passing, control of the John Sperling Voting Stock Trust, which holds a majority of the outstanding Apollo Group Class B common stock, will be exercised by a majority of three successor trustees: Mr. Sperling, Terri Bishop, who is employed by and is a Director of Apollo, and Darby Shupp, an employee of an entity affiliated with Dr. Sperling. No assurances can be given that the Apollo Group Class B shareholders will exercise their control of Apollo Group in the same manner that a majority of the outstanding Class A shareholders would if they were entitled to vote on actions currently reserved exclusively for our Class B shareholders. In addition, the control of a majority of our voting stock by Dr. Sperling makes it impossible for a third party to acquire voting control of us without Dr. Sperling’s consent.

 

We are a “Controlled Company” as defined in Rule 5615(c)(1) of the NASDAQ Listing Rules, because more than 50% of the voting power of Apollo Group is held by the John Sperling Voting Stock Trust. As a consequence, we are exempt from certain requirements of NASDAQ Listing Rule 5605, including that:

 

 

However, NASDAQ Listing Rule 5605(b)(2) does require that our independent directors have regularly scheduled meetings at which only independent directors are present (“executive sessions”). In addition, Internal Revenue Code Section 162(m) requires that a compensation committee of outside directors (within the meaning of Section 162(m)) approve stock option grants to executive officers in order for us to be able to claim deductions for the compensation expense attributable to such stock options. Notwithstanding the foregoing exemptions, we do have a majority of independent directors on our Board of Directors and we do have an Audit Committee, a Compensation Committee and a Nominating and Governance Committee composed entirely of independent directors.

 

The charters for the Compensation, Audit and Nominating and Governance Committees have been adopted by the Board of Directors and are available on our website, www.apollogrp.edu. These charters provide, among other items, that each member must be independent as such term is defined by the rules of the NASDAQ Stock Market LLC and the Securities and Exchange Commission.

If regulators do not approve or delay their approval of transactions involving a change of control of our company, our state licenses, accreditation, and ability to participate in Title IV programs and state grant programs may be impaired.

 

A change of ownership or control of Apollo Group, depending on the type of change, may have significant regulatory consequences for University of Phoenix and Western International University. Such a change of ownership or control could require recertification by the U.S. Department of Education, reauthorization by state licensing agencies, or the reevaluation of the accreditation by The Higher Learning Commission of the North Central Association of Colleges and Schools. The Department has adopted the change of ownership and control standards used by the federal securities laws for institutions owned by publicly-held corporations. Upon a change of ownership and control sufficient to require us to file a Form 8-K with the Securities and Exchange Commission, or a change in the identity of a controlling shareholder of Apollo Group, University of Phoenix and/or Western International University may cease to be eligible to participate in Title IV programs until recertified by the Department. There can be no assurances that such recertification would be obtained on a timely basis. Under some circumstances, the Department may continue an institution’s participation in the Title IV programs on a temporary provisional basis pending completion of the change in ownership approval process. In addition, some states where University of Phoenix, Western International University or CFFP is presently licensed have requirements governing change of ownership or control that require approval of the change to remain authorized to operate in those states, and participation in grant programs in some states may be interrupted or otherwise affected by a change of ownership or control. Moreover, University of Phoenix, Western International University and CFFP are required to report any material change in stock ownership to The Higher Learning Commission. In the event of a material change in stock ownership of Apollo Group, The Higher Learning Commission may seek to evaluate the effect of such a change of stock ownership on the continuing operations of University of Phoenix, Western International University and CFFP.

 

All of our voting stock is owned and controlled by Dr. John Sperling and Mr. Peter Sperling. We cannot prevent a change of ownership or control that would arise from a transfer of voting stock by Dr. Sperling or Mr. Sperling, including a transfer that may occur or be deemed to occur upon the death of one or both of Dr. Sperling or Mr. Sperling. Dr. and Mr. Sperling have established voting stock trusts and other agreements with the intent to maintain the Company’s voting stock in such a way as to prevent a change of ownership or control upon either’s death, but we cannot assure you that these arrangements will have the desired effect.

 

Risks Related to the Highly Regulated Industry in Which We Operate

 

U.S. Operations

 

If we fail to comply with the extensive regulatory requirements for our business, we could face significant monetary liabilities, fines and penalties, including loss of access to U.S. federal student loans and grants for our students.

 

As a provider of higher education, we are subject to extensive U.S. regulation on both the federal and state levels. In particular, the Higher Education Act, as reauthorized by the Higher Education Opportunity Act in August 2008, and related regulations impose significant regulatory scrutiny on University of Phoenix and Western International University, and all other higher education institutions that participate in the various federal student financial aid programs under Title IV of the Higher Education Act (“Title IV programs”). We collected the substantial majority of our fiscal year 2010 total consolidated net revenue from receipt of Title IV financial aid program funds. University of Phoenix represented approximately 91% of our fiscal year 2010 total consolidated net revenue and University of Phoenix generated 88% of its cash basis revenue for eligible tuition and fees during fiscal year 2010 from receipt of Title IV financial aid program funds excluding temporary relief.

 

These regulatory requirements cover virtually all phases of our U.S. operations, including educational program offerings, branching and classroom locations, instructional and administrative staff, administrative procedures, marketing and recruiting, financial operations, payment of refunds to students who withdraw,

maintenance of restricted cash, acquisitions or openings of new schools, commencement of new educational programs and changes in our corporate structure and ownership.

 

The Higher Education Act, as reauthorized, mandates specific regulatory responsibilities for each of the following components of the higher education regulatory triad: (1) the U.S. federal government through the U.S. Department of Education; (2) independent accrediting agencies recognized by the U.S. Department of Education; and (3) state higher education regulatory bodies.

 

The regulations, standards and policies of these regulatory agencies frequently change and are subject to interpretation, particularly where they are crafted for traditional, academic term-based schools rather than our non-term academic delivery model. Changes in, or new interpretations of, applicable laws, regulations, or standards could have a material adverse effect on our accreditation, authorization to operate in various states, permissible activities, receipt of funds under Title IV programs, or costs of doing business. We cannot predict with certainty how all of the requirements applied by these agencies will be interpreted or whether our schools will be able to comply with these requirements in the future.

 

From time to time, we identify inadvertent compliance deficiencies that we must address and, where appropriate, report to the U.S. Department of Education. Such reporting, even in regard to a minor compliance issue, could result in a more significant compliance review by the Department or even a full recertification review, which may require the expenditure of substantial administrative time and resources to address. If the Department concluded that these reported deficiencies reflect a lack of administrative capability, we could be subject to additional sanctions or even lose our eligibility to participate in Title IV programs. See A failure to demonstrate “administrative capability” or “financial responsibility” may result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business, below.

 

If we are found not to be in compliance with any of these regulations, standards or policies, any one of the relevant regulatory agencies may be able to do one or more of the following:

 

 

In addition, in some circumstances of noncompliance or alleged noncompliance, we may be subject to qui tam lawsuits under the Federal False Claims Act. In these actions, private plaintiffs seek to enforce remedies under the Act on behalf of the U.S. and, if successful, are entitled to recover their costs and to receive a portion of any amounts recovered by the U.S. in the lawsuit. These lawsuits can be prosecuted by a private plaintiff in respect of some action taken by us, even if the Department does not agree with plaintiff’s theory of liability.

 

Any of the penalties, injunctions, restrictions or other forms of censure listed above could have a material adverse effect on our business, financial condition, results of operations and cash flows. If we lose our Title IV

eligibility, we would experience a dramatic decline in revenue and we would be unable to continue our business as it currently is conducted.

 

Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business.

 

In November 2009, the U.S. Department of Education convened two new negotiated rulemaking teams related to Title IV program integrity issues and foreign school issues. The team addressing program integrity issues, which included representatives of the various higher education constituencies, was unable to reach consensus on all of the rules addressed by that team. Accordingly, under the negotiated rulemaking protocol, the Department was free to propose rules without regard to the tentative agreement reached regarding certain of the rules. The proposed program integrity rulemaking addresses numerous topics. The most significant proposals for our business are the following:

 

 

On June 18, 2010, the Department issued a Notice of Proposed Rulemaking (“NPRM”) in respect of the program integrity issues, other than the metrics for determining compliance with the gainful employment requirement. On July 26, 2010, the Department published a separate NPRM in respect of the gainful employment metrics. The Department has stated that its goal is to publish final rules by November 1, 2010, excluding significant sections related to gainful employment which the Department expects to publish in early 2011. The final rules, including some reporting and disclosure rules related to gainful employment described below, are expected to be effective July 1, 2011.

 

Incentive Compensation

 

A school participating in Title IV programs may not pay any commission, bonus or other incentive payments to any person involved in student recruitment or admissions or awarding of Title IV program funds, if such payments are based directly or indirectly on success in enrolling students or obtaining student financial aid. The law and regulations governing this requirement do not establish clear criteria for compliance in all circumstances, but there currently are twelve safe harbors that define specific types of compensation that are deemed to constitute permissible incentive compensation. Currently, we rely on several of these safe harbors to ensure that our compensation and recruitment practices comply with the applicable requirements.

 

In the rules proposed by the Department, these twelve safe harbors would be eliminated and, in lieu of the safe harbors, some of the relevant concepts relating to the incentive compensation limitations would be defined. These changes would increase the uncertainty about what constitutes incentive compensation and which employees are covered by the regulation.

 

In response to the Department’s concern about the impact of compensation structures that rely on the current safe harbors (reflected in the proposed rulemaking), and in order to enhance the admissions process for our students, we began considering an alternative compensation structure for our admissions personnel in early 2009. We have been developing this new structure, which complies with the Department’s proposed rule, over the past twelve months and expect to implement it on a broad scale during the first quarter of fiscal year 2011. In connection with this, we eliminated enrollment results as a component of compensation for our admissions personnel effective September 1, 2010.

 

We expect that this change in our approach to recruiting, with reduced emphasis on enrollment and increased emphasis on improving the student experience, will adversely impact our enrollment rates, particularly in the near-term, and increase our operating costs, perhaps materially. We believe this is in the

best interests of our students and it is consistent with our on-going efforts to lead the industry in addressing the concerns of the Department and others, including members of Congress, about admissions practices in the proprietary sector. We anticipate that this increased cost and the impact on our revenue from reduced enrollment will be offset partly by the benefits realized from improved student retention. However, we are not able to precisely predict the impact.

 

The elimination of the existing twelve safe harbors also could affect the manner in which we conduct our business in the following additional ways:

 

 

State Authorization

 

In the U.S., institutions that participate in Title IV programs must be authorized to operate by the appropriate postsecondary regulatory authority in each state where the institution has a physical presence, or be exempt from such regulatory authorization, usually based on recognized accreditation. As of August 31, 2010, University of Phoenix is authorized to operate or has confirmed an exemption to operate based upon its accreditation and has a physical presence in 39 states, Puerto Rico and the District of Columbia. University of Phoenix has held these authorizations or has confirmed an exemption for specific authority to operate based upon its accreditation for periods ranging from less than three years to over 25 years. As of August 31, 2010, University of Phoenix has also been approved to operate or has confirmed an exemption to operate based upon its accreditation in Alaska, Mississippi, Montana and South Dakota, but does not yet have a physical presence in these states. In five states, including California, University of Phoenix is qualified to operate without specific state regulatory approval due to available state exemptions that permit such operation if certain programmatic or other accreditation criteria are met. Under new rules proposed by the U.S. Department of Education, we may be required to seek and obtain specific regulatory approval to operate in these states and would not be entitled to rely on available exemptions based on accreditation. If we experience a delay in obtaining or cannot obtain these approvals, our business could be adversely impacted. Complicating this is the fact that the State of California, the state in which we conduct the most business by revenue, currently does not have a process for regulating educational institutions such as University of Phoenix. As a result, the manner in which the Department’s proposed regulation will apply to our business in California, and the impact of such regulation on our business, is uncertain. If we are unable to operate in California in a manner that would preserve Title IV eligibility for our students, our business would be materially and adversely impacted.

 

Gainful Employment

 

Under the Higher Education Act, as reauthorized, proprietary schools are eligible to participate in Title IV programs only in respect of educational programs that lead to “gainful employment in a recognized occupation.” Historically, this concept has not been defined in detail. In its July 26, 2010 NPRM, the U.S. Department of Education published proposed rules that would for the first time define gainful employment, which would apply on a program-by-program basis.

 

Under the proposed rules, gainful employment in respect of a particular program would be defined by reference to two debt-related tests: one based on student debt service-to-income ratios for program graduates, and the other based on student loan repayment rates for program enrollees. Based on the application of these

tests, a program may be eligible to participate in Title IV programs without restriction, may be eligible to participate with disclosure requirements, may be on restricted status and only able to participate with material restrictions (including enrollment limitations), or may be ineligible to participate.

 

The proposed debt service-to-income test measures the median annual student loan debt service of graduates of a program, as a percentage of their average annual earnings and/or their “discretionary income” (as defined), in each case measured over the preceding three years or, in some cases, the three years prior to the preceding three years. The proposed loan repayment test measures the loan repayment rate for former enrollees in (and not just graduates of) a program. The repayment rate is calculated as a percentage of all program enrollee Title IV loans that entered into repayment during the preceding four federal fiscal years that are in current repayment status, determined on a dollar weighted basis by reference to the original principal amount of such loans. A loan would be considered to be in current status if it has been fully repaid or debt service has been paid such that the principal was reduced during the preceding federal fiscal year.

 

Under the proposed tests, if a program’s median annual student loan debt service is less than 8% of average annual earnings or less than 20% of average annual discretionary income, and the program’s loan repayment rate is at least 45%, the program would be eligible to participate in Title IV programs with no new disclosure requirements. If a program’s median annual student loan debt service is above 12% of average annual earnings and above 30% of average annual discretionary income based on the preceding three years, and the program’s loan repayment rate is below 35%, the program would be ineligible to participate in Title IV programs. Programs with test results between these two extremes would, depending on the precise test outcomes, either be eligible to participate with disclosure requirements, or be placed on restricted status and only eligible to participate with material restrictions (including enrollment limitations).

 

The proposed rules provide for a two-year phase-in. For the award year beginning July 1, 2012, only the lowest-performing programs accounting for 5% of all graduates during the prior year would be subject to losing eligibility. The full application of the eligibility rules would commence with the award year beginning July 1, 2013.

 

The Department has stated that it intends to publish final rules by November 1, 2010 covering a portion of the proposed gainful employment rules. These rules would require proprietary institutions of higher education and postsecondary vocational institutions to provide prospective students with each eligible program’s graduation and job placement rates, and require colleges to provide the Department with information that will allow determination of student debt levels and incomes after program completion. Additionally, the rules would require institutions to provide certain information to the Department before new educational programs would be eligible to participate in Title IV programs, including five year enrollment projections and documentation from employers not affiliated with the institution that the new program’s curriculum aligns with recognized occupations at those employers’ businesses and that there are projected job vacancies or expected demand for such occupations at those businesses.

 

The above descriptions of the proposed gainful employment rules are qualified in their entirety by the text of the proposed rules, available at http://www2.ed.gov/legislation/FedRegister/proprule/2010-3/072610a.pdf. These proposed rules are complex and their application involves many interpretive and other issues, not all of which may be addressed in any final rulemaking.

 

If these rules are adopted in the form proposed, many of our programs may be ineligible for Title IV funding or restricted because they do not meet at least one of the specified tests. In addition, the continuing eligibility of our educational programs for Title IV funding would be at risk due to factors beyond our control, such as changes in the income level of our graduates, increases in interest rates, changes in the federal poverty income level relevant for calculating discretionary income, changes in the percentage of our former students who are current in repayment of their student loans, and other factors. The exposure to these external factors would hinder our ability to effectively manage our business. If a particular program ceased to be eligible for Title IV funding, in most cases it would not be practical to continue offering that program under our current business model. Adoption of the regulations in the form proposed could result in a significant realignment of the types of educational programs that are offered by us and by other proprietary institutions, in order to

comply with the rules or, most prominently, to avoid the uncertainty associated with compliance over time. This realignment could reduce our enrollment, perhaps materially.

 

The Department has not provided access to the income and debt service information sufficient to determine the impact of these proposed gainful employment rules on our programs. In August 2010, the Department published estimated loan repayment rates for all educational institutions participating in Title IV programs, determined on an institution-wide basis. The reported estimated rate for University of Phoenix was 44.2%. The actual application of the proposed loan repayment rate test would be done on a program-by-program basis and, therefore, the estimated rate for the institution is only a general guide for informational purposes.

 

We cannot predict the form of the final rules regarding program integrity that may be adopted by the Department. Compliance with these rules in the form proposed could reduce our enrollment, increase our cost of doing business, and have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Action by the U.S. Congress to revise the laws governing the federal student financial aid programs or reduce funding for those programs could reduce our student population and increase our costs of operation.

 

The U.S. Congress must periodically reauthorize the Higher Education Act and annually determine the funding level for each Title IV program. In 2008, the Higher Education Act was reauthorized through September 30, 2013 by the Higher Education Opportunity Act. Changes to the Higher Education Act are likely to result from subsequent reauthorizations, and the scope and substance of any such changes cannot be predicted. In recent months, there has been increased focus by the U.S. Congress on the role that proprietary educational institutions play in higher education. On June 17, 2010, the Education and Labor Committee of the U.S. House of Representatives held a hearing to examine the manner in which accrediting agencies review higher education institutions’ policies on credit hours and program length. This followed a report from the Office of the Inspector General of the U.S. Department of Education in December 2009 criticizing the accreditation of a proprietary school by a regional accrediting body and requesting that the Department review the appropriateness of its recognition of the accrediting body. On June 24, 2010, the Health, Education, Labor and Pensions Committee of the U.S. Senate (“HELP Committee”) released a report, entitled, “Emerging Risk?: An Overview of Growth, Spending, Student Debt and Unanswered Questions in For-Profit Higher Education” and held the first in a series of hearings to examine the proprietary education sector. Earlier, the Chairmen of each of these education committees, together with other members of Congress, requested the Government Accountability Office (“GAO”) to conduct a review and prepare a report with recommendations regarding various aspects of the proprietary sector, including recruitment practices, educational quality, student outcomes, the sufficiency of integrity safeguards against waste, fraud and abuse in federal student aid programs and the degree to which proprietary institutions’ revenue is composed of Title IV and other federal funding sources. The results of a portion of this review by the GAO were reported at a HELP Committee hearing on August 4, 2010, entitled, “For Profit Schools: The Student Recruitment Experience.” Sen. Tom Harkin, the Chairman of the HELP Committee, stated at the August hearing that he is concerned about the practices of proprietary schools, the increasing amount of Title IV funding received by the proprietary sector and the effectiveness of accrediting bodies in ensuring academic and other standards. In addition, Sen. Harkin has stated that the recently proposed regulations by the Department of Education regarding incentive compensation of recruiting personnel, gainful employment standards and other matters, while useful, are only a start to addressing the problems he perceives in the sector. Following the August hearing, Sen. Harkin requested a broad range of detailed information from 30 proprietary institutions, including Apollo Group. We have been and intend to continue being responsive to the requests of the HELP Committee. On September 30, 2010, the HELP Committee held a third hearing and Sen. Harkin’s staff released a memorandum entitled “The Return on the Federal Investment in For-Profit Education: Debt Without a Diploma.” Sen. Harkin has stated that another in this series of hearings will be held in December 2010.

 

We cannot predict what legislation, if any, will emanate from these Congressional committee hearings or what impact any such legislation might have on the proprietary education sector and our business in particular. Any action by Congress that significantly reduces Title IV program funding or the eligibility of our institutions

or students to participate in Title IV programs would have a material adverse effect on our financial condition, results of operations and cash flows. Congressional action could also require us to modify our practices in ways that could increase our administrative costs and reduce our profit margin, which could have a material adverse effect on our financial condition, results of operations and cash flows.

 

If the U.S. Congress significantly reduced the amount of available Title IV program funding, we would attempt to arrange for alternative sources of financial aid for our students, which may include lending funds directly to our students, but it is unlikely that private sources would be able to provide as much funding to our students on as favorable terms as is currently provided by Title IV. In addition, private organizations could require us to guarantee all or part of this assistance and we might incur other additional costs. For these reasons, private, alternative sources of student financial aid would only partly offset, if at all, the impact on our business of reduced Title IV program funding.

 

Our schools and programs would lose their eligibility to participate in federal student financial aid programs if the percentage of our revenues derived from those programs is too high, in which event we could not conduct our business as it is currently conducted.

 

A requirement of the Higher Education Act, as reauthorized by the Higher Education Opportunity Act, commonly referred to as the “90/10 Rule,” applies only to proprietary institutions of higher education, which includes University of Phoenix and Western International University. Under this rule, a proprietary institution will be ineligible to participate in Title IV programs if for any two consecutive fiscal years it derives more than 90% of its cash basis revenue, as defined in the rule, from Title IV programs. An institution that derives more than 90% of its revenue from Title IV programs for any single fiscal year will be automatically placed on provisional certification for two fiscal years and will be subject to possible additional sanctions determined to be appropriate under the circumstances by the U.S. Department of Education in the exercise of its broad discretion. While the Department has broad discretion to impose additional sanctions on such an institution, there is only limited precedent available to predict what those sanctions might be, particularly in the current regulatory environment. The Department could specify any additional conditions as a part of the provisional certification and the institution’s continued participation in Title IV programs. These conditions may include, among other things, restrictions on the total amount of Title IV program funds that may be distributed to students attending the institution; restrictions on programmatic and geographic expansion; requirements to obtain and post letters of credit; additional reporting requirements to include additional interim financial reporting; or any other conditions imposed by the Department. Should an institution be subject to a provisional certification at the time that its current program participation agreement expired, the effect on recertification of the institution or continued eligibility in Title IV programs pending recertification is uncertain. An institution that derives more than 90% of its revenue from Title IV programs for two consecutive fiscal years will be ineligible to participate in Title IV programs for at least two fiscal years. University of Phoenix and Western International University are required to calculate this percentage at the end of each fiscal year. If an institution is determined to be ineligible to participate in Title IV programs due to the 90/10 Rule, any disbursements of Title IV program funds while ineligible must be repaid to the Department.

 

The 90/10 Rule percentage for University of Phoenix has increased materially over the past several fiscal years and we expect further increases in the near term. These increases are primarily attributable to the following factors:

 

 

The Higher Education Opportunity Act provides temporary relief from the impact of the loan limit increases by excluding from the 90/10 Rule calculation any amounts received between July 1, 2008 and June 30, 2011 that are attributable to the increased annual loan limits. We refer to this as the “LLI relief.” The following table details the 90/10 Rule percentages for University of Phoenix and Western International University, as well as the percentages for University of Phoenix with the LLI relief, for fiscal years 2010 and 2009:

 

 

 

 

Based on currently available information, we expect that the 90/10 Rule percentage for University of Phoenix, net of the LLI relief, will approach 90% for fiscal year 2011, principally because of the expanded eligibility for and increases in the amount of Pell Grants. We have implemented various measures intended to reduce the percentage of University of Phoenix’s cash basis revenue attributable to Title IV funds, including emphasizing employer-paid and other direct-pay education programs, encouraging students to carefully evaluate the amount of necessary Title IV borrowing, and continued focus on professional development and continuing education programs. Although we believe these measures will favorably impact the 90/10 Rule calculation, they have had only limited impact to date and there is no assurance that they will be adequate to prevent the 90/10 Rule calculation from exceeding 90% in the future. We are considering other measures to favorably impact the 90/10 Rule calculation for University of Phoenix, including tuition price increases; however, we have substantially no control over the amount of Title IV student loans and grants sought by or awarded to our students.

 

Based on currently available information, we do not expect the 90/10 Rule percentage for University of Phoenix, net of the LLI relief, to exceed 90% for fiscal year 2011. However, we believe that, absent a change in recent trends or the implementation of additional effective measures to reduce the percentage, the 90/10 Rule percentage for University of Phoenix is likely to exceed 90% in fiscal year 2012 due to the expiration of the LLI relief in July 2011.

 

We believe that the most effective long-term solution to address the increasing 90/10 Rule percentage is a change in the 90/10 Rule itself. Because of the increases in Title IV student loan limits and grants in recent years, we believe that many proprietary institutions are experiencing pressure on their 90/10 Rule compliance. In our view, one potential unintended consequence of this pressure is higher tuition rates. This is because one of the more effective methods of reducing the 90/10 Rule percentage is to increase tuition prices above the applicable maximums for Title IV student loans and grants, requiring other sources of funding to resolve the remaining tuition balance, in order to reduce the percentage of revenue from Title IV sources. However, this consequence directly undermines the Department of Education’s interest in promoting affordable postsecondary education. Although modification of the rule could limit this undesirable impact on tuition, there is no assurance that the Department, or Congress, will address this problem by modifying the rule or will address it in a manner that timely and favorably impacts compliance by University of Phoenix.

 

Our efforts to reduce the 90/10 Rule percentage for University of Phoenix, especially if the percentage exceeds 90% for a fiscal year, may involve taking measures which reduce our revenue, increase our operating expenses, or both, in each case perhaps significantly. If the 90/10 Rule is not changed to provide relief for

proprietary institutions, we may be required to make structural changes to our business in order to remain in compliance, which changes may materially alter the manner in which we conduct our business and materially and adversely impact our business, financial condition, results of operations and cash flows. Furthermore, these required changes could make more difficult our ability to comply with other important regulatory requirements, such as the proposed gainful employment regulations and the cohort default rate regulations discussed under Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business, above, and An increase in our student loan default rates could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business, below.

 

An increase in our student loan default rates could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business.

 

To remain eligible to participate in Title IV programs, educational institutions must maintain student loan cohort default rates below specified levels. The U.S. Department of Education reviews an educational institution’s cohort default rate annually as a measure of administrative capability. Each cohort is the group of students who first enter into student loan repayment during a federal fiscal year (ending September 30). The currently applicable cohort default rate for each cohort is the percentage of the students in the cohort who default on their student loans prior to the end of the following federal fiscal year, which represents a two-year measuring period. The cohort default rates are published by the Department approximately 12 months after the end of the measuring period. Thus, in September 2010 the Department published the cohort default rates for the 2008 cohort, which measured the percentage of students who first entered into repayment during the year ended September 30, 2008 and defaulted prior to September 30, 2009. As discussed below, the measurement period for the cohort default rate has been increased to three years starting with the 2009 cohort.

 

If an educational institution’s two-year cohort default rate exceeds 10% for any one of the three preceding years, it must delay for 30 days the release of the first disbursement of U.S. federal student loan proceeds to first time borrowers enrolled in the first year of an undergraduate program. Western International University implemented a 30-day delay for such disbursements in fiscal year 2007 and University of Phoenix proactively implemented a 30-day delay in fiscal year 2009. If an institution’s two-year cohort default rate exceeds 25% for three consecutive years or 40% for any given year, it will be ineligible to participate in Title IV programs and, as a result, its students would not be eligible for federal student financial aid.

 

The cohort default rates for University of Phoenix, Western International University and for all proprietary postsecondary institutions for the federal fiscal years 2008, 2007 and 2006 were as follows:

 

 

 

 

The University of Phoenix cohort default rates have been increasing over the past several years, largely due to the transitioning of our associate’s degree students from Western International University to University of Phoenix beginning in April 2006 and the general expansion of the University of Phoenix associate’s degree program. Student loan default rates tend to be higher in our associate’s degree student population compared to our bachelor’s and our graduate degree student populations. We expect this upward trend to intensify due to the current challenging economic climate and the continuing effect of the historical growth in our associate’s degree student population. Consistent with this, the available preliminary data for the University of Phoenix 2009 cohort reflect a substantially higher default rate than the 2008 cohort, although we do not expect the rate to exceed 25%.

We have implemented initiatives to mitigate the increased risk of student loan defaults for University of Phoenix and Western International University students. We have engaged outside resources to assist the students who are at risk of default. These resources contact students and offer assistance, which includes providing students with specific loan repayment information, lender contact information and attempts to transfer these students to the lender to resolve their delinquency. In addition, we are intensely focused on student retention and enrolling students who have a reasonable chance to succeed in our programs, in part because the rate of default is higher among students who do not complete their degree program compared to students who graduate.

 

The July 2010 elimination of the Federal Family Education Loan Program (FFELP), under which private lenders originated and serviced federally guaranteed student loans, and the migration of all federal student loans to the Federal Direct Loan Program, under which the federal government lends directly to students, could adversely impact loan repayment rates and our cohort default rates, if the federal government is less effective in promoting timely repayment of federal student loans than the private lenders were under the FFELP.

 

If our student loan default rates approach the limits detailed above, we may be required to increase our efforts and resources dedicated to improving these default rates. In addition, because there is a lag between the funding of a student loan and a default thereunder, many of the borrowers who are in default or at risk of default are former students with whom we may have only limited contact. Accordingly, there can be no assurance that we would be able to effectively improve our default rates or improve them in a timely manner to meet the requirements for continued participation in Title IV funding if we experience a substantial increase in our student loan default rates.

 

The cohort default rate requirements were modified by the Higher Education Opportunity Act enacted in August 2008 to increase by one year the measuring period for each cohort. Starting with the 2009 cohort, the U.S. Department of Education will calculate both the current two-year and the new three-year cohort default rates. Beginning with the 2011 three-year cohort default rate published in September 2014, the three-year rates will be applied for purposes of measuring compliance with the requirements, as follows:

 

 

The Department has published, for informational purposes, “trial rates” to assist institutions in understanding the impact of the new three-year cohort default rate calculation. The trial three-year cohort default rates for prior periods are as follows:

 

 

If we fail to maintain our institutional accreditation or if our institutional accrediting body loses recognition by the U.S. Department of Education, we could lose our ability to participate in Title IV programs, which would materially and adversely affect our business.

 

University of Phoenix and Western International University are institutionally accredited by The Higher Learning Commission (“HLC”) of the North Central Association of Colleges and Schools, one of the six regional accrediting agencies recognized by the U.S. Department of Education. Accreditation by an accrediting

agency recognized by the U.S. Department of Education is required in order for an institution to become and remain eligible to participate in Title IV programs.

 

If the U.S. Department of Education ceased to recognize HLC for any reason, University of Phoenix and Western International University would not be eligible to participate in Title IV programs beginning 18 months after the date such recognition ceased unless HLC was again recognized or our institutions were accredited by another accrediting body recognized by the U.S. Department of Education. In December 2009, the Office of Inspector General of the U.S. Department of Education (“OIG”) requested that the U.S. Department of Education review the appropriateness of the U.S. Department of Education’s recognition of HLC as an accrediting body, following the OIG’s unfavorable review of HLC’s initial accreditation of a non-traditional, proprietary postsecondary educational institution. We cannot predict the outcome of the U.S. Department of Education’s review of HLC’s recognition. HLC accredits over 1,000 colleges and universities, including some of the most highly regarded universities in the U.S.

 

Regardless of the outcome of the U.S. Department of Education’s review of HLC, the focus by the OIG and the U.S. Department of Education on the process pursuant to which HLC accredited a non-traditional, proprietary postsecondary educational institution may make the accreditation review process more challenging for University of Phoenix and Western International University when they undergo their normal HLC accreditation review process in the future or in connection with programmatic or location expansion.

 

In addition, in August 2010, University of Phoenix received a letter from HLC requiring University of Phoenix to provide certain information and evidence of compliance with HLC accreditation standards. The letter related to the August 2010 report published by the U.S. Government Accountability Office (“GAO”) of its undercover investigation into the enrollment and recruiting practices of a number of proprietary institutions of higher education, including University of Phoenix. The letter required that University of Phoenix submit a report to HLC addressing the specific GAO allegations regarding University of Phoenix and any remedial measures being undertaken in response to the GAO report. In addition, the report was required to include (i) evidence demonstrating that University of Phoenix, on a university-wide basis, currently is meeting and in the future will meet the HLC Criteria for Accreditation relating to operating with integrity and compliance with all state and federal laws, (ii) evidence that University of Phoenix has adequate systems in place which currently and in the future will assure appropriate control of all employees engaged in the recruiting, marketing or admissions process, (iii) evidence demonstrating that Apollo Group is not encouraging inappropriate behavior on the part of recruiters and is taking steps to encourage appropriate behavior, and (iv) detailed information about University of Phoenix policies, procedures and practices relating to marketing, recruiting, admissions and other related matters. We submitted the response to the HLC on September 10, 2010 and subsequently received a request for additional information. We have been informed that our response will be evaluated by a special committee in early 2011, and that the committee will make recommendations, if any, to the HLC board. If, after review, HLC determines that our response is unsatisfactory, HLC has informed us that it may impose additional unspecified monitoring or sanctions. In addition, HLC has recently imposed additional requirements on University of Phoenix with respect to approval of new or relocated campuses and additional locations. These requirements may lengthen or make more challenging the approval process for these sites.

 

The loss of accreditation for any reason would, among other things, render our schools and programs ineligible to participate in Title IV programs, affect our authorization to operate and to grant degrees in certain states and decrease student demand. If University of Phoenix became ineligible to participate in Title IV programs, we could not conduct our business as it is currently conducted and it would have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Our business could be harmed if we experience a disruption in our ability to process student loans because of the phase-out of Family Education Loan Program loans and the corresponding transition to direct student loans under the Federal Direct Loan Program.

 

We collected the substantial majority of our fiscal year 2010 total consolidated net revenue from receipt of Title IV financial aid program funds, principally from federally guaranteed student loans under the Federal

Family Education Loan Program (FFELP). FFELP loans, which were originated by private lenders, were phased out as of July 1, 2010 pursuant to the federal Health Care and Education Reconciliation Act passed by Congress in March 2010. As of July 1, 2010, all new Title IV student loans are administered under the Federal Direct Loan Program (FDLP), in which the federal government lends directly to students. We completed the transition of loan origination and related servicing from the FFELP to the FDLP during the third quarter of fiscal year 2010.

 

Because all Title IV student loans are now processed under the FDLP, any processing disruptions by the U.S. Department of Education may impact our students’ ability to obtain student loans on a timely basis. If we experience a disruption in our ability to process student loans through the FDLP, either because of administrative challenges on our part or the inability of the Department to process the increased volume of direct loans on a timely basis, our business, financial condition, results of operations and cash flows could be adversely and materially affected.

 

If any regulatory audit, investigation or other proceeding finds us not in compliance with the numerous laws and regulations applicable to the postsecondary education industry, we may not be able to successfully challenge such finding and our business could suffer.

 

Due to the highly regulated nature of the postsecondary education industry, we are subject to audits, compliance reviews, inquiries, complaints, investigations, claims of non-compliance and lawsuits by federal and state governmental agencies, regulatory agencies, accrediting agencies, present and former students and employees, shareholders and other third parties, any of whom may allege violations of any of the regulatory requirements applicable to us. If the results of any such claims or actions are unfavorable to us, we may be required to pay monetary fines or penalties, be required to repay funds received under Title IV programs or state financial aid programs, have restrictions placed on or terminate our schools’ or programs’ eligibility to participate in Title IV programs or state financial aid programs, have limitations placed on or terminate our schools’ operations or ability to grant degrees and certificates, have our schools’ accreditations restricted or revoked, or be subject to civil or criminal penalties. Any one of these sanctions could materially adversely affect our business, financial condition, results of operations and cash flows and result in the imposition of significant restrictions on us and our ability to operate.

 

In February 2009, the Department performed a program review of University of Phoenix’s policies and procedures involving Title IV programs. On December 31, 2009, University of Phoenix received the Department’s Program Review Report, which was a preliminary report of the Department’s findings. We responded to the preliminary report in the third quarter of fiscal year 2010. The Department issued its Final Program Review Determination letter on June 16, 2010, which confirmed we had completed the corrective actions and satisfied the obligations arising from the review as described below.

 

On June 9, 2010, we posted a letter of credit in the amount of approximately $126 million as required to comply with the Department’s standards of financial responsibility. The Department’s regulations require institutions to post a letter of credit where a program review report cites untimely return of unearned Title IV funds for more than 10% of the sampled students in a period covered by the review. The letter of credit is fully cash collateralized and must be maintained until at least June 30, 2012.

 

Of the six findings contained in the Final Program Review Determination Letter, three related to University of Phoenix’s procedures for determining student withdrawal dates and associated timing of the return of unearned Title IV funds, which averaged no more than six days outside the required timeframe in the affected sample files. There were no findings that indicated incorrect amounts of Title IV funds had been returned. In the second quarter of fiscal year 2010, we made payments totaling $0.7 million to reimburse the Department for the cost of Title IV funds associated with these findings.

 

The remaining findings involved isolated clerical errors verifying student-supplied information and, as self-reported by University of Phoenix in 2008, the calculation of student financial need where students were eligible for tuition and fee waivers and discounts, and the use of Title IV funds for non-program purposes such as transcripts, applications and late fees. See U.S. Department of Education Audits and Other Matters in Note 19, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data.

If we fail to maintain any of our state authorizations, we would lose our ability to operate in that state and to participate in Title IV programs there.

 

University of Phoenix, Western International University and CFFP are authorized to operate and to grant degrees by the applicable state agency of each state where such authorization is required and where we maintain a campus, or are exempt from such regulatory authorization usually based on recognized accreditation. In addition, several states require University of Phoenix and Western International University to obtain separate authorization for the delivery of distance education to residents of those states. Compliance with these state requirements is also necessary for students in the respective states to participate in Title IV programs. The loss of such authorization in one or more states would render students resident in those states ineligible to participate in Title IV programs and could have a material adverse effect on our business, financial condition, results of operations and cash flows. Loss of authorization in one or more states could increase the likelihood of additional scrutiny and potential loss of operating and/or degree granting authority in other states in which we operate, which would further impact our business. In addition, under new rules proposed by the U.S. Department of Education, we may be required to seek and obtain specific regulatory approval to operate in certain states in which we are currently exempt from state authorization, and would not be entitled to rely on available exemptions based on accreditation. If we experience a delay in obtaining or cannot obtain these approvals, our business could be adversely impacted. See Pending rulemaking by the U.S. Department of Education could result in regulatory changes that materially and adversely affect our business, above.

 

A failure to demonstrate “administrative capability” or “financial responsibility” may result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business.

 

The U.S. Department of Education regulations specify extensive criteria an institution must satisfy to establish that it has the requisite administrative capability to participate in Title IV programs. The failure of an institution to satisfy any of the criteria used to assess administrative capability may cause the Department to determine that the institution lacks administrative capability and, therefore, subject the institution to additional scrutiny or deny eligibility for Title IV programs. These criteria require, among other things, that the institution:

 

 

Furthermore, to participate in Title IV programs, an eligible institution must satisfy specific measures of financial responsibility prescribed by the Department, or post a letter of credit in favor of the Department and possibly accept other conditions on its participation in Title IV programs. Pursuant to the Title IV regulations, each eligible higher education institution must satisfy a measure of financial responsibility that is based on a weighted average of three annual tests which assess the financial condition of the institution. The three tests measure primary reserve, equity, and net income ratios. The Primary Reserve Ratio is a measure of an

institution’s financial viability and liquidity. The Equity Ratio is a measure of an institution’s capital resources and its ability to borrow. The Net Income Ratio is a measure of an institution’s profitability. These tests provide three individual scores which are converted into a single composite score. The maximum composite score is 3.0. If the institution achieves a composite score of at least 1.5, it is considered financially responsible. A composite score from 1.0 to 1.4 is considered financially responsible, and the institution may continue to participate as a financially responsible institution for up to three years, subject to additional monitoring and other consequences. If an institution does not achieve a composite score of at least 1.0, it can be transferred from the “advance” system of payment of Title IV funds to cash monitoring status or to the “reimbursement” system of payment, under which the institution must disburse its own funds to students and document the students’ eligibility for Title IV program funds before receiving such funds from the U.S. Department of Education. The composite scores for Apollo Group, University of Phoenix and Western International University exceed 1.5.

 

If our schools eligible to participate in Title IV programs fail to maintain administrative capability or financial responsibility, as defined by the Department, those schools could lose their eligibility to participate in Title IV programs or have that eligibility adversely conditioned, which would have a material adverse effect on our business. Limitations on, or termination of, participation in Title IV programs as a result of the failure to demonstrate administrative capability or financial responsibility would limit students’ access to Title IV program funds, which could significantly reduce the enrollments and revenues of our schools eligible to participate in Title IV programs and materially and adversely affect our business, financial condition, results of operations and cash flows.

 

If we are not recertified to participate in Title IV programs by the U.S. Department of Education, we would lose eligibility to participate in Title IV programs and could not conduct our business as it is currently conducted.

 

University of Phoenix and Western International University are eligible and certified to participate in Title IV programs. University of Phoenix was recertified for Title IV programs in November 2009 and its current certification expires in December 2012. Western International University was recertified in May 2010 and its current certification expires in September 2014.

 

Generally, the recertification process includes a review by the Department of the institution’s educational programs and locations, administrative capability, financial responsibility, and other oversight categories. The Department could limit, suspend or terminate an institution’s participation in Title IV programs for violations of the Higher Education Act, as reauthorized, or Title IV regulations.

 

Continued Title IV eligibility is critical to the operation of our business. If University of Phoenix becomes ineligible to participate in Title IV federal student financial aid programs, we could not conduct our business as it is currently conducted and it would have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

If regulators do not approve our domestic acquisitions, the acquired schools’ state licenses, accreditation, and ability to participate in Title IV programs may be impaired.

 

When we acquire an institution, we must seek approval from the U.S. Department of Education, if the acquired institution participates in Title IV programs, and from most applicable state agencies and accrediting agencies because an acquisition is considered a change of ownership or control of the acquired institution under applicable regulatory standards. A change of ownership or control of an institution under the Department’s standards can result in the temporary suspension of the institution’s participation in the Title IV programs unless a timely and materially complete application for recertification is filed with the Department and the Department issues a temporary provisional certification. If we are unable to obtain approvals from the state agencies, accrediting agencies or Department for any institution we may acquire in the future, depending on the size of that acquisition, such a failure to obtain approval could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We will be subject to sanctions if we fail to properly calculate and make timely payment of refunds of Title IV program funds for students who withdraw before completing their educational program.

 

The Higher Education Act, as reauthorized, and U.S. Department of Education regulations require us to calculate refunds of unearned Title IV program funds disbursed to students who withdraw from their educational program before completing it. If refunds are not properly calculated or timely paid, we will be subject to sanctions imposed by the U.S. Department of Education, which could increase our cost of regulatory compliance and adversely affect our business, financial condition, results of operations and cash flows.

 

If IPD’s client institutions are sanctioned due to non-compliance with Title IV requirements, our business could be responsible for any resulting fines and penalties.

 

Our subsidiary, Institute for Professional Development, Inc. (“IPD”) provides to its client institutions numerous consulting and administrative services, including services that involve the handling and receipt of Title IV funds. As a result of this, IPD may be jointly and severally liable for any fines, penalties or other sanctions imposed by the U.S. Department of Education on the client institution for violation of applicable Title IV regulations, regardless of the degree of fault, if any, on IPD’s part. The imposition of such fines, penalties or other sanctions could have a material adverse impact on our business, financial condition, results of operations and cash flows.

 

Government regulations relating to the Internet could increase our cost of doing business and affect our ability to grow.

 

The increasing popularity and use of the Internet and other online services has led to and may lead to further adoption of new laws and regulatory practices in the U.S. or foreign countries and to new interpretations of existing laws and regulations. These new laws and interpretations may relate to issues such as online privacy, copyrights, trademarks and service marks, sales taxes, value-added taxes, withholding taxes, allocation and apportionment of income amongst various state, local and foreign jurisdictions, fair business practices and the requirement that online education institutions qualify to do business as foreign corporations or be licensed in one or more jurisdictions where they have no physical location or other presence. New laws, regulations or interpretations related to doing business over the Internet could increase our costs and materially and adversely affect our enrollments, which could have a material adverse affect on our business, financial condition, results of operations and cash flows.

 

Non-U.S. Operations

 

Our non-U.S. operations are subject to regulatory requirements of the applicable countries in which we operate, and our failure to comply with these requirements may result in substantial monetary liabilities, fines and penalties and a loss of authority to operate.

 

We operate physical and online educational institutions in the United Kingdom, Europe, Canada, Chile, Mexico, and elsewhere, and are actively seeking further expansion in other countries. Our operations in each of the relevant foreign jurisdictions are subject to educational and other regulations, which may differ materially from the regulations applicable to our U.S. operations.

 

Risks Related to Our Business

 

Ongoing and contemplated changes to our business may adversely affect our growth rate, profitability, financial condition, results of operations and cash flows.

 

Our ability to sustain our rate of growth or profitability depends on a number of factors, including our ability to obtain and maintain regulatory approvals, our ability to attract and retain students, our ability to maintain operating margins, our ability to recruit and retain high quality academic and administrative personnel and competitive factors. In addition, growth may place a significant strain on our resources and increase demands on our management information and reporting systems, financial management controls, and personnel. Although we have made a substantial investment in augmenting our financial and management

information systems and other resources to support future growth, it cannot be assured that we will have adequate capacity to accommodate substantial growth or that we will be able to manage further growth effectively. Failure to do so could adversely affect our business, financial condition, results of operations and cash flows.

 

In order to increase our focus on improving the student experience and attracting students who are more likely to persist in our programs, we have recently implemented or plan to implement various measures that are likely to adversely affect our growth and profitability, at least in the near term, including the following:

 

 

Each of these changes could adversely impact our business, especially in the near term. In combination, these changes may have a more pronounced adverse impact on our business, financial condition, results of operations and cash flows, particularly in the near term.

 

Our business may be adversely affected by a further economic slowdown in the U.S. or abroad or by an economic recovery in the U.S.

 

The U.S. and much of the world economy are experiencing difficult economic circumstances. We believe the recent economic downturn in the U.S., particularly the continuing high unemployment rate, has contributed to a portion of our recent enrollment growth as an increased number of working learners seek to advance their education to improve job security or reemployment prospects. This effect cannot be quantified. However, to the extent that the economic downturn and the associated unemployment have increased demand for our programs, an improving economy and increased employment may eliminate this effect and reduce such demand as fewer potential students seek to advance their education. This reduction could have a material adverse effect on our business, financial condition, results of operations and cash flows. Conversely, a worsening of economic and employment conditions may reduce the willingness of employers to sponsor educational opportunities for their employees, which could adversely impact our enrollment. In addition, worsening economic and employment conditions could adversely affect the ability or willingness of our former students to repay student loans, which could increase our bad debt expense and our student loan cohort default rate and require increased time, attention and resources to manage these defaults, which could have a material adverse effect on our business. See Risks Related to the Highly Regulated Industry in Which We Operate — Student loan defaults could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business, above.

If we are unable to successfully conclude pending litigation and governmental inquiries, our business, financial condition, results of operations and cash flows could be adversely affected.

 

We, certain of our subsidiaries, and certain of our current and former directors and executive officers have been named as defendants in various lawsuits.

 

In August 2008, the U.S. District Court for the District Court of Arizona vacated a judgment for damages against us in a securities class action lawsuit, and the plaintiffs appealed to the Ninth Circuit Court of Appeals. In connection with this judgment, we initially estimated in the second quarter of fiscal year 2008 that our loss would range from $120 million to $216 million and we recorded a charge for estimated damages at the midpoint of $168 million, which we reversed in the fourth quarter of fiscal year 2008 when the trial court vacated the judgment. On June 23, 2010, the Court of Appeals reversed the District Court’s ruling in our favor and ordered the District Court to enter judgment against us in accordance with the jury verdict. We intend to petition the U.S. Supreme Court for review of the Court of Appeals’ decision, but historically very few of such petitions are granted. While we are seeking Supreme Court review, the judgment in the District Court is stayed. If our petition to the Supreme Court is not granted and we return to the District Court for post-trial proceedings on class claims and an award of damages, we believe that the actual amount of damages will not be known until all court proceedings have been completed and eligible members of the class present the necessary information and documents to receive payment of the award. We have estimated for financial reporting purposes, using statistically valid models and a 60% confidence interval, that the damages could range from $127.2 million to $228.0 million, which includes our estimates of (a) damages payable to the plaintiff class; (b) the amount we may be required to reimburse our insurance carriers for amounts advanced for defense costs; and (c) future defense costs. Accordingly, in the third quarter of fiscal year 2010, we recorded a charge for estimated damages in the amount of $132.6 million, which, together with the existing reserve of $44.5 million recorded in the second quarter of fiscal year 2010, represents the mid-point of the estimated range of damages payable to the plaintiffs, plus the other estimated costs and expenses. During the fourth quarter of fiscal year 2010, we recorded a $0.9 million charge for incremental post-judgment interest.

 

On August 16, 2010, a securities class action complaint was filed in the U.S. District Court for the District of Arizona by Douglas N. Gaer naming us, John G. Sperling, Gregory W. Cappelli, Charles B. Edelstein, Joseph L. D’Amico, Brian L. Swartz and Gregory J. Iverson as defendants for allegedly making false and misleading statements regarding our business practices and prospects for growth. That complaint asserts a putative class period stemming from December 7, 2009 to August 3, 2010. A substantially similar complaint was also filed in the same court by John T. Fitch on September 23, 2010 making similar allegations against the same defendants for the same purported class period. Finally, on October 4, 2010, another purported securities class action complaint was filed in the same court by Robert Roth against the same defendants as well as Brian Mueller, Terri C. Bishop and Peter V. Sperling based upon the same general set of allegations, but with a defined class period of February 12, 2007 to August 3, 2010. The complaints allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. On October 15, 2010, three additional parties filed motions to consolidate the related actions and be appointed the lead plaintiff. Two of the proposed lead plaintiffs identify themselves as the “Apollo Institutional Investors Group” and the first consists of the Oregon Public Employees Retirement Fund, the Mineworkers’ Pension Scheme, and Amalgamated Bank. The second “Apollo Institutional Investors Group” consists of IBEW Local 640 and Arizona Chapter NECA Pension Trust Fund and the City of Birmingham Retirement and Relief System. The third proposed lead plaintiff is the Puerto Rico Government Employees and Judiciary Retirement System Administration. We have not yet responded to these complaints and anticipate that pursuant to the Private Securities Litigation Reform Act of 1995, the Court will appoint a lead plaintiff and lead counsel pursuant to the provisions of that law, and eventually a consolidated amended complaint will be filed.

 

We are also subject to various other lawsuits, investigations and claims, covering a range of matters, including, but not limited to, claims involving shareholders and employment matters. Refer to Note 19, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data, which is incorporated herein by reference, for further discussion of pending litigation and other proceedings. In

addition, changes in our business and pending actions by regulators and HLC may increase our risk of claims by shareholders.

 

We cannot predict the ultimate outcome of these matters and expect to incur significant defense costs and other expenses in connection with them. Such costs and expenses could have a material adverse effect on our business, financial condition, results of operations and cash flows and the market price of our common stock. We may be required to pay substantial damages or settlement costs in excess of our insurance coverage related to these matters, or may be required to pay substantial fines or penalties, any of which could have a further material adverse effect on our business, financial condition, results of operations and cash flows. An adverse termination in any of these matters could also materially and adversely affect our licenses, accreditation, and eligibility to participate in Title IV programs.

 

We are subject to the oversight of the Securities and Exchange Commission and other regulatory agencies, and investigations by these agencies could divert management’s focus and have a material adverse impact on our reputation and financial condition.

 

As a result of this government regulation and oversight, we may be subject to legal and administrative proceedings. For example, in October 2009, we received notification from the Enforcement Division of the Securities and Exchange Commission indicating that it had commenced an informal inquiry into our revenue recognition practices. Based on the information and documents that the Securities and Exchange Commission has requested from us and/or from our auditors, which relate to our revenue recognition practices and other matters, including our policies and practices relating to student refunds, the return of Title IV funds to lenders and bad debt reserves, the eventual scope, duration and outcome of the current inquiry cannot be determined at this time. However, we have devoted substantial time and incurred substantial legal and other expenses in connection with this inquiry and we may have to devote additional time and incur additional expenses in the future. The costs of responding to, and the publicity surrounding investigations or enforcement actions by the Securities and Exchange Commission or the Department of Justice, even if ultimately resolved favorably for us, could have a material adverse impact on our business, financial condition, results of operations and cash flows.

 

Our financial performance depends on our ability to continue to develop awareness among, and enroll and retain students; recent adverse publicity may negatively impact demand for our programs.

 

Building awareness of our schools and the programs we offer is critical to our ability to attract prospective students. If our schools are unable to successfully market and advertise their educational programs, our schools’ ability to attract and enroll prospective students in such programs could be adversely affected. It is also critical to our success that we convert these prospective students to enrolled students in a cost-effective manner and that these enrolled students remain active in our programs.

 

Recently, the proprietary postsecondary education sector has been, and it remains, under intense regulatory and other scrutiny which has led to media attention that in many instances has portrayed the sector in an unflattering light. This negative media attention may cause some prospective students to choose educational alternatives outside of the proprietary sector or may cause them to choose proprietary alternatives other than University of Phoenix, either of which could negatively impact our new enrollments.

 

Some of the additional factors that could prevent us from successfully enrolling and retaining students in our programs include:

 

 

 

If one or more of these factors reduces demand for our programs, our enrollment could be negatively affected or our costs associated with each new enrollment could increase, or both, either of which could have a material adverse impact on our business, financial condition, results of operations and cash flows.

 

If the proportion of our students who enroll with, and accumulate, fewer than 24 credits continues to increase, we may experience increased cost and reduced profitability.

 

In recent years, a substantial proportion of our overall growth has arisen from the increase in associate’s degree students enrolled in University of Phoenix. As a result of this, the proportion of our Degreed Enrollment composed of associate’s degree students has increased and may continue to increase in the future. We have experienced certain adverse effects from this shift, such as an increase in our student loan cohort default rate. Although the proportion of our Degreed Enrollment composed of associate’s degree students decreased in the fourth quarter of fiscal year 2010, Degreed Enrollment included an increased number of bachelor’s degree students with fewer than 24 incoming credits, which may contribute to a continued increase in our student loan cohort default rate. If the proportion of students with fewer than 24 incoming credits continues to increase in the future, we may experience additional consequences, such as higher cost per New Degreed Enrollment, lower retention rates and/or higher student services costs, an increase in the percentage of our revenue derived from Title IV funding under the 90/10 Rule, more limited ability to implement tuition price increases and other effects that may adversely affect our business, financial condition, results of operations and cash flows.

 

System disruptions and security threats to our computer networks could have a material adverse effect on our business.

 

The performance and reliability of our computer network infrastructure at our schools, including our online programs, is critical to our operations, reputation and ability to attract and retain students. Any computer system error or failure, regardless of cause, could result in outages that disrupt our online and on-ground operations. We have only limited redundancies in our core computer and network infrastructure, which is concentrated in a single geographic area. Because we do not have real-time comprehensive redundancies in our IT infrastructure, a catastrophic failure or unavailability for any reason of our principal data center may require us to replicate the function of this data center at our existing remote data facility or elsewhere. An event such as this may require equipping and restoring activities that could take up to several weeks to complete. The disruption from such an event could significantly impact our operations and have a material adverse effect on our business, financial condition, results of operations and cash flows, and could adversely affect our compliance with applicable regulations and accrediting body standards.

 

In addition, we face the threat to our computer systems of unauthorized access, computer hackers, computer viruses, malicious code, organized cyber attacks and other security problems and system disruptions. We have devoted and will continue to devote significant resources to the security of our computer systems, but they may still be vulnerable to these threats. A user who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in operations. As a result, we may be required to expend significant resources to protect against the threat of these system disruptions and security breaches or to alleviate problems caused by these disruptions and breaches. Any of these events could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We may not be able to successfully identify, pursue or integrate acquisitions; acquisitions may result in additional debt or dilution to our shareholders.

 

As part of our growth strategy, we are actively considering acquisition opportunities in the U.S. and worldwide. We have acquired and expect to acquire additional proprietary educational institutions that complement our strategic direction, some of which could be material. Any acquisition involves significant risks and uncertainties, including:

 

 

 

 

Acquisitions are inherently risky. We cannot be certain that our previous or future acquisitions will be successful and will not materially adversely affect our business, financial condition, results of operations and cash flows. We may not be able to identify suitable acquisition opportunities, acquire institutions on favorable terms, or successfully integrate or profitably operate acquired institutions. Future transactions may involve use of our cash resources, issuance of equity or debt securities, incurrence of other forms of debt or a significant increase in our financial leverage, which could adversely affect our business, financial condition, results of operations and cash flows, especially if the cash flows associated with any acquisition are not sufficient to cover the additional debt service. If we issue equity securities as consideration in an acquisition, current shareholders’ percentage ownership and earnings per share may be diluted. In addition, our acquisition of an educational institution could be considered a change in ownership and control of the acquired institution under applicable regulatory standards. For such an acquisition in the U.S., we may need approval from the U.S. Department of Education and applicable state agencies and accrediting agencies and possibly other regulatory bodies. Our inability to obtain such approvals with respect to a completed acquisition could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Our future operating results and the market price of our common stock could be materially adversely affected if we are required to further write down the carrying value of goodwill and/or other intangible assets associated with any of our reporting units in the future.

 

We review our goodwill and other indefinite-lived intangible asset balances for impairment on at least an annual basis through the application of a fair-value-based test. In assessing the fair value of our reporting

units, we rely primarily on using a discounted cash flow analysis which includes our estimates about the future cash flows of our reporting units that are based on assumptions consistent with our plans to manage the underlying businesses. Other factors we consider include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner or use of the acquired assets or the overall business strategy, and significant negative industry or economic trends. We recorded the following goodwill and other intangible asset impairments during fiscal year 2010:

 

 

For further discussion of these items, see Note 9, Goodwill and Intangible Assets, in Part II, Item 8, Financial Statements and Supplementary Data.

 

If our estimates or related assumptions change in the future, we may be required to record additional non-cash impairment charges for these assets. In the future, if we are required to significantly write down the carrying value of goodwill and/or other intangible assets associated with any of our reporting units, our operating results and the market price of our common stock may be materially adversely affected.

 

If we do not maintain existing, and develop additional, relationships with employers, our future growth may be impaired.

 

We currently have relationships with large employers to provide their employees with the opportunity to obtain degrees through us while continuing their employment. These relationships are an important part of our strategy as they provide us with a steady source of potential working learners for particular programs and also serve to increase our reputation among high-profile employers. In addition, these programs have a beneficial impact on our 90/10 Rule percentage calculation by reducing the proportion of our cash-basis revenues attributable to Title IV funds. If we are unable to develop new relationships, or if our existing relationships deteriorate or end, our efforts to seek these sources of potential working learners may be impaired, and this could materially and adversely affect our business, financial condition, results of operations and cash flows.

 

Budget constraints in states that provide state financial aid to our students could reduce the amount of such financial aid that is available to our students, which could reduce our enrollment and adversely affect our 90/10 Rule calculation.

 

Many states are experiencing severe budget deficits and constraints. Some of these states have reduced or eliminated various student financial assistance programs, and additional states may do so in the future. If our students who receive this type of assistance cannot secure alternate sources of funding, they may be forced to withdraw or reduce the rate at which they seek to complete their education. Other students who would otherwise have been eligible for state financial assistance may not be able to enroll without such aid. This reduced funding could decrease our enrollment and adversely affect our business, financial condition, results of operations and cash flows.

 

In addition, the reduction or elimination of these non-Title IV sources of student funding may adversely affect our 90/10 Rule calculation by increasing the proportion of the affected students’ funding needs satisfied by Title IV programs. This could negatively impact or increase the cost of our compliance with the 90/10 Rule, as discussed under the Risk Factor, “Our schools and programs would lose their eligibility to participate in federal student financial aid programs if the percentage of our revenues derived from those programs is too high,” above.

Our principal credit agreement limits our ability to take various actions.

 

Our principal credit agreement limits our ability to take various actions, including paying dividends, repurchasing shares and acquiring and disposing of assets or businesses. Accordingly, we may be restricted from taking actions that management believes would be desirable and in the best interests of us and our shareholders. Our principal credit agreement also requires us to satisfy specified financial and non-financial covenants, including covenants relating to regulatory compliance. A breach of any covenants contained in our credit agreement would result in an event of default under the agreement and allow the lenders to pursue various remedies, including accelerating the repayment of any indebtedness outstanding under the agreement, any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

Our financial performance depends, in part, on our ability to keep pace with changing market needs and technology; if we fail to keep pace or fail in implementing or adapting to new technologies, our business may be adversely affected.

 

Increasingly, prospective employers of students who graduate from our schools demand that their new employees possess appropriate technological skills and also appropriate “soft” skills, such as communication, critical thinking and teamwork skills. These skills can evolve rapidly in a changing economic and technological environment. Accordingly, it is important for our schools’ educational programs to evolve in response to these economic and technological changes. The expansion of existing programs and the development of new programs may not be accepted by current or prospective students or the employers of our graduates. Even if our schools are able to develop acceptable new programs, our schools may not be able to begin offering those new programs as quickly as required by prospective employers or as quickly as our competitors offer similar programs. In addition, we may be unable to obtain specialized accreditations or licensures that may make certain programs desirable to students. To offer a new academic program, we may be required to obtain federal, state and accrediting agency approvals, which may be conditioned or delayed in a manner that could significantly affect our growth plans. In addition, to be eligible for Title IV programs, a new academic program may need to be certified by the U.S. Department of Education. If we are unable to adequately respond to changes in market requirements due to regulatory or financial constraints, unusually rapid technological changes, or other factors, our ability to attract and retain students could be impaired, the rates at which our graduates obtain jobs involving their fields of study could suffer, and our business, financial condition, results of operations and cash flows could be adversely affected.

 

Establishing new academic programs or modifying existing programs requires us to make investments in management and capital expenditures, incur marketing expenses and reallocate other resources. We may have limited experience with the courses in new areas and may need to modify our systems and strategy or enter into arrangements with other educational institutions to provide new programs effectively and profitably. If we are unable to increase the number of students or offer new programs in a cost-effective manner, or are otherwise unable to manage effectively the operations of newly established academic programs, our business, financial condition, results of operations and cash flows could be adversely affected.

 

We have invested and continue to invest significant resources in information technology, which is a key element of our business strategy. Our information technology systems and tools could become impaired or obsolete due to our action or failure to act. For instance, we could install new information technology without accurately assessing its costs or benefits, or we could experience delayed or ineffective implementation of new information technology. Similarly, we could fail to respond in a timely or sufficiently competitive way to future technological developments in our industry. Should our action or failure to act impair or otherwise render our information technology less effective, this could have a material adverse effect on our business, financial condition, results of operations and cash flows.

A failure of our information systems to properly store, process and report relevant data may reduce our management’s effectiveness, interfere with our regulatory compliance and increase our operating expenses.

 

We are heavily dependent on the integrity of our data management systems. If these systems do not effectively collect, store, process and report relevant data for the operation of our business, whether due to equipment malfunction or constraints, software deficiencies, or human error, our ability to effectively plan, forecast and execute our business plan and comply with applicable laws and regulations, including the Higher Education Act, as reauthorized, and the regulations thereunder, will be impaired, perhaps materially. Any such impairment could materially and adversely affect our financial condition, results of operations, and cash flows.

 

The personal information that we collect may be vulnerable to breach, theft or loss that could adversely affect our reputation and operations.

 

Possession and use of personal information in our operations subjects us to risks and costs that could harm our business. Our educational institutions collect, use and retain large amounts of personal information regarding our students and their families, including social security numbers, tax return information, personal and family financial data and credit card numbers. We also collect and maintain personal information of our employees in the ordinary course of our business. Some of this personal information is held and managed by certain of our vendors. Although we use security and business controls to limit access and use of personal information, a third party may be able to circumvent those security and business controls, which could result in a breach of student or employee privacy. In addition, errors in the storage, use or transmission of personal information could result in a breach of student or employee privacy, and the increased availability and use of portable data devices by our employees and students increases the risk of unintentional disclosure of personal information. Possession and use of personal information in our operations also subjects us to legislative and regulatory burdens that could require notification of data breaches and restrict our use of personal information. We cannot assure you that a breach, loss or theft of personal information will not occur. A breach, theft or loss of personal information regarding our students and their families or our employees that is held by us or our vendors could have a material adverse effect on our reputation and results of operations and result in liability under state and federal privacy statutes and legal actions by state attorneys, general and private litigants, and any of which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

We face intense competition in the postsecondary education market from both public and private educational institutions, which could adversely affect our business.

 

Postsecondary education in our existing and new market areas is highly competitive. We compete with traditional public and private two-year and four-year colleges, other proprietary schools and alternatives to higher education. Some of our competitors, both public and private, have greater financial and other resources than we have. Our competitors, both public and private, may offer programs similar to ours at a lower tuition level as a result of government subsidies, government and foundation grants, tax-deductible contributions and other financial resources not available to proprietary institutions. In addition, many of our competitors have begun to offer distance learning and other online education programs. As the online and distance learning segment of the postsecondary education market matures, the intensity of the competition we face will increase further. This intense competition could adversely affect our business, financial condition, results of operations and cash flows.

 

Our expansion into new markets outside the U.S. subjects us to risks inherent in international operations.

 

As part of our growth strategy, through Apollo Global, Inc., our consolidated majority-owned subsidiary, we have acquired additional universities outside the U.S. and we intend to actively pursue further acquisitions. To the extent that we make such acquisitions, we will face risks that are inherent in international operations, including:

 

 

 

We may experience movements in foreign currency exchange rates which could adversely affect our operating results.

 

We report revenues, costs and earnings in U.S. dollars. Exchange rates between the U.S. dollar and the local currency in the countries where we operate are likely to fluctuate from period to period. Because consolidated financial results are reported in U.S. dollars, we are subject to the risk of translation losses for reporting purposes. When the U.S. dollar appreciates against the applicable local currency in any reporting period, our consolidated operating results are adversely impacted due to translation.

 

As we continue to expand our international operations, we will conduct more transactions in currencies other than the U.S. Dollar. To the extent that foreign revenue and expense transactions are not denominated in the local currency, we are also subject to the risk of transaction losses. Given the volatility of exchange rates, there is no assurance that we will be able to effectively manage currency transaction and/or translation risks. Fluctuations in foreign currency exchange rates could have a material adverse affect on our business, financial condition, results of operations and cash flows.

 

We rely on proprietary rights and intellectual property that may not be adequately protected under current laws, and we encounter disputes from time to time relating to our use of intellectual property.

 

Our success depends in part on our ability to protect our proprietary rights and intellectual property. We rely on a combination of copyrights, trademarks, trade secrets, patents, domain names and contractual agreements to protect our proprietary rights. For example, we rely on trademark protection in the U.S. and various foreign jurisdictions to protect our rights to various marks as well as distinctive logos and other marks associated with our services. We also rely on agreements under which we obtain intellectual property to own or license rights to use intellectual property developed by faculty members, content experts and other third-parties. We cannot assure you that these measures are adequate, that we have secured, or will be able to secure, appropriate permissions or protections for all of the intellectual property rights we use or claim rights to in the U.S. or various foreign jurisdictions, or that third parties will not terminate our license rights or infringe upon or otherwise violate our intellectual property rights or the intellectual property rights of others. Despite our efforts to protect these rights, unauthorized third parties may attempt to use, duplicate or copy the proprietary aspects of our student recruitment and educational delivery methods and systems, curricula, online resource material or other content. Our management’s attention may be diverted by these attempts and we may need to use funds in litigation to protect our proprietary rights against any infringement or violation, which could have a material adverse affect on our business, financial condition, results of operations and cash flows.

We may become party to disputes from time to time over rights and obligations concerning intellectual property, and we may not prevail in these disputes. For example, third parties may allege that we have infringed upon or not obtained sufficient rights in the technologies used in our educational delivery systems, the content of our courses or other training materials or in our ownership or uses of other intellectual property claimed by that third party. Some third party intellectual property rights may prove to be extremely broad, and it may not be possible for us to conduct our operations in such a way as to avoid violating those intellectual property rights. Any such intellectual property claim could subject us to costly litigation and impose a significant strain on our financial resources and management personnel regardless of whether such claim has merit. Our various liability insurance coverages, if any, may not cover potential claims of this type adequately or at all, and we may be required to alter the design and operation of our systems or the content of our courses or pay monetary damages or license fees to third parties, which could have a material adverse affect on our business, financial condition, results of operations and cash flows.

 

We may incur liability for the unauthorized duplication, distribution or other use of materials posted online.

 

In some instances, our employees, including faculty members, or our students may post various articles or other third-party content online in class discussion boards or in other venues. We may incur liability to third parties for the unauthorized duplication, distribution or other use of this material. Any such claims could subject us to costly litigation and impose a significant strain on our financial resources and management personnel regardless of whether the claims have merit. Our various liability insurance coverages, if any, may not cover potential claims of this type adequately or at all, and we may be required to alter or cease our uses of such material (which may include changing or removing content from our courses) or pay monetary damages, which could have a material adverse affect on our business, financial condition, results of operations and cash flows.

 

We may have unanticipated tax liabilities that could adversely impact our results of operations and financial condition.

 

We are subject to multiple types of taxes in the U.S., United Kingdom and various other foreign jurisdictions. The determination of our worldwide provision for income taxes and other tax accruals involves various judgments, and therefore the ultimate tax determination is subject to uncertainty. In addition, changes in tax laws, regulations, or rules may adversely affect our future reported financial results, may impact the way in which we conduct our business, or may increase the risk of audit by the Internal Revenue Service or other tax authority.

 

We are currently subject to an Internal Revenue Service audit relating to our U.S. federal income tax returns for our fiscal years 2006, 2007 and 2008, which was commenced in fiscal year 2009. In addition to this audit, we are subject to numerous ongoing audits by state, local and foreign tax authorities. Although we believe our tax accruals are reasonable, the final determination of tax audits in the U.S. or abroad and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our business, financial condition, results of operations and cash flows.

 

In addition, an increasing number of states are adopting new laws or changing their interpretation of existing laws regarding the apportionment of service revenues for corporate income tax purposes in a manner that could result in a larger proportion of our income being taxed by the states into which we sell services. These legislative and administrative changes could result in a portion of our income being taxed in both Arizona and other states. The overall scope of this issue will depend on the manner in which the Arizona Department of Revenue interprets applicable Arizona tax law and on whether certain adverse interpretations are upheld. The magnitude of this possible double taxation could continue to increase as more states change the manner in which they tax income from services. If we experience double taxation by states for a substantial portion of our income, it could have a material adverse effect on our business, financial condition, results of operations and cash flows.

 

 

None.

 

As of August 31, 2010, we utilized 472 facilities, the majority of which were leased. As of August 31, 2010, we were obligated to lease approximately 8.4 million square feet and owned approximately 1.2 million square feet, as follows:

 

 

 

 

Dual purpose space includes office and classroom facilities. Leases generally range from five to ten years with one to two renewal options for extended terms. We also lease space from time to time on a short-term basis in order to provide specific courses or programs. We evaluate current utilization of the educational facilities and projected enrollment growth to determine facility needs.

 

In addition to the above properties, we executed a lease agreement in fiscal year 2009 for two properties that are being constructed for which we do not have the right to control the use of the property under lease at August 31, 2010. When completed, the properties will have approximately 439,000 of aggregate square footage and we expect to begin using the properties in fiscal year 2011.

 

We are subject to various claims and contingencies which are in the scope of ordinary and routine litigation incidental to our business, including those related to regulation, business transactions, employee-related matters and taxes, among others. While the outcomes of these matters are uncertain, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

 

When we become aware of a claim or potential claim, the likelihood of any loss or exposure is assessed. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, we record a

liability for the loss. The liability recorded includes probable and estimable legal costs associated with the claim or potential claim. If the loss is not probable or the amount of the loss cannot be reasonably estimated, we disclose the claim if the likelihood of a potential loss is reasonably possible and the amount is material. For matters where no loss contingency is recorded, our policy is to expense legal fees as incurred.

 

A description of pending litigation, settlements, and other proceedings that are outside the scope of ordinary and routine litigation incidental to our business is provided under Note 19, Commitments and Contingencies, Pending Litigation and Settlements and Regulatory and Other Legal Matters, in Item 8, Financial Statements and Supplementary Data, which is incorporated herein by reference.

 

 

Market Information

 

Our Apollo Group Class A common stock trades on the NASDAQ Global Select Market under the symbol “APOL.” The holders of our Apollo Group Class A common stock are not entitled to any voting rights.

 

There is no established public trading market for our Apollo Group Class B common stock and all shares of our Apollo Group Class B common stock are beneficially owned by affiliates.

 

The table below sets forth the high and low bid share prices for our Apollo Group Class A common stock as reported by the NASDAQ Global Select Market.

 

 

Holders

 

As of August 31, 2010, there were approximately 259 registered holders of record of Apollo Class A common stock and four registered holders of record of Apollo Class B common stock. A substantially greater number of holders of Apollo Group Class A common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.

 

Dividends

 

Although we are permitted to pay dividends on our Apollo Class A and Apollo Class B common stock, subject to the satisfaction of applicable financial covenants in our principal credit facility, we have never paid cash dividends on our common stock. Dividends are payable at the discretion of the Board of Directors, and the Articles of Incorporation treat the declaration of dividends on the Apollo Class A and Apollo Class B common stock in an identical manner as follows: holders of our Apollo Class A common stock and Apollo Class B common stock are entitled to receive cash dividends, if and to the extent declared by the Board of Directors, payable to the holders of

either class or both classes of common stock in equal or unequal per share amounts, at the discretion of the Board of Directors. We have no current plan to pay dividends in the foreseeable future. The decision of our Board of Directors to pay future dividends will depend on general business conditions, the effect of a dividend payment on our financial condition and other factors the Board of Directors may consider relevant.

 

Recent Sales of Unregistered Securities

 

None.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The information required by Item 201(d) of Regulation S-K is provided under Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, “Equity Compensation Plan Information,” which is incorporated herein by reference.

 

Purchases of Equity Securities

 

Our Board of Directors has authorized programs to repurchase shares of Apollo Class A common stock, from time to time depending on market conditions and other considerations. The share repurchases under these programs for the three months ended August 31, 2010 have been as follows:

 

 

 

 

On February 18, 2010, our Board of Directors authorized a $500 million increase in the amount available under our share repurchase program up to an aggregate amount of $1 billion of Apollo Class A common stock. There is no expiration date on the repurchase authorizations and repurchases occur at our discretion. The amount and timing of future share repurchases, if any, will be made as market and business conditions warrant. Repurchases may be made on the open market or in privately negotiated transactions, pursuant to the applicable Securities and Exchange Commission rules, and may include repurchases pursuant to Securities and Exchange Commission Rule 10b5-1 nondiscretionary trading programs.

Company Stock Performance

 

The following graph compares the cumulative 5-year total return attained by shareholders on Apollo Class A common stock relative to the cumulative total returns of the S&P 500 index and a customized peer group of five companies that includes: Career Education Corp., Corinthian Colleges Inc., DeVry Inc., ITT Educational Services Inc., and Strayer Education Inc. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock, in the index, and in the peer group on August 31, 2005, and its relative performance is tracked through August 31, 2010.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Apollo Group, Inc.,
The S&P 500 Index and a Peer Group

 

 

*$100 invested on 8/31/05 in stock and index-including reinvestment of dividends.

Fiscal year ending August 31.

Source: Standard & Poor’s.

 

 

The information contained in the performance graph shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission nor shall such information be deemed incorporated by reference into any future filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filing.

 

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

 

The following selected consolidated financial data is qualified by reference to and should be read in conjunction with Item 8, Financial Statements and Supplementary Data, and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, to fully understand factors that may affect the comparability of the information presented below. The consolidated statements of income data for fiscal years 2010, 2009 and 2008, and the consolidated balance sheets data as of August 31, 2010 and 2009, were derived from the audited consolidated financial statements, included herein.

 

We have made certain reclassifications to the financial data presented below associated with our presentation of Insight Schools as discontinued operations, and our adoption of Financial Accounting Standards Board Statement of Financial Accounting Standards No. 160, “Non-controlling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51” (codified in ASC 810, “Consolidation”) on September 1, 2009. For further discussion of these reclassifications, refer to Note 2, Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data.