XNAS:APOL Apollo Group Inc Class A Annual Report 10-K Filing - 8/31/2012
Effective Date 8/31/2012
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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 29, 2012 (last business day of the registrant’s most recently completed second fiscal quarter), was approximately $4.6 billion. The number of shares outstanding for each of the registrant’s classes of common stock as of October 12, 2012 is as follows:
DOCUMENTS INCORPORATED BY REFERENCE Portions of the Information Statement for the 2013 Annual Meeting of Class B Shareholders (Part III) APOLLO GROUP, INC. AND SUBSIDIARIES FORM 10-K INDEX
2 Special Note Regarding Forward-Looking Statements 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. 3 Part I Item 1 – Business Overview Apollo Group, Inc. (“the Company,” “Apollo Group,” “Apollo,” “APOL,” “we,” “us” or “our”) is one of the world’s largest private education providers and has been an educational provider for approximately 40 years. We offer innovative and distinctive educational programs and services both online and on-campus at the undergraduate, master’s and doctoral levels principally through the following wholly-owned educational subsidiaries:
On September 12, 2011, we acquired all of the outstanding stock of Carnegie Learning, Inc. (“Carnegie Learning”), a publisher of research-based math curricula and adaptive learning software. The acquisition allows us to accelerate our efforts to incorporate adaptive learning into our academic platform and to provide tools which we believe will help raise student achievement levels, and support improved retention and graduation rates at University of Phoenix. Refer to Note 5, Acquisitions, in Item 8, Financial Statements and Supplementary Data. In addition, we are developing a business, Apollo Education Services, through which we intend to begin providing a variety of educational delivery services to other higher education institutions. In addition to these wholly-owned educational subsidiaries, we formed a joint venture with The Carlyle Group (“Carlyle”) in October 2007, called Apollo Global, Inc. (“Apollo Global”), to pursue investments primarily in the international education services industry. As of August 31, 2012, Apollo Group and Carlyle owned 85.6% and 14.4%, respectively. We offer educational programs and services through the following wholly-owned subsidiaries of Apollo Global:
On December 3, 2011, Apollo Global entered into an agreement with HT Media Limited, an Indian media company, to participate in a start-up, 50:50 joint venture intended to develop and provide educational services and programs in India. HT Media Limited, which is based in New Delhi, India, publishes the Hindustan Times, Hindustan and Mint newspapers, among other business activities. Subsequent to August 31, 2012, we purchased Carlyle’s remaining ownership interest in Apollo Global for $42.5 million cash, plus a contingent payment based on a portion of Apollo Global’s operating results through the fiscal years ending August 31, 2017. This transaction will be accounted for as an equity transaction resulting in the removal of Carlyle’s noncontrolling interest from our Consolidated Balance Sheets. Our educational institutions are as follows: 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 throughout the United States, including the Commonwealth of Puerto Rico. University of Phoenix’s online programs are designed to provide consistency 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 represented 91% of our total consolidated net revenue and more than 100% of our operating income in fiscal year 2012. IPD. IPD provides program development, administration and management consulting services to private colleges and universities (“IPD Client Institutions”) to establish or expand their programs for working learners. These services typically include degree program design, curriculum development, market research, student admissions services, 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. 4 BPP. BPP is headquartered in London, England and offers professional training through schools located in the U.K., a European network of BPP offices and the sale of books and other publications globally. BPP University College, comprised of BPP Law School and BPP Business School, 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 since 1976 to be awarded the title of “University College” by the U.K. During the fourth quarter of fiscal year 2012, BPP completed the sale of its subsidiary, Mander Portman Woodward (“MPW”), a U.K.-based secondary education institution, for £54.8 million (equivalent to $85.3 million as of the date of sale). Refer to Note 4, Discontinued Operations, in Item 8, Financial Statements and Supplementary Data. 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. 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 five campuses throughout Mexico. UNIACC. UNIACC is an arts and communications university which offers bachelor’s and master’s degree programs at campuses in Chile and online. Net Revenue The following table presents net revenue for fiscal years 2012, 2011 and 2010 for each of our reportable segments:
Refer to Note 18, 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. Our operations are generally subject to seasonal trends. We experience, and expect to continue to experience, fluctuations in our results of operations as a result of seasonal variations in the level of our institutions’ 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. 5 University of Phoenix Enrollment The following table details University of Phoenix enrollment for the indicated periods:
(1) Refer to Students below for a description of the manner in which we calculate Degreed Enrollment and New Degreed Enrollment. (2) Represents the average of Degreed Enrollment for the quarters ended August 31, 2011, November 30, 2011, February 29, 2012, May 31, 2012 and August 31, 2012. (3) Represents the average of Degreed Enrollment for the quarters ended August 31, 2010, November 30, 2010, February 28, 2011, May 31, 2011 and August 31, 2011. (4) Represents the average of Degreed Enrollment for the quarters ended August 31, 2009, November 30, 2009, February 28, 2010, May 31, 2010 and August 31, 2010. (5) Aggregate New Degreed Enrollment represents the sum of the four quarters New Degreed Enrollment in the respective fiscal years. General 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 2012, 2011, 2010, 2009 and 2008 relate to fiscal years 2012, 2011, 2010, 2009 and 2008, respectively. Strategy Our goal is to strengthen our position as a leading provider of high quality accessible education. Our principal focus is to provide innovative, high quality and impactful educational products and services in order for our students to maximize the benefit from their educational investment. We also look to engage our employer partners by developing programs that prepare our graduates with the skills and competencies employers need. We believe that providing a superior student experience, positioning our students to attain desired academic and life outcomes, and building strong employer connections are keys to building value for our shareholders. We intend to pursue our goal in a manner that is consistent with our core organizational values: have a passion for learning; embrace innovation; improve society; act with integrity; treat others as we would like to be treated; and empower excellence. These values provide the foundation for everything we do as a business. The key themes of our strategic plan are as follows:
6 To implement our strategy, we are working on a number of important initiatives including:
Industry Background Domestic Postsecondary Education The non-traditional education sector is a significant and growing component of the domestic postsecondary degree-granting education industry, which was estimated to be a $460 billion industry in 2010, according to the Digest of Education Statistics published in 2012 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). We believe that the proportion of today’s students who are non-traditional remains approximately the same. 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, due to the increasingly knowledge-based economy in the U.S. Many non-traditional students, who we also 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 an increasing proportion of colleges and universities are addressing the needs of working learners as discussed in Competition below, many traditional universities and institutions face the following challenges in effectively addressing the needs of working learners:
International Education 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. In addition, we believe that postsecondary education outside of the U.S. is experiencing governmental funding constraints that create opportunities for a broader private sector role. 7 We believe that the following key trends are driving the growth in private education worldwide:
Our Programs Our approximately 40 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 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 counseling, health care, sports and entertainment. University of Phoenix has campus locations and learning centers throughout the United States, including the Commonwealth of 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. All 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 online class materials are delivered electronically. 8 Components of our teaching/learning models at University of Phoenix for both online and on-campus classes include:
Our associate’s degree students attend nine week courses, offered in complementary pairs, year-round. Students and instructors interact electronically and non-simultaneously, resulting in increased access for students by allowing them to control the time and place of their participation.
We are actively working on major learning platform enhancements designed to deliver highly personalized learning to students, ease the administrative burden on faculty, improve overall student and faculty experiences, and lead to better educational outcomes. In addition, we are focused on adapting our existing services and developing new services, such as diagnostic tools and individual learning plans, to specifically assist students who have limited or no higher education experience or otherwise may be unprepared to succeed in our academic programs.
9 By achieving programmatic competencies, University of Phoenix graduates are expected to become proficient in the following areas:
We have developed an assessment matrix which outlines specific learning outcomes to measure whether students are meeting University of Phoenix learning goals. Multiple methods have been identified to assess each outcome. In February 2012, University of Phoenix published its fourth Academic Annual Report, which we believe provides a transparent assessment of how well University of Phoenix is serving its students’ needs, and which reflects its commitment to continuous improvement. The Academic Annual Report is available on the University of Phoenix website at www.phoenix.edu. Degree Programs and Services University of Phoenix offers degrees in the following program areas:
University of Phoenix and certain of our other institutions, including CFFP, also provide professional development education. 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. Instructional models include face-to-face, online and blended learning (simultaneous and non-simultaneous) methodologies. Our international operations faculty members consist of both full-time and part-time professors and our recruitment standards and processes are appropriate for the respective markets in which we operate. Degree Programs and Services Our international operations offer bachelor’s, master’s and doctoral degrees in a variety of degree programs and related areas of specialization, including degrees from BPP University College, which is comprised of BPP Law School and BPP Business School. 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. Our international institutions typically follow a course development process in which faculty members who are subject matter experts work with instructional designers to develop curriculum materials based on learning objectives provided by school academic officers. Curricula are tailored to the relevant standards applicable in each local market within which we operate. 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 10 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 work requirements vary by program, and not all programs have them. In addition to the above requirements, we require substantially all prospective University of Phoenix associate’s and bachelor’s students with fewer than 24 incoming credits to participate in University Orientation. This program is a free, three-week orientation designed to help inexperienced prospective students better understand the time commitments and 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 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 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 a quarter is composed of:
11 The following table details University of Phoenix Degreed Enrollment by degree type and as a percentage of total for the indicated periods:
The following chart details quarterly Degreed Enrollment by degree type for the respective periods:  University of Phoenix New Degreed Enrollment University of Phoenix New Degreed Enrollment for each quarter is composed of:
12 The following table details University of Phoenix New Degreed Enrollment by degree type and as a percentage of total for the indicated periods:
The following chart details quarterly New Degreed Enrollment by degree type for the respective periods:  13 University of Phoenix Student Demographics We have a diverse student population. The following tables provide the demographic characteristics of the students attending University of Phoenix courses in fiscal years 2012, 2011 and 2010:
(1) Based on students included in aggregate New Degreed Enrollment, which represents the sum of the four quarters New Degreed Enrollment in the respective fiscal years. (2) Based on voluntary reporting by students included in New Degreed Enrollment. For 2012, 2011 and 2010, 71%, 68% and 66%, respectively, of the students attending University of Phoenix courses provided this information. 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 enhancing our brand perception and utilizing our different communication channels to attract students who are more likely to persist in our programs. We are realigning our marketing efforts to better educate students about the options they have in higher learning and convey our value proposition and offerings to connect education to careers. Brand Brand advertising is intended to increase potential students’ understanding of our academic quality, 21st century innovative postsecondary education, commitment to service, academic outcomes and academic community achievements. 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 Many prospective students identify 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. We reduced our use of third-party operated sites and increased our use of branded media channels because we believe this approach will help us to better identify students who are more likely to persist in our 14 educational programs. Our website, phoenix.edu, provides prospective students with relevant information about University of Phoenix and will continue to evolve with in-depth programmatic and education to careers content. We intend to continue to employ the unique qualities of the Internet and its emerging technologies to enhance our brand 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, mobile phone applications and emerging video advertising. Sponsorships, Corporate Social Responsibility and Other We build our presence in communities through sponsorships, advertising and event marketing to support specific activities, including local and national career events, academic lecture series, workshops and symposiums on various current topics of interest and through our corporate social responsibility outreach program. 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. Relationships with Employers and Community Colleges We work closely with businesses and governmental agencies to meet their specific educational needs and have the ability to modify our existing programs or, in some cases, develop customized programs. These programs can be offered on-site at the employers’ offices or at select military bases. Our Workforce Solutions team is responsible for establishing relationships with employers and community colleges that we believe will lead to increased enrollment from those sources.
BPP enrolls the majority of its students through relationships with employers. The Phoenix Prep Center The Phoenix Prep Center serves prospective students by providing online tools, information, and resources that answer key questions and concerns for prospective students, including tests to assess a potential student’s academic abilities and readiness to pursue higher education, a tuition calculator and information on careers. 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 public and private two-year and four-year degree-granting regionally accredited colleges and universities, other proprietary degree-granting regionally accredited schools and alternatives to higher education. In addition, we face competition from various emerging nontraditional, credit-bearing and noncredit-bearing education programs, provided by both proprietary and not-for-profit providers, including massive open online courses offered worldwide without charge by traditional educational institutions and other direct-to-consumer education services. Some of our competitors have greater financial and nonfinancial resources than we have and are able to offer programs similar to ours at a lower tuition level for a variety of reasons, including the availability of direct and indirect government subsidies, government and foundation grants, large endowments, tax-deductible contributions and other financial resources not available to proprietary institutions, or by providing fewer student services or larger class sizes. An increasing number of traditional colleges and universities and community colleges are offering distance learning and other online education programs, including programs that are geared towards the needs of working learners. This trend has been accelerated by private companies that provide and/or manage online learning platforms for traditional colleges and community colleges. As the proportion of traditional colleges providing alternative learning modalities increases, we will face increasing competition for students from traditional colleges, including colleges with well-established reputations for excellence. As the online and distance learning segment of the postsecondary education market matures, we believe that the intensity of the competition we face will continue to increase. 15 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:
Employees We believe that our employee relations are satisfactory. As of August 31, 2012, we had the following employees:
(1) Most of our faculty members are adjunct, part-time faculty. Also includes 620 employees included in Non-Faculty who serve in both roles. (2) University of Phoenix faculty includes those faculty who have taught in the last twelve months and are also eligible to be scheduled to teach future courses. Subsequent to August 31, 2012, we adopted a plan to execute a strategic reduction in workforce. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Accreditation and Jurisdictional Authorizations Domestic Postsecondary Accreditation University of Phoenix is regionally accredited, 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. 16 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 regional accreditor 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 accreditor. In August 2010, HLC required University of Phoenix to provide certain information and evidence of compliance with HLC accreditation standards. This followed the August 2010 report published by the U.S. Government Accountability Office of its undercover investigation into the enrollment and recruiting practices of a number of proprietary institutions of higher education, including University of Phoenix. In July 2011, the Special Committee formed to review this matter completed its work, concluding that based on its limited review, it found no apparent evidence of systematic misrepresentations to students or that University of Phoenix’s procedures in the areas of recruiting, financial aid and admissions were significantly inadequate or inappropriate. HLC also stated that there remained significant questions and areas that University of Phoenix should work on improving. HLC is reviewing these areas of concern as part of its previously scheduled comprehensive reaffirmation evaluation visit, which began in March 2012. In September 2012, HLC required University of Phoenix to provide a response to data submitted on University of Phoenix’s 2012 Institutional Annual Report. HLC reviews data from all of its accredited and candidate for accreditation member institutions. HLC identified three non-financial indicators for which it sought additional information:
University of Phoenix expects to respond to HLC in late October 2012. HLC has indicated that it will assign several members of the current team reviewing University of Phoenix’s reaffirmation to evaluate University of Phoenix’s response to the report, and that their evaluation will become an appendix to the review team’s report on University of Phoenix’s reaffirmation. Refer to Part I, 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. 17 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. Prior to July 1, 2011, such authorization was not specifically required for the institution’s students to become eligible for Title IV programs if the institution was exempt from such regulatory authorization, usually based on recognized accreditation. University of Phoenix is specifically authorized to operate and has a physical presence in 37 states, the Commonwealth of Puerto Rico and the District of Columbia. In an additional three states, including California, University of Phoenix has a physical presence and is qualified to operate through June 30, 2013 without specific state regulatory approval due to available state exemptions and annual waivers from the U.S. Department of Education. All regionally accredited institutions, including University of Phoenix, are required to be evaluated separately for authorization to operate in the Commonwealth of 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. 18 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:
(1) Prior to November 2011, UNIACC was accredited by the National Accreditation Commission of Chile. In November 2011, the National Accreditation Commission elected not to renew the accreditation, which therefore lapsed. UNIACC’s appeal of this decision was denied in July 2012. The loss of accreditation from the National Accreditation Commission does not impact UNIACC’s ability to operate or confer degrees and does not directly affect UNIACC’s programmatic accreditations. However, this institutional accreditation is necessary for new UNIACC students to participate in government loan programs and for existing students to begin to participate in such programs for the first time. We expect to pursue re-accreditation with the National Accreditation Commission in fiscal year 2014 when regulations permit. Financial Aid Programs Domestic Postsecondary The principal source of federal student financial aid in the U.S. is Title IV of the Higher Education Act, as it is amended and reauthorized from time to time, and the related regulations adopted by the U.S. Department of Education. We refer to the financial aid programs under this Act as “Title IV” programs. Currently, the Higher Education Act is reauthorized through September 30, 2013. Financial aid under Title IV is awarded annually to eligible students. Some Title IV programs award financial aid 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 each 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 to remain eligible. Refer to Part I, 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, including changes applicable only to proprietary educational institutions, could reduce our enrollment and increase our costs of operation. 19 In addition to Title IV student financial aid, qualifying U.S. active military and veterans and their family members are eligible for federal student aid from various Department of Defense programs, including under the Post-9/11 GI Bill. We refer to the financial aid programs administered by the Department of Defense as “Military Benefit” programs. We collected the substantial majority of our fiscal year 2012 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 2012 total consolidated net revenue and University of Phoenix generated 84% of its cash basis revenue for eligible tuition and fees during fiscal year 2012 from the receipt of Title IV financial aid program funds, as calculated under the 90/10 Rule described below. Student loans currently are the most significant component of Title IV financial aid and are administered through the Federal Direct Loan Program. Annual and aggregate loan limits apply based on the student’s grade level and other factors. Currently, the maximum annual loan amounts range from $3,500 to $12,500 for undergraduate students and $20,500 for graduate students. There are two types of federal student loans: subsidized loans, which are based on the statutory calculation of student need, and unsubsidized loans, which are not based on student need. Neither type of student loan is based on creditworthiness. Students are not responsible for interest on subsidized loans while enrolled in school. Effective for loans first disbursed on or after July 1, 2012, graduate and professional students are no longer eligible for subsidized loans. 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. During fiscal year 2012, student loans (both subsidized and unsubsidized) represented approximately 77% 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 2012, Pell Grants represented approximately 23% of the gross Title IV funds received by University of Phoenix. The eligibility for and maximum amount of Pell Grants have increased over recent years. Since the 2006-2007 award year, the maximum annual Pell Grant award has increased from $4,050 to $5,550 for the 2012-2013 award year. Because the federal Pell Grant program is one of the largest non-defense discretionary spending programs in the federal budget, it is a target for reduction as Congress addresses the U.S. budget deficits. A reduction in the maximum annual Pell Grant amount or changes in eligibility could negatively impact enrollment and could result in increased student borrowing, which would make it more difficult for us to comply with other important regulatory requirements such as maintaining student loan cohort default rates below specified levels. Effective July 1, 2012, the duration of eligibility for Pell Grants was reduced from 18 to 12 semesters or the equivalent. This revised eligibility would not have had a material effect on the total Pell Grants disbursed to our students during fiscal year 2012 and is expected to have minimal impact for our business. The remaining funding for tuition and other fees paid by our students primarily consists of state-funded student financial aid, tuition assistance from employers and personal funds. Economic uncertainty over recent years has reduced the availability of state-funded student financial aid as many states grapple with historic budget shortfalls. In California, the state in which we conduct the most business by revenue, University of Phoenix students received approximately $21 million of Cal Grants in fiscal year 2012. Effective July 1, 2012, only schools with a graduation rate of at least 30% and a three-year federal student loan cohort default rate below 15.5% are eligible to participate in the Cal Grant program. As a result, new University of Phoenix students are no longer eligible for Cal Grants and continuing students will be eligible for only one additional year, and the maximum award for these students has been reduced by 20%. This change and other changes in state-funded student financial aid could result in increased student borrowing, decreased enrollment and adverse impacts on our 90/10 Rule percentage described below. International Government financial aid funding for students enrolled in our international institutions has not been widely available historically. Regulatory Environment Domestic Postsecondary Our domestic postsecondary institutions are subject to extensive federal and state regulations. The Higher Education Act, as reauthorized, and the related U.S. Department of Education 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:
20 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, must comply with the Higher Education Act, as reauthorized, and all applicable regulations thereunder, and must be authorized to operate by the appropriate regulatory authority in each state where the institution maintains a physical presence. We have summarized below recent material activity in the regulatory environment affecting our business and the most significant regulatory requirements applicable to our domestic postsecondary operations. 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. Refer to Part I, Item 1A, Risk Factors – Risks Related to the Highly Regulated Industry in Which We Operate. 90/10 Rule. University of Phoenix and Western International University, and all other proprietary institutions of higher education, are subject to the so-called “90/10 Rule” under the Higher Education Act, as reauthorized. 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 cash basis 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. 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. For example, the Department could impose conditions in the provisional certification such as:
In addition, if an institution is 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 cash-basis 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. 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 made while ineligible must be repaid to the Department. The following table details the 90/10 Rule percentages for University of Phoenix and Western International University for fiscal years 2012, 2011 and 2010:
(1) Calculated excluding the temporary relief from the impact of loan limit increases, which was allowable for amounts received and applied to eligible charges between July 1, 2008 and June 30, 2011 that were attributable to the increased annual loan limits. Although the University of Phoenix 90/10 Rule percentage for fiscal year 2012 has decreased from fiscal years 2011 and 2010, the 90/10 Rule percentage for University of Phoenix has increased materially over the years prior to fiscal year 2010. This prior increase was primarily attributable to the increase in student loan limits affected by the Ensuring Continued Access to Student Loans Act of 2008 and expanded eligibility for and increases in the maximum amount of Pell Grants. We believe the decrease in the University of Phoenix 90/10 Rule percentage in fiscal year 2012 compared to fiscal years 2011 and 2010 is primarily attributable to the reduction in the proportion of our students who are enrolled in our associate’s degree programs, which historically have had a higher percentage of Title IV funds applied to eligible tuition and fees, and emphasizing employer-paid and other direct-pay education programs. We have also implemented in recent years various other measures intended to reduce the percentage of University of Phoenix’s cash basis revenue attributable to Title IV funds, including encouraging students to carefully evaluate the amount of necessary Title IV borrowing and continued focus on 21 professional development and continuing education programs. We have substantially no control over the amount of Title IV student loans and grants sought by or awarded to our students. Based on recent trends, we do not expect the 90/10 Rule percentage for University of Phoenix to exceed 90% for fiscal year 2013. However, the 90/10 Rule percentage for University of Phoenix remains near 90% and could exceed 90% in the future depending on the degree to which our various initiatives are effective, the impact of future changes in our enrollment mix, and regulatory and other factors outside our control, including any reduction in Military Benefit programs or changes in the treatment of such funding for purposes of the 90/10 Rule calculation. Various legislative proposals have been introduced in Congress that would heighten the requirements of the 90/10 Rule. For example, in January 2012, the Protecting Our Students and Taxpayers Act was introduced in the U.S. Senate and, if adopted, would reduce the 90% maximum under the rule to the pre-1998 level of 85%, cause tuition derived from Military Benefit programs to be included in the 85% portion under the rule instead of the 10% portion as is the case today, and impose Title IV ineligibility after one year of noncompliance rather than two. If these or other proposals are adopted as proposed, University of Phoenix may be required to increase efforts and resources dedicated to reducing the percentage of cash basis revenue attributable to Title IV funds, which could materially and adversely affect our business. In addition, the ineligibility of University of Phoenix students for Cal Grants in California as discussed in Financial Aid Programs above, and reductions in other state-funded student financial aid programs could adversely impact our compliance with the 90/10 rule, because tuition revenue derived from such programs is included in the 10% portion of the rule calculation. Any necessary further 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. In addition, we may be required to make structural changes to our business in the future 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 it more difficult to comply with other important regulatory requirements, such as the cohort default rate regulations, which are discussed below. Cohort Default Rates. 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). 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 U.S. Department of Education approximately 12 months after the end of the measuring period. Thus, in September 2012 the Department published the two-year cohort default rates for the 2010 cohort, which measured the percentage of students who first entered into repayment during the year ended September 30, 2010 and defaulted prior to September 30, 2011. As discussed below, the measurement period for the cohort default rate has been increased to three years starting with the 2009 cohort and both three-year and two-year cohort default rates will be published each September until the 2011 three-year cohort default rate is published in September 2014. 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. University of Phoenix and Western International University implemented a 30-day delay for such disbursements a few years ago. If an institution’s two-year cohort default rate equals or exceeds 25% for three consecutive years or 40% for any given year, it will be ineligible to participate in Title IV programs. The two-year cohort default rates for University of Phoenix, Western International University and for all proprietary postsecondary institutions for the federal fiscal years 2010, 2009 and 2008 were as follows:
(1) Based on information published by the U.S. Department of Education. Although the University of Phoenix 2010 two-year cohort default rate decreased compared to the previous year, University of Phoenix cohort default rates have increased materially over the prior several years. We believe the increases over the prior several years are due to the challenging economic climate, the growth in our associate’s degree student population and changes in the manner in which student loans are serviced. 22 While we expect that the challenging economic environment will continue to put pressure on our student borrowers, we believe that our ongoing efforts to shift our student mix to a higher proportion of bachelor’s and graduate level students, the full implementation of our University Orientation program in November 2010 and our investment in student protection initiatives and repayment management services will continue to stabilize and over time favorably impact our rates. As part of our repayment management initiatives, effective with the 2009 cohort, we engaged third party service providers to assist our students who are at risk of default. These service providers contact students and offer assistance, which includes providing students with specific loan repayment information such as repayment options and loan servicer contact information, and they attempt to transfer these students to the relevant loan servicer 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. Based on the available preliminary data, we do not expect the University of Phoenix or Western International University 2011 two-year cohort default rates to equal or exceed 25%. In July 2010, the Federal Family Education Loan Program (FFELP), under which private lenders originated and serviced federally guaranteed student loans, was eliminated and all subsequent federal student loans were issued through the Federal Direct Loan Program under which the federal government lends directly to students. We believe this has adversely impacted loan repayment rates and our cohort default rates, because among other things, 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. The Department began publishing the official three-year cohort default rates with the publication of the 2009 cohort default rate in September 2012 and the Department will publish the three-year cohort default rates in addition to the two-year rates until the phase-in of the three-year measurement period is complete. If an institution’s three-year cohort default rate equals or exceeds 30% for any given year, it must establish a default prevention task force and develop a default prevention plan with measurable objectives for improving the cohort default rate. We believe that our current repayment management efforts meet these requirements. If an institution’s three-year cohort default rates for the 2009 and 2010 cohorts equals or exceeds 30%, the institution may be subject to provisional certification imposing various additional requirements for participation in Title IV programs. Beginning with the three-year cohort default rate for the 2011 cohort published in September 2014, only the three-year rates will be applied for purposes of measuring compliance with the requirements, as follows:
The consequences applicable to two-year cohort default rates will continue to apply through 2013 for the fiscal 2011 cohort. Set forth below is the official three-year cohort default rate for University of Phoenix, Western International University and all propriety postsecondary institutions for the 2009 cohort, as well as the informational, “trial” three-year rates previously published by the Department for the 2008 and 2007 cohorts:
(1) Based on information published by the U.S. Department of Education. (2) Trial rates published by the Department for informational purposes only. 23 U.S. Department of Education Rulemaking. In October 2010 and June 2011, the U.S. Department of Education promulgated new rules related to Title IV program integrity issues. The most significant of these rules for our business are the following:
Most of the rules were effective in July 2011. In June 2012, the U.S. District Court for the District of Columbia vacated rules requiring state authorization of distance education programs where an institution does not have a physical presence in a state, as well as enforcement by the Secretary of Education of violations of the expanded rules regarding misrepresentation. This ruling was upheld on appeal. The rules regarding the metrics for determining whether an academic program prepares students for gainful employment were also vacated by the U.S. District Court for the District of Columbia in June 2012, as discussed further below. In May 2011, the Department announced its intention to establish additional negotiated rulemaking committees to prepare proposed regulations under the Higher Education Act. In January 2012, two negotiation teams began their work on regulations relating to teacher preparation and student loan issues. These negotiations concluded in April 2012, and under the rulemaking protocol, the Department must issue a Notice of Proposed Rulemaking for public comment before promulgating final regulations on these issues. We expect the Department will issue notices of proposed rulemaking which, among other things, address modifications to student loan repayment plans and procedures, as well as new regulations defining high quality teacher preparation programs for determining the academic program’s eligibility to participate in Title IV programs. More information can be found at http://www2.ed.gov/policy/highered/reg/hearulemaking/2011/index.html. In May 2012, the Department announced its intention to establish a negotiated rulemaking committee to prepare proposed regulations under the Higher Education Act designed to prevent fraud and otherwise ensure proper use of Title IV program funds, especially within the context of current technologies. In particular, the Department intends that the regulations will address the use of debit cards and other banking mechanisms for disbursing federal student aid, improve and streamline the campus-based aid programs, and further help institutions prevent fraudulent student activity. Public hearings were held in May 2012 and the Department anticipates committee negotiations will begin in late 2012. More information can be found at http://www2.ed.gov/policy/highered/reg/hearulemaking/2012/index.html. Refer to Part I, Item 1A, Risk Factors – Risks Related to the Highly Regulated Industry in Which We Operate – Rulemaking by the U.S. Department of Education could materially and adversely affect our business. Incentive Compensation. The incentive compensation regulations, effective July 1, 2011, removed certain “safe harbors” that had previously defined the limits of the prohibition on the payment of any incentive compensation to persons involved in enrollment and financial aid functions. These regulations also on their face prohibit any revenue sharing arrangements between education services providers, such as our IPD business, and institutions that participate in Title IV programs. The Department clarified the scope of these regulations in a Dear Colleague letter dated March 17, 2011, in which among other things the Department indicated that these revenue sharing arrangements would be permissible, but only if the services provider is not an affiliate of an institution that participates in Title IV programs. We believe that IPD was one of only two such service providers, and we have had to restructure the commercial arrangements between IPD and its client educational institutions, which has adversely impacted IPD’s business. Our Apollo Education Services business, which we are currently developing, is expected to offer a range of services similar to IPD and, like IPD, is unable to structure commercial arrangements with its prospective client educational institutions on a revenue sharing basis, as is customary in the industry. We believe that this type of commercial arrangement is critical to the success of Apollo Education Services and our inability to offer it is a significant competitive disadvantage. Unless the Department favorably clarifies its interpretive position on this issue, the interpretation is reversed through judicial action or Congress addresses the problem through legislation, we will not be able to fully develop our Apollo Education Services business. 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. Prior to July 1, 2011, such authorization was not specifically required for the institution’s students to become eligible for Title IV programs if the 24 institution was exempt from such regulatory authorization, usually based on recognized accreditation. University of Phoenix is specifically authorized to operate and has a physical presence in 37 states, the Commonwealth of Puerto Rico and the District of Columbia. In an additional three states, including California, University of Phoenix has a physical presence and is qualified to operate through June 30, 2013 without specific state regulatory approval due to available state exemptions and annual waivers from the U.S. Department of Education. Under the new program integrity rules adopted by the Department effective July 1, 2011, we are required to obtain specific regulatory approval by June 30, 2013, or to seek a further waiver from the Department to operate in California, Hawaii and New Mexico. The current regulations do not provide for any such waivers after June 30, 2013. Each of these states now must adopt additional statutes or regulations in order to comply with the new regulations adopted by the Department in order for us and other institutions to remain eligible for Title IV funds in respect of operations within the states. We have no assurance that these states will be willing or able to adopt such additional statutes or regulations or that we will be able to complete the approval process in those states in order to obtain specific state regulatory approval. In order to obtain annual waivers that could allow us to operate without specific state approval through July 1, 2013, University of Phoenix must have a supporting letter from each such state and file a request for an annual waiver to be considered by the U.S. Department of Education. We have obtained such supporting letters in each of the three states noted above and have filed a request for an annual waiver through July 1, 2013 with the Department. The U.S. Department of Education has advised us that if University of Phoenix has such supporting letters, no specific approval of the annual waiver from the Department is required, and that the Department will not require additional approvals through June 30, 2013. 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 detailed regulations. On October 29, 2010 and June 13, 2011, the Department published final regulations on gainful employment. The final gainful employment rules defined – for the first time – the standards to measure “preparation for gainful employment in a recognized occupation.” The rules established three annual standards related to student loan borrowing by which gainful employment was to be measured for each academic program of study: (i) percentage of the program’s former students who entered repayment during the cohort period and are current in their student loan repayment, (ii) ratio of discretionary income to total student loan debt for the program’s completers and (iii) ratio of actual earnings to total student loan debt for the program’s completers. As adopted, the rules provided that an academic program that passed any one standard for a given year would be considered to be providing training leading to gainful employment. If an academic program failed all three metrics for a given year, the institution would be required to disclose the failure to existing and prospective students including the amount by which the program did not meet the minimum standards and describe the program’s plan for improvement. After two failures within three years, the institution would be required to inform students in the failing program that their debts may be unaffordable, that the program may lose eligibility, and what transfer options exist. After three failures within four years, the academic program would lose eligibility to participate in Title IV programs for at least three years. In addition, the rules as adopted required institutions to notify the Department at least 90 days before the commencement of new educational programs leading to gainful employment in recognized occupations, and in some cases, would require that the Department approve the program. These rules were vacated by the U.S. District Court for the District of Columbia on June 30, 2012. The court also vacated the rules requiring reporting to the Department of information about students who complete a program leading to gainful employment in a recognized occupation, including the amount of debt incurred under private loans or institutional finance plans, matriculation information, and end of year enrollment information. On July 30, 2012, the Department filed a motion asking the court to reinstate the requirement that institutions report information about student loan-repayment rates and debt-to-income ratios. The Court did not vacate the portion of the rules requiring proprietary postsecondary institutions to provide prospective students with each eligible program’s recognized occupations, cost, completion rate, job placement rate, and median loan debt of program completers beginning July 1, 2011. Those disclosures and the requirements for reporting information relating to our programs to the Department and to our students have increased our administrative burdens. These reporting requirements could impact student enrollment, persistence and retention in ways that we cannot now predict. For example, if our reported program information compares unfavorably with other reporting educational institutions, it could adversely impact demand for our programs. 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. University of Phoenix has submitted necessary documentation for re- 25 certification. In the event that the U.S. Department of Education does not complete University of Phoenix’s recertification process and issue a new Program Participation Agreement on or before December 31, 2012, it is anticipated that University of Phoenix’s eligibility will continue on a month-to-month basis until the Department issues its decision on the application. We have no reason to believe that our application will not be renewed in due course, although it would not be unusual for University of Phoenix to be continued on a month-to-month basis until the Department completes its review. 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 Program Reviews. The U.S. Department of Education periodically reviews institutions participating in Title IV programs for compliance with applicable standards and regulations. In July 2012, the Department commenced a program review of University of Phoenix’s compliance with requirements to verify student supplied information and report to the Department appropriate verification status codes relating to Title IV programs in which the University of Phoenix participates. The review covered federal financial aid years 2010–2011 and 2011–2012 through June 26, 2012. In July 2012, University of Phoenix received an Expedited Final Program Review Determination Letter from the Department. There were no findings in the program review. Office of the Inspector General of the U.S. Department of Education (“OIG”). In October 2011, the OIG notified us that it was conducting a nationwide audit of the Department’s program requirements, guidance, and monitoring of institutions of higher education offering distance education. In connection with the OIG’s audit of the Department, the OIG examined a sample of University of Phoenix students who enrolled during the period from July 1, 2010 to June 30, 2011. The OIG subsequently notified University of Phoenix that in the course of this review it identified certain conditions that the OIG believes are Title IV compliance exceptions at University of Phoenix. Although University of Phoenix is not the direct subject of the OIG’s audit of the Department, the OIG has asked University of Phoenix to respond so that it may consider University of Phoenix’s views in formulating its audit report of the Department. These exceptions relate principally to the calculation of the amount of Title IV funds returned after student withdrawals and the process for confirming student eligibility prior to disbursement of Title IV funds. 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. Refer to Part I, Item 1A, Risk Factors – Risks Related to the Highly Regulated Industry in Which We Operate – 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. 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 also 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 fiscal year 2012 composite scores for Apollo Group, University of Phoenix and Western International University were 2.4, 2.9 and 1.8, respectively. Refer to Part I, Item 1A, Risk Factors – Risks Related to the Highly Regulated Industry in Which We Operate – 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. 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 26 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 Title IV financial aid program funds held for students for unbilled educational services. As a trustee of these Title IV financial aid funds, we are required to maintain and restrict these funds pursuant to the terms of our program participation agreement with the U.S. Department of Education. These funds are included in restricted cash and cash equivalents in our Consolidated Balance Sheets in Item 8, Financial Statements and Supplementary Data. 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. There are also certain regulatory requirements associated with closing locations. Subsequent to August 31, 2012, we adopted a plan to realign University of Phoenix’s ground locations throughout the U.S., pursuant to which we will close a substantial number of locations. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. 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 require recertification by the U.S. Department of Education, reauthorization by state licensing agencies, and the reevaluation of accreditation by The Higher Learning Commission. If we experience a change of ownership and control sufficient to require 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, then University of Phoenix and Western International University may cease to be eligible 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 provisional basis pending completion of the change in ownership approval process. In addition, some states in which University of Phoenix, Western International University or CFFP are licensed require approval (in some cases, advance approval) of changes in ownership or control in order to remain authorized to operate in those states. Moreover, University of Phoenix, Western International University and CFFP are required to report any material change in stock ownership to their principal accrediting body, The Higher Learning Commission, and to obtain approval prior to undergoing any transaction that affects, or may affect, corporate control or governance at the institution. In the event of a material change in ownership, The Higher Learning Commission may undertake an evaluation of the effect of the change on the continuing operations of University of Phoenix, Western International University and CFFP. Refer to Part I, Item 1A, Risk Factors – Risks Related to the Control Over Our Voting Stock – 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, which could materially and adversely affect our business. Executive Order on Military and Veterans Benefits Programs. On April 27, 2012, President Obama issued an executive order regarding the establishment of principles for educational institutions receiving funding from federal military and veterans educational benefits programs, including those provided by the Post-9/11 Veterans Educational Assistance Act of 2008, as amended (the “Post-9/11 GI Bill”) and the Department of Defense Tuition Assistance Program. The executive order requires the Departments of Defense, Veterans Affairs and Education to establish and implement “Principles of Excellence” to apply to educational institutions receiving such funding. The goals of the Principles are broadly stated in the order and relate to disclosures of costs and amounts of costs covered by federal educational benefits, marketing standards, state authorization, accreditation approvals, standard institutional refund policies, educational plans and academic and financial advising. Various implementation mechanisms are included and the Secretaries of Defense and Veterans Affairs, in consultation with the Secretary of Education and the Director of the Consumer Financial Protection Bureau, submitted a plan to strengthen enforcement and compliance in July 2012. These Principles could increase the cost of delivering educational services to our military and veteran students. Refer to Part I, 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 27 funding for those programs, including changes applicable only to proprietary educational institutions, could reduce our enrollment and increase our costs of operation. 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 in July 2011, the U.S. Department of Education began publishing national lists annually disclosing the top five percent in each of nine institutional categories with the highest college costs and largest percentage cost increases. Institutions published on such lists may receive negative media attention that may cause some prospective students to choose educational alternatives. University of Phoenix and Western International University were not on the lists in July 2011 or July 2012. 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. 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 NE, 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 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. Item 1A – Risk Factors 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 flows 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. All of the Apollo Group Class B common stock, our only class of voting stock, is controlled by Dr. John G. Sperling, our founder and the Executive Chairman of our Board of Directors, and his son, Mr. Peter V. Sperling, the Vice Chairman of our board of directors. Specifically, approximately 51% of our Class B common stock is owned by a revocable grantor trust, of which Dr. Sperling is the sole trustee (the “JGS Trust”). During his lifetime, Dr. Sperling has the power to remove or replace all trustees of the JGS Trust and to direct the disposition of the Class B common stock held by the trust, including upon his death, subject to certain limitations, including the limitations on transfers set forth in the Shareholders Agreement, as amended, among the Class B shareholders and us. The remainder of our Class B common stock is owned by Mr. Sperling, also through a revocable grantor trust. Accordingly, 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 28 outstanding 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. Upon Dr. Sperling’s death or incapacity, the JGS Trust will become irrevocable and Mr. Sperling, Ms. Terri Bishop and Ms. Darby Shupp, who are members of our board of directors, will automatically be appointed as successor trustees, unless such event occurs prior to March 24, 2013, in which case Ms. Shupp will instead be appointed as a trustee on such later date. Following Dr. Sperling’s death, the trustees of the JGS Trust shall have the sole power to appoint successor and additional trustees. 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. After Dr. Sperling’s death, it will be impossible for a third party to acquire voting control of us without the approval of a majority of the trustees of the JGS Trust. No assurances can be given that the Apollo Group Class B shareholders, or the trustees of the JGS Trust, 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. We are a “Controlled Company” under the NASDAQ Listing Rules and therefore are exempt from certain corporate governance requirements, which could reduce the influence of independent directors on our management and strategic direction. 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 our outstanding stock is controlled by Dr. John G. Sperling. 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 Committee, Audit Committee and Nominating and Governance Committee 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 in the future our Board of Directors elects to rely on the exemptions permitted by the NASDAQ Listing Rules and reduce the number or proportion of independent directors on our Board and its key committees, the influence of independent directors on our management and strategy would be reduced and the influence of the holders of our Class B voting common stock on our management and strategy would increase. 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, which could materially and adversely affect our business. 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, and the reevaluation of accreditation by The Higher Learning Commission of the North Central Association of Colleges and Schools. If we experience a change of ownership and control sufficient to require 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, then University of Phoenix and 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 Title IV programs on a provisional basis pending completion of the change in ownership approval process. Continued participation in Title IV programs is critical to our business. Any disruption in our 29 eligibility to participate in Title IV programs would materially and adversely impact our business, financial condition, results of operations and cash flows. In addition, some states in which University of Phoenix, Western International University or CFFP are licensed require approval (in some cases, advance approval) of changes in ownership or control in order 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 in ownership or control. Moreover, University of Phoenix, Western International University and CFFP would be required to report any material change in stock ownership to their principal accrediting body, The Higher Learning Commission, and would be required to obtain approval prior to undergoing any transaction that affects, or may affect, corporate control or governance at the institution. In the event of a material change in the ownership of Apollo Group Class B common stock, The Higher Learning Commission may undertake an evaluation of the effect of the change on the continuing operations of University of Phoenix, Western International University and CFFP for purposes of determining if continued accreditation is appropriate. If the Commission determines that the change is such that prior approval by the Commission was required, but was not obtained, the Commission’s policies require it to consider withdrawal of accreditation. If accreditation by the Higher Learning Commission is suspended or withdrawn, University of Phoenix, Western International University and CFFP would not be eligible to participate in Title IV programs until the accreditation is reinstated by the Commission or is obtained from another appropriate accrediting body. There is no assurance that reinstatement of accreditation could be obtained on a timely basis, if at all, and accreditation from a different qualified accrediting authority, if available, would require a significant amount of time. Any material disruption in accreditation would materially and adversely impact our business, financial condition, results of operations and cash flows. All of the Apollo Group Class B common stock, our only class of voting stock, is controlled by Dr. John G. Sperling, the Executive Chairman of our Board of Directors, and his son, Mr. Peter V. Sperling, the Vice Chairman of our Board of Directors. Specifically, approximately 51% of our Class B common stock is owned by a revocable grantor trust (the “JGS Trust”), of which Dr. Sperling is the sole trustee. We cannot prevent a change of ownership or control that would arise from a transfer of voting stock by Dr. Sperling, Mr. Sperling or the JGS Trust, including a transfer that may occur or be deemed to occur upon the death of one or both of Dr. Sperling or Mr. Sperling or a transfer effected through an amendment of the JGS Trust. Risks Related to the Highly Regulated Industry in Which We Operate 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. We are subject to extensive U.S. federal and state regulation as a provider of postsecondary education. The principal federal regulatory regime is established under the Higher Education Act of 1965, as it is amended and reauthorized from time to time, and the regulations promulgated under the Act by the U.S. Department of Education. Among other matters, these regulations govern the participation by University of Phoenix and Western International University in federal student financial aid programs under Title IV of the Higher Education Act (“Title IV”), which is the principal source of funding for students at these universities. We collected the substantial majority of our fiscal year 2012 total consolidated net revenue from receipt of Title IV financial aid program funds. The Higher Education Act, as reauthorized, mandates specific regulatory responsibilities for each of the following components of the higher education regulatory triad: (1) the federal government through the U.S. Department of Education; (2) independent accrediting agencies recognized by the Department of Education; and (3) state higher education regulatory bodies. The applicable 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 applicable regulations, standards and policies of the various regulatory agencies frequently change and often are subject to interpretative challenges, particularly where they are crafted for traditional, academic term-based schools rather than our non-term and innovative academic delivery model. Changes in, or new interpretations of, applicable laws, regulations, standards or policies could have a material adverse effect on our accreditation, authorization to operate in various states, permissible activities, receipt of funds under Title IV programs, costs of doing business and our ability to implement beneficial changes in our academic or business model. We cannot predict how the requirements administered by these agencies will be applied or interpreted in the future, or whether our schools will be able to comply with any future changes in these requirements. 30 If we are found to have violated any applicable regulations, standards or policies, we may be subject to the following sanctions imposed by any one or more of the relevant regulatory agencies:
In connection with past U.S. Department of Education program reviews we have paid monetary penalties in various amounts, and in June 2010 we were required to post a $126 million letter of credit with the Department, which was released in fiscal year 2011. In addition, in some circumstances of noncompliance or alleged noncompliance, we may be subject to qui tam lawsuits under the Federal False Claims Act or various, similar state false claim statutes. In these actions, private plaintiffs seek to enforce remedies under the Act on behalf of the U.S. federal government and, if successful, are entitled to recover their costs and to receive a portion of any amounts recovered by the U.S. federal government in the lawsuit. These lawsuits can be prosecuted by a private plaintiff, even if the Department does not agree with plaintiff’s theory of liability. In 2009, we settled a qui tam lawsuit relating to alleged payment of incentive compensation to our enrollment counselors for a total payment of $80.5 million, and we currently are subject to a another qui tam lawsuit alleging payment of improper incentive compensation in subsequent periods. For more information about the pending qui tam case, Refer to Note 16, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data. In October 2011, the Office of the Inspector General of the U.S. Department of Education (“OIG”) notified us that it was conducting a nationwide audit of the Department’s program requirements, guidance, and monitoring of institutions of higher education offering distance education. In connection with the OIG’s audit of the Department, the OIG examined a sample of University of Phoenix students who enrolled during the period from July 1, 2010 to June 30, 2011. The OIG subsequently notified University of Phoenix that in the course of this review it identified certain conditions that the OIG believes are Title IV compliance exceptions at University of Phoenix. Although University of Phoenix is not the direct subject of the OIG’s audit of the Department, the OIG has asked University of Phoenix to respond so that it may consider University of Phoenix’s views in formulating its audit report of the Department. These exceptions relate principally to the calculation of the amount of Title IV funds returned after student withdrawals and the process for confirming student eligibility prior to disbursement of Title IV funds. For more information about this audit, refer to Note 16, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data. Any of the penalties, injunctions, restrictions, lawsuits 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. University of Phoenix’s certification to participate in Title IV programs expires in December 2012. If University of Phoenix is not recertified to participate in Title IV programs by the U.S. Department of Education, the University of Phoenix would not be eligible to participate in Title IV programs and we could not conduct our business as it is currently conducted. University of Phoenix and Western International University are certified by the U.S. Department of Education to participate in Title IV programs. University of Phoenix was recertified 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. 31 Action by the U.S. Congress to revise the laws governing the federal student financial aid programs or reduce funding for these programs, including changes applicable only to proprietary educational institutions, could reduce our enrollment 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, including changes in eligibility and funding for Title IV programs, are likely to occur in subsequent reauthorizations, but we cannot predict the scope or substance of any such changes. In April 2011, Congress permanently eliminated year-round Pell Grant awards beginning with the 2011-2012 award year as part of the fiscal year 2011 Continuing Resolution spending bill. This change, which did not reduce the maximum annual grant level, did not have a material impact on our business. However, because the Pell Grant program is one of the largest non-defense discretionary spending programs in the federal budget, it is a target for reduction as Congress addresses the unprecedented U.S. budget deficit. A reduction in the maximum annual Pell Grant amount or changes in eligibility could result in increased student borrowing, which would make more difficult our ability to comply with other important regulatory requirements, such as the cohort default rate regulations, which are discussed below, and could negatively impact enrollment. In addition to Congress’s focus on the federal government’s funding challenges, in recent years, there has been increased focus by Congress on the role that proprietary educational institutions play in higher education. In June 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. Also in June 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. At a subsequent hearing in August 2010, the Government Accountability Office (“GAO”) presented a report of its review of various aspects of the proprietary sector, including recruitment practices and the degree to which proprietary institutions’ revenue is composed of Title IV funding. Following this hearing, Sen. Tom Harkin, the Chairman of the HELP Committee, requested a broad range of detailed information from 30 proprietary institutions, including University of Phoenix. In September 2010, the HELP Committee held a third hearing and Sen. Harkin’s staff released its initial report entitled, “The Return on the Federal Investment in For-Profit Education: Debt Without a Diploma.” After additional hearings and roundtable discussions and review of the information provided by proprietary institutions, Senator Harkin’s staff released its final report in July 2012 entitled, “For Profit Higher Education: The Failure to Safeguard the Federal Investment and Ensure Student Success.” The final report was not adopted by the full committee and the minority committee staff criticized it for relying on discredited sources and refusing to examine similar concerns in the non-profit education sector. Nonetheless, the report may be influential as Congress begins the process of reauthorizing the Higher Education Act, which currently expires in September 2013. The report advocates significant changes in the requirements governing participation by for profit educational institutions in Title IV student financial aid programs, including the following:
In addition, other Congressional hearings and roundtable discussions may be held regarding various aspects of the education industry that may affect our business. We cannot predict what legislation, if any, may emanate from these Congressional committee hearings or what impact any such legislation might have on the proprietary education sector and our business in particular. The confluence of the increasing scrutiny in Congress of the proprietary education sector and the unprecedented federal budget deficits increases the likelihood of legislation that will adversely impact our business. Any action by Congress that significantly reduces Title IV program funding, whether through across-the-board funding reductions, sequestration or otherwise, or materially impacts the eligibility of our institutions or students to participate in Title IV programs would have a material adverse effect on our enrollment, financial condition, results of operations and cash flows. Congressional action also could require us to modify our practices in ways that increase our administrative costs and reduce our operating income. If Congress 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 private sources would not be able to provide as much funding to our students or on terms comparable to Title IV. In addition, private funding sources could require us to guarantee all or part of this assistance and we might incur other additional costs. For these reasons, private, 32 alternative sources of student financial aid would only partly offset, if at all, the impact on our business of reduced Title IV program funding, and would not be a practical alternative in the case of a significant reduction in Title IV financial aid. 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 Department is required in order for an institution to become and remain eligible to participate in Title IV programs. If the Department 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 Department. In December 2009, the Office of Inspector General of the Department (“OIG”) requested that the Department review the appropriateness of the Department’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. Regardless of any outcome from the Department’s review of HLC, the focus by the OIG and the Department 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 HLC reaffirmation reviews 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. University of Phoenix submitted its response to the HLC in September 2010. In July 2011, HLC informed University of Phoenix that the special committee formed to review this matter had completed its work, concluding that based on its limited review, it found no apparent evidence of systematic misrepresentations to students or that University of Phoenix’s procedures in the areas of recruiting, financial aid and admissions were significantly inadequate or inappropriate. HLC also stated that there remained significant questions as well as areas that University of Phoenix should work on improving. HLC indicated that these would be reviewed by the comprehensive evaluation team at its previously scheduled visit beginning in March 2012, which was its next comprehensive evaluation visit for reaffirmation. These questions relate to student loans in collection and the minimization of student loan defaults; the offering of limited career services, particularly in relation to University of Phoenix’s associate’s degree programs; timing of prospective student access to financial aid advisors during the recruiting process; academic qualifications of admissions personnel and financial aid advisors; the hiring and evaluation of financial aid officers; retention of students, including the relationship of remediation to retention; and the role of the University of Phoenix First Year Sequence, or curriculum, in relation to University of Phoenix’s transfer policy and impacts on student retention. The HLC’s reaffirmation evaluation of University of Phoenix began in March 2012, as scheduled, and is on-going at this time. HLC has indicated that it expects the evaluation to be complete during 2013. We cannot predict whether, and if so, to what extent, our on-going reengineering of our business processes to optimize our business and reduce costs, as discussed below, might have on the reaffirmation evaluation. 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. 33 Rulemaking by the U.S. Department of Education could materially and adversely affect our business. The U.S. Department of Education has promulgated a substantial number of new regulations in the past three years that impact our business, including the following:
These regulations have increased our operating cost and in some cases required us to change the manner in which we operate our business. New or amended regulations in the future, particularly regulations focused on the proprietary sector, could further negatively impact our business. 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. University of Phoenix and Western International University, and all other proprietary institutions of higher education, are subject to the so-called “90/10 Rule” under the Higher Education Act, as reauthorized. 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 cash basis 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. 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. For example, the Department could impose conditions in the provisional certification such as:
In addition, if an institution is 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 cash-basis 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. 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 made while ineligible must be repaid to the Department. 34 The following table details the 90/10 Rule percentages for University of Phoenix and Western International University for fiscal years 2012, 2011 and 2010:
(1) Calculated excluding the temporary relief from the impact of loan limit increases, which was allowable for amounts received and applied to eligible charges between July 1, 2008 and June 30, 2011 that were attributable to the increased annual loan limits. Although the University of Phoenix 90/10 Rule percentage for fiscal year 2012 has decreased from fiscal years 2011 and 2010, the 90/10 Rule percentage for University of Phoenix has increased materially over the years prior to fiscal year 2010. This prior increase was primarily attributable to the increase in student loan limits affected by the Ensuring Continued Access to Student Loans Act of 2008 and expanded eligibility for and increases in the maximum amount of Pell Grants. We believe the decrease in the University of Phoenix 90/10 Rule percentage in fiscal year 2012 compared to fiscal years 2011 and 2010 is primarily attributable to the reduction in the proportion of our students who are enrolled in our associate’s degree programs, which historically have had a higher percentage of Title IV funds applied to eligible tuition and fees, and emphasizing employer-paid and other direct-pay education programs. We have also implemented in recent years various other measures intended to reduce the percentage of University of Phoenix’s cash basis revenue attributable to Title IV funds, including encouraging students to carefully evaluate the amount of necessary Title IV borrowing and continued focus on professional development and continuing education programs. We have substantially no control over the amount of Title IV student loans and grants sought by or awarded to our students. Based on recent trends, we do not expect the 90/10 Rule percentage for University of Phoenix to exceed 90% for fiscal year 2013. However, the 90/10 Rule percentage for University of Phoenix remains near 90% and could exceed 90% in the future depending on the degree to which our various initiatives are effective, the impact of future changes in our enrollment mix, and regulatory and other factors outside our control, including any reduction in Military Benefit programs or changes in the treatment of such funding for purposes of the 90/10 Rule calculation. Various legislative proposals have been introduced in Congress that would heighten the requirements of the 90/10 Rule. For example, in January 2012, the Protecting Our Students and Taxpayers Act was introduced in the U.S. Senate and, if adopted, would reduce the 90% maximum under the rule to the pre-1998 level of 85%, cause tuition derived from Military Benefit programs to be included in the 85% portion under the rule instead of the 10% portion as is the case today, and impose Title IV ineligibility after one year of noncompliance rather than two. If these or other proposals are adopted as proposed, University of Phoenix may be required to increase efforts and resources dedicated to reducing the percentage of cash basis revenue attributable to Title IV funds, which could materially and adversely affect our business. In addition, the ineligibility of University of Phoenix students for Cal Grants in California as discussed in a separate risk factor below, and reductions in other state-funded student financial aid programs could adversely impact our compliance with the 90/10 rule, because tuition revenue derived from such programs is included in the 10% portion of the rule calculation. Any necessary further 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. In addition, we may be required to make structural changes to our business in the future 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 it more difficult to comply with other important regulatory requirements, such as the cohort default rate regulations, which are discussed 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. 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 U.S. Department of Education approximately 12 months after the end of the measuring period. Thus, in September 2012 the Department published the two-year cohort default rates for the 2010 cohort, which measured the percentage of students who first entered into repayment during the year ended September 30, 2010 and defaulted prior to September 30, 2011. As discussed below, the measurement period for the cohort default rate has 35 been increased to three years starting with the 2009 cohort and both three-year and two-year cohort default rates will be published each September until the 2011 three-year cohort default rate is published in September 2014. 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. University of Phoenix and Western International University implemented a 30-day delay for such disbursements a few years ago. If an institution’s two-year cohort default rate equals or exceeds 25% for three consecutive years or 40% for any given year, it will be ineligible to participate in Title IV programs. The two-year cohort default rates for University of Phoenix, Western International University and for all proprietary postsecondary institutions for the federal fiscal years 2010, 2009 and 2008 were as follows:
(1) Based on information published by the U.S. Department of Education. Although the University of Phoenix 2010 two-year cohort default rate decreased compared to the previous year, University of Phoenix cohort default rates have increased materially over the prior several years. We believe the University of Phoenix cohort default rate has been increasing over the past several years due to the challenging economic climate, the growth in our associate’s degree student population and changes in the manner in which student loans are serviced. While we expect that the challenging economic environment will continue to put pressure on our student borrowers, we believe that our ongoing efforts to shift our student mix to a higher proportion of bachelor’s and graduate level students, the full implementation of our University Orientation program in November 2010 and our investment in student protection initiatives and repayment management services will continue to stabilize and over time favorably impact our rates. As part of our repayment management initiatives, effective with the 2009 cohort, we engaged third party service providers to assist our students who are at risk of default. These service providers contact students and offer assistance, which includes providing students with specific loan repayment information such as repayment options and loan servicer contact information, and they attempt to transfer these students to the relevant loan servicer 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. Based on the available preliminary data, we do not expect the University of Phoenix or Western International University 2011 two-year cohort default rates to equal or exceed 25%. In July 2010, the Federal Family Education Loan Program (FFELP), under which private lenders originated and serviced federally guaranteed student loans, was eliminated and all subsequent federal student loans were issued through the Federal Direct Loan Program under which the federal government lends directly to students. We believe this has adversely impacted loan repayment rates and our cohort default rates, because among other things, 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. The Department began publishing the official three-year cohort default rates with the publication of the 2009 cohort default in September 2012 and the Department will publish the three-year cohort default rates in addition to the two-year rates until the phase-in of the three-year measurement period is complete. If an institution’s three-year cohort default rate equals or exceeds 30% for any given year, it must establish a default prevention task force and develop a default prevention plan with measurable objectives for improving the cohort default rate. We believe that our current repayment management efforts meet these requirements. If an institution’s three-year cohort default rates for the 2009 and 2010 cohorts equals or exceeds 30%, the institution may be subject to provisional certification imposing various additional requirements for participation in Title IV programs. 36 Beginning with the three-year cohort default rate for the 2011 cohort published in September 2014, only the three-year rates will be applied for purposes of measuring compliance with the requirements, as follows:
The consequences applicable to two-year cohort default rates will continue to apply through 2013 for the fiscal 2011 cohort. Set forth below is the official three-year cohort default rate for University of Phoenix, Western International University and all propriety postsecondary institutions for the 2009 cohort, as well as the informational, “trial” three-year rates previously published by the Department for the 2008 and 2007 cohorts:
(1) Based on information published by the U.S. Department of Education. (2) Trial rates published by the Department for information purposes only. The U.S. Department of Education gainful employment regulations may limit the programs we can offer students and increase our cost of operations. 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 detailed regulations. On October 29, 2010 and June 13, 2011, the Department published final regulations on gainful employment. The final gainful employment rules defined – for the first time – the standards to measure “preparation for gainful employment in a recognized occupation.” The rules established three annual standards related to student loan borrowing by which gainful employment was to be measured for each academic program of study: (i) percentage of the program’s former students who entered repayment during the cohort period and are current in their student loan repayment, (ii) ratio of discretionary income to total student loan debt for the program’s completers and (iii) ratio of actual earnings to total student loan debt for the program’s completers. As adopted, the rules provided that an academic program that passed any one standard for a given year would be considered to be providing training leading to gainful employment. If an academic program failed all three metrics for a given year, the institution would be required to disclose the failure to existing and prospective students including the amount by which the program did not meet the minimum standards and describe the program’s plan for improvement. After two failures within three years, the institution would be required to inform students in the failing program that their debts may be unaffordable, that the program may lose eligibility, and what transfer options exist. After three failures within four years, the academic program would lose eligibility to participate in Title IV programs for at least three years. In addition, the rules as adopted required institutions to notify the Department at least 90 days before the commencement of new educational programs leading to gainful employment in recognized occupations, and in some cases, would require that the Department approve the program. These rules were vacated by the U.S. District Court for the District of Columbia on June 30, 2012. The court also vacated the rules requiring reporting to the Department of information about students who complete a program leading to gainful employment in a recognized occupation, including the amount of debt incurred under private loans or institutional finance plans, matriculation information, and end of year enrollment information. On July 30, 2012, the Department filed a motion asking the court to reinstate the requirement that institutions report information about student loan-repayment rates and debt-to-income ratios. The Court did not vacate the portion of the rules requiring proprietary postsecondary institutions to provide prospective students with each eligible program’s recognized occupations, cost, completion rate, job placement rate, and median loan debt of program completers beginning July 1, 2011. The disclosure requirements and the requirements for reporting information relating to our programs to the Department and to our students have increased our administrative burdens. These reporting requirements could impact student enrollment, persistence and retention in ways that we cannot now predict. For example, if 37 our reported program information compares unfavorably with other reporting educational institutions, it could adversely impact demand for our programs. If the rules regarding gainful employment metrics are reinstated on appeal or similar rules are repromulgated by the Department in a manner that withstands challenge, 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 actual or deemed income level of our graduates, changes in student borrowing levels, 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 could reduce our ability to confidently offer or continue certain types of programs for which there is market demand, and therefore would impact our ability to maintain or grow our business. 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. 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. Prior to July 1, 2011, such authorization was not specifically required for the institution’s students to become eligible for Title IV programs if the institution was exempt from such regulatory authorization, usually based on recognized accreditation. University of Phoenix is specifically authorized to operate and has a physical presence in 37 states, the Commonwealth of Puerto Rico and the District of Columbia. In an additional three states, including California, University of Phoenix has a physical presence and is qualified to operate through June 30, 2013 without specific state regulatory approval due to available state exemptions and annual waivers from the U.S. Department of Education. Under the new program integrity rules adopted by the Department effective July 1, 2011, we are required to obtain specific regulatory approval by June 30, 2013, or to seek a further waiver from the Department to operate in California, Hawaii and New Mexico. The current regulations do not provide for any such waivers after June 30, 2013. Each of these states now must adopt additional statutes or regulations in order to comply with the new regulations adopted by the Department in order for us and other institutions to remain eligible for Title IV funds in respect of operations within the states. We have no assurance that these states will be willing or able to adopt such additional statutes or regulations or that we will be able to complete the approval process in those states in order to obtain specific state regulatory approval. In order to obtain annual waivers that could allow us to operate without specific state approval through July 1, 2013, University of Phoenix must have a supporting letter from each such state and file a request for an annual waiver to be considered by the U.S. Department of Education. We have obtained such supporting letters in each of the three states noted above and have filed a request for an annual waiver through July 1, 2013 with the Department. The U.S. Department of Education has advised us that if University of Phoenix has such supporting letters, no specific approval of the annual waiver from the Department is required, and that the Department will not require additional approvals through June 30, 2013. If we cannot obtain an additional annual waiver for the period after June 30, 2013 in those states in which we operate without specific state regulatory approval, and are thereafter unable to obtain the requisite approvals, our business could be adversely impacted, particularly in California, the state in which we conduct the most business by revenue. As a result, the manner in which the Department’s final regulation will apply to our business in these states, 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. 38 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 also 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 fiscal year 2012 composite scores for Apollo Group, University of Phoenix and Western International University were 2.4, 2.9 and 1.8, respectively. Under some circumstances, particularly if our composite scores approach 1.5 in the future, we may be limited in our ability to deploy capital to effect one or more desirable transactions or initiatives due to the impact on our composite scores. If we, or our schools eligible to participate in Title IV programs fail to maintain administrative capability or financial responsibility, as defined by the Department, our 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. Our business could be harmed if we experience a disruption in our ability to process student loans under the Federal Direct Loan Program. We collected the substantial majority of our fiscal year 2012 total consolidated net revenue from receipt of Title IV financial aid program funds, principally from federal student loans under the Federal Direct Loan Program (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 volume of direct loans on a timely basis, our business, financial condition, results of operations and cash flows could be adversely and materially affected. 39 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 percentage. 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. For example, in California, the state in which we conduct the most business by revenue, University of Phoenix students received approximately $21 million of Cal Grants in fiscal year 2012. Effective July 1, 2012, only schools with a graduation rate of at least 30% and a three-year federal student loan cohort default rate below 15.5% are eligible to participate in the Cal Grant program. As a result, new University of Phoenix students are no longer eligible for Cal Grants and continuing students will be eligible for only one additional year, and the maximum award for these students has been reduced by 20%. 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 percentage 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, in which event we could not conduct our business as it is currently conducted,” above. 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. Non-U.S. Operations Our non-U.S. operations are subject to risks not inherent in our U.S. operations, which could adversely affect our business. Through Apollo Global, we operate physical and online educational institutions in the United Kingdom, Europe, Chile, Mexico and elsewhere, and we are actively seeking further expansion in other countries, including India, where we have entered into a start-up joint venture. Our operations in each of the relevant foreign jurisdictions are subject to regulatory requirements relating to education providers, as well as foreign businesses. Many foreign countries have not fully embraced the proprietary education model, and in other countries, proprietary education remains controversial. As a result, our foreign operations are subject to the political risk that existing regulations will be interpreted unfavorably or new regulations will be adopted that render our business model impractical. In addition, our non-U.S. operations are subject to the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act which require extensive compliance vigilance on our part and, in some cases, puts our foreign operations at a competitive disadvantage with local companies. If one or more of our foreign operations ceases to be economically practical, we may be forced to discontinue such operations or seek a buyer, either of which might result in a substantial loss of value to Apollo Global and, therefore, Apollo Group. Risks Related to Our Business 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 and is becoming increasingly so. We compete with traditional public and private two-year and four-year degree-granting regionally accredited colleges and universities, other proprietary degree-granting regionally accredited schools and alternatives to higher education. In addition, we face competition from various emerging nontraditional, credit-bearing and noncredit-bearing education programs, provided by both proprietary and not-for-profit providers, including massive open online courses offered worldwide without charge by traditional educational institutions and other direct-to-consumer education services. Some of our competitors have greater financial and nonfinancial resources than we have and are able to offer programs similar to ours at a lower tuition level for a variety of reasons, including the availability of direct and indirect government subsidies, government and foundation grants, large endowments, tax-deductible contributions and other financial resources not available to proprietary institutions, or by providing fewer student services or larger class sizes. For example, a typical community college is subsidized by local or state 40 government and, as a result, tuition rates for associate’s degree programs are much lower at community colleges than at University of Phoenix. Also, like University of Phoenix, other proprietary educational institutions have begun to deploy pricing incentives to impact demand. We believe that price competition, principally through student scholarships, may increase throughout the industry in the future. In addition, an increasing number of traditional colleges and community colleges are offering distance learning and other online education programs, including programs that are geared towards the needs of working learners. This trend has been accelerated by private companies that provide and/or manage online learning platforms for traditional colleges and community colleges. As the proportion of traditional colleges providing alternative learning modalities increases, we will face increasing competition for students from traditional colleges, including colleges with well-established reputations for excellence. Already, this type of competition is significant for our graduate degree programs. As the online and distance learning segment of the postsecondary education market matures, we believe that the intensity of the competition we face will continue to increase. This intense competition could make it more challenging for us to enroll students who are likely to succeed in our educational programs, which could adversely affect our enrollment levels and put downward pressure on our tuition rates, either of which could materially and adversely affect our business, financial condition, results of operations and cash flows. Changes we are making to our business to enhance our ability to identify and enroll students who have a greater likelihood of succeeding and to improve the student experience may adversely affect our growth rate, profitability, financial condition, results of operations and cash flows. We are focused on improving the student experience and identifying and enrolling students who have a greater likelihood to succeed in our educational programs. In furtherance of this focus, 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 have continued in fiscal year 2012. These initiatives include, but are not limited to, the following:
We believe that the reduction in University of Phoenix aggregate New Degreed Enrollment during fiscal years 2012 and 2011 is principally due to the change in the evaluation and compensation structure for our admissions personnel, the full implementation of University Orientation, and the changes in our marketing approach. We expect that each of these measures will continue to reduce University of Phoenix net revenue, operating income and cash flow in fiscal year 2013, and potentially beyond. The on-going reengineering of our business processes, including a substantial reduction in our on-ground locations and a reduction in workforce, could negatively impact our enrollment and operating results. We are evaluating substantially all of our business processes, and reengineering them as necessary, to more efficiently support our business needs and objectives. In connection with this, we expect to close approximately half of our University of Phoenix ground facilities. These changes will directly impact approximately 4% of University of Phoenix Degreed Enrollment, or 13,000 students. In addition, we expect to reduce our full-time non-faculty workforce by approximately 800 employees during the course of fiscal year 2013, principally due to the ground facility closures. 41 Subsequent to fiscal year 2012, we will record charges associated with this business optimization. However, the actual costs that we will incur could be higher than expected and the benefits could be less than anticipated due to a number of factors, including:
These restructuring activities may adversely impact our ability to deliver services, enroll new students, negatively impact employee morale or have other adverse consequences for our business which cannot now be predicted, any of which could materially and adversely impact our business, financial condition, results of operations and cash flows. Our business may be adversely affected by changes in the U.S. economy. The U.S. and much of the world economy are experiencing difficult and uncertain economic circumstances. We believe that our enrollment is affected by changes in economic conditions, although the nature and magnitude of this effect are uncertain and may change over time. We believe that the sharp economic downturn in the U.S. beginning in 2008 contributed to our enrollment growth in our fiscal years 2009 and 2010 as an increased number of working learners sought to advance their education to improve job security or reemployment prospects. The modest improvement in the U.S. economy in 2011 and 2012 may have reduced this effect on demand for educational services among potential working learners, and contributed to the declines in New Degreed Enrollment that we experienced during fiscal years 2011 and 2012. A further improvement in economic conditions in the U.S. and, in particular, an improvement in the U.S. unemployment rate, may reduce demand among potential working learners for educational services. Such a 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 or discourage existing or potential students from pursuing education due to a perception that there are insufficient job opportunities or due to their increased economic uncertainty or otherwise, any of 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. Refer to Risks Related to the Highly Regulated Industry in Which We Operate – 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, above. Our financial performance depends on our ability to continue to develop awareness among, and enroll and retain students; 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. The proprietary postsecondary education sector is under intense regulatory and other scrutiny which has led to media attention that 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. 42 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 increases, we may experience increased cost and reduced profitability. Prior to fiscal year 2010, a substantial proportion of our overall growth arose from an increase in associate’s degree students enrolled in University of Phoenix. As a result of this, the proportion of our Degreed Enrollment composed of students who enroll with fewer than 24 credits increased. 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 fiscal years 2011 and 2012, the proportion of our bachelor’s degree students who enroll with fewer than 24 incoming credits has increased. If the proportion of students with fewer than 24 incoming credits continues to increase, 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, an increase in our student loan default rates, an increase in our bad debt expense, 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 or phone systems could have a material adverse effect on our business. The performance and reliability of our computer network and phone systems infrastructure at our schools, including our online programs, is critical to our operations, reputation and ability to attract and retain students. From time to time we experience intermittent outages of the information technology systems used by our students and by our employees, including system-wide outages. Any computer system error or failure, regardless of cause, could result in a substantial outage that materially disrupts our online and on-ground operations. Not all of our critical systems are protected by a validated formal disaster recovery plan and redundant disaster recovery infrastructure at a geographically remote data center. We are currently executing our plan to implement disaster recovery infrastructure for our remaining critical systems to allow timely recovery from catastrophic failure. For those systems not yet protected, 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, and could result in the loss of data. An event such as this may require service restoration activities that could take up to several weeks to complete. We also are upgrading a substantial portion of our key IT systems, including our student learning system, student services platform and corporate applications, and retiring the related legacy systems. Although these new systems are expected to improve the productivity, scalability, reliability and sustainability of our IT infrastructure, the transition from the legacy systems entails risk of unanticipated disruption or failure to fully replicate all necessary data processing and reporting functions, including in our core business functions. Any disruption in our IT systems, including any disruptions and system malfunctions that may arise from our upgrade initiative, could significantly impact our operations, reduce student and prospective student confidence in our educational institutions, adversely affect our compliance with applicable regulations and accrediting body standards and have a material adverse effect on our business, financial condition, results of operations and cash flows. We do not maintain material amounts of insurance in respect of some types of these disruptions, and there is no assurance that insurance proceeds, if available, would be adequate to compensate us for damages sustained due to these disruptions. 43 In addition, we face an ever increasing number of threats to our computer systems, including unauthorized activity and access, malicious perpetrators, system viruses, malicious code and organized cyber-attacks, which could breach our security and disrupt our systems. These risks increase when we are making changes to our IT system, such as our substantial IT upgrade initiative currently underway and our frequent updates to enable instructional innovation and address new student populations. From time to time we experience security events and incidents, and these reflect an increasing level of sophistication, organization and innovation. 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 and personally identifiable information or cause interruptions or malfunctions in operations, perhaps over an extended period of time prior to detection. As a result, we may be required to expend significant additional 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. Although we maintain insurance in respect of these types of events, there is no assurance that available insurance proceeds would be adequate to compensate us for damages sustained due to these events. 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, programs in which employers directly pay tuition 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 further develop our existing 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. 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 November 2010, the District Court for the District of Arizona consolidated three securities class action complaints into a single action entitled, In re Apollo Group, Inc. Securities Litigation and appointed the “Apollo Institutional Investors Group” consisting of the Oregon Public Employees Retirement Fund, the Mineworkers’ Pension Scheme, and Amalgamated Bank as lead plaintiffs. The consolidated complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and asserts a putative class period of May 21, 2007 to October 13, 2010. On May 25, 2011, we were notified that a qui tam complaint had been filed against us by private relators under the Federal False Claims Act and California False Claims Act. The complaint alleges, among other things, that University of Phoenix has violated the Federal False Claims Act since December 12, 2009 and the California False Claims Act for the preceding ten years by falsely certifying to the U.S. Department of Education and the State of California that University of Phoenix was in compliance with various regulations that require compliance with federal rules regarding the payment of incentive compensation to admissions personnel, in connection with University of Phoenix’s participation in student financial aid programs. In addition to injunctive relief and fines, the relators seek significant damages on behalf of the Department of Education and the State of California, including all student financial aid disbursed by the Department to our students since December 2009 and by the State of California to our students during the preceding ten years. During fiscal year 2011, we received notices from the Attorney General’s Office of each of Florida, Massachusetts and Delaware regarding their investigations under applicable consumer protection laws of the business practices at University of Phoenix. We believe that there may be an informal coalition of states considering investigations into recruiting practices and the financing of education at proprietary educational institutions, which may or may not include these three states. The consumer protection laws of states are broad and subject to substantial interpretation. If our past or current business practices at University of Phoenix are found to violate applicable consumer protection laws, we could be subject to monetary fines or penalties and possible limitations on the manner in which we conduct our business, which could materially and adversely affect our business, financial condition, results of operations and cash flows. To the extent that more states commence such investigations or multiple states act in a concerted manner, the cost of responding to these inquiries and investigations could increase significantly and the potential impact on our business would be substantially greater. In April 2012, we received notification from the Enforcement Division of the Securities and Exchange Commission requesting documents and information relating to certain stock sales by company insiders and our February 28, 2012 announcement filed with the Commission on Form 8-K regarding revised enrollment forecasts. We are cooperating fully with the Securities and Exchange Commission in connection with this investigation. 44 We are also subject to various other lawsuits, investigations and claims, covering a range of matters. Refer to Note 16, 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 accreditors may increase the risk of claims by our 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 outcome in any of these matters could also materially and adversely affect our licenses, accreditation and eligibility to participate in Title IV programs. Our acquisitions may not be successful and may result in additional debt or dilution to our shareholders, which could adversely affect our business. 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 financial performance depends, in part, on our ability to keep pace with changing education market needs and technology; if we fail to keep pace or fail in implementing or adapting to new educational offerings and technologies, our business may be adversely affected. Increasingly, employers demand that their new employees possess appropriate technological skills and also appropriate “soft” skills, such as communication, critical thinking and teamwork skills. The nature of the skills required can evolve rapidly in today’s changing economic and technological environment. Accordingly, it is important for our schools’ educational programs to evolve in response to 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 45 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 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 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. Refer to Note 16, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data, for a description of pending patent litigation. 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 including Facebook, PhoenixConnect, University of Phoenix’s proprietary social media network, and other social networks. The laws governing the fair use of these third-party materials are imprecise and adjudicated on a case-by-case basis, which makes it challenging to adopt and implement appropriately balanced institutional policies governing these practices. As a result, we could 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. 46 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 mobile 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 ensure 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. 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, 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:
Any one or more of these risks could negatively impact our non-U.S. operations and materially and adversely impact 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 authorities. Our U.S. federal income tax returns for our fiscal years 2006 through 2010 are currently under review by the Internal Revenue Service. In addition, 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. 47 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 have a material adverse effect on our business, financial condition, results of operations and cash flows. Item 1B – Unresolved Staff Comments None. Item 2 – Properties As of August 31, 2012, we utilized 358 facilities, the majority of which were leased, representing 9.4 million square feet and 0.6 million square feet of leased and owned property, respectively. The following table provides additional details:
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 to determine facility needs. During fiscal year 2011, we initiated a plan to rationalize a portion of our real estate in Phoenix, Arizona through space consolidation and reorganization. The plan consisted of abandoning all, or a portion of, four leased facilities, (approximately 443,000 square feet), which are included in the above table. Additionally, we adopted a plan to realign University of Phoenix’s ground locations throughout the U.S. subsequent to August 31, 2012, pursuant to which University of Phoenix will close 115 leased facilities comprising approximately two million square feet. Refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Item 3 – Legal Proceedings 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. 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 16, Commitments and Contingencies, Contingencies Related to Litigation and Other Proceedings and Other Matters, in Item 8, Financial Statements and Supplementary Data, which is incorporated herein by reference. 48 Item 4 – Mine Safety Disclosures Not applicable. PART II Item 5 – Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 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, 2012, there were approximately 237 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, 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 near term. 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, which is incorporated herein by reference. 49 Purchases of Equity Securities Our Board of Directors has authorized us to repurchase outstanding shares of Apollo Group Class A common stock, from time to time, depending on market conditions and other considerations. During the three months ended August 31, 2012, we repurchased approximately 2.0 million shares of our Class A common stock at a total cost of $63.5 million, representing a weighted average purchase price of $31.60 per share. The table below details our share repurchases during the three months ended August 31, 2012:
(1) Shares repurchased in the above table exclude approximately 0.2 million shares repurchased for $6.4 million during the three months ended August 31, 2012 related to tax withholding requirements on restricted stock units. These repurchases do not fall under the repurchase program described below, and therefore do not reduce the amount that is available for repurchase under that program. Refer to Note 13, Shareholders’ Equity, in Item 8, Financial Statements and Supplementary Data. As of August 31, 2012, we have no remaining availability under our share repurchase authorization. The amount and timing of future share repurchase authorizations and repurchases, if any, will be made as market and business conditions warrant. Repurchases may be made on the open market through various methods including but not limited to accelerated share repurchase programs, 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. 50 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 Corporation, 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, 2007, and its relative performance is tracked through August 31, 2012.  $100 invested on 8/31/07 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. 51 Item 6 – Selected Consolidated Financial Data 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 2012, 2011 and 2010, and the consolidated balance sheets data as of August 31, 2012 and 2011, were derived from the audited consolidated financial statements, included herein. We have made certain reclassifications to the Consolidated Statements of Income Data associated with our presentation of Mander Portman Woodward as discontinued operations. Refer to Note 4, Discontinued Operations, in Item 8, Financial Statements and Supplementary Data.
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