Updated from 8:37 a.m. EDT on March 27.Apollo Group's
(APOL)
earnings blew up tonight, and the stock went right along with it. The shares are already down 19% in after-hours trading, and the trading in the morning is likely to be equally brutal.
Earnings missed by a huge amount. Apollo reported EPS of 41 cents, excluding items, well below the 52-cent Street number. Revenue did grow 14% year over year, but, at $694 million, was materially short of the $703 million expectation.
Interestingly, enrollments and new starts were essentially in line with expectations (330,00 and 65,000, respectively), so the problems were mix- and expense-related. For instance, gross degree revenue grew 15% year over year, but discounting reduced the net yield. The discounts, such as scholarships or grants to associate degree graduates, are a legitimate retention tool, which will pay off longer term, but the impact is being felt now.
The crux of the call was the company's issues surrounding marketing, which affects the new starts. Although new starts of 65,000 met Street expectations, management admitted that a 6.2% level of growth would be inadequate to drive the level of revenue growth Apollo is targeting. For comparison, starts grew 9.9% last quarter.
Management blamed the slow start growth on the ongoing switch of online marketing from ad.com to the newly acquired Aptimus operation. Early in the quarter, the company felt that the analytics delivered by Aptimus were not adequate for managing and controlling the affiliates. By late February, the issues were resolved, and Apollo ramped ad spending aggressively. (February ad spend was up 25% year over year, and back-end loaded to late in the month.) Management indicated March lead-gen performance is satisfactory, so perhaps this issue is transitory.
On the expense side, the company front-end loaded hiring of enrollment counselors for sections of the country where it is expanding aggressively, such as the Midwest or Southeast. Apollo hired 550 out of a targeted 750, so naturally those folks will require some time to ramp to full productivity. The result was a cost per start of $2,700, materially higher than in past quarters. Advertising cost/start is stable, so the higher enrollment counselor drove all this increase.
Management expects the cost/start to decline in coming quarters as the hiring binge is absorbed.
Additional spending is expected to offset some savings that the company is generating in instructional costs and better pricing from certain vendors.
Apollo is building out 25 new resource centers based on the successful prototype introduced in Plano, Texas last year. The Insight high school chain is ramping quickly as it gains more state approvals. Insight should be operating in 10 states by the fall, up from four now. Finally, management is also testing various other retention initiatives that are impacting SG&A.
Student financial aid is still a looming issue for Apollo, although the data presented on the call seemed pretty benign. Bad debt expense increased a bit, to 3.85% of revenue from 3.5% last year, due to more associate degree students. Initiatives in collections and retention should help here. Management pointed out that private lenders still only constitute 4% of total financial aid offered to students; 96% of aid is via Title IV federal lending. The company added Bank of America
(BAC)
as a fifth preferred lender as of the end of February. If a financial aid crisis is brewing that could impact enrollments, the evidence for it is not here yet.
Net-net, there were few shocking revelations in the call commentary. Perhaps that makes the miss all the more shocking, as it is difficult to tie it to some new long-term development. Despite the stock already giving up 20% year to date, the selloff is justified by the level of "un-anticipation" of the miss -- no analysts were out detecting looming issues. Management was pretty far along in re-establishing its credibility after a huge upside last quarter. That credibility is now gone, of course, so the rebuilding process must begin anew.
APOL Preview: How's Bachelor Life?
A few investors are probably surprised that Apollo Group
(APOL)
would end up a victim of the credit crisis, until one considers that the vast majority of its students require financial aid to pay tuition. The stock is down 17% year-to-date despite reporting outstanding upside in the last quarter.
The fear manifesting itself in the stock this winter may be justified; recently, four private lenders announced their intention to exit the student loan business. Student loans to Harvard grads may be considered "prime" loans, whereas loans to University of Phoenix grads are closer to the Alt-A or subprime category.
Last quarter, management noted that most financial aid flows through the federal Title IV program, so is essentially low-risk financing. Only 4% of revenue is funded with private loans. If management reiterates this data and can convince investors that there aren't other hidden traps in the financing structure, there is potential for a nice short-covering rally.
The Street is expecting 52 cents EPS on $704 million in revenue, with enrollment growth in the 8% to 10% range. This level of revenue growth should enable the operating leverage story to continue, although analysts will contemplate whether normal holiday break seasonality this quarter is just seasonality or the start of a slowdown.
Investors will want to see some improvement in bachelor program enrollment starts, which are struggling lately. Cannibalization by Axia is a proximate cause. The offset will be Axia graduations into the full University of Phoenix program, so analysts will probe on the retention rate.
The call starts at 5:00 p.m. EDT.
At the time of publication, Dvorchak had no positions in the stocks mentioned, although positions can change at any time.
Gary Dvorchak is a managing partner of Aviance Capital Management, a Sarasota, Fla.-based institutional asset manager that manages $200 million in growth and value equities and fixed income. Dvorchak holds a master's degree in business administration from Northwestern University and a bachelor's degree in computer science from the University of Iowa.
