APOL Is in a Sorry State

Updated from 8:37 a.m. EDT on March 27.

Apollo Group's (APOL - commentary - Cramer's Take) 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.

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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.