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The following selected consolidated financial and operating data are qualified by reference to and should be read in conjunction with the consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The statement of income data for the years ended August 31, 2004, 2003, and 2002, and the balance sheet data as of August 31, 2004 and 2003, were derived from the audited consolidated financial statements, included herein. Diluted income per share and diluted weighted average shares outstanding have been retroactively restated for stock splits.

We did not pay any cash dividends on our common stock during any of the periods set forth in the table above.

This Annual Report, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements. The words “believes,” “expects,” “anticipates,” “estimates,” “plans,” and other similar statements of expectations identify forward-looking statements. Forward-looking statements are inherently uncertain and subject to risks. Such statements should be viewed with caution. Forward-looking statements in this Annual Report and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” include, but are not limited to, statements such as: 1) total purchases of property and equipment for the year ended August 31, 2005, are expected to range from $90 to $100 million; 2) we anticipate that these seasonal trends in the second and fourth quarters will continue in the future; 3) while the outcome of these legal proceedings are uncertain, management does not expect a material adverse effect on the Company’s business, financial position, results of operations, or cash flows to result from these actions; and 4) University of Phoenix currently plans on opening seven to nine new campuses during 2005. These forward-looking statements are based on our estimates, projections, beliefs, and assumptions and speak only as of the date made and are not guarantees of future performance.

Future events and actual results could differ materially from those set forth in the forward-looking statements as a result of many factors. Statements in this Annual Report, including “Notes to Consolidated Financial Statements” and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” describe factors, among others, that could contribute to or cause such differences. Additional factors that could cause actual results to differ materially from those expressed in such forward-looking statements include, without limitation: 1) new or revised interpretations of regulatory requirements that are or may become applicable to us; 2) changes in or new interpretations of applicable laws, rules, and regulations; 3) failure to maintain or renew required regulatory approvals, accreditation, or state authorizations by University of Phoenix or certain Institute for Professional Development client institutions; 4) failure to obtain authorizations from states in which University of Phoenix does not currently provide degree programs; 5) failure to obtain approval from The Higher Learning Commission for University of Phoenix to operate in new states; 6) our ability to continue to attract and retain students; 7) our ability to successfully defend litigation claims; 8) our ability to protect our intellectual property and proprietary rights; 9) our ability to recruit and retain key personnel; 10) our ability to successfully manage economic conditions, including stock market volatility; and 11) other factors set forth in this Annual Report. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this report will prove to be accurate. We undertake no obligation to publicly update or revise any forward-looking statements, or any facts, events, or circumstances after the date hereof that may bear upon forward-looking statements. You are advised, however, to consult any further disclosures we make in our reports filed with the Securities and Exchange Commission.

Apollo Group, Inc. has been providing higher education to working adults for over 25 years. We operate through our subsidiaries, The University of Phoenix, Inc., Institute for Professional Development, The College for Financial Planning Institutes Corporation, and Western International University, Inc. We currently offer our programs and services at 82 campuses and 137 learning centers in 39 states, Puerto Rico, and Vancouver, British Columbia. Our combined degree enrollment at August 31, 2004 was approximately 255,600. University of Phoenix is our largest subsidiary, with its tuition revenues currently representing approximately 95% of consolidated tuition revenues.

University of Phoenix had degree enrollments of approximately 227,800 adult students at August 31, 2004. University of Phoenix has successfully replicated its teaching/learning model while maintaining educational quality at 55 local campuses and 102 learning centers in 33 states, Puerto Rico, and Vancouver, British Columbia. University of Phoenix plans to continue increasing its student base by growing existing locations and opening new campuses and learning centers throughout the United States and Canada. New locations are selected based on an analysis of various factors, including the population of working adults in the area, the number of local employers and their educational reimbursement policies, and the availability of

similar programs offered by other institutions. In 2004, nine new University of Phoenix campuses were opened. University of Phoenix currently plans on opening seven to nine new campuses during 2005. University of Phoenix also offers its educational programs worldwide through its computerized educational delivery system. We plan to continue expanding our distance education programs and services. We will also continue to respond to the changing educational needs of working adults and their employers by introducing new undergraduate and graduate degree programs as well as training programs.

We believe that the international market for our services is a major growth opportunity. The United States is the most common destination for international students studying abroad. We believe that more working adult students would opt for a U.S. education that does not involve living in the U.S. because they could do so without leaving their employment and incurring the high travel and living costs and stringent visa requirements associated with studying abroad. Our belief is supported by the fact that University of Phoenix Online has students located in more than 130 countries. In addition, many U.S. residents live and work in foreign countries and could benefit from the opportunity to continue their education while abroad. We will continue to conduct market and operations research in various foreign countries where we believe there might be a demand for our programs.

Our future success is highly dependent on our ability to obtain, maintain, or renew required regulatory approvals, accreditation, or state authorizations. We are subject to extensive private, federal, and state regulation. The Higher Education Act of 1965, as amended (“Higher Education Act”), and the related regulations govern all higher education institutions participating in Title IV programs. The Higher Education Act mandates specific additional regulatory responsibilities for each of the following components:


	•	the accrediting agencies recognized by the U.S. Department of Education;

	•	the federal government through the U.S. Department of Education; and

	•	state higher education regulatory bodies.

All higher education institutions participating in Title IV programs must be accredited by an association recognized by the U.S. Department of Education. The U.S. Department of Education reviews all participating institutions for compliance with all applicable standards and regulations under the Higher Education Act. Accrediting associations are required to include the monitoring of Title IV programs compliance as part of their accreditation evaluations under the Higher Education Act.

Our institutions are covered by regional accreditation, which provides the following:


	•	recognition and acceptance by employers, other higher education institutions, and governmental entities of the degrees and credits earned by students;

	•	qualification to participate in Title IV programs; and

	•	qualification for authorization in certain states.

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, for authorization to operate as a degree-granting institution. The loss of accreditation would significantly reduce demand for our programs as it would prohibit us from offering degrees and credits that are recognized and accepted by employers, other higher education institutions, and governmental entities. It would also render us ineligible to participate in federal financial aid programs.

The Higher Education Act and the related regulations adopted by the U.S. Department of Education also impose numerous requirements with which institutions participating in the Title IV programs must comply. Students at University of Phoenix, Western International University, and Institute for Professional Development client institutions may receive federal financial aid under the Title IV programs. The College for Financial Planning does not participate in Title IV programs because most of its students are enrolled in non-degree programs. The failure to comply with any of the Title IV requirements could result in adverse action by the U.S. Department of Education against us, including the termination of Title IV eligibility, the imposition of fines, or the imposition of liabilities by the U.S. Department of Education. Institute for Professional

Our institutions are required to have authorization to operate as degree-granting institutions in each state where they physically provide education programs. Depending on the state, the addition of a degree program not offered previously or the addition of a new location must be included in the institution’s accreditation and be approved by the appropriate state authorization agency. The failure to obtain authorization to operate in new states, to add new programs, or to add new locations would adversely effect our ability to expand our business.

From October 3, 2000, to August 27, 2004, we had a class of stock, University of Phoenix Online common stock, outstanding, that reflected the separate performance of University of Phoenix Online, a campus within University of Phoenix. On August 6, 2004, our Board of Directors authorized the conversion of each share of University of Phoenix Online common stock to shares of Apollo Education Group Class A common stock effective August 27, 2004. In accordance with the terms of our Articles of Incorporation, each outstanding share of University of Phoenix Online common stock was converted into 1.11527 shares of Apollo Education Group Class A common stock as of August 27, 2004. The conversion resulted in the issuance of approximately 16.6 million new shares of Apollo Education Group Class A common stock. In addition, each unexercised option to purchase University of Phoenix Online common stock at August 27, 2004, was converted to 1.0766 options to purchase Apollo Education Group Class A common stock. The conversion ratio was based upon the relative market values of Apollo Education Group Class A common stock and University of Phoenix Online common stock at the close of the market on August 12, 2004, prior to the announcement. The conversion resulted in a $114.2 million reduction to income available to Apollo Education Group common stock related to the premium paid to convert outstanding shares of University of Phoenix Online common stock to Apollo Education Group Class A common stock and a non-cash stock-based compensation charge of $123.5 million related to the conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options. We have delisted the University of Phoenix Online common stock and will no longer report separate financial statements for University of Phoenix Online.

Securities and Exchange Commission Financial Reporting Release No. 60 requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 2 of the “Notes to Consolidated Financial Statements” for the year ended August 31, 2004, included in this Annual Report, includes a summary of the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements. The following is a brief discussion of the more critical accounting policies and methods used by us.

Approximately 94% of our tuition and other net revenues during 2004 consist of tuition revenues. Tuition revenue is recognized on a weekly basis, pro rata over the period of instruction. Our tuition and other net revenues also include rEsource® fees, application fees, commissions from the sale of education-related products, other student fees, and other income. Our tuition and other net revenues vary from period to period based on several factors that include: 1) the aggregate number of students attending classes; 2) the number of classes held during the period; and 3) the weighted average tuition price per credit hour (weighted by program and location). University of Phoenix tuition revenues currently represent approximately 95% of consolidated tuition revenues. Institute for Professional Development tuition revenues consist of the contractual share of tuition revenues from students enrolled in related programs at its client institutions. Institute for Professional Development’s contracts with its respective client institutions generally have terms of five to ten years with provisions for renewal.

Our educational programs range in length from one-day seminars to degree programs lasting up to four years. Students in our degree programs generally enroll in a program of study that encompasses a series of five to six-week courses that are taken consecutively over the length of the program. Students are billed on a

course-by-course basis when the student first attends a session, resulting in the recording of a receivable from the student and deferred tuition revenue in the amount of the billing. The related revenue for each course, including that portion of tuition revenues to which we are entitled under the terms of our revenue-sharing contracts with Institute for Professional Development client institutions, is recognized on a pro rata basis over the period of instruction for each course. Fees for rEsource®, our online delivery method for course materials, are also recognized on a pro rata basis over the period of instruction. Application fee revenue and related costs are deferred and recognized on a pro rata basis over the period of the program. Seminars, continuing education programs, and many of the College for Financial Planning’s non-degree programs are usually billed in one installment with the related revenue also recognized on a pro rata basis over the period of instruction.

Tuition and other revenues are shown net of discounts relating to a variety of promotional programs. Such discounts totaled $62.3 million (3.3% of gross revenues), $38.9 million (2.8% of gross revenues), and $23.2 million (2.3% of gross revenues) in 2004, 2003, and 2002, respectively.

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. Estimates are used in determining our allowance for doubtful accounts and are based on our historical collection experience, current trends, and a percentage of our accounts receivable by aging category. In determining these percentages, we look at historical write-offs of our receivables. A significant change in the aging of our accounts receivable balances would have an effect on the allowance for doubtful accounts balance. Our accounts receivable are written-off once the account is deemed to be uncollectible. This typically occurs once we have exhausted all efforts to collect the account which includes collection attempts by company employees and outside collection agencies.

Our effective tax rates differ from the statutory rate primarily due to state taxes and the tax impact of tax-exempt interest income. The effective tax rate was 39.2%, 38.5%, and 39.4% in 2004, 2003, and 2002, respectively. Our future effective tax rates could be adversely affected by changes in the valuation of our deferred tax assets or liabilities or changes in tax laws or interpretations thereof. In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

We are subject to the possibility of various loss contingencies arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.

Our intangible assets primarily consist of approximately $37.1 million in unamortized cost in excess of fair value of assets purchased (i.e. goodwill) resulting from our acquisitions of Western International University and the College for Financial Planning. Intangible assets, including cost in excess of fair value of assets purchased, are reviewed for impairment on an annual basis or whenever events or circumstances indicate that the estimated fair value is less than the related carrying value. The carrying value of cost in excess of fair value of assets purchased is assessed for any permanent impairment by evaluating the operating performance and using valuation techniques such as future discounted cash flows of the underlying businesses. In assessing the recoverability of our goodwill and other intangibles we must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. If these

estimates or their related assumptions change in the future, we may be required to record non-cash impairment charges for these assets not previously recorded. The Company has selected August 31 as the date on which it will perform its annual goodwill impairment test. The Company performed its annual impairment test as of August 31, 2004, and concluded that no impairment charge was required.

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, as revised in December 2003, (“FIN No. 46”). FIN No. 46 requires that companies that control another entity through interests other than voting interests should consolidate the controlled entity. FIN No. 46 applies to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. For those arrangements entered into prior to February 1, 2003, the provisions of FIN No. 46 were required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN No. 46 to the end of the first interim or annual period ending after December 15, 2003, for those arrangements entered into prior to February 1, 2003. The related disclosure requirements are effective immediately. The adoption of FIN No. 46 had no effect on our financial condition or results of operations.

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

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

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

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

Tuition and other net revenues increased by 34.3% to $1.798 billion in 2004, from $1.340 billion in 2003, primarily due to a 27.8% increase in degree student enrollments and tuition price increases averaging four to six percent (depending on the geographic area and program) at University of Phoenix. Most of our University of Phoenix campuses, which include their respective learning centers, had increases in net revenues and degree student enrollments from 2003 to 2004.

Tuition and other net revenues for 2004 and 2003, consist primarily of $1.682 billion and $1.261 billion, respectively, of net tuition revenues from students enrolled in degree programs and $9.9 million and $10.9 million, respectively, of net tuition revenues from students enrolled in non-degree programs.

Instructional costs and services increased by 24.9% to $765.5 million in 2004, from $612.9 million in 2003, due primarily to direct costs necessary to support the increase in degree student enrollments such as employee compensation and related expenses, faculty compensation, classroom lease expenses, and financial aid processing costs which increased $59.5 million, $25.5 million, $15.4 million, and $13.1 million, respectively, and the $9.8 million settlement with the U.S. Department of Education related to the Department’s recent program review. Instructional costs and services as a percentage of tuition and other net revenues decreased to 42.5% in 2004, from 45.8% in 2003, due primarily to greater tuition and other net revenues being spread over the fixed costs related to centralized student services, partially offset by the $9.8 million settlement with the U.S. Department of Education related to the Department’s recent program review. We may not be able to leverage our recurring costs to the same extent as we face increased costs related to our expansion into new geographic markets.

Selling and promotional expenses increased by 40.7% to $383.1 million in 2004, from $272.3 million in 2003, due primarily to an increase in enrollment advisors’ compensation and related expenses of $56.1 million and additional advertising expenditures of $48.1 million. Selling and promotional expenses as a percentage of tuition and other net revenues increased to 21.3% in 2004, from 20.3% in 2003, primarily as a result of the increase in the cost of enrollment advisors as a percentage of revenue of 1.1% between years, due principally to an increase in the number of enrollment advisors.

General and administrative expenses increased by 31.5% to $88.1 million in 2004, from $67.0 million in 2003, due primarily to increased employee compensation and related expenses of $10.2 million and small

increases in various other costs. General and administrative expenses as a percentage of tuition and other net revenues decreased to 4.9% in 2004, from 5.0% in 2003, due primarily to greater tuition and other net revenues being spread over the fixed costs related to various centralized functions such as information services, corporate accounting, and human resources.

The conversion of University of Phoenix Online common stock on August 27, 2004, required us to record a stock-based compensation charge related to the conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options. As required by Emerging Issues Task Force No. 00-23 “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44,” we expect to recognize approximately $146.6 million of non-cash pre-tax stock-based compensation expense related to the conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options. We recognized approximately $123.5 million of the pre-tax stock-based compensation expense in the fourth quarter of 2004 and will recognize the remaining $23.1 million as the options vest through 2006.

Net interest income and other increased to $18.3 million in 2004, from $14.5 million in 2003. This increase was primarily attributable to the increase in cash equivalents and marketable securities between periods primarily as a result of the investment of cash flows from operations. Interest expense was $79,000 and $273,000 in 2004 and 2003, respectively.

Our effective income tax rate increased to 39.2% in 2004, from 38.5% in 2003, primarily as a result of a refund of state income taxes received during 2003.

Tuition and other net revenues increased by 32.7% to $1.340 billion in 2003, from $1.009 billion in 2002, primarily due to a 26.8% increase in degree student enrollments and tuition price increases averaging four to six percent (depending on the geographic area and program) at University of Phoenix. Most of our University of Phoenix campuses, which include their respective learning centers, had increases in net revenues and degree student enrollments from 2002 to 2003.

Tuition and other net revenues for 2003 and 2002, consist primarily of $1.261 billion and $951.9 million, respectively, of net tuition revenues from students enrolled in degree programs and $10.9 million and $11.8 million, respectively, of net tuition revenues from students enrolled in non-degree programs.

Instructional costs and services increased by 23.0% to $612.9 million in 2003, from $498.5 million in 2002, due primarily to direct costs necessary to support the increase in degree student enrollments such as employee compensation and related expenses, faculty compensation, classroom lease expenses, and financial aid processing costs which increased $42.1 million, $26.9 million, $13.5 million, and $1.9 million, respectively. Instructional costs and services as a percentage of tuition and other net revenues decreased to 45.8% in 2003, from 49.4% in 2002, due primarily to greater tuition and other net revenues being spread over the fixed costs related to centralized student services.

Selling and promotional expenses increased by 36.9% to $272.3 million in 2003, from $198.9 million in 2002, due primarily to an increase in enrollment advisors’ compensation and related expenses of $32.4 million, additional advertising expenditures of $32.0 million, and small increases in various other costs. Selling and promotional expenses as a percentage of tuition and other net revenues increased to 20.3% in 2003, from 19.7% in 2002, as a result of the increase in the cost of enrollment advisors as a percentage of revenue of 0.6%, due principally to an increase in the number of enrollment advisors.

General and administrative expenses increased by 15.0% to $67.0 million in 2003, from $58.3 million in 2002, due primarily to increased employee compensation and related expenses of $5.1 million and small increases in various other costs. General and administrative expenses as a percentage of tuition and other net revenues decreased to 5.0% in 2003, from 5.8% in 2002, due primarily to greater tuition and other net revenues being spread over the fixed costs related to various centralized functions such as information services, corporate accounting, and human resources.

Net interest income and other increased to $14.5 million in 2003, from $12.1 million in 2002. This increase was attributable to the increase in cash equivalents and marketable securities between periods primarily as a result of the investment of cash flows from operations. Interest expense was $273,000 and $450,000 in 2003 and 2002, respectively.

Our effective income tax rate decreased to 38.5% in 2003, from 39.4% in 2002. This decrease was due primarily to higher tax-exempt interest income, as well as a decrease in state income tax expense and a refund of state income taxes.

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

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

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

The following sections discuss the effects of changes in our balance sheets, cash flows, and commitments and contingencies on our liquidity and capital resources.

Cash and cash equivalents and marketable securities. Cash and cash equivalents and marketable securities were $809.6 million as of August 31, 2004, a decrease of $88.6 million or 9.9% from $898.2 million at August 31, 2003. The decrease was primarily a result of the repurchase of Apollo Education Group Class A common stock and University of Phoenix Online common stock of $443.5 million and $118.0 million, respectively, and capital expenditures of $113.3 million partially offset by cash provided by operating activities of $513.4 million, cash provided by the issuance of Apollo Education Group Class A common stock and University of Phoenix Online common stock of $36.2 million and $14.9 million, respectively, related to employee stock option exercises and employee stock purchases, and the proceeds received from the sale-leaseback of buildings of $31.3 million.

Restricted cash. The U.S. Department of Education requires that Title IV Program funds collected in advance of student billings be kept in a separate cash or cash equivalent account until the students are billed for that portion of their program. In addition, all Title IV Program funds received by us through electronic funds transfer are subject to certain holding period restrictions. These funds generally remain in these separate accounts for an average of 60 to 75 days from receipt. As of August 31, 2004, we had approximately $184.5 million in these separate accounts, which are reflected in the Consolidated Balance Sheets as restricted cash, to comply with these requirements. These restrictions on cash have not affected our ability to fund daily operations.

Capital expenditures. Capital expenditures increased to $113.3 million during 2004, primarily due to the purchase of land, two buildings, and the capital improvements to the buildings totaling $33.0 million for future University of Phoenix Online expansion, and normal recurring capital expenditures due to the overall increase in student and employee levels resulting from the growth in the business. In June 2004, the two buildings were sold for $31.3 million and are being leased back under a ten-year lease agreement. The gain of $13.0 million on the sale of the buildings will be recognized over the term of the lease. Excluding the costs related to the land

and buildings for future University of Phoenix Online expansion, capital expenditures increased to $80.3 million for 2004, from $55.8 million for 2003. Total purchases of property and equipment for the year ended August 31, 2005, are expected to range from $90 to $100 million. These expenditures will primarily be related to new campuses and learning centers and increases in normal recurring capital expenditures due to the overall increase in student and employee levels resulting from the growth in the business.

We expect that cash provided by operating activities may fluctuate in future periods as a result of several factors, including fluctuations in our operating results, accounts receivable collections, and the timing of tax and other payments.

Financial responsibility. The Title IV Regulations, as revised, require all higher education institutions to meet a minimum composite score to be deemed financially responsible by the U.S. Department of Education. If the minimum composite score of 1.0 is not met, an institution would fall under alternative standards and may lose its eligibility to participate in Title IV Programs. The maximum composite score is 3.0. As of August 31, 2004, University of Phoenix’s and Western International University’s composite scores were both 3.0. These requirements apply separately to University of Phoenix and Western International University and to each of the respective Institute for Professional Development client institutions, but not to us on a consolidated basis.

Accounts receivable, net. Accounts receivable, net was $146.5 million and $123.7 million as of August 31, 2004 and 2003, respectively. Days sales outstanding (“DSO”) in receivables, net as of August 31, 2004 and 2003, were 30 days and 34 days, respectively. Our accounts receivable and DSO are primarily affected by collections performance. Improved collections performance will result in reduced DSO.

Leases. We currently lease the majority of our administrative and educational facilities under operating lease agreements. In some cases, classes are held in the facilities of the students’ employers at no charge to us. Lease terms generally range from five to ten years with one to two renewal options for extended terms. Management expects that as these leases expire, they will be renewed or replaced by other leases in the normal course of business. We are required to make additional payments under operating lease terms for taxes, insurance, and other operating expenses incurred during the operating lease period. We also lease space from time to time on a short-term basis in order to provide specific courses or programs.

Contractual obligations and other long-term liabilities. As of August 31, 2004, future minimum cash payments due under contractual obligations, including our non-cancelable operating lease agreements, are as follows, in thousands:

(1) Amounts primarily consist of a deferred compensation payment due to our Founder.

Contingencies. On approximately October 12, 2004, a class action complaint was filed in the United States District Court for the District of Arizona, captioned Sekuk Global Enterprises et. al. v. Apollo Group, Inc. et. al., Case No. CV 04-2147 PHX NVW. Plaintiff, a shareholder of the Company who purchased its shares in August and September of 2004, filed this class action on behalf of itself and all shareholders of the Company who acquired their shares between March 12, 2004 and September 14, 2004, and seeks certification as a class and monetary damages in unspecified amounts. Plaintiff alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated under the Exchange Act, by the

Company for its issuance of allegedly materially false and misleading statements in connection with its failure to publicly disclose the contents of the U.S. Department of Education’s program review report. A second class action complaint making similar allegations was filed on or about October 18, 2004, in the United States District Court for the District of Arizona, captioned Christopher Carmona et. al. v. Apollo Group, Inc. et. al., Case No. CV 04-2204 PHX EHC. A third class action complaint making similar allegations was filed on or about October 28, 2004, in the United States District Court for the District of Arizona, captioned Jack B. McBride et. al. v. Apollo Group, Inc. et. al., Case No. CV 04-2334 PHX LOA. While the outcome of these legal proceedings are uncertain, management does not expect a material adverse effect on our business, financial position, results of operations, or cash flows to result from these actions.

On August 29, 2003, we were notified that a qui tam action had been filed against us in the United States District Court for the Eastern District of California by two current employees on behalf of themselves and the federal government. A qui tam action is a civil lawsuit brought by one or more individuals (a qui tam “relator”) for an alleged submission to the federal government of a false claim for payment. A qui tam action is always filed under seal and remains under seal until the U.S. Department of Justice decides whether to intervene in the litigation. When the Government declines to intervene in a qui tam action, as it has done in this case, the relators may elect to pursue the litigation on behalf of the Government and, if they are successful, receive a portion of the federal government’s recovery. The qui tam action alleges, among other things, violations of the False Claims Act 31 U.S.C. § 3729(a)(1) and (2), by University of Phoenix for submission of a knowingly false or fraudulent claim for payment or approval, and knowingly false records or statements to get a false or fraudulent claim paid or approved in connection with federal student aid programs, and asserts that University of Phoenix improperly compensates its employees. On or about October 20, 2003, a motion to dismiss the action was filed and was subsequently granted with leave to amend the complaint. Subsequently, a second amended complaint was filed on or about March 3, 2004. A motion to dismiss this amended complaint was filed on or about March 22, 2004, and the case was subsequently dismissed with prejudice. On June 11, 2004, an appeal was filed with the United States Ninth Circuit Court of Appeals. While the outcome of this legal proceeding is uncertain, management does not expect a material adverse effect on our business, financial position, results of operations, or cash flows to result from this action.

The U.S. Department of Education conducted a program review of University of Phoenix for the period of September 1998 through February 2004. In February 2004, the U.S. Department of Education released to us its program review report, in which the Department detailed proposed violations of federal law related to the improper tying of employee compensation to enrollment. The program review report explicitly invited and anticipated review and response by University of Phoenix. In September 2004, University of Phoenix reached an agreement with the U.S. Department of Education, which acknowledged no admission or concession of any liability, wrongdoing, or violation whatsoever by University of Phoenix, and settled all outstanding issues with the U.S. Department of Education, by payment to the U.S. Department of Education of $9.8 million. We are currently the subject of lawsuits filed by shareholders who allege violations of the securities laws related to these events.

On approximately September 26, 2003, a class action complaint was filed in the Superior Court of the State of California for the County of Orange, captioned Bryan Sanders et. al. v. University of Phoenix, Inc. et. al., Case No. 03CC00430. Plaintiff, a former academic advisor with University of Phoenix, filed this class action on behalf of himself and current and former academic advisors employed by us in the State of California and seek certification as a class, monetary damages in unspecified amounts, and injunctive relief. Plaintiff alleges that during his employment, he and other academic advisors worked in excess of 8 hours per day or 40 hours per week, and contend that we failed to pay overtime. Two status conferences have occurred and the parties are now in the process of discovery. While the outcome of this legal proceeding is uncertain, management does not expect a material adverse effect on our business, financial position, results of operations, or cash flows to result from this action.

this class action on behalf of themselves and current and former enrollment advisors employed by us in the State of California and sought certification as a class, monetary damages in unspecified amounts, and injunctive relief. Plaintiffs alleged that during their employment, they and other enrollment advisors worked in excess of 8 hours per day or 40 hours per week, and contend that we failed to pay overtime. In July 2003, the Court denied the plaintiffs’ motion to certify a class. The parties nonetheless have negotiated a settlement on a class-wide basis. The settlement was approved by the Court and provides for a maximum payment of $2.3 million, which was deposited with the disbursing agent in August 2004. Payments of approximately $1.8 million were disbursed in September 2004. In addition, an agreed upon payment of $450,000 was paid to plaintiffs’ attorneys in the class settlement. Twenty-five class members opted out of the class settlement. Two of these individuals’ claims have been resolved and releases obtained. Of the remaining 23 opt outs, 11 have filed claims for overtime wages.

In November 2002, two former enrollment advisors at University of Phoenix Online filed an administrative claim with the Wage & Hour Division of the Department of Labor that they were incorrectly classified as exempt employees and therefore owed unpaid overtime. The Wage & Hour Division conducted an investigation, but issued no determination. The matter was then transferred to the Department of Labor, Office of the Solicitor, which asserted that unpaid overtime was due to all enrollment advisors employed at University of Phoenix Online after November 2001. On June 16, 2004, the parties reached a negotiated resolution of these claims, which included a maximum payment of $2.9 million, inclusive of interest and liquidated damages, to current and former enrollment advisors.

Based on the negotiated University of Phoenix Online settlement with the Department of Labor, University of Phoenix entered into negotiations to convert University of Phoenix enrollment advisors to the same exempt status. On July 23, 2004, the parties reached a negotiated resolution for current and former enrollment advisors, employed at University of Phoenix after June 1, 2002, which included a maximum payment of $3.5 million, inclusive of interest and liquidated damages.

The U.S. Department of Education Office of the Inspector General (“OIG”) audited the administration of the federal student financial assistance programs in connection with educational programs provided pursuant to contractual arrangements between Institute for Professional Development and certain of its client institutions. In audit reports issued to eight client institutions, the OIG asserted that the client institutions violated the statutory prohibition on the use of incentive payments for recruiting by paying Institute for Professional Development a percentage of tuition revenue. The reports further suggest that Institute for Professional Development paid its employees in a manner that included incentive-based compensation even though Institute for Professional Development based its compensation plans for recruiters on factors or qualities that were not solely related to the success in securing enrollments. Additionally, the audit reports question the client institutions’ interpretation of the “12-hour rule.” In September 2004, Institute for Professional Development reached a negotiated settlement with the U.S. Department of Education for $4.4 million.

We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is 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.

Our Board of Directors had previously authorized a program allocating up to $300 million of our funds to repurchase shares of Apollo Education Group Class A common stock and, during the period it was outstanding, University of Phoenix Online common stock. On June 25, 2004, an additional $500 million was approved bringing the total funds authorized for repurchase as of August 31, 2004, to $800 million. As of August 31, 2004, we had repurchased approximately 15,933,000 shares of Apollo Education Group Class A common stock at a total cost of approximately $558.8 million and 2,025,000 shares of University of Phoenix Online common stock at a total cost of $132.0 million. On October 1, 2004, our Board of Directors authorized a program allocating up to an additional $500 million of our funds to repurchase shares of Apollo Education

Based on past performance and current expectations, we believe that our cash and cash equivalents, marketable securities, and cash generated from operations will satisfy our working capital needs, capital expenditures, stock repurchases, commitments, and other liquidity requirements associated with our existing operations through at least the next 12 months. We believe that the most strategic uses of our cash resources include repurchase of shares and start-up costs associated with new campuses. There are no transactions, arrangements, and other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of our requirements for capital.

At August 31, 2004, we had no outstanding borrowings on our $10.0 million line of credit. Borrowings under the line of credit bear interest at LIBOR plus .75% or prime at our election. The line of credit is renewable annually, and any amounts borrowed under the line are payable upon its termination in February 2006.

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

We have audited the accompanying consolidated balance sheet of Apollo Group, Inc. and subsidiaries (the “Company”) as of August 31, 2004, and the related consolidated statements of income, other comprehensive income, shareholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Apollo Group, Inc. and subsidiaries as of August 31, 2004, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of income, of comprehensive income, of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of Apollo Group, Inc. and its subsidiaries at August 31, 2003, and the results of their operations and their cash flows for each of the two years in the period ended August 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of Apollo Group, Inc.’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States), which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

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

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY



	Common Stock


											University of
	Apollo Education Group										Phoenix Online


	Class A Nonvoting					Class B Voting					Nonvoting
																Additional
				Stated					Stated					Stated		Paid-In
	Shares			Value		Shares			Value		Shares			Value		Capital


	(In thousands)
Balance at August 31, 2001		171,355		$	103		484		$	1		12,596		$	—	$	185,424
Stock issued under stock purchase plans		112										156					4,191
Stock issued under stock option plans		1,680										1,894					7,631
Tax benefits of stock options exercised																	30,037
Stock issued to Apollo Education Group Class B shareholders		242
Fractional shares paid out in connection with stock split		(3	)														(128	)
Treasury stock purchases		(165	)									(390	)
Currency translation adjustment
Net income

Balance at August 31, 2002		173,221			103		484			1		14,256			—		227,155
Stock issued under stock purchase plans		94										118					6,008
Stock issued under stock option plans		2,106										1,436					14,113
Tax benefits of stock options exercised																	46,374
Treasury stock purchases		(141	)									(151	)
Conversion of Apollo Education Group Class B common stock to Apollo Education Group Class A common stock		6					(7	)
Currency translation adjustment
Net income

Balance at August 31, 2003		175,286			103		477			1		15,659			—		293,650
Stock issued under stock purchase plans		73										77					4,154
Stock issued under stock option plans		1,300										616					3,098
Tax benefits of stock options exercised																	39,590
Treasury stock purchases		(5,674	)									(1,484	)
Conversion of University of Phoenix Online common stock to Apollo Education Group Class A common stock		16,582										(14,868	)				(549,395	)
Stock dividends paid																	114,155
Stock-based compensation																	123,535
Currency translation adjustment
Net income

Balance at August 31, 2004		187,567		$	103		477		$	1		—		$	—	$	28,787

[Continued from above table, first column(s) repeated]



							University of
	Apollo Education Group						Phoenix Online


	Class A Treasury Stock						Treasury Stock									Accumulated
																Other			Total
				Stated						Stated			Retained			Comprehensive			Shareholders’
	Shares			Value			Shares			Value			Earnings			Income			Equity


	(In thousands)
Balance at August 31, 2001		5,789		$	(60,761	)		—		$	—		$	357,036		$	82		$	481,885
Stock issued under stock purchase plans		(112	)		1,196			(42	)		778									6,165
Stock issued under stock option plans		(1,680	)		17,881			(325	)		6,055									31,567
Tax benefits of stock options exercised																				30,037
Stock issued to Apollo Education Group Class B shareholders																				—
Fractional shares paid out in connection with stock split																				(128	)
Treasury stock purchases		165			(4,345	)		391			(7,359	)								(11,704	)
Currency translation adjustment																	21			21
Net income														161,150						161,150

Balance at August 31, 2002		4,162			(46,029	)		24			(526	)		518,186			103			698,993
Stock issued under stock purchase plans		(94	)		1,106															7,114
Stock issued under stock option plans		(2,106	)		24,008			(89	)		2,538									40,659
Tax benefits of stock options exercised																				46,374
Treasury stock purchases		141			(6,185	)		151			(6,613	)								(12,798	)
Conversion of Apollo Education Group Class B common stock to Apollo Education Group Class A common stock																				—
Currency translation adjustment																	(427	)		(427	)
Net income														247,010						247,010

Balance at August 31, 2003		2,103			(27,100	)		86			(4,601	)		765,196			(324	)		1,026,925
Stock issued under stock purchase plans		(73	)		2,057			(37	)		2,746									8,957
Stock issued under stock option plans		(1,300	)		27,264			(187	)		11,735									42,097
Tax benefits of stock options exercised																				39,590
Treasury stock purchases		5,674			(443,500	)		1,484			(117,996	)								(561,496	)
Conversion of University of Phoenix Online common stock to Apollo Education Group Class A common stock		(6,404	)		441,279			(1,346	)		108,116									—
Stock dividends paid														(114,155	)					—
Stock-based compensation																				123,535
Currency translation adjustment																	(241	)		(241	)
Net income														277,774						277,774

Balance at August 31, 2004		—		$	—			—		$	—		$	928,815		$	(565	)	$	957,141

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

Apollo Group, Inc. (“Apollo” or the “Company”), through its wholly-owned subsidiaries, The University of Phoenix, Inc. (“University of Phoenix”), Institute for Professional Development (“IPD”), The College for Financial Planning Institutes Corporation (the “College”), and Western International University, Inc. (“WIU”), has been providing higher education to working adults for over 25 years.

University of Phoenix is a regionally accredited, private institution of higher education offering associates, bachelors, masters, and doctoral degree programs in business, criminal justice, education, health care, human services, information technology, management, and nursing. University of Phoenix has 55 local campuses and 102 learning centers located in 33 states, Puerto Rico, and Vancouver, British Columbia. University of Phoenix also offers its educational programs worldwide through its computerized educational delivery system. University of Phoenix is accredited by The Higher Learning Commission (“HLC”) and is a member of the North Central Association of Colleges and Schools.

IPD provides program development and management services under long-term contracts to 23 regionally accredited private colleges and universities at 23 campuses and 32 learning centers in 23 states.

The College, located near Denver, Colorado, provides financial planning education programs, as well as regionally accredited graduate degree programs in financial planning, financial analysis, and finance.

WIU, which is accredited by HLC, currently offers undergraduate and graduate degree programs in Arizona.

The Company’s fiscal year is from September 1 to August 31. Unless otherwise stated, references to the years 2004, 2003, and 2002 relate to the fiscal years ended August 31, 2004, 2003, and 2002, respectively.

On March 24, 2000, our Board of Directors authorized the issuance of a new class of stock called University of Phoenix Online common stock, to reflect the separate performance of University of Phoenix Online, a campus within University of Phoenix. Our other businesses and our retained interest in University of Phoenix Online were subsequently referred to as “Apollo Education Group.” On October 3, 2000, an offering of 5,750,000 shares of University of Phoenix Online common stock was completed at a price of $14.00 per share. At the time of the offering this stock represented a 10.8% interest in that business with Apollo Education Group retaining the remaining 89.2% interest in University of Phoenix Online. This percentage subsequently decreased due to the issuance of shares related to the exercise of University of Phoenix Online stock options and the issuance of shares of University of Phoenix Online common stock as part of the Apollo Group, Inc. Employee Stock Purchase Plan, partially offset by the repurchase of shares of University of Phoenix Online common stock.

Apollo Group, Inc.’s Articles of Incorporation (“Articles”) gave us the right, at any time, to convert shares of University of Phoenix Online common stock to shares of Apollo Education Group Class A common stock. On August 6, 2004, our Board of Directors authorized the conversion of each share of University of Phoenix Online common stock to shares of Apollo Education Group Class A common stock effective August 27, 2004. In accordance with the terms of the Articles, each outstanding share of University of Phoenix Online common stock was converted into 1.11527 shares of Apollo Education Group Class A common stock as of August 27, 2004. The conversion ratio was based upon the relative market values of Apollo Education Group Class A common stock and University of Phoenix Online common stock averaged over the 20 trading days (July 9, 2004 through August 5, 2004) ending 5 trading days prior to August 12, 2004, the announcement date, and included a 10% premium on the value of University of Phoenix Online common stock, all as required by the terms of the Articles. The conversion resulted in the issuance of approximately 16.6 million new shares of Apollo Education Group Class A common stock. In addition, each

unexercised option to purchase University of Phoenix Online common stock at August 27, 2004, was converted to 1.0766 options to purchase Apollo Education Group Class A common stock. The conversion ratio was based upon the relative market values of Apollo Education Group Class A common stock and University of Phoenix Online common stock at the close of the market on August 12, 2004, prior to the announcement. As a result of the conversion of University of Phoenix Online common stock to Apollo Education Group Class A common stock, Apollo Group, Inc. will no longer report separate financial statements for University of Phoenix Online.

The conversion of University of Phoenix Online common stock required us to adjust net income attributable to Apollo Education Group common stock and University of Phoenix Online common stock by the premium paid to convert outstanding shares of University of Phoenix Online common stock to Apollo Education Group Class A common stock and to record a stock-based compensation charge related to the conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options.

As required by Statement of Financial Accounting Standards No. 128 Earnings per Share, the Company reduced income attributable to Apollo Education Group common stock in the fourth quarter of 2004 by $114.2 million related to the non-cash 10% premium paid to redeem the University of Phoenix Online common stock, as this premium is considered a benefit that constitutes an additional contractual return to University of Phoenix Online shareholders. The amount of the reduction to income attributable to Apollo Education Group common stock was calculated based on the number of University of Phoenix Online common stock shares outstanding and converted on August 27, 2004. This non-cash premium is included on the Consolidated Statements of Changes in Shareholders’ Equity and in the reconciliation of income attributable to Apollo Education Group common stock on the Consolidated Statements of Income as stock dividends paid.

As required by Emerging Issues Task Force No. 00-23, Issues Related to the Accounting for Stock Compensation under Accounting Principles Board (“APB”) Opinion No. 25 and Financial Accounting Standards Board (“FASB”) Interpretation No. 44, the Company expects to recognize approximately $146.6 million of non-cash pre-tax stock-based compensation expense related to the conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options, as the exchange of University of Phoenix Online employee stock options for Apollo Education Group employee and director stock options was accounted for as modification of the awards. The Company recognized approximately $123.5 million of the pre-tax stock-based compensation expense in the fourth quarter of 2004 and will recognize the remaining $23.1 million as the options vest through 2006.

The consolidated financial statements include the accounts of Apollo and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

The U.S. Department of Education requires that Title IV Program funds collected in advance of student billings be kept in a separate cash or cash equivalent account until the students are billed for that portion of their program. In addition, all Title IV Program funds received by the Company through electronic funds transfer are subject to certain holding period restrictions. These funds generally remain in these separate

accounts for an average of 60 to 75 days from date of receipt. Restricted cash is excluded from cash and cash equivalents in the Consolidated Statements of Cash Flows until the cash is transferred from these restricted accounts to the Company’s operating accounts. The Company’s restricted cash is invested primarily in municipal bonds, U.S. government sponsored enterprises, and auction market preferred stock with maturities of ninety days or less.

Investments in marketable securities such as municipal bonds and U.S. government sponsored enterprises are stated at amortized cost, which approximates fair value. It is the Company’s intention to hold its marketable securities until maturity. Investments in other long-term investments are carried at cost and are included in other assets in the Consolidated Balance Sheets.

Property and equipment is recorded at cost less accumulated depreciation. The Company capitalizes the cost of software used for internal operations once technological feasibility of the software has been demonstrated. Such costs consist primarily of custom-developed and packaged software and the direct labor costs of internally developed software. Depreciation is provided on all furniture, equipment, and related software using the straight-line method over the estimated useful lives of the related assets which range from three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful lives of the related assets. Maintenance and repairs are expensed as incurred.

Approximately 94%, 95%, and 95% of the Company’s tuition and other net revenues during the years ended August 31, 2004, 2003, and 2002, respectively, consist of tuition revenues. Tuition revenue is recognized on a weekly basis, pro rata over the period of instruction. Tuition and other net revenues also include rEsource® fees, application fees, commissions from the sale of education-related products, other student fees, and other income. Tuition and other net revenues vary from period to period based on several factors that include: 1) the aggregate number of students attending classes; 2) the number of classes held during the period; and 3) the weighted average tuition price per credit hour (weighted by program and location). University of Phoenix tuition revenues currently represent approximately 95% of consolidated tuition revenues. IPD tuition revenues consist of the contractual share of tuition revenues from students enrolled in related programs at its client institutions. IPD’s contracts with its respective client institutions generally have terms of five to ten years with provisions for renewal.

The Company’s educational programs range in length from one-day seminars to degree programs lasting up to four years. Students in the Company’s degree programs generally enroll in a program of study that encompasses a series of five to six-week courses that are taken consecutively over the length of the program. Students are billed on a course-by-course basis when the student first attends a session, resulting in the recording of a receivable from the student and deferred tuition revenue in the amount of the billing. The related revenue for each course, including that portion of tuition revenues to which the Company is entitled under the terms of its revenue-sharing contracts with IPD client institutions, is recognized on a pro rata basis over the period of instruction for each course. Fees for rEsource®, the Company’s online delivery method for course materials, are also recognized on a pro rata basis over the period of instruction. Application fee revenue and related costs are deferred and recognized on a pro rata basis over the period of the program. Seminars, continuing education programs, and many of the College’s non-degree programs are usually billed in one installment with the related revenue also recognized on a pro rata basis over the period of instruction.

Accounts receivable are reduced by an allowance for amounts that may become uncollectible in the future. Estimates are used in determining the allowance for doubtful accounts and are based on the Company’s historical collection experience, current trends, and a percentage of the Company’s accounts receivable by aging category. In determining these percentages, the Company looks at historical write-offs of its receivables. A significant change in the aging of the Company’s accounts receivable balances would have an effect on the allowance for doubtful accounts balance. The Company’s accounts receivable are written-off once the account is deemed to be uncollectible. This typically occurs once it has exhausted all efforts to collect the account which includes collection attempts by company employees and outside collection agencies.

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

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

At August 31, 2004 and 2003, the Company’s cost in excess of fair value of assets purchased (i.e. goodwill) related primarily to the acquisition of certain assets of the College and WIU. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 142, among other things, discontinues the requirement that goodwill resulting from purchase business combinations be amortized to expense over the related estimated useful life. Under this guidance, goodwill balances are subjected to an impairment analysis on an annual basis or whenever events or circumstances indicate that the estimated fair value is less than the related carrying value.

SFAS No. 142 requires that goodwill be tested for impairment using a two-step process. The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test must be performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

The Company adopted SFAS No. 142 effective September 1, 2001, and discontinued the amortization of goodwill as of that date. The Company has identified its various reporting units which consist of its wholly-owned subsidiaries, University of Phoenix, IPD, the College, and WIU. The Company has selected August 31 as the date on which it will perform its annual goodwill impairment test. The Company performed its annual impairment test as of August 31, 2004, and concluded that no impairment charge was required.

The carrying amount reported in the Consolidated Balance Sheets for cash and cash equivalents, restricted cash, marketable securities, accounts receivable, accounts payable, accrued liabilities, and student

deposits and deferred revenue approximate fair value because of the short-term nature of these financial instruments. The carrying value of the receivable from related party reasonably approximates its fair value as the stated interest rate approximates current market interest rates.

For the years ended August 31, 2003 and 2002, and the period between September 1, 2003 and August 27, 2004, the Company presented basic and diluted earnings per share for Apollo Education Group common stock and University of Phoenix Online common stock using the two-class method. The two-class method is an earnings allocation formula that determines the earnings per share for Apollo Education Group common stock and University of Phoenix Online common stock according to participation rights in undistributed earnings.

Basic earnings per share for Apollo Education Group common stock for these periods was calculated by dividing Apollo Education Group earnings (including its retained interest in University of Phoenix Online earnings) by the weighted average number of shares of Apollo Education Group Class A and Class B common stock outstanding. Diluted earnings per share was calculated similarly, except that it included the dilutive effect of the assumed exercise of options issuable under Apollo Group, Inc. incentive plans, exclusive of options granted with respect to University of Phoenix Online common stock.

Basic earnings per share for University of Phoenix Online common stock for these periods was calculated by dividing University of Phoenix Online earnings (excluding Apollo Education Group’s retained interest in University of Phoenix Online earnings) by the weighted average number of shares of University of Phoenix Online common stock outstanding. Diluted earnings per share was calculated similarly, except that it included the dilutive effect of the assumed exercise of options with respect to University of Phoenix Online common stock.

Beginning on August 28, 2004, the financial results of the Apollo Education Group common stock reflect the consolidated operations of the Apollo Group, Inc. Basic earnings per share is calculated using the weighted average number of Apollo Education Group Class A and Class B common shares outstanding during the period. Diluted income per share is calculated similarly except that it includes the dilutive effect of the assumed exercise of options issuable under Apollo Group, Inc. incentive plans.

Both basic and diluted weighted average shares have been retroactively restated for stock splits effected in the form of stock dividends. The amount of any tax benefit to be credited to additional paid-in capital related to the exercise of options is included when applying the treasury stock method to stock options in the computation of earnings per share.

The Company records rent expense using the straight-line method over the term of the lease agreement. Accordingly, deferred rental liabilities are provided for lease agreements that specify scheduled rent increases over the lease term. Rental deposits are provided for lease agreements that specify payments in advance or scheduled rent decreases over the lease term.

Selling and promotional costs consist primarily of compensation for enrollment advisors and corporate marketing, advertising costs, production of marketing materials, and other costs related to selling and promotional functions. The Company expenses selling and promotional costs as incurred.

Costs related to the start-up of new campuses and learning centers are expensed as incurred.

At August 31, 2004, the Company has four stock-based employee compensation plans, which are described more fully in Note 10. The Company applies the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for those plans. Stock-based employee compensation expense, except as previously discussed, is not reflected in the Consolidated Statements of Income as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), to stock-based employee compensation is as follows, in thousands, except per share amounts:


(1)	The University of Phoenix Online common stock was converted to Apollo Education Group Class A common stock effective August 27, 2004.

The effects of applying SFAS No. 123 in the above pro forma disclosures are not necessarily indicative of future amounts. The fair value of each option grant was estimated on the date of grant using the Black-Scholes method with the following weighted-average assumptions for grants for Apollo Education Group:

The fair value of each option grant was estimated on the date of grant using the Black-Scholes method with the following weighted-average assumptions for grants for University of Phoenix Online:


(1)	The University of Phoenix Online common stock was converted into Apollo Education Group Class A common stock effective August 27, 2004.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, as revised in December 2003, (“FIN No. 46”). FIN No. 46 requires that companies that control another entity through interests other than voting interests should consolidate the controlled entity. FIN No. 46 applies to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. For those arrangements entered into prior to February 1, 2003, the provisions of FIN No. 46 were required to be adopted at the beginning of the first interim or annual period beginning after June 15, 2003. However, in October 2003, the FASB deferred the effective date of FIN No. 46 to the end of the first interim or annual period ending after December 15, 2003, for those arrangements entered into prior to February 1, 2003. The related disclosure requirements are effective immediately. The adoption of FIN No. 46 had no effect on our financial condition or results of operations.

Bad debt expense was $26.9 million, $20.7 million, and $15.8 million for 2004, 2003, and 2002, respectively. Write-offs, net of recoveries, were $26.1 million, $17.4 million, and $16.3 million for 2004, 2003, and 2002, respectively.

Depreciation and amortization expense was $44.7 million, $41.0 million, and $35.1 million for 2004, 2003, and 2002, respectively.

Student deposits and current portion of deferred revenue consist of the following, in thousands:

In August 1998, the Company together with Hughes Network Systems and Hermes Onetouch, LLC (“Hermes”) formed Interactive Distance Learning, Inc. (“IDL”), a new corporation, to acquire One Touch Systems, a leading provider of interactive distance learning solutions. The Company contributed $10.7 million in October 1999 and $1.2 million in December 1999, in exchange for a 19% interest in the newly formed corporation. The Company accounted for its investment in IDL under the cost method. Hermes is currently owned by Dr. John G. Sperling, the founder and a director of the Company.

On December 14, 2001, Hermes acquired the Company’s investment in IDL in exchange for a promissory note in the principal amount of $11.9 million, which represented the related carrying value and approximated the related fair value as of that date. The promissory note accrues interest at an annual rate of six percent and is due at the earlier of December 14, 2021 or nine months after Dr. Sperling’s death. The promissory note is included in other assets in the Consolidated Balance Sheets as of August 31, 2004 and

2003. The carrying value of this receivable reasonably approximates its fair value as the stated interest rate approximates current market interest rates.

Effective July 15, 1999, the Company entered into contracts with Apollo International, Inc. to provide educational products and services in certain locations outside of the United States, Canada, and Puerto Rico. Dr. John G. Sperling is a director of Apollo International, Inc. Shares of Apollo International, Inc. stock are beneficially owned by the Company (2.6% for which we have paid $999,989) and by an investment entity controlled by Dr. John G. Sperling (30%). In addition, the Company has an option to acquire additional shares in Apollo International, Inc. The first educational offering under these agreements commenced in the Netherlands in September 1999, where approximately 60 students are enrolled. During the years ended August 31, 2004, 2003, and 2002, the Company received no revenue from Apollo International, Inc. for services rendered in connection with these contracts.

Effective September 2002, WIU entered into an agreement with Apollo International, Inc. that allows for WIU’s educational offerings to be made available in India. Apollo International, Inc. manages the relationship with the entities in India that are offering the WIU programs while WIU maintains the educational content of the programs. During the years ended August 31, 2004, 2003, and 2002, WIU received revenue totaling $37,000, $8,000, and $6,000, respectively, for services rendered in connection with this agreement.

Effective June 1, 1999, the Company entered into an agreement with Governmental Advocates, Inc. to provide consulting services to the Company with respect to matters concerning legislation, regulations, public policy, electoral politics, and any other topics of concern to it relating to state government in the state of California. Hedy Govenar, one of the Company’s directors, is the founder and Chairwoman of Governmental Advocates, Inc. On June 1, 2004, the Company renewed this agreement for an additional one year. Pursuant to the agreement, the Company paid consulting fees to Governmental Advocates, Inc. of $120,000 in 2004, 2003, and 2002.

The Company on occasion leases an airplane from Yo Pegasus, LLC, an entity controlled by Dr. John G. Sperling. Payments to this entity during the years ended August 31, 2004 and 2003, were $573,000 and $225,000, respectively. No payments were made to this entity during the year ended August 31, 2002.

At August 31, 2004, the Company had no outstanding borrowings on its $10.0 million line of credit. Borrowings under the line of credit bear interest at LIBOR plus .75% or prime at the Company’s election. Any amounts borrowed under the line are payable upon its termination in February 2006.

The undiscounted deferred compensation liability was $1.6 million at August 31, 2004 and 2003 and relates to the deferred compensation agreement between the Company and Dr. John G. Sperling executed in December 1993. The discount rate for this agreement was determined based on the estimated long-term rate of return on high-quality fixed income investments with cash flows similar to the agreement.

The related components of the income tax provision are as follows, in thousands:

The income tax provision differs from the tax that would result from application of the statutory U.S. federal income tax rate as follows:

The conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options resulted in a non-cash stock-based compensation charge of $123.5 million. This deferred compensation is not currently deductible for income tax purposes. Therefore, a deferred tax asset has been established based on the value of the vested, but unexercised options existing at August 31, 2004. The resulting deferred tax asset will be realized over subsequent years as the options are exercised.

Net deferred tax assets are reflected in the accompanying Consolidated Balance Sheets as follows, in thousands:

In light of the Company’s history of profitable operations, management has concluded that it is more likely than not that the Company will ultimately realize the full benefit of its deferred tax assets related to future deductible items. Accordingly, the Company believes that a valuation allowance is not required for its net deferred tax assets.

The Board of Directors of Apollo had previously authorized a program allocating up to $300 million in Company funds to repurchase shares of Apollo Education Group Class A common stock and, during the period it was outstanding, University of Phoenix Online common stock. On June 25, 2004 an additional $500 million was approved bringing the total funds authorized for repurchase as of August 31, 2004, to

$800 million. As of August 31, 2004, the Company had repurchased approximately 15,933,000 shares of Apollo Education Group Class A common stock at a total cost of approximately $558.8 million and 2,025,000 shares of University of Phoenix Online common stock at a total cost of $132.0 million. On October 1, 2004, the Board of Directors of Apollo authorized a program allocating up to an additional $500 million in Company funds to repurchase shares of Apollo Education Group Class A common stock. An additional 3,636,000 shares of Apollo Education Group Class A common stock were repurchased between September 1, 2004 and November 3, 2004 at a cost of approximately $259.0 million.

On April 4, 2002, the Board of Directors of Apollo authorized a 3-for-2 stock split of its Apollo Education Group Class A and Class B common stock to be affected in the form of a stock dividend. In connection with this split, holders of Apollo Education Group Class B common stock were issued one share of Apollo Education Group Class A common stock for every two shares of Apollo Education Group Class B common stock. All Apollo Education Group common stock amounts, Apollo Education Group common stock prices, and earnings per share figures for periods prior to the stock split have been restated to reflect the effect of the stock split.

Earnings attributable to different classes of the Company’s common stock are as follows, in thousands:

For the years ended August 31, 2004, 2003, and 2002, the earnings attributable to University of Phoenix Online common stock represent the portion of the earnings of University of Phoenix Online attributed to the shares of University of Phoenix Online common stock outstanding excluding Apollo Education Group’s retained interest in University of Phoenix Online. At the date of the issuance of the University of Phoenix Online common stock, Apollo Education Group retained an 89.2% interest in University of Phoenix Online. This percentage had decreased to 86.5% at August 27, 2004 (date of the conversion), due to the issuance of shares related to the exercise of University of Phoenix Online stock options and the issuance of shares of University of Phoenix Online common stock as part of the Apollo Group, Inc. Employee Stock Purchase Plan partially offset by the repurchase of shares of University of Phoenix Online common stock.

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

Basic earnings per share for Apollo Education Group common stock for the years ended August 31, 2004, 2003, and 2002, were computed by dividing Apollo Education Group earnings (including its retained interest in University of Phoenix Online earnings) by the weighted average number of Apollo Education Group common stock shares outstanding during the respective periods. Diluted earnings per share were calculated similarly, except that the dilutive effect of the assumed exercise of options issued under Apollo Group, Inc. incentive plans, exclusive of options granted and shares issued with respect to University of Phoenix Online common stock, is included.

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

Basic earnings per share of University of Phoenix Online common stock for the period from September 1, 2003, to August 27, 2004, and the years ended August 31, 2003 and 2002, were computed by dividing University of Phoenix Online earnings (excluding Apollo Education Group’s retained interest in University of Phoenix Online earnings) by the number of shares of University of Phoenix Online common stock outstanding during the respective periods. Diluted earnings per share were calculated similarly, except that the dilutive effect of the assumed exercise of options issued under Apollo Group, Inc. incentive plans with respect to University of Phoenix Online common stock, is included.

The Company provides various health, welfare, and disability benefits to its full-time, salaried employees which are funded primarily by Company contributions. The Company does not provide post-employment or post-retirement health care and life insurance benefits to its employees.

The Company sponsors a 401(k) plan for its employees which provides for salary reduction contributions by qualifying employees. Participant contributions are subject to certain restrictions as set forth in the Internal Revenue Code. Upon completion of one year of service and 1,000 hours worked the Company matches 30% of the eligible participant’s contributions. The Company’s matching contributions totaled $4.0 million, $3.2 million, and $3.5 million for 2004, 2003, and 2002, respectively.

The Company has four stock-based compensation plans: the Apollo Group, Inc., Second Amended and Restated Director Stock Plan (“Director Stock Plan”), the Apollo Group, Inc., Long-Term Incentive Plan (“LTIP”), the Apollo Group, Inc., Amended and Restated 2000 Stock Incentive Plan (“2000 Incentive Plan”), and the Apollo Group, Inc., Second Amended and Restated 1994 Employee Stock Purchase Plan (“Purchase Plan”).

The Director Stock Plan provided for an annual grant to the Company’s non-employee directors of options to purchase shares of the Company’s Apollo Education Group Class A common stock on September 1 of each year through 2003. Under the LTIP, the Company may grant options, incentive stock options, stock appreciation rights, and other stock-based awards in the Company’s Apollo Education Group Class A common stock to certain officers, key employees, or directors of the Company. Many of the options granted under the LTIP vest 25% per year. The vesting may be accelerated for individual employees if certain operational goals are met. Under the 2000 Incentive Plan, the Company may grant options, incentive stock options, stock appreciation rights, and other stock-based awards in the Company’s Apollo Education Group Class A common stock to certain officers, key employees, or directors of the Company. Prior to the conversion of University of Phoenix Online common stock to Apollo Education Group Class A common stock the Company had the ability to also grant options, incentive stock options, stock appreciation rights, and other stock-based awards for University of Phoenix Online common stock. Any unexercised University of Phoenix Online common stock options outstanding at August 27, 2004, were converted to options to purchase Apollo Education Group Class A common stock. Many of the options granted under the 2000 Incentive Plan vest over a four-year period. The vesting may be accelerated for individual employees if certain operational goals are met. The Purchase Plan allows employees of the Company to purchase shares of the Company’s Apollo Education Group Class A common stock and, during the period it was outstanding, University of Phoenix Online common stock, at quarterly intervals through periodic payroll deductions. The purchase price per share, in general, is 85% of the lower of 1) the fair market value (as defined in the Purchase Plan) on the enrollment date into the respective quarterly offering period or 2) the fair market value on the purchase date.

A summary of the activity related to stock options to purchase Apollo Education Group Class A common stock granted under the Director Stock Plan, the LTIP, and the 2000 Incentive Plan is as follows, in thousands, except per share amounts:

As part of the Company’s conversion of University of Phoenix Online common stock to Apollo Education Group Class A common stock, each unexercised option to purchase University of Phoenix Online common stock at August 27, 2004, was converted to 1.0766 options to purchase Apollo Education Group Class A common stock. The conversion ratio was based upon the relative market values of Apollo Education Group Class A common stock and University of Phoenix Online common stock at the close of the market on August 12, 2004, prior to the announcement. The issuance of these shares is shown in the table above as Converted from University of Phoenix Online common stock.

A summary of the activity related to stock options to purchase University of Phoenix Online common stock granted under the Director Stock Plan and the 2000 Incentive Plan is as follows, in thousands, except per share amounts:

The following table summarizes information about the stock options to purchase Apollo Education Group Class A common stock at August 31, 2004:

The Company is obligated under facility and equipment leases that are classified as operating leases. The following is a schedule of future minimum lease commitments as of August 31, 2004, in thousands:

Facility and equipment rent expense totaled $116.9 million, $99.8 million, and $85.3 million for 2004, 2003, and 2002, respectively.

On approximately October 12, 2004, a class action complaint was filed in the United States District Court for the District of Arizona, captioned Sekuk Global Enterprises et. al. v. Apollo Group, Inc. et. al., Case No. CV 04-2147 PHX NVW. Plaintiff, a shareholder of the Company who purchased its shares in August and September of 2004, filed this class action on behalf of itself and all shareholders of the Company who acquired their shares between March 12, 2004 and September 14, 2004, and seeks certification as a class and monetary damages in unspecified amounts. Plaintiff alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated under the Exchange Act, by the Company for its issuance of allegedly materially false and misleading statements in connection with its failure to publicly disclose the contents of the U.S. Department of Education’s program review report. A second class action complaint making similar allegations was filed on or about October 18, 2004, in the United States District Court for the District of Arizona, captioned Christopher Carmona et. al. v. Apollo Group, Inc. et. al., Case No. CV 04-2204 PHX EHC. A third class action complaint making similar allegations was filed on or about October 28, 2004, in the United States District Court for the District of Arizona, captioned Jack B. McBride et. al. v. Apollo Group, Inc. et. al., Case No. CV 04-2334 PHX LOA. While the outcome of these legal proceedings are uncertain, management does not expect a material adverse effect on the Company’s business, financial position, results of operations, or cash flows to result from these actions.

On August 29, 2003, the Company was notified that a qui tam action had been filed against it in the United States District Court for the Eastern District of California by two current employees on behalf of themselves and the federal government. A qui tam action is a civil lawsuit brought by one or more individuals (a qui tam “relator”) for an alleged submission to the federal government of a false claim for payment. A qui tam action is always filed under seal and remains under seal until the U.S. Department of Justice decides whether to intervene in the litigation. When the Government declines to intervene in a qui tam action, as it has done in this case, the relators may elect to pursue the litigation on behalf of the Government and, if they are successful, receive a portion of the federal government’s recovery. The qui tam action alleges, among other things, violations of the False Claims Act 31 U.S.C. § 3729(a)(1) and (2), by University of Phoenix for submission of a knowingly false or fraudulent claim for payment or approval, and knowingly false records or statements to get a false or fraudulent claim paid or approved in connection with federal student aid programs, and asserts that University of Phoenix improperly compensates its employees. On or about October 20, 2003, a motion to dismiss the action was filed and was subsequently granted with leave to amend the complaint. Subsequently, a second amended complaint was filed on or about March 3, 2004. A motion to dismiss this

amended complaint was filed on or about March 22, 2004, and the case was subsequently dismissed with prejudice. On June 11, 2004, an appeal was filed with the United States Ninth Circuit Court of Appeals. While the outcome of this legal proceeding is uncertain, management does not expect a material adverse effect on the Company’s business, financial position, results of operations, or cash flows to result from this action.

The U.S. Department of Education conducted a program review of University of Phoenix for the period of September 1998 through February 2004. In February 2004, the U.S. Department of Education released to the Company its program review report, in which the Department detailed proposed violations of federal law related to the improper tying of employee compensation to enrollment. The program review report explicitly invited and anticipated review and response by University of Phoenix. In September 2004, University of Phoenix reached an agreement with the U.S. Department of Education, which acknowledged no admission or concession of any liability, wrongdoing, or violation whatsoever by University of Phoenix, and settled all outstanding issues with the U.S. Department of Education, by payment to the U.S. Department of Education of $9.8 million. The Company is currently the subject of lawsuits filed by shareholders who allege violations of the securities laws related to these events.

On approximately September 26, 2003, a class action complaint was filed in the Superior Court of the State of California for the County of Orange, captioned Bryan Sanders et. al. v. University of Phoenix, Inc. et. al., Case No. 03CC00430. Plaintiff, a former academic advisor with University of Phoenix, filed this class action on behalf of himself and current and former academic advisors employed by the Company in the State of California and seek certification as a class, monetary damages in unspecified amounts, and injunctive relief. Plaintiff alleges that during his employment, he and other academic advisors worked in excess of 8 hours per day or 40 hours per week, and contend that the Company failed to pay overtime. Two status conferences have occurred and the parties are now in the process of discovery. While the outcome of this legal proceeding is uncertain, management does not expect a material adverse effect on the Company’s business, financial position, results of operations, or cash flows to result from this action.

On approximately December 19, 2001, a class action complaint was filed in the Superior Court of the State of California for the County of Solano, captioned Davis et. al. v. Apollo Group, Inc. et. al., Case No. FCS018663. Plaintiffs, one current and two former enrollment advisors with University of Phoenix, filed this class action on behalf of themselves and current and former enrollment advisors employed by the Company in the State of California and sought certification as a class, monetary damages in unspecified amounts, and injunctive relief. Plaintiffs alleged that during their employment, they and other enrollment advisors worked in excess of 8 hours per day or 40 hours per week, and contend that the Company failed to pay overtime. In July 2003, the Court denied the plaintiffs’ motion to certify a class. The parties nonetheless have negotiated a settlement on a class-wide basis. The settlement was approved by the Court and provides for a maximum payment of $2.3 million, which was deposited with the disbursing agent in August 2004. Payments of approximately $1.8 million were disbursed in September 2004. In addition, an agreed upon payment of $450,000 was paid to plaintiffs’ attorneys in the class settlement. Twenty-five class members opted out of the class settlement. Two of these individuals’ claims have been resolved and releases obtained. Of the remaining 23 opt outs, 11 have filed claims for overtime wages.

The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is uncertain, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

The Company operates exclusively in the educational industry providing higher education to working adults. The Company’s operations are aggregated into two reportable operating segments: the University of Phoenix segment and the Other Schools segment. Both segments are comprised of educational operations conducted in similar markets and produce similar economic results. The Company’s operations are also subject to a similar regulatory environment, which includes licensing and accreditation. The Other Schools segment includes its other subsidiaries; Institute for Professional Development, Western International University, and the College for Financial Planning, which are not material to the Company’s overall results.

The Company’s reportable segments have been determined based on the method by which management evaluates performance and allocates resources. Management evaluates performance based on subsidiary profit. This measure of profit includes charges allocating all corporate support costs to each segment, as part of a general allocation, but, excludes interest income and certain revenue and unallocated corporate charges. The revenue and corporate charges which are not allocated to individual segments are included in the Corporate segment.

The accounting policies of each segment are consistent with those described in the summary of significant accounting policies in Note 2. Transactions between segments, which are not significant, are consummated on a basis intended to reflect the market value of the underlying services and are eliminated upon consolidation.

Our principal operations are located in the United States, and our results of operations and long-lived assets in geographic regions outside of the United States are not significant. During the years ended August 31, 2004, 2003, and 2002, no individual customer accounted for more than 10% of our consolidated revenues.

Summary financial information by reportable segment is as follows, in thousands:

The following table sets forth selected unaudited quarterly financial information for each of the Company’s last eight quarters.



		Year Ended August 31,

		2004			2003			2002			2001			2000


		(In thousands, except per share amounts)
Revenues:
	Tuition and other, net	$	1,798,423		$	1,339,517		$	1,009,455		$	769,474		$	609,997

Costs and expenses:
	Instructional costs and services		765,495			612,940			498,454			410,084			352,874
	Selling and promotional		383,078			272,348			198,889			150,311			96,491
	General and administrative		88,090			66,970			58,260			48,076			46,555
	Stock-based compensation		123,535

			1,360,198			952,258			755,603			608,471			495,920

Income from operations			438,225			387,259			253,852			161,003			114,077
Interest income and other, net			18,263			14,545			12,072			14,106			6,228

Income before income taxes			456,488			401,804			265,924			175,109			120,305
Provision for income taxes			178,714			154,794			104,774			67,292			49,114

Net income		$	277,774		$	247,010		$	161,150		$	107,817		$	71,191

Income attributed to Apollo Education Group common stock:
Net income		$	277,774		$	247,010		$	161,150		$	107,817		$	71,191
Stock dividends paid			(114,155	)
Income attributed to University of Phoenix Online common shareholders			(25,819	)		(15,308	)		(7,989	)		(3,304	)

Income attributed to Apollo Education Group common shareholders		$	137,800		$	231,702		$	153,161		$	104,513		$	71,191

Income attributed to University of Phoenix Online common stock:
Net income		$	25,819		$	15,308		$	7,989		$	3,304
Stock dividends paid			114,155

Income attributed to University of Phoenix Online common shareholders		$	139,974		$	15,308		$	7,989		$	3,304

Earnings per share attributed to Apollo Education Group common stock:
Diluted income per share		$	0.77		$	1.30		$	0.87		$	0.60		$	0.41

Diluted weighted average shares outstanding			178,897			177,637			175,697			174,001			172,447

Earnings per share attributed to University of Phoenix Online common stock:
Diluted income per share		$	8.19		$	0.93		$	0.53		$	0.24

Diluted weighted average shares outstanding			17,081			16,518			15,098			13,657



		August 31,

		2004		2003		2002		2001		2000


		(Dollars in thousands)
Balance Sheet Data:
Cash, cash equivalents, and restricted cash		$	428,982	$	564,068	$	395,489	$	203,829	$	95,593
Marketable securities			565,086		481,734		293,166		198,105		64,246

Total cash, cash equivalents, restricted cash, and marketable securities		$	994,068	$	1,045,802	$	688,655	$	401,934	$	159,839

Total assets		$	1,452,273	$	1,378,204	$	979,642	$	680,343	$	404,790

Current liabilities		$	465,438	$	335,223	$	264,314	$	182,200	$	131,089
Long-term liabilities			29,694		16,056		16,335		16,258		12,493
Shareholders’ equity			957,141		1,026,925		698,993		481,885		261,208

Total liabilities and shareholders’ equity		$	1,452,273	$	1,378,204	$	979,642	$	680,343	$	404,790

Operating Statistics:
Degree enrollments at end of year			255,600		200,100		157,800		124,800		100,900

Number of locations:
	Campuses		82		71		65		58		54
	Learning centers		137		121		111		102		96

Total number of locations			219		192		176		160		150



		Year Ended August 31,

		2004			2003			2002

Revenues:
	Tuition and other, net		100.0	%		100.0	%		100.0	%

Costs and expenses:
	Instructional costs and services		42.5			45.8			49.4
	Selling and promotional		21.3			20.3			19.7
	General and administrative		4.9			5.0			5.8
	Stock-based compensation		6.9

			75.6			71.1			74.9

Income from operations			24.4			28.9			25.1
Interest income and other, net			1.0			1.1			1.2

Income before income taxes			25.4			30.0			26.3
Provision for income taxes			10.0			11.6			10.3

Net income			15.4	%		18.4	%		16.0	%



	Payments Due by Period

	Less Than						More Than
Contractual Obligations	1 Year		1-3 Years		3-5 Years		5 Years		Total

Operating lease obligations	$	108,839	$	200,801	$	154,937	$	127,200	$	591,777
Contractual obligations		450		180						630
Other long-term obligations¹		3		34				1,600		1,637

Total	$	109,292	$	201,015	$	154,937	$	128,800	$	594,044



		August 31,

		2004			2003


		(Dollars in thousands)
ASSETS:
Current assets
	Cash and cash equivalents	$	244,519		$	416,452
	Restricted cash		184,463			147,616
	Marketable securities		248,343			235,962
	Receivables, net		146,497			123,728
	Deferred tax assets, net		10,020			9,098
	Income taxes receivable					842
	Other current assets		20,842			16,545

Total current assets			854,684			950,243
Property and equipment, net			169,377			119,057
Marketable securities			316,743			245,772
Cost in excess of fair value of assets purchased, net			37,096			37,096
Deferred tax assets, net			47,520			1,155
Other assets (includes receivable from related party of $13,820 in 2004 and $13,107 in 2003)			26,853			24,881

Total assets		$	1,452,273		$	1,378,204

LIABILITIES AND SHAREHOLDERS’ EQUITY:
Current liabilities
	Current portion of long-term liabilities	$	3,186		$	3,231
	Accounts payable		50,895			29,314
	Accrued liabilities		69,481			49,525
	Income taxes payable		11,856
	Student deposits and current portion of deferred revenue		330,020			253,153

Total current liabilities			465,438			335,223
Deferred tuition revenue, less current portion			528			942
Long-term liabilities, less current portion			29,166			15,114

Total liabilities			495,132			351,279

Commitments and contingencies
Shareholders’ equity
Preferred stock, no par value, 1,000,000 shares authorized; none issued
Apollo Education Group Class A nonvoting common stock, no par value, 400,000,000 shares authorized; 187,567,000 and 175,286,000 issued and outstanding at August 31, 2004 and 2003, respectively			103			103
Apollo Education Group Class B voting common stock, no par value, 3,000,000 shares authorized; 477,000 issued and outstanding at August 31, 2004 and 2003			1			1
University of Phoenix Online nonvoting common stock, no par value, 400,000,000 shares authorized; 15,659,000 issued and outstanding at August 31, 2003
Additional paid-in capital			28,787			293,650
Apollo Education Group Class A treasury stock, at cost, 2,103,000 shares at August 31, 2003						(27,100	)
University of Phoenix Online treasury stock, at cost, 86,000 shares at August 31, 2003						(4,601	)
Retained earnings			928,815			765,196
Accumulated other comprehensive loss			(565	)		(324	)

Total shareholders’ equity			957,141			1,026,925

Total liabilities and shareholders’ equity		$	1,452,273		$	1,378,204


			The Period from
			September 1, 2003 to			Year Ended August 31,
			August 27,
			2004(1)			2003			2002

University of Phoenix Online
	Net income, as reported		$	139,974		$	15,308		$	7,989
	Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects			(568	)		(514	)		(542	)

	Pro forma net income		$	139,406		$	14,794		$	7,447
	Earnings per share:
		Basic — as reported	$	8.85		$	1.01		$	0.60
		Basic — pro forma	$	8.81		$	0.98		$	0.56
		Diluted — as reported	$	8.19		$	0.93		$	0.53
		Diluted — pro forma	$	8.16		$	0.89		$	0.50



								Year Ended August 31,
		The Period from
		September 1, 2003 to August 27,
		2004						2003						2002

				Weighted						Weighted						Weighted
				Average		Per Share				Average		Per Share				Average		Per Share
		Income		Shares		Amount		Income		Shares		Amount		Income		Shares		Amount

Basic income per share		$	139,974		15,825	$	8.85	$	15,308		15,154	$	1.01	$	7,989		13,243	$	0.60
Effect of dilutive securities:
	Stock options				1,256						1,364						1,855

Diluted income per share		$	139,974		17,081	$	8.19	$	15,308		16,518	$	0.93	$	7,989		15,098	$	0.53


													Weighted
													Average
				Director			2000						Exercise Price
	LTIP			Stock Plan			Incentive Plan			Total			Per Share

Outstanding at August 31, 2001		5,429			637			1,429			7,495		$	10.331
Granted					182			2,003			2,185			26.056
Exercised		(980	)		(441	)		(261	)		(1,682	)		10.909
Canceled		(289	)					(178	)		(467	)		16.521

Outstanding at August 31, 2002		4,160			378			2,993			7,531			14.383
Granted					121			1,510			1,631			42.558
Exercised		(1,235	)		(197	)		(674	)		(2,106	)		13.355
Canceled		(48	)		(20	)		(237	)		(305	)		25.356

Outstanding at August 31, 2003		2,877			282			3,592			6,751			21.015
Granted					81			3,042			3,123			67.435
Exercised		(364	)		(104	)		(832	)		(1,300	)		24.417
Canceled		(28	)					(96	)		(124	)		30.929
Converted from University of Phoenix Online common stock					52			2,829			2,881			20.413

Outstanding at August 31, 2004		2,485			311			8,535			11,331			33.158

Exercisable at August 31, 2004		1,835			311			5,341			7,487

Available for issuance at August 31, 2004		899			—			3,776			4,675



	Options Outstanding						Options Exercisable

			Weighted Avg.		Weighted Avg.				Weighted Avg.
			Contractual		Exercise				Exercise
	Number		Years		Price		Number		Price
Range of Exercise Prices	Outstanding		Remaining		Per Share		Exercisable		Per Share

	(In thousands)						(In thousands)
$0.724 to $6.502		2,146		4.71	$	5.616		1,594	$	5.791
$7.741 to $14.840		2,543		5.04	$	11.502		2,137	$	11.610
$17.647 to $41.830		1,933		7.21	$	24.773		1,824	$	24.731
$41.890 to $60.900		2,707		8.71	$	53.254		1,777	$	50.199
$61.800 to $91.000		2,002		9.55	$	71.108		155	$	64.909

$0.724 to $91.000		11,331		7.02	$	33.158		7,487	$	23.831



	Operating Leases

	Facilities		Equipment

2005	$	107,337	$	1,502
2006		104,062		992
2007		95,255		492
2008		84,818		14
2009		70,105
Thereafter		127,200

	$	588,777	$	3,000



		2004												2003

		Aug. 31,			May 31,			Feb. 29,			Nov. 30,			Aug. 31,			May 31,			Feb. 28,			Nov. 30,
		2004			2004			2004			2003			2003			2003			2003			2002


		(In thousands, except per share amounts)
Revenues:
	Tuition and other, net	$	492,753		$	496,999		$	396,862		$	411,809		$	371,273		$	364,166		$	295,181		$	308,897

Costs and expenses:
	Instructional costs and services		213,478			196,026			181,104			174,887			168,243			159,345			143,249			142,103
	Selling and promotional		110,762			103,287			87,390			81,639			76,547			70,990			64,485			60,326
	General and administrative		24,546			22,849			20,087			20,608			17,106			17,015			16,702			16,147
	Stock-based compensation		123,535

			472,321			322,162			288,581			277,134			261,896			247,350			224,436			218,576

Income from operations			20,432			174,837			108,281			134,675			109,377			116,816			70,745			90,321
Interest income and other, net			4,646			4,886			4,574			4,157			3,649			3,853			3,509			3,534

Income before income taxes			25,078			179,723			112,855			138,832			113,026			120,669			74,254			93,855
Provision for income taxes			9,414			70,387			44,352			54,561			42,648			46,412			28,568			37,166

Net income		$	15,664		$	109,336		$	68,503		$	84,271		$	70,378		$	74,257		$	45,686		$	56,689

Income (loss) attributed to Apollo Education Group common stock:
Net income		$	15,664		$	109,336		$	68,503		$	84,271		$	70,378		$	74,257		$	45,686		$	56,689
Stock dividends paid			(114,155	)
Income attributed to University of Phoenix Online common shareholders			(6,210	)		(8,233	)		(5,459	)		(5,916	)		(4,869	)		(4,441	)		(3,079	)		(2,919	)

Income (loss) attributed to Apollo Education Group common shareholders		$	(104,701	)	$	101,103		$	63,044		$	78,355		$	65,509		$	69,816		$	42,607		$	53,770

Income attributed to University of Phoenix Online common stock:
Net income		$	6,210		$	8,233		$	5,459		$	5,916		$	4,869		$	4,441		$	3,079		$	2,919
Stock dividends paid			114,155

Income attributed to University of Phoenix Online common shareholders		$	120,365		$	8,233		$	5,459		$	5,916		$	4,869		$	4,441		$	3,079		$	2,919

Earnings (loss) per share attributed to Apollo Education Group common stock:
Diluted income (loss) per share		$	(0.59	)	$	0.56		$	0.35		$	0.44		$	0.37		$	0.39		$	0.24		$	0.30

Diluted weighted average shares outstanding			178,577			179,360			178,924			178,726			178,426			177,931			177,309			176,884

Earnings per share attributed to University of Phoenix Online common stock:
Diluted income per share		$	7.18		$	0.48		$	0.32		$	0.34		$	0.29		$	0.27		$	0.19		$	0.18

Diluted weighted average shares outstanding			16,763			17,226			17,149			17,186			16,949			16,742			16,395			15,985


	*Revenue recognition*


	*Allowance for doubtful accounts*


	*Income taxes*


	*Loss contingencies*