e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2006


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 0-25232

APOLLO GROUP, INC.

(Exact name of registrant as specified in its charter)


ARIZONA (State or other jurisdiction of incorporation or organization)		86-0419443 (I.R.S. Employer Identification No.)

4615 EAST ELWOOD STREET, PHOENIX, ARIZONA 85040
(Address of principal executive offices, including zip code)

(480) 966-5394
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.


YES þ		NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Securities Exchange Act.


Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).


YES o		NO þ

AT APRIL 3, 2006, THE FOLLOWING SHARES OF STOCK WERE OUTSTANDING:


Apollo Education Group Class A common stock, no par value		172,295,000 Shares
Apollo Education Group Class B common stock, no par value		477,000 Shares

APOLLO GROUP, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX


		PAGE
PART I – FINANCIAL INFORMATION

Item 1. Financial Statements			1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			22
Item 3. Quantitative and Qualitative Disclosures about Market Risk			36
Item 4. Controls and Procedures			36

PART II – OTHER INFORMATION

Item 1. Legal Proceedings			36
Item 1A. Risk Factors			37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			37
Item 3. Defaults Upon Senior Securities			38
Item 4. Submission of Matters to a Vote of Security Holders			38
Item 5. Other Information			38
Item 6. Exhibits			38

SIGNATURES			39

EXHIBIT INDEX			40

EXHIBIT 3.1 –	Amended and Restated Articles of Incorporation of Apollo Group, Inc.
EXHIBIT 3.2 –	Amended and Restated Bylaws (as amended through March 2006) of Apollo Group, Inc.
EXHIBIT 15.1 –	Letter in Lieu of Consent
EXHIBIT 31.1 –	Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
EXHIBIT 31.2 –	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
EXHIBIT 32.1 –	Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EXHIBIT 32.2 –	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
EX-3.2
EX-15.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)


	February 28,			August 31,
(Dollars in thousands)	2006			2005
Assets:
Current assets
Cash and cash equivalents	$	20,539		$	145,607
Restricted cash		238,351			225,706
Marketable securities		97,801			224,112
Receivables, net		200,719			201,615
Deferred tax assets, net		17,565			14,991
Other current assets		19,738			23,058

Total current assets		594,713			835,089
Property and equipment, net		287,068			268,661
Marketable securities		76,079			97,350
Cost in excess of fair value of assets purchased, net		37,096			37,096
Deferred tax assets, net		32,193			35,756
Other assets (includes receivable from related party of $15,294 and $14,843 at February 28, 2006 and August 31, 2005, respectively)		28,003			28,993

Total assets	$	1,055,152		$	1,302,945

Liabilities and Shareholders’ Equity:
Current liabilities
Current portion of long-term liabilities	$	20,432		$	18,878
Accounts payable		44,879			40,129
Accrued liabilities		62,428			61,315
Income taxes payable		9,185			9,740
Student deposits and current portion of deferred revenue		391,914			387,910

Total current liabilities		528,838			517,972
Deferred tuition revenue, less current portion		359			351
Long-term liabilities, less current portion		84,537			77,748

Total liabilities		613,734			596,071

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; 188,002,000 issued at February 28, 2006 and August 31, 2005, and 172,205,000 and 179,184,000 outstanding at February 28, 2006 and August 31, 2005, 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 February 28, 2006 and August 31, 2005		1			1
Additional paid-in capital
Apollo Education Group Class A treasury stock, at cost, 15,797,000 and 8,818,000 shares at February 28, 2006 and August 31, 2005, respectively		(1,079,274	)		(645,742	)
Retained earnings		1,522,022			1,353,650
Accumulated other comprehensive loss		(1,434	)		(1,138	)

Total shareholders’ equity		441,418			706,874

Total liabilities and shareholders’ equity	$	1,055,152		$	1,302,945

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

APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)


	For the Three Months Ended				For the Six Months Ended
	February 28,				February 28,
(In thousands, except per share amounts)	2006		2005		2006		2005
Revenues:
Tuition and other, net	$	569,551	$	505,693	$	1,198,435	$	1,040,619

Costs and expenses:
Instructional costs and services		258,447		221,635		518,332		439,052
Selling and promotional		124,426		121,016		252,546		241,601
General and administrative		57,205		23,499		87,285		44,687

		440,078		366,150		858,163		725,340

Income from operations		129,473		139,543		340,272		315,279
Interest income and other, net		3,567		3,855		8,070		8,417

Income before income taxes		133,040		143,398		348,342		323,696
Provision for income taxes		52,405		56,284		136,933		127,051

Net income	$	80,635	$	87,114	$	211,409	$	196,645


Earnings per share attributed to Apollo Education Group common stock:

Basic income per share	$	0.46	$	0.47	$	1.20	$	1.06

Diluted income per share	$	0.46	$	0.47	$	1.19	$	1.04

Basic weighted average shares outstanding		173,496		183,742		175,800		185,056

Diluted weighted average shares outstanding		175,235		187,007		177,783		188,419

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

APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)


	Apollo Education Group Common Stock
												Apollo Education Group
	Class A Nonvoting				Class B Voting				Additional			Class A Treasury Stock									Accumulated Other			Total
			Stated				Stated		Paid-in						Stated			Retained			Comprehensive			Shareholders’
(In thousands)	Shares		Value		Shares		Value		Capital			Shares			Value			Earnings			Income			Equity

Six Months Ended February 28, 2005
Balance at August 31, 2004		187,567	$	103		477	$	1	$	28,787			—		$	—		$	928,815		$	(565	)	$	957,141
Treasury stock purchases													7,409			(542,988	)								(542,988	)
Stock issued under stock purchase plans		41								4,920			(38	)		2,757									7,677
Stock issued under stock option plans		394								(58,137	)		(1,313	)		95,047			(10,722	)					26,188
Tax benefits of stock options exercised										24,430															24,430
Currency translation adjustment																						(356	)		(356	)
Net income																			196,645						196,645

Balance at February 28, 2005		188,002	$	103		477	$	1	$	—			6,058		$	(445,184	)	$	1,114,738		$	(921	)	$	668,737


Six Months Ended February 28, 2006
Balance at August 31, 2005		188,002	$	103		477	$	1	$	—			8,818		$	(645,742	)	$	1,353,650		$	(1,138	)	$	706,874
Treasury stock purchases													8,092			(510,882	)								(510,882	)
Stock issued under stock purchase plans										(987	)		(75	)		5,187									4,200
Stock issued under stock option plans										(14,207	)		(1,038	)		72,163			(43,037	)					14,919
Tax benefits of stock options exercised										10,452															10,452
Stock-based compensation										18,529															18,529
Cancellation of former CEO’s stock options										(13,787	)														(13,787	)
Currency translation adjustment																						(296	)		(296	)
Net income																			211,409						211,409

Balance at February 28, 2006		188,002	$	103		477	$	1	$	—			15,797		$	(1,079,274	)	$	1,522,022		$	(1,434	)	$	441,418

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

APOLLO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)


	For the Six Months Ended
	February 28,
(In thousands)	2006			2005
Cash flows provided by (used for) operating activities:
Net income	$	211,409		$	196,645
Adjustments to reconcile net income to net cash provided by operating activities:
Stock-based compensation expense		10,983
Depreciation and amortization		32,100			25,093
Amortization of investment premiums		673			2,196
Provision for uncollectible accounts		39,883			18,919
Deferred income taxes		989			17,046
Tax benefits of stock options exercised					24,430
Excess tax benefits from stock-based compensation		(9,533	)
Cash received for tenant improvements		1,594			1,263
Changes in assets and liabilities
Receivables		(38,987	)		(43,660	)
Other assets		3,408			(4,132	)
Accounts payable and accrued liabilities		(9,647	)		(30,112	)
Income taxes		9,896			(26,076	)
Student deposits and deferred revenue		4,440			46,640
Other liabilities		3,058			1,689

Net cash provided by operating activities		260,266			229,941

Cash flows provided by (used for) investing activities:
Net additions to property and equipment		(15,350	)		(43,897	)
Development of land and buildings related to future Online expansion		(14,761	)
Purchase of marketable securities		(187,156	)		(18,961	)
Maturities of marketable securities		334,065			238,094
Purchase of restricted securities		(460,664	)		(173,731	)
Maturities of restricted securities		448,019			130,495
Purchase of other assets		(721	)		(1,253	)

Net cash provided by investing activities		103,432			130,747

Cash flows provided by (used for) financing activities:
Purchase of Apollo Education Group Class A common stock		(510,882	)		(542,988	)
Issuance of Apollo Education Group Class A common stock		19,119			33,865
Cash paid for cancellation of vested options		(6,240	)
Excess tax benefits from stock-based compensation		9,533

Net cash used for financing activities		(488,470	)		(509,123	)

Currency translation loss		(296	)		(356	)

Net decrease in cash and cash equivalents		(125,068	)		(148,791	)
Cash and cash equivalents at beginning of period		145,607			156,669

Cash and cash equivalents at end of period	$	20,539		$	7,878


Supplemental disclosure of non-cash investing activities
Tenant improvement allowances	$	10,777		$	7,795
Purchases of property and equipment included in accounts payable	$	15,510		$	4,960

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

APOLLO GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)

Note 1. Nature of Operations

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 almost 30 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 68 local campuses and 117 learning centers located in 34 states, Puerto Rico, Alberta, British Columbia, Netherlands, and Mexico. 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 38 learning centers in 25 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 is accredited by HLC, and currently offers undergraduate and graduate degree programs at local campuses in Arizona and through joint educational agreements in China and India. Axia College of Western International University offers associate degrees in business, criminal justice, general studies, health administration, and information technology worldwide through its computerized educational delivery system. The University of Phoenix board of directors and the Western International University board of directors have approved the transfer of Axia College from Western International University to University of Phoenix. On March 23, 2006, the Arizona State Board for Private Postsecondary Education confirmed that University of Phoenix had completed all necessary actions to transfer the Axia College programs, previously run by Western International University, to University of Phoenix, effective April 1, 2006.

This financial information reflects all adjustments, consisting only of normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. Unless otherwise noted, references to 2006 and 2005 refer to the periods ended February 28, 2006 and 2005, respectively.

Note 2. Significant Accounting Policies

Basis of presentation

The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the fiscal year ended August 31, 2005, included in the Company’s Form 10-K as filed with the Securities and Exchange Commission. The results of operations for the three-month and six-month periods ended February 28, 2006, are not necessarily indicative of the results to be expected for the entire fiscal year or any future period.

Principles of consolidation

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.

Cash and cash equivalents

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

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 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 and U.S. government-sponsored enterprises with maturities of 90 days or less. In 2005, the Company concluded that it was appropriate to reflect gross purchases and sales of these securities as investing activities in the Consolidated Statements of Cash Flows rather than reflecting the net change in restricted cash as an operating activity. Prior periods have been reclassified to provide consistent presentation. This revision in classification had no impact on the total assets, current assets, or net income of the Company.

Investments

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, other than auction-rate securities with auction or reset dates prior to the maturity date of the underlying security, 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

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.

Revenues, receivables, and related liabilities

Approximately 92.9% of the Company’s tuition and other net revenues during each of the six months ended February 28, 2006 and 2005, 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 fees for online delivery of course materials, 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 represented approximately 83.1% and 92.2% of consolidated tuition revenues during the six months ended February 28, 2006 and 2005, respectively. This decrease of University of Phoenix revenue as a percentage of total revenues is due to the significant increase in enrollment in associates degree programs at Axia College of Western International University between periods. Axia College began offering these programs in September 2004. 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 nine-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 the Company’s online delivery of 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.

2005, respectively, and $55.3 million (4.4% of gross revenues) and $49.0 million (4.5% of gross revenues) in the six months ended February 28, 2006 and 2005, respectively.

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 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.

Cost in excess of fair value of assets purchased

The Company’s cost in excess of fair value of assets purchased (i.e. goodwill) relates primarily to the acquisitions of the College and WIU. 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 the Company’s goodwill and other intangibles the Company 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, the Company 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, 2005, and concluded that no impairment charge was required.

Fair value of financial instruments

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.

Leases

The Company currently leases almost all of its administrative and educational facilities under operating lease agreements. Most lease agreements contain tenant improvement allowances, rent holidays, and/or rent escalation clauses. In instances where one or more of these items are included in a lease agreement, the Company records a deferred rent liability on the Consolidated Balance Sheets and amortizes the items on a straight-line basis over the term of the lease as additions or deductions to rent expense. 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. For leases with renewal options, the Company records rent expense and amortizes the leasehold improvements on a straight-line basis over the initial non-cancelable lease term (in instances where the lease term is shorter than the economic life of the asset) as the Company does not believe that the renewal of the option is reasonably assured. The Company is also 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.

The Company records leasehold improvements funded by landlord incentives or allowances under operating leases (“tenant improvement allowances”) as a leasehold improvement asset and deferred rent liability on the Consolidated Balance Sheets and as both an investing activity (addition to property and equipment) and a component of operating activities on the Consolidated Statements of Cash Flows. The Company also reflects cash reimbursements received for tenant improvement allowances during the periods presented as additions to property and equipment and an increase in operating activities in the Consolidated Statements of Cash Flows.

Rental deposits are provided for lease agreements that specify payments in advance or scheduled rent decreases over the lease term.

Selling and promotional costs

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.

Start-up costs

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

Stock-based compensation

On September 1, 2005, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“employee stock purchases”), based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of September 1, 2005, the first day of the Company’s fiscal year 2006. The Company’s Consolidated Financial Statements as of and for the three and six months ended February 28, 2006, reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the three and six months ended February 28, 2006, was $12.7 million and $18.5 million, respectively. There was no stock-based compensation expense related to employee stock options and employee stock purchases recognized during the three and six months ended February 28, 2005. See Note 9 for additional information.

SFAS 123(R) requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statement of Operations. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the intrinsic value method, no stock-based compensation expense had been recognized in the Company’s Consolidated Statement of Operations, other than as related to the conversion of University of Phoenix Online stock options into Apollo Education Group stock options, because the exercise price of the Company’s stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.

Stock-based compensation expense recognized in the Company’s Consolidated Statement of Operations for the first and second quarters of fiscal 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of August 31, 2005, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to August 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company changed its method of attributing the value of stock-based compensation to expense from the accelerated multiple-option approach to the straight-line single option method. Compensation expense for all share-based payment awards granted on or prior to August 31, 2005, will continue to be recognized using the accelerated multiple-option approach while compensation expense for all share-based payment awards granted subsequent to August 31, 2005, is recognized using the straight-line single-option method. As stock-based compensation expense recognized in the Consolidated Statement of Operations for the first and second quarters of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors.

Use of estimates

The preparation of financial statements in accordance with GAAP 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.

Recent accounting pronouncements

In March 2004, the FASB issued Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“EITF 03-1”). EITF 03-1 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB issued Staff Position EITF No. 03-1-1, which delays the effective date until additional guidance is issued for the application of the recognition and measurement provisions of EITF 03-1 to investments in securities that are impaired. The Company does not believe that the adoption of EITF 03-1 will have a material impact on its financial condition or results of operations.

In May 2005, the FASB issued Statement of Financial Accounting Standard No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154”). SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in nondiscretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. The Company plans to adopt SFAS 154 beginning in the first quarter of fiscal 2007.

Note 3. Balance Sheet Components

Marketable securities consist of the following, in thousands:


	February 28,				August 31,
	2006				2005
	Estimated		Amortized		Estimated		Amortized
Type	Market Value		Cost		Market Value		Cost

Classified as current:
Municipal bonds	$	59,600	$	59,845	$	120,822	$	121,310
U.S. government-sponsored enterprises		28,758		28,996		38,135		38,449
Auction-rate preferred stock		2,000		2,000		57,421		57,445
Corporate obligations		6,930		6,960		6,862		6,908

Total current marketable securities		97,288		97,801		223,240		224,112

Classified as noncurrent:
Municipal bonds due in 1-4 years		30,605		31,102		41,932		42,384
U.S. government-sponsored enterprises		36,047		38,000		46,199		47,994
Corporate obligations		6,083		6,977		6,086		6,972

Total noncurrent marketable securities		72,735		76,079		94,217		97,350

Total marketable securities	$	170,023	$	173,880	$	317,457	$	321,462

Receivables consist of the following, in thousands:


	February 28,			August 31,
	2006			2005

Trade receivables	$	227,377		$	220,753
Interest receivable		1,853			2,666

		229,230			223,419
Less allowance for doubtful accounts		(28,511	)		(21,804	)

Total receivables, net	$	200,719		$	201,615

Bad debt expense was $19.8 million and $9.9 million for the three months ended February 28, 2006 and 2005, respectively, and $39.9 million and $19.0 million for the six months ended February 28, 2006 and 2005, respectively. Write-offs, net of recoveries, were $17.4 million and $7.9 million for the three months ended February 28, 2006 and 2005, respectively, and $33.2 million and $14.9 million for the six months ended February 28, 2006 and 2005, respectively.

Property and equipment consist of the following, in thousands:


	February 28,			August 31,
	2006			2005

Furniture and equipment	$	291,273		$	277,471
Software		83,879			78,136
Leasehold improvements		101,509			99,847
Tenant improvement allowances		100,727			85,871
Land and buildings		34,329			15,113

		611,717			556,438
Less accumulated depreciation and amortization		(324,649	)		(287,777	)

Property and equipment, net	$	287,068		$	268,661

Depreciation and amortization expense was $18.6 million and $15.9 million for the three months ended February 28, 2006 and 2005, respectively, and $38.0 million and $31.0 million for the six months ended February 28, 2006 and 2005, respectively.

Accrued liabilities consist of the following, in thousands:


	February 28,		August 31,
	2006		2005

Faculty pay, bonuses, and employee related benefits	$	21,518	$	23,441
Accrued advertising		21,728		15,631
Other accrued liabilities		19,182		22,243

Total accrued liabilities	$	62,428	$	61,315

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


	February 28,		August 31,
	2006		2005

Student deposits	$	261,138	$	249,696
Current portion of deferred tuition revenue		125,549		131,900
Application fee revenue		5,227		6,314

Total student deposits and current portion of deferred revenue	$	391,914	$	387,910

Note 4. Related Party Transactions

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 acting Chairman of the Board 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 February 28, 2006, and August 31, 2005. The carrying value of this receivable reasonably approximates its fair value as the stated interest rate approximates current market interest rates.

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. 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%). 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. WIU received revenue of $18,000 and $16,000 during the three months ended February 28, 2006 and 2005, respectively, and $65,000 and $43,000 during the six months ended February 28, 2006 and 2005, 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, 2005, the Company renewed this agreement for an additional one year. Pursuant to the agreement, the Company paid consulting fees to Governmental Advocates, Inc. of $30,000 during the three-month periods ended February 28, 2006 and 2005, and $60,000 during the six-month periods ended February 28, 2006 and 2005.

The Company, on occasion, leases an airplane from Yo Pegasus, LLC, an entity controlled by Dr. John G. Sperling. Payments to this entity were $105,000 and $81,000 during the three-month periods ended February 28, 2006 and 2005, respectively, and $252,000 and $237,000 during the six-month periods ended February 28, 2006 and 2005, respectively.

Note 5. Long-Term Liabilities

Long-term liabilities consist of the following, in thousands:


	February 28,			August 31,
	2006			2005

Deferred compensation discounted at 7.5%	$	1,438		$	1,413
Deferred rent and other lease rebates		89,007			79,803
Deferred gain on sale-leasebacks and other contracts		12,896			13,757
Other long-term liabilities		1,628			1,653

Total long-term liabilities		104,969			96,626
Less current portion		(20,432	)		(18,878	)

Total long-term liabilities, net	$	84,537		$	77,748

The undiscounted deferred compensation liability was $1.6 million at February 28, 2006, and August 31, 2005, 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.

Note 6. Income Taxes

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


	For the Three Months Ended				For the Six Months Ended
	February 28,				February 28,
	2006		2005		2006		2005
Current:
Federal	$	36,652	$	43,342	$	111,225	$	90,917
State and other		8,385		8,693		24,719		19,088

Total current		45,037		52,035		135,944		110,005

Deferred:
Federal		6,484		3,737		870		14,993
State and other		884		512		119		2,053

Total deferred		7,368		4,249		989		17,046

Total provision for income taxes	$	52,405	$	56,284	$	136,933	$	127,051

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


	For the Three Months Ended						For the Six Months Ended
	February 28,						February 28,
	2006			2005			2006			2005
Statutory U.S. federal income tax rate		35.0	%		35.0	%		35.0	%		35.0	%
State income taxes, net of federal benefit		4.8	%		4.8	%		4.8	%		4.8	%
Other, net		-0.4	%		-0.5	%		-0.5	%		-0.5	%

Effective income tax rate		39.4	%		39.3	%		39.3	%		39.3	%

Deferred tax assets and liabilities consist of the following, in thousands:


	February 28,		August 31,
	2006		2005

Gross deferred tax assets:
Allowance for doubtful accounts	$	11,504	$	8,839
Deferred tuition revenue		677		882
Reserves		1,958		1,873
Stock-based compensation		30,798		39,139
Sale-leaseback		4,287		4,545
Deferred tenant improvement allowances		26,785		19,514
Other		8,605		6,143

Total gross deferred tax assets		84,614		80,935

Gross deferred tax liabilities:
Amortization of cost in excess of fair value of assets purchased		7,445		6,876
Depreciation of fixed assets		25,454		21,480
Other		1,957		1,832

Total gross deferred tax liabilities		34,856		30,188

Net deferred tax assets	$	49,758	$	50,747

The conversion of University of Phoenix Online stock options into Apollo Education Group Class A stock options resulted in non-cash stock-based compensation charges of $19.8 million and $123.5 million in 2005 and 2004, respectively. This deferred compensation is not currently deductible for income tax purposes. Therefore, a deferred tax asset was established based on the value of the vested, but unexercised, options existing at August 31, 2004. During the first six months of 2006, the net decrease in the deferred tax asset related to stock-based compensation was $8.3 million, as a result of the effect of options that were exercised or cancelled during the period that had previously been converted from University of Phoenix Online common stock options to Apollo Education Group common stock options, partially offset by the tax impact of SFAS 123(R). The remaining deferred tax asset will be realized over subsequent periods as options are exercised.

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


	February 28,		August 31,
	2006		2005

Current deferred tax assets, net	$	17,565	$	14,991
Noncurrent deferred tax assets, net		32,193		35,756

Net deferred tax assets	$	49,758	$	50,747

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.

Note 7. Common Stock

The Board of Directors of Apollo has previously authorized a program allocating up to $1.85 billion 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. While it was outstanding, the Company repurchased approximately 2,025,000 shares of University of Phoenix Online common stock at a total cost of $132.0 million. On December 9, 2005, the Board of Directors authorized a program allocating up to an additional $300 million of our funds to repurchase shares of Apollo Education Group Class A common stock. As of February 28, 2006, the Company had repurchased approximately 35,075,000 shares of Apollo Education Group Class A common stock at a total cost of approximately $1.9 billion. An additional 81,000 shares of Apollo Education Group Class A common stock were repurchased in March 2006 at a cost of approximately $4.0 million.

As of February 28, 2006, 3,025,000 shares of the Company’s treasury stock have been used to secure receivables between the Company and two of its subsidiaries.

Note 8. Earnings Per Share

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:


	For the Three Months Ended
	February 28,
	2006						2005
			Weighted						Weighted
			Average		Per Share				Average		Per Share
	Income		Shares		Amount		Income		Shares		Amount

Basic net income per share	$	80,635		173,496	$	0.46	$	87,114		183,742	$	0.47
Effect of dilutive securities:
Stock options				1,739						3,265

Diluted net income per share	$	80,635		175,235	$	0.46	$	87,114		187,007	$	0.47


	For the Six Months Ended
	February 28,
	2006						2005
			Weighted						Weighted
			Average		Per Share				Average		Per Share
	Income		Shares		Amount		Income		Shares		Amount

Basic net income per share	$	211,409		175,800	$	1.20	$	196,645		185,056	$	1.06
Effect of dilutive securities:
Stock options				1,983						3,363

Diluted net income per share	$	211,409		177,783	$	1.19	$	196,645		188,419	$	1.04

Basic earnings per share for Apollo Education Group common stock for the three and six months ended February 28, 2006 and 2005, were computed by dividing Apollo Education Group 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 is included.

Weighted average common shares outstanding, assuming dilution, includes the incremental effect of shares that would be issued upon the assumed exercise of stock options. For the three months ended February 28, 2006 and 2005, approximately 4,157,000 and 98,000, respectively, and for the six months ended February 28, 2006 and 2005, approximately 1,893,000 and 75,000, respectively, of the Company’s stock options outstanding were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than or equal to the average share price for the quarter, and, therefore, their inclusion would have been anti-dilutive. These options could be dilutive in the future if the average share price increases and is greater than the exercise price of these options.

Note 9. Employee and Director Benefit Plans

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.

401(k) plan

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 up to 15% of the participant’s gross compensation per paycheck. The Company’s matching contributions totaled $1.4 million and $1.1 million for the three months ended February 28, 2006 and 2005, respectively, and $2.6 million and $2.1 million for the six months ended February 28, 2006 and 2005, respectively.

Stock-based compensation plans

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. Third 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. No additional options are available for issuance under this plan.

Under the LTIP, the Company may grant non-qualified 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 non-qualified stock 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 non-qualified stock 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 the Company’s employees to purchase shares of Apollo Education Group Class A common stock at quarterly intervals through periodic payroll deductions at a price per share equal to 95% of the fair market value on the purchase date. Prior to the amendment and restatement of the Purchase Plan on October 1, 2005, the Apollo Group, Inc. Second Amended and Restated 1994 Employee Stock Purchase Plan (“Second Purchase Plan”) allowed the Company’s employees 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 a purchase price per share, in general, that was 85% of the lower of 1) the fair market value (as defined in the Second 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:


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

Outstanding at August 31, 2004		2,485			311			8,535			11,331		$	33.158
Granted								145			145			77.679
Exercised		(1,069	)		(45	)		(1,391	)		(2,505	)		16.969
Canceled		(52	)					(207	)		(259	)		46.241

Outstanding at August 31, 2005		1,364			266			7,082			8,712			38.167

Granted								1,835			1,835			64.056
Exercised		(431	)					(603	)		(1,034	)		14.437
Canceled		(6	)					(1,511	)		(1,517	)		60.728

Outstanding at February 28, 2006		927			266			6,803			7,996			42.903

Exercisable at February 28, 2006		749			266			4,331			5,346

Available for issuance at February 28, 2006		957						3,513			4,470

The following table summarizes information about the stock options to purchase Apollo Education Group Class A common stock at February 28, 2006:


	Options Outstanding						Options Exercisable
			Weighted Avg.		Weighted Avg.				Weighted Avg.
			Contractual		Exercise				Exercise
Range of	Number		Years		Price		Number		Price
Exercise Prices	Outstanding		Remaining		per Share		Exercisable		per Share
	(In thousands)						(In thousands)
$6.502-$14.840		2,049		4.13	$	10.035		1,872	$	9.946
$17.647-$41.920		1,951		6.00	$	29.756		1,922	$	29.578
$43.430-$63.790		2,343		8.33	$	62.087		768	$	60.510
$64.070-$80.710		1,609		7.99	$	71.501		740	$	71.337
$81.290-$91.000		44		3.38	$	88.243		44	$	88.243

$6.502-$91.000		7,996		6.59	$	42.903		5,346	$	33.412

Valuation and expense information under SFAS 123(R) and pro forma information under SFAS 123 for periods prior to fiscal 2006

On September 1, 2005, the Company adopted SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and directors including employee stock options and employee stock purchases related to the Purchase Plan based on estimated fair values. The following table summarizes stock-based compensation expense related to employee stock options and employee stock purchases under SFAS 123(R) for the time periods indicated, which was allocated as follows, in thousands:


	For the Three Months Ended		For the Six Months Ended
	February 28, 2006		February 28, 2006
Instructional costs and services	$	3,466	$	6,283
Selling and promotional		411		915
General and administrative		8,839		11,331

Stock-based compensation expense included in operating expenses		12,716		18,529

Tax benefit		5,010		7,284

Stock-based compensation expense related to employee stock options and employee stock purchases, net of tax	$	7,706	$	11,245

On January 11, 2006, Todd S. Nelson resigned as a director and an officer of the Company. As part of his Separation Agreement, the Company paid Mr. Nelson $32.7 million, a portion of which was in exchange for all of his outstanding vested and unvested options to purchase Company stock. This was accounted for as a cancellation of Mr. Nelson’s stock options under SFAS 123(R). The intrinsic value of the vested stock options ($6.2 million) and the acceleration of the stock-based compensation related to the non-vested stock options ($7.5 million) were accounted for as reductions in additional paid-in capital. Included in the general and administrative expense category during the three and six months ended February 28, 2006, is the stock-based compensation expense of $7.5 million related to the cancellation of Mr. Nelson’s stock options.

The table below reflects net income and basic and diluted net income per share for the three and six months ended February 28, 2006, compared with the pro forma information for the three and six months ended February 28, 2005, in thousands, except per share amounts:


	For the Three Months Ended						For the Six Months Ended
	February 28,						February 28,
	2006			2005			2006			2005
Net income(1)		N/A		$	87,114			N/A		$	196,645
Stock-based compensation expense related to employee stock options and employee stock purchases		(12,716	)		(6,856	)		(18,529	)		(13,868	)
Tax benefit		5,010			2,691			7,284			5,443

Stock-based compensation expense related to employee stock options and employee stock purchases, net of tax(2)		(7,706	)		(4,165	)		(11,245	)		(8,425	)

Net income, including the effect of stock-based compensation expense(1)	$	80,635		$	82,949		$	211,409		$	188,220

Basic net income per share(1)	$	0.46		$	0.47		$	1.20		$	1.06
Basic net income per share, including the effect of stock-based compensation expense(1)	$	0.46		$	0.45		$	1.20		$	1.02
Diluted net income per share(1)	$	0.46		$	0.47		$	1.19		$	1.04
Diluted net income per share, including the effect of stock-based compensation expense(1)	$	0.46		$	0.44		$	1.19		$	1.00

(1) Net income and net income per share prior to fiscal 2006 represents pro forma information based on SFAS 123 which does not include stock-based compensation expense for employee stock options and employee stock purchases because the Company did not adopt the recognition provisions of SFAS 123.

(2) Stock-based compensation expense prior to fiscal 2006 is calculated based on the pro forma application of SFAS 123.

As of February 28, 2006, total compensation cost related to nonvested stock options not yet recognized was $25.3 million, which is expected to be recognized over the next 15 months on a weighted-average basis.

The fair value of each option grant made during 2006 was estimated on the date of grant using the Black-Scholes method with the following weighted-average assumptions for grants for Apollo Education Group:


	For the Three Months Ended			For the Six Months Ended
	February 28, 2006			February 28, 2006
Dividend yield		0.0	%		0.0	%
Expected volatility		28.7	%		30.6	%
Risk-free interest rate		4.4	%		4.4	%
Expected lives (in years)		2.0			2.9
Weighted average fair value of options granted	$	11.92		$	16.49

The Company analyzed both its historical volatility and the implied volatility for two-year traded options on the Company’s stock to estimate the expected volatility consistent with SFAS 123(R) and SAB 107. Prior to the first quarter of fiscal 2006, the Company had used its historical stock price volatility in accordance with SFAS 123 for purposes of its pro forma information.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of the Company’s employee stock options. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.

The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding and has been determined based on an analysis of historical exercise behavior.

As stock-based compensation expense recognized in the Consolidated Statement of Operations for the first and second quarters of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. In the Company’s pro forma information required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for forfeitures as they occurred.

The fair value of each option grant made prior to 2006 was estimated on the date of grant using the Black-Scholes method with the following weighted-average assumptions for grants for Apollo Education Group:


	For the Three Months Ended			For the Six Months Ended
	February 28, 2005			February 28, 2005
Apollo Education Group
Dividend yield		0.0	%		0.0	%
Expected volatility		32.7	%		32.2	%
Risk-free interest rate		3.2	%		3.3	%
Expected lives (in years)		2.5			3.5
Weighted average fair value of options granted	$	19.22		$	21.21

The expected life and expected volatility of the stock options were based upon historical and other economic data trended into the future. Forfeitures of employee stock options were accounted for on an as-incurred basis.

Note 10. Commitments and 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. 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. The Court consolidated the three pending class action complaints and a consolidated class action complaint was filed on May 16, 2005 by the Lead Plaintiff. Lead Plaintiff purports to represent a class of the Company’s shareholders who acquired their shares between February 27, 2004, and September 14, 2004, and seeks monetary damages in unspecified amounts. Lead 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 their issuance of allegedly materially false and misleading statements in connection with their failure to publicly disclose the contents of the U.S. Department of Education’s program review report. A motion to dismiss the consolidated class action complaint was filed on June 15, 2005, on behalf of Apollo Group, Inc. and the individual named defendants. The Court denied the motion to dismiss on October 18, 2005. 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 August 29, 2003, the Company was notified that a qui tam action had been filed against it on March 7, 2003, in the United States District Court for the Eastern District of California by two current employees on behalf of themselves and the federal government. 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.

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 seeks 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 contends that the Company failed to pay overtime. On June 6, 2005, the court granted plaintiffs’ motion to remove Bryan Sanders as the named plaintiff and replace him with Deryl Clark and Romero Ontiveros. Plaintiff’s counsel has advised defendants and the court that Mr. Ontiveros no longer intends to serve as a named plaintiff. Five status conferences have occurred and the parties are now in the process of discovery. The court has granted defendants’ motion to transfer venue to the Superior Court of the State of California for the County of Solano. A management conference has been set for April 2006, and the Plaintiff’s motion to certify the class will be heard by the Court in May 2006. 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 Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcomes of these matters are uncertain, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

An unsecured letter of credit for Western International University, in the amount of $5.3 million, expiring in March 2007, is outstanding.

Note 11. Segment Reporting

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 three and six months ended February 28, 2006 and 2005, no individual customer accounted for more than 10% of our consolidated revenues.

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


	For the Three Months Ended					For the Six Months Ended
	February 28,					February 28,
	2006			2005		2006			2005
Tuition and other, net
University of Phoenix	$	463,239		$	455,967	$	993,167		$	954,443
Other Schools		106,245			49,357		204,929			85,124
Corporate		67			369		339			1,052

Total tuition and other, net	$	569,551		$	505,693	$	1,198,435		$	1,040,619


Income from operations:
University of Phoenix	$	112,329		$	131,014	$	295,299		$	299,671
Other Schools		26,031			8,228		56,031			14,668
Corporate		(8,887	)		301		(11,058	)		940

		129,473			139,543		340,272			315,279

Reconciling items:
Interest income and other, net		3,567			3,855		8,070			8,417

Income before income taxes	$	133,040		$	143,398	$	348,342		$	323,696

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of Apollo Group, Inc.
Phoenix, Arizona

We have reviewed the accompanying consolidated balance sheet of Apollo Group, Inc. and subsidiaries (the “Company”) as of February 28, 2006, and the related consolidated statements of income and of comprehensive income for the three-month and six-month periods ended February 28, 2006 and 2005, and of changes in shareholders’ equity and cash flows for the six-month periods ended February 28, 2006 and 2005. These interim financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Apollo Group, Inc. and subsidiaries as of August 31, 2005, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated November 10, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of August 31, 2005, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Deloitte & Touche LLP
Phoenix, Arizona
April 7, 2006

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand Apollo Group, Inc., our operations, and our present business environment. MD&A is provided as a supplement to—and should be read in conjunction with—our consolidated financial statements and the accompanying notes (“Notes”). This overview summarizes the MD&A, which includes the following sections:

	•		Forward-Looking Statements—cautionary information about forward-looking statements and a description of certain risks and uncertainties that could cause our actual results to differ materially from our historical results or our current expectations or projections.

	•		Our Business—a general description of our business and the education industry; our opportunities; and the challenges and risks of our business.

	•		Application of Critical Accounting Policies and Estimates—a discussion of accounting policies that require critical judgments and estimates and a summary of recent accounting pronouncements.

	•		Results of Operations—an analysis of our consolidated results of operations for the three-month and six-month periods presented in our consolidated financial statements. We operate in one business sector—education. Except to the extent that differences between our operating segments are material to an understanding of our business as a whole, we present the discussion in the MD&A on a consolidated basis.

	•		Liquidity, Capital Resources, and Financial Position—an analysis of cash flows, sources and uses of cash, commitments and contingencies, seasonality in the results of our operations, and the impact of inflation.

Forward-Looking Statements

This Form 10-Q, including MD&A, 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 Form 10-Q and MD&A include, but are not limited to, statements such as:

	•		University of Phoenix currently plans on opening seven to nine new campuses during 2006;

	•		tuition and other net revenues at University of Phoenix should begin to increase as a percentage of total revenues during the third quarter of 2006 as Axia College is transferred from Western International University to University of Phoenix;

	•		we anticipate that advertising spending will increase through the remainder of 2006 as we plan to spend more on lead generation;

	•		we anticipate the trend of higher information technology costs to continue during the remainder of 2006;

	•		total purchases of property and equipment for the year ended August 31, 2006, are expected to range from $100 to $120 million;

	•		we anticipate spending $103.0 million during 2006 and 2007 for the construction of a building for future Online expansion;

	•		while the outcomes of these audit 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;

	•		we anticipate that these seasonal trends in the second and fourth quarters will continue in the future; and

	•		while the outcomes 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.

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 Form 10-Q, including the Notes and MD&A, 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:

	•		new or revised interpretations of regulatory requirements that are or may become applicable to us;

	•		changes in, or new interpretations of, applicable laws, rules, and regulations;

	•		failure to maintain or renew any required regulatory approvals, accreditation, or state authorizations by University of Phoenix;

	•		failure to obtain authorizations from states in which University of Phoenix does not currently provide degree programs;

	•		our ability to continue to attract and retain students;

	•		our ability to successfully defend litigation claims;

	•		our ability to protect our intellectual property and proprietary rights;

	•		our ability to recruit and retain key personnel;

	•		our ability to successfully manage economic conditions, including stock market volatility; and

•

other factors set forth in this Form 10-Q.

In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this Form 10-Q 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.

Our Business

General

Apollo Group, Inc. has been providing higher education to working adults for almost 30 years. We operate through our subsidiaries: The University of Phoenix, Inc. (“University of Phoenix”), Institute for Professional Development, The College for Financial Planning Institutes Corporation (the “College for Financial Planning”), and Western International University, Inc. (“Western International University”). We currently offer our programs and services at 95 campuses and 159 learning centers in 39 states, Puerto Rico, Alberta, British Columbia, Netherlands, and Mexico. Our combined degree enrollment at February 28, 2006, was approximately 310,800. University of Phoenix is our largest subsidiary, with its tuition revenues representing approximately 83.1% of our consolidated tuition revenues during the six months ended February 28, 2006.

Our 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. Our operations are also subject to a similar regulatory environment, which includes licensing and accreditation. The Other Schools segment includes our other subsidiaries: Western International University, Institute for Professional Development, and the College for Financial Planning.

University of Phoenix is accredited by The Higher Learning Commission, and has been a member of the North Central Association of Colleges and Schools since 1978. University of Phoenix has successfully replicated its teaching/learning model while maintaining educational quality at 68 local campuses and 117 learning centers in 34 states, Puerto Rico, Alberta, British Columbia, Netherlands, and Mexico. University of Phoenix also offers its educational programs worldwide through its computerized educational delivery system. University of Phoenix has customized computer programs for student tracking, marketing, faculty recruitment and training, and academic quality management. These computer programs are intended to provide uniformity among University of Phoenix’s campuses and learning centers, which enhances University of Phoenix’s ability to expand into new markets while still maintaining academic quality.

Western International University is accredited by The Higher Learning Commission and currently offers undergraduate and graduate degree programs at local campuses in Arizona and through joint educational agreements in China and India. Axia College of Western International University offers associate degrees in business, criminal justice, general studies, health administration, and information technology worldwide through its computerized educational delivery system. The Axia College program is designed for students with little or no college experience and offers small classes of less than 20 students and dedicated faculty who are specially trained in facilitating the online learning experience.

The University of Phoenix board of directors and the Western International University board of directors have approved the transfer of Axia College from Western International University to University of Phoenix. On March 23, 2006, the Arizona State Board for Private Postsecondary Education confirmed that University of Phoenix had completed all necessary actions to transfer the Axia College programs, previously run by Western International University, to University of Phoenix, effective April 1, 2006.

Institute for Professional Development provides program development and management consulting services to regionally accredited private colleges and universities (“client institutions”) who are interested in expanding or developing their programs for working adults. These services typically include degree program design, curriculum development, market research, student recruitment, accounting, and administrative services. Institute for Professional Development provides these services at 23 campuses and 38 learning centers in 25 states in exchange for a contractual share of the tuition revenues generated from these programs. Institute for Professional Development’s contracts with its client institutions generally range in length from five to ten years with provisions for renewal.

The College for Financial Planning, located near Denver, Colorado, provides financial planning education programs, including the Certified Financial Planner Professional Education Program^™ certification, as well as regionally accredited graduate degree programs in financial planning, financial analysis, and finance. The College for Financial Planning also offers some of its non-degree programs at University of Phoenix campuses.

The Education Industry

We operate exclusively in the educational industry providing higher education to working adults. Working adults are a significant and growing component of the post-secondary education market. The market for adult education should continue to increase as working adults seek additional education and training to update and improve their skills, to enhance their earnings potential, and to keep pace with the rapidly expanding, knowledge-based economy.

Many working adults seek accredited degree programs that provide flexibility to accommodate the fixed schedules and time commitments associated with their professional and personal obligations. Our format enables working adults to attend classes and complete coursework on a more convenient schedule. Many universities currently do not effectively address the unique requirements of working adults due to the following specific constraints:

•

Traditional universities and colleges were designed to fulfill the educational needs of conventional, full-time students ages 18 to 24, who remain the primary focus of these universities and colleges. This focus has resulted in a capital-intensive teaching/learning model that may be characterized by:

	•		a high percentage of full-time, tenured faculty with doctoral degrees;

	•		fully-configured library facilities and related full-time staff;

	•		dormitories, student unions, and other significant plant assets to support the needs of younger students; and

	•		an emphasis on research and the related staff and facilities.

	•		The majority of accredited colleges and universities continue to provide the bulk of their educational programming from September to mid-December and from mid-January to May. As a result, most full-time faculty members only teach during that limited period of time. While this structure serves the needs of the full-time student, it limits the educational opportunity for working adults who must delay their education for up to five months during these spring, summer, and winter breaks.

	•		Traditional universities and colleges are also limited in their ability to market to, or provide the necessary customer service for, working adults because they require the development of additional administrative and enrollment infrastructure. We maintain a single-minded focus on serving the needs of working adults.

Higher education institutions such as us 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.

			Regional accreditation 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 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 institutions such as 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. Institute for Professional Development client institutions administer their own Title IV programs.

From time to time as part of the normal course of business, our subsidiaries are subject to periodic program reviews and audits by regulating bodies. The U.S. Department of Education, Office of Inspector General, conducted an audit of University of Phoenix for the period September 1, 2002, through March 31, 2004. On August 24, 2005, the Office of Inspector General issued a final audit report with recommendations to U.S. Department of Education. Except for two areas, the Office of Inspector General concluded that University of Phoenix had policies and procedures that provide reasonable assurances that the institution properly makes initial and subsequent disbursements to students enrolled in Title IV eligible programs. The U.S. Department of Education will ultimately issue a final audit determination letter on the two exceptions regarding disbursing funds to student accounts for allowable institutional charges and disbursing funds to students who were not in eligible programs. On December 22, 2005, the Office of Inspector General issued a separate audit report on their review of our policies and procedures for the calculation and return of Title IV funds. Except for one area, the Office of Inspector General concluded that University of Phoenix had policies and procedures that provide reasonable assurances that the institution properly identified withdrawn students, appropriately determined whether a return of Title IV calculation was required, returned Title IV for withdrawn students in a timely manner, and used appropriate methodologies for most aspects of calculating the return of Title IV aid. The U.S. Department of Education will ultimately issue a final audit determination letter on the one exception regarding the return of Title IV funds. While the outcomes of these audit 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.

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.

Opportunities

University of Phoenix expansion. University of Phoenix plans to continue increasing its student base by growing existing locations and by opening new campuses and learning centers throughout the United States, Canada, and Mexico. 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. University of Phoenix currently plans on opening seven to nine new campuses during 2006. In the first six months of 2006, two new University of Phoenix campuses were opened. Effective October 1, 2005, we took over operations of the Netherlands campus from Apollo International, Inc. In addition, during the first quarter of 2006, University of Phoenix entered into an agreement with Iowa Central Community College (“ICCC”) to provide ICCC with services in the areas of educational consulting and training, program development, faculty recruitment and screening, and student recruitment with respect to ICCC’s Associate of Applied Science Degree in Computer Networking. The University of Phoenix Online campus plans to continue expanding its 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.

Expand student base in associate degree programs. We plan to continue increasing the number of online students in our associate degree programs through the growth of Axia College. Axia College has been specifically designed to meet the special needs of low-credit working adults. We believe that the number of Axia College students will continue to increase significantly as we believe we are best positioned to meet the needs of these students through small class sizes and highly qualified staff.

International expansion. 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 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. In addition, we have entered into a number of joint educational agreements to provide educational content to degree programs located outside the United States. These agreements include an agreement with Apollo International, Inc. that allows for Western International University’s educational offerings to be made available in India and an educational program that was initiated in China as part of a joint educational agreement with Canadian Institute of Business and Technology (CIBT). We will continue to conduct market and operations research in various foreign countries where we believe there might be a demand for our programs.

Challenges and Risks

Competitive market. The higher education market is highly fragmented and competitive with no private or public institution enjoying a significant market share. We compete primarily with four-year and two-year degree-granting public and private regionally accredited colleges and universities. Many of these colleges and universities enroll working students in addition to the traditional 18 to 24 year-old students. We expect that these colleges and universities will continue to modify their existing programs

to serve working students more effectively. In addition, many colleges and universities have announced various distance education initiatives.

Regulatory, accreditation, and state authorization risks. Our future success is highly dependent on our ability to obtain, maintain, or renew required regulatory approvals, accreditation, and state authorizations. 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 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. The loss of Title IV eligibility would significantly reduce demand for our programs. 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.

Higher Education Act reauthorization. The U.S. Department of Education issues regulations based on the laws included in the Higher Education Act. The Higher Education Act has been extended to June 30, 2006. Changes in the law occur during the Congressional reauthorization process, with final regulations issued after that time. The reauthorization process could amend existing requirements or implement new requirements. Any action by Congress that significantly reduces funding for the federal student financial aid programs or the ability of our schools or students to participate in these programs could harm our business. Legislative action may also increase our administrative costs and burdens and require us to modify our practices in order for our schools to comply fully with applicable requirements, which could have a material adverse effect on our business.

Litigation. Regulatory agencies or third parties may commence investigations, bring claims, or institute litigation against us. Because we operate in a highly regulated industry, we may be subject from time to time to investigations, claims of non-compliance, or lawsuits by governmental agencies or third parties, which may allege statutory violations, regulatory infractions, or common law causes of action. If the results of the investigations are unfavorable to us or if we are unable to successfully defend against third-party lawsuits, we may be required to pay money damages or be subject to fines, penalties, injunctions or other censure that could have a materially adverse effect on our business. Even if we adequately address the issues raised by an agency investigation or successfully defend a third-party lawsuit, we may have to devote significant money and management resources to address these issues, which could harm our business. Adverse publicity regarding litigation against us could also negatively affect our business.

All of these challenges and risks have the potential to have a material adverse effect on the education industry and on us; however, we believe we are well positioned to appropriately address these challenges and risks.

Application of Critical Accounting Policies and Estimates

Management discussed with our Audit Committee the development, selection, and disclosure of our critical accounting policies and estimates and the application of these policies and estimates. The following is a brief discussion of the more critical accounting policies and methods used by us.

Basis of presentation and consolidation

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The consolidated financial statements include the accounts of Apollo Group, Inc. and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Revenue recognition

Approximately 92.9% of our tuition and other net revenues during the first six months of 2006 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 fees for our online delivery of course materials, 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 represent 83.1% of consolidated tuition revenues during the six months ended February 28, 2006. 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 nine-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 our online delivery of 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 $25.9 million (4.3% of gross revenues) and $30.7 million (5.7% of gross revenues) in the three months ended February 28, 2006 and 2005, respectively, and $55.3 million (4.4% of gross revenues) and $49.0 million (4.5% of gross revenues) in the six months ended February 28, 2006 and 2005, respectively.

Allowance for doubtful accounts

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.

Income taxes

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 39.4% and 39.3% in the three months ended February 28, 2006 and 2005, respectively, and 39.3% in both the six months ended February 28, 2006 and 2005. 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.

Loss contingencies

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.

Impairment of intangible assets

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. We have selected August 31 as the date on which we will perform our annual goodwill impairment test. We performed our annual impairment test as of August 31, 2005, and concluded that no impairment charge was required.

Stock-based compensation expense

On September 1, 2005, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“employee stock purchases”) based on estimated fair values. Stock-based compensation expense recognized

under SFAS 123(R) for the three and six months ended February 28, 2006, was $12.7 million and $18.5 million, respectively. There was no stock-based compensation expense related to employee stock options and employee stock purchases recognized during the three and six months ended February 28, 2005, because we did not adopt the recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). See Note 9 for additional information.

The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. The use of an option-pricing model requires the use of extensive actual employee exercise behavior data and the use of a number of complex assumptions including expected volatility, risk-free interest rate, expected dividends, and expected term. The weighted-average estimated value of employee stock options granted during the three and six months ended February 28, 2006, was $11.92 per share and $16.49 per share, respectively, with the following weighted-average assumptions:


	For the Three Months Ended			For the Six Months Ended
	February 28, 2006			February 28, 2006
Dividend yield		0.0	%		0.0	%
Expected volatility		28.7	%		30.6	%
Risk-free interest rate		4.4	%		4.4	%
Expected lives (in years)		2.0			2.9

We have analyzed both our historical volatility and the implied volatility for two-year traded options of our Apollo Education Group Class A common stock to estimate the expected volatility consistent with SFAS 123(R) and Staff Accounting Bulletin No. 107 (“SAB 107”). Prior to the first quarter of fiscal 2006, we had used our historical stock price volatility in accordance with SFAS 123 for purposes of our pro forma information.

The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our employee stock options. The dividend yield assumption is based on the history and expectation of dividend payouts. The estimated expected life represents the weighted-average period the stock options are expected to remain outstanding and has been determined based on an analysis of historical exercise behavior.

If factors change and we employ different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current period.

Recent accounting pronouncements

In March 2004, the Financial Accounting Standards Board (“FASB”) issued Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“EITF 03-1”). EITF 03-1 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB issued Staff Position EITF No. 03-1-1, which delays the effective date until additional guidance is issued for the application of the recognition and measurement provisions of EITF 03-1 to investments in securities that are impaired. We do not believe that the adoption of EITF 03-1 will have a material impact on our financial condition or results of operations.

In May 2005, the FASB issued Statement of Financial Accounting Standard No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3 (“SFAS 154”). SFAS 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in nondiscretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, nonfinancial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. We plan to adopt SFAS 154 beginning in the first quarter of fiscal 2007.

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 primarily 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 an analysis of our Consolidated Statements of Income for the periods indicated:


					Percent of Revenues
	For the Three Months Ended				For the Three Months Ended
	February 28,				February 28,						Percent Change
(In thousands, except percentages)	2006		2005		2006			2005			2006 vs. 2005

Revenues:
Tuition and other, net	$	569,551	$	505,693		100.0	%		100.0	%		12.6	%

Costs and expenses:
Instructional costs and services		258,447		221,635		45.4			43.8			16.6
Selling and promotional		124,426		121,016		21.8			23.9			2.8
General and administrative		57,205		23,499		10.1			4.7			143.4

		440,078		366,150		77.3			72.4			20.2

Income from operations		129,473		139,543		22.7			27.6			-7.2
Interest income and other, net		3,567		3,855		0.7			0.8			-7.5

Income before income taxes		133,040		143,398		23.4			28.4			-7.2
Provision for income taxes		52,405		56,284		9.2			11.2			-6.9

Net income	$	80,635	$	87,114		14.2	%		17.2	%		-7.4	%

Refer to the above Analysis of Consolidated Statements of Income when reading the results of operations discussion below.

THREE MONTHS ENDED FEBRUARY 28, 2006, COMPARED WITH THREE MONTHS ENDED FEBRUARY 28, 2005

Tuition and Other, Net

Our tuition and other net revenues increased by 12.6% in the three months ended February 28, 2006, from the three months ended February 28, 2005, primarily due to a 13.5% increase in average degree student enrollments and tuition price increases averaging four to six percent (depending on the geographic area and program), partially offset by an increase in our lower-tuition associates degree programs as a percentage of total degree student enrollments. As of February 28, 2006, 19.7% of our students are enrolled in associates degree programs compared with 10.6% of our students at February 28, 2005.

Tuition and other net revenues for the three months ended February 28, 2006 and 2005, consist primarily of $526.7 million and $467.6 million, respectively, of net tuition revenues from students enrolled in degree programs and $2.6 million and $2.7 million, respectively, of net tuition revenues from students enrolled in non-degree programs.

Information about our tuition and other net revenues by reportable segment on a percentage basis is as follows:


	For the Three Months Ended
	February 28,
	2006			2005

University of Phoenix		81.3	%		90.2	%
Other Schools		18.7			9.7
Corporate		0.0			0.1

Tuition and other, net		100.0	%		100.0	%

Tuition and other net revenues at Other Schools increased as a percentage of total revenues due to the significant increase in enrollment in associates degree programs at Axia College of Western International University between periods. Axia College began offering these programs in September 2004. Tuition and other net revenues at University of Phoenix should begin to increase as a percentage of total revenues during the third quarter of 2006 as Axia College is transferred from Western International University to University of Phoenix.

Instructional Costs and Services

Instructional costs and services increased by $36.8 million in the three months ended February 28, 2006, from the three months ended February 28, 2005. The following table sets forth the changes in significant components of instructional costs and services, in millions:


					Percent of Revenues
	For the Three Months Ended				For the Three Months Ended
	February 28,				February 28,						Percent Change
	2006		2005		2006			2005			2006 vs. 2005

Employee compensation and related expenses	$	90.1	$	81.3		15.9	%		16.1	%		10.8	%
Stock-based compensation		3.5				0.6	%
Faculty compensation		49.1		43.4		8.6	%		8.6	%		13.1	%
Classroom lease expenses and depreciation		46.3		41.7		8.1	%		8.2	%		11.0	%
Financial aid processing costs		12.7		10.4		2.2	%		2.1	%		22.1	%
Bad debt expense		19.8		9.9		3.5	%		1.9	%		100.0	%
Other instructional costs and services		36.9		34.9		6.5	%		6.9	%		5.7	%

Instructional costs and services	$	258.4	$	221.6		45.4	%		43.8	%		16.6	%

Instructional costs and services as a percentage of tuition and other net revenues increased in the three months ended February 28, 2006, versus the three months ended February 28, 2005, due primarily to an increase in bad debt expense and stock-based compensation charges, partially offset by greater tuition and other net revenues being spread over the fixed costs related to centralized student services. 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. The increase in bad debt expense as a percentage of revenue between 2005 and 2006 is the result of increased aged accounts receivable and write-offs between periods as a result of an increase in financial aid students that withdrew from class prior to their financial aid disbursement.

Selling and Promotional Expenses

Selling and promotional expenses increased by $3.4 million in the three months ended February 28, 2006, from the three months ended February 28, 2005. The following table sets forth the changes in significant components of selling and promotional expenses, in millions:


					Percent of Revenues
	For the Three Months Ended				For the Three Months Ended
	February 28,				February 28,						Percent Change
	2006		2005		2006			2005			2006 vs. 2005

Enrollment advisors’ compensation and related expenses	$	62.7	$	51.7		11.0	%		10.2	%		21.3	%
Stock-based compensation		0.4				0.0	%
Advertising		49.4		56.1		8.7	%		11.1	%		-11.9	%
Other selling and promotional expenses		11.9		13.2		2.1	%		2.6	%		-9.8	%

Selling and promotional expenses	$	124.4	$	121.0		21.8	%		23.9	%		2.8	%

Selling and promotional expenses as a percentage of tuition and other net revenues decreased in the three months ended February 28, 2006, versus the three months ended February 28, 2005, due principally to a decrease in advertising expense due to reduced advertising spending during the month of December, partially offset by an increase in enrollment advisors compensation and related expenses. We anticipate that advertising spending will increase through the remainder of 2006 as we plan to spend more on lead generation.

General and Administrative Expenses

General and administrative expenses increased by $33.7 million in the three months ended February 28, 2006, from the three months ended February 28, 2005. The following table sets forth the changes in significant components of general and administrative expenses, in millions:


					Percent of Revenues
	For the Three Months Ended				For the Three Months Ended
	February 28,				February 28,						Percent Change
	2006		2005		2006			2005			2006 vs. 2005

Employee compensation and related expenses	$	32.7	$	11.9		5.7	%		2.4	%		174.8	%
Stock-based compensation		8.8				1.6	%
Administrative space and depreciation		5.7		4.0		1.0	%		0.8	%		42.5	%
Other general and administrative expenses		10.0		7.6		1.8	%		1.5	%		31.6	%

General and administrative expenses	$	57.2	$	23.5		10.1	%		4.7	%		143.4	%

Included in the above employee compensation and related expenses and stock-based compensation are $19.0 million and $7.5 million, respectively, related to our former CEO’s Separation Agreement. Excluding these amounts, general and administrative expenses as a percentage of tuition and other net revenues increased from 4.7% in the three months ended February 28, 2005, to 5.4% in the three months ended February 28, 2006, due primarily to stock-based compensation charges and increases in employee compensation and related expenses and administrative space and depreciation costs due to higher information technology spending principally as a result of the opening of a redundant data center in August 2005. We anticipate the trend of higher information technology costs to continue during the remainder of 2006.

Interest Income and Other, Net

Net interest income and other decreased by $288,000 in the three months ended February 28, 2006, from the three months ended February 28, 2005. This decrease was attributable to the decrease in cash equivalents and marketable securities between periods, partially offset by higher yields earned on these securities as a result of interest rate increases. Interest expense was $69,000 and $37,000 in the three months ended February 28, 2006 and 2005, respectively.

Effective Income Tax Rate

Our effective income tax rate increased slightly to 39.4% in the three months ended February 28, 2006, from 39.3% in the three months ended February 28, 2005, due to lower tax-exempt interest income as a percentage of total income.

The following table sets forth an analysis of our Consolidated Statements of Income for the periods indicated:


					Percent of Revenues
	For the Six Months Ended				For the Six Months Ended
	February 28,				February 28,						Percent Change
(In thousands, except percentages)	2006		2005		2006			2005			2006 vs. 2005

Revenues:
Tuition and other, net	$	1,198,435	$	1,040,619		100.0	%		100.0	%		15.2	%

Costs and expenses:
Instructional costs and services		518,332		439,052		43.3			42.2			18.1
Selling and promotional		252,546		241,601		21.1			23.2			4.5
General and administrative		87,285		44,687		7.3			4.3			95.3

		858,163		725,340		71.7			69.7			18.3

Income from operations		340,272		315,279		28.3			30.3			7.9
Interest income and other, net		8,070		8,417		0.7			0.8			-4.1

Income before income taxes		348,342		323,696		29.0			31.1			7.6
Provision for income taxes		136,933		127,051		11.4			12.2			7.8

Net income	$	211,409	$	196,645		17.6	%		18.9	%		7.5	%

Refer to the above Analysis of Consolidated Statements of Income when reading the results of operations discussion below.

SIX MONTHS ENDED FEBRUARY 28, 2006, COMPARED WITH SIX MONTHS ENDED FEBRUARY 28, 2005

Tuition and Other, Net

Our tuition and other net revenues increased by 15.2% in the six months ended February 28, 2006, from the six months ended February 28, 2005, primarily due to a 14.6% increase in average degree student enrollments and tuition price increases averaging four to six percent (depending on the geographic area and program), partially offset by an increase in our lower-tuition associates degree programs as a percentage of total degree student enrollments.

Tuition and other net revenues for the six months ended February 28, 2006 and 2005, consist primarily of $1.1 billion and $961.1 million, respectively, of net tuition revenues from students enrolled in degree programs and $4.7 million and $5.4 million, respectively, of net tuition revenues from students enrolled in non-degree programs.

Information about our tuition and other net revenues by reportable segment on a percentage basis is as follows:


	For the Six Months Ended
	February 28,
	2006			2005

University of Phoenix		82.9	%		91.7	%
Other Schools		17.1			8.2
Corporate		0.0			0.1

Tuition and other, net		100.0	%		100.0	%

Instructional Costs and Services

Instructional costs and services increased by $79.3 million in the six months ended February 28, 2006, from the six months ended February 28, 2005. The following table sets forth the changes in significant components of instructional costs and services, in millions:


					Percent of Revenues
	For the Six Months Ended				For the Six Months Ended
	February 28,				February 28,						Percent Change
	2006		2005		2006			2005			2006 vs. 2005

Employee compensation and related expenses	$	178.3	$	161.8		14.9	%		15.6	%		10.2	%
Stock-based compensation		6.3				0.6	%
Faculty compensation		102.4		87.9		8.6	%		8.4	%		16.5	%
Classroom lease expenses and depreciation		92.7		82.0		7.7	%		7.9	%		13.0	%
Financial aid processing costs		25.5		20.7		2.1	%		2.0	%		23.2	%
Bad debt expense		39.9		19.0		3.3	%		1.8	%		110.0	%
Other instructional costs and services		73.2		67.7		6.1	%		6.5	%		8.1	%

Instructional costs and services	$	518.3	$	439.1		43.3	%		42.2	%		18.1	%

Instructional costs and services as a percentage of tuition and other net revenues increased in the six months ended February 28, 2006, versus the six months ended February 28, 2005, due primarily to an increase in bad debt expense and stock-based compensation charges, partially offset by greater tuition and other net revenues being spread over the fixed costs related to centralized student services. 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. The increase in bad debt expense as a percentage of revenue between 2005 and 2006 is the result of increased aged accounts receivable and write-offs between periods as a result of an increase in financial aid students that withdrew from class prior to their financial aid disbursement.

Selling and Promotional Expenses

Selling and promotional expenses increased by $10.9 million in the six months ended February 28, 2006, from the six months ended February 28, 2005. The following table sets forth the changes in significant components of selling and promotional expenses, in millions:


					Percent of Revenues
	For the Six Months Ended				For the Six Months Ended
	February 28,				February 28,						Percent Change
	2006		2005		2006			2005			2006 vs. 2005

Enrollment advisors’ compensation and related expenses	$	119.5	$	99.9		10.0	%		9.6	%		19.6	%
Stock-based compensation		0.9				0.1	%
Advertising		105.9		115.9		8.8	%		11.1	%		-8.6	%
Other selling and promotional expenses		26.2		25.8		2.2	%		2.5	%		1.6	%

Selling and promotional expenses	$	252.5	$	241.6		21.1	%		23.2	%		4.5	%

Selling and promotional expenses as a percentage of tuition and other net revenues decreased in the six months ended February 28, 2006, versus the six months ended February 28, 2005, due principally to a decrease in advertising expense due to reduced advertising spending, partially offset by an increase in enrollment advisors compensation and related expenses. We anticipate that advertising spending will increase through the remainder of 2006 as we plan to spend more on lead generation.

General and Administrative Expenses

General and administrative expenses increased by $42.6 million in the six months ended February 28, 2006, from the six months ended February 28, 2005. The following table sets forth the changes in significant components of general and administrative expenses, in millions:


					Percent of Revenues
	For the Six Months Ended				For the Six Months Ended
	February 28,				February 28,						Percent Change
	2006		2005		2006			2005			2006 vs. 2005

Employee compensation and related expenses	$	44.9	$	21.9		3.7	%		2.1	%		105.0	%
Stock-based compensation		11.3				0.9	%
Administrative space and depreciation		11.6		7.8		1.0	%		0.8	%		48.7	%
Other general and administrative expenses		19.5		15.0		1.6	%		1.4	%		30.0	%

General and administrative expenses	$	87.3	$	44.7		7.3	%		4.3	%		95.3	%

Included in the above employee compensation and related expenses and stock-based compensation are $19.0 million and $7.5 million, respectively, related to our former CEO’s Separation Agreement. Excluding these amounts, general and administrative expenses as a percentage of tuition and other net revenues increased from 4.3% in the six months ended February 28, 2005, to 5.1% the six months ended February 28, 2006, due primarily to stock-based compensation charges and increases in employee compensation and related expenses and administrative space and depreciation costs due to higher information technology spending principally as a result of the opening of a redundant data center in August 2005. We anticipate the trend of higher information technology costs to continue during the remainder of 2006.

Interest Income and Other, Net

Net interest income and other decreased by $347,000 in the six months ended February 28, 2006, from the six months ended February 28, 2005. This decrease was attributable to the decrease in cash equivalents and marketable securities between periods, partially offset by higher yields earned on these securities as a result of interest rate increases. Interest expense was $102,000 and $59,000 in the six months ended February 28, 2006 and 2005, respectively.

Effective Income Tax Rate

Our effective income tax rate remained consistent between periods at 39.3%.

Liquidity, Capital Resources, and Financial Position

Liquidity and Capital Resources

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 $194.4 million as of February 28, 2006, a decrease from $467.1 million at August 31, 2005. The decrease was primarily a result of the repurchase of Apollo Education Group Class A common stock of $510.9 million, and capital expenditures of $30.1 million partially

offset by cash provided by operating activities of $260.3 million and cash provided by the issuance of Apollo Education Group Class A common stock of $19.1 million, related to employee stock option exercises and employee stock purchases during the period.

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 February 28, 2006, we had approximately $238.4 million in this separate account, which is 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 decreased to $30.1 million during the six months ended February 28, 2006, from $43.9 million during the six months ended February 28, 2005, primarily due to reduced spending on furniture and equipment and leasehold improvements between periods. Total purchases of property and equipment for the year ended August 31, 2006, are expected to range from $100 to $120 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. In addition, we anticipate spending $103.0 million during 2006 and 2007 for the construction of a building for future Online expansion, of which $14.8 million had been incurred as of February 28, 2006. Upon completion, it is our intention to sell the building to a third party and lease it back.

Future cash flows. 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. 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 and the foreseeable future. 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.

Letter of credit. An unsecured letter of credit for Western International University, in the amount of $5.3 million, expiring in March 2007, is outstanding.

Accounts receivable, net. Accounts receivable, net was $200.7 million and $201.6 million as of February 28, 2006, and August 31, 2005, respectively. Days sales outstanding (“DSO”) in receivables, net as of February 28, 2006, and August 31, 2005, were 30 days and 33 days, respectively. Our accounts receivable and DSO are primarily affected by collections performance. Improved collections performance will result in reduced DSO.

Commitments and Contingencies

Leases. We currently lease the majority of our administrative and educational facilities under operating lease agreements. Most lease agreements contain tenant improvement allowances, rent holidays, and/or rent escalation clauses. In instances where one or more of these items are included in a lease agreement, we record a deferred rent liability on the Consolidated Balance Sheet and amortize the items on a straight-line basis over the term of the lease as additions or deductions to rent expense. 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. For leases with renewal options, we record rent expense and amortize the leasehold improvements on a straight-line basis over the initial non-cancelable lease term (in instances where the lease term is shorter than the economic life of the asset) as we do not believe that the renewal of the option is reasonably assured. 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.

We record leasehold improvements funded by landlord incentives or allowances under operating leases (“tenant improvement allowances”) as a leasehold improvement asset and deferred rent liability on the Consolidated Balance Sheets and as both an investing activity (addition to property and equipment) and a component of operating activities on the Consolidated Statements of Cash Flows. We also reflect cash reimbursements received for tenant improvement allowances during the periods presented as additions to property and equipment and an increase in operating activities in the Consolidated Statements of Cash Flows.

A tabular presentation of our contractual obligations at August 31, 2005, is provided in the “Liquidity and Capital Resources” portion of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Form 10-K as filed with the Securities and Exchange Commission. There were no material changes in our contractual obligations during the first six months of 2006.

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. 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. The Court consolidated the three pending class action complaints and a consolidated class action complaint was filed on May 16, 2005 by the Lead Plaintiff. Lead Plaintiff purports to represent a class of our shareholders who acquired their shares between February 27, 2004, and September 14, 2004, and seeks monetary damages in unspecified amounts. Lead 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 us for our issuance of allegedly materially false and misleading statements in connection with our failure to publicly disclose the contents of the U.S. Department of Education’s program review report. A motion to dismiss the consolidated class action complaint was filed on June 15, 2005, on behalf of Apollo Group, Inc. and the individual named defendants. The Court denied the motion to dismiss on October 18, 2005. 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.

On August 29, 2003, we were notified that a qui tam action had been filed against us on March 7, 2003, in the United States District Court for the Eastern District of California by two current employees on behalf of themselves and the federal government. 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.

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 seeks 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 contends that we failed to pay overtime. On June 6, 2005, the court granted plaintiffs’ motion to remove Bryan Sanders as the named plaintiff and replace him with Deryl Clark and Romero Ontiveros. Plaintiff’s counsel has advised defendants and the court that Mr. Ontiveros no longer intends to serve as a named plaintiff. Five status conferences have occurred and the parties are now in the process of discovery. The court has granted defendants’ motion to transfer venue to the Superior Court of the State of California for the County of Solano. A management conference has been set for April 2006, and the Plaintiff’s motion to certify the class will be heard by the Court in May 2006. 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.

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

Stock Repurchase Program

Our Board of Directors has previously authorized a program allocating up to $1.85 billion of our funds to repurchase shares of Apollo Education Group Class A common stock and University of Phoenix Online common stock. While it was outstanding, we repurchased approximately 2,025,000 shares of University of Phoenix Online common stock at a total cost of approximately $132.0 million. On December 9, 2005, our Board of Directors authorized a program allocating up to an additional $300 million of our funds to repurchase shares of Apollo Education Group Class A common stock. As of February 28, 2006, we had repurchased approximately 35,075,000 shares of Apollo Education Group Class A common stock at a total cost of approximately $1.9 billion. An additional 81,000 shares of Apollo Education Group Class A common stock were repurchased in March 2006 at a cost of approximately $4.0 million.

As of February 28, 2006, 3,025,000 shares of our treasury stock have been used to secure receivables between Apollo Group and two of its subsidiaries.

Seasonality in Results of Operations

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 through 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. Therefore, we analyze our expenses as a percentage of tuition and other net revenues in comparison to the percentages in the same period of the prior year.

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

Impact of Inflation

Inflation has not had a significant impact on our historical operations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our portfolio of marketable securities includes numerous issuers, varying types of securities, and varying maturities. We intend to hold all securities, other than auction-rate 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.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our Principal Executive Officer and our Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e), promulgated under the Exchange Act. Based on this evaluation, our Principal Executive Officer and Chief Financial Officer concluded that, as of the end of our most recently completed fiscal quarter, our disclosure controls and procedures were effective to ensure that information is recorded, processed, summarized, and reported on a timely basis.

There were no significant changes in our internal control over financial reporting that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within Apollo to disclose material information otherwise required to be set forth in our periodic reports.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

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. 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. The Court consolidated the three pending class action complaints and a consolidated class action complaint was filed on May 16, 2005 by the Lead Plaintiff. Lead Plaintiff purports to represent a class of our shareholders who acquired their shares between February 27, 2004, and September 14, 2004, and seeks monetary damages in unspecified amounts. Lead 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 us for our issuance of allegedly materially false and misleading statements in connection with our failure to publicly disclose the contents of the U.S. Department of Education’s program review report. A motion to dismiss the consolidated class action complaint was filed on June 15, 2005, on behalf of Apollo Group, Inc. and the individual named defendants. The Court denied the motion to dismiss on October 18, 2005. 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.

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 seeks 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 contends that we failed to pay overtime. On June 6, 2005, the court granted plaintiffs’ motion to remove Bryan Sanders as the named plaintiff and replace him with Deryl Clark and Romero Ontiveros. Plaintiff’s counsel has advised defendants and the court that Mr. Ontiveros no longer intends to serve as a named plaintiff. Five status conferences have occurred and the parties are now in the process of discovery. The court has granted defendants’ motion to transfer venue to the Superior Court of the State of California for the County of Solano. A management conference has been set for April 2006, and the Plaintiff’s motion to certify the class will be heard by the Court in May 2006. 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.

Item 1A. Risk Factors

No Change

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Apollo Education Group Class A common stock made by Apollo during the three months ended February 28, 2006, are as follows:

Approximate Dollar

Total Number of Shares

Value

Purchased as Part of

of Shares that May

Total Number

Publicly Announced

Yet be

of Shares

Average Price

Plans

Purchased Under the

Period

Purchased

Paid per Share

or Programs

Plans or Programs

December 1, 2005 - December 31, 2005

2,363,066

65.44

2,363,066

January 1, 2006 - January 31, 2006

1,184,976

59.36

1,184,976

February 1, 2006 - February 28, 2006

Total

3,548,042

63.41

3,548,042

140,140,435

Our Board of Directors authorized the following programs to repurchase shares of Apollo Education Group Class A common stock and, during the periods it was outstanding, University of Phoenix Online common stock:


	Amount
Date of Authorization	Authorized
	(in thousands)
September 25, 1998	$	40,000
May 13, 1999		20,000
October 25, 1999		40,000
March 24, 2000		50,000
March 28, 2003		150,000
June 25, 2004		500,000
October 1, 2004		500,000
March 25, 2005		250,000
October 7, 2005		300,000
December 9, 2005		300,000

	$	2,150,000

As of February 28, 2006, we had repurchased approximately 35,075,000 shares of Apollo Education Group Class A common stock at a total cost of approximately $1.9 billion. While it was outstanding, we repurchased approximately 2,025,000 shares of University of Phoenix Online common stock at a total cost of $132.0 million. There is no expiration date on the authorization of these funds and repurchases occur at our discretion. An additional 81,000 shares of Apollo Education Group Class A common stock were repurchased in March 2006 at a cost of approximately $4.0 million.

As of February 28, 2006, 3,025,000 shares of our treasury stock have been used to secure receivables between Apollo Group and two of its subsidiaries.

Item 3. Defaults Upon Senior Securities

Not Applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not Applicable

Item 5. Other Information

Effective March 31, 2006, our Bylaws were amended and restated to provide for indemnification for our current and former officers and directors.

Item 6. Exhibits

Exhibits:


EXHIBIT 3.1		Amended and Restated Articles of Incorporation of Apollo Group, Inc. (1)
EXHIBIT 3.2		Amended and Restated Bylaws (as amended through March 2006) of Apollo Group, Inc.*
EXHIBIT 15.1		Letter in Lieu of Consent*
EXHIBIT 31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
EXHIBIT 31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
EXHIBIT 32.1		Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
EXHIBIT 32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*


*		Filed herewith

(1)		Incorporated by reference to Exhibit 3.1 of Registration Statement No. 333-33370 on Form S-3/A, dated August 31, 2000


	For the Three Months Ended				For the Six Months Ended
	February 28,				February 28,
	2006		2005		2006			2005
Depreciation and Amortization:
University of Phoenix	$	9,161	$	8,697	$	19,513		$	17,306
Other Schools		1,276		995		2,421			1,811
Corporate		5,016		3,095		10,166			5,976

	$	15,453	$	12,787	$	32,100		$	25,093

Capital Expenditures:
University of Phoenix	$	18,786	$	13,458	$	32,083		$	27,607
Other Schools		919		896		1,117			1,497
Corporate		4,487		6,414		(3,089	)		14,793

	$	24,192	$	20,768	$	30,111		$	43,897


		APOLLO GROUP, INC. (Registrant)

Date: April 10, 2006

		By: /s/ Kenda B. Gonzales


		Kenda B. Gonzales
		Chief Financial Officer, Secretary, and Treasurer

		By: /s/ Daniel E. Bachus


		Daniel E. Bachus
		Chief Accounting Officer and Controller

		By: /s/ Brian Mueller


		Brian Mueller
		President


Exhibit Number		Description of Exhibit
3.1		Amended and Restated Articles of Incorporation of Apollo Group, Inc.(1)

3.2		Amended and Restated Bylaws (as amended through March 2006) of Apollo Group, Inc.*

15.1		Letter in Lieu of Consent*

31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*

32.1		Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*