Accounting for Bad Debts Students at the University of Waterloo were typically billed on a course-by-course basis when they first attended a session. At the time of billing, Omega established a receivable account and a matching deferred-revenue account. Revenue was recognized on a straight-line basis over the length of the applicable course, which is generally 5 to 9 weeks, and deferred revenue was likewise reduced. Students who withdrew from a course were entitled to a partial refund, generally based on the portion of the course they did not attend. Refunds were recorded as a reduction in deferred revenue during the period that a student withdrew from a class. Students tended to finance their education through some combination of Title IV funding, state financial aid, military benefits, tuition assistance from employers, and personal means. Like other educational institutions, the University of Waterloo had no control over the amount of Title IV funding awarded to their students and billed the Department of Education directly so that receivables' collectability was virtually certain. On the other hand, when students paid personally, there was apossibility that receivables would not be collectible. To account for the issue of uncollectible receivables, Omega reduced its receivables, as they were generated, by setting up allowances for amounts expected to become uncollectible. These estimates were based on historical collection experience, current trends, and other relevant factors. For example, the company increased its allowance for doubtful accounts after a student withdrew from an educational program. When an actual write-off occurred, the receivable was removed from the balance sheet, and the allowance for doubtful accounts was correspondingly decreased. (See Exhibit 3 for Omega's fiscal year 2012 balance sheet and income statement, and Exhibit 4 for historical information on Omega revenues, receivables, allowances for receivables expected to become uncollectible, provisions incurred in different periods for potentially uncollectible receivables, and write-offs as they took place.)OMEGA GROUP, INC. AND SUBSIDIARIES: CONSOLIDATED BALANCE SHEETS As of August 31 (in thousands) 2012 2011 ASSETS: Current assets Cash and cash equivalents 1,276,375 1,571,664 Restricted cash and cash equivalents 318,334 379,407 Accounts receivable, net 198,279 215,567 Prepaid taxes 26,341 35,629 Deferred tax assets, current portion 69,052 124,137 Other current assets 49,609 44,382 Total current assets 1,937,990 2,370,786 Property and equipment, net 571,629 553,027 Marketable securities 5,946 5,946 Goodwill 103,345 133,297 Intangible assets, net 149,034 121,117 Deferred tax assets, less current portion 77,628 70,949 Other assets 22,750 14,584 Total assets 2,868,322 3,269,706 LIABILITIES AND SHAREHOLDERS' EQUITY: Current liabilities Short-term borrowings and current portion of long-term debt 638,588 419,318 Accounts payable 74,872 69,551 Student deposits 362,143 424,045 Deferred revenue 254,555 293,436 Accrued and othercurrent liabilities 324,881 448,937 Total current liabilities 1,655,039 1,655,287 Long-term debt 81,323 179,691 Deferred tax liabilities 15,881 26,400 Other long-term liabilities 191,756 164,339 Total liabilities 1,943,999 2,025,717 Commitments and contingencies Shareholders' equity Preferred stock, no par value, 1,000 shares authorized; none issued Omega Group Class A nonvoting common stock, no par value, 400,000 shares authorized; 188,007 issued as of August 31, 2012 and 2011, and 111,768 and 130,004 outstanding as of August 31, 2012 and 2011, respectively 103 103 Omega Group Class B voting common stock, no par value, 3,000 shares authorized; 475 issued and outstanding as of August 31, 2012 and 2011 Additional paid-in capital 93,770 68,724 Omega Group Class A treasury stock, at cost, 76,239 and 58,003 shares as of August 31, 2012 and 2011, respectively (3,878,612] (3,125,175] Retained earnings 1,743,150 320,472 Accumulated other comprehensive loss (30,034] (23,761) Total Omega shareholders' equity 928,378 1,240,364 Noncontrolling (deficit) interests (4,055) 3,625 Total equity 924,323 1,243,989 Total liabilities and shareholders' equity 2,868,322 1,269,706OMEGA GROUP, INC. AND SUBSIDIARIES: CONSOLIDATED STATEMENTS OF INCOME Year Ended August 31, (In thousands, except per share data) 2012 2011 2010 Net revenue 4,253,337 4,711,049 4,906,613 Costs and expenses: Instructional and student advisory 1,800,569 1,759,986 1,720,059 Marketing 663,442 654,399 622,848 Admissions advisory 383,935 415,386 466,358 General and administrative 344,300 355,548 301,116 Depreciation and amortization 177,804 157,686 142,337 Provision for uncollectible accounts receivable 146,742 181,297 282,628 Restructuring and other charges 38,695 22,913 Goodwill and other intangibles impairment 16,788 219,927 184,570 Litigation charge (credit), net 4,725 (11,951) 177,982 Total costs and expenses 3,577,000 3,755,191 3,897,898 Operating income 676,337 955,858 1,008,715 Interest income 1,187 2,884 2,920 Interest expense (11,745) (8,931) (11,864) Other, net 476 [1,588) (685) Income from continuing operations before taxes 666,255 948,223 999,086 Provision for income taxes (283,072) (419,136) (463,619) Income from continuing operations 383,183 529,087 535,467 Income from discontinued operations, net of tax 3,823 5,709 13,886) Net income 417,006 535,796 521,581 Net loss attributable to noncontrolling interests 5,672 36,631 31,421 Net income attributable to Omega 422,678 572,427 553,002 Earnings (loss) per share - Basic: Continuing operations attributable to Omega 3.24 4.01 3.73 Discontinued operations attributable to Omega 0.24 0.04 0.09) Basic Income per share attributable to Omega 3.48 4.05 3.64 Earnings (loss) per share - Diluted: Continuing operations attributable to Omega 3.22 4.00 3.71 Discontinued operations attributable to Omega 0.23 0.04 10.09) Diluted income per share attributable to Omega 3.45 1.04 3.62 Basic weighted average shares outstanding 121,607 141,269 151,955 Diluted weighted average shares outstanding 122,357 141,750 152,906Note 6. Accounts Receivable, net as of August 31: (S in thousands) 2012 2011 Student accounts receivable 287,619 324,324 Less allowance for doubtful accounts (107,230) (128,897) Net student accounts receivable 180,389 195,427 Other receivables 17,890 20,140 Total accounts receivable, net 198,279 215,567 Student accounts receivable is composed primarily of amounts due related to tuition and educational services. Our student receivables are not collateralized; however, credit risk is reduced as the amount owed by any individual student is small relative to the total student receivables and the customer base is geographically diverse. The following table summarizes the activity in allowance for doubtful accounts for the fiscal years 2012, 2011 and 2010: Year Ended August 31, (S in thousands) 2012 2011 2010 Beginning allowance for doubtful accounts 128,897 192,857 110,420 Provision for uncollectible accounts receivable 146,742 181,297 282,628 Write-offs, net of recoveries (168,409) (245,257) (200,191) Ending allowance for doubtful accounts 107,230 128,897 192,8572010: Year Ended August 31. ( in thousands) 2011 2011 2010 Tuition and educational services revenue $ 4.124.629 97 % $ 4.549,010 96 % $ 4.738,712 96 % Educational materials revenue 294.499 7% 320.780 7% 324.951 7 % Services revenue 56.981 1 9% 76.500 2 96 84,185 2 % Other revenue 33.192 1 % 23.139 -% 22.414 % Gross revenue 4.509,301 106 % 4.969.429 105 % 5,170,262 105 % Less: Discounts (255,964) (6)96 (258,380) (5)96 (263,649) (5)16 Net revenue $ 4.253.337 100 % $ 4,711.049 100 % $ 4.906.613 100 %\fSince the 1970s, a bachelor's degree had become a more common requirement for employment in America's increasingly skill-based economy. While the U.S. college-age population increased by roughly 25 percent between 1970 and 2010, college enrollment grew by nearly 250 percent over the same period. In the coming decade, it is estimated that 60 percent of new jobs will require more than a high school diploma. One of the innovations that helped fulfill the growing demand for higher education was for-profit educational services companies. These companies primarily focused on employed learners who sought accredited degrees through programs that allowed flexibility around their work schedules. One of the most profitable companies in the for-profit education sector was Omega Group, best known for its largest subsidiary, the University of Waterloo.Omega Group Omega Group was one of the world's largest private education providers, offering both online and on-campus programs at the undergraduate, master's, and doctoral levels. Omega operated educational institutions in the United States, the United Kingdom, Mexico, and Chile, but its U.S.-based subsidiary, the University of Waterloo, represented approximately 91 percent of the company's net revenue in fiscal year 2012. Founded in 1976, by 2012, the University of Waterloo had grown to become the largest private university in the U.S., with an enrollment of over 350,000 students. Over 67 percent of students attending the University of Waterloo in 2012 were women, and approximately 50 percent were minorities. Omega's business model relied on low costs and a predictable inflow of revenues. It kept costs low by employing part- time and adjunct faculty as instructors, providing classroom facilities but no student housing, and building a scalable online educational delivery system. The cost of tuition of the schools operated by Omega, however, remained relatively high when compared to other public colleges. For example, tuition cost for a Bachelor of Science in Business at the University of Waterloowas $74,500. The same degree at the University of Arizona cost $44,200. Federal Student Financial Aid Programs In addition to for-profit educational services companies, increased college enrollment was facilitated, at least in part, by the U.S. government's decision to support various grant, loan, and work- study programs to help students pay for tuition and other education-related expenses. These programs were administered by the Department of Education under legislative authority provided by Title IV of the 1965 Higher Education Act. The Department of Education was created in 1867 with the primary role of collecting information on schools to help establish effective school systems. Federal aid to higher education began in 1890 with the passage of the Second Morrill Act. The end of World War II, however, led to a significant expansion of federal support in this area. The 1944 "GI Bill" authorized the Department of Education to provide financial assistance that would ultimately send almost 8 million World War II veterans to college. In the years that followed, additional federal student financial aid programs were established, such as Stafford Loans and Pell Grants.As the U.S. government became more actively involved in helping students pay for higher education, it established regulations to ensure that loans made to students were likely to be repaid. Specifically, any educational institution with a two-year cohort default rate greater than or equal to 40 percent in any given year or greater than or equal to 25 percent for three consecutive years would be ineligible to participate in Title IV programs. In addition to addressing concerns about student loan defaults, federal regulations also explicitly targeted for-profit educational services companies, focusing on their sources of revenue. For-profit educational services companies had been increasingly successful over time in securing a disproportionate share of federal funding for higher education. While for-profit schools accounted for only 10 percent of higher-education students during the 2009-2010 school year, they received 25percent of available funding from the Department of Education. (See Exhibit 1 for the top 10 for- profit recipients of Title IV funding during the 2010-11 school year.) Funding from the Department of Education was limited to certain eligible institutions. One of the regulations in this area was the 90/10 rule, which stated that any for-profit educational institution would be ineligible to participate in Title IV programs, if for two consecutive fiscal years it derived more than 90 percent of its cash-basis revenue for eligible tuition and fees from Title IV programs.' (Exhibit 2 provides historical information on 90/10 percentages for the University of Waterloo.)Exhibit 1 Top 10 For-Profit Recipients of Title IV Funding during 2010-2011 School Year 6,000 5,037 5,000 4,000 $ in millions 3,000 2,000 1,274 1,108 1,145 847 915 1,000 745 564 610 659 Grand Canyon Capella Argosy Walden Strayer ITT Technical Kaplan Ashford Devry University of Waterloo University University University University University Institute University University UniversitySigns of Trouble In the wake of the 2007-2009 financial crisis, many began to question the value of higher education. Skyrocketing tuition had grown by almost five times the rate of inflation since 1983 and had resulted in students taking on ever more debt. Toward the end of 2012, student-loan debt in the U.S. approached $1 trillion dollars. At the same time, diminished job prospects due to relatively weak economic conditions caused student-loan delinquencyes to rise, with student loans accounting for a higher percentage of household debt over 90 days past due than credit cards, mortgages, auto loans, and home-equity loans. While many blamed the financial crisis for high student-loan default rates, others pointed to another culprit: for-profit higher education. Differences in student outcomes had emerged between for-profit and not-for-profit schools. The three-year student-loan default rate for the 2008-2009 cohort of students was 8 percent at private not- for-profit schools and 11 percent at public not-for-profit schools, but it was 23 percent at for-profit schools. Of students who enrolled in for-profit schools in 2008-2009, 54 percent left without a degreeor certificate by mid-2010. The rates of loan defaults by students were closely related to the number of students leaving the institution with no degrees (See Exhibit 5 for historical information on two- and three-year student-loan default rates for the University of Waterloo). The Department of Education tracked the number of students who defaulted on their student loan, ie., the student failed to make payments within 3 years of entering repayment, which usually begun 6 months after leaving the program. Schools were encouraged to institute various default management programs for students by The Department of Education. Omega Group, like many other institutions, contracted with the General Revenue Corporation (GRC) to "cure" students who were approaching defaults. Internal documents of Omega indicated that nearly all cures were accomplished by putting students into temporary deferments or forbearances. The additional interest accrued during the forbearance period was added to the principal loan balance.Statistics like these helped corroborate stories of aggressive marketing tactics and deficient curricula that had dogged the for-profit higher-education industry for years. They also reinforced the negative reputation of for-profit educational services companies. Upon the release of a 2012 U.S. Senate report on the findings of a two-year investigation into the for-profit higher-education industry, Senator Tom Harkin (D-IA) commented, "In this report, you will find overwhelming documentation of overpriced tuition, predatory recruiting practices, sky-high dropout rates, billions of taxpayer dollars spent on aggressive marketing and advertising, and companies gaming regulations to maximize profits. These practices are not the exception-they are the norm; they are systemic throughout the industry, with very few exceptions." For-profit educational services companies had long been a darling of Wall Street analysts, who pointed to factors such as robust growth, a strong business model with great margins, and solid balance- sheet metrics in their "buy" ratings. However, all of this began to change in 2009 as bad press and regulatory scrutiny took their toll, souring market participants on for-profit educational services