10-K 1 apol-aug31201610k.htm 10-K Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended: August 31, 2016
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to ______
Commission File Number: 0-25232
aegcoverpagelogo.jpg
APOLLO EDUCATION 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.)
4025 S. RIVERPOINT PARKWAY, PHOENIX, ARIZONA 85040
(Address of principal executive offices)
Registrant’s telephone number, including area code: (480) 966-5394
Securities registered pursuant to Section 12(b) of the Act:
(Title of each class)
 
(Name of each exchange on which registered)
Apollo Education Group, Inc.
Class A common stock, no par value
 
The Nasdaq Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES þ    NO o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  YES o    NO þ
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES þ     NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o 
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES o     NO þ
No shares of Apollo Education Group, Inc. Class B common stock, its voting stock, are held by non-affiliates. The holders of Apollo Education Group, Inc. Class A common stock are not entitled to any voting rights. The aggregate market value of Apollo Education Group Class A common stock held by non-affiliates as of February 29, 2016 (last business day of the registrant’s most recently completed second fiscal quarter), was approximately $816 million.
As of October 13, 2016, there were 109,149,552 shares of Apollo’s Class A common stock outstanding and 475,149 shares of Apollo’s Class B common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Information Statement for the 2016 Annual Meeting of Class B Shareholders (Part III)
 



APOLLO EDUCATION GROUP, INC. AND SUBSIDIARIES
FORM 10-K
FOR THE FISCAL YEAR ENDED AUGUST 31, 2016
TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Apollo Education Group, Inc. | 2016 Form 10-K | 2


Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K, including Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact may be forward-looking statements. Such forward-looking statements include, among others, those statements regarding future events and future results of Apollo Education Group, Inc. that are based on current expectations, estimates, forecasts, and the beliefs and assumptions of us and our management, and speak only as of the date made and are not guarantees of future performance or results. In some cases, forward-looking statements can be identified by terminology such as “may,” “will,” “should,” “could,” “believe,” “expect,” “anticipate,” “estimate,” “plan,” “predict,” “target,” “potential,” “continue,” “objectives,” or the negative of these terms or other comparable terminology. Such forward-looking statements are necessarily estimates based upon current information and involve a number of risks and uncertainties. Such statements should be viewed with caution. Actual events or results may differ materially from the results anticipated in these forward-looking statements as a result of a variety of factors. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated by us include, but are not limited to:
Changes in regulation of the U.S. education industry and eligibility of proprietary schools to participate in U.S. federal student financial aid programs, including the factors discussed in Item 1, Business, under “Accreditation and Jurisdictional Authorizations,” “Financial Aid Programs” and “Regulatory Environment;”
The impact and effectiveness of the initiatives to transform University of Phoenix into a more focused, higher retaining and less complex institution, as discussed in Item 1, Business, under “University of Phoenix;”
Each of the factors discussed in Item 1A, Risk Factors; and
Those factors set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The cautionary statements referred to above also should be considered in connection with any subsequent written or oral forward-looking statements that may be issued by us or persons acting on our behalf. We undertake no obligation to publicly update or revise any forward-looking statements for any facts, events, or circumstances after the date hereof that may bear upon forward-looking statements. Furthermore, we cannot guarantee future results, events, levels of activity, performance, or achievements.
In this report, we refer to Apollo Education Group, Inc. as “the Company,” “Apollo Education Group,” “Apollo,” “APOL,” “we,” “us” or “our.”


Apollo Education Group, Inc. | 2016 Form 10-K | 3


Introductory Note Regarding Pending Merger
On February 7, 2016, we entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with AP VIII Queso Holdings, L.P. (“Queso”), an affiliate of Apollo Management VIII, L.P., which is a fund managed by an affiliate of Apollo Global Management, LLC, none of which is, or has ever been, affiliated with us. At the effective time of the merger, which, subject to the satisfaction of the closing conditions, is anticipated to be on or before February 1, 2017, the date on which the contract becomes terminable by either party, each share of our issued and outstanding Class A and Class B common stock will be converted pursuant to the terms of the Merger Agreement into the right to receive $10.00 per share in cash. On May 6, 2016, the Merger Agreement was approved by the holders of our outstanding Class A and Class B common stock, each voting separately as a class. Consummation of the merger is subject to various regulatory and customary approvals, and operating and other conditions. See Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Pending Merger, for additional information on the Merger Agreement and the pending merger.


Apollo Education Group, Inc. | 2016 Form 10-K | 4


PART I
Item 1. Business
Overview
Apollo Education Group, Inc. is a private education provider serving students since 1973. We seek to improve the lives of working adults across the globe by making unemployed learners job-ready and employed learners more productive in their careers and communities. We offer undergraduate, graduate, certificate and nondegree educational programs and services, online and on-campus, principally to working adults in the U.S. and abroad through the following:
University of Phoenix
Founded in 1976, The University of Phoenix, Inc. is a private university in the U.S. that has graduated more than 950,000 students. The University offers undergraduate and graduate degrees through its colleges and schools in a wide range of program areas, including business, education and nursing. A significant majority of the University’s approximately 140,000 students attend classes exclusively online, and the University also offers many of its educational programs and services at ground locations in selected major metropolitan areas throughout the U.S. In addition, the University offers a range of nondegree education programs for lifelong learners and students interested in developing skills and knowledge to improve their prospects of employment in their field of choice or advancement within their existing careers. In fiscal year 2016, University of Phoenix generated 78% of our consolidated net revenue.
Apollo Global
Our educational programs based outside the U.S. are primarily offered through our wholly-owned subsidiary, Apollo Global, Inc. We are increasing the extent of our international operations and we believe that our experience pioneering and delivering effective, flexible education to working adults can be utilized to successfully offer education in underserved international markets. Apollo Global served over 175,000 learners worldwide during fiscal year 2016, a significant portion of which represents students in short-term, nondegree programs and students that purchased certain self-study and/or asynchronous programs. Global serves its learners through the following:
BPP Holdings Limited (“BPP”) - BPP, which generated approximately half of Apollo Global’s fiscal year 2016 net revenue, is headquartered in London, England and offers professional training and exam preparation programs in a variety of areas and qualification training, undergraduate and graduate degrees through BPP University, which principally includes BPP Law School and BPP Business School. The majority of BPP’s professional training and exam preparation revenue is generated from accounting and law program areas. The majority of BPP University’s revenue represents law qualifications and law degree programs. BPP delivers most of its programs through a mix of online and on-ground instruction with locations throughout the United Kingdom and certain European countries.
Open Colleges Australia Pty Ltd (“Open Colleges”) - Open Colleges is headquartered in Sydney, Australia and offers nationally recognized and government approved nondegree certificates, diplomas and other qualifications in a diverse range of disciplines and industries, including health and wellness, business management and services, and community services. The programs are designed for adult learners and provide flexibility through an online, asynchronous delivery model.
Career Partner GmbH (“Career Partner”) - Career Partner is headquartered in Munich, Germany and offers undergraduate and graduate degrees primarily in business, and nondegree programs. Career Partner delivers instruction at ground locations in Germany and online.
Universidad Latinoamericana (“ULA”) - ULA is headquartered in Mexico City, Mexico and offers graduate and undergraduate degrees, high school and executive education in a variety of program areas and disciplines, including medical, dental and communications. ULA delivers instruction through a mix of online and on-ground delivery at its campuses and learning centers, principally in Mexico City.
Faculdade da Educacional da Lapa (“FAEL”) - FAEL is headquartered in Curitiba, Brazil and offers undergraduate and graduate degrees, primarily in the areas of business, education and technology. FAEL delivers instruction online and at ground locations throughout Brazil.
Apollo Global Chile S.A. (“Apollo Global Chile”) - Apollo Global Chile includes Universidad de Artes, Ciencias y Comunicación (“UNIACC”) and Instituto Superior de las Artes y Comunicaciones (“IACC”). UNIACC offers undergraduate and graduate degree programs in a variety of program areas principally at its campus in Santiago, Chile. IACC primarily offers degree and nondegree programs that are delivered online.
Milpark Education (Pty) Ltd. (“Milpark Education”) - Milpark Education is headquartered in Cape Town, South Africa and offers postsecondary education designed for adult learners, including undergraduate and graduate degrees primarily in business, and nondegree programs. Milpark Education delivers instruction principally through distance education and, in select instances, on-ground at its campuses in Cape Town and Johannesburg.


Apollo Education Group, Inc. | 2016 Form 10-K | 5


India Education Services Private Ltd (“India Education Services”) - India Education Services, a 50:50 joint venture with HT Media Limited, an Indian media company, operates the Bridge School of Management in India. The school offers nondegree management and business programs geared toward adult learners, delivered in a mix of online and on-ground teaching.
Other
The College for Financial Planning Institutes Corporation (“College for Financial Planning”) - College for Financial Planning was founded in 1972 and is the creator of the Certified Financial Planner or CFP designation. College for Financial Planning provides online financial services education programs, including graduate degrees in three majors, certificate programs, Financial Industry Regulatory Authority securities license training, and continuing education courses.
Western International University, Inc. - Western International University offers undergraduate and graduate degrees in a variety of program areas, including business, information technology and behavioral science. Western International University’s programs are designed to provide students with a more self-managed, streamlined and affordable online higher education solution, as they work to achieve their educational goals and advance their careers. Western International University also provides relevant solutions for employers to help solve their human capital needs through degree and nondegree programs that can be tailored to meet the needs of the specific employer.
TIY Academy, LLC (“The Iron Yard”) - The Iron Yard provides various nondegree bootcamp programs that are typically 12 weeks or less in duration, and provide intensive, immersive skills training designed to provide direct pathways to associated careers in information technology.
Apollo Professional Development - Apollo Professional Development provides relevant programs for employers to better help them recruit, develop and retain a qualified workforce.
Net Revenue
The following presents net revenue for each of our reportable segments for the respective periods:
 
Year Ended August 31,
($ in thousands)
2016
 
2015
 
2014
University of Phoenix
$
1,631,412

 
$
2,148,312

 
$
2,632,949

Apollo Global
433,700

 
391,217

 
338,008

Other
36,738

 
26,748

 
25,908

Net revenue
$
2,101,850

 
$
2,566,277

 
$
2,996,865

The information required by Item 101(b) and 101(d) of Regulation S-K is provided under Note 18, Segment Reporting, in Part II, Item 8, Financial Statements and Supplementary Data, which is incorporated herein by reference.
General
University of Phoenix was founded in 1976 and Apollo was incorporated in Arizona in 1981. Apollo maintains its principal executive offices at 4025 S. Riverpoint Parkway, Phoenix, Arizona 85040 and also maintains senior executive offices at 227 West Monroe Street, Suite 3600, Chicago, Illinois 60606. Our telephone number is (480) 966-5394 and our website address is www.apollo.edu.
Our fiscal year is from September 1 to August 31.


Apollo Education Group, Inc. | 2016 Form 10-K | 6


Strategy
The higher education industry is changing at an increasing pace due to a challenging political and regulatory environment, technological developments, evolving needs and objectives of students and employers, economic constraints affecting educational institutions and students, price competition, increased focus on affordability and value, inconsistent quality of secondary education in the U.S. and other factors that challenge many of the core principles underlying the industry.
During this period of transition within the organization and unprecedented industry challenges, we remain focused on our mission to improve the lives of our working adults through higher education. We are working to make unemployed learners job-ready and employed learners more productive in their careers and communities. Our strategy includes the following key themes:
Drive improvement in student progression and career outcomes - We believe that maximizing the value our students garner from their education is our top priority. We are focused on continuously improving our educational programs and services and providing the support needed to enable our students to successfully complete their programs and achieve their career goals.
Diversification and targeted growth - We intend to focus on diversification through growth at our international institutions and increasing our professional development and other nondegree programs, which includes business-to-business product and service offerings.
Operational excellence - We intend to continue our efforts to streamline operations, improve efficiency, ensure our cost structure is in line with our enrollment levels and deliver education more effectively and affordably in order to sustain long-term organizational strength and the ability to reinvest.
Industry
Domestic
The domestic postsecondary degree-granting education industry was estimated to be a more than $550 billion industry in 2013, according to a report published in 2016 by the U.S. Department of Education, with approximately 20 million students attending institutions that participate in U.S. federal financial aid programs. The Department projects that enrollment in postsecondary degree-granting institutions will grow 12% over the ten-year period ending in the fall of 2023 to approximately 23 million students. The degree-granting sector is highly fragmented with more than 4,700 domestic colleges and universities that participate in U.S. federal financial aid programs with no single institution having a significant market share.
Domestic higher education also includes a variety of nondegree programs including education certificate programs, continuing education, professional development, technology bootcamps and test preparation. We believe enrollment in nondegree programs is growing at a faster rate than enrollment in degree programs.
The majority of degree-seeking students today have one or more non-traditional characteristics (e.g., did not enroll immediately after high school graduation, attend part-time, work full-time, are financially independent for purposes of financial aid eligibility, have dependents other than a spouse, are single parents, or have no high school diploma). These non-traditional students (whom we generally refer to as working adults) typically are looking to improve their skills and enhance their earnings potential within the context of their careers or in pursuit of new careers. As the industry has shifted to more students with non-traditional characteristics, an increasing proportion of colleges and universities are addressing the needs of working adults. This includes colleges with well-established brand names that were historically focused on traditional students. See further discussion at Competition below.
The higher education industry is changing at an increasing pace as discussed in Strategy above. As a result, we see several forces impacting the higher education market in the near future:
Increased pressure for more affordable education programs from reputable brands and lower student loan debt;
Increased demand for certain education offerings, including nondegree programs, that lead to direct job pathways and require less time to complete;
Increased demand for effective remedial education and other services and programs for students who are underprepared for college;
Increased demand for proof of learning outcomes and education effectiveness; and
Continued contraction of the proprietary sector following the recent ceasing of operations and bankruptcy protection filing by two major proprietary education institutions, together serving over 110,000 students, due to delays in or denial by the Department of Education of Title IV funding for students, based in part on the existence of multiple investigations by various regulatory authorities. See further discussion at Regulatory Environment below.


Apollo Education Group, Inc. | 2016 Form 10-K | 7


International
There were approximately 175 million students enrolled in postsecondary education worldwide in 2012, excluding the U.S., according to a report published in 2016 by the U.S. Department of Education. The international higher education market and associated opportunities often vary significantly by country due to a variety of factors including, but not limited to, the political, cultural and regulatory environments, as well as the structure of pre- and postsecondary educational systems. Additionally, higher education is rapidly evolving and private education is playing an important role in advancing the development of education, specifically higher education and lifelong learning, in many countries around the world. Within the last several years, educational groups and other investors have been investing in education institutions and consolidating the market in several countries. However, we believe there are underserved international markets that provide growth opportunities for private education as a result of some or all of the following:
Insufficient public funding to meet demand for education;
Shortcomings in the quality of higher education offerings, resulting in the rise of supplemental training to meet industry demands in the developing world;
Worldwide appreciation of the importance that knowledge plays in economic progress; and
The availability and role of technology in education, broadening the accessibility and reach of education.
University of Phoenix
University of Phoenix was founded in 1976 to provide access to effective higher education for working adults who wanted to advance their knowledge and achieve their professional goals. The University has been an innovator in higher education and has graduated more than 950,000 students. The University offers undergraduate and graduate degrees through its colleges and schools in a wide range of program areas as well as various nondegree programs. A significant majority of the University’s students attend classes exclusively online and the proportion of the University’s online students has increased in recent years. Many of the University’s academic programs are also offered at ground locations in selected major metropolitan areas throughout the U.S.
The University’s vision is to be recognized as the most trusted provider of career-relevant higher education for working adults. In furtherance of this, the University offers career focused programs and an instructional model designed specifically to meet the educational needs of working adults, which is further discussed below.
Due in part to the rapidly changing higher education environment, particularly for proprietary institutions, and the competitive factors described in Competition below, the University’s enrollment has substantially declined since late 2010. The University is working to stabilize enrollment in the longer term by transforming itself into a more focused, higher retaining and less complex institution, including through:
Student outcomes initiatives designed to better prepare incoming students and to help existing students progress in their programs to completion. This includes tailoring initial course sequences to match the academic capabilities of students when they first enroll, continuing to assess our programs to retire or improve those which have lower retention rates or are less career relevant, adding more career-focused pathways that offer certificates and four-year bachelor’s degrees in key growth areas of the employment market, and piloting diagnostic tools for development of enhanced admissions guidelines and pathways expected to be implemented in fiscal year 2017.
Student experience initiatives such as concentrating on fewer ground locations in selected major metropolitan areas throughout the U.S. while maintaining a regional presence for both on-ground and online students, and continuing to improve the classroom experience by offering student cohort start dates approximately every five weeks for most programs to optimize class size and classroom dynamics.
Brand health and outreach initiatives designed to better manage the University’s marketing message, improve its ability to identify those students more likely to persist in its educational programs, and build on the University’s move away from third-party operated websites for marketing purposes.
Operational excellence initiatives designed to reduce costs, improve operations and facilitate future systems upgrades such as continuing the transition of technology systems from proprietary and legacy systems to commercial software and software as a service. This includes the University’s online classroom and developing increased student self-service capabilities in admissions, financial aid, academic planning and class scheduling.
We have experienced significant challenges in accurately predicting the effects on enrollment and retention of the various initiatives that we have developed and deployed in recent years. Accordingly, there is no assurance that our current transformation plan will stabilize enrollment, improve retention or achieve the other intended results, and the broad scope and number of simultaneous changes increases the risk of unexpected challenges and unintended consequences. Some of these initiatives have accelerated the enrollment decline at University of Phoenix in recent years, as discussed further in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations. Further, we expect that the University’s enrollment will continue declining as we implement the initiatives; however, we expect the rate of decline to moderate as compared to the rate we experienced during 2016 and that enrollment will not increase prior to fiscal year 2019.


Apollo Education Group, Inc. | 2016 Form 10-K | 8


Colleges & Schools and Programs
The University offers undergraduate and graduate degrees in a wide range of program areas through the following colleges and schools:
Colleges and Schools
School of Business
School of Nursing(1)
College of Social Sciences
College of Education
College of Humanities and Sciences
College of Security and Criminal Justice
School of Health Services Administration(1)
College of Information Systems and Technology
School of Advanced Studies
(1) Offered through the University’s College of Health Professions.
The School of Business, College of Social Sciences and College of Health Professions represent more than 70% of the University’s Degreed Enrollment. Refer to Students below for a definition of Degreed Enrollment.
Although degree programs represent the substantial majority of the University’s revenue, the University is focused on growing its nondegree continuing education programs, which include:
Individual, credit bearing courses in a variety of program areas, mostly from the University’s degree programs. These courses assist students in fulfilling their educational professional goals, maintaining licensures, and earning general elective credits to transfer into a degree program.
Noncredit bearing professional development programs designed to advance career-specific skills and knowledge for working professionals in a variety of program areas.
Test-preparation and certificate programs designed to help working professionals achieve industry-recognized certifications and/or successfully complete content-specific tests.
Degree seeking students also have the opportunity to benefit from the University’s nondegree programs by earning certificates that can be used in the workplace as they are working toward their ultimate degree goal with no additional tuition or time.
Instructional Model
University of Phoenix’s instructional model is designed specifically to meet the educational needs of working adults who seek accessibility, application of theory and practice, and access to practitioner faculty learning that has immediate application to the workplace. The delivery model is structured to enable students who are employed full-time or have other commitments to earn their degrees and still meet their personal and professional responsibilities. The University’s focus on working, non-traditional, non-residential students minimizes the need for capital-intensive facilities and services like dormitories, student unions, food service, health care, sports and entertainment.
Many of the University’s academic programs are offered at ground locations in selected major metropolitan areas throughout the U.S., but a significant majority of the University’s students attend classes exclusively online. The University currently employs a proprietary online learning system used by both faculty and students; however, University of Phoenix entered into an agreement in June 2015 with a leading provider of learning management systems to implement a new learning management system, which the University began piloting with certain students in calendar year 2016. The University believes this arrangement will reduce cost and complexity, make it easier to incorporate improvements and, over time, improve learning outcomes and enhance the student experience.
Components of University of Phoenix’s instructional model for both online and on-ground classes include:
Curriculum. Faculty content experts design the curriculum for the University’s programs, which enables it to offer current and relevant standardized programs to its students. The curricula are designed to integrate academic theory and professional practice and their application to the workplace.
Faculty. Substantially all University of Phoenix faculty possess either a master’s or doctoral degree. Faculty members typically have many years of experience in the field in which they instruct, and most teach on an adjunct basis.
Accessibility. Many of the University’s academic programs may be accessed either online or on-ground.
Active Learning Environment and Class Schedule. University of Phoenix courses involve collaborative learning activities and class schedules often vary in length and structure depending on degree level and delivery mode. The University recently reduced the number of student cohort start dates from approximately every week to approximately every five weeks for most programs in order to reduce complexity and improve the classroom experience.
Student Learning Resources. The University offers students and faculty a variety of education services including learning resources for their information and research needs, tutoring, student workshops and PhoenixConnect, the University’s proprietary academic social media network.


Apollo Education Group, Inc. | 2016 Form 10-K | 9


Marketing
University of Phoenix engages in a broad range of advertising and marketing activities to educate students about the options they have in higher learning and convey the University’s value proposition and offerings to connect education to careers. The University is focused on enhancing its brand perception and utilizing different communication channels, which are discussed below, to attract students who are more likely to persist in the University’s programs.
Internet. Many prospective students identify their education opportunities online through search engines, information and social network sites, various education portals on the Internet and school-specific sites such as the University’s phoenix.edu. The University advertises on the Internet using search engine keywords, banners, and custom advertising placements on targeted sites, such as education portals, career sites, and industry-specific websites. The University eliminated the use of third-party operated websites for marketing purposes in November 2015 in order to better manage its marketing message, improve its ability to identify those students more likely to persist in its educational programs, and reduce cost.
Brand. Brand advertising is intended to increase potential students’ awareness of the University’s academic quality, commitment to service, academic outcomes, academic community achievements and connection of education to careers. The University’s brand is advertised primarily through national and regional broadcast, radio, online video, social, and print media. Brand advertising also serves to expand the addressable market and establish brand consideration and familiarity with the University’s colleges and programs on both a national and a local basis.
Relationships with Employers and Community Colleges. We establish relationships with employers in part to provide the University with a source of potential working adults for particular programs. We also establish relationships with community colleges to connect their graduates with the University’s degree programs and other educational programs.
Sponsorships, Corporate Social Responsibility and Other. The University builds its presence in communities through sponsorships, advertising and event marketing to support specific activities, including local and national career events, academic lecture series, workshops and symposiums on various current topics of interest and through its corporate social responsibility outreach program.
Admissions
The University helps students understand the best fit with its programs by providing access to online tools and resources that answer key questions and concerns prior to admission. This includes assessments of a potential student’s learning style, academic abilities and readiness to pursue higher education, a tuition calculator and information on careers.
Admission to University of Phoenix undergraduate degree programs requires a high school diploma or equivalent, and proficiency in English. Admission to master and doctoral degree programs requires an undergraduate degree, and generally for doctoral programs, a master’s degree, from a regionally or nationally accredited college or university, a minimum grade point average and relevant work experience if applicable for the field of study. Additional admissions requirements may vary based on degree program. In addition, the University expects to implement enhanced admissions guidelines in fiscal year 2017.
Students
The following details University of Phoenix student enrollment for the respective periods:
 
 
Fiscal Year 2014
 
Fiscal Year 2015
 
Fiscal Year 2016
(Rounded to the nearest hundred)
 
Q1
 
Q2
 
Q3
 
Q4
 
Q1
 
Q2
 
Q3
 
Q4
 
Q1
 
Q2
 
Q3
 
Q4
Degreed Enrollment(1), (2)
 
263,000

 
250,300

 
241,900

 
233,500

 
227,400

 
213,800

 
206,900

 
190,700

 
176,900

 
162,400

 
155,600

 
142,500

New Degreed Enrollment(3)
 
41,700

 
32,500

 
33,900

 
38,600

 
39,600

 
28,300

 
29,400

 
26,500

 
24,500

 
17,200

 
17,900

 
19,400

(1) Represents students enrolled in a degree program who attended a credit bearing course during the quarter and had not graduated as of the end of the quarter; students who previously graduated from one degree program and started a new degree program in the quarter (e.g., a graduate of an associate’s degree program returns for a bachelor’s degree); and students participating in certain certificate programs of at least 18 credits with some course applicability into a related degree program.
(2) As described in Footnote 1, Degreed Enrollment includes students who attended a credit bearing course during the quarter and had not graduated as of the end of the quarter. The proportion of students included in Degreed Enrollment who have completed their academic work but not yet formally graduated (“academically complete students”) increased during the third and fourth quarters of fiscal year 2016 compared to prior periods due to changes in the manner in which graduation applications are processed. We estimate that the number of academically complete students reflected in this increase is approximately 2,000 - 3,000 for both the third and fourth quarters of fiscal year 2016.
(3) Represents new students and students who have been out of attendance for more than 12 months who enroll in a degree program and start a credit bearing course in the quarter; students who have previously graduated from a degree program and start a new degree program in the quarter; and students who commence participation in certain certificate programs of at least 18 credits with some course applicability into a related degree program.


Apollo Education Group, Inc. | 2016 Form 10-K | 10


Apollo Global
Our schools outside of the U.S. offer programs ranging from career oriented, nondegree certificate programs to accredited graduate degrees. BPP, as discussed further below, represents our largest international operation and generated approximately half of Apollo Global’s fiscal year 2016 net revenue. Our international institutions are spread throughout the world with locations in Europe, Australia, North America, South America, Africa and Asia. Apollo Global serves learners through the following:
Business and Headquarters
 
Principal Education Offerings
 
Students and Delivery Method
BPP; London, England
 
Substantially all of BPP’s revenue is generated by undergraduate and graduate degree programs at BPP University, and its nondegree programs. BPP University includes the BPP Law School and BPP Business School, with the law school generating the substantial majority of BPP University’s revenue. The nondegree programs primarily represent professional training and exam preparation.
 
Substantially all BPP students reside in the U.K., and fund their education with personal funds, private loans, government financial aid funding and, in some instances, tuition reimbursement or other forms of assistance from their employers.
Depending on the program, students are offered flexible learning models through on-campus, online, or blended delivery methods.
Open Colleges; Sydney, Australia
 
Open Colleges offers nondegree programs that include certificates, diplomas and other qualifications in a diverse range of disciplines and industries. Open Colleges’ revenue is not concentrated in any particular offering and its largest program areas are health and wellness, business management and services, and community services.
 
Substantially all Open Colleges students reside in Australia and fund their education with personal funds.
Open Colleges’ programs are delivered in an online, asynchronous format that provides students with the flexibility to complete programs at their convenience.
Career Partner; Munich, Germany
 
Career Partner offers undergraduate and graduate degrees primarily in business, and nondegree programs.
 
Substantially all Career Partner students reside in Germany and fund their education with personal funds.
Depending on the program, students are offered flexible learning models through on-campus or online delivery methods.
ULA; Mexico City, Mexico
 
ULA offers graduate and undergraduate degrees, high school and executive education in medical, dental and communications programs through a mix of online and on-ground delivery at its campuses and learning centers, principally in Mexico City.
 
Substantially all ULA students reside in Mexico and fund their education with personal funds.
Depending on the program, students are offered flexible learning models through on-campus, online or blended delivery methods.
FAEL; Curitiba, Brazil
 
FAEL offers undergraduate and graduate degrees, primarily in the areas of business, education and technology.
 
Substantially all FAEL students reside in Brazil, and fund their education with personal funds and, in some instances, fund a portion of their education with government financial aid programs.
Depending on the program, students are offered flexible learning models through distance education, on-campus, online or blended delivery methods.
Apollo Global Chile; Santiago, Chile
 
Apollo Global Chile includes UNIACC and IACC, which offer degree programs and nondegree programs in a variety of program areas primarily focused on arts and technology.
 
Substantially all UNIACC and IACC students reside in Chile and fund their education with personal funds.
Students are offered flexible learning models through on-campus or online delivery methods.
Milpark Education; Cape Town, South Africa
 
Milpark Education offers postsecondary education including undergraduate and graduate degrees, and nondegree programs. The substantial majority of Milpark Education’s programs are in business.
 
Substantially all Milpark Education students reside in South Africa and fund their education with personal funds and, in some instances, tuition reimbursement or other forms of assistance from their employers.
Depending on the program, students are offered flexible learning models through distance education and on-campus learning.
India Education Services; India
 
India Education Services, a 50:50 joint venture with HT Media Limited, an Indian media company, operates the Bridge School of Management, which offers nondegree management and business programs.
 
The Bridge School of Management is focused on attracting students that reside in India and offers flexible learning models through on-campus or online delivery methods.


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Competition
Domestic
The U.S. higher education industry is highly fragmented with no single private or public institution having a significant market share. We compete primarily with traditional public and private degree-granting regionally accredited colleges and universities, other proprietary degree-granting regionally accredited schools and alternatives to higher education. In addition, we face increasing competition from various emerging non-traditional, credit-bearing and noncredit-bearing education programs, offered by both proprietary and not-for-profit providers. Some of our competitors have greater financial and nonfinancial resources than we have and are able to offer programs similar to ours at a lower tuition level for a variety of reasons, including the availability of direct and indirect government subsidies, government and foundation grants, large endowments, tax-deductible contributions and other financial resources not available to proprietary institutions, or by providing fewer student services or larger class sizes. For example, a typical community college is subsidized by local or state government and, as a result, tuition rates for associate’s degree programs are much lower at community colleges than at University of Phoenix. Furthermore, various members of Congress have advocated for free or debt free post-secondary education at public universities, and the affordability of such education has been the subject of intense focus among candidates during the campaign leading up to the November 2016 elections in the U.S.
The nondegree sector of higher education is also highly fragmented and has substantially lower barriers to entry compared to degree granting institutions.
The higher education industry is changing at an increasing pace due to a challenging political and regulatory environment, technological developments, evolving needs and objectives of students and employers, economic constraints affecting educational institutions and students, price competition, increased focus on affordability and value, inconsistent quality of secondary education in the U.S. and other factors that challenge many of the core principles underlying the industry. Related to this, education providers are testing and adapting new education and operating models focused on reducing costs, time to complete and operational complexity. These recent innovations include competency based and adaptive learning, intensive and immersive skill focused bootcamps and career pathways, tools and services. In addition, one of our primary competitive advantages in the U.S. has been materially diminished as a significant and increasing number of traditional four-year and community colleges, which are subject to fewer regulatory constraints, offer an increasing array of distance learning and other online education programs, including programs that are offered wholly online and geared towards the needs of working adults. This trend has been accelerated by private companies that provide and/or manage online learning platforms for traditional four-year colleges and community colleges. As the proportion of traditional colleges and universities providing alternative learning modalities increases, we will face increased competition from these institutions, including those with highly regarded reputations, the degrees from which are perceived as more valuable in the workplace. Already, this type of competition is significant and has contributed to the substantial decline in University of Phoenix enrollment that began in late 2010.
Furthermore, as discussed above, University of Phoenix is piloting diagnostic tools for development of enhanced admissions guidelines expected to be implemented in fiscal year 2017. Many of the students who do not meet these enhanced admissions guidelines will not be eligible for admission to traditional four-year colleges and universities. Accordingly, these new admissions guidelines will increase the proportion of University of Phoenix’s potential students for which the University competes directly with the traditional educational institutions, further intensifying competition.
We believe that the primary factors on which we compete are the following:
Breadth of reliable and high-quality programs tied to careers;
Active and relevant curriculum development that considers the needs of employers;
The ability to provide flexible and/or convenient access to our programs and classes;
Career assessment and planning, and connecting career opportunities at leading companies to our students and alumni;
Cost and perceived value of our offerings;
Reputation of the institution and its programs;
Qualified and experienced faculty;
Differentiated student support services; and
Size of alumni network.


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International
In general, we operate in international markets that are highly competitive. Our international schools compete with other proprietary companies and, in certain instances, with government supported schools and institutions. Competitive factors for our international schools vary by country and, in some cases, by program offering. For example, BPP’s qualifications and law program offerings compete with other providers primarily based on reputation and student outcomes, including placement rates and exam pass rates. Competitive factors for all of our international offerings generally include the following:
Active and relevant curriculum development that considers the needs of employers; 
Breadth of reliable and high-quality programs and classes;
Qualified and experienced faculty;
Reputation of programs and classes;
The ability to provide flexible and/or convenient access to programs and classes; and
Program affordability.
Employees
As of August 31, 2016, we had approximately 9,000 non-faculty employees, the substantial majority of whom were employed full-time. We also had approximately 19,000 faculty members as of August 31, 2016, of which approximately 16,000 are University of Phoenix faculty. The substantial majority of the University’s faculty are adjunct faculty who have taught in the last twelve months and are eligible to teach future courses. We believe that our employee relations are satisfactory.
Accreditation and Jurisdictional Authorizations
Domestic
University of Phoenix is regionally accredited by the Higher Learning Commission (“HLC”), which provides the following:
Recognition and acceptance by employers, other higher education institutions and governmental entities of the degrees and credits earned by students;
Qualification to participate in student financial aid programs under Title IV of the Higher Education Act (“Title IV”)(in combination with state higher education operating and degree granting authority); and
Qualification for authority to operate 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, as a component of authorization to operate as a degree-granting institution.
In July 2013, the accreditation of University of Phoenix was reaffirmed by HLC, the University’s principal accreditor, through the 2022-2023 academic year. The University is subject to the Standard Pathway reaffirmation process, pursuant to which the University will host a comprehensive evaluation visit in 2017 and will undergo its next reaffirmation process in 2022-2023.


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Accreditation information for University of Phoenix and applicable programs is described below:
Institution/Program
 
Accrediting Body (Year Accredited)(1)
 
Status(1)
University of Phoenix
 
• The Higher Learning Commission (1978, reaffirmed in 1982, 1987, 1992, 1997, 2002 and 2013)
 
• Comprehensive evaluation visit scheduled for 2017
• Business programs
 
• Accreditation Council for Business Schools and Programs
 
• Reaffirmation visit expected in 2017
• Bachelor of Science in Nursing
 
• Commission on Collegiate Nursing Education (2005)
• Previously accredited by National League for Nursing Accrediting Commission from 1989 to 2005
 
• Reaffirmation visit expected in 2020
• Master of Science in Nursing
 
• Commission on Collegiate Nursing Education (2005)
• Previously accredited by National League for Nursing Accrediting Commission from 1996 to 2005
 
• Reaffirmation visit expected in 2020
• Master of Counseling in Clinical Mental Health (Arizona campuses)
 
• Council for Accreditation of Counseling and Related Educational Programs (2012)
 
• Reaffirmation visit expected in 2017 or 2018
• Master of Counseling in Mental Health Counseling (Utah campus)
 
• Council for Accreditation of Counseling and Related Educational Programs (2001, reaffirmed in 2010, and in 2012)
 
• Reaffirmation visit expected in 2017
• Master of Arts in Education with options in Elementary Teacher Education and Secondary Teacher Education
 
• National Council for Accreditation of Teacher Education (“NCATE”)
 
• The University has, or is pursuing, NCATE programmatic accreditation in those states where it is mandatory for operation
(1) The referenced years are on a calendar basis.
In addition to accreditation by independent accrediting bodies, our schools must be authorized to operate by the appropriate regulatory authorities in many of the jurisdictions in which they operate. Institutions that participate in Title IV programs must be authorized to operate by the appropriate postsecondary regulatory authority in each state where the institution has a physical presence. University of Phoenix is specifically authorized to operate in all of the domestic jurisdictions in which it operates. Some states assert authority to regulate all degree-granting institutions if their educational programs are available to their residents, whether or not the institutions maintain a physical presence within those states. University of Phoenix has obtained licensure in states which require such licensure and where students are enrolled. Refer to Regulatory Environment - U.S. Department of Education Rulemaking Initiatives for additional information regarding current state authorization rulemaking initiatives and Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - If we fail to maintain any of our state authorizations, we would lose our ability to operate in that state and to participate in Title IV programs there.
Our other domestic institutions maintain accreditations and/or the requisite authorizations in the jurisdictions in which they operate, as applicable. This includes Western International University, which has been accredited by HLC since 1984, and College for Financial Planning, which has been accredited by HLC since 1994.


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International
Our international businesses must be authorized by the relevant regulatory authorities under applicable local law, which in some cases requires accreditation, as described below:
BPP - BPP University Limited has been awarded degree awarding powers by the U.K. Privy Council, and certain of its awards are accredited by professional bodies toward professional qualifications. This designation is expected to require renewal during the 2018-2019 school year. Additionally, BPP Professional Education is an accredited training provider for a number of professional bodies offering training toward those bodies’ professional qualifications. BPP also has additional accreditations by country and/or program as applicable.
Open Colleges - Open Colleges operates four registered training organizations as approved by the Australian Skills Quality Authority (“ASQA”), the national regulator of vocational education programs. All four registrations were most recently renewed for the maximum allowable period with the first expiring and requiring renewal in our fiscal year 2018.
In mid-October 2016, Apollo Global’s two primary registered training organizations in Australia, Open Colleges Pty Ltd., and Integrated Care & Management Training, Pty Ltd., each received a notice of noncompliance and intention to make a decision to impose sanctions from ASQA. The notice, which followed a recent compliance audit, identified several alleged compliance deficiencies and stated that ASQA intended to make a decision on whether to impose sanctions on the institutions which could include cancellation of registration or imposition of lesser sanctions. One of the findings involves a change in the interpretation of applicable course requirements and will require changes in our procedures for student workplace skills assessments used in connection with courses that represent a substantial portion of the Open Colleges institutions’ enrollment.
Implementing an updated workplace skills assessment model in order to address ASQA’s concerns will require operational changes for these institutions and increase operating costs, perhaps substantially, and could have competitive implications.
We have until November 7, 2016 to respond to this notice of noncompliance. We cannot currently predict the timing or ultimate outcome of this matter. See Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - Changes by a regulator in the interpretation of applicable course requirements could materially impact our Open Colleges business in Australia.
Career Partner - Career Partner operates under its registration with the German Council of Science and Humanities. This registration was renewed for a period of ten years and is expected to require renewal in 2019. Career Partner also operates under additional programmatic accreditations, as applicable.
ULA - ULA is recognized as a University of Excellence, which is the highest level of institutional accreditation from the Mexican Federation of Private Institutions of Higher Education (Federación de Instituciones Mexicanas Particulares de Educación Superior). ULA operates under additional regional or programmatic regulators in Mexico, as applicable.
FAEL - FAEL is institutionally accredited by the Brazilian Ministry of Education to provide on-site and distance learning programs and also holds the applicable authorizations for the programs it provides.
Apollo Global Chile - UNIACC and IACC are regulated by the Chilean Ministry of Education (Ministerio de Educación de Chile) and have programmatic accreditations, as applicable. UNIACC and IACC are pursuing or expect to pursue institutional accreditation with the relevant accrediting body, but we cannot predict whether, or when, such accreditation may be granted.
Milpark Education - Milpark Education is registered with the South African Department of Higher Education and Training as a Private Higher Education Institution.
Bridge School of Management - The Bridge School of Management offers non-accredited programs.
Financial Aid Programs
Domestic
The principal source of federal student financial aid in the U.S. is Title IV of the Higher Education Act and regulations promulgated thereunder. We refer to the financial aid programs under this Act as “Title IV” programs. The U.S. Congress must periodically reauthorize the Higher Education Act and annually determine the funding level for each Title IV program. The most recent reauthorization of the Higher Education Act expired September 30, 2013, but Title IV student financial aid programs remain authorized and functioning. Congress continues to engage in discussion and activity regarding Higher Education Act reauthorization, but the timing and terms of any eventual reauthorization cannot be predicted.


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Financial aid under Title IV programs is awarded annually to eligible students. Some Title IV programs award financial aid on the basis of financial need, generally defined as the difference between the cost of attending an educational institution and the amount the student and/or the student’s family, as the case may be, can reasonably be expected to contribute to that cost. The amount of financial aid awarded to a student each academic year is based on many factors, including, but not limited to, program of study, grade level, Title IV annual loan limits, and financial need. We have substantially no control over the amount of Title IV student loans or grants sought by or awarded to our students. All recipients of Title IV program funds must maintain satisfactory academic progress within the guidelines published by the U.S. Department of Education to remain eligible. Refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - Action by the U.S. Congress to revise the laws governing federal student financial aid programs or reduce funding for these programs, including changes applicable only to proprietary educational institutions, could reduce our enrollment and increase our costs of operation.
In addition to Title IV programs, qualifying U.S. active military and veterans and their family members are eligible for federal student aid from various Departments of Defense and Veterans Affairs programs. We refer to the financial aid programs administered by these Departments as “military benefit” programs.
During fiscal year 2016, 79% of University of Phoenix’s cash basis revenue for eligible tuition and fees was derived from the receipt of Title IV program funds, as calculated under the 90/10 Rule described in Regulatory Environment below. These Title IV program funds are principally comprised of federal student loans and Pell Grants:
Student loans currently are the most significant component of Title IV program funds and are administered through the Federal Direct Loan Program. Annual and aggregate loan limits apply based on the student’s grade level and other factors. Currently, the maximum annual loan amounts range from $3,500 to $12,500 for undergraduate students and $20,500 for graduate students. There are two types of federal student loans: subsidized loans, which are based on the statutory calculation of student need, and unsubsidized loans, which are not based on student need. Neither type of student loan is based on creditworthiness. Students are not responsible for interest on subsidized loans while enrolled in school. Graduate and professional students are not eligible for subsidized loans. Students are responsible for the interest on unsubsidized loans while enrolled in school, but have the option to defer payment while enrolled. Repayment on federal student loans begins six months after the date the student ceases to be enrolled. The loans are repayable over the course of 10 years and, in some cases, longer. During fiscal year 2016, student loans (both subsidized and unsubsidized) represented approximately 76% of the gross Title IV program funds received by University of Phoenix.
Federal Pell Grants are awarded based on financial need and only to eligible undergraduate students who have not earned a bachelor’s or professional degree. Unlike loans, Pell Grants do not have to be repaid. The maximum annual Pell Grant award is $5,815 for the 2016-2017 award year. During fiscal year 2016, Pell Grants represented approximately 24% of the gross Title IV program funds received by University of Phoenix. Because the federal Pell Grant program is one of the largest non-defense discretionary spending programs in the federal budget, it is a target for reduction as Congress addresses the competing demands for funding and the chronic and significant U.S. budget deficit. Furthermore, a recent study by the U.S. Federal Reserve System demonstrated a direct relationship between student financial aid increases, including Pell Grant increases, and tuition increases, which could impact future Pell Grant amounts. A reduction in the maximum annual Pell Grant amount or changes in eligibility could negatively impact enrollment and could result in increased student borrowing, which would make it more difficult for us to comply with other important regulatory requirements such as maintaining student loan cohort default rates below specified levels.
The remaining funding for tuition and other fees paid by our students primarily consists of military benefit programs, tuition assistance from employers and personal funds.
On January 15, 2016, University of Phoenix was notified by the U.S. Department of Defense (“DoD”) that the University’s probationary status in respect of its participation in the DoD Tuition Assistance Program for active duty military personnel had been lifted, effective immediately. The University had been placed on probation in October 2015 pending a review by the Department of the University’s compliance with the DoD Voluntary Education Partnership Memorandum of Understanding with the University, which is the basis on which the University’s active duty military students participate in the DoD Tuition Assistance Program.
The University will be subject to a heightened compliance review for a period of one-year following the removal of probationary status. During this period, the University will continue to engage with the DoD and complete the production of information and documents previously requested by the DoD. In addition, the University will be subject to an enhanced compliance review in fiscal year 2017.
In fiscal year 2016, funding under the DoD Tuition Assistance Program represented less than 1% of the University’s net revenue.
Refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate.


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International
Although students enrolled at certain of our international institutions receive government financial aid funding, such funding is not a material component of our net revenue from international institutions.
Regulatory Environment
Domestic
Our domestic postsecondary institutions are subject to extensive U.S. federal and state regulations. The Higher Education Act, as reauthorized, and the related U.S. Department of Education regulations govern all higher education institutions participating in Title IV programs, and provide for a regulatory triad by mandating specific regulatory responsibilities for each of the following:
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.
To be eligible to participate in Title IV programs, a postsecondary institution must be accredited by an accrediting body recognized by the U.S. Department of Education, must comply with the Higher Education Act, as reauthorized, and all applicable regulations thereunder, and must be authorized to operate by the appropriate postsecondary regulatory authority in each state in which the institution operates, as applicable.
In addition to governance by the regulatory triad, there has been substantial and continuing increased focus in recent years by members of the U.S. Congress and federal agencies, including the Department of Education, the Consumer Financial Protection Bureau and the Federal Trade Commission, on the role that proprietary educational institutions play in higher education. Congressional hearings and roundtable discussions have been held regarding various aspects of the education industry, and reports have been issued that are highly critical of proprietary institutions and include a number of recommendations to be considered by Congress in connection with the upcoming reauthorization of the federal Higher Education Act. A group of influential U.S. senators has strongly and repeatedly encouraged the Departments of Education, Defense and Veterans Affairs to take action to limit or terminate the participation of proprietary educational institutions, including University of Phoenix, in existing tuition assistance programs.
The 2016 Democratic Party Platform for the November 2016 elections includes a plan highly critical of the proprietary education industry and vows to intensify the current focus on for-profit schools and to strengthen the gainful employment rules applicable to for-profit schools. The outcome of the November 2016 elections in the U.S. could increase the risk that the eligibility of proprietary schools to participate in Title IV student financial aid programs will be limited, perhaps materially.
In late 2014, the Department of Education formed an inter-agency task force focused on the proprietary sector involving multiple federal agencies and departments including the Federal Trade Commission, the U.S. Departments of Justice, Treasury and Veterans Affairs, the Consumer Financial Protection Bureau, the Securities and Exchange Commission, and numerous state Attorneys General, to coordinate activities and share information to protect students from unfair, deceptive and abusive policies and practices by proprietary higher education institutions. We expect that this challenging political and regulatory environment will continue for proprietary educational institutions, including University of Phoenix, for the foreseeable future, and may intensify.
In recent years, two major proprietary education institutions, together serving over 110,000 students, have ceased operations and filed for bankruptcy protection due to delays in or denial by the Department of Education of Title IV funding for students and requirements to post letters of credit, based in part on the existence of multiple investigations by various regulatory authorities. In neither case were the principal investigations completed nor were substantial enforcement actions commenced and prosecuted to conclusion. Accordingly, proprietary institutions are at risk of harmful delays or denial of Title IV funding for students due to investigations and other preliminary allegations, even if such investigations or allegations may ultimately be found to lack merit.
We have summarized below recent material activity in the regulatory environment affecting our business and the most significant regulatory requirements applicable to our domestic postsecondary operations. Changes in or new interpretations of applicable laws, rules, or regulations could have a material adverse effect on our eligibility to participate in Title IV programs, accreditation, authorization to operate in various states, permissible activities, and operating costs. The failure to maintain or renew any required regulatory approvals, accreditation, or state authorizations could have a material adverse effect on us. Refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate.


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Financial Aid Funding
The most recent reauthorization of the Higher Education Act expired September 30, 2013, but Title IV student financial aid programs remain authorized and functioning. Congress continues to engage in discussion and activity regarding Higher Education Act reauthorization, but the timing and terms of any eventual reauthorization cannot be predicted.
Title IV program funding is a potential target for reduction by Congress. Because the majority of our revenue is derived from Title IV programs, any action by Congress that reduces Title IV program funding, or which alters the eligibility of our institutions or students to participate in Title IV programs could have a material adverse effect on our enrollment and financial condition. Action by Congress or federal agencies could also require us to modify our practices in ways that increase our operating costs.
In addition to possible reductions in Title IV program funding, military benefit programs may be reduced as military branches address decreased funding. Reductions and/or changes in military benefit programs, or changes in our eligibility to participate in such programs, could result in increased student borrowing, decreased enrollment and adverse impacts on our 90/10 Rule percentage, as discussed below.
Eligibility and Certification Procedures
The Higher Education Act, as reauthorized, specifies the manner in which the U.S. Department of Education reviews institutions for eligibility and certification to participate in Title IV programs. Every educational institution involved in Title IV programs must be certified to participate and is required to periodically renew this certification, which is granted in a Program Participation Agreement with the institution.
University of Phoenix’s Title IV Program Participation Agreement expired on December 31, 2012. The University has submitted necessary documentation for recertification and its eligibility continues on a month-to-month basis until the Department issues its decision on the application. We believe that the University’s application will be renewed in due course. However, we cannot predict whether or to what extent the continued challenging political and regulatory climate, our pending merger, and other recent developments in general relating to the proprietary education sector and our business may have on the timing or outcome of the recertification process.
In February 2016, the Department notified the University that for the duration of the month-to-month continuation of the University’s Program Participation Agreement, University of Phoenix must obtain from the Department prior approval of substantial changes, including (i) the establishment of additional locations, (ii) any increase in the level of academic offering beyond those listed in the Institution’s Eligibility and Certification Approval Report and (iii) the addition of any educational program (including degree, nondegree, or short-term training programs). Some of these substantial changes include changes that previously could be implemented by the University upon notice to the Department and without prior approval.
Gainful Employment
Under the Higher Education Act, as reauthorized, proprietary schools are generally eligible to participate in Title IV programs only in respect of educational programs that lead to “gainful employment in a recognized occupation.” In connection with this requirement, proprietary postsecondary institutions are required to provide information to prospective students about each eligible program, including the relevant recognized occupations, cost, completion rate, job placement rate, and median loan debt of program completers.
In October 2014, the U.S. Department of Education published final regulations, effective July 1, 2015, on the metrics for determining whether an academic program prepares students for gainful employment in a recognized occupation. Under the final regulations, which apply on a program-by-program basis, students enrolled in a program will be eligible for Title IV student financial aid only if that program satisfies at least one of two tests relating to student debt service-to-earnings ratios. The two tests specify minimum student loan debt service-to-earnings ratios calculated on the basis of the average earnings of program graduates: one test measures student loan debt service as a percentage of total earnings, and the other test measures student loan debt service as a percentage of deemed discretionary earnings. If a program fails to meet both of the minimum ratios for one year, the institution will be required to provide a warning notice to prospective and enrolled students advising that the program may lose Title IV eligibility based on the final student loan debt service-to-earnings ratios for the next year. Programs that fail to meet both of the minimum ratios for two out of three years will immediately cease to be Title IV eligible for a period of at least three years.
The Department has indicated that it plans to issue the official 2014 gainful employment debt service-to-earnings ratios by January 2017, and we anticipate the 2015 ratios will be issued in early fiscal year 2018. We believe it is likely that some of University of Phoenix’s programs will be impacted by the gainful employment regulations. Beginning in September 2015 and continuing through early fiscal year 2017, the University ceased enrolling or plans to cease enrolling new students in programs it believes may be impacted in connection with its initiatives to transform itself into a more focused, higher retaining and less complex institution. As of August 31, 2016, students in such programs represented approximately 15% of the University’s


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Degreed Enrollment. Students who are currently enrolled in such programs, and who do not elect to enroll in a different University of Phoenix program, are being taught-out in due course.
Changes in student borrowing needs and practices, student loan interest rates, labor markets and other factors outside of our control could adversely impact compliance with these regulations for some of our programs in the future. The Department has not yet announced the future, annual protocol for calculating and disseminating the debt service-to-earnings ratios. We will not know of a program’s failure to meet the minimum ratios until well after the measuring period, and therefore students enrolled in such a program could lose their access to federal financial aid before completing the program. Accordingly, we will not have the opportunity to make program changes for any programs that did not meet either of the minimum ratios for 2014. If those programs also do not meet either of the minimum ratios for 2015, they will lose eligibility to participate in Title IV financial aid programs at the time the official 2015 ratios are published, which we anticipate will occur in early fiscal year 2018.
U.S. Department of Education Rulemaking Initiatives
In recent years, the U.S. Department of Education has engaged in rulemaking discussions intended to develop new regulations focused on various topics. The negotiated rulemaking process typically begins with the Department issuing proposed regulations open for public comment after which the Department responds and publishes final regulations. We cannot predict the content of any new regulations that may emerge from the negotiated rulemaking process or the potential impact of such regulations on our domestic institutions.
A negotiated rulemaking committee was convened by the Department in January 2016 on the topic of the process and standards for discharge of student loans, commonly known as defense to repayment, and certain other matters. The committee failed to reach consensus. In June 2016, the Department issued a Notice of Proposed Rulemaking to establish a new federal standard and a process for determining whether a borrower has a defense to repayment on federal student loans based on an act or omission of a school.
The proposed regulations would provide repayment relief to borrowers in respect of student loans first disbursed on or after July 1, 2017 where:
a school breaches contractual promises to a student;
certain judgments based on any state or federal law are entered against a school related to the loan or the educational services after a contested proceeding; or
the school makes substantial misrepresentations about the nature of its educational programs, financial charges or employability of graduates, or insubstantial misrepresentations where other factors are present, such as pressure to enroll quickly or taking advantage of students’ distress or lack of knowledge or sophistication.
As proposed, there would be no limitation on claims to discharge future amounts owed by the borrower and a six-year limitation (from the date of the breach) on claims to discharge amounts already paid by the borrower. The proposed regulations also would allow the Department to identify and grant relief to groups of students where there are common facts, including students who have not requested relief.
The proposed borrower defense definitions would not apply for loans first disbursed prior to July 1, 2017, and these loans will remain subject to the current borrower defense definitions; however, under the proposed rules, these loans will follow the same claims process, individual and group, and time limitations.
As proposed, the Department would be entitled to seek reimbursement from the school in most cases in respect of loans discharged under the new procedure.
In addition, the proposed regulations specify early warning triggers regarding financial distress that would automatically require a school to post a letter of credit in the amount of at least 10% of the school’s annual Title IV disbursements upon the occurrence of specified events including, but not limited to:
the commencement of a major lawsuit by a state or federal government entity, such as a state Attorney General, the Consumer Financial Protection Bureau or the Federal Trade Commission;
the filing of a substantial number of borrower defense claims;
default by the school on its debt obligations;
failure of the school to satisfy the 90/10 Rule;
programs failing to meet gainful employment regulations;
accrediting agency actions, including the requirement to submit teach-out plans or being placed on an accreditation status that could result in the school losing its accreditation; and/or
any event or condition the Department determines is likely to have a material adverse effect on the business, financial condition or results of operations of the institution.


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Each separate triggering event would result in a separate letter of credit requirement of at least 10% of annual Title IV disbursements. If a school experiences any of these triggers, the school would be required to warn prospective and current students that it has been required to provide enhanced financial protection to the Department.
Further, the proposed regulations would also institute a loan repayment rate for proprietary institutions and would require disclosure of such rate to prospective and enrolled students if such rate falls below specified levels.
The proposed regulations, if adopted, could result in significant potential risks for our business, since the precise standards for student loan discharge may be unclear or subject to interpretation in a manner that is adverse to us and not fully known or predictable in advance, and certain of the potential adverse consequences could arise from the mere commencement of enforcement actions by state or federal government entities, or the filing of student claims for debt relief, even if these actions and claims ultimately are found to lack merit. Furthermore, the potential significant discretion vested in the Department to administer the regulations, including fact-finding, and the subjective judgments regarding the triggers for debt relief of the letter of credit requirements may result in unexpected outcomes that materially and adversely affect our business. In order to reduce the risk associated with these proposed regulations, if adopted, we may need to modify our administrative and other student-facing practices and procedures in a manner that materially increases our costs and reduces our administrative effectiveness, and our flexibility in responding to state or federal and certain private lawsuits may be materially reduced because of the possible significant ancillary consequences of an adverse judgment or finding.
Recently, two major proprietary higher education institutions were forced to cease operations and seek bankruptcy protection due to delays in Title IV disbursements and requirements to post letters of credit imposed by the Department based in part on the existence of pending state and federal investigations and the Department’s judgment regarding various subjective matters such as the institution’s culture. These regulations, if adopted as proposed, would enhance the power of the Department to take summary action that could harm University of Phoenix and Apollo Education Group, perhaps materially, before we could effectively exercise our due process rights, even if the action is based on pending investigations or legal proceedings that ultimately are determined to lack merit.
The effective date of the proposed regulations, if adopted, cannot be determined at this time, but the proposed regulations could be effective as early as July 1, 2017. More information can be found at http://www2.ed.gov/policy/highered/reg/hearulemaking/2016/index.html.
A separate negotiated rulemaking process was convened by the Department in November 2013 on a variety of topics. Included among the topics was the proposed establishment of requirements for state authorization of distance education programs in order to demonstrate eligibility for Title IV eligibility. A negotiated rulemaking committee was established and met in early 2014. The committee failed to reach consensus. In July 2016, the Department issued draft regulations to establish new federal requirements for such eligibility.
The proposed regulations would establish new requirements to maintain state authorization for Title IV eligibility for distance education programs. Major provisions include, but are not limited to:
Requiring an institution offering distance education to have requisite state authority to offer such programs to state residents if required by the state;
Defining and recognizing acceptable state authorization reciprocity agreements;
Requiring institutions to document individualized state processes for resolving student complaints; and
Requiring an institution to provide extensive public and individualized disclosures to enrolled and prospective students regarding its programs offered solely through distance education, including information concerning adverse actions filed against the school by state entities or accrediting bodies.
As proposed, the regulations could be interpreted to allow individual states to impose new and diverse requirements on institutions and thereby reduce the regulatory and operational efficiency that our schools use in operating under the current State Authorization Reciprocity Agreement (“SARA”), which currently allows our Title IV eligible programs to operate in those states that have adopted SARA with only home state regulatory approval. States that have adopted SARA now constitute the majority of domestic jurisdictions.
Also as proposed, the regulations could be interpreted to require extensive new public disclosures based upon certain actions by accreditors and state entities, including state Attorneys General. Under some interpretations, the regulations could require disclosure to current and prospective students upon the mere filing of an adverse action and long after the initial action was resolved, even if resolved in favor of the institution.
The proposed regulations, if adopted, could result in significant potential risks for our business, since the precise regulatory scope and definitions for individualized state requirements and disclosures may be unclear or subject to interpretation in a manner that is adverse to us and not fully known or predictable in advance, and certain of the potential adverse consequences could arise from the mere commencement of adverse actions by government entities or accrediting bodies, even if these actions


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and claims ultimately are found to lack merit. Furthermore, the potential significant discretion vested in the Department to interpret and administer the regulations may result in unexpected outcomes that materially and adversely affect our business. In order to reduce the risk associated with these proposed regulations, if adopted, we may need to modify our administrative and other student-facing practices and procedures in a manner that materially increases our costs and reduces our administrative effectiveness.
The effective date of the proposed regulations, if adopted, cannot be determined at this time, but the proposed regulations could be effective as early as July 1, 2017.
Standards of Financial Responsibility
To participate in Title IV programs, the U.S. Department of Education regulations specify that an eligible institution of higher education must satisfy specific measures of financial responsibility prescribed by the Department, or post a letter of credit in favor of the Department and accept other conditions on its participation in Title IV programs. Pursuant to the Title IV program regulations, each eligible institution must satisfy a measure of financial responsibility that is based on a weighted average of the following three annual ratios which assess the financial condition of the institution:
Primary Reserve Ratio - measure of an institution’s financial viability and liquidity;
Equity Ratio - measure of an institution’s capital resources and its ability to borrow; and
Net Income Ratio - measure of an institution’s profitability.
These ratios provide three individual scores which are converted into a single composite score. The maximum composite score is 3.0. If an institution’s composite score is at least 1.5, it is considered financially responsible. If an institution’s composite score is less than 1.5 but is 1.0 or higher, it is still considered financially responsible, and the institution may continue to participate as a financially responsible institution for up to three years under the Department’s “zone” alternative. Under the zone alternative, the Department may subject the institution to various operating or other requirements, which may include being transferred from the “advance” method of payment of Title IV program funds to the heightened cash monitoring payment method under which the institution is required to make Title IV disbursements to eligible students and parents before it requests or receives funds from the Department for the amount of those disbursements, or being transferred to the more onerous reimbursement payment method under which an institution must submit to the Department documentation demonstrating the eligibility for each Title IV disbursement and wait for the Department’s approval before drawing down Title IV funds.
If an institution does not achieve a composite score of at least 1.0, it is subject to additional requirements in order to continue its participation in the Title IV programs, including submitting to the Department a letter of credit in an amount equal to at least ten percent, and at the Department’s discretion up to 50%, of the Title IV funds received by the institution during its most recently completed fiscal year, and being placed on provisional certification status, under which the institution must receive Department approval before implementing new locations or educational programs and comply with other restrictions, including reduced due process rights in subsequent proceedings before the Department.
In addition, under new regulations that took effect on July 1, 2016, institutions placed on either the heightened cash monitoring payment method or the reimbursement payment method must pay Title IV credit balances to students and parents before requesting Title IV funds from the Department and may not hold Title IV credit balances on behalf of students or parents, even if such balances are expected to be applied to future tuition payments.
The composite scores for Apollo Education Group and University of Phoenix, which are calculated as of the end of our fiscal year, were as follows for the indicated periods:
 
Fiscal Year
 
2016
 
2015
 
2014
Apollo Education Group
1.8
 
2.6
 
2.5
University of Phoenix
2.9
 
2.9
 
2.3
The decline in our fiscal year 2016 consolidated composite score was principally attributable to our decline in profitability, which included $73.4 million of goodwill impairment charges. Refer to Note 8, Goodwill and Intangibles, in Part II, Item 8, Financial Statements and Supplementary Data.
We believe that we may be able to take certain corrective measures to maintain composite scores of 1.5 or greater, if we determine that there is increased risk that our composite scores will fall below that level, depending on the circumstances causing the expected decline. However, such measures, if available, may require material modifications to our business and strategy that would adversely impact our future revenue and profitability and/or may involve the issuance of equity or equity-linked securities under challenging circumstances that could result in material dilution to our existing shareholders.


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For additional information, refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - A failure to demonstrate “financial responsibility” or “administrative capability” may result in the loss of eligibility to participate in Title IV programs and limit our access to liquidity, which would materially and adversely affect our business.
90/10 Rule
University of Phoenix, and all other proprietary institutions of higher education, are subject to the so-called “90/10 Rule” under the Higher Education Act, as reauthorized. Under this rule, a proprietary institution will be ineligible to participate in Title IV programs for at least two fiscal years if for any two consecutive fiscal years it derives more than 90% of its cash basis revenue, as defined in the rule, from Title IV programs. If an institution is determined to be ineligible, any disbursements of Title IV program funds made after the end of the second fiscal year in the measuring period must be repaid to the U.S. Department of Education. An institution that derives more than 90% of its cash basis revenue from Title IV programs for any single fiscal year will be automatically placed on provisional certification for two fiscal years and will be subject to possible additional sanctions determined to be appropriate under the circumstances by the Department. While the Department has broad discretion to impose additional sanctions on such an institution, there is only limited precedent available to predict what those sanctions might be, particularly in the current regulatory environment. For example, the Department could impose conditions in the provisional certification such as:
Restrictions on the total amount of Title IV program funds that may be disbursed to students;
Restrictions on programmatic and geographic expansion;
Requirements to obtain and post letters of credit;
Additional reporting requirements such as interim financial reporting; or
Any other conditions deemed appropriate by the Department.
The 90/10 Rule percentages for University of Phoenix were as follows for the indicated periods:
 
Year Ended August 31,
 
2016
 
2015
 
2014
University of Phoenix
79%
 
80%
 
81%
As the University’s enrollment has declined in recent years, the proportion of its student body that uses a lower percentage of Title IV program funds for eligible tuition and fees, such as students that receive tuition assistance from employers or that participate in military benefit programs, has increased. The University has also implemented various other measures in recent years intended to reduce the percentage of its cash basis revenue attributable to Title IV program funds, including encouraging students to carefully evaluate the amount of necessary Title IV program borrowing and increased focus on nondegree continuing education programs. The University has no direct control over the amount of Title IV student loans and grants sought by or awarded to eligible students.
Based on recent trends, we do not expect the 90/10 Rule percentage for University of Phoenix to exceed 90% for fiscal year 2017. However, the 90/10 Rule percentage for the University remains high and could exceed 90% in the future depending on the impact of future changes in the University’s enrollment mix, and regulatory and other factors outside our control, including any reduction in, or change in eligibility to participate in, military benefit programs or changes in the treatment of such funding for purposes of the 90/10 Rule calculation. On January 15, 2016, University of Phoenix was notified by the U.S. Department of Defense (“DoD”) that the University’s probationary status in respect of its participation in the DoD Tuition Assistance Program for active duty military personnel had been lifted, effective immediately. The University had been placed on probation in October 2015 pending a review by the Department of the University’s compliance with the DoD Voluntary Education Partnership Memorandum of Understanding with the University, which is the basis on which the University’s active duty military students participate in the DoD Tuition Assistance Program. The University will be subject to a heightened compliance review for a period of one-year following the removal of probationary status. During this period, the University will continue to engage with the DoD and complete the production of information and documents previously requested by the DoD. In addition, the University will be subject to an enhanced compliance review in fiscal year 2017. In fiscal year 2016, funding under the DoD Tuition Assistance Program represented less than 1% of the University’s net revenue.
Various legislative proposals have been introduced in Congress that would heighten the requirements of the 90/10 Rule, including proposals that would reduce the 90% maximum under the rule to the pre-1998 level of 85%, cause tuition derived from military benefit programs to be included in the 90% or 85% portion under the rule instead of the 10% portion, as is the case today, and impose Title IV program ineligibility after one year of noncompliance rather than two. If these or similar proposals are adopted, University of Phoenix would be required to increase efforts and resources dedicated to reducing the percentage of cash basis revenue attributable to Title IV program funds.


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Any necessary efforts to reduce the 90/10 Rule percentage for University of Phoenix, especially if the percentage exceeds 90% for a fiscal year, may involve taking measures which reduce our revenue, increase our operating expenses, or both, in each case perhaps significantly. In addition, we may be required to make structural changes to our business in the future in order to remain in compliance, which changes may materially alter the manner in which we conduct our business and materially and adversely impact our business and financial condition. Furthermore, these required changes could make it more difficult to comply with other important regulatory requirements, such as the student loan cohort default rate regulations, which are discussed below.
Student Loan Cohort Default Rates
To remain eligible to participate in Title IV programs, an educational institution’s student loan cohort default rates must remain below certain specified levels. Each cohort is the group of students who first enter into student loan repayment during a federal fiscal year (ending September 30) for a three-year measuring period. The cohort default rates are published by the U.S. Department of Education approximately 12 months after the end of the applicable measuring period. Thus, in September 2016, the Department published the cohort default rates for the 2013 cohort.
An educational institution loses eligibility to participate in Title IV programs if its cohort default rate equals or exceeds 40% for any given year or 30% for three consecutive years. If an institution’s cohort default rate equals or exceeds 30% for any given year, it must establish a default prevention task force and develop a default prevention plan with measurable objectives for improving the cohort default rate. We believe that our current repayment management efforts would meet these requirements.
Based on information published by the Department, the cohort default rates for University of Phoenix and for all proprietary postsecondary institutions for the applicable federal fiscal years were as follows:
 
Cohort Default Rates for
Cohort Years Ended September 30,
 
2013
 
2012
 
2011
University of Phoenix
13.3%
 
13.5%
 
19.0%
All proprietary postsecondary institutions
15.0%
 
15.8%
 
19.1%
We believe that our investment in student protection initiatives and repayment management services have favorably impacted our rates. As part of our repayment management initiatives, we engage third-party service providers to assist our students who are at risk of default. These service providers contact students and offer assistance, which includes providing students with specific loan repayment information such as repayment options and loan servicer contact information, and they attempt to transfer these students to the relevant loan servicer to resolve their delinquency. In addition, we are focused on enrolling students who are a better fit for our programs, in part because the rate of default is higher among students who do not complete their degree program compared to students who graduate. For additional information, refer to Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - An increase in student loan default rates could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business.
Administrative Capability
The Higher Education Act, as reauthorized, directs the U.S. Department of Education to assess the administrative capability of each institution to participate in Title IV programs. The failure of an institution to satisfy any of the criteria used to assess administrative capability may cause the Department to determine that the institution lacks administrative capability and, therefore, subject the institution to additional scrutiny or deny eligibility for Title IV programs.
State Authorization
Institutions that participate in Title IV programs must be authorized to operate by the appropriate postsecondary regulatory authority in each state where the institution has a physical presence. University of Phoenix is specifically authorized to operate in all of the domestic jurisdictions in which it operates. Some states assert authority to regulate all degree-granting institutions if their educational programs are available to their residents, whether or not the institutions maintain a physical presence within those states. University of Phoenix has obtained licensure in states which require such licensure and where students are enrolled.
Refer to U.S. Department of Education Rulemaking Initiatives above for additional information regarding current state authorization rulemaking initiatives.
U.S. Department of Education Program Reviews
The U.S. Department of Education periodically reviews institutions participating in Title IV programs for compliance with applicable standards and regulations. In August 2014, the Department commenced an ordinary course program review of University of Phoenix’s administration of Title IV programs covering federal financial aid years 2012-2013 and 2013-2014, as


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well as compliance with the Jeanne Clery Disclosure of Campus Security Policy and Campus Crime Statistics Act, the Drug-Free Schools and Communities Act and related regulations. During fiscal year 2015, the University received a Final Program Review Determination Letter with regard to this program review. All administrative matters are deemed by the Department to be resolved and/or closed, with the exception of findings regarding compliance with the Clery Act, which have been referred to the Department’s Clery Team and to the Administrative Action and Appeals Division which is standard protocol in such matters.
Federal Trade Commission Investigation
In July 2015, we received a Civil Investigative Demand from the U.S. Federal Trade Commission (the “FTC”) relating to an investigation to determine if certain unnamed persons, partnerships, corporations, or others have engaged or are engaging in deceptive or unfair acts or practices in or affecting commerce in the advertising, marketing, or sale of secondary or postsecondary educational products or services or educational accreditation products or services. The Demand requires us to produce documents and information regarding a broad spectrum of the business and practices of University of Phoenix, including in respect of marketing, recruiting, enrollment, financial aid, tuition and fees, academic programs, academic advising, student retention, billing and debt collection, complaints, accreditation, training, military recruitment, and other compliance matters, for the time period of January 1, 2011 to the present. We are cooperating with the investigation. We cannot predict the eventual scope, duration or outcome of the investigation at this time.
Attorney General Investigations
In August 2015, we received an Investigative Subpoena from the Office of the Attorney General of the State of California. The Subpoena requires us to produce documents and information regarding the business and practices of University of Phoenix relating to members and former members of the U.S. military and California National Guard, including marketing, recruiting, billing, financial aid, accommodation and other services for military personnel, compliance with federal Executive Order 13607 (Establishing Principles of Excellence for Educational Institutions Serving Service Members, Veterans, Spouses, and Other Family Members), and use of U.S. military logos and emblems in marketing, for the time period of July 1, 2010 to the present.
In February 2016, we received a Second Investigative Subpoena from the Office of the Attorney General of the State of California in the Matter of the Investigation of For-Profit Educational Institutions, following the Investigative Subpoena we received in August 2015. The Second Investigative Subpoena, which is not limited to matters involving military students, seeks the production of documents and information regarding a broad spectrum of the business and practices of Apollo and its subsidiaries, including University of Phoenix, relating to marketing, recruiting, compensation of enrollment advisors, complaints, financial aid, compliance, accreditation, other governmental investigations, private litigation and other matters, as well as additional information relating to marketing and services to members and former members of the U.S. military and California National Guard, for the time period of July 1, 2010 to the present.
We are cooperating with the California Attorney General in these investigative proceedings. We cannot predict the eventual scope, duration or outcome of the investigations at this time.
We are also subject to other Attorney General investigations. In addition, from time to time, we receive requests for information from state Attorneys General, accrediting bodies, state higher education regulatory bodies and other federal and state government agencies relating to investigations or inquiries being conducted by other state or federal agencies, pending litigation or specific complaints received from students or former students. These requests can be broad and time consuming to respond to, and there is a risk that they could expand and/or lead to a formal inquiry or investigation into our practices. Refer to Note 16, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data.
Office of the Inspector General of the U.S. Department of Education (“OIG”) Subpoena
On March 21, 2014, University of Phoenix received a subpoena from the Mid-Atlantic Region of the OIG. The subpoena seeks the production by the University of documents and detailed information regarding a broad spectrum of the activities conducted in the University’s Centralized Service Center for the Northeast Region located in Columbia, Maryland, for the time period of January 1, 2007 to the present, including information relating to marketing, recruitment, enrollment, financial aid processing, fraud prevention, student retention, personnel training, attendance, academic grading and other matters. We are cooperating with these requests. We cannot predict the eventual scope, duration or outcome of this matter at this time.
Restricted Cash
The U.S. Department of Education places restrictions on Title IV program funds held for students for unbilled educational services. As a trustee of these Title IV program funds, we are required to maintain and restrict these funds pursuant to the terms of our program participation agreement with the Department. These funds are included in Restricted cash and cash equivalents on our Consolidated Balance Sheets in Part II, Item 8, Financial Statements and Supplementary Data.


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Branching and Classroom Locations
The Title IV regulations contain specific requirements governing the establishment of new locations at which the eligible institution offers, or could offer, 50% or more of an educational program. The U.S. Department of Education requires that the institution notify the Department of each location offering 50% or more of an educational program prior to disbursing Title IV program funds to students at that location. University of Phoenix has procedures in place to ensure timely notification and acquisition of all necessary location approvals prior to disbursing Title IV program funds to students attending any new location. In addition, the Higher Learning Commission and state regulators have requirements for the establishment of new locations.
There are also certain regulatory requirements associated with closing locations, including the requirement to teach-out existing students. In recent years, University of Phoenix has reduced the number of its ground locations throughout the U.S and has closed or is in the process of closing approximately 150 ground locations. Refer to Note 2, Restructuring and Impairment Charges, in Part II, Item 8, Financial Statements and Supplementary Data.
Change of Ownership or Control
Approximately 51% of our outstanding Class B voting shares, our only class of voting stock, is held by the Apollo Class B Voting Stock Trust No. 1 (the “Class B Trust”), an irrevocable trust of which the current trustees are Peter V. Sperling, Chairman of our Board of Directors, Ms. Terri Bishop, the Vice Chair of our Board of Directors, and Ms. Darby Shupp, a member of our Board of Directors.
Any change of ownership or control of Apollo Education Group could require recertification by the U.S. Department of Education, the reevaluation of accreditation by the Higher Learning Commission (“HLC”) and the consent or reauthorization by state and foreign licensing agencies. If we experience a change of ownership or control, then University of Phoenix and certain of our other subsidiaries may cease to be eligible to participate in Title IV programs until recertified by the Department. There is no assurance that such recertification would be obtained on a timely basis. Under some circumstances, the Department may continue an institution’s participation in Title IV programs on a provisional basis pending completion of the change in ownership approval process.
In addition, University of Phoenix is required to report any material change in stock ownership to its principal institutional accrediting body, HLC, and must obtain approval prior to undergoing any transaction that affects, or may affect, its corporate control or governance. In the event of any such change, HLC may undertake an evaluation of the effect of the change on the continuing operations of University of Phoenix for purposes of determining if continued accreditation is appropriate, which evaluation may include a comprehensive review.
In addition, some states in which University of Phoenix is licensed require approval (in some cases, advance approval) of changes in ownership or control in order to remain authorized to operate in those states, and participation in grant programs in some states may be interrupted or otherwise affected by a change in ownership or control.
Refer to Part I, Item 1A, Risk Factors - Risks Related to the Control Over Our Voting Stock - Transactions involving a change of control of our company may impair our eligibility to participate in Title IV programs, our accreditation and our state licenses in a manner that materially and adversely affects our business.
International
Governmental regulations in foreign countries significantly affect our international operations. In recent years, there has been increased focus on educational institutions in certain of the countries in which we operate.
In September 2015, Open Colleges received a Notice from the Australian Competition and Consumer Commission (“ACCC”) requiring Open Colleges to produce information about student refunds upon withdrawal and related matters for the period of time since July 2014. In addition, Open Colleges receives inquiries and is subject to audits from time to time from governmental regulatory authorities, including an inquiry in October 2015 from the Australian Skills Quality Authority (“ASQA”), the national regulator of vocational education programs, regarding student complaints about marketing practices, refund policies and other matters (since concluded without material findings).
Following a recent compliance audit, Apollo Global’s two primary registered training organizations in Australia, Open Colleges Pty Ltd., and Integrated Care & Management Training, Pty Ltd., each received a notice of noncompliance and intention to make a decision to impose sanctions from ASQA. The notice identified several alleged compliance deficiencies and stated that ASQA intended to make a decision on whether to impose sanctions on the institutions which could include cancellation of registration or imposition of lesser sanctions. One of the findings involves a change in the interpretation of applicable course requirements and will require changes in our procedures for student workplace skills assessments used in connection with courses that represent a substantial portion of the Open Colleges institutions’ enrollment.


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Implementing an updated workplace skills assessment model in order to address ASQA’s concerns will require operational changes for these institutions and increase operating costs, perhaps substantially, and could have competitive implications.
We have until November 7, 2016 to respond to this notice of noncompliance. We cannot currently predict the timing or ultimate outcome of this matter. See Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - Changes by a regulator in the interpretation of applicable course requirements could materially impact our Open Colleges business in Australia.
In addition, UNIACC has been subject to investigations and inquiries involving certain aspects of its operations. For further discussion of this matter, refer to Note 16, Commitments and Contingencies, in Item 8, Financial Statements and Supplementary Data.
New or revised interpretations of regulatory requirements could have a material adverse effect on us. Changes in existing or new interpretations of applicable laws, rules, or regulations in the foreign jurisdictions in which we operate could have a material adverse effect on our accreditation, authorization to operate, permissible activities, and costs of doing business outside of the U.S. The failure to maintain or renew any required regulatory approvals could have a material adverse effect on our international operations.
Available Information
We file annual, quarterly and current reports with the Securities and Exchange Commission. You may read and copy any document we file at the Securities and Exchange Commission’s Public Reference Room at 100 F Street NE, Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for information on the Public Reference Room. The Securities and Exchange Commission maintains a website that contains annual, quarterly and current reports that issuers file electronically with the Securities and Exchange Commission. The Securities and Exchange Commission’s website is www.sec.gov.
Our website address is www.apollo.edu. We make available free of charge on our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Information Statements on Schedule 14C, Forms 3, 4, and 5 filed on behalf of directors and executive officers, and all amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission.
Item 1A. Risk Factors
You should carefully consider the risks and uncertainties described below and all other information contained in this Annual Report on Form 10-K. In order to help assess the major risks in our business, we have identified many, but not all, of these risks, categorized as Risks Related to our Pending Merger, Risks Related to the Highly Regulated Industry in Which We Operate, Risks Related to our Business and Risks Related to the Control Over our Voting Stock. Due to the scope of our operations, a wide range of factors could materially affect future developments and performance.
If any of the following risks are realized, our business, financial condition, cash flows and/or results of operations could be materially and adversely affected, and as a result, the trading price of our Class A common stock could be materially and adversely impacted. These risk factors should be read in conjunction with other information set forth in this Annual Report, including Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data, including the related Notes to Consolidated Financial Statements.
Risks Related to our Pending Merger
Our pending merger may not be consummated, which may adversely affect our business, and our business may suffer during the pendency of the merger as a result of uncertainty regarding consummation.
As described in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Pending Merger, on February 7, 2016, we entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with AP VIII Queso Holdings, L.P. (“Queso”), an affiliate of Apollo Management VIII, L.P., which is a fund managed by an affiliate of Apollo Global Management, LLC, none of which is, or has ever been, affiliated with us. At the effective time of the merger, which, subject to the satisfaction of the closing conditions, is anticipated to be on or before February 1, 2017, the date on which the contract becomes terminable by either party, each share of our issued and outstanding Class A and Class B common stock will be converted pursuant to the terms of the Merger Agreement into the right to receive $10.00 per share in cash. On May 6, 2016, the Merger Agreement was approved by the holders of our outstanding Class A and Class B common stock, each voting separately as a class.


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Consummation of the merger is subject to customary and other conditions, including:
(i)
the absence of certain conditions or restrictions in the response of the U.S. Department of Education to the pre-acquisition review application filed by University of Phoenix; and
(ii)
the receipt of consents or approvals from other federal, state and foreign educational governing bodies, including the Higher Learning Commission (“HLC”).
HLC has informed us that it does not intend to review our change of control application until after the Department of Education responds to our pending pre-acquisition review filing and Queso submits to the Department any required additional information. The Department’s review is pending and we cannot predict how the Department will respond to our filing.
In addition, consummation of the merger is subject to our satisfying certain minimum operating metrics, measured as of the first or second month end preceding the closing date, depending on the day of the month on which closing occurs, as follows:
(i)
Our aggregate cash, cash equivalents and marketable securities must not be less than the specified amount for the applicable month end;
(ii)
University of Phoenix fiscal year-to-date new degreed enrollments as of the applicable month end must not have declined by more than 15% from forecasted levels (which are derived from the projections we prepared in December 2015 in connection with the merger, which we refer to as the December 2015 forecast);
(iii)
University of Phoenix trailing twelve month net revenue as of the applicable month end shall not have declined by more than 10% from forecasted levels (which are derived from the December 2015 forecast); and
(iv)
Our consolidated trailing twelve month adjusted earnings before interest, taxes, depreciation and amortization as of the applicable month end shall not have declined by more than $75 million from forecasted levels (which are derived from the December 2015 forecast).
We satisfied each of these minimum operating metrics as of September 30, 2016, which is the relevant measurement date for a closing on or prior to November 9, 2016. We currently expect to satisfy these metrics if the closing occurs on or prior to February 1, 2017, which is the date on which the contract becomes terminable by either party if the closing conditions have not been met.
There is no assurance that the conditions to the consummation of the merger will be satisfied in a timely manner or at all.
If the merger is not consummated, our stock price could fall to the extent that the current trading price is supported by an assumption that the merger will be consummated. Furthermore, if the merger is not consummated, we may suffer other consequences that could adversely affect our business and financial condition, including the following:
we could be required to pay a termination fee of 2.75% of the aggregate per share merger consideration that would have been payable to the Company’s shareholders upon closing of the merger (approximately $27.5 million) under certain specified circumstances, but not including a termination solely due to our failure to satisfy the minimum operating metrics described above, as provided in the Merger Agreement;
a fall in our stock price could result in additional goodwill impairment charges that could result in our U.S. Department of Education fiscal year 2017 financial responsibility composite score falling below 1.5, which could severely stress our liquidity due to various regulatory consequences and could materially and adversely impact our strategy, operations and future profitability, as discussed in more detail in the risk factor below, Risks Related to the Highly Regulated Industry in Which We Operate - A failure to demonstrate “financial responsibility” or “administrative capability” may result in the loss of eligibility to participate in Title IV programs and limit our access to liquidity, which would materially and adversely affect our business;
our ability to enroll and retain new students could be impaired because potential students may perceive the termination of the merger as a sign of financial distress or as otherwise raising questions about the future of University of Phoenix;
we may not be able to take advantage of alternative business opportunities that we may have been able to pursue absent entering into the Merger Agreement;
we may experience a decrease in employee morale and an increase in employee departures; and
the failure of the merger to be consummated may result in negative publicity and may embolden the critics of the proprietary higher education sector generally and University of Phoenix specifically.


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Also, the pendency of the merger could adversely impact our business and financial condition, including as a result of the following:
the restrictions imposed in the Merger Agreement on our business and operations may prevent us from pursuing certain opportunities without approval of Queso;
the challenging political and regulatory environment we face may intensify in response to the proposed merger;
we may experience challenges in retaining and motivating current employees, and attracting and recruiting prospective employees;
our relationships with current students and employers could be adversely affected due to concern about our future;
due to activities related to the merger, the attention of our employees and management may be diverted from other opportunities that may have been beneficial to us; and
we may incur material expenses and liabilities in connection with the various legal proceedings related to the merger that have been instituted against us, our directors and others.
In addition, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services, other transaction costs and employee retention costs in connection with the merger, and these fees and costs are payable by us regardless of whether the merger is consummated.
For additional information related to the merger and the Merger Agreement, please refer to the following:
Current Report on Form 8-K filed with the Securities and Exchange Commission on February 8, 2016;
Definitive Proxy Statement filed with the Commission on March 23, 2016;
Supplement to the Definitive Proxy Statement filed with the Commission on May 2, 2016;
Amendments to the Merger Agreement attached to our Current Report on Form 8-K filed with the Commission on May 2, 2016; and
Quarterly Report on Form 10-Q filed with the Commission on July 8, 2016.
Risks Related to the Highly Regulated Industry in Which We Operate
If we fail to comply with the extensive regulatory requirements for our business, we could face significant monetary liabilities, fines and penalties, including loss of access to U.S. federal student loans and grants for our students.
Our domestic operations, including University of Phoenix, are subject to extensive U.S. federal and state regulation applicable to providers of postsecondary education. The principal federal regulatory regime is established under the Higher Education Act of 1965, as it is amended and reauthorized from time to time, and the regulations promulgated under the Act by the U.S. Department of Education. Among other matters, these regulations govern the participation by University of Phoenix in federal student financial aid programs under Title IV of the Higher Education Act (“Title IV”), which is the principal source of funding for students at the University. The majority of our fiscal year 2016 consolidated net revenue was derived from receipt of Title IV program funds disbursed to our students.
The Higher Education Act, as reauthorized, mandates specific regulatory responsibilities for each of the following components of the higher education regulatory triad: (1) the federal government through the U.S. Department of Education; (2) independent accrediting agencies recognized by the Department of Education; and (3) state higher education regulatory bodies.
The applicable regulatory requirements cover nearly all phases of our U.S. operations, including educational program offerings, branching and classroom locations, instructional and administrative staff, administrative procedures, marketing and recruiting, financial operations, payment of refunds to students who withdraw, maintenance of restricted cash, acquisitions or openings of new schools, commencement of new or cessation of existing educational programs and changes in our corporate structure and ownership.
The applicable regulations, standards and policies of the various regulatory agencies frequently change and often are subject to interpretative uncertainty, particularly where they are crafted for traditional, academic term-based schools rather than our non-term academic delivery model. Changes in, or new interpretations of, applicable laws, regulations, standards or policies could have a material adverse effect on our accreditation, authorization to operate in various states, permissible activities, receipt of funds under Title IV programs, costs of doing business and our ability to implement beneficial changes in our academic or business model. We cannot predict how the requirements administered by these agencies will be applied or interpreted in the future, or whether our schools will be able to comply with any future changes in these requirements.


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If we are found to have violated any applicable regulations, standards or policies, we may be subject to the following sanctions imposed by any one or more of the relevant regulatory agencies:
Monetary fines or penalties;
Limitation or termination of our operations or ability to grant degrees, diplomas and certificates;
Restriction or revocation of our accreditation, licensure or other operating authority;
Limitation, suspension or termination of our eligibility to participate in Title IV programs, military benefit programs or state financial aid programs;
Imposition by the U.S. Department of Education of heightened cash monitoring which could include a delay in the disbursement of Title IV program funds or transfer from the Department’s advance system of receiving Title IV program funds to its reimbursement system, under which a school must disburse its own funds to students and document the students’ eligibility for Title IV program funds before receiving such funds from the Department;
Repayment of funds received under Title IV programs or state financial aid programs;
Requirement to post a letter of credit with the U.S. Department of Education;
Other civil or criminal penalties; and/or
Other forms of censure.
In addition, in some circumstances of noncompliance or alleged noncompliance, we may be subject to qui tam lawsuits under the Federal False Claims Act or various, similar state false claim statutes. In these actions, private plaintiffs seek to enforce remedies under the Act on behalf of the federal government and, if successful, are entitled to recover their costs and to receive a portion of any amounts recovered by the federal government in the lawsuit. These lawsuits can be prosecuted by a private plaintiff, even if the Department does not agree with plaintiff’s theory of liability. In 2009, we settled a qui tam lawsuit relating to alleged payment of incentive compensation to our enrollment counselors for a total payment of $80.5 million, and we currently are subject to qui tam lawsuits, one of which alleges payment of improper incentive compensation in subsequent periods. For more information about the pending qui tam case, refer to Note 16, Commitments and Contingencies, in Part II, Item 8, Financial Statements and Supplementary Data.
The proprietary higher education industry is experiencing broad-based, intensifying scrutiny in the form of coordinated investigations and enforcement actions animated at least in part by influential members of Congress and the Obama Administration who seek to terminate the eligibility of for-profit institutions to participate in Title IV or other government financial aid programs. In October 2014, the Department of Education formed an inter-agency task force involving multiple federal agencies and departments including the Federal Trade Commission, the U.S. Departments of Justice, Treasury and Veterans Affairs, the Consumer Financial Protection Bureau, the Securities and Exchange Commission, and numerous state attorneys general, to coordinate activities and share information to protect students from unfair, deceptive and abusive policies and practices by proprietary higher education institutions. We believe that the recent investigations of University of Phoenix commenced by the Federal Trade Commission and the California Attorney General are related to this coordinated scrutiny of the industry and that this coordinated scrutiny could lead to the initiation of additional inquiries or claims against us either by participants in the inter-agency task force or other regulatory authorities, any of which could adversely affect our business and reputation. We expect that this challenging political and regulatory environment will continue for the foreseeable future, and may intensify.
Any of the penalties, funding delays, injunctions, restrictions, lawsuits or other forms of censure described above, and the associated reputational impact from ongoing investigations, could have a material adverse effect on our business and financial condition. In recent years, two major proprietary education institutions, together serving over 110,000 students, have ceased operations and filed for bankruptcy protection due to delays in or denial by the Department of Education of Title IV funding for students and requirements to post letters of credit, based in part on the existence of multiple investigations by various regulatory authorities. In neither case were the principal investigations completed nor were substantial enforcement actions commenced and prosecuted to conclusion. Accordingly, proprietary institutions are at risk of harmful delays or denial of Title IV funding for students due to investigations and other preliminary allegations, even if such investigations or allegations may ultimately be found to lack merit. If we lose our Title IV program eligibility, our business would not be sustainable. If our participation is materially conditioned or subject to material delays, we could experience a dramatic decline in revenue and we would be unable to continue our business as it currently is conducted.
The outcome of the November 2016 U.S. election could lead to a change in or elimination of our eligibility to participate in Title IV student financial aid programs, which could render our business unsustainable.
The outcome of the November 2016 elections in the U.S. could increase the risk of new legislation and changes in, or new interpretations of, existing laws, regulations, standards or policies, that would limit, perhaps materially, the eligibility of proprietary schools, such as University of Phoenix, to participate in Title IV student financial aid programs. Many such proposals have already been made by influential members of the Democratic Caucus in Congress. Furthermore, the passage of


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legislation implementing in whole or in part the Democratic Party Platform proposal to provide tuition free undergraduate education in the U.S. could significantly impact or render impractical our current domestic higher education business conducted by University of Phoenix.
If we fail to maintain our institutional accreditation, we would lose our ability to participate in Title IV programs, which would materially and adversely affect our business.
In July 2013, the accreditation of University of Phoenix was reaffirmed by the Higher Learning Commission (“HLC”), the University’s principal accreditor, through the 2022-2023 academic year. At the same time, HLC placed the University on Notice status for a two-year period due to concerns regarding governance, student assessment and faculty scholarship/research for doctoral programs. Notice status is a sanction that means that HLC has determined that an institution is on a course of action that, if continued, could lead the institution to be out of compliance with one or more of the HLC Criteria for Accreditation or Core Components.
The University submitted a Notice Report to HLC in November 2014 providing evidence that the University has ameliorated the conditions that led to the Notice status and continues to meet relevant accreditation requirements. The HLC Board of Trustees subsequently removed the University from Notice status, effective June 25, 2015.
We believe that the imposition of the sanction of notice adversely impacted the reputation of University of Phoenix and may have contributed to the University’s continuing decline in enrollment. In addition, the changes made by University of Phoenix to its corporate governance and administrative structure to address the concerns of HLC regarding independence have increased our operating costs and decreased our managerial flexibility to address the rapidly evolving and challenging postsecondary education market.
The University remains assigned by HLC to the Standard Pathway reaffirmation process, pursuant to which the University will host a comprehensive evaluation visit in 2017 and will undergo its next reaffirmation process in 2022-2023.
Continued institutional accreditation is critical to University of Phoenix’s business and necessary for the University to continue participating in the Title IV programs. If the University should lose its institutional accreditation, our business would be substantially impaired and we would not be able to continue our business as it is presently conducted.
The U.S. Department of Education gainful employment regulations may limit the programs we can offer students and increase our cost of operations.
Under the Higher Education Act, as reauthorized, proprietary schools are generally eligible to participate in Title IV programs only in respect of educational programs that lead to “gainful employment in a recognized occupation.” In connection with this requirement, proprietary postsecondary institutions are required to provide information to prospective students about each eligible program, including the relevant recognized occupations, cost, completion rate, job placement rate, and median loan debt of program completers. These reporting requirements increase our costs of operations and could adversely impact student enrollment, persistence and retention if our reported program information compares unfavorably with other reporting educational institutions.
In October 2014, the U.S. Department of Education published final regulations, effective July 1, 2015, on the metrics for determining whether an academic program prepares students for gainful employment in a recognized occupation. Under the final regulations, which apply on a program-by-program basis, students enrolled in a program will be eligible for Title IV student financial aid only if that program satisfies at least one of two tests relating to student debt service-to-earnings ratios. The two tests specify minimum student loan debt service-to-earnings ratios calculated on the basis of the average earnings of program graduates: one test measures student loan debt service as a percentage of total earnings, and the other test measures student loan debt service as a percentage of deemed discretionary earnings. If a program fails to meet both of the minimum ratios for one year, the institution will be required to provide a warning notice to prospective and enrolled students advising that the program may lose Title IV eligibility based on the final student loan debt service-to-earnings ratios for the next year. Programs that fail to meet both of the minimum ratios for two out of three years will immediately cease to be Title IV eligible for a period of at least three years.
The Department has indicated that it plans to issue the official 2014 gainful employment debt service-to-earnings ratios by January 2017, and we anticipate the 2015 ratios will be issued in early fiscal year 2018. We believe it is likely that some of University of Phoenix’s programs will be impacted by the gainful employment regulations. Beginning in September 2015 and continuing through early fiscal year 2017, the University ceased enrolling or plans to cease enrolling new students in programs it believes may be impacted in connection with its initiatives to transform itself into a more focused, higher retaining and less complex institution. As of August 31, 2016, students in such programs represented approximately 15% of the University’s Degreed Enrollment. Students who are currently enrolled in such programs, and who do not elect to enroll in a different University of Phoenix program, are being taught-out in due course.


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Changes in student borrowing needs and practices, student loan interest rates, labor markets and other factors outside of our control could adversely impact compliance with these regulations for some of our programs in the future. The Department has not yet announced the future, annual protocol for calculating and disseminating the debt service-to-earnings ratios. We will not know of a program’s failure to meet the minimum ratios until well after the measuring period, and therefore students enrolled in such a program could lose their access to federal financial aid before completing the program. Accordingly, we will not have the opportunity to make program changes for any programs that did not meet either of the minimum ratios for 2014. If those programs also do not meet either of the minimum ratios for 2015, they will lose eligibility to participate in Title IV financial aid programs at the time the official 2015 ratios are published, which we anticipate will occur in early fiscal year 2018.
Under these regulations, the continuing eligibility of our educational programs for Title IV funding is at risk due to factors beyond our control, such as changes in the actual or deemed income level of our graduates, changes in student borrowing levels, increases in interest rates, changes in the federal poverty income level relevant for calculating discretionary income, changes in the percentage of our former students who are current in repayment of their student loans, and other factors. The exposure to these external factors reduces our ability to confidently offer or continue certain types of programs for which there is market demand, and therefore adversely impacts our ability to maintain or grow our business.
In addition, if we are required to include a warning notice for any of our programs based on the debt service-to-earnings ratios, enrollment in those programs may decline materially, particularly in light of the recent widely-publicized difficulties experienced by students who were enrolled in schools that have closed. Accordingly, the inclusion of these required warnings could make continuation of the affected programs impractical, even if students in the programs are still eligible to participate in Title IV programs.
If any of our programs require a warning notice or cease to be eligible for Title IV student financial aid, we may incur substantial cost and expense, and lost revenue, in providing appropriate assistance to the affected students to complete their academic programs or transition to other programs inside or outside of our universities.
The Department of Education has proposed regulations setting forth new standards and procedures related to borrower defenses to repayment of Title IV loan obligations, the Department’s right of recovery against institutions following a successful borrower defense, and institutional financial responsibility. If the regulations are adopted as proposed, our business would be subject to significant and unpredictable risks, including the requirement to post substantial letters of credit due to unproven allegations or pending investigations, whether or not meritorious.
In June 2016, the Department issued a Notice of Proposed Rulemaking to establish a new federal standard and a process for determining whether a borrower has a defense to repayment on federal student loans based on an act or omission of a school. The proposed regulations would provide repayment relief to borrowers in respect of student loans first disbursed on or after July 1, 2017 where:
a school breaches contractual promises to a student;
certain judgments based on any state or federal law are entered against a school related to the loan or the educational services after a contested proceeding; or
the school makes substantial misrepresentations about the nature of its educational programs, financial charges or employability of graduates, or insubstantial misrepresentations where other factors are present, such as pressure to enroll quickly or taking advantage of students’ distress or lack of knowledge or sophistication.
As proposed, there would be no limitation on claims to discharge future amounts owed by the borrower and a six-year limitation (from the date of the breach) on claims to discharge amounts already paid by the borrower. The proposed regulations also would allow the Department to identify and grant relief to groups of students where there are common facts, including students who have not requested relief.
The proposed borrower defense definitions would not apply for loans first disbursed prior to July 1, 2017, and these loans will remain subject to the current borrower defense definitions; however, under the proposed rules, these loans will follow the same claims process, individual and group, and time limitations.
As proposed, the Department would be entitled to seek reimbursement from the school in most cases in respect of loans discharged under the new procedure.


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In addition, the proposed regulations specify early warning triggers regarding financial distress that would automatically require a school to post a letter of credit in the amount of at least 10% of the school’s annual Title IV disbursements upon the occurrence of specified events including, but not limited to:
the commencement of a major lawsuit by a state or federal government entity, such as a state Attorney General, the Consumer Financial Protection Bureau or the Federal Trade Commission;
the filing of a substantial number of borrower defense claims;
default by the school on its debt obligations;
failure of the school to satisfy the 90/10 Rule;
programs failing to meet gainful employment regulations;
accrediting agency actions, including the requirement to submit teach-out plans or being placed on an accreditation status that could result in the school losing its accreditation; and/or
any event or condition the Department determines is likely to have a material adverse effect on the business, financial condition or results of operations of the institution.
Each separate triggering event would result in a separate letter of credit requirement of at least 10% of annual Title IV disbursements. If a school experiences any of these triggers, the school would be required to warn prospective and current students that it has been required to provide enhanced financial protection to the Department.
Further, the proposed regulations would also institute a loan repayment rate for proprietary institutions and would require disclosure of such rate to prospective and enrolled students if such rate falls below specified levels.
The proposed regulations, if adopted, could result in significant potential risks for our business, since the precise standards for student loan discharge may be unclear or subject to interpretation in a manner that is adverse to us and not fully known or predictable in advance, and certain of the potential adverse consequences could arise from the mere commencement of enforcement actions by state or federal government entities, or the filing of student claims for debt relief, even if these actions and claims ultimately are found to lack merit. Furthermore, the potential significant discretion vested in the Department to administer the regulations, including fact-finding, and the subjective judgments regarding the triggers for debt relief or the letter of credit requirements may result in unexpected outcomes that materially and adversely affect our business. In order to reduce the risk associated with these proposed regulations, if adopted, we may need to modify our administrative and other student-facing practices and procedures in a manner that materially increases our costs and reduces our administrative effectiveness, and our flexibility in responding to state or federal and certain private lawsuits may be materially reduced because of the possible significant ancillary consequences of an adverse judgment or finding.
Recently, two major proprietary higher education institutions were forced to cease operations and seek bankruptcy protection due to delays in Title IV disbursements and requirements to post letters of credit imposed by the Department based in part on the existence of pending state and federal investigations and the Department’s judgment regarding various subjective matters such as the institution’s culture. These regulations, if adopted as proposed, would enhance the power of the Department to take summary action that could harm University of Phoenix and Apollo Education Group, perhaps materially, before we could effectively exercise our due process rights, even if the action is based on pending investigations or legal proceedings that ultimately are determined to lack merit.
The effective date of the proposed regulations, if adopted, cannot be determined at this time, but the proposed regulations could be effective as early as July 1, 2017. More information can be found at http://www2.ed.gov/policy/highered/reg/hearulemaking/2016/index.html.
Action by the U.S. Congress to revise the laws governing federal student financial aid programs or reduce funding for these programs, including changes applicable only to proprietary educational institutions, could reduce our enrollment and increase our costs of operation.
The U.S. Congress must periodically reauthorize the Higher Education Act and annually determine the funding level for each Title IV program. The most recent reauthorization of the Higher Education Act expired September 30, 2013, but Title IV student financial aid programs remain authorized and functioning. Congress continues to engage in discussion and activity regarding Higher Education Act reauthorization, but the timing and terms of any eventual reauthorization cannot be predicted.
The federal Pell Grant program is one of the largest non-defense discretionary spending programs in the federal budget. Because of this, it is a target for reduction as Congress addresses the competing demands for funding and the chronic and significant U.S. budget deficit. Furthermore, a recent study by the U.S. Federal Reserve System demonstrated a direct relationship between student financial aid increases, including Pell Grant increases, and tuition increases, which could impact future Pell Grant amounts. A reduction in the maximum annual Pell Grant amount or changes in eligibility could negatively impact enrollment and could result in increased student borrowing, which would make it more difficult for us to comply with other important regulatory requirements, such as maintaining student loan cohort default rates, which are discussed below.


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In addition to Congress’s focus on the federal government’s funding challenges, in recent years, there has been substantial and continuing increased focus by various members of the U.S. Congress and federal agencies, including the Department of Education, the Consumer Financial Protection Bureau and the Federal Trade Commission, on the role that proprietary educational institutions play in higher education. We expect this focus to continue and, as discussed above under The outcome of the November 2016 U.S. election could lead to a change in or elimination of our eligibility to participate in Title IV student financial aid programs, which could render our business unsustainable, the outcome of the November 2016 U.S. elections could materially impact the manner in which Congress addresses these matters. In recent years, Congressional hearings and roundtable discussions have been held regarding various aspects of the education industry, and reports have been issued that are highly critical of proprietary institutions and include a number of recommendations to be considered by Congress in connection with the upcoming reauthorization of the Higher Education Act as discussed above. A group of influential U.S. senators has strongly and repeatedly encouraged the Departments of Education, Defense and Veterans Affairs to take action to limit or terminate the participation of proprietary educational institutions, including University of Phoenix, in existing tuition assistance programs.
Because the majority of our revenue is derived from Title IV programs, any action by Congress that reduces Title IV program funding, or alters the eligibility of our institutions or students to participate in Title IV programs could have a material adverse effect on our enrollment and financial condition. Action by Congress or federal agencies could also require us to modify our practices in ways that increase our operating costs.
In addition to possible reductions in Title IV program funding, certain military benefit programs may be reduced as military branches address decreased funding. Reductions and/or changes in military benefit programs could result in increased student borrowing, decreased enrollment and adverse impacts on our 90/10 Rule percentage, as discussed below.
If Congress reduced the eligibility or amount of available Title IV program funding, we would attempt to arrange for alternative sources of financial aid for our students, which may include lending funds directly to our students. However, private sources would not be able to provide as much funding to our students or on terms comparable to Title IV programs and such programs are under intense scrutiny from the Consumer Financial Protection Bureau and other regulatory agencies. In addition, private funding sources could require us to guarantee all or part of this assistance and we might incur other additional costs. For these reasons, private, alternative sources of student financial aid would only partly offset, if at all, the impact on our business of reduced Title IV program eligibility or funding, and would not be a practical alternative in the case of a significant reduction in Title IV program eligibility or funding.
University of Phoenix’s certification to participate in Title IV programs expired in December 2012 and continues on a month-to-month basis. If University of Phoenix is not recertified to participate in Title IV programs by the U.S. Department of Education, University of Phoenix would not be eligible to participate in Title IV programs and we could not conduct our business as it is currently conducted.
University of Phoenix is certified by the U.S. Department of Education to participate in Title IV programs. The University was recertified in November 2009 and its current certification expired in December 2012. University of Phoenix has submitted necessary documentation for recertification and its eligibility continues on a month-to-month basis until the Department issues its decision on the application. We believe that the University’s application will be renewed in due course. However, we cannot predict whether or to what extent the continued challenging political and regulatory climate, our pending merger, and other recent developments in general relating to the proprietary education sector and our business may have on the timing or outcome of the recertification process.
In February 2016, the Department notified the University that for the duration of the month-to-month continuation of the University’s Program Participation Agreement, University of Phoenix must obtain from the Department prior approval of substantial changes, including (i) the establishment of additional locations, (ii) any increase in the level of academic offering beyond those listed in the Institution’s Eligibility and Certification Approval Report and (iii) the addition of any educational program (including degree, nondegree, or short-term training programs). Some of these substantial changes include changes that previously could be implemented by the University upon notice to the Department and without prior approval.
Continued Title IV program eligibility is critical to the operation of our business. If University of Phoenix becomes ineligible to participate in Title IV programs, or participation is materially limited, our business would be unsustainable.


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A failure to demonstrate “financial responsibility” or “administrative capability” may result in the loss of eligibility to participate in Title IV programs and limit our access to liquidity, which would materially and adversely affect our business.
To participate in Title IV programs, the U.S. Department of Education regulations specify that an eligible institution of higher education must satisfy specific measures of financial responsibility prescribed by the Department, or post a letter of credit in favor of the Department and accept other conditions on its participation in Title IV programs. Pursuant to the Title IV program regulations, each eligible institution must satisfy a measure of financial responsibility that is based on a weighted average of the following three annual ratios which assess the financial condition of the institution:
Primary Reserve Ratio - measure of an institution’s financial viability and liquidity;
Equity Ratio - measure of an institution’s capital resources and its ability to borrow; and
Net Income Ratio - measure of an institution’s profitability.
These ratios provide three individual scores which are converted into a single composite score. The maximum composite score is 3.0. If an institution’s composite score is at least 1.5, it is considered financially responsible. If an institution’s composite score is less than 1.5 but is 1.0 or higher, it is still considered financially responsible, and the institution may continue to participate as a financially responsible institution for up to three years under the Department’s “zone” alternative. Under the zone alternative, the Department may subject the institution to various operating or other requirements, which may include:
(i)
Being transferred from the “advance” method of payment of Title IV program funds to the heightened cash monitoring payment method under which the institution is required to make Title IV disbursements to eligible students and parents before it requests or receives funds from the Department for the amount of those disbursements, or being transferred to the more onerous reimbursement payment method under which an institution must submit to the Department documentation demonstrating the eligibility for each Title IV disbursement and wait for the Department’s approval before drawing down Title IV funds;
(ii)
The imposition of additional reporting requirements regarding certain oversight and financial events;
(iii)
Being required to submit to the Department its annual financial statements and Title IV compliance audits earlier than would otherwise be required;
(iv)
Being required to submit information about current operations and future plans; and
(v)
The imposition of additional obligations imposed by the Department.
If an institution does not achieve a composite score of at least 1.0, it is subject to additional requirements in order to continue its participation in the Title IV programs, including:
(i)
Submitting to the Department a letter of credit in an amount equal to at least ten percent, and at the Department’s discretion up to 50%, of the Title IV funds received by the institution during its most recently completed fiscal year;
(ii)
Complying with the “zone” alternative requirements described above;
(iii)
Being placed on provisional certification status, under which the institution must receive Department approval before implementing new locations or educational programs and comply with other restrictions, including reduced due process rights in subsequent proceedings before the Department;
(iv)
Demonstrating that it is current on its outstanding debt obligations, as defined by the Department; and
(v)
Complying with other requirements imposed by the Department.
In addition, under new regulations that took effect on July 1, 2016, institutions placed on either the heightened cash monitoring payment method or the reimbursement payment method must pay Title IV credit balances to students and parents before requesting Title IV funds from the Department and may not hold Title IV credit balances on behalf of students or parents, even if such balances are expected to be applied to future tuition payments.
The composite scores for Apollo Education Group and University of Phoenix, which are calculated as of the end of our fiscal year, were as follows for the indicated periods:
 
Fiscal Year
 
2016
 
2015
 
2014
Apollo Education Group
1.8
 
2.6
 
2.5
University of Phoenix
2.9
 
2.9
 
2.3
The decline in our fiscal year 2016 consolidated composite score was principally attributable to our decline in profitability, which included $73.4 million of goodwill impairment charges. Refer to Note 8, Goodwill and Intangibles, in Part II, Item 8, Financial Statements and Supplementary Data.


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We believe that we may be able to take certain corrective measures to maintain composite scores of 1.5 or greater, if we determine that there is increased risk that our composite scores will fall below that level, depending on the circumstances causing the expected decline. However, such measures, if available, may require material modifications to our business and strategy that would adversely impact our future revenue and profitability and/or may involve the issuance of equity or equity-linked securities under challenging circumstances that could result in material dilution to our existing shareholders.
If our composite score falls below 1.5, our liquidity could be subject to severe stress due to the following factors:
Although not required solely due to participation in the zone alternative discussed above, we could be required by the Department of Education to submit a letter of credit in an amount of 10% or more of our annual Title IV receipts as a result of factors related to the cause of our composite score decline, which letter of credit likely would need to be cash collateralized.
If the Department places University of Phoenix on the heightened cash monitoring payment method, we would need to deploy additional working capital to conduct our business due to the delay in receipt of Title IV funding. If University of Phoenix is placed on the reimbursement payment method, our working capital needs would increase significantly, the precise amount of which increase cannot be predicted because it would depend on the average length of time required by the Department to evaluate and approve our requests for reimbursement and the amount of any required letter of credit. In addition, under the new regulations that became effective July 1, 2016 regarding students’ Title IV fund credit balances, we would be required to significantly alter the manner in which we process and disburse Title IV funds, which would increase our operating costs and could have unexpected and material negative impacts on our operations.
The combined effect of the above factors could cause our business to no longer be sustainable without a significant infusion of equity or other funding. Under current market conditions, there is no assurance that other funding sources would be available in sufficient amounts on terms acceptable to us or at all, and any available equity funding would necessarily involve substantial dilution to our current shareholders.
In addition to the composite score requirements, the Department regulations specify extensive criteria an institution must satisfy to establish that it has the requisite administrative capability to participate in Title IV programs. The failure of an institution to satisfy any of the criteria used to assess administrative capability may cause the Department to determine that the institution lacks administrative capability and, therefore, subject the institution to additional scrutiny or deny eligibility for Title IV programs. These criteria require, among other things, that the institution:
Comply with all applicable Title IV program regulations;
Have capable and sufficient personnel to administer the Title IV programs;
Have acceptable methods of defining and measuring the satisfactory academic progress of its students;
Not have student loan cohort default rates above specified levels;
Have procedures in place for safeguarding federal funds;
Not be, and not have any principal or affiliate who is, debarred or suspended from federal contracting or engaging in activity that is cause for debarment or suspension;
Provide financial aid counseling to its students;
Refer to the Office of Inspector General any credible information indicating that any applicant, student, employee or agent of the institution has been engaged in any fraud or other illegal conduct involving Title IV programs;
Submit in a timely manner all reports and financial statements required by the regulations; and
Not otherwise appear to lack administrative capability.
If we, or our schools eligible to participate in Title IV programs fail to maintain administrative capability or financial responsibility, as defined by the Department, our schools could lose their eligibility to participate in Title IV programs or have that eligibility adversely conditioned, which could significantly reduce the enrollments and revenues of our schools eligible to participate in Title IV programs and materially and adversely affect our business and financial condition.
Our schools and programs would lose their eligibility to participate in federal student financial aid programs if the percentage of revenue derived from those programs is too high, in which event we could not conduct our business as it is currently conducted.
University of Phoenix, and all other proprietary institutions of higher education, are subject to the so-called “90/10 Rule” under the Higher Education Act, as reauthorized. Under this rule, a proprietary institution will be ineligible to participate in Title IV programs for at least two fiscal years if for any two consecutive fiscal years it derives more than 90% of its cash basis revenue, as defined in the rule, from Title IV programs. If an institution is determined to be ineligible, any disbursements of Title IV program funds made after the end of the second fiscal year in the measuring period must be repaid to the U.S. Department of Education. An institution that derives more than 90% of its cash basis revenue from Title IV programs for any single fiscal year


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will be automatically placed on provisional certification for two fiscal years and will be subject to possible additional sanctions determined to be appropriate under the circumstances by the Department. While the Department has broad discretion to impose additional sanctions on such an institution, there is only limited precedent available to predict what those sanctions might be, particularly in the current regulatory environment. For example, the Department could impose conditions in the provisional certification such as:
Restrictions on the total amount of Title IV program funds that may be disbursed to students;
Restrictions on programmatic and geographic expansion;
Requirements to obtain and post letters of credit;
Additional reporting requirements such as interim financial reporting; or
Any other conditions deemed appropriate by the Department.
The 90/10 Rule percentages for University of Phoenix were as follows for the indicated periods:
 
Year Ended August 31,
 
2016
 
2015
 
2014
University of Phoenix
79%
 
80%
 
81%
See the discussion of the 90/10 Rule in Part I, Item 1, Business - Regulatory Environment, above.
Any necessary efforts to reduce the 90/10 Rule percentage for University of Phoenix, especially if the percentage exceeds 90% for a fiscal year, may involve taking measures which reduce our revenue, increase our operating expenses, or both, in each case perhaps significantly. In addition, we may be required to make structural changes to our business in the future in order to remain in compliance, which changes may materially alter the manner in which we conduct our business and materially and adversely impact our business and financial condition. Furthermore, these required changes could make it more difficult to comply with other important regulatory requirements, such as the student loan cohort default rate regulations, which are discussed below.
In recent years, Congress has increased its focus on military benefit programs used for education at proprietary institutions. These military benefit programs are not part of Title IV, and therefore funding under these programs is not included in the 90% portion of the 90/10 Rule. Various bills have been introduced in Congress that would revise the 90/10 Rule to count Department of Defense tuition assistance and Department of Veterans Affairs Post-9/11 GI Bill veterans educational benefits toward the 90% limit, and to reduce the threshold to 85%. We cannot predict the likelihood that Congress will amend the 90/10 Rule in either manner. If all military benefit program funding was included in the 90% portion of the rule calculation, University of Phoenix’s fiscal year 2016 90/10 Rule percentage would have been higher.
An increase in student loan default rates could result in the loss of eligibility to participate in Title IV programs, which would materially and adversely affect our business.
To remain eligible to participate in Title IV programs, an educational institution’s student loan cohort default rates must remain below certain specified levels. Each cohort is the group of students who first enter into student loan repayment during a federal fiscal year (ending September 30) for a three-year measuring period.
An educational institution loses eligibility to participate in Title IV programs if its cohort default rate equals or exceeds 40% for any given year or 30% for three consecutive years. If an institution’s cohort default rate equals or exceeds 30% for any given year, it must establish a default prevention task force and develop a default prevention plan with measurable objectives for improving the cohort default rate.
Based on information published by the Department, the cohort default rates for University of Phoenix and for all proprietary postsecondary institutions for the applicable federal fiscal years were as follows:
 
Cohort Default Rates for
Cohort Years Ended September 30,
 
2013
 
2012
 
2011
University of Phoenix
13.3%
 
13.5%
 
19.0%
All proprietary postsecondary institutions
15.0%
 
15.8%
 
19.1%
See the discussion of cohort default rates in Part I, Item 1, Business - Regulatory Environment, above.
If our student loan default rates approach the applicable limits in the future, we may be required to increase efforts and resources dedicated to improving these default rates. This is challenging because most borrowers who are in default or at risk of default are no longer students, and we may have only limited contact with them. Furthermore, continued increased attention has been given by members of Congress and others on default aversion activities of proprietary education institutions. If such


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attention leads to congressional or regulatory action restricting the types of default aversion assistance that educational institutions are permitted to provide, the default rates of our former students may be negatively impacted. Such attention could also lead to Congressional proposals to increase the measuring period, which could negatively impact our default rates. Accordingly, there is no assurance that we would be able to effectively improve our default rates or improve them in a timely manner to meet the requirements for continued participation in Title IV programs if we experience a substantial increase in our student loan default rates.
If we fail to maintain any of our state authorizations, we would lose our ability to operate in that state and to participate in Title IV programs there.
Institutions that participate in Title IV programs must be authorized to operate by the appropriate postsecondary regulatory authority in each state where the institution has a physical presence. Prior to July 1, 2011, such authorization was not specifically required for the institution’s students to become eligible for Title IV programs. Under the program integrity rules adopted by the Department effective July 1, 2011, institutions are required to obtain specific regulatory approval to operate in such states. University of Phoenix is specifically authorized to operate in all of the domestic jurisdictions in which it operates. Some states assert authority to regulate all degree-granting institutions if their educational programs are available to their residents, whether or not the institutions maintain a physical presence within those states. University of Phoenix has obtained licensure in states which require such licensure and where students are enrolled.
A separate negotiated rulemaking process was convened by the Department in November 2013 on a variety of topics. Included among the topics was the proposed establishment of requirements for state authorization of distance education programs in order to demonstrate eligibility for Title IV eligibility. A negotiated rulemaking committee was established and met in early 2014. The committee failed to reach consensus. In July 2016, the Department issued draft regulations to establish new federal requirements for such eligibility.
The proposed regulations would establish new requirements to maintain state authorization for Title IV eligibility for distance education programs. Major provisions include, but are not limited to:
Requiring an institution offering distance education to have requisite state authority to offer such programs to state residents if required by the state;
Defining and recognizing acceptable state authorization reciprocity agreements;
Requiring institutions to document individualized state processes for resolving student complaints; and
Requiring an institution to provide extensive public and individualized disclosures to enrolled and prospective students regarding its programs offered solely through distance education, including information concerning adverse actions filed against the school by state entities or accrediting bodies.
As proposed, the regulations could be interpreted to allow individual states to impose new and diverse requirements on institutions and thereby reduce the regulatory and operational efficiency that our schools use in operating under the current State Authorization Reciprocity Agreement (“SARA”), which currently allows our Title IV eligible programs to operate in those states that have adopted SARA with only home state regulatory approval. States that have adopted SARA now constitute the majority of domestic jurisdictions.
Also as proposed, the regulations could be interpreted to require extensive new public disclosures based upon certain actions by accreditors and state entities, including state Attorneys General. Under some interpretations, the regulations could require disclosure to current and prospective students upon the mere filing of an adverse action and long after the initial action was resolved, even if resolved in favor of the institution.
The proposed regulations, if adopted, could result in significant potential risks for our business, since the precise regulatory scope and definitions for individualized state requirements and disclosures may be unclear or subject to interpretation in a manner that is adverse to us and not fully known or predictable in advance, and certain of the potential adverse consequences could arise from the mere commencement of adverse actions by government entities or accrediting bodies, even if these actions and claims ultimately are found to lack merit. Furthermore, the potential significant discretion vested in the Department to interpret and administer the regulations may result in unexpected outcomes that materially and adversely affect our business. In order to reduce the risk associated with these proposed regulations, if adopted, we may need to modify our administrative and other student-facing practices and procedures in a manner that materially increases our costs and reduces our administrative effectiveness.
The effective date of the proposed regulations, if adopted, cannot be determined at this time, but the proposed regulations could be effective as early as July 1, 2017.


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If our institutional accrediting body loses recognition by the U.S. Department of Education, we could lose our ability to participate in Title IV programs, which would materially and adversely affect our business.
University of Phoenix is institutionally accredited by the Higher Learning Commission (“HLC”), one of the six regional accrediting agencies recognized by the U.S. Department of Education. Accreditation by an accrediting agency recognized by the Department is required in order for an institution to become and remain eligible to participate in Title IV student financial aid programs.
If the Department ceased to recognize HLC for any reason, University of Phoenix would not be eligible to participate in Title IV programs beginning 18 months after the date such recognition ceased unless HLC was again recognized or our institutions were accredited by another accrediting body recognized by the Department. In June 2013, the National Advisory Committee on Institutional Quality and Integrity, a Committee that advises the Secretary of Education on matters related to postsecondary accreditation and eligibility, recommended to the Secretary that HLC have continuing recognition as an eligible accreditor with certain conditions and required reports.
If HLC ceased to be recognized by the Department and our affected schools failed to timely obtain replacement accreditation, our schools would cease to be eligible to participate in Title IV programs and our business would no longer be sustainable in its current form.
Non-U.S. Operations
Changes by a regulator in the interpretation of applicable course requirements could materially impact our Open Colleges business in Australia.
In mid-October 2016, Apollo Global’s two primary registered training organizations in Australia, Open Colleges Pty Ltd., and Integrated Care & Management Training, Pty Ltd., each received a notice of noncompliance and intention to make a decision to impose sanctions from the Australian Skills Quality Authority (“ASQA”), the national regulator of vocational education programs. The notice, which followed a recent compliance audit, identified several alleged compliance deficiencies and stated that ASQA intended to make a decision on whether to impose sanctions on the institutions which could include cancellation of registration or imposition of lesser sanctions. One of the findings involves a change in the interpretation of applicable course requirements and will require changes in our procedures for student workplace skills assessments used in connection with courses that represent a substantial portion of the Open Colleges institutions’ enrollment.
Implementing an updated workplace skills assessment model in order to address ASQA’s concerns will require operational changes for these institutions and increase operating costs, perhaps substantially. Furthermore, any resulting increases in tuition prices due to these changes could make our vocational training programs less competitive relative to available alternatives, especially traditional on-ground programs in large metropolitan areas.
Continued ASQA registration is critical to the continued operation of the Open Colleges and Integrated Care & Management Training businesses in Australia. If ASQA terminates the registration of these institutions or materially limits their participation, it could materially and adversely impact their and our business and operations.
We have until November 7, 2016 to respond to this notice of noncompliance. We cannot currently predict the timing or ultimate outcome of this matter.
Our non-U.S. operations are subject to risks not inherent in our U.S. operations, which could adversely affect our business.
We operate educational institutions in the United Kingdom, Australia, Germany, Mexico, South Africa, Brazil, Chile and elsewhere, and in India we offer educational programs through a joint venture. Our operations in each of the relevant foreign jurisdictions are subject to regulatory requirements relating to education providers, as well as foreign businesses. Many foreign countries have not fully embraced the proprietary education model, and in other countries, proprietary education remains controversial. As a result, our foreign operations are subject to the political risk that existing regulations will be interpreted unfavorably or new regulations will be adopted that have a significant negative impact on our business model or render it impractical. In addition, our non-U.S. operations are subject to the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act which require extensive compliance vigilance on our part and, in some cases, puts our foreign operations at a competitive disadvantage with local companies. If one or more of our foreign operations ceases to be economically practical, we may be forced to discontinue such operations or seek a buyer, either of which might result in a substantial loss of value to Apollo Education Group.


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Risks Related to Our Business
We face intense and increasing competition in the postsecondary education market from both public and private educational institutions, which has adversely affected our business.
Postsecondary education in our existing and new market areas is highly competitive and is becoming increasingly so as the industry is undergoing profound change at an unprecedented rate. We compete primarily with traditional public and private degree-granting regionally accredited colleges and universities, other proprietary degree-granting regionally accredited schools and alternatives to higher education. In addition, we face increasing competition from various emerging non-traditional, credit-bearing and noncredit-bearing education programs, offered by both proprietary and not-for-profit providers. Some of our competitors have greater financial and nonfinancial resources than we have and are able to offer programs similar to ours at a lower tuition level for a variety of reasons, including the availability of direct and indirect government subsidies, government and foundation grants, large endowments, tax-deductible contributions and other financial resources not available to proprietary institutions, or by providing fewer student services or larger class sizes. For example, a typical community college is subsidized by local or state government and, as a result, tuition rates for associate’s degree programs are much lower at community colleges than at University of Phoenix. Furthermore, various members of Congress have advocated for free or debt free post-secondary education at public universities, and the affordability of such education has been the subject of intense focus among candidates during the campaign leading up to the November 2016 elections in the U.S.
Also, like University of Phoenix, other proprietary educational institutions have begun to deploy pricing incentives to impact demand. We believe that price competition through targeted programs involving student scholarships and otherwise will continue throughout the industry. We have implemented scholarships and discounts which reduce the amount of tuition we receive, and further downward pressure on our tuition rates may cause us to implement further pricing incentives, which will adversely affect our revenue.
In addition, one of our primary competitive advantages in the U.S. has been materially diminished as a significant and increasing number of traditional four-year and community colleges, which are subject to fewer regulatory constraints, offer an increasing array of distance learning and other online education programs, including programs that are offered wholly online and geared towards the needs of working adults. This trend has been accelerated by private companies that provide and/or manage online learning platforms for traditional four-year colleges and community colleges. As the proportion of traditional colleges and universities providing alternative learning modalities increases, we will face increased competition from these institutions, including those with highly regarded reputations, the degrees from which are perceived as more valuable in the workplace. Already, this type of competition is significant and has contributed to the substantial decline in University of Phoenix enrollment that began in late 2010.
This intense competition makes it more challenging for us to enroll students who are likely to succeed in our educational programs, and has contributed to the substantial decline in University of Phoenix enrollment that began in late 2010 and put downward pressure on our tuition rates. We must adapt our business to meet these competitive challenges. The current initiative to transform University of Phoenix, as discussed below, is intended to address these competitive challenges.
We have launched a set of initiatives to transform University of Phoenix into a more focused institution; these initiatives will further reduce the University’s enrollment in the short-term and may not be successful in improving enrollment and retention in the longer term.
We are working to transform University of Phoenix into a more focused, higher retaining and less complex institution in order to improve student outcomes and stabilize enrollment. In furtherance of this, the University is implementing several important initiatives, as described in Part I, Item 1, Business - University of Phoenix. These initiatives require significant time, energy and resources, and involve many significant interrelated and simultaneous changes in the University’s processes and programs. We believe that some of the initiatives to transform University of Phoenix have accelerated the near term rate of decline in the University’s enrollment and revenue, which has increased the amount of necessary cost reductions. We have significantly reduced our operating costs over recent periods and further significant reductions are increasingly challenging. There is no assurance that we will be able to reduce costs to align with University of Phoenix’s reduced enrollment and revenue, especially if the University’s near term enrollment declines more than anticipated. Although we seek to effect these cost reductions in a manner that does not adversely impact the quality of our services to students, given the magnitude of these changes, they could result in near term disruption to our business which may further decrease our enrollment and revenues. Additionally, our fiscal year 2017 Department of Education financial responsibility composite score will be adversely impacted if we are not successful in reducing costs sufficiently during fiscal year 2017, whether due to our inability to effectuate planned cost reductions, greater than anticipated declines in our enrollment and revenue or other factors.


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Our financial performance depends on our ability to develop favorable awareness among, and enroll and retain students; adverse publicity has negatively impacted demand for our programs.
Building favorable awareness of our schools and the programs we offer is critical to our ability to attract prospective students. We expend significant resources on marketing. To the extent that our schools are unable to successfully market and advertise their educational programs, our schools’ ability to attract and enroll prospective students in such programs will be adversely affected. It is also critical to our success that we convert these prospective students to enrolled students in a cost-effective manner and that these enrolled students remain active in our programs.
During fiscal year 2016, University of Phoenix eliminated its use of third-party operated websites for marketing purposes in order to better manage the University’s marketing message, improve its ability to identify those students more likely to persist in its educational programs, and reduce cost. We believe that this change negatively impacted New Degreed Enrollment in fiscal year 2016.
The proprietary postsecondary education sector is under intense regulatory and other scrutiny which has led to media attention that has portrayed the sector in an unflattering light. This negative media attention has caused and may continue to cause some prospective students to choose educational alternatives outside of the proprietary sector or proprietary alternatives other than University of Phoenix, either of which could continue to negatively impact our new enrollments.
Some of the additional factors that could prevent us from successfully enrolling and retaining students in our programs include:
Increased competition from schools offering distance learning and other online educational programs;
A decrease in the perceived or actual economic benefits that students derive from our programs or education in general;
A decrease in or perceived low student pass rates for professional licenses and other examinations necessary for students to work in their chosen field;
Regulatory investigations or enforcement proceedings that may damage our or the industry’s reputation;
Increased regulation of online education, including in states in which we do not have a physical presence;
Litigation that may damage our reputation;
Inability to continue to recruit, train and retain quality faculty;
Student or employer dissatisfaction with the quality of our services and programs;
Tuition rate reductions by competitors that we are unwilling or unable to match;
A decline in the acceptance of online education;
Unavailability of ground locations where students want to attend; and
Disruptions to our information technology systems.
If one or more of these factors reduces demand for our programs, our enrollment could be further negatively affected or our costs associated with each new enrollment could increase, or both, either of which could have a material adverse impact on our business and financial condition.
Our financial performance depends, in part, on our ability to keep pace with changing education market needs; if we fail to keep pace or fail in implementing or adapting to new educational offerings and technologies, our business may be adversely affected.
The nature of the skills required by employers can evolve rapidly in today’s changing economic and technological environment. Accordingly, it is important for our schools’ educational programs to evolve in response to economic and technological changes. The expansion of existing programs and the development of new programs, including the changes discussed above to transform University of Phoenix, may not be accepted by current or prospective students or the employers of our graduates. Even if our schools are able to develop acceptable new programs, our schools may not be able to begin offering those new programs as quickly as required by prospective employers or as quickly as our competitors offer similar programs. In addition, we may be unable to obtain specialized accreditations or licensures that may make certain programs desirable to students. To offer a new academic program, we may be required to obtain federal, state and accrediting agency approvals, which may be conditioned or delayed in a manner that could significantly affect our growth plans. In addition, to be eligible for Title IV programs, a new academic program may need to be certified by the U.S. Department of Education. If we are unable to adequately respond to changes in market requirements due to regulatory or financial constraints, unusually rapid technological changes, or other factors, our ability to attract and retain students could be impaired, the rates at which our graduates obtain jobs involving their fields of study could suffer, and our business and financial condition could be adversely affected.
Establishing new academic programs or modifying existing programs requires us to make investments, incur marketing expenses and reallocate other resources. We may have limited experience with the courses in new areas and may need to


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modify our systems and strategy or enter into arrangements with other educational institutions to provide new programs effectively and profitably. If we are unable to offer new programs in a cost-effective manner, or are otherwise unable to manage effectively the operations of newly established academic programs, our business, financial condition and results of operations could be adversely affected.
If we do not maintain existing, and develop additional, relationships with employers, our business may be impaired.
We currently have relationships with large employers to provide their employees with the opportunity to obtain degrees and professional development certificates through us while continuing their employment. These relationships are an important part of our strategy as they provide us with potential working adults for particular programs and also serve to increase our reputation among high-profile employers. In addition, degree-granting programs in which employers directly pay tuition have a beneficial impact on our 90/10 Rule percentage calculation by reducing the proportion of our cash basis revenues attributable to Title IV program funds. If we are unable to develop new relationships or further develop our existing relationships, if our existing relationships deteriorate or end, or if we are unable to offer programs that teach skills demanded by employers, our efforts to seek these sources of potential working adults may be impaired, and this could materially and adversely affect our business and financial condition and our compliance with applicable regulations.
Our acquisitions may not be successful and may result in additional debt or dilution to our shareholders, which could adversely affect our business.
We have acquired and may in the future acquire additional proprietary educational institutions that complement our strategic direction. Any acquisition involves significant risks and uncertainties, including:
Inability to successfully integrate the acquired operations, including the information technology systems, into our institutions and maintain uniform standards, controls, policies and procedures;
Inability to successfully operate and grow the acquired businesses;
Distraction of management’s attention from normal business operations;
Challenges retaining the key employees of the acquired operation;
Operating, market or other challenges causing operating results to be less than projected;
Expenses associated with the acquisition;
Noncontrolling shareholder options that could require us to purchase shares in certain of our businesses that we do not wholly-own;
Challenges relating to conforming non-compliant financial reporting procedures to those required of a subsidiary of a U.S. reporting company, including procedures required by the Sarbanes-Oxley Act; and
Unidentified issues not discovered in our due diligence process, including commitments and/or contingencies.
Acquisitions are inherently risky. We have experienced many challenges in connection with our previous acquisitions and cannot be certain that any future acquisitions will be successful and will not materially adversely affect our business and financial condition. We may not be able to identify suitable acquisition opportunities, acquire institutions on favorable terms, or successfully integrate or profitably operate acquired institutions. Future transactions may involve use of our cash resources, issuance of equity or debt securities, incurrence of other forms of debt or a significant increase in our financial leverage, which could adversely affect our business and financial condition, especially if the cash flows associated with any acquisition are not sufficient to cover the additional debt service and could negatively impact our compliance with the U.S. Department of Education composite score measure of financial responsibility. If we issue equity securities as consideration in an acquisition, current shareholders’ percentage ownership and earnings per share may be diluted. In addition, our acquisition of an educational institution could be considered a change in ownership and control of the acquired institution under applicable regulatory standards. For such an acquisition in the U.S., we may need approval from the U.S. Department of Education and applicable state agencies and accrediting agencies and possibly other regulatory bodies. Our inability to obtain such approvals with respect to a completed acquisition could have a material adverse effect on our business and financial condition.


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Our expansion into new markets outside the U.S. subjects us to risks inherent in international operations.
As part of our growth strategy, we have acquired, and may continue to acquire schools and universities outside the U.S., and otherwise intend to grow our international operations. We will face risks that are inherent in international operations, including:
Complexity of operations across borders;
Compliance with foreign regulatory environments, including laws and regulations hindering proprietary education enterprises;
Changes in existing laws to prohibit or restrict proprietary education, whether arising from public discontent or otherwise;
Currency exchange rate fluctuations and/or price controls or restrictions on exchange of foreign currencies;
Monetary policy risks, such as inflation, hyperinflation and deflation;
Potential political and economic instability in the countries in which we operate;
Expropriation of assets by local governments;
Multiple and possibly overlapping and conflicting tax laws;
Compliance with anti-corruption regulations such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act of 2010;
Potential unionization of employees under local labor laws and local labor laws that make it more expensive and complex to negotiate with, retain or terminate employees;
Greater difficulty in utilizing and enforcing any acquired intellectual property and contract rights;
Investment and execution missteps due to a failure to understand the local culture and market;
Limitations on the repatriation of funds; and
Increased risk of acts of terrorism and war, epidemics and natural disasters.
Any one or more of these risks could negatively impact our non-U.S. operations and materially and adversely impact our business and financial condition.
Our current credit facility expires in April 2017. If we cannot arrange a replacement facility prior to that time, or at all, our available liquidity will be reduced which could limit our business operations.
Our existing syndicated $625 million unsecured revolving credit facility (the “Revolving Credit Facility”) expires in April 2017. Due to the current challenging business and regulatory climate for the proprietary education sector and the continued decline in our operating performance, we expect that any subsequent credit facility, if one can be arranged, will be substantially smaller and more expensive than our current facility. We believe that a number of lenders, including members of our Revolving Credit Facility syndicate, have made a decision to exit the proprietary education sector. Accordingly, there is no assurance that we will be able to timely arrange a replacement credit facility on terms acceptable to us or at all, and much will depend on near-term developments in our business and the proprietary education sector generally.
As of August 31, 2016, we had $30 million of outstanding borrowings under the Revolving Credit Facility and approximately $29 million of outstanding letters of credit. Also as of that date, we had $681 million of unrestricted cash and cash equivalents, and marketable securities. If we cannot replace the Revolving Credit Facility, our available liquidity will be reduced, and we may be required to post cash deposits to replace any outstanding letters of credit. In addition, the lack of a credit facility of an adequate size would limit our flexibility to operate our business, perhaps materially, which could adversely impact our future financial condition and operating results.
Brexit and related negative developments in the European Union could adversely impact our business and financial results.
The June 2016 referendum in the United Kingdom (“U.K.”) approving the exit of the U.K. from the European Union (“E.U.”)(widely referred to as “Brexit”) could cause disruptions to and create uncertainty surrounding our business, including affecting our relationships with our existing and future students and employees, which could have an adverse effect on our business, financial results and operations. The Referendum is non-binding; however, if passed into law, negotiations would commence to determine the future terms of the U.K.’s relationship with the E.U., including the terms of trade between the U.K. and the E.U. The effects of Brexit will depend on any agreements the U.K. makes to retain access to E.U. markets either during a transitional period or more permanently. These measures could impact the markets we serve and the tax jurisdictions in which we operate, and may cause us to lose students and employees. In addition, Brexit could lead to legal uncertainty and potentially divergent national laws and education-related regulations as the U.K. determines which E.U. laws to replace or replicate.
The announcement of Brexit caused significant volatility in global stock markets and currency exchange rate fluctuations that resulted in the strengthening of the U.S. dollar against the British pound. The strengthening of the U.S. dollar relative to other currencies may adversely affect our results of operations, because we translate revenue and expense denominated in foreign currencies into U.S. dollars for our consolidated financial statements.


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System disruptions to our computer networks or phone systems could have a material adverse effect on our business.
The performance and reliability of our computer network and phone systems infrastructure at our schools, including our online programs, is critical to our operations, reputation and ability to attract and retain students. From time to time we experience intermittent outages of the information technology systems used by our students and by our employees, including system-wide outages. Any computer system error or failure, regardless of cause, could result in a substantial outage that materially disrupts our online and ground operations. Not all of our critical systems are protected by a validated formal disaster recovery plan and redundant disaster recovery infrastructure at a geographically remote data center. We are continuing execution of our plan to implement disaster recovery infrastructure for our remaining critical systems to allow timely recovery from catastrophic failure. For those systems not yet protected, a catastrophic failure or unavailability for any reason of our principal data center may require us to replicate the function of this data center at our existing remote data facility or elsewhere, and could result in the loss of data. An event such as this may require service restoration activities that could take up to several weeks to complete.
We have upgraded or are in the process of upgrading a substantial portion of our key IT systems, including our online student classroom, student relationship and communications management platform, and corporate applications, and retiring the related legacy systems. Although these new systems are expected to improve the productivity, scalability, reliability and sustainability of our IT infrastructure, the transition from the legacy systems entails risk of unanticipated disruption or failure to fully replicate all necessary data processing and reporting functions, including in our core business functions.
Any disruption in our IT systems, including any disruptions and system malfunctions that may arise from our substantial IT systems upgrade initiative currently underway or outsourcing initiatives, could significantly impact our operations, reduce student and prospective student confidence in our educational institutions, adversely affect our compliance with applicable regulations and accrediting body standards and have a material adverse effect on our business and financial condition. Although we maintain insurance in respect of some types of these disruptions, there is no assurance that available insurance proceeds would be adequate to compensate us for damages sustained due to these disruptions.
Security threats to our computer systems, including breach of the personal information that we collect, could have a material adverse effect on our business.
We face an ever increasing number of threats to our computer systems, including unauthorized activity and access, malicious penetration, system viruses, malicious code and organized cyber-attacks, which could breach our security and disrupt our systems. These risks increase when we are making changes to our IT systems, such as our substantial IT systems upgrade initiative currently underway and our frequent updates to enable instructional innovation and address new student populations. Our size makes us a prominent target for hacking and other cyber-attacks within the education industry. From time to time we experience security events and incidents, and these reflect an increasing level of malicious sophistication, organization and innovation. We have devoted and will continue to devote significant resources to the security of our computer systems, but they may still be vulnerable to these threats. A user who circumvents security measures could misappropriate proprietary information or cause interruptions or malfunctions in operations, perhaps over an extended period of time prior to detection. As a result, we may be required to expend significant additional resources to protect against the threat of or alleviate problems caused by these system disruptions and security breaches. Any of these events could have a material adverse effect on our business and financial condition. Although we maintain insurance in respect of these types of events, there is no assurance that available insurance proceeds would be adequate to compensate us for damages sustained due to these events.
In addition, possession and use of personal information in our operations subjects us to risks and costs that could harm our business. Our educational institutions collect, use and retain large amounts of personal information regarding our students and their families, including social security numbers, tax return information and personal and family financial data. We also collect and maintain personal information of our employees in the ordinary course of our business. Some of this personal information is held and managed by certain of our vendors. Although we use security and business controls to limit access and use of personal information, a third-party may be able to circumvent those security and business controls, which could result in a breach of student or employee privacy. In addition, errors in the storage, use or transmission of personal information could result in a breach of student or employee privacy, and the increased availability and use of mobile data devices by our employees and students increases the risk of unintentional disclosure of personal information. Possession and use of personal information in our operations also subjects us to legislative and regulatory burdens that could require notification of data breaches and restrict our use of personal information. We cannot ensure that a breach, loss or theft of personal information will not occur. A breach, theft or loss of personal information regarding our students and their families or our employees that is held by us or our vendors could have a material adverse effect on our reputation and results of operations and result in liability under state and federal privacy statutes and legal actions by state attorneys, general and private litigants, and any of which could have a material adverse effect on our business and financial condition.


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If we cannot attract qualified new personnel or retain our existing senior management team, our business could be adversely affected.
Our future performance depends on the continued services and continuing contributions of our senior management to execute on our business plan and to identify and pursue new opportunities. Our future success also depends in large part on our continued ability to attract and retain qualified personnel. The loss of the services of our senior management for any reason could adversely affect our business and results of operations.
We have experienced a number of changes in senior management in recent years. A lack of management continuity could result in operational and administrative inefficiencies, make achievement of our strategic and management objectives more challenging and may make recruiting for future management positions more difficult. If we are unable to effectively manage our business through these management transitions, our business and results of operation could be adversely affected.
To effectively educate our students, we must continue to attract and retain qualified faculty members.
Our educational institutions employ approximately 19,000 faculty members, of which the substantial majority are adjunct, part-time faculty. In order to effectively educate our students, we must recruit and train a large number of faculty on an ongoing basis and keep our faculty engaged and focused on the mission of delivering quality education. If we cannot attract and retain sufficient qualified faculty members, or we fail to adequately train new faculty members, or our relations with faculty members deteriorate and lead to work stoppages or other disruptions, our ability to serve our students would be impaired and we may be required to reduce the scope or number of the classes available to our students, any of which could have a material adverse impact our business.
If we are unable to successfully conclude pending litigation and governmental inquiries, our business and financial condition could be adversely affected.
We, certain of our subsidiaries, and certain of our current and former directors and executive officers have been named as defendants in various lawsuits and we have received various governmental inquiries. Refer to Note 16, Commitments and Contingencies, and Note 17, Regulatory Matters, in Part II, Item 8, Financial Statements and Supplementary Data, for further discussion of pending litigation and other proceedings. In addition, changes in our business and pending actions by regulators and accreditors may increase the risk of claims.
We cannot predict the ultimate outcome of these matters and expect to incur significant defense costs and other expenses in connection with them. Such costs and expenses could have a material adverse effect on our financial condition and the market price of our common stock. We may be required to pay substantial damages or settlement costs in excess of our insurance coverage related to these matters, or may be required to pay substantial fines or penalties, any of which could have a further material adverse effect on our financial condition. An adverse outcome in any of these matters could also materially and adversely affect our licenses, accreditations and eligibility to participate in Title IV programs.
We rely on proprietary rights and intellectual property that may not be adequately protected under current laws, and we encounter disputes from time to time relating to our use of intellectual property.
Our success depends in part on our ability to protect our proprietary rights and intellectual property. We rely on a combination of copyrights, trademarks, trade secrets, patents, domain names and contractual agreements to protect our proprietary rights. For example, we rely on trademark protection in the U.S. and various foreign jurisdictions to protect our rights to various marks as well as distinctive logos and other marks associated with our services. We also rely on agreements under which we obtain intellectual property to own or license rights to use intellectual property developed by faculty members, content experts and other third-parties. We cannot assure that these measures are adequate, that we have secured, or will be able to secure, appropriate permissions or protections for all of the intellectual property rights we use or claim rights to in the U.S. or various foreign jurisdictions, or that third parties will not terminate our license rights or infringe upon or otherwise violate our intellectual property rights or the intellectual property rights of others. Despite our efforts to protect these rights, unauthorized third parties may attempt to use, duplicate or copy the proprietary aspects of our student recruitment and educational delivery methods and systems, curricula, online resource material or other content. Our management’s attention may be diverted by these attempts and we may need to use funds in litigation to protect our proprietary rights against any infringement or violation, which could have a material adverse affect on our business and financial condition.
We may become party to disputes from time to time over rights and obligations concerning intellectual property, and we may not prevail in these disputes. For example, third parties may allege that we have infringed upon or not obtained sufficient rights in the technologies used in our educational delivery systems, the content of our courses or other training materials or in our ownership or uses of other intellectual property claimed by that third-party. Some third-party intellectual property rights may prove to be extremely broad, and it may not be possible for us to conduct our operations in such a way as to avoid violating those intellectual property rights. Any such intellectual property claim could subject us to costly litigation and impose a significant strain on our financial resources and management personnel regardless of whether such claim has merit. Our various liability insurance coverages, if any, may not cover potential claims of this type adequately or at all, and we may be required to alter the design and operation of our systems or the content of our courses or pay monetary damages or license fees to third parties, which could have a material adverse affect on our business and financial condition.


Apollo Education Group, Inc. | 2016 Form 10-K | 44


We may incur liability for the unauthorized duplication, distribution or other use of materials posted online.
In some instances, our employees, including faculty members, or our students may post various articles or other third-party content online in class discussion boards or in other venues including Facebook, PhoenixConnect, University of Phoenix’s proprietary academic social media network, and other social networks. The laws governing the fair use of these third-party materials are imprecise and adjudicated on a case-by-case basis, which makes it challenging to adopt and implement appropriately balanced institutional policies governing these practices. As a result, we could incur liability to third parties for the unauthorized duplication, distribution or other use of this material. Any such claims could subject us to costly litigation and impose a significant strain on our financial resources and management personnel regardless of whether the claims have merit. Our various liability insurance coverages, if any, may not cover potential claims of this type adequately or at all, and we may be required to alter or cease our uses of such material, which may include changing or removing content from our courses, or pay monetary damages, which could have a material adverse affect on our business and financial condition.
We may have unanticipated tax liabilities that could adversely impact our results of operations and financial condition.
We are subject to multiple types of taxes in the U.S., United Kingdom and various other foreign jurisdictions. The determination of our worldwide provision for income taxes and other tax accruals involves various judgments, and therefore the ultimate tax determination is subject to uncertainty. In addition, changes in tax laws, regulations, or rules may adversely affect our future reported financial results, may impact the way in which we conduct our business, or may increase the risk of audit by the Internal Revenue Service (“IRS”) or other tax authorities.
During fiscal year 2015, the IRS completed its review of our U.S. federal income tax return for fiscal year 2014. Our federal income tax return for fiscal year 2013 is currently open for review by the IRS and we are also participating in the IRS’s Compliance Assurance Process for fiscal years 2015, 2016 and 2017, which is a voluntary program in which taxpayers seek to resolve all or most issues with the IRS prior to or soon after filing their U.S. federal income tax returns. Additionally, we are subject to numerous ongoing audits by state, local and foreign tax authorities with various tax years as early as 2007 that remain subject to examination.
Although we believe our tax accruals are reasonable, the final determination of tax returns under review or returns that may be reviewed in the future and any related litigation could result in tax liabilities that materially differ from our historical income tax provisions and accruals.
In addition, an increasing number of states and localities are adopting new laws or changing their interpretation of existing laws regarding the apportionment of service revenues for corporate income tax purposes in a manner that could result in a larger proportion of our income being taxed by the states into which we sell services. These legislative and administrative changes could have a material adverse effect on our business and financial condition.
Risks Related to the Control Over Our Voting Stock
Our Class A common stock has no voting rights. The Apollo Class B Voting Stock Trust No. 1 holds approximately 51% of our voting stock and controls substantially all actions requiring the vote or consent of our shareholders, which may discourage or make impractical a takeover and may have an adverse effect on the trading price of our Class A common stock.
Approximately 51% of our outstanding Class B voting shares, our only class of voting stock, is held by the Apollo Class B Voting Stock Trust No. 1 (the “Class B Trust”), an irrevocable trust of which the current trustees are Peter V. Sperling, Chairman of our Board of Directors, Ms. Terri Bishop, the Vice Chair of our Board of Directors, and Ms. Darby Shupp, a member of our Board of Directors. Mr. Peter Sperling owns the remaining 49% of our outstanding Class B voting stock through a revocable grantor trust. Accordingly, the Class B Trust and Mr. Peter Sperling together control the election of all members of our Board of Directors and substantially all other actions requiring a vote of our shareholders, except in certain limited circumstances. Holders of our outstanding Class A common stock do not have the right to vote for the election of directors or for substantially any other action requiring a vote of shareholders. The trustees of the Class B Trust have the sole power to appoint successor and additional trustees.
The control of a majority of our voting stock by the Class B Trust makes it impossible for a third-party to acquire voting control of us without the approval of a majority of the trustees of the Class B Trust. There is no assurance that the Apollo Education Group Class B shareholders, or the trustees of the Class B Trust, will exercise their control of Apollo Education Group in the same manner that a majority of the outstanding Class A shareholders would if they were entitled to vote on actions currently reserved exclusively for our Class B shareholders.


Apollo Education Group, Inc. | 2016 Form 10-K | 45


We are a Controlled Company under the Nasdaq Listing Rules and therefore are exempt from certain corporate governance requirements, which could reduce the influence of independent directors on our management and strategic direction.
We are a “Controlled Company” as defined in Rule 5615(c)(1) of the Nasdaq Listing Rules, because more than 50% of the voting power of our outstanding stock is controlled by the Class B Trust. As a consequence, we are exempt from certain requirements of Nasdaq Listing Rule 5605, including that:
Our Board be composed of a majority of Independent Directors (as defined in Nasdaq Listing Rule 5605(a)(2));
The compensation of our officers be determined by a majority of the independent directors or a compensation committee composed solely of independent directors; and
Nominations to the Board of Directors be made by a majority of the independent directors or a nominations committee composed solely of independent directors.
However, Nasdaq Listing Rule 5605(b)(2) does require that our independent directors have regularly scheduled meetings at which only independent directors are present (“executive sessions”). In addition, Internal Revenue Code Section 162(m) requires that a compensation committee of outside directors (within the meaning of Section 162(m)) approve performance-based compensation awards to executive officers in order for us to claim deductions for the compensation expense attributable to such awards. Notwithstanding the foregoing exemptions, we do have a majority of independent directors on our Board of Directors and we do have an Audit Committee, a Compensation Committee and a Nominating and Governance Committee composed entirely of independent directors.
The charters for the Compensation Committee, Audit Committee and Nominating and Governance Committee have been adopted by the Board of Directors and are available on our website, www.apollo.edu. These charters provide, among other items, that each member must be independent as such term is defined by the rules of the Nasdaq Stock Market LLC and the Securities and Exchange Commission.
If in the future our Board of Directors elects to rely on the exemptions permitted by the Nasdaq Listing Rules and reduce the number or proportion of independent directors on our Board and its key committees, the influence of independent directors on our management and strategy would be reduced and the influence of the holders of our Class B voting common stock on our management and strategy would increase.
Transactions involving a change of control of our company may impair our eligibility to participate in Title IV programs, our accreditation and our state licenses in a manner that materially and adversely affects our business.
A change of ownership or control of Apollo Education Group could require recertification by the U.S. Department of Education, the reevaluation of accreditation by HLC and the consent or reauthorization by state and foreign licensing agencies. If we experience a change of ownership or control, then University of Phoenix and certain of our other subsidiaries may cease to be eligible to participate in Title IV programs until recertified by the Department. The continuing participation of University of Phoenix in Title IV programs is critical to our business.
In addition, University of Phoenix is required to report any material change in stock ownership to its principal institutional accrediting body, HLC, and must obtain approval prior to undergoing any transaction that affects, or may affect, its corporate control or governance. In the event of any such change, HLC may undertake an evaluation of the effect of the change on the continuing operations of University of Phoenix for purposes of determining if continued accreditation is appropriate, which evaluation may include a comprehensive review. If accreditation by HLC is suspended or withdrawn, University of Phoenix would not be eligible to participate in Title IV programs until the accreditation is reinstated by the Commission or is obtained from another appropriate accrediting body.
In addition, some states in which University of Phoenix is licensed require approval (in some cases, advance approval) of changes in ownership or control in order to remain authorized to operate in those states, and participation in grant programs in some states may be interrupted or otherwise affected by a change in ownership or control.
In connection with our pending merger transaction, we have obtained or are seeking the necessary regulatory approvals.
As discussed above, approximately 51% of our outstanding Class B voting stock, our only class of voting stock, is held by the Class B Trust, and Mr. Peter Sperling beneficially owns the remaining 49% of such shares. If our pending merger transaction is not consummated, a future change in trustees of the Class B Trust, whether resulting from resignation, death, disability or otherwise, may be considered to be a change of control by the Department of Education, HLC or other regulatory authorities, depending on the circumstances.
We cannot prevent a change of ownership or control that would arise from a transfer of voting stock by the Class B Trust or Mr. Peter Sperling, including a transfer that may occur or be deemed to occur upon the resignation, death or incompetency of one or more of the trustees of the Class B Trust.


Apollo Education Group, Inc. | 2016 Form 10-K | 46


Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We lease and own real estate primarily in connection with providing educational programs and services. Our principal executive offices are located in Phoenix, Arizona, and we also maintain senior executive offices in Chicago, Illinois. Our properties consist of the following as of August 31, 2016:
 
 
Leased(4)
 
Owned
 
 
Square Feet
 
# of Properties
 
Square Feet
 
# of Properties
University of Phoenix(1)
 
3,935,000

 
134

 

 

Apollo Global(2)
 
940,000

 
73

 
572,000

 
17

Other(3)
 
1,074,000

 
29

 
3,000

 
1

 
 
5,949,000

 
236

 
575,000

 
18

(1) University of Phoenix has closed or is in the process of closing approximately 150 ground locations, as further discussed in Note 2, Restructuring and Impairment Charges, in Part II, Item 8, Financial Statements and Supplementary Data. The University continues to offer many of its academic programs at ground locations in selected major metropolitan areas throughout the U.S.
(2) Apollo Global’s properties are principally located in the United Kingdom, Mexico, Germany, Chile, South Africa, Australia and Brazil.
(3) The substantial majority of Other represents office space located in the U.S.
(4) We are rationalizing certain of our real estate facilities and ground locations in connection with our restructuring activities. The properties in the above table include 2.9 million of square feet we are exiting as part of our restructuring activities for which we still have a remaining lease obligation as of August 31, 2016.
Our properties consist of both office and dual purpose space, which includes classroom and office facilities. Leases generally range from five to ten years and often have renewal options for extended terms. We also lease space from time to time on a short-term basis in order to provide specific courses or programs. We periodically evaluate the current utilization of our educational facilities, projected enrollment and other relevant data to determine facility needs.
Item 3. Legal Proceedings
We are subject to various claims and contingencies that arise from time to time in the ordinary course of business, including those related to regulation, litigation, business transactions, employee-related matters and taxes, among others. 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.
A description of pending litigation, settlements, and other proceedings that fall outside the scope of ordinary and routine litigation incidental to our business is provided under Note 16, Commitments and Contingencies, in Item 8, Financial Statements and Supplementary Data, which is incorporated herein by reference.
Item 4. Mine Safety Disclosures
Not applicable.


Apollo Education Group, Inc. | 2016 Form 10-K | 47


PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market and Shareholders
Our Class A common stock is traded on the Nasdaq Global Select Market under the symbol “APOL.” As of August 31, 2016, there were 202 registered holders of record of our Class A common stock, none of which are entitled to any voting rights. Because many of our shares of Class A common stock are held by banks, brokers and other financial institutions on behalf of shareholders, there are a substantially greater number of shareholders represented by these registered holders.
The following sets forth the high and low sales prices per share for our Class A common stock as reported by the Nasdaq Global Select Market during each quarter of the two most recent fiscal years:
 
Fourth Quarter
 
Third Quarter
 
Second Quarter
 
First Quarter
 
High
 
Low
 
High
 
Low
 
High
 
Low
 
High
 
Low
Fiscal Year 2016
$
9.26

 
$
8.81

 
$
9.34

 
$
7.10

 
$
8.94

 
$
6.31

 
$
12.43

 
$
6.83

Fiscal Year 2015
$
17.36

 
$
10.20

 
$
28.53

 
$
16.05

 
$
34.55

 
$
24.82

 
$
31.44

 
$
23.30

There is no established public trading market for our Class B common stock and all shares of our Class B common stock are beneficially owned by three registered affiliate holders.
Dividends
Although we are permitted to pay dividends on our Class A and Class B common stock, we have never paid cash dividends on our common stock. Dividends are payable at the discretion of the Board of Directors, and the Articles of Incorporation treat the declaration of dividends on the Class A and Class B common stock in an identical manner as follows: holders of our Class A and Class B common stock are entitled to receive cash dividends, if and to the extent declared by the Board of Directors, payable to the holders of either class or both classes of common stock in equal or unequal per share amounts, at the discretion of the Board of Directors. We do not expect to pay dividends in the foreseeable future. The decision of our Board of Directors to pay future dividends will depend on general business conditions, the effect of a dividend payment on our financial condition and other factors the Board of Directors may consider relevant. We are prohibited from paying dividends under the agreements associated with our pending merger, as described further in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Pending Merger.
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance under Equity Compensation Plans
The information required by Item 201(d) of Regulation S-K is provided under Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, which is incorporated herein by reference.
Issuer Purchases of Equity Securities
Our Board of Directors has authorized us to repurchase outstanding shares of our Class A common stock from time to time depending on market conditions and other considerations. During fiscal year 2013, our Board of Directors authorized an increase in the amount available under our share repurchase program up to an aggregate amount of $250 million, of which $52.2 million remained available as of August 31, 2016. There is no expiration date on the repurchase authorizations and the amount and timing of future share repurchase authorizations and repurchases, if any, will be made as market and business conditions warrant. Repurchases occur at our discretion and may be made on the open market through various methods including but not limited to accelerated share repurchase programs, or in privately negotiated transactions, pursuant to the applicable Securities and Exchange Commission rules, and may include repurchases pursuant to Securities and Exchange Commission Rule 10b5-1 nondiscretionary trading programs. We are prohibited from repurchasing shares under the agreements associated with our pending merger, as described further in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Pending Merger.


Apollo Education Group, Inc. | 2016 Form 10-K | 48


We did not repurchase shares of our Class A common stock during the three months ended August 31, 2016, and the following details changes in our treasury stock during the three months ended August 31, 2016:
(In thousands, except per share data)
Total Number
of Shares
Repurchased
 
Average Price
Paid per Share
 
Total Number of
Shares Repurchased
as Part of Publicly
Announced Plans or
Programs
 
Maximum Value of
Shares Available
for Repurchase
Under the Plans or
Programs
Treasury stock as of May 31, 2016
79,814

 
$
49.06

 
79,814

 
$
52,224

New authorizations

 

 

 

Share repurchases

 

 

 

Share reissuances
(25
)
 
49.06

 
(25
)
 

Treasury stock as of June 30, 2016
79,789

 
$
49.06

 
79,789

 
$
52,224

New authorizations

 

 

 

Share repurchases

 

 

 

Share reissuances
(150
)
 
49.06

 
(150
)
 

Treasury stock as of July 31, 2016
79,639

 
$
49.06

 
79,639

 
$
52,224

New authorizations

 

 

 

Share repurchases

 

 

 

Share reissuances
(782
)
 
49.06

 
(782
)
 

Treasury stock as of August 31, 2016
78,857

 
$
49.06

 
78,857

 
$
52,224




Apollo Education Group, Inc. | 2016 Form 10-K | 49


Company Stock Performance
The following graph compares the five-year cumulative total return attained by shareholders on our Class A common stock relative to the cumulative total returns of the S&P 500 index and a customized peer group, which we modified in fiscal year 2016 as discussed below. Our Old Peer group consists of the following:
Old Peer Group
American Public Education, Inc.
Capella Education Company
DeVry Education Group Inc.
ITT Educational Services, Inc.(1)
Bridgepoint Education, Inc.
Career Education Corporation
Grand Canyon Education, Inc.
Strayer Education, Inc.
(1) In September 2016, ITT Educational Services, Inc.’s common stock was suspended from trading following a notification that proceedings had commenced to delist their common stock. Accordingly, we modified our peer group to remove ITT Educational Services, Inc. to better represent the companies included in our industry. We believe the New Peer Group, which is the same as the Old Peer Group detailed above, excluding ITT Educational Services, Inc., provides a more meaningful comparison to our overall business and operations.
An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our Class A common stock, in the S&P 500 Index, and in the old and new peer groups on August 31, 2011, and its relative performance is tracked through August 31, 2016. The stock price performance included in this graph is based on historical results and is not necessarily indicative of future stock price performance.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN*
Among Apollo, the S&P 500 Index and Peer Groups
aegperformancegraph2016.jpg
* $100 invested on August 31, 2011 in stock, index and peer groups, including reinvestment of dividends.
Source: Standard & Poor’s.
 
Fiscal Year Ending August 31,
 
2011
 
2012
 
2013
 
2014
 
2015
 
2016
Apollo
$
100

 
$
57

 
$
40

 
$
59

 
$
24

 
$
19

S&P 500 Index
100

 
118

 
140

 
175

 
176

 
198

New Peer Group
100

 
66

 
88

 
106

 
78

 
82

Old Peer Group
100

 
56

 
73

 
83

 
60

 
63

The information contained in the performance graph shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission nor shall such information be deemed incorporated by reference into any future filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filing.


Apollo Education Group, Inc. | 2016 Form 10-K | 50


Item 6. Selected Financial Data
The following selected financial data is derived from our consolidated financial statements and is qualified by reference to and should be read in conjunction with Item 8, Financial Statements and Supplementary Data, and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, to fully understand factors that may affect the comparability of the information. The historical results are not necessarily indicative of the results to be expected in any future period.
 
As of August 31,
($ in thousands)
2016
 
2015
 
2014
 
2013
 
2012
Cash and cash equivalents
$
464,024

 
$
503,705

 
$
1,228,813

 
$
1,414,485

 
$
1,276,375

Restricted cash and cash equivalents
142,170

 
198,369

 
224,135

 
259,174

 
318,334

Current marketable securities
197,886

 
194,676

 
187,472

 
105,809

 

Noncurrent marketable securities
18,758

 
95,815

 
87,811

 
43,941

 
5,946

Total assets(1)
2,012,906

 
2,201,064

 
3,081,045

 
2,996,475

 
2,868,848

Total debt
90,795

 
45,646

 
657,096

 
692,054

 
719,911

Total liabilities(1)
936,312

 
1,044,091

 
1,835,716

 
1,878,466

 
1,944,525

Redeemable noncontrolling interests
5,860

 
11,915

 
64,527

 

 

Total equity
1,070,734

 
1,145,058

 
1,180,802

 
1,118,009

 
924,323

 
Year Ended August 31,
(In thousands, except per share data)
2016
 
2015
 
2014
 
2013
 
2012
Net revenue
$
2,101,850

 
$
2,566,277

 
$
2,996,865

 
$
3,613,851

 
$
4,183,307

Operating (loss) income(2)
(65,593
)
 
114,944

 
354,964

 
455,979

 
700,928

(Loss) income from continuing operations
(81,339
)
 
47,480

 
221,430

 
267,477

 
397,553

Net (loss) income
(91,030
)
 
24,295

 
204,798

 
248,965

 
417,006

Net (loss) income attributable to Apollo
(84,554
)
 
29,755

 
209,304

 
248,526

 
422,678

(Loss) earnings per share - Basic:
 

 
 

 
 

 
 
 
 
Continuing operations attributable to Apollo
$
(0.69
)
 
$
0.49

 
$
2.03

 
$
2.37

 
$
3.36

Discontinued operations attributable to Apollo
(0.09
)
 
(0.21
)
 
(0.15
)
 
(0.17
)
 
0.12

Basic (loss) income per share attributable to Apollo
$
(0.78
)
 
$
0.28

 
$
1.88

 
$
2.20

 
$
3.48

(Loss) earnings per share - Diluted:
 

 
 

 
 

 
 

 
 

Continuing operations attributable to Apollo
$
(0.69
)
 
$
0.49

 
$
2.01

 
$
2.36

 
$
3.34

Discontinued operations attributable to Apollo
(0.09
)
 
(0.22
)
 
(0.15
)
 
(0.17
)
 
0.11

Diluted (loss) income per share attributable to Apollo
$
(0.78
)
 
$
0.27

 
$
1.86

 
$
2.19

 
$
3.45

Basic weighted average shares outstanding
108,660

 
108,092

 
111,354

 
112,712

 
121,607

Diluted weighted average shares outstanding
108,660

 
109,038

 
112,610

 
113,285

 
122,357

(1) Total assets and total liabilities for prior years have been updated to reflect the impact of the retrospective adoption of a new accounting standard during fiscal year 2016, which requires deferred tax assets and liabilities to be classified as noncurrent on the balance sheet. Refer to Note 1, Nature of Operations and Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data.
(2) Operating (loss) income includes:
Restructuring and impairment charges of $159.1 million, $81.8 million, $85.3 million, $197.0 million and $55.5 million in fiscal years 2016, 2015, 2014, 2013 and 2012, respectively;
Merger, acquisition and other related costs, net of $21.8 million, $6.2 million and $19.8 million in fiscal years 2016, 2015 and 2014, respectively; and
Litigation charges (credits) of $0.1 million, $13.9 million, $(24.6) million, and $4.7 million in fiscal years 2015, 2014, 2013 and 2012, respectively.


Apollo Education Group, Inc. | 2016 Form 10-K | 51


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help provide an understanding of our results of operations, financial condition and present business environment. The MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and related notes included in Item 8, Financial Statements and Supplementary Data.
Overview
Apollo Education Group, Inc. is a private education provider serving students since 1973. We believe that our success depends on providing high quality education and career-focused pathways, tools and services to students to maximize the benefits of their educational experience. We offer undergraduate, graduate, certificate and nondegree educational programs and services, online and on-campus, principally to working adults in the U.S. and abroad.
Substantially all of our net revenue is composed of tuition and fees for educational services. In fiscal year 2016, University of Phoenix generated 78% of our consolidated net revenue.
Pending Merger
On February 7, 2016, we entered into an Agreement and Plan of Merger (as amended, the “Merger Agreement”) with AP VIII Queso Holdings, L.P., a Delaware limited partnership (“Queso”) and Socrates Merger Sub, Inc., an Arizona corporation and a wholly owned subsidiary of Parent (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Queso. Queso is an affiliate of Apollo Management, L.P., a fund managed by an affiliate of Apollo Global Management, LLC, none of which is, or has ever been, affiliated with us. The Vistria Group, LP is a co-investor in Queso. Najafi Companies, LLC is a potential co-investor in Queso. At the effective time of the merger, which, subject to the satisfaction of the closing conditions, is anticipated to be on or before February 1, 2017, the date on which the contract becomes terminable by either party, each share of our issued and outstanding Class A and Class B common stock (other than shares owned by Queso and its subsidiaries and shares owned by us and our subsidiaries) will be converted pursuant to the terms of the Merger Agreement into the right to receive $10.00 per share in cash. On May 6, 2016, the Merger Agreement was approved by the holders of our outstanding Class A and Class B common stock, each voting separately as a class.
Consummation of the Merger is subject to customary and other conditions, including:
(i)
the absence of certain conditions or restrictions in the response of the U.S. Department of Education to the pre-acquisition review application filed by University of Phoenix; and
(ii)
the receipt of consents or approvals from other federal, state and foreign educational governing bodies, including the Higher Learning Commission (“HLC”).
HLC has informed us that it does not intend to review our change of control application until after the Department of Education responds to our pending pre-acquisition review filing and Queso submits to the Department any required additional information. The Department’s review is pending and we cannot predict how the Department will respond to our filing.
In addition, consummation of the Merger is subject to our satisfying certain minimum operating metrics, measured as of the first or second month end preceding the closing date, depending on the day of the month on which closing occurs, as follows:
(i)
Our aggregate cash, cash equivalents and marketable securities must not be less than the specified amount for the applicable month end;
(ii)
University of Phoenix fiscal year-to-date new degreed enrollments as of the applicable month end must not have declined by more than 15% from forecasted levels (which are derived from the projections we prepared in December 2015 in connection with the Merger, which we refer to as the December 2015 forecast);
(iii)
University of Phoenix trailing twelve month net revenue as of the applicable month end shall not have declined by more than 10% from forecasted levels (which are derived from the December 2015 forecast); and
(iv)
Our consolidated trailing twelve month adjusted earnings before interest, taxes, depreciation and amortization as of the applicable month end shall not have declined by more than $75 million from forecasted levels (which are derived from the December 2015 forecast).
We satisfied each of these minimum operating metrics as of September 30, 2016, which is the relevant measurement date for a closing on or prior to November 9, 2016. We currently expect to satisfy these metrics if the closing occurs on or prior to February 1, 2017, which is the date on which the contract becomes terminable by either party if the closing conditions have not been met.
There is no assurance that the conditions to the consummation of the Merger will be satisfied in a timely manner or at all.


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The Merger Agreement may be terminated by each of us and Queso under certain circumstances, including if the Merger is not consummated by 5:00 pm Eastern time on February 1, 2017. Upon termination of the Merger Agreement under certain specified circumstances, but not including a termination solely due to our failure to satisfy the minimum operating metrics described above, we will be required to pay Queso a termination fee of 2.75% of the aggregate per share merger consideration that would have been payable to the Company’s shareholders upon closing of the Merger (approximately $27.5 million), and under other specified circumstances, Queso will be required to pay us a reverse termination fee of $25.0 million. For additional information about some of the consequences that could arise from the failure to consummate the Merger, see Part I, Item 1A, Risk Factors - Risks Related to our Pending Merger - Our pending merger may not be consummated, which may adversely affect our business, and our business may suffer during the pendency of the merger as a result of uncertainty regarding consummation.
Assuming timely receipt of required regulatory approvals and the satisfaction or waiver of all other closing conditions, we anticipate that the Merger will be completed on or before February 1, 2017, the date on which the contract becomes terminable by either party.
On July 7, 2016, HLC formally notified us that the HLC Board of Trustees had voted to defer action on our change of control application until such time as the Department of Education provides us and HLC with a written response to the pre-acquisition applications filed by University of Phoenix and Western International University, and we and/or Queso has filed a substantive response to any requirements stipulated in the Department’s response. HLC indicated that it would consider the matter at a special meeting to be convened within 30 days of receiving the specified information, and that should such information not be received before September 28, 2016, the matter would automatically be scheduled for the November 2016 Board of Trustees meeting. In mid-October, HLC also requested that we update select information in our application for change of control so that HLC would have more current information, as well as requiring us to provide the previously requested Department of Education response and our response to it. We expect the Commission to take substantive action on the application after all such materials have been submitted.
For additional information related to the Merger and the Merger Agreement, please refer to the following:
Current Report on Form 8-K filed with the Securities and Exchange Commission on February 8, 2016;
Definitive Proxy Statement filed with the Commission on March 23, 2016;
Supplement to the Definitive Proxy Statement filed with the Commission on May 2, 2016;
Amendments to the Merger Agreement attached to our Current Report on Form 8-K filed with the Commission on May 2, 2016; and
Quarterly Report on Form 10-Q filed with the Commission on July 8, 2016.
Key Trends, Developments and Challenges
The following developments and trends present opportunities, challenges and risks relating to our business. For a more detailed discussion of our business, industry and risks, refer to Part I, Item 1, Business, and Part I, Item 1A, Risk Factors.
Rapidly Evolving and Highly Competitive Education Industry
The higher education industry is changing at an increasing pace due to a challenging political and regulatory environment (discussed further below), technological developments, evolving needs and objectives of students and employers, economic constraints affecting educational institutions and students, price competition, increased focus on affordability and value, inconsistent quality of secondary education in the U.S. and other factors that challenge many of the core principles underlying the industry. In addition, one of our primary competitive advantages in the U.S. has been materially diminished as a significant and increasing number of traditional four-year and community colleges, which are subject to fewer regulatory constraints, offer an increasing array of distance learning and other online education programs, including programs that are offered wholly online and geared towards the needs of working adults. In recent years we have not competed successfully with these traditional schools and this has contributed to the substantial decline in University of Phoenix enrollment that began in late 2010. See further discussion of enrollment in Results of Operations below.


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University of Phoenix Transformation
The University’s vision is to be recognized as the most trusted provider of career-relevant higher education for working adults. In furtherance of this, the University offers career focused programs and an instructional model designed specifically to meet the educational needs of working adults.
Due in part to the rapidly changing higher education environment, particularly for proprietary institutions, and the competitive factors described above, the University’s enrollment has substantially declined since late 2010. The University is working to stabilize enrollment in the longer term by transforming itself into a more focused, higher retaining and less complex institution, including through:
Student outcomes initiatives designed to better prepare incoming students and to help existing students progress in their programs to completion. This includes tailoring initial course sequences to match the academic capabilities of students when they first enroll, continuing to assess our programs to retire or improve those which have lower retention rates or are less career relevant, adding more career-focused pathways that offer certificates and four-year bachelor’s degrees in key growth areas of the employment market, and piloting diagnostic tools for development of enhanced admissions guidelines and pathways expected to be implemented in fiscal year 2017.
Student experience initiatives such as concentrating on fewer ground locations in selected major metropolitan areas throughout the U.S. while maintaining a regional presence for both on-ground and online students, and continuing to improve the classroom experience by offering student cohort start dates approximately every five weeks for most programs to optimize class size and classroom dynamics.
Brand health and outreach initiatives designed to better manage the University’s marketing message, improve its ability to identify those students more likely to persist in its educational programs, and build on the University’s move away from third-party operated websites for marketing purposes.
Operational excellence initiatives designed to reduce costs, improve operations and facilitate future systems upgrades such as continuing the transition of technology systems from proprietary and legacy systems to commercial software and software as a service. This includes the University’s online classroom and developing increased student self-service capabilities in admissions, financial aid, academic planning and class scheduling.
We have experienced significant challenges in accurately predicting the effects on enrollment and retention of the various initiatives that we have developed and deployed in recent years. Accordingly, there is no assurance that our current transformation plan will stabilize enrollment, improve retention or achieve the other intended results, and the broad scope and number of simultaneous changes increases the risk of unexpected challenges and unintended consequences. Some of these initiatives have accelerated the enrollment decline at University of Phoenix in recent years, as discussed further below in Results of Operations. Further, we expect that the University’s enrollment will continue declining as we implement the initiatives; however, we expect the rate of decline to moderate as compared to the rate we experienced during 2016 and that enrollment will not increase prior to fiscal year 2019.
Cost Reductions
We are intensely focused on reengineering our business processes and educational delivery systems to improve efficiencies and reduce costs to align with our declining enrollment and revenue in a manner that does not adversely impact the quality of our services to students. As discussed above, some of the initiatives to transform University of Phoenix have accelerated the near term rate of decline in the University’s enrollment and revenue, which has increased the amount of necessary cost reductions. In furtherance of this, we are closing underutilized or unnecessary University of Phoenix campus locations, reducing our workforce as necessary, streamlining and, where appropriate, automating our administrative and student facing services, outsourcing administrative and other services, evaluating the scope of our academic programs and delaying the implementation of certain of University of Phoenix’s transformation initiatives. Also, we have engaged outside advisors to assist us in identifying and effectuating these cost reduction initiatives. We have significantly reduced our operating costs over recent periods and further significant reductions are increasingly challenging. There is no assurance that we will be able to reduce costs to align with University of Phoenix’s reduced enrollment and revenue, especially if the University’s near term enrollment declines more than anticipated. Although we seek to effect these cost reductions in a manner that does not adversely impact the quality of our services to students, given the magnitude of these changes, they could result in near term disruption to our business which may further decrease our enrollment and revenues. Additionally, our fiscal year 2017 Department of Education financial responsibility composite score will be adversely impacted if we are not successful in reducing costs sufficiently during fiscal year 2017, whether due to our inability to effectuate planned cost reductions, greater than anticipated declines in our enrollment and revenue or other factors. See further discussion under Regulatory Environment - Financial Responsibility Composite Score and Results of Operations below.
Political and Regulatory Environment


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In recent years, there has been substantial and continuing increased focus by various members of the U.S. Congress and federal agencies, including the Department of Education, the Consumer Financial Protection Bureau and the Federal Trade Commission, on the role that proprietary educational institutions play in higher education. Congressional hearings and roundtable discussions have been held regarding various aspects of the education industry, and reports have been issued that are highly critical of proprietary institutions and include a number of recommendations to be considered by Congress in connection with the upcoming reauthorization of the Higher Education Act. A group of influential U.S. senators has strongly and repeatedly encouraged the Departments of Education, Defense and Veterans Affairs to take action to limit or terminate the participation of proprietary educational institutions, including University of Phoenix, in existing tuition assistance programs.
The 2016 Democratic Party Platform for the November 2016 elections includes a plan highly critical of the proprietary education industry and vows to intensify the current focus on for-profit schools and to strengthen the gainful employment rules applicable to for-profit schools. The outcome of the November 2016 elections in the U.S. could increase the risk that the eligibility of proprietary schools to participate in Title IV student financial aid programs will be limited, perhaps materially.
In late 2014, the Department of Education formed an inter-agency task force focused on the proprietary sector involving multiple federal agencies and departments including the Federal Trade Commission, the U.S. Departments of Justice, Treasury and Veterans Affairs, the Consumer Financial Protection Bureau, the Securities and Exchange Commission, and numerous state Attorneys General, to coordinate activities and share information to protect students from unfair, deceptive and abusive policies and practices by proprietary higher education institutions. We expect that this challenging political and regulatory environment will continue for proprietary educational institutions, including University of Phoenix, for the foreseeable future, and may intensify.
In recent years, two major proprietary education institutions, together serving over 110,000 students, have ceased operations and filed for bankruptcy protection due to delays in or denial by the Department of Education of Title IV funding for students and requirements to post letters of credit, based in part on the existence of multiple investigations by various regulatory authorities. In neither case were the principal investigations completed nor were substantial enforcement actions commenced and prosecuted to conclusion. Accordingly, proprietary institutions are at risk of harmful delays or denial of Title IV funding for students due to investigations and other preliminary allegations, even if such investigations or allegations may ultimately be found to lack merit.
The following summarizes additional significant political or regulatory matters applicable to our business.
Gainful Employment
Under the Higher Education Act, as reauthorized, proprietary schools are generally eligible to participate in Title IV programs only in respect of educational programs that lead to “gainful employment in a recognized occupation.” In connection with this requirement, proprietary postsecondary institutions are required to provide information to prospective students about each eligible program, including the relevant recognized occupations, cost, completion rate, job placement rate, and median loan debt of program completers.
In October 2014, the U.S. Department of Education published final regulations, effective July 1, 2015, on the metrics for determining whether an academic program prepares students for gainful employment in a recognized occupation. Under the final regulations, which apply on a program-by-program basis, students enrolled in a program will be eligible for Title IV student financial aid only if that program satisfies at least one of two tests relating to student debt service-to-earnings ratios. The two tests specify minimum student loan debt service-to-earnings ratios calculated on the basis of the average earnings of program graduates: one test measures student loan debt service as a percentage of total earnings, and the other test measures student loan debt service as a percentage of deemed discretionary earnings. If a program fails to meet both of the minimum ratios for one year, the institution will be required to provide a warning notice to prospective and enrolled students advising that the program may lose Title IV eligibility based on the final student loan debt service-to-earnings ratios for the next year. Programs that fail to meet both of the minimum ratios for two out of three years will immediately cease to be Title IV eligible for a period of at least three years.
The Department has indicated that it plans to issue the official 2014 gainful employment debt service-to-earnings ratios by January 2017, and we anticipate the 2015 ratios will be issued in early fiscal year 2018. We believe it is likely that some of University of Phoenix’s programs will be impacted by the gainful employment regulations. Beginning in September 2015 and continuing through early fiscal year 2017, the University ceased enrolling or plans to cease enrolling new students in programs it believes may be impacted in connection with its initiatives to transform itself into a more focused, higher retaining and less complex institution. As of August 31, 2016, students in such programs represented approximately 15% of the University’s Degreed Enrollment. Students who are currently enrolled in such programs, and who do not elect to enroll in a different University of Phoenix program, are being taught-out in due course.


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Changes in student borrowing needs and practices, student loan interest rates, labor markets and other factors outside of our control could adversely impact compliance with these regulations for some of our programs in the future. The Department has not yet announced the future, annual protocol for calculating and disseminating the debt service-to-earnings ratios. We will not know of a program’s failure to meet the minimum ratios until well after the measuring period, and therefore students enrolled in such a program could lose their access to federal financial aid before completing the program. Accordingly, we will not have the opportunity to make program changes for any programs that did not meet either of the minimum ratios for 2014. If those programs also do not meet either of the minimum ratios for 2015, they will lose eligibility to participate in Title IV financial aid programs at the time the official 2015 ratios are published, which we anticipate will occur in early fiscal year 2018.
U.S. Department of Education Rulemaking Initiatives
A negotiated rulemaking committee was convened by the Department in January 2016 on the topic of the process and standards for discharge of student loans, commonly known as defense to repayment, and certain other matters. The committee failed to reach consensus. In June 2016, the Department issued a Notice of Proposed Rulemaking to establish a new federal standard and a process for determining whether a borrower has a defense to repayment on federal student loans based on an act or omission of a school.
The proposed regulations would provide repayment relief to borrowers in respect of student loans first disbursed on or after July 1, 2017 where:
a school breaches contractual promises to a student;
certain judgments are entered against a school related to the loan or the educational services after a contested proceeding; or
the school makes substantial misrepresentations about the nature of its educational programs, financial charges or employability of graduates, or insubstantial misrepresentations where other factors are present, such as pressure to enroll quickly or taking advantage of students’ distress or lack of knowledge or sophistication.
As proposed, there would be no limitation on claims to discharge future amounts owed by the borrower and a six-year limitation (from the date of the breach) on claims to discharge amounts already paid by the borrower. The proposed regulations also would allow the Department to identify and grant relief to groups of students where there are common facts, including students who have not requested relief.
The proposed borrower defense definitions would not apply for loans first disbursed prior to July 1, 2017, and these loans will remain subject to the current borrower defense definitions; however, under the proposed rules, these loans will follow the same claims process, individual and group, and time limitations.
As proposed, the Department would be entitled to seek reimbursement from the school in most cases in respect of loans discharged under the new procedure.
In addition, the proposed regulations specify early warning triggers regarding financial distress that would automatically require a school to post a letter of credit in the amount of at least 10% of the school’s annual Title IV disbursements upon the occurrence of specified events including, but not limited to:
the commencement of a major lawsuit by a state or federal government entity, such as a state Attorney General, the Consumer Financial Protection Bureau or the Federal Trade Commission;
the filing of a substantial number of borrower defense claims;
default by the school on its debt obligations;
failure of the school to satisfy the 90/10 Rule;
programs failing to meet gainful employment regulations;
accrediting agency actions, including the requirement to submit teach-out plans or being placed on an accreditation status that could result in the school losing its accreditation; and/or
any event or condition the Department determines is likely to have a material adverse effect on the business, financial condition or results of operations of the institution.
Each separate triggering event would result in a separate letter of credit requirement of at least 10% of annual Title IV disbursements. If a school experiences any of these triggers, the school would be required to warn prospective and current students that it has been required to provide enhanced financial protection to the Department.
Further, the proposed regulations would also institute a loan repayment rate for proprietary institutions and would require disclosure of such rate to prospective and enrolled students if such rate falls below specified levels.


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The proposed regulations, if adopted, could result in significant potential risks for our business, since the precise standards for student loan discharge may be unclear or subject to interpretation in a manner that is adverse to us and not fully known or predictable in advance, and certain of the potential adverse consequences could arise from the mere commencement of enforcement actions by state or federal government entities, or the filing of student claims for debt relief, even if these actions and claims ultimately are found to lack merit. Furthermore, the potential significant discretion vested in the Department to administer the regulations, including fact-finding, may result in unexpected outcomes that materially and adversely affect our business. In order to reduce the risk associated with these proposed regulations, if adopted, we may need to modify our administrative and other student-facing practices and procedures in a manner that materially increases our costs and reduces our administrative effectiveness, and our flexibility in responding to state or federal and certain private lawsuits may be materially reduced because of the possible significant ancillary consequences of an adverse judgment or finding.
Recently, two major proprietary higher education institutions were forced to cease operations and seek bankruptcy protection due to delays in Title IV disbursements and requirements to post letters of credit imposed by the Department based in part on the existence of pending state and federal investigations and the Department’s judgment regarding various subjective matters such as the institution’s culture. These regulations, if adopted as proposed, would enhance the power of the Department to take summary action that could harm University of Phoenix and Apollo Education Group, perhaps materially, before we could effectively exercise our due process rights, even if the action is based on pending investigations or legal proceedings that ultimately are determined to lack merit.
The effective date of the proposed regulations, if adopted, cannot be determined at this time, but the proposed regulations could be effective as early as July 1, 2017. More information can be found at http://www2.ed.gov/policy/highered/reg/hearulemaking/2016/index.html.
A separate negotiated rulemaking process was convened by the Department in November 2013 on a variety of topics. Included among the topics was the proposed establishment of requirements for state authorization of distance education programs in order to demonstrate eligibility for Title IV eligibility. A negotiated rulemaking committee was established and met in early 2014. The committee failed to reach consensus. In July 2016, the Department issued draft regulations to establish new federal requirements for such eligibility.
The proposed regulations would establish new requirements to maintain state authorization for Title IV eligibility for distance education programs. Major provisions include, but are not limited to:
Requiring an institution offering distance education to have requisite state authority to offer such programs to state residents if required by the state;
Defining and recognizing acceptable state authorization reciprocity agreements;
Requiring institutions to document individualized state processes for resolving student complaints; and
Requiring an institution to provide extensive public and individualized disclosures to enrolled and prospective students regarding its programs offered solely through distance education, including information concerning adverse actions filed against the school by state entities or accrediting bodies.
As proposed, the regulations could be interpreted to allow individual states to impose new and diverse requirements on institutions and thereby reduce the regulatory and operational efficiency that our schools use in operating under the current State Authorization Reciprocity Agreement (“SARA”), which currently allows our Title IV eligible programs to operate in those states that have adopted SARA with only home state regulatory approval. States that have adopted SARA now constitute the majority of domestic jurisdictions.
Also as proposed, the regulations could be interpreted to require extensive new public disclosures based upon certain actions by accreditors and state entities, including state Attorneys General. Under some interpretations, the regulations could require disclosure to current and prospective students upon the mere filing of an adverse action and long after the initial action was resolved, even if resolved in favor of the institution.
The proposed regulations, if adopted, could result in significant potential risks for our business, since the precise regulatory scope and definitions for individualized state requirements and disclosures may be unclear or subject to interpretation in a manner that is adverse to us and not fully known or predictable in advance, and certain of the potential adverse consequences could arise from the mere commencement of adverse actions by government entities or accrediting bodies, even if these actions and claims ultimately are found to lack merit. Furthermore, the potential significant discretion vested in the Department to interpret and administer the regulations may result in unexpected outcomes that materially and adversely affect our business. In order to reduce the risk associated with these proposed regulations, if adopted, we may need to modify our administrative and other student-facing practices and procedures in a manner that materially increases our costs and reduces our administrative effectiveness.


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The effective date of the proposed regulations, if adopted, cannot be determined at this time, but the proposed regulations could be effective as early as July 1, 2017.
Financial Responsibility Composite Score
To participate in Title IV programs, the U.S. Department of Education regulations specify that an eligible institution of higher education must satisfy specific measures of financial responsibility prescribed by the Department, or post a letter of credit in favor of the Department and accept other conditions on its participation in Title IV programs. Pursuant to the Title IV program regulations, each eligible institution must satisfy a measure of financial responsibility that is based on a weighted average of the following three annual ratios which assess the financial condition of the institution:
Primary Reserve Ratio - measure of an institution’s financial viability and liquidity;
Equity Ratio - measure of an institution’s capital resources and its ability to borrow; and
Net Income Ratio - measure of an institution’s profitability.
These ratios provide three individual scores which are converted into a single composite score. The maximum composite score is 3.0. If an institution’s composite score is at least 1.5, it is considered financially responsible. If an institution’s composite score is less than 1.5 but is 1.0 or higher, it is still considered financially responsible, and the institution may continue to participate as a financially responsible institution for up to three years under the Department’s “zone” alternative. Under the zone alternative, the Department may subject the institution to various operating or other requirements, which may include being transferred from the “advance” method of payment of Title IV program funds to the heightened cash monitoring payment method under which the institution is required to make Title IV disbursements to eligible students and parents before it requests or receives funds from the Department for the amount of those disbursements, or being transferred to the more onerous reimbursement payment method under which an institution must submit to the Department documentation demonstrating the eligibility for each Title IV disbursement and wait for the Department’s approval before drawing down Title IV funds.
If an institution does not achieve a composite score of at least 1.0, it is subject to additional requirements in order to continue its participation in the Title IV programs, including submitting to the Department a letter of credit in an amount equal to at least ten percent, and at the Department’s discretion up to 50%, of the Title IV funds received by the institution during its most recently completed fiscal year, and being placed on provisional certification status, under which the institution must receive Department approval before implementing new locations or educational programs and comply with other restrictions, including reduced due process rights in subsequent proceedings before the Department.
In addition, under new regulations that took effect on July 1, 2016, institutions placed on either the heightened cash monitoring payment method or the reimbursement payment method must pay Title IV credit balances to students and parents before requesting Title IV funds from the Department and may not hold Title IV credit balances on behalf of students or parents, even if such balances are expected to be applied to future tuition payments.
The composite scores for Apollo Education Group and University of Phoenix, which are calculated as of the end of our fiscal year, were as follows for the indicated periods:
 
Fiscal Year
 
2016
 
2015
 
2014
Apollo Education Group
1.8
 
2.6
 
2.5
University of Phoenix
2.9
 
2.9
 
2.3
The decline in our fiscal year 2016 consolidated composite score was principally attributable to our decline in profitability, which included $73.4 million of goodwill impairment charges. Refer to Note 8, Goodwill and Intangibles, in Item 8, Financial Statements and Supplementary Data.
We believe that we may be able to take certain corrective measures to maintain composite scores of 1.5 or greater, if we determine that there is increased risk that our composite scores will fall below that level, depending on the circumstances causing the expected decline. However, such measures, if available, may require material modifications to our business and strategy that would adversely impact our future revenue and profitability and/or may involve the issuance of equity or equity-linked securities under challenging circumstances that could result in material dilution to our existing shareholders.


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U.S. Department of Education Program Participation Agreement
University of Phoenix’s Title IV Program Participation Agreement expired on December 31, 2012. The University has submitted necessary documentation for recertification and its eligibility continues on a month-to-month basis until the Department issues its decision on the application. We believe that the University’s application will be renewed in due course. However, we cannot predict whether or to what extent the continued challenging political and regulatory climate, our pending merger, and other recent developments in general relating to the proprietary education sector and our business may have on the timing or outcome of the recertification process.
In February 2016, the Department notified the University that for the duration of the month-to-month continuation of the University’s Program Participation Agreement, University of Phoenix must obtain from the Department prior approval of substantial changes, including (i) the establishment of additional locations, (ii) any increase in the level of academic offering beyond those listed in the Institution’s Eligibility and Certification Approval Report and (iii) the addition of any educational program (including degree, nondegree, or short-term training programs). Some of these substantial changes include changes that previously could be implemented by the University upon notice to the Department and without prior approval.
Continued Title IV program eligibility is critical to the operation of our business. If University of Phoenix becomes ineligible to participate in Title IV programs, or participation is materially limited, our business would be unsustainable.
Federal Trade Commission Investigation
In July 2015, we received a Civil Investigative Demand from the U.S. Federal Trade Commission (the “FTC”) relating to an investigation to determine if certain unnamed persons, partnerships, corporations, or others have engaged or are engaging in deceptive or unfair acts or practices in or affecting commerce in the advertising, marketing, or sale of secondary or postsecondary educational products or services or educational accreditation products or services. The Demand requires us to produce documents and information regarding a broad spectrum of the business and practices of University of Phoenix, including in respect of marketing, recruiting, enrollment, financial aid, tuition and fees, academic programs, academic advising, student retention, billing and debt collection, complaints, accreditation, training, military recruitment, and other compliance matters, for the time period of January 1, 2011 to the present. We are cooperating with the investigation. We cannot predict the eventual scope, duration or outcome of the investigation at this time.
Military Benefit Programs
U.S. Department of Defense Tuition Assistance Program
On January 15, 2016, University of Phoenix was notified by the U.S. Department of Defense (“DoD”) that the University’s probationary status in respect of its participation in the DoD Tuition Assistance Program for active duty military personnel had been lifted, effective immediately. The University had been placed on probation in October 2015 pending a review by the Department of the University’s compliance with the DoD Voluntary Education Partnership Memorandum of Understanding with the University, which is the basis on which the University’s active duty military students participate in the DoD Tuition Assistance Program.
The University will be subject to a heightened compliance review for a period of one-year following the removal of probationary status. During this period, the University will continue to engage with the DoD and complete the production of information and documents previously requested by the DoD. In addition, the University will be subject to an enhanced compliance review in fiscal year 2017.
In fiscal year 2016, funding under the DoD Tuition Assistance Program represented less than 1% of the University’s net revenue.
U.S. Department of Veterans Affairs Educational Benefits
University of Phoenix participates in the Department of Veterans Affairs educational benefits programs (“VA Programs”) for eligible veterans. Under these VA Programs, the educational locations serving veterans are subject to a compliance survey each year. Following the notice of probation in October 2015 from the Department of Defense, which has been subsequently lifted as described above, the Veterans Administration announced the commencement of the annual compliance survey, with an accelerated schedule and increased scope relative to prior years. The annual compliance review was completed with no adverse action imposed on the University. In fiscal year 2016, funding under VA Programs represented approximately 10% of University of Phoenix’s cash basis revenue, calculated on the same basis as for the 90/10 Rule.


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California Attorney General Investigations
In August 2015, we received an Investigative Subpoena from the Office of the Attorney General of the State of California. The Subpoena requires us to produce documents and information regarding the business and practices of University of Phoenix relating to members and former members of the U.S. military and California National Guard, including marketing, recruiting, billing, financial aid, accommodation and other services for military personnel, compliance with federal Executive Order 13607 (Establishing Principles of Excellence for Educational Institutions Serving Service Members, Veterans, Spouses, and Other Family Members), and use of U.S. military logos and emblems in marketing, for the time period of July 1, 2010 to the present.
In February 2016, we received a Second Investigative Subpoena from the Office of the Attorney General of the State of California in the Matter of the Investigation of For-Profit Educational Institutions, following the Investigative Subpoena we received in August 2015. The Second Investigative Subpoena, which is not limited to matters involving military students, seeks the production of documents and information regarding a broad spectrum of the business and practices of Apollo and its subsidiaries, including University of Phoenix, relating to marketing, recruiting, compensation of enrollment advisors, complaints, financial aid, compliance, accreditation, other governmental investigations, private litigation and other matters, as well as additional information relating to marketing and services to members and former members of the U.S. military and California National Guard, for the time period of July 1, 2010 to the present.
We are cooperating with the California Attorney General in these investigative proceedings. We cannot predict the eventual scope, duration or outcome of the investigations at this time.
Financial Aid Funding Levels
The most recent reauthorization of the Higher Education Act expired September 30, 2013, but Title IV student financial aid programs remain authorized and functioning. Congress continues to engage in discussion and activity regarding Higher Education Act reauthorization, but the timing and terms of any eventual reauthorization cannot be predicted.
Title IV program funding is a potential target for reduction by Congress. Because the majority of our revenue is derived from Title IV programs, any action by Congress that reduces Title IV program funding, or which alters the eligibility of our institutions or students to participate in Title IV programs could have a material adverse effect on our enrollment and financial condition. Action by Congress or federal agencies could also require us to modify our practices in ways that increase our operating costs.
In addition to possible reductions in Title IV program funding, military benefit programs may be reduced as military branches address decreased funding. Reductions and/or changes in military benefit programs, or changes in our eligibility to participate in such programs, could result in increased student borrowing, decreased enrollment and adverse impacts on our 90/10 Rule percentage.
Expansion of Global Operations
We have operations on six continents and recently expanded our global operations through the acquisition of Career Partner in the second quarter of fiscal year 2016 as discussed in Other Events below. The integration and operation of acquired businesses in foreign jurisdictions entails substantial regulatory, market and execution risks and, consistent with our experience to date, such acquisitions may not be accretive for an extended period of time. Furthermore, there has been increased focus in recent years on educational institutions in certain of the countries in which we operate.
In mid-October 2016, Apollo Global’s two primary registered training organizations in Australia, Open Colleges Pty Ltd., and Integrated Care & Management Training, Pty Ltd., each received a notice of noncompliance and intention to make a decision to impose sanctions from the Australian Skills Quality Authority (“ASQA”), the national regulator of vocational education programs. The notice, which followed a recent compliance audit, identified several alleged compliance deficiencies and stated that ASQA intended to make a decision on whether to impose sanctions on the institutions which could include cancellation of registration or imposition of lesser sanctions. One of the findings involves a change in the interpretation of applicable course requirements and will require changes in our procedures for student workplace skills assessments used in connection with courses that represent a substantial portion of the Open Colleges institutions’ enrollment.
Implementing an updated workplace skills assessment model in order to address ASQA’s concerns will require operational changes for these institutions and increase operating costs, perhaps substantially, and could have competitive implications.


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We have until November 7, 2016 to respond to this notice of noncompliance. We cannot currently predict the timing or ultimate outcome of this matter. See Part I, Item 1A, Risk Factors - Risks Related to the Highly Regulated Industry in Which We Operate - Changes by a regulator in the interpretation of applicable course requirements could materially impact our Open Colleges business in Australia.
Professional Development and Other Nondegree Programs
Although degree programs represent the substantial majority of our revenue, we have increased our professional development and other nondegree programs, which includes business-to-business product and service offerings, and immersive bootcamp programs in various locations in the U.S. We are focused on expanding these programs both domestically and internationally through our subsidiaries.
Other Events
In addition to the above items, we experienced the following other events during fiscal year 2016:
Executive Management Changes - Gregory J. Iverson was appointed as our Chief Financial Officer effective October 26, 2015 replacing Joseph L. D’Amico, who served as our Interim Chief Financial Officer since May 2015.
Career Partner GmbH Acquisition - On December 10, 2015, we acquired all of the outstanding shares of Career Partner GmbH (“Career Partner”), a provider of education and training programs in Germany. Refer to Note 4, Acquisitions, in Item 8, Financial Statements and Supplementary Data.
Critical Accounting Policies and Estimates
Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements in accordance with GAAP requires management to make certain estimates, assumptions and judgments that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Although we believe our estimates, assumptions and judgments are reasonable, actual results may differ from our estimates under different assumptions, judgments or conditions.
Our significant accounting policies, which are detailed in Note 1, Nature of Operations and Significant Accounting Policies, in Item 8, Financial Statements and Supplementary Data, describe the significant accounting policies and methods used in the preparation of our consolidated financial statements. Of our significant accounting policies, we consider the following policies to be critical as they involve a higher degree of subjective or complex judgments and assumptions, often as a result of the need to make estimates about the effect of inherently uncertain matters: (i) Revenue Recognition, (ii) Allowance for Doubtful Accounts, (iii) Goodwill and Intangibles, (iv) Other Long-Lived Asset Impairments, (v) Restructuring and Impairment Charges, (vi) Loss Contingencies, and (vii) Income Taxes.
Revenue Recognition
Substantially all of our net revenue is composed of tuition and fees from educational programs that range in length from one-day seminars to degree and nondegree programs lasting multiple years. University of Phoenix generated the substantial majority of our consolidated net revenue, and substantially all of the University’s net revenue is generated from degree programs. University of Phoenix students fund their education through loans and/or grants from U.S. federal financial aid programs established by Title IV of the Higher Education Act and regulations promulgated thereunder (“Title IV”), military benefit programs, tuition assistance from their employers, or personal funds.
Our net revenue generally varies from period to period based on several factors, including the aggregate number of students attending educational programs, the number of programs or classes held during the period, and the tuition price per program. The following summarizes our net revenue for the respective periods:
 
Year Ended August 31,
($ in thousands)
2016
 
2015
 
2014
Tuition and educational services(1)
$
2,147,029

 
102
 %
 
$
2,646,447

 
103
 %
 
$
3,030,064

 
101
 %
Educational materials
186,240

 
9
 %
 
224,434

 
9
 %
 
219,085

 
7
 %
Other
35,564

 
2
 %
 
21,045

 
1
 %
 
22,715

 
1
 %
Gross revenue
2,368,833

 
113
 %
 
2,891,926

 
113
 %
 
3,271,864

 
109
 %
Discounts
(266,983
)
 
(13
)%
 
(325,649
)
 
(13
)%
 
(274,999
)
 
(9
)%
Net revenue
$
2,101,850

 
100
 %
 
$
2,566,277

 
100
 %
 
$
2,996,865

 
100
 %
(1) Tuition and educational services revenue includes $17.4 million, $24.2 million and $32.3 million of tuition benefits for our employees and their eligible dependents during fiscal years 2016, 2015 and 2014, respectively. Such benefits are also included in instructional and student advisory expenses.


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We recognize revenue when persuasive evidence of an arrangement exists, services have been rendered or delivery has occurred, our fee or price to the customer is fixed or determinable, and collectibility is reasonably assured.
Tuition and educational services encompasses all educational delivery modes (i.e., online, on-ground, etc.), and we recognize revenue over the period of instruction as services are delivered to students, which may vary depending on the program structure.
Under University of Phoenix’s non-term academic delivery model, students generally enroll in a program of study encompassing a series of five- to nine-week courses taken consecutively over the length of the program. Students are billed separately for each course when the student first attends a course, resulting in the recording of a receivable from the student and deferred revenue in the amount of the billing. The University generally recognizes revenue evenly over the period of instruction (e.g., five weeks for a five-week course) as services are delivered to the student. For students who participate in the University’s risk-free, three-week program during their first credit-bearing course, the University does not recognize revenue for the risk-free period until students decide to continue beyond the risk-free period, which is when the tuition and fees become fixed and determinable.
University of Phoenix’s refund policy permits students who attend 60% or less of a course to be eligible for a refund for the portion of the course they did not attend. Accordingly, the University ceases revenue recognition for the remainder of a course if a student withdraws prior to the tuition refund period elapsing, and refunds result in a reduction of deferred revenue in the period that a student withdraws. This refund policy applies to students in most, but not all states, as some states require different policies. Additionally, the University reassesses collectibility throughout the period revenue is recognized when there are changes in facts or circumstances that indicate collectibility is no longer reasonably assured, including when the University determines that a student has withdrawn.
Tuition revenue for our Apollo Global operations is generally recognized over the length of the course and/or program. However, we recognize revenue associated with certain online programs, including Open Colleges’ offerings and certain programs at Career Partner, over the contractual period, or the period of time it takes students to complete their program, if shorter. As a result, revenue recognition for such programs generally extends beyond one year.
Educational materials encompasses online course materials delivered to students over the period of instruction, and various textbooks and other learning materials. We recognize revenue associated with online materials over the period of the related course to correspond with delivery of the materials to students. We recognize revenue for other educational materials when they have been delivered to and accepted by students or other customers.
Other includes non-tuition revenues such as fees students pay when submitting an enrollment application.
Discounts represent institutional scholarships, grants and promotions. This includes reductions in charges for tuition or other fees from our standard rates typically provided to military, corporate and other employer students. Discounts are generally recognized over the period of instruction in the same manner as the related revenue to which the discount relates.
University of Phoenix offers scholarship programs designed to improve the value proposition for students by providing the opportunity to earn increased tuition discounts as they progress in their programs. We estimate the amount of these future discounts based on our historical experience with student persistence and recognize the associated amount either over the period the discount is earned by the student or when the student is no longer eligible, as applicable. As of August 31, 2016 and 2015, we had $43.3 million and $44.7 million, respectively, of student discounts, grants and scholarships liabilities on our Consolidated Balance Sheets, the substantial majority of which represents the estimated amount of future discounts associated with these programs. We routinely evaluate our estimation methodology for these programs and modify them as necessary.
Sales and other indirect taxes collected from students and remitted to governmental authorities are excluded from net revenue. Collected but unremitted sales and other indirect taxes are included as a liability on our Consolidated Balance Sheets and are not material to our consolidated financial statements.
Allowance for Doubtful Accounts
We reduce our accounts receivable by an allowance for amounts that we expect to be uncollectible. We use estimates that are subjective and require judgment in determining the allowance for doubtful accounts, and estimates may vary depending on the institution or educational program that generated the accounts receivable. In general, our estimates are based on historical collection experience and write-offs, the aging of our receivables, and current trends. Our accounts receivable are written off once the account is deemed to be uncollectible, which typically occurs after outside collection agencies have pursued collection for approximately six months.


Apollo Education Group, Inc. | 2016 Form 10-K | 62


For our Title IV eligible institutions, program participation rules determine if we are required to return a portion of the funds to the U.S. Department of Education when a student with Title IV program funds withdraws. We are then entitled to collect these funds from the students, but collection rates for these types of receivables are significantly lower than our collection rates for receivables from students who remain in our educational programs.
We estimate our allowance for doubtful accounts for University of Phoenix’s receivables by considering a number of factors that we believe impact whether receivables will become uncollectible based on our collections experience. These factors include, but are not limited to, the student’s academic performance and previous college experience, as well as other student characteristics such as credit hours earned and method of payment. We also monitor and consider external factors such as changes in the economic and regulatory environment.
As of August 31, 2016, accounts receivable at our Apollo Global institutions represented approximately 50% of our consolidated gross accounts receivable. Our Apollo Global institutions estimate their respective allowance for doubtful accounts primarily based on historical collection experience and the aging of their receivables.
We routinely evaluate our estimation methodologies for all our institutions and educational programs for adequacy and modify them as necessary. In doing so, we believe our allowance for doubtful accounts reflects the amount of receivables that will become uncollectible by considering our most recent collections experience, changes in trends and other relevant facts.
We recorded bad debt expense of $55.9 million, $59.2 million and $53.8 million during fiscal years 2016, 2015 and 2014, respectively. Our allowance for doubtful accounts was $48.7 million and $42.3 million as of August 31, 2016 and 2015, respectively, which approximated 19% and 18% of gross student receivables as of the respective dates. For the purpose of sensitivity:
A one percent change in our allowance for doubtful accounts as a percentage of gross student receivables as of August 31, 2016 would have resulted in a pre-tax change in income of $2.6 million; and
If our bad debt expense were to change by one percent of net revenue for the fiscal year ended August 31, 2016, we would have recorded a pre-tax change in income of approximately $21.0 million.
Goodwill and Intangibles
Goodwill represents the excess of the purchase price of an acquired business over the amount assigned to the assets acquired and liabilities assumed. We allocate assets acquired, including goodwill, and liabilities assumed in business combinations to our respective reporting units. We identify our reporting units by assessing whether the components of our operating segments constitute businesses for which discrete financial information is available and segment management regularly reviews the operating results of those components.
Our intangibles principally consist of trademarks, regulatory accreditations and designations, and course curriculum. We assign indefinite lives to intangibles that we believe have the continued ability to generate cash flows indefinitely; have no legal, regulatory, contractual, economic or other factors limiting the useful life of the respective intangible; and we intend to renew the respective intangible, as applicable, and renewal can be accomplished at little cost.
Finite-lived intangibles are amortized on either a straight-line basis or using an accelerated method to reflect the pattern in which the economic benefits of the asset are expected to be consumed. The weighted average original useful life of our $40.5 million of finite-lived intangibles as of August 31, 2016 was 6.7 years.
We assess goodwill and indefinite-lived intangibles for impairment annually, or more frequently if events occur or circumstances change between annual tests that would more likely than not reduce the fair value of the respective reporting unit or indefinite-lived intangible below its carrying amount. We perform our annual indefinite-lived intangibles impairment tests on the same dates that we perform our annual goodwill impairment tests for the respective reporting units. In performing our impairment tests, we first consider the option to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit or intangible, as applicable, is less than its carrying amount. If we conclude that it is more likely than not that the fair value is less than the carrying amount based on our qualitative assessment, or that a qualitative assessment should not be performed, we proceed with the following quantitative impairment tests:
Goodwill - We compare the estimated fair value of the reporting unit to the carrying value of its net assets. If the fair value of the reporting unit exceeds the carrying value of the net assets of the reporting unit, goodwill is not impaired. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, we perform a hypothetical purchase price allocation to determine the implied fair value of the goodwill and compare it to the carrying value of the goodwill. An impairment loss is recognized to the extent the implied fair value of the goodwill is less than the carrying amount of the goodwill.
Indefinite-lived intangibles - We compare the estimated fair value of the intangible with its carrying value. If the carrying value of the intangible exceeds its fair value, an impairment loss is recognized in the amount of that excess.


Apollo Education Group, Inc. | 2016 Form 10-K | 63


Our goodwill and indefinite-lived intangibles for our reporting units within our reportable segments are summarized below:
($ in thousands)
Annual
Impairment
Test Date
 
Goodwill
as of August 31,
 
Indefinite-lived Intangibles
as of August 31,
2016
 
2015
2016
 
2015
University of Phoenix
May 31
 
$

 
$
71,812

 
$

 
$

Apollo Global(1):
 
 
 

 
 

 
 

 
 

Open Colleges
July 1
 
109,002

 
103,002

 

 

Career Partner
July 1
 
94,493

 

 
59,632

 

BPP
July 1
 

 

 
71,553

 
84,401

Milpark Education
July 1
 
16,156

 
17,760

 
5,129

 
5,638

FAEL
July 1
 
11,421

 
10,401

 
11,912

 
10,849

ULA
May 31
 
10,429

 
11,436

 
1,674

 
1,835

UNIACC
May 31
 

 

 
713

 
665

Other:
 
 
 

 
 

 
 

 
 

The Iron Yard
July 1
 
15,888

 
15,888

 

 

College for Financial Planning
August 31
 
15,310

 
15,310

 

 

Western International University
May 31
 

 
1,581

 

 

Total
 
 
$
272,699

 
$
247,190

 
$
150,613

 
$
103,388

(1) The functional currencies of our foreign subsidiaries are generally the local currencies. Accordingly, the goodwill and intangibles of our foreign subsidiaries are adjusted for translation into U.S. dollars using exchange rates in effect at the balance sheet dates. The balances will change in the future as a result of foreign currency translation adjustments.
The process of evaluating goodwill and indefinite-lived intangibles for impairment is subjective and requires significant judgment at many points during the analysis. If we elect to perform an optional qualitative analysis, we consider many factors including, but not limited to, general economic conditions, industry and market conditions, financial performance and key business drivers, long-term operating plans, and potential changes to significant assumptions used in the most recent fair value analysis for either the reporting unit or respective intangible.
When performing a quantitative goodwill or indefinite-lived intangibles impairment test, we generally determine fair value using an income-based approach, a market-based approach or a combination of both methods. The fair value determination consists primarily of using significant unobservable inputs (Level 3) under the fair value measurement standards. We believe the most critical assumptions and estimates in determining the estimated fair value of our reporting units or indefinite-lived intangibles include, but are not limited to, the amounts and timing of expected future cash flows, the discount rate applied to those cash flows, terminal growth rates, selection of comparable market multiples, assumed control premiums and applying weighting factors when multiple valuation methods are used. The assumptions used in determining our expected future cash flows consider various factors such as historical operating trends and long-term operating strategies and initiatives. The discount rate used by each reporting unit is based on our assumption of a prudent investor’s required rate of return of assuming the risk of investing in a particular company in a specific country. The terminal growth rate reflects the sustainable operating income a reporting unit could generate in a perpetual state as a function of revenue growth, inflation and future margin expectations.
Fiscal Year 2016 Impairment Testing
Our market capitalization declined significantly during the first quarter of fiscal year 2016 after we reported our fourth quarter fiscal year 2015 results and our business outlook for fiscal year 2016. We believe the decline in the first quarter of fiscal year 2016 was attributable to University of Phoenix’s lower enrollment, increasing risk associated with the proprietary education sector, and uncertainty associated with its strategy to transform into a more focused, higher retaining and less complex institution. Additionally, some of the initiatives associated with the University’s new strategy have accelerated the enrollment decline at the University and negatively impacted its cash flows in the short-term. Based on the decline in market capitalization, we performed an interim goodwill impairment analysis for University of Phoenix in the first quarter of fiscal year 2016.
University of Phoenix represents the substantial majority of our consolidated operating results and, as discussed above, we believe our market capitalization decline in the first quarter of fiscal year 2016 was attributable to the University. Accordingly, we estimated the fair value of our University of Phoenix reporting unit using a market-based valuation approach, which incorporated assumptions that we believe would be a reasonable market participant’s view of the increased risk and uncertainty associated with the University and its expected future cash flows. The market-based approach included multiples derived from


Apollo Education Group, Inc. | 2016 Form 10-K