Regulatory Matters

All U.S. federal student financial aid programs are established by Title IV of the Higher Education Act and regulations promulgated thereunder. 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 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 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.

Additionally, 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 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. The outcome of this matter is uncertain at this point and, based on the information available to us at present, we have not accrued any liability associated with this matter.

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 take 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
	2015	2014	2013
Apollo Education Group	2.6	2.5	2.6
University of Phoenix	2.9	2.3	2.5

As discussed in Note 7, Goodwill and Intangibles, in Item 1, Financial Statements, we recorded $73.4 million of goodwill impairment charges relating to our University of Phoenix and Western International University reporting units during the first quarter of fiscal year 2016, which was primarily the result of a substantial decline in our market capitalization. These impairment charges increase our fiscal year 2016 total operating expenses, which will negatively impact our fiscal year 2016 composite scores to be calculated as of August 31, 2016. If our profitability declines further than expected, including as a result of additional goodwill impairment charges, which could result from further declines in our market capitalization, higher than expected restructuring charges, our inability to execute on our currently planned cost reduction initiatives, a more than anticipated decline in enrollment, or other unexpected changes or developments, our fiscal year 2016 composite scores could fall below 1.5.

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 fiscal year 2016 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:


•	Our principal revolving credit facility, which expires in April 2017, requires that we maintain a composite score of at least 1.5. If our composite score falls below 1.5, it would be an event of default under the facility and any outstanding balance could be declared immediately due and payable.

•

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 and our revolving credit facility would not be available for this purpose.

•

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.

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.

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 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 discretionary earnings. If a program fails to meet either minimum ratio 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 debt service-to-earnings ratios for the next award year. Programs that fail to meet either of the minimum ratios for two out of three consecutive years will immediately cease to be Title IV eligible for a period of at least three years.

The Department has indicated that the official 2014 gainful employment debt service-to-earnings ratios will be issued sometime during calendar year 2016. The expected timing of the issuance of the 2015 ratios has not yet been announced. We believe it is likely that some of University of Phoenix’s programs will be impacted by the regulations. However, the University ceased enrolling new students in many of the 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, 2015, students in these programs that ceased enrolling new students represented approximately 10% of the University’s Degreed Enrollment. Students who were already enrolled in such programs, and who do not elect to enroll in a different University of Phoenix program, will be 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 protocol for calculating and disseminating the debt service-to-earnings ratios. Because the ratios will be issued by the Department after the measuring period, we may not know of a program’s failure to meet the tests until well after the measuring period, and students enrolled in such a program could lose their access to federal financial aid before completing the program.

Higher Learning Commission Accreditation

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 Title IV programs (in combination with state higher education operating and degree granting authority); and


•	Qualification for authority to operate in certain states.

In July 2013, the accreditation of University of Phoenix was reaffirmed by HLC 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.

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 Department and complete the production of information and documents previously requested by the Department. In addition, the University will be subject to an enhanced compliance review in fiscal year 2017.

In fiscal year 2015, 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 2015, 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.