Apollo Education Group's (APOL) CEO Greg Cappelli on Q3 2015 Results - Earnings Call Transcript

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Apollo Education Group, Inc. (NASDAQ:APOL) Q3 2015 Results Earnings Conference Call June 29, 2015 5:00 PM ET

Executives

Beth Coronelli - Vice President of Investor Relations

Greg Cappelli - Chief Executive Officer

Joseph D’Amico - Interim Chief Financial Officer

Greg Iverson - Chief Accounting Officer

Analysts

Corey Greendale - First Analysis

Denny Galindo - Morgan Stanley

Sara Gubins - Bank of America Merrill Lynch

Paul Ginocchio - Deutsche Bank

Peter Appert - Piper Jaffray

Phil Stiller - Citi

Michael Tarkan - Compass Point

Jeff Mueller - Robert W. Baird

Jeff Silber - BMO Capital Markets

Operator

Good afternoon. My name is Eric and I will be your conference operator today. At this time I would like to welcome everyone to the third quarter Apollo Earnings Conference Call. [Operator Instructions] I will now turn the call over to Beth Coronelli, Vice President of Investor Relations. Ms. Coronelli, please go ahead.

Beth Coronelli

Thank you for joining us. Participating on the call are Greg Cappelli, Chief Executive Officer of Apollo Education Group; and Joe D’Amico, Interim CFO here at Apollo. As we discuss our results today, unless noted otherwise, we will be comparing third quarter FY '15 to the third quarter FY '14.

I'd also like to remind you that the conference call contains forward-looking statements with respect to the future performance and financial condition of Apollo Education Group that involves risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in our quarterly reports on Form 10-K filed with the SEC, which is available on the Web site. The company disclaims any obligation to update any forward-looking statements made during this call.

Additionally, we may refer to non-GAAP measures which are intended to supplement but not a substitute for the most directly comparable GAAP measures. Our press release, available on our Web site, contains the financial and other quantitative information to be discussed today as well as a reconciliation of GAAP to non-GAAP measures.

I will now turn the call over to Greg.

Greg Cappelli

All right. Thank you, Beth. Good afternoon, everyone. Thanks for taking the time to participate in our conference call today. I will first, what I am going to do is turn the call over to Joe D’Amico, our Interim CFO, to review third quarter financial results with color around the key operating metrics and then I would like to talk to the next phase of our transformative strategic plan on which we are about to embark in University of Phoenix, our primary asset.

I will also briefly update you on the Apollo Global, or on Apollo Global, where we are going to continue to growth the top line in excess of 20% as well as our professional development division, where we just completed an investment in one of the leading IT bootcamps in the nation. And then I will close with a discussion on our outlook and then we will take Q&A.

Joe, welcome back and let's begin with your review.

Joseph D’Amico

Thank you, Greg and good afternoon everyone. It's actually great to back at Apollo, working closely with you and all the talented people throughout the organization. Excuse me, I have a cold, I will try to get through it.

To quickly recap our consolidated third quarter results. Revenue decreased 14% year-over-year to $682 million, below the lower end of the outlook of $690 million we provided in our second quarter call mostly due to lower retention and new enrollments which were slightly below our expectations. Operating income was $91 million, down 22% year-over-year and net income from continuing operations was $48 million or $0.44 per share.

Excluding special items, operating income was $102 million and net income from continuing operations was $58 million or $0.53 per share. Operating income was above the top end of our outlook range of $95 million as a result of our efforts to appropriately align our cost base with our revenues. Focusing on the University of Phoenix, revenue in the third quarter was $561 million, with operating income of $103 million. We enrolled 29,400 new students in the third quarter, down 13.3%, with total degree enrollments of 206,900, a decrease of 14.5% year-over-year.

Third quarter revenue per student or RPS, was down 4.6% year-over-year comparable to the second quarter and in line with our expectations. RPS for the fourth quarter is expected to be flat on a year-over-year basis. Discounts in the third quarter were 12.7% of revenue. They trended higher year-over-year, about a percentage point above our expectations with an increase in students accepting retention based scholarships.

We continue to expect discounts as a percentage of revenue for the full year to be approximately 12%. In the third quarter, University of Phoenix operating margin was 18.3% or 19.4% excluding special items, compared to 21.2% in the third quarter of 2014.

Moving on to Apollo Global. Third quarter revenue was $110 million, an increase of 9% year-over-year. The year-over-year growth rate on a constant currency basis would have been over 20%. In the third quarter, Apollo Global's operating income was $6 million, comparable to a loss of $14 million in the third quarter of 2014. Adjusting for depreciation in special items, it was $14 million in the fourth quarter. Apollo Global results were in line with our expectations and we continue to anticipate Global will be cash flow breakeven for fiscal 2015.

Turning now to our operating expenses. In the third quarter, total operating expenses excluding special items decreased approximately $74 million or 11% year-over-year, primarily as a result of lower enrollments as well a continued reduction of our cost base. Based on our actions taken to date, we have decreased our operating expense run rate when compared to fiscal 2014 by at least $200 million on an annualized basis.

With respect to the consolidated balance sheet and cash flows, at quarter end, our current cash and marketable securities were approximately $778 million and our outstanding debt was $55 million. Free cash flow for the quarter was $38 million.

Now I would like to spend a minute on our business outlook for the year. Based upon our current view, our range for fiscal 2015 is as follows. Net revenue of $2.6 billion to $2.62 billion, a decrease from our prior range of $2.63 billion to $2.68 billion. An operating income excluding special items of $190 million to $200 million, compared to our prior range of $200 million to $230 million. Again, we decreased our outlook due to lower anticipated retention and enrollment.

Excluding the impact of special items and potential release of uncertain tax position, we anticipate our rate to be about 43% for the full fiscal year 2015. We anticipate the University of Phoenix will end fiscal year 2015 with roughly 195,000 to 200,000 students.

In the fourth quarter, we continue to expect the absolute number of students to be about the same as the third quarter. It's important to note the fourth quarter of 2014 had stronger relative performance and therefore has created a more difficult comp. Greg will provide additional color on our outlook for fiscal 2016 and beyond as he closes the call. And with that, I will turn the call back over to you, Greg.

Greg Cappelli

All right. Thanks, Joe and I am sorry, we didn’t note earlier, we are also joined by Greg Iverson, our Chief Accounting Officer. He will be with us for the Q&A portion, so welcome Greg.

And with that as a backdrop, now I would like to spend time walking you through some additional elements of the strategy that University of Phoenix President, Tim Slottow and his team have spend significant time on working on this year.

The next phase of the plan solves issues that have been plaguing University of Phoenix, frankly since the inception of Axia College back in 2004. At that time the domestic higher education industry, particularly the for profit sector, was consistently growing in the double digits with significant growth and online delivery. Pricing power was strong, consistently at 5% or more. The regulatory environment, well, certainly never to be taken lightly, was significantly less complex than today. And the political climate was neutral for this sector.

So today all that’s obviously changed. Working learners have many more choices and competition for online students has increased dramatically. In 2010, our sector received a wakeup call in the regulatory front with a relentless pounding of the issues focused on reigning in any bad actors. Some of the criticism of the industry was well founded and some perhaps not as much. But nevertheless, it because absolute clearly to us that only those institutions willing to be leaders in the areas of regulatory compliance and transparency, those willing to put students first above all other priorities would have the opportunity to continue at that point to serve in the U.S. higher education system.

We met with and listened to many many key Congressional members in both the House and Senate, state regulators, attorneys general, leaders within the Department of Ed and The White House. We listened, we learned and we reacted with speed and vigor. We met with the challenges head on and the reforms we instituted were significant and lasting on many levels. And I just want to name a few of the actions that we took.

Beginning in November 2010 we were one of the first organizations to change recruiter comp, well before it was mandated. We implemented responsible borrowing tools and calculators beginning in the spring of 2011 to make the cost of college transparent to perspective students and to encourage students to make smart financial choices. We were among the first to put early surveillance systems in place to stop any attempted financial aid fraud schemes. We implemented student orientation in the fall of 2010 which we made mandatory as a three-week program for freshmen to help them better understand the rigors of our program before we allowed them to enroll or take on financial aid. And we built upon that, on what we learned around orientation, in 2014 introducing a risk-free period for incoming freshmen.

We rolled our new career tools beginning in 2013 to directly connect education to careers. Now, I mentioned some of these things because while they were clearly appropriate, there is no doubt these initiatives also took a toll on our operating and financial performance during the period. A period where the reputation of University of Phoenix was tarred by the broader environment and damaged in the public eye.

Looking over the landscape today, there are multiple examples of educational institutions either in serious jeopardy or literally going out of business. It's clear how important it was to take the bold steps we did, which allows us to be a more respected institution today. It's the bedrock in the foundation that needed to be put in place first, even prior to instituting our strategic plan for University of Phoenix that will eventually get us back to growth.

We have dramatically lowered our student cohort default rate from almost 30% several years back to now below the entire industry average. Over the last couple of years, we have seen some improvement from time to time in retention but clearly we are not satisfied with the results which have been below our expectations and the standards to which we hold ourselves accountable. As a result, collectively, we are doing a deeper strategic review and taking more dramatic steps.

Improving student outcomes including graduation rates is our top priority. It's the right thing to do for students. It's critical for our reputation and should also result in a superior economic model for shareholders. The University of Phoenix with support from Apollo has reviewed and studied numerous options around improving retention and completion rates. Going forward, in conjunction with our new college operating model we have discussed in the prior quarters, the University is preparing to take immediate action.

Let me highlight several key areas and then I will go into detail for each one. But they include, incorporating diagnostics and admissions criteria on student pathways back into the University. Retiring certain associate degree programs with low retention rates. Further refining our campus strategy to focus on major metro markets. Moving away from the complexity of starting students weekly. Moving away from proprietary and legacy IT systems. Driving self-service to enhance experience and efficiency.

First and probably most impactful of those, we are developing the front-end diagnostics and admissions criteria for newly entering students. And this is intended to help ensure that prospective students are better prepared for the rigors of undertaking a college degree program in University of Phoenix and will therefore complete their programs at a higher rate. We will also help provide additional pathway opportunities to these students, if necessary, prior to enrolling them into the university.

The implementation of diagnostics and admissions criteria will have a negative impact on enrollment in the near-term. But we fully expect retention improvement over time from this initiative as we ensure we are enrolling students best prepared to succeed in our rigorous programs. This will also help existing students receive a higher overall quality experience within our classrooms.

Second. We plan to retire certain associate degree programs that were primarily developed for the Axia model over a decade ago which have lower retention rates and from a financial standpoint, actually inferior returns on capital. These will be replaced with stronger, more career focused pathways that offer certificates and four-year bachelor's degrees in key growth areas of the market.

Third. The university is analyzing our campus footprint around the country and ensuring we place our focus and investment into fewer markets where we can continue to have a strong regional presence, while still keeping a national but more refined presence throughout the country. While this will allow us to operate in a more efficient manner, we also see opportunities to invest in the areas of hybrid or blended learning offerings which we have had success in internationally. This allows for deeper engagement at the local level with major employers, as well as nonprofit organizations to enhance opportunities for our students, faculty and alumni.

Fourth. We will be consolidating start dates, moving away from starting new cohorts every week at University of Phoenix. And while this may impact the timing around new enrollments, it's expected to reduce complexity and cost with the focus on increasing student satisfaction. This will also provide increased time to prepare incoming students, allows for more effective class sizes as well as improved faculty scheduling.

We have also recently implemented best practices and sophisticated workforce management tools and processes to better balance workloads and increase the productivity of our enrollment teams across the University, leading to better student service, increase operational efficiency and cost savings.

Fifth. We plan to move away from certain proprietary and legacy IT systems to more efficiently meet student and organizational needs over time. This means transitioning an increased portion of our technology portfolio to commercial software providers, allowing us to focus more of our time and investment on educating and student outcomes. While Apollo was among the first to design an online classroom and supporting system, in today's world it's simply not as efficient to continue to support complicated, custom-designed systems particularly with the newer quality systems we have more recently found with of the self providers that now exist within the marketplace. This is expected to reduce costs over the long term, increase operational efficiency and effectiveness while still very much supporting a strong student experience.

And finally, the University is in the process of developing enhanced capabilities in the areas of student self-service, including financial aid, academic planning, scheduling and the application process. This is also focused on improving the student experience and supporting our strategic objective to drive operational excellence. We will begin rolling out a number of these self-service capabilities later this year. While there is more work to do, significant progress is already being made to refocus University of Phoenix to best meet the needs of the marketplace.

This approach was designed to help the University continue to differentiate and to more tightly focus on student outcomes. Performance and accountability for each individual college within the University. We believe the initiatives I just reviewed in conjunction with the college-based approach will help the University of Phoenix to strive to earn again its reputation as the most trusted provider of career relevant higher education for working adults in the country.

Before I move on to the broader outlook, let me just quickly touch on Apollo Global where we are working to, one, deliver world-class experiences and outcomes for students and employers; two, expand our footprint as well as accelerate our organic growth, building a network leveraging our global presence and sharing best practices and to improve operational efficiency and effectiveness. At Global we anticipate revenues of about $400 million in 2015. Our goal is to grow revenues over the next five years by 20% annually on a constant currency basis. We are pleased with this segment of our business and look forward to continue to diversify our overall revenue mix.

You will notice that we begin providing enhanced metrics for Global earlier this year and we will continue to try and provide ways for you to appropriately analyze and value this important segment for Apollo. As Joe said, Global will be cash flow breakeven this year and we expect to be GAAP profitable in fiscal year '17.

The third key area of our business is our newest division, professional development, and I just want to touch on it briefly. This provides significant opportunities for Apollo supporting our strategy to diversify beyond reliance of Title IV funding and really essential to our plan to develop employer friendly, focused solutions that provide the link between education and talent development. We have recruited some impressive talent in this division. We continue to meet with Fortune 500 companies all over the country to ensure that we are building educational programs that are relevant to their training needs. We will be providing more information on this division in the coming quarters.

I just want to quickly highlight our recent investment in The Iron Yard, which is a leader in IT coding education. There is an increasing worldwide demand for highly qualified individuals with technology skills and The Iron Yard responds directly to this market need. With their proven immersive three-month training programs in software development and design, combined with our current IT bootcamps through RockIT, we intend to expand a new domestic and international market. This strongly supports our approach to provide programs to help students achieve their career and business goals in both degree and non-degree granting programs and to provide employers with the skilled individuals they need to grow.

To close, I would like to share some thoughts on our broader outlook. The actions we are announcing today will undoubtedly put pressure on our new student enrollment, revenue and operating margin in fiscal year '16. But we also firmly believe that with these actions we will begin to see improvement in retention and graduation rates at a higher level, a better student experience and ultimately improvement to the University's reputation.

It should also result in a better economic model for our shareholders over time. To offset this initial decline in enrollment we plan to take aggressive cost actions to align our costs with revenue until retention begins to improve, driving our operating margins back to the 15%-20% range over the next three to five years. I know there will be questions around the details. We wanted to tell you as early as possible about where we are headed, however it's early in the process of building out our fiscal year '16 budget and financial plan. Let me tell you what I am able to share with you today.

We are initially modeling about 150,000 total students at the end of fiscal '16. That’s about 50,000 students less than fiscal year '15 which we then expect to stabilize in '17 and grow thereafter. We are working now on identifying all areas of our cost base which we believe should allow us to reach a minimum of $150 million in operating profit in fiscal year '16. Again, a lots going to depend on how quickly we see results from implementing our front-end diagnostics and new entrance requirements. We are building in some but not a substantial amount of retention improvement in fiscal year '16. We do expect to see retention kick in more starting in fiscal year '17 and beyond.

And with respect to pricing, we are assuming it remains flat for modeling purposes throughout this period. On the Apollo Global front, there is nothing we see from a structural standpoint that won't allow it keep growing and also achieve margins in the 15% to 20% range over time.

Finally, I would like to quickly address our capital position. We are mindful that we have a significant amount of cash in the balance sheet available for use. I want to assure you that we regularly discuss the appropriate uses of our capital with our board. We care deeply about the long term returns on this capital. We are obviously going through a period of transformation where there is a higher than normal volatility within our sector and our company. And we will always look for the best uses of capital to drive long-term shareholder value.

I look forward to your questions and operator, if we could begin the Q&A. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Corey Greendale with First Analysis. Your line is open.

Corey Greendale

Greg, I realize that you're still mid-planning so I'm just going to try a couple of things here. First of all, pricing. Part of all of the noise in the sector has been that students I think have become more debt sensitive, more price sensitive. It sounds like price is not, at this point, one of the levers that you're talking about moving meaningfully for next year. Can you just talk about how much price may be on the table and why you're not thinking about moving that more?

Greg Cappelli

Sure. So on the new college operating model, every executive dean is looking at their markets from a competitive standpoint and they are advising on whether they need to increase, decrease, keep price the same. We no longer look at that across the board and decide on a price increase, right, for the entire university because all of the colleges, frankly, are in areas where you can imagine some are more competitive than others. They have different products, they have different competitive sets. And they just have much more data on how to look at it individually at this price.

Now last year when they did that analysis, there actually was a small overall price increase for the university which will start to kick in probably in the next quarter. But that is really conducted in a thorough way on an annual basis and at this point for modeling purposes, we see it staying flat but certainly we will update you as they do their work throughout the year.

Corey Greendale

And how -- I know that, among other things, I think you're a student of the Clayton Christensen philosophy, at least very much aware of it and I know that it's hard to totally change your model. But given that with each passing year it seems like more changes have to be made, it sounds like you're doing all the right things in terms of outcomes. But how are you thinking about whether it would make sense to make a more radical pull the band-aid off kind of change and drastically get away from degree programs and do much more shorter-term boot camp kind of things. More just in time badge kind of things. Just how are you thinking about that?

Greg Cappelli

Yes. It's a great question. The way I think about it is really from a degree granting standpoint we are pulling the band-aid off, if that’s the way you want to categorize it. We are exiting many of the associate programs that were begun ten plus years ago in certain areas where there is lower outcomes, it’s more difficult. There has been a tremendous amount of effort through technology, through investments made in adaptive learning in different areas to try to improve retention in degree granting programs. Right. And we are taking a more radical approach in the degree granting area with the diagnostics and the requirements to sit in one of our classrooms so that everybody is prepared and can have the same experience.

Now to your other points. By the way we think that will improve many things including the reputation of the University over time. This was a University, at one point, that had above average graduation rates in many different categories. We would like to try to get it back there. Now to your second point. We also value the non-degree granting world. We have spent countless hours sitting with Fortune 500 CEOs and their executive management teams. And it's very clear also that while there still is demand for degree granting programs, that there is a tremendous and growing need for non-degree programs and certificates as well. Both the University of Phoenix and Apollo Group are developing programs to satisfy those needs. We are studying and understanding their workforce, right, about the way they acquire talent. How they train it, how they place it inside the organization and how they can get a better ROI. Because the reality in this country is that 50% or more of the time, corporations spend their hard-earned dollars recruiting employees. Over 50% of the time they never get the ROI back on the investment they made because it's a misfit.

So we are taking that into consideration, all of that, and we are developing shorter-term programs some of which can stack into degrees, both at the Phoenix level and then at the Apollo level as well. Does that answer your question?

Corey Greendale

It does. I have one more quick one, if I might. And I should just say, by the way, that I'm not a believer that the degree as kind of the qualification of record is going away. It's more a question about University of Phoenix and how you're positioned.

Greg Cappelli

Absolutely.

Corey Greendale

The last quick question I had is just -- I think I heard you say you're going, are potentially going away from weekly starts. Given that the world seems to be at least moving in the direction of competency based education and more flexibility, I understand operationally why you're doing it but it seems counterintuitive to the way demand is going. So could you just address that?

Greg Cappelli

Yes. Yes, I can. So we are also working on competency based education programs at a couple of our institutions, including University of Phoenix, number one. Number two, competency based doesn’t mean that you have to start at students 52 times a year, 50 or 52 times a year. We are doing a lot of research, we have a lot of data back from students. And frankly we believe a fewer number of starts, there will still be plenty, but a fewer number of starts will help us organize the cohorts better. There will be better scheduling and completeness of the cohort so that once you announce a course, you are going to run it for sure. There will be better staffing around that cohort as well and we think better service levels and better outcomes.

So we have done a lot of research on it. There will be plenty of starts for students to start. It's not like there is only going to be a start two or three times a year. But we just think 50 is too many at this point, doing it weekly. There will also be some breaks that are built in that we feel are necessary, that students have talked about with us over the past year. So a lot of work was done in this area and we feel pretty good about the basis of where we are going to.

Operator

Your next question comes from the line of Denny Galindo with Morgan Stanley. Your line is open.

Denny Galindo

A lot of these changes seem to be moving away from things that leverage your scale, whether it's fewer start dates, less proprietary technology, reducing the geographic presence, differentiation by college. How do you think about that tradeoff between reducing these things that only you can do as the largest university and cutting costs? And then, what are the areas that really use your scale under the new strategy?

Greg Cappelli

Well, look, we are not really trying to delever the scale advantages from that standpoint but let me tell you what the biggest advantage is to levering scale. You spend dollars strategically to recruit students into your system. And if the students are staying, right, that is the true advantage to levering any platform or scale. Now it's true that we have had locations all over the country for many, many years. But what we are doing is we are not guessing, we are looking at lots of data, we are talking to corporations. We are talking to groups of individuals in sessions where we can understand their needs and we are just talking about getting out in front and positioning the University of Phoenix so it can have the most amount of success.

The scale really comes when you can lever the amount of money that you are spending on marketing, recruiting, the cost to acquire a student and the length of time that person stays with your cost basis. And that we very much believe that that’s possible going forward. But the very first thing we need to do here is to make sure we are getting the right kind of students sitting in the classroom and retaining in a higher level so everybody can have a great experience.

Denny Galindo

Okay, that's helpful. One other one on capital management. It sounds like you're kind of shrinking the organization to the right size and there is a little bit of uncertainty over the next two years as you finish your plan of what that size is. Does this mean you're going to shift away from repurchases and more towards acquisitions in say Apollo Global, as a use of capital over the next two years until you have a better idea of where the right size for the organization is?

Greg Cappelli

You know I didn’t say that. What I said is, given the circumstances we look at that capital every single quarter with our board, I think there are times when share repurchases have in the past and will continue to make sense. We look at sort of a pyramid of every dollar we use, whether it's in global or, frankly, we are investing back into certain areas of our domestic operations or the B2B solutions which we have been spending some money on at, professional development as well, and we look at those returns sort of in order. And we do think that there is an appropriateness at certain times for share repurchases as well and that will continue to be part of the dialogue going forward. It's hard for us to signal exactly how much we are going to spend and in what areas because we are not allowed to do that. But it certainly has been part of the conversation and is every quarter when we meet with our board.

Denny Galindo

And then lastly sort of along the same lines. When you think about preferred countries or regions to deploy some of that capital, are there any areas where you would pay a higher multiple than somewhere else just because it fits in with the strategy more? I'm thinking, I know Brazil is a place where there's been some assets available and it's starting to become a pretty large market. But are there any places that you think you'd go after a little bit more aggressively?

Greg Cappelli

Well, I don’t really think of it in terms of multiples although I do appreciate what you are saying there. The multiple is usually a function of growth and capital efficiency that we find. Recall that -- you might know that in Apollo Global, we have kept it very capital efficient. So even with the newer University of Phoenix strategy, we very, very, very much want the cash conversion cycle, right, to be efficient. It's always been a cash flowing vehicle because of the way it's been built and run. That’s exactly what we are doing in internationally as well. So when we find areas that we believe can grow faster with the same efficiency, yes, that effects I guess in this case the multiple or the price you pay.

However, we do sophisticated analysis to look at long-term value creation and it has to be there. We walk away from way more things than we ever end up buying or engaging in because we simply don’t think that’s possible. So the returns have to be attractive. We risk and adjust for the country risk as well, the political environments and then the growth opportunities. And we see some exceptional opportunities around the world. I might add that Apollo Global is just starting to realize the benefits of being a network together. That when we do go look at an asset in different locations now, we being with us the existing operator in the region and they already quickly can identify what needs to be done, right, to increase the returns before we even acquire the asset. So they are just getting to the point where they are being able to get leverage for their own size.

Operator

Your next question comes from the line of Sara Gubins with Bank of America Merrill Lynch. Your line is open

Sara Gubins

First, could you help us think about why you think 150,000 is the right amount to end up at? Given your student base, do you already have this size or something in the ballpark that are at the diagnostic levels that you're thinking about requiring?

Greg Cappelli

There has been a lot of work done to this point and analysis in looking at the student base. And you are right, there is no magic starting point but through the analysis and the data compilation, we think that’s a good starting point. Remember we need to model so that we can look at our cost basis. If it ends up being more than that, okay. But we are looking at that from a starting point for our costs so that we can get this organization back to 15% to 20%. We are not going to be at the mercy of the market whims over the next couple of years in terms of is it going to be up a little bit or down a little bit. We have an idea of where we want to go, where the bottom is, the costs that are going to come out to equal our revenues.

The levers, if you will, in the model for that and what can vary that we will be watching very closely are the rate of increase back up in retention versus the cost. Those are the two really key levers. And then of course as I said before pricing and the average revenue per student. So we are going to be looking at those very closely. But what we absolutely do want to do is improve the overall position of the University of Phoenix, right. Its brand, its reputation and its ability to recruit at a lower cost going forward.

When I look back 15 years ago, when this organization had 100,00 students there was a 20% plus margin. Now it was a different day for sure and the dynamics as I pointed out in the beginning of the call, were different. But it's doable. So we are focused on the data and we will be updating as we go along. It's a starting point.

Sara Gubins

Okay, great. And then following up on costs. So if I think about your comments, it sounds to me like we would expect to see starts somewhere in the ballpark of down about 35% next year which would translate to revenue probably down about 13%. And then that would translate to costs being down about $300 million. So that's taking out about another $250 million of fixed costs. I wanted to see if that sounds about right, where you think that would come from. And then if the goal is to get back up to 15% to 20% margins, presumably we would expect more cost cutting to come in fiscal '17 and beyond. Thanks.

Greg Cappelli

Yes, Sara. So what we are going to do, I wanted to -- our feeling is, it's very difficult to come out and explain a strategy like this if you don’t try to give some parameters around what to do with the model. And I totally appreciate that having sat in that seat. What I do want to say and as we are very, very hard at work building the budget and the financial plan for all of fiscal year '16, you are exactly right that the starts along with the pricing and the revenues need to be balanced with costs. And we are very very focused on that.

So as far as the categories of the cost, it's across the board of the entire organization. The organization is working hard together. Already on this, so it's not a surprise and that’s our goal. Our goal is to make sure that we are driving towards a 15% to 20% margin over the next three to five years. But we are on our full call. We are going to be going through our budget in more detail.

Joseph D’Amico

Sara, this is Joe. I just want to add that our rate of spend now on an annualized basis or at least the cost savings, as I said in the script, is down $200 million. So we have a good start toward this coming year and we continue to work on things with self-service and other IT changes that will help us be more efficient.

Greg Cappelli

It's across the entire organization. And by the way I totally understand the magnitude of the numbers you are talking about and we are working on it now.

Operator

Your next question comes from the line of Paul Ginocchio with Deutsche Bank. Your line is open.

Paul Ginocchio

Just the first one. Just on -- I think you said that total enrollment would be flat Q on Q or did you talk about new enrollment against the fourth quarter?

Joseph D’Amico

The absolute number would be about flat with Q3 but the comp is higher for Q4 of last year. So the new degree enrollments will be down more.

Greg Cappelli

And there will be some impact from our new plan in the fourth quarter already which is affecting it some in terms of personnel and recruiters and so on and so forth. So there is some of that in there as well.

Paul Ginocchio

Okay. So new enrollments are going to be flat Q on Q?

Greg Cappelli

Q on Q, that is correct.

Paul Ginocchio

Okay.

Greg Cappelli

That’s our estimate at this point.

Paul Ginocchio

And then there was a spike in other losses and I was just wondering what that was related to.

Joseph D’Amico

Could you say that one more time? I am sorry, Paul, we lost you for a second.

Paul Ginocchio

It seemed like there was higher other losses in the quarter versus a year ago. I am just wondering what those are, not global, not UOP?

Greg Cappelli

I am going to ask Greg to take a look at that in the information and we will come back during this call.

Paul Ginocchio

Okay. And then just, can you talk about which associate programs you are closing and how much of enrollment they are?

Greg Cappelli

Yes. So at one point associate degree programs spiked to over 50% or maybe even 60% of total enrollment. But we brought that down over the past few years as we talked about in the past. So of that 50,000 chunk that we will be taking out, it’s a meaningful percentage of it. Not all of it by any means but there is a meaningful percentage in there and then those that will graduate out of the program. The University of Phoenix intends to offer some very career focused areas of associates where it makes sense. We are just not going to be recruiting on a wide scale basis across the board, blanketing if you will the market in that area for associate programs any more. So there will be some areas of focus going forward but it will be a lot smaller.

Paul Ginocchio

Okay. And then just, you talked about Global growing 20%. Was that an organic number that you're talking about or does that include acquisitions?

Greg Cappelli

Yes. And again -- yes, it's organic. And I look at -- you know there have been acquisitions there but any acquisition that we make, right, the reason that we make it so we can grow it actually at an increased rate organically by leveraging everything, we call it One Apollo throughout the organization. And that actually is working for us. So we will continue to do that and only make acquisitions where it makes sense.

Paul Ginocchio

And just of that $400 million run rate for revenues, what percent is roughly Brazil?

Greg Cappelli

Brazil is very small for us at this point but it doubled in size year-over-year. So it is growing very rapidly. It's very capital efficient. We are excited about that market. I know that there is some issues in certain areas of it that we have not gone into. But we know the market well and we are excited about our prospects down there.

Paul Ginocchio

What percent of your students in Brazil get government financing?

Greg Cappelli

It's very very small at this point, almost none.

Operator

Your next question comes from the line of Peter Appert with Piper Jaffray. Your line is open

Peter Appert

Greg, the decision to further consolidate the campus network, is that mainly a cost driven strategy?

Greg Cappelli

No. Although it will significantly costs. Honestly, it's modernizing the university, that’s what we are doing in all the areas. We are literally in discussions with corporations about their workforces. We are doing town halls around the country in certain areas, trying to make sure we understand. We are going to continue to be in most of the big metro markets with our campus systems. But the leadership at University at Phoenix has looked very closely at where do we need to be, where can we be most effective. Let's invest in those areas, let's make sure we are offering hybrid programs. Things where we have had lots of success overseas.

So we are not trying to be everything to everyone in every market, that worked 20 years ago. We are picking the most important markets around the country, investing and going after those on a more local basis and we think we can be more effective doing it.

Peter Appert

I guess back to the cost issue, I'm just scratching my head a little in the context. You've been in cost reduction mode now for three, four years. You've been very successful and aggressive at that. I'm just concerned that how much more there is to do and when you start doing damage to the franchise.

Greg Cappelli

You know Peter, I will say this again -- and you are one of the original followers of the company. 15 years ago this company had a 20% margin at 100,000 students. So I think the whole key here is not to do damage, to improve the reputation. The thing you can't do as responsible fiduciaries of capital, of owners capital, and frankly as responsible owners of the University. You can't, in this case, have it both ways. I am talking for us. I am not saying for anybody else in the industry. We want to meaningfully improve outcomes. We have done everything we can in the regulatory front to be leaders and we will continue to do so. Now we want our reputation back like we used to have as an operator of a university that has high outcomes. Tim Slottow and his team knows how to do that. It's a bold plan, I agree. But if you are going to do that, you need to be mindful and considerate of costs as well. And we believe that you can do both.

Now this is an organization that hand built a lot of things over the years and we are getting better and more efficient and we are going to aggressively go after those costs. This plan actually calls for them to reinvest additional dollars into careers, into faculty, into the teaching model and experience, into hybrid areas. So there is a lot of stuff where we are going to be increasing investment by getting out of certain areas where -- you know what as I said before, having our own systems has worked for this company in the past but there is really good stuff out there now that’s even being built as we speak. So a year from now we are putting a tremendous amount of time effort, capital into technology where we can be levering not just being the sole provider of that and taking that money and reinvesting it back into the educational experience as well.

Peter Appert

Does the business stay cash flow positive in fiscal '16?

Greg Cappelli

Yes.

Operator

Your next question comes from the line of Phil Stiller with Citibank. Your line is open.

Phil Stiller

I guess, Greg, you're making a lot of changes with the University of Phoenix right now. I just wanted to get a better sense in terms of when these decisions were made and I guess what the timeline is for implementing it. So as we think about enrollment in fiscal '16, when should we see a fully annualized impact of all these changes?

Greg Cappelli

Okay. Good questions. So Tim Slottow, the President, the executive dean, his team of personal have been doing research on the University, well running it over the past year. So these decisions were made, frankly during the quarter. Where conclusions were made that if we want to achieve our goals on retention, outcomes, graduation rates, that this is the path that they feel will best lead us right to the promised land there. And we know there is short-term consequences to doing this but all of us who are here believe it's the right thing to do. You are graduating students at the national average, there is a not a lot of argument about your tax status. By the way, we feel like we have the ability and the capabilities to do this. I know it possesses a near term challenge but with that down the road comes benefits. It's a better economic model when it's working appropriately. You spend less money, not more, to acquire students because you are getting more referrals as we used to have in the past and it's just time for this organization to start moving down that road. Sorry, the second part of your question?

Phil Stiller

I was just trying to get a sense in terms of how long it will take to make these changes.

Greg Cappelli

So they are in the process of making the changes now. You will see some of the impact actually in the fourth quarter as I mentioned. Fiscal year '16 is when the bulk of the students will come out. There will be stabilization in '17 and growth beyond.

Phil Stiller

Okay. Can you give a little more color in terms of what admission requirements you're going to start imposing on new students?

Greg Cappelli

Honestly, not yet, and that’s from a competitive standpoint. They are actually using some really, really neat diagnostic tools technology. And there obviously will be requirements based on a number of different factors to get in to the university. And we will talk about that in the fourth quarter on the conference call. They are not just quite ready to do that yet.

Joseph D’Amico

Greg, I might add that some of the students that might not make it through the admissions, we are going to actually counsel them and help them figure out how do they get there education. So some might go back to a community college. There might be other programs available right here. There might be certificate programs, there might be other things that either we or others offer that will help them and then come to the university.

Greg Cappelli

What we found from doing that in some of our global businesses is some very very loyal people, who said thank you very much. They want through that and they actually end up enrolling later on with higher success rates.

Phil Stiller

I think it makes sense. The last question and I'll turn it over. Just clarifying on the margins, the guidance for this year implies a 7% or 8% operating margin and it seems like the initial commentary on '16 is similar in that ballpark. Just trying to square that with the 15% to 20% longer-term margins. Are you going to get there through further cost reductions or can you only get there if you grow revenues off that base?

Greg Cappelli

No, I think, first of all I don’t disagree with your comments there. What I would say is, think about what my comments in the levers were. So you are right, right. The students come out, an initial block of costs come out, right. And then there are more efficiencies that we have identified already that will be taking place along with continued work on the cost front going forward. However, you do need eventually retention to go up, right. So we are expecting that Peter. We think we are building in plenty of time for the stability for that period and then also new students to flatten out and begin to grow. So it's that combination. When you look at the model happening over the next couple of years and then margins starting to improve. So it is a combination of all those things including the cost.

Operator

Your next question comes from the line of Michael Tarkan with Compass Point. Your line is open.

Michael Tarkan

Just a couple here. Can you talk about your exposure to gainful employment, just what percentage of your programs would be affected by the new rules? Then I have a follow-up.

Greg Cappelli

Our exposure at this point is very small. Everybody has exposure to it. When I say that, I mean we feel very good about our positioning with the pass/fail line now. There will be this warning zone and we are looking at that closely but certainly we feel like all the work that we have done, I mentioned the bedrock. We wouldn’t even be talking about putting this plan into place, sort of phase two if you will, of this plan for University of Phoenix, had we not gotten the first piece done and complete because that is entry to the dance. So I feel very good about our positioning right now, overall, on the regulatory front and with respect to things like 90/10 and certainly getting gainful employment, which we believe in.

Michael Tarkan

Any sense as to what percentage of programs would either fall in that warning zone or below that at this point?

Greg Cappelli

You know what, I don’t have the data right in front of me but I know that our -- everybody at the University feels comfortable that we are in good shape on gainful employment at this point. I don’t have the warning zone data for you yet. And we are actually still all waiting for some data to get, as well that we need in certain areas. But certainly, I feel like that will not be a limiting factor to impact the speed at which the students come out in this plan, stabilize and then regenerate.

Michael Tarkan

Okay. And then last one for me. Just from a high level perspective here, the new start growth number that you're guiding to essentially for the fourth quarter, it looks like it's down around 24% year over year, 70% from the peak in 2009.

Greg Cappelli

I think that’s a little higher than --

Joseph D’Amico

It's closer to 21%.

Greg Cappelli

It's closer to 20% or 21%, I think it is a bit flat. But you are in the ballpark.

Michael Tarkan

Okay. So, my question is, I've been following the company for a long time, we've heard about a lot of transformation plans year after year. I know Brian has left but at what point is it in I guess shareholders' best interest for the board to take a harder look at management? Thank you.

Greg Cappelli

Sure. We are working very closely with the board. We are in close dialog. It is our perspective and our believe that we want the best people doing the right things for students, number one. Number two, just remember that the universities have their own personnel that run the universities, drive their own strategies. That Apollo is certainly here to provide the capital and the support. They have their own board of directors. But we are all here to work together and to get the job done and as I said before, management can change over time but regardless of who is running the businesses in this areas there is a couple of things there that you need to be mindful of.

Number one, the industry has changed very dramatically. Number two, you absolutely have to do the right things in the areas of regulatory and compliance. And number three, you always have to put the student first. So it's been a challenging five years in the industry and for this organization having been the largest player. But we are not taking shortcuts to get there and we are going to try to always do things the right way.

Operator

Your next question comes from the line of Jeff Mueller with Baird. Your line is open.

Jeff Mueller

Greg, now you're, I guess, firming it up that you've put the bedrock in place to enable phase 2 of the transformation. But at least as I understood it, maybe two years ago, I would have interpreted your comments at that time that you would have thought you would have been back to growth by now because of the transformational changes that you've made thus far. So I guess the first part of the question is, what's the post mortem on what you got wrong over the last two years. And then the second part is, as you talk about getting back to growth in 2017, any additional detail on what provides you or can provide investors confidence in that.

Greg Cappelli

Yes, Jeff, thank you. When I look back over, I think as I said before, some really well intended efforts to bring retention higher in this organization. But always doing so under the original premise that this has been a pretty open platform to do that. Right. So lots of good intention to bring people -- excuse me, to make improvements in retention in the overall model in a very tough and competitive and changing landscape as we know. We didn’t get those results in terms of taking anybody in and helping them to graduate and achieve thing on a national scale and I should elaborate that we were more in line with the averages. Now we are taking the next step to do that.

So we have tried a lot of things to do it. It hasn’t gone to the level of expectations that we believe are possible and so we are taking the next steps there. I am sorry, what was the second question?

Jeff Mueller

Yes. I guess I am just trying to -- where does your confidence come from for '17 and how do you instill that in investors in terms of getting back to growth in 2017? Is it that you're culling the programs that are currently in decline, you're preserving the things that are working, you're generally putting a better product into the market? I guess you referenced that a lot of this was data informed. So I know some of that's competitive, but anything that you can share with investors to provide them some of your confidence.

Greg Cappelli

We are making a lot of changes actually. A lot more than perhaps it sounds like we have done in the past. Not just for the diagnostics and requirements to get in. But the college operating model is just starting to kick in, right, and that’s taken a year for the University of Phoenix to develop. As I said, the University of Phoenix has its own capable management which by the way has changed dramatically over time. But what I would say is that it's a combination of the college operating model, it's a combination of the new diagnostics, the pathways, the technology, right. The things that we are putting in place that we do expect to get results by 2017 in terms of stability and growth.

Joseph D’Amico

So let me give you one example that might help. So in the past we had sort of one pathway for most of our students. They came in at the associates level, they took nine-week courses and we gave them a lot of support. What we found is that by setting two tracks, one for students that might not be quite as well prepared and one track that’s for students who are better prepared. We found that the list in terms of retention has gone up when compared to those old models. So we have data actually supporting that and we have done some pilots that are giving us confidence that it looks like we can achieve some of the objectives that we have laid out. But we also know that retention is not one thing. You have to do many things and over the years we have done, taken a lot of steps. Including, for example, full-time faculty. For example, changing the sequence of courses. Putting games in courses that help learners learn. Putting in predictive analytics, eliminating learning teams and courses.

So the things that we have done, we have learnt from and now we are packaging it all together in hopes and with an expectation that we get the results that we are seeking. And I will say one other thing, there has been a lot of change in management at the University of Phoenix and actually throughout the organization. So there is some different kind of thinking perhaps going into different kind of thinking and greater accountability going into this.

Operator

Your next question comes from the line of Jeff Silber with BMO Capital Markets. Your line is open.

Jeff Silber

I know it's late. Can you give us an update on the HLC review at the University of Phoenix, please?

Greg Cappelli

We do not have an update at this point. We are still in the process for waiting for our final results there and we will update you accordingly. It shouldn’t be long though.

Jeff Silber

Okay, that's great. And, I'm sorry, I know you gave soft color for where you think the framework is going on a model for the next few years, but I just want to double check. When you say enrollment stabilizing in 2017 potentially, what do you mean by stabilizing?

Greg Cappelli

So we talked about the number of enrollment going to 150,000 and stabilizing means at that level. So staying there and then working its way higher. And look, that could vary throughout the year in 2017, right. But that’s the framework that we are providing at this point. As is said, we will be giving some more color next quarter. Does that make sense?

Jeff Silber

Yes, it does. I just wanted to clarify. Thanks, so much.

Operator

Your next question comes from the line of Denny Galindo with Morgan Stanley. Your line is open.

Denny Galindo

Hi, guys, just one quick follow-up. Just on the diagnostic test that you're doing on the startups. I was wondering if you had any feel for of the people that don't get admitted because they fail this test. How many would be counseled to these other options and how many would, say, go to one of your other programs, like a certificate program or some of the other things you're doing? Or if it's may be too early to create some buckets?

Greg Cappelli

Sure. Thank you very much for the question. It is absolutely not just the test, there are a number of things in the diagnostic requirements that have to be met. Including in some cases, your age and other areas. But I won't go into a lot of detail there as they are in the process of putting those -- developing and putting those in place. What I will say is that, so when you look at those factors about everything that’s going into that, I should say those are all part of the factors that goes into determining how many people will be screened out or not. Obviously, there is a determination that’s going to be made around with any students whether they are appropriate for entrance and to be in class with other students. And if not, we will look at every student where it makes sense to counsel them through a pathway, either to stay within the Apollo family or, frankly as Joe said before, outside of the organization. We just want them to have the best experience. We want them to do the best thing for themselves. And at that point that they are successful, we will have other opportunities if they are successful outside or inside the organization in these pathways, to come back to the University of Phoenix.

There was a pilot that started in -- excuse me, there is a pilot starting in July and we are going to learn and adjust as appropriate.

Operator

There are no further audio questions at this time. I will turn the call back over the presenters.

Greg Cappelli

All right. Thank you everybody very much for your time today. We appreciate it. We will update you accordingly and we look forward to talking to you soon. Take care.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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