In 2009, after five years of extraordinary growth in its enrollment, the Apollo Education Group (NASDAQ: APOL), the parent company of the University of Phoenix, recognized that the days of booming enrollment in the Associate's degree programs it had launched in September 2004 were about to reverse, in part because the Great Recession, which had helped boost the school's enrollment, was ending.

At the same time, the leadership of the private educational institution realized that far fewer students graduating from its Associate's degree programs were making the transition to the University of Phoenix's Bachelor's degree programs than they had been counting upon. Worse, a much higher than expected number of students enrolled in its Associate's degree programs were failing to complete the program and were dropping out because they were not able to pass its required classes in Algebra.

To address its situation, the Apollo Education Group adopted a two-part strategy. It would:

Restructure its Associate's degree programs to be more closely integrated with its University of Phoenix division, which would help facilitate the transfer of students graduating from the Axia College division it established to launch its Associate's programs to the University of Phoenix' Bachelor's programs. Degrade its academic standards for passing its Associate's degree program's Algebra classes, which would enable a higher percentage of students enrolled in the program to pass.

The chart below, in which we've shown the enrollment figures for the University of Phoenix' Bachelor's and Associate's degree programs that we obtained from the Apollo Education Group's SEC filings, shows how that strategy played out.

In this chart, we see that the changes that the Apollo Education Group implemented in September 2009 succeeded on both counts. We first see that enrollment levels in the University of Phoenix' Bachelor degree programs increased in the year after its Associate's degree programs were integrated into the University of Phoenix division.

At the same time, we observe that enrollment levels in the University of Phoenix' Associate's degree programs, instead of beginning to fall as the U.S. economy exited from the worst part of the Great Recession, were able to be sustained near their peak levels for a year as the degradation of the school's academic standards allowed more students to remain in the program without dropping out.

Unfortunately for the Apollo Education Group and its investors, those changes were not sufficient to permanently sustain the enrollment levels of the University of Phoenix' Associate's degree programs, whose enrollment began to plummet shortly after an intense marketing effort during 2010 led enrollment to peak at its all time high in September 2010. Shortly afterward, in response to increasing criticism, the Apollo Education Group implemented reforms in its recruiting practices, which limited its ability to acquire and retain new students.

As for how the University of Phoenix degraded its academic standards, we have obtained copies of four documents that describe changes in student evaluation practices that would enable students to pass its Algebra classes with lower levels of proficiency.

That's possible because a student's performance in a math class, unlike nearly all other academic disciplines, may be fully evaluated according to objective standards, rather than by subjective ones, where a student's grade is based in part upon an instructor's opinion of how well they've learned the subject. In math classes, like Algebra, how well a student has learned the material covered in the class may be directly assessed by counting the number of assigned math problems that they correctly solve, where correct solutions are obtained by a rigorous application of logic that is fully independent of any opinions the instructor might have.

In a traditional math class, 100% of a student's level of proficiency is directly determined by the percentage of assigned math problems that they correctly solve. A student's grade for a class is then determined by that percentage, where a student correctly solving 94% or more problems might earn a letter grade of A, between 90% and 94% would earn an A-, and so on down the line, where a student correctly solving fewer than 60% of all the problems assigned during the class would fail, as they would not have demonstrated sufficient proficiency in solving math problems to be allowed to advance.

Having established that basis for evaluating student performance, let's look at the University of Phoenix' academic standards, as described in the following documents we obtained, first describing the academic standards that applied in classes that began in the nine months prior to September 2009:

Axia College of University of Phoenix MAT117 Algebra 1B Course Syllabus, Version 5, 15 December 2007 (PDF Document)

University of Phoenix Faculty Handbook 2007 (PDF Document)

In these two documents, we find that, at most, 90% of a student's grade is based upon an objective assessment of their proficiency in correctly solving assigned math problems, with 10% begin determined by the instructor's subjective assessment of the students' responses to Discussion Questions and their overall level of Participation in online discussions during the class. We further find that faculty members are not permitted to alter the percentage weighting of these assignments in determining a student's overall letter grade for the class.

And now in classes that began in September 2009 and afterward:

University of Phoenix Axia College MAT117 Algebra 1B Course Syllabus, Version 6, 2009 (PDF Document)

University of Phoenix Faculty Handbook 2009-2010 (PDF Document)

In these two documents, we find that although there has been no change at all in the materials or assignments for its MAT117 Algebra 1B class, faculty members are now able to alter the percentage weightings of assignments within their classes, with the official guidance that they should set a weighting of 20% for their subjective assessment of student responses to Discussion Questions and their overall level of Participation in online discussions during the class. This change means that, at most, 80% of a student's grade is now based upon the objective assessment of their proficiency in correctly solving assigned math problems.

The chart below reveals how that degradation in academic standards would affect a student's grade, as compared to how their performance would be evaluated in both a traditional math class and also the University of Phoenix' previous academic standards.

In the chart above, we focused on the key major thresholds between the letter grade divisions, where in a traditional math class, correctly solving 90% of all assigned problems would result in a student earning a letter grade of A-, 80% for a B-, 70% for a C- and 60% for a D-.

We see that prior to September 2009, a student earning these same letter grades would only need to correctly solve 80.1% of all assigned math problems to earn an A-, 71.2% for a B-, 62.3% for a C- and 53.4% for a D-, provided they earned the maximum possible scores for their other, subjectively graded activities. Another way to describe the University of Phoenix' pre-September 2009 grading system for its math classes is that a letter grade earned at the University of Phoenix is the equivalent of one lower letter grade at universities with higher academic standards.

But in September 2009 and afterward, we see that a given letter grade in a University of Phoenix math class is even more greatly diminished with respect to its equivalent letter grade in a traditional math class. Now, to earn an A-, a student who maximizes their scores in other graded activities can get an A- on their transcript with only having the demonstrate the same proficiency in solving math problems that a student earning a C- in a traditional math class would.

The same degradation carries through the entire grading scale, until reaching the bottom, where a student who failed to correctly solve at least half of the problems they were assigned could obtain a passing letter grade of D-, where a similar academic performance at both a traditional math class and at the University of Phoenix prior to September 2009 would be considered a failing score, where the student would not be permitted to progress to more advanced classes.

Consequently, the University of Phoenix didn't just degrade its academic standards, it also diminished the value of the degrees earned by its students prior to September 2009, as the institution never so much as placed an asterisk on the diplomas that it subsequently issued. That, in turn, is something that might have significant class action liability risks for the Apollo Education Group, not just on behalf of students who earned their diplomas from the institution before it degraded its academic standards in September 2009, but also for those earning the institution's academically degraded diplomas thereafter, as they are unable to demonstrate that they achieved the same level of academic proficiency on their transcripts that all previous graduates with the same earned letter grades did.

The Apollo Education Group will be releasing their fourth quarter results next month. It occurs to us that a sharp analyst participating in the related earnings call might wish to raise this particular issue with the company's current management.

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