10-Q 1 zvo063019form10-q.htm FORM 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
or
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: 001-34272
___________________________________________________________________________

ZOVIO INC
(Exact name of registrant as specified in its charter)
____________________________________________________________________________
Delaware
(State or other jurisdiction of
incorporation or organization)
59-3551629
(I.R.S. Employer
Identification No.)

1811 E. Northrop Blvd, Chandler, AZ 85286
(Address, including zip code, of principal executive offices)

(858) 668-2586
(Registrant’s telephone number, including area code)
____________________________________________________________________________

None
(Former name, former address and former fiscal year, if changed since last report)
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 ☒    No ☐
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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒    No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer ☐
Accelerated filer ☒
 
Non-accelerated filer ☐
Smaller reporting company ☒
 
 
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐    No ☒

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $0.01 per share
ZVO
The Nasdaq Stock Market LLC
The total number of shares of common stock outstanding as of August 2, 2019, was 30,259,905.




ZOVIO INC
FORM 10-Q
INDEX
 
 
 
 
 
 
 
 


2


PART I—FINANCIAL INFORMATION
Item 1.  Financial Statements.
ZOVIO INC
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except par value)
 
As of
June 30, 2019
 
As of
December 31, 2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
104,617

 
$
166,307

Restricted cash
20,049

 
18,619

Investments
2,344

 
2,068

Accounts receivable, net
33,720

 
27,015

Prepaid expenses and other current assets
25,754

 
18,255

Total current assets
186,484

 
232,264

Property and equipment, net
28,496

 
16,860

Operating lease assets
26,261

 

Goodwill and intangibles, net
47,199

 
12,441

Other long-term assets
8,704

 
7,927

Total assets
$
297,144

 
$
269,492

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
83,886

 
$
62,792

Deferred revenue and student deposits
59,384

 
63,834

Total current liabilities
143,270

 
126,626

Rent liability
24,928

 
3,183

Lease financing obligation

 
8,634

Other long-term liabilities
6,556

 
3,435

Total liabilities
174,754

 
141,878

Commitments and contingencies (see Note 15)

 

Stockholders' equity:
 
 
 
Preferred stock, $0.01 par value:
 
 
 
20,000 shares authorized; zero shares issued and outstanding at both June 30, 2019, and December 31, 2018

 

Common stock, $0.01 par value:
 
 
 
300,000 shares authorized; 65,628 and 65,289 issued, and 30,260 and 27,168 outstanding, at June 30, 2019 and December 31, 2018, respectively
659

 
653

Additional paid-in capital
185,293

 
205,157

Retained earnings
405,753

 
429,992

Treasury stock, 35,368 and 38,121 shares at cost at June 30, 2019, and at December 31, 2018, respectively
(469,315
)
 
(508,188
)
Total stockholders' equity
122,390

 
127,614

Total liabilities and stockholders' equity
$
297,144

 
$
269,492

The accompanying notes are an integral part of these condensed consolidated financial statements.


3


ZOVIO INC
Condensed Consolidated Statements of Income (Loss)
(Unaudited)
(In thousands, except per share amounts)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Revenue
$
107,495

 
$
119,037

 
$
217,259

 
$
235,814

Costs and expenses:
 
 
 
 
 
 
 
Instructional costs and services
55,088

 
54,397

 
107,026

 
111,011

Admissions advisory and marketing
44,810

 
39,875

 
93,882

 
88,069

General and administrative
22,532

 
12,549

 
38,452

 
25,297

Legal settlement expense

 
141

 

 
141

Restructuring and impairment expense
5,394

 
2,729

 
5,423

 
2,570

Total costs and expenses
127,824

 
109,691

 
244,783

 
227,088

Operating income (loss)
(20,329
)
 
9,346

 
(27,524
)
 
8,726

Other income, net
297

 
282

 
896

 
532

Income (loss) before income taxes
(20,032
)
 
9,628

 
(26,628
)
 
9,258

Income tax benefit
(2,435
)
 
(5,452
)
 
(2,389
)
 
(7,132
)
Net income (loss)
$
(17,597
)
 
$
15,080

 
$
(24,239
)
 
$
16,390

Income (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.58
)
 
$
0.56

 
$
(0.84
)
 
$
0.60

Diluted
$
(0.58
)
 
$
0.55

 
$
(0.84
)
 
$
0.60

Weighted average number of common shares outstanding used in computing income (loss) per share:
 
 
 
 
 
 
 
Basic
30,215

 
27,170

 
28,706

 
27,167

Diluted
30,215

 
27,348

 
28,706

 
27,491

The accompanying notes are an integral part of these condensed consolidated financial statements.


4


ZOVIO INC
Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)
(In thousands)

 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Stock
 
 
 
Shares
 
Par Value
 
Total
Balance at December 31, 2017
64,887

 
$
649

 
$
201,755

 
$
426,356

 
$
(505,764
)
 
$
122,996

Adoption of accounting standards (Note 2)

 

 

 
(1,000
)
 

 
(1,000
)
Stock-based compensation

 

 
1,165

 

 

 
1,165

Stock issued under stock incentive plan, net of shares held for taxes
186

 
2

 
(707
)
 

 

 
(705
)
Stock repurchase

 

 

 

 

 

Net income

 

 

 
1,310

 

 
1,310

Balance at March 31, 2018
65,073

 
$
651

 
$
202,213

 
$
426,666

 
$
(505,764
)
 
$
123,766

Stock-based compensation

 

 
1,160

 

 

 
1,160

Stock issued under employee stock purchase plan
16

 

 
98

 

 

 
98

Stock issued under stock incentive plan, net of shares held for taxes
20

 

 
(48
)
 

 

 
(48
)
Stock repurchase

 

 

 

 
(2,424
)
 
(2,424
)
Net income

 

 

 
15,080

 

 
15,080

Balance at June 30, 2018
65,109

 
$
651

 
$
203,423

 
$
441,746

 
$
(508,188
)
 
$
137,632


 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Treasury
Stock
 
 
 
Shares
 
Par Value
 
Total
Balance at December 31, 2018
65,289

 
$
653

 
$
205,157

 
$
429,992

 
$
(508,188
)
 
$
127,614

Stock-based compensation

 

 
1,706

 

 

 
1,706

Exercise of stock options
6

 
1

 
59

 

 

 
60

Stock issued under stock incentive plan, net of shares held for taxes
284

 
2

 
(757
)
 

 

 
(755
)
Net loss

 

 

 
(6,642
)
 

 
(6,642
)
Balance at March 31, 2019
65,579

 
$
656

 
$
206,165

 
$
423,350

 
$
(508,188
)
 
$
121,983

Stock-based compensation

 

 
3,596

 

 

 
3,596

Stock issued under employee stock purchase plan
29

 

 
96

 

 

 
96

Stock issued under stock incentive plan, net of shares held for taxes
20

 

 
(51
)
 

 

 
(51
)
Stock issued under acquisition

 
3

 
(24,513
)
 
 
 
38,873

 
14,363

Net loss

 

 

 
(17,597
)
 

 
(17,597
)
Balance at June 30, 2019
65,628

 
$
659

 
$
185,293

 
$
405,753

 
$
(469,315
)
 
$
122,390

The accompanying notes are an integral part of these condensed consolidated financial statements.


5


ZOVIO INC
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
 
Six Months Ended June 30,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(24,239
)
 
$
16,390

Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Provision for bad debts
7,525

 
11,872

Depreciation and amortization
4,198

 
3,533

Deferred income taxes
75

 
8

Stock-based compensation
5,302

 
2,325

Noncash lease expense
9,345

 

Net gain on marketable securities
(203
)
 
(24
)
Reassessment of lease charges
558

 
1,227

Loss on disposal or impairment of fixed assets

 
334

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(8,579
)
 
(19,900
)
Prepaid expenses and other current assets
(1,355
)
 
1,828

Other long-term assets
(684
)
 
737

Accounts payable and accrued liabilities
7,086

 
(10,588
)
Deferred revenue and student deposits
(7,000
)
 
(8,335
)
Operating lease liabilities
(11,517
)
 

Other liabilities
(2,630
)
 
(8,624
)
   Net cash used in operating activities
(22,118
)
 
(9,217
)
Cash flows from investing activities:
 
 
 
Capital expenditures
(17,767
)
 
(1,291
)
Purchases of investments
(74
)
 
(1,033
)
Capitalized costs for intangible assets
(293
)
 
(470
)
Cash paid in acquisition, net of cash acquired
(19,286
)
 

Sale of investments

 
975

   Net cash used in investing activities
(37,420
)
 
(1,819
)
Cash flows from financing activities:
 
 
 
Proceeds from exercise of stock options
60

 

Proceeds from the issuance of stock under employee stock purchase plan
96

 
98

Tax withholdings on issuance of stock awards
(806
)
 
(753
)
Repurchase of common stock

 
(2,424
)
   Net cash used in financing activities
(650
)
 
(3,079
)
Net decrease in cash, cash equivalents and restricted cash
(60,188
)
 
(14,115
)
Cash, cash equivalents and restricted cash at beginning of period
190,584

 
205,526

Cash, cash equivalents and restricted cash at end of period
$
130,396

 
$
191,411

 
 
 
 
Supplemental disclosure of non-cash transactions:
 
 
 
Purchase of equipment included in accounts payable and accrued liabilities
$
4,637

 
$
323

Issuance of common stock for vested restricted stock units
$
2,628

 
$
2,140

Consideration for acquisition in accounts payable and accrued liabilities
$
483

 
$

Issuance of common stock for acquisitions
$
14,363

 
$

 
 
 
 
Reconciliation of cash, cash equivalents, and restricted cash:
 
 
 
Cash and cash equivalents
$
104,617

 
$
171,596

Restricted cash
20,049

 
19,815

Long-term restricted cash
5,730

 

Total cash, cash equivalents and restricted cash
$
130,396

 
$
191,411

The accompanying notes are an integral part of these condensed consolidated financial statements.


6



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)


1. Nature of Business
Zovio Inc (the “Company”), formerly known as Bridgepoint Education, Inc., is a Delaware corporation, and is an education technology services company that partners with higher education institutions and employers to deliver innovative, personalized solutions to help learners and leaders achieve their aspirations. Its wholly owned subsidiary, Ashford University®, is a regionally accredited academic institution, which delivers programs primarily online. Ashford University offers associate’s, bachelor’s, master’s and doctoral programs. On April 1, 2019, the Company acquired Fullstack Academy, Inc (“Fullstack”) and on April 3, 2019, the Company acquired TutorMe.com, Inc. (“TutorMe”), which became wholly-owned subsidiaries of the Company. The operating results of Fullstack and TutorMe subsequent to the acquisition dates have been included in the Company's condensed consolidated results of operations. For further information regarding the acquisitions, refer to Note 3, “Business Combinations” to the condensed consolidated financial statements.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany transactions have been eliminated in consolidation.
Unaudited Interim Financial Information
The condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these financial statements do not include all of the information and footnotes required by GAAP for complete annual financial statements and should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the Securities and Exchange Commission (“SEC”) on March 12, 2019. In the opinion of management, the condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments, considered necessary to present a fair statement of the Company’s condensed consolidated financial position, results of operations and cash flows as of and for the periods presented.
Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP for complete annual financial statements.
Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the condensed consolidated financial statements. Actual results could differ from those estimates.
Restatement of Previously Issued Condensed Consolidated Financial Statements
Subsequent to the issuance of the Company’s unaudited condensed consolidated financial statements as of and for the three and six months ended June 30, 2018, the Company determined that such financial statements had errors related to: (i) revenue for the Corporate Full Tuition Grant (“FTG”) program portion of our student contracts which was misstated due to allowances that had not been properly determined and computational errors, which also resulted in misstatements in accounts receivable and its provision for bad debts, deferred revenue and student deposits, and the related income tax impact; and (ii) a misstatement in the adjustment to beginning retained earnings as of January 1, 2018 as a result of the incorrect adoption of ASU 2014-09, Revenue from Contracts with Customers, or Accounting Standards Codification Topic 606 (“ASC 606”) as it relates to the FTG program, resulting in a decrease of $2.2 million from the amount previously reported of $3.2 million to $1.0 million, as restated. As a result, the Company has restated the accompanying condensed consolidated financial statements for the three and six months ended June 30, 2018 from amounts previously reported to correct these matters. Management considers the restatement to be immaterial.


7



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

The following tables present a summary of the impact of the restatement corrections and other immaterial adjustments on the condensed consolidated statement of income (loss), the condensed consolidated statement of cash flows and the condensed consolidated statement of stockholders’ equity for the three and six months ended June 30, 2018. The following tables are presented in thousands, except per share data:
 
As Reported
 
As Restated
 
As Reported
 
As Restated
 
Three Months Ended
 
Six Months Ended
Condensed consolidated statement of income (loss) data:
June 30, 2018
 
June 30, 2018
Revenue
$
120,834

 
$
119,037

 
$
238,865

 
$
235,814

Instructional costs and services
$
53,986

 
$
54,397

 
$
110,848

 
$
111,011

Total costs and expenses
$
109,280

 
$
109,691

 
$
226,925

 
$
227,088

Operating income
$
11,554

 
$
9,346

 
$
11,940

 
$
8,726

Income before income taxes
$
11,836

 
$
9,628

 
$
12,472

 
$
9,258

Income tax benefit
$
(5,395
)
 
$
(5,452
)
 
$
(7,056
)
 
$
(7,132
)
Net income
$
17,231

 
$
15,080

 
$
19,528

 
$
16,390

Basic income per share
$
0.63

 
$
0.56

 
$
0.72

 
$
0.60

Diluted income per share
$
0.63

 
$
0.55

 
$
0.71

 
$
0.60

 
As Reported
 
As Restated
 
Six Months Ended
Condensed consolidated statement of cash flow data:
June 30, 2018
Net income
$
19,528

 
$
16,390

Provision for bad debts
$
11,709

 
$
11,872

Accounts receivable
$
(21,376
)
 
$
(19,900
)
Prepaid expenses and other current assets
$
1,904

 
$
1,828

Deferred revenue and student deposits
$
(9,910
)
 
$
(8,335
)
Cash flows used in operating activities
$
(9,217
)
 
$
(9,217
)
 
As Reported
 
As Restated
Condensed consolidated statement of stockholders’ equity data:
June 30, 2018
Retained earnings
$
448,195

 
$
441,746

Total stockholders’ equity
$
144,081

 
$
137,632

Comprehensive Income (Loss)
The Company has no components of other comprehensive income (loss), and therefore, comprehensive income (loss) equals net income (loss).
Leases
In accordance with ASU 2016-02, Leases (ASC 842) (“ASC 842”), leases are evaluated and classified as either operating or finance leases. The Company does not have any finance leases. The Company’s operating leases are included in operating lease assets, accounts payable and accrued liabilities, and noncurrent lease liabilities on the condensed consolidated balance sheets. Operating lease assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses its estimated incremental borrowing rate based on information available at the date of adoption in


8



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

calculating the present value of its existing lease payments. The incremental borrowing rate is determined using the U.S. Treasury rate adjusted to account for the Company’s credit rating and the collateralized nature of operating leases. The operating lease asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line method over the term of the lease.
Leased property and equipment meeting certain criteria are capitalized as finance lease assets, and the present value of the related lease payments is recognized as a finance lease liability on the condensed consolidated balance sheets. Amortization of capitalized leased assets is computed on the straight-line method over the term of the lease or the life of the related asset, whichever is shorter.
Business Combinations
The Company uses the acquisition method of accounting for business combinations. This method requires the use of significant estimates, assumptions and judgments in the determination of the estimated fair value of assets acquired and liabilities assumed in order to properly allocate the purchase price at the acquisition date. The estimates, assumptions and judgments are based in part on historical experience, industry data, information obtained from the management of the acquired companies and assistance from independent third-party appraisal firms. Examples of critical estimates include assigning values to the acquired identifiable intangible assets and valuing contingent consideration and earnout liabilities. For further information regarding the acquisitions, refer to Note 3, “Business Combinations” to the condensed consolidated financial statements.
Recent Accounting Pronouncements
In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update 2018-15 (“ASU 2018-15”), Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which amends ASC 350-40 to address a customer’s accounting for implementation costs incurred in a cloud computing arrangement (“CCA”) that is a service contract. The amendments in ASU 2018-15 align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. Specifically, ASU 2018-15 amends ASC 350 to include in its scope implementation costs of a CCA that is a service contract and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized in a CCA that is considered a service contract and which costs to expense. This guidance is effective for public companies for fiscal years, and interim fiscal periods within those fiscal years, beginning after December 15, 2019; early adoption is permitted. Entities are permitted to apply a retrospective or a prospective transition approach to adopt the guidance.  The Company early adopted ASU 2018-15 during the period ended March 31, 2019, on a prospective basis. The adoption of ASU 2018-15 did not have a material impact on the Company’s condensed consolidated financial statements.
The Company adopted ASU 2016-02, Leases (ASC 842), as of January 1, 2019, using the modified retrospective approach. The Company elected the ‘comparatives under ASC 840 option’ as a transitional practical expedient, which allows the Company to initially apply the new lease requirements at the effective date and recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. It also allows the Company to report comparative periods in the financial statements under previous GAAP under ASC 840, Leases (“ASC 840”). The Company also elected the ‘package of practical expedients’ permitted under the transition guidance, which allowed the Company to (i) carry forward the historical lease classification, (ii) forgo reassessment of whether any expired or existing contracts contain leases, and (iii) forgo reassessment of whether any previously unamortized initial direct costs continue to meet the definition of initial direct costs under ASC 842. The Company did not, however, elect the ‘hindsight’ practical expedient to reassess the lease term for existing leases. Additionally, the Company does not have land easements, therefore, practical expedients pertaining to land easements are not applicable to the Company.
For the accounting policy practical expedients, the Company elected the short-term lease exemption, under which any lease less than 12 months is excluded from recognition on the balance sheet. The Company elected not to recognize right of use assets and lease liabilities for short term leases, which has a lease term of 12 months or less and does not include an option to


9



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

purchase the underlying asset that the Company is reasonably certain to exercise. Additionally, the Company elected the non-separation of lease and non-lease components, and as a result, the Company does not need to account for lease components (e.g., fixed payments including rent) separately from the non-lease components (e.g., common-area maintenance costs).
Upon adoption of ASC 842, the Company recorded right-of-use assets of approximately $25.2 million, with corresponding operating lease liabilities of approximately $31.8 million, respectively, with an offset to accounts payable and accrued liabilities and other long-term liabilities of approximately $8.4 million to eliminate accrued rent and an offset to prepaid and other current assets of $1.7 million on the consolidated balance sheet as of January 1, 2019. The Company also derecognized an existing construction-in-process of approximately $8.6 million, with a corresponding debt obligation of the same amount for an asset under construction in build-to-suit lease arrangements. However, when the Company completed the related build-to-suit construction in April 2019, the Company recognized a right-of-use asset and lease liability on its balance sheet for the associated lease.
There was no adjustment to the opening balance of retained earnings upon adoption of the new standard given the nature of the impacts and the other transition practical expedients elected by the Company. Adoption of the standard impacted the Company’s previously reported results on January 1, 2019, as follows (in thousands):
 
Closing balance at December 31, 2018
 
Adjustments due to ASC 842
 
Opening balance at January 1, 2019
Assets
 
 
 
 
 
Prepaid and other current assets
$
18,255

 
$
(1,745
)
 
$
16,510

Property and equipment, net
$
16,860

 
$
(8,634
)
 
$
8,226

Operating lease assets (1) (2)
$

 
$
25,165

 
$
25,165

Liabilities and stockholder’s equity
 
 
 
 
 
Accounts payable and accrued liabilities
$
62,792

 
$
13,177

 
$
75,969

Noncurrent operating lease liabilities (3)
$
3,183

 
$
10,243

 
$
13,426

Lease financing obligation
$
8,634

 
$
(8,634
)
 
$

(1) 
Represents the reclassification of prepaid rent to operating lease assets
(2) 
Represents capitalization of operating lease assets
(3) 
Represents recognition of operating lease liabilities; Previously disclosed as rent liability for the portion related to accrued rent.

The standard did not materially impact the Company’s consolidated net earnings and had no material impact on the condensed consolidated statement of cash flows. For further information regarding leases, refer to Note 10, “Lease Obligations” to the condensed consolidated financial statements.
In June 2018, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The update requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The update requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. The update is effective for SEC filers for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will adopt this standard on January 1, 2020, and does not believe the adoption of ASU 2016-13 will have a material impact on the Company’s consolidated financial statements.


10



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

3. Business Combinations
Acquisition of FullStack Academy, Inc.
On April 1, 2019, the Company acquired Fullstack, a coding academy headquartered in New York, by acquiring all of the outstanding shares, pursuant to an Agreement and Plan of Reorganization (the “Fullstack Merger Agreement”). As of March 31, 2019, Fullstack had a carrying value of approximately $7.1 million of assets, excluding goodwill. At the closing of the Fullstack acquisition, the equityholders of Fullstack received consideration consisting of $17.5 million in cash (less purchase price adjustments of approximately $2.0 million, plus third-party expenses of approximately $2.0 million), and an aggregate of approximately 2,443,260 shares of the Company’s common stock, subject to escrow adjustments. Additionally, under the Fullstack Merger Agreement, the equityholders of Fullstack will be entitled to receive up to 2,250,000 shares of the Company’s common stock (the “Fullstack Contingent Consideration”). The Fullstack Merger Agreement contains an employee incentive retention pool of up to $5.0 million in cash, payable at times over a two-year period.
The assets and liabilities of Fullstack will be recorded on the Company’s condensed consolidated balance sheets at their preliminary estimated fair values as of April 1, 2019, the acquisition date. Fullstack’s results of operations will be included in the Company’s condensed consolidated statements of income (loss) from that date. Fullstack recognized revenue of $2.4 million, had an operating loss of $4.0 million, and net loss of $4.0 million for the three months ended June 30, 2019. For the three and six months ended June 30, 2019, the Company recorded acquisition-related expenses of $0.3 million and $0.9 million, respectively, in general and administrative on the condensed consolidated statement of income (loss), associated with the Fullstack acquisition. The Company accounts for business combinations using the acquisition method of accounting.
The following table summarizes the preliminary purchase price, as well as the preliminary allocation of the purchase price relating to the assets and liabilities purchased (in thousands):
Estimated cash consideration for acquired assets
$
17,540

Estimated fair value of equity
12,336

Preliminary fair value of contingent consideration payable
3,250

Total estimated purchase price
$
33,126

Preliminary Purchase Price Allocation:
 
Cash and cash equivalents
$
585

Accounts receivable
5,604

Prepaid and other assets
665

Property and equipment
167

Operating lease assets
1,297

Intangible assets
11,605

Other long-term assets
20

Accounts payable and accrued liabilities
(496
)
Deferred revenue
(2,350
)
Long-term liabilities
(1,297
)
Total identifiable net assets acquired
$
15,800

Deferred tax liability
(2,165
)
Goodwill
19,491

Total estimated purchase consideration
$
33,126

The fair value of the consideration to be paid exceeded the fair value of the net assets acquired and liabilities assumed, resulting in goodwill being recorded. Goodwill arising from the acquisition consists largely of future performance expected to be generated from new university and student relationships. None of the goodwill recognized is expected to be deductible for


11



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

income tax purposes. The above purchase price and purchase price allocation are preliminary and subject to future revision as the acquired assets and liabilities assumed are dependent upon the finalization of the related valuations. The fair values assigned to assets acquired and liabilities assumed for Fullstack are based upon managements best estimates and assumptions as of the reporting date, and are considered preliminary pending finalization of the valuations pertaining to tax liabilities assumed, including the calculation of deferred tax assets and liabilities.
The fair value of the common shares issued as part of the consideration paid was determined on the basis of the closing market price of the Company’s shares on the acquisition date, and also incorporated a discount for lack of marketability rates for various holding periods.
The Fullstack Contingent Consideration will become issuable, subject to the terms and conditions of the Fullstack Merger Agreement. Of the total contingent 2,250,000 shares, (i) 1,250,000 are based upon final determination of the achievement of certain employee retention and is being expensed over the retention period, (ii) 500,000 shares are based upon revenue performance in 2019 and 2020, earning on a sliding scale, in the event that the revenues for Fullstack are between $25.0 million and $35.0 million, and (iii) 500,000 shares are based upon contract performance milestones in 2019 and 2020, earned on a sliding scale, in the event that Fullstack obtains between 4 and 8 new university contracts. The fair value of the performance based Fullstack Contingent Consideration arrangements was estimated by applying a Monte Carlo simulation, based upon the result of forecast information. These measures are based upon significant inputs that are not observable by the market, and are therefore deemed to be Level 3 inputs. At each subsequent reporting date, the Company will remeasure the contingent consideration and recognize any changes in value. If the probability of achieving the performance target significantly changes from what was initially anticipated, the change could have a significant impact on the Company’s financial statements in the period recognized.
Acquisition of TutorMe.com, Inc.
On April 3, 2019, the Company acquired TutorMe, a provider of on-demand tutoring and online courses, headquartered in California, by acquiring all of the outstanding shares, pursuant to an Agreement and Plan of Reorganization (the “TutorMe Merger Agreement”). As of March 31, 2019, TutorMe had a carrying value of approximately $0.6 million of assets, excluding goodwill. At the closing of the TutorMe acquisition, in exchange for all outstanding shares of TutorMe capital stock and other rights to acquire or receive capital stock of TutorMe, the Company (i) paid a total of approximately $2.8 million in cash, subject to certain purchase price adjustments, (ii) issued a total of 309,852 shares of the Company’s common stock, and (iii) assumed all issued and outstanding options of TutorMe (the “Assumed Options”), of which a total of 231,406 shares of the Company’s common stock are underlying the Assumed Options that are subject to certain time-based vesting requirements and a total of 79,199 shares of the Company’s common stock are underlying the Assumed Options that are subject to certain performance-based vesting requirements. In addition, as part of the transactions contemplated by the TutorMe Merger Agreement, the Company (x) paid a total of approximately $1.2 million in cash to certain service providers of TutorMe as a transaction bonus and (y) issued a total of 293,621 PSUs to certain continuing service providers of TutorMe pursuant to the Company’s 2009 Stock Incentive Plan (as amended) and a form restricted stock unit agreement.
The assets and liabilities of TutorMe will be recorded on the Company’s condensed consolidated balance sheets at their preliminary estimated fair values as of April 3, 2019, the acquisition date. TutorMe’s results of operations will be included in the Company’s condensed consolidated statements of income (loss) from that date. TutorMe recognized revenue of $0.2 million, had an operating loss of $0.7 million, and net loss of $0.7 million for the three months ended June 30, 2019. For the three and six months ended June 30, 2019, the Company recorded acquisition-related expenses of $0.3 million and $0.6 million, respectively, in general and administrative on the condensed consolidated statement of income (loss), associated with the TutorMe Acquisition. The Company accounts for business combinations using the acquisition method of accounting.
The following table summarizes the preliminary purchase price, as well as the preliminary allocation of the purchase price relating to the assets and liabilities purchased (in thousands):
Estimated cash consideration for acquired assets
$
3,028

Estimated fair value of equity
2,026

Total estimated purchase price
$
5,054



12



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

Preliminary Purchase Price Allocation:
 
Cash and cash equivalents
$
214

Accounts receivable
46

Intangible assets
1,730

Accounts payable and accrued liabilities
(35
)
Deferred revenue
(200
)
Long-term liabilities
(3
)
Total identifiable net assets acquired
$
1,752

Deferred tax liability
(260
)
Goodwill
3,562

Total estimated purchase consideration
$
5,054

The fair value of the consideration to be paid exceeded the fair value of the net assets acquired and liabilities assumed, resulting in goodwill being recorded. Goodwill arising from the acquisition consists largely of future performance expected to be generated from new university and student relationships, as well as the developed technology. None of the goodwill recognized is expected to be deductible for income tax purposes. The above purchase price and purchase price allocation are preliminary and subject to future revision as the acquired assets and liabilities assumed are dependent upon the finalization of the related valuations. The fair values assigned to assets acquired and liabilities assumed for TutorMe are based upon managements best estimates and assumptions as of the reporting date, and are considered preliminary pending finalization of the valuations pertaining to tax liabilities assumed, including the calculation of deferred tax assets and liabilities.
The fair value of equity includes the common shares issued as part of the consideration paid was determined on the basis of the closing market price of the Company’s shares on the acquisition date, which also incorporated a discount for lack of marketability rates for various holding periods.
4. Revenue Recognition
Revenues are recognized when control of the promised goods or services are transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled in exchange for those goods or services. Determining whether a valid customer contract exists includes an assessment of whether amounts due under the contract are collectible. The Company performs this assessment at the beginning of every contract and subsequently thereafter if new information indicates there has been a significant change in facts and circumstances.
The Company’s contracts with customers generally include multiple performance obligations, which it identifies by assessing whether each good and service promised in the contract is distinct. For each performance obligation, the Company allocates the transaction price, including fixed and variable consideration, on the basis of the relative standalone selling prices of each good and service in the contract, which is determined using observable prices.
The following table presents the Company’s net revenue disaggregated based on the revenue source (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Tuition revenue, net
$
97,729

 
$
107,795

 
$
196,686

 
$
215,001

Digital materials revenue, net
6,201

 
6,638

 
13,058

 
12,666

Technology fee revenue, net
3,094

 
4,058

 
6,525

 
7,085

Other revenue, net (1)
471

 
546

 
990

 
1,062

Total revenue, net
$
107,495

 
$
119,037

 
$
217,259

 
$
235,814

(1) Primarily consists of revenues generated from services such as graduation fees, transcript fees, and other miscellaneous services.


13



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)


The following table presents the Company’s net revenue disaggregated based on the timing of revenue recognition (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Over time, over period of instruction
$
88,732

 
$
102,868

 
$
179,446

 
$
205,171

Over time, full tuition grant (1)
12,888

 
9,514

 
25,310

 
17,838

Point in time (2)
5,875

 
6,655

 
12,503

 
12,805

Total revenue, net
$
107,495

 
$
119,037

 
$
217,259

 
$
235,814

(1)
Represents revenue generated from the FTG program.
(2)
Represents revenue generated from digital textbooks and other miscellaneous fees.

The Company operates under one reportable segment. The Company generates the majority of its revenue from tuition, technology fees, and digital materials related to students whose primary funding source is governmental funding. Tuition represents amounts charged for course instruction, and technology fees represent amounts charged for the students’ use of the technology platform on which course instruction is delivered. Digital materials fees represent amounts charged for the digital textbooks that accompany the majority of courses taught at Ashford University. With the exception of students attending courses within the three-week conditional admission, the majority of tuition and technology fees are recognized as revenue as control of the services is transferred to the student, which occurs over the applicable period of instruction. Similarly, the majority of digital materials fees are recognized as revenue when control of the product has been transferred to the student, which occurs when the student is granted unrestricted access to the digital textbook, generally, on the first day of the course. Revenue generated from students within the conditional admission period is deferred and recognized when the student matriculates into Ashford University, which occurs in the fourth week of the course.
Ashford University’s online students generally enroll in a program that encompasses a series of five to six-week courses that are taken consecutively over the length of the program. With the exception of those students under conditional admission and students enrolled under the FTG program, online students are billed on a payment period basis on the first day of a course. Students under conditional admission are billed for the payment period upon matriculation.
If a student's attendance in a class precedes the receipt of cash from the student's source of funding, the Company establishes an account receivable and corresponding deferred revenue in the amount of the tuition due for that payment period. Cash received either directly from the student or from the student's source of funding reduces the balance of accounts receivable due from the student. Financial aid from sources such as the federal government's Title IV programs pertains to the online student's award year and is generally divided into two disbursement periods. As such, each disbursement period may contain funding for up to four courses. Financial aid disbursements are typically received during the online student's attendance in the first or second course. Since the majority of disbursements cover more courses than for which a student is currently enrolled, the amount received in excess effectively represents a prepayment from the online student for up to four courses. At the end of each accounting period, the deferred revenue and related account receivable balances are reduced to present amounts attributable to the current course.
In certain cases, Ashford University provides scholarships to students who qualify under various programs. These scholarships are recognized as direct reductions of revenue consistent with the timing of recognition associated with the related performance obligations. Also, for some customers, we do not expect to collect 100% of the consideration to which we are contractually entitled and, as a result, those customers may receive discounts or price adjustments that, based on historical Company practice, represent implied price concessions and are accounted for as variable consideration. The majority of these price concessions relate to amounts charged to students for goods and services, which management has determined will not be covered by the student’s primary funding source (generally, government aid) and, as a result, the student will become directly financially responsible for them. The reduction in the transaction price that results from this estimate of variable consideration reflects the amount the Company does not expect to be entitled to in exchange for the goods and services it will transfer to the students, as determined using historical experience and current factors, and includes performing a constraint analysis. These


14



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

estimates of variable consideration are recorded as direct reductions of revenue consistent with the timing of recognition associated with the related performance obligation.
A portion of tuition revenue, technology fee revenue, and digital materials revenue is generated from contracts with students enrolled under the FTG program, which is a 12-month grant that, when combined with a corporate partner’s annual tuition assistance program, enables eligible students to earn their degree without incurring student loan debt. Students enrolled under this program are eligible to take up to ten undergraduate or eight graduate courses per 12-month grant period and must first utilize 100% of the funds awarded under their employer’s annual tuition assistance program before they can be awarded the FTG grant. The grants awarded by Ashford University under the FTG program are considered a material right, and, as such, the Company records a contract liability for a portion of the consideration received or due under these contracts. The contract liability is recorded in deferred revenue and student deposits on the Company’s condensed consolidated balance sheets, and further discussed in the deferred revenue section below. The standalone selling price of the material right is determined based on the observable standalone selling price of the courses. The transaction price in each FTG contract is allocated to this material right on a relative standalone selling price basis. The contract liability is recognized as revenue at the earlier of satisfaction of the future obligation or its expiration. Billing of products and services transferred under a FTG student contract generally occurs after the conclusion of a course. There are no material differences between the timing of the products and services transferred and the payment terms.
Deferred Revenue
Deferred revenue consists of cash payments that are received or due in advance of the Company’s performance as well as deferrals associated with certain contracts that include a material right.
Below are the opening and closing balances of deferred revenue from the Company’s contracts with customers (in thousands):
 
Six Months Ended June 30,
 
2019
 
2018
Deferred revenue opening balance, January 1
$
21,768

 
$
22,001

Deferred revenue closing balance, June 30
24,009

 
24,388

Increase (Decrease)
$
2,241

 
$
2,387

For further information on deferred revenue and student deposits, refer to Note 8, “Other Significant Balance Sheet Accounts - Deferred Revenue and Student Deposits” and for further information on receivables, refer to Note 7, “Accounts Receivable, Net” within the condensed consolidated financial statements.
For the majority of the Company’s customers, payment for products and services is due at the beginning of each course. Under special circumstances, some customers may be offered non-interest bearing payment plan arrangements that can extend for up to a maximum of three years. These payment plan arrangements give rise to significant financing components. However, since the Company historically collects substantially all of the consideration to which it expects to be entitled under such payment plans within one year or less, the impact of these significant financing components is not material to any period presented.
The difference between the opening and closing balances of deferred revenue primarily results from the timing difference between the Company’s performance and the customer’s payment. For the six months ended June 30, 2019, the Company recognized $21.3 million of revenue that was included in the deferred revenue balance as of January 1, 2019. For the six months ended June 30, 2018, the Company recognized $21.6 million of revenue that was included in the deferred revenue balance as of January 1, 2018. Amounts reported in the closing balance of deferred revenue are expected to be recognized as revenue within the next 12 months.


15



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

5. Restructuring and Impairment Expense
During the three and six months ended June 30, 2019, the Company recognized $5.4 million and $5.4 million, respectively, of restructuring and impairment expense. During the three and six months ended June 30, 2018, the Company recognized $2.7 million and $2.6 million, respectively, of restructuring and impairment expense. These restructuring and impairment charges were comprised of the components described below.
The Company had previously vacated or consolidated properties in San Diego and Denver, and subsequently reassessed its obligations on non-cancelable leases. As a result of these reassessments, during the three and six months ended June 30, 2019 the Company recognized expense of approximately $0.5 million and $0.6 million, respectively. During the three and six months ended June 30, 2018, the Company recognized expense of approximately $1.7 million and $1.2 million, respectively.
For both the three and six months ended June 30, 2019, the Company recognized $5.0 million, respectively, as restructuring and impairment expense relating to severance costs for wages and benefits. There is an additional $2.2 million of related costs that will be recognized in the remainder of 2019, relating to employees that are required to render service. For the three and six months ended June 30, 2018, the Company recognized $0.7 million and $1.0 million, respectively, as restructuring and impairment expense relating to severance costs for wages and benefits, due to the Company’s execution of a strategic reorganization resulting in reductions in force. The reorganization was part of the Company’s overall reassessment of resources based upon benchmarking activities with competitors in the Company’s industry.
For both the three and six months ended June 30, 2019, the Company recognized a credit of $0.1 million, respectively, as a reversal to restructuring and impairment, relating to the closure of a component of the Company's business, which was originally recorded in the fourth quarter of 2018. No such credit/expense was recorded for the three and six months ended June 30, 2018.
The following table summarizes the amounts recorded in the restructuring and impairment charges line item on the Company’s condensed consolidated statements of income (loss) for each of the periods presented (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Asset impairment
$

 
$
325

 
$

 
$
325

Student transfer agreement costs
(139
)
 

 
(139
)
 

Severance costs
5,011

 
671

 
5,011

 
1,018

Lease exit and other costs
522

 
1,733

 
551

 
1,227

Total restructuring and impairment expense
$
5,394

 
$
2,729

 
$
5,423

 
$
2,570

The following table summarizes the changes in the Company's restructuring and impairment liability by type during the six months ended June 30, 2019 (in thousands):
 
Student Transfer Agreement Costs
 
Severance Costs
 
Lease Exit and Other Costs
 
Total
Balance at December 31, 2018
$
1,503

 
$
267

 
$
2,864

 
$
4,634

Restructuring and impairment expense
(139
)
 
5,011

 
551

 
5,423

Payments and adjustments
(13
)
 
(1,121
)
 
(2,489
)
 
(3,623
)
Balance at June 30, 2019
$
1,351

 
$
4,157

 
$
926

 
$
6,434

The restructuring liability amounts are recorded within either the (i) accounts payable and accrued liabilities account, (ii) lease liability account or (iii) other long-term liabilities account on the condensed consolidated balance sheets.


16



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

6. Fair Value Measurements
The following tables summarize the fair value information as of June 30, 2019 and December 31, 2018, respectively (in thousands):
 
As of June 30, 2019
 
Level 1
 
Level 2
 
Level 3
 
Total
Mutual funds
$
2,344

 
$

 
$

 
$
2,344

Contingent consideration
$

 
$

 
$
3,250

 
$
3,250

 
As of December 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
Mutual funds
$
2,068

 
$

 
$

 
$
2,068

The mutual funds in the tables above, represent the deferred compensation asset balances, which are considered to be trading securities. There were no transfers between level categories for investments during the periods presented. The Company’s deferred compensation asset balances are recorded in the investments line item on the Company’s condensed consolidated balance sheets, and are classified as Level 1 securities.
There were no differences between amortized cost and fair value of investments as of June 30, 2019 and December 31, 2018, respectively. There were no reclassifications out of accumulated other comprehensive income during either the six months ended June 30, 2019 and 2018.
The contingent consideration relates to shares to be issued as part of the acquisition of Fullstack. The contingent consideration is recorded in the other long-term liabilities line item on the Company’s condensed consolidated balance sheets, and are classified as Level 3 securities. For further information regarding acquisitions, refer to Note 3, “Business Combinations” to the condensed consolidated financial statements. The fair value of accrued contingent consideration is remeasured each reporting period. Increases or decreases in projected revenue and the related probabilities of achieving the forecast results, may result in a higher or lower fair value measurement. Changes in fair value resulting from changes in the likelihood of contingent payments are included in the condensed consolidated statements of income (loss).
7. Accounts Receivable, Net
Accounts receivable, net, consists of the following (in thousands):
 
As of
June 30, 2019
 
As of
December 31, 2018
Accounts receivable
$
43,563

 
$
39,195

Less allowance for doubtful accounts
9,843

 
12,180

Accounts receivable, net
$
33,720

 
$
27,015

There is an immaterial amount of accounts receivable, net, at each balance sheet date with a payment due date of greater than one year.


17



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

The following table presents the changes in the allowance for doubtful accounts for accounts receivable for the periods indicated (in thousands):
 
Beginning
Balance
 
Charged to
Expense
 
Deductions (1)
 
Ending
Balance
Allowance for doubtful accounts receivable:
 
 
 
 
 
 
 
For the six months ended June 30, 2019
$
12,180

 
$
7,525

 
$
(5,188
)
 
$
9,843

For the six months ended June 30, 2018
$
15,189

 
$
11,872

 
$
(9,227
)
 
$
12,544

(1)
Deductions represent accounts written off, net of recoveries.
8. Other Significant Balance Sheet Accounts
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consists of the following (in thousands):
 
As of
June 30, 2019
 
As of
December 31, 2018
Prepaid expenses
$
4,627

 
$
5,445

Prepaid licenses
6,398

 
5,840

Prepaid income taxes
198

 

Income tax receivable
4,241

 
5,044

Prepaid insurance
1,639

 
1,077

Insurance recoverable
911

 
723

Other current assets
7,740

 
126

Total prepaid expenses and other current assets
$
25,754

 
$
18,255

Property and Equipment, Net
Property and equipment, net, consists of the following (in thousands):
 
As of
June 30, 2019
 
As of
December 31, 2018
Buildings, build-to-suit
$

 
$
10,434

Furniture and office equipment
43,728

 
31,227

Software
7,652

 
7,517

Leasehold improvements
15,134

 
3,430

Vehicles
22

 
22

Total property and equipment
66,536

 
52,630

Less accumulated depreciation and amortization
(38,040
)
 
(35,770
)
Total property and equipment, net
$
28,496

 
$
16,860

For the three months ended June 30, 2019 and 2018, depreciation and amortization expense related to property and equipment was $1.3 million and $1.1 million, respectively. For the six months ended June 30, 2019 and 2018, depreciation and amortization expense was $2.3 million and $2.2 million, respectively.


18



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

Goodwill and Intangibles, Net
Goodwill and intangibles, net, consists of the following (in thousands):
 
June 30, 2019
Definite-lived intangible assets:
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Capitalized curriculum costs
$
20,923

 
$
(19,365
)
 
$
1,558

Purchased intangible assets
29,185

 
(8,670
)
 
20,515

   Total definite-lived intangible assets
$
50,108

 
$
(28,035
)
 
$
22,073

Goodwill and indefinite-lived intangibles
 
 
 
 
25,126

Total goodwill and intangibles, net
 
 
 
 
$
47,199

 
 
 
 
 
 
 
December 31, 2018
Definite-lived intangible assets:
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Capitalized curriculum costs
$
21,076

 
$
(19,338
)
 
$
1,738

Purchased intangible assets
15,850

 
(7,219
)
 
8,631

   Total definite-lived intangible assets
$
36,926

 
$
(26,557
)
 
$
10,369

Goodwill and indefinite-lived intangibles
 
 
 
 
2,072

Total goodwill and intangibles, net
 
 
 
 
$
12,441

The increase in goodwill relates to our acquisitions of Fullstack and TutorMe. For further information regarding the acquisitions, refer to Note 3, “Business Combinations” to the condensed consolidated financial statements. The amount of goodwill recognized is subject to change, pending the final determination of the fair value of assets acquired and liabilities assumed in connection with the acquisitions.
For the three months ended June 30, 2019 and 2018, amortization expense was $1.4 million and $0.7 million, respectively. For the six months ended June 30, 2019 and 2018, amortization expense was $1.9 million and $1.3 million, respectively.
The following table summarizes the estimated remaining amortization expense as of each fiscal year ended below (in thousands):
Year Ended December 31,
 
 
Remainder of 2019
$
2,665

2020
5,205

2021
4,015

2022
3,380

2023
3,300

Thereafter
3,508

Total future amortization expense
$
22,073



19



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consists of the following (in thousands):
 
As of
June 30, 2019
 
As of
December 31, 2018
Accounts payable
$
8,260

 
$
5,313

Accrued salaries and wages
11,918

 
7,807

Accrued bonus
3,596

 
8,147

Accrued vacation
6,042

 
7,929

Accrued litigation and fees
8,041

 
8,041

Accrued expenses
29,708

 
17,692

Current leases payable
14,035

 
5,768

Accrued insurance liability
2,286

 
2,095

Total accounts payable and accrued liabilities
$
83,886

 
$
62,792

Deferred Revenue and Student Deposits
Deferred revenue and student deposits consists of the following (in thousands):
 
As of
June 30, 2019
 
As of
December 31, 2018
Deferred revenue
$
24,009

 
$
21,768

Student deposits
35,375

 
42,066

Total deferred revenue and student deposits
$
59,384

 
$
63,834

Other Long-Term Liabilities
Other long-term liabilities consists of the following (in thousands):
 
As of
June 30, 2019
 
As of
December 31, 2018
Uncertain tax positions
$
873

 
$
865

Contingent consideration
3,250

 

Other long-term liabilities
2,433

 
2,570

Total other long-term liabilities
$
6,556

 
$
3,435

9. Credit Facilities
The Company has issued letters of credit that are collateralized with cash (held in restricted cash) in the aggregate amount of $16.6 million as of June 30, 2019. Included in this balance is $5.7 million of letters of credit recorded as long-term restricted cash as of June 30, 2019.
As part of its normal business operations, the Company is required to provide surety bonds in certain states in which the Company does business. The Company has entered into a surety bond facility with an insurance company to provide such bonds when required. As of June 30, 2019, the Company’s total available surety bond facility was $8.5 million and the surety had issued bonds totaling $8.1 million on the Company’s behalf under such facility.


20



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

10. Lease Obligations
Operating Leases
The Company leases various office facilities which expire at various dates through 2023. These facilities are used for academic operations, corporate functions, enrollment services and student support services. The Company does not have any leases other than its office facilities. All of the leases were classified as operating leases for the period ended June 30, 2019, and the Company does not have any finance leases. All of the leases, other than those that may qualify for the short-term scope exception of 12 months or less, are recorded on the Company’s condensed consolidated balance sheets.
During 2018, the Company entered into a lease agreement, which commenced in April 2019, consisting of approximately 131,000 square feet of office space located in Chandler, Arizona, which extends through 2030. The Company is involved in the construction and the build-out of the space, and as such, serves as the construction agent on behalf of the landlord. Under such arrangement, the Company has obligations to fund cost over-runs in its capacity as the construction agent. The Company has determined that under the new lease accounting standard ASC 842, it does not have control during construction, and as such has derecognized the asset and financing obligation as of January 1, 2019.
As of June 30, 2019, the lease amounts on the condensed consolidated balance sheets do not include any options to extend, nor any options for early termination. The Company’s lease agreements do not include rental payments adjusted periodically for inflation. The Company’s lease agreements do not contain any residual value guarantees or restrictive covenants. The Company is not a party to any related party arrangements with respect to its lease transactions.
Some of the more significant assumptions and judgments in determining the amounts to capitalize include the determination of the discount rate, which is discussed below.
Rental expense for the three and six months ended June 30, 2019 was $5.3 million and $9.7 million, respectively, calculated in accordance with ASC 842, and rental expense for the three and six months ended June 30, 2018 was $3.7 million and $7.6 million, respectively, calculated in accordance with ASC 840.
The Company has agreements to sublease certain portions of its office facilities, with three active subleases as of June 30, 2019. The Company’s subleases do not include any options to extend, nor any options for early termination. The Company’s subleases do not contain any residual value guarantees or restrictive covenants. All of the subleases were classified as operating leases for the period ended June 30, 2019. The Company is subleasing approximately 28,400 square feet of office space in San Diego, California with a remaining commitment to lease of 10 months and net lease payments of $0.6 million. The Company is subleasing approximately 72,200 square feet of office space in Denver, Colorado with a remaining commitment to lease of 26 months and net lease payments of $2.1 million. In April 2019, the Company entered into a sublease agreement of approximately 21,000 square feet of office space in Denver, Colorado with a remaining commitment to lease of 44 months and net lease payments of $2.1 million. Sublease income for the six months ended June 30, 2019 and 2018 was $1.6 million (in accordance with ASC 842) and $1.4 million (in accordance with ASC 840), respectively.
The following tables represent the classification and amounts recorded on the condensed consolidated balance sheets as of June 30, 2019 (in thousands):
Operating lease assets:
 
Arizona
$
8,653

California
7,738

Colorado
8,799

Iowa
170

New York
589

Other
312

Total
$
26,261



21



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

Operating lease liabilities:
 
Accounts payable and accrued liabilities
$
14,035

Rent liability
24,928

Total
$
38,963

The following table represents the classification and amounts recorded on the condensed consolidated statements of income (loss) for the six months ended June 30, 2019 (in thousands):
Operating lease costs
$
9,345

Short-term lease cost
79

Variable lease costs (1)
270

Less: Sub-lease income
(1,592
)
Total net lease costs
$
8,102

(1)
Variable components of the lease payments such as utilities, taxes and insurance, parking and maintenance costs.

The following table represents the maturities of lease liabilities as of June 30, 2019 (in thousands):
Remainder of 2019
$
9,827

2020
9,992

2021
6,494

2022
3,921

2023
2,750

2024
2,406

Thereafter
15,304

Total minimum payments
$
50,694

Less: Interest (1)
(11,731
)
Total net lease liabilities
$
38,963

(1)
Calculated using an appropriate interest rate for each individual lease. See the weighted-average discount rate noted below.

The following table summarizes the future minimum rental payments under non-cancelable operating lease arrangements in effect at December 31, 2018 (in thousands):
Year Ended December 31,
 
 
2019
$
20,382

2020
9,936

2021
6,460

2022
3,826

2023
2,726

Thereafter
17,710

Total minimum payments
$
61,040



22



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

The following table represents the lease term and discount rate used in the calculations as of June 30, 2019:
Weighted-average remaining lease term (in years):
 
  Operating leases
5.9 years

Weighted-average discount rate:
 
  Operating leases
7.4
%
The following table represents the cash flow information of operating leases for the six months ended June 30, 2019 (in thousands):
Cash paid for amounts included in the measurement of lease liabilities:
 
Operating cash flows from operating leases
$
11,517

11. Income (Loss) Per Share
Basic income (loss) per share is calculated by dividing net income (loss) available to common stockholders for the period by the weighted average number of common shares outstanding for the period.
Diluted income (loss) per share is calculated by dividing net income (loss) available to common stockholders for the period by the sum of (i) the weighted average number of common shares outstanding for the period, plus (ii) potentially dilutive securities outstanding during the period, if the effect is dilutive. Potentially dilutive securities for the periods presented include stock options, unvested restricted stock units (“RSUs”) and unvested performance stock units (“PSUs”).
The following table sets forth the computation of basic and diluted income (loss) per share for the periods indicated (in thousands, except per share data):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
(17,597
)
 
$
15,080

 
$
(24,239
)
 
$
16,390

Denominator:
 
 
 
 
 
 
 
Weighted average number of common shares outstanding
30,215

 
27,170

 
28,706

 
27,167

Effect of dilutive options and stock units

 
178

 

 
324

Diluted weighted average number of common shares outstanding
30,215

 
27,348

 
28,706

 
27,491

Income (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.58
)
 
$
0.56

 
$
(0.84
)
 
$
0.60

Diluted
$
(0.58
)
 
$
0.55

 
$
(0.84
)
 
$
0.60

The following table sets forth the number of stock options, RSUs and PSUs, excluded from the computation of diluted income (loss) per share for the periods indicated below because their effect was anti-dilutive (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Stock options
1,973

 
2,847

 
1,987

 
2,859

RSUs and PSUs
2,990

 
42

 
1,336

 
10



23



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

12. Stock-Based Compensation
The Company recorded $3.6 million and $1.2 million of stock-based compensation expense for the three months ended June 30, 2019 and 2018, respectively, and $5.3 million and $2.3 million of stock-based compensation expense for the six months ended June 30, 2019 and 2018, respectively. The related income tax benefit was $0.9 million and $0.3 million for the three months ended June 30, 2019 and 2018, respectively, and $1.3 million and $0.6 million for the six months ended June 30, 2019 and 2018, respectively.
During the six months ended June 30, 2019, the Company granted 1.2 million RSUs at a weighted average grant date fair value of $6.03 and 0.4 million RSUs vested. During the six months ended June 30, 2018, the Company granted 0.8 million RSUs at a grant date fair value of $6.75 and 0.3 million RSUs vested.
During the six months ended June 30, 2019, 0.8 million market-based PSUs were granted at a weighted average grant date fair value of $7.17 and no performance-based or market-based PSUs vested. During the six months ended June 30, 2018, no performance-based or market-based PSUs were granted and no performance-based or market-based PSUs vested.
During the six months ended June 30, 2019, the Company granted 0.2 million stock options at a grant date fair value of $4.28 and 6,274 stock options were exercised. During the six months ended June 30, 2018, the Company granted 35,088 stock options at a grant date fair value of $2.97 and no stock options were exercised.
As of June 30, 2019, there was unrecognized compensation cost of $15.7 million related to unvested stock options, RSUs and PSUs.
13. Income Taxes
The Company uses the asset-liability method to account for taxes. Under this method, deferred income tax assets and liabilities result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the condensed consolidated financial statements that will result in income and deductions in future years.
The Company recognizes deferred tax assets if realization of such assets is more-likely-than-not. In order to make this determination, the Company evaluates a number of factors including the ability to generate future taxable income from reversing taxable temporary differences, forecasts of financial and taxable income or loss, and the ability to carryback certain operating losses to refund taxes paid in prior years. The cumulative loss incurred over the three-year period ended June 30, 2019 constituted significant negative objective evidence against the Company’s ability to realize a benefit from its federal deferred tax assets. Such objective evidence limited the ability of the Company to consider in its evaluation certain subjective evidence such as the Company’s projections for future growth. On the basis of its evaluation, the Company determined that its deferred tax assets were not more-likely-than-not to be realized and that a valuation allowance against its deferred tax assets should continue to be maintained as of June 30, 2019.
The Company determines the interim income tax provision by applying the estimated effective income tax rate expected to be applicable for the full fiscal year to income before income taxes for the period. In determining the full year estimate, the Company does not include the estimated impact of unusual and/or infrequent items, which may cause significant variations in the customary relationship between income tax expense and income before income taxes.
The Company’s current effective income tax rate that has been applied to normal, recurring operations for the six months ended June 30, 2019 was (0.6)%. The Company’s actual effective income tax rate after discrete items was 9.0% for the six months ended June 30, 2019. The Company released approximately $2.4 million in valuation allowance as a result of tax benefits recorded in connection with our acquisitions during the second quarter of 2019 for which a deferred tax liability was established in purchase accounting.
As of June 30, 2019 and December 31, 2018, the Company had $0.9 million of gross unrecognized tax benefits, of which $0.7 million would impact the effective income tax rate if recognized. Although the Company cannot predict the timing of resolution with taxing authorities, if any, the Company believes it is reasonably possible that the total of the unrecognized tax benefits could change in the next twelve months due to settlement with tax authorities or expiration of the applicable statute of limitations. Although the Company believes the tax accruals provided are reasonable, the final determination of tax returns


24



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

under review or returns that may be reviewed in the future and any related litigation could result in tax liabilities that materially differ from the Company’s historical income tax provisions and accruals.
The Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The tax years 2001 through 2017 are open to examination by major taxing jurisdictions to which the Company is subject.
The Company is currently under Internal Revenue Service audit examinations of the Company’s income and payroll tax returns for the years 2013 through 2016.
The Company’s income tax returns for the tax years ended December 31, 2013 through 2015 are under examination by the California Franchise Tax Board. The audit examination is currently on hold until the Internal Revenue Service audit examination has been completed.
14. Regulatory
The Company is subject to extensive regulation by federal and state governmental agencies and accrediting bodies. In particular, the Higher Education Act of 1965, as amended (“Higher Education Act”), and the regulations promulgated thereunder by the U.S. Department of Education (“Department”) subject the Company to significant regulatory scrutiny on the basis of numerous standards that institutions of higher education must satisfy in order to participate in the various federal student financial aid programs under Title IV of the Higher Education Act (“Title IV programs”). Ashford University is regionally accredited by Western Association of Schools and Colleges Senior College and University Commission (“WSCUC”).
Department of Education Open Program Review of Ashford University
On July 7, 2016, Ashford University was notified by the Department that an off-site program review had been scheduled to assess Ashford University’s administration of the Title IV programs in which it participates. The off-site program review commenced on July 25, 2016 and covered students identified in the 2009-2012 calendar year data previously provided by Ashford University to the Department in response to a request for information received from the Multi-Regional and Foreign School Participation Division of the Department’s Office of Federal Student Aid (“FSA”) on December 10, 2015, but may be expanded if the Department deems such expansion appropriate.
On December 9, 2016, the Department informed Ashford University that it intended to continue the program review on-site at Ashford University. The on-site program review commenced on January 23, 2017 and initially covered the 2015-2016 and 2016-2017 award years, but may be expanded if the Department deems such expansion appropriate. To date, the Company has not received a draft report from the Department.
Program Participation Agreement for Ashford University
On April 23, 2018, Ashford University received an updated Program Participation Agreement from the Department. Based on the updated Program Participation Agreement, Ashford University is provisionally certified to participate in Federal Student Financial Aid Programs until March 31, 2021. Ashford University is required to submit its reapplication for continued certification by December 31, 2020.
WSCUC Accreditation of Ashford University
In July 2013, WSCUC granted Initial Accreditation to Ashford University for five years, until July 15, 2018. In December 2013, Ashford University effected its transition to WSCUC accreditation and designated its San Diego, California facilities as its main campus and its Clinton, Iowa campus as an additional location. As part of a continuing monitoring process, Ashford University hosted a visiting team from WSCUC on a special visit in April 2015. In July 2015, Ashford University received an Action Letter from WSCUC outlining the findings arising out of its visiting team's special visit. The Action Letter stated that the WSCUC visiting team found evidence that Ashford University continues to make progress in all six areas recommended by WSCUC in 2013. As part of its institutional review process, WSCUC commenced its comprehensive review of Ashford University with an off-site review in March 2018. Ashford University was notified on June 8, 2018 that the Ashford University


25



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

Accreditation Visit originally scheduled for fall 2018 had been rescheduled to April 3-5, 2019. The visit took place as scheduled and the WSCUC evaluation team provided a report of the visit. Ashford University then prepared a response to the report. The team report and Ashford University’s response were considered at the June 2019 WSCUC Commission meeting. On July 12, 2019, WSCUC notified Ashford University that it had reaffirmed its accreditation for six years.
In a separate action, Ashford University submitted a change of control and legal status application (the “Change of Control Application”) to convert to a nonprofit California public benefit corporation, and separate from the Company (the “Conversion Transaction”). On November 19, 2018 and March 6, 2019, WSCUC notified Ashford University that, pending the receipt and review of additional documents, WSCUC would defer any action on the Change of Control Application. Ashford University submitted the requested documentation related to the Conversion Transaction to WSCUC and the Change of Control Application was reconsidered by the assigned WSCUC evaluation team. The team’s report and recommendations were considered at the June 2019 WSCUC Commission meeting.
On July 12, 2019, WSCUC notified Ashford University that it had approved the Change of Control Application for the Conversion Transaction. The approval is subject to certain conditions which must be met prior to the close of the Conversion Transaction, including divestiture of financial and ownership interest in the Company by all Ashford University officers and related parties and submission of a revised services agreement with respect to the Conversion Transaction, including the incorporation of key performance indicators into that agreement. WSCUC is also requiring a post-implementation site visit of Ashford University within six months of the close of the Conversion Transaction. As part of the Conversion Transaction, Ashford University will become an independent, self-governed, nonprofit institution. Following the Conversion Transaction, the Company plans to operate as an education technology services company that will provide certain services to Ashford University and potentially, in the future, to other customers. The Company and Ashford University are continuing to finalize the terms of the Conversion Transaction pending the Department’s response to Ashford University’s preacquisition review application which is expected in the near future.
WSCUC also visited Ashford University on May 1, 2019 to conduct its federally mandated, six-month post-implementation review, due to the merger of University of the Rockies and into Ashford University which was finalized on October 31, 2018. WSCUC has verified that Ashford University has met all post-implementation requirements related to the merger of the two entities.
GI Bill Benefits
On May 20, 2016, the Company received a letter from the Iowa Department of Education (“Iowa DOE”) indicating that, as a result of the planned closure of the Clinton Campus, the Iowa State Approving Agency (“ISAA”) would no longer continue to approve Ashford University’s programs for benefits under the GI Bill after June 30, 2016, and recommending Ashford University seek approval through the State Approving Agency of jurisdiction for any location that meets the definition of a “main campus” or “branch campus.” Ashford University began the process of applying for approval through the State Approving Agency in California (“CSAAVE”), and the Company subsequently disclosed that on June 20, 2016 it received a second letter from the Iowa DOE indicating that the Iowa DOE had issued a stay of the ISAA’s withdrawal of approval of Ashford University’s programs for GI Bill benefits effective immediately until the earlier of (i) 90 days from June 20, 2016 or (ii) the date on which CSAAVE completed its review and issued a decision regarding the approval of Ashford University in California. Ashford University received communication from CSAAVE indicating that additional information and documentation would be required before Ashford University’s application could be considered for CSAAVE approval. Ashford University subsequently withdrew the CSAAVE application and continued working with the U.S. Department of Veterans Affairs (“VA”), the Iowa DOE and the ISAA to obtain continued approval of Ashford University’s programs for GI Bill benefits and to prevent any disruption of educational benefits to Ashford University’s veteran students.
On September 15, 2016, in response to a Petition for Declaratory and Injunctive Relief (“Petition”) filed by Ashford University, the Iowa District Court for Polk County entered a written order (“Order”) staying the Iowa DOE’s announced intention to withdraw the approval of Ashford University as a GI Bill eligible institution until the entry of a final and appealable order and judgment in the action. On June 23, 2017, the Iowa District Court held a hearing on Ashford University’s Petition and on July 17, 2017, the Court ruled in favor of the Iowa DOE and denied the petition. Ashford University filed a motion for reconsideration of this ruling, which was denied on August 17, 2017. On August 23, 2017, Ashford University filed a Petition to Vacate or Modify the Iowa District Court’s July 17, 2017 ruling, based on material evidence, newly discovered, which could not


26



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

with reasonable diligence have been previously discovered by Ashford University (“First Petition to Vacate”). On September 18, 2017, Ashford University appealed, inter alia, the July 17, 2017 ruling to the Iowa Supreme Court and posted an appeal bond, which stayed this matter pending resolution of Ashford University’s appeal. As a result, Ashford University’s approval was not withdrawn, and Ashford University’s programs remain approved for GI Bill purposes. The Assistant Attorney General handling this matter on behalf of the Iowa DOE also advised Ashford University that the Iowa DOE would take no action pending the post-ruling motions and appeal. On October 12, 2017, Judge Eliza Ovrom, the Iowa District Court Judge who issued the July 17, 2017 ruling, filed a Disclosure Statement revealing family ties to the Iowa Attorney General’s Office. Following motions by Ashford University for her recusal, Judge Ovrom recused herself from all further proceedings. On October 24, 2017, Ashford University filed with the Iowa Supreme Court a Petition to Vacate or, in the Alternative, for Limited Remand (“Second Petition to Vacate”), in which Ashford University argued that the July 17, 2017 ruling and all other material orders entered by Judge Ovrom should be vacated due to her previously undisclosed conflict of interest. On January 8, 2018, the Iowa Supreme Court remanded the Second Petition to Vacate to the District Court, where all proceedings in this matter were consolidated before Judge Michael Huppert. On April 26, 2018, Judge Huppert granted the Second Petition to Vacate and vacated all material rulings by Judge Ovrom, including the July 17, 2017 ruling, thus on June 21, 2018, the Iowa Supreme Court issued a Procedendo stating that the appeal was concluded. Judge Huppert’s decision mooted the First Petition to Vacate and Ashford’s appeal of, inter alia, the July 17, 2017 ruling. The case is now proceeding on the merits de novo before a new judge and Ashford filed its opening brief in support of the Petition on July 25, 2019.
On July 6, 2017, Ashford University received approval from the Arizona State Approving Agency (“ASAA”) to provide GI Bill benefits to its students. On September 13, 2017, the VA accepted the ASAA’s approval, subject to Ashford University's compliance with the approval requirements, and the University subsequently received a facility code from the VA. On November 9, 2017, the VA informed Ashford University that the ASAA had not provided sufficient evidence to establish that it has jurisdictional authority over Ashford University’s online programs. The VA stated that it intends to suspend payment of educational assistance and approval of new student enrollments and student re-enrollments for Ashford University’s online programs in 60 days unless corrective action was taken.
On November 17, 2017, Ashford University filed a petition for review in the United States Court of Appeals for the Federal Circuit challenging the VA’s actions. In response to that petition, the VA agreed to stay the actions with respect to the suspension and reenrollment it had announced on November 9, 2017 through the entry of judgment in the Federal Circuit case, on the condition that Ashford University request and submit an application for approval to CSAAVE on or before January 8, 2018. Ashford University submitted an application to CSAAVE for approval on January 5, 2018. On February 21, 2018, CSAAVE provided notice of its intention not to act on Ashford University’s initial application for approval for the training of veterans and other eligible persons. The notice directed Ashford University to request approval of its application by the VA. Ashford University continues to work in good faith with the VA while its petition for review remains pending with the Federal Circuit. In keeping with this commitment, Ashford University agreed, at the VA’s request, to submit another application to CSAAVE. Ashford University filed that additional application on November 19, 2018. On December 14, 2018, however, CSAAVE again informed Ashford University that it did not intend to act on Ashford University’s application, and again indicated that Ashford University could request approval of its application directly from the VA.
The parties completed all briefing for the petition for review on May 3, 2019 and the Court may schedule the matter for oral argument.


27



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

15. Commitments and Contingencies
Litigation
From time to time, the Company is a party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of business. When the Company becomes aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. In accordance with GAAP, the Company records loss contingencies in its financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated, the best estimate within that range should be accrued. If no estimate is better than another, the Company records the minimum estimated liability in the range. If the loss is not probable or the amount of the loss cannot be reasonably estimated, the Company discloses the nature of the specific claim if the likelihood of a potential loss is reasonably possible and the amount involved could be material. The Company continuously assesses the potential liability related to the Company’s pending litigation and revises its estimates when additional information becomes available. Below is a list of material legal proceedings to which the Company or its subsidiaries is a party.
California Attorney General Investigation of For-Profit Educational Institutions
In January 2013, the Company received from the Attorney General of the State of California (“CA Attorney General”) an Investigative Subpoena relating to the CA Attorney General’s investigation of for-profit educational institutions. Pursuant to the Investigative Subpoena, the CA Attorney General requested documents and detailed information for the time period March 1, 2009 to the date of the Investigative Subpoena. On July 24, 2013, the CA Attorney General filed a petition to enforce certain categories of the Investigative Subpoena related to recorded calls and electronic marketing data. On September 25, 2013, the Company reached an agreement with the CA Attorney General to produce certain categories of the documents requested in the petition and stipulated to continue the hearing on the petition to enforce from October 3, 2013 to January 9, 2014. On January 13, 2014 and June 19, 2014, the Company received additional Investigative Subpoenas from the CA Attorney General, each requesting additional documents and information for the time period March 1, 2009 through each such date.
Representatives from the Company met with representatives from the CA Attorney General’s office on several occasions to discuss the status of the investigation, additional information requests, and specific concerns related to possible unfair business practices in connection with the Company’s recruitment of students and debt collection practices.
The parties also discussed a potential resolution involving injunctive relief, other non-monetary remedies and a payment to the CA Attorney General and in the third quarter of 2016, the Company recorded an expense of $8.0 million related to the cost of resolving this matter.
The parties did not reach a resolution and on November 29, 2017, the CA Attorney General filed suit against Ashford University and Bridgepoint Education, now known as Zovio Inc.
The Company intends to vigorously defend this case and emphatically denies the allegations made by the CA Attorney General that it ever deliberately misled its students, falsely advertised its programs, or in any way was not fully accurate in its statements to investors. However, the outcome of this legal proceeding is uncertain at this point because of the many questions of fact and law that may arise. At present, the Company cannot reasonably estimate any updated range of loss for this action based on currently available information and as such, the prior accrual of $8.0 million remains.
Massachusetts Attorney General Investigation of Bridgepoint Education, Inc. and Ashford University
On July 21, 2014, the Company and Ashford University received from the Attorney General of the State of Massachusetts (“MA Attorney General”) a Civil Investigative Demand (“MA CID”) relating to the MA Attorney General’s investigation of for-profit educational institutions and whether the university’s business practices complied with Massachusetts consumer protection laws. Pursuant to the MA CID, the MA Attorney General has requested from the Company and Ashford University documents and information for the time period January 1, 2006 to present. The Company is cooperating with the investigation and cannot predict the eventual scope, duration or outcome of the investigation at this time. The Company has not accrued any liability associated with this action.


28



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

Department of Justice Civil Investigative Demand
On July 7, 2016, the Company received from the U.S. Department of Justice (“DOJ”) a Civil Investigative Demand (“DOJ CID”) related to the DOJ's investigation concerning allegations that the Company may have misstated Title IV refund revenue or overstated revenue associated with private secondary loan programs and thereby misrepresented its compliance with the 90/10 rule of the Higher Education Act. Pursuant to the DOJ CID, the DOJ has requested from the Company documents and information for fiscal years 2011 to 2015. The Company is cooperating with the DOJ and cannot predict the eventual scope, duration or outcome of the investigation at this time. The Company has not accrued any liability associated with this action.
Shareholder Derivative Actions
In re Bridgepoint, Inc. Shareholder Derivative Action
On July 24, 2012, a shareholder derivative complaint was filed in California Superior Court by Alonzo Martinez. In the complaint, the plaintiff asserts a derivative claim on the Company’s behalf against certain of its current and former officers and directors. The complaint is captioned Martinez v. Clark, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement on behalf of the Company, as well as other equitable relief and attorneys’ fees. On September 28, 2012, a substantially similar shareholder derivative complaint was filed in California Superior Court by David Adolph-Laroche. In the complaint, the plaintiff asserts a derivative claim on the Company’s behalf against certain of its current and former officers and directors. The complaint is captioned Adolph-Laroche v. Clark, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched.
On October 11, 2012, the Adolph-Laroche action was consolidated with the Martinez action and the case is now captioned In re Bridgepoint, Inc. Shareholder Derivative Action. A consolidated complaint was filed on December 18, 2012 and the defendants filed a motion to stay the case while the underlying securities class action is pending. The motion was granted by the Court on April 11, 2013. A status conference was held on October 10, 2013, during which the Court ordered the stay continued for the duration of discovery in the underlying securities class action, but permitted the plaintiff to receive copies of any discovery responses served in the underlying securities class action. The stay was lifted following the settlement of the underlying securities class action and all defendants filed demurrers on October 3, 2016, which were granted with leave to amend on October 6, 2017. On October 17, 2017, the plaintiff submitted a litigation demand to the Company's Board of Directors, which appointed a working group to evaluate the demand. The Board refused the demand and the Plaintiff filed a Second Amended Complaint on October 3, 2018. All defendants filed demurrers on December 21, 2018, which were granted by the Court on June 14, 2019. As a result, the Court entered a final order dismissing the case on July 8, 2019. Based on information available to the Company at present, it cannot reasonably estimate a range of loss and accordingly has not accrued any liability associated with this action.
Reardon v. Clark, et al.
On March 18, 2015, a shareholder derivative complaint was filed in the Superior Court of the State of California in San Diego. The complaint asserts derivative claims on the Company’s behalf against certain of its current and former officers and directors. The complaint is captioned Reardon v. Clark, et al. and generally alleges that the individual defendants breached their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement, as well as other equitable relief and attorneys’ fees. Following the dismissal of the underlying Zamir securities class action and pursuant to a stipulation among the parties, on May 10, 2018, the Court ordered the case stayed while the Company’s Board of Directors evaluated a litigation demand submitted by the plaintiff. After the Board of Directors refused the demand, the plaintiff agreed to voluntarily dismiss the case.
Larson v. Hackett, et al.
On January 19, 2017, a shareholder derivative complaint was filed in the Superior Court of the State of California in San Diego. The complaint asserts derivative claims on the Company's behalf against certain of its current and former officers and directors. The complaint is captioned Larson v. Hackett, et al. and generally alleges that the individual defendants breached


29



ZOVIO INC
Notes to Condensed Consolidated Financial Statements (Unaudited)

their fiduciary duties of candor, good faith and loyalty, wasted corporate assets and were unjustly enriched. The lawsuit seeks unspecified monetary relief and disgorgement, as well as other equitable relief and attorneys’ fees. Following the dismissal of the underlying Zamir securities class action and pursuant to a stipulation among the parties, on May 10, 2018, the Court ordered the case stayed while the Company’s Board of Directors evaluated a litigation demand submitted by the plaintiff. After the Board of Directors refused the demand, the plaintiff agreed to voluntarily dismiss the case.
Stein Securities Class Action
On March 8, 2019, a securities class action complaint (the “Stein Complaint”) was filed in the U.S. District Court for the Southern District of California by Shiva Stein naming the Company, Andrew Clark, Kevin Royal, and Joseph D’Amico as defendants (the “Defendants”). The Stein Complaint alleges that Defendants made false and materially misleading statements and failed to disclose material adverse facts regarding the Company's business, operations and prospects, specifically that the Company had applied an improper revenue recognition methodology to students enrolled in the FTG program. The Stein Complaint asserts a putative class period stemming from March 8, 2016 to March 7, 2019. The Stein Complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.
The Company is evaluating the Stein Complaint and intends to vigorously defend against the Stein Complaint. However, because of the many questions of fact and law that may arise, the outcome of the legal proceeding is uncertain at this point. Based on information available to the Company at present, the Company cannot reasonably estimate a range of loss and accordingly has not accrued any liability associated with this action the Stein Complaint.
SEC Informal Inquiry
On March 27, 2019, the Company received notice that the SEC Division of Enforcement began an informal inquiry regarding the Company, requesting various documents relating to the Company’s accounting practices, including FTG revenue recognition, receivables and other matters relating to the Company’s previously disclosed intention to restate its condensed financial statements for the three and nine months ended September 30, 2018.
Based on these requests, the eventual scope, duration and outcome of the inquiry cannot be predicted at this time. We are cooperating fully with the SEC in connection with the inquiry.
16. Subsequent Events
On July 12, 2019, WSCUC notified Ashford University that it had approved the Change of Control Application for the Conversion Transaction. On the same date, WSCUC also notified Ashford University that it had reaffirmed its accreditation for six years. For further information, refer to Note 14, “Regulatory - WSCUC Accreditation of Ashford University” to the condensed consolidated financial statements.
The Company evaluated events occurring between the end of its most recent fiscal year and the date of filing, noting no additional subsequent events.


30


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following Management’s Discussions and Analysis of Financial Condition and Results of Operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto included in Part I, Item 1 of this report and reflects the effects of the restatement discussed in Note 2 to the condensed consolidated financial statements. For additional information regarding our financial condition and results of operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018 (“Form 10-K”), filed with the Securities and Exchange Commission (“SEC”) on March 12, 2019, as well as our consolidated financial statements and related notes thereto included in Part II, Item 8 of the Form 10-K.
Unless the context indicates otherwise, in this report the terms “Zovio,” “the Company,” “we,” “us” and “our” refer to Zovio Inc, a Delaware corporation, and its wholly owned and indirect subsidiaries.
Forward-Looking Statements
This Quarterly Report on Form 10-Q (the “Form 10-Q”) contains “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 (“Exchange Act”). All statements other than statements of historical fact may be forward-looking statements. Forward-looking statements may include, among others, statements regarding future events, future financial and operating results, strategies, expectations, the competitive environment, regulation and the availability of financial resources, including, without limitation, statements regarding:

our ability to successfully convert Ashford University to a nonprofit California public benefit corporation and for Ashford University to separate from the Company, including meeting all required conditions and obtaining all required approvals;

Ashford University's ability to continue to operate as an accredited institution subject to the requirements of the State of California, Department of Consumer Affairs, Bureau for Private Postsecondary Education (the “BPPE”);

our ability to comply with the extensive and continually evolving regulatory framework applicable to us and Ashford University, including Title IV of the Higher Education Act of 1965, as amended (“Higher Education Act”), and its implementing regulations, the “defense to repayment” regulations, state laws and regulatory requirements, and accrediting agency requirements;
projections, predictions and expectations regarding our business, financial position, results of operations and liquidity, and enrollment trends at Ashford University;
our ability to obtain continued approval of Ashford’s programs for GI Bill benefits through the Iowa State Approving Agency (“ISAA”), the Arizona State Approving Agency (“ASAA”), or the California State Approving Agency for Veteran's Education (“CSAAVE”), and to prevent any disruption of educational benefits to Ashford’s veteran students;
the ability of Ashford to continue participating in the U.S. Department of Defense Tuition Assistance Program for active duty military personnel and to prevent any disruption of educational benefits to Ashford’s active duty military students;
the outcome of various lawsuits, claims and legal proceedings;
initiatives focused on student success, retention and academic quality;
expectations regarding the adequacy of our cash and cash equivalents and other sources of liquidity for ongoing operations;
expectations regarding capital expenditures;
our anticipated seasonal fluctuations in operational results;
management's goals and objectives; and


31


other similar matters that are not historical facts.
Forward-looking statements may generally be identified by the use of words such as “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar expressions, as well as statements in the future tense.
Forward-looking statements should not be interpreted as a guarantee of future performance or results and will not necessarily be accurate indications of the times at or by which such performance or results will be achieved. Forward-looking statements are based on information available at the time such statements are made and the current good faith beliefs, expectations and assumptions of management regarding future events. Such statements are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. For a discussion of some of these risks and uncertainties, see Part II, Item 1A, “Risk Factors” as well as the discussion of such risks and uncertainties contained in our other filings with the SEC, including the Form 10-K.
All forward-looking statements in this report are qualified in their entirety by the cautionary statements included in this report, and you should not place undue reliance on any forward-looking statements. These forward-looking statements speak only as of the date of this report. We assume no obligation to update or revise any forward-looking statements contained herein to reflect actual results or any changes in our assumptions or expectations or any other factors affecting such forward-looking statements, except to the extent required by applicable securities laws. If we do update or revise one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.
Overview
Zovio Inc is an education technology services company that partners with higher education institutions and employers to deliver innovative, personalized solutions to help learners and leaders achieve their aspirations. We were formerly known as Bridgepoint Education, Inc., and were a provider of postsecondary education services. Our wholly-owned subsidiary, Ashford University® is a regionally accredited academic institution, which delivers programs primarily online. Ashford University offers associate’s, bachelor’s, master’s and doctoral programs primarily online. As of June 30, 2019, Ashford University offered approximately 1,260 courses and approximately 90 degree programs.
Key operating data
In evaluating our operating performance, management focuses in large part on our (i) revenue, (ii) operating income (loss) and (iii) period-end enrollment at Ashford University. The following table, which should be read in conjunction with our condensed consolidated financial statements included in Part I, Item 1 of this report, presents our key operating data for each of the periods presented (in thousands, except for enrollment data):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Consolidated Statement of Income Data:
 
 
 
 
 
Revenue
$
107,495

 
$
119,037

 
$
217,259

 
$
235,814

Operating income (loss)
$
(20,329
)
 
$
9,346

 
$
(27,524
)
 
$
8,726

 
 
 
 
 
 
 
 
Consolidated Other Data:
 
 
 
 
 
 
 
Period-end enrollment (1)
37,910

 
40,097

 
37,910

 
40,097

(1)
We define period-end enrollment as the number of active students on the last day of the financial reporting period. A student is considered active if the student has attended a class within the prior 15 days or is on an institutionally-approved break not to exceed 45 days, unless the student has graduated or provided notice of withdrawal, or for new students who have completed their third week of attendance, and posted attendance in the fourth week.


32


Key enrollment trends
Enrollment at Ashford University decreased 5.5% to 37,910 students at June 30, 2019 as compared to 40,097 students at June 30, 2018. Enrollment decreased by 0.6% since the end of the preceding fiscal year, from 38,153 students at December 31, 2018 to 37,910 students at June 30, 2019.
We believe new enrollment has been impacted by the deliberate changes in our marketing strategy in which we significantly reduced our spending in the affiliate channel and reinvested some of those savings in other channels. We have been implementing this updated marketing strategy that reflects a shift in our advertising mix, in an effort to attract prospective students who have a higher probability of being academically successful, with the goal of making meaningful improvements to the efficiency of our advertising, admissions and marketing spend.
We believe the decline in enrollment is partially attributable to a general weakening in the overall education industry due in large part to increased regulatory scrutiny, as well as due to general strengthening of the economy which drives lower unemployment and increased competition.
We continue to focus our efforts on first stabilizing and then restarting enrollment growth. We are also making investments in the workflow along the student lifecycle to better support our incoming and current students. One area in which we are experiencing positive enrollment trends is within the Education Partnerships programs with various employers. These programs include the Corporate Full Tuition Grant (“FTG”) program, which provides companies with the opportunity to offer their employees a way to pursue and complete a college degree without incurring any student debt. Enrollments in the Education Partnerships programs account for approximately 28% of our total enrollment as of June 30, 2019. Revenue derived from Education Partnerships is cash pay, and is therefore not considered federal student aid for purposes of calculations under the 90/10 rule.
Additionally, as described below, we generally experience a seasonal increase in new enrollments during the first quarter of each year, subsequent to holiday break.
Trends and uncertainties regarding revenue and continuing operations
Acquisition of FullStack Academy
On April 1, 2019, we acquired Fullstack Academy, Inc. (“Fullstack”), a Delaware corporation, pursuant to an Agreement and Plan of Reorganization (the “Fullstack Merger Agreement”) entered into by the parties on March 12, 2019 (the “Fullstack Acquisition”). Following the Fullstack Acquisition, Fullstack became a wholly-owned subsidiary of the Company.
For information refer to Note 3, “Business Combinations” to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
Acquisition of TutorMe
On April 3, 2019, we acquired TutorMe.com, Inc., a California corporation (“TutorMe”) pursuant to an Agreement and Plan of Reorganization (the “TutorMe Merger Agreement”) entered into by the parties on April 3, 2019 (“TutorMe Acquisition”). TutorMe is an online education platform that provides on-demand tutoring and online courses. Following the TutorMe Acquisition, TutorMe became a wholly-owned subsidiary of the Company.
For information refer to Note 3, “Business Combinations” to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
Proposed conversion transaction
Ashford University submitted a change in control and legal status application (the “Change of Control Application”) to the Western Association of Schools and Colleges Senior College and University Commission (“WSCUC”) seeking approval to convert to a nonprofit California public benefit corporation, and separate from the Company (the “Conversion Transaction”). On November 19, 2018 and March 6, 2019, WSCUC notified Ashford University that, pending the receipt and review of additional documents, WSCUC would defer any action on the Change of Control Application. Ashford University submitted the requested documentation related to the Conversion Transaction to WSCUC and the application was reconsidered by the


33


assigned WSCUC evaluation team. The team’s report and recommendations were considered at the June 2019 WSCUC Commission meeting.
On July 12, 2019, WSCUC notified Ashford University that it had approved the Change of Control Application for the Conversion Transaction. The approval is subject to certain conditions which must be met prior to the close of the Conversion Transaction, including divestiture of financial and ownership interest in the Company by all Ashford University officers and related parties and submission of a revised services agreement with respect to the Conversion Transaction, including the incorporation of key performance indicators into that agreement. WSCUC is also requiring a post-implementation site visit of Ashford University within six months of the close of the Conversion Transaction. As part of the Conversion Transaction, Ashford University will become an independent, self-governed, nonprofit institution. Following the Conversion Transaction, the Company plans to operate as an education technology services company that will provide certain services to Ashford University and potentially, in the future, to other customers. On the same date, WSCUC also notified Ashford University that it had reaffirmed its accreditation for six years.
The Company and Ashford University are continuing to finalize the terms of the Conversion Transaction pending the Department of Education’s response to the preacquisition review application which is expected in the near future. We anticipate that the close of the Conversion Transaction may occur sometime between September 1, 2019 and the end of 2019.
Restructuring and impairment charges
We have implemented various restructuring plans to better align our resources with our business strategy and the related charges are recorded in the restructuring and impairment expense line item on our condensed consolidated statements of income (loss). Changes to these estimates could have a material impact on the Company’s condensed consolidated financial statements. For information regarding the restructuring and impairment charges recorded, refer to Note 5, “Restructuring and Impairment Expense” to our condensed consolidated financial statements included in Part I, Item 1 of this Form 10-Q.
Valuation allowance
We recognize deferred tax assets if realization of such assets is more-likely-than-not. In order to make this determination, we evaluate factors including the ability to generate future taxable income from reversing taxable temporary differences, forecasts of financial and taxable income or loss. The cumulative loss incurred over the three-year period ended June 30, 2019 constituted significant negative objective evidence against our ability to realize a benefit from our federal deferred tax assets. Such objective evidence limited our ability to consider in our evaluation other subjective evidence such as our projections for future growth. On the basis of our evaluation, we determined that our deferred tax assets were not more-likely-than-not to be realized and that a valuation allowance against our deferred tax assets should continue to be maintained as of June 30, 2019.
Recent Regulatory Developments
Negotiated Rulemaking and Other Executive Action
On July 31, 2018, the U.S. Department of Education (“Department”) published a notice in the Federal Register announcing its intention to establish a negotiated rulemaking committee (the “Rulemaking Committee”) to prepare proposed regulations for the Federal Student Aid programs authorized under Title IV of the Higher Education Act of 1965, as amended. In September 2018, interested parties commented at three public hearings on the topics suggested by the Department in the notice, and suggested additional topics for consideration for action by the Rulemaking Committee.
The Rulemaking Committee met from January through March of 2019 on topics related to accreditation, competency-based education, state approval of online programs, and distance learning. The Rulemaking Committee reached consensus on all topics and the Department issued proposed regulations based on that consensus on June 12, 2019 to be effective on July 1, 2020.
The Department proposes, among other things to: (1) define the roles and responsibilities of accrediting agencies, States, and the Department in oversight of institutions participating in the Federal Student Aid programs authorized under Title IV of the Higher Education Act of 1965, as amended (Title IV, Higher Education Act programs); (2) establish ‘‘substantial compliance’’ as the standard for agency recognition; (3) modify ‘‘substantive change’’ requirements to provide greater flexibility to institutions to innovate and respond to the needs of students and employers, while maintaining strict agency oversight in instances of more complicated or higher risk changes in institutional mission, program mix, or level of credential


34


offered; (4) clarify the Department’s accrediting agency recognition process, including accurate recognition of the geographic area within which an agency conducts business; and (5) modify the requirements for state authorization.
For additional information regarding negotiated rulemaking, see also the “Gainful Employment” and “Defense to Repayment” sections below.
Gainful Employment
In October 2014, the Department published gainful employment regulations impacting programs required to prepare graduates for gainful employment in a recognized occupation. The gainful employment regulations became effective July 1, 2015, with certain institutional disclosure requirements which became effective early 2017.
On July 1, 2019, the Department of Education published a final rule rescinding the Department’s 2014 gainful employment regulations. The Higher Education Act (“HEA”) requires that regulations affecting programs under Title IV of the HEA be published in final form by November 1, prior to the start of the award year (July 1) to which they become effective. This section also permits the Secretary to designate any regulation as one that an entity subject to the regulations may choose to implement earlier, as well as conditions for early implementation. The Department designated the regulatory changes for early implementation, and an institution that early implements the rescission must document its early implementation internally. Ashford University has chosen and documented early implementation.
Institutions that early implement the rescission of the gainful employment rule will not be required to report gainful employment data for the 2018-2019 award year to the National Student Loan Data System (“NSLDS”), which will be due October 1, 2019. Additionally, those institutions that early implement will not be required to comply with the current requirements that require institutions to include the disclosure template, or a link thereto, in their gainful employment program promotional materials and directly distribute the disclosure template to prospective students, which will be required starting on July 1, 2019. Institutions that early implement will no longer be required to post the gainful employment disclosure template and may remove the template and any other gainful employment disclosures from their web pages. Finally, an institution that early implements will not be required to comply with the certification requirements for gainful employment programs.
Defense to Repayment
On October 28, 2016, the Department published borrower defense to repayment regulations to change processes that assist students in gaining relief under certain provisions of the Direct Loan Program regulations. The defense to repayment provisions then in effect allowed a student to assert as a defense against repayment of federal direct loans any commission of fraud or other violation of applicable state law by the school related to such loans or the educational services for which the loans were provided. The borrower defense to repayment regulations were to become effective July 1, 2017.
On June 14, 2017, the Department announced a postponement of the 2016 defense to repayment regulations and its intention to resubmit the regulations through the negotiated rulemaking process. The Department announced an additional postponement on October 24, 2017. On February 14, 2018, the Department announced that it was postponing the effective date of this rule until July 1, 2019, so that it could complete the negotiated rulemaking process and develop the new regulations. Because the negotiated rulemaking committee did not reach consensus, the Department published a proposed regulation through a notice of proposed rulemaking (“NPRM”), took public comment, and planned to issue final regulations by November 1, 2018, effective July 1, 2019. This did not occur.
In September and October of 2018, the U.S. District Court for the District of Columbia issued a series of orders and opinions holding these procedural delays by the Department to be improper. The Court reinstated the 2016 repayment regulations as of October 16, 2018.
The 2016 defense to repayment regulations allow a borrower to assert a defense to repayment on the basis of a substantial misrepresentation, any other misrepresentation in cases where certain other factors are present, a breach of contract or a favorable nondefault contested judgment against a school for its act or omission relating to the making of the borrower’s loan or the provision of educational services for which the loan was provided. In addition, the financial responsibility standards contained in the new regulations establish the conditions or events that trigger the requirement for an institution to provide the Department with financial protection in the form of a letter of credit or other security against potential institutional liabilities. Triggering conditions or events include, among others, certain state, federal or accrediting agency actions or investigations, and in the case of publicly traded companies, receipt of certain warnings from the SEC or the applicable stock exchange, or the


35


failure to timely file a required annual or quarterly report with the SEC. The new regulations also prohibit schools from requiring that students agree to settle future disputes through arbitration.
On March 15, 2019, the Department issued guidance for the implementation of parts of the regulations. The guidance covers an institution's responsibility in regard to reporting mandatory and discretionary triggers as part of the financial responsibility standards, class action bans and pre-dispute arbitration agreements, submission of arbitral and judicial records, and repayment rates. We will continue to monitor guidance on or changes to the existing regulations.
State Authorization for Distance Education Rules
On December 19, 2016, the Department of Education published regulations related to state authorization of distance education effective July 1, 2018. On July 3, 2018, the Department published a notice delaying the effective date of the regulations until July 1, 2020, and proceeded to develop alternative regulations through consensus language which was achieved during a 2019 negotiated rulemaking process. However, the National Education Association and others filed a legal challenge to the delay in the United States District Court, Northern District of California, asking that the 2016 state authorization regulations be allowed to go into effect. On April 26, 2019, the Court vacated the Department’s delay of the 2016 state authorization regulations and reinstated the regulations effective May 26, 2019. Although the Department has stated that it intends to publish the alternative regulations for early implementation as soon as possible, the Company and Ashford University are currently evaluating the impact of the 2016 state authorization regulations and may incur additional costs and regulatory burdens during the interim period.
Cohort Default Rate
For each federal fiscal year, the Department calculates a rate of student defaults over a three-year measuring period for each educational institution, which is known as a “cohort default rate.” An institution may lose its eligibility to participate in the Direct Loan Program and the Federal Pell Grant Program if, for each of the three most recent federal fiscal years, 30% or more of its students who became subject to a repayment obligation in that federal fiscal year defaulted on such obligation by the end of the following federal fiscal year.
The most recent official three-year cohort default rates for Ashford University for the 2015, 2014 and 2013 federal fiscal years were 13.5%, 14.9% and 14.5%, respectively. The draft three-year cohort default rate for Ashford University for the 2016 federal fiscal year is 13.7%.
For additional information regarding the regulatory environment and related risks, see Part I, Item 1, “Business” and Part I, Item 1A, “Risk Factors” of the Form 10-K.
Seasonality
Our operations are generally subject to seasonal trends. We generally experience a seasonal increase in new enrollments during the first quarter of each year, subsequent to holiday break, as well as during the third quarter each year, when most other colleges and universities begin their fall semesters. While we enroll students throughout the year, our fourth quarter revenue generally is lower than other quarters due to the holiday break in December, with an increase in the first quarter of each year.
Critical Accounting Policies and Use of Estimates
The critical accounting policies and estimates used in the preparation of our consolidated financial statements are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Use of Estimates” included in Part II, Item 7 of the Form 10-K.
On January 1, 2019, the Company adopted ASU 2016-02, Leases (ASC 842), using the modified retrospective method. For information regarding the impact of this recent accounting pronouncements, refer to Note 2, “Summary of Significant Accounting Policies - Recent Accounting Pronouncements” as well as Note 10, “Lease Obligations” to our condensed consolidated financial statements included elsewhere in this report.
Business Combinations


36


We use the acquisition method of accounting for business combinations. This method requires the use of significant estimates, assumptions and judgments in the determination of the estimated fair value of assets acquired and liabilities assumed in order to properly allocate the purchase price at the acquisition date. The allocation of the purchase price for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired and liabilities assumed based on their respective fair values. The estimates, assumptions and judgments are based in part on historical experience, industry data, information obtained from the management of the acquired companies and assistance from independent third-party appraisal firms. Examples of critical estimates include assigning values to the acquired identifiable intangible assets and valuing contingent consideration and earnout liabilities. For further information regarding the acquisitions, refer to Note 3, “Business Combinations” to the condensed consolidated financial statements.
There were no other material changes to these critical accounting policies and estimates during the six months ended June 30, 2019.


37


Results of Operations
The following table sets forth our condensed consolidated statements of income data as a percentage of revenue for each of the periods indicated:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2019
 
2018
 
2019
 
2018
Revenue
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
Instructional costs and services
51.3

 
45.7

 
49.3

 
47.1

Admissions advisory and marketing
41.7

 
33.5

 
43.2

 
37.3

General and administrative
21.0

 
10.5

 
17.7

 
10.7

Legal settlement expense

 
0.1

 

 
0.1

Restructuring and impairment expense
5.0

 
2.3

 
2.5

 
1.1

Total costs and expenses
119.0

 
92.1

 
112.7

 
96.3

Operating income (loss)
(19.0
)
 
7.9

 
(12.7
)
 
3.7

Other income, net
0.3

 
0.2

 
0.4

 
0.2

Income (loss) before income taxes
(18.7
)
 
8.1

 
(12.3
)
 
3.9

Income tax benefit
(2.3
)
 
(4.6
)
 
(1.1
)
 
(3.1
)
Net income (loss)
(16.4
)%
 
12.7
 %
 
(11.2
)%
 
7.0
 %
Three Months Ended June 30, 2019 Compared to Three Months Ended June 30, 2018
Revenue. Our revenue for the three months ended June 30, 2019 and 2018, was $107.5 million and $119.0 million, respectively, representing a decrease of $11.5 million, or 9.7%. The decrease between periods was primarily due to a decrease of 6.1% in average weekly enrollment from 40,777 students for the three month period ended June 30, 2018 to 38,304 students for the three month period ended June 30, 2019. As a result of the decrease in enrollments, tuition revenue decreased by approximately $6.2 million, as well as a decrease in net revenue generated from course digital materials of approximately $0.7 million. The decrease in revenue between periods was also due to higher scholarships for the period, an increase of $7.1 million. The overall revenue decrease was partially offset by net revenue from subsidiaries of $2.6 million, as well as a tuition increase, effective as of January 1, 2019.
Instructional costs and services. Our instructional costs and services for the three months ended June 30, 2019 and 2018, were $55.1 million and $54.4 million, respectively, representing an increase of $0.7 million, or 1.3%. Specific increases between periods primarily include other subsidiary costs of $1.1 million, instructional supplies of $0.8 million, and consulting and professional fees of $0.5 million, partially offset by a decrease in bad debt of $1.6 million. Instructional costs and services, as a percentage of revenue, for the three months ended June 30, 2019 and 2018, were 51.3% and 45.7%, respectively, representing an increase of 5.6%. This increase primarily included increases in direct compensation of 1.8%, other subsidiary costs of 1.0%, corporate support services of 0.9%, instructional supplies of 0.8%, and information technology costs of 0.7%. As a percentage of revenue, bad debt expense was 3.6% for the three months ended June 30, 2019, compared to 4.6% for three months ended June 30, 2018.
Admissions advisory and marketing. Our admissions advisory and marketing expenses for the three months ended June 30, 2019 and 2018, were $44.8 million and $39.9 million, respectively, representing an increase of $4.9 million, or 12.4%. Specific factors contributing to the overall increase between periods were increases in advertising costs of $1.8 million, other subsidiary costs of $1.4 million, corporate support services of $1.2 million, and consulting and professional fees of $1.0 million. These increases were primarily offset by decreases in compensation costs of $0.8 million. Admissions advisory and marketing, as a percentage of revenue, for the three months ended June 30, 2019 and 2018, were 41.7% and 33.5%, respectively, representing an increase of 8.2%. This increase primarily included increases in advertising costs of 3.2%, other subsidiary costs of 1.3%, consulting and professional fees costs of 1.0%, corporate support services of 0.9%, compensation of 0.8%, facilities costs of 0.3%, and information technology costs of 0.2%.


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General and administrative. Our general and administrative expenses for the three months ended June 30, 2019 and 2018, were $22.5 million and $12.5 million, respectively, representing an increase of $10.0 million, or 79.6%. The increase between periods was primarily due to increases in acquisition costs of $5.8 million, administrative compensation of $4.0 million, and other administrative costs of $1.3 million, partially offset by a decrease in corporate support services of $1.4 million. General and administrative expenses, as a percentage of revenue, for the three months ended June 30, 2019 and 2018, were 21.0% and 10.5%, respectively, representing an increase of 10.5%. This increase was primarily due to increases in acquisition costs of 5.4%, administrative compensation of 4.4%, other administrative costs of 1.5%, and consulting and professional fees of 0.8%, partially offset by a decrease in corporate support services of 1.7%.
Legal settlement expense. For the three months ended June 30, 2019, there were no legal settlement expenses. There were $0.1 million legal settlement expenses for the three months ended June 30, 2018.
Restructuring and impairment charges. We recorded a charge of approximately $5.4 million to restructuring and impairment for the three months ended June 30, 2019, comprised primarily of severance costs resulting from a reduction in force, as well as revised estimates of lease charges. For the three months ended June 30, 2018, we recorded a charge of approximately $2.7 million of restructuring and impairment charges, comprised primarily of severance costs, revised estimates of lease charges as well as asset write-offs.
Other income, net. Our other income, net, was approximately $0.3 million for the three months ended June 30, 2019 and approximately $0.3 million for the three months ended June 30, 2018. The increase between periods was primarily due to increased interest income on average cash balances.
Income tax benefit. We recognized an income tax benefit of $2.4 million and $5.5 million, for the three months ended June 30, 2019 and 2018, respectively, at effective tax rates of 12.2% and (56.6)%, respectively.
Net income (loss). Our net loss was $17.6 million for the three months ended June 30, 2019, compared to net income of $15.1 million for the three months ended June 30, 2018, a $32.7 million decrease in net income as a result of the factors discussed above.
Six Months Ended June 30, 2019 Compared to Six Months Ended June 30, 2018
Revenue. Our revenue for the six months ended June 30, 2019 and 2018, was $217.3 million and $235.8 million, respectively, representing a decrease of $18.5 million, or 7.9%. The decrease between periods was primarily due to a decrease of 6.5% in average weekly enrollment from 41,076 students for the three month period ended June 30, 2018 to 38,396 students for the three month period ended June 30, 2019. As a result of the decrease in enrollments, tuition revenue decreased by approximately $8.3 million. The decrease in revenue between periods was also due to higher scholarships for the period, an increase of $13.3 million. The overall revenue decrease was partially offset by net revenue from subsidiaries of $2.6 million, a tuition increase, effective as of January 1, 2019, as well as an increase in net revenue generated from course digital materials of approximately $0.5 million.
Instructional costs and services. Our instructional costs and services for the six months ended June 30, 2019 and 2018, were $107.0 million and $111.0 million, respectively, representing a decrease of $4.0 million, or 3.6%. In addition to the decline in enrollment, specific decreases between periods include bad debt of $4.3 million, direct compensation costs of $1.7 million, corporate support services of $1.0 million, and instructor fees of $0.5 million. These decreases were partially offset by increases in instructional supplies of $1.8 million, information technology costs of $1.1 million and other subsidiary costs of $1.1 million. Instructional costs and services, as a percentage of revenue, for the six months ended June 30, 2019 and 2018, were 49.3% and 47.1%, respectively, representing an increase of 2.2%. This increase primarily included increases in information technology costs of 0.9%, direct compensation costs of 0.7%, instructional supplies of 0.8%, other subsidiary costs of 0.5%, instructor fees of 0.3%, and consulting and professional fees of 0.2%. These increases were partially offset by a decrease in bad debt of 1.6%. As a percentage of revenue, bad debt expense was 3.5% for the six months ended June 30, 2019, compared to 5.0% for the six months ended June 30, 2018.
Admissions advisory and marketing. Our admissions advisory and marketing expenses for the six months ended June 30, 2019 and 2018, were $93.9 million and $88.1 million, respectively, representing an increase of $5.8 million, or 6.6%. As a result of our change in marketing strategy and the shift in advertising mix, specific factors contributing to the overall increase between periods include increases in advertising costs of $3.1 million, consulting and professional fees of $1.4 million, corporate support services of $1.4 million, other subsidiary costs of $1.4 million, transaction costs of $0.5 million, and license


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fees of $0.3 million. These increases were partially offset by decreases in compensation costs of $2.6 million. Our admissions advisory and marketing expenses, as a percentage of revenue, for the six months ended June 30, 2019 and 2018, were 43.2% and 37.3%, respectively, representing an increase of 5.9%. This increase primarily included increases in advertising costs of 2.9%, consulting and professional fees of 0.7%, other subsidiary costs of 0.6%, corporate support services of 0.5%, information technology costs of 0.3%, transaction costs of 0.2%, and license fees of 0.2%.
General and administrative. Our general and administrative expenses for the six months ended June 30, 2019 and 2018, were $38.5 million and $25.3 million, respectively, representing an increase of $13.2 million, or 52.0%. The increase between periods was primarily due to increases in acquisition costs of $6.7 million, administrative compensation of $4.9 million, transaction costs of $1.3 million, and information technology costs of $0.7 million, partially offset by decreases in corporate support services of $0.4 million. Our general and administrative expenses, as a percentage of revenue, for the six months ended June 30, 2019 and 2018, were