3. Business Combinations

Merger with Capella Education Company

On August 1, 2018, the Company completed its merger with CEC and its wholly-owned subsidiaries, pursuant to a merger agreement dated October 29, 2017. The merger is expected to enable the Company to be a national leader in education innovation that improves affordability and enhances career outcomes by offering complementary programs and sharing academic and technological best practices, through a best-in-class corporate platform supporting two independent universities.

Pursuant to the merger agreement, the Company issued 0.875 shares of the Company’s common stock for each issued and outstanding share of CEC common stock. Outstanding equity awards held by CEC employees and certain nonemployee directors of CEC were assumed by the Company and converted into comparable Company awards at the exchange ratio. Outstanding equity awards held by CEC nonemployee directors who did not serve as directors of the Company after completion of the merger were converted to Company awards and settled. Outstanding equity awards held by former employees of CEC who left before completion of the merger were settled upon completion of the merger in exchange for cash payments as specified in the merger agreement.

The following table summarizes the components of the aggregate consideration transferred for the acquisition of CEC (in thousands):


Fair value of Company common stock issued in exchange for CEC outstanding shares(1)	$	1,209,483
Fair value of Company equity-based awards issued in exchange for CEC equity-based awards		27,478
Total fair value of consideration transferred	$	1,236,961

⁽¹⁾

The Company issued 10,263,775 common shares at a market price of $117.84 in exchange for each issued and outstanding share of CEC common stock.

The Company applied the acquisition method of accounting to CEC’s business, whereby the excess of the acquisition date fair value of consideration transferred over the fair value of identifiable net assets was allocated to goodwill. Goodwill reflects workforce and synergies expected from cost savings, operations, and revenue enhancements of the combined company that are expected to result from the acquisition. The goodwill recorded as part of the merger has been provisionally allocated to the Strayer University and Capella University reportable segments in the amount of $330.6 million and $395.2 million, respectively, and is not deductible for tax purposes.

The Company incurred $19.1 million of acquisition-related costs which were recognized in Merger costs in the consolidated statements of income. Issuance costs of $0.1 million were recognized in additional paid-in capital in the consolidated balance sheets.

The preliminary opening balance sheet is subject to adjustment based on final assessment of the fair values of certain acquired assets and liabilities, primarily intangible assets and income taxes. As the Company finalizes its assessment of the fair value of assets acquired and liabilities assumed, additional purchase price adjustments may be recorded during the measurement period. The Company reflects measurement period adjustments, if any, in the period in which the adjustments occur. During the fourth quarter of 2018, the Company reduced current assets by $0.5 million, long term assets by $1.4 million, and acquired deferred income tax liability by $0.1 million, which resulted in a $1.8 million increase to goodwill recognized in connection with the CEC merger.

The preliminary fair value of assets acquired and liabilities assumed as well as a reconciliation to consideration transferred is presented in the table below (in thousands):


Cash and cash equivalents	$	167,859
Marketable securities, current		31,419
Tuition receivable		39,141
Income tax receivable		163
Other current assets		8,496
Marketable securities, non-current		34,700
Property and equipment, net		53,182
Other assets		14,556
Intangible assets		349,800
Goodwill		725,740
Total assets acquired		1,425,056
Accounts payable and accrued expenses		(46,735)
Contract liabilities		(39,000)
Deferred income taxes		(100,123)
Other long term liabilities		(2,237)
Total liabilities assumed		(188,095)
Total consideration	$	1,236,961

The table below presents a summary of intangible assets acquired (in thousands) and the weighted average useful lives of these assets:


			Weighted Average
		Fair Value	Useful Life in Years
Trade names	$	183,800	Indefinite
Student relationships		166,000	3
	$	349,800

The Company determined the fair value of assets acquired and liabilities assumed based on assumptions that reasonable market participants would use while employing the concept of highest and best use of the assets and liabilities. The Company utilized the following assumptions, some of which include significant unobservable inputs which would qualify the valuations as Level 3 measurements, and valuation methodologies to determine fair value:

Intangible assets - To determine the fair value of the trade name, the Company used the relief from royalty approach. The excess earnings method was used to estimate the fair value of student relationships.

Property and equipment - Included in property and equipment is course content of $14.0 million, valued using the relief from royalty approach, and internally developed software of $5.0 million, valued using the cost approach. Each will be amortized over three years. All other property and equipment was valued at estimated cost.

Contract liabilities - The Company estimated the fair value of contract liabilities using the cost build-up method, which represents the cost to deliver the services plus a normal profit margin.

Other current and noncurrent assets and liabilities - The carrying value of all other assets and liabilities approximated fair value at the time of acquisition.

The operations of CEC were included in the consolidated financial statements as of the acquisition date. The revenue and net loss for CEC reported within the consolidated statements of income for the year ended December 31, 2018 were $160.4 million and $39.6 million, respectively.

Pro Forma Financial information

The following unaudited pro forma information has been presented as if the CEC acquisition occurred on January 1, 2017. The information is based on the historical results of operations of the acquired business, adjusted for:

The allocation of purchase price and related adjustments, including the adjustments to amortization expense related to the fair value of intangible assets acquired.

The exclusion of acquisition-related costs incurred during the years ended December 31, 2017 and 2018.

Associated tax-related impacts of adjustments.

Changes to align accounting policies.

The pro forma results do not necessarily represent what would have occurred if the acquisition had actually taken place on January 1, 2017, nor do they represent the results that may occur in the future. The pro forma adjustments are based on available information and upon assumptions the Company believes are reasonable to reflect the impact of this acquisition on the Company’s historical financial information on a supplemental pro forma basis (in thousands).


	Pro Forma Combined
	Year Ended		Year Ended
	December 31, 2017		December 31, 2018
Revenue	$	895,262	$	923,945
Net Income		16,364		41,058

Acquisition of New York Code and Design Academy

On January 13, 2016, the Company acquired all of the outstanding stock of the New York Code and Design Academy, Inc. (“NYCDA”), a provider of web and application software development courses based in New York City. The acquisition supports the Company’s strategy to complement its traditional degree offerings with a broader platform of educational services. The Company incurred approximately $0.2 million of acquisition-related costs, which were included in general and administration costs in the consolidated statements of income. The Company applied the acquisition method of accounting to the purchase of NYCDA’s business.

The purchase price included $2.4 million paid up front in cash, plus contingent cash payments of (a) up to $12.5 million payable based on NYCDA’s results of operations over a five-year period (the “Earnout”), and (b) $5.5 million payable based on NYCDA’s receipt of state regulatory permits. Pursuant to the terms of the acquisition, $1.0 million of the Earnout may be accelerated upon receipt of one of the state regulatory permits. The Company recorded total contingent consideration of $14.5 million at the time of acquisition. In April 2016 and August 2016, NYCDA received the state regulatory permits and the Company paid $6.0 and $0.5 million of contingent consideration to the sellers, respectively.

In addition, the Company paid a total of $4.6 million to two of NYCDA’s founders who are required to remain employed for at least three years from the acquisition date. If either of them terminates employment voluntarily, or is terminated for cause (as defined), he is required to reimburse the Company his respective portion of the retention amount. This amount was classified as prepaid compensation and is being amortized to compensation expense over three years.

The allocation of the purchase price was as follows (in thousands):


		Purchase
		Price
		Allocation	Useful Life
Cash	$	790
Other assets		1,265
Intangibles:
Trade name		5,660	Indefinite
Goodwill		13,944
Liabilities assumed		(4,734)
Total assets acquired and liabilities assumed, net		16,925
Less: contingent consideration		(14,500)
Less: cash acquired		(790)
Cash paid for acquisition, net of cash acquired	$	1,635

The fair value of the Earnout was initially measured using a probability weighted discounted cash flow model based on significant inputs not observable in the market (Level 3 inputs). Key assumptions included a discount rate of 4.5% and expected future value of payments of $12.5 million. During the fourth quarter of 2016, the Company revised its assumptions related to the timing of future cash flows, which resulted in a $1.3 million decrease to the carrying value of the Earnout liability fair value. During 2017, the Company further revised its near-term revenue projections for NYCDA and as a result estimated that no amounts under the Earnout would be paid. Accordingly, the Company recorded a $7.8 million fair value adjustment to reduce the Earnout liability to zero during the year ended December 31, 2017. The Earnout fair value adjustments are included in the Fair value adjustments and impairment of intangible assets line on the consolidated statements of income. No fair value adjustments were recorded to the Earnout liability in the year ended December 31, 2018. The maximum possible amount that could still be paid under the Earnout is $11.5 million.

Pro forma financial information for the NYCDA acquisition has not been presented as it was not material to the Company’s consolidated results.