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1. Nature of Business
Capella Education Company (the Company) was incorporated on December 27, 1991, and is the parent company of its wholly owned subsidiaries, Capella University (the University) and Resource Development International Limited (RDI). Capella University, founded in 1993, is an online postsecondary education services company offering a variety of bachelor's, master's and doctoral degree programs primarily delivered to working adults. The University is accredited by The Higher Learning Commission and is a member of the North Central Association of Colleges and Schools. In July 2011, the Company acquired RDI, which is an independent provider of United Kingdom (UK) university distance learning qualifications and markets, develops and delivers programs worldwide via its offices and partners across Asia, North America, Africa and Europe. The Company is also the majority owner of the joint venture Sophia Learning, LLC (Sophia). Sophia provides a social teaching and learning platform that integrates education with technology.
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2. Summary of Significant Accounting Policies
Consolidation
The consolidated financial statements include the accounts of the Company, the University, RDI and its subsidiaries, and Sophia, after elimination of intercompany accounts and transactions.
Unaudited Interim Financial Information
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of our consolidated results of operations, financial position and cash flows. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. Preparation of the Company's financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and footnotes. Actual results could differ from those estimates. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's consolidated financial statements and footnotes included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (2010 Annual Report on Form 10-K).
Marketable Securities
Management determines the appropriate designation of marketable securities at the time of purchase and re-evaluates such designation as of each balance sheet date. All of the Company's marketable securities were designated as available-for-sale as of September 30, 2011 and December 31, 2010.
Available-for-sale marketable securities are carried at fair value as determined by quoted market prices or other inputs either directly or indirectly observable in the marketplace for identical or similar assets, with unrealized gains and losses, net of tax, recognized through accumulated comprehensive income within shareholders' equity. Management reviews the fair value of the portfolio at least monthly, and evaluates individual securities with fair value below amortized cost at the balance sheet date. In order to determine whether impairment is other than temporary, management must conclude whether the Company intends to sell the impaired security and whether it is more likely than not that the Company will be required to sell the security before recovering its amortized cost basis.
If management intends to sell an impaired debt security or it is more likely than not the Company will be required to sell the security prior to recovering its amortized cost basis, an other-than-temporary impairment is deemed to have occurred. The amount of an other-than-temporary impairment related to a credit loss, or securities that management intends to sell before recovery, is recognized in earnings. The amount of an other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as other comprehensive income within shareholders' equity.
The cost of securities sold is based on the specific identification method. Amortization of premiums, accretion of discounts, interest, dividend income and realized gains and losses are included in investment income. The contractual maturity date of available-for-sale securities is based on the days remaining to the effective maturity. Certain reclassifications have been made to the contractual maturities as of December 31, 2010 in Note 5 to align with current reporting methods. The Company classifies all marketable securities as current assets because the assets are available to fund current operations.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Contingencies
The Company accrues for costs associated with contingencies including, but not limited to, regulatory compliance and legal matters when such costs are probable and reasonably estimable. Liabilities established to provide for contingencies are adjusted as further information develops, circumstances change, or contingencies are resolved. The Company bases these accruals on management's best estimate of such costs, which may vary from the ultimate cost and expenses associated with any such contingency.
Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price of an acquired business over the fair value assigned to the underlying assets acquired and assumed liabilities. At the time of an acquisition, the Company allocates the goodwill and related assets and liabilities to its respective reporting unit. The Company identifies its reporting unit by assessing whether the components of its operating segment constitutes businesses for which discrete financial information is available and management regularly reviews the operating results of those components. The Company assesses goodwill at least annually for impairment or more frequently if events occur or circumstances change between annual tests that would more likely than not reduce the fair value of the respective reporting unit below its carrying amount.
The Company tests for goodwill impairment at the reporting unit level by applying a two-step test. In the first step, the Company compares the fair value of the reporting unit to the carrying value of its net assets. If the fair value of the reporting unit exceeds the carrying value of the net assets of the reporting unit, goodwill is not impaired and no further testing is required. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, the Company performs a second step to determine the implied fair value of the goodwill and compare it to the carrying value of the goodwill. An impairment loss is recognized to the extent the implied fair value of the goodwill is less than the carrying amount of the goodwill.
Finite-lived intangible assets that are acquired in business combinations are recorded at fair market value on their acquisition date and are amortized on a straight-line basis to reflect the economic useful life of the asset. We do not currently have any infinite-lived intangible assets.
The U.S. dollar is the functional currency of the Company's entities operating in the United States (U.S.). The functional currency of the Company's entities operating outside the U.S. is the currency of the primary economic environment in which the entity primarily generates and expends cash, which is generally the local currency. The assets and liabilities of these operations are translated to U.S. dollars using exchange rates in effect at the balance sheet dates. The resulting translation adjustments and the effect of exchange rate changes on intercompany transactions of a long-term investment nature are included in shareholders' equity as a component of accumulated other comprehensive income (loss). Income and expense items are translated monthly at the average exchange rate for that period. The Company reports gains and losses from foreign exchange rate changes related to intercompany receivables and payables that are not of a long-term investment nature, as well as gains and losses from foreign currency denominated transactions, in the Consolidated Statements of Income.
Subsequent Events
The Company has evaluated events and transactions that occurred during the period subsequent to the balance sheet date. There have been no subsequent events that require recognition or disclosure in the financial statements.
Refer to the Company's "Summary of Significant Accounting Policies" footnote included in its 2010 Annual Report on Form 10-K for a complete summary of the Company's significant accounting policies.
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3. Recent Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) No. 2011-05, Comprehensive Income, which is included in Accounting Standards Codification (ASC) 220, Presentation of Comprehensive Income. This update improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. The guidance requires all nonowner changes in shareholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The Company elected early adoption; therefore, the guidance will be effective for its interim and annual reporting periods beginning September 30, 2011, and applied retrospectively. The adoption of this guidance did not have a material impact on the Company's financial condition, results of operations, or disclosures.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other, which is included in ASC 350, Testing Goodwill for Impairment. This update reduces the complexity, and potentially the cost, of testing goodwill for impairment. The guidance gives the Company the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, and in some cases skip the two-step impairment test. The guidance will be effective for the Company's interim and annual reporting periods beginning January 1, 2012, and applied prospectively. The Company does not expect adoption of this guidance to have a material impact on its financial condition, results of operations, or disclosures.
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5. Marketable Securities
The following is a summary of available-for-sale securities:
| As of September 30, 2011 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains |
Gross Unrealized (Losses) |
Estimated Fair Value |
|||||||||||||
| (in thousands) | ||||||||||||||||
|
Tax-exempt municipal securities |
$ | 85,756 | $ | 685 | $ | 0 | $ | 86,441 | ||||||||
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|
|
|
|
|
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Total |
$ | 85,756 | $ | 685 | $ | 0 | $ | 86,441 | ||||||||
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|||||||||
| As of December 31, 2010 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains |
Gross Unrealized (Losses) |
Estimated Fair Value |
|||||||||||||
| (in thousands) | ||||||||||||||||
|
Tax-exempt municipal securities |
$ | 114,604 | $ | 1,277 | $ | (63 | ) | $ | 115,818 | |||||||
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Total |
$ | 114,604 | $ | 1,277 | $ | (63 | ) | $ | 115,818 | |||||||
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The unrealized gains and losses on the Company's investments in municipal securities as of September 30, 2011 and December 31, 2010 were caused by changes in market values primarily due to interest rate changes. The Company did not have any securities in an unrealized loss position as of September 30, 2011. No other-than-temporary impairment charges were recorded for the three and nine months ended September 30, 2011 and 2010.
The following table summarizes the remaining contractual maturities of the Company's marketable securities:
| As of September 30, 2011 |
As of December 31, 2010 |
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| (in thousands) | ||||||||
|
Due within one year |
$ | 66,144 | $ | 58,998 | ||||
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Due after one year through five years |
20,297 | 56,820 | ||||||
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|
|
|||||
| $ | 86,441 | $ | 115,818 | |||||
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The following table is a summary of the proceeds from the sale and maturities of available-for-sale securities:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (in thousands) | ||||||||||||||||
|
Maturities of marketable securities |
$ | 13,225 | $ | 6,150 | $ | 30,685 | $ | 6,150 | ||||||||
|
Proceeds from the sale of marketable securities |
0 | 1,000 | 0 | 1,000 | ||||||||||||
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|
|
|||||||||
| $ | 13,225 | $ | 7,150 | $ | 30,685 | $ | 7,150 | |||||||||
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|
|
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|
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|
|
|
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The Company did not record any gross realized gains or gross realized losses during the three and nine months ended September 30, 2011 and 2010.
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The Company classifies assets recorded at fair value under the fair value hierarchy based upon the observability of inputs used in valuation techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. The fair value measurements are classified under the following hierarchy:
| • |
Level 1 – Observable inputs that reflect quoted market prices (unadjusted) for identical assets and liabilities in active markets; |
| • |
Level 2 – Observable inputs, other than quoted market prices, that are either directly or indirectly observable in the marketplace for identical or similar assets and liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities; and |
| • |
Level 3 – Unobservable inputs that are supported by little or no market activity that are significant to the fair value of assets or liabilities. |
When available, the Company uses quoted market prices to determine fair value, and such measurements are classified within Level 1. In some cases where market prices are not available, the Company makes use of observable market-based inputs to calculate fair value, in which case the measurements are classified within Level 2. Currently, the Company does not have any measurements with cash, cash equivalents and marketable securities classified within Level 3.
The following tables summarize certain information for assets measured at fair value on a recurring basis:
| Fair Value Measurements as of September 30, 2011 Using | ||||||||||||||||
|
Description |
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
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| (in thousands) | ||||||||||||||||
|
Cash and cash equivalents: |
||||||||||||||||
|
Cash |
$ | 5,969 | $ | 5,969 | $ | 0 | $ | 0 | ||||||||
|
Money market funds |
21,161 | 21,161 | 0 | 0 | ||||||||||||
|
Variable rate demand notes |
24,890 | 24,890 | 0 | 0 | ||||||||||||
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|
|
|
|
|
|
|
|
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|
Total cash and cash equivalents |
$ | 52,020 | $ | 52,020 | $ | 0 | $ | 0 | ||||||||
|
|
|
|
|
|
|
|
|
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|
Marketable securities: |
||||||||||||||||
|
Tax-exempt municipal securities |
$ | 86,441 | $ | 0 | $ | 86,441 | $ | 0 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Total marketable securities |
$ | 86,441 | $ | 0 | $ | 86,441 | $ | 0 | ||||||||
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| Fair Value Measurements as of December 31, 2010 Using | ||||||||||||||||
|
Description |
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
||||||||||||
| (in thousands) | ||||||||||||||||
|
Cash and cash equivalents: |
||||||||||||||||
|
Money market funds |
$ | 43,141 | $ | 43,141 | $ | 0 | $ | 0 | ||||||||
|
Variable rate demand notes |
34,275 | 34,275 | 0 | 0 | ||||||||||||
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|
|
|
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|
|
|
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|
Total cash and cash equivalents |
$ | 77,416 | $ | 77,416 | $ | 0 | $ | 0 | ||||||||
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|
|
|
|
|
|
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|
Marketable securities: |
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|
Tax-exempt municipal securities |
$ | 115,818 | $ | 0 | $ | 115,818 | $ | 0 | ||||||||
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|
|
|
|
|
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|
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|
Total marketable securities |
$ | 115,818 | $ | 0 | $ | 115,818 | $ | 0 | ||||||||
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|
|
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The Company measures cash and cash equivalents at fair value primarily using real-time quotes for transactions in active exchange markets involving identical assets. The variable rate demand notes contain a feature allowing the Company to require payment by the issuer on a daily or weekly basis. As a result, these securities are highly liquid and are classified as cash and cash equivalents. The Company's marketable securities are classified within Level 2 and are valued using readily available pricing sources for comparable instruments utilizing market observable inputs. The Company does not hold securities in inactive markets. The Company did not have any transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy during the first nine months of 2011.
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6. Accrued Liabilities
Accrued liabilities consist of the following:
| As of September 30, 2011 |
As of December 31, 2010 |
|||||||
| (in thousands) | ||||||||
|
Accrued compensation and benefits |
$ | 5,288 | $ | 14,055 | ||||
|
Accrued instructional |
6,093 | 4,544 | ||||||
|
Accrued vacation |
2,154 | 1,867 | ||||||
|
Other |
15,370 | 9,496 | ||||||
|
|
|
|
|
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| $ | 28,905 | $ | 29,962 | |||||
|
|
|
|
|
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"Other" in the table above consists primarily of vendor invoices accrued in the normal course of business.
In February 2011, we implemented a strategic reduction of workforce by eliminating approximately 120 positions and incurred charges of approximately $1.9 million in the nine months ended September 30, 2011. As of September 30, 2011 there was no remaining liability related to the reduction of workforce.
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7. Commitments and Contingencies
Leasehold Agreements
The Company leases its office facilities and certain office equipment under various noncancelable operating leases and has contractual obligations related to certain software license agreements. Effective August 29, 2011, the Company entered into an amendment of its current lease with Minneapolis 225 Holdings, LLC pursuant to which the Company renewed and extended its existing lease for premises at 225 South Sixth Street in Minneapolis, Minnesota through 2018.
Future minimum lease commitments under the leases as of September 30, 2011, are as follows:
| Operating | ||||
| (in thousands) | ||||
|
2011 |
$ | 1,647 | ||
|
2012 |
6,695 | |||
|
2013 |
6,277 | |||
|
2014 |
6,441 | |||
|
2015 |
6,539 | |||
|
2016 and thereafter |
19,941 | |||
|
|
|
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Total |
$ | 47,540 | ||
|
|
|
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The Company recognizes rent expense on a straight-line basis over the term of the lease, although the lease may include escalation clauses providing for lower payments at the beginning of the lease term and higher payments at the end of the lease term. Cash or lease incentives received from lessors are recognized on a straight-line basis as a reduction to rent from the date the Company takes possession of the property through the end of the lease term. The Company records the unamortized portion of the incentive as a component of deferred rent, in accrued liabilities or long-term liabilities, as appropriate.
Revolving Credit Facility
On September 30, 2011, the Company entered into an unsecured revolving credit agreement (the Credit Agreement) with Bank of America, N.A., and certain other lenders. The Credit Agreement provides $100.0 million of borrowing capacity (the credit facility), with an increase option of an additional $50.0 million. The Credit Agreement has a term of five years ending September 30, 2016.
Borrowings under the Credit Agreement bear interest at a rate equal to LIBOR plus an applicable rate of 1.75% to 2.25% based on the Company's consolidated leverage ratio or, at the Company's option, an alternative base rate (defined as the higher of (a) the federal funds rate plus 0.5%, (b) Bank of America's prime rate, or (c) the one-month LIBOR plus 1.0%) plus an applicable rate of 0.75% to 1.25% based on the Company's consolidated leverage ratio. The Credit Agreement requires payment of a commitment fee, based on the Company's consolidated leverage ratio, charged on the unused credit facility. Outstanding letters of credits are also charged a fee, based on the Company's consolidated leverage ratio. The Company capitalized approximately $0.5 million of transaction costs related to the credit facility, which will be amortized over a period of five years.
The Credit Agreement contains certain covenants that, among other things, require maintenance of certain financial ratios, as defined in the agreement. Failure to comply with the covenants contained in the Credit Agreement will constitute an event of default and could result in termination of the agreement and require payment of all outstanding borrowings. As of September 30, 2011, there were no borrowings under the credit facility and the Company was in compliance with all debt covenants.
Line of Credit
The Company's previous $10.0 million line of credit facility with Wells Fargo Bank, set to expire July 31, 2012, was terminated upon entering into the Credit Agreement. The $1.6 million letter of credit issued under the previous line of credit was cancelled and released by the Department of Education on July 20, 2011. There were no borrowings under the Wells Fargo Bank credit facility as of and for the nine months ended September 30, 2011, and as of and for the year ended December 31, 2010.
Litigation
On November 5, 2010, a purported securities class action lawsuit captioned Police Pension Fund of Peoria, Individually, and on Behalf of All Others Similarly Situated v. Capella Education Company, J. Kevin Gilligan and Lois M. Martin, was filed in the U.S. District Court for the District of Minnesota. The complaint names the Company and certain senior executives as defendants, and alleges the Company and the named defendants made false or misleading public statements about our business and prospects during the time period from February 16, 2010 through August 13, 2010 in violation of federal securities laws, and that these statements artificially inflated the trading price of the Company's common stock to the detriment of shareholders who purchased shares during that time. The plaintiff seeks compensatory damages for the purported class. Since that time, substantially similar complaints making similar allegations against the same defendants for the same purported class period were filed with the federal court. Pursuant to the Private Securities Litigation Reform Act of 1995, on April 13, 2011, the Court appointed Oklahoma Firefighters Pension and Retirement System as lead plaintiff and Abraham, Fruchter and Twersley, LLP, as lead counsel. A consolidated amended complaint, captioned Oklahoma Firefighters Pension and Retirement System, Individually and on Behalf of All Others Similarly Situated, v. Capella Education Company, J. Kevin Gilligan, Lois M. Martin and Amy L. Ronneberg, was filed on June 27, 2011. The Company filed a motion to dismiss the plaintiff's complaint on September 2, 2011, and a hearing on that motion is currently scheduled for December 21, 2011.
Discovery in this case has not yet begun. Because of the many questions of fact and law that may arise, the outcome of this legal proceeding is uncertain at this point. Based on information available to the Company at present, it cannot reasonably estimate a range of loss for this action and, accordingly, has not accrued any liability associated with this action.
In the ordinary conduct of business, the Company is subject to various lawsuits and claims covering a wide range of matters including, but not limited to, claims involving learners or graduates and routine employment matters. While the outcome of these matters is uncertain, the Company does not believe the outcome of these matters will have a material adverse impact on its consolidated financial position or results of operations.
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8. Stock Repurchase Program
The Company's stock repurchase program was announced in March 2008. The Board of Directors authorizes repurchases of outstanding shares of common stock, from time to time, depending on market conditions and other considerations. A summary of the Company's comprehensive stock repurchase activity for fiscal year 2010 through September 30, 2011, all of which was part of our publicly announced program, is presented below:
| (in thousands) | ||||
|
Board authorizations: |
||||
|
August 2010 |
$ | 60,662 | ||
|
February 2011 |
65,000 | |||
|
|
|
|||
|
Total amount authorized |
125,662 | |||
|
Total value of shares repurchased |
90,873 | |||
|
|
|
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|
Residual authorization |
$ | 34,789 | ||
|
|
|
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In addition to the Board authorizations outlined above, the Company executed a separate authorization under the stock repurchase program in July 2008 for repurchases up to an aggregate amount of $60.0 million in value of common stock, which has been fully utilized.
During the nine months ended September 30, 2011, the Company repurchased 1.7 million shares for total consideration of $78.1 million. Due to timing, cash payments made for these share repurchases were $77.3 million. The Company repurchased 0.5 million shares for total consideration of $36.5 million during the nine months ended September 30, 2010.
As of September 30, 2011, the Company had purchased an aggregate of 2.9 million shares under the program's outstanding authorizations at an average price per share of $52.45 totaling $150.9 million.
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|||
9. Stock-Based Compensation
The following table presents the Company's stock-based compensation expense recognized in the consolidated statements of income:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (in thousands) | ||||||||||||||||
|
Instructional costs and services |
$ | 317 | $ | 334 | $ | 835 | $ | 733 | ||||||||
|
Marketing and promotional |
150 | 125 | 420 | 286 | ||||||||||||
|
General and administrative |
814 | 613 | 1,936 | 1,419 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Stock-based compensation expense included in operating income |
1,281 | 1,072 | 3,191 | 2,438 | ||||||||||||
|
Tax benefit from stock-based compensation expense |
460 | 398 | 1,177 | 909 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Stock-based compensation expense, net of tax |
$ | 821 | $ | 674 | $ | 2,014 | $ | 1,529 | ||||||||
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|
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10. Noncontrolling Interest
Sophia became a majority owned subsidiary of the Company in 2010. The equity interest in Sophia not owned by the Company is reported as noncontrolling interest on the consolidated balance sheet of the Company. Losses incurred by Sophia were charged to the Company and to the noncontrolling interest holder based on ownership percentage.
There is a put option within the Sophia Learning, LLC agreement which permits the noncontrolling interest to put its shares to the Company within a specified time period. Since these shares are outside the control of the Company, the noncontrolling interest is considered contingently redeemable and thus is presented in mezzanine equity in the consolidated balance sheet. Pursuant to authoritative guidance, if the value of the contingently redeemable noncontrolling interest is less than the fair market value, and it is probable the contingency related to the put option will be met, then the carrying value of the contingently redeemable noncontrolling interest must be adjusted to fair market value through a charge directly to retained earnings. Although the Company has determined that it is probable that the put option will be exercised based upon the passage of time, the Company determined that a charge to retained earnings was not needed at September 30, 2011, as the value of the contingently redeemable noncontrolling interest approximated fair market value. The Company based this determination on the short time period from its latest investment in Sophia and September 30, 2011, and the current business activities at Sophia. Unobservable inputs are employed in determining the fair value of the redeemable noncontrolling interest and as such it is considered a Level 3 fair value measurement.
|
|||
11. Acquisition of RDI
On July 15, 2011, the Company acquired 100% of the share capital of RDI for £7.9 million (approximately $12.6 million), net of cash acquired. RDI is an independent provider of UK university distance learning qualifications and markets, develops and delivers these programs worldwide via its offices and partners across Asia, North America, Africa and Europe. RDI's online distance learning offerings span from degree-entry programs to doctoral level programs and are offered in a variety of disciplines, including business, management, psychology, law, and computing.
As a result of years of investment in its academic infrastructure, RDI has applied to the British Government for Taught Degree Awarding Powers (TDAP). If awarded, TDAP will enable RDI to independently validate its own degrees going forward under the auspices of the Quality Assurance Agency, a Government body that reviews the standards and quality of all UK universities. Under the terms of the agreement, the Company will make an additional payment of £4.0 million (approximately $6.4 million) if TDAP is granted to RDI.
The Company has preliminarily measured the fair value of the assets acquired and liabilities assumed in accordance with ASC 805 Business Combinations. The Company recorded goodwill of $16.4 million, and capitalized $7.6 million of intangible assets primarily consisting of partner and student relationships, trademark and trade name, learning model, and internally developed software. The estimated useful lives of the intangible assets range from two to ten years. The Company also recorded a liability of $5.7 million for the fair value of the TDAP contingent consideration, which is included in other liabilities as of September 30, 2011, and has recorded the acquired deferred revenue at its fair value of $1.6 million. The Company assumed net liabilities of £1.6 million (approximately $2.6 million) in this transaction.
The Company is in the process of finalizing the third party valuations of the intangible assets and contingent consideration values; thus, the preliminary measurements of intangible assets, goodwill, contingent consideration, and deferred income tax are subject to change as we finalize the purchase accounting for this transaction. The results of operations of RDI have been included in the Company's consolidated results of operations since the date of acquisition.
|
|||
12. Regulatory Supervision and Oversight
Capella University is subject to extensive regulation by federal and state governmental agencies and accrediting bodies. In particular, the Higher Education Act (HEA) and the regulations promulgated thereunder by the U.S. Department of Education (DOE) subject the University to significant regulatory scrutiny on the basis of numerous standards that schools must satisfy to participate in the various types of federal learner financial assistance under Title IV Programs.
To participate in the Title IV Programs, an institution must be authorized to offer its programs of instruction by the relevant agencies of the state in which it is located, accredited by an accrediting agency recognized by the DOE and certified as eligible by the DOE. The DOE will certify an institution to participate in the Title IV programs only after the institution has demonstrated compliance with the HEA and the DOE's extensive academic, administrative, and financial regulations regarding institutional eligibility. An institution must also demonstrate its compliance with these requirements to the DOE on an ongoing basis. The Company performs periodic reviews of its compliance with the various applicable regulatory requirements. The Company has not been notified by any of the various regulatory agencies of any significant noncompliance matters that would adversely impact its ability to participate in Title IV programs; however, the Office of Inspector General (OIG) has conducted a compliance audit of Capella University. The audit commenced on April 10, 2006 and we subsequently provided the OIG with periodic information, responded to follow up inquiries and facilitated site visits and access to Capella University's records. The OIG completed its field work in January 2007 and the Company received a draft audit report on August 23, 2007. Capella University provided written comments on the draft report to the OIG on September 25, 2007. On March 7, 2008, the OIG's final report was issued to the Acting Chief Operating Officer (COO) for Federal Student Aid (FSA), which is responsible for primary oversight of the Title IV funding programs. The Company responded to the final report on April 8, 2008. In 2009, Capella University provided FSA staff with certain additional requested information for financial aid years 2002-2003 through 2007-2008. The FSA will subsequently issue final findings and requirements for Capella University. The FSA may take certain actions, including requiring that we refund certain federal student aid funds, requiring us to modify our Title IV administration procedures, and/or requiring us to pay fines or penalties.
Based on the final audit report for the financial aid years 2002-2003 through 2004-2005, the most significant potential financial exposure from the audit pertains to repayments to the Department of Education that could be required if the OIG concludes that Capella University did not properly calculate the amount of Title IV funds required to be returned for learners that withdrew without providing an official notification of such withdrawal and without engaging in academic activity prior to such withdrawal. If it is determined that Capella University improperly withheld any portion of these funds, Capella University would be required to return the improperly withheld funds. The Company and the OIG have differing interpretations of the relevant regulations regarding what constitutes engagement in the unofficial withdrawal context. As the Company interprets the engagement requirement, it currently estimates that for the three year audit period, and for the subsequent aid years through 2007-2008, the total amount of Title IV funds not returned—for learners who withdrew without providing official notification and without engaging as required in the relevant regulations—was approximately $1.0 million including interest, but not including fines and penalties. If this difference of interpretation is ultimately resolved in a manner adverse to the Company, then the total amount of Title IV funds not returned for learners who withdrew without providing official notification would be greater than the amount the Company has currently estimated.
Political and budgetary concerns significantly affect the Title IV Programs. Congress reauthorizes the HEA and other laws governing Title IV Programs approximately every five to eight years. The last reauthorization of the HEA was completed in August 2008. Additionally, Congress reviews and determines appropriations for Title IV programs on an annual basis through the budget and appropriations processes. As of September 30, 2011, programs in which the Company's learners participate are operative and sufficiently funded.
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Consolidation
The consolidated financial statements include the accounts of the Company, the University, RDI and its subsidiaries, and Sophia, after elimination of intercompany accounts and transactions.
Unaudited Interim Financial Information
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, these statements include all adjustments (consisting of normal recurring adjustments) considered necessary to present a fair statement of our consolidated results of operations, financial position and cash flows. Operating results for any interim period are not necessarily indicative of the results that may be expected for the full year. Preparation of the Company's financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and footnotes. Actual results could differ from those estimates. This Quarterly Report on Form 10-Q should be read in conjunction with the Company's consolidated financial statements and footnotes included in its Annual Report on Form 10-K for the fiscal year ended December 31, 2010 (2010 Annual Report on Form 10-K).
Marketable Securities
Management determines the appropriate designation of marketable securities at the time of purchase and re-evaluates such designation as of each balance sheet date. All of the Company's marketable securities were designated as available-for-sale as of September 30, 2011 and December 31, 2010.
Available-for-sale marketable securities are carried at fair value as determined by quoted market prices or other inputs either directly or indirectly observable in the marketplace for identical or similar assets, with unrealized gains and losses, net of tax, recognized through accumulated comprehensive income within shareholders' equity. Management reviews the fair value of the portfolio at least monthly, and evaluates individual securities with fair value below amortized cost at the balance sheet date. In order to determine whether impairment is other than temporary, management must conclude whether the Company intends to sell the impaired security and whether it is more likely than not that the Company will be required to sell the security before recovering its amortized cost basis.
If management intends to sell an impaired debt security or it is more likely than not the Company will be required to sell the security prior to recovering its amortized cost basis, an other-than-temporary impairment is deemed to have occurred. The amount of an other-than-temporary impairment related to a credit loss, or securities that management intends to sell before recovery, is recognized in earnings. The amount of an other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as other comprehensive income within shareholders' equity.
The cost of securities sold is based on the specific identification method. Amortization of premiums, accretion of discounts, interest, dividend income and realized gains and losses are included in investment income. The contractual maturity date of available-for-sale securities is based on the days remaining to the effective maturity. Certain reclassifications have been made to the contractual maturities as of December 31, 2010 in Note 5 to align with current reporting methods. The Company classifies all marketable securities as current assets because the assets are available to fund current operations.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Contingencies
The Company accrues for costs associated with contingencies including, but not limited to, regulatory compliance and legal matters when such costs are probable and reasonably estimable. Liabilities established to provide for contingencies are adjusted as further information develops, circumstances change, or contingencies are resolved. The Company bases these accruals on management's best estimate of such costs, which may vary from the ultimate cost and expenses associated with any such contingency.
Goodwill and Intangible Assets
Goodwill represents the excess of the purchase price of an acquired business over the fair value assigned to the underlying assets acquired and assumed liabilities. At the time of an acquisition, the Company allocates the goodwill and related assets and liabilities to its respective reporting unit. The Company identifies its reporting unit by assessing whether the components of its operating segment constitutes businesses for which discrete financial information is available and management regularly reviews the operating results of those components. The Company assesses goodwill at least annually for impairment or more frequently if events occur or circumstances change between annual tests that would more likely than not reduce the fair value of the respective reporting unit below its carrying amount.
The Company tests for goodwill impairment at the reporting unit level by applying a two-step test. In the first step, the Company compares the fair value of the reporting unit to the carrying value of its net assets. If the fair value of the reporting unit exceeds the carrying value of the net assets of the reporting unit, goodwill is not impaired and no further testing is required. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, the Company performs a second step to determine the implied fair value of the goodwill and compare it to the carrying value of the goodwill. An impairment loss is recognized to the extent the implied fair value of the goodwill is less than the carrying amount of the goodwill.
Finite-lived intangible assets that are acquired in business combinations are recorded at fair market value on their acquisition date and are amortized on a straight-line basis to reflect the economic useful life of the asset. We do not currently have any infinite-lived intangible assets.
The U.S. dollar is the functional currency of the Company's entities operating in the United States (U.S.). The functional currency of the Company's entities operating outside the U.S. is the currency of the primary economic environment in which the entity primarily generates and expends cash, which is generally the local currency. The assets and liabilities of these operations are translated to U.S. dollars using exchange rates in effect at the balance sheet dates. The resulting translation adjustments and the effect of exchange rate changes on intercompany transactions of a long-term investment nature are included in shareholders' equity as a component of accumulated other comprehensive income (loss). Income and expense items are translated monthly at the average exchange rate for that period. The Company reports gains and losses from foreign exchange rate changes related to intercompany receivables and payables that are not of a long-term investment nature, as well as gains and losses from foreign currency denominated transactions, in the Consolidated Statements of Income.
Subsequent Events
The Company has evaluated events and transactions that occurred during the period subsequent to the balance sheet date. There have been no subsequent events that require recognition or disclosure in the financial statements.
Refer to the Company's "Summary of Significant Accounting Policies" footnote included in its 2010 Annual Report on Form 10-K for a complete summary of the Company's significant accounting policies.
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| As of September 30, 2011 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains |
Gross Unrealized (Losses) |
Estimated Fair Value |
|||||||||||||
| (in thousands) | ||||||||||||||||
|
Tax-exempt municipal securities |
$ | 85,756 | $ | 685 | $ | 0 | $ | 86,441 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
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Total |
$ | 85,756 | $ | 685 | $ | 0 | $ | 86,441 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| As of December 31, 2010 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains |
Gross Unrealized (Losses) |
Estimated Fair Value |
|||||||||||||
| (in thousands) | ||||||||||||||||
|
Tax-exempt municipal securities |
$ | 114,604 | $ | 1,277 | $ | (63 | ) | $ | 115,818 | |||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Total |
$ | 114,604 | $ | 1,277 | $ | (63 | ) | $ | 115,818 | |||||||
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|
|
|
|
|
|
|
|||||||||
| As of September 30, 2011 |
As of December 31, 2010 |
|||||||
| (in thousands) | ||||||||
|
Due within one year |
$ | 66,144 | $ | 58,998 | ||||
|
Due after one year through five years |
20,297 | 56,820 | ||||||
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|
|
|
|
|||||
| $ | 86,441 | $ | 115,818 | |||||
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|
|
|
|
|||||
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (in thousands) | ||||||||||||||||
|
Maturities of marketable securities |
$ | 13,225 | $ | 6,150 | $ | 30,685 | $ | 6,150 | ||||||||
|
Proceeds from the sale of marketable securities |
0 | 1,000 | 0 | 1,000 | ||||||||||||
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|
|
|
|
|
|
|
|
|||||||||
| $ | 13,225 | $ | 7,150 | $ | 30,685 | $ | 7,150 | |||||||||
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|
|
|
|
|||||||||
| Fair Value Measurements as of September 30, 2011 Using | ||||||||||||||||
|
Description |
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
||||||||||||
| (in thousands) | ||||||||||||||||
|
Cash and cash equivalents: |
||||||||||||||||
|
Cash |
$ | 5,969 | $ | 5,969 | $ | 0 | $ | 0 | ||||||||
|
Money market funds |
21,161 | 21,161 | 0 | 0 | ||||||||||||
|
Variable rate demand notes |
24,890 | 24,890 | 0 | 0 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Total cash and cash equivalents |
$ | 52,020 | $ | 52,020 | $ | 0 | $ | 0 | ||||||||
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|
|
|
|
|
|
|
|
|||||||||
|
Marketable securities: |
||||||||||||||||
|
Tax-exempt municipal securities |
$ | 86,441 | $ | 0 | $ | 86,441 | $ | 0 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Total marketable securities |
$ | 86,441 | $ | 0 | $ | 86,441 | $ | 0 | ||||||||
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|
|
|
|
|
|
|
|
|||||||||
| Fair Value Measurements as of December 31, 2010 Using | ||||||||||||||||
|
Description |
Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
||||||||||||
| (in thousands) | ||||||||||||||||
|
Cash and cash equivalents: |
||||||||||||||||
|
Money market funds |
$ | 43,141 | $ | 43,141 | $ | 0 | $ | 0 | ||||||||
|
Variable rate demand notes |
34,275 | 34,275 | 0 | 0 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Total cash and cash equivalents |
$ | 77,416 | $ | 77,416 | $ | 0 | $ | 0 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Marketable securities: |
||||||||||||||||
|
Tax-exempt municipal securities |
$ | 115,818 | $ | 0 | $ | 115,818 | $ | 0 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Total marketable securities |
$ | 115,818 | $ | 0 | $ | 115,818 | $ | 0 | ||||||||
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|
|
|
|
|
|
|
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|
|||
| As of September 30, 2011 |
As of December 31, 2010 |
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| (in thousands) | ||||||||
|
Accrued compensation and benefits |
$ | 5,288 | $ | 14,055 | ||||
|
Accrued instructional |
6,093 | 4,544 | ||||||
|
Accrued vacation |
2,154 | 1,867 | ||||||
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Other |
15,370 | 9,496 | ||||||
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|
|
|
|
|||||
| $ | 28,905 | $ | 29,962 | |||||
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|
|
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|
|||
| Operating | ||||
| (in thousands) | ||||
|
2011 |
$ | 1,647 | ||
|
2012 |
6,695 | |||
|
2013 |
6,277 | |||
|
2014 |
6,441 | |||
|
2015 |
6,539 | |||
|
2016 and thereafter |
19,941 | |||
|
|
|
|||
|
Total |
$ | 47,540 | ||
|
|
|
|||
|
|||
| (in thousands) | ||||
|
Board authorizations: |
||||
|
August 2010 |
$ | 60,662 | ||
|
February 2011 |
65,000 | |||
|
|
|
|||
|
Total amount authorized |
125,662 | |||
|
Total value of shares repurchased |
90,873 | |||
|
|
|
|||
|
Residual authorization |
$ | 34,789 | ||
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|
|
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|
|||
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2011 | 2010 | 2011 | 2010 | |||||||||||||
| (in thousands) | ||||||||||||||||
|
Instructional costs and services |
$ | 317 | $ | 334 | $ | 835 | $ | 733 | ||||||||
|
Marketing and promotional |
150 | 125 | 420 | 286 | ||||||||||||
|
General and administrative |
814 | 613 | 1,936 | 1,419 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Stock-based compensation expense included in operating income |
1,281 | 1,072 | 3,191 | 2,438 | ||||||||||||
|
Tax benefit from stock-based compensation expense |
460 | 398 | 1,177 | 909 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
|
Stock-based compensation expense, net of tax |
$ | 821 | $ | 674 | $ | 2,014 | $ | 1,529 | ||||||||
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