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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 September 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: 001-36376

2U, INC.
(Exact name of registrant as specified in its charter)

Delaware
26-2335939
 
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
 
7900 Harkins Road
Lanham,
MD
20706
 
(Address of Principal Executive Offices)
(Zip Code)
 

(301) 892-4350
(Registrant’s telephone number, including area code)

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, $0.001 par value per share
 
TWOU
 
The Nasdaq Global Select Market

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 every Interactive Data File required to be submitted 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 such files).   Yes   No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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
As of November 8, 2019, there were 63,476,902 shares of the registrant’s common stock, par value $0.001 per share, outstanding.
 



Table of Contents

TABLE OF CONTENTS
 
 
 
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018
 
 
Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited) for the three and nine months ended September 30, 2019 and 2018
 
 
Condensed Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the three and nine months ended September 30, 2019 and 2018
 
 
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2019 and 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



1


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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and which are subject to substantial risks and uncertainties. In some cases, you can identify forward-looking statements by the words “may,” “might,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “objective,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue” and “ongoing,” or the negative of these terms, or other comparable terminology intended to identify statements about the future. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Quarterly Report on Form 10-Q, we caution you that these statements are based on a combination of facts and factors currently known by us and our expectations of the future, about which we cannot be certain. Factors which may cause actual results to differ materially from current expectations include, but are not limited to:
trends in the higher education market and the market for online education, and expectations for growth in those markets;
the acceptance, adoption and growth of online learning by colleges and universities, faculty, students, employers, accreditors and state and federal licensing bodies;
our ability to comply with evolving regulations and legal obligations related to data privacy, data protection and information security;
our expectations about the potential benefits of our cloud-based software-as-a-service, or SaaS, technology and technology-enabled services to university clients and students;
our dependence on third parties to provide certain technological services or components used in our platform;
our ability to meet the anticipated launch dates of our graduate programs, short courses and boot camps;
our expectations about the predictability, visibility and recurring nature of our business model;
our ability to acquire new university clients and expand our graduate programs, short courses and boot camps with existing university clients;
our ability to successfully integrate the operations of our acquisitions, including Get Educated International Proprietary Limited, or GetSmarter, and Trilogy Education Services, Inc., or Trilogy, achieve the expected benefits of our acquisitions and manage, expand and grow the combined company;
our ability to service our substantial indebtedness and comply with the financial and other restrictive covenants contained in the credit agreement governing our senior secured term loan facility;
our ability to generate sufficient future operating cash flows from recent acquisitions to ensure related goodwill is not impaired;
our ability to execute our growth strategy in the international, undergraduate and non-degree alternative markets;
our ability to continue to acquire prospective students for our graduate programs, short courses and boot camps;
our ability to affect or increase student retention in our graduate programs;
our ability to attract, hire and retain qualified employees;
our expectations about the scalability of our cloud-based platform;
our expectations regarding future expenses in relation to future revenue;
potential changes in regulations applicable to us or our university clients; and
our expectations regarding the amount of time our cash balances and other available financial resources will be sufficient to fund our operations.

2


Table of Contents

 
You should refer to the risks described in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018, as amended and supplemented by Part II, Item 1A “Risk Factors” in this Quarterly Report, for a discussion of important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this Quarterly Report on Form 10-Q will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
 
You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. In this Quarterly Report on Form 10-Q, the terms “2U,” “Company,” “we,” “us,” and “our” refer to 2U, Inc. and its subsidiaries, unless the context indicates otherwise.

3


Table of Contents

PART I.  FINANCIAL INFORMATION
 
Item 1.       Financial Statements

2U, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts)
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
Assets
 

 
 

Current assets
 

 
 

Cash and cash equivalents
$
154,091

 
$
449,772

Restricted cash
16,739

 

Investments

 
25,000

Accounts receivable, net
84,797

 
32,636

Prepaid expenses and other assets
39,239

 
14,272

Total current assets
294,866

 
521,680

Property and equipment, net
56,105

 
52,299

Right-of-use assets
40,391

 

Goodwill
414,027

 
61,852

Amortizable intangible assets, net
336,373

 
136,605

University payments and other assets, non-current
71,808

 
34,918

Total assets
$
1,213,570

 
$
807,354

Liabilities and stockholders’ equity
 

 
 

Current liabilities
 

 
 

Accounts payable and accrued expenses
$
59,607

 
$
27,647

Accrued compensation and related benefits
27,256

 
23,001

Deferred revenue
58,634

 
8,345

Lease liability
7,104

 

Other current liabilities
12,362

 
9,487

Total current liabilities
164,963

 
68,480

Long-term debt
245,856

 
3,500

Deferred tax liabilities, net
6,172

 
6,949

Lease liability, non-current
62,709

 

Other liabilities, non-current
812

 
23,416

Total liabilities
480,512

 
102,345

Commitments and contingencies (Note 6)


 


Stockholders’ equity


 


Preferred stock, $0.001 par value, 5,000,000 shares authorized, none issued

 

Common stock, $0.001 par value, 200,000,000 shares authorized, 63,388,705 shares issued and outstanding as of September 30, 2019; 57,968,493 shares issued and outstanding as of December 31, 2018
63

 
58

Additional paid-in capital
1,180,298

 
957,631

Accumulated deficit
(434,804
)
 
(244,166
)
Accumulated other comprehensive loss
(12,499
)
 
(8,514
)
Total stockholders’ equity
733,058

 
705,009

Total liabilities and stockholders’ equity
$
1,213,570

 
$
807,354

 
See accompanying notes to condensed consolidated financial statements.

4


Table of Contents

2U, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Loss
(unaudited, in thousands, except share and per share amounts)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Revenue
$
153,798

 
$
106,963

 
$
411,493

 
$
296,674

Costs and expenses
 
 
 
 
 
 
 
Curriculum and teaching
21,336

 
6,351

 
41,345

 
16,665

Servicing and support
27,351

 
16,586

 
71,518

 
49,116

Technology and content development
34,132

 
16,361

 
79,969

 
45,436

Marketing and sales
93,521

 
60,548

 
260,231

 
171,982

General and administrative
42,040

 
18,974

 
93,471

 
63,323

Impairment charge
70,379

 

 
70,379

 

Total costs and expenses
288,759


118,820


616,913


346,522

Loss from operations
(134,961
)
 
(11,857
)
 
(205,420
)
 
(49,848
)
Interest income
924

 
1,799

 
5,087

 
3,053

Interest expense
(5,651
)
 
(27
)
 
(8,130
)
 
(81
)
Other expense, net
(710
)
 
(273
)
 
(1,093
)
 
(1,493
)
Loss before income taxes
(140,398
)

(10,358
)

(209,556
)

(48,369
)
Income tax (expense) benefit
(714
)
 
414

 
18,918

 
5,207

Net loss
$
(141,112
)

$
(9,944
)

$
(190,638
)

$
(43,162
)
Net loss per share, basic and diluted
$
(2.23
)
 
$
(0.17
)
 
$
(3.14
)
 
$
(0.78
)
Weighted-average shares of common stock outstanding, basic and diluted
63,358,890

 
57,663,361

 
60,690,536

 
55,128,845

Other comprehensive loss
 

 
 

 
 

 
 

Foreign currency translation adjustments, net of tax of $0 for all periods presented
(5,856
)
 
(2,781
)
 
(3,985
)
 
(12,327
)
Comprehensive loss
$
(146,968
)

$
(12,725
)

$
(194,623
)

$
(55,489
)
 
See accompanying notes to condensed consolidated financial statements.


5


Table of Contents

2U, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(unaudited, in thousands, except share amounts)
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Deficit
 
Accumulated
Other Comprehensive
Income (Loss)
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Balance, December 31, 2018
57,968,493

 
$
58

 
$
957,631

 
$
(244,166
)
 
$
(8,514
)
 
$
705,009

Exercise of stock options
211,506

 

 
1,928

 

 

 
1,928

Issuance of common stock in connection with settlement of restricted stock units, net of withholdings
9,319

 

 

 

 

 

Stock-based compensation expense

 

 
9,584

 

 

 
9,584

Net loss

 

 

 
(21,554
)
 

 
(21,554
)
Foreign currency translation adjustment

 

 

 

 
(372
)
 
(372
)
Balance, March 31, 2019
58,189,318

 
$
58

 
$
969,143

 
$
(265,720
)
 
$
(8,886
)
 
$
694,595

Exercise of stock options
85,539

 

 
452

 

 

 
452

Issuance of common stock in connection with settlement of restricted stock units, net of withholdings
348,418

 

 
(2,558
)
 

 

 
(2,558
)
Issuance of common stock in connection with business combination, net of offering costs
4,608,101

 
5

 
184,317

 

 

 
184,322

Stock-based compensation expense

 
 
 
9,967

 

 

 
9,967

Net loss

 

 

 
(27,972
)
 

 
(27,972
)
Foreign currency translation adjustment

 

 

 

 
2,243

 
2,243

Balance, June 30, 2019
63,231,376

 
$
63

 
$
1,161,321

 
$
(293,692
)
 
$
(6,643
)
 
$
861,049

Exercise of stock options
41,828

 

 
562

 

 

 
562

Issuance of common stock in connection with settlement of restricted stock units, net of withholdings
61,016

 

 
(15
)
 

 

 
(15
)
Issuance of common stock in connection with employee stock purchase plan
54,485

 

 
1,895

 

 

 
1,895

Stock-based compensation expense

 


 
16,535

 

 

 
16,535

Net loss

 

 

 
(141,112
)
 

 
(141,112
)
Foreign currency translation adjustment

 

 

 

 
(5,856
)
 
(5,856
)
Balance, September 30, 2019
63,388,705

 
$
63

 
$
1,180,298

 
$
(434,804
)
 
$
(12,499
)
 
$
733,058


See accompanying notes to condensed consolidated financial statements.

6


Table of Contents

2U, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity (Continued)
(unaudited, in thousands, except share amounts)
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Deficit
 
Accumulated
Other Comprehensive
Income (Loss)
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Balance, December 31, 2017
52,505,856

 
$
53

 
$
588,289

 
$
(205,836
)
 
$
5,326

 
$
387,832

Exercise of stock options
186,049

 

 
2,120

 

 

 
2,120

Issuance of common stock in connection with settlement of restricted stock units, net of withholdings
154,111

 

 
(1,002
)
 

 

 
(1,002
)
Stock-based compensation expense

 

 
7,122

 

 

 
7,122

Net loss

 

 

 
(14,871
)
 

 
(14,871
)
Foreign currency translation adjustment

 

 

 

 
4,632

 
4,632

Balance, March 31, 2018
52,846,016

 
$
53

 
$
596,529

 
$
(220,707
)
 
$
9,958

 
$
385,833

Exercise of stock options
315,482

 

 
2,673

 

 

 
2,673

Issuance of common stock in connection with settlement of restricted stock units, net of withholdings
320,753

 

 
(2,405
)
 

 

 
(2,405
)
Issuance of common stock in connection with a public offering of common stock, net of offering costs
3,833,334

 
4

 
330,858

 

 

 
330,862

Stock-based compensation expense

 

 
9,009

 

 

 
9,009

Net loss

 

 

 
(18,347
)
 

 
(18,347
)
Foreign currency translation adjustment

 

 

 

 
(14,178
)
 
(14,178
)
Balance, June 30, 2018
57,315,585

 
$
57

 
$
936,664

 
$
(239,054
)
 
$
(4,220
)
 
$
693,447

Exercise of stock options
499,043

 

 
2,239

 

 

 
2,239

Issuance of common stock in connection with settlement of restricted stock units, net of withholdings
68,228

 
1

 
(44
)
 

 

 
(43
)
Issuance of common stock in connection with employee stock purchase plan
22,483

 

 
1,278

 

 

 
1,278

Stock-based compensation expense

 

 
7,933

 

 

 
7,933

Net loss

 

 

 
(9,944
)
 

 
(9,944
)
Foreign currency translation adjustment

 

 

 

 
(2,781
)
 
(2,781
)
Balance, September 30, 2018
57,905,339

 
$
58

 
$
948,070

 
$
(248,998
)
 
$
(7,001
)
 
$
692,129


See accompanying notes to condensed consolidated financial statements.

7


Table of Contents

2U, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands) 
 
Nine Months Ended
September 30,
 
2019
 
2018
Cash flows from operating activities
 

 
 

Net loss
$
(190,638
)
 
$
(43,162
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization expense
46,639

 
23,382

Stock-based compensation expense
36,086

 
24,064

Non-cash lease expense
8,407

 

Bad debt expense
1,785

 

Impairment charge
70,379

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(39,743
)
 
(35,543
)
Payments to university clients
(22,257
)
 
(11,066
)
Prepaid expenses and other assets
(6,760
)
 
(5,426
)
Accounts payable and accrued expenses
12,712

 
10,796

Accrued compensation and related benefits
(109
)
 
1,185

Deferred revenue
20,162

 
12,210

Other liabilities, net
(24,263
)
 
(3,976
)
Other
1,939

 
1,493

Net cash used in operating activities
(85,661
)

(26,043
)
Cash flows from investing activities
 

 
 

Purchase of a business, net of cash acquired
(388,004
)
 

Additions of amortizable intangible assets
(50,950
)
 
(51,713
)
Purchases of property and equipment
(11,310
)
 
(8,027
)
Purchase of investments
(10,000
)
 
(25,000
)
Proceeds from maturities of investments
25,000

 

Advances made to university clients
(100
)
 
(300
)
Advances repaid by university clients
350

 
25

Other
4

 

Net cash used in investing activities
(435,010
)

(85,015
)
Cash flows from financing activities
 

 
 

Proceeds from issuance of common stock, net of offering costs

 
330,862

Proceeds from exercise of stock options
2,942

 
7,032

Proceeds from debt
243,726

 

Tax withholding payments associated with settlement of restricted stock units
(2,573
)
 
(3,450
)
Proceeds from ESPP share purchases
1,895

 
1,278

Payments for acquisition of amortizable intangible assets
(1,283
)
 
(4,900
)
Payment of debt issuance costs
(1,953
)
 

Net cash provided by financing activities
242,754


330,822

Effect of exchange rate changes on cash
(1,025
)
 
(908
)
Net (decrease) increase in cash, cash equivalents and restricted cash
(278,942
)
 
218,856

Cash, cash equivalents and restricted cash, beginning of period
449,772

 
223,370

Cash, cash equivalents and restricted cash, end of period
$
170,830


$
442,226

 
See accompanying notes to condensed consolidated financial statements.


8

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)



1.    Organization

2U, Inc. (together with its subsidiaries, the “Company”) is a leading education technology company that well-recognized nonprofit colleges and universities trust to bring them into the digital age. The Company’s comprehensive platform of tightly integrated technology and services provides the digital infrastructure universities need to attract, enroll, educate and support students at scale. With the Company’s platform, students can pursue their education anytime, anywhere, without quitting their jobs or moving; and university clients can improve educational outcomes, skills attainment and career prospects for a greater number of students than they could on their own.

The Company has two reportable segments: the Graduate Program Segment and the Alternative Credential Segment (formerly known as the Short Course Segment). The Company’s Graduate Program Segment provides services to well-recognized nonprofit colleges and universities, primarily in the United States, to enable the online delivery of graduate programs. The Company’s Alternative Credential Segment provides short form non-degree offerings, such as premium online short courses and technical skills-based boot camps, to working professionals around the world through relationships with leading universities. In the first quarter of 2019, we changed the name of this segment from Short Course to Alternative Credential to more accurately reflect the nature and breadth of educational offerings within this segment. Refer to Note 13 for further information about the Company’s segments.

On May 22, 2019, the Company completed its acquisition of Trilogy, a workforce accelerator that prepares adult learners for high-growth careers in the digital economy through its boot camp offerings. The acquisition expanded 2U’s university portfolio and deepened relationships across both 2U’s and Trilogy’s partners to make education more accessible for lifelong learners. The results of Trilogy’s operations are included in the Alternative Credential Segment. Refer to Note 3 for further information about the acquisition of Trilogy.
 
2.    Significant Accounting Policies

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements, which include the assets, liabilities, results of operations and cash flows of the Company have been prepared in accordance with: (i) generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information; (ii) the instructions to Form 10-Q; and (iii) the guidance of Rule 10-01 of Regulation S-X under the Securities Exchange Act of 1934, as amended, for financial statements required to be filed with the Securities and Exchange Commission (“SEC”). As permitted under such rules, certain notes and other financial information normally required by U.S. GAAP have been condensed or omitted. The Company believes the condensed consolidated financial statements reflect all normal and recurring adjustments necessary for a fair statement of the Company’s financial position, results of operations, and cash flows as of and for the periods presented herein. The Company’s results of operations for the three and nine months ended September 30, 2019 and 2018 may not be indicative of the Company’s future results. These condensed consolidated financial statements are unaudited and should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018. All significant intercompany accounts and transactions have been eliminated in consolidation.

The condensed consolidated balance sheet data as of December 31, 2018 was derived from the audited financial statements, but does not include all disclosures required by U.S. GAAP on an annual reporting basis.

Use of Estimates

The preparation of the condensed consolidated financial statements in accordance with U.S. GAAP requires management to make certain estimates and assumptions that affect the amounts reported herein. The Company bases its estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances. Significant estimates and assumptions are inherent in the analysis and the measurement of deferred tax assets and the recoverability of goodwill. Due to the inherent uncertainty involved in making estimates, actual results reported in

9

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

2.    Significant Accounting Policies (Continued)

future periods may be affected by changes in those estimates. The Company evaluates its estimates and assumptions on an ongoing basis.

Restricted Cash

The Company maintains restricted cash as collateral for standby letters of credit for the Company’s leased facilities and in connection with the deferred government grant obligations.

Investments

The Company’s investments within current assets on the condensed consolidated balance sheets relate to certificates of deposit with original maturities between three months and one year. As of December 31, 2018, the Company had a $25.0 million certificate of deposit included in investments that qualified as a Level 1 fair value measurement asset and was stated at cost, which approximated fair value. This certificate of deposit matured in the first quarter of 2019.

Revenue Recognition

The Company generates substantially all of its revenue from contractual arrangements, with either its university clients or students, to provide a comprehensive platform of tightly integrated technology and technology-enabled services that support its offerings.

Performance Obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.

The Graduate Program Segment derives revenue primarily from contractually specified percentages of the amounts the Company’s university clients receive from their students in 2U-enabled graduate programs for tuition and fees, less credit card fees and other specified charges the Company has agreed to exclude in certain university contracts. The Company’s contracts with university clients in this segment typically have terms of 10 to 15 years and have a single performance obligation, as the promises to provide a platform of tightly integrated technology and services that university clients need to attract, enroll, educate and support students are not distinct within the context of the contracts. The single performance obligation is delivered as the university clients receive and consume benefits, which occurs ratably over a series of academic terms. The amounts received from university clients over the term of the arrangement are variable in nature in that they are dependent upon the number of students that are enrolled in the program within each academic term. These amounts are allocated to and are recognized ratably over the related academic term, defined as the period beginning on the first day of classes through the last. Revenue is recognized net of an allowance, which is established for the Company’s expected obligation to refund tuition and fees to university clients.

The Alternative Credential Segment derives revenue primarily from contracts with students for the tuition and fees paid to enroll in, and progress through, the Company’s short courses and boot camps. The Company’s short courses run between six and 16 weeks, while boot camps run between 12 and 24 weeks. In this segment, the Company’s contracts with students include the delivery of the educational and related student support services and are treated as either a single performance obligation or multiple performance obligations, depending upon the offering being delivered. All performance obligations are satisfied ratably over the same presentation period, which is defined as the period beginning on the first day of the course through the last. The Company recognizes the gross proceeds received from the students enrolled and shares contractually specified amounts received from students with the associated university client, in exchange for licenses to use the university brand name and other university trademarks. These amounts are recognized as curriculum and teaching costs on the Company’s condensed consolidated statements of operations and comprehensive loss. The Company’s contracts with university clients in this segment are typically shorter and less restrictive than the Company’s contracts with university clients in the Graduate Program Segment.

Business Combinations

10

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

2.    Significant Accounting Policies (Continued)


The purchase price of an acquisition is allocated to the assets acquired, including intangible assets, and liabilities assumed, based on their respective fair values at the acquisition date. Acquisition-related costs are expensed as incurred. The excess of the cost of an acquired entity, net of the amounts assigned to the assets acquired and liabilities assumed, is recognized as goodwill. The net assets and results of operations of an acquired entity are included on the Company’s consolidated financial statements from the acquisition date.

Equity Interests

As of September 30, 2019, the Company had a $10.0 million investment in an education technology company recorded within university payments and other assets, non-current on the condensed consolidated balance sheet. This investment does not have a readily determinable fair value, and is accounted for as a cost method investment, which is subject to fair value remeasurement upon the occurrence of an observable event.

Marketing and Sales Costs

The majority of the marketing and sales costs incurred by the Company are directly related to acquiring students for its university clients’ graduate programs, with lesser amounts related to acquiring students for its short courses and boot camps and marketing and advertising efforts related to the Company’s own brand. For the three and nine months ended September 30, 2019 and 2018, costs related to the Company’s marketing and advertising efforts of its own brand were not material. All such costs are expensed as incurred and reported in marketing and sales expense on the Company’s condensed consolidated statements of operations and comprehensive loss.

Leases

For the Company’s operating leases, an assessment is performed to determine if an arrangement is a lease at inception. Right-of-use (“ROU”) assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. As the information necessary to determine the rate implicit in the Company’s leases is not readily available, the Company determines its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any prepaid lease payments made, less lease incentives. The Company’s lease terms include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. The Company does not have any finance leases for any periods presented.

The Company has elected, as an accounting policy for its leases of real estate, to account for lease and non-lease components in a contract as a single lease component. In addition, the recognition requirements are not applied to leases with a term of 12 months or less. Rather, the lease payments for short-term leases are recognized on the condensed consolidated statements of operations and comprehensive loss on a straight-line basis over the lease term.

Variable payments that depend on an index or a rate are initially measured using the index or rate at the lease commencement date. Such variable payments are included in the total lease payments when measuring the lease liabilities and ROU assets. The Company will only remeasure variable payments that depend on an index or a rate when the Company is remeasuring the lease liabilities due to any of the following occurring: (i) the lease is modified and the modification is not accounted for as a separate contract; (ii) a contingency, upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based, is resolved; (iii) there is a change in lease term; (iv) there is a change in the probability of exercising a purchase option; or (v) there is a change in the amount probable of being owed under residual value guarantees. Until the lease liabilities are remeasured due to one of the aforementioned events, additional payments for an increase in the index or rate will be recognized in the period in which they are incurred. Variable payments that do not depend on an index or a rate are excluded from the measurement of the lease liabilities and recognized in the condensed consolidated statements of operations and comprehensive loss in the period in which the obligation for those payments is incurred. 



11

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

2.    Significant Accounting Policies (Continued)

Long-Lived Asset Additions

During the nine months ended September 30, 2019, the Company had capital asset additions of $62.0 million in property and equipment and capitalized technology and content development, which included an immaterial amount of non-cash capital expenditures. Due to extended payment terms associated with the timing of cash capital expenditures made more than 90 days after the date of purchase, $1.3 million of these additions were classified as cash flows from financing activities in the condensed consolidated statement of cash flows for the nine months ended September 30, 2019.

During the nine months ended September 30, 2018, the Company had capital asset additions of $70.7 million in property and equipment and capitalized technology and content development, of which $6.1 million consisted of non-cash capital expenditures, primarily related to the acquisition of certain long-lived assets for which a liability was accrued.

Goodwill

Goodwill is the excess of purchase price over the fair value of identified net assets of businesses acquired. The Company’s goodwill balance relates to its acquisitions of GetSmarter in July 2017 and Trilogy in May 2019. The Company reviews goodwill at least annually, as of October 1. Between annual tests, goodwill is reviewed for possible impairment if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. The Company tests goodwill at the reporting unit level, which is an operating segment or one level below an operating segment. The Company initially assesses qualitative factors to determine if it is necessary to perform a quantitative goodwill impairment review. The Company reviews goodwill for impairment using a quantitative approach if it decides to bypass the qualitative assessment or determines that it is more likely than not that the fair value of a reporting unit is less than its carrying value based on a qualitative assessment. Upon completion of a quantitative assessment, the Company may be required to recognize an impairment based on the difference between the carrying value and the fair value of the reporting unit.

The determination of the fair value of a reporting unit using the income-based approach requires the Company to make significant assumptions and estimates. These assumptions and estimates primarily include, but are not limited to, the selection of appropriate peer group companies, control premiums and valuation multiples appropriate for acquisitions in the industry in which the Company competes, discount rates, terminal growth rates, and forecasts of revenue, operating income, depreciation and amortization expense, capital expenditures and future working capital requirements. When determining these assumptions and preparing these estimates, the Company considers each reporting unit’s historical results and current operating trends, revenues, profitability, cash flow results and forecasts, and industry trends. These estimates can be affected by a number of factors including, but not limited to, general economic and regulatory conditions, market capitalization, the continued efforts of competitors to gain market share and prospective student enrollment patterns.

In addition, the Company uses a market-based approach to estimate the value of the reporting unit. The market value is estimated by comparing the reporting unit to other publicly-traded companies and/or to publicly-disclosed business mergers and acquisitions in similar lines of business. The value of a reporting unit is based on pricing multiples of certain financial parameters observed in the comparable companies. The Company also makes estimates and assumptions for market values to determine a reporting unit’s estimated fair value.

The Company experienced a sustained decline in its stock price during the three months ended September 30, 2019, which management deemed a triggering event that required the Company to perform an interim goodwill impairment test as of September 1, 2019. The Company’s test relied in part on the work of an independent valuation firm engaged to provide inputs as to the fair value of the reporting units and to assist in the related calculations and analysis. The results of the interim impairment test indicated that the carrying value of the boot camp business acquired in 2019 within the Company’s Alternative Credential Segment exceeded the fair value by $70.4 million. The decrease in this reporting unit’s fair value was primarily due to lower expectations of future performance due to the impact of changes in key management as well as an increased focus in integrating the operations of the newly acquired reporting unit, which impacted the estimated operating cash flows. As a result, the Company recorded an impairment charge of $70.4 million on the condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2019.

Other than the recently impaired reporting unit, the Company had no reporting units whose estimated fair values as of September 30, 2019 exceeded their carrying value by less than 10%. It is possible that future changes in the Company’s

12

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

2.    Significant Accounting Policies (Continued)

circumstances, or in the variables associated with the judgments, assumptions and estimates used in assessing the fair value of our reporting units, could require the Company to record additional impairment charges in the future.

Debt Issuance Costs

Debt issuance costs are incurred as a result of entering into certain borrowing transactions and are presented as a reduction from the carrying amount of the debt liability on the Company’s condensed consolidated balance sheets. Debt issuance costs are amortized over the term of the associated debt instrument. The amortization of debt issuance costs is included as a component of interest expense on the Company’s condensed consolidated statements of operations and comprehensive loss. If the Company extinguishes debt prior to the end of the underlying instrument’s full term, some or all of the unamortized debt issuance costs may need to be written off, and a loss on extinguishment may need to be recognized. Refer to Note 8 for further information about the Company’s debt.

Recent Accounting Pronouncements

In April 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. ASU No. 2019-04 provides corrections, updates and clarifications to the previously issued updates of ASU No. 2016-01, ASU No. 2016-13 and ASU No. 2017-12. Various areas of the Accounting Standards Codification were impacted by the update. This standard follows the effective dates of the previously issued ASUs, unless an entity has already early adopted the previous ASUs, in which case the effective date will vary according to each specific ASU adoption. As the Company has adopted ASU No. 2016-01, the amendments related to ASU No. 2016-01 are effective for annual and interim periods in fiscal years beginning after December 15, 2019. As the Company has not yet adopted ASU No. 2016-13, the amendments related to ASU No. 2016-13 are effective for fiscal years beginning after December 15, 2019. Refer below for further discussion of ASU No. 2016-13. The Company is evaluating the impact that the amendments related to ASU Nos. 2016-13 and 2016-01 will have on its consolidated financial position and related disclosures. The amendments to ASU No. 2017-12 are not applicable to the Company.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which requires customers in cloud computing arrangements that are service contracts to follow the internal-use software guidance in ASC 350-40 to determine which implementation costs to capitalize as assets or expense as incurred. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company early adopted this ASU on July 1, 2018 under the prospective method. As a result of adopting this standard, as of September 30, 2019 and December 31, 2018, the Company had balances of $2.3 million and $0.4 million, respectively, of capitalized implementation costs incurred to integrate the software associated with its cloud computing arrangements, within university payments and other assets, non-current on the condensed consolidated balance sheets. Such capitalized costs are subject to amortization over the remaining contractual term of the associated cloud computing arrangement, with a useful life of between three to five years. The Company did not incur a material amount of such amortization for the three and nine months ended September 30, 2019.

In July 2018, the FASB issued ASU No. 2018-09, Codification Improvements, which clarifies and corrects unintended applications of guidance, and makes improvements to several Accounting Standards Codification topics. The applicable amendments in this ASU are effective for the Company in annual periods beginning after December 15, 2018. The Company adopted this ASU on January 1, 2019. Adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements or related disclosures.

In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments to nonemployees. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company adopted this ASU on January 1, 2019. Adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements or related disclosures.


13

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

2.    Significant Accounting Policies (Continued)

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates step two from the goodwill impairment test and requires an entity to recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value, up to the amount of goodwill allocated to that reporting unit. The amendments in this ASU are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company early adopted this ASU on January 1, 2019. Adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements or related disclosures.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Subsequently, the FASB has issued the following standards related to ASU No. 2016-13: ASU No. 2019-05, Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief; ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments; and ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments—Credit Losses. ASU No. 2016-13 requires entities to measure all expected credit losses for most financial assets held at the reporting date based on an expected loss model, which includes historical experience, current conditions, and reasonable and supportable forecasts. Entities will now use forward-looking information to better form their credit loss estimates. ASU No. 2016-13 also requires enhanced disclosures to help financial statement users better understand assumptions used in estimating expected credit losses. The amendments in these ASUs are effective for annual and interim periods in fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is evaluating the impact that the new guidance will have on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes ASC 840, Leases (Topic 840). The ASU introduces a model for lessees requiring most leases to be reported on the balance sheet. The Company adopted this ASU and the related amendments on January 1, 2019 under the modified retrospective transition method, which resulted in no cumulative-effect adjustment to retained earnings. The Company’s financial results for periods ending after January 1, 2019 are presented in accordance with the requirements of Topic 842, while prior period amounts are not adjusted and continue to be reported in accordance with Topic 840.

Upon adoption, the Company elected to not recognize ROU assets or lease liabilities for leases with a term of 12 months or less, as permitted by the short-term lease practical expedient. In transition, the Company also applied the package of practical expedients that permit entities to not reassess (i) whether expired or existing contracts contain a lease under the new standard, (ii) the lease classification for expired or existing leases, or (iii) whether previously capitalized initial direct costs would qualify for capitalization under the new standard. The Company also applied the practical expedient that permits a lessee to account for lease and non-lease components in a contract as a single lease component. In addition, the Company did not use hindsight during transition.

Upon adoption, the Company recorded ROU assets of approximately $34 million, which have been reduced for accrued rent, and the remaining balance of any lease incentives upon transition, and also recorded corresponding current and non-current lease liabilities for its operating leases of approximately $5 million and $58 million, respectively, on the condensed consolidated balance sheets. Adoption of this standard did not have a material impact on the Company’s condensed consolidated statements of operations and comprehensive loss, the condensed consolidated statements of changes in stockholders’ equity or the condensed consolidated statements of cash flows. Refer to Note 7 for more information about the Company’s lease-related obligations.


3.     Business Combination

On May 22, 2019, the Company completed its acquisition of Trilogy pursuant to an Agreement and Plan of Merger and Reorganization, dated as of April 7, 2019 (the “Merger Agreement”), for a net purchase price of $608.6 million in cash and stock consideration, subject to final adjustments related to working capital and indebtedness. Under the terms of the Merger Agreement, the Company has issued restricted stock units for shares of its common stock, par value $0.001 per share, to certain employees and officers of Trilogy. These awards were issued pursuant to the Company’s 2014 Equity Incentive Plan, are subject to future service requirements and will primarily vest over an 18-month period. In addition, a portion of the purchase price held in escrow was recognized as compensation expense in the three months ended September 30, 2019 as the service requirements of certain key employees was determined to be fulfilled. The net assets and results of operations of Trilogy are

14

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

3.    Business Combination (Continued)

included in the Company’s condensed consolidated financial statements within the Alternative Credential Segment as of May 22, 2019.

The following table reflects the Company’s provisional valuation of the assets acquired and liabilities assumed of Trilogy as of the date of the acquisition:
 
Estimated Average Useful Life (in years)
 
Purchase Price Allocation
 
 
 
(in thousands)
Cash and cash equivalents
 
 
$
35,320

Current assets
 
 
29,954

Property and equipment, net
 
 
2,411

Other non-current assets
 
 
6,276

Amortizable intangible assets:
 
 
 
Developed technology
3
 
48,096

Developed content
4
 
48,050

University client relationships
10
 
84,150

Trade names and domain names
5
 
7,100

Goodwill
 
 
425,678

Current liabilities
 
 
(56,917
)
Non-current liabilities
 
 
(21,523
)
 
 
 
$
608,595



The Company’s provisional valuation of the assets acquired and liabilities assumed is preliminary and the fair values recorded were based upon preliminary estimates, assumptions and other information compiled by management, and are subject to change (which could be significant) within the measurement period of up to one year from the acquisition date. During the three months ended September 30, 2019, the Company made adjustments to the provisional valuation that affected deferred tax liabilities and the residual goodwill. As of September 30, 2019, the Company is awaiting information to finalize the valuation, primarily related to the recording of intangible assets, the related deferred taxes and the final amount of residual goodwill.

The goodwill balance is primarily attributed to the assembled workforce, expanded market opportunities and operating synergies anticipated upon the integration of the operations of 2U and Trilogy. The goodwill resulting from the acquisition is not expected to be tax deductible. Refer to Note 4 for details.

The unaudited pro forma combined financial information below is presented for illustrative purposes and does not purport to represent what the results of operations would actually have been if the business combination occurred as of the dates indicated or what the results would be for any future periods. The following table presents the Company’s unaudited pro forma combined revenue and pro forma combined net loss, for the three and nine months ended September 30, 2019 and 2018 as if the acquisition of Trilogy had occurred on January 1, 2018:

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
 
(in thousands, except per share amounts)
Pro forma revenue
$
153,798

 
$
130,553

 
$
459,756

 
$
355,009

Pro forma net loss
(141,020
)
 
(24,715
)
 
(226,901
)
 
(99,204
)
Pro forma net loss per share, basic and diluted
$
(2.23
)
 
$
(0.43
)
 
$
(3.74
)
 
$
(1.80
)


4.     Goodwill and Amortizable Intangible Assets

The table below summarizes the changes in the carrying amount of goodwill by reportable segment:

15

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

4.    Goodwill and Amortizable Intangible Assets (Continued)

 
Graduate
Program Segment
 
Alternative
Credential Segment
 
Total
 
(in thousands)
Balance as of December 31, 2018
$

 
$
61,852

 
$
61,852

Goodwill recognized in connection with business combination

 
425,678

 
425,678

Impairment charge

 
(70,379
)
 
(70,379
)
Foreign currency translation adjustments

 
(3,124
)
 
(3,124
)
Balance as of September 30, 2019
$


$
414,027


$
414,027



The Company experienced a sustained decline in its stock price during the three months ended September 30, 2019, which management deemed a triggering event that required the Company to perform an interim goodwill impairment test as of September 1, 2019. The Company’s test relied in part on the work of an independent valuation firm engaged to provide inputs as to the fair value of the reporting units and to assist in the related calculations and analysis. The results of the interim impairment test indicated that the carrying value of the boot camp business acquired in 2019 within the Company’s Alternative Credential Segment exceeded the fair value by $70.4 million. The decrease in this reporting unit’s fair value was primarily due to lower expectations of future performance due to the impact of changes in key management as well as an increased focus in integrating the operations of the newly acquired reporting unit, which impacted the estimated operating cash flows. As a result, the Company recorded an impairment charge of $70.4 million on the condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2019.

Amortizable intangible assets, net consisted of the following as of:
 
 
 
September 30, 2019
 
December 31, 2018
 
Estimated
Average Useful
Life (in years)
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
(in thousands)
Capitalized technology
3-5
 
$
136,961

 
$
(32,625
)
 
$
104,336

 
$
68,291

 
$
(16,945
)
 
$
51,346

Capitalized content development
4-5
 
158,136

 
(46,457
)
 
111,679

 
79,725

 
(31,662
)
 
48,063

University client relationships
9-10
 
108,587

 
(9,148
)
 
99,439

 
25,616

 
(4,269
)
 
21,347

Trade names and domain names
5-10
 
25,856

 
(4,937
)
 
20,919

 
18,793

 
(2,944
)
 
15,849

Total amortizable intangible assets, net
 
 
$
429,540

 
$
(93,167
)
 
$
336,373

 
$
192,425

 
$
(55,820
)
 
$
136,605



The amounts presented in the table above include $24.2 million and $40.3 million of in process capitalized technology and content development as of September 30, 2019 and December 31, 2018, respectively. Amortizable intangible assets recognized in connection with the acquisition of Trilogy consisted of developed technology of $48.1 million, developed content of $48.1 million, university client relationships of $84.2 million and trade names and domain names of $7.1 million, and are included in the balances presented in the table above as of September 30, 2019.

During 2018, the Company acquired certain third-party technologies to enhance the Company’s platform, which is
referred to as the 2U Operating System, or 2UOS, for aggregate consideration of $9.5 million. As of September 30, 2019, the Company has a remaining obligation to pay the seller $0.7 million by December 31, 2019.


16

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

4.    Goodwill and Amortizable Intangible Assets (Continued)

The Company recorded amortization expense related to amortizable intangible assets of $19.2 million and $6.4 million for the three months ended September 30, 2019 and 2018, respectively. The Company recorded amortization expense related to amortizable intangible assets of $38.1 million and $17.1 million for the nine months ended September 30, 2019 and 2018, respectively.

As of September 30, 2019, the estimated future amortization expense for amortizable intangible assets placed in service is as follows (in thousands):
Remainder of 2019
$
18,998

2020
73,413

2021
67,803

2022
53,678

2023
35,611

Thereafter
62,699

Total
$
312,202



5.     Accrued Expenses

Included within accounts payable and accrued expenses on the Company’s condensed consolidated balance sheet as of September 30, 2019 was $20.8 million of accrued university and head tutor compensation and $19.7 million of accrued marketing costs. As of December 31, 2018, accounts payable and accrued expenses included $10.3 million of accrued marketing costs. As of September 30, 2019, the Company maintained a reserve for its September 2019 organizational restructuring of approximately $2.9 million related to employee termination benefits.

6.    Commitments and Contingencies

Legal Contingencies

From time to time, the Company is involved in legal proceedings and subject to claims in the ordinary course of its business.
    
With respect to current legal proceedings, the Company does not believe it is probable a material loss exceeding amounts already recognized has been incurred as of the date of the balance sheets presented herein.

The Company is involved in various claims and legal proceedings arising in the ordinary course of business. The Company accrues a liability when a loss is considered probable and the amount can be reasonably estimated. While the Company does not expect that the ultimate resolution of any existing claims and proceedings (other than the specific matter described below, if decided adversely), individually or in the aggregate, will have a material adverse effect on its financial position, an unfavorable outcome in some or all of these proceedings could have a material adverse impact on results of operations or cash flows for a particular period. This assessment is based on the Company’s current understanding of relevant facts and circumstances. As such, the Company’s view of these matters is subject to inherent uncertainties and may change in the future.
 
In re 2U, Inc., Securities Class Action, No. 1:19-cv-7390 (S.D.N.Y.)

On August 7 and 9, 2019, Aaron Harper and Anne M. Chinn filed putative class action complaints against the Company, Christopher J. Paucek, the Company’s CEO, and Catherine A. Graham, the Company’s former CFO, in the United States District Court for the Southern District of New York.  The district court consolidated the two actions on August 27, 2019, with the caption In re 2U, Inc., Securities Class Action, No. 1:19-cv-7390 (S.D.N.Y.). The complaints allege violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934, and SEC Rule 10b-5 promulgated thereunder, based upon allegedly false and misleading statements regarding the Company’s business prospects and financial projections. The proposed class consists of all persons who acquired the Company’s securities between February 26, 2018 and July 30, 2019.


17

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

6.    Commitments and Contingencies (Continued)


The Company believes that the claims are without merit and it intends to vigorously defend against these claims. However, due to the complex nature of the legal and factual issues involved, the outcome of this matter is not presently determinable.

Marketing and Sales Commitments

Certain of the agreements entered into between the Company and its university clients in the Graduate Program Segment require the Company to commit to meet certain staffing and spending investment thresholds related to marketing and sales activities. In addition, certain of the agreements in the Graduate Program Segment require the Company to invest up to agreed-upon levels in marketing the programs to achieve specified program performance. The Company believes it is currently in compliance with all such commitments.

Future Minimum Payments to University Clients

Pursuant to certain of the Company’s contracts in the Graduate Program Segment, the Company has made, or is obligated to make, payments to university clients in exchange for contract extensions and various marketing and other rights. As of September 30, 2019, the future minimum payments due to university clients has not materially changed relative to the amounts provided in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Contingent Payments

The Company has entered into agreements with certain of its university clients in the Graduate Program Segment under which the Company would be obligated to make future minimum payments in the event that certain program metrics are not achieved on an annual basis. The Company recognizes any estimated contingent payments under these agreements as contra revenue over the period in which they relate, and records a liability in other current liabilities on the condensed consolidated balance sheets.
As of September 30, 2019, the Company had an obligation to make an additional investment in an education technology company of up to $5.0 million, upon demand by the investee.
7.    Leases

The Company leases facilities under non-cancelable operating leases primarily in the United States, South Africa, the United Kingdom, Canada and Hong Kong. The Company’s operating leases have remaining lease terms of between one to 11 years, some of which include options to extend the leases for up to five years, and some of which include options to terminate the leases within one year. These options to extend the terms of the Company’s operating leases were not deemed to be reasonably certain of exercise as of lease commencement and are therefore not included in the determination of their respective non-cancelable lease terms. The future lease payments due under non-cancelable operating lease arrangements contain fixed rent increases over the term of the lease. The Company also leases office equipment under non-cancelable leases. The Company did not have any subleases as of September 30, 2019.

The components of lease expense consisted of the following for the periods presented:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2019
 
September 30, 2019
 
(in thousands)
Operating lease expense
$
3,053

 
$
8,389

Short-term lease expense
188

 
578

Variable lease expense
1,031

 
3,036

Total lease expense
$
4,272

 
$
12,003




18

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

7.    Leases (Continued)


As of September 30, 2019, for the Company’s operating leases, the weighted-average remaining lease term was 8.1 years and the weighted-average discount rate was 12.5%. For the nine months ended September 30, 2019, cash paid for amounts included in the measurement of operating lease liabilities was $9.6 million.

As of September 30, 2019, the maturities of operating lease liabilities were as follows (in thousands):
Remainder of 2019
$
3,865

2020
14,801

2021
13,801

2022
12,902

2023
12,508

Thereafter
55,165

Total lease payments
113,042

Less: imputed interest
(43,229
)
Total lease liability
$
69,813



As of September 30, 2019, the Company has additional operating leases for facilities that have not yet commenced with future minimum lease payments of approximately $99.3 million. These operating leases will commence during fiscal years 2019 through 2021, with lease terms of between four to twelve years.

As of December 31, 2018, the future minimum lease payments for operating leases having initial or remaining noncancellable lease terms in excess of one year were as follows (in thousands):
2019
$
12,941

2020
14,020

2021
13,900

2022
13,633

2023
13,959

Thereafter
68,347

Total future minimum lease payments
$
136,800



8.    Debt

The Company’s outstanding long-term debt was as follows:
 
September 30, 2019
 
December 31, 2018
 
(in thousands)
Senior secured term loan facility
$
250,000

 
$

Deferred government grant obligations
3,500

 
3,500

Less: unamortized debt issuance costs
(7,644
)
 

Long-term debt
$
245,856

 
$
3,500



The Company believes the carrying value of its long-term debt approximates the fair value of the debt as the terms and interest rates approximate the market rates. As of September 30, 2019 and December 31, 2018, the Company had no current portion of long-term debt.

Credit Agreement

On May 22, 2019, the Company entered into a credit agreement (the “Credit Agreement”) with Owl Rock Capital Corporation, as administrative agent and collateral agent, and certain other lenders party thereto that provides for a $250 million senior secured term loan facility (the “Term Loan”). Subject to certain exceptions, the Term Loan under the Credit Agreement may be increased or new term loans may be established in an amount not to exceed (i) $50 million plus (ii) the amount of certain prepayments made by the Company plus (iii) an unlimited amount, subject to the achievement of either a certain First

19

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

8.     Debt (Continued)

Lien LQA University Segment Revenue Leverage Ratio (as defined in the Credit Agreement) or a certain First Lien Net Leverage Ratio (as defined in the Credit Agreement), as applicable.

The Term Loan matures on May 22, 2024 and bears interest, at the Company’s option, at variable rates based on (i) a customary alternative base rate (with a floor of 2.00%) plus an applicable margin of 4.75% or (ii) an adjusted LIBOR rate (with a floor of 1.00%) for the interest period relevant to such borrowing plus an applicable margin of 5.75%. The effective interest rate of the Term Loan for the three and nine months ended September 30, 2019 was 9.04% and 9.11%, respectively. During the three and nine months ended September 30, 2019, the Company incurred interest expense of $5.5 million and $7.9 million, respectively, in connection with the Credit Agreement. As of September 30, 2019, the Company’s accrued interest balance associated with the Credit Agreement was $0.2 million.

Comerica Line of Credit

Effective in the second quarter of 2019, the Company terminated its $25.0 million revolving line of credit agreement and letters of credit with Comerica Bank. No amounts were outstanding under this credit agreement as of September 30, 2019 or December 31, 2018.

Deferred Government Grant Obligations

The Company has a total of two outstanding conditional loan agreements with Prince George’s County, Maryland and the State of Maryland for an aggregate amount of $3.5 million, each bearing an interest rate of 3% per annum. These agreements are conditional loan obligations that may be forgiven provided that the Company attains certain conditions related to employment levels at 2U’s Lanham, Maryland headquarters. The conditional loan with the State of Maryland has a maturity date of December 31, 2026, and the conditional loan with Prince George’s County, Maryland has a maturity date of June 22, 2027. The interest expense related to these loans for the three and nine months ended September 30, 2019 and 2018 was immaterial. As of September 30, 2019 and December 31, 2018, the Company’s combined accrued interest balance associated with the deferred government grant obligations was $0.2 million and $0.2 million, respectively.

Letters of Credit

Certain of the Company’s operating lease agreements entered into prior to September 30, 2019 require security deposits in the form of cash or an unconditional, irrevocable letter of credit. As of September 30, 2019, the Company has entered into standby letters of credit totaling $15.7 million as security deposits for the applicable leased facilities and in connection with the deferred government grant obligations.

The Company maintains restricted cash as collateral for standby letters of credit for the Company’s leased facilities and in connection with the deferred government grant obligations.



20

Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

9.    Income Taxes

The Company’s income tax provisions for all periods consist of federal, state and foreign income taxes. The income tax provisions for the three and nine months ended September 30, 2019 and 2018 were based on estimated full-year effective tax rates, including the mix of income for the period between higher-taxed and lower-taxed jurisdictions, after giving effect to significant items related specifically to the interim periods, and loss-making entities for which it is not more likely than not that a tax benefit will be realized.

The Company’s effective tax rate was approximately (1)% and 4% for the three months ended September 30, 2019 and 2018, respectively. The Company’s effective tax rate was approximately 9% and 11% for the nine months ended September 30, 2019 and 2018, respectively. A one-time tax benefit of approximately $17.8 million related to the acquisition of Trilogy was included in the Company’s income tax (expense) benefit for the nine months ended September 30, 2019. This one-time benefit relates to the reversal of the Company’s tax valuation allowance that was no longer needed as a result of recognizing an additional net deferred tax liability, due to the acquisition of Trilogy. Excluding the one-time tax benefit, the Company’s tax benefit of $1.1 million for the nine months ended September 30, 2019 related to losses generated by operations and the amortization of acquired intangibles in the Alternative Credential Segment that are expected to be realized through future reversing taxable temporary differences. The Company expects to continue to recognize a tax benefit in the future for the Alternative Credential Segment to the extent that this segment continues to generate pre-tax losses while carrying deferred tax liabilities that are in excess of deferred tax assets. To date, the Company has not been required to pay U.S. federal income taxes because of current and accumulated net operating losses.

10.    Stockholders’ Equity

On May 22, 2019, the Company issued 4,608,101 shares of common stock in connection with its acquisition of Trilogy.

On May 22, 2018, the Company sold 3,833,334 shares of its common stock to the public, including 500,000 shares sold pursuant to the underwriters’ over-allotment option, and received net proceeds of $330.9 million. The Company will use the net proceeds from this public offering of common stock for working capital and other general corporate purposes, including expenditures for marketing, technology and content development, in connection with new offering launches and growing existing offerings, as well as strategic acquisitions of, or investments in, complementary products, technologies, solutions or businesses.

As of September 30, 2019, the Company was authorized to issue 205,000,000 total shares of capital stock, consisting of 200,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of September 30, 2019, the Company had reserved a total of 14,423,479 of its authorized shares of common stock for future issuance as follows:
Outstanding stock options
4,404,386

Possible future issuance under 2014 Equity Incentive Plan
7,480,316

Outstanding restricted stock units
1,656,933

Available for future issuance under 2017 Employee Stock Purchase Plan
881,844

Total shares of common stock reserved for future issuance
14,423,479



The shares available for future issuance increased by 2,896,365 and 2,625,292 on January 1, 2019 and 2018, respectively, pursuant to the automatic share reserve increase provision under the Amended and Restated 2014 Equity Incentive Plan (the “2014 Plan”). The Company has not declared or paid cash dividends on its common stock to date.

11.    Stock-Based Compensation

The Company provides equity-based compensation awards to employees, independent contractors and directors as an effective means for attracting, retaining and motivating such individuals. The Company maintains two share-based compensation plans: the 2014 Plan and the 2008 Stock Incentive Plan (the “2008 Plan”). Upon the effective date of the 2014 Plan in January 2014, the Company ceased using the 2008 Plan to grant new equity awards and began using the 2014 Plan for grants of new equity awards.

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Table of Contents
2U, Inc.
Notes to Condensed Consolidated Financial Statements (Continued)
(unaudited)

11.    Stock-Based Compensation (Continued)



Stock-Based Compensation Expense

Stock-based compensation expense related to stock-based awards, as well as the 2017 Employee Stock Purchase Plan (the “ESPP”), is included in the following line items on the condensed consolidated statements of operations and comprehensive loss:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
 
(in thousands)
Curriculum and teaching
$
30

 
$
3

 
$
38

 
$
10

Servicing and support
2,626

 
1,346

 
6,129

 
3,538

Technology and content development
2,228

 
1,089

 
5,732

 
2,875

Marketing and sales
2,238

 
839

 
4,981

 
2,046

General and administrative
9,413

 
4,656

 
19,206

 
15,595

Total stock-based compensation expense
$
16,535

 
$
7,933


$
36,086


$