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| ABCO > SEC Filings for ABCO > Form 10-Q on 17-Feb-2004 | All Recent SEC Filings |
17-Feb-2004
Quarterly Report
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on our management's beliefs and assumptions and on information currently available to our management. Forward-looking statements include the information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, potential growth opportunities, the effects of future regulation and the effects of future competition. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words "believes," "expects," "anticipates," "intends," "plans," "estimates," or similar expressions. Forward-looking statements involve risks, uncertainties and assumptions. You should not put undue reliance on any forward-looking statements.
You should understand that many important factors, including our dependence on the health care industry, our membership-based business model, our inability to know in advance if new products will be successful, cost containment pressures on health care providers, economic and other conditions in the markets in which we operate, fluctuations in operating results, our potential exposure to loss of revenue resulting from our unconditional service guarantee, competition, and government regulations, could cause our results to differ materially from those expressed in forward-looking statements. These and other factors are discussed more fully in our 2003 annual report on Form 10-K that we filed with the Securities and Exchange Commission on June 27, 2003, and in our press release dated January 29, 2004, which we filed on Form 8-K with the Securities and Exchange Commission on January 29, 2004. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
Overview
We provide best practices research and analysis across the health care industry. Best practices research identifies and analyzes specific management initiatives, processes and strategies that have been determined to produce the best results in
solving common business problems or challenges. Members of each program typically are charged a fixed annual fee and have access to an integrated set of services including best practices research studies, executive education seminars, customized research briefs and web-based access to the program's content database and decision support tools.
Our revenues grew 22.4% in the first nine months of fiscal 2004 over the first nine months of fiscal 2003, and grew 20.9% in the three months ended December 31, 2003 over the three months ended December 31, 2002. We have increased our contract value 18.3% at December 31, 2003 over December 31, 2002. We define contract value as the aggregate annualized revenue attributed to all membership agreements in effect at a given point in time, without regard to initial term or remaining duration of any such agreement.
Our operating costs and expenses consist primarily of cost of services, member relations and marketing, general and administrative expenses and depreciation. Cost of services represents the costs associated with the production and delivery of our products and services. Member relations and marketing expenses include the costs of acquiring new members and renewing existing members. General and administrative expenses include the costs of human resources and recruiting, finance and accounting, management information systems, facilities management, new product development and other administrative functions.
Results of operations
The following table shows our consolidated statements of operations data expressed as a percentage of revenues for the periods indicated.
Three Months Ended Nine Months Ended
December 31, December 31,
2003 2002 2003 2002
Revenues 100.0 % 100.0 % 100.0 % 100.0 %
Costs and expenses:
Cost of services (excluding special compensation and
stock option related expense of 0.1%, 1.3%, 0.1% and
0.7%) 42.1 41.5 41.4 42.3 Member relations and marketing (excluding special compensation and stock option related expense of 0%, 0.5%, 0% and 0.2%) 20.9 20.4 20.2 19.8 General and administrative (excluding special compensation and stock option related expense of 0.3%, 1.5%, 0.4% and 0.6%) 13.4 12.3 13.2 12.5 Depreciation and loss on disposal of fixed assets 0.9 1.5 1.2 1.9 Special compensation arrangements 0.4 3.3 0.5 1.5
Income from operations 22.3 21.0 23.5 22.0 Interest income 2.5 1.0 2.2 0.8
Income before provision for income taxes 24.8 22.0 25.7 22.8 Provision for income taxes 10.1 9.3 10.4 9.7
Net income 14.7 % 12.7 % 15.3 % 13.1 %
Three and nine months ended December 31, 2003 and 2002
Revenues. Total revenues increased 20.9% to $31.3 million for the three months ended December 31, 2003, from $25.9 million for the three months ended December 31, 2002. Total revenues increased 22.4% to $89.7 million for the nine months ended December 31, 2003, from $73.3 million for the nine months ended December 31, 2002. The increase in revenues was primarily due to the introduction and expansion of new programs, cross-selling existing programs to existing members and, to a lesser degree, sales to new member organizations and price increases. Our contract value increased 18.3% to $120.5 million at December 31, 2003 from $101.8 million at December 31, 2002.
Cost of services. Cost of services increased 22.8% to $13.2 million or 42.1% of revenues for the three months ended December 31, 2003, from $10.7 million or 41.5% of revenues for the three months ended December 31, 2002. The increase in cost of services as a percentage of revenues for the three months ended December 31, 2003 is primarily due to the timing of member meetings, executive education onsites and best practices research studies delivered. Cost of services increased 19.4% to $37.1 million or 41.4% of revenues for the nine months ended December 31, 2003, from $31.0 million or 42.3% of revenues for the nine months ended December 31, 2002. The decrease in cost of services as a percentage of revenues that occurred during the nine months ended December 31, 2003 reflects the scaling of our programs over our larger revenue base. Because
each program offers a standardized set of services, our program cost structure is relatively fixed and the incremental cost to serve an additional member is low.
Member relations and marketing. Member relations and marketing costs increased 23.7% to $6.5 million, or 20.9% of revenues for the three months ended December 31, 2003, from $5.3 million, or 20.4% of revenues for the three months ended December 31, 2002. Member relations and marketing costs increased 25.2% to $18.2 million, or 20.2% of revenues for the nine months ended December 31, 2003, from $14.5 million, or 19.8% of revenues for the nine months ended December 31, 2002. The increase in member relations and marketing costs is primarily due to the increase in sales staff and related costs associated with the introduction of new memberships, as well as an increase in member relations personnel and related costs to serve the larger membership base.
General and administrative. General and administrative expenses increased 31.1% to $4.2 million, or 13.4% of revenues for the three months ended December 31, 2003, from $3.2 million, or 12.3% of revenues for the three months ended December 31, 2002. General and administrative expenses increased 29.7% to $11.8 million, or 13.2% of revenues for the nine months ended December 31, 2003, from $9.1 million, or 12.5% of revenues for the nine months ended December 31, 2002. The increase in general and administrative expenses as a percentage of revenues reflects increased spending for recruiting and new product development.
Depreciation and loss on disposal of fixed assets. This amount decreased 23.8% to $292,000 for the three months ended December 31, 2003, from $383,000 for the three months ended December 31, 2002. Depreciation expense decreased 22.0% to $1.1 million for the nine months ended December 31, 2003, from $1.4 million for the nine months ended December 31, 2002. The decrease was principally due to lower capital expenditures in fiscal 2004 and fiscal 2003 as compared to prior years.
Special compensation and stock option related expense. During the three and nine months ending December 31, 2003 and 2002, we recognized $122,000, $782,000, $443,000 and $782,000, respectively, in FICA tax expense relating to the exercise of stock options. In addition, we recorded special compensation expense of $83,000 and $282,000 for the three and nine months ended December 31, 2002, respectively, representing certain equity-based compensation arrangements we entered into with key employees prior to our initial public offering. Since our initial public offering, we have not entered, and we do not anticipate that in the future we will enter, into any special compensation arrangements.
Provision for income taxes. We recorded a provision for income taxes of $3.1 million, $2.4 million, $9.3 million and $7.1 million in the three and the nine months ended December 31, 2003 and 2002, respectively. The decrease in our effective income tax rate to 40.5% for the three and nine months ended December 31, 2003 from 42.5% for the three and nine months ended December 31, 2002 primarily reflects an increase in the amount of tax-exempt interest income earned on our portfolio of cash and cash equivalents and marketable securities and, to a lesser extent, changes in states where income was generated.
We will amend our 2003 Washington, D.C. income tax return to file as a Qualified High Technology Company. If approved, our Washington, D.C. income tax rate would be reduced to 0.0% and we would incur a noncash charge to earnings of approximately $2.2 million, representing the impact on our existing deferred tax asset of lowering the Washington, D.C. income tax rate. For further information please see Note 8 to our condensed consolidated financial statements included elsewhere in this Form 10-Q.
Liquidity and capital resources
Cash flows from operating activities. Program memberships are generally payable by members at the beginning of the contract term. The combination of net income and advance payment of program memberships typically results in operating activities generating net positive cash flows on an annual basis. We generated net cash flows from operating activities of $26.6 and $31.2 million for the nine months ended December 31, 2003 and 2002, respectively. As of December 31, 2003, we had approximately $121.0 million in cash and cash equivalents and marketable securities. Our marketable securities consist of U.S. government agency obligations and municipal obligations, primarily issued by the District of Columbia. We believe these funds, together with net positive cash flows from operating activities, will satisfy working capital, financing, and capital expenditure requirements for at least the next twelve months.
Cash flows from investing activities. We used cash in investing activities of $33.5 million and $31.8 million during the nine months ended December 31, 2003 and 2002, respectively. These expenditures consisted mostly of the purchase of marketable securities, offset slightly by capital expenditures.
Cash flows from financing activities. During the nine months ending December 31, 2003 and 2002, we received
$6.2 million and $20.7 million, respectively, in connection with the exercise of stock options. In addition, we received $240,000 and $266,000 in connection with the issuance of common stock under our employee stock purchase plan in the nine months ended December 31, 2003 and 2002, respectively.
The lease of approximately 100,000 square feet for our current headquarters space expires in April 2004. In October 2003, we signed a lease for approximately 106,000 square feet of new office space. We expect to move our headquarters into this new location upon the termination of our current lease, and we will incur costs associated with the construction and buildout of the new space. In addition, the terms of the new lease contain provisions for rental escalation based on the consumer price index and we expect to be required to pay our portion of executory costs such as taxes and insurance.
The following summarizes certain of our contractual obligations at December 31, 2003 and the minimum effect such obligations are expected to have on our liquidity and cash flows in future periods. These arrangements are more fully described in the notes to our audited financial statements which can be found in the Company's Form 10-K filed with the SEC in June 2003. The amounts below include future obligations under our new lease agreement.
Payments due by December 31,
Non-cancelable operating leases $ 66,849 $ 3,454 $ 11,825 $ 51,570
Facilities services contract 1,635 545 1,090 —
Total $ 68,484 $ 3,999 $ 12,915 $ 51,570
In connection with the new lease agreement, we obtained a standby letter of credit in the amount of approximately $3.2 million, naming the landlord as beneficiary, and we pledged $4 million of our marketable securities as collateral to the standby letter of credit.
At December 31, 2003 and March 31, 2003, we had no off-balance sheet financing or other arrangements with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities.
Significant Related Party Transactions
Transactions with DGB Enterprises, Inc.
Our former principal stockholder owns a controlling interest in certain entities that operate in different industries from us. In 1997, he created DGB Enterprises, Inc. to manage his various business interests including his ownership in us. To achieve operating efficiencies, DGB Enterprises, Inc. consolidated certain management and administrative functions for these entities, and assumed the primary lease on office space used by these entities and shared with us. We entered into the following transactions with DGB Enterprises, Inc.
Lease and Sublease Agreements
In fiscal 2000 we assigned our office lease to DGB Enterprises, Inc., transferred leasehold improvements related to our office space to DGB Enterprises, Inc. and subsequently entered into a sublease agreement with them on terms consistent with the original agreement. The lease agreement runs through April 2004. We incurred rent expense under this arrangement of $0.9 million and $0.9 million for the three months ended December 31, 2003 and 2002 respectively, and $2.6 million and $2.5 million for the nine months ended December 31, 2003 and 2002, respectively.
Administrative Services
In July 2001, we entered into an administrative services agreement whereby DGB Enterprises, Inc. provided us with services related to the facilities associated with our shared leased space, and we provided DGB Enterprises, Inc. and related entities owned or controlled by our founder, with certain administrative services. This agreement had a two-year term. Fees for the services were based on direct costs per transaction, square footage, headcount or a fixed cost per month that approximates the cost for each entity to internally provide or externally source these services. We believe these charges approximated the costs which would have been incurred had we operated on a stand-alone basis. We incurred net charges under the agreement of $0.3 million and $0.2 million for the three months ended December 31, 2003 and 2002, respectively, and $0.7 million and $0.5 million for the nine months ended December 31, 2003 and 2002, respectively.
Summary of Critical Accounting Policies
We have identified the following policies as critical to our business operations and the understanding of our results of operations. This listing is not a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management's judgment in their application. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result. However, certain of our accounting policies are particularly important to the presentation of our financial position and results of operations and may require the application of significant judgment by our management; as a result they are subject to an inherent degree of uncertainty. In applying those policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, our observance of trends in the industry, information provided by our members and information available from other outside sources, as appropriate. For a more detailed discussion on the application of these and other accounting policies, see "Note 3 — Summary of significant accounting policies" to our consolidated financial statements and related notes as reported on our Form 10-K filed with the Securities and Exchange Commission in June 2003. Our critical accounting policies include:
Use of estimates
The preparation of the unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue recognition
Revenues from renewable research memberships are recognized over the term of the related subscription, which is generally 12 months. Revenues from 12-month best practices installation support memberships are recognized as services are performed, limited by our pro rated refund policy. As a result, revenues for all programs are generally recognized ratably over the term of the related program agreement, which is generally 12 months. Fees are generally billable, and revenue recognition begins, when a letter agreement is signed by the member. Certain fees are billed on an installment basis. Members may request a refund of their fees, which is provided on a pro rata basis relative to the length of the service period. Our policy is to record the full amount of program agreement fees receivable and related deferred revenue when a letter agreement is signed by the member. As of December 31, 2003 and March 31, 2003, approximately $1.3 million and $0.3 million, respectively, of deferred revenues were to be recognized beyond the following 12 months.
Allowance for uncollectible revenue
Our ability to collect outstanding receivables from our members has an effect on our operating performance and cash flows. This effect is mitigated because memberships, which are predominantly annual contracts, are generally payable by members at the beginning of the contract term. We record an allowance for uncollectible revenue based on our ongoing monitoring of our members' credit and the aging of receivables.
Deferred incentive compensation
Direct incentive compensation related to the negotiation of new and renewal memberships is deferred and amortized over the term of the related memberships.
Deferred tax asset recoverability
For tax purposes, we have deferred income taxes consisting primarily of net operating loss carry forwards for regular federal and state income tax purposes generated from the exercise of common stock options. In estimating future tax consequences, Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109) generally considers all expected future events in the determination and evaluation of deferred tax assets and liabilities. We believe that our future taxable income will be sufficient for the full realization of the deferred income taxes. However, SFAS 109 does not consider the effect of future changes in existing tax laws or rates in the determination and evaluation of deferred tax assets and liabilities until the new tax laws or rates are enacted. We have established our deferred income tax assets and liabilities using currently enacted tax law and rates. We will recognize an adjustment to income for the impact of new tax laws or rates on the existing deferred tax assets and liabilities when and if new tax laws or rates are enacted.
Property and equipment
Property and equipment consists of furniture, fixtures, equipment and capitalized software development costs. Property and equipment is stated at cost, less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, ranging from three to seven years. Internal software development costs are accounted for in accordance with AICPA Statement of Position No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," and web development costs are accounted for in accordance with EITF 00-2, "Accounting for Web Site Development Costs." Capitalized internal software development costs and capitalized web development costs are amortized using the straight-line method over the estimated useful lives of the assets, which range from three to five years. Maintenance and repairs are charged to expense as incurred.
Recovery of long-lived assets
Long-lived assets and identifiable assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed. Impairment is identified by comparing the carrying value to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual dispositions. Impairment is measured and recorded on the basis of fair value determined using discounted cash flows. We consider expected cash flows and estimated future operating results, trends and other available information in assessing whether the carrying value of assets is impaired. We believe that no such impairment existed as of December 31 or March 31, 2003.
Concentrations of credit risk
Financial instruments that potentially expose us to significant concentrations of credit risk consist principally of cash and cash equivalents, marketable securities and membership fees receivable. We maintain cash and cash equivalents and marketable securities with financial institutions. The concentration of credit risk with respect to membership fees receivable is generally diversified due to our large number of members. However, we may be exposed to a declining membership base in periods of unforeseen market downturns, severe competition or regulatory developments. We perform periodic evaluations of the financial institutions and our membership base and establish allowances for potential credit losses.
Recent Accounting Pronouncements
In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51." This interpretation of ARB No. 51, "Consolidated Financial Statements," requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first reporting period beginning after December 15, 2003. The adoption of FIN 46 did not have a material impact on the Company's consolidated financial position or results of operations for the period ended December 31, 2003, and is not expected to have a material impact on the consolidated financial position or results of operations.
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