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ABCO > SEC Filings for ABCO > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for ADVISORY BOARD CO


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Unless the context indicates otherwise, references in this report to the "Company," the "registrant," "we," "our," and "us" mean The Advisory Board Company and its subsidiaries.

Our fiscal year ends on March 31. Fiscal 2013 is our fiscal year ending on March 31, 2013.

On June 18, 2012, the Company completed a two-for-one split of its outstanding shares of common stock in the form of a stock dividend. Each stockholder of record received one additional share of common stock for each share of common stock owned at the close of business on May 31, 2012. Share numbers and per share amounts presented below for dates before June 18, 2012 have been restated to reflect the impact of the stock split.

This management's discussion and analysis of financial condition and results of operations includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the "Exchange Act." Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. These statements can sometimes be identified by our use of forward-looking words such as "may," "will," "believes," "anticipates," "plans," "expects," "seeks," "estimates," or "intends" and similar expressions. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from the results, performance, or achievements expressed or implied by the forward-looking statements, including the factors discussed under "Item 1A. Risk Factors" in our annual report on Form 10-K for the fiscal year ended March 31, 2012, or the "2012 Form 10-K," filed with the Securities and Exchange Commission, or "SEC," and in our subsequent SEC reports. We undertake no obligation to update any forward-looking statements, whether as a result of circumstances or events that arise after the date the statements are made, new information, or otherwise.

Executive Overview

We provide best practices research and analysis, business intelligence and software tools, and management and advisory services to approximately 3,700 organizations, including hospitals, health systems, pharmaceutical and biotech companies, health care insurers, medical device companies, colleges, universities, and other educational institutions through discrete programs. Members of each program typically are charged a fixed fee and have access to an integrated set of services that may include best practice research studies, executive education seminars, customized research briefs, web-based access to the program's content database, and software tools.

Our three key areas of focus for fiscal 2013 are to continue to deliver world-class programs that drive significant returns for our members and ensure member loyalty through outstanding value delivery; to make select investments to capture the unique opportunities presented by current health care market conditions, through developing and launching new programs and acquiring products, services, and technologies that improve performance of our members; and to attract, develop, engage, and retain world-class talent across our organization. Success in all of these areas requires very strong execution across our business, and we have an intense focus on setting up each team to manage against and attain high goals in each area of our operations.

Our membership business model allows us to create value for our members by providing proven solutions to common and complex problems as well as quality content on a broad set of relevant issues. Our growth has been driven by strong renewal rates, ongoing addition of new memberships in our existing programs, continued new program launches, acquisition activity, and continued annual price increases. We believe high renewal rates are a reflection of our members' recognition of the value they derive from participating in our programs. Our revenue grew 25.4% in the six months ended September 30, 2012 over the prior year period. Our contract value increased 19.7% to $435.1 million as of September 30, 2012 from $363.6 million as of September 30, 2011. We define contract value as the aggregate annualized revenue attributed to all agreements in effect at a particular date, without regard to the initial term or remaining duration of any such agreement.

Our operating costs and expenses consist of cost of services, member relations and marketing, general and administrative expenses, and depreciation and amortization expenses. Cost of services includes the costs associated with the production and delivery of our products and services, consisting of compensation for research personnel, in-house faculty, software developers, and consultants; the organization and delivery of membership meetings, teleconferences, and other events; production of published materials; technology license fees; and costs of developing and supporting our web-based content and software tools. Member relations and marketing includes the costs of acquiring new members and the costs of account management, consisting of compensation, including sales incentives; travel and entertainment expenses; training of personnel; sales and marketing materials; and associated support services. General and administrative expenses include the costs of human resources and recruiting; finance and accounting; management information systems; facilities management; new program development; and other administrative functions. Depreciation and amortization expense includes the cost of depreciation of our property and equipment, amortization of costs associated with the development of software and tools that are offered as part of certain of our membership programs, and amortization of acquired developed technology. Included in our operating costs for each period presented are stock-based compensation expenses and expenses representing additional payroll taxes for compensation expense as a result of the taxable income employees recognized upon the exercise of common stock options and the vesting of restricted stock units.


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Acquisitions and dispositions that we have completed since April 1, 2011 affect the comparability of our results of operations for the three and six months ended September 30, 2012 and our results of operations for the same periods in our prior fiscal year, although the effect is not material.

Critical Accounting Policies

Our accounting policies, which are in compliance with U.S. generally accepted accounting principles, or "GAAP," require us to apply methodologies, estimates, and judgments that have a significant impact on the results we report in our financial statements. In our 2012 Form 10-K, we have discussed those material accounting policies that we believe are critical and require the use of complex judgment in their application. There have been no material changes to our policies since our last fiscal year ended March 31, 2012.

Non-GAAP Financial Presentation

This management's discussion and analysis presents supplemental measures of our performance which are derived from our consolidated financial information but which are not presented in our consolidated financial statements prepared in accordance with GAAP. These financial measures, which are considered "non-GAAP financial measures" under SEC rules, are referred to as adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share. See "Non-GAAP Financial Measures" below for definitions of such non-GAAP financial measures and reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure.

Results of Operations

The following table shows statements of income data expressed as a percentage of
revenue for the periods indicated:



                                                   Three Months Ended              Six Months Ended
                                                     September 30,                  September 30,
                                                  2012            2011           2012           2011
Revenue                                             100.0 %        100.0 %        100.0 %        100.0 %
Costs and expenses:
Cost of services, excluding depreciation and
amortization                                         51.5 %         54.4 %         53.7 %         54.2 %
Member relations and marketing                       19.4 %         20.2 %         18.9 %         21.2 %
General and administrative                           14.1 %         13.0 %         13.5 %         13.2 %
Depreciation and amortization                         4.0 %          3.8 %          4.0 %          3.8 %

Total costs and expenses                             89.0 %         91.4 %         90.1 %         92.4 %

Operating income                                     11.0 %          8.6 %          9.9 %          7.6 %
Other income, net                                     0.6 %          0.5 %          0.6 %          0.7 %

Income from continuing operations before
provision for income taxes and equity in
loss of unconsolidated entity                        11.7 %          9.0 %         10.5 %          8.3 %
Provision for income taxes                           (4.5 %)        (3.4 %)        (4.0 %)        (3.1 %)
Equity in loss of unconsolidated entity              (0.5 %)          -            (1.3 %)          -

Net income from continuing operations                 6.7 %          5.7 %          5.2 %          5.2 %
Discontinued operations:
Net income from discontinued operations                -              -              -             0.1 %

Net income before allocation to
noncontrolling interest                               6.7 %          5.7 %          5.2 %          5.3 %
Net loss attributable to noncontrolling
interest                                              0.1 %           -             0.1 %           -

Net income attributable to common
stockholders                                          6.8 %          5.7 %          5.3 %          5.3 %

Three and six months ended September 30, 2012 compared to the three and six months ended September 30, 2011

Overview. Net income attributable to common stockholders increased to $7.5 million in the three months ended September 30, 2012 from $5.2 million in the three months ended September 30, 2011. The increase in net income was primarily attributable to a 21.1% increase in revenue during the three months ended September 30, 2012, the effect of which was partially offset


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by increases of $7.2 million in cost of services incurred for new and growing programs, increases of $3.0 million in marketing and member relations due to increased sales teams, increases of $3.7 million in general and administrative expenses related to increases in finance, information technology, and human resources expense incurred to support our growing employee base, increases of $0.9 million in depreciation and amortization, and our net $0.6 million loss from our investment in Evolent Health, Inc., or "Evolent," which we established in the second quarter of fiscal 2012. Net income increased to $11.3 million in the six months ended September 30, 2012 from $9.1 million in the six months ended September 30, 2011. The increase in net income was primarily attributable to a 25.4% increase in revenue during the six months ended September 30, 2012, the effect of which was partially offset by increases of $22.4 million in cost of services incurred for new and growing programs, increases of $4.2 million in marketing and member relations due to increased sales teams, increases of $6.4 million in general and administrative expenses related to increases in finance, information technology, and human resources expense incurred to support our growing employee base, increases of $2.1 million in depreciation and amortization, and our net $2.7 million loss from our investment in Evolent.

Adjusted Net Income and Adjusted EBITDA. Adjusted net income increased 18.5% to $11.4 million in the three months ended September 30, 2012 from $9.6 million in the three months ended September 30, 2011, and adjusted EBITDA increased 22.6% to $20.8 million in the three months ended September 30, 2012 from $16.9 million in the three months ended September 30, 2011. Adjusted net income increased 25.8% to $22.5 million in the six months ended September 30, 2012 from $17.9 million in the six months ended September 30, 2011, and adjusted EBITDA increased 31.8% to $40.9 million in the six months ended September 30, 2012 from $31.1 million in the six months ended September 30, 2011. The increases in adjusted net income and adjusted EBITDA were due to increased revenue, the effect of which was partially offset by the costs of new and growing programs, increased investment in our general and administrative infrastructure to support our growing employee base, and an increase in the number of new sales teams.

Revenue. Total revenue increased 21.1% to $110.8 million in the three months ended September 30, 2012 from $91.5 million in the three months ended September 30, 2011, while contract value increased 19.7% to $435.1 million as of September 30, 2012 from $363.6 million as of September 30, 2011. Total revenue increased 25.4% to $214.9 million in the six months ended September 30, 2012 from $171.4 million in the six months ended September 30, 2011. The increases in revenue and contract value were primarily attributable to the introduction and expansion of new programs, including our August 1, 2011 acquisition of PivotHealth, LLC, or "PivotHealth," our cross-selling of existing programs to existing members, and, to a lesser degree, price increases. We offered 54 membership programs as of September 30, 2012 and 51 membership programs as of September 30, 2011.

Cost of services. Cost of services increased to $57.0 million in the three months ended September 30, 2012 from $49.8 million in the three months ended September 30, 2011. Cost of services increased to $115.4 million in the six months ended September 30, 2012 from $92.9 million in the six months ended September 30, 2011. The increases in cost of services for the three and six months ended September 30, 2012 were primarily due to growth and expansion of our Crimson and Southwind programs, including our 2011 acquisition of PivotHealth. Also affecting cost of services were costs associated with the delivery of program content and tools to our expanded membership base, including increased staffing, licensing fees, and other costs. As a percentage of revenue, cost of services was 51.5% and 54.4% for the three months ended September 30, 2012 and 2011, respectively, and 53.7% and 54.2% for the six months ended September 30, 2012 and 2011, respectively. As a percentage of revenue, cost of services decreased in the three and six months ended September 30, 2012 due to the scaling of our fixed cost infrastructure and, to a lesser extent, a decrease in fair value adjustments to our acquisition-related earn-out payments. Cost of services includes fair value adjustments to our acquisition-related earn-out liabilities of $2.3 million in the three months ended September 30, 2011, and $3.5 million and $5.5 million in the six months ended September 30, 2012 and 2011, respectively.

Member relations and marketing. Member relations and marketing expense increased 16.2% to $21.5 million in the three months ended September 30, 2012 from $18.5 million in the three months ended September 30, 2011. As a percentage of revenue, member relations and marketing expense in the three months ended September 30, 2012 and 2011 was 19.4% and 20.2%, respectively. Member relations and marketing expense increased 11.6% to $40.6 million in the six months ended September 30, 2012 from $36.4 million in the six months ended September 30, 2011. As a percentage of revenue, member relations and marketing expense in the six months ended September 30, 2012 and 2011 was 18.9% and 21.2%, respectively. The increases in member relations and marketing expense were primarily attributable to an increase in sales staff and related travel and other associated costs, as well as to an increase in member relations personnel and related costs required to serve our expanding membership base. During the three months ended September 30, 2012 and 2011, we had an average of 167 and 145 new business development teams, respectively.

General and administrative. General and administrative expense increased to $15.6 million in the three months ended September 30, 2012 from $11.9 million in the three months ended September 30, 2011. As a percentage of revenue, general and administrative expense increased to 14.1% in the three months ended September 30, 2012 from 13.0% in the three months ended September 30, 2011. General and administrative expense increased to $29.1 million in the six months ended September 30, 2012 from $22.7 million in the six months ended September 30, 2011. As a percentage of revenue, general and administrative expense increased


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slightly to 13.5% in the six months ended September 30, 2012 from 13.2% in the six months ended September 30, 2011. The increases in general and administrative costs for the three and six months ended September 30, 2012 were primarily attributable to increased costs incurred to improve our finance, human resources, information technology, and facility operations infrastructure to support our growing employee base and number of office locations, increased legal and external advisory spending related to our new credit facility and acquisition activity, and an increase in share-based compensation.

Depreciation and amortization. Depreciation and amortization expense increased to $4.4 million, or 4.0% of revenue, in the three months ended September 30, 2012, from $3.5 million, or 3.8% of revenue, in the three months ended September 30, 2011. Depreciation and amortization expense increased to $8.5 million, or 4.0% of revenue, in the six months ended September 30, 2012, from $6.5 million, or 3.8% of revenue, in the six months ended September 30, 2011. The increases in depreciation and amortization were primarily due to increased amortization expense from developed capitalized internal-use software tools, the PivotHealth acquisition in August 2011, and to a lesser extent, depreciation of our newly renovated Austin, Texas office and an expansion floor of our Washington, D.C. headquarters.

Other income, net. Other income, net increased to $0.7 million in the three months ended September 30, 2012 from $0.4 million in the three months ended September 30, 2011. Other income, net consists of interest income, interest expense, foreign exchange rate gains and losses, and losses on investment in common stock warrants. Higher average cash and investment balances contributed to an increase in interest income to $0.9 million in the three months ended September 30, 2012 from $0.6 million in the three months ended September 30, 2011. We recognized foreign exchange gains of $32,000 and foreign exchange losses of $0.1 million during the three months ended September 30, 2012 and 2011, respectively, as a result of the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies. During the three months ended September 30, 2012, we recognized a $0.1 million loss on our investment in common stock warrants and $0.1 million in interest expense. Other income, net increased to $1.3 million in the six months ended September 30, 2012 from $1.2 million in the six months ended September 30, 2011. Higher average cash and investment balances contributed to an increase in interest income to $1.7 million in the six months ended September 30, 2012 from $1.1 million in the six months ended September 30, 2011. We recognized foreign exchange losses of $0.2 million and foreign exchange gains of $0.2 million during the six months ended September 30, 2012 and 2011, respectively, as a result of the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies. During the six months ended September 30, 2012, we recognized a $0.1 million loss on our investment in common stock warrants and $0.1 million in interest expense.

Provision for income taxes. Our provision for income taxes was $4.9 million and $3.1 million in the three months ended September 30, 2012 and 2011, respectively. Our provision for income taxes was $8.6 million and $5.3 million in the six months ended September 30, 2012 and 2011, respectively. Our effective tax rate in the three and six months ended September 30, 2012 was 38.3% compared to 37.5% in the three and six months ended September 30, 2011. The increase in our effective tax rate for the three and six months ended September 30, 2012 was primarily due to the effect that higher estimated pre-tax income for fiscal year 2013, compared to our net income for fiscal year 2012, has on our effective rate when compared to the fixed nature of our Washington, D.C. tax credits that we receive under the New E-conomy Transformation Act of 2000. A slight increase in our effective state tax rate due to changes in apportionment factors also contributed to the increase in our effective tax rate.

Equity in loss of unconsolidated entity. Our proportionate share of the losses of Evolent during the three and six months ended September 30, 2012 were $1.7 million and $3.8 million, respectively, which were partially offset by a $1.1 million gain on investment recognized in connection with the dilution of our ownership percentage from 39% to 31% resulting from Evolent's second round of Series A preferred stock financing completed in July 2012. We did not recognize comparable losses in the prior year periods, as Evolent was formed on August 31, 2011.

Income from discontinued operations, net of tax. On January 20, 2012, we sold substantially all of the assets of our OptiLink business. As a result, the net income generated by OptiLink in the three and six months ended September 30, 2011 has been presented as discontinued operations.

Stock-based compensation expense. We recognized the following stock-based compensation expense in the consolidated statements of income line items for stock options and restricted stock units ("RSUs") issued under our stock incentive plans for the three and six months ended September 30, 2012 (in thousands, except per share amounts):

                                                    Three Months Ended            Six Months Ended
                                                      September 30,                September 30,
                                                    2012           2011          2012          2011
Stock-based compensation expense included in:
Costs and expenses:
Cost of services                                 $      989       $   847      $   1,993      $ 1,690
Member relations and marketing                          658           511          1,336        1,012
General and administrative                            1,758         1,442          3,582        2,813


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                                          Three Months Ended            Six Months Ended
                                             September 30,               September 30,
                                          2012           2011          2012          2011
 Depreciation and amortization                 -             -             -             -

 Total costs and expenses                   3,405         2,800         6,911         5,515

 Income from operations                    (3,405 )      (2,800 )      (6,911 )      (5,515 )

 Net income                             $  (2,101 )    $ (1,750 )    $ (4,264 )    $ (3,447 )

 Impact on diluted earnings per share   $    0.06      $   0.05      $   0.12      $   0.10

There are no stock-based compensation costs capitalized as part of the cost of an asset.

As of September 30, 2012, $31.0 million of total unrecognized compensation cost related to outstanding options and non-vested RSUs was expected to be recognized over a weighted average period of 1.5 years.

Non-GAAP Financial Measures

The tables below present information for the periods indicated about our adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share. We define "adjusted EBITDA" as net income attributable to common stockholders before provision for income taxes from continuing operations; other income, net, which includes interest income and expense, gains and losses on investment in common stock warrants, and foreign currency losses and gains; depreciation and amortization; equity in loss of unconsolidated entity and related gains or losses associated with the underlying investments; discontinued operations, net of tax; acquisition and similar transaction charges; fair value adjustments to acquisition-related earn-out liabilities; and share-based compensation expense. We define "adjusted net income" as net income attributable to common stockholders excluding, net of tax effect, equity in loss of unconsolidated entity and related gains or losses associated with the underlying investments; discontinued operations; gains and losses on investments in common stock warrants; amortization of acquisition-related intangibles; acquisition and similar transaction charges; fair value adjustments to acquisition-related earn-out liabilities; and share-based compensation expense. We define "non-GAAP earnings per diluted share" as earnings per diluted share excluding, net of tax effect, equity in loss of unconsolidated entity and related gains or losses associated with the underlying investments; discontinued operations; gains and losses on investments in common stock warrants; amortization of acquisition-related intangibles; acquisition and similar transaction charges; fair value adjustments to acquisition-related earn-out liabilities; and share-based compensation expense. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Presentation" in our 2012 Form 10-K for our reasons for including these financial measures in this report and for a description of material limitations with respect to the usefulness of such measures. A reconciliation of adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share to the most directly comparable GAAP financial measures is provided below (in thousands, except per share data).

                                                   Three Months Ended             Six Months Ended
                                                     September 30,                  September 30,
                                                  2012            2011           2012           2011

Net income attributable to common
stockholders                                    $   7,481       $  5,203       $ 11,322       $  9,074
Equity in loss of unconsolidated entity               592             -           2,716             -
Provision for income taxes from continuing
operations                                          4,944          3,104          8,646          5,327
Discontinued operations, net of tax                    -             (30 )           -            (195 )
Other income, net                                    (688 )         (448 )       (1,264 )       (1,245 )
Depreciation and amortization                       4,430          3,503          8,516          6,450
Acquisition and similar transaction charges           599            504            599            648
Fair value adjustments to
. . .
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