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ABCO > SEC Filings for ABCO > Form 10-K on 30-May-2013All Recent SEC Filings

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Form 10-K for ADVISORY BOARD CO


30-May-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We provide best practices research and analysis, business intelligence and software tools, and management and advisory services through discrete programs to approximately 4,100 organizations, including hospitals, health systems, pharmaceutical and biotech companies, health care insurers, medical device companies, colleges, universities, and other health care focused and educational institutions. 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 membership business model allows us to create value for our members by providing proven solutions to common and complex problems as well as high-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. Our member institution renewal rate was 91%, 92%, and 90% for fiscal 2011, 2012, and 2013, respectively. 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 30.7% in fiscal 2012 over fiscal 2011 and grew 17.1% in fiscal 2013 over fiscal 2012. Our contract value increased 30.9% to $398.3 million as of March 31, 2012 from March 31, 2011 and increased 17.1% to $466.3 million as of March 31, 2013 from March 31, 2012. We define contract value as the aggregate annualized revenue attributable to all agreements in effect at a particular date, without regard to the initial term or remaining duration of any such agreement. In each of our programs, we generally invoice and collect fees in advance of accrual revenue recognition.

Our operating costs and expenses consist of cost of services, member relations and marketing, general and administrative expenses, 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; costs of developing and supporting our web-based content and software tools; and fair value adjustments to acquisition-related earn-out liabilities. 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; legal; management information systems; real estate and 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 intangibles. 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 recognize upon their exercise of common stock options and the vesting of restricted stock units issued under our stock incentive plans.

Non-GAAP Financial Presentation

This management's discussion and analysis presents supplemental measures of our performance that are derived from our consolidated financial information but are not presented in our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or "GAAP." We refer to these financial measures, which are considered "non-GAAP financial measures" under SEC rules, as adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share. See "Non-GAAP Financial Measures" below for information about our use of these non-GAAP financial measures, including our reasons for including these measures, material limitations with respect to the usefulness of the 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:

                                                                    Year Ended March 31,
                                                              2011          2012          2013

Revenue                                                        100.0 %       100.0 %       100.0 %
Costs and expenses:
Cost of services, excluding depreciation and amortization       52.6          54.9          53.2
Member relations and marketing                                  22.7          19.9          18.9
General and administrative                                      13.5          12.9          13.8
Depreciation and amortization                                    2.1           2.4           4.4

Total costs and expenses                                        90.9          90.2          90.4

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                                                                   Year Ended March 31,
                                                             2011          2012          2013
Operating income                                               9.1           9.8           9.6
Other income, net                                              0.7           0.8           0.6

Income from continuing operations before provision for
income taxes and equity in loss of unconsolidated
entity                                                         9.8          10.6          10.2
Provision for income taxes                                    (3.4 )        (4.1 )        (3.8 )
Equity in loss of unconsolidated entity                         -           (0.4 )        (1.5 )

Net income from continuing operations                          6.4           6.2           4.9
Discontinued operations:
Income from discontinued operations, net of tax                0.2           0.1            -
Gain on sale of discontinued operations, net of tax             -            0.6            -

Net income from discontinued operations                        0.2           0.7            -

Net income before allocation to noncontrolling interest        6.5           6.8           4.9
Net loss attributable to noncontrolling interest                -             -            0.0

Net income attributable to common stockholders                 6.5 %         6.8 %         4.9 %

Fiscal years ended March 31, 2011, 2012, and 2013

Net income attributable to common stockholders. Net income attributable to common stockholders increased 36.5% from $18.5 million in fiscal 2011 to $25.3 million in fiscal 2012, and decreased 12.4% to $22.2 million in fiscal 2013. The increase in net income attributable to common stockholders in fiscal 2012 was primarily due to a 30.7% increase in revenue and a gain on the sale of discontinued operations of $2.2 million, net of taxes. The effect of these factors was partially offset by increases of $54.1 million in cost of services from newly developed, acquired, and growing programs, increases of $9.6 million in marketing and member relations expense from the addition of new sales teams, and increases of $9.7 million in general and administrative expense from increased new product development costs, and increases in finance, information technology, and human resources expense incurred to support our growing employee base. Our fiscal 2012 results included our proportionate share of the net loss of Evolent Health, Inc., or "Evolent," a venture we established in the second quarter of fiscal 2012. The decrease in net income attributable to common stockholders in fiscal 2013 was primarily due to a 21.7% increase in revenue, offset in part an increase in our proportionate share of the net loss of Evolent from $1.3 million to $6.8 million in fiscal 2013. Other factors that contributed to the lower net income in fiscal 2013 included increases of $41.9 million in cost of services to support newly developed, acquired and growing programs, increases of $11.4 million in marketing and member relations expense from the addition of new sales teams, and increases of $14.3 million in general and administrative expense related to increased new product development costs, and increases in finance, information technology, and human resources expense incurred to support our growing employee base.

Adjusted net income, non-GAAP earnings per diluted share, and adjusted EBITDA. Adjusted net income increased 41.2% from $27.9 million, or $0.85 non-GAAP earnings per diluted share, in fiscal 2011 to $39.4 million, or $1.13 non-GAAP earnings per diluted share, in fiscal 2012, and 13.7% to $44.8 million, or $1.23 non-GAAP earnings per diluted share, in fiscal 2013. Adjusted EBITDA increased 48.6% from $47.3 million in fiscal 2011 to $70.3 million in fiscal 2012, and 18.1% to $83.0 million in fiscal 2013. 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 expense resulting from the addition of new sales teams.

Revenue. Revenue increased 30.7% from $283.4 million in fiscal 2011 to $370.3 million in fiscal 2012, and 21.7% to $450.8 million in fiscal 2013. Our contract value increased 30.9% from $304.3 million as of March 31, 2011 to $398.3 million as of March 31, 2012, and 17.1% to $466.3 million as of March 31, 2013.

The increase in revenue in fiscal 2012 over fiscal 2011 was primarily attributable to the introduction and expansion of new programs, including revenue from our August 2011 acquisition of PivotHealth, LLC, or "PivotHealth," a full fiscal year of revenue from the February 2011 acquisition of Cielo MedSolutions, LLC, or "Cielo," the cross-selling of existing programs to existing members, and, to a lesser degree, price increases. The increase in revenue in fiscal 2013 over fiscal 2012 was primarily attributable to the introduction and expansion of new programs, including revenue from our fiscal 2013 acquisitions of ActiveStrategy, Inc. ("ActiveStrategy") and 360Fresh, Inc. ("360Fresh"), a full fiscal year of revenue from the August 1, 2011 acquisition of PivotHealth, our cross-selling of existing programs to existing members, and, to a lesser degree, price increases.

We offered 50 membership programs as of March 31, 2011, 53 membership programs as of March 31, 2012, and 57 membership programs as of March 31, 2013. Our membership base consisted of 3,179 member institutions as of March 31, 2011, 3,726 member institutions as of March 31, 2012, and 4,114 member institutions as of March 31, 2013. Our average contract value per member was $95,722 as of March 31, 2011, compared to $106,901 as of March 31, 2012, and $113,352 as of March 31, 2013.

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Cost of services. Cost of services increased 36.7% from $144.9 million in fiscal 2011 to $198.1 million in fiscal 2012, and 21.2% to $240.0 million in fiscal 2013. As a percentage of revenue, cost of services was 51.1% for fiscal 2011, 53.5% for fiscal 2012, and 53.2% for fiscal 2013. The increase of $53.2 million in cost of services for fiscal 2012 over fiscal 2011 was primarily attributable to growth and expansion of our Crimson and Southwind programs, an increase of $11.1 million from programs acquired in 2011, and $6.7 million in fair value adjustments to our acquisition-related earn-out liabilities. The increase of $41.9 million in cost of services for fiscal 2013 over fiscal 2012 was primarily attributable to an increase of $7.2 million in expenses related to our Southwind programs, which included a full year of Pivot expenses, and increases of $30.2 million in expenses related to our new and growing physician related software programs. The increases in cost of services over the three fiscal years also reflected higher costs associated with the delivery of program content and tools to our expanded membership base, including increased staffing, licensing fees, and other costs.

Member relations and marketing expense. Member relations and marketing expense increased 14.9% from $64.3 million in fiscal 2011 to $73.9 million in fiscal 2012, and 15.4% to $85.3 million in fiscal 2013. As a percentage of revenue, member relations and marketing expense in fiscal 2011, 2012, and 2013 was 22.7%, 19.9%, and 18.9%, respectively. The total dollar increases in member relations and marketing expense over each of the fiscal years 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. We had an average of 135, 148, and 172 new business development teams during fiscal 2011, 2012, and 2013, respectively.

General and administrative expense. General and administrative expense increased 25.3% from $38.2 million in fiscal 2011 to $47.9 million in fiscal 2012, and 29.8% to $62.2 million in fiscal 2013. As a percentage of revenue, general and administrative expense in fiscal 2011, 2012, and 2013 was 13.5%, 12.9%, and 13.8%, respectively. The increase of $9.7 million in general and administrative expense for fiscal 2012 was primarily attributable to an increase of $2.3 million in recruiting, human resources, and finance personnel costs incurred to support our growing employee base, an increase in new product development costs of $2.4 million, which included legal costs relating to our acquisitions of PivotHealth and Cielo and formation of Evolent, and an increase in share-based compensation of $2.0 million. The increase of $14.3 million in general and administrative expense for fiscal 2013 was primarily attributable to an increase of $8.0 million in costs incurred to improve our finance, human resources, and information technology infrastructure to support our growing employee base and number of office locations; increased legal infrastructure costs; external advisory spending related to our new credit facility of $0.6 million; and an increase in share-based compensation expense of $0.9 million. As of March 31, 2013, we had approximately 2,400 employees compared to approximately 1,850 employees as of March 31, 2012.

Depreciation and amortization. Depreciation and amortization expense increased from $10.1 million, or 3.6% of revenue, in fiscal 2011, to $14.1 million, or 3.8% of revenue, in fiscal 2012, and to $19.9 million, or 4.4% of revenue, in fiscal 2013. The increase in fiscal 2012 was primarily due to increased amortization expense from technology acquired in the Cielo acquisition, amortization expense attributable to developed capitalized internal-use software tools, and depreciation on our newly constructed Austin, Texas office and expansion of our Washington, D.C. headquarters. The increase in fiscal 2013 was primarily due to increased amortization expense attributable to developed capitalized internal-use software tools, amortization expense on intangibles acquired in our fiscal 2013 acquisitions of 360Fresh and ActiveStrategy, and depreciation on expansion of our Washington, D.C. headquarters.

Other income, net. Other income, net increased from $1.9 million in fiscal 2011 to $3.0 million in fiscal 2012, and decreased to $2.6 million in fiscal 2013. Other income, net consists of interest income, revolving credit facility fees, gains and losses on investment in common stock warrants, and foreign currency gains and losses. Other income, net consisted of interest income of $1.7 million and a foreign exchange rate gain of $0.2 million in fiscal 2011; interest income of $2.4 million, a foreign exchange rate gain of $0.1 million, and a gain of $0.5 million on an investment in common stock warrants in fiscal 2012; and interest income of $3.4 million, revolving credit facility fees of $0.4 million, a foreign exchange rate loss of $0.5 million, and a gain of $0.1 million on an investment in common stock warrants in fiscal 2013. Higher average cash and investment balances contributed to an increase in interest income from $1.7 million in fiscal 2011 to $2.4 million in fiscal 2012 and to $3.4 million in fiscal 2013. During fiscal 2011, 2012, and 2013, we recognized foreign exchange gains of $0.2 million, $0.1 million, and a foreign exchange loss of $0.5 million, respectively, as a result of the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies.

Provision for income taxes. Our provision for income taxes was $9.7 million, $15.2 million, and $17.3 million in fiscal 2011, 2012, and 2013, respectively. Our effective tax rate in fiscal 2011, 2012, and 2013 was 34.9%, 38.6%, and 37.5%, respectively. The increase in our effective tax rate in fiscal 2012 was primarily due to the effects that higher net income attributable to common stockholders has on our effective rate when compared to the fixed nature of our Washington D.C. tax credits that we receive due to our status as a Qualified High Technology Company under the New E-conomy Transformation Act of 2000. The decrease in our effective tax rate in fiscal 2013 was primarily due to a higher balance of tax-exempt investments and an increase in Washington, D.C. tax credits that we received under the New E-conomy Transformation Act of 2000, partially offset by a slight increase in our effective state tax rate due to changes in apportionment.

Equity in loss of unconsolidated entity. Our proportionate share of the losses of Evolent during fiscal 2012 and 2013 were $1.3 million and $6.8 million, respectively. Evolent was established in August 2011 and continues to be in the early stages of its business

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plan. As a result, we expect Evolent to incur losses and require additional funding in the future. The losses recognized during fiscal year 2013 were partially offset by a $1.1 million gain on investment recognized in connection with additional equity investment from certain early customers in July 2012.

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 of $0.4 million and $0.3 million in fiscal 2011, and 2012, respectively, has been presented as discontinued operations.

Gain on sale of discontinued operations. In fiscal 2012, we recorded a gain of $2.2 million from the sale of OptiLink, after tax.

Net loss attributable to noncontrolling interest. On July 5, 2012, we entered into an agreement with an entity created for the sole purpose of providing consulting services for us on an exclusive basis. We determined that this entity meets the definition of a variable interest entity over which we have significant influence and, as a result, have consolidated the results of this entity into our consolidated financial statements. As of March 31, 2013, we have a 0% ownership interest in this entity which resulted in income to us from the allocation of losses to the noncontrolling interest of $0.1 million in fiscal 2013.

Stock-based compensation expense. We recognized the following stock-based compensation expense in the consolidated statements of income line items for stock options and RSUs issued under our stock incentive plans and for shares issued under our employee stock purchase plan for fiscal 2011, 2012, and 2013 (in thousands except per share amounts):

                                                           Year Ended March 31,
                                                    2011          2012           2013

 Stock-based compensation expense included in:
 Costs and expenses:
 Cost of services                                 $  2,763      $   3,440      $   3,975
 Member relations and marketing                      1,663          2,133          2,643
 General and administrative                          4,366          6,413          7,295
 Depreciation and amortization                          -              -              -

 Total costs and expenses                            8,792         11,986         13,913

 Operating income                                   (8,792 )      (11,986 )      (13,913 )

 Net income attributable to common stockholders   $ (5,725 )    $  (7,359 )    $  (8,686 )

 Impact on diluted earnings per share             $  (0.18 )    $   (0.21 )    $   (0.24 )

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

Stock-based compensation expense by award type for fiscal 2011, 2012, and 2013 was as follows (in thousands):

                                                           Year Ended March 31,
                                                      2011         2012         2013

   Stock-based compensation expense by award type:
   Stock options                                     $ 3,590     $  5,072     $  5,000
   Restricted stock units                              5,202        6,914        8,913
   Employee stock purchase rights                         -            -            -

   Total stock-based compensation                    $ 8,792     $ 11,986     $ 13,913

As of March 31, 2013, $26.0 million of total unrecognized compensation cost related to stock-based compensation is expected to be recognized over a weighted average period of 1.4 years.

Non-GAAP Financial Measures

We use non-GAAP financial measures to supplement the financial information presented on a GAAP basis. The non-GAAP financial measures presented in this report include adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share. We define "adjusted EBITDA" as net income attributable to common stockholders before adjustment for the items set forth in the first table below. We define "adjusted net income" as net income attributable to common stockholders excluding the net of tax effect of the items set forth in the second table below, We define "non-GAAP earnings per diluted share" as earnings per diluted share excluding the net of tax effect of the items set forth in the third table below.

Our management believes that providing information about adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share facilitates an assessment by our investors of the Company's fundamental operating trends and addresses concerns of

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management and investors that the various gains and expenses excluded from these measures may obscure such underlying trends. Our management uses these non-GAAP financial measures, together with financial measures prepared in accordance with GAAP, to enhance its understanding of our core operating performance, which represents our views concerning our performance in the ordinary, ongoing, and customary course of our operations. In the future, we are likely to incur income and expenses similar to the items for which the applicable GAAP measures have been adjusted and to report non-GAAP financial measures excluding such items. Accordingly, the exclusion of those and similar items in our non-GAAP presentation should not be interpreted as implying that the items are non-recurring, infrequent, or unusual.

The information about our core operating performance provided by our non-GAAP financial measures is used by management for a variety of purposes. Management uses the non-GAAP financial measures for internal budgeting and other managerial purposes in part because the measures enable management to evaluate projected operating results and make comparative assessments of our performance over time while isolating the effects of items that vary from period to period without any correlation to core operating performance, such as tax rates, interest income and foreign currency exchange rates, periodic costs of certain capitalized tangible and intangible assets, share-based compensation expense, and certain non-cash and special charges. The effects of the foregoing items also vary widely among similar companies, and affect the ability of management and investors to make company-to-company comparisons. In addition, merger and acquisition activity can have inconsistent effects on earnings that are not related to core operating performance due, for instance, to charges relating to acquisition costs, the amortization of acquisition-related intangibles, and fluctuations in the fair value of contingent earn-out liabilities, and investments in common stock warrants. Companies also exhibit significant variations with respect to capital structure and cost of capital (which affect relative interest expense) and differences in taxation and book depreciation of facilities and equipment (which affect relative depreciation expense), including significant differences in the depreciable lives of similar assets among various companies. By eliminating some of the foregoing variations, management believes that the Company's non-GAAP financial measures allow management and investors to evaluate more effectively the Company's performance relative to that of its competitors and peer companies. Similarly, our management believes that because of the variety of equity awards used by companies, the varying methodologies for determining both share-based compensation and share-based compensation expense among companies, and from period to period, and the subjective assumptions involved in those determinations, excluding share-based compensation from our non-GAAP financial measures enhances company-to-company comparisons over multiple fiscal periods.

Our non-GAAP measures may be calculated differently from similarly titled measures reported by other companies due to differences in accounting policies and items excluded or included in the adjustments, which limits their usefulness as comparative measures. In addition, there are other limitations associated with the non-GAAP financial measures we use, including the following:

the non-GAAP financial measures generally do not reflect all depreciation and amortization, and although the assets being depreciated and amortized will in some cases have to be replaced in the future, the measures do not reflect any cash requirements for such replacements;

the non-GAAP financial measures do not reflect the expense of equity awards to employees;

the non-GAAP financial measures do not reflect the effect of earnings or charges resulting from matters that management considers not indicative of our ongoing operations, but which may recur from year to year; and

to the extent that we change our accounting for certain transactions or other items from period to period, our non-GAAP financial measures may not be directly comparable from period to period.

Our management compensates for these limitations by relying primarily on our GAAP results and using the non-GAAP financial measures only as a supplemental measure of our operating performance, and by considering independently the economic effects of the foregoing items that are or are not reflected in the . . .

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