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ABCO > SEC Filings for ABCO > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for ADVISORY BOARD CO

Form 10-Q for ADVISORY BOARD CO


12-Nov-2013

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 2014 is our fiscal year ending on March 31, 2014.

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, 2013, or the "2013 Form 10-K," filed with the Securities and Exchange Commission, or "SEC." 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 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 annual 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 four key areas of focus for fiscal 2014 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 and education market conditions, through developing and launching new programs and acquiring products, services, and technologies that improve performance for our members; to further align our internal sales and account management functions to allow us to serve members more effectively and to develop deeper and more powerful commercial relationships across our portfolio; and to attract, cultivate, 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 a heavy focus on setting each team up 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 17.1% in the six months ended September 30, 2013 over the prior year period. Our contract value increased 12.9% to $491.3 million as of September 30, 2013 from $435.1 million as of September 30, 2012. 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 software tools and web-based content. 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; facilities management; new program development; corporate 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 that we have completed since April 1, 2012 affect the comparability of our results of operations for the three and six months ended September 30, 2013 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 2013 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 fiscal year ended March 31, 2013.

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,
                                                   2013            2012           2013          2012
Revenue                                              100.0 %        100.0 %        100.0 %       100.0 %
Costs and expenses:
Cost of services, excluding depreciation and
amortization                                          54.4 %         51.5 %         54.0 %        53.7 %
Member relations and marketing                        17.3 %         19.4 %         17.6 %        18.9 %
General and administrative                            14.0 %         14.1 %         14.3 %        13.5 %
Depreciation and amortization                          5.4 %          4.0 %          5.3 %         4.0 %

Total costs and expenses                              91.1 %         89.0 %         91.2 %        90.1 %

Operating income                                       8.9 %         11.0 %          8.8 %         9.9 %
Other income, net                                      0.8 %          0.6 %          0.6 %         0.6 %

Income before provision for income taxes and
equity in gain (loss) of unconsolidated
entities                                               9.7 %         11.6 %          9.4 %        10.5 %
Provision for income taxes                            (3.7 %)        (4.4 %)        (3.6 %)       (4.0 %)
Equity in gain (loss) of unconsolidated
entities                                               1.0 %         (0.5 %)        (0.7 %)       (1.3 %)

Net income before allocation to
noncontrolling interest                                7.0 %          6.7 %          5.1 %         5.2 %
Net loss attributable to noncontrolling
interest                                                -             0.1 %           -            0.1 %

Net income attributable to common
stockholders                                           7.0 %          6.8 %          5.1 %         5.3 %

Three and six months ended September 30, 2013 compared to the three and six months ended September 30, 2012

Net income attributable to common stockholders. Net income attributable to common stockholders was $9.0 million in the three months ended September 30, 2013 compared to $7.5 million in the three months ended September 30, 2012. The increase in net income was primarily attributable to a $1.9 million increase in our proportionate share of the net gain/(loss) of Evolent, a 15.9% increase in revenue, and a $1.0 million increase in fair value gains related to acquisition-related earn-out liabilities as compared to the prior year period. The effect of these factors was partially offset by an increase in cost of services of $12.9 million incurred for new and growing programs, increases of $2.4 million in general and administrative expense related to increased investment in our legal and corporate development groups, increases of $0.7 million in marketing and member relations costs attributable to the addition of new sales teams, and an increase of $2.5 million in depreciation and amortization. Net income attributable to common stockholders was $12.7 million in the six months ended September 30, 2013 compared to $11.3 million in the six months ended September 30, 2012. The increase in net income was primarily attributable to a 17.1% increase in revenue and a $3.7 million decrease in fair value charges related to acquisition-related earn-out liabilities as compared to the prior year period. The effect of these factors was partially offset by


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an increase in cost of services of $20.5 million incurred for new and growing programs, increases of $6.9 million in general and administrative expense related to increased investment in our legal and corporate development groups, increases of $3.8 million in marketing and member relations costs attributable to the addition of new sales teams, and an increase of $4.7 million in depreciation and amortization.

Adjusted net income, non-GAAP earnings per diluted share, and adjusted EBITDA. Adjusted net income was $11.4 million for the three months ended September 30, 2013 and 2012, while adjusted EBITDA increased 7.4% to $22.3 million in the three months ended September 30, 2013 from $20.8 million in the three months ended September 30, 2012. Adjusted net income increased to $22.7 million in the six months ended September 30, 2013 from $22.5 million in the six months ended September 30, 2012, while adjusted EBITDA increased 9.3% to $44.8 million in the six months ended September 30, 2013 from $40.9 million in the six months ended September 30, 2012. 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 15.9% to $128.3 million in the three months ended September 30, 2013 from $110.8 million in the three months ended September 30, 2012. Total revenue increased 17.1% to $251.6 million in the six months ended September 30, 2013 from $214.9 million in the six months ended September 30, 2012, while contract value increased 12.9% to $491.3 million as of September 30, 2013 from $435.1 million as of September 30, 2012. The increases in revenue and contract value were primarily attributable to the introduction and expansion of new programs, including our fiscal 2013 acquisitions of ActiveStrategy, Inc. ("ActiveStrategy") and 360Fresh, Inc. ("360Fresh"), our cross-selling of existing programs to existing members, and, to a lesser degree, price increases. We offered 59 membership programs as of September 30, 2013 compared to 54 membership programs as of September 30, 2012.

Cost of services. Cost of services increased to $69.9 million in the three months ended September 30, 2013 from $57.0 million in the three months ended September 30, 2012. Cost of services increased to $135.8 million in the six months ended September 30, 2013 from $115.4 million in the six months ended September 30, 2012. The increase of $12.9 million in cost of services for the three months ended September 30, 2013 was primarily due to growth and expansion of our Crimson programs, as well as our recent acquisitions of ActiveStrategy, 360Fresh, and Medical Referral Source, Inc. ("MRS"). Cost of services in the current periods also reflected increased 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 54.4% and 51.5% for the three months ended September 30, 2013 and 2012, respectively, and 54.0% and 53.7% for the six months ended September 30, 2013 and 2012, respectively. Cost of services includes fair value adjustments to our acquisition-related earn-out liabilities of a $1.0 million decrease in the three months ended September 30, 2013, and a $0.3 million decrease and $3.5 million increase in the six months ended September 30, 2013 and 2012, respectively.

Member relations and marketing. Member relations and marketing expense increased to $22.2 million in the three months ended September 30, 2013 from $21.5 million in the three months ended September 30, 2012. As a percentage of revenue, member relations and marketing expense in the three months ended September 30, 2013 and 2012 was 17.3% and 19.4%, respectively. Member relations and marketing expense increased to $44.4 million in the six months ended September 30, 2013 from $40.6 million in the six months ended September 30, 2012. As a percentage of revenue, member relations and marketing expense in the six months ended September 30, 2013 and 2012 was 17.6% and 18.9%, respectively. The increase in member relations and marketing expense was 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, 2013 and 2012, we had an average of 185 and 167 new business development teams, respectively.

General and administrative. General and administrative expense increased to $18.0 million in the three months ended September 30, 2013 from $15.6 million in the three months ended September 30, 2012. As a percentage of revenue, general and administrative expense was 14.0% in the three months ended September 30, 2013 compared to 14.1% in the three months ended September 30, 2012. General and administrative expense increased to $36.0 million in the six months ended September 30, 2013 from $29.1 million in the six months ended September 30, 2012. As a percentage of revenue, general and administrative expense increased to 14.3% in the six months ended September 30, 2013 from 13.5% in the six months ended September 30, 2012. The increases in general and administrative expense for the three and six months ended September 30, 2013 was primarily attributable to increased information technology and infrastructure costs to support our growing employee base and number of office locations, and increased investments in our legal and corporate development groups.


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Depreciation and amortization. Depreciation expense increased to $6.9 million, or 5.4% of revenue, in the three months ended September 30, 2013, from $4.4 million, or 4.0% of revenue, in the three months ended September 30, 2012. Depreciation expense increased to $13.2 million, or 5.3% of revenue, in the six months ended September 30, 2013, from $8.5 million, or 4.0% of revenue, in the six months ended September 30, 2012. The increase in depreciation and amortization was primarily due to increased amortization expense from developed capitalized internal-use software tools, the ActiveStrategy, 360Fresh, and MRS acquisitions, and depreciation on our newly renovated Austin, San Francisco, and Nashville offices and on an expansion floor of our Washington, D.C. headquarters.

Other income, net. Other income, net was $1.1 million in the three months ended September 30, 2013, compared to $0.7 million in the three months ended September 30, 2012. Higher average cash and investment balances and interest earned on our loan to Evolent contributed to an increase in interest income to $1.1 million in the three months ended September 30, 2013 from $0.9 million in the three months ended September 30, 2012. We recognized foreign exchange gains of $0.1 million and foreign exchange losses of $32,000 during the three months ended September 30, 2013 and 2012, 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. During the three months ended September 30, 2013 and 2012, we recognized $0.2 million and $0.1 million, respectively, in fees under our revolving credit facility. Other income, net increased to $1.6 million in the six months ended September 30, 2013 from $1.3 million in the six months ended September 30, 2012. Higher average cash and investment balances and interest earned on our loan to Evolent contributed to an increase in interest income to $2.0 million in the six months ended September 30, 2013 from $1.7 million in the six months ended September 30, 2012. We recognized foreign exchange losses of $0.1 million and $0.2 million during the six months ended September 30, 2013 and 2012, 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. During the six months ended September 30, 2013 and 2012, we recognized $0.3 million and $0.1 million, respectively, in fees under our revolving credit facility.

Provision for income taxes. Our provision for income taxes was $4.8 million and $4.9 million in the three months ended September 30, 2013 and 2012, respectively, and $9.1 million and $8.6 million in the six months ended September 30, 2013 and 2012, respectively. Our effective tax rate in the three and six months ended September 30, 2013 was 38.5% compared to 38.3% in the three and six months ended September 30, 2012.

Equity in gain (loss) of unconsolidated entities. Our proportionate share of the losses of Evolent during the three and six months ended September 30, 2013 was $2.7 million and $5.9 million, respectively, partially offset by a gain of $4.0 recognized on the conversion into equity securities of all outstanding principal and accrued interest under our note receivable from Evolent. Our proportionate share of the losses of Evolent during the three and six months ended September 30, 2012 was $1.7 million and $3.8 million, respectively, 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. Evolent was established in August 2011 and continues to operate as an early-stage business. As a result, we expect Evolent to incur losses and require additional funding in the future.

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 issued under our stock incentive plans for the three and six months ended September 30, 2013 and 2012 (in thousands, except per share amounts):

                                                     Three Months Ended             Six Months Ended
                                                       September 30,                 September 30,
                                                    2013            2012           2013          2012
Stock-based compensation expense included in:
Costs and expenses:
Cost of services                                  $   1,284       $    989       $  2,689      $  1,993
Member relations and marketing                          925            658          1,901         1,336
General and administrative                            2,198          1,758          4,476         3,582
Depreciation and amortization                            -              -              -             -

Total costs and expenses                              4,407          3,405          9,066         6,911

Operating Income                                     (4,407 )       (3,405 )       (9,066 )      (6,911 )

Net income attributable to common stockholders    $  (2,710 )     $ (2,101 )     $ (5,576 )    $ (4,264 )

Impact on diluted earnings per share              $    0.08       $   0.06       $   0.15      $   0.12


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

As of September 30, 2013, $40.8 million of total unrecognized compensation cost related to stock-based compensation was expected to be recognized over a weighted average period of 2.8 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" for the three and six months ended September 30, 2013 and 2012 as net income attributable to common stockholders before adjustment for the items set forth in the first table below. We define "adjusted net income" for the three and six months ended September 30, 2013 and 2012 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" for the three and six months ended September 30, 2013 and 2012 as earnings per diluted share excluding the net of tax effect of the items set forth in the third table below. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-Non-GAAP Financial Presentation" in our 2013 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,
                                                   2013            2012           2013          2012
Net income attributable to common
stockholders                                     $   9,002       $  7,481       $ 12,695      $ 11,322
Equity in (gain) loss of unconsolidated
entities                                            (1,326 )          592          1,907         2,716
Provision for income taxes                           4,805          4,944          9,140         8,646
Other income, net                                   (1,091 )         (688 )       (1,614 )      (1,264 )
Depreciation and amortization                        6,886          4,430         13,240         8,516
Acquisition and similar transaction charges            573            599            573           599
Fair value adjustments to acquisition-related
earn-out liabilities                                  (950 )           -            (250 )       3,500
Share-based compensation expense                     4,407          3,405          9,066         6,911

Adjusted EBITDA                                  $  22,306       $ 20,763       $ 44,757      $ 40,946

                                                    Three Months Ended            Six Months Ended
                                                      September 30,                September 30,
                                                   2013            2012          2013          2012
Net income attributable to common
stockholders                                     $   9,002       $  7,481      $ 12,695      $ 11,322
Equity in (gain) loss of unconsolidated
entities                                            (1,326 )          592         1,907         2,716
Amortization of acquisition-related
intangibles, net of tax                              1,231            790         2,367         1,581
Acquisition and similar transaction charges,
net of tax                                             352            370           352           370
Fair value adjustments to acquisition-related
earn-out liabilities, net of tax                      (584 )           -           (154 )       2,160
Loss on investment in common stock warrants,
net of tax                                              -              68            -             68
Share-based compensation, net of tax                 2,710          2,101         5,576         4,264

Adjusted net income                              $  11,385       $ 11,402      $ 22,743      $ 22,481


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                                                    Three Months Ended           Six Months Ended
                                                      September 30,                September 30,
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