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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2013
or
¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File Number: 001-34849
THE CORPORATE EXECUTIVE BOARD COMPANY
(Exact name of registrant as specified in its charter)
Delaware | 52-2056410 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |
1919 North Lynn Street Arlington, Virginia | 22209 | |
(Address of principal executive offices) | (Zip Code) |
(571) 303-3000
(Registrant’s telephone number, including area code)
Not applicable
(Former name, former address or former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
The Company had 33,609,569 shares of common stock, par value $0.01 per share, outstanding at November 1, 2013.
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THE CORPORATE EXECUTIVE BOARD COMPANY
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THE CORPORATE EXECUTIVE BOARD COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
September 30, 2013 | December 31, 2012 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 77,847 | $ | 72,699 | ||||
Accounts receivable, net | 183,870 | 239,599 | ||||||
Deferred income taxes, net | 15,198 | 15,669 | ||||||
Deferred incentive compensation | 21,143 | 19,984 | ||||||
Prepaid expenses and other current assets | 41,019 | 19,068 | ||||||
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Total current assets | 339,077 | 367,019 | ||||||
Deferred income taxes, net | 3,424 | 283 | ||||||
Property and equipment, net | 108,505 | 96,962 | ||||||
Goodwill | 446,696 | 471,299 | ||||||
Intangible assets, net | 313,548 | 335,191 | ||||||
Other non-current assets | 58,961 | 51,495 | ||||||
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Total assets | $ | 1,270,211 | $ | 1,322,249 | ||||
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Liabilities and stockholders’ equity | ||||||||
Current liabilities: | ||||||||
Accounts payable and accrued liabilities | $ | 75,945 | $ | 84,363 | ||||
Accrued incentive compensation | 43,690 | 53,927 | ||||||
Deferred revenue | 350,255 | 365,747 | ||||||
Deferred income taxes, net | 1,245 | 3,537 | ||||||
Debt – current portion | 10,277 | 12,479 | ||||||
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Total current liabilities | 481,412 | 520,053 | ||||||
Deferred income taxes, net | 51,010 | 59,773 | ||||||
Other liabilities | 111,931 | 98,641 | ||||||
Debt – long term | 508,121 | 528,280 | ||||||
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Total liabilities | 1,152,474 | 1,206,747 | ||||||
Stockholders’ equity: | ||||||||
Common stock, par value $0.01; 100,000,000 shares authorized, 44,647,659 and 44,220,685 shares issued, and 33,599,626 and 33,337,337 shares outstanding at September 30, 2013 and December 31, 2012, respectively | 446 | 442 | ||||||
Additional paid-in capital | 440,307 | 427,491 | ||||||
Retained earnings | 342,677 | 345,907 | ||||||
Accumulated elements of other comprehensive income | 29,618 | 27,665 | ||||||
Treasury stock, at cost, 11,048,033 and 10,883,348 shares at September 30, 2013 and December 31, 2012, respectively | (695,311 | ) | (686,003 | ) | ||||
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Total stockholders’ equity | 117,737 | 115,502 | ||||||
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Total liabilities and stockholders’ equity | $ | 1,270,211 | $ | 1,322,249 | ||||
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See accompanying notes to condensed consolidated financial statements.
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THE CORPORATE EXECUTIVE BOARD COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue | $ | 201,735 | $ | 164,749 | $ | 596,617 | $ | 428,934 | ||||||||
Costs and expenses: | ||||||||||||||||
Cost of services | 72,387 | 60,182 | 219,175 | 151,161 | ||||||||||||
Member relations and marketing | 60,481 | 46,966 | 174,377 | 123,707 | ||||||||||||
General and administrative | 21,213 | 19,102 | 71,683 | 51,226 | ||||||||||||
Acquisition related costs | 4,022 | 18,557 | 7,044 | 21,286 | ||||||||||||
Impairment loss | 22,600 | — | 22,600 | — | ||||||||||||
Depreciation and amortization | 15,287 | 11,296 | 44,776 | 22,261 | ||||||||||||
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Total costs and expenses | 195,990 | 156,103 | 539,655 | 369,641 | ||||||||||||
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Operating profit | 5,745 | 8,646 | 56,962 | 59,293 | ||||||||||||
Other (expense) income, net | ||||||||||||||||
Interest income and other | (2,093 | ) | 1,619 | (797 | ) | 2,549 | ||||||||||
Interest expense | (4,956 | ) | (4,962 | ) | (17,596 | ) | (5,227 | ) | ||||||||
Debt extinguishment costs | (6,691 | ) | — | (6,691 | ) | — | ||||||||||
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Other (expense) income, net | (13,740 | ) | (3,343 | ) | (25,084 | ) | (2,678 | ) | ||||||||
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(Loss) income before provision for income taxes | (7,995 | ) | 5,303 | 31,878 | 56,615 | |||||||||||
Provision for income taxes | (2,612 | ) | 5,759 | 12,485 | 26,746 | |||||||||||
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Net (loss) income | $ | (5,383 | ) | $ | (456 | ) | $ | 19,393 | $ | 29,869 | ||||||
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Basic (loss) earnings per share | $ | (0.16 | ) | $ | (0.01 | ) | $ | 0.58 | $ | 0.89 | ||||||
Diluted (loss) earnings per share | $ | (0.16 | ) | $ | (0.01 | ) | $ | 0.57 | $ | 0.88 | ||||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 33,597 | 33,546 | 33,519 | 33,460 | ||||||||||||
Diluted | 33,933 | 33,863 | 33,899 | 33,809 | ||||||||||||
Dividends declared and paid per share | $ | 0.225 | $ | 0.175 | $ | 0.675 | $ | 0.525 |
See accompanying notes to condensed consolidated financial statements.
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THE CORPORATE EXECUTIVE BOARD COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net (loss) income | $ | (5,383 | ) | $ | (456 | ) | $ | 19,393 | $ | 29,869 | ||||||
Other comprehensive income (loss): | ||||||||||||||||
Foreign currency translation adjustment | 39,914 | 19,289 | 1,801 | 19,167 | ||||||||||||
Foreign currency hedge, net of tax | 455 | 95 | 238 | 237 | ||||||||||||
Interest rate swap, net of tax | (86 | ) | — | (86 | ) | — | ||||||||||
Change in unrealized gains on available-for-sale marketable securities, net of tax | — | (27 | ) | — | (121 | ) | ||||||||||
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Comprehensive income | $ | 34,900 | $ | 18,901 | $ | 21,346 | $ | 49,152 | ||||||||
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See accompanying notes to condensed consolidated financial statements.
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THE CORPORATE EXECUTIVE BOARD COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30, | ||||||||
2013 | 2012 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 19,393 | $ | 29,869 | ||||
Adjustments to reconcile net income to net cash flows provided by operating activities: | ||||||||
Impairment loss | 22,600 | — | ||||||
Debt extinguishment costs | 6,691 | — | ||||||
Exit costs | 1,007 | — | ||||||
Depreciation and amortization | 44,776 | 22,261 | ||||||
Amortization of credit facility issuance costs | 2,308 | 518 | ||||||
Deferred income taxes | (8,530 | ) | 1,578 | |||||
Share-based compensation | 9,123 | 6,717 | ||||||
Excess tax benefits from share-based compensation arrangements | (4,036 | ) | (1,938 | ) | ||||
Net foreign currency remeasurement and translation loss (gain) | 1,064 | (370 | ) | |||||
Amortization of marketable securities premiums, net | — | 68 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable, net | 56,554 | 48,172 | ||||||
Deferred incentive compensation | (1,059 | ) | (1,116 | ) | ||||
Prepaid expenses and other current assets | (21,665 | ) | (4,148 | ) | ||||
Other non-current assets | (1,107 | ) | 1,145 | |||||
Accounts payable and accrued liabilities | (11,863 | ) | (8,598 | ) | ||||
Accrued incentive compensation | (10,180 | ) | (3,691 | ) | ||||
Deferred revenue | (16,693 | ) | (16,273 | ) | ||||
Other liabilities | 6,621 | 3,135 | ||||||
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Net cash flows provided by operating activities | 95,004 | 77,329 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (23,038 | ) | (11,778 | ) | ||||
Cost method investments | (11,213 | ) | — | |||||
Acquisition of businesses, net of cash acquired | — | (669,476 | ) | |||||
Maturities of marketable securities | — | 5,130 | ||||||
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Net cash flows used in investing activities | (34,251 | ) | (676,124 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from credit facility | 5,000 | 555,000 | ||||||
Payments of credit facility | (29,314 | ) | — | |||||
Proceeds from the exercise of common stock options | 1,098 | 1,202 | ||||||
Proceeds from the issuance of common stock under the employee stock purchase plan | 653 | 461 | ||||||
Excess tax benefits from share-based compensation arrangements | 4,036 | 1,938 | ||||||
Credit facility issuance costs | (4,156 | ) | (19,176 | ) | ||||
Purchase of treasury shares | (2,751 | ) | — | |||||
Withholding of shares to satisfy minimum employee tax withholding for restricted stock units | (6,556 | ) | (3,618 | ) | ||||
Payment of dividends | (22,624 | ) | (17,570 | ) | ||||
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Net cash flows (used in) provided by financing activities | (54,614 | ) | 518,237 | |||||
Effect of exchange rates on cash | (991 | ) | 209 | |||||
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Net increase (decrease) in cash and cash equivalents | 5,148 | (80,349 | ) | |||||
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Cash and cash equivalents, beginning of period | 72,699 | 133,429 | ||||||
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Cash and cash equivalents, end of period | $ | 77,847 | $ | 53,080 | ||||
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See accompanying notes to condensed consolidated financial statements.
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THE CORPORATE EXECUTIVE BOARD COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Nature of Business and Basis of Presentation
The Corporate Executive Board Company (“CEB” or the “Company”) is a member-based advisory company. By combining the best practices of thousands of member companies with its advanced research methodologies and human capital analytics, CEB equips senior leaders and their teams with insight and actionable solutions to transform operations. This distinctive approach, pioneered by CEB, enables executives to harness peer perspectives and tap into breakthrough innovation without costly consulting or reinvention. The CEB member network includes more than 15,000 executives and the majority of top companies globally. On August 2, 2012, CEB completed the acquisition of SHL Group Holdings I and its subsidiaries (“SHL” or “SHL Talent Management Solutions”), a global leader in cloud-based talent measurement and management solutions headquartered in the United Kingdom (“UK”).
The accompanying condensed consolidated financial statements have been prepared in accordance with US generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) for reporting on Form 10-Q. Accordingly, certain information and disclosures required for complete consolidated financial statements are not included. It is recommended that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and related notes in CEB’s 2012 Annual Report on Form 10-K.
In management’s opinion, all adjustments, consisting of a normal recurring nature, considered necessary for a fair presentation of the condensed consolidated financial position, results of operations, and cash flows at the dates and for the periods presented have been included. The condensed consolidated balance sheet presented at December 31, 2012 has been derived from the financial statements that were audited by CEB’s independent registered public accounting firm. The results of operations for the three and nine months ended September 30, 2013 may not be indicative of the results that may be expected for the year ended December 31, 2013 or any other period within 2013.
Note 2. Recent Accounting Pronouncements
Recently Adopted
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02, Comprehensive Income (Topic 220), Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income. This update requires companies to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, companies are required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. This update was effective for CEB in the first quarter of 2013 and will be applied prospectively. Other than requiring additional disclosures, adoption of this new guidance did not have a significant impact on the Company’s condensed consolidated financial statements.
Note 3. Acquisitions
Investments in Other Entities
The Company made investments totaling $3.9 million in two private entities in the three months ended September 30, 2013 and $11.2 million in three private entities in the nine months ended September 30, 2013. At September 30, 2013, the Company has made five investments with an aggregate carrying amount of $14.6 million included in Other non-current assets in the condensed consolidated balance sheets. The cost method is used for these investments as the Company believes that due to the size and nature of the investments, it is not able to exercise significant influence on the investee entities. These investments are carried at their original cost and evaluated each reporting period for changes to their net realizable value. Because the investee entities are private companies without exchange traded securities, the fair value of the underlying investment is not readily available.
SHL
On August 2, 2012, CEB completed the acquisition of 100% of the equity interests of SHL pursuant to a sale and purchase agreement entered into on July 2, 2012. The acquisition significantly expanded the addressable market of both companies through an increased global presence across major developed and emerging markets, enhancing CEB’s ability to scale and extend its existing platform with technology-driven solutions.
The purchase price was approximately $654 million in cash. CEB used borrowings under a senior secured credit facility and approximately $121 million of its available cash on hand to fund the purchase price.
CEB has completed the purchase accounting for the SHL acquisition. Based on the fair value of the acquired assets and assumed liabilities as of the acquisition date, CEB’s final purchase accounting allocation is as follows: net tangible liabilities of $81.4 million, amortizable intangible assets of $323.2 million, and goodwill of $412.4 million. The preliminary allocation to goodwill at the time of the acquisition was $406.5 million. The difference of $5.9 million primarily relates to the assignment of deferred tax assets and liabilities to local tax jurisdictions. Changes in amounts allocated to acquired assets and assumed liabilities were not material and therefore the December 31, 2012 balance sheet was not recast. The allocation of goodwill by reportable segment was $53.6 million to PDRI and $358.8 million to SHL.
Goodwill and intangible assets are not deductible for tax purposes. As a result, the Company recorded a deferred tax liability of $89.5 million related to the difference in the book and tax basis of identifiable intangible assets. Deferred revenue at the acquisition date was recorded at fair value based on the estimated cost to provide the related services plus a reasonable profit margin on such costs. The reduction in deferred revenue from SHL’s historical cost to fair value was approximately $34 million. Of this amount, $17.1 million would have been recognized in 2012, and $8.9 million would have been recognized in the nine months ended September 30, 2013. The remaining $8.0 million would have been recognized primarily in 2014.
Pro Forma Financial Information
The following unaudited pro forma financial information summarizes the Company’s operating results as if the SHL acquisition had been completed on January 1, 2011. The pro forma financial information includes the impact of fair value adjustments, including a $34 million deferred revenue fair value adjustment on revenue recognized, amortization expense from acquired intangible assets, interest expense, and the related tax effects. In preparing the pro forma financial information, CEB has assumed that approximately $26 million of the deferred revenue fair value adjustment would be recognized in 2011 and approximately $8 million would be recognized in 2012. The following unaudited pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition occurred on January 1, 2011 and should not be construed as representative of the future consolidated results of operations or financial condition of the combined entity (unaudited and in thousands):
Three Months Ended September 30, 2012 | Nine Months Ended September 30, 2012 | |||||||
Pro forma revenue | $ | 189,184 | 560,125 | |||||
Pro forma net income | $ | 18,043 | 47,915 |
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Valtera
In February 2012, the Company completed the acquisition of Valtera Corporation (“Valtera”), a talent management company that provides tools and services to assist organizations in hiring, engaging, and developing talent. The Company acquired 100% of the equity interests for a cash payment of $22.4 million less cash acquired of $1.9 million. The Company allocated $8.8 million to intangible assets with a weighted average amortization period of 6 years and $11.4 million to goodwill. The operating results of Valtera are not considered material to the Company’s condensed consolidated financial statements. Accordingly, pro forma financial information has not been presented.
Note 4. Fair Value Measurements
Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. There is a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
• | Level 1 — Quoted prices in active markets for identical assets or liabilities. |
• | Level 2 — Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data. |
• | Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs. |
The Company has segregated all assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the tables below (in thousands):
September 30, 2013 | December 31, 2012 | |||||||||||||||||||||||
Level 1 | Level 2 | Level 3 | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
Financial assets | ||||||||||||||||||||||||
Cash and cash equivalents | $ | 77,847 | $ | — | $ | — | $ | 72,699 | $ | — | $ | — | ||||||||||||
Investments held through variable insurance products in a Rabbi Trust | — | 16,369 | — | — | 15,267 | — | ||||||||||||||||||
Forward currency exchange contracts | — | 590 | — | — | 111 | — | ||||||||||||||||||
Financial liabilities | ||||||||||||||||||||||||
Interest rate swap | — | 144 | — | — | — | — |
Investments held through variable insurance products in a Rabbi Trust, included in Other non-current assets, consist of mutual funds available only to institutional investors. The fair value of these investments are based on the fair value of the underlying investments held by the mutual funds allocated to each share of the mutual fund using a net asset value approach. The fair value of the underlying investments held by the mutual funds are observable inputs. The fair value for foreign currency exchange and interest rate swap contracts are based on bank quotations for similar instruments using models with market-based inputs.
Certain assets, such as goodwill, intangible assets, investments accounted for under the cost method, and liabilities are measured at fair value on a nonrecurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (e.g., when there is impairment). The Company measured the fair value of the PDRI and SHL reporting units and recorded a fair value adjustment relating to PDRI (see Note 6). Any such fair value measurements are included in the Level 3 fair value hierarchy.
Note 5. Accounts Receivable, net
Accounts receivable, net consists of the following (in thousands):
September 30, 2013 | December 31, 2012 | |||||||
Billed | $ | 123,541 | $ | 178,117 | ||||
Unbilled | 62,070 | 63,891 | ||||||
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185,611 | 242,008 | |||||||
Allowance for uncollectible revenue | (1,741 | ) | (2,409 | ) | ||||
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Accounts receivable, net | $ | 183,870 | $ | 239,599 | ||||
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Note 6. Goodwill
Changes in the carrying amount of goodwill are as follows (in thousands):
Nine Months Ended September 30, 2013 | Year Ended December 31, 2012 | |||||||
Beginning of period | $ | 471,299 | $ | 29,492 | ||||
Goodwill acquired | — | 424,664 | ||||||
Purchase accounting adjustments | (1,400 | ) | 7,300 | |||||
Impairment loss | (22,600 | ) | — | |||||
Impact of foreign currency | (603 | ) | 9,843 | |||||
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Net goodwill, end of period | $ | 446,696 | $ | 471,299 | ||||
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Accumulated impairment loss, end of period | $ | 22,600 | $ | — | ||||
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Goodwill for certain of the Company’s foreign subsidiaries is recorded in their functional currency, which is their local currency, and therefore is subject to foreign currency translation adjustments.
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PDRI Impairment Loss
As disclosed in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, the Company was beginning to see the effects of the US Federal government’s budget constraints in the financial results of PDRI, which is a reporting unit included in the CEB reportable segment. Based on insights gained from business activities that align with the US Federal government’s September 30th fiscal year-end and PDRI’s results of operations for the quarter ended September 30, 2013, the Company now believes that near to mid-term revenues for the PDRI reporting unit are likely to be constrained leading to lower revenues and cash flows. Based on these indicators of impairment, which also include rising interest rates, management concluded it was not more likely than not that the fair value of the PDRI reporting unit exceeded its carrying value at September 30, 2013. Accordingly, the Company completed an interim step one impairment analysis which indicated that the estimated fair value of the reporting unit did not exceed the carrying value. Consequently, the Company completed the second step of the impairment analysis which resulted in a $22.6 million after-tax goodwill impairment loss. This loss did not impact the Company’s current liquidity position or cash flows for 2013. Following the impairment, the PDRI reporting unit has $31.0 million of goodwill.
Management used the income approach (discounted cash flow model) to estimate the fair value of the reporting unit. The assumptions used in the income approach include revenue projections, EBITDA projections, estimated income tax rates, estimated capital expenditures, and an assumed discount rate based on various inputs. The assumptions which have the most significant effect on the determination of fair value are: 1) the projected revenues which include estimates for growth in future periods from expansion into other markets, 2) the projected cash flows which are driven by the revenue estimates and estimates of improved EBITDA margins in the future forecast period, and 3) the discount rate. Management, in conjunction with its valuation advisors, determined that due to the small size and specialized nature of the PDRI reporting unit, there was not sufficient comparable market data upon which to rely for purposes of establishing fair value of the reporting unit; however, management did consider comparable companies as a test of reasonableness for the estimate of fair value.
Under the income approach, management used internally generated projected financial information which included revenue growth rates that consider the Company’s plan for the expansion of PDRI into the commercial market. The near to mid-term EBITDA margins are also estimated to increase each year over the forecast period. The assumed discount rate utilized was 15.5%. The assumed discount rate includes consideration for the risks associated with the revenue growth and EBITDA margin improvement assumptions in the forecast period.
If all assumptions are held constant, a one percentage point increase in the discount rate would result in an approximately $4 million decrease in the estimated fair value of the reporting unit, primarily impacting goodwill. Assessing fair value includes, among other things, making key assumptions for estimating future cash flows and revenues. These assumptions are subject to a high degree of judgment and complexity. The Company makes every effort to estimate operating results as accurately as possible with the information available at the time the forecast is developed. However, changes in assumptions and estimates may affect the estimated fair value of the reporting unit and could result in an impairment in future periods. If PDRI is not successful in selling its services commercially, or if the US Federal government spending cuts are deeper than currently anticipated, updated estimates of operating results could result in future impairment.
SHL Indicators of Impairment
In the three months ended September 30, 2013, the Company identified interim indicators of impairment for the SHL reporting unit, including lower revenue and profits than had been anticipated at the time of the acquisition and rising interest rates. Upon identification of the interim impairment indicators, management completed step one of the interim impairment analysis. The carrying value was approximately $600 million at September 30, 2013, including approximately $375 million of goodwill and approximately $269 million of amortizable intangible assets. The estimated fair value of the SHL reporting unit exceeded its carrying value by approximately 1%. The estimate of fair value is based on information available as of the date of the assessment, which incorporates management assumptions about expected revenue and future cash flows and available market information for comparable companies.
The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment and estimates as the SHL reporting unit operates in a number of markets and geographical regions. Management used a combination of the income and market approaches and weighted the outcomes. The assumptions used in the income approach include revenue projections, EBITDA projections, estimated income tax rates, estimated capital expenditures, and an assumed discount rate based on various inputs. The assumptions used in the market approach include the selection of comparable companies which are subject to change based on the economic characteristics of the Company’s reporting units. The assumptions which have the most significant effect on the determination of fair value are: 1) the projected revenues which include accelerated revenue growth during the forecast period from recent initiatives undertaken to improve the effectiveness of sales operations, 2) the projected cash flows which reflect improvement in EBITDA margin from ongoing integration efforts, 3) the discount rate, and 4) the list of comparable companies used in the market approach.
Under the income approach, management used internally generated projected financial information which included revenue growth rates which reflect recent investments in the sales operations structure. The near to mid-term EBITDA margins are also estimated to increase each year over the forecast period. The assumed discount rate utilized was 13.0%. The assumed discount rate includes consideration for the risks associated with the revenue growth and EBITDA margin improvement assumptions in the forecast period.
Under the market approach, management used an average of revenue and EBITDA multiples. The revenue multiples utilized by the Company were in a range of 2.75 to 3.25 times current and future period revenue estimates. The EBITDA multiples utilized were in a range of 10 to 12 times current and future period EBITDA estimates.
If all assumptions are held constant, a one percentage point increase in the discount rate would result in an approximately $26 million decrease in the estimated fair value of the reporting unit. A 5.0% decrease in the selected market multiples would result in a $15 million decrease in the estimated fair value of the reporting unit. Such a change in either of these assumptions individually would result in the reporting unit failing step 1 of the goodwill impairment analysis.
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Assessing the fair value of the reporting unit includes, among other things, making key assumptions for estimating future cash flows and appropriate market multiples. The Company makes every effort to estimate future cash flows as accurately as possible with the information available at the time the forecast is developed. However, there can be no assurances that the estimates and assumptions will prove to be accurate predictions of future results. Changes in assumptions and estimates may affect the estimated fair value of the reporting unit and could result in an impairment in future periods. Factors that have the potential to create variances in the estimated fair value of the reporting unit include, but are not limited to, the following:
• | significant underperformance relative to expected historical or projected future operating results; |
• | significant change in the manner of use of the acquired asset or the strategy for the overall business; |
• | significant change in interest rates; |
• | significant negative industry or economic trend; and/or |
• | market capitalization relative to net book value. |
Note 7. Intangible Assets, net
Intangible assets, net at September 30, 2013 consist of the following (in thousands):
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Weighted-Average Amortization Period (in years) | |||||||||||||
Customer relationships | $ | 193,636 | $ | 24,789 | $ | 168,847 | 12.2 | |||||||||
Acquired intellectual property | 97,080 | 16,294 | 80,786 | 13.7 | ||||||||||||
Trade names | 64,823 | 6,598 | 58,225 | 13.4 | ||||||||||||
Software | 11,044 | 5,354 | 5,690 | 1.7 | ||||||||||||
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Total | $ | 366,583 | $ | 53,035 | $ | 313,548 | 12.6 | |||||||||
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Intangible assets, net at December 31, 2012 consist of the following (in thousands):
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Weighted-Average Amortization Period (in years) | |||||||||||||
Customer relationships | $ | 191,348 | $ | 12,731 | $ | 178,617 | 12.8 | |||||||||
Acquired intellectual property | 95,012 | 7,984 | 87,028 | 14.4 | ||||||||||||
Trade names | 64,082 | 2,910 | 61,172 | 14.1 | ||||||||||||
Software | 10,877 | 2,503 | 8,374 | 2.4 | ||||||||||||
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Total | $ | 361,319 | $ | 26,128 | $ | 335,191 | 13.2 | |||||||||
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The Company’s intangible assets for certain of its foreign subsidiaries are recorded in their functional currency, which is their local currency, and therefore are subject to foreign currency translation adjustments. As part of the interim impairment test for PDRI, the Company completed a recoverability test related to the amortizable intangible assets of PDRI and no adjustment was required.
Amortization expense was $8.7 million and $6.4 million in the three months ended September 30, 2013 and 2012, respectively. Amortization expense was $26.1 million and $9.3 million in the nine months ended September 30, 2013 and 2012, respectively. Future expected amortization of intangible assets at September 30, 2013 is as follows (in thousands):
2013 (1) | $ | 9,070 | ||
2014 | 34,324 | |||
2015 | 31,485 | |||
2016 | 28,379 | |||
2017 | 27,754 | |||
Thereafter | 182,536 | |||
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Total | $ | 313,548 | ||
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(1) | For the three months ended December 31, 2013 |
Note 8. Other Liabilities
Other liabilities consist of the following (in thousands):
September 30, 2013 | December 31, 2012 | |||||||
Deferred compensation | $ | 15,238 | $ | 12,397 | ||||
Lease incentives | 33,823 | 28,816 | ||||||
Deferred rent benefit | 32,738 | 28,351 | ||||||
Deferred revenue – long term | 11,676 | 10,523 | ||||||
Other | 18,456 | 18,554 | ||||||
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Total other liabilities | $ | 111,931 | $ | 98,641 | ||||
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Note 9. Senior Secured Credit Facilities
On July 2, 2012, the Company, together with certain of its subsidiaries acting as guarantors, entered into a senior secured credit agreement which was subsequently amended and restated on July 18, 2012, on August 1, 2012, and again on August 2, 2013 (as amended and restated, the “Credit Agreement”). The Credit Agreement originally provided for (i) a term loan A in an aggregate principal amount of $275 million (the “Term Loan A Facility”), (ii) a term loan B in an aggregate principal amount of $250 million (the “Term Loan B Facility” and together with the Term Loan A Facility, the “Term Facilities”) and (iii) a $100 million revolving credit facility (the “Revolving Credit Facility” and together with the Term Facilities, the “Senior Secured Credit Facilities”). The Term Loan A Facility and the Revolving Credit Facility were scheduled to mature on August 2, 2017 and the Term Loan B Facility was scheduled to mature on August 2, 2019.
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On August 2, 2012, in connection with the closing of the SHL acquisition, the full amounts of the Term Loan A Facility and the Term Loan B Facility were drawn and $30 million under the Revolving Credit Facility was drawn. In addition, approximately $6 million of availability under the Revolving Credit Facility was used to cover letters of credit that were issued to replace similar letters of credit previously issued under the Company’s prior senior unsecured credit facility which was terminated concurrently with the drawings under the Senior Secured Credit Facilities. The Company repaid $10 million of the principal amount outstanding under the Revolving Credit Facility in December 2012 and the remaining outstanding amount of $20 million in January 2013.
On August 2, 2013, the Company, together with certain of its subsidiaries acting as guarantors, entered into Amendment No. 3 (the “Amendment”) to the Credit Agreement. The Amendment (i) replaced the existing term A loans with new refinancing term A-1 loans (the “Refinancing Term A-1 Loans”) in an aggregate principal amount of $269.6 million, which was fully drawn on August 2, 2013, (ii) established a new tranche of incremental term A-1 loans (the “Incremental Term A-1 Loans” and together with the Refinancing Term A-1 Loans, the “Term A-1 Loans”) in an aggregate principal amount of $253.8 million, which was fully drawn on August 2, 2013, and (iii) increased the existing revolving commitments with new tranche A revolving commitments (the “Tranche A Revolving Commitments” and the loans thereunder, the “Tranche A Revolving Loans”) in an aggregate principal amount of $100 million for a total aggregate principal amount of $200 million, none of which was drawn in connection with the closing of the Amendment.
Amounts drawn under the Refinancing Term A-1 Loan tranche were used to prepay and terminate the Company’s existing Term Loan A Facility. Amounts drawn under the Incremental Term A-1 Loan tranche were used to prepay and terminate the Company’s existing Term Loan B Facility and pay transaction related fees and expenses.
The maturity date of all Term A-1 Loans is August 2, 2018. The principal amount of the Term A-1 Loans amortizes in quarterly installments equal to (i) for the first two years after the closing of the Amendment, approximately 2% of the original principal amount of the Term A-1 Loans and (ii) for the next three years thereafter, approximately 4% of the original principal amount of the Term A-1 Loans, with the balance payable at maturity. The termination date of all revolving commitments under the credit agreement, including the new Tranche A Revolving Commitments, is August 2, 2018. The Term A-1 Loans and Tranche A Revolving Loans will, at the option of the Company, bear interest at the Eurodollar Rate plus 2.25% or a base rate plus 1.25%, as applicable, with future “step-downs” upon achievement of specified first lien net leverage ratios. The annual interest rate on the Term A-1 Loans was 2.43% at September 30, 2013.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants, and events of default. The Company is required to comply with a net leverage ratio covenant on a quarterly basis. Mandatory prepayments attributable to excess cash flows will be based on the Company’s net leverage ratio and will be determined at the end of each fiscal year, beginning with the year ended December 31, 2013. Pursuant to the Amendment, a net leverage ratio of 2.0x or higher will trigger mandatory prepayments of 25% and a net leverage ratio of 2.5x or higher will trigger mandatory prepayments of 50% of excess cash flows. The Company currently does not believe that any mandatory prepayments will be required for the year ended December 31, 2013. In the event actual results or changes in estimates trigger the mandatory prepayment, such prepayment amount will be reclassified from long-term debt to current debt in the Company’s accompanying condensed consolidated balance sheets. The Company was in compliance with all of the covenants at September 30, 2013.
Certain investors of the Term Loan A Facility and the Term Loan B Facility reinvested in the Term A-1 Loans and the change in the present value of future cash flows between the investments was less than 10%. Accordingly, the Company accounted for this refinancing event for these investors as a debt modification. Certain investors of the Term Loan A Facility and the Term Loan B Facility either did not invest in the Term A-1 Loans or the change in the present value of future cash flows between the investments was greater than 10%. Accordingly, the Company accounted for this refinancing event for these investors as a debt extinguishment. The Tranche A Revolving Loans were accounted for as a modification as the borrowing capacity of the new arrangement was greater than the borrowing capacity of the old arrangement and there was no change to the investors. In applying debt modification accounting in the three months ended September 30, 2013, the Company recorded $12.9 million in loan origination fees and deferred financing costs, of which $10.6 million related to investors of the Term Facilities that reinvested in the Term A-1 Loans and the Revolving Credit Facility and $2.3 million related to costs associated with the refinancing. This amount is being amortized into interest expense over the term of the Term A-1 Loans using the effective interest method. In addition, the Company recorded $6.7 million in debt extinguishment costs, comprised of a $4.9 million write-off of loan origination fees and deferred financing fees for debt considered to be extinguished and $1.8 million of debt modification expense.
Total amortization expense of loan origination fees and deferred financing costs was $0.7 million and $2.3 million in the three and nine months ended September 30, 2013 and $0.5 million in the three and nine months ended September 30, 2012, respectively. The Company paid interest of $5.4 million and $16.2 million in the three and nine months ended September 30, 2013 and $2.6 million in the three and nine months ended September 30, 2012, respectively.
The future minimum payments for the Term A-1 Loans are as follows for the years ended December 31st (in thousands):
2013 (1) | $ | 2,687 | ||
2014 | 10,750 | |||
2015 | 15,750 | |||
2016 | 20,750 | |||
2017 | 20,750 | |||
2018 | 450,000 | |||
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Total principal payments | $ | 520,687 | ||
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(1) | For the three months ended December 31, 2013. |
The Company believes the carrying value of its long term debt approximates its fair value as the terms and interest rates approximate market rates.
Note 10. Stockholders’ Equity and Share-Based Compensation
Share-Based Compensation
Share-based compensation expense is recognized on a straight-line basis, net of an estimated forfeiture rate, for those shares expected to vest over the requisite service period of the award, which is generally the vesting term of four years. Forfeitures are estimated at the time of grant and adjusted, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The forfeiture rate is based on historical experience.
The Company recognized total share-based compensation costs of $3.3 million and $2.5 million in the three months ended September 30, 2013 and 2012, respectively, and $9.1 million and $6.7 million in the nine months ended September 30, 2013 and 2012, respectively. At September 30, 2013, $30.7 million of total estimated unrecognized share-based compensation cost is expected to be recognized over a weighted-average period of approximately 1.5 years.
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Restricted Stock Units
The following table summarizes the changes in RSUs:
Nine Months Ended September 30, 2013 | ||||||||
Number of RSUs | Weighted Average Grant Date Fair Value | |||||||
Non-vested, beginning of year | 788,725 | $ | 34.34 | |||||
Granted | 319,709 | 56.63 | ||||||
Forfeited | (31,931 | ) | 46.05 | |||||
Vested | (311,206 | ) | 28.94 | |||||
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Non-vested, end of period | 765,297 | $ | 46.58 | |||||
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Performance Based Stock Awards
CEB grants performance based restricted stock units (“PSAs”) to certain members of the corporate leadership team. The ultimate number of PSAs that will vest is based upon the achievement of specified levels of revenue and Adjusted EBITDA during the three-year period beginning on January 1st of the year of grant and ending on December 31st of the third calendar year following the date of grant. Vesting is also subject to continued employment through the end of the performance period.
The following table summarizes the changes in PSAs:
Nine Months Ended September 30, 2013 | ||||||||
Number of PSAs | Weighted Average Grant Date Fair Value | |||||||
Non-vested, beginning of year | 32,834 | $ | 41.87 | |||||
Granted | 27,805 | 56.15 | ||||||
Forfeited | — | — | ||||||
Vested | — | — | ||||||
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Non-vested, end of period | 60,639 | $ | 48.62 | |||||
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Dividends
On July 26, 2013, the Board of Directors declared a third quarter cash dividend of $0.225 per share. This dividend, totaling $7.5 million, was paid on September 30, 2013.
On November 7, 2013, the Board of Directors declared a fourth quarter cash dividend of $0.225 per share. The dividend is payable on December 31, 2013 to stockholders of record at the close of business on December 13, 2013. The Company funds its dividend payments with cash on hand and cash generated from operations.
Share Repurchases
In February 2013, the Company’s Board of Directors approved a $50 million stock repurchase program which is authorized through December 31, 2014. Repurchases may be made through open market purchases or privately negotiated transactions. The timing of repurchases and the exact number of shares of common stock to be repurchased will be determined by the Company’s management, in its discretion, and will depend upon market conditions and other factors. The program will be funded using cash on hand and cash generated from operations. The Company repurchased 48,100 shares for an aggregate purchase price of $2.8 million in the nine months ended September 30, 2013.
Note 11. Derivative Instruments and Hedging Activities
The Company’s international operations are subject to risks related to currency exchange fluctuations. Prices for the CEB segment’s products and services are denominated primarily in United States dollars (“USD”), including products and services sold to members that are located outside the United States. Many of the costs associated with the CEB segment operations located outside the United States are denominated in local currencies. As a consequence, increases in local currencies against the USD in countries where the CEB segment has foreign operations would result in higher effective operating costs and reduced earnings. The Company uses forward contracts, designated as cash flow hedging instruments, to protect against foreign currency exchange rate risks inherent with its cost reimbursement agreements with its UK subsidiary. A forward contract obligates the Company to exchange a predetermined amount of USD to make equivalent British pound sterling (“GBP”) payments equal to the value of such exchanges.
On September 27, 2013, the Company entered into an interest rate swap arrangement with a notional amount of $55 million which amortizes to $46.4 million through the August 2, 2018 maturity date of the Term A-1 Loans. The interest rate swap will effectively fix the Company’s interest payments on the hedged debt at 1.345% plus the credit spread on the debt. In October 2013, the Company entered into additional swap arrangements with a total notional amount of $220 million and similar terms to the $55 million swap entered into in September 2013. The arrangements, designated as cash flow hedging instruments, protect against adverse fluctuations in interest rates by reducing the Company’s exposure to variability in cash flows relating to interest payments on a portion of its outstanding debt.
The Company formally documents all relationships between hedging instruments and hedged items as well as its risk management objective and strategy for undertaking hedge transactions. The maximum length of time over which the Company is hedging its exposure to the variability in future cash flows related to foreign currency exchange rate risks is 12 months. The forward contracts and interest rate swap are recognized on the condensed consolidated balance sheets at fair value and changes in fair value measurements are reflected as adjustments to other comprehensive income (“OCI”). For the forward currency contracts, the unrealized gain/loss is reclassified from accumulated OCI to current earnings at such time as the actual foreign currency expenditures are made. There is generally no or an immaterial amount of ineffectiveness. The notional amount of outstanding forward currency contracts was 8.0 million GBP and 10.4 million GBP at September 30, 2013 and December 31, 2012.
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The fair value of derivative instruments on the Company’s condensed consolidated balance sheets are as follows (in thousands):
Balance Sheet Location | September 30, 2013 | December 31, 2012 | ||||||
Derivatives designated as hedging instruments: | ||||||||
Asset derivatives | ||||||||
Prepaid expenses and other current assets | $ | 590 | $ | 111 | ||||
Liability derivatives | ||||||||
Accounts payable and accrued liabilities | $ | 144 | $ | — | ||||
Derivatives not designated as hedging instruments: | ||||||||
Asset derivatives | ||||||||
Prepaid expenses and other current assets | $ | — | $ | 14 | ||||
Liability derivatives | ||||||||
Accounts payable and accrued expenses | $ | — | $ | 9 |
The pre-tax effect of the derivative instruments on the Company’s condensed consolidated statements of income (loss) is as follows (in thousands):
Location of Gain (Loss) (Effective portion) | Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective portion) | Derivatives in Cash Flow Hedging Relationships | Amount of Gain (Loss) Recognized in OCI on Derivative (Effective portion) | |||||||||||||||
Three Months Ended September 30, 2013 | Nine Months Ended September 30, 2013 | Three Months Ended September 30, 2013 | Nine Months Ended September 30, 2013 | |||||||||||||||
Cost of services | $ | 81 | (209 | ) | Forward currency contracts | $ | 940 | $ | (67 | ) | ||||||||
Member relations and marketing | 67 | (173 | ) | Interest rate swap | $ | (144 | ) | $ | (144 | ) | ||||||||
General & administrative | 32 | (84 | ) | |||||||||||||||
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Total | $ | 180 | (466 | ) | ||||||||||||||
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Location of Gain (Loss) (Effective portion) | Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective portion) | Derivatives in Cash Flow Hedging Relationships | Amount of Gain (Loss) Recognized in OCI on Derivative (Effective portion) | |||||||||||||||
Three Months Ended September 30, 2012 | Nine Months Ended September 30, 2012 | Three Months Ended September 30, 2012 | Nine Months Ended September 30, 2012 | |||||||||||||||
Cost of services | $ | 91 | $ | 136 | Forward currency contracts | $ | 361 | $ | 701 | |||||||||
Member relations and marketing | 75 | 113 | Interest rate swap | $ | — | $ | — | |||||||||||
General & administrative | 36 | 54 | ||||||||||||||||
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Total | $ | 202 | $ | 303 | ||||||||||||||
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Note 12. Income Taxes
The Company computes its provision for income taxes by applying the estimated annual effective tax rate to income from operations and adjusts the provision for discrete tax items recorded during the period. US income taxes are not provided for the undistributed earnings of the Company’s foreign subsidiaries including SHL, as such earnings are deemed to be permanently reinvested locally.
The effective tax rate for the nine months ended September 30, 2013 and 2012 was 39.2% and 47.2%, respectively. The decrease in the effective tax rate is largely due to a reduction in the UK tax rate, offset by the impact of the PDRI goodwill impairment loss, and the tax impact in 2012 of certain items arising from the SHL acquisition. In July 2013, the UK Finance Act of 2013 received royal assent leading to a scheduled reduction in the UK corporation tax rate to 20% by April 1, 2015. The impact of this legislative change on the Company’s net deferred tax liabilities was $4.6 million and was accounted for as a discrete item in the three months ended September 30, 2013. The $22.6 million impairment loss of non-deductible goodwill related to PDRI recognized in the three months ended September 30, 2013 was not treated as a discrete event; rather, it was considered to be a component of the estimated annual effective tax rate.
The Company made income tax payments of $10.5 million and $16.2 million in the three months ended September 30, 2013 and 2012, respectively, and $36.8 million and $27.6 million in the nine months ended September 30, 2013 and 2012, respectively. The Company had prepaid income taxes of approximately $17 million at September 30, 2013, which is included in Prepaid expenses and other current assets on the consolidated balance sheet.
The Internal Revenue Service commenced an examination of the Company’s US income tax returns for 2008 through 2010 in the second quarter of 2012. Management does not currently believe that the outcome of such examination will have a material adverse effect on the Company’s financial position, results of operations, or cash flows.
Note 13. Earnings per Share
A reconciliation of basic to diluted weighted average common shares outstanding is as follows (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Basic weighted average common shares outstanding | 33,597 | 33,546 | 33,519 | 33,460 | ||||||||||||
Effect of dilutive common shares outstanding | 336 | 317 | 380 | 349 | ||||||||||||
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Diluted weighted average common shares outstanding | 33,933 | 33,863 | 33,899 | 33,809 | ||||||||||||
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Approximately 0.3 million and 0.7 million shares in the three months ended September 30, 2013 and 2012, respectively, and approximately 0.4 million and 0.9 million shares in the nine months ended September 30, 2013 and 2012, respectively, have been excluded from the calculation of the dilutive effect shown above because their impact would be anti-dilutive. These shares related to share-based compensation awards.
Note 14. Commitments and Contingencies
Operating Leases
The Company leases office facilities that expire on various dates through 2028. Generally, the leases carry renewal provisions and rental escalations and require the Company to pay executory costs such as taxes and insurance. Future minimum rental payments under non-cancelable operating leases and future minimum receipts under subleases, excluding executory costs, are as follows at September 30, 2013:
Total | 2013* | YE 2014 | YE 2015 | YE 2016 | YE 2017 | Thereafter | ||||||||||||||||||||||
Operating lease obligations | $ | 614,725 | $ | 11,433 | $ | 49,523 | $ | 49,393 | $ | 49,570 | $ | 47,347 | $ | 407,459 | ||||||||||||||
Sublease receipts | (287,226 | ) | (3,569 | ) | (17,521 | ) | (20,171 | ) | (20,653 | ) | (21,597 | ) | (203,715 | ) | ||||||||||||||
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Total net lease obligations | $ | 327,499 | $ | 7,864 | $ | 32,002 | $ | 29,222 | $ | 28,917 | $ | 25,750 | $ | 203,744 | ||||||||||||||
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* | For the three months ended December 31, 2013. |
In September 2013, one of the subtenants of the CEB headquarters exercised its right under the sublease to acquire additional office space of approximately 32,000 square feet. This expansion period begins in October 2014 and will co-terminate with the subtenants other sub-leases in January 2028. The Company will receive an additional $21.5 million over the duration of the sublease.
Contingencies
From time to time, the Company is subject to litigation related to normal business operations. The Company vigorously defends itself in litigation and is not currently a party to, and the Company’s property is not subject to, any legal proceedings likely to materially affect the Company’s financial results.
The Company continues to evaluate potential tax exposures relating to sales and use, payroll, income and property tax laws, and regulations for various states in which the Company sells or supports its goods and services. Accruals for potential contingencies are recorded by the Company when it is probable that a liability has been incurred and the liability can be reasonably estimated. As additional information becomes available, changes in the estimates of the liability are reported in the period that those changes occur. The Company had a $5.8 million liability at both September 30, 2013 and December 31, 2012, respectively, relating to certain sales and use tax regulations for states in which the Company sells or supports its goods and services. The liability includes $2.6 million recorded in the purchase price allocation for SHL.
Note 15. Changes in Accumulated Elements of Other Comprehensive Income
Accumulated elements of other comprehensive income (“AOCI”) is included in the stockholders’ equity section of the condensed consolidated balance sheets. It is comprised of items that have not been recognized in earnings but may be recognized in earnings in the future when certain events occur. Changes in each component of AOCI are as follows (in thousands):
Three Months Ended September 30, 2013 | Cash Flow Hedges, Net of Tax | Foreign Currency Translation Adjustments | Total | |||||||||
Balance, June 30, 2013 | $ | (169 | ) | $ | (10,496 | ) | $ | (10,665 | ) | |||
Net unrealized gains | 478 | — | 478 | |||||||||
Reclassification of gains into earnings | (109 | ) | — | (109 | ) | |||||||
Net translation of investments in foreign operations | — | 25,331 | 25,331 | |||||||||
Net translation of intra-entity loans | — | 14,583 | 14,583 | |||||||||
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Net change in Accumulated elements of other comprehensive income | 369 | 39,914 | 40,283 | |||||||||
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Balance, September 30, 2013 | $ | 200 | $ | 29,418 | $ | 29,618 | ||||||
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Nine Months Ended September 30, 2013 | Cash Flow Hedges, Net of Tax | Foreign Currency Translation Adjustments | Total | |||||||||
Balance, December 31, 2012 | $ | 48 | $ | 27,617 | $ | 27,665 | ||||||
Net unrealized gains | (126 | ) | — | (126 | ) | |||||||
Reclassification of gains into earnings | 278 | — | 278 | |||||||||
Net translation of investments in foreign operations | — | 77 | 77 | |||||||||
Net translation of intra-entity loans | — | 1,724 | 1,724 | |||||||||
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Net change in Accumulated elements of other comprehensive income | 152 | 1,801 | 1,953 | |||||||||
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Balance, September 30, 2013 | $ | 200 | $ | 29,418 | $ | 29,618 | ||||||
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The translation impact of the intra-entity loans included in AOCI relates to those intercompany loans which the Company deems to be of a long-term investment nature.
Note 16. Segment Information
The Company manages the business in two reportable segments: CEB and SHL Talent Measurement Solutions.
The CEB segment, which includes the Company’s historical business operations prior to the SHL acquisition, provides comprehensive data analysis, research, and advisory services that align to executive leadership roles and key recurring decisions. CEB’s products and services focus on several key corporate functions across a wide range of industries. The CEB segment also includes the operations of PDRI, a service provider of customized personnel assessment tools and services to various agencies of the US government.
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The SHL Talent Measurement Solutions segment, which includes the operations of SHL (other than PDRI) that the Company acquired on August 2, 2012, provides cloud-based solutions for talent assessment and decision support as well as professional services that support those solutions, enabling client access to data, analytics and insights for assessing and managing employees and applicants. SHL Talent Measurement Solutions provides assessments that assist customers in determining potential candidates for employment and career planning as well as consulting services that are customizations to the assessments.
Management evaluates the performance of its operating segments based on segment Adjusted revenue, segment Adjusted EBITDA, and segment Adjusted EBITDA margin. The Company defines segment Adjusted revenue as segment revenue before the impact of the reduction of SHL Talent Measurement Solutions revenue recognized in the post-acquisition period to reflect the adjustment of deferred revenue at the SHL acquisition date to fair value. The Company defines segment Adjusted EBITDA as segment net income (loss) before loss from discontinued operations, net of provision for income taxes; interest expense, net; depreciation and amortization; provision for income taxes; the impact of the deferred revenue fair value adjustment; acquisition related costs; impairment loss; debt extinguishment costs; share-based compensation; costs associated with exit activities; restructuring costs; and gain on acquisition. Segment Adjusted EBITDA margin refers to segment Adjusted EBITDA as a percentage of segment Adjusted revenue.
Management uses these non-GAAP financial measures to evaluate and compare segment operating performance. These segment non-GAAP measures may be considered in addition to results prepared in accordance with GAAP, but they should not be considered a substitute for, or superior to, GAAP results.
Information for the Company’s reportable segments is as follows (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue | ||||||||||||||||
CEB segment | $ | 158,709 | $ | 144,217 | $ | 463,666 | $ | 408,402 | ||||||||
SHL Talent Measurement Solutions segment | 43,026 | 20,532 | 132,951 | 20,532 | ||||||||||||
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Total revenue | $ | 201,735 | $ | 164,749 | $ | 596,617 | $ | 428,934 | ||||||||
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Adjusted revenue | ||||||||||||||||
CEB segment | $ | 158,709 | $ | 144,217 | $ | 463,666 | $ | 408,402 | ||||||||
SHL Talent Measurement Solutions segment | 44,393 | 28,918 | 141,777 | 28,918 | ||||||||||||
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Total Adjusted revenue | $ | 203,102 | $ | 173,135 | $ | 605,443 | $ | 437,320 | ||||||||
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Adjusted EBITDA | ||||||||||||||||
CEB segment | $ | 45,014 | $ | 42,455 | $ | 124,879 | $ | 111,562 | ||||||||
SHL Talent Measurement Solutions segment | 5,125 | 7,991 | 23,483 | 7,991 | ||||||||||||
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Total Adjusted EBITDA | $ | 50,139 | $ | 50,446 | $ | 148,362 | $ | 119,553 | ||||||||
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Adjusted EBITDA margin | ||||||||||||||||
CEB segment | 28.4 | % | 29.4 | % | 26.9 | % | 27.3 | % | ||||||||
SHL Talent Measurement Solutions segment | 11.5 | 27.6 | 16.6 | 27.6 | ||||||||||||
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Total Adjusted EBITDA margin | 24.7 | % | 29.1 | % | 24.5 | % | 27.3 | % | ||||||||
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Depreciation and amortization | ||||||||||||||||
CEB segment | $ | 6,964 | $ | 6,055 | $ | 21,256 | $ | 17,020 | ||||||||
SHL Talent Measurement Solutions segment | 8,323 | 5,241 | 23,520 | 5,241 | ||||||||||||
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Total depreciation and amortization | $ | 15,287 | $ | 11,296 | $ | 44,776 | $ | 22,261 | ||||||||
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September 30, 2013 | December 31, 2012 | |||||||
Goodwill | ||||||||
CEB segment | $ | 71,625 | $ | 94,286 | ||||
SHL Talent Measurement Solutions segment | 375,071 | 377,013 | ||||||
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Total goodwill | $ | 446,696 | $ | 471,299 | ||||
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Total assets | ||||||||
CEB segment | $ | 497,852 | $ | 563,829 | ||||
SHL Talent Measurement Solutions segment | 772,359 | 758,420 | ||||||
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Total assets | $ | 1,270,211 | $ | 1,322,249 | ||||
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The following discussion includes forward-looking statements that involve certain risks and uncertainties. For additional information regarding forward-looking statements and risk factors, see “Forward-looking statements” and Part II, Item IA. “Risk Factors.”
Executive Overview
We deliver member-based advisory services, talent measurement assessments, and management solutions. We equip senior executives and their teams with essential information, actionable insights, analytical tools, and advisory support. Through our acquisition of SHL, we also provide cloud-based talent measurement and management solutions.
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Our acquisition of SHL, headquartered in the UK, significantly increased the breadth and geographic scope of our operations. As a result of the incurrence of substantial new indebtedness and the use of a significant amount of our cash on hand for the SHL acquisition in 2012, our financial condition differs significantly. Our operating results in 2013 will likely not be comparable to our operating results for prior periods and we are more exposed to foreign currency exchange rate fluctuations. Our business now consists of two reportable segments: CEB and SHL Talent Measurement Solutions.
CEB Segment
The CEB segment helps senior executives and their teams drive corporate performance by identifying and building on the proven best practices of the world’s best companies. We primarily deliver our products and services to a global client base through annual, fixed-fee membership subscriptions. Billings attributable to memberships for our CEB products and services initially are recorded as deferred revenue and then are generally recognized on a pro-rata basis over the membership contract term, which typically is 12 months. Generally, a member may request a refund of its membership fee during the membership term under our service guarantee. Refunds are provided from the date of the refund request on a pro-rata basis relative to the remaining term of the membership.
We offer comprehensive data analysis, research, and advisory services that align to executive leadership roles and key recurring decisions. To fully support our members, our products and services are offered across a wide range of industries and focus on several key corporate functions including: Finance, Corporate Services, and Corporate Strategy; Human Resources; Information Technology; Legal, Risk, and Compliance; and Sales, Marketing, and Communications.
In addition to these corporate functions, the CEB segment serves operational business leaders in the financial services industry and government agencies through insights, tools, and peer collaboration designed to drive effective executive decision making. The CEB segment also includes the results of operations of PDRI, a service provider of customized personnel assessment tools and services to various agencies of the US government and, beginning in 2013, the commercial sector.
SHL Talent Measurement Solutions Segment
The SHL Talent Measurement Solutions segment represents the acquired SHL business, excluding PDRI, and is a global provider of cloud-based solutions for talent assessment and decision support, enabling client access to data, analytics and insights for assessing and managing employees and applicants. SHL Talent Measurement Solutions primarily delivers assessments, consulting and training services. Assessment services are available online through metered and subscription arrangements. Consulting services are generally provided to customize assessment services and face to face assessments, delivered for a fixed fee. Training services consist of either bespoke or public courses related to use of assessments.
Non-GAAP Financial Measures
This Quarterly Report on Form 10-Q includes a discussion of Adjusted revenue, Adjusted EBITDA, Adjusted EBITDA margin, Adjusted net income, and Non-GAAP diluted earnings per share, all of which are non-GAAP financial measures provided as a complement to the results provided in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
The term “Adjusted revenue” refers to revenue before the impact of the reduction of SHL revenue recognized in the post-acquisition period to reflect the adjustment of deferred revenue at the SHL acquisition date to fair value (the “deferred revenue fair value adjustment”).
The term “Adjusted EBITDA” refers to net income before loss from discontinued operations, net of provision for income taxes; interest expense, net; depreciation and amortization; provision for income taxes; the impact of the deferred revenue fair value adjustment; acquisition related costs; impairment loss; debt extinguishment costs; share-based compensation; costs associated with exit activities; restructuring costs; and gain on acquisition.
The term “Adjusted EBITDA margin” refers to Adjusted EBITDA as a percentage of Adjusted revenue.
The term “Adjusted net income” refers to net income before loss from discontinued operations, net of provision for income taxes and excludes the after tax effects of the impact of the deferred revenue fair value adjustment; acquisition related costs; share-based compensation; impairment loss; debt extinguishment costs; amortization of acquisition related intangibles; costs associated with exit activities; restructuring costs; and gain on acquisition.
“Non-GAAP diluted earnings per share” refers to diluted earnings per share before the per share effect of loss from discontinued operations, net of provision for income taxes and excludes the after tax per share effects of the impact of the deferred revenue fair value adjustment; acquisition related costs; share-based compensation; impairment loss; debt extinguishment costs; amortization of acquisition related intangibles; costs associated with exit activities; restructuring costs; and gain on acquisition.
We believe that these non-GAAP financial measures are relevant and useful supplemental information for evaluating our results of operations as compared from period to period and as compared to our competitors. We use these non-GAAP financial measures for internal budgeting and other managerial purposes, including comparison against our competitors, when publicly providing our business outlook, and as a measurement for potential acquisitions. These non-GAAP financial measures are not defined in the same manner by all companies and therefore may not be comparable to other similarly titled measures used by other companies.
In connection with the SHL acquisition, we changed the definitions of our non-GAAP measures to adjust for the impact of the deferred revenue fair value adjustment to the opening balance sheet resulting from purchase accounting, amortization of related intangibles, acquisition related costs, and share-based compensation. This change was made to provide a more comprehensive understanding of our core operating results by eliminating the effect of acquisition related items from our GAAP operating results. The SHL acquisition was the first acquisition of sufficient size to cause these items to be significant. We believe that excluding these items is important in illustrating what our core operating results would have been had we not incurred these acquisition related items since the nature, size, and number of acquisitions can vary from period to period.
Our non-GAAP financial measures reflect adjustments based on the following items, as well as the related income tax effects:
• | Certain business combination accounting entries and expenses related to acquisitions: We have adjusted for the impact of the deferred revenue fair value adjustment, amortization of acquisition related intangibles, and acquisition related costs. We incurred significant expenses primarily in connection with our SHL acquisition and also incurred certain other operating expenses, which we generally would not have otherwise incurred in the periods presented as a part of our continuing operations. We believe that excluding these acquisition related items from our non-GAAP financial measures provides useful supplemental information to our investors and is important in illustrating what our core operating results would have been had we not incurred these acquisition related items since the nature, size, and number of acquisitions can vary from period to period. |
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• | Share-based compensation: Although share-based compensation is a key incentive offered to our employees, we evaluate our operating results excluding such expense. Accordingly, we exclude share-based compensation from our non-GAAP financial measures because we believe it provides valuable supplemental information that helps investors have a more complete understanding of our operating results. In addition, we believe the exclusion of this expense facilitates the ability of our investors to compare our operating results with those of other peer companies, many of which also exclude such expense in determining their non-GAAP measures, given varying valuation methodologies, subjective assumptions, and the variety and amount of award types that may be utilized. |
• | Impairment loss and debt extinguishment costs: We believe that excluding these items from our non-GAAP financial measures provides useful supplemental information to our investors and is important in illustrating what our core operating results would have been had we not incurred these items. We exclude these items because management does not believe they correlate to the ongoing operating results of the business. |
These non-GAAP measures may be considered in addition to results prepared in accordance with GAAP, but they should not be considered a substitute for, or superior to, GAAP results. We intend to continue to provide these non-GAAP financial measures as part of our future earnings discussions and, therefore, the inclusion of these non-GAAP financial measures will provide consistency in our financial reporting.
A reconciliation of each of the non-GAAP measures to the most directly comparable GAAP measure is provided below (in thousands).
The table below reconciles Revenue to Adjusted revenue (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue | $ | 201,735 | $ | 164,749 | $ | 596,617 | $ | 428,934 | ||||||||
Impact of deferred revenue fair value adjustment | 1,367 | 8,386 | 8,826 | 8,386 | ||||||||||||
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Adjusted revenue | $ | 203,102 | $ | 173,135 | $ | 605,443 | $ | 437,320 | ||||||||
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The table below reconciles Net (loss) income to Adjusted EBITDA (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net (loss) income | $ | (5,383 | ) | $ | (456 | ) | $ | 19,393 | $ | 29,869 | ||||||
Interest expense, net | 4,901 | 4,423 | 17,424 | 4,288 | ||||||||||||
Depreciation and amortization | 15,287 | 11,296 | 44,776 | 22,261 | ||||||||||||
Provision for income taxes | (2,612 | ) | 5,759 | 12,485 | 26,746 | |||||||||||
Impact of the deferred revenue fair value adjustment | 1,367 | 8,386 | 8,826 | 8,386 | ||||||||||||
Acquisition related costs | 4,022 | 18,557 | 7,044 | 21,286 | ||||||||||||
Impairment loss | 22,600 | — | 22,600 | — | ||||||||||||
Debt extinguishment costs | 6,691 | — | 6,691 | — | ||||||||||||
Share-based compensation | 3,266 | 2,481 | 9,123 | 6,717 | ||||||||||||
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Adjusted EBITDA | $ | 50,139 | $ | 50,446 | $ | 148,362 | $ | 119,553 | ||||||||
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Adjusted EBITDA margin | 24.7 | % | 29.1 | % | 24.5 | % | 27.3 | % | ||||||||
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The table below reconciles Net (loss) income to Adjusted net income (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Net (loss) income | $ | (5,383 | ) | $ | (456 | ) | $ | 19,393 | $ | 29,869 | ||||||
Impact of the deferred revenue fair value adjustment (1) | 1,088 | 6,105 | 6,398 | 6,105 | ||||||||||||
Acquisition related costs (1) | 2,624 | 14,604 | 4,582 | 16,227 | ||||||||||||
Impairment loss (2) | 18,401 | — | 18,401 | — | ||||||||||||
Debt extinguishment costs (1) | 4,001 | — | 4,001 | — | ||||||||||||
Share-based compensation (1) | 2,015 | 1,521 | 5,620 | 4,064 | ||||||||||||
Amortization of acquisition related intangibles (1) | 6,393 | 4,588 | 18,192 | 6,326 | ||||||||||||
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Adjusted net income | $ | 29,139 | $ | 26,362 | $ | 76,587 | $ | 62,591 | ||||||||
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The table below reconciles Diluted (loss) earnings per share to Non-GAAP diluted earnings per share:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Diluted (loss) earnings per share | $ | (0.16 | ) | $ | (0.01 | ) | $ | 0.57 | $ | 0.88 | ||||||
Impact of the deferred revenue fair value adjustment (1) | 0.03 | 0.18 | 0.19 | 0.18 | ||||||||||||
Acquisition related costs (1) | 0.08 | 0.43 | 0.13 | 0.48 | ||||||||||||
Impairment loss (2) | 0.54 | — | 0.54 | — | ||||||||||||
Debt extinguishment loss (1) | 0.12 | — | 0.12 | — | ||||||||||||
Share-based compensation (1) | 0.06 | 0.04 | 0.17 | 0.12 | ||||||||||||
Amortization of acquisition related intangibles (1) | 0.19 | 0.14 | 0.54 | 0.19 | ||||||||||||
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Non-GAAP diluted earnings per share | $ | 0.86 | $ | 0.78 | $ | 2.26 | $ | 1.85 | ||||||||
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(1) | Adjustments are net of the annual estimated income tax effect using statutory rates based on the relative amounts allocated to each jurisdiction. The following income tax rates were used: 28% in 2013 and 27% in 2012 for the deferred revenue fair value adjustment; 35% in 2013 and 25% in 2012 for acquisition related costs; 38% in 2013 and 39% in 2012 for share-based compensation; 40% in 2013 for debt extinguishment costs; and 32% in 2013 and 30% in 2012 for amortization of acquisition related intangibles. |
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(2) | The $22.6 million impairment loss of non-deductible goodwill related to PDRI recognized in the three months ended September 30, 2013 was not treated as a discrete event in the provision for income taxes; rather, it was considered to be a component of the estimated annual effective tax rate. As such, $4.8 million of the income tax effect associated with the non-deductible goodwill impairment loss was reflected in the income tax provision in the three and nine months ended September 30, 2013. The remaining tax effect of $4.2 million will be added back in the fourth quarter of 2013 to bring the full year adjustment to $22.6 million. |
Critical Accounting Policies
Our accounting policies require us to apply methodologies, estimates and judgments that have a significant impact on the results we report in our consolidated financial statements. In our 2012 Annual Report on Form 10-K, we discussed those material policies that we believe are critical and require the use of complex judgment in their application. There has been no significant changes to our critical accounting policies; however, the following is an update to our existing goodwill and intangible assets discussion included in our critical accounting policies:
Goodwill and Intangible Assets
Goodwill represents the purchase price of acquired businesses in excess of the fair market value of net assets acquired. Intangible assets include customer relationships, trade names, and software. We have a significant amount of goodwill and intangible assets on our balance sheet. We recognized approximately $412 million of goodwill and approximately $323 million of intangible assets from the SHL acquisition.
The potential for goodwill impairment is increased during a period of economic uncertainty. To the extent we acquire a company at a negotiated price that reflects, at least in part, anticipated future performance, subsequent market conditions may result in the acquired business performing at a lower level than was anticipated at the time of the acquisition. Any of these changes would reduce our operating results and could cause the market price of our common stock to decline. A slowing recovery or new recession in the United States, a slow recovery or further recession in Europe, and slowing growth in the global economy may result in declining performance that would require us to examine our goodwill for potential impairment.
We assess our goodwill for impairment at the reporting unit level. On a quarterly basis, we assess qualitative factors to determine whether the existence of events or circumstances leads to the determination that an indicator of impairment exists. These qualitative factors have been identified by management as the key performance indicators of each reporting unit. If, based on the assessment of the qualitative factors, an entity determines it is more-likely-than-not that the fair value of a reporting unit is does not exceed its carrying value, the entity would be required to perform the two-step impairment test. We test our goodwill for impairment annually on October 1st.
Factors we consider important that could trigger an interim impairment review include, but are not limited to, the following:
• | significant underperformance relative to expected historical or projected future operating results; |
• | significant change in the manner of our use of the acquired asset or the strategy for our overall business; |
• | significant change in prevailing interest rates; |
• | significant negative industry or economic trend; and/or |
• | market capitalization relative to net book value. |
If we determine, based on our quarterly assessment, that an impairment indicator exists, we complete the first step of the goodwill impairment process (“Step 1”). Step 1 is also completed during the annual goodwill impairment tests for each reporting unit, unless a reporting unit has significantly exceeded financial expectations and we believe it will continue to do so. Step 1 involves determining whether the estimated fair value of the reporting unit exceeds the respective book value. If the fair value exceeds the book value, goodwill of that reporting unit is not impaired. However, if the fair value does not exceed the book value of the reporting unit, goodwill may be impaired and additional analysis is required (“Step 2”). Step 2 of the goodwill impairment test compares the implied fair value of a reporting unit’s goodwill to its carrying value. The implied fair value of goodwill is derived by performing a hypothetical purchase price allocation for the reporting unit as of the measurement date, allocating the reporting unit’s estimated fair value to its assets and liabilities. The residual amount from performing this allocation represents the implied fair value of goodwill. To the extent this amount is below the carrying value of goodwill, an impairment loss is recorded.
In performing Step 1 of the goodwill impairment test, we compare the carrying amount of the reporting units to their estimated fair values. The estimated fair value of each reporting unit is calculated using one or both of the following: the income approach (discounted cash flows) and using market multiples derived from a set of competitors with comparable market characteristics (a market approach). The appropriate methodology is determined by management based on available information at the time of the test. In general, when both approaches are used, the estimated fair values are weighted. In general, the market approach is not weighted more than 50%.
The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment and estimates, as our businesses operate in a number of markets and geographical regions. The assumptions utilized in the evaluation of the impairment of goodwill under the market approach include the selection of comparable companies, which are subject to change based on the economic characteristics of our reporting units. The assumptions utilized in the evaluation of the impairment of goodwill under the income approach include revenue growth rates, cash flows, EBITDA, tax rates, capital expenditures, the weighted average cost of capital (“WACC”) and related discount rate, and expected long-term growth rates (residual growth rate). The assumptions which have the most significant effect on our valuations derived using a discounted cash flows methodology are: (1) revenue growth rate, (2) cash flow assumptions and (3) the discount rate. The assumptions utilized in the market approach include the selection of comparable companies, which are subject to change based on the economic characteristics of our reporting units. Revenue and EBITDA multiples for market comparable companies for the current and future fiscal periods are used to estimate the fair value of the reporting unit by applying those multiples to the projected financial information prepared by management.
The cash flows employed in the income approach are based on our most recent budgets, forecasts, and business plans as well as various growth rate assumptions for years beyond the current business plan period. Long-term growth rates represent the expected long-term growth rate for the Company, considering the industry in which we operate and the global economy. Discount rate assumptions are based on an assessment of the risk inherent in the future revenue streams and cash flows and our WACC. The risk adjusted discount rate used represents the estimated WACC for our reporting units. The discount rate is comprised of (1) a risk free rate of return, (2) an equity risk premium that is based on the rate of return on equity of publicly traded companies with business characteristics comparable to our reporting units, (3) the current after-tax market rate of return on debt of companies with business characteristics similar to our reporting units, each weighted by the relative market value percentages of our equity and debt, and (4) an appropriate Company specific risk premium.
2013 PDRI Interim Impairment Test
In the quarter ended June 30, 2013, we were beginning to see the impacts of the US Federal government budget constraints in the financial results of PDRI, which is a reporting unit included in the CEB reportable segment. Based on insights gained from business activities that align with the US Federal government’s September 30th fiscal year–end and PDRI’s results of operations for the quarter ended September 30, 2013, we now believe that near to mid-term revenues of the PDRI reporting unit are likely to be constrained leading to lower revenues and cash flows. Based on these indicators of impairment, which also include rising interest rates, we concluded it was not more likely than not that the fair value of the PDRI reporting unit exceeded its carrying value at September 30, 2013. Accordingly, we completed an interim Step 1 impairment analysis which indicated that the estimated fair value of the reporting unit determined did not exceed the carrying value. Consequently, we completed Step 2 of the interim impairment which resulted in a $22.6 million after-tax goodwill impairment loss. This loss did not impact our liquidity position or cash flows for 2013. Following the impairment, the PDRI reporting unit has $17.6 million of goodwill.
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We used the income approach (discounted cash flow model) to estimate the fair value of the reporting unit. The assumptions used in the income approach include revenue projections, EBITDA projections, estimated income tax rates, estimated capital expenditures, and an assumed discount rate based on various inputs. The assumptions which have the most significant effect on the determination of fair value are: 1) the projected revenues, which include estimates for growth in future periods from expansion into other markets, 2) the projected cash flows, which are driven by the revenue estimates and estimates of improved EBITDA margins in the future forecast period, and 3) the discount rate. In conjunction with our valuation advisors, we determined that due to the small size and specialized nature of the PDRI reporting unit, there was not sufficient comparable market data upon which to rely for purposes of establishing fair value of the reporting unit; however, we did consider comparable companies as a test of reasonableness for the estimate of fair value.
Under the income approach, we used a internally generated projected financial information which included revenue growth rates consider our plan for the expansion of PDRI into the commercial market. The near to mid-term EBITDA margins are also estimated to increase each year over the forecast period. The assumed discount rate utilized was 15.5%. The assumed discount rate includes consideration for the risks associated with the revenue growth and EBITDA margin improvement assumptions in the forecast period.
If all assumptions are held constant, a one percentage point increase in the discount rate would result in an approximately $4 million decrease in the estimated fair value of the reporting unit, primarily impacting goodwill. Assessing fair value includes, among other things, making key assumptions for estimating future cash flows and revenues. These assumptions are subject to a high degree of judgment and complexity. We make every effort to estimate operating results as accurately as possible with the information available at the time the forecast is developed. However, changes in assumptions and estimates may affect the estimated fair value of the reporting unit and could result in an impairment in future periods. If PDRI is not successful in selling its services commercially, or if the US Federal government spending cuts are deeper than currently anticipated, updated estimates of operating results could result in future impairment.
SHL Interim Impairment Test
In the three months ended September 30, 2013, we identified interim indicators of impairment for the SHL reporting unit, including lower revenue and profits than had been anticipated at the time of the acquisition and rising interest rates. Upon identification of the interim impairment indicators, we completed Step 1 of the interim impairment analysis. The carrying value of was approximately $600 million at September 30, 2013, including approximately $388 million of goodwill and $269 million of amortizable intangible assets. The estimated fair value of the SHL reporting unit exceeded its carrying value by approximately 1%. The estimate of fair value is based on the information available as of the date of the assessment, which incorporates management assumptions about expected revenue and future cash flows and available market information for comparable companies.
The process of evaluating the potential impairment of goodwill is highly subjective and requires significant judgment and estimates as the SHL reporting unit operates in a number of markets and geographical regions. We used a combination of the income and market approaches and weighted the outcomes. The assumptions used in the income approach include revenue projections, EBITDA projections, estimated income tax rates, estimated capital expenditures, and an assumed discount rate based on various inputs. The assumptions used in the market approach include the selection of the comparable companies which are subject to change based on the economic characteristics of our reporting units. The assumptions which have the most significant effect on the determination of fair value are: 1) the projected revenues which include accelerated revenue growth during the forecast period from recent initiatives undertaken to improve the effectiveness of sales operations, 2) the projected cash flows which reflect improvement in EBITDA margin from ongoing integration efforts, 3) the discount rate, and 4) the list of comparable companies used in the market approach.
Under the income approach, we used internally generated projected financial information which included revenue growth rates which reflect recent investments in the sales operations structure. The near to mid-term EBITDA margins are also estimated to increase each year over the forecast period. The assumed discount rate utilized was 13.0%. The assumed discount rate includes consideration for the risks associated with the revenue growth and EBITDA margin improvement assumptions in the forecast period.
Under the market approach, we used an average of revenue and EBITDA multiples. The revenue multiples utilized were in a range of 2.75 to 3.25 times current and future period revenue estimates. The EBITDA multiples utilized were in a range of 10 to 12 times current and future period EBITDA estimates.
Assessing the fair value of goodwill includes, among other things, making key assumptions for estimating future cash flows and appropriate market multiples. We make every effort to estimate future cash flows as accurately as possible with the information available at the time the forecast is developed. However, there can be no assurances that the estimates and assumptions will prove to be accurate predictions of future results. Changes in assumptions and estimates may affect the estimated fair value of the reporting unit and could result in an impairment in future periods.
2012 Iconoculture Interim Impairment Test
In the second quarter of 2012, we identified an indicator of a possible impairment of the carrying value of the Iconoculture reporting unit. Iconoculture sales bookings for the first six months of 2012 were lower than amounts previously estimated. Lower sales bookings may result in a decrease in revenue and cash flows from operations. The carrying value of the Iconoculture reporting unit was $13.7 million at June 30, 2012, including $11.5 million of goodwill and $4.5 million of intangible assets. We calculated the fair value of the reporting unit using a discounted cash flow model (income approach) for the subsequent five year period with a terminal value. We used a discount rate of 16% and current estimates of sales bookings and cash flows. The fair value the reporting unit exceeded its carrying value by approximately 4% at June 30, 2012 and by less than 1% at October 1, 2012.
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Consolidated Results of Operations
The following table presents an overview of our results of operations (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue | $ | 201,735 | $ | 164,749 | $ | 596,617 | $ | 428,934 | ||||||||
Costs and expenses: | ||||||||||||||||
Cost of services | 72,387 | 60,182 | 219,175 | 151,161 | ||||||||||||
Member relations and marketing | 60,481 | 46,966 | 174,377 | 123,707 | ||||||||||||
General and administrative | 21,213 | 19,102 | 71,683 | 51,226 | ||||||||||||
Acquisition related costs | 4,022 | 18,557 | 7,044 | 21,286 | ||||||||||||
Impairment loss | 22,600 | — | 22,600 | — | ||||||||||||
Depreciation and amortization | 15,287 | 11,296 | 44,776 | 22,261 | ||||||||||||
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Total costs and expenses | 195,990 | 156,103 | 539,655 | 369,641 | ||||||||||||
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Operating profit | 5,745 | 8,646 | 56,962 | 59,293 | ||||||||||||
Other (expense) income, net | ||||||||||||||||
Interest income and other | (2,093 | ) | 1,619 | (797 | ) | 2,549 | ||||||||||
Interest expense | (4,956 | ) | (4,692 | ) | (17,596 | ) | (5,227 | ) | ||||||||
Debt extinguishment costs | (6,691 | ) | — | (6,691 | ) | — | ||||||||||
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Total other (expense) income, net | (13,740 | ) | (3,343 | ) | (25,084 | ) | (2,678 | ) | ||||||||
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(Loss) income before provision for income taxes | (7,995 | ) | 5,303 | 31,878 | 56,615 | |||||||||||
Provision for income taxes | (2,612 | ) | 5,759 | 12,485 | 26,746 | |||||||||||
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Net (loss) income | $ | (5,383 | ) | $ | (456 | ) | $ | 19,393 | $ | 29,869 | ||||||
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Revenue was $201.7 million and $164.7 million in the three months ended September 30, 2013 and 2012, respectively. Revenue was $596.6 million and $428.9 million in the nine months ended September 30, 2013 and 2012, respectively. Total costs and expenses were $196.0 million and $156.1 million in the three months ended September 30, 2013 and 2012, respectively. Total costs and expenses were $539.7 million and $369.6 million in the nine months ended September 30, 2013 and 2012, respectively. Operating results include the impact of acquired companies from the date of acquisition: Valtera, Inc. (“Valtera”) was acquired on February 4, 2012 and SHL was acquired on August 2, 2012.
Adjusted revenue was $203.1 million and $173.1 million in the three months ended September 30, 2013 and 2012, respectively. Adjusted revenue was $605.4 million and $437.3 million in the nine months ended September 30, 2013 and 2012, respectively. Adjusted EBITDA was $50.1 million and $50.4 million in the three months ended September 30, 2013 and 2012, respectively. Adjusted EBITDA was $148.4 million and $119.6 million in the nine months ended September 30, 2013 and 2012, respectively. The increase in both Adjusted revenue and Adjusted EBITDA are a primarily a result of the acquisition of SHL in August 2012. Additionally, CEB segment revenue and Adjusted EBITDA has increased year over year.
See “Segment Results” below for a discussion of revenue and costs and expenses by segment.
Our operating costs and expenses consist of:
• | Cost of services, which represents the costs associated with the production and delivery of our services and products, consisting of compensation, including share-based compensation; internal and external product advisors; the organization and delivery of membership meetings, seminars, and other events; third-party consulting; ongoing product development costs; production of published materials, costs of developing and supporting our membership Web platform and digital delivery of services and products; and associated support services. |
• | Member relations and marketing, which represents the costs of acquiring new customers and the costs of account management, consisting of compensation, including sales incentives and share-based compensation; travel and related expenses; recruiting and training of personnel; sales and marketing materials; and associated support services, as well as the costs of maintaining our customer relationship management software. |
• | General and administrative, which represents the costs associated with the corporate and administrative functions, including human resources and recruiting, finance and accounting, legal, management information systems, facilities management, business development, and other. Costs include compensation, including share-based compensation; third-party consulting and compliance expenses; and associated support services. |
• | Acquisition related costs represent transaction and integration costs incurred in connection with acquisitions. |
• | Depreciation and amortization, consisting of amortization of intangible assets and depreciation of our property and equipment, including leasehold improvements, furniture, fixtures and equipment, capitalized software and website development costs. |
Other (Expense) Income, net
The following table presents the components of Other (expense) income, net (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Debt extinguishment costs | $ | (6,691 | ) | $ | — | $ | (6,691 | ) | $ | — | ||||||
Interest expense | (4,956 | ) | (4,962 | ) | (17,596 | ) | (5,227 | ) | ||||||||
Increase in fair value of deferred compensation plan assets | 784 | 609 | 1,409 | 1,360 | ||||||||||||
Foreign currency (loss) gain | (2,570 | ) | 201 | (2,634 | ) | (15 | ) | |||||||||
Interest income | 55 | 538 | 173 | 938 | ||||||||||||
Other | (362 | ) | 271 | 255 | 266 | |||||||||||
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Other (expense) income, net | $ | (13,740 | ) | $ | (3,343 | ) | $ | (25,084 | ) | $ | (2,678 | ) | ||||
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Debt extinguishment costs were a result of the August 2013 refinancing of our credit facility. The increase in interest expense reflects the costs of the borrowings incurred for the SHL acquisition as interest expense was incurred for the full nine months of 2013 compared to the period from August 2, 2012 through September 30, 2012. The foreign currency loss in three and nine months ended September 30, 2013 is primarily due to the remeasurement of cash held in USD by SHL.
Provision for Income Taxes
We compute our provision for income taxes by applying the estimated annual effective tax rate to income from operations and adjust the provision for discrete tax items recorded during the period. US income taxes are not provided for the undistributed earnings of our foreign subsidiaries including SHL, as such earnings are deemed to be permanently reinvested locally.
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The effective tax rate for the nine months ended September 30, 2013 and 2012 was 39.2% and 47.2%, respectively. The decrease in the effective tax rate is largely due to a reduction in the UK tax rate, offset by the impact of the PDRI goodwill impairment loss, and the tax impact in 2012 of certain items arising from the SHL acquisition. In July 2013, the UK Finance Act of 2013 received royal assent leading to a scheduled reduction in the UK corporation tax rate to 20% by April 1, 2015. The impact of this legislative change on our net deferred tax liabilities was $4.6 million and was accounted for as a discrete item in the three months ended September 30, 2013. The $22.6 million impairment loss of non-deductible goodwill related to PDRI recognized in the three months ended September 30, 2013 was not treated as a discrete event; rather, it was considered to be a component of the estimated annual effective tax rate. We currently anticipate that our 2013 effective tax rate will be approximately 47% not including any additional permanent book-tax differences that are not determinable at this time, such as future foreign currency translation gains or losses, or other discrete items that are currently not recognizable under US GAAP. Excluding the effect of the impairment loss, we anticipate that our 2013 effective tax rate will be approximately 34%.
We made income tax payments of $10.5 million and $16.2 million in the three months ended September 30, 2013 and 2012, respectively, and $36.8 million and $27.6 million in the nine months ended September 30, 2013 and 2012, respectively. We had prepaid income taxes of approximately $17 million at September 30, 2013, which is included in Prepaid expenses and other current assets on the consolidated balance sheet.
The Internal Revenue Service commenced an examination of our US income tax returns for 2008 through 2010 in the second quarter of 2012. Management does not currently believe that the outcome of such examination will have a material adverse effect on our financial position, results of operations, or cash flows.
Segment Results
CEB Segment Executive Overview
CEB has continued to perform well as noted by the 10.2% year over year Contract Value growth. We continue to attract new customers and have steadily grown the dollar investment per member institution. The solid performance at CEB was offset by the headwinds in the US government, most notably impacting PDRI.
Revenue was $158.7 million and $144.2 million in the three months ended September 30, 2013 and 2012, respectively. Revenue was $463.7 million and $408.4 million in the nine months ended September 30, 2013 and 2012, respectively. Adjusted EBITDA was $45.0 million and $42.5 million for the three months ended September 30, 2013 and 2012, respectively. Adjusted EBITDA was $124.9 million and $111.6 million for the nine months ended September 30, 2013 and 2012, respectively. The increase in Adjusted EBITDA is primarily due to an increase in revenue as noted by the increase in Contract Value and discussed in “CEB Segment Revenue” below.
Operating results include the impact of acquired companies from the date of acquisition: Valtera, Inc. (“Valtera”) was acquired on February 4, 2012 and PDRI was acquired on August 2, 2012. The three and nine months ended September 30, 2013 included $6.0 million and $19.1 million, respectively, of revenue from PDRI.
CEB Segment Operating Data
September 30, | ||||||||
2013 | 2012 | |||||||
CEB segment Contract Value (in thousands) (1) | $ | 575,878 | $ | 522,397 | ||||
CEB segment Member institutions | 6,336 | 5,944 | ||||||
CEB segment Contract Value per member institution | $ | 90,896 | $ | 87,844 | ||||
CEB segment Wallet retention rate (2) | 98 | % | 99 | % |
(1) | We define “CEB segment Contract Value” as the aggregate annualized revenue attributed to all agreements in effect at a given date without regard to the remaining duration of any such agreement. CEB segment Contract Value does not include the impact of PDRI. |
(2) | We define “CEB segment Wallet retention rate,” at the end of the quarter, as the total current year CEB segment Contract Value from prior year members as a percentage of the total prior year CEB segment Contract Value. The CEB segment Wallet retention rate does not include the impact of PDRI. |
CEB segment Contract Value increased $53.5 million, or 10.2%, at September 30, 2013 compared to September 30, 2012 primarily as a result of increased sales to new and existing large corporate members, and price increases.
CEB Segment Results of Operations
The financial results presented below include the results of operations for the CEB segment (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue | $ | 158,709 | $ | 144,217 | $ | 463,666 | $ | 408,402 | ||||||||
Costs and expenses: | ||||||||||||||||
Cost of services | 54,684 | 49,348 | 165,494 | 140,327 | ||||||||||||
Member relations and marketing | 44,367 | 40,070 | 130,129 | 116,811 | ||||||||||||
General and administrative | 16,929 | 15,898 | 51,677 | 48,022 | ||||||||||||
Acquisition related costs | 2,808 | 18,028 | 4,827 | 20,757 | ||||||||||||
Impairment loss | 22,600 | — | 22,600 | — | ||||||||||||
Depreciation and amortization | 6,964 | 6,055 | 21,256 | 17,020 | ||||||||||||
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Total costs and expenses | 148,352 | 129,399 | 395,983 | 342,937 | ||||||||||||
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Operating profit | 10,357 | 14,818 | 67,683 | 65,465 | ||||||||||||
Other (expense) income, net | ||||||||||||||||
Interest income and other | (466 | ) | 1,224 | 523 | 2,154 | |||||||||||
Interest expense | (4,956 | ) | (4,548 | ) | (17,596 | ) | (4,813 | ) | ||||||||
Debt extinguishment costs | (6,691 | ) | — | (6,691 | ) | — | ||||||||||
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Total other (expense) income, net | (12,113 | ) | (3,324 | ) | (23,764 | ) | (2,659 | ) | ||||||||
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(Loss) income before provision for income taxes | (1,756 | ) | 11,494 | 43,919 | 62,806 | |||||||||||
Provision for income taxes | 2,401 | 8,899 | 18,839 | 29,886 | ||||||||||||
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Net (loss) income | $ | (4,157 | ) | $ | 2,595 | $ | 25,080 | $ | 32,920 | |||||||
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Reconciliation of CEB segment net (loss) income to segment Adjusted EBITDA (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Segment net (loss) income | $ | (4,157 | ) | $ | 2,595 | $ | 25,080 | $ | 32,920 | |||||||
Interest expense, net | 4,901 | 4,423 | 17,424 | 4,288 | ||||||||||||
Depreciation and amortization | 6,964 | 6,055 | 21,256 | 17,020 | ||||||||||||
Provision for income taxes | 2,401 | 8,889 | 18,839 | 29,886 | ||||||||||||
Acquisition related costs | 2,808 | 18,028 | 4,827 | 20,757 | ||||||||||||
Impairment loss | 22,600 | — | 22,600 | — | ||||||||||||
Debt extinguishment costs | 6,691 | — | 6,691 | — | ||||||||||||
Share-based compensation | 2,806 | 2,455 | 8,162 | 6,691 | ||||||||||||
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Segment Adjusted EBITDA | $ | 45,014 | $ | 42,455 | $ | 124,879 | $ | 111,562 | ||||||||
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Segment Adjusted EBITDA margin | 28.4 | % | 29.4 | % | 26.9 | % | 27.3 | % | ||||||||
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CEB Segment Revenue
In the three months ended September 30, 2013, revenue increased $14.5 million, or 10.0%, to $158.7 million from $144.2 million in the three months ended September 30, 2012. In the nine months ended September 30, 2013, revenue increased $55.3 million, or 13.5%, to $463.7 million from $408.4 million in the nine months ended September 30, 2013 versus the same period of 2012.
The increases in 2013 were primarily due to an increase in sales bookings with new and existing CEB customers. In addition, the three and nine months ended September 30, 2013 included $6.0 million and $19.1 million, respectively, of revenue from PDRI. The three and nine months ended September 30, 2012 included $5.1 million of revenue from PDRI.
CEB Segment Costs and Expenses
In the three months ended September 30, 2013 and 2012, costs and expenses were $148.4 million and $129.4 million, respectively. In the nine months ended September 30, 2013 and 2012, costs and expenses were $396.0 million and $342.9 million, respectively. Included in costs and expenses in the three months ended September 30, 2013 was a $22.6 million goodwill impairment loss related to our PDRI reporting unit which is discussed in more detail below.
Changes in compensation and related costs, variable compensation, share-based compensation, third-party consulting, travel and related expenses, allocated facilities costs, additional costs from the businesses we acquired, and the impact of changes in the exchange rates of the US dollar to the GBP all contributed to year-over-year variances in costs and expenses. These items are allocated to Cost of services, Member relations and marketing, and General and administrative expenses. In 2013, costs and expenses include the full impact of the Valtera and PDRI acquisitions. We discuss the major components of costs and expenses on an aggregate basis below:
• | Compensation and related costs includes salaries, payroll taxes and benefits. The total expense was $61.6 million and $57.2 million in the three months ended September 30, 2013 and 2012, respectively, an increase of $4.4 million. The total expense was $185.9 million and $165.3 million in the nine months ended September 30, 2013 and 2012, respectively, an increase of $20.6 million. The increases were primarily due to headcount and salary increases, including the impact of the acquisitions discussed above. |
• | Variable compensation includes sales commissions and annual bonuses. Total expense was $17.2 million and $15.4 million in the three months ended September 30, 2013 and 2012, respectively, an increase of $1.8 million. Total expense was $50.8 million and $45.2 million in the nine months ended September 30, 2013 and 2012, respectively, an increase of $5.6 million. The increase was due to an increase in the estimated payout of annual bonuses due primarily to increased headcount and an increase in sales incentives resulting from increased sales bookings. |
• | Share-based compensation costs were $2.7 million and $2.5 million in the three months ended September 30, 2013 and 2012, respectively, an increase of $0.2 million. Share-based compensation costs were $8.0 million and $6.7 million in the nine months ended September 30, 2013 and 2012, respectively, an increase of $1.3 million. The increases were primarily due to increases in the total fair value of awards granted from 2010 through the present, which vest over a four year period. |
• | Third-party consulting costs include development costs for member facing technology, the use of third parties to deliver services to customers and external resources supporting the technology and finance departments. Total expense was $7.2 million and $4.8 million in the three months ended September 30, 2013 and 2012, respectively, an increase of $2.4 million. Total expense was $19.5 million and $14.5 million in the nine months ended September 30, 2013 and 2012, respectively, an increase of $5.0 million. The increases were primarily due to an increase in the use of consultants for member-facing technology development, the delivery of services, and the implementation of business systems enhancements. |
• | Travel and related expenses were $6.3 million and $5.9 million in the three months ended September 30, 2013 and 2012, respectively, an increase of $0.4 million. Travel and related expenses were $20.2 million and $17.9 million in the nine months ended September 30, 2013 and 2012, respectively, an increase of $2.3 million. The increases were primarily due to increased costs incurred in the delivery of advisory and research services. |
• | Allocated facilities costs, consisting primarily of rent, operating expenses, and real estate tax escalations, were $7.5 million and $6.5 million in the three months ended September 30, 2013 and 2012, respectively, an increase of $1.0 million. Allocated facilities costs were $21.4 million and $19.7 million in the nine months ended September 30, 2013 and 2012, respectively, an increase of $1.7 million. The increases are the result of the addition of new office space related to the expansion of our headquarters in Arlington, Virginia. |
• | CEB segment operating expenses are impacted by currency fluctuations, primarily in the value of the GBP compared to the US dollar. The value of the GBP versus the US dollar was approximately $0.03 lower, on average, in the three and nine months ended September 30, 2013 compared to the same periods of 2012. Costs incurred for foreign subsidiaries will fluctuate based on changes in foreign currency rates in addition to other operational factors. We enter into cash flow hedges for our CEB UK subsidiary to mitigate foreign currency risk, which offsets a portion of the impact foreign currency fluctuations have on the segment’s costs and expenses. |
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Cost of Services
The following table outlines the primary components of Cost of services (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
2013 | % of Revenues | 2012 | % of Revenues | 2013 | % of Revenues | 2012 | % of Revenues | |||||||||||||||||||||||||
Compensation and related | $ | 30,098 | 19.0 | % | $ | 28,187 | 19.5 | % | $ | 91,830 | 19.8 | % | $ | 79,248 | 19.4 | % | ||||||||||||||||
Variable compensation | 5,516 | 3.5 | 4,793 | 3.3 | 16,939 | 3.7 | 14,220 | 3.5 | ||||||||||||||||||||||||
Allocated facilities | 3,288 | 2.1 | 2,705 | 1.9 | 9,176 | 2.0 | 8,124 | 2.0 | ||||||||||||||||||||||||
Third-party consulting | 4,813 | 3.0 | 2,971 | 2.1 | 13,739 | 3.0 | 8,843 | 2.2 | ||||||||||||||||||||||||
Travel and related | 2,747 | 1.7 | 2,767 | 1.9 | 9,256 | 2.0 | 8,261 | 2.0 | ||||||||||||||||||||||||
Share-based compensation | 1,032 | 0.7 | 822 | 0.6 | 2,975 | 0.6 | 2,389 | 0.6 |
Cost of services increased 11.0%, or $5.4 million, to $54.7 million in the three months ended September 30, 2013 from $49.3 million in the three months ended September 30, 2012. The $1.9 million increase in compensation and related costs was primarily due to headcount and salary increases. The $0.7 million increase in variable compensation was due to an increase in estimated annual bonus payout as a result of increased headcount. The $1.8 million increase in third-party consulting relates to an increase in the use of third parties to deliver services to members. The $0.6 million increase in allocated facilities primarily relates to additional office space in Arlington, Virginia.
Cost of services increased 18.0%, or $25.2 million, to $165.5 million in the nine months ended September 30, 2013 from $140.3 million in the three months ended September 30, 2012. The $12.6 million increase in compensation and related costs and $2.7 million increase in variable compensation were primarily due to headcount and salary increases and the full period impact of acquired headcount from PDRI. The $4.9 million increase in third-party consulting relates to an increase in the use of third parties to deliver services to members. The $1.0 million increase in travel and related costs is primarily due to increased costs incurred in the delivery of advisory and research services. The $1.1 million increase in allocated facilities primarily relates to additional office space for the expansion of our Arlington, Virginia headquarters.
Cost of services as a percentage of revenue was 34.5% and 35.7% in the three and nine months ended September 30, 2013, respectively. Cost of services as a percentage of revenue was 34.2% and 34.4% in the three and nine months ended September 30, 2012, respectively.
Member Relations and Marketing
The following table outlines the primary components of Member relations and marketing (in thousands):
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2013 | % of Revenues | 2012 | % of Revenues | 2013 | % of Revenues | 2012 | % of Revenues | |||||||||||||||||||||||||
Compensation and related | $ | 22,412 | 14.1 | % | $ | 20,661 | 14.3 | % | $ | 66,560 | 14.4 | % | $ | 60,351 | 14.8 | % | ||||||||||||||||
Variable compensation | 9,931 | 6.3 | 8,909 | 6.2 | 28,054 | 6.1 | 25,804 | 6.3 | ||||||||||||||||||||||||
Allocated facilities | 3,350 | 2.1 | 2,869 | 2.0 | 9,660 | 2.1 | 8,714 | 2.1 | ||||||||||||||||||||||||
Third-party consulting | 444 | 0.3 | 749 | 0.5 | 1,581 | 0.3 | 2,006 | 0.5 | ||||||||||||||||||||||||
Travel and related | 2,892 | 1.8 | 2,600 | 1.8 | 9,079 | 2.0 | 8,211 | 2.0 | ||||||||||||||||||||||||
Share-based compensation | 604 | 0.4 | 480 | 0.3 | 1,691 | 0.4 | 1,328 | 0.3 |
Member relations and marketing increased 10.7%, or $4.3 million, to $44.4 million in the three months ended September 30, 2013 from $40.1 million in the three months ended September 30, 2012. The $1.8 million increase in compensation and related costs was primarily due to headcount and salary increases. The $1.0 million increase in variable compensation was due to an increase in sales incentives resulting from higher sales bookings and estimated annual bonus payouts as a result of increased headcount. The $0.5 million increase in allocated facilities primarily relates to additional office space for the expansion of our Arlington, Virginia headquarters.
Member relations and marketing increased 11.4%, or $13.3 million, to $130.1 million in the nine months ended September 30, 2013 from $116.8 million in the nine months ended September 30, 2012. The $6.2 million increase in compensation and related costs was primarily due to headcount and salary increases and acquired headcount from PDRI. The $2.3 million increase in variable compensation was due primarily to an increase in sales incentives resulting from higher sales bookings. The $0.9 million increase in allocated facilities primarily relates to additional office space for the expansion of our Arlington, Virginia headquarters. Additionally, employee search fees increased $0.4 million related to the increase in headcount noted above. These increases were offset by a $0.4 million decrease in third-party consulting.
Member relations and marketing expense as a percentage of revenue was 28.0% and 28.1% in the three and nine months ended September 30, 2013, respectively. Member relations and marketing expense as a percentage of revenue was 27.8% and 28.6% in the three and nine months ended September 30, 2012, respectively.
General and Administrative
The following table outlines the primary components of General and administrative (in thousands):
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2013 | % of Revenues | 2012 | % of Revenues | 2013 | % of Revenues | 2012 | % of Revenues | |||||||||||||||||||||||||
Compensation and related | $ | 9,092 | 5.7 | % | $ | 8,366 | 5.8 | % | $ | 27,559 | 5.9 | % | $ | 25,658 | 6.3 | % | ||||||||||||||||
Variable compensation | 1,761 | 1.1 | 1,715 | 1.2 | 5,809 | 1.3 | 5,163 | 1.3 | ||||||||||||||||||||||||
Allocated facilities | 901 | 0.6 | 940 | 0.7 | 2,541 | 0.5 | 2,833 | 0.7 | ||||||||||||||||||||||||
Third-party consulting | 1,967 | 1.2 | 1,049 | 0.7 | 4,160 | 0.9 | 3,629 | 0.9 | ||||||||||||||||||||||||
Share-based compensation | 1,097 | 0.7 | 1,160 | 0.8 | 3,331 | 0.7 | 2,974 | 0.7 |
General and administrative increased 6.3%, or $1.0 million, to $16.9 million in the three months ended September 30, 2013 from $15.9 million in the three months ended September 30, 2012. The $0.7 million increase in compensation and related costs was primarily due to headcount and salary increases. The $0.9 million increase in third-party consulting is primarily due to external support for technology and finance related projects.
General and administrative increased 7.7%, or $3.7 million, to $51.7 million in the nine months ended September 30, 2013 from $48.0 million in the nine months ended September 30, 2012. The $1.9 million increase in compensation and related costs was primarily due to headcount and salary increases and acquired headcount from PDRI. The $0.6 million increase in variable compensation was due to an increase in estimated annual bonus payout as a result of increased headcount. The $0.5 million increase in third-party consulting is primarily due to external support for technology and finance related projects.
General and administrative expense as a percentage of revenue was 10.7% and 11.1% in the three and nine months ended September 30, 2013, respectively. General and administrative expense as a percentage of revenue was 11.0% and 11.8% in the three and nine months ended September 30, 2012, respectively.
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Acquisition Related Costs
Acquisition related costs were $2.8 million and $18.0 million in the three months ended September 30, 2013 and 2012, respectively. Acquisition related costs were $4.8 million and $20.8 million in the nine months ended September 30, 2013 and 2012, respectively. Acquisition related costs in the three and nine months ended September 30, 2013 primarily relate to the integration of SHL including branding, consolidation of office locations and associated exit costs, and consolidation of the technology infrastructure. Acquisition related costs in the three and nine months ended September 30, 2012 primarily relate to transaction costs associated with the SHL acquisition.
Depreciation and Amortization
Depreciation and amortization increased 15.0%, or $0.9 million, to $7.0 million in the three months ended September 30, 2013 from $6.1 million in the three months ended September 30, 2012. Depreciation and amortization increased 24.9%, or $4.2 million, to $21.2 million in the nine months ended September 30, 2013 from $17.0 million in the nine months ended September 30, 2012. The following table outlines the primary components of Depreciation and amortization (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Depreciation | $ | 4,629 | $ | 3,864 | $ | 13,958 | $ | 11,965 | ||||||||
Amortization | 2,335 | 2,191 | 7,298 | 5,055 |
Depreciation increased $0.8 million and $2.0 million in the three and nine months ended September 30, 2013, respectively, over the same periods in the prior year. The increases are mainly the result of an increase in capitalizable purchases related primarily to investments in hardware and software purchased for the integration of SHL and equipment to support headcount growth and investments in member-facing technology. Amortization increased $0.1 million and $2.2 million in the three and nine months ended September 30, 2013, respectively, over the same periods in the prior year. The increases are due primarily to the amortization of PDRI intangible assets.
Depreciation and amortization expense as a percentage of revenue was 4.4% and 4.6% in the three and nine months ended September 30, 2013 and 4.2% in the three and nine months ended September 30, 2012, respectively.
Impairment loss
In the third quarter of 2013, PDRI recognized a non-deductible goodwill impairment loss of $22.6 million. The loss was primarily due to lower revenue and cash flow projections in the near and mid-terms that are a result of the US Federal government budget constraints. Management used the income approach to estimate the fair value of the reporting unit. The assumptions used in the income approach include revenue projections, EBITDA projections, estimated tax rates, estimated capital expenditures, and an assumed discount rate based on various inputs. This non-cash loss did not impact our liquidity position or cash flows.
SHL Talent Measurement Solutions Segment Executive Overview
We have rebranded our SHL segment to SHL Talent Measurement Solutions. Third quarter 2012 results discussed below are for the period from August 2, 2012, the date of acquisition, through September 30, 2012.
Revenue was $43.0 million and $133.0 million in the three and nine months ended September 30, 2013, respectively. Revenue was $20.5 million in the third quarter of 2012. Adjusted revenue, which refers to revenue before the impact of the deferred revenue fair value adjustment, was $44.4 million and $141.8 million in the three and nine months ended September 30, 2013, respectively. Adjusted revenue was $28.9 million for the third quarter of 2012. Total costs and expenses were $47.6 million and $143.7 million in the three and nine months ended September 30, 2013, respectively. Total costs and expenses were $26.7 million for the third quarter of 2012.
Adjusted EBITDA decreased 35.9%, or $2.9 million, in the three months ended September 30, 2013 to $5.1 million compared to $8.0 million for the third quarter of 2012. Adjusted EBITDA for the nine months ended September 30, 2013 was $23.5 million. The decrease in Adjusted EBITDA in the three months ended September 30, 2013 compared to the third quarter of 2012, was primarily due to higher expenses resulting from our investment in sales headcount. Variances in revenue and Adjusted revenue are discussed below.
SHL Talent Measurement Solutions Segment Results of Operations
The three and nine month periods ended September 30, 2012 represent the period from August 2, 2012, the date of acquisition, through September 30, 2012. Amounts from 2012 have been restated to exclude the operating results for PDRI which is currently included in the CEB segment but was included in the SHL Talent Measurement Solutions segment in the Form 10-Q filed with the SEC for the third quarter 2012.
The financial results presented below include the results of operations for the SHL Talent Measurement Solutions segment (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Revenue | $ | 43,026 | $ | 20,532 | $ | 132,951 | $ | 20,532 | ||||||||
Costs and expenses: | ||||||||||||||||
Cost of services | 17,703 | 10,834 | 53,681 | 10,834 | ||||||||||||
Member relations and marketing | 16,114 | 6,896 | 44,248 | 6,896 | ||||||||||||
General and administrative | 4,284 | 3,204 | 20,006 | 3,204 | ||||||||||||
Acquisition related costs | 1,214 | 529 | 2,217 | 529 | ||||||||||||
Depreciation and amortization | 8,323 | 5,241 | 23,520 | 5,241 | ||||||||||||
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Total costs and expenses | 47,638 | 26,704 | 143,672 | 26,704 | ||||||||||||
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Operating loss | (4,612 | ) | (6,172 | ) | (10,721 | ) | (6,172 | ) | ||||||||
Other (expense) income, net | ||||||||||||||||
Interest income and other | (1,627 | ) | 395 | (1,320 | ) | 395 | ||||||||||
Interest expense | — | (414 | ) | — | (414 | ) | ||||||||||
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Total other (expense) income, net | (1,627 | ) | (19 | ) | (1,320 | ) | (19 | ) | ||||||||
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Loss before provision for income taxes | (6,329 | ) | (6,191 | ) | (12,041 | ) | (6,191 | ) | ||||||||
Provision for income taxes | (5,013 | ) | (3,140 | ) | (6,354 | ) | (3,140 | ) | ||||||||
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Net loss | $ | (1,226 | ) | $ | (3,051 | ) | $ | (5,687 | ) | $ | (3,051 | ) | ||||
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Reconciliation of SHL Talent Measurement Solutions segment revenue to segment Adjusted revenue (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2103 | 2012 | 2013 | 2012 | |||||||||||||
Segment revenue | $ | 43,026 | $ | 20,532 | $ | 132,951 | $ | 20,532 | ||||||||
Impact of the deferred revenue fair value adjustment | 1,367 | 8,386 | 8,826 | 8,386 | ||||||||||||
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Segment Adjusted revenue | $ | 44,393 | $ | 28,918 | $ | 141,777 | $ | 28,918 | ||||||||
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Reconciliation of SHL Talent Measurement Solutions segment net loss to segment Adjusted EBITDA (in thousands):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Segment net loss | $ | (1,226 | ) | $ | (3,051 | ) | $ | (5,687 | ) | $ | (3,051 | ) | ||||
Depreciation and amortization | 8,323 | 5,241 | 23,520 | 5,241 | ||||||||||||
Provision for income taxes | (5,013 | ) | (3,140 | ) | (6,354 | ) | (3,140 | ) | ||||||||
Impact of the deferred revenue fair value adjustment | 1,367 | 8,386 | 8,826 | 8,386 | ||||||||||||
Acquisition related costs | 1,214 | 529 | 2,217 | 529 | ||||||||||||
Share-based compensation | 460 | 26 | 961 | 26 | ||||||||||||
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Segment Adjusted EBITDA | $ | 5,125 | $ | 7,991 | $ | 23,483 | $ | 7,991 | ||||||||
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Segment Adjusted EBITDA margin | 11.5 | % | 27.6 | % | 16.6 | % | 27.6 | % | ||||||||
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SHL Talent Measurement Solutions Segment Revenue
In the three months ended September 30, 2013, revenue increased $22.5 million to $43.0 million from $20.5 million in the three months ended September 30, 2012. The primary causes of the revenue increase were the purchase accounting adjustment to the acquisition date deferred revenue balance and the partial time period reported in 2012 of two months. On an adjusted basis, removing the impact of the deferred revenue adjustment, revenue in three months ended September 30, 2013 increased $15.5 million to $44.4 million from $28.9 million in the three months ended September 30, 2012. The primary cause of the revenue increase was the partial time period reported in 2012 of two months.
Revenue in the nine months ended September 30, 2013 was $133.0 million. Adjusted revenue in the nine months ended September 30, 2013 was $141.8 million.
SHL Talent Measurement Solutions Segment Costs and Expenses
In the three and nine months ended September 30, 2013, costs and expenses were $47.6 million and $143.7 million, respectively. In the three months ended September 30, 2012, costs and expenses were $26.7 million. Changes in compensation and related costs, variable compensation, travel and related costs, facilities costs, third-party consulting and the impact of changes in the exchange rates of GBP against the US dollar, Euro and other currencies all contributed to year-over-year variances in costs and expenses. These items are allocated to Cost of services, Member relations and marketing, and General and administrative expenses.
• | Compensation and related costs includes salaries, payroll taxes and benefits. |
• | Variable compensation includes sales commissions and annual bonuses. |
• | Third-party consulting costs include development costs for member facing technology, the use of third parties to deliver services to customers and external resources supporting the technology and finance departments. |
• | Travel and related expenses relate to sales staff travel and staff travel between and in support of operating office locations. |
• | Allocated facilities costs consist primarily of rent, operating expenses, and real estate tax escalations. The largest SHL facilities are located in Thames Ditton, United Kingdom, Alpharetta, Georgia, and Minneapolis, Minnesota. |
• | SHL Talent Measurement Solutions segment operating expenses are impacted by currency fluctuations, primarily in the value of the GBP compared to the US dollar and Euro. The value of the GBP versus the US dollar was approximately $0.03 lower, on average, in the three and nine months ended September 30, 2013 compared to the same periods of 2012. The value of the GBP versus the Euro was approximately $0.07 lower, on average, in the three and nine months ended September 30, 2012 compared to the same periods of 2012. Costs incurred for foreign subsidiaries will fluctuate based on changes in foreign currency rates in addition to other operational factors. |
Cost of Services
Cost of services in the three months ended September 30, 2013 and 2012 were $17.7 million and $10.8 million, respectively. Cost of services in the nine months ended September 30, 2013 were $53.7 million. A summary of the primary components is included in the table below for comparative purposes (in thousands):
Three Months Ended September 30,(1) | Nine Months Ended September 30, (1) | |||||||||||||||||||||||||||||||
2013 | % of Adjusted Revenues | 2012 | % of Adjusted Revenues | 2013 | % of Adjusted Revenues | 2012 | % of Adjusted Revenues | |||||||||||||||||||||||||
Compensation and related | $ | 10,717 | 24.1 | % | $ | 7,176 | 24.8 | % | $ | 33,223 | 23.4 | % | $ | 7,176 | 24.8 | % | ||||||||||||||||
Variable compensation | 1,345 | 3.0 | 291 | 1.0 | 3,087 | 2.2 | 291 | 1.0 | ||||||||||||||||||||||||
Third-party consulting | 1,879 | 4.2 | 705 | 2.4 | 5,712 | 4.0 | 705 | 2.4 | ||||||||||||||||||||||||
Travel and related | 1,073 | 2.4 | 356 | 1.2 | 2,986 | 2.1 | 356 | 1.2 | ||||||||||||||||||||||||
Allocated facilities | 994 | 2.2 | 670 | 2.3 | 3,007 | 2.1 | 670 | 2.3 |
(1) | The three and nine month periods for 2012 represent the period from August 2, 2012, the date of acquisition, through September 30, 2012. |
The primary cause for variances above relate to the timing of the SHL acquisition. Variable compensation for the three months ended September 30, 2013 includes a $0.3 million re-class from General and administrative relating to annual bonuses.
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Member Relations and Marketing
Member relations and marketing in the three months ended September 30, 2013 and 2012 were $16.1 million and $6.9 million, respectively. Member relations and marketing in the nine months ended September 30, 2013 were $44.2 million. A summary of the primary components is included in the table below (in thousands):
Three Months Ended September 30, (1) | Nine Months Ended September 30, (1) | |||||||||||||||||||||||||||||||
2013 | % of Adjusted Revenues | 2012 | % of Adjusted Revenues | 2013 | % of Adjusted Revenues | 2012 | % of Adjusted Revenues | |||||||||||||||||||||||||
Compensation and related | $ | 8,952 | 20.2 | % | $ | 4,175 | 14.4 | % | $ | 26,982 | 19.0 | % | $ | 4,175 | 14.4 | % | ||||||||||||||||
Variable compensation | 3,507 | 7.9 | 746 | 2.6 | 6,810 | 4.8 | 746 | 2.6 | ||||||||||||||||||||||||
Travel and related | 754 | 1.7 | 449 | 1.6 | 2,209 | 1.6 | 449 | 1.6 | ||||||||||||||||||||||||
Allocated facilities | 612 | 1.4 | 336 | 1.2 | 1,852 | 1.3 | 336 | 1.2 |
(1) | The three and nine month periods for 2012 represent the period from August 2, 2012, the date of acquisition, through September 30, 2012. |
In 2013, SHL Talent Measurement Solutions has made significant investments in sales headcounts, increasing staffing levels by approximately 35%. The increased staffing levels were made to invest in future revenue growth. Variable compensation for the three months ended September 30, 2013 includes a $1.6 million re-class from General and administrative relating to annual bonuses. Additionally, variances above relate to the timing of the SHL acquisition.
General and administrative
General and administrative in the three months ended September 30, 2013 and 2012 were $4.3 million and $3.2 million, respectively. General and administrative in the three months ended September 30, 2013 were $20.0 million. A summary of the primary components is included in the table below (in thousands):
Three Months Ended September 30, (1) | Nine Months Ended September 30, (1) | |||||||||||||||||||||||||||||||
2013 | % of Adjusted Revenues | 2012 | % of Adjusted Revenues | 2013 | % of Adjusted Revenues | 2012 | % of Adjusted Revenues | |||||||||||||||||||||||||
Compensation and related | $ | 3,645 | 8.2 | % | $ | 2,063 | 7.1 | % | $ | 10,818 | 7.6 | % | $ | 2,063 | 7.1 | % | ||||||||||||||||
Variable compensation | (1,777 | ) | (4.0 | ) | 159 | 0.6 | 1,461 | 1.0 | 159 | 0.6 |
(1) | The three and nine month periods for 2012 represent the period from August 2, 2012, the date of acquisition, through September 30, 2012. |
In 2013, SHL Talent Measurement Solutions increased its headcount in the IT and Finance departments to support future growth and enhance existing processes. Variable compensation for the quarter was negative due to reallocation of management bonuses to the Cost of services and Member relations and marketing line items. A total of $2.0 million was re-classed from General and Administrative in the three months ended September 30, 2013.
Acquisition Related Costs
Acquisition related costs were $1.2 million and $2.2 million in the three and nine months ended September 30, 2013, respectively. Acquisition related costs were $0.5 million in the three months ended September 30, 2012. Acquisition costs in 2013 relate to the integration of SHL, primarily re-branding and the integration of technology infrastructure.
Depreciation and Amortization
Three Months Ended September 30, (1) | Nine Months Ended September 30, (1) | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Depreciation | $ | 1,928 | $ | 1,002 | $ | 4,715 | $ | 1,002 | ||||||||
Amortization | 6,395 | 4,239 | 18,805 | 4,239 |
(1) | The three and nine month periods for 2012 represent the period from August 2, 2012, the date of acquisition, through September 30, 2012. |
Depreciation relates primarily to capitalizable costs of revenue generating internally developed software and computer equipment. Additionally, purchases of network and computer equipment have increased in 2013 for the integration of SHL and to support headcount growth. Amortization relates to intangible assets acquired in 2012 in conjunction with the SHL acquisition.
SHL Talent Measurement Solutions Segment Impairment Indicator
In the third quarter of 2013, we identified interim indicators of impairment for the SHL reporting unit, including lower revenue and profits than had been anticipated at the time of the acquisition and rising interest rates. Upon identification of the interim impairment indicators, management completed step one of the interim goodwill impairment analysis. The carrying value was approximately $600 million at September 30, 2013, including approximately $388 million of goodwill and approximately $269 million of amortizable intangible assets. The estimated fair value of the SHL Talent Measurement Solutions reporting unit exceeded its carrying value by approximately 1%.
Under the income approach, management used internally generated projected financial information which included revenue growth rates which reflect recent investments in the sales operations structure in this business. The near to mid-term EBITDA margins were also estimated to increase each year over the forecast period. The assumed discount rate utilized was 13.0%.
Under the market approach, management used an average of revenue and EBITDA multiples. The revenue multiples utilized by the Company were in a range of 2.75 to 3.25 times current and future period revenue estimates. The EBITDA multiples utilized were in a range of 10 to 12 times current and future period EBITDA estimates.
Liquidity and Capital Resources
Historically, cash flows generated from operating activities have been our primary source of liquidity. On July 2, 2012, in connection with the execution of the sale and purchase agreement related to the SHL acquisition, we entered into a senior secured credit agreement, which was subsequently amended and restated on July 18, 2012, on August 1, 2012, and again on August 2, 2013 (as amended and restated, the “Credit Agreement”). The Credit Agreement provides for (i) a term loan A in an aggregate principal amount of $275 million (the “Term Loan A Facility”), (ii) a term loan B in an aggregate principal amount of $250 million (the “Term Loan B Facility” and together with the Term Loan A Facility, the “Term Facilities”) and (iii) a $100 million revolving credit facility (the “Revolving Credit Facility” and together with the Term Loan Facilities, the “Senior Secured Credit Facilities”). The Term Loan A Facility and the Revolving Credit Facility were scheduled to mature on August 2, 2017 and the Term Loan B Facility was scheduled to mature on August 2, 2019.
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On August 2, 2012, in connection with the closing of the SHL acquisition, the full amounts of the Term Loan A Facility and the Term Loan B Facility were drawn and $30 million under the Revolving Credit Facility was drawn. In addition, approximately $6 million of availability under the Revolving Credit Facility was used to cover letters of credit that were issued to replace similar letters of credit previously issued under our prior senior unsecured credit facility which was terminated concurrently with the drawings under the Senior Secured Credit Facilities. In addition to the net proceeds from the Senior Secured Credit Facilities, we used approximately $121 million of our available cash on hand to pay the remainder of the SHL purchase price. We repaid $10 million of the principal amount outstanding under the Revolving Credit Facility in December 2012 and the remaining outstanding amount of $20 million in January 2013.
On August 2, 2013, we entered into Amendment No. 3 (the “Amendment”) to the Credit Agreement. The Amendment (i) replaced the existing term A loans with new refinancing term A-1 loans (the “Refinancing Term A-1 Loans”) in an aggregate principal amount of $269.6 million, which was fully drawn on August 2, 2013, (ii) established a new tranche of incremental term A-1 loans (the “Incremental Term A-1 Loans” and together with the Refinancing Term A-1 Loans, the “Term A-1 Loans”) in an aggregate principal amount of $253.8 million, which was fully drawn on August 2, 2013, and (iii) increased the existing revolving commitments with new tranche A revolving commitments (the “Tranche A Revolving Commitments” and the loans thereunder, the “Tranche A Revolving Loans”) in an aggregate principal amount of $100 million for a total aggregate principal amount of $200 million, none of which was drawn in connection with the closing of the Amendment.
Amounts drawn under the Refinancing Term A-1 Loan tranche were used to prepay and terminate our existing Term Loan A Facility. Amounts drawn under the Incremental Term A-1 Loan tranche were used to prepay and terminate our existing Term Loan B Facility and pay transaction related fees and expenses.
The maturity date of all Term A-1 Loans is August 2, 2018. The principal amount of the Term A-1 Loans amortizes in quarterly installments equal to (i) for the first two years after the closing of the Amendment, approximately 2% of the original principal amount of the Term A-1 Loans and (ii) for the next three years thereafter, approximately 4% of the original principal amount of the Term A-1 Loans, with the balance payable at maturity. The termination date of all revolving commitments under the credit agreement, including the new Tranche A Revolving Commitments, is August 2, 2018. The Term A-1 Loans and Tranche A Revolving Loans will, at our option, bear interest at the Eurodollar Rate plus 2.25% or a base rate plus 1.25%, as applicable, with future “step-downs” upon achievement of specified first lien net leverage ratios. The annual interest rate on the Term A-1 Loans was 2.43% at September 30, 2013.
We had cash and cash equivalents of $77.8 million and $72.7 million at September 30, 2013 and December 31, 2012, respectively. We believe that existing cash and cash equivalents and operating cash flows will be sufficient to support operations, including interest and required principal payments, anticipated capital expenditures, and the payment of dividends, as well as potential share repurchases for at least the next 12 months. Our future cash flows will depend on many factors, including our rate of CEB segment Contract Value growth and selective investments to expand our market presence and enhance technology. At September 30, 2013, available borrowings under the Revolving Credit Facility were approximately $193 million, which includes approximately $7 million reserved for outstanding letters of credit. The anticipated cash needs of our business could change significantly if we pursue and make investments in, or acquisitions of, complementary businesses, if economic conditions change from those currently prevailing or from those currently anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flows or profitability of our business. Any of these events or circumstances could involve significant additional funding needs in excess of the identified currently available sources, including our Revolving Credit Facility, and could require us to seek additional financing as an additional source of liquidity to meet those needs. Our ability to obtain additional financing, if necessary, is subject to a variety of factors that we cannot predict with certainty, including our future profitability; our relative levels of debt and equity; the volatility and overall condition of the capital markets; and the market prices of our securities. As a result, any additional financing may not be available on acceptable terms or at all.
Approximately $50 million of our cash is held by our foreign subsidiaries. We manage our worldwide cash requirements by considering available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. The repatriation of cash balances from certain of our subsidiaries could have adverse tax consequences; however, those balances are generally available without legal restrictions to fund ordinary business operations, capital projects, and future acquisitions. In the three months ended September 30, 2013, certain US Dollar cash accounts held by foreign subsidiaries were remeasured at the current exchange rate resulting in a $1.6 million loss reported in Interest income and other income.
Cash Flows
Nine Months Ended September 30, | ||||||||
2013 | 2012 | |||||||
Net cash flows provided by operating activities | $ | 95,004 | $ | 77,329 | ||||
Net cash flows used in investing activities | (34,251 | ) | (676,124 | ) | ||||
Net cash flows (used in) provided by financing activities | (54,614 | ) | 518,237 |
Historically, our primary uses of cash have been to fund acquisitions, capital expenditures, share repurchases, and dividend payments. With the Senior Secured Credit Facilities, our primary uses of cash also include debt service requirements.
Cash Flows from Operating Activities
Membership subscriptions, which principally are annually renewable agreements, generally are payable by members at the beginning of the contract term. Historically, the combination of revenue growth, profitable operations, and advance payments of membership subscriptions has resulted in net cash flows provided by operating activities.
Net cash flows provided by operating activities were $95.0 million and $77.3 million in the nine months ended September 30, 2013 and 2012, respectively. The primary drivers of the year-over-year increase were a decrease in acquisition related costs of $14.3 million and an increase in customer collections of $8.4 million. These inflows were partially offset by an increase in cash tax payments of $9.2 million, increases in incentive payments for sales commissions and annual bonuses, and interest expense. The nine month period of 2013 includes the full year impact of SHL cash flows whereby 2012 includes the period from August 2, 2012, the date of acquisition, through September 30, 2012.
We made income tax payments of $36.8 million and $27.6 million in the nine months ended September 30, 2013 and 2012, respectively and expect to continue making tax payments in future periods. The increase in income tax payments was primarily due to the acquisition of SHL in August 2012.
Cash Flows from Investing Activities
Our cash management, acquisition, and capital expenditure strategies affect cash flows from investing activities. Net cash flows used in investing activities were $34.3 million and $676.1 million in the nine months ended September 30, 2013 and 2012, respectively. In 2013, we used $23.0 million for capital expenditures, primarily on the SHL integration and computer and network equipment to support infrastructure and headcount growth. We also made strategic investments of $11.2 million. In 2012, we utilized $669.5 million for acquisitions of businesses, which included a payment of $648.3 million for SHL, net of cash acquired of $5.7 million.
In February 2012, we completed the acquisition of Valtera. We acquired 100% of the equity interests of Valtera for a cash payment of $22.4 million, net of cash acquired of $1.9 million. The cash payment includes $4.7 million which was placed in escrow and held until March 13, 2013 at which point the funds were released to the sellers.
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We estimate that capital expenditures to support our infrastructure will be between $29 million and $31 million in 2013. This includes approximately $7 million for tenant improvement allowances that are paid by the landlord directly to contractors and will not impact our cash flows.
Cash Flows from Financing Activities
Net cash flows used in financing activities in the nine months ended September 30, 2013 were $54.6 million. Net cash flows provided by financing activities in the nine months ended September 30, 2012 were $518.2 million. The primary use of cash in 2013 was $29.3 million used to repay amounts outstanding under our Senior Secured Credit Facilities. Additionally, we increased our quarterly dividend rate from $0.175 per share in 2012 to $0.225 per share in 2013. This resulted in a $5.1 million increase in dividend payments. We also used $2.8 million in the nine months ended September 30, 2013 to repurchase shares of our common stock pursuant to our stock repurchase program that was approved by the Board of Directors in February 2013. The primary source of cash in 2012 was the $555.0 million of proceeds from borrowings under the credit facilities that we entered into in connection with the SHL acquisition.
Commitments and Contingencies
We continue to evaluate potential tax exposure relating to sales and use, payroll, income and property tax laws, and regulations for various states in which we sell or support our goods and services. Accruals for potential contingencies are recorded when it is probable that a liability has been incurred, and the liability can be reasonably estimated. As additional information becomes available, changes in the estimates of the liability are reported in the period that those changes occur. We had a liability of $5.8 million at September 30, 2013 and December 31, 2012, respectively, relating to certain sales and use tax regulations for states in which we sell or support our goods and services.
Contractual Obligations
The following table summarizes our known contractual obligations at September 30, 2013 and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):
Payments Due by Period at September 30, 2013 | ||||||||||||||||||||||||||||
Total | YE 2013(1) | YE 2014 | YE 2015 | YE 2016 | YE 2017 | Thereafter | ||||||||||||||||||||||
Senior Secured Credit Facilities (2) | $ | 596,965 | $ | 6,922 | $ | 27,340 | $ | 31,989 | $ | 36,449 | $ | 35,766 | $ | 458,499 | ||||||||||||||
Operating lease obligations | 614,725 | 11,433 | 49,523 | 49,393 | 49,570 | 47,347 | 407,459 | |||||||||||||||||||||
Deferred compensation liability | 14,947 | — | 675 | 496 | 546 | 257 | 12,973 | |||||||||||||||||||||
Purchase commitments | 45,158 | 23,486 | 12,380 | 7,772 | 1,520 | — | — | |||||||||||||||||||||
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Total | $ | 1,271,795 | $ | 41,841 | $ | 89,918 | $ | 89,650 | $ | 88,085 | $ | 83,370 | $ | 878,931 | ||||||||||||||
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Sublease Receipts by Period (In Thousands) at September 30, 2013 | ||||||||||||||||||||||||||||
Total | YE 2013(1) | YE 2014 | YE 2015 | YE 2016 | YE 2017 | Thereafter | ||||||||||||||||||||||
Sublease receipts | $ | 287,226 | $ | 3,569 | $ | 17,521 | $ | 20,171 | $ | 20,653 | $ | 21,597 | $ | 203,715 |
(1) | For the three months ended December 31, 2013. |
(2) | Includes interest expense for the Term A-1 Loans calculated using variable interest rates at August 2, 2013 of 2.44%. We may be required to make mandatory prepayments with the net cash proceeds of certain debt issuances, equity issuances, insurance receipts, dispositions and excess cash flows. The amounts presented in the tables above do not reflect any mandatory prepayments that we may be required to pay. |
In September 2013, one of the subtenants of the CEB headquarters exercised their right under the sublease to acquire an additional 32,000 square feet of office space. This expansion period begins in October 2014 and will co-terminate with the subtenants other sub-leases in January 2028. We will receive an additional $21.5 million over the duration of the sublease.
Operating lease obligations include scheduled rent escalations. Purchase commitments primarily relate to information technology and infrastructure contracts.
Not included in the table above are unrecognized tax benefits of $7.8 million.
Off-Balance Sheet Arrangements
At September 30, 2013 and December 31, 2012, 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) established for purposes of facilitating off-balance sheet financing or other debt arrangements or for other contractually narrow or limited purposes.
Forward-looking Statements
This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks, uncertainties and assumptions. In addition, all statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenues, margins, expenses, provision for income taxes, earnings, cash flows, share repurchases, acquisition synergies, foreign currency exchange rates or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning expected development, performance or market share relating to products or services; any statements regarding future economic conditions or performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief; any statements regarding the impact of the SHL acquisition and related debt financing on our future business, financial results or financial condition, including our liquidity and capital resources; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. You are hereby cautioned that these statements are based upon our expectations at the time we make them and may be affected by important factors including, among others, the factors set forth below and in our filings with the US Securities and Exchange Commission, and consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them.
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Factors that could cause actual results to differ materially from those indicated by forward-looking statements include, among others, our dependence on renewals of our membership-based services; the sale of additional programs to existing members and our ability to attract new members; our potential failure to adapt to changing member needs and demands; our potential failure to develop and sell, or expand sales markets for our SHL tools and services; our potential inability to attract and retain a significant number of highly skilled employees or successfully manage succession planning issues; fluctuations in operating results; our potential inability to protect our intellectual property rights; our potential inability to adequately maintain and protect our information technology infrastructure and our member and client data; potential confusion about our rebranding, including our integration of the SHL brand; our potential exposure to loss of revenues resulting from our unconditional service guarantee; exposure to litigation related to our content; various factors that could affect our estimated income tax rate or our ability to utilize our deferred tax assets; changes in estimates, assumptions or revenue recognition policies used to prepare our consolidated financial statements, including those related to testing for potential goodwill impairment; our potential inability to make, integrate and maintain acquisitions and investments; the amount and timing of the benefits expected from acquisitions and investments including our acquisition of SHL, the risk that we will be required to recognize additional impairments to the carrying value of the significant goodwill and amortizable intangible asset amounts included in our balance sheet as a result of our acquisitions, which would require us to record charges that would reduce our reported results; our potential inability to effectively manage the risks associated with the indebtedness we incurred and the senior secured credit facilities we entered into in connection with our acquisition of SHL or any additional indebtedness we may incur in the future; our potential inability to effectively manage the risks associated with our international operations, including the risk of foreign currency exchange fluctuations; and our potential inability to effectively anticipate, plan for and respond to changing economic and financial markets conditions, especially in light of ongoing uncertainty in the worldwide economy, the US economy (including sequestration under the Budget Control Act of 2011) and possible volatility of our stock price. In Part I, “Item 1A. Risk Factors” of our 2012 Annual Report on Form 10-K, as filed with the SEC on March 1, 2013, we discuss in more detail various important factors that could cause actual results to differ from expected or historic results. It is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete statement of all potential risks or uncertainties. All forward-looking statements contained in this Quarterly Report on Form 10-Q are qualified by these cautionary statements and are made only as of the date this Quarterly Report on Form 10-Q is filed. We assume no obligation and do not intend to update these forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
There has been no material change in the Company’s assessment of its sensitivity to market risk since its presentation set forth in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in its 2012 Annual Report on Form 10-K.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
In connection with the preparation of this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer, with the participation of management, have evaluated our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of September 30, 2013, our disclosure controls and procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There have not been any changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
From time to time, the Company is subject to litigation related to normal business operations. The Company vigorously defends itself in litigation. The Company is not currently a party to, and the Company’s property is not subject to, any legal proceedings likely to materially affect our financial results.
In addition to the other information contained in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our 2012 Annual Report on Form 10-K. There were no material changes during the quarter ended September 30, 2013 to the information included in “Item 1A. Risk Factors” in our 2012 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
Total Number of Shares Purchased (1) | Average Price Paid Per Share | Total Number of Shares Purchased as Part of a Publicly Announced Plan | Approximate $ Value of Shares That May Yet Be Purchased Under the Plans (2) | |||||||||||||
July 1, 2013 to July 31, 2013(1) | 268 | $ | 66.67 | — | $ | 47,250,514 | ||||||||||
August 1, 2013 to August 31, 2013(1) | 1,009 | $ | 68.31 | — | $ | 47,250,514 | ||||||||||
September 1, 2013 to September 30, 2013(1) | 47 | $ | 69.38 | — | $ | 47,250,514 | ||||||||||
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Total | 1,324 | $ | 68.01 | — | ||||||||||||
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(1) | Represents shares of common stock surrendered by employees to the Company to satisfy minimum statutory employee tax withholding obligations. |
(2) | On February 5, 2013, our Board of Directors approved a $50 million stock repurchase program, which is authorized through December 31, 2014. Repurchases may be made through open market purchases or privately negotiated transactions. The timing of repurchases and the exact number of shares of common stock to be repurchased will be determined by our management, in its discretion, and will depend upon market conditions and other factors. The program will be funded using our cash on hand and cash generated from operations. |
Item 3. Defaults Upon Senior Securities.
None.
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Item 4. Mine Safety Disclosures.
Not applicable.
On November 7, 2013, the Board of Directors declared a fourth quarter cash dividend of $0.225 per share. The dividend is payable on December 31, 2013 to stockholders of record at the close of business on December 13, 2013. The Company funds its dividend payments with cash on hand and cash generated from operations.
(a) | Exhibits: |
Exhibit No. | Description | |
3.1 | Second Amended and Restated Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1, declared effective by the Securities and Exchange Commission on February 22, 1999 (Registration No. 333-5983).) | |
3.2 | Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3.2 to the Current Report on Form 8-K filed with the Securities and Exchange Commission on March 10, 2009.) | |
10.1 | Amendment No. 3 to the Credit Agreement, dated as of August 2, 2013, by and among The Corporate Executive Board Company, the Lenders party thereto and Bank of America, N.A., as Administrative Agent, Collateral Agent, Swing Line Lender and L/C Issuer (Incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 8, 2013.) | |
31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a — 14(a) of the Securities Exchange Act of 1934, as amended | |
31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a — 14(a) of the Securities Exchange Act of 1934, as amended | |
32.1* | Certifications pursuant to 18 U.S.C. Section 1350 | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Labels Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* | Filed herewith |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
THE CORPORATE EXECUTIVE BOARD COMPANY (Registrant) | ||||||
Date: November 12, 2013 | By: | /s/ Richard S. Lindahl | ||||
Richard S. Lindahl | ||||||
Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |
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Exhibit Index
Exhibit No. | Description | |
3.1 | Second Amended and Restated Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1, declared effective by the Securities and Exchange Commission on February 22, 1999 (Registration No. 333-5983).) | |
3.2 | Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3.2 to the Current Report on Form 8-K filed with the Securities and Exchange Commission on March 10, 2009.) | |
10.1 | Amendment No. 3 to the Credit Agreement, dated as of August 2, 2013, by and among The Corporate Executive Board Company, the Lenders party thereto and Bank of America, N.A., as Administrative Agent, Collateral Agent, Swing Line Lender and L/C Issuer (Incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 8, 2013.) | |
31.1* | Certification of the Chief Executive Officer pursuant to Rule 13a — 14(a) of the Securities Exchange Act of 1934, as amended | |
31.2* | Certification of the Chief Financial Officer pursuant to Rule 13a — 14(a) of the Securities Exchange Act of 1934, as amended | |
32.1* | Certifications pursuant to 18 U.S.C. Section 1350 | |
101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Labels Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* | Filed herewith |
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