UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Form 10-K
(Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the fiscal year ended March 31, 2004
Or
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
Commission File Number: 000-33283
THE ADVISORY BOARD COMPANY
| Delaware (State or other jurisdiction of incorporation or organization) | 52-1468699 (I.R.S. Employer Identification Number) |
| 2445 M Street, N.W. Washington, D.C. (Address of principal executive offices) | 20037 (Zip Code) |
202-266-5600
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Not applicable
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of class)
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. Yesx Noo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x
Indicate by check mark if the registrant is an accelerated filer (as defined in rule 12b-2 of the Act). Yesx Noo
Based upon the closing price of the registrant’s common stock as of September 30, 2003, the aggregate market value of the common stock held by non-affiliates of the registrant is $447,366,895*.
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: As of June 4, 2004, The Advisory Board Company had outstanding 17,690,143 shares of Common Stock, par value $0.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents incorporated by reference and the Part of the Form 10-K into which the document is incorporated:
None.
| * | Solely for purposes of this calculation, all executive officers and directors of the registrant and all shareholders reporting beneficial ownership of more than 5% of the registrant’s common stock are considered to be affiliates. |
A NOTE ABOUT FORWARD-LOOKING STATEMENTS
We have made forward-looking statements in this Form 10-K, including the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include the information concerning our possible or assumed results of operations, business strategies, financing plans, competitive position and potential growth opportunities. Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates” or similar expressions.
Forward-looking statements involve risks, uncertainties and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You should not put undue reliance on any forward-looking statements. We do not have any intention or obligation to update forward-looking statements after we distribute this Form 10-K.
You should understand that many important factors could cause our results to differ materially from those expressed in these forward-looking statements. Among the factors that could cause our future results to differ from those reflected in forward-looking statements are the risks discussed in this Form 10-K under the heading “Business-Risk Factors.”
Our Internet website address iswww.advisoryboardcompany.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission.
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PART I
Item 1. Business.
Overview
We provide best practices research and analysis to more than 2,300 hospitals, health systems, pharmaceutical and biotech companies, health care insurers and medical device companies in the United States, focusing on business strategy, operations and general management issues. Best practices research identifies, analyzes and describes specific management initiatives, strategies and processes that produce the best results in solving common problems or challenges. For a fixed annual fee, members of each program have access to an integrated set of services such as best practices research studies, executive education seminars, customized research briefs and web-based access to the program’s content database and decision support tools. Our member renewal rate for each of the last three fiscal years equaled or exceeded 87%, which we believe is a reflection of our members’ recognition of the value they derive from participating in our programs.
Our business was founded in 1979 to provide best practices research and analysis across all industries. We launched our first health care best practices program in 1986. In August 2001, we were incorporated as a Delaware corporation and completed our initial public offering in November 2001. Since April 2000, we have increased the total number of programs we offer from 6 to 21, and have grown our sales force from 16 business development teams in April 2000 to 60 as of March 31, 2004. For the fiscal year ended March 31, 2004, our revenues grew to $121.8 million, up 21% from the prior year, and we reported income from operations of $28.5 million, with earnings per diluted share of $1.00. As of March 31, 2004, we had $204.0 million in total assets.
Our membership-based model, in which members actively participate in our research and analysis, is central to our strategy. This model gives us privileged access to our members’ business practices, proprietary data and strategic plans and enables us to provide detailed best practices analyses on current industry issues. Each of our 21 programs targets the issues of a specific executive constituency or business function. We sell substantially all of our program memberships as one-year agreements.
Each of our programs offers a standardized set of services, allowing us to spread our largely fixed program cost structure across our membership base of participating companies. This economic model enables us to increase our revenues and operating margin as we expand the membership base of our programs over time and, we believe, permits members to learn about industry best practices at a fraction of the cost of a customized analysis performed by a major consulting firm.
Our membership includes some of the most prestigious health care institutions in the United States. As of March 31, 2004, 16 of the top 17 hospitals as ranked byU.S. News and World Reportwere members, including The Cleveland Clinic, Duke University Medical Center, Johns Hopkins Hospital, Massachusetts General Hospital and the UCLA Medical Center. Our membership also includes leading pharmaceutical and biotech companies, health care insurers and medical device companies, such as Johnson & Johnson, Medtronic, Merck and Wyeth Pharmaceuticals. Within these organizations, we serve a range of constituencies, including both the executive suite and the broader management team. Our programs currently reach more than 4,000 chief executive and chief operating officers and 40,000 senior executives, clinical leaders, department heads and product-line managers.
Our Target Market — The Health Care Industry
According to U.S. Department of Commerce statistics, the health care industry continues to grow rapidly. The Health Care Financing Administration estimates that spending in the United States for health care services was $1.7 trillion in 2003 and projects spending will grow at an annual rate of approximately 7% through 2013.
Health care companies rely on professional information services firms to help them develop strategies and improve operations to remain competitive in the dynamic industry environment. Health care is an important vertical market within the consulting and corporate training and development segments of the overall professional information services industry. The market for health care professional information services includes spending on all forms of consulting, benchmarking data, education and training, and market research services.
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We believe that the following characteristics of the health care industry make it especially suited for our business model of delivering professional information services regarding best practices on a standardized basis:
| • | Common Industry-Wide Issues.Health care companies of all sizes face many of the same complex strategic, operational and management issues, including increasing revenues, reducing costs, overcoming labor shortages, managing clinical innovation, improving productivity, reengineering business processes, increasing clinical quality and complying with new government regulations. Because the delivery of health care services is based upon very complex, interrelated processes that involve many types of health care companies, there is widespread interest in and broad applicability of standardized programs that address the major challenges facing the industry. | |||
| • | Fragmented Industry.Our target market within the health care industry consists of over 4,000 current or potential members in the United States. This target market includes many health care providers that deliver health care services primarily on a local or regional basis. As a result of this fragmentation, best practices that are pioneered in local or regional markets are rarely widely known throughout the industry. | |||
| • | Willingness to Share Best Practices.We believe that health care companies have a relatively high propensity to share best practices. Many companies are non-profit organizations or compete in a limited geographic market and do not consider companies outside their market to be their competitors. In addition, the health care industry has a long tradition of disseminating information as part of ongoing medical research and education activities. | |||
| • | Limited Financial Resources.A cooperative membership model that provides access to best practices on a shared-cost basis appeals to many cost-conscious health care companies that otherwise lack the financial resources to commission a customized study to address their critical issues. | |||
Business Strategy
To capitalize on the favorable trends and characteristics of the health care industry, we will continue to develop and operate membership-based best practices programs that research and analyze the critical issues facing the health care industry and distribute our findings to our members in a standardized manner.
Capitalize on Membership-Based Business Model
We believe our membership-based business model is key to our success. Our membership model enables us to target issues of relevance to a broad audience of health care companies and to draw on their experience to identify solutions. At the same time, our fixed fee economic model promotes frequent use of our programs and services by our members.
Focus on Best Practices Research for the Health Care Industry
We focus on researching the best practices within the health care industry, which we believe is especially suited for our business model. Our focus on health care has enabled us to develop a membership that includes the most progressive and highly regarded health care institutions where many industry issues are first identified and where many of the best practices originate. We believe that health care companies will continue to demand access to proven best practices and solutions to common industry problems on a cost-effective, cross-industry basis and that our reputation and success to date has uniquely positioned us as a leading source for identifying, evaluating and communicating these evolving solutions.
Leverage Our Intellectual Capital and Relationships by Providing Best Practices Installation Support
We are able to efficiently leverage research and relationships from our renewable programs to develop new programs offering best practices installation support, thereby generating additional revenues for a low incremental cost. Our research programs produce the best practices that we use to create new management tools and executive education modules. These tools are packaged and delivered as 12-month memberships for separate annual fees. Our research programs also provide a natural platform to identify member organizations seeking support in adopting the best practices profiled in our research to improve their own performance.
Scale Our Economic Model
Our economic model enables us to add new members to all of our programs for a low incremental cost per member, thereby growing our revenues and improving our operating margin as we increase the membership base of our existing programs. A significant portion of every program’s cost structure for delivering the program’s standardized services is fixed and therefore does not vary with the number of members who participate in a program. By targeting topics that will be of interest to a broad range of members, we are able to spread the fixed costs associated with our programs over a large number of potential members.
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Continue Research and Analysis Excellence
The quality of our research and analysis is a critical component of our success. Experienced program research directors are responsible for assuring that our research methodology is applied to all studies and that research quality is maintained across all programs. We are highly selective in our hiring, recruiting only the top graduates of the leading universities and graduate schools. We emphasize continual training of all employees in key areas, including industry analysis, economics, quantitative modeling, root-cause analysis and presentation skills.
Deliver Superior Value Proposition
We believe that our programs offer a compelling price-value proposition to participating members. Our standardized programs and scalable economic model allow us to provide access to best practices from leading institutions at a fraction of the cost any major consulting firm would charge to perform a comparable customized analysis. Members use our best practices research to improve the effectiveness of their organizations, often resulting in increased productivity and reduced operating costs. We believe that our program prices generally represent a small percentage of the potential bottom-line improvement members can achieve by successfully implementing one or more of the dozens of best practices they receive as members of a particular program. Our member renewal rate for each of the last three fiscal years equaled or exceeded 87%, reflecting our members’ recognition of the value they derived from participating in our programs.
Growth Strategy
Our growth strategy is to leverage our extensive membership, deep knowledge base of best practices and proven business formula to increase revenues and profitability.
Develop New Programs
We will continue developing new programs to cross-sell to existing members and to attract new member institutions. We actively manage a pipeline of new program concepts and rigorously evaluate and prioritize all target opportunities using well-defined new program development criteria. We involve industry thought-leaders from progressive and well-known companies as advisors early on in our new program development process and typically convert a high percentage of our advisors into paying members prior to launching the program. We plan to launch three to four new programs per year for at least the next three years.
Cross-Sell Additional Programs to Existing Members
Since April 2000, we have increased the number of programs we offer from 6 to 21, thereby significantly increasing our cross-sell opportunity. We actively cross-sell additional programs to our more than 2,300 members using a variety of tactics, including sales force visits, presentations at member meetings and announcements in our research publications and website.
Expand Focus on Health Care Operations
Having largely provided research on strategic issues prior to fiscal 2001, we began creating programs focused on our members’ operational issues such as managing their workforce, increasing hospital throughput, and lowering costs. Health systems are under continual pressure to improve operations to lower costs and improve quality of care. The delivery of health care services is an inherently complex process spanning many departments within a health system, significantly increasing the number of executive constituencies and business functions we can target with new programs. We believe that a large portion of the money spent by health systems on external consulting, training and management support services goes towards solving operational problems. Health care providers face many of the same operational issues, creating new opportunities for our standardized best practices research, analysis and installation support. We currently offer ten programs that focus on operational issues.
Target Additional Sectors of the Health Care Industry
In 1992 we launched our Health Care Industry Strategy program to educate pharmaceutical, biotech, health insurance and medical device companies on the major issues and challenges facing their largest customer segment, health care provider organizations. We plan to leverage the Health Care Industry Strategy program and the relationships we have developed with senior executives at leading pharmaceutical, biotech, health insurance and medical device companies to drive deeper and develop additional programs focused directly on the issues of these additional sectors of the health care industry. We will continue to target opportunities within these sectors that allow us to apply our business formula of launching programs that are largely fixed-cost in nature and offer a highly standardized solution.
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Our Membership
We believe that our membership brings together the broadest and deepest group of health care organizations and professionals in the industry. As of March 31, 2004, our membership consisted of more than 2,300 hospitals, health systems, pharmaceutical and biotech companies, health care insurers and medical device and supply companies. Within these organizations, our programs also serve a range of constituencies, including both the executive suite and the broader management team. Our programs currently reach over 4,000 chief executive and chief operating officers and 40,000 senior executives, clinical leaders, department heads and product line managers. No one member accounted for more than 2% of revenues in any of the last three fiscal years.
At the same time, we continually strive to involve some of the country’s most progressive health care companies in our membership. The participation of these members provides us with a window on the latest challenges confronting the health care industry and the most innovative best practices that we can share broadly throughout our membership. We serve 16 of the top 17 hospitals in theU.S. News and World Report 2002 America’s Best Hospitalsranking, 86 of the largest 100 health care delivery systems and 12 of the world’s 24 largest pharmaceutical companies were members.
The following table sets forth information with respect to membership programs, members and renewals as of the dates shown:
| March 31, | ||||||||||||||||||||
| 2000 | 2001 | 2002 | 2003 | 2004 | ||||||||||||||||
| Membership programs offered | 6 | 12 | 15 | 18 | 21 | |||||||||||||||
| Total members | 1,988 | 2,086 | 2,170 | 2,297 | 2,347 | |||||||||||||||
| Member renewal rate(1) | 86 | % | 86 | % | 88 | % | 89 | % | 87 | % | ||||||||||
| Contract value (in thousands of dollars)(2) | $ | 58,122 | $ | 69,873 | $ | 86,108 | $ | 106,745 | $ | 124,929 | ||||||||||
| (1) | For the year then ended. The percentage of member institutions at the beginning of a fiscal year that hold one or more memberships in any of our programs at the beginning of the next fiscal year, adjusted to reflect mergers, acquisitions or different affiliations of members that result in changes of control over individual institutions. | |||
| (2) | The aggregate annualized revenue attributed to all agreements in effect at a given point in time, without regard to the initial term or remaining duration of any such agreement. | |||
Programs and Services
Programs
We offer 21 distinct membership programs focused on identifying best-demonstrated management practices, critiquing widely-followed but ineffective practices, analyzing emerging trends within the health care industry, and supporting institutions’ efforts to adopt best practices to improve their own performance. Each year, our staff of research managers and analysts conducts thousands of interviews with health care industry executives on a large number of substantive areas, including:
| • | health care industry strategy | |||
| • | health care marketing | |||
| • | revenue management and product line development | |||
| • | health system cost reduction and clinical reform | |||
| • | nursing recruitment, retention and productivity | |||
| • | hospital department operations | |||
| • | pharmaceuticals and medical device technology | |||
We focus senior management on important problems by providing an unbiased, objective analysis of best practices used by some of the most successful health care companies to solve those problems, and by providing tools to accelerate the adoption of best practices within our member institutions.
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We believe our programs offer a cost-effective, time-efficient opportunity for senior executives to learn from the practices and experiences of other health care companies from around the country. We believe that member institutions can participate in and benefit from one of our programs for a fraction of the cost and time of proceeding independently either through an internal research project or by engaging a management consulting firm. At the same time, our program members receive a wide array of valuable, timely information derived from lessons learned from the industry’s most progressive participants. In fiscal 2004, we published 53 best practices research studies, provided executive education services to over 2,000 member companies reaching more than 40,000 executive and managerial participants, produced over 3,000 research briefs and delivered daily executive briefings via our password-protected website and email to over 30,000 executives.
Each research program is run by a research director who is responsible for applying our standard research methodologies to produce best practices studies and for maintaining the quality of all program services. Relying on member steering sessions, member topic polls and one-on-one interviews with top industry executives, each research director identifies the most timely and important topics of shared member interest and sets the program’s research priorities in an annual agenda. The annual agenda is used to communicate potential best practices study topics and associated program services to participating members, although the actual studies and services delivered to members across the corresponding time period may vary from what is described in the agenda. A team of research analysts and instructors is dedicated to each program, collectively researching the topics on the program agenda, writing the best practices studies and providing all other program services.
We currently offer 21 programs organized into two key practice areas, each of which targets a different executive constituency or business function. Our health care strategy programs serve CEOs, CFOs, board members, senior-most marketing and planning executives and major product line managers and focus on broad industry trends and business issues. Our health care operations programs serve executives and general managers operating key divisions and departments within health care companies and focus on operational issues such as process improvement, cost reduction, productivity and quality improvement. Within each practice area, we offer one or more platform programs focusing on enterprise-wide strategic or operational issues and serving senior executives within the organization, as well as more targeted programs which focus on specific strategic and operational issues and serve executives deeper within a member company.
Services
Each program charges a separate annual membership fee. The program fee is fixed for the duration of the membership agreement and entitles participating members to access all of a program’s membership services. The specific membership services vary by program and change over time as services are periodically added or removed. Our program services primarily include best practices research studies, executive education, daily on-line executive briefings, original executive inquiry service, best practices installation support and on-line access to proprietary content databases. Health care companies can only access our services within a program if they are members of the relevant program. A description of these services follows:
Best Practices Research Studies
Each best practices research study generally addresses a specific strategic challenge, operational issue or management concern. In fiscal 2004, we published 53 best practices research studies. Each research program typically publishes two to five best practices research studies annually. We design each study to present the conclusions and supporting best practices in a graphical format, enabling the intended audience to quickly assimilate the 100 to 250 pages of research content.
Each study comprises two principal elements — the essay and the best practices. The essay consists of a series of observations and supporting evidence that frames the problems or business issues, helping to communicate the need for change or action to the membership at large. Each study typically contains up to 20 best practices, and each best practice generally features a ten- to 15-page case study of narrative text, graphics and supporting analytical detail describing how the best practice works, how it was implemented and the best practice’s costs and benefits. In many cases, we assign pseudonyms to protect the confidentiality of proprietary information outlined in a study. Consistent application of our research methodology across all programs enables us to increase the number of our programs while maintaining research quality.
Every stage in the research and writing of a best practices study is highly standardized — from topic selection to secondary research, primary research and interviewing, root cause problem analysis, best practices analysis, best practices construction and report writing. All research staff members receive extensive training in our proprietary research methodologies. In addition, program research directors and their teams can call upon our Chief Research Officer to provide assistance in conducting economic analyses, screening best practices, editing reports and creating best practices installation support tools.
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Our best practices research and the resulting reports provide us with the intellectual capital that supports other services that we offer member companies. In the course of preparing a best practices study, a research team typically will review thousands of pages of business and academic literature to ground their understanding of the issues. Then they will conduct hundreds of in-depth interviews with health care companies, industry experts, consultants and academic leaders to identify and evaluate specific business strategies and management practices. During the course of its research, a team generally evaluates dozens of management practices to isolate those practices worthy of potential implementation by members, separating out demonstrated and proven business practices from those, whether popular or conventional, that largely have failed.
Executive Education
Relying on our proprietary best practices research, we deliver an executive education curriculum to member institutions nationwide. We offer executive education services through two channels — general membership meetings and presentations or facilitated discussions conducted on-site at member organizations. In either case, we use lively, interactive discussions to provide a deeper understanding of the best practices covered in our published reports. In fiscal 2004, we delivered executive education services to over 2,000 member organizations, reaching more than 40,000 executive participants. The executive education services are also an important lead generator for cross-selling new programs to existing members.
In certain programs, we host general membership meetings across the country, presenting the most important research findings from our annual program agendas to groups of 20 to 200 members. In fiscal 2004, we hosted more than 100 member meetings in the United States, and one meeting each in Australia and the United Kingdom.
Certain programs may also provide on-site executive education seminars and facilitated discussions as part of their membership services. Members of these programs can request to schedule an Advisory Board faculty member to travel to their organization to deliver executive education modules, typically one- to four-hour lectures, case studies or facilitated working group discussions, of the member’s choice. In fiscal 2004, we conducted over 3,000 on-site seminars at member organizations.
We deploy a staff of more than 30 full-time and part-time faculty who conduct the on-site education seminars. We update our library of executive education modules throughout the year as we translate new best practices research into executive education content.
Executive Briefings
To provide our member organizations with industry news and best practices on a more frequent basis than is possible with our longer reports, certain programs produce executive briefings that provide short, comprehensive summaries of our research findings, best practices, benchmark data and industry news. We provide two types of executive briefings, each available to our members through our password-protected website and by email.
Briefings.Each day, our editorial team reviews the nation’s health care news drawn from over 250 sources — including daily newspapers, news wires, magazines, clinical journals and city business journals — and summarizes relevant industry business and clinical news in a five- to ten-page report. We produce two versions of our Briefings, a daily briefing targeting health care executives, and a bi-weekly briefing for physician leaders.
Executive Watches.Our Executive Watch reports provide best practices, benchmark data and industry news for specific executive constituencies within health care companies. We currently produce six Executive Watch reports for the following executive constituencies: chief financial officers; chief nursing officers; senior marketing and planning executives; chief medical officers; cardiac administrators; and oncology administrators. Our Executive Watch reports are updated throughout the week.
Original Executive Inquiry Service
Certain programs permit members to assign short-answer, customized research requests to our research staff through our original executive inquiry service. Depending on the need of the requesting member, completed projects may include literature searches, vendor profiles, benchmark data or original primary research.
Original executive inquiry projects generally take 5 to 15 days to complete, depending on the depth of the information request and the type of research product desired. Our most in-depth research briefs generally contain two to four case study profiles of interviewed institutions, highlighting significant trends, successful practices and comparative responses to a range of questions. After we have completed and delivered the written brief to the requesting member, we make many of these briefs accessible to other members of the same program through our proprietary database.
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We believe that the original executive inquiry service builds our proprietary database and further encourages members to view us as a reliable and effective resource for best practices research.
Best Practices Installation Support
Seven of our programs provide members with support in installing the best practices profiled in our research studies within their own organizations. We offer members a standardized package of management tools supplemented by approximately five on-site sessions to educate relevant executives and line managers in their use. The majority of management tools and on-site curriculum derive from research content, data and documents gathered in the research process used to produce our best practices research studies, enabling us to create best practices installation modules quickly and for a low incremental cost. Our installation support includes both the management tools and the associated on-site sessions and is packaged and delivered to each member typically over a 12-month period.
We offer two types of management tools. The first type is diagnostic tools, which include self-assessment tests, data workbooks and discussion guides to help members select those best practices most likely to have a large impact within their own organizations. The second type is installation tools, which include task checklists, process flow diagrams, results-reporting templates, project plans, job descriptions, budgets, management reports, forms, surveys, policies and procedures, organization charts, memos and benchmark data, designed to help members implement particular best practices. By using our installation tools, members benefit from work already completed by other members, saving them time, cost and effort by providing tools proven successful in installing a best practice.
On-site education sessions are designed to help members organize, structure and manage an internal project team tasked with installing one or more best practices. Our on-site sessions help members reach internal consensus and develop action plans for installing best practices and tracking results.
Proprietary Database and On-line Services
Each research program maintains a password-protected proprietary electronic database of best practices and, in most cases, on-line quantitative benchmarking and survey data accessible only to members of the research program. We continually update our databases with new management practices, management tools, quantitative performance data and related information supplied by our members and derived by our researchers. Through password-protected Web sites, members of each program may commission customized research briefs, search and access the electronic library of research studies and graphics, review executive education modules, access our proprietary decision support tools and meeting schedules and communicate with our staff and other members. We include all information and graphics generated in best practices research studies and customized research briefs in the databases and make them accessible to member executives and our staff.
Since 1996, we have been offering our members Internet access to selected research content and other services in a digital format through a password-protected Internet site. The Internet has become an efficient and effective means for us to interact with our members and to deliver our products and services to our members and currently is our largest distribution channel. By providing a wide array of tools and content to our members online, we achieve deep penetration into each of our member organizations, allowing a broader group of executives, managers and front-line leaders access to critical support required for both their daily and more strategic decisions. As of March 31, 2004, our proprietary databases contained more than 30,000 profiles of management practices.
Pricing
We sell substantially all memberships in our programs as one-year agreements. Each program charges a separate fixed annual membership fee. Annual fees vary by program based on the target executive constituency and the specific combination of services provided to participating members. Annual fees for programs that offer best practices installation support generally are higher than annual fees for programs that do not offer this service. The annual fees paid by members within the same program also vary based on the size of the member institution and the total number of program memberships the member purchases. Membership fees may also be lower for the initial members of new programs. Membership agreements are generally paid in full within three months of the start of the membership period. All of our memberships also provide a pro rata service guarantee, which allows members to request a refund of the unexpired portion of their current year fee, pro rated from the start of the membership period.
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Sales and Marketing
At March 31, 2004, our sales force consisted of 60 new business development teams that are responsible for selling new memberships to assigned geographic market and program segments. Our two-person new business development teams sell programs to new clients as well as cross-sell programs to existing members of other programs. We also maintain approximately 25 separate member services teams of one to two people that are responsible for servicing and renewing existing memberships.
The separation of responsibility for new membership sales and membership renewals reflects the varying difficulty and cost of the respective functions. New business development representatives are compensated with a base salary and variable, goal-based incentive bonuses and travel on average 60% of the time, conducting face-to-face meetings with senior executives at current and prospective member institutions. Member services representatives assume more of an in-house coordinating role, conducting most of their responsibilities over the telephone.
Competition
We are not aware of any other entity that enables health care organizations to study as broad a range of best management practices for fixed annual fees. We compete indirectly against other professional information services providers, including consulting firms, market research firms and specialized providers of educational and training services. Other entities, such as state and national trade associations, group purchasing organizations, non-profit think-tanks and database companies, also offer research, consulting and education services to health care companies.
We believe that the principal competitive factors in our market include quality and timeliness of research and analysis, applicability and efficacy of recommendations, reliable delivery, depth and quality of the membership network, ability to meet changing customer needs, service and affordability. We believe we compete favorably with respect to each of these factors.
The Corporate Executive Board Company provides membership-based programs on a cross-industry basis that are similar to the types of programs that we sell to health care companies. We have a noncompetition agreement with The Corporate Executive Board Company that extends through January 1, 2007, which generally prohibits The Corporate Executive Board Company from selling programs to health care providers. This agreement also prohibits The Corporate Executive Board Company from selling programs to other types of health care organizations unless the programs address issues of a general business nature and are principally sold to companies and institutions not in the health care industry. This noncompetition agreement generally prohibits us from selling our programs to organizations principally engaged in businesses other than health care.
Employees
At March 31, 2004, we employed approximately 575 persons, all of whom are located at our headquarters in Washington, DC. None of our employees are represented by a collective bargaining arrangement. We believe that our relations with our employees are favorable.
We believe strongly in a culture of meritocracy, rewarding key contributors with opportunities for rapid professional growth and advancement as well as competitive compensation. Training is a critical job component for all of our employees, including industry analysis, economics, quantitative modeling, root-cause analysis and presentation skills.
Risk Factors
In addition to the other information in this Form 10-K, you should consider carefully the following risk factors in evaluating us and our business.
Our business is limited to the health care industry
We derive substantially all of our revenues from clients in the health care industry and, until January 1, 2007, are prohibited by an agreement with The Corporate Executive Board Company from selling our membership-based programs to companies and institutions principally engaged in businesses other than health care.
As a result, our business, financial condition and results of operations depend upon conditions affecting the health care industry generally and hospitals and health systems particularly. Our ability to grow will depend upon the growth of the health care industry generally as well as our ability to increase the number of programs and services that we sell to our members. Factors that adversely affect the revenues and cash flows of the health care industry, including operating results, capital requirements, regulation and litigation, can be expected to reduce the funds available for purchase of our products and services.
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We depend on renewals of our membership-based services
We derive most of our revenues from renewable memberships in our discrete annual programs. Our prospects therefore depend on our ability to achieve and sustain high renewal rates on existing programs and to enter into new membership arrangements. Failure to achieve high renewal rates would have a material adverse effect on our business, financial condition and operating results. Our success in securing renewals depends upon our ability to deliver consistent, high-quality and timely research and analysis with respect to issues, developments and trends that members view as important. We cannot assure you that we will be able to sustain the level of performance necessary to achieve a high rate of renewals and, as a result, we cannot assure you that we will be able to increase or even maintain our revenues.
Programs we launch in the future may not be successful
Our future success depends on our ability to develop new programs that serve specific health care constituencies and the changing needs of our current and prospective members for information, analysis and advice. We cannot assure you that our efforts to introduce new programs will be successful. Delays or failures during development or implementation, or lack of market acceptance, of new programs could have a material adverse effect on our business. Our business would be materially adversely affected if we were unable to develop and introduce successful new programs or other new services, or to make enhancements to existing programs, in a timely manner in response to member requirements.
We may experience difficulties sustaining a membership base in our installation support programs
Seven of our programs offer best practices installation support. These programs provide 12-month memberships to help participants accelerate the installation of best practices profiled in our research studies. Memberships in these programs are not individually renewable. In order to maintain our annual revenues and contract value from these programs, we will have to enroll new members each year as other members complete their 12-month program terms. We cannot assure you that we will be successful in selling these programs in the future. Lack of continued market acceptance of these programs could have a material adverse effect on our business.
We may experience difficulties in anticipating market trends
Our future success depends upon our ability to anticipate changing market trends and to adapt our research and analysis to meet the changing information and installation support needs of our members. We may not be able to provide helpful and timely research and analysis of developments and trends in a manner that meets market needs. Any such failure would have a material adverse effect on our business. The health care industry undergoes frequent and often dramatic changes, including the introduction of new and the obsolescence of old payments systems, changing regulatory environments, shifting strategies and market positions of major industry participants and changing objectives and expectations of health care consumers. This environment of rapid and continuous change presents significant challenges to our ability to provide our members with current and timely research, analysis and installation support on issues and topics of importance. Meeting these challenges requires the commitment of substantial resources. We cannot assure you that we will be able to meet these challenges.
Consolidation in the health care industry could adversely affect our business
Many health care providers, insurers, medical device companies and pharmaceutical companies have consolidated to create larger organizations. Further consolidation could reduce the number of current and potential clients for our services. A reduction in the size of our target market could have a material adverse effect on our business.
The larger organizations resulting from consolidation in the health care industry could have greater bargaining power, which could affect the current pricing structure for our services. In addition, group purchasing organizations and managed care organizations could increase pressure on providers of health care related services, like ourselves, to reduce prices. Our failure to maintain adequate pricing levels could have a material adverse effect on our business.
We must attract and retain a significant number of highly skilled employees
Our future success depends upon our ability to hire, train, motivate and retain a significant number of highly skilled employees, particularly research analysts and sales and marketing staff. Our inability to do so would have a material adverse effect on our business. We have experienced, and expect to continue to experience, intense competition for professional personnel from management consulting firms and other producers of research and analysis services. Many of these firms have substantially greater financial resources than we do to attract and compensate qualified personnel. We cannot assure you that we will be successful in attracting a sufficient number of highly skilled employees in the future, or that we will be successful in training, motivating and retaining the employees we are able to hire.
11
Potential liability claims may adversely affect our business
Our services, which involve recommendations and advice to health care providers regarding complex business and operational processes, regulatory and compliance issues and labor practices, may give rise to liability claims by our members or by third parties who bring claims against our members and us. Health care providers increasingly are the subject of litigation, and we cannot assure you that we would not also be the subject of such litigation based on our advice and services. A successful liability claim brought against us may adversely affect our reputation in the health care industry and could have a material adverse effect on our business, financial condition and results of operations. We cannot assure you that we would have adequate insurance coverage for claims against us.
Cost containment pressures on health care providers may adversely affect our business
Health care providers have come under increasing pressure to contain operating costs in response to changes in reimbursement rates and increases in labor costs driven by workforce shortages. Health care financing entities, such as Medicare, Medicaid and private health plans, periodically adjust reimbursement rates to health care providers in response to changes in government legislation or market pressure to slow the growth of health care costs. As a result, health care providers may pressure professional information services companies to lower the cost of the services they provide. Our failure to maintain our revenues or operating margin could have a material adverse effect on our business.
The expiration of our noncompetition agreement with The Corporate Executive Board Company may adversely affect our business
We have a noncompetition agreement with The Corporate Executive Board Company which generally prohibits The Corporate Executive Board Company from selling any membership-based products and services to health care providers. Additionally, The Corporate Executive Board Company is prohibited from selling such products and services to other types of health care organizations unless the products and services are of a general business nature and are principally sold to companies and institutions not in the health care industry. This agreement ends on January 1, 2007. After that date, The Corporate Executive Board Company may sell membership-based products and services in direct competition with us. Direct competition with The Corporate Executive Board Company may have a material adverse effect on our revenues.
Regulatory change in our market may adversely affect our business
Changing political, economic and regulatory influences on health care providers could have a material adverse effect on our business, financial condition and results of operations. These influences affect the purchasing practices and operations of health care organizations. Federal and state legislatures periodically have considered programs to reform or amend the United States health care system at both the federal and state level. These efforts could adversely affect our members by resulting in lower reimbursement rates for health care providers, which could change the environment in which providers operate and reduce the willingness or ability of our members to renew or pay for our products and services.
We may be unable to protect our intellectual property rights
We rely on copyright laws, as well as nondisclosure and confidentiality arrangements, to protect our proprietary rights in our products and services. We cannot assure you that the steps we have taken to protect our intellectual property rights will be adequate to deter misappropriation of our rights or that we will be able to detect unauthorized uses and take timely and effective steps to enforce our rights. If unauthorized uses of our proprietary products and services were to occur, we might be required to engage in costly and time-consuming litigation to enforce our rights. We cannot assure you that we would prevail in such litigation. If others were able to use our intellectual property, our ability to charge fees for our services would be adversely affected.
We may be exposed to litigation related to content
As a publisher and distributor of original research and analysis and user of licensed third-party content, we face potential liability for defamation, negligence and copyright and trademark infringement. Any such litigation, whether or not resulting in a judgment against us, could have a material adverse effect on our business, financial condition and results of operations. Third-party content includes information created or provided by information services organizations and consultants whom we retain and may be delivered in writing, over the Internet or orally to our members.
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We may face damage to our professional reputation or legal liability if our clients are not satisfied with our services
As a provider of best practices research and analysis, our professional reputation is an important factor in attracting and retaining our members and in building relationships with the progressive health care companies that supply many of the best practices we feature in our research. If members were to become dissatisfied with the quality of our best practices research and the services we provide, our professional reputation could be damaged. If we fail to meet our contractual obligations, we could be subject to legal liability or loss of client relationships.
We may not be able to fully realize our deferred tax asset
For tax purposes, we have deferred income taxes consisting primarily of net operating loss carry forwards for regular federal and state income tax purposes generated from the exercise of common stock options. In estimating future tax consequences, Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” generally considers all expected future events in the determination and evaluation of deferred tax assets and liabilities. We believe that our future taxable income will be sufficient for the full realization of the deferred income taxes. However, Statement of Financial Accounting Standards No. 109 does not consider the effect of future changes in existing tax laws or changes in existing tax rates in the determination and evaluation of deferred tax assets and liabilities until the new tax laws or rates are enacted. If the tax laws or rates are changed, if we are approved as a Qualified High Technology Company for Washington, DC taxes, or if our future taxable income is less than what we believe it will be, we may not be able to fully realize our deferred tax asset.
There may be risks related to our status as a Qualified High Technology Company.
The Office of Tax and Revenue of the Government of the District of Columbia (the “Office of Tax and Revenue”) has adopted regulations in accordance with the New E-Conomy Transformation Act of 2000 (the “Act”) that modify the income and franchise tax, sales and use tax and personal property tax regulations, effective April 2001. Specifically, the regulations provide certain credits, exemptions and other benefits to a Qualified High Technology Company (“QHTC”). We have performed an analysis to support our position that we meet the definition of a QHTC under provisions of the Act. As a QHTC, our Washington, D.C. statutory income tax rate will be 0.0% for five years and 6.0% thereafter, versus 9.975% prior to this qualification, and we are eligible for certain Washington, D.C. income tax credits and other benefits. We have filed a claim for refund of sales and use taxes previously paid to the Office of Tax and Revenue and are currently in discussions with the Office of Tax and Revenue regarding our claim. We cannot assure you that the Office of Tax and Revenue will accept our application and approve us for status as a QHTC under the Act, or that our business activities and operations will continue to qualify as QHTC activities under the Act in the future.
Item 2. Properties.
The lease on our former headquarters facility expired May 31, 2004. As of June 1, 2004, our headquarters are located in approximately 106,000 square feet of office space in Washington, DC. The facilities accommodate research, marketing and sales, information technology, administration, graphic services and operations personnel. We lease our office facilities, and the lease expires in June 2019. The terms of the lease on the new facility contain provisions for rental escalation and we are required to pay our portion of executory costs such as taxes and insurance. We are also obligated to take additional expansion space in the building pursuant to the lease. We believe that our facilities are adequate for our current needs and that additional facilities are available for lease to meet any future needs.
Item 3. Legal Proceedings.
From time to time, we are subject to ordinary routine litigation incidental to our normal business operations. We are not currently a party to, and our property is not subject to, any material legal proceedings.
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Item 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of The Advisory Board Company was held on February 25, 2004. The following is a tabulation of the voting on the proposal presented at the Annual Meeting of Stockholders:
Proposal No. 1 — Election of Directors
| Elected Director | Votes For | Votes Withheld | ||||||
| Marc N. Casper | 13,797,404 | 649,464 | ||||||
| Michael A. D’Amato | 13,759,965 | 686,903 | ||||||
| Kelt Kindick | 13,803,804 | 643,064 | ||||||
| Joseph E. Laird, Jr. | 13,821,834 | 625,034 | ||||||
| Frank J. Williams | 13,891,915 | 554,953 | ||||||
| Jeffrey D. Zients | 13,817,135 | 629,733 | ||||||
| LeAnne M. Zumwalt | 14,028,188 | 418,680 | ||||||
The directors elected pursuant to the foregoing proposal constitute all of the members of our board of directors.
Proposal No. 2 — Appointment of Ernst & Young, LLP as Independent Auditors for the Fiscal Year Ending March 31, 2004.
The appointment of Ernst & Young LLP was ratified.
| Shares voted FOR | 13,892,579 | |||
| Shares voted AGAINST | 554,031 | |||
| Shares voted to ABSTAIN | 258 |
Next Annual Meeting and Stockholder Proposals
The next annual meeting of stockholders was originally scheduled for August 25, 2004. We are changing the date of the annual meeting of stockholders to November 15, 2004, at 10:00 a.m. Eastern Standard Time, at our offices at 2445 M Street, NW, Washington, DC, 20037. Under Securities and Exchange Commission rules, any stockholder who intends to present a proposal at the next annual meeting of stockholders must submit the proposal to us at our principal executive offices, pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, no later than July 22, 2004, which is a reasonable time before we begin to print and mail our proxy materials, and must satisfy the other requirements of Rule 14a-8 under the Securities Exchange Act of 1934 in order for the proposal to be considered for inclusion in our Proxy Statement and Proxy Card for that meeting. Any stockholder who wishes to bring a proposal before our next annual meeting of stockholders, but does not wish to include it in our proxy materials, or wishes to nominate one or more persons to serve as Directors, must provide written notice of the proposal to our Secretary at our principal executive offices after August 6, 2004, and before August 17, 2004, and must satisfy the requirements of our Bylaws. If a stockholder making such a proposal does not also satisfy the requirements of Rule 14a-4(c) under the Securities Exchange Act of 1934, we may exercise discretionary voting authority over proxies we solicit in determining how to vote on the proposal.
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PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters, Issuer Purchases of Equity Securities.
Our common stock has been quoted on the Nasdaq National Market under the symbol “ABCO” since our initial public offering on November 12, 2001. As of June 4, 2004, there were eight stockholders of record of the common stock. The following table sets forth, for the periods indicated, the high and low sales prices per share of our common stock as reported on the Nasdaq National Market.
| High | Low | |||||||
Fiscal Year Ending March 31, 2003: | ||||||||
| First quarter | $ | 43.34 | $ | 31.76 | ||||
| Second quarter | 37.46 | 26.37 | ||||||
| Third quarter | 35.04 | 25.31 | ||||||
| Fourth quarter | 35.02 | 28.85 | ||||||
Fiscal Year Ending March 31, 2004: | ||||||||
| First quarter | $ | 41.40 | $ | 33.57 | ||||
| Second quarter | 48.74 | 38.74 | ||||||
| Third quarter | 47.94 | 31.74 | ||||||
| Fourth quarter | 40.47 | 32.13 | ||||||
We have not declared or paid any cash dividend on our common stock since the closing of our initial public offering. We do not anticipate declaring or paying any cash dividends in the foreseeable future. The timing and amount of future cash dividends, if any, would be determined by our Board of Directors and would depend upon our earnings, financial condition and cash requirements.
The remaining information called for by this item relating to “Securities Authorized for Issuance Under Equity Compensation Plans” is included in Item 12 of Part III of this Form 10-K.
Issuer Purchases of Equity Securities
In January 2004, our Board of Directors authorized the repurchase of up to $50 million of our common stock in the open market and privately negotiated transactions subject to market conditions. No minimum number of shares has been fixed.
| Total Number | Approximate | |||||||||||||||
| Of Shares | Dollar Value of | |||||||||||||||
| Purchased as | Shares That | |||||||||||||||
| Part of a | May Yet Be | |||||||||||||||
| Total Number | Average Price | Publicly | Purchased | |||||||||||||
| Of Shares | Paid | Announced | Under | |||||||||||||
| Purchased | Per Share | Plan | The Plan | |||||||||||||
| January 1, 2004 to January 31, 2004 | — | $ | — | — | $ | 50,000,000 | ||||||||||
| February 1, 2004 to February 29, 2004 | — | $ | — | — | $ | 50,000,000 | ||||||||||
| March 1, 2004 to March 31, 2004 | 349,320 | $ | 34.84 | 349,320 | $ | 37,830,595 | ||||||||||
| Total | 349,320 | $ | 34.84 | 349,320 | ||||||||||||
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Item 6. Selected Financial Data
The following table sets forth selected financial and operating data. The selected financial data presented below as of March 31, 2000 and 2001, and for the two fiscal years in the period ended March 31, 2001, have been derived from our financial statements which have been audited by Arthur Andersen LLP, independent public accountants. The selected financial data presented below as of March 31, 2002, 2003 and 2004 and for the three fiscal years in the period ended March 31, 2004, have been derived from our financial statements which have been audited by Ernst & Young LLP, independent auditors. You should read the selected financial data presented below in conjunction with our financial statements, the notes to our financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Form 10-K.
| Fiscal Year Ended March 31, | ||||||||||||||||||||
| 2000 | 2001 | 2002 | 2003 | 2004 | ||||||||||||||||
| (In thousands except per share amounts) | ||||||||||||||||||||
Statement of Operations Data: | ||||||||||||||||||||
| Revenues | $ | 58,535 | $ | 63,727 | $ | 80,970 | $ | 100,714 | $ | 121,847 | ||||||||||
| Costs and expenses: | ||||||||||||||||||||
| Cost of services (excluding special compensation and stock option related expenses of $1,766, $1,821, $645, $615 and $560) (1) (2) | 27,441 | 33,644 | 37,142 | 41,598 | 50,167 | |||||||||||||||
| Member relations and marketing (excluding special compensation and stock option related expenses of $836, $679, $0, $133 and $256) (1) (2) | 8,741 | 12,588 | 16,100 | 19,842 | 24,599 | |||||||||||||||
| General and administrative (excluding special compensation and stock option related expenses of $408, $344, $837, $399 and $857) (1) (2) (3) | 8,524 | 9,768 | 10,659 | 12,507 | 15,445 | |||||||||||||||
| Depreciation and loss on disposal of fixed assets | 1,762 | 1,539 | 2,030 | 1,827 | 1,415 | |||||||||||||||
| Special compensation and stock option related expenses (1) (2) | 3,010 | 2,844 | 1,482 | 1,147 | 1,673 | |||||||||||||||
| Affiliate company charge (4) | 4,097 | 4,505 | 2,676 | — | — | |||||||||||||||
| Total costs and expenses | 53,575 | 64,888 | 70,089 | 76,921 | 93,299 | |||||||||||||||
| Income (loss) from operations | 4,960 | (1,161 | ) | 10,881 | 23,793 | 28,548 | ||||||||||||||
| Interest income | 592 | 471 | 453 | 1,038 | 2,911 | |||||||||||||||
| Income (loss) before (provision) benefit for income taxes | 5,552 | (690 | ) | 11,334 | 24,831 | 31,459 | ||||||||||||||
| (Provision) benefit for income taxes (5) | (559 | ) | 68 | (1,358 | ) | (10,392 | ) | (12,739 | ) | |||||||||||
| Net income (loss) | $ | 4,993 | $ | (622 | ) | $ | 9,976 | $ | 14,439 | $ | 18,720 | |||||||||
| Earnings (loss) per share: | ||||||||||||||||||||
| Net income (loss) per share — basic | $ | 0.36 | $ | (0.04 | ) | $ | 0.73 | $ | 1.10 | $ | 1.19 | |||||||||
| Net income (loss) per share — diluted | $ | 0.34 | $ | (0.04 | ) | $ | 0.62 | $ | 0.85 | $ | 1.00 | |||||||||
| Basic weighted average number of shares outstanding | 13,977 | 13,977 | 13,748 | 13,139 | 15,745 | |||||||||||||||
| Diluted weighted average number of shares outstanding | 14,725 | 13,977 | 16,089 | 16,996 | 18,680 | |||||||||||||||
| March 31, | ||||||||||||||||||||
| 2000 | 2001 | 2002 | 2003 | 2004 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
Balance Sheet Data: | ||||||||||||||||||||
| Cash and cash equivalents and marketable securities | $ | 5,433 | $ | 20,853 | $ | 23,959 | $ | 90,407 | $ | 139,809 | ||||||||||
| Working capital (deficit) | (13,662 | ) | (6,793 | ) | (20,374 | ) | (18,110 | ) | (6,293 | ) | ||||||||||
| Total assets | 29,195 | 44,009 | 48,506 | 117,923 | 203,999 | |||||||||||||||
| Deferred revenues | 29,592 | 39,270 | 51,538 | 63,653 | 72,410 | |||||||||||||||
| Total stockholders’ (deficit) equity | (10,229 | ) | (1,531 | ) | (16,587 | ) | 41,495 | 115,623 | ||||||||||||
| March 31, | ||||||||||||||||||||
| 2000 | 2001 | 2002 | 2003 | 2004 | ||||||||||||||||
Other Operating Data: | ||||||||||||||||||||
| Membership programs offered | 6 | 12 | 15 | 18 | 21 | |||||||||||||||
| Total members | 1,988 | 2,086 | 2,170 | 2,297 | 2,347 | |||||||||||||||
| Member renewal rate(6) | 86 | % | 86 | % | 88 | % | 89 | % | 87 | % | ||||||||||
| Contract value (in thousands)(7) | $ | 58,122 | $ | 69,873 | $ | 86,108 | $ | 106,745 | $ | 124,929 | ||||||||||
| Contract value per member(8) | $ | 29,236 | $ | 33,496 | $ | 39,681 | $ | 46,472 | $ | 53,229 | ||||||||||
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| March 31, | ||||||||||||
| 2000 | 2001 | 2002 | ||||||||||
Pro forma data (unaudited): (9) | ||||||||||||
| Income (loss) before pro forma provision for income taxes | $ | 5,552 | $ | (690 | ) | $ | 11,334 | |||||
| Pro forma (provision) benefit for income taxes (5) | (2,360 | ) | 293 | (4,817 | ) | |||||||
| Pro forma net income (loss) | $ | 3,192 | $ | (397 | ) | $ | 6,517 | |||||
| Pro forma earnings (loss) per share: | ||||||||||||
| Net income (loss) per share — basic | $ | 0.23 | $ | (0.03 | ) | $ | 0.47 | |||||
| Net income (loss) per share — diluted | $ | 0.22 | $ | (0.03 | ) | $ | 0.45 | |||||
| Basic weighted average number of shares outstanding | 13,977 | 13,977 | 13,748 | |||||||||
| Diluted weighted average number of shares outstanding | 14,472 | 13,977 | 14,403 | |||||||||
| (1) | As a private company, we entered into special equity-based compensation arrangements with key employees. These arrangements were predominantly the repurchase of stock options and a special bonus paid to optionholders. Since our initial public offering, we have not entered, and we do not anticipate that in the future we will enter, into any special compensation arrangements. | |
| (2) | We recognized approximately $781,000 and $1,673,000 in compensation expense reflecting additional Federal Insurance Corporation Act taxes as a result of the taxable income that the employees recognized upon the exercise of common stock options in fiscal 2003 and fiscal 2004, respectively. | |
| (3) | General and administrative expenses prior to fiscal 2003 include certain amounts paid to DGB Enterprises, Inc., a corporation owned by our former principal stockholder, for management services. See note 9 to our financial statements for more information regarding these charges. Since our initial public offering, we provide these management services internally at a cost similar to the amounts paid to DGB Enterprises in the past. | |
| (4) | Charges from DGB Enterprises, Inc. for strategic direction and oversight. See note 9 to our financial statements for more information regarding these charges. As of October 1, 2001, our newly constituted Board of Directors began to provide strategic direction and oversight services and, consequently, we no longer pay the affiliate company charge. | |
| (5) | In conjunction with our initial public offering, our S corporation election terminated and we are now subject to U.S. federal and state income taxes at prevailing corporate rates. | |
| (6) | The percentage of member institutions at the beginning of a fiscal year that hold one or more memberships in any of our programs at the beginning of the next fiscal year, adjusted to reflect mergers, acquisitions or different affiliations of members that result in changes of control over individual institutions. | |
| (7) | The aggregate annualized revenue attributed to all agreements in effect at a given point in time, without regard to the initial term or remaining duration of any such agreement. | |
| (8) | Total contract value divided by the number of members. | |
| (9) | A reconciliation of historical to pro forma results is presented to provide comparisons with prior periods in a manner we believe would be consistent if we had been a C corporation for fiscal 2002 and prior years, utilizing an effective tax rate of 42.5%. |
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
We provide best practices research and analysis across the health care industry. Best practices research identifies and analyzes specific management initiatives, processes and strategies that have been determined to produce the best results in solving common business problems or challenges. Members of each program are typically charged a fixed annual fee and have access to an integrated set of services, including best practices research studies, executive education seminars, customized research briefs and web-based access to the program’s content database and decision support tools.
Our revenues grew 21.0% in fiscal 2004 over fiscal 2003, and grew 24.4% in fiscal 2003 over fiscal 2002. We increased our contract value by 17.0% at March 31, 2004 over March 31, 2003, and by 24.0% at March 31, 2003 over March 31, 2002. We define contract value as the aggregate annualized revenue attributed to all membership agreements in effect at a given point in time, without regard to the initial term or remaining duration of any such agreement.
Memberships in each of our fourteen best practices research programs are renewable at the end of their one-year membership contracts. Our remaining programs provide best practices installation support. These 12-month program memberships help participants accelerate the adoption of best practices profiled in our research studies, and are therefore not individually renewable. Renewable programs generated more than 80% of our revenues in fiscal 2004, with the balance of our revenues generated by programs providing installation support.
Costs associated with a new program initially increase more rapidly than revenues following introduction of the program because revenues associated with the new program are recognized ratably over the membership year while costs are expensed as incurred. Because we offer a standardized set of services, however, our program cost structure is relatively fixed and the incremental cost to serve an additional member is low. In fiscal 2004, our income from operations was $28.5 million, compared to $23.8 million in fiscal 2003.
Our operating costs and expenses consist of cost of services, member relations and marketing, general and administrative expenses and depreciation. Cost of services represents the costs associated with the production and delivery of our products and services. Member relations and marketing expenses include the costs of acquiring new members and renewing existing members. General and administrative expenses include the costs of human resources and recruiting, finance and accounting, management information systems, facilities management, new program development and other administrative functions.
We completed our initial public offering in November 2001. As a private company, we entered into the following arrangements which were discontinued in connection with our initial public offering. Accordingly, we believe the effect of these items on our historical financial statements are not indicative of future results.
| • | We entered into special equity-based compensation arrangements with key employees. These arrangements were predominantly the repurchase of stock options and a special bonus paid to optionholders in the absence of a public market for our stock. Since our initial public offering, we have not entered, and do not anticipate that in the future we will enter into any special compensation arrangements, although we incurred charges of $366,000 in fiscal 2003 with respect to arrangements entered into prior to our initial public offering. | |||
| • | We paid the affiliate company charge to DGB Enterprises, Inc., a corporation created by our former principal stockholder in 1997 to manage his various business interests, for strategic direction and oversight. As of October 1, 2001, our newly constituted Board of Directors began to provide this strategic direction and oversight and, consequently, we no longer pay the affiliate company charge. | |||
Prior to our initial public offering, we were treated as an S corporation for federal income tax purposes. As an S corporation, our taxable income or loss flowed through to, and was reportable by, our stockholders. Accordingly, we did not make any provision for federal income taxes in our financial statements for periods ending prior to the closing of our initial public offering. In conjunction with our initial public offering, our S corporation status terminated and we became subject to federal income taxes at prevailing corporate rates. The impact of this change resulted in a benefit for income taxes of $1.6 million during the three months ended December 31, 2001.
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Results of Operations
The following table shows statement of income data expressed as a percentage of revenues for the periods indicated.
| Fiscal Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Revenues | 100.0 | % | 100.0 | % | 100.0 | % | ||||||
| Costs and expenses: | ||||||||||||
| Cost of services (excluding special compensation and stock option related expenses of 0.8%, 0.6% and 0.4%) | 45.9 | 41.3 | 41.2 | |||||||||
| Member relations and marketing (excluding special compensation and stock option related expenses of 0.0%, 0.1% and 0.2%) | 19.9 | 19.7 | 20.2 | |||||||||
| General and administrative (excluding special compensation and stock option related expenses of 1.0%, 0.5% and 0.7%) | 13.2 | 12.4 | 12.7 | |||||||||
| Depreciation and loss on disposal of fixed assets | 2.5 | 1.8 | 1.2 | |||||||||
| Special compensation and stock option related expenses | 1.8 | 1.2 | 1.3 | |||||||||
| Affiliate company charge | 3.3 | — | — | |||||||||
| Total costs and expenses | 86.6 | 76.4 | 76.6 | |||||||||
| Income from operations | 13.4 | 23.6 | 23.4 | |||||||||
| Interest income | 0.6 | 1.0 | 2.4 | |||||||||
| Income before provision for income taxes | 14.0 | 24.6 | 25.8 | |||||||||
| Provision for income taxes | (1.7 | ) | (10.3 | ) | (10.4 | ) | ||||||
| Net income | 12.3 | % | 14.3 | % | 15.4 | % | ||||||
Fiscal years ended March 31, 2002, 2003 and 2004
Revenues.Total revenues increased 24.4% from $81.0 million in fiscal 2002 to $100.7 million in fiscal 2003, and increased 21.0% to $121.8 million in fiscal 2004. The increase in revenues was primarily due to the introduction and expansion of new programs, cross-selling existing programs to existing members, and, to a lesser degree, sales to new member organizations and price increases. We offered 15 membership programs as of March 31, 2002, 18 as of March 31, 2003 and 21 as of March 31, 2004. Our contract value increased 24.0% from $86.1 million at March 31, 2002 to $106.7 million at March 31, 2003, and increased 17.0% to $124.9 million at March 31, 2004. We define contract value as the aggregate annualized revenue attributed to all membership agreements in effect at a given point in time, without regard to the initial term or remaining duration of any such agreement.
Cost of services.Cost of services increased 12.0% from $37.1 million, or 45.9% of revenues, in fiscal 2002, to $41.6 million, or 41.3% of revenues, in fiscal 2003 and increased 20.6% to $50.2 million, or 41.2% of revenues in fiscal 2004. Costs associated with a new program initially increase more rapidly than revenues following introduction of the program because revenues associated with the new program are recognized ratably over the membership year while costs are expensed as incurred. Because we offer a standardized set of services, our program cost structure is relatively fixed and the incremental cost to serve an additional member is low. Consequently, while cost of services increased since fiscal 2002, it has decreased as a percentage of revenues.
Member relations and marketing.Member relations and marketing expense increased 23.2% from $16.1 million or 19.9% of revenues in fiscal 2002 to $19.8 million, or 19.7% of revenues, in fiscal 2003, and increased 24.0% to $24.6 million, or 20.2% of revenues, in fiscal 2004. The increase in member relations and marketing expense was primarily due to an increase in sales staff and related costs associated with the introduction of new programs, as well as an increase in member relations personnel and related costs to serve the expanding membership base.
General and administrative.General and administrative expense increased from $10.7 million, or 13.2% of revenues, in fiscal 2002 to $12.5 million, or 12.4% of revenues, in fiscal 2003, and increased to $15.4 million, or 12.7% of revenues, in fiscal 2004 with the development of new programs and the expansion of several administrative functions. The decrease as a percent of revenues in fiscal 2003 reflects the leveraging of resources across our larger revenue base. The increase in fiscal 2004 reflects increased investment in recruiting and hiring efforts in the member relations and new product development areas. General and administrative expense includes approximately $1.2 million, $0.7 million and $1.0 million in fiscal 2002, 2003 and 2004, respectively, of net charges from DGB Enterprises, Inc. for expenses related to management services, shared space and facilities and certain administrative functions. We believe these charges approximate the expense which would have been incurred had we provided the equivalent services internally. See note 9 to our financial statements for a detailed description of the administrative services agreement with DGB Enterprises, Inc.
Depreciation.Depreciation expense decreased from $2.0 million, or 2.5% of revenues in fiscal 2002, to $1.8 million, or 1.8% of revenues in fiscal 2003, and decreased to $1.4 million, or 1.2% of revenues in fiscal 2004. The decrease in fiscal 2003 was due to lower capital expenditures in fiscal 2002 and fiscal 2003 as compared to prior years. In fiscal 2004, we incurred construction costs in connection with our move to our new headquarters facility and depreciation expense may increase in future periods as a result.
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Special compensation and stock option related expenses.Special compensation and stock option related expenses decreased from $1.5 million in fiscal 2002 to $1.1 million in fiscal 2003, and increased to $1.7 million in fiscal 2004. Since our initial public offering, we have not entered into, and we do not anticipate that we will enter in the future, any special compensation arrangements. See note 11 to our financial statements for a detailed description of these arrangements. In fiscal 2003 and 2004, we recognized approximately $781,000 and $1.7 million in compensation expense reflecting additional Federal Insurance Corporation Act (FICA) taxes as a result of the taxable income that employees recognized upon the exercise of common stock options.
Affiliate company charge.Affiliate company charge was $2.7 million in fiscal 2002 and as of October 1, 2001, we no longer pay the affiliate company charge. See note 9 to our financial statements for more information regarding this charge.
Interest income. Interest income increased $2.9 million in fiscal 2004, from $1.0 million in fiscal 2003 and $453,000 in fiscal 2002. The growth was principally from income associated with the increased levels of cash, cash equivalents and marketable securities. Cash, cash equivalents and marketable securities increased as a result of cash flows from operating activities and cash flows from financing activities as further discussed in the liquidity and capital resources section below.
Provision for income taxes.We recorded a provision for income taxes of $12.7 million, $10.4 million and $7.1 million in fiscal 2004, 2003 and 2002, respectively. Our effective income tax rate decreased to 40.5% as of January 1, 2003 from 42.5% primarily due to an increase in the amount of tax-exempt interest income earned on our portfolio of cash and cash equivalents and marketable securities and, to a lesser extent, changes in states where income was generated.
We will amend our 2003 Washington, DC income tax return to file as a Qualified High Technology Company. If approved, our Washington, DC income tax rate would be reduced to 0.0% and we would incur a noncash charge to earnings of approximately $5.8 million, representing the impact on our existing deferred tax asset of lowering the Washington, DC income tax rate. For further information please see Note 7 to our consolidated financial statements included elsewhere in this Form 10-K.
Liquidity and Capital Resources
Cash flows from operating activities.Program memberships are generally payable by members at the beginning of the contract term. The combination of revenue growth and advance payment of memberships typically results in operating activities generating net positive cash flows on an annual basis. Net cash flows provided by operating activities were $19.9 million in fiscal 2002, $44.5 million in fiscal 2003 and $39.7 million in fiscal 2004. We had approximately $139.8 million in cash and cash equivalents and marketable securities at March 31, 2004. We expect that these funds and expected net positive cash flows from operations will satisfy working capital, financing activities and capital expenditure requirements for at least the next 12 months.
Cash flows from investing activities.Net cash flows used in investing activities during fiscal 2002 were $0.9 million, consisting of purchases of property and equipment. Net cash flows used in investing activities in fiscal 2003 were $57.0 million, consisting of purchases of marketable securities of $56.5 million and purchases of property and equipment of $0.5 million. We used net cash flows in investing activities in fiscal 2004 of $46.5 million, consisting of purchases of marketable securities of $54.7 million offset by $13.4 million in proceeds on the redemption of marketable securities and purchases of property and equipment of $5.2 million, which includes approximately $4.6 million of expenditures relating to our new headquarters facility discussed below.
Cash flows from financing activities.In fiscal 2002, we distributed $15.9 million to our pre-IPO stockholders, consisting of $13.0 million of cash and $2.9 million of offering costs and other cash distributions we paid in conjunction with our initial public offering. We generated $21.8 million and $14.9 million in cash from financing activities in fiscal 2003 and 2004, respectively, of which $21.5 million and $26.8 million, respectively, was from the receipt of cash for the exercise of stock options in conjunction with sales of our common stock by our employees. Also in fiscal 2003 and 2004, we received approximately $351,000 and $331,000, respectively, in proceeds from the issuance of common stock under our employee stock purchase plan. In January 2004, our Board of Directors authorized a share repurchase of up to $50 million of our common stock, and as of March 31, 2004, we had repurchased 349,320 shares of our common stock at a total cost of approximately $12.2 million.
The lease on our former headquarters facility expired May 31, 2004. As of June 1, 2004, our headquarters are located in approximately 106,000 square feet of office space in Washington, DC. The facilities accommodate research, marketing and sales, information technology, administration, graphic services and operations personnel. We lease our office facilities, and the lease expires in June 2019. The terms of the lease on the new facility contain provisions for rental escalation and we are required to pay our portion of executory costs such as taxes and insurance. We are also obligated to take additional expansion space in the building pursuant to the lease. We believe that our facilities are adequate for our current needs and that additional facilities are available for lease to meet any future needs.
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We have entered into a $3.2 million letter of credit agreement with a commercial bank which expires October 5, 2004, to provide a security deposit for our new office lease. We pledged certain assets as collateral under the letter of credit agreement. To date, no amounts have been drawn on this agreement.
The following summarizes certain of our contractual obligations at March 31, 2004 and the effect such obligations are expected to have on our liquidity and cash flows in future periods. These arrangements are more fully described in Notes 9 and 12 to the consolidated financial statements.
| Payments due by Period (in thousands) | ||||||||||||||||||||
| Total | <1 Year | 1-3 Yrs | 4-5 Yrs | >5 Yrs | ||||||||||||||||
| Non-cancelable operating leases | $ | 50,517 | $ | 3,131 | $ | 8,603 | $ | 7,622 | $ | 31,161 | ||||||||||
| Facilities services contract | 1,499 | 545 | 954 | — | — | |||||||||||||||
| Total | $ | 52,016 | 3,676 | $ | 9,557 | $ | 7,622 | $ | 31,161 | |||||||||||
At March 31, 2003 and 2004, we have 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.
Share Repurchase
In January 2004, we announced that our Board of Directors authorized a share repurchase of up to $50 million of our common stock. Repurchases will be made from time to time in open market and privately negotiated transactions subject to market conditions. No minimum number of shares has been fixed. We will fund our share repurchases with cash on hand and cash generated from operations.
Exercise of Certain Options
Options granted to certain of our optionholders under our 1997 and 2001 stock-based incentive compensation plans were exercised to acquire shares sold at various times in fiscal 2003 and fiscal 2004. Upon the exercise of these options we received a total of approximately $21.5 million in fiscal 2003 and $26.8 million in fiscal 2004 in cash in payment of option exercise prices.
We recognized approximately $781,000 and $1.7 million in compensation expense reflecting additional Federal Insurance Corporation Act taxes as a result of the taxable income that employees recognized upon the exercise of non-qualified common stock options in fiscal 2003 and 2004, respectively. We also incurred additional compensation expense for tax reporting purposes, but not for financial reporting purposes, that increased our deferred tax asset to reflect allowable tax deductions that will be realized in the determination of our income tax liability and therefore reduce our future income tax payments. In connection with these transactions, our deferred tax asset increased by approximately $20.9 million and $40.0 million in fiscal 2003 and 2004, respectively. Although our provision for income taxes in the consolidated statements of income did not change since the tax benefit associated with the option exercises is recorded directly into stockholders’ equity, our actual cash payments will be reduced as we utilize our deferred tax asset. As a result of the receipt of cash for the exercise of options, the incurrence of additional compensation expense and the recognition of a deferred tax asset, our stockholders’ equity increased by approximately $40.6 million and $65.1 million in fiscal 2003 and 2004, respectively, in connection with the exercise of stock options.
Significant Related Party Transactions
Transactions with DGB Enterprises, Inc.
Our founder, David G. Bradley owns a controlling interest in certain entities that operate in different industries from us. In 1997, our founder created DGB Enterprises, Inc. to manage his various business interests including his ownership in us. To achieve operating efficiencies, DGB Enterprises, Inc. consolidated certain management and administrative functions for these entities, and assumed the primary lease on office space used by these entities and shared with us. We entered into the following transactions with DGB Enterprises and these other interests as follows:
Management Services
DGB Enterprises, Inc. provided us with direct senior management services, which resulted in an allocation in the three months ended June 30, 2001 in the amount of $96,000, for compensation and related charges for our acting Chief Executive Officer. The Chief Executive Officer services charge was phased out in June 2001 when we hired a permanent Chief Executive Officer. We believe these charges approximate the costs which would have been incurred had we operated on a stand-alone basis.
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Administrative Services
From January 2000 to June 2001, the majority of our administrative functions, including recruiting, human resources, facilities and telecommunications, were provided under an administrative services agreement by DGB Enterprises, Inc., which provided similar services to all entities under our founder’s control. In July 2001, we entered into a new administrative services agreement whereby we assumed internal management of substantially all these administrative functions while DGB Enterprises, Inc. continued to provide us with services related to the facilities associated with our shared leased space. Under the new agreement we provide DGB Enterprises, Inc., and related entities owned or controlled by our founder, with a variety of administrative services including services related to information technology and support, payroll and accounting and recruiting. This new agreement has a two-year term. Fees for the services provided under all these agreements are based on direct costs per transaction, square footage, headcount or a fixed cost per month that approximates the cost for each entity to internally provide or externally source these services. We believe these net charges approximate the costs which would have been incurred had we operated on a stand-alone basis. We incurred net charges under all these arrangements in the amount of $1.1 million, $0.7 million and $1.0 million for fiscal 2002, 2003 and 2004, respectively.
Affiliate Company Charge
DGB Enterprises, Inc. assessed a fee for strategic direction and oversight services to us and to each of the entities controlled by our founder. The charge was calculated as a percentage of revenue. As of October 1, 2001, our newly constituted Board of Directors began to provide these services and the affiliate company charge, which amounted to $2.7 million in fiscal 2002, was eliminated.
Lease and Sublease Agreements
In fiscal 2000 we assigned our office lease to DGB Enterprises, Inc., transferred leasehold improvements related to our office space to DGB Enterprises, Inc. and subsequently entered into a sublease agreement with them on terms consistent with the original agreement. The lease agreement runs through May 2004. We incurred rent expense under this arrangement of $3.2 million, $3.4 million, and $3.6 million for fiscal 2002, 2003 and 2004, respectively.
Transactions with The Corporate Executive Board Company
In October 1997, the Company spun-off The Corporate Executive Board Company, a division that provided best practices research and analysis focusing on corporate strategy, operations and general management issues for non-health care companies.
We have a noncompetition agreement with The Corporate Executive Board Company which generally prohibits The Corporate Executive Board Company from selling any membership-based products and services to health care providers. Additionally, The Corporate Executive Board Company is prohibited from selling such products and services to other types of health care organizations unless the products and services are of a general business nature and are principally sold to companies and institutions not in the health care industry. This agreement ends on January 1, 2007. After that date, The Corporate Executive Board Company may sell membership-based products and services in direct competition with us, which may have a material adverse effect on our revenues.
In conjunction with the spin-off of The Corporate Executive Board Company and in order to assist in its transition to an independent corporation, we and The Corporate Executive Board Company entered into a royalty free license agreement, an administrative services agreement, a vendor contracts agreement and sublease agreement. Under these arrangements, we provided services of approximately $110,000 in fiscal 2002, and each of these arrangements has expired or been terminated.
Transactions with our Officers, Directors and Stockholders
Prior to our initial public offering, we made loans to Jeffrey D. Zients, our Chairman of the Board, and Michael A. D’Amato, one of our directors. In connection with our initial public offering in November 2001, we made cash and noncash distributions of $15.9 million, including these loans, to our then existing stockholders. We also distributed approximately $13.0 million in cash to our founder in May and June 2001. In addition, in April 2001 we funded a loan to Scott A. Schirmeier, our General Manager, Sales and Marketing, which was repaid with interest in December 2001.
In May 2001, we entered into a stock option agreement with our founder pursuant to which we had an option to purchase 4,564,061 shares of our common stock at $7.13 per share. This option was intended to provide us with shares to be issued upon the exercise of outstanding employee stock options so that our stockholders would not experience dilution because of the issuance of new shares upon such exercise. Our founder terminated this option immediately prior to our initial public offering by transferring shares of our common stock to us in an amount equal to the excess of the fair value of the stock over the exercise price of the option.
For more information on all of these transactions, see note 9 to our consolidated financial statements.
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Summary of Critical Accounting Policies
We have identified the following policies as critical to our business operations and the understanding of our results of operations. This listing is not a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. However, certain of our accounting policies are particularly important to the presentation of our financial position and results of operations and may require the application of significant judgment by our management; as a result they are subject to an inherent degree of uncertainty. In applying those policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, our observance of trends in the industry, information provided by our members and information available from other outside sources, as appropriate. For a more detailed discussion on the application of these and other accounting policies, see Note 2 to our consolidated financial statements. Our critical accounting policies include:
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenue recognition
Revenues from renewable research memberships and best practices installation support memberships are recognized over the term of the related subscription agreement, which is generally 12 months. Fees are generally billable, and the full amount of program agreement fees receivable and related deferred revenue are recorded, when a letter agreement is signed by the member. Certain fees are billed on an installment basis. Members may request a refund of their fees, which is provided on a pro rata basis relative to the length of the service period. As of March 31, 2002, 2003 and 2004, approximately $1.0 million, $0.3 million and $1.3 million, respectively, of deferred revenues were to be recognized beyond the following 12 months.
Cash equivalents and marketable securities
Included in cash equivalents are marketable securities that mature within three months of purchase. Investments with maturities of more than three months are classified as marketable securities. As of March 31, 2003 and 2004, the Company’s marketable securities consisted of U.S. government agency obligations and Washington, D.C. and other state tax-exempt notes and bonds. The Company’s marketable securities, which are classified as available-for-sale, are carried at fair market value based on quoted market prices. The net unrealized gains and losses on available-for-sale marketable securities are excluded from net income and are included within accumulated elements of comprehensive income. The specific identification method is used to compute the realized gains and losses on the sale of marketable securities. Current marketable securities have maturity dates within twelve months of the balance sheet date. The Company may not hold its marketable securities to maturity and may elect to sell the securities at any time.
Allowance for uncollectible revenue
Our ability to collect outstanding receivables from our members has an effect on our operating performance and cash flows. This effect is mitigated because memberships, which are predominantly annual contracts, are generally payable by members at the beginning of the contract term. We record an allowance for uncollectible revenue as a reduction of revenue based on our ongoing monitoring of our members’ credit and the aging of receivables.
Deferred incentive compensation
Direct incentive compensation related to the negotiation of new and renewal memberships is deferred and amortized on a straight line basis over the term of the related memberships.
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Deferred tax asset recoverability
For tax purposes, we have deferred income tax assets consisting primarily of net operating loss carry forwards for regular federal and state income tax purposes generated from the exercise of common stock options. In estimating future tax consequences, Statement of Financial Accounting Standards No. 109,Accounting for Income Taxes(SFAS No. 109) generally considers all expected future events in the determination and evaluation of deferred tax assets and liabilities. We believe that our future taxable income will be sufficient for the full realization of the deferred income taxes. However, SFAS No. 109 does not consider the effect of future changes in existing tax laws or rates in the determination and evaluation of deferred tax assets and liabilities until the new tax laws or rates are enacted. We have established our deferred income tax assets and liabilities using currently enacted tax law and rates. We will recognize an adjustment for the impact of new tax laws or rates on the existing deferred tax assets and liabilities when and if new tax laws or rates are enacted.
Washington, D.C. income tax incentives
The Office of Tax and Revenue of the Government of the District of Columbia (the “Office of Tax and Revenue”) has adopted regulations in accordance with the New E-Conomy Transformation Act of 2000 (the “Act”) that modify the income and franchise tax, sales and use tax, and personal property tax regulations, effective April 2001. Specifically, the regulations provide certain credits, exemptions and other benefits to a Qualified High Technology Company (“QHTC”).
We have performed an analysis to support our position that we meet the definition of a QHTC under the provisions of the Act. Accordingly, we will amend our 2003 Washington, DC income tax return and certain sales and use tax returns, to file as a QHTC. As a QHTC, our Washington, DC income tax rate will be 0.0% and we will be eligible for certain Washington, DC income tax credits. In addition, we will be entitled to relief from certain sales and use taxes. While we believe we qualify as a QHTC, we have not recognized the impact of this election within the financial statements for the fiscal year ended March 31, 2004 because of uncertainties inherent in the regulations, as adopted.
For financial reporting purposes, we have valued our deferred income tax assets and liabilities using Washington, DC’s currently enacted income tax rate of 9.975%. Additionally, we have continued to provide for income, sales and use taxes as if we were not a QHTC. However, if we had received a determination that we qualified for QHTC status, we would have recorded a charge to earnings of approximately $5.8 million, representing the effects on our existing deferred tax assets of reducing the Washington, DC income tax rate to 0.0%, net of any income tax credits discussed above. If we determine it is more likely than not that the Office of Tax and Revenue will accept our election as a QHTC, we will record the applicable charge. Additionally, we would recognize the refund of any previously paid or provided sales and use taxes at that time.
Recovery of long-lived assets
Long-lived assets and identifiable assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed. Impairment is identified by comparing the carrying value to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual dispositions. Impairment is measured and recorded on the basis of fair value determined using discounted cash flows. We consider expected cash flows and estimated future operating results, trends and other available information in assessing whether the carrying value of assets is impaired. We believe no such impairment existed as of March 31, 2004 or 2003.
Recent Accounting Pronouncements
In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51.” This interpretation of ARB No. 51, “Consolidated Financial Statements,” requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. We adopted FIN 46 as of March 31, 2004. The adoption had no impact on our consolidated financial statements.
In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” (“Issue 00-21”). Issue 00-21 provides guidance for determining the unit(s) of accounting in arrangements that include multiple products, services, and/or rights to use assets. The adoption of Issue 00-21 had no impact on the Company’s financial statements.
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate risk primarily through our portfolio of cash, cash equivalents and marketable securities, which is designed for safety of principal and liquidity. Cash and cash equivalents include investments in highly liquid U.S. Treasury obligations with maturities of less than three months. At March 31, 2004, our marketable securities consist of $16.0 million in tax-exempt notes and bonds issued by the District of Columbia, $3.0 million in tax-exempt notes and bonds issued by other states, and $79.4 million in U.S. government agency securities. The average maturity on all our marketable securities as of March 31, 2004 was approximately 4.9 years. We perform periodic evaluations of the relative credit ratings related to the cash, cash equivalents and marketable securities. This portfolio is subject to inherent interest rate risk as investments mature and are reinvested at current market interest rates. We currently do not use derivative financial instruments to adjust our portfolio risk or income profile. Due to the nature of our investments we have not prepared quantitative disclosure for interest rate sensitivity in accordance with Item 305 of Regulation S-K as we believe the effect of interest rate fluctuations would not be material.
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Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of The Advisory Board Company:
We have audited the accompanying consolidated balance sheets of The Advisory Board Company and subsidiaries as of March 31, 2003 and 2004, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended March 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Advisory Board Company and subsidiaries as of March 31, 2003 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2004, in conformity with U.S. generally accepted accounting principles.
| /s/ ERNST & YOUNG LLP | ||
| Baltimore, Maryland | ||
| April 28, 2004 |
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THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
| March 31, | ||||||||
| 2003 | 2004 | |||||||
ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 33,301 | $ | 41,389 | ||||
| Marketable securities | — | 3,737 | ||||||
| Membership fees receivable, net | 9,234 | 14,338 | ||||||
| Prepaid expenses and other current assets | 1,600 | 3,121 | ||||||
| Deferred income taxes | 11,532 | 17,123 | ||||||
| Deferred incentive compensation | 2,259 | 2,375 | ||||||
| Total current assets | 57,926 | 82,083 | ||||||
| Property and equipment, net | 2,891 | 6,701 | ||||||
| Deferred income taxes, net of current portion | — | 20,532 | ||||||
| Marketable securities | 57,106 | 94,683 | ||||||
| Total assets | $ | 117,923 | $ | 203,999 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Deferred revenues | $ | 63,653 | $ | 72,410 | ||||
| Accounts payable and accrued liabilities | 5,484 | 8,262 | ||||||
| Accrued incentive compensation | 6,899 | 7,704 | ||||||
| Total current liabilities | 76,036 | 88,376 | ||||||
| Long-term liabilities: | ||||||||
| Deferred income taxes | 392 | — | ||||||
| Total liabilities | 76,428 | 88,376 | ||||||
| Commitments and contingencies | ||||||||
| Stockholders’ equity: | ||||||||
| Preferred stock, $0.01 par value; 5,000,000 shares authorized, zero issued and outstanding | — | — | ||||||
| Common stock, $0.01 par value; 90,000,000 shares authorized, 14,779,567 and 18,323,526 shares issued at March 31, 2003 and 2004, respectively, and 14,779,567 and 17,974,206 shares outstanding at March 31, 2003 and 2004, respectively | 148 | 183 | ||||||
| Additional paid-in capital | 21,821 | 88,885 | ||||||
| Retained earnings | 18,974 | 37,694 | ||||||
| Accumulated elements of other comprehensive income | 552 | 1,031 | ||||||
| Treasury stock, zero and 349,320 shares at March 31, 2003 and 2004, respectively | — | (12,170 | ) | |||||
| Total stockholders’ equity | 41,495 | 115,623 | ||||||
| Total liabilities and stockholders’ equity | $ | 117,923 | $ | 203,999 | ||||
The accompanying notes are an integral part of these consolidated statements.
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THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Revenues: | $ | 80,970 | $ | 100,714 | $ | 121,847 | ||||||
| Costs and expenses: | ||||||||||||
| Cost of services (excluding special compensation and stock option related expenses of $645, $615 and $560) | 37,142 | 41,598 | 50,167 | |||||||||
| Member relations and marketing (excluding special compensation and stock option related expenses of $0, $133 and $256) | 16,100 | 19,842 | 24,599 | |||||||||
| General and administrative (excluding special compensation and stock option related expenses of $837, $399 and $857) | 10,659 | 12,507 | 15,445 | |||||||||
| Depreciation and loss on disposal of fixed assets | 2,030 | 1,827 | 1,415 | |||||||||
| Special compensation and stock option related expenses | 1,482 | 1,147 | 1,673 | |||||||||
| Affiliate company charge | 2,676 | — | — | |||||||||
| Total costs and expenses | 70,089 | 76,921 | 93,299 | |||||||||
| Income from operations | 10,881 | 23,793 | 28,548 | |||||||||
| Interest income | 453 | 1,038 | 2,911 | |||||||||
| Income before provision for income taxes | 11,334 | 24,831 | 31,459 | |||||||||
| Provision for income taxes | (1,358 | ) | (10,392 | ) | (12,739 | ) | ||||||
| Net income | $ | 9,976 | $ | 14,439 | $ | 18,720 | ||||||
| Earnings per share: | ||||||||||||
| Historical net income per share — basic | $ | 0.73 | $ | 1.10 | $ | 1.19 | ||||||
| Historical net income per share — diluted | $ | 0.62 | $ | 0.85 | $ | 1.00 | ||||||
| Basic weighted average number of shares outstanding | 13,748 | 13,139 | 15,745 | |||||||||
| Diluted weighted average number of shares outstanding | 16,089 | 16,996 | 18,680 | |||||||||
| Pro forma statements of income data (unaudited): | ||||||||||||
| Income before provision for income taxes, as reported | $ | 11,334 | ||||||||||
| Pro forma income tax provision | (4,817 | ) | ||||||||||
| Pro forma net income | $ | 6,517 | ||||||||||
| Pro forma net income per share — basic | $ | 0.47 | ||||||||||
| Pro forma net income per share — diluted | $ | 0.41 | ||||||||||
The accompanying notes are an integral part of these consolidated statements.
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THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share amounts)
| (Accumulated | ||||||||||||||||||||||||
| Common Stock | Additional | Promissory | Deficit) | |||||||||||||||||||||
| Paid-in | Deferred | Notes | Retained | |||||||||||||||||||||
| Shares | Amount | Capital | Compensation | Receivable | Earnings | |||||||||||||||||||
Balance at March 31, 2001 | 13,977,200 | $ | 140 | $ | 10,817 | $ | (700 | ) | $ | — | $ | (11,788 | ) | |||||||||||
| Cash distributions to stockholder | — | — | — | — | — | (12,971 | ) | |||||||||||||||||
| Deferred compensation pursuant to stock option repurchase agreements | — | — | — | (1,050 | ) | — | — | |||||||||||||||||
| Amortization of deferred compensation | — | — | — | 1,384 | — | — | ||||||||||||||||||
| Exercise of stock options | 1,023,872 | 10 | 3,544 | — | — | — | ||||||||||||||||||
| Issuance of promissory notes receivable | — | — | — | — | (3,346 | ) | — | |||||||||||||||||
| Interest earned on promissory notes | — | — | — | — | (100 | ) | — | |||||||||||||||||
| Net income - pre-termination of S corporation status | — | — | — | — | — | 5,441 | ||||||||||||||||||
| Noncash distributions to stockholders in connection with initial public offering | — | — | — | — | 3,446 | (13,027 | ) | |||||||||||||||||
| Payment of offering costs and other distributions | — | — | — | — | — | (2,922 | ) | |||||||||||||||||
| Termination of S corporation status | — | — | (35,267 | ) | — | — | 35,267 | |||||||||||||||||
| Receipt of shares from stockholder pursuant to stock option agreement | (2,851,337 | ) | (29 | ) | 29 | — | — | — | ||||||||||||||||
| Net income - post-termination of S corporation status | — | — | — | — | — | 4,535 | ||||||||||||||||||
Balance at March 31, 2002 | 12,149,735 | 121 | (20,877 | ) | (366 | ) | — | 4,535 | ||||||||||||||||
| Amortization of deferred compensation | — | — | — | 366 | — | — | ||||||||||||||||||
| Exercise of stock options | 2,616,382 | 26 | 21,427 | — | — | — | ||||||||||||||||||
| Tax benefit on exercise of options | — | — | 20,921 | — | — | — | ||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | 13,450 | 1 | 350 | — | — | — | ||||||||||||||||||
| Unrealized gains on available-for-sale marketable securities, net of income taxes | — | — | — | — | — | — | ||||||||||||||||||
| Net income | — | — | — | — | — | 14,439 | ||||||||||||||||||
Balance at March 31, 2003 | 14,779,567 | 148 | 21,821 | — | — | 18,974 | ||||||||||||||||||
| Exercise of stock options | 3,533,296 | 35 | 26,737 | — | — | — | ||||||||||||||||||
| Tax benefit on exercise of options | — | — | 39,996 | — | — | — | ||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | 10,663 | — | 331 | — | — | — | ||||||||||||||||||
| Purchase of treasury stock | (349,320 | ) | — | — | — | — | — | |||||||||||||||||
| Net unrealized gains on available-for-sale marketable securities, net of income taxes | — | — | — | — | — | — | ||||||||||||||||||
| Net income | — | — | — | — | — | 18,720 | ||||||||||||||||||
Balance at March 31, 2004 | 17,974,206 | $ | 183 | $ | 88,885 | $ | — | $ | — | $ | 37,694 | |||||||||||||
[Continued from above table, first column(s) repeated]
| Accumulated | ||||||||||||||||
| Elements | ||||||||||||||||
| Of Other | Annual | |||||||||||||||
| Comprehensive | Treasury | Comprehensive | ||||||||||||||
| Income | Stock | Total | Income | |||||||||||||
Balance at March 31, 2001 | $ | — | $ | — | $ | (1,531 | ) | |||||||||
| Cash distributions to stockholder | — | — | (12,971 | ) | $ | — | ||||||||||
| Deferred compensation pursuant to stock option repurchase agreements | — | — | (1,050 | ) | — | |||||||||||
| Amortization of deferred compensation | — | — | 1,384 | — | ||||||||||||
| Exercise of stock options | — | — | 3,554 | — | ||||||||||||
| Issuance of promissory notes receivable | — | — | (3,346 | ) | — | |||||||||||
| Interest earned on promissory notes | — | — | (100 | ) | — | |||||||||||
| Net income - pre-termination of S corporation status | — | — | 5,441 | 5,441 | ||||||||||||
| Noncash distributions to stockholders in connection with initial public offering | — | — | (9,581 | ) | — | |||||||||||
| Payment of offering costs and other distributions | — | — | (2,922 | ) | — | |||||||||||
| Termination of S corporation status | — | — | — | — | ||||||||||||
| Receipt of shares from stockholder pursuant to stock option agreement | — | — | — | — | ||||||||||||
| Net income - post-termination of S corporation status | — | — | — | 4,535 | ||||||||||||
Balance at March 31, 2002 | — | — | (16,587 | ) | $ | 9,976 | ||||||||||
| Amortization of deferred compensation | — | — | 366 | $ | — | |||||||||||
| Exercise of stock options | — | — | 21,453 | — | ||||||||||||
| Tax benefit on exercise of options | — | — | 20,921 | — | ||||||||||||
| Issuance of common stock under employee stock purchase plan | — | — | 351 | — | ||||||||||||
| Unrealized gains on available-for-sale marketable securities, net of income taxes | 552 | — | 552 | 552 | ||||||||||||
| Net income | — | — | 14,439 | 14,439 | ||||||||||||
Balance at March 31, 2003 | 552 | — | 41,495 | $ | 14,991 | |||||||||||
| Exercise of stock options | — | — | 26,772 | $ | — | |||||||||||
| Tax benefit on exercise of options | — | — | 39,996 | — | ||||||||||||
| Issuance of common stock under employee stock purchase plan | — | — | 331 | — | ||||||||||||
| Purchase of treasury stock | — | (12,170 | ) | (12,170 | ) | — | ||||||||||
| Net unrealized gains on available-for-sale marketable securities, net of income taxes | 479 | — | 479 | 479 | ||||||||||||
| Net income | — | — | 18,720 | 18,720 | ||||||||||||
Balance at March 31, 2004 | $ | 1,031 | $ | (12,170 | ) | $ | 115,623 | $ | 19,199 | |||||||
The accompanying notes are an integral part of these consolidated statements.
29
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
Cash flows from operating activities: | ||||||||||||
| Net income | $ | 9,976 | $ | 14,439 | $ | 18,720 | ||||||
| Adjustments to reconcile net income to net cash flows provided by operating activities — | ||||||||||||
| Depreciation | 1,929 | 1,722 | 1,415 | |||||||||
| Loss on disposal of fixed assets | 101 | 105 | — | |||||||||
| Special compensation arrangements | (37 | ) | (363 | ) | — | |||||||
| Deferred income taxes and tax benefits resulting from the exercise of common stock options | (2,305 | ) | 6,140 | 12,644 | ||||||||
| Amortization of marketable securities premiums | — | 352 | 755 | |||||||||
| Changes in operating assets and liabilities: | ||||||||||||
| Membership fees receivable | (2,269 | ) | 4,865 | (5,104 | ) | |||||||
| Prepaid expenses and other current assets | (286 | ) | (657 | ) | (1,521 | ) | ||||||
| Deferred incentive compensation | (691 | ) | (365 | ) | (116 | ) | ||||||
| Payable to/receivable from affiliates | (6,479 | ) | — | — | ||||||||
| Deferred revenues | 12,268 | 12,115 | 8,757 | |||||||||
| Accounts payable and accrued liabilities | 4,478 | 4,955 | 3,356 | |||||||||
| Accrued incentive compensation | 3,178 | 1,240 | 805 | |||||||||
| Net cash flows provided by operating activities | 19,863 | 44,548 | 39,711 | |||||||||
Cash flows from investing activities: | ||||||||||||
| Purchases of property and equipment | (864 | ) | (531 | ) | (5,225 | ) | ||||||
| Redemption of marketable securities | — | — | 13,350 | |||||||||
| Purchases of marketable securities | — | (56,515 | ) | (54,661 | ) | |||||||
| Net cash flows used in investing activities | (864 | ) | (57,046 | ) | (46,536 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
| Proceeds on issuance of stock from exercise of options | — | 21,453 | 26,772 | |||||||||
| Reimbursement of offering costs | — | 992 | 149 | |||||||||
| Payment of offering costs and other distributions | (2,922 | ) | (956 | ) | (169 | ) | ||||||
| Issuance of common stock under employee stock purchase plan | — | 351 | 331 | |||||||||
| Purchase of treasury shares | — | — | (12,170 | ) | ||||||||
| Distributions to stockholder | (12,971 | ) | — | — | ||||||||
| Net cash flows (used in) provided by financing activities | (15,893 | ) | 21,840 | 14,913 | ||||||||
Net increase in cash and cash equivalents | 3,106 | 9,342 | 8,088 | |||||||||
| Cash and cash equivalents, beginning of year | 20,853 | 23,959 | 33,301 | |||||||||
| Cash and cash equivalents, end of year | $ | 23,959 | $ | 33,301 | $ | 41,389 | ||||||
Supplemental disclosure of cash flow information: | ||||||||||||
| Noncash distributions to stockholders | $ | 13,027 | $ | — | $ | — | ||||||
| Cash paid during the year for income taxes | $ | 270 | $ | 1,000 | $ | — | ||||||
The accompanying notes are an integral part of these consolidated statements.
30
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business description
The Advisory Board Company (the Company) provides best practices research and analysis to the health care industry, focusing on business strategy, operations and general management issues. Best practices research and analysis identifies, analyzes and describes specific management initiatives, processes and strategies that produce the best results in solving common business problems or challenges.
2. Stock splits, reincorporation and initial public offering
On October 26, 2001, the Company completed a 16.84-for-1 stock split of its Class A voting shares and Class B nonvoting shares. In addition, all the Class A and Class B shares were converted to shares of Common Stock. All share and per share amounts have been retroactively adjusted to give effect to this action. In August 2002 the Company retired its Class A Voting Common Stock and Class B Nonvoting Common Stock.
To change its state of incorporation, the Company was merged into a newly formed Delaware corporation on August 13, 2001. No effect was given to this reincorporation for accounting purposes. The new corporation is authorized to issue 125,000,000 shares of stock consisting of:
| • | 20,000 shares of Class A Voting Common Stock, par value $0.01 per share; | |||
| • | 29,980,000 shares Class B Nonvoting Common Stock, par value $0.01 per share; | |||
| • | 90,000,000 shares of Common Stock, par value $0.01 per share; and | |||
| • | 5,000,000 shares of Preferred Stock, par value $0.01 per share. | |||
In November 2001, the Company completed its initial public offering in which the Company’s founder and former principal stockholder sold 5,750,000 shares of the Company’s common stock. The Company did not receive any proceeds from this offering.
3. Basis of presentation and summary of significant accounting policies
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries Advisory Board Services, Inc. (ABSI) and Advisory Board Investments, Inc. (ABII), both of which were formed during the year ended March 31, 2003. ABSI holds the Company’s trademarks and service marks, and ABII holds certain of the Company’s marketable securities. All significant intercompany transactions have been eliminated.
Cash equivalents and marketable securities
Included in cash equivalents are marketable securities that mature within three months of purchase. Investments with maturities of more than three months are classified as marketable securities. As of March 31, 2003 and 2004, the Company’s marketable securities consisted of U.S. government agency obligations and Washington, D.C. and other state tax-exempt notes and bonds. The Company’s marketable securities, which are classified as available-for-sale, are carried at fair market value based on quoted market prices. The net unrealized gains and losses on available-for-sale marketable securities are excluded from net income and are included within accumulated elements of other comprehensive income. The specific identification method is used to compute the realized gains and losses on the sale of marketable securities. Current marketable securities have maturity dates within twelve months of the balance sheet date. The Company may not hold its marketable securities to maturity and may elect to sell the securities at any time.
Property and equipment
Property and equipment consists of leasehold improvements, furniture, fixtures, equipment, and capitalized internal software development costs. Property and equipment is stated at cost, less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, ranging from three to fifteen years. Internal software development costs are accounted for in accordance with AICPA Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” and web development costs are accounted for in accordance with EITF 00-2, “Accounting for Web Site Development Costs.” Capitalized internal software development costs and capitalized web development costs are amortized using the straight-line method over the estimated useful lives of the assets, which range from three to five years. Maintenance and repairs are charged to expense as incurred.
31
Recovery of long-lived assets
Long-lived assets and identifiable assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be addressed. Impairment is identified by comparing the carrying value to the estimated undiscounted future cash flows expected to result from the use of the assets and their eventual dispositions. Impairment is measured and recorded on the basis of fair value. The Company considers expected cash flows and estimated future operating results, trends, and other available information in assessing whether the carrying value of assets is impaired. The Company believes that no such impairment existed as of March 31, 2003 and 2004.
Revenue recognition
Revenues from renewable research memberships and best practices installation support memberships are recognized over the term of the related subscription agreement, which is generally 12 months. Fees are generally billable, and the full amount of program agreement fees receivable and related deferred revenue are recorded, when a letter agreement is signed by the member. Certain fees are billed on an installment basis. Members may request a refund of their fees, which is provided on a pro rata basis relative to the length of the service period. As of March 31, 2002, 2003 and 2004, approximately $1.0 million, $0.3 million and $1.3 million, respectively, of deferred revenues were to be recognized beyond the following 12 months.
Allowance for uncollectible revenue
The Company’s ability to collect outstanding receivables from its members has an effect on the Company’s operating performance and cash flows. This effect is mitigated because memberships, which are predominantly annual contracts, are generally payable by members at the beginning of the contract term. The Company records an allowance for uncollectible revenue as a reduction of revenue based on its ongoing monitoring of members’ credit and the aging of receivables.
Deferred incentive compensation
Direct incentive compensation related to the negotiation of new and renewal memberships is deferred and amortized over the term of the related memberships.
Earnings per share
Basic earnings per share is computed by dividing net income by the number of weighted average common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the number of weighted average common shares and common share equivalents outstanding during the period. Common share equivalents consist of common shares issuable upon the exercise of outstanding common stock options. The number of weighted average common share equivalents outstanding is determined in accordance with the treasury stock method, using the Company’s prevailing tax rates. A reconciliation of basic to diluted weighted average common shares outstanding is as follows (in thousands):
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Basic weighted average common shares outstanding | 13,748 | 13,139 | 15,745 | |||||||||
| Weighted average common share equivalents outstanding | 2,341 | 3,857 | 2,935 | |||||||||
| Diluted weighted average common shares outstanding | 16,089 | 16,996 | 18,680 | |||||||||
Concentrations of risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, marketable securities and membership fees receivable. The Company maintains cash and cash equivalents and marketable securities with financial institutions. Marketable securities consist of U.S. government agency obligations and municipal obligations, primarily from the District of Columbia. The Company performs periodic evaluations of the relative credit ratings related to the cash, cash equivalents and marketable securities. The credit risk with respect to membership fees receivable is generally diversified due to the large number of entities comprising the Company’s membership base, and the Company establishes allowances for potential credit losses.
32
The Company generates revenues from customers located outside the United States. For each of the years ended March 31, 2002, 2003 and 2004, the Company generated approximately 1% of revenues from customers outside the United States. No one customer accounted for more than 2% of revenues for any period presented.
Income taxes
Deferred income taxes are determined on the asset and liability method. Under this method, temporary differences arise as a result of the difference between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or the entire deferred tax asset will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax law and tax rates on the date of the enactment of the change.
Fair value of financial instruments
The fair value of current assets and current liabilities approximates their carrying value due to their short maturity.
Segment reporting
Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” requires a business enterprise, based upon a management approach, to disclose financial and descriptive information about its operating segments. Operating segments are components of an enterprise about which separate financial information is available and regularly evaluated by the chief operating decision maker of an enterprise. Under this definition, the Company operated as a single segment for all periods presented.
Research and development costs
Costs related to the research and development of new company programs are expensed when incurred.
Stock-based compensation
The Company has several stock-based compensation plans, which are described more fully in Note 11. The Company accounts for those plans using the intrinsic value method of expense recognition and measurement prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations (collectively, “APB No. 25”). In accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended by Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure (“SFAS No. 148”),” the pro forma stock-based compensation cost, net income and basic and diluted earnings per share is computed as if the fair value based method of expense recognition and measurement prescribed by SFAS No. 123 had been applied to all options.
The fair values of options granted from the date of the Spin-Off, were estimated at the date of grant for each period using the Black-Scholes option pricing model with the following weighted average assumptions:
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Risk free interest rate | 5.2 | % | 3.91 | % | 2.63 | % | ||||||
| Dividend yield | — | — | — | |||||||||
| Weighted average expected lives of options | 6.5 years | 7.5 years | 5 years | |||||||||
| Expected volatility | 94 | % | 48 | % | 40 | % | ||||||
| Weighted average fair values of options granted | $ | 10.72 | $ | 19.01 | $ | 13.62 | ||||||
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price characteristics that are significantly different from those of traded options. Because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock rights.
33
For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the estimated service period. If the Company had used the fair value accounting provisions of SFAS No. 123, pro forma net income (loss) for each period would have been as follows (in thousands, except per share information):
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Net income, as reported | $ | 9,976 | $ | 14,439 | $ | 18,720 | ||||||
| Deduct: Total stock-based compensation expense determined under fair value based methods for all awards, net of related tax effects | (5,989 | ) | (7,753 | ) | (8,843 | ) | ||||||
| Pro forma net income | $ | 3,987 | $ | 6,686 | $ | 9,877 | ||||||
| Pro forma net income per share: | ||||||||||||
| Basic — as reported | $ | 0.73 | $ | 1.10 | $ | 1.19 | ||||||
| Diluted — as reported | $ | 0.62 | $ | 0.85 | $ | 1.00 | ||||||
| Basic — pro forma | $ | 0.29 | $ | 0.51 | $ | 0.63 | ||||||
| Diluted — pro forma | $ | 0.25 | $ | 0.41 | $ | 0.54 | ||||||
The pro forma results may not necessarily be indicative of future results.
Use of estimates in preparation of consolidated financial statements
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent accounting pronouncements
In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51.” This interpretation of ARB No. 51, “Consolidated Financial Statements,” requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The Company adopted FIN 46 as of March 31, 2004. The adoption had no impact on the consolidated financial statements.
In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” (“Issue 00-21”). Issue 00-21 provides guidance for determining the unit(s) of accounting in arrangements that include multiple products, services, and/or rights to use assets. The adoption of Issue 00-21 had no impact on the Company’s financial statements.
4. Marketable securities
The aggregate value, amortized cost, gross unrealized gains and gross unrealized losses on available-for-sale marketable securities are as follows (in thousands):
| As of March 31, 2004 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Unrealized | Unrealized | |||||||||||||||
| Market Value | Amortized Cost | Gains | Losses | |||||||||||||
| U.S. government agency obligations | $ | 79,412 | $ | 78,329 | $ | 1,245 | $ | (162 | ) | |||||||
| Washington, D.C. tax exempt obligations | 15,989 | 15,469 | 520 | — | ||||||||||||
| Tax exempt obligations of other states | 3,019 | 2,921 | 98 | — | ||||||||||||
| $ | 98,420 | $ | 96,719 | $ | 1,863 | $ | (162 | ) | ||||||||
| As of March 31, 2003 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Unrealized | Unrealized | |||||||||||||||
| Market Value | Amortized Cost | Gains | Losses | |||||||||||||
| U.S. government agency obligations | $ | 37,861 | $ | 37,371 | $ | 494 | $ | (4 | ) | |||||||
| Washington, D.C. tax exempt obligations | 16,215 | 15,819 | 396 | — | ||||||||||||
| Tax exempt obligations of other states | 3,030 | 2,973 | 57 | — | ||||||||||||
| $ | 57,106 | $ | 56,163 | $ | 947 | $ | (4 | ) | ||||||||
34
The following table summarizes marketable securities maturities (in thousands):
| As of March 31, 2004 | ||||||||
| Fair Market Value | Amortized Cost | |||||||
| Matures in less than 1 year | $ | 3,737 | $ | 3,729 | ||||
| Matures after 1 year through 5 years | 40,465 | 39,649 | ||||||
| Matures after 5 years through 10 years | 54,218 | 53,341 | ||||||
| $ | 98,420 | $ | 96,719 | |||||
The average maturity on all marketable securities held by the Company as of March 31, 2004 was approximately 4.9 years.
5. Membership fees receivable
Membership fees receivable consist of the following (in thousands):
| As of March 31, | ||||||||
| 2003 | 2004 | |||||||
| Billed fees receivable | $ | 7,161 | $ | 9,718 | ||||
| Unbilled fees receivable | 3,723 | 6,270 | ||||||
| 10,884 | 15,988 | |||||||
| Allowance for uncollectible revenue | (1,650 | ) | (1,650 | ) | ||||
| Membership fees receivable, net | $ | 9,234 | $ | 14,338 | ||||
Billed fees receivable represent invoiced membership fees. Unbilled fees receivable represent fees due to be billed to members who have elected to pay on an installment basis.
6. Property and equipment
Property and equipment consists of the following (in thousands):
| As of March 31, | ||||||||
| 2003 | 2004 | |||||||
| Leasehold improvements, furniture, fixtures and equipment | $ | 8,225 | $ | 13,426 | ||||
| Software and web development costs | 4,036 | 4,060 | ||||||
| 12,261 | 17,486 | |||||||
| Accumulated depreciation | (9,370 | ) | (10,785 | ) | ||||
| Property and equipment, net | $ | 2,891 | $ | 6,701 | ||||
7. Income taxes
The Company is a calendar year taxpayer and, prior to November 2001, was treated as an S corporation for federal income tax purposes, whereby taxable income or losses flowed through to, and were reportable by, the individual stockholders. Accordingly, prior to November 2001, no provision was made for federal income taxes in the consolidated financial statements. The District of Columbia, as well as several states, however, assess a corporate level tax even on S corporations. In conjunction with an initial public offering in November 2001, the Company became subject to federal income taxes at prevailing corporate rates. At the date of conversion to a taxable corporation, the Company recorded a net deferred tax asset of $1.6 million, representing the difference between the book and income tax bases of recorded tax assets and liabilities. The Company presents unaudited pro forma information for the year ended March 31, 2002, which reflects results of operations the Company would have reported if it had been subject to federal income taxes for the entire year. The Company had no income taxes payable as of March 31, 2003 and 2004.
The (provision) benefit for income taxes consists of the following (in thousands):
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Current | $ | (3,663 | ) | $ | (10,155 | ) | $ | (13,357 | ) | |||
| Deferred | 2,305 | (237 | ) | 618 | ||||||||
| Provision for income taxes | $ | (1,358 | ) | $ | (10,392 | ) | $ | (12,739 | ) | |||
35
Deferred income taxes are provided for temporary differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. The tax effect of these temporary differences is presented below (in thousands):
| As of March 31, | ||||||||
| 2003 | 2004 | |||||||
| Deferred income tax assets: | ||||||||
| Net operating loss carryforward | $ | 8,345 | $ | 34,522 | ||||
| Compensation accrued for financial reporting purposes | 3,337 | 3,750 | ||||||
| Reserve for uncollectible revenue | 684 | 684 | ||||||
| Long term membership contracts | 103 | 354 | ||||||
| Deferred income tax liabilities: | ||||||||
| Unrealized gains on available-for-sale securities | (392 | ) | (670 | ) | ||||
| Deferred incentive compensation | (937 | ) | (985 | ) | ||||
| Net deferred income tax assets | $ | 11,140 | $ | 37,655 | ||||
The provision for income taxes differs from the amount of income taxes determined by applying the applicable income tax statutory rates to income before provision for income taxes as follows:
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Statutory U.S. federal income tax rate | 34.0 | % | 35.0 | % | 35.0 | % | ||||||
| State income tax, net of U.S. federal income tax benefit | 6.6 | 6.5 | 6.5 | |||||||||
| Termination of S corporation status | (14.9 | ) | — | — | ||||||||
| Phase-in rate differential | (16.3 | ) | — | — | ||||||||
| Other permanent differences, net | 2.6 | 0.4 | (1.0 | ) | ||||||||
| Effective tax rate | 12.0 | % | 41.9 | % | 40.5 | % | ||||||
The Company has deferred income tax assets, consisting primarily of net operating loss (NOL) carryforwards for regular Federal and state income tax purposes generated from the exercise of common stock options. In estimating future tax consequences, Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (SFAS No. 109) generally considers all expected future events in the determination and evaluation of deferred tax assets and liabilities. The Company believes that its future taxable income will be sufficient for the full realization of its deferred income tax assets. However, SFAS No. 109 does not consider the effect of future changes in existing laws or rates in the determination and evaluation of deferred tax assets and liabilities until the new tax laws or rates are enacted. The Company has established its deferred income tax assets and liabilities using currently enacted tax laws and rates. The Company will recognize into income an adjustment for the impact of new tax laws or rates on the existing deferred tax assets and liabilities when new tax laws or rates are enacted.
The Company has net operating losses in the amount of approximately $83.2 million at March 31, 2004. The net operating losses expire between 2022 and 2024. The Company utilized tax benefits from the exercise of stock options that were recorded in the consolidated statement of equity that offsets the current tax provision that was recorded in the consolidated statement of income which resulted in no current tax liability for the year ended March 31, 2004.
Washington, DC income tax incentives
The Office of Tax and Revenue of the Government of the District of Columbia (the “Office of Tax and Revenue”) has adopted regulations in accordance with the New E-Conomy Transformation Act of 2000 (the “Act”) that modify the income and franchise tax, sales and use tax, and personal property tax regulations, effective April 2001. Specifically, the regulations provide certain credits, exemptions and other benefits to a Qualified High Technology Company (“QHTC”).
The Company has performed an analysis to support its position that it meets the definition of a QHTC under the provisions of the Act. Accordingly, the Company will amend its 2003 Washington, DC income tax return and certain sales and use tax returns, to file as a QHTC. As a QHTC, the Company’s Washington, DC income tax rate will be 0.0% for five years and the Company will be eligible for certain Washington, DC income tax credits. In addition the Company will be entitled to relief from certain sales and use taxes. While the Company believes it qualifies as a QHTC, the Company has not recognized the impact of this election within the consolidated financial statements, because of uncertainties inherent in the regulations, as adopted.
For financial reporting purposes, the Company has valued its deferred income tax assets and liabilities using Washington, DC’s currently enacted income tax rate of 9.975%. Additionally, the Company has continued to provide for income, sales and use taxes as if the Company were not a QHTC. However, if the Company had received a determination that it qualified for QHTC status as of March 31, 2004, it would have recorded a noncash charge to earnings up to approximately $5.8 million, representing the effects on its existing deferred tax assets of reducing the Washington, DC income tax rate to 0.0%, net of any income tax credits discussed above. If the Company determines it is more likely than not that the Office of Tax and Revenue will accept the Company’s election as a QHTC, the Company will record the applicable charge. Additionally, the Company would recognize the refund of any previously paid or provided sales and use taxes at that time.
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8. Comprehensive income
Comprehensive income is defined as net income plus the net-of-tax impact of foreign currency translation adjustments, minimum pension liability adjustments, and net unrealized gains and losses on certain investments in marketable securities. Comprehensive income for the years ended March 31, 2002, 2003 and 2004 was $10.0 million, $15.0 million and $19.2 million, respectively. The accumulated elements of other comprehensive income, net of tax, included within stockholders’ equity on the consolidated balance sheets are comprised solely of the changes in net unrealized gains and losses on marketable securities.
9. Transactions with affiliates
Background
The Company had or currently has certain transactions with affiliated entities, including the sharing of certain administrative functions and charges incurred for strategic direction and oversight prior to the Company’s initial public offering in November 2001. These transactions are summarized below:
Transactions with entities controlled by the former principal stockholder
Administrative Services
From January 2000 to June 30, 2001, the majority of the Company’s administrative functions, including recruiting, career management, facilities and telecommunications, were provided by DGB Enterprises, Inc. (DGB Enterprises), an entity which managed our former principal stockholder’s various business interests including his ownership interest in the Company. The Company and DGB Enterprises entered into an administrative services agreement which provided for fees for these services based on direct costs per transaction, square footage, headcount or a fixed cost per month that approximated the cost for each entity to internally provide or externally source these services.
As of July 1, 2001, the Company and DGB Enterprises entered into a new Administrative Services Agreement (New ASA), whereby the Company assumed internal management of substantially all these administrative functions while DGB Enterprises continued to provide services related to the facilities associated with the shared leased space (see Lease and Sublease Agreements below). Under the New ASA, the Company provides certain services to DGB Enterprises and other affiliated entities for fees based on direct costs per transaction, square footage, headcount or a fixed cost per month that approximates the cost for each entity to internally provide or externally source these services. The New ASA expired in June 2003, however the Company and DGB Enterprises have continued the arrangements on a month-to-month basis. These net charges, which management believes approximate the expenses which would have been incurred had the Company operated on a stand-alone basis, are included in the Company’s general and administrative expenses.
The Company performs and receives certain services from other affiliated entities. These net charges are included in Transactions with Other Related Entities in the accompanying Receivable from Affiliates table.
Lease and Sublease Agreements
On July 1, 1999, the Company assigned its headquarters lease for office space to DGB Enterprises and subsequently entered into a Sublease Agreement with DGB Enterprises whereby the Company leased the space it occupies on terms consistent with the original lease agreement through April 2004, which was extended to May 31, 2004.
Other Transactions
In November 2001, in conjunction with its initial public offering, the Company made cash and noncash distributions to its stockholders of $15.9 million. In May and June 2001, the Company distributed approximately $13.0 million to its former principal stockholder.
Transactions with The Corporate Executive Board Company
In October 1997, the Company spun-off (the Spin-Off) The Corporate Executive Board Company (CEB), a division of the Company that provided best practices research and analysis focusing on corporate strategy, operations and general management issues for non-health care companies.
The Company has a noncompetition agreement with CEB that extends through January 1, 2007, which generally prohibits CEB from selling programs to health care providers. This agreement also prohibits CEB from selling programs to other types of health care organizations unless the programs address issues of a general business nature and are principally sold to companies and institutions not in the health care industry. This noncompetition agreement generally prohibits the Company from selling its programs to organizations principally engaged in businesses other than health care.
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Also in conjunction with the Spin-Off, and in order to assist in its transition to an independent corporation, the Company and CEB entered into a royalty free license agreement, an administrative services agreement (ASA), a vendor contracts agreement (VCA) and sublease agreement. Each of these arrangements has expired or been terminated.
Affiliate company charge
DGB Enterprises assessed a fee for strategic direction and oversight services to each of the entities controlled by the Company’s former principal stockholder, including the Company. This charge was eliminated in October 2001.
Receivable from affiliates
The transactions discussed above are as follows (in thousands):
| Year Ended March 31, | ||||||||||||
| 2002 | 2003 | 2004 | ||||||||||
| Balance at beginning of year | $ | 1,889 | $ | — | $ | — | ||||||
| Transactions with CEB: | ||||||||||||
| ASA charges | 16 | — | — | |||||||||
| VCA charges | 94 | — | — | |||||||||
| Transactions with DGB: | ||||||||||||
| Management services | (96 | ) | — | — | ||||||||
| ASA charges, net | (1,077 | ) | (748 | ) | (1,043 | ) | ||||||
| Sublease charge | (3,246 | ) | (3,412 | ) | (3,557 | ) | ||||||
| Affiliate company charge | (2,676 | ) | — | — | ||||||||
| Distributions in connection with initial public offering | (8,368 | ) | — | — | ||||||||
| Transactions with other related entities: | ||||||||||||
| ASA charges, net | (11 | ) | (46 | ) | (46 | ) | ||||||
| (15,364 | ) | (4,206 | ) | (4,646 | ) | |||||||
| Net cash transfers from the Company | 13,475 | 4,206 | 4,646 | |||||||||
| Balance at end of year | $ | — | $ | — | $ | — | ||||||
10. Public offerings of common stock
Options granted to certain of the Company’s option holders under the Company’s 1997 and 2001 stock-based incentive compensation plans were exercised to acquire shares sold in public offerings at various times in fiscal 2003 and fiscal 2004. Upon the exercise of these options the Company received a total of approximately $21.5 million and $26.8 million in fiscal 2003 and 2004, respectively, in cash in payment of option exercise prices.
The Company recognized approximately $781,000 and $1.7 million in compensation expense reflecting additional Federal Insurance Corporation Act taxes as a result of the taxable income that employees recognized upon the exercise of non-qualified common stock options in fiscal 2003 and 2004, respectively. The Company also incurred additional compensation expense for tax reporting purposes, but not for financial reporting purposes, that increased the deferred tax asset to reflect allowable tax deductions that will be realized in the determination of the Company��s income tax liability and therefore reduce its future income tax payments. In connection with these transactions, the Company’s deferred tax asset increased by approximately $20.9 million and $40.0 million in fiscal 2003 and 2004, respectively. Although the provision for income taxes for financial reporting purposes did not change, the Company’s actual cash payments will be reduced as the deferred tax asset is utilized. As a result of the receipt of cash for the exercise of options, the incurrence of additional compensation expense and the recognition of a deferred tax asset, the Company’s stockholders’ equity increased by approximately $40.6 million and $65.1 million in fiscal 2003 and 2004, respectively, in connection with the exercise of stock options.
11. Stock option plans, special compensation arrangements and other employee benefit plans
Stock-based incentive compensation plans
The 1997 Stock-Based Incentive Compensation Plan (1997 Plan) provided for the issuance of options to purchase up to 10,104,000 shares of Class B nonvoting common stock. In connection with the Company’s initial public offering, the stock options granted pursuant to the 1997 Plan generally became exercisable in equal portions on each of the first three anniversaries of the initial public offering. The New Options generally expire five years after the initial public offering.
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On June 1, 2001, the Company adopted the 2001 Stock-Based Incentive Compensation Plan (2001 Plan). The 2001 Plan is designed to provide for the grant of stock options that qualify as incentive stock options as well as stock options that do not qualify as incentive stock options under Section 422 of the Internal Revenue Code. Stock options granted pursuant to the 2001 Plan may only be granted to the Company’s officers, independent contractors, employees and prospective employees. The aggregate number of shares of the Company’s common stock issuable under the 2001 Plan may not exceed 2,357,600 shares. To date, all options granted under the 2001 Plan have been granted to employees.
On June 1, 2001, the Company adopted the Directors’ Stock Plan (Directors’ Plan). Any person who is, or is elected to be, a member of the Company’s board of directors or the board of directors of a subsidiary of the Company is eligible for the award of stock options and/or stock grants under the Directors’ Plan. The Directors’ Plan is intended to operate in a manner that exempts grants of stock from Section 16(b) of the Securities Exchange Act of 1934. The maximum number of shares of the Company’s common stock that can be issued under the Directors’ Plan is 842,000.
The Company’s former principal stockholder issued options to acquire 2,778,600 shares of the Company’s common stock owned by him. These options were cancelled during fiscal 2002. In accordance with APB Opinion No. 25, the Company has accounted for these options as if the Company issued the options directly.
Stock Option Repurchase Agreements
During fiscal 2001, the Company entered into an agreement to repurchase certain stock options at a fixed price. In August 2001, the Company entered into two additional Stock Option Repurchase Agreements (collectively, the Stock Option Repurchase Agreements). Compensation expense is recognized under these Stock Option Repurchase Agreements over the relevant required employment periods. Total compensation expense was $1.4 million, $0.4 million and zero in fiscal 2002, 2003 and 2004, respectively.
Option to purchase stock from the former principal stockholder
The Company had an option to purchase 4,564,061 shares of common stock from the former principal stockholder at $7.13 per share, pursuant to a stock option agreement dated May 1, 2001. This option was intended to provide shares to be issued upon the exercise of outstanding employee stock options so that the Company’s stockholders would not experience dilution because of the issuance of new shares upon such exercise. Upon completion of the IPO, the former principal stockholder terminated the option by issuing to the Company 2,851,337 shares, representing the excess of the fair value of the stock over the exercise price of the option. The Company then immediately cancelled these shares and they are no longer considered issued and outstanding.
Transactions under stock option plans
The following table summarizes the changes in common stock options for all of the common stock option plans described above.
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| Number of | Exercise Price | Weighted Average | ||||||||||
| Options | Per Share | Exercise Price | ||||||||||
| Outstanding at March 31, 2001 | 12,273,026 | $ | 2.91 - 13.06 | $ | 7.13 | |||||||
| Options granted | 1,647,016 | 7.13 - 19.00 | 14.11 | |||||||||
| Options exercised | (1,023,872 | ) | 2.91 - 7.13 | 3.27 | ||||||||
| Options cancelled | (3,096,254 | ) | 7.13 - 19.00 | 8.06 | ||||||||
| Outstanding at March 31, 2002 | 9,799,916 | 2.91 - 19.00 | 8.42 | |||||||||
| Options granted | 638,416 | 29.28 - 36.12 | 30.44 | |||||||||
| Options exercised | (2,616,382 | ) | 5.94 - 19.00 | 8.20 | ||||||||
| Options cancelled | (67,180 | ) | 7.13 - 29.77 | 14.65 | ||||||||
| Outstanding at March 31, 2003 | 7,754,770 | 2.91 – 36.12 | 10.26 | |||||||||
| Options granted | 896,000 | 34.44 – 47.49 | 35.15 | |||||||||
| Options exercised | (3,533,296 | ) | 2.91 – 29.28 | 7.55 | ||||||||
| Options cancelled | (141,045 | ) | 7.13 – 29.28 | 18.60 | ||||||||
| Outstanding at March 31, 2004 | 4,976,429 | $ | 7.13 – 47.49 | $ | 16.34 | |||||||
Exercise prices for options outstanding at March 31, 2004, are as follows:
| Weighted | ||||||||||||||||||||
| Average | ||||||||||||||||||||
| Weighted | Remaining | Weighted | ||||||||||||||||||
| Range of | Number | Average | Contractual | Number | Average | |||||||||||||||
| Exercise Prices | Outstanding | Exercise Price | Life - Years | Exercisable | Exercise Price | |||||||||||||||
| $ 7.13 – 10.09 | 2,821,343 | $ | 7.16 | 3.2 | 432,696 | $ | 7.30 | |||||||||||||
| 10.10 – 11.88 | 93,519 | 11.19 | 3.7 | 9,039 | 11.88 | |||||||||||||||
| 19.00 – 23.75 | 609,151 | 19.00 | 7.6 | 136,318 | 19.00 | |||||||||||||||
| 28.49 – 33.24 | 508,000 | 30.28 | 8.8 | 76,250 | 29.67 | |||||||||||||||
| 33.25 – 37.99 | 922,416 | 34.80 | 9.8 | 42,416 | 33.63 | |||||||||||||||
| 42.74 – 47.49 | 22,000 | 47.46 | 9.5 | — | — | |||||||||||||||
| $ 7.13 – 47.49 | 4,976,429 | $ | 16.34 | 5.6 | 696,719 | $ | 13.70 | |||||||||||||
On May 31, 2001, certain employees of the Company exercised options to purchase 1,023,872 shares of Class B nonvoting common stock at a weighted average exercise price of $3.27 per share. The Company advanced funds to the employees equal to the aggregate exercise price of the options, in exchange for full recourse 6.5% promissory notes from the employees.
Benefit Plan
The Company sponsors a defined contribution 401(k) plan (the Plan) for all employees who have reached the age of twenty-one. The Company provides contributions equal to 50% of an employee’s contribution up to a maximum of 4% of base salary. Contributions to the Plan for the years ended March 31, 2002, 2003 and 2004 were approximately $438,000, $499,000 and $573,000, respectively.
Employee Stock Purchase Plan
On October 25, 2001, the Company established an employee stock purchase plan (the ESPP). Under the ESPP, employees may authorize payroll deductions not to exceed 15% of their salary to purchase shares of the Company’s common stock quarterly at 85% of the lesser of the share price on the first or last day of the quarter. The ESPP is authorized to issue up to 842,000 shares of the Company’s common stock. Employees began contributing to the ESPP on April 1, 2002, and for the years ended March 31, 2003 and 2004, the Company issued 13,450 and 10,663 shares of common stock under the ESPP, respectively.
12. Commitments and contingencies
Operating Leases
The Company assigned its office lease to DGB Enterprises as of July 1, 1999, and subsequently entered into a sub-lease agreement (the Sublease) with DGB Enterprises, which expires in May 2004. The Company remains jointly and severally liable for all obligations under the original lease.
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In October 2003, the Company entered into a new lease for its headquarters space (New Lease) which takes effect June 1, 2004 and has a 15-year term. The terms of the New Lease contain provisions for rental escalation and the Company is required to pay its portion of executory costs such as taxes and insurance. The Company is also obligated to take additional expansion space in the building pursuant to the lease. The Company’s future minimum lease payments under the Sublease and New Lease, including expansion space but excluding rental escalation and executory costs, are as follows (in thousands):
| Year Ending March 31, | ||||||||
| 2005 | $ | 3,131 | ||||||
| 2006 | 2,958 | |||||||
| 2007 | 2,278 | |||||||
| 2008 | 3,367 | |||||||
| 2009 | 3,839 | |||||||
| Thereafter | 34,944 | |||||||
| Total | $ | 50,517 | ||||||
Rent expense during the years ended March 31, 2002, 2003 and 2004 was approximately $3.4 million, $3.6 million and $3.7 million, respectively.
The Company entered into a $3.2 million letter of credit agreement with a commercial bank which expires October 5, 2004, to provide a security deposit for the New Lease. Certain assets have been pledged as collateral under the letter of credit agreement. To date, no amounts have been drawn on this agreement.
Litigation
From time to time, the Company is subject to ordinary routine litigation incidental to its normal business operations. The Company is not a party to, and its property is not subject to, any material legal proceedings.
Other
The Company has outsourced certain office functions to a vendor under a five-year services contract that includes minimum commitments of approximately $45,000 per month through December 2006.
13. Quarterly financial data (unaudited)
Unaudited summarized financial data by quarter for the years ended March 31, 2003 and 2004 is as follows (in thousands, except per share amounts):
| Fiscal 2003 Quarter Ended | ||||||||||||||||
| June 30 | September 30 | December 31 | March 31 | |||||||||||||
| Revenues | $ | 22,929 | $ | 24,488 | $ | 25,865 | $ | 27,432 | ||||||||
| Cost of services | 9,609 | 10,708 | 10,726 | 10,555 | ||||||||||||
| Income from operations | 5,243 | 5,466 | 5,414 | 7,670 | ||||||||||||
| Income before income taxes | 5,379 | 5,650 | 5,683 | 8,119 | ||||||||||||
| Net income | 3,090 | 3,249 | 3,269 | 4,831 | ||||||||||||
| Earnings per share: | ||||||||||||||||
| Basic | $ | 0.25 | $ | 0.27 | $ | 0.24 | $ | 0.33 | ||||||||
| Diluted | $ | 0.19 | $ | 0.20 | $ | 0.19 | $ | 0.27 | ||||||||
| Fiscal 2004 Quarter Ended | ||||||||||||||||
| June 30 | September 30 | December 31 | March 31 | |||||||||||||
| Revenues | $ | 28,449 | $ | 29,951 | $ | 31,262 | $ | 32,185 | ||||||||
| Cost of services | 11,617 | 12,291 | 13,167 | 13,092 | ||||||||||||
| Income from operations | 6,863 | 7,218 | 6,958 | 7,509 | ||||||||||||
| Income before income taxes | 7,444 | 7,898 | 7,739 | 8,378 | ||||||||||||
| Net income | 4,430 | 4,700 | 4,605 | 4,985 | ||||||||||||
| Earnings per share: | ||||||||||||||||
| Basic | $ | 0.29 | $ | 0.30 | $ | 0.29 | $ | 0.30 | ||||||||
| Diluted | $ | 0.24 | $ | 0.25 | $ | 0.25 | $ | 0.26 | ||||||||
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Item 9. Changes in and disagreements with Accountants on Accounting and Financial Disclosures.
None.
Item 9A. Controls and Procedures.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14 as of March 31, 2004. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to the company required to be included in our periodic reports filed with the Securities and Exchange Commission. There have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of this evaluation.
No changes in our internal controls over financial reporting occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The following table sets forth the names, ages and positions within The Advisory Board Company of the persons who serve as our directors and executive officers as of March 31, 2004.
| Directors and Executive Officers | Age | Position | ||||||
| Jeffrey D. Zients | 37 | Chairman of the Board of Directors | ||||||
| Frank J. Williams | 37 | Chief Executive Officer and Director | ||||||
| Marc N. Casper | 36 | Director | ||||||
| Michael A. D’Amato | 50 | Director | ||||||
| Kelt Kindick | 49 | Director | ||||||
| Joseph E. Laird, Jr. | 58 | Director | ||||||
| LeAnne M. Zumwalt | 45 | Director | ||||||
| Scott M. Fassbach | 44 | Chief Research Officer | ||||||
| David L. Felsenthal | 33 | Chief Financial Officer | ||||||
| Scott A. Schirmeier | 35 | General Manager, Sales and Marketing | ||||||
| Richard A. Schwartz | 38 | General Manager, Research | ||||||
Jeffrey D. Zientsjoined us in 1992, served as Chief Executive Officer from July 1998 until June 2001 and became our Chairman of the Board in June 2001. Mr. Zients also served as the Chief Operating Officer of DGB Enterprises from 1997 through 2003. Prior to July 1998, Mr. Zients held various positions with us, including Chief Operating Officer from 1996 to July 1998. From the time of our spin-off of The Corporate Executive Board Company until April 2001, Mr. Zients was a director of The Corporate Executive Board Company, and was Chairman of the Board of The Corporate Executive Board Company from January 2000 to April 2001. Prior to joining us, Mr. Zients was employed at Mercer Management Consulting and Bain & Company. Mr. Zients received a B.S. from Duke University.
Frank J. Williamsjoined us in September 2000 as an Executive Vice President and has been our Chief Executive Officer and a director since June 2001. From June 2000 through January 2001, Mr. Williams was also the President of an affiliated company, eHospital NewCo Inc., focused on developing and delivering health care content to patients and providers via the internet. From May 1999 to May 2000, Mr. Williams served as the President of MedAmerica OnCall, a provider of outsourced services to physician organizations, hospitals, and managed care entities. Mr. Williams also served as a Vice President of Vivra Incorporated and as the General Manager of Vivra Orthopedics, an operational division of Vivra Specialty Partners, a private health care services and technology firm. Earlier in his career, Mr. Williams was employed by Bain & Company. Mr. Williams received a B.A. from University of California, Berkeley, and an M.B.A. from Harvard Business School.
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Marc N. Casperhas served on our Board of Directors since February 2003. Mr. Casper is Senior Vice President of Thermo Electron Corporation, which provides instrumentation and services to the pharmaceutical, biotechnology and industrial laboratory markets. Previously, Mr. Casper served as President, Chief Executive Officer and Director of Kendro Laboratory Products, which produces sample preparation and processing equipment. In 1997, Mr. Casper joined Dade Behring, Inc., which provides products and systems serving the global clinical diagnostics market, as Executive Vice President for Europe, Asia and Intercontinental. He was promoted to President-Americas in 1999. Mr. Casper started his career with Bain & Company as a strategy consultant and later joined Bain Capital, a leading leveraged-buyout firm. Mr. Casper is a member of the board of directors of the Analytical and Life Science Systems Association. Mr. Casper received a B.A. from Wesleyan University, and an M.B.A. from Harvard Business School.
Michael A. D’Amatoserved as our Executive Vice President from July 1998 to June 2001, and as our Chief Financial Officer from 1996 until July 1998. He has been a director since June 2001. From 1997 through 2003, Mr. D’Amato also served as the Chief Financial Officer of DGB Enterprises, and was the Chief Financial Officer of The Corporate Executive Board Company from October 1997 until November 1998. Mr. D’Amato was also a member of the board of directors of The Corporate Executive Board Company from July 1998 until November 12, 2001. Mr. D’Amato was a partner at Bain & Company from 1982 to 1995. Mr. D’Amato received a B.S. from Massachusetts Institute of Technology and an M.B.A. from Harvard Business School.
Kelt Kindickhas been a director since November 2001. Mr. Kindick is presently Chief Financial Officer of the Commonwealth of Massachusetts. In addition, he serves as a Director at Bain & Company, a privately held management consulting firm. Mr. Kindick joined Bain & Company in 1980, was elected partner in 1986, served as Managing Director of the firm’s Boston office from 1991 to 1996 and as Chairman of the firm’s executive committee from 1998 to 1999. Mr. Kindick received a B.A. from Franklin & Marshall College and an M.B.A. from Harvard Business School.
Joseph E. Laird, Jr.has been a director since November 2001. Mr. Laird is presently the Chairman and Chief Executive Officer of Laird Squared, LLC, an investment banking company serving the database information services industry. From 1989 to 1998, Mr. Laird was a Managing Director of Veronis, Suhler & Associates, a leading specialty merchant bank that serves the media and information industries. From 1975 to 1989, Mr. Laird held a variety of positions, including senior securities analyst and investment strategist, for PaineWebber Mitchell and Hambrecht & Quist. Mr. Laird serves on the board of directors of FactSet Research Systems, a publicly held financial information services database integrator. Mr. Laird received an A.B. from Franklin & Marshall College and an M.B.A. from the Wharton School of Business at the University of Pennsylvania.
LeAnne M. Zumwalthas been a director since November 2001. Ms. Zumwalt is presently a Vice President of DaVita, Inc., a publicly held provider of dialysis services. From 1997 through 1999, Ms. Zumwalt was the Chief Financial Officer of Vivra Specialty Partners, a privately held health care services and technology firm. From 1991 to 1997, Ms. Zumwalt held several executive positions, including Chief Financial Officer and Treasurer, with Vivra Incorporated, a publicly held provider of dialysis services. Ms. Zumwalt also served on the board of directors of Vivra Incorporated from 1994 to 1997. Prior to joining Vivra Incorporated, Ms. Zumwalt was with Ernst & Young LLP for ten years. Ms. Zumwalt received a B.S. from Pacific Union College.
Scott M. Fassbachfirst joined us in 1987. He has been our Chief Research Officer since March 2000. From 1987 through 1990, and from 1991 through March 2000, Mr. Fassbach served in various management capacities with us. From 1990 to 1991, Mr. Fassbach worked in Ernst & Young’s health care consulting practice. Mr. Fassbach received a B.A. from Johns Hopkins University and an M.A. from Harvard University.
David L. Felsenthalfirst joined us in 1992. He has been our Chief Financial Officer, Treasurer and Secretary since April 2001. From September 1999 to March 2001, Mr. Felsenthal was Vice President of an affiliated company, eHospital NewCo Inc., focused on developing and delivering health care content to patients and providers via the internet. From 1997 to 1999, Mr. Felsenthal worked as Director of Business Development and Special Assistant to the CEO/ CFO of Vivra Specialty Partners, a private health care services and technology firm. From 1992 through 1995, Mr. Felsenthal held various positions with us, including research analyst, manager and director of the original executive inquiry research department. Mr. Felsenthal received an A.B. degree from Princeton University and an M.B.A. from Stanford University.
Scott A. Schirmeierjoined us in 1995 and has been our General Manager, Sales and Marketing, since June 2001. From 1995 to June 2001, Mr. Schirmeier held various management positions overseeing marketing, sales and relationship management functions, including Senior Director, Sales and Relationship Management from July 1998 to March 2000, and Executive Director, Sales and Marketing from March 2000 to June 2001. Mr. Schirmeier received a B.A. from Colby College.
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Richard A. Schwartzjoined us in 1992 and has been our General Manager, Research since June 2001. Prior to June 2001, Mr. Schwartz held various management positions in our research programs, including Executive Director, Research from June 1996 to March 2000, and Executive Vice President from March 2000 to May 2001. Mr. Schwartz received a B.A. from Stanford University and an M.B.A. from Duke University.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our directors, executive officers, and 10% stockholders to file forms with the Securities and Exchange Commission to report their beneficial ownership of our stock and any changes in beneficial ownership. Anyone required to file forms with the Securities and Exchange Commission must also send copies of the forms to us. We have reviewed all forms provided to us. Based on that review and on written information given to us by our executive officers and directors, we believe that all Section 16(a) filing requirements were met during fiscal 2004.
Audit Committee Financial Expert
The Board of Directors has determined that Ms. LeAnne M. Zumwalt, Chair of the Audit Committee, is an audit committee financial expert as defined by Item 401(h) of Regulation S-K under the Exchange Act and is independent within the meaning of Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.
Audit Committee
We have a separately designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are Mr. Casper, Mr. Kindick and Ms. Zumwalt.
Code of Ethics
We have adopted a code of ethics that applies to all of our senior financial officers (including our chief executive officer, chief financial officer, chief accounting officer, controller and any person performing similar functions), known as The Advisory Board Company Code of Ethics for Finance Team Members. We have filed a copy of this code of ethics as Exhibit 14.1 to this Form 10-K.
Item 11. Executive Compensation.
The following table presents certain information concerning compensation earned for services rendered for fiscal 2002, 2003 and 2004 by the Chief Executive Officer and the four other most highly paid persons who served as executive officers during fiscal 2004 (the “Named Officers”).
| Long-Term | ||||||||||||||||||||
| Annual Compensation | Compensation | |||||||||||||||||||
| Fiscal | Number of | All Other | ||||||||||||||||||
| Name and Principal Position | Year | Salary | Bonus | Options | Compensation | |||||||||||||||
| Frank J. Williams | 2004 | $ | 500,000 | $ | 100,000 | 85,000 | $ | — | ||||||||||||
| Chief Executive Officer and Director (1) | 2003 | $ | 500,000 | $ | 200,000 | 50,000 | $ | — | ||||||||||||
| 2002 | $ | 487,500 | (2) | $ | 100,000 | 267,080 | $ | — | ||||||||||||
| Scott M. Fassbach | 2004 | $ | 535,600 | $ | — | 27,000 | $ | — | ||||||||||||
| Chief Research Officer | 2003 | $ | 535,600 | $ | 15,000 | 12,000 | $ | — | ||||||||||||
| 2002 | $ | 539,500 | $ | 10,000 | 17,000 | $ | — | |||||||||||||
| David L. Felsenthal | 2004 | $ | 300,000 | $ | 85,000 | 27,000 | $ | — | ||||||||||||
| Chief Financial Officer, Secretary and Treasurer | 2003 | $ | 300,000 | $ | 75,000 | 16,000 | $ | — | ||||||||||||
| 2002 | $ | 286,250 | $ | 40,000 | 84,360 | $ | — | |||||||||||||
| Scott A. Schirmeier | 2004 | $ | 315,000 | $ | — | 22,000 | $ | — | ||||||||||||
| General Manager, Sales and Marketing | 2003 | $ | 315,000 | $ | 80,000 | 12,000 | $ | — | ||||||||||||
| 2002 | $ | 307,750 | $ | 55,425 | 17,000 | $ | — | |||||||||||||
| Richard A. Schwartz | 2004 | $ | 482,040 | $ | 30,000 | 25,000 | $ | — | ||||||||||||
| General Manager, Research | 2003 | $ | 482,040 | $ | 17,000 | 12,000 | $ | 400,000 | (3) | |||||||||||
| 2002 | $ | 485,550 | $ | 12,000 | 17,000 | $ | 300,000 | (3) | ||||||||||||
| (1) | Mr. Williams was named our Chief Executive Officer on June 1, 2001. | |||
| (2) | Includes payments by DGB Enterprises, Inc., which were allocated to us for services provided during fiscal 2002. | |||
| (3) | Represents payments made pursuant to special equity-based compensation arrangements we entered into with selected employees while we were a private company. Since our initial public offering, we have not entered, and we do not anticipate that in the future we will enter, into any new special equity-based compensation arrangements. | |||
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Option Grants in Fiscal 2004
The following table shows information about stock option grants to our Named Officers during fiscal 2004. These options are included in the Summary Compensation Table above. All options were granted at fair market value under The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan. All of the options granted have ten-year terms. The rules of the Securities and Exchange Commission require us to show hypothetical gains that the Named Officers would have for these options at the end of their ten-year terms. These gains are calculated assuming annual compound stock price appreciation of 5% and 10% from the date the option was originally granted to the end of the option term. The 5% and 10% assumed annual compound rates of stock price appreciation are required by Securities and Exchange Commission rules. They are not our estimate or projection of future stock prices.
Stock Option Grants in Fiscal 2004
| Individual Grants | Potential Realizable | |||||||||||||||||||||||
| Value at Assumed | ||||||||||||||||||||||||
| % of Total | Annual Rates of | |||||||||||||||||||||||
| Options | Stock Price | |||||||||||||||||||||||
| Number of | Granted to | Appreciation for | ||||||||||||||||||||||
| Shares | Employees | Exercise | Option Term | |||||||||||||||||||||
| Underlying | in | Price | Expiration | |||||||||||||||||||||
| Name | Option Grants | Fiscal Year | (per share) | Date | 5% | 10% | ||||||||||||||||||
| Frank J. Williams | 85,000 | 9.6 | % | $ | 34.81 | March 8, 2014 | $ | 1,860,805 | $ | 4,715,645 | ||||||||||||||
| David L. Felsenthal | 27,000 | 3.0 | $ | 34.81 | March 8, 2014 | 591,079 | 1,497,911 | |||||||||||||||||
| Scott M. Fassbach | 27,000 | 3.0 | $ | 34.81 | March 8, 2014 | 591,079 | 1,497,911 | |||||||||||||||||
| Richard A. Schwartz | 25,000 | 2.8 | $ | 34.81 | March 8, 2014 | 547,296 | 1,386,954 | |||||||||||||||||
| Scott A. Schirmeier | 22,000 | 2.5 | $ | 34.81 | March 8, 2014 | 481,620 | 1,220,520 | |||||||||||||||||
Option Exercises in Fiscal 2004 and Fiscal Year-End Option Values
The following table shows information about the value realized on option exercises for each of our Named Officers during fiscal 2003 and the value of their unexercised options at the end of fiscal 2003. Value realized, or gain, is measured as the difference between the exercise price and market value or the price at which the shares were sold on the date of exercise.
Aggregated Option Exercises in Fiscal 2004
and Year-End Option Values
| Number of Securities | Value of Unexercised | |||||||||||||||||||||||
| Underlying Unexercised | In-the-Money Options at | |||||||||||||||||||||||
| Shares | Options at Fiscal Year-End | Fiscal Year-End (1) | ||||||||||||||||||||||
| Acquired | Value | |||||||||||||||||||||||
| Name | On Exercise | Realized | Exercisable | Unexercisable | Exercisable | Unexercisable | ||||||||||||||||||
| Frank J. Williams | 140,000 | $ | 3,837,400 | 176,543 | 430,147 | $ | 5,220,377 | $ | 8,331,597 | |||||||||||||||
| David L. Felsenthal | — | — | 76,947 | 132,973 | 2,275,323 | 2,527,512 | ||||||||||||||||||
| Scott M. Fassbach | 220,000 | 6,030,200 | 68,017 | 333,158 | 2,011,263 | 8,599,092 | ||||||||||||||||||
| Richard A. Schwartz | 150,858 | 4,135,018 | — | 204,858 | — | 4,860,621 | ||||||||||||||||||
| Scott A. Schirmeier | 110,863 | 3,088,854 | — | 119,763 | — | 2,427,402 | ||||||||||||||||||
| (1) | Based on the closing price of our common stock on March 31, 2004 of $36.70 per share. |
Board of Directors Compensation
The Board of Directors or, to the extent authorized by the Board, the Compensation Committee, sets directors’ compensation under The Advisory Board Company Directors’ Stock Plan and such other arrangements as are deemed to be appropriate. Upon joining our Board of Directors, directors who were not otherwise Company employees received a one-time grant of options to purchase 40,416 shares of common stock. Upon joining our Board of Directors, the Chairman of our Board of Directors received a one-time grant of options to purchase 60,624 shares of common stock. Non-employee directors also receive a grant of options to purchase 10,000 shares of common stock annually and a $15,000 annual retainer. The Chairman of the Board of Directors receives a grant of options to purchase 20,000 shares of common stock annually and a $30,000 annual retainer. Directors who are also employees in other capacities do not receive additional compensation for their service on the Board of Directors. Compensation paid to Mr. Williams for fiscal 2004 is described above in Item 11 of this Annual Report on Form 10-K.
45
Employment Contracts, Termination of Employment and Change of Control Arrangements
Option Plans
The Advisory Board Company 1997 Stock-Based Incentive Compensation Plan, The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan and The Advisory Board Company Directors’ Stock Plan
In the event that there is any change in the number or kind of the outstanding shares of our common stock, whether by reason of merger, consolidation or otherwise, then the plan administrator of The Advisory Board Company 1997 Stock-Based Incentive Compensation Plan, The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan and The Advisory Board Company Directors’ Stock Plan (the “Plans”) shall determine the appropriate adjustment, if any. In addition, in the event of such a change, the plan administrator may accelerate the time or times at which any option granted under The Advisory Board Company 1997 or 2001 Stock-Based Incentive Compensation Plans may be exercised and may provide for cancellation of accelerated options that are not exercised within a time prescribed by the plan administrator in its sole discretion. Options granted under the Plans generally provide that, if an optionee’s employment is terminated for any reason other than for cause or voluntary resignation, all options granted under the Plans vest immediately.
Employment Arrangements
Mr. Williams is employed as our Chief Executive Officer pursuant to the terms of an employment agreement which continues in effect until his termination or separation from the Company. Under the terms of the employment agreement, Mr. Williams received an annual salary of $500,000 in fiscal 2004. Mr. Williams’ annual salary is subject to periodic increase at the discretion of the Board of Directors, and upon recommendation by the Compensation Committee. Mr. Williams’ employment agreement also provides for an annual discretionary bonus. In fiscal 2004, Mr. Williams was awarded a bonus of $100,000 based on his managerial performance. The employment agreement requires Mr. Williams to devote his efforts and abilities to us on a full-time basis. If Mr. Williams is terminated without cause, the employment agreement provides that he will continue to receive his base salary for one year after the date of termination and that all the options granted to him will vest and become exercisable.
Upon a change of control, 50% of all options granted to Mr. Williams will vest and immediately become exercisable on the date of the change of control and the remaining 50% of all options granted to him will vest and immediately be exercisable on the second anniversary of the change of control. For this purpose, a change of control includes the acquisition by any person of more than 50% of our stock and the merger of the Company, but does not include a purchase or merger with The Corporate Executive Board Company or a private buyout by a group including our management.
Mr. Williams is also party to a noncompetition agreement with us. Under the terms of this agreement, Mr. Williams may not compete with us or solicit our employees for a period of two years after the termination of his employment. This agreement also provides that Mr. Williams may not disclose any of our confidential or proprietary information, must disclose business opportunities to us and must return all of our property upon the termination of his employment.
Messrs. Fassbach, Felsenthal, Schirmeier and Schwartz are parties to agreements with us concerning exclusive services, confidential information, business opportunities, noncompetition, non-solicitation and work product. Messrs. Zients and D’Amato are parties to agreements with us concerning confidential information, business opportunities, noncompetition and non-solicitation. These agreements prohibit those individuals from competing with us or soliciting our employees during their tenure as members of our Board of Directors or as employees, as the case may be, and, if the individual is terminated for cause or resigns, for a period of two years thereafter. These agreements also provide that Messrs. Zients, D’Amato, Fassbach, Felsenthal, Schirmeier and Schwartz will not disclose any of our confidential or proprietary information.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information regarding the beneficial ownership of the Company’s common stock as of June 4, 2004, by (i) each person known to the Company to own 5% or more of the Company’s common stock, (ii) each Named Officer (as defined in the section of this annual report on Form 100-K entitled “Executive Compensation”), (iii) each director or director nominee and (iv) all current directors and executive officers as a group.
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| Amount and Nature of | ||||||||||||||||
| Beneficial | Total | |||||||||||||||
| Ownership (1) | Equity Stake (2) | |||||||||||||||
| Name of Beneficial Owner | Number | Percent | Number | Percent | ||||||||||||
| David G. Bradley(3) | 1,383,756 | 7.8 | % | 1,383,756 | 7.8 | % | ||||||||||
| Jeffrey D. Zients(4) | 168,066 | * | 188,066 | 1.1 | ||||||||||||
| Frank J. Williams(5) | 176,543 | * | 606,690 | 3.3 | ||||||||||||
| Marc N. Casper(6) | 40,416 | * | 50,416 | * | ||||||||||||
| Michael A. D’Amato(7) | 48,188 | * | 58,188 | * | ||||||||||||
| Kelt Kindick(8) | 50,416 | * | 60,416 | * | ||||||||||||
| Joseph E. Laird, Jr.(9) | 37,416 | * | 47,416 | * | ||||||||||||
| LeAnne M. Zumwalt(10) | 50,416 | * | 60,416 | * | ||||||||||||
| David L. Felsenthal(11) | 76,947 | * | 209,920 | 1.2 | ||||||||||||
| Scott M. Fassbach(12) | 68,017 | * | 401,175 | 2.2 | ||||||||||||
| Richard A. Schwartz | 3,000 | * | 207,858 | 1.2 | ||||||||||||
| Scott A. Schirmeier | — | — | 119,763 | * | ||||||||||||
| Brahman Entities(13) | 1,100,500 | 6.2 | 1,100,500 | 6.2 | ||||||||||||
| Delaware Management Entities(14) | 2,077,694 | 11.7 | 2,077,694 | 11.7 | ||||||||||||
| All directors, director nominees and executive officers as a group (11 people) | 719,425 | 3.9 | 2,010,324 | 10.3 | ||||||||||||
* Indicates ownership of less than 1%
(1) Unless indicated in the notes, each stockholder has sole voting and investment power for all shares shown, subject to community property laws that may apply to create shared voting and investment power. Included in shares owned by each stockholder are options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(2) The number column indicates the number of shares owned assuming the exercise of all options, whether vested or unvested, without regard to whether or not the options are exercisable within 60 days of June 4, 2004. Percentages in the percent column are calculated on a diluted basis, assuming that all shares subject to options are deemed to be outstanding, whether vested or unvested and without regard to whether the options are exercisable within 60 days of June 4, 2004.
(3) As reported in a Schedule 13G/A filed on February 13, 2004. The address of David G. Bradley is The Atlantic Media Company, 600 New Hampshire Avenue, NW, Washington, DC, 20037.
(4) Beneficial ownership includes 60,416 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(5) Beneficial ownership includes 176,543 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(6) Beneficial ownership includes 40,416 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(7) Beneficial ownership includes 10,000 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(8) Beneficial ownership includes 50,416 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(9) Beneficial ownership includes 37,416 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(10) Beneficial ownership includes 50,416 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(11) Beneficial ownership includes 76,947 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(12) Beneficial ownership includes 68,017 shares issuable upon the exercise of options held by the stockholder that are currently exercisable or exercisable within 60 days of June 4, 2004.
(13) As reported in a Schedule 13G/A filed with the Securities and Exchange Commission on February 17, 2004 by Brahman Partners II, L.P. (“BPII”), Brahman Partners III, L.P. (“BPIII”); BY Partners, L.P.; (“BYP”); Brahman Institutional Partners, L.P. (“BIP”); Brahman C.P.F. Partners, L.P. (“BCPF”); Brahman Management, L.L.C. (“BMLLC”), Brahman Capital Corp. (“BCC”), Peter A. Hochfelder, Robert J. Sobel and Mitchell A. Kuflik (BPII, BPIII, BIP, BYP, BCPF, BMLLC, BCC and Messrs. Hochfelder, Sobel and Kuflik, are referred to collectively as the “Brahman Entities”). BMLLC is the sole general partner of BPII, BPIII, BIP, BYP and BCPF. Pursuant to an investment advisory contract, BCC has the power to vote and dispose of shares held by BYP. Messrs. Hochfelder, Sobel and Kuflik are the managing members of BMLLC and the executive officers and directors of BCC. According to the Schedule 13G/A filed by the Brahman Entities, of the 1,100,500 shares, BPII has shared voting and dispositive power over 140,700 shares; BPIII has shared voting and dispositive power over 96,000 shares; BIP has shared voting and dispositive power over 133,800 shares; BYP has shared voting and dispositive power over 296,900 shares; BCPF has shared voting and dispositive power over 86,900 shares; BMLLC has shared voting and dispositive power over 754,300 shares; BCC has shared voting and dispositive power over 643,100 shares; and each of Messrs. Hochfelder, Sobel and Kuflik has shared voting and dispositive power over 1,100,500. The address of the Brahman Entities is 350 Madison Avenue, 22nd Floor, New York, NY, 10017.
(14) As reported in a Schedule 13G/A filed with the Securities and Exchange Commission on March 5, 2004 by Delaware Management Holdings and Delaware Management Business Trust (the “Delaware Management Entities”). The Delaware Management Entities are the beneficial owners of an aggregate of 2,077,694 shares, with sole power to vote 2,073,804 shares and sole power to dispose of 2,077,694 shares. The ultimate parent of the Delaware Management Entities is Liberty National Corp. The address of the Delaware Management Entities is 2005 Market Street, Philadelphia, PA, 19103.
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Equity Compensation Plan Information
The table below provides information about our compensation plans at March 31, 2004.
| Number of | Number of | |||||||||||||||
| securities to be | securities remaining | |||||||||||||||
| issued upon | available for future | |||||||||||||||
| exercise of | Weighted average | issuance under equity | ||||||||||||||
| outstanding | exercise price of | compensation plans | Total securities | |||||||||||||
| options, warrants | outstanding options, | (excluding securities | reflected in columns | |||||||||||||
| and rights | warrants and rights | reflected in column (a) | (a) and (c) | |||||||||||||
| Plan Category | (a) | (b) | (c) | (d) | ||||||||||||
| Equity compensation plans approved by stockholders | 4,976,429 | $ | 16.34 | 1,971,508 | 6.947,937 | |||||||||||
| Equity compensation plans not approved by stockholders | — | — | — | — | ||||||||||||
| Total | 4,976,429 | $ | 16.34 | 1,971,508 | 6,947,937 | |||||||||||
Item 13. Certain Relationships and Related Transactions.
Transactions with DGB Enterprises, Inc.
Our founder, David G. Bradley owns a controlling interest in certain entities that operate in different industries from us. In 1997, our founder created DGB Enterprises, Inc. to manage his various business interests including his ownership in us. To achieve operating efficiencies, DGB Enterprises, Inc. consolidated certain management and administrative functions for these entities, and assumed the primary lease on office space used by these entities and shared with us. We entered into the following transactions with DGB Enterprises and these other interests as follows:
Management Services
DGB Enterprises, Inc. provided us with direct senior management services, which resulted in an allocation in the three months ended June 30, 2001 in the amount of $96,000, for compensation and related charges for our acting Chief Executive Officer. The Chief Executive Officer services charge was phased out in June 2001 when we hired a permanent Chief Executive Officer. We believe these charges approximate the costs which would have been incurred had we operated on a stand-alone basis.
Administrative Services
From January 2000 to June 2001, the majority of our administrative functions, including recruiting, human resources, facilities and telecommunications, were provided under an administrative services agreement by DGB Enterprises, Inc., which provided similar services to all entities under our founder’s control. In July 2001, we entered into a new administrative services agreement whereby we assumed internal management of substantially all these administrative functions while DGB Enterprises, Inc. continued to provide us with services related to the facilities associated with our shared leased space. Under the new agreement we provide DGB Enterprises, Inc., and related entities owned or controlled by our founder, with a variety of administrative services including services related to information technology and support, payroll and accounting and recruiting. This new agreement has a two-year term. Fees for the services provided under all these agreements are based on direct costs per transaction, square footage, headcount or a fixed cost per month that approximates the cost for each entity to internally provide or externally source these services. We believe these net charges approximate the costs which would have been incurred had we operated on a stand-alone basis. We incurred net charges under all these arrangements in the amount of $1.1 million, $0.7 million and $1.0 million for fiscal 2002, 2003 and 2004, respectively.
Affiliate Company Charge
DGB Enterprises, Inc. assessed a fee for strategic direction and oversight services to us and to each of the entities controlled by our founder. The charge was calculated as a percentage of revenue. As of October 1, 2001, our newly constituted Board of Directors began to provide these services and the affiliate company charge, which amounted to $2.7 million in fiscal 2002, was eliminated.
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Lease and Sublease Agreements
In fiscal 2000 we assigned our office lease to DGB Enterprises, Inc., transferred leasehold improvements related to our office space to DGB Enterprises, Inc. and subsequently entered into a sublease agreement with them on terms consistent with the original agreement. The lease agreement runs through May 2004. We incurred rent expense under this arrangement of $3.2 million, $3.4 million, and $3.6 million for fiscal 2002, 2003 and 2004, respectively.
Transactions with The Corporate Executive Board Company
In October 1997, the Company spun-off The Corporate Executive Board Company, a division that provided best practices research and analysis focusing on corporate strategy, operations and general management issues for non-health care companies.
We have a noncompetition agreement with The Corporate Executive Board Company which generally prohibits The Corporate Executive Board Company from selling any membership-based products and services to health care providers. Additionally, The Corporate Executive Board Company is prohibited from selling such products and services to other types of health care organizations unless the products and services are of a general business nature and are principally sold to companies and institutions not in the health care industry. This agreement ends on January 1, 2007. After that date, The Corporate Executive Board Company may sell membership-based products and services in direct competition with us, which may have a material adverse effect on our revenues.
In conjunction with the spin-off of The Corporate Executive Board Company and in order to assist in its transition to an independent corporation, we and The Corporate Executive Board Company entered into a royalty free license agreement, an administrative services agreement, a vendor contracts agreement and sublease agreement. Under these arrangements, we provided services of approximately $110,000 in fiscal 2002, and each of these arrangements has expired or been terminated.
Transactions with our Officers, Directors and Stockholders
Prior to our initial public offering, we made loans to Jeffrey D. Zients, our Chairman of the Board, and Michael A. D’Amato, one of our directors. In connection with our initial public offering in November 2001, we made cash and noncash distributions of $15.9 million, including these loans, to our then existing stockholders. We also distributed approximately $13.0 million in cash to our founder in May and June 2001. In addition, in April 2001 we funded a loan to Scott A. Schirmeier, our General Manager, Sales and Marketing, which was repaid with interest in December 2001.
In May 2001, we entered into a stock option agreement with our founder pursuant to which we had an option to purchase 4,564,061 shares of our common stock at $7.13 per share. This option was intended to provide us with shares to be issued upon the exercise of outstanding employee stock options so that our stockholders would not experience dilution because of the issuance of new shares upon such exercise. Our founder terminated this option immediately prior to our initial public offering by transferring shares of our common stock to us in an amount equal to the excess of the fair value of the stock over the exercise price of the option.
For more information on all of these transactions, see note 9 to our consolidated financial statements.
Item 15. Principal Accounting Fees and Services.
Fees paid to our independent auditors, Ernst & Young, LLP, for each of the past two years are set forth below.
| Fiscal Year Ended March 31, | ||||||||
| 2004 | 2003 | |||||||
| Audit fees | $ | 167,048 | $ | 106,500 | ||||
| Audit-related fees | 23,135 | 153,500 | ||||||
| Tax fees | 106,355 | 143,200 | ||||||
| All other fees | — | — | ||||||
| Total | $ | 296,538 | $ | 406,200 | ||||
Audit Fees
Audit fees were for professional services rendered for the audit of the Company’s annual financial statements for the fiscal years ended March 31, 2004 and 2003, the reviews of the financial statements included in the Company’s quarterly reports on Forms 10-Q for the quarterly periods in the fiscal years ended March 31, 2004 and 2003 and services in connection with the Company’s statutory and regulatory filings for the fiscal years ended March 31, 2004 and 2003.
49
Audit-Related Fees
Audit related fees were for assurance and related services rendered that are reasonably related to the audit and reviews of the Company’s financial statements for the fiscal years ended March 31, 2004 and 2003, exclusive of the fees disclosed as Audit Fees above. These fees include benefit plan audits, assistance with registration statements and comfort letters and consents not performed directly in connection with the audit.
Tax Fees
Tax fees were for services related to tax compliance, consulting and planning services rendered during the fiscal years ended March 31, 2004 and 2003.
All Other Fees
We did not incur fees for any other services, exclusive of the fees disclosed above relating to audit, audit-related and tax services, rendered during the fiscal years ended March 31, 2004 and 2003.
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a)(1) The following financial statements of the registrant and report of independent auditors are included in item 8 hereof:
| Report of Independent Auditors | ||||
| Consolidated Balance Sheets as of March 31, 2003 and 2004 | ||||
| Consolidated Statements of Income for the years ended March 31, 2002, 2003 and 2004 | ||||
| Consolidated Statements of Changes in Stockholders’ Equity for the years ended March 31, 2002, 2003 and 2004 | ||||
| Consolidated Statements of Cash Flows for the years ended March 31, 2002, 2003 and 2004 | ||||
| Notes to Consolidated Financial Statements. | ||||
| (a)(2) | Except as provided below, all schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission either have been included in the Financial Statements or are not required under the related instructions, or are not applicable and therefore have been omitted. | |
| Schedule II — Valuation and Qualifying Accounts |
| (a)(3) | The following exhibits are either provided with this Form 10-K or are incorporated herein by reference: |
| Exhibit | ||||
| Number | Description of Exhibit | |||
| 1.1 | [Omitted] | |||
| *3.1 | Certificate of Incorporation. | |||
| *3.2 | Bylaws. | |||
| *4.1 | Form of Common Stock Certificate. | |||
| 5.1 | [Omitted] | |||
| +*10.1 | Employment Agreement, effective as of November 12, 2001, between Frank J. Williams and the Advisory Board Company. | |||
| *10.2 | Noncompetition Agreement, effective as of November 12, 2001, between Frank J. Williams and the Advisory Board Company. | |||
| *10.3 | Noncompetition Agreement, effective as of November 12, 2001, between David G. Bradley and the Advisory Board Company. | |||
| *10.4 | Noncompetition Agreement, dated January 1, 1999, among The Corporate Executive Board Company, David G. Bradley and the Advisory Board Company. | |||
| *10.5 | Form of Agreement Concerning Exclusive Services, Confidential Information, Business Opportunities, Non-Competition, Non-Solicitation and Work Product, as executed by The Advisory Board Company and each of Michael A. D’Amato, Jeffrey D. Zients, Scott M. Fassbach, Richard A. Schwartz and Scott A. Schirmeier. | |||
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| Exhibit | ||||
| Number | Description of Exhibit | |||
| *10.6 | Stock Option Agreement, dated May 1, 2001, between David G. Bradley and the Advisory Board Company | |||
| +*10.7 | Letter to Jeffrey D. Zients from The Advisory Board Company regarding vesting of unexercised options and Notice of Exercise for Non-qualified Stock Options, dated May 31, 2001, as amended by letter, dated July 30, 2001, to Jeffrey D. Zients from The Advisory Board Company. | |||
| *10.8 | Secured Promissory Note and Pledge Agreement, dated May 31, 2001, between Jeffrey D. Zients and The Advisory Board Company. | |||
| +*10.9 | Class B Nonvoting Common Stock Option Exercise Agreement, dated May 31, 2001, between Michael A. D’Amato and The Advisory Board Company, as amended by letter, dated July 30, 2001, to Michael A. D’Amato from The Advisory Board Company. | |||
| *10.10 | Secured Promissory Note and Pledge Agreement, dated May 31, 2001, between Michael A. D’Amato and The Advisory Board Company. | |||
| +*10.11 | The Advisory Board Company 1997 Stock-Based Incentive Compensation Plan, as amended on October 31, 1997. | |||
| +*10.12 | Form of Stock Option Agreement pursuant to The Advisory Board Company 1997 Stock-Based Incentive Compensation Plan, as executed by The Advisory Board Company and each of Frank J. Williams, Jeffrey D. Zients, Michael A. D’Amato, Scott M. Fassbach, Richard A. Schwartz and Scott A. Schirmeier. | |||
| +*10.13 | The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan, adopted on June 1, 2001. | |||
| +*10.14 | Form of Term Sheet and Standard Terms and Conditions pursuant to The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan. | |||
| +*10.15 | The Advisory Board Company Directors’ Stock Plan, adopted on June 1, 2001. | |||
| +*10.16 | Form of Term Sheet and Standard Terms and Conditions pursuant to The Advisory Board Company Directors’ Stock Plan, as executed by The Advisory Board Company and each of Jeffrey D. Zients and Michael A. D’Amato. | |||
| +*10.17 | Option Repurchase Plan, dated March 31, 2001, between Richard A. Schwartz and The Advisory Board Company. | |||
| +*10.18 | Equity Value Agreement, dated October 31, 1997, between Richard A. Schwartz and The Advisory Board Company. | |||
| +*10.19 | Form of Liquid Markets Agreement, as executed by The Advisory Board Company and each of Scott M. Fassbach and Richard A. Schwartz. | |||
| +*10.20 | Equity Repurchase Plan, dated August 1997, between Scott M. Fassbach and The Advisory Board Company. | |||
| *10.21 | Registration Rights Agreement, dated July 1, 2001, among David G. Bradley, Jeffrey D. Zients, Michael A. D’Amato and the Advisory Board Company | |||
| *10.22 | Cross Indemnity Agreement, dated July 1, 2001, among David G. Bradley, Jeffrey D. Zients, Michael A. D’Amato and The Advisory Board Company. | |||
| *10.23 | Promissory Note, dated December 21, 1999, between David G. Bradley and The Advisory Board Company. | |||
| *10.24 | Promissory Note, dated March 31, 2001, between Scott A. Schirmeier and The Advisory Board Company. | |||
| *10.25 | Administrative Services Agreement, dated July 21, 1998, between The Corporate Executive Board Company and The Advisory Board Company. | |||
| *10.26 | Vendor Contracts Agreement, dated July 21, 1998, between The Corporate Executive Board Company and The Advisory Board Company. | |||
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| Exhibit | ||
| Number | Description of Exhibit | |
| *10.27 | Sublease Agreement, dated July 21, 1998, between The Corporate Executive Board Company and The Advisory Board Company. | |
| *10.28 | License Agreement, dated January 19, 1999, between The Corporate Executive Board Company and The Advisory Board Company. | |
| *10.29 | Lease Guaranty Agreement, dated June 25, 1998, between The Corporate Executive Board Company and The Advisory Board Company. | |
| *10.30 | Administrative Services Agreement, dated July 1, 2001, between DGB Enterprises, Inc. and The Advisory Board Company. | |
| *10.31 | Lease Assignment Agreement, dated July 1, 1999, between DGB Enterprises, Inc. and The Advisory Board Company. | |
| *10.32 | Sublease Agreement, dated January 1, 2000, between DGB Enterprises, Inc. and The Advisory Board Company. | |
| *10.33 | Form of Indemnity Agreement to be executed between The Advisory Board Company and certain officers, directors and employees. | |
| +*10.34 | Employee Stock Purchase Plan, adopted on October 25, 2001. | |
| *10.35 | Letter Agreement, dated October 25, 2001, between The Corporate Executive Board Company and The Advisory Board Company amending the Noncompetition Agreement, dated January 1, 1999, among The Corporate Executive Board Company, David G. Bradley and The Advisory Board Company. | |
| **10.36 | BB&T Loan Agreement, dated November 9, 2001, by and between Branch Banking and Trust Company and The Advisory Board Company. | |
| ^10.37 | Agreement of Lease, dated October 7, 2003, between The Advisory Board Company and 2445 M Street Property LLC | |
| 14.1 | Code of Ethics | |
| 21.1 | Subsidiaries of the Registrant | |
| 23.1 | Consent of Ernst & Young LLP | |
| 31.1 | Certification of Frank J. Williams Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification of David L. Felsenthal Pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certification of Frank J. Williams Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification of David L. Felsenthal Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| ++99.9 | Letter to the Securities and Exchange Commission regarding representations made by Arthur Andersen LLP. |
| * | Incorporated by reference to the registrant’s registration statement on Form S-1, declared effective by the Securities and Exchange Commission on November 9, 2001. | |
| ** | Incorporated by reference to the registrant’s quarterly report on Form 10-Q, as filed on February 13, 2002. | |
| ^ | Incorporated by reference to the registrant’s quarterly report on Form 10-Q, as filed on February 12, 2004. | |
| + | Compensation arrangement. | |
| ++ | Incorporated by reference to the registrant’s annual report on Form 10-K, as filed on May 10, 2002. | |
(b)(4) Reports on Form 8-K
On January 29, 2004 we filed a Current Report on Form 8-K furnishing a press release where we announced and commented on our financial results for the third quarter of our fiscal year ending March 31, 2004, we provided a financial outlook for calendar year 2004, and we announced our Board of Directors authorized a share repurchase of our Common Stock.
On February 25, 2004, we filed a Current Report on Form 8-K announcing certain of our stockholders entered into an underwriting agreement providing for the sale by the existing stockholders of 2,524,754 shares of our common stock par value $0.01 per share in a registered public offering.
(c) Exhibits
The exhibits listed in the accompanying index to exhibits are filed or incorporated by reference as part of this annual report.
(d) Financial Statement Schedules
The financial statement schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission were either not required under the related instructions or they are inapplicable and therefore have been omitted except for Schedule II — Valuation and Qualifying Accounts, which is provided below.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders of The Advisory Board Company:
We have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of The Advisory Board Company as of March 31, 2004 and 2003, and for each of the three years in the period ended March 31, 2004, and have issued our report thereon dated April 28, 2004 (included elsewhere in this Form 10-K). Our audits also included the financial statement schedule listed in Item 15 of this Form 10-K. This schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Baltimore, Maryland
April 28, 2004
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THE ADVISORY BOARD COMPANY
SCHEDULE II — Valuation and Qualifying Accounts
(In thousands)
| Additions | ||||||||||||||||||||
| Balance at | Additions | Charged to | Deductions | Balance at | ||||||||||||||||
| Beginning | Charged to | Other | From | End of | ||||||||||||||||
| of Year | Revenue | Accounts | Reserve | Year | ||||||||||||||||
| Year ending March 31, 2002 Allowance for uncollectible revenue | $ | 1,287 | $ | 1,232 | $ | — | $ | 569 | $ | 1,950 | ||||||||||
| $ | 1,287 | $ | 1,232 | $ | — | $ | 569 | $ | 1,950 | |||||||||||
| Year ending March 31, 2003 Allowance for uncollectible revenue | $ | 1,950 | $ | 1,385 | $ | — | $ | 1,685 | $ | 1,650 | ||||||||||
| $ | 1,950 | $ | 1,385 | $ | — | $ | 1,685 | $ | 1,650 | |||||||||||
| Year ending March 31, 2004 Allowance for uncollectible revenue | $ | 1,650 | $ | 1,325 | $ | — | $ | 1,325 | $ | 1,650 | ||||||||||
| $ | 1,650 | $ | 1,325 | $ | — | $ | 1,325 | $ | 1,650 | |||||||||||
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SIGNATURES
Pursuant to the requirements of Section 13 or15(d) 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 dated as of June 11, 2004.
| The Advisory Board Company | ||
| /s/ Frank J. Williams Frank J. Williams, Chief Executive Officer |
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons in the capacities indicated on the dates indicated.
| Signature | Title | Date | ||
/s/ Jeffrey D. Zients Jeffrey D. Zients | Chairman of the Board of Directors | June 11, 2004 | ||
/s/ Frank J. Williams Frank J. Williams | Chief Executive Officer (Principal Executive Officer) and Director | June 11, 2004 | ||
/s/ David L. Felsenthal David L. Felsenthal | Chief Financial Officer (Principal Financial and Accounting Officer), Secretary and Treasurer | June 11, 2004 | ||
/s/ Marc N. Casper Marc N. Casper | Director | June 11, 2004 | ||
/s/ Michael A. D’Amato Michael A. D’Amato | Director | June 11, 2004 | ||
/s/ Kelt Kindick Kelt Kindick | Director | June 11, 2004 | ||
/s/ Joseph E. Laird, Jr. Joseph E. Laird, Jr. | Director | June 11, 2004 | ||
/s/ LeAnne M. Zumwalt LeAnne M. Zumwalt | Director | June 11, 2004 |
55