SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
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¨ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from April 1, 2014 to December 31, 2014
Commission file number: 000-33283
THE ADVISORY BOARD COMPANY
(Exact name of registrant as specified in its charter)
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Delaware | | 52-1468699 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
2445 M Street, N.W., Washington, D.C. 20037
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: 202-266-5600
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class | | Name of each exchange on which registered |
Common Stock, par value $0.01 | | The NASDAQ Stock Market LLC |
| | (NASDAQ Global Select Market) |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
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. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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| Large accelerated filer | | þ | | Accelerated filer | | ¨ |
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| Non-accelerated filer | | ¨ (Do not check if smaller reporting company) | | Smaller reporting company | | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
Based upon the closing price of the registrant’s common stock as reported on the NASDAQ Global Select Market on September 30, 2014, the aggregate market value of the common stock held by non-affiliates of the registrant was $1,677,099,112.
The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding on February 20, 2015 was 42,184,511.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates by reference certain portions of the registrant’s definitive proxy statement for the 2015 annual meeting of stockholders to be filed with the Commission no later than 120 days after the end of the fiscal period covered by this report.
THE ADVISORY BOARD COMPANY
TABLE OF CONTENTS
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EXPLANATORY NOTE REGARDING THIS TRANSITION REPORT
In November 2014, we elected to change our fiscal year from the period beginning on April 1 and ending on March 31 to the period beginning on January 1 and ending on December 31. As a result, this report on Form 10-K is a transition report and includes financial information for the transition period from April 1, 2014 through December 31, 2014. Subsequent to this report, our reports on Form 10‑K will cover the calendar year, January 1 to December 31, which will be our fiscal year. We refer in this report to the period beginning on April 1, 2014 and ending on December 31, 2014 as the “transition period.” We refer in this report to the period beginning on April 1, 2013 and ending on March 31, 2014 as “fiscal 2014” and the period beginning on April 1, 2012 and ending on March 31, 2013 as “fiscal 2013.”
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report includes “forward-looking statements.” The words “may,” “will,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “aim,” “seek,” and similar expressions as they relate to us or our management are intended to identify these forward-looking statements. All statements by us regarding our expected financial position, revenues, cash flows and other operating results, business strategy, legal proceedings, and similar matters are forward-looking statements. Our expectations expressed or implied in these forward-looking statements may not turn out to be correct. Our results could be materially different from our expectations because of various risks, including the risks discussed in this report under “Part I – Item 1A – Risk Factors.” Any forward-looking statement speaks only as of the date of this report, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances, including unanticipated events, after the date of this report.
PART I
We have derived some of the information contained in this report concerning the markets and industry in which we operate and the customers we serve from publicly available information and from industry sources. Although we believe that this publicly available information and the information provided by these industry sources are reliable, we have not independently verified the accuracy of any of this information.
Until our most recent fiscal year, our fiscal year was the 12-month period ending on March 31. Our 2014 fiscal year ended on March 31, 2014 and our 2013 fiscal year ended on March 31, 2013. In November 2014, we elected to change our fiscal year-end from March 31 to December 31. As a result, our most recently-completed fiscal period is a nine-month transition period that began on April 1, 2014 and ended on December 31, 2014.
Unless the context indicates otherwise, references in this report to the “Company,” “The Advisory Board,” “we,” “our,” and “us” mean The Advisory Board Company and its consolidated subsidiaries.
On June 18, 2012, the Company completed a two-for-one split of its outstanding shares of common stock in the form of a stock dividend. Each stockholder of record received one additional share of common stock for each share of common stock owned at the close of business on May 31, 2012. Share numbers and per share amounts presented in this report for dates before June 18, 2012 have been restated to reflect the impact of the stock split.
Item 1. Business.
Overview
We are a leading provider of insight-driven performance improvement software and solutions to the rapidly changing health care and higher education industries. Through our subscription-based membership programs, we leverage our intellectual capital to help our clients, which we refer to as our members, solve their most critical business problems. As of the date of this report, we served approximately 5,000 members.
We launched our first health care program in 1986 and our first higher education program in 2007. Since becoming a public company in 2001, we have increased the number of discrete programs we offer from 13 to 65 as of December 31, 2014. Our health care programs address a range of clinical and business issues, including physician alignment and engagement, network management and growth strategy, value-based care and population health, revenue cycle, clinical operations, and supply chain. Our higher education programs support colleges and universities in enrollment management, academic programming and student learning, faculty recruitment and retention, student advising and success, alumni affairs and advancement, and college and university operations. All of our programs are rooted in best practices and extend across four key areas:
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• | Best practices research and insight. Our best practices research and insight programs provide the foundation for all of our other programs. These programs are focused on understanding industry dynamics, identifying best-demonstrated management practices, critically evaluating widely-followed but ineffective practices, and analyzing emerging trends within the health care and education industries. |
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• | Performance technology software. Our cloud-based business intelligence and software applications allow members to combine insights derived from our best practices research with their own operational and financial data to identify and assess revenue-maximizing, cost-saving, or performance improvement opportunities. |
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• | Consulting and management services. Our consulting and management services programs assist our members’ own efforts to adopt and implement best practices to improve their performance. |
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• | Data- and tech-enabled services. Our data- and tech-enabled services draw on our extensive data resources, distinctive technology platforms, and deep expertise gained over years of experience to apply best practices on behalf of our members and deliver superior results. |
Corporate Information
We were incorporated in Maryland in 1979 and reincorporated in Delaware in 2001. The mailing address of our principal executive offices is 2445 M Street, N.W., Washington, D.C., 20037, and our telephone number is (202) 266-5600.
We maintain a corporate Internet website at www.advisory.com. We make available free of charge through our website this transition report on Form 10-K, our annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on
Form 8-K, and all amendments to those reports, as soon as reasonably practicable after we electronically file or furnish the reports with the Securities and Exchange Commission, or SEC. The contents of our website are not a part of this transition report on Form 10-K.
Recent Developments
Acquisition of Royall
On January 9, 2015, we completed our acquisition of Royall Acquisition Co. by purchasing 100% of Royall Acquisition Co.’s outstanding capital stock from Royall Holdings, LLC. As a result of this transaction, Royall Acquisition Co. and its three wholly-owned subsidiaries became wholly-owned subsidiaries of The Advisory Board. Unless the context indicates otherwise, references in this report to “Royall” mean Royall Acquisition Co. and its three subsidiaries.
The purchase price for the acquisition, before taking into account specified adjustments, was approximately $871 million, consisting of $750 million in cash and 2,428,364 shares of our common stock, valued at approximately $121 million based on our closing stock price of $49.92 on January 9, 2015, as reported on the NASDAQ Global Select Market. We funded the cash portion of the purchase price and the costs and expenses related to the acquisition with cash on hand and the proceeds from new $775 million senior secured credit facilities, consisting of a $725 million senior secured term loan facility and a $50 million undrawn revolving credit facility, we obtained on the acquisition closing date. Upon the closing of these credit facilities, we terminated the $150 million revolving credit facility we obtained in 2012.
Royall is a leading provider of strategic, data-driven student engagement and enrollment management, financial aid optimization, and alumni fundraising solutions to the higher education industry. Royall’s goal is to help traditional, non-profit colleges and universities strengthen their national reputations, broaden student enrollment, improve overall academic profiles, and enhance revenue. Over its 25-year history, Royall has developed an effective approach to setting institution-specific engagement and enrollment strategies, using data-driven insights to develop effective messaging, leveraging its tech-enabled platform across multiple communication channels, and deploying analytics to optimize the student enrollment process.
With our acquisition of Royall, we are a full-service provider to the nation’s colleges and universities of solutions to help our members address their rapidly evolving challenges. Throughout our 35-year history, we have focused on providing differentiated, renewable, and scalable solutions to transforming industries, namely health care and higher education. Our growth strategy includes adding new members, expanding relationships with existing members, and introducing new programs and solutions across both health care and higher education. Central to our higher education growth strategy is developing products and services that support our members across the entire student lifecycle: finding and enrolling the right students; optimally allocating financial aid; providing effective learning; and graduating students on time to employment and positive contributions in their communities. Our acquisition of Royall furthers this strategy by adding new front-end student engagement and enrollment management capabilities to our existing offerings, including our Student Success Collaborative, which utilizes predictive analytics to help institutions positively influence outcomes with at-risk and off-path students. Combining these assets creates a large data resource and analytical engine for promoting both student engagement and student success.
Financing Transactions
On January 27, 2015, we completed a public offering of 5,405,000 shares of our common stock at a price to public of $43.00 per share, less an underwriting discount of $1.935 per share, for a net per share purchase price of $41.065. In the offering, we sold 3,650,000 shares of common stock and Royall Holdings LLC, the former owner of Royall, sold 1,755,000 of the shares of common stock we issued to it as part of the equity component of the purchase price for Royall. We did not receive any proceeds from the sale of our common stock by Royall Holdings, LLC. We applied all $149.9 million of the net offering proceeds received by us, after deducting the underwriting discount, and other cash on hand to repay $149.9 million principal amount of term loans outstanding under the $725 million senior secured term loan facility we obtained on January 9, 2015 to fund the cash portion of the purchase price for Royall, as described above.
On February 6, 2015, we obtained $675 million of new senior secured credit facilities, consisting of a five-year $575 million senior secured term loan facility and a $100 million senior secured revolving credit facility. We applied $575 million of proceeds from borrowings under our new term loan facility to repay all amounts outstanding under our former term loan facility, and we terminated both of our former credit facilities.
Our Markets
Over our 35-year history, we have focused on providing differentiated, scalable, and renewable solutions to the rapidly transforming health care and higher education industries. Within the health care market, we primarily serve U.S. hospitals and health systems, and also sell programs to pharmaceutical, biotechnology, and medical device companies, as well as to health
care insurers. The Centers for Medicare and Medicaid Services estimated that spending in the United States for health care services will be $3.2 trillion in 2015 and expects that such spending will grow to over $5.2 trillion by 2023. Within the higher education market, we serve a range of public and private colleges and universities. The U.S. Department of Education estimates post-secondary education to be a $488 billion market involving the participation of more than 21 million students and 7,200 institutions, including both degree-granting and other education organizations.
Both health care and higher education organizations rely on external service providers to help them develop strategies, consolidate and analyze data, improve operations and processes, and train staff in order to remain competitive in a dynamic industry environment. We believe that certain characteristics of the health care and higher education industries make them especially suited for our business model of standardized delivery of information services and software rooted in shared best practices:
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• | Undergoing transformation: Both the health care and higher education industries are undergoing tremendous change. Health care providers are facing an aging population, increasing cost and margin pressures, new regulations related to the Affordable Care Act, and movement from fee-for-service to value-based reimbursement. Colleges and universities are confronting a slower growing student population, shrinking state budgets, rising cost concerns, heightened attention on value and outcomes, and a movement towards performance-based funding. According to Inside Higher Ed, 61% of colleges and universities missed their undergraduate enrollment targets in 2014. During these times of significant change, health care and higher education institutions are in greater need of, and are actively seeking, best practices to address their mounting challenges. |
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• | Common and complex industry-wide issues: Health care and higher education organizations of all types and sizes face many of the same complex strategic, operational, and management issues. Institutions are working to increase revenue, reduce costs, improve productivity and performance, manage innovation, reengineer business processes, and comply with new government regulations. Because the delivery of health care and higher education services is based on complex, interrelated processes, there is widespread interest in and broad applicability of standardized programs that address the major challenges facing the industries. |
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• | Fragmented target industries: We believe that our target market consists of over 15,000 health care organizations and over 5,000 higher education institutions. Many of these organizations deliver 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. In addition, best practices for one type of organization may not provide the same positive results for a different type of organization. |
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• | Willingness to share best practices: We believe that health care and higher education organizations display a relatively high propensity to share best practices. Many health systems and universities are non-profit organizations or compete in a limited geographic market and do not consider organizations outside their market to be their competitors. In addition, the health care and higher education industries have a charter above commerce in serving their communities and their end customers and have a long tradition of disseminating information as part of ongoing research and education activities. |
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• | Need for data and analytics: Health care data reside in numerous source systems both within and dispersed across a variety of organizations, including hospitals, physician practices, and government and commercial payers. Higher education data similarly are derived from a broad range of sources, which encompass students, parents, employers, high schools, colleges and universities, and other non-traditional education institutions. To achieve higher-quality outcomes and control costs, organizations within these markets exhibit a strong and continuing need for data and the systematic analysis of data, or analytics, to help them understand their current performance and identify opportunities for improvement. |
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• | Value orientation: A membership model that provides access to best practices and performance technology software on a shared-cost basis appeals to many value-focused health care and higher education organizations that may be reluctant to make discretionary investments in an exclusive, higher-priced, customized engagement or bespoke software solution to address their critical issues. |
Our Strengths
We are a mission-driven organization with core values, a service ethic, and a results-oriented approach dedicated to helping health care and higher education institutions solve their most pressing problems. Our competitive strengths include the following:
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• | Market leader in rapidly changing markets. We are a market leader in both the health care and higher education markets, serving a majority of U.S. hospitals and health systems and a large number of U.S. |
colleges and universities. The ongoing transformation of these industries is presenting new challenges and creating demand for new programs and services. Our expertise in health care and higher education allows us to attract into our membership base progressive and highly-regarded institutions where many industry issues are first recognized and where many best practices originate. We believe our reputation and success to date have positioned us as a premier source and partner for identifying, evaluating, communicating, and providing solutions that respond to evolving market needs. Our acquisition of Royall significantly enhances our market leadership in higher education and allows us to better serve our members through a variety of new offerings across the student lifecycle.
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• | A superior value proposition to members. We believe our programs offer access to best practices and software at a fraction of the cost that other business services firms charge to provide a comparable customized analysis or solution. Members use our programs to improve the effectiveness of their organizations by increasing productivity, reducing operating costs, and enhancing revenue. We believe that our program prices generally represent a small percentage of the potential benefit members can achieve through successful application of even a portion of the best practices and software that they receive. In addition, our fixed-fee pricing promotes frequent use of our programs by our members, which we believe increases both the value members receive and their loyalty to our programs. |
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• | Extensive membership base and longstanding member relationships. Our membership includes some of the largest and most prestigious health care and higher education institutions in the United States, including 16 of the 17 2014-2015 U.S. News and World Report honor roll hospitals and 91% of the U.S. News and World Report’s top 100 universities for 2015. As of December 31, 2014, our programs reached more than 10,000 chief executive and chief operating officers and 126,000 other senior executives, clinical leaders, department heads, and product-line managers. Royall’s customer base is similarly distinguished and loyal, with Royall having served its 20 largest clients for an average of 13 years. Our membership-based model, in which members participate in our research on an annual basis, gives us privileged access to our members’ business practices, proprietary data, and strategic plans, enabling us not only to identify and share emerging best practices but also to develop first-in-class and best-in-class new programs and services to meet our members’ changing needs. |
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• | Broad, insight-driven offerings. We provide a distinctively broad and deep set of best practices research programs, performance technology software programs, consulting and management services, and tech-enabled services, allowing us to assist our members in a variety of ways depending on their specific needs and problem areas. Our health care programs address a wide range of issues, including physician performance, network management, value-based care, revenue cycle, and clinical operations. Our higher education programs focus on such topics as enrollment management, academic programming, faculty productivity, student success, and advancement. Our performance technology software programs and tech-enabled services differ from those of our competitors in that they are rooted in best practices, aggregate and standardize data from disparate source systems, and are part of a complementary platform of offerings. |
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• | Highly renewable, visible, and scalable business model. We derive most of our revenue from multi-year, renewable memberships across our discrete annual programs. Our member institution renewal rate has equaled or exceeded 90% for each of the last four fiscal years through March 31, 2014, which we believe reflects our members’ recognition of the value they derive from participating in our programs. Royall has a comparable recurring revenue business and has achieved net revenue renewal rates in its core undergraduate enrollment management business at or above 90% over each of its last five fiscal years. In addition, we can identify approximately 85% of our annual revenues at the beginning of the calendar year by considering our deferred revenues and renewals based on recent experience. Our economic model, which features a standardized set of services and a highly-fixed program cost structure, enables us to add new members to our programs for a low incremental delivery cost, thereby increasing revenue, disproportionately increasing operating profit, and funding investment in new programs for our members. |
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• | Consistent financial performance and strong cash flows. Since becoming a public company in 2001, we have increased our number of members, contract value per member, total contract value, and revenue nearly every year, including during economic downturns. Over the last five fiscal years through March 31, 2014, our number of members has grown by an average of 10% annually from 2,761 to 4,534, while our contract value per member has expanded by an average of 8% annually, from approximately $80,000 to approximately $120,000. Our revenue has increased by an average of 19% each year over the same period. The combination of revenue growth, profitable operations, and payment for memberships in advance of accrual revenue typically results in our cash flows from operations exceeding our net income and often approximating our adjusted EBITDA. |
Growth Strategy
We believe we are well positioned to capitalize on the favorable characteristics in our target markets and deploy our competitive strengths to continue growing our business. As part of our growth strategy, we plan to:
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• | Add new health care and higher education members. We operate in robust markets. We believe there are over 15,000 potential members in the health care market and over 5,000 potential members in the higher education market. Although we currently have an established membership base in these markets, which has been significantly enhanced by our recent acquisition of Royall, we actively seek to continue adding new customers. We believe that our business model and existing membership base represent significant assets that we can use to attract additional non-provider health care members and international health care and higher education members. We currently serve approximately 400 non-U.S. health care organizations through programs that rely on research and analysis primarily derived from our work with U.S. health care organizations. In addition, we are seeking to expand our work with pharmaceutical, biotechnology, medical device, and health insurance companies, as well as with other organizations with an interest in U.S. hospital and health system operations, performance, and data. |
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• | Expand relationships with and create additional value for existing members. We have developed broad and deep relationships with approximately 5,000 members and over 230,000 executives across our health care and higher education programs. As members recognize benefits from one program, they may seek out or become strong candidates for other programs and services. In addition, our steady interaction with members through sales force visits, program development and delivery, and account management provides us with insight into which of our programs would be most suitable for them. Since 2009, we have increased contract value per member by 50%, from approximately $80,000 to approximately $120,000 as of March 31, 2014, by selling additional programs to existing members, but $120,000 remains a small portion of many institutions’ expenditures on professional services. Our acquisition of Royall, which generated average net revenue per client of approximately $403,000 in its most recent fiscal year from its core undergraduate enrollment management business, enables us to offer important new student engagement and enrollment management programs to Advisory Board members. |
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• | Continue innovating through member-driven product development. As our markets rapidly evolve, we seek to expand our portfolio of programs and services through development of new programs and successful execution and integration of acquisitions and strategic partnerships. Each year, we pursue a rigorous research process involving extensive member feedback, in which we build a large pipeline of potential new program concepts before concentrating our efforts on specific program launches of greatest interest to our members. Our research and development process benefits from the involvement of industry thought-leaders from progressive and well-known organizations that act as advisors, as well as from information we gather from hundreds of member interviews. Before officially rolling out a new program, we typically convert a high percentage of our advisors to paying members, which gives us a recognizable group of early partners to champion our programs and services to others. Over the last several years, we have added four to five new programs annually, which we offer to existing members and use to attract new members. We currently plan to continue introducing a comparable number of programs on an annual basis through a mixture of internal development activities and acquisitions. |
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• | Use differentiated data and expertise to provide comprehensive solutions to members. As the health care and higher education industries continue their transformation, our members increasingly are looking to consolidate and replace their individual vendors and products with strategic partners, integrated technology platforms, and comprehensive solutions. We believe many of our members will consider us particularly well suited to respond to this demand based on our differentiated data acquisition and standardization capabilities, compiled robust data sets across thousands of physicians, patients, and students, and reputation for deep industry expertise and a strategic approach to solving issues. |
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• | Leverage recent acquisitions as platforms for growth. We have a track record of leveraging acquisitions to promote future growth. For example, since acquiring Crimson in 2008, we have increased Crimson-related revenue from $2 million to over $140 million. We expect our recent acquisition of Royall to present significant expansion prospects, as we serve our members comprehensively across the student lifecycle. We also believe that combining our data and expertise in promoting student success with Royall’s experience in fostering student engagement and advancement will create substantial new product development opportunities. |
Our Offerings
As of December 31, 2014, we offered 65 distinct membership programs, rooted in best practices and extending across the four key areas of best practices research and insight, performance technology software, consulting and management services, and data- and tech-enabled services.
Program Attributes
Our programs are targeted at serving member executives and using our insights and deep programmatic resources to produce tangible and significant results for our members. Our insight-driven programs include best practices research studies, executive education, proprietary content databases and online tools, daily online executive briefings, original executive inquiry services, business intelligence and software applications, consulting and management services, and tech-enabled services. We typically charge a separate annual membership fee for each program that is fixed for the duration of the membership agreement and entitles participating members to access all of a program’s membership services. Most programs are renewable, multi-year contracts. The specific membership services vary by program and change over time as services are periodically added or removed. Institutions may access our services within a program only if they are members of that program. The types of services we provide include those described below.
Best Practices Research and Insights Programs
We focus the senior management teams of our member organizations on important problems by providing an analysis of best practices used by some of the most successful organizations to solve those problems, and by providing tools and services to accelerate the adoption of best practices within our member institutions. Each of our best practices research programs is targeted at a specific member executive and addresses for each year the executive’s specific strategic challenges, operational issues, and management concerns. Each program includes access to studies, executive education, proprietary databases and online services, and executive briefings, among other services, as we continue to enhance the programs with innovative features. For each best practices research program, we typically publish two to four best practices research studies or modules annually. We design each study and module to present the conclusions and supporting best practices in a graphical format, enabling the intended audience to assimilate quickly the 100 to 250 pages of research content. Consistent application of our research methodology and extensive staff member training across all programs enable us to maintain a high level of research quality in the programs.
In addition to our research studies, we deliver an executive education curriculum based on our proprietary research to member institutions nationwide through four channels: general membership meetings; presentations conducted on-site at member organizations; on-call access to experts; and frequent teleconferences. In all four settings, we use interactive discussions to provide a deeper understanding and facilitate practical application of the best practices we have identified. In the nine-month period ended December 31, 2014, we delivered executive education services to approximately 2,900 member organizations, reaching more than 112,000 executive and managerial participants through more than 330 member meetings, over 2,300 on-site seminars, and over 140 webconferences. These interactions serve as an important building block for our relationships with members, allowing us the opportunity to gather input about our research agendas and services, generate leads for cross-selling additional programs to existing members, and identify ideas for potential new programs.
Across our research programs, we also offer a variety of databases, cloud-based content, and online tools and calculators to increase the utility of our research, facilitate analysis of an organization’s current performance, and assist the adoption of best practices at member institutions. Each research program has a dedicated section on our password-protected member website, accessible only to members of the program, that includes such items as best practices, executive modules, online data, audit toolkits, and market forecasting instruments. Through the website, members of each program may search and access program-specific content, which includes the ability to access an electronic library of past and current research studies, review executive education modules, view meeting schedules, and communicate with our staff and other members.
Performance Technology Software Programs
Each of our performance technology software programs is anchored by cloud-based software applications that are regularly updated with member-specific data and provide all member institutions with access to specific performance improvement metrics. The software applications pull data from disparate legacy information systems through standardized data extracts and, with analytics and proprietary metrics informed by our best practices research and insights, transform hard-to-access legacy data into performance reports and benchmarks offering actionable insight for managers and executives. Members in these programs receive best practices from our research and benchmarking against peer organizations, and engage in regular interaction with our employees who are tasked with helping our members analyze their institution-specific data and suggesting tactics for improving performance.
The software programs are renewable and address perennial problems in areas in which we have developed significant knowledge through our research programs. In health care, these include revenue cycle efficiency, assistance with physician management, supply and other cost optimization, throughput in the emergency department and surgical suites, utilization management, workforce management and optimization, and improvement in quality of outcomes. Our primary software program for higher education helps institutions improve student advising and increase student success by identifying and positively influencing choices by at-risk and off-path students.
Our software programs are cloud-based, allowing members to derive value with minimal upfront investment costs. Cloud-based software allows continual access via the Internet and can quickly be updated, delivering new program content and functionality to all members with minimal disruption. Our software is built to be flexible and easy to use, offering members ad hoc querying, performance alerts, drill-down analysis, and comparative benchmarking. Our performance technology membership model allows our members to benchmark themselves against each other and learn how other members captured value from our software applications.
Through the combination of our research and access to the software, members gain insight into areas of opportunity for operational or financial improvement, receive best practices toolkits to capture the improvement, and directly use our resources to inform front-line decisions on an hourly, daily, and weekly basis. Our programs allow members to transform their data into information they can use to enhance performance, enabling them to quantify areas of opportunity and identify value captured through use of our programs.
Consulting and Management Services
Through our consulting and management services, we provide on-the-ground support for major turnaround and performance improvement initiatives, as well as best practice, day-in-day-out professional management of key areas of the hospital or medical group. We assist in three primary ways: expert counsel, including business planning and strategy development; dedicated support, including interim senior management to oversee a specific change management process for a defined period; and long-term management, involving a seasoned group of senior executives on-site for an extended period to provide hands-on, practical advice and execution against financial and operational goals.
Our consulting engagements deliver meaningful insights and results on issues such as value-based care and population health, clinical quality and care redesign, operational capacity and workforce efficiency, and revenue cycle optimization. Our clients benefit from outcomes-focused consultants experienced in change management, access to best practice performance criteria, industry standard and proprietary benchmarks, implementation-oriented recommendations, and an objective third-party perspective.
Data- and Tech-Enabled Services
For some critical and complex business functions, we offer members data- and tech-enabled services as a means to deliver results when our best practices cannot be as effectively implemented directly by our members and their staff. The outsourced services are end-to-end and iterative by nature: we work closely with the member to understand the challenge and clarify the member’s objectives in addressing the challenge; we apply strategic data analytics to segment the problem and identify specific opportunities and strategies; we use various technology platforms and solutions to implement those strategies; and we measure the effectiveness of the adopted strategies. A key focus is continuously improving and optimizing the outcomes.
Our data- and tech-enabled services draw on our considerable data resources, distinctive technology platforms, and deep expertise gained over years of experience, all of which are difficult or costly to transfer to members. Our data sets often include over one billion records or interactions and are constantly updated and enhanced. Our technology platforms are proprietary and multi-faceted, allowing us to work with a range of members on a particular type of issue. Our know-how expands each year with new learnings from our best practices research as well as new experiences solving similar problems on behalf of hundreds of organizations.
The focus of our data- and tech-enabled services is hospital and health system supply chain optimization and, with the acquisition of Royall, student engagement and enrollment management. These services are often delivered under one-year, renewable contracts, and, given the importance of the functions provided and the strength of the results delivered, tend to evolve into extended relationships. For example, Royall has served its 20 largest clients for an average of 13 years.
Our Membership
As of the date of this report, our membership consisted of approximately 5,000 members, composed primarily of hospitals and health systems and colleges and universities, as well as selected other health care and higher education institutions. Each of our programs targets the issues of a specific executive constituency or business function. Our programs serve a range of constituencies, including both the most senior executives and the broader management team. As of the date of
this report, our programs reached over 10,000 chief executive and chief operating officers and more than 126,000 other senior executives, clinical leaders, department heads, and product-line managers. No one member accounted for more than 1.5% of our revenue in the nine-month period ended December 31, 2014 or either of our fiscal years ended March 31, 2013 or 2014. We generated approximately 4%, 3%, and 4% of our revenue from members outside the United States in the nine-month period ended December 31, 2014 and for fiscal 2014 and fiscal 2014, respectively.
We seek to involve the country’s most progressive health care and education organizations in our membership. The participation of these members provides us with a window into the latest challenges confronting the industries we serve and the most innovative best practices that we can share broadly throughout our membership. As of December 31, 2014, we served 16 of the 17 honor roll hospitals listed in the 2014-2015 U.S. News and World Report ranking, all of the largest 100 health care delivery systems, 30 of the world’s largest pharmaceutical and medical device companies, and 91 of the U.S. News and World Report top 100 universities for 2015.
The following table sets forth information with respect to membership programs and contract value as of the dates shown and for the periods indicated:
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| | | | | | | | | | | | | | | | | | | |
| December 31, | | March 31, |
| 2014 | | 2014 | | 2013 | | 2012 | | 2011 |
Membership programs offered | 65 |
| | 62 |
| | 57 |
| | 53 |
| | 49 |
|
Contract value (in thousands of dollars) (1) | $ | 601,842 |
| | $ | 541,903 |
| | $ | 466,329 |
| | $ | 398,313 |
| | $ | 304,299 |
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(1) | Shows the aggregate annualized revenue attributable to all agreements in effect on the last day of the fiscal period, without regard to the initial term or remaining duration of any such agreement. |
Pricing and Contracts
We typically charge a separate fixed annual membership fee for each program that covers all the services in the program. Annual fees vary by program based on the target executive constituency and the specific combination of services we provide to participating members. Annual fees for best practices research programs generally are payable in advance. Annual fees for programs that offer consulting and management services or software are higher than annual fees for research and insights programs. 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. On average, we increase membership fees 2% to 3% per year. Membership fees also may be lower for the initial members of new programs. In some of our programs, we charge our members for certain direct billable expenses, such as travel expenses. Most of our memberships are multi-year agreements.
Sales and Marketing
As of December 31, 2014, our sales force consisted of 206 new business development teams that are responsible for selling new memberships. Each new business development team generally consists of two employees, one of whom travels to meet in person with prospective members, and a second who provides support from the office. Our new business development teams sell programs to new members as well as cross-sell additional programs to existing members of other programs.
We maintain separate member services teams 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 functions, as well as the different skills required for each. New business development representatives are compensated with a base salary and variable, goal-based incentive bonuses and typically travel at least 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 relationship management role and perform most of their responsibilities over the telephone.
Intellectual Property
We offer our members a range of products to which we claim intellectual property rights, including research content, online services, databases, electronic tools, cloud-based applications, performance metrics, and software products. We own and control a variety of trade secrets, confidential information, trademarks, trade names, copyrights, and other intellectual property rights that, in the aggregate, are of material importance to our business. We are licensed to use certain technology and other intellectual property rights owned and controlled by others, and license other companies to use certain technology and other intellectual property that we control. We consider our trademarks, service marks, databases, software, and other intellectual property to be proprietary, and rely on a combination of copyright, trademark, trade secret, non-disclosure, and contractual
safeguards to protect our intellectual property rights. We have been granted federal registration for some of our trademarks and service marks.
Competition
We are not aware of any other organization that offers services to health care or education organizations for fixed annual fees across as broad a range of best practices and performance technology software as those offered by our company. We compete in some discrete programs and for discretionary expenditures against health care-focused, education-focused, and multi-industry firms. These include consulting and strategy firms; market research, data, benchmarking, and forecasting providers; technology vendors and services firms; health care information technology firms; technology advisory firms; and specialized providers of educational and training services. Other organizations, such as state and national trade associations, group purchasing organizations, non-profit think-tanks, and database companies, also may offer research, consulting, tools, and education services to health care and education organizations.
We believe that the principal competitive factors in our market include quality and timeliness of research and analysis, applicability and efficacy of recommendations, strength and depth of relationships with member senior executives, reliability and effectiveness of software applications, distinctiveness of dashboards and user interfaces, depth and quality of the customer network, ability to meet the changing needs of current and prospective members, measurable returns on customer investment, and service and affordability. We believe we compete favorably with respect to each of these factors.
In February 2014, we extended the collaboration agreement with The Corporate Executive Board Company to enhance our services to members and explore new product development opportunities. To advance these efforts, which require our two companies to share proprietary information related to best practices products and services, the agreement includes a limited non-competition provision.
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.
Employees
As of December 31, 2014, we employed approximately 3,100 professionals, approximately 2,000 of whom are based in our headquarters in Washington, D.C. None of our employees are represented by a collective bargaining arrangement.
We added approximately 340 employees as a result of our acquisition of Royall on January 9, 2015.
Government Regulation
The health care and higher education industries are highly regulated and subject to changing political, legislative, regulatory, and other influences. Existing and new federal and state laws and regulations affecting the health care and higher education industries could create unexpected liabilities for us, could cause us or our members to incur additional costs and could restrict our or our members’ operations. Many of the laws are complex and their application to us, our members, or the specific services and relationships we have with our members are not always clear. Our failure to anticipate accurately the application of these laws and regulations, or our other failure to comply, could create liability for us, result in adverse publicity, and otherwise negatively affect our business. See the “Risk Factors” section of this report for more information about the impact of government regulation on our company.
Executive Officers
The following table sets forth as of December 31, 2014 the names, ages, and positions of the persons who serve as our executive officers.
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| | | | |
Executive Officers | | Age | | Position |
Robert W. Musslewhite | | 45 | | Chief Executive Officer and Chairman |
David L. Felsenthal | | 44 | | President and Director |
Michael T. Kirshbaum | | 38 | | Chief Financial Officer and Treasurer |
Evan R. Farber | | 42 | | General Counsel and Corporate Secretary |
Cormac F. Miller | | 41 | | Executive Vice President |
Richard A. Schwartz | | 49 | | President, Performance Technologies and Consulting |
Mary D. Van Hoose | | 50 | | Chief Talent Officer |
Our executive officers are appointed by, and serve at the pleasure of, our board of directors.
Robert W. Musslewhite has served as our Chief Executive Officer since September 2008. Mr. Musslewhite joined us in 2003, initially serving in executive roles in strategic planning and new product development. In 2007, Mr. Musslewhite was named Executive Vice President and general manager in charge of software-based programs, and he became CEO the following year. Before joining us, Mr. Musslewhite was an Associate Principal in the Washington, D.C., Amsterdam, and Dallas offices of McKinsey & Company, an international consulting firm, where he served a range of clients across the consumer products industry and other industries and was a co-leader of McKinsey’s Pricing Center. Mr. Musslewhite received an A.B. degree in Economics from Princeton University and a J.D. from Harvard Law School.
David L. Felsenthal became our President in September 2008. Mr. Felsenthal first joined us in 1992. He served as Chief Financial Officer, Secretary, and Treasurer from April 2001 through February 2006 before his service as an Executive Vice President beginning in February 2006 and as Chief Operating Officer from January 2007 to September 2008. 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 in research and new product development. Mr. Felsenthal received an A.B. degree from Princeton University and an M.B.A. from Stanford University.
Michael T. Kirshbaum became our Chief Financial Officer in February 2006 and Treasurer in March 2007. Mr. Kirshbaum joined us in 1998, and before his current role held a variety of positions in the finance group, most recently serving as Senior Director of Finance. In that role, Mr. Kirshbaum was responsible for most of our finance operations, including our overall financial strategy and budgeting process, as well as a number of other accounting functions. Mr. Kirshbaum received a B.S. degree in Economics from Duke University.
Evan R. Farber joined us in October 2007 as General Counsel and also has served as Corporate Secretary since November 2007. Before joining us, Mr. Farber was a partner at Hogan & Hartson L.L.P. (now Hogan Lovells US LLP), an international law firm, where he practiced corporate, securities, transactional, and commercial law. Mr. Farber received a B.A. degree from Binghamton University, State University of New York, and a J.D. from The George Washington University Law School.
Cormac F. Miller was named Executive Vice President in August 2011, with responsibility for corporate strategy and new product development. Before his promotion to Executive Vice President, he served as our Executive Director, Strategic Planning and New Product Development since January 2007. Mr. Miller joined us in 1996 and held various management positions within our research programs, including Executive Director, Research from October 2005 to December 2006, and Managing Director from October 2002 through October 2005. Mr. Miller received a B.S. degree from the University of Wisconsin-Madison.
Richard A. Schwartz became our President, Performance Technologies and Consulting in March 2014. He previously served as Executive Vice President since February 2006, responsible for strategic planning and general management of our physician-oriented programs. Mr. Schwartz joined us in 1992 and held various management positions within our research programs, including Executive Director, Research from June 1996 to March 2000. In addition, Mr. Schwartz served as our General Manager, Research from 2001 to 2006. Mr. Schwartz received a B.A. degree from Stanford University and an M.B.A. from Duke University.
Mary D. Van Hoose has served as Chief Talent Officer since 2009. In this role Ms. Van Hoose oversees recruiting, retention, engagement, and development of our staff worldwide, and works closely with the executive team on a broad range of issues that include organizational planning, goal setting, leadership development, and firm communication. Ms. Van Hoose joined us in 1991 and initially served as a research analyst focusing on certain clinical best practices for hospitals and health care providers. From 2000 to 2009, Ms. Van Hoose served as our Executive Director of Career Management. Ms. Van Hoose received a B.A. degree from the University of Virginia.
Item 1A. Risk Factors.
We describe below what we believe are currently the material risks and uncertainties we face, but they are not the only risks and uncertainties we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, also may become important factors that could adversely affect our business, financial condition, results of operations, and prospects.
Factors that adversely affect the financial condition of the health care industry could have a negative impact on us.
We historically have derived most of our revenue from members in the health care industry. As a result, our business, financial condition, and results of operations could be adversely affected by conditions affecting the health care industry generally and hospitals and health systems in particular. Our ability to grow will depend upon the economic environment of the health care industry as well as our ability to increase the number of programs and services that we sell to our members. There are many factors that could affect the purchasing practices, operations, and, ultimately, the operating funds of health care organizations, such as reimbursement policies for health care expenses, consolidation in the health care industry, and regulation, litigation, and general economic conditions. Because of current macro-economic conditions, many health care delivery organizations continue to experience deteriorating cash flow, access to credit, and budgets. It is unclear what long-term effects general economic conditions will have on the health care industry and in turn on us.
The health care industry is highly regulated and is subject to changing political, legislative, regulatory, and other influences. Existing and new federal and state laws and regulations affecting the health care industry could create unexpected liabilities for us, could cause us or our members to incur additional costs, and could restrict our or our members’ operations. Many health care laws are complex and their application to us, our members, or the specific services and relationships we have with our members is not always clear. In addition, federal and state legislatures periodically have considered programs to reform or amend the U.S. health care system at both the federal and state level, such as the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.
Because of the significant implementation issues arising under these laws, it is unclear what long-term effects they will have on the health care industry and in turn on our business, financial condition, and results of operations. Among other effects, we could be required to make unplanned modifications of our products and services or could suffer delays or cancellations of orders or reductions in demand for our products and services as a result of changes in regulations affecting the health care industry, such as any increased regulation by governmental agencies of the purchase and sale of medical products, changes to the Health Insurance Portability and Accountability Act of 1995, and the regulations that have been issued under it, which we refer to collectively as HIPAA, and other federal or state privacy laws, laws relating to the tax-exempt status of many of our members, or restrictions on permissible discounts and other financial arrangements. Our failure to anticipate accurately the application of these laws and regulations, or our failure to comply with them, could create liability for us, result in adverse publicity, and negatively affect our business.
Federal and state regulations governing our members in the education industry may negatively affect our members’ businesses, marketing practices, and budgets, any or all of which could have a material adverse effect on our ability to generate revenue.
As a result of our recent acquisition of Royall, we will derive an increasing amount of revenue from post-secondary educational institutions. Such educational institutions are subject to extensive federal and state regulation, including the Higher Education Act, Department of Education regulations, and individual state higher education regulations. The regulations govern many aspects of the operations of our higher education members, including marketing and recruiting activities, as well as their eligibility to participate in Title IV federal student financial aid programs, which is the principal source of funding for many of our members. There have been significant changes to these regulations in the recent past, and a high level of regulatory activity and heightened legislative scrutiny is expected to continue. Changes in, new interpretations of, or noncompliance with applicable laws, regulations, standards, or policies applicable to our members could have a material adverse effect on their accreditation, authorization to operate in various states, or receipt of funds under Title IV programs, any of which, in turn, may harm our ability to generate revenue from these members and thereby negatively affect our financial results.
Our revenue and results of operations may suffer if we are unable to sustain high renewal rates on our memberships.
We derive most of our revenue 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. Our success in securing renewals depends upon the continuity of our principal contacts at a member organization, our members’ budgetary environment, and our ability to deliver consistent, reliable, high-quality, and timely research, tools, and analysis with respect to issues, developments, and
trends that members view as important. We may not be able to sustain the level of performance necessary to achieve a high rate of renewals and, as a result, may not increase our revenue or even maintain our current revenue levels.
If we are unable to maintain our reputation and expand our name recognition, we may have difficulty attracting new business and retaining current members.
Our professional reputation is an important factor in attracting and retaining our members and in building relationships with the progressive health care and education organizations that supply many of the best practices we feature in our research. We believe that establishing and maintaining a good reputation and name recognition are critical for attracting and retaining members. Promotion and enhancement of our reputation will depend largely on our success in continuing to provide effective solutions. Our brand name and reputation will suffer, and our ability to attract new members or retain existing members could be adversely affected, if members do not perceive our solutions to be effective or of high quality or if there inaccuracies or defects in our solutions.
If we are not able to offer new and valuable products and services, our business may suffer.
Our ability to increase our revenue depends on our ability to develop new products and services that serve specific constituencies, to anticipate changing market trends, and to adapt our research, tools, and analysis to meet the changing 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 could cause some of our existing products and services to become obsolete, particularly in the health care industry, where needs continue to evolve rapidly with the introduction of new technology and the obsolescence of old technology, changing payment systems and regulatory requirements, 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 timely research, business intelligence and software tools, and consulting and management services for issues and topics of importance. As a result, we must continue to invest resources in development of new programs and services in order to enhance our existing products and services and introduce new high-quality products and services that will appeal to members and potential members. Many of our member relationships are non-exclusive or terminable after a specified term. If our new or modified product and service innovations are not responsive to user preferences or industry or regulatory changes, are not appropriately timed with market opportunity, or are not effectively brought to market, we may lose existing members, be unable to obtain new members, or incur impairment of capitalized software development assets.
Because our programs offer a standardized set of services that allows us to spread our largely fixed program cost structure across our membership base of participating organizations, we may lose money on or terminate a program if we are unable to attract or retain a sufficient number of members in that program to cover our costs. Terminating a program could adversely affect our business by causing dissatisfaction among members of the terminated program and impairing our reputation with current and potential members.
Competition may adversely affect our business.
Any failure by us to adequately identify, understand, or address competitive pressures could have a material adverse effect on our business. We compete in discrete programs and for discretionary dollars against health care-focused, higher education-focused, and multi-industry firms. These include consulting and strategy firms; market research, data, benchmarking and forecasting providers; technology vendors and services firms; health care information technology firms; technology advisory 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 may offer research, consulting, tools, and education services to health care and education organizations that are competitive with our programs.
We compete on the basis of several factors, including breadth, depth, and quality of product and service offerings, ability to deliver clinical, financial, and operational performance improvement through the use of products and services, quality and reliability of services, ease of use and convenience, brand recognition, and the ability to integrate services with existing technology. Some of our competitors are more established, benefit from greater name recognition, have larger member bases, and have substantially greater financial, technical, and marketing resources. Other of our competitors have proprietary technology that differentiates their product and service offerings from ours. As a result of these competitive advantages, our competitors and potential competitors may be able to respond more quickly to market forces, undertake more extensive marketing campaigns for their brands, products, and services, and make more attractive offers to our members.
We also compete on the basis of price. We may be subject to pricing pressures as a result of, among other factors, competition within the industry, consolidation of healthcare industry participants, practices of managed care organizations, government action affecting reimbursement, government action affecting access to student loans, and financial stress experienced by our members. If our pricing experiences significant downward pressure, our business will be less profitable and our results of operations will be adversely affected.
We cannot be certain that we will be able to retain our current members or expand our member base in this competitive environment. If we do not retain current members or expand our member base, our business, financial condition, and results of operations will be harmed. Moreover, we expect that competition will continue to increase as a result of consolidation in both the healthcare information technology and healthcare industries. If one or more of our competitors or potential competitors were to merge or partner with another of our competitors, the change in the competitive landscape also could adversely affect our ability to compete effectively and could harm our business, financial condition, and results of operations.
Our prospects will suffer if we are not able to hire, train, motivate, manage, and retain a significant number of highly skilled employees.
Our future success depends upon our ability to hire, train, motivate, manage, and retain a significant number of highly skilled employees, particularly research analysts, technical experts, and sales and marketing staff. We have experienced, and expect to continue to experience, competition for professional personnel from management consulting firms and other producers of research, technology, and analysis services. Hiring, training, motivating, managing, and retaining employees with the skills we need is time-consuming and expensive. Any failure by us to address our staffing needs in an effective manner could hinder our ability to continue to provide high-quality products and services, implement tools, complete existing member engagements, or attract new members.
Unsuccessful design or implementation of our software may harm our future financial results.
Software development and implementation can take long periods of time and require significant capital investments. If our business intelligence and software tools are less effective, cost-efficient, or attractive to our members than they anticipate or do not function as expected or designed, we may not recover the development costs, and our competitive position, operations, or financial results could be adversely affected. In addition, any defects in our business intelligence and software tools or other intellectual property could result in additional development costs, the diversion of technical and other resources from our other development efforts, significant cost to resolve the defect, loss of members, harm to our reputation, risk of nonpayment, loss of revenue, and exposure to liability claims. We also rely on technology and implementation support provided by others in certain of our programs that offer business intelligence and software tools. Our business could be harmed by defects in this technology or by the failure of third parties to provide timely and accurate services.
Some of our products and services are complex and require significant work to implement. If the member implementation process is not executed successfully or if execution is delayed, our relationships with some of our members may be adversely impacted, and our results of operations may be negatively affected. In addition, cancellation of any of our products and services after implementation has begun may involve loss to us of time, effort, and resources invested in the canceled implementation as well as lost opportunity for acquiring other members over the same period.
We may experience significant delays in generating, or an inability to generate, revenue if potential members take a long time to evaluate our products and services.
A key element of our strategy is to market our products and services directly to health care providers, such as health systems and acute care hospitals, and education institutions, such as colleges and research universities, to increase the number of our products and services utilized by existing members. If we are unable to sell additional products and services to existing hospital, health system, and education members, or enter into and maintain favorable relationships with other health care providers or education organizations, our ability to increase our revenue could be materially adversely affected. We do not control many of the factors that will influence the decisions of these organizations regarding the purchase of our products and services. The evaluation process sometimes can be lengthy and involve significant technical evaluation and commitment of personnel by these organizations. The use of our products and services also may be delayed due to reluctance to change or modify existing procedures.
Unsuccessful delivery of our consulting and management services may harm our future financial success.
Several of our programs provide strategic and operational support to our member institutions to help them achieve key clinical quality and financial performance goals, as well as to accelerate the implementation of best practices profiled in our
research studies. If the member delivery process is not executed successfully or if execution is delayed, our relationships with some of our members and our results of operations may be negatively affected. We also are subject to loss of revenue arising from the fact that these consulting and management memberships are not individually renewable. To maintain our annual revenue and contract value from these programs, we will have to enroll new members each year as other members complete their program terms. We may not be successful in selling these programs in the future as a result of a lack of continued market acceptance of the programs or other factors.
Federal and state privacy and security laws may increase the costs of operation and expose us to civil and criminal sanctions.
We must comply with extensive federal and state requirements regarding the use, disclosure, retention, and security of patient health care information. Failure by us to comply with any of the applicable federal and state laws regarding patient privacy, identity theft prevention and detection, breach notification, and data security may subject us to penalties, including civil monetary penalties and, in some circumstances, criminal penalties or contractual liability under our agreements with our members. In addition, any such failure may harm our reputation and adversely affect our ability to retain existing members and attract new members.
The Health Insurance Portability and Accountability Act of 1996, the Health Information Technology for Economic and Clinical Health Act (or the HITECH Act, which was enacted as part of the American Recovery and Reinvestment Act of 2009), and the implementing regulations that have been issued under these statutes contain substantial restrictions and requirements with respect to the use and disclosure of individuals’ protected health information. These restrictions and requirements are set forth in the Privacy Rule and Security Rule portions of HIPAA. The HIPAA Privacy Rule prohibits a covered entity from using or disclosing an individual’s protected health information unless the use or disclosure is authorized by the individual or is specifically required or permitted under the Privacy Rule and requires covered entities to provide individuals with certain rights with respect to their protected health information. The Privacy Rule imposes a complex system of requirements on covered entities for complying with these basic standards. Under the HIPAA Security Rule, covered entities must establish administrative, physical, and technical safeguards to protect the confidentiality, integrity, and availability of electronic protected health information maintained or transmitted by them or by others on their behalf.
The HIPAA Privacy and Security Rules historically have applied directly to covered entities, such as our members who are health care providers that engage in HIPAA-defined standard electronic transactions or health plans. Because some of our members disclose protected health information to us so that we may use that information to provide certain services to them, we are a “business associate” of those members. To provide members with services that involve the use or disclosure of protected health information, the HIPAA Privacy and Security Rules require us to enter into business associate agreements with our members. Such agreements must, among other matters, provide adequate written assurances:
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• | as to how we will use and disclose the protected health information; |
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• | that we will implement reasonable administrative, physical, and technical safeguards to protect such information from misuse; |
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• | that we will enter into similar agreements with our agents and subcontractors that have access to the information; |
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• | that we will report security incidents and other inappropriate uses or disclosures of the information; and |
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• | that we will assist the covered entity with certain of its duties under the Privacy Rule. |
In February 2009, the U.S. Congress enacted the HITECH Act. On January 25, 2013, the United States Department of Health and Human Services, Office for Civil Rights, published a final rule modifying the HIPAA Privacy, Security, Enforcement, and Breach Notification Rules, referred to as the Final HIPAA Omnibus Rule, that implemented many of the provisions of the HITECH Act. Under the Final HIPAA Omnibus Rule, the privacy and security requirements of HIPAA have been modified and expanded. The Final HIPAA Omnibus Rule applies certain of the HIPAA privacy and security requirements directly to business associates of covered entities. We must now directly comply with certain aspects of the Privacy and Security Rules, and are also subject to enforcement for a violation of HIPAA. The Final HIPAA Omnibus Rule also imposes mandatory federal requirements for both covered entities and business associates regarding notification of breaches of unsecured protected health information. The Final HIPAA Omnibus Rule became effective on March 26, 2013, and covered entities and business associates were required to comply with it by September 23, 2013.
Any failure or perception of failure of our products or services to meet HIPAA and related regulatory requirements could expose us to risks of investigation, notification, litigation, penalty, or enforcement, could adversely affect demand for our products and services, and force us to expend significant capital and other resources to modify our products or services to address the privacy and security requirements of our members and HIPAA.
In addition to our obligations under HIPAA, most states have enacted patient confidentiality laws that protect against the disclosure of confidential medical information, and many states have adopted or are considering adopting further legislation in this area, including privacy safeguards, security standards, and data security breach notification requirements. We may be required to comply with these state laws, if they are more stringent than HIPAA requirements and therefore not preempted by the federal requirements.
We are unable to predict what changes to HIPAA or other federal or state laws or regulations might be made in the future or how those changes could affect our business, products, services, or the associated costs of compliance.
Federal or state governmental authorities may impose additional data security standards or additional privacy or other restrictions on the collection, use, transmission, and other disclosures of health information that would limit, forbid, or regulate the use or transmission of health information pertaining to U.S. patients outside of the United States. Such legislation, if adopted, could render operations outside of the United States impracticable or substantially more expensive. In addition, although most of our business is conducted in the United States, some of our businesses and operations are international in nature and consequently are subject to regulation in the jurisdictions in which we conduct those operations. We may be obligated to comply with these regulatory regimes, which include, among other matters, privacy and data protection regulations (including requirements for cross-border data transfers) that vary from jurisdiction to jurisdiction.
We or our members or other third parties with whom we conduct business may experience difficulties in complying with or interpreting federal regulations governing certain electronic transactions, which may negatively affect our service levels or result in enforcement actions against us.
HIPAA and its implementing regulations mandate format, data content, and provider identifier standards that must be used in certain electronic transactions, such as claims, payment advice, and eligibility inquiries. Although our systems are capable of transmitting transactions that comply with these requirements, some members or other third parties with whom we conduct business may interpret HIPAA transaction requirements differently than we do or may require us to use legacy formats or include legacy identifiers as they make the transition to full compliance. In cases where members or other third parties require conformity with their interpretations or require us to accommodate legacy transactions or identifiers as a condition of successful transactions, we may attempt to comply with their requirements, but may be subject to enforcement actions as a result. We are actively working to modify our systems for the implementation of updated standard code sets for diagnoses and procedures that are currently scheduled to take full effect in October 2015. We may not be successful in responding to the new requirements and any changes that we make to our transactions and software may result in errors or otherwise negatively affect our service levels. We also may experience complications in supporting clients that have not fully complied with the revised requirements as of the applicable compliance date.
Our higher education industry members are required to comply with The Family Educational Rights and Privacy Act, or FERPA, and if we violate obligations relating to such members’ FERPA compliance, our reputation and business could suffer.
FERPA generally prohibits an institution of higher education from disclosing personally identifiable information from a student’s education records without the student’s consent. Our members disclose to us certain information that originates from or constitutes a student education record under FERPA and must make such disclosures to us in compliance with FERPA. As an entity that provides services to institutions, we are indirectly subject to FERPA and may not transfer or otherwise disclose any personally identifiable information from a student record to another party other than in a manner permitted under the statute. Any violation of us by FERPA could result in a material breach of contract with one or more of our members and could harm our reputation. Further, if we disclose student information in violation of FERPA, the Department of Education could require one or more members to suspend our access to student information for an extended period.
If we or our subcontractors or agents cause a violation of the Higher Education Act and corresponding regulations established by the Department of Education as they relate to the ban on incentive compensation, we could be liable to our members for substantial fines, sanctions, or other liabilities.
Many of our higher education members are subject to the ban on incentive compensation established under the Higher Education Act and corresponding regulations established by the Department of Education. Such institutions are prohibited from
providing any incentive payments based directly or indirectly on success in securing enrollments or financial aid to any persons or “entities” engaged in any student recruiting or admission activities or in making decisions regarding the award of student financial assistance. Such entities would include us to the extent that we are engaged in any student recruiting or admission activities, or in making decisions regarding financial aid, for a member. Moreover, the ban on incentive compensation extends to incentive payments, based directly or indirectly on success in securing enrollments or financial aid, to the employees of such entities if the employees are involved with or responsible for admissions, recruiting, or financial aid activities. If we or our subcontractors or agents act in a manner that causes a violation of the incentive compensation rule, we could be liable to our members for substantial fines, sanctions, or other liabilities, including liabilities related to “whistleblower” claims under the federal False Claims Act. Any such claims, even if without merit, could require us to incur significant costs to defend the claim, distract management’s attention from our operations, and damage our reputation.
If we or our subcontractors or agents act in a manner that causes a violation of the Department of Education’s misrepresentation rule, or similar federal and state regulatory requirements, we could face fines, sanctions, and other liabilities.
Many of our higher education members are subject to other regulations promulgated by the Department of Education that affect our student recruitment activities, including the misrepresentation rule. The misrepresentation rule is broad in scope and may apply to certain statements our employees, subcontractors, or agents may make on behalf of or at the direction of a higher education member about the nature of a member’s program, a member’s financial charges, or the employability of graduates of a member’s program. A violation of this rule, or other federal or state regulations applicable to our activities, based on statements or conduct by us or by an employee, subcontractor, or agent performing services for members could negatively affect our reputation, result in the termination of member contracts, require us to pay the fees associated with indemnifying a member from private claims or government investigations, or require us to pay substantial fines, sanctions, or other liabilities.
We could suffer a loss of revenue and increased costs, exposure to significant liability, reputational harm, and other serious negative consequences if we sustain cyber attacks or other data security breaches that disrupt our operations or result in the dissemination of proprietary or confidential information about us or our members or other third parties.
We manage and store various proprietary information and sensitive or confidential data relating to our operations. We may be subject to breaches of the information technology systems we use for these purposes. Experienced computer programmers and hackers may be able to penetrate our network security and misappropriate or compromise our confidential information or that of third parties, create system disruptions, or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our products or otherwise exploit any security vulnerabilities of our products. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system.
The costs to us to eliminate or address the foregoing security problems and security vulnerabilities before or after a cyber incident could be significant. Our remediation efforts may not be successful and could result in interruptions, delays, or cessation of service, and loss of existing or potential members that may impede our critical functions. In addition, breaches of our security measures and the unapproved dissemination of proprietary information or sensitive or confidential data about us or our members or other third parties could expose us, our members, or other third parties affected to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation, or otherwise harm our business. In addition, we rely in certain limited capacities on third-party data management providers whose possible security problems and security vulnerabilities may have similar effects on us.
Our business could be harmed by disruptions in service or operational or security failures at our data centers or at other service provider locations related to the storage, transmission, and presentation of member data.
Our data centers and service provider locations store and transmit critical member data that is essential to our business. While these locations are chosen for their stability, failover capabilities, and system controls, we do not directly control the continued or uninterrupted availability of every location. Interruptions in service or damage to locations may be caused by natural disasters, power loss, Internet or network failures, operator error, security breaches, computer viruses, denial-of-service attacks, or similar events, and could result in service interruptions, delays in access, or the destruction of data. Disaster recovery, data backups, and business continuity planning address many of these possible service interruptions, but the varied types and severity of the interruptions that could occur may render our safeguards inadequate. These service interruption events could impair our ability to deliver services or deliverables or cause us to miss service level agreements in our agreements with our members, which could negatively affect our ability to retain existing members and attract new members.
We may be liable to our members and may lose members if we are unable to collect and maintain member data or if we lose member data.
Because of the large amount of data that we collect and manage from our members and other third parties and the increasing use of technology in our programs, hardware failures or errors in our processes or systems could result in data loss or corruption or cause the information that we collect to be incomplete or contain inaccuracies that our members regard as significant. Further, our ability to collect and report data may be interrupted or limited by a number of factors, including the failure of our network, software systems, or business intelligence tools, or the terms of our members’ contracts with their third-party suppliers. Computer viruses may harm our systems, causing us to lose data, and the transmission of computer viruses could expose us to litigation. In addition to potential liability, if we supply inaccurate information or experience interruptions in our ability to capture, store, supply, utilize, and report information, our reputation could be harmed and we could lose existing members and experience difficulties in attracting new members.
Failure by our members to obtain proper permissions and waivers for use and disclosure of the information we receive from them or on their behalf may result in claims against us or may limit or prevent our use of data, which could harm our business.
We require our members to provide necessary notices and to obtain necessary permissions and waivers for use and disclosure of the information that we receive, and we require contractual assurances from them that they have done so and will do so. If they do not obtain necessary permissions and waivers, our use and disclosure of information that we receive from them or on their behalf may be limited or prohibited by state or federal privacy laws or other laws. Any such failure to obtain proper permissions and waivers could impair our functions, processes, and databases that reflect, contain, or are based upon such data and may prevent our use of such data. In addition, such a failure could interfere with or prevent creation or use of rules and analyses or limit other data-driven activities that benefit us. Moreover, we may be subject to claims or liability for use or disclosure of information by reason of our lack of a valid notice, permission, or waiver. These claims or liabilities could subject us to unexpected costs and adversely affect our operating results.
Our sources of data might restrict our use of or refuse to license us such data, which could adversely affect our ability to provide certain products or services.
A portion of the data that we use is either purchased or licensed from third parties or is obtained from our members for specific engagements. We also obtain a portion of the data that we use from public records. If a substantial number of data providers, including our members, were to withdraw or no longer provide their data to us, our ability to provide products and services to our members could be materially adversely affected. We believe that we currently have the rights necessary to use the data that are incorporated into our products and services. In the future, however, data providers could seek to withdraw their data from us if there is a competitive reason to do so, if legislation is passed restricting the use of the data, or if judicial interpretations are issued restricting use of the data. Further, our licenses for information may not allow us to use that information for all potential or contemplated applications and products.
If our products or services fail to provide accurate information, or if our content or any other element of our products or services is associated with incorrect, inaccurate, or faulty coding, billing, or claims submissions to Medicare or any other third-party payor, we could be liable for damages to customers or the government.
Our products and content were developed based on the laws, regulations, and third-party payor rules in existence at the time such software and content was developed. Members could assert claims against us or the government, or qui tam relators on behalf of the government could assert claims against us under the federal False Claims Act or similar state laws, if we interpret those laws, regulations, or rules incorrectly; the laws, regulations, or rules materially change at any point after the software and content was developed; we fail to provide up-to-date, accurate information; or our products or services are otherwise associated with incorrect, inaccurate, or faulty coding, billing, or claims submissions by our members. The assertion of such claims and ensuing litigation, regardless of the resolution, could result in substantial costs to us, divert management’s attention from operations, damage our reputation, and decrease market acceptance of our services. Although we attempt to limit by contract our liability to customers for damages, the allocations of responsibility and limitations of liability set forth in our contracts may not be enforceable or otherwise protect us from liability for damages. We cannot limit liability the government could seek to impose on us under the False Claims Act.
If we fail to comply with federal and state laws governing health care fraud and abuse or reimbursement, we may be subject to civil and criminal penalties or loss of eligibility to participate in government health care programs.
A number of federal and state laws, including physician self-referral laws, anti-kickback restrictions, and laws prohibiting the submission of false or fraudulent claims, apply to health care providers, physicians, and others that make, offer, seek, or receive referrals or payments for products or services that may be paid for through any federal or state health care program and, in some instances, private programs. These laws are complex and change rapidly and may be applied to our business in ways that we do not anticipate. Federal and state regulatory and law enforcement authorities recently have increased enforcement activities with respect to Medicare and Medicaid fraud and abuse regulations and other health care reimbursement laws and rules. From time to time, participants in the health care industry receive inquiries or subpoenas to produce documents in connection with government investigations. We could be required to expend significant time and resources to comply with these requests, and the attention of our management team could be diverted from operations by these efforts.
These laws and regulations may change rapidly, and it is frequently unclear how they apply to our business. Errors created by our proprietary applications or that relate to claims or cost report information or services that relate to relationships between our members and other health care providers, including physicians, may be determined or alleged to be in violation of these laws and regulations. Any failure of our proprietary applications or services to comply with these laws and regulations could result in substantial civil or criminal liability and could, among other things, adversely affect demand for our services, invalidate all or portions of some of our contracts with our members, require us to change or terminate some portions of our business, cause us to be disqualified from serving customers doing business with government payors, and give our members the right to terminate our contracts with them.
If we are unable to maintain our third-party providers or strategic alliances, or enter into new alliances, we may be unable to expand our current business.
Our business strategy includes entering into strategic alliances and affiliations with leading service providers. If existing alliances are terminated or we are unable to enter into alliances with such providers, we may be unable to maintain or increase our market presence. We work closely with our strategic partners either to expand our penetration in certain areas or to expand our market capabilities. We may not achieve our objectives through these alliances. Many of these companies have multiple relationships and they may not regard us as significant to their business. Moreover, these companies, in certain circumstances, may pursue relationships with our competitors or develop or acquire products and services that compete with our products and services.
Our business could be harmed if we are no longer able to license or integrate third-party technologies and data.
We depend upon licenses from third-party vendors for some of the technology and data used in our business intelligence and software tools, for some of the technology platforms upon which these tools operate. We also use third-party software to maintain and enhance content generation and delivery, and to support our technology infrastructure. These technologies might not continue to be available to us on commercially reasonable terms, or at all. Most of these licenses can be renewed only by mutual agreement and may be terminated if we breach the terms of the license and fail to cure the breach within a specified period. Our inability to obtain any of these licenses could delay our ability to provide services until alternative technology can be identified, licensed, and integrated, which may harm our financial condition and results of operations. Some of our third-party licenses are non-exclusive, and our competitors may obtain the right to use any of the technology covered by these licenses to compete directly with us.
Our use of third-party technologies exposes us to increased risks, including risks associated with the integration of new technology into our solutions, the diversion of our resources from development of our own proprietary technology, and the generation of revenue from licensed technology sufficient to offset associated procurement and maintenance costs. In addition, if our vendors choose to discontinue support of the licensed technology in the future, we might not be able to modify or adapt our own solutions to operate as effectively without this technology.
Potential liability claims may adversely affect our business.
Our services, which involve recommendations and advice to organizations 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. Health care and education organizations often are the subject of regulatory scrutiny and litigation, and we also may become the subject of such litigation based on our advice and services. Any such litigation, whether or not resulting in a judgment against us, may adversely affect our reputation and could have a material
adverse effect on our financial condition and results of operations. We may not have adequate insurance coverage for claims against us.
If the protection of our intellectual property is inadequate, our competitors may gain access to our intellectual property and we may lose our competitive advantage.
Our success as a company depends in part upon our ability to protect our intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including trade secrets, copyrights, and trademarks, as well as customary contractual protections with employees, contractors, members, and partners. The steps we have taken to protect our intellectual property rights may not be adequate to deter misappropriation of our rights and may not enable us to detect unauthorized uses and take timely and effective steps to enforce our rights. Our financial condition and results of operations could be negatively affected if we lose our competitive advantage because others are able to use our intellectual property. 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 may not prevail in any such litigation.
If we are alleged to infringe, misappropriate, or violate the proprietary rights of third parties, we could incur unanticipated expense and be prevented from providing our products and services.
We could be subject to intellectual property infringement, misappropriation, or other intellectual property violation claims as our research content and applications’ functionality overlaps with competitive products, and third parties may claim that we do not own or have rights to use all intellectual property rights used in the conduct of our business. We cannot assure you that infringement, misappropriation, or claims alleging intellectual property violations will not be asserted against us. Also, we cannot assure you that any such claims will be unsuccessful. We could incur substantial costs and diversion of management resources defending any such claims. Further, a party making a claim against us could secure a judgment awarding substantial damages, as well as injunctive or other equitable relief that could effectively block our ability to provide products or services. Licenses for any intellectual property of third parties that might be required for our products or services may not be available on commercially reasonable terms, or at all. Such claims also might require us to indemnify of our members at significant expense.
A number of our contracts with our members contain indemnity provisions in which we indemnify such members against certain losses that may arise from third-party claims that are brought in connection with the use of our products.
Our exposure to risks associated with the use of intellectual property may be increased as a result of our acquisitions of technology, as we have limited information about the development process with respect to such technology or the care taken to safeguard against infringement risks. In addition, third parties may make infringement and similar or related claims after we have acquired technology that had not been asserted prior to our acquisition.
Our use of open source technology could impose limitations on our ability to commercialize our software applications.
Many of our software applications incorporate open source software components that are licensed to us under various public domain licenses. Some open source software licenses require users who distribute open source software as part of their software to disclose publicly all or part of the source code to such software or make available any derivative works of the open source code on unfavorable terms or at no cost. There is little or no legal precedent governing the interpretation of many of the terms of these licenses and therefore the potential impact of such terms on our business is unknown. There is a risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to market our software applications. Although we monitor our use of open source software and try to ensure that none is used in a manner that would require us to disclose our source code or that would otherwise breach the terms of an open source agreement, such a use could inadvertently occur. In such an event, we may be required to release our proprietary source code, pay damages for breach of contract, re-engineer our offering, discontinue sales of our offering in the event re-engineering cannot be accomplished on a timely basis, or take other remedial action that may divert resources away from our development efforts. Any of these actions could cause us to breach customer contracts, harm our reputation, result in customer losses or claims, increase our costs, or otherwise adversely affect our business and operating results.
We make estimates and assumptions in connection with the preparation of our consolidated financial statements, and any changes to those estimates and assumptions could have a material adverse effect on our operating results.
In connection with the preparation of our consolidated financial statements, we use certain estimates and assumptions based on historical experience and other factors. Our most critical accounting estimates are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report. In addition, as discussed in Note 2 to
our consolidated financial statements for the nine months ended December 31, 2014 included elsewhere in this report, we make certain estimates, including decisions related to provisions for uncollectible revenue, income taxes, and other contingencies. While we believe that these estimates and assumptions are reasonable under the circumstances, they are subject to significant uncertainties, some of which are beyond our control. If any of these estimates and assumptions should change or prove to have been incorrect, our reported operating results could be materially adversely affected.
Any significant increase in bad debt in excess of recorded estimates would have a negative impact on our business, financial condition, and results of operations.
Our operations may incur unexpected losses from unforeseen exposures to member credit risk. We initially evaluate the collectibility of our accounts receivable based on a number of factors, including a specific member’s ability to meet its financial obligations to us, the length of time the receivables are past due, and historical collections experience. Based on these assessments, we record a reserve for specific account balances as well as a general reserve based on our historical experience for bad debt to reduce the related receivables to the amount we expect to collect from members. If circumstances related to specific members change as a result of economic conditions or otherwise, such as a limited ability to meet financial obligations due to bankruptcy, or if conditions deteriorate to the extent that our past collection experience is no longer relevant, the amount of accounts receivable that we are able to collect may be less than our previous estimates as we experience bad debt in excess of reserves previously recorded.
The unaudited pro forma financial data for The Advisory Board included in this transition report is preliminary, and our actual financial position and operations after the Royall acquisition may differ materially from the unaudited pro forma financial data included in this transition report.
The unaudited pro forma financial data for The Advisory Board included in this transition report is presented for informational purposes only and is not necessarily indicative of what our actual financial position or operations would have been if our recent acquisitions had been completed on the dates indicated. Our actual results and financial position after the Royall acquisition may differ materially and adversely from the unaudited pro forma financial data included in this transition report.
We may fail to realize the anticipated benefits of our acquisition of Royall.
Our future success will depend in part on our ability to realize the new revenue opportunities and other benefits that we expect to achieve from the integration of the Royall businesses into our company. Our operating results and financial condition will be adversely affected if we are unable to integrate successfully Royall’s operations into our own, fail to achieve new revenue opportunities, incur unforeseen costs and expenses, or experience unexpected operating difficulties that offset anticipated benefits. In particular, the integration of our and the Royall businesses will involve, among other matters, integration of sales, marketing, billing, accounting, management, personnel, payroll, and other systems.
Integrating Royall’s business and our business may divert our management’s attention away from other operations.
Successful integration of Royall’s operations, services, and personnel into our own may place a significant burden on our management and internal resources. The diversion of management’s attention and any difficulties encountered in the transition and integration process otherwise could harm our business, financial condition, and operating results. The integration will require efforts from each company, including the coordination of general and administrative functions, such as employee benefits, payroll, financial reporting, and purchasing functions. Delays in successfully integrating and managing employee benefits could lead to employee dissatisfaction and turnover. Problems in integrating purchasing and financial reporting could result in control issues, including unplanned costs.
We may pursue other acquisition opportunities, which could subject us to considerable business and financial risk.
We evaluate potential acquisitions of complementary businesses on an ongoing basis and may from time to time pursue acquisition opportunities. We may not be successful in identifying acquisition opportunities, assessing the value, strengths, and weaknesses of these opportunities, or completing acquisitions on acceptable terms. Future acquisitions may result in dilution to our earnings, including as a result of dilutive issuances of equity securities we may pay as acquisition consideration. Acquisitions may expose us to particular business and financial risks, including risks that we may:
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• | suffer the diversion of financial and management resources from existing operations; |
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• | incur indebtedness and assume additional liabilities, known and unknown, including liabilities relating to the use of intellectual property we acquire; |
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• | incur significant additional capital expenditures, transaction expenses, operating expenses, and non-recurring acquisition-related and integration charges; |
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• | experience an adverse impact on our earnings from the amortization or impairment of acquired goodwill and other intangible assets; |
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• | fail to integrate successfully the operations and personnel of the acquired businesses; |
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• | enter new markets or market new products with which we are not entirely familiar; and |
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• | fail to retain key personnel of, vendors to, and clients of the acquired businesses. |
If we are unable to manage the risks associated with acquisitions, or if we experience unforeseen expenses, difficulties, complications, or delays frequently encountered in connection with the integration of acquired entities and the expansion of operations, we may fail to achieve expected cost savings, revenue opportunities, and other expected benefits of our acquisition strategy and may be required to focus resources on integrating the acquired operations rather than on our primary product and service offerings.
Any significant impairment of our goodwill would lead to a decrease in our assets and a reduction in our net operating performance.
As of December 31, 2014, after giving pro forma effect to our acquisition of Royall, we had goodwill of approximately $863.9 million, which constituted approximately 42% of our total pro forma assets as of that date. If we make changes in our business strategy or if market or other conditions adversely affect our business operations, we may be forced to record an impairment change, which would lead to a decrease in our assets and a reduction in our net operating performance. If the testing performed indicates that impairment has occurred, we will be required to record an impairment charge for the difference between the carrying value of the goodwill and the implied fair value of the goodwill in the period in which the determination is made. The testing of goodwill for impairment requires us to make significant estimates about the future performance and cash flows of our company, as well as other assumptions. These estimates can be affected by numerous factors, including changes in economic, industry, or market conditions, changes in underlying business operations, future reporting unit operating performance, existing or new product market acceptance, changes in competition, or changes in technologies. Any changes in key assumptions, or actual performance compared with those assumptions, about our business and its future prospects or other assumptions could affect the fair value of one or more reporting units, and result in an impairment charge.
We may invest in companies for strategic reasons and may not realize a return on our investments.
From time to time, we may make investments in companies to further their strategic objectives and support our key business initiatives. Such investments could include equity or debt instruments in private companies, and many of which may be non-marketable at the time of our initial investment. These companies may range from early-stage companies that are often still defining their strategic direction to more mature companies with established revenue streams and business models. The success of these companies may depend on product development, market acceptance, operational efficiency, and other key business factors. The companies in which we invest may fail because they may not be able to secure additional funding, obtain favorable investment terms for future financings, or take advantage of liquidity events such as public offerings, mergers, and private sales. If any of these private companies fails, we could lose all or part of our investment in that company. If we determine that impairment indicators exist and that there are other-than-temporary declines in the fair value of the investments, we may be required to write down the investments to their fair value and recognize the related write-down as an investment loss.
Our level of debt and interest payment obligations may limit our growth and operational flexibility.
As of March 4, 2015, we had approximately $575 million in aggregate principal amount of outstanding indebtedness, consisting of borrowings under the $575 million senior secured term loan facility we obtained on February 6, 2015, as described elsewhere in this report. We may incur an additional $100 million of indebtedness under our senior secured revolving credit facility. This substantial level of indebtedness may have important consequences. For example, it may:
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• | require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, and other general corporate purposes; |
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• | limit our ability to obtain additional financing to expand our business or alleviate liquidity constraints, as a result of financial and other restrictive covenants in our indebtedness; |
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• | limit our ability to pursue our acquisition strategy; |
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• | increase our vulnerability to general adverse economic and industry conditions; |
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• | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and |
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• | place us at a competitive disadvantage relative to companies that have less indebtedness. |
Covenants under our senior secured credit agreement may restrict our future operations.
Our senior secured credit agreement imposes operating and financial restrictions that limit our discretion on certain business matters, which could make it more difficult for us to expand, finance our operations, and engage in other business activities that may be in our interest. These restrictions include a requirement that we comply on a quarterly basis with financial covenants. Our debt covenants limit our ability and the ability of our subsidiaries to:
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• | repurchase shares of our common stock or make other restricted payments; |
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• | make investments in or loans to other parties; |
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• | engage in mergers and acquisitions; |
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• | enter into transactions with affiliates; |
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• | enter into sale and leaseback transactions; and |
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• | engage in businesses other than businesses of the type we conduct currently. |
We may incur indebtedness in addition to the foregoing indebtedness. Any additional indebtedness we may incur in the future may subject us to similar or even more restrictive conditions.
If we are required to collect sales and use taxes on the programs we sell in additional jurisdictions, we may be subject to liability for past sales and incur additional related costs and expenses and may experience a decrease in our future sales.
We may lose sales or incur significant expenses if states are successful in imposing state sales and use taxes on our services. A successful assertion by one or more states that we should collect sales or other taxes on the sale of our services could result in substantial tax liabilities for past sales, decrease our ability to compete with software vendors subject to sales
and use taxes, and otherwise harm our business. Each state has different rules and regulations governing sales and use taxes, and these rules and regulations are subject to varying interpretations that may change over time. We review these rules and regulations periodically and, when we believe that our services are subject to sales and use taxes in a particular state, may approach state tax authorities to determine how to comply with their rules and regulations. We may become subject to sales and use taxes and related interest and penalties for past sales in states where we believe no compliance is necessary. If we are required to collect and pay back taxes and the associated interest and penalties, and if our members fail or refuse to reimburse us for all or a portion of these amounts, we will incur unplanned expenses that may be substantial. Moreover, imposition of such taxes on our future services will effectively increase the cost of such services to our members and may adversely affect our ability to retain existing clients or to gain new members in the states in which such taxes are imposed.
We may not be able to fully realize our deferred tax assets.
For tax purposes, we have deferred income tax assets consisting primarily of state income tax credit and net operating loss carryforwards. As of December 31, 2014, our deferred income tax assets totaled approximately $14.7 million, which constituted approximately 1% of our total assets as of that date. If our future taxable income is less than we believe it will be, we may not be able to fully realize our deferred tax assets. In estimating future tax consequences, we do 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 laws and rates, including the estimated effects of our status as a Qualified High Technology Company on our Washington, D.C. deferred tax assets. We will recognize an adjustment to income 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 that have an impact on our deferred income taxes.
If our members who operate as not-for profit entities lose their tax-exempt status, those members would suffer significant adverse tax consequences which, in turn, could adversely affect their ability to purchase products or services from us.
State tax authorities have challenged the tax-exempt status of hospitals and other health care facilities claiming such status on the basis that they are operating as charitable or religious organizations. The outcome of these cases has been mixed, with some facilities retaining their tax-exempt status and others being denied the ability to continue operating as not-for profit, tax-exempt entities under state law. In addition, many states have removed sales tax exemptions previously available to not-for-profit entities, and both the Internal Revenue Service and the U.S. Congress are investigating the practices of non-for profit hospitals. Those facilities denied tax exemptions could be subject to the imposition of tax penalties and assessments that could have a material adverse impact on their cash flow, financial strength, and, in some cases, continuing viability. If the tax-exempt status of any of our members is revoked or compromised by new legislation or interpretation of existing legislation, that member’s financial health could be adversely affected, which could negatively affect our sales to the member.
We could become subject to regulation by the Food and Drug Administration if functionality in one or more of our software tools causes the software to be considered a medical device.
The overall framework of the laws and regulations administered by the Food and Drug Administration, or FDA, applies to all products that meet the definition of a “medical device.” To the extent that functionality in one or more of our current or future software products causes the software to be considered a medical device under existing FDA regulations or policies or under regulations and policies now under active consideration by the FDA, we, as a provider of application functionality, could be required, depending on the functionality, to:
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• | register our company and list products with the FDA; |
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• | notify the FDA and demonstrate substantial equivalence to other products on the market before marketing our functionality; |
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• | obtain FDA approval by demonstrating the safety and effectiveness of the regulated products prior to marketing; and |
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• | comply with various FDA regulations, including the agency’s quality system regulation, medical device reporting regulations, corrections and removal reporting regulations, and post-market surveillance regulations. |
The FDA can impose extensive requirements governing pre- and post-market conditions, such as service investigation and conditions relating to approval, labeling, and manufacturing. In addition, the FDA can impose extensive requirements governing development controls and quality assurance processes. Any application of FDA regulations to our business could
adversely affect our financial results by increasing our operating costs, slowing our time to market for regulated software products, and making it uneconomical to offer some software products.
Our growing operations in India expose us to risks that could have an adverse effect on our costs of operations.
As of December 31, 2014, we employed approximately 230 employees in India through our Indian subsidiary, ABCO Advisory Services India Private Ltd., which expects to continue adding personnel. While there are cost advantages to operating in India, significant growth in the technology sector in India has increased competition to attract and retain skilled employees and has led to a commensurate increase in compensation expense. In the future, we may not be able to hire and retain such personnel at compensation levels consistent with our existing compensation and salary structure in India. In addition, our reliance on a workforce in India exposes us to disruptions in the business, political, and economic environment in that region. Maintenance of a stable political environment is important to our operations, and terrorist attacks and acts of violence or war may directly affect our physical facilities and workforce or contribute to general instability. Our operations in India require us to comply with complex local laws and regulatory requirements and expose us to foreign currency exchange rate risk. Our Indian operations also may subject us to trade restrictions, reduced or inadequate protection for intellectual property rights, and security breaches. Negative developments in any of these areas could increase our costs of operations or otherwise harm our business.
As a result of the inherent limitations in our internal control over financial reporting, misstatements due to error or fraud may occur and not be detected.
Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed by us in reports we file with or submit to the SEC under the Exchange Act is accumulated and communicated to management and recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms. We believe that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. In addition, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by an unauthorized override of the controls.
Any failure by us to maintain effective internal control over financial reporting may adversely affect investor confidence in our company and, as a result, the value of our common stock.
We are required under Section 404 of the Sarbanes-Oxley Act to furnish a report by management on the effectiveness of our internal control over financial reporting and to include a report by our independent auditors attesting to such effectiveness. Any failure by us to maintain effective internal control over financial reporting could adversely affect our ability to report accurately our financial condition or results of operations. If we are unable to conclude that our internal control over financial reporting is effective, or if our independent auditors determine that we have a material weakness or significant deficiency in our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline, and we could be subject to sanctions or investigations by the SEC or other regulatory authorities. Failure to remedy any material weakness in our internal control over financial reporting, or to implement or maintain other effective control systems required of public companies, also could restrict our future access to the capital markets. In our quarterly report on Form 10-Q for the three months ended December 31, 2013, we reported our management’s conclusion that there was a material weakness in our internal control over financial reporting related to capitalization of software development costs as of December 31, 2013. We subsequently remediated that material weakness.
Our issuance of additional capital stock in connection with financings, acquisitions, investments, our stock incentive plans, or otherwise could adversely affect the market price of our common stock.
Our charter authorizes us to issue up to 135,000,000 shares of common stock and up to 5,000,000 shares of preferred stock with such rights and preferences as may be determined by our board of directors. Subject to compliance with applicable rules and regulations and our debt covenants, we may issue our shares of common stock or securities convertible into our common stock from time to time in connection with a financing, acquisition, investment, our stock incentive plans, or otherwise. We may issue additional shares of common stock at a discount from the market price of our common stock on the issue date. Any issuance of stock could result in substantial dilution to our existing stockholders and cause the market price of our common stock to decline.
Provisions in our charter and bylaws could discourage takeover attempts we oppose even if our stockholders might benefit from a change in control of our company.
Provisions in our charter and bylaws may make it difficult and expensive for a third party to pursue a takeover attempt we oppose even if a change in control of our company would be beneficial to the interests of our stockholders. These provisions also could make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take other corporate actions you support. The charter and bylaw provisions:
| |
• | provide that the number of directors that will constitute the entire board of directors will be determined by a resolution of a majority of the board; |
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• | provide that any vacancy on the board of directors may be filled only by the affirmative vote of a majority of the remaining directors then in office; |
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• | provide that a special meeting of stockholders may be called only by a majority of the directors then in office, by the chairman of the board of directors, or by any holder or holders of at least 40% of the outstanding shares of capital stock then entitled to vote on any matter for which the special meeting is being called; |
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• | prohibit stockholders from taking action by written consent in lieu of a meeting with respect to any actions that are required or permitted to be taken by stockholders at any annual or special meeting of stockholders; |
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• | provide authority for our board of directors without stockholder approval to provide for the issuance of up to 5,000,000 shares of preferred stock, in one or more classes or series, with terms and conditions, and having rights, privileges and preferences, to be determined by the board of directors; and |
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• | establish advance notice procedures for stockholders to make nominations of candidates for election as directors or to present any other business for consideration at any annual or special stockholder meeting. |
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our headquarters is located in approximately 290,000 square feet of office space in Washington, D.C. The facilities accommodate research, delivery, marketing and sales, software development, information technology, administration, and operations personnel. Approximately 73% of our headquarters facilities is under an operating lease that expires in June 2019. The lease contains provisions for rental escalation and requires us to pay our portion of our executory costs such as taxes, insurance, and operating expenses. The remaining space in our headquarters facility is under a sublease expiring in 2017. The sublease contains provisions for annual rental escalations with no obligation to pay the additional executory costs noted above.
As of December 31, 2014, we leased office space under operating leases in Houston, Texas; Birmingham, Alabama; Austin, Texas; Nashville, Tennessee; Vernon Hills, Illinois; Evanston, Illinois; San Francisco, California; Ann Arbor, Michigan; Plymouth Meeting, Pennsylvania; Tucson, Arizona; and London, England. We also lease office space in Chennai, India through our Indian subsidiary, ABCO Advisory Services India Private Ltd. For information about our leases, see Note 16, “Commitments and contingencies,” to our consolidated financial statements included elsewhere in this report. We believe that our facilities are adequate for our current needs and that additional facilities will be available for lease on a commercially reasonable basis to accommodate our anticipated growth.
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.
Item 4. Mine Safety Disclosures.
None.
PART II
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Item 5. | Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Our common stock is listed on the Global Select Market of The NASDAQ Stock Market LLC and is traded under the NASDAQ symbol “ABCO.” The following table sets forth, for the fiscal periods indicated, the high and low sales prices per share of our common stock as reported on the NASDAQ Global Select Market.
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| | | | | | | |
| High | | Low |
Transition Period Ended December 31, 2014: | | | |
First quarter | $ | 66.04 |
| | $ | 46.58 |
|
Second quarter | $ | 55.22 |
| | $ | 43.00 |
|
Third quarter | $ | 54.62 |
| | $ | 37.47 |
|
Fiscal Year Ended March 31, 2014: | | | |
First quarter | $ | 55.31 |
| | $ | 44.20 |
|
Second quarter | $ | 60.43 |
| | $ | 52.86 |
|
Third quarter | $ | 70.55 |
| | $ | 59.14 |
|
Fourth quarter | $ | 70.14 |
| | $ | 54.79 |
|
As of February 20, 2015, there were eight holders of record of our common stock and 42,184,511 shares of common stock outstanding. The number of record holders does not include individuals or entities who beneficially own shares but whose shares are held of record by a broker, bank, or other nominee, but does include each such broker, bank, or other nominee as one record holder.
We have not declared or paid any cash dividends on our common stock since we became a public company in 2001. We do not currently anticipate declaring or paying any cash dividends. The timing and amount of future cash dividends, if any, is periodically evaluated by our board of directors and would depend on, among other factors, our earnings, financial condition, cash requirements, and restrictions on dividend payments under our senior secured credit facilities.
The Advisory Board Company Stock Comparable Performance Graph
The graph below compares the cumulative total stockholder return on our common stock during the period from March 31, 2010 through December 31, 2014, with the cumulative total return on the S&P 500 Index, the Russell 2000 Index, and the NASDAQ Composite Index for the same period. The comparison assumes that $100 was invested on March 31, 2010 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any. The comparisons in the graph below are based on historical data and are not intended to forecast the possible future performance of our common stock.
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| | | | | | | | | | | | | | | | |
| | The Advisory Board Company | | S&P 500 Index | | Russell 2000 Index | | NASDAQ Composite Index |
March 31, 2010 | | $ | 100 |
| | $ | 100 |
| | $ | 100 |
| | $ | 100 |
|
March 31, 2011 | | $ | 163 |
| | $ | 116 |
| | $ | 126 |
| | $ | 117 |
|
March 31, 2012 | | $ | 281 |
| | $ | 126 |
| | $ | 126 |
| | $ | 131 |
|
March 31, 2013 | | $ | 333 |
| | $ | 143 |
| | $ | 146 |
| | $ | 141 |
|
March 31, 2014 | | $ | 408 |
| | $ | 174 |
| | $ | 182 |
| | $ | 183 |
|
December 31, 2014 | | $ | 311 |
| | $ | 195 |
| | $ | 189 |
| | $ | 209 |
|
Item 6. Selected Financial Data.
The following table presents our selected financial data. The table should be read in conjunction with our consolidated financial statements, the notes to the consolidated financial statements, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.
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| | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended December 31, | | Year Ended March 31, |
| | 2014 | | 2013 | | 2014 | | 2013 | | 2012 | | 2011 |
(In thousands except per share amounts) | | | | (unaudited) | | | | | | | | |
| | | | | | | | | | | | |
Statements of Operations Data: | | | | | | | | | | | | |
Revenue | | $ | 436,228 |
| | $ | 382,595 |
| | $ | 520,596 |
| | $ | 450,837 |
| | $ | 370,345 |
| | $ | 283,439 |
|
Costs and expenses: | | | | | | | | | | | | |
Cost of services, excluding depreciation and amortization | | 230,169 |
| | 205,328 |
| | 272,523 |
| | 237,605 |
| | 197,937 |
| | 144,906 |
|
Member relations and marketing | | 81,244 |
| | 69,886 |
| | 96,298 |
| | 85,264 |
| | 73,875 |
| | 64,295 |
|
General and administrative | | 75,483 |
| | 55,426 |
| | 74,169 |
| | 62,185 |
| | 47,892 |
| | 38,225 |
|
Depreciation and amortization | | 29,994 |
| | 21,952 |
| | 30,420 |
| | 20,308 |
| | 14,269 |
| | 10,108 |
|
Impairment of capitalized software | | 2,086 |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Total costs and expenses | | 418,976 |
| | 352,592 |
| | 473,410 |
| | 405,362 |
| | 333,973 |
| | 257,534 |
|
Operating income | | 17,252 |
| | 30,003 |
| | 47,186 |
| | 45,475 |
| | 36,372 |
| | 25,905 |
|
Other (loss) income, net | | (1,327 | ) | | 1,974 |
| | 2,706 |
| | 2,604 |
| | 3,034 |
| | 1,866 |
|
Income from continuing operations before provision for income taxes and equity in loss of unconsolidated entities | | 15,925 |
| | 31,977 |
| | 49,892 |
| | 48,079 |
| | 39,406 |
| | 27,771 |
|
Provision for income taxes | | (4,831 | ) | | (12,311 | ) | | (19,208 | ) | | (18,023 | ) | | (15,207 | ) | | (9,691 | ) |
Equity in loss of unconsolidated entities | | (6,540 | ) | | (3,320 | ) | | (6,051 | ) | | (6,756 | ) | | (1,337 | ) | | — |
|
Net income from continuing operations | | 4,554 |
| | 16,346 |
| | 24,633 |
| | 23,300 |
| | 22,862 |
| | 18,080 |
|
Discontinued operations: | | | | | | | | | | | | |
Income from discontinued operations, net of tax (1) | | — |
| | — |
| | — |
| | — |
| | 286 |
| | 444 |
|
Gain on sale of discontinued operations, net of tax | | — |
| | — |
| | — |
| | — |
| | 2,155 |
| | — |
|
Net income from discontinued operations | | | | — |
| | — |
| | — |
| | 2,441 |
| | 444 |
|
Net income before allocation to noncontrolling interest | | 4,554 |
| | 16,346 |
| | 24,633 |
| | 23,300 |
| | 25,303 |
| | 18,524 |
|
Net (loss) income and accretion to redemption value attributable to noncontrolling interest | | (6,253 | ) | | 119 |
| | 119 |
| | 108 |
| | — |
| | — |
|
Net (loss) income attributable to common stockholders | | $ | (1,699 | ) | | $ | 16,465 |
| | $ | 24,752 |
| | $ | 23,408 |
| | $ | 25,303 |
| | $ | 18,524 |
|
Earnings per share – basic: | | | | | | | | | | | | |
Net (loss) income from continuing operations attributable to common stockholders | | $ | (0.05 | ) | | $ | 0.46 |
| | $ | 0.69 |
| | $ | 0.67 |
| | $ | 0.70 |
| | $ | 0.57 |
|
Net income from discontinued operations attributable to common stockholders | | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 0.07 |
| | $ | 0.02 |
|
Net (loss) income attributable to common stockholders per share – basic | | $ | (0.05 | ) | | $ | 0.46 |
| | $ | 0.69 |
| | $ | 0.67 |
| | $ | 0.77 |
| | $ | 0.59 |
|
Earnings per share – diluted: | | | | | | | | | | | | |
Net (loss) income from continuing operations attributable to common stockholders | | $ | (0.05 | ) | | $ | 0.45 |
| | $ | 0.67 |
| | $ | 0.64 |
| | $ | 0.66 |
| | $ | 0.55 |
|
Net income from discontinued operations attributable to common stockholders | | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 0.07 |
| | $ | 0.02 |
|
Net (loss) income attributable to common stockholders per share – diluted | | $ | (0.05 | ) | | $ | 0.45 |
| | $ | 0.67 |
| | $ | 0.64 |
| | $ | 0.73 |
| | $ | 0.57 |
|
Weighted average number of shares outstanding: | | | | | | | | | | | | |
Basic | | 36,213 |
| | 35,812 |
| | 35,909 |
| | 34,723 |
| | 32,808 |
| | 31,466 |
|
Diluted | | 36,213 |
| | 36,876 |
| | 36,959 |
| | 36,306 |
| | 34,660 |
| | 32,830 |
|
—————————————
| |
(1) | Income from discontinued operations for all periods presented includes the operating results for OptiLink, a business that was sold in January 2012. |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended December 31, | | Year Ended March 31, |
| 2014 | | 2013 | | 2014 | | 2013 | | 2012 | | 2011 |
(In thousands except per share amounts) | | | (unaudited) | | | | | | | | |
| |
Stock-based compensation expense included in Statement of Operations: | | | | | | | | | | | |
Costs and expenses: | | | | | | | | | | | |
Cost of services | $ | 5,977 |
| | $ | 4,145 |
| | $ | 5,527 |
| | $ | 3,975 |
| | $ | 3,440 |
| | $ | 2,763 |
|
Member relations and marketing | 3,348 |
| | 2,845 |
| | 3,688 |
| | 2,643 |
| | 2,133 |
| | 1,663 |
|
General and administrative | 8,640 |
| | 6,804 |
| | 9,002 |
| | 7,295 |
| | 6,413 |
| | 4,366 |
|
Total costs and expenses | 17,965 |
| | 13,794 |
| | 18,217 |
| | 13,913 |
| | 11,986 |
| | 8,792 |
|
Operating income | (17,965 | ) | | (13,794 | ) | | (18,217 | ) | | (13,913 | ) | | (11,986 | ) | | (8,792 | ) |
Net loss attributable to common stockholders | $ | (12,515 | ) | | $ | (8,484 | ) | | $ | (11,204 | ) | | $ | (8,686 | ) | | $ | (7,359 | ) | | $ | (5,725 | ) |
Impact on earnings per share: | | | | | | | | | | | |
Net loss attributable to common stockholders per share – diluted | $ | (0.35 | ) | | $ | (0.23 | ) | | $ | (0.30 | ) | | $ | (0.24 | ) | | $ | (0.21 | ) | | $ | (0.18 | ) |
|
| | | | | | | | | | | | | | | | | | | |
| December 31, | | March 31, |
| 2014 | | 2014 | | 2013 | | 2012 | | 2011 |
(In thousands) | |
| | | | | | | | | |
Balance Sheet Data: | | | | | | | | | |
Cash and cash equivalents | $ | 72,936 |
| | $ | 23,129 |
| | $ | 57,829 |
| | $ | 60,642 |
| | $ | 30,378 |
|
Marketable securities | 14,714 |
| | 164,396 |
| | 156,839 |
| | 127,444 |
| | 86,179 |
|
Working capital (deficit) | 50,518 |
| | (59,912 | ) | | (26,761 | ) | | (28,783 | ) | | (65,953 | ) |
Total assets | 1,126,366 |
| | 1,041,335 |
| | 897,933 |
| | 706,307 |
| | 491,432 |
|
Deferred revenue | 668,799 |
| | 587,359 |
| | 503,025 |
| | 391,920 |
| | 262,751 |
|
Total stockholders’ equity | 320,051 |
| | 337,059 |
| | 282,820 |
| | 217,302 |
| | 148,836 |
|
|
| | | | | | | | | | | | | | | | | | | |
| December 31, | | March 31, |
| 2014 | | 2014 | | 2013 | | 2012 | | 2011 |
| (unaudited) |
Other Operating Data: | | | | | | | | | |
Membership programs offered | 65 |
| | 62 |
| | 57 |
| | 53 |
| | 49 |
|
Contract value (in thousands) (1) | $ | 601,842 |
| | $ | 541,903 |
| | $ | 466,329 |
| | $ | 398,313 |
| | $ | 304,299 |
|
—————————————
| |
(1) | Represents the aggregate annualized revenue attributable to all agreements in effect at a particular date, without regard to the initial term or remaining duration of any such agreement. |
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
The following management’s discussion and analysis should be read in conjunction with our audited consolidated financial statements included elsewhere in this report.
Until our most recent fiscal year, our fiscal year was the 12-month period ending on March 31. Our 2014 fiscal year ended on March 31, 2014 and our 2013 fiscal year ended on March 31, 2013. In November 2014, we elected to change our fiscal year-end from March 31 to December 31. As a result, our most recently-completed fiscal period is a nine-month transition period that began on April 1, 2014 and ended on December 31, 2014.
In this management’s discussion and analysis, when the financial results for the 2014 transition period are compared to the financial results for the prior year period, we compare the audited results for the nine-month period ended December 31, 2014 to the unaudited results for the nine-month period ended December 31, 2013. When the financial results for fiscal 2014 are compared to the financial results for fiscal 2013, we compare the results of our two previous fiscal years, or the twelve-month periods ended March 31, 2014 and March 31, 2013.
Acquisition of Royall
As discussed elsewhere in this report, on January 9, 2015, after the end of our transition period ended on December 31, 2014, we completed our acquisition of Royall, a leading provider of strategic, data-driven student engagement and enrollment management, financial aid optimization, and alumni fundraising solutions to the higher education industry. For additional information about Royall and the terms of the acquisition and related transactions, see “Business,” and “Liquidity and Capital Resources” below. In light of our acquisition of Royall, our future results may not be comparable to our historical results.
Overview of Our Operations
We are a leading provider of insight-driven performance improvement software and solutions to the rapidly changing health care and higher education industries. Through our subscription-based membership programs, we leverage our intellectual capital to help members solve their most critical business problems. As of the date of this report, we serve approximately 5,000 members, including hospitals, health systems and other health care organizations, and colleges and universities.
Our membership business model allows us to create value for our members by providing proven solutions to common and complex problems as well as high-quality content and innovative software on a broad set of relevant issues. Our growth has been driven by the addition of new members, strong renewal rates, expansion of our relationships with existing members, new program launches, acquisition activity, and annual price increases. Our member institution renewal rate was 90% , 90%, and 90% for the nine months ended December 31, 2014 and fiscal 2014 and 2013, respectively. We believe high renewal rates reflect of our members’ recognition of the value they derive from participating in our programs.
Our revenue grew 14.0% in the nine months ended December 31, 2014 over the nine months ended December 31, 2013, and 15.5% in fiscal 2014 over fiscal 2013. Our contract value increased 15.2% to $601.8 million as of December 31, 2014 from December 31, 2013, and 16.2% to $541.9 million as of March 31, 2014 from March 31, 2013. We define contract value as the aggregate annualized revenue attributable to all agreements in effect at a particular date, without regard to the initial term or remaining duration of any such agreement. In each of our programs, we generally invoice and collect fees in advance of accrual revenue recognition.
Our operating costs and expenses consist of cost of services, member relations and marketing expense, general and administrative expenses, depreciation and amortization expense, and impairment of capitalized software.
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• | Cost of services includes the costs associated with the production and delivery of our products and services, consisting of compensation for research personnel, in-house faculty, software developers, and consultants; costs of the organization and delivery of membership meetings, teleconferences, and other events; production of published materials; technology license fees; costs of developing and supporting our cloud-based content and performance technology software; and fair value adjustments to acquisition-related earn-out liabilities. |
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• | Member relations and marketing expense includes the costs of acquiring new members and the costs of account management, and includes compensation (including sales incentives), travel and entertainment expenses, and costs for training of personnel, sales and marketing materials, and associated support services. |
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• | General and administrative expense includes the costs of human resources and recruiting; finance and accounting; legal support; management information systems; real estate and facilities management; corporate development; new program development; and other administrative functions. |
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• | Depreciation and amortization expense includes the cost of depreciation of our property and equipment; amortization of costs associated with the development of software and tools that are offered as part of certain of our membership programs; and amortization of acquired intangibles. |
| |
• | Impairment of capitalized software includes the impairment charge taken to write down internally developed capitalized software balances to their current fair value. |
Our operating costs for each period include stock-based compensation expenses and expenses representing additional payroll taxes for compensation expense as a result of the taxable income employees recognize upon their exercise of common stock options and the vesting of restricted stock units issued under our stock incentive plans.
Non-GAAP Financial Presentation
This management’s discussion and analysis presents supplemental measures of our performance that are derived from our consolidated financial information but are not presented in our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America, or “GAAP.” We refer to these financial measures, which are considered “non-GAAP financial measures” under SEC rules, as adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share. See “Non-GAAP Financial Measures” below for information about our use of these non-GAAP financial measures, including our reasons for including these measures, material limitations with respect to the usefulness of the measures, and reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure.
Results of Operations
The following table shows statements of operations data expressed as a percentage of revenue for the periods indicated:
|
| | | | | | | |
| Nine Months Ended December 31, | | Year Ended March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
| | | (Unaudited) | | | | |
Revenue | 100.0% | | 100.0% | | 100.0% | | 100.0% |
Costs and expenses: | | | | |
| | |
Cost of services, excluding depreciation and amortization | 52.8 | | 53.7 | | 52.3 | | 52.7 |
Member relations and marketing | 18.6 | | 18.3 | | 18.5 | | 18.9 |
General and administrative | 17.3 | | 14.5 | | 14.2 | | 13.8 |
Depreciation and amortization | 6.9 | | 5.7 | | 5.8 | | 4.5 |
Impairment of capitalized software | 0.5 | | — | | — | | — |
Total costs and expenses | 96.1 | | 92.2 | | 90.8 | | 89.9 |
Operating income | 3.9 | | 7.8 | | 9.2 | | 10.1 |
Other income, net | (0.3) | | 0.5 | | 0.5 | | 0.6 |
Income before provision for income taxes and equity in loss of unconsolidated entities | 3.6 | | 8.3 | | 9.7 | | 10.7 |
Provision for income taxes | (1.1) | | (3.2) | | (3.7) | | (4.0) |
Equity in loss of unconsolidated entities | (1.5) | | (0.8) | | (1.2) | | (1.5) |
Net income before allocation to noncontrolling interest | 1.0 | | 4.3 | | 4.8 | | 5.2 |
Net loss and accretion to redemption value attributable to noncontrolling interest | (1.4) | | — | | — | | — |
Net (loss) income attributable to common stockholders | (0.4) | | 4.3 | | 4.8 | | 5.2 |
Nine months ended December 31, 2014 compared to the nine months ended December 31, 2013 and fiscal year ended March 31, 2014 compared to fiscal year ended March 31, 2013
Net (loss) income attributable to common stockholders. Net loss attributable to common stockholders for the nine months ended December 31, 2014 was $1.7 million compared to net income attributable to common stockholders of $16.5 million for the nine months ended December 31, 2013. The change in net (loss) income attributable to common stockholders was the result of an accretion charge to the estimated redemption amount of our redeemable noncontrolling interest of $6.3 million, an increase of $4.0 million in acquisition-related costs, a $3.2 million increase in our equity in loss of unconsolidated entities, and a $2.1 million impairment of capitalized internally developed software assets. The effect of these factors was partially offset by a 14.0% increase in revenue from $382.6 million to $436.2 million.
Net income attributable to common stockholders increased 5.7% to $24.8 million in fiscal 2014 from $23.4 million in fiscal 2013. The increase in net income attributable to common stockholders in fiscal year 2014 was primarily attributable to a 15.5% increase in revenue from $450.8 million to $520.6 million and a $8.2 million decrease in fair value charges resulting from a $4.4 million decrease in acquisition-related earn-out fair value charges in fiscal 2014 compared to a $3.8 million increase in fiscal 2013. The effect of these factors was partially offset by an increase in cost of services of $34.9 million incurred for five newly developed programs, four acquired companies, and growth of existing programs, an increase of $12.0 million in general and administrative expense related to increased investment in certain of our administrative groups to support our growing employee base and number of offices, an increase of $11.0 million in marketing and member relations costs primarily attributable to the addition of new sales teams, and an increase of $10.1 million in depreciation and amortization due to increased capital expenditures, including for internally developed software, and an increase in amortization of newly acquired intangibles.
Adjusted net income, non-GAAP earnings per diluted share, and adjusted EBITDA. For the nine months ended December 31, 2014, adjusted net income increased 9.7% to $35.4 million from $32.3 million. For the nine months ended December 31, 2014, non-GAAP earnings per diluted share increased to $0.98 from non-GAAP earnings per diluted share of $0.88 for the nine months ended December 31, 2013. Adjusted EBITDA increased 9.0% to $72.1 million for the nine months ended December 31, 2014 from $66.2 million for the nine months ended December 31, 2013. The increases in adjusted net income and adjusted EBITDA for the nine months ended December 31, 2014 were due to increased revenue, the effect of which was partially offset by the costs of new and growing programs, increased investment in our general and administrative infrastructure to support our growing employee base, and an increase in the number of new sales teams.
Adjusted net income decreased to $44.9 million in fiscal 2014 from $45.4 million in fiscal 2013. In fiscal 2014, non-GAAP earnings per diluted share decreased to $1.22 from $1.25 non-GAAP earnings per diluted share in fiscal 2013. Adjusted EBITDA increased 9.2% from $84.4 million in fiscal 2013 to $92.2 million in fiscal 2014. The increase in adjusted EBITDA in fiscal 2014 was due to increased revenue, the effect of which was partially offset by the costs of new and growing programs, increased investment in our general and administrative infrastructure to support our growing employee base, and an increase in the number of new sales teams. The decrease in adjusted net income for fiscal 2014 was attributable primarily to an increase in tax rate, as well as to an increase of $10.1 million in depreciation and amortization due to increased capital expenditures, including for internally developed software, and an increase in amortization of newly acquired intangibles.
Revenue. Revenue increased 14.0% to $436.2 million for the nine months ended December 31, 2014 from $382.6 million for the nine months ended December 31, 2013. Our contract value increased 15.2% to $601.8 million as of December 31, 2014 from $522.5 million as of December 31, 2013. The increase in revenue for the nine months ended December 31, 2014 over the nine months ended December 31, 2013 was primarily attributable to the introduction and expansion of new programs, our cross-selling of existing programs to existing members, a full nine months of revenue from the prior period acquisitions of Care Team Connect, Inc., or Care Team Connect, and Medical Referral Source, Inc., or MRS, an increase in large and bundled services contracts, and, to a lesser degree, price increases.
Revenue increased 15.5% to $520.6 million in fiscal 2014 from $450.8 million in fiscal 2013. Our contract value increased 16.2% to $541.9 million as of March 31, 2014 from $466.3 million as of March 31, 2013. The increase in revenue in fiscal 2014 over fiscal 2013 was primarily attributable to our cross-selling of existing programs to existing members, the introduction and expansion of new programs, including a full year of revenue from our acquisitions of ActiveStrategy, Inc., or ActiveStrategy, and 360Fresh, Inc., or 360Fresh, and revenue from our fiscal 2014 acquisitions of Care Team Connect, and MRS, and to a lesser degree, price increases.
We offered 65 membership programs as of December 31, 2014 compared to 61 membership programs as of December 31, 2013. We offered 62 membership programs as of March 31, 2014 compared to 57 membership programs as of March 31, 2013. Our membership base consisted of approximately 5,000 member institutions as of December 31, 2014, approximately 4,500 member institutions as of March 31, 2014, and approximately 4,100 member institutions as of March 31, 2013.
Cost of services. For the nine months ended December 31, 2014, cost of services increased 12.1% to $230.2 million from $205.3 million for the nine months ended December 31, 2013. As a percentage of revenue, cost of services was 52.8% for the nine months ended December 31, 2014 and 53.7% for the nine months ended December 31, 2013. The increase of $24.8 million in cost of services for the nine months ended December 31, 2014 over the prior nine months was primarily attributable to increases of $8.3 million in expenses related to our new and growing physician-related software programs, as well as to costs of $14.7 million incurred in connection with programs launched from acquisitions completed during fiscal 2014 and 2013. Cost of services included fair value adjustments to our acquisition-related earn-out liabilities of a decrease of $0.6 million and a decrease of $0.3 million for the nine months ended December 31, 2014 and 2013, respectively.
Cost of services increased 14.7% to $272.5 million in fiscal 2014 from $237.6 million in fiscal 2013. As a percentage of revenue, cost of services was 52.3% for fiscal 2014 and 52.7% for fiscal 2013. The increase of $34.9 million in cost of services was primarily attributable to the growth and expansion of our physician-related software programs of $13.7 million, as well as to costs incurred in connection with our acquisitions of ActiveStrategy, 360Fresh, MRS, and Care Team Connect. The increases in cost of services also reflected increased costs associated with the delivery of program content and tools to our expanded membership base, including increased staffing expenses and licensing fees. Cost of services included fair value adjustments to our acquisition-related earn-out liabilities of a decrease of $4.4 million in fiscal 2014 and an increase of $3.8 million in fiscal 2013.
Member relations and marketing expense. For the nine months ended December 31, 2014, member relations and marketing expense increased 16.3% to $81.2 million from $69.9 million for the nine months ended December 31, 2013. As a percentage of revenue, member relations and marketing expense for the nine months ended December 31, 2014 increased to 18.6% from 18.3% for the nine months ended December 31, 2013. The total dollar increases in member relations and marketing expense were primarily attributable to an increase in sales staff and related travel and other associated costs, as well as to an increase in member relations personnel and related costs required to serve our expanding membership base. We had an average of 203 and 184 new business development teams during the nine months ended December 31, 2014 and 2013, respectively.
Member relations and marketing expense increased 12.9% to $96.3 million in fiscal 2014 from $85.3 million in fiscal 2013. As a percentage of revenue, member relations and marketing expense in fiscal 2014 and 2013 was 18.5% and 18.9%, respectively. The total dollar increases in member relations and marketing expense were primarily attributable to an increase in sales staff and related travel and other associated costs, as well as to an increase in member relations personnel and related costs required to serve our expanding membership base. We had an average of 188 and 172 new business development teams during fiscal 2014 and 2013, respectively.
General and administrative expense. For the nine months ended December 31, 2014, general and administrative expenses increased 36.2% to $75.5 million from $55.4 million for the nine months ended December 31, 2013. As a percentage of revenue, general and administrative expense for the nine months ended December 31, 2014 increased to 17.3% from 14.5% for the nine months ended December 31, 2013. The increase of $20.1 million in general and administrative expense for the nine months ended December 31, 2014 over the nine months ended December 31, 2013 was primarily attributable to an increase of $7.4 million in costs related to investment in our human resources, finance, and information technology infrastructure to support our growing employee base and number of office locations, an increase of $4.0 million in acquisition-related costs, and an increase of $1.8 million in share-based compensation expense. As of December 31, 2014, we had approximately 3,200 employees compared to approximately 2,700 employees as of December 31, 2013.
General and administrative expense increased 19.3% to $74.2 million in fiscal 2014 from $62.2 million in fiscal 2013. As a percentage of revenue, general and administrative expense for fiscal 2014 and 2013 was 14.2% and 13.8%, respectively. The increase of $12.0 million in general and administrative expense for fiscal 2014 over fiscal 2013 was primarily attributable to an increase of $6.1 million of costs related to investment in our human resources, information technology, and infrastructure to support our growing employee base and number of office locations, an increase in share-based compensation expense of $1.7 million, and increased investments in our legal and corporate development groups. As of March 31, 2014, we had approximately 2,800 employees compared to approximately 2,400 employees as of March 31, 2013.
Depreciation and amortization. For the nine months ended December 31, 2014, depreciation and amortization expense increased to $30.0 million, or 6.9% of revenue, from $22.0 million, or 5.7% of revenue, for the nine months ended December 31, 2013. The increase in such expense in the nine months ended December 31, 2014 compared to the nine months ended December 31, 2013 was primarily due to increased amortization expense from developed capitalized internal-use software, amortization of intangible assets related to our acquisition of MRS, Care Team Connect, Healthpost Inc., or HealthPost, Clinovations, LLC, or Clinovations, and ThoughtWright, LLC d/b/a GradesFirst, or GradesFirst, and depreciation of our newly renovated Austin, San Francisco, and Nashville offices and an expansion floor of our Washington, D.C. headquarters.
Depreciation and amortization expense increased to $30.4 million, or 5.8% of revenue, in fiscal 2014 from $20.3 million, or 4.5% of revenue, in fiscal 2013. The increase in fiscal 2014 was primarily due to increased amortization expense from developed capitalized internal-use software, amortization of intangible assets related to the ActiveStrategy, 360Fresh, MRS, and Care Team Connect acquisitions, and depreciation of our newly renovated Austin, San Francisco, and Nashville offices and an expansion floor of our Washington, D.C. headquarters.
Impairment of capitalized software. During the nine months ended December 31, 2014, we concluded that certain internally developed capitalized software for sale assets were not fully recoverable. We had recently updated and integrated new functionality into one of our software programs, and as a result recognized a $2.1 million impairment on the remaining unamortized costs which were associated with older functionality. There was no comparable expense in the prior periods.
Other (expense) income, net. Other income, net consists of interest income, revolving credit facility fees, gains and losses on investment in common stock warrants, and foreign currency gains and losses. For the nine months ended December 31, 2014, other expense, net was $1.3 million compared to $2.0 million of income for the nine months ended December 31, 2013. Other expense, net in the nine months ended December 31, 2014 consisted of interest income of $1.1 million, offset by a foreign exchange rate loss of $1.7 million, revolving credit facility fees of $0.5 million, a loss of $0.2 million on an investment in common stock warrants and a realized loss of $0.1 million on the sale of bonds. For the nine months ended December 31, 2013, other income, net consisted of interest income of $2.6 million, of which $0.4 million related to interest earned on our loan to Evolent Health, Inc., or Evolent, which was converted to a preferred stock interest in Evolent Health LLC, or Evolent LLC, in September of 2013, offset by revolving credit facility fees of $0.4 million, and a foreign exchange rate loss of $0.2 million. The foreign currency gains and losses reflected the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies.
Other income, net increased to $2.7 million in fiscal 2014 from $2.6 million in fiscal 2013. Other income, net in fiscal 2014 consisted of interest income of $3.3 million, and a realized gain of $0.2 million on sale of marketable securities, offset by revolving credit facility fees of $0.6 million and a foreign exchange rate loss of $0.2 million, and in fiscal 2013 consisted of interest income of $3.4 million and a gain of $0.1 million on an investment in common stock warrants, offset by a foreign exchange rate loss of $0.5 million and revolving credit facility fees of $0.4 million. Consistent average cash and investment balances between fiscal 2014 and 2013 resulted in investment income of $3.3 million in fiscal 2014 compared to $3.4 million in fiscal 2013.
Provision for income taxes. Our provision for income taxes for the nine months ended December 31, 2014 was $4.8 million compared to $12.3 million for the nine months ended December 31, 2013. Our effective tax rate of 30.3% in the nine months ended December 31, 2014 decreased from our effective tax rate of 38.5% for the nine months ended December 31, 2013. The decrease in the effective tax rate for the nine months ended December 31, 2014 was primarily attributable to a discrete tax benefit relating to federal research and development tax credits claimed during the transition period relating to tax years 2012, 2013, and 2014.
Our provision for income taxes for fiscal 2014 and 2013 was $19.2 million and $18.0 million, respectively. Our effective tax rate in fiscal 2014 and 2013 was 38.5% and 37.5%, respectively. The increase in our effective tax rate in fiscal 2014 was primarily attributable to a lower balance of tax-exempt investments and a slight increase in our effective state tax rate as a result of changes in apportionment of revenue.
Equity in loss of unconsolidated entities. Our share of the losses of Evolent and Evolent LLC, for the nine months ended December 31, 2014 increased to $6.5 million from $3.3 million for the nine months ended December 31, 2013. Our proportionate share of the losses for fiscal 2014 and 2013 was $6.1 million and $6.8 million, respectively.
Evolent was established in August 2011. Our initial Series A investment in Evolent was accounted for under the equity method until Evolent completed a restructuring in connection with a financing round in September 2013. Following the restructuring and financing, it was determined that our Series A investment should be accounted for using the cost method. As a result, we no longer recognize our percentage of the entity's losses related to our Series A investment.
In September 2013, we invested in the Series B convertible preferred stock of Evolent LLC. Subsequent to September 2013, equity in loss of unconsolidated entities includes only our portion of Evolent LLC's losses related to our Series B investment. The losses recognized during fiscal 2013 were partially offset by a $1.1 million gain on investment recognized in connection with additional equity investment from certain early customers in July 2012. The losses recognized during fiscal year 2014 were partially offset by a $4.0 million gain on the conversion into equity securities of all outstanding principal and accrued interest under notes outstanding to Evolent as of March 31, 2013. There were no such gains or losses recorded in the nine months ended December 31, 2014. Evolent LLC continues to be in the early stages of its business plan, and as a result, we expect Evolent LLC to incur losses in the future.
Net income (loss) and accretion to redemption value of noncontrolling interest. On July 5, 2012, we entered into an agreement with an entity created for the sole purpose of providing consulting services for us on an exclusive basis. We determined that this entity met the definition of a variable interest entity over which we have significant influence and, as a result, have consolidated the results of this entity into our consolidated financial statements. During the nine months ended December 31, 2014, we determined that the conditions to satisfy the put option discussed further in Note 11, "Noncontrolling interest," of the consolidated financial statements included elsewhere in this report were probable of achievement and at such time recorded an accretion charge to the estimated redemption amount of our redeemable noncontrolling interest of $6.3 million. On December 5, 2014, the put option was exercised by the previous owners of the entity. As of December 31, 2014, we have a 100% ownership interest in this entity and it is fully consolidated in our financial statements. In fiscal 2014 and 2013, $0.1 million of income was recorded in the allocation of losses to the noncontrolling interest.
Stock-based compensation expense. We recognized the following stock-based compensation expense in the consolidated statements of operations line items for stock options and RSUs issued under our stock incentive plans for the nine months ended December 31, 2014 and 2013 and fiscal 2014 and 2013 (in thousands except per share amounts):
|
| | | | | | | | | | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, | | March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Stock-based compensation expense included in: | | | | | | | |
Costs and expenses: | | | | | | | |
Cost of services | $ | 5,977 |
| | $ | 4,145 |
| | 5,527 |
| | 3,975 |
|
Member relations and marketing | 3,348 |
| | 2,845 |
| | 3,688 |
| | 2,643 |
|
General and administrative | 8,640 |
| | 6,804 |
| | 9,002 |
| | 7,295 |
|
Depreciation and amortization | — |
| | — |
| | — |
| | — |
|
Total costs and expenses | 17,965 |
| | 13,794 |
| | 18,217 |
| | 13,913 |
|
Operating income | (17,965 | ) | | (13,794 | ) | | (18,217 | ) | | (13,913 | ) |
Net (loss) income attributable to common stockholders | $ | (12,515 | ) | | $ | (8,484 | ) | | $ | (11,204 | ) | | $ | (8,686 | ) |
Impact on diluted earnings per share | $ | (0.35 | ) | | $ | (0.23 | ) | | $ | (0.30 | ) | | $ | (0.24 | ) |
There are no stock-based compensation costs capitalized as part of the cost of an asset.
Stock-based compensation expense by award type for the nine months ended December 31, 2014 and 2013 and fiscal 2014 and 2013 was as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, | | March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Stock-based compensation expense by award type: | | | | | | | |
Stock options | $ | 5,431 |
| | $ | 3,692 |
| | 4,846 |
| | $ | 5,000 |
|
Restricted stock units | 12,534 |
| | 10,102 |
| | 13,371 |
| | 8,913 |
|
Total stock-based compensation | $ | 17,965 |
| | $ | 13,794 |
| | $ | 18,217 |
| | $ | 13,913 |
|
As of December 31, 2014, $55.3 million of total unrecognized compensation cost related to stock-based compensation is expected to be recognized over a weighted average period of 3.0 years.
Liquidity and Capital Resources
Cash flows generated from operating activities represent our primary source of liquidity. Following the January 2015 acquisition of Royall and the related financing transactions, we believe that existing cash and cash equivalents, and operating cash flows will be sufficient to support our expected operating and capital expenditures, as well as debt service obligations, during at least the next 12 months. We had cash, cash equivalents, and marketable securities balances of $87.7 million as of December 31, 2014 and $187.5 million as of March 31, 2014. We expended $36.0 million and $16.2 million in cash to purchase shares of our common stock through our share repurchase program during the nine months ended December 31, 2014 and 2013, respectively. We expended $70.2 million and $46.0 million in cash for acquisitions during the nine months ended December 31, 2014 and 2013, respectively.
Cash Flows
Cash flows from operating activities. The combination of revenue growth, profitable operations, and payment for memberships in advance of accrual revenue typically results in operating activities that generate cash flows in excess of net income attributable to common stockholders on an annual basis. Net cash flows provided by operating activities were $65.2 million and $73.6 million for the nine months ended December 31, 2014 and 2013, respectively. The decrease in net cash flows provided by operating activities for the nine months ended December 31, 2014 was due to the timing of member payments received and, to a lesser extent, an increase in certain acquisition-related earn-out payments classified as cash flows used in operating activities.
Net cash flows provided by operating activities were $76.7 million and $83.3 million in fiscal 2014 and 2013, respectively. The decrease in net cash flows provided by operating activities in fiscal 2014 was primarily due to the timing of certain vendor payments.
Cash flows from investing activities. Our cash management, investment and acquisition strategy, and capital expenditure programs affect investing cash flows. For the nine months ended December 31, 2014, net cash flows provided by investing activities were $29.3 million compared to cash used in investing activities of $91.2 million for the nine months ended December 31, 2013. Net cash flows used in investing activities were $125.6 million and $106.9 million in fiscal 2014 and 2013, respectively.
In the nine months ended December 31, 2014, investing activities provided $29.3 million in cash, primarily consisting of net redemptions of $151.4 million of marketable securities, partially offset by capital expenditures of $52.0 million, and expenditures of $70.2 million for our acquisitions of HealthPost, GradesFirst, and Clinovations.
In the nine months ended December 31, 2013, investing activities used $91.2 million in cash, primarily consisting of expenditures of $46.0 million for our acquisitions of Care Team Connect and MRS, capital expenditures of $39.4 million, a contribution of $15.6 million to Evolent LLC, and net redemptions of $9.9 million of marketable securities.
In fiscal 2014, investing activities used $125.6 million in cash, primarily consisting of capital expenditures of $49.1 million, expenditures of $46.0 million for our acquisitions of Care Team Connect and MRS, a contribution of $15.6 million to Evolent LLC, and net purchases of $14.8 million of marketable securities.
In fiscal 2013, investing activities used $106.9 million in cash, primarily consisting of capital expenditures of $40.4 million, expenditures of $31.9 million for our acquisitions of 360Fresh and ActiveStrategy, net purchases of $31.3 million of marketable securities, and the purchase of a $4.4 million note receivable from Evolent, partially offset by $1.1 million released from escrow related to the sale of OptiLink.
Cash flows from financing activities. We had net cash flows used in financing activities of $44.6 million for the nine months ended December 31, 2014 compared to cash provided by financing activities of $12.5 million for the nine months ended December 31, 2013. Cash flows provided by financing activities totaled $14.2 million and $20.8 million in fiscal 2014 and 2013, respectively.
In the nine months ended December 31, 2014, we had net cash flows used in financing activities of $44.6 million, consisting of our repurchase of 731,559 shares of our common stock for approximately $36.0 million, a $6.1 million payment for the acquisition of a non-controlling interest, and our use of $7.6 million to satisfy minimum employee tax withholding for vested restricted stock units. The effect of those items was partially offset by our receipt of $4.3 million from the exercise of stock options, $0.4 million in excess tax benefits resulting from the exercise of employee options, and $0.4 million from the issuance of common stock under our employee stock purchase plan.
In the nine months ended December 31, 2013, we had net cash flows provided by financing activities of $12.5 million, consisting of $17.5 million from the exercise of stock options, $16.6 million in excess tax benefits resulting from the exercise
of employee options, and $0.4 million from the issuance of common stock under our employee stock purchase plan. The effect of those items was partially offset by our repurchase of 286,232 shares of our common stock for approximately $16.2 million and our use of $5.8 million to satisfy minimum employee tax withholding for vested restricted stock units.
In fiscal 2014, we had net cash flows provided by financing activities of $14.2 million, consisting of $22.0 million from the exercise of stock options, $19.5 million in excess tax benefits resulting from the exercise of employee options, and $0.5 million from the issuance of common stock under our employee stock purchase plan. The effect of those items was partially offset by our repurchase of 376,532 shares of our common stock for approximately $21.9 million and our use of $5.9 million to satisfy minimum employee tax withholding for vested restricted stock units.
In fiscal 2013, we had net cash flows provided by financing activities of $20.8 million, consisting of $24.1 million from the exercise of stock options, $20.5 million in excess tax benefits resulting from the exercise of employee options, and $0.4 million from the issuance of common stock under our employee stock purchase plan. The effect of those items was partially offset by our repurchase of 98,433 shares of our common stock for approximately $18.0 million, our use of $4.1 million to satisfy minimum employee tax withholding for vested restricted stock units, $1.4 million expended in acquisition-related earn-out payments, and $0.8 million used to pay credit facility issuance costs.
2012 Revolving Credit Facility
On July 30, 2012, we obtained a $150.0 million five-year senior secured revolving credit facility, or 2012 revolving credit facility, under a credit agreement with a syndicate of lenders. For a description of the terms of this facility, which was terminated on January 9, 2015, see “Note 12, revolving credit facility,” to the consolidated financial statements included elsewhere in this report. No amounts were outstanding under the facility as of December 31, 2014.
2015 Senior Secured Credit Facilities
For a description of the transactions in which we terminated our 2012 revolving credit facility on January 9, 2015 and replaced the credit facilities we obtained on January 9, 2015 with the credit facilities described below, see “Business – Recent Developments – Financing Transactions.”
On February 6, 2015, we entered into a credit agreement, dated as of February 6, 2015, with the lenders party thereto, JPMorgan Chase Bank, N.A., as administrative agent, and the other parties to the agreement. The lenders under the credit agreement on the closing date of February 6, 2015 provided us with $675 million of senior secured credit facilities, or credit facilities, for application to the prepayment of all borrowings then outstanding under our prior credit agreement.
The credit facilities consist of (a) a five-year senior secured term loan facility, or term facility, in the original principal amount of $575 million and (b) a five-year senior secured revolving credit facility, or revolving facility, under which up to $100 million principal amount of borrowings and other credit extensions may be outstanding at any time.
The Advisory Board Company is the borrower under the credit facilities. The Advisory Board Company’s obligations under the credit facilities are guaranteed by our domestic subsidiaries, subject to certain exceptions, and the obligations of The Advisory Board Company and the subsidiary guarantors under the credit facilities are secured by a first-priority security interest in substantially all of the assets of The Advisory Board Company and such domestic subsidiaries.
The credit facilities contain customary negative covenants restricting certain actions that may be taken by us and our subsidiaries. Subject to specified exceptions, these covenants limit our ability and the ability of our subsidiaries to incur indebtedness, create liens on their assets, pay cash dividends, repurchase our common stock and make other restricted payments, make investments in or loans to other parties, sell assets, engage in mergers and acquisitions, enter into transactions with affiliates, enter into sale and leaseback transactions, and change their businesses. The credit facilities also contain customary affirmative covenants, including, among others, covenants requiring compliance with laws, maintenance of corporate existence, licenses, properties and insurance, payment of taxes and performance of other material obligations, and delivery of financial and other information to the lenders. The credit facilities contain customary events of default, including a change of control of The Advisory Board Company. We are required to maintain compliance with financial covenants consisting of (a) a maximum total leverage ratio and (b) a minimum interest coverage ratio, each measured as of the last day of each fiscal quarter, for a period consisting of our most recently completed four fiscal quarters.
All $575 million of term loans available under the term facility were drawn on the facility closing date to prepay all borrowings outstanding under our prior credit agreement. We will be able to elect, subject to pro forma compliance with the foregoing financial covenants and other customary conditions, to solicit the lenders under the credit facilities or other prospective lenders to add one or more incremental term loan facilities to the credit facilities or to increase commitments under
the revolving facility in an aggregate amount of no more than (a) $150 million plus (b) the amount of voluntary prepayments of borrowings under the credit facilities not funded with the incurrence of other long-term indebtedness. Any such voluntary prepayments of loans under the revolving facility must be accompanied by permanent reductions of commitments under the revolving facility.
To the extent not previously paid, the term facility will mature, and all term loans outstanding under the facility will become due and payable, on February 6, 2020. The term loans are repayable in quarterly installments, commencing with the quarter ending on June 30, 2015, equal to a specified percentage of the aggregate principal amount drawn on the facility closing date, as follows: (a) 1.25% for each of the first eight full fiscal quarters following the facility closing date; (b) 2.5% for each of the ninth through twelfth full fiscal quarters following the facility closing date; and (c) 3.75% for each of the thirteenth through nineteenth full fiscal quarters following the facility closing date. We also are required to make principal prepayments under the term facility from the net proceeds of specified types of asset sales, casualty events and incurrences of debt. We may voluntarily prepay outstanding term loans without premium or penalty.
Amounts drawn under the term facility generally bear interest, payable quarterly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate, or LIBOR, plus an initial margin of 2.75%, subject in each case to margin reductions based on our total leverage ratio from time to time. The interest rate on the alternate base rate loans will fluctuate as the base rate fluctuates, while the interest rate on the LIBOR loans will be adjusted at the end of each applicable interest period. Interest on alternate base rate loans will be payable quarterly in arrears, while interest on the LIBOR loans will be payable at the end of each applicable interest period, except that, in the case of any interest period longer than three months, interest will be payable at the end of each three-month period.
The revolving facility was undrawn at the facility closing date. The revolving facility will mature, and all revolving loans outstanding under the facility will become due and payable, on February 6, 2020. The facility loans may be borrowed, repaid, and reborrowed from time to time during the term of the facility. We may use the proceeds of borrowings under the revolving facility, when drawn, to finance working capital needs and for general corporate purposes, including permitted acquisitions.
Amounts drawn under the revolving facility generally bear interest, payable quarterly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate plus an initial margin of 2.75%, subject in each case to margin reductions based on our total leverage ratio from time to time.
We are obligated to pay a commitment fee at an initial rate of 0.40%, subject to reduction based on our total leverage ratio from time to time, accruing on the average daily amount of available commitments under the revolving facility.
Contractual Obligations
The following summarizes our contractual obligations as of December 31, 2014. These obligations relate to leases for our headquarters and other offices as well as a non-cancelable agreement for the purchase of data. These are more fully described in Note 16, “Commitments and contingencies,” to our consolidated financial statements included elsewhere in this report.
|
| | | | | | | | | | | | | | | | | | | |
| Payment due by period (in thousands) |
| Total | | Less than 1 year | | 1-3 years | | 3-5 years | | More than 5 years |
Non-cancelable operating leases | $ | 78,717 |
| | $ | 17,200 |
| | $ | 32,636 |
| | $ | 21,331 |
| | $ | 7,550 |
|
Purchase obligation | $ | 11,000 |
| | $ | 5,000 |
| | $ | 5,000 |
| | $ | 1,000 |
| | $ | — |
|
In addition to the contractual obligations above, as of December 31, 2014 we have payments of up to $12.9 million contingently payable through December 31, 2014 related to business acquisitions. For additional detail, see Note 4, “Fair value measurements,” to our consolidated financial statements included elsewhere in this report. The table above does not reflect payment obligations under the senior secured credit facilities we obtained on February 6, 2015 and which are described above.
Share Repurchase Program
In January 2004, our board of directors authorized the repurchase by us from time to time of up to $50 million of our common stock. This authorization was increased in cumulative amount to $100 million in October 2004, to $150 million in February 2006, to $200 million in January 2007, to $250 million in July 2007, to $350 million in April 2008 and up to $450 million in May 2013. We intend to fund any future share repurchases with cash on hand and with cash generated from operations. No minimum number of shares for repurchase has been fixed, and the share repurchase authorization has no expiration date. All repurchases have been made in the open market pursuant to this publicly announced repurchase program. As of December 31, 2014, the remaining authorized repurchase amount was $51.2 million. Our ability to repurchase common stock is restricted by the covenants in our senior secured credit facilities.
Exercise of Stock Options and Purchases Under Our Employee Stock Purchase Plan
Options granted to participants under our stock-based incentive compensation plans that were exercised to acquire shares generated cash of approximately $4.3 million and $17.5 million in the nine months ended December 31, 2014 and 2013, respectively, and $22.0 million and $24.1 million for fiscal 2014 and 2013, respectively, from payment of option exercise prices.
Cash flows of approximately $0.4 million and $0.4 million for the nine months ended December 31, 2014 and 2013, respectively, and $0.5 million and $0.4 million for fiscal 2014 and 2013, respectively, were provided by discounted stock purchases by participants under our employee stock purchase plan.
Off-Balance Sheet Arrangements
As of December 31, 2014, we had no off-balance sheet financing or other arrangements with unconsolidated entities or financial partnerships (such as entities often referred to as structured finance or special purpose entities) established for purposes of facilitating off-balance sheet financing or other debt arrangements or for other contractually limited purposes.
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 identification of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with no need for management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. Certain of our accounting policies are particularly important to the presentation of our financial condition and results of operations and may require the application of significant judgment by our management. 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 observation 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, “Summary of significant accounting policies,” to our consolidated financial statements included elsewhere in this report. Our critical accounting policies are discussed below.
Revenue Recognition
Revenue is recognized when (1) there is persuasive evidence of an arrangement, (2) the fee is fixed or determinable, (3) services have been rendered and payment has been contractually earned, and (4) collectibility is reasonably assured. Fees are generally billable when a letter of agreement is signed by the member, and fees receivable during the subsequent twelve-month period and related deferred revenue are recorded upon the commencement of the membership or collection of fees, if earlier. In many of our higher priced programs and membership agreements with terms that are greater than one year, fees may be billed on an installment basis.
Our membership agreements with our customers generally include more than one deliverable. Deliverables are determined based upon the availability and delivery method of the services and may include: best practices research; executive education curricula; cloud-based content, databases, and calculators; performance or benchmarking reports; diagnostic tools; interactive advisory support; and performance technology software. Access to such deliverables is generally available on an unlimited basis over the membership period. When an agreement contains multiple deliverables, we review the deliverables to determine if they qualify as separate units of accounting. In order for deliverables in a multiple-deliverable arrangement to be treated as separate units of accounting, the deliverables must have standalone value upon delivery, and delivery or performance of undelivered items in an arrangement with a general right of return must be probable. If we determine that there are separate units of accounting, arrangement consideration at the inception of the membership period is allocated to all deliverables based on the relative selling price method in accordance with the selling price hierarchy. Because of the unique nature of our products, neither vendor specific objective evidence nor third-party evidence is available. Therefore, we utilize best estimate of
selling price to allocate arrangement consideration in multiple element arrangements. Best estimate of selling price is an estimate and, as such, could change over time.
Our membership programs may contain certain deliverables that do not have standalone value and therefore are not accounted for separately. In general, the deliverables in membership programs are consistently available throughout the membership period, and, as a result, the consideration is recognized ratably over the membership period. When a service offering includes unlimited and limited service offerings, revenue is recognized over the appropriate service period, either ratably, if the service is consistently available, or, if the service is not consistently available, upon the earlier of the delivery of the service or the completion of the membership period, provided that all other criteria for recognition have been met.
Certain membership programs incorporate hosted performance technology software. In many of these agreements, members are charged set-up fees in addition to subscription fees for access to the hosted cloud-based performance technology software and related membership services. Both set-up fees and subscription fees are recognized ratably over the term of the membership agreement, which is generally three years, and is consistent with the pattern of the delivery of services under these arrangements. Upon launch of a new program that incorporates software, all program revenue is deferred until the program is generally available for release to our membership, and then recognized ratably over the remainder of the contract term of each agreement.
We also perform professional services sold under separate agreements that include management and consulting services. We recognize professional services revenues on a time-and-materials basis as services are rendered.
Although we believe that our approach to estimates and judgments with respect to revenue recognition is reasonable, actual results could differ and we may be exposed to increases or decreases in revenue that could be material.
Allowance for Uncollectible Revenue
Our ability to collect outstanding receivables from our members has an effect on our operating performance and cash flows. We maintain an allowance for uncollectible revenue as a reduction of revenue based on our ongoing monitoring of members’ credit and the aging of receivables. To determine the allowance for uncollectible revenue, we examine our collections history, the age of accounts receivable in question, any specific member collection issues that have been identified, general market conditions, and current economic trends.
Basis of Presentation and Consolidation
We may enter into various agreements with unrelated third parties to provide, directly or indirectly, services to our members or prospective members. We must determine for each of these business arrangements, which could include an investment by us in the third party, whether to consolidate the third party or account for our investment under the equity or cost basis of accounting. We determine whether to consolidate certain entities based on our rights and obligations under the agreements, applying the applicable accounting guidance. For investment interests that we do not consolidate, we evaluate the guidance to determine the accounting framework to apply. The application of the rules in evaluating the accounting treatment for each agreement is complex and requires substantial management judgment. Therefore, we believe the decision to choose an appropriate accounting framework is a critical accounting estimate. We evaluate our accounting for investments on a regular basis, including when a significant change in the design of an entity occurs.
Property and Equipment
Property and equipment consists of leasehold improvements, furniture, fixtures, equipment, capitalized internal use software development costs, and acquired developed technology. Property and equipment is stated at cost, less accumulated depreciation and amortization. In certain membership programs, we provide performance technology software under a hosting arrangement where the software application resides on our or our service providers’ hardware. The members do not take delivery of the software and only receive access to the software during the term of their membership agreement.
Computer software development costs that are incurred in the preliminary project stage for internal use software are expensed as incurred. During the development stage, direct consulting costs and payroll and payroll-related costs for employees that are directly associated with each project are capitalized and amortized over the estimated useful life of the software once it is placed into operation. Capitalized software is amortized using the straight-line method over its estimated useful life, which is generally five years. Replacements and major improvements are capitalized, while maintenance and repairs are charged to expense as incurred.
Acquired developed technology represents the fair value of technology acquired through a business combination that resides on our or our service providers’ hardware and is made available to members through the memberships. Amortization for
acquired developed software is included in the depreciation and amortization line item of our consolidated statements of operations. Acquired developed software is amortized over its estimated useful life of six years based on the cash flow estimate used to determine the value of the intangible asset at its acquisition.
Furniture, fixtures, and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful lives of the assets or the lease term.
Business Combinations
We record acquisitions using the purchase method of accounting. All of the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration are recognized at their fair value on the acquisition date. All subsequent changes to a valuation allowance or uncertain tax position that relate to the acquired company and existed at the acquisition date that occur both within the measurement period and as a result of facts and circumstances that existed at the acquisition date are recognized as an adjustment to goodwill. All other changes in a valuation allowance are recognized as a reduction or increase to expense or as a direct adjustment to additional paid-in capital as required. We capitalize any acquired in-process research and development as an intangible asset and amortize it over its estimated useful life. Acquisition-related costs are recorded as expenses in the consolidated financial statements. Increases or decreases in the fair value of contingent consideration obligations resulting from changes in the estimates of earn-out results can materially impact the financial statements. As of December 31, 2014, we had a liability of $12.9 million for contingent consideration related to acquisitions.
Goodwill and Other Intangible Assets
The excess cost of an acquisition over the fair value of the net assets acquired is recorded as goodwill. Goodwill and other intangible assets with indefinite lives are not amortized, as historically these assets have been tested for impairment on an annual basis as of March 31, or more frequently if events or changes in circumstances indicate potential impairment. In conjunction with our change in fiscal year and beginning in the nine-month period ended December 31, 2014, we changed the date we perform our annual test for impairment to October 1, the first day of the fourth quarter of our new fiscal year. We assess goodwill impairment at the reporting unit level.
When testing for impairment, we first perform a qualitative assessment on a reporting unit to determine whether further quantitative impairment testing is necessary. If an initial qualitative assessment identifies that it is more likely than not that the
carrying value of a reporting unit exceeds its estimated fair value, additional quantitative testing is performed. If the quantitative testing indicates that goodwill is impaired, the carrying value of goodwill is written down to fair value. We determine the fair value of our reporting units based on the income approach, under which the fair value of a reporting unit is calculated based on the present value of estimated future cash flows and other market data. Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, discount rates, and future economic and market conditions. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. These valuations require the use of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur. Based on our qualitative assessment as of October 1, 2014, we had no reporting unit that our management believed was at risk of failing an impairment test that would result in an impairment charge. No quantitative testing was therefore deemed necessary. No changes were noted which would affect our conclusions as of December 31, 2014.
Other intangible assets consist of capitalized software for sale and acquired intangibles. We capitalize consulting costs and payroll and payroll-related costs for employees directly related to building a software product once technological feasibility is established. We determine that technological feasibility is established by the completion of a detailed program design or, in its absence, completion of a working model. Once the software product is ready for general availability, we cease capitalizing costs and begin amortizing the intangible asset on a straight-line basis over its estimated useful life through depreciation and amortization on our consolidated statements of operations. The weighted average estimated useful life of capitalized software is five years. Other intangible assets include assets that arise from business combinations and that consist of developed technology for both internal use and for sale, non-competition covenants, trademarks, contracts, and customer relationships that are amortized, on a straight-line basis, over six months to ten years. Finite-lived intangible assets are required to be amortized over their useful lives and are evaluated for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.
Future business and economic conditions, as well as differences related to any of the assumptions discussed herein, could materially affect the financial statements through impairment of goodwill and intangibles and/or acceleration of the amortization period of the purchased intangibles, which are finite-lived assets.
Recovery of Long-lived Assets (Excluding Goodwill)
We record our long-lived assets, such as property and equipment, at cost. We review the carrying value of our long-lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be fully recoverable. The test for recoverability is made using an estimate of the undiscounted expected future cash flows and, if required, the impairment loss, if any, is measured as the amount that the carrying value of the asset exceeds the asset’s fair value if the asset is not recoverable. 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. If we determine that an asset’s carrying value is impaired, we will record a write-down of the carrying value of the identified asset and charge the impairment as an operating expense in the period in which the determination is made. Although we believe that the carrying values of our long-lived assets are appropriately stated, changes in our business strategy or market conditions or significant technological developments could significantly affect these judgments and require adjustments to recorded asset balances.
Deferred Incentive Compensation and Other Charges
Incentive compensation to our employees related to the negotiation of new and renewal memberships, license fees to third-party vendors for tools, data, and software incorporated in specific memberships that include performance technology software, and other direct and incremental costs associated with specific memberships are deferred and amortized over the term of the related memberships.
Income Taxes
Deferred income taxes are determined using 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 bases. Deferred tax assets are reduced by a valuation allowance when, in our management's opinion, 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.
Stock-based Compensation
We measure and recognize stock-based compensation cost based on the estimated fair values of the stock-based awards on the grant date. Stock-based compensation costs are recognized as an expense in the consolidated statements of operations over the vesting periods of the awards. We calculate the grant date estimated fair value of all stock options, with the exception of the stock options issued with market-based conditions, using a Black-Scholes valuation model. The fair value of stock options issued with both performance-based and market-based conditions is calculated on the date of grant using a Monte Carlo model.
Determining the estimated fair value of stock-based awards is subjective in nature and involves the use of significant estimates and assumptions, including the term of the stock-based awards, risk-free interest rates over the vesting period, expected dividend rates, the price volatility of our shares, forfeiture rates of the awards, and the impact of market conditions. The probability of achieving performance conditions and the estimated time to achieve such performance conditions are significant estimates in determining when and in what amount to recognize stock-based awards with performance conditions. Such estimates are made based on the historical achievement of similar conditions and the Company's estimated operating plan. As these factors change, the estimates of probability and estimated time to achieve performance conditions are updated. Forfeitures are estimated at the time of grant and adjusted, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The forfeiture rate is based on historical experience. Our fair value estimates are based on assumptions we believe are reasonable but that are inherently uncertain. The fair value of all restricted stock units, with the exception of the restricted stock units issued with market-based conditions, is determined as the fair market value of the underlying shares on the date of grant. The fair value of restricted stock units issued with both performance-based and market-based conditions is calculated on the date of grant using a Monte Carlo model. To the extent we change the terms of our employee stock-based compensation programs, experience market volatility in the pricing of our common stock that increases the implied volatility calculation, or refine different assumptions in future periods such as the probability or timing of achieving performance conditions and forfeiture rates that differ from our current estimates, among other potential factors, the stock-based compensation expense that we record in future periods and the tax benefits that we realize may differ significantly from the expense and the tax benefits we have recorded in previous reporting periods.
Recent Accounting Pronouncements
See Note 2, “Summary of significant accounting policies,” to our consolidated financial statements included elsewhere in this report for a description of recent accounting pronouncements, including the expected dates of adoption.
Non-GAAP Financial Measures
We use non-GAAP financial measures to supplement the financial information presented on a GAAP basis. The non-GAAP financial measures presented in this report include adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share. We define “adjusted EBITDA” as net income attributable to common stockholders before adjustment for the items set forth in the first table below. We define “adjusted net income” as net income attributable to common stockholders excluding the net of tax effect of the items set forth in the second table below, We define “non-GAAP earnings per diluted share” as earnings per diluted share excluding the net of tax effect of the items set forth in the third table below.
Our management believes that providing information about adjusted EBITDA, adjusted net income, and non-GAAP earnings per diluted share facilitates an assessment by our investors of the Company’s fundamental operating trends and addresses concerns of management and investors that the various gains and expenses excluded from these measures may obscure such underlying trends. Our management uses these non-GAAP financial measures, together with financial measures prepared in accordance with GAAP, to enhance its understanding of our core operating performance, which represents our views concerning our performance in the ordinary, ongoing, and customary course of our operations. In the future, we are likely to incur income and expenses similar to the items for which the applicable GAAP measures have been adjusted and to report non-GAAP financial measures excluding such items. Accordingly, the exclusion of those and similar items in our non-GAAP presentation should not be interpreted as implying that the items are non-recurring, infrequent, or unusual.
The information about our core operating performance provided by our non-GAAP financial measures is used by management for a variety of purposes. Management uses the non-GAAP financial measures for internal budgeting and other managerial purposes in part because the measures enable management to evaluate projected operating results and make comparative assessments of our performance over time while isolating the effects of items that vary from period to period without any or with limited correlation to core operating performance, such as tax rates, interest income and foreign currency exchange rates, periodic costs of certain capitalized tangible and intangible assets, share-based compensation expense, and certain non-cash and special charges. The effects of the foregoing items also vary widely among similar companies, and affect the ability of management and investors to make company-to-company comparisons. In addition, merger and acquisition activity can have inconsistent effects on earnings that are not related to core operating performance due, for instance, to charges relating to acquisition costs, the amortization of acquisition-related intangibles, and fluctuations in the fair value of contingent earn-out liabilities. Companies also exhibit significant variations with respect to capital structure and cost of capital (which affect relative interest expense) and differences in taxation and book depreciation of facilities and equipment (which affect relative depreciation expense), including significant differences in the depreciable lives of similar assets among various companies. By eliminating some of the foregoing variations, management believes that the Company’s non-GAAP financial measures allow management and investors to evaluate more effectively the Company’s performance relative to that of its competitors and peer companies. Similarly, our management believes that because of the variety of equity awards used by companies, the varying methodologies for determining both share-based compensation and share-based compensation expense among companies, and from period to period, and the subjective assumptions involved in those determinations, excluding share-based compensation from our non-GAAP financial measures enhances company-to-company comparisons over multiple fiscal periods.
Our non-GAAP measures may be calculated differently from similarly titled measures reported by other companies due to differences in accounting policies and items excluded or included in the adjustments, which limits their usefulness as comparative measures. In addition, there are other limitations associated with the non-GAAP financial measures we use, including the following:
| |
• | the non-GAAP financial measures generally do not reflect all depreciation and amortization, and although the assets being depreciated and amortized will in some cases have to be replaced in the future, the measures do not reflect any cash requirements for such replacements; |
| |
• | the non-GAAP financial measures do not reflect the expense of equity awards to employees; |
| |
• | the non-GAAP financial measures do not reflect the effect of earnings or charges resulting from matters that management considers not indicative of our ongoing operations, but which may recur from year to year; and |
| |
• | to the extent that we change our accounting for certain transactions or other items from period to period, our non-GAAP financial measures may not be directly comparable from period to period. |
Our management compensates for these limitations by relying primarily on our GAAP results and using the non-GAAP financial measures only as a supplemental measure of our operating performance, and by considering independently the economic effects of the foregoing items that are or are not reflected in the non-GAAP measures. Because of their limitations, our non-GAAP financial measures should be considered by our investors only in addition to financial measures prepared in
accordance with GAAP, and should not be considered to be a substitute for, or superior to, the GAAP measures as indicators of operating performance.
A reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measures is provided below (unaudited, in thousands):
|
| | | | | | | | | | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, | | March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net (loss) income attributable to common stockholders | $ | (1,699 | ) | | 16,465 |
| | $ | 24,752 |
| | $ | 23,408 |
|
Equity in loss of unconsolidated entities | 6,540 |
| | 3,320 |
| | 6,051 |
| | 6,756 |
|
Accretion of non-controlling interest to redemption value | 6,253 |
| | — |
| | — |
| | — |
|
Provision for income taxes from continuing operations | 4,831 |
| | 12,311 |
| | 19,208 |
| | 18,023 |
|
Other expense (income), net | 1,327 |
| | (1,974 | ) | | (2,706 | ) | | (2,604 | ) |
Depreciation and amortization | 29,994 |
| | 21,952 |
| | 30,420 |
| | 20,308 |
|
Impairment of capitalized software | 2,086 |
| | — |
| | — |
| | — |
|
Acquisition and transaction charges | 4,592 |
| | 573 |
| | 573 |
| | 851 |
|
Vacation accrual charge related to change in fiscal year (1) | 850 |
| | — |
| | — |
| | — |
|
Fair value adjustments to acquisition-related earn-out liabilities | (600 | ) | | (250 | ) | | (4,350 | ) | | 3,759 |
|
Stock-based compensation expense | 17,965 |
| | 13,794 |
| | 18,217 |
| | 13,913 |
|
Adjusted EBITDA | $ | 72,139 |
| | $ | 66,191 |
| | $ | 92,165 |
| | $ | 84,414 |
|
—————————————
| |
(1) | The company maintains a "use it or lose it" employee vacation policy based on a March 31 fiscal year end. During the transition period, and in anticipation of the fiscal year end change described in this report, the Company recorded an incremental adjustment to vacation accrual. We expect that this liability will be utilized by March 31, 2015 as employees either use or lose vacation. Prior amounts were not material. |
|
| | | | | | | | | | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, | | March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Net (loss) income attributable to common stockholders | $ | (1,699 | ) | | $ | 16,465 |
| | $ | 24,752 |
| | $ | 23,408 |
|
Equity in loss of unconsolidated entities | 6,540 |
| | 3,320 |
| | 6,051 |
| | 6,756 |
|
Accretion of non-controlling interest to redemption value | 6,253 |
| | — |
| | — |
| | — |
|
Amortization of acquisition-related intangibles, net of tax | 5,651 |
| | 3,790 |
| | 5,221 |
| | 3,804 |
|
Impairment of capitalized software, net of tax | 1,502 |
| | — |
| | — |
| | — |
|
Acquisition and similar transaction charges, net of tax | 3,275 |
| | 352 |
| | 352 |
| | 525 |
|
Fair value adjustments to acquisition-related earn-out liabilities, net of tax | (499 | ) | | (154 | ) | | (2,675 | ) | | 2,331 |
|
Gain on investment in common stock warrants, net of tax | 108 |
| | — |
| | — |
| | (68 | ) |
Vacation accrual charge related to change in fiscal year, net of tax | 777 |
| | — |
| | — |
| | — |
|
Stock-based compensation expense, net of tax | 13,492 |
| | 8,484 |
| | 11,204 |
| | 8,686 |
|
Adjusted net income (2) | $ | 35,400 |
| | $ | 32,257 |
| | $ | 44,905 |
| | $ | 45,442 |
|
| |
(2) | Effective tax rate used to calculate "net of tax" for the nine month period amounts excludes the effect of taxes of $828,000, related to unconsolidated equity method investment. |
|
| | | | | | | | | | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, | | March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
GAAP (loss) earnings per diluted share | $ | (0.05 | ) | | $ | 0.45 |
| | $ | 0.67 |
| | $ | 0.64 |
|
Equity in loss of unconsolidated entities | 0.18 |
| | 0.09 |
| | 0.17 |
| | 0.19 |
|
Accretion of non-controlling interest to redemption value | 0.18 |
| | — |
| | — |
| | — |
|
Amortization of acquisition-related intangibles, net of tax | 0.16 |
| | 0.10 |
| | 0.14 |
| | 0.11 |
|
Impairment of capitalized software, net of tax | 0.04 |
| | — |
| | — | | — |
Acquisition and similar transaction charges, net of tax | 0.09 |
| | 0.01 |
| | 0.01 |
| | 0.01 |
|
Fair value adjustments to acquisition-related earn-out liabilities, net of tax | (0.01 | ) | | — |
| | (0.07 | ) | | 0.06 |
|
Gain on investment in common stock warrants, net of tax | — |
| | — |
| | — |
| | — |
|
Vacation accrual charge related to change in fiscal year, net of tax | 0.02 |
| | — |
| | — |
| | — |
|
Stock-based compensation expense, net of tax | 0.37 |
| | 0.23 |
| | 0.30 |
| | 0.24 |
|
Non-GAAP earnings per diluted share | $ | 0.98 |
| | $ | 0.88 |
| | $ | 1.22 |
| | $ | 1.25 |
|
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate 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 and, after December 31, 2014, on our variable-rate debt outstanding under our senior secured credit facilities. Cash and cash equivalents include investments in highly liquid U.S. Treasury obligations with maturities of less than three months. As of December 31, 2014, our marketable securities consisted of $12.8 million in tax-exempt notes and bonds issued by various states, and $1.9 million in U.S. government-sponsored enterprise securities. The weighted average maturity on all our marketable securities as of December 31, 2014 was approximately 8.0 years. We perform periodic evaluations of the relative credit ratings related to our cash, cash equivalents, and marketable securities. Our 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. Because of the nature of our investments we have not prepared quantitative disclosure for interest rate sensitivity in accordance with Item 305 of the SEC’s Regulation S-K as we believe the effect of interest rate fluctuations would not be material.
As of the date of this report, we also are exposed to interest rate risk associated with the $575 million principal amount of variable-rate debt we incurred in February 6, 2015 under our senior secured term loan facility. Amounts drawn under the term facility generally bear interest, payable quarterly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate, plus an initial margin of 2.75%, subject in each case to margin reductions based on our total leverage ratio from time to time. As of the date of this report, our outstanding term loans accrued interest at an annual rate of 3.01%. A 10 percent increase in LIBOR would increase our annual cash interest expense on our variable-rate debt by approximately $0.1 million.
Foreign Currency Risk. Our international operations, which accounted for approximately 3.9% of our revenue for the nine months ended December 31, 2014, subject us to risks related to currency exchange fluctuations. Prices for our services sold to members located outside the United States are sometimes denominated in local currencies (primarily the British Pound Sterling). As a consequence, increases in the U.S. dollar against local currencies in countries where we have members would result in a foreign exchange loss recognized by us. For the nine months ended December 31, 2014 and 2013, we recorded a foreign currency exchange loss of $1.7 million and $0.2 million, respectively. In fiscal 2014 and 2013, we recorded a foreign currency exchange loss of $0.2 million and $0.5 million, respectively. These amounts are included in other income, net in our consolidated statements of operations. A hypothetical 10% change in foreign currency exchange rates would not have a material impact on our financial position as of December 31, 2014.
Item 8. Financial Statements and Supplementary Data.
Report of Management’s Assessment of Internal Control Over Financial Reporting
Management is responsible for the preparation and integrity of our consolidated financial statements appearing in our Transition Report. Our consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America and include amounts based on management’s estimates and judgments. All other financial information in this report has been presented on a basis consistent with the information included in our consolidated financial statements.
Management is also responsible for establishing and maintaining adequate internal control over financial reporting. We maintain a system of internal control that is designed to provide reasonable assurance as to the reliable preparation and presentation of our consolidated financial statements in accordance with generally accepted accounting principles, as well as to safeguard assets from unauthorized use or disposition.
Our control environment is the foundation for our system of internal control over financial reporting and is reflected in our Code of Ethics for Employees, Code of Business Conduct and Ethics for Members of the Board of Directors and Code of Ethics for Finance Team Members. Our internal control over financial reporting is supported by formal policies and procedures which are reviewed, modified and improved as changes occur in business conditions and operations.
The Audit Committee of the Board of Directors, which is composed solely of outside directors, meets periodically with members of management and the independent registered public accounting firm to review and discuss internal control over financial reporting and accounting and financial reporting matters. The independent registered public accounting firm reports to the Audit Committee and accordingly has full and free access to the Audit Committee at any time.
Management, with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2014 based on the framework in Internal Control—Integrated Framework (2013 Framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission. This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, management has concluded that our internal control over financial reporting was effective as of December 31, 2014.
We excluded Clinovations LLC, which is included in our consolidated financial statements, from our assessment of internal control over financial reporting as of December 31, 2014 because it was acquired by the Company in a purchase business combination on November 7, 2014 and accounted for less than 1% of total and net assets, as of December 31, 2014 and less than 1% and 5% of revenues and net income, respectively, for the nine months then ended.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Ernst & Young LLP, an independent registered public accounting firm which has issued a report on our consolidated financial statements included in this Transition Report, has issued an attestation report on the effectiveness of internal control over financial reporting, which is included herein.
|
| |
| |
/s/ Robert W. Musslewhite | |
| |
Robert W. Musslewhite | |
Chief Executive Officer and Director | |
March 4, 2015 | |
| |
/s/ Michael T. Kirshbaum | |
| |
Michael T. Kirshbaum | |
Chief Financial Officer and Treasurer | |
March 4, 2015 | |
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting
The Board of Directors and Stockholders of
The Advisory Board Company and subsidiaries
We have audited The Advisory Board Company and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). The Advisory Board Company and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Report of Management’s Assessment of Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Clinovations, LLC which is included in the December 31, 2014 consolidated financial statements of The Advisory Board Company and subsidiaries and constituted less than 1% of total and net assets as of December 31, 2014 and less than 1% and 5% of revenues and net income, respectively, for the nine months then ended. Our audit of internal control over financial reporting of The Advisory Board Company and subsidiaries also did not include an evaluation of the internal control over financial reporting of Clinovations, LLC.
In our opinion, The Advisory Board Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of The Advisory Board Company and subsidiaries as of December 31, 2014 and March 31, 2014, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for the transition period ended December 31, 2014 and for each of the two years in the period ended March 31, 2014 of The Advisory Board Company and subsidiaries, and our report dated March 4, 2015 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Baltimore, Maryland
March 4, 2015
Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements
The Board of Directors and Stockholders of
The Advisory Board Company and subsidiaries
We have audited the accompanying consolidated balance sheets of The Advisory Board Company and subsidiaries as of December 31, 2014 and March 31, 2014, and the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for the nine months ended December 31, 2014 and for each of the two years in the period ended March 31, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit the financial statements of Evolent Health LLC, as of December 31, 2014 and for the nine months ended December 31, 2014, a corporation in which the Company has an 11.3% interest as of December 31, 2014. In the consolidated financial statements, the Company’s investment in Evolent Health LLC is stated at $9.3 million as of December 31, 2014 and the Company’s equity in the net loss of Evolent Health LLC is stated at $6.5 million for the nine months ended December 31, 2014. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Evolent Health LLC, is based solely on the report of the other auditors.
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 and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of The Advisory Board Company and subsidiaries at December 31, 2014 and March 31, 2014, and the consolidated results of their operations and their cash flows for the nine months ended December 31, 2014 and for each of the two years in the period ended March 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), The Advisory Board Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 4, 2015, expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Baltimore, Maryland
March 4, 2015
Report of Independent Registered Public Accounting Firm
To the Board of Directors of Evolent Health LLC:
In our opinion, the accompanying balance sheet and the related statements of operations and comprehensive loss, of changes in members’ equity and redeemable preferred units and of cash flows present fairly, in all material respects, the financial position of Evolent Health LLC at December 31, 2014, and the results of its operations and its cash flows for the nine months ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. 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 audit. We conducted our audit of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
March 2, 2015
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
|
| | | | | | | |
| December 31, | | March 31, |
| 2014 | | 2014 |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 72,936 |
| | $ | 23,129 |
|
Marketable securities, current | 14,714 |
| | 2,452 |
|
Membership fees receivable, net | 539,061 |
| | 447,897 |
|
Prepaid expenses and other current assets | 23,254 |
| | 27,212 |
|
Deferred income taxes, current | 14,695 |
| | 5,511 |
|
Total current assets | 664,660 |
| | 506,201 |
|
Property and equipment, net | 135,107 |
| | 102,457 |
|
Intangible assets, net | 38,973 |
| | 33,755 |
|
Deferred incentive compensation and other charges | 86,045 |
| | 86,147 |
|
Marketable securities, net of current portion | — |
| | 161,944 |
|
Goodwill | 186,895 |
| | 129,424 |
|
Investments in and advances to unconsolidated entities | 9,316 |
| | 15,857 |
|
Other non-current assets | 5,370 |
| | 5,550 |
|
Total assets | $ | 1,126,366 |
| | $ | 1,041,335 |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current liabilities: | | | |
Deferred revenue, current | $ | 501,785 |
| | $ | 459,827 |
|
Accounts payable and accrued liabilities | 80,284 |
| | 77,815 |
|
Accrued incentive compensation | 32,073 |
| | 28,471 |
|
Total current liabilities | 614,142 |
| | 566,113 |
|
Deferred revenue, net of current portion | 167,014 |
| | 127,532 |
|
Deferred income taxes, net of current portion | 9,855 |
| | 1,556 |
|
Other long-term liabilities | 15,304 |
| | 8,975 |
|
Total liabilities | 806,315 |
| | 704,176 |
|
Redeemable noncontrolling interest | — |
| | 100 |
|
The Advisory Board Company’s stockholders’ equity: | | | |
Preferred stock, par value $0.01; 5,000,000 shares authorized, zero shares issued and outstanding | — |
| | — |
|
Common stock, par value $0.01; 135,000,000 shares authorized, 36,087,754 and 36,321,825 shares issued and outstanding as of December 31, 2014 and March 31, 2014, respectively | 361 |
| | 363 |
|
Additional paid-in capital | 442,528 |
| | 429,932 |
|
Accumulated deficit | (122,920 | ) | | (91,468 | ) |
Accumulated other comprehensive income (loss) | 82 |
| | (1,541 | ) |
Total stockholders’ equity controlling interest | 320,051 |
| | 337,286 |
|
Equity attributable to noncontrolling interest | — |
| | (227 | ) |
Total stockholders’ equity | 320,051 |
| | 337,059 |
|
Total liabilities and stockholders’ equity | $ | 1,126,366 |
| | $ | 1,041,335 |
|
The accompanying notes are an integral part of these consolidated balance sheets.
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
|
| | | | | | | | | | | | | | | |
| Nine Months Ended December 31, | | Year Ended March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
| | | (unaudited) | | | | |
Revenue | $ | 436,228 |
| | $ | 382,595 |
| | $ | 520,596 |
| | $ | 450,837 |
|
Costs and expenses: | | | | | | | |
Cost of services, excluding depreciation and amortization | 230,169 |
| | 205,328 |
| | 272,523 |
| | 237,605 |
|
Member relations and marketing | 81,244 |
| | 69,886 |
| | 96,298 |
| | 85,264 |
|
General and administrative | 75,483 |
| | 55,426 |
| | 74,169 |
| | 62,185 |
|
Depreciation and amortization | 29,994 |
| | 21,952 |
| | 30,420 |
| | 20,308 |
|
Impairment of capitalized software | 2,086 |
| | — |
| | — |
| | — |
|
Operating income | 17,252 |
| | 30,003 |
| | 47,186 |
| | 45,475 |
|
Other (expense) income, net | (1,327 | ) | | 1,974 |
| | 2,706 |
| | 2,604 |
|
Income before provision for income taxes and equity in loss of unconsolidated entities | 15,925 |
| | 31,977 |
| | 49,892 |
| | 48,079 |
|
Provision for income taxes | (4,831 | ) | | (12,311 | ) | | (19,208 | ) | | (18,023 | ) |
Equity in loss of unconsolidated entities | (6,540 | ) | | (3,320 | ) | | (6,051 | ) | | (6,756 | ) |
Net income before allocation to noncontrolling interest | 4,554 |
| | 16,346 |
| | 24,633 |
| | 23,300 |
|
Net loss and accretion to redemption value attributable to noncontrolling interest | (6,253 | ) | | 119 |
| | 119 |
| | 108 |
|
Net (loss) income attributable to common stockholders | $ | (1,699 | ) | | $ | 16,465 |
| | $ | 24,752 |
| | $ | 23,408 |
|
| | | | | | | |
Net (loss) income attributable to common stockholders per share — basic | (0.05 | ) | | 0.46 |
| | 0.69 |
| | 0.67 |
|
Net (loss) income attributable to common stockholders per share — diluted | (0.05 | ) | | 0.45 |
| | 0.67 |
| | 0.64 |
|
Weighted average number of shares outstanding: | | | | | | | |
Basic | 36,213 |
| | 35,812 |
| | 35,909 |
| | 34,723 |
|
Diluted | 36,213 |
| | 36,876 |
| | 36,959 |
| | 36,306 |
|
The accompanying notes are an integral part of these consolidated statements.
THE ADVISORY BOARD COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
|
| | | | | | | | | | | | | | | |
| Nine Months Ended December 31, | | Year Ended March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
| | | (unaudited) | | | | |
Net (loss) income attributable to common stockholders | $ | (1,699 | ) | | $ | 16,465 |
| | $ | 24,752 |
| | $ | 23,408 |
|
Other comprehensive income: | | | | | | | |
Net unrealized gains (losses) on marketable securities, net of tax | 1,623 |
| | (3,757 | ) | | (2,802 | ) | | 55 |
|
Comprehensive (loss) income | $ | (76 | ) | | $ | 12,708 |
| | $ | 21,950 |
| | $ | 23,463 |
|
The accompanying notes are an integral part of these consolidated financial statements.
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share amounts)
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | Accumulated
Elements of
Other Comprehensive Income (Loss) | | | | | | |
| Common Shares | | Additional Paid-in Capital | | Retained Earnings | | | Treasury Stock | | Noncontrolling
Interest | | |
| Stock | | Amount | | | | | | | Total |
Balance as of March 31, 2012 | 33,729,780 |
| | $ | 235 |
| | $ | 315,648 |
| | $ | 190,000 |
| | $ | 1,206 |
| | $ | (289,784 | ) | | $ | — |
| | $ | 217,305 |
|
Proceeds from exercise of stock options | 1,470,978 |
| | 12 |
| | 24,137 |
| | — |
| | — |
| | — |
| | — |
| | 24,149 |
|
Vesting of restricted stock units, net of shares withheld to satisfy minimum employee tax withholding | 202,865 |
| | 1 |
| | (4,140 | ) | | — |
| | — |
| | — |
| | — |
| | (4,139 | ) |
Excess tax benefits from stock-based awards | — |
| | — |
| | 20,535 |
| | — |
| | — |
| | — |
| | — |
| | 20,535 |
|
Proceeds from issuance of common stock under employee stock purchase plan | 7,748 |
| | — |
| | 363 |
| | — |
| | — |
| | — |
| | — |
| | 363 |
|
Stock-based compensation expense | — |
| | — |
| | 13,913 |
| | — |
| | — |
| | — |
| | — |
| | 13,913 |
|
Release of Southwind earn-out payable in common stock | 112,408 |
| | 1 |
| | 5,338 |
| | — |
| | — |
| | — |
| | — |
| | 5,339 |
|
Retirement of treasury stock | — |
| | (70 | ) | | — |
| | (307,714 | ) | | — |
| | 307,784 |
| | — |
| | — |
|
Stock Split | — |
| | 172 |
| | (172 | ) | | — |
| | — |
| | — |
| | — |
| | — |
|
Purchases of treasury stock | (385,314 | ) | | — |
| | — |
| | — |
| | — |
| | (18,000 | ) | | — |
| | (18,000 | ) |
Change in net unrealized gains (losses) on available-for-sale marketable securities, net of income taxes of ($33) | — |
| | — |
| | — |
| | — |
| | 55 |
| | — |
| | — |
| | 55 |
|
Net income | — |
| | — |
| | — |
| | 23,408 |
| | — |
| | — |
| | (108 | ) | | 23,300 |
|
Balance as of March 31, 2013 | 35,138,465 |
| | $ | 351 |
| | $ | 375,622 |
| | $ | (94,306 | ) | | $ | 1,261 |
| | $ | — |
| | $ | (108 | ) | | $ | 282,820 |
|
Proceeds from exercise of stock options | 1,323,728 |
| | 13 |
| | 22,023 |
| | — |
| | — |
| | — |
| | — |
| | 22,036 |
|
Vesting of restricted stock units, net of shares withheld to satisfy minimum employee tax withholding | 227,202 |
| | 2 |
| | (5,920 | ) | | — |
| | — |
| | — |
| | — |
| | (5,918 | ) |
Excess tax benefits from stock-based awards | — |
| | — |
| | 19,476 |
| | — |
| | — |
| | — |
| | — |
| | 19,476 |
|
Proceeds from issuance of common stock under employee stock purchase plan | 8,962 |
| | — |
| | 514 |
| | — |
| | — |
| | — |
| | — |
| | 514 |
|
Stock-based compensation expense | — |
| | — |
| | 18,217 |
| | — |
| | — |
| | — |
| | — |
| | 18,217 |
|
Retirement of treasury stock | — |
| | (3 | ) | | — |
| | (21,914 | ) | | — |
| | 21,917 |
| | — |
| | — |
|
Purchases of treasury stock | (376,532 | ) | | — |
| | — |
| | — |
| | — |
| | (21,917 | ) | | — |
| | (21,917 | ) |
Change in net unrealized gains (losses) on available-for-sale marketable securities, net of income taxes of ($1,760) | — |
| | — |
| | — |
| | — |
| | (2,802 | ) | | — |
| | — |
| | (2,802 | ) |
Net income | — |
| | — |
| | — |
| | 24,752 |
| | — |
| | — |
| | (119 | ) | | 24,633 |
|
Balance as of March 31, 2014 | 36,321,825 |
| | $ | 363 |
| | $ | 429,932 |
| | $ | (91,468 | ) | | $ | (1,541 | ) | | $ | — |
| | $ | (227 | ) | | $ | 337,059 |
|
Proceeds from exercise of stock options | 233,999 |
| | 3 |
| | 4,294 |
| | — |
| | — |
| | — |
| | — |
| | 4,297 |
|
Vesting of restricted stock units, net of shares withheld to satisfy minimum employee tax withholding | 254,248 |
| | 3 |
| | (7,611 | ) | | — |
| | — |
| | — |
| | — |
| | (7,608 | ) |
Excess tax benefits from stock-based awards | — |
| | — |
| | 392 |
| | — |
| | — |
| | — |
| | — |
| | 392 |
|
Proceeds from issuance of common stock under employee stock purchase plan | 9,241 |
| | — |
| | 432 |
| | — |
| | — |
| | — |
| | — |
| | 432 |
|
Stock-based compensation expense | — |
| | — |
| | 17,964 |
| | — |
| | — |
| | — |
| | — |
| | 17,964 |
|
Retirement of treasury stock | — |
| | (8 | ) | | — |
| | (36,006 | ) | | — |
| | 36,014 |
| | — |
| | — |
|
Purchases of treasury stock | (731,559 | ) | | — |
| | — |
| | — |
| | — |
| | (36,014 | ) | | — |
| | (36,014 | ) |
Net activity related to noncontrolling interests | — |
| | — |
| | 3,378 |
| | — |
| | — |
| | — |
| | 227 |
| | 3,605 |
|
Change in net unrealized gains (losses) on available-for-sale marketable securities, net of income taxes of ($1,147) | — |
| | — |
| | — |
| | — |
| | 1,623 |
| | — |
| | — |
| | 1,623 |
|
Net income | — |
| | — |
| | (6,253 | ) | | 4,554 |
| | — |
| | — |
| | — |
| | (1,699 | ) |
Balance as of December 31, 2014 | 36,087,754 |
| | $ | 361 |
| | $ | 442,528 |
| | $ | (122,920 | ) | | $ | 82 |
| | $ | — |
| | $ | — |
| | $ | 320,051 |
|
The accompanying notes are an integral part of these consolidated statements.
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
|
| | | | | | | | | | | | | | | |
| Nine Months Ended December 31, | | Year Ended
March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
| | | (unaudited) | | | | |
Cash flows from operating activities: | | | | | | | |
Net income before allocation to noncontrolling interest | $ | 4,554 |
| | 16,346 |
| | $ | 24,633 |
| | $ | 23,300 |
|
Adjustments to reconcile net income before allocation to noncontrolling interest to net cash provided by operating activities: | | | | | | | |
Depreciation and amortization | 29,994 |
| | 21,952 |
| | 30,420 |
| | 20,308 |
|
Impairment of capitalized software | 2,086 |
| | — |
| | — |
| | — |
|
Deferred income taxes | (1,083 | ) | | (585 | ) | | 7,795 |
| | 641 |
|
Excess tax benefits from stock-based awards | (392 | ) | | (16,583 | ) | | (19,476 | ) | | (20,535 | ) |
Stock-based compensation expense | 17,964 |
| | 13,794 |
| | 18,217 |
| | 13,913 |
|
Amortization of marketable securities premiums | 1,274 |
| | 2,020 |
| | 2,667 |
| | 2,031 |
|
Loss / (Gain) on investment in common stock warrants | 180 |
| | — |
| | — |
| | (100 | ) |
Equity in loss of unconsolidated entities | 6,540 |
| | 3,320 |
| | 6,051 |
| | 6,756 |
|
Changes in operating assets and liabilities: | | | | | | | |
Membership fees receivable | (82,689 | ) | | (79,697 | ) | | (63,077 | ) | | (87,672 | ) |
Prepaid expenses and other current assets | 4,936 |
| | 16,264 |
| | 7,741 |
| | (7,469 | ) |
Deferred incentive compensation and other charges | 102 |
| | (11,548 | ) | | (12,645 | ) | | (20,133 | ) |
Deferred revenues | 78,160 |
| | 101,861 |
| | 72,137 |
| | 110,099 |
|
Accounts payable and accrued liabilities | 5,107 |
| | 3,921 |
| | 4,277 |
| | 50,290 |
|
Acquisition-related earn-out payments | (3,348 | ) | | (2,212 | ) | | (2,212 | ) | | (3,011 | ) |
Accrued incentive compensation | 3,602 |
| | 3,877 |
| | 7,065 |
| | 2,342 |
|
Other long-term liabilities | (1,815 | ) | | 855 |
| | (6,891 | ) | | (7,499 | ) |
Net cash provided by operating activities | 65,172 |
| | 73,585 |
| | 76,702 |
| | 83,261 |
|
Cash flows from investing activities: | | | | | | | |
Purchases of property and equipment | (48,134 | ) | | (35,692 | ) | | (44,058 | ) | | (36,979 | ) |
Capitalized external use software development costs | (3,826 | ) | | (3,722 | ) | | (5,071 | ) | | (3,393 | ) |
Cash paid for acquisition, net of cash acquired | (70,208 | ) | | (46,036 | ) | | (46,036 | ) | | (31,887 | ) |
Proceeds from sale of discontinued operations, net of selling costs | — |
| | — |
| | — |
| | 1,050 |
|
Investments in and loans to unconsolidated entities | — |
| | (15,641 | ) | | (15,641 | ) | | (4,358 | ) |
Redemptions of marketable securities | 151,420 |
| | 48,676 |
| | 56,647 |
| | 35,376 |
|
Purchases of marketable securities | — |
| | (38,762 | ) | | (71,419 | ) | | (66,710 | ) |
Net cash provided by / (used in) investing activities | 29,252 |
| | (91,177 | ) | | (125,578 | ) | | (106,901 | ) |
Cash flows from financing activities: | | | | | | | |
Proceeds from issuance of common stock from exercise of stock options | 4,294 |
| | 17,478 |
| | 22,023 |
| | 24,137 |
|
Withholding of shares to satisfy minimum employee tax withholding for vested restricted stock units | (7,611 | ) | | (5,796 | ) | | (5,920 | ) | | (4,140 | ) |
Contributions from noncontrolling interest | — |
| | — |
| | — |
| | 100 |
|
Payment for acquisition of noncontrolling interest | (6,110 | ) | | — |
| | — |
| | — |
|
Credit facility issuance costs | — |
| | — |
| | — |
| | (769 | ) |
Proceeds from issuance of common stock under employee stock purchase plan | 432 |
| | 374 |
| | 514 |
| | 363 |
|
Excess tax benefits from stock-based awards | 392 |
| | 16,583 |
| | 19,476 |
| | 20,535 |
|
Acquisition-related earn-out payments | — |
| | — |
| | — |
| | (1,400 | ) |
Purchases of treasury stock | (36,014 | ) | | (16,159 | ) | | (21,917 | ) | | (17,999 | ) |
Net cash (used in) / provided by financing activities | (44,617 | ) | | 12,480 |
| | 14,176 |
| | 20,827 |
|
Net increase / (decrease) in cash and cash equivalents | 49,807 |
| | (5,112 | ) | | (34,700 | ) | | (2,813 | ) |
Cash and cash equivalents, beginning of period | 23,129 |
| | 57,829 |
| | 57,829 |
| | 60,642 |
|
Cash and cash equivalents, end of period | $ | 72,936 |
| | $ | 52,717 |
| | $ | 23,129 |
| | $ | 57,829 |
|
Supplemental disclosure of cash flow information: | | | | | | | |
Cash paid (received) for income taxes | $ | 32 |
| | $ | 508 |
| | $ | (633 | ) | | $ | 3,491 |
|
The accompanying notes are an integral part of these consolidated statements.
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| |
Note 1. | Business description |
The Advisory Board Company (individually and collectively with its subsidiaries, the “Company”) provides best practices research and insight, performance technology software, consulting and management services, and data- and tech-enabled services through discrete programs to hospitals, health systems, pharmaceutical and biotechnology companies, health care insurers, medical device companies, and colleges, universities, and other health care-focused organizations and educational institutions. Members of each subscription-based membership program are typically charged a separate fixed annual fee and have access to an integrated set of services that may include best practices research studies, executive education, proprietary content databases and online tools, daily online executive briefings, original executive inquiry services, cloud-based business intelligence and software applications, consulting and management services, and tech-enabled services.
| |
Note 2. | Summary of significant accounting policies |
Basis of presentation and consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The Company uses the equity method to account for equity investments in instances in which it owns common stock or securities deemed to be in-substance common stock and has the ability to exercise significant influence, but not control, over the investee and for all investments in partnerships or limited liability companies where the investee maintains separate capital accounts for each investor. Investments in which the Company holds securities that are not in-substance common stock, or holds common stock or in-substance common stock, but has little or no influence over the investee, are accounted for using the cost method. All significant intercompany transactions and balances have been eliminated.
Fiscal year
The Company changed its fiscal year to the calendar twelve months ending December 31, effective beginning with the period ended on December 31, 2014. As a result, the current fiscal period was shortened from twelve months to a nine-month transition period ended on December 31, 2014. In these consolidated statements, including the notes thereto, the current period financial results ended December 31, 2014 are for a nine-month period. Audited results for the twelve months ended March 31, 2014 and 2013 are both for twelve-month periods. In addition, the Company's consolidated statements of operations and consolidated statements of cash flows include unaudited comparative amounts for the nine-month period ended December 31, 2013. All references herein to a fiscal year prior to December 31, 2014 refer to the twelve months ended March 31 of such year.
Use of estimates in preparation of consolidated financial statements
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These accounting principles require the Company to make certain estimates, judgments, and assumptions. For cases where the Company is required to make certain estimates, judgments, and assumptions, the Company believes that the estimates, judgments, and assumptions upon which it relies are reasonable based upon information available to the Company at the time that these estimates, judgments, and assumptions are made. These estimates, judgments, and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements as well as the reported amounts of revenue and expenses during the periods presented. To the extent there are material differences between these estimates, judgments, or assumptions and actual results, the Company’s financial statements will be affected. The Company’s estimates, judgments, and assumptions may include: estimates of bad debt reserves; estimates to establish employee bonus and commission accruals; estimates to establish vacation accruals; estimates of the fair value of contingent earn-out liabilities; estimates of the useful lives of acquired or internally developed intangible assets; estimates of the fair value of goodwill and intangibles and evaluation of impairment; determination of when investment impairments are other-than-temporary; estimates of the recoverability of deferred tax assets; and estimates of the potential for future tax consequences of events that have been recognized in the Company’s financial statements or tax returns.
Cash equivalents and marketable securities
Included in cash equivalents are marketable securities with original maturities of three months or less at purchase. Investments with original maturities of more than three months are classified as marketable securities. As of December 31, 2014, all marketable securities are classified as current as they are expected to be liquidated within the next twelve months, regardless of their contractual maturity dates. As of December 31, 2014 and March 31, 2014, the Company’s marketable securities consisted of U.S. government-sponsored enterprise obligations and various 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 attributable to common stockholders and are included within accumulated other comprehensive income, net of tax. The specific identification method is used to compute the realized gains and losses on the sale of marketable securities.
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. 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. To determine the allowance for uncollectible revenue, the Company examines its collections history, the age of accounts receivable in question, any specific member collection issues that have been identified, general market conditions, and current economic trends. Membership fees receivable balances are not collateralized.
Property and equipment
Property and equipment consists of leasehold improvements, furniture, fixtures, equipment, capitalized internal use software development costs, and acquired developed technology. Property and equipment is stated at cost, less accumulated depreciation and amortization. In certain membership programs, the Company provides software applications under a hosting arrangement where the software application resides on the Company’s or its service providers’ hardware. The members do not take delivery of the software and receive access to the software only during the term of their membership agreement.
Computer software development costs that are incurred in the preliminary project stage for internal use software are expensed as incurred. During the development stage, direct consulting costs and payroll and payroll-related costs for employees that are directly associated with each project are capitalized and amortized over the estimated useful life of the software once it is placed into operation. Internally developed capitalized software is classified as software within property and equipment and is amortized using the straight-line method over its estimated useful life, which is generally five years. Replacements and major improvements are capitalized, while maintenance and repairs are charged to expense as incurred. Amortization expense for internally developed capitalized software for the nine months ended December 31, 2014, recorded in depreciation and amortization on the consolidated statements of operations, was approximately $9.3 million. Amortization expense for internally developed capitalized software for the fiscal years ended March 31, 2014 and 2013, recorded in depreciation and amortization on the consolidated statements of operations, was approximately $9.2 million and $4.8 million, respectively.
Acquired developed technology represents the fair value of technology acquired through a business combination that resides on the Company’s or its service providers’ hardware and is made available to members though the memberships. Amortization for acquired developed software is included in depreciation and amortization on the consolidated statements of operations. Acquired developed software is amortized over a weighted average estimated useful life of six years based on the cash flow estimate used to determine the value of the intangible asset at its acquisition. The amount of acquired developed software amortization included in depreciation and amortization for the nine months ended December 31, 2014 was approximately $2.0 million . The amount of acquired developed software amortization included in depreciation and amortization for the fiscal years ended March 31, 2014 and 2013 was approximately $1.7 million and $0.9 million, respectively.
Furniture, fixtures, and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful lives of the assets or the lease term. There are no capitalized leases included in property and equipment. The amount of depreciation expense recognized on plant, property, and equipment during the nine months ended December 31, 2014 was approximately $11.4 million. The amount of depreciation expense recognized on plant, property, and equipment for the fiscal years ended March 31, 2014 and 2013 was approximately $11.5 million and $8.4 million, respectively.
Business combinations
The Company records acquisitions using the purchase method of accounting. All of the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration are recognized at their fair value on the acquisition date. All subsequent changes to a valuation allowance or uncertain tax position that relate to the acquired company and existed at the acquisition date that occur both within the measurement period and as a result of facts and circumstances that existed at the acquisition date are recognized as an adjustment to goodwill. Any acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. Acquisition-related costs are recorded as expenses in the consolidated financial statements. The results of operations of acquired businesses are included in the consolidated financial statements from the acquisition date.
Goodwill and other intangible assets
The excess cost of an acquisition over the fair value of the net assets acquired is recorded as goodwill. The primary factors that generate goodwill are the value of synergies between the acquired entities and the Company and the acquired assembled workforce, neither of which qualifies as an identifiable intangible asset. The Company’s goodwill and other intangible assets with indefinite lives are not amortized. During the transitional period ended December 31, 2014, the Company voluntarily changed the date of its annual goodwill impairment testing from the last day of its former fiscal year-end (March 31) to the first day of the fourth quarter of its new fiscal year (October 1). This voluntary change is preferable under the circumstances as it provides the Company with additional time to complete its annual goodwill impairment testing in advance of its year-end reporting and results in better alignment with the Company’s strategic planning and forecasting process. The voluntary change in accounting principle related to the annual testing date will not delay, accelerate or avoid an impairment charge. This change is not applied retrospectively as it is impracticable to do so because retrospective application would require application of significant estimates and assumptions with the use of hindsight. Accordingly, the change will be applied prospectively.
When testing for impairment, the Company first performs a qualitative assessment on a reporting unit to determine whether further quantitative impairment testing is necessary. If an initial qualitative assessment identifies that it is more likely than not that the carrying value of a reporting unit exceeds its estimated fair value, additional quantitative testing is performed. If the quantitative testing indicates that goodwill is impaired, the carrying value of goodwill is written down to fair value. If the quantitative testing is performed, the Company would determine the fair value of its reporting units based on the income approach and other market data. Under the income approach, the fair value of a reporting unit is calculated based on the present value of estimated future cash flows. The Company has two reporting units used to assess goodwill impairment.
Based on the Company’s qualitative assessment as of October 1, 2014, management believed that no reporting unit was at risk of failing an impairment test that would result in an impairment charge. No quantitative testing was therefore deemed necessary. No changes were noted which would affect the Company's conclusions as of December 31, 2014.
Other intangible assets consist of capitalized software for sale and acquired intangibles. The Company capitalizes consulting costs and payroll and payroll-related costs for employees directly related to building a software product for sale once technological feasibility is established. The Company determines that technological feasibility is established by the completion of a detailed program design or, in its absence, completion of a working model. Once the software product is ready for general availability, the Company ceases capitalizing costs and begins amortizing the intangible asset on a straight-line basis over its estimated useful life. The weighted average estimated useful life of capitalized software is five years. Other intangible assets include those assets that arise from business combinations and that consist of developed technology both for internal use and external sale, non-competition covenants, trademarks, contracts, and customer relationships that are amortized, on a straight-line basis, over one year to twelve years. Finite-lived intangible assets are required to be amortized over their useful lives and are evaluated for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.
Recovery of long-lived assets (excluding goodwill)
The Company records long-lived assets, such as property and equipment, at cost. The carrying value of long-lived assets is reviewed for possible impairment whenever events or changes in circumstances suggest the carrying value of a long-lived asset may not be fully recoverable. The test for recoverability is made using an estimate of the undiscounted expected future cash flows and, if required, the impairment loss is measured as the amount that the carrying value of the asset exceeds the asset’s fair value if the asset is not recoverable. 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. If it is determined that an asset’s carrying value is impaired, a write-down of the carrying value of the identified asset will be recorded as an operating expense on the consolidated statements of operations in the period in which the determination is made.
Fair value of financial instruments
The Company’s short-term financial instruments consist of cash and cash equivalents, membership fees receivable, accrued expenses, and accounts payable. The carrying value of the Company’s financial instruments as of December 31, 2014 and March 31, 2014 approximates their fair value due to their short-term nature. The Company’s marketable securities consisting of U.S. government-sponsored enterprise obligations and various state tax-exempt notes and bonds are classified as available-for-sale and are carried at fair market value based on quoted market prices. The Company’s financial instruments also include cost method investments in private entities. These investments are in preferred securities that are not marketable and, therefore, management has concluded that it is not practicable to estimate the fair value of these financial instruments.
Derivative instruments
The Company holds warrants to purchase common stock in an entity that meet the definition of a derivative. Derivative instruments are carried at fair value on the consolidated balance sheets. Gains or losses from changes in the fair value of the warrants are recognized on the consolidated statements of operations in the period in which they occur.
Revenue recognition
Revenue is recognized when (1) there is persuasive evidence of an arrangement, (2) the fee is fixed or determinable, (3) services have been rendered and payment has been contractually earned, and (4) collectibility is reasonably assured. Fees are generally billable when a letter of agreement is signed by the member, and fees receivable during the subsequent twelve-month period and related deferred revenue are recorded upon the commencement of the membership or collection of fees, if earlier. In many of the Company’s higher priced programs and membership agreements with terms that are greater than one year, fees may be billed on an installment basis.
The Company’s membership agreements with its customers generally include more than one deliverable. Deliverables are determined based upon the availability and delivery method of the services and may include: best practices research; executive education curricula; cloud-based content, databases, and calculators; performance or benchmarking reports; diagnostic tools; interactive advisory support; and performance technology software. Access to such deliverables is generally available on an unlimited basis over the membership period. When an agreement contains multiple deliverables, the Company reviews the deliverables to determine if they qualify as separate units of accounting. In order for deliverables in a multiple-deliverable arrangement to be treated as separate units of accounting, the deliverables must have standalone value upon delivery, and delivery or performance of undelivered items in an arrangement with a general right of return must be probable. If the Company determines that there are separate units of accounting, arrangement consideration at the inception of the membership period is allocated to all deliverables based on the relative selling price method in accordance with the selling price hierarchy. Because of the unique nature of the Company’s products, neither vendor specific objective evidence nor third-party evidence is available. Therefore, the Company utilizes best estimate of selling price to allocate arrangement consideration in multiple element arrangements.
The Company’s membership programs may contain certain deliverables that do not have standalone value and therefore are not accounted for separately. In general, the deliverables in membership programs are consistently available throughout the membership period, and, as a result, the consideration is recognized ratably over the membership period. When a service offering includes unlimited and limited service offerings, revenue is recognized over the appropriate service period, either ratably, if the service is consistently available, or, if the service is not consistently available, upon the earlier of the delivery of the service or the completion of the membership period, provided that all other criteria for recognition have been met.
Certain membership programs incorporate hosted performance technology software. In many of these agreements, members are charged set-up fees in addition to subscription fees for access to the hosted cloud-based software and related membership services. Both set-up fees and subscription fees are recognized ratably over the term of the membership agreement, which is generally three years, and is consistent with the pattern of the delivery of services under these arrangements. Upon launch of a new program that incorporates software, all program revenue is deferred until the program is generally available for release to the Company’s membership, and then recognized ratably over the remainder of the contract term of each agreement.
The Company also performs professional services sold under separate agreements that include management and consulting services. The Company recognizes professional services revenues on a time-and-materials basis as services are rendered.
Deferred incentive compensation and other charges
Incentive compensation to employees related to the negotiation of new and renewal memberships, license fees to third-party vendors for tools, data, and software incorporated in specific memberships that include performance technology software, and other direct and incremental costs associated with specific memberships are deferred and amortized over the term of the related memberships.
Deferred compensation plan
The Company has a Deferred Compensation Plan (the "Plan") for certain employees to provide an opportunity to defer compensation on a pre-tax basis. The Plan provides for deferred amounts to be credited with investment returns based upon investment options selected by participants from alternatives designated from time to time by the plan administrative committee. Investment earnings associated with the Plan’s assets are included in other income, net while changes in individual participant account balances are recorded as compensation expense in the consolidated statements of operations. The Plan also
allows the Company to make discretionary contributions at any time based on individual or overall Company performance, which may be subject to a different vesting schedule than elective deferrals, and provides that the Company may make contributions in an amount equal to the amount of any 401(k) plan matching contribution that is not credited to the participant’s 401(k) account due to such employee's participation in the Plan. The Company did not make any discretionary contributions to the Plan in the nine months ended December 31, 2014 or in the fiscal years ended March 31, 2014 or 2013. The income earned and expense incurred related to the Plan was immaterial for the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013.
Operating leases
The Company recognizes rent expense under operating leases on a straight-line basis over the non-cancelable term of the lease, including free-rent periods. Lease incentives relating to allowances provided by landlords are amortized over the term of the lease as a reduction of rent expense. The Company recognizes sublease income on a straight-line basis over the term of the sublease, including free rent periods and escalations, as a reduction of rent expense. Costs associated with acquiring a subtenant, including broker commissions and tenant allowances, are amortized over the sublease term as a reduction of sublease income.
Stock-based compensation
The Company has several stock-based compensation plans which are described more fully in Note 14, “Stock-based compensation.” These plans provide for the granting of stock options and restricted stock units (“RSUs”) to employees, non-employee members of the Company’s Board of Directors and any other service providers who have been retained to provide consulting, advisory, or other services to the Company. Stock-based compensation cost is measured at the grant date of the stock-based awards based on their fair values, and is recognized as an expense in the consolidated statements of operations over the vesting periods of the awards. The fair value of RSUs, with the exception of RSUs issued with both performance and market-based conditions, is determined as the fair market value of the underlying shares on the date of grant. The fair value of RSUs issued with market-based conditions is calculated on the date of grant using a Monte Carlo option-pricing model. The Company calculates the fair value of all stock option awards, with the exception of the stock options issued with market-based conditions, on the date of grant using the Black-Scholes model. The fair value of stock options issued with market-based conditions is calculated on the date of grant using a Monte Carlo option-pricing model. Forfeitures are estimated based on historical experience at the time of grant and adjusted, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company bases its fair value estimates on assumptions it believes to be reasonable but that are inherently uncertain.
For awards with performance conditions, the probability of achieving performance conditions and estimated time to achieve such performance conditions are measured at each reporting period and are used to determine when and in what amount to recognize stock-based awards with performance conditions.
Other (expense) income, net
Other expense, net for the nine months ended December 31, 2014 includes $1.1 million of interest income earned from the Company’s marketable securities, a $1.7 million loss on foreign exchange rates, $0.5 million in credit facility fees, a $0.1 million realized loss on sale of marketable securities, and a $0.2 million loss on an investment in common stock warrants. Other income, net for the fiscal year ended March 31, 2014 includes $3.3 million of interest income earned from the Company’s marketable securities, a $0.2 million loss on foreign exchange rates, $0.6 million in credit facility fees, and a $0.2 million realized gain on sale of marketable securities. Other income, net for the fiscal year ended March 31, 2013 includes $3.4 million of interest income earned from the Company’s marketable securities, a $0.5 million loss on foreign exchange rates, $0.3 million in credit facility fees, and a $0.1 million gain on an investment in common stock warrants.
Income taxes
Deferred income taxes are determined using 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 bases. 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.
Redeemable noncontrolling interest
Noncontrolling interests with redemption features, such as put options, that are not solely within the Company's control are considered a redeemable noncontrolling interest and are reported in the mezzanine section between liabilities and equity on
the Company's consolidated balance sheets. The noncontrolling interest with redemption features is recorded at the greater of the initial carrying amount adjusted for the noncontrolling interest's share of net income or loss or its redemption value. The redemption value is calculated, based on contractual agreements, in the period when it is determined to be probable that the noncontrolling interest will be redeemed. The difference between the carrying amount and the redemption value are recorded as a reduction to additional paid-in capital (because the Company has a deficit in retained earnings) on the balance sheet and a reduction to arrive at net income attributable to common stockholders on the consolidated statements of operations. Subsequent changes in the redemption value based on achievement of criteria specified in the applicable agreements are recorded in the period they occur. As of December 31, 2014, the Company had no redeemable noncontrolling interests, as the put option associated with such redeemable noncontrolling interests in effect as of March 31, 2014 was exercised prior to December 31, 2014.
Concentrations of risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of membership fees receivable, cash and cash equivalents, and marketable securities. The credit risk with respect to membership fees receivable is generally diversified due to the large number of entities constituting the Company’s membership base, and the Company establishes allowances for potential credit losses. No one member accounted for more than 1.5% of revenue for any period presented. The Company maintains cash and cash equivalents and marketable securities with financial institutions, which may at times exceed federally insured limits. Marketable securities consist of U.S. government-sponsored enterprise obligations and various state tax-exempt notes and bonds. The Company performs periodic evaluations of the relative credit ratings related to the cash, cash equivalents, and marketable securities.
In the nine-months ended December 31, 2014, the Company generated approximately 3.9% of revenue from members outside the United States. In the fiscal years ended March 31, 2014 and 2013, the Company generated approximately 3.1% and 4.0% of revenue, respectively, from members outside the United States. The Company’s limited international operations subject the Company to risks related to currency exchange fluctuations. Prices for the Company’s services sold to members located outside the United States are sometimes denominated in local currencies. Increases in the value of the U.S. dollar against local currencies in countries where the Company has members may result in a foreign exchange gain or loss recognized by the Company. Such foreign exchange gains or losses are included in other (expenses) income, net in the consolidated statement of operations.
Earnings per share
Basic earnings per share is computed by dividing net income attributable to common stockholders by the number of weighted average common shares outstanding during the period. Diluted earnings per share ("diluted EPS") is computed by dividing net income attributable to common stockholders by the number of weighted average common shares increased by the dilutive effects of potential common shares outstanding during the period. The number of potential common shares outstanding is determined in accordance with the treasury stock method, using the Company’s prevailing tax rates. Certain potential common share equivalents were not included in the computation because their effect was anti-dilutive.
A reconciliation of basic to diluted weighted average common shares outstanding is as follows (in thousands):
|
| | | | | | | | | | | |
| Nine Months Ended December 31, | | Year Ended March 31, |
| 2014 | | 2013 | | 2014 | | 2013 |
Basic weighted average common shares outstanding | 36,213 |
| | 35,812 |
| | 35,909 |
| | 34,723 |
|
Effect of dilutive outstanding stock-based awards | — |
| | 1,064 |
| | 1,050 |
| | 1,583 |
|
Diluted weighted average common shares outstanding | 36,213 |
| | 36,876 |
| | 36,959 |
| | 36,306 |
|
In the nine months ended December 31, 2014, 2.6 million shares related to share-based compensation awards have been excluded from the calculation of the effect of dilutive outstanding stock-based awards shown above because their effect was anti-dilutive. For fiscal years ended March 31, 2014 and 2013, 1.0 million and 341,000 shares, respectively, related to share-based compensation awards have been excluded from the calculation of the effect of dilutive outstanding stock-based awards shown above because their effect was anti-dilutive.
As of December 31, 2014, the Company had outstanding 1.0 million nonqualified stock options and 0.2 million RSUs that contained either performance or market conditions, or both, and therefore are treated as contingently issuable awards. These awards are excluded from the diluted EPS until the reporting period in which the necessary conditions are achieved. To the
extent all necessary conditions have not yet been satisfied, the number of contingently issuable shares included in diluted EPS will be based on the number of shares, if any, that would be issuable if the end of the reporting period were the end of the contingency period. As of December 31, 2014, none of these contingently issuable awards have been included within the diluted EPS calculation.
Recent accounting pronouncements
Changes to GAAP are established by the Financial Accounting Standards Board (“FASB”) in the form of accounting standards updates (“ASUs”) to the FASB’s Accounting Standards Codification. The Company considers the applicability and impact of all recent ASUs. ASUs not identified below were assessed and determined to be not applicable or are expected to have an immaterial impact on the Company’s consolidated financial position and results of operations.
Recently adopted
In July 2013, the FASB issued accounting guidance related to income taxes, which requires entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the tax law. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted. The Company adopted this guidance on April 1, 2014. Adoption did not have a material effect on the Company's financial position or results of operations.
Recently issued
In May 2014, the FASB issued accounting guidance related to revenue recognition. The new standard supersedes most of the existing revenue recognition guidance under GAAP, and requires revenue to be recognized when goods or services are transferred to a customer in an amount that reflects the consideration a company expects to receive. The new standard may require more judgment and estimates while recognizing revenue, which could result in additional disclosures to the financial statements. The standard is effective for the Company in the fiscal year ending December 31, 2017. The Company is currently evaluating the revenue recognition impact this guidance will have once implemented.
In August 2014, the FASB issued Accounting Standards Update 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40). This ASU requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. It requires an assessment for a period of one year after the date on which the financial statements are issued. Further, based on certain conditions and circumstances, additional disclosures may be required. This ASU is effective beginning with the first annual period ending after December 15, 2016, and for all annual and interim periods thereafter. Early application is permitted. The Company does not expect this ASU to have an impact on the Company’s consolidated financial statements or related disclosures.
Increasing service to members through the introduction and expansion of new programs is a key component of the Company's growth strategy. From time to time the Company supplements its organic new program development efforts with acquisitions that allow it to introduce new programs and services to its members, or that complement and enhance the value of existing programs through the addition of new capabilities.
Royall Acquisition Co.
On December 10, 2014, the Company entered into a material agreement to acquire 100% of the outstanding common stock of Royall Acquisition Co. ("Royall") for an estimated purchase price of approximately $850 million, subject to customary closing conditions. The Royall acquisition closed on January 9, 2015. Refer to Note 19, "Subsequent events," for further details regarding this acquisition.
Transition Period Acquisitions
During the nine months ended December 31, 2014, the Company completed three acquisitions qualifying as business combinations in exchange for aggregate net cash consideration of $71.3 million. The total purchase price has been allocated on a preliminary basis to identifiable assets acquired and liabilities assumed including $16.6 million to intangible assets with a weighted average amortization period of 8.3 years and $57.5 million to goodwill, of which $33.9 million is tax deductible. The completed acquisitions in the nine months ended December 31, 2014, both individually and in the aggregate, were not significant to the Company's consolidated results of operations.
Fiscal 2014 Acquisitions
During fiscal 2014, the Company completed two acquisitions qualifying as business combinations in exchange for aggregate net cash consideration of $46.0 million. In the aggregate, the Company allocated $11.4 million to intangible assets with a weighted average amortization period of 7.4 years and $33.7 million to goodwill. The goodwill is not deductible for tax purposes. The completed acquisitions in fiscal 2014, both individually and in the aggregate, were not significant to the Company's consolidated results of operations.
Fiscal 2013 Acquisitions
During fiscal 2013, the Company completed two acquisitions qualifying as business combinations in exchange for aggregate net cash consideration of $31.9 million. In the aggregate, the Company allocated $15.4 million to intangible assets with a weighted average amortization period of 7.0 years and $21.3 million to goodwill. The goodwill is not deductible for tax purposes. The completed acquisitions in fiscal 2013, both individually and in the aggregate, were not significant to the Company's consolidated results of operations.
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Note 4. | Fair value measurements |
Financial assets and liabilities
The estimated fair values of financial instruments are determined based on relevant market information. These estimates involve uncertainty and cannot be determined with precision. The Company’s financial instruments consist primarily of cash, cash equivalents, marketable securities, and common stock warrants. In addition, contingent earn-out liabilities resulting from business combinations are recorded at fair value. The following methods and assumptions are used to estimate the fair value of each class of financial assets or liabilities that are valued on a recurring basis.
Cash and cash equivalents. This includes all cash and liquid investments with an original maturity of three months or less from the date acquired. The carrying amount approximates fair value because of the short maturity of these instruments. Cash equivalents also consist of money market funds with fair values based on quoted market prices. The Company’s cash and cash equivalents are held at major commercial banks.
Marketable securities. The Company’s marketable securities, consisting of U.S. government-sponsored enterprise obligations and various state tax-exempt notes and bonds, are classified as available-for-sale and are carried at market value based on quoted market prices.
Common stock warrants. The Company holds warrants to purchase common stock in an entity that provides technology tools and support services to health care providers, including the Company’s members. The warrants are exercisable for up to 6,015,000 of the shares of the entity if and when certain performance criteria are met. The warrants meet the definition of a derivative and are carried at fair value in other non-current assets on the consolidated balance sheets. Gains or losses from changes in the fair value of the warrants are recognized in other income, net on the consolidated statements of operations. See Note 10, “Other non-current assets,” for additional information. The fair value of these warrants is determined using a Black-Scholes-Merton model. Key inputs into this methodology are the estimate of the underlying value of the common shares of the entity that issued the warrants and the estimate of level of performance criteria that will be achieved. The entity that issued the warrants is privately held and the estimate of performance criteria to be met is specific to the Company. These inputs are unobservable and are considered key estimates made by the Company.
Contingent earn-out liabilities. This class of financial liabilities represents the Company’s estimated fair value of the contingent earn-out liabilities related to acquisitions based on probability assessments of certain performance achievements during the earn-out periods. Contingent earn-out liabilities are included in other long-term liabilities on the consolidated balance sheets. See Note 3, “Acquisitions,” for additional information.
Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The valuation can be determined using widely accepted valuation techniques, such as the market approach (comparable market prices) and the income approach (present value of future income or cash flow). As a basis for applying a market-based approach in fair value measurements, GAAP establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The three levels are:
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• | Level 1—Quoted prices in active markets for identical assets or liabilities. |
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• | Level 2—Observable market-based inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. |
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• | Level 3—Unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies. |
Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. There were no significant transfers between Level 1, Level 2, or Level 3 during the nine months ended December 31, 2014 or for the fiscal year ended March 31, 2014.
The Company’s financial assets and liabilities subject to fair value measurements on a recurring basis and the necessary disclosures are as follows (in thousands):
|
| | | | | | | | | | | | | | | |
| Fair value as of | | Fair value measurement as of December 31, 2014 using fair value hierarchy |
| December 31, 2014 | Level 1 | | Level 2 | | Level 3 |
Financial assets | | | | | | | |
Cash and cash equivalents (1) | $ | 72,936 |
| | $ | 72,936 |
| | $ | — |
| | $ | — |
|
Available-for-sale marketable securities (2) | 14,714 |
| | — |
| | 14,714 |
| | — |
|
Common stock warrants (3) | 370 |
| | — |
| | — |
| | 370 |
|
Financial liabilities | | | | | | | |
Contingent earn-out liabilities (4) | 12,946 |
| | — |
| | — |
| | 12,946 |
|
|
| | | | | | | | | | | | | | | |
| Fair value as of | | Fair value measurement as of March 31, 2014 using fair value hierarchy |
| March 31, 2014 | | Level 1 | | Level 2 | | Level 3 |
Financial assets | | | | | | | |
Cash and cash equivalents (1) | $ | 23,129 |
| | $ | 23,129 |
| | $ | — |
| | $ | — |
|
Available-for-sale marketable securities (2) | 164,396 |
| | — |
| | 164,396 |
| | — |
|
Common stock warrants (3) | 550 |
| | — |
| | — |
| | 550 |
|
Financial liabilities | | | | | | | |
Contingent earn-out liabilities (4) | 8,750 |
| | — |
| | — |
| | 8,750 |
|
—————————————
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(1) | Fair value is based on quoted market prices. |
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(2) | Fair value is determined using quoted market prices of the assets. |
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(3) | The fair value of the common stock warrants as of December 31, 2014 and March 31, 2014 was calculated to be $0.22 per share and $0.44 per share, respectively, using a Black-Scholes-Merton model. The significant assumptions as of December 31, 2014 were as follows: risk-free interest rate of 1.6%; expected term of 4.46 years; expected volatility of 76.11%; dividend yield of 0%; weighted average share price of $0.49 per share; and expected warrants to become exercisable of approximately 1,776,500 shares. The significant assumptions as of March 31, 2014 were as follows: risk-free interest rate of 1.7%; expected term of 5.22 years; expected volatility of 36.77%; dividend yield of 0%; weighted average share price of $1.12 per share; and warrants expected to become exercisable between 1,000,000 and 1,400,000 shares. |
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(4) | This fair value measurement is based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions in measuring fair value using the income approach. In developing these estimates, the Company considered certain performance projections, historical results, and general macro-economic environment and industry trends. |
Common stock warrants
The Company’s fair value estimate of the common stock warrants received in connection with its June 2009 investment was zero as of the investment date. Changes in the fair value of the common stock warrants subsequent to the investment date are recognized in earnings in the periods during which the estimated fair value changes. The change in the fair value of the warrants for the nine months ended December 31, 2014 was driven primarily by the net impact of changes in the underlying assumptions. There was no change in the fair value of the warrants for the fiscal year ended March 31, 2014.
The following table represents a reconciliation of the change in the fair value of the common stock warrants for the nine months ended December 31, 2014 and the fiscal year ended March 31, 2014 (in thousands):
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| | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, 2014 | | March 31, 2014 |
Beginning balance | $ | 550 |
| | $ | 550 |
|
Fair value change in common stock warrants (1) | (180 | ) | | — |
|
Ending balance | $ | 370 |
| | $ | 550 |
|
—————————————
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(1) | Amounts were recognized in other income, net on the consolidated statements of operations. |
Contingent earn-out liabilities
The Company entered into an earn-out agreement in connection with its acquisition of Southwind Health Partners, L.L.C. and Southwind Navigator, LLC (together, “Southwind”) in December 2009. The Company’s fair value estimate of the Southwind earn-out liability was $5.6 million as of the date of acquisition. The fair value of the Southwind earn-out liability was impacted by changes in the Company’s stock price and by changes in estimates regarding expected operating results through the end of the evaluation period, which was December 31, 2014.
In October 2012, the Company transferred 112,408 shares of its common stock to the former owners of Southwind to satisfy the component of the contingent obligation payable in the Company’s common stock, which reduced the related earn-out liability by $5.4 million. As of December 31, 2014, $18.0 million had been earned and paid in cash and shares to the former owners of the Southwind business. As of December 31, 2014, based on current facts and circumstances, the estimated aggregate fair value of the remaining contingent obligation was $3.2 million, which will be paid in cash at various intervals through April 2016. The fair value of the Southwind earn-out liability was impacted by changes in estimates regarding expected operating results and a discount rate, which was 3.8% as of December 31, 2014, to reflect the reduced uncertainty resulting from the end of the evaluation period being reached.
The Company’s fair value estimate of the earn-out liability related to the Company’s acquisition of 360Fresh, Inc. (“360Fresh”) in November 2012 was $2.5 million. The Company and the stockholder representative of 360Fresh agreed that the earn-out liability period would end on January 9, 2015 and that the final earn-out payment would be $1.5 million.
The Company entered into an earn-out agreement in connection with its acquisition of PivotHealth, LLC (“PivotHealth”) in August 2011. The Company's fair value estimate of the PivotHealth earn-out liability was $2.9 million as of the date of acquisition. The fair value of the PivotHealth earn-out liability was impacted by changes in estimates regarding expected operating results through the end of the evaluation period on August 31, 2014. Based on the results of PivotHealth's operating results, the contingent obligation for PivotHealth at the end of its evaluation period and as of December 31, 2014 was $0.
The Company's fair value estimate of the earn-out liability related to the Company's acquisition of Clinovations, LLC (“Clinovations”) in November 2014 was $4.5 million. The fair value of the Clinovations earn-out liability will be impacted by changes in estimates regarding expected operating results through the evaluation period, which end on December 31, 2017. A portion of the earn-out liability will be paid in the form of the Company’s common stock. The maximum payout of the earn-out is $9.5 million while the minimum is zero. Based on the results of Clinovations' operating results, the contingent obligation for Clinovations as of December 31, 2014 was $4.5 million. The fair value of the Clinovations earn-out liability is impacted by changes in estimates regarding expected operating results, discount rates for each evaluation period, which vary from 6.4% to 7.2%, and the volatility of the Company stock, which was 30% as of December 31, 2014.
The Company's fair value estimate of the earn-out liability related to the Company's acquisition of ThoughtWright, LLC d/b/a GradesFirst (“GradesFirst”) in December 2014 was $3.6 million. The fair value of the GradesFirst earn-out liability will be impacted by changes in estimates regarding expected operating results through the evaluation period, which ends on December 31, 2015. The maximum payout of the earn-out is $4.0 million while the minimum is zero. Based on the results of GradesFirst's operating results, the contingent obligation for GradesFirst as of December 31, 2014 was $3.6 million. The fair
value of the GradesFirst earn-out liability is impacted by changes in estimates regarding expected operating results and a discount rate, which was 14.5% as of December 31, 2014.
Changes in the fair value of the contingent earn-out liabilities subsequent to the acquisition date, including changes arising from events that occurred after the acquisition date, such as changes in the Company’s estimate of performance achievements, discount rates, and stock price, are recognized in earnings in the periods during which the estimated fair value changes. The following table represents a reconciliation of the change in the contingent earn-out liabilities for the nine months ended December 31, 2014 and the fiscal year ended March 31, 2014 (in thousands):
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| | | | | | | |
| Nine Months Ended | | Year Ended |
| December 31, 2014 | | March 31, 2014 |
Beginning balance | $ | 8,750 |
| | $ | 15,200 |
|
Fair value change in Southwind contingent earn-out liability (1) | 500 |
| | (3,350 | ) |
Fair value change in 360Fresh contingent earn-out liability (1) | (1,100 | ) | | 100 |
|
Fair value change in PivotHealth contingent earn-out liability (1) | — |
| | (1,000 | ) |
Southwind earn-out payment | (3,348 | ) | | (2,200 | ) |
Addition of GradesFirst contingent earn-out liability | 3,600 |
| | — |
|
Addition of Clinovations contingent earn-out liability | 4,544 |
| | — |
|
Ending balance | $ | 12,946 |
| | $ | 8,750 |
|
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(1) | Amounts were recognized in cost of services on the consolidated statements of operations. |
Non-recurring fair value measurements
During the fiscal year ended March 31, 2014, the Company recognized a gain of $4.0 million on the conversion of notes receivable from Evolent Health, Inc., (“Evolent”) into Series B convertible preferred stock of Evolent Health LLC (“Evolent LLC”). See Note 9, “Investments in and advances to unconsolidated entities,” for additional information. The amount of the gain was based on the excess of the fair value of the Series B convertible preferred stock received over the carrying value of the notes receivable exchanged. The fair value of the Series B convertible preferred stock used to calculate the gain was determined by reference to the per share price of issuances of the Series B convertible preferred stock by Evolent LLC to a third party at the same time as the Company exchanged its notes receivable. As this transaction was not made in an active market, this measure is considered a Level 2 fair value measurement. There was no such gain for the nine months ended December 31, 2014.
Non-financial assets and liabilities
Certain assets and liabilities are measured at fair value on a nonrecurring basis, so that the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (e.g., when there is evidence of impairment). During the nine months ended December 31, 2014, certain of the Company’s capitalized software for sale assets were measured and recorded at fair value due to circumstances that indicated that the carrying values of the assets were not fully recoverable. As a result, the Company recognized an impairment of approximately $2.1 million within the consolidated statement of operations. The Company utilized the discounted cash flow method to determine the fair value of the capitalized software assets as of December 31, 2014. Cash flows were determined based on the Company’s estimates of future operating results and discounted using an internal rate of return consistent with that used by the Company to evaluate cash flows of other assets of a similar nature. Due to the significant unobservable inputs inherent in discounted cash flow methodologies, this method is classified as Level 3 in the fair value hierarchy. During the fiscal years ended March 31, 2014 and 2013, no fair value adjustments or material fair value measurements were required for non-financial assets or liabilities.
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Note 5. | 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):
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| | | | | | | | | | | | | | | |
| As of December 31, 2014 |
| Fair value | | Amortized cost | | Gross unrealized gains | | Gross unrealized losses |
U.S. government-sponsored enterprises | $ | 1,915 |
| | $ | 1,915 |
| | $ | — |
| | $ | — |
|
Tax exempt obligations of states | 12,799 |
| | 12,647 |
| | 152 |
| | — |
|
| $ | 14,714 |
| | $ | 14,562 |
| | $ | 152 |
| | $ | — |
|
| | | | | | | |
| As of March 31, 2014 |
| Fair value | | Amortized cost | | Gross unrealized gains | | Gross unrealized losses |
U.S. government-sponsored enterprises | $ | 29,291 |
| | $ | 30,344 |
| | $ | — |
| | $ | 1,053 |
|
Tax exempt obligations of states | 135,105 |
| | 136,653 |
| | 1,060 |
| | 2,608 |
|
| $ | 164,396 |
| | $ | 166,997 |
| | $ | 1,060 |
| | $ | 3,661 |
|
The following table summarizes marketable securities maturities (in thousands):
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| | | | | | | |
| As of December 31, 2014 |
| Fair market value | | Amortized cost |
Matures in less than 1 year | $ | 25 |
| | $ | 25 |
|
Matures after 1 year through 5 years | 3,468 |
| | 3,450 |
|
Matures after 5 years through 10 years | 7,263 |
| | 7,129 |
|
Matures after 10 years through 20 years | 3,958 |
| | 3,958 |
|
| $ | 14,714 |
| | $ | 14,562 |
|
There were $1.3 million in gross realized gains on sales of available-for-sale investments and $1.4 million in gross realized losses on sales of available-for-sale investments for the nine months ended December 31, 2014, including a $0.2 million loss for investments that were deemed to be other-than-temporarily impaired. There were $0.5 million in gross realized gains on sales of available-for-sale investments and $0.4 million in gross realized losses on sales of available-for-sale investments for the fiscal year ended March 31, 2014. There were no gross realized gains or losses on sales of available-for-sale investments for the fiscal year ended March 31, 2013.
The weighted average maturity on all marketable securities held by the Company as of December 31, 2014 was approximately 8.0 years. Pre-tax net unrealized gains on the Company’s investments of $0.2 million as indicated above were caused by the increase in market interest rates compared to the average interest rate of the Company’s marketable securities portfolio along with an other-than-temporary impairment of $0.2 million recognized as of December 31, 2014. The Company recognized an other-than-temporary impairment for all securities in an unrealized loss position as the difference between fair market value and amortized cost as of December 31, 2014. Following the other-than-temporary impairment, the amortized cost of the securities was equal to the fair market value as of December 31, 2014. The Company recorded the other-than-temporary impairment as the Company sold the securities to help fund its acquisition of Royall Acquisition Co., and had the intent to do so as of the balance sheet date. Refer to Note 19, "Subsequent events," for further details regarding this acquisition.
The Company has reflected the net unrealized gains, net of tax, in accumulated other comprehensive income on the consolidated balance sheets.
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Note 6. | Membership fees receivable |
Membership fees receivable consist of the following (in thousands):
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| | | | | | | |
| As of | | As of |
| December 31, 2014 | | March 31, 2014 |
Billed fees receivable | $ | 117,104 |
| | $ | 87,476 |
|
Unbilled fees receivable | 429,487 |
| | 367,271 |
|
Membership fees receivable, gross | 546,591 |
| | 454,747 |
|
Allowance for uncollectible revenue | (7,530 | ) | | (6,850 | ) |
Membership fees receivable, net | $ | 539,061 |
| | $ | 447,897 |
|
Billed fees receivable represent invoiced membership fees. Unbilled fees receivable represent fees due to be billed to members who have elected to pay for their membership on an installment basis. All of the unbilled fees recorded are expected to be billed in the next twelve months.
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Note 7. | Property and equipment |
Property and equipment consists of the following (in thousands):
|
| | | | | | | |
| As of | | As of |
| December 31, 2014 | | March 31, 2014 |
Leasehold improvements | $ | 54,156 |
| | $ | 39,425 |
|
Furniture, fixtures and equipment | 51,593 |
| | 43,112 |
|
Software | 132,949 |
| | 100,808 |
|
Property and equipment, gross | 238,698 |
| | 183,345 |
|
Accumulated depreciation and amortization | (103,591 | ) | | (80,888 | ) |
Property and equipment, net | $ | 135,107 |
| | $ | 102,457 |
|
The Company evaluates its long-lived assets for impairment when changes in circumstances exist that suggests the carrying value of a long-lived asset may not be fully recoverable. If an indication of impairment exists, and the Company’s net book value of the related assets is not fully recoverable based upon an analysis of its estimated undiscounted future cash flows, the assets are written down to their estimated fair value. The Company did not recognize any impairment losses on any of its property and equipment for the nine months ended December 31, 2014 or during the fiscal year ended March 31, 2014.
As of December 31, 2014 and March 31, 2014, the carrying value of internally developed capitalized software was $61.0 million and $46.0 million, respectively.
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Note 8. | Goodwill and intangibles |
Included in the Company’s goodwill and intangibles balances are goodwill and acquired intangibles and internally developed capitalized software for sale. Goodwill is not amortized as it has an estimated infinite life. Goodwill is reviewed for impairment at least annually as of October 1, the first date of the fourth quarter of the Company's new fiscal year, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company believes that no such impairment indicators existed during the nine months ended December 31, 2014 or for the fiscal years ended March 31, 2014 or 2013. There was no impairment of goodwill recorded during the nine months ended December 31, 2014 or the fiscal year ended March 31, 2014 or 2013.
Changes in the carrying amount of goodwill are as follows (in thousands):
|
| | | | | | | |
| As of | | As of |
| December 31, 2014 | | March 31, 2014 |
Beginning of period | $ | 129,424 |
| | $ | 95,540 |
|
Goodwill acquired | 57,471 |
| | 33,884 |
|
Ending balance | $ | 186,895 |
| | $ | 129,424 |
|
Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which range from one year to twelve years. As of December 31, 2014, the weighted average remaining useful life of acquired intangibles was approximately 6.4 years. As of December 31, 2014, the weighted average remaining useful life of internally developed intangibles was approximately 4.1 years.
The gross and net carrying balances and accumulated amortization of intangibles are as follows (in thousands):
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| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | As of December 31, 2014 | | As of March 31, 2014 |
| Weighted average useful life | | Gross carrying amount | | Accumulated amortization | | Net carrying amount | | Gross carrying amount | | Accumulated amortization | | Net carrying amount |
Intangibles | | | | | | | | | | | | | |
Internally developed intangible for sale: | | | | | | | | | | | | | |
Capitalized software | 5.0 | | $ | 13,268 |
| | $ | (4,009 | ) | | $ | 9,259 |
| | $ | 11,508 |
| | $ | (2,266 | ) | | $ | 9,242 |
|
Acquired intangibles: | | | | | | | | | | | | | |
Developed software | 6.1 | | 19,250 |
| | (10,238 | ) | | 9,012 |
| | 19,250 |
| | (7,875 | ) | | 11,375 |
|
Customer relationships | 8.4 | | 25,610 |
| | (8,662 | ) | | 16,948 |
| | 15,910 |
| | (6,800 | ) | | 9,110 |
|
Trademarks | 5.7 | | 4,900 |
| | (3,048 | ) | | 1,852 |
| | 4,200 |
| | (2,680 | ) | | 1,520 |
|
Non-compete agreements | 3.8 | | 1,600 |
| | (1,234 | ) | | 366 |
| | 1,400 |
| | (900 | ) | | 500 |
|
Customer contracts | 4.7 | | 6,449 |
| | (4,913 | ) | | 1,536 |
| | 6,299 |
| | (4,291 | ) | | 2,008 |
|
Total other intangibles | | | $ | 71,077 |
| | $ | (32,104 | ) | | $ | 38,973 |
| | $ | 58,567 |
| | $ | (24,812 | ) | | $ | 33,755 |
|
At December 31, 2014, the Company concluded that certain internally developed capitalized software for sale assets were not fully recoverable. The Company had recently updated and integrated new functionality into one of its software programs, and as a result recognized a $2.1 million impairment on the remaining unamortized costs which were associated with older functionality.
Amortization expense for intangible assets for the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, recorded in depreciation and amortization on the consolidated statements of operations, was approximately $7.3 million, $8.0 million, and $5.8 million, respectively. The following approximates the aggregate amortization expense to be recorded in depreciation and amortization on the consolidated statements of operations for each of the following five fiscal years ending December 31, 2015 through 2019: $8.7 million, $7.5 million, $6.7 million, $5.8 million, and $4.0 million, respectively, and $6.3 million thereafter.
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Note 9. | Investments in and advances to unconsolidated entities |
In August 2011, the Company entered into an agreement with UPMC to establish Evolent for the purpose of driving provider-led, value-driven care with innovative technology, integrated data and analytics, and services. The Company provided $10.0 million and other non-cash contributions to Evolent for an initial equity interest of 44% in Series A convertible preferred stock of Evolent and the right to appoint one person to Evolent’s board of directors. The Company exercises significant influence over Evolent, but does not control Evolent and is not the primary beneficiary of Evolent’s activities. At the time of formation, the Series A convertible preferred stock of Evolent was deemed to be in-substance common stock. As a result, the Company’s investment in Evolent was accounted for under the equity method of accounting, with the Company’s proportionate share of the income or loss recognized in the consolidated statements of operations. In addition, a member of the Company’s Board of Directors serves as the chief executive officer of Evolent.
In September 2013, Evolent completed a reorganization in connection with a new round of equity financing (the “Series B Issuance”). Evolent’s reorganization included the creation of Evolent Health Holdings, Inc. (“Holdings”) and the conversion
of Evolent into Evolent LLC, a limited liability company that is treated as a partnership for tax purposes. The Company's investment in Evolent was converted into the equivalent investment in Holdings. Immediately following the reorganization, Holdings owned 57% of the equity interests in Evolent LLC. Holdings has no other operations other than its investment in Evolent LLC. The Company, together with certain other investors, also holds direct equity interests in Evolent LLC, which will continue as the operating company that will conduct the Evolent business. The Company participated in the Series B Issuance by providing $9.6 million in cash and converting $10.1 million in principal and accrued interest of the convertible term note described above in exchange for 1,302,172 shares of Series B convertible preferred stock in Evolent LLC and the right to appoint an additional person to the boards of directors of both Evolent LLC and Holdings. The conversion of all outstanding principal and accrued interest under the note into equity securities generated a $4.0 million gain. The gain is included in equity in loss of unconsolidated entities on the consolidated statements of operations for the fiscal year ended March 31, 2014. There is no such gain for the nine months ended December 31, 2014. Immediately following the Series B Issuance and reorganization, the Company owned 23.6% of Holdings through its Series A convertible preferred investment and 11.5% of Evolent LLC through its Series B convertible preferred investment.
On the date of the Series B Issuance, the Company re-evaluated the accounting for its investment in Holdings’ Series A convertible preferred stock. The Company determined that its Series A convertible preferred investment in Holdings should be accounted for under the cost method instead of the equity method since the investment no longer qualified as in-substance common stock. The carrying value of the Company’s Series A convertible preferred investment in Holdings was $0 as of December 31, 2014 and March 31, 2014.
Evolent LLC maintains separate capital accounts for each of its members. Therefore, the Company accounts for its Series B convertible preferred investment in Evolent LLC under the equity method. As a result of the earnings and loss allocation methodology provided for in the Evolent LLC Operating Agreement and Evolent's cumulative net loss position, the Company currently is allocated approximately 20% of the Evolent LLC losses. The Company’s share of the losses of Evolent LLC based on the allocation rules in the Evolent LLC agreements that was applied to the carrying value of its investment in Evolent LLC was $6.3 million for the nine months ended December 31, 2014 and $3.8 million for the fiscal year ended March 31, 2014. In addition, $0.2 million for the nine months ended December 31, 2014 and $0.4 million for the fiscal year ended March 31, 2014 related to amortization of basis differences related to identified intangible assets was applied to the carrying value of its investment in Evolent LLC. This basis difference accounted for approximately $3.6 million and $3.8 million of the carrying balance of the Company's investment in Series B convertible preferred stock of Evolent LLC as of December 31, 2014 and March 31, 2014, respectively. As a result, the carrying balance of the Company’s investment in Series B convertible preferred stock of Evolent LLC was $9.3 million as of December 31, 2014 and $15.9 million as of March 31, 2014.
Because of Evolent LLC's treatment as a partnership for tax purposes, the losses of Evolent LLC pass through to the Company and the other members. The Company's proportionate share of the losses of Evolent LLC are recorded net of the estimated tax benefit that the Company believes will be realized from the losses in equity in loss of unconsolidated entities on the consolidated statements of operations. As a result of uncertainty associated with the realization of the deferred tax assets resulting from the tax benefit of the Evolent LLC losses, the Company has provided a full valuation allowance against this deferred tax asset as of December 31, 2014 and March 31, 2014.
As of December 31, 2014, the Company owned 23.3% of Holdings through its Series A convertible preferred investment and Holdings owned approximately 57.2% of Evolent LLC. As of March 31, 2014, the Company owned 23.1% Holdings through its Series A convertible preferred investment and Holdings owned approximately 57.4% of Evolent LLC.
As of December 31, 2014 the Company owned 11.4% of Evolent LLC through its Series B convertible preferred investment. As of March 31, 2014, the Company owned of and 11.3% of Evolent LLC through its Series B convertible preferred investment.
During the fiscal year ended March 31, 2014, the Company’s share of the losses of Evolent that was applied to the carrying value of its investment in Series A convertible preferred stock of Evolent was $1.9 million. The Company’s share of the losses of Evolent during the fiscal years ended March 31, 2014 and 2013 was $10.1 million and $7.9 million, respectively. Equity in loss of unconsolidated entities on the consolidated statements of operations for the fiscal year ended March 31, 2013 includes a dilution gain of $1.1 million which the Company recognized in connection with Evolent’s July 2012 financing round. Evolent LLC is in the early stages of its business plan and, as a result, the Company expects both Holdings and its majority-owned subsidiary Evolent LLC to continue to incur losses in the future. The Company’s investment in Evolent LLC is evaluated for impairment whenever events or changes in circumstances indicate that there may be an other-than-temporary decline in value. As of December 31, 2014, the Company believes that no impairment charge is necessary.
The following is a summary of the financial position of Evolent LLC as of the dates presented:
|
| | | | | | | |
| As of | | As of |
| December 31, 2014 | | March 31, 2014 |
Assets: | | | |
Current assets | $ | 56,718 |
| | $ | 78,692 |
|
Non-current assets | 27,586 |
| | 20,151 |
|
Total assets | $ | 84,304 |
| | $ | 98,843 |
|
Liabilities and Members’ Equity: | | | |
Current liabilities | $ | 50,029 |
| | $ | 35,333 |
|
Non-current liabilities | 5,772 |
| | 3,173 |
|
Total liabilities | 55,801 |
| | 38,506 |
|
Redeemable equity | 15,734 |
| | 33,306 |
|
Members’ equity | 12,769 |
| | 27,031 |
|
Total liabilities and members’ equity | $ | 84,304 |
| | $ | 98,843 |
|
The following is a summary of the operating results of Evolent LLC (or its predecessor) for the periods presented:
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 (1) | | 2013 |
Revenue | $ | 80,812 |
| | $ | 54,899 |
| | $ | 13,082 |
|
Operating expenses | (118,579 | ) | | (89,475 | ) | | (36,183 | ) |
Depreciation and amortization | (3,038 | ) | | (2,147 | ) | | (1,038 | ) |
Interest, net | 168 |
| | (630 | ) | | (149 | ) |
Taxes | — |
| | (7 | ) | | 333 |
|
Net loss | $ | (40,637 | ) | | $ | (37,360 | ) | | $ | (23,955 | ) |
____________
(1) In December 2014, Evolent LLC reissued previously released financial statements to reflect a correction in their recognition of stock-based compensation. Based on the Evolent LLC's methodology of allocating profits and losses to its members, the change in the stock-based compensation expense of Evolent LLC did not affect the Company’s consolidated balance sheets, consolidated statements of operations, or consolidated statements of cash flows for any period.
| |
Note 10. | Other non-current assets |
In June 2009, the Company invested in the convertible preferred stock of a private company that provides technology tools and support services to health care providers, including the Company’s members. In addition, the Company entered into a licensing agreement with that company. As part of its investment, the Company received warrants to purchase up to 6,015,000 shares of the company’s common stock at an exercise price of $1.00 per share as certain performance criteria are met. The warrants are exercisable through June 19, 2019. The warrants contain a net settlement feature and therefore are considered to be a derivative financial instrument. A reduction of $180,000 was made to the fair value of the warrants for the nine months ended December 31, 2014. The change in the fair value of the warrants for the nine months ended December 31, 2014 was driven primarily by the net impact of changes in the underlying assumptions. The warrants are recorded at their fair value, which was estimated at $370,000 as of December 31, 2014 and $550,000 as of March 31, 2014 , and are included in other non-current assets on the consolidated balance sheets.
The change in the fair value of the warrants is recorded in other income, net on the consolidated statements of operations. For additional information regarding the fair value of these warrants, see Note 4, “Fair value measurements.” The convertible preferred stock investment is recorded at cost, and the carrying amount of this investment as of December 31, 2014 of $5.0 million is included in other non-current assets on the consolidated balance sheets. The convertible preferred stock accrues dividends at an annual rate of 8% that are payable if and when declared by the investee’s board of directors. As of December 31, 2014, no dividends had been declared by the investee or recorded by the Company. This investment is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of this asset may not be recoverable. The Company has reviewed this asset for impairment and believes that no impairment existed in the nine months ended December 31, 2014 or the fiscal year ended March 31, 2014.
| |
Note 11. | Noncontrolling interest |
In July 2012, the Company entered into an agreement with an entity created for the sole purpose of providing consulting services for the Company on an exclusive basis. The Company’s relationship with the entity was governed by a services agreement and other documents that provided the entity’s owners the conditional right to require the Company to purchase their ownership interests (“Put Option”), for a price based on a formula set forth in the agreement, at any time after certain conditions were satisfied through December 31, 2014. These agreements also provided the Company a conditional right to require the entity’s owners to sell their ownership interests to the Company (“Call Option”) over the same period. In April 2014, an amendment to these agreements provided for an extension of both the Put Option and Call Option to be exercisable through June 30, 2015. The equity interest in this entity was initially classified as a redeemable noncontrolling interest, which is presented outside of permanent equity as the redemption was not solely within the Company’s control. The Company recorded these interests at their initial fair value, adjusting the basis prospectively for the noncontrolling holders’ share of the respective consolidated investments’ results of operations and applicable changes in ownership. The Company determined that this entity met the definition of a variable interest entity over which it had significant influence and, as a result, had consolidated the results of this entity into its consolidated financial statements. The noncontrolling interest represents the entity’s owners’ claims on consolidated investments where the Company owns less than a 100% interest. Losses attributable to noncontrolling interest for the nine months ended December 31, 2014 were $0.2 million. Losses attributable to noncontrolling interest for the fiscal years ended March 31, 2014 and 2013 were $0.1 million and $0.1 million, respectively.
On December 5, 2014, the conditions required for the entity's owners to exercise the Put Option were satisfied and the entity's owners exercised the Put Option. The Company paid $6.1 million to acquire 100% of the equity. The purchase price allocated to the allocated equity of $6.1 million is recorded as a reduction to net income attributable to common stockholders on the accompanying consolidated statements of operations as an adjustment to additional paid-in capital on the accompanying consolidated balance sheet as the Company has an accumulated deficit. Prior to the exercise of the Put Option, the Company had a 0% interest in this entity. In conjunction with the exercise of the Put Option, the Company recorded a deferred tax asset of $3.4 million related to basis differences.
| |
Note 12. | Revolving credit facility |
In July 2012, the Company entered into a $150.0 million five-year senior secured revolving credit facility under a credit agreement with a syndicate of lenders. The Company incurred financing fees of $0.8 million in relation to this transaction. Under the revolving credit facility, up to $150.0 million principal amount of borrowings and other credit extensions could be outstanding at any time, subject to compliance with specified financial ratios and the satisfaction of other customary conditions to borrowing. The maximum principal amount available under the credit agreement was able to be increased by up to an additional $50.0 million in minimum increments of $10.0 million at the Company’s election upon the satisfaction of specified conditions. The credit agreement contained a sublimit for up to $5.0 million principal amount of swing line loans outstanding at any time and a sublimit for the issuance of up to $10.0 million of letters of credit outstanding at any time. The facility loans could be borrowed, repaid, and reborrowed from time to time during the term of the facility and were set to mature and be payable in full on July 30, 2017. Consequently, the amount outstanding under the revolving credit facility at the end of a period may not have been reflective of the total amounts outstanding during such period.
Amounts borrowed under the revolving credit facility generally would bear interest at an annual rate calculated, at the Company’s option, on the basis of either (a) an alternate base rate plus the applicable margin for alternate base rate loans under the credit agreement, which ranges from 0.75% to 1.5% based on the Company’s total leverage ratio, or (b) an adjusted London interbank offered rate ("LIBOR") plus the applicable margin for eurocurrency loans under the credit agreement, which ranges from 1.75% to 2.50% based on the Company’s total leverage ratio. The Company was required to pay a commitment fee on the unutilized portion of the facility at an annual rate of between 0.25% and 0.40% based on the Company’s total leverage ratio.
As of December 31, 2014 and March 31, 2014, there were no amounts outstanding under the revolving credit facility and $150.0 million was available for borrowing.
The Company is required under the revolving credit facility to satisfy three financial ratios on a quarterly basis. The Company was in compliance with these financial covenants as of December 31, 2014.
As discussed in Note 19, “Subsequent events,” the Company terminated this credit facility as of January 9, 2015 in conjunction with its acquisition of Royall Acquisition Co. Refer to Note 19, "Subsequent events," for further details regarding this transaction.
| |
Note 13. | Stockholders’ equity |
In May 2013, the Company’s Board of Directors authorized an increase in its cumulative share repurchase program to $450 million of the Company’s common stock. The Company repurchased 731,559 shares, 376,532 shares and 385,314 shares of its common stock at a total cost of approximately $36.0 million, $21.9 million, and $18.0 million in the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, respectively, pursuant to its share repurchase program. The total amount of common stock purchased from inception under the program as of December 31, 2014 was 16,758,185 shares at a total cost of $398.8 million. All repurchases to date have been made in the open market and shares have been retired as of December 31, 2014. No minimum number of shares subject to repurchase has been fixed and the share repurchase authorization has no expiration date. The Company has funded its share repurchases with cash on hand, proceeds from the sale of marketable securities, and cash generated from operations. As of December 31, 2014, the remaining authorized repurchase amount was $51.2 million.
During the nine months ended December 31, 2014, the Company retired 731,559 shares of its treasury stock. Upon retirement, these shares resumed the status of authorized but unissued stock. The treasury stock retirement resulted in reductions to common stock of $7,300, treasury stock of $36.0 million, and retained earnings of $36.0 million. During the fiscal year ended March 31, 2014, the Company retired 376,532 shares of its treasury stock. Upon retirement, these shares resumed the status of authorized but unissued stock. The treasury stock retirement resulted in reductions to common stock of $3,000, treasury stock of $21.9 million, and retained earnings of $21.9 million. A total of 16,758,185 shares of treasury stock have been retired to date. There was no effect on the total stockholders’ equity position as a result of the retirement.
On May 1, 2012, the Company’s Board of Directors approved a two-for-one split of the Company’s common stock to be effected in the form of a stock dividend. As a result of this action, one additional share was issued on June 18, 2012 for each share held by stockholders of record at the close of business on May 31, 2012. The stock split did not have an impact on the Company’s consolidated financial position or results of operations. Share and per share amounts presented in the consolidated financial statements for dates before June 18, 2012 have been restated to reflect the impact of the stock split.
| |
Note 14. | Stock-based compensation |
Equity incentive plans
The Company issues awards, including stock options and RSUs, under the Company’s 2005 Stock Incentive Plan (the “2005 Plan”) and 2009 Stock Incentive Plan (the “2009 Plan”). On September 5, 2013, the Company's stockholders approved an amendment to the 2009 Plan that increased the number of shares of common stock authorized for issuance under the plan by 2,125,000 shares. The aggregate number of shares of the Company’s common stock available for issuance under the 2009 Plan, as amended, may not exceed 6,735,000, plus the shares that remained available for issuance under the 2006 Plan as of June 26, 2009 and the number of shares subject to outstanding awards under the 2006 Plan that, on or after such date, cease for any reason to be subject to such awards (other than reason of exercise or settlement of the awards to the extent they are exercised for or settled in vested and non-forfeitable shares). On September 5, 2013, the Company's stockholders also approved an amendment to the 2009 Plan that increased the maximum term for stock option and freestanding stock appreciation rights awards granted under the plan from five years to seven years. The aggregate number of shares of the Company’s common stock available for issuance under the 2005 Plan may not exceed 3,200,000, plus the shares that remained available for issuance under the Company’s 2001 Stock Incentive Plan (the “2001 Plan”) as of November 15, 2005 and shares subject to outstanding awards under the 2001 Plan that, on or after such date, cease for any reason to be subject to such awards (other than reason of exercise or settlement of the awards to the extent they are exercised for or settled in vested and non-forfeitable shares). Stock-based awards granted under the 2005 Plan have a seven-year maximum contractual term. As of December 31, 2014, there were 589,236 shares available for issuance under the 2009 Plan and 715,670 shares available for issuance under the 2005 Plan.
The 2009 Plan and the 2005 Plan (the “Plans”) are administered by the Compensation Committee of the Company’s Board of Directors, which has the authority to determine which officers, directors, employees, and other service providers are awarded options or share awards pursuant to the Plans and to determine the terms of the awards. Grants may consist of treasury shares or newly issued shares. Options are rights to purchase common stock of the Company at the fair market value on the date of grant. The exercise price of a stock option or other equity-based award is equal to the closing price of the Company’s common stock on the date of grant. The Company generally awards non-qualified options, but the Plans permit the issuance of options intended to qualify as incentive stock options under Section 422 of the Internal Revenue Code. Holders of options do not participate in dividends, if any, until after the exercise of the award. RSUs are equity settled stock-based compensation arrangements of a number of shares of the Company’s common stock. RSU holders do not participate in dividends, if any, nor do they have voting rights until the restrictions lapse.
On June 23, 2014, the Compensation Committee of the Board of Directors approved a grant of 947,117 nonqualified stock options and 101,474 RSUs to certain executive officers of the Company. The awards are subject to both performance-
based and market-based conditions and will vest based upon the achievement of specified levels of both sustained contract value and sustained stock price during the performance period, which could extend to March 31, 2019. The vesting of the RSUs is also subject to a one-year service condition, which requires the recipient to remain employed with the Company for at least one year following the date on which the applicable performance and market conditions are achieved. As of December 31, 2014, the Company has concluded that it is probable that all awards will vest at the highest level of achievements over a five-year period. The estimated requisite service period, which includes the current estimate of the time to achieve the performance and market conditions at the highest level is five years for the stock options and six years for the RSUs, inclusive of the one-year service condition. The options and RSUs are included in the tables below.
Stock option activity. During the nine months ended December 31, 2014 and for the fiscal years ended March 31, 2014 and 2013, the Company granted 1,144,973, 536,958, and 361,844 stock options, respectively, with a weighted average exercise price of $52.28, $51.71, and $44.00, respectively.
The weighted average fair value of options granted with performance and market conditions, valued using a Monte Carlo model, during the nine months ended December 31, 2014 is estimated at $13.82 per share on the date of grant using the following weighted average assumptions: risk-free interest rate of 1.7%; an expected life of approximately 5 years; volatility of 30%; and dividend yield of 0.0% over the expected life of the option.
The weighted average fair value of all other options granted during the nine months ended December 31, 2014 is estimated at $17.72 per share on the date of grant using the following weighted average assumptions: risk-free interest rate of 1.7%; an expected life of approximately 5.47 years; volatility of 30.65%; and dividend yield of 0.0% over the expected life of the option.
During the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, participants exercised 233,999, 1,327,358, and 1,477,219 options for a total intrinsic value of $7.3 million, $53.7 million, and $44.3 million, respectively. Intrinsic value is calculated as the number of shares exercised times the Company’s stock price at exercise less the exercise price of the option.
The following table summarizes the changes in common stock options during the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013 for all of the Company's stock incentive plans.
|
| | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | | Year Ended March 31, |
| December 31, 2014 | | | 2014 | | 2013 |
| Number of Options | | Weighted Average Exercise Price | | | Number of Options | | Weighted Average Exercise Price | | Number of Options | | Weighted Average Exercise Price |
Outstanding, beginning of year | 1,830,323 |
| | $ | 32.82 |
| | | 2,692,353 |
| | $ | 21.06 |
| | 3,812,228 |
| | $ | 17.05 |
|
Granted | 1,144,973 |
| | 52.28 |
| | | 536,958 |
| | 51.71 |
| | 361,844 |
| | 44.00 |
|
Exercised | (233,999 | ) | | 18.36 |
| | | (1,327,358 | ) | | 16.60 |
| | (1,477,219 | ) | | 16.35 |
|
Forfeited | — |
| | — |
| | | (71,630 | ) | | 32.93 |
| | (4,500 | ) | | 9.26 |
|
Outstanding, end of year | 2,741,297 |
| | $ | 42.19 |
| (1) | | 1,830,323 |
| | $ | 32.82 |
| | 2,692,353 |
| | $ | 21.06 |
|
Exercisable, end of year | 858,238 |
| | $ | 26.16 |
| (2) | | | | | | | | |
—————————————
| |
(1) | The weighted average remaining contractual term for the nine months ended December 31, 2014 is approximately four years and the aggregate intrinsic value is $24.3 million. |
| |
(2) | The weighted average remaining contractual term for the nine months ended December 31, 2014 is approximately two years and the aggregate intrinsic value is $19.6 million. |
The aggregate intrinsic value shown in the footnotes of the table above is the sum of the amounts by which the quoted market price of the Company’s common stock on the NASDAQ Global Select Market exceeded the exercise price of the options as of December 31, 2014, for those options for which the quoted market price was in excess of the exercise price. This amount changes over time based on changes in the fair market value of the Company’s common stock. During the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, 411,259, 850,087, and 710,972 options, respectively, vested with fair values of $4.2 million, $5.3 million, and $3.8 million, respectively.
The following table summarizes the exercise prices and contractual lives of all options outstanding under the Company's stock incentive plans as of December 31, 2014:
|
| | | | | | | | |
| Options Outstanding and Exercisable |
Range of Exercise Prices | Shares | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Life - Years |
$ 0.00 – $ 9.99 | 170,950 |
| | $ | 9.26 |
| | 1.3 |
10.00 – 19.99 | 169,600 |
| | 16.58 |
| | 2.1 |
20.00 – 29.99 | 406,445 |
| | 24.56 |
| | 2.2 |
30.00 – 39.99 | 5,000 |
| | 34.06 |
| | 1.9 |
40.00 – 49.99 | 725,811 |
| | 46.15 |
| | 3.5 |
50.00 – 59.99 | 1,156,226 |
| | 52.33 |
| | 6.5 |
60.00 – 69.99 | 107,265 |
| | 66.06 |
| | 6.2 |
$ 0.00 – $ 69.99 | 2,741,297 |
| | $ | 42.19 |
| | 4.4 |
Restricted stock unit activity. During the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, the Company granted 336,113, 550,384 , and 342,240 RSUs, respectively, the majority of which vest in four equal annual installments on the anniversary of the grant date. The valuation of RSUs is determined as the fair market value of the underlying shares on the date of grant. The weighted average grant date fair value of RSUs granted without market conditions for the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013 was $54.67, $53.64, and $44.39, respectively. The weighted average fair value of RSUs granted with performance and market conditions during the nine months ended December 31, 2014 is estimated at $15.75 per share on the date of grant using the following weighted average assumptions: risk-free interest rate of 1.7%; an expected life of approximately 5 years; volatility of 30%; and dividend yield of 0.0% over the expected life of the RSUs. No RSUs with performance and market conditions vested during the nine months ended December 31, 2014.
During the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, participants vested in 387,377, 346,310, and 292,020 RSUs, respectively, for a total intrinsic value of $22.0 million, $17.2 million, and $13.6 million, respectively. Intrinsic value is calculated as the number of shares vested times the Company’s closing stock price on the NASDAQ Global Select Market at the vesting date. Of the RSUs vested in the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, 133,129, 119,108, and 89,155 shares, respectively, were withheld to satisfy minimum employee tax withholding.
The following table summarizes the changes in RSUs during the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013 for all of the stock incentive plans described above.
|
| | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
| Number of RSUs | | Weighted Average Grant Date Fair Value | | Number of RSUs | | Weighted Average Grant Date Fair Value | | Number of RSUs | | Weighted Average Grant Date Fair Value |
Non-vested, beginning of year | 1,110,462 |
| | $ | 42.05 |
| | 943,206 |
| | $ | 29.50 |
| | 896,640 |
| | $ | 20.77 |
|
Granted | 336,113 |
| | $ | 42.92 |
| | 550,384 |
| | $ | 53.64 |
| | 342,240 |
| | $ | 44.39 |
|
Forfeited | (12,616 | ) | | $ | 50.40 |
| | (36,818 | ) | | $ | 39.88 |
| | (3,654 | ) | | $ | 19.98 |
|
Vested | (387,377 | ) | | $ | 32.27 |
| | (346,310 | ) | | $ | 26.53 |
| | (292,020 | ) | | $ | 20.26 |
|
Non-vested, end of year | 1,046,582 |
| | $ | 45.84 |
| | 1,110,462 |
| | $ | 42.05 |
| | 943,206 |
| | $ | 29.50 |
|
Employee stock purchase plan
The Company sponsors an employee stock purchase plan (“ESPP”) for all eligible employees. Under the ESPP, employees authorize payroll deductions from 1% to 15% of their eligible compensation to purchase shares of the Company’s
common stock. Under the ESPP, shares of the Company’s common stock may be purchased at the end of each fiscal quarter at 95% of the closing price of the Company’s common stock. A total of 1,684,000 shares of the Company’s common stock are authorized under the ESPP. As of December 31, 2014, a total of 1,477,966 shares were available for issuance under the ESPP. During the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, the Company issued 9,241, 8,962, and 7,748 shares, respectively, under the ESPP at an average price of $46.64, $57.31, and $46.77 per share, respectively. The compensation expense related to the ESPP recorded in the nine months ended December 31, 2014 and 2013, and the fiscal years ended March 31, 2014 and 2013 was not material to the consolidated financial statements.
Valuation assumptions and equity based award activity
As discussed in Note 2, “Summary of significant accounting policies,” determining the estimated fair value of stock-based awards is judgmental in nature and involves the use of significant estimates and assumptions, including the term of the stock-based awards, risk-free interest rates over the vesting period, expected dividend rates, the price volatility of the Company’s shares, and forfeiture rates of the awards.
Stock option valuation
The Company calculates the fair value of all stock option awards, with the exception of the stock options issued with market-based conditions, on the date of grant using the Black-Scholes model. Those stock option awards that have market-based conditions are valued using a Monte Carlo model. The expected term for its stock options is determined through analysis of historical data on employee exercises, vesting periods of awards, and post-vesting employment termination behavior. The risk-free interest rate is based on U.S. Treasury bonds issued with life terms similar to the expected life of the grant. Volatility is calculated based on historical volatility of the daily closing price of the Company’s common stock continuously compounded with a look-back period similar to the terms of the expected life of the grant. The Company has not declared or paid any cash dividends on its common stock since the closing of its initial public offering and does not currently anticipate declaring or paying any cash dividends. The timing and amount of future cash dividends, if any, is periodically evaluated by the Company’s Board of Directors and would depend upon, among other factors, the Company’s earnings, financial condition, cash requirements, and contractual restrictions.
The following average key assumptions were used in the valuation of all stock options granted in each respective period:
|
| | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
Stock option grants: | | | | | |
Risk-free interest rate | 1.53% – 1.75% |
| | 0.34% – 1.71% |
| | 0.43% – 1.15% |
|
Expected lives in years | 5.00 – 5.47 |
| | 3.25 – 5.50 |
| | 3.25 – 5.50 |
|
Expected volatility | 29.8% – 30.9% |
| | 30.4% – 38.0% |
| | 33.2% – 40.7% |
|
Dividend yield | — | % | | — | % | | — | % |
Weighted average exercise price of options granted | 52.28 |
| | 51.71 |
| | 44.00 |
|
Weighted average grant date fair value of options granted | 14.49 |
| | 14.77 |
| | 13.33 |
|
Number of options granted | 1,144,973 |
| | 536,958 |
| | 361,844 |
|
Valuation for restricted stock units
RSUs are valued at the grant date closing price of the Company’s common stock as reported on the NASDAQ Global Select Market.
Valuation for employee stock purchase rights
The value of employee stock purchase rights for shares of stock purchased under the ESPP is determined as the fair market value of the underlying shares on the date of purchase as determined by the closing price of the Company’s common stock as reported on the NASDAQ Global Select Market, less the purchase price, which is 95% of the closing price of the Company’s common stock. The ESPP enrollment begins on the first day of the quarter. Stock purchases occur on the last day of the quarter, with only eligible employee payroll deductions for the period used to calculate the shares purchased. There is no estimate of grant date fair value or estimated forfeitures, since actual compensation expense was recorded in the period on the purchase date. The fair value of employee stock purchase rights is equivalent to a 5% discount of the purchase date closing price.
Forfeitures
Forfeitures are estimated based on historical experience at the time of grant and adjusted, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense is recognized on a straight-line basis, net of an estimated forfeiture rate, for only those shares expected to vest over the requisite service period of the award, which is generally the option vesting term, and can range from six months to four years. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods. The Company analyzes forfeiture rates using four separate groups, one group for members of the Company’s Board of Directors, two separate groups of executives based on seniority, and one group for general employees. In the nine months ended December 31, 2014, the Company decreased its estimated forfeiture rate for one of the executive groups from 5% to 2.5%. Forfeiture rates for the remaining groups are 0%, 1%, and 10% for members of the Company's Board of Directors, one of the groups of executives, and general employees, respectively.
Compensation expense
The Company recognized stock-based compensation expense in the following consolidated statements of operations line items for stock options and RSUs and for shares issued under the Company’s ESPP, for the nine months ended December 31, 2014 and 2013, and for the fiscal years ended March 31, 2014 and 2013 (in thousands, except per share amounts):
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
Stock-based compensation expense included in: | | | | | |
Costs and expenses: | | | | | |
Cost of services | $ | 5,977 |
| | $ | 5,527 |
| | $ | 3,975 |
|
Member relations and marketing | 3,348 |
| | 3,688 |
| | 2,643 |
|
General and administrative | 8,640 |
| | 9,002 |
| | 7,295 |
|
Depreciation and amortization | — |
| | — |
| | — |
|
Total costs and expenses | 17,965 |
| | 18,217 |
| | 13,913 |
|
Operating income | (17,965 | ) | | (18,217 | ) | | (13,913 | ) |
Net (loss) income attributable to common stockholders | $ | (12,515 | ) | | $ | (11,204 | ) | | $ | (8,686 | ) |
Impact on diluted earnings per share | $ | (0.35 | ) | | $ | (0.30 | ) | | $ | (0.24 | ) |
There are no stock-based compensation costs capitalized as part of the cost of an asset.
Stock-based compensation expense by award type is shown below (in thousands):
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
Stock-based compensation expense by award type: | | | | | |
Stock options | $ | 5,431 |
| | $ | 4,846 |
| | $ | 5,000 |
|
Restricted stock units | 12,534 |
| | 13,371 |
| | 8,913 |
|
Total stock-based compensation | $ | 17,965 |
| | $ | 18,217 |
| | $ | 13,913 |
|
As of December 31, 2014, $55.3 million of total unrecognized compensation cost related to stock-based compensation was expected to be recognized over a weighted average period of 3.0 years.
Tax benefits
The benefits of tax deductions in excess of recognized book compensation expense are reported as a financing cash inflow in the consolidated statements of cash flows. Approximately $0.4 million, $19.5 million, and $20.5 million of tax benefits associated with the exercise of employee stock options and RSUs were recorded as cash from financing activities in the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, respectively.
The provision for income taxes consists of the following (in thousands):
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
Current tax expense |
|
| |
|
| |
|
|
Federal | $ | 3,614 |
| | $ | 9,493 |
| | $ | 13,243 |
|
State and local | 1,680 |
| | 1,373 |
| | 3,515 |
|
Foreign | 620 |
| | 547 |
| | 624 |
|
Total current tax expense | $ | 5,914 |
| | $ | 11,413 |
| | $ | 17,382 |
|
Deferred tax (benefit) expense |
|
| |
| | |
Federal | $ | 1,003 |
| | $ | 7,591 |
| | $ | 507 |
|
State and local | (2,086 | ) | | 204 |
| | 134 |
|
Foreign | — |
| | — |
| | — |
|
Total deferred tax (benefit) expense | $ | (1,083 | ) | | $ | 7,795 |
| | $ | 641 |
|
Provision for income taxes | $ | 4,831 |
| | $ | 19,208 |
| | $ | 18,023 |
|
The components of Income before provision for income taxes were as follows (in thousands):
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
U.S. sources | $ | 13,594 |
| | $ | 47,863 |
| | $ | 45,750 |
|
Non-U.S. sources | 2,331 |
| | 2,029 |
| | 2,329 |
|
Total | $ | 15,925 |
| | $ | 49,892 |
| | $ | 48,079 |
|
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:
|
| | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
Statutory U.S. federal income tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
Section 162(m) compensation | 11.7 | % | | 1.6 | % | | 3.4 | % |
State income tax, net of U.S. federal income tax benefit | 7.4 | % | | 6.0 | % | | 5.9 | % |
Tax-exempt interest income | (2.5 | )% | | (1.7 | )% | | (2.0 | )% |
Washington, D.C. QHTC income tax credits | (9.8 | )% | | (4.0 | )% | | (5.4 | )% |
Uncertain Tax Position | 5.4 | % | | — | % | | — | % |
Federal R&D credit - non-current | (25.7 | )% | | — | % | | — | % |
Return to accrual adjustment | 5.9 | % | | — | % | | — | % |
Other permanent differences, net | 2.9 | % | | 1.6 | % | | 0.6 | % |
Effective tax rate on continuing operations | 30.3 | % | | 38.5 | % | | 37.5 | % |
Deferred income taxes are provided for temporary differences between the tax bases of assets and liabilities and their reported amounts on the consolidated financial statements. The tax effect of these temporary differences is presented below (in thousands):
|
| | | | | | | |
| As of | | As of |
| December 31, 2014 | | March 31, 2014 |
Deferred income tax assets (liabilities): | | | |
Washington, D.C. QHTC income tax credits | $ | 11,571 |
| | $ | 11,199 |
|
Federal R&D credits | 3,718 |
| | — |
|
Deferred compensation accrued for financial reporting purposes | 11,228 |
| | 11,692 |
|
Stock-based compensation | 11,350 |
| | 8,942 |
|
Acquired net operating loss carryforwards | 4,909 |
| | 5,444 |
|
Reserve for uncollectible revenue | 3,123 |
| | 2,812 |
|
Book/tax basis difference in investment in unconsolidated entities | 5,141 |
| | 1,677 |
|
Unrealized losses on available-for-sale securities | 39 |
| | 1,270 |
|
Acquired intangibles and goodwill | — |
| | — |
|
Other | 1,591 |
| | 1,628 |
|
Total deferred tax assets | 52,670 |
| | 44,664 |
|
Valuation allowance | (5,141 | ) | | (1,677 | ) |
Total deferred tax assets, net of valuation allowance | 47,529 |
|
| 42,987 |
|
Capitalized software development costs | (29,157 | ) | | (22,659 | ) |
Deferred incentive compensation and other deferred charges | (12,710 | ) | | (9,234 | ) |
Acquired intangibles and goodwill; and acquisition related costs | (118 | ) | | (5,097 | ) |
Depreciation | (548 | ) | | (1,616 | ) |
Other | (156 | ) | | (426 | ) |
Total deferred tax liabilities | (42,689 | ) | | (39,032 | ) |
Net deferred income tax assets | $ | 4,840 |
| | $ | 3,955 |
|
The Company has $4.9 million of U.S. federal and state net operating loss carryforwards available at December 31, 2014, some of which are a result of recent acquisitions. These carryforwards will be used to offset future income but maybe limited by the change in ownership rules in Section 382 of the Internal Revenue Code. These net operating loss carryforwards will begin to expire in 2022. The Company anticipates it will be able to use all of its acquired net operating loss carryforwards. In estimating future tax consequences, the Company generally considers all expected future events in the determination and evaluation of deferred tax assets and liabilities. The Company believes that its estimated future ordinary taxable income will be sufficient for the full realization of its deferred income tax assets other than its investment in unconsolidated subsidiaries which may generate a capital loss. The effect of future changes in existing laws or rates is not considered in the determination and evaluation of deferred tax assets and liabilities until the new tax laws or rates are enacted.
The Company has recorded a deferred tax asset resulting from the book tax basis difference in investment in unconsolidated entities. The Company has recorded a $5.1 million valuation allowance related to this asset.
The Company uses a more-likely-than-not recognition threshold based on the technical merits of the tax position taken for the financial statement recognition and measurement of a tax position. If a tax position does not meet the more-likely-than-not initial recognition threshold, no benefit is recorded in the financial statements. The Company does not currently anticipate that the total amounts of unrecognized tax benefits will significantly change within the next twelve months. The Company classifies interest and penalties on any unrecognized tax benefits as a component of the provision for income taxes. No interest or penalties were recognized in the consolidated statements of operations for the nine months ended December 31, 2014 or the fiscal years ended March 31, 2014 and 2013. The Company files income tax returns in U.S. federal and state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state, and local tax examinations for filings in major tax jurisdictions before 2011.
Deferred U.S. income taxes have not been provided for the portion of the difference between book and tax basis in non-U.S. subsidiaries, which is essentially permanent in duration. Determination of the amount of these taxes is not practicable.
During the transition period ended December 31, 2014, the Company claimed $4.6 million in Federal R&D credits for the 2012, 2013 and 2014 tax years.
Uncertain Tax Positions
The following table summarizes the activity related to our reserve for unrecognized tax positions (in thousands):
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
Balance at beginning of the period | $ | — |
| | $ | — |
| | $ | — |
|
Additions based on tax positions related to the current periods | 497 |
| | — |
| | — |
|
Additions for tax positions of prior periods | 331 |
| | — |
| | — |
|
Positions assumed in acquisition | — |
| | — |
| | — |
|
Reductions for tax positions of prior periods | — |
| | — |
| | — |
|
Reductions for lapse of statute of limitations | — |
| | — |
| | — |
|
Settlements | — |
| | — |
| | — |
|
Balance at end of the period | $ | 828 |
| | $ | — |
| | $ | — |
|
If the Company was able to recognize the uncertain tax positions of $0.8 million, the entire balance would affect the Company’s effective tax rate.
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”) provides regulations that modify the income and franchise tax, sales and use tax, and personal property tax regulations for Qualified High Technology Companies (“QHTC”) doing business in the District of Columbia.
In February 2006, the Company received notification from the Office of Tax and Revenue that its certification as a QHTC under the New E-conomy Transformation Act of 2000 had been accepted effective as of January 1, 2004. As a QHTC, the Company’s Washington, D.C. statutory income tax rate was 0.0% through calendar year 2008 and 6.0% thereafter, compared to 9.975% prior to this qualification. Under that Act, the Company is also eligible for certain Washington, D.C. income tax credits and other benefits. As of December 31, 2014, the Company has $17.8 million of Washington, D.C. tax credits with expiration dates ranging from 2017 to 2024.
Although not officially enacted as of the filing of this document because the required Congressional review period has not yet expired, new legislation has been passed by the District of Columbia City Council that would affect the way that the Company pays income taxes on a go-forward basis. The Company is still analyzing the full impact of these law changes; however, if enacted, it is expected that the Company would recognize a reduction to write off substantially all of its District of Columbia deferred tax asset balances during the first quarter of 2015.
| |
Note 16. | Commitments and contingencies |
Operating leases
The Company leases approximately 73% of its headquarters space under an operating lease that expires in 2019. Leasehold improvements related to leases are depreciated over the term of the lease and totaled approximately $35.7 million, net, and $25.3 million, net, as of December 31, 2014 and March 31, 2014, respectively. The terms of the lease contain provisions for rental escalation, and the Company is required to pay its portion of executory costs such as taxes, insurance, and operating expenses. The remaining space in the headquarters facility is under a sublease expiring in 2017. The sublease contains provisions for annual rental escalations with no obligation to pay additional executory costs noted above.
The Company leases office space under operating leases in Houston, Texas; Birmingham, Alabama; Austin, Texas; Nashville, Tennessee; Vernon Hills, Illinois; Evanston, Illinois; San Francisco, California; Ann Arbor, Michigan; Plymouth Meeting, Pennsylvania; Tucson, Arizona; and London, England. The Company also leases office space in Chennai, India through its Indian subsidiary, ABCO Advisory Services India Private Ltd. The lease expiration dates are July 2018 for the Alabama lease, March 2021 for the Texas leases, April 2020 for the Tennessee leases, March 2015 for the Illinois leases, August 2017 for the California lease, March 2015 for the Michigan lease, September 2016 for the Pennsylvania lease, August 2015 for the Arizona lease, July 2015 for the England lease, and November 2016 for the India lease.
The Company recognized rental and executory expenses of $13.2 million , $17.4 million, and $14.2 million in the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, related to these leases. The Company subleases office space in Nashville, Tennessee. The total of minimum rentals to be received in the future under non-cancelable subleases as of December 31, 2014 is $0.5 million.
The following table details the future minimum lease payments under the Company’s current leases, excluding rental escalation and executory costs (in thousands):
|
| | | |
Year Ending December 31, | |
2015 | 17,200 |
|
2016 | 17,570 |
|
2017 | 15,066 |
|
2018 | 13,630 |
|
2019 | 7,701 |
|
Thereafter | 7,550 |
|
Total | $ | 78,717 |
|
Purchase obligation
The Company has entered into a non-cancelable agreement for the purchase of data. As of December 31, 2014, the Company’s minimum obligation in connection with this agreement extends through May 2019. The minimum payments expected to be made under this agreement for each of the following four fiscal years ending December 31, 2015 through 2018 are: $5.0 million, $3.0 million, $2.0 million, and $1.0 million, respectively.
Benefit plan
The Company sponsors a defined contribution 401(k) plan (the “401(k) Plan”) for all employees who have reached the age of 21. The Company provides discretionary matching contributions in the range of 0% to 100%, which percentage is determined by the Company after the end of the applicable plan year, of an employee’s contribution up to a maximum of 4% of base salary. Contributions to the 401(k) Plan for the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013, were approximately $0.0 million, $4.6 million, and $2.7 million, respectively.
Litigation
From time to time, the Company is subject to ordinary routine litigation incidental to its normal business operations. As of December 31, 2014, the Company was not a party to, and its property was not subject to, any material legal proceedings.
| |
Note 17. | Segment and geographic areas |
Operating segments are defined as components of an enterprise for which separate financial information is available and regularly evaluated by the chief operating decision maker, who is the chief executive officer, in deciding how to allocate resources and assessing performance. Under this definition, the Company has one operating segment as of December 31, 2014. Over the past few years, the Company has completed several acquisitions. These acquisitions have allowed the Company to expand its existing offerings and enhance membership services. The Company’s business operates in one operating segment because the Company’s chief operating decision maker evaluates the Company’s financial information and resources and assesses the performance of these resources on a consolidated basis. Since the Company operates in one operating segment, all required financial segment information can be found in the consolidated financial statements.
Substantially all of the Company’s identifiable assets are located in the United States. The following table sets forth revenue information for each geographic area for the nine months ended December 31, 2014 and the fiscal years ended March 31, 2014 and 2013 (in thousands):
|
| | | | | | | | | | | |
| Nine Months Ended | | Year Ended March 31, |
| December 31, 2014 | | 2014 | | 2013 |
United States | $ | 419,420 |
| | $ | 504,211 |
| | $ | 434,640 |
|
Other countries | 16,808 |
| | 16,385 |
| | 16,197 |
|
Total revenue | $ | 436,228 |
| | $ | 520,596 |
| | $ | 450,837 |
|
Note 18.Quarterly financial data (unaudited)
Unaudited summarized financial data by quarter for nine months ended December 31, 2014 and the fiscal year ended March 31, 2014 are as follows (in thousands, except per share amounts):
|
| | | | | | | | | | | | | | | |
| | | Period Ended December 31, 2014 Quarter Ended |
| | | June 30, | | September 30, | | December 31, |
Revenue | | | $ | 141,820 |
| | $ | 144,220 |
| | $ | 150,188 |
|
Operating income | | | $ | 9,236 |
| | $ | 9,098 |
| | $ | (1,082 | ) |
(Loss) income before provision for income taxes and equity in loss of unconsolidated entities | | | $ | 9,946 |
| | $ | 8,247 |
| | $ | (2,268 | ) |
Net income attributed to common stockholders | | | $ | (3,177 | ) | | $ | 6,490 |
| | $ | (5,012 | ) |
Earnings per share: | | | | | | | |
Basic | | | (0.09 | ) | | 0.18 |
| | (0.14 | ) |
Diluted | | | (0.09 | ) | | 0.18 |
| | (0.14 | ) |
| | | | | | | |
| Fiscal 2014 Quarter Ended |
| June 30, | | September 30, | | December 31, | | March 31, |
Revenue | $ | 123,216 |
| | $ | 128,341 |
| | $ | 131,038 |
| | $ | 138,001 |
|
Operating income | $ | 10,738 |
| | $ | 11,390 |
| | $ | 7,875 |
| | $ | 17,183 |
|
Income from continuing operations before provision for income taxes and equity in loss of unconsolidated entities | $ | 11,261 |
| | $ | 12,481 |
| | $ | 8,235 |
| | $ | 17,915 |
|
Net income attributable to common stockholders | $ | 3,692 |
| | $ | 9,002 |
| | $ | 3,771 |
| | $ | 8,287 |
|
Earnings per share: | | | | | | | |
Basic | 0.10 |
| | 0.25 |
| | 0.10 |
| | 0.23 |
|
Diluted | 0.10 |
| | 0.24 |
| | 0.10 |
| | 0.22 |
|
Note 19.Subsequent events
Acquisition of Royall
On January 9, 2015, the Company completed its acquisition from Royall Holdings, LLC ("the Seller") of 100% of the outstanding capital stock of Royall, a higher education industry leader in strategic, data-driven student engagement and enrollment management solutions.
Total consideration consisted of the following (in thousands):
|
| | | |
| | |
Net cash paid (1) | $ | 743,849 |
|
Fair value of equity issued | | 121,224 |
|
Total | $ | 865,073 |
|
______
(1) Net of estimated working capital adjustment of $6,151.
On January 9, 2015, in connection with the completion of the acquisition of Royall, the Company entered into a credit agreement with various lenders. Under the terms of the credit agreement, lenders provided the Company with $775 million of senior secured credit facilities for application to the acquisition of Royall and the Company’s corporate needs after the closing of the Royall acquisition. The credit facilities consisted of a term loan facility in the principal amount of $725 million, maturing on January 9, 2022, and a revolving credit facility under which up to $50 million principal amount of borrowings and other credit extensions could be outstanding at any time, maturing on January 9, 2020.
Amounts drawn under the term facility generally bore interest, payable quarterly, at an annual rate calculated, at the Company’s option, on the basis of either (a) an alternate base rate plus an initial margin of 3.00% or (b) the applicable London interbank offered rate (subject to a 1.00% floor) plus an initial margin of 4.00%, subject in each case to margin reductions based on the Company's total leverage ratio from time to time. The interest rate for the term loan facility as of January 9, 2015 was 5.00%. The revolving facility was undrawn at the facility closing date. All $725 million of term loans available under the term loan facility were drawn at the closing of the acquisition to pay the majority of the cash purchase price for the Royall capital stock. Total original issue discount of $21.8 million and deferred financing fees of $2.8 million were recorded related to this credit agreement.
The fair value of equity issued was approximately $121.2 million based on 2,428,364 shares of the Company's common stock valued at $49.92 per share, which was the closing price on January 9, 2015 as reported on the NASDAQ Global Select Market. The 2,428,364 shares issued to the Seller was the minimum number of shares that could have been issued under the pricing collar set forth in the purchase agreement, since the volume-weighted average trading price of the Company’s common stock on the NASDAQ Global Select Market for the 15 consecutive trading days ending on (and including) January 7, 2015 was higher than the pricing collar ceiling price of $41.18.
The Company has not yet finalized the allocation of the Royall’s purchase consideration to assets acquired and liabilities assumed. The total purchase price has been allocated on a preliminary basis to identifiable assets acquired and liabilities assumed based upon valuation procedures performed to-date. As of the date of this report, the valuation studies necessary to determine the fair market value of the assets acquired and liabilities assumed and the related allocations of purchase price are preliminary. The Company's judgments used to determine the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially affect the Company’s results of operations. A final determination of fair values will be based on the actual identifiable tangible and intangible assets acquired and liabilities assumed that existed as of the closing date of the acquisition. The final purchase price allocation will be based, in part, on third-party appraisals and may be different from the amounts outlined below. The allocation of the purchase price and the estimates and assumptions are subject to change until the Company completes all of the necessary valuations and income tax analysis, which will be no longer than one year from the acquisition date.
The fair value and useful lives assigned to Royall’s trade names, technology, and customer relationships intangible assets have been estimated based on preliminary valuation studies utilizing widely accepted valuation methodologies and principles.
The preliminary purchase price allocation to other identifiable intangible assets is as follows (in thousands):
|
| | | | | |
| Estimated Average Useful Lives (years) | | Estimated Fair Value |
Trade name | 10 | | $ | 10,000 |
|
Technology - database and analytics | 4 | | 8,000 |
|
Technology - developed software | 11 | | 30,000 |
|
Customer relationships | 16 | | 234,000 |
|
Total | | | $ | 282,000 |
|
A preliminary purchase price allocation resulting from the acquisition of Royall is outlined below (in thousands):
|
| | | | |
| | As of January 9, 2015 |
Consideration paid for the acquisition: | | $ | 865,073 |
|
| | |
Allocated to: | | |
Membership fees receivable, net | | 30,590 |
|
Prepaid expenses and other current assets | | 5,291 |
|
Property and equipment, net | | 6,205 |
|
Intangible assets, net | | 282,000 |
|
Current taxes payable | | (1,374 | ) |
Deferred revenue, current | | (13,204 | ) |
Accounts payable and accrued liabilities | | (9,231 | ) |
Deferred income taxes, net of current portion | | (91,277 | ) |
Preliminary fair value of net assets acquired | | $ | 209,000 |
|
Preliminary allocation to goodwill | | $ | 656,073 |
|
The preliminary goodwill is primarily attributable to the assembled workforce of Royall and synergies and economies of scale expected from combining the operations of the Company and Royall. The goodwill recognized is not deductible for tax purposes.
Estimated acquisition-related costs of $9.7 million are expected to be incurred and included in general and administrative costs in the Company’s consolidated statements of operations. Of this amount, $3.3 million was recognized in the nine months ended December 31, 2014 and $6.4 million will be recognized in the first quarter of 2015.
Royall inducement plan
On January 9, 2015, in conjunction with the Royall acquisition, the Company created The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees to enable the Company to award options and restricted stock units to persons employed by Royall as an inducement to employees entering into and continuing employment with the Company or its current or future subsidiaries upon consummation of the Royall acquisition. Under the terms of this plan, the aggregate number of shares issuable pursuant to all awards may not exceed 1,906,666 and consisted of performance-based stock options to purchase an aggregate of 1,760,000 shares of common stock, and performance-based restricted stock units for an aggregate of 146,666 shares of common stock. Both the performance-based stock options and performance-based restricted stock units are also subject to service conditions.
Stock options granted under the inducement plan have an exercise price equal to $49.92, the closing price of The Advisory Board Company’s common stock on January 9, 2015 as reported on the NASDAQ Global Select Market. The stock options have a seven year term and are eligible to vest, if performance-based vesting criteria are satisfied, in installments commencing in January 2017 and ending in January 2020. The restricted stock units were valued at $49.92 and are also eligible to vest in installments commencing in January 2017 and ending in January 2020, subject to satisfaction of performance-based vesting criteria. The vesting criteria in both cases are based on performance of the Royall programs and services. The aggregate grant date fair value of the performance-based stock options, assuming all performance targets are met, is estimated to be approximately $20.6 million. The aggregate grant date fair value of the performance-based restricted stock units, assuming all performance targets are met, is estimated at approximately $7.3 million. Based on the current estimates of future performance against the targets, the Company currently expects 50% of the performance-based stock options and restricted stock units to vest, respectively.
The Company estimates that Royall will achieve 70-99% of the performance targets. The actual stock-based compensation expense the Company will recognize is dependent upon, but not limited to, Royall satisfying certain performance conditions and continued employment of award recipients at the time performance conditions are met. The actual amount the Company will recognize may increase or decrease based on the actual results of Royall and employment conditions at the time performance conditions are met. The following average key assumptions were used in the valuation of the stock options issued to Royall employees using the Black-Scholes model:
Risk-free interest rate: 0.69% -1.67%
Expected lives in years: 2-5
Expected volatility: 30.10%-32.85%
Dividend yield: 0%
Estimated forfeitures: 5.2%
Fair value of stock options issued: $9.45- $15.16
Equity offering
On January 21, 2015, the Company closed the registered public offering of 3,650,000 shares of common stock by the Company pursuant to registration rights granted by the Company to the Seller in connection with the acquisition of Royall, and 1,755,000 shares of common stock by the Seller that were issued to the Seller as the equity component of the acquisition consideration. The shares were sold at a price to public of $43.00 per share, less an underwriting discount of $1.935 per share, for a net per share purchase price of $41.065. The net proceeds received by the Company were approximately $149.9 million after deducting the underwriting discount. The Company did not receive any proceeds from the sale by the Seller of the Company's common stock. The Company used the net proceeds from the offering to repay approximately $149.9 million principal amount of loans outstanding under its $725 million senior secured term loan facility. This payment resulted in a debt extinguishment expense of $4.5 million related to original issue discount and $0.3 million related to deferred financing fees.
Refinancing of credit facility
On February 6, 2015, the Company entered into a new credit agreement with various lenders. The new credit agreement consists of a five-year senior secured term loan facility in the original principal amount of $575 million and a five-year senior secured revolving credit facility under which up to $100 million principal amount of borrowings and other credit extensions may be outstanding at any time. The proceeds of the term loan were used to repay and retire all loans outstanding under the term loan facility obtained on January 9, 2015. The revolving credit facility was not drawn down on February 6, 2015. Amounts drawn under the term loan and revolving credit facilities bear interest, payable quarterly, at an annual rate calculated, at the Company’s option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate plus an initial margin of 2.75%, subject in each case to margin reductions based on the Company’s total leverage ratio from time to time. At the time of issuance, the stated interest rate on the new borrowings was 3.01%. The lenders under this new credit agreement included the lenders from the January 9, 2015 agreement as well as new lenders. For those lenders to this agreement that also participated in the January 9, 2015 agreement, the Company concluded that the new credit agreement represented a modification of the debt. As a modification, the original issue discount and deferred financing fees associated with the original borrowings carried forward to the new borrowings. Any fees paid to or received from these lenders are recorded as an adjustment to the original issue discount. Any fees paid to third parties are recorded as expense. Further, because the level of participation in the borrowings by the lenders under the original credit agreement was significantly less under the new agreement than under the old agreement, the Company will write off a portion of the original issue discount and deferred financing fees related to the old agreement. Following this write-off, the Company will record a loss on the refinancing of $12.4 million in the first quarter of 2015 and have original issue discount of $3.9 million and deferred financing fees of $1.1 million related to the February 6, 2015 credit facilities. Including stated interest of 3.01% and amortization of original issue discount and deferred financing fees, the effective interest rate on the borrowings under the new credit agreement was 3.2% at the time of issuance.
Pro forma financial statements
The impact of the Royall acquisition and the related debt financing and refinancing and common stock issuance is reflected in the following unaudited pro forma consolidated balance sheet as if such transactions occurred on December 31, 2014, and in the following unaudited pro forma condensed combined statement of operations for the nine months ended December 31, 2014 as if such transactions occurred on April 1, 2014. The following unaudited pro forma condensed combined financial information is based upon a preliminary purchase price allocation for Royall as outlined above. Differences between the preliminary and final purchase price allocation could be significant.
The pro forma information has been prepared with the following considerations:
| |
(1) | The unaudited pro forma condensed consolidated financial information has been prepared using the acquisition method of accounting under existing GAAP. The Company is the acquirer for accounting purposes. |
| |
(2) | The pro forma combined financial information does not reflect any operating cost synergy savings that the combined company may achieve as a result of the acquisition, the costs necessary to achieve these operating cost synergy savings, or additional charges necessary as a result of the integration. |
|
| | | | |
THE ADVISORY BOARD COMPANY AND SUBSIDIARIES |
UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET |
AS OF DECEMBER 31, 2014 |
(In thousands, except share and per share amounts) |
| | |
| | Total Pro Forma |
ASSETS | | |
Current assets: | | |
Cash and cash equivalents | | $ | 37,565 |
|
Marketable securities, current | | — |
|
Membership fees receivable, net | | 557,373 |
|
Prepaid expenses and other current assets | | 27,366 |
|
Deferred income taxes, current | | 13,622 |
|
Total current assets | | 635,926 |
|
Property and equipment, net | | 141,339 |
|
Intangible assets, net | | 320,973 |
|
Deferred incentive compensation and other charges | | 86,045 |
|
Marketable securities, net of current portion | | — |
|
Goodwill | | 863,907 |
|
Investments in and advances to unconsolidated entities | | 9,316 |
|
Other non-current assets | | 6,498 |
|
Total assets | | $ | 2,064,004 |
|
| | |
LIABILITIES AND STOCKHOLDERS' EQUITY | | |
Current liabilities: | | |
Deferred revenue, current | | $ | 513,591 |
|
Accounts payable and accrued liabilities | | 84,290 |
|
Accrued incentive compensation | | 32,073 |
|
Current maturities of note payable | | 7,188 |
|
Total current liabilities | | 637,142 |
|
Deferred revenue, net of current portion | | 167,014 |
|
Deferred income taxes, net of current portion | | 103,147 |
|
Notes payable, less current portion | | 563,907 |
|
Other long-term liabilities | | 15,304 |
|
Total liabilities | | 1,486,514 |
|
| | |
Redeemable noncontrolling interest | | — |
|
| | |
The Advisory Board Company's stockholders' equity: | | |
Preferred stock, par value $0.01; 5,000,000 shares authorized, zero shares issued and outstanding | | — |
|
Common stock, par value $0.01; 135,000,000 share authorized, 42,166,118 shares issued and outstanding as of December 31, 2014 on a pro forma basis | | 421 |
|
Additional paid-in capital | | 713,579 |
|
Accumulated deficit | | (136,510 | ) |
Total stockholders' equity (deficit) controlling interest | | 577,490 |
|
Equity attributable to noncontrolling interest | | — |
|
Total stockholders' equity (deficit) | | 577,490 |
|
Total liabilities and stockholders' equity (deficit) | | $ | 2,064,004 |
|
|
| | | | | |
| | Nine Months Ended |
| | December 31, 2014 |
| | (unaudited) |
| | (pro forma) |
Pro forma revenue | | $ | 510,719 |
| |
Pro forma net loss attributable to common stockholders | | (19,959 | ) | |
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
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-15(b) as of December 31, 2014. 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. 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, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2014, our disclosure controls and procedures were effective.
No changes in our internal control over financial reporting occurred during the last three months of the nine months ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Consistent with guidance issued by the Securities and Exchange Commission that an assessment of internal control over financial reporting of a recently acquired business may be omitted from management's evaluation, management is excluding from its assessment Clinovations LLC, which we acquired on November 7, 2014, and which accounted for less than 1% of our total and net assets, as of December 31, 2014 and less than 1% and 5% of our revenues and net income, respectively, for the nine months then ended.
See Item 8, “Financial Statements and Supplementary Data,” of this transition report on Form 10-K for the Report of Management’s Assessment of Internal Control Over Financial Reporting and the Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting.
Item 9B. Other Information.
None.
PART III
Item 10. Directors, Executive Officers, and Corporate Governance.
See “Executive Officers” in Part I, Item 1 of this transition report on Form 10-K for information about our executive officers, which is incorporated by reference in this Item 10. Other information required by this Item 10 is incorporated herein by reference to our definitive proxy statement for our 2015 annual meeting of stockholders, referred to as the “ 2015 proxy statement,” which we will file with the SEC on or before 120 days after our transition period ended December 31, 2014, and which appears in the 2015 proxy statement, including under the captions “Proposal No. 1—Election of Directors,” “Board Corporate Governance Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
We have adopted a code of ethics for our senior financial officers 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. The code of ethics for our senior financial officers is available to the public in the “The Firm—Investor Relations—Governance” section of our website at www.advisory.com. Any person may request a copy of the code of ethics for our senior financial officers, without charge, by writing to us at The Advisory Board Company, 2445 M Street, N.W., Washington, D.C. 20037, Attention: Corporate Secretary. We intend to satisfy the SEC’s disclosure requirements regarding amendments to, or waivers of, the code of ethics for our senior financial officers by posting such information on our website.
Item 11. Executive Compensation.
Information required by this Item 11 is incorporated herein by reference to the 2015 proxy statement, including the information in the 2015 proxy statement appearing under the captions “Board Corporate Governance Matters,” “Compensation Committee Report on Executive Compensation,” “Compensation Discussion and Analysis,” “Executive Compensation” and “Potential Payments Upon Termination of Employment or Change of Control.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information required by this Item 12 is incorporated herein by reference to the 2015 proxy statement, including the information in the 2015 proxy statement appearing under the captions “Security Ownership” and “Equity Compensation Plan Information.”
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information required by this Item 13 is incorporated herein by reference to the 2015 proxy statement, including the information in the 2015 proxy statement appearing under the caption “Board Corporate Governance Matters.”
Item 14. Principal Accounting Fees and Services.
Information required by this Item 14 is incorporated herein by reference to the 2015 proxy statement, including the information in the 2015 proxy statement appearing under the caption “Proposal No. 2—Ratification of the Selection of Ernst & Young LLP as Independent Registered Public Accounting Firm for the Fiscal Year Ending December 31, 2015.”
Part IV
Item 15. Exhibits, Financial Statement Schedules.
(a) The following documents are filed as part of this report:
(1) The following financial statements of the registrant and report of independent registered public accounting firm are included in Item 8 hereof:
Report of Independent Registered Public Accounting Firm on the Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm on Evolent Health LLC
Consolidated Balance Sheets as of December 31, 2014 and March 31, 2014
Consolidated Statements of Operations for the nine-month periods ended December 31, 2014 and 2013 and years ended March 31, 2014 and 2013
Consolidated Statements of Comprehensive Income for the nine-month periods ended December 31, 2014 and 2013 and years ended March 31, 2014 and 2013
Consolidated Statements of Changes in Stockholders’ Equity for the nine-month period ended December 31, 2014 and years ended March 31, 2014 and 2013
Consolidated Statements of Cash Flows for the nine-month periods ended December 31, 2014 and 2013 and years ended March 31, 2014 and 2013
Notes to Consolidated Financial Statements.
(2) Except as provided below, all financial statement 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
(3) In accordance with Rule 3-09 of Regulation S-X, the audited financial statements as of December 31, 2014 and 2013, and for the three years ended December 31, 2014, of Evolent Health LLC, an equity investee, are filed as an exhibit to this transition report on Form 10-K. The audited financial statements of Evolent Health LLC include audited financial statements for the equity investee's most recent fiscal year, which ended on December 31, 2014. The Company's consolidated statements of operations included in Item 8 reflect nine months of the Company's proportionate share of Evolent Health LLC's operations for the transition period.
(4) The following exhibits are either provided with this Form 10-K or are incorporated herein by reference:
|
| | |
Exhibit Number | | Description of Exhibit |
| | |
2.1 | | Stock Purchase Agreement, dated as of December 10, 2014, by and among Royall Holdings, LLC, Royall Acquisition Co. and The Advisory Board Company (the “Company” or the "Registrant"). Incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission (the “Commission”) on December 11, 2014. |
| |
3.1 | | Restated Certificate of Incorporation of the Company. Incorporated by reference to Exhibit 3.1 of the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2012. |
| |
3.2 | | Amended and Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 14, 2007. |
| |
4.1 | | Form of Common Stock Certificate. Incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-1/A filed with the Commission on October 29, 2001. |
| |
10.1* | | The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan. Incorporated by reference to Exhibit 10.13 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.2* | | Form of Term Sheet and Standard Terms and Conditions pursuant to The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan. Incorporated by reference to Exhibit 10.14 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.3* | | The Advisory Board Company Directors’ Stock Plan. Incorporated by reference to Exhibit 10.15 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.4* | | Form of Term Sheet and Standard Terms and Conditions for Director Non-qualified Stock Options pursuant to The Advisory Board Company Directors’ Stock Plan. Incorporated by reference to Exhibit 10.16 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.5 | | Form of Indemnity Agreement between the Company and certain officers, directors and employees. Incorporated by reference to Exhibit 10.33 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.6 | | Form of Indemnification Agreement between the Company and certain officers, directors and employees. Incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009. |
| |
10.7* | | Employee Stock Purchase Plan. Incorporated by reference to Exhibit 10.34 of the Company’s Registration Statement on Form S-1/A filed with the Commission on October 29, 2001. |
| |
10.8* | | The Advisory Board Company 2005 Stock Incentive Plan. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 17, 2005. |
| |
10.9* | | Form of Standard Terms and Conditions for Restricted Stock Units pursuant to The Advisory Board Company 2005 Stock Incentive Plan. Incorporated by reference to Exhibit 10.39 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2006. |
|
| | |
Exhibit Number | | Description of Exhibit |
| |
10.10* | | Form of Restricted Stock Unit Award Agreement pursuant to The Advisory Board Company 2005 Stock Incentive Plan. Incorporated by reference to Exhibit 10.40 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2006. |
| |
10.11* | | The Advisory Board Company 2006 Stock Incentive Plan. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 17, 2006. |
| |
10.12* | | Form of Restricted Stock Award Agreement pursuant to The Advisory Board Company 2005 and 2006 Stock Incentive Plans. Incorporated by reference to Exhibit 10.3 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008. |
| |
10.13* | | Form of Award Agreement for Non-qualified Stock Options pursuant to The Advisory Board Company 2005 and 2006 Stock Incentive Plans. Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for quarter ended September 30, 2008. |
| |
10.14* | | The Advisory Board Company Amended and Restated 2009 Stock Incentive Plan. Incorporated by reference to Appendix A to the Definitive Proxy Statement of the Company filed on Schedule 14A with the Commission on July 26, 2013. |
| |
10.15* | | Form of Award Agreement for Restricted Stock Units pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on September 16, 2009. |
| |
10.16* | | Form of Award Agreement for Qualified Stock Options pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on September 16, 2009. |
| |
10.17* | | Form of Award Agreement for Non-Qualified Stock Options pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on September 16, 2009. |
| |
10.18* | | 2014 Form of Award Agreement for Non-Qualified Stock Options for certain employees pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.18 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2014. |
| | |
10.1* | | Employment Agreement, dated as of September 12, 2008, between the Company and Frank J. Williams. Incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008. |
| |
10.20* | | Amended and Restated Employment Agreement, entered into as of November 3, 2010, between the Company and Frank J. Williams. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 9, 2010. |
| |
10.21* | | Amended and Restated Employment Agreement, dated as of April 3, 2013, between the Company and Robert W. Musslewhite. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on April 8, 2013. |
| |
10.22* | | Amended and Restated Employment Agreement, dated as of April 3, 2013, between the Company and David L. Felsenthal. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on April 8, 2013. |
| |
10.23* | | Executive Nonqualified Excess Plan of The Advisory Board Company, effective May 1, 2013. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on April 8, 2013. |
| |
10.24 | | Agreement of Lease, dated October 20, 2003, between the Company and 2445 M Street Property LLC. Incorporated by reference to Exhibit 10.37 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003. |
| |
10.25 | | Agreement to Commercial Note and attachments thereto, dated November 7, 2006, between SunTrust Bank and the Company. Incorporated by reference to Exhibit 10.34 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. |
| | |
|
| | |
Exhibit Number | | Description of Exhibit |
| | |
10.26 | | Investment Property Security Agreement, dated as of November 7, 2006, by and between SunTrust Bank, Merrill Lynch and the Company. Incorporated by reference to Exhibit 10.35 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. |
| |
10.27 | | Collaboration Agreement, dated as of February 6, 2007, between The Corporate Executive Board Company and the Company (the “Collaboration Agreement”). Incorporated by reference to Exhibit 10.42 of the Company’s Annual Report on Form 10-K filed for the fiscal year ended March 31, 2007. On May 27, 2008, the Commission granted confidential treatment with respect to certain portions of the Collaboration Agreement. |
| |
10.28 | | Letter agreement, dated February 4, 2010, between the Company and The Corporate Executive Board Company concerning the Collaboration Agreement, dated February 6, 2007. Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended December 30, 2009. |
| |
10.29 | | Letter agreement, dated November 7, 2011, between the Company and The Corporate Executive Board Company concerning the Collaboration Agreement, dated February 6, 2007. Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011. |
| | |
10.30 | | Letter agreement, dated February 5, 2014, between the Company and The Corporate Executive Board Company concerning the Collaboration Agreement, dated February 6, 2007. Incorporated by reference to Exhibit 10.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2013. |
| |
10.31 | | Credit Agreement, dated as of July 30, 2012, among the Company, the lenders party thereto from time to time, JPMorgan Chase Bank, N.A., as administrative agent (the “Administrative Agent”) and the other agents party thereto. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on August 3, 2012. |
| |
10.32 | | Guaranty, dated as of July 30, 2012, by Advisory Board Investments, Inc. in favor of the Administrative Agent. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on August 3, 2012. |
| |
10.33 | | Pledge and Security Agreement, dated as of July 30, 2012, among the Company, Advisory Board Investments, Inc., and the Administrative Agent. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on August 3, 2012. |
| | |
10.34
| | Financing Commitment Agreement, dated December 10, 2014, among the Company, J.P. Morgan Securities LLC, JPMorgan Chase Bank, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Bank of America, N.A. Filed herewith. |
| | |
10.35
| | Credit Agreement, dated as of January 9, 2015, among the Company, the Lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, and the other parties thereto. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
| | |
10.36
| | Pledge and Security Agreement, entered into as of January 9, 2015, among the Company and the Subsidiaries of the Company party thereto, as Grantors, and JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
| | |
10.37
| | Guaranty made as of January 9, 2015 by the Subsidiaries of the Company party thereto in favor of JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
| | |
10.38
| | Registration Rights and Governance Agreement, dated as of January 9, 2015, among the Company and Royall Holdings, LLC. Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
| | |
10.39
| | The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees. Incorporated by reference to Exhibit 4.4 of the Company’s Registration Statement on Form S-8 filed with the Commission on February 9, 2015. |
| | |
10.40
| | Form of Award Agreement for Restricted Stock Units pursuant to The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees. Filed herewith. |
| | |
10.41
| | Form of Award Agreement for Non-Qualified Stock Options pursuant to The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees. Filed herewith. |
| | |
10.42
| | Credit Agreement, dated as of February 6, 2015, among the Company, the Lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, and the other parties thereto. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on February 10, 2015. |
| | |
|
| | |
Exhibit
Number | | Description of Exhibit |
| | |
10.43
| | Pledge and Security Agreement, entered into as of February 6, 2015, among the Company and the Subsidiaries of the Company party thereto, as Grantors, and JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on February 10, 2015. |
| | |
10.44
| | Guaranty made as of February 6, 2015 by the Subsidiaries of the Company party thereto in favor of JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on February 10, 2015. |
| | |
21.1 | | Subsidiaries of the Registrant. Filed herewith. |
| |
23.1 | | Consent of Independent Registered Public Accounting Firm with respect to the consolidated financial statements of the Company. Filed herewith. |
| |
23.2 | | Consent of Independent Auditor with respect to the financial statements of Evolent Health LLC. Filed herewith. |
| |
31.1 | | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended. Filed herewith. |
| |
31.2 | | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended. Filed herewith. |
| |
32.1 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. Filed herewith. |
| |
99.1 | | Financial statements as of December 31, 2014 and 2013, and for the three years ended December 31, 2014, of Evolent Health LLC. Filed herewith. |
| | |
101 | | XBRL (Extensible Business Reporting Language). The following financial statements from the Company’s Transition Report on Form 10-K for the period ended December 31, 2014, formatted in XBRL: (i) Consolidated Balance Sheets (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements. |
|
| |
* | Management contracts or compensation plans or arrangements in which directors or executive officers participate. |
THE ADVISORY BOARD COMPANY
SCHEDULE II—Valuation and Qualifying Accounts
(In thousands)
|
| | | | | | | | | | | | | | | | | | | |
| Balance at Beginning of Year | | Additions Charged to Revenue | | Additions Charged to Other Accounts | | Deductions From Reserve | | Balance at End of Year |
Year ended March 31, 2013 Allowance for uncollectible revenue | $ | 5,540 |
| | $ | 5,685 |
| | $ | — |
| | $ | 5,459 |
| | $ | 5,766 |
|
Year ended March 31, 2014 Allowance for uncollectible revenue | $ | 5,766 |
| | $ | 8,011 |
| | $ | — |
| | $ | 6,927 |
| | $ | 6,850 |
|
Nine months ended December 31, 2014 Allowance for uncollectible revenue | $ | 6,850 |
| | $ | 8,938 |
| | $ | — |
| | $ | 8,258 |
| | $ | 7,530 |
|
SIGNATURES
Pursuant to the requirements of Section 13 or 15(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.
|
| | | | |
| | | | |
| | | | The Advisory Board Company |
| | |
Date: March 4, 2015 | | | | /s/ Robert W. Musslewhite |
| | |
| | | | Robert W. Musslewhite, |
| | | | Chief Executive Officer and Chairman |
Pursuant to the requirements of the Securities Exchange 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/ Robert W. Musslewhite | | Chief Executive Officer and Chairman | | March 4, 2015 |
Robert W. Musslewhite | | (Principal Executive Officer) | | |
| | |
/s/ Michael T. Kirshbaum | | Chief Financial Officer and Treasurer (Principal Financial Officer and Principal Accounting Officer) | | March 4, 2015 |
Michael T. Kirshbaum | | | |
| | |
/s/ Sanju K. Bansal | | Director | | March 4, 2015 |
Sanju K. Bansal | | | | |
| | |
/s/ David L. Felsenthal | | Director | | March 4, 2015 |
David L. Felsenthal | | | | |
| | |
/s/ Peter J. Grua | | Director | | March 4, 2015 |
Peter J. Grua | | | | |
| | | | |
/s/ Nancy Killefer | | Director | | March 4, 2015 |
Nancy Killefer | | | | |
| | |
/s/ Kelt Kindick | | Lead Director | | March 4, 2015 |
Kelt Kindick | | | | |
| | |
/s/ Mark R. Neaman | | Director | | March 4, 2015 |
Mark R. Neaman | | | | |
| | |
/s/ Leon D. Shapiro | | Director | | March 4, 2015 |
Leon D. Shapiro | | | | |
| | |
/s/ Frank J. Williams | | Vice Chairman | | March 4, 2015 |
Frank J. Williams | | | | |
| | |
/s/ LeAnne M. Zumwalt | | Director | | March 4, 2015 |
LeAnne M. Zumwalt | | | | |
INDEX TO EXHIBITS
|
| | |
Exhibit Number | | Description of Exhibit |
| | |
2.1 | | Stock Purchase Agreement, dated as of December 10, 2014, by and among Royall Holdings, LLC, Royall Acquisition Co. and The Advisory Board Company (the “Company” or the "Registrant"). Incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission (the “Commission”) on December 11, 2014. |
| |
3.1 | | Restated Certificate of Incorporation of the Company. Incorporated by reference to Exhibit 3.1 of the Quarterly Report on Form 10-Q of the Company for the quarter ended September 30, 2012. |
| |
3.2 | | Amended and Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 14, 2007. |
| |
4.1 | | Form of Common Stock Certificate. Incorporated by reference to Exhibit 4.1 of the Company’s Registration Statement on Form S-1/A filed with the Commission on October 29, 2001. |
| |
10.1* | | The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan. Incorporated by reference to Exhibit 10.13 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.2* | | Form of Term Sheet and Standard Terms and Conditions pursuant to The Advisory Board Company 2001 Stock-Based Incentive Compensation Plan. Incorporated by reference to Exhibit 10.14 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.3* | | The Advisory Board Company Directors’ Stock Plan. Incorporated by reference to Exhibit 10.15 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.4* | | Form of Term Sheet and Standard Terms and Conditions for Director Non-qualified Stock Options pursuant to The Advisory Board Company Directors’ Stock Plan. Incorporated by reference to Exhibit 10.16 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.5 | | Form of Indemnity Agreement between the Company and certain officers, directors and employees. Incorporated by reference to Exhibit 10.33 of the Company’s Registration Statement on Form S-1/A filed with the Commission on August 22, 2001. |
| |
10.6 | | Form of Indemnification Agreement between the Company and certain officers, directors and employees. Incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2009. |
| |
10.7* | | Employee Stock Purchase Plan. Incorporated by reference to Exhibit 10.34 of the Company’s Registration Statement on Form S-1/A filed with the Commission on October 29, 2001. |
| |
10.8* | | The Advisory Board Company 2005 Stock Incentive Plan. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 17, 2005. |
| |
10.9* | | Form of Standard Terms and Conditions for Restricted Stock Units pursuant to The Advisory Board Company 2005 Stock Incentive Plan. Incorporated by reference to Exhibit 10.39 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2006. |
| |
10.10* | | Form of Restricted Stock Unit Award Agreement pursuant to The Advisory Board Company 2005 Stock Incentive Plan. Incorporated by reference to Exhibit 10.40 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2006. |
| |
10.11* | | The Advisory Board Company 2006 Stock Incentive Plan. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 17, 2006. |
| |
10.12* | | Form of Restricted Stock Award Agreement pursuant to The Advisory Board Company 2005 and 2006 Stock Incentive Plans. Incorporated by reference to Exhibit 10.3 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008. |
| |
10.13* | | Form of Award Agreement for Non-qualified Stock Options pursuant to The Advisory Board Company 2005 and 2006 Stock Incentive Plans. Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for quarter ended September 30, 2008. |
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10.14* | | The Advisory Board Company Amended and Restated 2009 Stock Incentive Plan. Incorporated by reference to Appendix A to the Definitive Proxy Statement of the Company filed with the Commission on July 26, 2013. |
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10.15* | | Form of Award Agreement for Restricted Stock Units pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on September 16, 2009. |
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Exhibit Number | | Description of Exhibit |
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10.16* | | Form of Award Agreement for Qualified Stock Options pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on September 16, 2009. |
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10.17* | | Form of Award Agreement for Non-Qualified Stock Options pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on September 16, 2009. |
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10.18* | | 2014 Form of Award Agreement for Non-Qualified Stock Options for certain employees pursuant to The Advisory Board Company 2005 and 2009 Stock Incentive Plans. Incorporated by reference to Exhibit 10.18 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2014. |
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10.19* | | Employment Agreement, dated as of September 12, 2008, between the Company and Frank J. Williams. Incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2008. |
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10.20* | | Amended and Restated Employment Agreement, entered into as of November 3, 2010, between the Company and Frank J. Williams. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on November 9, 2010. |
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10.21* | | Amended and Restated Employment Agreement, dated as of April 3, 2013, between the Company and Robert W. Musslewhite. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on April 8, 2013. |
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10.22* | | Amended and Restated Employment Agreement, dated as of April 3, 2013, between the Company and David L. Felsenthal. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on April 8, 2013. |
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10.23* | | Executive Nonqualified Excess Plan of The Advisory Board Company, effective May 1, 2013. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on April 8, 2013. |
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10.24 | | Agreement of Lease, dated October 20, 2003, between the Company and 2445 M Street Property LLC. Incorporated by reference to Exhibit 10.37 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003. |
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10.25 | | Agreement to Commercial Note and attachments thereto, dated November 7, 2006, between SunTrust Bank and the Company. Incorporated by reference to Exhibit 10.34 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. |
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10.26 | | Investment Property Security Agreement, dated as of November 7, 2006, by and between SunTrust Bank, Merrill Lynch and the Company. Incorporated by reference to Exhibit 10.35 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006. |
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10.27 | | Collaboration Agreement, dated as of February 6, 2007, between The Corporate Executive Board Company and the Company (the “Collaboration Agreement”). Incorporated by reference to Exhibit 10.42 of the Company’s Annual Report on Form 10-K filed for the fiscal year ended March 31, 2007. On May 27, 2008, the Commission granted confidential treatment with respect to certain portions of the Collaboration Agreement. |
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10.28 | | Letter agreement, dated February 4, 2010, between the Company and The Corporate Executive Board Company concerning the Collaboration Agreement, dated February 6, 2007. Incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended December 30, 2009. |
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10.29 | | Letter agreement, dated November 7, 2011, between the Company and The Corporate Executive Board Company concerning the Collaboration Agreement, dated February 6, 2007. Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011. |
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10.30 | | Letter agreement, dated February 5, 2014, between the Company and The Corporate Executive Board Company concerning the Collaboration Agreement, dated February 6, 2007. Incorporated by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2013. |
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10.31 | | Credit Agreement, dated as of July 30, 2012, among the Company, the lenders party thereto from time to time, JPMorgan Chase Bank, N.A., as administrative agent (the “Administrative Agent”) and the other agents party thereto. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on August 3, 2012. |
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10.32 | | Guaranty, dated as of July 30, 2012, by Advisory Board Investments, Inc. in favor of the Administrative Agent. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on August 3, 2012. |
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Exhibit Number | | Description of Exhibit |
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10.33 | | Pledge and Security Agreement, dated as of July 30, 2012, among the Company, Advisory Board Investments, Inc., and the Administrative Agent. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on August 3, 2012. |
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10.34
| | Financing Commitment Agreement, dated December 10, 2014, among the Company, J.P. Morgan Securities LLC, JPMorgan Chase Bank, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporated and Bank of America, N.A. Filed herewith. |
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10.35
| | Credit Agreement, dated as of January 9, 2015, among the Company, the Lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, and the other parties thereto. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
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10.36
| | Pledge and Security Agreement, entered into as of January 9, 2015, among the Company and the Subsidiaries of the Company party thereto, as Grantors, and JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
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10.37
| | Guaranty made as of January 9, 2015 by the Subsidiaries of the Company party thereto in favor of JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
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10.38
| | Registration Rights and Governance Agreement, dated as of January 9, 2015, among the Company and Royall Holdings, LLC. Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on January 12, 2015. |
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10.39
| | The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees. Incorporated by reference to Exhibit 4.4 of the Company’s Registration Statement on Form S-8 filed with the Commission on February 9, 2015. |
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10.40
| | Form of Award Agreement for Restricted Stock Units pursuant to The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees. Filed herewith. |
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10.41
| | Form of Award Agreement for Non-Qualified Stock Options pursuant to The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees. Filed herewith. |
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10.42
| | Credit Agreement, dated as of February 6, 2015, among the Company, the Lenders party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, and the other parties thereto. Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the Commission on February 10, 2015.
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10.43
| | Pledge and Security Agreement, entered into as of February 6, 2015, among the Company and the Subsidiaries of the Company party thereto, as Grantors, and JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on February 10, 2015. |
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10.44
| | Guaranty made as of February 6, 2015 by the Subsidiaries of the Company party thereto in favor of JPMorgan Chase Bank, N.A., as Administrative Agent. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on February 10, 2015. |
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21.1 | | Subsidiaries of the Registrant. Filed herewith. |
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23.1 | | Consent of Independent Registered Public Accounting Firm with respect to the consolidated financial statements of the Company. Filed herewith. |
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23.2 | | Consent of Independent Auditor with respect to the financial statements of Evolent Health LLC. Filed herewith. |
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31.1 | | Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended. Filed herewith. |
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31.2 | | Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as amended. Filed herewith. |
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32.1 | | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. Filed herewith. |
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99.1 | | Financial statements as of December 31, 2014 and 2013, and for the three years ended December 31, 2014, of Evolent Health LLC. Filed herewith. |
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Exhibit
Number | | Description of Exhibit |
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101 | | XBRL (Extensible Business Reporting Language). The following financial statements from the Company’s Transition Report on Form 10-K for the period ended December 31, 2014, formatted in XBRL: (i) Consolidated Balance Sheets (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements. |
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* | Management contracts or compensation plans or arrangements in which directors or executive officers participate. |
Exhibit 10.34
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J.P. MORGAN SECURITIES LLC
JPMORGAN CHASE BANK, N.A.
383 Madison Avenue
New York, New York 10017 | MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
BANK OF AMERICA, N.A.
One Bryant Park
New York, New York 10036 |
December 10, 2014
Project Ram
$775 Million Senior Secured Credit Facilities
Commitment Letter
The Advisory Board Company
2445 M Street, NW
Washington, D.C. 20037
Attention: Michael T. Kirshbaum, Chief Financial Officer
and Treasurer
Ladies and Gentlemen:
The Advisory Board Company (the “Borrower” or “you”) has advised J.P. Morgan Securities LLC (“JPMorgan”), JPMorgan Chase Bank, N.A. (“JPMorgan Chase Bank”), Merrill Lynch, Pierce, Fenner & Smith Incorporated (together with its designated affiliates, “Merrill Lynch”) and Bank of America, N.A. (“Bank of America”) (JPMorgan Chase Bank and Bank of America, each, a “Bank” and, together, the “Banks”) that you intend to acquire directly or indirectly (the “Acquisition”) all of the issued and outstanding equity interests of a company previously identified to us as “Ram” (the “Target”) pursuant to a stock purchase agreement (the “Purchase Agreement”). You have further advised us that, in connection with the foregoing, you intend to consummate the other Transactions described in the Transaction Description attached hereto as Exhibit A (the “Transaction Description”). Capitalized terms used but not defined herein shall have the meanings assigned to them in the Transaction Description or the Summary of Terms and Conditions attached hereto as Exhibit B (the “Term Sheet”; this commitment letter, the Transaction Description, the Term Sheet and the Summary of Additional Conditions attached hereto as Exhibit C, collectively, the “Commitment Letter”).
1.Commitments. In connection with the foregoing, (a) JPMorgan Chase Bank is pleased to advise you of its several, but not joint, commitment to provide 57.14% of the principal amount of the Credit Facilities and (b) Bank of America is pleased to advise you of its several, but not joint, commitment to provide 42.86% of the principal amount of the Credit Facilities, in each case upon the terms and subject to the conditions set forth in this Commitment Letter.
You shall have the right, at any time until 5 business days after the date this Commitment Letter and the Fee Letter referred to below are executed and delivered by you, to obtain commitments from additional banks, financial institutions and other entities (the “Additional Commitment Lenders” and, together with the Banks, each, an “Initial Commitment Lender” and, collectively, the “Initial Commitment Lenders”) to assume the rights and obligations of the Banks hereunder in respect of up to
30% of the commitments under the Credit Facilities (allocated ratably between the Credit Facilities); provided that no Additional Commitment Lender shall receive economics that are greater than the economics allocated to a Bank hereunder; provided, further, that the Additional Commitment Lenders and the assignment and assumption documentation shall be reasonably acceptable to the Banks. The Banks’ commitments shall be reduced pro rata by the aggregate amount of commitments held by the Additional Commitment Lenders upon the execution by such Additional Commitment Lenders of such documentation.
2.Titles and Roles. It is agreed that (a) each of JPMorgan and Merrill Lynch will act as a joint bookrunner and a joint lead arranger for the Credit Facilities and (b) JPMorgan Chase Bank will act as sole administrative agent and collateral agent for the Credit Facilities, in each case upon the terms and subject to the conditions set forth or referred to in this Commitment Letter. Subject to the limitations set forth in the immediately preceding paragraph, you may appoint any Additional Commitment Lender or its affiliate as an additional co-agent and one or more joint bookrunners and joint lead arrangers reasonably acceptable to the Banks (the “Additional Arrangers” and, together with JPMorgan and Merrill Lynch, each, an “Arranger” and, collectively, the “Arrangers” and, together with the Initial Commitment Lenders and their respective affiliates, the “Commitment Parties,” “we” or “us”). We, in such capacities, will perform the duties and exercise the authority customarily performed and exercised by us in such roles. You agree that JPMorgan will have “left” placement in any and all marketing materials or other documentation used in connection with the Credit Facilities and the role and responsibilities customarily associated with such placement and Merrill Lynch will appear immediately “on the right” of JPMorgan in any and all marketing materials or other documentation used in connection with the Credit Facilities. You and we further agree that no other titles will be awarded (other than those expressly contemplated by this Commitment Letter and the Fee Letter referred to below) in connection with the Credit Facilities unless you and we shall agree.
3.Syndication. We intend to syndicate the Credit Facilities to a group of lenders (together with the Initial Commitment Lenders, the “Lenders”) identified by us in consultation with you and subject to your consent (such consent not to be unreasonably withheld or delayed) and to the provisions set forth below; provided that notwithstanding the right of the Initial Commitment Lenders to syndicate each of the Credit Facilities and receive commitments with respect thereto, it is agreed that any syndication of, or receipt of commitments in respect of, all or any portion of the Initial Commitment Lenders’ commitments hereunder prior to the initial funding under the Credit Facilities shall not be a condition to the Initial Commitment Lenders’ commitments nor reduce the Initial Commitment Lenders’ commitments hereunder with respect to any of the Credit Facilities (provided, further, that, notwithstanding the foregoing, (i) any reduction of the Initial Commitment Lenders’ commitments hereunder as a result of an assignment to any Additional Commitment Lender pursuant to Section 1 and (ii) assignments of any Initial Commitment Lender’s commitments which are effective simultaneously with the funding of such commitments by the assignee thereof, shall be permitted) (the date of such initial funding under the Credit Facilities, the “Closing Date”) and, unless you otherwise agree in writing, (a) except in connection with assignments to any Additional Commitment Lender pursuant to Section 1, no Initial Commitment Lender shall be relieved, released or novated from its obligations hereunder (including its obligation to fund the Credit Facilities on the date of the consummation of the Transactions) until after the Closing Date has occurred and (b) each Initial Commitment Lender shall retain exclusive control over all rights and obligations with respect to its commitments, including all rights with respect to consents, modifications and amendments, until the Closing Date has occurred.
Each Commitment Party agrees not to syndicate any of the commitments with respect to the Credit Facilities to any of the following (collectively, “Disqualified Lenders”): (a) certain financial
institutions and other entities (and affiliates of any such financial institution or other entity to the extent such affiliates are clearly identifiable on the basis of such affiliates’ names) that have been specified by you in writing to JPMorgan and Merrill Lynch on or prior to the date hereof; (b) direct competitors of you or your subsidiaries or the Target or its subsidiaries specified by you to JPMorgan and Merrill Lynch in writing on or prior to the date hereof or subsequently updated in writing to the Administrative Agent after the Syndication Date (each such entity, a “Competitor”); provided that the foregoing shall not apply retroactively to disqualify any parties that have previously acquired an assignment or participation interest in the Loans to the extent that any such party was not a Disqualified Lender at the time of the applicable assignment or participation, as the case may be; or (c) affiliates of Competitors to the extent such affiliates are clearly identifiable on the basis of such affiliates’ names; provided that a Competitor or an affiliate of a Competitor shall not include any bona fide debt fund or investment vehicle (other than a person excluded pursuant to clause (a) above) that is engaged in making, purchasing, holding or otherwise investing in commercial loans and similar extensions of credit in the ordinary course of business which is managed, sponsored or advised by any person controlling, controlled by or under common control with such Competitor or affiliate thereof, as applicable, and for which no personnel involved with the investment of such Competitor or affiliate thereof, as applicable, (i) makes (or has the right to make or participate with others in making) any investment decisions or (ii) has access to any information (other than information that is publicly available), in either case relating to the Target (or, after the Closing Date, the Borrower) or any entity that forms a part of the Target’s business (or, after the Closing Date, the Borrower’s business), including subsidiaries of the Target or, after the Closing Date, the Borrower.
You agree actively to assist us in completing a timely syndication of the Credit Facilities (it being understood that the syndication of the Credit Facilities will occur after the Closing Date unless otherwise agreed by the Arrangers and the Company) that is reasonably satisfactory to us and you. Such assistance shall include, without limitation, until the earlier to occur of (a) a Successful Syndication (as defined in the Fee Letter) and (b) ninety (90) days after the Closing Date (such earlier date, the “Syndication Date”), (i) your using commercially reasonable efforts to ensure that any syndication efforts benefit materially from your existing lending and investment banking relationships and, to the extent practical and appropriate and provided for in the Purchase Agreement, those of the Target; (ii) your ensuring direct contact between senior management, representatives and advisors of you, on the one hand, and the proposed Lenders, on the other hand (and your using commercially reasonable efforts to ensure contact between senior management, representatives and advisors of the Target (to the extent provided for in the Purchase Agreement), on the one hand, and the proposed Lenders, on the other hand), in all such cases at times mutually agreed upon; (iii) your assisting and your using commercially reasonable efforts to cause the Target (to the extent provided for in the Purchase Agreement) to assist in the preparation of a customary Confidential Information Memorandum for the Credit Facilities and other customary marketing materials to be used in connection with the syndication (collectively the “Marketing Materials”); (iv) your affording the Arrangers a period of at least ninety (90) days following the Closing Date to syndicate the Credit Facilities; (v) prior to the Closing Date, your using commercially reasonable efforts (which commercially reasonable efforts shall not require you to change the proposed terms of the Credit Facilities) to procure a corporate credit rating and a corporate family rating in respect of the Borrower from Standard & Poor’s Financial Services LLC (“S&P”) and Moody’s Investors Service, Inc. (“Moody’s”), respectively, and ratings for each of the Credit Facilities from each of S&P and Moody’s; (vi) the hosting, with the Arrangers, of one or more meetings of prospective Lenders at times and locations to be mutually agreed upon; and (vii) from the date hereof through the Syndication Date, your ensuring that, except in connection with any Excluded Financings (as defined below), there shall be no competing issues of debt securities or commercial bank or other credit facilities of the Borrower, the Target or any of their respective subsidiaries being offered, placed or arranged (other than replacements, extensions and renewals of existing indebtedness that matures prior to the Closing Date) if such debt
securities or commercial bank or other credit facilities would have, in the reasonable judgment of JPMorgan and Merrill Lynch, a detrimental effect upon the syndication of the Credit Facilities. For purposes of this Commitment Letter, the term “Excluded Financings” means any issuance, offering, placement or arrangement of debt securities or commercial bank or other credit facilities relating to (A) indebtedness to be agreed upon to remain outstanding after the Closing Date, (B) indebtedness incurred by the Target (or any of its subsidiaries) prior to the Closing Date to the extent permitted by the Purchase Agreement, (C) indebtedness incurred by you or any of your subsidiaries pursuant to capital leases and vendor financings, borrowings under the Existing Credit Agreement, and other ordinary course incurrences of indebtedness by you or your subsidiaries (other than pursuant to incremental facilities) permitted by the Existing Credit Agreement, (D) intercompany indebtedness and (E) from and after the Closing Date, borrowings under the Credit Facilities, indebtedness incurred by you or any of your subsidiaries pursuant to capital leases and vendor financings, and other ordinary course incurrences of indebtedness by you or your subsidiaries (other than pursuant to incremental facilities) permitted by the Credit Facilities. Notwithstanding anything to the contrary contained in this Commitment Letter or the Fee Letter, but without limiting your obligations to assist with syndication efforts as set forth herein, it is agreed that none of (a) the commencement nor completion of the syndication of the Credit Facilities, (b) the receipt of any ratings from S&P and/or Moody’s or (c) any of the other agreements, obligations or provisions of this paragraph shall constitute a condition to the availability of the Credit Facilities on the Closing Date.
In consultation with you, the Arrangers will manage all aspects of any syndication of the Credit Facilities, including decisions as to the selection of institutions to be approached and when they will be approached, when their commitments will be accepted, which institutions will participate, the allocation of the commitments among the Lenders and the amount and distribution of fees among the Lenders. To assist the Arrangers in their syndication efforts, you agree promptly to prepare and furnish (and, to the extent provided for in the Purchase Agreement, to use commercially reasonable efforts to cause the Target to provide) to the Arrangers all customary information with respect to you, the Target and each of your and its respective subsidiaries and the Transactions, including all projections (including financial estimates, budgets, forecasts and other forward-looking information, the “Projections”) and other financial information, as the Arrangers may reasonably request in connection with the structuring, arrangement and syndication of the Credit Facilities. For the avoidance of doubt you will not be required to provide any information to the extent that the provision thereof would violate any law, rule or regulation, or any obligation of confidentiality binding upon you, the Target or any of your respective affiliates; provided that, in the event that you do not provide information in reliance on this sentence, you shall provide notice to the Arrangers that such information is being withheld and, with respect to obligations of confidentiality that are contractual in nature, you shall use your commercially reasonable efforts to communicate the information subject to such obligations of confidentiality in a way that would not violate the applicable obligations; provided, further, that none of the foregoing shall be construed to limit any of the Borrower’s representations and warranties or any of the conditions, in any such case, set forth in this Commitment Letter or the Facilities Documentation. Notwithstanding anything herein to the contrary, the only financial statements that shall be required to be provided to the Arrangers as part of the Marketing Materials prior to the Closing Date shall be the financial statements required to be delivered pursuant to Exhibit C hereto.
You acknowledge that (a) the Arrangers on your behalf will make available “Information Materials” (which for purposes of this Commitment Letter shall mean the Information (as defined below), together with the Projections, other customary offering and marketing material and any Confidential Information Memorandum, collectively, with the Term Sheet) to the proposed syndicate of Lenders by posting the Information Materials on IntraLinks or another similar electronic system and (b) certain
prospective Lenders (such Lenders, “Public Lenders”; all other Lenders, “Private Lenders”) may have personnel that do not wish to receive material non-public information (within the meaning of the United States federal securities laws, or in the case of the Target and its subsidiaries, information that would not be required to be disclosed in public filings if the Target was an SEC reporting company, “MNPI”) with respect to you, the Target, and your and its respective affiliates or any other entity, or the respective securities of any of the foregoing, and who may be engaged in investment and other market-related activities with respect to such entities’ securities. You will assist us in preparing an additional version of the Information Materials not containing MNPI (the “Public Information Materials”) to be distributed to prospective Public Lenders.
Before distribution of any Information Materials (a) to prospective Private Lenders, you shall provide us with a customary letter authorizing the dissemination of the Information Materials and containing a customary “10b-5” representation and (b) to prospective Public Lenders, you shall provide us with a customary letter authorizing the dissemination of the Public Information Materials, confirming the absence of MNPI therefrom and containing a customary “10b-5” representation. In addition, at our request, you shall identify Public Information Materials by clearly and conspicuously marking such Public Information Materials as “PUBLIC.”
You agree that the Arrangers on your behalf may distribute the following documents to all prospective Lenders, unless you advise the Arrangers in writing (including by e-mail) within a reasonable time prior to their intended distributions that such material should only be distributed to prospective Private Lenders: (a) administrative materials for prospective Lenders such as lender meeting invitations and funding and closing memoranda; (b) notifications of changes to the previously disclosed terms of the Credit Facilities; and (c) other materials intended for prospective Lenders after the initial distribution of the Information Materials, including drafts and final versions of definitive documents with respect to the Credit Facilities. If you advise us that any of the foregoing items should be distributed only to prospective Private Lenders, then the Arrangers will not distribute such materials to prospective Public Lenders without your consent. You agree that Information Materials made available to prospective Public Lenders in accordance with this Commitment Letter shall not contain MNPI.
4.Information. You hereby represent and warrant that (with respect to the Target and its subsidiaries, to the best of your knowledge), (a) all written information and written data, other than the Projections and information of a general economic or industry-specific nature, that have been or will be made available to the Commitment Parties by or on behalf of you or any of your representatives in connection with the transactions contemplated hereby (the “Information”), are or will be, when furnished, taken as a whole, complete and correct in all material respects and do not or will not, when furnished, contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements contained therein taken as a whole not materially misleading in the light of the circumstances under which such statements are made and (b) the Projections and information of a general economic or industry-specific nature that have been or will be furnished to the Commitment Parties by or on behalf of you or any of your representatives have been or will be prepared in good faith based upon assumptions that you believe to be reasonable at the time prepared and at the time the related Projections are made available to the Commitment Parties; it being understood that (i) the Projections are not to be viewed as facts and that actual results during the period or periods covered by any such Projections may differ significantly from the projected results and such differences may be material and (ii) the Projections are subject to significant uncertainties and contingencies, many of which are beyond your control, and no assurance can be given that any projected results will be realized. You agree that if, at any time prior to the Syndication Date, you become aware that any of the representations in the preceding sentence would be incorrect in any material respect if the Information and Projections were being furnished, and such representations were being made, at such time, then you will promptly supplement (or prior to the Closing Date with respect to Information and Projections concerning the Target and its subsidiaries you will, subject to any applicable limitations on your rights as set forth in the Purchase Agreement, use commercially reasonable efforts to promptly supplement) the Information and the Projections so that such representations will be true and correct in all material respects under those circumstances. In arranging and syndicating the Credit Facilities, the Commitment Parties will be entitled to use and rely primarily on the Information and the Projections and information of a general economic or industry-specific nature without responsibility for the independent verification thereof. Notwithstanding anything to the contrary in this Commitment Letter, the Fee Letter, the Facilities Documentation (as defined in Exhibit B hereto) or any other letter agreement or other undertaking concerning the financing of the Transactions, none of the making of any representation under this numbered paragraph 4 or any supplement thereto or the accuracy of any such representation shall constitute a condition to the availability and initial funding of the Credit Facilities on the Closing Date; provided that the foregoing shall not limit any condition referred to in numbered paragraph 6 of this Commitment Letter.
5.Fees. As consideration for the commitments of the Commitment Parties hereunder and their agreement to perform the services described herein, you agree to pay (or cause to be paid) the fees set forth in, and in accordance with the respective terms of, the Term Sheet and the Fee Letter dated the date hereof and delivered herewith with respect to the Credit Facilities (the “Fee Letter”). Once paid, such fees shall not be refundable under any circumstances.
6.Conditions. The commitments of the Initial Commitment Lenders hereunder to fund the Credit Facilities on the Closing Date and the agreements of the Arrangers to perform the services described herein are subject solely to (a) the conditions set forth in the section entitled “Conditions to Initial Borrowing” in Exhibit B hereto and (b) the conditions set forth in the Summary of Additional Conditions in Exhibit C hereto, and upon satisfaction (or waiver by the Initial Commitment Lenders) of such conditions, the initial funding of the Credit Facilities shall occur; it being understood and agreed that there are no other conditions (implied or otherwise) to the commitments hereunder, including compliance with the other terms of this Commitment Letter, the Fee Letter and the Facilities Documentation.
Notwithstanding anything to the contrary in this Commitment Letter (including each of the exhibits attached hereto), the Fee Letter, the Facilities Documentation or any other letter agreement or other undertaking concerning the financing of the Transactions to the contrary, (a) the only representations the accuracy of which shall be a condition to the availability and initial funding of the Credit Facilities on the Closing Date, as set forth in Exhibit C hereto, shall be (i) such of the representations made by, or with respect to, the Target in the Purchase Agreement as are material to the interests of the Lenders, but only to the extent that you (and/or your affiliates party to the Purchase Agreement) have the right (taking into account any applicable cure provisions) to terminate your (and/or their) obligations under the Purchase Agreement or decline to consummate the Acquisition (in each case, in accordance with the terms thereof) as a result of a breach of such representations in the Purchase Agreement (to such extent, the “Specified Purchase Agreement Representations”) and (ii) the Specified Representations (as defined below) and (b) the terms of the Facilities Documentation shall be in a form such that they do not impair the availability of the Credit Facilities on the Closing Date if the conditions set forth in the section entitled “Conditions to Initial Borrowing” in Exhibit B hereto and the conditions set forth in the Summary of Additional Conditions in Exhibit C hereto are satisfied (or waived by the Commitment Parties) (provided that, to the extent any security interest in any Collateral (as defined in Exhibit B hereto) is not or cannot be provided or perfected on the Closing Date (other than the perfection of the security interests (A) in the certificated equity securities of any U.S. domestic subsidiaries of the Borrower (to the extent required by the Term Sheet) and (B) in other assets with respect to which a lien may be perfected by the filing of a financing statement under the Uniform Commercial Code) after your use of commercially reasonable efforts to do so or without undue burden or expense, then the provision and/or perfection of a security interest in such Collateral shall not constitute a condition precedent to the availability of the Credit Facilities on the Closing Date, but instead shall be required to be delivered after the Closing Date pursuant to arrangements and timing to be mutually agreed by the Administrative Agent (as defined in Exhibit B hereto) and the Borrower acting reasonably but (including in the absence of such mutual agreement) no later than ninety (90) days after the Closing Date (or such longer period as the Administrative Agent may determine in its reasonable discretion)). For purposes hereof, “Specified Representations” means the representations and warranties of the Borrower and the Guarantors (as defined in Exhibit B hereto) to be set forth in the Facilities Documentation relating to organizational existence of the Borrower and its subsidiaries; power and authority, due authorization, execution, delivery and enforceability, in each case, related to the borrowing under, guaranteeing under, performance of, and granting of security interests in the Collateral pursuant to the Facilities Documentation; solvency as of the Closing Date (after giving effect to the Transactions) of the Borrower and its subsidiaries on a consolidated basis (solvency to be defined in a manner consistent with the manner in which solvency is defined in the solvency certificate to be delivered pursuant to Exhibit C hereto); Federal Reserve margin regulations; the PATRIOT Act (as defined below); the use of proceeds of the Credit Facilities not violating the Foreign Corrupt Practices Act (the “FCPA”), regulations promulgated by the Office of Foreign Assets Control (“OFAC”) or anti-money laundering laws; neither the Borrower nor any Guarantor being a “sanctioned person” under OFAC or equivalent statutes in relevant jurisdictions; the Investment Company Act of 1940; the incurrence of the loans and the provision of the guarantees, in each case under the Credit Facilities, and the granting of the security interests in the Collateral to secure the Credit Facilities not conflicting with the organizational documents of the Borrower or any Guarantor; and, subject to the proviso in clause (b) of the immediately preceding sentence, creation, validity and perfection of security interests in the Collateral. This paragraph, and the provisions herein, shall be referred to as the “Limited Conditionality Provisions.”
7.Indemnification; Expenses. You agree (a) to indemnify and hold harmless the Commitment Parties, their affiliates and their respective officers, directors, employees, affiliates and agents (each, an “indemnified person”) from and against any and all losses, claims, damages and liabilities to which any such indemnified person may become subject arising out of or in connection with this Commitment Letter, the Credit Facilities, the Transactions or any related transaction or any claim, litigation, investigation or proceeding (any such claim, litigation, investigation or proceeding, a “proceeding”) relating to any of the foregoing, regardless of whether any such indemnified person is a party thereto, whether or not such proceedings are brought by you, your equity holders, affiliates or creditors or any other third person, and to reimburse each indemnified person within thirty (30) days after written demand (which demand shall include reasonably detailed documentation supporting such request) for any reasonable documented out-of-pocket legal expenses incurred in connection with investigating or defending any of the foregoing by one firm of counsel for all indemnified persons, taken as a whole (and, if necessary, by a single firm of local counsel in each appropriate jurisdiction for all indemnified persons, taken as a whole, and, in the case of an actual or perceived conflict of interest, one additional counsel in each relevant jurisdiction), or other reasonable documented out-of-pocket expenses incurred in connection with investigating or defending any of the foregoing, provided that the foregoing indemnity will not apply, as to any indemnified person, to (i) losses, claims, damages, liabilities or related expenses (A) to the extent they are found in a final, non-appealable judgment of a court of competent jurisdiction to have resulted from the willful misconduct, bad faith or gross negligence of such indemnified person or any of such indemnified person’s controlled or controlling affiliates or any of its or their respective officers, directors, employees, agents, controlling persons, members or representatives (collectively, such indemnified person’s “related persons”), (B) arising out of a material breach by such indemnified person (or any of such indemnified person’s related persons) of its obligations under this Commitment Letter or the Fee Letter (as determined by a court of competent jurisdiction in a final and non-appealable judgment) or (C) arising out of any claim, action, suit, inquiry, litigation, investigation or proceeding that does not involve an act or omission of you or any of your subsidiaries and that is brought by an indemnified person against any other indemnified person (other than any claim, action, suit, inquiry, litigation, investigation or proceeding against any Commitment Party in its capacity or in fulfilling its role as the Administrative Agent or an Arranger under the Credit Facilities) or (ii) any expenses of the type referred to in clause (b) of this sentence except to the extent such expenses would otherwise be of the type referred to in this clause (a), and (b) to reimburse the Commitment Parties from time to time, within thirty (30) days after receipt of a reasonably detailed invoice (or on the Closing Date to the extent invoiced at least three (3) business days prior to the Closing Date), for all reasonable documented out-of-pocket expenses (including, but not limited to, expenses of their due diligence investigation, fees of consultants hired with your prior written consent (such consent not to be unreasonably withheld or delayed), syndication expenses, travel expenses and fees, disbursements and other charges of counsel identified in the Term Sheet and of a single firm of local counsel to the Arrangers in each appropriate jurisdiction and, in the case of an actual or perceived conflict of interest, one additional counsel in each relevant jurisdiction, in each case incurred in connection with the Credit Facilities and the preparation, negotiation and enforcement of this Commitment Letter, the Fee Letter, the Facilities Documentation and any ancillary documents or security arrangements in connection therewith. You acknowledge that we may receive a benefit, including without limitation, a discount, credit or other accommodation, from any of such counsel based on the fees such counsel may receive on account of their relationship with us, including, without limitation, fees paid pursuant hereto.
You shall not be liable for any settlement of any proceeding (or expenses related thereto) effected without your consent (which consent shall not be unreasonably withheld, conditioned or delayed), but if settled with your written consent, or if there is a final judgment, by a court of competent jurisdiction, for the plaintiff against an indemnified person in any such proceeding, you agree to indemnify and hold
harmless each indemnified person to the extent and in the manner set forth above. You shall not, without the prior written consent of an indemnified person (which consent shall not be unreasonably withheld or conditioned or delayed), effect any settlement of any pending or threatened proceeding against an indemnified person in respect of which indemnity could have been sought hereunder by such indemnified person unless (a) such settlement includes an unconditional release of such indemnified person from all liability or claims that are the subject matter of such proceeding and (b) such settlement does not include any statement as to any admission of fault.
No indemnified person shall be liable for any damages arising from the use by others of any information or other materials obtained through internet, electronic, telecommunications or other information transmission systems except to the extent such damages are found in final, non-appealable judgment of a court of competent jurisdiction to have resulted from the willful misconduct, bad faith or gross negligence of such indemnified person or any of its related persons.
No indemnified person or (except solely as a result of your indemnification obligations set forth above to the extent an indemnified person is found so liable) you, or any of the affiliates or officers, directors, employees, advisors and agents of such indemnified person or you, shall be liable for any indirect, special, punitive or consequential damages in connection with this Commitment Letter, the Fee Letter, the Facilities or the transactions contemplated hereby.
8.Sharing of Information; Affiliate Activities. You acknowledge that each Commitment Party and its affiliates (the term “Commitment Party” as used below in this paragraph being understood to include such affiliates) may be providing debt financing, equity capital or other services (including financial advisory services) to other persons in respect of which you may have conflicting interests regarding the transactions described herein and otherwise. No Commitment Party will use confidential information obtained from you by virtue of the transactions contemplated by this Commitment Letter or its other relationships with you in connection with the performance by such Commitment Party of services for other persons, and no Commitment Party will furnish any such information to other persons. You also acknowledge that no Commitment Party has any obligation to use in connection with the transactions contemplated hereby, or to furnish to you, confidential information obtained from other persons.
You further acknowledge that each Commitment Party may from time to time effect transactions, for its own or its affiliates’ account or the account of customers, and hold positions in equity, debt and other securities or financial instruments (including bank loans and other obligations) of the Borrower, the Target and their respective subsidiaries and other persons with which the Borrower, the Target or their respective subsidiaries may have commercial or other relationships. You acknowledge that JPMorgan Chase Bank, an affiliate of JPMorgan, currently is acting as administrative agent, and JP Morgan Chase Bank and Bank of America, an affiliate of Merrill Lynch, currently are acting as lenders under that certain Credit Agreement, dated as of July 30, 2012 (as amended, supplemented or otherwise modified from time to time, the “Existing Credit Agreement”), and the Borrower’s and its affiliates’ rights and obligations under any other agreement with JPMorgan, Merrill Lynch or any of their respective affiliates (including the Existing Credit Agreement) that currently or hereafter may exist are, and shall be, separate and distinct from the rights and obligations of the parties pursuant to this Commitment Letter, and none of such rights and obligations under such other agreements shall be affected by JPMorgan’s or Merrill Lynch’s performance or lack of performance of services hereunder. The Borrower further acknowledges that JPMorgan, Merrill Lynch or any of their respective affiliates may currently or in the future participate in other debt or equity transactions on behalf of or render financial advisory services to the Borrower or other companies that may be involved in a competing transaction. The Borrower hereby agrees that
JPMorgan and Merrill Lynch may render its services under this Commitment Letter notwithstanding any actual or potential conflict of interest presented by the foregoing, and the Borrower hereby waives any conflict of interest claims relating to the relationship between JPMorgan, Merrill Lynch and the Borrower and its affiliates in connection with the engagement contemplated hereby, on the one hand, and the exercise by JPMorgan, Merrill Lynch or any of their respective affiliates of any of their rights and duties under any credit or other agreement (including the Existing Credit Agreement), on the other hand. The terms of this paragraph shall survive the expiration or termination of this Commitment Letter for any reason whatsoever.
Each Commitment Party may employ the services of its affiliates in providing certain services hereunder and, in connection with the provision of such services, may exchange with such affiliates information concerning you and the other persons that may be the subject of the transactions contemplated by this Commitment Letter, and, to the extent so employed, such affiliates shall be entitled to the benefits afforded to, and subject to the confidentiality obligations of, such Commitment Party hereunder.
In connection with all aspects of each transaction contemplated by this Commitment Letter, you acknowledge and agree that: (a) (i) the arranging and other services described herein regarding the Credit Facilities are arm’s-length commercial transactions between you and your affiliates, on the one hand, and each Arranger, on the other hand, (ii) you have consulted your own legal, accounting, regulatory and tax advisors to the extent you have deemed appropriate, and (iii) you are capable of evaluating, and understand and accept, the terms, risks and conditions of the transactions contemplated hereby; (b) (i) each of the Arrangers has been, is and will be acting solely as a principal and, except as otherwise expressly agreed in writing by the relevant parties, has not been, is not and will not be acting as an advisor, agent or fiduciary for you, any of your affiliates or any other person or entity and (ii) none of the Arrangers has any obligation to you or your affiliates with respect to the transactions contemplated hereby except those obligations expressly set forth herein; and (c) each of the Arrangers and their respective affiliates may be engaged in a broad range of transactions that involve interests that differ from yours and those of your affiliates, and any Arranger will have no obligation to disclose any of such interests to you or your affiliates. To the fullest extent permitted by law, you hereby waive and release any claims that you may have against any Lead Arranger with respect to any breach or alleged breach of agency or fiduciary duty in connection with any aspect of any transaction contemplated by this Commitment Letter.
9.Confidentiality. This Commitment Letter is delivered to you on the understanding that neither this Commitment Letter (including the Term Sheet) nor the Fee Letter nor any of their terms or substance shall be disclosed, directly or indirectly, to any other person (including, without limitation, other potential providers or arrangers of financing) except (a) to your subsidiaries and affiliates and your and their respective officers, directors, employees, agents, attorneys, accountants, financial or other advisors and controlling persons who are informed of the confidential nature thereof, on a confidential and need-to-know basis, (b) if the Commitment Parties consent in writing to such proposed disclosure or (c) pursuant to the order of any court or administrative agency or in any pending legal, judicial or administrative proceeding, or otherwise as required by applicable law, rule or regulation or compulsory legal process or to the extent requested or required by governmental and/or regulatory authorities, in each case based on the reasonable advice of your legal counsel (in which case you agree, to the extent practicable and not prohibited by applicable law, rule or regulation, to inform us promptly thereof prior to making any such disclosure); provided that (i) you may disclose the Commitment Letter and its contents (but not the Fee Letter or the contents thereof, subject to the foregoing) in any syndication or other marketing materials in connection with the Credit Facilities (including the Information Materials), in a report, registration statement, proxy statement or other document filed by you with the Securities and Exchange Commission (including as an exhibit filed pursuant thereto, subject to the foregoing) or in any offering document used by you in an unregistered offering of your securities if, in your judgment, such disclosure is required by the federal securities laws or the rules and regulations of the Securities and Exchange Commission thereunder, or in connection with any other public or regulatory filing requirement relating to the Credit Facilities and the Transactions, (ii) you may disclose on a confidential basis the Transaction Description, the Term Sheet and Exhibit C hereto, and the contents thereof, to potential Lenders and to credit rating agencies in connection with your seeking to obtain ratings for the Borrower and the Credit Facilities, (iii) you may disclose the aggregate fee amount contained in the Fee Letter as part of the Projections, pro forma information or a generic disclosure of aggregate sources and uses related to fee amounts related to the Transactions to the extent customary or required in offering and marketing materials for the Credit Facilities or in any public or regulatory filing requirement (including any filing requirement of the Securities and Exchange Commission) relating to the Transactions (and only to the extent aggregated with all other fees and expenses of the Transactions and not presented as an individual line item unless required by applicable law, rule or regulation in your judgment) and (iv) you may disclose this Commitment Letter and its contents and, if the fee amounts payable pursuant to the Fee Letter, the economic terms of the “Market Flex Provisions” in the Fee Letter, and such other portions as mutually agreed have been redacted in a manner reasonably agreed by us (including the portions thereof addressing fees payable to the Commitment Parties and/or the Lenders), you may disclose the Fee Letter and the contents thereof to the Target, its subsidiaries and its and their respective officers, directors, employees, agents, attorneys, accountants, financial or other advisors, controlling persons and equity holders, on a confidential and need-to-know basis.
Each Commitment Party and its affiliates will use all non-public information provided to any of them or such affiliates by or on behalf of you hereunder or in connection with the Transactions solely for the purpose of providing the services which are the subject of this Commitment Letter and negotiating, evaluating and consummating the transactions contemplated hereby and shall treat confidentially all such information and shall not publish, disclose or otherwise divulge such information; provided that nothing herein shall prevent such Commitment Party and its affiliates from disclosing any such information (a) pursuant to the order of any court or administrative agency or in any pending legal, judicial or administrative proceeding, or otherwise as required by applicable law, rule or regulation or compulsory legal process based on the reasonable advice of counsel (in which case such Commitment Party agrees (except with respect to any audit or examination conducted by bank accountants or any self-regulatory authority or governmental or regulatory authority exercising examination or regulatory authority), to the
extent practicable and not prohibited by applicable law, rule or regulation, to inform you promptly thereof prior to making any such disclosure), (b) upon the request or demand of any regulatory authority having jurisdiction, or purporting to have jurisdiction, over such Commitment Party or any of its affiliates (in which case such Commitment Party agrees (except with respect to any audit or examination conducted by bank accountants or any self-regulatory authority or governmental or regulatory authority exercising examination or regulatory authority), to the extent practicable and not prohibited by applicable law, rule or regulation, to inform you promptly thereof prior to making any such disclosure), (c) to the extent that such information becomes publicly available other than by reason of improper disclosure by such Commitment Party or any of its affiliates or any related parties thereto in violation of any confidentiality obligations owing to you, the Target or any of your or its respective subsidiaries or affiliates or related parties (including those set forth in this paragraph), (d) to the extent that such information is received by such Commitment Party from a third party that is not, to such Commitment Party’s knowledge, subject to contractual or fiduciary confidentiality obligations owing to you, the Target, or any of your or its respective subsidiaries or affiliates or any related parties thereto, (e) to the extent that such information is independently developed by such Commitment Party, (f) to such Commitment Party’s affiliates and to its and their respective employees, legal counsel, independent auditors, rating agencies, professionals and other experts or agents who need to know such information in connection with the Transactions and who are informed of the confidential nature of such information and who are subject to customary confidentiality obligations of professional practice or who agree to be bound by the terms of this paragraph (or language substantially similar to this paragraph) (with each such Commitment Party, to the extent within its control, responsible for such person’s compliance with this paragraph), (g) to prospective Additional Commitment Lenders, Lenders, hedge providers, participants or assignees or (h) for purposes of establishing a “due diligence” defense; provided that for purposes of clause (g) above, the disclosure of any such information to any Additional Commitment Lenders, Lenders, hedge providers, participants or assignees or prospective Additional Commitment Lenders, Lenders, hedge providers, participants or assignees referred to above shall be made subject to the acknowledgment and acceptance by each such Additional Commitment Lender, Lender, hedge provider, participant or assignee or prospective Additional Commitment Lender, Lender, hedge provider, participant or assignee that such information is being disseminated on a confidential basis (on substantially the terms set forth in this paragraph or as is otherwise reasonably acceptable to you and such Commitment Party, including, without limitation, as agreed in any Information Materials or other marketing materials) in accordance with the standard syndication processes of such Commitment Party or customary market standards for dissemination of such type of information, which shall in any event require “click through” or other affirmative actions on the part of recipient to access such information. In the event that the Credit Facilities are funded, the obligations of the Commitment Parties and their respective affiliates, if any, under this paragraph shall terminate automatically and be superseded by the confidentiality provisions in the Facilities Documentation upon the initial funding thereunder to the extent that such provisions are binding on such Commitment Parties. Otherwise, the confidentiality provisions set forth in this paragraph shall survive the termination of this Commitment Letter and expire and shall be of no further effect after the second anniversary of the date hereof.
10.Miscellaneous. This Commitment Letter shall not be assignable by any party hereto without the prior written consent of the other parties hereto (and any purported assignment without such consent shall be null and void), is intended to be solely for the benefit of the parties hereto and is not intended to confer any benefits upon, or create any rights in favor of, any person other than the parties hereto (and the indemnified persons to the extent expressly provided for herein). Notwithstanding the foregoing sentence, (a) each Bank may assign a portion of its commitment hereunder to any Additional Commitment Lender in accordance with, and as contemplated by, this Commitment Letter, and (b) the Commitment Parties may syndicate the Credit Facilities and receive commitments with respect thereto in accordance with, and as contemplated by, this Commitment Letter.
This Commitment Letter may not be amended or waived except by an instrument in writing signed by you and each Commitment Party. This Commitment Letter may be executed in any number of counterparts, each of which shall be an original, and all of which, when taken together, shall constitute one agreement. Delivery of an executed signature page of this Commitment Letter by facsimile transmission shall be effective as delivery of a manually executed counterpart hereof.
This Commitment Letter and the Fee Letter supersede all prior understandings, whether written or oral, between us and you with respect to the Credit Facilities.
This Commitment Letter shall be governed by, and construed and interpreted in accordance with, the laws of the State of New York without regard to any principle of conflicts of law that could require the application of any other law; provided that for purposes of determining (a) whether a Company Material Adverse Effect (as defined in Exhibit C hereto) shall have occurred, (b) the accuracy of any representation made by, or with respect to, the Target in the Purchase Agreement and whether as a result of any inaccuracy thereof you (and/or your affiliates party to the Purchase Agreement) have the right to terminate your (and/or their) obligations thereunder or decline to consummate the Acquisition and (c) whether the Acquisition has been consummated in accordance with the terms of the Purchase Agreement, the Commitment Letter shall in each case be governed by, and construed and interpreted in accordance with, the laws of the State of Delaware, regardless of the laws that might otherwise govern under any applicable principles of conflicts of laws thereof.
Each of the parties hereto agrees that this Commitment Letter is a binding and enforceable agreement with respect to the subject matter contained herein, including an agreement to negotiate in good faith the Facilities Documentation by the parties hereto in a manner consistent with this Commitment Letter, it being acknowledged and agreed that the commitment provided hereunder is subject to conditions set forth or referred to in numbered paragraph 6 hereof.
EACH OF THE PARTIES HERETO IRREVOCABLY WAIVES THE RIGHT TO TRIAL BY JURY IN ANY ACTION, PROCEEDING, CLAIM OR COUNTERCLAIM BROUGHT BY OR ON BEHALF OF ANY PARTY RELATED TO OR ARISING OUT OF THIS COMMITMENT LETTER OR THE FEE LETTER OR THE PERFORMANCE OF SERVICES HEREUNDER OR THEREUNDER.
Each of the parties hereto hereby irrevocably and unconditionally (a) submits, for itself and its property, to the exclusive jurisdiction of any New York State court or Federal court of the United States of America sitting in New York County, Borough of Manhattan, in the State of New York, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Commitment Letter, the Fee Letter or the transactions contemplated hereby or thereby, or for recognition or enforcement of any judgment, and agrees that all claims in respect of any such action or proceeding shall be heard and determined in such New York State court or, to the extent permitted by law, in such Federal court, (b)
waives, to the fullest extent it may legally and effectively do so, any objection which it may now or hereafter have to the laying of venue of any suit, action or proceeding arising out of or relating to this Commitment Letter, the Fee Letter or the transactions contemplated hereby or thereby in any New York State court or in any such Federal court, (c) waives, to the fullest extent permitted by law, the defense of an inconvenient forum to the maintenance of such action or proceeding in any such court and (d) agrees that a final judgment in any such suit, action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Each of the parties hereto agrees that service of process, summons, notice or document by registered mail addressed to you or us at the addresses set forth above shall be effective service of process for any suit, action or proceeding brought in any such court.
We hereby notify you that pursuant to the requirements of the USA PATRIOT Act (Title III of Pub. L. 107-56 (signed into law October 26, 2001) (the “PATRIOT Act”), each of us and each of the Lenders may be required to obtain, verify and record information that identifies the Borrower and the Guarantors, which information may include their names, addresses, tax identification numbers and other information that will allow each of us and the Lenders to identify the Borrower and the Guarantors in accordance with the PATRIOT Act. This notice is given in accordance with the requirements of the PATRIOT Act and is effective for each of the Commitment Parties and the other Lenders. You hereby agree that the Arranger shall be permitted to share any and all such information with the Lenders.
The compensation, reimbursement, syndication, indemnification and confidentiality provisions contained herein and in the Fee Letter and any other provision herein or therein which by its terms expressly survives the termination of this Commitment Letter shall remain in full force and effect regardless of whether the Facilities Documentation shall be executed and delivered and notwithstanding the termination of this Commitment Letter or the commitments hereunder; provided that, notwithstanding the foregoing, your obligations under this Commitment Letter (other than (a) provisions relating to titles awarded in connection with the Credit Facilities and assistance to be provided by you in connection with the syndication thereof and (b) the confidentiality provisions set forth above) shall automatically terminate and be superseded by the provisions of the Facilities Documentation upon the initial funding thereunder, and you shall automatically be released from all liability in connection therewith at such time.
If the foregoing correctly sets forth our agreement, please indicate your acceptance of the terms of this Commitment Letter and of the Fee Letter by returning to Bank on behalf of the Commitment Parties, executed counterparts hereof and of the Fee Letter not later than 11:59 p.m., New York City time, on December 10, 2014. The Initial Commitment Lenders’ commitments and the obligations of the Commitment Parties hereunder will automatically expire at such time in the event that Bank has not received such executed counterparts in accordance with the immediately preceding sentence. If you do so execute and deliver to us this Commitment Letter and the Fee Letter, we agree to hold our commitment available for you until the earliest of (a) after execution of the Purchase Agreement, the termination of the Purchase Agreement (other than with respect to ongoing indemnities, confidentiality obligations and similar provisions) without the consummation of the Acquisition having occurred, (b) the consummation of the Acquisition with or without the initial funding of the Credit Facilities and (c) 11:59 p.m., New York City time, on the date that is two business days after March 2, 2015 (such earliest time, the “Expiration Date”). Upon the occurrence of any of the events referred to in the preceding sentence, this Commitment Letter and the commitments of the Initial Commitment Lenders hereunder and the agreement of the Commitment Parties to provide the services described herein shall automatically terminate.
We are pleased to have been given the opportunity to assist you in connection with this important financing.
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| Very truly yours, |
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| J.P. MORGAN SECURITIES LLC |
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| By: | /s/ Jeffrey Bracchitta | |
| | Name: Jeffrey Bracchitta | |
| | Title: Executive Director | |
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| JPMORGAN CHASE BANK, N.A. | |
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| By: | /s/ James A. Knight | |
| | Name: James A. Knight | |
| | Title: Vice President | |
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| MERRILL LYNCH, PIERCE, FENNER & SMITH |
| INCORPORATED |
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| By: | /s/ Matt Lynn | |
| | Name: Matt Lynn | |
| | Title: Managing Director | |
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| BANK OF AMERICA, N.A. | |
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| By: | /s/ Monica Sevila | |
| | Name: Monica Sevila | |
| | Title: Senior Vice President | |
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Accepted and agreed to as of | |
the date first above written: | |
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THE ADVISORY BOARD COMPANY | |
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By: | /s/ Michael Kirshbaum | |
| Name: Michael Kirshbaum | |
| Title: Chief Financial Officer | |
EXHIBIT A
Transaction Description
Capitalized terms used but not defined in this Exhibit A shall have the meanings set forth in the Commitment Letter. In the case of any such capitalized term that is subject to multiple and differing definitions, the appropriate meaning thereof in this Exhibit A shall be determined by reference to the context in which it is used.
The Borrower intends to consummate the Acquisition pursuant to the Purchase Agreement.
In connection with the foregoing, it is intended that:
(a) Pursuant to the Purchase Agreement, the Borrower will consummate the Acquisition and, if applicable, the other transactions described therein or related thereto.
(b) The Borrower will obtain $775.0 million in senior secured credit facilities (the “Credit Facilities”) described in Exhibit B to the Commitment Letter consisting of (i) a $725.0 million term loan facility and (ii) a $50.0 million revolving credit facility.
(c) The Borrower will issue $100 million of its common stock directly to the sellers as a portion of the purchase price in connection with the Acquisition.
(d) All existing third-party indebtedness for borrowed money of each of the Borrower, the Target and their respective subsidiaries (which may exclude certain indebtedness that the Arrangers reasonably agree may remain outstanding after the Closing Date) will be refinanced, repaid, redeemed, defeased or otherwise discharged and the Existing Credit Agreement will be terminated.
(e) The proceeds of the Credit Facilities (to the extent borrowed on the Closing Date) will be applied to pay (i) a portion of the purchase price in connection with the Acquisition and (ii) the fees, costs and expenses incurred in connection with the Transactions (such fees and expenses, the “Transaction Costs”).
The transactions described above (including the payment of the Transaction Costs) are collectively referred to herein as the “Transactions.”
EXHIBIT B
CREDIT FACILITIES
Summary of Terms and Conditions
1. PARTIES
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Borrower: | The Borrower, a Delaware corporation. |
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Guarantors: | Each of the Borrower’s direct and indirect, existing and future, material majority-owned domestic subsidiaries, including the Target and the Target’s material majority-owned domestic subsidiaries (collectively, the “Guarantors”; the Borrower and the Guarantors, collectively, the “Loan Parties”), other than a domestic subsidiary (a) that has no material assets other than the equity interests in foreign subsidiaries that are controlled foreign corporations within the meaning of Section 957 of the Internal Revenue Code (a “CFC Holdco”) or (b) that is owned by a foreign subsidiary that is controlled foreign corporation within the meaning of Section 957 of the Internal Revenue Code (a “CFC”); provided that the Guarantors shall not include any domestic subsidiary that is prohibited by applicable law, rule or regulation or by any contractual obligation existing on the Closing Date from guaranteeing any indebtedness. |
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Arrangers: | JPMorgan and Merrill Lynch will act as lead arrangers for the Credit Facilities (together with any additional lead arrangers appointed by the Borrower, each in such capacity, a “Lead Arranger” and collectively, the “Lead Arrangers”), and will perform the duties customarily associated with such roles. Other joint lead arrangers may be appointed by the Borrower as contemplated in the Commitment Letter. |
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Administrative Agent: | JPMorgan Chase Bank (in such capacity, the “Administrative Agent”). |
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Syndication Agent: | At the option of the Borrower, one or more financial institutions identified by the Borrower (in such capacity, the “Syndication Agent”). |
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Documentation Agent: | At the option of the Borrower, one or more financial institutions identified by the Borrower (in such capacity, the “Documentation Agent”). |
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Lenders: | A syndicate of banks, financial institutions and other entities, including the Banks, arranged by the Arrangers (collectively, the “Lenders”). |
2. TYPES AND AMOUNTS OF SENIOR FACILITIES
A. Term Facility
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Type and Amount: | A seven-year term loan facility, subject to increase at the Borrower’s election to the extent required to account for any original issue discount or upfront fees required pursuant to the “market flex” provisions in the Fee Letter (the “Term Facility”), in the amount of $725.0 million (the loans thereunder, the “Term Loans”). The Term Loans shall be repayable in equal quarterly installments of 1.00% per year, commencing on the last business day of the first full fiscal quarter ending after the Closing Date, with the balance payable on the date that is seven years after the Closing Date (the “Term Facility Termination Date”). |
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Maturity: | The Term Facility Termination Date. |
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Availability: | The Term Loans shall be made in a single drawing on the Closing Date (as defined below). |
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Purpose: | The proceeds of the Term Loans shall be used to finance a portion of the Transactions. |
B. Revolving Facility
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Type and Amount: | A five-year revolving facility (the “Revolving Facility”; the commitments thereunder, the “Revolving Commitments”) in the amount of $50.0 million (the loans thereunder, the “Revolving Loans”; and together with the Term Loans, the “Loans”). |
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Availability: | The Revolving Facility shall be available on a revolving basis during the period commencing on the Closing Date and ending on the date that is five years after the Closing Date (the “Revolving Termination Date”). The Revolving Facility shall be available in minimum principal amounts and upon notice to be agreed upon but consistent with this Term Sheet; provided that the amount of Revolving Loans that may be borrowed on the Closing Date shall be limited to an amount sufficient (a) to replace or provide credit support for any existing letters of credit (including by “grandfathering” such existing letters of credit into the Revolving Facility) and (b) to fund any ordinary course working capital requirements of the Borrower and its subsidiaries on the Closing Date and additional amounts not to exceed an aggregate amount to be agreed upon. Amounts repaid or prepaid under the Revolving Facility may be reborrowed. |
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Maturity: | The Revolving Termination Date. |
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Letters of Credit: | A portion of the Revolving Facility not in excess of an amount to be determined shall be available for the issuance of letters of |
credit (the “Letters of Credit”) by JPMorgan Chase Bank and Bank of America, N.A. (each in such capacity, an “Issuing Lender”). No Letter of Credit shall have an expiration date after the earlier of (a) one year after the date of issuance and (b) five business days prior to the Revolving Termination Date, provided that (i) any Letter of Credit with a one-year tenor may provide for the renewal thereof for additional one-year periods (which shall in no event extend beyond the date referred to in clause (b) above), and (ii) if acceptable to the Issuing Lender, Letters of Credit may have expiration dates following the Revolving Termination Date so long as on such Revolving Termination Date any such Letter of Credit is cash collateralized in a manner reasonably satisfactory to the Issuing Lender or such other arrangements as may be acceptable to the Issuing Lender have been put in place.
Drawings under any Letter of Credit shall be reimbursed by the Borrower (whether with its own funds or with the proceeds of Revolving Loans) on the same business day; provided that the Facilities Documentation will provide for conversions of Letter of Credit reimbursement obligations into Revolving Loans upon satisfaction of the “Conditions to All Borrowings” section below. To the extent that the Borrower does not so reimburse the Issuing Lender and the reimbursement obligations are not converted into Revolving Loans, the Lenders under the Revolving Facility shall be irrevocably and unconditionally obligated to reimburse the Issuing Lender on a pro rata basis.
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Purpose: | The proceeds of the Revolving Loans shall be used from time to time on or after the Closing Date to finance the working capital needs of the Borrower and its subsidiaries and for general corporate purposes (including, without limitation, for capital expenditures, acquisitions, investments, restricted payments and any other transaction not prohibited by the Facilities Documentation); provided that the amount of Revolving Loans permitted to be incurred on the Closing Date shall be subject to the restrictions set forth in the “Availability” section above. |
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C. Incremental Facilities: | The Facilities Documentation will permit the Borrower to add one or more incremental term loan facilities to the Credit Facilities (each, an “Incremental Term Facility”) and/or increase commitments under the Revolving Facility (any such increase, an “Incremental Revolving Facility”; the Incremental Term Facilities and the Incremental Revolving Facilities are collectively referred to as “Incremental Facilities”) in an aggregate amount not to exceed (x) $100.0 million (provided the First Lien Leverage Ratio (to be defined in the Facilities Documentation in a customary manner to be agreed upon) on a pro forma basis on the date of incurrence of any such |
Incremental Facility (including any amount thereof proposed to be incurred pursuant to clause (y) below) and after giving effect thereto is no greater than 5.00 to 1.0) plus (y) the amount of any voluntary prepayment of the Term Facility or payment of Revolving Loans accompanied by permanent reductions of the Revolving Commitments not funded with the incurrence of other long-term indebtedness plus (z) any additional amounts so long as such First Lien Leverage Ratio on a pro forma basis on the date of incurrence of any such Incremental Facility and after giving effect thereto is no greater than 4.00 to 1.0; provided that (i) no Lender will be required to participate in any such Incremental Facility, (ii) no event of default or default under the Credit Facilities exists or would exist after giving effect thereto, (iii) the representations and warranties in the Facilities Documentation shall be true and correct in all material respects, (iv) on a pro forma basis on the date of incurrence thereof and after giving effect thereto (assuming, in the case of an Incremental Revolving Facility, the full drawing thereunder), the Financial Covenant would be satisfied, (v) the maturity date of any Incremental Term Facility shall be no earlier than the maturity date for the Term Facility, (vi) the weighted average life to maturity of any Incremental Term Facility shall be no shorter than the weighted average life to maturity of the Term Facility, (vii) the yield for any Incremental Term Facility (each an “Incremental Term Loan”) shall be determined by the Borrower and the lenders of the Incremental Term Facility; provided that, in the event that the “effective yield” for such Incremental Term Facility determined as of the initial funding date for such Incremental Term Facility is greater than the “effective yield” for the then‑existing Term Facility (including any Incremental Term Loans outstanding prior to the incurrence of such additional Incremental Term Loans) by more than 50 basis points, then the “effective yield” for the Term Facility shall be increased to the extent necessary so that the “effective yield” for such Incremental Term Facility is not more than 50 basis points higher than the “effective yield” for the Term Facility, and the “effective yield” for the Revolving Facility shall be increased by a like amount; provided, further, that in determining the “effective yield” applicable to the Term Facility and the “effective yield” for such Incremental Term Facility, (x) original issue discount (“OID”) or upfront fees (which shall be deemed to constitute like amounts of OID) payable by the Borrower for the account of the Lenders of the Term Facility or such Incremental Term Facility in the primary syndication thereof shall be included (with OID being equated to interest based on an assumed four-year life to maturity), (y) customary arrangement or commitment fees payable to the Arrangers (or their affiliates) in connection with the Term Facility or to one or more arrangers (or their affiliates) of such Incremental Term Facility shall be
excluded, and (z) if the LIBOR or Base Rate floor for such Incremental Term Facility is greater than the LIBOR or Base Rate floor, respectively, for the existing Term Facility, the difference between such floor for such Incremental Term Facility and the existing Term Facility shall be equated to an increase in the “effective yield” for purposes of this clause (vii), (viii) each Incremental Facility will be secured by a pari passu lien on the Collateral (as defined below) securing the Credit Facilities in each case on terms and pursuant to documentation reasonably satisfactory to the Administrative Agent and (ix) any Incremental Revolving Facility shall be on terms and pursuant to documentation applicable to the Revolving Facility and any Incremental Term Facility shall be on terms and pursuant to documentation to be determined, provided that, to the extent such terms and documentation are not consistent with the Term Facility (except to the extent permitted by clause (v) or (vi) above), they shall be reasonably satisfactory to the Administrative Agent.
3. CERTAIN PAYMENT PROVISIONS
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Fees and Interest Rates: | As set forth on Annex I. |
Optional Prepayments and
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Commitment Reductions: | Loans may be prepaid and commitments under the Revolving Facility may be reduced by the Borrower in minimum amounts to be agreed upon and without premium or penalty, except as set forth below. Optional prepayments of the Term Loans shall be applied as specified by the Borrower. Optional prepayments of the Term Loans may not be reborrowed. |
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Mandatory Prepayments: | The following amounts shall be applied to prepay the Term Loans: |
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(a) | 100% of the net cash proceeds of any incurrence of indebtedness after the Closing Date by the Borrower or any of its restricted subsidiaries, other than indebtedness permitted under the Facilities Documentation (except permitted refinancing indebtedness). |
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(b) | 100% of the net proceeds of any non-ordinary course asset sale or other non-ordinary course disposition of property (including as a result of casualty or condemnation) by the Borrower or any of its subsidiaries in excess of a threshold to be agreed upon, except for (i) net proceeds from sales of obsolete or worn-out property and property no longer useful in such person’s business, and other customary exceptions to be agreed upon, (ii) net cash proceeds that are reinvested (or |
committed to be reinvested) in the business of the Borrower or any of its subsidiaries within 12 months after such sale or disposition or, if so committed within such 12-month period, reinvested within six months thereafter, and (iii) certain other customary exceptions to be agreed upon.
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(c) | Beginning for the Borrower’s fiscal year ending December 31, 2015, 50% of excess cash flow (to be defined in a customary manner and subject to a minimum threshold to be agreed upon) minus voluntary repayments of the Loans (excluding repayments of Revolving Loans not accompanied by a permanent reduction in the Revolving Commitments and including the amount of cash used for any repayments of the Loans occurring as a result of below-par purchases thereof by the Borrower or any of its subsidiaries) payable no later than 90 days following the fiscal year end for each fiscal year of the Borrower, subject to step-downs for any fiscal year to 25%, if the First Lien Leverage Ratio is less than or equal to 4.00 to 1.00 and 0%, if the First Lien Leverage Ratio is less than or equal to 3.00 to 1.00. In addition to including an adjustment for changes in working capital and deducting cash charges that were added back to Consolidated EBITDA or excluded from the calculation of Consolidated Net Income (and corresponding increases for the reverse), excess cash flow shall be reduced by the amount of cash from operations (i) used during the applicable measurement fiscal year for capital expenditures, permitted acquisitions, certain other investments (including investments in joint ventures) and certain restricted payments to be agreed upon and (ii) at the option of the Borrower, committed for the purpose described in clause (i) for use during the period of the first three months following the measurement fiscal year and before the excess cash flow prepayment date for such measurement year (without duplication). |
Mandatory prepayments of the Term Loans shall be applied first to scheduled installments thereof occurring within the next 12 months in direct order of maturity and second ratably to the remaining respective installments thereof. Mandatory prepayments of the Term Loans may not be reborrowed.
The Revolving Loans shall be prepaid and the Letters of Credit shall be cash collateralized or replaced to the extent such extensions of credit exceed the Revolving Commitments.
Holders of Loans under the Term Facility may decline to accept any mandatory prepayment described above and, under such circumstances, all amounts that would be otherwise used to prepay loans under the Term Facility may be retained by the Borrower and used for any purpose not prohibited by the Facilities Documentation.
Prepayments from excess cash flow and asset sale proceeds of foreign subsidiaries will be subject to customary limitations under the Facilities Documentation, including to the extent that (i) the repatriation of funds to fund such prepayments is prohibited, restricted or delayed by applicable local laws and (ii) the repatriation of funds to fund such prepayments would result in material adverse tax consequences.
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Call Premium: | Any (a) prepayment of the Term Loans using proceeds of indebtedness incurred by the Borrower or any of its subsidiaries from a substantially concurrent incurrence of indebtedness for which the effective yield (determined on the same basis as provided in the “Incremental Facilities” section above) payable thereon on the date of such prepayment is lower than the effective yield applicable to the Term Loans on the date of such prepayment and (b) repricing of the Term Loans pursuant to an amendment to the Facilities Documentation resulting in the effective yield applicable to the Term Loans thereon on the date of such amendment being lower than the effective yield applicable to the Term Loans on the date immediately prior to such amendment plus the Applicable Margin with respect to the Term Loans on the date immediately prior to such amendment shall be accompanied by a prepayment fee equal to 1.0% of the aggregate principal amount of such prepayment (or, in the case of clause (b) above, of the aggregate amount of Term Loans outstanding immediately prior to such amendment) if made following the Closing Date and on or prior to the first anniversary of the Closing Date; provided that no such call premium shall be due and payable to an Initial Commitment Lender pursuant to clause (a) above in respect of Term Loans held since the Closing Date. |
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4. COLLATERAL | Subject in all respects to the Limited Conditionality Provisions and customary exceptions, including exceptions of the type set forth in the Existing Credit Agreement, the obligations of each Loan Party in respect of the Credit Facilities and any swap agreements and cash management arrangements, in either case provided by any Lender or agent (or any affiliate of a Lender or agent) shall be secured by a perfected first priority security interest in substantially all of its tangible and intangible assets (including, without limitation, intellectual property, fee-owned real property and all of the capital stock of the Borrower and |
each of its direct and indirect subsidiaries (limited, in the case of voting capital stock of CFCs and CFC Holdcos, to 65% of the voting capital stock (and 100% of the non-voting capital stock) of such CFCs and CFC Holdcos)), but excluding assets of foreign subsidiaries. Security interests in all of the Collateral shall be created on terms and pursuant to documentation reasonably satisfactory to the Administrative Agent and subject to customary exceptions to be agreed upon, including exceptions of the type set forth in the Existing Credit Agreement. Without limiting the foregoing, any lease, license, permit, contract, property right or agreement otherwise constituting the Collateral shall not be subject to pledges, security interests or mortgages in circumstances in which the subjection of such property to a pledge, security interest or mortgage is not permitted by law, regulation or any such lease, license, permit, contract, property right or agreement (after giving effect to the applicable provisions of the Uniform Commercial Code) and excluding proceeds and receivables thereof, as determined by the Borrower in its commercially reasonable judgment acting in good faith and in consultation with its legal and tax advisors.
5. CERTAIN CONDITIONS
Conditions to Initial
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Borrowing: | The initial borrowing under the Credit Facilities on the Closing Date will be subject to the applicable conditions set forth in numbered paragraph 6 of the Commitment Letter and Exhibit C thereto. The Facilities Documentation shall not contain (a) any conditions other than the conditions expressly set forth in the “Conditions to All Borrowings” section below, numbered paragraph 6 of the Commitment Letter or Exhibit C thereto or (b) any representation or warranty, affirmative, negative or financial covenant or event of default not set forth in numbered paragraph 6 of the Commitment Letter or Exhibit C thereto, the accuracy, compliance or absence, respectively, of or with which would be a condition to the initial borrowing under the Credit Facilities. The failure of any representation or warranty (other than the Specified Purchase Agreement Representations and the Specified Representations to the extent set forth in Exhibit C to the Commitment Letter) to be true and correct in all material respects on the Closing Date will not constitute the failure of a condition to funding or a default under the Credit Facilities. |
Conditions to All Borrowings
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After the Closing Date: | The making of each extension of credit after the Closing Date shall be conditioned upon (a) delivery of a customary borrowing/issuance notice, (b) the accuracy in all material respects (or in all respects if qualified by materiality or material adverse effect) of all representations and warranties in the Facilities |
Documentation (subject, on the Closing Date, to the Limited Conditionality Provisions) and (c) after the Closing Date there being no default or event of default in existence at the time of, or after giving effect to the making of, such extension of credit (in each case, other than in connection with any Incremental Facility incurred or obtained in connection with an acquisition to the extent the acquisition is not conditioned on the availability of, or on obtaining, third-party financing, in which case and to the extent the foregoing conditions are not required by the applicable incremental assumption agreement, the representations and warranties may be limited to the customary “specified representations” and “acquisition agreement representations,” the “default stopper” may be limited to no payment or bankruptcy default or event of default in existence at the time of, or after giving effect to the making of, such extension of credit, and any such other of the foregoing conditions as are not required by the applicable incremental assumption agreement may be excluded as conditions thereunder).
6. CERTAIN DOCUMENTATION MATTERS
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Facilities Documentation: | The definitive documentation with respect to the Credit Facilities (the “Facilities Documentation”) will contain only those mandatory prepayments, representations and warranties, affirmative, financial and negative covenants, and events of default expressly set forth in this Term Sheet and conditions expressly set forth in the “Conditions to All Borrowers” section above, numbered paragraph 6 of the Commitment Letter and Exhibit C thereto and will take into account current market conditions, and in any event will contain only customary loan document provisions and other terms and provisions in each case to be mutually reasonably agreed upon, the definitive terms of which will be negotiated in good faith. |
Representations and
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Warranties: | Subject to customary exceptions and other exceptions and qualifications to be agreed upon (including Material Adverse Effect (as defined below): accuracy of historical financial statements; no material adverse change; corporate existence; compliance with laws and material agreements; corporate power and authority; enforceability of the Facilities Documentation; no conflicts; no material litigation; ownership of property; intellectual property; taxes; Federal Reserve margin regulations; labor matters; ERISA; Investment Company Act of 1940; subsidiaries; insurance; no default; liens; accuracy of disclosure; use of proceeds; environmental matters; true written disclosure in all material respects as of the Closing Date; creation and perfection of security interests in the Collateral; consolidated |
solvency on the Closing Date; PATRIOT Act; FCPA; OFAC; and anti-money laundering laws.
“Material Adverse Effect” means, any event, circumstance or condition that has had or could reasonably be expected to have a material and adverse effect on (i) the business or financial condition of Borrower and its restricted subsidiaries, taken as a whole, (ii) the ability of the Borrower and the Guarantors, taken as a whole, to perform their payment obligations under the Facilities Documentation, or (iii) the rights and remedies of the Agents and the Lenders thereunder.
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Affirmative Covenants: | Subject to customary exceptions and qualifications to be agreed upon: delivery of financial statements; delivery of the Marketing Materials within 5 business days of the Closing Date; accountants’ letters, officers’ certificates and other information reasonably requested by the Lenders; quarterly Lender calls (which shall be satisfied by inviting Lenders to calls with the Borrower’s securities holders); payment of taxes and other obligations; continuation of business and maintenance of existence and of material rights and privileges; compliance with laws (including environmental laws); ERISA; PATRIOT Act; OFAC FCPA; anti-money laundering laws; maintenance of property (other than ordinary wear and tear, casualty and condemnation) and customary insurance; maintenance of books and records; reasonable right of the Administrative Agent to inspect property and books and records (during an Event of Default and other than in respect of information subject to privilege or confidentiality obligations); use of proceeds; subsidiary guarantors; notices of defaults, material adverse litigation, ERISA events and material adverse changes; guaranty and collateral requirements and further assurances (including, without limitation, with respect to security interests in after-acquired property); Syndication assistance (consistent with the Commitment Letter); and use of commercially reasonable efforts to maintain any ratings obtained from S&P or Moody’s. |
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Financial Covenants: | Term Facility: None. |
Revolving Facility: Maintenance of a maximum First Lien Leverage Ratio of 5.75 to 1.00, subject to (a) a step-down to a maximum First Lien Leverage Ratio of 5.25 to 1.00 on March 31, 2016 through December 31, 2016 and (b) an additional step-down to a maximum First Lien Leverage Ratio of 4.75 to 1.00 on December, 31, 2016 through the Revolving Termination Date (the “Financial Covenant”):
The Financial Covenant shall be calculated on a consolidated basis and for each consecutive four fiscal quarter period.
Calculations will be made on a pro forma basis for acquisitions and dispositions outside the ordinary course of business (and incurrences and repayments of indebtedness in connection therewith) including the Transactions, as if they had occurred at the beginning of the applicable period.
The Financial Covenant shall be calculated (a) without giving effect to any election under Accounting Standards Codification 825-10-25 (or any other Accounting Standards Codification or Financial Accounting Standard having a similar result or effect) to value any indebtedness or other liabilities of the Borrower or any subsidiary at “fair value,” as defined therein and (b) without giving effect to any treatment of indebtedness in respect of convertible debt instruments under Accounting Standards Codification 470-20 (or any other Accounting Standards Codification or Financial Accounting Standard having a similar result or effect) to value any such indebtedness in a reduced or bifurcated manner as described therein, and such indebtedness shall at all times be valued at the full stated principal amount thereof.
The Borrower may cure any default under the Financial Covenant by prepaying and terminating the Revolving Facility.
“Consolidated EBITDA” shall be defined in a manner to be mutually agreed upon, but in any event shall include, without duplication, add-backs or deductions, as the case may be, to Consolidated Net Income (as defined below) for (a) taxes, depreciation, amortization and interest expense (including fees and expenses paid in connection with the Credit Facilities), (b) other non-cash charges, gains, income, expenses or losses, (c) fees and expenses in connection with the Transactions, (d) pro forma “run rate” cost savings, operating expense reductions, synergies and operating improvements related to acquisitions, dispositions and other specified transactions, restructurings, cost savings initiatives and other initiatives that are reasonably identifiable and projected by the Borrower in good faith to result from actions that have been taken or initiated or are expected to be taken (in the good faith determination of the Borrower) and realized within 18 months after such acquisition, disposition or other specified transaction, restructuring, cost savings initiative or other initiative subject to a cap of 20% of Consolidated EBITDA in any period of four consecutive quarters, prior to giving effect to the pro forma adjustments for such period; (e) other accruals, costs, charges, fees and expenses (including rationalization, legal, tax, structuring and other costs and expenses) related to acquisitions, investments, dividends, dispositions, restructurings, or issuances of debt or equity, in each case, whether or not consummated, permitted under the
Facilities Documentation, including fees, costs and charges in connection with the Transactions and modifications to the Credit Facilities, (f) letter of credit fees, (g) non-controlling or minority interest expense consisting of income attributable to third parties in non-wholly owned subsidiaries, (h) non-cash costs or expenses incurred pursuant to any management equity plan, stock option plan, benefit plans or any other stock subscription or shareholder agreement and (i) other add-backs and deductions to be mutually agreed upon.
“Consolidated Net Income” in a manner to be mutually agreed upon but in any event shall exclude, without duplication, the following: (a) extraordinary, unusual or non-recurring charges, gains, income, expenses or losses, including restructuring costs, integration costs, retention, recruiting, relocation and signing bonuses, severance costs and post-employment benefit plans, (b) gains or losses from disposed of, abandoned or discontinued operations or fixed assets, (c) after-tax gains or losses attributable to business dispositions and early extinguishment or buy-back of indebtedness, hedging agreements or other derivative instruments, (d) impairment charges or asset write-offs, (e) non-cash gains or losses resulting from fair value accounting required pursuant to GAAP, (f) any negative non-cash impact resulting from expenses due to purchase accounting, (g) gains or losses associated with the valuation of earn-out obligations or hedging obligations, (h) expenses with respect to liability or casualty events, and lost revenues or earnings, in each case to the extent of applicable insurance proceeds received or reasonably expected to be received in respect thereof within 365 days (with a subsequent deduction if not so received) and (i) the cumulative effect of a change in accounting principles to the extent included in net income for the period.
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Unrestricted Subsidiaries: | The Facilities Documentation will contain provisions pursuant to which the Borrower will be permitted to designate any existing or subsequently acquired or organized subsidiary as an “unrestricted subsidiary” and subsequently re-designate any such unrestricted subsidiary as a restricted subsidiary so long as no default or event of default then exists or would result therefrom; provided that after giving effect to any such designation or re-designation, the Borrower and its restricted subsidiaries shall be in pro forma compliance with a customary leverage test to be agreed upon for the most recent period for which financial statements are available. Unrestricted subsidiaries shall not be subject to the mandatory prepayment, representations and warranties, affirmative or negative covenant, financial covenant or event of default provisions of the Facilities Documentation. The results of operations and indebtedness of unrestricted subsidiaries generally will not be taken into account for purposes |
of calculating financial ratios contained in the Facilities Documentation.
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Negative Covenants: | The following negative covenants will apply, subject to (a) customary exceptions and qualifications, (b) other exceptions and qualifications to be agreed upon and (c) the exceptions described below: |
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1. | Limitation on non-ordinary course dispositions of assets, with exceptions permitting, among other transactions, (a) the non-ordinary course disposition of assets in an aggregate annual amount not to exceed $50.0 million, (b) unlimited non-ordinary course dispositions of assets subject only to (i) the Borrower’s receipt of fair market value (as determined by the Borrower in good faith), (ii) at least 75% of the proceeds consisting of cash or cash equivalents (including customary designated non-cash consideration), and (iii) net cash proceeds being reinvested or used to repay indebtedness to the extent required by the mandatory prepayment provisions thereof, (c) the disposition of stock or other equity interests of Evolent Health Holdings, Inc. or Evolent Health LLC, (d) permitted sale and leaseback transactions, (e) dispositions of non-core assets acquired in connection with a permitted acquisition or other permitted investment, provided that the fair market value of such non-core assets shall be less than 25% of the purchase price of such acquisition or the value of such investment, and (f) intercompany transfers, subject to a cap on transfers to non-Loan Parties to be agreed upon. |
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2. | Limitation on mergers with and acquisitions of any entity that becomes a restricted subsidiary to include only (a) the absence of an event of default under the Credit Facilities on the date the agreement for such acquisition is executed and after giving pro forma effect to such acquisition, (b) customary line of business restrictions and (c) a sublimit for non-Guarantor subsidiaries to be agreed upon. |
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3. | Limitations on dividends and other distributions on equity interests, stock repurchases and optional redemptions or optional prepayments of junior indebtedness (collectively, “restricted payments”), with exceptions for, among other restricted payments, (a) permitted refinancings of junior indebtedness, (b) redemption of options and other equity awards issued by the Borrower to any future, present or former directors, officers, employees and consultants (or certain affiliates |
of such persons), up to an annual amount to be mutually agreed upon, (c) additional restricted payments in an aggregate amount not to exceed the applicable “Builder Basket,” which shall be a cumulative amount equal to (i) $50.0 million (the “Starter Basket”), plus (ii) the cumulative retained portion of Excess Cash Flow (i.e., Excess Cash Flow not otherwise required to be applied to prepay the Term Loans; provided that the retained portion of Excess Cash Flow for any fiscal year shall not be less than $0), plus (iii) the cash proceeds of new public or private equity issuances by the Borrower (other than of disqualified stock), plus (iv) the net cash proceeds received by the Borrower from debt and disqualified stock issuances that have been issued after the Closing Date and which have been exchanged or converted into qualified equity, plus (v) returns, profits, distributions and similar amounts received in cash or cash equivalents by the Borrower and its restricted subsidiaries on designated permitted investments, plus (vi) additional assets customarily included in builder baskets in connection with such negative covenant, and (d) unlimited restricted payments if the leverage ratio, to be calculated in a customary fashion to be agreed upon (the “Leverage Ratio”), on a pro forma basis is not greater than 4.0 to 1.0 and subject to no continuing event of default under the Credit Facilities.
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4. | Limitation on indebtedness, which shall, among other exceptions, (a) permit the incurrence of indebtedness, including the assumption of indebtedness in connection with permitted acquisitions, if, after giving effect to the incurrence of such indebtedness and the use of proceeds thereof, the Leverage Ratio on a pro forma basis is not greater than 5.00 to 1.0, (b) permit the incurrence of purchase money indebtedness and capital lease obligations in a principal amount outstanding at any time to be mutually agreed upon, (c) include a general basket for indebtedness in a principal amount outstanding at any time not to exceed the greater of $50.0 million and 5.0% of consolidated total assets, to be calculated in a customary manner to be agreed upon (“Consolidated Total Assets”), (d) permit specified refinancings, including of the Credit Facilities, (e) permit other indebtedness existing on the Closing Date (and refinancings thereof), (f) permit indebtedness of joint ventures and/or indebtedness incurred on behalf thereof or representing guarantees of indebtedness of joint ventures in an aggregate outstanding principal amount not to exceed the greater of $25.0 million and 2.5% of |
Consolidated Total Assets, (g) permit non-speculative hedging arrangements and (h) permit indebtedness equivalent to, and incurred in lieu of, permitted Incremental Facilities, subject to customary limitations.
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5. | Limitation on loans and other investments (collectively, “investments”), which, among other exceptions, shall (a) include a general basket of $75.0 million for all investments plus the Builder Basket (to the extent not otherwise applied), (b) include a basket of $15.0 million for investments in Evolent Health Holdings, Inc. or Evolent Health LLC, (c) permit unlimited acquisitions of entities that will become restricted subsidiaries and Guarantors, (d) include a basket of $30.0 million for investments in non-Guarantor restricted subsidiaries, (e) permit unlimited investments if the Leverage Ratio on a pro forma basis is not greater than 4.25 to 1.0, (f) include a basket of $15.0 million for investments in unrestricted subsidiaries and (g) include a basket of $25.0 million for investment in the entity or entities that will own the Borrower’s new headquarters building and related real and personal property to be made in connection with the Borrower’s entry into a lease of such headquarters building. |
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6. | Limitation on liens, which, among other exceptions, shall (a) permit the incurrence of liens on assets of non-Guarantor subsidiaries so long as such liens secure obligations of non-Guarantor subsidiaries that are otherwise permitted, subject to a cap to be agreed upon, (b) permit liens existing on the Closing Date, (c) include a general basket for liens securing obligations in an amount outstanding at any time not to exceed the greater of $25.0 million and 2.5% of Consolidated Total Assets, (d) permit purchase money indebtedness and capital leases, (e) permit refinancing liens of any liens that were permitted when incurred and (f) permit liens on acquired assets securing indebtedness of any acquired entity that may be assumed in connection with any permitted acquisition; provided that such assumed indebtedness and liens were not incurred in contemplation of the applicable acquisition. |
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7. | Limitation on sale and leaseback transactions with exceptions permitting, among other transactions, (a) sale and leaseback transactions in respect of any excluded property to be mutually agreed upon or any property of a non-Guarantor subsidiary, (b) sale and leaseback transactions in respect of any after-acquired property |
consummated within 365 days after the acquisition thereof and (c) unlimited sale and leaseback transactions if, after giving effect to any such transaction with aggregate net proceeds exceeding $15.0 million, (i) the transaction is for fair market value (as determined in good faith by the Borrower), (ii) at least 75% of the proceeds thereof consist of cash or cash equivalents and (iii) net cash proceeds are reinvested or used to repay indebtedness to the extent required by the mandatory prepayment provisions.
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8. | Limitation on transactions with affiliates, with exceptions permitting, among other matters, (a) transactions effected on an arm’s-length basis, which may be established through approved by a committee of independent directors and shall not require the receipt of a fairness opinion or other third-party valuation or opinion, and (b) transactions among the Borrower and its subsidiaries or among such subsidiaries not otherwise restricted under the Credit Facilities. |
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9. | Limitation on changes in the business of the Borrower and its restricted subsidiaries. |
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10. | Limitation on restrictions of subsidiaries to pay dividends or make distributions. |
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11. | Limitation on changes to fiscal year (other than to conform to the Borrower’s fiscal year) absent consent of the Administrative Agent, provided that this covenant shall not limit the previously-announced change in the Borrower’s fiscal year-end from March 31 to December 31, resulting in a short fiscal year commencing on April 1, 2014 and ending on December 31, 2014. |
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12. | Limitation on modifications to organizational documents. |
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Events of Default: | Nonpayment of principal when due; nonpayment of interest, fees or other amounts after a customary grace period to be agreed upon; material inaccuracy of a representation or warranty when made or deemed made; violation of a covenant (subject, in the case of affirmative covenants, other than notices of default, to a 30-day grace period following written notice from the Administrative Agent); cross-acceleration and cross-default to other material indebtedness; bankruptcy events with respect to the Borrower or a material subsidiary (subject, in the case of certain involuntary events, to a customary grace period to be agreed upon); certain ERISA events subject to Material Adverse |
Effect; default of obligations under material agreements subject to Material Adverse Effect; material unpaid, final judgments that have not been vacated, discharged, stayed or bonded pending appeal within 60 days from the entry thereof; actual or asserted (by a loan party in writing) invalidity of any material guarantee or material security document; and a change of control of the Borrower (as defined in the Existing Credit Agreement). Notwithstanding the foregoing, a breach of the Financial Covenant shall not constitute an event of default for purposes of the Term Facility unless Lenders holding more than 50% of the Revolving Commitments have accelerated the Revolving Facility and/or terminated the Revolving Commitments as a result of such breach.
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Voting: | Amendments and waivers with respect to the Facilities Documentation shall require the approval of Lenders holding more than 50% of the aggregate amount of the Term Loans and Revolving Commitments, except that: (a) the consent of each Lender directly affected thereby shall be required with respect to (i) reductions in the amount or extensions of the scheduled date of amortization or maturity of any Loan, (ii) reductions in the rate of interest (other than a waiver of default interest) or the amount of any fees owed to such Lender (it being understood that any change in the definitions of any ratio used in the calculation of such pricing (or the component definitions) shall not constitute a reduction in any rate of interest or fees, and that Lenders holding more than 50% of the aggregate amount of the Term Loans and Revolving Commitments may waive or amend the Financial Covenant (or the component definitions) or the conditions to borrowing under the Revolving Facility without the consent of any other Lender), and (iii) increases in the amount (other than with respect to any Incremental Facility) or extensions of the expiry date of such Lender’s commitment; and (b) the consent of 100% of the Lenders shall be required with respect to (i) reductions of any of the voting percentages, (ii) modifications of the pro rata payment and payment waterfall provisions, (iii) releases of all or substantially all the Collateral (other than in accordance with the Facilities Documentation) and (iv) releases of all or substantially all of the Guarantors (other than in accordance with the Facilities Documentation); provided that the Facilities Documentation shall include customary provisions for the right of individual Lenders to agree to extend the maturity date of their portion of the Term Loans upon the request of the Borrower and without the consent of any other Lender. The Credit Documentation shall contain provisions to permit the amendment and extension and/or replacement of the Credit Facilities (including any Incremental Facility), which may be provided by the existing Lenders or, subject to the reasonable consent of the Administrative Agent if required under the |
“Assignments and Participations” section below, other persons who become Lenders in connection therewith.
Assignments and
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Participations: | The Lenders shall be permitted to assign all or a portion of their Loans and commitments with the consent, not to be unreasonably withheld or delayed, of: (a) the Borrower (provided that the Borrower shall be deemed to have consented to any such assignment unless it shall object thereto by written notice to the Administrative Agent within 10 business days after having received notice thereof), unless (i) the assignee is a Lender, an affiliate of a Lender or an approved fund or (ii) a payment or bankruptcy (with respect to the Borrower) event of default has occurred and is continuing; (b) the Administrative Agent; and (c) the Issuing Lender, unless a Term Loan is being assigned. Notwithstanding the foregoing, no consent of the Borrower shall be required in connection with assignments of Term Loans in the primary syndication except for a proposed assignment to a Disqualified Lender. Non-pro rata assignments shall be permitted. In the case of partial assignments (other than to another Lender, an affiliate of a Lender or an approved fund), the minimum assignment amount shall be $1,000,000 (in the case of the Term Facility) and $1,000,000 (in the case of the Revolving Facility), in each case unless otherwise agreed upon by the Borrower and the Administrative Agent. The Administrative Agent shall receive from the relevant assignor or assignee a processing and recordation fee of $3,500 in connection with all assignments. The Lenders shall also be permitted to sell participations in their Loans (other than to any Disqualified Lender; provided that the list of Disqualified Lenders shall have been made available to all Lenders). Participants shall have the same benefits as the Lenders with respect to yield protection and increased cost provisions subject to customary limitations. Voting rights of a participant shall be limited to those matters set forth in clause (a) and clause (b) under the “Voting” section above with respect to which the affirmative vote of the Lender from which such participant purchased its participation would be required. Pledges of Loans in accordance with applicable law shall be permitted without restriction. |
The Facilities Documentation shall provide that Term Loans may be purchased by and assigned to the Borrower or any subsidiary (each an “Affiliated Lender”) of the Borrower on a non-pro rata basis through open market purchases or Dutch auctions open to all Lenders on a pro rata basis, in each case subject to customary limitations on such purchases and assignments to be agreed upon and in accordance with customary procedures, including, but not limited to, the
following: (a) the Borrower and its restricted subsidiaries shall cause any loans or commitments assigned to it or them to be cancelled, (b) Affiliated Lenders may not purchase Revolving Loans or Revolving Commitments except from a defaulting Revolving Lender and (c) the Borrower and its subsidiaries may not purchase any loans so long as any event of default has occurred and is continuing.
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Yield Protection: | The Facilities Documentation shall contain customary provisions (a) protecting the Lenders against increased costs or loss of yield resulting from changes in reserve, tax, capital adequacy, liquidity and other requirements of law (including reflecting that both (x) the Dodd-Frank Wall Street Reform and Consumer Protection Act and all requests, rules, guidelines, requirements and directives thereunder, issued in connection therewith or in implementation thereof and (y) all requests, rules, guidelines, requirements and directives promulgated by the Bank for International Settlements, the Basel Committee on Banking Supervision (or any successor or similar authority) or the United States or foreign regulatory authorities, in each case pursuant to Basel III shall, in the case of each of the foregoing clause (x) and clause (y), be deemed to be a change in law regardless of the date enacted, adopted or issued) and from the imposition of or changes in withholding or other taxes and (b) indemnifying the Lenders for “breakage costs” incurred in connection with, among other things, any prepayment of a Eurodollar Loan (as defined in Annex I hereto) on a day other than the last day of an interest period with respect thereto. |
Expenses and
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Indemnification: | The Borrower shall pay (a) all reasonable and documented out-of-pocket expenses of the Administrative Agent and the Arrangers associated with the syndication of the Credit Facilities and the preparation, execution, delivery and administration of the Facilities Documentation and any amendment or waiver with respect thereto (including the reasonable fees, disbursements and other charges of one primary counsel and one local counsel in each applicable jurisdiction and, in the case of any actual or perceived conflict of interest, one additional counsel in each relevant jurisdiction); and (b) all out-of-pocket expenses of the Administrative Agent and the Lenders (including the reasonable fees, disbursements and other charges of one primary counsel and of any special and local counsel to the Administrative Agent and one additional counsel for all Lenders other than the Administrative Agent and additional counsel in light of actual or potential conflicts of interest or the availability of different claims or defenses) in connection with the enforcement of the Facilities Documentation. |
The Administrative Agent, the Arranger and the Lenders (and their affiliates and their respective officers, directors, employees, advisors and agents) will have no liability for, and will be indemnified and held harmless against, any losses, claims, damages, liabilities or expenses incurred in respect of the financing contemplated hereby or the use or the proposed use of proceeds thereof, except to the extent they are found by a final, non-appealable judgment of a court of competent jurisdiction to arise from (1) the (x) bad faith, willful misconduct or gross negligence of the indemnified party, (y) material breach of the Facilities Documentation by the indemnified party pursuant to a claim initiated by the Borrower) or (2) any dispute solely among indemnified parties (not arising as a result of any act or omission by the Borrower or any of its subsidiaries) other than claims against the Administrative Agent, the Issuing Bank, a lead arranger, a bookrunner or any person undertaking a similar role under the Credit Facilities or the Facilities Documentation.
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Defaulting Lenders: | The Facilities Documentation will contain the Administrative Agent’s customary provisions in respect of defaulting lenders. |
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Replacement of Lenders: | The Facilities Documentation will contain customary provisions to be mutually agreed upon in respect of replacement of Lenders. |
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Governing Law and Forum: | State of New York. |
Counsel to the Administrative
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Agent and the Arrangers: | Cahill Gordon & Reindel LLP. |
Annex I to Exhibit B
INTEREST AND CERTAIN FEES
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Interest Rate Options: | The Borrower may elect that the Loans comprising each borrowing bear interest at a rate per annum equal to (a) the ABR plus the Applicable Margin or (b) the Eurodollar Rate plus the Applicable Margin. |
As used herein:
“Applicable Margin” means (a) with respect to Revolving Loans, (i) 2.50%, in the case of ABR Loans and (ii) 3.50%, in the case of Eurodollar Loans, with a step-down to be agreed upon, and (b) with respect to Term Loans, (i) 3.00%, in the case of ABR Loans and (ii) 4.00%, in the case of Eurodollar Loans. The foregoing margins applicable to Revolving Loans shall be subject to change after financial statements have been delivered for two full fiscal quarters after the Closing Date by amounts to be agreed upon based on the achievement of performance targets to be determined and provided that no event of default is in existence.
“Eurodollar Rate” and “ABR” will have meanings customary and appropriate for financings of this type; provided that, with respect to the Term Facility, the Eurodollar Rate will be deemed to be not less than 1.00% per annum and ABR will be deemed to be not less than 100 basis points higher than one-month Eurodollar Rate.
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Interest Payment Dates: | In the case of Loans bearing interest based upon the ABR (“ABR Loans”), quarterly in arrears. |
In the case of Loans bearing interest based upon the Eurodollar Rate (“Eurodollar Loans”) on the last day of each relevant interest period and, in the case of any interest period longer than three months, on each successive date three months after the first day of such interest period.
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Commitment Fees: | The Borrower shall pay a commitment fee calculated at a rate per annum equal to 0.50% on the average daily unused portion of the Revolving Facility, payable quarterly in arrears. Following delivery of financial statements for the first full fiscal quarter after the Closing Date, the Revolving Facility Commitment Fee rate shall be subject to a step-down to 0.375% per annum at a First Lien Leverage Ratio level to be specified in the Facilities Documentation. |
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Letter of Credit Fees: | The Borrower shall pay a fee on all outstanding Letters of Credit at a per annum rate equal to the Applicable Margin then in effect |
with respect to Eurodollar Loans under the Revolving Facility on the face amount of each such Letter of Credit. Such fee shall be shared ratably among the Lenders participating in the Revolving Facility and shall be payable quarterly in arrears.
A fronting fee equal to 0.125% per annum on the face amount of each Letter of Credit shall be payable quarterly in arrears to the Issuing Lender for its own account. In addition, customary administrative, issuance, amendment, payment and negotiation charges shall be payable to the Issuing Lender for its own account.
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Default Rate: | At any time when the Borrower is in default in the payment of any amount of principal due under the Credit Facilities, all outstanding Loans shall bear interest at 2% above the rate otherwise applicable thereto. Overdue interest, fees and other amounts shall bear interest at 2% above the rate applicable to the relevant ABR Loans. |
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Rate and Fee Basis: | All per annum rates shall be calculated on the basis of a year of 360 days (or 365/366 days, in the case of ABR Loans the interest rate payable on which is then based on the Prime Rate) for actual days elapsed. “Prime Rate” means the rate of interest publicly announced by Bank as its prime rate in effect at its principal office in New York City. |
EXHIBIT C
CREDIT FACILITIES
Summary of Additional Conditions
Except as otherwise set forth below, the initial borrowings under the Credit Facilities on the Closing Date shall be subject to the following additional conditions (which shall be satisfied or waived prior to or substantially concurrently with the other Transactions):
(a) The Acquisition shall have been consummated, or shall be consummated substantially concurrently with the initial borrowings under the Credit Facilities, in all material respects in accordance with the terms of the Purchase Agreement, after giving effect to any modifications, amendments, consents or waivers by you thereto or thereunder, other than any modifications, amendments, consents or waivers that are materially adverse to the interests of the Lenders or the Commitment Parties in their capacities as such, unless consented to in writing by the Initial Commitment Lenders (such consent not to be unreasonably withheld, delayed or conditioned); provided that, (i) a reduction in the Acquisition consideration in excess of 10% of the Acquisition consideration (which, for the avoidance of doubt, shall not include any reduction pursuant to any purchase price or similar adjustment provisions set forth in the Purchase Agreement) pursuant to the Purchase Agreement will be deemed to be materially adverse to the interests of the Lenders and the Commitment Parties and will require the written consent of the Initial Commitment Lenders, (ii) a reduction in the Acquisition consideration (which, for the avoidance of doubt, shall not include any reduction pursuant to any purchase price or similar adjustment provisions set forth in the Purchase Agreement) by not in excess of 10% of the Acquisition consideration pursuant to the Purchase Agreement will not be deemed to be materially adverse to the interests of the Lenders or the Commitment Parties and will not require the written consent of the Initial Commitment Lenders (it being understood that any reduction in the Acquisition consideration by not in excess of 10% shall be applied dollar for dollar to reduce the aggregate principal amount of the Term Facility), and (iii) any increase in the Acquisition consideration will not be deemed to be materially adverse to the interests of the Lenders or the Commitment Parties and will not require the written consent of the Initial Commitment Lenders so long as such increase (A) is not in excess of 10% of the Acquisition consideration pursuant to the Purchase Agreement, or (B) is funded solely by (x) the cash proceeds from an issuance of common stock of the Borrower or (y) consideration in the form of the issuance of common stock of the Borrower, or a combination thereof.
(b) The Specified Purchase Agreement Representations shall be true and correct in all material respects to the extent required by the Limited Conditionality Provisions and the Specified Representations shall be true and correct in all material respects (except in the case of any Specified Purchase Agreement Representation or any Specified Representation which expressly relates to a given date or period, such representation and warranty shall be true and correct in all material respects as of the respective date or for the respective period, as the case may be); provided that to the extent that any Specified Representation is qualified by or subject to a “material adverse effect,” “material adverse change” or similar term or qualification, the definition thereof shall be a “Material Adverse Effect” as defined in Exhibit B above for purposes of any such representation and warranty made or deemed made on, or as of, the Closing Date (or a date prior thereto).
(c) After giving effect to the Transactions, the Borrower and its subsidiaries shall have outstanding no third-party indebtedness for borrowed money, other than the Senior Facilities, Excluded Financings and any other indebtedness that the Arrangers reasonably agree may remain outstanding after the Closing Date. The Administrative Agent shall have received reasonably satisfactory evidence of repayment of all indebtedness to be repaid on the Closing Date and of the discharge (or the making of arrangements for discharge) of all indebtedness and liens other than indebtedness and liens permitted to remain outstanding under the Facilities Documentation.
(d) All fees required to be paid on the Closing Date pursuant to the Commitment Letter and the Fee Letter and reasonable and documented out-of-pocket expenses required to be paid on the Closing Date pursuant to the Commitment Letter with respect to expenses, to the extent invoiced at least three business days prior to the Closing Date, shall, upon the initial borrowing under the Credit Facilities, have been paid.
(e) Except as set forth in the Disclosure Schedules (as defined in the Purchase Agreement), since June 30, 2014, there shall not have occurred a Company Material Adverse Effect with respect to the Target and its subsidiaries. For purposes of this condition, “Company Material Adverse Effect” shall be defined as defined in the Section 9.01 of the Purchase Agreement as in effect on the date hereof.
(f) The Arrangers shall have received (i) audited consolidated balance sheets of the Borrower and its consolidated subsidiaries as at the end of, and related statements of income, comprehensive income and cash flows of the Borrower and its consolidated subsidiaries for, the three most recently completed fiscal years of the Borrower and (ii) an unaudited consolidated balance sheet of the Borrower and its consolidated subsidiaries as at the end of, and related statements of income, comprehensive income and cash flows of the Borrower and its consolidated subsidiaries for, each fiscal quarter of the Borrower and its consolidated subsidiaries subsequent to the last fiscal year for which financial statements were prepared pursuant to the preceding clause (i) and ended at least 45 days before the Closing Date, together with financial statements for each corresponding fiscal quarter of the previous year, in each case, prepared in accordance with GAAP (it being agreed that the Arrangers have received the audited financial statements required by clause (i) and the unaudited financial statements required by clause (ii) for the fiscal quarters ended June 30, 2014 and September 30, 2014).
(g) The Arrangers shall have received (i) audited consolidated balance sheets of Royall Acquisition Co. and its consolidated Subsidiaries as of June 30, 2014, 2013 and 2012, (ii) audited statements of income, comprehensive income and cash flows of (A) Royall Acquisition Co. and its consolidated Subsidiaries for each of the two years in the period ended June 30, 2014, (B) Royall Acquisition Co. and its consolidated Subsidiaries for the period from December 23, 2011 to June 30, 2012 and (C) the predecessor company of Royall Acquisition Co. and its consolidated Subsidiaries for the period from July 1, 2011 to December 22, 2011, all reported on by PricewaterhouseCoopers LLP (without a “going concern” or like qualification or exception and without any qualification or exception as to the scope of such audit) to the effect that such consolidated financial statements have been prepared in accordance with GAAP, consistently applied throughout the periods indicated, and present fairly in all material respects the consolidated financial condition and results of operations , in each case, of the applicable company and its Subsidiaries (taken as a whole) as of the dates and for the periods referred to therein, (iii) in in form satisfying the requirements of PCAOB AU Section 722, Interim Financial
Information (SAS 100), (A) unaudited consolidated balance sheets of Royall Acquisition Co. and its consolidated Subsidiaries as of each of September 30, 2014, and September 30, 2013, (B) unaudited consolidated statements of income and comprehensive income of Royall Acquisition Co. and its consolidated Subsidiaries for each of the three-month periods ended September 30, 2014, June 30, 2014 and September 30, 2013 and (C) unaudited consolidated statements of cash flows of Royall Acquisition Co. and its consolidated Subsidiaries for each of the three-month periods then ended September 30, 2014 and September 30, 2013.
(h) The Arrangers shall have received a pro forma consolidated balance sheet and related pro forma consolidated statement of income of the Borrower as of, and for the twelve-month period ending on, the last day of the most recently completed four-fiscal quarter period ended at least 45 days (or 90 days, if such four-fiscal quarter period is the end of the Borrower’s fiscal year) prior to the Closing Date, prepared in good faith by the Borrower after giving effect to the Transactions as if the Transactions had occurred as of such date (in the case of such balance sheet) or at the beginning of such period (in the case of such income statement), but need not include adjustments for purchase accounting (including adjustments of the type contemplated by Financial Accounting Standards Board Accounting Standards Codification 805, Business Combinations (formerly SFAS 141R)).
(i) Subject in all respects to the Limited Conditionality Provisions, all documents and instruments required to perfect the Administrative Agent’s first priority security interest in the Collateral shall have been executed and delivered and, if applicable, be in proper form for filing.
(j) The Facilities Documentation shall have been executed and delivered by the signatories party thereto and the Administrative Agent shall have received (i) customary closing certificates, borrowing notices, legal opinions, corporate documents and resolutions or other evidence of authority for the Loan Parties and (ii) a solvency certificate from the chief financial officer of the Borrower, in the form attached as Annex A hereto.
(k) The Administrative Agent and the Arrangers shall have received, at least three business days prior to the Closing Date, all documentation and other information about the Borrower and the Guarantors that shall have been reasonably requested by the Administrative Agent or the Arrangers in writing at least 10 business days prior to the Closing Date and that the Administrative Agent and the Arrangers reasonably determine is required by United States regulatory authorities under applicable “know your customer” and anti-money laundering rules and regulations, including, without limitation, the PATRIOT Act.
(l) The closing and initial funding of the Credit Facilities shall have occurred on or before the Expiration Date.
ANNEX A
Form of Solvency Certificate
[ ], 201[ ]
This Solvency Certificate (this “Certificate”) is delivered pursuant to Section [ ] of the Credit Agreement, dated as of [ ] (as amended, supplemented or otherwise modified through the date hereof, the “Credit Agreement”), by and among The Advisory Board Company (the “Borrower”), the lending institutions from time to time parties thereto and [ ], as the Administrative Agent. Unless otherwise defined herein, capitalized terms used in this Certificate shall have the meanings set forth in the Credit Agreement.
I, [ ], the Chief Financial Officer of the Borrower, in that capacity only and not in my individual capacity (and without personal liability), DO HEREBY CERTIFY on behalf of the Borrower that as of the date hereof, and based upon facts and circumstances as they exist as of the date hereof (and disclaiming any responsibility for changes in such facts and circumstances after the date hereof), that:
1. For purposes of this certificate, the terms below shall have the following definitions:
(a) “Fair Value”
The amount at which the assets (both tangible and intangible), in their entirety, of the Borrower and its subsidiaries taken as a whole would change hands between a willing buyer and a willing seller, within a commercially reasonable period of time, each having reasonable knowledge of the relevant facts, with neither being under any compulsion to act.
(b) “Present Fair Salable Value”
The amount that could be obtained by an independent willing seller from an independent willing buyer if the assets of the Borrower and its subsidiaries taken as a whole are sold with reasonable promptness in an arm’s-length transaction under present conditions for the sale of comparable business enterprises insofar as such conditions can be reasonably evaluated.
(c) “Liabilities”
The recorded liabilities (including contingent liabilities that would be recorded in accordance with GAAP) of the Borrower and its subsidiaries taken as a whole, as of the date hereof after giving effect to the consummation of the Transactions, determined in accordance with GAAP consistently applied.
(d) “Will be able to pay their Liabilities as they mature”
For the period from the date hereof through the Maturity Date, the Borrower and its subsidiaries on a consolidated basis taken as a whole will have sufficient assets and cash flow to pay their Liabilities as those liabilities mature or (in the case of contingent Liabilities) otherwise become payable, in light of business conducted or anticipated to be conducted by the Borrower and its subsidiaries as reflected in the projected financial statements and in light of the anticipated credit capacity.
(e) “Do not have Unreasonably Small Capital”
The Borrower and its subsidiaries on a consolidated basis taken as a whole after consummation of the Transactions is a going concern and has sufficient capital to reasonably ensure that it will continue to be a going concern for the period from the date hereof through the Maturity Date. I understand that “unreasonably small capital” depends upon the nature of the particular business or businesses conducted or to be conducted, and I have reached my conclusion based on the needs and anticipated needs for capital of the business conducted or anticipated to be conducted by the Borrower and its subsidiaries on a consolidated basis as reflected in the projected financial statements and in light of the anticipated credit capacity.
2. Based on and subject to the foregoing, I hereby certify on behalf of the Borrower that after giving effect to the consummation of the Transactions, it is my opinion that (i) the Fair Value of the assets of the Borrower and its subsidiaries on a consolidated basis taken as a whole exceeds their Liabilities; (ii) the Present Fair Salable Value of the assets of the Borrower and its subsidiaries on a consolidated basis taken as a whole exceeds their Liabilities; (iii) the Borrower and its subsidiaries on a consolidated basis taken as a whole do not have Unreasonably Small Capital; and (iv) the Borrower and its subsidiaries taken as a whole will be able to pay their Liabilities as they mature.
3. In reaching the conclusions set forth in this Certificate, the undersigned has made such investigations and inquiries as the undersigned has deemed appropriate, having taken into account the nature of the particular business anticipated to be conducted by the Borrower and the Subsidiaries after consummation of the transactions contemplated by the Credit Agreement.
[Remainder of Page Intentionally Left Blank]
IN WITNESS WHEREOF, I have executed this Certificate as of the date first written above.
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| The Advisory Board Company |
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| By: | |
| | Name: |
| | Title: Chief Financial Officer |
Exhibit 10.40
FORM OF
THE ADVISORY BOARD COMPANY
AWARD AGREEMENT FOR
INDUCEMENT RESTRICTED STOCK UNITS
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(1) | Grant. Pursuant to the provisions of The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees (the “Plan”), you, a Participant, have been granted a Restricted Stock Unit Award of Restricted Stock Units (“RSUs”). The grant to you of the RSUs is subject to the following provisions, as well as to the Vesting Schedule (the “Vesting Schedule”) and the Standard Terms and Conditions for Restricted Stock Units (the “Standard Terms and Conditions”), copies of which are attached hereto, and the Plan. |
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(2) | Basic Principles. The initial value of one share of common stock, par value $0.01 per share (“Common Stock”), of The Advisory Board Company (the “Company”) for purposes of determining the value of each RSU is $___. At such time as the RSU becomes payable to you, the award may be settled all or partly in cash or all or partly in ___________ shares of Common Stock, as will be determined in the sole discretion of the Administrator of the Plan at such time. In addition, the award to be paid to you will be subject to applicable Federal, state and local tax withholding. When the RSU becomes payable to you, the resulting compensation will not increase or otherwise affect your benefits under any other benefit program maintained by the Company. |
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(3) | Vesting Rules. Your ability to receive a payment in respect of an RSU will depend upon the vesting provisions associated with the RSU. Your RSUs will be paid to you as they become vested as set forth below in the Standard Terms and Conditions. Except as specifically set forth in this Agreement, in the event that you terminate employment or are no longer in the service of the Company for any reason, all of your then-unvested RSUs will be forfeited. |
Your RSUs will vest pursuant to the Vesting Schedule attached hereto.
By executing this Agreement, you hereby agree that the grant of your RSU award is subject to all the provisions of Plan, the Vesting Schedule, and to the Standard Terms and Conditions. Should you have any questions with respect to this document or the rules pertaining to the RSU, please contact a Company representative.
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THE ADVISORY BOARD COMPANY | | PARTICIPANT |
By: | | By: |
Name: | | Name: |
Title: | | Address: |
THE ADVISORY BOARD COMPANY
STANDARD TERMS AND CONDITIONS FOR
INDUCEMENT RESTRICTED STOCK UNITS
These Standard Terms and Conditions apply to any Award of Restricted Stock Units granted to a Participant under The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees (the “Plan”), which are evidenced by an Award Agreement for Restricted Stock Units or an action of the Administrator that specifically refers to these Standard Terms and Conditions. Certain capitalized terms not otherwise defined herein are defined in the Plan.
1.TERMS OF RESTRICTED STOCK UNITS
THE ADVISORY BOARD COMPANY, a Delaware corporation (the “Company”), has granted to the Participant named in the Restricted Stock Unit Agreement provided to said Participant herewith (the “RSU Agreement”) an award of a number of Restricted Stock Units (the “Award”) specified in the RSU Agreement. Each Restricted Stock Unit represents the right to receive one share of the Company's common stock, $0.01 par value per share (the “Common Stock”), upon the terms and subject to the conditions set forth in the RSU Agreement, including the Vesting Schedule attached thereto (the “Vesting Schedule”), these Standard Terms and Conditions, and the Plan, each as amended from time to time. For purposes of these Standard Terms and Conditions and the RSU Agreement, any reference to the Company shall, unless the context requires otherwise, include a reference to any Subsidiary.
2.VESTING OF RESTRICTED STOCK UNITS
The Award shall not be vested as of the Grant Date set forth in the RSU Agreement and shall be forfeitable unless and until otherwise vested pursuant to the terms of the RSU Agreement, the Vesting Schedule, and these Standard Terms and Conditions.
After the Grant Date, subject to termination as provided in the Vesting Schedule, these Standard Terms and Conditions or the Plan, or except as otherwise determined or approved by the Administrator, the Award shall become vested as described in the Vesting Schedule with respect to that number of Restricted Stock Units as set forth in the RSU Agreement. Each date on which Restricted Stock Units subject to the Award vest is referred to herein as a “Vesting Date.” For purposes of this Award, the Vesting Date will refer to that date in the Calculation Month that the Company determines whether RSUs have vested. Notwithstanding anything herein or in the RSU Agreement to the contrary, if a Vesting Date is not a business day, the applicable portion of the Award shall vest on the next following business day. Restricted Stock Units granted under the Award that have vested and are no longer subject to forfeiture are referred to herein as “Vested Units.” Restricted Stock Units granted under the Award that are not vested and remain subject to forfeiture are referred to herein as “Unvested Units.” The vesting period of an Award shall be suspended by the Administrator during any period in which the Participant is on an approved leave of absence.
3.SETTLEMENT OF RESTRICTED STOCK UNITS
Each Vested Unit will be settled by the delivery of one share of Common Stock or cash in an amount equivalent to the value of one share of Common Stock (or any combination of cash and Common Stock as may be determined in the sole discretion of the Administrator), subject to adjustment under Section 10 of the Plan, to the Participant or, in the event of the Participant's death, to the Participant's estate, heir or beneficiary, as soon as practicable following the applicable Vesting Date but in no event later than March 15 of the year that immediately follows the end of the Applicable Period; provided that the Participant has satisfied all of the tax withholding obligations described in Section 6 below, and that the Participant has completed, signed and returned any documents and taken any additional action that the Company deems appropriate to enable it to accomplish the delivery of the shares of Common Stock and/or cash. The issuance of any shares of Common Stock hereunder may be effected by the issuance of a stock certificate, recording shares on the stock records of the Company or by crediting shares in an account established on the Participant's behalf with a brokerage firm or other custodian, in each case as determined by the Company. Fractional shares will not be issued pursuant to the Award.
Notwithstanding the above, (i) for administrative or other reasons, the Company may from time to time temporarily suspend the issuance of shares of Common Stock in respect of Vested Units, (ii) the Company shall not be obligated to deliver any shares of the Common Stock during any period when the Company determines that the delivery of shares hereunder would violate any federal, state or other applicable laws, (iii) the Company may issue shares of Common Stock hereunder subject to any restrictive legends that, as determined by the Company's counsel, are necessary to comply with securities or other regulatory requirements, and (iv) the date on which shares are issued hereunder may include a delay in order to provide the Company such time as it determines appropriate to address tax withholding and other administrative matters.
4.RIGHTS AS STOCKHOLDER
Prior to any issuance of shares of Common Stock in settlement of the Award, no shares of Common Stock will be reserved or earmarked for the Participant or the Participant's account nor shall the Participant have any of the rights of a stockholder with respect to such shares. The Participant will not be entitled to any privileges of ownership of the shares of Common Stock (including, without limitation, any voting or dividend rights) underlying Vested Units and/or Unvested Units unless and until shares of Common Stock are actually delivered to the Participant hereunder.
5.RESTRICTIONS ON RESALES OF SHARES
The Company may impose such restrictions, conditions or limitations as it determines appropriate as to the timing and manner of any resales by the Participant or other subsequent transfers by the Participant of any shares of Common Stock issued in respect of Vested Units, including without limitation (a) restrictions under an insider trading policy or pursuant to applicable law, (b) restrictions designed to delay and/or coordinate the timing and manner of sales by Participant and other holders and (c) restrictions as to the use of a specified brokerage firm for such resales or other transfers.
6.INCOME TAXES; TAX WITHHOLDING OBLIGATIONS
The Participant will be subject to federal and state income and other tax withholding requirements on a date (generally, the Vesting Date) determined by applicable law (any such date, the “Taxable Date”), based on the Fair Market Value of the shares of Common Stock underlying the Restricted Stock Units that vest on the Vesting Date. The Participant will be solely responsible for the payment of all U.S. federal income and other taxes, including any state, local or non-U.S. income or employment tax obligation that may be related to the Vested Units, including any such taxes that are required to be withheld and paid over to the applicable tax authorities (the “Tax Withholding Obligation”). The Participant will be responsible for the satisfaction of such Tax Withholding Obligation in a manner acceptable to the Company in its sole discretion.
By accepting the Award the Participant agrees that, unless the Company specifies that the Participant must otherwise satisfy any withholding obligations, the Company is authorized to withhold from the shares of Common Stock issuable or cash equivalent value payable to the Participant in respect of Vested Units the whole number of shares or cash equivalent having a value (as determined by the Company consistent with any applicable tax requirements) on the Taxable Date or the first trading day before the Taxable Date sufficient to satisfy the applicable Tax Withholding Obligation. If the withheld shares are not sufficient to satisfy the Participant's Tax Withholding Obligation, the Participant agrees to pay to the Company as soon as practicable any amount of the Tax Withholding Obligation that is not satisfied by the withholding of shares of Common Stock described above.
The Company may refuse to issue any shares of Common Stock to the Participant until the Participant satisfies the Tax Withholding Obligation. The Participant acknowledges that the Company has the right to retain without notice from shares issuable under the Award or from salary or other amounts payable to the Participant, shares or cash having a value sufficient to satisfy the Tax Withholding Obligation.
The Participant is ultimately liable and responsible for all taxes owed by the Participant in connection with the Award, regardless of any action the Company takes or any transaction pursuant to this Section 6 with respect to any Tax Withholding Obligations that arise in connection with the Award. The Company makes no representation or undertaking
regarding the treatment of any tax withholding in connection with the grant, issuance, vesting or settlement of the Award or the subsequent sale of any of the shares of Common Stock underlying Vested Units. The Company does not commit and is under no obligation to structure the Award to reduce or eliminate the Participant's tax liability.
7.NON-TRANSFERABILITY OF AWARD
Unless otherwise provided by the Administrator, the Participant may not assign, transfer or pledge the Award, the shares of Common Stock subject thereto or any right or interest therein to anyone other than by will or the laws of descent and distribution. The Company may cancel the Participant's Award if the Participant attempts to assign or transfer it in a manner inconsistent with this Section 7.
8.THE PLAN AND OTHER AGREEMENTS
In addition to these Standard Terms and Conditions, the Award shall be subject to the terms of the Plan, which are incorporated into these Standard Terms and Conditions by this reference. In the event of a conflict between the terms and conditions of these Standard Terms and Conditions and the Plan, the Plan controls.
The RSU Agreement, the Vesting Schedule, these Standard Terms and Conditions and the Plan constitute the entire understanding between the Participant and the Company regarding the RSUs. Any other prior agreements, commitments or negotiations concerning the RSUs are superseded. The RSU Agreement, the Vesting Schedule and these Standard Terms and Conditions may, however, be amended by a subsequent agreement between the Company and a Participant that specifically addresses the treatment of the Award.
9.LIMITATION OF INTEREST IN SHARES SUBJECT TO AWARD
Neither the Participant (individually or as a member of a group) nor any beneficiary or other person claiming under or through the Participant shall have any right, title, interest, or privilege in or to any shares of Common Stock allocated or reserved for the purpose of the Plan or subject to the RSU Agreement or these Standard Terms and Conditions except as to such shares of Common Stock, if any, as shall have been issued to such person in respect of Vested Units.
10.NOT A CONTRACT FOR EMPLOYMENT
Nothing in the Plan, in the RSU Agreement, the Vesting Schedule, these Standard Terms and Conditions or any other instrument executed pursuant to the Plan shall confer upon the Participant any right to continue in the Company's employ or service nor limit in any way the Company's right to terminate the Participant's employment or service at any time for any reason.
11.NO LIABILITY OF COMPANY
The Company and any affiliate that is in existence or hereafter comes into existence shall not be liable to the Participant or any other person as to: (a) the non-issuance or sale of shares of Common Stock as to which the Company has been unable to obtain from any regulatory body having jurisdiction the authority deemed by the Company's counsel to be necessary to the lawful issuance and sale of any shares hereunder; and (b) any tax consequence expected, but not realized, by the Participant or other person due to the receipt, vesting or settlement of any Award granted hereunder.
12.NOTICES
All notices, requests, demands and other communications pursuant to these Standard Terms and Conditions shall be in writing and shall be deemed to have been duly given if personally delivered, telexed or telecopied to, or, if mailed, when received by, the other party at the following addresses (or at such other address as shall be given in writing by either party to the other):
If to the Company to:
The Advisory Board Company
2445 M Street, N.W.
Washington, D.C. 20037
Attention: Administrator of Stock Incentive Plan
If to the Participant, to the address set forth below the Participant's signature on the RSU Agreement.
13.GENERAL
In the event that any provision of these Standard Terms and Conditions is declared to be illegal, invalid or otherwise unenforceable by a court of competent jurisdiction, such provision shall be reformed, if possible, to the extent necessary to render it legal, valid and enforceable, or otherwise deleted, and the remainder of these Standard Terms and Conditions shall not be affected except to the extent necessary to reform or delete such illegal, invalid or unenforceable provision.
The headings preceding the text of the sections hereof are inserted solely for convenience of reference, and shall not constitute a part of these Standard Terms and Conditions, nor shall they affect its meaning, construction or effect.
These Standard Terms and Conditions shall inure to the benefit of and be binding upon the parties hereto and their respective permitted heirs, beneficiaries, successors and assigns.
14.FURTHER ASSURANCES
Participant shall cooperate and take such action as may be reasonably requested by the Company to carry out the provisions and purposes of these Standard Terms and Conditions. Participant acknowledges and agrees that the terms and conditions of this Award, including the performance metrics set forth in the Vesting Schedule are sensitive and proprietary to the Company. The Participant shall not disclose the terms and conditions of this Award to any other person other than to Participant’s legal or tax advisor in connection with obtaining legal or tax advice. Any breach of this provision may result in forfeiture of the Award.
15.ELECTRONIC DELIVERY
The Company may, in its sole discretion, decide to deliver any documents related to any awards granted under the Plan by electronic means or to request the Participant's consent to participate in the Plan by electronic means. By accepting the Award, the Participant consents to receive such documents by electronic delivery and, if requested, to agree to participate in the Plan through an on-line or electronic system established and maintained by the Company or another third party designated by the Company, and such consent shall remain in effect throughout the Participant's term of employment or service with the Company and thereafter until withdrawn in writing by the Participant.
16.SECTION 409A COMPLIANCE
Notwithstanding anything in this Agreement to the contrary:
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A. | a termination of employment or service shall not be deemed to have occurred for purposes of settlement of any portion of the Award upon or following a termination of employment or service unless such termination is also a "separation from service" within the meaning of Section 409A of the Code and, for purposes of any such provision of the RSU Agreement or these Standard Terms and Conditions, references to a "termination," "termination of employment" or like terms shall mean "separation from service;" and |
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B. | if Participant is deemed on the date of termination to be a "specified employee" within the meaning of that term under Section 409A(a)(2)(B) of the Code, then with regard to the settlement of any portion of the Award that is considered deferred compensation under Section 409A of the Code payable on account of a "separation from service," such settlement shall occur on the date that is the earlier of (i) the expiration of the six-month period measured from the date of such "separation from service" of the Participant, and (ii) the date of Participant's death. |
Exhibit 10.41
FORM OF
THE ADVISORY BOARD COMPANY
AWARD AGREEMENT FOR
INDUCEMENT NON-QUALIFIED STOCK OPTIONS
FOR GOOD AND VALUABLE CONSIDERATION, The Advisory Board Company, a Delaware corporation (the “Company”), hereby grants to Optionee named below the stock option (the “Option”) to purchase any part or all of the number of shares of its common stock, par value $0.01 per share (the “Common Stock”), that are covered by this Option, as specified below, at the Exercise Price per share specified below and upon the terms and subject to the conditions set forth in this Award Agreement, The Advisory Board Company Inducement Stock Incentive Plan for Royall Employees (as may be amended from time to time, the “Plan”), the Vesting Schedule, a copy of which is attached hereto, and the Standard Terms and Conditions for Non-Qualified Stock Options, a copy of which is attached hereto, as may be amended from time to time. This Option is granted pursuant to the Plan and is subject to and qualified in its entirety by the Plan.
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Plan: |
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Name of Optionee: |
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Grant Date: |
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Number of Shares of Common Stock covered by Option: |
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Exercise Price Per Share: |
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Expiration Date: |
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This Option is not intended to qualify as an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended. By executing and delivering this Award Agreement, Optionee acknowledges that he or she has received and read, and agrees that this Option shall be subject to, the terms of this Award Agreement, the Vesting Schedule attached hereto and made a part hereof, the Standard Terms and Conditions attached hereto and made a part hereof, and the Plan.
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THE ADVISORY BOARD COMPANY | | THE OPTIONEE |
By: | | |
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Name: | | Name: |
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Title: | | Address: |
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THE ADVISORY BOARD COMPANY
STANDARD TERMS AND CONDITIONS FOR
INDUCEMENT NON-QUALIFIED STOCK OPTIONS
1. TERMS OF OPTION
The Advisory Board Company, a Delaware corporation (the “Company”), has granted to the Optionee named in the Award Agreement to which these Standard Terms and Conditions are attached (the “Award Agreement”) options (the “Option”) to purchase any part or all of the number of shares of the Company’s common stock, $0.01 par value per share (the “Common Stock”), set forth in the Award Agreement, at the purchase price per share and upon the other terms and subject to the conditions set forth in the Award Agreement, including the Vesting Schedule attached thereto (the “Vesting Schedule”), these Standard Terms and Conditions, and the Plan specified in the Award Agreement (the “Plan”). For purposes of these Standard Terms and Conditions and the Award Agreement, any reference to the Company shall include a reference to any Subsidiary. Certain capitalized terms not otherwise defined herein are defined in the Plan.
2. EXERCISE OF OPTION
The exercise price (the “Exercise Price”) of the Option is set forth in the Award Agreement. To the extent not previously exercised (and subject to termination as provided in these Standard Terms and Conditions or the Plan, or as determined or approved by the Administrator), the Option shall be exercisable on and after the date and to the extent it becomes vested, as described in the Vesting Schedule, to purchase up to that number of shares of Common Stock as set forth in the Award Agreement.
To exercise the Option (or any part thereof), the Optionee shall deliver a “Notice of Exercise” to the Company specifying the number of whole shares of Common Stock the Optionee wishes to purchase and how the Optionee’s shares of Common Stock should be registered (in the Optionee’s name only or in the Optionee’s and the Optionee’s spouse’s names as community property or as joint tenants with right of survivorship).
The Company shall not be obligated to issue any shares of Common Stock until the Optionee shall have paid the total Exercise Price for that number of shares of Common Stock. The Exercise Price may be paid:
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B. | by payment under an arrangement with a broker where payment is made pursuant to an irrevocable commitment by a broker to deliver all or part of the proceeds from the sale of the Option shares to the Company, |
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C. | by tendering (either physically or by attestation) shares of Common Stock owned by the Optionee that have a fair market value on the date of exercise equal to the total Exercise Price but only if such will not result in an accounting charge to the Company, or |
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D. | by any combination of the foregoing or in such other form(s) of consideration as the Administrator (as defined in the Plan) in its discretion shall specify. |
Fractional shares may not be exercised. Shares of Common Stock will be issued as soon as practical after exercise. Notwithstanding the above, the Company shall not be obligated to deliver any shares of Common Stock during any period when the Company determines that the exercisability of the Option or the delivery of shares hereunder would violate any federal, state or other applicable laws.
3. EXPIRATION OF OPTION
Except as provided in this Section 3 or as set forth in the Vesting Schedule, the Option shall expire and cease to be exercisable as of the Expiration Date set forth in the Award Agreement or, if earlier, as set forth below:
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A. | Upon the death of the Optionee while in the employ of the Company or any Subsidiary or while serving as a member of the Board, or upon the date of a termination of the Optionee’s employment as a result of the Total and Permanent Disablement of the Optionee, (i) any part of the Option that is unexercisable as of the date of death or termination, as the case may be, shall remain unexercisable and shall terminate as of such date and (ii) any part of the Option that is exercisable as of the date of death or termination, as the case may be, shall expire on the earlier of twelve (12) months following such date and the Expiration Date of the Option. |
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B. | Upon the date of a termination of the Optionee’s employment or service with the Company, (i) any part of the Option that is unexercisable as of such termination date shall remain unexercisable and shall terminate as of such date, and (ii) any part of the Option that is exercisable as of such termination date shall expire on the earlier of ninety (90) days following such date or the Expiration Date of the Option. |
4. RESTRICTIONS ON RESALES OF OPTION SHARES
The Company may impose such restrictions, conditions or limitations as it determines appropriate as to the timing and manner of any resales by the Optionee or other subsequent transfers by the Optionee of any shares of Common Stock issued as a result of the exercise of the Option, including without limitation (a) restrictions under an insider trading policy or pursuant to applicable law, (b) restrictions designed to delay and/or coordinate the timing and manner of sales by Optionee and other optionholders and (c) restrictions as to the use of a specified brokerage firm for such resales or other transfers.
5. INCOME TAXES; TAX WITHHOLDING OBLIGATIONS
The Optionee will be subject to federal and state income and other tax withholding requirements on the date determined by applicable law (generally, the date of exercise), based on the excess of the fair market value of the shares of Common Stock underlying the portion of the Option that is exercised over the Exercise Price. The Optionee will be solely responsible for the payment of all U.S. federal income and other taxes, including any state, local or non-U.S. income or employment tax obligation that may be related to the exercise of the Option, including any such taxes that are required to be withheld and paid over to the applicable tax authorities (the “Tax Withholding Obligation”). The Optionee will be responsible for the satisfaction of such Tax Withholding Obligation in a manner acceptable to the Company in its sole discretion.
The Company may refuse to issue any shares of Common Stock to the Optionee until the Optionee satisfies the Tax Withholding Obligation. The Optionee acknowledges that the Company has the right to retain without notice from shares issuable upon exercise of the Option (or any portion thereof) or from salary or other amounts payable to the Optionee, shares or cash having a value sufficient to satisfy the Tax Withholding Obligation.
The Optionee is ultimately liable and responsible for all taxes owed by the Optionee in connection with the Option, regardless of any action the Company takes or any transaction pursuant to this Section 5 with respect to any Tax Withholding Obligations that arise in connection with the Option. The Company makes no representation or undertaking regarding the treatment of any tax withholding in connection with the grant, issuance, vesting or exercise of the Option or the subsequent sale of any of the shares
of Common Stock acquired upon exercise of the Option. The Company does not commit and is under no obligation to structure the Option to reduce or eliminate the Optionee’s tax liability.
The Option is not intended to qualify as an incentive stock option under Section 422 of the Internal Revenue Code of 1986, as amended, and will be interpreted accordingly.
6. NON-TRANSFERABILITY OF OPTION
Unless otherwise provided by the Administrator, the Optionee may not assign or transfer the Option to anyone other than by will or the laws of descent and distribution and the Option shall be exercisable only by the Optionee during his or her lifetime. The Company may cancel the Optionee’s Option if the Optionee attempts to assign or transfer it in a manner inconsistent with this Section 6.
7. THE PLAN AND OTHER AGREEMENTS
The provisions of the Plan are incorporated into these Standard Terms and Conditions by this reference. In the event of a conflict between the terms and conditions of these Standard Terms and Conditions and the Plan, the Plan controls.
The Award Agreement, the Vesting Schedule, these Standard Terms and Conditions, and the Plan constitute the entire understanding between the Optionee and the Company regarding the Option. Any other prior agreements, commitments or negotiations concerning the Option are superseded. The Award Agreement, the Vesting Schedule and these Standard Terms and Conditions may, however, be amended by a subsequent agreement between the Company and the Optionee that specifically addresses the treatment of the Award.
8. LIMITATION OF INTEREST IN SHARES SUBJECT TO OPTION
Neither the Optionee (individually or as a member of a group) nor any beneficiary or other person claiming under or through the Optionee shall have any right (including without limitation dividend and voting rights), title, interest, or privilege in or to any shares of Common Stock allocated or reserved for the purpose of the Plan or subject to the Award Agreement or these Standard Terms and Conditions except as to such shares of Common Stock, if any, as shall have been issued to such person upon exercise of the Option or any part of it.
9. NOT A CONTRACT FOR EMPLOYMENT
Nothing in the Plan, in the Award Agreement, the Vesting Schedule, these Standard Terms and Conditions or any other instrument executed pursuant to the Plan shall confer upon the Optionee any right to continue in the Company’s employ or service nor limit in any way the Company’s right to terminate the Optionee’s employment or service at any time for any reason.
10. NO LIABILITY OF COMPANY
The Company and any affiliate that is in existence or hereafter comes into existence shall not be liable to the Optionee or any other person as to: (a) the non-issuance or sale of shares of Common Stock as to which the Company has been unable to obtain from any regulatory body having jurisdiction the authority deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any shares hereunder; and (b) any tax consequence expected, but not realized, by the Optionee or other person due to the receipt, exercise or settlement of any Option granted hereunder.
11. NOTICES
All notices, requests, demands and other communications pursuant to these Standard Terms and Conditions shall be in writing and shall be deemed to have been duly given if personally delivered, telexed or telecopied to, or, if mailed, when received by, the other party at the following addresses (or at such other address as shall be given in writing by either party to the other):
If to the Company to:
The Advisory Board Company
2445 M Street, N.W.
Washington, D.C. 20037
Attention: Administrator of Stock Incentive Plan
If to the Optionee, to the address set forth below the Optionee’s signature on the Award Agreement.
12. GENERAL
In the event that any provision of these Standard Terms and Conditions is declared to be illegal, invalid or otherwise unenforceable by a court of competent jurisdiction, such provision shall be reformed, if possible, to the extent necessary to render it legal, valid and enforceable, or otherwise deleted, and the remainder of these Standard Terms and Conditions shall not be affected except to the extent necessary to reform or delete such illegal, invalid or unenforceable provision.
The headings preceding the text of the sections hereof are inserted solely for convenience of reference, and shall not constitute a part of these Standard Terms and Conditions, nor shall they affect its meaning, construction or effect.
These Standard Terms and Conditions shall inure to the benefit of and be binding upon the parties hereto and their respective permitted heirs, beneficiaries, successors and assigns.
13. FURTHER ASSURANCES
Participant shall cooperate and take such action as may be reasonably requested by the Company in order to carry out the provisions and purposes of these Standard Terms and Conditions. Participant acknowledges and agrees that the terms and conditions of this Award, including the performance metrics set forth in the Vesting Schedule are sensitive and proprietary to the Company. The Participant shall not disclose the terms and conditions of this Award to any other person other than to Participant’s legal or tax advisor in connection with obtaining legal or tax advice. Any breach of this provision may result in forfeiture of the Award.
14. ELECTRONIC DELIVERY
The Company may, in its sole discretion, decide to deliver any documents related to any awards granted under the Plan by electronic means or to request the Optionee’s consent to participate in the Plan by electronic means. By accepting the Award, the Optionee consents to receive such documents by electronic delivery and, if requested, to agree to participate in the Plan through an on-line or electronic system established and maintained by the Company or another third party designated by the Company, and such consent shall remain in effect throughout the Participant’s term of employment or service with the Company and thereafter until withdrawn in writing by the Optionee.
Exhibit 21.1
Subsidiaries of the Registrant
The following is a list of subsidiaries of The Advisory Board Company.
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Name | | Jurisdiction of Organization |
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Advancement Services, Inc. | | Virginia |
Advisory Board Investments, Inc. | | Delaware |
ABCO International Holdings, LLC | | Delaware |
ABCO Advisory Services India Private Limited | | India |
Royall Acquisition Company | | Delaware |
Royall & Company | | Virginia |
Royall & Company Holding, Inc. | | Delaware |
The Advisory Board (Chile) SpA | | Chile |
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
We consent to the incorporation by reference in the following Registration Statements of The Advisory Board Company:
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Form | Registration Number | Date Filed |
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S-8 | 333-201982 | 02/09/15 |
S-3 | 333-201608 | 01/20/15 |
S-8 | 333-192270 | 11/12/13 |
S-8 | 333-177006 | 09/26/11 |
S-8 | 333-162032 | 09/21/09 |
S-8 | 333-140757 | 02/16/07 |
S-3 | 333-122850 | 02/16/05 |
S-3 | 333-112712 | 02/11/04 |
S-3 | 333-104584 | 04/16/03 |
S-8 | 333-84422 | 03/18/02 |
of our reports dated March 4, 2015, with respect to the consolidated financial statements and schedule of The Advisory Board Company and subsidiaries and the effectiveness of internal control over financial reporting of The Advisory Board Company and subsidiaries, included in this Annual Report (Form 10-K) of the Advisory Board Company for the nine months ended December 31, 2014.
/s/ Ernst & Young LLP
Baltimore, Maryland
March 4, 2015
Exhibit 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-210982, 333-192270, 333-177006, 333-162032, 333-140757, 333-84422) and Form S-3 (Nos. 333-201608, 333-122850, 333-112712, 333-104584) of The Advisory Board Company of our reports dated March 2, 2015 relating to the financial statements of Evolent Health LLC, which appear in this Annual Report on Form 10‑K.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
March 2, 2015
Exhibit 31.1
CERTIFICATION
I, Robert W. Musslewhite, certify that:
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1. | I have reviewed this transition report on Form 10-K of The Advisory Board Company; |
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2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
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3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
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4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
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(a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
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(b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
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(c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
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(d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
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5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
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(a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
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(b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
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Date: March 4, 2015 | | | | /s/ Robert W. Musslewhite |
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Exhibit 31.2
CERTIFICATION
I, Michael T. Kirshbaum, certify that:
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1. | I have reviewed this transition report on Form 10-K of The Advisory Board Company; |
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2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
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3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
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4. | The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
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(a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
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(b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
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(c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| |
(d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
|
| |
5. | The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| |
(a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| |
(b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
|
| | | | |
| | | | |
Date: March 4, 2015 | | | | /s/ Michael T. Kirshbaum |
| | |
| | | | Michael T. Kirshbaum |
| | | | Chief Financial Officer and Treasurer |
Exhibit 32.1
THE ADVISORY BOARD COMPANY
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Each of the undersigned hereby certifies, in his capacity as an officer of The Advisory Board Company (the “Company”), for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:
| |
(1) | The Transition Report on Form 10-K of the Company for the period ended December 31, 2014 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and |
| |
(2) | The information contained in such Transition Report on Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company. |
|
| |
| |
/s/ Robert W. Musslewhite | |
| |
Robert W. Musslewhite | |
Chief Executive Officer | |
March 4, 2015 | |
| |
/s/ Michael T. Kirshbaum | |
| |
Michael T. Kirshbaum | |
Chief Financial Officer and Treasurer | |
March 4, 2015 | |
Evolent Health LLC
Financial Statements
December 31, 2014 and 2013
Evolent Health LLC
Table of Contents
|
| |
| Page(s) |
Report of Independent Registered Public Accounting Firm | |
Balance Sheets | |
Statements of Operations and Comprehensive Loss | |
Statements of Cash Flows | |
Statements of Changes in Members' Equity and Redeemable Preferred Units | |
Notes to Financial Statements | |
Report of Independent Registered Public Accounting Firm
To the Board of Directors of Evolent Health LLC:
In our opinion, the accompanying balance sheets and the related statements of operations and comprehensive loss, of changes in members’ equity and redeemable preferred units and of cash flows present fairly, in all material respects, the financial position of Evolent Health LLC at December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. 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 of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
March 2, 2015
EVOLENT HEALTH LLC
BALANCE SHEETS
(in thousands, except share data)
|
| | | | | | | |
| As of December 31, |
| 2014 | | 2013 |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 15,134 |
| | $ | 67,891 |
|
Restricted cash | 3,470 |
| | 500 |
|
Accounts receivable (amounts related to affiliates: 2014 - $4,386; 2013 - $1,508) | 9,477 |
| | 10,520 |
|
Prepaid expenses and other current assets | 2,218 |
| | 1,381 |
|
Investments | 26,419 |
| | — |
|
Total current assets | 56,718 |
| | 80,292 |
|
Restricted cash | 2,508 |
| | 1,714 |
|
Restricted investments | — |
| | 2,352 |
|
Property, plant and equipment, net | 22,774 |
| | 14,291 |
|
Intangible assets, net | 647 |
| | 1,574 |
|
Other long term assets | 1,657 |
| | 1,752 |
|
Total assets | $ | 84,304 |
| | $ | 101,975 |
|
| | | |
LIABILITIES, REDEEMABLE PREFERRED UNITS AND MEMBERS’ EQUITY | | | |
Liabilities | | | |
Current liabilities: | | | |
Accounts payable (amounts related to affiliates: 2014 - $572; 2013 - $0) | $ | 7,694 |
| | $ | 1,976 |
|
Accrued liabilities (amounts related to affiliates: 2014 - $4,316; 2013 - $1,000) | 18,178 |
| | 10,288 |
|
Deferred revenue | 23,256 |
| | 16,374 |
|
Other current liabilities | 901 |
| | 684 |
|
Total current liabilities | 50,029 |
| | 29,322 |
|
Deferred rent | 5,772 |
| | 3,358 |
|
Other long term liabilities | — |
| | — |
|
Total liabilities | 55,801 |
| | 32,680 |
|
| | | |
Commitments and Contingencies (See Note 9) | | | |
| | | |
Redeemable Preferred Units | | | |
Series B redeemable preferred units – 3,591,844 units issued and outstanding; liquidation value of $60,777 and $56,364 as of December 31, 2014 and 2013, respectively | 15,734 |
| | 38,251 |
|
Series B-1 redeemable preferred units – 488,281 units authorized; 90,105 units issued and outstanding; liquidation value of $1,478 as of December 31, 2014; no units authorized, issued, or outstanding as of December 31, 2013 | — |
| | — |
|
Total redeemable preferred units | 15,734 |
| | 38,251 |
|
| | | |
Members' Equity | | | |
Series A preferred units – 3,900,000 units authorized; 3,825,000 and 3,900,000 issued and outstanding; liquidation value of $48,218 and $45,994 as of December 31, 2014 and 2013, respectively | — |
| | — |
|
Series B preferred units – 6,510,860 units authorized; 2,919,016 units issued and outstanding; liquidation value of $49,393 and $45,806 as of December 31, 2014 and 2013, respectively | 12,769 |
| | 31,044 |
|
Class A common units – 1,011,871 and 956,506 units authorized, issued and outstanding as of December 31, 2014 and 2013, respectively | — |
| | — |
|
Series A preferred stock – $.001 par value, no units authorized, issued or outstanding; no liquidation value as of December 31, 2014 and 2013 | — |
| | — |
|
Class A common stock – $.001 par value, no shares authorized, issued or outstanding as of December 31, 2014 and 2013 | — |
| | — |
|
Additional paid-in-capital | — |
| | — |
|
Accumulated deficit | — |
| | — |
|
Total members’ equity | 12,769 |
| | 31,044 |
|
Total liabilities, redeemable preferred units and members' equity | $ | 84,304 |
| | $ | 101,975 |
|
See accompanying Notes to Financial Statements
2
EVOLENT HEALTH LLC
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(in thousands)
|
| | | | | | | | | | | |
| For the Years Ended December 31, |
| 2014 | | 2013 | | 2012 |
Revenues | | | | | |
Transformation(1) | $ | 36,289 |
| | $ | 34,560 |
| | $ | 7,290 |
|
Platform and operations(1) | 64,599 |
| | 5,721 |
| | 1,056 |
|
Total revenues | 100,888 |
| | 40,281 |
| | 8,346 |
|
| | | | | |
Expenses | | | | | |
Cost of revenues (exclusive of depreciation and amortization presented separately below)(1) | 73,122 |
| | 46,327 |
| | 11,274 |
|
Selling, general and administrative expenses(1) | 76,521 |
| | 24,103 |
| | 15,977 |
|
Depreciation and amortization expenses | 3,694 |
| | 1,838 |
| | 714 |
|
Total operating expenses | 153,337 |
| | 72,268 |
| | 27,965 |
|
Operating income (loss) | (52,449 | ) | | (31,987 | ) | | (19,619 | ) |
Interest (income) expense, net | (195 | ) | | 820 |
| | (18 | ) |
Other (income) expense, net | 9 |
| | (1 | ) | | (1 | ) |
Income (loss) before income tax | (52,263 | ) | | (32,806 | ) | | (19,600 | ) |
Income tax expense (benefit) | — |
| | 8 |
| | (337 | ) |
Net income (loss) and comprehensive income (loss) | $ | (52,263 | ) | | $ | (32,814 | ) | | $ | (19,263 | ) |
| | | | | |
(1) Amounts related to affiliates included above are as follows (See Note 14): | | | | | |
Transformation | $ | 8,930 |
| | $ | 12,177 |
| | $ | 5,041 |
|
Platform and operations | 28,847 |
| | 5,000 |
| | 1,056 |
|
Cost of revenues (exclusive of depreciation and amortization presented separately above) | 14,488 |
| | 1,935 |
| | 649 |
|
Selling, general and administrative expenses | 227 |
| | 833 |
| | 421 |
|
See accompanying Notes to Financial Statements
3
EVOLENT HEALTH LLC
STATEMENTS OF CASH FLOWS
(in thousands)
|
| | | | | | | | | | | |
| For the Years Ended December 31, |
| 2014 | | 2013 | | 2012 |
Cash Flows from Operating Activities | | | | | |
Net income (loss) | $ | (52,263 | ) | | $ | (32,814 | ) | | $ | (19,263 | ) |
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | | | | | |
Change in accounts receivable | 1,043 |
| | (8,649 | ) | | (1,792 | ) |
Change in prepaid expenses and other current assets | (405 | ) | | (1,046 | ) | | (240 | ) |
Change in other long term assets | 1,751 |
| | (1,718 | ) | | — |
|
Change in accounts payable | 5,547 |
| | (227 | ) | | 385 |
|
Change in accrued liabilities | 7,860 |
| | 5,502 |
| | 3,179 |
|
Change in deferred revenue | 6,882 |
| | 11,756 |
| | 4,418 |
|
Change in other current liabilities | 217 |
| | 599 |
| | 85 |
|
Change in deferred rent | 2,414 |
| | 3,358 |
| | — |
|
Depreciation and amortization expense | 3,694 |
| | 1,838 |
| | 714 |
|
Non-cash interest expense | — |
| | 829 |
| | — |
|
Stock-based compensation expense | 11,091 |
| | 1,235 |
| | 87 |
|
Deferred income taxes | — |
| | — |
| | (340 | ) |
Other | 48 |
| | 45 |
| | — |
|
Net cash provided by (used in) operating activities | (12,121 | ) | | (19,292 | ) | | (12,767 | ) |
| | | | | |
Cash Flows from Investing Activities | | | | | |
Purchases of investments | (56,169 | ) | | (74,401 | ) | | (3,850 | ) |
Sales of investments | 32,000 |
| | 74,450 |
| | 2,400 |
|
Purchases of property and equipment | (11,034 | ) | | (10,965 | ) | | (2,329 | ) |
Change in restricted cash | (3,576 | ) | | (2,216 | ) | | — |
|
Net cash provided by (used in) investing activities | (38,779 | ) | | (13,132 | ) | | (3,779 | ) |
| | | | | |
Cash Flows from Financing Activities | | | | | |
Proceeds from issuance of series A preferred units | — |
| | — |
| | 4,500 |
|
Proceeds from issuance of series B preferred units, net | — |
| | 72,163 |
| | — |
|
Proceeds from issuance of series B-1 preferred units, net | 961 |
| | — |
| | — |
|
Proceeds from issuance of convertible notes | — |
| | 23,000 |
| | — |
|
Proceeds from issuance of common units | 47 |
| | — |
| | — |
|
Payments of deferred offering costs | (1,365 | ) | | — |
| | — |
|
Repurchase of series A preferred units | (1,500 | ) | | (100 | ) | | — |
|
Net cash provided by (used in) financing activities | (1,857 | ) | | 95,063 |
| | 4,500 |
|
| | | | | |
Net increase (decrease) in cash and cash equivalents | (52,757 | ) | | 62,639 |
| | (12,046 | ) |
Cash and cash equivalents as of beginning-of-year | 67,891 |
| | 5,252 |
| | 17,298 |
|
Cash and cash equivalents as of end-of-year | $ | 15,134 |
| | $ | 67,891 |
| | $ | 5,252 |
|
| | | | | |
Supplemental Disclosure of Non-cash Investing and Financing Activities | | | | | |
Accrued property and equipment purchases | $ | 96 |
| | $ | 707 |
| | $ | 1,574 |
|
Conversion of accrued interest from convertible notes to equity | — |
| | 829 |
| | — |
|
Conversion of convertible notes to equity | — |
| | 23,000 |
| | — |
|
Non-cash settlement of accounts receivable through reacquisition of series A preferred stock | — |
| | 219 |
| | — |
|
Non-cash settlement of accounts payable through issuance of class A common units | 279 |
| | — |
| | — |
|
Non-cash issuance of series B-1 preferred units | 593 |
| | — |
| | — |
|
Accrued deferred offering costs | 196 |
| | — |
| | — |
|
See accompanying Notes to Financial Statements
4
EVOLENT HEALTH LLC
STATEMENTS OF CHANGES IN MEMBER’S EQUITY AND REDEEMABLE PREFERRED UNITS
(in thousands)
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Series B Redeemable Preferred Units | | Series B-1 Redeemable
Preferred Units | | Total Redeemable Preferred Units | Series A
Preferred Units | | Series B
Preferred Units | | Class A
Common Units | | Series A
Preferred Stock | | Class A
Common Stock | | Additional Paid- In-Capital | | Accumulated Deficit | | Total Members' Equity |
| | Units | | Amount | | Units | | Amount | | | Units | | Amount | | Units | | Amount | | Units | | Amount | | Shares | | Amount | | Shares | | Amount | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance, as of December 31, 2011 | | — |
| | $ | — |
| | — |
| | $ | — |
| | $ | — |
| — |
| | $ | — |
| | — |
| | $ | — |
| | — |
| | $ | — |
| | 3,500 |
| | $ | 4 |
| | 381 |
| | $ | — |
| | $ | 21,193 |
| | $ | (1,320 | ) | | $ | 19,877 |
|
Issuance of preferred stock, net of expenses | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 450 |
| | — |
| | — |
| | — |
| | 4,500 |
| | — |
| | 4,500 |
|
Issuance of restricted stock | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 562 |
| | — |
| | — |
| | — |
| | — |
|
Stock-based compensation expense | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 87 |
| | — |
| | 87 |
|
Net loss | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (19,263 | ) | | (19,263 | ) |
Balance as of December 31, 2012 | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 3,950 |
| | 4 |
| | 943 |
| | — |
| | 25,780 |
| | (20,583 | ) | | 5,201 |
|
Repurchase of preferred stock | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (50 | ) | | — |
| | — |
| | — |
| | (319 | ) | | — |
| | (319 | ) |
Issuance of restricted stock prior to reorganization | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 15 |
| | — |
| | — |
| | — |
| | — |
|
Stock-based compensation expense prior to reorganization | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 92 |
| | — |
| | 92 |
|
Net income (loss) prior to reorganization | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (21,982 | ) | | (21,982 | ) |
Issuance of series B preferred units, net of expenses | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | 6,511 |
| | 95,992 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 95,992 |
|
Reorganization to limited liability company | | — |
| | — |
| | — |
| | — |
| | — |
| 3,900 |
| | — |
| | — |
| | (17,009 | ) | | 958 |
| | 1 |
| | (3,900 | ) | | (4 | ) | | (958 | ) | | — |
| | (25,553 | ) | | 42,565 |
| | — |
|
Forfeiture of restricted stock | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | (2 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Stock-based compensation expense subsequent to reorganization | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | 1,143 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 1,143 |
|
Allocation of net income (loss) subsequent to reorganization | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | (9,688 | ) | | — |
| | (1,144 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (10,832 | ) |
Reclassification to redeemable units | | 3,592 |
| | 38,251 |
| | — |
| | — |
| | 38,251 |
| — |
| | — |
| | (3,592 | ) | | (38,251 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (38,251 | ) |
Balance as of December 31, 2013 | | 3,592 |
| | 38,251 |
| | — |
| | — |
| | 38,251 |
| 3,900 |
| | — |
| | 2,919 |
| | 31,044 |
| | 956 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 31,044 |
|
Stock-based compensation expense | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | — |
| | 11,091 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 11,091 |
|
Repurchase of preferred units | | — |
| | (828 | ) | | — |
| | — |
| | (828 | ) | (75 | ) | | — |
| | — |
| | (672 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (672 | ) |
Issuance of series B-1 preferred units, net of expenses | | — |
| | — |
| | 90 |
| | 1,554 |
| | 1,554 |
| — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Forfeiture of restricted stock | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | (12 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
|
Issuance of common units to Evolent Holdings | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | 3 |
| | 47 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 47 |
|
Non-cash issuance of common units to Evolent Holdings | | — |
| | — |
| | — |
| | — |
| | — |
| — |
| | — |
| | — |
| | — |
| | 65 |
| | 279 |
| | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | 279 |
|
Net income (loss) | | — |
| | (21,689 | ) | | — |
| | (1,554 | ) | | (23,243 | ) | — |
| | — |
| | — |
| | (17,603 | ) | | — |
| | (11,417 | ) | | — |
| | — |
| | — |
| | — |
| | — |
| | — |
| | (29,020 | ) |
Balance as of December 31, 2014 | | 3,592 |
| | $ | 15,734 |
| | 90 |
| | $ | — |
| | $ | 15,734 |
| 3,825 |
| | $ | — |
| | 2,919 |
| | $ | 12,769 |
| | 1,012 |
| | $ | — |
| | — |
| | $ | — |
| | — |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | 12,769 |
|
See accompanying Notes to Financial Statements
5
EVOLENT HEALTH LLC
NOTES TO FINANCIAL STATEMENTS
1. Organization
Evolent Health LLC (“Evolent LLC” or the “Company” which also may be referred to as “we,” “our” or “us”) is a managed services firm that supports integrated health systems in their migration toward value-based care and population health management. The Company’s services include providing customers with a robust population management platform, integrated data and analytics capabilities, pharmacy benefit management services and comprehensive health plan administration services. Together these services enable health systems to manage patient health in a more cost-effective manner without sacrificing quality. The Company’s contracts are structured as a combination of advisory fees, monthly member service fees and gain-sharing incentives. The Company's headquarters is located in Arlington, Virginia.
The Company was originally organized as a corporation in August 2011 and was capitalized through contributions of cash and intangible assets in exchange for preferred stock. At the time of the formation, the founding investors, The Advisory Board Company (“The Advisory Board”) and UPMC (“University of Pittsburgh Medical Center “), each contributed $10 million in cash to the Company. In addition, UPMC contributed a $3 million software license for use and resale by the Company as part of its service offerings. Each party also contributed various other items, such as a business plan, and entered into various agreements with the Company, such as reseller agreements. Each of these other contributions were determined to have no material value at the date of contribution and the agreements reflected terms consistent with a marketplace participant.
On September 23, 2013, the Company undertook a reorganization (the “Reorganization”) in which Evolent Health Holdings, Inc. (“Evolent Holdings”) was formed and the existing company (Evolent Health Inc. or “Evolent, Inc.”) converted into a limited liability company. Following the conversion of Evolent, Inc. into a limited liability company, the Company completed the issuance of $100 million of series B preferred units to new and existing investors. There are certain rights and preferences related to the series B preferred units set forth in the Company’s limited liability company agreement and a Master Investors' Rights Agreement between the investors. This transaction and these rights and preferences are further discussed in Note 4.
Since its inception, the Company has incurred substantial losses and cash outflows from operations. Failure to generate sufficient revenue and income could have a material adverse effect on the Company’s ability to achieve its business objectives. The Company has financed its operations through the issuance of preferred units. The Company believes it has sufficient liquidity for the next 12 months as of December 31, 2014.
2. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation
The accompanying financial statements are prepared in accordance with United States of America generally accepted accounting principles (“GAAP”). Our GAAP policies, which significantly affect the determination of financial condition, results of operations and cash flows are summarized below.
Summary of Significant Accounting Policies
Accounting Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Those estimates are inherently subject to change and actual results could differ from those estimates. Included among the material (or potentially material) reported amounts and disclosures that require use of estimates are: revenue recognition, impairment of long lived assets, common stock valuation, stock-based incentive compensation, income taxes and the potential effects of resolving litigated matters.
Fair Value Measurement
Our measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which would include our own credit risk. Our estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (“exit price”) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (“entry price”). Pursuant to the Fair Value Measurements and Disclosures Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), we categorize our financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows:
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• | Level 1 – inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the reporting date; |
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• | Level 2 – inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies; |
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• | Level 3 – inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability. |
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The Company measures certain assets and liabilities, including property and equipment and intangible assets, at fair value on a nonrecurring basis. These assets and liabilities are recognized at fair value when they are deemed to be impaired. As of December 31, 2014 and 2013, no assets or liabilities were remeasured at fair value subsequent to their initial recognition.
Cash and cash equivalents
Cash and cash equivalents are carried at cost, which approximates fair value, and include cash on hand, deposits in banks and money market funds with an original maturity of three months or less.
Restricted cash
Restricted cash is carried at cost, which approximates fair value, and includes $3.7 million in letters of credit for facility leases, $2.2 million in collateral with a financial institution for certain services that the financial institution provides to the Company and other restricted balances as of December 31, 2014.
Accounts receivable and allowance for doubtful accounts
Accounts receivable are recorded at the invoiced amount and do not bear interest. The Company’s contracts typically include installment payments that do not necessarily correlate to the pattern of revenue recognition. Accounts receivable and the corresponding deferred revenue amounts are recorded when amounts are contractually billable under long-term member service agreements. In assessing the valuation of the allowance for doubtful accounts, management reviews the collectability of accounts receivable in aggregate and on an individual account basis. Any accounts that are determined to be uncollectible are written off against the allowance. The allowance is adjusted periodically based on management's determination of collectability. As of December 31, 2014 and 2013, the Company has not recorded an allowance for doubtful accounts as all amounts due were deemed collectible.
Investments and restricted investments
Investments include marketable securities with original maturities greater than three months.
As of December 31, 2014, the Company’s investments included U.S. agency obligations, treasury bills and certificates of deposit. As of December 31, 2013, the Company’s investments included treasury bills and certificates of deposit. The Company’s investments are classified as held-to-maturity and are carried at amortized cost. New investments are expected to be invested in similar securities where there is minimal exposure to value changes for the Company.
Property and equipment
Property and equipment are carried at cost less allowances for depreciation and amortization. Provisions for depreciation and amortization of property and equipment owned for company use are computed on the straight-line method over the estimated useful lives of the assets, which include furniture and equipment, computers, software development costs and leasehold improvements. The following summarizes the estimated useful lives by asset classification:
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Furniture and equipment | 3 years |
Computer hardware | 3 years |
Software development costs | 3 to 5 years |
Leasehold improvements | Shorter of useful life or remaining lease term |
When an item is sold or retired, the cost and related accumulated depreciation or amortization is eliminated and the resulting gain or loss, if any, is recorded in the Statements of Operations and Comprehensive Income (Loss).
We periodically review the carrying value of our long-lived assets, including property and equipment, for impairment whenever events or circumstances indicate that the carrying amount of such assets may not be fully recoverable. For long-lived assets to be held and used, impairments are recognized when the carrying amount of a long-lived asset group is not recoverable and exceeds fair value. The carrying amount of a long-lived asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset group. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset group exceeds its fair value.
Software development costs
The Company capitalizes certain software development costs, consisting primarily of personnel and related expenses for employees and third parties who devote time to their respective projects. Internal-use software costs are capitalized during the application development stage – when the research stage is complete and management has committed to a project to develop software that will be used for its intended purpose. Any costs incurred during subsequent efforts to significantly upgrade and enhance the functionality of the software are also capitalized. Capitalized software costs are included in property and equipment on the Balance Sheets. Amortization of internal-use software costs begins once the project is substantially complete and the software is ready for its intended purpose. These capitalized costs are amortized on a straight-line basis over their estimated useful life. Expenditures during the research and development phase are expensed as incurred. General and administrative departmental costs, training, maintenance costs and customer support are also expensed as incurred.
Identifiable intangible assets
Identified intangible assets are recorded at their estimated fair values at the date of acquisition and are amortized over their respective estimated useful lives using a method of amortization that reflects the pattern in which the economic benefits of the intangible assets are used.
Leases
The Company leases all of its office space and enters into various other operating lease agreements in conducting its business. At the inception of each lease, the Company evaluates the lease agreement to determine whether the lease is an operating or capital lease. The operating lease agreements may contain tenant improvement allowances, rent holidays or rent escalation clauses. When such items are included in a lease agreement, the Company records a deferred rent asset or liability on the balance sheets equal to the difference between the rent expense and future minimum lease payments due. The rent expense related to these items is recognized on a straight-line basis in the Statements of Operations and Comprehensive Income (Loss) over the terms of the leases. As of December 31, 2014, the Company had not entered into any capital leases.
Deferred revenue
Deferred revenue consists of billings or payments received in advance of providing the requisite services or other instances where the revenue recognition criteria have not been met. Our transformation revenues are recognized based on proportionate performance and we typically bill based on a fixed invoicing schedule which gives rise to deferred revenue when the pace of work performed is slower than the rate at which we bill. Our platform and operations revenues are recognized in the month in which services are rendered and we typically bill in advance of the service period which similarly gives rise to deferred revenue.
Commitments and contingencies
Contingencies arising from litigation, fines, penalties and other sources are recorded when deemed probable and reasonably estimable.
Revenue recognition
Revenue from the Company's services is recognized when there is persuasive evidence of an arrangement, delivery has taken place, revenue is fixed or determinable and collectability of the associated receivable is reasonably assured.
Pursuant to the accounting rules for arrangements with multiple deliverables, we evaluate each deliverable to determine whether it represents a separate unit of accounting based on the following criteria: (i) if the delivered item has value to the customer on a standalone basis, and (ii) if the contract includes a general right of return relative to the delivered item, and delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the vendor. Revenue is then allocated to the units of accounting based on each unit's relative selling price.
The Company enters into different types of contracts with its partners depending on where the partner may be in its transition towards value based care. The contracts generally have multiple deliverables; however, typically there is only one unit of accounting because the deliverables do not have standalone value. The Company’s contracts may include the delivery of a combination of one or more of the Company’s service offerings. In these situations, the Company determines whether such arrangements with multiple service offerings should be treated as separate units of accounting based on how the elements are bid or negotiated, whether the customer can accept separate elements of the arrangement and the relationship between the pricing on the elements individually and combined. Because of the unique nature of the Company’s services, neither vendor specific objective evidence nor third-party evidence is available. Therefore, the Company utilizes best estimate of selling price to allocate arrangement consideration in multiple element arrangements. As of December 31, 2014, blueprint contracts have required allocation to the units of accounting as discussed further below. In addition one contract with multiple deliverables for transformation and platform and operations services was executed during 2014 and we allocated value based upon the best estimate of selling price.
Revenue recognition – Transformation
The Company enters into two different types of contracts during the transformation phase: blueprint contracts and implementation contracts. Blueprint contracts are fee-for-service, where the Company provides a strategic assessment for its partners in exchange for a fixed fee that is paid over the term of the engagement. The Company recognizes revenue associated with blueprint contracts based on proportionate performance. Revenue is recognized each period in proportion to the amount of the contract completed during that
period based upon the level of effort expended to date compared to the total estimated level of effort necessary over the term of the contract as the output of the contracts is not reflective of the value of the contract delivered each period. These contracts may contain credits for fees related to signing a future long term agreement by a certain date. The credits are assessed to determine whether they reflect significant and incremental discounts compared to discounts in the original blueprints. If discounts are significant and incremental, the Company allocates the discount between the blueprint contract and future purchases. If the future credit expires unused, it is recognized as revenue at that time.
Based on the strategic assessment generated in a blueprint contract, a partner may decide to move forward with a population health or health plan strategy. In these cases, the partner enters into an implementation contract in which the Company provides services related to the launch of this strategy. These contracts last twelve to fifteen months and are typically fixed fee in nature. The Company recognizes revenue associated with implementation contracts based on proportionate performance. Revenue is recognized each period in proportion to the amount of the contract completed during that period based upon the level of effort expended to date compared to the total estimated level of effort necessary over the term of the contract as the output of the contracts is not reflective of the value of the contract delivered each period. Billings associated with these contracts are typically scheduled in installments over the term of the agreement.
Revenue recognition – Platform and operations
After the transformation phase, the Company enters into multi-year service contracts with the partners where various population health, health plan operations and pharmacy benefit management services are provided on an ongoing basis to the members of the Company’s partners’ plans in exchange for a monthly service fee. Members are individuals that are covered by the respective member service contracts and typically include the partners’ employees and its customers. Revenue from these contracts is recognized in the month in which the services are delivered. In some cases, there is an “at risk” portion of the service fee that could be refunded to the partner if certain service levels are not attained. The Company monitors its compliance with service levels to determine whether a refund will be provided to the partner and records an estimate of these refunds. To date the Company’s history is limited for these contracts; therefore, the full potential refund is deferred until all obligations are met.
Cost of revenues
The Company’s cost of revenue includes the cost of products and services. These costs consist primarily of employees, contract and consulting services and their associated expenses, which are directly attributable to clinical and field operations and analysis.
Selling, general and administrative expenses
Selling, general and administrative expenses include expenses for corporate overhead and business development activities. The Company did not incur any advertising expense for the years ended December 31, 2014, 2013 and 2012.
Stock-based compensation
The Company’s employees are granted stock-based awards in Evolent Holdings and the Company is contractually required to issue a similar amount and class of membership equity to Evolent Holdings, in accordance with the Company’s Amended and Restated Operating Agreement. As discussed in Note 10, prior to the Reorganization, stock-based compensation followed an employee model as the awards were granted in the stock of the Company to employees of the Company. Subsequent to the Reorganization, the stock-based compensation awards are granted in the stock of the Company’s equity-method investor, Evolent Holdings, to employees of Evolent LLC. As such, Evolent LLC is required to utilize a non-employee model for recognizing stock-based compensation, which requires the awards to be marked-to-market through net income at the end of each reporting period until vesting occurs.
We expense the fair value of stock awards included in our incentive compensation plans. As of the date our stock awards are approved, the fair value of stock options is determined using a Black-Scholes options valuation methodology. The fair value of the awards is expensed over the performance or service period, which generally corresponds to the vesting period, and is recognized as an increase to common units in members’ equity.
Income taxes
On September 23, 2013, the Company underwent a legal entity and tax restructuring pursuant to which the Company’s federal and state income tax status and classification changed from a corporation, subject to federal and state income taxes, to a partnership, whereby the Company’s members are responsible for reporting income or loss based on such member’s respective share of the Company’s income and expenses as reported for tax purposes. As a result of this restructuring, the Company ceased recognizing all of its federal and state deferred tax assets and liabilities as of September 23, 2013.
3. Recently Issued Accounting Standards
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, in order to clarify the principles of recognizing revenue. This standard establishes the core principle of recognizing revenue to depict the transfer of promised goods or services in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services. The FASB defines a five-step process that systematically identifies the various components of the revenue recognition process, culminating with the recognition of revenue upon satisfaction of an entity’s performance obligation. By completing all five steps of the process, the core principles of revenue recognition will be achieved. The amendments in the standard are effective for
annual and interim reporting periods beginning after December 15, 2016, with early adoption prohibited. We will adopt the requirements of this standard effective January 1, 2017, and are currently evaluating the impact of the adoption on our consolidated financial condition and results of operations.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40). This standard requires management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards by requiring an assessment for a period of one year after the date that the financial statements are issued. Further, based on certain conditions and circumstances, additional disclosures may be required. This standard is effective beginning with the first annual period ending after December 15, 2016, and for all annual and interim periods thereafter. Early application is permitted. The Company does not expect this standard to have an impact on the Company’s financial statements or related disclosures.
4. Members’ Equity and Redeemable Preferred Units
Reorganization
On September 23, 2013, Evolent, Inc. completed a corporate reorganization in connection with a new round of equity financing (the “series B financing”). Evolent, Inc.’s reorganization included the creation of Evolent Holdings and the conversion of Evolent, Inc. into Evolent LLC, a limited liability company that is treated as a partnership for tax purposes. Each share of Evolent, Inc.’s capital stock outstanding immediately prior to the Reorganization was exchanged for a share of the capital stock of Evolent Holdings of the same class or series and with substantially similar rights, preferences, privileges, restrictions and limitations. Evolent LLC then issued to Evolent Holdings a like number of membership units of the same class or series and with substantially similar rights, preferences, privileges, restrictions and limitations, as the shares of capital stock issued by Evolent Holdings to the former shareholders of Evolent, Inc. This reorganization represented a transaction among entities with a high degree of common ownership as, both prior and subsequent to the Reorganization, the shareholders held the same economic and voting interests in Evolent LLC (through their respective ownership interests in Evolent Holdings) that they previously held in Evolent, Inc. The conversion of Evolent, Inc. into Evolent LLC represents a conversion from a taxable entity into an entity that is not separately taxable and is treated as a pass-through to its members. The conversion from a “C” corporation to an LLC was treated as a discrete transaction in these financial statements.
As of the date of the Reorganization, the existing stockholders’ deficit of Evolent, Inc. was allocated to the members of Evolent LLC based upon the rights and preferences of the membership units representing each member’s investment, and determined in accordance with Evolent’s Amended and Restated Operating Agreement (the “LLC Agreement”). The allocation of profits and losses to the members of Evolent are to be made in accordance with the terms of the LLC Agreement. Profits are allocated to the members’ capital accounts based on the hypothetical liquidation at book value basis of accounting which allocates profits and losses to the members based upon the value that would accrue to each member at each period end based upon a theoretical liquidation at book value at that time.
Capital structure
Subsequent to the Reorganization, the Company has the authority to issue common units, series A preferred units, series B preferred units, and series B-1 preferred units. As discussed in “Right to sell by significant securityholders” below, certain preferred units are redeemable by significant securityholders, not to exceed the value of the preferred units held by the significant securityholder with the largest number of units. Additionally, as discussed further in “Redemption of series B-1 preferred units” below, certain preferred units are redeemable. These amounts have been classified as redeemable preferred units.
Common units
As of December 31, 2014 and 2013, the Company’s LLC Agreement authorizes the Company to issue common units equal to the number of shares of common stock of Evolent Holdings outstanding immediately following the Reorganization, plus an additional number of common units as may be issued in accordance with the terms of the LLC Agreement and the Master Investor Rights’ Agreement.
Series A preferred units
The outstanding series A preferred units were issued to Evolent Holdings in the Reorganization.
In August 2013, prior to the Reorganization, Evolent, Inc. repurchased 50,000 shares of series A preferred stock from a customer for $0.1 million in cash and the forgiveness and discharge by the Company of $0.2 million in amounts due under a contract with the customer.
In July 2014, Evolent Holdings repurchased 75,000 shares of series A preferred stock from a customer for an aggregate purchase price of $1.5 million. Evolent LLC repurchased 75,000 shares of series A preferred units from Evolent Holdings for the same value.
Series B preferred units
In September 2013, the Company entered into the Series B Preferred Security Purchase Agreement, which authorized the issuance of 6,510,860 series B preferred units, all of which were issued and outstanding as of December 31, 2014 and 2013. The series B preferred units were issued in September 2013 in exchange for cash proceeds of $76.2 million and the conversion of $23.8 million of
convertible notes issued by Evolent Health, Inc., including accrued interest of $0.8 million. Of the outstanding series B preferred units, 1,616,844 are held by Evolent Holdings and the remaining units were issued to The Advisory Board and TPG Growth II, LP (“TPG”).
Series B-1 preferred units
In January 2014, Evolent Holdings issued 65,105 shares of series B-1 preferred stock to a customer of Evolent LLC for aggregate proceeds of $1.0 million paid to Evolent LLC. Evolent LLC issued 65,105 series B-1 preferred units to Evolent Holdings in exchange for these shares.
In July 2014, Evolent Holdings issued 25,000 shares of series B-1 preferred stock for zero consideration to a customer of Evolent LLC. Evolent LLC issued 25,000 series B-1 preferred units to Evolent Holdings in exchange for these shares. This stock, valued at $0.6 million, is reflected as a deferred asset on our Balance Sheets and is being recognized as a reduction to revenue over the term of the related customer’s contract, as it represents an inducement related to the entire value of the revenue contract. The value of the stock was based upon a contemporaneous valuation.
Master Investors’ Rights Agreement
In connection with the Reorganization, the Investors’ Rights Agreement by and among Evolent, Inc. and certain of its shareholders was amended, restated and renamed as the Master Investors’ Rights Agreement. The Master Investors’ Rights Agreement was entered into on September 23, 2013, by the Company, Evolent Holdings, and the shareholders and members of each of the Company and Evolent Holdings. The Master Investors’ Rights Agreement provides that the Company’s Board of Directors shall initially consist of seven members, including two designees of UPMC, two designees of The Advisory Board, two designees of TPG and the Chief Executive Officer. The Master Investors’ Rights Agreement grants to UPMC, The Advisory Board and TPG the right to purchase their respective pro rata portions of certain offers of new equity securities by Evolent Holdings, and establishes certain conditions and restrictions on the transferability of Evolent Holdings’ capital stock.
Preferred unit rights and preferences
In accordance with the Company’s LLC Agreement, holders of preferred units are entitled to the following rights and preferences:
Liquidation preference
In the event of any voluntary or involuntary liquidation or winding up of the Company (the “Liquidation Event”), distribution shall be made as follows:
First, to the holders of series B preferred units, pro rata in proportion to the number of series B preferred units held by such holders, until the holders of such series B preferred units receive in respect of each series B preferred unit held by them, the adjusted series B liquidation preference amount;
Second, to the holders of series A preferred units, pro rata in proportion to the number of series A preferred units held by such holders, until the holders of such series A preferred units receive in respect of each series A preferred unit held by them, the adjusted series A liquidation preference amount;
Third, to the holders of series B-1 preferred units, pro rata in proportion to the number of series B-1 preferred units held by such holders, until the holders of such series B-1 preferred units receive in respect of each series B-1 preferred unit held by them, the adjusted series B-1 liquidation preference amount;
Fourth, to the holders of common units, pro rata in proportion to the number of common units held by such holders.
As of December 31, 2014, the aggregate liquidation preference in respect of the series B, series A, and series B-1 preferred units were $110.2 million, $48.2 million and $1.5 million respectively.
Voting rights
The holders of preferred units vote together with holders of common units as a single class upon all matters submitted to a vote of members. Each preferred unit is entitled to the number of votes equal to the number of common units into which the preferred unit is at the time convertible.
Optional conversion
Each preferred unit is convertible, at the option of the holder thereof, at any time and from time to time, into such number of fully paid and non-assessable common units as determined by dividing the original issue price of the preferred unit by the applicable conversion price (initially $10.00 per unit for series A and $15.36 per unit for series B and series B-1). The conversion price is subject to certain adjustments in accordance with the LLC Agreement; however, there have been no adjustments to date.
Mandatory conversion
Each preferred unit shall automatically convert into that number of common units as is determined by dividing the original issue price of the preferred unit by the applicable conversion price, upon the occurrence of either the agreement of the holders of at least 75% of the then outstanding preferred units voting together as a single class, or the closing of the sale of Evolent Holdings’ common stock (or
a successor in interest to the Company) in a firm commitment underwritten public offering pursuant to an effective registration statement under the Securities Act of 1933, in which the gross cash proceeds to Evolent Holdings (before deduction of underwriting discount, commissions and expenses of sale) are at least $75 million and the price per share paid by the public for common stock of Evolent Holdings is at least three times the original series B issue price.
Right to sell by significant securityholders
If any time after September 23, 2018, but before September 23, 2020, any significant securityholder (i.e., The Advisory Board, UPMC or TPG) wishes to pursue a sale of the Company, and neither of the other significant securityholders (the “remaining significant securityholders”) wishes to pursue the sale process, then the selling significant securityholder shall have the right to sell and the remaining significant securityholders may purchase (or cause the Company to purchase) the units of the selling significant securityholder at the then fair value. This right applies to series A and series B preferred units. This provision provides that in certain circumstances two of the three significant securityholders can cause the Company to repurchase the selling significant securityholder’s units. As such, these shares are classified as mezzanine equity on the balance sheets. However, as the maximum number of units that the Company can be obligated to repurchase by the remaining significant securityholders is the number of units held by the significant securityholder that holds the largest number of units, this is the amount that is presented in mezzanine equity.
Redemption of series B-1 preferred units
The series B-1 preferred units contain a purchaser-initiated redemption that states that under certain circumstances the purchaser may force the redemption of the preferred units to the Company. As this event is not solely within the control of the Company, these preferred units are presented in mezzanine equity.
Dividends and distributions
The holders of preferred units are entitled to receive a preferred return for each outstanding preferred unit payable in preference and priority to the payment of distributions on common units. The preferred return accrues on a daily basis at a rate of 8% per annum from the original issuance date (and in the case of the series A preferred units, from the date of the original issuance of shares of series A preferred stock by Evolent Health, Inc.). All accrued but unpaid preferred returns are payable when, as and if declared by the Board of Directors or upon the occurrence of a liquidation event. As of December 31, 2014, holders of preferred units have an aggregate accrued and unpaid preferred return in respect of the series B, series A and series B-1 preferred units of $10.2 million, $10.0 million and $0.1 million, respectively.
Allocation of profits and losses
The allocation of profits and losses to the members are based on the hypothetical liquidation at book value basis of accounting which allocates profits and losses to the shareholders based upon the value that would accrue to each shareholder at each period end based upon a theoretical liquidation at book value at that time. In accordance with the LLC Agreement, profits and losses for each year shall be allocated among the members in a manner such that the capital account balance of each such member for each class or series of units held by the member, immediately after making such allocation and after taking into account amounts specially allocated pursuant to the LLC Agreement, is as nearly as possible (limited to the amounts of profit and losses available for allocation), on a proportionate basis equal to (a) the distributions that would be made to such member with respect to each class or series of units held by the member, if the Company were dissolved, its affairs wound up and its assets sold for cash equal to their book value, all Company liabilities were satisfied (limited with respect to each non-recourse liability to the book value of the assets securing such liability), and the net assets of the Company were distributed in accordance with the LLC Agreement to the members immediately after making such allocation, minus (b) such member’s share of the Company’s minimum gain (as defined in the LLC agreement) and such member’s share of nonrecourse debt minimum gain (as defined in the LLC agreement).
In accordance with the LLC Agreement, distributions (other than distributions in order to satisfy the income tax liabilities of the members) shall be made as follows: (i) first to the holders of series B preferred units, until such holders have received an amount per series B unit equal to $1.23 per annum, calculated from the date of issuance of each such unit (the “series B preferred return”), then (ii) to the holders of series A preferred units, until such holders have received an amount per series A unit equal to $0.80 per annum, calculated from the date of issuance by Evolent Holdings of the corresponding share of series A preferred stock (the “series A preferred return”), then (iii) to the holders of series B preferred units, until such holders have received an amount equal to the series B liquidation preference, then (iv) to the holders of series A preferred units, until such holders have received an amount equal to the series A liquidation preference, then (v) to the holders of series B-1 preferred units until such holders have received an amount per unit equal to $1.23 per annum, calculated from the date of issuance of each such unit (the “Series B-1 Preferred Return”), then (vi) to the holders of series B-1 preferred units, until such holders have received an aggregate amount equal to the original issue price of the series B-1 preferred units, then (vii) to the holders of common units, until such holders have received an amount equal to the series A liquidation preference, then (viii) to the holders of series A preferred units and common units, until such holders have received, an aggregate amount equal to the series B liquidation preference, and then (ix) to the holders of preferred units and common units pro rata based upon the number of units held by each such holder.
Issuance of common unit instrument to UPMC
The Company issued a contingent instrument to UPMC as a part of a reseller, services and non-competition. In the event that certain revenue targets related to the agreement are not met during the period commencing August 31, 2011, and ending August 30, 2015, the
Company must issue up to 250,000 common units to make up for the shortfall. This is considered a financial instrument that is revalued each period. Based upon the probability of meeting the revenue targets set forth in the agreement, it has been determined that the fair value of the financial instrument was zero as of December 31, 2014 and 2013. The Company reevaluates the value of the financial instrument each reporting period.
Capital structure prior to reorganization
Prior to the Reorganization, the Company was a “C” Corporation authorized to issue Series A Preferred Stock and Common Stock. The rights and preferences related to these shares were consistent with that of the membership units above, except for the rights described in “Right to sell by significant securityholders” described above.
5. Debt
During the period from January 2013, through September 2013, interim funding was provided to the Company from existing investors in the form of convertible term notes bearing interest at a rate of 8% per annum, with such interest accruing on a daily basis and compounded annually. The total outstanding principal amount of the interim funding provided was $23.0 million. Total interest expense and accrued interest associated with these convertible notes was $0.8 million. On the closing of the series B financing on September 23, 2013, the convertible notes and accrued interest were converted into series B preferred units or shares of series B preferred stock, as applicable, on a dollar for dollar basis. As of December 31, 2014 and 2013, there was no outstanding debt.
6. Investments
The following summarizes our investments (in thousands):
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| As of December 31, 2014 |
| Amortized Costs | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
U.S. agency obligations | $ | 24,069 |
| | $ | — |
| | $ | 4 |
| | $ | 24,065 |
|
Certificates of deposits | 1,750 |
| | — |
| | — |
| | 1,750 |
|
U.S. Treasury bills | 600 |
| | — |
| | — |
| | 600 |
|
Total investments | $ | 26,419 |
| | $ | — |
| | $ | 4 |
| | $ | 26,415 |
|
|
| | | | | | | | | | | | | | | |
| As of December 31, 2013 |
| Amortized Costs | | Gross Unrealized Gains | | Gross Unrealized Losses | | Fair Value |
Certificates of Deposits | $ | 1,750 |
| | $ | — |
| | $ | — |
| | $ | 1,750 |
|
U.S. Treasury bills | 602 |
| | — |
| | — |
| | 602 |
|
Total investments | $ | 2,352 |
| | $ | — |
| | $ | — |
| | $ | 2,352 |
|
U.S. agency obligations, certificates of deposit and U.S. Treasury bills
U.S. agency obligations, certificates of deposit and U.S. Treasury bills are classified as held-to-maturity based on the maturity dates and intent to hold. As of December 31, 2013, the Company held these investments to secure a letter of credit related to its leased space. There were no identified events or changes in circumstances that had a significant adverse effect on the values of these investments. If there was evidence of a decline in value, which is other than temporary, the amounts would be written down to their estimated recoverable value.
Contractual maturities
The contractual maturities of our held-to-maturity U.S. agency obligations, certificates of deposits and U.S. Treasury bills (in thousands) were as follows:
|
| | | | | | | | | | | | | | | |
| As of December 31, |
| 2014 | | 2013 |
| Amortized Cost | | Fair Value | | Amortized Cost | | Fair Value |
Due in one year or less | $ | 26,419 |
| | $ | 26,415 |
| | $ | — |
| | $ | — |
|
Due after one year | — |
| | — |
| | 2,352 |
| | 2,352 |
|
Total | $ | 26,419 |
| | $ | 26,415 |
| | $ | 2,352 |
| | $ | 2,352 |
|
7. Property and Equipment
The following summarizes our property and equipment (in thousands):
|
| | | | | | | |
| As of December 31, |
| 2014 | | 2013 |
Leasehold improvements | $ | 8,246 |
| | $ | 5,852 |
|
Furniture and equipment | 2,419 |
| | 1,589 |
|
Computer hardware and software | 756 |
| | 593 |
|
Internal use software | 15,337 |
| | 7,594 |
|
Total property and equipment | 26,758 |
| | 15,628 |
|
Accumulated depreciation and amortization | (3,984 | ) | | (1,337 | ) |
Total property and equipment, net | $ | 22,774 |
| | $ | 14,291 |
|
The Company includes capitalized internal-use software development costs in property and equipment. The Company capitalized $7.7 million, $7.6 million and zero of these software development costs for the years ended December 31, 2014, 2013 and 2012, respectively. The net book value of capitalized internal use software development costs was $14.2 million and $7.5 million as of December 31, 2014 and 2013, respectively.
Depreciation expense related to property and equipment was $2.7 million, $1.2 million and $0.1 million for the years ended December 31, 2014, 2013 and 2012, respectively, of which amortization expense related to capitalized internal-use software development costs was $1.0 million, $0.1 million and zero for the years ended December 31, 2014, 2013 and 2012, respectively.
8. Intangible Assets
UPMC contributed to the Company a software license for use and resale as part of its service offerings valued at $3.0 million and a five year useful life. The Company utilized the contributed software for its ongoing customers while also developing a proprietary platform, Identifi. The new platform went live in October 2014 at which time the Company estimated that all customers would be migrated to the new platform by April 2015. In order to appropriately reflect the change in use of the contributed software, the Company revised the expected useful life of the contributed software license to conclude in April 2015. Details of our intangible asset (in thousands) are presented below:
|
| | | | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2014 | | As of December 31, 2013 |
| Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Value |
Software | $ | 2,952 |
| | $ | (2,305 | ) | | $ | 647 |
| | $ | 2,952 |
| | $ | (1,378 | ) | | $ | 1,574 |
|
Amortization expense related to intangible assets for the years ended December 31, 2014, 2013 and 2012, was $0.9 million, $0.6 million and $0.6 million, respectively. As of December 31, 2014, $0.6 million remained to be amortized during 2015.
9. Commitments and Contingencies
Revenue Guarantees
UPMC reseller agreement
The Company and UPMC are parties to a Reseller, Services and Non-Competition Agreement, dated August 31, 2011 (the “Original UPMC Reseller Agreement”), which was amended and restated by the parties on June 27, 2013 (as so amended, the “UPMC Reseller Agreement”). Under the terms of the UPMC Reseller Agreement, UPMC has appointed the Company as a non-exclusive reseller of certain services, subject to certain conditions and limitations specified in the UPMC Reseller Agreement. If the Company fails to generate minimum revenue for UPMC as a result of the provision of services during the four year period ending August 31, 2015, UPMC shall be entitled to receive, for no consideration, up to 250,000 common units, based on a formula set forth in the UPMC Reseller Agreement. In consideration for the Company’s obligations under the UPMC Reseller Agreement and subject to certain conditions described therein, UPMC has agreed not to sell certain products and services directly to the Company’s customers and top prospects. As of December 31, 2014, the Company expected to surpass the minimum revenue threshold under this agreement by the first quarter 2015.
The Advisory Board Company Reseller Agreement
The Company and The Advisory Board are parties to a Services, Reseller, and Non-Competition Agreement, dated August 31, 2011 (the “Original Advisory Board Reseller Agreement”), which was amended and restated by the parties on June 27, 2013 (as so amended, the “Advisory Board Company Reseller Agreement”). Under the terms of the Advisory Board Company Reseller Agreement, The Advisory Board shall provide certain services to the Company on an as-requested basis. The Company met its
obligation to purchase $0.2 million during the first year of the agreement. In addition, The Advisory Board has a right of first offer to provide certain specified services during the term of the Agreement. Lastly, under the Advisory Board Company Reseller Agreement, the Company and The Advisory Board agreed to forego the establishment of a Value-Based Care Innovation Center (the “Center”), which had been contemplated by the Original The Advisory Board Reseller Agreement and pursuant to which the Company would pay The Advisory Board for the provision of services during the first two years of the Center’s operation. In lieu of the establishment of the Center, the Company agreed to purchase and did purchase an additional $1.0 million of services from The Advisory Board prior to August 31, 2014. As of December 31, 2014, the Company has met this commitment.
Commitments
Lease commitments
The Company entered into a lease agreement for its office location in Arlington, Virginia on December 10, 2012. In connection with the lease, the Company is required to maintain a $2.0 million letter of credit which declines annually throughout the term of the lease as a guarantee of scheduled rent payments under the lease. On March 1, 2013, the Company amended the lease to include an additional floor, an additional 29,120 square feet. In conjunction with the amendment commencing March 1, 2013, the Company was required to hold an additional $1.7 million in restricted cash for the additional space. On April 1, 2014, the Company amended the lease to include an additional floor, an additional 27,813 square feet. As of December 31, 2014, the letter of credit balance in connection with the lease was $3.7 million.
Total rental expense on operating leases for the years ended December 31, 2014, 2013 and 2012, was $3.3 million, $1.5 million and $0.3 million, respectively. Future minimum rental commitments (in thousands) as of December 31, 2014, were as follows:
|
| | | |
2015 | $ | 2,866 |
|
2016 | 3,254 |
|
2017 | 3,335 |
|
2018 | 3,418 |
|
2019 | 3,504 |
|
Thereafter | 3,592 |
|
Total | $ | 19,969 |
|
Indemnifications
The Company’s managed service agreements generally include a provision by which the Company agrees to defend its customers against third party claims (a) for death, bodily injury, or damage to personal property caused by Company negligence or willful misconduct, (b) by former or current Company employees arising from such managed service agreements, (c) for intellectual property infringement under specified conditions, and (d) for Company violation of applicable laws, and to indemnify them against any damages and costs awarded in connection with such claims. To date, the Company has not incurred any material costs as a result of such warranties and indemnities and has not accrued any liabilities related to such obligations in the accompanying financial statements.
Registration rights agreement
The Company entered into a Master Investors' Rights Agreement with its preferred shareholders. Pursuant to this agreement, the Company has granted the preferred shareholders certain registration rights which obligate the Company to file registration statements in the future with respect to the registration of the common shares underlying the preferred units.
Concentration of credit risk
The Company is subject to significant concentrations of credit risk related to cash and cash equivalents, short term investments and accounts receivable. The Company's cash and cash equivalents and short term investments are held at financial institutions that management believes to be of high credit quality. While the Company maintains its cash and cash equivalents and short term investments with financial institutions with high credit ratings, it often maintains these deposits in federally insured financial institutions in excess of federally insured limits. The Company has not experienced any losses on cash and cash equivalents and short term investments to date. The following table summarizes those customers who represented at least 10% of our revenues or accounts receivable for the periods presented:
|
| | | | | | | | | | | | | | |
| As of or For the Years Ended Decenber 31, |
| 2014 | | 2013 | | 2014 | | 2013 | | 2012 |
| Accounts Receivable | | Revenues |
Customer A | 10 | % | | * |
| | * |
| | 11 | % | | 41 | % |
Customer B | * |
| | 12 | % | | 14 | % | | 11 | % | | 16 | % |
Customer C | 37 | % | | 14 | % | | 16 | % | | 30 | % | | 20 | % |
Customer D | 17 | % | | 34 | % | | 21 | % | | 16 | % | | * |
|
Customer E | 15 | % | | 36 | % | | 25 | % | | 13 | % | | * |
|
Customer F | * |
| | * |
| | * |
| | * |
| | 12 | % |
Customer G | 14 | % | | * |
| | * |
| | * |
| | * |
|
* Represents less than 10% of the respective balance
10. Stock-based Incentive Plan
Evolent Holdings sponsors a stock-based incentive plan for Evolent LLC employees that provides for the issuance of stock options and restricted stock in Evolent Holdings’ common stock. Stock-based awards vest over a four year period and expire ten years from the date of grant. Prior to the Reorganization, stock-based compensation followed an employee model as the awards were granted in the stock of the company to employees of the company. Subsequent to the Reorganization, the stock-based compensation awards are granted in the stock of the Company’s equity-method investor, Evolent Holdings, to employees of Evolent LLC. As such, the Company is required to utilize a non-employee model for recognizing stock-based compensation, which requires the awards to be marked-to-market through net income at the end of each reporting period until vesting occurs.
Under the Company’s Amended and Restated Operating Agreement, the Company is required to issue an identical amount of common units to Evolent Holdings in exchange for its underlying stock. As a result, the Company records a capital contribution from Evolent Holdings each time a stock award is granted. We issue new units to satisfy option exercises.
The 2011 Equity Incentive Plan was amended on September 23, 2013, to increase the number of shares authorized to 2,285,317 shares of Evolent Holdings common stock. As of December 31, 2014, 1,039,100 stock options and 943,810 shares of restricted stock of Evolent Holdings have been issued under the Plan.
Common stock valuation
The historical valuations of Evolent Holdings’ common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. In the absence of a public trading market, we considered all relevant facts and circumstances known at the time of valuation, made certain assumptions based on future expectations and exercised significant judgment to determine the fair value of Evolent Holdings’ common stock. The factors considered in determining the fair value include, but are not limited to the following:
| |
• | Third-party valuations of Evolent Holdings’ common stock; |
| |
• | Recent issuances of preferred stock, as well as the rights, preferences and privileges of our preferred stock relative to its common stock; |
| |
• | Evolent Holdings’ historical financial results and estimated trends and projections for Evolent Holdings’ future operating and financial performance; |
| |
• | Likelihood of achieving a liquidity event, such as an initial public offering or sale of Evolent Holdings, given prevailing market conditions; |
| |
• | The market performance of comparable, publicly-traded companies; and |
| |
• | The overall economic and industry conditions and outlook. |
Prior to December 31, 2014, when estimating the value of Evolent Holdings’ common stock, our Board of Directors determined the equity value of the business by primarily considering income-based approaches. The income-based approach estimates value based on the expectation of future cash flows that a company will generate and the residual value of the company after the forecasted period. The future cash flows are discounted using a discount rate derived based upon venture capital rates commensurate with Evolent
Holdings’ risk profile. Additionally, we applied a discount to recognize the lack of marketability due to being a closely held company. Finally, we estimated the time to a future liquidity event at each valuation date based upon our expectations at each valuation date.
As of December 31, 2014, we utilized a probability-weighted expected return method (“PWERM”) to determine the value of Evolent Holdings’ common stock due to the three distinct liquidity events considered as of the valuation date. An analysis of the future values of Evolent Holdings was performed for each of the potential liquidity events, and the value of the common stock was determined for each liquidity event at the time of each liquidity event and discounted back to the present using a risk-adjusted discount rate. The present values of the common stock under each liquidity event were then weighted based on the probability of each outcome occurring to determine the value of the common stock. We utilized a combination of the income-based approach and market approach for the distinct liquidity events. A discounted cash flow analysis was used for the income approach. Under the market approach, a market multiple was selected based on the estimated exit timing.
In order to determine the fair value of Evolent Holdings’ common stock, we generally first determine Evolent Holdings’ business enterprise value (“BEV”) and then allocate the BEV to each element of Evolent Holdings’ capital structure (preferred stock, common stock and options). Evolent Holdings’ indicated BEV at each valuation date was allocated to the shares of preferred stock, common stock and options using the Black-Scholes option pricing model. Estimates of the volatility of our common stock were based on available information on the volatility of common stock of comparable, publicly-traded companies and estimates of expected term were based on the estimated time to a liquidity event.
Total compensation expense (in thousands) by award type and line item in our Statements of Operations and Comprehensive Income (Loss) were as follows:
|
| | | | | | | | | | | |
| For the Years Ended December 31, |
| 2014 | | 2013 | | 2012 |
Stock options | $ | 3,125 |
| | $ | — |
| | $ | — |
|
Restricted stock | 7,966 |
| | 1,235 |
| | 87 |
|
Total | $ | 11,091 |
| | $ | 1,235 |
| | $ | 87 |
|
|
| | | | | | | | | | | |
| For the Years Ended December 31, |
| 2014 | | 2013 | | 2012 |
Cost of revenue | $ | 758 |
| | $ | 86 |
| | $ | — |
|
Selling, general and administrative expenses | 10,333 |
| | 1,149 |
| | 87 |
|
Total | $ | 11,091 |
| | $ | 1,235 |
| | $ | 87 |
|
Total unrecognized compensation expense (in thousands) and expected weighted-average life (in years) by award type as of December 31, 2014, were as follows:
|
| | | | | | |
| Expense | | Weighted- Average Period |
Stock options | $ | 11,438 |
| | 3.09 |
|
Restricted stock | 4,072 |
| | 1.21 |
|
Total | $ | 15,510 |
| | |
Stock options
The option price assumptions used for our stock option awards were as follows:
|
| | | |
Weighted-average fair value per option granted | $ | 7.48 |
|
Assumptions: | |
Expected life (in years) | 6.25 |
|
Expected volatility | 35 | % |
Risk-free interest rate | 1.8 - 2% |
|
Dividend yield | 0% |
|
No options were granted during 2013 or 2012.
The fair value of options is determined using a Black-Scholes options valuation model with the assumptions disclosed in the table above. The dividend rate is based on the expected dividend rate during the expected life of the option. Expected volatility is based on the historical volatility of a peer group of public companies over the most recent period commensurate with the estimated expected
term of the Company’s awards. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life of the options granted represents the weighted-average period of time from the grant date to the date of exercise, expiration or cancellation based on the midpoint convention.
Information with respect to our stock options (aggregate intrinsic value shown in thousands) was as follows:
|
| | | | | | | | | | | | | |
| Shares | | Weighted- Average Exercise Price | | Weighted- Average Remaining Contractual Term | | Aggregate Intrinsic Value |
Outstanding as of December 31, 2013 | — |
| | $ | — |
| | | | |
Granted | 1,039,100 |
| | 15.36 |
| | | | |
Exercised | (3,000 | ) | | 15.36 |
| | | | |
Outstanding as of December 31, 2014 | 1,036,100 |
| | $ | 15.36 |
| | 9.36 |
| | $ | 12,537 |
|
Vested and expected to vest after December 31, 2014 | 984,295 |
| | $ | 15.36 |
| | 9.36 |
| | $ | 11,910 |
|
Exercisable at December 31, 2014 | 184,150 |
| | $ | 15.36 |
| | 9.26 |
| | $ | 2,228 |
|
The total fair value of options vested during the years ended December 31, 2014, 2013 and 2012, was $2.3 million, zero and zero, respectively. The total intrinsic value of options exercised during the year ended December 31, 2014, was less than $0.1 million.
Restricted stock
As of December 31, 2014 and 2013, the Company issued 943,810 and 956,506 common units, respectively, to Evolent Holdings, in connection with the issuance by Evolent Holdings of shares of its common stock to employees of the Company. These shares were issued in the form of restricted stock awards. The awards, which vest ratably over a four year period, were issued to the respective employees for no consideration. The aggregate value of the units issued to Evolent Holdings in connection with each restricted stock award is recognized as compensation expense over the vesting period.
Information with respect to our restricted stock awards was as follows:
|
| | | | | | |
| Shares | | Weighted- Average Grant-Date Fair Value |
Outstanding as of December 31, 2013 | 568,749 |
| | $ | 0.60 |
|
Vested | (237,105 | ) | | 0.59 |
|
Forfeited | (12,696 | ) | | 1.22 |
|
Outstanding as of December 31, 2014 | 318,948 |
| | $ | 0.59 |
|
11. Income Taxes
After the Reorganization, the Company is no longer a taxable entity as it was converted from a corporation to a partnership. As a result of the reorganization, the Company ceased the recognition of all federal and state deferred tax assets and liabilities as of September 23, 2013.
Deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws.
For financial reporting purposes, loss before income tax is derived from domestic sources. The current provision and deferred benefit for taxes on income for the period ending December 31, 2013, was less than $0.1 million, and pertains entirely to the period during 2013 for which the Company was classified and treated as a corporation. No income tax expense or benefit has been recorded within these financial statements for the period during 2013 for which the Company was classified and treated as a partnership.
The current provision and deferred benefit for taxes on income for the period ending December 31, 2012, were zero and $0.3 million, respectively. The Company was classified and treated as a corporation, subject to entity level tax, during 2012 and through the date of Reorganization in 2013.
The effective tax rate for the years ending December 31, 2013 and 2012, was 0% and 2%, respectively. The effective tax rate varies from the U.S. statutory rate due to the impact of the valuation allowance. The effective tax rate varied from the U.S. federal statutory tax rate principally due to the following as of December 31, 2012:
|
| | |
U.S statutory tax rate | 35.0 | % |
U.S. state income taxes, net of U.S federal tax benefit | 4.0 | % |
Change in valuation allowance | (36.8 | )% |
Other, net | (0.4 | )% |
Effective rate | 1.8 | % |
As of each applicable year-end, the Company has not recognized any uncertain tax positions, penalties or interest as we have concluded that no such positions exist. The Company is not currently subject to income tax audits in any U.S. or state jurisdictions for any tax year.
12. Defined Contribution Plan
We sponsor a tax-qualified 401(k) retirement plan that provides eligible U.S. employees with an opportunity to save for retirement on a tax advantaged basis. We make matching contributions to the plan in accordance with the plan documents and various limitations under Section 401(a) of the Internal Revenue Code of 1986, as amended. Expenses for these plans were $2.3 million, $1.1 million and $0.2 million for the years ended December 31, 2014, 2013 and 2012, respectively.
13. Accrued Liabilities
Details of accrued liabilities (in thousands) are presented below:
|
| | | | | | | |
| As of December 31, |
| 2014 | | 2013 |
Accrued salaries and benefits | $ | 14,305 |
| | $ | 7,993 |
|
Self-insurance liability | 1,156 |
| | — |
|
Other accrued liabilities | 2,717 |
| | 2,295 |
|
Total accrued liabilities | $ | 18,178 |
| | $ | 10,288 |
|
During 2014, the Company began to self-insure for certain levels of medical, and dental coverage. Our self-insurance liabilty includes the estimated costs of these self-insurance programs at the present value of projected settlements based on history of settled claims, including payment patterns and the fixed nature of the individual settlements. During 2014, we incurred and paid claims related to the current year of $6.4 million and $5.3 million, respectively.
14. Related Parties
The Company works closely with both of its founding shareholders, The Advisory Board d UPMC. The relationship with The Advisory Board is centered on educating health system CEOs on innovations in the healthcare space. In return, the Company makes valuable connections with CEOs of health systems that could then become customers. The Company’s relationship with UPMC is a more traditional subcontractor one where UPMC has agreed to execute certain tasks necessary to deliver on the Company’s customer commitments.
As of December 31, 2014, the Company had no accounts receivable due from The Advisory Board or UPMC. The Company had no accounts payable or accrued expenses due to The Advisory Board and accounts payable and accrued expenses of $4.9 million to UPMC as of December 31, 2014. Total expenses attributable to The Advisory Board and UPMC for the year ended December 31, 2014, were $0.2 million and $14.5 million, respectively.
As of December 31, 2013, the Company had no accounts receivable due from The Advisory Board or UPMC. The Company had no accounts payable or accrued expenses to The Advisory Board and accounts payable and accrued expenses of $1.0 million to UPMC as of December 31, 2013. Total expenses attributable to The Advisory Board and UPMC for the year ended December 31, 2013, were $0.8 million and $1.9 million, respectively.
Total expenses attributable to The Advisory Board and UPMC for the year ended December 31, 2012, were $0.4 million and $0.6 million, respectively.
During 2012, the Company sold preferred series A shares to certain customers for strategic purposes while concurrently entering into revenue contracts with those customers. The Company concluded the $4.5 million in gross proceeds collected for those shares represented fair value of the shares at the time of sale. The Company recognized $23.3 million, $17.2 million and $6.1 million of revenue related to these customers for the years ended December 31, 2014, 2013 and 2012, respectively. As of December 31, 2014 and 2013, the Company had accounts receivable balances of $4.4 million and $1.5 million, respectively, related to these customers.
In January 2014, Evolent Holdings issued shares of series B-1 preferred stock to a customer for strategic purposes while the Company concurrently entered into a revenue contract with the customer. The Company issued an identical number of membership units to Evolent Holdings and recorded the proceeds in the form of a capital contribution. Based on a contemporaneous valuation, the Company concluded that the $1.0 million in gross proceeds was consistent with fair value. As of and for the year ended December 31, 2014, the Company had accounts receivable of less than $0.1 million and recognized $14.4 million of revenue related to this customer.
In July 2014, Evolent Holdings repurchased 75,000 shares of series A preferred stock from a customer while the Company concurrently negotiated terms of a revenue arrangement. The Company repurchased an identical number of membership units for the same value from Evolent Holdings. Based on a contemporaneous valuation, the Company concluded that the repurchase was consistent with fair value. Additionally, Evolent Holdings issued 25,000 shares of series B-1 preferred stock to the same customer of the Company for no consideration while the Company concurrently negotiated terms of a revenue arrangement. The Company issued an identical number of membership units to Evolent Holdings. As this occurred concurrently with the revenue negotiation, this was determined to represent an inducement related to the revenue contract, and the fair value of the shares issued will be recorded as a reduction to revenue over the term of the revenue agreement. As of December 31, 2014, the Company recorded a current asset of $0.1 million and a non-current asset of $0.5 million related to this inducement. As of and for the year ended December 31, 2014, the Company had accounts receivable of $3.5 million and recognized $16.2 million of revenue related to this customer, which are included in the amounts noted above for our series A affiliates.
15. Subsequent Events
The Company completed its subsequent events assessment through March 2, 2015. No material subsequent events were identified.
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