NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Business description and basis of presentation
The Advisory Board Company (individually and collectively with its subsidiaries, the “Company”) provides best practices research and insight, performance technology software, data- and tech-enabled services, and consulting and management services, through discrete programs to hospitals, health systems, independent medical groups, 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 software applications, data- and tech-enabled services, and consulting and management services.
The unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) for reporting on Form 10-Q. Accordingly, certain information and footnote disclosures required for complete financial statements are not included herein. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes as reported in the Company’s Form 10-K for the year ended December 31, 2015 and the Company’s quarterly report on Form 10-Q for the quarterly period ended March 31, 2016.
The unaudited 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 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. All significant intercompany transactions and balances have been eliminated.
In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows as of the dates and for the periods presented have been included. The consolidated balance sheet presented as of December 31, 2015 has been derived from the financial statements that have been audited by the Company’s independent registered public accounting firm. The consolidated results of operations for the three and six months ended June 30, 2016 may not be indicative of the results that may be expected for the Company’s fiscal year ending December 31, 2016, or any other period.
Note 2. Recent accounting pronouncements
Recently adopted
In April 2015, the Financial Accounting Standards Board ("FASB") issued guidance on the presentation of debt issuance costs. The guidance requires debt issuance costs related to a recognized debt liability to be presented as a direct deduction from the carrying amount of that debt liability and only impacts financial position presentation. In August 2015, the FASB issued guidance related to the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. The guidance codified the Securities and Exchange Commission staff's view on the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements consistent with prior practice as an asset. The Company adopted these standards retrospectively on January 1, 2016. The impact the adoption had on the Company's consolidated financial position as of December 31, 2015 is disclosed below. The adoption had no effect on the Company's results of operations for any period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported
|
|
Adjustments
|
|
As adjusted
|
Prepaid expenses and other current assets
|
$
|
22,651
|
|
|
$
|
(108
|
)
|
|
$
|
22,543
|
|
Deferred incentive compensation and other charges
|
81,462
|
|
|
(281
|
)
|
|
81,181
|
|
Total assets
|
1,979,866
|
|
|
(389
|
)
|
|
1,979,477
|
|
Debt, current
|
27,851
|
|
|
(108
|
)
|
|
27,743
|
|
Debt, net of current portion
|
522,367
|
|
|
(281
|
)
|
|
522,086
|
|
Total liabilities
|
1,530,775
|
|
|
(389
|
)
|
|
1,530,386
|
|
Total liabilities and stockholders’ equity
|
1,979,866
|
|
|
(389
|
)
|
|
1,979,477
|
|
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 relating to the recognition of revenue, which could result in additional disclosures to the financial statements. The original effective date of the new standard was for annual and interim reporting periods beginning after December 15, 2016. In July 2015, the FASB decided to defer by one year the effective date of this new revenue recognition standard. As a result, the new standard will be effective for annual and interim reporting periods beginning after December 15, 2017, with an option that permits companies to adopt the standard as early as the original effective date. Early application prior to the original effective date is not permitted. The Company plans to adopt this standard on January 1, 2018. The Company is evaluating the effect that the updated standard will have on its consolidated financial statements and related disclosures and has not yet selected a transition method.
In February 2016, the FASB issued accounting guidance relating to leases. The guidance requires that lessees recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The new guidance also requires disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative information. The guidance is effective for annual reporting and interim periods beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.
In March 2016, the FASB issued accounting guidance relating to stock compensation. The guidance simplifies various aspects of the accounting for share-based payments. While aimed at reducing the cost and complexity of the accounting for share-based payments, the amendments are expected to impact net income, earnings per share, and the statement of cash flows. The guidance is effective for annual reporting and interim periods beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.
Note 3. Acquisitions
Increasing service to members through the introduction and expansion of new programs and services 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 offerings to its members, or that complement and enhance the value of existing products and services through the addition of new capabilities.
Royall Acquisition Co.
On January 9, 2015, the Company completed the acquisition of all of the issued and outstanding capital stock of Royall Acquisition Co. (together with its subsidiaries, “Royall”) from Royall Holdings, LLC (the “Seller”). Royall is an education market leader in strategic, data-driven student engagement and enrollment management solutions.
Total consideration consisted of the following (in thousands):
|
|
|
|
|
|
|
Net cash paid (1)
|
$
|
744,193
|
|
Fair value of equity issued
|
121,224
|
|
Total
|
$
|
865,417
|
|
(1) Net of cash acquired of
$7,065
and a working capital adjustment payment of
$1,278
.
On January 9, 2015, in connection with the completion of the acquisition of Royall, the Company entered into a credit agreement with various lenders. See Note 8, "Debt," for further details regarding 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 of the common stock on January 9, 2015 as reported on the NASDAQ Global Select Market.
The purchase price allocation resulting from the acquisition of Royall is set forth below (in thousands):
|
|
|
|
|
|
|
|
As of January 9, 2015
|
Consideration paid for the acquisition
|
|
$
|
865,417
|
|
|
|
|
Allocated to:
|
|
|
Membership fees receivable, net
|
|
29,239
|
|
Prepaid expenses and other current assets
|
|
8,237
|
|
Property and equipment
|
|
44,209
|
|
Intangible assets, net
|
|
262,000
|
|
Deferred revenue, current
|
|
(18,300
|
)
|
Accounts payable and accrued liabilities
|
|
(5,621
|
)
|
Deferred income taxes, net of current portion
|
|
(102,599
|
)
|
Preliminary fair value of net assets acquired
|
|
$
|
217,165
|
|
Preliminary allocation to goodwill
|
|
$
|
648,252
|
|
Acquisition-related costs of
$9.9 million
were incurred related to this transaction. Of this amount,
$6.6 million
was recognized and included in general and administrative costs in the Company’s consolidated statements of operations for the six months ended June 30, 2015.
Royall goodwill impairment
Goodwill is reviewed for impairment at least annually as of October 1, which is the first date of the fourth quarter of the Company's fiscal year, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company performs its goodwill impairment test at the reporting unit level, which is one level below the operating segment. The Company has
one
operating segment, which is consistent with the way management runs the business and allocates resources. The operating segment has been divided into two reporting units largely as a result of the Royall acquisition and continued integration efforts. The
two
reporting units are Royall and the remaining Advisory Board business ("Core ABC"). Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination.
As of the October 1, 2015 goodwill impairment assessment, the Royall reporting unit failed the step one test and the Company performed the step two test. In connection with the step two test, the Company estimated the fair value of identifiable intangible assets and deferred revenue using methodologies consistent with those used in the original Royall purchase price allocation. Key assumptions were updated to reflect the current outlook for the Royall business as well as market conditions. The step two analysis resulted in a goodwill impairment of
$99.1 million
, which was recorded in the year ended December 31, 2015.
Pro forma
The following table presents the Company’s pro forma consolidated revenues and net income for the three and six months ended June 30, 2015. The unaudited pro forma results include the historical statements of operations information of the Company and of Royall, giving effect to the acquisition of Royall and related financing as if they had occurred on January 1, 2014. The unaudited pro forma financial information presented below does not reflect the effect of any actual or anticipated synergies expected to result from the acquisition of Royall. Accordingly, the unaudited pro forma financial information is not necessarily indicative of the results of operations that would have been recognized had the acquisition of Royall and the related financing been effected on the assumed date.
The unaudited pro forma results are set forth below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unaudited Pro Forma Results
|
|
Three Months Ended June 30, 2015
|
|
Six Months Ended June 30, 2015
|
Revenue
|
$
|
190,199
|
|
|
$
|
378,197
|
|
Net income
|
$
|
12,331
|
|
|
$
|
10,416
|
|
For the six months ended June 30, 2015, the pro forma results, prepared in accordance with GAAP, include the following pro forma adjustments related to the acquisition of Royall:
|
|
(i)
|
an increase in revenue of
$2.8 million
and an increase in expense of
$1.7 million
for Royall's activity from January 1, 2015 to the January 9, 2015 acquisition date;
|
|
|
(ii)
|
an increase in revenue of
$12.5 million
representing the purchase accounting fair value effect to revenue that was recognized in the six months ended June 30, 2015;
|
|
|
(iii)
|
an increase in amortization expense related to the fair value of the identifiable intangible assets of
$0.4 million
;
|
|
|
(iv)
|
the elimination, and replacement, of the historical Royall interest expense with the interest expense from the Company's new senior secured term credit facility totaling
$9.5 million
;
|
|
|
(v)
|
the elimination of
$17.4 million
of loss on financing activities related to the acquisition-related debt activity; and
|
|
|
(vi)
|
the elimination of
$6.6 million
of acquisition-related costs.
|
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, and interest rate swaps. 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 is 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.
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. The performance targets are specific to the operation of the acquired company subsequent to the acquisition. These inputs are considered key estimates made by the Company that are unobservable because there are no active markets to support them. Contingent earn-out liabilities are included in accounts payable and accrued liabilities and other long-term liabilities on the consolidated balance sheets.
Interest rate swaps
. The Company uses interest rate swaps to manage interest rate risk. The fair values of interest rate swaps are determined using the market standard methodology of discounting the future variable cash payments, or receipts, over the life of the agreements. The variable interest rates used in the calculation of projected receipts are based on observable market interest rate curves.
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), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). As a basis for applying a market-based approach
in fair value measurements, GAAP establishes a fair value hierarchy that prioritizes into three broad levels the inputs to valuation techniques used to measure fair value. The following is a brief description of those three levels:
|
|
•
|
Level 1—Quoted prices in active markets for identical assets or liabilities.
|
|
|
•
|
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.
|
|
|
•
|
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
six
months ended
June 30, 2016
or 2015.
The Company’s financial assets and liabilities subject to fair value measurements on a recurring basis and the related classifications are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value
as of June 30,
|
|
Fair value measurement as of June 30, 2016
using fair value hierarchy
|
|
2016
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Financial assets
|
|
|
|
|
|
|
|
Cash and cash equivalents (1)
|
$
|
17,487
|
|
|
$
|
17,487
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Financial liabilities
|
|
|
|
|
|
|
|
Interest rate swaps (2)
|
4,779
|
|
|
—
|
|
|
4,779
|
|
|
—
|
|
Contingent earn-out liabilities (3)
|
3,280
|
|
|
—
|
|
|
—
|
|
|
3,280
|
|
|
|
|
|
|
|
|
|
|
Fair value
as of December 31,
|
|
Fair value measurement as of December 31, 2015
using fair value hierarchy
|
|
2015
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Financial assets
|
|
|
|
|
|
|
|
Cash and cash equivalents (1)
|
$
|
71,825
|
|
|
$
|
71,825
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest rate swaps (2)
|
419
|
|
|
—
|
|
|
419
|
|
|
—
|
|
Financial liabilities
|
|
|
|
|
|
|
|
Contingent earn-out liabilities (3)
|
7,250
|
|
|
—
|
|
|
—
|
|
|
7,250
|
|
|
|
(1)
|
Fair value is based on quoted market prices.
|
|
|
(2)
|
Fair value is determined using market standard models with observable inputs.
|
|
|
(3)
|
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 macroeconomic environment and industry trends.
|
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 affected 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. As of
June 30, 2016
,
$21.4 million
had been earned and paid in cash and shares to the former owners of the Southwind business, which includes the final payment of
$1.0 million
that was paid during the six months ended June 30, 2016. There is
no
remaining contingent obligation related to this earn-out agreement.
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
as of the date of acquisition. The fair value of the Clinovations earn-out liability is affected by changes in estimates regarding expected operating results through the evaluation periods, which will end
on December 31, 2017 with payments extending through April 2018. 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 liability is
$9.5 million
, while the minimum is
$0
. Based on the results of Clinovations’ operating results, the fair value of the contingent obligation for Clinovations as of June 30, 2016 was estimated at
$2.9 million
. The fair value of the Clinovations earn-out liability is affected by changes in estimates regarding expected operating results, discount rates for each evaluation period, which vary from approximately
6.7%
to
7.5%
, and the volatility of the Company's common stock, which was
27.0%
as of June 30, 2016.
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
as of the date of acquisition. The fair value of the GradesFirst earn-out liability was affected by changes in estimates regarding expected operating results through the evaluation period, which ended on December 31, 2015. The maximum earn-out potential of
$4.0 million
was earned during the evaluation period and paid during the six months ended June 30, 2016. There is
no
remaining contingent obligation related to this earn-out agreement.
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 three and months ended
June 30, 2016
and 2015 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Beginning balance
|
$
|
1,505
|
|
|
$
|
11,790
|
|
|
$
|
7,250
|
|
|
$
|
12,946
|
|
Addition due to acquisition
|
—
|
|
|
—
|
|
|
357
|
|
|
—
|
|
Fair value change in Southwind contingent earn-out liability (1)
|
—
|
|
|
—
|
|
|
—
|
|
|
209
|
|
Fair value change in Clinovations contingent earn-out liability (1)
|
1,750
|
|
|
(1,427
|
)
|
|
680
|
|
|
(1,292
|
)
|
Fair value change in other contingent earn-out liabilities (1)
|
25
|
|
|
—
|
|
|
25
|
|
|
—
|
|
Southwind earn-out payments
|
—
|
|
|
(1,947
|
)
|
|
(1,032
|
)
|
|
(1,947
|
)
|
GradesFirst earn-out payments
|
—
|
|
|
—
|
|
|
(4,000
|
)
|
|
—
|
|
360Fresh, Inc. earn-out payments
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,500
|
)
|
Ending balance
|
$
|
3,280
|
|
|
$
|
8,416
|
|
|
$
|
3,280
|
|
|
$
|
8,416
|
|
|
|
(1)
|
Amounts were recognized in cost of services on the consolidated statements of operations.
|
Financial instruments not recorded at fair value on a recurring basis
Equity method investments
. The Company's equity method investments represent the Company's ownership interest in Evolent Health, Inc. and its subsidiary, Evolent Health LLC. The fair value of the Company's ownership interest in Evolent Health, Inc. and its subsidiary prior to any discount was
$222.5 million
as of June 30, 2016 based on the quoted closing stock price as reported on the New York Stock Exchange. For further information, see Note 7, "Investments in unconsolidated entities." The fair value of the Company's equity method investments is measured quarterly for disclosure purposes. The Company's equity method investments are recorded at fair value only if an impairment charge is recognized.
Credit facilities
. The Company estimates that the fair value of its credit facilities was
$553.5
million as of June 30, 2016. The fair value was determined based on discounting the future expected variable cash payments over the life of the loan. The variable interest rates used in the calculation are based on observable market interest rates. The credit facilities would be classified as Level 2 within the fair value hierarchy if it were measured at fair value.
Non-financial assets and liabilities
Certain assets and liabilities are not measured at fair value on an ongoing basis but instead are measured at fair value on a non-recurring basis, so that such assets and liabilities are subject to fair value adjustments in certain circumstances (such as when there is evidence of impairment). During the
six
months ended
June 30, 2016
and 2015,
no
fair value adjustments or material fair value measurements were required for non-financial assets or liabilities.
Note 5. 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 only receive access to the software during the term of their membership agreement. Software development costs that are incurred in the preliminary project stage 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 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.
The acquired developed technology, which includes acquired software, databases, and analytics, is classified as software within property and equipment because the developed software application, database, or analytic resides on the Company’s or its service providers’ hardware. Amortization for acquired developed technology is included in depreciation and amortization on the Company’s consolidated statements of operations. Developed technology obtained through acquisitions is amortized using the straight-line method over the estimated useful life used in determining the fair value of the assets at acquisition. As of
June 30, 2016
, the weighted average useful life of existing acquired developed technology was approximately
eight
years. The amount of acquired developed technology amortization included in depreciation and amortization for the
three and six
months ended
June 30, 2016
was approximately
$2.3 million
and
$4.6 million
, respectively. The amount of acquired developed technology amortization included in depreciation and amortization for the
three and six
months ended
June 30, 2015
was approximately
$2.6 million
and
$4.6 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, net for the periods presented. The amount of depreciation expense recognized on furniture, fixtures, and equipment during the
three and six
months ended
June 30, 2016
was
$5.4 million
and
$10.8 million
, respectively. The amount of depreciation expense recognized on furniture, fixtures, and equipment during the
three and six
months ended
June 30, 2015
was
$5.0 million
and
$9.9 million
, respectively.
Internally developed capitalized software related to the Company's hosted software is classified as software within property and equipment and has an estimated useful life of
five
years. The carrying value of internally developed capitalized software was
$73.2 million
as of both
June 30, 2016
and December 31, 2015. Amortization expense for internally developed capitalized software for the
three and six
months ended
June 30, 2016
recorded in depreciation and amortization on the accompanying statements of operations, was approximately
$5.5 million
and
$11.9 million
, respectively. Amortization expense for internally developed capitalized software for the three and six months ended
June 30, 2015
recorded in depreciation and amortization on the consolidated statements of operations, was approximately
$4.8 million
and
$9.0 million
, respectively.
Property and equipment consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
As of
|
|
June 30, 2016
|
|
December 31, 2015
|
Leasehold improvements
|
$
|
67,015
|
|
|
$
|
63,608
|
|
Furniture, fixtures, and equipment
|
65,762
|
|
|
62,790
|
|
Software
|
213,677
|
|
|
202,384
|
|
Construction in progress, subject to a build-to-suit lease
|
15,054
|
|
|
2,700
|
|
Property and equipment, gross
|
361,508
|
|
|
331,482
|
|
Accumulated depreciation and amortization
|
(173,524
|
)
|
|
(148,425
|
)
|
Property and equipment, net
|
$
|
187,984
|
|
|
$
|
183,057
|
|
The Company evaluates its long-lived assets for impairment when changes in circumstances exist that suggest 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. During the
six
months ended
June 30, 2016
, the Company recognized a
$1.0 million
impairment loss recorded in depreciation and amortization on the consolidated statements of operations related to certain internally developed software that is no longer in use. The Company did
no
t recognize
any
impairment losses on any of its long-lived assets during the
six
months ended
June 30, 2015
.
Note 6. Goodwill and intangibles
Included in the Company’s goodwill and intangibles balances are goodwill and acquired intangibles, as well as internally developed capitalized software for sale. Goodwill is not amortized because it has an estimated indefinite life. Goodwill is reviewed for impairment at least annually as of October 1, 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
six
months ended
June 30, 2016
or
2015
. There was
no
impairment of goodwill recorded in the
six
months ended
June 30, 2016
or
2015
.
The following illustrates the change in the goodwill balance for the
six
months ended
June 30, 2016
(in thousands):
|
|
|
|
|
|
As of
|
|
June 30, 2016
|
Beginning balance
|
$
|
738,200
|
|
Acquisitions
|
2,258
|
|
Ending balance
|
$
|
740,458
|
|
Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which range from
2
years to
17
years. As of
June 30, 2016
, the weighted average remaining useful life of acquired intangibles was approximately
13.6
years. As of
June 30, 2016
, the weighted average remaining useful life of internally developed intangibles was approximately
3.6
years. The gross and net carrying balances and accumulated amortization of intangibles are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2016
|
|
As of December 31, 2015
|
|
Weighted
average
useful life
|
|
Gross
carrying
amount
|
|
Accumulated
amortization
|
|
Net
carrying
amount
|
|
Gross
carrying
amount
|
|
Accumulated
amortization
|
|
Net
carrying
amount
|
Intangibles
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Internally developed software for sale
|
5.0
|
|
$
|
18,510
|
|
|
$
|
(8,350
|
)
|
|
$
|
10,160
|
|
|
$
|
16,902
|
|
|
$
|
(6,796
|
)
|
|
$
|
10,106
|
|
Acquired intangibles:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Developed software
|
5.2
|
|
9,450
|
|
|
(8,325
|
)
|
|
1,125
|
|
|
9,450
|
|
|
(8,075
|
)
|
|
1,375
|
|
Customer relationships
|
16.2
|
|
277,710
|
|
|
(34,379
|
)
|
|
243,331
|
|
|
277,710
|
|
|
(25,769
|
)
|
|
251,941
|
|
Trademarks
|
8.6
|
|
14,900
|
|
|
(5,225
|
)
|
|
9,675
|
|
|
14,900
|
|
|
(4,490
|
)
|
|
10,410
|
|
Non-compete agreements
|
3.8
|
|
1,400
|
|
|
(1,394
|
)
|
|
6
|
|
|
1,400
|
|
|
(1,379
|
)
|
|
21
|
|
Customer contracts
|
4.7
|
|
6,449
|
|
|
(5,798
|
)
|
|
651
|
|
|
6,449
|
|
|
(5,581
|
)
|
|
868
|
|
Total intangibles
|
|
|
$
|
328,419
|
|
|
$
|
(63,471
|
)
|
|
$
|
264,948
|
|
|
$
|
326,811
|
|
|
$
|
(52,090
|
)
|
|
$
|
274,721
|
|
Amortization expense for intangible assets for the
three and six
months ended
June 30, 2016
, recorded in depreciation and amortization on the consolidated statements of operations, was approximately
$5.7 million
and
$11.4 million
, respectively. Amortization expense for intangible assets for the
three and six
months ended
June 30, 2015
was approximately
$6.1 million
and
$12.3 million
, respectively. The following approximates the aggregate amortization expense to be recorded in depreciation and amortization on the consolidated statements of operations for the remaining six months of the fiscal year ending December 31, 2016, for each of the following fiscal years ending December 31, 2017 through 2020, and thereafter:
$11.4 million
,
$22.2 million
,
$21.3 million
,
$19.6 million
, and
$18.4 million
, respectively, and
$172.0 million
thereafter.
Note 7. Investments in unconsolidated entities
As of
June 30, 2016
, the Company held an
8.7%
direct equity interest in Evolent Health LLC (“Evolent LLC”) and a
15.0%
equity ownership interest in Evolent Health, Inc. (“Evolent Inc.”), which had no material operations outside of its
70.8%
ownership interest in Evolent LLC. These investments are accounted for under the equity method, with the Company’s proportionate share of the investees’ losses recognized in the consolidated statements of operations. The Company has the right to designate
two
individuals to Evolent Inc.'s board of directors, which seats were occupied by the Company’s Company's Chief Financial Officer and an unaffiliated designee of the Company as of
June 30, 2016
.
During the three months ended
June 30, 2016
, the Company's proportionate share of the losses of Evolent Inc. was
$1.2 million
. The Company recorded
$0.3 million
of these losses against the remaining carrying amount of its investment. The remaining losses were not recorded as they exceeded the Company's investment balance. The Company will track these unrecorded losses until such time as the Company's investment in Evolent Inc. produces earnings or a gain sufficient to offset the unrecorded losses. During the six months ended June 30, 2016, the Company's proportionate shares of the losses of Evolent Inc. was
$2.0 million
, of which
$1.1 million
was recognized in the consolidated statements of operations offset by a
$1.1 million
dilution gain. The carrying balance of the Company’s investment in Evolent Inc. was
$0.0 million
as of
June 30, 2016
. The Company had a total of
$0.9 million
in unrecorded losses related to its investment in Evolent Inc. as of June 30, 2016.
During the three months ended
June 30, 2016
, the Company's proportionate share of the losses of Evolent LLC was
$1.0 million
. The Company recorded
$0.2 million
of these losses against the remaining carrying amount of its investment. The remaining losses were not recorded as they exceeded the Company's investment balance. During the six months ended June 30, 2016, the Company's proportionate share of the losses of Evolent LLC was
$2.5 million
, of which
$1.6 million
was recognized in the consolidated statements of operations, offset by a
$0.9 million
dilution gain. The carrying balance of the Company’s investment in Evolent LLC was
$0.0 million
as of
June 30, 2016
. The Company had a total of
$0.8 million
in unrecorded losses related to its investment in Evolent LLC as of June 30, 2016.
Because of Evolent LLC's treatment as a partnership for federal income 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 is recorded net of the estimated tax benefit the Company believes will be realized from the equity in loss of unconsolidated entities on the consolidated statements of operations. Historically, the Company had provided a full valuation allowance against the deferred tax asset resulting from these benefits. During the three months ended June 30, 2015, the Company determined that it was more-likely-than not able to realize the deferred tax assets associated with its investment in Evolent LLC as a result of the reorganization related to Evolent Inc.'s initial public offering; accordingly, a tax benefit of
$6.7 million
was recorded to release the valuation allowance previously recorded. An additional tax benefit of
$1.5 million
was recorded in the three months ended June 30, 2015 for tax benefits associated with current year losses received from Evolent LLC. In the three and six months ended
June 30, 2016
, additional tax benefits of
$0.1 million
and
$0.3 million
, respectively, were recorded for the tax effects of current year losses received from Evolent LLC. Prior to Evolent Inc.’s initial public offering of common stock in June 2015, the Company had provided a full valuation allowance against the deferred tax asset resulting from these benefits.
The equity in (loss) income of unconsolidated entities on the consolidated statement of operations for the combined Evolent entities consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Dilution gain
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,026
|
|
|
$
|
—
|
|
Allocated share of losses
|
(511
|
)
|
|
(4,265
|
)
|
|
(2,732
|
)
|
|
(6,644
|
)
|
Tax benefit
|
100
|
|
|
8,265
|
|
|
261
|
|
|
8,265
|
|
Equity in (loss) income of unconsolidated entities
|
$
|
(411
|
)
|
|
$
|
4,000
|
|
|
$
|
(445
|
)
|
|
$
|
1,621
|
|
In connection with Evolent Inc.'s initial public offering and the related reorganization, the Company and certain investors in Evolent LLC entered into a tax receivables agreement with Evolent Inc. Under the terms of that agreement, Evolent Inc. will make cash payments to the Company and certain investors in amounts equal to
85%
of Evolent Inc.'s actual tax benefit realized from various tax attributes related to activity before the initial public offering. Interest will be included on the tax savings at the applicable London interbank offered rate plus 100 basis points. The tax receivables agreement will generally apply to Evolent Inc.'s taxable years up to and including the
15
th anniversary date of the transaction. As of
June 30, 2016
, the Company had not received any payments pursuant to the tax receivables agreement. As the amount the Company will receive pursuant to the tax receivables agreement is unknown, the Company will recognize payments, if any, associated with this agreement when such payments are received.
As of
June 30, 2016
, the Company’s basis in the Evolent entities was less than its proportional interest in the equity of Evolent Inc. and Evolent LLC in the amounts of
$80.4 million
and
$68.2 million
, respectively. The Company has excluded the effects of the purchase and push down accounting in its determination of the equity in such loss, thereby reducing its share of losses from Evolent Inc. and Evolent LLC for the affected periods. As a result, the basis differences will decrease over time.
Evolent LLC is in the early stages of its business plan and, as a result, the Company expects both Evolent Inc. and Evolent LLC to continue to incur losses. The Company’s investments are evaluated for impairment whenever events or changes in circumstances indicate that there may be an other-than-temporary decline in value. As of June 30, 2016, the Company believes that no impairment charge is necessary. For additional information on the fair value of the Company’s investment in the Evolent entities, see Note 4, “Fair value measurements.”
Note 8. Debt
On February 6, 2015, the Company obtained
$675 million
of senior secured credit facilities, referred to as the “credit facilities,” under a credit agreement with a syndicate of lenders. The credit facilities were amended on October 30, 2015. The amended credit facilities consist of (a) a
five
-year senior secured term loan facility in the principal amount of
$475 million
, or “term facility,” and (b) a
five
-year senior secured revolving credit facility, or “revolving credit facility,” under which up to
$200 million
principal amount of borrowings and other credit extensions may be outstanding at any time. 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
2.25%
, subject in each case to margin reductions based on the Company’s total leverage ratio from time to time. As of
June 30, 2016
, based on the Company's historical leverage ratio, the interest rate margin was
2.00%
and the stated annual interest rate on outstanding borrowings was
2.47%
.
On June 10, 2016, the Company drew down
$17.0 million
of borrowings under its revolving credit facility. The draw down borrowings have a maturity of
three
months and accrue interest at an annual rate of
2.66%
. As of
June 30, 2016
, there was
$117.0 million
outstanding under the revolving credit facility and
$63.9 million
available for future borrowings. As of
June 30, 2016
,
$19.1 million
of standby letters of credit had been issued under the revolving credit facility.
Long-term debt is summarized as follows (in thousands):
|
|
|
|
|
|
As of
June 30, 2016
|
2.47% term facility due fiscal 2020 ($439,062 face value less unamortized discount of $3,101)
|
$
|
435,961
|
|
Revolving credit facility
|
117,000
|
|
Less: Amounts due in next twelve months ($52,946 face value less unamortized discount of $1,000)
|
(51,946
|
)
|
Total long-term debt
|
$
|
501,015
|
|
The credit agreement contains customary representations and warranties, events of default and financial and other covenants, including covenants that require the Company to maintain a maximum total leverage ratio and a minimum interest coverage ratio. The Company's compliance with the
two
financial covenants is measured as of the end of each fiscal quarter. The Company was in compliance with these financial covenants as of
June 30, 2016
.
Interest expense for the three months ended
June 30, 2016
and 2015 was
$4.4 million
and
$5.2 million
, inclusive of
$0.3 million
and
$0.3 million
of amortization of debt issuance costs, and
$0.6 million
and
$0.7 million
of payments related to the interest rate swaps described below, respectively. Interest expense for the six months ended June 30, 2016 and 2015 was
$9.2 million
and
$10.8 million
, inclusive of
$0.7 million
and
$0.7 million
of amortization of debt issuance costs, and
$1.2 million
and
$0.7 million
of payments related to the interest rate swaps described below, respectively.
Swap agreements
Through its term facility, the Company is exposed to interest rate risk. In April 2015, to minimize the impact of changes in interest rates on its interest payments, the Company entered into
three
interest rate swap agreements with financial institutions to swap a portion of its variable-rate interest payments for fixed-rate interest payments. The interest rate swap derivative financial instruments are recorded on the consolidated balance sheets at fair value, which is based on observable market-based expectations of future interest rates.
At hedge inception, the Company entered into interest rate swap arrangements with notional amounts totaling
$287.5 million
. The swap was structured to have a declining notional amount which matches the amortization schedule of the term facility. As of
June 30, 2016
, the principal amount hedged was
$269.5 million
. The interest rate swap agreements mature in February 2020 and have periodic interest settlements, both consistent with the terms of the Company's term facility. Under this
agreement, the Company is entitled to receive a floating rate based on the 1-month London interbank offered rate and obligated to pay an average fixed rate of
1.282%
on the outstanding notional amount. The Company has designated the interest rate swap as a cash flow hedge of the variability of interest payments under its term facility due to changes in the LIBOR benchmark interest rate. The difference between cash paid and received is recorded within interest expense on the consolidated statements of operations.
As of
June 30, 2016
and December 31, 2015, the fair value of the interest rate swaps was a liability of
$4.8 million
and an asset of
$0.4 million
, respectively, and was recorded within other long-term liabilities on the Company's consolidated balance sheets. For the three months ended
June 30, 2016
and 2015, the change in fair value of the swaps, net of tax, was a decrease of
$0.4 million
and an increase of
$0.7 million
, respectively, and was reported as a component of accumulated other comprehensive (loss) income. For the six months ended
June 30, 2016
and 2015, the change in fair value of the swaps, net of tax, was a decrease of
$2.9 million
and an increase
$0.7 million
, respectively. There was
no
material hedge ineffectiveness as of
June 30, 2016
and 2015. Changes in fair value are reclassified from accumulated other comprehensive (loss) income into earnings in the same period in which the hedged item affects earnings.
If, at any time, the swap is determined to be ineffective, in whole or in part, due to changes in the interest rate swap or underlying debt agreements, the fair value of the portion of the swap determined to be ineffective will be recognized as a gain or loss on the consolidated statements of operations for the applicable period.
Note 9. Stockholders’ equity
In November 2015, the Company’s board of directors authorized an increase in its cumulative share repurchase program to
$550 million
of the Company's common stock. The Company repurchased
803,217
and
1,740,247
shares of its common stock at a total cost of approximately
$26.2 million
and
$53.6 million
in the
three
and
six
months ended
June 30, 2016
, respectively, pursuant to its share repurchase program. The Company did not repurchase any shares in the
three
and
six
months ended
June 30, 2015
. The total amount of common stock purchased from inception under the program through
June 30, 2016
was
19,567,789
shares at a total cost of
$505.5 million
. All such repurchases have been made in the open market, and all repurchased shares have been retired as of
June 30, 2016
.
No
minimum number of shares subject to repurchase has been fixed, and the share repurchase authorization has no expiration date. As of
June 30, 2016
, the remaining authorized repurchase amount was
$44.5 million
.
Note 10. Stock-based compensation
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, the "inducement plan," 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
. The awards consisted of performance-based stock options to purchase an aggregate of
1,751,000
shares of common stock and performance-based restricted stock units ("RSUs") for an aggregate of
145,867
shares of common stock. Both the performance-based stock options and performance-based RSUs are also subject to service conditions.
Stock options granted under the inducement plan have an exercise price equal to
$49.92
, which was the closing price of the 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 RSUs 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
$26.8 million
. The aggregate grant date fair value of the performance-based RSUs, assuming all performance targets are met, is estimated at approximately
$7.3 million
. As of
June 30, 2016
, the Company expects that Royall will achieve
70%
to
99%
of the performance targets, which would result in vesting of
50%
of the performance-based stock options and
50%
of the RSUs eligible to vest, subject to forfeitures. The option and RSU awards are reflected in the tables below.
The actual stock-based compensation expense the Company will recognize is dependent upon Royall satisfying the applicable 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 Royall's actual results and the employment status of the award recipients at the time performance conditions are met.
Stock incentive plans
On June 9, 2015, the Company's stockholders approved an amendment to the Company's 2009 Stock Incentive Plan (the “2009 Plan”) that increased the number of shares of common stock authorized for issuance under the plan by
3,800,000
shares. The aggregate number of shares of the Company’s common stock available for issuance under the 2009 Plan, as amended, may not e
xceed
10,535,000
.
Performance-based stock option grant.
On March 2, 2016, the compensation committee of the board of directors approved a grant of
319,900
nonqualified performance-based stock options under the 2009 Plan to certain executive officers of the Company. These awards are subject to market conditions and portions will vest, with all awards vesting if the highest levels of the performance are achieved, based on the achievement of sustained stock price during the performance period, which could extend to March 2, 2023. The Company has concluded that it is probable that all awards will vest at the highest level of achievement. The estimated requisite service period, which includes the current estimate of the time to achieve the market conditions is
1.2 years
. The option awards are reflected in the table below.
The following table summarizes the changes in common stock options outstanding under the Company’s stock incentive plans during the
six
months ended
June 30, 2016
and
2015
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
performance-based options
|
|
Weighted
average
exercise
price
|
|
Number of
service-based options
|
|
Weighted
average
exercise
price
|
Outstanding, as of December 31, 2014
|
994,605
|
|
|
$
|
50.96
|
|
|
1,746,692
|
|
|
$
|
37.19
|
|
Granted
|
1,774,820
|
|
|
49.90
|
|
|
328,096
|
|
|
53.42
|
|
Exercised
|
—
|
|
|
—
|
|
|
(128,669
|
)
|
|
23.43
|
|
Forfeited
|
(751,800
|
)
|
|
49.92
|
|
|
(13,569
|
)
|
|
60.27
|
|
Outstanding, as of June 30, 2015
|
2,017,625
|
|
|
$
|
50.30
|
|
|
1,932,550
|
|
|
$
|
40.70
|
|
|
|
|
|
|
|
|
|
|
Number of
performance-based options
|
|
Weighted
average
exercise
price
|
|
Number of
service-based options
|
|
Weighted
average
exercise
price
|
Outstanding, as of December 31, 2015
|
2,013,325
|
|
|
$
|
50.42
|
|
|
1,843,110
|
|
|
$
|
41.73
|
|
Granted
|
319,900
|
|
|
28.20
|
|
|
1,005,756
|
|
|
28.31
|
|
Exercised
|
—
|
|
|
—
|
|
|
(237,158
|
)
|
|
15.29
|
|
Forfeited
|
(215,370
|
)
|
|
49.92
|
|
|
(22,195
|
)
|
|
53.38
|
|
Expired
|
—
|
|
|
—
|
|
|
(17,347
|
)
|
|
51.77
|
|
Outstanding, as of June 30, 2016
|
2,117,855
|
|
|
$
|
47.11
|
|
|
2,572,166
|
|
|
$
|
38.75
|
|
Exercisable, as of June 30, 2016
|
20,000
|
|
|
$
|
29.58
|
|
|
1,073,586
|
|
|
$
|
41.80
|
|
The weighted average fair value of the service-based options, valued using a Black-Scholes model, granted during the
six
months ended
June 30, 2016
was estimated at
$9.86
per share on the date of grant using the following weighted average assumptions: risk-free interest rate of
1.2%
; an expected term of approximately
5.1
years; expected volatility of
37.46%
; and dividend yield of
0.0%
over the expected life of the option.
The weighted average fair value of performance-based options granted with market conditions, valued using a Monte Carlo model, during the
six
months ended
June 30, 2016
was estimated at
$10.21
per share on the date of grant using the following weighted average assumptions: risk-free interest rate of
1.6%
; an expected term of
6.4
years; volatility of
36.5%
; and dividend yield of
0.0%
over the expected life of the option.
No
options with performance and/or market conditions vested during the
six
months ended
June 30, 2016
and
10,000
options with performance conditions vested during the
six
months ended June 30, 2015.
The following table summarizes the changes in RSUs granted under the Company’s stock incentive plans during the
six
months ended
June 30, 2016
and
2015
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
performance-based RSUs
|
|
Weighted average
grant date
fair value
|
|
Number of
service-based RSUs
|
|
Weighted average
grant date
fair value
|
Non-vested, December 31, 2014
|
189,497
|
|
|
$
|
31.82
|
|
|
857,085
|
|
|
$
|
48.94
|
|
Granted
|
169,204
|
|
|
49.74
|
|
|
347,958
|
|
|
53.10
|
|
Forfeited
|
(69,389
|
)
|
|
47.90
|
|
|
(19,278
|
)
|
|
56.15
|
|
Vested
|
(2,200
|
)
|
|
29.58
|
|
|
(357,487
|
)
|
|
43.46
|
|
Non-vested, June 30, 2015
|
287,112
|
|
|
$
|
38.51
|
|
|
828,278
|
|
|
$
|
52.89
|
|
|
|
|
|
|
|
|
|
|
Number of
performance-based RSUs
|
|
Weighted average
grant date
fair value
|
|
Number of
service-based RSUs
|
|
Weighted average
grant date
fair value
|
Non-vested, December 31, 2015
|
301,032
|
|
|
$
|
39.10
|
|
|
839,613
|
|
|
$
|
52.82
|
|
Granted
|
23,580
|
|
|
32.28
|
|
|
467,177
|
|
|
30.36
|
|
Forfeited
|
(33,429
|
)
|
|
50.77
|
|
|
(41,089
|
)
|
|
47.73
|
|
Vested
|
—
|
|
|
—
|
|
|
(312,131
|
)
|
|
51.43
|
|
Non-vested, June 30, 2016
|
291,183
|
|
|
$
|
37.21
|
|
|
953,570
|
|
|
$
|
42.49
|
|
The Company recognized stock-based compensation expense in the following consolidated statements of operations line items for stock options and RSUs for the three and
six
months ended
June 30, 2016
and
2015
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Stock-based compensation expense included in:
|
|
|
|
|
|
|
|
Costs and expenses:
|
|
|
|
|
|
|
|
Cost of services
|
$
|
2,493
|
|
|
$
|
2,566
|
|
|
$
|
4,680
|
|
|
$
|
4,458
|
|
Member relations and marketing
|
1,387
|
|
|
1,455
|
|
|
2,501
|
|
|
2,601
|
|
General and administrative
|
4,085
|
|
|
4,610
|
|
|
7,766
|
|
|
7,977
|
|
Total costs and expenses
|
$
|
7,965
|
|
|
$
|
8,631
|
|
|
$
|
14,947
|
|
|
$
|
15,036
|
|
There are
no
stock-based compensation costs capitalized as part of the cost of an asset.
As of
June 30, 2016
,
$66.0 million
of total unrecognized compensation cost related to outstanding options and non-vested RSUs was expected to be recognized over a weighted average period of
2.7
years.
Note 11. Income taxes
The Company's effective tax rates were
38.1%
and
47.9%
for the three months ended
June 30, 2016
and 2015, respectively. The Company's effective tax rates were
36.6%
and
(23.9)%
for the six months ended
June 30, 2016
and 2015, respectively. Included in the tax expense for the six months ended June 30, 2016 was a discrete benefit of
$0.6 million
which primarily related to state law changes and the settlement of uncertain tax positions during the period. For the six month period ended June 30, 2015, the Company recognized a discrete tax benefit of
$10.8 million
related to the write-off of accumulated Washington, D.C. tax credits. The write-off was a result of changes in the District of Columbia tax laws effective January 1, 2015 and resulted in income tax expense in the six month period ended June 30, 2015.
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 expect that the total amounts of unrecognized tax benefits will significantly change within the next 12 months. The Company classifies interest and penalties on any unrecognized tax benefits as a component of the provision for income taxes. The Company recognized an immaterial amount of interest in the consolidated statements of operations during the three and
six
months ended
June 30, 2016
and
$0.2 million
in interest and penalties in the consolidated statements of operations in both the three and
six
months ended June 30, 2015.
The Company files income tax returns in U.S. federal and state and foreign jurisdictions. With limited exceptions, the Company is no longer subject to U.S. federal, state, and local tax examinations for filings in major tax jurisdictions before 2010.
Note 12. Earnings per share
Basic earnings per share is computed by dividing net income by the number of weighted average common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the number of weighted average common shares and potentially dilutive 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
June 30,
|
|
Six Months Ended
June 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
Basic weighted average common shares outstanding
|
40,365
|
|
|
42,440
|
|
|
40,928
|
|
|
41,686
|
|
Effect of dilutive outstanding stock-based awards
|
205
|
|
|
474
|
|
|
294
|
|
|
—
|
|
Diluted weighted average common shares outstanding
|
40,570
|
|
|
42,914
|
|
|
41,222
|
|
|
41,686
|
|
In the
three
months ended
June 30, 2016
and
2015
,
2.8 million
and
0.7 million
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. In the
six
months ended
June 30, 2016
and
2015
,
2.6 million
and
2.8 million
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
June 30, 2016
, the Company had
2.1
million nonqualified stock options and
0.3
million RSUs that contained either performance or market conditions, or both, and therefore are treated as contingently issuable awards. As of
June 30, 2015
, the Company had
2.0
million nonqualified stock options and
0.3
million RSUs that contained either performance or market conditions and were treated as contingently issuable awards. These awards are excluded from diluted earnings per share 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 earnings per share 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. A total of
19,971
contingently issuable shares were included within the diluted earnings per share calculations three and six months ending
June 30, 2016
as the related performance goals were met as of
June 30, 2016
. There were
no
contingently issuable awards included within the diluted earnings per share calculations for the three and six months ending
June 30, 2015
.
Note 13. Subsequent Events
On July 12, 2016, Evolent Inc. entered into an agreement and plan of merger for the acquisition of Valence Health, Inc. When closed, this transaction is expected to reduce the Company’s ownership in Evolent Inc. and Evolent LLC. The Company is currently evaluating the effect that this dilution has on its investment and will finalize its accounting for this transaction once the transaction closes and the final valuation report is available.