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Form 10-Q ADVISORY BOARD CO For: Sep 30

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November 9, 2016 4:29 PM EST

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2016
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 000-33283
 
 
tabclogopantone.jpg
THE ADVISORY BOARD COMPANY
(Exact name of registrant as specified in its charter)
 
Delaware
 
52-1468699
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
 
2445 M Street, NW, Washington, D.C.
 
20037
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (202) 266-5600
 
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 Web site, 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 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.:
Large accelerated filer
 
þ
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
As of November 1, 2016, the registrant had outstanding 40,147,292 shares of Common Stock, par value $0.01 per share.
 
 
 
 
 


THE ADVISORY BOARD COMPANY
INDEX TO FORM 10-Q
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements.

THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
 
September 30,
2016
 
December 31,
2015
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
55,088

 
$
71,825

Membership fees receivable, net
621,904

 
605,444

Prepaid expenses and other current assets
20,262

 
22,543

Total current assets
697,254

 
699,812

Property and equipment, net
207,608

 
183,057

Intangible assets, net
260,039

 
274,721

Deferred incentive compensation and other charges
66,554

 
81,181

Goodwill
739,507

 
738,200

Equity method investments
—

 
706

Other non-current assets
—

 
1,800

Total assets
$
1,970,962

 
$
1,979,477

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Deferred revenue, current
$
570,403

 
$
581,471

Accounts payable and accrued liabilities
77,193

 
74,879

Accrued incentive compensation
24,126

 
41,173

Debt, current
42,145

 
27,743

Total current liabilities
713,867

 
725,266

Deferred revenue, net of current portion
167,639

 
173,953

Deferred income taxes
81,811

 
93,893

Debt, net of current portion
486,880

 
522,086

Financing obligation
33,186

 
2,700

Other long-term liabilities
16,982

 
12,488

Total liabilities
1,500,365

 
1,530,386

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, 40,135,392 and 41,572,523 shares issued and outstanding as of September 30, 2016 and December 31, 2015, respectively
401

 
416

Additional paid-in capital
774,103

 
744,333

Accumulated deficit
(302,085
)
 
(295,860
)
Accumulated other comprehensive (loss) income
(1,822
)
 
202

Total stockholders’ equity
470,597

 
449,091

Total liabilities and stockholders’ equity
$
1,970,962

 
$
1,979,477


The accompanying notes are an integral part of these consolidated balance sheets.

1

THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
200,455

 
$
200,492

 
$
599,572

 
$
563,397

Costs and expenses:
 
 
 
 
 
 
 
Cost of services, excluding depreciation and amortization
104,215

 
101,362

 
296,604

 
289,388

Member relations and marketing
32,706

 
30,792

 
97,819

 
90,893

General and administrative
32,227

 
30,678

 
96,274

 
93,205

Depreciation and amortization
19,173

 
18,509

 
57,857

 
54,282

Operating income
12,134

 
19,151

 
51,018

 
35,629

Other expense:


 


 
 
 
 
Interest expense
(4,530
)
 
(5,450
)
 
(13,738
)
 
(16,216
)
Other expense, net
(1,516
)
 
(1,150
)
 
(2,380
)
 
(2,397
)
Loss on financing activities
—

 
—

 
—

 
(17,398
)
Total other expense, net
(6,046
)
 
(6,600
)
 
(16,118
)
 
(36,011
)
Income (loss) before provision for income taxes and gains (losses) from equity method investments
6,088

 
12,551

 
34,900

 
(382
)
Provision for income taxes
(3,279
)
 
(8,590
)
 
(13,812
)
 
(11,684
)
Gains (losses) from equity method investments
34,729

 
(3,289
)
 
34,284

 
(1,668
)
Net income (loss)
$
37,538

 
$
672

 
$
55,372

 
$
(13,734
)
Earnings per share
 
 
 
 
 
 
 
Net income (loss) per share—basic
$
0.94

 
$
0.02

 
$
1.36

 
$
(0.33
)
Net income (loss) per share—diluted
$
0.93

 
$
0.02

 
$
1.35

 
$
(0.33
)
Weighted average number of shares outstanding:
 
 
 
 
 
 
 
Basic
40,102

 
42,320

 
40,651

 
41,900

Diluted
40,492

 
42,788

 
40,977

 
41,900

The accompanying notes are an integral part of these consolidated financial statements.

2

THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
37,538

 
$
672

 
$
55,372

 
$
(13,734
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Net unrealized loss on available-for-sale securities, net of income tax (benefit) expense of $0 and $0 for the three months ended September 30, 2016 and 2015, respectively; and $0 and $(150) for the nine months ended September 30, 2016 and 2015, respectively
—

 
—

 
—

 
(81
)
Net unrealized gain (loss) on cash flow hedges, net of income tax (benefit) expense of $610 and $(1,316) for the three months ended September 30, 2016 and 2015, respectively; and $(1,350) and $(871) for the nine months ended September 30, 2016 and 2015, respectively
846

 
(2,132
)
 
(2,024
)
 
(1,410
)
Comprehensive income (loss)
$
38,384

 
$
(1,460
)
 
$
53,348

 
$
(15,225
)
The accompanying notes are an integral part of these consolidated financial statements.

3

THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Nine Months Ended 
 September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income (loss)
$
55,372

 
$
(13,734
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
57,857

 
54,282

Loss on financing activities
—

 
17,398

Amortization of debt issuance costs
1,017

 
983

Deferred income taxes
(9,776
)
 
9,912

Excess tax benefits from stock-based awards
(3,925
)
 
(2,804
)
Stock-based compensation expense
22,914

 
22,130

Gain on investment in common stock warrants
—

 
(70
)
Loss on cost method investment
1,800

 
—

Gain on partial sale of equity method investment
(29,679
)
 
—

Equity from (income) loss of equity method investments
(4,605
)
 
1,668

Changes in operating assets and liabilities (net of the effect of acquisitions):
 
 
 
Membership fees receivable
(16,460
)
 
(35,774
)
Prepaid expenses and other current assets
11,945

 
7,596

Deferred incentive compensation and other charges
14,495

 
2,977

Other non-current assets
—

 
(258
)
Deferred revenue
(17,382
)
 
58,469

Accounts payable and accrued liabilities
(9,898
)
 
(5,595
)
Acquisition-related earn-out payments
(1,432
)
 
(2,198
)
Accrued incentive compensation
(17,047
)
 
(4,222
)
Other long-term liabilities
1,263

 
(3,203
)
Net cash provided by operating activities
56,459

 
107,557

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(34,808
)
 
(39,498
)
Capitalized external-use software development costs
(2,434
)
 
(2,965
)
Cash paid for acquisitions, net of cash acquired
(1,900
)
 
(746,693
)
Cash paid for investment in equity method investment
—

 
(3,006
)
Cash received from partial sale of equity method investment
48,565

 
—

Redemptions of marketable securities
—

 
14,714

Net cash provided by (used in) investing activities
9,423

 
(777,448
)
Cash flows from financing activities:
 
 
 
Proceeds from debt, net
17,000

 
1,280,292

Pay down of debt
(38,562
)
 
(739,377
)
Debt issuance costs
—

 
(2,568
)
Proceeds from issuance of common stock, net of selling costs
—

 
148,786

Proceeds from issuance of common stock from exercise of stock options
3,337

 
3,262

Withholding of shares to satisfy minimum employee tax withholding for vested restricted stock units
(3,473
)
 
(6,058
)
Proceeds from issuance of common stock under employee stock purchase plan
370

 
389

Acquisition-related earn-out payments
(3,600
)
 
(1,500
)
Excess tax benefits from stock-based awards
3,925

 
2,804

Purchases of treasury stock
(61,616
)
 
(33,000
)
Net cash (used in) provided by financing activities
(82,619
)
 
653,030

Net decrease in cash and cash equivalents
(16,737
)
 
(16,861
)
Cash and cash equivalents, beginning of period
71,825

 
72,936

Cash and cash equivalents, end of period
$
55,088

 
$
56,075


The accompanying notes are an integral part of these consolidated financial statements.

4

THE ADVISORY BOARD COMPANY AND SUBSIDIARIES
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 Annual Report on Form 10-K for the year ended December 31, 2015 and the Company’s Quarterly Reports on Form 10-Q for subsequent quarters.
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 nine months ended September 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.
In connection with the preparation of the unaudited consolidated financial statements, the Company recorded corrections of certain out-of-period, immaterial misstatements that occurred in prior periods. These corrections resulted in an increase to the provision for income taxes of $4.2 million and $4.4 million for the three and nine months ended September 30, 2016, respectively, primarily related to recording reserves for tax positions taken in prior periods. These corrections also resulted in a decrease to income tax expense of $5.1 million included in gains (losses) from equity method investees for the three and nine months ended September 30, 2016 related to recording a deferred tax asset for the outside basis difference in the Company's investment in Evolent, Inc. The impact of these out-of-period corrections on net income for the three and nine months ended September 30, 2016 was not significant. 


5

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 SEC 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.
In August 2016, the FASB issued accounting guidance relating to the statement of cash flows. The guidance clarifies how certain cash receipts and cash payments are presented in the statement of cash flows. The guidance is effective for annual reporting and interim periods beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact of the new guidance on its consolidated financial statements.

6

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. 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
)
Fair value of net assets acquired
 
$
217,165

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 nine months ended September 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. Goodwill is assigned to the reporting unit or units that benefit from the synergies arising from each business combination.

7

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. In addition, the Company recorded an adjustment to the Royall purchase price allocation resulting in an increase to deferred tax assets and a reduction of goodwill of approximately $1 million during the three months ended September 30, 2016.
Pro forma
The following table presents the Company’s pro forma consolidated revenues and net income for the three and nine months ended September 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 September 30, 2015
 
Nine Months Ended September 30, 2015
Revenue
$
200,492
 
 
$
578,689
 
Net income
$
672
 
 
$
11,088
 

For the nine months ended September 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 nine months ended September 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 $15.0 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

8

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. See Note 8, "Debt."
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 nine months ended September 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 September 30,
 
Fair value measurement as of September 30, 2016
using fair value hierarchy
 
2016
 
Level 1
 
Level 2
 
Level 3
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents (1)
$
55,088

 
$
55,088

 
$
—

 
$
—

Financial liabilities
 
 
 
 
 
 
 
Interest rate swaps (2)
3,052

 
—

 
3,052

 
—

Contingent earn-out liabilities (3)
1,365

 
—

 
—

 
1,365

 
 
 
 
 
 
 
 
 
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.

9

Contingent earn-out liabilities
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. During the three months ended September 30, 2016, 62,269 shares were issued to pay a portion of the earn-out liability. 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 September 30, 2016 was estimated at $0.8 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 28.0% as of September 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 nine months ended September 30, 2016. There is no remaining contingent obligation related to this earn-out agreement.
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 September 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 nine months ended September 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 nine months ended September 30, 2016 and 2015 (in thousands):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Beginning balance
$
3,280

 
$
8,416

 
$
7,250

 
$
12,946

Addition due to acquisition
—

 
—

 
357

 
—

Fair value change in Clinovations contingent earn-out liability (1)
647

 
(1,297
)
 
1,327

 
(2,589
)
Fair value change in GradesFirst contingent earn-out liability (1)
—

 
200

 
—

 
200

Fair value change in Southwind contingent earn-out liability (1)
—

 
40

 
—

 
249

Fair value change in other contingent earn-out liabilities (1)
141

 
—

 
166

 
—

Southwind earn-out payments
—

 
(334
)
 
(1,032
)
 
(2,281
)
Clinovations earn-out share-based payment
(2,703
)
 
—

 
(2,703
)
 
—

GradesFirst earn-out payments
—

 
—

 
(4,000
)
 
—

360Fresh, Inc. earn-out payments
—

 
—

 
—

 
(1,500
)
Ending balance
$
1,365

 
$
7,025

 
$
1,365

 
$
7,025

 
(1)
Amounts were recognized in cost of services on the consolidated statements of operations.

10

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 $229.9 million as of September 30, 2016 based on the quoted closing stock price as reported on the New York Stock Exchange. For further information, see Note 7, "Equity method investments." 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 $530.5 million as of September 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 nine months ended September 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 September 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 nine months ended September 30, 2016 was approximately $2.1 million and $6.7 million, respectively. The amount of acquired developed technology amortization included in depreciation and amortization for the three and nine months ended September 30, 2015 was approximately $2.4 million and $7.0 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 nine months ended September 30, 2016 was $5.7 million and $16.6 million, respectively. The amount of depreciation expense recognized on furniture, fixtures, and equipment during the three and nine months ended September 30, 2015 was $5.1 million and $15.0 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. As of September 30, 2016 and December 31, 2015, the carrying value of internally developed capitalized software was $75.1 million and $73.2 million, respectively. Amortization expense for internally developed capitalized software for the three and nine months ended September 30, 2016 recorded in depreciation and amortization on the accompanying statements of operations, was approximately $5.6 million and $17.5 million, respectively. Amortization expense for internally developed capitalized software for the three and nine months ended September 30, 2015 recorded in depreciation and amortization on the consolidated statements of operations, was approximately $4.9 million and $13.9 million, respectively.

11

Property and equipment consists of the following (in thousands):
 
 
As of
 
September 30, 2016
 
December 31, 2015
Leasehold improvements
$
69,194

 
$
63,608

Furniture, fixtures, and equipment
67,593

 
62,790

Software
224,479

 
202,384

Construction in progress, subject to a build-to-suit lease
33,186

 
2,700

Property and equipment, gross
394,452

 
331,482

Accumulated depreciation and amortization
(186,844
)
 
(148,425
)
Property and equipment, net
$
207,608

 
$
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 nine months ended September 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 not recognize any impairment losses on any of its long-lived assets during the nine months ended September 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 nine months ended September 30, 2016 or 2015. There was no impairment of goodwill recorded in the nine months ended September 30, 2016 or 2015.
The following illustrates the change in the goodwill balance for the nine months ended September 30, 2016 (in thousands):
 
As of
 
September 30, 2016
Beginning balance
$
738,200

Acquisitions
2,258

       Adjustment related to Royall acquisition (1)
(951
)
Ending balance
$
739,507

 
(1) Represents an adjustment to the purchase price allocation resulting in an increase to deferred tax assets and a reduction of goodwill.
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 September 30, 2016, the weighted average remaining useful life of acquired intangibles was approximately 13.4 years. As of September 30, 2016, the weighted average remaining useful life of internally developed intangibles was approximately 3.5 years.

12

The gross and net carrying balances and accumulated amortization of intangibles are as follows (in thousands):
 
 
 
 
As of September 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
 
$
19,336

 
$
(9,177
)
 
$
10,159

 
$
16,902

 
$
(6,796
)
 
$
10,106

Acquired intangibles:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed software
5.2
 
9,450

 
(8,450
)
 
1,000

 
9,450

 
(8,075
)
 
1,375

Customer relationships
16.2
 
277,710

 
(38,678
)
 
239,032

 
277,710

 
(25,769
)
 
251,941

Trademarks
8.6
 
14,900

 
(5,593
)
 
9,307

 
14,900

 
(4,490
)
 
10,410

Non-compete agreements
3.8
 
1,400

 
(1,400
)
 
—

 
1,400

 
(1,379
)
 
21

Customer contracts
4.7
 
6,449

 
(5,908
)
 
541

 
6,449

 
(5,581
)
 
868

Total intangibles
 
 
$
329,245

 
$
(69,206
)
 
$
260,039

 
$
326,811

 
$
(52,090
)
 
$
274,721


Amortization expense for intangible assets for the three and nine months ended September 30, 2016, recorded in depreciation and amortization on the consolidated statements of operations, was approximately $5.7 million and $17.1 million, respectively. Amortization expense for intangible assets for the three and nine months ended September 30, 2015 was approximately $6.1 million and $18.4 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 three months of the fiscal year ending December 31, 2016, for each of the following fiscal years ending December 31, 2017 through 2020, and thereafter: $5.7 million, $22.4 million, $21.4 million, $19.8 million, and $18.5 million, respectively, and $172.2 million thereafter.
Note 7. Equity method investments
As of September 30, 2016, the Company held an 8.6% equity interest in Evolent Health LLC (“Evolent LLC”) and a 9.2% equity ownership interest in Evolent Health, Inc. (“Evolent Inc.”), which had no material operations outside of its 74.6% 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, who were the Company’s Chief Financial Officer and an unaffiliated designee of the Company as of September 30, 2016.
During the three months ended September 30, 2016, the Company sold a portion of its interest in Evolent Inc., retaining a 9.2% interest immediately after such sale. Total cash received from the transaction was $48.6 million and resulted in the recognition of an after tax gain of $29.7 million in the three and nine months ended September 30, 2016. During the three months ended September 30, 2016, the Company's proportionate share of the losses of Evolent Inc. was $1.2 million. These 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 nine months ended September 30, 2016, the Company's proportionate share of the losses of Evolent Inc. was $3.5 million, of which $1.5 million was recognized in the consolidated statements of operations. The carrying balance of the Company’s investment in Evolent Inc. was $0.0 million as of September 30, 2016. The Company had a total of $1.8 million in unrecorded losses related to its investment in Evolent Inc. as of September 30, 2016.
During the three months ended September 30, 2016, the Company's proportionate share of the losses of Evolent LLC was $1.3 million. These losses were not recorded as they exceeded the Company's investment balance. During the nine months ended September 30, 2016, the Company's proportionate share of the losses of Evolent LLC was $3.5 million, of which $1.2 million was recognized in the consolidated statements of operations. The carrying balance of the Company’s investment in Evolent LLC was $0.0 million as of September 30, 2016. The Company had a total of $1.5 million in unrecorded losses related to its investment in Evolent LLC as of September 30, 2016.
At the time of the reorganization and IPO of Evolent Inc., the Company carried over its basis in the investment resulting in a significant difference between its basis and its proportionate share in the equity of Evolent Inc. As of September 30, 2016, the basis difference totaled $50.8 million and will decrease over time through amortization and upon any sale or dilutive transactions. The Company has excluded the effects of the purchase and push down accounting applied by Evolent Inc. upon

13

gaining control of Evolent LLC in its determination of the equity in Evolent LLC losses, thereby reducing its share of losses from Evolent LLC for the affected periods.
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 equity method investments 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 nine months ended September 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 $0.9 million was recorded in the nine months ended September 30, 2015 for tax benefits associated with current year losses received from Evolent LLC. In the three and nine months ended September 30, 2016, additional tax benefits of $5.1 million and $5.4 million, respectively, were recorded for the tax effects of current year losses received from Evolent LLC and prior period adjustments. In the three and nine months ended September 30, 2016, tax expense of $18.9 million was recorded for the tax effect of the current period gain on sale of shares in Evolent, Inc.
The gains (losses) from equity method investments on the consolidated statement of operations for the combined Evolent entities consisted of the following (in thousands):
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Dilution gain
$
—

 
$
—

 
$
2,026

 
$
—

Gain on partial sale of investment
48,565

 
—

 
48,565

 
—

Allocated share of losses
—

 
(2,594
)
 
(2,732
)
 
(9,238
)
Tax (expense) benefit
(13,836
)
 
(695
)
 
(13,575
)
 
7,570

       Gains (losses) from equity method investments
$
34,729

 
$
(3,289
)
 
$
34,284

 
$
(1,668
)
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 15th anniversary date of the transaction. As of September 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.
The following is a summary of the financial position of Evolent LLC as of the dates presented. The period from June 4 to December 31, 2015 includes the effects of purchase accounting pushed down to Evolent LLC as part of the initial public offering which Evolent Inc. completed on June 4, 2015.
 
As of
 
September 30, 2016
 
December 31, 2015
Assets:
 
 
 
Current assets
$
191,429

 
$
184,463

Non-current assets
659,851

 
831,051

Total assets
$
851,280

 
$
1,015,514

Liabilities and members’ equity:
 
 
 
Current liabilities
$
65,315

 
$
59,506

Non-current liabilities
7,998

 
111

Total liabilities
73,313

 
59,617

Members’ equity
777,967

 
955,897

Total liabilities and members’ equity
$
851,280

 
$
1,015,514



14

The following is a summary of the operating results of Evolent LLC for the periods presented which include the effects of purchase accounting pushed down to Evolent LLC as part of the initial public offering which Evolent Inc. completed on June 4, 2015. The period from June 4 to December 31, 2015 reflects the impact of the push down accounting that was recorded on the Evolent LLC financial statements.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
Period June 4 - September 30,
 
Period January 1 - June 3,
 
2016
 
2015
 
2016
 
2015
 
2015
Revenue
$
60,210

 
$
40,406

 
$
166,177

 
$
50,820

 
$
61,814

Cost of revenue (exclusive of depreciation and amortization)
33,905

 
24,762

 
95,294

 
32,649

 
44,839

Gross profit
$
26,305

 
$
15,644

 
$
70,883

 
$
18,171

 
$
16,975

 
 
 
 
 
 
 
 
 
 
Net loss
$
(16,029
)
 
$
(17,192
)
 
$
(203,199
)
 
$
(28,718
)
 
$
(44,079
)
The following is a summary of the consolidated financial position of Evolent Inc. as of the dates presented:
 
As of
 
September 30, 2016
 
December 31, 2015
Assets:
 
 
 
Current assets
$
191,429

 
$
184,463

Non-current assets
659,851

 
831,051

Total assets
$
851,280

 
$
1,015,514

Liabilities and shareholders' equity:
 
 
 
Current liabilities
$
65,329

 
$
59,506

Non-current liabilities
26,094

 
21,429

Total liabilities
91,423

 
80,935

Total shareholders' equity (deficit) attributable to Evolent Health, Inc.
562,228

 
649,341

Non-controlling interests
197,629

 
285,238

Total liabilities and shareholders’ equity
$
851,280

 
$
1,015,514

The following is a summary of the consolidated operating results of Evolent Inc. for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Revenue
 
$
60,210

 
$
40,406

 
$
166,177

 
$
50,820

Cost of revenue (exclusive of depreciation and amortization)
 
33,905

 
24,762

 
95,294

 
32,649

Gross profit
 
$
26,305

 
$
15,644

 
$
70,883

 
$
18,171

 
 
 
 
 
 
 
 
 
Income (loss) before income taxes and non-controlling interests
 
$
(16,031
)
 
$
(17,192
)
 
$
(203,199
)
 
$
357,250

Net income (loss)
 
$
(15,775
)
 
$
(17,088
)
 
$
(201,585
)
 
$
328,081

Net income (loss) attributable to Evolent Health, Inc.
 
$
(11,208
)
 
$
(11,980
)
 
$
(142,335
)
 
$
336,613

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 September 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.”

15

Note 8. Debt
On February 6, 2015, the Company obtained $675 million of senior secured credit facilities (“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 (“term facility”) and (b) a five-year senior secured revolving credit facility (“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 facility 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 1.25% 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 September 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 2.53%.
In June 2016 the Company drew down $17.0 million of borrowings under its revolving credit facility which was repaid during the three months ended September 30, 2016. The draw down borrowings had a maturity of three months and accrued interest at an annual rate of 2.66%. As of September 30, 2016 there was $100.0 million outstanding under the revolving credit facility and $80.9 million available for future borrowings. As of September 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
September 30, 2016
2.53% term facility due fiscal 2020 ($431,875 face value less unamortized discount of $2,850)
$
429,025

Revolving credit facility
100,000

Less: Amounts due in next twelve months ($43,125 face value less unamortized discount of $980)
(42,145
)
      Total long-term debt
$
486,880

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 September 30, 2016.
Interest expense for the three months ended September 30, 2016 and 2015 was $4.5 million and $5.5 million, inclusive of $0.3 million and $0.3 million of amortization of debt issuance costs, and $0.5 million and $0.8 million of payments related to the interest rate swaps described below, respectively. Interest expense for the nine months ended September 30, 2016 and 2015 was $13.7 million and $16.2 million, inclusive of $1.0 million and $1.0 million of amortization of debt issuance costs, and $1.7 million and $1.3 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 September 30, 2016, the principal amount hedged was $265.9 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 September 30, 2016 and December 31, 2015, the fair value of the interest rate swaps was a liability of $3.1 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 September 30, 2016 and 2015, the change in fair value of the swaps, net of tax, was an increase of $0.8 million and an decrease of $2.1 million, respectively, and was reported as a component of accumulated other comprehensive income (loss). For the nine months ended September 30, 2016 and 2015, the change in fair value of the swaps,

16

net of tax, was a decrease of $2.1 million and an decrease $1.4 million, respectively. There was no hedge ineffectiveness as of September 30, 2016 and 2015. Changes in fair value are reclassified from accumulated other comprehensive income (loss) 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 211,011 and 1,951,258 shares of its common stock at a total cost of approximately $8.0 million and $61.6 million in the three and nine months ended September 30, 2016, respectively, pursuant to its share repurchase program. The Company repurchased 677,503 shares of its common stock at a total cost of approximately $33.0 million in the three and nine months ended September 30, 2015. The total amount of common stock purchased from inception under the program through September 30, 2016 was 19,778,800 shares at a total cost of $513.5 million. All such repurchases have been made in the open market, and all repurchased shares have been retired as of September 30, 2016. No minimum number of shares subject to repurchase has been fixed, and the share repurchase authorization has no expiration date. As of September 30, 2016, the remaining authorized repurchase amount was $36.5 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 ("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, was estimated to be approximately $26.8 million. The aggregate grant date fair value of the performance-based RSUs, assuming all performance targets are met, was estimated at approximately $7.3 million. As of September 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 exceed 10,535,000.

17

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, as the market-based performance obligations for these awards were satisfied during the three months ended September 30, 2016. The estimated requisite service period, which includes the current estimate of the time to achieve the market conditions is one year. 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 nine months ended September 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
—

 
—

 
(144,739
)
 
22.53

Forfeited
(756,100
)
 
49.92

 
(13,569
)
 
60.27

Outstanding, as of September 30, 2015
2,013,325

 
$
50.42

 
1,916,480

 
$
40.91

 
 
 
 
 
 
 
 
 
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

 
1,025,100

 
28.52

Exercised
—

 
—

 
(251,458
)
 
15.36

Forfeited
(215,370
)
 
49.92

 
(22,195
)
 
53.38

Expired
—

 
—

 
(17,347
)
 
51.77

Outstanding, as of September 30, 2016
2,117,855

 
$
47.11

 
2,577,210

 
$
38.88

Exercisable, as of September 30, 2016
26,872

 
$
34.91

 
1,069,703

 
$
42.10

The weighted average fair value of the service-based options, valued using a Black-Scholes model, granted during the nine months ended September 30, 2016 was estimated at $9.94 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 37.48%; 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 nine months ended September 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.
During the nine months ended September 30, 2016, 6,872 options with performance and/or market conditions vested. During the nine months ended September 30, 2015, 10,000 options with performance conditions vested.

18

The following table summarizes the changes in RSUs granted under the Company’s stock incentive plans during the nine months ended September 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

 
349,566

 
53.09

Forfeited
(78,005
)
 
48.16

 
(31,152
)
 
55.75

Vested
(2,200
)
 
29.58

 
(360,454
)
 
43.59

Non-vested, September 30, 2015
278,496

 
$
38.15

 
815,045

 
$
52.87

 
 
 
 
 
 
 
 
 
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

 
490,165

 
30.92

Forfeited
(66,139
)
 
51.15

 
(56,067
)
 
47.36

Vested
(893
)
 
50.41

 
(314,553
)
 
51.47

Non-vested, September 30, 2016
257,580

 
$
35.34

 
959,158

 
$
42.39

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 nine months ended September 30, 2016 and 2015 (in thousands):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Stock-based compensation expense included in:
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
Cost of services
$
2,443

 
$
2,423

 
$
7,123

 
$
6,881

Member relations and marketing
1,342

 
1,306

 
3,843

 
3,907

General and administrative
4,182

 
3,365

 
11,948

 
11,342

Total costs and expenses
$
7,967

 
$
7,094

 
$
22,914

 
$
22,130

There are no stock-based compensation costs capitalized as part of the cost of an asset.
As of September 30, 2016, $58.4 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 2.6 years.
Note 11. Income taxes
The Company's effective tax rates were 53.9% and 68.4% for the three months ended September 30, 2016 and 2015, respectively. The Company's effective tax rates were 39.6% and (3,058.6)% for the nine months ended September 30, 2016 and 2015, respectively. Included in the tax expense for the nine months ended September 30, 2016 was a discrete tax expense of $1.2 million which primarily related to an increase in reserves for uncertain tax positions. For the nine months ended September 30, 2015, the Company recognized a discrete tax expense 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 nine months ended September 30, 2015.

19

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 months ended September 30, 2016 and September 30, 2015. The Company recognized $0.1 million and $0.3 million in interest and penalties in the consolidated statements of operations in the nine months ended September 30, 2016 and September 30, 2015, respectively. 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 2012.
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 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Basic weighted average common shares outstanding
40,102

 
42,320

 
40,651

 
41,900

Effect of dilutive outstanding stock-based awards
390

 
468

 
326

 
—

Diluted weighted average common shares outstanding
40,492

 
42,788

 
40,977

 
41,900

In the three months ended September 30, 2016 and 2015, 1.6 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 nine months ended September 30, 2016 and 2015, 1.7 million and 2.7 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.
As of September 30, 2016, the Company had 1.8 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. As of September 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 42,585 and 11,532 incremental shares for dilution related to contingently issuable awards were included within the diluted earnings per share calculations for the three and nine months ended September 30, 2016, respectively, as the related performance goals were met as of September 30, 2016. There were no contingently issuable awards included within the diluted earnings per share calculations for the three and nine months ended September 30, 2015.

20

Note 13. Supplemental cash flow
A summary of supplemental cash flow information for the nine months ended September 30, 2016 and 2015 is presented below (in thousands):
 
Nine Months Ended 
 September 30,
 
2016
 
2015
Cash paid (received) for:
 
 
 
Income taxes
$
10,324

 
$
(8,363
)
Interest
$
10,648

 
$
13,744

 
 
 
 
Non-cash activities:
 
 
 
Clinovations earn-out liability share-based payment
$
2,703

 
$
—

Increase in estimated cost of construction of a building under a build-to-suit lease
$
30,486

 
$
—

Note 14. Subsequent events
On October 3, 2016, Evolent Inc. issued stock in connection with the acquisition of Valence Health, Inc. This transaction reduced the Company’s ownership in Evolent Inc. from 9.2% to 7.9% and reduced the Company's ownership in Evolent LLC from 8.6% to 7.7%. The Company is currently evaluating the effect that this dilution has on the recorded value of its investment.


21

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Unless the context indicates otherwise, references in this management’s discussion and analysis to “we,” “our,” and “us” mean The Advisory Board Company and its consolidated subsidiaries.
This management’s discussion and analysis includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. These statements can sometimes be identified by our use of such forward-looking words as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should,” “will,” “would,” and similar words and expressions. These statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from the results, performance, or achievements expressed or implied by the forward-looking statements, including the factors discussed under “Item 1A. Risk Factors” in our annual report on Form 10-K for the fiscal year ended December 31, 2015, or the “2015 Form 10-K.” We undertake no obligation to update any forward-looking statements, whether as a result of circumstances or events that arise after the date the statements are made, new information, or otherwise.
Executive Overview
We are a leading provider of insight-driven performance improvement software and solutions to the rapidly changing health care and 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 served approximately 5,500 members, including hospitals, health systems and other health care organizations, and colleges and universities.
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, tech-enabled services, and consulting and management services.
Our five key areas of focus for the fiscal year are to orient our delivery infrastructure to be more coordinated around each member; innovate our commercial model to continue moving towards a relationship-based approach to our sales; accelerate our growth strategy by investing in both platform expansion and new offerings and services within each member problem area; align our organization with our strategy to ensure that structure, governance, and incentives support our goals; and continue to meet our commitments both to our members through continuing to deliver a strong return on investment and to our shareholders through achieving performance targets.
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 expansion of our relationships with existing members, strong renewal rates, acquisition activity, new program launches, addition of new members, and annual price increases. Our revenue grew 6.4% in the nine months ended September 30, 2016 over the nine months ended September 30, 2015. Our contract value increased 3.4% to $786.2 million as of September 30, 2016 from $760.3 million as of September 30, 2015. 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, and depreciation and amortization expense.
•
Cost of services includes the costs associated with the production and delivery of our products and services, consisting of compensation for research, creative, data, and analysis personnel, consultants, software developers, and in-house faculty; 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.
•
Member relations and marketing expense includes the costs of acquiring new members and the costs of account management, and consists of compensation (including sales incentives); travel and entertainment expenses; costs for training personnel; sales and marketing materials; and associated support services.
•
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.

22

•
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.
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.
Acquisitions that we have completed since December 31, 2014, including our acquisition of Royall Acquisition Co. (together with its subsidiaries, “Royall”) in January 2015, affect the comparability of our results of operations for the three and nine months ended September 30, 2016 to our results of operations for the comparable prior year periods.
Critical Accounting Policies
Our accounting policies, which are in compliance with U.S. generally accepted accounting principles, or “GAAP,” require us to apply methodologies, estimates, and judgments that have a significant effect on the results we report in our financial statements. In our 2015 Form 10-K, we have discussed those material accounting policies that we believe are critical and require the use of complex judgment in their application. There have been no material changes to our policies since our fiscal year ended December 31, 2015.
Non-GAAP Financial Presentation
This management’s discussion and analysis presents supplemental measures of our performance which are derived from our consolidated financial information but which are not presented in our consolidated financial statements prepared in accordance with GAAP. These financial measures, which are considered “non-GAAP financial measures” under SEC rules, are referred to as adjusted revenue, adjusted EBITDA, adjusted net income, non-GAAP earnings per diluted share, adjusted effective tax rate, and adjusted weighted average common shares outstanding - diluted. See “Non-GAAP Financial Measures” below for reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure and for a discussion of our management's reasons for presenting such non-GAAP financial measures and of some of the material limitations associated with the use of such measures.

23

Results of Operations
The following tables show consolidated statements of operations data, including the amounts expressed as a percentage of revenue for the periods indicated (in thousands, except percentages):
 
Three Months Ended September 30,
 
2016
 
2015
Revenue
$
200,455

 
100.0
 %
 
$
200,492

 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
Cost of services, excluding depreciation and amortization
104,215

 
52.0
 %
 
101,362

 
50.6
 %
Member relations and marketing
32,706

 
16.3
 %
 
30,792

 
15.4
 %
General and administrative
32,227

 
16.1
 %
 
30,678

 
15.3
 %
Depreciation and amortization
19,173

 
9.6
 %
 
18,509

 
9.1
 %
Total costs and expenses
188,321

 
94.0
 %
 
181,341

 
90.4
 %
Operating income
12,134

 
6.0
 %
 
19,151

 
9.6
 %
Other expense:
 
 
 
 
 
 
 
Interest expense
(4,530
)
 
(2.3
)%
 
(5,450
)
 
(2.7
)%
Other expense, net
(1,516
)
 
(0.7
)%
 
(1,150
)
 
(0.6
)%
Total other expense, net
(6,046
)
 
(3.0
)%
 
(6,600
)
 
(3.3
)%
Income before provision for income taxes and gains (losses) from equity method investments
6,088

 
3.0
 %
 
12,551

 
6.3
 %
Provision for income taxes
(3,279
)
 
(1.6
)%
 
(8,590
)
 
(4.3
)%
Gains (losses) from equity method investments
34,729

 
17.3
 %
 
(3,289
)
 
(1.7
)%
Net income
$
37,538

 
18.7
 %
 
$
672

 
0.3
 %
 
Nine Months Ended September 30,
 
2016
 
2015
Revenue
$
599,572

 
100.0
 %
 
$
563,397

 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
Cost of services, excluding depreciation and amortization
296,604

 
49.5
 %
 
289,388

 
51.4
 %
Member relations and marketing
97,819

 
16.3
 %
 
90,893

 
16.1
 %
General and administrative
96,274

 
16.1
 %
 
93,205

 
16.5
 %
Depreciation and amortization
57,857

 
9.6
 %
 
54,282

 
9.7
 %
Total costs and expenses
548,554

 
91.5
 %
 
527,768

 
93.7
 %
Operating income
51,018

 
8.5
 %
 
35,629

 
6.3
 %
Other expense:
 
 
 
 
 
 
 
Interest expense
(13,738
)
 
(2.3
)%
 
(16,216
)
 
(2.9
)%
Other expense, net
(2,380
)
 
(0.4
)%
 
(2,397
)
 
(0.4
)%
Loss on financing activities
—

 
—
 %
 
(17,398
)
 
(3.1
)%
Total other expense, net
(16,118
)
 
(2.7
)%
 
(36,011
)
 
(6.4
)%
Income before provision for income taxes and gains (losses) from equity method investments
34,900

 
5.8
 %
 
(382
)
 
(0.1
)%
Provision for income taxes
(13,812
)
 
(2.3
)%
 
(11,684
)
 
(2.1
)%
Gains (losses) from equity method investments
34,284

 
5.7
 %
 
(1,668
)
 
(0.2
)%
Net income (loss)
$
55,372

 
9.2
 %
 
$
(13,734
)
 
(2.4
)%

24

Three and nine months ended September 30, 2016 compared to the three and nine months ended September 30, 2015
Net income (loss). Net income was $37.5 million in the three months ended September 30, 2016 compared to $0.7 million in the three months ended September 30, 2015. The significant increase in net income in the three months ended September 30, 2016 was primarily attributable to a $29.7 million post-tax gain recorded in the three months ended September 30, 2016 on the sale of a portion of our shares in Evolent, Inc., the effect of which was partially offset by a $1.8 million loss on our cost method investment.
Net income was $55.4 million in the nine months ended September 30, 2016 compared to a net loss of $13.7 million in the nine months ended September 30, 2015. The net loss in the prior year period was primarily attributable to financing losses of $17.4 million and a $10.8 million discrete tax expense related to a write-off of accumulated Washington, D.C. income tax credits as a result of changes in District of Columbia tax laws effective January 1, 2015. We did not incur comparable expenses in the current period. Our net income in the 2016 nine-month period reflected an increase in revenue of $36.2 million, a $29.7 million post-tax gain on the sale of a portion of our shares in Evolent Inc., and a $2.5 million decrease in interest expense.
Revenue. Total revenue increased 6.4% to $599.6 million in the nine months ended September 30, 2016 from $563.4 million in the nine months ended September 30, 2015, while contract value increased 3.4% to $786.2 million as of September 30, 2016 from $760.3 million as of September 30, 2015. The increases in the nine months ended September 30, 2016 were attributable to growth in our Royall enrollment services, education research programs, student success software program, and EMR optimization services offering. In the three months ended September 30, 2016 and 2015, revenue remained consistent at $200.5 million. Total revenue during the three months ended September 30, 2015 was high due to the inclusion of items that were recognized earlier in the calendar year than expected, offsetting the growth from new programs in the quarter ended September 30, 2016.
Cost of services. Cost of services increased to $104.2 million in the three months ended September 30, 2016 from $101.4 million in the three months ended September 30, 2015, and increased to $296.6 million in the nine months ended September 30, 2016 from $289.4 million in the nine months ended September 30, 2015. As a percentage of revenue, cost of services was 52.0% and 50.6% in the three months ended September 30, 2016 and September 30, 2015, respectively, and 49.5% and 51.4% in the nine months ended September 30, 2016 and September 30, 2015, respectively. The decrease in cost of services as a percentage of revenue for the nine months ended September 30, 2016 was attributable to the scalability of incremental revenue inherent in our model. Cost of services included fair value adjustments to our acquisition-related earn-out liabilities which consisted of an increase of $0.8 million and a decrease of $1.1 million in the three months ended September 30, 2016 and 2015, respectively, and an increase of $1.5 million and a decrease of $2.1 million in the nine months ended September 30, 2016 and 2015, respectively.
Member relations and marketing expense. Member relations and marketing expense increased to $32.7 million in the three months ended September 30, 2016 from $30.8 million in the three months ended September 30, 2015, and increased to $97.8 million in the nine months ended September 30, 2016 from $90.9 million in the nine months ended September 30, 2015. The increases in member relations and marketing expense were primarily attributable to increases 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. As a percentage of revenue, member relations and marketing expense was 16.3% and 15.4% in the three months ended September 30, 2016 and 2015, respectively, and 16.3% and 16.1% in the nine months ended September 30, 2016 and 2015, respectively.
General and administrative expense. General and administrative expense increased to $32.2 million in the three months ended September 30, 2016 from $30.7 million in the three months ended September 30, 2015, and increased to $96.3 million in the nine months ended September 30, 2016 from $93.2 million in the nine months ended September 30, 2015. The increases in general and administrative expense in the three and nine months periods ended September 30, 2016 were primarily attributable to increased investment in administrative functions and office space to support our growing organization, partially offset by the recognition of $6.6 million in acquisition costs related to our acquisition of Royall in the nine months ended September 30, 2015. As a percentage of revenue, general and administrative expense increased to 16.1% in the three months ended September 30, 2016 from 15.3% in the three months ended September 30, 2015, and decreased to 16.1% in the nine months ended September 30, 2016 from 16.5% in the nine months ended September 30, 2015.
Depreciation and amortization expense. Depreciation and amortization expense increased to $19.2 million in the three months ended September 30, 2016 from $18.5 million in the three months ended September 30, 2015, and increased to $57.9 million in the nine months ended September 30, 2016 from $54.3 million in the nine months ended September 30, 2015. As a percentage of revenue, depreciation and amortization expense was 9.6% and 9.1% in the three months ended September 30, 2016 and 2015, respectively, and 9.6% and 9.7% in the nine months ended September 30, 2016 and 2015, respectively. The increases in depreciation and amortization expense in the current periods were primarily attributable to increased amortization expense from developed capitalized internal-use software and depreciation of improvements made to build-out new office space.

25

Interest expense. Interest expense decreased to $4.5 million for the three months ended September 30, 2016 from $5.5 million for the three months ended September 30, 2015, and decreased to $13.7 million for the nine months ended September 30, 2016 from $16.2 million for the nine months ended September 30, 2015. The decreases in interest expense were due to lower debt balances following our retirement of $150 million of indebtedness during the three months ended March 31, 2015, as well as a related refinancing that occurred during the three months ended December 31, 2015.
Other expense, net. Other expense, net was $1.5 million in the three months ended September 30, 2016 compared to $1.2 million in the three months ended September 30, 2015 and $2.4 million in both the nine month periods ended September 30, 2016 and 2015. We recognized foreign exchange gains of $0.1 million and losses of $1.1 million in the three months ended September 30, 2016 and 2015, respectively, and losses of $0.6 million and $2.4 million in the nine months ended September 30, 2016 and 2015, respectively, as a result of the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies. In addition, we incurred a $1.8 million loss on a cost method investment during the three months ended September 30, 2016.
Loss on financing activities. We recognized a loss on financing activities of $17.4 million in connection with the refinancing of acquisition indebtedness during the nine months ended September 30, 2015. There was no comparable activity in the nine months ended September 30, 2016.
Provision for income taxes. Our provision for income taxes was $3.3 million and $8.6 million for the three months ended September 30, 2016 and 2015, respectively, and $13.8 million and $11.7 million for the nine months ended September 30, 2016 and 2015, respectively. Our effective tax rate for the three months ended September 30, 2016 was 53.9% compared to 68.4% for the three months ended September 30, 2015. Our effective tax rate for the nine months ended September 30, 2016 was 39.6% compared to (3,058.6)% for the nine months ended September 30, 2015. Included in the tax expense for the nine months ended September 30, 2016 was a discrete tax expense of $1.2 million which primarily related to an increase in reserves for uncertain tax positions. Our results for the nine months ended September 30, 2015 included a discrete tax expense of $10.8 million related to a write-off of accumulated Washington, D.C. income tax credits as a result of changes in District of Columbia tax laws effective January 1, 2015. The 2015 effective tax rate was also increased by the non-deductible portion of the acquisition costs related to our purchase of Royall and lower pre-tax book income due to our loss on financing activities.
Gains (losses) from equity method investments. Gains and losses from our investments in Evolent LLC and Evolent Inc., net of tax, was a gain of $34.7 million in the three months ended September 30, 2016 and a loss of $3.3 million in the three months ended September 30, 2015. Gains and losses from investments in Evolent LLC and Evolent Inc., net of tax, was a gain of $34.3 million in the nine months ended September 30, 2016 and a loss of $1.7 million in the nine months ended September 30, 2015. The primary driver for the gains in the current periods was the sale of a portion of our ownership interest in Evolent Inc. during the three months ended September 30, 2016. Total cash received from the transaction was $48.6 million and resulted in the recognition of a post-tax gain of $29.7 million in the three and nine months ended September 30, 2016. Our results for the nine months ended September 30, 2015 included a $7.6 million tax benefit from the release of a valuation allowance, as we had determined that we are more-likely-than not able to realize deferred tax assets associated with our investment in Evolent LLC. We had a total of $3.3 million in unrecorded losses related to our investment in Evolent Inc. and Evolent LLC as of September 30, 2016. These unrecorded losses are being tracked and will be recognized at such time as our investments in Evolent Inc. and Evolent LLC generate earnings or other gains.
Stock-based compensation expense. We recognized the following stock-based compensation expense in the consolidated statements of operations line items for stock options and restricted stock units, or "RSUs," issued under our stock incentive plans for the three and nine months ended September 30, 2016 and 2015 (in thousands):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Stock-based compensation expense included in:
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
Cost of services
$
2,443

 
$
2,423

 
$
7,123

 
$
6,881

Member relations and marketing
1,342

 
1,306

 
3,843

 
3,907

General and administrative
4,182

 
3,365

 
11,948

 
11,342

Total costs and expenses
$
7,967

 
$
7,094

 
$
22,914

 
$
22,130

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

26

As of September 30, 2016, $58.4 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 2.6 years.
Non-GAAP Financial Measures
The tables below present supplemental measures of our performance which we have derived from our consolidated financial information but which are not presented in our consolidated financial statements prepared in accordance with GAAP. We refer to these financial measures, which are considered “non-GAAP financial measures” under SEC rules, as adjusted revenue, adjusted EBITDA, adjusted net income, non-GAAP earnings per diluted share, adjusted effective tax rate, and adjusted weighted average common shares outstanding-diluted.
Our management uses these non-GAAP financial measures, together with financial measures prepared in accordance with GAAP, to enhance understanding by investors of our core operating performance, as well as for internal forecasting purposes. Our management believes that providing information about these non-GAAP financial measures facilitates an assessment by our investors of our fundamental operating trends and addresses concerns of investors that various financing, acquisition-related, non-cash and other effects included in GAAP measures may obscure such underlying trends. We believe that, by highlighting such trends relating to our underlying performance, our non-GAAP presentation helps our investors to make meaningful period-to-period comparisons of our results.
There are limitations to the use of our non-GAAP financial measures. These non-GAAP financial measures may not be comparable to similarly titled measures of other companies. Other companies, including companies in our industry, may calculate non-GAAP financial measures differently than we do, limiting the usefulness of those measures for comparative purposes.
Our non-GAAP financial measures exclude the items discussed below. Because the excluded items have a material impact on our financial results, we use non-GAAP financial measures to supplement financial information presented in accordance with GAAP.
Reconciliations of each non-GAAP financial measure to its most directly comparable GAAP financial measure are set forth below. We encourage you to review the reconciliations in conjunction with the presentation of the non-GAAP financial measures for each of the periods presented. The discussion below presents information about each of the non-GAAP financial measures and our reasons for excluding the enumerated items from our non-GAAP results. In future fiscal periods, we may exclude such items and may incur income and expenses similar to these excluded items. Accordingly, the exclusion of these items and other similar items in our non-GAAP presentation should not be interpreted as implying that these items are non-recurring, infrequent, or unusual.
Adjusted Revenue
We adjust revenue to exclude the impact of acquisition-related deferred revenue fair value adjustments. Our management believes that the adjustments for these items more closely correlate the reported financial measure with the ordinary and ongoing course of our operations.
Adjusted Net Income and Non-GAAP Earnings Per Diluted Share
We present adjusted net income and non-GAAP earnings per diluted share to provide investors with a meaningful, consistent comparison of our operating results and trends for the periods presented. Our management believes that these measures are also useful to investors by allowing investors to evaluate our operations using the same tools that management uses to evaluate our past performance and prospects for future performance. These two non-GAAP financial measures reflect adjustments based on the exclusion of the following items as well as adjustments for related income tax effects:
•
Effect on revenue of fair value adjustments to acquisition-related deferred revenue: We adjust revenue to exclude the impact of acquisition-related deferred revenue fair value adjustments. Our management believes that the adjustments for these items more closely correlate the reported financial measure with the ordinary and ongoing course of our operations.
•
Gain (loss) from equity method investments: We have excluded our proportionate share of income (loss) and other gains recorded in connection with our equity method investments. Our management believes that the exclusion of such amounts allows investors to better understand our core operating results.
•
Amortization of acquisition-related intangible assets: Amortization of acquisition-related intangible assets consists of amortization of customer relationships, developed technology, and trade names. Amortization charges for acquired intangible assets are significantly affected by the timing and magnitude of our acquisitions, and these charges may

27

vary in amount from period to period. We exclude these charges to facilitate a more meaningful evaluation of our current operating performance and comparisons to our past operating performance.
•
Loss on financing activities: We have excluded loss on financing activities, as this item represents a non-cash charge. In addition, the amount and frequency of such charges are not consistent over time and are significantly affected by the timing and size of debt refinancing transactions.
•
Acquisition and similar transaction charges: We have excluded certain acquisition-related charges resulting from acquisitions (including legal, accounting, and due diligence costs) to allow more comparable comparisons of our financial results to our historical operations. Such charges generally are not relevant to assessing the long-term performance of the acquired assets, and are not a material consideration in management’s evaluation of potential acquisitions. In addition, the frequency and amount of such charges vary significantly based on the size and timing of the acquisitions and the maturities of the businesses being acquired. 
•
Fair value adjustments to acquisition-related earn-out liabilities: We have excluded the impact of acquisition-related contingent consideration non-cash adjustments due to the inherent uncertainty and volatility associated with such amounts based on changes in assumptions with respect to fair value estimates. The amount and frequency of such adjustments are not consistent across transactions and are significantly affected by the timing and size of our acquisitions, the future outlook of the acquired business, the estimated discount rate, and the nature of the transaction consideration.
•
Stock-based compensation expense: Although stock-based compensation is a key incentive offered to our employees, we evaluate our operating results excluding such expense because the expense can vary significantly from period to period based on our share price, as well as the timing, size, and nature of equity awards granted. In addition, our management believes that the exclusion of this expense facilitates the ability of our investors to compare our operating results with those of other companies, many of which also exclude such expense in determining their non-GAAP financial measures.
•
Other corporate expenses: We have excluded certain other expenses that are the result of other, non-comparable events, primarily charges associated with the fair valuing of certain equity instruments. These events arise outside of the ordinary course of our continuing operations. We exclude these charges to facilitate a more meaningful evaluation of our current operating performance and comparisons to our past operating performance.
•
Income tax effects and adjustments: During the twelve months ended December 31, 2015, we adjusted for the impact of certain discrete items included in the effective tax rate, including items unrelated to the current year, changes in statutory tax rates, or other items that are not indicative of our ongoing operations. We exclude these items because management believes it will facilitate the comparison of the annual effective tax rate over time. The adjusted effective tax rate is calculated by dividing the adjusted provision for income taxes, which excludes discrete items and the tax effects of the other non-GAAP adjustments (using statutory rates), by the adjusted income before the provision for income taxes.
Adjusted EBITDA
Adjusted EBITDA reflects the adjustments to net income prepared on a GAAP basis, as discussed above, and, to the extent not already subject to such adjustments, excludes expenses related to interest, taxes, depreciation and amortization. Companies exhibit significant variations with respect to capital structure and cost of capital (which affects 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 these variations and reflecting the other adjustments, discussed above, our management believes that this non-GAAP financial measure allows investors to evaluate more effectively our fundamental operating performance relative to that of other companies.
Adjusted Effective Tax Rate
Adjusted effective tax rate is the effective tax rate prepared on a GAAP basis adjusted for the impact of certain non-cash items included in the effective tax rate, including changes in statutory tax regulations and other items that are not indicative of our ongoing operations. We exclude these items because our management believes this non-GAAP financial measure will facilitate the comparison by investors of our annual effective tax rates over time. The adjusted effective tax rate is calculated by dividing the adjusted provision for income taxes, which excludes specified items and the tax effects of the other non-GAAP adjustments (using statutory rates), by the adjusted income before the provision for income taxes.

28

There are various 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; and
•
the non-GAAP financial measures do not reflect the effect of earnings or charges resulting from matters that our management considers not indicative of our ongoing operations, but which may recur from year to year.
Because of their limitations, our non-GAAP financial measures are not meant to be considered as indicators of performance in isolation from or as a substitute for revenue, net income, earnings per diluted share, effective tax rate, and weighted average common shares outstanding-diluted prepared in accordance with GAAP, and should be read only in conjunction with financial information presented on a GAAP basis.
Adjusted net income and adjusted EBITDA. Adjusted net income was $11.3 million for the three months ended September 30, 2016 compared to $14.2 million for the three months ended September 30, 2015, and adjusted EBITDA was $41.0 million for the three months ended September 30, 2016 compared to $43.7 million for the three months ended September 30, 2015. Adjusted net income increased 14.0% to $49.8 million for the nine months ended September 30, 2016 from $43.7 million for the nine months ended September 30, 2015, and adjusted EBITDA increased 6.2% to $136.1 million for the nine months ended September 30, 2016 from $128.2 million for the nine months ended September 30, 2015. The increases in adjusted EBITDA and adjusted net income for the nine month period were attributable to continued growth in our Royall enrollment services, education research programs, student success software program, and EMR optimization services offering. This revenue growth was partially offset by higher marketing and member relations costs and increased depreciation and amortization attributable to increased amortization expense from developed capitalized internal-use software and depreciation of real estate improvements. The decreases in adjusted EBITDA and adjusted net income for the three month period compared to the prior year were attributable to lower revenue growth due to the inclusion of items in the prior year period which were recognized earlier than expected in the calendar year. In addition, we recognized a $1.8 million loss on a cost method investment during the three months ended September 30, 2016 and we had a higher than usual effective tax rate during the current period.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
200,455

 
$
200,492

 
$
599,572

 
$
563,397

Effect on revenue of fair value adjustments to acquisition-related deferred revenue
—

 
—

 
—

 
12,499

Adjusted revenue
$
200,455

 
$
200,492

 
$
599,572

 
$
575,896



29

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
37,538

 
$
672

 
$
55,372

 
$
(13,734
)
Effect on revenue of fair value adjustments to acquisition-related deferred revenue
—

 
—

 
—

 
12,499

Gains (Losses) from equity method investments
(34,729
)
 
3,289

 
(34,284
)
 
1,668

Provision for income taxes
3,279

 
8,590

 
13,812

 
11,684

Loss on financing activities
—

 
—

 
—

 
17,398

Interest expense
4,530

 
5,450

 
13,738

 
16,216

Other expense, net
1,516

 
1,150

 
2,380

 
2,397

Depreciation and amortization
19,173

 
18,509

 
57,857

 
54,282

Acquisition and similar transaction charges
—

 
—

 
—

 
6,610

Fair value adjustments to acquisition-related earn-out liabilities
788

 
(1,057
)
 
1,493

 
(2,140
)
Build-to-suit land rent
931

 
—

 
2,801

 
—

Vacation accrual adjustment
—

 
—

 
—

 
(850
)
Stock-based compensation
7,967

 
7,094

 
22,914

 
22,130

Adjusted EBITDA
$
40,993

 
$
43,697

 
$
136,083

 
$
128,160

     
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
37,538

 
$
672

 
$
55,372

 
$
(13,734
)
Effect on revenue of fair value adjustments to acquisition-related deferred revenue
—

 
—

 
—

 
12,499

Gains (losses) from equity method investments
(34,729
)
 
3,289

 
(34,284
)
 
1,668

Amortization of acquisition-related intangibles
7,026

 
7,740

 
21,425

 
23,320

Loss on financing activities
—

 
—

 
—

 
17,398

Acquisition and similar transaction charges
—

 
—

 
—

 
6,610

Fair value adjustments to acquisition-related earn-out liabilities
788

 
(1,057
)
 
1,493

 
(2,140
)
Gain on investment in common stock warrants
—

 
—

 
—

 
(70
)
Loss on cost method investment
1,800

 
—

 
1,800

 
—

Build-to-suit land rent
931

 
—

 
2,801

 
—

Vacation accrual adjustment
—

 
—

 
—

 
(850
)
Stock-based compensation
7,967

 
7,094

 
22,914

 
22,130

Income tax effects and adjustments
(9,980
)
 
(3,494
)
 
(21,743
)
 
(23,148
)
Adjusted net income
$
11,341

 
$
14,244

 
$
49,778

 
$
43,683



30

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
GAAP earnings (loss) per diluted share
$
0.93

 
$
0.02

 
$
1.35

 
$
(0.33
)
Effect on revenue of fair value adjustments to acquisition-related deferred revenue
—

 
—

 
—

 
0.29

Gains (losses) from equity method investments
(0.86
)
 
0.08

 
(0.84
)
 
0.04

Amortization of acquisition-related intangibles
0.18

 
0.18

 
0.52

 
0.55

Loss on financing activities
—

 
—

 
—

 
0.41

Acquisition and similar transaction charges
—

 
—

 
—

 
0.16

Fair value adjustments to acquisition-related earn-out liabilities
0.02

 
(0.03
)
 
0.04

 
(0.05
)
Gain on investment in common stock warrants
—

 
—

 
—

 
—

Loss on cost method investment
0.04

 
—

 
0.04

 
—

Build-to-suit land rent
0.02

 
—

 
0.07

 
—

Vacation accrual adjustment
—

 
—

 
—

 
(0.02
)
Stock-based compensation
0.20

 
0.16

 
0.56

 
0.53

Income tax effects and adjustments
(0.25
)
 
(0.08
)
 
(0.53
)
 
(0.55
)
Non-GAAP adjusted earnings per diluted share
$
0.28

 
$
0.33

 
$
1.21

 
$
1.03


 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Effective tax rate
53.9
%
 
68.4
 %
 
39.6
%
 
(3,058.6
)%
Effect on tax rate of Washington, D.C. tax law change, including write-off of Washington, D.C. income tax credits
—
%
 
—
 %
 
—
%
 
3,240.6
 %
Effect on tax rate of loss on financing activities
—
%
 
(9.0
)%
 
—
%
 
(17.9
)%
Effect on tax rate of equity method investment related FIN 48 liability
—
%
 
—
 %
 
—
%
 
—
 %
Effect on tax rate of Royall acquisition costs and other tax items
—
%
 
(13.5
)%
 
—
%
 
(119.7
)%
     Adjusted effective tax rate
53.9
%
 
45.9
 %
 
39.6
%
 
44.4
 %

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Weighted average common shares outstanding - diluted
40,492

 
42,788

 
40,977

 
41,900

Dilutive shares outstanding
—

 
—

 
—

 
525

Adjusted weighted average common shares outstanding - diluted
40,492

 
42,788

 
40,977

 
42,425


Liquidity and Capital Resources
Cash flows generated from operating activities represent our primary source of liquidity. We believe that operating cash flows and existing cash and cash equivalents 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 and cash equivalents of $55.1 million as of September 30, 2016 compared to $71.8 million as of December 31, 2015. We expended $61.6 million in cash to purchase shares of our common stock through our share repurchase program during the nine months ended September 30, 2016. During the nine months ended September 30, 2015, we expended $33.0 million in cash to purchase shares of our common stock through our share repurchase program.

31

Cash flows
Cash flows from operating activities. The combination of revenue growth, profitable operations, and payment for services in advance of accrual revenue typically results in operating activities that generate cash flows in excess of net income on an annual basis. Cash flows from operating activities fluctuate from quarter to quarter based on the timing of new and renewal contracts as well as certain expenses. Net cash flows provided by operating activities decreased to $56.5 million in the nine months ended September 30, 2016 from net cash flows provided by operating activities of $107.6 million in the nine months ended September 30, 2015. The decrease in net cash flows provided by operating activities in the nine months ended September 30, 2016 was primarily attributable to lower cash collections in the current period when compared to above average cash collections in the prior year period, as well as to an increase in tax payments of $18.7 million during the current period.
Cash flows from investing activities. Our cash management and investment strategy and capital expenditure programs affect investing cash flows. Net cash flows provided by investing activities was $9.4 million in the nine months ended September 30, 2016 compared to net cash flows used in investing activities of $777.4 million in the nine months ended September 30, 2015. Investing activities during the nine months ended September 30, 2016 primarily consisted of $48.6 million of cash received from the sale of a portion of our ownership interest in Evolent Inc. during the three months ended September 30, 2016, which was partially offset by $37.2 million in capital expenditures and payments of $1.9 million for acquisitions. Investing activities during the nine months ended September 30, 2015 consisted of payments of $746.7 million for acquisitions and $42.5 million in capital expenditures, the effects of which were partially offset by redemptions of marketable securities of $14.7 million.
Cash flows from financing activities. We had net cash flows used in financing activities of $82.6 million and net cash flows provided by financing activities of $653.0 million in the nine months ended September 30, 2016 and 2015, respectively. Cash flows from financing activities during the nine months ended September 30, 2016 consisted of the repurchase of $61.6 million of shares under our stock repurchase program, $38.6 million of debt repayments, $3.6 million of acquisition-related earn-out payments, and the withholding of $3.5 million of shares to satisfy the minimum employee tax withholding for vested RSUs. These cash flows were offset in part by $17.0 million of proceeds from borrowings under our revolving credit facility, $3.9 million in additional tax benefits related to stock-based compensation arrangements, and $3.3 million of proceeds from the issuance of common stock upon the exercise of stock options.
Financing activities during the nine months ended September 30, 2015 primarily consisted of $1.3 billion in proceeds from borrowings under our senior secured term loan facilities obtained to finance our acquisition of Royall and to retire and refinance such indebtedness. These cash flows were offset in part by $739.4 million of debt repayments in connection with the foregoing financings. In addition, financing activities during the nine months ended September 30, 2015 included $148.8 million in proceeds from issuance of common stock, net of selling costs, in an underwritten public offering conducted to retire a portion of the Royall acquisition indebtedness, $3.3 million of proceeds from the issuance of common stock upon the exercise of stock options, and $2.8 million in additional tax benefits related to stock-based compensation arrangements, offset in part by the withholding of $6.1 million of shares to satisfy the minimum employee tax withholding for vested RSUs, $2.6 million of debt issuance costs, and a $1.5 million acquisition-related earn-out payment.
Senior secured credit facilities
On February 6, 2015, we 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.
Term facility. As of September 30, 2016, $431.9 million was outstanding under the term 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, which commenced with the quarter ended 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) 2.50% 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 monthly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.25% or (b) the applicable London interbank offered rate, or “LIBOR,” plus an initial margin of 2.25%, subject in each case to margin reductions based on our total leverage

32

ratio from time to time. As of September 30, 2016, based on our historical leverage ratio, the interest rate margin was 2.00%. 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 monthly in arrears, while interest on 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.
Revolving credit facility. In June 2016, we drew down borrowings of $17.0 million under our revolving credit facility. The borrowing had a maturity of three months and was repaid in the three months ended September 30, 2016. As of September 30, 2016, under the revolving credit facility, $100.0 million of borrowings were outstanding, $19.1 million of standby letters of credit had been issued, and $80.9 million was available for future borrowings.
The revolving credit 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 credit facility, when drawn, to finance working capital needs and for general corporate purposes, including permitted acquisitions.
Amounts drawn under the revolving credit 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 1.25% or (b) the applicable London interbank offered rate plus an initial margin of 2.25%, subject in each case to margin reductions based on our total leverage ratio from time to time. As of September 30, 2016, based on our historical leverage ratio, the interest rate margin was 2.00%.
We are obligated to pay a commitment fee at an initial annual rate of 0.25%, 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 credit facility.
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 our fiscal quarter, for a period consisting of our most recently completed four fiscal quarters. We were in compliance with these financial covenants as of September 30, 2016.
Contractual Obligations
The following summarizes our contractual obligations as of September 30, 2016. These obligations relate to our debt, leases for our headquarters and other offices, a non-cancelable agreement for the purchase of data, and interest payments on debt obligations.
 
Payment due by period
(in thousands)
 
Total
 
Less than 1 year
 
1-3 years
 
3-5 years
 
More than 5 years
Long-term debt
$
529,025

 
$
42,145

 
$
149,284

 
$
337,596

 
$
—

Build-to-suit lease obligation
$
446,134

 
$
—

 
$
—

 
$
41,534

 
$
404,600

Non-cancelable operating leases
$
80,542

 
$
18,409

 
$
35,429

 
$
17,302

 
$
9,402

Purchase obligation
$
3,000

 
$
811

 
$
2,189

 
$
—

 
$
—

Interest payments on debt obligations
$
37,384

 
$
13,138

 
$
21,503

 
$
2,743

 
$
—


Off-Balance Sheet Arrangements
As of September 30, 2016, we had no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition or results of operations.
Seasonality
Our revenues and operating results normally fluctuate as a result of seasonal variations in our business, principally due to certain education program offerings in which contracts typically are aligned with our members' academic year. Historically, these education programs have had lower revenues in the second and third calendar quarters and higher revenues in the first and fourth calendar quarters. We expect quarterly fluctuations in operating results to continue as a result of seasonal patterns. Such patterns may change, however, as a result of changes in service, timing, contract terms, new program offerings, increased sales, or acquisitions.

33

Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
Interest rate risk. As of September 30, 2016, we had $431.9 million of outstanding borrowings under our term facility and $100.0 million of outstanding borrowings under our revolving credit facility. Amounts drawn under each 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 1.25% or (b) the applicable London interbank offered rate, plus an initial margin of 2.25%, subject in each case to margin reductions based on our total leverage ratio from time to time. As of September 30, 2016, our outstanding borrowings accrued interest at an annual rate of 2.53%. Accordingly, we are exposed to fluctuations in interest rates on borrowings under the facilities. A hypothetical 10% increase in LIBOR would increase our annual cash interest expense on our variable-rate debt by approximately $0.3 million.
We utilize three interest rate swaps to manage exposure to interest rates on a portion of the variable rate of our indebtedness. Our interest rate swaps are with major financial institutions and are not used for speculative or trading purposes. As of September 30, 2016, the outstanding notional amount on the interest rate swaps was $265.9 million. Our objective with respect to these interest rate swaps is to protect us against adverse fluctuations in interest rates by reducing our exposure to variability in cash flows relating to interest payments on a portion of our outstanding debt. We have designated our interest rate swaps as cash flow hedges, and changes in the fair value of the interest rate swaps are recognized in other comprehensive income (loss). Hedge ineffectiveness, if any, associated with the interest rate swap will be reported in interest expense. We recorded the interest rate swaps at fair value, which amounted to a liability of $3.1 million as of September 30, 2016.
Foreign currency risk. Our international operations, which account for approximately 2.4% of our revenue, 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 British Pound Sterling). As a consequence, increases in the value of the U.S. dollar against local currencies in countries where we have members would result in a foreign exchange transaction loss recognized by us. We recognized foreign exchange gains of $0.1 million and foreign exchange losses of $1.1 million in the three months ended September 30, 2016 and 2015, respectively, and losses of $0.6 million and $2.4 million in the nine months ended September 30, 2016 and 2015, respectively, which are included in other expense, net in our consolidated statements of operations appearing elsewhere in this report. A hypothetical 10% change in foreign currency exchange rates would not have had a material effect on our financial position as of September 30, 2016.


34

Item 4.
Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.
As previously disclosed under “Item 9A—Controls and Procedures” in our Annual Report on Form 10-K for our fiscal year ended December 31, 2015, we concluded that our disclosure controls and procedures were not effective as of December 31, 2015 due to two material weaknesses in our internal control over financial reporting described below. During the quarter ended June 30, 2016, we identified a material weakness related to the internal controls over the income tax process the we disclosed in our Quarterly Report on Form 10-Q for that quarter. Based on the previously disclosed material weaknesses which we continue to work to remediate and view as an integral part of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the three months ended September 30, 2016, our disclosure controls and procedures were not effective. In light of the weaknesses in internal control over financial reporting, prior to filing our Annual Report on Form 10-K for our fiscal year ended December 31, 2015, and prior to filing this Quarterly Report on Form 10-Q, we completed substantive procedures that have allowed us to conclude that, notwithstanding the material weaknesses in our internal control over financial reporting described below, the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial position, results of operations, and cash flows for the periods presented in conformity with GAAP.
The material weaknesses in our internal control over financial reporting, which are described more fully in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2016, that continued to exist as of September 30, 2016 are as follows:
1.
We did not have sufficient controls to properly identify and account for customer cancellation provisions and contingent fee arrangements. These errors were attributable to insufficient qualified personnel to handle complex revenue arrangements, as well as to limitations of our revenue recognition system.
2.
We did not have sufficient controls over the review of third-party valuations and related projected financial information related to business combinations. Due to the subjectivity of the estimates inherent in the process and the materiality of the transaction, management concluded that these control deficiencies potentially would not prevent or detect a material misstatement. 
3.
We did not have sufficient management review controls over the income tax process, resulting in the identification of errors in current and prior periods in the income tax accounts. Management concluded these control deficiencies potentially would not prevent or detect a material misstatement.
Management's Remediation Initiatives
We are making progress toward achieving the effectiveness of our disclosure controls and procedures. Remediation generally requires making changes to how controls are designed and then adhering to those changes for a sufficient period of time to ensure that the effectiveness of those changes is demonstrated with an appropriate amount of consistency. We have assigned some personnel to implement and monitor our short-term and long-term remediation plans and other personnel to oversee the necessary remedial changes to the overall design of our internal control environment and to address the root causes of our material weaknesses.
Our initiatives, summarized below, are intended to remediate our material weaknesses and to continue to enhance our internal control over financial reporting.
1.
With respect to the material weakness in the revenue recognition controls, we have made control improvements, including a contemporaneous review of contracts and the dedication of additional subject matter expert staff, and are planning an upgraded software solution to properly account for complex contract terms, including customer cancellation provisions and contingent fee arrangements.
2.
With respect to the material weakness in the business combination controls, we have made control improvements including standardized review procedures over third-party valuations and related projections. In addition, we have added resources to our accounting and financial reporting functions to facilitate the timely execution of the process improvements.

35

3.
With respect to the material weakness in the income tax controls, we have made control improvements, including expanded procedures over completeness and accuracy of data utilized in our tax provision and enhanced documentation of management review controls.
(b) Changes in Internal Control over Financial Reporting
We are taking actions to remediate the material weaknesses related to our internal control over financial reporting, as described above. However, our remediation efforts were not complete as of September 30, 2016. Other than the changes disclosed above, there were no material changes in our internal control over financial reporting identified in connection with the evaluation required by Rules 13a-15 and 15d-15 under the Exchange Act that occurred during the three months ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

36

PART II. OTHER INFORMATION
 
Item 1A.
Risk Factors.
As discussed in this report, our actual results could differ materially from the expected results expressed or implied in our forward-looking statements. There have been no material changes in our risk factors from those described in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. The risks described in that report are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, or operating results.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
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. That 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, to $450 million in May 2013, and to $550 million in November 2015. All repurchases have been made in the open market pursuant to this publicly announced repurchase program. No minimum number of shares has been fixed, and the share repurchase authorization has no expiration date. A summary of the share repurchase activity for the three months ended September 30, 2016 is as follows:
 
Total number of
shares purchased
 
Average price
paid per share
 
Total number of
shares purchased as
part of publicly
announced plans or
programs
 
Approximate
dollar value of
shares that may
yet be purchased
under the plan
July 1 to July 31, 2016
210,331

 
$
37.92

 
210,331

 
$
36,569,604

August 1 to August 31, 2016
680

 
$
37.13

 
680

 
$
36,544,339

September 1 to September 30, 2016
—

 
$
—

 
—

 
$
36,544,339

Total
211,011

 
$
37.91

 
211,011

 
 
As of September 30, 2016, we had repurchased a total of 19,778,800 shares under our repurchase program since the program’s inception.
During the three months ended September 30, 2016, we issued 62,269 shares of our common stock to the former owners of Clinovations, LLC in payment of a portion of an earn-out obligation we incurred when we acquired Clinovations, LLC in November 2014. This non-public transaction was effected in reliance on the exemption from the registration requirements of the Securities Act of 1933 afforded by Section 4(a)(2) thereof and Regulation D thereunder.


37

Item 6.
Exhibits.
(a) Exhibits. The Company files herewith or incorporates by reference herein the exhibits identified below. The Company files Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K under Commission File No. 000-33283.
12.1

 
Computation of Ratio of Earnings to Fixed Charges
 
 
 
31.1

 
Certification of the Chief Executive Officer pursuant to Rule13a-14(a) under the Securities Exchange Act of 1934, as amended
 
 
31.2

 
Certification of the Chief Financial Officer pursuant to Rule13a-14(a) under the Securities Exchange Act of 1934, as amended
 
 
32.1

 
Certifications pursuant to 18 U.S.C. Section 1350
 
 
101

 
XBRL (Extensible Business Reporting Language). The following materials from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2016, formatted in XBRL: (i) Consolidated Balance Sheets as of September 30, 2016 (unaudited) and December 31, 2015, (ii) Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015, (iii) Unaudited Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2016 and 2015, (v) Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015, and (v) Notes to Unaudited Consolidated Financial Statements


38

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
THE ADVISORY BOARD COMPANY
 
 
 
 
Date: November 9, 2016
 
 
 
By:
/s/ Michael T. Kirshbaum
 
 
 
 
 
Michael T. Kirshbaum
 
 
 
 
 
Chief Financial Officer and Treasurer
(Duly Authorized Officer)

39

INDEX TO EXHIBITS
 
Exhibit
Number
 
Description of Exhibit
12.1

 
Computation of Ratio of Earnings to Fixed Charges
 
 
 
31.1

 
Certification of the Chief Executive Officer pursuant to Rule13a-14(a) under the Securities Exchange Act of 1934, as amended
 
 
31.2

 
Certification of the Chief Financial Officer pursuant to Rule13a-14(a) under the Securities Exchange Act of 1934, as amended
 
 
32.1

 
Certifications pursuant to 18 U.S.C. Section 1350
 
 
101

 
XBRL (Extensible Business Reporting Language). The following materials from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2016, formatted in XBRL: (i) Consolidated Balance Sheets as of September 30, 2016 (unaudited) and December 31, 2015, (ii) Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015, (iii) Unaudited Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2016 and 2015, (v) Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015, and (v) Notes to Unaudited Consolidated Financial Statements


40
Exhibit 12.1


Computation of ratio of earnings to fixed charges (a)
(dollars in thousands)

 
Nine Months Ended September 30, 2016
 
Year Ended
December 31, 2015
 
Year Ended
March 31, 2014
 
Year Ended
March 31, 2013
 
Year Ended
March 31, 2012
 
Year Ended
March 31, 2011
Pre-tax income from continuing operations before adjustment for income or loss from equity investees
$
34,900

 
$
(99,418
)
 
$
48,661

 
$
47,728

 
$
39,406

 
$
28,145

Fixed charges
18,403

 
26,537

 
4,833

 
3,582

 
2,650

 
2,189

 
 
 
 
 
 
 
 
 
 
 
 
Total earnings available for fixed charges
$
53,303

 
$
(72,881
)
 
$
53,494

 
$
51,310

 
$
42,056

 
$
30,334

 
 
 
 
 
 
 
 
 
 
 
 
Fixed charges:
 
 
 
 
 
 
 
 
 
 
 
   Interest factor of rental expense
$
4,665

 
$
5,416

 
$
4,254

 
$
3,214

 
$
2,650

 
$
2,189

Interest expense
13,738

 
21,121

 
579

 
368

 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
 
Total fixed charges
18,403

 
26,537

 
4,833

 
3,582

 
2,650

 
2,189

 
 
 
 
 
 
 
 
 
 
 
 
Ratio of earnings to fixed charges
2.90x

 
*

 
11.06x

 
14.32x

 
15.87x

 
13.86x

 
 
 
 
 
 
 
 
 
 
 
 
 

*Earnings for the year ended December 31, 2015 were inadequate to cover fixed charges by $46,344.
(a)
The Advisory Board Company had no preferred equity securities outstanding and did not pay preferred dividends in any of the periods presented. Consequently, the ratio of earnings to combined fixed charges and preferred stock dividends for each of such periods is identical to the ratio of earnings to fixed charges as indicated above.
The Advisory Board Company computes its ratio of earnings to fixed charges by dividing pre-tax income (loss) from continuing operations, before adjustment for income or loss from equity investees, plus fixed charges and less capitalized interest, by fixed charges. Fixed charges consist of interest expense, including interest expense from amortized premiums, discounts and capitalized expenses related to indebtedness, and the estimated portion of rental expense deemed by the Company to be representative of the interest factor of rental payments under operating leases, which the Company estimates to be one-third of such payments.

 


Exhibit 31.1
CERTIFICATION
I, Robert W. Musslewhite, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of The Advisory Board Company;
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;
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;
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:
(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;
(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;
(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:
November 9, 2016
 
 
 
 
 
/s/ Robert W. Musslewhite
 
 
 
 
 
 
 
Robert W. Musslewhite
 
 
 
 
 
 
 
Chief Executive Officer




Exhibit 31.2
CERTIFICATION
I, Michael T. Kirshbaum, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of The Advisory Board Company;
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;
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;
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:
(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;
(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;
(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: November 9, 2016
 
 
 
 
 
/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 Quarterly Report on Form 10-Q of the Company for the quarterly period ended September 30, 2016 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 Quarterly Report on Form 10-Q 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
 
November 9, 2016
 
 
 
 
 
 
/s/ Michael T. Kirshbaum
 
Michael T. Kirshbaum
 
Chief Financial Officer and Treasurer
 
November 9, 2016
 



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