UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2015
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
 
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 August 1, 2015, the registrant had outstanding 42,558,075 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)
 
June 30,
2015
 
December 31,
2014
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
49,550

 
$
72,936

Marketable securities, current
—

 
14,714

Membership fees receivable, net
603,173

 
539,061

Prepaid expenses and other current assets
34,295

 
23,254

Deferred income taxes, current
16,035

 
14,695

Total current assets
703,053

 
664,660

Property and equipment, net
178,690

 
135,107

Intangible assets, net
290,744

 
38,973

Deferred incentive compensation and other charges
86,351

 
86,045

Goodwill
840,809

 
186,895

Investments in unconsolidated entities
5,680

 
9,316

Other non-current assets
5,698

 
5,370

Total assets
$
2,111,025

 
$
1,126,366

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Deferred revenue, current
$
563,349

 
$
501,785

Accounts payable and accrued liabilities
71,191

 
80,284

Accrued incentive compensation
20,042

 
32,073

Debt, current
27,880

 
—

Total current liabilities
682,462

 
614,142

Deferred revenue, net of current portion
168,854

 
167,014

Deferred income taxes, net of current portion
122,348

 
9,855

Debt, net of current portion
536,395

 
—

Other long-term liabilities
10,136

 
15,304

Total liabilities
1,520,195

 
806,315

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, 42,545,088 and 36,087,754 shares issued and outstanding as of June 30, 2015 and December 31, 2014, respectively
425

 
361

Additional paid-in capital
727,551

 
442,528

Accumulated deficit
(137,893
)
 
(122,920
)
Accumulated other comprehensive income
747

 
82

Total stockholders’ equity
590,830

 
320,051

Total liabilities and stockholders’ equity
$
2,111,025

 
$
1,126,366


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 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
184,661

 
$
141,820

 
$
364,456

 
$
279,821

Costs and expenses:
 
 
 
 
 
 
 
Cost of services, excluding depreciation and amortization
92,221

 
74,218

 
187,528

 
141,413

Member relations and marketing
29,375

 
26,576

 
60,101

 
52,988

General and administrative
30,853

 
22,712

 
62,527

 
41,455

Depreciation and amortization
19,499

 
9,078

 
36,573

 
17,546

Operating income
12,713

 
9,236

 
17,727

 
26,419

Other (expense) income:
 
 
 
 
 
 
 
Interest expense
(5,154
)
 
—

 
(10,766
)
 
—

Other (expense) income, net
(128
)
 
710

 
(1,247
)
 
1,442

Loss on financing activities
—

 
—

 
(17,398
)
 
—

Total other (expense) income, net
(5,282
)
 
710

 
(29,411
)
 
1,442

Income (loss) before provision for income taxes and equity in income (loss) of unconsolidated entities
7,431

 
9,946

 
(11,684
)
 
27,861

Provision for income taxes
(2,716
)
 
(3,933
)
 
(4,910
)
 
(10,830
)
Equity in income (loss) of unconsolidated entities
4,000

 
(2,150
)
 
1,621

 
(4,881
)
Net income before allocation to noncontrolling interest
$
8,715

 
$
3,863

 
$
(14,973
)
 
$
12,150

Accretion to redemption value of noncontrolling interest
—

 
(7,040
)
 
—

 
(7,040
)
Net income (loss) attributable to common stockholders
8,715

 
(3,177
)
 
(14,973
)
 
5,110

Earnings per share
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders per share—basic
$
0.21

 
$
(0.09
)
 
$
(0.36
)
 
$
0.14

Net income (loss) attributable to common stockholders per share—diluted
$
0.20

 
$
(0.09
)
 
$
(0.36
)
 
$
0.14

Weighted average number of shares outstanding:
 
 
 
 
 
 
 
Basic
42,440

 
36,413

 
41,686

 
36,310

Diluted
42,914

 
36,413

 
41,686

 
37,125

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 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss) attributable to common stockholders
$
8,715

 
$
(3,177
)
 
$
(14,973
)
 
$
5,110

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Net unrealized (losses) gains on available-for-sale securities, net of income taxes of $0 and $531 for the three months ended June 30, 2015 and 2014, respectively, and $150 and $1,123 for the six months ended June 30, 2015 and 2014, respectively
—

 
810

 
(81
)
 
1,765

Net unrealized gains on cash flow hedges, net of income taxes of $449 and $0 for the three months ended June 30, 2015 and 2014, respectively, and $449 and $0 for the six months ended June 30, 2015 and 2014, respectively
747

 
—

 
747

 
—

Comprehensive income (loss)
$
9,462

 
$
(2,367
)
 
$
(14,307
)
 
$
6,875

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)
 
Six Months Ended 
 June 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net (loss) income before allocation to noncontrolling interest
$
(14,973
)
 
$
12,150

Adjustments to reconcile net income before allocation to noncontrolling interest to net cash provided by operating activities:
 
 
 
Depreciation and amortization
36,573

 
17,546

Loss on financing activities
17,398

 
—

Amortization of debt issuance costs
703

 
—

Deferred income taxes
11,356

 
9,806

Excess tax benefits from stock-based awards
(2,745
)
 
(7,900
)
Stock-based compensation expense
15,036

 
9,964

Amortization of marketable securities premiums
—

 
1,235

Loss on investment in common stock warrants
(70
)
 
180

Equity in (income) loss of unconsolidated entities
(1,621
)
 
4,881

Changes in operating assets and liabilities (net of the effect of acquisition):
 
 
 
Membership fees receivable
(34,872
)
 
(10,953
)
Prepaid expenses and other current assets
(178
)
 
(5,336
)
Deferred incentive compensation and other charges
870

 
3,801

Other non-current assets
(258
)
 
—

Deferred revenue
45,104

 
(7,406
)
Accounts payable and accrued liabilities
(10,949
)
 
1,069

Acquisition-related earn-out payments
(1,948
)
 
(2,798
)
Accrued incentive compensation
(12,031
)
 
(13,700
)
Other long-term liabilities
(5,168
)
 
(7,207
)
Net cash provided by operating activities
42,227

 
5,332

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(23,783
)
 
(20,331
)
Capitalized external use software development costs
(2,181
)
 
(2,689
)
Cash paid for acquisition, net of cash acquired
(744,193
)
 
(25,830
)
Cash paid for cost method investment
(3,006
)
 
—

Redemptions of marketable securities
14,714

 
81,669

Purchases of marketable securities
—

 
(32,510
)
Net cash (used in) provided by investing activities
(758,449
)
 
309

Cash flows from financing activities:
 
 
 
Proceeds from debt, net
1,280,292

 
—

Pay down of debt
(732,189
)
 
—

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
3,014

 
5,810

Withholding of shares to satisfy minimum employee tax withholding for vested restricted stock units
(6,007
)
 
(7,735
)
Proceeds from issuance of common stock under employee stock purchase plan
263

 
296

Acquisition-related earn-out payments
(1,500
)
 
—

Excess tax benefits from stock-based awards
2,745

 
7,900

Contributions from non controlling interest
—

 
200

Purchases of treasury stock
—

 
(23,772
)
Net cash provided by (used in) financing activities
692,836

 
(17,301
)
Net increase (decrease) in cash and cash equivalents
(23,386
)
 
(11,660
)
Cash and cash equivalents, beginning of period
72,936

 
52,717

Cash and cash equivalents, end of period
$
49,550

 
$
41,057


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, consulting and management services, and data- and tech-enabled services through discrete programs to hospitals, health systems, pharmaceutical and biotechnology companies, health care insurers, medical device companies, and colleges, universities, and other health care-focused organizations and educational institutions. Members of each subscription-based membership program are typically charged a separate fixed annual fee and have access to an integrated set of services that may include best practices research studies, executive education, proprietary content databases and online tools, daily online executive briefings, original executive inquiry services, cloud-based software applications, consulting and management services, and tech-enabled 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 transition report on Form 10-KT for the nine-month period ended December 31, 2014 and the Company’s quarterly report on Form 10-Q for the quarterly period ended March 31, 2015.
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 or securities deemed to be in-substance common stock and has the ability to exercise significant influence, but not control, over the investee and for all investments in partnerships or limited liability companies where the investee maintains separate capital accounts for each investor. Investments in which the Company holds securities that are not in-substance common stock, or holds common stock or in-substance common stock but has little or no influence over the investee, are accounted for using the cost method. All significant intercompany transactions and balances have been eliminated.
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, 2014 has been derived from the financial statements that have been audited by the Company’s independent registered public accounting firm. The consolidated results of operations for the three and six months ended June 30, 2015 may not be indicative of the results that may be expected for the Company’s fiscal year ending December 31, 2015, or any other period.
Note 2. Recent accounting pronouncements
Recently issued
In May 2014, the Financial Accounting Standards Board ("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 reporting periods beginning after December 15, 2016, including interim periods within that reporting period. 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 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 is currently evaluating the revenue recognition effect this guidance will have once implemented.
In June 2014, the FASB issued accounting guidance related to share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This guidance clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. The standard is effective for fiscal years beginning after December 15, 2015. The Company is currently evaluating the effect this guidance will have once implemented.
In August 2014, the FASB issued guidance on the assessment of an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The guidance requires such

5

an assessment for a period of one year after the date that the financial statements are issued. Further, based on certain conditions and circumstances, additional disclosures may be required. The applicable guidance is effective beginning with the first annual period ending after December 15, 2016, and for all annual and interim periods thereafter. The Company is currently evaluating the effect this guidance will have once implemented.
In April 2015, the FASB issued guidance on the presentation of debt issuance costs. The new standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective for annual and interim periods beginning after December 15, 2015, with early adoption permitted. The Company is currently evaluating the effect this guidance will have once implemented.
In April 2015, the FASB issued guidance to clarify the customer's accounting for fees paid in a cloud computing arrangement. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The Company is currently evaluating the effect this guidance will have once implemented.
Note 3. Acquisitions

Increasing service to members through the introduction and expansion of new programs is a key component of the Company's growth strategy. From time to time the Company supplements its organic new program development efforts with acquisitions that allow it to introduce new programs and services to its members, or that complement and enhance the value of existing programs through the addition of new capabilities.
Royall Acquisition Co.
On January 9, 2015, the Company completed the acquisition of all of the issued and outstanding capital stock of Royall Acquisition Co. (together with its subsidiaries, “Royall”) from Royall Holdings, LLC (the “Seller”). Royall is a higher 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.
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 10, "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 on January 9, 2015 as reported on the NASDAQ Global Select Market. The 2,428,364 shares issued to the Seller was the minimum number of shares that could have been issued under the pricing collar set forth in the purchase agreement, since the volume-weighted average trading price of the Company’s common stock on the NASDAQ Global Select Market for the 15 consecutive trading days ending on (and including) January 7, 2015 was higher than the pricing collar ceiling price of $41.18.
The Company has not yet finalized the allocation of the Royall purchase consideration to assets acquired and liabilities assumed. The total purchase price has been allocated on a preliminary basis to identifiable assets acquired and liabilities assumed based upon valuation procedures performed to-date. As of the date of this report, the valuation studies necessary to determine the fair market value of the assets acquired, including asset useful lives, and liabilities assumed and the related allocations of purchase price have not been finalized. The Company's judgments used to determine the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially affect the Company’s results of operations. A final determination of fair values will be based on the actual identifiable tangible and intangible assets acquired and liabilities assumed that existed as of the closing date of the acquisition. In addition, the Company is finalizing its income tax analysis of the acquisition, including an evaluation of assumed uncertain tax positions. The final purchase price allocation may be different from the amounts outlined below. The allocation of the purchase price and the estimates and assumptions are subject to change until the Company completes all of the necessary valuations and income tax analysis, which will be no longer than one year from the acquisition date.

6

The fair value and useful lives assigned to Royall’s trade name and customer relationships intangible assets have been estimated based on valuation studies utilizing widely accepted valuation methodologies and principles.
The preliminary purchase price allocation to other identifiable intangible assets is as follows (in thousands):
 
Estimated Average Useful Lives (years)
 
Estimated Fair Value
Trade name
10
 
$
10,000

Customer relationships
17
 
252,000

Total
 
 
$
262,000

The fair value and useful lives assigned to Royall’s technology were based on valuation studies utilizing widely accepted valuation methodologies and principles. The technology is classified as software within property and equipment because the developed software application resides on the Company’s or its service providers’ hardware.
The preliminary purchase price allocation to Royall's technology, included in Property and equipment is as follows (in thousands):
 
Estimated Average Useful Lives (years)
 
Estimated Fair Value
Technology - database and analytics
4
 
13,000

Technology - developed software
8
 
25,000

Total
 
 
$
38,000


A preliminary 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
 
7,479

Property and equipment
 
44,209

Intangible assets, net
 
262,000

Deferred revenue, current
 
(18,300
)
Accounts payable and accrued liabilities
 
(5,308
)
Deferred income taxes, net of current portion
 
(107,655
)
Preliminary fair value of net assets acquired
 
$
211,664

Preliminary allocation to goodwill
 
$
653,753


During the quarter ended June 30, 2015, the Company increased its preliminary estimate of the fair value of the acquired customer relationships by $17 million, resulting in a $10 million reduction in goodwill and a $7 million increase in the net deferred tax liability recorded. In addition, the Company refined its estimate of the useful lives of its customer relationship and developed software assets. The impact of these changes on amortization expense was not material and was recognized entirely in the quarter ended June 30, 2015.
The preliminary goodwill is primarily attributable to the assembled workforce of Royall and synergies and economies of scale expected from combining the operations of the Company and Royall. Of the goodwill recognized, $107.7 million is deductible for tax purposes.

7

Acquisition-related costs of $9.8 million were incurred and included in general and administrative costs in the Company’s consolidated statements of operations. Of this amount, $3.2 million was recognized in the transition period ended December 31, 2014, and $6.6 million was recognized in the six months ended June 30, 2015.
The six months ended June 30, 2015 includes the operations of Royall for the period from January 9, 2015 through June 30, 2015. The condensed consolidated statements of operations for the six months ended June 30, 2015 includes $46.9 million of revenues and $8.9 million of net income, respectively, contributed by Royall.
The following table presents the Company’s pro forma consolidated revenues and net income (loss) attributable to common stockholders for the three and six months ended June 30, 2015 and 2014. 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. As described below under “Transition Period Acquisitions,” the Company consummated certain other acquisitions during the transition period ended December 31, 2014; however, the Company has not included the results prior to the acquisitions in these pro forma results as their effect would not have been material.
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 as they would have been had the acquisition of Royall and the related financing been effected on the assumed date.
The unaudited pro forma results are set forth below (in thousands):
 
Unaudited Pro Forma Results
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
191,277

 
$
162,816

 
$
379,748

 
$
326,512

Net income (loss) attributable to common stockholders
13,337

 
(6,203
)
 
9,630

 
(17,359
)
For the six months ended June 30, 2015, the pro forma results, prepared in accordance with GAAP, include the following pro forma adjustments related to the acquisition of Royall:
 
(i)
an increase in non-recurring transaction expenses of $9.8 million in the six months ended June 30, 2014 to reflect the assumption that the Royall acquisition occurred on January 1, 2014;
(ii)
the elimination of $6.6 million of acquisition costs recorded in the six months ended June 30, 2015 as these are now presented in the corresponding period of 2014;
(iii)
an increase in amortization expense related to the fair value of the identifiable intangible assets of $0.4 million and $9.0 million in the six months ended June 30, 2015 and 2014, respectively;
(iv)
a reduction in revenue of $12.5 million in the six months ended June 30, 2014, representing the purchase accounting fair value effect to revenue the Company would have recognized during the six months ended June 30, 2014 had the acquisition of Royall occurred on January 1, 2014 and an increase in revenue of $12.5 million in the six months ended June 30, 2015, representing the purchase accounting fair value effect to revenue that was recognized in 2015;
(v)
the elimination and replacement of the historical Royall interest expense with the interest expense from the Company's new senior secured term credit facility totaling $9.5 million and $9.2 million in the six months ended June 30, 2015 and 2014, respectively;
(vi)
an increase in compensation expense related to the inducement equity awards issued to certain Royall employees totaling $0.1 million and $2.9 million in the six months ended June 30, 2015 and 2014, respectively;
(vii)
an increase in non-recurring loss on financing activities expenses of $17.4 million in the six months ended June 30, 2014 to reflect the assumption that the Royall acquisition and related financings occurred in the 2014 period; and
(viii)
the elimination of $17.4 million of loss on financing activities recorded in the six months ended June 30, 2015 as these are now presented in the corresponding period in 2014.

For the three months ended June 30, 2015 and 2014, 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 amortization expense related to the fair value of the identifiable intangible assets of $3.9 million in the three months ended June 30, 2014;

8

(ii)
a reduction in revenue of $6.6 million in the three months ended June 30, 2014, representing the purchase accounting fair value effect to revenue the Company would have recognized during the three months ended June 30, 2014 had the acquisition of Royall occurred on January 1, 2014, and an increase in revenue of $6.6 million in the three months ended June 30, 2015, representing the purchase accounting fair value effect to revenue that was recognized in the quarter ended June 30, 2015;
(iii)
the elimination of $0.9 million of acquisition costs recorded in the three months ended June 30, 2015 as these are now presented in the corresponding period of 2014;
(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 $4.6 million in the three months ended June 30, 2014; and
(v)
an increase in compensation expense related to the inducement equity awards issued to certain Royall employees totaling $1.5 million in the three months ended June 30, 2014.
Transition period acquisitions

During the nine months ended December 31, 2014, the Company completed three acquisitions qualifying as business combinations in exchange for aggregate net cash consideration of $71.3 million. The total purchase price has been allocated to identifiable assets acquired and liabilities assumed, including $16.6 million to intangible assets with a weighted average amortization period of 8.3 years and $57.7 million to goodwill, of which $33.9 million is tax deductible. The completed acquisitions in the nine months ended December 31, 2014, both individually and in the aggregate, were not significant to the Company's consolidated results of operations.
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 and cash equivalents, marketable securities, common stock warrants, 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 consist of money market funds with original maturity dates of less than three months for which the fair value is based on quoted market prices. The Company’s cash and cash equivalents are held at major commercial banks.
Marketable securities. The Company’s marketable securities as of December 31, 2014, consisting of U.S. government-sponsored enterprise obligations and various state tax-exempt notes and bonds, were classified as available-for-sale and carried at fair market value based on quoted market prices.
Common stock warrants. The Company holds warrants to purchase common stock in an entity that provides technology tools and support services to health care providers, including the Company’s members. The warrants are exercisable for up to 6,015,000 shares of the entity's common stock if and as certain performance criteria are met. The warrants meet the definition of a derivative and are carried at fair value in other non-current assets on the consolidated balance sheets. Gains or losses from changes in the fair value of the warrants are recognized in other (expense) income, net on the consolidated statements of operations. See Note 9, “Other non-current assets,” for additional information. The fair value of the warrants is determined using a Black-Scholes-Merton model. Key inputs into this methodology are the estimate of the underlying value of the common shares of the entity that issued the warrants and the estimate of the level of performance criteria that will be achieved. The entity that issued the warrants is privately held and the estimate of performance criteria to be met is specific to the Company. These inputs are unobservable and are considered key estimates made by the Company.
Contingent earn-out liabilities. This class of financial liabilities represents the Company’s estimated fair value of the contingent earn-out liabilities related to acquisitions based on probability assessments of certain performance achievements during the earn-out periods. The performance targets are specific to the operation of the acquired company subsequent to the acquisition. These inputs are considered key estimates made by the Company that are unobservable because there are no active markets to support them. Contingent earn-out liabilities are included in accounts payable and accrued liabilities and other long-term liabilities on the consolidated balance sheets.

9

Interest rate swaps. The Company uses interest rate swaps to manage interest rate risk. The fair value 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 cash payments, or receipts, are based on observable market interest rate curves.
Measurements
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The valuation can be determined using widely accepted valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost). As a basis for applying a market-based approach in fair value measurements, GAAP establishes a fair value hierarchy that prioritizes into three broad levels the inputs to valuation techniques used to measure fair value. The following is a brief description of those three levels:
 
•
Level 1—Quoted prices in active markets for identical assets or liabilities.
•
Level 2—Observable market-based inputs other than Level 1 inputs, such as quoted prices for similar assets or liabilities in active markets; quoted prices for similar or identical assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
•
Level 3—Unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies.
Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. There were no significant transfers between Level 1, Level 2, or Level 3 during the six months ended June 30, 2015 or 2014.

10

The Company’s financial assets and liabilities subject to fair value measurements on a recurring basis and the necessary disclosures are as follows (in thousands):
 
 
Fair Value
as of June 30,
 
Fair Value Measurement as of June 30, 2015
using fair value hierarchy
 
2015
 
Level 1
 
Level 2
 
Level 3
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
49,550

 
$
49,550

 
$
—

 
$
—

Common stock warrants (1)
440

 
—

 
—

 
440

Interest rate swaps
1,176

 
—

 
1,176

 
—

Financial liabilities
 
 
 
 
 
 
 
Contingent earn-out liabilities (2)
8,416

 
—

 
—

 
8,416

 
Fair Value
as of December 31,
 
Fair Value Measurement as of December 31, 2014
using fair value hierarchy
 
2014
 
Level 1
 
Level 2
 
Level 3
Financial assets
 
 
 
 
 
 
 
Cash and cash equivalents
$
72,936

 
$
72,936

 
$
—

 
$
—

Available-for-sale marketable securities
14,714

 
—

 
14,714

 
—

Common stock warrants (1)
370

 
—

 
—

 
370

Financial liabilities
 
 
 
 
 
 
 
Contingent earn-out liabilities (2)
12,946

 
—

 
—

 
12,946

 
(1)
The fair value of the common stock warrants as of June 30, 2015 and December 31, 2014 was calculated to be $0.21 and $0.22 per share, respectively, using a Black-Scholes-Merton model. The significant assumptions as of June 30, 2015 were as follows: risk-free interest rate of 1.3%; expected term of 3.97 years; expected volatility of 75.40%; dividend yield of 0.0%; weighted average share price of $0.52 per share; and warrants expected to become exercisable between
1,776,500 and 2,157,500 shares. The significant assumptions as of December 31, 2014 were as follows: risk-free interest rate of 1.6%; expected term of 4.46 years; expected volatility of 76.11%; dividend yield of 0.0%; weighted average share price of $0.49 per share; and expected warrants to become exercisable of approximately 1,776,500 shares.
(2)
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.

Common stock warrants
The Company’s fair value estimate of the common stock warrants received in connection with its investment was zero as of the June 2009 investment date. Changes in the fair value of the common stock warrants subsequent to the investment date are recognized in earnings in the periods during which the estimated fair value changes. The following table represents a reconciliation of the change in the fair value of the common stock warrants for the three and six months ended June 30, 2015 and 2014, (in thousands):
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Beginning balance
$
370

 
$
550

 
$
370

 
$
550

Fair value change in common stock warrants (1)
70

 
(180
)
 
70

 
(180
)
Ending balance
$
440

 
$
370

 
$
440

 
$
370

 
(1)
Amounts were recognized in other income, net on the consolidated statements of operations.


11

Contingent earn-out liabilities
The Company entered into an earn-out agreement in connection with its acquisition of Southwind Health Partners, L.L.C. and Southwind Navigator, LLC (together, “Southwind”) on December 31, 2009. The Company’s fair value estimate of the Southwind earn-out liability was $5.6 million as of the date of acquisition. The fair value of the Southwind earn-out liability was affected by changes in the Company's stock price and by changes in estimates regarding expected operating results through the end of the evaluation period, which was December 31, 2014.
As of June 30, 2015, $18.0 million had been earned and paid in cash and shares to the former owners of the Southwind business. As of June 30, 2015, based on current facts and circumstances, the estimated aggregate fair value of the remaining contingent obligation earned over the evaluation period was $3.4 million. The fair value of the Southwind earn-out liability is affected by changes in the discount rate, which was 1.9% as of June 30, 2015. The remaining obligation will be paid at various intervals through April 2016.
The Company entered into an earn-out agreement in connection with its acquisition of 360Fresh, Inc. (“360Fresh”) on November 15, 2012. The Company’s fair value estimate of the 360Fresh earn-out liability was $2.5 million as of the date of acquisition. The earn-out liability period ended on January 9, 2015 and the final earn-out payment of $1.5 million was made in the six months ended June 30, 2015.
The Company's fair value estimate of the earn-out liability related to the Company’s acquisition of Clinovations, LLC (“Clinovations”) on November 7, 2014 was $4.5 million. 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. A portion of the earn-out liability will be paid in the form of the Company’s common stock. The maximum payout of the earn-out liability is $9.5 million, while the minimum is zero. Based on the results of Clinovations’ operating results, the contingent obligation for Clinovations as of June 30, 2015 was $3.3 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 7.7% to 9.4% and the volatility of the Company's common stock, which was 25% as of June 30, 2015.
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”) on December 15, 2014 was $3.6 million. The fair value of the GradesFirst earn-out liability is affected by changes in estimates regarding expected operating results through the evaluation period, which will end on December 31, 2015. The maximum payout of the earn-out liability is $4.0 million, while the minimum is zero. Based on GradesFirst’s operating results, the fair value of the contingent obligation for GradesFirst as of June 30, 2015 was estimated as $3.6 million. The fair value of the GradesFirst earn-out liability is affected by changes in estimates regarding expected operating results, probability of achieving the operating results, and a discount rate, which was 1.9% as of June 30, 2015.
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 six months ended June 30, 2015 and 2014 (in thousands):
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Beginning balance
$
11,790

 
$
8,750

 
$
12,946

 
$
12,800

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

 
—

 
209

 
(4,150
)
Fair value change in Clinovations contingent earn-out liability (1)
(1,427
)
 
—

 
(1,292
)
 
—

Fair value change in 360Fresh contingent earn-out liability (1)
—

 
(100
)
 
—

 
—

Southwind earn-out payments
(1,947
)
 
(2,800
)
 
(1,947
)
 
(2,800
)
360Fresh earn-out payments
—

 
—

 
(1,500
)
 
—

Ending balance
$
8,416

 
$
5,850

 
$
8,416

 
$
5,850

 
(1)
Amounts were recognized in cost of services on the consolidated statements of operations.
Financial instruments not recorded at fair value on a recurring basis
The fair value of the Company's equity method investments is measured quarterly for disclosure purposes. The Company's equity method investments are only recorded at fair value only if an impairment charge is recognized.

12

Equity method investments. Our equity method investments represent the Company's ownership interest in Evolent Health, Inc., or Evolent Inc, and its subsidiary, Evolent Health LLC, or Evolent LLC. The fair value of the Company's ownership interest in Evolent Inc. and its subsidiary was $226 million as of June 30, 2015 based on the quoted closing stock price. For further information, see Note 8, "Investments in unconsolidated entities."
Senior secured term loan. We estimate that the fair value of our senior secured term loan was $574.5 million as of June 30, 2015. 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 senior secured term loan would be classified as Level 2 within the fair value hierarchy if it were measured at fair value.
Non-financial assets and liabilities
Certain assets and liabilities are not measured at fair value on an ongoing basis but instead are measured at fair value on a non-recurring basis, so that such assets and liabilities are subject to fair value adjustments in certain circumstances (such as when there is evidence of impairment). During the six months ended June 30, 2015 and 2014, no fair value adjustments or material fair value measurements were required for non-financial assets or liabilities.
Note 5. Marketable securities
As a result of the Royall acquisition on January 9, 2015, the Company liquidated its remaining marketable securities, and therefore the Company had no marketable securities as of June 30, 2015. The aggregate fair value, amortized cost, gross unrealized gains, and gross unrealized losses on available-for-sale marketable securities as of December 31, 2014 are as follows (in thousands): 
 
As of December 31, 2014
 
Fair
value
 
Amortized
cost
 
Gross
unrealized
gains
 
Gross
unrealized
losses
U.S. government-sponsored enterprises
$
1,915

 
$
1,915

 
$
—

 
$
—

Tax exempt obligations of states
12,799

 
12,647

 
152

 
—

 
$
14,714

 
$
14,562

 
$
152

 
$
—


The Company recognized gross realized gains of $0.1 million on sales of available-for-sale investments during the six months ended June 30, 2015. There were $0.9 million in gross realized gains on sales of available-for-sale investments and $0.5 million in gross realized losses on sales of available-for-sale investments during the six months ended June 30, 2014.
Note 6. Property and equipment
Property and equipment consists of leasehold improvements, furniture, fixtures, equipment, capitalized internal use software development costs, and acquired developed technology. Property and equipment is stated at cost, less accumulated depreciation and amortization. In certain membership programs, the Company provides software applications under a hosting arrangement where the software application resides on the Company’s or its service providers’ hardware. The members do not take delivery of the software and only receive access to the software during the term of their membership agreement. Software development costs that are incurred in the preliminary project stage are expensed as incurred. During the development stage, direct consulting costs and payroll and payroll-related costs for employees that are directly associated with each project are capitalized and amortized over the estimated useful life of the software once placed into operation. Capitalized software is amortized using the straight-line method over its estimated useful life, which is generally five years. Replacements and major improvements are capitalized, while maintenance and repairs are charged to expense as incurred.
The acquired developed technology which includes acquired software, databases, and analytics, is classified as software within property and equipment because the developed software application, database, or analytic resides on the Company’s or its service providers’ hardware. Amortization for acquired developed technology is included in depreciation and amortization on the Company’s consolidated statements of operations. Developed technology obtained through acquisitions is amortized using the straight-line method over the estimated useful life used in determining the fair value of the assets at acquisition. As of June 30, 2015, the weighted average useful life of existing acquired developed technology was approximately seven years. The amount of acquired developed technology amortization included in depreciation and amortization for the three and six months ended June 30, 2015 was approximately $2.6 million and $4.6 million, respectively. The amount of acquired developed

13

technology amortization included in depreciation and amortization for the three and six months ended June 30, 2014 was approximately $0.6 million and $1.2 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 for the periods presented. The amount of depreciation expense recognized on furniture, fixtures, and equipment during the three and six months ended June 30, 2015 was $5.0 million and $9.9 million. The amount of depreciation expense recognized on furniture, fixtures, and equipment during the three and six months ended June 30, 2014 was $3.3 million and $6.5 million, respectively.
Internally developed capitalized software is classified as software within property and equipment and has an estimated useful life of five years. As of June 30, 2015 and December 31, 2014, the carrying value of internally developed capitalized software was $68.5 million and $61.0 million, respectively. Amortization expense for internally developed capitalized software for the three and six months ended June 30, 2015, recorded in depreciation and amortization on the accompanying consolidated statements of operations, was approximately $5.9 million and $9.9 million, respectively. Amortization expense for internally developed capitalized software for the three and six months ended June 30, 2014, was approximately $2.8 million and $5.2 million, respectively.
Property and equipment consists of the following (in thousands):
 
 
As of
 
June 30, 2015
 
December 31, 2014
Leasehold improvements
$
58,415

 
$
54,156

Furniture, fixtures, and equipment
57,749

 
51,593

Software
190,392

 
132,949

Property and equipment, gross
306,556

 
238,698

Accumulated depreciation and amortization
(127,866
)
 
(103,591
)
Property and equipment, net
$
178,690

 
$
135,107

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. The Company did not recognize any impairment losses on any of its long-lived assets during the six months ended June 30, 2015 or 2014.
Note 7. Goodwill and intangibles
Included in the Company’s goodwill and intangibles balances are goodwill and acquired intangibles, and internally developed capitalized software for sale. Goodwill is not amortized because it has an estimated indefinite life. Goodwill is reviewed for impairment at least annually as of October 1, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company believes that no such impairment indicators existed during the six months ended June 30, 2015 or 2014. There was no impairment of goodwill recorded in the six months ended June 30, 2015 or 2014.
The following illustrates the change in the goodwill balance for the six months ended June 30, 2015 (in thousands):
 
As of
 
June 30, 2015
Beginning of period
$
186,895

Acquisition
653,753

Purchase accounting adjustment
161

Ending balance
$
840,809

Intangible assets with finite lives are amortized on a straight-line basis over their estimated useful lives, which range from one year to seventeen years. As of June 30, 2015, the weighted average remaining useful life of acquired intangibles was

14

approximately 15.4 years. As of June 30, 2015, the weighted average remaining useful life of internally developed intangibles was approximately 3.9 years.
The gross and net carrying balances and accumulated amortization of intangibles are as follows (in thousands):
 
 
 
 
As of June 30, 2015
 
As of December 31, 2014
 
Weighted
average
useful life
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
carrying
amount
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
carrying
amount
Intangibles
 
 
 
 
 
 
 
 
 
 
 
 
 
Internally developed software for sale
5.0
 
$
15,334

 
$
(5,295
)
 
$
10,039

 
$
13,268

 
$
(4,009
)
 
$
9,259

Acquired intangibles:
 
 
 
 
 
 
 
 
 
 
 
 
 
Developed software
6.1
 
19,250

 
(11,500
)
 
7,750

 
19,250

 
(10,238
)
 
9,012

Customer relationships
16.2
 
277,610

 
(17,110
)
 
260,500

 
25,610

 
(8,662
)
 
16,948

Trademarks
8.6
 
14,900

 
(3,755
)
 
11,145

 
4,900

 
(3,048
)
 
1,852

Non-compete agreements
3.8
 
1,600

 
(1,409
)
 
191

 
1,600

 
(1,234
)
 
366

Customer contracts
4.7
 
6,449

 
(5,330
)
 
1,119

 
6,449

 
(4,913
)
 
1,536

Total intangibles
 
 
$
335,143

 
$
(44,399
)
 
$
290,744

 
$
71,077

 
$
(32,104
)
 
$
38,973


Amortization expense for intangible assets for the three and six months ended June 30, 2015, recorded in depreciation and amortization on the consolidated statements of operations, was approximately $6.1 million and $12.3 million, respectively. Amortization expense for intangible assets for the three and six months ended June 30, 2014 was approximately $2.3 million and $5.5 million, respectively. The following approximates the aggregate amortization expense to be recorded in depreciation and amortization on the consolidated statements of operations for the remaining six months of the fiscal year ending December 31, 2015 and for each of the following fiscal years ending December 31, 2016 through 2019: $12.1 million, $23.7 million, $23.0 million, $22.0 million, and $20.2 million, respectively, and $189.7 million thereafter.
Note 8. Investments in unconsolidated entities
The Company held an equity interest in Evolent Health Holdings, Inc. (“Holdings”) and historically accounted for its investment under the cost method because the Company owned convertible preferred shares that were not considered in-substance common stock. The convertible preferred stock investment had a carrying value of $0 as of December 31, 2014. On May 8, 2015, the Company agreed to acquire additional shares of Holdings from another investor in Holdings, which increased the Company’s carrying value for its cost method investment in Holdings to approximately $3 million.
On June 4, 2015, Holdings completed a reorganization in connection with its initial public offering (the “IPO” and together with the reorganization, the “Transaction”). The reorganization included the creation of Evolent Health, Inc. (“Evolent Inc.”) and the merger of the two entities such that Holdings was dissolved and Evolent Inc. was the surviving entity. The Company’s convertible preferred investment in Holdings was ultimately exchanged for shares of Class A common stock of Evolent Inc. on a 1-for-4 basis. The Class A common stock provides the Company voting and economic rights with respect to Evolent Inc. in proportion to the Company's ownership percentage in Evolent Inc. The Company carried over its basis in Holdings to its investment in Evolent Inc. in connection with the exchange. For additional information on the fair value of the Company’s investment after the IPO, see Note 4, “Fair value measurements.” The Company continues to hold two of the eight seats on Evolent Inc.'s board, which are occupied by the Company's Chief Executive Officer and the Company's Chief Financial Officer.
Following the Transaction, the Company held a 15.4% equity ownership interest in Evolent Inc. that is accounted for under the equity method of accounting, with the Company’s proportionate share of Evolent Inc.’s losses recognized in the consolidated statements of operations. The Company’s share of the losses of Evolent Inc. that was applied to the carrying value of its investment in Evolent Inc. during the three months ended June 30, 2015 was $1.1 million. The carrying balance of the Company’s investment in Evolent Inc. was $1.9 million as of June 30, 2015.
In addition, the Company continues to hold an equity interest in Evolent Health LLC (“Evolent LLC”), a limited liability company that is treated as a partnership for tax purposes. As of December 31, 2014, the Company’s convertible preferred investment in Evolent LLC had a carrying value of $9.3 million. In connection with the Transaction described above, the Company’s convertible preferred investment in Evolent LLC was converted on a 1-for-4 basis to Class B common units. As of

15

June 30, 2015, the Company holds an 8.8% equity interest in Evolent LLC that continues to be accounted for under the equity method, with the Company’s proportionate share of Evolent LLC’s losses recognized in the consolidated statements of operations. The Class B common units provide the Company economic rights with respect to Evolent LLC in proportion to the Company's ownership percentage in Evolent LLC but no voting rights.
During the three and six months ended June 30, 2015, the Company’s share of the losses of Evolent LLC that was applied to the carrying value of its investment in Evolent LLC was $3.2 million and $5.6 million, respectively. During the three and six months ended June 30, 2014, the Company’s share of the losses of Evolent LLC that was applied to the carrying value of its investment in Evolent LLC was $2.1 million and $4.9 million, respectively. The carrying balance of the Company’s investment in Evolent LLC was $3.8 million as of June 30, 2015.
Because of Evolent LLC's treatment as a partnership for tax purposes, the losses of Evolent LLC pass through to the Company and the other members. The Company's proportionate share of the losses of Evolent LLC is recorded net of the estimated tax benefit that the Company believes will be realized from the equity in loss of unconsolidated entities on the consolidated statements of operations. Historically, the Company had provided a full valuation allowance against the deferred tax asset resulting from these benefits. During the three months ended June 30, 2015, the Company determined that it is now more-likely-than not able to realize the deferred tax assets associated with its investment in Evolent LLC as a result of the Transaction; accordingly, a tax benefit of $6.7 million was recorded to release the valuation allowance previously recorded.  An additional tax benefit of $1.5 million has been recorded in the three months ended June 30, 2015 for tax benefits associated with current year losses received from Evolent LLC.
The equity in income (loss) of unconsolidated entities on the consolidated statement of operations consisted of the following:

 
Three Months Ended 
June 30,
 
Six Months Ended 
June 30,
 
2015
 
2014
 
2015
 
2014
Evolent Inc.
$
(1,054
)
 
$
—

 
$
(1,054
)
 
$
—

Evolent LLC
(3,211
)
 
(2,150
)
 
(5,590
)
 
(4,881
)
Tax benefits recognized in current period
8,265

 
—

 
8,265

 
—

       Equity in income (loss) of unconsolidated entities
$
4,000

 
$
(2,150
)
 
$
1,621

 
$
(4,881
)
In connection with the Transaction, the Company received Class B common shares in Evolent Inc. in an amount proportionate to the amount of Class B common units of Evolent LLC owned by the Company. The class B common shares provide the Company a voting, but not economic, interest. These Class B common shares are subject to an exchange agreement whereby the Company may exchange one or more Class B common units of Evolent LLC, together with an equal number of shares of Class B common stock of Evolent Inc., for shares of Class A common stock of Evolent Inc.
In connection with the Transaction, 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 pre-IPO activity. Interest will be included on the tax savings at a rate of LIBOR 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 June 30, 2015, the Company has not received any payments pursuant to the terms of the tax receivables agreement. As the amount the Company will receive related to the tax receivables agreement is unknown, the Company will recognize payments, if any, associated with this agreement when received.
As of June 30, 2015, Evolent Inc. had no material operations outside of its 70.3% ownership interest in Evolent LLC. As a result, the Company has presented below the financial position and operating results of Evolent LLC. In connection with the reorganization, Evolent Inc. gained control of and now consolidates Evolent LLC. Evolent Inc. applied purchase accounting and pushed down its new basis to the separate Evolent LLC financial statements as included in the presentation below. The Company has not recognized the effects of the purchase accounting or push down accounting applied by Evolent Inc. and Evolent LLC, respectively. The Company had pre-existing basis differences related to its investment in Evolent LLC at the time of the reorganization. As of June 30, 2015, the Company’s basis in the entities was less than its proportional interest in the equity of Evolent Inc. and Evolent LLC in the amounts of $98.9 million and $82.6 million, respectively. The Company has excluded the effects of the purchase and push down accounting in its determination of the equity in loss, thereby reducing its share of losses from Evolent Inc. and Evolent LLC for the affected periods. As a result, the basis differences will decrease over time.


16

The following is a summary of the financial position of Evolent LLC as of the dates presented (unaudited, in thousands), which include the effects of purchase accounting pushed down to Evolent LLC as part of the IPO that occurred on June 4, 2015.
 
As of
 
June 30, 2015
 
December 31, 2014
Assets:
 
 
 
Current assets
$
250,982

 
$
56,718

Non-current assets
788,197

 
27,586

Total assets
$
1,039,179

 
$
84,304

Liabilities and Members’ Equity:
 
 
 
Current liabilities
$
60,714

 
$
55,801

Total liabilities
60,714

 
55,801

Members’ equity
978,465

 
28,503

Total liabilities and members’ equity
$
1,039,179

 
$
84,304


The following is a summary of the operating results of Evolent LLC for the periods presented (unaudited, in thousands), which include the effects of purchase accounting pushed down to Evolent LLC as part of the IPO that occurred on June 4, 2015. The period from June 4 to June 30, 2015 reflects the impact of the push down accounting that was recorded on the Evolent LLC financial statements.
 
Period June 4 - June 30
 
 
Period April 1 - June 3
 
Three Months Ended 
 June 30,
 
Period June 4 - June 30
 
 
Period January 1 - June 3
 
Six Months Ended 
 June 30,
 
2015
 
 
2015
 
2014
 
2015
 
 
2015
 
2014
Revenue
$
10,414

 
 
$
24,774

 
$
24,189

 
$
10,414

 
 
$
61,814

 
$
44,265

Cost of revenue (exclusive of depreciation and amortization)
7,887

 
 
18,385

 
18,045

 
7,887

 
 
44,839

 
32,867

Gross profit
2,527

 
 
6,389

 
6,144

 
2,527

 
 
16,975

 
11,398

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating loss
(11,539)

 
 
(24,771)

 
(12,974)

 
(11,539)

 
 
(44,119)

 
(24,618)

Net loss
(11,526)

 
 
(24,764)

 
(12,916)

 
(11,526)

 
 
(44,079)

 
(24,542)


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 investment in Evolent LLC is evaluated for impairment whenever events or changes in circumstances indicate that there may be an other-than-temporary decline in value. As of June 30, 2015, the Company believes that no impairment charge is necessary.
Note 9. Other non-current assets
In June 2009, the Company invested in the convertible preferred stock of a private company that provides technology tools and support services to health care providers, including the Company’s members. In addition, the Company entered into a licensing agreement with that company. As part of its investment, the Company received warrants to purchase up to 6,015,000 shares of the company’s common stock at an exercise price of $1.00 per share as certain performance criteria are met. The warrants are exercisable through June 19, 2019. The warrants contain a net settlement feature and therefore are considered to be a derivative financial instrument. The warrants are recorded at their estimated fair value, which was $440,000 as of June 30, 2015 and $370,000 as of December 31, 2014, and are included in other non-current assets on the consolidated balance sheets. The change in the estimated fair value of the warrants is recorded in other (expense) income, net on the consolidated statements of operations. For additional information regarding the fair value of these warrants, see Note 4, “Fair value measurements.” The convertible preferred stock investment is recorded at cost, and the carrying amount of this investment of $5.0 million as of June 30, 2015 is included in other non-current assets on the consolidated balance sheets. The convertible preferred stock accrues dividends at an annual rate of 8% that are payable if and when declared by the investee’s board of directors. As of June 30, 2015, no dividends had been declared by the investee or recorded by the Company. This investment is reviewed for

17

impairment whenever events or changes in circumstances indicate that the carrying amount of this asset may not be recoverable. The Company believes that no such impairment indicators existed during the six months ended June 30, 2015.
Note 10. Debt
Senior secured revolving credit facility obtained in July 2012
In July 2012, the Company entered into a $150.0 million five-year senior secured revolving credit facility under a credit agreement with a syndicate of lenders which was set to mature and be payable in full on July 30, 2017. As of December 31, 2014, the Company had unamortized deferred financing fees of $0.4 million related to this transaction.
Senior secured credit facilities obtained in January 2015
On January 9, 2015, in connection with the completion of the acquisition of Royall, the Company entered into a credit agreement with various lenders. This credit agreement replaced the July 2012 secured revolving credit facility. Under the terms of the January 9, 2015 credit agreement, lenders provided the Company with $775 million of senior secured credit facilities for application to the acquisition of Royall and the Company’s corporate needs after the closing of the Royall acquisition. The credit facilities consisted of a term loan facility in the principal amount of $725 million, maturing on January 9, 2022, and a revolving credit facility under which up to $50 million principal amount of borrowings and other credit extensions could be outstanding at any time, maturing on January 9, 2020.
Amounts drawn under the term facility generally bore interest, payable quarterly, at an annual rate calculated, at the Company’s option, on the basis of either (a) an alternate base rate plus an initial margin of 3.00% or (b) the applicable London interbank offered rate (subject to a 1.00% floor) plus an initial margin of 4.00%, subject in each case to margin reductions based on the Company's total leverage ratio from time to time. The annual interest rate for the term loan facility as of January 9, 2015 was 5.00%. The revolving facility was undrawn at the facility closing date. All $725 million of term loans available under the term loan facility were drawn at the closing of the acquisition to pay the majority of the cash purchase price for the Royall capital stock. Total original issue discount of $21.8 million and deferred financing fees of $2.8 million were recorded related to this credit agreement. The Company recognized a loss of $0.2 million on the modification of the July 2012 revolving credit facility. This loss was recorded in loss on financing activities within the consolidated statements of operations.
Equity offering in January 2015
On January 21, 2015, the Company closed on a registered public offering of its common stock. The Company used the net proceeds from the offering plus available cash to repay approximately $149.9 million principal amount of loans outstanding under its $725 million senior secured term loan facility. This payment resulted in a loss on financing activities of $4.5 million related to original issue discount and $0.3 million related to deferred financing fees. The total $4.8 million loss was recognized in loss on financing activities within the consolidated statement of operations.
Senior secured credit facilities obtained in February 2015
On February 6, 2015, the Company entered into a new credit agreement with various lenders. The new credit agreement consists of a five-year senior secured term loan facility in the original principal amount of $575 million and a five-year senior secured revolving credit facility under which up to $100 million principal amount of borrowings and other credit extensions may be outstanding at any time. The proceeds of the term loan were used to repay and retire all loans outstanding under the term loan facility obtained on January 9, 2015. The revolving credit facility was not drawn down on February 6, 2015. Amounts drawn under the term loan and revolving credit facilities bear interest, payable quarterly, at an annual rate calculated, at the Company’s option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate plus an initial margin of 2.75%, subject in each case to margin reductions based on the Company’s total leverage ratio from time to time. At the time of issuance, the stated annual interest rate on the borrowing was 3.01%. As of June 30, 2015, the stated annual interest rate on the borrowing was 2.94%.
The lenders under the new credit agreement included the lenders from the January 9, 2015 agreement as well as new lenders. For those lenders to this agreement that also participated in the January 9, 2015 agreement, the Company concluded that the new credit agreement represented a modification of the debt. As a modification, the original issue discount and deferred financing fees associated with the original borrowings carried forward to the new borrowings. Any fees paid to or received from these lenders are recorded as an adjustment to the original issue discount. Any fees paid to third parties are recorded as expense. The Company received a net refund of $2.4 million from the original creditors in the January 9, 2015 agreement, which was treated as a reduction to the original issue discount and deferred financing fees. Further, because the level of participation in the borrowings by the lenders under the original credit agreement was significantly less under the new agreement than under the original agreement, the Company recognized a debt modification expense of $12.4 million related to

18

a portion of the original issue discount and deferred financing fees from the old agreement. This $12.4 million expense is recorded as a loss on financing activities within the consolidated statement of operations. Following this write-off, the Company had original issue discount of $3.9 million and deferred financing fees of $1.1 million related to the February 6, 2015 credit facilities.

As of June 30, 2015, there were no amounts outstanding under the revolving credit facility and $100.0 million was available for borrowing.

Interest expense for the three and six months ended June 30, 2015 was $5.2 million, inclusive of $0.3 million amortization of debt issuance costs, and $10.8 million, inclusive of $0.7 million amortization of debt issuance costs, respectively.

Long-term debt is summarized as follows (in thousands): 
 
June 30, 2015
2.94% Senior Secured Note due fiscal 2020 ($567,813 face value less unamortized discount of $3,538)
$
564,275

 
 
Less: amounts due in next twelve months ($28,750 face value less unamortized discount of $870)
(27,880
)
Total
$
536,395

The credit agreement contains customary representations and warranties, events of default and financial and other covenants, including covenants that require the Company to maintain a maximum total leverage ratio and a minimum interest coverage ratio. The Company's compliance with the two financial covenants is measured as of the end of each fiscal quarter. The Company was in compliance with these financial covenants as of June 30, 2015.
Swap agreements

Through its senior secured term loan facility, the Company is exposed to interest rate risk. To minimize the impact of changes in interest rates on its interest payments, in April 2015, 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 in the consolidated balance sheet 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 loan. As of June 30, 2015, the principal amount hedged was $283.9 million. The interest rate swap agreements mature in February 2020 and have periodic interest settlements, both consistent with the terms of the Company's senior secured term loan facility. Under this agreement, the Company is entitled to receive a floating rate based on the 1-month LIBOR 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 senior secured term loan 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 statement of operations.
  
As of June 30, 2015, the fair value of the interest rate swaps was an asset of $1.2 million and was recorded in the Company's consolidated balance sheet within other noncurrent asset, with the effective portion of the gain, net of tax, reported as a component of accumulated other comprehensive income. There was no hedge ineffectiveness as of June 30, 2015. Changes in fair value are reclassified from accumulated other comprehensive income into earnings in the same period that 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 in the consolidated statement of operations for the applicable period.

19

Note 11.
Noncontrolling interest
In July 2012, the Company entered into an agreement with an entity created for the sole purpose of providing consulting services for the Company on an exclusive basis. The Company’s relationship with the entity was governed by a services agreement and other documents that provided the entity’s owners the conditional right to require the Company to purchase their ownership interests (the “Put Option”), for a price based on a formula set forth in the agreement, at any time after certain conditions were satisfied through December 31, 2014. The equity interest in this entity was classified as a redeemable noncontrolling interest.
During the three months ended June 30, 2014, management determined that it was probable that the Put Option would become exercisable prior to its expiration. As a result, the redeemable noncontrolling interest was increased to the estimated redemption amount of $7.1 million from its carrying value of $0.1 million. The accretion to the redemption value of $7.0 million was recorded in additional paid-in capital on the consolidated balance sheet as the Company had an accumulated deficit as of June 30, 2014. In addition, the accretion to redemption value was recorded as a reduction to net income attributable to common stockholders on the consolidated statements of operations in the three months ended June 30, 2014. Prior to June 30, 2014, management had determined that exercisability was not probable.
On December 5, 2014, the conditions required for the entity's owners to exercise the Put Option were satisfied, and the entity's owners exercised the Put Option. The Company paid $6.1 million to acquire 100% of the equity. Prior to the exercise of the Put Option, the Company had a 0% interest in this entity. In conjunction with the exercise of the Put Option, the Company recorded a deferred tax asset of $3.4 million related to basis differences. As a result of the exercise of the Put Option, there was no noncontrolling interest for the three and six months ended June 30, 2015.
Note 12. Stockholders’ equity
On May 8, 2013, the Company’s Board of Directors authorized the Company to repurchase an additional $100 million of the Company’s common stock under its share repurchase program, bringing the total authorized repurchase amount under the program to $450 million since its inception. The Company did not repurchase any shares in the six months ended June 30, 2015. The Company repurchased 364,662 and 454,962 shares of its common stock at a total cost of approximately $18.0 million and $23.8 million in the three and six months ended June 30, 2014, respectively. The total amount of common stock purchased from inception under the program through June 30, 2015 was 16,758,185 shares at a total cost of $398.8 million. All such repurchases have been made in the open market, and all repurchased shares have been retired as of June 30, 2015. No minimum number of shares subject to repurchase has been fixed, and the share repurchase authorization has no expiration date. As of June 30, 2015, the remaining authorized repurchase amount was $51.2 million.
Equity offering
On January 21, 2015, the Company closed the registered public offering of 3,650,000 shares of common stock by the Company, and pursuant to registration rights granted by the Company to the Seller in connection with the acquisition of Royall, 1,755,000 shares of common stock held by the Seller that were issued to the Seller as the equity component of the acquisition consideration. The shares were sold at a price to public of $43.00 per share, less an underwriting discount of $1.935 per share, for a net per share purchase price of $41.065. The Company also incurred selling costs of $1.1 million directly related to this equity offering. The net proceeds received by the Company were approximately $148.8 million after deducting the underwriting discount and selling costs. As of June 30, 2015, the Company remained obligated under a registration rights agreement to register for sale, under certain conditions, the remaining 362,364 shares of common stock of the Company held by the Seller.

20

Note 13. 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 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 for an aggregate of 145,867 shares of common stock. Both the performance-based stock options and performance-based restricted stock units are also subject to service conditions.
Stock options granted under the inducement plan have an exercise price equal to $49.92, 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 restricted stock units were valued at $49.92 and are also eligible to vest in installments commencing in January 2017 and ending in January 2020, subject to satisfaction of performance-based vesting criteria. The vesting criteria in both cases are based on performance of the Royall programs and services. The aggregate grant date fair value of the performance-based stock options, assuming all performance targets are met, is estimated to be approximately $26.8 million. The aggregate grant date fair value of the performance-based restricted stock units, assuming all performance targets are met, is estimated at approximately $7.3 million. As of June 30, 2015, the Company expects that Royall will achieve 70% to 99% of the performance targets, which equates to 50% of the performance-based stock options and 50% of the restricted stock units being eligible to vest, subject to forfeitures. The option and restricted stock unit awards are reflected in the following tables.
The actual stock-based compensation expense the Company will recognize is dependent upon, but not limited to, 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.
On June 23, 2014, the Compensation Committee of the Board of Directors approved a long-term incentive plan ("LTIP") under which nonqualified stock options and restricted stock units ("RSUs") would be granted to certain executive officers of the Company. As of June 30, 2015, 970,937 nonqualified stock options and 104,026 restricted stock units (“RSUs”) have been granted under the LTIP. The awards are subject to both performance-based and market-based conditions and portions will vest, with all awards vesting if the highest levels are achieved, based upon the achievement of specified levels of both sustained contract value and sustained stock price during the performance period, which could extend to March 31, 2019. The vesting of the RSUs also is subject to a one-year service condition, which requires the recipient to remain employed with the Company for at least the year following the date on which the applicable performance and market conditions are achieved. The Company has concluded that it is probable that all awards will vest at the highest level of achievements over a five year period. The estimated requisite service period, which includes the current estimate of the time to achieve the performance and market conditions at the highest level is five years for the stock options and six years for the RSUs, inclusive of the one-year service condition. The option and RSU awards are reflected in the following tables.

21

The following table summarizes the changes in common stock options granted under the Company’s stock incentive plans during the six months ended June 30, 2015 and 2014:
 
 
Six Months Ended June 30,
 
2015
 
2014
 
Number of
options
 
Weighted
average
exercise
price
 
Number of
options
 
Weighted
average
exercise
price
Outstanding, beginning of period
2,741,297

 
$
42.19

 
2,018,334

 
$
28.91

Granted
2,102,916

 
50.45

 
1,238,669

 
53.39

Exercised
(128,669
)
 
23.43

 
(354,161
)
 
16.42

Forfeited
(765,369
)
 
50.11

 
—

 
—

Cancellations
—

 
—

 
—

 
—

Outstanding, end of period
3,950,175

 
$
45.66

 
2,902,842

 
$
40.88

Exercisable, end of period
1,100,879

 
$
31.60

 
 
 
 
The weighted average fair value of the options granted during the six months ended June 30, 2015 is estimated at $15.49 per share on the date of grant using the following weighted average assumptions: risk-free interest rate of 1.6%; an expected term of approximately 5.1 years; expected volatility of 31.20%; and dividend yield of 0.0% over the expected life of the option.
The following table summarizes the changes in RSUs granted under the Company’s stock incentive plans during the six months ended June 30, 2015 and 2014:
 
 
Six Months Ended June 30,
 
2015
 
2014
 
Number of
RSUs
 
Weighted
average
grant
date
fair
value
 
Number of
RSUs
 
Weighted
average
grant
date
fair
value
Non-vested, beginning of period
1,046,582

 
$
45.84

 
986,422

 
$
38.66

Granted
517,162

 
52.00

 
460,812

 
49.62

Forfeited
(88,667
)
 
49.70

 
(3,196
)
 
48.33

Vested
(359,687
)
 
43.37

 
(393,977
)
 
32.20

Non-vested, end of period
1,115,390

 
$
49.19

 
1,050,061

 
$
45.86

No RSUs with performance and market conditions vested during the six months ended June 30, 2015.


22

The Company recognized stock-based compensation expense in the following consolidated statements of operations line items for stock options and RSUs for the three and six months ended June 30, 2015 and 2014 (in thousands, except per share amounts):
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Stock-based compensation expense included in:
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
Cost of services
$
2,566

 
$
2,089

 
$
4,458

 
$
3,471

Member relations and marketing
1,455

 
1,081

 
2,601

 
1,924

General and administrative
4,610

 
2,371

 
7,977

 
4,569

Depreciation and amortization
—

 
—

 
—

 
—

Total costs and expenses
$
8,631

 
$
5,541

 
$
15,036

 
$
9,964

There are no stock-based compensation costs capitalized as part of the cost of an asset.
As of June 30, 2015, $73.0 million of total unrecognized compensation cost related to outstanding options and non-vested RSUs was expected to be recognized over a weighted average period of 3.0 years.
Note 14. Income taxes
The effective tax rates were 36.5% and 39.5% for the three months ended June 30, 2015 and 2014, respectively. The effective tax rates were (42.0)% and 38.9% for the six months ended June 30, 2015 and 2014, respectively. The tax benefit on the six month period's pre-tax loss was offset by a $10.8 million discrete item related to the write-off of accumulated Washington, D.C. tax credits in the three months ended March 31, 2015. The write-off was a result of changes in the District of Columbia tax laws effective January 1, 2015 and resulted in income tax expense in the six month period ended June 30, 2015. The effective tax rate was increased by this discrete item, 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.
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 anticipate 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. We recognized $0.2 million of interest in the consolidated statements of operations for the six months ended June 30, 2015 and no interest or penalties were recognized in the consolidated statements of operations for the six months ended June 30, 2014. The Company files income tax returns in U.S. federal and state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state, and local tax examinations for filings in major tax jurisdictions before 2008.
Note 15. 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.

23

A reconciliation of basic to diluted weighted average common shares outstanding is as follows (in thousands): 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Basic weighted average common shares outstanding
42,440

 
36,413

 
41,686

 
36,310

Effect of dilutive outstanding stock-based awards
474

 
—

 
—

 
815

Diluted weighted average common shares outstanding
42,914

 
36,413

 
41,686

 
37,125

In the three months ended June 30, 2015 and 2014, 0.7 million and 2.8 million shares, respectively, related to share-based compensation awards have been excluded from the calculation of the effect of dilutive outstanding stock-based awards shown above because their effect was anti-dilutive. In the six months ended June 30, 2015 and 2014, 2.8 million and 0.4 million shares, respectively, related to share-based compensation awards have been excluded from the calculation of the effect of dilutive outstanding stock-based awards shown above because their effect was anti-dilutive.

As of June 30, 2015, the Company had 2.0 million nonqualified stock options and 0.3 million RSUs that contained either performance or market conditions, or both, and therefore are treated as contingently issuable awards. As of June 30, 2014, the Company had 1.0 million nonqualified stock options and 0.2 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 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. As of June 30, 2015 and 2014, none of these contingently issuable awards has been included within the diluted earnings per share calculations.

24

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 the “Company,” “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 transition report on Form 10-K for the period ended December 31, 2014, or the “2014 Form 10-KT,” filed with the Securities and Exchange Commission. 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 higher education industries. Through our subscription-based membership programs, we leverage our intellectual capital to help members solve their most critical business problems. As of the date of this report, we served approximately 5,200 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, consulting and management services, and tech-enabled services.
Our five key areas of focus for the fiscal year are to drive to even higher member impact by working with members to maximize the value they receive from individual memberships; to develop deeper and more powerful commercial relationships across our portfolio; to continue to focus on growth through selected investments to capture the unique opportunities presented by current health care and education market conditions, through developing and launching new programs and acquiring products, services, and technologies that improve performance for our members; to meet our financial commitments; and to attract, cultivate, engage, and retain world-class talent across our organization. Success in all of these areas requires very strong execution across our business, and we have a heavy focus on setting up each team to manage towards and attain high goals in each area of our operations.
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. We believe high renewal rates reflect our members’ recognition of the value they derive from participating in our programs. Our revenue grew 30.2% in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. Our contract value increased 35.2% to $741.7 million as of June 30, 2015 from $548.4 million as of June 30, 2014. 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 expenses.
•
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.

25

•
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 expenses include 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.
•
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, 2013 affect the comparability of our results of operations for the six months ended June 30, 2015 and our results of operations for the same periods in our prior fiscal year.
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 2014 Form 10-KT, 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 transition period ended December 31, 2014.
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 tax rate, and adjusted weighted average common shares outstanding - diluted. See “Non-GAAP Financial Measures” below for information about our use of these non-GAAP financial measures, including our reasons for including the measures, material limitations with respect to the usefulness of such measures, and reconciliations of each non-GAAP financial measure to the most directly comparable GAAP financial measure.

26

Results of Operations
The following table shows consolidated statements of operations data including the amounts expressed as a percentage of revenue for the periods indicated:
 
 
Three Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
184,661

 
$
141,820

 
100.0
 %
 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
Cost of services, excluding depreciation and amortization
92,221

 
74,218

 
49.9
 %
 
52.3
 %
Member relations and marketing
29,375

 
26,576

 
15.9
 %
 
18.7
 %
General and administrative
30,853

 
22,712

 
16.7
 %
 
16.0
 %
Depreciation and amortization
19,499

 
9,078

 
10.6
 %
 
6.4
 %
Total costs and expenses
171,948

 
132,584

 
93.1
 %
 
93.4
 %
Operating income
12,713

 
9,236

 
6.9
 %
 
6.5
 %
Other (expense) income:
 
 
 
 
 
 
 
Interest expense
(5,154
)
 
—

 
(2.8
)%
 
—
 %
Other (expense) income, net
(128
)
 
710

 
(0.1
)%
 
0.5
 %
Loss on financing activities
—

 
—

 
—
 %
 
—
 %
Total other (expense) income, net
(5,282
)
 
710

 
(2.9
)%
 
0.5
 %
Income before provision for income taxes and equity in income loss of unconsolidated entities
7,431

 
9,946

 
4.0
 %
 
7.0
 %
Provision for income taxes
(2,716
)
 
(3,933
)
 
(1.5
)%
 
(2.8
)%
Equity in income (loss) of unconsolidated entities
4,000

 
(2,150
)
 
2.2
 %
 
(1.5
)%
Net income before allocation to noncontrolling interest
$
8,715

 
$
3,863

 
4.7
 %
 
2.7
 %
Accretion to redemption value of noncontrolling interest
—

 
(7,040
)
 
—
 %
 
(5.0
)%
Net income (loss) attributable to common stockholders
$
8,715

 
$
(3,177
)
 
4.7
 %
 
(2.2
)%

27

 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
364,456

 
$
279,821

 
100.0
 %
 
100.0
 %
Costs and expenses:
 
 
 
 
 
 
 
Cost of services, excluding depreciation and amortization
187,528

 
141,413

 
51.5
 %
 
50.5
 %
Member relations and marketing
60,101

 
52,988

 
16.5
 %
 
18.9
 %
General and administrative
62,527

 
41,455

 
17.2
 %
 
14.8
 %
Depreciation and amortization
36,573

 
17,546

 
10.0
 %
 
6.3
 %
Total costs and expenses
346,729

 
253,402

 
95.1
 %
 
90.5
 %
Operating income
17,727

 
26,419

 
4.9
 %
 
9.5
 %
Other (expense) income:
 
 
 
 
 
 
 
Interest expense
(10,766
)
 
—

 
(3.0
)%
 
—
 %
Other (expense) income, net
(1,247
)
 
1,442

 
(0.3
)%
 
0.5
 %
Loss on financing activities
(17,398
)
 
—

 
(4.8
)%
 
—
 %
Total other (expense) income, net
(29,411
)
 
1,442

 
(8.1
)%
 
0.5
 %
(Loss) Income before provision for income taxes and equity in income (loss) of unconsolidated entities
(11,684
)
 
27,861

 
(3.2
)%
 
10.0
 %
Provision for income taxes
(4,910
)
 
(10,830
)
 
(1.3
)%
 
(3.9
)%
Equity in income (loss) of unconsolidated entities
1,621

 
(4,881
)
 
0.4
 %
 
(1.7
)%
Net (loss) income before allocation to noncontrolling interest
$
(14,973
)
 
$
12,150

 
(4.1
)%
 
4.4
 %
Net loss and accretion to redemption value of noncontrolling interest
—

 
(7,040
)
 
—
 %
 
(2.5
)%
Net (loss) income attributable to common stockholders
$
(14,973
)
 
$
5,110

 
(4.1
)%
 
1.9
 %
Three and six months ended June 30, 2015 compared to the three and six months ended June 30, 2014
Net income (loss) attributable to common stockholders. Net income attributable to common stockholders was $8.7 million in the three months ended June 30, 2015 compared to net loss attributable to common stockholders of $(3.2) million in the three months ended June 30, 2014. The principal factors contributing to the change included equity in income of unconsolidated entities of $4.0 million compared to a loss of $(2.2) million in the prior year period, a non-cash accretion of $7.1 million associated with the change in the redemption value of our redeemable noncontrolling interest in the prior year period, and a 30.2% increase in revenue over the prior year period. The effects of these items were partially offset by $5.2 million in interest expense.
Net loss attributable to common stockholders was $(15.0) million in the six months ended June 30, 2015 compared to net income attributable to common stockholders of $5.1 million in the six months ended June 30, 2014. The principal factors contributing to the change included $17.4 million related to loss on financing activities, an $11.6 million discrete tax item related to a write-off of accumulated Washington, D.C. tax credits as a result of changes in District of Columbia tax laws effective January 1, 2015, $10.7 million in interest expense related to new indebtedness, $6.6 million in acquisition-related costs, a $4.1 million decrease to acquisition-related earn-out liabilities recorded in the prior year period, and increases in operating expenses related to our acquisition of Royall Acquisition Co., or Royall. The effects of these items were partially offset by equity in income of unconsolidated entities of $1.6 million compared to a loss of $(4.9) million in the prior year period, a non-cash accretion of $7.1 million associated with the change in the redemption value of our redeemable noncontrolling interest in the prior year period, and a 30.2% increase in revenue over the prior year period.
Revenue. Total revenue increased 30.2% to $184.7 million in the three months ended June 30, 2015 from $141.8 million in the three months ended June 30, 2014. Total revenue increased 30.2% to $364.5 million in the six months ended June 30, 2015 from $279.8 million in the six months ended June 30, 2014, while contract value increased 35.2% to $741.7 million as of June 30, 2015 from $548.4 million as of June 30, 2014. The increases in revenue and contract value were attributable to our acquisition of Royall in combination with strong performance in our consulting and management offerings including our recent acquisition of Clinovations, LLC, or Clinovations, strong sales in our higher education research and software programs and in our Crimson programs. We offered 67 membership programs as of June 30, 2015 compared to 62 membership programs as of June 30, 2014.

28

Cost of services. Cost of services increased to $92.2 million for the three months ended June 30, 2015 from $74.2 million for the three months ended June 30, 2014. Cost of services increased to $187.5 million for the six months ended June 30, 2015 from $141.4 million for the six months ended June 30, 2014. The increase in cost of services for the three and six months ended June 30, 2015 was primarily due to our acquisition of Royall and the continued growth and expansion of our Crimson programs, as well as our recent acquisitions of ThoughtWright, LLA d/b/a Grades First, or GradesFirst, and Clinovations. Cost of services in the current period also reflected increased costs associated with the delivery of program content and tools to our expanded membership base, including increased staffing, licensing fees, and other costs. As a percentage of revenue, cost of services was 49.9% and 52.3% for the three months ended June 30, 2015 and June 30, 2014, respectively, and 51.5% and 50.5% for the six months ended June 30, 2015 and June 30, 2014, respectively. Cost of services included fair value adjustments to our acquisition-related earn-out liabilities consisting of a $1.4 million decrease and a $0.1 million decrease in the three months ended June 30, 2015 and 2014, respectively, and a $1.1 million decrease and a $4.2 million decrease in the six months ended June 30, 2015 and 2014, respectively.
Member relations and marketing. Member relations and marketing expense increased to $29.4 million in the three months ended June 30, 2015 from $26.6 million in the three months ended June 30, 2014. As a percentage of revenue, member relations and marketing expense in the three months ended June 30, 2015 and 2014 was 15.9% and 18.7%, respectively. Member relations and marketing expense increased to $60.1 million in the six months ended June 30, 2015 from $53.0 million in the six months ended June 30, 2014. As a percentage of revenue, member relations and marketing expense in the six months ended June 30, 2015 and 2014 was 16.5% and 18.9%, respectively. The increase in member relations and marketing expense was primarily attributable to an increase in sales staff and related travel and other associated costs, as well as to an increase in member relations personnel and related costs required to serve our expanding membership base.
General and administrative. General and administrative expense increased to $30.9 million in the three months ended June 30, 2015 from $22.7 million in the three months ended June 30, 2014. As a percentage of revenue, general and administrative expense increased to 16.7% in the three months ended June 30, 2015 from 16.0% in the three months ended June 30, 2014. General and administrative expense increased to $62.5 million in the six months ended June 30, 2015 from $41.5 million in the six months ended June 30, 2014. As a percentage of revenue, general and administrative expense increased to 17.2% in the six months ended June 30, 2015 from 14.8% in the six months ended June 30, 2014. The increase in general and administrative expense in the three month period ended June 30, 2015 was primarily attributable to $1.0 million in acquisition costs related to our acquisition of Royall, increased investment in functions and office space to support our larger organization and the integration of recent acquisitions. For the six months ended June 30, 2015, we recognized a total of $6.6 million in acquisition costs related to our acquisition of Royall.

Depreciation and amortization. Depreciation and amortization expense increased to $19.5 million, or 10.6% of revenue, in the three months ended June 30, 2015, from $9.1 million, or 6.4% of revenue, in the three months ended June 30, 2014. Depreciation expense increased to $36.6 million, or 10.0% of revenue in the six months ended June 30, 2015, from $17.5 million, or 6.3% of revenue in the six months ended June 30, 2014. The increases in depreciation and amortization in the three and six month periods ended June 30, 2015 were primarily attributable to increased amortization expense from acquired intangibles of $6.2 and $11.4 million, respectively, relating to our recent acquisitions of Royall, GradesFirst, and Clinovations, developed capitalized internal use software, and depreciation of improvements made to new expansion floors in our Washington, D.C. headquarters.
Interest expense. Interest expense of $5.2 million and $10.8 million for the three and six months ended June 30, 2015, respectively, was incurred on indebtedness assumed to fund the Royall acquisition on January 9, 2015 and on indebtedness obtained on February 6, 2015 to refinance and retire such acquisition indebtedness. There was no comparable activity in the prior year periods.
Other (expense) income, net. Other (expense) income, net decreased to a $(0.1) million loss in the three months ended June 30, 2015, from a $0.7 million gain in the three months ended June 30, 2014. We recognized a loss of $(0.2) million and a gain of $0.3 million as a result of the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies in the three months ended June 30, 2015 and 2014, respectively. We also incurred a $0.1 million gain on the change in fair value of common stock warrants during the three months ended June 30, 2015. During the three months ended June 30, 2014 we earned $0.4 million in interest income on our marketable security balance. As of June 30, 2015 we no longer owned marketable securities. Other (expense) income, net decreased to a $(1.2) million loss in the six months ended June 30, 2015, from a $1.4 million gain in the six months ended June 30, 2014. We recognized a loss of $1.3 million and a gain of $0.4 million as a result of the effect of fluctuating currency rates on our receivable balances denominated in foreign currencies in the six months ended June 30, 2015 and 2014, respectively. We also incurred a $0.1 million gain on the change in fair value of common stock warrants during the six months ended June 30, 2015. During the six months ended June 30, 2014 we earned $1.0 million in interest income on our marketable security balance.

29

Loss on financing activities. A loss on financing activities of $(17.4) million was recognized in connection with the refinancing of acquisition indebtedness during the first quarter of 2015, as discussed above. There was no comparable activity in the prior year period.
Provision for income taxes. Our provision for income taxes was $2.7 million and $3.9 million in the three months ended June 30, 2015 and 2014, respectively, and $4.9 million and $10.8 million in the six months ended June 30, 2015 and 2014, respectively. Our effective tax rate in the three months ended June 30, 2015 was 36.5% compared to 39.5% in the three months ended June 30, 2014. Our effective tax rate in the six months ended June 30, 2015 was (42.0)% compared to 38.9% in the six months ended June 30, 2014. The tax benefit of the pre-tax loss for the six months ended June 30, 2015 was offset by an $11.6 million discrete tax item 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 resulting in income tax expense for the period. The effective tax rate was increased by this discrete item, 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.
Equity in income (loss) of unconsolidated entities. Our proportionate share of gains and (losses) of investments in Evolent entities, net of tax during the three months ended June 30, 2015 and 2014 was $4.0 million and $(2.2) million, respectively. Included in the gain for the three months ended June 30, 2015 is $8.2 million tax benefit from the release of a valuation allowance as the Company determined that it is now more-likely-than not able to realize deferred tax assets associated with its investment in Evolent LLC. Our proportionate share of gains and (losses) of investments in Evolent entities, net of tax during the six months ended June 30, 2015 and 2014 was $1.6 million and $(4.9) million, respectively. Evolent was established in August 2011 and continues to operate as an early-stage business. As a result, we expect Evolent LLC to incur losses in the future.

Net income (loss) and accretion to redemption value of noncontrolling interest. During the three months ended June 30, 2014, we determined that it was probable that the put option related to our noncontrolling interest would become exercisable prior to its expiration. As a result, we recorded an accretion to the estimated redemption amount of our redeemable noncontrolling interest of $7.0 million in the three months ended June 30, 2014.
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 six months ended June 30, 2015 and 2014 (in thousands, except per share amounts):
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Stock-based compensation expense included in:
 
 
 
 
 
 
 
Costs and expenses:
 
 
 
 
 
 
 
Cost of services
$
2,566

 
$
2,089

 
$
4,458

 
$
3,471

Member relations and marketing
1,455

 
1,081

 
2,601

 
1,924

General and administrative
4,610

 
2,371

 
7,977

 
4,569

Depreciation and amortization
—

 
—

 
—

 
—

Total costs and expenses
$
8,631

 
$
5,541

 
15,036

 
9,964


There are no stock-based compensation costs capitalized as part of the cost of an asset.
As of June 30, 2015, $73.0 million of total unrecognized compensation cost related to outstanding options and non-vested RSUs was expected to be recognized over a weighted average period of 3.0 years.
Non-GAAP Financial Measures
The tables and related discussion below present information for the periods indicated about our 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. We define "adjusted revenue" for the three and six months ended June 30, 2015 and 2014 as revenue excluding the adjustments set forth in the first table below. We define “adjusted EBITDA” for the three and six months ended June 30, 2015 and 2014 as net income excluding adjustments for the items set forth in the second table below. We define “adjusted net income” for the three and six months ended June 30, 2015 and 2014 as net income

30

excluding the net of tax effect of the items set forth in the third table below. We define “non-GAAP earnings per diluted share” for the three and six months ended June 30, 2015 and 2014 as earnings per diluted share excluding the net of tax effect of the items set forth in the fourth table below. We define “adjusted effective tax rate” for the three and six months ended June 30, 2015 and 2014 as the effective tax rate excluding the effect of the items set forth in the fifth table below. We define “adjusted weighted average common shares outstanding - diluted” for the three and six months ended June 30, 2015 and 2014 as weighted average common shares outstanding - diluted excluding the effect of the items set forth in the sixth table below.
Our management believes that providing information about 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 facilitates an assessment by our investors of the Company’s fundamental operating trends and addresses concerns of management and investors that the various gains and expenses excluded from these measures may obscure such underlying trends. Our management uses these non-GAAP financial measures, together with financial measures prepared in accordance with GAAP, to enhance its understanding of our core operating performance, which represents our views concerning our performance in the ordinary, ongoing, and customary course of our operations. In the future, we are likely to incur income and expenses similar to the items for which the applicable GAAP measures have been adjusted and to report non-GAAP financial measures excluding such items. Accordingly, the exclusion of those and similar items in our non-GAAP presentation should not be interpreted as implying that the items are non-recurring, infrequent, or unusual.
The information about our core operating performance provided by our non-GAAP financial measures is used by management for a variety of purposes. Management uses the non-GAAP financial measures for internal budgeting and other managerial purposes in part because the measures enable management to evaluate projected operating results and make comparative assessments of our performance over time while isolating the effects of items that vary from period to period without any or with limited correlation to core operating performance, such as interest expense and foreign currency exchange rates, periodic costs of certain capitalized tangible and intangible assets, stock-based compensation expense, tax rates, and certain non-cash and special charges. The effects of the foregoing items also vary widely among similar companies, and affect the ability of management and investors to make company-to-company comparisons. In addition, merger and acquisition activity can have inconsistent effects on earnings that are not related to core operating performance due, for instance, to charges relating to acquisition costs, the amortization of acquisition-related intangibles, and fluctuations in the fair value of contingent earn-out liabilities. Companies also exhibit significant variations with respect to capital structure and cost of capital (which affect relative interest expense) and differences in taxation and book depreciation of facilities and equipment (which affect relative depreciation expense), including significant differences in the depreciable lives of similar assets among various companies. By eliminating some of the foregoing variations, management believes that our non-GAAP financial measures allow management and investors to evaluate more effectively our performance relative to that of our competitors and peer companies. Similarly, our management believes that because of the variety of equity awards used by companies, the varying methodologies for determining both stock-based compensation and stock-based compensation expense among companies, and from period to period, and the subjective assumptions involved in those determinations, excluding stock-based compensation from our non-GAAP financial measures enhances company-to-company comparisons over multiple fiscal periods.
Our non-GAAP measures may be calculated differently from similarly titled measures reported by other companies due to differences in accounting policies and items excluded or included in the adjustments, which limits their usefulness as comparative measures. In addition, there are other limitations associated with the non-GAAP financial measures we use, including the following:
    
•
the non-GAAP financial measures generally do not reflect all depreciation and amortization, and although the assets being depreciated and amortized will in some cases have to be replaced in the future, the measures do not reflect any cash requirements for such replacements;

•
the non-GAAP financial measures do not reflect the expense of equity awards to employees;

•
the non-GAAP financial measures do not reflect the effect of earnings or charges resulting from matters that management considers not indicative of our ongoing operations, but which may recur from year to year; and

•
to the extent that we change our accounting for certain transactions or other items from period to period, our non-GAAP financial measures may not be directly comparable from period to period.

Our management compensates for these limitations by relying primarily on our GAAP results and using the non-GAAP financial measures only as a supplemental measure of our operating performance, and by considering independently the economic effects of the foregoing items that are or are not reflected in the non-GAAP measures. Because of their limitations, our non-GAAP financial measures should be considered by our investors only in addition to financial measures prepared in

31

accordance with GAAP, and should not be considered to be a substitute for, or superior to, the GAAP measures as indicators of operating performance.
A reconciliation of 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 to the most directly comparable GAAP financial measures is provided below (in thousands, except per share data).
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Revenue
$
184,661

 
$
141,820

 
$
364,456

 
$
279,821

Effect on revenue of fair value adjustments to acquisition-related deferred revenue
6,617

 
—

 
12,499

 
—

Adjusted revenue
$
191,278

 
$
141,820

 
$
376,955

 
$
279,821

Adjusted revenue. Total adjusted revenue increased 34.9% to $191.3 million in the three months ended June 30, 2015 from $141.8 million in the three months ended June 30, 2014. Total adjusted revenue increased 34.7% to $377.0 million in the six months ended June 30, 2015 from $279.8 million in the six months ended June 30, 2014. The increase in adjusted revenue was attributable to our acquisition of Royall, our cross-selling of existing programs to existing members, the introduction and expansion of new programs, and, to a lesser degree, price increases.

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss) attributable to common stockholders
$
8,715

 
$
(3,177
)
 
$
(14,973
)
 
$
5,110

Effect on revenue of fair value adjustments to acquisition-related deferred revenue
6,617

 
—

 
12,499

 
—

Equity in (income) loss of unconsolidated entities
(4,000
)
 
2,150

 
(1,621
)
 
4,881

Accretion of non-controlling interest to redemption value
—

 
7,040

 
—

 
7,040

Provision for income taxes
2,716

 
3,933

 
4,910

 
10,830

Loss on financing activities
—

 
—

 
17,398

 
—

Interest expense
5,154

 
—

 
10,766

 
—

Other expense (income), net
128

 
(710
)
 
1,247

 
(1,442
)
Depreciation and amortization
19,499

 
9,078

 
36,573

 
17,546

Acquisition and similar transaction charges
961

 
268

 
6,610

 
268

Fair value adjustments to acquisition-related earn-out liabilities
(1,427
)
 
(100
)
 
(1,083
)
 
(4,200
)
Vacation accrual adjustment
—

 
—

 
(850
)
 
—

Stock-based compensation
8,631

 
5,541

 
15,036

 
9,964

Adjusted EBITDA
$
46,994

 
$
24,023

 
$
86,512

 
$
49,997

 

32

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss) attributable to common stockholders
$
8,715

 
$
(3,177
)
 
$
(14,973
)
 
$
5,110

Effect of adjusted tax rate on net income (loss)
(494
)
 
—

 
10,130

 
—

Effect on revenue of fair value adjustments to acquisition-related deferred revenue, net of adjusted tax rate
3,759

 
—

 
7,047

 
—

Equity in (income) loss of unconsolidated entities
(4,000
)
 
2,150

 
(1,621
)
 
4,881

Accretion of noncontrolling interest to redemption value
—

 
7,040

 
—

 
7,040

Amortization of acquisition-related intangibles, net of adjusted tax rate
4,562

 
1,452

 
8,782

 
2,883

Loss on financing activities, net of adjusted tax rate
—

 
—

 
9,725

 
—

Acquisition and similar transaction charges, net of adjusted tax rate
546

 
162

 
3,704

 
162

Fair value adjustments to acquisition-related earn-out liabilities, net of adjusted tax rate
(811
)
 
(61
)
 
(619
)
 
(2,583
)
Gain/loss on investment in common stock warrants, net of tax
(40
)
 
108

 
(40
)
 
108

Vacation accrual adjustment, net of adjusted tax rate
—

 
—

 
(475
)
 
—

Stock-based compensation, net of adjusted tax rate
4,902

 
3,351

 
8,482

 
6,071

Adjusted net income
$
17,139

 
$
11,025

 
$
30,142

 
$
23,672

Adjusted net income and adjusted EBITDA. Adjusted net income increased to $17.1 million for the three months ended June 30, 2015 from $11.0 million for the three months ended June 30, 2014, while adjusted EBITDA increased 95.6% to $47.0 million for the three months ended June 30, 2015 from $24.0 million for the three months ended June 30, 2014. Adjusted net income increased to $30.1 million for the six months ended June 30, 2015 from $23.7 million for the six months ended June 30, 2014, while adjusted EBITDA increased 73.0% to $86.5 million for the six months ended June 30, 2015 from $50.0 million for the six months ended June 30, 2014. The increases in adjusted EBITDA and adjusted net income were attributable to our increased revenue and the acquisition of Royall partially offset by increased investment in our general and administrative infrastructure to support our growing employee base, higher marketing and member relations costs attributable to an increase in the number of new sales teams, and the costs of new and growing programs.

 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
GAAP earnings (loss) per diluted share
$
0.20

 
$
(0.09
)
 
$
(0.36
)
 
$
0.13

Effect of adjusted tax rate on net income (loss)
(0.01
)
 
—

 
0.24

 
—

Effect on revenue of fair value adjustments to acquisition-related deferred revenue, net of adjusted tax rate
0.09

 
—

 
0.17

 
—

Equity in (income) loss of unconsolidated entities
(0.09
)
 
0.06

 
(0.04
)
 
0.13

Accretion of noncontrolling interest to redemption value
—

 
0.19

 
—

 
0.19

Amortization of acquisition-related intangibles, net of adjusted tax rate
0.11

 
0.04

 
0.21

 
0.08

Loss on financing activities, net of adjusted tax rate
—

 
—

 
0.23

 
—

Acquisition and similar transaction charges, net of adjusted tax rate
0.01

 
0.01

 
0.09

 
0.01

Fair value adjustments to acquisition-related earn-out liabilities, net of adjusted tax rate
(0.02
)
 
—

 
(0.02
)
 
(0.07
)
Vacation accrual adjustment, net of adjusted tax rate
—

 
—

 
(0.01
)
 
—

Stock-based compensation, net of adjusted tax rate
0.11

 
0.09

 
0.20

 
0.17

Non-GAAP earnings per diluted share
$
0.40

 
$
0.30

 
$
0.71

 
$
0.64


33




 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Effective tax rate
36.5
 %
 
39.5
%
 
(42.0
)%
 
38.9
%
Effect on tax rate of Washington, D.C. tax law change, including write-off of Washington, D.C. income tax credits
—
 %
 
—
%
 
91.3
 %
 
—
%
Effect on tax rate of loss on financing activities
0.9
 %
 
—
%
 
(8.5
)%
 
—
%
Effect on tax rate of unconsolidated equity method investment related FIN 48 liability
(3.5
)%
 
—
%
 
—
 %
 
—
%
Effect on tax rate of Royall acquisition costs and other tax items
9.3
 %
 
—
%
 
2.8
 %
 
—
%
     Adjusted effective tax rate
43.2
 %
 
39.5
%
 
43.6
 %
 
38.9
%


 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Weighted average common shares outstanding - Diluted
$
42,914

 
$
36,413

 
$
41,686

 
$
37,125

Dilutive shares outstanding
—

 
628

 
555

 
—

     Adjusted weighted average common shares outstanding - Diluted
42,914

 
37,041

 
42,241

 
37,125


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.
On January 9, 2015, The Company paid $744.2 million in cash and $121.2 million in equity to acquire Royall. The Company obtained its cash largely from borrowings under a senior secured term loan facility we obtained in conjunction with the acquisition. We had cash, cash equivalents, and marketable securities balances of $49.6 million as of June 30, 2015 and $87.7 million as of December 31, 2014. We expended $0.0 million and $23.8 million in cash to purchase shares of our common stock through our share repurchase program during the six months ended June 30, 2015 and 2014, respectively.

Cash flows
Cash flows from operating activities. The combination of revenue growth, profitable operations, and payment for memberships in advance of accrual revenue typically results in operating activities that generate cash flows in excess of net income 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, and the second quarter of our fiscal year typically provides the lowest quarterly cash flows from operations. Net cash flows provided by operating activities increased to $42.2 million in the six months ended June 30, 2015, from net cash flows provided by operating activities of $5.3 million in the six months ended June 30, 2014. The increase in net cash flows provided by operating activities in the current quarter was primarily attributable to large acceleration in cash collections in the current period, as well as the addition of Royall.
Cash flows from investing activities. Our cash management and investment strategy and capital expenditure programs affect investing cash flows. Net cash flows used in investing activities increased to $758.4 million in the six months ended June 30, 2015 from net cash flows provided by investing activities of $0.3 million in the six months ended June 30, 2014. Investing activities during the six months ended June 30, 2015 consisted of payment of $744.2 million for our acquisition of Royall and capital expenditures of $26.0 million, partially offset by redemptions of marketable securities of $14.7 million.

34

Investing activities during the six months ended June 30, 2014 consisted of payments of $25.8 million for acquisitions and capital expenditures of $23.0 million, partially offset by redemption of marketable securities of $49.2 million.
Cash flows from financing activities. We had net cash flows provided by financing activities of $692.8 million and net cash flows used in financing activities of $17.3 million in the six months ended June 30, 2015 and 2014, respectively. Cash flows from financing activities during the six months ended June 30, 2015 primarily consisted of $1.3 billion of proceeds from borrowings under our senior secured term loan facilities, $148.8 million proceeds from issuance of common stock, net of selling costs, $3.0 million of proceeds from the issuance of common stock upon the exercise of stock options, and $2.7 million in additional tax benefits related to stock-based compensation arrangements. These cash flows were offset in part by $732.2 million of debt repayments, $6.0 million shares to satisfy the minimum employee tax withholding for vested restricted stock units, $2.6 million of debt issuance costs, and a $1.5 million earn-out payment.
Financing activities during the six months ended June 30, 2014 primarily consisted of the repurchase of $23.8 million in shares under our stock repurchase program and the withholding of $7.7 million in shares to satisfy the minimum employee tax withholding for vested restricted stock units, the effects of which were partially offset by $7.9 million in additional tax benefits related to stock-based compensation arrangements and $5.8 million of proceeds from the issuance of common stock upon the exercise of stock options.

Senior secured credit facilities

On February 6, 2015, we entered into a credit agreement with the lenders party thereto, JPMorgan Chase Bank, N.A., as administrative agent, and the other parties to the agreement. The lenders under the credit agreement on the closing date of February 6, 2015 provided us with $675 million of senior secured credit facilities, or credit facilities, for application in part to the prepayment of all borrowings then outstanding under the credit agreement we had entered into on January 9, 2015 in connection with our acquisition of Royall.

The credit facilities consist of (a) a five-year senior secured term loan facility, or term facility, in the original principal amount of $575 million and (b) a five-year senior secured revolving credit facility, or revolving facility, under which up to $100 million principal amount of borrowings and other credit extensions may be outstanding at any time.

The Advisory Board Company is the borrower under the credit facilities. The Advisory Board Company’s obligations under the credit facilities are guaranteed by our domestic subsidiaries, subject to certain exceptions, and the obligations of The Advisory Board Company and the subsidiary guarantors under the credit facilities are secured by a first-priority security interest in substantially all of the assets of The Advisory Board Company and such domestic subsidiaries.

The credit facilities contain customary negative covenants restricting certain actions that may be taken by us and our subsidiaries. Subject to specified exceptions, these covenants limit our ability and the ability of our subsidiaries to incur indebtedness, create liens on their assets, pay cash dividends, repurchase our common stock and make other restricted payments, make investments in or loans to other parties, sell assets, engage in mergers and acquisitions, enter into transactions with affiliates, enter into sale and leaseback transactions, and change their businesses. The credit facilities also contain customary affirmative covenants, including, among others, covenants requiring compliance with laws, maintenance of corporate existence, licenses, properties and insurance, payment of taxes and performance of other material obligations, and delivery of financial and other information to the lenders. The credit facilities contain customary events of default, including a change of control of The Advisory Board Company. We are required to maintain compliance with financial covenants consisting of (a) a maximum total leverage ratio and (b) a minimum interest coverage ratio, each measured as of the last day of each fiscal quarter, for a period consisting of our most recently completed four fiscal quarters. We were in compliance with both financial covenants as of June 30, 2015.

All $575 million of term loans available under the term facility were drawn on the facility closing date to prepay all borrowings outstanding under our prior credit agreement. We will be able to elect, subject to pro forma compliance with the foregoing financial covenants and other customary conditions, to solicit the lenders under the credit facilities or other prospective lenders to add one or more incremental term loan facilities to the credit facilities or to increase commitments under the revolving facility in an aggregate amount of no more than (a) $150 million plus (b) the amount of voluntary prepayments of borrowings under the credit facilities not funded with the incurrence of other long-term indebtedness. Any such voluntary prepayments of loans under the revolving facility must be accompanied by permanent reductions of commitments under the revolving facility.

To the extent not previously paid, the term facility will mature, and all term loans outstanding under the facility will become due and payable, on February 6, 2020. The term loans are repayable in quarterly installments, commencing with the

35

quarter ending on June 30, 2015, equal to a specified percentage of the aggregate principal amount drawn on the facility closing date, as follows: (a) 1.25% for each of the first eight full fiscal quarters following the facility closing date; (b) 2.5% for each of the ninth through twelfth full fiscal quarters following the facility closing date; and (c) 3.75% for each of the thirteenth through nineteenth full fiscal quarters following the facility closing date. We also are required to make principal prepayments under the term facility from the net proceeds of specified types of asset sales, casualty events, and incurrences of debt. We may voluntarily prepay outstanding term loans without premium or penalty.
Amounts drawn under the term facility generally bear interest, payable quarterly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate, or LIBOR, plus an initial margin of 2.75%, subject in each case to margin reductions based on our total leverage ratio from time to time. The interest rate on the alternate base rate loans will fluctuate as the base rate fluctuates, while the interest rate on the LIBOR loans will be adjusted at the end of each applicable interest period. Interest on alternate base rate loans will be payable quarterly in arrears, while interest on the LIBOR loans will be payable at the end of each applicable interest period, except that, in the case of any interest period longer than three months, interest will be payable at the end of each three-month period.

The revolving facility was undrawn at the facility closing date. The revolving facility will mature, and all revolving loans outstanding under the facility will become due and payable, on February 6, 2020. The facility loans may be borrowed, repaid, and reborrowed from time to time during the term of the facility. We may use the proceeds of borrowings under the revolving facility, when drawn, to finance working capital needs and for general corporate purposes, including permitted acquisitions. There were no amounts outstanding under this facility as of June 30, 2015.

Amounts drawn under the revolving facility generally bear interest, payable quarterly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate plus an initial margin of 2.75%, subject in each case to margin reductions based on our total leverage ratio from time to time.

We are obligated to pay a commitment fee at an initial rate of 0.40%, subject to reduction based on our total leverage ratio from time to time, accruing on the average daily amount of available commitments under the revolving facility.
Contractual Obligations

Our 2014 Form 10-KT discloses certain commitments and contractual obligations that existed as of December 31, 2014. In the first quarter of 2015, we entered into a new lease for office space in Chicago, Illinois. As part of the Royall acquisition, we assumed Royall's office leases in Richmond, Virginia and Bloomington, Minnesota. The updated table of commitments and contractual obligations below, which is presented as of June 30, 2015, reflects the future minimum lease payments under these leases excluding rental escalation and executory costs.

The following table also includes the contractual principal payments under our indebtedness as of June 30, 2015 resulting from our incurrence of indebtedness under the senior secured term credit facility we obtained on February 6, 2015, as described above.

 
Payment due by period
(in thousands)
 
Total
 
Less than 1 year
 
1-3 years
 
3-5 years
 
More than 5 years
Principal payments
$
567,812

 
$
28,750

 
$
100,625

 
$
438,437

 
$
—

Non-cancelable operating leases
$
17,166

 
$
889

 
$
4,421

 
$
5,376

 
$
6,480


Off-Balance Sheet Arrangements
As of June 30, 2015, we had no material off-balance sheet arrangements as defined under SEC rules.

36

Seasonality
Our revenues and operating results normally fluctuate as a result of seasonal variations in our business, principally due to certain higher education program offerings where contracts are typically aligned with our members' academic year. Historically, these higher education programs have had lower revenues in the third fiscal quarter and higher revenues in the first and fourth fiscal 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 new program offerings, increased sales, or acquisitions.

Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
Interest rate risk. We are exposed to interest rate risk associated with the $575 million principal amount of variable-rate debt we incurred in February 6, 2015 under our senior secured term loan facility. Amounts drawn under the term facility generally bear interest, payable quarterly, at an annual rate calculated, at our option, on the basis of either (a) an alternate base rate plus an initial margin of 1.75% or (b) the applicable London interbank offered rate, plus an initial margin of 2.75%, subject in each case to margin reductions based on our total leverage ratio from time to time. As of June 30, 2015, our outstanding term loans accrued interest at an annual rate of 2.94%. As of that date, 10% increase in LIBOR would have increased our annual cash interest expense on our variable-rate debt by approximately $0.1 million.
The Company entered into three interest rate swaps to hedge approximately 50% of the Company’s debt principal, which is equal to $283.9 million as of June 30, 2015. The Company’s objective with respect to these interest rate swaps is to protect the Company against adverse fluctuations in interest rates by reducing its exposure to variability in cash flows relating to interest payments on a portion of its outstanding debt. The Company is meeting its objective by hedging the risk of changes in its cash flows (interest payments) attributable to changes in the one-month U.S. dollar-denominated LIBOR swap rate, the designated benchmark interest rate being hedged.
Foreign currency risk. Our international operations, which account for approximately 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 recorded foreign currency exchange losses of $(0.2) million during the three and six months ended June 30, 2015, which are included in other (expense) income, net in our consolidated statements of operations appearing elsewhere in this report. We recorded foreign currency exchange gains of $0.3 million during the three and six months ended June 30, 2014, which are included in other (expense) income, 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 June 30, 2015.

Item 4.
Controls and Procedures.

Our Chief Executive Officer, or “CEO,” and Chief Financial Officer, or “CFO,” have evaluated the effectiveness of our disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this quarterly report as required by Rule 13a-15(b) or 15d-15(b) under the Exchange Act.
Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Based upon our evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures were effective. We excluded Royall Acquisition Co. and subsidiaries, which are included in our consolidated financial statements, from our assessment of internal control over financial reporting as of June 30, 2015 because it was acquired by the Company in a business combination on January 9, 2015.
During the period covered by this quarterly report, there have been no changes to our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

37

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. In addition to the other information set forth in this report, the factors discussed in Part I, “Item 1A. Risk Factors” in our 2014 Form 10-KT could materially affect our business, financial condition, or operating results. The risks described in our 2014 Form 10-KT and in our subsequently filed SEC reports 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.
Described below is a risk facing our business in addition to the risks described in our 2014 Form 10-KT.
We will be unable to file our periodic reports with the Securities and Exchange Commission on a timely basis if we do not receive timely delivery by Evolent of its financial statements to us.
As of June 30, 2015, we owned 15.4% of Evolent Health Inc., or “Evolent Inc.,” through our Class A common stock investment, and 8.8% of Evolent Health LLC, or “Evolent LLC,” through our Class B common units investment. We account for our investments in Evolent Inc. and Evolent LLC under the equity method. As a result, the consolidated financial statements included in our periodic reports reflect an allocation attributable to our economic interest in these entities. Our ability to file future periodic reports with the Securities and Exchange Commission on a timely basis therefore depends on Evolent's ability to complete, and Evolent's compliance with its contractual obligation to complete and deliver to us its financial statements sufficiently in advance of our SEC reporting deadlines in order for us accurately to reflect its results in our consolidated financial statements. A failure to report our financial results on an accurate or timely basis could result in sanctions, lawsuits, delisting of our shares from the NASDAQ Global Select Market, or other adverse consequences that could materially harm our business.

38

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.
10.1

 
The Advisory Board Company Amended and Restated 2009 Stock Incentive Plan. Filed herewith.
 
 
 
10.2

 
2015 Form of Award Agreement for Restricted Stock Units pursuant to The Advisory Board Company 2009 Stock Incentive Plan. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2015.
 
 
 
10.3

 
2015 Form of Award Agreement for Qualified Stock Options pursuant to The Advisory Board Company 2009 Stock Incentive Plan. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2015.
 
 
 
10.4

 
2015 Form of Award Agreement for Non-Qualified Stock Options pursuant to The Advisory Board Company 2009 Stock Incentive Plan. Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2015.
 
 
 
12.1

 
Computation of Ratio of Earnings to Fixed Charges. Filed herewith.
 
 
 
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 June 30, 2015, formatted in XBRL: (i) Consolidated Balance Sheets as of June 30, 2015 (unaudited) and December 31, 2014, (ii) Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2015 and 2014, (iii) Unaudited Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2015 and 2014, (v) Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014, and (v) Notes to Unaudited Consolidated Financial Statements.


39

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: August 7, 2015
 
 
 
By:
/s/ Michael T. Kirshbaum
 
 
 
 
 
Michael T. Kirshbaum
 
 
 
 
 
Chief Financial Officer and Treasurer
(Duly Authorized Officer)

40

INDEX TO EXHIBITS
 
Exhibit
Number
 
Description of Exhibit
 
 
10.1

 
The Advisory Board Company Amended and Restated 2009 Stock Incentive Plan. Filed herewith.
 
 
 
10.2

 
2015 Form of Award Agreement for Restricted Stock Units pursuant to The Advisory Board Company 2009 Stock Incentive Plan. Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2015.
 
 
 
10.3

 
2015 Form of Award Agreement for Qualified Stock Options pursuant to The Advisory Board Company 2009 Stock Incentive Plan. Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2015.
 
 
 
10.4

 
2015 Form of Award Agreement for Non-Qualified Stock Options pursuant to The Advisory Board Company 2009 Stock Incentive Plan. Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the Commission on June 15, 2015.
 
 
 
12.1

 
Computation of Ratio of Earnings to Fixed Charges. Filed herewith.
 
 
 
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 June 30, 2015, formatted in XBRL: (i) Consolidated Balance Sheets as of June 30, 2015 (unaudited) and December 31, 2014, (ii) Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2015 and 2014, (iii) Unaudited Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2015 and 2014, (v) Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014, and (v) Notes to Unaudited Consolidated Financial Statements.


41




THE ADVISORY BOARD COMPANY
AMENDED AND RESTATED 2009 STOCK INCENTIVE PLAN

1. Purpose
The purpose of The Advisory Board Company 2009 Stock Incentive Plan (the “Plan”) is to enable The Advisory Board Company, a Delaware corporation and its Subsidiaries (collectively, the “Company”), to attract, retain and motivate Nonemployee Directors, officers, employees and service providers, and to further align the interests of such persons with those of Company stockholders by providing for or increasing the proprietary interest of such persons in the Company. The Plan supersedes the Company’s 2006 Stock Incentive Plan with respect to future awards, and provides for the grant of Incentive and Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock and Restricted Stock Units, any of which may be performance-based, and for Incentive Bonuses, which may be paid in cash or stock or a combination thereof, as determined by the Administrator.
2. Definitions
As used in the Plan, the following terms shall have the meanings set forth below:
(a) “Administrator” means the Administrator of the Plan in accordance with Section 18.
(b) “Amendment Date” means June 9, 2015.
(c) “Award” means an Incentive Stock Option, Nonqualified Stock Option, Stock Appreciation Right, Restricted Stock, Restricted Stock Unit or Incentive Bonus granted to a Participant pursuant to the provisions of the Plan, any of which the Administrator may structure to qualify in whole or in part as a Performance Award.
(d) “Award Agreement” means a written agreement or other instrument as may be approved from time to time by the Administrator implementing the grant of each Award. An Agreement may be in the form of an agreement to be executed by both the Participant and the Company (or an authorized representative of the Company) or certificates, notices or similar instruments as approved by the Administrator.
(e) “Board” means the board of directors of the Company.
(f) “Change of Control” when used in the Plan or any Award granted under the Plan, shall have the meaning specified by the Administrator in the terms of an Award Agreement or otherwise but shall be defined to mean only the occurrence or consummation of a change of control transaction or event and shall not consist solely of the announcement of or stockholder approval of any such transaction or event.
(g) “Code” means the Internal Revenue Code of 1986, as amended from time to time, and the rulings and regulations issues thereunder.
(h) “Fair Market Value” means, as of any date, the official closing price per share at which the Shares are sold in the regular way on the NASDAQ Global Select Market or, if no Shares are traded on the NASDAQ Global Select Market on the date in question, then for the next preceding date for which Shares are traded on the NASDAQ Global Select Market or, if the Shares are at any time no longer traded on the NASDAQ Global Select Market, the closing price per share at which the Shares are sold on such other exchange, listing, quotation or similar service, or if no such closing price is available, such other method, consistent with Section 409A of the Code, as the Administrator may determine.
(i) “Incentive Bonus” means a bonus opportunity awarded under Section 9 pursuant to which a Participant may become entitled to receive an amount based on satisfaction of such performance criteria as are specified in the Award Agreement.
(j) “Incentive Stock Option” means a stock option that is intended to qualify as an “incentive stock option” within the meaning of Section 422 of the Code.
(k) “Nonemployee Director” means each person who is, or is elected to be, a member of the Board and who is not an employee of the Company or any Subsidiary.
(l) “Nonqualified Stock Option” means a stock option that is not intended to qualify as an “incentive stock option” within the meaning of Section 422 of the Code.
(m) “Option” means an Incentive Stock Option and/or a Nonqualified Stock Option granted pursuant to Section 6 of the Plan.
(n) “Participant” means any individual described in Section 3 to whom Awards have been granted from time to time by the Administrator and any authorized transferee of such individual.




(o) “Performance Award” means an Award, the grant, issuance, retention, vesting or settlement of which is subject to satisfaction of one or more Qualifying Performance Criteria established pursuant to Section 13.
(p) “Plan” means The Advisory Board Company Amended and Restated 2009 Stock Incentive Plan as set forth herein and as amended from time to time.
(q) “Qualifying Performance Criteria” has the meaning set forth in Section 13(b). As used in Section 13(b), the term “contract value” means the aggregate annualized revenue attributed to all agreements in effect at a given date without regard to the remaining duration of any such agreement, and the term “client renewal rate” means the percentage of member institutions renewed, adjusted to reflect reductions in member institutions resulting from mergers and acquisitions of members.
(r) “Restricted Stock” means Shares granted pursuant to Section 8 of the Plan.
(s) “Restricted Stock Unit” means an Award granted to a Participant pursuant to Section 8 pursuant to which Shares or cash in lieu thereof may be issued in the future.
(t) “Retirement” has the meaning specified by the Administrator in the terms of an Award Agreement or, in the absence of any such term, for Participants other than Nonemployee Directors shall mean retirement from active employment with the Company and its Subsidiaries at or after age 65. The determination of the Administrator as to an individual’s Retirement shall be conclusive on all parties.
(u) “Share” means a share of the Company’s common stock, par value $.01, subject to adjustment as provided in Section 12.
(v) “Specified Share Amount” means a number of Shares equal to a maximum of 5% of all Shares available for issuance under this Plan as of the Amendment Date.
(w) “Stock Appreciation Right” means a right granted pursuant to Section 7 of the Plan that entitles the Participant to receive, in cash or Shares or a combination thereof, as determined by the Administrator, value equal to or otherwise based on the excess of (i) the market price of a specified number of Shares at the time of exercise over (ii) the exercise price of the right, as established by the Administrator on the date of grant.
(x) “Subsidiary” means any corporation (other than the Company) in an unbroken chain of corporations beginning with the Company where each of the corporations in the unbroken chain other than the last corporation owns stock possessing at least 50 percent or more of the total combined voting power of all classes of stock in one of the other corporations in the chain, and if specifically determined by the Administrator in the context other than with respect to Incentive Stock Options, may include an entity in which the Company has a significant ownership interest or that is directly or indirectly controlled by the Company.
(y) “Termination of Employment” means, for Awards made prior to July 26, 2011, ceasing to serve as a full-time employee of the Company and its Subsidiaries and, for Awards made on or after July 26, 2011, ceasing to serve as an employee of the Company or its Subsidiaries, or, with respect to a Nonemployee Director or other service provider, ceasing to serve as such for the Company, except that with respect to all or any Awards held by a Participant (i) the Administrator may determine, subject to Section 6(d), that an approved leave of absence or, for Awards made prior to July 26, 2011, approved employment on a less than full-time basis is not considered a Termination of Employment, (ii) the Administrator may determine that a transition of employment to service with a partnership, joint venture or corporation not meeting the requirements of a Subsidiary in which the Company or a Subsidiary is a party is not considered a Termination of Employment, (iii) service as a member of the Board or other service provider shall constitute continued employment with respect to Awards granted to a Participant while he or she served as an employee and (iv) service as an employee of the Company or a Subsidiary shall constitute continued employment with respect to Awards granted to a Participant while he or she served as a member of the Board or other service provider. The Administrator shall determine whether any corporate transaction, such as a sale or spin-off of a division or subsidiary that employs a Participant, shall be deemed to result in a Termination of Employment with the Company and its Subsidiaries for purposes of any affected Participant’s Options, and the Administrator’s decision shall be final and binding.
(z) “Total and Permanent Disablement” has the meaning specified by the Administrator in the terms of an Award Agreement or, in the absence of any such term or in the case of an Option intending to qualify as an Incentive Stock Option, the inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. The determination of the Administrator as to an individual’s Total and Permanent Disablement shall be conclusive on all parties.
(aa) “2005 Plan” means The Advisory Board Company 2005 Stock Incentive Plan.
(bb) “2006 Plan” means The Advisory Board Company 2006 Stock Incentive Plan.





3. Eligibility
Any person who is a current or prospective officer or employee (within the meaning of Section 5635(c) of the NASDAQ Stock Market Listing Requirements) of the Company or of any Subsidiary shall be eligible for selection by the Administrator for the grant of Awards hereunder. In addition, Nonemployee Directors and any other service providers who have been retained to provide consulting, advisory or other services to the Company or to any Subsidiary shall be eligible for the grant of Awards hereunder as determined by the Administrator. Options intending to qualify as Incentive Stock Options may only be granted to employees of the Company or any Subsidiary within the meaning of the Code, as selected by the Administrator. For purposes of this Plan, the Chairman of the Board’s status as an employee shall be determined by the Administrator.
4. Effective Date and Termination of Plan
This Plan was adopted by the Board as of June 22, 2009, and it became effective (the “Effective Date”) on September 11, 2009, the date on which it was approved by the Company’s stockholders. All Awards granted under this Plan are subject to, and may not be exercised before, the approval of this Plan by the affirmative vote of the holders of a majority of the outstanding Shares present, or represented by proxy, and entitled to vote, at a meeting of the Company’s stockholders or by written consent in accordance with the laws of the State of Delaware; provided that if such approval by the stockholders of the Company does not occur within one year of the date that this Plan was adopted by the Board, all Awards previously granted under this Plan shall be void. The Plan shall remain available for the grant of Awards until the tenth (10th) anniversary of the Effective Date. Notwithstanding the foregoing, the Plan may be terminated at such earlier time as the Board may determine. Termination of the Plan will not affect the rights and obligations of the Participants and the Company arising under Awards theretofore granted and then in effect.
5. Shares Subject to the Plan and to Awards
(a) Aggregate Limits.
The aggregate number of Shares issuable pursuant to all Awards made on or after the Amendment Date shall not exceed 3,800,000 Shares, plus (i) any Shares that were authorized for issuance under the Plan as of the Amendment Date that remain available for issuance under the Plan as of the Amendment Date, plus (ii) any Shares that were authorized for issuance under the 2005 Plan as of the Amendment Date that remain available for issuance under the 2005 Plan as of the Amendment Date, plus (iii) any Shares subject to outstanding awards under the Plan and the 2005 Plan as of the Amendment Date that on or after the Amendment Date cease for any reason to be subject to such awards (other than by reason of exercise or settlement of the awards to the extent they are exercised for or settled in vested and nonforfeitable Shares), plus (iv) any Shares subject to outstanding awards under the 2006 Plan as of June 26, 2009 that on or after the Amendment Date cease for any reason to be subject to such awards (other than by reason of exercise or settlement of the awards to the extent they are exercised for or settled in vested and nonforfeitable Shares). For purposes of the share limit under the preceding sentence, any Shares granted under Options or Stock Appreciation Rights shall be counted against this limit on a one-for-one basis and any Shares granted as Awards other than Options or Stock Appreciation Rights shall be counted against this limit as two and one one-hundredths (2.01) Shares for every one (1) Share subject to such Award. The aggregate number of Shares available for grant under this Plan and the number of Shares subject to outstanding Awards shall be subject to adjustment as provided in Section 12. The Shares issued pursuant to Awards granted under this Plan may be Shares that are authorized and unissued or Shares that were reacquired by the Company, including Shares purchased in the open market.
(b) Issuance of Shares.
For purposes of Section 5(a), the aggregate number of Shares issued under this Plan at any time shall equal only the number of Shares actually issued upon exercise or settlement of an Award. Notwithstanding the foregoing, Shares subject to an Award under the Plan may not again be made available for issuance under the Plan if such Shares are: (i) Shares that were subject to a stock-settled Stock Appreciation Right and were not issued upon the net settlement or net exercise of such Stock Appreciation Right, (ii) Shares used to pay the exercise price of an Option, (iii) Shares delivered to or withheld by the Company to pay the withholding taxes related to an Award, or (iv) Shares repurchased on the open market with the proceeds of an Option exercise. Shares subject to Awards that have been canceled, expired, forfeited or otherwise not issued under an Award and Shares subject to Awards settled in cash shall not count as Shares issued under this Plan. Any Shares that again become available for grant pursuant to Section 5(a) or this Section 5(b) shall be added back as one (1) Share if such shares were subject to Options or Stock Appreciation Rights granted under the Plan, and as two and one one-hundredths (2.01) Shares if such shares were subject to Awards other than Options or Stock Appreciation Rights granted under the Plan.
(c) Tax Code Limits.
The aggregate number of Shares subject to Awards granted under this Plan during any calendar year to any one Participant shall not exceed 1,000,000, which number shall be calculated and adjusted pursuant to Section 12 only to the extent that such calculation or adjustment will not affect the status of any Award intended to qualify as “performance-based




compensation” under Section 162(m) of the Code but which number shall not count any tandem SARs (as defined in Section 7). The aggregate number of Shares subject to Options and Stock Appreciation Rights granted under this Plan during any calendar year to any one Participant shall not exceed 1,000,000, which number shall be calculated and adjusted pursuant to Section 12 only to the extent that such calculation or adjustment will not affect the status of any Award intended to qualify as “performance-based compensation” under Section 162(m) of the Code. The aggregate number of Shares subject to Awards other than Options or Stock Appreciation Rights granted under this Plan during any calendar year to any one Participant shall not exceed 1,000,000, which number shall be calculated and adjusted pursuant to Section 12 only to the extent that such calculation or adjustment will not affect the status of any Award intended to qualify as “performance-based compensation” under Section 162(m) of the Code. The aggregate number of Shares that may be issued pursuant to the exercise of Incentive Stock Options granted under this Plan shall not exceed 2,110,000, which number shall be calculated and adjusted pursuant to Section 12 only to the extent that such calculation or adjustment will not affect the status of any option intended to qualify as an Incentive Stock Option under Section 422 of the Code. The maximum amount payable pursuant to that portion of an Incentive Bonus granted in any calendar year to any Participant under this Plan that is intended to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code shall not exceed five million dollars ($5,000,000).
(d) Director Awards.
The aggregate number of Shares subject to Options and Stock Appreciation Rights granted under this Plan during any calendar year to any one Nonemployee Director shall not exceed 60,000, and the aggregate number of Shares issued or issuable under all Awards granted under this Plan other than Options or Stock Appreciation Rights during any calendar year to any one Nonemployee Director shall not exceed 30,000; provided, however, that in the calendar year in which a Nonemployee Director first joins the Board of Directors or is first designated as Chairman of the Board of Directors or Lead Director, the maximum number of shares subject to Awards granted to the Participant may be up to two hundred percent (200%) of the number of shares set forth in the foregoing limits and the foregoing limits shall not count any tandem SARs (as defined in Section 7).
(e) Awards to Service Providers.
The aggregate number of Shares issued under this Plan pursuant to all Awards granted to service providers shall not exceed 200,000.
(f) Assumed Awards of Acquired Corporations.
In the event that the Company acquires another corporation and assumes outstanding equity awards of such acquired corporation, the number of Shares authorized for issuance under this Plan shall be increased to the extent necessary to satisfy such assumed equity awards (as adjusted, to the extent appropriate, using the exchange ratio or other adjustment or valuation ratio or formula used in such acquisition or combination to determine the consideration payable to the holders of common stock of the entities party to such acquisition or combination) and such Shares shall not reduce the Shares otherwise authorized for issuance under the Plan.
(g) Awards of Acquired Corporations.
In the event that a corporation acquired by the Company, or with which the Company combines, has shares available under a pre-existing plan approved by stockholders and not adopted in contemplation of such acquisition or combination, the shares available for grant pursuant to the terms of such pre-existing plan (as adjusted, to the extent appropriate, using the exchange ratio or other adjustment or valuation ratio or formula used in such acquisition or combination to determine the consideration payable to the holders of common stock of the entities party to such acquisition or combination) may be used for Awards under the Plan and shall not reduce the Shares authorized for issuance under the Plan; provided that Awards using such available shares shall not be made after the date awards or grants could have been made under the terms of the pre-existing plan, absent the acquisition or combination, and shall only be made to individuals who were not employees, directors or consultants of the Company immediately before such acquisition or combination.
6. Options
(a) Option Awards.
Options may be granted at any time and from time to time prior to the termination of the Plan to Participants as determined by the Administrator. No Participant shall have any rights as a stockholder with respect to any Shares subject to Option hereunder until said Shares have been issued. Each Option shall be evidenced by an Award Agreement. Options granted pursuant to the Plan need not be identical but each Option must contain and be subject to the terms and conditions set forth below.
(b) Price.
The Administrator will establish the exercise price per Share under each Option, which, in no event will be less than the Fair Market Value of the Shares on the date of grant; provided, however, that the exercise price per Share with respect to an Option that is granted in connection with a merger or other acquisition as a substitute or replacement award for options held by




optionees of the acquired entity may be less than 100% of the market price of the Shares on the date such Option is granted if such exercise price is based on a formula set forth in the terms of the options held by such optionees or in the terms of the agreement providing for such merger or other acquisition. The exercise price of any Option may be paid in Shares, cash or a combination thereof, as determined by the Administrator, including an irrevocable commitment by a broker to pay over such amount from a sale of the Shares issuable under an Option, the delivery of previously owned Shares and withholding of Shares otherwise deliverable upon exercise.
(c) No Repricing without Stockholder Approval.
Other than in connection with a change in the Company’s capitalization (as described in Section 12), at any time when the exercise price of an Option is above the Fair Market Value of a Share, the Company shall not, without stockholder approval, reduce the exercise price of such Option and shall not exchange such Option for cash or a new Award with a lower (or no) exercise price.
(d) Provisions Applicable to Options.
The date on which Options become exercisable shall be determined at the sole discretion of the Administrator and set forth in an Award Agreement. For Awards made on or after the Amendment Date, except as next described, the vesting and/or exercise of (i) any Option that is based solely upon performance criteria and level of achievement versus such criteria shall be subject to a performance period of not less than twelve (12) months, and (ii) any Option under which vesting or exercise is based solely upon continued employment and/or the passage of time may not vest or be exercised in full prior to thirty-six (36) months following the date of grant of such Option, if such Option is awarded to a Participant who is not a Nonemployee Director, and prior to twelve (12) months following the date of grant of such Option, if such Option is awarded to a Nonemployee Director. Notwithstanding the preceding, the Administrator may provide for the vesting and/or exercisability under any such Option in the event of the Participant’s death or Total and Permanent Disablement, in connection with a change of control of the Company, or, with respect to an Option granted twelve (12) months or more before the date of a Termination of Employment of the Participant, in connection with such Termination of Employment. Furthermore, in applying the thirty-six (36) month minimum vesting rule under this Section 6(d), such vesting and/or exercise may be subject to pro-rata vesting over such thirty-six (36) month period following a one (1) year minimum vesting period. Unless provided otherwise in the applicable Award Agreement, to the extent that the Administrator determines that an approved leave of absence or employment on a less than full-time basis is not a Termination of Employment or for Awards made on or after July 26, 2011, that the Participant is employed on a less than full-time basis, the vesting period and/or exercisability of an Option shall be adjusted by the Administrator during or to reflect the effects of any period during which the Participant is on an approved leave of absence or is employed on a less than full-time basis.
(e) Term of Options and Termination of Employment:
The Administrator shall establish the term of each Option, which in no case shall exceed a maximum term of seven (7) years from the date of grant. Unless an Option earlier expires upon the expiration date established pursuant to the foregoing sentence, upon the Participant’s Termination of Employment, his or her rights to exercise an Option then held shall be only as follows, unless the Administrator specifies otherwise:
(1) Death.
Upon the death of a Participant while in the employ of the Company or any Subsidiary or while serving as a member of the Board, all of the Participant’s Options then held shall be exercisable by his or her estate, heir or beneficiary at any time during the one (1) year period commencing on the date of death. Any and all of the deceased Participant’s Options that are not exercised during the one (1) year commencing on the date of death shall terminate as of the end of such one (1) year period.
If a Participant should die within ninety (90) days of his or her Termination of Employment with the Company and its Subsidiaries, an Option shall be exercisable by his or her estate, heir or beneficiary at any time during the one (1) year period commencing on the date of termination, but only to the extent of the number of Shares as to which such Option was exercisable as of the date of such termination. Any and all of the deceased Participant’s Options that are not exercised during the one (1) year period commencing on the date of termination shall terminate as of the end of such one (1) year period. A Participant’s estate shall mean his or her legal representative or other person who so acquires the right to exercise the Option by bequest or inheritance or by reason of the death of the Participant.
(2) Total and Permanent Disablement.
Upon Termination of Employment as a result of the Total and Permanent Disablement of any Participant, all of the Participant’s Options then held shall be exercisable during the one (1) year period commencing on the date of termination. Any and all Options that are not exercised during the one (1) year period commencing on the date of termination shall terminate as of the end of such one (1) year period.
(3) Retirement.




Upon Retirement of a Participant, the Participant’s Options then held shall be exercisable during the one (1) year period commencing on the date of Retirement. The number of Shares with respect to which the Options shall be exercisable shall equal the total number of Shares that were exercisable under the Participant’s Option on the date of his or her Retirement. Any and all Options that are not exercised during the one (1) year period commencing on the date of termination shall terminate as of the end of such one (1) year period.
(4) Other Reasons.
Upon the date of a Participant’s Termination of Employment for any reason other than those stated above in Sections 6(e)(1), 6(e)(2) and 6(e)(3) or as described in Section 15, (A) to the extent that any Option is not exercisable as of such termination date, such portion of the Option shall remain unexercisable and shall terminate as of such date, and (B) to the extent that any Option is exercisable as of such termination date, such portion of the Option shall expire on the earlier of (i) ninety (90) days following such date and (ii) the expiration date of such Option.
(f) Incentive Stock Options.
Notwithstanding anything to the contrary in this Section 6, in the case of the grant of an Option intending to qualify as an Incentive Stock Option: (i) if the Participant owns stock possessing more than 10 percent of the combined voting power of all classes of stock of the Company, the exercise price of such Option must be at least 110 percent of the Fair Market Value of the Shares on the date of grant and the Option must expire within a period of not more than five (5) years from the date of grant, and (ii) Termination of Employment will occur when the person to whom an Award was granted ceases to be an employee (as determined in accordance with Section 3401(c) of the Code and the regulations promulgated thereunder) of the Company and its Subsidiaries. Notwithstanding anything in this Section 6 to the contrary, Options designated as Incentive Stock Options shall not be eligible for treatment under the Code as Incentive Stock Options (and will be deemed to be Nonqualified Stock Options) to the extent that either (a) the aggregate Fair Market Value of Shares (determined as of the time of grant) with respect to which such Options are exercisable for the first time by the Participant during any calendar year (under all plans of the Company and any Subsidiary) exceeds $100,000, taking Options into account in the order in which they were granted, or (b) such Options otherwise remain exercisable but are not exercised within three (3) months of Termination of Employment (or such other period of time provided in Section 422 of the Code).
7. Stock Appreciation Rights
Stock Appreciation Rights may be granted to Participants from time to time either in tandem with or as a component of other Awards granted under the Plan (“tandem SARs”) or not in conjunction with other Awards (“freestanding SARs”) and may, but need not, relate to a specific Option granted under Section 6. The provisions of Stock Appreciation Rights need not be the same with respect to each grant or each recipient. Any Stock Appreciation Right granted in tandem with an Award may be granted at the same time such Award is granted or at any time thereafter before exercise or expiration of such Award. All freestanding SARs shall be granted subject to the same terms and conditions applicable to Options as set forth in Section 6 (including the minimum vesting provisions of Section 6(d)) and all tandem SARs shall have the same exercise price, vesting, exercisability, forfeiture and termination provisions as the Award to which they relate. Subject to the provisions of Section 6 and the immediately preceding sentence, the Administrator may impose such other conditions or restrictions on any Stock Appreciation Right as it shall deem appropriate. Stock Appreciation Rights may be settled in Shares, cash or a combination thereof, as determined by the Administrator and set forth in the applicable Award Agreement. Other than in connection with a change in the Company’s capitalization (as described in Section 12), at any time when the exercise price of a Stock Appreciation Right is above the Fair Market Value of a Share, the Company shall not, without stockholder approval, reduce the exercise price of such Stock Appreciation Right and shall not exchange such Stock Appreciation Right for cash or a new Award with a lower (or no) exercise price.
8. Restricted Stock and Restricted Stock Units
(a) Restricted Stock and Restricted Stock Unit Awards.
Restricted Stock and Restricted Stock Units may be granted at any time and from time to time prior to the termination of the Plan to Participants as determined by the Administrator. Restricted Stock is an award or issuance of Shares the grant, issuance, retention, vesting and/or transferability of which is subject during specified periods of time to such conditions (including continued employment or performance conditions) and terms as the Administrator deems appropriate. Restricted Stock Units are Awards denominated in units of Shares under which the issuance of Shares or cash is subject to such conditions (including continued employment or performance conditions) and terms as the Administrator deems appropriate. Each grant of Restricted Stock and Restricted Stock Units shall be evidenced by an Award Agreement. Unless determined otherwise by the Administrator, each Restricted Stock Unit will be equal to one Share and will entitle a Participant to either the issuance of Shares or payment of an amount of cash determined with reference to the value of Shares. To the extent determined by the Administrator, Restricted Stock and Restricted Stock Units may be satisfied or settled in Shares, cash or a combination thereof. Restricted Stock and Restricted Stock Units granted pursuant to the Plan need not be identical but each grant of Restricted Stock and Restricted Stock Units must contain and be subject to the terms and conditions set forth below.




(b) Contents of Agreement.
Each Award Agreement shall contain provisions regarding (i) the number of Shares or Restricted Stock Units subject to such Award or a formula for determining such number, (ii) the purchase price of the Shares, if any, and the means of payment, (iii) the performance criteria, if any, and level of achievement versus these criteria that shall determine the number of Shares or Restricted Stock Units granted, issued, retainable and/or vested, (iv) such terms and conditions on the grant, issuance, vesting and/or forfeiture of the Shares or Restricted Stock Units as may be determined from time to time by the Administrator, (v) the term of the performance period, if any, as to which performance will be measured for determining the number of such Shares or Restricted Stock Units, and (vi) restrictions on the transferability of the Shares or Restricted Stock Units. Shares issued under a Restricted Stock Award may be issued in the name of the Participant and held by the Participant or held by the Company, in each case as the Administrator may provide.
(c) Vesting and Performance Criteria.
The grant, issuance, retention, vesting and/or settlement of shares of Restricted Stock and Restricted Stock Units will occur when and in such installments as the Administrator determines or under criteria the Administrator establishes, which may include Qualifying Performance Criteria. Except as next described, (i) the grant, issuance, retention, vesting and/or settlement of Shares under any such Award that is based solely upon performance criteria and level of achievement versus such criteria shall be subject to a performance period of not less than twelve (12) months, and (ii) the grant, issuance, retention, vesting and/or settlement of any Restricted Stock or Restricted Stock Unit Award that is based solely upon continued employment and/or the passage of time may not vest or be settled in full prior to thirty-six (36) months following its date of grant, if such Award is granted to a Participant who is not a Nonemployee Director, and prior to twelve (12) months following its date of grant, if such Award is granted to a Nonemployee Director. Notwithstanding the preceding, the Administrator may provide for the satisfaction and/or lapse of all conditions under any such Award in the event of the Participant’s death or Total and Permanent Disablement, in connection with a change of control of the Company, or, with respect to any such Award granted twelve (12) months or more before the date of a Termination of Employment of the Participant, in connection with such Termination of Employment, and the Administrator may provide that any such restriction or limitation will not apply in the case of a Restricted Stock or Restricted Stock Unit Award that is issued in payment or settlement of compensation that has been earned by the Participant. Furthermore, in applying the thirty-six (36) month minimum vesting rule under this Section 8(c), such grant, issuance, retention, vesting and/or settlement may be subject to pro-rata vesting over such thirty-six (36) month period following a one (1) year minimum vesting period. Notwithstanding anything in this Plan to the contrary, the performance criteria for any Restricted Stock or Restricted Stock Unit that is intended to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code will be a measure based on one or more Qualifying Performance Criteria selected by the Administrator and specified when the Award is granted.
(d) Discretionary Adjustments and Limits.
Subject to the limits imposed under Section 162(m) of the Code for Awards that are intended to qualify as “performance-based compensation,” notwithstanding the satisfaction of any performance goals, the number of Shares granted, issued, retainable and/or vested under an Award of Restricted Stock or Restricted Stock Units on account of either financial performance or personal performance evaluations may, to the extent specified in the Award Agreement, be reduced, but not increased, by the Administrator on the basis of such further considerations as the Administrator shall determine.
(e) Voting Rights.
Unless otherwise determined by the Administrator, Participants holding shares of Restricted Stock granted hereunder may exercise full voting rights with respect to those shares during the period of restriction. Participants shall have no voting rights with respect to Shares underlying Restricted Stock Units unless and until such Shares are reflected as issued and outstanding shares on the Company’s stock ledger.
(f) Dividends and Distributions.
Participants in whose name Restricted Stock is granted shall be entitled to receive all dividends and other distributions paid with respect to those Shares, unless determined otherwise by the Administrator. The Administrator will determine whether any such dividends or distributions will be automatically reinvested in additional shares of Restricted Stock and subject to the same restrictions on transferability as the Restricted Stock with respect to which they were distributed or whether such dividends or distributions will be paid in cash. Shares underlying Restricted Stock Units shall be entitled to dividends or dividend equivalents only to the extent provided by the Administrator. Dividends paid on Restricted Stock which vests or is earned based upon the achievement of performance criteria shall not vest unless such performance criteria for such Restricted Stock are achieved, and if such performance goals are not achieved, the Participant granted such Restricted Stock shall promptly forfeit and repay to the Company such dividend payments. Dividend equivalents granted as a component of another Award, which vests or is earned based upon the achievement of performance criteria, shall not vest unless such performance criteria for such underlying Award are achieved.




9. Incentive Bonuses
(a) General.
Each Incentive Bonus Award will confer upon the Participant the opportunity to earn a future payment tied to the level of achievement with respect to one or more performance criteria established for a performance period of not less than one year.
(b) Incentive Bonus Document.
The terms of any Incentive Bonus will be set forth in an Award Agreement. Each Award Agreement evidencing an Incentive Bonus shall contain provisions regarding (i) the target and maximum amount payable to the Participant as an Incentive Bonus, (ii) the performance criteria and level of achievement versus these criteria that shall determine the amount of such payment, (iii) the term of the performance period as to which performance shall be measured for determining the amount of any payment, (iv) the timing of any payment earned by virtue of performance, (v) restrictions on the alienation or transfer of the Incentive Bonus prior to actual payment, (vi) forfeiture provisions and (vii) such further terms and conditions, in each case not inconsistent with this Plan as may be determined from time to time by the Administrator.
(c) Performance Criteria.
The Administrator shall establish the performance criteria and level of achievement versus these criteria that shall determine the target and maximum amount payable under an Incentive Bonus, which criteria may be based on financial performance and/or personal performance evaluations. The Administrator may specify the percentage of the target Incentive Bonus that is intended to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code. Notwithstanding anything to the contrary herein, the performance criteria for any portion of an Incentive Bonus that is intended by the Administrator to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code shall be a measure based on one or more Qualifying Performance Criteria (as defined in Section 13(b)) selected by the Administrator and specified at the time the Incentive Bonus is granted. The Administrator shall certify the extent to which any Qualifying Performance Criteria has been satisfied, and the amount payable as a result thereof, prior to payment of any Incentive Bonus that is intended to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code.
(d) Timing and Form of Payment.
The Administrator shall determine the timing of payment of any Incentive Bonus. Payment of the amount due under an Incentive Bonus may be made in cash or in Shares, as determined by the Administrator. The Administrator may provide for or, subject to such terms and conditions as the Administrator may specify, may permit a Participant to elect for the payment of any Incentive Bonus to be deferred to a specified date or event.
(e) Discretionary Adjustments.
Notwithstanding satisfaction of any performance goals, the amount paid under an Incentive Bonus on account of either financial performance or personal performance evaluations may, to the extent specified in the Award Agreement, be reduced, but not increased, by the Administrator on the basis of such further considerations as the Administrator shall determine.
10. Deferral of Gains
The Administrator may, in an Award Agreement or otherwise, provide for the deferred delivery of Shares upon settlement, vesting or other events with respect to Restricted Stock or Restricted Stock Units, or in payment or satisfaction of an Incentive Bonus. Notwithstanding anything herein to the contrary, in no event will any deferral of the delivery of Shares or any other payment with respect to any Award be allowed if the Administrator determines, in its sole discretion, that the deferral would result in the imposition of the additional tax under Section 409A(a)(1)(B) of the Code. No Award shall provide for deferral of compensation that does not comply with Section 409A of the Code, unless the Board, at the time of grant, specifically provides that the Award is not intended to comply with Section 409A of the Code. The Company shall have no liability to a Participant, or any other party, if an Award that is intended to be exempt from, or compliant with, Section 409A of the Code is not so exempt or compliant or for any action taken by the Board.
11. Conditions and Restrictions Upon Securities Subject to Awards
The Administrator may provide that the Shares issued upon exercise of an Option or Stock Appreciation Right or otherwise subject to or issued under an Award shall be subject to such further agreements, restrictions, conditions or limitations as the Administrator in its discretion may specify prior to the exercise of such Option or Stock Appreciation Right or the grant, vesting or settlement of such Award, including without limitation, conditions on vesting or transferability, forfeiture or repurchase provisions and method of payment for the Shares issued upon exercise, vesting or settlement of such Award (including the actual or constructive surrender of Shares already owned by the Participant) or payment of taxes arising in connection with an Award. Without limiting the foregoing, such restrictions may address the timing and manner of any resales by the Participant or other subsequent transfers by the Participant of any Shares issued under an Award, including without limitation (i) restrictions under an insider trading policy or pursuant to applicable law, (ii) restrictions designed to delay and/or coordinate the timing and manner of sales by Participant and holders of other Company equity compensation arrangements,




(iii) restrictions as to the use of a specified brokerage firm for such resales or other transfers and (iv) provisions requiring Shares to be sold on the open market or to the Company in order to satisfy tax withholding or other obligations.
12. Adjustment of and Changes in the Stock
The number and kind of Shares available for issuance under this Plan (including under any Awards then outstanding), and the number and kind of Shares subject to the individual limits set forth in Section 5 of this Plan, shall be equitably adjusted by the Administrator to reflect any reorganization, reclassification, combination of shares, stock split, reverse stock split, spin-off, dividend or distribution of securities, property or cash (other than regular, quarterly cash dividends), or any other event or transaction that affects the number or kind of Shares of the Company outstanding. Such adjustment may be designed to comply with Section 424 of the Code or, except as otherwise expressly provided in Section 5(c) of this Plan, may be designed to treat the Shares available under the Plan and subject to Awards as if they were all outstanding on the record date for such event or transaction or to increase the number of such Shares to reflect a deemed reinvestment in Shares of the amount distributed to the Company’s securityholders. The terms of any outstanding Award shall also be equitably adjusted by the Administrator as to price, number or kind of Shares subject to such Award and other terms to reflect the foregoing events, which adjustments need not be uniform as between different Awards or different types of Awards.
In the event there shall be any other change in the number or kind of outstanding Shares, or any stock or other securities into which such Shares shall have been changed, or for which it shall have been exchanged, by reason of a change of control, other merger, consolidation or otherwise, then the Administrator shall determine the appropriate and equitable adjustment to be effected. In addition, in the event of such change described in this paragraph, the Administrator may accelerate the time or times at which any Award may be exercised and may provide for cancellation of such accelerated Awards that are not exercised within a time prescribed by the Administrator in its sole discretion.
No right to purchase fractional shares shall result from any adjustment in Awards pursuant to this Section 12. In case of any such adjustment, the Shares subject to the Award shall be rounded down to the nearest whole share. The Company shall notify Participants holding Awards subject to any adjustments pursuant to this Section 12 of such adjustment, but (whether or not notice is given) such adjustment shall be effective and binding for all purposes of the Plan.
13. Qualifying Performance-Based Compensation
(a) General.
The Administrator may establish performance criteria and level of achievement versus such criteria that shall determine the number of Shares to be granted, retained, vested, issued or issuable under or in settlement of or the amount payable pursuant to an Award, which criteria may be based on Qualifying Performance Criteria or other standards of financial performance and/or personal performance evaluations. In addition, the Administrator may specify that an Award or a portion of an Award is intended to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code, provided that the performance criteria for such Award or portion of an Award that is intended by the Administrator to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code shall be a measure based on one or more Qualifying Performance Criteria selected by the Administrator and specified at the time the Award is granted. The Administrator shall certify the extent to which any Qualifying Performance Criteria has been satisfied, and the amount payable as a result thereof, prior to payment, settlement or vesting of any Award that is intended to satisfy the requirements for “performance-based compensation” under Section 162(m) of the Code. Notwithstanding satisfaction of any performance goals, the number of Shares issued under or the amount paid under an Award may, to the extent specified in the Award Agreement, be reduced, but not increased, by the Administrator on the basis of such further considerations as the Administrator in its sole discretion shall determine.
(b) Qualifying Performance Criteria.
For purposes of this Plan, the term “Qualifying Performance Criteria” shall mean any one or more of the following performance criteria, or derivations of such performance criteria, either individually, alternatively or in any combination, applied to either the Company as a whole or to a business unit or Subsidiary, either individually, alternatively or in any combination, and measured either annually or cumulatively over a period of years, on an absolute basis or relative to a pre-established target, to previous years’ results or to a designated comparison group, in each case as specified by the Administrator:
•
net earnings or net income;
•
operating earnings or operating income;
•
operating profit or net operating profit;
•
pretax earnings;
•
earnings per share;
•
stock price, including growth measures and total stockholder return;




•
earnings before interest and taxes;
•
earnings before interest, taxes, depreciation, and/or amortization;
•
earnings before interest, taxes, depreciation, and/or amortization as adjusted to exclude any one or more of the following:
•
share-based compensation expense;
•
provision for income taxes from continuing operations;
•
income from discontinued operations;
•
gain on sale of discontinued operations;
•
equity in loss of unconsolidated entity;
•
gain on cancellation of debt;
•
debt extinguishment and related costs;
•
restructuring, separation, and/or integration charges and costs;
•
reorganization and/or recapitalization charges and costs;
•
impairment charges;
•
fair value adjustments to acquisition-related earn-out liabilities;
•
acquisition and similar transaction charges;
•
gain or loss related to investments; and
•
gain on investment in common stock warrants;
•
sales or revenue targets, whether in general, by type of product or service, or by type of customer;
•
contract value growth;
•
gross, operating or profit margins;
•
return measures, including return on assets or net assets, capital (including return on total capital or return on invested capital), investment, equity, sales, revenue, or operating revenue;
•
cash flow (before or after dividends), including:
•
operating cash flow;
•
free cash flow, defined as cash flow from operations less capital expenditures;
•
levered free cash flow, defined as free cash flow less interest expense;
•
cash flow return on equity; and
•
cash flow return on investment;
•
productivity ratios;
•
expense targets;
•
market share;
•
financial ratios as provided in debt agreements of the company and its subsidiaries;
•
working capital targets;
•
completion of acquisitions of assets, businesses, or companies;
•
completion of divestitures and asset sales;
•
customer satisfaction or customer service;
•
market capitalization;
•
economic value added;
•
debt leverage (debt to capital);
•
operating ratio;
•
contract value; or
•
client renewal rate.

To the extent consistent with Section 162(m) of the Code, (A) unless the Administrator otherwise establishes in writing in connection an Award at the time the Award is granted, the Administrator shall appropriately adjust any evaluation of performance under Qualifying Performance Criteria to eliminate the effects of charges for restructurings, discontinued operations, extraordinary items and all items of gain, loss or expense determined to be extraordinary or unusual in nature or




related to the disposal of a segment of a business or related to a change in accounting principle, all as determined in accordance with standards established by opinion No. 30 of the Accounting Principles Board (APA Opinion No. 30) or other applicable or successor accounting provisions, as well as the cumulative effect of accounting changes, in each case as determined in accordance with generally accepted accounting principles or identified in the Company’s financial statements or notes to the financial statements, and (B) the Administrator may appropriately adjust any evaluation of performance under Qualifying Performance Criteria to exclude any of the following events that occurs during a performance period: (i) asset write-downs, (ii) litigation or claims, judgments, or settlements, (iii) acquisitions or divestitures, (iv) foreign exchange gains and losses, (v) accruals of any amounts for payment under this Plan or any other compensation arrangement maintained by the Company, and (vi) the impact of repurchase of shares of stock under share repurchase programs.
14. Transferability
Each Award may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated by a Participant other than by will or the laws of descent and distribution, and each Option or Stock Appreciation Right shall be exercisable only by the Participant during his or her lifetime. Notwithstanding the foregoing, to the extent permitted by the Administrator, the person to whom an Award is initially granted (the “Grantee”) may transfer an Award to any “family member” of the Grantee (as such term is defined in Section 1(a)(5) of the General Instructions to Form S-8 under the Securities Act of 1933, as amended (“Form S-8”)), to trusts solely for the benefit of such family members and to partnerships in which such family members and/or trusts are the only partners; provided that, (i) as a condition thereof, the transferor and the transferee must execute a written agreement containing such terms as specified by the Administrator, and (ii) the transfer is pursuant to a gift or a domestic relations order to the extent permitted under the General Instructions to Form S-8. Except to the extent specified otherwise in the agreement the Administrator provides for the Grantee and transferee to execute, all vesting, exercisability and forfeiture provisions that are conditioned on the Grantee’s continued employment or service shall continue to be determined with reference to the Grantee’s employment or service (and not to the status of the transferee) after any transfer of an Award pursuant to this Section 14, and the responsibility to pay any taxes in connection with an Award shall remain with the Grantee notwithstanding any transfer other than by will or intestate succession.
15. Suspension or Termination of Awards
Except as otherwise provided by the Administrator, if at any time (including after a notice of exercise has been delivered or an award has vested) the Chief Executive Officer or any other person designated by the Administrator (each such person, an “Authorized Officer”) reasonably believes that a Participant may have committed an Act of Misconduct as described in this Section 15, the Authorized Officer, Administrator or the Board may suspend the Participant’s rights to exercise any Option, to vest in an Award, and/or to receive payment for or receive Shares in settlement of an Award pending a determination of whether an Act of Misconduct has been committed. If the Administrator or an Authorized Officer determines a Participant has committed an act of embezzlement, fraud, dishonesty, nonpayment of any obligation owed to the Company or any Subsidiary, breach of fiduciary duty, violation of Company ethics policy or code of conduct, or deliberate disregard of the Company or Subsidiary rules resulting in loss, damage or injury to the Company or any Subsidiary, or if a Participant makes an unauthorized disclosure of any Company or Subsidiary trade secret or confidential information, solicits any employee or service provider to leave the employ or cease providing services to the Company or any Subsidiary, breaches any intellectual property or assignment of inventions covenant, engages in any conduct constituting unfair competition, breaches any non-competition agreement, induces any Company or Subsidiary customer to breach a contract with the Company or any Subsidiary or to cease doing business with the Company or any Subsidiary, or induces any principal for whom the Company or any Subsidiary acts as agent to terminate such agency relationship (any of the foregoing acts, an “Act of Misconduct”), then except as otherwise provided by the Administrator, (i) neither the Participant nor his or her estate nor transferee shall be entitled to exercise any Option or Stock Appreciation Right whatsoever, vest in or have the restrictions on an Award lapse, or otherwise receive payment of an Award, (ii) the Participant will forfeit all outstanding Awards and (iii) the Participant may be required, at the Administrator’s sole discretion, to return and/or repay to the Company any then unvested Shares previously issued under the Plan. In making such determination, the Administrator or an Authorized Officer shall give the Participant an opportunity to appear and present evidence on his or her behalf at a hearing before the Administrator or its designee or an opportunity to submit written comments, documents, information and arguments to be considered by the Administrator. Any dispute by a Participant or other person as to the determination of the Administrator shall be resolved pursuant to Section 23 of the Plan.
Any Award granted pursuant to the Plan shall be subject to mandatory repayment by the Participant to the Company to the extent the Participant is, or in the future becomes, subject to (a) any Company “clawback” or recoupment policy that is adopted to comply with the requirements of any applicable law, rule or regulation, or otherwise, or (b) any law, rule or regulation which imposes mandatory recoupment, under circumstances set forth in such law, rule or regulation.
16. Compliance with Laws and Regulations
This Plan, the grant, issuance, vesting, exercise and settlement of Awards thereunder, and the obligation of the Company to sell, issue or deliver Shares under such Awards, shall be subject to all applicable foreign, federal, state and local laws, rules and regulations, stock exchange rules and regulations, and to such approvals by any governmental or regulatory




agency as may be required. The Company shall not be required to register in a Participant’s name or deliver any Shares prior to the completion of any registration or qualification of such shares under any foreign, federal, state or local law or any ruling or regulation of any government body which the Administrator shall determine to be necessary or advisable. To the extent the Company is unable to or the Administrator deems it infeasible to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder, the Company and its Subsidiaries shall be relieved of any liability with respect to the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. No Option shall be exercisable and no Shares shall be issued and/or transferable under any other Award unless a registration statement with respect to the Shares underlying such Option is effective and current or the Company has determined that such registration is unnecessary.
In the event an Award is granted to or held by a Participant who is employed or providing services outside the United States, the Administrator may, in its sole discretion, modify the provisions of the Plan or of such Award as they pertain to such individual to comply with applicable foreign law or to recognize differences in local law, currency or tax policy. The Administrator may also impose conditions on the grant, issuance, exercise, vesting, settlement or retention of Awards in order to comply with such foreign law and/or to minimize the Company’s obligations with respect to tax equalization for Participants employed outside their home country.
17. Withholding
To the extent required by applicable federal, state, local or foreign law, a Participant shall be required to satisfy, in a manner satisfactory to the Company, any withholding tax obligations that arise by reason of an Option exercise, disposition of Shares issued under an Incentive Stock Option, the vesting of or settlement of an Award, an election pursuant to Section 83(b) of the Code or otherwise with respect to an Award. To the extent a Participant makes an election under Section 83(b) of the Code, within ten days of filing such election with the Internal Revenue Service, the Participant must notify the Company in writing of such election. The Company and its Subsidiaries shall not be required to issue Shares, make any payment or recognize the transfer or disposition of Shares until all such obligations are satisfied. The Administrator may provide for or permit these obligations to be satisfied through the mandatory or elective sale of Shares and/or by having the Company withhold a portion of the Shares that otherwise would be issued to him or her upon exercise of the Option or the vesting or settlement of an Award, or by tendering Shares previously acquired.
18. Administration of the Plan
(a) Administrator of the Plan.
The Plan shall be administered by the Administrator who shall be the Compensation Committee of the Board or, in the absence of a Compensation Committee, the Board itself. Any power of the Administrator may also be exercised by the Board, except to the extent that the grant or exercise of such authority would cause any Award or transaction to become subject to (or lose an exemption under) the short-swing profit recovery provisions of Section 16 of the Securities Exchange Act of 1934 or cause an Award designated as a Performance Award not to qualify for treatment as performance-based compensation under Section 162(m) of the Code. To the extent that any permitted action taken by the Board conflicts with action taken by the Administrator, the Board action shall control. To the extent permitted by applicable law, the Compensation Committee may by resolution authorize one or more officers of the Company to perform any or all things that the Administrator is authorized and empowered to do or perform under the Plan, and for all purposes under this Plan, such officer or officers shall be treated as the Administrator; provided, however, that the resolution so authorizing such officer or officers shall specify the total number of Awards (if any) such officer or officers may award pursuant to such delegated authority, and any such Award shall be subject to the form of Option agreement theretofore approved by the Compensation Committee. No such officer shall designate himself or herself as a recipient of any Awards granted under authority delegated to such officer. The Compensation Committee hereby designates the Secretary of the Company and the head of the Company’s human resource function to assist the Administrator in the administration of the Plan and execute agreements evidencing Awards made under this Plan or other documents entered into under this Plan on behalf of the Administrator or the Company. In addition, the Compensation Committee may delegate any or all aspects of the day-to-day administration of the Plan to one or more officers or employees of the Company or any Subsidiary, and/or to one or more agents.
(b) Powers of Administrator.
Subject to the express provisions of this Plan, the Administrator shall be authorized and empowered to do all things that it determines to be necessary or appropriate in connection with the administration of this Plan, including, without limitation: (i) to prescribe, amend and rescind rules and regulations relating to this Plan and to define terms not otherwise defined herein; (ii) to determine which persons are Participants, to which of such Participants, if any, Awards shall be granted hereunder and the timing of any such Awards; (iii) to grant Awards to Participants and determine the terms and conditions thereof, including the number of Shares subject to Awards and the exercise or purchase price of such Shares and the circumstances under which Awards become exercisable or vested or are forfeited or expire, which terms may but need not be conditioned upon the passage of time, continued employment, the satisfaction of performance criteria, the occurrence of certain




events (including events which the Board or the Administrator determine constitute a change of control), or other factors; (iv) to establish and verify the extent of satisfaction of any performance goals or other conditions applicable to the grant, issuance, exercisability, vesting and/or ability to retain any Award; (v) to prescribe and amend the terms of the agreements or other documents evidencing Awards made under this Plan (which need not be identical) and the terms of or form of any document or notice required to be delivered to the Company by Participants under this Plan; (vi) to determine the extent to which adjustments are required pursuant to Section 12; (vii) to interpret and construe this Plan, any rules and regulations under this Plan and the terms and conditions of any Award granted hereunder; (viii) to approve corrections in the documentation or administration of any Award; and (ix) to make all other determinations deemed necessary or advisable for the administration of this Plan. The Administrator may, in its sole and absolute discretion, without amendment to the Plan, (x) extend the post-Termination of Employment exercisability of previously vested Options and Stock Appreciation Rights and (y) provide from and after the Amendment Date for vesting of an Award or the satisfaction and/or lapse of conditions under an Award in circumstances other than those referred to in Section 6(d) or Section 8(c) of this Plan, so long as the number of Shares underlying all such Awards subject to such vesting or satisfaction and/or lapse of conditions in such other circumstances shall not exceed the Specified Share Amount.
(c) Determinations by the Administrator.
All decisions, determinations and interpretations by the Administrator regarding the Plan, any rules and regulations under the Plan and the terms and conditions of or operation of any Award granted hereunder, shall be final and binding on all Participants, beneficiaries, heirs, assigns or other persons holding or claiming rights under the Plan or any Award. The Administrator shall consider such factors as it deems relevant, in its sole and absolute discretion, to making such decisions, determinations and interpretations including, without limitation, the recommendations or advice of any officer or other employee of the Company and such attorneys, consultants and accountants as it may select.
(d) Subsidiary Awards.
In the case of a grant of an Award to any Participant employed by a Subsidiary, such grant may, if the Administrator so directs, be implemented by the Company issuing any subject Shares to the Subsidiary, for such lawful consideration as the Administrator may determine, upon the condition or understanding that the Subsidiary will transfer the Shares to the Participant in accordance with the terms of the Award specified by the Administrator pursuant to the provisions of the Plan. Notwithstanding any other provision hereof, such Award may be issued by and in the name of the Subsidiary and shall be deemed granted on such date as the Administrator shall determine.
(e) Other Committees.
The Board may appoint one or more committees of the Board, each composed of one or more directors of the Company who need not be Nonemployee Directors, which may administer the Plan with respect to Participants who are not “officers” as defined in Rule 16a-1(f) under the Securities Exchange Act of 1934, as amended, or directors of the Company, may grant Awards under the Plan to such Participants, and may determine all terms of such Awards, subject to the requirements of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, Section 162(m) of the Code and, for so long as the Stock is listed on The NASDAQ Stock Exchange LLC, the rules of such stock exchange.
19. Amendment of the Plan or Awards
The Board may amend, alter or discontinue this Plan and the Administrator may amend, or alter any agreement or other document evidencing an Award made under this Plan but, except as provided pursuant to the provisions of Section 12, no such amendment shall, without the approval of the stockholders of the Company:
(a) increase the maximum number of Shares for which Awards may be granted under this Plan;
(b) reduce the price at which Options or Stock Appreciation Rights may be granted below the Fair Market Value as provided for in Sections 6(b) and 7;
(c) reduce the exercise price of outstanding Options or Stock Appreciation Rights;
(d) extend the term of this Plan;
(e) change the class of persons eligible to be Participants;
(f) otherwise amend the Plan in any manner requiring stockholder approval by law or under the NASDAQ Global Select Market listing requirements; or
(g) increase the individual maximum limits in Sections 5(c) and 5(d).
No amendment or alteration to the Plan or an Award or Award Agreement shall be made which would impair the rights of the holder of an Award, without such holder’s consent, provided that no such consent shall be required if the Administrator determines in its sole discretion and prior to the date of any change of control (as defined in the applicable Award Agreement) that such amendment or alteration either is required or advisable in order for the Company, the Plan or the Award to satisfy any




law or regulation or to meet the requirements of or avoid adverse financial accounting consequences under any accounting standard.
20. No Liability of Company
The Company and any Subsidiary or affiliate which is in existence or hereafter comes into existence shall not be liable to a Participant or any other person as to: (i) the non-issuance or sale of Shares as to which the Company has been unable to obtain from any regulatory body having jurisdiction the authority deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder; and (ii) any tax consequence expected, but not realized, by any Participant or other person due to the receipt, exercise or settlement of any Award granted hereunder.
21. Non-Exclusivity of Plan
Neither the adoption of this Plan by the Board nor the submission of this Plan to the stockholders of the Company for approval shall be construed as creating any limitations on the power of the Board or the Administrator to adopt such other incentive arrangements as either may deem desirable, including without limitation, the granting of restricted stock or stock options otherwise than under this Plan or an arrangement not intended to qualify under Code Section 162(m), and such arrangements may be either generally applicable or applicable only in specific cases.
22. Governing Law
This Plan and any agreements or other documents hereunder shall be interpreted and construed in accordance with the laws of the Delaware and applicable federal law. Any reference in this Plan or in the agreement or other document evidencing any Awards to a provision of law or to a rule or regulation shall be deemed to include any successor law, rule or regulation of similar effect or applicability.
23. Arbitration of Disputes
In the event a Participant or other holder of an Award or person claiming a right under an Award or the Plan believes that a decision by the Administrator with respect to such person or Award was arbitrary or capricious, the person may request arbitration with respect to such decision. The review by the arbitrator shall be limited to determining whether the Participant or other Award holder has proven that the Administrator’s decision was arbitrary or capricious. This arbitration shall be the sole and exclusive review permitted of the Administrator’s decision. Participants, Award holders and persons claiming rights under an Award or the Plan explicitly waive any right to judicial review.
Notice of demand for arbitration shall be made in writing to the Administrator within thirty (30) days after the applicable decision by the Administrator. The arbitrator shall be selected by those members of the Board who are neither members of the Compensation Committee of the Board nor employees of the Company or any Subsidiary. If there are no such members of the Board, the arbitrator shall be selected by the Board. The arbitrator shall be an individual who is an attorney licensed to practice law in the jurisdiction in which the Company’s headquarters are then located. Such arbitrator shall be neutral within the meaning of the Commercial Rules of Dispute Resolution of the American Arbitration Association; provided, however, that the arbitration shall not be administered by the American Arbitration Association. Any challenge to the neutrality of the arbitrator shall be resolved by the arbitrator whose decision shall be final and conclusive. The arbitration shall be administered and conducted by the arbitrator pursuant to the Commercial Rules of Dispute Resolution of the American Arbitration Association. Each side shall bear its own fees and expenses, including its own attorney’s fees, and each side shall bear one half of the arbitrator’s fees and expenses. The decision of the arbitrator on the issue(s) presented for arbitration shall be final and conclusive and may be enforced in any court of competent jurisdiction.
24. No Right to Employment, Reelection or Continued Service
Nothing in this Plan or an Award Agreement shall interfere with or limit in any way the right of the Company, its Subsidiaries and/or its affiliates to terminate any Participant’s employment, service on the Board or service for the Company at any time or for any reason not prohibited by law, nor shall this Plan or an Award itself confer upon any Participant any right to continue his or her employment or service for any specified period of time. Neither an Award nor any benefits arising under this Plan shall constitute an employment contract with the Company, any Subsidiary and/or its affiliates. Subject to Sections 4 and 19, this Plan and the benefits hereunder may be terminated at any time in the sole and exclusive discretion of the Board without giving rise to any liability on the part of the Company, its Subsidiaries and/or its affiliates.
25. Unfunded Plan
The Plan is intended to be an unfunded plan. Participants are and shall at all times be general creditors of the Company with respect to their Awards. If the Administrator or the Company chooses to set aside funds in a trust or otherwise for the payment of Awards under the Plan, such funds shall at all times be subject to the claims of the creditors of the Company in the event of its bankruptcy or insolvency.
* * *




The Plan was adopted by the Board as of June 22, 2009 and approved by the stockholders on September 11, 2009. On July 26, 2011, the Board adopted an amendment to increase the total number of Shares issuable under the Plan, which became effective upon stockholder approval thereof at the Company’s 2011 annual meeting of stockholders held on September 13, 2011. On July 19, 2013, the Board adopted additional amendments to the Plan, which became effective upon stockholder approval thereof at the Company’s 2013 annual meeting of stockholders held on September 5, 2013. On April 20, 2015, the Board adopted an amendment to increase the total number of Shares issuable under the Plan and certain additional amendments to the Plan, which became effective upon stockholder approval of the amendment to increase the total number of Shares issuable under the Plan at the Company’s 2015 annual meeting of stockholders held on June 9, 2015.
 
 
 
THE ADVISORY BOARD COMPANY
 
 
 
By:
 
/s/ Evan Farber
 
 
 
Name:
 
Evan Farber
 
 
 
Title:
 
General Counsel and Corporate Secretary








Exhibit 12.1


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

 
Six Months Ended
June 30, 2015
 
Nine Months Ended
December 31, 2014
 
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
$
(11,684
)
 
$
15,925

 
$
49,892

 
$
48,079

 
$
39,406

 
$
28,145

Fixed charges
13,367

 
4,378

 
4,833

 
3,582

 
2,650

 
2,189

 
 
 
 
 
 
 
 
 
 
 
 
Total earnings available for fixed charges
$
1,683

 
$
20,303

 
$
54,725

 
$
51,661

 
$
42,056

 
$
29,960

 
 
 
 
 
 
 
 
 
 
 
 
Fixed charges:
 
 
 
 
 
 
 
 
 
 
 
   Interest component of rental payments
$
2,601

 
$
3,920

 
$
4,254

 
$
3,214

 
$
2,650

 
$
2,189

Interest expense
10,766

 
458

 
579

 
368

 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
 
Total fixed charges
13,367

 
4,378

 
4,833

 
3,582

 
2,650

 
2,189

 
 
 
 
 
 
 
 
 
 
 
 
Ratio of earnings to fixed charges
*

 
4.64x

 
11.32x

 
14.42x

 
15.87x

 
13.69x

 
 
 
 
 
 
 
 
 
 
 
 
* Earnings for the six months ended June 30, 2015 were inadequate to cover fixed charges by $11,684

(a)
The Advisory Board had no preferred equity securities outstanding and did not pay preferred dividends in any of the periods presented. Consequently, the Advisory Board’s ratio of earnings to combined fixed charges and preferred stock dividends for each of such periods is identical to the Advisory Board’s ratio of earnings to fixed charges as indicated above.
The Advisory Board 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 Advisory Board to be representative of the interest factor of rental payments under operating leases, which the Advisory Board 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: August 7, 2015
 
 
 
 
 
/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: August 7, 2015
 
 
 
 
 
/s/ Michael T. Kirshbaum
 
 
 
 
 
 
Michael T. Kirshbaum,
 
 
 
 
 
 
Chief Financial Officer and Treasurer






Exhibit 32.1
THE ADVISORY BOARD COMPANY
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Each of the undersigned hereby certifies, in his capacity as an officer of The Advisory Board Company (the “Company”), for purposes of 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:
 
(1)
The Quarterly Report on Form 10-Q of the Company for the quarterly period ended June 30, 2015 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
 
August 7, 2015
 
 
 
 
 
 
/s/ Michael T. Kirshbaum
 
Michael T. Kirshbaum
 
Chief Financial Officer and Treasurer
 
August 7, 2015
 


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