UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2016

or

Commission File Number: 001-34849

 

CEB Inc.

(Exact name of registrant as specified in its charter)

 

 

 

(571) 303-3000

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address or former fiscal year, if changed since last report)

 

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  ☒    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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

The Company had 32,228,207 shares of common stock, par value $0.01 per share, outstanding at October 28, 2016.

 

 

 

 

 

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CEB Inc.

INDEX TO FORM 10-Q

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

 

Item 1. Financial Statements.

CEB Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

 

See accompanying notes to condensed consolidated financial statements.

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CEB Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

 

See accompanying notes to condensed consolidated financial statements.

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CEB Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(In thousands)

(Unaudited)

 

 

See accompanying notes to condensed consolidated financial statements.

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CEB Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

See accompanying notes to condensed consolidated financial statements.

 

 

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CEB Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Nature of Business and Basis of Presentation

CEB Inc. (“CEB” or “Company”) is a best practice insight and technology company. In partnership with leading organizations around the globe, CEB develops innovative solutions to drive corporate performance. CEB’s mission is to unlock the potential of organizations and leaders by advancing the science and practice of management.

The accompanying condensed consolidated financial statements have been prepared in accordance with US generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) for reporting on Form 10-Q. Accordingly, certain information and disclosures required for complete consolidated financial statements are not included. It is recommended that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and related notes in CEB’s 2015 Annual Report on Form 10-K.

In management’s opinion, all adjustments, consisting of a normal recurring nature, considered necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows at the dates and in the periods presented have been included. The consolidated balance sheet at December 31, 2015 has been derived from the financial statements that were audited by CEB’s independent registered public accounting firm. The results of operations for the three and nine months ended September 30, 2016 may not be indicative of the results that may be expected in the year ended December 31, 2016 or any other period within 2016.

 

 

Note 2. Recent Accounting Pronouncements

Recently adopted

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-05, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. This ASU requires management to evaluate each cloud computing arrangement in order to determine whether it includes a software license that must be accounted for separately from hosted services. ASU 2015-05 also eliminates the existing requirement for customers to account for software licenses they acquire by analogizing to the guidance on leases. If the arrangement involves a software license, the Company evaluates whether the costs meet the criteria for capitalization as internal-use software. If the arrangement does not involve a software license, the Company accounts for the arrangement as a service contract and expenses the costs as incurred. The Company adopted this accounting standard prospectively on January 1, 2016. The Company began incurring significant costs in connection with its business transformation initiative beginning in 2016 for the development and implementation of cloud-based computing systems that will consolidate and standardize its sales processes and financial systems. These arrangements are primarily accounted for as service contracts, and therefore, the implementation costs are expensed as incurred and include software license fees, third-party vendor costs related to the implementation and development of the systems, and costs related to employees that are solely dedicated to the initiative.

Not yet adopted

In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory. This ASU will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory in the period in which the transfer occurs. The guidance is effective for annual periods beginning after December 15, 2017 and requires companies to apply a modified retrospective approach with a cumulative catch-up adjustment to opening retained earnings in the period of adoption. The Company currently has deferred $2.4 million of income tax effects from past intercompany transactions that are recorded as Other assets and is expected to be adjusted to opening retained earnings when the Company adopts the standard on January 1, 2018.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments (Topic 230). This ASU addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company does not expect the adoption of this ASU will have a material impact on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). This ASU requires excess tax benefits and tax deficiencies to be recorded in the income statement when awards are settled. This ASU also addresses simplifications related to statement of cash flows classification, accounting for forfeitures, and minimum statutory tax withholding requirements. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company estimates an adjustment to opening retained earnings of less than $1 million when it adopts the standard on January 1, 2017.

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In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires entities to recognize assets and liabilities for most leases on their balance sheets. It also requires additional qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the effect that this standard will have on its consolidated financial statements and related disclosures but expects that the adoption of ADU 2016-02 will result in a significant increase to the Company’s long-term assets and liabilities.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU requires entities to recognize revenue through the application of a five-step model, which includes identification of the contract, identification of the performance obligations, determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue as the entity satisfies the performance obligations. The standard is effective for periods beginning after December 15, 2017, with early adoption permitted. The Company is in the process of evaluating the methods of adoption and assessing the impact on its consolidated financial statements and related disclosures and expects to adopt the standard on January 1, 2018.

 

 

Note 3. Acquisitions and Other Investments

From time to time, the Company evaluates potential acquisitions that either strategically fit with or expand existing product offerings.

Evanta

On April 29, 2016, the Company completed the acquisition of 100% of the outstanding capital stock of CXO Acquisition Co. and Sports Leadership Acquisition Co. (collectively referred to as “Evanta”). Evanta focuses on C-suite executive development and collaboration solutions for peer-to-peer engagement, networking, and leadership training between information technology and security, human resources, and finance. Evanta primarily generates revenue from sponsorship fees for its events, and that revenue is recognized on the date the event occurs. As such, revenue generated from sponsorship fees is seasonal in nature, with a majority recognized in the second and the fourth quarters.

The transaction was accounted for as a business combination and the results of operations of Evanta have been included in the CEB segment since the date of acquisition. Total consideration was $269.2 million, net of $17.6 million cash acquired. A portion of the purchase price was deposited in an escrow account to secure the indemnification obligations of the seller. The Company amended its senior secured credit agreement to allow for additional term loan and revolving credit borrowings in order to fund the acquisition.

The following table summarizes the preliminary purchase price allocation based on the estimated fair value of the acquired assets and assumed liabilities as of the acquisition date (in thousands):

 

 

Deferred revenue at the acquisition date was recorded at fair value, which was estimated based on the cost to provide the related services plus a reasonable profit margin on such costs. The Company preliminarily allocated $51.2 million to amortizable intangible assets with a weighted average amortization period of 6.4 years. The intangible assets consist of $27.7 million of customer relationships, $16.4 million of software, and $7.1 million of intellectual property with a weighted average amortization period of 7.0, 6.1, and 5.0 years, respectively. The estimated aggregate amortization expense for each of the succeeding five years ended December 31, 2016 through 2020 is $5.6 million, $8.4 million, $8.4 million, $7.6 million, and $7.2 million, respectively, and $14.0 million thereafter. There was $24.5 million of tax deductible intangible assets, which are expected to be tax deductible through 2027. The remaining intangible assets are not deductible for tax purposes. As a result, the Company recorded a deferred tax liability of approximately $10.8 million related to the difference in book and tax basis of identifiable intangible assets. The Company allocated $237.3 million to goodwill, of which $48.1 million is expected to be tax deductible through 2027. The goodwill balance primarily represents the Company’s expected ability to generate future cash flows, drive revenue growth, and lower customer acquisition costs across both Evanta and CEB by leveraging existing executive relationships and enhancing the content of CEB service offerings and events.

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The Company is still evaluating the fair value of acquired assets and liabilities and therefore, the final allocation of the purchase price has not been completed. The allocation of the purchase price will be finalized upon the receipt of final valuations for the underlying assets and liabilities and the necessary management reviews thereof.

The amounts of revenue and net loss of Evanta since the acquisition date included in the consolidated statements of operations was $1.1 million and $4.1 million, respectively, in the three months ended September 30, 2016 and $12.6 million and $2.6 million, respectively, in the nine months ended September 30, 2016.

Pro Forma Financial Information

The following unaudited pro forma financial information summarizes the Company’s results of operations as if the Evanta acquisition had been completed on January 1, 2015. The pro forma financial information presented includes the impact of the fair value adjustment for deferred revenue, amortization expense from acquired intangible assets, interest expense, and related tax effects. The following unaudited pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition occurred on January 1, 2015 and should not be construed as representative of the future consolidated results of operations or financial condition of the combined entity (in thousands):

 

 

Pro forma revenue was reduced by $0.9 million and $8.9 million related to the deferred revenue fair value adjustment in the three and nine months ended September 30, 2015. Pro forma net income reflects material, nonrecurring adjustments of $0.6 million and $5.4 million related to the deferred revenue fair value adjustment in the three and nine months ended September 30, 2015, respectively, and $1.0 million of debt modification costs directly attributable to the acquisition in the nine months ended September 30, 2015.

Other Investments

The Company held a total of eleven and nine investments in private entities with an aggregate carrying amount of $27.7 million and $23.3 million at September 30, 2016 and December 31, 2015, respectively, for which the cost method was used. These investments are carried at their original cost and evaluated each reporting period as to whether an event or change in circumstances has occurred in the period that may have an adverse effect on the net realizable value of the assets. Because the investee entities are private companies without exchange traded securities, the fair value of the underlying investment is not practical to estimate.

The Company also has an equity ownership in one private entity for which the equity method is used. The aggregate carrying amount was $5.7 million and $6.1 million at September 30, 2016 and December 31, 2015, respectively.

 

 

Note 4. Fair Value Measurements

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. There is a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

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The Company has segregated all assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the tables below (in thousands):

 

 

Investments held through variable insurance products in a Rabbi Trust consist of mutual funds available only to institutional investors. The fair value of these investments is based on the fair value of the underlying investments held by the mutual funds allocated to each share of the mutual fund using a net asset value approach. The fair value of the underlying investments held by the mutual funds is based on observable inputs. The fair value of foreign currency exchange contracts and interest rate swaps are based on bank quotations for similar instruments using models with market-based inputs.

Available-for-sale securities primarily represent the Company’s investments in promissory notes of private entities. The Company utilized various unobservable inputs, including the estimate of the fair value of the stock of the underlying company, interest rate trends, and probability of future conversions, to determine the fair value.

The fair value of the Company’s Senior Secured Credit Facilities and senior notes are based on Level 2 inputs using quoted market prices for similar issuances after considering observable market-based inputs such as quality, interest rates, and other characteristics. The carrying value of the Company’s Term A-3 Loans and Revolving Credit Facility approximate their fair value as the terms and interest rate approximate market rates. The carrying value of the senior notes approximates their fair value based on a review of recent market trading activity.

Changes to the fair values classified within Level 3 were as follows (in thousands):

 

 

 

Note 5. Accounts Receivable, net

Accounts receivable, net consisted of the following (in thousands):

 

 

 

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Note 6. Goodwill

Changes in the carrying amount of goodwill were as follows (in thousands):

 

 

 

Note 7. Intangible Assets, Net

Intangible assets, net at September 30, 2016 consisted of the following (in thousands):

 

 

Amortization expense was $17.1 million and $8.7 million in the three months ended September 30, 2016 and 2015 and $52.4 million and $26.5 million in the nine months ended September 30, 2016 and 2015, respectively. In the fourth quarter of 2015, the estimated useful life of the SHL trade name was changed to December 31, 2016 thereby increasing amortization in 2016. Future expected amortization of intangible assets at September 30, 2016, calculated using foreign currency exchange rates in effect at the balance sheet date, was as follows for the remainder of 2016 and for future years ended December 31 (in thousands):

 

 

 

Note 8. Other Liabilities

Other liabilities consisted of the following (in thousands):

 

 

Included in Other at September 30, 2016 was $3.0 million related to a non-compete obligation through 2020 with the Company’s CEO in connection with his decision to step down as Chairman and CEO.

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Note 9. Debt

Debt consisted of the following (in thousands):

 

 

Future minimum payments of debt outstanding at September 30, 2016 were as follows for the years ended December 31 (in thousands):

 

 

Senior Secured Credit Facilities Amendment

On April 29, 2016, in connection with the closing of the Evanta acquisition, the Company, together with certain of its subsidiaries acting as guarantors, entered into Amendment No. 5 (“Amendment No. 5”) to the Company’s senior secured credit agreement (as amended, restated, supplemented, or otherwise modified from time to time, the “Credit Agreement”). Amendment No. 5 (i) increased the size of the Company’s existing term A-2 facility (“Term A-2 Facility”) by $150.0 million (such increase, the “Additional Term A Loans”) and (ii) increased its revolving credit facility by $100.0 million for a total available amount of $350.0 million (“Revolving Credit Facility” and, together with the Term A-2 Facility, the “Senior Secured Credit Facilities”). Amendment No. 5 also refinanced all term loans outstanding under the Senior Secured Credit Facilities (“Term A-2 Term Loans”) and Additional Term A Loans into a single tranche (the existing Term A-2 Term Loans plus the Additional Term A Loans, together as refinanced, “Term A-3 Loans”) and extended the maturity date of the Senior Secured Credit Facilities from June 9, 2020 to April 29, 2021. The principal amount of the Term A-3 Loans amortizes in quarterly installments equal to (i) for the first two years commencing on June 30, 2016, 2% of the original principal amount of the Term A-3 Loans and (ii) for the next three years thereafter, 4% of the original principal amount of the Term A-3 Loans with the balance payable at maturity.

Borrowings under the Senior Secured Credit Facilities bear interest at rates based on the ratio of the Company’s and its subsidiaries’ consolidated indebtedness to the Company’s and its subsidiaries’ consolidated EBITDA (as defined in the Credit Agreement) for applicable periods specified in the Senior Secured Credit Facilities. The interest rate per annum applicable to the loans under the Senior Secured Credit Facilities will be based on a fluctuating rate of interest equal to the sum of an applicable margin and, at the Company’s election from time to time, of either (1) a base rate determined by reference to the highest of (a) the rate as publicly announced from time to time by Bank of America as its “prime rate”, (b) the federal funds effective rate plus 0.50%, and (c) the one-month LIBOR plus 1.00%, or (2) a Eurocurrency rate determined by reference to LIBOR with a term, as selected by the Company, of one, two, three, or six months (or twelve months if consented to by all the lenders under the applicable loan). Borrowings under the Senior Secured Credit Facilities will be subject to a “zero percent” floor in the case of LIBOR loans.

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The Senior Secured Credit Facilities are secured by certain collateral, subject to certain exceptions and thresholds, including (a) a perfected first priority security interests in substantially all tangible and intangible personal property and fee-owned real property of the Company and each of the Company’s wholly-owned material domestic subsidiaries, including the newly acquired Evanta entities and their subsidiaries and (b) a perfected first priority pledge of (i) the equity interests of each direct domestic restricted subsidiary of the Company and each of the Company’s wholly-owned material subsidiaries, including the newly acquired Evanta entities and their subsidiaries and (ii) 65% of the stock of each material first-tier foreign restricted subsidiary of the Company. On April 29, 2016, the Company and the newly acquired Evanta entities and their subsidiaries entered into the applicable security documents, and certain collateral was pledged thereunder.

The Company evaluated each investor of the Term A-2 Loans that reinvested in the Term A-3 Loans. The change in the present value of the future cash flows between the investments was less than 10% and, thus, the debt refinancing was accounted for as a debt modification for which the Company expensed $1.7 million of debt issuance costs paid to third parties and capitalized debt issuance costs paid to the creditors as a reduction to debt. The Company determined a new effective interest rate to amortize the capitalized debt issuance costs. In addition, debt issuance costs related to the revolving commitments under the Revolving Credit Facility were deferred and amortized over the extended term since the borrowing capacity of the new arrangement was greater than the borrowing capacity of the old arrangement.

In June 2015, the Company used the proceeds from the offering of the senior notes, together with borrowings under the Term A-2 Loans and cash on hand, to prepay and terminate the Company’s then existing Term A-1 Loans and to pay related fees and expenses. Accordingly, the Company recognized debt modification costs based on its evaluation of the refinanced borrowings for each investor. The Company expensed $4.8 million in debt modification costs related to these debt transactions.

 

 

Note 10. Derivative Instruments and Hedging Activities

The Company’s international operations are subject to risks related to currency exchange fluctuations. The Company uses forward currency contracts, designated as cash flow hedging instruments, to protect against foreign currency exchange rate risks inherent with revenue and cost reimbursement transactions. A forward currency contract obligates the Company to exchange a predetermined amount of one currency to make equivalent payments in another currency equal to the value of such exchange.

The Company has entered into forward currency contracts to sell Australian dollars (“AUD”) and Euros (“EUR”) and buy British pound sterling (“GBP”), which will settle at various times through December 31, 2016. These contracts have been designated as cash flow hedges of anticipated revenue to be recognized in the local currency and are expected to have no or an immaterial amount of ineffectiveness. The contracts provide a natural offset to GBP costs. The notional amount of outstanding forward currency contracts at September 30, 2016 was AUD 6.2 million and EUR 10.7 million. In October 2016, the Company entered into additional forward currency contracts to sell AUD 5.4 million and EUR 4.4 million.

The fair value of derivative instruments in the condensed consolidated balance sheets was as follows (in thousands):

 

 

The pre-tax derivative instrument gains and losses recognized in OCI were as follows (in thousands):

 

 

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The pre-tax effect of derivative instruments in the condensed consolidated statements of operations was as follows (in thousands):

 

 

 

Note 11. Stockholders’ Equity and Share-Based Compensation

Share-Based Compensation

The Company has restricted stock units (“RSUs”), stock appreciation rights (“SARs”), and performance share awards (“PSAs”) outstanding that were granted to employees and directors. Share-based compensation expense is recognized on a straight-line basis, net of an estimated forfeiture rate, for those shares expected to vest over the requisite service period of the award, which is generally the vesting term of four years.

The Company recognized share-based compensation costs of $4.9 million and $4.3 million in the three months ended September 30, 2016 and 2015 and $14.1 million and $13.3 million in the nine months ended September 30, 2016 and 2015, respectively. These amounts are allocated to Cost of services, Member relations and marketing, and General and administrative expenses in the condensed consolidated statements of operations. The total income tax benefit for share-based compensation arrangements was $2.0 million and $1.7 million in the three months ended September 30, 2016 and 2015 and $5.6 million and $5.3 million in the nine months ended September 30, 2016 and 2015, respectively. At September 30, 2016, $36.1 million of total estimated unrecognized share-based compensation cost is expected to be recognized over a weighted-average period of approximately 3 years.

In the nine months ended September 30, 2016, the Company granted 452,788 RSUs and 46,597 PSAs with a weighted-average grant date fair value of $59.61 and $58.74, respectively. Additionally, 249,951 RSUs vested in the nine months ended September 30, 2016 with a weighted-average grant date fair value of $61.96.

Share Repurchases

In February 2016, the Company’s Board of Directors approved a $150 million stock repurchase program, which is authorized through December 31, 2017. Repurchases may be made through open market purchases or privately negotiated transactions. The timing of repurchases and the exact number of shares of common stock to be repurchased will be determined by the Company’s management, in its discretion, and will depend upon market conditions and other factors.

The Company repurchased 0.9 million shares of its common stock at a total cost of $52.5 million pursuant to publicly announced plans in the nine months ended September 30, 2016 (no repurchases were made in the three months ended September 30, 2016). Other repurchase activity was related to common stock surrendered by employees to satisfy federal and state tax withholding obligations.

Dividends

The Company funds its dividend payments with cash on hand and cash generated from operations. The Company declared and paid a quarterly cash dividend of $0.4125 per share in each of the first three quarters of 2016. In November 2016, the Board of Directors declared a fourth quarter 2016 cash dividend of $0.4125 per share. The dividend is payable on December 30, 2016 to stockholders of record at the close of business on December 15, 2016.

 

 

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Note 12. Restructuring Costs

In the fourth quarter of 2015, the Company committed to a workforce reduction plan (“2015 Plan”) as it identified areas for change in the market structure, initiated other actions to streamline operations, and rebalanced the management mix in certain areas. Total pre-tax restructuring charges related to the 2015 Plan were $6.2 million, consisting primarily of severance and related termination benefits. Of this amount, $5.1 million and $1.1 million was recognized in the fourth quarter of 2015 and in the first half of 2016, respectively, as Restructuring costs in the consolidated statements of operations. Substantially all of the cash was paid in 2016. The Company does not expect to incur any additional costs associated with the 2015 Plan.

 

 

Note 13. Income Taxes

The Company computes the provision for income taxes by applying the estimated annual effective tax rate to income from operations and adjusting the provision for discrete tax items. US income taxes are not provided for certain undistributed earnings of foreign subsidiaries, as such earnings are deemed to be permanently reinvested locally.

The effective tax rate was 27.2% and 34.1% in the three and nine months ended September 30, 2016 and 21.9% and 22.7% in the three and nine months ended September 30, 2015, respectively.

The Company’s effective tax rate in the three and nine months ended September 30, 2016 differed from the federal statutory rate of 35% primarily due to the benefits of a UK financing transaction, the overall impact of earnings within and outside the US, state income taxes, and US government incentives, such as research tax credits and deductions related to domestic production activities. In addition, the Company recognized a discrete tax benefit of $1.6 million and $1.1 million in the three and nine months ended September 30, 2016, respectively. The discrete tax benefit in the three months ended September 30, 2016 primarily related to a $1.2 million benefit associated with amending 2012-2013 tax returns. The discrete tax benefit in the nine months ended September 30, 2016 was primarily related to a $1.2 million benefit associated with amending 2012-2013 tax returns offset by discrete tax expense of $0.4 million from changes in tax planning strategies.

The Company’s effective tax rate in the three and nine months ended September 30, 2015 differed from the federal statutory rate due to discrete items, foreign tax credits, government provided tax incentives, and the benefits of a UK financing transaction, which were partially offset by state income taxes. The Company recognized a discrete tax benefit of $4.4 million and $11.5 million in the three and nine months ended September 30, 2015, respectively. The discrete tax benefit in the three and nine months ended September 30, 2015 was primarily related to amending certain US returns resulting in the recognition of $0.3 million and $2.2 million of tax benefits for US foreign tax credits that were previously taken as deductions, and $1.7 million and $6.2 million in tax benefits for US government provided incentives for domestic productions activities and research and development credits and $2.2 million and $2.2 million related to other tax planning strategies, respectively.

The Company made income tax payments of $2.4 million and $4.1 million in the three months ended September 30, 2016 and 2015, and $19.4 million and $49.6 million in the nine months ended September 30, 2016 and 2015, respectively. The Company had net prepaid income taxes of $14.5 million at September 30, 2016 included in Prepaid expenses and other current assets.

 

 

Note 14. Earnings per Share

A reconciliation of basic to diluted weighted average common shares outstanding was as follows (in thousands):

 

 

 

Note 15. Commitments and Contingencies

Contingencies

From time to time, the Company is subject to litigation related to normal business operations. The Company vigorously defends itself in litigation and is not currently a party to, and the Company’s property is not subject to, any legal proceedings likely to materially affect its financial results.

 

 

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Note 16. Changes in Accumulated Other Comprehensive (Loss) Income

Accumulated elements of other comprehensive (loss) income (“AOCI”) is comprised of items that have not been recognized in earnings but may be recognized in earnings in the future when certain events occur. Changes in each component of AOCI in the three and nine months ended September 30, 2016 were as follows (in thousands):

 

 

 

 

Note 17. Segment Information

Operating segments are components of an enterprise about which separate financial information is available and regularly evaluated by the chief operating decision maker of an enterprise. The Company has two reportable segments, CEB and CEB Talent Assessment. The CEB segment includes the legacy CEB business, PDRI and Evanta. The CEB Talent Assessment Segment includes the legacy SHL business. The Company’s segment profit measure is Adjusted EBITDA.

Information for the Company’s reportable segments was as follows (in thousands):

 

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The table below reconciles revenue to Adjusted revenue (in thousands):

 

 

The table below reconciles net income to Adjusted EBITDA (in thousands):

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. The following discussion includes forward-looking statements that involve certain risks and uncertainties. For additional information regarding forward-looking statements and risk factors, see “Forward-looking statements” and Part II, Item IA. “Risk Factors.”

Business Overview

We are a best practice insight and technology company. In partnership with leading organizations around the globe, we develop innovative solutions to drive corporate performance. Our mission is to unlock the potential of organizations and leaders by advancing the science and practice of management. We operate through two reporting segments: CEB and CEB Talent Assessment.

CEB Segment

The CEB segment includes legacy CEB, Personnel Decision Research Institution, Inc. (“PDRI”), and Evanta. The CEB segment provides comprehensive data analysis, research, and advisory services that align to executive leadership roles and key recurring decisions and enable members to focus efforts to address emerging and recurring business challenges efficiently and effectively. With the acquisition of Evanta, CEB provides services that focus on C-suite executive development and collaboration solutions for peer-to-peer engagement, networking, and leadership training. PDRI provides customized personnel assessment tools and services to various agencies of the US government and also to commercial enterprises.

Our primary source of revenue is the delivery of annual, fixed-fee membership subscriptions to a global base of customers. In addition, we offer professional services that relate to workforce survey and analytics, executive and staff training, and talent assessment services. Included in the CEB Segment is the revenue from the Evanta acquisition, which is mainly generated from sponsorship fees for its events and is recognized on the date the event occurs. As such, the revenue generated from sponsorship fees is seasonal in nature, with a majority recognized in the second and the fourth quarters. Evanta also generates revenue from a membership based service and an online leadership development learning platform both of which are recognized on a pro rata basis over the membership term of service, which is generally 12 months.

Our membership subscriptions include continuous access to comprehensive data analysis, research, and advisory services that align to executive leadership roles and key recurring decisions. To fully support our members, our products and services are offered across a wide range of industries and focus on several key corporate functions including: Human Resources; Finance; Innovation and Strategy; Legal, Risk and Compliance; Marketing and Communications; Sales and Service; and Information Technology. In addition to these corporate functions, the CEB segment serves operational business leaders in the financial services industry and government agencies through insights, tools, and peer collaboration designed to drive effective executive decision making.

Our professional services are primarily delivered to Human Resources and Sales executives. Human Resources based professional services address the entire employee life cycle, helping executives improve business performance by realizing the value and potential of their people. Sales based professional services assist our member companies with changing the way they engage customers to ensure greater success through sales management training, sales staff development, and organizational alignment. The term of professional services engagements varies based on the depth of the service purchased and the size of the member organization.

CEB Talent Assessment Segment

Our CEB Talent Assessment segment primarily consists of the acquired SHL Group Holdings I (“SHL”) business without PDRI. We offer cloud based talent assessment solutions, development, strategy, analytics, decision support, and professional services that support those solutions, enabling client access to data, analytics, and insights for assessing and managing employees and applicants. CEB Talent Assessment assists clients with determining potential candidates for employment and developing existing employees and also provides consulting services that help maximize the utility of assessment data. The tools and services provided by CEB Talent Assessment use science and data to develop talent strategies for clients that are linked to business results.

Our focus is primarily on supporting the Human Resources function and we also market services to other corporate functions. CEB Talent Assessment offerings include cognitive ability assessments, skills and/or knowledge assessments, personality questionnaires, and job/role simulations and are generally implemented as pre-hire or post-hire applications. Our proprietary workshops and technical training provide an executive education curriculum supported by e-learning resources for members seeking to enhance skill development for their staff. These tools and services use science and data to develop talent strategies for clients that are linked to business results. Assessment services are available online through metered and subscription arrangements. Consulting services are generally provided to customize assessment services and face to face assessments and are delivered for a fixed fee. Training services consist of either bespoke or public courses related to use of assessments.

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Non-GAAP Financial Measures

This Quarterly Report on Form 10-Q includes a discussion of Adjusted revenue, Adjusted effective tax rate, Adjusted EBITDA, Adjusted EBITDA margin, Adjusted net income, Non-GAAP diluted earnings per share, and constant currency financial information, all of which are non-GAAP financial measures provided as a complement to the results provided in accordance with accounting principles generally accepted in the United States of America (“GAAP”). “Adjusted EBITDA margin” refers to Adjusted EBITDA as a percentage of Adjusted revenue. A reconciliation of these non-GAAP measures to the most directly comparable GAAP measures is included in the accompanying tables.

We believe that these non-GAAP financial measures are relevant and useful supplemental information for evaluating our results of operations as compared from period to period and as compared to our competitors. We use these non-GAAP financial measures for internal budgeting and other managerial purposes, including comparison against our competitors, when publicly providing our business outlook, and as a measurement for potential acquisitions. These non-GAAP financial measures are not defined in the same manner by all companies and therefore may not be comparable to other similarly titled measures used by other companies.

Our non-GAAP financial measures reflect adjustments based on the following items, as well as the related income tax effects:

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We are a global company that reports financial information in USD. Foreign currency exchange rate fluctuations affect the amounts reported from translating foreign revenues and expenses into USD. These rate fluctuations can have a significant effect on our reported operating results. As a supplement to our reported operating results, we present constant currency financial information. We use constant currency financial information to provide a framework to assess how our business performed excluding the effects of changes in foreign currency translation rates. Management believes this information is useful to investors to facilitate comparison of operating results and better identify trends in our businesses. To calculate financial information on a constant currency basis, financial information in the current period for amounts recorded in currencies other than the USD is translated into USD at the average exchange rates in effect during the comparable period of the prior year (rather than the actual exchange rates in effect during the current year period).

These non-GAAP measures may be considered in addition to results prepared in accordance with GAAP, but they should not be considered a substitute for, or superior to, GAAP results. We intend to continue to provide these non-GAAP financial measures as part of our future earnings discussions and, therefore, the inclusion of these non-GAAP financial measures will provide consistency in our financial reporting.

A reconciliation of these non-GAAP measures to the most directly comparable GAAP measure is provided below (in thousands, except per-share amounts):

Adjusted Revenue

 

 

 

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Constant Currency Adjusted Revenue

 

 

Adjusted EBITDA

 

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 Adjusted EBITDA (continued)

 

 

Constant Currency Adjusted EBITDA

 

 

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Adjusted Net Income

 

 

Non-GAAP Diluted Earnings per Share

 

 

Adjusted Effective Tax Rate

 

 

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Critical Accounting Policies

The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, fair value measures, and related disclosures of assets and liabilities. In our 2015 Annual Report on Form 10-K, we discussed our material accounting policies that we believe are critical and require the use of complex judgment in their application. There have been no changes to our critical accounting policies since that time.

 

Consolidated Results of Operations

The following table presents an overview of our results of operations (in thousands):

 

 

See “Segment Results” below for a discussion of revenue and costs and expenses by segment.

Our operating costs and expenses consist of:

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Other (Expense) Income, Net

The following table presents the components of Other (expense) income, net (in thousands):

 

 

Other (expense) income increased $4.7 million in the three months ended September 30, 2016 compared to the same period of 2015 primarily as a result of higher interest expense associated with the Senior Secured Credit Facilities from additional borrowings and higher interest rates, and a lower net non-operating foreign currency gain. The increase was partially offset by an increase in the fair value of deferred compensation plan assets.

Other (expense) income increased $2.1 million in the nine months ended September 30, 2016 compared to the same period of 2015 primarily as a result of higher interest expense associated with the Senior Secured Credit Facilities from additional borrowings and higher interest rates, and a lower net non-operating foreign currency gain. The increase was partially offset by lower debt modification costs and by an increase in the fair value of deferred compensation plan assets.

The net non-operating foreign currency gain (loss) is primarily due to the remeasurement of US cash balances held by subsidiaries with a functional currency other than the US dollar, certain intercompany notes, and the balance sheets of non-US subsidiaries whose functional currency is the US dollar. In October 2015, we implemented a revised corporate structure to geographically align our intellectual property with our US and global commercial operations, which resulted in a significant change for certain non-US subsidiaries that previously, had a US functional currency because they were dependent on the parent company for financing. As a result, the functional currency of substantially all of our wholly owned subsidiaries is now the applicable local currency and translation adjustments are recorded in a separate component of stockholders’ equity (as opposed to adjustments previously resulting from the remeasurement process, which were recorded in net income). Changes in the net non-operating foreign currency gain (loss) in the three and nine months ended September 30, 2016 compared to the comparable period in 2015 was primarily due to the impact of currency fluctuations on the remeasurement of intercompany notes and the balance sheets of non-US subsidiaries whose functional currency is the US dollar.

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Provision for Income Taxes

We compute the provision for income taxes by applying the estimated annual effective tax rate to income from operations and adjusting the provision for discrete tax items. US income taxes are not provided for certain undistributed earnings of foreign subsidiaries, as such earnings are deemed to be permanently reinvested locally.

The effective tax rate was 27.2% and 34.1% in the three and nine months ended September 30, 2016 and 21.9% and 22.7% in the three and nine months ended September 30, 2015, respectively.

Our effective tax rate in the three and nine months ended September 30, 2016 differed from the federal statutory rate of 35% primarily due to the benefits of a UK financing transaction, the overall impact of earnings within and outside the US, state income taxes, and US government incentives, such as research tax credits and deductions related to domestic production activities. In addition, we recognized a discrete tax benefit of $1.6 million and $1.1 million in the three and nine months ended September 30, 2016. The discrete tax benefit in the three months ended September 30, 2016 primarily related to a $1.2 million benefit associated with amending 2012-2013 tax returns. The discrete tax benefit in the nine months ended September 30, 2016 was primarily related to a $1.2 million benefit associated with amending 2012-2013 tax returns offset by discrete tax expense of $0.4 million from changes in tax planning strategies.

Our effective tax rate in the three and nine months ended September 30, 2015 differed from the federal statutory rate due to discrete items, foreign tax credits, government provided tax incentives, and the benefits of a UK financing transaction, which were partially offset by state income taxes. We recognized a discrete tax benefit of $4.4 million and $11.5 million in the three and nine months ended September 30, 2015, respectively. The discrete tax benefit in the three and nine months ended September 30, 2015 was primarily related to amending certain US returns resulting in the recognition of $0.3 million and $2.2 million of tax benefits for US foreign tax credits that were previously taken as deductions; $1.7 million and $6.2 million in tax benefits for US government provided incentives for domestic productions activities and research and development credits and $2.2 million and $2.2 million related to other tax planning strategies, respectively.

In October 2015, we aligned our contracting and intellectual property arrangements to correspond to changes in our managerial structure for our US and global commercial operations. The commercial operations were changed to support the integration of SHL, which we acquired in August 2012 and which is headquartered in the UK, resulting in the need for two separate and distinct commercial structures to better serve our members: one located in the US, marketing and selling our products and services to US customers; and another managed in the UK, marketing and selling our products and services to all of our international customers.

As part of this, we entered into intercompany cross-license agreements between the US and the UK operations granting the respective entities the rights to use each other’s intellectual property. Our UK subsidiaries sell products and services to the international (non-US) market. These subsidiaries contract with non-US customers and therefore, earn the associated revenue. The resulting mix of income in the US and UK jurisdictions with their differing tax rates is expected to lower our overall effective tax rate. While this realignment is expected to lower the effective tax rate over time, operational variations, including accelerated amortization of intangible assets, and discrete tax items during the year will affect the effective tax rate on a quarterly basis.

The Adjusted effective tax rate was 33.4% and 32.8% in the three months ended September 30, 2016 and 2015, and 33.5% and 34.7% in the nine months ended September 30, 2016 and 2015, respectively. The decrease in the Adjusted effective tax rate in the nine months ended September 30, 2016 period was primarily related to the impact of the reallocation of operating income from the US to foreign jurisdictions caused by the realignment of business processes for certain non-US customer revenues. We believe this is a meaningful measure to facilitate the comparison of the annual effective rate over time. We expect the Adjusted effective tax rate to be between 32% and 34% for the year ended December 31, 2016. However, the tax provision is subject to a number of uncertainties including the global allocation of income across tax jurisdictions, tax law changes, and other discrete items.

In March 2016, Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2016-09, Compensation – Stock Compensation (refer to Note 2), which we will adopt on January 1, 2017. Among other provisions, this ASU requires tax deficiencies and excess tax benefits to be treated as a discrete income tax item and recorded as income tax expense or benefit in the income statement when awards are settled. Therefore, we expect an increase in the volatility of income tax expense that will occur primarily in the first half of each year because of the timing of when outstanding awards are scheduled to vest. Based on the awards currently outstanding and a stock price of $50 per share, we expect to recognize a tax deficiency in 2017 that would increase our income tax provision by approximately $2 million. A hypothetical change of $10 in our stock price would impact this tax deficiency by approximately $1 million.

We made income tax payments of $2.4 million and $4.1 million in the three months ended September 30, 2016 and 2015 and $19.4 million and $49.6 million in the nine months ended September 30, 2016 and 2015, respectively. The $30.2 million reduction in payments related primarily to US tax benefits recognized in 2015, which resulted in overpayments. We had net prepaid income taxes of $14.5 million at September 30, 2016 included in Prepaid expenses and other current assets.

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Segment Results

CEB Segment Operating Data

 

 

CEB Segment Results of Operations

The results of operations for the CEB segment are presented below (in thousands):

 

 

CEB Segment Revenue

The following table outlines CEB segment Revenue (in thousands):

 

 

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Revenue decreased $0.7 million, or 0.4%, in the three months ended September 30, 2016 from the three months ended September 30, 2015. The decrease was primarily attributable to a decrease in sales bookings in the North American large corporate customer base; fewer additional service offerings, such as education and training, accompanying our subscription products; and the impact of lower foreign currency exchange rates against the USD for the comparable periods.

 

Revenue increased $14.8 million, or 2.7%, in the nine months ended September 30, 2016 from the nine months ended September 30, 2015. The increase was primarily attributable to the April 29, 2016 acquisition of Evanta, which contributed revenue of $12.6 million in the nine months ended September 30, 2016, and to a lesser extent, revenue from companies acquired in the third and fourth quarters of 2015. The increase was partially offset by a decrease in sales bookings and the impact of lower foreign currency exchange rates against the USD for the comparable periods.

Following the June 2016 announcement of Brexit, there was significant volatility in global currency exchange rate fluctuations that resulted in the strengthening of the USD against foreign currencies in which we conduct business. Because sales that we make in currencies other than the USD are translated into USD for purposes of preparing our financial statements, our future reported revenue will continue to be negatively impacted if exchange rates for foreign currencies against the USD, primarily the British pound sterling (“GBP”), Euro and Australian dollar (“AUD”), remain at current or lower levels.

Adjusted revenue increased $0.2 million, or 0.1%, in the three months ended September 30, 2016 from the three months ended September 30, 2015. Adjusted revenue increased $24.9 million, or 4.6%, in the nine months ended September 30, 2016 from the nine months ended September 30, 2015. The increase was primarily attributable to the April 29, 2016 acquisition of Evanta, which contributed Adjusted revenue of $21.5 million, including an $8.9 million adjustment related to the reduction in the deferred revenue balance due to purchase accounting, in the nine months ended September 30, 2016, and to a lesser extent, Adjusted revenue from companies acquired in the third and fourth quarters of 2015. The increase was partially offset by a decrease in sales bookings and the impact of lower foreign currency exchange rates against the USD for the comparable periods. On a constant currency basis, Adjusted revenue increased $0.8 million, or 0.4%, and $27.6 million, or 5.1%, in the three and nine months ended September 30, 2016 from the three and nine months ended September 30, 2015, respectively.

CEB Segment Costs and Expenses

Costs and expenses were $163.1 million in the three months ended September 30, 2016, an increase of $21.9 million from $141.2 million in the three months ended September 30, 2015. Costs and expenses were $489.7 million in the nine months ended September 30, 2016, an increase of $62.2 million from $427.5 million in the nine months ended September 30, 2015. The acquisition of Evanta accounted for $8.1 million and $16.8 million of costs and expenses in the three and nine months ended September 30, 2016, respectively. The transition agreement signed in August 2016 with our CEO accounted for $3.0 million of costs and expenses in the three and nine months ended September 30, 2016. Changes in compensation and related costs, variable compensation, share-based compensation, third-party consulting costs, travel and related expenses, facilities costs, additional costs from the other businesses we acquired, and the impact of changes in the exchange rates of the USD to GBP, Euro, and AUD all contributed to year-over-year variances in costs and expenses. We discuss the major components of costs and expenses on an aggregate basis below:

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Cost of Services

The following table outlines the primary components of Cost of services (in thousands):

 

 

Cost of services increased 9.1%, or $5.4 million to $65.7 million in the three months ended September 30, 2016 from $60.3 million in the three months ended September 30, 2015. The $3.3 million increase in compensation and related costs was primarily due to an increase in headcount, including the impact of acquisitions and salary increases. In addition to the items in the table above, the increase in the fair value of deferred compensation plan assets was $0.9 million, costs associated with the delivery of member meetings and teleconferences and database services increased $0.8 million, and costs related to the delivery of Evanta event services were $0.8 million. These costs were partially offset by a $1.5 million decrease in variable compensation due to a decrease in the total expected payout of annual bonuses.

 

 

Cost of services increased 8.7%, or $16.1 million to $200.8 million in the nine months ended September 30, 2016 from $184.7 million in the nine months ended September 30, 2015. The $6.6 million increase in compensation and related costs was primarily due to an increase in headcount, including the impact of acquisitions and salary increases. The $1.6 million increase in travel and related costs was primarily due to costs incurred in the delivery of services. In addition to the items in the table above, the increase in the fair value of deferred compensation plan assets was $1.2 million, costs associated with the delivery of member meetings and teleconferences and database services increased $2.7 million, and costs related to the delivery of Evanta event services were $3.0 million.

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Member Relations and Marketing

The following table outlines the primary components of Member relations and marketing (in thousands):

 

 

Member relations and marketing increased 1.9%, or $1.0 million, to $54.9 million in the three months ended September 30, 2016 from $53.9 million in the three months ended September 30, 2015. The $1.2 million increase in compensation and related costs was primarily due to costs associated with an increase in sales headcount. In addition to the items in the table above, the increase in the fair value of deferred compensation plan assets was $1.0 million.

 

 

Member relations and marketing increased 6.3%, or $9.9 million, to $166.4 million in the nine months ended September 30, 2016 from $156.5 million in the nine months ended September 30, 2015. The $8.0 million increase in compensation and related costs was primarily due to costs associated with an increase in sales headcount. In addition to the items in the table above, the increase in the fair value of deferred compensation plan assets was $1.3 million.

General and Administrative

The following table outlines the primary components of General and administrative (in thousands):

 

 

General and administrative increased 25.8%, or $4.8 million, to $23.6 million in the three months ended September 30, 2016 from $18.8 million in the three months ended September 30, 2015. In addition to the $0.9 million increase in compensation and related costs due to an increase in headcount, the increase was primarily related to the transition agreement signed in August 2016 with our CEO, which accounting for $3.0 million. Also, legal and accounting fees increased $0.9 million. These costs were partially offset by a $0.8 million decrease in variable compensation due to a decrease in the total expected payout of annual bonuses.

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General and administrative increased 10.4%, or $6.3 million, to $66.3 million in the nine months ended September 30, 2016 from $60.0 million in the nine months ended September 30, 2015. In addition to the $1.9 million increase in compensation and related costs due to an increase in headcount, the increase was primarily related to the transition agreement signed in August 2016 with our CEO, which accounting for $3.0 million. Also, legal and accounting fees increased $1.4 million. These costs were partially offset by a $1.2 million decrease in variable compensation due to a decrease in the total expected payout of annual bonuses.

Depreciation and Amortization

The following table outlines the components of Depreciation and amortization (in thousands):

 

 

Depreciation and amortization increased 43.5%, or $3.5 million, to $11.3 million in the three months ended September 30, 2016 from $7.8 million in the three months ended September 30, 2015. The $2.5 million increase in amortization expense was primarily due to the amortization of intangible assets related to the Evanta acquisition in the second quarter of 2016 and other acquisitions in the third and fourth quarter of 2015. The $0.9 million increase in depreciation expense was primarily due to acquisitions made in 2015 and 2016.

 

 

Depreciation and amortization increased 30.4%, or $7.7 million, to $33.2 million in the nine months ended September 30, 2016 from $25.5 million in the nine months ended September 30, 2015. The $6.7 million increase in amortization expense was primarily due to the acceleration of amortization expense of an asset acquired in 2014 and acquisitions made in 2015 and 2016. The $1.0 million increase in depreciation expense was primarily due to acquisitions made in 2015 and 2016.

Business Transformation Costs

Business transformation costs were $6.8 million and $16.3 million in the three and nine months ended September 30, 2016, respectively, and related to the development and implementation of cloud-based computing systems and training that will consolidate and standardize our sales processes and financial systems. Costs primarily include software license fees and third-party vendor costs for the implementation and development of the systems, and costs for employees who are solely dedicated to the project.

Acquisition Related Costs

Acquisition related costs were $0.8 million and $6.0 million in the three and nine months ended September 30, 2016, respectively. These costs are primarily related to the Evanta acquisition.

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CEB Talent Assessment Segment Operating Data

 

 

CEB Talent Assessment Segment Results of Operations

The results of operations for the CEB Talent Assessment segment are presented below (in thousands):

 

 

CEB Talent Assessment Segment Revenue

The following table outlines CEB Talent Assessment Segment Revenue (in thousands):

 

 

Revenue decreased $1.4 million, or 2.9%, in the three months ended September 30, 2016 from the three months ended September 30, 2015. Revenue decreased $4.6 million, or 3.2%, in the nine months ended September 30, 2016 from the nine months ended September 30, 2015. This decrease was primarily attributed to the impact of lower foreign currency exchange rates against the USD for the comparable periods.

Adjusted revenue decreased $1.6 million, or 3.4%, in the three months ended September 30, 2016 from the three months ended September 30, 2015. The impact of the deferred revenue fair value adjustment was $0.2 million in the three months ended September 30, 2015. Adjusted revenue decreased $5.9 million, or 4.0%, in the nine months ended September 30, 2016 from the nine months ended September 30, 2015. The impact of the deferred revenue fair value adjustment was $1.3 million in the nine months ended September 30, 2015. On a constant currency basis, Adjusted revenue remained the same in the three months ended September 30, 2016 from the three months ended September 30, 2015 and decreased $0.8 million, or 0.5%, in the nine months ended September 30, 2016 from the nine months ended September 30, 2015.

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The CEB Talent Assessment segment includes international operations that subject us to risks related to currency exchange fluctuations. The functional currencies of the subsidiaries in the CEB Talent Assessment segment are the respective local currencies of the subsidiaries. The subsidiaries contract and invoice in local currencies, thus revenue is impacted by the fluctuations in foreign currency rates, specifically, the exchange rate of GBP, AUD, and Euro against the USD. Following the June 2016 announcement of Brexit, there was significant volatility in global currency exchange rate fluctuations that resulted in the strengthening of the USD against foreign currencies in which we conduct business. Our future revenue will continue to be negatively impacted if the current reduced exchange rates for foreign currencies against the USD continue.

CEB Talent Assessment Segment Costs and Expenses

Costs and expenses were $49.2 million in the three months ended September 30, 2016, an increase of $1.9 million from $47.3 million in the three months ended September 30, 2015. Costs and expenses were $157.7 million in the nine months ended September 30, 2016, an increase of $12.0 million from $145.7 million in the nine months ended September 30, 2015. The increase in costs and expenses in the three and nine months ended September 30, 2016 was primarily attributable to a $7.0 million and $22.2 million net increase, respectively, in amortization expense primarily related to the change in the estimated useful life of the SHL trade name, which was made in 2015. The primary expenses incurred by the CEB Talent Assessment segment are compensation and related costs, variable compensation, third-party consulting costs, travel and related costs, and facilities costs. Costs and expenses are also impacted by changes in the exchange rates of GBP, Euro, and other currencies. CEB Talent Assessment segment costs and expenses are denominated primarily in GBP; therefore, with revenues being denominated in local currencies as discussed above, operating profit is impacted by the fluctuations in currencies against GBP. We discuss the major components of costs and expenses on an aggregate basis below:

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Cost of Services

The following table outlines the primary components of Cost of services (in thousands):

 

 

Cost of services decreased 12.9%, or $2.4 million, to $16.2 million in the three months ended September 30, 2016 from $18.6 million in the three months ended September 30, 2015. The $1.0 million decrease in compensation and related costs and the $0.4 million decrease in variable compensation were primarily due to the decline in the value of GBP against the USD partially offset by an increase in the cost of services function headcount.

 

 

Cost of services decreased 5.6%, or $3.2 million, to $52.1 million in the nine months ended September 30, 2016 from $55.3 million in the nine months ended September 30, 2015. The $1.0 million decrease in compensation and related costs was primarily due to the decline in the value of GBP against the USD partially offset by an increase in the cost of services function headcount. In addition to the items in the table above, product and assessment costs decreased $0.8 million and external IT costs and telecommunication costs decreased $0.6 million.

Member Relations and Marketing

The following table outlines the primary components of Member relations and marketing (in thousands):

 

 

Member relations and marketing increased 2.6%, or $0.3 million, to $13.2 million in the three months ended September 30, 2016 from $12.9 million in the three months ended September 30, 2015. The $0.6 million increase in variable compensation was primarily due to a higher sales incentive rate in the current year versus the prior year partially offset by the decline in the value of GBP against the USD.

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Member relations and marketing decreased 4.2%, or $1.7 million, to $40.1 million in the nine months ended September 30, 2016 from $41.8 million in the nine months ended September 30, 2015. The $0.8 million decrease in compensation and related costs was primarily due to the decline in the value of GBP against the USD partially offset by an increase in the member relations and marketing headcount. In addition to the items in the table above, product and assessment costs decreased $0.8 million and advertising costs decreased $0.3 million. The $0.9 million increase in variable compensation was primarily due to a higher sales incentive rate in the current year versus the prior year partially offset by the decline in the value of GBP against the USD.

General and Administrative

The following table outlines the primary components of General and administrative (in thousands):

 

 

General and administrative decreased 23.8%, or $2.0 million, to $6.1 million in the three months ended September 30, 2016 from $8.1 million in the three months ended September 30, 2015. The $1.1 million decrease in compensation and related costs was primarily due to a decrease in the general and administrative function headcount and the decline in the value of GBP against the USD.

 

 

General and administrative decreased 9.9%, or $2.4 million, to $21.5 million in the nine months ended September 30, 2016 from $23.9 million in the nine months ended September 30, 2015. The $2.3 million decrease in compensation and related costs was primarily due to a decrease in the general and administrative function headcount and the decline in the value of GBP against the USD.

Depreciation and Amortization

The following table outlines the primary components of Depreciation and amortization (in thousands):

 

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Depreciation and amortization increased 76.6%, or $5.9 million, to $13.6 million in the three months ended September 30, 2016 from $7.7 million in the three months ended September 30, 2015. The increase in amortization expense was primarily related to the acceleration of amortization expense as a result of the change in the estimated useful life of the SHL trade name, which is being amortized through December 31, 2016. The change in estimated useful life resulted in an increase in amortization of $7.0 million in the three months ended September 30, 2016 and was partially offset by the decline in the value of GBP against the USD.

 

 

Depreciation and amortization increased 82.9%, or $19.8 million, to $43.6 million in the nine months ended September 30, 2016 from $23.8 million in the nine months ended September 30, 2015. The increase in amortization expense was primarily related to the acceleration of amortization expense as a result of the change in the estimated useful life of the SHL trade name, which is being amortized through December 31, 2016. The change in estimated useful life resulted in an increase in amortization of $22.2 million in the nine months ended September 30, 2016 and was partially offset by the decline in the value of GBP against the USD.

CEB Talent Assessment Goodwill

The Company continues to monitor actual versus forecasted results and external factors that may impact the enterprise value of the CEB Talent Assessment reporting unit. In June 2016, the United Kingdom (“UK”) held a referendum in which voters approved an exit from the European Union (“EU”), commonly referred to as Brexit. The announcement of Brexit has resulted in significant volatility in global stock markets and currency exchange rate fluctuations that resulted in strengthening of the USD relative to other foreign currencies in which the CEB Talent Assessment segment conducts business. The announcement of Brexit and potential withdrawal of the UK from the EU may also lead to increased global economic uncertainty, which may cause our customers to closely monitor their costs and reduce their spending budgets. The reporting unit’s revenues are primarily derived from local currencies while approximately 60% of the operating expenses are denominated in GBP. An increase in the value of GBP versus other global currencies may adversely impact profitability of the segment.

We continue to evaluate our forecasts, including key inputs and assumptions, and other factors that may impact the fair value of the reporting unit such as market comparable company multiples, interest rates, and global economic conditions, including the uncertainty related to Brexit. We have not identified any indicators of impairment. The effect of the decline in GBP has favorably impacted the segment’s reported results, and a decline in the reporting unit’s carrying value have supported that the fair value of the reporting unit still more likely than not exceeds its carrying value, though by less than 10%.  

This reporting unit remains at risk for future impairment if the projected operating results are not met or other inputs into the fair value measurements change. We will perform our annual goodwill impairment test as of October 1 and continue to evaluate for impairment indicators on a quarterly basis.

 

Liquidity and Capital Resources

On April 29, 2016, in connection with the closing of the Evanta acquisition, CEB Inc., together with certain of our subsidiaries acting as guarantors, entered into Amendment No. 5 (“Amendment No. 5”) to the Company’s senior secured credit agreement (as amended, restated, supplemented or otherwise modified from time to time, the “Credit Agreement”). Amendment No. 5 (i) increased the size of the Company’s existing term A-2 facility (“Term A-2 Facility”) by $150.0 million (such increase, the “Additional Term A Loans”) and (ii) increased its revolving credit facility by $100.0 million for a total available amount of $350.0 million (“Revolving Credit Facility” and, together with the Term A-2 Facility, the “Senior Secured Credit Facilities”). Amendment No. 5 also refinanced all term loans outstanding under the Senior Secured Credit Facilities (“Term A-2 Term Loans”) and Additional Term A Loans into a single tranche (the existing Term A-2 Term Loans plus the Additional Term A Loans, together as refinanced, “Term A-3 Loans”) and extended the maturity date of the Senior Secured Credit Facilities from June 9, 2020 to April 29, 2021. The principal amount of the Term A-3 Loans amortizes in quarterly installments equal to (i) for the first two years commencing on June 30, 2016, 2% of the original principal amount of the Term A-3 Loans and (ii) for the next three years thereafter, 4% of the original principal amount of the Term A-3 Loans with the balance payable at maturity.

Borrowings under the Senior Secured Credit Facilities bear interest at rates based on the ratio of the Company’s and its subsidiaries’ consolidated indebtedness to the Company’s and its subsidiaries’ consolidated EBITDA (as defined in the Credit Agreement) for applicable periods specified in the Senior Secured Credit Facilities. The interest rate per annum applicable to the loans under the Senior Secured Credit Facilities will be based on a fluctuating rate of interest equal to the sum of an applicable margin and, at the

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Company’s election from time to time, of either (1) a base rate determined by reference to the highest of (a) the rate as publicly announced from time to time by Bank of America as its “prime rate”, (b) the federal funds effective rate plus 0.50% and (c) the one-month LIBOR plus 1.00%, or (2) a Eurocurrency rate determined by reference to LIBOR with a term, as selected by the Company, of one, two, three, or six months (or twelve months if consented to by all the lenders under the applicable loan). Borrowings under the Senior Secured Credit Facilities will be subject to a “zero percent” floor in the case of LIBOR loans.

The Senior Secured Credit Facilities are secured by certain collateral, subject to certain exceptions and thresholds, including (a) a perfected first priority security interests in substantially all tangible and intangible personal property and fee-owned real property of the Company and each of the Company’s wholly-owned material domestic subsidiaries, including the newly acquired Evanta entities and their subsidiaries and (b) a perfected first priority pledge of (i) the equity interests of each direct domestic restricted subsidiary of the Company and each of the Company’s wholly-owned material subsidiaries, including the newly acquired Evanta entities and their subsidiaries and (ii) 65% of the stock of each material first-tier foreign restricted subsidiary of the Company. On April 29, 2016, the Company and the newly acquired Evanta entities and their subsidiaries entered into the applicable security documents, and certain collateral was pledged thereunder.

At September 30, 2016, we had $392.3 million of Term A-3 Loans outstanding with an annual interest rate of 2.27% and borrowings of $250.0 million under the Revolving Credit Facility with a weighted average annual interest rate of 2.27%. We were in compliance with all of the covenants under the Credit Agreement at September 30, 2016.

We had cash and cash equivalents of $135.8 million and $113.3 million at September 30, 2016 and December 31, 2015, respectively. Cash held by our foreign subsidiaries was $117.3 million at September 30, 2016. We manage our worldwide cash requirements by considering available funds among the many subsidiaries through which we conduct our business and the cost effectiveness with which those funds can be accessed. The repatriation of cash balances from certain of our subsidiaries could have adverse tax consequences; however, those balances are generally available without legal restrictions to fund ordinary business operations, capital projects, and future acquisitions.

We believe that existing cash and cash equivalents, operating cash flows, and availability under the Revolving Credit Facility will be sufficient to support operations, including interest and required principal payments, anticipated capital expenditures, and the payment of dividends, as well as potential share repurchases for at least the next 12 months. Our future cash flows will depend on many factors, including our rate of Contract Value growth and investments in operations to expand market presence and enhance technology. At September 30, 2016, available borrowings under the Revolving Credit Facility were $88.9 million after reduction of $250.0 million of outstanding borrowings and $11.1 million of outstanding letters of credit. In November 2016, outstanding letters of credit increased to $21.4 million. We expect to place increased emphasis and priority on deleveraging in the near term. The anticipated cash needs of our business could change significantly if we pursue and make investments in, or acquisitions of, complementary businesses, such as the recently completed Evanta acquisition, if economic conditions change from those currently prevailing or from those currently anticipated, or if other unexpected circumstances arise that may have a material effect on the cash flows or profitability of our business. Any of these events or circumstances could involve significant additional funding needs in excess of the identified currently available sources, including our Revolving Credit Facility, and could require us to seek additional financing as an additional source of liquidity to meet those needs. Our ability to obtain additional financing, if necessary, is subject to a variety of factors that we cannot predict with certainty, including our future profitability; our relative levels of debt and equity; the volatility and overall condition of the capital markets; and the market prices of our securities. As a result, any additional financing may not be available on acceptable terms or at all.

Cash Flows

 

 

Our primary uses of cash have been to fund acquisitions, debt service requirements, capital expenditures, share repurchases, and dividend payments.

Cash Flows from Operating Activities

Our operating assets and liabilities consist primarily of billed and unbilled accounts receivable, accounts payable, accrued expenses, accrued incentive compensation, and deferred revenue. The timing of billings and collections of receivables as well as payments for compensation arrangements affect the changes in these balances. CEB segment membership subscriptions, which principally are annually renewable agreements, generally are payable by members at the beginning of the contract term. CEB Talent Assessment

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segment services are generally invoiced as services are delivered. Historically, the combination of revenue growth, profitable operations, and advance payments of membership subscriptions has resulted in net cash flows provided by operating activities.

Net cash flows provided by operating activities decreased $8.9 million in the nine months ended September 30, 2016 from the same period in 2015. The decrease in cash flows from operations was primarily due to lower sales bookings growth on a year-over-year basis, which resulted in lower cash collections, and higher interest payments partially offset by lower cash income tax payments in the current period.

Total income tax payments were $19.4 million and $49.6 million in the nine months ended September 30, 2016 and 2015, respectively. The $30.2 million reduction in income tax payments was primarily due to certain US tax benefits we were able to recognize in 2015, which resulted in overpayments. We expect our future tax payments to increase in 2017 compared to 2016.

We made interest payments of $15.4 million and $8.4 million in the nine months ended September 30, 2016 and 2015, respectively. Subject to our ability to pay down our debt, our interest payments are expected to remain at elevated levels in future periods due to the additional borrowings in April 2016 to fund the Evanta acquisition.

Cash Flows from Investing Activities

Our cash management, acquisition, and capital expenditure strategies affect cash flows from investing activities. Net cash flows used in investing activities increased $253.3 million in the nine months ended September 30, 2016 from the same period in 2015. We utilized $269.2 million for the acquisition of Evanta, which included a payment of $286.8 million, less $17.6 million of cash acquired.

In the nine months ended September 30, 2016, we used $15.7 million for capital expenditures primarily for computer and network equipment to support infrastructure and the implementation of new products and enhancements to client-facing platforms. We also made an additional $5.3 million investment in two private entities.

We estimate that capital expenditures to support our infrastructure will be approximately $30 million to $32 million in 2016.

Cash Flows from Financing Activities

Net cash flows provided by financing activities increased $277.3 million in the nine months ended September 30, 2016 from the same period in 2015. In the nine months ended September 30, 2016, we borrowed $405.0 million under the Senior Secured Credit Facilities and repaid amounts outstanding on our credit facilities of $80.2 million. Further, we used $53.6 million in the nine months ended September 30, 2016 to repurchase shares of our common stock, an increase of $10.9 million from the nine months ended September 30, 2015. We increased our quarterly dividend rate from $0.375 per share in 2015 to $0.4125 per share beginning in the first quarter of 2016, resulting in additional dividend payments of $2.3 million in the nine months ended September 30, 2016.

Contractual Obligations

There were no material changes at September 30, 2016 to the contractual obligations table disclosed in our June 30, 2016 Quarterly Report on Form 10-Q.

Off-Balance Sheet Arrangements

At September 30, 2016 and December 31, 2015, we had no off-balance sheet financing or other arrangements with unconsolidated entities or financial partnerships (such as entities often referred to as structured finance or special purpose entities) established for purposes of facilitating off-balance sheet financing or other debt arrangements or for other contractually narrow or limited purposes.

Forward-looking Statements

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that involve risks, uncertainties and assumptions. Statements using words such as “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” and variations of such words or similar expressions are intended to identify forward-looking statements. In addition, all statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins, expenses, provision for income taxes, earnings, cash flows, share repurchases, acquisition synergies, foreign currency exchange rates, or other financial items; any statements of the plans, strategies, and objectives of management for future operations; any statements concerning expected development, performance or market share relating to products or services; any statements regarding future economic conditions or

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performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief; any statements regarding the impact of our acquisitions and any related debt financing on our future business, financial results or financial condition, including our liquidity and capital resources; and any statements of assumptions underlying any of the foregoing. You are hereby cautioned that these statements are based upon our expectations at the time we make them and may be affected by important factors including, among others, the factors set forth below and in our filings with the US Securities and Exchange Commission (“SEC”), and consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. Our expectations, beliefs, and projections are expressed in good faith and we believe there is a reasonable basis for them.

Factors that could cause actual results to differ materially from those indicated by forward-looking statements include, among others:

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In Part I, “Item 1A. Risk Factors” of our 2015 Annual Report on Form 10-K, as filed with the SEC on February 26, 2016, and Part II, “Item 1A. Risk Factors” of our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2016, as filed with the SEC on August 9, 2016, and in Part II, “Item 1A Risk Factors” below, we discuss in more detail various important factors that could cause actual results to differ from expected or historic results. It is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete statement of all potential risks or uncertainties. All forward-looking statements contained in this Quarterly Report on Form 10-Q are qualified by these cautionary statements and are made only as of the date this Quarterly Report on Form 10-Q is filed. We assume no obligation and do not intend to update these forward-looking statements, whether as a result of new information, future events, or otherwise.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There has been no material change in the Company’s assessment of its sensitivity to market risk since its presentation set forth in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in its 2015 Annual Report on Form 10-K.

 

 

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

In connection with the preparation of this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer, with the participation of management, have evaluated our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (“Exchange Act”)). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of September 30, 2016, our disclosure controls and procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting that occurred in the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

PART II. OTHER INFORMATION

 

 

Item 1. Legal Proceedings.

From time to time, the Company is subject to litigation related to normal business operations. The Company vigorously defends itself in litigation and is not currently a party to, and the Company’s property is not subject to, any legal proceedings likely to materially affect its financial results.

 

 

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Item 1A. Risk Factors.

In addition to the other information contained in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our 2015 Annual Report on Form 10-K and Part II, “Item 1A. Risk Factors” of our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2016. Except as presented below, there were no material changes during the quarter ended September 30, 2016 to the information included in “Item 1A. Risk Factors” in our 2015 Annual Report on Form 10-K and Part II, “Item 1A. Risk Factors” of our Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2016.

If we do not successfully manage the transition associated with the decision to step down by our long-time Chairman and Chief Executive Officer, it could be viewed negatively by our members, customers, suppliers, employees, shareholders and other stakeholders and could have an adverse impact on our business.

On August 30, 2016, Thomas L. Monahan, III notified CEB that he intends to step down from his positions as Chairman and Chief Executive Officer upon the appointment by CEB’s board of directors (the “Board”) of a new Chief Executive Officer (“CEO”). The Board has an active search process underway to select the Company’s next CEO. Mr. Monahan has entered into an agreement with the Company to provide for a transition period during which he will remain employed by the Company and continue in his current positions, pending the selection of his successor. In addition to selecting a new CEO, the Board will need to decide whether to separate the positions of Chairman and CEO. Such a separation would represent a change in governance structure from the structure that has been in place at the Company for many years.

Executive leadership transitions can be inherently difficult to manage, and Mr. Monahan’s long tenure and significant influence on the business may add to the complexity of this transition process. An inadequate transition of our Chairman and CEO positions may cause disruption to our business and to our relationships with members, customers and employees. Among other things, management transition inherently causes some loss of institutional knowledge and often results in some degree of strategic and operational change. These can negatively affect execution, and our results of operations and financial condition could suffer as a result. If we do not successfully manage this transition, it could be viewed negatively by our members, customers, suppliers, shareholders and other stakeholders and could have an adverse impact on our business. In addition, if we are unable to attract and retain a qualified candidate to become our new CEO in a timely manner, or if we do not implement an effective new governance approach if the Board decides to separate the offices of Chairman and CEO, our ability to meet our financial and operational goals and strategic plans, as well as our financial performance, may be adversely impacted.

These changes also may make it more difficult to retain other key employees. In October 2016, we entered into retention agreements with our Chief Administrative Officer and our Chief Financial Officer to provide them with incentives to remain in their positions with the Company at least throughout the CEO succession process. There can be no assurance that they will remain with the Company throughout the transition process or how the process will affect other key employees. The loss of any member of our senior management could impair our ability to execute our business plan and could therefore have a material adverse effect on our business, results of operations and financial condition.

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Issuer Purchases of Equity Securities

 

 

 

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Item 3. Defaults Upon Senior Securities.

None.

 

 

Item 4. Mine Safety Disclosures.

Not applicable.

 

 

Item 5. Other Information.

None.

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Item 6. Exhibits.

 

 

 

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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.

 

 

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Exhibit Index

 

 

 

 

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