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Corporate Executive Board (NYSE:CEB)

Q4 2012 Earnings Call

February 07, 2013 9:00 am ET

Executives

Richard S. Lindahl - Chief Financial Officer and Principal Accounting Officer

Thomas L. Monahan - Chairman and Chief Executive Officer

Analysts

Gary E. Bisbee - Barclays Capital, Research Division

David Ridley-Lane - BofA Merrill Lynch, Research Division

Timothy McHugh - William Blair & Company L.L.C., Research Division

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

Operator

Good morning, and welcome to the Corporate Executive Board's Fourth Quarter 2012 Conference Call. Today's call is being recorded and will be available for replay beginning today and through Friday, through February 17, by dialing (719) 457-0820. The replay passcode is 5487622. The replay will also be available beginning later today and through February 17 at the company's website and at www.earnings.com.

To the extent any non-GAAP financial measure is discussed in today's call, you will also find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP by going to the company's website and following the Investor's link to yesterday's news release. You will also find a PDF of the supporting material that the company will use in its prepared remarks this morning by going to Investor's page and following the link to the Fourth Quarter 2012 Earnings Conference Call.

Please review the second page of these materials which includes important information about any forward-looking information included in the presentation.

This conference may also contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding the Corporate Executive Board's expected quarterly and annual financial performance for fiscal year 2013 or beyond. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements.

Without limiting the foregoing discussions of forecasts, estimates, targets, plans, beliefs, expectations and the like are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by important factors, among others, set forth in the Corporate Executive Board's filings with the Securities and Exchange Commission and in its fourth quarter news release.

Consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

At this time, for opening remarks, I would like to turn the conference over to the company's Chief Financial Officer, Mr. Richard Lindahl. Please go ahead, sir.

Richard S. Lindahl

Thank you, Jessica, and good morning, everyone. My name is Rich Lindahl, I'm the Chief Financial Officer of CEB. Thank you, all, for calling or logging in to our fourth quarter and full year 2012 earnings report.

On today's call, I will review our 2012 financial results and guidance for the year ahead. Tom Monahan, our Chief Executive Officer, will then take over to share additional insight on our 2012 accomplishments and discuss our growth strategy and priorities for 2013. Then, we will take your questions.

Please turn to Slide 3 of our presentation and we'll start with a quick summary of key financial highlights.

Overall, we are pleased with our 2012 results, which reflect our success in the market and point to the strong value proposition we offer our customers.

We are seeing solid growth momentum across most of our business and are optimistic about the year ahead. Accordingly, we are planning for continued top line growth, attractive profitability and strong cash flows, which enable us to maintain our financial flexibility, invest in further growth opportunities and return capital to shareholders.

Let's turn to Slide 4 for a summary recap of our results. Revenue was $193.7 million in the fourth quarter and $622.7 million for the full year of 2012, reflecting year-over-year increases of 46.8% and 28.5%, respectively.

Adjusted EBITDA margin was 27% in the fourth quarter and 27.2% for all of 2012.

Earnings per diluted share were $0.21 in the fourth quarter and $1.10 for the full year of 2012, and reflect costs related to the SHL acquisition.

Non-GAAP diluted earnings per share increased 6.2% to $0.69 for the fourth quarter and 36.4% to $2.55 for the full year of 2012.

The business also continues to generate strong cash flows, which are augmented by the addition of SHL.

Cash flows from operating activities were $122.2 million in 2012, an increase of 21.8% over 2011.

So all in all, these results showed that our business gained financial momentum in the quarter.

Now let's turn to Slide 5 to review our key operating metrics. I'll touch on a few highlights here, and then Tom will provide more regional and segment color in his remarks.

CEB segment contract value at December 31 was $561.8 million, and was up 12.5% compared to the prior year. This year-over-year increase was mainly fueled by solid double-digit bookings growth, reflecting sustained momentum in North America and Asia Pacific, along with an uptick in EMEA.

Contract value also includes $9.6 million from Valtera, which, as we've said, is fully integrated with our legacy CEB employee analytics business.

For the SHL segment, adjusted revenue was $46.8 million in the fourth quarter, consistent with the expectations we shared on our last earnings call and a modest improvement in year-over-year growth versus the third quarter.

CEB segment wallet retention rate of 102% at December 31 remained in the normal range and was also supported by an uptick in cross-sell activity in the quarter.

SHL segment, while at retention rate, was 97% at December 31, also in the normal range and reflective of strong recurring revenue in that part of our business.

Growth in total CEB segment member institutions further extended year-to-date gains by increasing 6.1% compared to last year.

Growth was fairly evenly split between middle market and large corporate customers.

Finally, CEB segment contract value per member institution continued to improve, and it grew 6% to $92,300.

Of note, the average contract value across our top 200 largest accounts has increased to $800,000, reflecting continued cross sales of both member subscriptions and premium services to these customers.

Please turn to Slide 6 and I'll walk through key segment highlights. Before I do so, I want to be sure you note that we have modified our segment definitions and are now including PDRI results within the CEB segment.

We have begun to more closely coordinate PDRI's operations with CEB's government practice and therefore, it is more appropriate to align our segment reporting accordingly. As you can see, our fourth quarter results benefited from both solid organic gains in our CEB segment and the addition of SHL.

CEB segment revenue was $155.7 million in the fourth quarter, an 18% increase compared to $132 million in the fourth quarter of 2011. Included in the CEB segment is approximately $12.2 million of inorganic revenue in the quarter from PDRI and Valtera.

The SHL segment contributed $38.1 million of revenue in the fourth quarter, which is net of an $8.7 million deferred revenue fair value adjustment. Additional quarterly reductions will be recognized going forward and we currently estimate the total impact on 2013 revenue will be approximately $13 million.

Moving on to operating expenses. Cost of services in the fourth quarter increased by $29.3 million versus the fourth quarter of 2011. Acquired businesses represented about 80% of this increase, with the additional balance coming from product enhancement efforts and support for a larger customer base, including increased capacity to deliver premium services.

Member relations and marketing expense increased by $18.6 million in the fourth quarter versus the prior year period. Acquisitions were the biggest factor here as well, representing about 65% of the change. We also added more sales capacity, increased our marketing and branding spend and saw higher commissions driven by the growth in bookings.

General and administrative costs in the fourth quarter were up $7.8 million compared to the prior year, with about 95% of the increase driven by the addition of SHL and Valtera.

Acquisition-related costs were $3.2 million in the fourth quarter. Interest income and other was net expense of $0.7 million in the fourth quarter of 2012 compared to $0.7 million of income in the fourth quarter of 2011, with the change primarily due to higher foreign currency losses and a smaller gain on deferred compensation plan assets.

Interest expense in the fourth quarter was $6.7 million versus $0.2 million in the prior year period, reflecting the interest on the new debt raised to fund the SHL acquisition in August.

Total company adjusted EBITDA margin in the fourth quarter was 27% versus 30.8% in the fourth quarter of 2011.

At the segment level, adjusted EBITDA margin in the quarter was 27.6% for the CEB segment and 24.8% for the SHL segment.

CEB segment margins reflect forward hiring activity, higher bonus and commission accruals and the normalization of revenue recognition accounting as compared to the prior year.

As expected, SHL segment margins declined sequentially from the third quarter on lower position vacancy, project delivery costs and some forward hiring.

One more comment on total adjusted EBITDA margin. As we discussed on our last call, throughout the year, we delayed a number of investments while we focused first on the acquisition process, and then turned much of our attention to integration. Accordingly, we deployed fewer dollars against these initiatives than originally planned, which resulted in approximately 125 basis points of full year favorability for consolidated adjusted EBITDA margin.

Depreciation and amortization in the fourth quarter was $15.6 million, an increase of $10.9 million compared to the fourth quarter of 2011.

Most of this change is from higher amortization of intangible assets resulting from the SHL and Valtera acquisitions.

Our effective tax rate in 2012 was 50.3%. This rate is higher than we forecast in November, primarily because of the final distribution of pre-tax income across our global operating subsidiaries, resulted in a greater concentration of taxable income in higher tax jurisdictions and less ability to claim foreign tax credits than previously estimated.

In addition, as we've previously indicated, the rate this year is higher than the statutory rates due to the nondeductibility of certain items for tax, primarily transaction costs related to the SHL acquisition.

In terms of our balance sheet. Accounts receivable was $239.6 million at December 31, which includes $52.2 million for SHL and PDRI.

The current portion of deferred revenue was $365.7 million at December 31, including $36.1 million from the SHL segment.

As compared to the prior year, CEB segment deferred revenue, which includes $5 million from PDRI, increased by 15.5% due to year-over-year bookings growth and is a positive leading indicator for CEB segment revenue.

Please turn to Slide 7 for a review of our capital allocation priorities, which remain the same as they have been the last several years. First, we will maintain a strong financial position. You can see from our balance sheet that we ended the year with $72.7 million of cash. In addition, on December 31, the amount available under our revolving credit facility was $74 million, reflecting a $10 million repayment during the fourth quarter.

We also paid the remaining $20 million revolver balance in January. Accordingly, our current revolver availability is now $94 million.

As you know, one of the great features about our business is the high ratio of cash flow to earnings, due in large part to favorable working capital characteristics. Over the past several years, the ratio of cash flows from operations to adjusted net income has averaged about 1.5x. We expect that relationship to again hold through in 2013 or perhaps be a little better [ph]. As a result, we expected our credit profile will continue to improve throughout the year, as reflected by a net debt adjusted to EBITDA ratio of 2x or lower by year-end.

We also have said that we will provide current cash returns to shareholders and highlight the attractive financial characteristics of our economic model by growing our dividend in line with earnings and cash flow.

Earlier this week, our board declared a first quarter dividend of $0.225 per share, which reflects a 30% increase over the dividend rate paid in 2012. Finally, we be plan to use stock buybacks to offset dilution and maintain a constant share count.

During the fourth quarter, we purchased $10 million of stock on the open market, pursuant to the authorization which expired at the end of 2012. In addition, earlier this week, our board approved a new $50 million share repurchase program. Management will determine the amount and timing of purchases, and the authorization will run through December 31, 2014.

Now let's move on to our outlook. The following comments are intended to fall under the Safe Harbor provisions outlined at the beginning of the call and are based on preliminary assumptions which are subject to change over time.

Please turn to Slide 8, which highlights our outlook for the year ahead. Overall, we are planning for a year of continued solid revenue growth, attractive margin production and increased investment to pursue several short- and long-term growth opportunities that we see in our business.

Starting at the top line, we expect adjusted revenue of $825 million to $845 million. This forecast compares to a pro forma figure of $762 million if we had owned SHL for all of 2012.

As I mentioned earlier, we currently expect the deferred revenue fair value adjustment to be approximately $13 million this year, and so the implied revenue outlook is therefore $812 million to $832 million. Based on this revenue profile, we are planning for adjusted EBITDA margin in the range of 25% to 26.5%. Several factors are at work here. To the positive, we expect to see continued scaling of G&A an existing product costs, as well as improved productivity among our tenured sales people.

We will also realize initial benefits from acquisition cost synergies. Offsetting these items are the impact of the timing shift to 2013 of costs originally planned for 2012, a higher mix of revenue from our fast-growing but lower-margin premium services and additional investments and product development, sales capacity, marketing, branding and other growth initiatives.

For 2013, we expect to incur $8 million to $10 million of acquisition-related costs as we work through the next phase of SHL acquisition -- integration.

Depreciation and amortization in 2013 is expected to be in the range of $62 million to $64 million and capital expenditures are expected to be approximately $29 million to $31 million, including $45 million of integration projects.

The effective tax rate for this year is currently estimated to be approximately 40% to 41%, depending on the distribution of global income and excluding any nonrecurring permanent book-tax differences, such as foreign currency gains or losses.

These elements combine to imply that our non-GAAP diluted earnings per share are expected to be in the range of $2.85 to $3.15 in 2013.

While we don't provide quarterly guidance, I'll share a few thoughts on what to expect as we progress throughout the year.

Overall, we should see similar seasonal trends in the CEB segment as we've seen in the past, which implies a flat to perhaps slightly down sequential revenue trend in the first quarter, followed by sequential quarterly increases throughout the year.

In the SHL segment, we continue to expect more improvement in adjusted revenues in the second half than the first half of the year.

On the expense side, in both segments, we are working hard to deploy many of our growth investments early in the year. In addition, expect to see seasonal cost elements that influence expenses higher in the second and fourth quarters in the CEB segment. All of these factors are likely to drive margins lower in the first half of the year before they improve in the second half.

That's it for the financial summary. I'll now turn the call over to Tom, who will share more color on our operations and growth strategy in the year ahead.

Thomas L. Monahan

Thanks, Rich and good morning, and thanks to everybody for calling and/or logging in this morning. We appreciate the opportunity to bring you up to speed in the business and are excited to share our plans to grow in size and impact across the coming year.

Before I add some color to Rich's summary, let me make a few larger observations about 2012, which was clearly a watershed year for CEB. We enjoyed healthy organic revenue and profit growth in all of our markets and domain areas and we coupled this with important strategic investments in SHL and Valtera that deepened our connections to important member work and extended our growth horizons. I'm proud of the work that our teams did to deliver for our members and to create a platform for future growth.

Their efforts ensured that CEB exited 2012 with the core elements of its investment thesis substantially strengthened. You can see them on Page 9.

Everything we did in 2012 supported the foundational value proposition for our investors. We further enhanced our leadership positions in areas of growing corporate demand, we've built and added rich, new insights, data and tools to help senior corporate executives set a course for their organization and get the right people in the right places to execute. Our now larger and completely global business enjoys high margins, scalable assets, recurring revenue and cash flows that run as a multiple of net income. And finally, our success allows us to make focused investments that help ensure continued healthy growth.

Before I outline how we'll bring these priorities to life, let me share just a bit more detail about our accomplishments in 2012.

The obvious place to begin is with the clear-eyed assessment of the operating environment we are navigating. We continue to operate in a very complex economic environment with anemic growth, at best, across the developed markets. As we benchmark member plans, we don't see it getting a lot better in 2013. Our average large cap member is seeking to grind out modest top line growth in 2013, and they have a weary eye on the still dysfunctional political climate in the U.S. This is not an environment that rewards wasted effort, and we see companies eager for help in allocating people and resources and ensuring that their operations are at a best-practice standard. But to help them be at their best, we have to be at our best, connecting our insights, data and tools to their needs via inspired sales and service. And very often in 2012, our teams executed to a high standard.

As you can see from both the Q4 results and the year-end CEB number, we sustained and in some cases, accelerated momentum across much of the business in Q4, which sets us up well for 2013.

Within the CEB product lines, the story strengthened as the year unfolded. Both North America and APAC sustained growth rates above the corporate average for the full year. The good news in the fourth quarter came from Europe, where the team engineered a very solid year-on-year quarterly growth number with an impressive late-year push. While no one expects the going in Europe to be easy anytime soon, it's a powerful testament both to the value which this team creates for their members and to their intensity and focus.

All of our end markets grew at healthy rate, with both mid-market and large corp showing solid year-on-year progress. A notable story here was the success of our government markets team, which posted very solid growth against the backdrop of significant austerity in the U.S. federal sector. This is obviously a very small portion of our overall footprint, and we are exceedingly watchful in an era of significantly constrained budgets. But this area's rapid growth is impressive evidence of our ability to help even the most budget-constrained executives realize value.

Finally, all of our domains grew at a healthy rate, with our sales, technology and broader talent management areas seeing particular strength as we cross-sold members additional products and they opted into higher levels of premium support. We're pleased with this dynamic, but it does provide a little offset to the natural scaling of the business as our premium services sometimes have a higher proportion of variable cost.

In the SHL product line, the story was a bit more positive than we had projected in November, with the business, overall, showing very modest growth of the quarter on an adjusted revenue basis. The original story was broadly similar to what our CEB products have seen this year, with Europe offsetting steady performance in Asia, the Middle East and in the Americas.

All in all, I'm proud of what our teams accomplished across 2012. Our financial outcomes are evidence that our teams are doing a great job helping our members navigate in a very complex economic environment. We entered the year with momentum in a number of our businesses, a richer asset base to draw from, a stronger and larger team and an expanded market to attack. And our goals for 2013 reflect our focus on continued healthy growth, strong profit and investment for the future.

Let me spend a minute on each of our core priorities: delivering business -- surplus business value to members, leading the analytic transformation of talent management and achieving brand recognition that matches our global impact.

Please turn to Slide 10. Priority one, delivering surplus business value. From the earliest days of our company, our goal has been to ensure that our members see substantial, tangible business value from their investments of time and money with us. Our goal is not simply to provide them with a fair return, but to give them insights, tools and advice that lead to transformative outcomes for their team, function or company. Everything we do aims to help a member grow revenue, reduce cost, manage risk and ultimately, transform their organization.

Doing this well requires that we develop uniquely valuable insights into the levers of business value, link these resources to member decisions through compelling advice, instruction and technology and create demand by inspired sales and service. When we do this well, we create game-changing outcomes for our members at a fraction of the cost of other sources of advice and support, and we allow them to hardwire these outcomes via people and technology. Or as one of our members in the power generation business put it, "It's almost like having a consulting firm at your fingertips without having to pay the exorbitant consulting fees."

Through this, we earn the right to keep and grow our relationships with our members and in 2012, we saw plenty of evidence that our team did an outstanding job. We posted a wallet retention rate for the CEB product of 102%, in the SHL products of 97%. Our largest customers rapidly grew their relationship with us, with our top 200, on average, growing more than 15%. A small portion of this came from the addition of Valtera, which is a great Fortune 100 franchise, but most of it represents strong cross-selling.

You can see the steady growth that we enjoyed in this segment to the right of the slide. You'll also note that we crossed the threshold of 6,000 member institutions for the first time due to strong large corporate new sales globally and strength in our middle market team. This growth was underpinned by a strong increase in usage of our online platforms and a significant expansion of the impact of our advisory team. And at the core, as always, was authoritative actionable research on topics as various -- varied as new drivers of employee productivity, better ways of delivering IT services and identification of key leverage points for compliance management.

Our goals for 2013 are to continue to help members achieve great outcomes through effective, creative execution and focused investments to enhance our impact. A few areas in particular that we'll be focused on: continuing to invest in our firm level talent and performance data management assets. With the addition of SHL's rich data set, we now have the most comprehensive view into the drivers of leadership, success, functional and corporate performance and employee engagement and productivity across all geographies and functions, and we're investing to make that valuable to all of our members. Second, advancing the development of technologies and tools that tie our resources to the most important repeating workflows, particularly in the area of functional benchmarking, employment analytics and talent audits.

Finally, continue our investment in the people in process to create moments of impact where our great resources can create a wow factor for our member.

Please turn to Page 11. Priority number 2, lead the analytic transformation of talent management. As we discussed, we see an enormous multi-year opportunity at helping members navigate across functions, manage talent with rigor and analytic depth. As one early adopter of these analytics remark to us, "Now we can make sure that we have the right people with the right skills and the right behaviors in the right place at the right time." As we've said, most companies don't manage human capital with the rigor of other corporate assets, so not many people can yet make that claim. We see this as a significant opportunity.

This has been a long-time focus of our program domains, and it is an area where we radically accelerated our capability in 2012 with the acquisitions of Valtera and SHL. We anticipate significant long-term growth opportunity here, and I see a few areas of focus in 2013. Job 1 is ramping our SHL products back to their normal growth zone. The focus here is on great execution globally and on investing to build our North America sales and service capability.

As in all our businesses, there's a lag between making these investments and seeing their impact on the top line, so we anticipate some early year margin compression in this business as we establish the foundation for faster growth later into the year and into 2014. Job 2 is to leverage our now broader footprint to bring compelling new propositions to market. This takes 2 main forms: bringing our broader set of capabilities to our HR buyers and developing new applications for execs outside of HR. We're seeing some positive early indicators that we can combine our assets in compelling new ways for HR execs.

Just last month, one of our top account management teams installed a multi-year agreement with a large technology firm that spanned pre- and post-hire assessments from SHL, performance management tools from Valtera and HR best practice resources from our CLC area. And our first effort to sell into new buying centers, the Challenger selection and assessment product in our sales effectiveness area, continues to gain strong traction. To the right, you see the tangible benefits of applying analytic disciplines to sales hires. Reps selected based on high assessment scores perform 10% above the average and attrit at 16% less. If you ran this process for 3 years at a large sales organization, you'd drive overall sales team performance, growth and profitability by double digits on an annual basis.

With results like this, you can expect to see our second launch outside of HR in the new year.

Finally, job 3 is concluding our SHL integration, so we can operate as a single entity with respect to both our markets and our operations. We've made good progress here with the SHL leadership transition now largely complete, along with the integration of our finance, legal, HR and technology operations. We've also started to add some CEB folks to the SHL senior team globally and in the Americas, and I'd expect to see some SHL talent move the other way.

Finally, we've identified and begun to realize our cost synergy targets, which will flow into the P&L across the year. We'll measure our success by the growth of these product lines in the impact we have on member decisions. As Rich said, the early part of the year is likely to be an investment cycle as we ramp more top line growth later in the year.

Please turn to Page 12. Priority 3, achieving brand recognition that matches our global impact. For many years in our corporate history, we were content to be a well-kept secret. We took great pride in having huge impact on companies as a relative unknown amidst the larger professional services brands. We're also content to let individual products and service lines develop differentiated market voices.

We've realized over time, however, that the CEB brand is vital to having impact on member decisions and member companies, and accordingly have begun to invest in building a clear, compelling story about CEB in all of our markets.

Our focus this year will be on 3 fronts: first, continuing to raise the visibility of the CEB brand across all of our markets, primarily through consistency in how we talk about our risk capabilities and demonstrated track record of impact. We will also continue to invest in gaining recognition among our key buyers through targeted events and media coverage, an area where we continue to see very strong year-on-year growth.

The second front will be the integration of the SHL brand into the CEB brand framework. This will be an important and challenging effort as our corporate footprints have very little geographic overlap. In essence, this integration represents the debut of our respective capabilities in a good number of markets globally. You can see the timelines and the treatments on the right-hand side of the page.

A strong brand will pave the way for more cross sells and new sales as existing customers recognize the full breadth of what we can do and as more prospects globally associate great business outcomes with the power of our work.

The third, and likely most important element of our brand, is continuing to build one of the world's elite talent brands. We don't run arms and legs consulting businesses . We are far more dependent on the quality of talent we attract and grow than the quantity. This requires that we create compelling careers that attract, keep and grow top researchers, advisors, technologists and business builders.

We had a great year on the talent front, enjoying strong retention of our high performers and adding hundreds more of great new CEB-ers. Our talent, metrics are all at the high end of our historical ranges across all our communities, and we are determined to keep it that way.

2012 saw us invest heavily in new training and development resources that accelerate the careers of our people and boost their impact on our members. And as you would probably guess, we practice what we preach, using strong analytics to measure every talent investment carefully.

Before we transition to Q&A, let me make one last point about our brand. Our brand isn't our logo, our colors or our tagline. Our brand, simply put, is what we do for people, the collective set of outcomes that help our members achieve by connecting great insights, data and tools for important decisions. And this happens through high impact moments where our people create, connect and deliver value thousands of times each week.

So to close out, 2012 was a year where we demonstrated and strengthened all elements of CEB's core investment thesis, which you see on Page 13. First, we strengthened our leadership in areas of growing corporate demand. Second, we created even more valuable insights, data and tools to help members solve big dollar problems, and we connected these resources to member work via inspired sales, service, advice and technology. We grew and extended our highly profitable recurring revenue business model and demonstrated a cash generative power of the business.

Looking forward to 2013, we have clear focus on a few priorities that will set us up for across the year and beyond, delivering surplus value to members, leaving the analytic transformation of talent management and achieving brand recognition that matches our global impact. I'm proud of how well our teams accomplished that in 2012 against a tough economic backdrop, a dysfunctional political process and significant change within the company. Our success allows us to create returns for our holders -- our owners, build compelling careers for our people and invest to push out the frontier of value and impact for our members.

We have much work ahead, but we entered with 2013 to considerable momentum and large opportunity in a skilled, committed team. We'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go first to Gary Bisbee with Barclays Capital.

Gary E. Bisbee - Barclays Capital, Research Division

I guess the first question, encouraging commentary you made on how Europe transpired in the fourth quarter. Can you give us a little more color? Was this just better sales execution? Or how did that pick up the trend versus what you've seen in the prior quarter or 2?

Thomas L. Monahan

I think, obviously, it wasn't a macro tailwind as the markets there continue to be very difficult. I think 2 things we saw. One was, I do think companies there have settled into a new normal and are grinding out ways to try to create some profit and value for their investors. And we don't need a tailwind, we just need stability. Second is that team is blooded by battle. It's a strong team that worked like heck to be able to articulate and create value for customers there. And they're operating in a tough environment, but they're no strangers to it. I think their skills, capability and commitment helped us create great outcomes. We're very pleased with the resurgence of Europe in the quarter.

Gary E. Bisbee - Barclays Capital, Research Division

And can you be a little more specific on how the SHL business did? I think you've said it grew modestly more than the third quarter, did I hear that right? And is that -- similar things going on there?

Richard S. Lindahl

Yes, Gary, this is Rich. On the -- if you look at it on an adjusted revenues basis, the year-over-year growth was a little bit less than 2% at SHL.

Gary E. Bisbee - Barclays Capital, Research Division

Okay, good. And then, the $8 million to $10 million of integration costs that you said would be in 2013, is that in or out of the adjusted EPS? And can you be a little more specific what types of spend are within that $8 million to $10 million?

Richard S. Lindahl

Sure. That is -- we adjust those costs out of both adjusted EBITDA margin and non-GAAP EPS. And those are going to be things -- there's a good chunk on the re-branding effort that Tom described during his presentation. There's also some cost to implement the right compliance processes, including making sure that we meet the deadline for adhering to Sarbanes-Oxley requirements. And there's some other IT-related integration costs that don't end up getting capitalized.

Gary E. Bisbee - Barclays Capital, Research Division

Okay. And then, just [indiscernible] I want to clarify, 2 things, the PDRI being moved into the CEB segment, did that -- was that additive to contract value?

Richard S. Lindahl

No, there's no contract value for PDRI.

Gary E. Bisbee - Barclays Capital, Research Division

Okay. And then just how about the -- you said it was the $7.5 million on profit. What did it do on adjusted EBITDA? Is that a profitable business at this point?

Richard S. Lindahl

It was $7.5 million on revenue in the quarter, and their margins are comparable to the CEB segment overall.

Operator

We'll go next to David Ridley-Lane with Bank of America Merrill Lynch.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Sure. What is your expectation for pricing on the core CEB membership in 2013?

Richard S. Lindahl

We -- go ahead, Tom.

Thomas L. Monahan

David, as you know, our pricing philosophy is pretty consistent. We aim for 3% to 5% same-store sales pricing across. And you've seen us stay pretty much within that -- in that trend across time with the exception of the steepest parts of the downturn. I'd expect we'll be in that range again this year. Last year, we probably came a little closer to the lower end after a couple of years of being at the higher end. But we aim, first and foremost, to make sure we're stepping up the impact in usage and value and then monetizing that through a consistent same-store sales price increases.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Okay. And then would you expect, inside that 25% to 26.5% adjusted EBITDA margin, wherever you end up for 2013, is that the new base that you would think [ph] then begin to grow, as you've said in your long-term margin outlook, 25 basis points a year? Or would you be expecting some additional catch up in cost synergies related to SHL to kind of help you put out outsize margin expansion in 2014?

Richard S. Lindahl

David, this is Rich. I would say that overall, we expect to stay on that trajectory of, on average, about 25 basis points over a multiple-year time period. As we've talked about, that can be more or less in every -- in any given year. You certainly saw it to be more last year due to the factors that we described. And there'll be some help, certainly, from some of the cost synergies there. But I think that kind of long-term average of 25 basis points is the best assumption at this point in time.

Thomas L. Monahan

Yes. We think that lets us balance both continued returns, but also we see lots of opportunity. We want to make sure we're prudently investing it across time.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Got it. And then do you have pro forma adjusted EBITDA margin for what it would've been in 2012, given a full year of SHL? I'm just trying to gauge the year-over-year margin change embedded in the guidance.

Richard S. Lindahl

Yes, it's not materially different from what we reported.

David Ridley-Lane - BofA Merrill Lynch, Research Division

So the 27.2% that was reported?

Richard S. Lindahl

Yes, it's in that zone.

Operator

We'll go next to Tim McHugh with William Blair.

Timothy McHugh - William Blair & Company L.L.C., Research Division

First, I just want to ask, can you help us understand if we look at the legacy business, client growth, while solid, was a little slower than last quarter while retention picked up. Does that mean -- should we infer -- the contract value, you absolutely did a better job with cross-sell, I guess, than new client additions? I guess, how do we -- the trade-off between those metrics, can you give us kind of the color behind it?

Thomas L. Monahan

Tim, I think first, we're happy with both outcomes. So I think we're pleased with how teams are executing both. You probably see a little bit of the Europe story still flowing through the new customer adds because that team's success was going to be, as you'd guess, more anchored on existing customers who knew us and knew how to use us. So that's still a tough environment to go kick open a new door and say, "Hi, I'm here to help you buy something you've never bought before." We're still catching up on that capability there. But more of the success in Europe came in -- came via cross-sell, et cetera. And I think -- so I think you'll probably see a little bit of that news flowing through to the new customer number. We're very happy with both. We're happy to cross that 6,000 member barrier, which is great, and we're happy to see our existing customers finding enough value to keep investing with us.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay. And you mentioned the faster growth from the slightly lower margin premium services. I'm assuming most of that is the Leadership Academy and similar businesses. How big is that as a percentage of revenue, and how much lower is the margin?

Thomas L. Monahan

If you look at premium services across all segments, so think about the portions of the SHL business where our professional services team will come in and help you choose what assessment you want and link them to your systems, or the CEB business where we might take fair employment analytics and break it out by business unit so you can pick what you're seeing about your employees, down to the individual country or business unit level. Overall, it's about 20% of the overall CEB total, and the margins are under the corporate average. Obviously, they're profitable, but they are under the corporate average, and that offsets some of the scaling we get. Now it also makes the highly scalable components of our business more sticky and embeds us deeper in member workflows. So we're very happy to make that connection to members and make the business more sticky going forward. It's about 20% in total across all our businesses. And you did see us take a step up from then, probably historically, about 10% within CEB. It took a step up to about 20% with the integration of SHL.

Timothy McHugh - William Blair & Company L.L.C., Research Division

Okay, great. And last question, just now that your 4, 5 months out from the SHL acquisition, I think, your commentary generally sounded positive. But as you've gotten deeper into it, the ability to kind of cross-sell and enhance SHL's growth and especially in the U.S., can you give us just, I guess, a summary of do you feel better about that? Is it -- are there any -- is there any thing that's been more challenging than you would've expect when you first did the deal?

Thomas L. Monahan

Short answer to anything more challenging, no. I think we've seen on the 2 fronts that we've identified, one is simply bring the SHL product set to a broader footprint. We've seen good early indicators there, and we're learning. I shared the -- one of the examples we have one of our teams being able to present and integrate the capabilities well across the waterfront of needs that an HR team has. And then early returns from taking the tools and technologies and applying them in other domain areas are positive as well. So nothing that has surprised us. As I said from the outset, our -- both sales teams were big [ph] to begin with. So this was -- we didn't want to pull everyone offline and say, "Okay, let's all learn the exciting new products we have." And we're taking it step by step to make sure that this is accretive to sales force activity and not dilutive or distracting. So we're getting smart about what we need to do and scaling the elements that work as we land on them.

Operator

We'll go next to Shlomo Rosenbaum of Stifel, Nicolaus.

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Just to go over, I want to make sure I understood right. The year-over-year organic growth rate of SHL on a pro forma basis was about 2%?

Richard S. Lindahl

For the quarter, yes. And that's on an adjusted revenues basis. It was a little bit less than 2%.

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Got you. And what -- can you just talk about -- give us a little bit more detail on the geographies. The big issue was Europe, and it sounded like Europe picked up at CEB, but not necessarily at SHL. Can you just talk a little bit about what's going on in the geographies more?

Thomas L. Monahan

Yes, I think the story in North America and APAC in the CEB segment has been year-on-year strength throughout the year. Europe picked up in the CEB business in Q4, and they had a real nice late surge. The team executed very well. The same general trends we're applying across SHL, they've just have more Europe than we did in the historical CEB business. So I think you'd see, overall, more annualized strength in APAC, Middle East and the Americas and offset by a larger piece of the business from Europe. Obviously, if we -- given that, that business in Q4 began to show improvement off Q3, that implies that there was more consistency and stability in the European markets in the quarter.

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Do you think that it was a macro stability that helped you improve over there in Europe in SHL? Or was there anything that you guys -- you would put an effort into over there particularly?

Thomas L. Monahan

Yes. I think -- we talked about this in the Q3 about we are not yet able to gauge how much of Q3 is just distraction. This was a company that went through a major corporate -- they got acquired in Q3 in a very fast timetable. We closed the business very fast. And so there's some portion of distraction factor as we've closed the transaction, transition the leadership team, put in place plans that you can see starting to wear off in Q4, just people getting back to business. I was kidding with some of the SHL leaders this week, but I had 3 or 4 phone calls with them and every single one of them was about growth. Every single one of them was about a customer situation we thought we could leverage. So we're kind of out of talking about organizations, et cetera, and we're into talking about how we blend our capabilities in ways to create new value for customers. And I think that's an important trend, just getting out of the integration period and into the growth period. So I don't want to say it was distraction factor beginning to abate, but I think that's part of it.

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then, Rich, can you talk to us about the level of free cash flow we could expect in 2013?

Richard S. Lindahl

Yes. Well, we provided some guidance in terms of what you should expect the ratio of operating cash flow to adjusted net income to be. And so I think you can do that math and then the CapEx is roughly $29 million to $31 million. So that would be the way you get free cash flow.

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And are there any particular items of CapEx in 2013 that are kind of integration type of items that won't -- you don't expect to recur on a go forward basis?

Richard S. Lindahl

Yes. I think we're expecting about $4 million to $5 million of that total to be related to integration. Some of that is connectivity for offices on a capital basis and some other system integration efforts that we need to do.

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then just in terms of the timeline, in terms of generating new products from the combined CEB SHL product teams, I mean, how do you guys things think about it in terms of coming out with new products over this coming year? Is there a number of membership launches that you guys are expecting from that? I know, Tom, your approach has been, first of all, don't break anything, which sounds right. But just in terms of coming up with something that's combined, if you could talk about that.

Thomas L. Monahan

Yes. We're already at the first -- we worked real hard to get the first product to the market, which was that Challenger add to our sales effectiveness suite. And early returns for member conversations there had been very promising. So job 1 is continuing to scale that and get that into more hands and in front of more members. That's also the most -- as you know, sales is easily the most quantifiable element of corporate activity. So it's a great place where immediate returns, great paybacks, real precision around better management matters so much. Beyond that, you heard Rich say we're investing significant dollars in new product launches this year, and I think some of that will be applying these great new resources to new areas within the -- in the executive suite. And frankly, we have some other ideas that we're going to -- were great ideas prior to the SHL combination that we want to make sure we get to market. So I think, over the year, you'll see a balance of new products late of talent, analytics and selection assessment products and new product launches elsewhere in the business. We're -- with the integration period behind us, we're very much focused now on bringing new stuff to the market.

Operator

[Operator Instructions] We'll take our next question from Joseph Foresi of Janney Montgomery Scott.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

My first question here is just on SHL. Could you give us some idea what your expectations are built into guidance for 2013 growth in that practice? And when can we expect that margin profile to kind of return to corporate average? I think -- I know you talked about the back half of your being better for margins. But I'm just trying to get a feel for those numbers.

Thomas L. Monahan

Sure. I think what we're expecting is that the growth is going to be relatively muted in the early part of the year as we continue to build traction there in the business. And obviously, also, it's going to be a tougher comparison relative to the first half of last year. We would expect better growth in the second half of the year. And we would hope to get the full year impact into kind of the mid- somewhat high single-digit area, which would be the bottom end of our typical multi-year growth range. As far as the margin expectations go, clearly, this is a big investment year at SHL, as well as in the CEB segment, but in particular, with the SHL segment, so you will see margin compression especially early in the year. We'd hope to see some improvement as revenue growth improves and we get to see some of the benefit of those investments at the end of the year. But it's probably next year before you see meaningful improvement on a full year basis there.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Okay. And then just on the sales cycle this year, in general, how did that fit versus kind of what your expectations were? I mean, obviously, we can see what the contract value was. But how did that fit versus your expectations? And obviously, Europe was better, but I'm just trying to get a feel for how -- versus your expectations and what you see maybe this year versus prior years?

Thomas L. Monahan

Sales cycle for us, it tends to be pretty consistent year in, year out and the CEB segment is kind of 50 to 70 days, more than that in the SHL segment as there's more configuration of the product. And in the CEB segment, the products are configured to be buyable and so it isn't a -- we really try to make the -- compress the sales cycle by not having products that require 150 people in a room in multiple loops. So we didn't see much change in the sales cycle in either business. Obviously, the sale cycle compresses a little bit as you come to the end of the year and people have certainty about their budgets and they have clarity about what their objectives are for the next year. And if we're doing our job right, we're making it very clear to them that in a world of scarce budget dollars, their ability to execute is contingent on their expanding relationship with us. And then we spend the year after that making sure that's true.

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

It's kind of actually 2 parts. First, going back to the sale cycle, I know that maybe financial services in that segment had been sort of lighter before. Any changes across the segments as far as buying decisions or optimism given sort of as we head into 2013 versus maybe pessimism versus last year or the last couple of years? And then just on the housekeeping side of things, can you give some idea what you're expecting on the stock comp and any of the things outside of guidance that make up the non-GAAP number?

Thomas L. Monahan

[Audio Gap]

Industry verticals level. The one I called out, which was government was -- is a small sector for us, but it was just surprising. I think it's a powerful testament to that team's ability to create some value. But the rest of the industry verticals all performed at a pretty healthy level. When we benchmark budgets, I think to oversimplify, I think the financial services continues to look at hiring patterns that may be a little different as they try to rationalize some of their business lines. But broadly, most industry verticals have a very similar outlook on 2013, which is modest growth, even more modest approach as to hiring, people trying to get more out of what they've got, grind more profit out of the resources they have. But on the flip side, it's a stable market. Nobody is in panic mode. People are -- they've taken their belts, they're marching forward with some resolve and that's a good environment for us to sell into. There isn't much news at the segment level, but changes that across different end markets.

Richard S. Lindahl

And Joe, on the stock comp piece, our guidance contemplates roughly $13 million of stock comp expense in the year.

Operator

And we'll take our last question from Jeff Rosetti of Janney Montgomery Scott.

Jeffrey Rossetti - Janney Montgomery Scott LLC, Research Division

My question was answered.

Operator

And at this time, I will turn the conference back over to Mr. Tom Monahan.

Thomas L. Monahan

Thank you all for calling and/or logging in today. Rich and I will be out in the road a lot over the next month. We will be at the Bayer Business Services Conference up in New York later this month, and we look forward to seeing many of you there or elsewhere in our travels. Looking further ahead, we hope, if you've got your calendars out, you can plan to join us here in Waterview for our annual Investor Day on June 14. We'd like that opportunity to bring you up to speed on the business at a different level of depth to get to meet management and to demo some products. It's always a good day, and we hope people make time for it.

Richard S. Lindahl

Thanks very much.

Operator

This concludes today's conference. Thank you for your participation.

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