Corporate Executive Board Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: CEB Inc. (CEB)

Corporate Executive Board (NYSE:CEB)

Q1 2013 Earnings Call

May 02, 2013 9:00 am ET


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

Thomas L. Monahan - Chairman and Chief Executive Officer


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

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

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

Gary E. Bisbee - Barclays Capital, Research Division

Ato Garrett - Deutsche Bank AG, Research Division

David Ridley-Lane - BofA Merrill Lynch, Research Division

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division


Good morning, and welcome to CEB's First Quarter 2013 Conference Call. Today's call is being recorded and will be available for replay beginning today and through May 12 by dialing (719) 457-0820. The replay passcode is 8645042. The replay will also be available beginning later today and through May 12 at the company's website and at

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 Investors link to yesterday's news release. You'll also find a PDF of the supporting materials that the company will use in its prepared remarks this morning by going to the Investors page and following the link to the first quarter 2013 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 call may also contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding CEB's expected quarterly and annual financial performance for fiscal 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 CEB's filings with the Securities and Exchange Commission and in its first 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'd 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, Scott, and good morning, everyone. This is Rich Lindahl, CFO of CEB. Thank you for calling or logging in to our first quarter 2013 earnings report.

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

Please turn to Slide 3 of our presentation and we'll start with a quick summary of today's report. The headline is that we are off to a good start in 2013. We enjoyed continued growth in both our CEB and SHL operating segments and have taken important steps forward on our investment plan for the year.

We continue to pursue our growth strategy by leveraging our capabilities even as we navigate around the pockets of volatility that remain in the market. Overall, we are pleased with our progress on the year and comfortable reaffirming our guidance.

Let's turn to Slide 4 for a summary recap of our results. Revenue was $190.3 million in the first quarter of 2013, an increase of 48.1% on a year-over-year basis.

Adjusted EBITDA margin was 24.2% in the first quarter compared to 26.4% in the first quarter of 2012. Diluted earnings per share were $0.33, and non-GAAP diluted earnings per share increased 26.4% to $0.67 for the first quarter of 2013.

Finally, cash flows from operations were $111.4 million in the first quarter, which as you know, is our seasonally strongest cash flow period.

Now let's turn to Slide 5 to review our key operating metrics, which were solid across the board and consistent with the seasonal dynamics of our business. Along with the fourth quarter, the first quarter of the year is typically one of the strongest in terms of total bookings. However, unlike the fourth quarter, the first quarter is more heavily weighted towards contract renewals than new business, as our teams focus on setting up and building their pipelines for the year ahead. As a result, while we usually see good year-over-year growth in the first quarter, on a sequential basis, it is common for contract value, institution counts and quarterly revenue to decline. The SHL segment shares many of these same characteristics as the CEB segment, and so these outcomes are relatively consistent across the business.

CEB segment contract value at March 31, 2013, was $548.7 million, up 11.9% versus March 31, 2012, and reflecting solid bookings growth over the past year.

For the SHL segment, adjusted revenue was $46.6 million in the first quarter, an increase of 2.2% compared to the first quarter of 2012. Growth in adjusted revenue was somewhat constrained by the stronger U.S. dollar during the quarter. As on a constant currency basis, SHL adjusted revenue growth was 3.6%.

CEB segment wallet retention rate was 100% at March 31, 2013, in the normal range and up slightly compared to the 99% the prior year. SHL segment wallet retention rate was 96% at March 31, 2013, also in the normal range and reflective of the strong recurring revenue we see in that part of the business.

Total CEB segment member institutions grew 5.5% to 6,048 in the first quarter, and we continue to add institutions in both our middle market and large corporate memberships.

Finally, CEB segment contract value per member institution was $90,700 at March 31, a 6.1% increase over the first quarter of 2012.

Please turn now to Slide 6 and I'll review key segment highlights for the quarter. As you can see, our first quarter results benefited from both solid organic gains in our CEB segment and the addition of SHL. CEB segment revenue was $148.1 million in the first quarter, a 15.3% increase compared to $128.5 million in the first quarter of 2012.

Included in the CEB segment is approximately $6.8 million of inorganic revenue from PDRI, and so our organic growth rate was 10% in the quarter.

The SHL segment contributed $42.1 million of revenue in the first quarter, net of a $4.5 million reduction to reflect the 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 first quarter increased by $27.3 million versus the first quarter of 2012. Acquired businesses represented about 78% of this increase, with the additional balance coming from continued product development and increased service delivery capacity, both consistent with the investment plan for the year we outlined in February.

Member relations and marketing expense increased by $17.5 million in the first quarter versus the prior year period. Acquisitions were the biggest factor here as well, representing about 75% of the change. The remaining portion is largely driven by increased headcount for our sales and marketing teams, which again reflects investments in our targeted priorities.

General and administrative costs in the first quarter were up $9.2 million compared to the prior year, with about 94% of the increase due to acquired businesses.

Acquisition-related costs of $1 million in the first quarter were driven by planned integration expenses.

Interest and other income was $1.6 million in the first quarter of 2013, about the same as the first quarter of 2012, with the biggest component in each year being the gain on deferred compensation plan assets.

Interest expense in the first quarter was $6.4 million versus $0.1 million in the prior year period, reflecting the interest on the debt raised to fund the SHL acquisition in August of 2012.

Total company adjusted EBITDA margin in the first quarter was 24.2% versus 26.4% in the first quarter of 2012. At the segment level, adjusted EBITDA margin in the quarter was 26.2% for the CEB segment and 17.9% for the SHL segment.

CEB segment margins were relatively flat compared to the prior year and consistent with our typical seasonal investment profile.

Regarding our SHL business. On our last call, we've noted that an area of focus in 2013 is adding capacity to grow in key markets. Accordingly, SHL segment margins declined meaningfully from the fourth quarter, largely due to increased costs from new sales staff and other customer-facing headcount. The timing of annual merit pay increases and muted revenue growth in the quarter also impacted these markets.

Depreciation and amortization in the first quarter was $14.7 million, an increase of $9.7 million compared to the first quarter of 2012. Most of this change is from higher amortization of intangible assets resulting from the SHL acquisition.

Our effective tax rate in the first quarter was 37.2%, which is below our prior guidance for taxes in 2013. As we have previously said, the SHL acquisition offers us more avenues to develop and implement tax planning strategies. The first quarter tax rate reflects progress against some of these opportunities, including a one-time 2% benefit to the rate in 2013, and a recurring benefit of approximately 2% that resulted from part of our acquisition tax structuring plan.

Please turn to Slide 7 for select balance sheet and cash flow highlights.

Our seasonally strong first quarter cash flows left us in a healthy financial position with $142 million of cash at March 31. Accounts receivable was $175.7 million at March 31, which includes $56.1 million for SHL and PDRI.

The current portion of deferred revenue was $396.4 million at March 31, including $53.2 million from SHL and PDRI.

As compared to the prior year, CEB segment deferred revenue, excluding PDRI, increased by 11.2% to $343.2 million, a positive leading indicator for CEB segment revenue.

We ended the quarter with $517.6 million of total debt on the balance sheet, and we are on track to reach a net debt to adjusted EBITDA ratio of under 2x by the end of the year. We also maintained access to additional liquidity via the $93 million of undrawn availability under our revolver.

During the quarter, we spent $8.8 million on capital expenditures, largely on application platform enhancements, system infrastructure, office buildout costs and integration items.

We repaid $23.3 million of debt outstanding, including the remaining $20 million revolver balance as previously disclosed.

We continued to return cash to shareholders by paying out $7.5 million of dividends in the quarter. As we have previously discussed, we plan to use stock buybacks to offset dilution and maintain a constant share count. We did not have any buyback activity during the first quarter and thus, maintain $50 million of availability under the share repurchase program approved by the board earlier this year.

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.

In short, we are reaffirming the guidance we initially provided in February. As we said then, we are planning for 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 currently expect adjusted revenue of $825 million to $845 million, and that the reduction in revenue from the deferred revenue fair value adjustment will be approximately $13 million this year. So the implied revenue outlook is, therefore, $812 million to $832 million.

While our first quarter results were solid, our more global business has greater top line exposure to currency volatility than in the past, and our U.S. government teams are facing growth headwinds, given sequestration and uncertainty over the federal budget. As a result, we still see a wide array of potential outcomes and are currently tracking near the midpoint of our revenue range for the year on a reported U.S. dollar basis, assuming exchange rates remain in about the same place going forward.

We are planning for adjusted EBITDA margin between 25% and 26.5%, depending largely on where we land in the revenue range.

Let me give you some color on how we see the remainder of the year playing out in each of our segments.

In the CEB segment, we expect a sequential decline in margins in the second quarter before then seeing sequential increases in the third and fourth quarters. While we expect CEB segment revenue to grow sequentially for the rest of this year, we also will have the typical seasonal lift in operating expenses in the second quarter, driven by merit pay increases, payroll taxes, our busiest meeting and event season and additional headcount costs in the product and sales teams.

In the SHL segment, we expect margins to remain relatively flat the next 2 quarters before improving in Q4. As we've said previously, we are adding sales and delivery capacity in that part of the business to set ourselves up for better top line growth as we exit 2013.

Accordingly, we are planning for another sequential uptick in SHL operating -- segment operating expenses in the second quarter due to the run rate impact of new hires and seasonal increases in event and project delivery expenses.

While costs will likely level off in the third quarter, in the near term, this trend in expenses will offset anticipated improvements in SHL segment adjusted revenue growth.

For 2013, we expect to incur $8 million to $10 million of acquisition-related costs as we continue to the next phase of SHL integration. Depreciation and amortization in 2013 is expected to be between $61 million and $63 million, and capital expenditures are expected to be approximately $29 million to $31 million, including $4 million to $5 million on integration projects.

Let me comment for just a moment about our projected tax rate going forward. Currently, we expect our 2013 effective tax rate to be approximately 37%, reflecting the benefits previously described. We also now expect an ongoing normalized effective tax rate in the range of 37% to 39%. The effective tax rate is dependent on the distribution of global income and excludes any additional permanent book tax differences that are not determinable at this time, such as future foreign currency translation gains or losses or other discrete items that are not currently recognizable under U.S. GAAP. We are monitoring international regulatory developments, especially in the United Kingdom, which appears to be moving toward lower tax rates in the years ahead.

We will also continue to pursue strategies which will allow us to operate in a tax efficient manner.

To recap, through the first quarter, we are very much on track. Solid overall bookings combined with planned growth investments to produce the outcomes we expected in the first quarter. At the same time, we have seen some volatility in currencies and headwinds from sequestration. So full year revenue is currently tracking near the midpoint of our range.

We are also continuing with our 2013 investment plans, which may push margins below the midpoint of our range.

As an offset, we now expect a more favorable tax rate for the year. So taking all of these puts and takes into account, we are maintaining our outlook for 2013 non-GAAP diluted earnings per share in a range of $2.85 to $3.15. And as you'd expect, the distribution of quarterly earnings will follow the margin trends I described just a minute ago.

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 strategies in the year ahead.

Thomas L. Monahan

Thanks, Rich. Let me add my welcome to everyone who's joined us today. We're eager to update you on our start to 2013 and our exciting work to advance the business.

As Rich outlined in his remarks, we delivered a solid performance in the first quarter that positions us well to meet our commitments for 2013.

Let me pick up the story on Slide 9. The solid start was in the context of an operating environment that is still mixed. The first quarter was punctuated by events like the Cyprus banking crisis and the U.S. federal government sequestration. Despite such turbulence, corporate leaders are staying in the course they first charted coming out of the global financial crisis. In the face of low growth in developed markets, they are seeking to grind out modest top line growth and drive productivity gains. You can see these themes repeat in the Q1 earnings calls we've already heard from the largest companies who are showing healthy profit despite seeing revenues pinched by Europe and currency.

As we've noted in previous calls, companies are eager for help in optimizing the allocation of people and budgets, while ensuring that operations are at a best-practice standard. The good news is that we have an ever increasing portfolio of resources to help them set direction for their functions, select and align talent, to accomplish their goals and measure and interpret results. Our progress to date indicates that we're positioned against areas of real need and that our teams are executing at a high standard.

Let me take a moment to share several Q1 performance highlights. I'll then spend a few minutes updating you on progress we made on each of our core priorities, delivering surplus value to members, leading the analytic transformation of talent management and achieving brand recognition that matches our global impact.

Starting with the performance highlights, we're pleased that the majority of our end markets have begun the year with a healthy organic growth rate. Obviously, North America large corporate results were strong and important to achieving our overall number, but a few others have stood out.

We continue to see year-over-year strength in our middle market business, as that team brings compelling products to a very large addressable market.

Our teams in Asia Pacific also had a good quarter, sustaining a multiyear growth rate above our corporate average. One other notable area of strength in Q1 was our financial services vertical product line. Although this sector of the global economy remains challenged, our teams performed well with targeted offerings aligned against areas of real need, such as product and channel management, and technology selection and implementation.

We also some areas -- saw some areas that lagged to the corporate growth rate. Europe continues to face economic headwinds, but our business remains stable. On our last earnings call, we showed that the European team engineered a solid fourth quarter performance but was still behind the corporate average.

We continue to see our teams there make progress in Q1, but don't yet expect this business to contribute to the overall corporate growth rate, particularly in U.S. dollar terms and current exchange rates.

Still, even as we wait for a broader momentum to take hold, we are seeing bright spots within our business like the performance of the SHL team in Continental Europe.

As Rich said, we also find it difficult to grow those product lines that focus on the U.S. federal sector. We talked to the past few quarters about fast growth in our government business, but we weren't counting on more of that this year. With U.S. federal government sequestration taking hold in Q1, it's clear that the headwinds on near-term performance have strengthened.

As 2013 unfolds, we'll get a better sense of whether this is a timing issue as clients confront the sequester or whether we are confronting a permanently smaller opportunity.

Looking forward, it's important to keep in mind that this sector represents only about 5% of total revenues across CEB's subscription products and PDRI. And moreover, we enjoy a very strong competitive position as federal managers confront challenging new problems with much smaller budgets than they're used to.

Finally, all of our content domains got off to good starts in 2013. Two areas of continued strength in opportunity were technology and sales. Corporate IT is clearly undergoing a fundamental restructuring. We remain well positioned to support companies navigating this transition through strong insight and innovative services.

Sales effectiveness also remains critical to companies trying to get more sales out of their current team to drive growth in the tough economy.

Our leading edge content has provided a strong foundation for new products and services that hardwire these insights in the companies.

Finally, we remain excited about talent management as a critical area of focus for executives and the distinctive strength for CEB. I'll share more about our work here in a moment.

In summary, I'm pleased with what our teams delivered in the first quarter. We made a solid start to the year and set ourselves up for success in 2013. We'll continue to track against our commitments in the coming months, while working to build a strong future for our business.

Let me now share some of those highlights by updating you on our core priorities.

Please turn to Slide 10 for an update on our first priority: delivering surplus business value. Our goal is to ensure that our members see surplus business value from their investments of time and money with our firm. By business value, we mean growing recognition, reduce -- growing revenue, reducing costs, reducing risk and ultimately, transforming the organization. To deliver these outcomes, we developed uniquely valuable insights into the levers of business value, link these resources to member decisions through compelling advice, instruction and technology and create demand through 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 enable them to hardwire our solution into their own organizations.

The clearest measure of our progress against this goal is our ability to keep and grow our relationships with members. As Rich mentioned, Q1 has some distinctive contours for CEB. We booked roughly 30% of our target for the year in the quarter substantially over which renewal activity, as many of our largest customers renew their portfolio.

Our sales teams usually confront a smaller new sales opportunity as they rebuilt their pipelines after Q4. Our metrics for the quarter reflect this. With wallet retention at 100% and contract value per member up by more than 6%, we are clearly off to a strong start.

We cannot deliver these results without high-value content that deliver superior business value. One highlight of the first quarter was groundbreaking new work we published on information security management. While the importance of this topic is underscored by a constant flow of security breach headlines, CEB brings a unique perspective. Our strong franchise in IT and depth in related fields, such as legal and compliance, gives us a 360-degree view of the operational reality that our members confront.

Our team found that the real news was buried beneath the headlines. The issue is not so much the mounting number and severity of security breaches, but rather the new centrality of information to corporate strategies. 79% of our member companies now report that information-based strategies are core to their corporate agenda.

The most common of these, data mining, social media, mobility and cloud-based architectures, demand freer rather than more restrictive loads of information.

The fact, as you can see from the right-hand side of the slide, current security policies impose a huge cost on the business in terms of wasted employee effort in time, lost innovation and project shortfalls. And companies still face millions of dollars of direct loss. This is an area where the cure, at least it's currently administered, is worse than the disease.

To help our members manage risks while maximizing the business value of information, our team created a new set of risk governance models and tools. The member CIOs, General Counsels, information security officers and strategists have reported immediate value for being able to match their information management strategies through their risk appetites.

One member, a top 20 global bank, reported that by "Reorganizing information risk management to focus on business risks and move accountability to business partners, we not only strip weeks out of our project cycle, but also substantially improve our risk posture."

In addition to developing must-have content, we're also focusing on several areas mentioned on our last call, including investing in talent and performance managed benchmarking tools, advancing technology that ties our resources to executive workflows and investing in people and processes to generate world-class service for our members.

Please turn to Slide 11 for an update on our second priority: leading the analytic transformation of talent management. For some time now, we've described with excitement the opportunity to help senior executives manage talent with increasing rigor and analytical depth. With all the hype around big data, we see executive teams looking for new tools and insights to manage their most important assets. And CEB is uniquely positioned to support them.

We've long focused on talent management topics in our research, but our acquisitions of Valtera and SHL in 2012 significantly advanced our ability to provide the necessary data and tools to fully unlock the power of these insights. Our job has been to effectively integrate these assets into a broader business and bring our collective value to bear on CEB member needs.

We're pleased with our progress. We've been disciplined in our approach to these integrations, including an early focus on giving the right leadership team across this business area. We're now past that stage and we are pleased with both the capability and energy of the people we have in place. It's a strong mix of leaders staying on, key SHL team members stepping up and experienced CEB leaders rotating into this product line.

Overall, retention, engagement and capability of this team have exceeded our expectations. We're thrilled by our newfound depth and reach. We also have largely completed the organizational integration of our back-office functions. Completing these foundational activities allows us to concentrate on the real work of bringing our large set of capabilities to bear on the world's leading companies. And there are 3 areas of particular focus. The first is simply ramping growth in the business. Our tactics here have been to intensively manage upstream sales and delivery activities and to invest more heavily in sales and services capacity in key markets. While there is some lag in realizing the returns on these ladder investments, we're making good progress as we see healthy growth in key leading indicators in the sales pipeline. And importantly, we see great receptivity to the technology and subscription offerings.

Overall, we are on course with plans for the year and we're excited for the future.

The second area of focus is leveraging our broader footprint to bring compelling new propositions to market. I'm excited both about our opportunity here and our progress to date. Most notable is the entry of the Challenger Selection & Assessment product, which has gotten off to a very fast start. This validates our thesis that executives outside of HR are eager for help with key talent issues.

We see many opportunities like Challenger Selection & Assessment to provide powerful integrated talent management support to the companies we serve. You can see the categories of opportunity to the right of the slide.

The third critical component of this effort is integrated packaging of our resources, so that members know how best they can drive value in their organization. You can see in our goal to the bottom right hand of the slide. We've kicked off an important work stream to this end. Over the next few quarters, we'll integrating the SHL solutions into the broader CEB brand architecture. In the process, we'll communicate forcefully with the market and our membership about how we can help them. We look forward to updating you more on this and the broader talent management story in the coming quarters.

Please turn to slide 12 for an update on our third priority: achieving brand recognition that matches our global impact. We know that a strong CEB brand is vital to having impact on member companies. Ultimately, it also translates to real financial returns for us. We can drive increased cross-sales and new sales as members continually associate great business outcomes with our work.

We're investing to build a clear, compelling story about CEB in all of our markets, with work underway in 2013 on 3 important dimensions.

In addition to the SHL rebranding work I just mentioned, we are also raising the visibility of the CEB brand through simple and consistent articulations of our capabilities and impact. And we are continuing to build an elite talent brand.

A particular focus of our branding strategy at this time of year is our hosting and participating in a range of high-profile events. You can see the different forms this takes to the right-hand side of the page. As you already know, we routinely host gatherings of senior executives to shape our work, share best practices and move our ideas into their organizations.

The classic format for this is 20-or-so CXOs in a business school classroom or board room, no vendors, media or junior staff, just senior executives wrestling with real shared problems using our unique data and insights to solve them. Even as the business has become ever more digital, in fact, maybe because it has become ever more digital, we find demand for this sort of exchange to be really strong. We will now do this more than 800 times this year all over the world.

In addition, this regular series of retreats, we now host or participate in a number of larger-scale and higher-profile events. You can see these to the middle of the page. These serve us an opportunity to gather senior stakeholders across teams, including potential members across a variety of domains or markets to examine pressing challenges. These events are larger in scale, think hundreds, not dozens of attendees, and feature a much broader array of participants. And unlike our senior executive retreats, which are entirely off the record, these events explicitly aim to create public dialogue.

Let me share a few examples. In April, we hosted a sold-out financial services technology conference in a major event in our sales and marketing area focused on selling and serving small businesses through digital channels.

Looking forward in May, senior consumer marketing, advertising and product executives will gather in Miami for CEB's Iconosphere. And we're hosting a major SHL LINK here in Washington, D.C. next week.

For the rest of the year, our schedule is packed, with our teams hosting major events like their B2B Sales and Marketing Summit in Las Vegas, and our IT and HR summits on both sides of the Atlantic.

We also maintain a presence at some major industry events. Most notably, we had a major presence at the Society for Industrial Organizational Psychology event in Houston, where CEB researchers led 63 of the panels. We're also very proud that some of our top researchers are gaining global recognition for their work. Among those recognized this year are Nancy Tippins who won the SIOP distinctive professional achievement award for her pioneering work in using technology to help companies make people decisions. Across the year, we'll match our own event schedule with key external events, like HR Tech.

Each of these opportunities helps highlight what is unique about CEB. We ground our work in deep analytic rigor, unmatched network breadth and cross-functional perspective and link it to high-value member work and decisions to innovative technology and inspired service.

In addition to ensuring that our brand stands for tremendous impact on members, we also aim to build a brand that stands for unique opportunity for exceptional talent.

Our goal is to attract and select top people by creating a compelling employment value proposition that hinges on first getting great people and then choosing only the best. Then we offer them an opportunity to work with other talented people, challenge an unparalleled customer base and pursue intensive skill development. I'm pleased that we saw great outcomes on all of these fronts this quarter. We enjoyed strong retention of our best people and saw robust pipelines of new applicants. And we continue to invest in rich training and development programs to accelerate the development of our highest performers.

Across the board, our talent metrics remain strong, but our ambitions run higher. We're tapping new sources of talent to build our sales presence globally and we are continuing to engage with our highest performers to create new compelling opportunities for CEB careers.

So to sum up on Page 13. We're off to a very solid start on the year, growing the business and getting our key strategic investments in place. We're pleased to be on track to an ambitious set of full year goals, despite a still murky economic picture. And as always, we're pleased to work with such a driven talented group of people to create great outcomes for the world's best companies.

I'm energized by such great colleagues and proud of what we are accomplishing together. We have much work ahead in the next 3 quarters, but I believe we have the right momentum in place to achieve impressive goals. We'll now take your questions.

Question-and-Answer Session


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

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

My first question here is just on SHL. I think we have talked about kind of a return to growth at the end of this year. I'm wondering if you could just comment -- I know you talked about it in your prepared remarks, about how that business integration is going? And is there any change in what your previous guidance was for the end of the year? And maybe you can remind us of where we stand with that?

Thomas L. Monahan

Joe, we're happy with how SHL got out of the gate. I think on balance, our view is that, that business is on track. We've had a real disciplined approach to integration, tried to move the organization first through the transition period, then laying the groundwork through some additional investments to create growth. And we're already seeing early pretty good returns from that. I think the business is on track. We feel great about both the growth opportunity that we face in that business alone and some of the opportunities we see on the new product front. Again, we've been very pleased by our first cross-business new product offering, which was an entry into the sales space. That had both great internal collaboration to make it happen but also terrific market receptivity. So we think that business is on track for a good year.

Richard S. Lindahl

Joe, just to be clear, there's no change in our expectation for what SHL is going to do during the year. We expect more muted growth in the first half of the year and better growth as we exit the year.

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

Sure. And I would imagine margins also coming back after this quarter, correct?

Richard S. Lindahl

We -- at SHL, we expect margins to remain relatively flat in the second and third quarters to where they are in the first quarter with improvements in the fourth quarter.

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

Got it. Okay. And then just moving on to some of your commentary about the U.S. government and some of the currency headwinds that you're facing. I know you pointed towards more the midpoint of the guidance. But could you give us a little more color, either quantitatively or qualitatively around sort of where we stand with that versus your initial guidance? I know you gave the percentage of revenue from government and a little color around that, but I wonder if you could just dig a little deeper into those 2 areas?

Thomas L. Monahan

Let me talk the government piece and I'll ask Rich to comment a bit on the currency piece. Our positioning in government, as you know, is strong but small. It's about give or take 5% of revenue, and as with most of our businesses, these are typically recurring contracts, multiyear relationships targeted on pretty high-value levers in the budget. Early in the year, we had seen it's difficult to grow to get someone to try to do a new thing and that affects everything we're doing in the government. So where they're using us, we've got an opportunity to keep that relationship alive and feel good about it. But our ability to go crack open a new budget when someone keeps hearing from their boss sequester, sequester, sequester has been difficult. We're still figuring out whether that's a Q1 activity as people digest the news and try to figure out how they're going to operate or whether it just means it's going to flow through the year. I don't think we have enough comfort there as to whether we're going to struggle to grow the business all year long. But in the near term, finding growth there has been challenging. We like our competitive position in the medium term a lot, if these guys are needing to look for new sources of support and help at a much lower cost than they're used to having these massive projects to support. But in the near term, cracking open new budgets is difficult.

Richard S. Lindahl

And Joe, this is Rich. On currencies, the most dominant influence is the relative dollar strength, U.S. dollar strength against the British pound. You've seen that rate bounce around a lot just as of the beginning of the year. I think we started the year at about GBP 1.62 to dollars. It got as low as GBP 1.48 or GBP 1.49. As recently, as a couple of weeks ago, it was about GBP 1.52 and now, I think, today, it's somewhere in the GBP 1.55 range. So it's bouncing around. I would say, as a rule of thumb, for the rest of the year, for the final 9 months of the year, of every $0.01 of movement will influence revenue by about $1 million on the full year. So that just gives you a little bit of a rule of thumb.

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

Okay, great. And then last one for me. We're about a quarter of the way through the year. Wonder if you could just give us some qualitative commentary about sort of how you feel about the business. Obviously, you've reaffirmed guidance, but are deal closures happening at the same rate that you expected? Is pricing holding stable? Have you seen any changes in the deal sizes? I guess I'm just wondering as we come through the first quarter, obviously, outside of guidance, what you're seeing in the market?

Thomas L. Monahan

I mean, I'd say Q1 felt like Q1 in many respects. It's a big renewal quarter. Obviously, the strength in the metrics indicates that our teams got out and did a great job creating relationships that endure and sustain and secured some of our biggest relationships to go forward for the coming years. So we feel good. There are pockets of some volatility that we discussed. There are some pockets where member demand is spiking and the net effect of all that is we're on track for the year.


And we'll take our next question from Tim McHugh with William Blair & Company.

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

First one is just PDRI, and is that business a little more influenced by the government and is that when -- why that was down a little bit? And I guess just how that should influence what we expect for that going forward?

Thomas L. Monahan

Yes. PDRI is substantially almost all of the U.S. federal government. So yes, that's -- yes, they are obviously holding their own, but it's harder to find that next opportunity for growth. We're hopeful as the year unfolds. It's a great set of resources that are a very valuable toolkit for federal managers confronting some new challenges. But in this quarter, people were definitely a little quiet and a little reticent to go try the next new thing. They were trying to sort out their own new budget reality. So yes, the PDRI is a government-focused business.

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

Okay. And just to be clear on Europe, is what you're saying that they were still -- was it still up year-over-year but just not near the corporate average? Or I guess, is Europe flat, up, down a little, I guess, at this point?

Thomas L. Monahan

Yes, it's -- the short answer is it's hard to tell in Q1 because Q1 is such a heavy renewal quarter. As we said, we saw modest growth in Europe in Q4 for the first time in several quarters. Q1 is such a heavy renewal quarter. It's hard to even get a picture of growth prospects for the year. I'd say, to give you some color, so far, 2013 feels more like Q4 2012 than the rest of '12. We did see some bright spots, notably the SHL continental team showed good momentum. But we think on balance, for the year, we hope for modest growth. It's going to be difficult to grow. We don't think they'll catch up with the corporate average this year based on what we've seen. I think there's the opportunity to generate some modest growth.

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

Okay. And then SHL, so you commented that Continental Europe is a little better. I guess as I look at the last 3 quarters, it seems like while the growth rate is not back to the level you want, it's come up a little bit to year-over-year, the constant currency growth rate. Is that because the continental more so than you accelerating the growth in the U.S. or somewhere else?

Thomas L. Monahan

I think broadly, the dynamics in all of our business is looking more or less the same by region. The one outlier we saw was more of momentum in the continent than you would've expected if you read the newspaper. And while -- I'll be honest here, one swallow does not a spring makes so I'd be careful to over generalize about the health of the European economy because of the performance of our team on the ground there. Yes, I don't think there were any economic tailwinds helping out. I just think the team did a great job executing it. It proves that when teams are doing a great job executing, even a pretty difficult economy can be a growth opportunity for us.

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

Okay. But is it fair you're yet to really see some of the initiatives to try and accelerate the growth in the U.S. SHL? That's more of something that's on the comment of future then.

Thomas L. Monahan

Yes, I think the real potential, given SHL's underpenetration in this market, realizing that potential lies ahead for us.

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

Okay. But it did sound like you expect sequential growth going into Q2?

Thomas L. Monahan

Yes. Some sequential growth, yes.

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

Okay. And the last question I had. Just for the legacy CEB, the contract value growth has been a little bit stronger than kind of the organic growth we saw for -- or organic revenue growth that we saw for Q1. Is there anything with that -- was some of that just timing? Or is there, I guess, were some of the non -- kind of nonsubscription parts of the revenue a little slower than the kind of subscription piece?

Richard S. Lindahl

Yes. It's largely timing issues, Tim. It's -- we've talked about the business mix shifting a little bit towards some more of these premium services, where the revenue recognition is not as evenly distributed as the core subscription products. And so that's really the main reason.

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

Is there -- I mean is there a timing then throughout the year where we would expect that, that should catch up or is it -- if it's predictable, when it will?

Richard S. Lindahl

Yes. I mean, I think when we look at it on a full year basis, which is really the way we manage the business, we expect that the trend should be pretty consistent for the full year.


We'll take our next question from Shlomo Rosenbaum with Stifel.

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

Tom, what was the sales force growth at SHL in the quarter?

Thomas L. Monahan

I don't think we've discussed it, but you can safely assume looking at the margin, it was good and faster than the corporate growth rate.

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

Okay. I mean are we talking -- can you give like percentage-wise? Are you looking to double it? Give us an idea over the year.

Thomas L. Monahan

It really varies by market. Assume though, the biggest opportunity for the ramp is in North America, if you look at the size of that business, relative to, let's say, even just CEB's relationships with HR executives in that market. That's going to be probably a multiple of the corporate growth rate. In other markets, it's a percentage and basis points above the corporate growth rates. So Americas is going to be the big outlier there and that will be a multiple of the corporate growth rate.

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

And did you see growth in SHL kind of pick up through the quarter? In other words, as you guys started at the end of the year, kind of worked out the personnel issues with the acquisition? Did you start to see that the growth pick up through the quarter?

Thomas L. Monahan

I don't know if it was much a news within the quarter. I think if you think about the quarter, the investments aren't going to have any impact on the quarter. And these are new people arriving. They're showing up in the budget and at a desk before they show up in the market. So it was more just great execution from day 1 by the team that was there on Jan 1, getting out and doing a good work to execute. So yes, I don't think there was any particular news in the quarter. In that business as in all of our businesses, you build a pipeline across the quarter and you keep trying to monetize as the quarter goes. So the end of the quarter's always a little busier, but I don't think there's any particular news vis-a-vis previous quarters there.

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

Okay. And then in terms of new product development schedule, I mean, for CEB and SHL in a joint way, do you have like a number of products that you're planning to roll out over the year? You talked about one that you guys worked on last year. There are a new number of new memberships that you're planning to come out with? Can you just give us a little more detail there?

Thomas L. Monahan

Yes. In some sense, it'll be hard to give you a perfect number. And that some of these become adds to a comprehensive suite where we're already in market with and it'll get sold as a portion of a broader package. On balance, I think we try to target one major new offer every quarter give or take. Some quarters, we have 2. Some quarters, we have 0, but that's roughly, roughly the pace that we target.

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

So I'm seeing -- that's for the combined CEB-SHL I'm seeing in the HR space for the quarter?

Thomas L. Monahan

Well I'd say in the talent management space more broadly. If you think about a good chunk of the opportunity, is building talent management capabilities. Let's say, a head of sales, as we've shown, can use them to manage their organization effectively.

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

And then, Rich, is there a change in the timing of free cash flow over the year because of the SHL acquisition? In other words, is there -- are we going to see a little bit more of a smoothing?

Richard S. Lindahl

Not in any meaningful way. I think obviously, we're planning on higher CapEx this year. And that ended up being maybe a little more front-loaded in the first quarter, so that had some impact on free cash flow in the first quarter. But on balance, you shouldn't see a significant impact.


And we'll take our next question from Gary Bisbee from Barclays Capital.

Gary E. Bisbee - Barclays Capital, Research Division

I guess on SHL, just 2 more questions on that. What goes into the commentary that you expect that to rebound in the fourth quarter? Is it just a sense of what you think the sales cycle will be to get these new assets you put in last fall and this winter up and running? How much confidence do you have that? Is that backed by the history of what the sales cycle look like? Or is it other factors? I guess I'm just trying to gauge the conviction or confidence that, that happens if the macro remained somewhat challenged like it is today.

Thomas L. Monahan

The way -- when we think about building a plan, we look at the inputs, the outputs we're trying to get. When we look -- when we target growth, what we look at is, do we have the sales capacity in place? Are they adequately skilled, motivated, et cetera, to go make that happen? And then secondly, can we monitor their activities to see if they are touching enough customers, generating enough new contracts? And the plan for the year was to get people on the ground early in the year, get them up the learning curve and continue to keep working to create more moments of impact in the marketplace. And as of today, both the number in caliber of people we've brought in to the business and so far the activity of the sales and service organization probably to generate moments of impact and create invoices and sales momentum, et cetera both look good. So we've got lots of distance to travel before the end of the year. But measuring what we can measure today and knowing the caliber of people we've got, we've got confidence that business will continue to show momentum across the year.

Gary E. Bisbee - Barclays Capital, Research Division

Okay. And then have you worked out or can you share with us how your existing sales force in the core CEB business will be incentivized or encouraged to make introductions and help the SHL product? And do they feel like that sort of a nuisance for them? Or is that an opportunity where they can either make money or at least feel like they're driving more with their customers?

Richard S. Lindahl

We obviously think selling -- particularly in North America, selling a broader set of services, including the SHL products to our existing installed base is a huge opportunity, particularly, even where they are underpenetrated. We ran some modest pilots in Q4 to see what vector would look like. So we're pleased with the results. I think we've -- it gives us good, clear focus for this year. Two things that we'll be working on, one is the rebrand, which gives us an opportunity to go out and explain ourselves to our customers in a very effective manner. So there are teams explaining the conversation. Obviously, they'll have incentives to do that, et cetera. And then secondly, it's also important that sales teams outside of HR have new packages to talk about. We're already doing that in sales. So we've run some pilots. We have confidence we can target the right things. It is important -- we wanted to make sure -- we also don't want to be in a position where we distract teams from what they're already supposed to be doing. We're being very careful and very focused in terms of how we roll these things out. So no one sells the new thing at the expense of selling or renewing the great thing they already have. So we're trying to be very planful about how we add these capabilities and these opportunities to our existing sales team.

Gary E. Bisbee - Barclays Capital, Research Division

Great. And then lastly, just outside of SHL, how is the whole premium service model evolved over the last year? You talked a lot more about it at last year's Investor Day than we'd heard in the past. Is that becoming -- and I know it's typically been lower margin, but is that becoming a more material revenue contributor? Or is it still really in its infancy?

Thomas L. Monahan

Yes, if you look at the total business across both segments, it's about 20 -- and what we call premium service is about 20% of what we do. Obviously, a good chunk of that is in SHL, where when someone chooses their solution, there's a start-up project of sorts to get it linked to the right systems and choose what populations they want and what skill bases they're trying to engineer. So on balance, on a percentage basis, more of it's in the SHL business than in the CEB business. In the CEB business, the core philosophy of the business hasn't changed. We like renewable, scalable subscription products. We have found there are places where members ask for a little bit extra help either installing something or interpreting something or doing a little bit of planning using some data we've helped them with. And we've put in place some services that allow us to do that in a profitable way that both help them to get better impact from the work they're already buying and to some degree, gain broader exposure to what else we can do for them. So we're comfortable with its positioning in our business. And I don't think you'll see it swing wildly as a share of the business over the coming quarters or year.

Gary E. Bisbee - Barclays Capital, Research Division

But what about the concept of getting a basic technology or offering within the subscription, but then having an upsell to a more detailed one? I know there was a talk a while ago with the Genesee product and surveying that you could get some basic one. If you want to do it more, you had to pay more. Is that material or is that still really small at this point?

Thomas L. Monahan

Yes, it's -- I think you'd find it in all of our domains at this point that there's -- you saw us talk about the IT Roadmap Builder product, which is an extension of some of the work we've done in architecture and infrastructure. It's the next level of impact in depth. You've seen in HR where we have the very light tools you can use to do workforce planning and then you can upgrade to the CEB Valtera heavier set of tools. You see it in sales where there's some light work you can do to measure sales force productivity and you can upgrade it to heavier packages that help you work on productivity, skill building, selection and assessment. So absolutely, it's a key piece of what we do. Now some of that flows through as a premium service. Some just looks like a subscription. So it's not -- not all of that shows up in premium services. And not all of it is anything other than just a core subscription.


We'll take our next question from Ato Garrett with Deutsche Bank.

Ato Garrett - Deutsche Bank AG, Research Division

Just 2 quick questions for me. One, I want to confirm that the contract value growth, was all that organic? Was there any acquisition left in there? And then two, when you're looking at the additional investments that you're going to be making for SHL, are those going to be spread evenly through the balance of the year? Or are they going to be lumpier in 1 quarter versus another?

Richard S. Lindahl

Yes, Ato, this is Rich. As far as the contract value question, that's -- all of that is organic. We anniversary-ed the Valtera acquisition, so that's all considered organic at this point. As far as the investments in SHL, safe to assume there's a bigger push in adding headcount earlier in the year than later. We -- you certainly saw some of that reflected in the first quarter margins. You'll see some more of it in the second quarter. And then you should see that expense profile more level after the second quarter.


[Operator Instructions] And we'll take our final question from David Ridley-Lane with Merrill Lynch.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Sure. Just wondering across the 5 end markets, where are you seeing the strongest demand and maybe some weaker demand? And I'm just kind of curious, is HR really outperforming with the addition of SHL or is it a bit too early to see that?

Thomas L. Monahan

Yes, I think across the 5 domains, there wasn't a ton of news. I remarked in the call that obviously, talent management continues to be an important theme, both in HR and beyond. Some of the things we've done to lift the SHL data out and drop it in the places like R&D or sales end up animating not only the core HR business, but helping some of the others. We also saw a great demand, as I said in my remarks, there's been a wholesale rethinking of corporate IT underway for the past couple of years, and that's really helped our technology team as they've been delivering some great value to members as they think through their organizations and structures. We've seen the sales area within sales and marketing. I guess B2B marketing is well and supported. That's been very strong. Members are trying to find growth any way they can and they realize that their existing sales organization, performing at a very high level, is a very efficient way to think about growing. So they've turned to us for a lot of help and that team has rolled out a lot of great products and services to support it. So there was no -- and obviously, the other domains are very strong. So the talent management theme plays out beyond just HR. And broadly, we're seeing pretty even performance across the end markets.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Got it. And then maybe one for Rich. Based on first quarter's adjusted EBITDA margin, your commentary for second quarter, it sounds like second half is going to be critical to getting into the full year range guidance. Is this is mostly revenue leverage? Or are there some actual cost reductions that will be coming out in the second half?

Richard S. Lindahl

You won't see cost reductions other than in the sense of we have some seasonal patterns that go through the year, which you've seen in the business in the past. So cost will certainly fluctuate. But the seasonal impact will probably be the more dominant factor there. Certainly, revenue leverage is going to be important. We do expect sequential revenue growth as we go through the rest of the year. And -- but having said that, we're also on track with our investment plan for the year and the thesis that we put together for making this a stronger business as possible as we exit 2013 and go into 2014.

David Ridley-Lane - BofA Merrill Lynch, Research Division

Got it. And do you have any stats you could share on the progress of cross-selling SHL into your legacy CEB customer base vis-a-vis? The member count that you gave us is just CEB members, so it's a bit difficult to tell how that's progressing.

Thomas L. Monahan

I -- we don't have any stats and if we did, they'd be small. Our goal has been focused small pilots. And the goal of the SHL team has been, given they already had great opportunity in front of them, to execute on that first. So you'll see that cross-selling grow particularly as the rebranding and remessaging takes hold. But right now, we don't have any stats. And if they did, they would -- they'd in the dozens, not the millions, in terms of number of clients, not dollars.


And we've had one final question come in from Tobey Sommer with SunTrust.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

I was wondering if you could quantify what the currency impact was in the quarter? And relative to, I guess, the pound, which you identified as having a relationship to revenue, what your currency assumption is going forward in the guidance?

Richard S. Lindahl

Sure, Tobey. This is in terms of the impact on a year-over-year basis, we said the SHL adjusted revenue growth was 2.2%. On a constant currency basis, it would have been 3.6%. So there was about a 1.4% drag due to currencies. And that's roughly $600,000. And as far as going forward, we're assuming that it stays relevantly constant to where it was in the first quarter, which was about 1.55%, give or take.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Okay. Relative to the tax rate, could you kind of size the opportunity over time? You gave some commentary for this year, but what sort of movement and improvement could you have in the tax rate over a longer period?

Richard S. Lindahl

Yes, I think that remains to be seen on a few levels. I think certainly, if you look at -- we're at 37.2% for this year. That's net of a one-time benefit of 2%. So if we haven't had that one-time factor, it would've been more like 39% this year. We've said that as we see it today, the current view on normalized tax rate is in a range of 37% to 39%, so you could see it steadily improve over the next couple of years. There's always a possibility that there could be new discrete items come in that could move it up or down, one way or the other. As we identify additional strategies or if there are additional developments in foreign jurisdictions, in particular in the United Kingdom, which has signaled rate decreases as we go forward over the next couple of years. And that can also help influence the tax rate as well.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

And your -- what sort of free cash flow is implied this year relative to your EPS guidance now that you've had kind of a quarter of cash flow under your belt? And do you expect CapEx declines next year to help cash flow?

Richard S. Lindahl

So we don't put out an explicit free cash flow metric or guidance. What we've talked about is operating cash flow to adjusted net income being in the range of 1.5x, and capital expenditures on a normalized basis being roughly about 3% of revenue going forward. So we are a somewhat more technology-intensive business now, particularly with the addition of SHL and also with the services that we are introducing and that Tom has talked about earlier in the call. So CapEx in that kind of 3%. Maybe some years, even a little bit higher than that of revenue is certainly in our field of vision at this point. And then you can do your free cash flow calculation off of that.

Tobey Sommer - SunTrust Robinson Humphrey, Inc., Research Division

Okay. Last question for me. You kind of talked about SHL margin progression quarterly as being flat for a couple of more quarters probably, and then some improvement in the fourth quarter. Based on that kind of expectation, what do you see as an opportunity for '14? Because I know, we're early days in SHL and those first few quarters that you own it won't really reflect what it will look like longer-term.

Richard S. Lindahl

Yes. I think we're certainly not ready to talk about 2014 at this point of the year. What we've talked about previously is that on average, we think the consolidated EBITDA margin can improve roughly 25 basis points per year. There's no reason to change that expectation at this point. So that's what we're going to stick with.


And with no further questions, I'd like to turn the call back over to Mr. Monahan for any additional or closing remarks.

Thomas L. Monahan

Thanks, everybody, for calling in or logging in to today's event. Rich and I look forward to seeing many of you in our travels over the next few months. In May, we'll be at the JPMorgan TMT Conference in Boston, and the Bank of America Merrill Lynch business services event in New York. And in June, we'll be at the William Blair Growth Stock Conference in Chicago. As we shared on our last call, we also look forward to hosting people for our Annual Investor Day on June 14 in our Washington, D.C. office. The event will be simulcast over the web, but if you're interested in attending in person, please contact Rich for additional information. We look forward to keeping you up to date in the CEB story across the remainder of the year.


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

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