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The Advisory Board (NASDAQ:ABCO)

Q1 2014 Earnings Call

July 31, 2013 5:30 pm ET

Executives

Robert W. Musslewhite - Chairman and Chief Executive Officer

Michael T. Kirshbaum - Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

Ryan Daniels - William Blair & Company L.L.C., Research Division

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

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Paul Ginocchio - Deutsche Bank AG, Research Division

Matthew J. Kempler - Sidoti & Company, LLC

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

Operator

Welcome to The Advisory Board Company's First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. Your host for the call today is Mr. Robert Musslewhite, Chief Executive Officer of The Advisory Board Company. This call will be archived and available from 8:00 p.m. this evening until 11:00 p.m. on August 7 via webcast on the company's website in the section entitled Investor Relations.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding The Advisory Board Company's expected quarterly and annual financial performance for calendar 2013. 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 Advisory Board Company's filings with the Securities and Exchange Commission and in its first financial quarter news release. Consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. For additional information on the company's results and outlook, please refer to its first fiscal quarter news release. 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, I will turn the call over to the company's Chief Executive Officer, Mr. Robert Musslewhite.

Robert W. Musslewhite

Thank you, and good evening. I'm Robert Musslewhite, Chairman and CEO of The Advisory Board and I'm joined today by Michael Kirshbaum, our Chief Financial Officer.

We have a 3-part agenda for this evening's call. First, I will give you a summary of our performance for the quarter ended June 30, 2013, covering our financial results, as well as the discussion of some of the notable developments of the quarter. I will then turn it over to Michael to take us through a more detailed review of the financials. And finally, I will close with an update on our key operational and strategic priorities. As always, we'll be happy to take questions at the end of the session.

In the quarter ended June 30, 2013, Advisory Board revenues increased 18% to $123.2 million from $104.1 million in the quarter ended June 30, 2012. Net income was $3.7 million or $0.10 per diluted share compared to $3.8 million or $0.11 per diluted share for the same period a year ago. Adjusted EBITDA was $22.5 million for the quarter compared to $20.2 million from the first quarter of fiscal 2013. Contracts value increased 16% to $475.8 million as of June 30, 2013, up from $411.6 million as of June 30, 2012.

Our continued strong performance this quarter is due to the superior value we provide to our members through our comprehensive portfolio of offerings, outstanding member service and excellent product quality. Our more than 4,100 health care and higher education members face tremendous complexity due to demographic shift, revenue pressure, a new value orientation and transformation of their business models. With an overall member renewal rate of 90%, we are clearly the partner of choice as members seek both to enhance performance in the current environment and to set strategy to succeed in the future.

The reason why is clear. At all levels of the firm, we are fully focused on driving tangible results for our members. We recently held an internal forum for staff to share member results with the executive team and the stories were tremendous in both quantity and quality. I thought that sharing a few would illustrate the many deep ways we are working in partnership with our members to solve their most pressing problems. One staff member explained the work he had been doing with a midwestern 500-bed hospital through Crimson, our software-based program focused on physician management. The tool revealed that the hospital had a $2.5 million cost-reduction opportunity in a particular psychiatric diagnosis. Armed with data from the analytic tool and his clinical background, our dedicated advisor was able to engage hospital psychiatric leadership team to pursue this opportunity. We successfully worked with the physicians to develop and implement new evidence-based protocols, inter-disciplinary rounds and other best practices. The result of this hard work and physician culture change, was reduced lengths of stay, cost and readmissions.

Overall, the hospital achieved an average savings per case of over $2,000, resulting in an annualized cost savings of more than $2 million.

Another staff member discussed her work with the 9 hospital system in the south through our nursing operations performance program. Our team worked with the chief nursing officer of the health care system to drive performance improvement throughout the system. By engaging the CNOs at each facility, our team was able to improve performance on a unit-by-unit basis across the entire health system, leveraging our software tool to identify individual units with cost and quality variances, establishing action plans and timelines for each and driving accountability for improvement. The hard work resulted in improvements at every facility for an overall decrease in the use of premium labor by over 78,000 hours. The result in savings totaled $5.5 million.

A third staff member described the impact that we had with Crimson Market Advantage at a 500-bed hospital that is the flagship of a multi-hospital system in the Midwest. The hospital is located on the fringe of a highly competitive urban market and needed to defend and grow surgical market share in the face of a new competitor entering the market. Through Crimson Market Advantage, the hospital used their data-driven approach to target and strengthen relationships with key specialists and referring primary care physicians. The targeted outreach efforts resulted in $5 million in adjusted new revenue over 4 months. Across all our memberships, there are stories like these of tangible return on investment that our members received through their work with us. Given these results, the case to continue and expand advisory board relationships is an easy one for members to make. The value proposition of membership is clear.

Another key part of our value proposition to members is the insight we offer on critical strategic questions. Members value our deep expertise, extensive knowledge base and ability to make sense of the changing landscapes in their industries. Our annual series of health care CEO roundtable meetings always puts the best of our strategic insight on full display, with presentations that both cover the State of the Union and healthcare sector and address the key up-at-night questions for our top executive members.

Registration for this year's series has been record-breaking with nearly all of our member institutions represented. The popularity of these sessions and members' outstanding feedback on them indicates that this year's agenda is of particular interest. Perhaps that is not surprising, given our message, which is somewhat counterintuitive. Much of what the industry has been focused on has been the threat to hospitals' margins and traditional business models, the aging population that is sicker and will be costlier to treat, the reimbursement changes that the government and commercial insurers are making to fee for service reimbursements and new entrants from outside the traditional provider universe that increased competition.

Our work explores these issues, of course, but is more focused on the opportunities that today's market present for hospitals and health systems, ways they can control their own destiny and succeed in the new health care economy. The research we present details how organizations willing to take intelligent risks can grow market share, market footprint and market impact by delivering distinctive solutions to a range of purchasers from payers to employers to individuals that address the particular problems purchasers know that they have today, as well as those that will become apparent as the population ages and our economy evolves. With outstanding meeting scores and member feedback, it is clear that the growth-focused meeting agenda has really resonated with our members' CEOs.

Given our members' focus on intelligent growth, our Crimson Market Advantage program has continued to perform very well. Tighter integration across the care continuum is and will continue to be important in a variety of growth scenarios. Under current fee-for-service conditions, Crimson Market Advantage provides total market visibility on non-owned physician practices to help drive referrals to the hospital. Under newer integrated reimbursement models, where hospitals might own physician practices, Crimson Market Advantage helps maximize the total health system contribution at the owned practices.

We recently acquired MRS [ph], a small Tucson-based technology company that we expect will complement and bolster our work with the large and growing Crimson Market Advantage membership. As with our typical acquisition, we will spend the next several months working to scale their organization and its technology and prepare sales teams for a new product launch, which we expect to announce in an upcoming quarter. We also expect the financial impact to be similar to that of our typical acquisition with some near-term dilution as we make these investments but strong contribution to our growth in earnings over the next several years as we build out products incorporating the technology and sign on new members to these programs.

Before I turn things over to Michael, I wanted to give a quick update on our work in higher education. Since we launched our first higher education membership in 2007, we have continued to grow our scalable, thriving practice, leveraging the lessons we learned from building our Health Care business. We now have more than 500 member institutions, ranging from Ivy League universities such as Harvard and Dartmouth, to large state schools like Arizona State and LSU, to community colleges including Ivy Tech and Technical College System of Georgia. Our 5 research memberships serve the provost, the head of student affairs, the top university business executive and leader of continuing an online education, as well as the leaders of community colleges.

Collectively, the programs take on a dozen major research initiatives each year, complemented with nearly 600 shorter reports for smaller audiences. For example, our university business executive program has developed a robust set of resources on the key topics for this constituency. The research covers strategic topics such as alternative revenues, globalization and risk management and also more tactical topics including managing energy costs, procurement and space management. And the membership is currently hosting its annual meeting series with the keynote presentations representing this mix of strategic and operational and it is garnering very strong feedback.

Our work with provost is another highlight within our education memberships. Our recent meeting series for this constituency has also been well received, with comments like, "This is my first provost roundtable and I'm so glad I attended," "It was wonderful and far more helpful to me than any other conference." And, "Really cutting-edge information and just-in-time strategies," and "Great environment for interaction and learning."

In addition to this feedback, the value stories from our provost were also impressive. One prestigious private university that we have worked with had seen a drop in endowment income during the recession and felt significant pressure not to raise tuition given value questions in a market where many recent graduates struggle to find jobs. Struggling to chart a valuable course forward, the provost came to one of our national meetings that included research on online and continuing education. Despite her skepticism about the value and quality of these channels, our research showed her that more than a few prestigious private schools had seen tremendous success with online degree programs and have seen no degradation in quality. She ended up bringing in one of our experts for a day-long retreat with their deans and the university president. Across the day, the group decided to make online education a key part of the university's strategy and to move forward aggressively into this area, and we have supported their subsequent successful implementation of several professional masters programs.

As you can see, our work in the higher education market has given us an excellent vantage point on the most pressing problems facing institutions of learning today. Foremost among them is improving student success. Universities have never been under more pressure to improve graduation rates. With national 5-year graduation rates barely above 50%, both the public at large and key funders are growing impatient. An increasing number of states are tying higher education funding to graduation rate performance, and colleges and universities are finding that the traditional focus on first-year student retention and investments in other support services are not succeeding in inflecting performance.

In this context, am pleased to announce today our Student Success Performance Program, our first software-based program for our higher education members. Leveraging the most innovative in and out of industry ideas, the Student Success Program combines technology, research and predictive analytics into a renewable membership to help institutions positively inflect outcomes with at-risk and off-path students.

Recognizing that most institutions have amassed a wealth of untapped economic data, we partner with progressive institutions to uncover hidden insights about the patterns of academic success and failure and deliver this actionable intelligence to the advisors and retention specialists who work directly with students. The program is off to a good start with a robust charter membership that includes Rutgers University, Indiana University, University of Missouri, University of North Florida and Georgia State University. We're excited about the growth potential of software-based memberships for the higher education market, and we view this launch as the first step in leveraging our research beachhead to build a business serving colleges and universities with our software and analytics.

Let me now turn the agenda over to Michael to review our financial results in more detail.

Michael T. Kirshbaum

Thanks, Robert. I've organized today's financial review around 6 categories: income statement; balance sheet; cash flow; contract value; our recent acquisition; and outlook for the remainder of calendar year 2013.

First, the income statement. A quick reminder on our March 31 fiscal yearend, which means that we just finished the first quarter of fiscal year 2014. For the quarter just ended, revenue increased 18.3% to $123.2 million, up from $104.1 million in the same period the prior year. Adjusted EBITDA for the quarter ending June 30, 2013, was $22.5 million, up from $20.2 million in the same period of the prior year. Adjusted net income was $11.4 million compared to $11.1 million last year, and non-GAAP earnings per diluted share were $0.31 compared to $0.31 last year. The adjusted numbers for the quarter ending June 30, 2013 and 2012 exclude transaction-related cost and amortization, equity and loss from unconsolidated entity, as well as share-based compensation expense. A reconciliation of GAAP to adjusted non-GAAP results can be found in our press release.

GAAP net income attributable to common stockholders and earnings per diluted share for the quarter ending June 30, 2013, were $3.7 million and $0.10, respectively. Cost of services increased to $66 million or 53.5% of revenue in the quarter ended June 30, 2013, compared to $58.4 million or 56% of revenue in the same quarter the prior year. The increase in the cost of services are due to increased expense for new and growing programs, inclusive of our acquisitions of ActiveStrategy and 360Fresh during the prior fiscal year, netted by lower fair value charges from our acquisition-related earnings and our liabilities when compared to last June.

Member relations and marketing expense were $22.2 million or 18% of revenue in the quarter ended June 30, 2013, compared to $19.1 million or 18.4% of revenue in the same quarter the prior year. G&A expense increased $18 million or 14.6% of revenue in the quarter ended June 30, 2013, compared to $13.5 million or 12.9% of revenue in the same quarter the prior year, due primarily to an increase in investment in our IT infrastructure to support our growing employee base and number of office locations, as well as increased investments in our new product development and corporate development groups.

Depreciation and amortization expense in the quarter was $6.4 million or 5.2% of revenue compared to $4.1 million or 3.9% of revenue in the same quarter the prior year. The increase is due to capital investments in our growing technology programs, the recent ActiveStrategy and 360Fresh acquisitions, as well as additional depreciation from leasehold improvements related to expansion space in our Austin, Texas, San Francisco and Washington, D.C. offices.

Other income net in the quarter was $522,000 compared to $576,000 in the same period the prior year. This quarter's other income consists of interest income of $852,000, a loss of $191,000 from changes in foreign currency exchange rates affecting our receivables from international members and $139,000 of fees related to our credit facility. During the quarter ended June 30, 2012, we had interest income of $824,000 and a loss of $248,000 from changes in foreign currency exchange rates.

Turning to balance sheet. Membership fees receivable, which excludes long-term receivables was $387.2 million as of June 30, 2013, an increase of 20% compared to June 30, 2012. Excluding the effects of progress payments, DSOs on billed AR were 61 days as of June 30, 2013, compared to 55 days as of June 30, 2012. Total deferred revenue, net of amounts that we build up to 12 months was $523 million as of June 30, 2013, an increase of 20% over June 30, 2012. Excluding long-term deferred, the current portion of deferred revenue balance as of June 30, 2013 was $411.6 million, up 19% over the prior year.

Looking at cash flow, during the 3 months ended June 30, 2013, our cash used from operating activities was $3.6 million compared to $2.4 million used in the same quarter of last year. We use historically our low cash flow during the year, due to timing of member payments in our annual bonus cycle. And for fiscal year 2014, we continue to expect cash flow to generate from operations to be on our typical range of 1.5x to 2x adjusted net income.

Capital expenditures for 3 months ending June 30, 2013, were approximately $11.7 million compared to $8.5 million for the 3 months ended June 30, 2012. For 3 months ended June 30, 2013, we repurchased $6.2 million of stock or approximately 119,000 shares. This brings our total share repurchase since the inception of the program in 2004 to $347 million or 15.7 million shares. As of June 30, 2013, the remaining authorized share repurchase amount was $103 million. As of June 30, 2013, our cash, cash equivalents and marketable securities balances were approximately $192.1 million, representing approximately $5.25 per diluted share.

At the contract value, contract value increased 15.6% to $475.8 million as of June 30, 2013, up from $411.6 million as of June 30, 2012. We define contract value as the aggregate annualized revenue attributable to all agreements in effect at any given point in time without regard to initial term or remaining duration of any such agreements. The contracts of more than 12 months duration include only 12 months of contract value.

Turning to our recent acquisition. We're also announcing our purchase of MRS on July 8. MRS is a small Arizona-based technology firm with products that will supplement our existing position for our programs. The purchase price were approximately $11.5 million for standard escrows and no additional amount. We expect the acquisition to contribute minimal incremental revenue in calendar 2013, and expect EBITDA dilution for the remainder of this year to be approximately $2.5 million.

With respect to the outlook for remainder of calendar 2013, the following comments are intended to follow into the safe harbor provisions outlined at the beginning of the call and are based on preliminary assumptions, which are subject to change over time. For calendar 2013, we're updating our revenue guidance to a range of approximately $500 million to $505 million, up from the previous range of $495 million to $505 million. Also as a result of the MRS acquisition, we are updating our guidance for calendar year 2013 adjusted EBITDA to be in the range of approximately $87.5 million to $92.5 million, from a previous range of $90 million to $95 million, and non-GAAP earnings per diluted share to be in a range of approximately $1.15 to $1.25, from a previous range of $1.18 to $1.28.

For calendar 2013, we expect share-based compensation expense to be approximately $17.5 million, and expect amortization from acquisition-related intangible assets to be in the range of $7 million to $8 million. We expect our effective tax rate in fiscal 2014 to be approximately 38% to 39%.

This concludes the financial summary. I'll now turn things back over to Robert.

Robert W. Musslewhite

Thanks, Michael. I'd like to conclude with a few comments about our priorities headed into the second half of the calendar year and then we will take any questions you have. As I mentioned in our last call, we have 4 key priorities this year to ensure that we are making smart investments executing in a high standard and continuing to deliver world-class programs that drives significant returns for our members.

Our 4 priorities are especially important right now as we are extremely focused at all levels on finishing out the year with good momentum. There first, ensuring outstanding member value. We continue to find new ways to enhance the research, software, service and impact we provide to members of all of our programs. The examples of member value I discussed at the beginning of this call, along with the many others that we hear from our members each day, illustrates that our focus here continues to pay off. Further, we are actively working on new projects that open up opportunity for us to have an even greater impact on health care and higher education across the country. Our health care work with the State of Rhode Island is one example. Most recently, we were selected to partner with the Gates Foundation to investigate the drivers of higher education costs. For the project, we will partner with several of our member institutions to explore the drivers of cost through the analysis of financial and programmatic data. It is a fantastic project, an intangible sign of our strong standing in the higher education market.

It is very exciting to be engaging on the top industry issues in these new ways. Given the enormously complex challenges facing the sectors we serve, our members need our support at every level and 4,100 institutions are consistently turning to us to help them with their key challenges and top priorities.

Second, continuing our relentless focus on growth. With our clear vision of future market and member needs based on our research expertise and relationships across the industry, we continue to come to market with the right products at the right time in order to carry out our growth formula. Our track record of strong acquisitions that bolster key capabilities and add value complements our organic growth through internal new program development and both approaches drive our continued cross-sell success. We continue to invest resources to ensure that we are developing and, where appropriate, acquiring the programs and capabilities to support our members in this time of tremendous change in our markets.

Third, continuing to evolve our go-to-market model. Our new initiatives to further align our internal sales and account management organizations are proceeding well, and we are continuing to enhance our coordination and impact from members. The changes are allowing us to serve members more effectively and migrate to even deeper and more powerful commercial relationships across our portfolio. Our staff has done an outstanding job at implementing the new initiatives and they're constantly focused on both providing gold standard service and maximizing our ability to deepen and expand member relationships.

Finally, we are consistently focused on attracting, cultivating, engaging and retaining world-class talent. With an employee base of 2,500 people and growing, doing so with scale has become a top priority. The executive team, along with our Board of Directors spend significant time here. We're focused on ensuring that we are hiring the best people with a wide range of skill sets, identifying talent across the organization, developing our employees, deploying them in the most leveraged ways and recognizing and rewarding them for the excellent work that they do.

Our statistics show us that we have the right formula, with staff members at all levels rapidly advancing in their careers here and record level engagement and retention. Talent is our most important asset and will continue to be a top priority for me, our executive team and throughout the company.

Let me close my prepared remarks here. Thank you for participating in tonight's call, and we'll now open up the line for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ryan Daniels at William Blair.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Let me begin with a quick financial one. I guess, for Michael, it looks like your member relations and marketing expense is down sequentially, I think, for the first time in a while. Can you talk a little bit about why that might be the case? I don't know if it relates to some of the sales changes you've made? And then, should we expect that to rebound a bit though, looking forward to the second half of the year?

Michael T. Kirshbaum

Yes. I think -- thanks, Ryan, for the question. It's mainly timing related. In general, I would expect sales expense to be a consistent percent of revenue going forward. For this quarter versus last quarter, it's a little bit on incentives, travel and timing of headcount.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay. That's helpful. And then, Robert, maybe just a little more insight on the realignment of some of the internal sales and account management teams. It sounds like you're pretty pleased with how that's progressed over the last year. I mean, what is that really manifesting? And are you seeing some of these enterprise-level accounts purchase more of your products or get more utilization of them and higher ROI which will lead to those in the future? Just any more color there on how that's really manifesting in the financial performance thus far?

Robert W. Musslewhite

Yes, I'd say it's not showing up in financial performance yet. We wouldn't have expected it to, it's pretty early. If you look at the accounts, remember, this was an effort to really try to, number 1, internally coordinate our sales account management and delivery teams against the institutions most likely to drive growth for us going forward. And then, secondly, invest more senior talents and higher level talent against those so the proportion of investment that's going into them is proportionately higher. Doing that at the beginning of this year, you wouldn't usually expect that to drive kind of additional sales. I will say that the anecdotal or the leading metrics that we get have been very positive. So certainly, for each of those accounts, we have a much more detailed account plan than we've ever had. We have much more understanding of their specific needs and priorities as members and which parts of our product portfolio are likely to be most relevant to them in the current environment. And so everything feels positive and I'd expect us to start seeing some better performance there relative to the track they would've been on, but I wouldn't really expect to see it before the end of this year in terms of financial results.

Ryan Daniels - William Blair & Company L.L.C., Research Division

Okay. That's helpful color. And then, one more and I'll hop back in the queue. Obviously, one of the big things in health care of late has been some of the system consolidation we're seeing. And I wonder if you could just remind us of your view on hospital consolidation? How it impacts your business? I think, in the past, you've talked a little bit at how it could be perhaps a tailwind for the tools, maybe a bit of a headwind for research, so net-net, a positive. But any color there and then any specific opportunities and challenges presented by the 2 large system deals that we've heard about since your last call?

Robert W. Musslewhite

Yes. Great question. I'd say you got it, pretty much hit the nail in the head. Our consolidation is generally not great for the Research business. We have 2,700 hospital and health system members who work with almost everybody. When there's consolidation, it's usually people who have advisory research on both sides of it. And it's hard to get 2x the pricing when it's 1 plus 1, and institutions merging into another one. So we tend to get some pressure on pricing there. Sometimes there's a cross opportunity from misaligned portfolio, but in general, we've been selling the research programs a long time, so we tend to have pretty good penetration. On the tools side, it has been more of a neutral to slight positive and probably more in recent years as we've done a better job penetrating at the system level. So if a large system with whom we work takes on another system, we tend to have reasonable access to extend the relationship from the original systems hospital to the new systems hospitals. That can work the other way if someone acquires a big system that we don't work with, but increasingly, our penetration of systems with tools has also gone up. So that's one. And then there tends to be, because the tools are newer, some nonoverlapping portfolio, almost in every case. And so the acquiring organization and the acquired organization are working with different tools and have hopefully value stories, reach those different tools that will give us an opportunity to cross-sell across those hospitals. So I think that in that case, it can be a positive. The 2 large recent mergers, we have relationships with everybody, so that's the good news. I'd say, without going too deep into it, we probably had, on one of them, better relationships with the acquirer, and the other one, better relationships with the acquiree. How that shakes out in terms of how things play out for us would remain to be determined. I don't want to opine as to whether it's good or bad. But certainly, we're working hard to be sure that the combined institution understands the value of our programs that they're using and we have a chance to penetrate them further. The final thing I'd say is just that as consolidation has become more and more an issue and that's certainly a strategic issue that our members turned us for which is advice on how they ought to think about their markets and their footprints and how we can help them. So I think, overall, it's reflective of the market change that's been good for our research work, certainly with members.

Operator

Our next question comes from Shlomo Rosenbaum with Stifel.

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

First, just a couple of housekeeping things. What's -- what are the loan to, I assume it's Evolent Health?

Robert W. Musslewhite

Yes. Sorry, you asked -- the name of the company is Evolent Health, yes.

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

What's -- is that -- what's the nature of that? Is that a short-term loan, long-term loan? Are you -- why didn't you put in more equity? I mean, what's that going to be? But are you guys going to be a source of financing for them on an ongoing basis?

Michael T. Kirshbaum

Shlomo, if you remember, Evolent is a joint venture between us and UPMC we put together a little over a year ago. And we put in some initial equity. I think they are in the process of doing another round of fundraising. And to get them there, we put in a bridge loan that will convert equity upon the next round of fundraising.

Robert W. Musslewhite

And on your broader question, we'd expect to be continuing to put some equity into Evolent going forward and we've been pleased with the progress thus far and think that they're on track to hit the business plan performance if not exceed it.

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

Okay. And is there -- I know people have asked this in the past, is there an eventual thought of bringing that in-house given the optimistic nature you guys have in their success?

Robert W. Musslewhite

I think of it more as one option of several down the line. It'd be premature to say that, that's the direction we're going to go. It's a lot to figure out. They have 2 customers today, and hopefully, we'll be signing on a lot more over the next year or so and bringing them into outsourced population health management. So I think it remains to be seen kind of how they do, how the market evolves and what our members are asking for. So at this point, that's certainly one of several options.

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

Okay. Great. And then, the reduction in EBITDA and EPS guidance is strictly because of this new acquisition, I just want to confirm that?

Michael T. Kirshbaum

Yes.

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

Okay. And then, Robert, can you give me just a little bit more detail on the software tool for higher education. What does the tool exactly enable the client to do with it? How do you enable success of a student? Are you identifying where they should be having outreach and whether they -- the students should be having more tutoring? I'm just trying to figure out, what does the tool do?

Robert W. Musslewhite

Yes. So think of it as a tool that takes all relevant data, amount of students passed through an institution, and allows the academic advisor to understand when a student might be at risk for dropping out or graduating late, and allowing targeted intervention at those times. And so if you think about it, a typical academic advisor might have several hundred students under them and not a very easy way to determine if a student's on track or off track, they get their grades and they kind of see their course enrollment. What we can do is we pull historical data, so we start to understand what are key predictive elements about a student's ability to graduate and graduate on time and not drop out of the program. And can we flag when students hit some of those barriers or warning pointes early to the academic advisors so they can take corrective action. So for example, for a specific institution and a specific degree program, we actually know what milestones are there and are predictive of that kind of behavior. The example I use, just based on a specific institution's data, we'd be able to predict that a nursing major who didn't take -- sorry, didn't complete a certain math course by the end of her second year might be 50% less likely to complete her degree. It's things like that. And so what we've seen is members using the tool having significant uptick in retention efforts. Obviously, we haven't been at this a long time but I would expect that if you get late year retention efforts up, you would expect for graduation rates to improve and early graduation rates to improve. So early feedback has been very good. Of course, along with the other thing we do, I talked about the tool, but there is that -- as is typical of all of our technology programs, there's huge distinctiveness from using the research to know what metric should be used, how to use the metrics and the tool to actually improve performance and we provide benchmarking cohort case studies and insight from across different majors and institutions so we can leverage the power of the networks that we're building with lots of different members to make it a better and better program.

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

Understood. And is this tool, can you give us just like an idea as to the potential mark that you have like over 500 institutions, isn't it the kind of thing that you think as just got broad appeal across all the institutions that are signed up with you right now?

Robert W. Musslewhite

Yes. So I'd say the primary target market is the 1,500 4-year colleges and universities out there. Probably, the top majority of those, say, 900 to 1,000, we think are immediate prospects for this. There are also 1,600 roughly 2-year schools -- probably not, we haven't really targeted our efforts there yet. So it's hard to know whether or not we could penetrate those, but I'd say top 200 or 300 of those could be of significant value from the product. And if you look at the sales so far, as you mentioned, the 500, we're roughly 50 members. I'd say that most of those are sales to current research members.

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

Did you have the same installation timeframe as kind of a health care membership?

Robert W. Musslewhite

Yes. At this phase, the program launch, it's similar to implementation times for other programs at this phase of launch. As you know, as we grow the program bigger, we tend to get operational and more efficient in implementation and we get those times down. But you take a typical health care launch at roughly this number of members, it's about the same amount of implementation time.

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

And last question is the pricing on this kind of tool?

Robert W. Musslewhite

It's comparable.

Operator

Our next question comes from Jamie Stockton of Wells Fargo.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

I guess, maybe the first one. The MRS business, can you give us a revenue number on that? If you did, I missed it, I'm sorry.

Michael T. Kirshbaum

Yes, they're -- Jamie, they're a very small company, less than $1 million of revenue right now, they have about 11 employees that are running about $1 million of loss right now.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. All right. And then, the Evolent business, I don't know that we've had a -- like a significant update on that recently. Obviously, there's still a pretty decent operating loss that you guys are consolidating from it. Can you just give us some color on how things are going there and whether or not we should just expect the consolidation of the loss to kind of be status quo?

Robert W. Musslewhite

Yes, I'll speak to the business and I'll let Michael talk about the financial impact. The Evolent has its charter customer, MedSTAR, who is working with Piedmont and WellStar in Atlanta, and has several other customers that they're doing early work with. It's going quite well. In terms of customer attraction, they're ahead of the pace that we expected when we launched the business. The good and bad news of attracting customers into that business is that it's expensive to serve the customers upfront, so you're talking about contracts that could be dozens of millions of dollars over time in terms of really taking on and managing populations for members. But to do that and to really care manage and provide the support needed for that takes a lot of people and so you're scaling up on a member-by-member basis with a lot of arms and legs. This is the model we knew was going to be part of Evolent, but it doesn't mean that it takes a lot of cash to get the business up and running and to get to a good financial profile. So again, it's right on track with the plan if not at a little bit ahead of it from the customer attraction and revenue side. They've hired up, I don't know their staff count exactly, but it's over 200 people in the business. Incredible talent there, just building what feels like a very good business that should have some success out there. It's obviously not out of the woods because we haven't gone through a full cycle with the charter members yet and proven the value delivery but indications there feel very good. UPMC has done this and done this very, very well at UPMC and had very good cost trends and quality results through their own health plan work. And those are the capabilities that Evolent can bring to bear for the institutions and populations that helps them manage. And so we just continue to feel good about the progress there.

Michael T. Kirshbaum

And in terms of the financial impact, obviously, they're a startup company. They're working with initial customers now. And as Robert mentioned, their business model requires them to make substantial investments ahead of core revenue for their customers. So they have potential losses this year. And we take a portion of their losses through our income statement and I would expect that to be fairly consistent going forward with the one variable being, during the next round of financing, what our ultimate ownership percentage will be may change. And so our percentage of losses may move a little bit.

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Okay. And then just one more on the Evolent business. Robert, the headcount year-over-year, that sounds like it's roughly a double. Would you say that's roughly accurate?

Robert W. Musslewhite

Double from [indiscernible].

Jamie Stockton - Wells Fargo Securities, LLC, Research Division

Of headcount, yes.

Robert W. Musslewhite

Yes. About right.

Operator

The next question comes from Paul Ginocchio of Deutsche Bank.

Paul Ginocchio - Deutsche Bank AG, Research Division

Robert, just on the revenue guidance change, is that also 100% due to the acquisition or was there any underlying improvement there also? Then a follow up.

Michael T. Kirshbaum

Paul, that's not due to the acquisition. We're basically acquiring less than $1 million, potentially less than $1 million of revenue with deferred revenue right now and it's almost immaterial. So that adjustment is basically due to their performance throughout the year.

Paul Ginocchio - Deutsche Bank AG, Research Division

Great. And then, I thought you said a deferred revenue growth was a little bit different than what I'm seeing in the model on a year-on-year basis I've gotten, it was sort of a 7% or 12%, if you're at short term or all-in, that's a little bit of a deceleration. Can you just talk through that, please?

Michael T. Kirshbaum

Yes, it's mostly a last year issue. If you remember, last year, we had a big spike in the numbers we reported. And there was a reclassification we had to make to those numbers. So the June 2012 numbers were -- there's an adjustment made to them. It will be in our Q coming up. You'll be able to see it. So the 19% and the 20% numbers I gave you, you'll be able to count. There's basically an adjustment to AR and deferred last quarter due to how the gross down worked where those numbers where each, both AR and deferred, were about the same amount.

Paul Ginocchio - Deutsche Bank AG, Research Division

Great. And could you give us an update on clients from Crimson Market Advantage?

Michael T. Kirshbaum

Yes, it continues to grow very well. It's several hundred members. It's now our second largest program behind Crimson and closing the gap on Crimson actually.

Operator

Our next question comes from Matthew Kempler of Sidoti & Company.

Matthew J. Kempler - Sidoti & Company, LLC

So first, on the MRS acquisition, I might have missed it, but is this more about competitor consolidation or does the company provide specific technology or data that Advisory didn't have with Market Advantage?

Robert W. Musslewhite

I think the way to think about it is it's got a Web-based referral management platform that helps facilitate the actual referral and does so in ways that incorporates things like cost and quality metrics of physicians. So it's a benefit to the referring physician because it makes it easiest to benefit to the receiving physician or hospital because it makes it easy and gets on the right patient that should be headed there.

Michael T. Kirshbaum

It's a new capability, it's very complementary to our existing products.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. So ultimately, will these 2 solutions be combined together?

Robert W. Musslewhite

I think there will be capabilities we used in Crimson Market Advantage, but we'd expect to have a new product launch associated with the new capability.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then, on the Student Success Program. In the past, we have talked about how there's been a lot of interest in the pipeline and building out some higher ed software programs but healthcare tends to take the priority because we can bring it to a larger network faster. So maybe you can just share a little bit more about what is it that you find special about this specific program and opportunity that helps it leapfrog some of the health care programs you may be focusing on?

Robert W. Musslewhite

Well, I think, the way I think about it is, I don't feel like we're slowing down the pace of health care investment and launches and exploration. So I view this as something that we've been working on for awhile and it's always hard to steer more and more dollars to higher ed. So this is kind of our higher ed initiative this year. We've been very interested in launching technology programs here. And felt like this space, as a higher ed membership, or really, it's an Advisory Board issue set, is a hot space. It's something that members care a lot about. It's something that they're feeling a lot of pressure around. Our research would indicate that sales conversion rate and our success in market should be comparable to what it is in healthcare, and obviously, the higher ed is a little bit smaller market. But with the tools-based program, given these price points, if we can penetrate the relevant market fairly well, that would shape up as a very nice sized and margin program. And so in some ways, the performance of this program would be a guide for us to how we might think about higher ed investments going forward but we definitely wanted to try one at least and we felt like this was the right place to do it.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then, could you give us an update on where we are on the internal investment cycle in terms of infrastructure and systems, and maybe big picture barring future acquisitions, what are your thoughts about renewed leverage in the business?

Michael T. Kirshbaum

Yes, Matt, on the G&A side, we've obviously grown that a lot in the last 2 years. The businesses has roughly doubled in the last 3 or 4 years. And so we've made some investments in IT, recruiting, legal, finance, all of our infrastructure functions just to keep pace with the growth. We are still making investments but obviously towards the tail end of that and we'd expect to see some G&A leverage going forward. I don't know if it's next year, but probably the year after that. So you see more scale in G&A. Overall margins, obviously, we expect sales cost to continue to grow online with revenue cost of services with mid-teens revenue growth. We should be able to see some modest margin expansion depending on the nature of investments we're making in a given year, but that sort of tempers the business, we think it's still the same.

Operator

Our next question comes from Joseph Foresi at Janney Montgomery Scott.

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

I wonder if you could talk about contract value growth? Is that growth rate at sort of a sustainable level in the short term? And did you see any impact this quarter from sequestration now?

Robert W. Musslewhite

I think that it's right in line with expectations. We've certainly feel good about where we are in the year and how things have been going in the market. Feels like it certainly has some challenges for our members on both sides of the business, both on the health care and higher ed side. But the buying for products that really helped them deal with the challenges today has felt good and continues to feel good. So I think that number would be right on where we would expect it. I don't really think that we saw a direct sequestration hits. I think what you are seeing on the health care side is members who feel some degree of apprehension, and number one, around the current market forces and how to best manage them in a world where they're really transitioning their business model from a fee-for-service world to something in the next several years that's going to be much more value-based and potentially put them at risk for cost and quality. And secondly, they certainly do look ahead at the extra Medicare cuts and how that's going to play out and they're feeling like they have to be looking at their margin and finding leverage to improve their margin because the near-term outlook on pricing is certainly lower. So the way we think about that is there's a lot of levers that they have to pull to address both those challenges and our product portfolio is very well-tailored against those. But I always tell people, look, we do have a member base that's feeling some margin pressure and we need to be sure that we're helping them with those pressures and staying relevant and improving the value of our programs. So that's the challenge for us to execute on, and thus far, it's been going well.

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

Okay. And then, on the acquisition pipeline, the last couple of acquisitions seem to be coming in below company margin. Maybe you could talk a little bit about what the pipeline looks like from a valuation perspective and from a profitability [indiscernible] potential acquisitions, do you put a premium to strategy over profitability?

Robert W. Musslewhite

So you faded out in the middle of your question. But I think I got what it was which is talk a little bit about the pipeline and talking about the financial profile, the types of companies we look at and how they will likely impact us and how we think about the criteria for selecting those, is that right?

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

Yes, that's right.

Robert W. Musslewhite

Okay. So the pipeline feels very, very good. We have -- we look at a lot of companies. We don't do a lot of deals. The deals we do tend to be very aligned with our growth strategy. So deals are always strategy-led which is where is the place that members are pushing us to help them. We feel like there's a very acute demand, there's a place where we can add a lot of value and if we acquire a capability or a product or a tool or service that will help them do that in a productive way over the long term, and that's a better deal than trying to manufacture it ourselves or build it ourselves or hire the people ourselves in the near term, that's a tenet to be a very good formula. If you look back, that's how Crimson started. It's how we do it with Concuity. It's how we do it with Southwind. The smaller companies that have great tools that apply to a big member need tends to be very good for us from a strategic perspective, and then ultimately, from a financial perspective. Those deals tend to be dilutive in their first year. They tend to kind of breakeven on a cash basis in their second year and then tend to be productive beyond that. That's generally how those things work because they are small companies that you want to invest a lot in scaling them before we take them out -- as we take them up broadly to our membership. So that's been the general formula. That doesn't apply to every company in the pipeline. There are certainly some companies in the pipeline where an acquisition would be accretive to our earnings and would have a good growth profile. We haven't necessarily done any of those deals for various reasons, I mean, there's all kinds of reasons why you don't end up doing a deal. But I don't think every deal is going to necessarily have this profile and there are certainly some larger high functioning, well-growing companies that we look at. So I guess what I'd say is I'd expect the pace of acquisition to continue to be about the same. We've kind of said 2 or so over the next 18 months feels like the right level. Certainly hope that the one we're announcing now turns into a great acquisition that's Crimson-like and that's always a goal. But it's hard to say when things happen or what types of sizes of companies happen when, because it's really driven by the strategy and then the ability to get the deals done.

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

Okay. And last one for me. I know it's early stage and you just kind of picked up 360Fresh. But if we could get a -- your early impressions of that potential market there and the analytics side, that would be great and then sort of the progress you made there?

Robert W. Musslewhite

So 360Fresh is going well. What we're excited about 360Fresh is that it really brings some capabilities that we felt were important as we looked ahead at where Crimson was going. And those are things like the ability to pull new clinical data that we weren't necessarily pulling before into our Crimson analytics. The ability to take that data and run predictive analytics on it to provide insight in close to realtime or realtime for decision-makers who are in the process of making care decisions and doing that in a way that members felt like it was flexible to their specific institutions' needs. So that's been -- I think, it's exactly where we want to be taking the product. It's going very well. I think the way you'd manifest the success of 360 is through continued growth on the Crimson side and use of this analytic capability and driving to larger member value for each of our Crimson members. And so far, we have early good progress there, but it's probably too early to judge the ultimate impact of that acquisition other than to say the capabilities are great and we've gotten fantastic feedback from the members who started to use it.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Musslewhite for any closing comments.

Robert W. Musslewhite

So thank you all for joining tonight, and we appreciate you all joining the call. I'm hoping we will see a lot of you at our Investor Day on September 24. We're looking forward to hosting another one of those this year and have a good agenda that's starting to take shape. And I'll look forward to following up with some of you in the next several weeks in advance of that meeting. So thank you for the questions tonight and we'll talk to you soon. Good night.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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