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Executives

Richard Lindahl – CFO

Tom Monahan – Chairman and CEO

Analysts

Tim McHugh – William Blair & Company

David Ridley-Lane – Bank of America

Paul Ginocchio – Deutsche Bank

Dan Leben – Robert W. Baird

Shlomo Rosenbaum – Stifel Nicolaus

Gary Bisbee – Barclays Capital

The Corporate Executive Board Company (EXBD) Q3 2010 Earnings Call Transcript November 2, 2010 9:00 AM ET

Unidentified Corporate Speaker

Good morning. And welcome to the Corporate Executive Board’s third quarter 2010 conference call. Today’s call is being recorded and will be available for replay beginning today and through November 11th by dialing 719-457-0820. The confirmation code for the replay is 8004809. The replay will also be available beginning later today and through August 11th at the company’s website, which is executiveboard.com and at www.earnings.com.

To the extent any non-GAAP financial measures 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 will also find a PDF of the supporting materials that the company will use in its prepared remarks this morning by following the Investors link to the third quarter webcast. 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 contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding the Corporate Executive Board’s expected quarterly and annual financial performance for fiscal 2010 or fiscal 2011. 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 or forecasts, estimates, targets, plans, beliefs, expectations and the like are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by important factors among others set forth in the Corporate Executive Board’s filings with the Securities and Exchange Commission and in its third quarter news release.

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

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

Richard Lindahl

Okay. Thank you, Scott. Good morning, everybody. I’m Rich Lindahl, Chief Financial Officer of the Corporate Executive Board. Thank you for calling or logging into our third quarter 2010 conference call. Here is a quick overview of our time together this morning.

I will begin by giving you a financial perspective on the quarter and reviewing our 2010 guidance. Next, Tom Monahan, our Chief Executive Officer, will provide an update on our operational progress and the strategic priorities we are following to build long-term shareholder value. Then we will take your questions.

Please turn to slide three of our presentation for the key messages we’d like you to take away from today’s discussion. We delivered another solid performance in the third quarter as our team stayed focused on executing against our priorities. We experienced continued strength and renewals and made additional progress on cross-sales and new sales. As a result, we are seeing encouraging growth trends in both contract value and revenues.

While, as expected, our operating expenses increased sequentially, our quarterly profits reflected both a later spending ramp than initially anticipated in some favorability in non-operating items. We expect the current momentum in revenue to continue and also plan to follow through on planned investments through the end of the year. Accordingly, we are updating our guidance to incorporate the latest trends and expectations for the business in 2010.

Please turn to slide four for an overview of our financial results. At September 30, 2010, contract value was $421.6 million, which is an increase of 8.9% from September 30, 2009. As expected, contract value increased sequentially and ended the quarter up $11.5 million or 2.8% from June 30. Continued strength in program renewals and progress on cross-sales and new sales produced another sequential increase in both large corporate and middle market memberships.

Revenues were $112.1 million in the third quarter, a 5% increase compared to $106.8 million in the third quarter of 2009. On a sequential basis, revenues increased by 2.3% from the second quarter, driven mostly by year-to-date contract value growth and also a full quarter of revenues from Iconoculture.

The combination of cost of service, member relations and marketing, and general and administrative costs increased by $9.2 million from the third quarter of 2009 to the third quarter of 2010. About two-thirds of this increase was due to the additions of Tower Group and Iconoculture, with the balance driven mostly by additional staff in the product and commercial functions.

On a sequential basis, these operating expenses increased by $2.4 million from the second to the third quarters of 2010. This increase was expected, although it came at a slower rate than previously anticipated. Additional hiring in our product functions contributed to the sequential increase in cost of services. And in member relations and marketing, we added some frontline and support staff in the commercial area, increased our marketing spend, and saw higher incentive expense as a result of the growth in bookings. And third quarter expenses in both categories reflected a full quarter of activity from Iconoculture.

During the third quarter, we recorded a pretax non-cash impairment loss of $12.6 million related to Toolbox.com. The recovery in the online advertising market has been slower to develop than previously anticipated, which has negatively impacted Toolbox revenues and year-to-date operating results. The related charge reflects the write-down of most of the remaining goodwill plus impairment of certain other intangible assets associated with Toolbox.

Other income in the third quarter increased $2.3 million compared to the third quarter of 2009, primarily due to a $1.7 million swing from a gain to a loss in foreign currency charges. On a sequential basis, other income increased by $3.9 million driven by changes in deferred compensation plan earnings and an increased foreign currency gain.

Adjusted EBITDA margin in the third quarter was 25.2% versus 28.0% in the third quarter of 2009. Last year’s margin benefited from the timing of cost reduction actions implemented ahead of anticipated revenue declines. On a sequential basis, adjusted EBITDA margin increased 310 basis points from the second quarter, helped in part by the sequential increase in other income.

Depreciation and amortization in the third quarter decreased by $600,000 from the prior year period and by $1.1 million from the second quarter, in both cases due largely to the completion of asset depreciation cycles. Our effective tax rate in the third quarter was 39%, and our full year 2009 effective tax rate is currently expected to be 41%. The third quarter rate reflects the year-to-date true-up to the revised full year rate. The annual rate may fluctuate based on changes and estimates that occur in Q4.

Diluted earnings per share was $0.20 in the third quarter of 2010 compared to $0.41 in the third quarter of 2009. Non-GAAP diluted earnings per share was $0.43 in the third quarter of 2010, a decline of 5.2% from the $0.45 we reported in the prior year period and a 34.4% increase from the $0.32 recorded in the second quarter.

Membership frees receivable increased to $88.8 million on September 30, 2010 as compared to $80.9 million at June 30, 2010. Days sales outstanding were 71 days for the third quarter, consistent with historical ranges.

We saw the typical third quarter decrease in deferred revenues, as the current portion declined sequentially by $27.9 million or 12.3% to $199.3 million at September 30. However, as compared to the prior year period, deferred revenues increased by 10.5% due to improved year-over-year bookings. I would also note that the annual and sequential rates of change are similar to our pre-recession experience, which we believe provided positive indication of future growth.

Year-to-date cash flows from operations were $47.1 million, an increase of 310% versus the first nine months of 2009. During the third quarter, we released an additional $4 million related to the Iconoculture acquisition, bringing year-to-date outflows to approximately $13 million through September 30, net of cash acquired.

Year-to-date capital expenditures totaled $4.2 million, and we paid our $11.3 million in dividends during the first nine months of the year. We ended the third quarter with $93.2 million in cash, cash equivalents, and marketable securities. As of September 30, we had $21.1 million in remaining share repurchase authorization.

Turning to slide five, we present several perspectives on our operating trends that point to the firming of our foundation we’ve been putting in place for future growth. On the top left, you will note that we saw 2.8% sequential gain in contract value in the third quarter. This rate was solid, although slower than in the second quarter, which had a one-time benefit from the Iconoculture acquisition.

As we’ve been rebuilding momentum over the past year, we’ve discussed operating trends in the context of sequential changes in contract value. Now that we are seeing a more stable growth pattern emerge, we will instead focus on annual changes in order to provide better seasonal comparability. The chart at the top right corner of the page shows the encouraging trends in annual contract value and deferred revenue growth. These metrics are leading indicators of future revenue, and as you can see, both have steadily improved over the past four quarters.

Our progress during the third quarter came as a result of sustained momentum in program renewal rates and continued improvements in cross-sales and new sales across all our practice groups, which led to improved cross-sell ratios in both large corporate and middle market.

Our North American teams turned in a particularly strong performance during the quarter, growing both sequentially and on a year-over-year basis. Our Asia-Pacific group was solid, and in Europe, our teams continued to gain traction in their first full quarter operating under the account management model.

Next, I’ll discuss 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 six, which again shows the lag effect concept we have previously described and let me remind you that this is simply an illustrative graphic.

As we have discussed with you since the beginning of the year, because we recognize revenue over the life of our contracts, there is a lag between changes in contract value and the time it takes for those changes to be fully reflected in our revenues. Our third quarter results extended the progress made throughout the year, and we expect full year revenue to reflect some further gain in contract value and, to a lesser extent, revenues in the fourth quarter.

Our year-to-date results also point to the fact that we have followed through on our plans to make selective investments where we see clear opportunities to accelerate our return to growth. In some cases, our anticipated spending ramp this year has developed later than we initially expected. However, as we close out the year and head into 2011, we continue to expect our operating margins to be pressured by a combination of the revenue lag and a higher expense base.

Turning to slide seven, I will review our updated outlook for 2010. As discussed, we have seen improved performance through September 30 and expect the combination of sustained renewal rates, improved cross-sales, and better new sales is likely to result in at least some additional contract value growth this year.

Fourth quarter revenue should be comparable to somewhat higher than the run rate seen in the third quarter depending on the timing of bookings and the contribution of non-subscription revenues. Net-net, we believe our prior full year revenue guidance remains appropriate.

On the expense and capital investment side, we expect to follow through on our investment ramp as we add sales and service capacity, drive initiatives such as the new member portal, and continue product development and launch readiness. We also expect that the seasonal lift in fourth quarter booking activities will drive some amount of expense increase.

Our outlook contemplate these revenue trends and additional investment plans as well as potential macroeconomic or internal execution risks, in particular, the ongoing European transition to our new commercial model. Accordingly, we are updating our guidance for 2010 as follows.

Annual revenues remain in the range of $430 million to $440 million; adjusted EBITDA margin increases to a range of between 22% to 24%; non-GAAP diluted earnings per share increases to a range of $1.35 to $1.50; depreciation and amortization expense remains in the range of $19 million to $21 million; and capital expenditures remains in the range of approximately $6 million to $8 million. The above guidance represents our best estimate at this point, and we will update you as appropriate.

That’s it for the financial summary. Please turn to slide eight, and I’ll turn the call over to Tom.

Tom Monahan

Thank you, Rich. Good morning. As Rich has made clear, we are encouraged by our performance in the quarter. Our teams around the world continued to drive member performance by developing must-have resources and insights and connecting them to our members’ work. Before I get too deep into my progress report, let me make one quick comment on Toolbox. Rich discussed the impairment loss we reported in the quarter, largely as a result of weak revenue performance in the difficult advertising market.

Toolbox team has done a great job building a preeminent network to users and has an early following among HR and finance professionals. But we clearly have work to do in monetizing this great community. To get after this, we have made a small investment to add some sales and business development talent and are piloting some new revenue opportunities. We will monitor this investment carefully and are just as necessary to make sure that we get the right returns.

More broadly, while we are pleased with the momentum that our teams have created over the past several quarters, we are also aware that we currently only support a fraction of the member work and decisions that we can and should. We believe we are now in a position to begin to step up the pace on the three levers of growth for us.

First, fully realizing the revenue potential of existing members. With more than 35 products to sell to the largest companies, we currently sell only an average of 3.33 for each of our largest members. Growing revenues per member through high renewal rates, solid pricing power, cross-sales, and additional services remains the single biggest opportunity to our business. And given that it’s renewable, scalable revenue, we focus a disproportionate amount of our energies on this effort.

The second lever is adding great new members with high long-term potential, particularly in targeted growth markets. We can clearly see that such areas as middle market, international markets, and government markets continue to offer significant opportunities for us. And finally, the lever that really puts the power into the other two. We must create great new products that address emerging member concerns and better tie our data and thought leadership to member work and decisions.

To drive these growth levels, we will continue to focus our four key operating priorities, which are, number one, providing large customer loyalty through high-value personal engagement; number two, investing globally in our strongest brands; number three, improving the member experience to enhance technology and analytics platforms; and number four, elevating member performance through great content and innovative products.

Let me take you through where we are in each of these and what we plan through the rest of the year. Please turn to slide nine, driving large customer loyalty to high-value personal engagement. Our member list of more than 5,000 companies globally is easily one of the most impressive customer lists across the business and professional services sector. With 85% penetration of the Fortune 500 and impressive engagement leading companies in every major market globally, we have a remarkable presence upon which to build.

The change effort that we began in 2008 is now complete and operating around the globe. What we now have in place the commercial operations is proving that we can engage new companies and grow the relationships we have created. We completed the go-to-market transition in EMEA in Q2, and Q3 was our first full quarter of operations.

We are very pleased with the fast pace with which teams are learning their new roles in territories and driving member impact. Through their diligent work, together with that of our account and new sales teams in North America and Asia-Pac, we saw large corporate cross-sell go up from 3.29 to 3.33.

This growth is particularly impressive given the solid quarter we had on new customer acquisition, which usually tends to damp down the number. Going forward, we will focus our energy entirely on bringing the performance and productivity of the great teams we have in place to an even higher level and on adding capacity in key markets and goals.

On slide 10, you will see our second priority, investing globally in our strongest brands. We are addressing this priority on two major fronts. First, continuing to build public recognition of the powerful resources in our core domains; and second, leveraging that strength to grow quickly in key growth markets. We made real progress on both fronts in the quarter.

Many of you likely saw the announcement of our strategic alliance with the NYSE Euronext group. This will help us build stronger presence with large-cap CFOs, their teams, and their colleagues, both here in North America and in key markets around the world. Our work together is already off to a strong start, as our teams have begun sharing some specifically developed content with NYSE-listed companies. We have also begun to leverage Euronext’s strong international relationships to build our brand presence in key international markets.

We continue to use our proprietary data and insights to build public recognition for our resources. As always, our insights into the availability and productivity of corporate union capital were broadly cited in the media, particularly our contrarian findings about the loss of ambition among the highest performing employees. Also at this time of year, media organizations are particularly interested in our deep view into corporate budgets. And you likely have seen our work on IT spending widely referenced.

Overall, this heightened level of visibility has helped us take quantitative [ph] mind for our current members and to keep prospective members. Beyond our normal state of several hundred principals-only meetings in the quarter, we also hosted some important events in the past several months that helped us showcase important work and engage key members in prospects. Most notably, our finance and sales and marketing divisions, each hosted their first ever member summits across the past six weeks.

The events were really terrific, attracting about 800 members in the multi-day sessions, which featured great speakers like former UK Prime Minister, Tony Blair. These sessions dove deep into key topics, ranging from crisis management, the aftermath of BP, to integrating insight developments into sales training. We’re really pleased with the scope and impact of these events and have seen them help us build our brand among new potential members.

These investments to build and globalize our strongest brands help us to grow our member network, particularly in target markets. And here we saw real solidity in the quarter. After several quarters in which our growth was driven almost entirely by cross-sales in large corporate and new sales to middle market companies, we saw renewability to add great new names in the membership list across all of our market segments.

We continue to see very healthy growth in our three important growth markets; our North America middle market team, our EMEA and Asia teams, and our government market teams, all posted solid gains. Across the fourth quarter, our focus will be on continuing to brand those unique assets that help current and prospective members understand how best we can help them.

We will continue to find ways to share our strongest work and forms that reach senior executives. And in particular, we are putting energy behind our firm-level work on 2011 priority-setting entitled Executive Guidance. This resource gave these members a 360-degree look that what other executives are wrestling with so they can each develop their own plan.

For example, you can imagine how much more effective a CIO, the Chief Human Resources Officer, will be with knowledge of sales executive priorities. This is not only a rich resource available to all our members across programs, but it also reinforces our core value proposition to a wide audience. We will also continue to add great talent to teams targeting our key growth markets; middle market, EMEA, Asia-Pac, and government.

Please turn to slide 11. Our third priority is improving the member experience to enhance technology and analytics platforms. Our goal here is to keep ensuring that we complement our great research and high end service capabilities with leading edge technology tools that both support our service and advisory personnel and link our resources directly to member workflows.

Our investments here abide both to ensure high usage and renewal rates among existing members and to leverage our strong data and content to revenue streams. Much of our work in the quarter focused on beginning to roll out our new member portal, which will further enhance the member experience. As you’d guess, we are adding a lot of functionality to help some individual find views and share the most relevant data and research.

The tools and resources that we are putting at their disposal will enable us to invent our resources ever more tightly into their workflow. We have also developed some innovative capabilities that will use our technology footprint to better link members with our service, advisory and research staff. In particular, we are excited about the capability we’ve developed called workspace, which allows us to package data and research targeted to each member’s context. We are quite excited about this rollout, as we think it will accelerate ROE favorable trends in member usage.

Going forward, our efforts will focus on enabling members to drive our content and tools deeper into their organizations. You may have seen one recent example of this with our launch of our manager portal in our middle market HR product in the quarter. Our effort here was driven by some pretty alarming data from our research about the deteriorating impact, managers on employee engagement and productivity.

This tool versions some powerful HR content, help members deliver maximum productivity from their teams. In a similar vein, we are currently working on version 3.0 of our GenView data and content tool to help managers interpret and respond to their own employee feedback.

On slide 12, our fourth priority is elevating member performance through great content and innovative products. Our business begins and ends with content, built with deep research, data and analysis. It’s our ability to give members definitive answers to their most pressing recurring decisions that causes them to engage, buy and renew their relationships with us. And great content assets also pave the way to new revenue streams, as our teams work to turn a single data asset into a recurring part of a member’s work.

Right now, most of our member companies are deep in the process of finalizing their budgets and plans for 2011. To do this well, they often rely on our cost data and insights about performance. Here are two timely examples. This year we have drawn on this broad and deep base of research to support our member CFOs, the overwhelming majority of whom are wrestling with one simple but extremely difficult question. How do I fund selective OpEx and CapEx investments necessary for growth without sacrificing the very hard to achieve cost gains of the past several years?

We looked at our multi-decade performance data on nearly 2,000 companies across North America, Europe and Asia to find clues to post-recession performance. The bad news is that very few companies demonstrate consistent performance across multiple economic cycles. In fact, of the 2,000 stable enough data to be included in the multi-decade sample, fewer than 150 grew the top line and expanded margins in at least half the years in this sample.

How these companies are intelligent growth companies? And they are focused on generating consistent performance in avoiding distracting cycles in whatever [ph] expansion, risk and retrenchment. One shared foundation of their strategy was aggressive CapEx and OpEx spending in the trough. In other words, it bold stands through the environment we are now in. We used these insights to update key budgeting and forecasting tools that link tightly to member work.

And another example, also related to the budget cycle, we have just released a powerful new resource to help members model out and manage their legal costs in partner with CT TyMetrix, the leading corporate legal spend management software to analyze more than $4 billion worth of corporate legal spending. The effort not only resulted in a series of insights about legal cost management, but in a series of new tools to help members model out legal costs and manage law firm billings.

You can see that our research leads to immediate member impact. We also mind our findings to create new products to expand existing relationships and capture new ones. The two recent new products to the cluster of issues related to corporate integrity. Areas such as internal audit, compliance, ethics, legal and regulatory, and governance management have been traditional strong rules of ours across our finance and legal practice area, as we have masked networks of leading companies in rich schemes of unique data, insights and tools.

Our most recent product to emerge from our research in this area is the Risk Integration Strategy Council, which serves the executives and teams responsible for identifying and coordinating key risk processes across the enterprise, driven partly by the recession and the attendant operating, liquidity, technology and human capital risks that occurred. We have seen a rapid acceleration of corporate focus on a more integrated, holistic treatment of enterprise risk.

We have been able to create research analysis and tools to help these members benchmark the likelihood and potential severity of key risks and to assemble plans to mitigate and manage the most worrisome sources of risk. As always, our work here has benefited from the advising council of a great group of early members, including companies as diverse as Archer Daniels Midland, eBay, Lockheed Martin, PepsiCo and Vanguard.

Our second product is an extension of our leadership academies platform to the legal space. Our effort addresses growing sentiment on the part of the general counsels and risk managers that legal teams need to be engaging the business much further upstream, as they are making business decisions, rather than merely when legal consequences begin to arise.

Working with some of the world’s leading legal departments, we’ve built a program that gives corporate lawyers the tools and skills that productively engage, allowing business leaders in ways that lead to early identification, avoidance or resolution in the key risks. In essence, a range of corporate legal departments rely on us to continually add a range of business and management skills to their legal team. We are obviously excited about the way it extends our footprint in the legal, governance and risk base inside large companies.

To sum up, our track record of insight and impact across our legal, governance and finance claims leaves us very well positioned in a world of heightened risk, governance and regulatory awareness. Our extensive member network and deep (inaudible) insights and data have enabled us to build up strong new products here and point to several other opportunities for continued growth.

Moving forward, expect us to put continued energy against both fronts; developing leading edge data, insights and resources and developing new products in our target domains. Beyond their in-the-moment support from member planning, our research teams are focused on preparing compelling research agendas for the coming year. These not only help us develop work plans for our research teams, but give members an early view of the resources that will help them achieve their priorities.

We’re also focused on extending the impact of our great data and content through new products that tie our data in thinking directly to member work. The addition of the two new products we discussed brings our overall product count to 50 and reinforces our stated strategy of driving ever deeper into our target domains. Together with very strong performance in the quarter from the Iconoculture team, these products form an important part of a solid launch late for the year.

While we would expect to see the product count grow steadily from here, it’s important to realize that new products are not the only means we have for growing the business. Indeed, over time, product count may not be the most salient indicator of our total growth potential. As teams find ways to add features and services to our products that members are happy to pay for.

All in all, we are feeling pretty good about the quarter and quite confident about our long-term growth potential. We are getting the traction we expected from our re-organization and seeing renewed strength in all of our key growth factors. Needless to say, none of this would be possible without the incredible people who work here. In the research teams, we work relentlessly to create must-have content and data that members can’t get anywhere else to relationship teams that are fast becoming trusted resources, to the sales teams prospecting and developing new relationships on a global basis.

I feel that we bring an unmatched talent asset to bear on the problems of the world’s best companies. I’m proud of their performance and privilege to work with them. They are mission-focused. My job over the coming year is to make sure they have the support and resources they need to do their best work and speed their progress. With our re-organization behind us and are fully operational, we are focused on realizing the huge potential we have before us.

Thanks very much. Rich and I will now take the questions.

Question-and-Answer Session

Operator

(Operator instructions) We’ll go to our first question from Tim McHugh with William Blair & Company.

Tim McHugh – William Blair & Company

Hi, thanks, guys. First, I want to ask about the pricing environment. Can you just give us an update on, I guess, first of all, what you are doing with kind of the normalized pricing across the board? And then, also trying to get a sense of the growth in deferred revenue and contract value. How much of that is going – I'm trying to get a sense of not just pricing in terms of the price increase, but the average revenue per customer perhaps as you continue to add new programs in there. Can you help us think about the growth profile going forward? Is it more evenly weighted between cross-sell and perhaps an increase of revenue per subscriber than in the past, or how should we think about it going forward?

Richard Lindahl

Hi, Tim, it’s Rich. I’ll take the first part and then Tom will take on the second. As far as pricing, consistent with what we told you on the last quarter, we are encouraged that we’re seeing trends revert back to where they had been before the downturn, back to our historical ranges of kind of 3% to 5% annual price increases. And we’re encouraged by the progress we are making there.

Tom Monahan

Hey, Jim, it’s Tom. On the composition of growth, I think any given period of time, you will find that of the three levers for growing the business; the first being renewal and cross-sell, the second being selling to new customers, and the third being new products. In any given period, you’re going to find that first bucket is disproportionately the largest in this past – past quarter being no exception, given the number of customers we have and the range of products we have. And right now, still low amount of revenue per customer, the biggest single driver across any period can be our ability to continue to take the products we have and get them in support of members we are already working with.

Tim McHugh – William Blair & Company

Okay. And then, Rich, can you talk a little bit – I know you said DSOs were within the historical range, but the AR has grown a lot faster than the revenue this year and the offset is true for the kind of the current liability of the accounts payable. So, does it impact the cash flow a little bit? Can you just a talk a little bit on what’s going on there on a year-over-year basis? Was it just tough comparisons last year?

Tom Monahan

Yes. There’s certainly a little bit of that, particularly on the payables side. But I think on the receivables side, there really isn’t any major change to speak of. I mean, we’re still collecting roughly 85% of our revenues on the front end of a relationship. We did see – we did have some turnover in the collections area during the quarter that took us a little bit longer to fill than we would have liked, but we’re back to fully staffed again and we’re starting to see those trends improve. So I would expect we’ll have a better outcome by the end of the year.

Tim McHugh – William Blair & Company

Okay. Thank you.

Operator

Our next question is David Ridley-Lane with Bank of America.

David Ridley-Lane – Bank of America

Sure. What is sales headcount on a year-over-year basis?

Richard Lindahl

We don’t disclose a specific number there. But sales headcount still represents – goal-bearing headcount is still about 25% of our total headcount. And we will give you an update on total headcount at the end of the year.

David Ridley-Lane – Bank of America

Okay. And what was the quarter-on-quarter change in non-subscription revenue in the third quarter?

Richard Lindahl

It’s still a small piece of our revenue. It didn’t drive a lot. It was down slightly second quarter to third quarter.

David Ridley-Lane – Bank of America

Okay. And –

Tom Monahan

As you know, David, our focus is always going to be getting the subscription revenue in the door, given the renewability, visibility and the scalability of it. So we work teams very, very hard to make sure we’re getting after that. And we see non-subscription revenue generally as an ability to respond to member need, but we’re not as focused on it.

David Ridley-Lane – Bank of America

Okay. And then how does the link to the sales cycle today compared to pre-recession norms?

Tom Monahan

It’s a little harder to do apples-to-apples there across a lot of our sales organization because of the account management structure. But I’d say we are starting to see it get closer to pre-recession normalcy. I wouldn’t yet say we’re at – I wouldn’t yet say corporate budgets are at a place where it’s easy to sell, but I think our teams are at a level of maturity where they are doing a good job of moving prospects through the sales process. So I think it’s getting to a level of consistency, but not all the way there, because as you can see from a macro economy, it’s earning a dollar in a corporate budget is still a little more challenging than it was in the run-up to the recession.

David Ridley-Lane – Bank of America

Okay. And then maybe one more. Any update on the push for international mid-markets programs?

Tom Monahan

We are in the early days of scoping out the opportunity there. It’s obviously huge, and we’ve got some resources starting to get to work to figure out what it might look like. As you know, we want to make sure the economics of the middle market programs were broadly comparable with those of large corporate wider place where we believe that’s true. Given the fact that we see, give or take, 10,000 middle market companies outside the US, that will be great target to our programs. It ranks pretty high on our opportunity set. But no major progress to report since the last quarter.

David Ridley-Lane – Bank of America

Okay. Thank you very much.

Operator

We will go next to Paul Ginocchio with Deutsche Bank.

Paul Ginocchio – Deutsche Bank

Thanks. Just two questions on the cross-sell ratio. First, the Q-on-Q increase in this quarter wasn’t quite as big as the last quarter. Did you say that was because of the new sales structure you bring to in Europe, or what else should we be thinking about? And then second, is there a way to materially improve the cross-sell ratio? I mean, what’s the diversity of the number of programs that make up the bulk of the 3.33 programs? And do you think there is a program out there that would become another key program that would then take that cross-sell ratio up to maybe 4.0, 4.5? Do you understand my question?

Richard Lindahl

On the first part of the question, I think what we saw was we actually had more new sales success in the third quarter. And as you know, when we add a new customer, they typically will sign up for just one program initially. And so we had a little bit of an offsetting force there against the cross-sell ratio that kind of needed its growth a little bit quarter-to-quarter.

Paul Ginocchio – Deutsche Bank

Great.

Tom Monahan

Hey, Paul, it’s Tom. As to the question, is there a lead program or something that we would love every member to take us up on, the answer is sure. We’re always looking for that. The way it works the nature of those, these products tend to be independent conversations with different buying standards, as you know what I mean, taking five parallel selling forces into most large companies and have a similar structure in middle market. And we’re still working with individual executives on their individual priorities. So we see less of a pattern in terms of purchase than you might expect.

As a bunch of washed up ex-consultants, we look at that all the time because we make our job easier if we knew that. Everyone bought program A first and then program B and then program C. But we’re in individual conversations with individual executives lining our resources up against their needs. So the path each individual company follows with a product that is very different. But certainly, the key criteria of any new product we might launch is how many of our member companies we think we’ll take it as fast as possible.

Paul Ginocchio – Deutsche Bank

Okay. So I guess the diversity makes up the average of 2.92 is pretty high. It’s not three to five programs that make a bulk of it?

Tom Monahan

Yes. They are higher than you would expect, but I think that reflects the fact that we have lots of different opportunities to engage in given company and lots of different reasons why someone will get involved with us at any given point in time.

Paul Ginocchio – Deutsche Bank

Great. Thank you.

Operator

Our next question is Dan Leben with Robert W. Baird.

Dan Leben – Robert W. Baird

Hi, good morning. Could you talk a little bit more about the performance in Europe with the sales transition, what you saw just sequentially in some of the progress they gain particularly as they move through the quarter?

Tom Monahan

Sure. Again, as I said in the call, we cut over to the new go-to-market models in Q2. Q3 was our first full quarter of operations, and we were pleased at the rate with which people were learning new behaviors, getting engaged with new members that they are supporting and driving the business. They work pretty hard through the summer, which sometimes can be a little slower in Europe, to make sure they were out ahead of the opportunity, and we are very pleased with their progress so far. But early days still. We expect even bigger things going forward.

Dan Leben – Robert W. Baird

Great. And then any vertical industries you’d point out as being particularly strong or weak in the quarter?

Tom Monahan

On a relative basis, the story of this year continues to be the fact that FS, which was a very challenging sector, is now restored to a state of normalcy for us. And it’s a big and important sector, and we’re thrilled that it’s back. So FS is the big outlier on a relative-to-the-last-couple-of-years basis. All of the rest of the sectors look pretty consistent.

Dan Leben – Robert W. Baird

And then last one from me, just on the expenses and not ramping quite as quickly as you thought, was that a situation where you are having trouble finding the right people or some other things, or was it just a matter of rolling out new programs and pushing the timing back a little bit?

Tom Monahan

It’s funny. We have been – part of it was just timing. We did do more of the hiring later in the quarter than we expected. More broadly, our research is pointing to – for the type of talent we recruit, labor markets are always tight. If you look – we do a lot of work on this for our members and you see wide dispersions in labor availability by segment. And the types of people we need top-decile talent aren’t any more abundant today than they were four years ago. So we have to work very hard to find great people and give them the compelling reason to come work here because we’re not targeting the sectors that have been most severely affected by the unemployment rate.

Dan Leben – Robert W. Baird

Great. And then just do not want to get into 2011 guidance or anything, but should we expect that these investments are going to continue to ramp up and maybe start seeing some of what you originally planned in 2010 and 2011, or all of the hires are going to get made this year?

Richard Lindahl

We will update you on our plans for 2011, but suffice it to say, we are following through on some of these planned investments. We would expect some of this hiring to continue. In fact, we’ve seen some of it in the early part of the quarter, in the fourth quarter. And so, for the foreseeable future, we still expect that combination of revenue lag and higher expenses to have the same impact on margins that we’ve been talking about this year.

Dan Leben – Robert W. Baird

Great. Thanks, guys.

Operator

The next question comes from Shlomo Rosenbaum with Stifel Nicolaus.

Shlomo Rosenbaum – Stifel Nicolaus

Hi, guys. Thanks for taking my questions. I’m just trying to walk through – it seems like you guys are expressing confidence in gaining traction on the sales environment, and it seems to be boring out from the contract value improvement. But the cash flow took a big step down this quarter. And I’m just trying to reconcile the bookings that which seem to be – at least want to calculate them based on deferred revenue, not necessarily being that strong with the contract value going up. Is there something in there in the contract value? Just to ask the same question that was asked beforehand, that would not necessarily go into deferred revenue?

Richard Lindahl

No, there is nothing there. I think there is nothing that I would point to that would cause any kind of difference.

Shlomo Rosenbaum – Stifel Nicolaus

So how do you understand the big cash outflow in the quarter? I mean, just give us a clue as to what’s going on.

Richard Lindahl

Again, I think a lot of that was driven by – collections were a little bit slower than we would have liked to see. Again, as I talked about, we had some unfilled staffing positions, which put us a little bit behind the curve there. As I said, we filled all those and we are seeing collections start to pick up again. So I would expect we will see better performance in the fourth quarter.

Shlomo Rosenbaum – Stifel Nicolaus

So, is there a big improvement, like after the quarter, once you started to fill some of that? Did you see big inflow of cash?

Richard Lindahl

Yes. I mean, without being specific, we’ve definitely seen improvements in those trends in the early part of the quarter.

Shlomo Rosenbaum – Stifel Nicolaus

Okay. And then just in terms of the sales environment, I want to get this a little more clear, are you guys – are you seeing more of a turn in the economy over the last quarter improving or are you finding that your sales force is becoming more effective that would be the kind of thing that you guys would probably track very acutely?

Tom Monahan

Shlomo, what I’d say is, it’s hard to really pull apart those effects perfectly. I don’t think any of our member companies would yet sign up for the concept that they are being powered by a tailwind. The macroeconomic conditions are still pretty murky and muddy. And I think most companies are muddling along, if you will. That said, they certainly feel a lot more stable than they did a year or certainly two years ago at this time, and they’ve got a bunch of problems on their desk, they’ve got to go make headway against.

So while they are not looking at any big tailwind that’s powering their business, they are feeling the headwinds they felt across the past couple of years and they are trying to turn their attention to getting their problems solved and making progress. I think that’s an important part of it. I do also think our teams are doing a great job. So we’ve gone through a lot of change. We’ve put new challenges in front of people and they are responding very, very well. So our internal metrics would suggest that a good bit of our success is being powered by our teams.

Shlomo Rosenbaum – Stifel Nicolaus

And then my last question is, you guys have been focusing for a while on improving your products so that they can really become part of your customers’ workflows. Can you just talk – give us more specifics as to what exactly you are doing and how you expect that to embed itself a lot more to customers’ workflows?

Tom Monahan

So I think the – at a macro level, what we’re making sure we’ve done is understand a year in the life of a given membership that we’re serving, what are the big decision they have to make with the recurring workflows that we’ve got and making sure we’ve got either service moments or technology tools lined up against them. An easy example is, if you are in the CFO’s organization, you are obsessive about forecasting. How do I build forecasts, bottom up on the business and triangulate them against external data?

So we have a nice tool that helps someone go up and take some external data, take their internal data and understand what gaps there might be between the way the worlds use them and the way their competitors are performing and the way they are projecting to perform. So it takes our insights about forecasting and planning and turns it into a technology tool that enables someone to create and deliver both. Just a good example. But I think in pretty much every one of our programs, we are finding ways either through service moments or through technology-based tools to help someone address the big decision points of recurring workflows in their quarter or year.

Shlomo Rosenbaum – Stifel Nicolaus

And for some of these things, let’s say, with the forecasting tool, does that become just part of the regular cost of a membership? Are you guys able to charge any more for that?

Tom Monahan

All the above. There are places where we will add resources they bolt on that drives a price increase. There are places where it supplants other activities we were doing in the program and just becomes part of the value proposition that drives renewals, and certainly heard in the quarter that some of the things we’re doing to help companies manage risk become a new product.

Shlomo Rosenbaum – Stifel Nicolaus

All right. Thanks a lot.

Operator

And our next question comes from Gary Bisbee with Barclays Capital.

Gary Bisbee – Barclays Capital

Hi, guys. Good morning. I guess the first question, you sounded maybe – and it may just be conservatism, but there were some cautioning that there you are expecting continued improvement in the fourth quarter, but maybe not as much on either contract value or revenue. Did I hear that right? And if so, can you give us a sense as to why you’d expect that?

Richard Lindahl

Yes. I mean, I think fourth quarter is a big quarter. There is a lot of business comes for renewal, and we also are focused on looking for new business. And so I think that we just – we're optimistic about how we’re going to end the year. We expect to finish the year on a positive note, but to make same kind of sequential progress that we’ve made in the prior two quarters is going to be very challenging.

Gary Bisbee – Barclays Capital

In terms of what, the sequential growth in dollar terms in contract value or –?

Richard Lindahl

In contract – starting with contract value. And again, there is a larger renewal pool in the fourth quarter than you had in the third quarter. And so that’s a bigger starting point that you have to begin from. And then on revenues, again, the lag effect comes into play. So it takes a little bit longer to follow through there. So we would expect that we will see some progress, but we again don’t expect the same kinds of lifts necessarily that you’ve seen in the second and the third quarters.

Gary Bisbee – Barclays Capital

Okay. And then on the comment on costs, can you be any more specific on what cost (inaudible) as quickly as expected? I feel like that there has been a recurring trend for two years and at some point it started to get skeptical as to how much you really spend. Should I think of this as largely headcount or other –?

Richard Lindahl

Yes.

Gary Bisbee – Barclays Capital

And if so, in what part of the organization? Are there other expenses that have been delayed here?

Tom Monahan

I think pretty much the only meaningful category expense of our company are people-related expenses or things we do to put our resources in place to support those people. So when we talk about spending ramps, what we’re talking about is hiring ramps. Last year, we had a very aggressive pasture toward the cost structure early in the year. So we – our storyline there was much more about getting out ahead of anticipated revenue declines.

This year, as we scale back up, it’s about top decile talent, is finding great people. And for a few positions in a company of our size, those slide to later in the quarter, you end up with a cost profile for the quarter that looks a little different than you thought at the beginning. But I’m happy with our ability to compete for great talent. We’ve brought great people into the door. It’s just more of them came in in September and October than August. I guess, in retrospect, there probably was a vacation effect there, but we’re feeling pretty good about our hiring capability and our ability to compete for great people in the labor markets.

Gary Bisbee – Barclays Capital

Is that largely within the sales and service organization or is it starting to be within the research staff or product development as well or –?

Tom Monahan

It’s both sides. We’re looking for great people on both sides. And I think the general bias of our management teams across the board is rather wait a couple more weeks and find a really great person and then fill a chair. And collectively, that sometimes can result in the hiring ramp being a little bit behind.

Gary Bisbee – Barclays Capital

Okay. Given that it’s, I guess it’s fair to say, a reasonably significant transition in exactly what the sales and service people are doing in some of the roles and responsibilities and probably how you will grade their performance, what’s the turn-in or turnover been like, as you’ve implemented this over the last 18 months? Is it mostly the same folks or you had to change the profile of who you are hiring and who is successful in this new model?

Tom Monahan

At the outset, we paid a lot of attention to the people who are taking on these new roles. And in effect, every single person is re-interviewed for their jobs at the points of transition. We knew we had terrific talents, so a lot of the roles could be filled by people we already had in-house. But there was a little transition at the point of transition back in Q2 2009 and Q2 2010, as we went through the major pieces of North America and EMEA. Since that point, we’ve been very pleased with attrition.

We’ve been – I think people are engaged by these new roles we’re putting. Like in most talent-driven organizations, we pay a ton of attention to attrition. And to date this year, attrition is tracked well below historical rates, roughly consistent with 2009 levels. We think we’re seeing some benefits from the re-organization efforts, which resulted in more compelling jobs. So, at the point of transition, yes, since transitions, we’re happy with the results.

Gary Bisbee – Barclays Capital

Okay. And then I guess just the last one from me. Any insight you can give on how we should think about forecasting what the non-operating items, which continue to seem to be a significant item more quarters than not?

Richard Lindahl

Yes. I mean, it’s definitely a challenge as it relates to the foreign currency gain or loss position. I mean, obviously that’s driven by the movement in the British pound relative to the dollar. The deferred compensation plan impact on other income, I would point out, there is an offsetting impact up in the operating expenses above. That’s just the way the accounting works. So, on a normalized basis, those kind of wash each other out. But other than that, we certainly are going to try to point out to you anything that you need to be aware of before it happens. But there is very little we can do about forecasting foreign currency changes.

Gary Bisbee – Barclays Capital

Okay. Thanks a lot.

Operator

And it appears we have no further question. Thank you. At this time, I’d like to turn the conference back over to Mr. Monahan for any closing remarks.

Tom Monahan

Thanks, everybody, for calling in or logging in this morning. We look forward to keeping you up to date on our various initiatives in the progress we are making in the marketplaces. We will be at the William Blair Conference early next month and look forward to seeing folks there or out in the road in our various travels across the autumn and winter.

Operator

And that does conclude today’s conference. Thank you for the participation.

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