Corporate Executive Board's CEO Discusses Q2 2011 Results - Earnings Call Transcript

Aug. 2.11 | About: CEB Inc. (CEB)

Corporate Executive Board (EXBD) Q2 2011 Earnings Call August 2, 2011 9:00 AM ET

Executives

Richard Lindahl - Chief Financial Officer and Principal Accounting Officer

Thomas Monahan - Chairman and Chief Executive Officer

Analysts

Paul Ginocchio - Deutsche Bank AG

Toni Kaplan - Morgan Stanley

Daniel Leben - Robert W. Baird & Co. Incorporated

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

David Ridley-Lane - BofA Merrill Lynch

Gary Bisbee - Barclays Capital

Timothy McHugh - William Blair & Company L.L.C.

Operator

Good morning, and welcome to the Corporate Executive Board's Second Quarter 2011 Conference Call. Today's call is being recorded and will be available for replay beginning today and through August 10 by dialing (719) 457-0820. The confirmation code for the replay is 5170146. The replay will also be available beginning later today and through August 10 at the company's website 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 going to the Investors page and clicking on the second quarter webcast. Please review the second page of these materials, which includes important information about forward-looking information included in the presentation.

This conference call may contain -- may also contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding the Corporate Executive Board’s expected quarterly and annual financial performance for fiscal 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 of forecasts, estimates, targets, plans, beliefs, expectations and the like are intended to identify forward-looking statements. You are hereby cautioned that these statements may be affected by important factors, among others, set forth in the Corporate Executive Board’s filings with the Securities and Exchange Commission and in its second quarter news release. Consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

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

Richard Lindahl

Thank you, Scott, and good morning, everyone. I'm Rich Lindahl, Chief Financial Officer of the Corporate Executive Board, and I'd like to thank you for calling or logging in to our second quarter 2011 earnings call. Here's a quick overview of our time together this morning. I'll begin by giving you a financial perspective on the quarter, and we'll also review our 2011 outlook. 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 3 of our presentation for the key messages we'd like you to take away from today's discussion. First, our growth continues at a solid pace. Second, the operating trends of the business remain healthy. And finally, we are on track to deliver our annual commitments. Now I'll comment more on this last point shortly, as it is important to note that with our 2011 investment plan largely complete, we expect improved margins through the second half, with the most significant gains coming in the fourth quarter.

Please turn to Slide 4 for an overview of our financial results. At June 30, 2011, Contract Value was $456.8 million, which is an increase of 11.4% from June 30, 2010. Virtually all parts of our business contributed to the growth, with the strongest relative performance seen in North America and Asia Pacific. We did see some groups lag our firm average, most notably in the government sector, which remains challenged by the ongoing federal budget uncertainty and in Europe, where our teams are still completing the commercial transition begun last year and managing through still sluggish and uncertain macroeconomic conditions. Revenues were $119.2 million in the second quarter of 2011, an 8.8% increase compared to $109.6 million in the second quarter of 2010. As we have previously discussed, on January 1, we adopted the FASB's new guidance on revenue recognition. Under these new accounting rules, we deferred recognition of approximately $2.1 million of revenue in the second quarter that would have previously been recognized under the prior rules. This additional amount brings our total year-to-date deferral to $3.6 million. We expect another such net deferral of revenue to occur in the third quarter before recognizing a portion of the year-to-date deferrals in the fourth quarter, and the remainder of such revenue in early 2012. As a result, we currently estimate that the full year net deferral of revenue from 2011 into 2012, will be approximately $3.5 million. Revenues were also influenced by the timing of bookings through the quarter. April bookings were relatively slow, which tempered the second quarter revenue growth, even though the pace of bookings increased solidly in May and especially June. Moving on to operating expenses, cost of services in the second quarter of 2011, increased by $4.6 million versus the second quarter of 2010. Personnel and other compensation costs were again, the biggest component of this change, driven by the acquisition of Iconoculture, investments in product development and expansion of our advisory staff. We also saw increases in more variable costs linked to the size of our business space such as travel, member meetings and content delivery. Member relations and marketing expense increased by $5.9 million in the second quarter versus the prior-year period, as a result of higher staffing levels and increased sales commissions due to the cumulative growth in bookings. As a reminder, this line also reflects the bulk of our international staff investment, which has increased as we pursue growth opportunities in Asia and Europe.

General and administrative costs increased by $2.1 million in the second quarter of 2011 versus the second quarter of 2010. This rise was driven by higher head count, recruiting and system enhancement expenses. Other income was $0.3 million in the second quarter compared to a net expense of $0.8 million in the second quarter of 2010. Most of the year-over-year improvement can be attributed to last year's $0.9 million decrease in the fair value of deferred compensation plan assets in the second quarter of 2010. Adjusted EBITDA margin in the second quarter of 2011 was 18.9% versus 22.1% in the second quarter of 2010, reflecting an annual reduction, which resulted from the impact of the operating investments we have discussed over the past several quarters. As a reminder, we do not adjust our stock compensation expense, which was $2.1 million in the second quarter of 2011, when calculating adjusted EBITDA margin. Depreciation and amortization in the second quarter of 2011 was $4.6 million, a decrease of $1.1 million compared to the second quarter of 2010. This reduction is attributed to lower amortization from Toolbox and intangible assets, and the completion of equipment depreciation cycles. In the second quarter, our effective tax rate was 42.9%. During the quarter, we recognized a discrete event related to the realized ability of a state deferred tax asset, causing an increase in the rate for the quarter. We continue to estimate, however, that our tax rate will be approximately 41% for the year, excluding the effects of unrealized currency translation gains and losses. Diluted earnings per share in the second quarter of 2011 was $0.30 or $0.02 lower than the $0.32 we reported in the prior year period, as the year-over-year growth in revenues was offset by the higher operating costs associated with our investment plan for this year.

Turning to the balance sheet. Membership fees receivable decreased seasonally to $87.8 million at June 30, 2011, as compared to $141.3 million at December 31, 2010. Average days sales outstanding were 67 days for the second quarter, consistent with historical seasonal ranges. Deferred revenues declined seasonally and the current portion was $260.2 million at June 30, 2011. As compared to the prior year, deferred revenues increased by 14.5% from the second quarter of 2010, due to improved year-over-year bookings. We continue to be encouraged by these trends and the favorable implications they have on our near term revenue growth. Year-to-date cash flows from operations were $54.3 million through June 30, 2011, a decrease of 3.2% versus the first half of 2010. The cash flow benefits from recent booking trends were offset, primarily, by higher incentive payments made this year, as compared to 2010. During the first half of 2011, we spent $4.6 million on capital expenditures and paid out the Iconoculture earnout and hold back. We also paid $10.3 million in dividends in the first 2 quarters of this year and finished with $159.6 million in cash, cash equivalents and marketable securities on hand at June 30, 2011. So to sum up the quarterly financials. Our cumulative growth and bookings has led to solid improvements in Contract Value, revenues and deferred revenues, while our first half operating investments tempered the relative -- the related impact on profits.

Please turn to Slide 5 for an update on the new operating metrics we have been providing this year. The headline here is that the trends remain healthy and continue to demonstrate growth in the key drivers of both our current and future revenue. On the left side of the chart, you'll see another solid year-over-year increase in Wallet retention. This metric is defined as the total current year Contract Value from prior year members as a percentage of total prior-year Contract Value. As such, it measures our success at expanding institutional relationships through effective retention, cross-sell and price improvement efforts. All 3 of these drivers gained traction over the past year, and as you can see, Wallet retention grew by 13%, rising from 91% in the second quarter of 2010 to 103% in the second quarter of 2011. In the center of the page, we showed that we grew our customer base by 7% over the past year, as total member institutions increased from 5,024 to 5,378. This improvement reflects are success in reengaging former members, establishing new relationships with large domestic and international corporate customers, and further penetrating the middle market opportunity. The net result of all these efforts can be seen on the right-hand side of the page, which shows the Contract Value per member institution grew by approximately 4% from $81,600 in the second quarter of 2010 to $84,900 in the second quarter of 2011. 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 with are subject to change over time. Please turn to Slide 6. As we discussed on our last earnings call, we have constructed our 2011 plan with an eye towards balancing profit and cash flow growth with select investments to create long term value. Given both seasonality factors and our strategy of deploying investment resources early in the year, we anticipated that full year earnings growth would be back-end loaded. We continue to pursue sustainable top line growth, attractive profitability and improving cash flow from our existing subscription business. And we have made additional investments in new products and market extensions to further enhance organic growth.

Our year-to-date results keep us on track to deliver on a financial outlook we provided to you in May, and we are currently pacing to the midpoint of our guidance ranges. Our Contract Value and deferred revenue balances point to continued growth in quarterly revenues. Where we land the full year will be a function of both second-half bookings performance and the degree to which we recognize revenue in the year that has been deferred under the new accounting guidelines. With our annual investment plan largely complete, we expect total quarterly operating expenses to remain relatively flat through year end. Accordingly, we currently anticipate improved revenues and earnings during the second half of 2011, and as a result, we are reaffirming our 2011 outlook as follows: annual revenues ranging from $480 million to $500 million; adjusted EBITDA margin of between 22% and 23%; non-GAAP diluted earnings per share of $1.50 to $1.65; depreciation and amortization expense of approximately $17 million to $18 million; and capital expenditures of approximately $8 million to $10 million. Before I close, I just want to emphasize an important point about our outlook.

Because we are transitioning into 2011 to the new revenue recognition accounting rules, we are experiencing a onetime change in quarterly EPS patterns. While we still expect to see typical seasonal bookings trends drive flat or perhaps modest growth in operating expenses, a portion of the revenue from contracts we've already booked will not begin to flow through our income statement until the fourth quarter. As a result, while we anticipate some sequential improvement in both revenues and earnings in the third quarter, we expect to see larger gains in the fourth quarter, as we deliver against our full year 2011 outlook. That's it for the financial summary. Please turn to Slide 7, and I'll turn the call over to Tom.

Thomas Monahan

Thank you, Rich. Good morning. As Rich articulated, we made steady progress through the first half of 2011 and remain on track to deliver on our annual commitments. Our goal was to invest early in the year and steadily generate bookings growth against an annual target. With our 2011 investment plan largely complete and bookings tracking to plan, we're well set-up for Contract Value and revenue growth and margin expansion across the back half of the year, particularly, in the fourth quarter. On balance, the business as a whole is performing well, with, as usual, some pockets of particular strength and/or challenge. The economic picture may be far from robust, but most of our markets have remained stable. This gives our teams a solid platform for engaging and supporting executive members. And like our member companies, we've also got our eyes on policymakers today, and we'll adapt our strategy accordingly, as macro- and policy conditions unfold. As a reminder, we invest in 3 levers to grow the business, which are captured on Slide 7. First, we grow relationships with existing customers. This is our largest and most scalable growth opportunity overtime, as we work to connect more of our resources to the more than 5,300 member companies already in our network. Second, we add new customers. More than 17,000 companies across the globe have yet to initiate a relationship with us. We are concentrating our investments in markets with large opportunities, such as middle market and select international markets. Third, we had new products and services that target uncovered needs in our key buying centers. Developing these products and services requires near term investments that provides platforms for future growth and helps strengthen relationships with member companies. The second 2 leverage represent the bulk of our investment activity, which does result in short-term margin compression as we set initiatives in motion. As I outlined on our Q4 call and updated you on last quarter, we have 4 core priorities for 2011 that focus on moving these growth leverages. We've captured these on Slide 8.

First, creating uniquely valuable insights into corporate performance; second, driving loyalty, growth and brand strength through high-value member engagement; third, investing globally in key markets; and fourth, leveraging technology in service to deliver innovative products.

Let me update you on progress against each of these priorities. Please turn to Slide 9, where I will discuss our first priority, creating uniquely valuable insights into corporate performance.

As always, our objective is to create must-have research, data, analytics and content that engages our members and underpins growth. We believe that our business begins and ends with great content built from our deep research, powerful data and unique analytic tools. I'm very pleased with our progress on this front across the first half of 2011. Last quarter, I showed the highlights from recent work in our HR practice on building an effective strategy in China, and we have great work being developed all over the firm, from resources to help technology executives extract value from mounting piles of data, to tools that help strategize and navigate emerging markets, to data that helps sales executives streamline and close consensus-based sales. Some recent work from our governance, legal and risk area is equally noteworthy. Helping companies manage all aspects of, what we call, corporate integrity has been an important growth area for us. It's an area where our ability to bring powerful analysis and practical resources to the table has created real value. We find that the realms of integrity and ethics are often long on emotional appeal, but short on either deep-data or hard-edged economic focused. Five years ago, our members asked us to fill this gap and take a hard look of the factual relationship between employee misconduct, corporate culture and corporate performance. And to create tools and best practices, we're driving high integrity performance cultures. Five years later, thanks to the participation of more than 130 member companies and over 500,000 of their employees, we have built a rich data asset that provides a global map of corporate integrity and clearly defines how managing integrity can lift corporate performance. As you can imagine, we leveraged this outstanding asset in many ways. In our recent work entitled Turning Ethics Into Outcomes, we outlined 3 key steps for managing risk and improving performance. Arming leaders with the tools and practices to generate, what we call, integrity capital has real economic benefit. Integrity leaders incur 1/8 the cost of misconduct compared to competitors and have 12% lower labor costs because their employees invest more discretionary effort. These are just 2 of the reasons companies with strong integrity capital deliver shareholder returns 5.8 percentage points higher than the average company across the long term.

We recently hosted an event at the New York Stock Exchange entitled Making Integrity Pay to examine the impact of corporate culture on business performance. The event featured a roundtable discussion with some member company's CEOs. Greg Babe, CEO of Bayer Corporation; Jeffrey Immelt, CEO of GE; Gord Nixon, Chief Executive of The Royal Bank of Canada; and Glenn Renwick, CEO of Progressive Insurance. Each of these companies have been identified by our research as having a high integrity culture, and it was great to talk about what practices they had put in place to drive great outcomes.

Please turn to Slide 10, where I'll discuss our second priority, driving member loyalty, growth and brand strength through high-value engagement. As a reminder, our objective here is to leverage effective support of our members to grow our business through renewals, pricing power and the sale of additional products and services. Wallet retention was, again, at the high end of our historical range at 103% compared to 91% at this time last year. As a reminder, this metric provides an integrated view of our effectiveness at maintaining member relationships, realizing price increases and selling additional products and services. We're pleased with the solid outcome for the quarter. You've also heard us commit to adding capacity in our new sales team, both in the large corporate and middle markets. We've been successful in adding high caliber talent to both sets of teams and are now getting new hires up to speed quickly in the marketplace. You can see the results of this investment in our continued new member growth.

As you know, we also punctuate our daily support for members with a variety of events and meetings across the year that allow us to engage many members at once.

One particularly noteworthy example in this quarter was our Enterprise Council on Small Business Summit. We hosted the event in New Orleans. It was a great venue for convening more than 250 marketers and sales leaders from more than 130 companies, and we took the time to highlight and engage directly with the entrepreneurs and small businesses, helping the city recover post-Katrina. The Enterprise Council on Small Business helps marketers and sales people at our member companies understand and reach the small business marketplace. It's a giant opportunity yet one that most corporations find difficult to crack. We use the summit to share insights on customer advocacy drawn from our extensive data on small business owner preferences. Sessions explore how small business referrals occur, as well as how to tap the silent majority of satisfied small-business customers, whose positive experiences don't translate into vocal endorsements. One of the big highlights of the event was our honoring member company, Staples, with the first-ever Small Business Choice Award, which reflected the opinions of thousands of small business owners in our data set. We are proud to honor them for their innovative strategies and to outline their best practices in reaching this market.

Please turn to Slide 11, where I'll discuss our third priority, investing globally in key markets. Our objective here is to accelerate new member acquisition and growth of existing members through select market level investments. We see much opportunity to drive both growth and strengthen our competitive barriers by achieving higher penetrations -- higher penetration levels in our key markets. However, tapping this opportunity does require near-term investment to lay a foundation in in-market sales and service and content adaptation. While we can leverage our global data, research and best practice assets, it is important that we invest in making our support highly relevant to companies in target markets.

At the midpoint of 2011, we've made very solid progress putting resources in place in our key markets. Along with continued strength in North America large corporate, our middle market platform and our expanding presence in the Asia-Pacific region, these all continue to produce growth above the firm's average. As you'd expect, our efforts in the government market continue to be challenged in the near term by budget difficulties at the federal and state levels. However, our team continues to produce results, proving the resonance of our resources even in this cloudy environment. We continue to believe that long term trends toward performance management to optimize scarce budget dollars will create higher levels of demand for our products in this very large market. Last quarter, I also called out our opportunity in the EMEA region and our investment in establishing a Germany-based team. We've also updated you over the last several quarters about our go-to-market transitions in the region. While we have completed these transitions and investments, the economic cloud in Europe has slowed our overall growth rate. We see long term opportunity in the region and are supporting our teams with strong marketing investment and versioning of the product set to make sure we're positioned for continued growth.

Please turn to Slide 12, where I'll discuss our fourth priority, leveraging technology and service to deliver innovative products. Our objective here is to create and grow revenue streams by linking research and content to new member decisions and workflows. Last quarter, I noted that you would see us de-emphasize product count as a metric going forward. While new products are important to our growth, they aren't the only way we invest in our products set. Our teams are also intensely focused on developing innovative new features and resources for our existing products, which can broaden our usage, increase stickiness and add to our pricing power. This quarter, I want to share 2 examples of these new features. The first is a great example of how we continue to innovate in some of our most established products. One of our strongest platforms has historically been our product for heads of procurement, the Procurement Strategy Council. As you would imagine, our rate franchise here is not only an attractive opportunity on its own, given the big dollar decisions on these executives desks, but it's also strategically important as these executives can be a key influencer on other buying decisions. We've recently added new service to this platform called Bootcamps. We heard from procurement heads that they need our help getting their teams to use our tools and data as part of their everyday work flow. We've developed these sessions for their category level teams. Let's say the team responsible for managing travel vendors or even more challenging categories like legal spending can work through practical applications of our content with their peers from other companies. These case-study-based sessions are built around the most cutting edge topics in procurement and efficiently transfer our data, best practices and tools into the workflows of our member organizations. These resources allow us to couple are senior-level insights with direct impact on vendor negotiations. And they ensure that members actually reap real cost savings from our tools. Market response has been overwhelmingly positive and has increased the growth rate and stickiness of the product. One member commented, "I love practical approaches, and I'm going to be able to bring a lot of improvement opportunities right back to my company. Thank you for the game-changing insights".

The second is an example of how our installed base can be a platform for upgrades and additional services. As you know, our strong middle market platform supports heads of HR at hundreds of midsize companies through the Human Resources Leadership Council product. We found that these executives face an urgent need, how to develop and train line managers without the resources to implement a formal company-wide program. We were able to reengineer and repackage tools and resources from elsewhere in our HR practice into a turnkey solution on demand for our members. The resulting solution focuses on the most critical managerial skills, as identified by more than 10 years of HR practice research and employs a blend-in learning approach with the e-learning content, detailed online manuals, online tactical tools, templates and diagnostics to reinforce key skills and help managers incorporate them into their daily work.

Market reception has been very strong. We repositioned this service as an upgrade option to our existing product, and member response has been great. You'll recall that when we originally barged into the middle-market, we expected that our products will be priced in the $7,000 to $10,000 range. Now thanks to creative product upgrades like this, our average middle-market product relationship is priced in the $12,000 to $15,000 dollar range. Beyond our investments in new product development, we are also continuing to bring our recent acquisitions to CEB caliber scale and, ultimately, CEB caliber margins. We're pleased with the early results, but continue to see opportunities to reap further benefits from tighter integrations.

Let me close with a note about our leaders and our people. When we talk about making investments in the business, we are really talking about developing the people we have and adding great new CEB caliber talent to the business. Across the first half of the year, we saw great success on both fronts. We continue to see great outcomes in attracting, retaining and developing key staff, partly as a result of specific investments in training and development and partly as a result of great efforts by our leaders to coach and mentor proven and new staff. I'm delighted by the quality of hires we've made and they join a highly engaged team committed to moving our business forward.

To summarize our outlook on the year. With our 2011 investment plan now largely complete and bookings tracking toward an annual plan, we are well positioned to deliver our annual commitments for revenue and profit. We'll now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And first, we'll go to David Ridley-Lane with Merrill Lynch.

David Ridley-Lane - BofA Merrill Lynch

So just to make sure, the second quarter operating expenses, were they're roughly in line with your internal budget or were there some unexpected costs in the quarter?

Richard Lindahl

I would say that, they were consistent with our expectations. There were a couple things that aren't really material enough to call out that were more onetime in nature that had an impact there, but certainly they were consistent with the pattern we had expected expenses to follow through the year.

David Ridley-Lane - BofA Merrill Lynch

Okay. And are you -- have you seen any client pushback to the price increases you instituted at the start of the year? And then are you running more towards the high or the low end of that 3% to 5% range here as we sit in the middle of the year?

Richard Lindahl

Yes, I would say, we have not seen material pushback. I think we've been able to justify the enhanced value that we're delivering consistent with those price increases. And we are in that range, and we're probably trending a little bit towards the higher end.

David Ridley-Lane - BofA Merrill Lynch

Okay, great. And then you've been kind enough in the past as we talked about financial services, clients and how the growth rate there has been. If you have those numbers handy, I'd love to sort of check in on those clients.

Thomas Monahan

Hey, David, this is Tom. I'd say the growth in the business has been pretty even across all sectors. And that would include Financial Services, which is as you know, was the deeply challenged sector and is still our largest sector. I'd say Financial Services' performance was in line with other sectors across the quarter and across the last 12 months. As a whole, it makes up, give or take 20% of our business, and so it's a very important sector. It's good to see it being a lot healthier than it was. From a sectoral basis, the only sector we've seen with particular challenges remains government, the state and federal level, where those budget issues have made it harder for our team to grow. They're still growing the business, but they're, for obvious reasons, lagging the firm growth rate, largely as a result of budget certainty rather than budget level for a good chunk of the first half of the year. A lot of people in a lot of places just weren't sure whether they even had a budget to operate with. So we're thinking that as things start to move through Congress, we'll be in a better position to grow that business at a fast rate. That's the really -- the only real sector news of note.

David Ridley-Lane - BofA Merrill Lynch

Okay, great, and I'll try this. Your kind enough to share sort of the inter-quarter bookings trend. Any comment on July?

Richard Lindahl

Yes, I mean, we really don't provide inter-quarter commentary while the quarter is going on, but suffice to say that we're comfortable we're heading in the right direction.

Operator

And next we'll go to Tim McHugh with William Blair & Company.

Timothy McHugh - William Blair & Company L.L.C.

Just following up a little bit on that question. Can you talk a little bit about what was different in April versus May, and then it sounds like especially June? What parts of the business performed better or worse, I guess, that kind of swung around that performance?

Thomas Monahan

Hey, Tim, it's Tom. I think part of what we saw was a very, very strong Q1. We got out of the gates fast, worked very hard to get off to a good start and did a great job closing out the Q1 pipeline. As we look back at April, it didn't seem to be so much market factors as us just having to rebuild some pipelines, as we came off a strong quarterly close. And as teams did that and stayed very focused throughout the quarter, we saw some a momentum built. And obviously, we continue to work on refining sales processes in our approaches, so that we can even out bookings throughout the quarter, but I think this was a situation where a strong quarter led to a little bit of a dry pipeline at the start of the next one that the teams then mobilized against.

Timothy McHugh - William Blair & Company L.L.C.

Okay. And then can you talk a little bit more or give a little more color on Europe? It sounded like -- you said the -- you're commentary there was a little softer than last quarter, when you were describing an accelerating or improving signs of performance there. You mentioned a softer economic environment. Is that in relation to -- I guess, one just comment on that? And then secondly, can you comment on does -- how does that differ between the change in kind of the sales model over there versus the new investments that you're making into the market? Is it impacting both or are you seeing a particular change or difference in one of those versus what you might have expected?

Richard Lindahl

I think the larger story in Europe is that we're only one year into the channel change and probably only about 5, 6 months into the investment profile we put in place. So it's early days on both. We continue to see the teams track toward a rate of improvement that looks very broadly comparable with what we saw in North America. It is safe to say, though, there are more markets in that part of the world that are deeply challenged, and as a result, growth rate in Europe is lower than the firm average growth rate. They're still growing and they're getting the good outcomes. And we're seeing the teams mature and learn the new models and penetrate these markets at a deeper rate than we have historically, but it's lagging a little bit the profile we're seeing in North America, and we think some of that is the fact that there was some cloudiness in the macroeconomic situation in Europe in the first half. But we're pleased with the team's progress, and we think we're very well set-up for a good second half.

Timothy McHugh - William Blair & Company L.L.C.

Does that performance in anyway make you want to, I guess, toss the pace of additional investments beyond what you've made in a given time for some of those to play out, or would you continue to be aggressive in expanding kind of your presence over in Europe?

Richard Lindahl

Our plan for the year was always to make the investments in the first half. So we are more comfortable with the investment levels we put in place and now we're working earning returns from them. And I think our guidance shows that towards the second half of the year, we're going to be more about realizing returns from investments than making additional investments. We'll, of course, find selective places to put money to work but we are comfortable. We got off to a fast start, got the right people and the right investments in the right places, and that we're working hard to keep growing.

Operator

And next we'll go to Gary Bisbee with Barclays Capital.

Gary Bisbee - Barclays Capital

I guess just a little bit more color, if you could, on the commentary that you expect cost to be broadly flat in the second half. With this level, it seems to me, with revenue likely accelerating, you'd probably see cost of services rising at least a bit. And I assume there's still some follow-through on these membership relations investments you've made. Does that mean G&A would be down? Or you sort of think on across all of the cost lines broadly that the sequential growth in cost will slow?

Richard Lindahl

Yes. I'll take that on, Gary, it's Rich. I think -- let me just start by just reiterating a couple of things that I think are helpful to remember. First, as we said a couple times already, we intentionally deployed some investment resources early in the year, and some of these are clearly cost that do add to our run rate and will remain in place for the second half. But there are some others like recruiting and some third-party expenses to support product development that are going to dissipate as we slow down hiring and move into deployment mode on a number of products we've been developing. Another big influence from the second quarter that we've talked about in the past is some seasonal factors that come into play and drive some higher expenses in the second quarter. And these are things like service delivery from an increase volume of our executive meeting series and also, the impact you have on higher payroll taxes, as we pay out annual incentives. We're going to get some benefits on the margins from the second sublease that we had put in place. We started realizing those benefits in the second quarter about midway through the second quarter. That's roughly $450,000 a month in reduced rent expense. That's going to help out, going forward. And as I mentioned, in response to David's question, again, while none of them are material enough to call out separately, we did have a few items that hit in the quarter that were more onetime in nature, and most of those actually hit in the G&A line. So if we kind of look forward from here sequentially, I would say, cost of services is probably likely to be flat, potentially down sequentially as seasonal factors in the product expenses normalized. I think you may see some increases on the member relations and marketing side, depending on booking trends and some decisions we may make to add some capacity to set up for 2012. And I do think you'll see G&A cost decrease, as we move sequentially through the rest of the year. So net-net, we think OpEx is relatively flat, could be a little down, could be a little up, but relatively flat to second quarter for the third and fourth quarters.

Gary Bisbee - Barclays Capital

That's really helpful. I appreciate that. I guess the follow-up on that. When I think about the business historically, and I realize you've changed the model a lot, but during the years when there was real consistent revenue growth for year after year after year, the member relations investments or the sales head count when you used to give us that metric, you really needed 25% sales head count growth to deliver 25% revenue. And there was never a whole lot of leverage on that line. so where you got the leverage overtime was much more, I would guess, on cost of services and in G&A, and I would guess it was selling more of the service -- selling an existing subscription to more customers and getting the leverage on research, I guess, how do we think about the capacity that's within your business right now for if we're about to enter and hopefully a couple year period of solid revenue growth to start to get leverage again. Any commentary on what that can look like from high level?

Richard Lindahl

Yes. I think as we've talked about over the last couple of quarters and at the Investor Day, I think fundamentally, our economic model is essentially the same. And I think, the way you described it is pretty accurate at a high level. We do expect to see better leverage overall on cost of service over time. We have deployed additional resources in cost of service in a form of executive advisers to provide a better customer experience and better retention, and healthier, sustainable revenue growth overtime.

We are also -- have been making investments in the member relations and marketing line, not only to add capacity, but also to provide support and training and infrastructure to make our salespeople as effective as they can be over time. And clearly, in G&A, that's where we would expect the most leverage overtime as well. So we do have the ability. We have high visibility as we go through to our annual planning cycles, and we set up our investment plan every year consistent with that, with the goal of continuing to deliver attractive revenue growth and profitability overtime.

Gary Bisbee - Barclays Capital

And so would it be a reasonable statement to make that given all the investments you made this year, in 2012 if you hit the longer-term revenue targets you laid out in Investor Day that the business is set up to have some decent leverage come back into the model mixture?

Richard Lindahl

You know, I think that opportunity is there, but that's a decision that we'll make as we go through our planning cycle in terms of what opportunities do we see to drive additional investments to drive better revenue performance over time.

Gary Bisbee - Barclays Capital

I guess one last question. Tom, you talked about investing in additional tools and insights to, I guess, enrich some of the existing products. I know that's been a focus for a while here. Is that work being done by the existing research staff or is there a new layer of investment, maybe IT people, cost that we should think about over time coming into the business as you continue to focus on that?

Thomas Monahan

Gary, I think it depends on the nature of the investment of the feature we're adding, Certainly, sometimes the technology investment that we make that can either be done by our own technology team that's obviously contractable in the outside, and we have partners we work with. And when Rich talks about some onetime expense, that's where you might see that. There might be development expense to bring a new layer of analytic manipulation to a great data set we've got.

Over the past couple of years, we've also steadily invested in what we call our advisory layer. These are the folks who sit face-to-face with executives or get with them on the phone and help them figure out, among these incredibly rich intellectual property assets, data, best practices, tools, which ones best map to the problem they have right now. And that is -- that will show up in the cost of services lines. So those are -- those come in more evenly, tend to vary as you'd expect with the growth of the revenue line. And probably, less scalable than our classic researchers, but the cost of services line item is still far and away the most scalable part of the business that as we add members to an existing product set, there's that core research team and that great intellectual property asset at the center that we get leverage out off in lots of different ways.

Operator

Moving on to Shlomo Rosenbaum of Stifel, Nicolaus.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

I want to get more into the nitty gritty of the bookings. If I go ahead and take the change in deferred revenue and kind of calculate my own bookings number, I get kind of a 1% bookings growth. And if I want to normalize for Iconoculture, which is -- it happened last year, it looks like the bookings actually declined year-over-year. Is that a fair assessment as to what happened?

Richard Lindahl

Shlomo, it's Rich. Actually, no, it's not. The derived year-over-year growth in bookings number that you can get by performing that calculation, in this case, is actually wrong and pretty significantly understates our actual bookings growth. The reason is because there's noise created by the addition of Iconoculture last year, which actually led you to derive a higher bookings number last year than we actually experienced. So we certainly did not have negative growth in bookings, and I just want to be very clear and definitive about that. We did, as we talked about in the call, we did get off to slower start in the first -- I'm sorry, we got off to a strong start in the first quarter and also a bit of a slower start in April, although we did pick up the pace in May and June. And I think if you look at the growth in Contract Value and especially in deferred revenues, you can see that, that would imply solid bookings growth as we came through the quarter as well.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Can you just walk me through why Iconoculture skewed that. I would think that normally when you make an acquisition, the deferred revenue gets written off, so it would not have been added to in the historical year?

Richard Lindahl

Well, certainly, no. I mean, not the portion that was still to be recognized as revenue, did not get written off. I think, essentially, you're getting the Contract Value last year, it didn't really come through as bookings per se, it was just a starting -- an add-in to the base.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

But the deferred revenue where, I'm doing that calculation to the extent of my ability, wouldn't you have been writing off any deferred revenue that was there already for Iconoculture when you bought it?.

Richard Lindahl

No, I mean, still to be earned and recognized.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Okay. So I'm going to have to take that off-line to get more detail on that, but that something that seems -- can you maybe just help us by giving us a figure, some kind of bookings growth number year-over-year, if I normalize for Iconoculture? In other words, was it a range of 5% to 10% growth? Was it 1% to 5% growth? How should we think of the bookings?

Richard Lindahl

I would say, it was at the higher end of those ranges. Certainly, slower than first quarter, but the higher end of those ranges you just laid out.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

The higher end of the 5% to 10% growth?

Richard Lindahl

Yes.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Then just picking up on some of the questions that people are asking in terms of how to understand the seasonality of the business and some of the expenses. Just member relations and marketing, is there -- should we expect any kind of leverage off of that line item? I mean, normally when I talk to you guys, you say, "Don't expect anything off of that." And as you grow the revenue, should we still expect that, that's going to be kind of the part that you grow everything else kind of flat to down?

Thomas Monahan

We find over the economic cycle that, that tends to vary pretty closely with the revenue. One of the ways you do see, when that -- where you see that number shrink as a percentage of revenue tends to be where the economy is very strong. What's happening there is basically you have a little more leverage off your selling efforts because things that, in a more difficult economy take 3 calls, take 2 calls in a good economy. So you see it vary a little bit over the economy cycle, but in general, we don't expect a lot of leverage on that line item.

You will find localized examples of getting some leverage. So when we put a new team into a market, that often start out with a smaller book of business than that level of expense would be justified. And as we come down the scale curve in that market, you'll see some amortization of that full cost. That's at the market level, and most of the market level investment shows up in that line item. So you find some places within there we get a little bit of leverage. And you'll find that over the economy cycle as a percentage of sales, it can vary a little bit. But in general, that's where our sales and servicing expense sits, and that tends -- the activity levels tend to vary with revenue and the servicing levels tend to vary with revenue.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Okay, that's good color. And then, can you comment a little bit of how much of your Contract Value growth is pricing versus volume? Should I think of it is as kind of 3% to 4% pricing and then anything else year-over-year would be volume increases?.

Richard Lindahl

Yes, I mean again, we're getting pricing increases in the 3% to 5% range. That's what we've been targeting and we're in that range. As I said earlier to Dave, probably towards the higher end. That is certainly helping our growth year-over-year.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

And then just a little bit more commentary on Europe. Would you say that the change in the economic outlook for Europe, as resulting in your guidance, your expectations for guidance tracking towards the midpoint of the guidance versus the high end of last quarter. In other words, how should we characterize that change in what's going on in Europe?

Thomas Monahan

I don't want to be a, don't want to pretend that I'm an economics soothsayer who can give you a long term view on the European economies. I would say, on balance, there's more noise in those economies right now. And also we're much still early in our market transition there. So we're pleased with the pace our teams are setting. I don't think we changed anything in our outlook of the year based on what we see happening macro-economically. You'll recall the guidance range is something we stepped up last quarter. And as we said, we are tracking towards the middle of it right now, and obviously, as always, trying to push to the other boundaries of any target we've got. But right now, we're tracking toward the middle of it. I don't think it's based on macroeconomic factors so much as how bookings growth is trended.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

So, there's no real change -- what you're trying to convey, at least the way I'm hearing it, is that there's no real change in the way you guys are expecting to deliver on your guidance vis-a-vis last quarter in aggregate?

Richard Lindahl

No, I mean, I think we're comfortable saying we're pacing to the midpoint of the range and that's -- and pushing to do better than that, if possible.

Operator

Moving on to Paul Ginocchio with Deutsche Bank.

Paul Ginocchio - Deutsche Bank AG

Did you talk about the size of potentially the accounting change impact of 3Q revenues? And then how much you would recoup in the fourth quarters? Any way to size that? And whatever you don't recoup in the fourth quarter, would we assume you'll recoup it in the first. And I got a couple of minor follow-ups.

Richard Lindahl

Yes, so we -- just to recap, we are at -- the net deferral through June 30 is $3.6 million, and we expect that the net deferral for the year will be roughly $3.5 million. So net-net between now and the end of the year, it's going to be essentially awash, but there will be an additional deferral in the third quarter, probably comparable to what we had in the second quarter. And the rest of it comes in the first quarter next year.

Paul Ginocchio - Deutsche Bank AG

And then the divergence right now between Contract Value growth and deferred revenue growth, is that -- is some of that coming from this accounting change where you're putting more revenues into deferred?

Richard Lindahl

That's exactly right.

Paul Ginocchio - Deutsche Bank AG

Great. And then finally, can you size your government exposure?

Richard Lindahl

I don't think we disclosed that, specifically. It's certainly not a material piece of our business, but it's...

Thomas Monahan

It's a lot smaller than a share of the economy. And put it that way, no. It's a focus area for us because ironically we are very under-penetrated in it and we've seen a lot of evidence that across the longer term, the world there is swinging toward our way of looking at things. Performance-oriented, intensive performance management disciplines in Finance, HR, IT, the places that we tend to be very strong. So we like it as a target market over the longer term. It's still relatively small compared to our total book of business. But it is -- and that team is growing, but it's hard to --it's hard for them to grow at the rate of the firm given some of the economic noise and some of the budgetary noise they are encountering.

Paul Ginocchio - Deutsche Bank AG

It sounds like it's less than 5%?

Richard Lindahl

I think that's fair.

Thomas Monahan

Yes.

Operator

A follow-up question will come from Dan Leben with Robert W. Baird.

Daniel Leben - Robert W. Baird & Co. Incorporated

On these deferrals, there are no costs involved with these. These are 100% pull-through, correct?

Thomas Monahan

That's correct.

Operator

And we'll now go to Toni Kaplan with Morgan Stanley.

Toni Kaplan - Morgan Stanley

How much did FX impact revenue this quarter?.

Richard Lindahl

FX?

Toni Kaplan - Morgan Stanley

Yes.

Richard Lindahl

Well, we bill all of our -- substantially all of our revenues are billed in U.S. dollars. So there was really no impact on revenues.

Toni Kaplan - Morgan Stanley

Okay, great. And you mentioned that the investment is largely complete. Is that like 90% complete, 75% complete, if you could actually...

Richard Lindahl

I'm comfortable saying basically 90%.

Thomas Monahan

As the year unfolds, we just add a little color there. In the fourth quarter, if the revenue profile allows, we sometimes get out ahead of key sales force investments for the next year. And that's a great way to get out and make sure there our sales team ready to go next year when the guns sound. But I think beyond that, we are pretty comfortable with the level of investment we've make.

Toni Kaplan - Morgan Stanley

And then one last one. The wallet share has sort of been pretty strong in the last 3 quarters. Just wondering, do you think these levels are sustainable?

Richard Lindahl

We certainly think the pieces are in place to continue to deliver solid numbers on wallet retention, and we've got everybody focused on delivering those outcomes.

Operator

And we have no further questions at this time. I would now like to turn the conference back over to Tom Monahan for any additional or closing remarks.

Thomas Monahan

Not much to say other than thank you all for logging in this morning and/or calling in. Rich and I will be out on the road a bit in Q3, so we look forward to keeping you up to date on the EXBD story. Thanks very much.

Operator

And this does conclude today's conference. We do thank you all for joining us.

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