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IHS INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) As described in the "Forward-Looking Statements" section at the start of this Form 10-K, we make forward-looking statements throughout this report. These forward-looking statements generally are identified by the use of the words "may," "might," "will," "should," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," or "continue," the negative of these terms, and other similar expressions. Forward-looking statements are based on current expectations, assumptions, and projections that are subject to risks and uncertainties, which may cause actual results to differ materially from the forward-looking statements. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is outlined under the "Risk Factors" section elsewhere in this Form 10-K. We do not intend to update or publicly revise these forward-looking statements, whether as a result of new information, future events, or otherwise. The following discussion of our financial condition and operating results should be read in conjunction with "Selected Financial Data," our consolidated financial statements and accompanying notes included in this Form 10-K, and important information and disclosure that we routinely post to our website (www.ihs.com). Executive Summary Business Overview We are a leading source of information, insight and analytics in critical areas that shape today's business landscape. Businesses and governments in more than 165 countries around the globe rely on our comprehensive content, expert independent analysis and flexible delivery methods to make high-impact decisions and develop strategies with speed and confidence. We have been in business since 1959 and became a publicly traded company on the New York Stock Exchange in 2005. Headquartered in Englewood, Colorado, USA, we are committed to sustainable, profitable growth and employ more than 6,000 people in 31 countries around the world. Inherent in all of our strategies is a firm commitment to put our customers first in everything that we do. We believe that maintaining a disciplined "outside-in" approach will allow us to better serve our customers and our stockholders. To achieve that goal, we have organized our business around our customers and the geographies in which they reside: Americas, EMEA, and APAC. This structure allows us to tailor and expand the solutions we offer to meet the unique needs of our customers both globally and in local markets. Subscriptions represent over 75% of our total revenue. We sell our offerings primarily through subscriptions, which tend to generate recurring revenue and cash flow for us. Our subscriptions are usually for one-year periods and we have historically seen high renewal rates. Subscriptions are generally paid in full within one or two months after the subscription period commences; as a result, the timing of our cash flows generally precedes the recognition of revenue and income. Our business has seasonal aspects. Our fourth quarter typically generates our highest quarterly levels of revenue and profit. Conversely, our first quarter generally has our lowest levels of revenue and profit. We also experience event-driven seasonality in our business; for instance, IHS CERAWeek, our annual energy executive gathering, is held during our second quarter. Another example is the triennial release of the Boiler Pressure Vessel Code (BPVC) engineering standard, which generates revenue for us predominantly in the third quarter of every third year. The BPVC benefit most recently occurred in the third quarter of 2010. During 2012, we invested in our people, platforms, processes, and products at a significant rate through a series of initiatives designed to boost colleague productivity, increase efficiencies, develop new and enhanced products, and create scalable platforms designed to accommodate future revenue growth without having to incur proportional increases in costs to support that growth. These initiatives include, but are not limited to: • Vanguard - Vanguard is our plan for consolidating and standardizing billing systems, general ledgers, sales-force automation capabilities, and all supporting business processes. We are implementing Vanguard through a series of releases, which commenced in the summer of 2011 and are expected to be completed by the end of calendar 2013. In early December 2012, we implemented our fourth release, and we now have approximately 70% of our revenue transactions flowing through the Vanguard system. 21-------------------------------------------------------------------------------- Table of Contents • Product development - In 2012, we had a significant number of new product introductions and enhancements. We continue to focus on product development and expect to have a significant number of new product introductions and enhancements in 2013 as well. • Customer Care Centers of Excellence - Our three regional Customer Care Centers of Excellence are now fully operational. These centers consolidate customer-care and transaction-processing capabilities, and simplify and standardize our approach to providing dedicated customer service. Global Operations Approximately 50% of our revenue is transacted outside of the United States; however, only about 30% of our revenue is transacted in currencies other than the U.S. dollar. As a result, a strengthening U.S. dollar relative to certain currencies has a negative impact on our revenue; conversely, a weakening U.S. dollar has a positive impact on our revenue. However, the impact on operating income is diminished due to certain operating expenses denominated in currencies other than the U.S. dollar. Our largest foreign currency exposures, in order of magnitude, are the British Pound, the Canadian Dollar, and the Euro. See "Qualitative and Quantitative Disclosures About Market Risk - Foreign Currency Exchange Rate Risk" for additional discussion of the impacts of foreign currencies on our operations. Key Performance Indicators We believe that revenue growth, Adjusted EBITDA (both in dollars and margin), and free cash flow are the key measures of our success. Adjusted EBITDA and free cash flow are non-GAAP financial measures (as defined by the rules of the Securities and Exchange Commission) that are further discussed in the following paragraphs. Revenue growth. We review year-over-year revenue growth in our segments as a key measure of our success in addressing customer needs in each region of the world in which we operate. We measure revenue growth in terms of organic, acquisitive, and foreign currency impacts. We define these components as follows: • Organic - We define organic revenue growth as total revenue growth from continuing operations for all factors other than acquisitions and foreign currency. We drive this type of revenue growth through value realization (pricing), expanding wallet share of existing customers through up-selling and cross-selling efforts, securing new customer business, and through the sale of new offerings. • Acquisitive - We define acquisition-related revenue as the revenue generated from acquired products and services from the date of acquisition to the first anniversary date of that acquisition. This type of growth comes as a result of our strategy to purchase, integrate, and leverage the value of assets we acquire. • Foreign currency - We define the foreign currency impact on revenue as the difference between current revenue at current exchange rates and current revenue at the corresponding prior period exchange rates. Due to the significance of revenue transacted in foreign currencies, we measure the impact of foreign currency movements on revenue. We also review revenue by transaction type. Understanding revenue by transaction type helps us identify broad changes in product mix. We summarize our transaction type revenue into the following two categories: • Subscription revenue represents the significant majority of our revenue, and is comprised of subscriptions to our various information offerings and software maintenance. • Non-subscription revenue represents consulting services (e.g., research and analysis, modeling, and forecasting), single-document product sales, software license sales and associated services, conferences and events, and advertising. Our non-subscription products and services are an important part of our business because they complement our subscription business in creating strong and comprehensive customer relationships. Non-GAAP measures. We use non-GAAP financial measures such as Adjusted EBITDA and free cash flow in our operational and financial decision-making, and believe that such measures allow us to focus on what we deem to be more reliable indicators of ongoing operating performance (Adjusted EBITDA) and our ability to generate cash flow from operations (free cash flow). We also believe that investors may find non-GAAP financial measures useful for the same reasons, although we caution readers that non-GAAP financial measures are not a substitute for GAAP financial measures or disclosures. None of these non-GAAP financial measures are recognized terms under GAAP and do not purport to be an alternative to net income or operating cash flow as an indicator of operating performance or any other GAAP measure. Throughout this section on 22-------------------------------------------------------------------------------- Table of Contents management's discussion and analysis and on our IHS website, we provide reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures. Adjusted EBITDA. EBITDA and Adjusted EBITDA are used by many of our investors, research analysts, investment bankers, and lenders to assess our operating performance. For example, a measure similar to Adjusted EBITDA is required by the lenders under our term loans and revolving credit agreement. We define EBITDA as net income plus or minus net interest, plus provision for income taxes, depreciation, and amortization. Our definition of Adjusted EBITDA further excludes (i) non-cash items (e.g., stock-based compensation expense) and (ii) items that management does not consider to be useful in assessing our operating performance (e.g., acquisition-related costs, restructuring charges, income or loss from discontinued operations, pension settlement and mark-to-market adjustments, and gain or loss on sale of assets). Free Cash Flow. We define free cash flow as net cash provided by operating activities less capital expenditures. We define Adjusted Free Cash Flow as free cash flow plus the pension deficit funding we contributed in early 2012. Because not all companies use identical calculations, our presentation of non-GAAP financial measures may not be comparable to other similarly titled measures of other companies. However, these measures can still be useful in evaluating our performance against our peer companies because we believe the measures provide users with valuable insight into key components of GAAP financial disclosures. For example, a company with higher GAAP net income may not be as appealing to investors if its net income is more heavily comprised of gains on asset sales. Likewise, eliminating the effects of interest income and expense moderates the impact of a company's capital structure on its performance. Business Combinations During the year ended November 30, 2012, we completed eight business combinations for a total purchase price of approximately $306 million. During the year ended November 30, 2011, we completed five primary business combinations for a total purchase price of approximately $730 million. During the year ended November 30, 2010, we completed seven business combinations for a total purchase price of approximately $335 million. Our consolidated financial statements include the results of operations and cash flows for these business combinations beginning on their respective dates of acquisition. Acquisitions are a key part of our growth strategy, and we expect that they will continue to be very important for us. We focus on acquisitions that have long-term growth potential, target high-growth markets, and fill a strategic need in our business portfolio as we seek to provide comprehensive solutions to our customers. Timely integration of these acquisitions provides us with increased organic growth potential as we connect these offerings for our customers. Pricing information We customize many of our sales offerings to meet individual customer needs and base our pricing on a number of factors, including the number of customer locations, the number of simultaneous users, and the breadth of the content to be included in the offering. Because of the level of offering customization we employ, it is difficult for us to evaluate pricing impacts on a period-to-period basis. This analysis is further complicated by the fact that the offering sets purchased by customers are often not constant between periods. As a result, we are not able to precisely differentiate between pricing and volume impacts on changes in revenue. Other Items Cost of operating our business. We incur our cost of revenue primarily to acquire, manage, and deliver our offerings. These costs include personnel, information technology, and occupancy costs, as well as royalty payments to third-party information providers. Royalty payments are based on the level of subscription sales from certain product offerings. Our sales, general, and administrative expenses include wages and other personnel costs, commissions, corporate occupancy costs, and marketing costs. A large portion of our operating expenses are not directly commensurate with volume sold, particularly in our subscription-based business. Some of our revenue is driven from the sale of specifications and standards; a portion of this content is obtained from standards development organizations. Stock-based compensation expense. We issue equity awards to our employees, almost exclusively restricted stock units, for which we record cost over the respective vesting periods. The typical vesting period is three years, and none of the grants 23-------------------------------------------------------------------------------- Table of Contents exceed eight years. As of November 30, 2012, we had approximately 2.8 million stock-based awards outstanding, of which approximately 1.1 million were performance-based awards. The majority of the annual grants for our highest-ranking employees are performance-based awards. The vesting of the performance shares granted in 2011 and 2012 is principally based on achieving certain financial performance levels during fiscal years 2013 and 2014. As of November 30, 2012, we believe that the target number of shares issuable for the 2013 and 2014 fiscal years will vest based on meeting certain performance targets. Using these estimates in addition to estimated 2013 grants, projected stock-based compensation expense for 2013 is expected to be approximately $138-142 million. Grant date fair values that differ from our projections or a change in the actual performance levels that we achieve could result in a change in the actual amount of stock-based compensation that we recognize. For example, in the event we do not achieve the projected performance metrics for 2013 or 2014, our stock-based compensation expense could decrease. Conversely, if we exceed the projected performance metrics, our stock-based compensation could increase. Pension and postretirement benefits. We provide the following pension and postretirement plans: • U.S. Retirement Income Plan (U.S. RIP) - this closed defined-benefit plan covers the majority of our employees in the United States. • U.K. Retirement Income Plan (U.K. RIP) - this frozen defined-benefit plan covers a limited number of our employees in the United Kingdom. • Postretirement medical plan - this plan is a contributory plan that provides access to group rates for U.S. employees who meet specified conditions. • Supplemental Income Plan (SIP) - this plan is a non-qualified pension plan for certain company personnel. During 2011, we undertook a comprehensive review of our U.S. RIP designed to ensure that we maintained market-competitive employee benefits while decreasing volatility. As a result of our analysis, we took the following steps in 2011 and 2012: • Settled certain pension obligations. In 2011, we settled retiree obligations by purchasing annuities for the retiree population from a third-party insurer. In 2012, we offered lump-sum buyouts to former colleagues who are not yet receiving benefits, with nearly 60% of the eligible participants accepting the offer. The combination of these settlements resulted in a significant reduction in our pension obligations and assets, allowing us to reduce volatility in the plan. • Changed our pension plan investment strategies. Our pension plan investment strategy now creates a better match of our pension assets and pension obligations. Approximately 75% of our U.S. RIP assets are now invested in fixed income securities with durations similar to the expected timing of pension obligation payouts. • Changed our pension accounting policy. In 2011, we changed our pension accounting policy to an accelerated recognition method that recognizes gains and losses in the income statement more quickly than under the previous method, including a mark-to-market pension adjustment that we record in the fourth quarter of each year. • Accelerated funding of plan contributions. We accelerated plan funding by contributing approximately $65 million to the plan in December 2011, the first month of our fiscal 2012. Approximately $57 million of this contribution allowed us to bring all deficit funding current through November 30, 2011 and pay fees and expenses associated with the third-party annuity contracts, with the remaining $8 million used to fund estimated 2012 pension costs. In December 2012, the first month of our fiscal 2013, we contributed approximately $10 million to the U.S. RIP to fund estimated 2013 pension costs. • Closed the plan to future participants. In the first quarter of fiscal 2012, we made the decision to close the U.S. RIP to new participants effective January 1, 2012. In place of the U.S. RIP benefits, colleagues hired after January 1, 2012 receive a company non-elective contribution to their 401(k) plan balances if they are an active employee at the end of the year. Restructuring Charges. We continue to evaluate opportunities to streamline our operations. During the last three years, we have incurred direct and incremental costs associated with consolidating positions to our Centers of Excellence as we complete successive Vanguard releases, eliminating positions to accomplish other operational efficiencies, closing facilities, and consolidating legacy data centers, including certain contract termination costs. We expect to continue to incur costs related to these and other similar activities in future periods, resulting in additional restructuring charges. Discontinued Operations. We continue to evaluate our product portfolio, with a focus on assessing the growth profile and strategic fit of all of our offerings, ensuring they support core businesses, enable sustainable high growth rates, and provide a scalable market capability. Some of these businesses may be treated as discontinued operations if we ultimately decide to sell or abandon them, providing they meet the accounting criteria for treatment as discontinued operations. 24-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP. In applying U.S. GAAP, we make significant estimates and judgments that affect our reported amounts of assets, liabilities, revenues, and expenses, as well as disclosure of contingent assets and liabilities. We believe that our accounting estimates and judgments were reasonable when made, but in many instances we reasonably could have used different accounting estimates. In addition, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on historical experience and other assumptions that we believe are reasonable, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which are discussed further below. Revenue Recognition. The majority of our offerings are provided under agreements containing standard terms and conditions. Approximately 76% of our revenue is derived from the sale of subscriptions, which is initially deferred and then recognized ratably as delivered over the subscription period (generally 12 months). These standard agreements typically do not require any significant judgments about when revenue should be recognized. For non-standard agreements, we generally make judgments about revenue recognition matters such as: •Whether sufficient legally binding terms and conditions exist; •Whether customer acceptance has been achieved; and •Progress on certain consulting projects where revenue is recognized on a proportional performance basis. We review customer agreements and utilize advice from legal counsel, as appropriate, in evaluating the binding nature of contract terms and conditions, as well as whether customer acceptance has been achieved. We estimate progress on consulting project deliverables based on our knowledge and judgment about the current status of individual consulting engagements. Historically, our judgments and estimates have been reasonably accurate, as we have not experienced significant disputes with our customers regarding the timing and acceptance of delivered products and services. However, our actual experience in future periods with respect to binding terms and conditions and customer acceptance may differ from our historical experience. Business Combinations. We allocate the total cost of an acquisition to the underlying net assets based on their respective estimated fair values. As part of this allocation process, we identify and attribute values and estimated lives to the intangible assets acquired. These determinations involve significant estimates and assumptions about several highly subjective variables, including future cash flows, discount rates, and asset lives. There are also different valuation models for each component, the selection of which requires considerable judgment. Our estimates and assumptions may be based, in part, on the availability of listed market prices or other transparent market data. These determinations will affect the amount of amortization expense recognized in future periods. We base our fair value estimates on assumptions we believe are reasonable, but recognize that the assumptions are inherently uncertain. Depending on the size of the purchase price of a particular acquisition and the mix of intangible assets acquired, the purchase price allocation could be materially impacted by applying a different set of assumptions and estimates. Goodwill and Other Intangible Assets. We make various assumptions about our goodwill and other intangible assets, including their estimated useful lives and whether any potential impairment events have occurred. We perform impairment analyses on the carrying values of goodwill and indefinite-lived intangible assets at least annually. Additionally, we review the carrying value of goodwill and other intangible assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Examples of such events or changes in circumstances, many of which are subjective in nature, include the following: •Significant negative industry or economic trends; •A significant change in the manner of our use of the acquired assets or our strategy; •A significant decrease in the market value of the asset; and •A significant change in legal factors or in the business climate that could affect the value of the asset. If an impairment indicator is present, we perform an analysis to confirm whether an impairment has actually occurred and if so, the amount of the required charge. For finite-lived intangible assets, we review the carrying amount at least annually to determine whether current events or circumstances require an adjustment to the carrying amount. A finite-lived intangible asset is considered to be impaired if its 25-------------------------------------------------------------------------------- Table of Contents carrying value exceeds the estimated future undiscounted cash flows to be derived from it. Any impairment is measured by the amount that the carrying value of such assets exceeds their fair value. For indefinite-lived intangible assets other than goodwill, we first conduct a qualitative analysis to determine whether we believe it is more likely than not that an asset has been impaired. If we believe an impairment has occurred, we then evaluate for impairment by comparing the amount by which the carrying value of the asset exceeds its fair value, primarily based on estimated discounted cash flows. We exercise judgment in selecting the assumptions used in the estimated discounted cash flows analysis. For goodwill, we determine the fair value of each reporting unit, then compare the fair value of each reporting unit to its carrying value. If carrying value exceeds fair value for any reporting unit, then we calculate and compare the implied fair value of goodwill to the carrying amount of goodwill and record an impairment charge for any excess of carrying value over implied fair value. The determination of fair value requires a number of significant assumptions and judgments, including assumptions about future economic conditions, revenue growth, operating margins, and discount rates. The use of different estimates or assumptions within our projected future cash flows model, or the use of a methodology other than a projected future cash flow model, could result in significantly different fair values for our goodwill and other intangible assets. Income Taxes. We exercise significant judgment in determining our provision for income taxes, current tax assets and liabilities, deferred tax assets and liabilities, future taxable income (for purposes of assessing our ability to realize future benefit from our deferred tax assets), and recorded reserves related to uncertain tax positions. A valuation allowance is established to reduce our deferred tax assets to the amount that is considered more likely than not to be realized through the generation of future taxable income and other tax planning opportunities. To the extent that a determination is made to establish or adjust a valuation allowance, the expense or benefit is recorded in the period in which the determination is made. If actual results differ from estimates we have used, or if we adjust these estimates in future periods, our operating results and financial position could be materially affected. Pension and Postretirement Benefits. We account for our pension and postretirement plans in accordance with U.S. generally accepted accounting principles. During the fourth quarter of each fiscal year (or upon any remeasurement date), we immediately recognize net actuarial gains or losses in excess of a corridor in our operating results. The corridor amount is equivalent to 10% of the greater of the market-related value of plan assets or the plan's benefit obligation at the beginning of the year. We use the actual fair value of plan assets at the measurement date as the measure of the market-related value of plan assets. We make a number of key assumptions in measuring our plan obligations, many of which are highly susceptible to change from period to period. These assumptions include the discount rate, the long-term expected return on plan assets, and various demographic assumptions, as follows: • Discount rate - we utilized a bond matching model that averages a bond universe of about 500 AA-graded non-callable bondsbetween the 10th and 90th percentiles for each maturity group as a proxy for setting the discount rate at year-end. • Asset returns are based upon the anticipated average rate of earnings expected on invested funds of the plan over thelong-term. • Demographic assumptions (such as turnover, retirement, and disability) are based upon historical experience and are monitored on a continuing basis to determine if adjustments to these assumptions are warranted in order to better reflect anticipated future experience. Depending on the assumptions and estimates used, our net periodic pension and postretirement benefit expense could vary significantly within a range of possible outcomes and could have a material impact on our financial results. Discount rates and expected rates of return on plan assets are selected at the end of a given fiscal year and will impact expense in the subsequent year. A fifty-basis-point decrease in certain assumptions made at the beginning of 2012 would have resulted in the following effects on 2012 pension expense and the projected benefit obligation (PBO) as of November 30, 2012 (in thousands): 26-------------------------------------------------------------------------------- Table of Contents Impact to Pension Results - U.S. RIP Increase/(Decrease) on 2012 Increase/(Decrease) on Change in assumption Pre-Tax Expense November 30, 2012 PBO 50-basis-point decrease in discount rate $ 6,539 $ 7,462 50-basis-point increase in discount rate (4,896 ) (6,705 ) 50-basis-point decrease in expected return on assets (679 ) - 50-basis-point increase in expected return on assets 679 - Impact to Pension Results - U.K. RIP Increase/(Decrease) on 2012 Increase/(Decrease) on Change in assumption Pre-Tax Expense November 30, 2012 PBO 50-basis-point decrease in discount rate $ 3,629 $ 4,051 50-basis-point increase in discount rate (3,643 ) (4,050 ) 50-basis-point decrease in expected return on assets (187 ) - 50-basis-point increase in expected return on assets 187 - Stock-Based Compensation. Our stock plans provide for the grant of various equity awards, including performance-based awards. For time-based restricted stock unit grants, we calculate stock-based compensation cost by multiplying the grant date fair market value by the number of shares granted, reduced for estimated forfeitures. The estimated forfeiture rate is based on historical experience, and we update our calculations quarterly based on actual experience. For performance-based restricted stock unit grants, we calculate stock-based compensation cost by multiplying the grant date fair market value by the number of shares granted, reduced for estimated forfeitures. Each quarter, we evaluate the probability of the number of shares that are expected to vest and adjust as appropriate. For example, in the event we do not achieve the projected performance metrics for 2013 or 2014, our stock-based compensation expense would decrease. Conversely, if we exceed the projected performance metrics, our stock-based compensation would increase. Results of Operations Total Revenue Total revenue for 2012 increased 15% compared to the same period of 2011. Total revenue for 2011 increased 25% compared to the same period in 2010. The table below displays the percentage point change in revenue due to organic, acquisitive, and foreign currency factors when comparing 2012 to 2011 and 2011 to 2010. Increase (Decrease) in Total Revenue Foreign (All amounts represent percentage points) Organic Acquisitive Currency 2012 vs. 2011 5 % 11 % (1 )% 2011 vs. 2010 * 9 % 16 % 2 % * Excludes the impact of non-subscription revenue associated with the triennial release of a certain engineering standard. Unadjusted organic revenue growth was approximately 8%. 2012 vs. 2011. The 5% organic revenue growth for the year ended November 30, 2012 was primarily attributable to continued strength in our subscription-based business, which has consistently provided an organic revenue growth rate of seven percent or higher over the last two and a half years. The subscription-based business represented 76% of total revenue. The non-subscription business decreased organically by four percent. The acquisition-related revenue growth for 2012 was due to acquisitions we made this year, as well as the run-out of acquisitions made in 2011. Acquisitions made during 2012 include the following: • CAPS, Displaybank, IMS Research, and BDW Automotive in the second quarter of 2012, and 27-------------------------------------------------------------------------------- Table of Contents • X DAR, CyberRegs, GlobalSpec, and Invention Machine in the third quarter of 2012. 2011 vs. 2010. The 9% organic revenue growth for 2011 was broad-based in nature, with both the subscription and non-subscription business contributing to the growth. The subscription-based business, representing 77% of total revenue, increased 8% organically, and after excluding the 2010 revenue associated with the triennial release of the BPVC, the non-subscription businesses all contributed positively to the overall growth as well. The acquisition-related revenue growth for 2011 was due to acquisitions we made in 2011, as well as the run-out of acquisitions made in 2010. Acquisitions made during 2011 include the following: • ODS-Petrodata, Dyadem, and CMAI in the second quarter of 2011, • SMT in the third quarter of 2011, and • Purvin & Gertz in the fourth quarter of 2011. Revenue by Segment (geography) Year Ended November 30, % Change % Change (In thousands, except 2012 vs. 2011 vs. percentages) 2012 2011 2010 2011 2010 Revenue: Americas $ 912,490 $ 798,673 655,449 14 % 22 % EMEA 443,385 384,441 304,375 15 % 26 % APAC 173,994 142,524 97,918 22 % 46 % Total revenue $ 1,529,869 $ 1,325,638 $ 1,057,742 15 % 25 % As a percent of total revenue: Americas 60 % 60 % 62 % EMEA 29 % 29 % 29 % APAC 11 % 11 % 9 % The percentage change in each geography segment is due to the factors described in the following table. 2012 vs. 2011 2011 vs. 2010 (All amounts represent Foreign Foreign percentage points) Organic Acquisitive Currency Organic Acquisitive Currency Americas revenue 3 % 11 % - % 8 % 14 % 1 % EMEA revenue 7 % 10 % (2 )% 6 % 18 % 3 % APAC revenue 9 % 14 % - % 18 % 25 % 3 % 2012 vs. 2011. We experienced organic revenue growth in all three geographies, with subscription-based revenue driving the majority of the increases. Organic growth for the Americas was driven largely by a seven percent organic increase in subscription revenue, partially offset by a ten percent organic decline in non-subscription revenue, which was caused by significant increases in sales cycles and delays in customer decisions on key projects due to macro-economic and geopolitical uncertainty. EMEA's organic growth was broad-based, with subscriptions growing at a six percent rate and non-subscriptions growing at eight percent. A portion of the non-subscription increase was primarily due to an increase in consulting revenue. APAC's organic growth continues to be a strong contributor, with a 12 percent growth rate for subscriptions and a one percent growth rate for non-subscriptions. 2011 vs. 2010. We experienced broad-based organic revenue growth in all three geographies, with subscription-based revenue and Energy revenue providing key contributions to the growth. We doubled our presence in Latin America and APAC primarily through investment during 2011 in an effort to take advantage of these high-opportunity geographies. Revenue by Transaction Type 28-------------------------------------------------------------------------------- Table of Contents Year Ended November 30, % Change % Change (In thousands, except 2012 vs. 2011 vs. percentages) 2012 2011 2010 2011 2010 Revenue: Subscription $ 1,157,347 $ 1,020,800 $ 835,322 13 % 22 % Non-subscription revenue 372,522 304,838 222,420 22 % 37 % Total revenue $ 1,529,869 $ 1,325,638 $ 1,057,742 15 % 25 % As a percent of total revenue: Subscription 76 % 77 % 79 % Non-subscription revenue 24 % 23 % 21 % 2012 vs. 2011. Relative to the 13 percent subscription revenue growth for the year ended November 30, 2012, approximately eight percent is due to organic growth. This trend is especially important for us, as subscription-based revenue is at the core of our business model. Subscriptions represent a steady and predictable source of revenue for us, and we continue to see good traction in our pricing practices and stable renewal rates. The 22% increase in the non-subscription business was primarily due to acquisitions, with non-subscription revenue decreasing four percent organically during the year. Non-subscription performance slowed in key service lines and in new license revenue as sales cycles extended and there was a pause in customers' discretionary capital and expense spending. 2011 vs. 2010. Relative to the 22 percent subscription revenue growth for the year ended November 30, 2011, approximately eight percent was due to organic growth. The non-subscription business also performed well in 2011, with positive organic growth in all areas after excluding the BPVC engineering standard impact from 2010. Operating Expenses The following table shows our operating expenses and the associated percentages of revenue. Year Ended November 30, % Change % Change (In thousands, except 2012 vs. 2011 vs. percentages) 2012 2011 2010 2011 2010 Operating expenses: Cost of revenue $ 624,514 $ 558,492 $ 446,971 12 % 25 % SG&A expense $ 534,043 $ 453,481 $ 358,012 18 % 27 % Depreciation and amortization expense $ 118,243 $ 88,039 59,474 34 % 48 % As a percent of revenue: Cost of revenue 41 % 42 % 42 % SG&A expense 35 % 34 % 34 % Depreciation and amortization expense 8 % 7 % 6 % Supplemental information: SG&A expense excluding stock-based compensation $ 418,706 $ 370,967 $ 295,171 13 % 26 % As a percent of revenue 27 % 28 % 28 % Cost of Revenue In 2012, 2011, and 2010, cost of revenue increased in line with the increase in revenue. We continue to invest in our people, platforms, processes, and products in support of our goals to increase top- and bottom-line growth. Selling, General and Administrative (SG&A) Expense We evaluate our SG&A expense excluding stock-based compensation expense. While we continue to invest in our business, we also strive to invest only where necessary to drive scale and growth in key industries and core markets. SG&A expense has consequently remained relatively flat as a percentage of revenue compared to the prior-year periods. 29-------------------------------------------------------------------------------- Table of Contents Our stock-based compensation expense has continued to increase each year as a result of an increase in the number of employees, an increase in our stock price, and the achievement or overachievement of certain performance metrics. We expect that stock-based compensation expense will continue to grow in future years, as we utilize our stock plan to reward and provide an incentive for our colleagues to help the business succeed. Depreciation and Amortization Expense For 2012, compared to 2011, depreciation and amortization expense increased primarily due to the increase in depreciable and amortizable assets from acquisitions, as well as an increase of approximately $10 million in capital expenditures. For 2011, compared to 2010, our depreciation and amortization expense increased primarily due to the increase in depreciable and amortizable assets from acquisitions, as well as an increase of approximately $23 million in capital expenditures related to our various investment initiatives in our facilities and infrastructure. Restructuring We incurred $17 million of restructuring charges during 2012, which is an increase over prior years because of the benefits that we are now starting to realize with respect to Vanguard and other company priorities that allow us to simplify our processes and standardize our platforms in order to enable our existing workforce to accomplish more with the same or fewer resources. Acquisition-related Costs We incurred $4 million of costs in 2012 for integration and other acquisition-related activities. Because acquisitions are a key component of our growth strategy, we expect that we will continue to perform similar activities for future acquisitions, and we intend to continue identifying these costs in a separate line item of our financial statements. Pension and Postretirement Expense The following table shows the components of net periodic pension and postretirement expense (in thousands): Year Ended November 30, 2012 2011 2010 Net service cost $ 7,996 $ 3,101 $ 1,852 Settlement expense 4,930 21,359 -Fourth quarter mark-to-market adjustment 11,991 20,535 8,735 Total $ 24,917 $ 44,995 $ 10,587 In 2011 and 2012, pension and postretirement expense has been considerably higher due to the settlement costs incurred to annuitize retirees in 2011 and to facilitate the lump-sum buyout offers that we made in 2012. Pension and postretirement expense was further impacted by the fourth quarter mark-to-market adjustments that we recorded in accordance with our accounting policy for pension and postretirement benefits. We expect 2013 net service cost, prior to any fourth quarter mark-to-market adjustments, to be approximately $9 million. As we have completed the major elements of our U.S. RIP redesign as previously outlined, we do not expect to incur any settlement expense in 2013. Operating Income by Segment (geography) 30-------------------------------------------------------------------------------- Table of Contents Year Ended November 30, % Change (In thousands, except 2012 vs. % Change 2011 percentages) 2012 2011 2010 2011 vs. 2010 Operating income: Americas $ 262,953 $ 224,699 $ 197,146 17 % 14 % EMEA 95,144 82,314 66,363 16 % 24 % APAC 46,042 44,452 32,601 4 % 36 % Shared services (196,852 ) (178,997 ) (121,981 ) Total operating income $ 207,287 $ 172,468 $ 174,129 20 % (1 )% As a percent of segment revenue: Americas 29 % 28 % 30 % EMEA 21 % 21 % 22 % APAC 26 % 31 % 33 % 2012 vs. 2011. The increase to Americas operating income margin was primarily driven by cost management efforts in the region. We are continuing to carefully manage our business costs during these difficult economic times. EMEA operating income margin was relatively flat as a percentage of segment revenue. As with the Americas, we continue to manage costs in this region, despite increases in depreciation and amortization costs when compared with the prior year. The decrease in APAC operating income margin continues to be driven by our increased investment in our sales and operations teams in the region. Shared services operating expense increased primarily because of the increase in stock-based compensation expense for 2012. We allocate all stock-based compensation expense to our shared services function. A portion of this increase was offset by a decrease in pension and postretirement expense. 2011 vs. 2010. The decrease to Americas operating income margin was primarily driven by the effects of recent acquisition activity, particularly in the form of increased depreciation and amortization associated with acquired intangible assets, as well as associated integration and other acquisition-related costs. EMEA operating income margin was relatively flat, with minor fluctuations attributable to increased depreciation and amortization and SG&A costs. The decrease in APAC operating income margin is primarily a result of an increase in SG&A investment to drive growth opportunities in this emerging market. Shared services operating expense increased primarily because of the change in pension accounting and the annuitization of retiree pension obligations, as well as an increase in stock-based compensation expense for 2011. Provision for Income Taxes Our effective tax rate for the year ended November 30, 2012 was 15.7%, compared to 16.5% in 2011 and 22.7% in 2010. The effective tax rate for fiscal year 2012 varies from the effective tax rates for fiscal years 2011 and 2010 primarily as a result of higher profit levels, lower tax rates, and incentive credits in our foreign tax jurisdictions. Because of the discrete nature of certain tax benefits we received in 2012, we expect that our effective tax rate will increase next year. Adjusted EBITDA (non-GAAP measure) 31-------------------------------------------------------------------------------- Table of Contents Year Ended November 30, % Change (In thousands, except 2012 vs. % Change 2011 percentages) 2012 2011 2010 2011 vs. 2010 Net income $ 158,168 $ 135,415 $ 137,740 17 % (2 )% Interest income (999 ) (862 ) (655 ) Interest expense 20,573 11,346 2,036Provision for income taxes 29,564 26,695 39,231 Depreciation and amortization 118,243 88,039 59,474 EBITDA $ 325,549 $ 260,633 $ 237,826 25 % 10 % Stock-based compensation expense 121,543 86,194 66,474 Restructuring charges 16,829 1,242 9,022 Acquisition-related costs 4,147 8,000 - Non-cash net periodic pension and postretirement expense 16,922 44,648 9,598 Income from discontinued operations, net (19 ) (126 ) (4,223 ) Adjusted EBITDA $ 484,971 $ 400,591 $ 318,697 21 % 26 % Adjusted EBITDA as a percentage of revenue 31.7 % 30.2 % 30.1 % Our Adjusted EBITDA for 2012 increased primarily because of our organic subscription revenue growth, acquisitions, and the leverage in our business model, despite the fact we continued to invest substantially in both the core business and in key transformative initiatives. Our 2011 Adjusted EBITDA increased for many of the same reasons as in 2012, in addition to seeing continuing improvement in our recent acquisitions' collective margin as the year progressed. Financial Condition (In thousands, As of November except percentages) 30, 2012 As of November 30, 2011 Dollar change Percent change Accounts receivable, net $ 372,117 $ 326,009 $ 46,108 14 % Accrued compensation 50,497 57,516 (7,019 ) (12 )% Deferred revenue 515,318 487,172 28,146 6 % The increase in our accounts receivable balance was primarily due to the acquisitions we made in 2012 and higher sales, and is in line with the overall increase in revenue. The decrease in accrued compensation is primarily due to lower attainment of certain performance objectives associated with our annual incentive plan, as well as a payroll accrual timing difference. The increase in deferred revenue is primarily due to organic growth. The organic growth rate in deferred revenue was muted by the timing of billings associated with our SAP implementation, as well as the timing of certain renewals. Liquidity and Capital Resources As of November 30, 2012, we had cash and cash equivalents of $345 million, of which approximately $276 million is currently held by our foreign subsidiaries. The cash held by our foreign subsidiaries is not available to fund domestic operations, as we have deemed the earnings of these subsidiaries to be indefinitely reinvested. We also had $1.061 billion of debt as of November 30, 2012, which has contributed to an increase in interest expense in 2012, and which will continue to result in increased interest expense for the near future. We have generated strong cash flows from operations over the last few years. Because of our cash, debt, cash flow, and the additional financing that we secured in August 2012, we believe we will have sufficient cash to meet our working capital and capital expenditure needs. Historically, we were not required to make cash contributions to our U.S. RIP pension plan because of its funded status. However, due to the global economic downturn, which negatively impacted the returns on our pension assets, we were required to make a cash contribution to our U.S. RIP in fiscal 2012. In considering that requirement and the various changes to our pension strategy, including the annuitization of retiree pension obligations, bringing our pension deficit current, and funding 32-------------------------------------------------------------------------------- Table of Contents our 2012 pension costs, we made a $65 million contribution to the pension plan in December 2011, the first month of our 2012 fiscal year. Approximately $57 million of the contribution was used for the annuitization and bringing our deficit current, with the remaining $8 million used to fund expected 2012 pension costs. In December 2012, the first month of our 2013 fiscal year, we made a $10 million contribution to the pension plan to fund estimated 2013 pension costs, and we anticipate that we will continue to contribute approximately the same amount in future years to cover annual service costs. Our future capital requirements will depend on many factors, including the level of future acquisitions, the need for additional facilities or facility improvements, the timing and extent of spending to support product development efforts, information technology infrastructure investments, investments in our internal business applications, and the continued market acceptance of our offerings. We could be required, or could elect, to seek additional funding through public or private equity or debt financing for any possible future acquisitions; however, additional funds may not be available on terms acceptable to us. We expect our capital expenditures to be approximately five percent of revenue in 2013. Cash Flows Year Ended November 30, % Change (In thousands, except 2012 vs. % Change 2011 percentages) 2012 2011 2010 2011 vs. 2010 Net cash provided by operating activities $ 314,373 $ 342,050 $ 266,188 (8 )% 28 % Net cash used in investing activities (375,260 ) (793,238 ) (366,960 ) (53 )% 116 % Net cash provided by financing activities 179,411 482,817 181,602 (63 )% 166 % 2012 vs. 2011. The decrease in net cash provided by operating activities was principally due to the $65 million pension funding contribution we made in December 2011, partially offset by continued improvements in business performance. Our subscription-based business model continues to be a cash flow generator that is aided by positive working capital characteristics that do not generally require substantial working capital increases to support our growth. The decrease in net cash used in investing activities was principally due to smaller acquisitions that we completed in 2012 compared to 2011, particularly the acquisition of SMT. Part of the decrease was offset by increased capital expenditures associated with continued investment in the business. The decrease in net cash provided by financing activities for 2012 was principally due to the significant amount of borrowings against our credit facility in 2011 that we used to fund the acquisition of SMT. In 2012, we also began a treasury share repurchase program in the fourth quarter that contributed to significant financing cash outflows. 2011 vs. 2010. The increase in net cash provided by operating activities was principally due to continued profitable business growth, as evidenced by healthy organic revenue growth rates. The increase in net cash used in investing activities was principally due to significant acquisition activities in the second and third quarters of 2011, particularly the acquisition of SMT. We also significantly increased capital expenditures for various investment initiatives in our facilities and infrastructure. The increase in net cash provided by financing activities for 2012 was principally due to borrowings against our credit facility to fund the acquisition of SMT. Free Cash Flow (non-GAAP measure) The following table reconciles our non-GAAP free cash flow measure to net cash provided by operating activities. Year Ended November 30, % Change (In thousands, except % Change 2012 2011 vs. percentages) 2012 2011 2010 vs. 2011 2010 Net cash provided by operating activities $ 314,373 $ 342,050 $ 266,188 Capital expenditures on property and equipment (64,732 ) (54,340 ) (31,836 ) Free cash flow 249,641 287,710 234,352 Pension deficit funding 57,000 - - Adjusted free cash flow $ 306,641 $ 287,710 $ 234,352 7 % 23 % 33-------------------------------------------------------------------------------- Table of Contents Our free cash flow has historically been very healthy, and we expect that it will continue to be a significant source of funding for our business strategy of growth through organic and acquisitive means. Credit Facility and Other Debt Please refer to Note 8 to the Consolidated Financial Statements in this Form 10-K for a discussion of the current status of our term loans and revolving credit agreement, including the recent expansion of our credit facility and the completion of a new term loan agreement. We utilized the proceeds from the August 29, 2012 term loan transactions to reduce the outstanding borrowings under the revolver; consequently, there was no net increase to our debt position as a result of the transactions. The additional capacity created within the revolver will be used for general corporate purposes, including acquisitions and working capital. Share Repurchase Programs Please refer to Part II, Item 5 and Note 16 to the Consolidated Financial Statements in this Form 10-K for a discussion of our share repurchase programs. Off-Balance Sheet Transactions We have no off-balance sheet transactions. Contractual Obligations and Commercial Commitments We have various contractual obligations and commercial commitments that are recorded as liabilities in our consolidated financial statements. Other items, such as certain purchase commitments and other executory contracts, are not recognized as liabilities in our consolidated financial statements but are required to be disclosed. The following table summarizes our contractual obligations and commercial commitments at November 30, 2012, along with the obligations associated with our term loans, and the future periods in which such obligations are expected to be settled in cash (in thousands): Payment due by period Contractual Obligations and Less than 1 More than 5 Commercial Commitments Total year 1 - 3 years 3 - 5 years years Term loan debt and interest $ 785,137 $ 68,328 $ 689,707 $ 27,102 $ - Operating lease obligations 200,716 43,643 65,834 51,196 40,043 Unconditional purchase obligations 28,343 12,194 16,083 66 - Total $ 1,014,196 $ 124,165 $ 771,624 $ 78,364 $ 40,043 We have four pension and postretirement benefit plans, with the following estimated cash contributions for 2013: • U.S. RIP - We made a $10 million contribution to the U.S. RIP in December 2012, the first month of our fiscal 2013, primarily to be used to fund estimated 2013 pension costs. • U.K. RIP - We expect to contribute approximately $1.8 million to the UK RIP in 2013. • SIP - We expect to contribute approximately $0.7 million to the SIP during 2013. • Postretirement medical plan - We expect to contribute approximately $0.9 million to the postretirement medical plan during 2013. We have $310 million of outstanding borrowings under our credit facility revolver at a current annual interest rate of 1.75%. The credit facility has a five-year term ending in January 2016. Recent Accounting Pronouncements Please refer to Note 2 to the Consolidated Financial Statements in this Form 10-K for a discussion of recent accounting pronouncements and their anticipated effect on our business. |