ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations covers periods prior to and including the closing of the Acquisition on June 6, 2012 (the Predecessor Period) and periods from the inception of Truven Holding (April 20, 2012) through December 31, 2013, which was after the closing of the Acquisition (the Successor Period). Accordingly, the discussion and analysis of the Predecessor Period does not reflect the significant impact that the Acquisition had on us, including, without limitation, increased leverage, the impact of acquisition accounting and debt service requirements. You should read the following discussion and analysis in conjunction with our consolidated financial statements as of December 31, 2013, and the related notes thereto included elsewhere in this annual report. The Successor 's consolidated financial statements for the period ended December 31, 2013 represent the consolidated financial position of Truven Holding and its subsidiaries. This discussion and analysis contains forward-looking statements that are based on management's current expectations, estimates and projections about our
business and operations. Our actual results may differ materially from those currently anticipated and expressed in such forward-looking statements as a result of various factors.
Predecessor Period-The accompanying combined financial statements of the Thomson Reuters Healthcare business (our "Predecessor") prior to the Acquisition, include the combined financial statements of TRHI and certain assets owned by subsidiaries of Thomson Reuters Corporation ("Thomson Reuters" or the "Predecessor Parent").
The combined financial statements of our Predecessor and the consolidated financial statements of the Successor included in this report have been prepared in conformity with generally accepted accounting principles in the Unites States of America ("GAAP"). The combined financial statements of our Predecessor have been derived from the accounting records of Thomson Reuters using historical results of operations and the historical bases of assets and liabilities, adjusted as necessary to conform to GAAP. All significant transactions between our Predecessor and other Thomson Reuters entities are included in our Predecessor's combined financial statements. Management believes the assumptions underlying our Predecessor's combined financial statements are reasonable. However, the combined financial statements may not necessarily reflect what our Predecessor's results of operations, financial position and cash flows would have been had it operated as a standalone company without the shared resources of Thomson Reuters for the periods presented.
In January 2014, management initiated a plan that will change the Company's segment structure in mid 2014 with the objective of focusing on more effective business and market facing opportunities and to simplify the business decision-making process. The operating segments are expected to be realigned to Commercial and Government division structures that will be headed by a separate segment manager directly reporting to the Chief Operating Decision Maker ("CODM"). The Commercial segment is expected to include Payer's Employer/HealthPlan and Pharma channels, and the Hospitals and Clinicians business. These businesses are expected to benefit from each other and are viewed as one business that can provide integrated or combined services to a broader market. The Government segment will be mainly comprised of Payer's Federal and State Government channels.
In February 2014, the company formed an integration task force to start the implementation plan for the various functional areas and will work with managers and employees to build and leverage best practices currently being executed. As changes are currently being evaluated and implemented, the current operating/reporting segments will be operating/reporting the same way and the CODM will continue to review the results of operations of the segments based on the current reporting segment structure until such time that the new segments are fully implemented. Concurrent with the change in operating/reporting segments, management is also currently evaluating the impact of these changes in the future financial statements.
Clinicians- The Clinicians segment delivers high value content, solutions and sophisticated decision support tools primarily to hospitals and health systems for use by nurses, physicians and pharmacists. These solutions and tools are aimed at improving patient care, reducing medication errors and enhancing disease and condition management.
Under the Transitional Services Agreement that was executed in connection with the Acquisition, the Stock Seller agreed to continue to provide certain services (including, but not limited to, data hosting, management information services support, campus services support, accounts payable, general ledger and payroll systems support, human resources administration support and facilities) for certain pre-determined periods and at pre-determined negotiated rates, as specified therein, depending upon the specific services to be provided. During this period, we incurred duplicate costs while using services provided to us under the Transitional Services Agreement. Such fees are, in the aggregate, in line with the allocation and direct costs reflected in our Predecessor's statement of comprehensive loss for the period ended June 6, 2012. As of December 31, 2013, we have completed our administrative infrastructure, and all of these functions have been assumed by us or by third parties on our behalf, including hosting services of certain technology infrastructure. The expense incurred under this transition service agreement amounted to $12.3 million from April 20, 2012 to December 31, 2012, and $10.5 million for the year ended December 31, 2013.
We have also incurred $22.1 million and $21.2 million of other costs related to our transition as a standalone company from June 7, 2012 through December 31, 2012 and from January 1, 2013 through December 31, 2013, of which $13 million and $3 million relates to capital expenditures related to data center migration, separating the IT infrastructure from our Predecessor Parent, respectively. We do not expect to incur additional costs related to separation of IT infrastructure from our Predecessor or additional fees under the Transitional Services Agreement in 2014.
Deferred Revenue; Fair Value Adjustments Our revenues are derived from the sale of subscription data, analytics solutions and services. Our revenues from the sale of subscription data and analytics solutions are typically billed annually in advance and recognized on a straight-line basis over the contract term, which is typically one to three years. As a result, cash collections from customers for subscription data and analytic solutions can be greater than the revenue recognized (which only correspond to those revenues associated with services already rendered). In cases of billings in advance or advanced receipt of payments from customers, we record deferred revenue, a liability that is reduced as revenue is recognized. Our revenues from services are invoiced according to the terms of the contract, typically in arrears (after the corresponding services have been rendered), and recognized over the term of the contract. Contracts for services vary in length from a few months to several years. The carrying value of our deferred revenue as of June 6, 2012 totaled $138.7 million. Following the completion of the Acquisition, we determined, with the assistance of a third-party valuation firm, that the fair value of our deferred revenue should be adjusted to $80.2 million. As a result, deferred revenue on certain contracts of $58.5 million was written off, which negatively impacted our revenue for the year ended December 31, 2013, and Successor Period from April 20, 2012 to December 31, 2012, by $8.8 million and $43.5 million, respectively. The write-off will have a future aggregate negative impact of $6.3 million with the majority reflected over the next 24 months.
Results of Operations
The following section provides a comparative discussion of our results of operations for the year ended December 31, 2013, the combined 2012 Predecessor and Successor Periods, and the Predecessor year ended December 31, 2011 respectively, and should be read in conjunction with our consolidated and combined financial statements for the year ended December 31, 2013 and the related notes thereto, included elsewhere in this Annual Report. Factors that relate primarily to a specific business segment are discussed in more detail within that business segment.
Year ended December 31, 2013 compared to year ended December 31, 2012 (Predecessor fiscal Period from January 1, 2012 to June 6, 2012 and Successor fiscal Period from April 20, 2012 to December 31, 2012)
In order to present a more clear description and meaningful discussion and analysis of our performance during fiscal 2012, our discussion of the 2012 fiscal year combines the results for the period from January 1, 2012 to June 6, 2012 (Predecessor Period) and the period April 20, 2012 to December 31, 2012 (Successor Period). These combined periods do not purport to represent what our results of operations would have been for the year ended December 31, 2012 on a Predecessor basis or a Successor basis. The following table summarizes our consolidated and combined results of operations for the periods indicated:
Year ended From inception (April December 31, 20, 2012) to December January 1, 2012 Combined Year ended (Dollars in thousands) 2013 % of revenue 31, 2012 to June 6, 2012 December 31, 2012 % of revenue Change % change (Successor) (Successor) (Predecessor) Revenues, net $ 492,702 100 % $ 241,786 $ 208,998 $ 450,784 100 % $ 41,918 9 % Operating costs and expenses Cost of revenues, excluding depreciation and amortization(a) (265,541 ) (54 )% (141,558 ) (112,050 ) (253,608 ) (56 )% (11,933 ) 5 % Selling and marketing, excluding depreciation and amortization(b) (56,157 ) (11 )% (30,958 ) (25,917 ) (56,875 ) (13 )% 718 (1 )% General and administrative, excluding depreciation and amortization(c) (41,042 ) (8 )% (13,042 ) (27,173 ) (40,215 ) (9 )% (827 ) 2 % Allocation of costs from Predecessor Parent and affiliates(d) - - % - (10,003 ) (10,003 ) (2 )% 10,003 (100 )% Depreciation (21,219 ) (4 )% (6,700 ) (6,805 ) (13,505 ) (3 )% (7,714 ) 57 % Amortization of developed technology and content (31,894 ) (6 )% (15,470 ) (12,460 ) (27,930 ) (6 )% (3,964 ) 14 % Amortization of other identifiable intangible assets(e) (34,460 ) (7 )% (19,527 ) (8,226 ) (27,753 ) (6 )% (6,707 ) 24 % Goodwill impairment (366,662 ) (74 )% - - - - % (366,662 ) NM Other operating expenses(f) (35,038 ) (7 )% (49,622 ) (18,803 ) (68,425 ) (15 )% 33,387 (49 )% Total operating costs and expenses (852,013 ) (173 )% (276,877 ) (221,437 ) (498,314 ) (111 )% (353,699 ) 71 % Operating income (loss) (359,311 ) (73 )% (35,091 ) (12,439 ) (47,530 ) (11 )% (311,781 ) 656 % Net interest income (expense) (g) (70,581 ) (14 )% (49,014 ) 3 (49,011 ) (11 )% (21,570 ) 44 % Other finance costs (24 ) - % - - - - % (24 ) - % Income (Loss) before income taxes (429,916 ) (87 )% (84,105 ) (12,436 ) (96,541 ) (21 )% (333,375 ) 345 % Benefit from income taxes 84,927 17 % 29,993 4,803 34,796 8 % 50,131 144 % Net loss $ (344,989 ) (70 )% $ (54,112 ) $ (7,633 ) $ (61,745 ) (14 )% $ (283,244 ) 459 %
(a) Includes all personnel and other costs attributable to a revenue stream, including but not limited to, client support, client operations, product management, royalties, allocation of technology support costs relating to market data and professional service costs.
(b) Includes all personnel and other costs related to sales and marketing, including but not limited to, sales and marketing staff, commissions and marketing events.
(c) Includes all personnel and other costs related to general administration as well as costs shared across the organization, including but not limited to technology, finance and strategy.
(d) As described in Note 18 to the financial statements, included elsewhere in this Annual Report, our Predecessor historically engaged in related party transactions with Thomson Reuters relative to certain support services, including among others, finance, accounting, treasury, tax, transaction processing, information technology, legal, human resources, payroll, insurance and real estate management.
(e) Includes amortization of definitelived trade names and acquired customer relationship assets.
(f) Includes costs incurred to transition the Company to a standalone business. These costs include nonrecurring expenses associated with data center migration, separating the infrastructure from Predecessor Parent, and the related consulting and professional fees. Also includes severance and retention bonuses relating to the Acquisition and Sponsor fee for Veritas Capital. See Note 14 to the consolidated and combined financial statements included elsewhere in this report.
(g) Interest earned or paid related to third party transactions.
Discussion of year ended December 31, 2013 (Successor) compared to year ended December 31, 2012 (Combined Successor and Predecessor Periods) Revenues, net
Other operating expenses
Operating income (loss)
Mar 31, 2014