filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following section discusses management's view of the financial condition and results of operations of FIS and its consolidated subsidiaries as of December 31, 2020 and 2019, and for the years ended December 31, 2020, 2019 and 2018, unless otherwise noted.
This section should be read in conjunction with the audited consolidated financial statements and related notes of FIS included elsewhere in this Annual Report. Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. See "Forward-Looking Information" and "Risk Factors" in Item 1A of this Annual Report for a discussion of the uncertainties, risks and assumptions associated with these forward-looking statements that could cause future results to differ materially from those reflected in this section.
Business Trends and Conditions
Our revenue is primarily derived from a combination of technology and processing services, payment transaction fees, professional services and software license fees. While we are a global company and do business around the world, the majority of our revenue is generated by clients in the U.S. The majority of our international revenue is generated by clients in the U.K., Germany, Australia, Canada, Brazil and India. The majority of our revenue has historically been recurring and has been provided under multi-year Banking and Capital Markets contracts that contribute relative stability to our revenue stream. These services, in general, are considered critical to our clients' operations. Although Merchant has a lesser percentage of multi-year contracts, substantially all of its revenue is recurring. A considerable portion of our Merchant recurring revenue, and to a lesser extent a portion of our Banking and Capital Markets recurring revenue, is derived from transaction processing fees that fluctuate with the number or value of transactions processed, among other variable measures, associated with consumer, commercial and capital markets activity. Professional services revenue is typically non-recurring, though recognition often occurs over time rather than at a point in time. Sales of software licenses are typically non-recurring with point-in-time recognition and are less predictable.
COVID-19 continued to impact our financial results in the fourth quarter of 2020. In certain locations, where government lockdowns and shelter-in-place orders have been tightened, consumer spending impacting our Merchant payments volume, and related transaction revenue has been adversely impacted after partially recovering in the third quarter of 2020. Certain discretionary spending verticals, including travel, airlines and restaurants, continue to be significantly impacted. The Company's revenue continues to be impacted by reduced payment processing volumes within our Merchant segment and, to a lesser extent, transaction volume within our Banking segment.
We have seen some slowdown in customer decision-making on sales and implementation of our solutions, as well as on software licenses and professional services. These delays, due largely to client caution, have adversely affected our business, results of operations and financial condition in the fourth quarter of 2020 and could continue, although the magnitude and duration of their ultimate effect is not possible to predict and has not been material to date. We have continued to prioritize investments in solutions that help address the needs of our clients in order to increase the Company's potential to resume strong revenue growth following the pandemic.
In response to COVID-19, we are continuing to take several actions to manage discretionary expenses, including reducing office space, prohibiting most travel and reducing incentive compensation, as well as accelerating automation and functional alignment across the organization. These actions reduced such expenses by approximately $300 million in 2020. Of this amount, approximately $220 million relates to reduced incentive compensation for 2020, which we do not anticipate occurring with respect to 2021 incentive compensation.
Our extension of higher-than-usual levels of credit to our merchant clients as part of funds settlement in connection with payments to their customers, for, among other things, refunds for cancelled trips and events lessened as the year progressed, although increasing government lockdown orders in the fourth quarter could adversely impact credit extensions and chargebacks. We are exposed to losses if our merchant customers are unable to repay the credit we have extended or to fund their liability for chargebacks due to closure, insolvency, bankruptcy or other reasons. This increase in extended credit or potential liability for chargebacks did not have a material impact on our liquidity for the three- and twelve-month periods ended December 31, 2020, although certain of our merchant clients have ceased doing business, at least for a period of time, and we continue to monitor their impact on our liquidity, results of operations and financial condition.
We continue to assist financial institutions in migrating to outsourced integrated technology solutions to improve their profitability and address increasing and ongoing regulatory requirements. As a provider of outsourcing solutions, we benefit from multi-year recurring revenue streams, which help moderate the effects of broader year-to-year economic and market
changes that otherwise might have a larger impact on our results of operations. We believe our integrated solutions and outsourced services are well-positioned to address this outsourcing trend across the markets we serve. However, delays in implementation of our solutions caused by the uncertainty of the COVID-19 pandemic may temporarily slow future revenue growth to an extent not yet determined.
Over the last five years, we have moved approximately 73% of our server compute, primarily in North America, to our FIS cloud located in our strategic data centers, and our goal is to increase that percentage to 80% by the end of 2021. This allows us to further enhance security for our clients' data and increases the flexibility and speed with which we can provide solutions and services to our clients, eventually at lesser cost. Concurrently, we have continued to consolidate our data centers, closing seven data centers in 2019 and an additional six data centers in 2020. Our consolidation has generated a savings for the Company as of year-end 2020 of approximately $240 million in run-rate annual expense reduction since the program's inception in mid-2016. We plan to close and consolidate approximately seven more data centers by the end of 2021, which should result in additional run rate annual expense reduction of approximately $10 million.
We continue to invest in modernization, innovation and integrated solutions and services to meet the demands of the markets we serve and compete with global banks, financial and other technology providers, and emerging technology innovators. We invest both organically and through investment opportunities in companies building complementary technologies in the financial services space. Our internal efforts in research and development activities have related primarily to the modernization of our proprietary core systems in each of our segments, design and development of next generation digital and innovative solutions and development of processing systems and related software applications and risk management platforms. We have increased our investments in these areas in each of the last three years. Our innovation efforts have recently resulted in bringing to market our Modern Banking Platform that is among the first cloud-native core banking solutions. We expect to continue our practice of investing an appropriate level of resources to maintain, enhance and extend the functionality of our proprietary systems and existing software applications, to develop new and innovative software applications and systems to address emerging technology trends in response to the needs of our clients and to enhance the capabilities of our outsourcing infrastructure.
We have invested in the development of new solutions by establishing the position of the Chief Growth Officer in 2020 and building staff within that office. This office prioritizes development and investment in new solutions in collaboration with our segment leaders, including investment in fintech venture opportunities with innovative new solutions.
FIS continues to carefully monitor the effects of the ongoing COVID-19 pandemic as conditions continue to evolve. Since the beginning of the pandemic, the Company has taken several actions to protect its employees while maintaining business continuity, including implementing its comprehensive Pandemic Plan. The Pandemic Plan includes site-specific plans as well as travel restrictions, medical response protocols, work-from-home strategies and enhanced cleaning within our locations. As a critical infrastructure provider for the global economy, FIS continues to operate around the world to serve our clients.
The spread of COVID-19 has caused us to modify our business practices (including restricting employee travel, developing social distancing plans for our employees and cancelling physical participation in meetings, events and conferences), and we may take further actions as may be required by government authorities or as we determine are in the best interests of our employees, clients and business partners. Where government lockdowns have prohibited or slowed down certain functions at specific locations, FIS has outfitted employees to provide services from home or transferred work to other locations. Nearly 95% of our employees remain in a work-from-home status and have been effectively outfitted to continue to provide all necessary services to our clients. We continued this work-from-home status in most locations since the impact of the pandemic began in mid-March 2020 through the end of the year, as the safety of our employees is a top priority. Additionally, for its employees, the Company has expanded sick leave for employees affected by COVID-19, expanded telemedicine internationally, provided special pay for certain employees involved in critical infrastructure who could not work from home, and expanded its FIS Cares program to benefit employees in need around the world.
Consumer preference continues to shift from traditional branch banking services to digital banking solutions, and our clients seek to provide a single integrated banking experience through their branch, mobile, internet and voice banking channels. The COVID-19 pandemic appears to be accelerating digitization of banking and payment services by requiring, in many cases, banks and bank customers to transact through digital channels. We have been providing our large regional banking customers in the U.S. with Digital One, an integrated digital banking platform, and are now adding functionality and offering Digital One to our community bank clients to provide a consistent, omnichannel experience for consumers of banking services across self-service channels like mobile banking and online banking, as well as supporting channels for bank staff operating in bank branches and contact centers. The uniform customer experience extends to support a broad range of financial services including opening new accounts, servicing of existing accounts, money movement services, and personal financial
management, as well as other consumer, small business and commercial banking capabilities. Digital One is integrated into several of the core banking platforms offered by FIS and is also offered to customers of non-FIS core banking systems.
We anticipate consolidation within the banking industry will continue, primarily in the form of merger and acquisition activity among financial institutions, which we believe as a whole is detrimental to the profitability of the financial technology industry. However, consolidation resulting from specific merger and acquisition transactions may be beneficial to our business. When consolidations of financial institutions occur, merger partners often operate systems obtained from competing service providers. The newly formed entity generally makes a determination to migrate its core and payments systems to a single platform. When a financial institution processing client is involved in a consolidation, we may benefit by their expanding the use of our services if such services are chosen to survive the consolidation and to support the newly combined entity. Conversely, we may lose revenue if we are providing services to both entities, or if a client of ours is involved in a consolidation and our services are not chosen to survive the consolidation and to support the newly combined entity. It is also possible that larger financial institutions resulting from consolidation may have greater leverage in negotiating terms or could decide to perform in-house some or all of the services that we currently provide or could provide. We seek to mitigate the risks of consolidations by offering other competitive services to take advantage of specific opportunities at the surviving company.
As a result of the Worldpay acquisition completed on July 31, 2019, FIS is now a global leader in the merchant solutions industry, with differentiated solutions throughout the payments market, including capabilities in global eCommerce, integrated payments, and enterprise payments and data security solutions in business-to-business ("B2B") payments. These solutions bring together advanced payments technologies at each stage of the transaction life cycle. The Worldpay acquisition broadened our solution portfolio, enabling us to significantly expand our merchant acquiring solutions, including our capabilities in the growing eCommerce and integrated payment segments of the market, which are in demand among our merchant clients as they look for ways to integrate technology into their business models. The combination also favorably impacts our business mix with a greater concentration in higher growth and higher margin services. The Worldpay acquisition significantly increased our revenue as well as our amortization expense for acquired intangibles and our acquisition, integration and other costs. However, due to the COVID-19 pandemic, our merchant processing revenue has been adversely impacted, particularly in the discretionary spending areas of travel, airlines, and restaurants, and we expect revenue will continue to be adversely impacted until the economic effects and government, company, and public travel restrictions due to the pandemic subside around the world.
Following the Worldpay acquisition, we are focused on completing post-merger integration to achieve potential incremental revenue opportunities and expense efficiencies created by the combination of the two companies. We have a history of successfully integrating the operations and technology platforms of acquired companies, including winding down legacy environments and consolidating platforms from other acquisitions into our environment. Based on prior integration experience, we developed integration plans to achieve the potential benefits created by the Worldpay acquisition. As of the end of 2020, our achievement of revenue synergies remains on track to meet or exceed our current targets driven by successful cross-sell of our heritage Premium Payback solution into heritage Worldpay clients and by leveraging our heritage Worldpay sales and distribution teams, expanding on our existing relationships with financial institutions to establish merchant referral agreements and optimizing our network routing capabilities. We have also exceeded our original target for expense synergies, as we have successfully integrated organizational structures, reduced corporate overhead and achieved cost savings within our operating environment, and expect to continue to achieve additional expense synergies during 2021.
We continue to see demand for innovative solutions in the payments market that will deliver faster, more convenient payment solutions in mobile channels, internet applications and cards. The payment processing industry is adopting new technologies, developing new solutions and services, evolving new business models and being affected by new market entrants and by an evolving regulatory environment. As merchants and financial institutions respond to these changes by seeking services to help them enhance their own offerings to consumers, including the ability to accept card-not-present ("CNP") payments in eCommerce and mobile environments as well as contactless cards and mobile wallets at the point-of-sale, FIS believes that payment processors will seek to develop additional capabilities in order to serve clients' evolving needs. To facilitate this expansion, we believe that payment processors will need to enhance their technology platforms so they can deliver these capabilities and differentiate their offerings from other providers. The COVID-19 pandemic appears to be accelerating digitization of payment services by requiring, in many cases, businesses and consumers to transact through digital channels.
We believe that these market changes present both an opportunity and a risk for us, and we cannot predict which emerging technologies or solutions will be successful. However, FIS believes that payment processors, like FIS, that have scalable, integrated business models, provide solutions across the payment processing value chain and utilize broad distribution capabilities will be best positioned to enable emerging alternative electronic payment technologies. Further, FIS believes that its depth of capabilities and breadth of distribution will enhance its position as emerging payment technologies are adopted by merchants and other businesses. FIS' ability to partner with non-financial institution enterprises, such as mobile payment
providers and internet, retail and social media companies, could create attractive growth opportunities as these new entrants seek to become more active participants in the development of alternative electronic payment technologies and to facilitate the convergence of retail, online, mobile and social commerce applications.
Globally, attacks on information technology systems continue to grow in frequency, complexity and sophistication. This is a trend we expect to continue. Such attacks have become a point of focus for individuals, businesses and governmental entities. The objectives of these attacks include, among other things, gaining unauthorized access to systems to facilitate financial fraud, disrupt operations, cause denial of service events, corrupt data, and steal non-public information. These circumstances present both a threat and an opportunity for FIS. As part of our business, we electronically receive, process, store and transmit a wide range of confidential information, including sensitive customer information and personal consumer data. We also operate payment, cash access and prepaid card systems.
FIS remains focused on making strategic investments in information security to protect our clients and our information systems. These investments include both capital expenditures and operating expense related to hardware, software, personnel and consulting services. We also participate in industry and governmental initiatives to improve information security for our clients. Through the expertise we have gained with this ongoing focus and involvement, we have developed fraud, security, risk management and compliance solutions to target this growth opportunity in the financial services industry.
Critical Accounting Policies and Estimates
The accounting policies described below are those we consider critical in preparing our consolidated financial statements. These policies require management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosures with respect to contingent liabilities and assets at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual amounts could differ from those estimates. See Note 2 to the consolidated financial statements for a more detailed description of the significant accounting policies that have been followed in preparing our consolidated financial statements.
Revenue Recognition
The Company generates revenue in a number of ways, including from the delivery of account- or transaction-based processing, SaaS, BPaaS, cloud offerings, software licensing, software-related services and professional services. Our contracts frequently contain non-standard terms that require judgment to determine the appropriate impact on revenue recognition. We are frequently a party to multiple concurrent contracts with the same client. These situations require judgment to determine whether the individual contracts should be combined or evaluated separately for purposes of revenue recognition. In making this determination, we consider the timing of negotiating and executing the contracts, whether the different elements of the contracts are negotiated as a package with a single commercial objective, whether the solutions or services promised in the contracts are a single performance obligation, and whether any of the payment terms of the contracts are interrelated. Our individual contracts also frequently include multiple promised solutions or services. At contract inception, we assess the solutions and services promised in our contracts with customers and identify a performance obligation for each promise to transfer to the customer a solution or service (or bundle of solutions or services) that is distinct - i.e., if a solution or service is separately identifiable from other items in the bundled package and if a customer can benefit from it on its own or with other resources that are readily available to the customer. We must apply judgment in these circumstances in determining whether individual promised solutions or services can be considered distinct or should instead be combined with other promised solutions or services in the contract. We recognize revenue when or as we satisfy a performance obligation by transferring control of a solution or service to a customer. We must use judgment to determine whether revenue is measured at a point in time or over time, to determine when the customer obtains control for performance obligations satisfied at a point in time and to determine the appropriate measure of progress for performance obligations satisfied over time. Judgment is also required in estimating and allocating variable consideration to one or more, but not all, performance obligations in a contract, determining the standalone selling prices of each performance obligation, and allocating the transaction price to each distinct performance obligation in a contract.
Due to the large number, broad nature and average size of individual contracts we are party to, the impact of judgments and assumptions that we apply in recognizing revenue for any single contract is not likely to have a material effect on our consolidated operations or financial position. However, the broader accounting policy assumptions that we apply across similar contracts or classes of clients could significantly influence the timing and amount of revenue recognized in our historical and future results of operations or financial position.
Capitalized Software Development Costs
Capitalized software development costs require judgment in determining when costs should be capitalized, the appropriate period over which to amortize the capitalized costs, and whether there is impairment of unamortized capitalized costs. We capitalize software development costs when technological feasibility of the software has been established (for software to be marketed) or at the beginning of application development (for internal-use software). In determining useful lives for amortization, we consider historical results and technological trends that may influence the estimate. Useful lives for capitalized software development costs typically range from three to 10 years.
The Company assesses the recorded value of capitalized software development costs for impairment on a regular basis by comparing the carrying value to the estimated future cash flows to be generated by the underlying software asset (net realizable value analysis for software to be marketed). There are inherent uncertainties in determining the expected useful life or cash flows to be generated from capitalized software development costs. For the year ended December 31, 2019, we recorded $87 million in asset impairments, primarily related to certain software to be marketed. For the years ended December 31, 2020 and 2018, respectively, we have not had more than minimal charges for impairments of software. While we have not historically experienced significant changes in these balances due to changes in estimates, our results of operations could be subject to such changes in the future.
Purchase Accounting
We allocate the purchase price of acquired businesses to the assets acquired and liabilities assumed in the transaction at their estimated fair values. The estimates used to determine the fair value of long-lived assets, such as intangible assets and software, are complex and require a significant amount of management judgment. We typically engage third-party valuation specialists to assist us in making fair value determinations. The third-party valuation specialists generally use discounted cash flow models, which require internally-developed assumptions, to determine the acquisition fair value of customer relationship intangible assets and developed technology software assets. Assumptions for customer relationship asset valuations typically include forecasted revenue attributable to existing customer contracts and relationships, estimated annual attrition, forecasted EBITDA margin, and estimated weighted average cost of capital and discount rates. Assumptions for software asset valuations typically include forecasted revenue attributable to the software assets, obsolescence rates, estimated royalty rates and estimated weighted average cost of capital and discount rates.
While we use our best estimates and assumptions to determine the fair values of the assets acquired and the liabilities assumed, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to our consolidated statements of earnings.
We are also required to estimate the useful lives of intangible assets to determine the amount of acquisition-related intangible asset amortization expense to record in future periods. The determination of asset lives affects our results of operations as different types of assets have different useful lives, and certain assets may be considered to have indefinite useful lives. We periodically review the estimated useful lives assigned to our finite-lived intangible assets to determine whether such estimated useful lives continue to be appropriate.
See Note 3 to the consolidated financial statements for discussion of the Virtus acquisition in 2020 and Worldpay acquisition in 2019. We had no significant business combinations during 2018.
Goodwill
Goodwill was $53.3 billion and $52.2 billion as of December 31, 2020 and 2019, respectively. The Company assesses goodwill for impairment by reporting unit on an annual basis during the fourth quarter or more frequently if circumstances indicate potential impairment. Our reporting units are the same as our primary operating segments, with additional reporting units for certain non-strategic businesses within the Corporate and Other segment. Goodwill impairment assessments require a significant amount of management judgment, and a meaningful change in one or more of the underlying forecasts, estimates, or assumptions used in testing goodwill for impairment could result in a material impact on the Company's results of operations and financial position. Based on the results of our assessments for 2020, $94 million of goodwill related to certain non-strategic businesses within the Corporate and Other segment was impaired. For all other reporting units for all periods presented, goodwill was not impaired.
When performing a qualitative assessment, we consider events and circumstances to determine if it is more likely than not that a reporting unit's carrying amount exceeds its fair value, including factors such as macroeconomic conditions, industry and
market conditions, cost factors, overall financial performance, events affecting the reporting unit or Company as a whole, including a sustained decrease in stock price. We examine those factors most likely to affect each reporting unit's fair value.
When performing a quantitative assessment, we typically engage third-party valuation specialists to assist us in determining the fair value of the reporting unit based on a weighted average of multiple valuation techniques, typically a combination of an income approach and a market approach. The income approach calculates a value based upon the present value of estimated future cash flows, while the market approach uses earnings multiples of similarly situated guideline public companies. The income approach involves the use of significant estimates and assumptions regarding forecasted revenue, growth rates, operating margins, capital expenditures, and other factors used to calculate estimated future cash flows. In addition, risk-adjusted discount rates and future economic and market conditions and other assumptions are applied. The market approach involves the selection of guideline public companies and earnings multiples considering factors such as markets of operation, solutions offered, and risk profiles.
For each of 2019 and 2018, we began our annual assessment with the qualitative assessment and concluded that it remained more likely than not that the fair value of each of our reporting units continued to exceed the carrying amounts. For 2020, we began our annual assessment for the Banking Solutions and Capital Market Solutions reporting units with qualitative assessments and concluded that that it remained more likely than not that the fair value of each of the reporting units continued to exceed their respective carrying amounts. Based on the qualitative assessment performed for these reporting units, and because there was a substantial excess of fair value over carrying amount in our previous third-party valuations performed in 2015 for Banking Solutions- and Capital Market Solutions-related businesses, we believe the likelihood of obtaining materially different results based on a change of assumptions is low.
For Merchant Solutions, we began our 2020 annual assessment with a quantitative assessment due to the economic impact of the COVID-19 pandemic on our Merchant Solutions business and its primary operations being recently acquired as part of the Worldpay acquisition. As a result of the assessment, the fair value of the reporting unit was estimated to be in excess of carrying amount by approximately 4%. The fair value was determined with the assistance of third-party valuation specialists, using an equal weighting of the income and market approaches based on an evaluation of the availability and relevance of guideline public companies having similar risks, participating in similar markets, and providing similar solutions for their customers.
For the income approach to estimating the fair value of the Merchant Solutions reporting unit, we estimated future cash flows using internal forecasts, which were developed considering historical operating performance, expected economic conditions and industry and market trends, including the impact of the COVID-19 global pandemic and expected impact of planned business initiatives. At the end of the forecast period, we used a long-term growth rate to determine the terminal value based on an evaluation of the minimum expected terminal growth rate of the Merchant Solutions reporting unit, as well as broader economic considerations such as inflation and foreign exchange rates. Due to the inherent uncertainties involved in making estimates and assumptions, actual results may differ from those determined based on our forecasts.
In computing the present value of estimated future cash flows, we used a risk-adjusted discount rate based on an assessment of the weighted average cost of capital calculation for the Merchant Solutions reporting unit and relevant guideline public companies. We believe the discount rate used is commensurate with the risks and uncertainties inherent in the Merchant Solutions business and in our internally developed forecasts, but the rate is subject to change in future periods based on changes in the U.S. Treasury rate, inflation, and other factors.
The estimated fair value of the Merchant Solutions reporting unit was derived from the valuation techniques described above, incorporating forecasts and assumptions. The estimated fair value of the Merchant Solutions reporting unit is sensitive to changes in these forecasts and assumptions, and such changes could impact the determination of goodwill impairment. We performed sensitivity analyses around certain assumptions in order to assess the reasonableness of the assumptions and the resulting estimated fair value. For example, a hypothetical 100-basis-point increase in the discount rate yielded an estimated fair value for the Merchant Solutions reporting unit below its carrying amount.
Given the results of the Merchant Solutions reporting unit quantitative assessment, the reporting unit is at risk for future goodwill impairment as it is reasonably possible that, among other factors, future developments related to the economic impact of the COVID-19 pandemic on our Merchant Solutions business, such as an extended duration of the pandemic and/or government-imposed shutdowns, prolonged economic downturn or recession, or lack of governmental support for recovery, could have a material impact on one or more of the estimates and assumptions used to evaluate goodwill impairment and could result in future goodwill impairment.
Related-Party Transactions
We are a party to certain historical related-party agreements as discussed in Note 18 to the consolidated financial statements.
Factors Affecting Comparability
For information regarding factors affecting comparability, see "Item 6. Selected Financial Data." As a result of the transactions noted in Item 6. Selected Financial Data, our financial position, results of operations, earnings per share and cash flows in the periods covered by the consolidated financial statements may not be directly comparable.
Consolidated Results of Operations
This section generally discusses fiscal year 2020 compared to 2019. Discussions of fiscal year 2019 compared to 2018 not included herein can be found in Part II, "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for fiscal year 2019, filed with the Securities and Exchange Commission on February 23, 2020.
| Year ended December 31, | |||||||||||||||||||||||
| 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Revenue | $ | 12,552 | $ | 10,333 | $ | 2,219 | 21 | % | |||||||||||||||
| Cost of revenue | (8,348) | (6,610) | (1,738) | 26 | |||||||||||||||||||
| Gross profit | 4,204 | 3,723 | 481 | 13 | |||||||||||||||||||
| Gross profit margin | 33 | % | 36 | % | |||||||||||||||||||
| Selling, general and administrative expenses | (3,516) | (2,667) | (849) | 32 | |||||||||||||||||||
| Asset impairments | (136) | (87) | (49) | 56 | |||||||||||||||||||
| Operating income | 552 | 969 | (417) | (43) | |||||||||||||||||||
| Operating margin | 4 | % | 9 | % |
Revenue
Revenue increased primarily due to incremental revenue from the Worldpay acquisition. Revenue was adversely impacted by reduced payment processing volumes within our Merchant Solutions segment and, to a lesser extent, transaction volume within our Banking Solutions segment, as a result of the COVID-19 pandemic. See Segment Results of Operations below for more detailed explanation.
Cost of Revenue, Gross Profit and Gross Profit Margin
Gross profit increased primarily due to the revenue variances noted above. Gross profit margin decreased primarily due to higher acquired intangible asset amortization expense, partially offset by higher margin revenue from the Worldpay acquisition.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased primarily due to incremental Worldpay corporate and infrastructure expenses and higher acquisition, integration and other costs. These increases were partially offset by lower discretionary spending during the COVID-19 pandemic.
Asset Impairments
During 2020, the Company recorded asset impairments totaling $136 million related to goodwill for certain non-strategic businesses and to certain long-lived assets related to reducing office space. During 2019, the Company recorded asset impairments totaling $87 million primarily related to certain software resulting from the Company's net realizable value analysis.
Operating Income and Operating Margin
The annual change in operating income resulted from the revenue and cost variances noted above. The operating margin during 2020 was negatively impacted by higher acquired intangible asset amortization expense, higher acquisition, integration and other costs and asset impairments of $136 million. The operating margin during 2019 was negatively impacted by higher acquired intangible asset amortization expense, higher acquisition, integration and other costs and asset impairments of $87 million.
Total Other Income (Expense), Net
| Year ended December 31, | |||||||||||||||||||||||
| 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||
| Other income (expense): | (In millions) | ||||||||||||||||||||||
| Interest expense, net | $ | (334) | $ | (337) | $ | 3 | (1) | % | |||||||||||||||
| Other income (expense), net | 48 | (219) | 267 | (122) | |||||||||||||||||||
| Total other income (expense), net | $ | (286) | $ | (556) | 270 | (49) |
The decrease in interest expense, net is primarily due to a lower weighted average interest rate on the outstanding debt throughout the year, notwithstanding the increase in outstanding debt as a result of the Worldpay acquisition, partially offset by a decrease in interest income as compared to the prior year that included interest income on the proceeds from the Worldpay acquisition-related debt issuances prior to closing.
Other income (expense), net for 2020 primarily represents the fair value adjustment on certain non-operating assets and liabilities, foreign currency transaction remeasurement gains and losses and the pending settlement amount of the Reliance Trust claims, which is further described in Note 16 to the consolidated financial statements.
Other income (expense), net for 2019 primarily includes a pre-tax charge of approximately $217 million in tender premiums and fees and the write-off of previously capitalized debt issuance costs on the early redemption of approximately $3.0 billion in aggregate principal amount of our senior notes as well as approximately $33 million of acquisition financing costs related to the acquisition of Worldpay. These items were partially offset by the non-cash foreign currency gain on non-hedged Euro- and Pound Sterling-denominated notes issued to finance the Worldpay acquisition, during the period from the date of issue of the notes to the date of the acquisition.
Provision (Benefit) for Income Taxes
| Year ended December 31, | |||||||||||||||||||||||
| 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Provision (benefit) for income taxes | $ | 96 | $ | 100 | $ | (4) | (4) | % | |||||||||||||||
| Effective tax rate | 36 | % | 24 | % |
The effective tax rate for the 2020 period includes a one-time net remeasurement of certain deferred tax liabilities due to the increase in the U.K. corporate statutory tax rate from 17% to 19% enacted on July 22, 2020. The effective tax rate for 2019 includes a detriment of $44 million due to non-deductible executive stock compensation primarily driven by acceleration of converted heritage Worldpay stock compensation awards and the accrual of additional stock compensation due to reaching certain Worldpay synergy targets and a detriment of $21 million due to the post-acquisition combined state income tax rates.
Segment Results of Operations
FIS reports its financial performance based on the following segments: Merchant Solutions, Banking Solutions, Capital
Market Solutions, and Corporate and Other. The Company reclassified certain non-strategic businesses from Merchant Solutions, Banking Solutions, and Capital Market Solutions into Corporate and Other during the year ended December 31, 2020, and recast all prior-period segment information presented.
Adjusted EBITDA is defined as net earnings (loss) before net interest expense, net other income (expense), income tax provision (benefit), equity method investment earnings (loss), depreciation and amortization, and excludes certain costs and other transactions that management deems non-operational in nature. This measure is reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segments and assessing their performance. For this
reason, Adjusted EBITDA, as it relates to our segments, is presented in conformity with FASB ASC Topic 280, Segment Reporting. The non-operational items affecting the segment profit measure generally include purchase accounting adjustments; acquisition, integration and certain other costs and asset impairments. Adjusted EBITDA also excludes incremental and direct costs resulting from the COVID-19 pandemic. These costs and adjustments are recorded in the Corporate and Other segment for the periods discussed below. Adjusted EBITDA for the respective segments excludes the foregoing costs and adjustments. Financial information, including details of Adjusted EBITDA, for each of our segments is set forth in Note 22 to the consolidated financial statements.
Merchant Solutions
| Years ended December 31, | $ Change | % Change | |||||||||||||||||||||||||||||||||||||||
| 2020 vs | 2019 vs | 2020 vs | 2019 vs | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 3,767 | $ | 1,942 | $ | 208 | $ | 1,825 | $ | 1,734 | 94 | % | NM | ||||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 1,752 | $ | 967 | $ | 45 | 785 | 922 | 81 | NM | |||||||||||||||||||||||||||||||
| Adjusted EBITDA margin | 46.5 | % | 49.8 | % | 21.6 | % | |||||||||||||||||||||||||||||||||||
| Adjusted EBITDA margin basis points change | (330) | NM |
Year ended December 31, 2020:
Revenue increased primarily due to incremental revenue from the Worldpay acquisition totaling $1,834 million, including a favorable foreign currency impact of less than 1%, driven by a weaker U.S. Dollar versus the British Pound Sterling. Revenue was adversely impacted by declines in payment processing volumes in certain discretionary spending verticals, including travel, airlines and restaurants, as a result of the COVID-19 pandemic.
The increase in adjusted EBITDA primarily resulted from the incremental revenue from the Worldpay acquisition. The decrease in adjusted EBITDA margin was due to decreasing volumes of high-margin services as a result of the COVID-19 pandemic.
Year ended December 31, 2019:
Revenue increased primarily due to incremental revenue from the Worldpay acquisition totaling $1,722 million.
Adjusted EBITDA and adjusted EBITDA margin increased primarily due to the incremental revenue from the Worldpay acquisition at a higher margin.
Banking Solutions
| Years ended December 31, | $ Change | % Change | |||||||||||||||||||||||||||||||||||||||
| 2020 vs | 2019 vs | 2020 vs | 2019 vs | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 5,944 | $ | 5,592 | $ | 5,416 | $ | 352 | $ | 176 | 6 | % | 3 | % | |||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 2,556 | $ | 2,402 | $ | 2,192 | 154 | 210 | 6 | 10 | |||||||||||||||||||||||||||||||
| Adjusted EBITDA margin | 43.0 | % | 43.0 | % | 40.5 | % | |||||||||||||||||||||||||||||||||||
| Adjusted EBITDA margin basis points change | — | 250 |
Year ended December 31, 2020:
Revenue increased primarily due to incremental revenue from the Worldpay acquisition contributing 4% and other items contributing an aggregate of 5%. Other items in Banking Solutions revenue were attributable to increased demand for our core and digital banking offerings and COVID-19 pandemic-related programs including recurring revenue due to card production and prepaid card services and non-recurring revenue due to Paycheck Protection Program ("PPP") loan processing. Banking Solutions revenue was also adversely impacted by lower issuer processing due to the COVID-19 pandemic. These items were partially offset by (1) a decrease in non-recurring revenue from Latin America payments contributing less than (1%); (2) a
decrease in termination fees contributing less than (1%); and (3) an unfavorable foreign currency impact to growth contributing less than (1%), primarily driven by a stronger U.S. Dollar versus the Brazilian Real and Indian Rupee.
Adjusted EBITDA increased primarily due to the revenue variances noted above. Adjusted EBITDA margin was flat primarily due to lower-margin revenue mix offset by discretionary expense management.
Year ended December 31, 2019:
Revenue increased primarily due to (1) incremental revenue from the Worldpay acquisition contributing 3%; (2) increased termination fees contributing less than 1%; and (3) other items contributing an aggregate of 4% due in part to license and professional services growth in the wealth and retirement business, strong network and back-office volumes, and growth in the card production business. These items were partially offset by the unwinding of the Brazilian Venture offset in part by the new commercial agreement with Banco Bradesco and growth in Latin America payments contributing (3%) and the reduction in revenue from the sale of Reliance Trust Company of Delaware business contributing less than (1%). Banking Solutions had an unfavorable foreign currency impact contributing less than (1%), driven primarily by a stronger U.S. Dollar versus the Brazilian Real, Euro and British Pound.
Adjusted EBITDA increased primarily due to the revenue variances noted above. Adjusted EBITDA margin increased primarily due to positive revenue mix, the addition of higher margin Worldpay revenue, and the unwinding of lower margin Brazilian Venture revenue.
Capital Market Solutions
| Years ended December 31, | $ Change | % Change | |||||||||||||||||||||||||||||||||||||||
| 2020 vs | 2019 vs | 2020 vs | 2019 vs | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 2,440 | $ | 2,318 | $ | 2,258 | $ | 122 | $ | 60 | 5 | % | 3 | % | |||||||||||||||||||||||||||
| Adjusted EBITDA | $ | 1,147 | $ | 1,073 | $ | 1,024 | 74 | 49 | 7 | 5 | |||||||||||||||||||||||||||||||
| Adjusted EBITDA margin | 47.0 | % | 46.3 | % | 45.4 | % | |||||||||||||||||||||||||||||||||||
| Adjusted EBITDA margin basis points change | 70 | 90 |
Year ended December 31, 2020:
Revenue increased primarily due to the purchase of a majority interest in Virtus Partners contributing 3% and strong managed services growth contributing 2%. Revenue also benefited from a favorable foreign currency impact contributing less than 1%, primarily driven by a weaker U.S. Dollar versus the Euro and the Swedish Krona.
Adjusted EBITDA increased primarily due to the revenue impacts mentioned above. Adjusted EBITDA margin increased primarily due to ongoing expense initiatives and discretionary expense management.
Year ended December 31, 2019:
Revenue increased primarily due to strong managed services growth, contributing 1%, and the remaining revenue contributing 2% primarily due to increased demand for risk and compliance offerings. These items were partially offset by unfavorable foreign currency impact contributing less than (1%), primarily driven by a stronger U.S. Dollar versus the British Pound Sterling and Swedish Krona.
Adjusted EBITDA and adjusted EBITDA margin increased due to continued cost management.
Corporate and Other
| Years ended December 31, | $ Change | % Change | |||||||||||||||||||||||||||||||||||||||
| 2020 vs | 2019 vs | 2020 vs | 2019 vs | ||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | |||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 401 | $ | 481 | $ | 541 | $ | (80) | $ | (60) | (17) | % | (11) | % | |||||||||||||||||||||||||||
| Adjusted EBITDA | $ | (195) | $ | (238) | $ | (128) | 43 | (110) | (18) | 86 |
The Corporate and Other segment results consist of selling, general and administrative expenses and depreciation and intangible asset amortization not otherwise allocated to the reportable segments. Corporate and Other also includes operations from non-strategic businesses.
Year ended December 31, 2020:
Revenue decreased primarily due to client attrition in certain of our non-strategic businesses.
Adjusted EBITDA increased primarily due to lower discretionary expenses during the COVID-19 pandemic and operating expense synergy cost actions, partially offset by adjusted EBITDA decline in non-strategic businesses.
Year ended December 31, 2019:
Revenue decreased primarily due to the sale of the Certegy Check Services business unit in North America during the third quarter of 2018.
Adjusted EBITDA decreased primarily due to incremental Worldpay corporate and infrastructure expenses and increased corporate health care and other benefit plan expenses.
Liquidity and Capital Resources
Cash Requirements
Our ongoing cash requirements include operating expenses, income taxes, tax receivable obligations, mandatory debt service payments, capital expenditures, stockholder dividends, regulatory requirements, working capital and timing differences in settlement-related assets and liabilities and may include discretionary debt repayments, share repurchases and business acquisitions. Our principal sources of funds are cash generated by operations and borrowings, including the capacity under our Revolving Credit Facility, the U.S. commercial paper program and the Euro-commercial paper program discussed in Note 12 to the consolidated financial statements.
As of December 31, 2020, the Company had $4,600 million of available liquidity, including $1,959 million of cash and cash equivalents and $2,641 million of capacity available under its Revolving Credit Facility. Approximately $1,443 million of cash and cash equivalents is held by our foreign entities. The majority of our cash and cash equivalents represents net deposits-in-transit at the balance sheet dates and relates to daily settlement activity and regulatory requirements. Debt outstanding totaled $20.0 billion, with an effective weighted average interest rate of 1.7%.
The Company's liquidity continued to improve throughout the year as compared to the onset of the pandemic. Additionally, the volume of consumer refunds continued to decline, thereby reducing the higher-than-usual levels of credit that were extended at the onset of the pandemic to our merchant clients as part of the funds settlement process. Our liquidity could be impacted if economic conditions deteriorate or as a result of governmental measures that might be imposed in response to the COVID-19 pandemic.
The Company remains committed to reducing its leverage incurred in the Worldpay acquisition while ensuring ample liquidity and expects to reach its target leverage in 2021.
We expect that cash and cash equivalents plus cash flows from operations over the next 12 months will be sufficient to fund our operating cash requirements, capital expenditures and mandatory debt service payments.
We currently expect to continue to pay quarterly dividends. However, the amount, declaration and payment of future dividends is at the discretion of our Board of Directors and depends on, among other things, our investment opportunities,
results of operations, financial condition, cash requirements, future prospects, the duration and impact of the COVID-19 pandemic, and other factors that may be considered relevant by our Board of Directors, including legal and contractual restrictions. Additionally, the payment of cash dividends may be limited by covenants in certain debt agreements. In January 2021, the Board of Directors approved a dividend increase of 11% to $0.39 per share per quarter beginning with the first quarter of 2021. A regular quarterly dividend of $0.39 per common share is payable on March 26, 2021, to shareholders of record as of the close of business on March 12, 2021.
The existing plan authorizing share repurchases approved by the Board of Directors in 2017 expired as of December 31, 2020. Management temporarily suspended share repurchases during 2020 as a result of the Worldpay transaction to accelerate debt repayment. In January 2021, our Board of Directors approved a new share repurchase program under which it authorized the Company to repurchase up to 100 million shares of our common stock at management's discretion from time to time on the open market or in privately negotiated transactions and through Rule 10b5-1 plans. The new repurchase program has no expiration date and may be suspended for periods, amended or discontinued at any time.
Cash Flows from Operations
Cash flows from operations were $4,442 million, $2,410 million and $1,993 million in 2020, 2019 and 2018, respectively. Our net cash provided by operating activities consists primarily of net earnings, adjusted to add back depreciation and amortization. Cash flows from operations increased $2,032 million in 2020 and $417 million in 2019. The 2020 increase in cash flows from operations is primarily due to increased cash flow from the Worldpay operations, including the timing of settlement activity, partially offset by Worldpay integration-related expenses and lower net earnings from the COVID-19 pandemic. The 2019 increase in cash flows from operations is primarily due to increased cash flow due to the Worldpay acquisition, partially offset by the timing of working capital and Worldpay acquisition transaction- and integration-related expenses. The 2018 period included U.S. federal estimated income tax payments normally due in the third and fourth quarters of 2017 that were paid during the first quarter of 2018 due to the Hurricane Irma Relief Program.
Capital Expenditures and Other Investing Activities
Our principal capital expenditures are for software (purchased and internally developed) and additions to property and equipment. We invested approximately $1,129 million, $828 million and $622 million in capital expenditures (excluding other financing obligations for certain hardware and software) during 2020, 2019 and 2018, respectively. We expect to continue investing in property and equipment, purchased software and internally developed software to support our business.
In 2020 and 2019, we used $469 million and $6,629 million of cash (net of cash acquired, including restricted cash) primarily for the Virtus acquisition and for the Worldpay acquisition, respectively. See Note 3 to the consolidated financial statements.
Financing
For more information regarding the Company's debt and financing activity, see Note 12 to the consolidated financial statements.
Contractual Obligations
FIS' long-term contractual obligations generally include its long-term debt, interest on long-term debt, lease payments on certain of its property and equipment and payments for certain purchase commitments and other obligations. The following table summarizes FIS' significant contractual obligations and commitments as of December 31, 2020 (in millions):
| Payments Due in | ||||||||||||||||||||||||||||||||
| Less than | 1-3 | 3-5 | More than | |||||||||||||||||||||||||||||
| Type of Obligation | Total | 1 Year | Years | Years | 5 Years | |||||||||||||||||||||||||||
| Long-term debt (1) | $ | 17,383 | $ | 1,314 | $ | 4,177 | $ | 3,258 | $ | 8,634 | ||||||||||||||||||||||
| Interest (2) | 2,906 | 315 | 598 | 495 | 1,498 | |||||||||||||||||||||||||||
| Operating leases | 665 | 159 | 232 | 136 | 138 | |||||||||||||||||||||||||||
| Purchase commitments (3) | 791 | 335 | 397 | 59 | — | |||||||||||||||||||||||||||
| Obligations under TRA (4) | 532 | 85 | 379 | 68 | — | |||||||||||||||||||||||||||
| Total | $ | 22,277 | $ | 2,208 | $ | 5,783 | $ | 4,016 | $ | 10,270 |
(1)The principal amounts assume no changes in currency rates for our notes denominated in Euro and GBP. See Note 12 to the consolidated financial statements for more details.
(2)The calculations above assume that (a) applicable margins and commitment fees remain constant; (b) all floating-rate debt is priced at the rates in effect as of December 31, 2020; (c) no refinancing occurs at debt maturity; (d) only mandatory debt repayments are made; (e) no new hedging transactions are effected; and (f) there are no currency effects.
(3)Includes obligations principally related to software, maintenance support, and telecommunication and network services as well as to third-party processors to provide gateway authorization and other processing services. Also includes the capital obligation related to the construction of our new headquarters.
(4)Obligation represents estimated Tax Receivable Agreement ("TRA") payments to Fifth Third Bank. See Note 16 to the consolidated financial statements for more details.
Off-Balance Sheet Arrangements
FIS does not have any off-balance sheet arrangements.
Recent Accounting Pronouncements
Recently Adopted Accounting Guidance
In August 2018, the FASB issued ASU No. 2018-15 ("ASU 2018-15"), Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This ASU clarifies that implementation costs incurred by customers in cloud computing arrangements should be deferred and recognized over the term of the arrangement if those costs would be capitalized by the customer in a software licensing arrangement under the internal-use software guidance. FIS adopted ASU 2018-05 on January 1, 2020, using the prospective approach. The adoption of this new standard did not have a material impact on the Company's consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurements on Credit Losses of Financial Instruments. This ASU was subsequently amended by ASU No. 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses (collectively, "Topic 326"). The primary objectives of Topic 326 are to implement new methodology for calculating credit losses on financial instruments, such as trade receivables, based on lifetime expected credit losses and to broaden the types of information companies must use when calculating the estimated losses. The new guidance also applies to contract assets arising from contracts with customers. FIS adopted Topic 326 on January 1, 2020, using the modified retrospective approach and recorded an immaterial cumulative effect adjustment in retained earnings as of January 1, 2020.
Recent Accounting Guidance Not Yet Adopted
No other new accounting pronouncement issued or effective during the fiscal year had or is expected to have a material impact on our consolidated financial statements or disclosures.
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