filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
59K characters. Original on sec.gov ·
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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The following discussion and analysis should be read in conjunction with the "Selected Financial Data" and the consolidated financial statements and related notes included elsewhere in this report.
OVERVIEW
Background and Overview
We provide integrated computer systems for in-house and outsourced data processing to commercial banks, credit unions and other financial institutions. We have developed and acquired banking and credit union application software systems that we market, together with compatible computer hardware, to these financial institutions. We also perform data conversion and software implementation services for our systems and provide continuing customer support services after the systems are implemented. For our customers who prefer not to make an up-front capital investment in software and hardware, we provide our full range of products and services on an outsourced basis through our eight data centers in six physical locations and 20 item-processing centers located throughout the United States.
A detailed discussion of the major components of the results of operations follows. All amounts are in thousands and discussions compare fiscal 2008 to fiscal 2007 and compare fiscal 2007 to fiscal 2006.
We derive revenues from three primary sources:
- software licenses;
- support and service fees, which include implementation services; and
- hardware sales, which includes all non-software remarketed products.
Over the last five fiscal years, our revenues have grown from $467,415 in fiscal 2004 to $742,926 in fiscal 2008. Net income has grown from $62,315 in fiscal 2004 to $104,222 in fiscal 2008. This growth has resulted primarily from internal expansion supplemented by strategic acquisitions, allowing us to develop and acquire new products and services for approximately 2,300 customers who utilize our core software systems as of June 30, 2008.
Since the start of fiscal 2004, we have completed 16 acquisitions. All of these acquisitions were accounted for using the purchase method of accounting and our consolidated financial statements include the results of operations of the acquired companies from their respective acquisition dates.
License revenue represents the sale and delivery of application software systems contracted with us by the customer. We license our proprietary software products under standard license agreements that typically provide the customer with a non-exclusive, non-transferable right to use the software on a single computer and for a single financial institution location.
Support and services fees are generated from implementation services contracted with us by the customer, ongoing support services to assist the customer in operating the systems and to enhance and update the software, and from providing outsourced data processing services and Electronic Funds Transfer ("EFT") support services. Outsourcing services are performed through our data and item processing centers. Revenues from outsourced item and data processing and EFT support services are primarily derived from monthly usage or transaction fees typically under five-year service contracts with our customers.
Cost of license fees represents the third party vendor costs associated with license fee revenue.
Cost of services represents costs associated with conversion and implementation efforts, ongoing support for our in-house customers, operation of our data and item processing centers providing services for our outsourced customers, EFT services, and direct operation costs.
We have entered into remarketing agreements with several hardware manufacturers under which we sell computer hardware and related services to our customers. Cost of hardware consists of the direct and related costs of purchasing the equipment from the manufacturers and delivery to our customers.
We have two business segments: bank systems and services and credit union systems and services. The respective segments include all related license, support and service, and hardware sales along with the related cost of sales.
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RESULTS OF OPERATIONS
FISCAL 2008 COMPARED TO FISCAL 2007
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Fiscal 2008 showed strong growth in support and service revenues, tempered somewhat by leaner gross and operating margins. As a result, an 11% increase in total revenue yielded income from continuing operations that was flat in comparison to fiscal 2007.
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REVENUE
| License Reveue | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| License | $ | 73,553 | $ | 76,403 | -4% | |
| Percentage of total revenue | 10% | 11% |
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License revenue represents the delivery and acceptance of application software systems contracted with us by the customer. We license our proprietary software products under standard license agreements that typically provide the customer with a non-exclusive, non-transferable right to use the software on a single computer and for a single financial institution location.
License revenue decreased by $2,850 compared to last fiscal year mainly due to a decrease in the number of new license agreements and an overall decrease in the average transaction size in comparison to the prior fiscal year. When compared with last year, many of our software solutions experienced a decrease in license revenue. Those products that had the most significant decreases included Yellow Hammer Fraud Detective™ (our fraud detection/prevention solution), Silverlake® (our flagship core software solution for larger banks), and Synergy (our enterprise content management solution). A significant portion of the decrease in license revenue can be attributed to the continuing shift in demand by banks and credit unions toward our outsourcing services from an in-house delivery. While many products had decreases in revenue during the current fiscal year, some products did very well, including Episys®, our flagship core processing system aimed at larger credit unions, and Yellow Hammer™ BSA, our new compliance and risk mitigation solution.
| Support and Service Revenue | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| Support and service | $ | 580,334 | $ | 501,722 | +16% | |
| Percentage of total revenue | 78% | 75% |
| Year Over Year Change | $ Change | % Change | |||
|---|---|---|---|---|---|
| In-House Support & Other Services | $ | 32,685 | 15% | ||
| EFT Support | 30,601 | 29% | |||
| Outsourcing Services | 11,467 | 10% | |||
| Implementation Services | 3,859 | 6% | |||
| Total Increase | $ | 78,612 | |||
Support and service revenues are generated from implementation services (including conversion, installation, configuration and training), annual support to assist the customer in operating their systems and to enhance and update the software, outsourced data processing services and EFT Support services (including ATM and debit card transaction processing, online bill payment services, remote deposit capture and Check 21 transaction processing services).
There was strong growth in all of the support and service revenue components. In-house support and other services increased partially as a result of increased implementations of recently acquired products. In addition, because annual maintenance fees are based on supported institutions' asset size, in-house support revenues increase as our customers' assets grow. EFT support, which includes ATM/debit card processing, on-line bill pay, remote deposit capture and Check 21 transaction processing services, experienced the largest percentage growth due to increased customer activity and expansion of our customer base. Outsourcing services for banks and credit unions also continue to drive revenue growth at a strong pace as we add new bank and credit union customers and increase volume. Implementation services revenue increased during the year partially due to implementations of newly acquired or developed software products, as well as an increase in merger conversions for existing customers that acquired other financial institutions.
| Hardware Revenue | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| Hardware | $ | 89,039 | $ | 88,342 | +1% | |
| Percentage of total revenue | 12% | 13% |
The Company has entered into remarketing agreements with several hardware manufacturers under which we sell computer hardware, hardware maintenance and related services to our customers. Revenue related to hardware sales is recognized when the hardware is shipped to our customers.
Hardware revenue increased slightly in the current fiscal year because a small decrease in the sale of major hardware components was offset by slight increases in revenue from the sale of financial institution forms and supplies and from hardware maintenance contracts.
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COST OF SALES AND GROSS PROFIT
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Cost of license represents the cost of software from third party vendors through remarketing agreements. These costs are recognized when license revenue is recognized. Cost of support and service represents costs associated with conversion and implementation efforts, ongoing support for our in-house customers, operation of our data and item centers providing services for our outsourced customers, EFT processing services and direct operating costs. These costs are recognized as they are incurred. Cost of hardware consists of the direct and related costs of purchasing the equipment from the manufacturers and delivery to our customers. These costs are recognized at the same time as the related hardware revenue is recognized. Ongoing operating costs to provide support to our customers are recognized as they are incurred.
| Cost of Sales and Gross Profit | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| Cost of License | $ | 6,698 | $ | 4,277 | +57% | |
| Percentage of total revenue | <1% | <1% | ||||
| License Gross Profit | $ | 66,855 | $ | 72,126 | -7% | |
| Gross Profit Margin | 91% | 94% | ||||
| Cost of support and service | $ | 364,140 | $ | 309,919 | +17% | |
| Percentage of total revenue | 49% | 47% | ||||
| Support and Service Gross Profit | $ | 216,194 | $ | 191,803 | +13% | |
| Gross Profit Margin | 37% | 38% | ||||
| Cost of hardware | $ | 64,862 | $ | 65,469 | -1% | |
| Percentage of total revenue | 9% | 10% | ||||
| Hardware Gross Profit | $ | 24,177 | $ | 22,873 | +6% | |
| Gross Profit Margin | 27% | 26% | ||||
| TOTAL COST OF SALES | $ | 435,700 | $ | 379,665 | +15% | |
| Percentage of total revenue | 59% | 57% | ||||
| TOTAL GROSS PROFIT | $ | 307,226 | $ | 286,802 | +7% | |
| Gross Profit Margin | 41% | 43% |
Cost of license increased for the fiscal year due to greater third party reseller agreement software vendor costs. Gross profit margin on license revenue decreased because a larger percentage of the revenue from licenses was attributable to these sales under reseller agreements where the gross margins are significantly lower than on our owned products. Cost of support and service increased for the year primarily due to additional personnel costs, costs related to the expansion of infrastructure (including depreciation, amortization, and maintenance contracts) and increases in the direct costs of providing services (such as transaction processing charges and the cost of third party maintenance) as compared to last year. These increases were commensurate with the increase in support and service revenue. The gross profit margin decreased to 37% from 38% in support and service. Cost of hardware decreased for the year. Hardware gross profit margin increased slightly due to sales mix.
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OPERATING EXPENSES
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| Selling and Marketing | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| Selling and marketing | $ | 55,916 | $ | 50,195 | +11% | |
| Percentage of total revenue | 8% | 8% |
Dedicated sales forces, inside sales teams, technical sales support teams and channel partners conduct our sales efforts for our two market segments, and are overseen by regional sales managers. Our sales executives are responsible for pursuing lead generation activities for new core customers. Our account executives nurture long-term relationships with our client base and cross sell our many complementary products and services.
For the 2008 fiscal year, the selling and marketing expenses increase was due to growth in personnel costs, particularly commission expenses on sales of services, which resulted from increased services revenue. Selling and Marketing expenses remained steady for both years at 8% of total revenue.
| Research and Development | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| Research and development | $ | 43,326 | $ | 35,962 | +20% | |
| Percentage of total revenue | 6% | 5% |
We devote significant effort and expense to develop new software, service products and continually upgrade and enhance our existing offerings. Typically, we upgrade our various core and complementary software applications once per year. We believe our research and development efforts are highly efficient because of the extensive experience of our research and development staff and because our product development is highly customer-driven.
Research and development expenses grew primarily due to employee costs associated with an 11% increase in headcount for ongoing development of new products and enhancements to existing products. In addition, recent acquisitions have research and development expenses that exceed the average for the remainder of the Company, which has contributed to the increase from the prior fiscal year. Research and development expenses increased slightly to 6% of total revenue from 5% in fiscal 2007.
| General and Administrative | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2008 | 2007 | |||||
| General and administrative | $ | 43,775 | $ | 40,617 | +8% | |
| Percentage of total revenue | 6% | 6% |
General and administrative costs include all expenses related to finance, legal, human resources, plus all administrative costs. General and administrative expense increased primarily due to employee costs associated with a 4% increase in headcount and to an increase in professional services fees (fees for accounting, legal and business consultants). Also impacting the increase was growth in travel and lodging expenses (including the cost of aircraft fuel). General and administrative costs remained at 6% of total revenue for both fiscal years.
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INTEREST INCOME (EXPENSE)
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Interest income decreased 37% from $3,406 to $2,145 due primarily to lower average invested balances coupled with lower interest rates on invested balances. Interest expense increased 10% from $1,757 to $1,928 due to higher average outstanding borrowings on the revolving bank credit facilities.
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PROVISION FOR INCOME TAXES
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The provision for income taxes was $59,139 or 36.0% of income before income taxes in fiscal 2008 compared with $56,033 or 34.7% of income before income taxes fiscal 2007. The increase was due to the renewal of the Research and Experimentation Credit ("R&E Credit"), during fiscal year 2007, retroactive to January 1, 2006. Renewal of this credit had a significant tax benefit in fiscal year 2007 since retroactive renewal required the recording of an additional six months of credit during fiscal year 2007 related to fiscal year 2006. In addition, the R&E Credit expired as of December 31, 2007, which also contributed to the increase in the tax rate for fiscal year 2008.
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INCOME FROM CONTINUING OPERATIONS
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Income from continuing operations remained relatively flat, moving from $105,644, or $1.15 per diluted share in fiscal 2007 to $105,287, or $1.17 per diluted share in fiscal 2008.
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DISCONTINUED OPERATIONS
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Loss on discontinued operations, net of taxes, was $1,065 for fiscal 2008. The loss included a loss on the sale of Banc Insurance Services, Inc. and Banc Insurance Agency, Inc. of $2,718, and a $1,457 loss on the operations of the two companies. The income tax benefit on the loss amount was $3,110. The loss on operations of the disposed companies for fiscal 2007 included a loss from operations of $1,474, netted with the income tax benefit of $511.
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FISCAL 2007 COMPARED TO FISCAL 2006
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Fiscal 2007 showed strong growth in support and service revenues and improved gross and operating margins, tempered somewhat by decreases in software license revenues. This performance allowed us to leverage a 13% increase in total revenue to a 16% increase in net income.
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REVENUE
| License Revenue | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| License | $ | 76,403 | $ | 84,014 | -9% | |
| Percentage of total revenue | 11% | 14% |
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License revenue represents the delivery and acceptance of application software systems contracted by us with the customer. We license our proprietary software products under standard license agreements that typically provide the customer with a non-exclusive, non-transferable right to use the software on a single computer and for a single financial institution location.
License revenue decreased by $7,611 compared to last fiscal year mainly due to a decrease in the number of new license agreements and an overall decrease in the average transaction size in comparison to the prior fiscal year. When compared with last year, many of our software solutions experienced a decrease in license revenue. Those products that had the most significant decreases included Yellow Hammer Fraud Detective™ (our fraud detection/prevention solution), Silverlake® (our flagship core software solution for larger banks), NetTeller Online Banking™ (our bank-branded internet banking solution), and Episys® (our flagship core software solution for larger credit unions). A significant portion of the decrease in license revenue can be attributed to the continuing shift in demand from banks and credit unions toward our outsourcing services from an in-house delivery, which do not require software license agreements. Another contributing factor is the market penetration we have with several of our products including Episys and NetTeller which has caused us to anticipate reduced license sales for these products compared to prior years.
| Support and Service Revenue | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| Support and service | $ | 501,722 | $ | 424,333 | +18% | |
| Percentage of total revenue | 75% | 72% |
| Year Over Year Change | $ Change | % Change | ||
|---|---|---|---|---|
| In-House Support & Other Services | $ | 21,111 | 11% | |
| EFT Support | 28,879 | 38% | ||
| Outsourcing Services | 15,957 | 16% | ||
| Implementation Services | 11,442 | 24% | ||
| Total Increase | $ | 77,389 | ||
Support and service revenues are generated from implementation services (including conversion, installation, configuration and training), annual support to assist the customer in operating their systems and to enhance and update the software, outsourced data processing services and EFT support services.
There was strong growth in all of the support and service revenue components. In-house support and other services increased partially as a result of increased implementations of recently acquired products. In addition, because annual maintenance fees are based on supported institutions' asset size, in-house support revenues increase as our customers' assets grow. EFT support, which includes ATM/debit card processing, on-line bill pay, remote deposit capture and Check 21 transaction processing services, experienced the largest percentage and dollar growth. Outsourcing services for banks and credit unions also continue to drive revenue growth at a strong pace as we add new bank and credit union customers and increase volume. Implementation services revenue increased during the year primarily due to an increase in the number of in-house implementations, as well as an increase in merger conversions for existing customers that acquired other financial institutions.
| Hardware Revenue | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| Hardware | $ | 88,342 | $ | 82,530 | +7% | |
| Percentage of total revenue | 13% | 14% |
The Company has entered into remarketing agreements with several hardware manufacturers under which we sell computer hardware, hardware maintenance and related services to our customers. Revenue related to hardware sales is recognized when the hardware is shipped to our customers.
Hardware revenue increased mainly due to an increase in the number of hardware systems and components delivered in the year compared to last fiscal year. In particular, there has been a significant increase in revenue from hardware components used in our remote deposit capture product for imaging and exchanging of checks.
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COST OF SALES AND GROSS PROFIT
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Cost of license represents the cost of software from third party vendors through remarketing agreements. These costs are recognized when license revenue is recognized. Cost of support and service represents costs associated with conversion and implementation efforts, ongoing support for our in-house customers, operation of our data and item centers providing services for our outsourced customers, EFT processing services and direct operating costs. These costs are recognized as they are incurred. Cost of hardware consists of the direct and related costs of purchasing the equipment from the manufacturers and delivery to our customers. These costs are recognized at the same time as the related hardware revenue is recognized. Ongoing operating costs to provide support to our customers are recognized as they are incurred.
| Cost of Sales and Gross Profit | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| Cost of License | $ | 4,277 | $ | 2,717 | +57% | |
| Percentage of total revenue | <1% | <1% | ||||
| License Gross Profit | $ | 72,126 | $ | 81,297 | -11% | |
| Gross Profit Margin | 94% | 97% | ||||
| Cost of support and service | $ | 309,919 | $ | 270,485 | +15% | |
| Percentage of total revenue | 47% | 46% | ||||
| Support and Service Gross Profit | $ | 191,803 | $ | 153,848 | +25% | |
| Gross Profit Margin | 38% | 36% | ||||
| Cost of hardware | $ | 65,469 | $ | 60,658 | +8% | |
| Percentage of total revenue | 10% | 10% | ||||
| Hardware Gross Profit | $ | 22,873 | $ | 21,872 | +5% | |
| Gross Profit Margin | 26% | 27% | ||||
| TOTAL COST OF SALES | $ | 379,665 | $ | 333,860 | +14% | |
| Percentage of total revenue | 57% | 57% | ||||
| TOTAL GROSS PROFIT | $ | 286,802 | $ | 257,017 | +12% | |
| Gross Profit Margin | 43% | 43% |
Cost of license increased for the fiscal year due to greater third party reseller agreement software vendor costs. Gross profit margin on license revenue decreased because a larger percentage of the revenue from licenses was attributable to these sales under reseller agreements where the gross margins are significantly lower than on our owned products. Cost of support and service increased for the year primarily due to additional personnel costs (including an 8% increase in headcount), costs related to the expansion of infrastructure (including depreciation, amortization, and maintenance contracts) and increases in the direct costs of providing services (such as transaction processing charges) as compared to last year. The gross profit margin increased to 38% from 36% in support and service, primarily due to a shift in sales mix toward services with higher margins, such as our EFT Support services. Cost of hardware increased for the year, in line with the increase in hardware sales. Hardware gross profit margin decreased slightly due to lower vendor rebates received during the year compared to the prior year. Incentives and rebates received from vendors fluctuate quarterly and annually due to changing thresholds established by the vendors.
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OPERATING EXPENSES
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| Selling and Marketing | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| Selling and marketing | $ | 50,195 | $ | 49,126 | +2% | |
| Percentage of total revenue | 8% | 8% |
Dedicated sales forces, inside sales teams, technical sales support teams and channel partners conduct our sales efforts for our market segments, and are overseen by regional sales managers. Our sales executives are responsible for pursuing lead generation activities for new core customers. Our account executives nurture long-term relationships with our client base and cross sell our many complementary products and services.
For the 2007 fiscal year, the selling and marketing expenses increase was due to growth in personnel costs, particularly commission expenses. Selling and Marketing expenses remained steady for both years at 8% of total revenue.
| Research and Development | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| Research and development | $ | 35,962 | $ | 31,874 | +13% | |
| Percentage of total revenue | 5% | 5% |
We devote significant effort and expense to develop new software, to service products and to continually upgrade and enhance our existing offerings. Typically, we upgrade our various core and complementary software applications once per year. We believe our research and development efforts are highly efficient because of the extensive experience of our research and development staff and because our product development is highly customer-driven.
Research and development expenses grew primarily due to employee costs associated with a 13% increase in headcount for ongoing development of new products and enhancements to existing products. Research and development expenses remained at 5% of total revenue for both fiscal years.
| General and Administrative | ||||||
|---|---|---|---|---|---|---|
| Year Ended June 30, | % Change | |||||
| 2007 | 2006 | |||||
| General and administrative | $ | 40,617 | $ | 35,196 | +15% | |
| Percentage of total revenue | 6% | 6% |
General and administrative costs include all expenses related to finance, legal, human resources, plus all administrative costs. General and administrative expense increased primarily due to employee costs associated with a 3% increase in headcount and increased expenses related to stock options. In addition, during the first half of fiscal 2006, a new accounting system was being actively developed and a percentage of salaries were being capitalized. Also impacting the increase was growth in overhead related costs such as insurance, depreciation and amortization, professional services and maintenance contracts. General and administrative costs remained at 6% of total revenue for both fiscal years.
INTEREST INCOME (EXPENSE) Interest income increased 65% from $2,066 to $3,406 due primarily to larger invested balances coupled with higher interest rates on invested balances. Interest expense increased 30% from $1,355 to $1,757 due to borrowings on the revolving bank credit facilities.
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PROVISION FOR INCOME TAXES
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The provision for income taxes was $56,033 or 34.7% of income before income taxes in fiscal 2007 compared with $50,669 or 35.8% of income before income taxes fiscal 2006. The decrease in the percentage for fiscal 2007 is primarily due to the renewal of the Research and Experimentation Credit retroactive to January 1, 2006, which required the recording of an additional six months of credit during fiscal year 2007 related to fiscal year 2006. This created a significant tax benefit (approximately $3,000 additional benefit over the prior year) for fiscal 2007.
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INCOME FROM CONTINUING OPERATIONS
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Income from continuing operations increased 16% from $90,863, or $0.97 per diluted share in fiscal 2006 to $105,643, or $1.16 per diluted share in fiscal 2007.
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Business Segment Discussion
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| Bank Systems and Services | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | % Change | 2007 | % Change | 2006 | ||||||
| Revenue | $ 616,390 | +11% | $ 555,861 | +15% | $ 481,558 | |||||
| Gross Profit | $ 255,870 | +5% | $ 244,788 | +14% | $ 215,387 | |||||
| Gross Profit Margin | 42% | 44% | 45% | |||||||
In fiscal 2008, the revenue increase in the bank systems and services business segment is primarily due to continued growth in support and service revenue, particularly EFT support which experienced 29% revenue growth and in-house support which experienced 16% revenue growth. The growth in these components was partially offset by a 13% decrease in license revenue. Gross profit margin decreased as the mix of revenue shifted away from license revenue (which carries the largest margins) toward support and service revenue. Hardware revenue decreased by 2%; however, a shift in sales mix during fiscal 2008 compared to fiscal 2007 led to a slightly higher hardware margin.
In fiscal 2007, the revenue increase in the bank systems and services business segment was primarily due to continued growth in support and service revenue, particularly EFT support which experienced 40% revenue growth. Gross profit margin remained flat as growth generated by increasing EFT support revenue, which carries higher margins than other components of support and service revenue, was offset by decreasing license profit margin. Profit from license revenue decreased due to both a decrease in revenue and to an increase in the number of sales that were subject to third party seller agreements. Hardware revenue increased by 11%; however, lower vendor rebates during fiscal 2007 compared to fiscal 2006 led to a slightly lower hardware margin.
| Credit Union Systems and Services | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2008 | % Change | 2007 | % Change | 2006 | ||||||
| Revenue | $ 126,536 | +14% | $ 110,606 | +1% | $ 109,319 | |||||
| Gross Profit | $ 51,356 | +22% | $ 42,014 | +1% | $ 41,630 | |||||
| Gross Profit Margin | 41% | 38% | 38% | |||||||
In fiscal 2008, revenues in the credit union systems and services business segment increased 14% from fiscal 2007. All revenue components within the segment experienced growth during fiscal 2008. License revenue generated the largest dollar growth in revenue as Episys®, our flagship core processing system aimed at larger credit unions, experienced strong sales throughout the year. Support and service revenue, which is the largest component of total revenues for the credit union segment, experienced growth in EFT support (34%) and in in-house support (10%). Gross profit in this business segment increased $9,344 in fiscal 2008 compared to fiscal 2007, due primarily to the increase in license revenue, which carries the highest margins.
In fiscal 2007, revenues in the credit union systems and services business segment increased slightly from fiscal 2006. This increase is mainly due to growth in support and service revenue, mostly offset by decreases in license and hardware revenue. Support and service revenue, which is the largest component of total revenues for the credit union segment, experienced growth in EFT support (26%) and in outsourcing revenue (24%). Gross profit in this business segment remained flat in fiscal 2007 compared to fiscal 2006.
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Liquidity and Capital Resources
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We have historically generated positive cash flow from operations and have generally used funds generated from operations and short-term borrowings on our revolving credit facility to meet capital requirements. We expect this trend to continue in the future.
The Company's cash and cash equivalents decreased to $65,565 at June 30, 2008 from $88,617 at June 30, 2007.
The following table summarizes net cash from operating activities in the statement of cash flows:
| Year ended June 30, | ||||||
|---|---|---|---|---|---|---|
| 2008 | 2007 | 2006 | ||||
| Net income | $ | 104,222 | $ | 104,681 | $ | 89,923 |
| Non-cash expenses | 70,420 | 56,348 | 52,788 | |||
| Change in receivables | (2,913) | (28,853) | 30,413 | |||
| Change in deferred revenue | 5,100 | 24,576 | 10,561 | |||
| Change in other assets and liabilities | 4,172 | 17,495 | (14,247) | |||
| Net cash from operating activities | $ | 181,001 | $ | 174,247 | $ | 169,438 |
Cash provided by operations increased $6,754 to $181,001 for the fiscal year ended June 30, 2008 as compared to $174,247 for the fiscal year ended June 30, 2007. This increase is primarily attributable to an increase in expenses that do not have a corresponding cash outflow, such as depreciation and amortization, as a percentage of total net income.
Cash used in investing activities for the fiscal year ended June 2008 was $102,148 and includes payments for acquisitions of $48,109, plus $1,215 in contingent consideration paid on prior years' acquisitions. During fiscal 2007, payments for acquisitions totaled $34,006, plus $5,301 paid on earn-outs and other acquisition adjustments. Capital expenditures for fiscal 2008 were $31,105 compared to $34,202 for fiscal 2007. Cash used for software development in fiscal 2008 was $23,736 compared to $20,743 during the prior year.
Net cash used in financing activities for the current fiscal year was $101,905 and includes the repurchase of 4,200 shares of our common stock for $100,996, the payment of dividends of $24,683 and $429 net repayment on our revolving credit facilities. Cash used in financing activities was partially offset by proceeds of $20,394 from the exercise of stock options and the sale of common stock and $3,809 excess tax benefits from stock option exercises. During fiscal 2007, net cash used in financing activities included the repurchase of our common stock for $98,413 and the payment of dividends of $21,685. As in the current year, cash used in fiscal 2007 was partially offset by proceeds from the exercise of stock options and the sale of common stock of $29,212, $4,640 excess tax benefits from stock option exercises and $19,388 net borrowings on revolving credit facilities.
At June 30, 2008, the Company had negative working capital of $11,418; however, the largest component of current liabilities was deferred revenue of $212,375. The cash outlay necessary to provide the services related to these deferred revenues is significantly less than this recorded balance. Therefore, we do not anticipate any liquidity problems to result from this condition.
US financial markets and many of the largest US financial institutions have recently been shaken by negative developments in the home mortgage industry and the mortgage markets, and particularly the markets for subprime mortgage-backed securities. While we believe it is too early to predict what effect, if any, these developments may have, we have not experienced any significant issues with our current collection efforts, and we believe that any future impact to our liquidity would be minimized by our access to available lines of credit.
The Board of Directors has authorized the Company to repurchase shares of its common stock. Under this authorization, the Company may finance its share repurchases with available cash reserves of short-term borrowings on its existing credit facility. The share repurchase program does not include specific price targets or timetables and may be suspended at any time. At June 30, 2007, there were 7,101 shares in treasury stock and the Company had the remaining authority to repurchase up to 2,890 shares. On February 4, 2008, the Company's Board of Directors approved a 5,000 share increase to the stock repurchase authorization. On August 25, 2008, subsequent to the fiscal year 2008 ending, the Company's Board of Directors approved an additional 5,000 share increase to the stock repurchase authorization. During fiscal 2008, the Company repurchased 4,200 shares for $100,996. The total cost of treasury shares at June 30, 2008 is $251,180. At June 30, 2008, there were 11,301 shares in treasury stock and the Company had the authority to repurchase up to 3,690 additional shares.
Subsequent to June 30, 2008, the Company's Board of Directors declared a cash dividend of $.075 per share on its common stock payable on September 19, 2008, to stockholders of record on September 5, 2008. Current funds from operations are adequate for this purpose. The Board has indicated that it plans to continue paying dividends as long as the Company's financial picture continues to be favorable.
The Company renewed a bank credit line on April 28, 2008 which provides for funding of up to $5,000 and bears interest at the bank's prime rate less 1% (4.00% at June 30, 2008). The credit line matures on April 29, 2010. At June 30, 2008, no amount was outstanding.
The Company renewed a credit line on March 7, 2008 which provides for funding of up to $8,000 and bears interest at the Federal Reserve Board's prime rate (5.00% at June 30, 2008). The credit line expires March 7, 2009 and is secured by $1,000 of investments. There were no outstanding amounts at June 30, 2008.
An unsecured revolving bank credit facility allows short-term borrowings of up to $150,000, which may be increased by the Company at any time until maturity to $225,000. The unsecured revolving bank credit facility bears interest at a rate equal to (a) LIBOR or (b) an alternate base rate (the greater of (a) the Federal Funds Rate plus 0.5% or (b) the Prime Rate), plus an applicable percentage in each case determined by the Company's leverage ratio. The unsecured revolving credit line terminates May 31, 2012. At June 30, 2008, the outstanding revolving bank credit facility balance was $70,000. This outstanding balance bears interest at a weighted average rate of 3.11%.
The Company has entered into various capital lease obligations for the use of certain computer equipment. Included in property and equipment are related assets of $1,169, less accumulated depreciation of $651. At June 30, 2008, $201 was outstanding, of which $177 was included in current maturities. Maturities of capital lease payments by fiscal year are $177 in fiscal 2009 and $24 in fiscal 2010.
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Contractual Obligations and Other Commitments
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At June 30, 2008 the Company's total off balance sheet contractual obligations were $30,240. This balance consists of $28,496 of long-term operating leases for various facilities and equipment which expire from 2008 to 2017 and the remaining $1,744 is for purchase commitments related to property and equipment. The Company also has contingent earn-out obligations of up to $12,752 to the sellers in an acquisition completed during fiscal year 2005 and an acquisition completed in fiscal 2008. These amounts are payable over the next two years based upon net operating income achieved by the individual acquired business units. The table excludes $4,793 of liabilities under the Financial Accounting Standards Board's Interpretation No. 48, "Accounting for Uncertainty in Income Taxes," as we are unable to reasonably estimate the ultimate amount or timing of settlement.
| Contractual obligations by | Less than | More than | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| period as of June 30, 2008 | 1 year | 1-3 years | 3-5 years | 5 years | TOTAL | |||||
| Operating lease obligations | $ | $8,389 | $ | $10,393 | $ | $4,623 | $ | $5,091 | $ | $28,496 |
| Capital lease obligations | 177 | 24 | - | - | 201 | |||||
| Note payable, including accrued interest | 70,183 | - | - | - | 70,183 | |||||
| Purchase obligations | 1,744 | - | - | - | 1,744 | |||||
| Total | $ | 80,493 | $ | 10,417 | $ | 4,623 | $ | 5,091 | $ | 100,624 |
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement on Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and requires enhanced disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements. SFAS 157 is effective for the Company beginning July 1, 2008. We do not anticipate that the adoption of this Standard will have a material impact on the Company's consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities-Including and amendment of FASB Statement No. 115" ("SFAS 159"). SFAS 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair value to measure its financial assets and liabilities. If the use of fair value is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred. The fair value election is irrevocable and generally made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to retained earnings. Subsequent to the adoption of SFAS 159, changes in fair value are recognized in earnings. SFAS 159 is effective for the Company beginning July 1, 2008. The adoption of this Standard did not have a material impact on the Company's consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," ("SFAS 141(R)") which replaces SFAS No. 141. SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquire and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for the Company on July 1, 2009. SFAS 141(R) will have an impact on the Company's accounting for business combinations on a prospective basis once adopted; however, the materiality of that impact cannot be determined.
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CRITICAL ACCOUNTING POLICIES
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We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). The significant accounting policies are discussed in Note 1 to the consolidated financial statements. The preparation of consolidated financial statements in accordance with U.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosure of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements.
We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions would have a material effect on the consolidated financial statements.
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Revenue Recognition
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We recognize revenue in accordance with the provisions of Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-9, "Software Revenue Recognition, with Respect to Certain Transactions," and clarified by Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition in Financial Statements," SAB 104, "Revenue Recognition," and Emerging Issues Task Force Issue No. 00-21 ("EITF 00-21"), "Accounting for Revenue Arrangements with Multiple Deliverables." The application of these pronouncements requires judgment, including whether a software arrangement includes multiple elements, whether any elements are essential to the functionality of any other elements, and whether vendor-specific objective evidence ("VSOE") of fair value exists for those elements. Customers receive certain elements of our products over time. Changes to the elements in a software arrangement or in our ability to identify VSOE for those elements could materially impact the amount of earned and unearned revenue reflected in the financial statements.
License Fee Revenue. For software license agreements that do not require significant modification or customization of the software, the Company recognizes software license revenue when persuasive evidence of an arrangement exists, delivery of the product has occurred, the license fee is fixed and determinable and collection is probable. The Company's software license agreements generally include multiple products and services or "elements." None of these elements alone are deemed to be essential to the functionality of the other elements. SOP 97-2, as amended by SOP 98-9, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on VSOE of fair value. Fair value is determined for license fees based upon the price charged when sold separately. In the event that we determine that VSOE does not exist for one or more of the delivered elements of a software arrangement, but does exist for all of the undelivered elements, revenue is recognized the residual method allowed by SOP 98-9. Under the residual method, a residual amount of the total arrangement fee is recognized as revenue for the delivered elements after the established fair value of all undelivered elements has been deducted.
Support and Service Fee Revenue. Implementation services are generally for installation, training, implementation, and configuration. These services are not considered essential to the functionality of the related software. VSOE of fair value is established by pricing used when these services are sold separately. Generally revenue is recognized when services are completed. On certain larger implementations, revenue is recognized based on milestones during the implementation. Milestones are triggered by tasks completed or based on direct labor hours.
Maintenance support revenue is recognized pro-rata over the contract period, typically one year. VSOE of fair value is determined based on contract renewal rates.
Outsourced data processing services and ATM, debit card, and other transaction processing services revenues are recognized in the month the transactions were processed or the services were rendered.
Hardware Revenue: Hardware revenue is recognized upon delivery to the customer, when title and risk of loss are transferred. In most cases, we do not stock in inventory the hardware products we sell, but arrange for third-party suppliers to drop-ship the products to our customers on our behalf. Some of our hardware revenues are derived under "arrangements" as defined by SOP 97-2. To the extent hardware revenue is subject to SOP 97-2 and is not deemed essential to the functionality of any of the other elements to the arrangement, it is recognized based on VSOE of fair value at the time of delivery. For these transactions, the Company follows the guidance provided in Emerging Issues Task Force Issue ("EITF") No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." Based upon the indicators provided within this consensus, the Company records the revenue related to our drop-ship transactions at gross and the related costs are included in cost of hardware. The Company also remarkets maintenance contracts on hardware to our customers. Hardware maintenance revenue is recognized ratably over the agreement period.
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Depreciation and Amortization Expense
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The calculation of depreciation and amortization expense is based on the estimated economic lives of the underlying property, plant and equipment and intangible assets, which have been examined for their useful life and determined that no impairment exists. We believe it is unlikely that any significant changes to the useful lives of our tangible and intangible assets will occur in the near term, but rapid changes in technology or changes in market conditions could result in revisions to such estimates that could materially affect the carrying value of these assets and the Company's future consolidated operating results. All long lived assets are tested for valuation and potential impairment on a scheduled annual basis.
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Capitalization of software development costs
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We capitalize certain costs incurred to develop commercial software products and to develop or purchase internal-use software. Significant estimates and assumptions include: determining the appropriate period over which to amortize the capitalized costs based on the estimated useful lives, estimating the marketability of the commercial software products and related future revenues, and assessing the unamortized cost balances for impairment. For commercial software products, determining the appropriate amortization period is based on estimates of future revenues from sales of the products. We consider various factors to project marketability and future revenues, including an assessment of alternative solutions or products, current and historical demand for the product, and anticipated changes in technology that may make the product obsolete. A significant change in an estimate related to one or more software products could result in a material change to our results of operations.
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Estimates used to determine current and deferred income taxes
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We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We also must determine the likelihood of recoverability of deferred tax assets, and adjust any valuation allowances accordingly. Considerations include the period of expiration of the tax asset, planned use of the tax asset, and historical and projected taxable income as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in one or more of these factors. Also, FIN 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect our financial results.
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Assumptions related to purchase accounting and goodwill
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We account for our acquisitions using the purchase method of accounting. This method requires estimates to determine the fair values of assets and liabilities acquired, including judgments to determine any acquired intangible assets such as customer-related intangibles, as well as assessments of the fair value of existing assets such as property and equipment. Liabilities acquired can include balances for litigation and other contingency reserves established prior to or at the time of acquisition, and require judgment in ascertaining a reasonable value. Third party valuation firms may be used to assist in the appraisal of certain assets and liabilities, but even those determinations would be based on significant estimates provided by us, such as forecasted revenues or profits on contract-related intangibles. Numerous factors are typically considered in the purchase accounting assessments, which are conducted by Company professionals from legal, finance, human resources, information systems, program management and other disciplines. Changes in assumptions and estimates of the acquired assets and liabilities would result in changes to the fair values, resulting in an offsetting change to the goodwill balance associated with the business acquired.
As goodwill is not amortized, goodwill balances are regularly assessed for potential impairment. Such assessments require an analysis of future cash flow projections as well as a determination of an appropriate discount rate to calculate present values. Cash flow projections are based on management-approved estimates, which involve the input of numerous Company professionals from finance, operations and program management. Key factors used in estimating future cash flows include assessments of labor and other direct costs on existing contracts, estimates of overhead costs and other indirect costs, and assessments of new business prospects and projected win rates. Significant changes in the estimates and assumptions used in purchase accounting and goodwill impairment testing can have a material effect on the consolidated financial statements.
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Forward Looking Statements
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Except for the historical information contained herein, the matters discussed in the Management's Discussion and Analysis of Financial Condition and Results of Operations and other portions of this report contain forward-looking statements within the meaning of federal securities laws. Actual results are subject to risks and uncertainties, including both those specific to the Company and those specific to the industry, which could cause results to differ materially from those contemplated. The risks and uncertainties include, but are not limited to, the matters detailed in "Risk Factors" in Item 1A of this report. Undue reliance should not be placed on the forward-looking statements. The Company does not undertake any obligation to publicly update any forward-looking statements.
Potential risks and uncertainties which could adversely affect the Company include: the financial health of the financial services industry, our ability to continue or effectively manage growth, adapting our products and services to changes in technology, changes in our strategic relationships, price competition, loss of key employees, consolidation in the banking or credit union industry, increased government regulation, network or internet security problems, operational problems in our outsourcing facilities and others listed in "Risk Factors" at Item 1A.
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