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 discussion should be read in conjunction with our historical financial statements and the related notes included elsewhere in this annual report on Form 10-K, as well as the discussion under “Selected Consolidated Financial Data.” This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in or implied by any of the forward-looking statements as a result of various factors, including but not limited to those listed under “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”
Verisk is a leading data analytics provider serving customers in insurance, energy and specialized markets, and financial services. Using advanced technologies to collect and analyze billions of records, we draw on unique data assets and deep domain expertise to provide innovations that may be integrated into customer workflows. We offer predictive analytics and decision support solutions to customers in rating, underwriting, claims, catastrophe and weather risk, natural resources intelligence, economic forecasting, and many other fields. In the United States, or U.S., and around the world, we help customers protect people, property, and financial assets. Refer to Item 1. Business for further discussion.
Our customers use our solutions to make better decisions about risk and opportunities with greater efficiency and discipline. We refer to these products and services as “solutions” due to the integration among our products and the flexibility that enables our customers to purchase components or the comprehensive package of products. These solutions take various forms, including data, statistical models or tailored analytics, all designed to allow our customers to make more logical decisions. We believe our solutions for analyzing risk positively impact our customers’ revenues and help them better manage their costs.
We previously reported results based on two operating segments, Decision Analytics and Risk Assessment. During the first quarter of 2018, the chief operating decision maker, or CODM, changed how he makes operating decisions, assesses the performance of the business, and allocates resources in a manner that caused the Company's operating segments to change. Consequently, effective as of the first quarter of 2018, our operating segments are based on three vertical markets we serve: Insurance, Energy and Specialized Markets, and Financial Services. These three operating segments are also our reportable segments, which have been retroactively recast to reflect the new segments in all periods presented.
Our Insurance segment provides underwriting and ratings, and claims insurance data for the U.S. P&C insurance industry. This segment's revenues represented approximately 71% and 72% of our revenues for the years ended December 31, 2018 and 2017, respectively. Our Energy and Specialized Markets segment provides research and consulting data analytics for the global energy, chemicals, and metals and mining industries. Our Energy and Specialized Markets segment's revenues represented approximately 22% and 21% of our revenues for the years ended December 31, 2018 and 2017, respectively. Our Financial Services segment provides competitive benchmarking, decisioning algorithms, business intelligence, and customized analytic services to financial institutions, payment networks and processors, alternative lenders, regulators and merchants. Our Financial Services segment's revenues represented approximately 7% of our revenues for the years ended December 31, 2018 and 2017.
Executive Summary
Key Performance Metrics
We believe our business’s ability to grow recurring revenue and generate positive cash flow is the key indicator of the successful execution of our business strategy. We use year-over-year revenue and EBITDA growth as metrics to measure our performance. EBITDA and EBITDA margin are non-GAAP financial measures (see Note 2 within Item 6. Selected Financial Data section of Management’s Discussion and Analysis of Financial Condition and Results of Operations). The respective GAAP financial measures are net income and net income margin.
Revenue growth. We use year-over-year revenue growth as a key performance metric. We assess revenue growth based on our ability to generate increased revenue through increased sales to existing customers, sales to new customers, sales of new or expanded solutions to existing and new customers, and strategic acquisitions of new businesses.
EBITDA growth. We use EBITDA growth as a proxy for the cash generated by the business. EBITDA growth serves as a measure of our ability to balance the size of revenue growth with cost management and investing for future growth.
EBITDA margin. We use EBITDA margin as a metric to assess segment performance and scalability of our business. We assess EBITDA margin based on our ability to increase revenues while controlling expense growth.
Revenues
We earn revenues through agreements for hosted subscriptions, advisory/consulting services, and for transactional solutions, recurring and non-recurring. Subscriptions for our solutions are generally paid in advance of rendering services either quarterly or in full upon commencement of the subscription period, which is usually for one year and automatically renewed each year. As a result, the timing of our cash flows generally precedes our recognition of revenues and income and our cash flow from operations tends to be higher in the first quarter as we receive subscription payments. Examples of these arrangements include subscriptions that allow our customers to access our standardized coverage language, our claims fraud database or our actuarial services throughout the subscription period. In general, we experience minimal revenue seasonality within the business.
Approximately 82% and 81% of the revenues in our Insurance segment for the years ended December 31, 2018 and 2017 were derived from hosted subscriptions through agreements (generally one to five years) for our solutions. Our customers in this segment include most of the P&C insurance providers in the U.S. Approximately 78% and 82% of the revenues in our Energy and Specialized Markets segment for the years ended December 31, 2018 and 2017, respectively, were derived from hosted subscriptions with long-term agreements for our solutions. Our customers in this segment include most of the top 10 global energy providers around the world. Approximately 73% and 72% of the revenues in our Financial Services segment for the years ended December 31, 2018 and 2017, respectively, were derived from subscriptions with long-term agreements for our solutions, respectively. Our customers in this segment include financial institutions, payment networks and processors, alternative lenders, regulators, merchants, and all of the top 30 credit card issuers in North America, the United Kingdom, and Australia.
We also provide advisory/consulting services, which help our customers get more value out of our analytics and their subscriptions. In addition, certain of our solutions are paid for by our customers on a transactional basis, recurring and non-recurring. For example, we have solutions that allow our customers to access property-specific rating and underwriting information to price a policy on a commercial building, or compare a P&C insurance or a workers' compensation claim with information in our databases, or use our repair cost estimation solutions on a case-by-case basis. For the years ended December 31, 2018 and 2017, approximately 20% and 19%, respectively, of our revenues were derived from providing transactional and advisory/consulting solutions.
Principal Operating Costs and Expenses
Personnel expenses are a major component of both our cost of revenues and selling, general and administrative expenses. Personnel expenses, which represented approximately 58% and 59% of our total operating expenses for the years ended December 31, 2018 and 2017, respectively, include salaries, benefits, incentive compensation, equity compensation costs, sales commissions, employment taxes, recruiting costs, and outsourced temporary agency costs.
We assign personnel expenses between two categories, cost of revenues and selling, general and administrative costs, based on the actual costs associated with each employee. We categorize employees who maintain our solutions as cost of revenues, and all other personnel, including executive managers, sales people, marketing, business development, finance, legal, human resources, and administrative services, as selling, general and administrative expenses. A significant portion of our other
operating costs, such as facilities and communications, are either captured within cost of revenues or selling, general and administrative expense based on the nature of the work being performed.
While we expect to grow our headcount over time to take advantage of our market opportunities, we believe that the economies of scale in our operating model will allow us to grow our personnel expenses at a lower rate than revenues. Historically, our EBITDA margin has improved because we have been able to increase revenues without a proportionate corresponding increase in expenses. However, part of our corporate strategy is to invest in new solutions and new businesses, which may offset margin expansion.
Cost of Revenues. Our cost of revenues consists primarily of personnel expenses. Cost of revenues also includes the expenses associated with the acquisition and verification of data, the maintenance of our existing solutions and the development and enhancement of our next-generation solutions. Our cost of revenues excludes depreciation and amortization.
Selling, General and Administrative Expense. Our selling, general and administrative expense also consists primarily of personnel costs. A portion of the other operating costs such as facilities, insurance and communications are allocated to selling, general and administrative costs based on the nature of the work being performed by the employee. Our selling, general and administrative expenses excludes depreciation and amortization.
Trends Affecting Our Business
We serve customers in three primary vertical markets: P&C insurance, energy and specialized markets, and financial services. The industry trends in each of those markets can affect our business.
A significant change in P&C insurers’ profitability could affect the demand for our solutions. For insurers, the keys to profitability include increasing investment income, premium growth and disciplined underwriting of risks. Investment income remains under pressure as a result of low interest rates. Growth in P&C insurers’ direct written premiums is cyclical, with total industry premium growth receding from a peak of 14.8% in 2002 to a trough of negative 3.1% in 2009 and subsequently recovering to 4.4% in 2012, 4.3% in 2013, 4.4% in 2014, 3.7% in 2015, 3.7% in 2016 and 4.7% in 2017. In recent years, we have signed multi-year contracts with certain customers, and pricing is fixed at the beginning of each multi-year period; pricing for other customers is still linked to prior years' premiums.
Based on the most recent results available, direct premium growth and net premium growth accelerated in 2018. However, insurers were also challenged by heightened catastrophic losses in 2018 associated with major hurricanes, such as Florence and Michael, and several devastating wildfires in the state of California, coupled with additional losses reported from the three major hurricanes in 2017 - Harvey, Irma, and Maria. These events illustrate the need for broader coverages, such as flood to meet the changing needs of communities. We continue to provide the necessary resources to meet insurer needs.
Trends in catastrophe and non-catastrophe weather losses can have an effect on our customers’ profitability, and therefore on their appetite for buying analytics to help them manage their risks. Any increase or decrease in frequency or severity of weather events over time could lead to an increased or decreased demand for our catastrophe modeling, catastrophe loss information, and repair cost solutions. Likewise, any structural changes in the reinsurance and related brokerage industry from the recent influx of alternative capital or newer technologies could affect demand for our products. We also have a portion of our revenue related to the number of claims processed due to losses, which can be impacted by seasonal storm activity. The need by our customers to fight insurance fraud - both in claims and at policy inception - could lead to increased demand for our underwriting and claims solutions.
Trends in the energy, chemicals, and metals and mining sectors and activity in financial markets can influence our revenues. During 2018, the Brent oil price reached a peak of over approximately 80 dollar per barrel before falling under approximately 60 dollar per barrel by year end reflecting an oversupply in the market. The Organization of the Petroleum Exporting Countries, or OPEC, announced a significant cut in production beginning January 1, 2019 to help balance the market. In the upstream sector there are five global trends. First, capital investments have recovered from the cyclical low, the start of spend on a new global phase of significant liquefied natural gas projects adding momentum in 2019. Second, the industry’s ongoing progress in reducing costs have been boosted by digitalization initiatives as well as over-capacity in the service sector in many regions, leading to improved economics and more projects reaching a final investment decision. Third, tight oil production in the U.S. lower 48 is still on a strong growth trajectory and remains a focus of global merger and acquisition activity as the industry consolidates. Fourth, resource capture continues to be focused on lower risk opportunities with competitive bidding in 2019 to develop discovered fields in Qatar (gas) and Brazil (oil). Fifth, many countries are reviewing their existing fiscal policies to ensure that they are competitive and attract investment. In the wider energy sector the energy transition is gaining momentum, most evidently in the rapid penetration of renewables into power and the emergence of electric vehicles – the latter set to present a competitive challenge to the internal combustion engine in the coming decades and
with implications for oil demand in the long term. Petrochemicals is a key growth segment for oil demand, but the disposal of plastics is increasingly in the public eye as a social and environmental concern. New legislation limiting sulphur content in marine fuels comes into effect in 2020 with profound implications for refiners and major fuel consumers, such as airlines. As environmental concerns and the move to decarbonization gather pace, we will continue to evolve our offerings to meet the needs of our customers in a dynamic market and remain increasingly well positioned to serve our customers' information and analytical needs.
Market trends continue to influence our Financial Services segment in important ways. As we look forward towards 2019, increasing fraud and delinquency loss rates worldwide are strengthening demand for robust risk solutions which we are addressing via a range of new fraud solutions, which we have initially launched in Mexico. Additionally, higher levels of regulatory scrutiny as well as greater regulatory alignment worldwide is increasing demand for compliance and reporting tools, which we are tackling via our range of compliance products developed both within our Financial Services segment. In order to better serve our customers, add to our data asset, and expand our expertise, we made a number of acquisitions in the past year, including Marketview, which provides analytical solutions for banks, acquirers, merchants and government in New Zealand. These new businesses offer new solutions for existing and new clients of our core business, and enable us to develop product and cost synergies going forward, and join our existing businesses that we acquired earlier and have integrated during 2018.
Description of Acquisitions
We acquired twenty-two businesses since January 1, 2016. These acquisitions affect the comparability of our consolidated results of operations between periods. See Note 10 to our consolidated financial statements included in this annual report on Form 10-K for further discussions on the below acquisitions.
2018 Acquisitions
On December 14, 2018, we acquired Rulebook, whose proprietary pricing engine can be used for internal pricing and underwriting as well as external distribution for the insurance market through its platform. Rulebook furthers our goal of providing solutions to the global insurance market, including a comprehensive chain of solutions to specialty insurers for mitigating risk and optimizing total cost of operations. Rulebook is part of the underwriting and ratings category within the Insurance segment.
On June 20, 2018, we acquired 100 percent of the stock of Validus-IVC Limited, or Validus, a provider of claims management solutions and developer of the subrogation portal in the UK, verifyTM. Validus has become part of the claims category within our Insurance segment. The integration of Validus' verifyTM platform with our global claims analytic services allows insurers to take advantage of enhanced analytic and technology tools to help improve and automate the claims settlement process.
On February 21, 2018, we acquired 100 percent of the stock of Business Insight Limited, Business Insight, a provider of predictive analytics for insurers in the U.K. and Ireland. Business Insight has become part of the underwriting and ratings category within the Insurance segment. Business Insight offers a comprehensive set of peril models to support underwriting and rating for the commercial property and homeowners insurance market.
On January 5, 2018, we acquired 100 percent of the stock of Marketview Limited, or Marketview. Marketview is a provider of consumer spending analysis and insights across the retail, hospitality, property, and government sectors in New Zealand. Marketview has become part of the Financial Services segment. The acquisition helps expand the our solutions related to consumer spending analytics across the Australasia and Oceania regions by combining its domain expertise and proprietary data assets with those of Marketview.
2017 Acquisitions
On December 29, 2017, we acquired 100 percent of the stock of PowerAdvocate, a provider of market, cost intelligence, and supply chain solutions serving the energy sector. Within our Energy and Specialized Markets segment, PowerAdvocate expands our offerings to the energy sector by adding proprietary spend data and cost models and providing insight into customers' cost savings opportunities.
On December 22, 2017, we acquired the net assets of Service Software, LLC., or Service Software, a provider of business management software for the construction industry. Within our Insurance segment, Service Software expands our offerings to the insurance sector by integrating with the existing loss quantification solutions, which makes it possible for restoration professionals to save time by sharing job information, reducing duplicate data entry, and increasing productivity.
On November 9, 2017, we acquired 100 percent of the stock of Rebmark Legal Solutions Ltd., or Rebmark, a provider of injury claims solutions, within the Insurance segment. Rebmark’s solutions aid claimant and defendant lawyers, barristers, and claims handlers with the preparation of schedules of loss, which is useful in complex, high-value injury claims where calculations can be time-consuming and there is greater potential for error.
On August 31, 2017, we acquired 100 percent of the stock of LCI, a provider of risk insight, prediction, and management solutions for banks and creditors. LCI has become part of the Financial Services segment. This acquisition brings together our proprietary data assets and LCI's proprietary time-series data, including consumer and commercial bankruptcies, consumer behavior, and legal and technical terms associated with debtor settlements.
On August 23, 2017, we acquired 100 percent of the stock of Sequel, a provider of commercial and specialty insurance and reinsurance software based in the U.K. Sequel has become part of the Insurance segment. The acquisition of Sequel further enhances our comprehensive offerings to the global complex commercial and specialty insurance industry, enabling integrated global data analytics through a specialized end-to-end workflow solution.
On August 3, 2017, we acquired 100 percent of the stock of G2, a provider of merchant risk intelligence solutions for acquirers, commercial banks, and other payment system providers. G2 has become part of the Financial Services segment. The acquisition of G2 positions us to further enhance our offerings to clients and partners, by providing solutions that help fight fraud, transaction laundering, and reputational risk within the global payments and e-commerce ecosystem.
During the three months ended June 30, 2017, we acquired the net assets of the Aerial Imagery acquisitions, a group of similar but unrelated companies, which give us broad geographic coverage of the U.S. for aerial image capture purposes. The Aerial Imagery acquisitions provide multi-spectral aerial photographic services with expertise in offering digital photogrammetric and remote sensing data for mapping and surveying applications. Within our Insurance segment, the Aerial Imagery acquisitions enable us to enhance and maintain its database of images with the required frequency, resolution, and coverage across the U.S. to support our objective as the leading provider of loss quantification data, analytics, and decision-support solutions to the insurance industry, and the photogrammetry, surveying, mapping, and other related markets.
On May 19, 2017, we acquired 100 percent of the stock of MAKE Consulting A/S, or MAKE, a research and advisory business specializing in wind power. MAKE has become part of the Energy and Specialized Markets segment. MAKE enhances our offering to existing customers and forms a market analysis and advisory consortium on renewables and the transformation of the global electricity industry. With detailed coverage of power market fundamentals, solar, wind, energy storage, and grid edge technologies, the Energy and Specialized Markets segment is positioned to bring customers market analysis and insight on the evolution of the energy landscape and provide a comprehensive platform for the future.
On March 31, 2017, we acquired 100 percent of the stock of Fintellix Solutions Private Limited, or Fintellix, a Bangalore-based data solutions company specializing in the development of data management platforms and regulatory reporting solutions for financial institutions. Fintellix has become part of the Financial Services segment. The acquisition of Fintellix positions us to expand the data hosting and regulatory platforms and better address the increasingly complex needs of its customers.
On February 24, 2017, we acquired 100 percent of the stock of Emergent Network Intelligence Limited, or ENI, a developer in insurance claims efficiency and fraud detection solutions based in the U.K.. With the acquisition of ENI within the Insurance segment, our customers in the U.K. can take advantage of technologically advanced tools that allow them to improve motor vehicle claims workflow and reduce their costs and exposure to fraud.
On February 16, 2017, we acquired 100 percent of the stock of Healix International Holdings Limited, or Healix, a software analytics provider in automated medical risk assessment for the travel insurance industry. Healix is within our Insurance segment. The acquisition further expands our offerings for the global insurance industry, providing solutions that are embedded with customer workflows and can help underwrite medical coverage for travelers with greater speed, accuracy, and efficiency.
On January 21, 2017, we acquired 100 percent of the stock of Arium Limited, or Arium. Arium specializes in liability risk modeling and decision support. Arium has become part of the insurance vertical within the Insurance segment, and enables us to provide its customers with additional modeling solutions and analytics for the casualty market.
2016 Acquisitions
On November 23, 2016, we acquired the net assets of IntelliStance, LLC, or MarketStance, a provider of market intelligence data and analytics to the property/casualty insurance market. MarketStance has become part of our Insurance segment. MarketStance has built a proprietary analytics model to provide actionable insights on customer's profitability that enhances our existing offerings.
On November 11, 2016, we acquired 100 percent of the stock of The GeoInformation Group Limited, or GeoInformation, a provider of geographic data solutions. GeoInformation offers mapping services and geospatial data and analytic solutions to companies and public sector organizations. GeoInformation's resources complement the risk management and predictive analytics capabilities internationally within the Insurance segment.
On October 20, 2016, we acquired 100 percent of the stock of Analyze Re, Inc., or Analyze Re, a software analytics provider for the reinsurance and insurance industries. Analyze Re has become part of our Insurance segment and enables us to provide our customers with additional real-time pricing, exposure management, and enterprise portfolio roll-up capabilities.
On August 19, 2016, we acquired the net assets of data and subscriptions business of Quest Offshore Resources, Inc, or Quest Offshore, which supplies market intelligence to the offshore oil and gas sector. The data and subscriptions business has become part of the Energy and Specialized Markets segment and complements its existing upstream analysis expertise.
On July 26, 2016, we acquired 100 percent of the stock of Greentech Media, Inc., or Greentech Media, an information services provider for the electricity and renewables sector. Greentech Media has become part of the Energy and Specialized Markets segment and enables us to provide our customers with market intelligence across several categories, including solar generation, energy storage, and smart grids that react to changes in supply and demand.
On April 14, 2016, we acquired 100 percent of the stock of Risk Intelligence Ireland Limited, or RII, a provider of fraud detection, compliance, risk control, and process automation services to the Irish insurance industry. RII enhances the ability of our Insurance segment to serve the international insurance market.
Description of Discontinued Operations
On June 1, 2016, we sold our healthcare business, Verisk Health. The purchase price consisted of a cash consideration of $714.6 million, net of closing adjustments of $5.4 million, and proceeds from a promissory note associated with the sale of $100.0 million, that was received in August 2018. Results of operations for the healthcare business are reported as discontinued operations for the year ended December 31, 2016 and for all prior periods presented. See Note 11 to our consolidated financial statements included in this annual report on Form 10-K.
Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
Consolidated Results of Continuing Operations
Revenues
Revenues were $2,395.1 million for the year ended December 31, 2018 compared to $2,145.2 million for the year ended December 31, 2017, an increase of $249.9 million or 11.6%. In 2017 and 2018, we acquired the following companies, Rebmark, Service Software, PowerAdvocate, Marketview, Business Insight, Validus, and Rulebook, collectively referred to as our recent acquisitions, which we define as acquisitions not owned for a significant portion of both the current period and/or prior period and would therefore impact the comparability of the financial results. Excluding revenues of $110.9 million from our recent acquisitions, our revenue growth was $139.0 million or 6.5%. Revenues within our Insurance segment, excluding our recent acquisitions of Rebmark, Service Software, Business Insight, Validus, and Rulebook, increased by $111.3 million or 7.2%. Revenues in our Energy and Specialized Market segment, excluding our recent acquisition of PowerAdvocate, increased by $30.6 million or 6.9%. Revenues in our Financial Services segment, excluding our recent acquisition of Marketview, decreased by $2.9 million or 2.0%. Refer to the Results of Continuing Operations by Segment within this section for further information regarding our revenues.
| 2018 | 2017 | Percentage change | Percentage change excluding recent acquisitions | ||||||||||
| (in millions) | |||||||||||||
| Insurance | $ | 1,705.9 | $ | 1,550.6 | 10.0 | % | 7.2 | % | |||||
| Energy and Specialized Markets | 513.3 | 444.6 | 15.4 | % | 6.9 | % | |||||||
| Financial Services | 175.9 | 150.0 | 17.3 | % | (2.0 | )% | |||||||
| Total revenues | $ | 2,395.1 | $ | 2,145.2 | 11.6 | % | 6.5 | % |
Cost of Revenues
Cost of revenues was $886.2 million for the year ended December 31, 2018 compared to $783.8 million for the year ended December 31, 2017, an increase of $102.4 million or 13.1%. Our recent acquisitions accounted for an increase of $55.0 million in cost of revenues, primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, our cost of revenues increased $47.4 million or 6.1%. The increase was primarily due to increases in salaries and employee benefits cost of $30.8 million, data costs and data processing fees of $5.0 million, rent and facilities expenses of $4.8 million, information technology expense of $4.2 million, and other operating costs of $2.6 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SGA, were $378.7 million for the year ended December 31, 2018 compared to $322.8 million for the year ended December 31, 2017, an increase of $55.9 million or 17.3%. Our recent acquisitions accounted for an increase of $30.6 million in SGA, primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, SGA increased $25.3 million or 8.1%. The increase was primarily due to increases in salaries and employee benefits (which include annual salaries increase, medical costs, and long term equity compensation plan costs) of $17.8 million, information technology expense of $3.8 million, professional consulting fees of $2.4 million, and other general and administrative of $1.3 million.
Depreciation and Amortization of Fixed Assets
Depreciation and amortization of fixed assets was $165.3 million for the year ended December 31, 2018 compared to $135.6 million for the year ended December 31, 2017, an increase of $29.7 million or 21.9%. The increase in depreciation and amortization of fixed assets includes depreciation and amortization related to our recent acquisitions of $9.4 million. The remaining increase primarily relates to depreciation and amortization of hardware and software development costs and aircraft equipment placed into production to support data capacity expansion and revenue growth.
Amortization of Intangible Assets
Amortization of intangible assets was $130.8 million for the year ended December 31, 2018 compared to $101.8 million for the year ended December 31, 2017, an increase of $29.0 million or 28.5%. The increase in amortization of intangible assets was primarily due to amortization related to our recent acquisitions of $26.0 million and currency fluctuations impacting amortization denominated in currencies other than U.S. dollars.
Investment Income and Others, Net
Investment income and others, net was a gain of $15.3 million for the year ended December 31, 2018 compared to a gain of $9.2 million for the year ended December 31, 2017. The increase of $6.1 million was primarily due to a realized gain of $12.3 million on the repayment of subordinated promissory note receivable in August 2018, prior to its maturity. This gain was partially offset by a reduction in interest income on the note due to the payoff that occurred in August 2018.
Interest Expense
Interest expense was $129.7 million for the year ended December 31, 2018 compared to $119.4 million for the year ended December 31, 2017, an increase of $10.3 million or 8.6%. The increase was due to our higher average outstanding borrowings for the year ended December 31, 2018 related to the credit facility. These higher average outstanding borrowings in 2018 were primarily associated with the funding of our share repurchase program and the acquisition of PowerAdvocate, which occurred in December of 2017.
Provision for Income Taxes
The provision for income taxes was $121.0 million for the year ended December 31, 2018 compared to $135.9 million for the year ended December 31, 2017, a decrease of $14.9 million or 11.0%. The effective tax rate was 16.8% for the year ended December 31, 2018 compared to 19.7% for the year ended December 31, 2017. The decrease in the effective tax rate in 2018 compared to 2017 was primarily due to the impact of tax reform lowering the U.S. tax rate from 35.0% to 21.0%, as well as the impact of greater tax benefits from equity compensation.
Net Income
The net income margin for our consolidated results was 25.0% for the year ended December 31, 2018 compared to 25.9% for the year ended December 31, 2017.
EBITDA
The EBITDA margin for our consolidated results was 47.8% for the year ended December 31, 2018 compared to 48.8% for the year ended December 31, 2017. The EBITDA margin for the year ended December 31, 2018 was negatively impacted by the recent acquisitions with slightly lower margins.
Results of Continuing Operations by Segment
Insurance
Revenues
Revenues for our Insurance segment were $1,705.9 million for the year ended December 31, 2018 compared to $1,550.6 million for the year ended December 31, 2017, an increase of $155.3 million or 10.0%. Excluding revenues of $44.0 million from our recent acquisitions of Rebmark, Service Software, Business Insight, Validus, and Rulebook, Insurance revenues increased $111.3 million or 7.2%.
| 2018 | 2017 | Percentage change | Percentage change excluding recent acquisitions | ||||||||||
| (in millions) | |||||||||||||
| Underwriting & rating | $ | 1,144.5 | $ | 1,046.9 | 9.3 | % | 6.6 | % | |||||
| Claims | 561.4 | 503.7 | 11.5 | % | 8.5 | % | |||||||
| Total Insurance | $ | 1,705.9 | $ | 1,550.6 | 10.0 | % | 7.2 | % |
Our underwriting & rating revenue increased $97.6 million or 9.3%; excluding revenues from recent acquisitions of $29.0 million, our underwriting & rating revenue increased $68.6 million or 6.6%, primarily resulted from an increase in prices derived from continued enhancements to the content of the solutions within our industry-standard insurance programs as well as selling expanded solutions to existing customers. In addition, property-specific underwriting solutions and catastrophe modeling services contributed to the growth.
Our claims revenue increased $57.7 million or 11.5%; excluding revenues from recent acquisitions of $15.0 million, our claims revenue increased $42.7 million or 8.5%, primarily due to growth in our repair cost estimating solutions, claims analytics and aerial imagery solutions revenue. The repair costs estimating and aerial imagery-based solutions contributed approximately $16.0 million in revenues related to severe storms for the year ended December 31, 2017, which did not reoccur in 2018.
Cost of Revenues
Cost of revenues for our Insurance segment was $568.1 million for the year ended December 31, 2018 compared to $510.4 million for the year ended December 31, 2017, an increase of $57.7 million or 11.3%. Our recent acquisitions within the Insurance segment represented an increase of $22.0 million in cost of revenues, which was primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, our cost of revenues increased $35.7 million or 7.0%. The increase was primarily due to increases in salaries and employee benefits of $21.3 million, rent and facilities expenses of $4.2 million, data costs and data processing fees of $3.6 million, information technology expense of $3.4 million, and other operating costs of $3.2 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for our Insurance segment were $218.8 million for the year ended December 31, 2018 compared to $196.1 million for the year ended December 31, 2017, an increase of $22.7 million or 11.6%. Our recent acquisitions within the Insurance segment, accounted for an increase of $10.4 million in SGA, was primarily related to salaries and employee benefits. Excluding costs associated with our recent acquisitions, SGA increased $12.3 million or 6.5%. The increase was primarily due to increases in salaries and employee benefits (which include annual salaries increase, medical costs, and long term equity compensation plan costs) of $8.4 million, information technology expense of $3.0 million, and professional consulting fees of $1.0 million. These increases were offset by a decrease in other general expenses of $0.1 million.
EBITDA
EBITDA for our Insurance segment was $932.2 million for the year ended December 31, 2018 compared to $855.8 million for the year ended December 31, 2017. The EBITDA margin for our Insurance segment was 54.6% for the year ended December 31, 2018 compared to 55.2% for the year ended December 31, 2017. The EBITDA margin for the year ended December 31, 2018 was negatively impacted by the recent acquisitions with slightly lower margins.
Energy and Specialized Markets
Revenues
Revenues for our Energy and Specialized Markets segment were $513.3 million for the year ended December 31, 2018 compared to $444.6 million for the year ended December 31, 2017, an increase of $68.7 million or 15.4%. Excluding revenues of $38.1 million from our recent acquisition of PowerAdvocate, revenues for our Energy and Specialized Markets increased $30.6 million or 6.9% for the year ended December 31, 2018. The increase within this segment primarily resulted from continuing end-market improvements in the energy sector and growth in our environmental health and safety service revenue.
Cost of Revenues
Cost of revenues for our Energy and Specialized Markets segment was $218.2 million for the year ended December 31, 2018 compared to $193.8 million for the year ended December 31, 2017, an increase of $24.4 million or 12.6%. Our recent acquisition within this segment represented an increase of $13.9 million in cost of revenues, which was primarily related to salaries and employee benefits. Excluding the impact of our recent acquisition, our cost of revenues increased $10.5 million or 5.4%. The increase was primarily due to increases in salaries and employee benefit costs of $7.1 million, rent and facilities expense of $0.5 million, information technology expense of $0.5 million, and other operating costs of $2.5 million. These increases were offset by a decrease in data costs and data processing fees of $0.1 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for our Energy and Specialized Markets segment were $141.1 million for the year ended December 31, 2018 compared to $114.4 million for the year ended December 31, 2017, an increase of $26.7 million or 23.3%. Our recent acquisition within this segment accounted for an increase of $16.2 million in SGA expenses, which was primarily related to salaries and employee benefits. Excluding costs associated with our recent acquisition, SGA increased $10.5 million or 9.1%. The increase was primarily due to increases in salaries and employee benefit costs of $8.0 million, information technology expenses of $0.8 million, professional consulting costs of $0.2 million and other general expense of $1.5 million.
EBITDA
EBITDA for our Energy and Specialized Markets segment was $154.4 million for the year ended December 31, 2018 compared to $133.6 million for the year ended December 31, 2017. The EBITDA margin for our Energy and Specialized Markets segment was 30.1% for the year ended December 31, 2018 compared to 30.0% for the year ended December 31, 2017.
Financial Services
Revenues
Revenues for our Financial Services segment were $175.9 million for the year ended December 31, 2018 compared to $150.0 million for the year ended December 31, 2017, an increase of $25.9 million or 17.3%. Excluding revenues of $28.8 million from our recent acquisition of Marketview, revenues for our Financial Services decreased $2.9 million or 2.0% for the year ended December 31, 2018. The decrease within this segment resulted from nonrecurring project revenues that occurred during the year ended December 31, 2017 and did not reoccur in 2018, which offset the growth in portfolio management solutions and spend informed analytics revenues.
Cost of Revenues
Cost of revenues for our Financial Services segment was $99.9 million for the year ended December 31, 2018 compared to $79.6 million for the year ended December 31, 2017, an increase of $20.3 million or 25.5%. Our recent acquisition within this segment represented an increase of $19.1 million in cost of revenues, which was primarily related to salaries and employee benefits. Excluding the impact of our recent acquisition, our cost of revenues increased $1.2 million or 1.6%. The increase was primarily due to increases in salaries and employee benefit costs of $2.4 million, data costs and data processing fees of $1.5 million, information technology expense of $0.3 million, and rent and facilities expense of $0.1 million. These increases were offset by a decrease in other operating costs of $3.1 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for our Financial Services segment were $18.8 million for the year ended December 31, 2018 compared to $12.3 million for the year ended December 31, 2017, an increase of $6.5 million or 52.7%. Our recent acquisition within this segment accounted for an increase of $4.0 million in SGA expenses, which was primarily related to salaries and employee benefits. Excluding costs associated with our recent acquisition, SGA increased $2.5 million or 24.7%. The increase was primarily due to increases in salaries and employee benefit costs of $1.4 million, and professional consulting costs of $1.2 million. The increases were offset by a decrease in other general expense of $0.1 million.
EBITDA
EBITDA for our Financial Services segment was $58.9 million for the year ended December 31, 2018 compared to $58.4 million for the year ended December 31, 2017. The EBITDA margin for our Financial Services segment was 33.5% for the year ended December 31, 2018 compared to 39.0% for the year ended December 31, 2017. The decrease in EBITDA margin was primarily due to an acquisition contingent payment of $3.5 million related to the Fintellix acquisition that negatively impacted our margin for the year ended December 31, 2018.
Year Ended December 31, 2017 Compared to Year Ended December 31, 2016
Consolidated Results of Continuing Operations
Revenues
Revenues were $2,145.2 million for the year ended December 31, 2017 compared to $1,995.2 million for the year ended December 31, 2016, an increase of $150.0 million or 7.5%. Excluding revenues of $61.3 million from RII, Greentech Media, Quest Offshore, Analyze Re, GeoInformation, MarketStance, Arium, Healix, ENI, Fintellix, MAKE, Aerial Imagery acquisitions, G2, Sequel, LCI, Rebmark, and Service Software, collectively referred to as our recent acquisitions, which we define as acquisitions not owned for a significant portion of both the current period and/or prior period and would therefore impact the comparability of the financial results, our revenue growth was $88.7 million or 4.5%. Revenues within our Insurance segment, excluding our recent acquisitions of RII, Analyze Re, GeoInformation, MarketStance, Arium, Healix, ENI, Aerial Imagery, Sequel, Rebmark, and Service Software, increased by $102.3 million or 7.2%. Revenues in our Energy and Specialized Markets segment, excluding our recent acquisitions of Greentech Media, Quest Offshore, and MAKE, decreased by $9.5 million or 2.2%. Revenues in our Financial Services segment, excluding our recent acquisitions of Fintellix, G2, and LCI, decreased by $4.1 million or 3.0%. Refer to the Results of Continuing Operations by Segment within this section for further information regarding our revenues.
| 2017 | 2016 | Percentage change | Percentage change excluding recent acquisitions | ||||||||||
| (in millions) | |||||||||||||
| Insurance | $ | 1,550.6 | $ | 1,419.1 | 9.3 | % | 7.2 | % | |||||
| Energy and Specialized Markets | 444.6 | 442.8 | 0.4 | % | (2.2 | )% | |||||||
| Financial Services | 150.0 | 133.3 | 12.5 | % | (3.0 | )% | |||||||
| Total revenues | $ | 2,145.2 | $ | 1,995.2 | 7.5 | % | 4.5 | % |
Cost of Revenues
Cost of revenues was $783.8 million for the year ended December 31, 2017 compared to $714.4 million for the year ended December 31, 2016, an increase of $69.4 million or 9.7%. Our recent acquisitions accounted for an increase of $45.3
million in cost of revenues, primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, our cost of revenues increased $24.1 million or 3.4%. The increase was primarily due to increases in salaries and employee benefits cost of $30.7 million, data costs and data processing fees of $6.1 million, information technology expense of $1.7 million and other operating costs of $0.1 million. These increases were offset by a decrease in a nonrecurring ESOP charge of $14.5 million, which occurred in 2016. The ESOP charge was related to the stretch-out of our ESOP loan, which was paid off in 2015.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, or SGA, were $322.8 million for the year ended December 31, 2017 compared to $301.6 million for the year ended December 31, 2016, an increase of $21.2 million or 7.0%. Our recent acquisitions accounted for an increase of $13.7 million in SGA, primarily related to salaries and employee benefits, and transaction costs. Excluding the impact of our recent acquisitions, SGA increased $7.5 million or 2.5%. The increase was primarily due to increases in salaries and employee benefits of $8.8 million, professional consulting fees of $4.0 million and other general and administrative of $0.2 million. These increases were offset by a decrease in information technology expense of $1.2 million and a 2016 ESOP charge of $4.3 million.
Depreciation and Amortization of Fixed Assets
Depreciation and amortization of fixed assets was $135.6 million for the year ended December 31, 2017 compared to$119.1 million for the year ended December 31, 2016, an increase of $16.5 million or 13.8%. The increase in depreciation and amortization of fixed assets includes depreciation and amortization related to our recent acquisitions of $3.8 million. The remaining increase primarily relates to depreciation and amortization of hardware and software development costs placed into production to support data capacity expansion and revenue growth.
Amortization of Intangible Assets
Amortization of intangible assets was $101.8 million for the year ended December 31, 2017 compared to $92.5 million for the year ended December 31, 2016, an increase of $9.3 million or 10.1%. The increase in amortization of intangible assets was primarily related to our recent acquisitions of $13.5 million offset by currency fluctuations impacting amortization denominated in currencies other than U.S. dollars.
Investment Income and Others, Net
Investment income and others, net was a gain of $9.2 million for the year ended December 31, 2017 compared to $6.1 million for the year ended December 31, 2016, an increase of $3.1 million. The increase was primarily related to an increase in interest income of $5.1 million generated from the subordinated promissory note associated with the divestiture of our healthcare business. This increase was offset by a gain on sale of equity investments of $1.5 million in 2016.
Interest Expense
Interest expense was $119.4 million for the year ended December 31, 2017 compared to $120.0 million for the year ended December 31, 2016, a decrease of $0.6 million or 0.5%, as a result of the Second Amendment to the Credit Facility in May 2016, which reduced the borrowing capacity from $1,750.0 million to $1,500.0 million.
Provision for Income Taxes
The provision for income taxes was $135.9 million for the year ended December 31, 2017 compared to $202.2 million for the year ended December 31, 2016, a decrease of $66.3 million or 32.8%. The effective tax rate was 19.7% for the year ended December 31, 2017 compared to 30.9% for the year ended December 31, 2016. The decrease in the effective tax rate in 2017 compared to 2016 was primarily due to lowered federal income tax rates as a result of U.S. Tax Reform and the adoption of ASU No. 2016-09, partially offset by legislation enacted in the U.K.
Net Income
The net income margin for our consolidated results, including discontinued operations, was 25.9% for the year ended December 31, 2017 compared to 28.1% for the year ended December 31, 2016. Our net income margin for the year ended December 31, 2017 was positively impacted by the 2017 tax reform legislation of 4.2%. Our net income margin for the year ended December 31, 2016 was positively impacted by the discontinued operations, including the gain on sale of our healthcare business of 5.5% and lowered by an ESOP charge of 0.6%.
EBITDA
The EBITDA margin for our consolidated results, including discontinued operations, was 48.8% for the year ended December 31, 2017 compared to 59.4% for the year ended December 31, 2016. Our EBITDA margin for the year ended December 31, 2016 was positively impacted by the discontinued operations, including the gain on sale of our healthcare business, of 10.0%, which was partially offset by the impact from an ESOP charge of 0.9%.
Results of Continuing Operations by Segment
Insurance
Revenues
Revenues for our Insurance segment were $1,550.6 million for the year ended December 31, 2017 compared to $1,419.1 million for the year ended December 31, 2016, an increase of $131.5 million or 9.3%. Excluding revenues of $29.2 million from our recent acquisitions of RII, GeoInformation, MarketStance, Analyze Re, Arium, Healix, ENI, Aerial Imagery acquisitions, Sequel, Rebmark, and Service Software, Insurance revenues increased $102.3 million or 7.2%.
| 2017 | 2016 | Percentage change | Percentage change excluding recent acquisitions | ||||||||||
| (in millions) | |||||||||||||
| Underwriting & rating | $ | 1,046.9 | $ | 970.5 | 7.9 | % | 5.6 | % | |||||
| Claims | 503.7 | 448.6 | 12.3 | % | 10.6 | % | |||||||
| Total Insurance | $ | 1,550.6 | $ | 1,419.1 | 9.3 | % | 7.2 | % |
Our underwriting & rating revenue increased $76.4 million or 7.9%; excluding revenues from recent acquisitions of $21.6 million, our underwriting & rating revenue increased $54.8 million or 5.6%, primarily resulted from an increase in prices derived from continued enhancements to the content of the solutions within our industry-standard insurance programs as well as selling expanded solutions to existing customers. In addition, catastrophe modeling services contributed to the growth.
Our claims revenue increased $55.1 million or 12.3%; excluding revenues from recent acquisitions of $7.6 million, our claims revenue increased $47.5 million or 10.6%, primarily due to growth in our repair cost estimating solutions, claims analytics and aerial imagery solutions revenue. The severe storm-related repair costs estimating and aerial imagery-based solutions contributed approximately $16.0 million for the year ended December 31, 2017, which did not exist in 2016.
Cost of Revenues
Cost of revenues for our Insurance segment was $510.4 million for the year ended December 31, 2017 compared to $469.6 million for the year ended December 31, 2016, an increase of $40.8 million or 8.7%. Our recent acquisitions within the Insurance segment represented an increase of $24.6 million in cost of revenues, which was primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, our cost of revenues increased $16.2 million or 3.5%. The increase was primarily due to increases in salaries and employee benefits of $22.7 million, data costs and data processing fees of $6.3 million, and information technology expense of $1.9 million. These increases were offset by decreases in an ESOP charge of $14.5 million that occurred in 2016 and other operating costs of $0.2 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for our Insurance segment were $196.1 million for the year ended December 31, 2017 compared to $178.1 million for the year ended December 31, 2016, an increase of $18.0 million or 10.1%. Our recent acquisitions within the Insurance segment, accounted for an increase of $7.4 million in SGA, was primarily related to salaries and employee benefits, and transaction costs. Excluding costs associated with our recent acquisitions, SGA increased $10.6 million or 6.0%. The increase was primarily due to increases in salaries and employee benefits of $10.6 million, professional consulting fees of $3.6 million, and information technology expense of $0.7 million. These increases were offset by a decrease in an ESOP charge of $4.3 million that occurred in 2016.
EBITDA
EBITDA for our Insurance segment was $855.8 million for the year ended December 31, 2017 compared to $779.2 million for the year ended December 31, 2016. The EBITDA margin was 55.2% for the year ended December 31, 2017 and 54.9% for the year ended December 31, 2016. The margin for the year ended December 31, 2016 was negatively impacted by an ESOP charge of 1.3%.
Energy and Specialized Markets
Revenues
Revenues for our Energy and Specialized Markets were $444.6 million for the year ended December 31, 2017 compared to $442.8 million for the year ended December 31, 2016, an increase of $1.8 million or 0.4%. Excluding revenues of $11.3 million from our recent acquisitions of Greentech Media, Quest Offshore, and MAKE, our Energy and Specialized Markets revenue decreased $9.5 million or 2.2% due to the continuing end-market and currency tailwinds affecting the energy business and declines in our environmental health and safety services.
Cost of Revenues
Cost of revenues for our Energy and Specialized Markets segment was $193.8 million for the year ended December 31, 2017 compared to $177.1 million for the year ended December 31, 2016, an increase of $16.7 million or 9.4%. Our recent acquisitions within this segment represented an increase of $7.2 million in cost of revenues, which was primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, our cost of revenues increased $9.5 million or 5.4%. The increase was primarily due to increases in salaries and employee benefit costs of $9.1 million, information technology expense of $0.2 million, and other operating costs of $0.2 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for our Energy and Specialized Markets segment were $114.4 million for the year ended December 31, 2017 compared to $113.4 million for the year ended December 31, 2016, an increase of $1.0 million or 0.9%. Our recent acquisitions within this segment accounted for an increase of $2.6 million in SGA expenses, which was primarily related to salaries and employee benefits and transaction costs. Excluding costs associated with our recent acquisitions, SGA decreased $1.6 million or 1.4%. The decrease was primarily due to decreases in information technology expenses of $1.7 million and professional consulting costs of $0.6 million. These decreases were offset by increases in salaries and employee benefit costs of $0.4 million and other general expense of $0.3 million.
EBITDA
EBITDA for our Energy and Specialized Markets segment was $133.6 million for the year ended December 31, 2017 compared to $151.2 million for the year ended December 31, 2016. The EBITDA margin was 30.0% for the year ended December 31, 2017 compared to 34.2% for the year ended December 31, 2016. The decrease in margin for the year ended December 31, 2017 was primarily due to the impact of movements in the U.S. dollar relative to British pounds.
Financial Services
Revenues
Revenues for our Financial Services were $150.0 million for the year ended December 31, 2017 compared to $133.3 million for the year ended December 31, 2016, an increase of $16.7 million or 12.5%. Excluding revenues of $20.8 million from our recent acquisitions of Fintellix, G2, and LCI, our financial services revenue decreased $4.1 million or 3.0%. The decrease was primarily due to several contract completions in 2016 partially offset by growth in media effectiveness solutions.
Cost of Revenues
Cost of revenues for our Financial Services segment was $79.6 million for the year ended December 31, 2017 compared to $67.7 million for the year ended December 31, 2016, an increase of $11.9 million or 17.7%. Our recent acquisitions within this segment represented an increase of $13.5 million in cost of revenues, which was primarily related to salaries and employee benefits. Excluding the impact of our recent acquisitions, our cost of revenues decreased $1.6 million or 2.2%. The decrease was primarily due to decreases in salaries and employee benefit costs of $1.1 million, information technology expense of $0.4 million, and data costs and data processing fees of $0.2 million. These decreases were offset by an increase in other operating costs of $0.1 million.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for our Financial Services segment were $12.3 million for the year ended December 31, 2017 compared to $10.1 million for the year ended December 31, 2016, an increase of $2.2 million or 21.8%. Our recent acquisitions within this segment accounted for an increase of $3.7 million in SGA expenses, which was primarily related to salaries and employee benefits and transaction costs. Excluding costs associated with our recent acquisitions, SGA decreased $1.5 million or 14.8%. The decrease was primarily due to decreases in salaries and employee benefit costs of $2.2 million and information technology expenses of $0.2 million, and other general expense of $0.1 million. These decreases were offset by an increase in professional consulting costs of $1.0 million.
EBITDA
EBITDA for our Financial Services segment was $58.4 million for the year ended December 31, 2017 compared to $320.9 million for the year ended December 31, 2016. The EBITDA margin was 39.0% for the year ended December 31, 2017 and for the year ended December 31, 2016, including our discontinued operations, the EBITDA margin was 240.7%. Our EBITDA margin for the year ended December 31, 2016 was primarily impacted by discontinued operations, including the gain on sale of our healthcare business, of 199.5%.
Quarterly Results of Operations
The following table sets forth our quarterly unaudited consolidated statement of operations data for each of the eight quarters in the period ended December 31, 2018. In management’s opinion, the quarterly data has been prepared on the same basis as the audited consolidated financial statements included in this annual report on Form 10-K, and reflects all necessary adjustments for a fair presentation of this data. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.
| For the Quarters Ended | |||||||||||||||
| March 31, | June 30, | September 30, | December 31, | Full Year | |||||||||||
| 2018 | 2018 | ||||||||||||||
| (in millions, except for per share data) | |||||||||||||||
| Statement of operations data: | |||||||||||||||
| Revenues | $ | 581.2 | $ | 601.3 | $ | 598.7 | $ | 613.9 | $ | 2,395.1 | |||||
| Operating income | $ | 194.5 | $ | 212.3 | $ | 211.1 | $ | 216.2 | $ | 834.1 | |||||
| Net income | $ | 133.0 | $ | 153.5 | $ | 166.0 | $ | 146.2 | $ | 598.7 | |||||
| Basic net income per share | $ | 0.81 | $ | 0.93 | $ | 1.01 | $ | 0.89 | $ | 3.63 | |||||
| Diluted net income per share | $ | 0.79 | $ | 0.91 | $ | 0.99 | $ | 0.87 | $ | 3.56 | |||||
| For the Quarters Ended | |||||||||||||||
| March 31, | June 30, | September 30, | December 31, | Full Year | |||||||||||
| 2017 | 2017 | ||||||||||||||
| (in millions, except for per share data) | |||||||||||||||
| Statement of operations data: | |||||||||||||||
| Revenues | $ | 502.6 | $ | 523.2 | $ | 549.1 | $ | 570.3 | $ | 2,145.2 | |||||
| Operating income | $ | 187.7 | $ | 195.0 | $ | 208.4 | $ | 210.1 | $ | 801.2 | |||||
| Net income | $ | 108.8 | $ | 121.0 | $ | 120.7 | $ | 204.6 | $ | 555.1 | |||||
| Basic net income per share | $ | 0.65 | $ | 0.73 | $ | 0.73 | $ | 1.24 | $ | 3.36 | |||||
| Diluted net income per share | $ | 0.64 | $ | 0.72 | $ | 0.72 | $ | 1.22 | $ | 3.29 |
Liquidity and Capital Resources
As of December 31, 2018 and 2017, we had cash and cash equivalents and available-for-sale securities of $142.8 million and $146.1 million, respectively. Subscriptions for our solutions are billed and generally paid in advance of rendering services either quarterly or in full upon commencement of the subscription period, which is usually for one year. Subscriptions are automatically renewed at the beginning of each calendar year. We have historically generated significant cash flows from operations. As a result of this factor, as well as the availability of funds under our syndicated revolving credit facility, we believe we will have sufficient cash to meet our working capital and capital expenditure needs, and to fuel our future growth plans.
We have historically managed the business with a working capital deficit due to the fact that, as described above, we offer our solutions and services primarily through annual subscriptions or long-term contracts, which are generally prepaid quarterly or annually in advance of the services being rendered. When cash is received for prepayment of invoices, we record an asset (cash and cash equivalents) on our balance sheet with the offset recorded as a current liability (deferred revenues). This current liability is deferred revenue that does not require a direct cash outflow since our customers have prepaid and are obligated to purchase the services. In most businesses, growth in revenue typically leads to an increase in the accounts receivable balance causing a use of cash as a company grows. Unlike these businesses, our cash position is favorably affected by revenue growth, which results in a source of cash due to our customers prepaying for most of our services.
Our consolidated capital expenditures as a percentage of consolidated revenues for the years ended December 31, 2018 and 2017, were 9.6% and 8.6%, respectively. Expenditures related to developing and enhancing our solutions are predominately related to internal-use software and are capitalized in accordance with ASC 350-40, “Accounting for Costs of Computer Software Developed or Obtained for Internal Use.” We also capitalize amounts in accordance with ASC 985-20, “Software to be Sold, Leased or Otherwise Marketed.”
We have also historically used a portion of our cash for repurchases of our common stock from our stockholders. For the years ended December 31, 2018, 2017 and 2016, we repurchased $438.6 million, $276.3 million and $326.8 million, respectively, of our common stock.
Financing and Financing Capacity
We had total debt, excluding capital lease obligations, unamortized discounts and debt issuance costs of $2,715.0 million and $3,015.0 million at December 31, 2018 and 2017, respectively. The debt at December 31, 2018 primarily consists of senior notes issued in 2015, 2012 and 2011 and borrowings outstanding under our committed senior unsecured Syndicated Revolving Credit Facility, or the Credit Facility, described below. Interest on the senior notes is payable semi-annually each year. The unamortized discount and debt issuance costs were recorded as "Long-term debt" in the accompanying consolidated balance sheets, and will be amortized to "Interest expense" in the accompanying consolidated statements of operations within this Form 10-K over the life of the respective senior note. The indenture governing the senior notes restricts our ability to, among other things, create certain liens, enter into sale/leaseback transactions and consolidate with, sell, lease, convey, or otherwise transfer all or substantially all of our assets, or merge with or into, any other person or entity. As of December 31, 2018, we had senior notes with an aggregate principal amount of $2,300.0 million outstanding, and we were in compliance with our financial debt covenants. In January 2019, we repaid a total of $250.0 million of the $2,300.0 million outstanding borrowings at December 31, 2018 under the senior notes.
We have a credit facility with a borrowing capacity of $1,500.0 million with Bank of America N.A., JP Morgan Chase, N.A., Sun Trust Bank, Wells Fargo Bank, N.A., Citizens Bank, N.A., Morgan Stanley, N.A., HSBC Bank USA, N.A., Royal Bank of Canada, BNP Paribas, TD Bank, N.A., and The Northern Trust Company. On May 18, 2017, we entered into the third amendment to the Credit Facility, which, among other things, extended the maturity date one year to May 15, 2022. The Credit Facility may be used for general corporate purposes, including working capital needs and capital expenditures, acquisitions and the share repurchase program, or the Repurchase Program. The Credit Facility contains certain financial and other covenants that, among other things, impose certain restrictions on indebtedness, liens, investments, and capital expenditures. These covenants also place restrictions on mergers, asset sales, sale/leaseback transactions, payments between us and our subsidiaries, and certain transactions with affiliates. The financial covenants require that, at the end of any fiscal quarter, we have a consolidated interest coverage ratio of at least 3.0 to 1.0 and that we maintain, during any period of four fiscal quarters, a consolidated funded debt leverage ratio of 3.5 to 1.0. We were in compliance with all financial covenants under the Credit Facility as of December 31, 2018. Interest on borrowings under the Credit Facility is payable at an interest rate of LIBOR plus 1.125% to 1.625%, depending upon the consolidated funded debt leverage ratio. During the year ended December 31, 2018, we had borrowings of $325.0 million and repayments of $625.0 million under the Credit Facility. As of December 31, 2018 and 2017, we had outstanding borrowings under the Credit Facility of $415.0 million and $715.0 million, respectively. Subsequent to December 31, 2018, we had borrowings of $275.0 million under the Credit Facility, which were primarily utilized to pay down the $250.0 million of senior notes due on January 15, 2019. In addition, we subsequently repaid a total of $175.0 million of the $415.0 million outstanding borrowings at December 31, 2018 under the Credit Facility.
Cash Flow
The following table summarizes our cash flow data for the years ended December 31:
| 2018 | 2017 | 2016 | |||||||||
| (in millions) | |||||||||||
| Net cash provided by operating activities | $ | 934.4 | $ | 743.5 | $ | 577.5 | |||||
| Net cash (used in) provided by investing activities | $ | (265.4 | ) | $ | (1,105.5 | ) | $ | 493.2 | |||
| Net cash (used in) provided by financing activities | $ | (669.8 | ) | $ | 362.5 | $ | (1,064.2 | ) |
Operating Activities
Net cash provided by operating activities increased to $934.4 million for the year ended December 31, 2018 compared to $743.5 million for the year ended December 31, 2017. The increase of $190.9 million in net cash provided by operating activities was primarily due to an increase in cash receipts from customers driven by an increase in revenues and operating profit, as well as a reduction in tax payments primarily due to the impact of tax reform lowering the U.S. tax rate from 35.0% to 21.0% and the impact of greater tax benefits from equity compensation in the current year versus the prior year.
Net cash provided by operating activities increased to $743.5 million for the year ended December 31, 2017 compared to $577.5 million for the year ended December 31, 2016. The increase of $166.0 million in net cash provided by operating
activities was primarily due to an increase in cash receipts from customers driven by an increase in revenues and operating profit. Our net cash provided by operating activities for the year ended December 31, 2016 also included a $99.9 million tax payment related to the gain on the sale of our healthcare business and a one-time cash funding of our ESOP plan of $18.8 million. These operating cash expenditures in 2016 did not occur in 2017.
Investing Activities
Net cash used in investing activities of $265.4 million for the year ended December 31, 2018 was primarily related to capital expenditures of $231.0 million and acquisitions of $153.1 million including escrow funding, partially offset by proceeds from the repayment of the subordinated promissory note receivable of $121.4 million.
Net cash used in investing activities of $1,105.5 million for the year ended December 31, 2017 was primarily related to acquisitions, including escrow funding, of $914.9 million and capital expenditures of $183.5 million.
Net cash provided by investing activities of $493.2 million for the year ended December 31, 2016 was primarily related to proceeds from the sale our healthcare business of $714.6 million, partially offset by capital expenditures of $156.5 million and acquisitions including escrow payments of $74.1 million.
Financing Activities
Net cash used in financing activities of $669.8 million for the year ended December 31, 2018 was primarily related to share repurchases of $438.6 million, net debt repayments of $300.0 million of borrowings under our Credit Facility, partially offset by proceeds from stock option exercises and other option-related items of $83.6 million.
Net cash provided by financing activities of $362.5 million for the year ended December 31, 2017 was primarily related to $615.0 million of borrowings, net under our Credit Facilities and proceeds from stock option exercises, net of net share settlement of taxes from restricted stock, of $32.1 million, partially offset by share repurchases of $276.3 million.
Net cash used in financing activities of $1,064.2 million for the year ended December 31, 2016 was primarily related to a $770.0 million repayments of borrowings under our Credit Facilities and share repurchases of $326.8 million, partially offset by proceeds from stock option exercises and other option-related items of $38.0 million.
Contractual Obligations
The following table summarizes our contractual obligations at December 31, 2018 and the future periods in which such obligations are expected to be settled in cash:
| Payments Due by Period | |||||||||||||||||||
| Total | Less than 1 year | 2-3 years | 4-5 years | More than 5 years | |||||||||||||||
| (in millions) | |||||||||||||||||||
| Contractual obligations | |||||||||||||||||||
| Long-term debt, current portion of long-term debt and interest | $ | 3,572.6 | $ | 762.2 | $ | 624.2 | $ | 470.6 | $ | 1,715.6 | |||||||||
| Operating leases | 339.8 | 46.0 | 83.5 | 62.7 | 147.6 | ||||||||||||||
| Pension and postretirement plans (1) | 29.7 | 2.6 | 4.3 | 3.9 | 18.9 | ||||||||||||||
| Capital lease obligations | 29.2 | 8.3 | 18.1 | 2.8 | — | ||||||||||||||
| Other long-term liabilities (2) | 0.9 | 0.3 | 0.1 | 0.1 | 0.4 | ||||||||||||||
| Total (3) | $ | 3,972.2 | $ | 819.4 | $ | 730.2 | $ | 540.1 | $ | 1,882.5 |
| (1) | Our funding policy is to contribute at least equal to the minimum legal funding requirement. |
| (2) | Other long-term liabilities consist of our employee-related deferred compensation plan. We also have a deferred compensation plan for our Board of Directors; however, based on past performance and the uncertainty of the dollar amounts to be paid, if any, we have excluded such amounts from the above table. |
| (3) | Unrecognized tax benefits of approximately $17.4 million have been recorded as liabilities in accordance with ASC 740, which have been omitted from the table above, and we are uncertain as to if or when such amounts may be settled, with the exception of those amounts subject to a statute of limitation. Related to the unrecognized tax benefits, we also have recorded a liability for potential penalties and interest of $5.7 million. |
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements require management to make estimates and judgments that affect reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the dates of the financial statements and revenue and expenses during the reporting periods. These estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances. On an ongoing basis, management evaluates its estimates, including those related to revenue recognition, goodwill and intangible assets, pension and other post retirement benefits, stock based compensation, and income taxes. Actual results may differ from these assumptions or conditions.
Revenue Recognition
We recognize revenue based on the transfer of promised goods or services to customers for the amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. Revenue is recognized in a five-step model: 1) identify the contract with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract; and 5) recognize revenue when or as the company satisfies a performance obligation. Revenues for hosted subscription services are recognized ratably over the subscription term. Revenues from certain discrete project based advisory/consulting services are recognized over time by measuring the progress toward complete satisfaction of the performance obligation, based on the input method of consulting hours worked; this aligns with the results achieved and value transferred to the customer. Revenues from transactional solutions are recognized as the solutions are delivered or services performed at point in time.
We invoice our customers in annual, quarterly, or monthly installments. Amounts billed and collected in advance are recorded as deferred revenues on the balance sheet and are recognized as the services are performed and revenue recognition criteria are met.
Stock-Based Compensation
Stock-based compensation cost, including stock options, restricted stock, and performance share units, or PSUs, is measured at the grant date, based on the fair value of the awards granted, and is recognized as expense over the requisite service period. The fair value of stock options is measured using a Black-Scholes option-pricing model, which requires the use of several estimates, including expected term, expected risk-free interest rate, expected volatility, and expected dividend yield. The fair value of the restricted stock is determined using the closing price of the Company's common stock on the grant date. The fair value of PSUs is determined on the grant date using the Monte Carlo Simulation model.
Option grants and restricted stock awards are generally expensed ratably over the four-year vesting period. PSUs are generally expensed ratably over the three-year vesting period. We follow the substantive vesting period approach for awards granted after January 1, 2005, which requires that stock-based compensation expense be recognized over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service.
We estimate expected forfeitures of equity awards at the date of grant and recognize compensation expense only for those awards expected to vest. The forfeiture assumption is ultimately adjusted to the actual forfeiture rate.
Goodwill and Intangibles
Goodwill represents the excess of acquisition costs over the fair value of tangible net assets and identifiable intangible assets of the businesses acquired. Goodwill and intangible assets deemed to have indefinite lives are not amortized. Intangible assets determined to have definite lives are amortized over their useful lives. Goodwill and intangible assets with indefinite lives are subject to impairment testing annually as of June 30, or whenever events or changes in circumstances indicate that the carrying amount may not be fully recoverable, using the guidance and criteria described in the accounting standard for Goodwill and Other Intangible Assets. This testing compares carrying values to fair values and, when appropriate, the carrying value of these assets is reduced to fair value.
As of December 31, 2018, we had goodwill of $3,361.5 million, which represents 57.0% of our total assets. During 2018, we performed an impairment test as of June 30, 2018 and confirmed that no impairment charge was necessary. There are many assumptions and estimates used that directly impact the results of impairment testing, including an estimate of future expected revenues, earnings and cash flows, useful lives and discount rates applied to such expected cash flows in order to
estimate fair value. We have the ability to influence the outcome and ultimate results based on the assumptions and estimates we choose for determining the fair value of our reporting units. To mitigate undue influence, we set criteria and benchmarks that are reviewed and approved by various levels of management and reviewed by other independent parties. The determination of whether or not goodwill or indefinite-lived acquired intangible assets have become impaired involves a significant level of judgment in the assumptions and estimates underlying the approach used to determine the value of our reporting units. Changes in our strategy or market conditions could significantly impact these judgments and require an impairment to be recorded to intangible assets and goodwill. There have been no goodwill impairment indicators subsequent to the impairment test performed as of June 30, 2018. For the year ended December 31, 2018, there were no impairment indicators related to our intangible assets.
We allocate the fair value of the purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of the purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. Such valuations require management to make significant estimates and assumptions, especially with respect to intangible assets. The estimates used in valuing the intangible assets are determined with the assistance of third party specialists, a discounted cash flow analysis and estimates made by management. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. During the measurement period, which is not to exceed one year from the acquisition date, we may record adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to earnings.
Income Taxes
In projecting future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we use to manage the underlying businesses. The calculation of our tax liabilities also involves dealing with uncertainties in the application and evolution of complex tax laws and regulations in other jurisdictions.
We account for uncertain tax positions in accordance with Accounting for Uncertainty in Income Taxes — an interpretation of ASC 740, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under this interpretation, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position.
We recognize and adjust our liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.
On December 22, 2017 the Tax Cuts and Job Act (“Tax Act”) was enacted. The Tax Act included a number of changes to U.S. tax laws, most notably a reduction in the U.S. corporate tax rate from 35.0% to 21.0%. As a result of the corporate tax rate reduction, the Company recognized a tax benefit in 2017 of $89.1 million due to the re-measurement of its deferred tax assets and liabilities. In accordance with Staff Accounting Bulletin (SAB) No. 118, the Company completed the analysis of the impacts of the 2017 Tax Act in the fourth quarter of 2018, resulting in an incremental charge of $1.0 million as income tax expense to reflect the final remeasurement of deferred tax assets and liabilities of $88.1 million.
We estimate unrecognized tax positions of $0.9 million that may be recognized by December 31, 2019, due to expiration of statutes of limitations and resolution of audits with taxing authorities, net of additional uncertain tax positions.
As of December 31, 2018, we have gross federal, state, and foreign income tax net operating loss carryforwards of $186.5 million, which will expire at various dates from 2019 through 2038. Such net operating loss carryforwards expire as follows:
| Years | (In millions) | ||
| 2019-2026 | $ | 15.9 | |
| 2027-2031 | 7.1 | ||
| 2032-2038 | 163.5 | ||
| Total | $ | 186.5 |
The net deferred income tax liability of $339.5 million consists primarily of timing differences involving depreciation and amortization.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements, refer to Note 2(s) to the audited consolidated financial statements included elsewhere in this annual report on Form 10-K.
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