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SS&C TECHNOLOGIES HOLDINGS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) CRITICAL ACCOUNTING POLICIES Certain of our accounting policies require the application of significant judgment by our management, and such judgments are reflected in the amounts reported in our consolidated financial statements. In applying these policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of estimates. Those estimates are based on our historical experience, terms of existing contracts, management's observation of trends in the industry, information provided by our clients and information available from other outside sources, as appropriate. Actual results may differ significantly from the estimates contained in our consolidated financial statements. There have been no material changes to our critical accounting estimates and assumptions or the judgments affecting the application of those estimates and assumptions since our filing of the 2010 Form 10-K. Our critical accounting policies are described in the 2010 Form 10-K and include: • Revenue Recognition • Allowance for Doubtful Accounts • Long-Lived Assets, Intangible Assets and Goodwill • Acquisition Accounting • Income Taxes • Stock-Based Compensation Results of Operations for the Three and Six Months Ended June 30, 2011 and 2010 The following table sets forth revenues (in thousands) and changes in revenues for the periods indicated: Three Months Ended Six Months Ended June 30, % June 30, % 2011 2010 Change 2011 2010 Change Revenues: Software licenses $ 4,982 $ 6,074 -18 % $ 11,555 $ 11,663 -1 % Maintenance 19,418 17,817 9 % 38,865 35,836 8 % Professional services 5,860 5,099 15 % 11,127 10,488 6 % Software-enabled services 61,543 52,628 17 % 119,263 101,805 17 % Total revenues $ 91,803 $ 81,618 12 % $ 180,810 $ 159,792 13 % The following table sets forth the percentage of our revenues represented by each of the following sources of revenues for the periods indicated: Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Revenues: Software licenses 5 % 7 % 6 % 7 % Maintenance 21 % 22 % 22 % 22 % Professional services 7 % 6 % 6 % 7 % Software-enabled services 67 % 65 % 66 % 64 % Total revenues 100 % 100 % 100 % 100 % 12 -------------------------------------------------------------------------------- Table of Contents Revenues Our revenues consist primarily of software-enabled services and maintenance revenues, and, to a lesser degree, software license and professional services revenues. As a general matter, our software license and professional services revenues fluctuate based on the number of new licensing clients, while fluctuations in our software-enabled services revenues are attributable to the number of new software-enabled services clients, the number of outsourced transactions provided to our existing clients and total assets under management in our clients' portfolios. Maintenance revenues vary based on the rate by which we add or lose maintenance clients over time and, to a lesser extent, on the annual increases in maintenance fees, which are generally derived from the consumer price index. Revenues for the three months ended June 30, 2011 were $91.8 million compared to $81.6 million for the same period in 2010. The revenue increase of $10.2 million, or 12%, was primarily due to revenues from products and services that we acquired through our acquisitions of TOS in October 2010, TSW in December 2010 and BXML in March 2011, which added $5.4 million in revenues in the aggregate, and an increase of $3.4 million in revenues for businesses and products that we have owned for at least 12 months, or organic revenues. The favorable impact from foreign currency translation accounted for $1.4 million of the increase, resulting from the weakness of the U.S. dollar relative to currencies such as the Canadian dollar, the British pound, the Australian dollar and the euro. Revenues for the six months ended June 30, 2011 were $180.8 million compared to $159.8 million for the same period in 2010. The revenue increase of $21.0 million, or 13%, was primarily due to revenues from products and services that we acquired through our acquisitions of GIPS in February 2010, TOS in October 2010, TSW in December 2010 and BXML in March 2011, which added $9.7 million in revenues in the aggregate, and an increase of $8.8 million in organic revenues. The favorable impact from foreign currency translation accounted for $2.5 million of the increase, resulting from the weakness of the U.S. dollar relative to currencies such as the Canadian dollar, the British pound, the Australian dollar and the euro. Software Licenses. Software license revenues were $5.0 million and $6.1 million for the three months ended June 30, 2011 and 2010, respectively. The decrease in software license revenues of $1.1 million, or 18%, was primarily due to a decrease of $2.2 million in organic software license revenues, partially offset by revenues from acquisitions, which contributed $1.1 million. Software license revenues were $11.6 million and $11.7 million for the six months ended June 30, 2011 and 2010, respectively. The decrease in software license revenues of $0.1 million, or 1%, was primarily due to a decrease of $1.4 million in organic software license revenues, partially offset by revenues from acquisitions, which contributed $1.2 million, and a favorable impact from foreign currency translation of $0.1 million. Software license revenues will vary depending on the timing, size and nature of our license transactions. For example, the average size of our software license transactions and the number of large transactions may fluctuate on a period-to-period basis. For the three and six months ended June 30, 2011, revenues from term licenses increased while the average size and number of perpetual license transactions decreased from those for the three and six months ended June 30, 2010. Additionally, software license revenues will vary among the various products that we offer, due to differences such as the timing of new releases and variances in economic conditions affecting opportunities in the vertical markets served by such products. Maintenance. Maintenance revenues were $19.4 million and $17.8 million for the three months ended June 30, 2011 and 2010, respectively. The increase in maintenance revenues of $1.6 million, or 9%, was primarily due to revenue from acquisitions, which contributed $1.1 million in the aggregate, a favorable impact from foreign currency translation of $0.3 million and an increase in organic maintenance revenues of $0.2 million. Maintenance revenues were $38.9 million and $35.8 million for the six months ended June 30, 2011 and 2010, respectively. The increase in maintenance revenues of $3.1 million, or 8%, was primarily due to revenues from acquisitions, which contributed $2.4 million in the aggregate, a favorable impact from foreign currency translation of $0.4 million and an increase in organic maintenance revenues of $0.3 million. We typically provide maintenance services under one-year renewable contracts that provide for an annual increase in fees, which are generally derived from the percentage change in the consumer price index. Future maintenance revenue growth is dependent on our ability to retain existing clients, add new license clients and increase average maintenance fees. Professional Services. Professional services revenues were $5.9 million and $5.1 million for the three months ended June 30, 2011 and 2010, respectively. The increase of $0.8 million, or 15%, was primarily due to revenues from acquisitions, which contributed $1.0 million in the aggregate, and a favorable impact from foreign currency translation of $0.1 million, partially offset by a decrease of $0.3 million in organic professional services revenues. Professional services revenues were $11.1 million and $10.5 million for the six months ended June 30, 2011 and 2010, respectively. The increase of $0.6 million, or 6%, was primarily due to revenues from acquisitions, which contributed $1.7 million in the aggregate, and a favorable impact from foreign currency translation of $0.2 million, partially offset by a decrease of $1.3 million in organic professional services revenues. Our overall software license revenue levels and market demand for professional services will continue to have an effect on our professional services revenues. Software-Enabled Services. Software-enabled services revenues were $61.5 million and $52.6 million for the three months ended June 30, 2011 and 2010, respectively. The increase in software-enabled services revenues of $8.9 million, or 17%, was primarily due to an increase of $5.7 million in organic software-enabled services revenues, revenues from acquisitions, which contributed $2.2 million in the aggregate, and a favorable impact from foreign currency translation of $1.0 million. Software-enabled services revenues were $119.3 million and $101.8 million for the six months ended June 30, 2011 and 2010, respectively. The increase in software-enabled services revenues of $17.5 million, or 17%, was primarily due to an increase of $11.3 million in organic software-enabled services revenues, revenues from acquisitions, which contributed $4.4 million in the aggregate, and a favorable impact from foreign currency translation of $1.8 million. Future software-enabled services revenue growth is dependent on our ability to retain existing clients, add new clients and increase average fees. 13 -------------------------------------------------------------------------------- Table of Contents Cost of Revenues Total cost of revenues was $45.6 million and $40.9 million for the three months ended June 30, 2011 and 2010, respectively. The gross margin was 50% for each of the three-month periods ended June 30, 2011 and 2010. Our costs of revenues increased by $4.7 million, or 11%, primarily as a result of an increase of $2.5 million in costs to support organic revenue growth, our acquisitions, which added cost of revenues of $1.2 million in the aggregate, an increase in costs of $0.7 million related to the unfavorable effect of foreign currency translation and an increase in amortization expense of $0.5 million, partially offset by a decrease in stock-based compensation expense of $0.2 million. Total cost of revenues was $90.1 million and $80.1 million for the six months ended June 30, 2011 and 2010, respectively. The gross margin was 50% for each of the six-month periods ended June 30, 2011 and 2010. Our costs of revenues increased by $10.0 million, or 13%, primarily as a result of an increase of $5.4 million in costs to support organic revenue growth, our acquisitions, which added cost of revenues of $2.7 million in the aggregate, an increase in costs of $1.3 million related to the unfavorable effect of foreign currency translation and an increase in amortization expense of $0.7 million, partially offset by a decrease in stock-based compensation of $0.1 million. Cost of Software Licenses. Cost of software license revenues consists primarily of amortization expense of completed technology, royalties, third-party software, and the costs of product media, packaging and documentation. The cost of software license revenues was $1.7 million and $1.9 million for the three months ended June 30, 2011 and 2010, respectively. The decrease in cost of software licenses was primarily due to a reduction of $0.2 million in amortization expense. Cost of software license revenues as a percentage of such revenues was 34% and 31% for the three-month periods ended June 30, 2011 and 2010, respectively. The cost of software license revenues was $3.4 million and $3.8 million for the six months ended June 30, 2011 and 2010, respectively. The decrease in cost of software licenses was primarily due to a reduction of $0.4 million in amortization expense. Cost of software license revenues as a percentage of such revenues was 29% and 33% for the six-month periods ended June 30, 2011 and 2010, respectively. Cost of Maintenance. Cost of maintenance revenues consists primarily of technical client support, costs associated with the distribution of products and regulatory updates and amortization of intangible assets. The cost of maintenance revenues was $8.8 million and $8.1 million for the three months ended June 30, 2011 and 2010, respectively. The increase in cost of maintenance revenues of $0.7 million, or 9%, was primarily due to additional amortization expense of $0.4 million, our acquisitions, which added $0.2 million in costs in the aggregate, and an increase in costs of $0.1 million related to foreign currency translation. Cost of maintenance revenues as a percentage of these revenues was 45% for each of the three-month periods ended June 30, 2011 and 2010. The cost of maintenance revenues was $17.5 million and $16.1 million for the six months ended June 30, 2011 and 2010, respectively. The increase in cost of maintenance revenues of $1.4 million, or 9%, was primarily due to additional amortization expense of $0.8 million, our acquisitions, which added $0.4 million in costs in the aggregate, and an increase in costs of $0.2 million related to foreign currency translation. Cost of maintenance revenues as a percentage of these revenues was 45% for each of the six-month periods ended June 30, 2011 and 2010. Cost of Professional Services. Cost of professional services revenues consists primarily of the cost related to personnel utilized to provide implementation, conversion and training services to our software licensees, as well as system integration, custom programming and actuarial consulting services. The cost of professional services revenues was $4.0 million and $3.3 million for the three months ended June 30, 2011 and 2010, respectively. The increase in costs of professional services revenues of $0.7 million, or 22%, was primarily related to an increase of $0.5 million in personnel costs to support projects, our acquisitions, which added $0.2 million in costs in the aggregate, and an increase in costs of $0.1 million related to foreign currency translation, partially offset by a decrease in stock-based compensation expense of $0.1 million. Cost of professional services revenues as a percentage of these revenues was 68% for the three months ended June 30, 2011 compared to 64% for the three months ended June 30, 2010. The cost of professional services revenues was $7.6 million and $6.6 million for the six months ended June 30, 2011 and 2010, respectively. The increase in costs of professional services revenues of $1.0 million, or 14%, was primarily related to our acquisitions, which added $0.6 million in costs in the aggregate, an increase in costs of $0.2 million related to foreign currency translation and an increase of $0.2 million in personnel costs to support projects. Cost of professional services revenues as a percentage of these revenues was 68% for the six months ended June 30, 2011 compared to 63% for the six months ended June 30, 2010. 14-------------------------------------------------------------------------------- Table of Contents Cost of Software-Enabled Services. Cost of software-enabled services revenues consists primarily of the cost related to personnel utilized in servicing our software-enabled services clients and amortization of intangible assets. The cost of software-enabled services revenues was $31.2 million and $27.7 million for the three months ended June 30, 2011 and 2010, respectively. The increase in costs of software-enabled services revenues of $3.5 million, or 13%, was primarily related to an increase of $2.0 million in costs to support the growth of organic software-enabled services revenues, our acquisitions, which added $0.8 million in costs in the aggregate, an increase in costs of $0.5 million related to foreign currency translation and an increase in costs of $0.3 million related to amortization expense, partially offset by a decrease in stock-based compensation expense of $0.1 million. Cost of software-enabled services revenues as a percentage of these revenues was 51% for the three months ended June 30, 2011 compared to 53% for the three months ended June 30, 2010. The cost of software-enabled services revenues was $61.7 million and $53.6 million for the six months ended June 30, 2011 and 2010, respectively. The increase in costs of software-enabled services revenues of $8.1 million, or 15%, was primarily related to an increase of $5.2 million in costs to support the growth of organic software-enabled services revenues, our acquisitions, which added $1.8 million in costs in the aggregate, an increase in costs of $0.9 million related to foreign currency translation and an increase in costs of $0.3 million related to amortization expense, partially offset by a decrease in stock-based compensation expense of $0.1 million. Cost of software-enabled services revenues as a percentage of these revenues was 52% for the six months ended June 30, 2011 compared to 53% for the six months ended June 30, 2010. Operating Expenses Total operating expenses were $23.3 million and $20.9 million for the three months ended June 30, 2011 and 2010, respectively. The increase in total operating expenses of $2.4 million, or 11%, was primarily due to our acquisitions of TOS, TSW and BXML, which added $1.6 million in costs in the aggregate, an increase in costs of $0.4 million related to foreign currency translation and an increase in costs of $0.4 million to support organic revenue growth. Total operating expenses as a percentage of total revenues were 25% for the three months ended June 30, 2011 compared to 26% for the three months ended June 30, 2010. Total operating expenses were $44.7 million and $40.5 million for the six months ended June 30, 2011 and 2010, respectively. The increase in total operating expenses of $4.2 million, or 10%, was primarily due to our acquisitions of GIPS, TOS, TSW and BXML, which added $3.1 million in costs in the aggregate, an increase in costs of $0.6 million related to foreign currency translation and an increase in costs of $0.3 million related to stock-based compensation. Total operating expenses as a percentage of total revenues were 25% for each of the six-month periods ended June 30, 2011 and June 30, 2010. Selling and Marketing. Selling and marketing expenses consist primarily of the personnel costs associated with the selling and marketing of our products, including salaries, commissions and travel and entertainment. Such expenses also include amortization of intangible assets, the cost of branch sales offices, trade shows and marketing and promotional materials. Selling and marketing expenses were $7.0 million and $6.5 million for the three months ended June 30, 2011 and 2010, respectively, representing 8% of total revenues in each of those periods. The increase in selling and marketing expenses of $0.5 million, or 8%, was primarily related to our acquisitions, which added $0.3 million in costs, and an increase in costs of $0.2 million related to foreign currency translation. Selling and marketing expenses were $13.9 million and $12.6 million for the six months ended June 30, 2011 and 2010, respectively, representing 8% of total revenues in those periods. The increase in selling and marketing expenses of $1.3 million, or 10%, was primarily related to our acquisitions, which added $0.9 million in costs and an increase in costs of $0.4 million related to foreign currency translation. Research and Development. Research and development expenses consist primarily of personnel costs attributable to the enhancement of existing products and the development of new software products. Research and development expenses were $9.1 million and $7.9 million for the three months ended June 30, 2011 and 2010, respectively, representing 10% of total revenues in each of those periods. The increase in research and development expenses of $1.2 million, or 15%, was primarily related to our acquisitions, which added $1.0 million in costs in the aggregate, and an increase in costs of $0.2 million related to foreign currency translation. Research and development expenses were $17.0 million and $15.6 million for the six months ended June 30, 2011 and 2010, respectively, representing 9% and 10% of total revenues in those periods, respectively. The increase in research and development expenses of $1.4 million, or 9%, was primarily related to our acquisitions, which added $1.6 million in costs in the aggregate, and an increase in costs of $0.3 million related to foreign currency translation, partially offset by a decrease in costs of $0.5 million as more costs were eligible for capitalization in 2011 compared to 2010. General and Administrative. General and administrative expenses consist primarily of personnel costs related to management, accounting and finance, information management, human resources and administration and associated overhead costs, as well as fees for professional services. General and administrative expenses were $7.2 million and $6.5 million for the three months ended June 30, 2011 and 2010, respectively, representing 8% of total revenues in each of those periods. The increase in general and administrative expenses of $0.7 million, or 10%, was primarily related to our acquisitions, which added $0.3 million in costs in the aggregate, an increase of $0.3 million in costs to support organic revenue growth and an increase in costs of $0.1 million related to foreign currency translation. General and administrative expenses were $13.7 million and $12.2 million for the six months ended June 30, 2011 and 2010, respectively, representing 8% of total revenues in each of those periods. The increase in general and administrative expenses of $1.5 million, or 12%, was primarily related to our acquisitions, which added $0.6 million in costs in the aggregate, an increase of $0.5 million in costs to support organic revenue growth, an increase in costs of $0.3 million related to stock-based compensation and an increase in costs of $0.1 million related to foreign currency translation. 15 -------------------------------------------------------------------------------- Table of Contents Interest Expense, Net. Net interest expense for the three months ended June 30, 2011 and 2010 was $3.5 million and $8.1 million, respectively. Net interest expense for the six months ended June 30, 2011 and 2010 was $8.6 million and $17.1 million, respectively. Net interest expense is primarily related to interest expense on debt outstanding under our senior credit facility and 11 3/4% senior subordinated notes due 2013. The decrease in interest expense of $4.6 million for the three-month period and $8.5 million for the six-month period reflects the lower average debt balance resulting from net repayments of debt, including the partial redemptions of our senior subordinated notes in April 2010 and March 2011 (discussed further in Liquidity and Capital Resources). Other Income (Expense), Net. Other income, net for the three months ended June 30, 2011 and 2010 consisted primarily of foreign currency gains. Other expense, net for the six months ended June 30, 2011 consisted of foreign currency losses and fees associated with the redemption of our 11 3/4% senior subordinated notes due 2013, which is discussed further in Liquidity and Capital Resources, partially offset by a refund of facilities charges. Loss on Extinguishment of Debt. Loss on extinguishment of debt for the six months ended June 30, 2011 consisted of $2.0 million in note redemption premiums and $0.9 million from the write-offs of deferred financing costs associated with the redemption of $66.6 million of our 11 3/4% senior subordinated notes due 2013, which is discussed further in Liquidity and Capital Resources. Loss on extinguishment of debt for the three and six months ended June 30, 2010 consisted of $4.2 million in note redemption premiums and $1.3 million for the write-offs of deferred financing costs associated with the redemption of $71.75 million of our 11 3/4% senior subordinated notes due 2013 during the period. Provision for Income Taxes. We had effective tax rates of 33.3% and 31.5% for the three months ended June 30, 2011 and 2010, respectively. We had effective tax rates of 33.4% and 19.6% for the six months ended June 30, 2011 and 2010, respectively. The lower effective tax rate for the six months ended June 30, 2010 was due to the 2010 reversal of uncertain income tax positions, refunds and enacted rate changes in the three months ended March 31, 2010. Our effective tax rate includes the effect of operations outside the United States, which historically have been taxed at rates lower than the U.S. statutory rate. While we have income from multiple foreign sources, the majority of our non-U.S. operations are in Canada and the United Kingdom, where we anticipate the statutory rates to be between 26% and 28% for the year ended December 31, 2011. Additionally, the foreign effective tax rate is benefited by certain other permanent items, such as enacted rate changes. The expected effective tax rate for the year ended December 31, 2011 is forecasted to be between 33% and 34%. A future proportionate change in the composition of income before income taxes from foreign and domestic tax jurisdictions could impact our periodic effective tax rate. Liquidity and Capital Resources Our principal cash requirements are to finance the costs of our operations pending the billing and collection of client receivables, to fund payments with respect to our indebtedness, to invest in research and development and to acquire complementary businesses or assets. We expect our cash on hand and cash flows from operations to provide sufficient liquidity to fund our current obligations, projected working capital requirements and capital spending for at least the next twelve months. Our cash and cash equivalents at June 30, 2011 were $82.6 million, a decrease of $2.2 million from $84.8 million at December 31, 2010. The decrease in cash is due primarily to net repayments of debt and cash used for an acquisition and capital expenditures, partially offset by net proceeds of $52.0 million from our follow-on public offering of common stock in February 2011 and cash provided by operations. Net cash provided by operating activities was $41.1 million for the six months ended June 30, 2011. Cash provided by operating activities was primarily due to net income of $22.9 million adjusted for non-cash items of $23.0 million, partially offset by changes in our working capital accounts totaling $4.8 million. The changes in our working capital accounts were driven by decreases in accrued expenses and other liabilities and increases in income tax receivables and prepaid expenses and other assets, partially offset by increases in deferred revenues and accounts payable and a decrease in accounts receivable. The decrease in accrued expenses was primarily due to the payment of annual employee bonuses. The increase in deferred revenues was primarily due to the collection of annual maintenance fees. The decrease in accounts receivable was primarily due to the improvement in days' sales outstanding. Investing activities used net cash of $19.0 million for the six months ended June 30, 2011, primarily related to $14.8 million cash paid for our acquisition of BMXL, $3.1 million in cash paid for capital expenditures and $1.1 million in cash paid for capitalized software. 16-------------------------------------------------------------------------------- Table of Contents Financing activities used net cash of $24.8 million for the six months ended June 30, 2011, representing $87.8 million in repayments of debt, partially offset by $52.0 million in net proceeds from our follow-on offering, proceeds of $6.2 million from stock option exercises and income tax windfall benefits of $4.8 million related to the exercise of stock options. The repayment of debt during the period reflects our use of proceeds from our follow-on offering and available cash to redeem $66.6 million in principal amount of our outstanding 11 3/4% senior subordinated notes due 2013 at a redemption price of 102.9375% of principal amount. We have made a permanent reinvestment determination in certain non-U.S. operations that have historically generated positive operating cash flows. At June 30, 2011, we held approximately $10.6 million in cash and cash equivalents at non-U.S. subsidiaries where we had made such a determination and in turn no provision for U.S. income taxes had been made. As of June 30, 2011, we believe we have sufficient foreign tax credits available to offset tax obligations associated with repatriation of these funds. Off-Balance Sheet Arrangements We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Senior Credit Facilities SS&C's borrowings under the senior credit facilities bear interest at either a floating base rate or a Eurocurrency rate plus, in each case, an applicable margin. In addition, SS&C pays a commitment fee in respect of unused revolving commitments at a rate that is adjusted based on its leverage ratio. SS&C is obligated to make quarterly principal payments on the term loan totaling $1.4 million per year. Subject to certain exceptions, thresholds and other limitations, SS&C is required to prepay outstanding loans under the senior credit facilities with the net proceeds of certain asset dispositions and certain debt issuances and 50% of its excess cash flow (as defined in the agreements governing the senior credit facilities), which percentage will be reduced if SS&C reaches certain leverage ratio thresholds. The obligations under SS&C's senior credit facilities are guaranteed by us and all of SS&C's existing and future material wholly-owned U.S. subsidiaries, with certain exceptions as set forth in the credit agreement. The obligations of the Canadian borrower are guaranteed by us, SS&C and each of SS&C's U.S. and Canadian subsidiaries, with certain exceptions as set forth in the credit agreement. The obligations under the senior credit facilities are secured by a perfected first priority security interest in all of SS&C's capital stock and all of the capital stock or other equity interests held by us, SS&C and each of SS&C's existing and future U.S. subsidiary guarantors (subject to certain limitations for equity interests of foreign subsidiaries and other exceptions as set forth in the credit agreement) and all of our and SS&C's tangible and intangible assets and the tangible and intangible assets of each of SS&C's existing and future U.S. subsidiary guarantors, with certain exceptions as set forth in the credit agreement. The Canadian borrower's borrowings under the senior credit facilities and all guarantees thereof are secured by a perfected first priority security interest in all of SS&C's capital stock and all of the capital stock or other equity interests held by us, SS&C and each of SS&C's existing and future U.S. and Canadian subsidiary guarantors, with certain exceptions as set forth in the credit agreement, and all of our and SS&C's tangible and intangible assets and the tangible and intangible assets of each of SS&C's existing and future U.S. and Canadian subsidiary guarantors, with certain exceptions as set forth in the credit agreement. The senior credit facilities contain a number of covenants that, among other things, restrict, subject to certain exceptions, SS&C's (and its restricted subsidiaries') ability to incur additional indebtedness, pay dividends and distributions on capital stock, create liens on assets, enter into sale and lease-back transactions, repay subordinated indebtedness, make capital expenditures, engage in certain transactions with affiliates, dispose of assets and engage in mergers or acquisitions. In addition, under the senior credit facilities, SS&C is required to satisfy and maintain a maximum total leverage ratio and a minimum interest coverage ratio. SS&C was in compliance with all covenants at June 30, 2011. 11 3/4% Senior Subordinated Notes due 2013 The 11 3/4% senior subordinated notes due 2013 are unsecured senior subordinated obligations of SS&C that are subordinated in right of payment to all existing and future senior debt, including the senior credit facilities. The senior subordinated notes will be pari passu in right of payment to all future senior subordinated debt. 17 -------------------------------------------------------------------------------- Table of Contents The senior subordinated notes are redeemable in whole or in part, at SS&C's option, at any time at varying redemption prices that generally include premiums, which are defined in the indenture governing the senior subordinated notes. In addition, upon a change of control, SS&C is required to make an offer to redeem all of the senior subordinated notes at a redemption price equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest. In March 2011, SS&C redeemed $66.6 million in principal amount of its outstanding 113/4 % senior subordinated notes due 2013 at a redemption price of 102.9375% of the principal amount, plus accrued and unpaid interest on such amount to, but excluding, March 17, 2011, the date of the redemption. The indenture governing the senior subordinated notes contains a number of covenants including, among others, covenants that restrict, subject to certain exceptions, SS&C's ability and the ability of its restricted subsidiaries to incur additional indebtedness, pay dividends, make certain investments, create liens, dispose of certain assets and engage in mergers or acquisitions. Covenant Compliance Under the senior credit facilities, SS&C is required to satisfy and maintain specified financial ratios and other financial condition tests. As of June 30, 2011, SS&C was in compliance with the financial and non-financial covenants. SS&C's continued ability to meet these financial ratios and tests can be affected by events beyond our control, and we cannot assure you that SS&C will continue to meet these ratios and tests. A breach of any of these covenants could result in a default under the senior credit facilities. Upon the occurrence of any event of default under the senior credit facilities, the lenders could elect to declare all amounts outstanding under the senior credit facilities to be immediately due and payable and terminate all commitments to extend further credit. Consolidated EBITDA is a non-GAAP financial measure used in key financial covenants contained in the senior credit facilities, which are material facilities supporting our capital structure and providing liquidity to our business. Consolidated EBITDA is defined as earnings before interest, taxes, depreciation and amortization (EBITDA), further adjusted to exclude unusual items and other adjustments permitted in calculating covenant compliance under the senior credit facilities. We believe that the inclusion of supplementary adjustments to EBITDA applied in presenting Consolidated EBITDA is appropriate to provide additional information to investors to demonstrate compliance with the specified financial ratios and other financial condition tests contained in the senior credit facilities. Management uses Consolidated EBITDA to gauge the costs of our capital structure on a day-to-day basis when full financial statements are unavailable. Management further believes that providing this information allows our investors greater transparency and a better understanding of our ability to meet our debt service obligations and make capital expenditures. A breach of any of the covenants in the senior credit facilities that are tied to ratios based on Consolidated EBITDA could result in a default under that agreement, in which case the lenders could elect to declare all amounts borrowed due and payable and to terminate any commitments they have to provide further borrowings. Any such acceleration would also result in a default under the indenture governing the 11 3/4% senior subordinated notes due 2013. Any such default and subsequent acceleration of payments under our debt agreements would have a material adverse effect on our results of operations, financial position and cash flows. Additionally, under our debt agreements, our ability to engage in activities such as incurring additional indebtedness, making investments and paying dividends is also tied to ratios based on Consolidated EBITDA. Consolidated EBITDA does not represent net income or cash flow from operations as those terms are defined by GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. Further, the senior credit facilities require that Consolidated EBITDA be calculated for the most recent four fiscal quarters. As a result, the measure can be disproportionately affected by a particularly strong or weak quarter. Further, it may not be comparable to the measure for any subsequent four-quarter period or any complete fiscal year. Consolidated EBITDA is not a recognized measurement under GAAP, and investors should not consider Consolidated EBITDA as a substitute for measures of our financial performance and liquidity as determined in accordance with GAAP, such as net income, operating income or net cash provided by operating activities. Because other companies may calculate Consolidated EBITDA differently than we do, Consolidated EBITDA may not be comparable to similarly titled measures reported by other companies. Consolidated EBITDA has other limitations as an analytical tool, when compared to the use of net income (loss), which is the most directly comparable GAAP financial measure, including: • Consolidated EBITDA does not reflect the provision of income tax expense in our various jurisdictions; • Consolidated EBITDA does not reflect the significant interest expense we incur as a result of our debt leverage; • Consolidated EBITDA does not reflect any attribution of costs to our operations related to our investments and capital expenditures through depreciation and amortization charges; 18 -------------------------------------------------------------------------------- Table of Contents • Consolidated EBITDA does not reflect the cost of compensation we provide to our employees in the form of stock option awards; and • Consolidated EBITDA excludes expenses that we believe are unusual or non-recurring, but which others may believe are normal expenses for the operation of a business. The following is a reconciliation of net income to Consolidated EBITDA (in thousands) as defined in the senior credit facilities. Three Months Ended Six Months Ended Twelve Months Ended June 30, June 30, June 30, 2011 2010 2011 2010 2011 Net income $ 13,028 $ 4,362 $ 22,862 $ 13,383 $ 41,892 Interest expense (1) 3,474 13,538 11,482 22,555 24,819 Income taxes 6,512 2,004 11,490 3,272 20,252 Depreciation and amortization 10,612 10,184 20,990 20,297 41,421 EBITDA 33,626 30,088 66,824 59,507 128,384 Purchase accounting adjustments (2) (102 ) (60 ) (204 ) (37 ) (405 ) Unusual or non-recurring charges (3) 123 (267 ) 659 84 250 Acquired EBITDA and cost savings (4) - - 443 192 2,856 Stock-based compensation 3,638 3,882 5,435 5,232 13,457 Capital-based taxes 2 228 154 454 791 Other (5) 116 (45 ) 86 161 (36 ) Consolidated EBITDA $ 37,403 $ 33,826 $ 73,397 $ 65,593 $ 145,297 (1) Interest expense includes loss from extinguishment of debt shown as a separate line item on our Statement of Operations. (2) Purchase accounting adjustments include (a) an adjustment to increase revenues by the amount that would have been recognized if deferred revenue were not adjusted to fair value at the date of acquisitions and (b) an adjustment to increase rent expense by the amount that would have been recognized if lease obligations were not adjusted to fair value at the date of acquisitions. (3) Unusual or non-recurring charges include foreign currency gains and losses, severance expenses, proceeds from legal and other settlements and other expenses, such as expenses associated with the bond redemption, acquisitions and facility refund. (4) Acquired EBITDA and cost savings reflects the EBITDA impact of significant businesses that were acquired during the period as if the acquisition occurred at the beginning of the period and cost savings to be realized from such acquisitions. (5) Other includes management fees and related expenses paid to The Carlyle Group and the non-cash portion of straight-line rent expense. The covenant restricting capital expenditures for the year ending December 31, 2011 limits expenditures to $23.7 million. Actual capital expenditures through June 30, 2011 were $3.1 million. The covenant requirements for total leverage ratio and minimum interest coverage ratio and the actual ratios for the twelve months ended June 30, 2011 are as follows: Covenant Actual Requirements Ratios Maximum consolidated total leverage to Consolidated EBITDA ratio(1) 5.50 x 1.20 x Minimum Consolidated EBITDA to consolidated net interest coverage ratio 2.25 x 7.24 x (1) Calculated as the ratio of funded debt, less cash on hand up to a maximum of $30.0 million, to Consolidated EBITDA, as defined by the senior credit facility, for the period of four consecutive fiscal quarters ended on the measurement date. Funded debt is comprised of indebtedness for borrowed money, notes, bonds or similar instruments, and capital lease obligations. This covenant is applied at the end of each quarter. 19 -------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements In June 2011, the FASB issued ASU No. 2011-05, "Comprehensive Income" (ASU 2011-05). ASU 2011-05 intends to enhance comparability and transparency of other comprehensive income components. The guidance provides an option to present total comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements. ASU 2011-05 eliminates the option to present other comprehensive income components as part of the statement of changes in shareowners' equity. The provisions of ASU 2011-05 will be applied retrospectively for interim and annual periods beginning after December 15, 2011. Early application is permitted. We are currently evaluating the impact of ASU 2011-05. In May 2011, the FASB issued ASU No. 2011-04, "Fair Value Measurement" (ASU 2011-04). ASU 2011-04 amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. The changes are effective prospectively for interim and annual periods beginning after December 15, 2011. We are currently evaluating the impact of ASU 2011-04. In December 2010, the FASB issued ASU No. 2010-29, which updates the guidance in ASC Topic 805, Business Combinations (ASU 2010-29). The objective of ASU 2010-29 is to address diversity in practice regarding the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in ASU 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This guidance is effective for business combinations with an acquisition date on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. We adopted this standard beginning January 1, 2011, and the adoption did not have a material impact on our financial position, results of operations or cash flows. In December 2010, the FASB issued ASU No. 2010-28, Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (ASU 2010-28). ASU 2010-28 modifies Step 1 of the goodwill impairment test so that for those reporting units with zero or negative carrying amounts, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not based on an assessment of qualitative indicators that goodwill impairment exists. In determining whether it is more likely than not that goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that impairment may exist. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. We adopted this standard beginning January 1, 2011, and the adoption did not have a material impact on our financial position, results of operations or cash flows. Item 3. Quantitative and Qualitative Disclosures About Market Risk We do not use derivative financial instruments for trading or speculative purposes. We have invested our available cash in short-term, highly liquid financial instruments, having initial maturities of three months or less. When necessary, we have borrowed to fund acquisitions. At June 30, 2011, excluding capital leases, we had total debt of $203.7 million, including $137.1 million of variable interest rate debt. At June 30, 2011, $13.1 million of our debt was denominated in Canadian dollars. We expect that our foreign denominated debt will be serviced through our Canadian operations. During the six months ended June 30, 2011, approximately 31% of our revenues were from clients located outside the United States. A portion of the revenues from clients located outside the United States is denominated in foreign currencies, the majority being denominated in the Canadian dollar. While revenues and expenses of our foreign operations are primarily denominated in their respective local currencies, some of our subsidiaries do enter into certain transactions in currencies other than their functional currency. These transactions consist primarily of cross-currency intercompany balances and trade receivables and payables. As a result of these transactions, we have exposure to changes in foreign currency exchange rates that result in foreign currency transaction gains or losses, which we report in other income (expense). These outstanding amounts were reduced during 2010, and we do not believe that our foreign currency transaction gains or losses will be material during 2011. The amount of these balances may fluctuate in the future as we bill customers and buy products or services in currencies other than our functional currency, which could increase our exposure to foreign currency exchange rates in the future. We continue to monitor our exposure to foreign currency exchange rates as a result of our foreign currency denominated debt, our acquisitions and changes in our operations. We do not enter into any market risk sensitive instruments for trading purposes. 20 -------------------------------------------------------------------------------- Table of Contents The foregoing risk management discussion and the effect thereof are forward-looking statements. Actual results in the future may differ materially from these projected results due to actual developments in global financial markets. The analytical methods used by us to assess and minimize risk discussed above should not be considered projections of future events or losses. Item 4. Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2011. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the "Exchange Act"), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by the company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2011, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level. There have not been any changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |