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ACI WORLDWIDE, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements This report contains forward-looking statements based on current expectations that involve a number of risks and uncertainties. Generally, forward-looking statements do not relate strictly to historical or current facts and may include words or phrases such as "believes," "will," "expects," "anticipates," "intends," and words and phrases of similar impact. The forward-looking statements are made pursuant to safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. Forward-looking statements in this report include, but are not limited to, statements regarding future operations, business strategy, business environment, key trends, and, in each case, statements related to expected financial and other benefits. Many of these factors will be important in determining our actual future results. Any or all of the forward-looking statements in this report may turn out to be incorrect. They may be based on inaccurate assumptions or may not account for known or unknown risks and uncertainties. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from those expressed or implied in any forward-looking statements, and our business, financial condition and results of operations could be materially and adversely affected. In addition, we disclaim any obligation to update any forward-looking statements after the date of this report, except as required by law. All of the forward-looking statements in this report are expressly qualified by the risk factors discussed in our filings with the Securities and Exchange Commission ("SEC"). Such factors include, but are not limited to, risks related to: • increased competition; • the performance of our strategic product, BASE24-eps; • demand for our products; • restrictions and other financial covenants in our credit facility; • consolidations and failures in the financial services industry; • customer reluctance to switch to a new vendor; • our strategy to migrate customers to our next generation products; • the accuracy of management's backlog estimates; • failure to obtain renewals of customer contracts or to obtain such renewals on favorable terms; • delay or cancellation of customer projects or inaccurate project completion estimates; • global economic conditions impact on demand for our products and services; • volatility and disruption of the capital and credit markets and adverse changes in the global economy; • difficulty meeting our debt service requirements; • impairment of our goodwill or intangible assets; • risks from potential future litigation; • future acquisitions, strategic partnerships and investments and litigation; • risk of difficulties integrating Online Resources Corporation ("ORCC"), Official Payments Holdings, Inc. ("OPAY") and Retail Decisions Europe Limited and Retail Decisions, Inc.(collectively "ReD"), which may cause us to fail to realize anticipated benefits of the acquisitions; • the complexity of our products and services and the risk that they may contain hidden defects; • risks of failing to comply with money transmitter rules and regulations; • compliance of our products with applicable legislation, governmental regulations and industry standards; • our compliance with privacy regulations; • risks of being subject to security breaches or viruses; • the protection of our intellectual property in intellectual property litigation; • certain payment funding methods expose us to the credit and/or operating risk of our clients; • the cyclical nature of our revenue and earnings and the accuracy of forecasts due to the concentration of revenue generating activity during the final weeks of each quarter; • business interruptions or failure of our information technology and communication systems; • our offshore software development activities; • risks from operating internationally; • exposure to unknown tax liabilities; and • volatility in our stock price. The cautionary statements in this report expressly qualify all of our forward-looking statements. The following discussion should be read together with our financial statements and related notes contained in this report and with the financial statements and related notes and Management's Discussion & Analysis in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed February 28, 2014. Results for the three and nine months ended September 30, 2014, are not necessarily indicative of results that may be attained in the future. 26-------------------------------------------------------------------------------- Table of Contents Overview ACI Worldwide powers electronic payments and banking for nearly 2,600 financial institutions, retailers and processors around the world. Through our comprehensive suite of software products and hosted services, we deliver a broad range of solutions for payment processing; card and merchant management; online banking; mobile, branch and voice banking; fraud detection; trade finance; and electronic bill presentment and payment. In addition to our own products, we distribute, or act as a sales agent for, software developed by third parties. Our products are sold and supported through distribution networks covering three geographic regions - the Americas, EMEA and Asia/Pacific. Each distribution network has its own globally coordinated sales force and supplements its sales force with independent reseller and/or distributor networks. Our products and services are used principally by financial institutions, retailers and electronic payment processors, both in domestic and international markets. Accordingly, our business and operating results are influenced by trends such as information technology spending levels, the growth rate of the electronic payments industry, mandated regulatory changes, and changes in the number and type of customers in the financial services industry. Our products are marketed under the ACI Worldwide, ACI Payment Systems, ACI Universal Payments and Official Payments brands. We derive a significant amount of our revenues from international operations and believe we have large opportunities for growth in international markets as well as continued expansion domestically in the United States. Refining our global infrastructure is a critical component of driving our growth. We have launched a globalization strategy which includes elements intended to streamline our supply chain and maximize expertise in several geographic locations to support a growing international customer base and competitive needs. We utilize our Irish subsidiaries to manage certain of our intellectual property rights and to oversee and manage certain international product development and commercialization efforts. We also continue to grow centers of expertise in Timisoara, Romania and Pune and Bangalore in India as well as key operational centers such as Capetown, South Africa and in multiple locations in the United States. Key trends that currently impact our strategies and operations include: Increasing electronic payment transaction volumes. Electronic payment volumes continue to increase around the world, taking market share from traditional cash and check transactions. In February 2011 Boston Consulting Group predicted that noncash payment transactions would grow in volume at an annual rate of 9% from 309 billion in 2010 to 740 billion in 2020, with varying growth rates based on the type of payment and part of the world. We leverage the growth in transaction volumes through the licensing of new systems to customers whose older systems cannot handle increased volume and through the licensing of capacity upgrades to existing customers. Adoption of real-time delivery. Customer expectations, from both consumers and corporate, are driving the payments world to more real-time delivery. In the UK, payments sent through the traditional ACH multi day batch service can now be sent through the Faster Payments service giving almost immediate access to the funds and this is being considered in several countries including Singapore and the US. Corporate customers expect real-time information on the status of their payments instead of waiting for an end of day report. And regulators expect banks to be monitoring key measures like liquidity in real time. ACI's focus has always been on the real-time execution of transactions and delivery of information through real-time tools such as dashboards so our experience will be valuable in addressing this trend. Increasing competition. The electronic payments market is highly competitive and subject to rapid change. Our competition comes from in-house information technology departments, third-party electronic payment processors and third-party software companies located both within and outside of the United States. Many of these companies are significantly larger than us and have significantly greater financial, technical and marketing resources. As electronic payment transaction volumes increase, third-party processors tend to provide competition to our solutions, particularly among customers that do not seek to differentiate their electronic payment offerings or are eliminating banks from the payments service, reducing the need for our solutions. As consolidation in the financial services industry continues, we anticipate that competition for those customers will intensify. Adoption of cloud technology. In an effort to leverage lower-cost computing technologies some financial institutions, retailers, billers and electronic payment processors are seeking to transition their systems to make use of cloud technology. Our ACI On Demand SaaS hosting service addresses this market need. 27 -------------------------------------------------------------------------------- Table of Contents Electronic payments fraud and compliance. As electronic payment transaction volumes increase, criminal elements continue to find ways to commit a growing volume of fraudulent transactions using a wide range of techniques. Financial institutions, retailers and electronic payment processors continue to seek ways to leverage new technologies to identify and prevent fraudulent transactions and other attacks such as denial of service attacks. Due to concerns with international terrorism and money laundering, financial institutions in particular are being faced with increasing scrutiny and regulatory pressures. In addition, several high-profile data breaches at major retailers further heightened visibility and awareness of payments fraud and risk-related issues. We continue to see opportunity to offer our fraud detection solutions to help customers manage the growing levels of electronic payment fraud and compliance activity. Adoption of smartcard technology. In many markets, card issuers are being required to issue new cards with embedded chip technology, most recently in the United States. Chip-based cards are more secure, harder to copy and offer the opportunity for multiple functions on one card (e.g. debit, credit, electronic purse, identification, health records, etc.). The EMV standard for issuing and processing debit and credit card transactions has emerged as the global standard, with many regions throughout the world working on EMV rollouts. The primary benefit of EMV deployment is a reduction in electronic payment fraud, with the additional benefit that the core infrastructure necessary for multi-function chip cards is being put in place (e.g., chip card readers in ATMs and POS devices) allowing the deployment of other technologies like contactless. We are working with many customers around the world to facilitate EMV deployments, leveraging several of our solutions. Single Euro Payments Area ("SEPA"). The SEPA, primarily focused on the European Economic Community and the United Kingdom, is designed to facilitate lower costs for cross-border payments and reduce timeframes for settling electronic payment transactions. Deadlines for SEPA payment mechanisms will drive more volume to these systems with the potential to cause banks to review the capabilities of the systems supporting these payments. Our retail and wholesale banking solutions facilitate key functions that help financial institutions address these mandated regulations. Financial institution consolidation. Consolidation continues on a national and international basis, as financial institutions seek to add market share and increase overall efficiency. Such consolidations have increased, and may continue to increase, in their number, size and market impact as a result of the recent global economic crisis and the financial crisis affecting the banking and financial industries. There are several potential negative effects of increased consolidation activity. Continuing consolidation of financial institutions may result in a smaller number of existing and potential customers for our products and services. Consolidation of two of our customers could result in reduced revenues if the combined entity were to negotiate greater volume discounts or discontinue use of certain of our products. Additionally, if a non-customer and a customer combine and the combined entity decides to forego future use of our products, our revenue would decline. Conversely, we could benefit from the combination of a non-customer and a customer when the combined entity continues use of our products and, as a larger combined entity, increases its demand for our products and services. We tend to focus on larger financial institutions as customers, often resulting in our solutions being the solutions that survive in the consolidated entity. Global vendor sourcing. Global and regional financial institutions, processors and retailers are aiming to reduce costs in supplier management by picking suppliers who can service them across all their geographies instead of allowing each country operation to choose suppliers independently. Our global footprint from both a customer and a delivery perspective enable us to be successful in this global sourced market. However, projects in these environments tend to be more complex and therefore of higher risk. Electronic payments convergence. As electronic payment volumes grow and pressures to lower overall cost per transaction increase, financial institutions are seeking methods to consolidate their payment processing across the enterprise. We believe that the strategy of using service-oriented-architectures to allow for re-use of common electronic payment functions such as authentication, authorization, routing and settlement will become more common. Using these techniques, financial institutions will be able to reduce costs, increase overall service levels, enable one-to-one marketing in multiple bank channels, leverage volumes for improved pricing and liquidity, and manage enterprise risk. Our Universal Payments strategy is, in part, focused on this trend, by creating integrated payment functions that can be re-used by multiple bank channels, across both the consumer and wholesale bank. While this trend presents an opportunity for us, it may also expand the competition from third-party electronic payment technology and service providers specializing in other forms of electronic payments. Many of these providers are larger than us and have significantly greater financial, technical and marketing resources. Mobile banking and payments. There is a growing demand for the ability to carry out banking services or make payments using a mobile phone. Our customers have been making use of existing products to deploy mobile banking, mobile payment, mobile commerce and mobile payment solutions for their customers in many countries. In addition, ACI has invested in mobile products of our own and via partnerships to support mobile functionality in the marketplace. 28-------------------------------------------------------------------------------- Table of Contents The banking, financial services and payments industries have come under increased scrutiny from federal, state and foreign lawmakers and regulators in response to the crises in the financial markets and the global recession. In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which was signed into law July 21, 2010, represents a comprehensive overhaul of the U.S. financial services industry and requires the implementation of many new regulations that will have a direct impact on our customers and potential customers. These regulatory changes may create both opportunities and challenges for us. The application of the new regulations on our customers could create an opportunity for us to market our product capabilities and the flexibility of our solutions to assist our customers in addressing these regulations. At the same time, these regulatory changes may have an adverse impact on our operations and our financial results as we adjust our activities in light of increased compliance costs and customer requirements. It is currently too difficult to predict the long term extent to which the Dodd-Frank Act or the resulting regulations will impact our business and the businesses of our current and potential customers. Several other factors related to our business may have a significant impact on our operating results from year to year. For example, the accounting rules governing the timing of revenue recognition in the software industry are complex and it can be difficult to estimate when we will recognize revenue generated by a given transaction. Factors such as maturity of the software product licensed, payment terms, creditworthiness of the customer, and timing of delivery or acceptance of our products often cause revenues related to sales generated in one period to be deferred and recognized in later periods. For arrangements in which services revenue is deferred, related direct and incremental costs may also be deferred. Additionally, while the majority of our contracts are denominated in the United States dollar, a substantial portion of our sales are made, and some of our expenses are incurred, in the local currency of countries other than the United States. Fluctuations in currency exchange rates in a given period may result in the recognition of gains or losses for that period. We continue to seek ways to grow through organic sources, partnerships, alliances, and acquisitions. We continually look for potential acquisitions designed to improve our solutions' breadth or provide access to new markets. As part of our acquisition strategy, we seek acquisition candidates that are strategic, capable of being integrated into our operating environment, and financially accretive to our financial performance. Restructuring During the nine months ended September 30, 2014, we reduced our headcount as a part of our integration of recent acquisitions. In connection with these actions, approximately $3.2 million and $6.0 million of termination costs were recognized in general and administrative expense in the accompanying condensed consolidated statements of income during the three and nine months ended September 30, 2014, respectively. The charges by segment were as follows for the three months ended September 30, 2014: $1.7 million in the Americas segment, $0.5 million in the Asia/Pacific segment, and $1.0 million in the EMEA segment. The charges by segment were as follows for the nine months ended September 30, 2014: $3.8 million in the Americas segment, $1.0 million in the Asia/Pacific segment, and $1.2 million in the EMEA segment. Approximately $6.3 million of termination costs were paid during the nine months ended September 30, 2014. The remaining liability is expected to be paid over the next 12 months. Fiscal 2014 Acquisitions On August 12, 2014, we completed our acquisition of ReD for $205.1 million in cash. We have included the financial results of ReD in our condensed consolidated financial statements from the date of acquisition. As a leader in fraud prevention solutions, the acquisition of ReD enhances our Universal Payments strategy and further strengthens our leadership position in the fast-growing payments risk management space. Backlog Included in backlog estimates are all software license fees, maintenance fees and services fees specified in executed contracts, as well as revenues from assumed contract renewals to the extent that we believe recognition of the related revenue will occur within the corresponding backlog period. We have historically included assumed renewals in backlog estimates based upon automatic renewal provisions in the executed contract and our historic experience with customer renewal rates. Our 60-month backlog estimate represents expected revenues from existing customers using the following key assumptions: • Maintenance fees are assumed to exist for the duration of the license term for those contracts in which the committed maintenance term is less than the committed license term. • License, facilities management, and software hosting arrangements are assumed to renew at the end of their committed term at a rate consistent with our historical experiences. • Non-recurring license arrangements are assumed to renew as recurring revenue streams. • Foreign currency exchange rates are assumed to remain constant over the 60-month backlog period for those contracts stated in currencies other than the U.S. dollar. • Our pricing policies and practices are assumed to remain constant over the 60-month backlog period. 29 -------------------------------------------------------------------------------- Table of Contents In computing our 60-month backlog estimate, the following items are specifically not taken into account: • Anticipated increases in transaction, account, or processing volumes in customer systems. • Optional annual uplifts or inflationary increases in recurring fees. • Services engagements, other than facilities management and software hosting engagements, are not assumed to renew over the 60-month backlog period. • The potential impact of merger activity within our markets and/or customers. We review our customer renewal experience on an annual basis. The impact of this review and subsequent update may result in a revision to the renewal assumptions used in computing the 60-month and 12-month backlog estimates. In the event a revision to renewal assumptions is determined to be necessary, prior periods will be adjusted for comparability purposes. The following table sets forth our 60-month backlog estimate, by geographic region, as of September 30, 2014, June 30, 2014, March 31, 2014 and December 31, 2013 (in millions). The September 30, 2014 60-month backlog estimate includes approximately $205 million as a result of the acquisition of ReD. Dollar amounts reflect foreign currency exchange rates as of each period end. September 30, June 30, March 31, December 31, 2014 2014 2014 2013 Americas $ 3,000 $ 2,874 $ 2,858 $ 2,831 EMEA 826 765 767 747 Asia/Pacific 288 285 285 283 Total $ 4,114 $ 3,924 $ 3,910 $ 3,861 September 30, June 30, March 31, December 31, 2014 2014 2014 2013 Committed $ 1,660 $ 1,637 $ 1,629 $ 1,742 Renewal 2,454 2,287 2,281 2,119 Total $ 4,114 $ 3,924 $ 3,910 $ 3,861 Included in our 60-month backlog estimates are amounts expected to be recognized during the initial license term of customer contracts ("Committed Backlog") and amounts expected to be recognized from assumed renewals of existing customer contracts ("Renewal Backlog"). Amounts expected to be recognized from assumed contract renewals are based on our historical renewal experience. We also estimate 12-month backlog, segregated between monthly recurring and non-recurring revenues, using a methodology consistent with the 60-month backlog estimate. Monthly recurring revenues include all monthly license fees, maintenance fees and processing services fees. Non-recurring revenues include other software license fees and services fees. Amounts included in our 12-month backlog estimate assume renewal of one-time license fees on a monthly fee basis if such renewal is expected to occur in the next 12 months. The following table sets forth our 12-month backlog estimate, by geographic region, as of September 30, 2014, June 30, 2014, March 31, 2014 and December 31, 2013 (in millions). The September 30, 2014 12-month backlog estimate includes approximately $42 million as a result of the acquisition of ReD. For all periods reported, approximately 90% of our 12-month backlog estimate is committed backlog and approximately 10% of our 12-month backlog estimate is renewal backlog. Dollar amounts reflect currency exchange rates as of each period end. 30 -------------------------------------------------------------------------------- Table of Contents September 30, 2014 June 30, 2014 Monthly Monthly Recurring Non-Recurring Total Recurring Non-Recurring Total Americas $ 593 $ 58 $ 651 $ 569 $ 71 $ 640 EMEA 143 36 179 131 43 174 Asia/Pacific 54 14 68 51 20 71 Total $ 790 $ 108 $ 898 $ 751 $ 134 $ 885 March 31, 2014 December 31, 2013 Monthly Monthly Recurring Non-Recurring Total Recurring Non-Recurring Total Americas $ 574 $ 64 $ 638 $ 571 $ 63 $ 634 EMEA 127 50 177 130 38 168 Asia/Pacific 52 16 68 53 15 68 Total $ 753 $ 130 $ 883 $ 754 $ 116 $ 870 Estimates of future financial results are inherently unreliable. Our backlog estimates require substantial judgment and are based on a number of assumptions as described above. These assumptions may turn out to be inaccurate or wrong, including for reasons outside of management's control. For example, our customers may attempt to renegotiate or terminate their contracts for a number of reasons, including mergers, changes in their financial condition, or general changes in economic conditions in the customer's industry or geographic location, or we may experience delays in the development or delivery of products or services specified in customer contracts which may cause the actual renewal rates and amounts to differ from historical experiences. Changes in foreign currency exchange rates may also impact the amount of revenue actually recognized in future periods. Accordingly, there can be no assurance that amounts included in backlog estimates will actually generate the specified revenues or that the actual revenues will be generated within the corresponding 12-month or 60-month period. Additionally, because backlog estimates are operating metrics, the estimates are not required to be subject to the same level of internal review or controls as a GAAP financial measure. RESULTS OF OPERATIONS The following table presents the condensed consolidated statements of income as well as the percentage relationship to total revenues of items included in our condensed consolidated statements of income (amounts in thousands): Three-Month Period Ended September 30, 2014 Compared to the Three-Month Period Ended September 30, 2013 Revenues 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Revenues: Initial license fees (ILFs) $ 35,841 14.4 % $ 1,697 5.0 % $ 34,144 16.0 % Monthly license fees (MLFs) 21,812 8.7 % (280 ) -1.3 % 22,092 10.3 % License 57,653 23.1 % 1,417 2.5 % 56,236 26.3 % Maintenance 63,764 25.5 % 3,307 5.5 % 60,457 28.3 % Services 28,194 11.3 % (2,046 ) -6.8 % 30,240 14.1 % Hosting 100,033 40.1 % 33,027 49.3 % 67,006 31.3 % Total revenues $ 249,644 100.0 % $ 35,705 16.7 % $ 213,939 100.0 % Total revenue for the three months ended September 30, 2014 increased $35.7 million, or 17%, as compared to the same period in 2013. The increase is the result of a $33.0 million, or 49%, increase in hosting revenue, a $3.3 million, or 6%, increase in maintenance revenue and a $1.4 million, or 3% increase in license revenue partially offset by a $2.0 million, or 7%, decrease in services revenue. The increase in total revenue for the three months ended September 30, 2014 as compared to the same period in 2013 was due to a $36.1 million, or 26%, increase in the Americas reportable segment and a $5.1 million, or 10%, increase in the EMEA reportable segment partially offset by a $5.5 million, or 22%, decrease in the Asia/Pacific reportable segment. 31-------------------------------------------------------------------------------- Table of Contents The addition of OPAY and ReD contributed $34.6 million, or 16%, of the increase in total revenue for the three months ended September 30, 2014. Excluding the impact of the incremental revenue from the addition of OPAY and ReD, total revenue for the three months ended September 30, 2014 increased $1.1 million. License Revenue Customers purchase the right to license ACI software for the term of their agreement which term is generally 60 months. Within these agreements are specified capacity limits typically based on customer transaction volumes. ACI employs measurement tools that monitor the number of transactions processed by customers and if contractually specified limits are exceeded, additional fees are charged for the overage. Capacity overages may occur at varying times throughout the term of the agreement depending on the product, the size of the customer, and the significance of customer transaction volume growth. Depending on specific circumstances, multiple overages or no overages may occur during the term of the agreement. Initial License Revenue Initial license revenue includes license and capacity revenues that do not recur on a monthly or quarterly basis. Included in initial license revenue are license and capacity fees that are recognizable at the inception of the agreement and license and capacity fees that are recognizable at interim points during the term of the agreement, including those that are recognizable annually due to negotiated customer payment terms. Initial license revenue increased by $1.7 million, or 5%, during the three months ended September 30, 2014, as compared to the same period in 2013. Initial license revenue increased in the Americas and EMEA reportable segments by $1.7 million each, partially offset by a decrease in the Asia/Pacific reportable segment of $1.7 million. The increase in initial license revenue was partially offset by a decline in capacity related revenues of $0.5 million primarily in the Asia/Pacific reportable segment during the three months ended September 30, 2014 as compared to the same period in 2013. The increase in initial license revenue is primarily due to an increase in sales while the decrease in capacity related revenues is primarily due to the timing and relative size of capacity events as compared to the same period in 2013. Monthly License Revenue Monthly license revenue is license and capacity revenue that is paid monthly or quarterly due to negotiated customer payment terms as well as initial license and capacity fees that are recognized as revenue ratably over an extended period as monthly license revenue. Monthly license revenue decreased $0.3 million, or 1%, during the three months ended September 30, 2014, as compared to the same period in 2013 with the EMEA and Asia/Pacific reportable segments decreasing by $0.5 million and $0.7 million, respectively, partially offset by an increase in the Americas reportable segment of $0.9 million. Maintenance Revenue Maintenance revenue includes standard and enhanced maintenance or any post contract support fees received from customers for the provision of product support services. Maintenance revenue during the three months ended September 30, 2014, as compared to the same period in 2013 increased $3.3 million, or 6%. Maintenance revenue increased in the Americas, EMEA and Asia/Pacific reportable segments by $1.8 million, $1.2 million and $0.3 million, respectively. Increases in maintenance revenue are primarily driven by increases in our customer installation base, expanded product usage from existing customers, and increased adoption of our enhanced support services programs. Services Revenue Services revenue includes fees earned through implementation services, professional services and facilities management services. Implementation services include product installations, product configurations, and retrofit custom software modifications ("CSMs"). Professional services include business consultancy, technical consultancy, on-site support services, CSMs, product education, and testing services. These services include new customer implementations as well as existing customer migrations to new products or new releases of existing products. During the period in which non-essential services revenue is being deferred, direct and incremental costs related to the performance of these services are also being deferred. During the period in which essential services revenue is being deferred, direct and indirect costs related to the performance of these services are also being deferred. Services revenue during the three months ended September 30, 2014 as compared to the same period in 2013 decreased by $2.0 million, or 7%. Implementation and professional services decreased in the Asia/Pacific reportable segment by $3.4 million, partially offset by increases in the Americas and EMEA reportable segments of $0.6 million and $0.8 million, respectively. Hosting Revenue Hosting revenue includes fees earned through hosting and on-demand arrangements. All revenue from hosting and on-demand arrangements that does not qualify for treatment as separate units of accounting, which include set-up fees, implementation or customization services, and product support services, are included in hosting revenue. For 2014, hosting revenue also includes fees paid by our clients as a part of the acquired EBPP products. Fees may be paid by our clients or directly by their customers and may be a percentage of the underlying transaction amount, a fixed fee per executed transaction or a monthly fee for each customer enrolled. 32 -------------------------------------------------------------------------------- Table of Contents Hosting revenue during the three months ended September 30, 2014 as compared to the same period in 2013 increased $33.0 million, or 49%, primarily due to the addition of OPAY and ReD. Operating Expenses 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Operating expenses: Cost of license $ 5,433 2.2 % $ (455 ) -7.7 % $ 5,888 2.8 % Cost of maintenance, services and hosting 105,319 42.2 % 24,371 30.1 % 80,948 37.8 % Research and development 36,321 14.5 % 2,679 8.0 % 33,642 15.7 % Selling and marketing 27,078 10.8 % 2,980 12.4 % 24,098 11.3 % General and administrative 25,329 10.1 % 770 3.1 % 24,559 11.5 % Depreciation and amortization 18,295 7.3 % 3,046 20.0 % 15,249 7.1 % Total operating expenses $ 217,775 87.2 % $ 33,391 18.1 % $ 184,384 86.2 % Total operating expenses for the three months ended September 30, 2014 increased $33.4 million, or 18%, as compared to the same period of 2013. Included in operating expenses for the three months ended September 30, 2014 were approximately $30.5 million of incremental operating expenses related to the added operations of ORCC, OPAY and ReD. There were approximately $7.3 million and $8.7 million of significant transaction related expenses incurred in the three months ended September 30, 2014, and September 30, 2013, respectively. Significant transaction related expenses for the three months ended September 30, 2014 included $3.3 million of personnel related charges and $4.0 million of professional and other expenses related to the acquisition of OPAY and ReD. Excluding these expenses, total operating expenses increased $4.3 million in the three months ended September 30, 2014 compared to the same period in 2013 primarily due to a $2.0 million increase in our professional and promotion expenses. Cost of License The cost of license for our products sold includes third-party software royalties as well as the amortization of purchased and developed software for resale. In general, the cost of license for our products is minimal because we internally develop most of the software components, the cost of which is reflected in research and development expense as it is incurred as technological feasibility coincides with general availability of the software components. Cost of license decreased $0.5 million, or 8%, in the three months ended September 30, 2014 compared to the same period in 2013 primarily due to a decrease in third party royalty fees. Cost of Maintenance, Services and Hosting Cost of maintenance, services and hosting includes costs to provide hosting services and both the costs of maintaining our software products as well as the service costs required to deliver, install and support software at customer sites. Maintenance costs include the efforts associated with providing the customer with upgrades, 24-hour help desk, post go-live (remote) support and production-type support for software that was previously installed at a customer location. Service costs include human resource costs and other incidental costs such as travel and training required for both pre go-live and post go-live support. Such efforts include project management, delivery, product customization and implementation, installation support, consulting, configuration, and on-site support. Hosting costs related to the acquired EBPP products include payment card interchange fees, assessments payable to banks and payment card processing fees. Cost of maintenance, services, and hosting increased $24.4 million, or 30%, in the three months ended September 30, 2014 compared to the same period in 2013. There were $21.6 million of incremental expenses related to the added operations of ORCC, OPAY and ReD in the three months ended September 30, 2014. Excluding these expenses, the cost of maintenance, services and hosting increased $2.8 million compared to the same period in 2013 due to an increase in third party contractor expenses. Research and Development Research and development ("R&D") expenses are primarily human resource costs related to the creation of new products, improvements made to existing products as well as compatibility with new operating system releases and generations of hardware. 33 -------------------------------------------------------------------------------- Table of Contents Research and development expense increased $2.7 million, or 8%, in the three months ended September 30, 2014 compared to the same period in 2013 primarily the result of $2.4 million of incremental expenses related to the added operations of ORCC, OPAY, and ReD in the quarter ended September 30, 2014. Selling and Marketing Selling and marketing includes both the costs related to selling our products to current and prospective customers as well as the costs related to promoting the Company, its products and the research efforts required to measure customers' future needs and satisfaction levels. Selling costs are primarily the human resource and travel costs related to the effort expended to license our products and services to current and potential clients within defined territories and/or industries as well as the management of the overall relationship with customer accounts. Selling costs also include the costs associated with assisting distributors in their efforts to sell our products and services in their respective local markets. Marketing costs include costs needed to promote the Company and its products as well as perform or acquire market research to help us better understand what products our customers are looking for in the future. Marketing costs also include the costs associated with measuring customers' opinions toward the Company, our products and personnel. Selling and marketing expense increased $3.0 million, or 12%, in the three months ended September 30, 2014 compared to the same period in 2013. There were $1.6 million of incremental expenses related to the added operations of ORCC, OPAY and ReD in the quarter ended September 30, 2014. Excluding these expenses, total operating expenses increased $1.4 million in the three months ended September 30, 2014 compared to the same period in 2013 primarily due to an increase in personnel related expenses. General and Administrative General and administrative expenses are primarily human resource costs including executive salaries and benefits, personnel administration costs, and the costs of corporate support functions such as legal, administrative, human resources and finance and accounting. General and administrative expense increased $0.8 million, or 3%, in the three months ended September 30, 2014. Included in general and administrative expenses for the three months ended September 30, 2014 were approximately $2.2 million of incremental expenses related to the added operations of ORCC, OPAY, and ReD. There were approximately $6.5 million and $8.7 million of significant transaction related expenses incurred in the three months ended September 30, 2014, and September 30, 2013, respectively. Excluding these items, total general and administrative expenses increased $0.8 million in the three months ended September 30, 2014 compared to the same period in the prior year primarily due to an increase in bad debt allowances partially offset by lower personnel related expenses. Depreciation and Amortization Depreciation and amortization expense increased $3.0 million, or 20%, in the three months ended September 30, 2014 compared to the same period in 2013 primarily due to acquisition related intangibles. Other Income and Expense 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Other income (expense): Interest expense $ (10,416 ) -4.2 % $ (2,963 ) 39.8 % $ (7,453 ) -3.5 % Interest income 98 0.0 % (61 ) -38.4 % 159 0.1 % Other, net 3,614 1.4 % 6,766 -214.7 % (3,152 ) -1.5 % Total other income (expense) $ (6,704 ) -2.7 % $ 3,742 -35.8 % $ (10,446 ) -4.9 % Interest expense for the three months ended September 30, 2014 increased $3.0 million, or 40%, as compared to the same period in 2013 due to the increase in debt obtained in 2014. Interest income for the three months ended September 30, 2014 was flat as compared to the same period in 2013. Other, net consists of foreign currency gains (losses) and other non-operating items. We realized foreign currency gains of $3.6 million for the three months ended September 30, 2014 and foreign currency losses of $2.9 million during the same period in 2013. 34 -------------------------------------------------------------------------------- Table of Contents Income Taxes 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Income tax expense $ 9,433 3.8 % $ 4,086 76.4 % $ 5,347 2.5 % Effective Income tax rate 37.5 % 28.0 % The effective tax rate for the three months ended September 30, 2014 was 37.5%. The earnings of our foreign entities for the three months ended September 30, 2014 were $7.3 million. The tax rates in the foreign jurisdictions in which we operate are less than the domestic tax rate. The effective tax rate for the three months ended September 30, 2014 was positively impacted by profits in certain foreign jurisdictions taxed at lower rates and negatively impacted by domestic profits taxed at a higher rate and by losses in other foreign jurisdictions taxed at lower rates. The effective tax rate for the three months ended September 30, 2013 was 28.0%. The earnings of our foreign entities for the three months ended September 30, 2013 were $7.4 million. The tax rates in the foreign jurisdictions in which we operate are less than the domestic tax rate. The effective tax rate for the three months ended September 30, 2013 was positively impacted by foreign profits taxed at lower rates. The effective tax rate for the three months ended September 30, 2013 was negatively impacted by acquisition related expenses that are not deductible for tax purposes. Our effective tax rate could fluctuate significantly on a quarterly basis and could be negatively affected to the extent earnings are lower in the countries in which we operate that have a lower statutory rate or higher in the countries in which we operate that have a higher statutory rate or the extent we have losses sustained in countries where the future utilization of losses are uncertain. Our effective tax rate could also fluctuate due to changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, accounting principles, or interpretations thereof. In addition, we are occasionally subject to examination of our income tax returns by tax authorities in the jurisdictions we operate. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Nine-Month Period Ended September 30, 2014 Compared to the Nine-Month Period Ended September 30, 2013 Revenues 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Revenues: Initial license fees (ILFs) $ 85,851 11.8 % $ 2,506 3.0 % $ 83,345 14.3 % Monthly license fees (MLFs) 68,881 9.5 % 920 1.4 % 67,961 11.7 % License 154,732 21.3 % 3,426 2.3 % 151,306 26.0 % Maintenance 188,572 26.0 % 11,651 6.6 % 176,921 30.4 % Services 75,773 10.4 % (5,360 ) -6.6 % 81,133 13.9 % Hosting 306,848 42.3 % 134,442 78.0 % 172,406 29.6 % Total revenues $ 725,925 100.0 % $ 144,159 24.8 % $ 581,766 100.0 % Total revenue for the nine months ended September 30, 2014 increased $144.2 million, or 25%, as compared to the same period in 2013. The increase is the result of a $134.4 million, or 78%, increase in hosting revenue, an $11.7 million, or 7%, increase in maintenance revenue, and a $3.4 million, or 2%, increase in license revenue partially offset by a $5.4 million, or 7%, decrease in services revenue. The increase in total revenue for the nine months ended September 30, 2014 as compared to the same period in 2013 was due to a $135.9 million, or 37%, increase in the Americas reportable segment and a $15.6 million, or 11%, increase in the EMEA reportable segment partially offset by a $7.4 million, or 11%, decrease in the Asia/Pacific reportable segment. ORCC contributed an incremental $28.5 million, or 5%, of the increase in total revenue for the nine months ended September 30, 2014 compared to the same period in 2013. The addition of OPAY and ReD contributed $107.5 million, or 18%, of the increase in total revenue for the nine months ended September 30, 2014. Excluding the impact of the incremental revenue from ORCC and addition of OPAY and ReD revenues, total revenue for the nine months ended September 30, 2014 increased $8.2 million, or 1%. The increase in total revenue, excluding the addition of ORCC, OPAY and ReD, is primarily due to an increase in maintenance fee revenue, partially offset by a decrease in services revenue, recognized during the nine months ended September 30, 2014 as compared to the same period in 2013. 35 -------------------------------------------------------------------------------- Table of Contents Initial License Revenue Initial license revenue increased by $2.5 million, or 3%, during the nine months ended September 30, 2014, as compared to the same period in 2013. Initial license revenue increased in the EMEA reportable segment by $7.0 million, partially offset by declines in the Americas and Asia/Pacific reportable segments of $1.7 million and $2.8 million, respectively. The increase in initial license revenue is primarily due to an increase in sales during the nine months ended September 30, 2014. The increase in initial license revenue was partially offset by a decline in capacity related revenues of $6.9 million, primarily in the Americas reportable segment, due to the timing and relative size of capacity events during the nine months ended September 30, 2014 as compared to the same period in 2013. Monthly License Revenue Monthly license revenue increased $0.9 million, or 1%, during the nine months ended September 30, 2014, as compared to the same period in 2013 with the Americas and Asia/Pacific reportable segment increasing by $0.5 million and $1.2 million, respectively, partially offset by a decline in the EMEA reportable segments of $0.8 million. Maintenance Revenue Maintenance revenue during the nine months ended September 30, 2014, as compared to the same period in 2013 increased $11.7 million, or 7%. Maintenance revenue increased in the Americas, EMEA and Asia/Pacific reportable segments by $4.0 million, $5.5 million and $2.2 million, respectively. Increases in maintenance revenue are primarily driven by increases in our customer installation base, expanded product usage from existing customers, and increased adoption of our enhanced support services programs. Services Revenue Services revenue during the nine months ended September 30, 2014 as compared to the same period in 2013 decreased by $5.4 million, or 7%. Implementation and professional services decreased in the Americas and Asia/Pacific reportable segment by $1.2 million and $8.0 million, respectively, partially offset by an increase in the EMEA reportable segment of $3.8 million. The decrease in services revenue in the Americas reportable segment was partially offset by an increase of $2.1 million due to incremental ORCC revenues. Hosting Revenue Hosting revenue during the nine months ended September 30, 2014 as compared to the same period in 2013 increased $134.4 million, or 78%, due to incremental ORCC revenues and the addition of OPAY and ReD. Operating Expenses 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Operating expenses: Cost of license $ 18,066 2.5 % $ 91 0.5 % $ 17,975 3.1 % Cost of maintenance, services and hosting 325,801 44.9 % 100,409 44.5 % 225,392 38.7 % Research and development 112,653 15.5 % 3,471 3.2 % 109,182 18.8 % Selling and marketing 82,994 11.4 % 6,284 8.2 % 76,710 13.2 % General and administrative 75,127 10.3 % (616 ) -0.8 % 75,743 13.0 % Depreciation and amortization 52,383 7.2 % 12,687 32.0 % 39,696 6.8 % Total operating expenses $ 667,024 91.9 % $ 122,326 22.5 % $ 544,698 93.6 % Total operating expenses for the nine months ended September 30, 2014 increased $122.3 million, or 23% as compared to the same period of 2013. For the nine months ended September 30, 2014, there were approximately $118.4 million of incremental operating expenses related to the added operations of ORCC, OPAY and ReD. There were approximately $16.6 million and $19.2 million of significant transaction related expenses incurred in the nine months ended September 30, 2014 and September 30, 2013, respectively. Significant transaction related expenses for the nine months ended September 30, 2014 included $6.9 million of personnel related charges and $9.7 million of professional and other expenses related to the acquisition of ORCC, OPAY and ReD. Excluding these expenses, total operating expenses increased $6.5 million in the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to an increase in personnel related expenses. 36-------------------------------------------------------------------------------- Table of Contents Cost of License Cost of software license increased $0.1 million, or 1%, in the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to acquisition related software amortization. Cost of Maintenance, Services and Hosting Cost of maintenance, services, and hosting increased $100.4 million, or 45%, in the nine months ended September 30, 2014 compared to the same period in 2013. There were $91.3 million of incremental expenses related to the added operations of ORCC, OPAY, and ReD. Excluding these expenses, the cost of maintenance, services and hosting fees increased $9.1 million in the nine months ended September 30, 2014 compared to the same period in 2013 due primarily to $3.1 million higher third party contractor expenses and $4.3 million higher personnel related expenses. Research and Development Research and development expense increased $3.5 million, or 3%, in the nine months ended September 30, 2014 compared to the same period in 2013 primarily the result of $6.7 million of incremental expenses related to the addition of ORCC, OPAY, and ReD in the nine months ending September 30, 2014, partially offset by lower contractor costs. Selling and Marketing Selling and marketing expense increased $6.3 million, or 8%, in the nine months ended September 30, 2014 compared to the same period in 2013. There were $4.2 million of incremental expenses related to the added operations of ORCC, OPAY and ReD. Excluding these expenses, the cost of selling and marketing increased $2.1 million in the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to an increase in personnel related expenses. General and Administrative General and administrative expense decreased $0.6 million, or 1%, in the nine months ended September 30, 2014. The decrease was primarily due to a decrease in significant transaction related expense incurred of approximately $15.7 million during the nine months ended September 30, 2014 compared to $19.2 million for the same period in 2013. Significant transaction related expenses included personnel related charges and professional and other expenses related to the acquisitions of ORCC, OPAY and ReD, partially offset by an increase in our bad debt allowance. Depreciation and Amortization Depreciation and amortization expense increased $12.7 million, or 32%, in the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to depreciation and amortization of acquisition related intangibles and higher capital expenditures. Other Income and Expense 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Other income (expense): Interest expense $ (28,920 ) -4.0 % $ (11,517 ) 66.2 % $ (17,403 ) -3.0 % Interest income 432 0.1 % (69 ) -13.8 % 501 0.1 % Other, net (1,344 ) -0.2 % 162 -10.8 % (1,506 ) -0.3 % Total other income (expense) $ (29,832 ) -4.1 % $ (11,424 ) 62.1 % $ (18,408 ) -3.2 % Interest expense for the nine months ended September 30, 2014 increased $11.5 million, or 66%, as compared to the same period in 2013 due to the increase in debt obtained in 2014. Interest income for the nine months ended September 30, 2014 was flat as compared to the same period in 2013. Other, net consists of foreign currency losses and other non-operating items. Foreign currency losses for the nine months ended September 30, 2014 and 2013 were $1.2 million and $0.8 million, respectively. 37-------------------------------------------------------------------------------- Table of Contents Income Taxes 2014 2013 % of Total $ Change % Change % of Total Amount Revenue vs 2013 vs 2013 Amount Revenue Income tax expense $ 7,875 1.1 % $ 2,692 51.9 % $ 5,183 0.9 % Effective Income tax rate 27.1 % 27.8 % The effective tax rate for the nine months ended September 30, 2014 was 27.1%. The earnings of our foreign entities for the nine months ended September 30, 2014 were $31.6 million. The tax rates in the foreign jurisdictions in which we operate are less than the domestic tax rate. The effective tax rate for the nine months ended September 30, 2014 was positively impacted by profits in certain foreign jurisdictions taxed at lower rates and domestic losses taxed at a higher rate, partially offset by losses in other foreign jurisdictions taxed at lower rates. The effective tax rate for the nine months ended September 30, 2013 was 27.8%. The earnings of our foreign entities for the nine months ended September 30, 2013 were $18.9 million. The tax rates in the foreign jurisdictions in which we operate are less than the domestic tax rate. The effective tax rate for the nine months ended September 30, 2013 was positively impacted by foreign profits taxed at lower rates and a domestic loss taxed at a higher rate as well as recognition of $1.4 million tax benefit as a result of implementing the 2012 American Taxpayer Relief Act. The effective tax rate for the nine months ended September 30, 2013 was negatively impacted by acquisition related expenses that are not deductible for tax purposes as well as an increase in the valuation allowance against foreign tax credits as a result of the acquisition of ORCC. Our effective tax rate could fluctuate significantly on a quarterly basis and could be negatively affected to the extent earnings are lower in the countries in which we operate that have a lower statutory rate or higher in the countries in which we operate that have a higher statutory rate or the extent we have losses sustained in countries where the future utilization of losses are uncertain. Our effective tax rate could also fluctuate due to changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, accounting principles, or interpretations thereof. In addition, we are occasionally subject to examination of our income tax returns by tax authorities in the jurisdictions we operate. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Segment Results The following table presents revenues and income before income taxes for the periods indicated by geographic region (in thousands): Three Months Ended Nine Months Ended September 30, September 30, (in thousands) 2014 2013 2014 2013 Revenues: Americas $ 172,918 $ 136,812 $ 505,432 $ 369,504 EMEA 56,793 51,692 161,604 145,982 Asia/Pacific 19,933 25,435 58,889 66,280 $ 249,644 $ 213,939 $ 725,925 $ 581,766 Income (loss) before income taxes: Americas $ 37,746 $ 36,320 $ 80,779 $ 79,612 EMEA 30,186 14,968 72,526 43,176 Asia/Pacific 9,048 10,641 25,130 19,828 Corporate (51,815 ) (42,820 ) (149,366 ) (123,956 ) $ 25,165 $ 19,109 $ 29,069 $ 18,660 Reportable segment results are impacted by both direct expenses and allocated shared function costs such as global product development, global customer operations and global product management. Shared function costs are allocated to the geographic reportable segments as a percentage of revenue or as a percentage of headcount. All administrative costs that are not directly attributable or able to be allocated to a geographic segment are included in the corporate line item. 38 -------------------------------------------------------------------------------- Table of Contents The increase in revenue and income before income taxes for the Americas segment during the three months ended September 30, 2014 is primarily due to the incremental impact of ORCC and the addition of ReD and OPAY operations. The EMEA segment's income before income taxes increased as a result of increased revenue as well as lower relative personnel related costs. The Asia/Pacific segment's income before income taxes decreased primarily as a result of a decrease in revenue. The increase in the Corporate loss before income taxes for the three months ended September 30, 2014, is primarily due to an increase in amortization on acquired intangibles and interest expense. Amortization of acquired intangible assets was approximately $11.8 million and $9.2 million during the three months ended September 30, 2014 and 2013, respectively. Interest expense on long term debt was approximately $10.4 million and $7.4 million during the three months ended September 30, 2014 and 2013, respectively. The increase in revenue and income before income taxes for the Americas segment during the nine months ended September 30, 2014 is primarily due to the incremental impact of ORCC and the addition of ReD and OPAY operations. The EMEA segment's income before income taxes increased as result of increased revenue as well as lower relative personnel related costs. The Asia/Pacific segment's income before income taxes increased primarily as a result of reduced personnel costs. The increase in the Corporate loss before income taxes for the nine months ended September 30, 2014, is primarily due to an increase in amortization on acquired intangibles and interest expense. Amortization of acquired intangible assets was approximately $34.4 million and $25.2 million during the nine months ended September 30, 2014 and 2013, respectively. Interest expense on long term debt was approximately $28.8 million and $17.2 million during the nine months ended September 30, 2014 and 2013, respectively. Liquidity and Capital Resources General Our primary liquidity needs are: (i) to fund normal operating expenses; (ii) to meet the interest and principal requirements of our outstanding indebtedness; and (iii) to fund acquisitions, capital expenditures and lease payments. We believe these needs will be satisfied using cash flow generated by our operations, our cash and cash equivalents and available borrowings under our Credit Agreement. As of September 30, 2014, we had $60.1 million in cash and cash equivalents. Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less. As of September 30, 2014, $44.2 million of the $60.1 million of cash and cash equivalents was held by our foreign subsidiaries. If these funds were needed for our operations in the U.S. we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. The following table sets forth summary cash flow data for the periods indicated. Nine Months Ended September 30, 2014 2013 (amounts in thousands) Net cash provided by (used by): Operating activities $ 71,983 $ 86,560 Investing activities (231,772 ) (282,562 ) Financing activities 125,646 287,731 Net cash flows provided by operating activities for the nine months ended September 30, 2014 amounted to $72.0 million as compared to $86.6 million during the same period in 2013. The comparative period decrease in cash provided by operating activities was primarily due to lower contribution from receivables partially offset by stronger earnings during the first nine months of 2014 when compared to the same period in 2013. Our current policy is to use our operating cash flow primarily for funding capital expenditures, lease payments, stock repurchases and acquisitions. During the first nine months of 2014 we used cash of $204.3 million, net of $0.8 million in cash acquired, to acquire ReD. In addition, we used $27.4 million to purchase software, property and equipment and other investments during the nine month ended September 30, 2014. During the nine months ended September 30, 2013, we paid $250.2 million, net of $9.9 million in cash acquired, to acquire ORCC. In addition, we paid $14.0 million, net of $0.2 million in cash acquired, to acquire PTESA during the first nine months of 2013. 39-------------------------------------------------------------------------------- Table of Contents During the nine months ended September 30, 2014, we used $70.0 million to repurchase common stock. We received proceeds of $150.0 million and repaid $37.6 million on the Term Credit Facility during the first nine months of 2014. We received net proceeds of $78.5 million from Revolving Credit Facility during the nine months ended September 30, 2014. In addition, during the first nine months of 2014, we received proceeds of $23.6 million, including corresponding excess tax benefits, from the exercises of stock options and the issuance of common stock under our 1999 Employee Stock Purchase Plan, as amended, and used $5.0 million for the repurchase of restricted stock and performance shares for tax withholdings. In the first nine months of 2013, we received proceeds of $300.0 million from our Term Credit Facility to fund our purchase of ORCC. In addition, we received proceeds of $300.0 million from our Senior Notes during the first nine months of 2013. We used $188.0 million of this debt to repay the Revolving Credit Facility and $80.6 million to repurchase common stock during the first nine months of 2013. We may decide to use cash to acquire new products and services or enhance existing products and services through acquisitions of other companies, product lines, technologies and personnel, or through investments in other companies. We believe that our existing sources of liquidity, including cash on hand and cash provided by operating activities, will satisfy our projected liquidity requirements, which primarily consists of working capital requirements, for the next twelve months and foreseeable future. Debt As of September 30, 2014, we had $78.5 million and $567.8 million outstanding under our Revolving and Term Credit Facilities, with up to $171.5 million of unused borrowings under the Revolving Credit Facility portion of the Credit Agreement, as amended. The amount of unused borrowings actually available varies in accordance with the terms of the agreement. The Credit Agreement contains certain affirmative and negative covenants, including limitations on the incurrence of indebtedness, asset dispositions, acquisitions, investments, dividends and other restricted payments, liens and transactions with affiliates. The Credit Agreement also contains financial covenants relating to maximum permitted leverage ratio and the minimum fixed charge coverage ratio. The Revolving Credit Facility does not contain any subjective acceleration features and does not have any required payment or principal reduction schedule and is included as a long-term liability in our condensed consolidated balance sheet. At September 30, 2014 (and at all times during this period) we were in compliance with our debt covenants. The interest rate in effect on our Credit Agreement at September 30, 2014 was 2.41%. On August 20, 2013, we completed a $300 million offering of 6.375% Senior Notes due in 2020 (the "Notes") at an issue price of 100% of the principal amount in a private placement for resale to qualified institutional buyers. The Notes bear an interest rate of 6.375% per annum, payable semi-annually in arrears on August 15 and February 15 of each year, commencing on February 15, 2014. Interest will accrue from August 20, 2013. The Notes will mature on August 15, 2020. On August 12, 2014, we borrowed an additional $150 million under our Term Credit Facility as amended. These additional borrowings were used in connection with the ReD acquisition that was completed on August 12, 2014. On August 12, 2014, the Fifth Amendment to the Credit Agreement became effective. The Fifth Amendment, among other things, permitted the acquisition of ReD, increased the aggregate amount of permitted intercompany indebtedness between us and our subsidiaries that are guarantors under the credit facility and our subsidiaries that are not guarantors under the credit facility from $75 million to $225 million and increased the amount of unsecured indebtedness permitted under the credit facility from $350 million to $500 million, in each case subject to the terms of the Credit Agreement, as amended. The Fifth Amendment also amends the Collateral Agreement dated November 10, 2011 (as amended prior to August 12, 2014) among us, OPAY, the other grantors party thereto and Wells Fargo Bank, National Association, as administrative agent, to release the administrative agent's security interest in, and lien on, certain property of OPAY. In connection with the incremental borrowings under the Term Credit Facility and the Fifth Amendment, we incurred debt issuance costs of $4.5 million, of which $4.4 million were paid as of September 30, 2014. Stock Repurchase Program As of December 31, 2011, our Board of Directors had approved a stock repurchase program authorizing us, from time to time as market and business conditions warrant, to acquire up to $210 million of our common stock. In February 2012, our Board of Directors approved an increase of $52.1 million to our current stock repurchase authorization, bringing the total authorization to $262.1 million. 40 -------------------------------------------------------------------------------- Table of Contents On September 13, 2012, our Board of Directors approved the repurchase of up to 7,500,000 shares of our common stock, or up to $113.0 million in place of the remaining repurchase amounts previously authorized. In July 2013, our Board of Directors approved an additional $100 million for the stock repurchase program. In February 2014, our Board of Directors approved an additional $100 million for the stock repurchase program. We repurchased 3,578,427 shares for $70.0 million under the program during the nine months ended September 30, 2014. Under the program to date, we have purchased 37,108,467 shares for approximately $395.8 million. The maximum remaining authorized for purchase under the stock repurchase program was approximately $138.3 million as of September 30, 2014. There is no guarantee as to the exact number of shares that will be repurchased by us. Repurchased shares are returned to the status of authorized but unissued shares of common stock. In March 2005, our Board of Directors approved a plan under Rule 10b5-1 of the Securities Exchange Act of 1934 to facilitate the repurchase of shares of common stock under the existing stock repurchase program. Under our Rule 10b5-1 plan, we have delegated authority over the timing and amount of repurchases to an independent broker who does not have access to inside information about the Company. Rule 10b5-1 allows us, through the independent broker, to purchase shares at times when we ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time immediately preceding the end of the fiscal quarter through a period three business days following our quarterly earnings release. Contractual Obligations and Commercial Commitments For the nine months ended September 30, 2014, other than as discussed below, there have been no material changes to the contractual obligations and commercial commitments disclosed in Item 7 of our Form 10-K for the fiscal year ended December 31, 2013. Payments due by Period (amounts in thousands) Less than More than Total 1 year 1-3 years 3-5 years 5 years Contractual Obligations Acquired operating lease obligations (1) $ 5,074 $ 291 $ 2,277 $ 1,925 $ 581 New operating lease obligations (2) 10,851 284 4,188 3,480 2,899 Term Credit Facility (3) 567,787 83,381 190,586 293,820 - Term Credit Facility interest (4) 38,068 12,966 19,329 5,773 - Revolving Credit Facility (3) 78,500 - - 78,500 - Revolving Credit Facility interest (4) 7,410 1,892 3,784 1,734 - Total $ 707,690 $ 98,814 $ 220,164 $ 385,232 $ 3,480 (1) Operating leases acquired as a result of the ReD acquisition. (2) New operating lease obligations entered into during the nine months ended September 30, 2014. (3) Increases in the Term Credit Facility and Revolving Credit Facility primarily represent debt used to partially fund acquisitions during the nine months ended September 30, 2014. (4) Based upon the debt outstanding and interest rate in effect at September 30, 2014 of 2.41%. We are unable to reasonably estimate the ultimate amount or timing of settlement of our reserves for income taxes under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 740, Income Tax. The liability for unrecognized tax benefits at September 30, 2014 is $16.2 million. Critical Accounting Estimates The preparation of the condensed consolidated financial statements requires that we make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and other assumptions that we believe to be proper and reasonable under the circumstances. We continually evaluate the appropriateness of estimates and assumptions used in the preparation of our condensed consolidated financial statements. Actual results could differ from those estimates. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following: • Revenue Recognition • Allowance for Doubtful Accounts 41 -------------------------------------------------------------------------------- Table of Contents • Business Combinations • Intangible Assets and Goodwill • Stock-Based Compensation • Accounting for Income Taxes During the nine months ended September 30, 2014, there were no significant changes to our critical accounting policies and estimates other than as disclosed in Note 1, Condensed Consolidated Financial Statements. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended December 31, 2013, filed on February 28, 2014, for a more complete discussion of our critical accounting policies and estimates. |