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| FIS > SEC Filings for FIS > Form 10-Q on 7-Nov-2012 | All Recent SEC Filings |
7-Nov-2012
Quarterly Report
The following discussion should be read in conjunction with Item 1: Condensed
Consolidated Financial Statements (Unaudited) and the Notes thereto included
elsewhere in this report. The discussion below contains forward-looking
statements within the meaning of the U.S. federal securities laws. Statements
that are not historical facts, including statements about our expectations,
hopes, intentions, or strategies regarding the future, are forward-looking
statements. These statements relate to future events and our future results, and
involve a number of risks and uncertainties. Forward-looking statements are
based on management's beliefs, as well as assumptions made by, and information
currently available to, management. Any statements that refer to beliefs,
expectations, projections or other characterizations of future events or
circumstances and other statements that are not historical facts are
forward-looking statements.
Actual results, performance or achievement could differ materially from those
contained in these forward-looking statements. The risks and uncertainties that
forward-looking statements are subject to include without limitation: changes
and conditions in general economic, business and political conditions, including
the possibility of intensified international hostilities, acts of terrorism, and
changes and conditions in either or both the United States and international
lending, capital and financial markets; the effect of legislative initiatives or
proposals, statutory changes, governmental or other applicable regulations
and/or changes in industry requirements, including privacy regulations; the
adequacy of our cash flow and earnings and other conditions which may affect our
ability to pay our quarterly dividend at the planned level; the effects of our
leverage which may limit the funds available to make acquisitions and invest in
our business, pay dividends and repurchase shares; the risks of reduction in
revenue from the elimination of existing and potential customers due to
consolidation in or new laws or regulations affecting the banking, retail and
financial services industries or due to financial failures or other setbacks
suffered by firms in those industries; changes in the growth rates of the
markets for core processing, card issuer, and transaction processing services;
failures to adapt our services and products to changes in technology or in the
marketplace; internal or external security breaches of our systems, including
those relating to the theft of personal information and computer viruses
affecting our software or platforms, and the reactions of customers, card
associations and others to any such events; the reaction of our current and
potential customers to the regulatory letter we received about information
security, risk management and internal audit following the security breach we
experienced in early 2011 and to any future communications about such topics
from our regulators or from us; the failure to achieve some or all of the
benefits that we expect from acquisitions; our potential inability to find
suitable acquisition candidates or finance such acquisitions, which depends upon
the availability of adequate cash reserves from operations or of acceptable
financing terms and the variability of our stock price, or difficulties in
integrating past and future acquired technology or business' operations,
services, clients and personnel; competitive pressures on product pricing and
services including the ability to attract new, or retain existing, customers; an
operational or natural disaster at one of our major operations centers; and
other risks detailed in the "Statement Regarding Forward-Looking Information,"
"Risk Factors" and other sections of the Company's Annual Report on Form 10-K
for the year ended December 31, 2011, this Form 10-Q and our other filings with
the Securities and Exchange Commission.
Other unknown or unpredictable factors also could have a material adverse effect
on our business, financial condition, results of operations and prospects.
Accordingly, readers should not place undue reliance on these forward-looking
statements. These forward-looking statements are inherently subject to
uncertainties, risks and changes in circumstances that are difficult to predict.
Except as required by applicable law or regulation, we do not undertake (and
expressly disclaim) any obligation and do not intend to publicly update or
review any of these forward-looking statements, whether as a result of new
information, future events or otherwise.
FIS is a leading global provider dedicated to banking and payments technologies. With a long history deeply rooted in the financial services sector, FIS serves more than 14,000 institutions in over 100 countries. Headquartered in Jacksonville, Florida, FIS employs more than 32,000 people worldwide and holds leadership positions in payment processing and banking solutions, providing software, services and outsourcing of the technology that drives financial institutions. FIS tops the annual FinTech 100 list for 2012 and 2011, and is a member of the Fortune 500 U.S. and of the Standard and Poor's (S&P) 500® Index. We have four reporting segments: FSG, PSG, ISG and Corporate and Other. A description of these segments is included in Note 11 to the Notes to Condensed Consolidated Financial Statements (Unaudited). Revenues by segment and the results of operations of our segments are discussed below in Segment Results of Operations.
Business Trends and Conditions
Our revenue is derived from a combination of recurring services, professional services and software license fees. Recurring services, which have historically represented more than 80% of our revenue, are provided under multi-year contracts that contribute relative stability to our revenue stream. However, a significant portion of these recurring revenues are derived from transaction processing fees and fluctuate with the level of deposit and card transactions associated with consumer and commercial activity. Sales of software licenses and professional services are less predictable and a portion can be regarded as discretionary spending by our customers. We continually seek opportunities to enhance revenues and to manage our costs and capital expenditures prudently in light of any shifting revenue trends in response to broader economic conditions.
We acquired Capco in December 2010, to broaden our capabilities to provide strategic and business transformation consulting. While Capco has generated increased revenues, the lower profit margin realized for professional services as compared to our other solutions has resulted in profit margin compression. The addition of Capco has also reduced the relative proportion of our recurring revenue stream.
As the payment market continues to evolve from paper-based to electronic, we continue to add new services responsive to this trend. Card transactions continue to increase as a percentage of total point-of-sale payments, which fuels continuing demand for card-related services. In recent years, we have added a variety of stored-value card types, Internet banking, mobile solutions and electronic bill presentment/payment services, as well as a number of card enhancement and loyalty/reward programs. The common goal of these offerings continues to be convenience and security for the consumer coupled with value to the financial institution. The evolution to electronic transactions also intensifies the vulnerability to fraud, increasing the demand for our risk management solutions. At the same time, the use of checks continues to decline as a percentage of total payments, which negatively impacts our check warranty and item-processing businesses.
We compete for both licensing and outsourcing business, and thus are affected by the decisions of financial institutions to utilize our services under an outsourced arrangement or to process in-house under a software license and maintenance agreement. As a provider of outsourcing solutions, we benefit from multi-year recurring revenue streams, which help moderate the effects of year-to-year economic changes on our results of operations. One of the current trends in the financial services industry from which we are benefiting is the migration by our clients to an outsourced model to improve their profitability.
While we are cautious regarding broader economic improvement, we expect banks to continue investing in new technology and believe we are well positioned to capitalize as the overall market continues to recover. We anticipate consolidation within the banking industry to continue, including additional bank failures and continuing merger and acquisition activity. As a whole, consolidation activity is detrimental to our business. Consolidation resulting from specific merger and acquisition transactions may be beneficial or detrimental to our business. When consolidations occur, merger partners often operate disparate systems licensed from competing service providers. The newly formed entity generally makes a determination to migrate its core and payments systems to a single platform. When a financial institution processing client is involved in a consolidation, we may benefit by expanding the use of our services if such services are chosen to survive the consolidation and support the newly combined entity. Conversely, we may lose market share if we are providing services to both entities, or we are not the merging parties' provider of core or payment processing, or if a customer of ours is involved in a consolidation and our services are not chosen to survive the consolidation and support the newly combined entity. It is also possible that larger financial institutions resulting from consolidation would have greater leverage in negotiating terms or could decide to perform in-house some or all of the services that we currently provide or could provide. We seek to mitigate the risks of consolidations by offering other competitive services to take advantage of specific opportunities at the surviving company.
The acquisition of M&I Bank by BMO Harris Bank, both of whom are customers of FIS, is a consolidation that will have a financial impact on the Company. We disclosed in our June 30, 2012 Form 10-Q that we estimated a decline in annual EBITDA run rate of approximately $60 million, and that we expected the 2013 impact to be approximately half that amount. We now expect that the 2013 impact will be substantially offset by termination and settlement fees and additional professional services from BMO Harris Bank, and other activities expected to occur with BMO Harris Bank.
The Dodd-Frank Act and associated Durbin Amendment were passed and signed into law in 2010. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, establishes the new federal Bureau of Consumer Financial Protection and will require this and other federal agencies to implement many new regulations. Regulations under the Durbin Amendment, released by the Federal Reserve in June 2011, mandate a cap on debit transaction interchange fees for card issuers with assets greater than $10.0 billion. This legislated interchange fee cap has the potential to alter the type and/or volume of card-based transactions that we process on behalf of our customers. We believe we are competitively positioned to offset or take advantage of any potential shifts in payment transaction volume as we offer multiple
payment solutions and options to our clients. We also believe that compliance with the network exclusivity provisions of the Durbin Amendment, which require all debit card issuers to have at least two unaffiliated networks for purposes of processing signature debit and PIN debit transactions, could positively or negatively impact transaction volumes in our NYCE PIN debit network. These new regulations could result in the need for us to make capital investments to modify our products and services to facilitate our existing customers and potential customers' compliance. Further, the requirements of the new regulations and the timing of their effective dates could result in changes in our customers' business practices that may alter their delivery of services to consumers and the timing of their investment decisions, which could change the demand for our software and services as well as alter the type or volume of transactions that we process on behalf of our customers.
Notwithstanding challenging global economic conditions, our international business continued to experience growth across most major regions during the three and nine months ended September 30, 2012, including Europe and Brazil. The majority of our European revenue is generated by clients in Germany, France and the United Kingdom. Those countries encountering the most significant economic challenges, including Spain, Italy, Greece, Ireland and Portugal, account for less than 2% of our international revenue base and less than 0.5% of our consolidated revenue.
Information Security
Globally, attacks on information technology systems continue to grow in
frequency, complexity and sophistication. Such attacks have become a point of
focus for individuals, businesses and governmental entities. The objectives of
these attacks include, among other things, gaining unauthorized access to
systems to facilitate financial fraud, disrupt operations, cause denial of
service events, corrupt data, and steal non-public, sensitive information. As
part of our business, we electronically receive, process, store and transmit a
wide range of confidential information, including but not limited to sensitive
information of our customers and personal consumer data. We also operate
payment, cash access and prepaid card systems.
As previously disclosed, in the first quarter of 2011 we experienced a
cyber-incident during which intruders gained unauthorized access to FIS'
network. During the incident, the intruders moved across a number of information
technology environments, viewed and downloaded information, and ultimately
executed approximately $13.0 million in unauthorized ATM transactions through
our Sunrise prepaid card platform resulting in a loss to FIS. We are aware of no
evidence that any of our clients or their customers suffered any direct
financial loss as a result of the 2011 cyber-incident.
While the attackers engaged in tactics and techniques designed to obscure their
movements during the incident and prevent re-creation of their activities fully,
we are aware of no evidence of any misuse of any client information gained by
the intruders from our information technology systems environments. This lack of
evidence of any misuse is consistent with the opinions of the cyber security
consultant we retained in March, 2011 and representatives of law enforcement
that the intrusion was focused on the theft of money from the Sunrise prepaid
platform. A law enforcement investigation of the cyber-incident is ongoing. We
have been notified that several arrests have been made.
Since the incident, we have been taking significant steps to improve our
information security, including but not limited to:
• Increasing monitoring of the servers within our environment to identify
potential unauthorized activity and implementing enhanced fraud monitoring
and network controls;
• Completing the necessary re-certifying of Payment Card Industry (PCI) Data Security Standard compliance of the Sunrise prepaid platform;
• Implementing enhanced information security processes, including creating a cross-functional team to implement enhanced transaction monitoring to detect or prevent fraudulent activity;
• Expanding risk assessment coverage of Internet-facing products and services;
• Enhancing our Information Security Strategic Plan with short-term and long-term measures to improve FIS' information security;
• The hiring of a new Chief Information Security Officer ("CISO") and Chief Risk Officer ("CRO") and additional technical information security and risk management personnel;
• Improving our inventory of technology, data and information security assets worldwide;
• Enhancing layers of network security, including intrusion prevention, firewall restrictions, and employee access restrictions; and
• Enhancing network segmentation to separate production environments.
In late February 2012, the U.S. Government agencies that regulate federal financial institutions and provide regulatory oversight for FIS issued a confidential exam report related to our information security, risk management and internal audit functions. We responded to this report and described the actions that we have taken and will take to improve these functions. The regulatory agencies distributed a letter to our clients in March 2012 describing the enhancements they had requested in our
information security, risk management and internal audit functions. This letter
acknowledged our commitment to expeditiously address these requests.
In addition, we engaged a third party expert on behalf of our clients to perform
an independent review of our progress in improving our Information Security,
Risk Management and Internal Audit initiatives. The expert's report was dated as
of July 31, 2012 (and then posted on our client portal). As part of its review
engagement, the expert confirmed the status of our stated progress in enhancing
our Information Security, Risk Management and Internal Audit programs.
Given the sequential and year-over-year improvement in sales to North American
financial institutions in the third quarter of 2012, we do not believe that the
above referenced February 2012 regulatory letter had a significant negative
impact on new sales in the third quarter. We are continuing to monitor sales
activity and any potential impact of the incident, including our and our
regulator's communications.
After hiring our new Chief Information Security Officer and to better understand
the cyber-incident, we commissioned an additional third party factual
investigation to comprehensively and objectively analyze the 2011
cyber-incident, which is expected to be completed in the next few months. We
plan to then communicate material findings, if any, of this investigation to
affected clients. If additional information regarding the incident is
discovered, or our current understanding of the attackers' activities during the
incident changes, it could potentially have a materially adverse effect on us.
We are continuing to work closely with and communicate to our clients about the
cyber-incident. We are also continuing to focus on improving our internal
information security and risk management functions across the company, and
assisting our customers in doing the same. We have increased the amounts spent
on information security in 2011 and 2012. Due to the increased frequency and the
evolving nature of cyber-incidents we expect to continue to implement
enhancements to protect the security of our information technology systems and
data, as well as the information technology data of our clients that we possess.
Critical Accounting Policies
There have been no significant changes to our critical accounting policies as
disclosed in our Annual Report on Form 10-K for the year ended December 31,
2011.
Transactions with Related Parties
See Note 2 to the Notes to Condensed Consolidated Financial Statements
(Unaudited) for a detailed description of transactions with related parties.
Comparisons of three-months and nine-months ended September 30, 2012 and 2011
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