SS&C Technologies Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unaudited results are compared with 2017. Comparisons are materially affected by acquisitions, particularly DST, consolidated from April 16, 2018; prior periods were not recast for ASC 606.
Business context and reporting period
SS&C provides software-enabled outsourcing and software, maintenance and related services to financial services and healthcare clients. The DST acquisition substantially expanded the business and changed the revenue mix. CACEIS North America was acquired in June 2018.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $992.4 million | $418.2 million | $2,310.1 million | $1,236.9 million |
| Gross profit / margin | $412.3 million / 41.5% | $198.4 million / 47.4% | $897.0 million / 38.8% | $575.9 million / 46.6% |
| Operating income | $180.6 million | $103.9 million | $216.7 million | $283.6 million |
| Net income | $57.0 million | $64.2 million | $44.5 million | $163.5 million |
| Diluted EPS | $0.23 | $0.30 | $0.19 | $0.77 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $322.4 million | $308.5 million |
- Q3 revenue rose 137.3%; management attributed $563.2 million of the increase to acquisitions. Nine-month revenue increased 86.8%, with acquisitions contributing $1,039.6 million.
- Q3 software-enabled services revenue was $827.3 million; license, maintenance and related revenue was $165.1 million. The respective nine-month amounts were $1,863.7 million and $446.4 million.
- Gross margin declined year over year in both periods. Management cited acquisition-related costs, higher costs supporting services growth, and acquisition-related severance among the factors affecting costs.
- Cash and cash equivalents were $732.2 million at September 30, versus $64.1 million at year-end 2017. The balance sheet also included $604.3 million of funds receivable and held for clients, offset by $604.3 million of client fund obligations; client funds are not freely available liquidity.
- Debt carrying value was $6,686.1 million, including $6,615.0 million long-term and $71.1 million current. The senior secured facilities had a 4.49% weighted-average interest rate. The company reported $245.6 million available on its revolving facility.
Material changes and unusual items
- DST was acquired for approximately $5.1 billion in cash. Its results contributed $1,030.3 million of revenue from acquisition through September 30. The purchase added substantial goodwill and intangible assets and was financed principally with new debt and a $1.4 billion common-stock offering.
- Q3 operating income increased, but nine-month operating income and net income decreased. The nine-month results include $96.4 million of DST transaction expenses, $58.8 million of acquisition-related severance, a $44.4 million debt-extinguishment loss, higher interest expense, and increased acquisition-related amortization.
- Net interest expense was $78.1 million in Q3 and $173.7 million year to date, up from $26.3 million and $81.6 million, respectively, mainly due to DST-related borrowings and higher average interest rates.
- The nine-month income tax benefit was $28.3 million, while Q3 had a $60.9 million tax provision. Reported effective rates were (174.7)% year to date and 51.7% for Q3, affected by low pretax income, permanent differences and discrete tax items. Management forecast a 15%–17% consolidated effective tax rate for 2018.
- ASC 606 adoption increased opening retained earnings by $65.8 million before tax ($47.9 million net of tax). Its reported revenue impact was a decrease of $7.2 million in Q3 and $28.6 million year to date; cash flows were unaffected.
- Foreign currency translation reduced comprehensive income by $54.2 million in Q3 and $84.6 million year to date.
Liquidity, outlook, risks and contingencies
- Operating cash flow was $322.4 million year to date; investing activities used $4,669.1 million, primarily for acquisitions, while financing activities provided $5,552.5 million. Management said cash on hand, operating cash flows and available credit were expected to cover obligations, working capital and capital spending for at least the next 12 months.
- The company reported a 4.02x consolidated net secured leverage ratio against a maximum covenant level of 7.25x at September 30. Nearly all debt was variable-rate; management estimated a 1 percentage-point rate increase would raise annual interest expense by approximately $67.3 million.
- On October 1, 2018, SS&C acquired Eze Software for approximately $1.45 billion, funded with cash and $875 million of incremental term debt. This occurred after quarter end and is not included in September 30 balances.
- SS&C had agreed to acquire Intralinks for approximately $1.5 billion, expected to close in Q4 2018 subject to regulatory and other conditions. Planned funding was $1.0 billion cash and $0.5 billion stock; financing commitments of up to $1.0 billion were disclosed.
- Legal matters include a DST-related ERISA class action, a Department of Labor investigation letter, an individual lawsuit and 253 substantially similar arbitration demands. Management had not determined their effect and stated it did not believe other proceedings would have a material adverse effect.
- Management stated disclosure controls were effective. It was still reviewing the design and operating effectiveness of financial-reporting controls for DST’s separate systems and processes.
Important facts for investors to verify
- How much reported growth and margin change reflects DST and other acquisitions versus underlying organic performance; reported comparisons also use different revenue-recognition standards.
- Debt and interest burden after the Eze acquisition and any completion of the Intralinks transaction, including compliance with leverage and other credit-agreement covenants.
- Integration costs, severance completion, expected synergies and acquisition-related amortization or impairment risks.
- The resolution, potential exposure and accounting implications of the DST ERISA litigation, DOL matter and arbitration demands.
- Whether the 2018 tax-rate forecast and liquidity expectations remain achievable given discrete tax items, variable-rate debt and planned acquisition funding.