FIS

Business Context and Reporting Period

Company: Fidelity National Information Services, Inc. (FIS)
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2006
Overview: FIS is a leading provider of technology solutions and processing services to the financial services industry. The reporting period reflects the integration of the February 1, 2006, merger with Certegy Inc., which was accounted for as a reverse acquisition. The company operates through two primary segments: Transaction Processing Services (TPS) and Lender Processing Services (LPS). A significant corporate development during the period was the agreement to merge with Fidelity National Financial, Inc. (FNF), finalized in November 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased significantly compared to the prior year periods (Three months: +54.8%; Nine months: +45.9%). This growth is primarily attributed to the inclusion of Certegy Inc. revenues following the February 1, 2006, merger.
• Margin Compression: Gross margins decreased from 35.9% to 28.5% (three months) and from 35.3% to 29.6% (nine months). Operating margins declined from 17.7% to 15.7% (three months) and from 16.0% to 14.2% (nine months). Management attributes this to the lower-margin profile of Certegy's business and incremental purchase accounting amortization.
• Expense Increases: Cost of revenues and Selling, General, and Administrative (SG&A) expenses rose due to the merger. SG&A specifically saw a notable increase in stock-based compensation ($37.2 million for the nine months ended Sep 30, 2006, vs. $16.0 million in 2005), driven by the vesting of performance-based options.
• Interest Expense: Interest expense increased to $142.0 million for the nine months ended Sep 30, 2006, compared to $87.4 million in the prior year, reflecting higher average borrowings and interest rates following the 2005 recapitalization.

Guidance, Outlook, and Risks

• Merger with FNF: FIS entered into a merger agreement with FNF to eliminate FNF's holding company structure. The transaction was expected to close in November 2006. Management anticipates benefits including increased ability to issue stock for acquisitions and improved trading liquidity.
• Refinancing: In November 2006, FIS announced plans to refinance its Term Loans and Revolver with a new $3.1 billion facility, aiming to extend maturities and adjust terms.
• Capital Allocation: The Board authorized a $200 million stock repurchase program in October 2006. The company also pays a quarterly dividend of $0.05 per share, subject to debt covenant limitations ($60 million annual cap).
• Risk Factors:
  • Integration Risks: Potential failure to achieve anticipated synergies from the Certegy merger or the FNF merger.
  • Leverage: High debt levels may limit funds available for acquisitions and investments.
  • Market Conditions: Sensitivity to real estate activity levels (affecting LPS segment) and banking industry consolidation (affecting TPS segment).
  • Legal Proceedings: Ongoing litigation involving Grace & Digital Information Technology Co., Ltd., alleging FCPA and RICO violations. Management believes these will not have a material adverse effect.

Investor Verification Checklist

• Merger Accounting: Verify the final accounting treatment of the FNF merger and its impact on future earnings per share and balance sheet leverage.
• Debt Covenants: Confirm compliance with financial covenants (leverage and interest coverage ratios) under the existing credit facilities, especially given the high debt load.
• Stock-Based Compensation: Assess the sustainability of SG&A expenses, noting the one-time impact of the $24.5 million performance option vesting in 2006.
• Goodwill Valuation: Monitor the $3.78 billion goodwill balance for potential impairment risks, particularly given the integration of Certegy and market volatility.
• Refinancing Execution: Track the successful closing of the announced $3.1 billion refinancing to ensure favorable terms and extended maturities.