The following section provides management's view of the Company's financial
condition and results of operations and should be read in conjunction with the
audited consolidated financial statements, and related notes included elsewhere
in this report. All dollar and share amounts, except per share amounts, are in
thousands and discussions compare fiscal 2021 to fiscal 2020. Discussions of
fiscal 2019 items and comparisons between fiscal 2019 and fiscal 2020 that are
not included in this Form 10-K can be found in Part II, Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in our
Annual Report on Form 10-K for the fiscal year ended
OVERVIEW
Jack Henry & Associates, Inc. is headquartered inMonett, Missouri , employs approximately 6,800 full-time and part-time associates nationwide, and is a leading provider of technology solutions and payment processing services primarily for financial services organizations. Its solutions serve nearly 8,400 customers and are marketed and supported through three primary brands. Jack Henry Banking® is a leading provider of integrated data processing systems solutions toU.S. banks ranging from de novo to multi-billion-dollar institutions with assets up to$50 billion . Symitar® is a leading provider of core data processing solutions for credit unions of all sizes. ProfitStars® provides highly specialized core agnostic products and services that enable financial institutions of every asset size and charter, and diverse corporate entities outside the financial services industry, to mitigate and control risks, optimize revenue and growth opportunities, and contain costs. JKHY's integrated solutions are available for on-premise installation and delivery in our private cloud. Each of our brands share the fundamental commitment to provide high-quality business solutions, service levels that consistently exceed customer expectations, integration of solutions and practical new technologies. The quality of our solutions, our high service standards, and the fundamental way we do business typically foster long-term customer relationships, attract prospective customers, and have enabled us to capture substantial market share. Through internal product development, disciplined acquisitions, and alliances with companies offering niche solutions that complement our proprietary solutions, we regularly introduce new products and services and generate new cross-sales opportunities across our three primary marketed brands. We provide compatible computer hardware for our on-premise installations and secure processing environments for our outsourced solutions in our private cloud. We perform data conversions, software implementations, initial and ongoing customer training, and ongoing customer support services. We believe our primary competitive advantage is customer service. Our support infrastructure and strict standards provide service levels we believe to be the highest in the markets we serve and generate high levels of customer satisfaction and retention. We consistently measure customer satisfaction using comprehensive annual surveys and randomly generated daily surveys we receive in our everyday business. Dedicated surveys are also used to grade specific aspects of our customer experience, including product implementation, education, and consulting services. Our two primary revenue streams are "services and support" and "processing." Services and support includes: "private and public cloud" fees (formerly known as "outsourcing and cloud" fees - see Note 2 to the consolidated financial statements) that predominantly have contract terms of seven years or longer at inception; "product delivery and services" revenue, which includes revenue from the sales of licenses, implementation services, deconversion fees, consulting, and hardware; and "on-premise support" revenue (formerly known as "in-house support" revenue - see Note 2 to the consolidated financial statements), composed of maintenance fees which primarily contain annual contract terms. Processing revenue includes: "remittance" revenue from payment processing, remote capture, and ACH transactions; "card" fees, including card transaction processing and monthly fees; and "transaction and digital" revenue, which includes transaction and mobile processing fees. We continually seek opportunities to increase revenue while at the same time containing costs to expand margins. We have four reportable segments: Core, Payments, Complementary, and Corporate and Other. The respective segments include all related revenues along with the related cost of sales. COVID-19 Impact and Response Since its outbreak in early 2020, COVID-19 has rapidly spread and continues to represent a public health concern. The health, safety, and well-being of our employees and customers is of paramount importance to us. InMarch 23
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Table of Contents 2020, we established an internal task force composed of executive officers and other members of management to frequently assess updates to the COVID-19 situation and recommend Company actions. We offered remote working as a recommended option to employees whose job duties allowed them to work off-site and we suspended all non-essential business travel. This company-wide recommendation extended untilJuly 1, 2021 , at which point we began transition to a return to our facilities and normalization of travel activities. Individual decisions on returning to the office were manager-coordinated and based on conversations with specific teams and departments. A large number of our employees requested to remain fully remote or participate in a hybrid approach where they would split their time between remote and in-person working. We have not required employees who return to our facilities to receive vaccinations, but we have provided information on vaccine providers, as well as hosted on-site COVID-19 vaccination clinics at several of our facilities for our employees and their families. OnAugust 3, 2021 , we reimplemented our company-wide recommendation for remote work and are encouraging a cautious approach to business travel based on the spread of the Delta variant and increased infection rates. For those employees who are at our facilities, we have introduced enhanced sanitation procedures and we require face masks for both vaccinated and unvaccinated employees. As ofAugust 13, 2021 , the majority of our employees were continuing to work remotely either full time or in a hybrid capacity. Customers We work closely with our customers who are scheduled for on-site visits to ensure their needs are met while taking necessary safety precautions when our employees are required to be at a customer site. Delays of customer system installations due to COVID-19 have been limited, and we have developed processes to handle remote installations when available. We expect these processes to provide flexibility and value both during and after the COVID-19 pandemic. Even though a substantial portion of our workforce has worked remotely during the outbreak and business travel has been curtailed, we have not yet experienced significant disruption to our operations. We believe our technological capabilities are well positioned to allow our employees to work remotely without materially impacting our business. Financial impact Despite the changes and restrictions caused by COVID-19, the overall financial and operational impact on our business has been limited and our liquidity, balance sheet, and business trends remain strong. We experienced positive operating cash flows during fiscal 2021, and we do not expect that to change in the near term. However, we are unable to accurately predict the future impact of COVID-19 due to a number of uncertainties, including further government actions; the duration, severity and recurrence of the outbreak, including the onset of variants of the virus; the speed and effectiveness of vaccine and treatment developments; the speed of economic recovery; the potential impact to our customers, vendors, and employees; and how the potential impact might affect future customer services, processing and installation-related revenue, and processes and efficiencies within the Company directly or indirectly impacting financial results. We will continue to monitor COVID-19 and its possible impact on the Company and to take steps necessary to protect the health and safety of our employees and customers. For a further discussion of the uncertainties and risks associated with COVID-19, see Part II, Item 1A "Risk Factors" in this Annual Report on Form 10-K. A detailed discussion of the major components of the results of operations follows. RESULTS OF OPERATIONS FISCAL 2021 COMPARED TO FISCAL 2020 In fiscal 2021, total revenue increased 4% or$61,158 , compared to fiscal 2020. Reducing total revenue for the effects of deconversion fees of$20,635 for the current fiscal year and$53,914 for the prior fiscal year, and for revenue from acquisitions and divestitures in fiscal 2021 of$9 and in fiscal 2020 of$3,574 , results in a 6% increase, or$98,002 . This increase was primarily driven by growth in card processing, data processing and hosting fee, Jack Henry digital and remittance fee, and software usage fee revenues, partially offset by lower hardware revenues and decreased pass-through billable travel and user group expenses year over year due to COVID-19 travel limitations (see "COVID-19 Impact and Response" above). Operating expenses increased 3% in fiscal 2021 compared to fiscal 2020, primarily due to higher costs related to our card payment processing platform associated with corresponding increases in revenue, higher personnel costs, and increased operating licenses and fees, partially offset by more capitalized costs related to research and development, travel expense savings as a result of COVID-19 travel limitations (see "COVID-19 Impact and Response" above), the gain on sale of assets this fiscal year compared to the loss last fiscal year, and lower hardware costs associated with a corresponding decrease in revenues. 24
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Table of Contents We move into fiscal 2022 following strong performance in fiscal 2021. Significant portions of our business continue to provide recurring revenue and our sales pipeline is also encouraging. Our customers continue to face regulatory and operational challenges which our products and services address, and in these times, they have an even greater need for our solutions that directly address institutional profitability, efficiency, and security. We believe our strong balance sheet, access to extensive lines of credit, the strength of our existing product line and an unwavering commitment to superior customer service position us well to address current and future opportunities. A detailed discussion of the major components of the results of operations for the fiscal year endedJune 30, 2021 follows. REVENUE Services and Support Revenue Year Ended June 30, % Change 2021 2020 Services and support$ 1,048,206 $ 1,051,451 - % Percentage of total revenue 60 % 62 %
Services and support includes: "private and public cloud" fees that
predominantly have contract terms of seven years or greater at inception;
"product delivery and services" revenue, which includes revenue from the sales
of licenses, implementation services, deconversion fees, consulting, and
hardware; and "on-premise support" revenue, which is composed primarily of
maintenance fees with annual contract terms.
In the fiscal year ended
% Year Ended June 30, Change 2021 2020 Processing$ 710,019 $ 645,616 10 % Percentage of total revenue 40 % 38 %
Processing revenue includes: "remittance" revenue from payment processing,
remote capture, and automated clearinghouse ("ACH") transactions; "card" fees,
including card transaction processing and monthly fees; and "transaction and
digital" revenue, which includes transaction and mobile processing fees. We
continually seek opportunities to increase revenue while at the same time
containing costs to expand margins.
Processing revenue increased 10% for the fiscal year ended
OPERATING EXPENSES Cost of Revenue % Year Ended June 30, Change 2021 2020 Cost of revenue$ 1,063,399 $ 1,008,464 5 % Percentage of total revenue 60 % 59 %
Cost of revenue for fiscal 2021 increased 5% compared to fiscal 2020. Reducing
total cost of revenue for the effects of deconversion fees from each year, which
totaled
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Table of Contents Response" above) and lower hardware costs corresponding with decreased hardware revenue. Cost of revenue increased 1% as a percentage of total revenue for fiscal 2021 compared to fiscal 2020. Research and Development % Year EndedJune 30 , Change 2021 2020
Research and development
6 % 6 % We devote significant effort and expense to develop new software, service products and continually upgrade and enhance our existing offerings. We believe our research and development efforts are highly efficient because of the extensive experience of our research and development staff and because our product development is highly customer driven. Research and development expenses for fiscal 2021 decreased 1% compared to fiscal 2020. The decrease was primarily due to higher capitalized research and development costs partially offset by an increase in personnel costs. The consistency of this expense category for the fiscal years presented reflected our continuing commitment to the development of strategic products. Research and development expense remained consistent as a percentage of total revenue for fiscal 2021 and fiscal 2020. Selling, General, and Administrative % Year EndedJune 30 , Change 2021 2020
Selling, general, and administrative
11 % 12 % Selling, general, and administrative costs included all expenses related to sales efforts, commissions, finance, legal, and human resources, plus all administrative costs. Selling, general, and administrative expenses for fiscal 2021 decreased 6% compared to fiscal 2020. Reducing total selling, general, and administrative expense for the effects of deconversion fees from each year, which totaled$489 in fiscal 2021 and$973 in fiscal 2020, and for the effects of acquisitions, divestitures, and gain/loss of$(1,950) for the current fiscal year and of$4,893 for the prior fiscal year, selling, general, and administrative expense decreased 2% compared to fiscal 2020. This decrease was primarily due to travel expense and other savings as a result of COVID-19 travel limitations partially offset by increased personnel costs. COVID-19 related savings included our national sales meeting,Jack Henry Annual Conference, andSymitar Education Conference being held virtually during the current fiscal year (see "COVID-19 Impact and Response" above). Selling, general, and administrative expense decreased 1% as a percentage of total revenue for fiscal 2021 compared to fiscal 2020. INTEREST INCOME AND EXPENSE % Year Ended June 30, Change 2021 2020 Interest income$ 150 $ 1,137 (87) % Interest expense$ (1,144) $ (688) 66 %
Interest income fluctuated due to changes in invested balances and yields on invested balances. Interest expense increased in fiscal 2021 mainly due to the timing and amounts of borrowed balances. PROVISION/ (BENEFIT) FOR INCOME TAXES
% Year Ended June 30, Change 2021 2020 Provision/ (Benefit) for income taxes$ 86,256 $ 84,408 2 % Effective rate 21.7 % 22.1 %
The decrease in the Company's effective tax rate in fiscal 2021 compared to fiscal 2020 was primarily due to a greater benefit in the current fiscal year related to stock-based compensation.
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Table of Contents NET INCOME % Year Ended June 30, Change 2021 2020 Net income$ 311,469 $ 296,668 5 % Diluted earnings per share$ 4.12 $ 3.86 7 %
Net income grew 5% to
REPORTABLE SEGMENT DISCUSSION The Company is a leading provider of technology solutions and payment processing services primarily for financial services organizations. The Company's operations are classified into four reportable segments: Core, Payments, Complementary, and Corporate and Other. The Core segment provides core information processing platforms to banks and credit unions, which consist of integrated applications required to process deposit, loan, and general ledger transactions, and maintain centralized customer/member information. The Payments segment provides secure payment processing tools and services, including ATM, debit, and credit card processing services; online and mobile bill pay solutions; ACH origination and remote deposit capture processing; and risk management products and services. The Complementary segment provides additional software, hosted processing platforms, and services, including call center support, and network security management, consulting, and monitoring, that can be integrated with our core solutions and many can be used independently. The Corporate and Other segment includes revenue and costs from hardware and other products not attributed to any of the other three segments, as well as operating costs not directly attributable to the other three segments. During the second quarter of fiscal 2021, Jack Henry's call center was consolidated into the Complementary segment. As a result of this consolidation, immaterial adjustments were made during fiscal 2021 to reclassify related revenue and costs recognized during the fiscal years endedJune 30, 2020 and 2019 from the Core to the Complementary segment. The total related revenue reclassified was$20,797 for fiscal 2020 and$13,515 for fiscal 2019. The total related cost of revenue reclassified was$12,386 for fiscal 2020 and$8,513 for fiscal 2019. Core 2021 % Change 2020 Revenue$ 564,096 - %$ 561,369 Cost of Revenue$ 247,285 3 %$ 240,492
In fiscal 2021, revenue in the Core segment remained consistent compared to
fiscal 2020. Reducing total Core revenue by the effects of deconversion fees
from both years, which totaled
2021 % Change 2020 Revenue$ 642,308 7 %$ 597,693 Cost of Revenue$ 353,581 11 %$ 319,739
In fiscal 2021, revenue in the Payments segment increased 7% compared to fiscal
2020. Reducing total Payments revenue by the effects of deconversion fees from
both years, which totaled
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Table of Contents other costs related to the organic growth in card processing and remittance fees. Cost of revenue increased 1.5% as a percentage of revenue for fiscal 2021 compared to fiscal 2020. Complementary 2021 % Change 2020 Revenue$ 505,928 4 %$ 484,146 Cost of Revenue$ 212,627 4 %$ 203,963
Revenue in the Complementary segment increased 4% for fiscal 2021 compared to
fiscal 2020. Reducing total Complementary revenue by the effects of deconversion
fees from both years, which totaled
2021 % Change 2020 Revenue$ 45,893 (15) %$ 53,859 Cost of Revenue$ 249,906 2 %$ 244,270
Revenue in the Corporate and Other segment decreased 15% for fiscal 2021 compared to fiscal 2020. The decrease was mainly due to decreased hardware revenue and lower pass-through user group revenue due to COVID-19 limitations (see "COVID-19 Impact and Response" above). Cost of revenue for the Corporate and Other segment includes operating costs not directly attributable to any of the other three segments and increased 2% for fiscal 2021 compared to fiscal 2020. The increased cost of revenue was primarily related to increased licenses and fees and personnel costs, partially offset by lower hardware costs associated with the decrease in hardware revenue.
LIQUIDITY AND CAPITAL RESOURCES The Company's cash and cash equivalents decreased to$50,992 atJune 30, 2021 from$213,345 atJune 30, 2020 . Cash was lower at the end of fiscal 2021 compared to the end of fiscal 2020 primarily due to the increase in net cash used in financing activities, including an increase in the purchase of treasury stock of approximately$360,000 and the decrease in cash provided by operating activities, including lower deconversion fees collected of approximately$22,000 or about 61% year over year. Decreases in cash were partially offset by an increase in credit facility borrowings and a decrease in cash used in investing activities, including a 57% decrease in capital expenditures and a decrease in cash used for acquisitions year over year. The following table summarizes net cash from operating activities in the statement of cash flows: Year Ended June 30, 2021 2020 Net income$ 311,469 $ 296,668 Non-cash expenses 211,266 218,004 Change in receivables (6,112) 10,540 Change in deferred revenue 6,541 (4,871)
Change in other assets and liabilities (61,035) (9,809)
Net cash provided by operating activities
Cash provided by operating activities for fiscal 2021 decreased 9% compared to
fiscal 2020. Cash from operations is primarily used to repay debt, pay dividends
and repurchase stock, and for capital expenditures.
Cash used in investing activities for fiscal 2021 totaled
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Table of Contents for the purchase and development of internal use software; and$13,300 for purchase of investments. This was partially offset by$6,187 of proceeds from asset sales and$5,000 of proceeds from investment maturities. Cash used in investing activities for fiscal 2020 totaled$197,906 and included:$117,262 for the ongoing enhancements and development of existing and new product and service offerings; capital expenditures on facilities and equipment of$53,538 , mainly for the purchase of computer equipment;$30,376 , net of cash acquired, for the purchases of Geezeo;$6,710 for the purchase and development of internal use software; and$1,150 for the purchase of investments. These expenditures were partially offset by$11,130 of proceeds from the sale of assets. Financing activities used cash of$462,232 for fiscal 2021 and included$431,529 for the purchase of treasury shares and$133,800 for dividends paid to stockholders. These expenditures were partially offset by$3,211 of net cash inflow related to stock-based compensation and borrowings and repayments on our revolving credit facility which netted to a borrowing of$100,000 . Financing activities used cash in fiscal 2020 of$192,909 and included$127,421 for dividends paid to stockholders and$71,549 for the purchase of treasury shares. These expenditures were partially offset by$6,094 of net cash inflow related to stock-based compensation. Borrowings and repayments on our revolving credit facility netted to zero atJune 30, 2020 . Capital Requirements and Resources The Company generally uses existing resources and funds generated from operations to meet its capital requirements. Capital expenditures totaling$22,988 and$53,538 for fiscal years endedJune 30, 2021 andJune 30, 2020 , respectively, were made primarily for additional equipment and the improvement of existing facilities. These additions were funded from cash generated by operations. AtJune 30, 2021 , the Company had no significant outstanding purchase commitments related to property and equipment. The COVID-19 pandemic has created significant uncertainty as to general global economic and market conditions for the beginning of our fiscal 2022 and beyond. We believe we have adequate capital resources and sufficient access to external financing sources to satisfy our current and reasonably anticipated requirements for funds to conduct our operations and meet other needs in the ordinary course of our business. However, as the impact of the COVID-19 pandemic on the economy and our operations evolves, we will continue to assess our liquidity needs. AtJune 30, 2021 , the Company had contractual obligations of$1,179,284 , including operating lease obligations and$1,112,731 related to off-balance sheet purchase obligations. Included in off-balance sheet purchase obligations were open purchase orders of$84,736 and a strategic services agreement entered into by JKHY in fiscal 2017 with First Data® and PSCU® to provide full-service debit and credit card processing on a single platform to all existing core bank and credit union customers, as well as to expand our card processing platform to financial institutions outside our core customer base. This agreement and subsequent amendments include a total purchase commitment atJune 30, 2021 of$1,027,995 over the remaining term of the contract, which currently extends untilJanuary 2036 , subject to certain renewal terms. Contractual obligations exclude$9,942 of liabilities for uncertain tax positions as we are unable to reasonably estimate the ultimate amount or timing of settlement. The Board of Directors has authorized the Company to repurchase shares of its common stock. Under this authorization, the Company may finance its share repurchases with available cash reserves or short-term borrowings on its existing credit facilities. The share repurchase program does not include specific price targets or timetables and may be suspended at any time. AtJune 30, 2021 , there were 29,793 shares in treasury stock and the Company had the remaining authority to repurchase up to 5,198 additional shares. The total cost of treasury shares atJune 30, 2021 was$1,613,202 . During fiscal 2021, the Company repurchased 2,800 treasury shares for$431,529 . AtJune 30, 2020 , there were 26,993 shares in treasury stock and the Company had authority to repurchase up to 2,998 additional shares. Revolving credit facility OnFebruary 10, 2020 , the Company entered into a five-year senior, unsecured revolving credit facility. The credit facility allows for borrowings of up to$300,000 , which may be increased by the Company at any time until maturity to$700,000 . The credit facility bears interest at a variable rate equal to (a) a rate based on a eurocurrency rate or (b) an alternate base rate (the highest of (i) 0%, (ii) theU.S. Bank prime rate for such day, (iii) the sum of the Federal Funds Effective Rate for such day plus 0.50% and (iv) the eurocurrency rate for a one-month interest period on such day for dollars plus 1.0%), plus an applicable percentage in each case determined by the Company's leverage ratio. The credit facility is guaranteed by certain subsidiaries of the Company and is subject to various financial covenants that require the Company to maintain certain financial ratios as defined in the credit facility agreement. As ofJune 30, 2021 , the Company was in compliance with all such covenants. The revolving credit facility terminatesFebruary 10, 2025 . There was a$100,000 outstanding balance under the credit facility atJune 30, 2021 and no outstanding balance under this credit facility atJune 30, 2020 . 29
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Table of Contents The Company also terminated its prior unsecured credit agreement onFebruary 10, 2020 . Other lines of credit The Company has an unsecured bank credit line which provides for funding of up to$5,000 and bears interest at the prime rate less 1%. The credit line was renewed inMay 2019 and modified inMarch 2021 to extend the expiration toApril 30, 2023 . There was no balance outstanding atJune 30, 2021 orJune 30, 2020 . RECENT ACCOUNTING PRONOUNCEMENTS Recently Adopted Accounting Guidance InJanuary 2017 , the FASB issued Accounting Standard Update ("ASU") No. 2017-04, Intangibles -Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates Step 2 of the goodwill impairment test that had required a hypothetical purchase price allocation. Rather, entities should apply the same impairment assessment to all reporting units and recognize an impairment loss for the amount by which a reporting unit's carrying amount exceeds its fair value, without exceeding the total amount of goodwill allocated to that reporting unit. Entities will continue to have the option to perform a qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The Company adopted ASU No. 2017-04 onJuly 1, 2020 and the adoption did not have a material impact on its consolidated financial statements. InJune 2016 , the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), or CECL, which prescribes an impairment model for most financial instruments based on expected losses rather than incurred losses. Under this model, an estimate of expected credit losses over the contractual life of the instrument is to be recorded as of the end of a reporting period as an allowance to offset the amortized cost basis, resulting in a net presentation of the amount expected to be collected on the financial instrument. For most instruments, entities must apply the standard using a cumulative-effect adjustment to beginning retained earnings as of the beginning of the fiscal year of adoption. The Company adopted CECL effectiveJuly 1, 2020 using the required modified retrospective approach, which resulted in a cumulative-effect decrease to beginning retained earnings of$493 . Financial assets and liabilities held by the Company subject to the "expected credit loss" model prescribed by CECL include trade and other receivables as well as contract assets (see Note 1 to the consolidated financial statements). Not Adopted at Fiscal Year End In December of 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which removes certain exceptions and simplifies other requirements of Topic 740 guidance. The ASU is effective for the Company onJuly 1, 2021 . The Company adopted ASU 2019-12 effectiveJuly 1, 2021 and the adoption did not have a material impact on its consolidated financial statements. CRITICAL ACCOUNTING ESTIMATES We prepare our consolidated financial statements in accordance withU.S. GAAP. The significant accounting policies are discussed in Note 1 to the consolidated financial statements. The preparation of consolidated financial statements in accordance withU.S. GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, as well as disclosure of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements. We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions would have a material effect on the consolidated financial statements. Revenue Recognition We generate revenue from data processing, transaction processing, software licensing and related services, professional services, and hardware sales. Significant Judgments in Application of the Guidance Identification of Performance Obligations We enter into contracts with customers that may include multiple types of goods and services. At contract inception, we assess the solutions and services promised in our contracts with customers and identify a performance 30
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Table of Contents obligation for each promise to transfer to the customer a solution or service (or bundle of solutions or services) that is distinct - that is, if the solution or service is separately identifiable from other items in the arrangement and if the customer can benefit from the solution or service on its own or together with other resources that are readily available. Significant judgment is used in the identification and accounting for all performance obligations. We recognize revenue when or as we satisfy each performance obligation by transferring control of a solution or service to the customer. Determination of Transaction Price The amount of revenue recognized is based on the consideration we expect to receive in exchange for transferring goods and services to the customer. Our contracts with our customers frequently contain some component of variable consideration. We estimate variable consideration in our contracts primarily using the expected value method, based on both historical and current information. Where appropriate, we may constrain the estimated variable consideration included in the transaction price in the event of a high degree of uncertainty as to the final consideration amount. Significant judgment is used in the estimate of variable consideration of customer contracts that are long-term and include uncertain transactional volumes. Technology or service components from third parties are frequently included in or combined with our applications or service offerings. Whether we recognize revenue based on the gross amount billed to the customer or the net amount retained involves judgment in determining whether we control the good or service before it is transferred to the customer. This assessment is made at the performance obligation level. Allocation of Transaction Price The transaction price, once determined, is allocated between the various performance obligations in the contract based upon their relative standalone selling prices. The standalone selling prices are determined based on the prices at which we separately sell each good or service. For items that are not sold separately, we estimate the standalone selling prices using all information that is reasonably available, including reference to historical pricing data. Contract Costs We incur incremental costs to obtain a contract as well as costs to fulfill contracts with customers that are expected to be recovered. These costs consist primarily of sales commissions, which are incurred only if a contract is obtained, and customer conversion or implementation-related costs. Capitalized costs are amortized based on the transfer of goods or services to which the asset relates, in line with the percentage of revenue recognized for each performance obligation to which the costs are allocated. Depreciation and Amortization Expense The calculation of depreciation and amortization expense is based on the estimated economic lives of the underlying property, plant and equipment and intangible assets, which have been examined for their useful life and determined that no impairment exists. We believe it is unlikely that any significant changes to the useful lives of our tangible and intangible assets will occur in the near term, but rapid changes in technology or changes in market conditions could result in revisions to such estimates that could materially affect the carrying value of these assets and our future consolidated operating results. For long-lived assets, we consider whether any impairment indicators are present. If impairment indicators are identified, we test the recoverability of the long-lived assets. If this recoverability test is failed, we determine the fair value of the long-lived assets and recognize an impairment loss if the fair value is less than its carrying value. Capitalization of software development costs We capitalize certain costs incurred to develop commercial software products. For software that is to be sold, significant areas of judgment include: establishing when technological feasibility has been met and costs should be capitalized, determining the appropriate period over which to amortize the capitalized costs based on the estimated useful lives, estimating the marketability of the commercial software products and related future revenues, and assessing the unamortized cost balances for impairment. Costs incurred prior to establishing technological feasibility are expensed as incurred. Amortization begins on the date of general release and the appropriate amortization period is based on estimates of future revenues from sales of the products. We consider various factors to project marketability and future revenues, including an assessment of alternative solutions or products, current and historical demand for the product, and anticipated changes in technology that may make the product obsolete. For internal use software, capitalization begins at the beginning of application development. Costs incurred prior to this are expensed as incurred. Significant estimates and assumptions include determining the appropriate 31
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Table of Contents amortization period based on the estimated useful life and assessing the unamortized cost balances for impairment. Amortization begins on the date the software is placed in service and the amortization period is based on estimated useful life. A significant change in an estimate related to one or more software products could result in a material change to our results of operations. Estimates used to determine current and deferred income taxes We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes. We also must determine the likelihood of recoverability of deferred tax assets and adjust any valuation allowances accordingly. Considerations include the period of expiration of the tax asset, planned use of the tax asset, and historical and projected taxable income as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in one or more of these factors. Also, liabilities for uncertain tax positions require significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect our financial results. Assumptions related to purchase accounting and goodwill We account for our acquisitions using the purchase method of accounting. This method requires estimates to determine the fair values of assets and liabilities acquired, including judgments to determine any acquired intangible assets such as customer-related intangibles, as well as assessments of the fair value of existing assets such as property and equipment. Liabilities acquired can include balances for litigation and other contingency reserves established prior to or at the time of acquisition and require judgment in ascertaining a reasonable value. Third-party valuation firms may be used to assist in the appraisal of certain assets and liabilities, but even those determinations would be based on significant estimates provided by us, such as forecast revenues or profits on contract-related intangibles. Numerous factors are typically considered in the purchase accounting assessments, which are conducted by Company professionals from legal, finance, human resources, information systems, program management and other disciplines. Changes in assumptions and estimates of the acquired assets and liabilities would result in changes to the fair values, resulting in an offsetting change to the goodwill balance associated with the business acquired. As goodwill is not amortized, goodwill balances are regularly assessed for potential impairment. Such assessments include a qualitative assessment of factors that may indicate a potential for impairment, such as: macroeconomic conditions, industry and market changes, our overall financial performance, changes in share price, and an assessment of other events or changes in circumstances that could negatively impact us. If that qualitative assessment indicates a potential for impairment, a quantitative assessment is then required, including an analysis of future cash flow projections as well as a determination of an appropriate discount rate to calculate present values. Cash flow projections are based on management-approved estimates, which involve the input of numerous Company professionals from finance, operations and program management. Key factors used in estimating future cash flows include assessments of labor and other direct costs on existing contracts, estimates of overhead costs and other indirect costs, and assessments of new business prospects and projected win rates. Our most recent assessment indicates that no reporting units are currently at risk of impairment as the fair value of each reporting unit is significantly in excess of the carrying value. However, significant changes in the estimates and assumptions used in purchase accounting and goodwill impairment testing could have a material effect on the consolidated financial statements.
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