FACTSET RESEARCH SYSTEMS INC - Quarter Report: 2018 May (Form 10-Q)

 

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		Three Months Ended May 31,								Nine Months Ended May 31,
(In thousands, except per share data)		2018				2017				2018				2017
Revenues		$	339,911			$	312,120			$	1,004,283			$	894,537
Operating expenses
Cost of services			165,073				146,426				489,829				405,311
Selling, general and administrative			81,573				78,052				236,606				219,519
Total operating expenses			246,646				224,478				726,435				624,830
Operating income			93,265				87,642				277,848				269,707
Other expense
Loss on sale of business			0				0				0				(1,223	)
Interest expense, net of interest income			(3,754	)			(2,413	)			(9,945	)			(3,945	)
Total other expense			(3,754	)			(2,413	)			(9,945	)			(5,168	)
Income before income taxes			89,511				85,229				267,903				264,539
Provision for income taxes			14,765				19,815				69,641				65,832
Net income		$	74,746			$	65,414			$	198,262			$	198,707
Basic earnings per common share		$	1.94			$	1.66			$	5.10			$	5.03
Diluted earnings per common share		$	1.91			$	1.66			$	5.01			$	5.00
Basic weighted average common shares			38,594				39,317				38,890				39,528
Diluted weighted average common shares			39,104				39,457				39,543				39,736

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		Three Months Ended May 31,								Nine Months Ended May 31,
(In thousands)		2018				2017				2018				2017
Net income		$	74,746			$	65,414			$	198,262			$	198,707
Other comprehensive income (loss), net of tax
Net unrealized (loss) gain on cash flow hedges*			(2,361	)			2,385				(4,105	)			4,233
Foreign currency translation adjustments			(20,126	)			21,316				(2,260	)			10,680
Other comprehensive (loss) income			(22,487	)			23,701				(6,365	)			14,913
Comprehensive income		$	52,259			$	89,115			$	191,897			$	213,620

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		May 31, 2018				August 31, 2017
(In thousands, except share data)		(Unaudited)
ASSETS
Cash and cash equivalents		$	213,061			$	194,731
Investments			30,485				32,444
Accounts receivable, net of reserves of $3,446 at May 31, 2018 and $2,738 at August 31, 2017			145,255				148,331
Prepaid taxes			9,236				7,076
Deferred taxes			0				2,668
Prepaid expenses and other current assets			31,573				24,126
Total current assets			429,610				409,376
Property, equipment and leasehold improvements, net			94,380				100,454
Goodwill			704,807				707,560
Intangible assets, net			155,776				173,543
Deferred taxes			7,916				7,412
Other assets			14,683				14,970
TOTAL ASSETS		$	1,407,172			$	1,413,315
LIABILITIES
Accounts payable and accrued expenses		$	62,772			$	59,214
Accrued compensation			40,257				61,083
Deferred fees			57,528				47,495
Deferred taxes			0				2,382
Taxes payable			12,670				9,112
Dividends payable			24,566				21,853
Total current liabilities			197,793				201,139
Long-term debt			574,739				575,000
Deferred taxes			23,627				24,892
Deferred fees			7,007				3,921
Taxes payable			29,010				11,484
Deferred rent and other non-current liabilities			39,663				37,188
TOTAL LIABILITIES		$	871,839			$	853,624
Commitments and contingencies (See Note 17)
STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued		$	0			$	0
Common stock, $.01 par value, 150,000,000 shares authorized, 39,124,581 and 51,845,132 shares issued; 38,384,581 and 39,023,032 shares outstanding at May 31, 2018 and August 31, 2017, respectively			391				518
Additional paid-in capital			642,906				741,748
Treasury stock, at cost: 740,000 and 12,822,100 shares at May 31, 2018 and August 31, 2017, respectively			(145,342	)			(1,606,678	)
Retained earnings			78,463				1,458,823
Accumulated other comprehensive loss			(41,085	)			(34,720	)
TOTAL STOCKHOLDERS’ EQUITY		$	535,333			$	559,691
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	1,407,172			$	1,413,315

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		Nine Months Ended May 31,
(in thousands)		2018				2017
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	198,262			$	198,707
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			42,848				33,770
Stock-based compensation expense			23,241				20,873
Loss on sale of business			0				1,223
Deferred income taxes			848				8,829
Loss on disposition of assets			18				33
Tax benefits from share-based payment arrangements			0				(9,798	)
Changes in assets and liabilities, net of effects of acquisitions
Accounts receivable, net of reserves			3,067				(29,310	)
Accounts payable and accrued expenses			3,423				1,548
Accrued compensation			(20,629	)			(17,299	)
Deferred fees			13,027				2,638
Taxes payable, net of prepaid taxes			25,928				6,081
Prepaid expenses and other assets			(11,503	)			440
Deferred rent and other non-current liabilities			621				2,766
Other working capital accounts, net			191				(189	)
Net cash provided by operating activities			279,342				220,312
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of businesses, net of cash acquired			0				(301,843	)
Purchases of investments			(9,608	)			(29,982	)
Proceeds from sales of investments			9,872				23,399
Purchases of property, equipment and leasehold improvements, net of proceeds from dispositions			(18,375	)			(25,981	)
Net cash used in investing activities			(18,111	)			(334,407	)
CASH FLOWS FROM FINANCING ACTIVITIES
Dividend payments			(65,037	)			(59,124	)
Repurchases of common stock			(235,869	)			(214,766	)
Proceeds from debt			0				575,000
Repayment of debt			0				(300,000	)
Debt issuance costs			0				(437	)
Other financing activities			2,218				(1,223	)
Proceeds from employee stock plans			57,529				42,159
Tax benefits from share-based payment arrangements			0				9,798
Net cash used by financing activities			(241,159	)			51,407
Effect of exchange rate changes on cash and cash equivalents			(1,742	)			(3,961	)
Net increase (decrease) in cash and cash equivalents			18,330				(66,649	)
Cash and cash equivalents at beginning of period			194,731				228,407
Cash and cash equivalents at end of period		$	213,061			$	161,758

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1. ORGANIZATION AND NATURE OF BUSINESS

 

FactSet Research Systems Inc. (the “Company” or “FactSet”) is a global provider of integrated financial information, analytical applications and industry-leading service for the global investment community. The Company delivers insight and information to investment professionals through its analytics, service, content, and technology. These professionals include portfolio managers, investment research professionals, investment bankers, risk and performance analysts, and wealth advisors. From streaming real-time data to historical information, including quotes, estimates, news and commentary, FactSet offers unique and third-party content through desktop, web, mobile and off-platform solutions. The Company’s broad application suite offers tools and resources including company and industry analyses, full screening tools, portfolio analysis, risk profiles, alpha-testing, portfolio optimization and research management solutions. With recent acquisitions, FactSet has continued to expand its solutions across the investment lifecycle from idea generation to performance and client reporting. The Company’s revenues are primarily derived from subscriptions to products and services such as workstations, analytics, enterprise data, research management, and trade execution.

 

 

2. BASIS OF PRESENTATION

 

FactSet conducts business globally and is managed on a geographic basis. The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany activity and balances have been eliminated from the consolidated financial statements.

 

The unaudited condensed consolidated financial statements of FactSet and the accompanying notes included in this Quarterly Report on Form 10-Q are prepared in accordance with generally accepted accounting principles in the United States ("GAAP").  In the opinion of management, the accompanying condensed consolidated financial statements include all normal recurring adjustments, transactions or events discretely impacting the interim periods considered necessary to fairly state our results of operations, financial position and cash flows. The information in this Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2017.

 

The Company has evaluated subsequent events through the date that the financial statements were issued.

 

 

3. RECENT ACCOUNTING PRONOUNCEMENTS

 

As of May 31, 2018, FactSet implemented all applicable new accounting standards and updates issued by the Financial Accounting Standards Board (“FASB”) that were in effect. There were no new standards or updates adopted during the first nine months of fiscal 2018 that had a material impact on the consolidated financial statements.

 

New Accounting Standards or Updates Recently Adopted

 

Balance Sheet Classification of Deferred Taxes

During the first quarter of fiscal 2018, FactSet adopted the accounting standard update issued by the FASB in November 2015 to simplify the presentation of deferred taxes on the balance sheet. This accounting standard update required an entity to present all deferred tax assets and deferred tax liabilities as non-current on the balance sheet. Under the previous guidance, entities were required to separately present deferred taxes as current or non-current. Netting deferred tax assets and deferred tax liabilities by tax jurisdiction is still required under the new guidance. This accounting standard update is a change to the balance sheet presentation only. The changes have been applied prospectively as permitted by the standard and prior periods have not been restated.

 

Share-Based Payments

During the first quarter of fiscal 2018, FactSet adopted the accounting standard update issued by the FASB in March 2016, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. This accounting standard update increases the volatility within the Company’s provision for income taxes as all excess tax benefits or deficiencies related to share-based payments that were previously reported within equity are now recognized in the consolidated statement of income. The adoption of this standard resulted in the recognition of $7.1 million of excess tax benefits to FactSet’s provision for income taxes during the first nine months of fiscal 2018. In addition, this standard changed the classification of excess tax benefits presented in the Company's consolidated statements of cash flows from a financing activity to an operating activity, which was applied on a prospective basis as permitted by the standard. Prior periods were not restated. Share-based payment expense continues to reflect estimated forfeitures of share-based payment awards. The remaining provisions of this standard did not have a material impact on the Company’s consolidated financial statements.

 

 

Income Taxes

During the third quarter of fiscal 2018, FactSet adopted the accounting standard update issued by the FASB in March 2018, which provides guidance related to income tax accounting implications under the Tax Cuts and Jobs Act (“TCJA”) enacted on December 22, 2017, effective January 1, 2018. Areas of clarification under the update are the measurement period timeframe, changes in subsequent reporting periods, and reporting requirements as they relate to the TCJA. Due to the complexity of the TCJA, the standard update allows companies to record provisional amounts, or reasonable estimates of the tax effects of the TCJA during a measurement period not to exceed one year from the enactment date. As a result of the TCJA, FactSet recorded a one-time transition tax expense of $23.2 million and a non-recurring $2.2 million tax expense related to the remeasurement of the net U.S. deferred tax position during the second quarter of fiscal 2018. The Company will continue to analyze the TCJA and related accounting guidance and interpretations in order to finalize any impacts within the one-year measurement period from the TCJA enactment date. 

 

Recent Accounting Standards or Updates Not Yet Effective

 

Revenue Recognition

In May 2014 and July 2015, the FASB issued accounting standard updates, which clarified principles for recognizing revenue arising from contracts with clients and superseded most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to clients in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also requires increased disclosures including the nature, amount, timing, and uncertainty of revenues and cash flows related to contracts with clients. In addition to a potential change in the timing of revenue recognition, the new standard will require incremental contract acquisition costs (such as sales commissions) for client sales to be capitalized and amortized over the contract period. Currently these costs are expensed as incurred. Contract acquisition costs, such as sales commissions, have historically not been material to FactSet, thus a change in the accounting for them is not expected to have a material impact to the Company. FactSet is on schedule in establishing new accounting policies, refining existing processes, and ensuring internal controls necessary to support the requirements of the new standard are in place.

 

The standard allows two methods of adoption: i) retrospectively to each prior period presented (“full retrospective method”), or ii) retrospectively with the cumulative effect recognized in retained earnings as of the date of adoption ("modified retrospective method"). FactSet plans to adopt the new standard using the modified retrospective method at the beginning of its first quarter of fiscal 2019. The Company is currently evaluating the impact of these accounting standard updates on its consolidated financial statements.

 

Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued an accounting standard update to amend its current guidance on the classification and measurement of certain financial instruments. The accounting standard update significantly revises an entity’s accounting related to the presentation of certain fair value changes for financial liabilities measured at fair value. This guidance also amends certain disclosure requirements associated with the fair value of financial instruments. This guidance will be effective for FactSet beginning in the first quarter of fiscal 2019. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

Leases

In February 2016, the FASB issued an accounting standard update related to accounting for leases. The guidance introduces a lessee model that requires most leases to be reported on the balance sheet. The accounting standard update aligns many of the underlying principles of the new lessor model with those in the FASB’s new revenue recognition standard. The guidance also eliminates the requirement in current U.S. GAAP for an entity to use bright-line tests in determining lease classification. This accounting standard update will be effective for FactSet beginning in the first quarter of fiscal 2020, with early adoption in fiscal 2019 permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

Cash Flow Simplification

In August 2016, the FASB issued an accounting standard update, which simplifies how certain transactions are classified in the statement of cash flows. This includes revised guidance on the cash flow classification of debt prepayments and debt extinguishment costs, contingent consideration payments made after a business combination and distributions received from equity method investments. The guidance is intended to reduce diversity in practice across all industries. This accounting standard update will be effective for FactSet beginning in the first quarter of fiscal 2019. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

 

Income Taxes on Intra-Entity Transfers of Assets

In October 2016, the FASB issued an accounting standard update, which removes the prohibition against the immediate recognition of the current and deferred income tax effects of intra-entity transfers of assets other than inventory. The guidance is intended to reduce diversity in practice related to the tax consequences of certain types of intra-entity asset transfers, particularly those involving intellectual property. This accounting standard update will be effective for FactSet beginning in the first quarter of fiscal 2019. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

Goodwill Impairment Test

In January 2017, the FASB issued an accounting standard update, which removes the requirement for companies to compare the implied fair value of goodwill with its carrying amount as part of step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This accounting standard update will be effective for FactSet beginning in the first quarter of fiscal 2021, with early adoption permitted for any impairment tests performed after January 1, 2017. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

Hedge Accounting Simplification

In August 2017, the FASB issued an accounting standard update to reduce the complexity and simplify the application of hedging accounting. The guidance refines and expands hedge accounting for both financial and nonfinancial risk components, eliminates the need to separately measure and report hedge ineffectiveness, and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This guidance will be effective for FactSet beginning in the first quarter of fiscal 2020, with early adoption permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

Share-Based Payments

In May 2017, the FASB issued an accounting standard update, which amends the scope of modification accounting for share-based payment arrangements. The guidance focuses on changes to the terms or conditions of share-based payment awards that would require the application of modification accounting and specifies that an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. This accounting standard update will be effective for FactSet beginning in the first quarter of fiscal 2019, with early adoption permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income 

In February 2018, the FASB issued an accounting standard update, which allows companies to reclassify certain stranded income tax effects resulting from the enactment of the Tax Cuts and Jobs Act (the "TCJA") from accumulated other comprehensive income to retained earnings. This accounting standard update will be effective for FactSet beginning in the first quarter of fiscal 2019, with early adoption permitted. The Company is currently evaluating the impact of this accounting standard update on its consolidated financial statements.

 

No other new accounting pronouncements issued or effective as of May 31, 2018 have had or are expected to have an impact on the Company’s consolidated financial statements.

 

 

4. FAIR VALUE MEASURES

 

Fair value is defined as the price that would be received from selling an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, the use of various valuation methodologies, including market, income and cost approaches is permissible. The Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. 

 

Fair Value Hierarchy

 

The accounting guidance for fair value measurements establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value based on the reliability of inputs. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect their placement within the fair value hierarchy levels. FactSet has categorized its cash equivalents, investments and derivatives within the fair value hierarchy as follows:

 

Level 1 – applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities. These Level 1 assets and liabilities include the Company’s corporate money market funds that are classified as cash equivalents.

 

 

Level 2 – applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data. The Company’s certificates of deposit, mutual funds and derivative instruments are classified as Level 2.

 

Level 3 – applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities. There were no Level 3 assets or liabilities held by the Company as of May 31, 2018 or August 31, 2017.

 

(a) Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The following tables shows by level within the fair value hierarchy the Company’s assets and liabilities that are measured at fair value on a recurring basis at May 31, 2018 and August 31, 2017:

 

 

 

 

(1)

The Company’s corporate money market funds are traded in an active market and the net asset value of each fund on the last day of the quarter is used to determine its fair value. As such, the Company’s corporate money market funds are classified as Level 1 and included in cash and cash equivalents on the Consolidated Balance Sheets.

 

(2)

The Company’s mutual funds have a fair value based on the fair value of the underlying investments held by the mutual funds allocated to each share of the mutual fund using a net asset value approach. The fair value of the underlying investments is based on observable inputs. As such, the Company’s mutual funds are classified as Level 2 and are classified as investments (short-term) on the Consolidated Balance Sheets.

 

 

(3)

The Company’s certificates of deposit held for investment are not debt securities and are classified as Level 2. These certificates of deposit have original maturities greater than three months, but less than one year and, as such, are classified as investments (short-term) on the Consolidated Balance Sheets.

 

(4)

The Company utilizes the income approach to measure fair value for its derivative instruments (foreign currency forward contracts). The income approach uses pricing models that rely on market observable inputs such as spot, forward and interest rates, as well as credit default swap spreads and therefore, are classified as Level 2.

 

The Company did not have any transfers between Level 1 and Level 2 fair value measurements during the periods presented.

 

(b) Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

 

Certain assets, including goodwill and intangible assets, and liabilities, are measured at fair value on a non-recurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances such as when they are deemed to be other-than-temporarily impaired. The fair values of these non-financial assets and liabilities are determined based on valuation techniques using the best information available and may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost exceeds its fair value, based upon the results of such valuations. During the nine months ended May 31, 2018, no fair value adjustments or material fair value measurements were required for the Company’s non-financial assets or liabilities.

 

(c) Assets and Liabilities Measured at Fair Value for Disclosure Purposes Only

 

As of May 31, 2018, and August 31, 2017, the fair value of the Company’s long-term debt was $575.0 million, respectively, which approximated its carrying amount given its floating interest rate basis. The fair value of the Company’s long-term debt was determined based on quoted market prices for debt with a similar maturity, and thus categorized as Level 2 in the fair value hierarchy.

 

5. DERIVATIVE INSTRUMENTS

 

Cash Flow Hedges

 

FactSet conducts business outside the U.S. in several currencies including the British Pound Sterling, Euro, Indian Rupee, Japanese Yen and Philippine Peso. As such, it is exposed to movements in foreign currency exchange rates compared to the U.S. dollar. The Company utilizes derivative instruments (foreign currency forward contracts) to manage the exposures related to the effects of foreign exchange rate fluctuations and reduce the volatility of earnings and cash flows associated with changes in foreign currency. The Company does not enter into foreign currency forward contracts for trading or speculative purposes. In designing a specific hedging approach, FactSet considered several factors, including offsetting exposures, the significance of exposures, the forecasting of risk and the potential effectiveness of the hedge. The gains and losses on foreign currency forward contracts offset the variability in operating expenses associated with currency movements. The changes in fair value for these foreign currency forward contracts are initially reported as a component of accumulated other comprehensive loss (“AOCL”) and subsequently reclassified into operating expenses when the hedged exposure affects earnings. There was no discontinuance of cash flow hedges during the first nine months of fiscal 2018 and 2017, and as such, no corresponding gains or losses related to changes in the value of the Company’s contracts were reclassified into earnings prior to settlement.

 

As of May 31, 2018, FactSet maintained the following foreign currency forward contracts to hedge its exposures:

 

●

Indian Rupee - foreign currency forward contracts to hedge approximately 75% of its Indian Rupee exposure through the third quarter of fiscal 2019 and 50% of its exposure from the fourth quarter of fiscal 2019 through the end of the second quarter of fiscal 2020.

 

●

Philippine Peso - foreign currency forward contracts to hedge approximately 75% of its Philippine Peso exposure through the fourth quarter of fiscal 2020.

 

 

The following is a summary of all hedging positions and corresponding fair values:

 

 

 

As of May 31, 2018, the gross notional value of foreign currency forward contracts to purchase Indian Rupees with U.S. dollars was Rs. 3.7 billion. The gross notional value of foreign currency forward contracts to purchase Philippine Pesos with U.S. dollars was Php 3.1 billion.

 

Counterparty Credit Risk

 

As a result of the use of derivative instruments, the Company is exposed to counterparty credit risk. FactSet has incorporated counterparty risk into the fair value of its derivative assets and its own credit risk into the value of the Company’s derivative liabilities, when applicable. FactSet calculates credit risk from observable data related to credit default swaps (“CDS”) as quoted by publicly available information. Counterparty risk is represented by CDS spreads related to the senior secured debt of the respective bank with whom FactSet has executed these derivative transactions. As CDS spread information is not available for FactSet, the Company’s credit risk is determined based on using a simple average of CDS spreads for peer companies. To mitigate counterparty credit risk, FactSet enters into contracts with large financial institutions and regularly reviews its credit exposure balances as well as the creditworthiness of the counterparties. The Company does not expect any losses as a result of default of its counterparties.

 

Fair Value of Derivative Instruments 

 

The following table provides the fair value of derivative instruments:

 

 

All derivatives were designated as hedging instruments as of May 31, 2018 and August 31, 2017, respectively.

 

Derivatives in Cash Flow Hedging Relationships

 

The following table provides the pre-tax effect of derivative instruments in cash flow hedging relationships for the three months ended May 31, 2018 and 2017:

 

 

The following table provides the pre-tax effect of derivative instruments in cash flow hedging relationships for the nine months ended May 31, 2018 and 2017:

 

 

No amount of ineffectiveness was recorded in the Consolidated Statements of Income for these designated cash flow hedges and all components of each derivative’s gain or loss was included in the assessment of hedge effectiveness. As of May 31, 2018, FactSet estimates that approximately $2.3 million of net derivative gains related to its cash flow hedges included in AOCL will be reclassified into earnings within the next 12 months.

 

Offsetting of Derivative Instruments

 

FactSet’s master netting and other similar arrangements with its respective counterparties allow for net settlement under certain conditions. As of May 31, 2018 and August 31, 2017, there were no net settlements recorded on Consolidated Balance Sheets.

 

 

 

6. OTHER COMPREHENSIVE INCOME (LOSS) AND ACCUMULATED OTHER COMPREHENSIVE LOSS

 

The components of other comprehensive income and amounts reclassified out of AOCL into earnings during the three months ended May 31, 2018 and 2017 are as follows:

 

 

 

(1)

Reclassified to Selling, General and Administrative Expenses

 

 

The components of other comprehensive income and amounts reclassified out of AOCL into earnings during the nine months ended May 31, 2018 and 2017 are as follows:

 

 

 

(2)

Reclassified to Selling, General and Administrative Expenses

 

The components of AOCL are as follows:

 

 

 

 

7. SEGMENT INFORMATION

 

Operating segments are defined as components of an enterprise that engage in business activities from which they may earn revenues and incur expenses, whose operating results are regularly reviewed by the enterprise’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. The Chief Executive Officer (“CEO”) and senior management jointly review financial information at the operating segment level. Senior management consists of certain executives who directly report to the CEO, consisting of the Chief Financial Officer, Chief Technology and Product Officer, Global Head of Sales and Client Solutions, General Counsel and Chief Human Resources Officer. Senior management, along with the CEO, constitute FactSet’s chief operating decision making group (“CODMG”) and is responsible for making decisions about resources allocated amongst the operating segments based on actual results.

 

FactSet’s operating segments are aligned with how the Company, including its CODMG, manages the business and the demographic markets in which FactSet serves. The Company’s internal financial reporting structure is based on three segments; the U.S., Europe and Asia Pacific. FactSet believes this alignment helps it better manage the business and view the markets the Company serves, which are centered on providing integrated global financial and economic information. The primary functional groups within the U.S., Europe and Asia Pacific segments include sales, consulting, data collection, product development and software engineering, which provide global financial and economic information to investment managers, investment banks and other financial services professionals.

 

The U.S. segment services investment professionals including financial institutions throughout the Americas. The European and Asia Pacific segments service investment professionals located throughout Europe and the Asia Pacific region, respectively. Segment revenues reflect direct sales to clients based in their respective geographic locations. Each segment records compensation expense, including stock-based compensation, amortization of intangible assets, depreciation of furniture and fixtures, amortization of leasehold improvements, communication costs, professional fees, rent expense, travel, office and other direct expenses.

 

 

Expenditures associated with the Company’s data centers, data costs and corporate charges are recorded by the U.S. segment and are not allocated to the other segments. The centers of excellence, who focus primarily on content collection and are located in India and the Philippines, benefit all of the Company’s operating segments and thus the expenses incurred at these locations are allocated to each segment based on a percentage of revenues. Of the total $704.8 million of goodwill reported by the Company at May 31, 2018, 54% was recorded in the U.S. segment, 45% in the European segment and the remaining 1% in the Asia Pacific segment.

 

The following reflects the results of operations of the segments consistent with the Company’s management system. These results are used by management, both in evaluating the performance of, and in allocating resources to, each of the segments.

 

 

 

 

 

 

8. BUSINESS COMBINATIONS

 

BISAM

 

On March 17, 2017, FactSet acquired BI-SAM Technologies (“BISAM”) for a total purchase price of $217.6 million. BISAM is a global provider of portfolio performance and attribution, multi-asset risk, GIPS composites management and reporting. BISAM’s product offerings include B-One, BISAM’s cross-asset solution, which will serve as a complement to both FactSet’s portfolio analytics suite and client reporting solutions, and Cognity, which enhances FactSet’s risk analysis for derivatives and quantitative portfolio construction. These factors contributed to a purchase price in excess of fair value of BISAM’s net tangible and intangible assets, leading to the recognition of goodwill. At the time of acquisition, BISAM employed over 160 employees based primarily in its New York, Boston, Paris, London and Sofia offices. Total transaction costs of $3.2 million were recorded within Selling, General and Administrative (“SG&A”) expenses in the Consolidated Statements of Income during fiscal 2017.

 

Allocation of the purchase price to the assets acquired and liabilities assumed was finalized during the fourth quarter of fiscal 2017. There were no significant adjustments between the preliminary and final allocation. The total purchase price was allocated to BISAM’s net tangible and intangible assets based upon their estimated fair value as of the date of acquisition.

 

 

 

 

Intangible assets of $56.6 million have been allocated to amortizable intangible assets consisting of client relationships, amortized over 16 years using an accelerated amortization method; software technology, amortized over five years using a straight-line amortization method; and a trade name, amortized over four years using a straight-line amortization method.

 

Goodwill totaling $173.9 million represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. Goodwill generated from the BISAM acquisition is included in the U.S. and European segments and is not deductible for income tax purposes. The results of operations of BISAM have been included in the Company’s Consolidated Statements of Income since the completion of the acquisition on March 17, 2017. Pro forma information has not been presented because the effect of the BISAM acquisition is not material to the Company’s consolidated financial results.

 

Vermilion

 

On November 8, 2016, FactSet acquired Vermilion Holdings Limited (“Vermilion”) for a total purchase price of $67.9 million. Vermilion is a global provider of client reporting and communications software and services to the financial services industry. Client reporting is a growing area of the market as regulatory requirements rise; and with the acquisition of Vermilion and its Vermilion Reporting Suite (“VRS”), FactSet now offers a workflow around all elements of the client reporting process, which it expects will expand as investors grow increasingly sophisticated. This factor contributed to a purchase price in excess of fair value of Vermilion’s net tangible and intangible assets, leading to the recognition of goodwill. At the time of acquisition, Vermilion employed 59 individuals in its London, Boston and Singapore offices. Total transaction costs of $0.7 million were recorded within SG&A expenses in the Consolidated Statements of Income during fiscal 2017.

 

Allocation of the purchase price to the assets acquired and liabilities assumed was finalized during the third quarter of fiscal 2017. There were no significant adjustments between the preliminary and final allocation. The total purchase price was allocated to Vermilion’s net tangible and intangible assets based upon their estimated fair value as of the date of acquisition. Based upon the purchase price and the valuation, the allocation is as follows:

 

 

Intangible assets of $18.2 million have been allocated to amortizable intangible assets consisting of client relationships, amortized over 15 years using an accelerated amortization method; software technology, amortized over six years using a straight-line amortization method; non-compete agreements, amortized over three years using a straight-line amortization method; and a trade name, amortized over four years using a straight-line amortization method.

 

Goodwill totaling $51.2 million represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. Goodwill generated from the Vermilion acquisition is included in the European segment and is not deductible for income tax purposes. The results of operations of Vermilion have been included in the Company’s Consolidated Statements of Income since the completion of the acquisition on November 8, 2016. Pro forma information has not been presented because the effect of the Vermilion acquisition is not material to the Company’s consolidated financial results.

 

 

 

9. GOODWILL

 

Changes in the carrying amount of goodwill by segment for the nine months ended May 31, 2018, are as follows:

 

 

Goodwill is not amortized as it is estimated to have an indefinite life. At least annually, the Company is required to test goodwill at the reporting unit level for potential impairment, and, if impaired, write down to fair value based on the present value of discounted cash flows. The Company’s reporting units evaluated for potential impairment were the U.S., Europe and Asia Pacific, which reflect the level of internal reporting the Company uses to manage its business and operations. The three reporting units are consistent with the operating segments reported as there is no discrete financial information available for the subsidiaries within each operating segment. The Company performed its annual goodwill impairment test during the fourth quarter of fiscal 2017, consistent with the timing of previous years, at which time it was determined that there was no impairment, with the fair value of each of the Company’s reporting units significantly exceeding carrying value.

 

 

10. INTANGIBLE ASSETS

 

FactSet’s identifiable intangible assets consist of acquired content databases, client relationships, software technology, non-compete agreements and trade names resulting from previous acquisitions, which have been fully integrated into the Company’s operations. The weighted average useful life of FactSet’s acquired identifiable intangible assets at May 31, 2018 was 11.5 years. The Company amortizes intangible assets over their estimated useful lives, which are evaluated quarterly to determine whether events and circumstances warrant a revision to the remaining period of amortization. There have been no changes to the estimate of the remaining useful lives during the first nine months of fiscal 2018. Amortizable intangible assets are tested for impairment, if indicators of impairment are present, based on undiscounted cash flows, and, if impaired, written down to fair value based on discounted cash flows. No impairment of intangible assets has been identified during any of the periods presented. The intangible assets have no assigned residual values.

 

The gross carrying amounts and accumulated amortization totals related to the Company’s identifiable intangible assets are as follows:

 

 

 

Amortization expense recorded for intangible assets was $6.2 million and $5.8 million for the three months ended May 31, 2018 and 2017, respectively. Amortization expense recorded for intangible assets was $18.6 million and $13.8 million for the nine months ended May 31, 2018 and 2017, respectively. As of May 31, 2018, estimated intangible asset amortization expense for each of the next five years and thereafter is as follows:

 

 

 

 

11. COMMON STOCK AND EARNINGS PER SHARE

 

On May 7, 2018, FactSet’s Board of Directors approved a regular quarterly dividend of $0.64 per share. The cash dividend of $24.6 million was paid on June 19, 2018 to common stockholders of record at the close of business on May 31, 2018.

 

Shares of common stock outstanding were as follows:

 

 

(1)

For the nine months ended May 31, 2018 and 2017, the Company repurchased 5,563 and 37,042 shares, or $1.0 million and $5.7 million, of common stock, respectively, in settlement of employee tax withholding obligations due upon the vesting of restricted stock.

 

A reconciliation of the weighted average shares outstanding used in the basic and diluted earnings per share (“EPS”) computations is as follows:

 

 

 

Dilutive potential common shares consist of stock options and unvested restricted stock awards. The were no stock options excluded from the calculation of diluted EPS for the three months ended May 31, 2018 as no options would have been anti-dilutive. The number of stock options excluded from the calculation of diluted EPS for the three months ended May 31, 2017 was 492,649 because their inclusion would have been anti-dilutive.

 

For the three months ended May 31, 2018 and 2017, the number of performance-based stock options excluded from the calculation of diluted EPS was 249,443 and 754,561, respectively. Performance-based stock options are omitted from the calculation of diluted EPS until the performance criteria are probable of being achieved.

 

 

12. STOCKHOLDERS’ EQUITY

 

Preferred Stock

 

At May 31, 2018 and August 31, 2017, there were 10,000,000 shares of preferred stock ($0.01 par value per share) authorized, of which no shares were issued and outstanding. FactSet’s Board of Directors may from time to time authorize the issuance of one or more series of preferred stock and, in connection with the creation of such series, determine the characteristics of each such series including, without limitation, the preference and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions of the series.

 

Common Stock

 

At May 31, 2018 and August 31, 2017, there were 150,000,000 shares of common stock ($0.01 par value per share) authorized, of which 39,124,581 and 51,845,132 shares were issued, respectively. The authorized shares of common stock are issuable for any proper corporate purpose, including future stock splits, stock dividends, acquisitions, raising equity capital or to adopt additional employee benefit plans.

 

Treasury Stock

 

On January 31, 2018, FactSet retired 13,292,689 shares of treasury stock. These retired shares are now included in the Company’s pool of authorized but unissued shares. The retired treasury stock was initially recorded using the cost method and had a carrying value of $1.7 billion at January 31, 2018. The Company’s accounting policy upon the formal retirement of treasury stock is to deduct its par value from common stock ($0.1 million), reduce additional paid-in capital (“APIC”) by the average amount recorded in APIC when stock was originally issued ($186.7 million) and any remaining excess of cost as a deduction from retained earnings ($1.5 billion). As of May 31, 2018, there were 740,000 shares of treasury stock (at cost) outstanding, a decrease compared to 12,822,100 as of August 31, 2017 due to the aforementioned treasury stock retirement on January 31, 2018.

 

Share Repurchase Program

 

Repurchases will be made from time to time in the open market and privately negotiated transactions, subject to market conditions. During the first nine months of fiscal 2018, the Company repurchased 1,204,920 shares for $234.8 million compared to 1,284,822 shares for $208.8 million in the prior year comparable period.

 

On March 26, 2018, the Board of Directors of FactSet approved a $300.0 million expansion to the existing share repurchase program. Subsequent to this expansion $309.3 million remain authorized for future share repurchases as of May 31, 2018. No minimum number of shares to be repurchased has been fixed. There is no timeframe to complete the repurchase program and it is expected that share repurchases will be paid using existing and future cash generated by operations.

 

Restricted Stock Vesting

 

Restricted stock awards entitle the holder to shares of common stock as the awards vest over time. During the first nine months of fiscal 2018, 15,063 of previously granted restricted stock awards vested and were included in common stock outstanding as of May 31, 2018 (less 5,563 shares repurchased from employees to cover their cost of taxes upon vesting of the restricted stock). During the same period a year ago, 101,234 of previously granted restricted stock awards vested and were included in common stock outstanding as of May 31, 2017 (less 37,042 shares repurchased from employees to cover their cost of taxes upon vesting of the restricted stock).

 

 

Dividends

 

The Company’s Board of Directors declared the following historical dividends: 

 

 

All of the above cash dividends were paid from existing cash resources. Future dividend payments will depend on the Company’s earnings, capital requirements, financial condition and other factors considered relevant by the Company and is subject to final determination by the Company’s Board of Directors.

 

 

13. EMPLOYEE STOCK OPTION AND RETIREMENT PLANS

 

Stock Option Awards

 

On December 19, 2017, the Company’s stockholders approved the amended and restated FactSet Research Systems Inc. 2004 Stock Option and Award Plan, as Amended and Restated, which was renamed the Stock Option and Award Plan, as Amended and Restated (the “Long Term Incentive Plan” or “LTIP”). As part of the approved amendment, an additional 5,750,000 shares of common stock were added to the LTIP’s share reserve and the expiration date was extended to December 19, 2027. The LTIP provides for the grant of share-based awards, including stock options and restricted stock awards to employees of FactSet. Stock options granted under the LTIP expire not more than ten years from the date of grant and the majority vest ratably over a period of five years. Options become vested and exercisable provided the employee continues employment with the Company through the applicable vesting date and remain exercisable until expiration or cancellation. Options are not transferable or assignable other than by will or the laws of descent and distribution. During the grantee’s lifetime, the options may be exercised only by the grantee.

 

Stock Option Activity

 

During the first nine months of fiscal 2018, FactSet granted 569,305 stock options at a weighted average exercise price of $190.04 to existing employees of the Company. As of May 31, 2018, a total of 3,279,096 stock options were outstanding, at a weighted average exercise price of $151.79. Unamortized stock-based compensation of $65 million is expected to be recognized as stock-based compensation expense over the remaining weighted average vesting period of 3.3 years.

 

A summary of stock option activity is as follows:

 

 

 

 

The total number of in-the-money options exercisable as of May 31, 2018 was 1.1 million with a weighted average exercise price of $124.52. The total number of in-the-money options exercisable as of August 31, 2017 was 0.9 million with a weighted average exercise price of $105.14. As of May 31, 2018 and August 31, 2017, the aggregate intrinsic value of in-the-money stock options exercisable was $84.1 million and $49.7 million, respectively. Aggregate intrinsic value represents the difference between the Company’s closing stock prices of $201.01 and $157.18 on May 31, 2018 and August 31, 2017, respectively, and the exercise price multiplied by the number of options exercisable as of that date. The total pre-tax intrinsic value of stock options exercised during the three months ended May 31, 2018 and 2017 was $5.2 million and $4.3 million, respectively. The total pre-tax intrinsic value of stock options exercised during the nine months ended May 31, 2018 and 2017 was $40.3 million and $34.8 million, respectively.

 

Performance-based Stock Options

 

Performance-based stock options require management to make assumptions regarding the likelihood of achieving Company performance targets. The number of performance-based options that vest will be predicated on the Company achieving performance levels during the measurement period subsequent to the date of grant. Dependent on the financial performance levels attained by FactSet, a percentage of the performance-based stock options will vest to the grantees of those stock options. However, there is no current guarantee that such options will vest in whole or in part.

 

February 2015 Performance-based Option Grant Review

In connection with the acquisition of Code Red, FactSet granted 68,761 performance-based options during the second quarter of fiscal 2015 that are eligible to cliff vest based on a four-year measurement period ending February 28, 2019. In the second quarter of fiscal 2018, FactSet modified the vesting criteria of the grant, which resulted in 40% of the options deemed eligible to vest, with the remaining options forfeited. No cumulative catch-up adjustment was required because FactSet had expected the 40% level to be achieved. The option holders must remain employed by FactSet through February 28, 2019 in order for the options to vest. As of May 31, 2018, total unamortized stock-based compensation of $0.2 million will be recognized as expense over the remaining vesting period of 0.7 years.

 

January 2017 Performance-based Option Grant Review

In connection with the acquisition of Vermilion, FactSet granted 61,744 performance-based stock options in January 2017. These performance-based options will vest 40% on the second anniversary date of the grant and 20% on each subsequent anniversary date if certain Vermilion revenue and operating income targets are achieved by November 30, 2018. The option holders must also remain employed by FactSet for the options to be eligible to vest. As of May 31, 2018, FactSet does not believe these growth targets are probable of being achieved, and as such, no stock-based compensation expense is expected to be recognized in connection with these performance-based options. A change in the actual financial performance levels achieved by Vermilion in future periods could result in the following changes to the current estimate of the vesting percentage and related expense:

 

 

* Amounts represent the cumulative catch-up adjustment to be recorded if there was a change in the vesting percentage as of May 31, 2018. 

 

June 2017 Performance-based Option Grant Review

In connection with the acquisition of BISAM, FactSet granted 206,417 performance-based stock options in June 2017. These performance-based options will vest 40% on the second anniversary date of the grant and 20% on each subsequent anniversary date if certain BISAM revenue and operating income targets are achieved by March 31, 2019. The option holders must also remain employed by FactSet for the options to be eligible to vest. As of May 31, 2018, FactSet does not believe these growth targets are probable of being achieved, and as such, no stock-based compensation expense is expected to be recognized in connection with these performance-based options. A change in the actual financial performance levels achieved by BISAM in future fiscal years could result in the following changes to the current estimate of the vesting percentage and related expense:

 

 

* Amounts represent the cumulative catch-up adjustment to be recorded if there was a change in the vesting percentage as of May 31, 2018. 

 

Restricted Stock and Stock Unit Awards

 

The Company’s Option Plan permits the issuance of restricted stock and restricted stock units. Restricted stock awards are subject to continued employment over a specified period.

 

 

Restricted Stock and Stock Unit Awards Activity

 

During the first nine months of fiscal 2018, FactSet granted 961 restricted stock awards to employees of the Company at a weighted average grant date fair value of $182.17. These restricted stock awards vest over a weighted average period of 5.0 years from grant date.

 

As of May 31, 2018, a total of 153,842 shares of restricted stock and restricted stock units were unvested and outstanding, which results in unamortized stock-based compensation of $13.3 million to be recognized as stock-based compensation expense over the remaining weighted average vesting period of 3 years.

 

A summary of restricted stock award activity is as follows:

 

 

As of May 31, 2018 and August 31, 2017, the aggregate fair value of unvested restricted stock was $30.9 million and $28.6 million, respectively. Aggregate fair value of unvested restricted stock represents the Company’s closing stock prices of $201.01 and $157.18 on May 31, 2018 and August 31, 2017, respectively, multiplied by the number of unvested restricted stock as of that date.

 

The total pre-tax fair value of restricted stock that vested during the three months ended May 31, 2018 and 2017 was less than $0.1 million in each period, respectively. The total pre-tax fair value of restricted stock that vested during the nine months ended May 31, 2018 and 2017 was $2.8 million and $15.6 million, respectively.

 

Share-based Awards Available for Grant

 

A summary of share-based awards available for grant is as follows:

 

 

 

(1)

Each restricted stock award granted is equivalent to 2.5 shares granted under the Company’s Option Plan.

 

(2)

Under the Company’s Option Plan, for each restricted stock award canceled/forfeited, an equivalent of 2.5 shares is added back to the available share-based awards balance.

 

(3)

On December 19, 2017, the Company’s stockholders approved the LTIP. As part of the approval, an additional 5,750,000 shares of common stock were added to the LTIP’s share reserve.

 

(4)

On December 19, 2017, the Company’s stockholders approved the amended and restated 2008 Non-Employee Directors’ Stock Option Plan, which was renamed the Non-Employee Directors’ Stock Option and Award Plan, as Amended and Restated (the “Director Plan”).  As part of the approval, an additional 250,000 shares of commons stock were added to the Director Plan share reserve.

 

 

Employee Stock Purchase Plan

 

On December 19, 2017, the Company’s stockholders approved the amended and restated 2008 Employee Stock Purchase Plan, as Amended and Restated, which was renamed the Employee Stock Purchase Plan, as Amended and Restated (the “ESPP”). Shares of FactSet common stock may be purchased by eligible employees under the ESPP in three-month intervals at a purchase price equal to at least 85% of the lesser of the fair market value of the Company’s common stock on either the first day or the last day of each three-month offering period. Employee purchases may not exceed 10% of their gross compensation and a $25,000 contribution limit during an offering period.

 

During the three months ended May 31, 2018 employees purchased 16,312 shares at a weighted average price of $170.86 as compared to 17,314 shares at a weighted average price of $140.84 for the three months ended May 31, 2017. During the nine months ended May 31, 2018, employees purchased 50,706 shares at a weighted average price of $156.88 as compared to 54,554 shares at a weighted average price of $137.38 for the nine months ended May 31, 2017. At May 31, 2018, the ESPP had 282,466 shares reserved for future issuance.

 

401(k) Plan

 

The Company established its 401(k) Plan in fiscal 1993. The 401(k) Plan is a defined contribution plan covering all full-time, U.S. employees of the Company and is subject to the provisions of the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986 (“IRC”). Each year, participants may contribute up to 60% of their eligible annual compensation, subject to annual limitations established by the IRC. The Company matches up to 4% of employees’ earnings, capped at the Internal Revenue Service annual maximum. Company matching contributions are subject to a five year graduated vesting schedule. All full-time, U.S. employees are eligible for the matching contribution by the Company. The Company contributed $8.5 million and $7.3 million in matching contributions to employee 401(k) accounts during the nine months ended May 31, 2018 and 2017, respectively.

 

 

14. STOCK-BASED COMPENSATION

 

The Company recognized total stock-based compensation expense of $7.8 million and $23.2 million during the three and nine months ended May 31, 2018, respectively. Similarly, the Company recognized total stock-based compensation expense of $7.3 million and $20.9 million during the three and nine months ended May 31, 2017, respectively. As of May 31, 2018, $78.3 million of total unrecognized compensation expense related to non-vested equity awards is expected to be recognized over a weighted average period of 3.2 years. There was no stock-based compensation capitalized as of May 31, 2018 or August 31, 2017, respectively.

 

Employee Stock Option Fair Value Determinations

 

The Company utilizes the lattice-binomial option-pricing model (“binomial model”) to estimate the fair value of new employee stock option grants. The Company’s determination of fair value of stock option awards on the date of grant using the binomial model is affected by the Company’s stock price as well as assumptions regarding a number of variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, interest rates, option forfeitures and employee stock option exercise behaviors.

 

Q1 2018	553,942 nonperformance-based employee stock options were granted at a weighted average exercise price of $189.98 and a weighted average estimated fair value of $48.27 per share.
Q2 2018	15,363 nonperformance-based employee stock options were granted at a weighted average exercise price of $192.11 and a weighted average estimated fair value of $48.82 per share.
Q3 2018	There were no employee stock options granted during the three months ended May 31, 2018.
Q1 2017	671,263 non performance-based employee stock options and 22,460 performance-based employee stock options were granted at a weighted average exercise price of $152.51 and a weighted average estimated fair value of $39.60 per share.
Q2 2017	61,744 performance-based employee stock options were granted at a weighted average exercise price of $169.16 and a weighted average estimated fair value of $43.81 per share.
Q3 2017	11,604 nonperformance-based employee stock options were granted at a weighted average exercise price of $163.05 and a weighted average estimated fair value of $42.23 per share.

 

 

The weighted average estimated fair value of employee stock options granted was determined using the binomial model with the following weighted average assumptions:

 

 

* There were no employee stock options granted during the three months ended May 31, 2018.

 

 

The risk-free interest rate assumption for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatility is based on a combination of historical volatility of the Company’s stock and implied volatilities of publicly traded options to buy FactSet common stock with contractual terms closest to the expected life of options granted to employees. The approach to utilize a mix of historical and implied volatility was based upon the availability of actively traded options on the Company’s stock and the Company’s assessment that a combination of implied volatility and historical volatility is best representative of future stock price trends. The Company uses historical data to estimate option exercises and employee termination within the valuation model. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts. The expected life of employee stock options represents the weighted average period the stock options are expected to remain outstanding and is a derived output of the binomial model. The binomial model estimates employees exercise behavior based on the option’s remaining vested life and the extent to which the option is in-the-money. The binomial model estimates the probability of exercise as a function of these two variables based on the entire history of exercises and cancellations of all past option grants made by the Company.

 

Non-Employee Director Stock Option Fair Value Determinations

 

On December 19, 2017, the Company’s stockholders approved the Director Plan. The Director Plan provides for the grant of share-based awards, including stock options, to non-employee directors of FactSet. As part of the stockholder approval, the expiration date of the Director Plan was extended to December 19, 2027 and the number of shares reserved for issuance under the Director Plan was increased by 250,000. As of May 31, 2018, shares available for future grant were 273,222.

 

The Company utilizes the Black-Scholes model to estimate the fair value of non-employee Director stock option grants. The Company’s determination of fair value of share-based payment awards on the date of grant is affected by the Company’s stock price as well as assumptions regarding a number of variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, interest rates, option forfeitures and employee stock option exercise behaviors.

 

Fiscal 2018

On January 12, 2018, FactSet granted 18,963 stock options to the Company’s non-employee Directors. These options have a weighted average estimated fair value of $38.76 per share, using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

 

 

Fiscal 2017

On January 13, 2017, FactSet granted 23,846 stock options to the Company’s non-employee Directors, including one-time new Director grants of 2,104 stock options each for Malcolm Frank and Sheila B. Jordan, who were elected to FactSet’s Board of Directors on December 20, 2016. All of the options granted on January 13, 2017 have a weighted average estimated fair value of $35.65 per share, using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

 

Restricted Stock Fair Value Determinations

 

Restricted stock granted to employees entitles the holder to shares of common stock as the award vests over time, but not to dividends declared on the underlying shares while the restricted stock is unvested. The grant date fair value of restricted stock awards is measured by reducing the grant date price of FactSet’s share by the present value of the dividends expected to be paid on the underlying stock during the requisite service period, discounted at the appropriate risk-free interest rate. Restricted stock awards are amortized to expense over the vesting period. During the first nine months of fiscal 2018, there were 961 restricted stock awards granted with a weighted average grant date fair value of $182.17. During the first nine months of fiscal 2017, there were 12,927 restricted stock awards granted with a weighted average grant date fair value of $157.50.

 

Employee Stock Purchase Plan Fair Value Determinations

 

During the three months ended May 31, 2018, employees purchased 16,312 shares at a weighted average price of $170.86 as compared to 17,314 shares at a weighted average price of $140.84 for the three months ended May 31, 2017. During the nine months ended May 31, 2018, employees purchased 50,706 shares at a weighted average price of $156.88 as compared to 54,554 shares at a weighted average price of $137.38 for the nine months ended May 31, 2017. Stock-based compensation expense recorded during the three months ended May 31, 2018 and 2017, relating to the ESPP, was $0.6 million and $0.5 million, respectively. Stock-based compensation expense recorded for the nine months ended May 31, 2018 and 2017, relating to the ESPP, was $1.6 million and $1.5 million, respectively.

 

The weighted average estimated fair value for the shares repurchased under the ESPP was calculated using the Black-Scholes model with the following assumptions:

 

 

 

 

Accuracy of Fair Value Estimates 

 

The Company is responsible for determining the assumptions used in estimating the fair value of its share-based payment awards. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, interest rates, option forfeiture rates and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable.

 

 

 

15. INCOME TAXES

 

Income tax expense is based on taxable income determined in accordance with current enacted laws and tax rates. Deferred income taxes are recorded for the temporary differences between the financial statement and tax bases of assets and liabilities using currently enacted tax rates.

 

Provision for Income Taxes

 

The provision for income taxes is as follows:

 

 

FactSet’s effective tax rate is based on recurring factors and nonrecurring events, including the taxation of foreign income. The Company’s effective tax rate will vary based on, among other things, changes in levels of foreign income, as well as discrete and other nonrecurring events that may not be predictable. On December 22, 2017, the U.S. government enacted comprehensive tax legislation through the TCJA. The TCJA significantly revises the U.S. corporate income tax including, lowering the statutory U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018, implementing a modified territorial tax system and imposing a mandatory one-time transition tax on accumulated earnings and profits (“E&P”) of foreign subsidiaries that were previously deferred from U.S. income taxes. While the Company has not finalized the accounting for the tax effects of the enactment of the TCJA, FactSet has made a reasonable estimate of the effects on the existing U.S. deferred tax balances and the one-time transition tax. The Company will continue to refine its calculations as additional analyses are completed. In addition, the estimates may also be affected by changes in interpretations at the federal and state levels, and any additional regulatory guidance that may be issued.

 

FactSet had approximately $250 million in undistributed foreign E&P generated prior to December 31, 2017, which resulted in a one-time transition tax expense of $23.2 million recorded during the second quarter of fiscal 2018, payable over an eight-year period. This amount may change as the Company finalizes the calculation of foreign E&P previously deferred from U.S. federal taxation, as well as the analysis of available foreign tax credits. Due to the changes in taxation of undistributed foreign earnings under the TCJA, FactSet will continue to analyze foreign subsidiary earnings, as well as global working capital requirements, and may repatriate earnings when the amounts are remitted substantially free of additional tax.

 

Due to FactSet’s August 31 fiscal year-end, the lower tax rate was phased in, resulting in a blended U.S. statutory federal rate of 25.7% for the full fiscal 2018 year and a 21% rate for subsequent years. The reduction in the statutory federal rate also required the remeasurement of the Company’s net U.S. deferred tax position, which resulted in a non-recurring tax charge of $2.2 million recorded during the second quarter of fiscal 2018. The provisional expense related to the one-time transition tax on the undistributed foreign earnings and the non-recurring tax charge from the remeasurement of deferred taxes were partially offset by the lower blended U.S. statutory rate and the recognition of excess tax benefits from the adoption of the employee share-based payment accounting standard.

 

Deferred Tax Assets and Liabilities

 

The significant components of deferred tax assets that are recorded in the Consolidated Balance Sheets were as follows:

 

 

 

The significant components of deferred tax liabilities that are recorded in the Consolidated Balance Sheets were as follows:

 

 

Unrecognized Tax Positions

 

Applicable accounting guidance prescribes a comprehensive model for the financial statement recognition, measurement, classification and disclosure of uncertain tax positions that a company has taken or expects to take on a tax return. A company can recognize the financial effect of an income tax position only if it is more likely than not (greater than 50%) that the tax position will prevail upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit or expense can be recognized in the consolidated financial statements. The tax benefits recognized are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. Additionally, companies are required to accrue interest on all tax exposures for which reserves have been established, consistent with jurisdictional tax laws.

 

As of May 31, 2018, the Company had gross unrecognized tax benefits totaling $8.6 million, including $1 million of accrued interest, recorded as Non-current taxes payable within the Consolidated Balance Sheet. Unrecognized tax benefits represent tax positions taken on tax returns but not yet recognized in the consolidated financial statements. When applicable, the Company adjusts the previously recorded tax expense to reflect examination results when the position is ultimately settled. The Company regularly engages in discussions and negotiations with tax authorities regarding tax matters in various jurisdictions. It is reasonably possible that certain federal, foreign, and state tax matters may be concluded in the next 12 months. However, FactSet has no reason to believe that such audits will result in the payment of additional taxes and/or penalties that would have a material adverse effect on the Company’s results of operations or financial position, beyond current estimates. Any changes in accounting estimates resulting from new developments with respect to uncertain tax positions will be recorded as appropriate. The Company does not currently anticipate that the total amounts of unrecognized tax benefits will significantly change within the next 12 months.

 

The following table summarizes the changes in the balance of gross unrecognized tax benefits during the first nine months of fiscal 2018:

 

 

In the normal course of business, the Company’s tax filings are subject to audit by federal, state and foreign tax authorities.

 

At May 31, 2018, the Company remained subject to examination in the following major tax jurisdictions:

 

 

 

 

16. LONG-TERM DEBT

 

FactSet’s debt obligations consisted of the following:

 

 

On March 17, 2017, the Company entered into a Credit Agreement (the “2017 Credit Agreement”) between FactSet, as the borrower, and PNC Bank, National Association (“PNC”), as the administrative agent and lender. The 2017 Credit Agreement provides for a $575.0 million revolving credit facility (the “2017 Revolving Credit Facility”). FactSet may request borrowings under the 2017 Revolving Credit Facility until its maturity date of March 17, 2020. The 2017 Credit Agreement also allows FactSet, subject to certain requirements, to arrange for additional borrowings with PNC for an aggregate amount of up to $225.0 million, provided that any such request for additional borrowings must be in a minimum amount of $25.0 million. Borrowings under the loan bear interest on the outstanding principal amount at a rate equal to the daily LIBOR rate plus 1.00%. Interest on the loan outstanding is payable quarterly in arrears and on the maturity date. There are no prepayment penalties if the Company elects to prepay the outstanding loan amounts prior to the scheduled maturity date. The principal balance is payable in full on the maturity date.

 

In conjunction with FactSet’s entrance into the 2017 Credit Agreement, the Company borrowed $575.0 million in the form of a LIBOR rate loan under the 2017 Revolving Credit Facility. Proceeds from the 2017 Revolving Credit Facility were also used to fund FactSet’s acquisition of BISAM.

 

All outstanding loan amounts are reported as Long-term debt within the Consolidated Balance Sheet, and net of related amortized loan origination fees at May 31, 2018. The loan origination fees are amortized into interest expense over the term of the loan using the effective interest method. During the three months ended May 31, 2018 and 2017, the Company paid approximately $4.3 million and $2.9 million in interest on its outstanding debt amounts, respectively. During the nine months ended May 31, 2018 and 2017, the Company paid approximately $11.3 million and $5.3 million in interest on its outstanding debt amounts, respectively. As of May 31, 2018, no commitment fee was owed by FactSet since it borrowed the full amount under the 2017 Credit Agreement.

 

The 2017 Credit Agreement contained covenants restricting certain FactSet activities, which are usual and customary for this type of loan. In addition, the 2017 Credit Agreement required that FactSet maintain a consolidated leverage ratio, as measured by total funded debt/EBITDA below a specified level as of the end of each fiscal quarter. The Company was in compliance with all of the covenants of the 2017 Credit Agreement as of May 31, 2018 and August 31, 2017.

 

 

17. COMMITMENTS AND CONTINGENCIES

 

Commitments represent obligations, such as those for future purchases of goods or services that are not yet recorded on the balance sheet as liabilities. FactSet records liabilities for commitments when incurred (i.e., when the goods or services are received).

 

Lease Commitments

 

At May 31, 2018, FactSet leased approximately 202,000 square feet of existing office space for its headquarters at 601 Merritt 7, Norwalk, Connecticut. On February 14, 2018, the Company entered into a new lease to relocate its corporate headquarters to 45 Glover Avenue in Norwalk, Connecticut. The new location will comprise approximately 173,000 square feet of office space. FactSet expects to take possession of the newly leased property on or around January 1, 2019, for fit-out purposes. The Company will continue to occupy its existing headquarters space until the new headquarters property is ready for occupancy, currently estimated to be in the second quarter of fiscal 2020. Including new lease agreements executed during fiscal 2018, the Company’s worldwide leased office space increased to approximately 1,760,000 square feet at May 31, 2018, up 617,000 square feet, or 54.0%, from August 31, 2017. This increase was primarily related to the lease of additional office space in the Philippines and the new headquarters lease signed in February 2018. The Company’s significant locations are listed under Item 2, Properties, within the Annual Report on Form 10-K for the fiscal year ended August 31, 2017. The Company’s non-cancelable operating leases expire on various dates through 2035. The Company believes the amount of leased office space as of May 31, 2018 is adequate for its current needs and that additional space is available for lease to meet any future needs.

 

 

 

Total minimum rental payments associated with the leases are recorded as rent expense (a component of SG&A expense) on a straight-line basis over the periods of the respective non-cancelable lease terms. Future minimum commitments for the Company’s operating leases in place as of May 31, 2018, including the fully executed lease for its new headquarters in Norwalk, Connecticut are as follows:

 

 

Rent expense (including operating costs) for all operating leases amounted to $14.1 million and $12.4 million during the three months ended May 31, 2018 and 2017, respectively. Rent expense for all operating leases amounted to $40.6 million and $35.3 million during the nine months ended May 31, 2018 and 2017, respectively. At May 31, 2018, and August 31, 2017, deferred rent reported within the Consolidated Balance Sheets totaled $38.7 million and $37.4 million, of which $34.4 million and $33.5 million, respectively, was reported as a non-current liability within the line item Deferred Rent and Other Non-Current Liabilities.

 

Approximately $2.2 million of standby letters of credit have been issued during the ordinary course of business in connection with the Company’s leased office space as of May 31, 2018. These standby letters of credit contain covenants that, among other things, require FactSet to maintain minimum levels of consolidated net worth and certain leverage and fixed charge ratios. As of May 31, 2018, FactSet was in compliance with all covenants contained in the standby letters of credit.

 

Purchase Commitments with Suppliers

 

Purchase obligations represent payments due in future periods in respect of commitments to the Company’s various data vendors as well as commitments to purchase goods and services such as telecommunication and computer maintenance services. These purchase commitments are agreements that are enforceable and legally binding on FactSet and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. As of August 31, 2017, the Company had total purchase commitments with suppliers of $81.0 million. There were no material changes in the Company’s purchase commitments with suppliers during the first nine months of fiscal 2018.

 

Contingencies

 

Income Taxes

Uncertain income tax positions are accounted for in accordance with applicable accounting guidance (see Note 15). FactSet is currently under audit by tax authorities and has reserved for potential adjustments to its provision for income taxes that may result from examinations by, or any negotiated settlements with, these tax authorities. The Company believes that the final outcome of these examinations or settlements will not have a material effect on its results of operations. If events occur which indicate payment of these amounts is unnecessary, the reversal of the liabilities would result in the recognition of tax benefits in the period FactSet determines the liabilities are no longer necessary. If the Company’s estimates of the federal, state, and foreign income tax liabilities are less than the ultimate assessment, a further charge to expense would result.

 

Legal Matters

FactSet accrues non income-tax liabilities for contingencies when management believes that a loss is probable and the amounts can be reasonably estimated, while contingent gains are recognized only when realized. The Company is engaged in various legal proceedings, claims and litigation that have arisen in the ordinary course of business, including employment matters, commercial and intellectual property litigation. The outcome of all of the matters against the Company is subject to future resolution, including the uncertainties of litigation. Based on information available at May 31, 2018, FactSet’s management believes that the ultimate outcome of these unresolved matters against the Company, individually or in the aggregate, will not have a material adverse effect on the Company's consolidated financial position, its results of operations or its cash flows.

 

 

Sales Tax Matters

In the third quarter of fiscal 2018, FactSet received a letter from the Massachusetts Department of Revenue relating to prior tax periods. The letter requested additional sales information in order to determine if a notice of intent to assess should be issued to FactSet. Based upon a preliminary review of their request, the Company believes the state may assess sales tax, and underpayment penalties and interest, on previously recorded sales transactions. FactSet disagrees with the preliminary conclusions reached by the state auditor and intends to dispute vigorously these matters. Due to the uncertainty surrounding the assessment process, the Company is unable to reasonably estimate the ultimate outcome of this matter and as such, has not recorded a liability as of May 31, 2018. While FactSet believes that it will ultimately prevail, if the Company is presented with a formal assessment and is required to pay it, the amount could have a material impact on the Company’s consolidated financial position, cash flows and results of operations.

 

Indemnifications

As permitted or required under Delaware law and to the maximum extent allowable under that law, FactSet has certain obligations to indemnify its current and former officers and directors for certain events or occurrences while the officer or director is, or was serving, at FactSet’s request in such capacity. These indemnification obligations are valid as long as the director or officer acted in good faith and in a manner the person reasonably believed to be in, or not opposed to, the best interests of the Company, and with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future payments FactSet could be required to make under these indemnification obligations is unlimited; however, FactSet has a director and officer insurance policy that it believes mitigates FactSet's exposure and may enable FactSet to recover a portion of any future amounts paid. The Company believes the estimated fair value of these indemnification obligations is immaterial.

 

Concentrations of Credit Risk

 

Cash equivalents

Cash and cash equivalents are maintained primarily with five financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. These deposits may be redeemed upon demand and are maintained with financial institutions with reputable credit and therefore bear minimal credit risk. The Company seeks to mitigate its credit risks by spreading such risks across multiple counterparties and monitoring the risk profiles of these counterparties.

 

Accounts Receivable 

Accounts receivable are unsecured and derived from revenues earned from clients located around the globe. FactSet does not require collateral from its clients but performs credit evaluations on an ongoing basis. The Company maintains reserves for potential write-offs and evaluates the adequacy of the reserves periodically. These losses have historically been within expectations. No single client represented 10% or more of FactSet’s total revenues in any period presented. At May 31, 2018, the Company’s largest individual client accounted for approximately 2% of total annual subscriptions, and subscriptions from the ten largest clients did not surpass 15% of total annual subscriptions, consistent with August 31, 2017. As of May 31, 2018, the receivable reserve was $3.4 million compared to a reserve of $2.7 million as of August 31, 2017.

 

Derivative Instruments

As a result of the use of derivative instruments, the Company is exposed to counterparty credit risk. FactSet has incorporated counterparty risk into the fair value of its derivative assets and its own credit risk into the value of the Company’s derivative liabilities, when applicable. FactSet calculates credit risk from observable data related to CDS as quoted by publicly available information. Counterparty risk is represented by CDS spreads related to the senior secured debt of the respective bank with whom FactSet has executed these derivative transactions. Because CDS spread information is not available for FactSet, the Company’s credit risk is determined based on using a simple average of CDS spreads for peer companies as determined by FactSet. To mitigate counterparty credit risk, FactSet enters into contracts with large financial institutions and regularly reviews credit exposure balances as well as the creditworthiness of the counterparties.

 

 

18. SUBSEQUENT EVENT

 

On July 5, 2018, the Company entered into a separation of employment and general release agreement with Edward Baker-Greene (the “Agreement”), pursuant to which Mr. Baker-Greene will remain in his current position as Chief Human Resources Officer (“CHRO”) until his successor is appointed, participate in an orderly transition of duties to the new CHRO and remain an employee of FactSet until his effective termination date of November 30, 2018. In exchange for fulfilling these obligations to the Company, Mr. Baker-Greene will receive, under the terms of the Agreement, the following: (i) a lump sum separation payment of $387,500 on the first scheduled payroll after December 1, 2018; (ii) continued base salary of $300,000 through November 30, 2018; (iii) the acceleration of the vesting of certain outstanding stock options; and (iv) certain other ancillary benefits. The foregoing description of the Agreement is a summary only and is qualified in its entirety by reference to the full text of the Agreement which is attached hereto as Exhibit 10.2 to this Quarterly Report on Form 10-Q and incorporated herein by reference.

 

 

 

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