UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
______________________________________________
Commission file number 1-10254
______________________________________________
T|SYS| Logo [GRAPHIC OMITTED]
Total System Services, Inc.
_____________________________________________________________________________
(Exact name of registrant as specified in its charter)
Georgia 58-1493818
_____________________________________________________________________________
(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
______________________________________________________________________________
(Address of principal executive offices) (Zip Code)
(706) 649-2310
______________________________________________________________________________
(Registrant's telephone number, including area code)
_______________________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AS OF: August 14, 2002
- ------------------------------- -----------------------------------
Common Stock, $.10 par value 197,049,470
T|SYS| Logo[GRAPHIC OMITTED]
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - June 30, 2002 and December 31, 2001 ............................ 3
Consolidated Statements of Income (unaudited) - Three and six months ended June 30, 2002 and June 30, 2001 4
Consolidated Statements of Cash Flows (unaudited) - Six months ended June 30, 2002 and 2001 .............. 6
Notes to Unaudited Consolidated Financial Statements ..................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations .................................................................................................. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................................ 37
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders ....................................................... 38
Item 6. Exhibits and Reports on Form 8-K .......................................................................... 39
Signatures ................................................................................................................. 40
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $59.3 million and $45.9
million on deposit with a related party at 2002 and 2001,
respectively) $ 77,657,398 55,961,088
Accounts receivable, net of allowance for doubtful accounts
and billing adjustments of $9.7 million and $5.4 million
at 2002 and 2001, respectively 122,264,695 113,318,623
Prepaid expenses and other current assets 41,537,123 37,074,206
- ---------------------------------------------------------------------------------------------------------------------------------
Total current assets 241,459,216 206,353,917
Property and equipment, less accumulated depreciation and amortization
of $118.5 million and $109.3 million at 2002 and 2001, respectively 118,244,130 120,799,905
Computer software, less accumulated amortization of $128.8 million and
$111.8 million at 2002 and 2001, respectively 188,058,976 170,889,575
Other assets 158,296,981 145,741,354
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 706,059,303 643,784,751
============================================
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 11,844,074 24,129,727
Accrued salaries and employee benefits 20,127,960 39,687,428
Other current liabilities (includes $3.0 million and $2.4 million payable to
related parties at 2002 and 2001, respectively) 63,554,995 34,147,121
- ---------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 95,527,029 97,964,276
Deferred income tax liabilities 47,623,693 42,650,211
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 143,150,722 140,614,487
- ---------------------------------------------------------------------------------------------------------------------------------
Minority interest in consolidated subsidiary 2,618,481 2,358,578
- ---------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock - $.10 par value. Authorized 600,000,000 shares;
197,254,087 and 195,079,087 issued at 2002 and 2001, respectively;
197,049,470 and 194,778,670 outstanding at 2002 and 2001, respectively 19,725,409 19,507,909
Additional paid-in capital 15,559,945 9,360,223
Accumulated other comprehensive loss (452,842) (3,455,338)
Treasury stock (3,316,703) (3,533,325)
Retained earnings 528,774,291 478,932,217
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 560,290,100 500,811,686
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 706,059,303 643,784,751
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3-
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended
June 30,
------------------------------------------
2002 2001
- -------------------------------------------------------------------------------------------------------------- -----------------
Revenues:
Electronic payment processing services (includes $4.9 million
and $8.6 million from related parties for 2002 and 2001, respectively) $ 149,123,252 139,966,024
Other services (includes $1.7 million and $1.7 million from related parties
for 2002 and 2001, respectively) 27,978,492 21,367,955
--------------------- -----------------
Revenues before reimbursable items 177,101,744 161,333,979
Reimbursable items (includes $2.6 million and $2.7 million from related parties
for 2002 and 2001, respectively) 59,912,522 59,559,983
--------------------- -----------------
Total revenues 237,014,266 220,893,962
--------------------- -----------------
Expenses:
Salaries and other personnel expense 70,910,121 62,517,169
Net occupancy and equipment expense 41,050,737 43,862,313
Other operating expenses (includes $2.2 million and $1.7 million to related parties
for 2002 and 2001, respectively) 28,069,526 19,969,940
Loss on disposal of equipment, net 3,965 73,816
--------------------- -----------------
Expenses before reimbursable items 140,034,349 126,423,238
Reimbursable items 59,912,522 59,559,983
--------------------- -----------------
Total expenses 199,946,871 185,983,221
--------------------- -----------------
Equity in income of joint ventures 4,904,416 4,470,578
--------------------- -----------------
Operating income 41,971,811 39,381,319
--------------------- -----------------
Nonoperating income (expense):
Interest income, net (includes $239,000 and $513,000 from related parties
for 2002 and 2001, respectively) 983,584 635,863
Minority interest in consolidated subsidiary's net income (46,745) (34,632)
Other, net 183,421 (41,125)
-------------------- ------------------
Total nonoperating income 1,120,260 560,106
-------------------- ------------------
Income before income taxes 43,092,071 39,941,425
Income taxes 13,762,073 13,985,031
-------------------- ------------------
Net income $ 29,329,998 25,956,394
==================== ==================
Basic earnings per share $ .15 .13
==================== ==================
Diluted earnings per share $ .15 .13
==================== ==================
Weighted average common shares outstanding 197,003,560 194,773,366
Increase due to assumed issuance of shares related to stock options outstanding 687,234 909,068
--------------------- ------------------
Weighted average common and common equivalent shares outstanding 197,690,794 195,682,434
===================== ==================
Cash dividends per common share $ .0175 .0150
===================== ==================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4-
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
------------------------------------------
2002 2001
- ------------------------------------------------------------------------------------------------------------- -----------------
Revenues:
Electronic payment processing services (includes $9.1 million
and $16.7 million from related parties for 2002 and 2001, respectively) $ 288,306,841 269,327,252
Other services (includes $3.4 million and $5.1 million from related parties
for 2002 and 2001, respectively) 55,625,724 45,178,706
--------------------- -----------------
Revenues before reimbursable items 343,932,565 314,505,958
Reimbursable items (includes $4.9 million and $5.1 million from related
parties for 2002 and 2001, respectively) 116,907,265 122,122,051
--------------------- -----------------
Total revenues 460,839,830 436,628,009
--------------------- -----------------
Expenses:
Salaries and other personnel expense 136,738,998 123,802,488
Net occupancy and equipment expense 84,682,536 84,919,642
Other operating expenses (includes $4.4 million and $5.0 million to related
parties for 2002 and 2001, respectively) 50,157,764 41,560,108
Loss on disposal of equipment, net 2,867 93,589
--------------------- -----------------
Expenses before reimbursable items 271,582,165 250,375,827
Reimbursable items 116,907,265 122,122,051
--------------------- -----------------
Total expenses 388,489,430 372,497,878
--------------------- -----------------
Equity in income of joint ventures 9,378,091 7,707,192
--------------------- -----------------
Operating income 81,728,491 71,837,323
--------------------- -----------------
Nonoperating income (expense):
Interest income, net (includes $461,000 and $1.4 million from related parties
for 2002 and 2001, respectively) 1,347,143 1,644,398
Minority interest in consolidated subsidiary's net income (32,819) (9,430)
Other, net (1,084) (41,125)
-------------------- ------------------
Total nonoperating income 1,313,240 1,593,843
-------------------- ------------------
Income before income taxes 83,041,731 73,431,166
Income taxes 26,798,049 25,460,152
-------------------- ------------------
Net income $ 56,243,682 47,971,014
==================== ==================
Basic earnings per share $ .29 .25
==================== ==================
Diluted earnings per share $ .28 .25
==================== ==================
Weighted average common shares outstanding 196,983,384 194,766,817
Increase due to assumed issuance of shares related to stock options outstanding 752,343 848,467
-------------------- ------------------
Weighted average common and common equivalent shares outstanding 197,735,727 195,615,284
==================== ==================
Cash dividends per common share $ .0325 .0300
==================== ==================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
------------------------------------------
2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 56,243,682 47,971,014
Adjustments to reconcile net income to net cash provided by operating
Minority interest in consolidated subsidiary's net income 32,818 9,431
Equity in income of joint ventures (9,378,091) (7,707,192)
Depreciation and amortization 29,235,475 27,267,067
Provision for doubtful accounts and billing adjustments 4,827,845 196,263
Provision for transaction processing accruals 6,914,710 420,037
Deferred income tax expense 4,973,482 3,027,985
Loss on disposal of equipment, net 2,867 93,590
(Increase) decrease in:
Accounts receivable (10,344,926) (5,679,758)
Prepaid expenses and other assets 4,704,082 (3,479,726)
Increase (decrease) in:
Accounts payable (12,387,992) (28,242,119)
Accrued salaries and employee benefits (19,559,468) (16,807,046)
Other current liabilities 16,269,039 (76,097)
------------------------------------------
Net cash provided by operating activities 71,533,523 16,993,449
------------------------------------------
Cash flows from investing activities:
Purchase of property and equipment (5,893,578) (15,718,940)
Additions to computer software (34,005,269) (29,783,814)
Proceeds from disposal of equipment 3,962 961,887
Cash acquired in acquisition of subsidiary 5,557,092 -
Dividends received from joint ventures 17,855,119 10,410,281
Increase in contract acquisition costs (27,683,763) (11,711,435)
------------------------------------------
Net cash used in investing activities (44,166,437) (45,842,021)
------------------------------------------
Cash flows from financing activities:
Dividends paid on common stock (5,875,326) (5,355,609)
Proceeds from exercise of stock options 204,550 263,164
------------------------------------------
Net cash used in financing activities (5,670,776) (5,092,445)
------------------------------------------
Net increase (decrease) in cash and cash equivalents $ 21,696,310 (33,941,017)
Cash and cash equivalents at beginning of year 55,961,088 80,071,895
------------------------------------------
Cash and cash equivalents at end of year $ 77,657,398 46,130,878
==========================================
Cash paid for interest (net of capitalized amounts) $ 5,906 1,983
==========================================
Cash paid for income taxes (net of refunds received) $ (11,421,407) 22,538,128
==========================================
Significant noncash transaction: In January 2002, the Company acquired TSYS
Total Debt Management, Inc. through the issuance of 2,175,000 shares of common
stock with a market value of $43.5 million.
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Notes to Unaudited Consolidated Financial Statements
Note 1 - Basis of Presentation The accompanying unaudited consolidated financial
statements represent the accounts of Total System Services, Inc.(R) (TSYS(R));
its wholly owned subsidiaries, Columbus Depot Equipment CompanySM (CDECSM),
Columbus Productions, Inc.SM (CPI), TSYS Canada, Inc.SM (TCI) and TSYS Total
Debt Management, Inc. (TDM); and its majority owned foreign subsidiary, GP
Network Corporation (GP Net). These financial statements have been prepared in
accordance with the instructions to Form 10-Q and do not include all information
and footnotes necessary for a fair presentation of financial position, results
of operations and cash flows in conformity with generally accepted accounting
principles. All adjustments, consisting of normal recurring accruals, which, in
the opinion of management, are necessary for a fair presentation of financial
position and results of operations for the periods covered by this report have
been included. The accompanying unaudited consolidated financial statements
should be read in conjunction with the Company's consolidated financial
statements and related notes appearing in the Company's 2001 annual report
previously filed on Form 10-K.
Note 2 - Supplementary Balance Sheet Information
Cash and cash equivalent balances are summarized as follows:
June 30, 2002 December 31, 2001
---------------- -----------------
Cash and cash equivalents $ 56,892,393 $ 45,998,283
Cash in foreign countries 17,568,728 9,962,805
Restricted cash 3,196,277 -
---------------- --------------
Total $ 77,657,398 $ 55,961,088
================ ==============
Significant components of prepaid expenses and other current assets are
summarized as follows:
June 30, 2002 December 31, 2001
-------------- -----------------
Contract acquisition costs:
Payment for processing
rights, net $ 12,145,409 $ 9,244,092
Conversion costs, net 3,175,888 2,655,865
Prepaid expenses 8,995,820 10,634,921
Other 17,220,006 14,539,328
-------------- -------------
Total $ 41,537,123 $ 37,074,206
============== =============
Significant components of other assets are summarized as follows:
June 30, 2002 December 31, 2001
-------------- -----------------
Contract acquisition costs:
Payment for processing
rights, net $ 77,410,895 $ 62,151,758
Conversion costs, net 20,218,965 13,031,517
Equity investments, net 43,119,121 51,566,564
Other 17,548,000 18,991,515
-------------- -------------
Total $ 158,296,981 $ 145,741,354
============== ==============
- 7 -
Notes to Unaudited Consolidated Financial Statements (continued)
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $2.6 million and $1.1 million for the three
months ended June 30, 2002 and 2001, respectively. Amortization related to
payments for processing rights was $5.0 million and $2.1 million for the six
months ended June 30, 2002 and 2001, respectively.
Amortization expense related to conversion costs, which is recorded in
other expenses, was $795,000 and $564,000 for the three months ended June 30,
2002 and 2001, respectively. Amortization expense related to conversion costs
was $1.5 million and $1.1 million for the six months ended June 30, 2002 and
2001, respectively.
Significant components of other current liabilities are summarized as
follows:
June 30, 2002 December 31, 2001
------------- -----------------
Customer postage
deposits $ 18,036,088 $ 19,065,119
Transaction processing
provisions 11,011,361 7,291,441
Other 34,507,546 7,790,561
------------- -------------
Total $ 63,554,995 $ 34,147,121
============= ==============
Note 3 - Comprehensive Income
Comprehensive income for TSYS consists of net income and foreign currency
translation adjustments recorded as a component of shareholders' equity.
Comprehensive income for the three months ended June 30 is as follows:
2002 2001
-------------- --------------
Net income $ 29,329,998 $ 25,956,394
Other comprehensive
income (loss):
Foreign currency
translation adjustments,
net of tax 4,012,931 (576,332)
-------------- -------------
Comprehensive income $ 33,342,929 $ 25,380,062
============== =============
Comprehensive income for the six months ended June 30 is as follows:
2002 2001
-------------- --------------
Net income $ 56,243,682 $ 47,971,014
Other comprehensive
income (loss):
Foreign currency
translation adjustments,
net of tax 3,002,496 (2,794,214)
-------------- --------------
Comprehensive income $ 59,246,178 $ 45,176,800
=============== ==============
The income tax effects allocated to and the cumulative balance of
accumulated other comprehensive loss are as follows:
Balance at December 31, Pretax Balance at
2001 amount Tax benefit June 30, 2002
-----------------------------------------------------------------------------
Foreign currency
translation
adjustments ($3,455,338) 4,757,013 (1,754,517) ($452,842)
===========================================================================
- 8 -
Notes to Unaudited Consolidated Financial Statements (continued)
Note 4 - Segment Reporting and Major Customers
The Company reports selected information about operating segments in
accordance with Statement of Financial Accounting Standards No. 131 (SFAS 131).
With the Company's recent expansion in Europe and its strategic decision to
further expand its business internationally, combined with the integration of
its business process management and e-commerce subsidiaries, the Company revised
its segment information in the first quarter of 2002 to reflect the information
that the chief operating decision maker (CODM) uses to make resource allocation
and strategic decisions. The CODM at TSYS consists of the chief executive
officer, the president and the four executive vice presidents.
Through online accounting and electronic payment processing systems, Total
System Services, Inc. provides electronic payment processing services and other
related services to card-issuing institutions in the United States, Mexico,
Canada, Honduras, Europe and the Caribbean. The reportable units are segmented
based upon geographic locations. Domestic-based processing services include
electronic payment processing services and other services provided from the
United States. Domestic-based processing services segment includes the financial
results of TSYS, excluding its foreign branch offices, and the following
subsidiaries: CDEC, CPI and TDM. International-based processing services include
electronic payment processing services and other services provided outside the
United States. International-based processing services include the financial
results of TCI, GP Net and TSYS' branch offices in Europe and Japan.
Domestic-based International-based
Operating Segments processing services processing services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
At June 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 705,587,319 92,882,216 $ 798,469,535
Intersegment eliminations (92,294,083) (116,149) (92,410,232)
-------------------------- ------------------------- ------------------------
Total assets $ 613,293,236 92,766,067 $ 706,059,303
========================== ========================= ========================
- ---------------------------------------------------------------------------- ------------------------------------------------------
At December 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 643,615,591 91,657,540 $ 735,273,131
Intersegment eliminations (91,419,159) (69,221) (91,488,380)
-------------------------- ------------------------- ------------------------
Total assets $ 552,196,432 91,588,319 $ 643,784,751
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 220,737,946 16,669,193 $ 237,407,139
Intersegment revenue (1,401) (391,472) (392,873)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 220,736,545 16,277,721 $ 237,014,266
========================== ========================= ========================
Equity in income of joint ventures $ 4,690,639 213,777 $ 4,904,416
========================== ========================= ========================
Segment operating income $ 40,561,874 1,409,937 $ 41,971,811
========================== ========================= ========================
Income taxes $ 13,090,961 671,112 $ 13,762,073
========================== ========================= ========================
Net income $ 28,325,009 1,004,989 $ 29,329,998
========================== ========================= ========================
- 9 -
Notes to Unaudited Consolidated Financial Statements (continued)
Domestic-based International-based
Operating Segments processing services processing services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 216,116,560 5,053,564 $ 221,170,124
Intersegment revenue (2,395) (273,767) (276,162)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 216,114,165 4,779,797 $ 220,893,962
========================== ========================= ========================
Equity in income of joint ventures $ 3,938,073 532,505 $ 4,470,578
========================== ========================= ========================
Segment operating income $ 45,535,034 (6,153,715) $ 39,381,319
========================== ========================= ========================
Income taxes $ 16,315,665 (2,330,634) $ 13,985,031
========================== ========================= ========================
Net income $ 29,828,718 (3,872,324) $ 25,956,394
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 429,889,590 31,742,566 $ 461,632,156
Intersegment revenue (2,857) (789,469) (792,326)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 429,886,733 30,953,097 $ 460,839,830
========================== ========================= ========================
Equity in income of joint ventures $ 8,917,080 461,011 $ 9,378,091
========================== ========================= ========================
Segment operating income $ 80,065,339 1,663,152 $ 81,728,491
========================== ========================= ========================
Income taxes $ 26,021,354 776,695 $ 26,798,049
========================== ========================= ========================
Net income $ 55,209,774 1,033,908 $ 56,243,682
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Six Months Ended June 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 429,311,299 7,879,048 $ 437,190,347
Intersegment revenue (2,542) (559,796) (562,338)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 429,308,757 7,319,252 $ 436,628,009
========================== ========================= ========================
Equity in income of joint ventures $ 6,554,631 1,152,561 $ 7,707,192
========================== ========================= ========================
Segment operating income $ 83,967,806 (12,130,483) $ 71,837,323
========================== ========================= ========================
Income taxes $ 29,936,853 (4,476,701) $ 25,460,152
========================== ========================= ========================
Net income $ 55,625,386 (7,654,372) $ 47,971,014
========================== ========================= ========================
The following geographic area data represent revenues for the three and six
months ended June 30, 2002 and 2001, respectively, based on the geographic
locations of customers.
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------ ------------------------------------------
(Dollars in millions) 2002 2001 2002 2001
------------------- ----------------- ------------------ --------------------
United States $ 202.4 202.1 395.2 401.3
Europe 13.8 2.4 26.0 2.4
Canada 10.7 10.0 20.5 19.9
Mexico 7.1 3.6 13.1 7.2
Japan 2.5 2.3 4.9 4.8
Other 0.5 0.5 1.1 1.0
------------------- ----------------- ------------------ --------------------
Totals $ 237.0 220.9 460.8 436.6
=================== ================= ================== ====================
- 10 -
Notes to Unaudited Consolidated Financial Statements (continued)
The Company maintains property and equipment in the United States, Europe,
Canada and Japan. The following geographic area data represent net property and
equipment balances by region:
At June 30, At December 31,
---------------- --------------------
(Dollars in millions) 2002 2001
---------------- --------------------
United States $ 95.7 98.7
Europe 20.9 20.9
Canada 0.1 0.1
Japan 1.5 1.1
---------------- --------------
Totals $ 118.2 120.8
================ ==============
Major Customers
For the three months ended June 30, 2002, the Company had two major
customers which accounted for approximately 34.4%, or $81.6 million, of total
revenues. For the three months ended June 30, 2001, TSYS had two major customers
that accounted for 37.3%, or $82.4 million, of total revenues. Revenues from
major customers for the periods reported are attributable to both reporting
segments.
Three Months Ended June 30,
----------------------------------------------------------------------
2002 2001
--------------------------------- -------------------------------
Revenue % of Total % of Total
(Dollars in millions) Dollars Revenues Dollars Revenues
--------------------------------- -------------------------------
One $ 48.0 20.2% $ 40.7 18.4%
Two 33.6 14.2 41.7 18.9
------------------------------- -------------------------------
Totals $ 81.6 34.4% $ 82.4 37.3%
=============================== ===============================
For the six months ended June 30, 2002, the Company had two major customers
which accounted for approximately 34.4%, or $158.8 million, of total revenues.
For the six months ended June 30, 2001, TSYS had two major customers that
accounted for 37.3%, or $162.7 million, of total revenues. Revenues from major
customers for the periods reported are attributable to both reporting segments.
Six Months Ended June 30,
-----------------------------------------------------------------------
2002 2001
--------------------------------- --------------------------------
Revenue % of Total % of Total
(Dollars in millions) Dollars Revenues Dollars Revenues
--------------------------------- --------------------------------
One $ 90.5 19.6% $ 81.5 18.7%
Two 68.3 14.8 81.2 18.6
------------------------------- -------------------------------
Totals $ 158.8 34.4% $ 162.7 37.3%
=============================== ===============================
- 11 -
Notes to Unaudited Consolidated Financial Statements (continued)
Note 5 - Supplementary Cash Flow Information
Cash flows used in additions to computer software for the six months ended
June 30, 2002 and 2001 are summarized as follows:
June 30, 2002 June 30, 2001
---------------- -----------------
Purchased programs $ 18,110,929 $ 22,696,456
Developed software 15,894,340 7,087,358
---------------- -----------------
Total $ 34,005,269 $ 29,783,814
================ =================
Cash flows used in additions to contract acquisition costs for the six
months ended June 30 2002 and 2001 are summarized as follows:
June 30, 2002 June 30, 2001
----------------- -------------------
Cash payments for
processing rights $ 21,541,138 $ 3,844,447
Conversion costs 6,142,625 7,866,988
---------------- -----------------
Total $ 27,683,763 $ 11,711,435
================ =================
Note 6 - Recent Accounting Pronouncements
As a result of the Financial Accounting Standards Board's (FASB's) Emerging
Issues Task Force 01-14 (EITF 01-14), formerly known as Staff Announcement Topic
D-103, "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenue. Historically, TSYS has not
reflected such reimbursements in its consolidated statements of income. The
largest reimbursement expenses for which TSYS is reimbursed by clients are
postage and express courier charges.
EITF 01-14 was adopted by the Company on January 1, 2002. Upon application
of EITF 01-14, comparative financial statements for prior periods have been
reclassified to provide consistent presentation.
In July 2001, the FASB issued Statement No. 141 (SFAS 141), "Business
Combinations," and Statement No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets." SFAS 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. SFAS 141 also
specifies criteria that intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. The Company adopted the provisions of SFAS 141 July 1, 2001, the
effect of which was not significant.
SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 also requires
that intangible assets with estimable useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." The Company adopted SFAS 142 January 1,
2002.
- 12 -
Notes to Unaudited Consolidated Financial Statements (continued)
At June 30, 2002, the Company has unamortized goodwill in the amount of
$3.6 million. As a result of implementing SFAS 142, the Company incurred no
amortization expense of goodwill during the three and six months ended June 30,
2002, respectively. Amortization expense related to goodwill was $213,000 and
$428,000 for the three and six months ended June 30, 2001, respectively.
The Company's transitional impairment analysis of its unamortized goodwill
balance did not have a material effect on the Company's financial condition or
results of operations.
In June 2001, the FASB issued Statement No. 143 (SFAS 143), "Accounting for
Asset Retirement Obligations," which addresses accounting and reporting for
asset retirement costs of long-lived assets resulting from legal obligations
associated with acquisition, construction, or development transactions. The
Company plans to adopt SFAS 143 in the first quarter of fiscal year 2003.
Management will evaluate the impact of the adoption of this statement on the
consolidated financial statements during fiscal year 2002.
In October 2001, the FASB issued Statement No. 144 (SFAS 144), "Accounting
for the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business (as previously
defined in that Opinion). This Statement also amends Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception
to consolidation for a subsidiary for which control is likely to be temporary.
SFAS 144 improves financial reporting by requiring that one accounting
model be used for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and by broadening the presentation
of discontinued operations to include more disposal transactions.
The Company adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144
did not have a material effect on the Company's financial condition or results
of operations.
In April 2002, the FASB issued Statement No. 145 (SFAS 145), "Rescission of
FASB Statements No. 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS 145 updates, clarifies and simplifies existing
accounting pronouncements. SFAS 145 requires that in certain circumstances
previous items classified as extraordinary that do not meet the criteria in
Opinion 30 must be reclassified. The Statement is effective for fiscal years
beginning after May 15, 2002. Management does not expect the adoption of SFAS
145 to have a material effect on the Company's financial condition or results of
operations.
- 13 -
Notes to Unaudited Consolidated Financial Statements (continued)
In July 2002, the FASB issued Statement No. 146 (SFAS 146), "Accounting for
Costs Associated with Exit or Disposal Activities). SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". This Statement requires recognition of a
liability for a cost associated with an exit or disposal activity when the
liability is incurred, as opposed to when the entity commits to an exit plan
under EITF No. 94-3. The Statement is effective prospectively for exit or
disposal activities initiated after December 31, 2002. Management does not
anticipate that SFAS 146 will have a material impact on the Company's financial
condition or results of operations.
Note 7 - Commitments and Contingencies
At December 31, 2001, a prospective client of the Company had a loan
balance of $7.5 million with Columbus Bank and Trust Company, which TSYS agreed
to guarantee. In April 2002, the remaining balance of the loan to CB&T was
repaid.
Note 8 - Reclassification
Certain reclassifications have been made to the 2001 financial statements
to conform to the presentation adopted in 2002.
Note 9 - Acquisition
Effective January 1, 2002, TSYS acquired TSYS Total Debt Management, Inc.
(TDM) from Synovus Financial Corp. in exchange for 2,175,000 newly issued shares
of TSYS common stock with a market value of $43.5 million. TDM provides
third-party collection services which expands and complements the Company's
product offerings. TDM operates as a separate subsidiary of TSYS.
Because the acquisition of TDM was a transaction between entities under
common control, the Company is reflecting the acquisition at historical cost in
accordance with SFAS 141 and is reflecting the results of operations of TDM in
the Company's financial statements beginning January 1, 2002.
The Company has not restated periods prior to 2002 for this transaction
because such restatement is not significant to the Company's financial
statements.
Presented below are the pro forma consolidated results of TSYS' operations
for the three months and six months ended June 30, 2002 and 2001, respectively,
as though the acquisition of TDM had occurred at the beginning of 2001, compared
to TSYS' actual consolidated results of operations for 2002.
Three Months Ended June 30, Six Months Ended June 30,
------------------ --------------------- ------------------ ----------------
2002 2001 2002 2001
------------------ --------------------- ------------------ ----------------
Revenues $ 237,014,266 225,008,584 460,839,830 444,955,454
Net income 29,329,998 26,242,056 56,243,682 48,576,894
Basic earnings per share .15 .13 .29 .25
Diluted Earnings per share .15 .13 .28 .25
- 14 -
TOTAL SYSTEM SERVICES, INC.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Review
This Financial Review provides a discussion of critical accounting policies,
related party transactions, and off-balance sheet arrangements. This Financial
Review also discusses the results of operations, financial condition, liquidity
and capital resources of TSYS and outlines the factors that have affected its
recent earnings, as well as those factors that may affect its future earnings.
Critical Accounting Policies
TSYS' (The Company's) financial position and results of operations are impacted
by the accounting policies the Company has adopted. In order to get a full
understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed.
Risks and Uncertainties and Use of Estimates: Factors that could affect the
Company's future operating results and cause actual results to vary materially
from expectations include, but are not limited to, lower than anticipated growth
from existing customers, an inability to attract new customers and grow
internationally, an inability to grow through acquisitions or successfully
integrate acquisitions, an inability to control expenses, technology changes,
financial services consolidation, increased regulatory mandates, a decline in
the use of cards as a payment mechanism, a decline in the financial stability of
the Company's customers and uncertain economic conditions. Negative developments
in these or other risk factors could have a material adverse effect on the
Company's financial position and results of operations.
The Company has prepared the accompanying consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America. In preparing financial statements, it is necessary for management to
make assumptions and estimates affecting the amounts reported in the
consolidated financial statements and related notes. These estimates and
assumptions are developed based upon all information available. Actual results
can differ from assumed and estimated amounts.
A summary of the Company's critical accounting policies follows:
Accounts Receivable: Accounts receivable balances are stated net of allowances
for doubtful accounts and billing adjustments of $9.7 million and $5.4 million
at June 30, 2002 and December 31, 2001, respectively. The allowance represents
7.3% and 4.5% of accounts receivable at June 30, 2002 and December 31, 2001,
respectively. TSYS' client base mainly consists of financial institutions and
other card issuers such as major retailers. Historically, the majority of the
Company's account receivable balances have been current and the number of days
outstanding is low.
TSYS records allowances for doubtful accounts when it is probable that the
accounts receivable balance will not be collected. When estimating the
allowances for doubtful accounts, the Company takes into consideration such
factors as its day-to-day knowledge of the financial condition of specific
customers, the industry and size of its customers, the overall composition of
its accounts receivable aging, prior history with specific customers of accounts
receivable write-offs and prior
- 15 -
Critical Accounting Policies (continued)
history of allowances in proportion to the overall receivable balance. This
analysis includes an on going and continuous communication with its largest
customers and those customers with past due balances. A financial decline of any
one of these customers could have an adverse and material effect on
collectibility of receivables and thus the adequacy of the allowance for
doubtful accounts.
Increases in the allowance for doubtful accounts are recorded as bad debt
expense and are reflected in other operating expenses in the Company's
consolidated statements of income. Write-offs of uncollectible accounts are
charged against the allowance for doubtful accounts.
TSYS records allowances for billing adjustments for actual and potential
billing discrepancies. When estimating the allowance for billing adjustments,
the Company considers its overall history of billing adjustments, as well as its
history with specific customers and known disputes. Increases in the allowance
for billing adjustments are recorded as a reduction of revenues in the Company's
consolidated statements of income and actual adjustments to invoices are charged
against the allowance for billing adjustments.
Revenue Recognition: The Company's electronic payment processing revenues are
derived from long-term processing contracts with banks and other institutions
and are recognized as revenues at the time the service is performed. Electronic
payment processing revenues are generated primarily from charges based on the
number of accounts billed, transactions and authorizations processed, statements
mailed, and other processing services for cardholder accounts on file. Most of
these contracts have prescribed minimums. The terms of contracts generally range
from three to ten years in length. To date, revenues derived under fixed price
contracts have not been significant.
The Company's other service revenues are derived from recovery collections
work, bankruptcy process management, legal account management, skip tracing,
printing activities and customer relationship management services, such as call
center activities for card activation and balance transfer requests. The
contract terms for these services are generally shorter in nature, and some are
project based. Revenue is recognized on these other services either on a per
unit or a fixed price basis. The Company uses the percentage of completion
method of accounting for its fixed price contracts.
Contract Acquisition Costs: The Company capitalizes contract acquisition costs
related to signing or renewing long-term contracts. These costs, primarily
consisting of cash payments for rights to provide processing services and
internal conversion and software development costs, are amortized using the
straight-line method over the contract term beginning when the client's
cardholder accounts are converted to the system and generating revenues. All
costs incurred prior to contract execution are expensed as incurred.
The amortization of contract acquisition costs associated with cash
payments is recorded net of revenues in the Company's consolidated statements of
income. The amortization of contract acquisition costs associated with
conversion activity is recorded as other operating expenses in the Company's
consolidated statements of income. The Company evaluates the carrying value of
contract acquisition costs for impairment for each customer on the basis of
whether these costs are fully recoverable from expected undiscounted net
operating cash flows of the related contract. The
- 16 -
Critical Accounting Policies (continued)
determination of expected undiscounted net operating cash flows requires
management to make estimates.
These costs may become impaired with the loss of a contract, the financial
decline of a customer, termination of conversion efforts after a contract is
signed, diminished prospects for current customers or if the Company's estimates
of future cash flows differ from actual results. Capitalized contract
acquisition costs are classified in prepaid expenses and other current assets
and in other assets.
Software Development Costs: The Company develops software that is used in
providing electronic payment processing and other services to clients. Software
development costs are capitalized once technological feasibility of the software
product has been established. Costs incurred prior to establishing technological
feasibility are expensed as incurred. Technological feasibility is established
when the Company has completed all planning, designing, coding and testing
activities that are necessary to determine that a product can be produced to
meet its design specifications, including functions, features and technical
performance requirements. Capitalization of costs ceases when the product is
available to customers for general use. The Company evaluates the unamortized
capitalized costs of software development as compared to the net realizable
value of the software product which is determined by projected future net cash
flows. The amount by which the unamortized software development costs exceed the
net realizable value is written off. Software development costs are amortized
using the greater of (1) the straight-line method over its estimated useful life
(which ranges from 3-10 years) or (2) the ratio of current revenues to total
anticipated revenue over its useful life.
Software development costs may become impaired in situations where
development efforts are abandoned due to the viability of the planned project
becoming doubtful or due to technological obsolescence of the planned software
product.
Transaction Processing Provisions: The Company has made certain estimates to
accrue for contract contingencies (performance penalties) and processing errors.
A significant number of the Company's contracts with large customers contain
service level agreements which can result in TSYS incurring performance
penalties if such service levels are not met. When providing for these accruals,
the Company takes into consideration such factors as the prior history of
performance penalties and processing errors incurred, contractual penalties
inherent in the Company's contracts, progress towards meeting milestones and
performance penalties and known processing errors not covered by insurance.
These accruals are included in other current liabilities in the
accompanying consolidated balance sheets. Increases in transaction processing
provisions are charged to other operating expenses in the Company's consolidated
statements of income and payments for performance penalties and processing
errors are charged against the accrual.
Impairment of Long-lived Assets and Intangibles: The Company evaluates the
recoverability of property and equipment, and other long-lived assets, by
comparing the carrying amount of the asset against the estimated undiscounted
net cash flows associated with it. Should the sum of the expected future cash
flows be less than the carrying value of the asset being evaluated, the Company
uses fair
- 17 -
Critical Accounting Policies (continued)
value in determining the amount of impairment loss that should be recorded. The
determination of undiscounted net operating cash flows requires management to
make estimates.
Equity Investments: TSYS' 49% investment in Total System Services de Mexico,
S.A. de C.V. (TSYS de Mexico), a bankcard data processing support operation
located in Mexico, is accounted for using the equity method of accounting, as is
TSYS' 50% investment in Vital Processing Services L.L.C. (Vital), a merchant
processing operation headquartered in Tempe, Arizona.
Income Taxes: Income taxes reflected in TSYS' consolidated financial statements
are computed based on the taxable income of TSYS as if TSYS were a stand-alone
tax paying entity. A consolidated federal income tax return is filed for Synovus
and its majority owned subsidiaries, including TSYS.
The Company accounts for income taxes in accordance with the asset and
liability method. Under the asset and liability method, deferred income tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred income
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred income tax assets
and liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.
Income tax provisions require the use of management judgments, which are
subject to challenge by various taxing authorities. Estimates relate to the
determination of taxable income, the determination of temporary differences
between book and tax bases, as well as anticipated tax credits and related
provisions.
Related Party Transactions
The Company provides electronic payment processing services and other
services for its parent company, Synovus Financial Corp. (Synovus), and its
affiliates, and for Vital and TSYS de Mexico. The services are performed under
contracts that are similar to its contracts with other customers. The Company
believes the terms and conditions of transactions between the Company and these
related parties are comparable to those which could have been obtained in
transactions with unaffiliated parties. The Company's margins with respect to
related party transactions are comparable to margins recognized in transactions
with unrelated third parties. The amounts related to these transactions are
disclosed on the face of TSYS' consolidated financial statements.
Off-Balance Sheet Arrangements
Operating Leases: As a method of funding its operations, TSYS employs
noncancelable operating leases for computer equipment, software and facilities.
These leases allow the Company to provide the latest technology while avoiding
the risk of ownership because of potential rapid technological obsolescence.
Neither the assets nor liabilities related to these leases are included on the
balance sheet. Alternatively, the Company discloses the amount of operating
expense associated with these agreements for each period including future cash
obligations with respect to such arrangements. One of the Company's most
significant leases is its synthetic lease used to finance its corporate campus.
- 18 -
Off-Balance Sheet Arrangements (continued)
Synthetic Lease: In 1997, the Company entered into an operating lease agreement
with a special purpose entity (SPE) for the Company's corporate campus. The
business purpose of the SPE was to provide a means of financing the Company's
corporate campus. The assets and liabilities of the SPE consists solely of the
cost of the building and the loans from a consortium of banks. The cost of the
building and the outstanding principal balance of the debt included on the
financial statements of the SPE both approximate $93.5 million. The lease, which
is guaranteed by Synovus, provides for substantial residual value guarantees.
The amount of the Company's residual value guarantee relative to the assets
under this lease is approximately $81.4 million. In accordance with current
accounting principles, no asset or obligation is recorded on the Company's
consolidated balance sheets.
The terms of this lease financing arrangement require, among other things,
that the Company maintain certain minimum financial ratios and provide certain
information to the lessor. TSYS is also subject to interest rate risk associated
with the lease on its campus facilities because of the short-term variable rate
nature of the SPE's debt. The payments under the operating lease arrangement,
which can be locked in for six month intervals, are tied to the London Interbank
Offered Rate (LIBOR) plus a margin of 45 basis points for the secured portion
and a margin of 135 basis points for the unsecured portion. In the event that
LIBOR rates increase, operating expenses could increase proportionately.
The campus lease expires November 2002. The Company has the option to
either renew the lease subject to prevailing market rates or purchase the
property at its original cost. The Company is currently evaluating which option
to pursue.
If the Company elects to purchase the property from the SPE, such funds
would be used to repay the SPE loan facility. The Company has several options
available for financing the purchase of the property. Sources of financing may
include short-term and/or long-term borrowings from financial institutions or
the issuance of equity or debt securities.
- 19 -
Results of Operations
The following table sets forth certain revenue and expense items as a
percentage of total revenues and the percentage increases or decreases in those
items for the three months ended June 30, 2002 and 2001:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
---------------- ------------------
2002 2001 2002 vs. 2001
----- ------ ------------------
Revenues:
Electronic payment processing services 62.9% 63.4% 6.5%
Other services 11.8 9.6 30.9
------ ------
Revenues before reimbursable items 74.7 73.0 9.8
Reimbursable items 25.3 27.0 0.6
------ ------
Total revenues 100.0 100.0 7.3
------ ------
Expenses:
Salaries and other personnel expense 29.9 28.3 13.4
Net occupancy and equipment expense 17.3 19.9 (6.4)
Other operating expenses 11.9 9.0 40.6
------ ------
Expenses before reimbursable items 59.1 57.2 10.8
Reimbursable items 25.3 27.0 0.6
------ ------
Total expenses 84.4 84.2 7.5
------ ------
Equity in income of joint ventures 2.1 2.0 9.7
------ ------
Operating income 17.7 17.8 6.6
Nonoperating income 0.5 0.3 nm
------ ------
Income before income taxes 18.2 18.1 7.9
Income taxes 5.8 6.3 (1.6)
------ ------
Net income 12.4% 11.8% 13.0%
====== ======
nm = not meaningful
- 20 -
Results of Operations (continued)
The following table sets forth certain revenue and expense items as a
percentage of total revenues and the percentage increases or decreases in those
items for the six months ended June 30, 2002 and 2001:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
---------------- ------------------
2002 2001 2002 vs. 2001
----- ------ ------------------
Revenues:
Electronic payment processing services 62.5% 61.7% 7.0%
Other services 12.1 10.3 23.1
------ ------
Revenues before reimbursable items 74.6 72.0 9.4
Reimbursable items 25.4 28.0 (4.3)
------ ------
Total revenues 100.0 100.0 5.5
------ ------
Expenses:
Salaries and other personnel expense 29.7 28.4 10.4
Net occupancy and equipment expense 18.4 19.4 (0.3)
Other operating expenses 10.8 9.5 20.7
------ ------
Expenses before reimbursable items 58.9 57.3 8.5
Reimbursable items 25.4 28.0 (4.3)
------ ------
Total expenses 84.3 85.3 4.3
------ ------
Equity in income of joint ventures 2.0 1.8 21.7
------ ------
Operating income 17.7 16.5 13.8
Nonoperating income 0.3 0.3 (17.6)
------ ------
Income before income taxes 18.0 16.8 13.1
Income taxes 5.8 5.8 5.3
------ ------
Net income 12.2% 11.0% 17.2%
====== ======
nm = not meaningful
Revenues
Total revenues increased $16.1 million, or 7.3%, and $24.2 million, or
5.5%, during the three and six months ended June 30, 2002, respectively,
compared to the same periods in 2001. Excluding reimbursable items, revenues
increased $15.8 million, or 9.8%, and $29.4 million, or 9.4%, during the three
and six months ended June 30, 2002, respectively, compared to the same periods
in 2001. TSYS' revenues are derived from providing electronic payment processing
and related services to banks and other institutions, generally under long-term
processing contracts. TSYS' services are provided through the Company's
cardholder systems, TS2 and TS1, to financial institutions and other
organizations throughout the United States, Mexico, Canada, Honduras, the
Caribbean and Europe. The Company currently offers merchant services to
financial institutions and other organizations in Japan through its majority
owned subsidiary, GP Net.
- 21 -
Results of Operations (continued)
Due to the seasonal nature of credit card transactions, TSYS' revenues and
results of operations have generally increased in the fourth quarter of each
year because of increased transaction and authorization volumes during the
traditional holiday shopping season. Furthermore, growth in card portfolios of
existing clients, the conversion of cardholder accounts of new clients to the
Company's processing platforms, and the loss of cardholder accounts impact the
results of operations from period to period. Another factor, among others, which
may affect TSYS' revenues and results of operations from time to time is the
sale by a client of its business, its card portfolio or a segment of its
accounts to a party which processes cardholder accounts internally or uses
another third-party processor.
Processing contracts with large clients, representing a significant portion
of the Company's total revenues, generally provide for discounts on certain
services based on the size and activity of clients' portfolios. Therefore,
electronic payment processing revenues and the related margins are influenced by
the client mix relative to the size of client card portfolios, as well as the
number and activity of individual cardholder accounts processed for each client.
Consolidation among financial institutions has resulted in an increasingly
concentrated client base, which results in a changing client mix toward larger
clients. Consolidation in the financial services and retail industries could
favorably or unfavorably impact TSYS' financial condition and results of
operations in the future.
The Company experienced a drop in transaction and authorization volumes on
September 11, 2001 and the following weeks as a result of the terrorist attacks.
In the ensuing weeks, those processing volumes returned to normal levels as
consumers resumed their daily activities. TSYS did not experience any material
financial impact as a result of the September 11th attacks, although TSYS did
experience a delay by potential clients with regards to pursuing processing
agreements as those clients focused on matters such as disaster recovery and
other internal processes. TSYS believes that potential clients are now
evaluating outsourcing arrangements.
Electronic Payment Processing Services
Revenues from electronic payment processing services increased $9.2
million, or 6.5%, and $19.0 million, or 7.0%, for the three and six months ended
June 30, 2002, respectively, compared to the same periods in 2001. Revenues for
the second quarter 2001 also included a one-time nonrecurring deconversion
penalty of $7.5 million from two departing clients. Excluding the nonrecurring
fee received in 2001, revenues from recurring operations before reimbursables
would have increased 15.1% for the second quarter of 2002 compared to the same
period in 2001.
Electronic payment processing revenues are generated primarily from charges
based on the number of accounts billed, transactions and authorizations
processed, statements mailed, credit bureau requests, cards embossed and mailed,
and other processing services for cardholder accounts on file. Cardholder
accounts on file include active and inactive consumer credit, retail, debit,
stored value and commercial card accounts. Due to the number of cardholder
accounts processed by TSYS and the expanding use of cards, as well as increases
in the scope of services offered to clients, revenues relating to electronic
payment processing services have continued to grow.
- 22 -
Results of Operations (continued)
The Company provides services to its clients including processing consumer,
retail and commercial cards. Consumer cards include Visa and MasterCard credit
and debit cards as well as American Express and stored value cards. Retail cards
include private label and gift cards. Commercial cards include purchasing cards,
corporate cards and fleet cards for employees. The following table summarizes
TSYS' accounts on file by portfolio type:
Accounts on File by Type June 30, 2002 June 30, 2001
- ------------------------- ------------------------ ------------------------ ----------------
(in millions) Number % Number % % Change
------------- -------- ------------- ---------- ----------------
Consumer 127.4 56.2 109.4 54.1 16.4
Retail 80.6 35.6 76.3 37.8 5.6
Commercial 18.7 8.2 16.4 8.1 14.4
- -------------------------- --------- ------ ------- -------
Total 226.7 100.0 202.1 100.0 12.2
========= ====== ======== =======
Average cardholder accounts on file for the three months ended June 30,
2002 were 229.1 million, an increase of approximately 15.0% over the average of
199.2 million for the same period in 2001. Average cardholder accounts on file
for the six months ended June 30, 2002 were 226.7 million, an increase of
approximately 14.1% over the average of 198.8 million for the same period in
2001. Cardholder accounts on file at June 30, 2002 were 226.7 million, a 12.2%
increase compared to the 202.1 million accounts on file at June 30, 2001. The
change in cardholder accounts on file from June 2001 to June 2002 included the
deconversion and purging of 14.6 million accounts, the addition of approximately
22.3 million accounts attributable to the internal growth of existing clients,
and approximately 16.9 million accounts for new clients.
TSYS expects to continue expanding its market share in the consumer, retail
and commercial card arenas. The Company's future growth in consumer cards is
dependent upon new clients, international expansion and continued internal
growth of clients' portfolios.
In April 2002, the Company announced that it had entered into a five-year
agreement with Accenture valued in excess of $120 million to provide processing
services for the U.S. Department of Education. TSYS began processing all new
originations for the Department of Education on April 26, 2002. The agreement
also involves converting all existing student records to TSYS' new stand-alone
platform during several phases. The conversion phases are scheduled to begin and
to be completed during the first half of 2003 and TSYS estimates it should have
a total of 10 million records at that point. Revenues generated from Accenture
in 2002 related to processing student loans will not be material.
TSYS is positioned as a major third-party processor of retail cards.
Traditional retail card operations are beginning to increase the activity of
their card portfolios by converting inactive accounts to Visa/MasterCard
consumer cards. TSYS is able to provide its extensive bankcard processing tools
and techniques, as well as value-added functionality, to traditional retail card
operations allowing better segmentation and potentially increased profitability
for customers. TSYS does not receive as much revenue from retail cards, on a per
account basis, as it does for a consumer card because consumer cards
traditionally generate more transactions. Retail cards are generally limited to
a particular location or retail chain. Consumer cards are widely accepted at
numerous retail outlets.
- 23 -
Results of Operations (continued)
TSYS' major retail client converted approximately 5.6 million accounts of
its portfolio from traditional retail accounts to consumer accounts since June
2001. The same retail client has purged approximately 8 million inactive retail
accounts on file.
In January 2002, TSYS announced the signing of a multiyear agreement to
process 13 million Fashion Bug private-label card accounts for Charming Shoppes,
Inc., one of the leading specialty apparel retailers in America. During the
second quarter of 2002, Charming Shoppes purged approximately 3 million inactive
accounts on file.
TSYS has a dominant market share position in the domestic Visa and
MasterCard commercial card processing arena. Future growth in this area is
dependent upon increased card activity with more purchasing by businesses being
transacted electronically and additional firms realizing the benefits of
converting their paper-based purchasing systems to electronic transactions using
commercial cards.
TSYS provides processing services to its clients worldwide. TSYS plans to
continue to expand its service offerings to other countries in the future. The
following table summarizes TSYS' accounts on file by area:
Accounts on File by Area June 30, 2002 June 30, 2001
- ------------------------- ----------------------- --------------------- -----------
(in millions) Number % Number % % Change
------------- -------- ----------- -------- ----------
Domestic 197.8 87.3 179.1 88.6 10.5
Foreign 28.9 12.7 23.0 11.4 25.4
- ------------------------- ------------- -------- ----------- -------- --------
Total 226.7 100.0 202.1 100.0 12.2
============= ======== =========== ======== ========
In 2000, the Company announced the signing of The Royal Bank of Scotland
Group plc (RBS) and Allied Irish Banks plc (AIB) to multiyear processing
agreements. The portfolios of both clients were fully converted by the middle of
the third quarter of 2001. As a result, the growth in accounts on file in
foreign locations is expected to decline from the 25.4% shown in the table
above. With the completed conversions of RBS and AIB, TSYS became the leading
third-party international processor.
On August 6, 2002, TSYS announced the signing of a 10-year outsourcing
agreement with CIBC to process more than 5 million Visa accounts. The portfolio
will be converted in early 2003 to TS2. In a separate agreement, TSYS announced
in January 2002 that it would process the new "entourage" line of American
Express products for CIBC, including Canada's first nationwide chip card. TSYS
has supported other CIBC card products since 1994.
The Company's electronic payment processing service revenues are also
impacted by the use of value added products and services of TSYS' processing
systems by clients. Value added products and services are optional features each
client can choose to subscribe to in order to potentially increase the financial
performance of its portfolio. Value added products and services include: risk
management tools and techniques, such as credit evaluation, fraud detection and
prevention, and behavior analysis tools; and revenue enhancement tools, such as
loyalty programs and bonus rewards. For the three months ended June 30, 2002 and
2001, value added products and services represented 13.2% and 11.0%, or $31.2
million and $24.3 million, of total revenues, respectively. For the six
- 24 -
Results of Operations (continued)
months ended June 30, 2002 and 2001, value added products and services
represented 12.4% and 11.4%, or $57.2 million and $49.8 million, of total
revenues, respectively. Revenues from value added products and services
increased 28.6%, or $6.9 million, for the three months ended June 30, 2002,
compared to the same period in 2001. Revenues from value added products and
services increased 14.8%, or $7.4 million, for the six months ended June 30,
2002, compared to the same period in 2001. In 2001, the Company changed its
accounting policy for recognizing revenue for one of the value added products
and services it offers clients. The Company was recognizing revenue one month in
arrears. Due to historical data the Company has accumulated over a set amount of
time, the Company determined that it now can estimate its current monthly
revenue with some precision. During the six months ended June 30, 2001, the
Company recognized, as a result of the change, seven months of revenue, or an
additional $1.4 million, for this one value added product and service.
Other Services
Revenues from other services consist primarily of revenues generated by
TSYS' wholly owned subsidiaries. Revenues from other services increased $6.6
million, or 30.9%, in the second quarter of 2002, compared to the second quarter
of 2001. Revenues from other services increased $10.4 million, or 23.1%, for the
first six months of 2002, compared to the same period in 2001. The majority of
the increase in revenues is the result of the acquisition of TSYS Total Debt
Management, Inc. (TDM) from Synovus Financial Corp. on January 1, 2002. TDM
provides recovery collections work, bankruptcy process management, legal account
management and skip tracing. Because the acquisition of TDM was a transaction
between entities under common control, the Company is reflecting the acquisition
at historical cost in accordance with SFAS 141 and is reflecting the results of
operations of TDM in the Company's financial statements beginning January 1,
2002. The Company has not restated periods prior to 2002 because such
restatement is not significant to the Company's financial statements. As
discussed above, the Company's revenues from other services, excluding the
effect of TDM, were comparable in the 2002 periods to the 2001 periods.
For the three and six months ended June 30 2002, TDM's revenues were
approximately $5.0 million and $10.3 million, respectively. Other services
revenues related to call center and business process management were
approximately the same for the second quarter of 2002 compared to the same
period last year. During the second quarter of 2001, a client stopped
outsourcing certain functions as a result of the client's need to reduce
expenses. As a result, other service revenues were negatively impacted.
Reimbursable Items
As a result of the Financial Accounting Standards Board's (FASB's) Emerging
Issues Task Force 01-14 (EITF 01-14), formerly known as Staff Announcement Topic
D-103, "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenue. Historically, TSYS has not
reflected such reimbursements in its consolidated statements of income. The
largest reimbursement expenses for which TSYS is reimbursed by clients, are
postage and express courier charges. Reimbursable items remained comparable for
the three months ended June 30, 2002, as compared to the same period last year.
Reimbursable items decreased $5.2 million, or 4.3%, for the six months ended
June 30, 2002, as compared to the same period last year. The decrease is the
result of certain clients decreasing mailing activities, such as the reissuance
of cards, and the loss of certain clients. The majority of reimbursable items
relate to the Company's domestic based clients.
- 25 -
Results of Operations (continued)
Major Customers
A significant amount of the Company's revenues is derived from long-term
contracts with large customers, including certain major customers. For the three
months ended June 30, 2002, the Company had two major customers. The two major
customers for the quarter ended June 30, 2002 accounted for approximately 34.4%,
or $81.6 million, of total revenues. For the three months ended June 30, 2001,
TSYS had two major customers that accounted for 37.3%, or $82.4 million, of
total revenues. The two major customers for the six months ended June 30, 2002
accounted for approximately 34.4%, or $158.8 million, of total revenues. For the
six months ended June 30, 2001, TSYS had two major customers that accounted for
37.3%, or $162.7 million, of total revenues. The loss of one of the Company's
major customers, or other significant customers, could have a material adverse
effect on the Company's financial condition and results of operations.
In October 2001, the Company announced it had signed a 10-year extension to
its long-term credit card processing agreement with one of its major customers,
Providian Financial Corporation (Providian), which included a cash payment for
processing rights of $12.7 million.
In late 2001 and in 2002, Providian made several announcements regarding
concerns about its financial status, related changes in management and the sale
of a portion of its portfolio. As a result of these announcements, TSYS
management is actively monitoring Providian's financial status through frequent
interaction with Providian's senior management.
During the second quarter of 2002, Providian contracted with TSYS to
perform back-up servicing in the case of default (trigger event) on their
Gateway Master Trust portfolio. Based on its contact with Providian's senior
management, TSYS does not anticipate that the trigger event will occur. The
revenues generated from providing back-up servicing for Providian will not have
a material impact upon TSYS' results operations.
Operating Expenses
Total expenses increased 7.5% and 4.3% for the three and six months ended
June 30, 2002, respectively, compared to the same periods in 2001. Excluding
reimbursable items, total expenses increased 10.8% and 8.5% for the three and
six months ended June 30, 2002, respectively, compared to the same periods in
2001. The increases in operating expenses are attributable to increases in each
of the expense categories as described below.
Employment expenses increased $8.4 million, or 13.4%, for the three months
ended June 30, 2002, compared to the same period in 2001. Employment expenses
increased $12.9 million, or 10.4%, for the six months ended June 30, 2002,
compared to the same period in 2001. The addition of employees associated with
the acquisition of TDM increased employment expenses $2.9 million and $6.3
million for the three months and six months ended June 30, 2002. The remaining
change in employment expenses is associated with the growth in the number of
employees, normal salary increases and related benefits. The average number of
employees in the second quarter of 2002 increased to 5,179, a 7.4% increase over
4,821 in the same period of 2001. The average number of employees for the first
six months of 2002 increased to 5,165, an 8.1% increase over 4,779 in the same
period of 2001. At July 31, 2002, TSYS had 4,946 full-time and 245 part-time
employees.
- 26 -
Results of Operations (continued)
Net occupancy and equipment expense decreased $2.8 million, or 6.4%, for
the three months ended June 30, 2002, and remained the same for the six months
ended June 30, 2002, respectively, over the same periods in 2001. Due to rapidly
changing technology in computer equipment, TSYS' equipment needs are achieved to
a large extent through operating leases. Computer equipment and software
rentals, which represent the largest component of net occupancy and equipment
expense, decreased approximately $4.1 million in the second quarter of 2002,
compared to the same period of 2001. Computer equipment and software rentals
decreased approximately $3.6 million in the first six months of 2002, compared
to the same period of 2001. The decrease is the result of recent legislation
whereby TSYS expects to recoup approximately $4.0 million of sales and use tax
paid to the state of Georgia for 2001 for various equipment and software
programs, including leased equipment and software. The Company also reduced its
capitalized computer equipment and other equipment balances by approximately
$1.0 million in conjunction with the sales tax refund for 2001. Depreciation and
software amortization increased $1.3 million and $2.7 million during the three
and six months ended June 30, 2002, compared to the same periods in 2001.
During 2000, the Company established a data processing center in Europe and
purchased a building to house client services personnel. Although it only began
processing accounts for its new European clients in mid-2001, the Company had to
build the necessary infrastructure in order to begin processing those accounts
in 2001. Through the first six months of 2001, the Company incurred $12.0
million of net operating expense related to the expansion in Europe.
Other operating expenses for the second quarter of 2002 increased $8.1
million, or 40.6%, compared to the same period in 2001. Other operating expenses
for the first six months of 2002 increased $8.6 million, or 20.7%, compared to
the same period in 2001. During the second quarter of 2002, TSYS added to client
contingencies and transaction processing reserves related to client specific
situations.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $4.9 million
and $4.5 million for the second quarters of 2002 and 2001, respectively. TSYS'
share of income from its equity in joint ventures was $9.4 million and $7.7
million for the first six months of 2002 and 2001, respectively. The increase
for the quarter is attributable mainly to Vital Processing Services (Vital).
During the three months ended June 30, 2002, the Company's equity in income
of joint ventures related to Vital was $4.7 million, a 19.1% increase, or
$752,000, compared to $3.9 million for the same period last year. During the six
months ended June 30, 2002, the Company's equity in income of joint ventures
related to Vital was $8.9 million, a 36.0% increase, or $2.3 million, compared
to $6.6 million for the same period last year. Vital's improved operating
efficiencies and controlling of expenses were the main factors in its improved
financial results.
In 1993, the Company reached an agreement to form a joint venture with a
number of Mexican banks and recorded, and continues to record, its 49% ownership
in the joint venture using the equity method of accounting. The operation, Total
System Services de Mexico, S.A. de C.V. (TSYS de Mexico), provided credit card
related processing for the joint venture member banks and others. Recently,
several joint venture participants and/or clients have consolidated. This
- 27 -
Results of Operations (continued)
consolidation has resulted in TSYS de Mexico having joint venture participants
that are not also processing clients of the joint venture. In order to address
this issue, during 2001, TSYS and its TSYS de Mexico joint venture participants
agreed to separate the bankcard processing services that TSYS de Mexico
previously outsourced to TSYS from the primary services provided directly by the
joint venture to its clients. The joint venture will continue to print
statements and provide card-issuing support services to the joint venture
clients. As a result, new processing agreements were negotiated between the
Mexican bank clients of the joint venture and TSYS.
The joint venture will continue to share the profits among the joint
venture participants from the services which the joint venture continues to
provide. TSYS' ownership percentage continues to be 49% of the joint venture,
and TSYS uses the equity method of accounting because it does not control the
operations of the joint venture. The Company has executed contracts with banks
that represent approximately 98% of its account-on-file base in Mexico. The net
effect of the restructuring will be minimal and is resulting in a decrease in
equity in income of joint ventures while TSYS' electronic payment processing
revenues and operating expenses increase. During the three months ended June 30,
2002, the Company's equity in income of joint ventures related to TSYS de Mexico
was $214,000, a 59.8% decrease, or $319,000, compared to $533,000 for the same
period last year. During the six months ended June 30, 2002, the Company's
equity in income of joint ventures related to TSYS de Mexico was $461,000, a
60.0% decrease, or $692,000, compared to $1.2 million for the same period last
year. Electronic payment processing revenues from clients based in Mexico was
$7.1 million for the second quarter ended June 30, 2002, a 96.3% increase over
the $3.6 million for the second quarter ended June 30, 2001. Electronic payment
processing revenues from clients based in Mexico was $13.1 million for the first
six months of June 30, 2002, an 81.2% increase over the $7.2 million for the
same period last year. The increase in revenues is attributable to increased
account on file growth of approximately 43.5% and the restructuring of the joint
venture agreement. The Company was notified by its largest client in Mexico that
it intends to utilize its internal global platform and does not plan on renewing
its processing agreement with TSYS when it expires in the first quarter of 2003.
As a result, management expects that electronic payment processing revenues for
2003 from Mexico will decrease when compared to electronic payment processing
revenues from Mexico for 2002.
As a result of the restructuring of its joint agreement, TSYS agreed to pay
TSYS de Mexico a management fee for certain client relationship services that
TSYS de Mexico has assumed from TSYS. TSYS paid TSYS de Mexico a management fee
of $214,000 and $461,000 for the three and six months ended June 30, 2002,
respectively.
Operating Income
Operating income increased 6.6% for the three months ended June 30, 2002,
over the same period in 2001. Operating income increased 13.8% for the six
months ended June 30, 2002, over the same period in 2001. The increase in
operating income was the result of the Company's commitment to contain the
growth in operating expenses below the growth rate in revenues. Excluding equity
in income of joint ventures, operating income increased 6.2% and 12.8% for the
three and six months ended June 30, 2002, respectively, over the same periods in
2001.
- 28 -
Results of Operations (continued)
The Company's operating profit margin for the second quarter of 2002 was
17.7%, compared to 17.8% for the same period last year. The Company's operating
profit margin for the first six months of 2002 was 17.7%, compared to 16.5% for
the same period last year. Excluding reimbursable items, the Company's operating
profit margin for the three and six months ended June 30, 2002 was 23.7% and
23.8%, respectively, compared to 24.4% and 22.8% for the three and six months
ended June 30, 2001, respectively. During the second quarter of 2001, the
Company received one-time nonrecurring termination penalties from departing two
customers of $7.5 million, which raised the Company's operating margins. The
Company's focus on expense control was the main reason for the improved margin.
Nonoperating Income
Interest income, net, includes interest income of $984,000 and no interest
expense for the second quarter of 2002. During the second quarter of 2001,
interest income, net, included interest income of $637,000 and $2,000 of
interest expense. During the first six months of 2002, interest income, net,
included interest income of $1.4 million and $6,000 of interest expense. During
the first six months of 2001, interest income, net, included interest income of
$1.6 million and $2,000 of interest expense. The decrease in interest income for
the three months ending June 30, 2002, as compared to the same period in 2001,
was primarily the result of lower short-term interest rates. During the three
months ended June 30, 2002, the Company recorded interest income of $534,000
from the state of Georgia on the sales tax refund referred to above.
Income Taxes
TSYS' effective income tax rate for the three months ended June 30, 2002
was 31.9%, compared to 35.0% for the same period in 2001. TSYS' effective income
tax rate for the first six months of 2002 was 32.3%, compared to 34.7% for the
same period in 2001. The decrease was the result of additional tax credits in
2002. The Company expects its effective income tax rate for 2002 to be
approximately 33%.
Net Income
Net income for the three months ended June 30, 2002 increased 13.0% to
$29.3 million, or basic and diluted earnings per share of $0.15, compared to
$26.0 million, or basic and diluted earnings per share of $0.13, for the same
period in 2001. The Company's net profit margin for the second quarter of 2002
was 12.4%, compared to 11.8% for the same period last year. Excluding
reimbursable items, the Company's net profit margin for the second quarter of
2002 was 16.6%, compared to 16.1% for the three months ended June 30, 2001.
Net income for the first six months ended June 30, 2002 increased 17.2% to
$56.2 million, or basic earnings per share of $0.29 and diluted earnings per
share of $0.28, compared to $48.0 million, or basic and diluted earnings per
share of $0.25, for the same period in 2001. The Company's net profit margin for
the first six months of 2002 was 12.2%, compared to 11.0% for the same period
last year. Excluding reimbursable items, the Company's net profit margin for the
first six months of 2002 was 16.4%, compared to 15.3% for the six months ended
June 30, 2001.
- 29 -
Results of Operations (continued)
Projected Outlook for 2002
TSYS expects an increase in net income for 2002 over 2001 of 20%. This
anticipated increase in net income is based in part upon the following
assumptions: a 10-12% internal growth rate for existing portfolios; an
aggressive focus on expense control and productivity improvement; the successful
implementation and market acceptance of new product offerings; and an increase
in the total cardholder base to approximately 235 million accounts. Factors that
could prevent TSYS from achieving this objective include the merger of TSYS
clients with entities that are not TSYS clients or the sale of portfolios by
TSYS clients to entities that are not TSYS clients, adverse developments with
respect to existing and prospective clients, including, but not limited to,
TSYS' sub-prime clients, TSYS' inability to control expenses and uncertain
economic conditions, among others.
Extended Financial Outlook for 2003
With the continued expansion of the Company's businesses, both domestically
and internationally, market acceptance of new products and services and
aggressive expense management, TSYS expects to increase its annual net income by
at least 20-25% in 2003 as compared to 2002. Factors that could prevent TSYS
from achieving this objective include delays in the decision-making process of
prospective clients, failure to sign prospective clients, the merger of TSYS
clients with entities that are not TSYS clients or the sale of portfolios by
TSYS clients to entities that are not TSYS clients, adverse developments with
respect to existing and prospective clients, including, but not limited to,
TSYS' sub-prime clients, TSYS' inability to control expenses and uncertain
economic conditions.
Liquidity and Capital Resources
The Consolidated Statements of Cash Flows detail the Company's cash flows
from operating, investing and financing activities. TSYS' primary method of
funding its operations and growth has been cash generated from current
operations and the occasional use of borrowed funds to supplement financing of
capital expenditures. TSYS' net cash provided by operating activities for the
first six months of 2002 was $71.5 million, compared to $17.0 million in 2001.
The net cash provided by operating activities in 2001 was negatively impacted by
cash commitments with expanding in Europe without the benefit of any processing
revenue and by certain working capital changes, primarily the payment of a
software obligation that was included in accounts payable in December 2000 that
was made to benefit future periods with more favorable licensing terms. The
major uses of cash generated from operations have been the internal development
and purchase of computer software, the addition of property and equipment,
primarily computer equipment, investment in client incentives and conversion
costs, and the payment of cash dividends.
During the second quarter of 2002, TSYS purchased property and equipment of
$3.1 million, compared to $9.6 million during the same period last year. During
the first six months of 2002, TSYS purchased property and equipment of $5.9
million, compared to $15.7 million during the same period last year.
Expenditures for purchased computer software were $12.6 million for the
three months ended June 30, 2002, compared to $8.7 million for the same period
in 2001. Expenditures for purchased computer software were $18.1 million for the
six months ended June 30, 2002, compared to $22.7 million for the same period in
2001. Additions to capitalized software development costs, including
enhancements to and development of TS2 processing systems, were $5.7 million for
the three month
- 30 -
Liquidity and Capital Resources (continued)
period ending June 30, 2002, compared to $4.0 million for the same period in
2001. Additions to capitalized software development costs were $15.9 million for
the six month period ending June 30, 2002, compared to $7.1 million for the same
period in 2001.
Due to the complexity of the differences between the English language and
Asian languages, computer systems require two bytes to store an Asian character
compared to one byte in the English language. With the opening of a branch
office in Japan to facilitate its marketing of card processing services, TSYS
began modifying its current TS2 system to be able to accommodate language and
currency differences with Asia, commonly referred to as the "double byte
project." During the three months ended June 30, 2002, the Company capitalized
$1.7 million, bringing the total capitalized in 2002 to $3.9 million. The
Company has capitalized a total of $7.9 million since the project began. The
Company completed the core double-byte architecture during the second quarter of
2002.
The Company is developing a new commercial card system, which is built upon
the architectural design of TS2. The new system will provide enhanced reporting
and increased purchasing controls. The Company capitalized approximately $1.2
million for the three months ended June 30, 2002, bringing the total capitalized
in 2002 to $2.2 million, related to this new processing platform. The Company
has capitalized a total of $35.7 million since the project began. The Company
expects to complete the system and make it available for general use by the
fourth quarter of 2002.
The Company is developing its Integrated Payments Platform supporting the
online and offline debit and stored value markets, giving clients access to all
national and regional networks, EBT programs, ATM driving and switching services
for online debit processing. The Company capitalized approximately $366,000 for
the three months ended June 30, 2002 on these additional systems, bringing the
total capitalized in 2002 to $2.8 million. The Company has capitalized a total
of $5.1 million since the project began.
The Company developed TSYS ProphIT(R), a Web-based process management
system that provides direct access to account information and other system
interfaces to help streamline an organization's business processes. TSYS ProphIT
was developed for TSYS' existing clients, and future development is expected to
provide other financial institutions and retailers with completely customized
workflows that work on any processing system. The Company capitalized
approximately $2.2 million for the three months ended June 30, 2002 on TSYS
ProphIT, bringing the total capitalized in 2002 to $6.0 million. The Company has
capitalized a total of $10.1 million since the project began.
During the three months ended June 30, 2002, the Company made investments
in contract acquisition costs of $18.5 million compared to $7.2 million for the
same period in 2001. During the six months ended June 30, 2002, the Company made
investments in contract acquisition costs of $27.7 million compared to $11.7
million for the same period in 2001. These amounts include cash payments for
processing rights, third-party development costs and other direct salary related
costs incurred in connection with converting new customers to the Company's
processing systems. Included in the $27.7 million investment for contract
acquisition costs for the first six months of 2002
- 31 -
Liquidity and Capital Resources (continued)
are cash payments to clients for processing rights of $21.5 million. During the
second quarter of 2002, the Company paid $14.0 million in cash for processing
rights as part of its agreement with CIBC.
Dividends on common stock of $3.0 million were paid in the second quarter
of 2002, bringing the total paid in 2002 to $5.9 million. On April 18, 2002, the
Company announced a 16.7% increase in its quarterly dividend from $0.0150 to
$0.0175 per share. The Company also increased the number of authorized shares
from 300 million to 600 million. On February 26, 2001, the Company announced a
20% increase in its quarterly cash dividend from $0.0125 to $0.0150 per share.
In 1997, the Company entered into an operating lease agreement relating to
the corporate campus. The lease provides for a substantial residual value
guarantee, up to $81.4 million, and includes purchase options at the original
cost of the property. Real estate taxes, insurance, maintenance and operating
expenses applicable to the leased property are obligations of the Company. The
campus lease expires November 2002. The Company has the option to either renew
the lease subject to prevailing market rates or purchase the property at its
original cost. The Company is currently evaluating which option to pursue.
If the Company elects to purchase the property from the SPE, such funds
would be used to repay the SPE loan facility. The Company has several options
available for financing the purchase of the property. Sources of financing may
include short-term and/or long-term borrowings from financial institutions or
the issuance of equity or debt securities.
In July 2000, TSYS broke ground on a 32,000 square foot childcare facility
which is located on the northeast corner of the campus. The new facility offers
the Company's employees an alternative option for childcare needs. The facility
was completed at a cost of approximately $3.5 million and opened in August 2001.
The Company will be able to recoup its building costs through current and future
state tax credits from the state of Georgia for setting up a company-sponsored
childcare facility.
In March 2001, the Company announced plans to move its printing subsidiary,
Columbus Productions, Inc. (CPI), and its materials management division into a
new building in east Columbus. The 61,000 square-foot building was completed in
August 2001 at a cost of approximately $3.7 million. In conjunction with the
move, CPI sold its existing location for $960,000. While waiting on construction
of the new building to be completed, CPI was leasing the existing facility from
the new owner.
In September 1999, Synovus Financial Corp. (Synovus) completed the
acquisition of the debt collection and bankruptcy management business offered by
Wallace & de Mayo. The services provided by Wallace & de Mayo include recovery
collections work, bankruptcy process management, legal account management and
skip tracing. These services were being marketed under the name TSYS Total Debt
Management, Inc. (TDM) through the Company for which Synovus paid TSYS a
management fee of $374,000 and $749,000 for the three and six months ended June
30, 2001, respectively.
- 32 -
Liquidity and Capital Resources (continued)
Effective January 1, 2002, TSYS acquired TDM in exchange for 2,175,000
newly issued shares of TSYS common stock with a market value of $43.5 million.
TDM will now operate as a wholly owned subsidiary of TSYS. This transaction
increased Synovus' ownership of TSYS to 81.1% in 2002.
In May 2000, Synovus completed the acquisition of ProCard, Inc. (ProCard),
a leading provider of software and Internet tools designed to assist
organizations with the management of purchasing, travel and fleet card programs.
ProCard's software solutions have been integrated into TSYS' processing
solutions and offer TSYS the opportunity to further expand its services to
ProCard's clients. The Company assists in managing ProCard, for which the
Company was paid a management fee of $76,000 by Synovus for the three months
ended June 30, 2002 and 2001. For the first six months of 2002 and 2001, the
Company was paid a management fee of $152,000 by Synovus.
TSYS operates internationally and is subject to potentially adverse
movements in foreign currency rate changes. Since December 2000, TSYS has not
entered into foreign exchange forward contracts to reduce its exposure to
foreign currency rate changes. The Company has determined that, once it begins
processing for additional European clients, it may explore potential hedging
instruments to safeguard it from significant currency translation risks.
Although the impact of inflation on its operations cannot be precisely
determined, the Company believes that by controlling its operating expenses and
by taking advantage of more efficient computer hardware and software, it can
minimize the impact of inflation.
TSYS may seek additional external sources of capital in the future. The
form of any such financing will vary depending upon prevailing market and other
conditions and may include short-term or long-term borrowings from financial
institutions or the issuance of additional equity and/or debt securities such as
industrial revenue bonds. However, there can be no assurance that funds will be
available on terms acceptable to TSYS. Management expects that TSYS will
continue to be able to fund a significant portion of its capital expenditure
needs through internally generated cash in the future, as evidenced by TSYS'
current ratio of 2.5:1. At June 30, 2002, TSYS had working capital of $145.9
million compared to $108.4 million at December 31, 2001.
Recent Accounting Pronouncements
In July 2001, the FASB issued Statement No. 141 (SFAS 141), "Business
Combinations," and Statement No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets." SFAS 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. SFAS 141 also
specifies criteria that intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. The Company adopted the provisions of SFAS 141 July 1, 2001, the
effect of which was not significant.
SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 also requires
that intangible assets with estimable useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for
- 33 -
Recent Accounting Pronouncements (continued)
impairment in accordance with Statement of Financial Accounting Standards No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." The Company adopted SFAS 142 January 1, 2002.
At June 30, 2002, the Company has unamortized goodwill in the amount of
$3.6 million. As a result of implementing SFAS 142, the Company incurred no
amortization expense of goodwill during the three and six months ended June 30,
2002, respectively. Amortization expense related to goodwill was $213,000 and
$428,000 for the three and six months ended June 30, 2001, respectively.
The Company's transitional impairment analysis of its unamortized goodwill
balance did not have a material effect on the Company's financial condition or
results of operations.
In June 2001, the FASB issued Statement No. 143 (SFAS 143), "Accounting for
Asset Retirement Obligations," which addresses accounting and reporting for
asset retirement costs of long-lived assets resulting from legal obligations
associated with acquisition, construction, or development transactions. The
Company plans to adopt SFAS 143 in the first quarter of fiscal year 2003.
Management will evaluate the impact of the adoption of this statement on the
consolidated financial statements during fiscal year 2002.
In October 2001, the FASB issued Statement No. 144 (SFAS 144), "Accounting
for the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business (as previously
defined in that Opinion). This Statement also amends Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception
to consolidation for a subsidiary for which control is likely to be temporary.
SFAS 144 improves financial reporting by requiring that one accounting
model be used for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and by broadening the presentation
of discontinued operations to include more disposal transactions.
The Company adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144
did not have a material effect on the Company's financial condition or results
of operations.
In April 2002, the FASB issued Statement No. 145 (SFAS 145), "Rescission of
FASB Statements No. 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS 145 updates, clarifies and simplifies existing
accounting pronouncements. SFAS 145 requires that in certain circumstances
previous items classified as extraordinary that do not meet the criteria in
Opinion 30 must be reclassified. The Statement is effective for fiscal years
beginning after May 15, 2002. Management does not expect the adoption of SFAS
145 to have a material effect on the Company's financial condition or results of
operations.
- 34 -
Recent Accounting Pronouncements (continued)
In July 2002, the FASB issued Statement No. 146 (SFAS 146), "Accounting for
Costs Associated with Exit or Disposal Activities). SFAS 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". This Statement requires recognition of a
liability for a cost associated with an exit or disposal activity when the
liability is incurred, as opposed to when the entity commits to an exit plan
under EITF No. 94-3. The Statement is effective prospectively for exit or
disposal activities initiated after December 31, 2002. Management does not
anticipate that SFAS 146 will have a material impact on the Company's financial
condition or results of operations.
Forward-Looking Statements
Certain statements contained in this filing which are not statements of
historical fact constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act (the Act). These forward-looking
statements include, among others, statements regarding TSYS' belief with respect
to potential clients evaluating outsourcing arrangements, expected expansion of
its position in the consumer card, retail card and commercial card arenas,
expectations with respect to its obligations to perform back-up servicing for
Providian being "triggered", expected growth in net income for 2002 over 2001,
the expected increase in net income for 2003, TSYS' expected expenditures on and
timeframes for completing its new commercial card system or other development
projects, the expected impact on TSYS of recent accounting pronouncements and
the assumptions underlying such statements, including, with respect to TSYS'
expected increase in net income; TSYS' expected internal growth rate for
existing portfolios; an aggressive focus on expense control and productivity
improvement; the successful implementation and market acceptance of new product
offerings; expected increases in the number of accounts on file; expected
increases in revenues; and expected increases in revenues attributable to
international clients. In addition, certain statements in future filings by TSYS
with the Securities and Exchange Commission, in press releases, and in oral and
written statements made by or with the approval of TSYS which are not statements
of historical fact constitute forward-looking statements within the meaning of
the Act. Examples of forward-looking statements include, but are not limited to:
(i) projections of revenue, income or loss, earnings or loss per share, the
payment or nonpayment of dividends, capital structure and other financial items;
(ii) statements of plans and objectives of TSYS or its management or Board of
Directors, including those relating to products or services; (iii) statements of
future economic performance; and (iv) statements of assumptions underlying such
statements. Words such as "believes," "anticipates," "expects," "intends,"
"targeted," and similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements.
Prospective investors are cautioned that any such forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties, and that actual results may differ materially from those
contemplated by such forward-looking statements. A number of important factors
could cause actual results to differ materially from those contemplated by the
forward-looking statements in this filing. Many of these factors are beyond
TSYS' ability to control or predict. The factors include, but are not limited
to: (i) adverse developments with respect to TSYS' sub-prime clients; (ii) lower
than anticipated internal growth rates for TSYS' existing customers; (iii) TSYS'
inability to control expenses and increase market share; (iv) TSYS' inability to
successfully bring new products to market, including, but not limited to stored
value products, e-commerce
- 35 -
Forward-Looking Statements (continued)
products, loan processing products and other processing services; (v) the
inability of TSYS to grow its business through acquisitions; (vi) TSYS'
inability to increase the revenues derived from international sources; (vii)
adverse developments with respect to entering into contracts with new clients
and retaining current clients; (viii) the merger of TSYS clients with entities
that are not TSYS clients or the sale of portfolios by TSYS clients to entities
that are not TSYS clients; (ix) TSYS' inability to anticipate and respond to
technological changes, particularly with respect to e-commerce; (x) adverse
developments with respect to the successful conversion of clients; (xi) the
absence of significant changes in foreign exchange spreads between the United
States and the countries TSYS transacts business in, to include Mexico, United
Kingdom, Japan, Canada and the European Union; (xii) changes in consumer
spending, borrowing and saving habits, including a shift from credit to debit
cards; (xiii) changes in laws, regulations, credit card association rules or
other industry standards affecting TSYS' business which require significant
product redevelopment efforts; (xiv) the effect of changes in accounting
policies and practices as may be adopted by the Financial Accounting Standards
Board or the Securities and Exchange Commission; (xv) the costs and effects of
litigation; (xvi) adverse developments with respect to the credit card industry
in general; (xvii) TSYS' inability to successfully manage any impact from
slowing economic conditions or consumer spending; (xviii) the occurrence of
catastrophic events that would impact TSYS' or its major customers' operating
facilities, communications systems and technology, or that has a material
negative impact on current economic conditions or levels of consumer spending;
(xix) successfully managing the potential both for patent protection and patent
liability in the context of rapidly developing legal framework for expansive
software patent protection; and (xx) overall market conditions.
Such forward-looking statements speak only as of the date on which such
statements are made, and TSYS undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made to reflect the occurrence of unanticipated events.
- 36 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
TSYS is exposed to foreign exchange risk because it has assets,
liabilities, revenues and expenses denominated in foreign currencies including
the Euro, British Pound, Mexican Peso, Canadian Dollar and Japanese Yen. These
currencies are translated into U.S. dollars at current exchange rates, except
for revenues, costs and expenses, and net income, which are translated at the
average exchange rates for each reporting period. Net exchange gains or losses
resulting from the translation of assets and liabilities of TSYS' foreign
operations, net of tax, are accumulated in a separate section of shareholders'
equity titled accumulated other comprehensive income or loss. The amount of
other comprehensive income for the three and six months ended June 30, 2002 was
$4.0 million and $3.0 million, as compared to other comprehensive loss for the
same 2001 periods of $576,000 and $2.8 million, respectively. Currently, TSYS
does not use financial instruments to hedge its exposure to exchange rate
changes.
The carrying value of the net assets of its foreign operations in Europe,
Mexico, Canada and Japan was approximately (in U.S. dollars) $84.3 million, $3.1
million, $157,000 and $7.9 million, respectively, at June 30, 2002.
Interest Rate Risk
TSYS is also exposed to interest rate risk associated with the investing of
available cash and the lease on its campus facilities. TSYS invests available
cash in conservative short-term instruments and is primarily subject to changes
in the short-term interest rates.
The payments under the operating lease arrangement of the campus facilities
are tied to the London Interbank Offered Rate. TSYS locks into interest rates
for six-month intervals. The extent that rates change in a six-month period
represents TSYS' exposure.
The lease is scheduled to expire in November 2002. However, TSYS has the
option to either renew the lease subject to prevailing market rates or to
purchase the property at the original cost of the property. As a result, TSYS
could have an interest rate risk in the future associated with a future
obligation with respect to the corporate campus.
Concentration of Credit Risk
TSYS works to maintain a large and diverse customer base across various
industries to minimize the credit risk of any one customer to TSYS' accounts
receivable amounts. In addition, TSYS performs ongoing credit evaluations of its
certain customers' and certain suppliers' financial condition. TSYS does,
however, have two major customers that account for a large portion of its
revenues, which subject it to credit risk.
In late 2001 and 2002, Providian Financial Corporation (Providian), one of
TSYS' major customers, made several announcements regarding concerns about its
financial status, related changes in management and the sale of a portion of its
portfolio. As a result of the announcements, TSYS management is actively
monitoring Providian's status through frequent interaction with its senior
management.
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TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 4 - Submission of Matters to a Vote of Security Holders
The annual shareholders' meeting of Total System Services, Inc. was held
April 18, 2002. There were three proposals voted on at the meeting.
Proposal I voted on at the meeting was the election of five directors.
Following is a tabulation of votes for each nominee:
WITHHELD
VOTES AUTHORITY
NOMINEE FOR TO VOTE
- -------------------------------- ------------- ---------------
G. Wayne Clough 192,256,009 98,462
Samuel A. Nunn 192,106,011 248,460
H. Lynn Page 192,290,043 64,428
Philip W. Tomlinson 192,290,341 64,130
Richard W. Ussery 192,291,977 62,494
Proposal II voted on at the meeting was the proposal to approve the Total
System Services, Inc. 2002 Long-Term Incentive Plan. Following is a tabulation
of votes:
FOR 190,141,633
AGAINST 2,051,038
ABSTAIN 161,800
Proposal III voted on at the meeting was the proposal to approve the
Synovus Financial Corp. 2002 Long-Term Incentive Plan. Following is a tabulation
of votes:
FOR 189,722,282
AGAINST 2,433,595
ABSTAIN 198,594
- 38 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 6 - Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit Number Description
--------------------- --------------------------------------------------
99.1 Certification of Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
b) Forms 8-K filed since the previous Form 10-Q filing.
1. The report dated July 12, 2002 included the following important
event:
Effective August 1, 2002, Total System Services, Inc.
("Registrant") will begin utilizing Mellon Investor Services
LLC as its new transfer agent, registrar and dividend
disbursing agent for TSYS common stock.
2. The report dated July 16, 2002 included the following important
event:
On July 16, 2002, Total System Services, Inc. ("Registrant")
issued a press release with respect to its second quarter
2002 earnings.
- 39 -
TOTAL SYSTEM SERVICES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL SYSTEM SERVICES, INC.
Date: August 14, 2002 by: /s/ Richard W. Ussery
-----------------------------
Richard W. Ussery
Chairman of the Board
and Chief Executive Officer
Date: August 14, 2002 by: /s/ James B. Lipham
-----------------------------
James B. Lipham
Chief Financial Officer
- 40 -