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: September 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
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Commission file number 1-10254
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T|SYS| LOGO [GRAPHIC OMITTED]
Total System Services, Inc.
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(Exact name of registrant as specified in its charter)
Georgia 58-1493818
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(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
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(Address of principal executive offices) (Zip Code)
(706) 649-2310
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(Registrant's telephone number, including area code)
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(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: November 13, 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) - September 30, 2002
and December 31, 2001 .................................. 3
Consolidated Statements of Income (unaudited) - Three and nine
months ended September 30, 2002 and September 30, 2001 . 4
Consolidated Statements of Cash Flows (unaudited) - Nine months
ended September 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 .............................. 16
Item 3. Quantitative and Qualitative Disclosures About Market
Risk ................................................... 41
Item 4. Management's Analysis of Disclosure Controls and
Procedures ............................................. 43
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K .......................... 44
Signatures ............................................................ 45
Certifications ........................................................ 46
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
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September 30, December 31,
2002 2001
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Assets
Current assets:
Cash and cash equivalents (includes $92.1 million and $45.9 million on
deposit with a related party at 2002 and 2001, respectively) ............. $ 117,632,633 55,961,088
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $8.3 million and $5.4 million at 2002 and 2001,
respectively .............................................................. 118,131,937 113,318,623
Prepaid expenses and other current assets .................................. 41,093,065 37,074,206
------------- -------------
Total current assets ................................................... 276,857,635 206,353,917
Property and equipment, less accumulated depreciation and amortization of
$121.5 million and $109.3 million at 2002 and 2001, respectively .......... 116,959,563 120,799,905
Computer software, less accumulated amortization of $137.7 million and
$111.8 million at 2002 and 2001, respectively ............................. 187,301,634 170,889,575
Other assets ................................................................. 166,374,262 145,741,354
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Total assets ........................................................... $ 747,493,094 643,784,751
============= =============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ........................................................... $ 6,756,086 24,129,727
Accrued salaries and employee benefits ..................................... 37,022,067 39,687,428
Other current liabilities (includes $3.0 million and $2.4 million payable to
related parties at 2002 and 2001, respectively) ......................... 66,806,453 34,147,121
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Total current liabilities .............................................. 110,584,606 97,964,276
Deferred income tax liabilities .............................................. 44,982,128 42,650,211
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Total liabilities ...................................................... 155,566,734 140,614,487
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Minority interest in consolidated subsidiary ................................. 2,668,426 2,358,578
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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 ................................................. 15,559,944 9,360,223
Accumulated other comprehensive loss ....................................... (382,384) (3,455,338)
Treasury stock ............................................................. (3,316,703) (3,533,325)
Retained earnings .......................................................... 557,671,668 478,932,217
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Total shareholders' equity .............................................. 589,257,934 500,811,686
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Total liabilities and shareholders' equity .............................. $ 747,493,094 643,784,751
============= =============
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
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Three months ended
September 30,
-----------------------------------------
2002 2001
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Revenues:
Electronic payment processing services (includes $5.1 million and $8.3 million
from related parties for 2002 and 2001, respectively) .......................... $ 153,169,233 141,564,128
Other services (includes $1.8 million and $1.5 million from related parties for
2002 and 2001, respectively) ................................................... 25,448,484 19,590,470
------------- -------------
Revenues before reimbursable items ............................................ 178,617,717 161,154,598
Reimbursable items (includes $2.5 million and $2.5 million from related parties
for 2002 and 2001, respectively) ............................................... 56,314,016 54,993,195
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Total revenues ................................................................ 234,931,733 216,147,793
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Expenses:
Salaries and other personnel expense .............................................. 75,873,555 66,849,672
Net occupancy and equipment expense ............................................... 43,921,774 41,346,429
Other operating expenses (includes $2.1 million and $1.5 million to related parties
for 2002 and 2001, respectively) ................................................ 18,955,110 19,477,994
Loss on disposal of equipment, net ................................................ (63,666) (391)
------------- -------------
Expenses before reimbursable items ............................................ 138,686,773 127,673,704
Reimbursable items ............................................................... 56,314,016 54,993,195
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Total expenses ................................................................ 195,000,789 182,666,897
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Equity in income of joint ventures .................................................. 5,262,411 4,602,864
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Operating income .............................................................. 45,193,355 38,083,758
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Nonoperating income (expense):
Interest income, net (includes $336,000 and $541,000 from related parties for
2002 and 2001, respectively) ...................................................... 720,232 597,700
Minority interest in consolidated subsidiary's net income .......................... (99,922) (82,133)
Gain (loss) on foreign currency translation, net ................................... 2,144,535 16,121
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Total nonoperating income ..................................................... 2,764,845 531,688
------------- -------------
Income before income taxes .................................................... 47,958,200 38,615,446
Income taxes ...................................................................... 15,611,662 13,157,128
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Net income .................................................................... $ 32,346,538 25,458,318
============= =============
Basic earnings per share ...................................................... $ 0.16 0.13
============= =============
Diluted earnings per share .................................................... $ 0.16 0.13
============= =============
Weighted average common shares outstanding .................................... 197,049,470 194,778,566
Increase due to assumed issuance of shares related to stock options
outstanding ................................................................ 308,621 934,337
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Weighted average common and common equivalent shares outstanding .............. 197,358,091 195,712,903
============= =============
Cash dividends per common share ............................................... $ 0.0175 0.0150
============= =============
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
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Nine months ended
September 30,
------------------------------
2002 2001
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Revenues:
Electronic payment processing services (includes $14.2 million and $25.0 million
from related parties for 2002 and 2001, respectively) .......................... $ 441,476,074 410,891,380
Other services (includes $5.2 million and $4.9 million from related parties for
2002 and 2001, respectively) ................................................... 81,074,208 64,769,176
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Revenues before reimbursable items ............................................ 522,550,282 475,660,556
Reimbursable items (includes $7.4 million and $7.6 million from related parties
for 2002 and 2001, respectively) ............................................... 173,221,281 177,115,246
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Total revenues ................................................................ 695,771,563 652,775,802
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Expenses:
Salaries and other personnel expense .............................................. 212,612,553 190,652,160
Net occupancy and equipment expense ............................................... 128,604,310 126,266,071
Other operating expenses (includes $7.0 million and $5.6 million to related
parties for 2002 and 2001, respectively) ...................................... 69,112,874 61,038,102
Loss on disposal of equipment, net ................................................ (60,799) 93,198
------------- -------------
Expenses before reimbursable items ............................................ 410,268,938 378,049,531
Reimbursable items ............................................................... 173,221,281 177,115,246
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Total expenses ................................................................ 583,490,219 555,164,777
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Equity in income of joint ventures .................................................. 14,640,502 12,310,056
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Operating income .............................................................. 126,921,846 109,921,081
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Nonoperating income (expense):
Interest income, net (includes $810,000 and $2.0 million from related parties
for 2002 and 2001, respectively) ................................................. 2,067,375 2,242,098
Minority interest in consolidated subsidiary's net income .......................... (132,741) (91,563)
Gain(Loss) on foreign currency translation, net .................................... 2,143,451 (25,004)
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Total nonoperating income ..................................................... 4,078,085 2,125,531
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Income before income taxes .................................................... 130,999,931 112,046,612
Income taxes ...................................................................... 42,409,711 38,617,280
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Net income .................................................................... $ 88,590,220 73,429,332
============= =============
Basic earnings per share ...................................................... $ 0.45 0.38
============= =============
Diluted earnings per share .................................................... $ 0.45 0.38
============= =============
Weighted average common shares outstanding .................................... 197,005,655 194,770,776
Increase due to assumed issuance of shares related to stock options
outstanding ................................................................. 605,903 878,532
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Weighted average common and common equivalent shares outstanding .............. 197,611,558 195,649,308
============= =============
Cash dividends per common share ............................................... $ 0.050 0.045
============= =============
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
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Nine months ended
September 30,
-------------------------------------
2002 2001
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Cash flows from operating activities:
Net income .......................................................... $ 88,590,220 73,429,332
Adjustments to reconcile net income to net cash provided by
operating activities:
Minority interest in consolidated subsidiary's net income ........ 132,741 91,563
Equity in income of joint ventures .............................. (14,640,502) (12,310,056)
(Gain)Loss on foreign currency translation, net ................. (2,143,451) 25,004
Depreciation and amortization ................................... 44,521,460 40,151,808
Charges for bad debt and billing adjustments .................... 3,405,410 156,557
Charges for transaction processing .............................. 5,665,643 (1,311,042)
Deferred income tax expense ..................................... 2,331,917 6,316,041
(Gain)Loss on disposal of equipment, net ......................... (60,799) 93,198
(Increase) decrease in:
Accounts receivable ............................................. (4,789,733) (24,521,066)
Prepaid expenses and other assets ............................... 7,814,889 911,980
Increase (decrease) in:
Accounts payable ................................................ (15,332,528) (29,310,680)
Accrued salaries and employee benefits .......................... (2,665,361) (10,567,346)
Other current liabilities ....................................... 20,683,155 10,868,550
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Net cash provided by operating activities ................... 133,513,061 54,023,843
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Cash flows from investing activities:
Purchase of property and equipment .................................. (9,626,565) (24,127,157)
Additions to computer software ...................................... (42,258,963) (34,066,439)
Proceeds from disposal of equipment ................................. 68,322 962,387
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 .............................. (34,316,924) (12,709,917)
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Net cash used in investing activities ....................... (62,721,919) (59,530,845)
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Cash flows from financing activities:
Dividends paid on common stock ................................... (9,324,147) (8,277,257)
Proceeds from exercise of stock options .......................... 204,550 264,365
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Net cash used in financing activities ....................... (9,119,597) (8,012,892)
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Net increase (decrease) in cash and cash equivalents ........ $ 61,671,545 (13,519,894)
Cash and cash equivalents at beginning of year ........................ 55,961,088 80,071,895
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Cash and cash equivalents at end of year .............................. $ 117,632,633 66,552,001
============= =============
Cash paid for interest (net of capitalized amounts) .............. $ 5,909 30,749
============= =============
Cash paid for income taxes (net of refunds received) ............. $ 25,418,973 22,086,953
============= =============
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.
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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 Company(SM) (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:
September 30, 2002 December 31, 2001
-------------------------- ---------------------------
Cash and cash equivalents in domestic accounts $ 88,188,352 $ 45,998,283
Cash and cash equivalents in foreign accounts 25,361,931 9,962,805
Restricted cash 3,867,635 -
-------------------------- ---------------------------
Total $ 117,632,633 $ 55,961,088
========================== ===========================
Significant components of prepaid expenses and other current assets are
summarized as follows:
September 30, 2002 December 31, 2001
------------------------- ---------------------------
Contract acquisition costs:
Payments for processing rights, net $ 11,223,887 $ 9,244,092
Conversion costs, net 5,675,697 2,655,865
Prepaid expenses 7,535,925 10,634,921
Other 16,657,556 14,539,328
------------------------- ---------------------------
Total $ 41,093,065 $ 37,074,206
========================= ===========================
Significant components of other assets are summarized as follows:
September 30, 2002 December 31, 2001
------------------------- ---------------------------
Contract acquisition costs:
Payments for processing rights, net $ 77,725,320 $ 62,151,758
Conversion costs, net 22,269,683 13,031,517
Equity investments, net 48,309,037 51,566,564
Other 18,070,222 18,991,515
------------------------- ---------------------------
Total $ 166,374,262 $ 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 $2.7 million and $1.8 million for the three
months ended September 30, 2002 and 2001, respectively. Amortization related to
payments for processing rights was $7.7 million and $3.9 million for the nine
months ended September 30, 2002 and 2001, respectively.
Amortization expense related to conversion costs, which is recorded in
other operating expenses, was $805,000 and ($1.4 million) for the three months
ended September 30, 2002 and 2001, respectively. Amortization expense related to
conversion costs was $2.3 million and ($262,000) for the nine months ended
September 30, 2002 and 2001, respectively.
The Company had certain contractual obligations related to the timing and
accuracy of conversions. The Company estimated the potential liability and
recorded it as a contra asset against prepaid conversion costs. During the third
quarter of 2001, the obligations were either met through completed conversions,
or expired, resulting in the Company adjusting a $2.0 million accrual. As a
result, amortization expense in the third quarter of 2001 was negative.
Significant components of other current liabilities are summarized as
follows:
September 30, 2002 December 31, 2001
------------------------- -----------------------------
Customer postage deposits $ 18,653,849 $ 19,065,119
Transaction processing provisions 9,173,499 7,291,441
Other 38,979,105 7,790,561
------------------------- -----------------------------
Total $ 66,806,453 $ 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 September 30 is as follows:
2002 2001
-------------------------- --------------------------
Net income $ 32,346,538 $ 25,458,318
Other comprehensive income (loss):
Foreign currency translation adjustments,
net of tax 70,458 2,060,336
-------------------------- --------------------------
Comprehensive income $ 32,416,996 $ 27,518,654
========================== ==========================
Comprehensive income for the nine months ended September 30 is as follows:
2002 2001
------------------------- --------------------------
Net income $ 88,590,220 $ 73,429,332
Other comprehensive income (loss):
Foreign currency translation adjustments,
net of tax 3,072,954 (733,879)
------------------------- --------------------------
Comprehensive income $ 91,663,174 $ 72,695,453
========================= ==========================
- 8 -
Notes to Unaudited Consolidated Financial Statements (continued)
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 September 30, 2002
----------------------- --------------- --------------- ----------------------
Foreign currency translation
adjustments ($3,455,338) 4,863,556 (1,790,602) ($382,384)
======================= =============== =============== ======================
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 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 makers (CODMs) use to make resource allocation and
strategic decisions. The CODMs at TSYS consist 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
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At September 30, 2002
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Identifiable assets $ 744,763,982 94,673,451 $ 839,437,433
Intersegment eliminations (91,896,058) (48,281) (91,944,339)
-------------------------- ------------------------- ------------------------
Total assets $ 652,867,924 94,625,170 $ 747,493,094
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
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 September 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 218,518,035 16,701,468 $ 235,219,503
Intersegment revenue (1,413) (286,357) (287,770)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 218,516,622 16,415,111 $ 234,931,733
========================== ========================= ========================
Equity in income of joint ventures $ 5,044,508 217,903 $ 5,262,411
========================== ========================= ========================
- 9 -
Notes to Unaudited Consolidated Financial Statements (continued)
Domestic-based International-based
Operating Segments processing services processing services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Segment operating income $ 44,442,867 750,488 $ 45,193,355
========================== ========================= ========================
Income taxes $ 14,741,649 870,013 $ 15,611,662
========================== ========================= ========================
Net income $ 30,824,024 1,522,514 $ 32,346,538
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 204,074,918 12,309,518 $ 216,384,436
Intersegment revenue (2,351) (234,292) (236,643)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 204,072,567 12,075,226 $ 216,147,793
========================== ========================= ========================
Equity in income of joint ventures $ 4,178,767 424,097 $ 4,602,864
========================== ========================= ========================
Segment operating income $ 40,210,023 (2,126,265) $ 38,083,758
========================== ========================= ========================
Income taxes $ 14,001,751 (844,623) $ 13,157,128
========================== ========================= ========================
Net income $ 26,783,584 (1,325,266) $ 25,458,318
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 648,407,623 48,444,035 $ 696,851,658
Intersegment revenue (4,269) (1,075,826) (1,080,095)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 648,403,354 47,368,209 $ 695,771,563
========================== ========================= ========================
Equity in income of joint ventures $ 13,961,588 678,914 $ 14,640,502
========================== ========================= ========================
Segment operating income $ 124,508,206 2,413,640 $ 126,921,846
========================== ========================= ========================
Income taxes $ 40,763,003 1,646,708 $ 42,409,711
========================== ========================= ========================
Net income $ 86,033,798 2,556,422 $ 88,590,220
========================== ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Nine Months Ended September 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
-------------------------- ------------------------- ------------------------
Total revenue $ 633,386,216 20,188,566 $ 653,574,782
Intersegment revenue (4,892) (794,088) (798,980)
-------------------------- ------------------------- ------------------------
Revenue from external customers $ 633,381,324 19,394,478 $ 652,775,802
========================== ========================= ========================
Equity in income of joint ventures $ 10,733,399 1,576,657 $ 12,310,056
========================== ========================= ========================
Segment operating income $ 124,177,828 (14,256,747) $ 109,921,081
========================== ========================= ========================
Income taxes $ 43,938,604 (5,321,324) $ 38,617,280
========================== ========================= ========================
Net income $ 82,408,970 (8,979,638) $ 73,429,332
========================== ========================= ========================
Revenues for domestic-based processing services include electronic payment
processing services and other services provided from the United States to
clients based in the United States or other countries. Revenues from
international-based processing services include electronic payment processing
services and other services provided outside the United States to clients based
predominantly outside the United States.
- 10 -
Notes to Unaudited Consolidated Financial Statements (continued)
The following geographic area data represent revenues for the three and
nine months ended September 30, 2002 and 2001, respectively, based on the
geographic locations of customers.
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------------- --------------------------------------------
(Dollars in millions) 2002 2001 2002 2001
------------------- ----------------- ------------------ ----------------------
United States $ 197.0 189.2 592.1 590.6
Europe 13.7 10.2 39.8 12.1
Canada 12.0 9.7 32.6 30.1
Mexico 7.3 4.1 20.4 11.3
Japan 2.7 2.4 7.6 7.2
Other 2.2 0.5 3.3 1.5
------------------- ----------------- ------------------ ----------------------
Totals $ 234.9 216.1 695.8 652.8
=================== ================= ================== ======================
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 September 30, At December 31,
(Dollars in millions) 2002 2001
-------------------------- -----------------------------
United States $ 94.4 98.7
Europe 21.0 20.9
Canada 0.1 0.1
Japan 1.5 1.1
-------------------------- -----------------------------
Totals $ 117.0 120.8
========================== =============================
Major Customers
For the three months ended September 30, 2002, the Company had two major
customers which accounted for approximately 31.4%, or $73.5 million, of total
revenues. For the three months ended September 30, 2001, TSYS had two major
customers that accounted for 36.7%, or $79.2 million, of total revenues.
Revenues from major customers for the periods reported are attributable to the
domestic-based processing services segments.
Three Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
Revenue % of Total % of Total
(Dollars in millions) Dollars Revenues Dollars Revenues
------------------------------------- -------------------------------------
One $ 42.6 18.2 % $ 38.9 18.0 %
Two 30.9 13.2 40.3 18.7
------------------------------- -------------------------------
Totals $ 73.5 31.4 % $ 79.2 36.7 %
=============================== ===============================
- 11 -
Notes to Unaudited Consolidated Financial Statements (continued)
For the nine months ended September 30, 2002, the Company had two major
customers which accounted for approximately 33.4%, or $232.3 million, of total
revenues. For the nine months ended September 30, 2001, TSYS had two major
customers that accounted for 37.1%, or $242.0 million, of total revenues.
Revenues from major customers for the periods reported are attributable to the
domestic-based processing services segments.
Nine Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
Revenue % of Total % of Total
(Dollars in millions) Dollars Revenues Dollars Revenues
------------------------------------- -------------------------------------
One $ 133.1 19.1 % $ 120.5 18.5 %
Two 99.2 14.3 121.5 18.6
------------------------------- -------------------------------
Totals $ 232.3 33.4 % $ 242.0 37.1 %
=============================== ===============================
Note 5 - Supplementary Cash Flow Information
Cash flows used in additions to computer software for the nine months ended
September 30, 2002 and 2001 are summarized as follows:
September 30, 2002 September 30, 2001
------------------------- -----------------------------
Purchased programs $ 20,686,317 $ 25,811,213
Developed software 21,572,646 8,255,226
------------------------- -----------------------------
Total $ 42,258,963 $ 34,066,439
========================= =============================
Cash flows used in additions to contract acquisition costs for the nine
months ended September 30, 2002 and 2001 are summarized as follows:
September 30, 2002 September 30, 2001
------------------------- -----------------------------
Payments for processing rights $ 22,941,138 $ 3,844,447
Conversion costs 11,375,786 8,865,470
------------------------- -----------------------------
Total $ 34,316,924 $ 12,709,917
========================= =============================
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.
- 12 -
Notes to Unaudited Consolidated Financial Statements (continued)
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. 144 (SFAS144), "Accounting for the Impairment or Disposal of
Long-Lived Assets." The Company adopted SFAS 142 January 1, 2002.
At September 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 nine months ended
September 30, 2002, respectively. Amortization expense related to goodwill was
$214,000 and $642,000 for the three and nine months ended September 30, 2001,
respectively.
The Company's transitional and annual impairment analyses of its
unamortized goodwill balance did not result in any impairment.
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 does not anticipate the expected obligation to have a significant
impact upon the Company's financial condition or results of operations as a
result of adopting SFAS 143.
In October 2001, the FASB issued SFAS 144, which 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.
- 13 -
Notes to Unaudited Consolidated Financial Statements (continued)
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.
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.
- 14 -
Notes to Unaudited Consolidated Financial Statements (continued)
Presented below are the pro forma consolidated results of TSYS' operations
for the three months and nine months ended September 30, 2002 and 2001,
respectively, as though the acquisition of TDM had occurred at the beginning of
2001. This pro forma information is based on the historical financial statements
of TDM. Pro forma results do not include any actual or anticipated cost savings
or expenses of the planned integration of TSYS and TDM, and are not necessarily
indicative of the results which would have occurred if the business combination
had been in effect on the dates indicated, or which may result in the future.
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------------- --------------------------------------------
2002 2001 2002 2001
------------------ ------------------------- ----------------- --------------------------
Revenues $ 234,931,733 220,219,164 695,771,563 665,124,480
Net income 32,346,538 25,693,039 88,590,220 74,269,748
Basic earnings per share 0.16 0.13 0.45 0.38
Diluted Earnings per share 0.16 0.13 0.45 0.38
Note 10 - Subsequent Event: ProCard, Inc. Acquisition
On November 1, 2002, TSYS completed the acquisition of ProCard, Inc.
(ProCard) from its majority shareholder, Synovus, for $30.0 million in cash.
ProCard is a leader in customized, Internet, Intranet and client/server software
solutions for commercial card management programs. Due to the technological
nature of the business, TSYS has assisted in the management of ProCard since
Synovus acquired it in May 2000. Revenues associated with ProCard's business
will be recorded in electronic payment processing services and will be
classified in domestic-based processing services for segment reporting.
Because the acquisition of ProCard was a transaction between entities under
common control, the Company is reflecting the acquisition at historical cost in
accordance with SFAS 141. In accordance with the provisions of SFAS 141, TSYS
will restate its financial statements for the periods that Synovus controlled
both ProCard and TSYS.
- 15 -
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 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 $8.3 million and $5.4 million
at September 30, 2002 and December 31, 2001, respectively. The allowance
represents 6.5% and 4.5% of total accounts receivable at September 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
- 16 -
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 large 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.
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. 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 determination of expected
undiscounted net operating cash flows requires management to make estimates.
- 17 -
Critical Accounting Policies (continued)
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
undiscounted 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 and decreases 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
- 18 -
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. 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 financial statement 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.
- 19 -
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 ranging from 45 basis points to 135 basis
points. 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 in the process of renewing the
lease for a period up to 12 months. Under the proposed 12-month renewal,
payments under the operating lease arrangement will be tied to the LIBOR plus a
margin ranging from 95 basis points to 185 basis points. The Company is
currently evaluating its financing alternatives for 2003 after the renewal
period expires but expects to refinance in a manner in which operating expenses
are estimated to increase.
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.
- 20 -
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 September 30, 2002 and 2001:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2002 2001 2002 vs. 2001
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 65.2 % 65.5 % 8.2 %
Other services 10.8 9.1 29.9
---------- ---------
Revenues before reimbursable items 76.0 74.6 10.8
Reimbursable items 24.0 25.4 2.4
------------- ----------
Total revenues 100.0 100.0 8.7
------------- ----------
Expenses:
Salaries and other personnel expense 32.3 30.9 13.5
Net occupancy and equipment expense 18.7 19.1 6.2
Other operating expenses 8.0 9.1 (2.7)
------------- ----------
Expenses before reimbursable items 59.0 59.1 8.6
Reimbursable items 24.0 25.4 2.4
------------- ----------
Total expenses 83.0 84.5 6.8
------------- ----------
Equity in income of joint ventures 2.2 2.1 14.3
------------- ----------
Operating income 19.2 17.6 18.7
Nonoperating income 1.2 0.3 nm
------------- ----------
Income before income taxes 20.4 17.9 24.2
Income taxes 6.6 6.1 18.7
------------- ----------
Net income 13.8 % 11.8 % 27.1 %
============= ==========
nm = not meaningful
- 21 -
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 nine months ended September 30, 2002 and 2001:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2002 2001 2002 vs. 2001
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 63.4 % 63.0 % 7.4 %
Other services 11.7 9.9 25.2
------------- ----------
Revenues before reimbursable items 75.1 72.9 9.9
Reimbursable items 24.9 27.1 (2.2)
------------- ----------
Total revenues 100.0 100.0 6.6
------------- ----------
Expenses:
Salaries and other personnel expense 30.6 29.2 11.5
Net occupancy and equipment expense 18.5 19.3 1.9
Other operating expenses 9.9 9.5 13.2
------------- ----------
Expenses before reimbursable items 59.0 58.0 8.5
Reimbursable items 24.9 27.1 (2.2)
------------- ----------
Total expenses 83.9 85.1 5.1
------------- ----------
Equity in income of joint ventures 2.1 1.9 18.9
------------- ----------
Operating income 18.2 16.8 15.5
Nonoperating income 0.6 0.3 91.9
------------- ----------
Income before income taxes 18.8 17.1 16.9
Income taxes 6.1 5.9 9.8
------------- ----------
Net income 12.7 % 11.2 % 20.6 %
============= ==========
Revenues
Total revenues increased $18.8 million, or 8.7%, and $43.0 million, or
6.6%, during the three and nine months ended September 30, 2002, respectively,
compared to the same periods in 2001. Excluding reimbursable items, revenues
increased $17.5 million, or 10.8%, and $46.9 million, or 9.9%, during the three
and nine months ended September 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, and through its joint venture, Vital Processing
Services, LLC (Vital).
- 22 -
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 $11.6
million, or 8.2%, and $30.6 million, or 7.4%, for the three and nine months
ended September 30, 2002, respectively, compared to the same periods 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 bureaus requested, 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, student loan 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.
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:
- 23 -
Results of Operations (continued)
Accounts on File by Type September 30, 2002 September 30, 2001
----------------------------------- ---------------------------- -------------------------- ----------------
(in millions) Number % Number % % Change
------------- -------------- ------------ ------------- ----------------
Consumer 141.0 59.8 117.4 55.2 20.1
Retail 75.4 32.0 77.4 36.5 (2.6)
Commercial 19.4 8.2 17.6 8.3 10.1
----------------------------------- ------------- -------------- ------------ -------------
Total 235.8 100.0 212.4 100.0 11.0
============= ============== ============ =============
Average cardholder accounts on file for the three months ended September
30, 2002 were 231.8 million, an increase of approximately 10.0% over the average
of 210.7 million for the same period in 2001. Average cardholder accounts on
file for the nine months ended September 30, 2002 were 228.4 million, an
increase of approximately 12.7% over the average of 202.7 million for the same
period in 2001. Cardholder accounts on file at September 30, 2002 were 235.8
million, a 11.0% increase compared to the 212.4 million accounts on file at
September 30, 2001. The change in cardholder accounts on file from September
2001 to September 2002 included the deconversion and purging of 11.0 million
accounts, the addition of approximately 22.2 million accounts attributable to
the internal growth of existing clients, and approximately 12.2 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 origination
loans for the Department of Education on April 26, 2002, and is currently
processing 3.9 million accounts. The agreement also involves converting all
existing student accounts to TSYS' new stand-alone platform during several
phases. The conversion phases are scheduled to be completed in the third quarter
of 2003, and TSYS estimates it should have a total of 9 million accounts after
completion of these conversions.
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 consumer cards 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.
TSYS' largest retail client has converted approximately 15.0 million
accounts of its portfolio from traditional retail accounts to consumer accounts
since September 2001. The same retail client has purged approximately 1.5
million inactive retail accounts on file.
- 24 -
Results of Operations (continued)
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 and third quarters of 2002, Charming Shoppes purged approximately 6
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 based on the
geographic domicile of processing clients:
Accounts on File by Area September 30, 2002 September 30, 2001
-------------------------------- ----------------------------- -------------------------- ------------
(in millions) Number % Number % % Change
----------------------------- -------------------------- ------------
Domestic 206.5 87.6 185.8 87.5 11.2
Foreign 29.3 12.4 26.6 12.5 10.0
-------------------------------- ----------------------------- ---------------------------
Total 235.8 100.0 212.4 100.0 11.0
============================= ===========================
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. 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 processing
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 September 30,
2002 and 2001, value added products and services represented 13.3% and 12.4%, or
$31.3 million and $26.9 million, of total revenues, respectively. For the nine
months ended September 30, 2002 and 2001, value added products and services
represented 12.7% and 11.8%, or $88.5 million and $76.7 million, of total
revenues, respectively. Revenues from value added products and services
increased 16.5%, or $4.4 million, for the three months ended September 30, 2002,
compared to the same period in 2001. Revenues from value added products and
services increased 15.4%, or $11.8 million, for the nine months ended September
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
- 25 -
Results of Operations (continued)
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 nine
months ended September 30, 2001, the Company recognized, as a result of the
change, ten 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 $5.9
million, or 29.9%, in the third quarter of 2002, compared to the third quarter
of 2001. Revenues from other services increased $16.3 million, or 25.2%, for the
first nine 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. 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 nine months ended September 30, 2002, TDM's revenues were
approximately $4.7 million and $15.1 million, respectively. Other services
revenues related to call center and business process management were
approximately the same for the third quarter of 2002 compared to the same period
last year.
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 increased $1.3 million,
or 2.4%, for the three months ended September 30, 2002, as compared to the same
period last year. Reimbursable items decreased $3.9 million, or 2.2%, for the
nine months ended September 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.
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 September 30, 2002, the Company had two major customers. The two
major customers for the quarter ended September 30, 2002 accounted for
approximately 31.4%, or $73.5 million, of total revenues. For the three months
ended September 30, 2001, TSYS had two major customers that accounted for 36.7%,
or
- 26 -
Results of Operations (continued)
$79.2 million, of total revenues. The two major customers for the nine months
ended September 30, 2002 accounted for approximately 33.4%, or $232.3 million,
of total revenues. For the nine months ended September 30, 2001, TSYS had two
major customers that accounted for 37.1%, or $242.0 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 its Gateway
Master Trust portfolio. Based on 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 6.8% and 5.1% for the three and nine months ended
September 30, 2002, respectively, compared to the same periods in 2001.
Excluding reimbursable items, total expenses increased 8.6% and 8.5% for the
three and nine months ended September 30, 2002, respectively, compared to the
same periods in 2001. The increases in operating expenses are attributable to
changes in each of the expense categories as described below.
Employment expenses increased $9.0 million, or 13.5%, for the three months
ended September 30, 2002, compared to the same period in 2001. Employment
expenses increased $22.0 million, or 11.5%, for the nine months ended September
30, 2002, compared to the same period in 2001. The addition of employees
associated with the acquisition of TDM increased employment expenses $2.6
million and $8.9 million for the three months and nine months ended September
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 third quarter of 2002 increased to 5,073,
a 5.0% increase over 4,833 in the same period of 2001. The average number of
employees for the first nine months of 2002 increased to 5,134, an 7.1% increase
over 4,794 in the same period of 2001. At October 31, 2002, TSYS had 4,982
full-time and 227 part-time employees.
Net occupancy and equipment expense increased $2.6 million, or 6.2%, for
the three months ended September 30, 2002, and increased $2.3 million, or 1.9%,
for the nine months ended September 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
- 27 -
Results of Operations (continued)
and equipment expense, increased approximately $277,000 in the third quarter of
2002, compared to the same period of 2001. Computer equipment and software
rentals decreased approximately $3.3 million in the first nine months of 2002,
compared to the same period of 2001. The decrease is the result of legislation
whereby TSYS recouped approximately $4.0 million of sales and use tax paid and
expensed in 2001. Depreciation and software amortization increased $1.9 million
and $4.6 million during the three and nine months ended September 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 nine months of 2001, the Company incurred $9.4
million of net operating expense related to the expansion in Europe.
Other operating expenses for the third quarter of 2002 decreased $523,000,
or 2.7%, compared to the same period in 2001. Other operating expenses for the
first nine months of 2002 increased $8.1 million, or 13.2%, compared to the same
period in 2001. The increase for the nine month period ended September 30, 2002
is primarily related to an increase in transaction processing provision expense.
Other operating expenses include, among other things, charges for
processing errors, contractual commitments and bad debt expense. As described in
the Critical Accounting Policies section, management's evaluation of the
adequacy of its transaction processing reserves and allowance for doubtful
accounts is based on a formal analysis which assesses the probability of losses
related to contractual contingencies, processing errors and uncollectible
accounts. Increases and decreases in transaction processing provisions and
charges for bad debt expense are reflected in other operating expenses.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $5.3 million
and $4.6 million for the third quarters of 2002 and 2001, respectively. TSYS'
share of income from its equity in joint ventures was $14.6 million and $12.3
million for the first nine months of 2002 and 2001, respectively. The increase
for the quarter is attributable mainly to Vital.
The Company considers Vital to be an integral part of its overall
processing operations and an important part of its overall market strategy.
Prior to forming the joint venture, TSYS performed back-end merchant processing
services for its clients. The revenues and expenses associated with merchant
processing were included in operating profits. In 1996, the Company formed Vital
with Visa U.S.A. in order to expand its merchant processing business. The
majority of Vital's clients are issuing clients of TSYS. TSYS remains involved
in the daily processing of Vital's merchant clients, and embedded within TSYS'
operating expenses are expenses related to merchant processing. In its ordinary
course of business, TSYS, which still owns the merchant processing software,
provides back-end processing services to Vital. For the three and nine months
ended September 30, 2002, TSYS generated $4.0 million and $11.4 million of
revenue from Vital, respectively. For the three and nine months ended September
30, 2001, TSYS generated $3.0 million and $9.1 million of revenue from Vital,
respectively.
- 28 -
Results of Operations (continued)
During the three months ended September 30, 2002, the Company's equity in
income of joint ventures related to Vital was $5.0 million, a 20.7% increase, or
$866,000, compared to $4.2 million for the same period last year. During the
nine months ended September 30, 2002, the Company's equity in income of joint
ventures related to Vital was $14.0 million, a 30.1% increase, or $3.3 million,
compared to $10.7 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
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 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 September 30, 2002, the Company's equity
in income of joint ventures related to TSYS de Mexico was $218,000, a 48.6%
decrease, or $206,000, compared to $424,000 for the same period last year.
During the nine months ended September 30, 2002, the Company's equity in income
of joint ventures related to TSYS de Mexico was $679,000, a 56.9% decrease, or
$898,000, compared to $1.6 million for the same period last year. Electronic
payment processing revenues from clients based in Mexico was $7.3 million for
the third quarter ended September 30, 2002, a 78.3% increase over the $4.1
million for the third quarter ended September 30, 2001. Electronic payment
processing revenues from clients based in Mexico was $20.4 million for the first
nine months of September 30, 2002, an 80.1% increase over the $11.3 million for
the same period last year. The increase in revenues is attributable to increased
account on file growth of approximately 44.1% 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.
However, the client has indicated that the deconversion may be delayed until the
second quarter of 2003. The client in Mexico represents approximately 56% of
TSYS' revenues from Mexico. 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.
- 29 -
Results of Operations (continued)
As a result of the restructuring of its joint agreement, TSYS agreed to pay
TSYS de Mexico a processing support fee for certain client relationship and
network services that TSYS de Mexico has assumed from TSYS. TSYS paid TSYS de
Mexico a management fee of $231,000 and $685,000 for the three and nine months
ended September 30, 2002, respectively.
Operating Income
Operating income increased 18.7% for the three months ended September 30,
2002, over the same period in 2001. Operating income increased 15.5% for the
nine months ended September 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 19.3% and 15.0% for the
three and nine months ended September 30, 2002, respectively, over the same
periods in 2001.
The Company's operating profit margin for the third quarter of 2002 was
19.2%, compared to 17.6% for the same period last year. The Company's operating
profit margin for the first nine months of 2002 was 18.2%, compared to 16.8% for
the same period last year. Excluding reimbursable items, the Company's operating
profit margin for the three and nine months ended September 30, 2002 was 25.3%
and 24.3%, respectively, compared to 23.6% and 23.1% for the three and nine
months ended September 30, 2001, respectively. The Company's focus on expense
control was the main reason for the improved margin.
Nonoperating Income
Interest income, net, includes interest income of $720,000 and no interest
expense for the third quarter of 2002. During the third quarter of 2001,
interest income, net, included interest income of $626,000 and $29,000 of
interest expense. During the first nine months of 2002, interest income, net,
included interest income of $2.1 million and $6,000 of interest expense. During
the first nine months of 2001, interest income, net, included interest income of
$2.3 million and $31,000 of interest expense. The increase in interest income
for the three months ending September 30, 2002, as compared to the same period
in 2001, was primarily the result of higher cash balances available for
investment.
In July 2002, the Company restructured a portion of its permanent financing
of its UK operation as an intercompany loan. The financing requires the unit to
repay the financing in US dollars. The functional currency of the European
operations is the British Pound Sterling. As the Company translates the European
operations statements into US dollars, the translated balance of the financing
(liability) is adjusted upwards or downwards to match the US-dollar obligation
(receivable) on the Company's financial statement. The upwards or downwards
adjustment is recorded as a gain or loss on foreign currency translation. As a
result of the restructuring, the Company recorded a foreign currency translation
gain of $2.1 million on the Company's financing with its European operations
during the third quarter of 2002. The balance of the financing at September 30,
2002 was approximately $13.2 million.
As a result of the restructuring of a portion of its UK investment, the
Company has a greater exposure to currency risk. The Company is exploring
potential hedging instruments to safeguard it from significant currency
translation risks.
- 30 -
Results of Operations (continued)
Income Taxes
TSYS' effective income tax rate for the three months ended September 30,
2002 was 32.6%, compared to 34.1% for the same period in 2001. TSYS' effective
income tax rate for the first nine months of 2002 was 32.4%, compared to 34.5%
for the same period in 2001. The decrease was the result of additional tax
credits realized 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 September 30, 2002 increased 27.1% to
$32.3 million, or basic and diluted earnings per share of $0.16, compared to
$25.5 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 third quarter of 2002
was 13.8%, compared to 11.8% for the same period last year. Excluding
reimbursable items, the Company's net profit margin for the third quarter of
2002 was 18.1%, compared to 15.8% for the three months ended September 30, 2001.
Net income for the first nine months ended September 30, 2002 increased
20.6% to $88.6 million, or basic and diluted earnings per share of $0.45,
compared to $73.4 million, or basic and diluted earnings per share of $0.38, for
the same period in 2001. The Company's net profit margin for the first nine
months of 2002 was 12.7%, compared to 11.3% for the same period last year.
Excluding reimbursable items, the Company's net profit margin for the first nine
months of 2002 was 17.0%, compared to 15.4% for the nine months ended September
30, 2001.
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 240 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
TSYS expects its 2003 net income to exceed its 2002 net income by 12-15%.
The assumptions underlying 2003's net income forecast are an increase in
revenues (excluding reimbursables) between 9-10%, an internal growth rate of
accounts of existing clients of approximately 11% and a continued focus on
expense management. Although TSYS remains optimistic about the possibilities of
signing a major client, this forecast does not include any revenues or expenses
associated with signing and converting a major client. 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.
- 31 -
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.
Free Cash Flow
For the first nine months of 2002, TSYS generated a positive free cash flow
of $70.7 million, compared to a negative free cash flow of $6.5 million for the
same period last year. The components of free cash flow for the nine months
ended September 30, 2002 and 2001 are:
------------------------------------------------- ----------------------------------------
Nine Months Ending Sept 30,
----------------------------------------
2002 2001
------------------------------------------------- ------------------- --------------------
Free Cash Flow:
------------------------------------------------- ------------------- --------------------
Cash Provided by Operating Activities $133.5 $54.0
Cash Dividends Received/Acquired $23.4 $10.4
Cash for Property/Software Additions ($51.9) ($58.2)
Cash for Contract Acquisition ($34.3) ($12.7)
------------------------------------------------- ------------------- --------------------
Free Cash Flow: $70.7 ($ 6.5)
------------------------------------------------- ------------------- --------------------
Cash Flows From Operating Activities
TSYS' main source of funds is derived from operating activities,
specifically net income and cash received as dividends from joint ventures.
During the three months ended September 30, 2002, the Company generated $61.9
million in cash from operating activities compared to $37.0 million for the same
period last year. For the first nine months of 2002, the Company generated a
total of $156.9 million in cash from operating activities, cash dividends
received from joint ventures and cash acquired through acquisitions, compared to
a total of $64.4 million for the same period last year.
TSYS' net cash provided by operating activities for the first nine months
of 2002 was $133.5 million, compared to $54.0 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.
Cash Flows Used In Investing Activities
Cash is used to fund new property, plant and equipment additions, as well
as to fund new software purchases and software development. The Company used
$12.0 million in cash for property, equipment and software additions for the
three months ended September 30, 2002, compared to $12.7 million for the three
months ended September 30, 2001. For the first nine months of 2002 and 2001, the
Company used $51.9 and $58.2 million, respectively, for the purchase of
property, equipment and software.
- 32 -
Liquidity and Capital Resources (continued)
Property, Plant and Equipment
During the third quarter of 2002, TSYS purchased property and equipment of
$3.7 million, compared to $8.4 million during the same period last year. During
the first nine months of 2002, TSYS purchased property and equipment of $9.6
million, compared to $24.1 million during the same period last year.
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.
Software
Expenditures for purchased computer software were $2.6 million for the
three months ended September 30, 2002, compared to $3.1 million for the same
period in 2001. Expenditures for purchased computer software were $20.7 million
for the nine months ended September 30, 2002, compared to $25.8 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 period ending September 30, 2002, compared to $1.2
million for the same period in 2001. Additions to capitalized software
development costs were $21.6 million for the nine month period ending September
30, 2002, compared to $8.3 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 September 30, 2002, the Company
capitalized $912,000, bringing the total capitalized in 2002 to $4.9 million.
The Company has capitalized a total of $8.8 million since the project began. The
Company completed the core double-byte architecture during the second quarter of
2002.
The Company is in the final stages of developing a new commercial card
system, which is built upon the architectural design of TS2. The new system
provides enhanced reporting multi-languages/currencies, and global commercial
card processing for multinational corporations on a single platform. The Company
capitalized approximately $738,000 for the three months ended September 30,
2002, bringing the total capitalized in 2002 to $3.0 million, related to this
new processing platform. The Company has capitalized a total of $36.4 million
since the project began.
- 33 -
Liquidity and Capital Resources (continued)
The Company expects to complete the system and make it available for general use
in 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 $1.5 million
for the three months ended September 30, 2002 on these additional systems,
bringing the total capitalized in 2002 to $4.4 million. The Company has
capitalized a total of $6.7 million since the project began. The Company expects
to complete the system in phases. Phase 1 is expected to be completed by the end
of the second quarter of 2003.
The Company continues to develop 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 is currently being offered to TSYS' existing clients. Continued
development of TSYS ProphIT will add increased and enhanced functionality to the
core platform and allow TSYS to offer TSYS ProphIT to much broader markets, such
as financial services, insurance, utilities, telecommunications and health care.
The Company capitalized approximately $2.3 million for the three months ended
September 30, 2002 on TSYS ProphIT, bringing the total capitalized in 2002 to
$8.3 million. The Company has capitalized a total of $12.5 million since the
project began. The Company has issued two releases of TSYS ProphIT and
anticipates introducing future releases as the enhancements are completed.
Contract Acquisition Costs
Occasionally, TSYS will use 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.
For the three and nine months ended September 30, 2002, TSYS used $6.6 million
and $34.3 million, respectively, for contract acquisition costs. For the three
and nine months ended September 30, 2001, TSYS used $1.0 million and $12.7
million, respectively, for contract acquisition costs.
During the three months ended September 30, 2002, the Company made
investments in contract acquisition costs of $6.6 million compared to $1.0
million for the same period in 2001. During the nine months ended September 30,
2002, the Company made investments in contract acquisition costs of $34.3
million compared to $12.7 million for the same period in 2001. Included in the
$34.3 million investment for contract acquisition costs for the first nine
months of 2002 are cash payments to clients for processing rights of $22.9
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.
Cash Flows Used In Financing Activities
The Company's main use of cash in financing activities are the payment of
dividends. Dividends on common stock of $3.4 million were paid in the third
quarter of 2002, bringing the total paid in 2002 to $9.3 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.
- 34 -
Liquidity and Capital Resources (continued)
Additional Cash Flow Information
Off-Balance Sheet Financing
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 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 ranging from 45 basis points to 135 basis
points. 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 in the process of renewing the
lease for a period up to 12 months. Under the proposed 12-month renewal,
payments under the operating lease arrangement will be tied to the LIBOR plus a
margin ranging from 95 basis points to 185 basis points. The Company is
currently evaluating its financing alternatives for 2003 after the renewal
period expires but expects to refinance in a manner in which operating expenses
are estimated to increase.
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.
Significant Noncash Transaction
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 included 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 $1.1 million for the three and nine months ended
September 30, 2001, respectively.
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 now operates as a wholly owned subsidiary of TSYS. This transaction
increased Synovus' ownership of TSYS to 81.1% in 2002.
- 35 -
Liquidity and Capital Resources (continued)
Subsequent Event
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 September 30, 2002 and 2001. For the first nine months of 2002 and 2001,
the Company was paid a management fee of $227,000 by Synovus.
On October 15, 2002 the board of directors of TSYS approved the purchase of
ProCard from Synovus for $30.0 million in cash. On November 1, 2002, TSYS
completed the acquisition.
Because the acquisition of ProCard was a transaction between entities under
common control, the Company is reflecting the acquisition at historical cost in
accordance with SFAS 141. In accordance with the provisions of SFAS 141, TSYS
will restate its financial statements for the periods that Synovus controlled
both ProCard and TSYS.
Foreign Exchange
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.
In July 2002, the Company restructured a portion of its permanent financing
of its UK operation as an intercompany loan. The financing requires the unit to
repay the financing in US dollars. The functional currency of the European
operations is the British Pound Sterling. As the Company translates the European
operations statements into US dollars, the translated balance of the financing
(liability) is adjusted upwards or downwards to match the US-dollar obligation
(receivable) on the Company's financial statement. The upwards or downwards
adjustment is recorded as a gain or loss on foreign currency translation. As a
result of the restructuring, the Company recorded a foreign currency translation
gain of $2.1 million on the Company's financing with its European operations
during the third quarter of 2002. The balance of the financing at September 30,
2002 was approximately $13.2 million.
As a result of the restructuring of a portion of its UK investment, the
Company has a greater exposure to currency risk. The Company is exploring
potential hedging instruments to safeguard it from significant currency
translation risks.
Impact of Inflation
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.
- 36 -
Liquidity and Capital Resources (continued)
Working Capital
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 September 30, 2002, TSYS had working capital of
$166.3 million compared to $108.4 million at December 31, 2001.
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. 144 (SFAS144), "Accounting for the Impairment or Disposal of
Long-Lived Assets." The Company adopted SFAS 142 January 1, 2002.
At September 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 nine months ended
September 30, 2002, respectively. Amortization expense related to goodwill was
$214,000 and $642,000 for the three and nine months ended September 30, 2001,
respectively.
- 37 -
Recent Accounting Pronouncements (continued)
The Company's transitional and annual impairment analyses of its
unamortized goodwill balance did not result in any impairment. Management does
not expect its annual impairment analysis will result in any impairment.
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 does not anticipate the expected obligation to have a significant
impact upon the Company's financial condition or results of operations as a
result of adopting SFAS 143.
In October 2001, the FASB issued SFAS 144, which 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.
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.
- 38 -
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 the impact of recent accounting pronouncements on 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 the years 2002
and 2003, expected completion dates for new processing systems and the
assumptions underlying such statements, including, with respect to TSYS'
expected increase in net income for 2003; an increase in revenues (excluding
reimbursables) between 9-10%; an internal growth rate of accounts of existing
clients of approximately 11%; and continued aggressive expense management. 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 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'
- 39 -
Forward-Looking Statements (continued)
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;
(xx) hostilities in the Middle East or elsewhere; (xxi) Vital's earnings are
lower than anticipated; and (xxii) 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.
- 40 -
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 months ended September 30, 2002 was
$70,500, compared to $2.1 million for the three months ended September 30, 2001.
The amount of other comprehensive income for the nine months ended September 30,
2002 was $3.1 million, as compared to other comprehensive loss of $734,000 for
the same period last year. 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) $70.3 million, $3.3
million, $78,000 and $8.4 million, respectively, at September 30, 2002.
In July 2002, the Company restructured a portion of its permanent financing
of its UK operation as an intercompany loan. The financing requires the unit to
repay the financing in US dollars. The functional currency of the European
operations is the British Pound Sterling. As the Company translates the European
operations statements into US dollars, the translated balance of the financing
(liability) is adjusted upwards or downwards to match the US-dollar obligation
(receivable) on the Company's financial statement. The upwards or downwards
adjustment is recorded as a gain or loss on foreign currency translation. As a
result of the reclass, the Company recorded a foreign currency translation gain
of $2.1 million on the Company's financing with its European operations during
the third quarter of 2002. The balance of the financing at September 30, 2002
was approximately $13.2 million.
Currently, there are no regularly scheduled payments under the financing
arrangement, although the balance is expected to be repaid over time. The
following represents the potential effect on income before income taxes of
hypothetical shifts in the foreign currency exchange rate between the British
Pound Sterling and the U.S. dollar of plus or minus 100 basis points, 500 basis
points and 1,000 points based on the intercompany loan balance at September 30,
2002.
------------------------------------------------
Effect of a Basis Point Change of :
------------------------------------------------
+/- 100 +/- 500 +/- 1,000
--------------- --------------- ----------------
Effect on income before income taxes $ 131,600 658,000 1,316,000
--------------- --------------- ----------------
The foreign currency risks associated with other balance sheet accounts is not
significant.
- 41 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk (continued)
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 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 in the process of renewing the
lease for a period up to 12 months. Under the proposed 12-month renewal,
payments under the operating lease arrangement will be tied to the LIBOR plus a
margin ranging from 95 basis points to 185 basis points. The Company is
currently evaluating its financing alternatives for 2003 after the renewal
period expires, but expects to refinance in a manner in which operating expenses
are estimated to increase.
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.
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.
- 42 -
TOTAL SYSTEM SERVICES, INC.
Item 4 - Management's Analysis of Disclosure Controls and Procedures
As required by SEC rules, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures within 90 days of the
filing date of this quarterly report. This evaluation was carried out under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer. Based on this
evaluation, these officers have concluded that the design and operation of our
disclosure controls and procedures are effective. There were no significant
changes to our internal controls or in other factors that could significantly
affect internal controls subsequent to the date of their evaluation.
- 43 -
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 October 15, 2002 included the following
important event:
On October 15, 2002, Total System Services, Inc.
("Registrant") issued a press release with respect to its
third quarter 2002 earnings.
- 44 -
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: November 13, 2002 by: /s/ Richard W. Ussery
----------------------------
Richard W. Ussery
Chairman of the Board
and Chief Executive Officer
Date: November 13, 2002 by: /s/ James B. Lipham
----------------------------
James B. Lipham
Chief Financial Officer
- 45 -
TOTAL SYSTEM SERVICES, INC.
Chief Executive Officer Certification
I, Richard W. Ussery, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Total System
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002
/s/ Richard W. Ussery
------------------------
Richard W. Ussery
Chief Executive Officer
- 46 -
TOTAL SYSTEM SERVICES, INC.
Chief Financial Officer Certification
I, James B. Lipham, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Total System
Services, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 13, 2002
/s/ James B. Lipham
------------------------
James B. Lipham
Chief Financial Officer
- 47-
TOTAL SYSTEM SERVICES, INC.
Exhibit Index
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
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