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: March 31, 2005
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from To
------------------------------------------------
Commission file number 1-10254
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TSYS LOGO (OBJECT OMITTED)
Total System Services, Inc.
www.tsys.com
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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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
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: May 4, 2005
--------------------------------- -------------------------------
Common Stock, $.10 par value 197,075,431
Page 1
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - March 31, 2005 and December 31, 2004 3
Consolidated Statements of Income (unaudited) - Three months ended
March 31, 2005 and 2004 5
Consolidated Statements of Cash Flows (unaudited) - Three months ended
March 31, 2005 and 2004 6
Notes to Unaudited Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
operations 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
Item 4. Controls and Procedures 42
Part II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 43
Item 6. Exhibits 44
Signatures 45
Exhibit Index 46
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
(in thousands, except per share information) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $26.3 million and $176.6 million on
on deposit with a related party at 2005 and 2004, respectively) $ 97,916 231,806
Restricted cash (includes $5.6 million and $5.7 million on deposit with a
related party at 2005 and 2004, respectively) 29,107 24,993
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $14.5 million and $6.8 million at 2005 and 2004, respectively;
(includes $1.6 million and $0.9 million from a related party at 2005 and
2004, respecitively) 192,008 144,827
Deferred income tax assets 8,757 10,791
Prepaid expenses and other current assets 43,053 35,739
--------------------------------------------
Total current assets 370,841 448,156
Property and equipment, net of accumulated depreciation and amortization of
$165.4 million and $158.7 million at 2005 and 2004, respectively 274,704 263,584
Computer software, net of accumulated amortization of $267.8 million and $252.9
million at 2005 and 2004, respectively 294,663 268,647
Contract acquisition costs, net 164,360 132,428
Goodwill, net 113,548 70,561
Other intangible assets, net of accumulated amortization of $2.8 million and
million and $2.2 million at 2005 and 2004, respectively 16,173 4,692
Equity investments 4,987 54,400
Other assets 37,750 39,475
--------------------------------------------
Total assets $ 1,277,029 1,281,943
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Balance Sheets (continued)
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
(in thousands, except per share information) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable (includes $0.3 million payable to related parties at 2005
and 2004, respectively) $ 39,370 75,188
Accrued salaries and employee benefits 30,434 46,725
Current portion of long-term debt, obligations under capital leases and
software obligations 1,930 1,828
Other current liabilities (includes $6.4 million and $6.6 million payable to
related parties at 2005 and 2004, respectively) 156,932 154,162
--------------------------------------------
Total current liabilities 228,666 277,903
Obligations under capital leases and software obligations, excluding current
portion 3,891 4,508
Long-term debt (includes $1.0 million payable to related parties at 2005) 1,317 -
Deferred income tax liabilities 138,323 131,106
--------------------------------------------
Total liabilities 372,197 413,517
--------------------------------------------
Minority interests in consolidated subsidiaries 3,850 3,814
--------------------------------------------
Shareholders' equity:
Common stock - $.10 par value. Authorized 600,000 shares; 197,809 and 197,587
issued at 2005 and 2004, respectively; 197,071 and 196,849 outstanding at
2005 and 2004, respectively 19,781 19,759
Additional paid-in capital 45,262 44,732
Accumulated other comprehensive income 12,950 15,373
Treasury stock (shares of 738 held at 2005 and 2004, respectively) (13,573) (13,573)
Retained earnings 836,562 798,321
--------------------------------------------
Total shareholders' equity 900,982 864,612
--------------------------------------------
Total liabilities and shareholders' equity $ 1,277,029 1,281,943
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
Three months ended
March 31,
----------------------------------
(in thousands, except per share information) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $1.2 million and $1.1
million from related parties for 2005 and 2004, respectively) $ 204,757 177,392
Merchant services (includes $2.4 million and $3.2 million from related parties
for 2005 and 2004, respectively) 27,105 6,364
Other services (includes $1.5 million and $1.6 million from related parties
for 2005 and 2004, respectively) 48,514 40,848
--------------------------------------------
Revenues before reimbursable items 280,376 224,604
Reimbursable items (includes $1.8 million and $2.3 million from related
parties for 2005 and 2004, respectively) 69,608 60,632
--------------------------------------------
Total revenues 349,984 285,236
--------------------------------------------
Expenses:
Salaries and other personnel expense 97,517 87,862
Net occupancy and equipment expense 65,393 58,049
Other operating expenses (includes $2.0 million and $2.3 million to related
parties for 2005 and 2004, respectively) 51,160 34,551
--------------------------------------------
Expenses before reimbursable items 214,070 180,462
Reimbursable items 69,608 60,632
--------------------------------------------
Total expenses 283,678 241,094
--------------------------------------------
Operating income 66,306 44,142
--------------------------------------------
Nonoperating income (expense):
Interest income (includes $511 and $176 from related parties for 2005 and 2004,
respectively) 1,219 505
Interest expense (70) (743)
Loss on foreign currency translation, net (333) (71)
--------------------------------------------
Total nonoperating income (expense) 816 (309)
--------------------------------------------
Income before income taxes, minority interest and equity in income of
joint ventures 67,122 43,833
Income taxes 24,680 16,755
Minority interests in consolidated subsidiaries' net income (69) (93)
Equity in income of joint ventures 3,750 5,576
--------------------------------------------
Net income $ 46,123 32,561
============================================
Basic earnings per share $ 0.23 0.17
============================================
Diluted earnings per share $ 0.23 0.17
============================================
Weighted average common shares outstanding 197,023 196,844
Increase due to assumed issuance of shares related to stock
options outstanding 207 370
--------------------------------------------
Weighted average common and common equivalent shares outstanding 197,230 197,214
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
Three months ended
March 31,
--------------------------------------------
(in thousands) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 46,123 32,561
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Minority interests in consolidated subsidiaries' net income 69 93
Loss on foreign currency translation, net 333 71
Equity in income of joint ventures (3,750) (5,576)
Depreciation and amortization 32,739 26,115
Impairment of developed software 3,137 -
Provisions for (recoveries of) bad debt expenses and billing adjustments 3,178 (704)
Charges for transaction processing provisions 3,109 925
Deferred income tax expense (benefit) 10,566 (2,460)
Loss on disposal of equipment, net 323 38
(Increase) decrease in:
Accounts receivable (17,897) (12,112)
Prepaid expenses and other assets 2,932 (15,013)
Increase (decrease) in:
Accounts payable (53,610) 2,019
Accrued salaries and employee benefits (32,546) (18,116)
Billings in excess of costs and profits on uncompleted contracts - (6,749)
Other current liabilities (39,241) 42,867
--------------------------------------------
Net cash (used in) provided by operating activities (44,535) 43,959
--------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment, net (10,702) (19,535)
Additions to licensed computer software from vendors (5,869) (7,370)
Additions to internally developed computer software (709) (1,982)
Cash acquired in acquisition 38,799 -
Cash used in acquisition (95,782) -
Dividends received from joint ventures - 15,000
Contract acquisition costs (5,442) (1,857)
--------------------------------------------
Net cash used in investing activities (79,705) (15,744)
--------------------------------------------
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
Three months ended
March 31,
----------------------------------------
(in thousands) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Purchases of common stock - (1,189)
Proceeds from borrowing of long-term debt 14,125 -
Principal payments on long-term debt borrowings (13,154) -
Principal payments on capital lease obligations and software obligations (550) (41,589)
Dividends paid on common stock (includes $6.4 million and $3.2 million paid
to related parties at 2005 and 2004, respectively) (7,874) (3,936)
Proceeds from exercise of stock options - 1,142
--------------------------------------------
Net cash used in financing activities (7,453) (45,572)
--------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (2,197) 742
--------------------------------------------
Net decrease in cash and cash equivalents $ (133,890) (16,615)
Cash and cash equivalents at beginning of year 231,806 122,874
--------------------------------------------
Cash and cash equivalents at end of period $ 97,916 106,259
============================================
Cash paid for interest $ 70 743
============================================
Cash paid for income taxes (net of refunds) $ 21,359 (9,821)
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 7 -
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) or the Company); its wholly
owned subsidiaries, Columbus Depot Equipment CompanySM (CDECSM), Columbus
Productions, Inc.SM (CPI), TSYS Canada, Inc.SM (TSYS Canada), TSYS Total Debt
Management, Inc. (TDM), ProCard, Inc. (ProCard), TSYS Japan Co., Ltd. (TSYS
Japan), Enhancement Services Corporation (ESC), TSYS Technology Center, Inc.
(TTC), TSYS Prepaid, Inc. (TPI) and Vital Processing Services, L.L.C. (Vital)
and its wholly owned and majority owned subsidiaries; and TSYS' 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 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
could differ from estimated amounts. 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 summary of significant accounting policies,
consolidated financial statements and related notes appearing in the Company's
2004 annual report previously filed on Form 10-K. Results of interim periods are
not necessarily indicative of results to be expected for the year.
Certain reclassifications have been made to the 2004 financial statements
to conform to the presentation adopted in 2005.
Note 2 - Supplementary Balance Sheet Information
Cash and cash equivalent balances are summarized as follows:
(in thousands) March 31, 2005 December 31, 2004
-------------------------------------------------------------------------------- ---------------------------
Cash and cash equivalents in domestic accounts $ 55,668 177,117
Cash and cash equivalents in foreign accounts 42,248 54,689
-------------------------- ---------------------------
Total $ 97,916 231,806
========================== ===========================
- 8 -
Notes to Unaudited Consolidated Financial Statements (continued)
The Company maintains accounts denominated in U.S. dollars, Euros, British
Pounds Sterling (BPS), Canadian dollars and Japanese Yen.
Significant components of prepaid expenses and other current assets are summarized as follows:
(in thousands) March 31, 2005 December 31, 2004
-------------------------------------------------------------------------------- ---------------------------
Prepaid expenses $ 12,630 11,767
Supplies Inventory 12,534 7,646
Other 17,889 16,326
-------------------------- --------------------------
Total $ 43,053 35,739
========================== ==========================
Significant components of contract acquisition costs, net of accumulated amortization, are summarized as follows:
(in thousands) March 31, 2005 December 31, 2004
-------------------------------------------------------------------------------- --------------------------
Payments for processing rights, net $ 121,445 91,787
Conversion costs, net 42,915 40,641
-------------------------- --------------------------
Total $ 164,360 132,428
========================== ==========================
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $3.5 million and $3.4 million for the three
months ended March 31, 2005 and 2004, respectively.
Amortization related to conversion costs, which is recorded in other
operating expenses, was $3.4 million and $2.7 million for the three months ended
March 31, 2005 and 2004, respectively.
Significant components of other current liabilities are summarized as follows:
(in thousands) March 31, 2005 December 31, 2004
-------------------------------------------------------------------------------- --------------------------
Accrued expenses $ 53,205 43,229
Client liabilities 29,031 24,660
Deferred revenues 24,448 27,720
Transaction processing provisions 8,581 9,284
Dividends payable 7,883 7,874
Client postage deposits 6,396 6,184
Income taxes payable 14,122 21,279
Other 13,266 13,932
-------------------------- ---------------------------
Total $ 156,932 154,162
========================== ===========================
Note 3 - Comprehensive Income
Comprehensive income for TSYS consists of net income and foreign currency
translation adjustments recorded as a component of shareholders' equity.
- 9 -
Notes to Unaudited Consolidated Financial Statements (continued)
Comprehensive income for the three months ended March 31 is as follows:
(in thousands) 2005 2004
------------------------------------------------------------------------------- ---------------------------
Net income $ 46,123 $ 32,561
Other comprehensive income (loss):
Foreign currency translation adjustments,
net of tax (2,423) 1,930
-------------------------- --------------------------
Comprehensive income $ 43,700 $ 34,491
========================== ==========================
The income tax effects allocated to and the cumulative balance of accumulated other comprehensive income are as follows:
Balance at December 31, Pretax Balance at
(in thousands) 2004 amount Tax effect March 31, 2005
- ---------------------------------------------------------------------------------------------------------------------
Foreign currency translation
adjustments $15,373 (3,739) 1,316 $12,950
=================================================================================
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 No.
131). The Company's segment information reflects the information that the chief
operating decision maker (CODM) uses to make resource allocation and strategic
decisions. The CODM at TSYS consists of the chairman of the board, the chief
executive officer, the president and the three senior executive vice presidents.
On March 1, 2005, TSYS acquired the remaining 50% equity stake that Visa
U.S.A. held in Vital. As a result of the acquisition, the Company revised its
segment information to reflect the information that the CODM uses to make
resource allocations and strategic decisions. The revision included adding a new
segment, merchant processing services, to include the information regarding
Vital.
Through online accounting and electronic payment processing systems, TSYS
provides electronic payment processing and other related services to
card-issuing institutions in the United States, Mexico, Canada, Honduras, Europe
and Puerto Rico. The Company has three reportable segments: domestic-based
support services, international-based support services and merchant processing
services. Domestic-based support services include electronic payment processing
services and other services provided from the United States. Domestic-based
support services segment includes the financial results of TSYS, excluding its
foreign branch offices, and including the following subsidiaries: CDEC, CPI,
TSYS Canada, TDM, ProCard, ESC, TTC and TPI.
International-based support services include electronic payment processing
and other services provided outside the United States. International-based
support services include the financial results of GP Net, TSYS Japan and
TSYS'branch offices in Europe and Japan. TSYS' share of the equity earnings of
its TotalSystem Services de Mexico, S.A. de C.V. joint venture is included in
international-based support services. Merchant processing services include the
financial results of Vital. For periods prior to the acquisition, TSYS has
reclassified TSYS' share of its equity earnings of Vital from domestic- based
support services to merchant processing services.
- 10 -
Notes to Unaudited Consolidated Financial Statements (continued)
Domestic- International- Merchant
based support based support processing
Operating Segments (in thousands) services services services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
At March 31, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,200,179 182,333 198,082 $ 1,580,594
Intersegment eliminations (303,565) - - (303,565)
--------------- --------------- --------------- ---------------
Total assets $ 896,614 182,333 198,082 $ 1,277,029
=============== =============== =============== ===============
- ------------------------------------------------------------------------------------------------------------------------------------
At December 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,265,567 169,877 - $ 1,435,444
Intersegment eliminations (153,501) - - (153,501)
--------------- --------------- --------------- ---------------
Total assets $ 1,112,066 169,877 - $ 1,281,943
=============== =============== =============== ===============
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 229,521 30,848 21,289 $ 281,658
Intersegment revenue (1,282) - - (1,282)
--------------- --------------- --------------- ---------------
Revenues before reimbursables
from external customers $ 228,239 30,848 21,289 $ 280,376
=============== =============== =============== ===============
Segment total revenue $ 290,527 36,614 24,826 $ 351,967
Intersegment revenue (1,983) - - (1,983)
--------------- --------------- --------------- ---------------
Revenue from external customers $ 288,544 36,614 24,826 $ 349,984
=============== =============== =============== ===============
Depreciation and amortization $ 27,459 3,768 1,512 $ 32,739
=============== =============== =============== ===============
Segment operating income $ 60,413 2,841 3,052 $ 66,306
=============== =============== =============== ===============
Income taxes $ 20,726 1,639 2,315 $ 24,680
=============== =============== =============== ===============
Equity in income of joint ventures $ - 509 3,241 $ 3,750
=============== =============== =============== ===============
Net income $ 40,328 1,756 4,039 $ 46,123
=============== =============== =============== ===============
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 201,618 22,986 - $ 224,604
Intersegment revenue - - - -
--------------- --------------- --------------- ---------------
Revenues before reimbursables
from external customers $ 201,618 22,986 - $ 224,604
=============== =============== =============== ===============
Segment total revenue $ 260,620 24,618 - $ 285,238
Intersegment revenue (2) - - (2)
--------------- --------------- --------------- ---------------
Revenue from external customers $ 260,618 24,618 - $ 285,236
================ =============== =============== ===============
Depreciation and amortization $ 23,284 2,831 - $ 26,115
=============== =============== =============== ===============
Segment operating income $ 39,573 4,569 - $ 44,142
=============== =============== =============== ===============
- 11 -
Notes to Unaudited Consolidated Financial Statements (continued)
Domestic- International- Merchant
based support based support processing
Operating Segments (in thousands) services services services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
At March 31, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Income taxes $ 13,382 1,593 1,780 $ 16,755
================== =============== =============== ===============
Equity in income of joint ventures $ - 375 5,201 $ 5,576
================== =============== =============== ===============
Net income $ 26,024 3,117 3,420 $ 32,561
================== =============== =============== ===============
Revenues for domestic-based support services include electronic payment
processing and other services provided from the United States to clients
domiciled in the United States or other countries. Revenues from
international-based support services include electronic payment processing and
other services provided outside the United States to clients domiciled mainly
outside the United States.
The following geographic area data represent revenues for the three months
ended March 31, 2005 and 2004, respectively, based on the domicile of customers.
Three months ended March 31,
---------------------------------------------------
(in millions) 2005 2004
----------------------------- ----------------------- -----------------------
United States $ 290.0 237.0
Europe 33.0 21.3
Canada* 21.0 19.7
Japan 3.7 3.5
Mexico 1.7 3.0
Other 0.6 0.7
------------------- --------------------------
Totals $ 350.0 285.2
=================== ==========================
* These revenues in 2004 include those generated from the Caribbean accounts
owned by a Canadian institution.
The following table reconciles geographic revenues to revenues by reporting
segment for the three months ended March 31, 2005 and 2004, respectively, based
on the domicile of customers.
Three months ended March 31,
---------------------------------------------------------------------------------
Domestic-based International-based Merchant processing
support services support services services
---------------------------------------------------------------------------------
(in millions): 2005 2004 2005 2004 2005 2004
---------------------------------------------------------------------------------
United States $265.3 237.1 - - 24.7 -
Europe 0.1 0.1 32.9 21.1 - -
Canada* 21.0 19.7 - - - -
Japan - - 3.7 3.5 - -
Mexico 1.7 3.0 - - - -
Other 0.5 0.7 - - 0.1 -
--------------------------------------------------------------------------------
$288.6 260.6 36.6 24.6 24.8 -
================================================================================
- 12 -
Notes to Unaudited Consolidated Financial Statements (continued)
The Company maintains property and equipment in the United States, Europe,
Japan and Canada. The following geographic area data represent net property and
equipment balances by region:
At March 31, At December 31,
(in millions) 2005 2004
--------------------------------------------------------------- ----------------------------
United States $ 213.1 200.6
Europe 59.6 60.8
Japan 1.9 2.1
Canada 0.1 0.1
--------------------------------------------------------------- ----------------------------
Totals $ 274.7 263.6
========================== ============================
Major Customers
For the three months ended March 31, 2005, the Company had one major
customer which accounted for approximately 20.6%, or $72.2 million, of total
revenues. For the three months ended March 31, 2004, TSYS had one major customer
that accounted for 18.3%, or $52.2 million, of total revenues. Revenues from
this major customer for the periods reported are attributable to the
domestic-based support services segment and merchant processing services.
Note 5 - Stock-Based Compensation
The Company maintains stock-based compensation plans for purposes of
incenting and retaining employees. The Company accounts for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25 (APB
No. 25), "Accounting for Stock Issued to Employees," and related
Interpretations. Under APB No. 25, TSYS does not recognize compensation expense
for a stock option grant if the exercise price is equal to or greater than the
fair market value of the common stock on the grant date.
The following table illustrates the effect on net income and earnings per
share for the three months ended March 31, 2005 and 2004, respectively, if the
Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for
Stock-Based Compensation," to stock-based employee compensation granted in the
form of TSYS and Synovus Financial Corp. (Synovus) stock options.
- 13 -
Notes to Unaudited Consolidated Financial Statements (continued)
(in thousands, except per share data) March 31, 2005 March 31, 2004
------------------------------------------------------------------------------- ------------------------------
Net income, as reported $ 46,123 $ 32,561
Add: Stock-based employee compensation
expense, net of tax 180 -
Deduct: Stock-based employee compensation
expense determined under the fair value
based method for all awards, net of
related income tax effects
(1,576) (1,330)
-------------------------- ------------------------------
Net income, as adjusted $ 44,727 $ 31,231
========================== ==============================
Earnings per share:
Basic - as reported $ 0.23 $ 0.17
========================== ==============================
Basic - as adjusted $ 0.23 $ 0.16
========================== ==============================
Diluted - as reported $ 0.23 $ 0.17
========================== ==============================
Diluted - as adjusted $ 0.23 $ 0.16
========================== ==============================
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123 (revised) (SFAS No. 123R)
"Share-Based Payment." SFAS No. 123R will require the Company to recognize
compensation expense for the unvested portion for outstanding stock-based
compensation granted in the form of stock options based on the grant-date fair
value of those awards calculated under SFAS No. 123 for pro forma disclosures.
On April 14, 2005, the Securities and Exchange Commission (SEC) approved a
rule that delays the effective date of SFAS No. 123R for public companies that
do not file as small business issuers until the first annual or interim
reporting period of the first fiscal year that begins on or after June 15, 2005.
The Company plans to adopt SFAS No. 123R on January 1, 2006.
Note 6 - Long-Term Debt
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
March 31, 2005, TSYS had an outstanding balance on the line of credit in the
amount of $984,000.
Note 7 - Supplementary Cash Flow Information
Cash used for contract acquisition costs for the three months ended March
31, 2005 and 2004, respectively, are summarized as follows:
(in thousands) March 31, 2005 March 31, 2004
------------------------------------------------------------------------------ ----------------------------
Conversion costs $ 5,442 $ 1,857
Payments for processing rights - -
------------------------------------------------------------------------------ ----------------------------
Total $ 5,422 $ 1,857
========================== ============================
- 14 -
Notes to Unaudited Consolidated Financial Statements (continued)
Note 8 - Legal Proceedings
The Company is subject to lawsuits, claims and other complaints arising out
of the ordinary conduct of its business. In the opinion of management, based in
part upon the advise of legal counsel, all matters are believed to be adequately
covered by insurance, or if not covered, are believed to be without merit or are
of such kind or involve such amounts that would not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company if disposed of unfavorably. The Company establishes reserves for
expected future litigation exposures that TSYS determines to be both probable
and reasonably estimable.
The Company has received notification from the United States Attorneys'
Office for the Northern District of California that the United States Department
of Justice is investigating whether the Company and/or one of its large credit
card processing clients violated the False Claims Act, 31 U.S.C. SS3729-33, in
connection with mailings made on behalf of the client from July 1997 through
November 2001. The subject matter of the investigation relates to the U.S.
Postal Service's Move Update Requirements. In general, the Postal Service's Move
Update Requirements are designed to reduce the volume of mail that is returned
to sender as undeliverable as addressed. In effect, these requirements provide,
among other things, various procedures that may be utilized to maintain the
accuracy of mailing lists in exchange for discounts on postal rates. The Company
has received a subpoena from the Office of the Inspector General of the U.S.
Postal Service, and has produced documents responsive to the subpoena. The
Company continues to cooperate with the Department of Justice in the
investigation, and there can be no assurance as to the timing or outcome of the
investigation, including whether the investigation will result in any criminal
or civil fines, penalties, judgments or treble damages or other claims against
the Company. The Company established a reserve during the quarter ended March
31, 2005 relating to this investigation. However, there can be no assurance that
the Company will not suffer a loss in connection with this investigation in an
amount exceeding such reserve or that the Company will not be required to
reserve additional amounts in future periods.
Note 9 - Business Combinations
Vital Processing Services, L.L.C, a limited liability company, was
established in May 1996 as a 50/50 merchant processing joint venture between
TSYS and Visa U.S.A. ("Visa"). Vital is a leader in providing integrated
end-to-end electronic transaction processing services primarily to large
financial institutions and other merchant acquirers. Vital processes all payment
forms including credit, debit, electronic benefit transfer and check truncation
for merchants of all sizes across a wide array of retail market segments.
On March 1, 2005, TSYS acquired the remaining 50% of Vital from Visa for
$95.8 million in cash, including $782,000 of direct acquisition costs. Vital is
now a separate, wholly owned subsidiary of TSYS. As a result of the acquisition
of control of Vital, TSYS changed from the equity method of accounting for the
investment in Vital and began consolidating Vital's balance sheet and results of
operations in the statements of income effective March 1, 2005. In accordance
with authoritative accounting guidelines, TSYS recorded the acquisition of the
incremental 50% interest as a business combination, requiring that TSYS allocate
the purchase price to the assets acquired and liabilities assumed based on their
relative fair values. The Company is in the process of finalizing the purchase
price allocation and has preliminarily allocated approximately $38.0 million to
goodwill, approximately
- 15 -
Notes to Unaudited Consolidated Financial Statements (continued)
$30.5 million to other identifiable intangible assets and the remaining amount
to the assets and liabilities acquired. Of the $30.5 million other identifiable
intangible assets, the Company has allocated $18.5 million to computer software
and the remaining amount to other intangible assets. The Company believes the
acquisition of Vital allows TSYS to be a complete provider of value-based
services at both ends of the payment chain and strengthens the relationship TSYS
enjoys with some of world's largest card issuers by placing them closer to the
point of sale. Revenues associated with Vital are included in merchant services
and are classified in merchant processing services for segment reporting
purposes.
The Company is in the process of completing its purchase price allocation
related to the acquisition. Since TSYS acquired less than 100% of the
outstanding shares of the acquired enterprise, the valuation of assets acquired
and liabilities assumed in the acquisition was based on a pro rata allocation of
the fair values of the assets acquired and liabilities assumed and the
historical financial statement carrying amounts of the assets and liabilities of
the acquired enterprise. As a result, TSYS recorded the fair value of the 50%
interest of Vital's assets acquired and liabilities assumed as of March 1, 2005.
The Company recorded 50% of Vital's historical carrying values of assets and
liabilities representing the interest TSYS originally owned. The preliminary
purchase price allocation is presented below:
(in thousands)
-----------------------------------------------------
Cash and cash equivalents $19,399
Intangible assets 30,500
Goodwill 38,002
Other assets 39,087
---------------
Total assets acquired 126,988
---------------
Other liabilities 31,157
---------------
Total liabilities assumed 31,157
---------------
Minority interest 49
---------------
Net assets acquired $95,782
===============
On August 2, 2004, TSYS completed the acquisition of Clarity Payment
Solutions, Inc. (Clarity) for $53.0 million in cash and had direct acquisition
costs in the amount of $515,000. Clarity was renamed TSYS Prepaid, Inc. (TSYS
Prepaid). The Company is in the process of finalizing the purchase price
allocation and has preliminarily allocated approximately $40.9 million to
goodwill, approximately $10.9 million to other intangibles and the remaining
amount to the assets and liabilities acquired. Of the $10.9 million intangibles,
the Company has allocated $8.5 million to computer software and the remaining
amount to other intangible assets. TSYS Prepaid is a leading provider of prepaid
card solutions that utilize the Visa, MasterCard, EFT and ATM networks for
Fortune 500 companies as well as domestic and international financial
institutions. The Company believes the acquisition of TSYS Prepaid enhances
TSYS' processing services by adding enhanced functionality and distinct value
differentiation for TSYS and its clients. TSYS Prepaid operates as a separate,
wholly owned subsidiary of TSYS. Revenues associated with TSYS Prepaid are
included in electronic payment processing services and are classified in
domestic-based support services for segment reporting purposes.
- 16 -
Notes to Unaudited Consolidated Financial Statements (continued)
The Company is in the process of completing its purchase price allocation
related to the acquisition. The preliminary purchase price allocation is
presented below:
(in thousands)
-----------------------------------------------------
Cash and cash equivalents $ 2,422
Restricted cash 16,672
Intangible assets 10,900
Goodwill 40,931
Other assets 4,817
---------------
Total assets acquired 75,742
---------------
Other liabilities 22,227
---------------
Total liabilities assumed 22,227
---------------
Net assets acquired $53,515
===============
Pro forma
Presented below are the pro forma consolidated results of operations for
the three months ended March 31, 2005 and 2004, respectively, as though the
acquisitions of Vital and TSYS Prepaid, Inc. had occurred on January 1, 2004.
This pro forma information is based on the historical financial statements of
Vital and TSYS Prepaid. Pro forma results do not include any actual or
anticipated cost savings or expenses of the planned integration of TSYS, Vital
and TSYS Prepaid, and are not necessarily indicative of the results which would
have occurred if the business combinations had been in effect on the dates
indicated, or which may result in the future.
(in thousands, except per share data) Three months ended March 31,
-----------------------------------------------------------------------------------------------
2005 2004
-----------------------------------------------------------------------------------------------
Revenues $ 393,573 357,019
Net income 48,127 34,556
Basic earnings per share 0.24 0.18
Diluted earnings per share 0.24 0.18
- 17 -
TOTAL SYSTEM SERVICES, INC.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Overview
Total System Services, Inc.'s (TSYS' or the Company's) revenues are derived
from providing electronic payment processing and related services to financial
and nonfinancial institutions, generally under long-term processing contracts.
TSYS' services are provided primarily through the Company's cardholder systems,
TS2 and TS1, to financial institutions and other organizations throughout the
United States, Mexico, Canada, Honduras, Puerto Rico and Europe. The Company
currently offers merchant services to financial institutions and other
organizations through its majority owned subsidiary, GP Network Corporation (GP
Net), and its wholly owned subsidiary, Vital Processing Services, L.L.C.
(Vital).
Due to the somewhat seasonal nature of the credit card industry, 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 or declines
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
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. Consolidation in either the financial services or
retail industries, a change in the economic environment in the retail sector, or
a change in the mix of payments between cash and cards could favorably or
unfavorably impact TSYS' financial position, results of operations and cash
flows in the future.
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including certain major customers. 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 and increasing pressure on the Company's operating profit margins.
The Company provides services to its clients including processing consumer,
retail, commercial, government services, stored value and debit cards. Consumer
cards include Visa and MasterCard credit cards as well as American Express
cards. Retail cards include private label and gift cards. Commercial cards
include purchasing cards, corporate cards and fleet cards for employees.
Government services accounts on file consist mainly of student loan processing
accounts. Stored value accounts include prepaid cards, including loyalty
incentive cards and flexible spending cards, and stored value cards. Debit cards
consist mainly of on-line (PIN-based) and off-line (signature-based) accounts.
The tables on page 23 summarize TSYS' accounts on file (AOF) information as of
March 31, 2005 and 2004.
- 18 -
Financial Overview (continued)
A summary of the financial highlights occurring during 2005, as compared to
2004, is provided below:
(in millions, except earnings per share data) Three months ended March 31,
--------------------------------------------------------------------------------------------------------
Percent
2005 2004 Change
----------------------------------------------------------------- ------------ ------------ ------------
Revenues Before Reimbursables $280.4 224.6 24.8
Total Revenues 350.0 285.2 22.7
Operating Income 66.3 44.1 50.2
Net Income 46.1 32.6 41.7
Basic EPS 0.23 0.17 41.5
Diluted EPS 0.23 0.17 41.7
Accounts on File 370.6 280.4 32.2
Significant highlights for 2005 include:
o The Company acquired the remaining 50% interest from Visa
U.S.A. (Visa) of Vital Processing Services, L.L.C. (Vital)
for $95.8 million.
o TSYS signed a seven-year contract with ABN AMRO Bank,
Barneveld, Netherlands, which represents the first
processing agreement with a card issuer based in continental
Europe. Additionally, TSYS will provide customer care
services on behalf of ABN AMRO by managing a customer
contact center in The Netherlands. The center will support
full end-to-end customer service, including general customer
service queries, application processing, chargebacks and
dispute handling, fraud and collections.
o TSYS and Bank of America agreed to add five years to the
current agreement to provide exclusive processing services
through 2014. The expanded relationship covers all consumer
and commercial credit Visa and MasterCard accounts issued by
Bank of America, as well as the recently acquired portfolio
of FleetBoston Financial Corp. (FleetBoston), which was
converted to TSYS in mid-March.
o MBNA, based in Wilmington, Delaware, extended its existing
seven-year relationship with TSYS for commercial-card
processing services by an additional three years.
o TSYS successfully implemented two retail gift card programs
in Europe - one for HMV, the largest retailer of music, DVD
and games in the UK and another for Hunkemoller, a leading
specialist retailer in The Netherlands, with outlets in
Germany, Denmark, France, Luxembourg and Belgium.
o TSYS Prepaid, Inc. (TSYS Prepaid) announced it was
sponsoring the creation of an industry-wide prepaid card
trade association. The trade association will help advance
the rapidly evolving prepaid market, focusing primarily on
branded cards using open networks such as Visa and
MasterCard, as well as EFT and ATM networks.
o TSYS announced that Answers, etc. will use TSYS Prepaid's
platform to power the Zoomcard Prepaid MasterCard. The
Zoomcard, issued by KeyBank, is accepted at more than
900,000 ATMs and more than 24 million merchant locations
worldwide.
- 19 -
Financial Overview (continued)
Industry Developments
Consolidation among financial institutions, particularly in the area of
credit card operations continued to be a major industry risk. In 2003, Sears'
credit card business was sold to Citigroup, Inc. (Citigroup). The impact of the
transaction between Sears and Citigroup on the financial position, results of
operations and cash flows of TSYS cannot be determined at this time.
Financial Review
This Financial Review provides a discussion of critical accounting policies
and estimates, related party transactions and off-balance sheet arrangements.
This Financial Review also discusses the results of operations, financial
position, 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 and Estimates
The Company's financial position, results of operations and cash flows are
impacted by the accounting policies the Company has adopted. In order to gain a
full understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed.
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, loss of one of the Company's
major customers or other significant clients, an inability to grow through
acquisitions or successfully integrate acquisitions, an inability to control
expenses, technology changes, financial services consolidation, change in
regulatory mandates, a decline in the use of cards as a payment mechanism, a
decline in the financial stability of the Company's clients and uncertain
economic conditions. Negative developments in these or other risk factors could
have a material adverse effect on the Company's financial position, results of
operations and cash flows.
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
could differ from estimated amounts.
For a detailed discussion regarding the Company's critical accounting
policies and estimates, see "Item 7: Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2004. There have been no material
changes to the Company's critical accounting policies, estimates and assumptions
or the judgments affecting the application of those estimates and assumptions in
2005.
Related Party Transactions
The Company provides electronic payment processing and other services to
its parent company, Synovus Financial Corp. (Synovus) and its affiliates, and to
the Company's joint venture, Total System Services de Mexico, S.A. de. C.V.
(TSYS de Mexico). The services are performed under contracts that are similar to
its contracts with other customers. The Company believes the terms and
conditions of transactions between the Company and these related parties are
comparable to those which could have been obtained in transactions with
unaffiliated parties. The Company's margins with respect to related
- 20 -
Related Party Transactions (continued)
party transactions are comparable to margins recognized in transactions with
unrelated third parties. The amounts related to these transactions are disclosed
on the face of TSYS' consolidated financial statements.
Line of Credit
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured debt and
includes covenants requiring the Company to maintain certain minimum financial
ratios. At March 31, 2005, TSYS had an outstanding balance on the line of credit
in the amount of $984,000.
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. Neither the assets nor obligations related to these
leases are included on the balance sheet.
Results of Operations
The following table sets forth certain income statement captions as a
percentage of total revenues and the percentage increases or decreases in those
items for the three months ended March 31, 2005 and 2004:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2005 2004 2005 vs. 2004
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 58.5 % 62.2 % 15.4 %
Merchant services 7.7 2.2 325.9
Other services 13.9 14.3 18.8
------------- ----------
Revenues before reimbursable items 80.1 78.7 24.8
Reimbursable items 19.9 21.3 14.8
------------- ----------
Total revenues 100.0 100.0 22.7
------------- ----------
Expenses:
Salaries and other personnel expense 27.9 30.8 11.0
Net occupancy and equipment expense 18.7 20.3 12.7
Other operating expenses 14.6 12.1 48.1
------------- ----------
Expenses before reimbursable items 61.2 63.2 18.6
Reimbursable items 19.9 21.3 14.8
------------- ----------
Total expenses 81.1 84.5 17.7
------------- ----------
Operating income 18.9 15.5 50.2
Nonoperating income 0.3 (0.1) 363.9
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 19.2 15.4 53.1
Income taxes 7.1 6.0 47.3
- 21 -
Results of Operations (continued)
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2005 2004 2005 vs. 2004
------------- ---------- ------------------------
Minority interests in consolidated subsidiaries' net
income (0.0) (0.0) (25.2)
Equity in income of joint ventures 1.1 2.0 (32.7)
------------- ----------
Net income 13.2 % 11.4 % 41.7 %
============= ==========
Revenues
Total revenues increased $64.7 million, or 22.7%, during the three months
ended March 31, 2005, compared to the same period in 2004. The increase in
revenues for the three months ended March 31, 2005 includes an increase of $1.1
million related to the effects of currency translation of its foreign-based
subsidiaries and branches. Excluding reimbursable items, revenues increased
$55.8 million, or 24.8%, during the three months ended March 31, 2005, compared
to the same period in 2004.
International Revenues
TSYS provides services to its clients worldwide and plans to continue to
expand its service offerings internationally in the future. Total revenues from
clients domiciled outside the United States for the three months ended March 31,
2005 and 2004, respectively, are summarized below:
Three months ended March 31,
-------------------------------------------------
(in millions) 2005 2004 % Change
---------------- ----------------- --------------
Europe $ 33.0 21.3 55.3%
Canada 21.0 19.7 6.8
Japan 3.7 3.5 7.9
Mexico 1.7 3.0 (43.1)
Other 0.6 0.7 (19.5)
---------------- -----------------
Totals $ 60.0 48.2 24.8%
================ =================
Total revenues from clients based in Europe were $33.0 million for the
three months ended March 31, 2005, a 55.3% increase compared to the $21.3
million for the same period last year. The growth in revenues in 2005 from
clients based in Europe was a result of the growth of existing clients, the
conversion of new accounts, the effect of currency translation and the increased
use of value added products and services by clients in Europe.
Total revenues from clients based in Mexico were $1.7 million for the three
months ended March 31, 2005, a 43.1% decrease compared to the $3.0 million for
the same period last year. During 2003, a Mexican client notified the Company of
its intentions to utilize its internal global platform and to deconvert in
mid-2004. As a result, revenues for 2005 from Mexico have decreased
significantly when compared to revenues from Mexico for 2004.
- 22 -
Results of Operations (continued)
Value Added Products and Services
The Company's revenues are impacted by the use of optional value added
products and services of TSYS' processing systems. Value added products and
services are optional features to which each client can choose to subscribe 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 and customer retention programs, such as
loyalty programs and bonus rewards. These revenues can increase or decrease over
time as clients subscribe to or cancel these services. Value added products and
services are included mainly in electronic payment processing services revenue.
For the three months ended March 31, 2005 and 2004, value added products
and services represented 13.1% and 13.7%, respectively, of total revenues.
Revenues from these products and services, which include some reimbursable items
paid to third-party vendors, increased 17.7%, or $6.9 million, for the three
months ended March 31, 2005 compared to the same period last year.
Major Customers
A significant amount of the Company's revenues are derived from long-term
contracts with large clients, including certain major customers. For the three
months ended March 31, 2005, the Company had one major customer which accounted
for approximately 20.6%, or $72.2 million, of total revenues. For the three
months ended March 31, 2004, TSYS had one major customer that accounted for
18.3%, or $52.2 million, of total revenues.
As previously mentioned, on January 25, 2005, the Company announced that it
had extended its agreement with its major customer for an additional five years
through 2014.
Electronic Payment Processing Services
Electronic payment processing revenues are generated primarily from charges
based on the number of accounts on file, transactions and authorizations
processed, statements mailed, 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, government
services 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. Revenues from electronic payment
processing services increased $27.4 million, or 15.4%, for the three months
ended March 31, 2005, compared to the same period in 2004.
- 23 -
Results of Operations (continued)
Accounts on File (AOF) Data (in millions):
AOF
2005 2004 % Change
------------ ------------ ---------------
At March 31, 370.6 280.4 32.2%
YTD Average 362.9 278.2 30.5%
AOF by Portfolio Type
2005 2004
---------------------------- --------------------------
At March 31, AOF % AOF % % Change
----------------------------------- ------------- -------------- ------------ ------------- ----------------
Consumer 213.4 57.6 147.0 52.4 45.2
Retail 94.1 25.4 86.8 31.0 8.5
Commercial 26.8 7.2 22.2 7.9 21.0
Government services 16.7 4.5 14.2 5.1 17.5
Stored value 12.6 3.4 4.0 1.4 219.2
Debit 7.0 1.9 6.2 2.2 11.0
----------------------------------- ------------- -------------- ------------ -------------
Total 370.6 100.0 280.4 100.0 32.2
============= ============== ============ =============
AOF by Geographic Area
2005 2004
---------------------------- ---------------------------
At March 31, AOF % AOF % % Change
---------------------------------- ------------- -------------- ------------- ------------- ------------------
Domestic 319.7 86.3 235.4 84.0 35.8
International 50.9 13.7 45.0 16.0 13.2
---------------------------------- ------------- -------------- ------------- -------------
Total 370.6 100.0 280.4 100.0 32.2
============= ============== ============= =============
Note: The accounts on file distinction between domestic and international
is based on the geographic domicile of processing clients.
Activity in AOF
March 2004 to March March 2003 to March
2005 2004
---------------------- ----------------------
Beginning balance 280.4 254.2
Internal growth of existing clients 34.0 28.9
New clients 62.5 13.2
Purges/Sales (5.1) (12.1)
Deconversions (1.2) (3.8)
---------------------- ----------------------
Ending balance 370.6 280.4
====================== ======================
On March 3, 2003, the Company announced that Bank One had selected TSYS to
upgrade its credit card processing. Under the long-term software licensing and
services agreement, TSYS is to provide electronic payment processing services to
Bank One's credit card accounts for at least two years starting in 2004
(excluding statement and card production services). Following the provision of
processing services, TSYS is to license a modified version of its TS2 consumer
and commercial software to Bank One through a perpetual license with a six-year
payment term. This agreement has been superseded by the agreement with JP Morgan
Chase & Co. (Chase) as described below. The
- 24 -
Results of Operations (continued)
Company used the percentage-of-completion accounting method for its
agreement with Bank One and recognized revenues in proportion to costs incurred.
TSYS' revenues from Bank One were less than 10% of total revenues for the three
months ended March 31, 2005.
On July 1, 2004, Bank One and Chase merged under the name Chase. On October
13, 2004, TSYS finalized a definitive agreement with Chase to service the
combined card portfolios of Chase Card Services and to upgrade its
card-processing technology. The agreement extends a relationship that started
with TSYS and the former Bank One Corp. in March 2003. Pursuant to the revised
agreement, the first phase of the project was executed successfully and Bank
One's remaining accounts were converted to a modified version of TS2 processing
platform during the fourth quarter of 2004, according to the project's original
schedule. Chase is expected to convert its consumer and commercial accounts to
the modified version of TS2 in the second half of 2005, after which TSYS expects
to maintain the card-processing functions of Chase Card Services for at least
two years. Chase Card Services then has the option to either extend the
processing agreement for up to five additional two-year periods or migrate the
portfolio in-house, under a perpetual license of a modified version of TS2 with
a six-year payment term.
As a result of the new agreement with Chase, TSYS discontinued its use of
the percentage-of- completion accounting method for the original agreement with
Bank One. The revised agreement is being accounted for in accordance with
Financial Accounting Standards Board's (FASB's) Emerging Issues Task Force No.
00-21 (EITF No. 00-21), "Accounting for Revenue Arrangements with Multiple
Deliverables," and other applicable guidance.
TSYS expects that the 2005 earnings per share (EPS) impact of the Chase
agreement will be $0.05-$0.06 per share and the 2006 EPS impact will be
$0.06-$0.07 per share. Beyond 2006, the annual EPS impact of the agreement will
depend upon Chase Card Services' decision to continue the processing agreement
or to exercise its option to license the software.
On March 31, 2004, Bank of America acquired FleetBoston. In connection with
the extended agreement with Bank of America, TSYS converted the FleetBoston card
portfolio to TSYS' processing system in March 2005.
In July 2003, Sears and Citigroup announced an agreement for the sale by
Sears to Citigroup of the Sears credit card and financial services businesses.
Sears and Citigroup are both clients of TSYS. TSYS and Sears are parties to a
10-year agreement, which was renewed in January of 2000, under which TSYS
provides transaction processing for more than 82.0 million Sears accounts. For
the three months ended March 31, 2005, TSYS' revenues from the agreement with
Sears represented less than 10% of TSYS' consolidated revenues. The agreement
includes provisions for termination for convenience prior to its expiration upon
the payment of a termination fee. The TSYS/Sears agreement also grants to Sears
the one-time right to market test TSYS' pricing and functionality after May 1,
2004, which Citigroup is in the process of conducting. Potential results of such
market test, in which TSYS is a participant, include continuation of the
processing agreement under its existing terms, continuation of the processing
agreement under mutually agreed modified terms, or termination of the processing
agreement after May 1, 2006 without a termination fee. The impact of the
transaction between Sears and Citigroup on the financial position, results of
operations and cash flows of TSYS cannot be determined at this time.
- 25 -
Results of Operations (continued)
On August 2, 2004, TSYS completed the acquisition of Clarity Payment
Solutions, Inc. (Clarity) for $53.0 million in cash and had direct acquisition
costs in the amount of $515,000. Clarity was renamed TSYS Prepaid. Refer to Note
9 in the notes to unaudited consolidated financial statements for more
information on the acquisition of TSYS Prepaid. For the three months ended March
31, 2005, TSYS' electronic payment processing services revenues include $6.5
million of TSYS Prepaid's revenues.
Merchant Services
Merchant services revenues are derived from electronic transaction
processing services primarily to large financial institutions and other merchant
acquirers. Revenues from merchant services include processing all payment forms
including credit, debit, electronic benefit transfer and check truncation for
merchants of all sizes across a wide array of retail market segments. Merchant
services' products and services include: authorization and capture of electronic
transactions; clearing and settlement of electronic transactions; information
reporting services related to electronic transactions; merchant billing
services; and point of sale terminal sales and service.
Revenues from merchant services consist of revenues generated by TSYS'
wholly owned subsidiary Vital and majority owned subsidiary GP Net. Merchant
services revenue for the quarter was $27.1 million compared to $6.4 million for
the same period last year. The increase is completely attributable to the
consolidation of Vital's results effective March 1, 2005. Prior to the
acquisition of Vital, TSYS' revenues included fees TSYS charged to Vital for
back-end processing support.
On March 1, 2005, TSYS acquired the remaining 50% of Vital from Visa for
$95.8 million in cash, including $782,000 of direct acquisition costs. Vital is
now a separate, wholly owned subsidiary of TSYS. As a result of the acquisition
of control of Vital, TSYS changed from the equity method of accounting for the
investment in Vital and began consolidating Vital's balance sheet and results of
operations. Refer to Note 9 in the notes to unaudited consolidated financial
statements for more information on the acquisition of Vital.
Other Services
Revenues from other services consist primarily of revenues generated by
TSYS' wholly owned subsidiaries not included in electronic payment processing
services or merchant services, as well as TSYS' business process management
services. Revenues from other services increased $7.7 million, or 18.8%, for the
three months ended March 31, 2005, compared to the same period in 2004. Other
services revenue increased primarily due to increases associated with TSYS'
business process management services. Revenues from TSYS' business process
management increased $6.0 million for the three months ended March 31, 2005 as
compared to the same period in 2004.
Reimbursable Items
As a result of the FASB's Emerging Issues Task Force No. 01-14 (EITF No.
01-14), "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenues and expenses. Reimbursable items
increased $9.0 million, or 14.8%, for the three months ended March 31, 2005, as
compared to the same period last year. Of the $9.0 million increase, $3.9
million is attributable to Vital and TSYS Prepaid. The majority of reimbursable
items relates to the Company's domestic-based clients and is primarily costs
associated with postage.
- 26 -
Results of Operations (continued)
Operating Expenses
Total expenses increased 17.7% for the three months ended March 31, 2005,
compared to the same period in2004. The increase in expense includes an increase
of $1.0 million related to the effects of currency translation of its
foreign-based subsidiaries and branches. Excluding reimbursable items, total
expenses increased 18.6% for the three months ended March 31, 2005, compared to
the same period in 2004. The increase in operating expenses is attributable to
changes in each of the expense categories as described below.
Salaries and Other Personnel Expense
Summarized below are the major components of salaries and other personnel
expenses:
Three months ended March 31,
--------------------------------------------------
(in thousands) 2005 2004 % Change
----------------- ---------------- ---------------
Salaries $ 78,080 68,919 13.3
Employee benefits 20,824 16,889 23.3
Nonemployee wages 3,514 4,117 (14.7)
Other 721 977 (26.1)
Less capitalized expenses (5,622) (3,040) 84.9
----------------- ----------------
Totals $ 97,517 87,862 11.0
================= ================
Salaries and other personnel expenses increased $9.7 million, or 11.0%, for
the three months ended March 31, 2005 compared to the same period in 2004. Of
the $9.7 million increase, $8.1 million is the result of employee related
expenses of Vital and TSYS Prepaid. In addition, the change in employment
expenses is associated with the normal salary increases and related benefits, as
well as higher levels of employment costs categorized as software development
and contract acquisition costs. The growth in employment expenses included an
increase in the accrual for performance-based incentive benefits.
The Company's salaries and personnel expenses is greatly influenced by the
number of employees. Below is a summary of the Company's employee data:
Employee Data:
(Full-time Equivalents) 2005 2004 % Change
----------------------------------- -------------- ------------- ----------------
At March 31, 6,417 5,530 16.0
YTD Average 5,863 5,612 4.5
During the first quarter of 2005, TSYS added 738 employees associated with
the acquisition of Vital. During the third quarter of 2004, TSYS added 67
employees associated with the TSYS Prepaid acquisition.
- 27 -
Results of Operations (continued)
Net Occupancy and Equipment Expense Summarized below are the major
components of net occupancy and equipment expenses:
Three months ended March 31,
--------------------------------------------------
(in thousands) 2005 2004 % Change
----------------- ---------------- ---------------
Equipment and software rentals $ 24,588 22,445 9.6
Depreciation and amortization 23,502 19,441 20.9
Repairs and maintenance 8,146 11,410 (28.6)
Impairment of developed software 3,137 - na
Other 6,020 4,753 26.6
----------------- ----------------
Totals $ 65,393 58,049 12.7
================= ================
na-not applicable
Net occupancy and equipment expense increased $7.3 million, or 12.7%, for
the three months ended March 31, 2005 over the same period in 2004. Of the $7.3
million increase, $1.8 million is the result of occupancy and equipment related
expenses of Vital and TSYS Prepaid.
TSYS' equipment needs are met to a large extent through operating leases.
The Company continues to add leased equipment and software expense necessary to
add capacity for new conversions scheduled in 2005. During the quarter ended
March 31, 2005, TSYS recognized an impairment loss on developed software of $3.1
million. Also, the results for 2005 include expenses associated with the new
data centre in Europe, which became operational in August 2004.
The Company is developing its Integrated Payments (IP) Platform supporting
the on-line and off-line debit and stored value markets, which will give clients
access to all national and regional networks, EBT programs, ATM driving and
switching services for online debit processing. The Company has invested a total
of $6.3 million since the project began.
Development relating specifically to the IP on-line debit platform
primarily consisted of a third-party software solution. During the first quarter
of 2005, the Company evaluated its debit solution and decided to modify its
approach in the debit processing market. With the acquisition of Vital and debit
alternatives now available, TSYS determined that it would no longer market this
third-party software product as its on-line debit solution. TSYS will continue
to support this product for existing clients and will enhance and develop a new
solution. As a result, TSYS recognized an impairment charge in net occupancy and
equipment expense of approximately $3.1 million related to this asset. The
impairment charge is reflected in the domestic-based support services segment.
- 28 -
Results of Operations (continued)
Other Operating Expenses
Summarized below are the major components of other operating expenses:
Three months ended March 31,
-------------------------------------------------
(in thousands) 2005 2004 % Change
-------------------------------------------------
Court costs associated with debt collection services $ 7,981 9,807 (18.6)
Supplies and stationery 6,681 6,703 (0.3)
Third-party data processing services 4,797 1,230 290.0
Professional advisory services 4,508 1,643 174.3
Amortization of conversion costs 3,454 2,718 27.1
Bad debt expense and billing adjustments 3,178 (704) 551.4
Transaction processing provisions 3,109 925 236.1
Terminal deployment costs 2,298 - nm
Management fees 2,071 2,250 (7.9)
Amortization of acquisition intangibles 1,291 466 176.8
Other 13,843 9,548 45.0
Less capitalized expenses (2,051) (35) nm
---------------------------------
Totals $ 51,160 34,551 48.1
=================================
nm = not meaningful
Other operating expenses for the three months ended March 31, 2005
increased $16.6 million, or 48.1%, as compared to the same period in 2004. Of
the $16.6 million increase, $14.1 million is the result of other operating
related expenses of Vital and TSYS Prepaid.
Other operating expenses include, among other things, amortization of
conversion costs, costs associated with delivering merchant services,
professional advisory fees and court costs associated with its debt collection
business. Other operating expenses also include charges for processing errors,
contractual commitments and bad debt expense. As described in the Critical
Accounting Policies section in the 2004 Form 10-K, 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. For the
three months ended March 31, 2005, the Company's transaction processing expenses
increased $2.2 million compared to the same period in 2004.
Operating Income
Operating income increased 50.2% for the three months ended March 31, 2005,
over the same period in 2004. The Company's operating profit margin for the
three months ended March 31, 2005 was 18.9%, compared to 15.5% for the same
period last year. The margins for 2005 increased when compared to the same
period in 2004 mainly as a result of increased revenues and a continued focus on
expense control.
- 29 -
Results of Operations (continued)
Management believes that reimbursable items distort operating profit margin
as defined by generally accepted accounting principles. Management evaluates the
Company's operating performance based upon operating margin excluding
reimbursable items. Management believes that operating profit margin excluding
reimbursable items is more useful because reimbursable items do not impact
profitability as the Company receives reimbursement for expenses incurred on
behalf of its clients. Excluding reimbursable items, the Company's operating
profit margin for the three months ended March 31, 2005 was 23.6%, compared to
19.7% for the three months ended March 31, 2004.
Below is the reconciliation between reported operating margin and adjusted
operating margin excluding reimbursable items for the three months ended March
31, 2005 and 2004, respectively:
Three months ended March 31,
--------------------------------------------------------------------------------------------
2005 2004
--------------------------------------------------------------------------------------------
Operating income (a) $ 66,306 44,142
================= =================
Total revenues (b) $ 349,984 285,236
================= =================
Operating margin (as reported) (a)/(b) 18.9% 15.5%
================= =================
Revenue before reimbursable items (c) $ 280,376 224,604
================= =================
Adjusted operating margin (a)/(c) 23.6% 19.7%
================= =================
Nonoperating Income (Expense)
Interest income for the three months ended March 31, 2005 was $1.2 million,
an increase of $714,000 compared to $505,000 for the same period in 2004. The
increase is related to the fluctuation in the amount of cash available for
investment and short-term interest rates.
Interest expense for the three months ended March 31, 2005 was $70,000, a
decrease of $673,000 compared to $743,000 for the same period in 2004. The
decrease is the result of the interest expense in 2004 related to the Company's
software obligations. On March 31, 2004, TSYS paid the remaining obligations for
mainframe software licenses.
The Company records foreign currency translation adjustments on
foreign-denominated balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British
Pounds Sterling (BPS). As the Company translates the foreign-denominated cash
balances into US dollars, the translated cash balance is adjusted upward or
downward depending upon the foreign currency exchange movements. The upward or
downward adjustment is recorded as a gain or loss on foreign currency
translation in the Company's statements of income. As those cash accounts have
increased, the upward or downward adjustments have increased. The majority of
the translation loss of $333,000 for the three months ended March 31, 2005
relates to the translation of cash accounts. The balance of the Company's
foreign-denominated cash accounts subject to risk of translation gains or losses
at March 31, 2005 was approximately $3.8 million, the majority of which is
denominated in BPS.
- 30 -
Results of Operations (continued)
Income Taxes
TSYS' effective income tax rate for the three months ended March 31, 2005
was 35.1%, compared to 34.2% for the same period in 2004. The increase in the
effective tax rate for the three months ended March 31, 2005 is as a result of
increased foreign earnings. The calculation of the effective tax rate is income
taxes divided by TSYS' pretax income adjusted for minority interests in
consolidated subsidiaries' net income and equity earnings of the Vital joint
venture. The Company expects its effective income tax rate for 2005 to be
approximately 35%-36%.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $3.8 million
for the three months ended March 31, 2005 compared to $5.6 million for the same
period in 2004. The decrease for the quarter is primarily attributable to the
purchase of the remaining 50% of Vital on March 1, 2005 and the inclusion of
Vital's operating results in TSYS' statement of income. Refer to Note 9 in the
notes to unaudited consolidated financial statement for more information on the
acquisition of Vital.
Vital Processing Services, L.L.C.
During the three months ended March 31, 2005, the Company's equity in
income of joint ventures related to Vital was $3.2 million, a 37.7% decrease, or
$2.0 million, compared to $5.2 million for the same period last year. As a
result of the acquisition of control of Vital, TSYS changed from the equity
method of accounting for the investment in Vital and began consolidating Vital's
balance sheet and results of operations in the statements of income beginning
March 1, 2005.
TSYS de Mexico
The Company has a joint venture with a number of Mexican banks and records
its 49% ownership in the jointventure using the equity method of accounting. The
operation, Total System Services de Mexico, S.A. de C.V. (TSYS de Mexico),
prints statements and provides card-issuing support services to the joint
venture clients.
During the three months ended March 31, 2005, the Company's equity in
income of joint ventures related to TSYS de Mexico was $509,000, a 35.7%
increase, or $134,000 compared to $375,000 for the same period last year.
TSYS pays 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 processing support fee of $34,000 and $63,000 for the
three months ended March 31, 2005 and 2004, respectively. This processing
support fee decreased as a result of the deconversion of a TSYS client in
Mexico.
Net Income
Net income for the three months ended March 31, 2005 increased 41.7% to
$46.1 million, or basic and diluted earnings per share of $0.23, compared to
$32.6 million, or basic and diluted earnings per share of $0.17, for the same
period in 2004.
Net Profit Margin
The Company's net profit margin for the three months ended March 31, 2005
was 13.2%, compared to 11.4% for the same period last year.
- 31 -
Results of Operations (continued)
Management believes that reimbursable items distort net profit margin as
defined by generally accepted accounting principles. Management evaluates the
Company's operating performance based upon net profit margin excluding
reimbursable items. Management believes that net profit margin excluding
reimbursable items is more useful because reimbursable items do not impact
profitability as the Company receives reimbursement for expenses incurred on
behalf of its clients.
Excluding reimbursable items, the Company's net profit margin for the three
months ended March 31, 2005 was 16.5%, compared to 14.5% for the three months
ended March 31, 2004.
Below is the reconciliation between reported net profit margin and adjusted
net profit margin excluding reimbursable items for the three months ended March
31, 2005 and 2004, respectively:
Three months ended
March 31,
-------------------------------------------------------------------------------------------
2005 2004
-------------------------------------------------------------------------------------------
Net income (a) $ 46,123 32,561
================== =================
Total revenues (b) $ 349,984 285,236
================== =================
Net profit margin (as reported) (a)/(b) 13.2% 11.4%
================== =================
Revenue before reimbursable items (c) $ 280,376 224,604
================== =================
Adjusted net profit margin (a)/(c) 16.5% 14.5%
================== =================
Projected Outlook for 2005
On April 19, 2005, TSYS announced it was raising its projected outlook for
2005. TSYS now expects its 2005 net income growth to be in the range of 22%-25%,
based on the following assumptions: revenue before reimbursable items increasing
30%-33% in 2005; Vital adding $225-$235 million in annual revenue; accounts on
file at the end of 2005 increasing to approximately 430-435 million; and no
significant client losses or additions through 2005, other than those previously
announced.
On April 14, 2005, the Securities and Exchange Commission (SEC) approved a
rule that delays the effective date of SFAS No. 123R for public companies that
do not file as small business issuers until the first annual or interim
reporting period of the first fiscal year that begins on or after June 15, 2005.
The Company plans on adopting SFAS No. 123R on January 1, 2006. The Company
expects that the impact of adopting SFAS No. 123R for expensing existing stock
options will have a negative impact upon its results of operations and statement
of position. The Company expects that the impact of expensing existing stock
option grants, as well as the impact of any anticipated stock option grants to
be approximately $0.02-$0.03 per share in 2006. The Company does not expect the
impact of adopting SFAS No. 123R to have a material impact upon its cash flow.
Financial Position, 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 use of leases. TSYS has occasionally used borrowed funds to
supplement financing of capital expenditures.
- 32 -
Financial Position, Liquidity and Capital Resources (continued)
Cash Flows From Operating Activities
Three months ended
March 31,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Net income $ 46,123 32,561
Depreciation and amortization 32,739 26,115
Other non cash items and charges, net 14,466 (7,613)
Working capital items (137,863) (7,104)
----------------- -----------------
Net cash (used in) provided from operating activities $ (44,535) 43,959
================= =================
TSYS' main source of funds is derived from operating activities,
specifically net income. During the three months ended March 31, 2005, the
Company used $44.5 million in cash for operating activities compared to
generating $44.0 million for the same period last year. The decrease in 2005 in
net cash provided from operating activities was the result of the use of cash
for working capital items.
Working capital items include accounts receivable, prepaid expenses and
other assets, accounts payable, accrued salaries and employee benefits and other
current liabilities. The change in accounts receivable at March 31, 2005 as
compared to December 31, 2004 is the result of timing of collections compared to
billings. The change in accounts payable and other liabilities for the same
period is the result of the timing of payments for long-term software contracts,
funding of performance-based incentives and payments of vendor invoices.
Cash Flows From Investing Activities
Three months ended
March 31,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Purchase of property and equipment, net $ (10,702) (19,535)
Additions to licensed computer software from vendors (5,869) (7,370)
Additions to internally developed computer software (709) (1,982)
Cash used in acquisitions, net of cash acquired (56,983) -
Dividends from joint ventures - 15,000
Contract acquisition costs (5,442) (1,857)
----------------- -----------------
Net cash used in investing activities $ (79,705) (15,744)
================= =================
The major uses of cash for investing activities have been the addition of
property and equipment, primarily computer equipment, the purchase of licensed
and internal development of computer software, investments in contract
acquisition costs associated with obtaining and servicing new or existing
clients, and business acquisitions. The major source of funds from investing
activities is the dividend payment from its joint ventures. The Company used
$79.7 million in cash for investing activities for the three months ended March
31, 2005, compared to $15.7 million for the same period in 2004. The major use
of cash for investing activities in 2005 was for the purchase of Vital.
- 33 -
Financial Position, Liquidity and Capital Resources (continued)
Property and Equipment
Capital expenditures for property and equipment during the three month
periods ended March 31, 2005 and 2004 were $10.7 million and $19.5 million,
respectively. The majority of the capital expenditure amounts relate to computer
equipment and the completion of the new European data centre.
Licensed Computer Software from Vendors
Expenditures for licensed computer software from vendors were $5.9 million
and $7.4 million for the three months ended March 31, 2005 and 2004,
respectively. These additions relate to annual site licenses for mainframe
processing systems whose fees are based upon a measure of TSYS' computer
processing capacity, commonly referred to as millions of instructions per second
or MIPs.
Internally Developed Computer Software Costs
Additions to internally developed computer software costs, including
enhancements to, and development of, TS2 processing systems, were $709,000 and
$2.0 million for the three month periods ended March 31, 2005 and 2004,
respectively. The decline in the amount capitalized as software development
costs in 2005, as compared to 2004, is the result of several projects being
completed in prior periods. The Company remains committed to developing and
enhancing its processing solutions to expand its service offerings. In addition
to developing solutions, the Company has expanded its service offerings through
strategic acquisitions, such as TSYS Prepaid.
The Company continues to develop TSYS ProphIT, 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' processing clients with general
release of the core platform having occurred in the fourth quarter of 2003.
Continued development of TSYS ProphIT provides increased and enhanced
functionality to the core platform, to include additional customer service
functions. The Company has invested a total of $30.4 million since the project
began.
The Company is developing its Integrated Payments Platform supporting the
on-line and off-line debit and stored value markets, which will give clients
access to all national and regional networks, EBT programs, ATM driving and
switching services for online debit processing. The Company has invested a total
of $6.3 million since the project began. The Company expects to complete the
system in phases.
As previously mentioned on page 28, the Company evaluated its debit
solution and decided to modify its approach in the debit processing market.
During the first quarter of 2005, TSYS recognized an impairment charge in net
occupancy and equipment expense of approximately $3.1 million related to its
on-line debit solution.
Cash Used in Acquisitions
During the three months ended March 31, 2005, the Company purchased Vital
for approximately $95.0 million, and had direct acquisition costs of $782,000.
Dividends Received from Joint Ventures
During the three months ended March 31, 2004, the Company received a
dividend payment of $15.0 million from its Vital joint venture.
- 34 -
Financial Position, Liquidity and Capital Resources (continued)
Contract Acquisition Costs
TSYS makes cash payments for processing rights, third-party development
costs and other direct salary related costs in connection with converting new
customers to the Company's processing systems. The Company's investments in
contract acquisition costs were $5.4 million for the three months ended March
31, 2005, compared to $1.9 million for the three months ended March 31, 2004.
The Company did not have any cash payments for processing rights during the
three months ended March 31, 2005 nor for the same period last year. Conversion
cost additions were $5.4 million and $1.9 million for the three months ended
March 31, 2005 and 2004, respectively. The increase in the amount of conversion
cost additions for 2005, as compared to 2004, is the result of the discontinued
use of the percentage-of-completion accounting method for TSYS' agreement with
Bank One.
Cash Flows From Financing Activities
Three months ended
March 31,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Proceeds from borrowings of long-term debt $ 14,125 -
Principal payments on long-term debt borrowings, capital lease obligations
and software obligations (13,704) (41,589)
Dividends paid on common stock (7,874) (3,936)
Purchase of common stock - (1,189)
Other - 1,142
----------------- -----------------
Net cash used in financing activities $ (7,453) (45,572)
================= =================
The major use of cash for financing activities has been the principal
payments on capital lease and software obligations, the payment of dividends and
the purchase of stock under the stock repurchase plan as described below. The
main source of cash from financing activities has been the occasional use of
borrowed funds. Net cash used in financing activities for the three months ended
March 31, 2005 was $7.5 million mainly as a result of the payments of dividends.
Net cash used in financing activities for the three months ended March 31, 2004
was $45.6 million mainly as a result of the payments related to the software
obligations, and to a lesser extent, the purchases of common stock and payments
of dividends.
Software Obligations
On March 31, 2004, the Company paid in full the obligations related to
licensed mainframe software. The effective interest rates related to the
software obligations were well above current market rates.
Line of Credit
TSYS has a $45.0 million long-term line of credit from a banking affiliate
of Synovus. A detailed discussion related to the line of credit is in Note 6 in
the notes to the unaudited consolidated financial statements on page 14.
- 35 -
Financial Position, Liquidity and Capital Resources (continued)
Stock Repurchase Plan
On April 15, 2003, TSYS announced that its board had approved a stock
repurchase plan to purchase up to 2 million shares, which represents slightly
more than five percent of the shares of TSYS stock held by shareholders other
than Synovus. The shares may be purchased from time to time over the next two
years and will depend on various factors including price, market conditions,
acquisitions and the general financial position of TSYS. Repurchased shares will
be used for general corporate purposes. For the first three months of 2005, the
Company did not purchase any shares. Since the plan was announced, the Company
has purchased 577,491 shares at an average cost of $19.07 per share. The plan
expired on April 15, 2005.
Dividends
Dividends on common stock in the amount of $7.9 million were paid during
the three months ended March 31, 2005 compared to $3.9 million paid during the
three months ended March 31, 2004. On April 21, 2005, the Company announced it
would increase its quarterly dividend by 50% from $0.04 to $0.06 per share. This
dividend amount will be payable on July 1, 2005, to shareholders of record at
the close of business on June 23, 2005. On April 15, 2004, the Company announced
it would double its quarterly dividend from $0.02 to $0.04 per share.
Significant Noncash Transactions
During the first quarter of 2005, the Company issued 221,902 shares of
common stock to certain key executive officers and non-management members of its
board of directors under restricted stock bonus awards for services to be
provided by such officers and directors in the future. The market value of the
common stock at the date of issuance is included as a reduction of additional
paid-in capital in the shareholders' equity section of the Company's
consolidated balance sheet and is amortized as compensation expense over the
vesting period of the awards. Common stock issued under restricted stock bonus
awards is considered outstanding for purposes of the computation of basic and
diluted earnings per share.
Foreign Exchange
TSYS operates internationally and is subject to potentially adverse
movements in foreign currency exchange rates. Since December 2000, TSYS has not
entered into foreign exchange forward contracts to reduce its exposure to
foreign currency rate changes. TSYS continues to analyze potential hedging
instruments to safeguard it from significant foreign 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.
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
- 36 -
Working Capital (continued)
a significant portion of its capital expenditure needs through internally
generated cash in the future, as evidenced by TSYS' current ratio of 1.6. At
March 31, 2005, TSYS had working capital of $142.2 million compared to $170.3
million at December 31, 2004.
Legal Proceedings
The Company is subject to lawsuits, claims and other complaints arising out
of the ordinary conduct of its business. In the opinion of management, based in
part upon the advise of legal counsel, all matters are believed to be adequately
covered by insurance, or if not covered, are believed to be without merit or are
of such kind or involve such amounts that would not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company if disposed of unfavorably. The Company establishes reserves for
expected future litigation exposures that TSYS determines to be both probable
and reasonably estimable.
The Company has received notification from the United States Attorneys'
Office for the Northern District of California that the United States Department
of Justice is investigating whether the Company and/or one of its large credit
card processing clients violated the False Claims Act, 31 U.S.C. SS3729-33, in
connection with mailings made on behalf of the client from July 1997 through
November 2001. The subject matter of the investigation relates to the U.S.
Postal Service's Move Update Requirements. In general, the Postal Service's Move
Update Requirements are designed to reduce the volume of mail that is returned
to sender as undeliverable as addressed. In effect, these requirements provide,
among other things, various procedures that may be utilized to maintain the
accuracy of mailing lists in exchange for discounts on postal rates. The Company
has received a subpoena from the Office of the Inspector General of the U.S.
Postal Service, and has produced documents responsive to the subpoena. The
Company continues to cooperate with the Department of Justice in the
investigation, and there can be no assurance as to the timing or outcome of the
investigation, including whether the investigation will result in any criminal
or civil fines, penalties, judgments or treble damages or other claims against
the Company. The Company established a reserve during the quarter ended March
31, 2005 relating to this investigation. However, there can be no assurance that
the Company will not suffer a loss in connection with this investigation in an
amount exceeding such reserve or that the Company will not be required to
reserve additional amounts in future periods.
Recent Accounting Pronouncements
The Company's Annual Report on Form 10-K for the year ended December 31,
2004, as filed with the Securities and Exchange Commission (SEC), contains a
discussion of recent accounting pronouncements and the expected impact on the
Company's financial statements. The following accounting standards have been
modified during this year and are expected to have a material impact on the
financial statements of the Company.
On April 14, 2005, the Securities and Exchange Commission (SEC) approved a
rule that delays the effective date of SFAS No. 123R for public companies that
do not file as small business issuers until the first annual or interim
reporting period of the first fiscal year that begins on or after June 15, 2005.
The Company plans on adopting SFAS No. 123R on January 1, 2006. The Company
expects that the impact of adopting SFAS No. 123R for expensing existing stock
options will have a negative impact upon its results of operations and statement
of position. The Company expects that the impact of expensing existing stock
option grants, as well as the impact of any anticipated stock option grants to
be
- 37 -
Recent Accounting Pronouncements (continued)
approximately $0.02-$0.03 per share in 2006. The Company does not expect the
impact of adopting SFAS No. 123R to have a material impact upon its cash flow.
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' expectation that it
will convert Chase's portfolios in the second half of 2005 and maintain the
card-processing functions of Chase for at least two years, TSYS' expectation
with respect to the impact of the Chase contract on its earnings per share
growth for 2005 and 2006, the expected adoption date of expensing stock options
and the expected financial impact of expensing options, TSYS' expected growth in
net income for 2005, any matter that may arise out of the United States
Department of Justice's investigation, and the assumptions underlying such
statements, including, with respect to TSYS' expected increase in net income for
2005, an increase in revenues before reimbursable items of 30-33%; Vital
Processing Services adding $225-$235 million in annual revenues; accounts on
file at the end of 2005 will be between 430 and 435 million; and no significant
client losses or additions through 2005, other than those previously announced.
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,"
"estimates," "projects," "plans," "may," "could," "should," "would," and similar
expressions are intended to identify forward-looking statements but are not the
exclusive means of identifying these statements.
These statements are based upon the current beliefs and expectations of
TSYS' management and are subject to significant risks and uncertainties. Actual
results may differ materially from those contemplated by the forward-looking
statements. A number of important factors could cause actual results to differ
materially from those contemplated by our forward-looking statements. Many of
these factors are beyond TSYS' ability to control or predict. These factors
include, but are not limited to: (i) revenues that are lower than anticipated;
(ii) Vital's addition to revenue is lower than anticipated; (iii) accounts on
file at the end of 2005 are lower than anticipated; (iv) TSYS incurs expenses
associated with the signing of a significant client; (v) internal growth rates
for TSYS' existing customers are lower than anticipated; (vi) TSYS does not
convert clients' portfolios as scheduled; (vii) adverse developments with
respect to foreign currency exchange rates; (viii) adverse developments with
respect to entering into contracts with new clients and retaining current
clients; (ix) 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;
(x) TSYS is unable to control expenses and increase market share; (xi) adverse
developments with respect to the credit card industry in general; (xii) TSYS is
unable to successfully manage any impact from slowing economic conditions or
consumer spending; (xiii) the impact of acquisitions, including their being more
difficult to integrate than anticipated; (xiv) the costs and effects of
litigation, investigations or similar matters or adverse facts and developments
relating thereto; (xv) the impact of changes in
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Forward-Looking Statements (continued)
accounting principles; (xvi) TSYS' inability to timely, successfully and
cost-effectively improve and implement processing systems to provide new
products, increased functionality and increased efficiencies; (xvii) TSYS'
inability to anticipate and respond to technological changes, particularly with
respect to e-commerce; (xviii) changes occur in laws, regulations, credit card
associations rules or other industry standards affecting TSYS' business which
require significant product redevelopment efforts or reduce the market for or
value of its products; (xix) successfully managing the potential both for patent
protection and patent liability in the context of rapidly developing legal
framework for expansive patent protection; (xx) no material breach of security
of any of our systems; (xxi) overall market conditions; (xxii) the impact on
TSYS' business, as well as on the risks set forth above, of various domestic or
international military or terrorist activities or conflicts; and (xxiii) TSYS'
ability to manage the foregoing and other risks.
These forward-looking statements speak only as of the date on which they
are made, and TSYS undertakes no obligation to update any forward-looking
statement as a result of new information, future developments or otherwise.
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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 loss for the three months ended March 31, 2005 was $2.4
million compared to other comprehensive income of $1.9 million for the same
period in 2004. 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) $140.1 million,
$5.0 million, $0.8 million and $14.0 million, respectively, at March 31, 2005.
The Company also records foreign currency translation adjustments
associated with other balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British Pound
Sterling (BPS). As the Company translates the foreign-denominated cash balances
into US dollars, the translated cash balance is adjusted upward or downward
depending upon the foreign currency exchange movements. The upward or downward
adjustment is recorded as a gain or loss on foreign currency translation in the
Company's statements of income. As those cash accounts have increased, the
upward or downward adjustments have increased. The majority of the translation
loss of $333,000 for the three months ended March 31, 2005 relates to the
translation of cash accounts. The balance of the foreign-denominated cash
accounts subject to risk of translation gains or losses at March 31, 2005 was
approximately $3.8 million, the majority of which is denominated in BPS.
The following represents the potential effect on income before income taxes
of hypothetical shifts in the foreign currency exchange rate between the BPS and
the U.S. dollar of plus or minus 100 basis points, 500 basis points and 1,000
basis points based on the foreign-denominated cash account balance at March 31,
2005.
---------------------------------------------------------------------------------------------
Effect of Basis Point Change
---------------------------------------------------------------------------------------------
Increase in basis point of Decrease in basis point of
--------------- ----------------- ---------------- ------------ -------------- --------------
(in thousands) 100 500 1,000 100 500 1,000
--------------- ----------------- ---------------- ------------ -------------- --------------
Effect on income before
income taxes $ (38) (191) (383) 38 191 383
--------------- ----------------- ---------------- ------------ -------------- --------------
The foreign currency risks associated with other currencies is not significant.
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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 use of long-term debt associated with its line of credit
as discussed below. TSYS invests available cash in conservative short-term
instruments and is primarily subject to changes in the short-term interest
rates.
In connection with the purchase of the campus, TSYS obtained a $45.0
million long-term line of credit from a banking affiliate of Synovus. The line
is an automatic draw down facility. The interest rate for the line of credit is
the London Interbank Offered Rate (LIBOR) plus 150 basis points. In addition,
there is a charge of 15 basis points on any funds unused. As the LIBOR rate
changes, TSYS will be subject to interest rate risk. At March 31, 2005, TSYS had
an outstanding balance of $984,000 on the line of credit.
Concentration of Credit Risk
TSYS works to maintain a large and diverse client base across various
industries to minimize the credit risk of any one client to TSYS' accounts
receivable amounts. In addition, TSYS performs ongoing credit evaluations of its
certain clients' and certain suppliers' financial condition. TSYS does, however,
have one major customer that accounts for a large portion of its revenues, which
subject it to credit risk.
Concentration of Volume of Business Transacted Risk
TSYS works to maintain a large and diverse client base across various
industries to minimize the risk of any one client accounting for a large portion
of its revenues. TSYS does, however, have one major customer that accounts for a
large portion of its revenues. This one major customer has a long-term
relationship with the Company.
TSYS utilizes several large and diverse suppliers across various industries
to minimize its reliance on any one supplier. However, TSYS does rely on a
relatively few major suppliers for a significant portion of its licensed
computer software and hardware needs. The relationship with these particular
vendors is well established. These particular vendors are large, well-known and
respected entities in their industry.
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TOTAL SYSTEM SERVICES, INC.
Item 4 - Controls and Procedures
We have evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period covered by this
quarterly report as required by Rule 13a-15 of the Securities Exchange Act of
1934, as amended. This evaluation was carried out under the supervision and with
the participation of our management, including our chief executive officer and
chief financial officer. Based on this evaluation, these officers have concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to TSYS (including its consolidated
subsidiaries) required to be included in our periodic Securities and Exchange
Commission filings. No change in TSYS' internal control over financial reporting
occurred during the period covered by this report that materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
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TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth information regarding the Company's
purchases of its common stock on a monthly basis during the three months ended
March 31, 2005:
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
Total Number of Shares Maximum Number of
Purchased as Part of Shares That May Yet Be
Total Number of Shares Average Price Paid per Publicly Announced Purchased Under the
Period Purchased Share Plans or Programs Plans or Programs
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
1,422,509
January 2005 - $- - 1,422,509
February 2005 - - - 1,422,509
March 2005 - - - 1,422,509
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
Total - $-
======================== ========================
In April 2003, the Company announced a plan to purchase up to 2.0 million
shares of its common stock from time to time and at various prices over the
ensuing two years. During the three months ended March 31, 2005, the Company did
not repurchase any shares of its common stock. Over the course of the plan,
through March 31, 2005, the Company repurchased 577,491 shares of its common
stock at a cost of $11.0 million, or an average cost of $19.07 per share. The
plan expired on April 15, 2005.
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TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 6 - Exhibits
a) Exhibits
Exhibit Number Description
--------------------- ---------------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
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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: May 4, 2005 by: /s/ Philip W. Tomlinson
---------------------------------------------------------------
Philip W. Tomlinson
Chief Executive Officer
Date: May 4, 2005 by: /s/ James B. Lipham
---------------------------------------------------------------
James B. Lipham
Chief Financial Officer
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TOTAL SYSTEM SERVICES, INC.
Exhibit Index
Exhibit Number Description
--------------------- --------------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
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