UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
(Mark One)
| [X] |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2003
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 0-30791
eFunds Corporation
| Delaware | 39-1506286 | |||
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) | |||
| Gainey Center II | ||||
| 8501 N. Scottsdale Road, Suite 300 | ||||
| Scottsdale, Arizona | 85253 | |||
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code: (480) 629-7700
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 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 [ ]
The number of shares outstanding of the registrant’s common stock, par value $.01 per share, at August 7, 2003 was 46,804,187.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
eFUNDS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| (Unaudited) | |||||||||||
| June 30, | December 31, | ||||||||||
| (dollars in thousands) | 2003 | 2002 | |||||||||
Current assets: |
|||||||||||
Cash and cash equivalents |
$ | 156,278 | $ | 119,487 | |||||||
Deposits subject to compensating balance arrangements |
477 | 1,133 | |||||||||
Restricted custodial cash |
2,304 | 3,046 | |||||||||
Accounts receivable – net |
59,817 | 59,311 | |||||||||
Deferred income taxes |
11,188 | 11,580 | |||||||||
Prepaid expenses and other current assets |
16,202 | 17,865 | |||||||||
Assets held for sale |
1,372 | 13,310 | |||||||||
Total current assets |
247,638 | 225,732 | |||||||||
Property and equipment – net |
48,815 | 50,764 | |||||||||
Long-term investments |
3,575 | 3,758 | |||||||||
Intangibles: |
|||||||||||
Goodwill |
116,254 | 114,036 | |||||||||
Other intangible assets – net |
56,039 | 61,836 | |||||||||
Total intangibles – net |
172,293 | 175,872 | |||||||||
Other non-current assets |
2,882 | 3,292 | |||||||||
Total non-current assets |
227,565 | 233,686 | |||||||||
Total assets |
$ | 475,203 | $ | 459,418 | |||||||
Current liabilities: |
|||||||||||
Accounts payable |
$ | 24,182 | $ | 32,598 | |||||||
Accrued liabilities |
44,400 | 30,937 | |||||||||
Accrued contract losses |
5,658 | 7,578 | |||||||||
Deferred revenue |
8,595 | 3,423 | |||||||||
Long-term debt due within one year |
1,552 | 1,401 | |||||||||
Total current liabilities |
84,387 | 75,937 | |||||||||
Long-term debt |
1,144 | 1,338 | |||||||||
Deferred income taxes |
9,187 | 9,202 | |||||||||
Other long-term liabilities |
5,501 | 9,421 | |||||||||
Total liabilities |
100,219 | 95,898 | |||||||||
Commitments and contingencies (Notes 10 and 11) |
|||||||||||
Stockholders’ equity: |
|||||||||||
Preferred stock $.01 par value; 100,000,000 shares authorized; no shares
issued and outstanding |
— | — | |||||||||
Common stock $.01 par value (authorized: 250,000,000 shares; issued and
outstanding: 46,804,154 shares at June 30, 2003 and 46,702,496 at
December 31, 2002) |
468 | 467 | |||||||||
Additional paid-in capital |
412,069 | 411,451 | |||||||||
Accumulated deficit |
(36,750 | ) | (46,495 | ) | |||||||
Accumulated other comprehensive loss |
(803 | ) | (1,903 | ) | |||||||
Stockholders’ equity |
374,984 | 363,520 | |||||||||
Total liabilities and stockholders’ equity |
$ | 475,203 | $ | 459,418 | |||||||
See Notes to Condensed Consolidated Financial Statements
1
eFUNDS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||
| (in thousands, except per share amounts) | 2003 | 2002 | 2003 | 2002 | |||||||||||||||
Net revenue |
$ | 132,956 | $ | 133,471 | $ | 263,484 | $ | 267,468 | |||||||||||
Operating expenses: |
|||||||||||||||||||
Processing, communication, and service costs |
59,939 | 53,111 | 115,645 | 103,898 | |||||||||||||||
Employee costs |
45,084 | 45,699 | 92,013 | 96,717 | |||||||||||||||
Depreciation and amortization |
8,834 | 9,701 | 17,623 | 19,243 | |||||||||||||||
Other operating costs |
12,185 | 9,001 | 24,712 | 19,193 | |||||||||||||||
Restructuring charges |
— | 10,446 | — | 10,446 | |||||||||||||||
Total operating expenses |
126,042 | 127,958 | 249,993 | 249,497 | |||||||||||||||
Income from operations |
6,914 | 5,513 | 13,491 | 17,971 | |||||||||||||||
Other income – net |
616 | 203 | 860 | 605 | |||||||||||||||
Income before income taxes |
7,530 | 5,716 | 14,351 | 18,576 | |||||||||||||||
Provision for income taxes |
(2,417 | ) | (1,240 | ) | (4,606 | ) | (5,574 | ) | |||||||||||
Net income |
$ | 5,113 | $ | 4,476 | $ | 9,745 | $ | 13,002 | |||||||||||
Weighted average shares outstanding |
46,754 | 46,578 | 46,729 | 46,526 | |||||||||||||||
Weighted average shares and potential dilutive shares outstanding |
47,031 | 47,027 | 46,876 | 47,394 | |||||||||||||||
Net income per share – basic |
$ | 0.11 | $ | 0.10 | $ | 0.21 | $ | 0.28 | |||||||||||
Net income per share – diluted |
$ | 0.11 | $ | 0.10 | $ | 0.21 | $ | 0.27 | |||||||||||
See Notes to Condensed Consolidated Financial Statements
2
eFUNDS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| Six Months Ended | ||||||||||||
| June 30, | ||||||||||||
| (in thousands) | 2003 | 2002 | ||||||||||
Cash flows from operating activities: |
||||||||||||
Net income |
$ | 9,745 | $ | 13,002 | ||||||||
Adjustments to reconcile net income to net cash provided
by operating activities: |
||||||||||||
Depreciation |
7,380 | 9,574 | ||||||||||
Amortization of intangibles |
10,243 | 9,669 | ||||||||||
Loss on disposals of property and equipment |
340 | 3,153 | ||||||||||
Deferred income taxes |
377 | 398 | ||||||||||
Changes in assets and liabilities: |
||||||||||||
Restricted custodial cash |
742 | (3,552 | ) | |||||||||
Accounts receivable |
(506 | ) | 3,086 | |||||||||
Accounts payable |
(8,416 | ) | 5,703 | |||||||||
Accrued contract losses |
(1,920 | ) | (3,146 | ) | ||||||||
Deferred revenue |
5,172 | (1,343 | ) | |||||||||
Other assets and liabilities |
13,167 | (4,400 | ) | |||||||||
Net cash provided by operating activities |
36,324 | 32,144 | ||||||||||
Cash flows from investing activities: |
||||||||||||
Capital expenditures |
(8,950 | ) | (11,596 | ) | ||||||||
Acquisitions |
— | (22,300 | ) | |||||||||
Proceeds from sale of property and equipment |
11,938 | — | ||||||||||
Other |
(2,218 | ) | 26 | |||||||||
Net cash provided by (used in) investing activities |
770 | (33,870 | ) | |||||||||
Cash flows from financing activities: |
||||||||||||
Payments on long-term debt |
(922 | ) | (1,619 | ) | ||||||||
Issuance of common stock |
619 | 2,396 | ||||||||||
Net cash (used in) provided by financing activities |
(303 | ) | 777 | |||||||||
Net increase (decrease) in cash and cash equivalents |
36,791 | (949 | ) | |||||||||
Cash and cash equivalents at beginning of period |
119,487 | 101,871 | ||||||||||
Cash and cash equivalents at end of period |
$ | 156,278 | $ | 100,922 | ||||||||
Supplemental disclosures: |
||||||||||||
Cash paid for income taxes |
$ | 1,349 | $ | 3,549 | ||||||||
Noncash investing and financing activities: |
||||||||||||
Purchase of assets under capital lease obligations |
$ | 878 | $ | — | ||||||||
See Notes to Condensed Consolidated Financial Statements
3
eFUNDS CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – DESCRIPTION OF BUSINESS
AND BASIS OF PRESENTATION:
eFunds Corporation and its wholly-owned subsidiaries (the Company) provide
transaction processing, risk management and professional services to financial
institutions, retailers, electronic funds transfer networks and government
agencies. The Company has four operating segments: Electronic Payments;
Automated Teller Machine (ATM) Management; Risk Management; and Global
Outsourcing. The Electronic Payments segment provides electronic funds transfer
(EFT) software sales, software applications development, maintenance and
installation, processing services including automated clearinghouse (ACH) and
EFT as well as electronic benefit transfer (EBT) services for government
agencies. The ATM Management segment provides ATM deployment, management and
branding services. The Risk Management segment provides risk management based
data and other products to financial institutions, retailers and other
businesses that assist in detecting fraud and assessing the risk of opening a
new account or accepting a check. The Global Outsourcing segment provides
information technology services and business process outsourcing services.
The unaudited condensed consolidated financial statements of the Company for the three and six month periods ended June 30, 2003 and 2002 have been prepared in accordance with accounting principles generally accepted in the United States of America and with the instructions to Form 10-Q and Article 10 of Regulation S-X. All material intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results for a full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2002 included in our 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).
NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES:
New Accounting Pronouncements
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on
EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF
Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or
rights to use assets. The provisions of EITF Issue No. 00-21 will apply to
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. The Company does not believe that the adoption of EITF Issue No. 00-21
will have a material effect on its consolidated financial position or results
of operations.
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” Interpretation No. 46 prescribes how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. This interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among the parties involved. Interpretation No. 46 is effective immediately for variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. The interpretation applies in the first fiscal year or interim period beginning after June 15, 2003 to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company does not believe the adoption of Interpretation No. 46 will have a material impact on its financial position or results of operations.
Employee Stock-Based Compensation
Until 2000, the Company’s employees participated in the stock incentive program
of Deluxe Corporation, its former parent company. In connection with the
Company’s initial public offering and its subsequent spin-off from Deluxe, the
Company adopted new stock incentive programs for the benefit of its employees.
The Company accounts for those plans using the intrinsic value method
prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for
Stock Issued to Employees,” and related interpretations. No stock-based
employee compensation
4
cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provision of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” to its stock-based employee compensation.
| Three Months Ended | Six Months Ended | ||||||||||||||||
| June 30, | June 30, | ||||||||||||||||
| (in thousands, except per share amounts) | 2003 | 2002 | 2003 | 2002 | |||||||||||||
Net income, as reported |
$ | 5,113 | $ | 4,476 | $ | 9,745 | $ | 13,002 | |||||||||
Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of tax |
(735 | ) | (1,634 | ) | (1,288 | ) | (3,422 | ) | |||||||||
Pro forma net income |
$ | 4,378 | $ | 2,842 | $ | 8,457 | $ | 9,580 | |||||||||
Earnings per share: |
|||||||||||||||||
Basic-as reported |
$ | 0.11 | $ | 0.10 | $ | 0.21 | $ | 0.28 | |||||||||
Basic-pro forma |
$ | 0.09 | $ | 0.06 | $ | 0.18 | $ | 0.21 | |||||||||
Diluted-as reported |
$ | 0.11 | $ | 0.10 | $ | 0.21 | $ | 0.27 | |||||||||
Diluted-pro forma |
$ | 0.09 | $ | 0.06 | $ | 0.18 | $ | 0.20 | |||||||||
For purposes of applying SFAS No. 123, the weighted average estimated fair value of stock options granted during the three and six month periods ended June 30, 2003 was $3.33 and $3.62, respectively, and $8.10 and $7.34 for the same periods in 2002. This value was estimated at the option grant date using a Black-Scholes option-pricing model.
NOTE 3 – INTANGIBLES:
Intangible assets consist primarily of goodwill, capitalized software costs and
acquired contracts. Other intangible assets, both acquired and developed,
subject to amortization were as follows:
| June 30, 2003 | ||||||||||||||||
| Wtd. Avg. | ||||||||||||||||
| Amortization | Gross | |||||||||||||||
| Period | Carrying | Accumulated | ||||||||||||||
| (in thousands) | In Years | Amounts | Amortization | Net | ||||||||||||
Software-internal use |
3.8 | $ | 71,942 | $ | (46,111 | ) | $ | 25,831 | ||||||||
Acquired contracts |
11.6 | 22,263 | (2,599 | ) | 19,664 | |||||||||||
Other |
4.8 | 74,814 | (64,270 | ) | 10,544 | |||||||||||
| $ | 169,019 | $ | (112,980 | ) | $ | 56,039 | ||||||||||
| December 31, 2002 | ||||||||||||||||
| Wtd. Avg. | ||||||||||||||||
| Amortization | Gross | |||||||||||||||
| Period | Carrying | Accumulated | ||||||||||||||
| (in thousands) | In Years | Amounts | Amortization | Net | ||||||||||||
Software-internal use |
3.8 | $ | 69,111 | $ | (39,672 | ) | $ | 29,439 | ||||||||
Acquired contracts |
11.6 | 22,262 | (1,455 | ) | 20,807 | |||||||||||
Other |
4.8 | 73,353 | (61,763 | ) | 11,590 | |||||||||||
| $ | 164,726 | $ | (102,890 | ) | $ | 61,836 | ||||||||||
For the three and six month periods ended June 30, 2003, amortization expense for intangible assets was $5.1 million and $10.2 million, respectively, and $5.0 million and $9.7 million for the three and six month periods ended June 30, 2002, respectively. The estimated annual amortization expense for intangible assets held at June 30, 2003 is $20 million, $16 million, $13 million, $6 million and $3 million for the years 2003, 2004, 2005, 2006 and 2007, respectively.
5
The change in the carrying amount of goodwill for the quarter ended June 30, 2003 is as follows:
| Electronic | ATM | Risk | Global | |||||||||||||||||||||
| (in thousands) | Payments | Management | Management | Outsourcing | Other | Total | ||||||||||||||||||
Balance as of December 31, 2002 |
$ | 1,600 | $ | 75,547 | $ | 5,724 | $ | 20,559 | $ | 10,606 | $ | 114,036 | ||||||||||||
Contingent consideration |
— | 2,218 | — | — | — | 2,218 | ||||||||||||||||||
Balance as of June 30, 2003 |
$ | 1,600 | $ | 77,765 | $ | 5,724 | $ | 20,559 | $ | 10,606 | $ | 116,254 | ||||||||||||
NOTE 4 – RESTRUCTURING AND ASSET IMPAIRMENT CHARGES:
Long-lived assets held for sale
During the third quarter of 2002, the Company undertook to sell certain
facilities in Glendale, Wisconsin, and Runcorn, UK. At that time, pursuant to
SFAS No. 144, “Accounting for the Impairment of Long-Lived Assets,” the Company
recorded a $3.0 million asset write-down to reflect the property and equipment
at Glendale held for sale at its estimated fair value, less selling costs.
During the first quarter of 2003, the Glendale facility was sold for net
proceeds of approximately $12 million. The Company also entered into an
agreement with the buyer for a short-term leaseback. The gain of approximately
$0.6 million from this sale is being amortized over the term of the leaseback.
Restructuring accruals
During the second quarter of 2002, the Company recorded restructuring and asset
impairment charges of $3.4 million for severance benefits, $5.7 million for
lease-related costs as a result of the consolidation of facilities, and a net
charge of $1.3 million related to software impairment and other charges. The
following table summarizes the change in the Company’s restructuring accruals
for the six month period ended June 30, 2003, including the long-term portion
of approximately $2.7 million at June 30, 2003:
| Severance | Lease-Related | |||||||||||
| (in thousands) | Related | Costs & Other | Total | |||||||||
Balance December 31, 2002 |
$ | 1,798 | $ | 5,187 | $ | 6,985 | ||||||
Cash payments |
(338 | ) | (793 | ) | (1,131 | ) | ||||||
Balance March 31, 2003 |
1,460 | 4,394 | 5,854 | |||||||||
Cash payments |
(611 | ) | (259 | ) | (870 | ) | ||||||
Balance June 30, 2003 |
$ | 849 | $ | 4,135 | $ | 4,984 | ||||||
NOTE 5 – ACCRUED CONTRACT LOSSES:
The Company’s accrued contract losses pertain to long-term service contracts
with government agencies for transaction processing in the electronic payments
segment. The following table summarizes the activity of the accrued contract
loss reserve:
| (in thousands) | 2003 | 2002 | ||||||
Balance at beginning of year |
$ | 7,578 | $ | 14,777 | ||||
Charges to loss reserve |
(1,003 | ) | (1,208 | ) | ||||
Balance at March 31 |
6,575 | 13,569 | ||||||
Charges to loss reserve |
(917 | ) | (938 | ) | ||||
Cash payments |
— | (1,000 | ) | |||||
Balance at June 30 |
$ | 5,658 | $ | 11,631 | ||||
NOTE 6 – LONG-TERM DEBT:
Long-term debt was as follows:
| June 30, | December 31, | ||||||||
| (in thousands) | 2003 | 2002 | |||||||
Capital leases and other |
$ | 2,696 | $ | 2,739 | |||||
Less amount due within one year |
(1,552 | ) | (1,401 | ) | |||||
Total |
$ | 1,144 | $ | 1,338 | |||||
Long-term debt consists principally of capital lease obligations related to equipment. The capital lease obligations bear interest rates of 3.4% to 13.5% and are due through the year 2007. Carrying value approximates fair value for these obligations.
6
NOTE 7 – INCOME PER SHARE:
The following table reflects the calculation of basic and diluted income per
share:
| Three Months Ended | Six Months Ended | |||||||||||||||||
| June 30, | June 30, | |||||||||||||||||
| (in thousands, except per share amounts) | 2003 | 2002 | 2003 | 2002 | ||||||||||||||
Net income per share — basic |
||||||||||||||||||
Net income |
$ | 5,113 | $ | 4,476 | $ | 9,745 | $ | 13,002 | ||||||||||
Weighted average shares outstanding |
46,754 | 46,578 | 46,729 | 46,526 | ||||||||||||||
Net income per share — basic |
$ | 0.11 | $ | 0.10 | $ | 0.21 | $ | 0.28 | ||||||||||
Net income per share — diluted |
||||||||||||||||||
Net income |
$ | 5,113 | $ | 4,476 | $ | 9,745 | $ | 13,002 | ||||||||||
Weighted average shares outstanding |
46,754 | 46,578 | 46,729 | 46,526 | ||||||||||||||
Dilutive impact of options |
277 | 449 | 147 | 868 | ||||||||||||||
Weighted average shares and potential dilutive shares outstanding |
47,031 | 47,027 | 46,876 | 47,394 | ||||||||||||||
Net income per share — diluted |
$ | 0.11 | $ | 0.10 | $ | 0.21 | $ | 0.27 | ||||||||||
NOTE 8 – COMPREHENSIVE INCOME:
The Company’s total comprehensive income for the three month periods ended June
30, 2003 and 2002 was $5.9 million and $4.6 million, respectively, and was
$10.8 million and $12.8 million for the six months ended June 30, 2003 and
2002, respectively. The Company’s total comprehensive income consists of net
income and foreign currency translation adjustments.
NOTE 9 – BUSINESS SEGMENT INFORMATION:
Effective this quarter, the Company’s segment reporting has been revised to
reflect organizational changes and the additional allocation of overhead to the
business segments. To facilitate the delivery of a full range of processing
solutions from software licensing through outsourced processing, the Company
now manages its EFT software sales in its Electronic Payments segment. This
service was previously managed under its Professional Services segment.
Full-service collection activities, which were formerly managed under the
Company’s Risk Management segment, and account verification services, which
were previously managed under the Company’s Electronic Payments segment, are
both now under the executive leadership of its Global Outsourcing segment.
Currently, the Company’s business segments are: Electronic Payments; ATM
Management; Risk Management; and Global Outsourcing. The Company reports
segment information consistent with the way management internally disaggregates
its operations to assess performance and to allocate resources. The Electronic
Payments segment provides EFT software sales, ACH, EFT and other processing
services as well as EBT services for government agencies. The ATM Management
segment provides ATM deployment, management and branding services. The Risk
Management segment provides risk management based data and other products to
financial institutions, retailers and other businesses that assist in detecting
fraud and assessing the risk of opening a new account or accepting a check. The
Global Outsourcing segment provides information technologies services and
business process outsourcing services.
The accounting policies of the segments are the same as those applied to the Company on a consolidated basis. For internal reporting purposes, the Company groups costs based upon managerial control. The majority of these managed cost groups are directly assigned to a reportable segment. For cost groups supporting more than one reportable segment, the costs are assigned based upon the product line or project benefited. The assignment of costs is based upon estimates of factors considered most appropriate for the cost group such as transactions, calls, customers, square footage, revenues and headcount. The Company does not allocate expenses that benefit all segments and are corporate or administrative in nature. These costs include, among other things, executive leadership costs, investor relations and general legal, consulting, accounting and finance costs.
7
Information concerning operations in the Company’s reportable segments is as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||
| (in thousands) | 2003 | 2002 | 2003 | 2002 | ||||||||||||||
Net revenue: |
||||||||||||||||||
Electronic payments |
$ | 45,340 | $ | 52,485 | $ | 88,560 | $ | 109,752 | ||||||||||
ATM management |
36,346 | 27,510 | 70,173 | 48,150 | ||||||||||||||
Risk management |
32,788 | 32,159 | 65,895 | 65,430 | ||||||||||||||
Global outsourcing |
18,482 | 21,317 | 38,856 | 44,136 | ||||||||||||||
Total net revenue |
132,956 | 133,471 | 263,484 | 267,468 | ||||||||||||||
Operating expenses before overhead,
restructuring and other charges: |
||||||||||||||||||
Electronic payments |
33,044 | 32,432 | 63,853 | 68,477 | ||||||||||||||
ATM management |
34,097 | 26,321 | 66,182 | 46,550 | ||||||||||||||
Risk management |
21,762 | 25,010 | 43,416 | 51,667 | ||||||||||||||
Global outsourcing |
16,394 | 14,147 | 33,740 | 31,769 | ||||||||||||||
Total operating expenses before
overhead, restructuring and other
charges |
105,297 | 97,910 | 207,191 | 198,463 | ||||||||||||||
Allocated overhead: |
||||||||||||||||||
Electronic payments |
2,509 | 2,677 | 5,414 | 4,950 | ||||||||||||||
ATM management |
1,629 | 1,601 | 3,848 | 2,935 | ||||||||||||||
Risk management |
2,476 | 2,303 | 5,249 | 4,496 | ||||||||||||||
Global outsourcing |
1,824 | 1,957 | 4,199 | 3,821 | ||||||||||||||
Corporate |
12,307 | 11,064 | 24,092 | 24,386 | ||||||||||||||
Total allocated overhead |
20,745 | 19,602 | 42,802 | 40,588 | ||||||||||||||
Restructuring and other charges: |
||||||||||||||||||
Electronic payments |
— | 2,494 | — | 2,494 | ||||||||||||||
ATM management |
— | 58 | — | 58 | ||||||||||||||
Risk management |
— | 4,264 | — | 4,264 | ||||||||||||||
Global outsourcing |
— | 721 | — | 721 | ||||||||||||||
Corporate |
— | 2,909 | — | 2,909 | ||||||||||||||
Total restructuring and other charges |
— | 10,446 | — | 10,446 | ||||||||||||||
Income (loss) from operations: |
||||||||||||||||||
Electronic payments |
9,787 | 14,882 | 19,293 | 33,831 | ||||||||||||||
ATM management |
620 | (470 | ) | 143 | (1,393 | ) | ||||||||||||
Risk management |
8,550 | 582 | 17,230 | 5,003 | ||||||||||||||
Global outsourcing |
264 | 4,492 | 917 | 7,825 | ||||||||||||||
Corporate |
(12,307 | ) | (13,973 | ) | (24,092 | ) | (27,295 | ) | ||||||||||
Income from operations |
$ | 6,914 | $ | 5,513 | $ | 13,491 | $ | 17,971 | ||||||||||
The Company has not disclosed assets, interest revenue, interest expense or income taxes by segment because this information is not reviewed by the chief operating decision maker, produced internally nor practicable to prepare. Depreciation and amortization for each of the Company’s reporting segments is as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||
| (in thousands) | 2003 | 2002 | 2003 | 2002 | ||||||||||||||
Depreciation and amortization: |
||||||||||||||||||
Electronic payments |
$ | 1,973 | $ | 2,905 | $ | 3,879 | $ | 5,750 | ||||||||||
ATM management |
1,229 | 840 | 2,614 | 1,640 | ||||||||||||||
Risk management |
1,577 | 1,864 | 3,196 | 3,708 | ||||||||||||||
Global outsourcing |
828 | 772 | 1,578 | 1,524 | ||||||||||||||
Corporate |
3,227 | 3,320 | 6,356 | 6,621 | ||||||||||||||
Total depreciation and amortization |
$ | 8,834 | $ | 9,701 | $ | 17,623 | $ | 19,243 | ||||||||||
8
Revenue is attributed to geographic areas based on the location of the assets producing the revenue. The Company’s total net revenue and property and equipment by geographic area are as follows:
| Total Net Revenue | |||||||||||||||||
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||
| (in thousands) | 2003 | 2002 | 2003 | 2002 | |||||||||||||
United States |
$ | 119,801 | $ | 122,437 | $ | 239,557 | $ | 243,809 | |||||||||
United Kingdom |
5,761 | 2,729 | 9,508 | 7,480 | |||||||||||||
India |
4,444 | 5,879 | 9,012 | 11,879 | |||||||||||||
Canada |
2,950 | 2,426 | 5,407 | 4,300 | |||||||||||||
Total consolidated |
$ | 132,956 | $ | 133,471 | $ | 263,484 | $ | 267,468 | |||||||||
| Property and Equipment | |||||||||
| June 30, | December 31, | ||||||||
| (in thousands) | 2003 | 2002 | |||||||
United States |
$ | 38,605 | $ | 41,038 | |||||
United Kingdom |
374 | 276 | |||||||
India |
9,206 | 8,713 | |||||||
Canada |
630 | 737 | |||||||
Total consolidated |
$ | 48,815 | $ | 50,764 | |||||
NOTE 10 – LEGAL PROCEEDINGS:
The Company is party to various legal actions arising in the ordinary course of
business. In the opinion of management, the final disposition of these matters
will not have a material adverse effect on the Company’s financial position,
results of operations, or cash flows.
The Company is currently the subject of an investigation by the SEC. In the course of its investigation, the SEC staff has sought from the Company various documents and information concerning the financial results and transactions that were the subject of restatement by the Company in March and December 2002. In January 2003, the SEC staff received a formal order of investigation, which empowers it to issue subpoenas to the Company and third parties. The Company has been cooperating fully with the SEC staff and intends to continue to do so. The Company may, however, be the subject of additional inquiries or become subject to a fine or other remedies. The Company has incurred, and may continue to incur, significant legal expenses in connection with this investigation.
The Company and its current and former chief executive and chief financial officers are defendants in three federal securities actions filed in November and December 2002 in the U.S. District Court for the Eastern District of Wisconsin (the Federal Securities Actions). The complaints in these actions are substantially identical and allege, among other things, that during the period from February 2, 2001 to October 24, 2002 the defendants made false and misleading statements and omissions of material facts and that the plaintiffs and other members of a putative class of shareholders suffered damages as a result. The defendants in the Federal Securities Actions have moved to have the actions transferred to the District of Arizona and also have moved to dismiss the actions on various grounds. These motions are pending before the Court. Also pending before the Court is a motion by one of the plaintiffs to consolidate the three actions, for his appointment as class representative and for his selection of lead counsel.
The Company is also a nominal defendant in two substantially identical shareholder derivative actions filed in the Superior Court of Arizona, Maricopa County in January 2003 (the Shareholder Derivative Actions). The complaints allege, among other things, that certain current and former Company directors named in the complaints as defendants breached their fiduciary duties to the Company in connection with certain alleged issues involving the Company’s accounting practices and internal controls. The complaints also name as a defendant the Company’s external auditor. In response to a joint motion by the parties in the Shareholder Derivative Actions to stay these proceedings pending the resolution of the motions to dismiss the Federal Securities Actions, the Court stayed these proceedings through September 10, 2003. Because the motions to dismiss the Federal Securities Actions will likely still be pending on September 10th, the Company expects the parties in the Shareholder Derivative Actions to seek an extension of this stay.
The Company believes the Federal Securities and Shareholder Derivative Actions are without merit and intends to vigorously defend itself. However, the Company cannot predict the outcome of these actions with certainty.
9
NOTE 11 – COMMITMENTS AND CONTINGENCIES:
Future commercial commitments
In connection with the Company’s government services, collection and ATM
placement activities, the Company posts surety bonds with state agencies
guaranteeing its performance of certain obligations related to the relevant
contracts or state requirements. The aggregate amount of such bonds outstanding
at June 30, 2003 was $4.3 million.
At June 30, 2003, the Company provided guarantees of $1.2 million on certain equipment lease payments for Canadian customers of its subsidiary Access Cash International (ACI). These guarantees were established prior to the Company’s acquisition of ACI in 2001 and expire through December 2007. The Company would be required to make payments under these guarantees in the event that the ACI customers could not meet their own payment obligations. Through June 30, 2003, the Company has been required to make payments of approximately $128,000 pursuant to these guarantees. The customers’ ATM equipment assets are utilized as collateral on these guarantees. There are no amounts being carried as liabilities for the Company’s obligations under these guarantees.
The Company has approximately $0.4 million in time deposits, denominated in Indian rupees, related to the guarantee by its Indian operations of performance on a customer contract and certain obligations related to local government requirements.
Contractual cash obligations
As of December 31, 2002, the Company had contractual cash obligations for
operating leases, outsourcing and maintenance obligations through 2012 in the
aggregate amount of $101.0 million. These contractual cash obligations had not
materially changed from this amount at June 30, 2003.
Other commitments
In December 2001, the Company entered into a subscription agreement to acquire
a 15% interest in Webtel Pty. Ltd., an Australian corporation (Webtel).
Pursuant to the subscription agreement, the Company invested $1.3 million in
Webtel in 2001 and committed to invest an additional $0.8 million upon the
satisfaction of certain conditions specified in the subscription agreement.
The Company operates a call center in Mumbai, India under a customer contract. The customer is entitled to acquire a minority interest in, or sole ownership of, certain assets used by the Company in performing call center operations for the customer as well as transition assistance. The price at which such ownership interest may be acquired by the customer is based on a formula as set forth in the contract. As of June 30, 2003, the customer had earned a discount of approximately 10% on the formula price for these assets.
ACI has vault cash agreements with various financial institutions which provide cash to certain of the ATMs owned or managed by ACI. Although some portion of this cash may be physically located in the ATMs owned or managed by ACI, this cash is not included in cash and cash equivalents on the Company’s consolidated balance sheet because ACI does not take title to the cash under the bailee/bailor relationship established by the agreements. Based upon the daily outstanding balance of funds provided to the ATMs, ACI generally pays a monthly fee ranging from prime, as defined, plus one half percent up to prime plus 5%. The average monthly rate paid during the first six months of 2003 approximated 7.4%. The Company indemnifies the financial institutions against any loss of the cash in the ATMs. One of the agreements requires ACI to maintain a security account equal to 1% of the daily outstanding balance. The agreements may be terminated upon notice by either party and have various expiration dates ranging from January to November 2004. Total cash provided pursuant to these vault cash agreements was approximately $31 million at June 30, 2003.
As part of its transaction processing business, the Company provides cash settlement services to financial institutions and state and local governments. These services involve the movement of funds between the various parties associated with an ATM, POS or EBT transaction and this activity results in a balance due to the Company at the end of each business day that it recoups over the next few business days. The balances due the Company are included in cash on its consolidated balance sheets. As of June 30, 2003, approximately $13 million of settlement payments were due to the Company and it received these funds in early July 2003. The Company is required to maintain sufficient cash on hand to fund the daily settlement advances made by it against the payments to be received through the settlement process. The typical overnight settlement balance due to the Company ranges from $5 million to $20 million. The Company also seeks to maintain an additional cash balance of approximately $35
10
million to ensure that it can advance funds to its processing customers if unusual circumstances prevent the Company from timely processing their settlement files. The Company is evaluating means to reduce the need to maintain these minimum cash balance levels, including the possibility of obtaining an overnight credit facility to fund these obligations.
The Company enters into standard indemnification agreements in the ordinary course of business. Pursuant to the Company’s contracts with its customers, the Company generally agrees to indemnify users of its products and services and hold them harmless from and against patent, copyright or other intellectual property infringement claims brought by a third party related to those products or services. The Company’s agreements may also provide indemnification for claims relating to property damage or personal injury resulting from the performance of services by the Company or its subcontractors. Historically, the Company’s costs to defend lawsuits or settle claims relating to these indemnity agreements have not been significant.
The Company’s amended and restated certificate of incorporation and by-laws require it to indemnify its directors, officers, employees and other agents to the fullest extent permitted by Delaware law. The Company’s amended and restated certificate of incorporation also permits the Company to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in such capacity, regardless of whether the amended and restated certificate of incorporation would permit such indemnifications. These indemnification obligations are implicated with respect to the directors and officers of the Company named as defendants in the Federal Securities Actions and Shareholder Derivative Actions described in Note 10 – Legal Proceedings.
NOTE 12 – SUBSEQUENT EVENT:
On July 11, 2003, the Company entered into an agreement for the sale of its
facility in Runcorn, United Kingdom. The Company does not expect that this
agreement will have a material impact on its statement of operations, although
it does expect a minor gain on the sale of the property. This asset is
classified on the Company’s balance sheet as assets held for sale.
11
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with our condensed consolidated financial statements and the notes to those financial statements included in this Quarterly Report on Form 10-Q and the 2002 Annual Report on Form 10-K we previously filed with the Securities Exchange Commission. In addition to historical information, this discussion contains “forward-looking statements” as defined in the U.S. Private Securities Litigation Reform Act of 1995. All forward-looking statements are subject to various risks and uncertainties that could cause our actual future results to differ materially from those presently anticipated due to a variety of factors, including those discussed in Item 5 of this Quarterly Report on Form 10-Q.
OVERVIEW
eFunds Corporation and its wholly-owned subsidiaries (the “Company,” “we” or
“us”) provide transaction processing, risk management and professional and
outsourcing services to financial institutions, retailers, electronic funds
transfer networks and government agencies. The Company has four operating
segments: Electronic Payments; Automated Teller Machine (ATM) Management; Risk
Management; and Global Outsourcing. The Electronic Payments segment provides
electronic funds transfer (EFT) software sales, software applications
development, maintenance and installation, processing services including
automated clearinghouse (ACH), EFT, and other processing services as well as
electronic benefits transfer (EBT) services for government agencies. The ATM
Management segment provides ATM deployment, management and branding services.
The Risk Management segment provides risk management based data and other
products to financial institutions, retailers and other businesses that assist
in detecting fraud and assessing the risk of opening a new account or accepting
a check. The Global Outsourcing segment provides information technology and
business process outsourcing services.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles that are generally
accepted in the United States of America. The preparation of these financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosure of
contingent assets and liabilities. On an on-going basis, we evaluate our
estimates and judgments, including those related to revenue recognition,
intangible assets, reserves and allowances, income taxes and stock-based
compensation. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances. The
results of these estimates form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe the following critical accounting policies affect the more significant judgments and estimates we use in the preparation of our consolidated financial statements.
Revenue recognition
Our net revenues consist of fees for transaction processing and related
services, decision support, maintenance and support, government services,
information technology consulting, business process management services and
software and data licensing. Our revenue recognition policies for these various
fees are as follows:
| • | Transaction processing and service fees are recognized in the period that the service is performed. These services consist of processing our customers’ electronic debit transactions and settling the funds with the financial institutions involved in the transactions. Additionally, these services include monitoring ATMs to alert our customers when potential problems occur. These fees are charged on a per transaction basis, depending on the contractual arrangement with the customer. Government services fees are recognized in the period services are provided based on monthly fees per benefits recipient. | |
| In connection with the provision of services in the ATM management services segment, we earn surcharge and interchange fees. Surcharge fees are the fees the user of an ATM pays at the time of the transaction and interchange fees are paid by that user’s financial institution. Generally, our arrangements call for us to pay a fee to the occupants of the property at which the ATM is physically located. The amount of this fee typically has some relationship to the surcharge and interchange fees that are collected by us from that ATM. Based upon the underlying contractual provisions related to our arrangements, we record the surcharge and interchange fees that |
12
| we collect at their gross amounts as revenue and the amounts owed to the occupant of the property at which the ATM is physically located as a processing, communication and service cost. | ||
| • | Risk management fees are recognized as revenue in the period the services are provided. Risk management services consist of new account applicant and check verification screenings to manage the risk associated with account openings and check acceptance. These fees are based on the number of inquiries against the databases used for screening purposes or monthly fees based on the net monthly sales of the retailer using our check verification products or other similar measures, depending on the product and service. | |
| • | We also provide professional services consisting of information technology consulting and business process management services. Revenue from providing such services is generally recognized under one of two methods, depending on the relevant contractual terms. Under the time and materials method, which is applied to nearly all of our professional services contracts, revenue is based on a fee per hour basis and is recognized as hours are completed. Under the fixed contract method, a pre-set fee is agreed upon for a project, and revenue is recognized proportionately to the percentage of completion of the project. If the information technology consulting services involve the significant customization of software that has been licensed from us, the license fee is also recognized proportionately to the percentage of completion of the project. | |
| • | Software and data license fees for standard products are recognized when a license agreement has been signed, the license fee is fixed and determinable, collectibility of the license fee is probable, delivery has occurred and there are no uncertainties surrounding product acceptance. If a license contains customer acceptance criteria for which significant uncertainties exist, the revenue is recognized upon the earlier of customer acceptance or the expiration of the acceptance period. Certain of our software products include multiple modules and the license fee charged to the customer is based on the modules licensed. If a customer contract requires that we deliver multiple elements, then upfront fees are recognized as revenue if vendor specific objective evidence of fair value exists for each of the undelivered elements. If vendor specific objective evidence of fair value does not exist for the undelivered elements, then the total fees of the arrangement are recognized over the term of the related agreement based upon delivery of all essential elements. | |
| • | Software maintenance and support revenue is recognized ratably over the term of the contract or as the services are provided. |
The process involved in evaluating the appropriateness of revenue recognition involves judgments about vendor-specific objective evidence of the fair value of each of the various elements to be delivered in a sale that has multiple components, collectibility of fees, and projections of costs to complete projects for our customers.
Intangible Assets
Our intangible assets consist primarily of goodwill, capitalized software costs
and acquired contracts. We capitalize the cost of software developed or
obtained for internal use once the preliminary project stage has been
completed, management commits to funding the project and it is probable that
the project will be completed and that the software will be used to perform the
function intended. Capitalized costs include only (1) external direct costs of
materials and services consumed in developing or obtaining internal-use
software, (2) payroll and payroll-related costs for employees who are directly
associated with and who devote time to the internal-use software project and
(3) interest costs incurred, when material, while developing internal-use
software. Capitalization of costs ceases when the project is substantially
complete and the software is ready for its intended use. Software developed or
obtained for internal use is tested for impairment whenever events or changes
in circumstances indicate that its carrying amount may not be recoverable.
We capitalize the cost of software developed for licensing and resale once technological feasibility has been established. Costs incurred prior to establishing technological feasibility are expensed as incurred. Technological feasibility is established when we have completed all planning, designing, coding and testing activities that are necessary to determine that a product can be produced to meet its design specifications, including functions, features and technical performance requirements. Capitalization of costs ceases when the product is available for general release to customers. Such costs are amortized on a product-by-product basis normally over three years and no longer than five years. Software developed for resale is carried at the lesser of amortized cost or net realizable value.
13
When we acquire other companies, generally accepted accounting principles require that we make estimates regarding the fair value of the acquired company’s tangible assets and liabilities and identifiable intangible assets. Based upon these estimates, we then allocate the purchase price to the assets and liabilities of the acquired company for the purpose of recording these items in our financial records. Any unallocated purchase price is considered to be, and recorded as, goodwill. The distinction between the amount of the purchase price allocated either to tangible assets and liabilities or identifiable intangible assets and goodwill is significant because goodwill is not amortized to our statement of operations but is instead subject to an annual impairment test. Estimates inherent in this purchase price allocation process include assumptions regarding the timing and amounts of future cash inflows and outflows, the saleability of inventories, selection of discount rates, contract renewal rates and general market conditions. Where appropriate, we use third-party valuation professionals to assist us in making these estimates.
The process of evaluating goodwill and other intangible assets, including capitalized software costs and acquired contracts, for impairment involves judgments about market conditions and economic indicators, estimates of future cash flows and assumptions about our strategic plans with regard to our operations. To the extent additional information arises or our strategies change, it is possible that our conclusions regarding the carrying value of our intangible assets could change and materially affect our financial position or results of operations.
Reserves and Allowances
We maintain a reserve for expected future losses on certain government EBT
contracts. Our estimates of these losses are based on a variety of assumptions
including assumptions about future welfare case levels, the number of
transactions per case and the costs related to processing these transactions
and providing support services. These assumptions are subject to significant
uncertainties and may differ substantially from actual results. In the event
such differences arise, a revision to the loss contract reserve would be
required. Any such revision could have a material effect on our financial
position or results of operations.
We maintain an allowance for doubtful accounts for estimated losses resulting from our customers failing to make required payments. We develop our estimate of this allowance based on our experience with specific customers, our understanding of their current economic circumstances and our own judgment as to the likelihood of their ultimate payment. We also consider our collection experience with the balance of our receivables portfolio and make estimates regarding collectibility based on trends in aging. If the financial condition of our customers were to deteriorate, thereby impairing their ability to make payments, an increase in this allowance could be required in a future period.
Income Taxes
Accounting for income taxes requires significant judgments in the development
of estimates used in income tax calculations. Such judgments include, but are
not limited to, the likelihood that the Company will realize the benefits of
net operating loss carry-forwards, the adequacy of valuation allowances, the
rates used to measure transactions with foreign subsidiaries and the
development of valuation models used for measuring the value of certain
transactions. Further, our operations are governed by and subject to government
regulations in the United States and in foreign countries in which we operate,
including laws and regulations relating to taxation and the judgments and
estimates we use are subject to challenge by domestic and foreign taxing
authorities. The Company recognizes tax liabilities at such time as they are
judged to be probable of being incurred and they can be reasonably estimated.
It is possible that either foreign or domestic taxing authorities could
challenge our judgments and estimates and draw conclusions that would cause us
to incur tax liabilities in excess of those currently recorded.
We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Although we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we will be able to realize our deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period any such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period any such determination was made.
We consider the undistributed earnings of our foreign subsidiaries to be permanently invested and, accordingly, we have not provided for U.S. Federal, state income or applicable foreign withholding taxes on those amounts. Undistributed earnings of our foreign subsidiaries amounted to approximately $26.6 million at June 30, 2003. Upon
14
any distribution of those earnings in the form of dividends or otherwise, we would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and applicable withholding taxes payable to the foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with such a hypothetical calculation.
Stock-based compensation
We issue stock options to our employees under the eFunds Corporation 2000 Stock
Option Plan. Generally accepted accounting principles provide two alternative
methods of accounting for stock options issued under the terms and conditions
pursuant to which we typically issue options. One alternative is to estimate
the fair value of the stock option at the date of grant and amortize that value
as an expense to operations over the contractual vesting period. The other
option available currently to companies reporting under generally accepted
accounting principles is to estimate the fair value of the option at the grant
date but only reflect the impact of the amortization in a footnote to the
financial statements and to forgo adjusting the statement of operations. The
method a company chooses to apply is a matter of policy. Consistent with our
past practices, we utilize the second of these options and we reflect the
impact of the option amortization in the footnotes to our financial statements.
As illustrated in Note 2 to the financial statements, were we to change our
accounting policy on this matter to reflect the expense in our statement of
operations, or should generally accepted accounting principles change to
require us to reflect this expense in our statements of operations, our results
of operations would be adversely affected.
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, the relative composition of net revenue and selected statements of operations data as a percentage of net revenue:
| Three Months Ended | Six Months Ended | |||||||||||||||||
| June 30, | June 30, | |||||||||||||||||
| 2003 | 2002 | 2003 | 2002 | |||||||||||||||
Net revenue |
||||||||||||||||||
Electronic payments |
34.1 | % | 39.3 | % | 33.6 | % | 41.0 | % | ||||||||||
ATM management |
27.3 | 20.6 | 26.6 | 18.0 | ||||||||||||||
Risk management |
24.7 | 24.1 | 25.0 | 24.5 | ||||||||||||||
Global outsourcing |
13.9 | 16.0 | 14.8 | 16.5 | ||||||||||||||
Total net revenue |
100.0 | 100.0 | 100.0 | 100.0 | ||||||||||||||
Operating expenses |
||||||||||||||||||
Processing, communication and service costs |
45.1 | 39.8 | 43.8 | 38.8 | ||||||||||||||
Employee costs |
33.9 | 34.2 | 34.9 | 36.2 | ||||||||||||||
Depreciation and amortization |
6.6 | 7.3 | 6.7 | 7.2 | ||||||||||||||
Other operating costs |
9.2 | 6.8 | 9.4 | 7.2 | ||||||||||||||
Restructuring charges |
— | 7.8 | — | 3.9 | ||||||||||||||
Total operating expenses |
94.8 | 95.9 | 94.8 | 93.3 | ||||||||||||||
Income from operations |
5.2 | 4.1 | 5.2 | 6.7 | ||||||||||||||
Other income – net |
0.4 | 0.2 | 0.3 | 0.2 | ||||||||||||||
Income before income taxes |
5.6 | 4.3 | 5.5 | 6.9 | ||||||||||||||
Provision for income taxes |
(1.8 | ) | (0.9 | ) | (1.8 | ) | (2.0 | ) | ||||||||||
Net income |
3.8 | % | 3.4 | % | 3.7 | % | 4.9 | % | ||||||||||
THREE AND SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 2002
Net revenue – Net revenue decreased $0.5 million, or 0.4%, to $133.0 million
for the second quarter of 2003 from $133.5 million for the same period of 2002.
Net revenue decreased $4.0 million for the first six months of 2003, or 1.5%,
to $263.5 million from $267.5 million for the first six months of 2002.
Electronic Payments net revenue decreased $7.2 million, or 13.7%, to $45.3 million in the second quarter of 2003 as compared to $52.5 million for the same period of 2002. Net revenue decreased $21.2 million, or 19.3%, to $88.6 million for the first six months of 2003 from $109.8 million for the first six months of 2002. The expiration of our processing contract with the STAR network at the end of 2002 contributed significantly to this decline. Revenues under this contract were approximately $5.5 million and $11.3 million for the second quarter and first six months of 2002, respectively. Processing revenues were also affected by price concessions given in 2003 in connection with contract renewals and extensions. Revenue from government services also declined due to the expiration of contracts at the end of 2002. The effect of these expirations was offset somewhat by revenues from new EBT contracts.
15
Citibank has been awarded the new EBT contract for the Western States EBT Alliance (WSEA) and we currently act as a subcontractor to Citibank servicing this coalition. We expect, however, that our role as subcontractor to the WSEA will be discontinued under the new contract. This transition will begin to impact our business somewhat in the second half of 2003 and we expect to see our revenues from this coalition largely roll-off by the end of 2004. Revenues from this coalition for the first half of 2003 were approximately $3 million.
Revenues from software sales increased $0.9 million in the second quarter of 2003 as compared to the same period of the prior year, and decreased $4.3 million for the first six months of 2003 as compared to 2002. The following table illustrates our revenue from software sales:
| Three Months Ended | Six Months Ended | |||||||||||||||
| June 30, | June 30, | |||||||||||||||
| (in thousands) | 2003 | 2002 | 2003 | 2002 | ||||||||||||
License fees |
$ | 2,908 | $ | 1,787 | $ | 5,620 | $ | 9,486 | ||||||||
Maintenance |
3,436 | 3,309 | 6,727 | 6,726 | ||||||||||||
Software modifications |
1,636 | 2,009 | 2,975 | 3,425 | ||||||||||||
| $ | 7,980 | $ | 7,105 | $ | 15,322 | $ | 19,637 | |||||||||
ATM Management net revenue increased $8.8 million, or 32.0%, to $36.3 million in the second quarter of 2003 from $27.5 million for the same period in 2002, and increased $22.0 million, or 45.6%, to $70.2 million for the first six months of 2003 from $48.2 million for the first six months of 2002. These increases are primarily due to our acquisition of independent ATM networks in 2002. In addition, ATM branding revenues and equipment sales increased approximately $1 million and $3 million, respectively, in the first six months of 2003 as compared to the same period in 2002.
Risk Management net revenue increased $0.6 million, or 1.9%, to $32.8 million for the second quarter in 2003 from $32.2 million in the second quarter of 2002. Net revenue remained relatively flat for the first six months of 2003 as compared to the same period in 2002. Revenues from our ChexSystemsSM suite of products increased in the both periods of 2003 as compared to the same periods of the prior year. These increases were, however, offset by declines in sales of our SCANSM products over the prior year periods. The decrease in revenues from SCAN products was attributable primarily to pricing concessions. We expect that revenues from our ChexSystems suite of products will continue to increase during 2003 and that revenue from our SCAN products will be flat for the remainder of 2003.
Global Outsourcing net revenue decreased $2.8 million, or 13.1%, to $18.5 million for the second quarter of 2003 from $21.3 million for the same period of the prior year, and decreased $5.2 million, or 11.8%, to $38.9 million for the first six months of 2003 from $44.1 million in 2002. The decreases are primarily due to an approximate $5 million decline in the revenues we received from Deluxe Corporation for the first six months of 2003 as compared to the prior year. In accordance with our agreement with Deluxe, a minimal short-fall fee, based upon a formula in the contract reflective of our estimated lost profits, will be billed to Deluxe if it fails to reach the minimum target level of $43 million for software development services for 2003. We do not currently anticipate that our 2003 revenues from Deluxe will achieve this minimum target level.
Business process management (BPM) revenues, which include outsourcing and customer contact center services, remained relatively flat for the second quarter of 2003 as compared to the same period of the prior year. Future growth in our BPM business will depend on the acquisition of new clients and the expansion of the services we provide our existing clients.
Processing, communication and service costs – This category includes the cost of transaction processing, telecommunications expense, computer equipment, promotional services and the payments we make to the occupants of the property where the ATMs we own or manage are located. Total costs in this category increased $6.8 million, or 12.8%, to $59.9 million for the second quarter of 2003 from $53.1 million for the same period of the prior year and $11.7 million, or 11.3%, to $115.6 million for the first six months of 2003 from $103.9 million for 2002. These costs were 45.1% and 43.9% of net revenues in the second quarter and first six months of 2003, respectively, compared to 39.8% and 38.8% in the respective periods for 2002. Third party processing costs have increased (approximately $6 million for the second quarter of 2003 and approximately $14 million for the first six months of 2003) with the increase in ATM processing volumes due to the acquisitions in the ATM management services segment. At June 30, 2003, we provided the processing for approximately 11,800 of the 15,600 U.S. ATMs
16
in our network. We expect the processing for the approximately 3,800 remaining U.S. ATMs will be transitioned to our networks as existing contractual commitments expire or as the economics associated with accelerated contract cancellations make it logical to do so, with approximately 1,500 such conversions expected to occur in the remainder of 2003. Due to existing contractual commitments, processing for the approximately 1,500 ATMs we have in Canada will not likely be transitioned to our networks for a substantial period of time. The increase in ATM processing costs was partially offset by reductions in costs associated with a government services contract that expired at the end of 2002 and reductions in services contracts related to our risk products, including the transitioning of certain contact center operations from subcontractors to our contact center in India.
Employee costs – Expenditures in this category represent employee compensation and related employee expenses, benefits and travel. These costs decreased $0.6 million, or 1.3%, to $45.1 million for the second quarter of 2003 from $45.7 million for the same period of 2002 and decreased $4.7 million, or 4.9%, to $92.0 million for the first six months of 2003 from $96.7 million in 2002. As a percentage of net revenue, employee costs were 33.9% and 34.9% for the second quarter and first six months of 2003, respectively, compared to 34.2% and 36.2% for the same periods of the prior year.
Although our full-time equivalent employees increased from approximately 4,400 at June 30, 2002 to 4,500 at June 30, 2003, we have realized cost savings of approximately $5 million and $10 million for the second quarter and first six months of 2003, respectively, from the re-deployment of certain product development and business process activities to our India based operations. We expect this trend to continue in future periods. At June 30, 2003, more than 60% of our full-time equivalent employees are located at our Indian facilities.
This decrease was offset by an increase in performance-based compensation of approximately $5 million for both the second quarter and first six months of 2003. The accrual for performance-based compensation was eliminated during the second quarter of 2002, but has been reinstated for 2003.
Depreciation and amortization – These costs represent the depreciation of our facilities and equipment and the amortization of our intangible assets, such as capitalized software costs and acquired contracts. Depreciation and amortization expense decreased $0.9 million, or 9.3%, to $8.8 million for the second quarter of 2003 from $9.7 million for the same period of 2002, and decreased $1.6 million, or 8.3%, to $17.6 million for the first six months of 2003 from $19.2 million for the same period of the prior year. These costs were 6.6% and 6.7% of net revenue for the second quarter and first six months of 2003, respectively, and 7.3% and 7.2% of revenue for the same periods of the prior year. The decrease is due to the cessation of depreciation of certain assets reclassified as held for sale during the third quarter of 2002 and a reduction in amortizable intangible assets due to impairments taken in the second and third quarters of the prior year. These reductions were partially offset by an increase in the amortization of customer contracts acquired with the independent ATM businesses purchased during 2002.
Other operating costs – Expenditures in this category include facility costs, professional, consulting and temporary services, bad debt, and certain administrative costs. Other operating expenses increased $3.2 million, or 35.6%, to $12.2 million for the second quarter of 2003 from $9.0 million for the same period of 2002, and increased $5.5 million, or 28.6%, to $24.7 million for the first six months of 2003 from $19.2 million in 2002. These expenses were 9.2% and 9.4% of net revenue for the second quarter and first six months of 2003, respectively, and 6.8% and 7.2% for the same periods in the prior year. The increase is due to a $2.5 million reduction to the estimate for uncollectible accounts we recorded in the second quarter of the 2002 and increased consulting fees related to the business improvement initiatives we commenced in the fourth quarter of 2002. These initiatives are focused on process enhancements that we believe will ultimately result in cost savings through improved operating efficiencies. We expect to continue to incur consulting fees related to this effort into 2004.
Restructuring and asset impairment charges – During the second quarter of 2002, we recorded restructuring and asset impairment charges of $3.4 million for severance benefits, $5.7 million for lease-related costs as a result of the consolidation of facilities, and a net charge of $1.3 million related to software impairment and other charges. In conjunction with the business process improvement initiatives in progress, we are evaluating the need for additional restructuring charges relative to severance benefits.
Other income – net – Other income – net was $0.6 million for the second quarter of 2003 compared to $0.2 million for the same period of the prior year, and $0.9 million for the first six months of 2003 compared to $0.6 million in
17
2002. Interest and investment income increased to $0.7 million for the second quarter of 2003 from $0.5 million for the same period of the prior year, and increased to $1.2 million for the first six months of 2003 from $0.8 million for 2002.
Provision for income taxes – The provision for income taxes was $2.4 million and $4.6 million for the second quarter and first six months of 2003, respectively, resulting in an annualized effective tax rate of 32.1%, which is consistent with our effective tax rate at the end of 2002. Our effective tax rate is determined largely by the proportional share of our projected consolidated income earned by our Indian subsidiary. Our Indian software development and business process management operations qualify for tax incentives associated with businesses that operate within designated geographic locations within India. These incentives generally provide us with exemptions from Indian income tax on certain business income generated from these operations and phase out through March 2009.
Business Segment Information
The following table presents, for the periods indicated, operating income by
segment as a percentage of segment revenue and the unallocated corporate
expenses and income from operations as a percentage of total revenue:
| Three Months Ended | Six Months Ended | ||||||||||||||||
| June 30, | June 30, | ||||||||||||||||
| 2003 | 2002 | 2003 | 2002 | ||||||||||||||
Income (loss) from operations
(as a percentage of segment revenue): |
|||||||||||||||||
Electronic payments |
21.6 | % | 28.4 | % | 21.8 | % | 30.8 | % | |||||||||
ATM management |
1.7 | (1.7 | ) | 0.2 | (2.9 | ) | |||||||||||
Risk management |
26.1 | 1.8 | 26.1 | 7.6 | |||||||||||||
Global outsourcing |
1.4 | 21.1 | 2.4 | 17.7 | |||||||||||||
(as a percentage of total revenue): |
|||||||||||||||||
Corporate |
(9.3 | ) | (10.5 | ) | (9.1 | ) | (10.2 | ) | |||||||||
Consolidated income from operations |
5.2 | % | 4.1 | % | 5.1 | % | 6.7 | % | |||||||||
Income from operations in the Electronic Payments segment decreased to $9.8 million for the second quarter of 2003 from $14.9 million for the second quarter of the prior year, and decreased to $19.3 million for the first six months of 2003 from $33.8 million for 2002. As a percent of net segment revenues, operating margins were 21.6% and 21.8% for the second quarter and first six months of 2003, respectively, a decrease from the 28.4% and 30.8% margins for the same periods of the prior year. Margins in the Electronic Payments segment in 2002 reflected restructuring charges of $2.5 million. Margins in the current year have been adversely affected by the expiration of processing and government services contracts at the end of 2002 and pricing concessions given in 2003. In addition, margins decreased during the first six months of 2003 due to reduced software sales.
Income from operations in the ATM Management segment increased to $0.6 million for the second quarter of 2003 from a loss of $0.5 million for the same period of 2002, and increased to $0.1 million for the first six months of 2003 compared to a loss of $1.4 million in 2002. As a percent of net segment revenues, operating margins were 1.7% and 0.2% for the second quarter and first six months of 2003, respectively, an increase from the negative margins of (1.7)% and (2.9)% for the same periods of the prior year. This improvement resulted from higher branding revenues and equipment sales and cost savings from integration efforts. We will continue to seek to improve the margins in this business in future periods by offering a comprehensive suite of ATM management services to large retailers and financial institutions, the further integration of acquired businesses and the transition of additional acquired ATMs to our internal processing systems.
Income from operations in the Risk Management segment was $8.6 million for the second quarter of 2003 compared to $0.6 million in the same period of the prior year. Operating income increased to $17.2 million for the first six months of 2003 from $5.0 million in the prior year. Operating margins were 26.1% of net segment revenues for both the second quarter and first six months of 2003, an increase from the 1.8% and 7.6% for the same periods of the prior year. This improvement is the result of reduced employee and third party processing costs. In addition, restructuring costs of $4.3 million were charged to this segment during the second quarter and first six months of 2002.
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Income from operations in the Global Outsourcing business segment was $0.3 million for the second quarter of 2003 compared to income of $4.5 million for the same period of the prior year, and income from operations decreased to $0.9 million for the first six months of 2003 from $7.8 million in 2002. Operating margins were 1.4% and 2.4% of net segment revenues for the second quarter and first six months of 2003, respectively, a decrease from the 21.1% and 17.7% seen in the respective periods of the prior year. The prior year results benefited from the reversal of the accrual for performance-based compensation and the current year results have been adversely impacted by the reduction in IT outsourcing and BPM services provided to Deluxe.
Unallocated corporate overhead includes, among other expenses, executive leadership costs, investor relations and general legal, consulting, accounting and finance costs. These expenses decreased to $12.3 million for the second quarter of 2003 from $14.0 million for the second quarter of 2002, and decreased to $24.1 million in the first six months of 2003 from $27.3 million in 2002. The second quarter of 2002 included $2.9 million in restructuring charges that were more than offset by a $2.5 million reduction to the estimate for uncollectible accounts and the reversal of the accrual for performance-based compensation. Results for the second quarter of 2003 reflect higher consulting fees due to the business improvement initiatives commenced in the fourth quarter of 2002.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
At June 30, 2003, net working capital was $163.3 million, compared to $149.8 million at December 31, 2002. Cash and cash equivalents, including our cash in ATMs of approximately $6 million, totaled $156.3 million at June 30, 2003, an increase of $36.8 million from December 31, 2002. This increase was the result of positive operating cash flow, including an approximately $5 million tax settlement we received from Deluxe and the $11.9 million in proceeds we received from the sale of our Glendale facility. At June 30, 2003, we had $2.3 million of restricted cash that we temporarily hold in custodial accounts on behalf of clients and $0.5 million of deposits subject to compensating balance arrangements. Included in cash and cash equivalents at June 30, 2003 was approximately $20 million held in Indian bank accounts denominated in Rupees or U.S. Dollars. These funds are available for international operations and investments. Repatriation of these funds to the United States, other than through ordinary course of business intercompany settlements, would however, likely have unfavorable tax implications.
As part of our transaction processing business, we provide cash settlement services to financial institutions and state and local governments. These services involve the movement of funds between the various parties associated with an ATM, POS or EBT transaction and this activity results in a balance due to us at the end of each business day that we recoup over the next few business days. The balances due us are included in cash on our consolidated balance sheets. As of June 30, 2003, approximately $13 million of settlement payments were due to us and we received these funds in early July 2003. We are required to maintain sufficient cash on hand to fund the daily settlement advances we make against the payments we receive through the settlement process. The typical overnight settlement balance due to us ranges from $5 million to $20 million. We also seek to maintain an additional cash balance of approximately $35 million to ensure that we can advance funds to our processing customers if unusual circumstances prevent us from timely processing their settlement files. We are evaluating means to reduce the need for us to maintain these minimum cash balance levels, including the possibility of obtaining an overnight credit facility to fund these obligations.
We have vault cash agreements with various financial institutions that provide cash to certain of the ATMs owned or managed by us. Although some portion of this cash may be physically located in the ATMs that we own or manage, these funds are not included in cash and cash equivalents on our consolidated balance sheet because we do not take title to it under the bailee/bailor relationship as established by the agreements. Based upon the daily outstanding balance of funds provided to the ATMs, we generally pay a monthly fee ranging from prime, as defined, plus one half percent up to prime plus 5%. We indemnify the financial institutions against any loss of the vault cash in the ATMs. One of the agreements requires us to maintain a security amount equal to 1% of the daily outstanding balance. The average monthly rate paid during the first six months of 2003 approximated 7.4%. The agreements may be terminated upon notice by either party and have various expiration dates ranging from January to November 2004. Total cash provided pursuant to these vault cash agreements was approximately $31 million at June 30, 2003.
Our operations, capital expenditures and acquisitions are financed primarily through the cash flow from our operations. Our short-term liquidity needs and long term capital expenditure requirements will be provided from cash and cash equivalents on hand and cash flow from operations.
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Prior to our acquisition of ACI in 2001, we had committed to guarantee up to approximately $1.8 million of equipment lease payments for its Canadian customers and as of June 30, 2003, we had guaranteed lease payments amounting to $1.2 million. Through June 30, 2003, we have been required to make payments of $128,000 pursuant to these guarantees.
We have pledged $0.4 million of time deposits, denominated in Indian Rupees, as collateral related to a guarantee of performance on a customer contract and certain obligations related to local government requirements.
In connection with our government services business, collection and ATM placement activities, we post surety bonds with state agencies guaranteeing our performance of certain obligations related to the relevant contracts or state requirements. The aggregate amount of such bonds outstanding at June 30, 2003 was $4.3 million.
As of December 31, 2002 our contractual cash obligations for operating leases, outsourcing and maintenance obligations totaled $101 million through 2006. Our contractual cash obligations had not materially changed from this amount at June 30, 2003. Obligations under capital leases at June 30, 2003 totaled $2.7 million and are payable through 2007.
The following table sets forth a summary of our cash flow activity and should be read in conjunction with our consolidated statements of cash flows:
| Summary of Cash Flows | ||||||||
| Six Months Ended June 30, | ||||||||
| (in thousands) | 2003 | 2002 | ||||||
Cash provided by operating activities |
$ | 36,324 | $ | 32,144 | ||||
Cash provided by (used in) investing activities |
770 | (33,870 | ) | |||||
Cash (used in) provided by financing activities |
(303 | ) | 777 | |||||
Net increase (decrease) in cash and cash equivalents |
$ | 36,791 | $ | (949 | ) | |||
Cash flows from operating activities were approximately $36.3 million and $32.1 million for the six months ended June 30, 2003 and 2002, respectively. The increase in operating cash flow is attributable primarily to income we earned, as adjusted for the non-cash effect of depreciation and amortization, and the effect of changes in other assets and liabilities, which includes increases in accrued expenses such as performance-based compensation and income taxes.
Cash provided by investing activities was $0.8 million for the six months ended June 30, 2003. Our investing activities for this period included net proceeds of $11.9 million from the sale of our Glendale facility offset by expenditures for fixed assets and software of $8.9 million. Cash used in investing activities was $33.9 million for the six months ended June 30, 2002, primarily related to the $22.3 million used in connection with the acquisition of independent ATM management companies and assets and expenditures for fixed assets and software of $11.6 million.
Cash used in financing activities was $0.3 million for the six months ended June 30, 2003. We received $0.6 million from the exercise of stock options and purchases pursuant to our employee stock purchase plan, and we used cash to repay debt of $0.9 million. Cash provided by financing activities was $0.8 million for the six months ended June 30, 2002. We used cash to repay debt of $1.6 million during this period, although these payments were more than offset by the proceeds from the exercise of stock options and purchases pursuant to our employee stock purchase plan of $2.4 million.
RECENT ACCOUNTING PRONOUNCEMENTS
New Accounting Pronouncements
In November 2002, the EITF reached a consensus on Emerging Issues Task Force
(EITF) Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF
Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or
rights to use assets. The provisions of EITF Issue No. 00-21 will apply to
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. We do not believe that the adoption of EITF Issue No. 00-21 will have a
material effect on our consolidated financial position or results of
operations.
20
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of Accounting Research Bulletin No. 51, “Consolidated Financial Statements.” Interpretation No. 46 prescribes how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. This interpretation requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. Interpretation No. 46 is effective immediately for variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. The interpretation applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. We do not believe the adoption of Interpretation No. 46 will have a material impact on our financial position or results of operations.
FORWARD-LOOKING STATEMENTS –
In addition to historical and pro forma information, this Quarterly Report
contains “forward-looking statements” as defined in the U.S. Private Securities
Litigation Reform Act of 1995. All forward-looking statements are subject to
various risks and uncertainties that could cause actual results to differ
materially from those described in the statements. Some of the factors that
could cause actual results to differ from those that are presently anticipated
are discussed in Item 5 of this Quarterly Report.
We currently expect that the full year 2003 diluted earnings per share and revenue will be in line with our reported results for 2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the potential for loss due to adverse changes in the
fair value of financial instruments. We operate internationally and are subject
to potentially adverse movements in foreign currency exchange rates and
interest rates. These exposures may change over time as our business evolves
and could have an adverse impact on our financial results. We have not entered
into any derivative instruments or hedging contracts to reduce our exposure to
adverse foreign currency rate or interest rate changes. Currently, we receive
non-U.S. dollar denominated revenues and incur non-U.S. dollar denominated
operating expenses in the United Kingdom, India and Canada. We also have assets
located in these countries. The principal currencies creating foreign exchange
rate risk for us are the British pound, Indian rupee and Canadian dollar. For
the three months ended June 30, 2003, less than 10% of our net revenues and
operating expenses were denominated in non-U.S. dollar currencies. We do not
believe that our net income for the three months ended June 30, 2003 would have
been materially affected if the U.S. dollar had appreciated or depreciated by
10% against the British pound, the Indian rupee or the Canadian dollar.
Changes in interest rates could impact our anticipated interest income on cash equivalents and interest expense on variable short-term debt. A 10% adverse change in interest rates from the interest rates in effect at June 30, 2003 would not, however, have a material adverse effect on our net income for the three months ended June 30, 2003 or our financial condition at June 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
The Company’s management, under the supervision and with the participation of
its Chief Executive Officer and Chief Financial Officer, evaluated the
Company’s disclosure controls and procedures as of June 30, 2003, and concluded
that these controls and procedures are effective. There have been no
significant changes in the internal controls related to financial reporting
that have materially affected, or are reasonably likely to materially affect
these controls.
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is currently the subject of an investigation by the Securities and
Exchange Commission (the SEC). In the course of its investigation, the SEC
staff has sought from the Company various documents and information concerning
the financial results and transactions that were the subject of restatement by
the Company in March and December 2002. In January 2003, the SEC staff
received a formal order of investigation, which empowers it to issue subpoenas
to the Company and to third parties. The Company has been cooperating fully
with the SEC staff and intends to continue to do so. The Company may, however,
be the subject of additional inquiries or become subject to a fine or other
remedies. The Company has incurred, and may continue to incur, significant
legal expenses in connection with this investigation.
The Company and its current and former chief executive and chief financial officers are defendants in three federal securities actions filed in November and December 2002 in the U.S. District Court for the Eastern District of Wisconsin (the Federal Securities Actions). The complaints in these actions are substantially identical and allege, among other things, that during the period from February 2, 2001 to October 24, 2002 the defendants made false and misleading statements and omissions of material facts and that the plaintiffs and other members of a putative class of shareholders suffered damages as a result. The defendants in the Federal Securities Actions have moved to have the actions transferred to the District of Arizona and also have moved to dismiss the actions on various grounds. These motions are pending before the Court. Also pending before the Court is a motion by one of the plaintiffs to consolidate the three actions, for his appointment as class representative and for his selection of lead counsel.
The Company is also a nominal defendant in two substantially identical shareholder derivative actions filed in the Superior Court of Arizona, Maricopa County in January 2003 (the Shareholder Derivative Actions). The complaints allege, among other things, that certain of its current and former Company directors, named in the complaints as defendants, breached their fiduciary duties to the Company in connection with certain alleged issues involving the Company’s accounting practices and internal controls. The complaints also name as a defendant the Company’s external auditor. In response to a joint motion by the parties in the Shareholder Derivative Actions to stay these proceedings pending the resolution of the motions to dismiss the Federal Securities Actions, the Court stayed these proceedings through September 10, 2003. Because the motions to dismiss the Federal Securities Actions will likely still be pending on September 10th, the Company expects the parties in the Shareholder Derivative Actions to seek an extension of this stay.
The Company believes the Federal Securities and Shareholder Derivative Actions are without merit and intends to vigorously defend itself. However, the Company cannot predict the outcome of these actions with certainty.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual stockholder’s meeting on May 23, 2003. 42,594,250
shares were represented at the meeting, constituting 91.11% of the shares
outstanding and eligible to vote. Two items were considered at the meeting and
the results of the voting were as follows:
Proposal 1. To Elect two Nominees to the Board of Directors:
| Nominee | For | Withheld | ||||||
Paul F. Walsh |
42,056,638 | 537,612 | ||||||
John J. (Jack) Boyle III |
40,201,988 | 2,392,262 | ||||||
The terms of office of our other directors, Janet M. Clarke, Robert C. Nakasone, Sheila A. Penrose and Jack Robinson also continued after the meeting.
Proposal 2. To ratify the selection of Deloitte & Touche LLP as the Company’s Independent Auditors for 2003:
| For | Against | Abstain | ||||||
41,430,116 |
1,084,279 | 79,855 | ||||||
22
ITEM 5. OTHER INFORMATION
RISK FACTORS AND CAUTIONARY STATEMENTS.
When used in this Quarterly Report on Form 10-Q and in future filings by the
Company with the Securities and Exchange Commission, in our press releases,
letters and reports to stockholders and in oral statements made by our
representatives, the words or phrases ‘should result,’ ‘are expected to,’
‘targeted,’ ‘will continue,’ ‘will approximate,’ ‘is anticipated,’ ‘estimate,’
‘project’ or similar expressions are intended to identify ‘forward-looking
statements’ within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are necessarily subject to certain risks and
uncertainties, including those discussed below, that could cause our actual
results to differ materially from our historical experience and our present
expectations or projections. Caution should be taken not to place undue
reliance on any such forward-looking statements, which speak only as of the
date made. The factors listed below could affect our financial performance and
could cause our actual results for future periods to differ from any opinions
or statements expressed with respect thereto. Such differences could be
material and adverse. We will not undertake and specifically decline any
obligation to publicly release the result of any revisions that may be made to
any forward-looking statements to reflect events or circumstances occurring
after the date of such statements or to reflect the occurrence of anticipated
or unanticipated events.
WE ARE UNABLE TO PREDICT THE RESULTS OF THE INVESTIGATION WITH THE SEC AND THE
PENDING STOCKHOLDERS LITIGATION.
We are currently the subject of an investigation by the Securities and Exchange
Commission (the SEC). In the course of its investigation, the SEC staff has
sought from us various documents and information concerning the financial
results and transactions that were the subject of restatement by us in March
and December 2002. In January 2003, the SEC staff received a formal order of
investigation, which empowers it to issue subpoenas to us and to third parties.
We have been cooperating fully with the SEC staff and intend to continue to do
so. We may, however, be the subject of additional inquiries or become subject
to a fine or other remedies. We also have incurred, and may continue to incur,
significant legal expenses in connection with this investigation.
Our company and our current and former chief executive and chief financial officers are defendants in three federal securities actions filed in November and December 2002 in the U.S. District Court for the Eastern District of Wisconsin (the Federal Securities Actions). The complaints in these actions are substantially identical and allege, among other things, that during the period from February 2, 2001 to October 24, 2002 the defendants made false and misleading statements and omissions of material facts and that the plaintiffs and other members of a putative class of shareholders suffered damages as a result. The defendants in the Federal Securities Actions have moved to have the actions transferred to the District of Arizona and also have moved to dismiss the actions on various grounds. These motions are pending before the Court.
Also pending before the Court is a motion by one of the plaintiffs to consolidate the three actions, for his appointment as class representative and for his selection of lead counsel. We are also a nominal defendant in two substantially identical shareholder derivative actions filed in the Superior Court of Arizona, Maricopa County in January 2003 (the Shareholder Derivative Actions). The complaints allege, among other things, that certain of our current and former directors named in the complaints as defendants, breached their fiduciary duties to the Company in connection with certain alleged issues involving the Company’s accounting practices and internal controls. The complaints also name as a defendant the Company’s external auditor. In response to a joint motion by the parties in the Shareholder Derivative Actions to stay these proceedings pending the resolution of the motions to dismiss the Federal Securities Actions, the Court stayed these proceedings through September 10, 2003. Because the motions to dismiss the Federal Securities Actions will likely still be pending on September 10th, we expect the parties in the Shareholder Derivative Actions to seek an extension of this stay.
We believe the Federal Securities and Shareholder Derivative Actions are without merit and intend to vigorously defend ourselves. However, we cannot predict the outcome of these actions with certainty. We are likely to incur significant legal expense in connection with the defense of these claims. In addition, if we are not successful in our efforts to seek dismissal of these actions, we could incur substantial other expenses.
23
ESTIMATES OF FUTURE FINANCIAL RESULTS ARE INHERENTLY UNRELIABLE.
From time to time, our representatives may make public predictions or forecasts
regarding the Company’s future results, including estimates regarding future
revenues, expense levels, tax rates, capital expenditures, earnings or earnings
from operations. Any forecast regarding our future performance reflects various
assumptions. These assumptions are subject to significant uncertainties, and,
as a matter of course, many of them will prove to be incorrect. Further, the
achievement of any forecast depends on numerous factors, including the
considerations specific to our business that are outlined in this discussion as
well as general economic and geopolitical trends that can adversely affect the
market for our products and services. Many of the factors that can adversely
affect our business are beyond our control. As a result, there can be no
assurance that our performance will be consistent with any management forecasts
or that the variation from such forecasts will not be material and adverse.
Investors are cautioned not to base their entire analysis of our business and
prospects upon isolated predictions, but instead are encouraged to utilize the
entire available mix of historical and forward-looking information made
available by us, and other information relating to our Company and its
products, when evaluating our prospective results of operations.
WE ARE UNABLE TO PREDICT THE RESULTS OF A PURPORTED CLASS ACTION LAWSUIT FILED
IN FLORIDA
On June 17, 2003, we were sued in U.S. District Court, Middle District of
Florida, Fort Meyers Division by Russell V. Rosen alleging violations of the
Federal Driver’s Privacy Protection Act. The plaintiff alleges that we
purchased motor vehicle records from the State of Florida and used that data
for marketing and other purposes that are not permitted under the Federal law.
The plaintiff is seeking actual damages to be determined or liquidated damages
of not less than $2,500 for each affected member of the purported class, plus
costs and attorney’s fees. The plaintiff is also asking for injunctive relief
that would prohibit us from obtaining, disclosing and using personal
information of the plaintiff and other members of the purported class in
violation of the statute. We cannot predict whether the plaintiff will be
successful in certifying this complaint as a class action.
We believe that we have meritorious defenses with regard to the allegations made in this lawsuit and intend to vigorously defend this action. Litigation is, however, by its nature uncertain and an unfavorable resolution of this lawsuit could materially adversely affect our business, results of operation or financial condition.
CONSOLIDATION IN THE INDUSTRIES WE SERVE MAY ADVERSELY AFFECT OUR ABILITY TO
SELL OUR PRODUCTS AND SERVICES.
Mergers, acquisitions and personnel changes at financial institutions and
electronic funds transfer networks may adversely affect our business, financial
condition and results of operations. Currently, the banking and EFT industries
are consolidating, causing the number of financial institutions and processing
networks to decline. This consolidation could cause us to lose:
| - | current and potential customers; | ||
| - | market share if the combined entity determines that it is more efficient to develop in-house products and services similar to ours or use our competitors’ product and services; and | ||
| - | revenue if the combined institution is able to negotiate a greater volume discount for, or discontinue the use of, our products and services. |
For example, the STAR network was one of the larger customers of our electronic payments business before it was purchased by one of our competitors, Concord EFS during 2001. First Data Corporation, which owns a substantial equity interest in the NYCE Network, has now agreed to purchase Concord EFS. Both the STAR and NYCE networks utilize our electronic funds transfer software. We cannot predict what effect the combination of these two companies would have on our business.
OUR EFFORTS TO IMPROVE THE MARGINS OF OUR ATM MANAGEMENT COMPANIES MAY NOT BE
SUCCESSFUL.
During 2001 and 2002, we acquired a number of independent ATM management
companies and we now operate the largest network of off-premise ATMs in North
America. For the six months ended 2003, this business segment contributed
revenues of $70.2 million, or 26.6% of our total revenues, at an operating
margin of 0.2%. We do not presently anticipate that we will acquire additional
ATM management companies.
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Our ability to improve the margins of this business will require us to effectively integrate the operations of acquired businesses into our organization, efficiently manage the deployment of the ATMs and generate additional sources of revenue. A key component of our integration efforts is the migration of the processing of the transactions generated at ATMs we manage from third parties to our own data centers. We provide the processing for 11,800 of the 15,600 ATMs we manage in the United States and we plan to convert approximately 1,500 of the remaining machines by the end of 2003. Processing for the approximately 2,300 remaining U.S. ATMs will be transitioned to our networks as existing contractual commitments expire or as the economics associated with accelerated contract cancellations makes it logical to do so. We do not, however, expect to convert the 1,500 ATMs we manage in Canada to our networks for a substantial period of time, if at all. All of the conversions require a degree of cooperation from existing third-party processors and so no assurance can be given that we will be successful in our conversion efforts.
We expect improvement in our ATM business to come primarily from additional revenues from branding and other value-added services and the marketing of larger scale ATM management programs to financial institutions and large retailers. We are also seeking to (i) reduce our operating costs through the integration of sales, marketing, operations and facilities, (ii) eliminate third party processing fees by migrating the processing of ATM transactions to our data centers and (iii) redeploy under-performing or idle ATMs. If we are not successful in our effort to improve the revenues and profitability of our ATM business, our future results of operations will be adversely affected. In addition, the expansion of the installed base of ATMs may require the application of increased amounts of cash to keep the machines appropriately supplied with cash for withdrawal by consumers.
OUR ABILITY TO EXPAND THROUGH ACQUISITIONS INVOLVES RISKS AND MAY NOT BE
SUCCESSFUL.
We are currently considering possible acquisitions to complement and grow our
existing businesses. Our ability to expand through acquisitions involves many
risks, including:
| - | the operations, technology and personnel of any acquired companies may be difficult to integrate; | ||
| - | the allocation of management resources to consummate these transactions may disrupt our day to day business; | ||
| - | acquired businesses may not achieve anticipated revenues, earnings or cash flow. Such a shortfall could require us to write-down the goodwill associated with any acquired company, which would adversely affect our reported earnings. |
WE FACE INTENSE COMPETITION IN ALL AREAS OF OUR BUSINESS, AND IF WE DO NOT
COMPETE EFFECTIVELY, OUR BUSINESS WILL BE HARMED.
We face intense competition from a number of companies and we expect that
competition will intensify as the movement towards increasing consolidation
within the financial services industry continues. Many of our competitors have
significantly greater financial, technical and marketing resources, greater
name recognition and a larger installed customer base than we do.
In the electronic payments market, our principal competitors include:
| - | third-party debit network processors, including First Data Corporation, VISA Debit Processing Services, Concord EFS, Midwest Payment Systems and Fiserv; | ||
| - | financial institutions that have developed in-house processing capabilities or services similar to ours, including Wells Fargo, M&I Bank and Fifth Third National Bank; | ||
| - | electronic funds transfer software providers, including Transaction System Architects, S2, Oasis, Mosaic and PaySys. |
In the ATM management market, our competitors include Concord EFS, Genpass, certain ATM equipment manufacturers and numerous independent service organizations (ISOs).
In the risk management market, our principal competitors include:
| - | providers of fraud management data and software including Primary Payment Systems (a subsidiary of Concord EFS), Equifax, Experian and TransUnion; | ||
| - | retail check verification and electronic check processing providers, including Certegy and Telecheck, a subsidiary of First Data Corporation. |
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In the global outsourcing market, our competitors include:
| - | outsourcing solutions companies, including Spectramind/Wipro Ltd, Daksh and Infosys Technologies. |
In the market for electronic transaction processing, the principal factors on which we compete are price and service levels. Following the loss of our contract with the STAR network, the proportion of our electronic processing revenues derived from the processing of transactions that originate from ATMs has substantially increased due to the loss of the POS debit transactions that were formerly routed through our switch by the STAR network. The future growth of our revenues in this market is dependent upon securing an increasing volume of transactions. If we cannot control our transaction processing expenses, we may not remain price competitive and our revenues will be adversely affected. Our revenues can also be adversely affected by pricing concessions, such as those we made in the first quarter of 2003 to retain a significant processing customer, we make in order to retain our existing customers or attract new customers. In addition, some of our competitors have indicated that they may be prepared to provide customer prospects with up-front cash incentives to acquire or retain their processing business. Given that these competitors have substantially greater financial resources than we do, it will be difficult for us to obtain significant new processing customers, or retain the customers we have, if this approach becomes a significant competitive factor.
We have also seen an effort by processors such as First Data, Concord and VISA that are affiliated with branded networks to seek exclusive processing relationships with the debit card-issuing financial institutions who subscribe to their networks. Ownership or control of a branded network may also enable these competitors to influence the interchange fees financial institutions receive from retailers who accept debit transactions from the consumers who hold debit cards issued by these network participants. We are unable to predict whether this trend towards an increasing level of vertical integration between transaction processors and branded debit networks, and the horizontal integration that could result from the combination of First Data Corporation and Concord EFS, will have a positive or negative impact upon our processing business over the long-term. Our software business competes primarily upon the basis of the quality and reliability of our software and its conformance to the current and future requirements of our customers. If we do not maintain the technological relevance of our software offerings or fail to anticipate shifts in customer requirements, our ability to sell our software products will be impaired.
In the market for ATM deployment, processing and management services, the primary basis of competition is price and service levels. Our ability to sell additional machines and processing contracts in this market is dependant on our ability to control our costs while maintaining effective levels of customer service. If we are not successful in these efforts we will not achieve the growth objectives we have for our ATM management or electronic transaction processing businesses.
Competition for our risk management products is based primarily on the quantity and quality of the data available to us for this purpose and, to a somewhat lesser degree, price. Our competitive position in these markets could be harmed if our competitors were able to compile different data sources and analytical capabilities that proved to be more effective than our products. In addition, we continue to experience competitive pressure on the pricing for our check verification service.
Our business process outsourcing and information technology services offerings compete primarily on the basis of the quality of service levels and, to some degree, price. The future growth of this aspect of our business is dependent on demonstrating to our current and prospective customers that we are a dependable and efficient service provider.
In addition to our current competitors, it is reasonable to expect that we will encounter substantial competition from new companies. No assurance can be given that we will be able to compete effectively against current and future competitors. Increased competition could result in price reductions, reduced gross margins or loss of market share.
IF WE EXPERIENCE SYSTEM FAILURES, THE PRODUCTS AND SERVICES WE PROVIDE TO OUR CUSTOMERS COULD BE DELAYED OR INTERRUPTED, WHICH WOULD HARM OUR BUSINESS AND REPUTATION AND RESULT IN THE LOSS OF CUSTOMERS.
Our ability to provide reliable service largely depends on the efficient and uninterrupted operations of our computer and telecommunications network systems and our data centers. Any significant interruptions could severely harm our business and reputation and result in a loss of revenue and customers. We could also be required to apply substantial amounts of our available cash to fund our settlement obligations and it is possible that we would not have
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sufficient resources in the event of a severe and persistent outage. Our systems and operations could be exposed to damage or interruption from fire, natural disaster, unlawful acts, power loss, telecommunications failure, unauthorized entry and computer viruses. Although we have taken steps to prevent system failures, we cannot be certain that our measures will be successful and that we will not experience service interruptions. Further, our property and business interruption insurance may not be adequate to compensate us for all losses or failures that may occur. We expect to expend significant amounts to upgrade our business continuity capabilities in future periods.
LEGISLATION COULD HARM OUR ABILITY TO COLLECT AND USE DATA, INCREASE OUR
OPERATING COSTS OR OTHERWISE HARM OUR BUSINESS.
Existing and new laws and regulations relating to consumer privacy protection
could harm our ability to collect and use consumer data, increase our operating
costs or otherwise harm our business. We collect personal data about consumers
for use in our risk management products. Due to the increasing public concern
over consumer privacy rights, Congress and state legislatures have adopted and
are considering adopting laws and regulations restricting the purchase, sale
and sharing of personal information about consumers. A material increase in the
scope of these types of restrictions could impair the efficacy of our risk
management products.
The federal financial modernization law, known as the Gramm-Leach-Bliley Act, imposes significant consumer information privacy requirements on any entity engaged in the business of providing financial services, including entities that provide services to financial institutions. Federal agencies, such as the Comptroller of the Currency and the Federal Trade Commission, have issued regulations to implement these requirements. The Act requires covered companies to develop and implement policies to protect the security and confidentiality of consumers’ nonpublic personal information and to disclose those policies to consumers before a customer relationship is established and annually thereafter. In addition, the Act requires covered companies to give an opt-out notice to consumers before sharing consumer information with third parties. The opt-out notice requirement in the Act is subject to several exceptions for credit reporting and fraud prevention purposes. Although we believe these exceptions apply to our business, government agencies could interpret their regulations in a manner that could expand the scope of the Act in ways which could adversely affect our business. In addition, even if the regulations do not affect us directly, uncertainty over the scope of the regulations could make financial institutions unwilling or reluctant to share consumer-related information with us.
The Gramm-Leach-Bliley Act does not prohibit state legislation or regulations that are more restrictive on our collection and use of data. More restrictive legislation or regulations have been introduced in the past and could be introduced in the future in Congress and the states. For example, in the past legislation has been proposed which would require consumers to opt in to any plan which would allow their nonpublic personal information to be disclosed. We are unable to predict whether more restrictive legislation or regulations will be adopted in the future. Any future legislation or regulations could have a negative impact on our business.
The pre-emptive provisions of the Federal Fair Credit Reporting Act, which governs our SCAN(SM) and ChexSystems(SM) businesses, are currently scheduled to expire in January 2004. The expiration of these provisions means that state governments could also seek to issue legislation or regulations in this area. The creation of additional state regulations could complicate our compliance efforts and otherwise have a negative impact on our business. We are unable to predict whether the Federal pre-emptive provisions will be continued or whether any state would thereafter seek to implement more stringent requirements if they are not so continued.
In addition, regulations are currently being considered regarding the application of the Americans with Disabilities Act to ATM networks. Although any regulations could result in increased opportunities for ATM sales by us, they could also require us to retire or retrofit portions of the ATM base we own and could motivate some of our customers to elect to retire their ATMs. It is also possible that existing ATM networks will be exempted from any future regulations. We are unable at this time to determine whether, and to what extent, any final regulations will impact our business.
IF THE SECURITY OF OUR DATABASES IS COMPROMISED, OUR REPUTATION COULD SUFFER
AND CUSTOMERS MAY NOT BE WILLING TO USE OUR PRODUCTS AND SERVICES.
If the security of our databases is compromised, our business could be
materially adversely affected. In our electronic payments and risk management
businesses, we collect personal consumer data, such as names and addresses,
social security numbers, drivers’ license numbers, checking and savings account
numbers and payment history records. Unauthorized access to our database could
result in the theft or publication of personal confidential
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information and the deletion or modification of personal records or otherwise cause interruptions in our operations. These concerns about security are increased when we transmit information overseas or over the Internet. A security or privacy breach may:
| - | deter customers from using our products and services; | ||
| - | harm our reputation; | ||
| - | expose us to liability; | ||
| - | increase our operating expenses to remediate problems caused by the breach; and | ||
| - | decrease market acceptance of electronic commerce transactions in general. |
OUR SALES TO DELUXE HAVE BEEN DECLINING.
The revenues we received from Deluxe declined by approximately $5 million
during the first six months of 2003 from the comparable period in 2002.
Although Deluxe has established minimum spending targets of $43 million per
year through March 31, 2005 for software development and maintenance services
it obtains from us, further efforts at expense reduction by Deluxe could cause
the revenues we receive from Deluxe to continue to decline. We do not expect
that sales to Deluxe in 2003 will reach this minimum target level. The loss of
Deluxe as a customer or a continuing material reduction in the amount of
services it orders from us would materially adversely affect our future results
of operations. Our current contract with Deluxe expires in March 2005.
WE MAY EXPERIENCE SOFTWARE DEFECTS, DEVELOPMENT DELAYS AND INSTALLATION
DIFFICULTIES, WHICH WOULD HARM OUR BUSINESS AND REPUTATION AND EXPOSE US TO
POTENTIAL LIABILITY.
Our services and products are based on sophisticated software and computing
systems and we often encounter delays when developing new products and
services. Further, the software underlying our products and services has
occasionally contained and may in the future contain undetected errors or
defects when first introduced or when new versions are released. In addition,
we may experience difficulties in installing or integrating our products and
technologies on platforms used by our customers or in new environments, such as
the Internet. Defects in our software products, errors or delays in the
processing of electronic transactions or other difficulties could result in:
| - | delays in market acceptance; | ||
| - | additional development costs; | ||
| - | diversion of technical and other resources; | ||
| - | loss of customers; | ||
| - | negative publicity; or | ||
| - | exposure to liability claims. |
Although we attempt to limit our potential liability for warranty claims through disclaimers and limitation-of-liability provisions in our license and client agreements, we cannot be certain that these measures will be successful in limiting our liability.
THERE ARE A NUMBER OF RISKS ASSOCIATED WITH OUR INTERNATIONAL SALES AND
OPERATIONS THAT COULD HARM OUR BUSINESS.
Because we currently sell some of our products and services in Europe,
Australia and Canada and provide outsourcing services from India, our business
is subject to risks associated with doing business internationally. Also, we
may not be successful in selling our services outside of the United States. For
the six month period ended June 30, 2003, we generated approximately 9.1% of
our net sales outside of the United States. Our future results could be harmed
by a variety of factors, including:
| - | changes in foreign currency exchange rates; | ||
| - | changes in a specific country’s or region’s political and economic conditions, particularly in emerging markets; | ||
| - | potentially unfavorable tax rules; | ||
| - | tariffs, duties and other trade barriers; | ||
| - | reduced protection for intellectual property rights; | ||
| - | challenges in managing widespread operations; | ||
| - | changes in foreign laws and regulatory requirements or in foreign policy; and | ||
| - | varying business practices in foreign countries. |
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In addition, the process of selling our outsourcing services typically involves visits to our sites in India by prospective customers. Increased levels of international tension can result in prospective clients postponing or canceling plans to visit our facilities, lengthening the sales cycle and otherwise inhibiting our ability to grow this business. Political opposition to the use of offshore resources such as our India-based operations and domestic security concerns that can make it more difficult for foreign nationals to obtain U.S. visas can potentially have a similar effect.
CHANGES IN INDIAN TAX LAWS COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our Indian software development and business process management operations
qualify for tax incentives associated with businesses which operate within
designated geographic locations. These incentives generally provide us with
exemptions from Indian tax on certain business income generated from these
operations and phase out through March 2009. We cannot assure you that these
tax benefits will be continued in the future at their current levels or at all.
If our Indian tax benefits are reduced or eliminated, our taxes in future
periods would increase. Such an increase could reduce our profits.
WE FACE TERMINATION AND COMPLIANCE RISKS WITH RESPECT TO OUR GOVERNMENT
CONTRACTS.
All of our government contracts can be terminated at any time, without cause,
by the contracting governmental entity. We realized approximately 8.4% of our
net sales in the first six months of 2003 (before reimbursed expenses) pursuant
to contracts of this type. If a government contract is so terminated, we are
generally entitled only to receive compensation for the services provided or
costs incurred at the time of termination and a reasonable profit on the
contract work performed prior to the date of termination. In addition, all of
our government contracts require us to comply with various contract provisions
and procurement regulations, and in some cases, accounting requirements.
Violations of some of these provisions could, if not cured, result in
termination of the contract and fines.
There will be a decline in the revenues of the government services business in 2003 due to the expiration of existing contracts. Our Medicaid eligibility verification contract with the state of New York expired in December 2002. The approximate annual revenue from this contract was $12 million. An EBT contract that generated approximately $4 million in revenue in 2002 also expired at the end of 2002. Although we have obtained and continue to seek additional EBT contracts, these new contracts will not generate sufficient revenues in 2003 to offset the approximately $16 million decline in revenues we will experience due to the contract expirations described above.
In addition, Citibank has been awarded the EBT contract for the Western States EBT Alliance (Arizona, Alaska, Colorado, Guam, Hawaii, Idaho and Washington). We currently act as a subcontractor to Citibank for this alliance and this relationship generated approximately $5.6 million in revenues (excluding revenues derived from reimbursed expenses) in 2002. We expect that, as a result of Citibank being awarded this EBT contract, our role as a subcontractor will be discontinued. This transition will begin to impact our business in 2003 and we expect to see the significant contracts for this coalition largely roll-off by the end of 2004.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS.
Despite our efforts to protect our intellectual property rights, third parties
may infringe or misappropriate our intellectual property rights, or otherwise
independently develop substantially equivalent products and services. The loss
of intellectual property protection or the inability to secure or enforce
intellectual property protection could harm our business and ability to
compete. We rely on a combination of trademark and copyright laws, trade secret
protection and confidentiality and license agreements to protect our
trademarks, software and know-how. We have also applied for patent protection
on some of the features of our newer products. We may be required to spend
significant resources to protect our trade secrets and monitor and police our
intellectual property rights.
Third parties may assert infringement claims against us in the future. In particular, there has been a substantial increase in the issuance of business process patents, which may have broad commercial implications. Claims for infringement of all types of patents are becoming an increasing source of litigation. If we become subject to an infringement claim, we may be required to modify our products, services and technologies or obtain a license to permit our continued use of those rights. We may not be able to do either of these things in a timely manner or upon reasonable terms and conditions. Failure to do so could seriously harm our business and operating results. In addition, future litigation relating to infringement claims could result in substantial costs to us and a diversion of
29
management resources. Adverse determinations in any litigation or proceeding could also subject us to significant liabilities and could prevent us from using some of our products, services or technologies.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT A
CHANGE IN CONTROL.
Provisions of our certificate of incorporation and bylaws and Delaware law may
delay or prevent a change in control of our Company that you may consider
favorable. These provisions include the following:
| - | no cumulative voting by stockholders for directors; | ||
| - | a classified board of directors with three-year staggered terms; | ||
| - | the ability of our board to set the size of the board of directors, to create new directorships and to fill vacancies; | ||
| - | the ability of our board to issue preferred stock, without stockholder approval, with rights and preferences that may be superior to our common stock; | ||
| - | the ability of our board to amend our bylaws; | ||
| - | a prohibition of stockholder action by written consent; | ||
| - | advance notice requirements for stockholder proposals and for nominating candidates to our board; | ||
| - | restrictions under Delaware law on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock; | ||
| - | a requirement that 66-2/3% of our stockholders and 66-2/3% of our directors approve certain corporate transactions, including mergers and consolidations, sales of assets or amendments to our certificate of incorporation; and | ||
| - | we have adopted a stockholder rights plan, which discourages the unauthorized acquisition of 15% or more of our common stock or an unauthorized exchange or tender offer. |
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed as part of this report:
| Exhibit | ||||
| No. | Description | Method of filing | ||
| 3.1 | Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1 (the “S-1”) filed by the Company with the Securities and Exchange Commission (“the Commission”) on April 4, 2000, Registration No. 333-33992) | * | ||
| 3.2 | Bylaws (incorporated by reference to Exhibit 3.2 to the S-1) | * | ||
| 4.1 | Form of common stock certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the S-1 filed by the Company with the Commission on May 15, 2000 (“Amendment No. 1”), Registration No. 333-33992) | * | ||
| 4.2 | Form of Rights Agreement by and between the Company and Rights Agent, (incorporated by reference to Exhibit 4.2 to Amendment No. 1) | * | ||
| 4.3 | Certificate of Designation of Series A Participating Preferred Stock (incorporated by reference to Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000) | * | ||
| 31.1 | Section 302 Certification by Mr. Paul F. Walsh | Filed herewith | ||
| 31.2 | Section 302 Certification by Mr. Thomas S. Liston | Filed herewith | ||
| 32.1 | Section 906 Certification by Mr. Paul F. Walsh and Mr. Thomas S. Liston | Filed herewith |
*Incorporated by reference
(b) Reports on Form 8-K
On April 16, 2003, the Company filed a report on Form 8-K reporting, under Items 7 and 9 of that form, the date of its first quarter earnings announcement and that its results for the first quarter of 2003 were consistent with its internal expectations and supported its previous guidance.
On April 30, 2003, the Company furnished a report on Form 8-K which included, pursuant to Items 7 and 9 of that form, a press release announcing the Company’s first quarter 2003 financial results. This press release included the Company’s condensed consolidated balance sheets at March 31, 2003 and December 31, 2002, and its condensed consolidated statements of operations and cash flows for the three months ended March 31, 2003 and March 31, 2002.
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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.
|
eFunds Corporation (Registrant) |
||
| Date: August 14, 2003 | /s/ Paul F. Walsh | |
|
|
||
|
Paul F. Walsh Chief Executive Officer and Chairman |
||
| Date: August 14, 2003 | /s/ Thomas S. Liston | |
|
|
||
|
Thomas S. Liston Chief Financial Officer |
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Index to Exhibits
| Exhibit | ||||||
| No. | Description | Page Number | ||||
| 31.1 | Section 302 Certification by Mr. Paul F. Walsh | |||||
| 31.2 | Section 302 Certification by Mr. Thomas S. Liston | |||||
| 32.1 | Section 906 Certification by Mr. Paul F. Walsh and Mr. Thomas S. Liston | |||||
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