National Processing 10-Q 2001 Q1 Quarterly report

TABLE OF CONTENTS

Part I. Financial Information
	Item 1. Consolidated Financial Statements (unaudited)
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosure About Market Risk
Part II — Other Information
SIGNATURES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange of 1934

For the quarterly period ended March 31, 2001

or

/ / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from________________to___________

Commission File Number: 1-11905

National Processing, Inc.
(Exact name of Registrant as specified in its charter)

Ohio (State or other jurisdiction of incorporation or organization)	61-1303983 (I.R.S. Employer Identification No.)
1231 Durrett Lane Louisville, Kentucky (Address of principal executive offices)	40213-2008 (Zip Code)

(502) 315-2000
(Registrant’s telephone number, including area code)

      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 as of April 30, 2001 was 51,231,387.

NATIONAL PROCESSING, INC.

INDEX

Part I. Financial Information

			Page No.
	Item 1.	Consolidated Financial Statements (unaudited)
		Consolidated Balance Sheets — March 31, 2001 and December 31, 2000		3
		Consolidated Statements of Income — Three Months Ended March 31, 2001 and 2000		4
		Consolidated Statement of Changes in Shareholders’ Equity — Three Months Ended March 31, 2001		5
		Consolidated Statements of Cash Flows — Three Months Ended March 31, 2001 and 2000		6
		Notes to Consolidated Financial Statements		7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		9
	Item 3.	Quantitative and Qualitative Disclosure About Market Risk		11
Part II.		Other Information
	Item 1.	Legal Proceedings (None)
	Item 2.	Changes in Securities and Use of Proceeds (None)
	Item 3.	Defaults Upon Senior Securities (None)
	Item 4.	Submission of Matters to a Vote of Security Holders (None)
	Item 5.	Other Information (None)
	Item 6.	Exhibits and Reports on Form 8-K		12
Signatures				12

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National Processing, Inc.
Consolidated Balance Sheets
Unaudited
(Dollars in thousands)

		March 31		December 31
		2001		2000
Assets
Current assets:
	Cash and cash equivalents	$	70,875	$	68,590
	Eurodollar deposits		56,000		56,000
	Accounts receivable — trade		89,750		128,627
	Restricted deposits — customer funds		31,362		31,543
	Deferred tax assets		1,392		2,283
	Other current assets		11,671		9,901
Total current assets			261,050		296,944
Property and equipment:
	Furniture and equipment		71,088		69,417
	Building and leasehold improvements		19,580		19,231
	Software		25,518		24,418
	Property leased from affiliate		4,173		4,173
	Land and improvements		2,390		2,390
			122,749		119,629
Less: Accumulated depreciation and amortization			60,499		58,675
Property and equipment, net			62,250		60,954
Other assets:
	Goodwill, net of accumulated amortization of $7,479 in 2001   and $6,939 in 2000		78,859		79,399
	Other intangible assets		27,403		29,697
	Deferred tax assets		19,145		4,149
	Other assets		6,234		6,328
Total other assets			131,641		119,573
Total assets		$	454,941	$	477,471
Liabilities and shareholders’ equity
Current liabilities:
	Restricted deposits — customer funds	$	31,362	$	31,543
	Accounts payable — trade		12,553		15,243
	Accrued bankcard assessments		21,015		24,458
	Income tax payable		12,275		7,865
	Other accrued liabilities		26,957		33,630
Total current liabilities			104,162		112,739
Obligation under property leased from affiliate			1,960		1,993
Deferred tax liabilities			307		1,181
Total liabilities			106,429		115,913
Shareholders’ equity:
	Preferred stock, without par value; 5,000,000 shares   authorized; no shares issued or outstanding		—		—
	Common stock, without par value; 95,000,000 shares   authorized; 51,214,393 and 50,935,460 shares issued and   outstanding in 2001 and 2000, respectively		1		1
	Contributed capital		182,744		178,729
	Retained earnings		165,767		182,828
Total shareholders’ equity			348,512		361,558
Total liabilities and shareholders’ equity		$	454,941	$	477,471

See notes to consolidated financial statements

3

National Processing, Inc.
Consolidated Statements of Income
Unaudited
(In thousands, except per share amounts)

	Three Months Ended
	March 31
	2001		2000
Revenue	$	109,045	$	97,867
Operating expense		81,858		71,109
General and administrative expense		5,575		7,752
Depreciation and amortization		5,180		5,375
Operating profit		16,432		13,631
Net interest income		2,220		1,815
Income before provision for income taxes		18,652		15,446
Provision for income taxes		7,113		5,898
Net income	$	11,539	$	9,548
Basic income per common share	$	0.226	$	0.188
Diluted income per common share	$	0.223	$	0.188

See notes to consolidated financial statements

4

National Processing, Inc.
Consolidated Statement of Changes in Shareholders’ Equity
Unaudited
(In thousands)

	Common		Contributed		Retained
	Stock		Capital		Earnings			Total
Balance at January 1, 2001	$	1	$	178,729	$	182,828		$	361,558
Net income		—		—		11,539			11,539
Common control business unit purchase (Note 3)		—		—		(28,600	)		(28,600	)
Issuance of common shares under stock-based compensation plans, including related tax effects		—		4,015		—			4,015
Balance at March 31, 2001	$	1	$	182,744	$	165,767		$	348,512

See notes to consolidated financial statements

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National Processing, Inc.
Consolidated Statements of Cash Flows
Unaudited
(In thousands)

				Three Months Ended
				March 31
				2001			2000
Operating Activities
	Net income			$	11,539		$	9,548
	Items not requiring cash currently:
			Depreciation and amortization		5,180			5,375
			Deferred income taxes		421			107
			Loss on disposition of fixed assets		32			5
	Change in current assets and liabilities:
			Accounts receivable — trade		38,877			30,960
			Accounts payable — trade		(2,690	)		(1,565	)
			Accrued bankcard assessments		(3,443	)		(3,241	)
			Income taxes payable		4,929			(3,482	)
			Other current assets/liabilities		(8,443	)		(3,016	)
			Other, net		1,194			(547	)
	Net cash provided by operating activities				47,596			34,144
Investing Activities
	Capital expenditures				(4,778	)		(3,249	)
	Proceeds from sales of fixed assets				4			36
	Purchases of Eurodollar deposits				—			(20,000	)
	Proceeds from maturities of Eurodollar deposits				—			20,000
	Common control business unit purchase				(44,000	)		—
	Acquisitions, net of cash acquired				—			(2,000	)
	Net cash used in investing activities				(48,774	)		(5,213	)
Financing Activities
	Principal payments under property leased from affiliate				(33	)		(33	)
	Issuance of common stock				3,496			12
	Net cash provided by financing activities				3,463			(21	)
Net increase in cash and cash equivalents					2,285			28,910
Cash and cash equivalents, beginning of period					68,590			32,042
Cash and cash equivalents, end of period				$	70,875		$	60,952
Supplemental cash flow information:
		Taxes paid		$	1,621		$	7,735

See notes to consolidated financial statements

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NATIONAL PROCESSING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES

      The consolidated financial statements include the accounts of National Processing, Inc. and its subsidiaries (the Company). All significant intercompany transactions and balances have been eliminated. The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. For the interim periods presented, management believes the unaudited consolidated financial statements reflect all adjustments of a normal recurring nature and disclosures which are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.

      Although the balance sheet at December 31, 2000 has been derived from the audited consolidated financial statements at that date, the accompanying interim consolidated financial statements do not include all of the information and footnotes required by generally accepted accounting principles. These interim financial statements should be read in conjunction with the Company’s 2000 Annual Report on Form 10-K.

      Certain 2000 amounts have been reclassified to conform with the 2001 presentation.

2. COMMITMENTS AND CONTINGENCIES

      In the normal course of business, the Company is involved in litigation from time to time. In the opinion of management, the ultimate liability, if any, arising from this litigation is not expected to have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

3. ACQUISITIONS

      On January 8, 2001, the Company purchased the merchant services business units from several of National City Corporation’s (National City) banking subsidiaries for $44.0 million in cash. This acquisition included merchant contracts and additional sales personnel. National Processing also assumed responsibility for all merchant processing sales efforts throughout National City’s 1,200 branch network via an exclusive multi-year marketing agreement. The Company already provided the authorization and settlement processing for these merchants via a third party processing contract with National City. During the first quarter of 2001, the Company recorded $4.0 million of incremental revenue as a result of this acquisition.

      The acquisition was accounted for as a transaction among entities under common control and was recorded at the historical cost bases of National City. The excess of the cash paid over the historical cost bases was recorded as a reduction in equity, net of income taxes.

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4. NET INCOME PER COMMON SHARE

      The calculation of net income per common share follows (in thousands, except per share amounts):

		Three Months Ended
		March 31
		2001		2000
BASIC
	Net income	$	11,539	$	9,548
	Average common shares outstanding		51,060		50,786
	Net income per common share — basic	$	0.226	$	0.188
DILUTED
	Net income	$	11,539	$	9,548
	Average common shares outstanding		51,060		50,786
	Stock option adjustment		591		58
	Average common shares outstanding — diluted		51,651		50,844
	Net income per common share — diluted	$	0.223	$	0.188

5. SEGMENT REPORTING

      The Company operates two business segments — Merchant Card Services and Corporate Outsourcing Solutions. Merchant Card Services authorizes, processes and settles credit and debit card transactions. Corporate Outsourcing Solutions provides financial settlement, image scanning, data capture, storage and retrieval, and value-added customer reporting services.

      The accounting policies of the reportable segments are the same as those of the Company. Prior period amounts have been classified to conform to the current line of business reporting structure.

      General and administrative expenses are allocated to the segments based upon various methods determined by the nature of the expenses. There are no intersegment revenues. Depreciation and amortization expense for corporate fixed assets is allocated to the segments. Corporate net operating assets are comprised primarily of cash, Eurodollar deposits and income tax balances.

(Dollars in thousands)	Merchant		Corporate
	Card		Outsourcing				Consolidated
	Services		Solutions		Corporate		Total
For the three months ended March 31, 2001
Revenue	$	85,340	$	23,705	$	—	$	109,045
Operating profit		13,603		2,829		—		16,432
Depreciation and amortization		3,492		1,688		—		5,180
Net interest income		1,817		403		—		2,220
Net operating assets		124,026		52,049		172,437		348,512
For the three months ended March 31, 2000
Revenue	$	70,911	$	26,956	$	—	$	97,867
Operating profit		10,661		2,970		—		13,631
Depreciation and amortization		3,371		2,004		—		5,375
Net interest income		1,419		396		—		1,815
Net operating assets		106,338		48,959		170,669		325,966

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Components of Revenue and Expenses

      Revenue.

      The Company’s Merchant Card Services revenue is primarily derived from fees paid by merchants for the authorization, processing and settlement of credit and debit card transactions. Fees are earned either on a “per transaction” basis or on a “discount” basis, which is a percent of dollar volume processed. Revenue is recorded net of interchange fees charged by the credit card associations as such costs are not controlled by the Company.

      Corporate Outsourcing Solutions revenue is generated from a variety of financial and administrative processing solutions provided to customers. These solutions include financial settlement, image scanning, data capture, storage and retrieval, and value-added customer reporting. A portion of Corporate Outsourcing Solutions revenue is earned from an exclusive long-term contract with the Airlines Reporting Corporation under which the Company is compensated on a “cost-plus” basis.

      A small portion of revenue is derived from earnings on customer cash balances, which are maintained pursuant to contract terms.

      Expenses.

      Expenses include costs of providing services to customers including wages and personnel costs, assessment fees, authorization fees, data processing costs, and general and administrative expenses.

Results of Operations

Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000

				2001				2000				Change
						% of				% of
(Dollars in thousands)				Amount		Revenues		Amount		Revenues		Amount			%
Revenue:
	Merchant Card Services			$	85,340		78	$	70,911		72	$	14,429			20
	Corporate Outsourcing Solutions				23,705		22		26,956		28		(3,251	)		(12	)
		Total Revenue			109,045		100		97,867		100		11,178			11
Expenses:
	Merchant Card Services				71,737		84		60,250		85		11,487			19
	Corporate Outsourcing Solutions				20,876		88		23,986		89		(3,110	)		(13	)
		Total Expenses			92,613		85		84,236		86		8,377			10
Operating Profit:
	Merchant Card Services				13,603		16		10,661		15		2,942			28
	Corporate Outsourcing Solutions				2,829		12		2,970		11		(141	)		(5	)
			Total Operating Profit		16,432		15		13,631		14		2,801			21
Net Interest Income					2,220		2		1,815		2		405			22
Income Before Taxes					18,652		17		15,446		16		3,206			21
Provision for Income Taxes					7,113		7		5,898		6		1,215			21
Net Income				$	11,539		11	$	9,548		10	$	1,991			21

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Merchant Card Services

      Revenue for the three months ended March 31, 2001 increased 20% to $85.3 million from $70.9 million in 2000. Revenue increased primarily due to increases in transaction and dollar volume processed of 28% and 26%, respectively, as well as the acquisition from National City’s banking subsidiaries of their merchant business units which occurred on January 8, 2001. This acquisition contributed $4.0 million of incremental revenue in the first quarter of 2001. The volume increases were primarily due to the addition of new national customers, strong execution in the regional sales channels, and continued expansion in new vertical markets.

      Expenses for the three months ended March 31, 2001 increased 19% to $71.7 million from $60.3 million in 2000 primarily due to increased processing volume. Operating margins as a percentage of revenue increased to 16% from 15%, primarily due to economies of scale from increased volume, the addition of National City’s merchant business units, and lower general and administrative expenses. Operating profit for the quarter ended March 31, 2001 increased 28% to $13.6 million from $10.7 million in the 2000 first quarter due primarily to the factors outlined above.

Corporate Outsourcing Solutions

      Revenue for the three months ended March 31, 2001 decreased 12% to $23.7 million from $27.0 million in 2000. Three key factors contributed to this decline. First, during 2000, initiatives were implemented to either re-price or terminate certain contracts that did not meet the Company’s core competencies and/or profit objectives. Most of these contracts were terminated during 2000. Second, conversion from paper to electronic ticketing and reporting is continuing in the airline industry, which reduced demand for the Company’s data capture services. Third, during the first quarter of 2001, the Company exited a small collections business located in Denver, Colorado. These declines were partially offset by revenue growth in the Company’s healthcare claims processing business and electronic-based settlement businesses.

      Expenses for the three months ended March 31, 2001 decreased 13% to $20.9 million from $24.0 million in 2000 due primarily to decreased volume, planned staff reductions, and other cost savings initiatives. Operating profit for the quarter ended March 31, 2001 decreased 5% to $2.8 million from $3.0 million in the 2000 first quarter as a result of the items discussed above.

Net Interest Income

      Net interest income for the three months ending March 31, 2001, increased 22% to $2.2 million due to higher average interest rates and higher average cash and Eurodollar deposit balances.

Provision for Income Taxes

      The effective tax rate was 38.1% for the first quarter of 2001 compared to 38.2% for the same period a year ago.

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Seasonality

      The Company experiences seasonality in its businesses and typically realizes higher revenue in the third and fourth calendar quarters, reflecting increased transaction volume in the summer and holiday months.

Liquidity and Capital Resources

      The Company’s primary uses of capital include capital expenditures, working capital and acquisitions. Future business acquisitions may be funded through current liquidity, borrowed funds, and/or issuances of common stock.

      The Company’s capital expenditures include amounts paid for computers, external and internally developed software, scanning and other document processing equipment as well as improvements to operating facilities. During the three month period ended March 31, 2001, the Company’s capital expenditures totaled $4.8 million. Such expenditures were financed from operating cash flow, which totaled $47.6 million for the three month period. Operating cash flow during the three month period ended March 31, 2000 totaled $34.1 million and capital expenditures were $3.2 million. Operating cash flow increased in the 2001 period compared to 2000 due to strong operating results from the Merchant Card Services business segment. It is anticipated future capital expenditures will be funded with operating cash flow.

      On January 8, 2001, the Company acquired the merchant services business units from several National City banking subsidiaries for $44.0 million.

      As the Company does not carry significant amounts of inventory and historically has experienced short collection periods for its accounts receivable, it does not require substantial working capital to support revenue growth. Working capital requirements will vary depending upon future acquisition activity. Increases in working capital needs are expected to be financed through operating cash flow and current cash balances.

      The Company maintains restricted cash balances held on behalf of clients pending distribution to vendors, which are shown on the balance sheet as assets and equivalent offsetting liabilities. These cash balances totaled $31.4 million and $31.5 million as of March 31, 2001 and December 31, 2000, respectively.

Forward Looking Statements and Risk Factors

      The section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). Although management believes the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially. Please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000 for risks and uncertainties that could cause actual results to differ materially.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

      There have been no material changes in market risk as disclosed in the Company’s 2000 Annual Report on Form 10-K.

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Part II — Other Information

Item 1. Legal Proceedings (None)

Item 2. Changes in Securities and Use of Proceeds (None)

Item 3. Defaults Upon Senior Securities (None)

Item 4. Submission of Matters to a Vote of Security Holders (None)

Item 5. Other Information (None)

Item 6. Exhibits and Reports on Form 8-K:

a. Exhibits (None)

b. Reports on Form 8-K

      January 9, 2001: On January 8, 2001, the Registrant issued a press release announcing the purchase of the merchant services business units from National City Corporation’s banking subsidiaries.

      January 22, 2001: On January 22, 2001, the Registrant issued a press release reporting earnings for the quarter and year ended December 31, 2000.

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.

		NATIONAL PROCESSING, INC.
Date:	May 14, 2001	By: /s/ Thomas A. Wimsett
		Thomas A. Wimsett
		President and Chief Executive Officer
		(Duly Authorized Signer)
		By: /s/ David E. Fountain
		David E. Fountain
		Senior Vice President and Chief Financial Officer
		(Principal Financial Officer)

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