UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-10254
T|SYS|
Total System Services, Inc.
(Exact name of registrant as specified in its charter)
Georgia 58-1493818
(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
(Address of principal executive offices) (Zip Code)
(706) 649-2310
(Registrant's telephone number, including area code)
_______________________________________________________________________________
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AS OF: May 13, 2002
- ---------------------------------------- ----------------------------------
Common Stock, $.10 par value 196,982,670
T|SYS|
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - March 31, 2002 and
December 31, 2001 3
Consolidated Statements of Income (unaudited) - Three months
ended March 31, 2002 and 2001 4
Consolidated Statements of Cash Flows (unaudited) - Three
months ended March 31, 2002 and 2001 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
2002 2001
- ---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $65.8 million and $45.9 million on
deposit with a related party at 2002 and 2001, respectively) $ 81,919,239 55,961,088
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $7.7 million and $5.4 million at 2002 and 2001, respectively 114,140,957 113,318,623
Prepaid expenses and other current assets 36,062,831 37,074,206
- ---------------------------------------------------------------------------------------------------------------------------------
Total current assets 232,123,027 206,353,917
Property and equipment, less accumulated depreciation and amortization of
$115.7 million and $109.3 million at 2002 and 2001, repectively 120,183,167 120,799,905
Computer software, less accumulated amortization of $119.8 million and $111.8
million at 2002 and 2001, respectively 178,739,433 170,889,575
Other assets 154,070,876 145,741,354
- ----------------------------------------------------------------------------------------------------------------------------------
Total assets $ 685,116,503 643,784,751
============================================
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 6,564,341 24,129,727
Accrued salaries and employee benefits 40,903,970 39,687,428
Other current liabilities (includes $2.5 million and $2.4 million payable to
related parties at 2002 and 2001, respectively) 54,035,863 34,147,121
- ---------------------------------------------------------------------------------------------------------------------------------
Total current liabilities 101,504,174 97,964,276
Deferred income tax liabilities 51,181,983 42,650,211
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 152,686,157 140,614,487
- ---------------------------------------------------------------------------------------------------------------------------------
Minority interest in consolidated subsidiary 2,307,596 2,358,578
- ---------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Common stock - $.10 par value. Authorized 600,000,000 shares; 197,254,087
and 195,079,087 issued at 2002 and 2001, respectively; 196,972,820 and
194,778,670 outstanding at 2002 and 2001, respectively 19,725,409 19.507,909
Additional paid-in capital 11,548,650 9,360,223
Accumulated other comprehensive loss (4,465,773) (3,455,338)
Treasury stock (3,504,806) (3,533,325)
Retained earnings 506,819,270 478,932,217
- ---------------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 530,122,750 500,811,686
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 685,116,503 643,784,751
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Three months ended
March 31,
------------------------------------------
2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $6.6 million and $8.2 million
from related parties for 2002 and 2001, respectively) $ 139,183,589 129,361,228
Other services (includes $1.7 million and $1.7 million from related parties for
2002 and 2001, respectively) 27,647,232 23,810,751
------------------------------------------
Revenues before reimbursable items 166,830,821 153,171,979
Reimbursable items (includes $2.3 million and $2.4 million from related parties
for 2002 and 2001, respectively) 56,994,743 62,562,068
------------------------------------------
Total revenues 223,825,564 215,734,047
------------------------------------------
Expenses:
Salaries and other personnel expense 65,828,877 61,285,319
Net occupancy and equipment expense 43,631,799 41,057,329
Other operating expenses (includes $2.2 million and $2.1 million to related parties
for 2002 and 2001, respectively) 22,088,239 21,590,168
(Gain) loss on disposal of equipment, net (1,098) 19,773
------------------------------------------
Expenses before reimbursable items 131,547,817 123,952,589
Reimbursable items 56,994,743 62,562,068
------------------------------------------
Total expenses 188,542,560 186,514,657
------------------------------------------
Equity in income of joint ventures 4,473,675 3,236,614
------------------------------------------
Operating income 39,756,679 32,456,004
------------------------------------------
Nonoperating income (expense):
Interest income, net (includes $222,000 and $918,000 from a related party for 2002
and 2001, respectively) 363,559 1,008,535
Minority interest in consolidated subsidiary's net income 13,926 25,202
Other, net (184,505) -
------------------------------------------
Total nonoperating income 192,980 1,033,737
------------------------------------------
Income before income taxes 39,949,659 33,489,741
Income taxes 13,035,976 11,475,121
------------------------------------------
Net income $ 26,913,683 22,014,620
==========================================
Basic earnings per share $ .14 .11
==========================================
Diluted earnings per share $ .14 .11
==========================================
Weighted average common shares outstanding 196,962,984 194,760,194
Increase due to assumed issuance of shares related to stock options outstanding 760,193 773,893
------------------------------------------
Weighted average common and common equivalent shares outstanding 197,723,177 195,534,087
==========================================
Cash dividends per common share $ .015 .015
==========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Three months ended
March 31,
------------------------------------------
2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 26,913,683 22,014,620
Adjustments to reconcile net income to net cash provided by operating
Minority interest in consolidated subsidiary's net income (13,926) (25,202)
Equity in income of joint ventures (4,473,675) (3,236,614)
Depreciation and amortization 13,819,970 12,775,358
Provision for doubtful accounts and billing adjustments 1,160,669 41,132
Provision for transaction processing accruals 636,948 (377,151)
Deferred income tax expense 8,531,772 5,104,319
(Gain) loss on disposal of equipment, net (1,098) 19,773
(Increase) decrease in:
Accounts receivable 1,445,988 (2,990,448)
Prepaid expenses and other assets 3,856,509 (4,949,316)
Increase (decrease) in:
Accounts payable (17,667,725) (27,953,859)
Accrued salaries and employee benefits 913,111 (16,227,610)
Other current liabilities 15,775,991 15,089,236
------------------------------------------
Net cash provided by (used in) operating activities 50,898,217 (715,762)
------------------------------------------
Cash flows from investing activities:
Purchase of property and equipment (2,751,334) (6,131,337)
Additions to computer software (15,690,293) (17,136,400)
Proceeds from disposal of equipment 2,062 960,500
Cash acquired in acquisition of subsidiary 5,557,092 -
Dividends received from joint ventures - 3,335,440
Increase in contract acquisition costs (9,176,780) (4,509,099)
------------------------------------------
Net cash used in investing activities (22,059,253) (23,480,896)
------------------------------------------
Cash flows from financing activities:
Dividends paid on common stock (2,921,657) (2,434,218)
Proceeds from exercise of stock options 40,844 229,066
------------------------------------------
Net cash used in financing activities (2,880,813) (2,205,152)
------------------------------------------
Net increase (decrease) in cash and cash equivalents $ 25,958,151 (26,401,810)
Cash and cash equivalents at beginning of year 55,961,088 80,071,895
------------------------------------------
Cash and cash equivalents at end of year $ 81,919,239 53,670,085
==========================================
Cash paid for interest (net of capitalized amounts) $ 5,679 -
==========================================
Cash paid for income taxes (net of refunds received) $ (13,440,518) 422,657
==========================================
Significant noncash transaction: In January 2002, the Company acquired TSYS
Total Debt Management, Inc. through the issuance of 2,175,000 shares of common
stock with a market value of $43.5 million.
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Notes to Unaudited Consolidated Financial Statements
Note 1 - Basis of Presentation The accompanying unaudited consolidated
financial statements represent the accounts of Total System Services, Inc.(R)
(TSYS(R)); its wholly owned subsidiaries, Columbus Depot Equipment Company(SM)
(CDEC(SM)), Columbus Productions, Inc.SM (CPI), TSYS Canada, Inc.SM (TCI) and
TSYS Total Debt Management, Inc. (TDM); and its majority owned foreign
subsidiary, GP Network Corporation (GP Net). These financial statements have
been prepared in accordance with the instructions to Form 10-Q and do not
include all information and footnotes necessary for a fair presentation of
financial position, results of operations and cash flows in conformity with
generally accepted accounting principles. All adjustments, consisting of normal
recurring accruals, which, in the opinion of management, are necessary for a
fair statement of financial position and results of operations for the periods
covered by this report have been included. The accompanying unaudited
consolidated financial statements should be read in conjunction with the
Company's consolidated financial statements and related notes appearing in the
Company's 2001 annual report previously filed on Form 10-K.
Note 2 - Supplementary Balance Sheet Information
Significant components of prepaid expenses and other current assets are
summarized as follows:
March 31, 2002 December 31, 2001
------------------- ----------------------
Contract acquisition costs, net $ 13,417,899 $ 11,899,957
Prepaid expenses 10,906,651 10,634,921
Other 11,738,281 14,539,328
------------------- ----------------------
Total $ 36,062,831 $ 37,074,206
=================== =======================
Significant components of other assets are summarized as follows:
March 31, 2002 December 31, 2001
--------------------- ---------------------
Contract acquisition costs, net $ 79,066,752 $ 75,183,275
Equity investments, net 55,966,605 51,566,564
Other 19,037,519 18,991,515
--------------------- ---------------------
Total $ 154,070,876 $ 145,741,354
===================== =====================
Amortization expense related to contract acquisition costs was $3.1 million
and $1.5 million for the three months ended March 31, 2002 and 2001,
respectively.
- 6 -
Notes to Unaudited Consolidated Financial Statements (continued)
Significant components of other current liabilities are summarized as
follows:
March 31, 2002 December 31, 2001
-------------------- --------------------
Customer postage deposits $ 14,756,249 $ 19,065,119
Transaction processing
provisions 5,211,370 5,326,554
Other 34,068,244 9,755,448
------------------- --------------------
Total $ 54,035,863 $ 34,147,121
=================== ====================
Note 3 - Comprehensive Income
Comprehensive income for TSYS consists of net income and foreign currency
translation adjustments recorded as a component of shareholders' equity.
Comprehensive income for the three months ended March 31 is as follows:
2002 2001
--------------- -----------------
Net income $ 26,913,683 $ 22,014,620
Other comprehensive income (loss):
Foreign currency translation adjustments,
net of tax (1,010,435) (2,217,882)
--------------- -----------------
Comprehensive income $ 25,903,248 $ 19,796,738
=============== =================
The income tax effects allocated to and the cumulative balance of
accumulated other comprehensive loss are as follows:
Balance at December 31, Pretax Balance at
2001 amount Tax benefit March 31, 2002
-----------------------------------------------------------------------------------------------------------------------
Foreign currency translation
adjustments ($3,455,338) (1,579,333) 568,898 ($4,465,773)
====================================================================================
Note 4 - Segment Reporting and Major Customers
The Company reports selected information about operating segments in
accordance with Statement of Financial Accounting Standards No. 131 (SFAS 131).
With the Company's recent expansion in Europe and its strategic decision to
further expand its business internationally, combined with the integration of
its business process management and e-commerce subsidiaries, the Company has
revised its segment information to reflect the information that the chief
operating decision maker (CODM) uses to make resource allocation and strategic
decisions. The CODM at TSYS consists of the chief executive officer, the
president and the four executive vice presidents.
Through online accounting and electronic payment processing systems, Total
System Services, Inc. provides electronic payment processing services and other
related services to card-issuing institutions in the United States, Mexico,
Canada, Honduras, Europe and the Caribbean. The reportable units are segmented
based upon geographic locations. Domestic-based processing services
- 7 -
Notes to Unaudited Consolidated Financial Statements (continued)
include electronic payment processing services and other services provided from
the United States. Domestic-based processing services segment includes the
financial results of TSYS, excluding its foreign branch offices, and the
following subsidiaries: CDEC, CPI and TDM. International-based processing
services include electronic payment processing services and other services
provided outside the United States. International-based processing services
include the financial results of TCI, GP Net and TSYS' branch offices in Europe
and Japan.
Domestic-based International-based
Operating Segments processing services processing services Consolidated
- -----------------------------------------------------------------------------------------------------------------------------------
At March 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 685,180,209 95,542,774 $ 780,722,983
Intersegment eliminations (95,487,825) (118,655) (95,606,480)
-------------------------- ------------------------- -----------------------
Total assets $ 589,692,384 95,424,119 $ 685,116,503
========================== ========================= =======================
- -----------------------------------------------------------------------------------------------------------------------------------
At December 31, 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 643,615,591 91,657,540 $ 735,273,131
Intersegment eliminations (91,419,159) (69,221) (91,488,380)
-------------------------- ------------------------- -----------------------
Total assets $ 552,196,432 91,588,319 $ 643,784,751
========================== ========================= =======================
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 209,151,644 15,073,373 $ 224,225,017
Intersegment revenue (1,456) (397,997) (399,453)
-------------------------- ------------------------- -----------------------
Revenue from external customers $ 209,150,188 14,675,376 $ 223,825,564
========================== ========================= =======================
Equity in income of joint ventures $ 4,226,441 247,234 $ 4,473,675
========================== ========================= =======================
Segment operating income $ 39,503,463 253,216 $ 39,756,679
========================== ========================= =======================
Income taxes $ 12,930,393 105,583 $ 13,035,976
========================== ========================= =======================
Net income $ 26,884,762 28,921 $ 26,913,683
========================== ========================= =======================
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 213,194,738 2,825,485 $ 216,020,223
Intersegment revenue (147) (286,029) (286,176)
-------------------------- ------------------------- -----------------------
Revenue from external customers $ 213,194,591 2,539,456 $ 215,734,047
========================== ========================= =======================
Equity in income of joint ventures $ 2,616,558 620,056 $ 3,236,614
========================== ========================= =======================
Segment operating income $ 38,432,771 (5,976,767) $ 32,456,004
========================== ========================= =======================
Income taxes $ 13,621,189 (2,146,068) $ 11,475,121
========================== ========================= =======================
Net income $ 25,796,668 (3,782,048) $ 22,014,620
========================== ========================= =======================
- 8 -
Notes to Unaudited Consolidated Financial Statements (continued)
The following geographic area data represent revenues for the three months
ended March 31, 2002 and 2001, respectively, based on the geographic locations
of customers.
Three Months Ended March 31,
-----------------------------------------------
(Dollars in millions) 2002 2001
--------------------- --------------------
United States $ 192.9 198.7
Europe 12.2 0.6
Canada* 9.8 9.9
Mexico 6.0 3.6
Japan 2.4 2.4
Other 0.5 0.5
--------------------- --------------------
Totals $ 223.8 215.7
===================== ====================
*These revenues include those generated from the Caribbean accounts owned by a
Canadian institution.
The Company maintains property and equipment in the United States, Europe,
Canada and Japan. The following geographic area data represent net property and
equipment balances by region:
At March 31, At December 31,
---------------------- --------------------
(Dollars in millions) 2002 2001
---------------------- --------------------
United States $ 98.8 98.7
Europe 20.0 20.9
Canada 0.1 0.1
Japan 1.3 1.1
-------------------- ---------------------
Totals $ 120.2 120.8
==================== =====================
Major Customers For the three months ended March 31, 2002, the Company had
two major customers which accounted for approximately 34.5%, or $77.2 million,
of total revenues. For the three months ended March 31, 2001, TSYS had two major
customers that accounted for 37.2%, or $80.2 million, of total revenues.
Revenues from major customers for the periods reported are attributable to both
reporting segments.
Three Months Ended March 31,
------------------------------------------------------------------------
2002 2001
------------------------------------- ---------------------------------
Revenue % of Total % of Total
(Dollars in millions) Dollars Revenues Dollars Revenues
------------------------------------- ---------------------------------
One $ 42.5 19.0% $ 40.8 18.9%
Two 34.7 15.5 39.4 18.3
------------------- ------------ ------------------ -----------
Totals $ 77.2 34.5% $ 80.2 37.2%
=============================== ================== ==========
- 9 -
Notes to Unaudited Consolidated Financial Statements (continued)
Note 5 - Recent Accounting Pronouncements
As a result of the Financial Accounting Standards Board's (FASB's) Emerging
Issues Task Force 01-14 (EITF 01-14), formerly known as Staff Announcement Topic
D-103, "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenue. Historically, TSYS has not
reflected such reimbursements in its consolidated statements of income. The
largest reimbursement expenses for which TSYS is reimbursed by clients are
postage and express courier charges.
EITF 01-14 was adopted by the Company on January 1, 2002. Upon application
of EITF 01-14, comparative financial statements for prior periods have been
reclassified to provide consistent presentation.
In July 2001, the FASB issued Statement No. 141 (SFAS 141), "Business
Combinations," and Statement No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets." SFAS 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. SFAS 141 also
specifies criteria that intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. The Company adopted the provisions of SFAS 141 July 1, 2002, the
effect of which was not significant.
SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 also requires
that intangible assets with estimable useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." The Company adopted SFAS 142 January 1,
2002.
At March 31, 2002, the Company has unamortized goodwill in the amount of
$3.6 million. As a result of implementing SFAS 142, the Company incurred no
amortization expense of goodwill during the three months ended March 31, 2002.
Amortization expense related to goodwill was $215,000 for the three months ended
March 31, 2001. The Company is in the process of completing its transitional
impairment analysis on goodwill and does not anticipate having any transitional
impairment losses.
In October 2001, the FASB issued Statement No. 144 (SFAS 144), "Accounting
for the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business (as previously
defined in that Opinion). This Statement also amends
- 10 -
Notes to Unaudited Consolidated Financial Statements (continued)
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," to
eliminate the exception to consolidation for a subsidiary for which control is
likely to be temporary.
SFAS 144 improves financial reporting by requiring that one accounting
model be used for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and by broadening the presentation
of discontinued operations to include more disposal transactions.
The Company adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144
did not have a material effect on the Company's financial condition or results
of operations.
Note 6 - Commitments and Contingencies
At March 31, 2002, the Company has guaranteed a loan of Columbus Bank and
Trust Company. As of March 31, 2002, all payments on the loan have been made
timely. The remaining balance at March 31, 2002 was $7.0 million. In April 2002,
the remaining balance of the loan to CB&T was repaid.
Note 7 - Reclassification
Certain reclassifications have been made to the 2001 financial statements
to conform to the presentation adopted in 2002.
Note 8 - Acquisition
Effective January 1, 2002, TSYS acquired TSYS Total Debt Management, Inc.
(TDM) from Columbus Bank and Trust Company in exchange for 2,175,000 newly
issued shares of TSYS common stock with a market value of $43.5 million. TDM
provides third-party collection services which expands and complements the
Company's product offerings. TDM operates as a separate subsidiary of TSYS.
Because the acquisition of TDM was a transaction between entities under
common control, the Company is reflecting the acquisition at historical cost in
accordance with SFAS 141 and is reflecting the results of operations of TDM in
the Company's financial statements beginning January 1, 2002.
The Company does not plan on restating periods prior to 2002 because such
restatement was not material. Presented below are the pro forma consolidated
results of TSYS' operations for the three months ended March 31, 2002 and 2001,
as though the acquisition of TDM had occurred at the beginning of 2001, compared
to TSYS' actual consolidated results of operations for 2002.
Three Months Ended March 31,
------------------------------------
2002 2001
------------------ ---------------
Revenues $ 223,825,564 219,946,870
Net income 26,913,683 22,334,833
Earnings per share
- basic and diluted .14 .11
- 11 -
TOTAL SYSTEM SERVICES, INC.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Review
This Financial Review provides a discussion of critical accounting policies,
related party transactions, and off-balance sheet arrangements. This Financial
Review also discusses the results of operations, financial condition, liquidity
and capital resources of TSYS and outlines the factors that have affected its
recent earnings, as well as those factors that may affect its future earnings.
Critical Accounting Policies
TSYS' (The Company's) financial position and results of operations are impacted
by the accounting policies the Company has adopted. In order to get a full
understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed.
Risks and Uncertainties and Use of Estimates: The Company has prepared the
accompanying consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America. In preparing
financial statements, it is necessary for management to make assumptions and
estimates affecting the amounts reported in the consolidated financial
statements and related notes. These estimates and assumptions are developed
based upon all information available. Actual results can differ from assumed and
estimated amounts.
Factors that could affect the Company's future operating results and cause
actual results to vary materially from expectations include, but are not limited
to, lower than anticipated growth from existing customers, an inability to
attract new customers and grow internationally, an inability to grow through
acquisitions or successfully integrate acquisitions, an inability to control
expenses, technology changes, financial services consolidation, increased
regulatory mandates, a decline in the use of cards as a payment mechanism, a
decline in the financial stability of the Company's customers and uncertain
economic conditions. Negative developments in these or other risk factors could
have a material adverse effect on the Company's financial position and results
of operations.
A summary of the Company's critical accounting policies follows:
Accounts Receivable: Accounts receivable balances are stated net of allowances
for doubtful accounts and billing adjustments of $7.7 million and $5.4 million
at March 31, 2002 and December 31, 2001, respectively. The allowance represents
6.4% and 4.5% of accounts receivable at March 31, 2002 and December 31, 2001,
respectively. TSYS' client base mainly consists of financial institutions and
other card issuers such as major retailers. Historically, the Company has not
incurred any significant write-offs.
TSYS records allowances for doubtful accounts when it is probable that the
accounts receivable balance will not be collected. When estimating the
allowances for doubtful accounts, the Company takes into consideration such
factors as its day-to-day knowledge of specific customers, the industry and size
of its customers, the overall composition of its accounts receivable aging,
prior history of accounts receivable write-offs and prior history of allowances
in proportion to the overall
- 12 -
Critical Accounting Policies (continued)
receivable balance. This analysis includes an on-going and continuous
communication with its largest customers. A financial decline of any one of
these customers could have an adverse and material effect on collectibility of
receivables.
Increases in the allowance for doubtful accounts are recorded as bad debt
expense and are reflected in other operating expenses in the Company's
consolidated statements of income.
TSYS records provisions for billing adjustments for potential billing
discrepancies. When estimating the provision for billing adjustments, the
Company considers prior history of billing adjustments. Increases in the
provision for billing adjustments are recorded as a reduction of revenues in the
Company's consolidated statements of income.
Revenue Recognition: The Company's electronic payment processing revenues are
derived from long-term processing contracts with banks and other institutions
and are recognized as revenues at the time the service is performed. Electronic
payment processing revenues are generated primarily from charges based on the
number of accounts billed, transactions and authorizations processed, statements
mailed, and other processing services for cardholder accounts on file. Most of
these contracts have prescribed minimums. The terms of contracts generally range
from three to ten years in length.
The Company's other service revenues are derived from printing activities
and customer relationship management services, such as call center activities
for card activation and balance transfer requests. The contract terms for these
services are generally shorter in nature, and some are project based. Revenue is
recognized on these other services either on a per unit or a fixed price basis.
The Company uses the percentage of completion method of accounting for its fixed
price contracts.
Contract Acquisition Costs: The Company capitalizes contract acquisition costs
related to signing or renewing long-term contracts. These costs, primarily
consisting of cash payments for rights to provide processing services and
internal conversion and software development costs, are amortized using the
straight-line method over the contract term beginning when the client's
cardholder accounts are converted to the system. All costs incurred prior to
contract execution are expensed as incurred.
The amortization of contract acquisition costs adjustments is recorded net
of revenues in the Company's consolidated statements of income. The Company
evaluates the carrying value of contract acquisition costs for impairment on the
basis of whether these costs are fully recoverable from expected undiscounted
net operating cash flows of the related contract. The determination of expected
undiscounted net operating cash flows requires management to make estimates.
These costs may become impaired with the loss of a contract, the financial
decline of a customer, termination of conversion efforts after a contract is
signed, diminished prospects for current customers or if the Company's estimates
of future cash flows differ from actual results. Capitalized contract
acquisition costs are classified in prepaid and other assets.
Software Development Costs: The Company develops software that is used in
providing transaction processing services to clients. Software development costs
are capitalized once technological feasibility of the software has been
established. Costs incurred prior to establishing technological feasibility are
expensed as incurred. Technological feasibility is established when the Company
has
- 13 -
Critical Accounting Policies (continued)
completed all planning, designing, coding and testing activities that are
necessary to determine that a product can be produced to meet its design
specifications, including functions, features and technical performance
requirements. Capitalization of costs ceases when the product is available to
customers for general use. The Company evaluates the unamortized capitalized
costs of software development as compared to the net realizable value of the
development which is determined by projected future cash flows. The amount by
which the unamortized software development costs exceed the net realizable value
are written off. Software development costs are amortized using the greater of
(1) the straight-line method over the estimated useful life (which ranges from
3-10 years) or (2) the ratio of current revenues to current anticipated
revenues.
Software development costs may become impaired in situations where
development efforts are abandoned due to the viability of the planned project
becoming doubtful or due to technological obsolescence of the planned project.
Transaction Processing Provisions: The Company has made certain estimates to
accrue for contract contingencies and processing errors. When providing for
these accruals, the Company takes into consideration such factors as the prior
history of contract penalties and processing errors incurred, contractual
penalties inherent in the Company's contracts, progress towards meeting
milestones and amounts not covered by insurance.
These accruals are recorded in other current liabilities in the
accompanying consolidated balance sheets. Increases and decreases in transaction
processing provisions are reflected in other operating expenses in the Company's
consolidated statements of income.
Impairment of Long-lived Assets and Intangibles: The Company evaluates the
recoverability of property and equipment, identifiable intangibles and goodwill
by comparing the carrying amount of the asset against the estimated undiscounted
cash flows associated with it. Should the sum of the expected future cash flows
be less than the carrying value of the asset being evaluated, the Company uses
fair value in determining the amount of impairment loss that should be recorded.
The determination of undiscounted net operating cash flows requires management
to make estimates.
Equity Investments: TSYS' 49% investment in Total System Services de Mexico,
S.A. de C.V. (TSYS de Mexico), a bankcard data processing support operation
located in Mexico, is accounted for using the equity method of accounting, as is
TSYS' 50% investment in Vital Processing Services L.L.C. (Vital), a merchant
processing operation headquartered in Tempe, Arizona.
Income Taxes: Income taxes reflected in TSYS' consolidated financial statements
are computed based on the taxable income of TSYS as if TSYS were a stand-alone
tax paying entity. A consolidated federal income tax return is filed for Synovus
and its majority owned subsidiaries, including TSYS.
The Company accounts for income taxes in accordance with the asset and
liability method. Under the asset and liability method, deferred income tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred income
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in
- 14 -
Critical Accounting Policies (continued)
which those temporary differences are expected to be recovered or settled. The
effect on deferred income tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Income tax provisions require the use of management judgments, which are
subject to challenge by various taxing authorities. Estimates relate to the
determination of taxable income, the determination of temporary differences
between book and tax bases, as well as anticipated tax credits and related
provisions.
Related Party Transactions
The Company provides electronic payment processing services and other
services for its parent company, Synovus Financial Corp. (Synovus), and its
affiliates, and for Vital and TSYS de Mexico. The services are performed under
negotiated contracts. The Company believes the terms and conditions of
transactions between the Company and Synovus and its affiliates are comparable
to those which could have been obtained in transactions with unaffiliated
parties. The Company's margins with respect to related party transactions are
comparable to margins recognized in transactions with unrelated third parties.
The amounts of the significant agreements are disclosed on the face of TSYS'
consolidated financial statements.
Off-Balance Sheet Arrangements
Operating Leases: As a method of funding its operations, TSYS employs
noncancelable operating leases for computer equipment, software and facilities.
These leases allow the Company to provide the latest technology while avoiding
the ownership risk of technological obsolescence. Neither the assets nor
liabilities related to these leases are included on the balance sheet. One of
the Company's most significant leases is its synthetic lease for its corporate
campus.
Synthetic Lease: In 1997, the Company entered into an operating lease agreement
with a special purpose entity (SPE) for the Company's corporate campus. The
business purpose of the SPE was to provide a means of financing the Company's
corporate campus. The assets and liabilities of the SPE consists solely of the
cost of the building and the loans from a consortium of banks. The cost of the
building and the outstanding principal balance of the debt resident within the
financial statements of the SPE both approximate $93.5 million. The lease, which
is guaranteed by Synovus, provides for substantial residual value guarantees.
The amount of the residual value guarantees relative to the assets under this
lease is approximately $81.4 million. Due to the nature of the lease, no asset
or obligation is recorded on the Company's consolidated balance sheets.
The terms of this lease financing arrangement require, among other things,
that the Company maintain certain minimum financial ratios and provide certain
information to the lessor. TSYS is also subject to interest rate risk associated
with the lease on its campus facilities. The payments under the operating lease
arrangement, which can be locked in for six month intervals, are tied to the
floating London Interbank Offered Rate (LIBOR). In the event that LIBOR rates
increase, operating expenses could increase proportionately.
The campus lease expires November 2002. The Company has the option to
either renew the lease subject to prevailing market rates or purchase the
property at its original. The Company is currently evaluating which option to
pursue. As a result, the Company will have a future cash
- 15 -
Off-Balance Sheet Arrangements (continued)
obligation with respect to the corporate campus beyond the lease expiration of
November 2002.
Results of Operations
The following table sets forth certain revenue and expense items as a
percentage of total revenues and the percentage increases or decreases in those
items for the three months ended March 31:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2002 2001 2002 vs. 2001
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 62.1 % 60.0 % 7.6 %
Other services 12.4 11.0 16.1
------------- ----------
Revenues before reimbursable items 74.5 71.0 8.9
Reimbursable items 25.5 29.0 (8.9)
------------- ----------
Total revenues 100.0 100.0 3.8
------------- ----------
Expenses:
Salaries and other personnel expense 29.4 28.4 7.4
Net occupancy and equipment expense 19.5 19.0 6.3
Other operating expenses 9.9 10.0 2.3
(Gain) loss on disposal of equipment, net (0.0) 0.0 na
------------- ----------
Expenses before reimbursable items 58.8 57.4 6.1
Reimbursable items 25.5 29.0 (8.9)
------------- ----------
Total expenses 84.3 86.4 1.1
------------- ----------
Equity in income of joint ventures 2.0 1.5 38.2
------------- ----------
Operating income 17.7 15.1 22.4
Nonoperating income 0.1 0.4 (81.3)
------------- ----------
Income before income taxes 17.8 15.5 19.3
Income taxes 5.8 5.3 13.6
------------- ----------
Net income 12.0 % 10.2 % 22.3 %
============= ==========
na = not applicable
Revenues Total revenues increased $8.1 million, or 3.8%, during the three
months ended March 31, 2002, compared to the same period in 2001. Excluding
reimbursable items, revenues increased $13.7 million, or 8.9%, during the three
months ended March 31, 2002, compared to the same period in 2001. TSYS' revenues
are derived from providing electronic payment processing and related services to
banks and other institutions, generally under long-term processing contracts.
TSYS' services are provided through the Company's cardholder systems, TS2 and
TS1, to financial institutions and other organizations throughout the United
States, Mexico, Canada, Honduras, the
- 16 -
Results of Operations (continued)
Caribbean and Europe. The Company currently offers merchant services to
financial institutions and other organizations in Japan.
Revenues from electronic payment processing services increased $9.8
million, or 7.6%, for the three months ended March 31, 2002, compared to the
same period in 2001. Electronic payment processing revenues are generated
primarily from charges based on the number of accounts billed, transactions and
authorizations processed, statements mailed, credit bureau requests, cards
embossed and mailed, and other processing services for cardholder accounts on
file. Cardholder accounts on file include active and inactive consumer credit,
retail, debit, stored value and commercial card accounts. Due to the number of
cardholder accounts processed by TSYS and the expanding use of cards, as well as
increases in the scope of services offered to clients, revenues relating to
electronic payment processing services have continued to grow. Processing
contracts with large clients, representing a significant portion of the
Company's total revenues, generally provide for discounts on certain services
based on the size and activity of clients' portfolios. Therefore, electronic
payment processing revenues and the related margins are influenced by the client
mix relative to the size of client card portfolios, as well as the number and
activity of individual cardholder accounts processed for each client.
Due to the somewhat seasonal nature of the credit card industry, TSYS'
revenues and results of operations have generally increased in the fourth
quarter of each year because of increased transaction and authorization volumes
during the traditional holiday shopping season. Furthermore, growth in card
portfolios of existing clients, the conversion of cardholder accounts of new
clients to the Company's processing platforms, and the loss of cardholder
accounts impact the results of operations from period to period. Another factor,
among others, which may affect TSYS' revenues and results of operations from
time to time is the sale by a client of its business, its card portfolio or a
segment of its accounts to a party which processes cardholder accounts
internally or uses another third-party processor. Consolidation in the financial
services and retail industries could favorably or unfavorably impact TSYS'
financial condition and results of operations in the future.
Average cardholder accounts on file for the three months ended March 31,
2002 were 224.3 million, an increase of approximately 13.1% over the average of
198.3 million for the same period in 2001. Cardholder accounts on file at March
31, 2002 were 229.2 million, a 15.0% increase compared to the 199.2 million
accounts on file at March 31, 2001. The change in cardholder accounts on file
from March 2001 to March 2002 included the deconversion and purging of 22.5
million accounts, the addition of approximately 29.4 million accounts
attributable to the internal growth of existing clients, and approximately 23.1
million accounts for new clients.
The Company provides services to its clients including processing
commercial, retail and consumer cards. Consumer cards include Visa and
MasterCard credit and debit cards as well as American Express and stored value
cards. Retail cards include private label and gift cards. Commercial cards
include purchasing cards, corporate cards and fleet cards for employees. The
following table summarizes TSYS' accounts on file by portfolio type:
- 17 -
Results of Operations (continued)
Accounts on File Types
(in millions) March 31, 2002 March 31, 2001 % Change
- ----------------------- --------------- ---------------- ---------------
Consumer 126,770,696 98,998,811 28.1
Retail 83,859,957 85,048,907 (1.4)
Commercial 18,520,124 15,176,250 22.0
- ----------------------- --------------- ----------------
Total 229,150,777 199,223,968 15.0
=============== ================
TSYS expects to expand its position in the consumer card, retail card and
commercial card arenas. The Company's future growth in the consumer card arena
is dependent upon increased card activity, new clients, international expansion
and continued internal growth of clients' portfolios.
TSYS is positioned as a major third-party processor of retail cards.
Traditional retail card operations are beginning to increase the activity of
their portfolios by converting inactive accounts to Visa/MasterCard consumer
cards. TSYS is able to provide its extensive bankcard processing tools and
techniques, as well as value-added functionality, to traditional retail card
operations allowing better segmentation and potentially increased profitability
for clients. TSYS does not receive as much revenue from retail clients, on a per
account basis, as it does for a consumer card because consumer cards
traditionally generate more transactions. Retail cards are generally limited to
a particular location or retail chain. Consumer cards are widely accepted at
various retail outlets.
TSYS' major retail client converted approximately 8 million accounts of its
portfolio from traditional retail accounts to consumer accounts since March
2001. The same retail client has purged approximately 8 million inactive retail
accounts on file.
In January 2002, TSYS announced the signing of a multiyear agreement to
process 13 million Fashion Bug private-label card accounts for Charming Shoppes,
Inc., one of the leading specialty apparel retailers in America.
TSYS has a dominant market share position in the domestic Visa and
MasterCard commercial card processing arena. Future growth in this area is
dependent upon increased card activity with more purchasing by businesses being
transacted electronically and additional firms realizing the benefits of
converting their paper-based purchasing systems to electronic transactions.
TSYS provides processing services to its clients worldwide. TSYS plans to
continue to expand its service offerings to other countries in the future. The
following table summarizes TSYS' accounts on file by area:
Accounts on File by Area
(in millions) March 31, 2002 March 31, 2001 % Change
- -------------------------- ---------------- ----------------- ------------
Domestic 201,107,032 181,917,464 10.5
Foreign 28,043,745 17,306,504 62.0
- -------------------------- ---------------- -----------------
Total 229,150,777 199,223,968 15.0
================ =================
In 2000, the Company announced the signing of The Royal Bank of Scotland
Group plc (RBS) and Allied Irish Banks plc (AIB) to multiyear processing
agreements. The portfolios of both clients
- 18 -
Results of Operations (continued)
were fully converted by the middle of the third quarter of 2001. With the
completed conversions of RBS and AIB, TSYS became the leading third-party
international processor.
The Company's electronic payment processing service revenues are also
impacted by the use of value added products and services of TSYS' processing
systems by clients. Value added products and services are optional features each
client can choose to subscribe to in order to increase the financial performance
of its portfolio. Value added products and services include: risk management
tools and techniques, such as credit evaluation, fraud detection and prevention,
and behavior analysis tools; and revenue enhancement tools, such as loyalty
programs and bonus rewards. For the three months ended March 31, 2002 and 2001,
value added products and services represented 11.6% and 11.8%, or $26.0 million
and $25.5 million, of total revenues, respectively. Revenues from value added
products and services were up 1.6%, or $406,000, for the three months ended
March 31, 2002, compared to the same period in 2001. In 2001, the Company
changed its accounting policy for recognizing revenue for one of the value added
products and services it offers clients. The Company was recognizing revenue one
month in arrears. Due to historical data the Company has accumulated over a set
amount of time, the Company determined that it now can estimate its current
monthly revenue with some precision. During the three months ended March 31,
2001, the Company recognized, as a result of the change, four months of revenue,
or an additional $1.4 million, for this one value added product and service.
A significant amount of the Company's revenues is derived from long-term
contracts with large customers, including certain major customers. For the three
months ended March 31, 2002, the Company had two major customers. The two major
customers for the quarter ended March 31, 2002 accounted for approximately
34.5%, or $77.2 million, of total revenues. For the three months ended March 31,
2001, TSYS had two major customers that accounted for 37.2%, or $80.2 million,
of total revenues. The loss of one of the Company's major customers, or other
significant customers, could have a material adverse effect on the Company's
financial condition and results of operations.
In October 2001, the Company announced it had signed a 10-year extension to
its long-term credit card processing agreement with one of its major customers,
Providian Financial Corporation, which included a cash payment for processing
rights of $12.7 million.
In late 2001 and in 2002, Providian made several announcements regarding
concerns about its financial status, related changes in management and the sale
of a portion of its portfolio. As a result of these announcements, TSYS
management is actively monitoring Providian's status through frequent
interaction.
The Company experienced a drop in transaction and authorization volumes on
September 11, 2001 and the following weeks as a result of the terrorist attacks.
In the ensuing weeks, those processing volumes returned to normal levels as
consumers resumed their daily activities. TSYS did not experience any material
financial impact as a result of the September 11th attacks. TSYS continues to
experience a delay by potential clients with regards to pursuing processing
agreements as those clients continue to focus on matters such as disaster
recovery and other internal processes.
- 19 -
Results of Operations (continued)
In April 2002, the Company announced that it had entered into a five-year
agreement with Accenture valued in excess of $120 million to process
postsecondary student grant and loan funding for the U.S. Department of
Education. TSYS began processing all new originations for theDepartment of
Education on April 26, 2002. The agreement also involves converting all existing
student records currently residing on two legacy systems to TSYS' new
stand-alone platform during several phases. The first conversion phase is
scheduled to begin in December 2002, with an estimated 4 million records.
Revenues from other services consist primarily of revenues generated by
TSYS' wholly owned subsidiaries. Revenues from other services increased $3.8
million, or 16.1%, in the first quarter of 2002, compared to the first quarter
of 2001. The majority of the increase in revenues is the result of the
acquisition of TSYS Total Debt Management, Inc. (TDM) from Synovus Financial
Corp. on January 1, 2002. TDM provides recovery collections work, bankruptcy
process management, legal account management and skip tracing. Because the
acquisition of TDM was a transaction between entities under common control, the
Company is reflecting the acquisition at historical cost in accordance with SFAS
141 and is reflecting the results of operations of TDM in the Company's
financial statements beginning January 1, 2002. The Company does not plan to
restate periods prior to 2002 because such restatement would not material.
For the first quarter of 2002, TDM's revenues were approximately $5.2
million. Other services revenues related to call center and business process
management were down for the first quarter of 2002 compared to the same period
last year. During the second quarter of 2001, a client stopped outsourcing
certain functions as a result of the client's need to reduce expenses. As a
result, other service revenues were negatively impacted.
As a result of the Financial Accounting Standards Board's (FASB's) Emerging
Issues Task Force 01-14 (EITF 01-14), formerly known as Staff Announcement Topic
D-103, "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenue. Historically, TSYS has not
reflected such reimbursements in its consolidated statements of income. The
largest reimbursement expenses for which TSYS is reimbursed by clients, are
postage and express courier charges. Reimbursable items decreased $5.6 million,
or 8.9%, for the first quarter of 2002, as compared to the same period last
year. The decrease is the result of certain clients decreasing mailing
activities, such as the reissuance of cards and the loss of certain clients. The
vast majority of the reimbursable items relate to the Company's domestic based
clients.
Operating Expenses
Total expenses increased 1.1% for the three months ended March 31, 2002,
compared to the same period in 2001. Excluding reimbursable items, total
expenses increased 6.1% for the three months ended March 31, 2002, compared to
the same period in 2001. The increases in operating expenses are attributable to
increases in a majority of expense categories as described below.
Employment expenses increased $4.5 million, or 7.4%, for the three months
ended March 31, 2002, compared to the same period in 2001. The addition of
employees associated with the acquisition of TDM increased employment expenses
$3.2 million in 2002. The remaining change in employment expenses is associated
with the growth in the number of employees, normal salary
- 20 -
Results of Operations (continued)
increases and related benefits. The average number of employees in the first
quarter of 2002 increased to 5,168, a 9.0% increase over 4,741 in the same
period of 2001. At April 30, 2002, TSYS had 5,086 full-time and 254 part-time
employees.
Net occupancy and equipment expense increased $2.6 million, or 6.3%, for
the three months ended March 31, 2002, over the same period in 2001. Computer
equipment and software rentals, which represent the largest component of net
occupancy and equipment expense, increased approximately $600,000 in the first
quarter of 2002, compared to the same period of 2001. Due to rapidly changing
technology in computer equipment, TSYS' equipment needs are achieved to a large
extent through operating leases.
During 2000, the Company established a data processing center in Europe and
purchased a building to house client services personnel. Although it only began
processing accounts for its new European clients in mid-2001, the Company had to
build the necessary infrastructure in order to begin processing those accounts
in 2001. Through the first three months of 2001, the Company incurred $5.9
million of net operating expense related to the expansion in Europe.
Other operating expenses for the first three months of 2002 increased
$498,000, or 2.3%, compared to the same period in 2001. The Company's concerted
efforts on cost controls, specifically a decrease in the amortization of client
conversion costs and a reduction in processing errors helped offset increases in
travel and amortization of client incentives.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $4.5 million
and $3.2 million for the first quarters of 2002 and 2001, respectively. The
increase for the quarter is attributable mainly to Vital Processing Services
(Vital). During the first quarter of 2001, Vital incurred additional processing
expenses related to the merchant terminal business it acquired in 2000.
In 1993, the Company reached an agreement to form a joint venture with a
number of Mexican banks and recorded, and continues to record, its 49% ownership
in the joint venture using the equity method of accounting. The operation, Total
System Services de Mexico, S.A. de C.V. (TSYS de Mexico), provided credit card
related processing for the joint venture member banks and others. Recently,
several joint venture participants and/or clients have consolidated. This
consolidation has resulted in TSYS de Mexico having joint venture participants
that are not also processing clients of the joint venture. In order to address
this issue, during 2001, the Company and its TSYS de Mexico joint venture
participants agreed to separate the bankcard processing services that TSYS de
Mexico previously outsourced to the Company from the primary services provided
directly by the joint venture to its clients. The joint venture will continue to
print statements and provide card-issuing services to the joint venture clients.
As a result, new processing agreements were negotiated between the Mexican bank
clients of the joint venture and the Company.
The joint venture will continue to share the profits among the joint
venture participants from the services which the joint venture continues to
provide. TSYS' ownership percentage continues to be 49% of the joint venture,
and TSYS uses the equity method of accounting because it does not control the
operations of the joint venture. The Company has executed contracts with banks
that represent approximately 98% of its account-on-file base in Mexico. The net
effect of the restructuring
- 21 -
Results of Operations (continued)
will be minimal and is resulting in a decrease in equity in income of joint
ventures while TSYS' electronic payment processing revenues increase. During the
three months ended March 31, 2002, the Company's equity in income of joint
ventures related to TSYS de Mexico was $253,000, a 59.1%decrease, or $367,000,
compared to $620,000 for the same period last year. Electronic payment
processing revenues from clients based in Mexico was $6.0 million for the three
months ended March 31, 2002, a 66.1% increase over the $3.6 million for the
three months ended March 31, 2001. The increase in revenues is attributable to
the restructuring of the joint venture agreement and increased account on file
growth. There remains uncertainty in the Mexican economy which management
continues to monitor.
As a result of the restructuring of its joint agreement, TSYS agreed to pay
TSYS de Mexico a management fee for certain client relationship services that
TSYS de Mexico has assumed from TSYS. TSYS paid TSYS de Mexico a management fee
of $222,300 for the three months ended March 31, 2002.
Nonoperating Income
Interest income, net, includes interest income of $369,000 and $6,000 of
interest expense for the first quarter of 2002. During the first quarter of
2001, interest income, net, included interest income of $1.0 million and no
interest expense. The decrease in interest income for the three months ending
March 31, 2002, as compared to the same period in 2001, was primarily the result
of lower short-term interest rates and lower levels of cash available for
investment.
Operating Income
Operating income increased 22.4% for the three months ended March 31, 2002,
over the same period in 2001. The increase in operating income was the result of
the Company's commitment to contain the growth in operating expenses below the
growth rate in revenues.
The Company's operating profit margin for the first quarter of 2002 was
17.8%, compared to 15.1% for the same period last year. Excluding reimbursable
items, the Company's operating profit margin for the first quarter of 2002 was
23.8%, compared to 21.2% for the three months ended March 31, 2001. The
Company's focus on expense control was the main reason for the improved margin.
Income Taxes
TSYS' effective income tax rate for the first quarter of 2002 was 32.6%,
compared to 34.3% for the same period in 2001. TSYS was able to recognize
additional tax credits in 2002. The effective tax rate for the first quarter
2002 was the same as the fourth quarter of 2001. The Company expects its
effective income tax rate for 2002 to be approximately 33%.
Net Income
Net income for the three months ended March 31, 2002 increased 22.3% to
$26.9 million, or basic and diluted earnings per share of $.14, compared to
$22.0 million, or basic and diluted earnings per share of $.11, for the same
period in 2001. The Company's net profit margin for the first quarter of 2002
was 12.0%, compared to 10.2% for the same period last year. Excluding
reimbursable items, the Company's net profit margin for the first quarter of
2002 was 16.1%, compared to 14.4% for the three months ended March 31, 2001.
- 22 -
Results of Operations (continued)
Projected Outlook for 2002
TSYS expects an increase in net income for 2002 over 2001 of 20%. This
anticipated increase in net income is based in part upon the following
assumptions: a 10-12% internal growth rate for existing portfolios; an
aggressive focus on expense control and productivity improvement; the successful
implementation and market acceptance of new product offerings; and an increase
in the total cardholder base to approximately 245 million accounts. Factors that
could prevent TSYS from achieving this objective include the merger of TSYS
clients with entities that are not TSYS clients or the sale of portfolios by
TSYS clients to entities that are not TSYS clients, adverse developments with
respect to existing and prospective clients, including, but not limited to,
TSYS' sub-prime clients, TSYS' inability to control expenses and uncertain
economic conditions.
Extended Financial Outlook for 2003
With the continued expansion of the Company's businesses, both domestically
and internationally, market acceptance of new products and services and
aggressive expense management, TSYS expects to increase its annual net income by
at least 20-25% in 2003 as compared to 2002. TSYS' strategic plan has identified
growth strategies that are expected to enable the Company to achieve the
following 2003 financial goals: 300 million cardholder accounts on file; $1
billion in total revenues; and 20% of total revenues derived from international
sources. Factors that could prevent TSYS from achieving this objective include
delays in the decision-making process of prospective clients, failure to sign
prospective clients, the merger of TSYS clients with entities that are not TSYS
clients or the sale of portfolios by TSYS clients to entities that are not TSYS
clients, adverse developments with respect to existing and prospective clients,
including, but not limited to, TSYS' sub-prime clients, TSYS' inability to
control expenses and uncertain economic conditions.
Liquidity and Capital Resources
The Consolidated Statements of Cash Flows detail the Company's cash flows
from operating, investing and financing activities. TSYS' primary method of
funding its operations and growth has been cash generated from current
operations and the occasional use of borrowed funds to supplement financing of
capital expenditures. TSYS' net cash provided by operating activities for the
first quarter of 2002 was $50.9 million, compared to a use by operating
activities of $716,000 in 2001. The decline in 2001 in net cash provided by
operating activities was the result of paying a software obligation that arose
in December 2000 and cash commitments with expanding in Europe without the
benefit of any processing revenue. The major uses of cash generated from
operations have been the internal development and purchase of computer software,
the addition of property and equipment, investment in contract acquisition
costs, and the payment of cash dividends.
During the first quarter of 2002, TSYS purchased property and equipment of
$2.8 million, compared to $6.1 million during the same period last year.
Expenditures for purchased computer software were $5.6 million for the first
three months of 2002, compared to $14.0 million for the same period in 2001.
Additions to capitalized software development costs, including enhancements to
and development of TS2 processing systems, were $10.1 million for the period
ending March 31, 2002, compared to $3.1 million for the same period in 2001.
Due to the complexity of the differences between the English language and
Asian languages, computer systems require two bytes to store an Asian character
compared to one byte in the English language. With the opening of a branch
office in Japan to facilitate its marketing of card processing
- 23 -
Liquidity and Capital Resources (continued)
services, TSYS began modifying its current TS2 system to be able to accommodate
language and currency differences with Asia, commonly referred to as the "double
byte project." During the first three months of 2002, the Company capitalized
$2.3 million. The Company expects to complete the base program by the end of the
second quarter of 2002.
The Company is developing a new commercial card system, which is built upon
the architectural design of TS2. The new system will provide enhanced reporting,
increased purchasing controls and flexible billing options. The Company
capitalized approximately $1.1 million for the first three months of 2002
related to this new processing platform. The Company expects to complete the
system and make it available for general use by the fourth quarter of 2002.
The Company is also developing additional systems, primarily its Integrated
Payments Platform and a business process workflow solution. The Integrated
Payments Platform supports the online and offline debit and stored value
markets, giving clients access to all national and regional networks, EBT
programs, ATM driving and switching services for online debit processing. The
business process workflow solution is a front-end system that increases workflow
process efficiency. The Company capitalized approximately $6.7 million for the
three months ended March 31, 2002 on these additional systems.
During the first three months of 2002, the Company made investments in
contract acquisition costs of $9.2 million compared to $4.5 million for the
first three months of 2001. These amounts include cash payments for processing
rights, third-party development costs and other direct salary related costs
incurred in connection with converting new customers to the Company's processing
systems. Included in the $9.2 million investment for contract acquisition costs
for the first quarter of 2002 are cash payments to clients for processing rights
of $6.5 million.
At March 31, 2002, the Company has guaranteed a loan of Columbus Bank and
Trust Company. As of March 31, 2002, all payments on the loan have been made
timely. The remaining balance at March 31, 2002 was $7.0 million. In April 2002,
the remaining balance of the loan to CB&T was repaid.
Dividends on common stock of $2.9 million were paid in the first quarter of
2002. On April 18, 2002, the Company announced a 16.7% increase in its quarterly
dividend from $0.0150 to $0.0175 per share. On February 26, 2001, the Company
announced a 20% increase in its quarterly cash dividend from $0.0125 to $0.0150
per share.
In 1997, the Company entered into an operating lease agreement relating to
the corporate campus. The lease provides for a substantial residual value
guarantee, up to $81.4 million, and includes purchase options at the original
cost of the property. Real estate taxes, insurance, maintenance and operating
expenses applicable to the leased property are obligations of the Company. The
campus lease expires November 2002. The Company has the option to either renew
the lease subject to prevailing market rates or purchase the property at its
original. The Company is currently evaluating which option to pursue.
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Liquidity and Capital Resources (continued)
In July 2000, TSYS broke ground on a 32,000 square foot childcare facility
which is located on the northeast corner of the campus. The new facility offers
the Company's employees an alternative option for childcare needs. The facility
was completed at a cost of approximately $3.5 million and opened in August 2001.
The Company will be able to recoup its building costs through current and future
state tax credits from the state of Georgia for setting up a company-sponsored
childcare facility.
In March 2001, the Company announced plans to move its printing subsidiary,
Columbus Productions, Inc. (CPI), and its materials management division into a
new building in east Columbus. The 61,000 square-foot building was completed in
August 2001 at a cost of approximately $3.7 million. In conjunction with the
move, CPI sold its existing location for $960,000. While waiting on construction
of the new building to be completed, CPI was leasing the existing facility from
the new owner.
In September 1999, Synovus Financial Corp. (Synovus) completed the
acquisition of the debt collection and bankruptcy management business offered by
Wallace & de Mayo. The services provided by Wallace & de Mayo include recovery
collections work, bankruptcy process management, legal account management and
skip tracing. These services were being marketed under the name TSYS Total Debt
Management, Inc. (TDM) through the Company for which Synovus paid TSYS a
management fee of $374,000 for the three months ended March 31, 2001.
Effective January 1, 2002, TSYS acquired TDM in exchange for 2,175,000
newly issued shares of TSYS common stock with a market value of $43.5 million.
TDM will now operate as a wholly owned subsidiary of TSYS. This transaction
increased CB&T's ownership of TSYS to 81.1% in 2002.
In May 2000, Synovus completed the acquisition of ProCard, Inc. (ProCard),
a leading provider of software and Internet tools designed to assist
organizations with the management of purchasing, travel and fleet card programs.
ProCard's software solutions have been integrated into TSYS' processing
solutions and offer TSYS the opportunity to further expand its services to
ProCard's clients. The Company assists in managing ProCard, for which the
Company was paid a management fee of $85,000 by Synovus for the three months
ended March 31, 2002, compared to $76,000 for the same period last year.
TSYS operates internationally and is subject to potentially adverse
movements in foreign currency rate changes. Since December 2000, TSYS has not
entered into foreign exchange forward contracts to reduce its exposure to
foreign currency rate changes. The Company has determined that, once it begins
processing for additional European clients, it may explore potential hedging
instruments to safeguard it from significant currency translation risks.
Although the impact of inflation on its operations cannot be precisely
determined, the Company believes that by controlling its operating expenses and
by taking advantage of more efficient computer hardware and software, it can
minimize the impact of inflation.
- 25 -
Liquidity and Capital Resources (continued)
TSYS may seek additional external sources of capital in the future. The
form of any such financing will vary depending upon prevailing market and other
conditions and may include short-term or long-term borrowings from financial
institutions or the issuance of additional equity and/or debt securities such as
industrial revenue bonds. However, there can be no assurance that funds will be
available on terms acceptable to TSYS. Management expects that TSYS will
continue to be able to fund a significant portion of its capital expenditure
needs through internally generated cash in the future, as evidenced by TSYS'
current ratio of 2.3:1. At March 31, 2002, TSYS had working capital of $130.6
million compared to $108.4 million at December 31, 2001.
Recent Accounting Pronouncements
In July 2001, the FASB issued Statement No. 141 (SFAS 141), "Business
Combinations," and Statement No. 142 (SFAS 142), "Goodwill and Other Intangible
Assets." SFAS 141 requires that the purchase method of accounting be used for
all business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. SFAS 141 also
specifies criteria that intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill, noting
that any purchase price allocable to an assembled workforce may not be accounted
for separately. The Company adopted the provisions of SFAS 141 July 1, 2002, the
effect of which was not significant.
SFAS 142 requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 also requires
that intangible assets with estimable useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." The Company adopted SFAS 142 January 1,
2002.
At March 31, 2002, the Company has unamortized goodwill in the amount of
$3.6 million. As a result of implementing SFAS 142, the Company incurred no
amortization expense of goodwill during the three months ended March 31, 2002.
Amortization expense related to goodwill was $215,000 for the three months ended
March 31, 2001. The Company is in the process of completing its transitional
impairment analysis on goodwill and does not anticipate having any transitional
impairment losses.
In October 2001, the FASB issued Statement No. 144 (SFAS 144), "Accounting
for the Impairment or Disposal of Long-Lived Assets." SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 supersedes FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and the accounting and reporting provisions of APB Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions", for the disposal of a segment of a business (as previously
defined in that Opinion). This Statement also amends Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to eliminate the exception
to consolidation for a subsidiary for which control is likely to be temporary.
- 26 -
Recent Accounting Pronouncements (continued)
SFAS 144 improves financial reporting by requiring that one accounting
model be used for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and by broadening the presentation
of discontinued operations to include more disposal transactions.
The Company adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144
did not have a material effect on the Company's financial condition or results
of operations.
Forward-Looking Statements
Certain statements contained in this filing which are not statements of
historical fact constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act (the Act). These forward-looking
statements include, among others, statements regarding TSYS' expected expansion
of its position in the consumer card, retail card and commercial card arenas,
expected growth in net income for 2002 over 2001, the expected increase in net
income for 2003, TSYS' expected expenditures on and timeframes for completing
its double byte project or other development projects, the expected impact of
recent accounting pronouncements on TSYS and the assumptions underlying such
statements, including, with respect to TSYS' expected increase in net income;
TSYS' expected internal growth rate for existing portfolios; an aggressive focus
on expense control and productivity improvement; the successful implementation
and market acceptance of new product offerings; expected increases in the number
of accounts on file; expected increases in revenues; and expected increases in
revenues attributable to international clients. In addition, certain statements
in future filings by TSYS with the Securities and Exchange Commission, in press
releases, and in oral and written statements made by or with the approval of
TSYS which are not statements of historical fact constitute forward-looking
statements within the meaning of the Act. Examples of forward-looking statements
include, but are not limited to: (i) projections of revenue, income or loss,
earnings or loss per share, the payment or nonpayment of dividends, capital
structure and other financial items; (ii) statements of plans and objectives of
TSYS or its management or Board of Directors, including those relating to
products or services; (iii) statements of future economic performance; and (iv)
statements of assumptions underlying such statements. Words such as "believes,"
"anticipates," "expects," "intends," "targeted," and similar expressions are
intended to identify forward-looking statements but are not the exclusive means
of identifying such statements.
Prospective investors are cautioned that any such forward-looking
statements are not guarantees of future performance and involve risks and
uncertainties, and that actual results may differ materially from those
contemplated by such forward-looking statements. A number of important factors
could cause actual results to differ materially from those contemplated by the
forward-looking statements in this filing. Many of these factors are beyond
TSYS' ability to control or predict. The factors include, but are not limited
to: (i) adverse developments with respect to TSYS' sub-prime clients; (ii) lower
than anticipated internal growth rates for TSYS' existing customers; (iii) TSYS'
inability to control expenses and increase market share; (iv) TSYS' inability to
successfully bring new products to market, including, but not limited to stored
value products, e-commerce products, loan processing products and other
processing services; (v) the inability of TSYS to grow its business through
acquisitions; (vi) TSYS' inability to increase the revenues derived from
international sources; (vii) adverse developments with respect to entering into
contracts with new clients and retaining current clients; (viii) the merger of
TSYS clients with entities that are not TSYS clients or the sale of portfolios
by TSYS clients to entities that are not TSYS clients; (ix) TSYS' inability to
anticipate and respond to technological changes, particularly with respect to
e-commerce; (x) adverse
- 27 -
Forward-Looking Statements (continued)
developments with respect to the successful conversion of clients; (xi) the
absence of significant changes in foreign exchange spreads between the United
States and the countries TSYS transacts business in, to include Mexico, United
Kingdom, Japan, Canada and the European Union; (xii) changes in consumer
spending, borrowing and saving habits, including a shift from credit to debit
cards; (xiii) changes in laws, regulations, credit card association rules or
other industry standards affecting TSYS' business which require significant
product redevelopment efforts; (xiv) the effect of changes in accounting
policies and practices as may be adopted by the Financial Accounting Standards
Board or the Securities and Exchange Commission; (xv) the costs and effects of
litigation; (xvi) adverse developments with respect to the credit card industry
in general; (xvii) TSYS' inability to successfully manage any impact from
slowing economic conditions or consumer spending; (xviii) the occurrence of
catastrophic events that would impact TSYS' or its major customers' operating
facilities, communications systems and technology, or that has a material
negative impact on current economic conditions or levels of consumer spending;
(xix) successfully managing the potential both for patent protection and patent
liability in the context of rapidly developing legal framework for expansive
software patent protection; and (xx) overall market conditions.
Such forward-looking statements speak only as of the date on which such
statements are made, and TSYS undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made to reflect the occurrence of unanticipated events.
- 28 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
TSYS is exposed to foreign exchange risk because it has revenues and
expenses denominated in foreign currencies including the Euro, British Pound,
Mexican Peso, Canadian Dollar and Japanese Yen. These currencies are translated
into U.S. dollars at current exchange rates, except for revenues, costs and
expenses, and net income, which are translated at the average exchange rate for
each reporting period. Net exchange gains or losses resulting from the
translation of assets and liabilities of TSYS' foreign operations, net of tax,
are accumulated in a separate section of shareholders' equity titled accumulated
other comprehensive income or loss. The amount of other comprehensive loss for
the first three months ended March 31, 2002 was $1.0 million. Currently, TSYS
does not use financial instruments to hedge its exposure to exchange rate
changes.
The carrying value of the net assets of its foreign operations in Europe,
Mexico, Canada and Japan was approximately (in U.S. dollars) $76.1 million, $4.2
million, $187,000 and $6.5 million, respectively, at March 31, 2002.
Interest Rate Risk
TSYS is also exposed to interest rate risk associated with the investing of
available cash and the lease on its campus facilities. TSYS invests available
cash in conservative short-term instruments and is primarily subject to changes
in the short-term interest rates.
The payments under the operating lease arrangement of the campus facilities
are tied to the London Interbank Offered Rate. TSYS locks into interest rates
for six-month intervals. The extent that rates change in a six-month period
represents TSYS' exposure.
The lease is scheduled to expire in November 2002. However, TSYS has the
option to either renew the lease subject to prevailing market rates or to
purchase the property at the original cost of the property. As a result, TSYS
could have an interest rate risk in the future associated with a future
obligation with respect to the corporate campus.
Concentration of Credit Risk
TSYS works to maintain a large and diverse customer base across various
industries to minimize the credit risk of any one customer to TSYS' accounts
receivable amounts. In addition, TSYS performs ongoing credit evaluations of its
customers' and suppliers' financial condition. TSYS does, however, have two
major customers that account for a large portion of its revenues, which subject
it to credit risk.
In late 2001 and 2002, one of TSYS' major customers made several
announcements regarding concerns about its financial status, related changes in
management and the sale of a portion of its portfolio. As a result of the
announcements, TSYS management is actively monitoring the client's status
through frequent interaction.
- 29 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 6 - Exhibits and Reports on Form 8-K
a) Forms 8-K filed since the Form 10-K filing.
1. The report dated April 15, 2002 included the following important event:
On April 15, 2002, Total System Services, Inc. ("Registrant") issued a
press release with respect to its first quarter 2002 earnings.
2. The report dated April 30, 2002 included the following important event:
On April 30, 2002, Total System Services, Inc. ("Registrant") issued a
press release with respect to its execution of a five-year agreement
with Accenture to process post secondary student grant and loan
funding for the U.S. Department of Education.
- 30 -
TOTAL SYSTEM SERVICES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL SYSTEM SERVICES, INC.
Date: May 14, 2002 by: /s/ Richard W. Ussery
----------------------------
Richard W. Ussery
Chairman of the Board
and Chief Executive Officer
Date: May 14, 2002 by: /s/ James B. Lipham
---------------------------
James B. Lipham
Chief Financial Officer
- 31 -