UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 2004
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from To
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Commission file number 1-10254
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T|SYS| LOGO [OBJECT OMITTED]
Total System Services, Inc.
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Georgia 58-1493818
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(State or other jurisdiction of incorporation or (I.R.S. Employer
organization) Identification No.)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
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(Address of principal executive offices) (Zip Code)
(706) 649-2310
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest
CLASS OUTSTANDING AS OF: November 5, 2004
- ------------------------ -------------------------------------
Common Stock, $.10 par value 196,848,529
T|SYS LOGO [OBJECT OMITTED]
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
------
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - September 30, 2004 and
December 31,2003 3
Consolidated Statements of Income (unaudited) - Three and nine months
ended September 30, 2004 and 2003 5
Consolidated Statements of Cash Flows (unaudited) - Nine months ended
September 30, 2004 and 2003 7
Notes to Unaudited Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 42
Item 4. Controls and Procedures 44
Part II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 45
Item 6. Exhibits 46
Signatures 47
Exhibit Index 48
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(in thousands, except per share information) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $67.9 million and $80.8 million on
deposit with a related party at 2004 and 2003, respectively) $ 114,878 122,874
Restricted cash (includes $4.1 million and $7.6 million on deposit with a
related party at 2004 and 2003, respectively) 19,342 7,679
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $6.6 million and $9.8 million at 2004 and 2003, respectively 160,867 120,646
Deferred income tax assets - 401
Costs and profits in excess of billings on uncompleted contracts 7,272 -
Prepaid expenses and other current assets 26,149 22,764
--------------------------------------------
Total current assets 328,508 274,364
Property and equipment, net of accumulated depreciation and amortization of
$154.2 million and $136.9 million at 2004 and 2003, respectively 262,738 232,076
Computer software, net of accumulated amortization of $240.1 million and $202.3
million at 2004 and 2003, respectively 234,346 258,090
Contract acquisition costs, net 130,037 125,472
Equity investments 69,919 66,708
Goodwill, net 73,464 29,626
Other assets 28,985 14,900
--------------------------------------------
Total assets $ 1,127,997 1,001,236
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Balance Sheets (continued)
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(in thousands, except per share information) 2004 2003
- ---------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 22,989 17,549
Accrued salaries and employee benefits 37,142 32,562
Current portion of obligations under capital leases and software obligations 1,519 15,231
Billings in excess of costs and profit on uncompleted contracts - 17,573
Deferred income tax liabilities 22,903 -
Other current liabilities (includes $6.5 million and $4.3 million payable to
related parties at 2004 and 2003, respectively) 117,972 64,056
--------------------------------------------
Total current liabilities 202,525 146,971
Obligations under capital leases and software obligations, excluding current
portion 4,290 29,748
Deferred income tax liabilities 95,865 88,544
--------------------------------------------
Total liabilities 302,680 265,263
--------------------------------------------
Minority interest in consolidated subsidiary 3,541 3,439
--------------------------------------------
Shareholders' equity:
Common stock - $.10 par value. Authorized 600,000 shares; 197,587 and
197,504 issued at 2004 and 2003, respectively; 196,849 and 196,815
outstanding at 2004 and 2003, respectively 19,759 19,750
Additional paid-in capital 42,716 41,574
Accumulated other comprehensive income 9,649 8,314
Treasury stock (shares of 738 and 689 at 2004 and 2003, respectively) (13,573) (12,426)
Retained earnings 763,225 675,322
--------------------------------------------
Total shareholders' equity 821,776 732,534
--------------------------------------------
Total liabilities and shareholders' equity $ 1,127,997 1,001,236
============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
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Three months ended
September 30,
-------------------------------------------
(in thousands, except per share information) 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $4.7 million from related
parties for both 2004 and 2003, respectively) $ 205,410 179,447
Other services (includes $1.5 million and $1.9 million from related parties
for 2004 and 2003, respectively) 43,006 30,927
-------------------------------------------
Revenues before reimbursable items 248,416 210,374
Reimbursable items (includes $2.4 million and $2.1 million from related
parties for 2004 and 2003, respectively) 56,577 55,740
-------------------------------------------
Total revenues 304,993 266,114
-------------------------------------------
Expenses:
Salaries and other personnel expense 99,561 81,488
Net occupancy and equipment expense 58,915 51,043
Other operating expenses (includes $2.3 million to related parties for 2004
and 2003) 37,945 28,944
-------------------------------------------
Expenses before reimbursable items 196,421 161,475
Reimbursable items 56,577 55,740
-------------------------------------------
Total expenses 252,998 217,215
-------------------------------------------
Operating income 51,995 48,899
-------------------------------------------
Nonoperating income (expense):
Interest income (includes $183 and $10 from related parties for 2004 and
2003, respectively) 667 484
Interest expense (95) (36)
Gain (loss) on foreign currency translation, net 146 (246)
-------------------------------------------
Total nonoperating income 718 202
-------------------------------------------
Income before income taxes, minority interest and equity in income
of joint ventures 52,713 49,101
Income taxes 20,410 17,509
Minority interest in consolidated subsidiary's net income (80) (1)
Equity in income of joint ventures 6,918 3,921
-------------------------------------------
Net income $ 39,141 35,512
===========================================
Basic earnings per share $ 0.20 0.18
===========================================
Diluted earnings per share $ 0.20 0.18
===========================================
Weighted average common shares outstanding 196,849 196,748
Increase due to assumed issuance of shares related to stock options
outstanding 361 696
-------------------------------------------
Weighted average common and common equivalent shares outstanding
197,210 197,444
===========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
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Nine months ended
September 30,
-------------------------------------------
(in thousands, except per share information) 2004 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $14.3 million and $13.7
million from related parties for 2004 and 2003, respectively) $ 581,029 524,579
Other services (includes $4.8 million and $5.2 million from related parties
for 2004 and 2003, respectively) 125,681 81,735
-------------------------------------------
Revenues before reimbursable items 706,710 606,314
Reimbursable items (includes $7.1 million and $6.8 million from related
parties for 2004 and 2003, respectively) 173,141 168,852
-------------------------------------------
Total revenues 879,851 775,166
-------------------------------------------
Expenses:
Salaries and other personnel expense 269,647 241,184
Net occupancy and equipment expense 183,457 153,035
Other operating expenses (includes $6.9 million and $6.8 million to related
parties for 2004 and 2003, respectively) 110,197 75,272
-------------------------------------------
Expenses before reimbursable items 563,301 469,491
Reimbursable items 173,141 168,852
-------------------------------------------
Total expenses 736,442 638,343
-------------------------------------------
Operating income 143,409 136,823
-------------------------------------------
Nonoperating income (expense):
Interest income (includes $500 and $495 from related parties for 2004 and
2003, respectively) 1,709 2,365
Interest expense (877) (66)
Gain on foreign currency translation, net 45 916
-------------------------------------------
Total nonoperating income 877 3,215
-------------------------------------------
Income before income taxes, minority interest and equity in income of joint
ventures 144,286 140,038
Income taxes 55,636 51,131
Minority interest in consolidated subsidiary's net income (240) (261)
Equity in income of joint ventures 19,178 12,909
-------------------------------------------
Net income $ 107,588 101,555
===========================================
Basic earnings per share $ 0.55 0.52
===========================================
Diluted earnings per share $ 0.55 0.51
===========================================
Weighted average common shares outstanding 196,846 196,832
Increase due to assumed issuance of shares related to stock options
outstanding 367 494
-------------------------------------------
Weighted average common and common equivalent shares outstanding 197,213 197,326
===========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
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Nine months ended
September 30,
------------------------------------------
(in thousands) 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 107,588 101,555
Adjustments to reconcile net income to net cash provided by operating
activities:
Minority interest in consolidated subsidiary's net income 240 261
Gain on foreign currency translation, net (45) (916)
Equity in income of joint ventures (19,178) (12,909)
Depreciation and amortization 79,517 71,057
Impairment of developed software 10,059 -
(Recoveries of) provisions for bad debt expenses and billing
adjustments (1,147) 1,892
Charges for transaction processing 5,621 3,093
Deferred income tax expense 29,590 21,248
Loss (gain) on disposal of equipment, net 384 (35)
(Increase) decrease in:
Accounts receivable (36,139) (3,950)
Costs and profits in excess of billings on uncompleted contracts (7,272) -
Prepaid expenses and other assets (4,822) (8,317)
Increase (decrease) in:
Accounts payable 6,066 3,711
Accrued salaries and employee benefits 4,584 (14,659)
Billings in excess of costs and profit on uncompleted contracts (17,573) 24,074
Other current liabilities 22,210 (16,399)
------------------------------------------
Net cash provided by operating activities 179,683 169,706
------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment, net (49,815) (113,449)
Additions to licensed computer software from vendors (19,237) (35,682)
Additions to internally developed computer software (3,996) (13,945)
Cash acquired in acquisitions 2,422 4,442
Cash used in acquisitions (53,000) (36,000)
Dividends received from joint ventures 15,876 5,278
Contract acquisition costs (22,441) (17,904)
------------------------------------------
Net cash used in investing activities (130,191) (207,260)
------------------------------------------
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 7 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
------------------------------------------
(in thousands) 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Purchases of common stock (1,188) (9,485)
Proceeds from long-term debt borrowings - 20,234
Principal payments on long-term debt - (20,234)
Principal payments on capital lease obligations and software obligations (42,321) (147)
Dividends paid on common stock (15,747) (10,828)
Proceeds from exercise of stock options 1,193 3,929
------------------------------------------
Net cash used in financing activities (58,063) (16,531)
------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 575 545
------------------------------------------
Net decrease in cash and cash equivalents $ (7,996) (53,540)
Cash and cash equivalents at beginning of year 122,874 109,171
------------------------------------------
Cash and cash equivalents at end of period $ 114,878 55,631
==========================================
Cash paid for interest $ 877 66
==========================================
Cash paid for income taxes (net of refunds) $ 17,621 42,463
==========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 8 -
TOTAL SYSTEM SERVICES, INC.
Notes to Unaudited Consolidated Financial Statements
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements represent the
accounts of Total System Services, Inc.(R)(TSYS(R) or the Company); its wholly
owned subsidiaries, Columbus Depot Equipment CompanySM (CDECSM), Columbus
Productions, Inc.SM (CPI), TSYS Canada, Inc.SM (TSYS Canada), TSYS Total Debt
Management, Inc. (TDM), ProCard, Inc. (ProCard), TSYS Japan Co., Ltd. (TSYS
Japan), Enhancement Services Corporation (ESC), TSYS Technology Center, Inc.
(TTC) and TSYS Prepaid, Inc. (TPI); 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 accounting principles generally accepted in
the United States of America. In preparing financial statements, it is necessary
for management to make assumptions and estimates affecting the amounts reported
in the consolidated financial statements and related notes. These estimates and
assumptions are developed based upon all information available. Actual results
could differ from estimated amounts. All adjustments, consisting of normal
recurring accruals, which, in the opinion of management, are necessary for a
fair presentation of financial position and results of operations for the
periods covered by this report have been included.
The accompanying unaudited consolidated financial statements should be read
in conjunction with the Company's summary of significant accounting policies,
consolidated financial statements and related notes appearing in the Company's
2003 annual report previously filed on Form 10-K. Results of interim periods are
not necessarily indicative of results to be expected for the year.
Certainreclassifications have been made to the 2003 financial statements to
conform to the presentation adopted in 2004.
Note 2 - Supplementary Balance Sheet Information
Cash and cash equivalent balances are summarized as follows:
(in thousands) September 30, 2004 December 31, 2003
------------------------------------------------------------------------------ --------------------------
Cash and cash equivalents in domestic accounts $ 68,714 80,812
Cash and cash equivalents in foreign accounts 46,164 42,062
-------------------------- --------------------------
Total $ 114,878 122,874
========================== ==========================
- 9 -
Notes to Unaudited Consolidated Financial Statements (continued)
The Company maintains accounts denominated in U.S. dollars, Euros, British
Pounds Sterling (BPS), Canadian dollars and Japanese Yen.
Significant components of prepaid expenses and other current assets are
summarized as follows:
(in thousands) September 30, 2004 December 31, 2003
------------------------------------------------------------------------------ --------------------------
Prepaid expenses $ 11,678 11,667
Supplies 5,841 3,544
Other 8,630 7,553
-------------------------- --------------------------
Total $ 26,149 22,764
========================== ==========================
Significant components of contract acquisition costs, net of
accumulated amortization, are summarized as follows:
(in thousands) September 30, 2004 December 31, 2003
------------------------------------------------------------------------------ --------------------------
Payments for processing rights, net $ 91,041 84,448
Conversion costs, net 38,996 41,024
-------------------------- --------------------------
Total $ 130,037 125,472
========================== ==========================
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $3.4 million for both the three months ended
September 30, 2004 and 2003, respectively. For the nine months ended September
30, 2004 and 2003, amortization related to payments for processing rights was
$10.2 million and $9.7 million, respectively.
Amortization related to conversion costs, which is recorded in other
operating expenses, was $2.8 million and $2.2 million for the three months ended
September 30, 2004 and 2003, respectively. For the nine months ended September
30, 2004 and 2003, amortization expense related to conversion costs was $8.3
million and $5.0 million, respectively.
Significant components of other current liabilities are summarized as
follows:
(in thousands) September 30, 2004 December 31, 2003
------------------------------------------------------------------------------ ----------------------------
Accrued expenses $ 39,701 16,879
Client liabilities 19,186 7,804
Deferred revenues 18,186 11,639
Transaction processing provisions 8,684 5,091
Dividends payable 7,874 3,936
Customer postage deposits 6,247 11,519
Other 18,094 7,188
-------------------------- ----------------------------
Total $ 117,972 64,056
========================== ============================
Note 3 - Comprehensive Income
Comprehensive income for TSYS consists of net income and foreign currency
translation adjustments recorded as a component of shareholders' equity.
- 10 -
Notes to Unaudited Consolidated Financial Statements (continued)
Comprehensive income for the three months ended September 30 is as follows:
(in thousands) 2004 2003
-------------------------------------------------------------------------------- --------------------------
Net income $ 39,141 $ 35,512
Other comprehensive income:
Foreign currency translation adjustments,
net of tax (1,227) 470
-------------------------- --------------------------
Comprehensive income $ 37,914 $ 35,982
========================== ==========================
Comprehensive income for the nine months ended September 30 is as follows:
(in thousands) 2004 2003
-------------------------------------------------------------------------------- --------------------------
Net income $ 107,588 $ 101,555
Other comprehensive income:
Foreign currency translation adjustments,
net of tax 1,335 2,093
-------------------------- --------------------------
Comprehensive income $ 108,923 $ 103,648
========================== ==========================
The income tax effects allocated to and the cumulative balance of
accumulated other comprehensive income are as follows:
Balance at December 31, Pretax Balance at
(in thousands) 2003 amount Tax effect September 30, 2004
---------------------------------------------------------------------------------------
Foreign currency translation
adjustments $8,314 2,105 (770) $9,649
=======================================================================================
Note 4 - Segment Reporting and Major Customers
The Company reports selected information about operating segments in
accordance with Statement of Financial Accounting Standards No. 131 (SFAS No.
131). The Company's segment information reflects the information that the chief
operating decision makers (CODMs) use to make resource allocation and strategic
decisions. The CODMs at TSYS consist of the chairman of the board, the chief
executive officer, the president and the three senior executive vice presidents.
In the fourth quarter of 2003, the Company revised its segment information
to reflect the information that the CODMs use to make resource allocations and
strategic decisions. The revision moved TSYS Canada from international-based
services into the domestic-based services. TSYS Canada primarily provides
programming services to TSYS.
Through online accounting and electronic payment processing systems, TSYS
provides electronic payment processing and other related services to
card-issuing institutions in the United States, Mexico, Canada, Honduras, Europe
and the Caribbean. The reportable units are segmented based upon geographic
locations. Domestic-based services include electronic payment processing
services and other services provided from the United States. Domestic-based
services segment includes the financial results of TSYS, excluding its foreign
branch offices, and including the following subsidiaries: CDEC, CPI, TSYS
Canada, TDM, ProCard, ESC, TTC and TPI. TSYS' share of the equity earnings of
its Vital Processing Services L.L.C. (Vital) joint venture is included in
domestic-based services. International-based services include electronic payment
processing and other services provided outside the United
- 11 -
Notes to Unaudited Consolidated Financial Statements (continued)
States. International-based services include the financial results of GP Net,
TSYS Japan and TSYS' branch offices in Europe and Japan. TSYS' share of the
equity earnings of its TSYS System Services de Mexico, S.A. de C.V. joint
venture is included in international-based services.
Operating Segments Domestic-based International-based Consolidated
(in thousands) services services
- ------------------------------------------------------------------------------------------------------------------------------------
At September 30, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,111,236 168,458 $ 1,279,694
Intersegment eliminations (151,697) - (151,697)
------------------------- ------------------------- ------------------------
Total assets $ 959,539 168,458 $ 1,127,997
========================= ========================= ========================
- ---------------------------------------------------------------------------- ------------------------------------------------------
At December 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 994,822 139,028 $ 1,133,850
Intersegment eliminations (132,614) - (132,614)
------------------------- ------------------------- ------------------------
Total assets $ 862,208 139,028 $ 1,001,236
========================= ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended September 30, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Segment total revenue $ 273,496 31,499 $ 304,995
Intersegment revenue (2) - (2)
------------------------- ------------------------- ------------------------
Total revenue $ 273,494 31,499 $ 304,993
========================= ========================= ========================
Depreciation and amortization $ 23,190 3,549 $ 26,739
========================= ========================= ========================
Segment operating income $ 45,328 6,667 $ 51,995
========================= ========================= ========================
Income taxes $ 16,940 3,470 $ 20,410
========================= ========================= ========================
Equity in income of joint ventures $ 6,369 549 $ 6,918
========================= ========================= ========================
Net income $ 34,126 5,015 $ 39,141
========================= ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended September 30, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Segment total revenue $ 246,191 19,925 $ 266,116
Intersegment revenue (2) - (2)
-------------------------- ------------------------- ------------------------
Total revenue $ 246,189 19,925 $ 266,114
========================== ========================= ========================
Depreciation and amortization $ 22,328 3,132 $ 25,460
========================== ========================= ========================
Segment operating income $ 47,075 1,824 $ 48,899
========================== ========================= ========================
Income taxes $ 16,630 879 $ 17,509
========================== ========================= ========================
Equity in income of joint ventures $ 3,620 301 $ 3,921
========================== ========================= ========================
Net income $ 34,619 893 $ 35,512
========================== ========================= ========================
- 12 -
Notes to Unaudited Consolidated Financial Statements (continued)
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Segment total revenue $ 796,230 83,628 $ 879,858
Intersegment revenue (7) - (7)
------------------------- ------------------------- ------------------------
Total revenue $ 796,223 83,628 $ 879,851
========================= ========================= ========================
Depreciation and amortization $ 69,950 9,567 $ 79,517
========================= ========================= ========================
Segment operating income $ 125,399 18,010 $ 143,409
========================= ========================= ========================
Income taxes $ 48,036 7,600 $ 55,636
========================= ========================= ========================
Equity in income of joint ventures $ 17,936 1,242 $ 19,178
========================= ========================= ========================
Net income $ 94,971 12,617 $ 107,588
========================= ========================= ========================
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
Segment total revenue $ 717,160 58,011 $ 775,171
Intersegment revenue (5) - (5)
--------------------------- ------------------------- ---------------------------
Total revenue $ 717,155 58,011 $ 775,166
=========================== ========================= ===========================
Depreciation and amortization $ 62,905 8,152 $ 71,057
=========================== ========================= ===========================
Segment operating income $ 129,127 7,696 $ 136,823
=========================== ========================= ===========================
Income taxes $ 48,346 2,785 $ 51,131
=========================== ========================= ===========================
Equity in income of joint ventures $ 12,112 797 $ 12,909
=========================== ========================= ===========================
Net income $ 96,657 4,898 $ 101,555
=========================== ========================= ===========================
Revenues for domestic-based services include electronic payment processing
and other services provided from the United States to clients domiciled in the
United States or other countries. Revenues from international-based services
include electronic payment processing and other services provided outside the
United States to clients domiciled mainly outside the United States.
The following geographic area data represent revenues for the three and
nine months ended September 30, 2004 and 2003, respectively, based on the
domicile of customers.
Three months ended September 30, Nine months ended September 30,
-------------------------------------------- ---------------------------------------------
(in thousands) 2004 2003 2004 2003
- ----------------------------- ---- ------------------- --------------------- -- ---------------------- --------------
United States $ 247,919 214,799 722,300 632,419
Europe 28,215 16,894 73,711 49,249
Canada* 21,395 20,052 62,354 55,181
Japan 3,447 2,992 10,302 8,724
Mexico 3,349 10,693 9,163 27,779
Other 668 684 2,021 1,814
------------------- --------------------- ---------------------- --------------
Totals $ 304,993 266,114 879,851 775,166
=================== ===================== ====================== ==============
- 13 -
Notes to Unaudited Consolidated Financial Statements (continued)
The following table reconciles geographic revenues to revenues by reporting
segment for the three months ended September 30, 2004 and 2003, respectively,
based on the domicile of customers.
Domestic-based services International-based services
---------------------------------------- -- ------------------------------------
( in thousands) 2004 2003 2004 2003
- ----------------------------- ---- ----------------- ----------------- -- ----------------- ------------------
United States $ 247,919 214,799 - -
Europe 163 - 28,052 16,894
Canada* 21,395 20,052 - -
Japan - - 3,447 2,992
Mexico 3,349 10,693 - -
Other 668 684 - -
- ----------------------------- ---- ----------------- ----------------- -- ----------------- ------------------
Totals $ 273,494 246,228 31,499 19,886
================= ================= == ================= ==================
The following table reconciles geographic revenues to revenues by reporting
segment for the nine months ended September 30, 2004 and 2003, respectively,
based on the domicile of customers.
Domestic-based services International-based services
---------------------------------------- -- ------------------------------------
( in thousands) 2004 2003 2004 2003
- ----------------------------- ---- ----------------- ----------------- -- ----------------- ------------------
United States $ 722,300 632,419 - -
Europe 385 - 73,326 49,249
Canada* 62,354 55,181 - -
Japan - - 10,302 8,724
Mexico 9,163 27,779 - -
Other 2,021 1,814 - -
- ----------------------------- ---- ----------------- ----------------- -- ----------------- ------------------
Totals $ 796,223 717,193 83,628 57,973
================= ================= == ================= ==================
* 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,
Japan and Canada. The following geographic area data represent net property and
equipment balances by region:
At September 30, At December 31,
(in millions) 2004 2003
--------------------------------------------------------------- -----------------------------
United States $ 203.2 192.7
Europe 57.6 37.2
Japan 1.7 2.0
Canada 0.2 0.2
--------------------------------------------------------------- -----------------------------
Totals $ 262.7 232.1
========================== =============================
Major Customers For the three months ended September 30, 2004, the Company
had two major customers which accounted forapproximately 25.6%, or $78.3
million, of total revenues. For the three months ended September 30, 2003, TSYS
had two major customers that accounted for 27.4%, or $72.8 million, of total
revenues. Revenues from major customers for the periods reported are
attributable to the domestic-based services segment.
- 14 -
Notes to Unaudited Consolidated Financial Statements (continued)
Three months ended September 30,
-----------------------------------------------------------------------------
2004 2003
------------------------------------- -------------------------------------
Revenue % of Total % of Total
(in millions) Dollars Revenues Dollars Revenues
--------------------------------------------------------------------------- -------------------------------------
Customer One $ 55.3 18.1 % $ 46.5 17.5 %
Customer Two 23.0 7.5 26.3 9.9
--------------------------------------------------------------------- -------------------------------
Totals $ 78.3 25.6 % $ 72.8 27.4 %
=============================== ===============================
For the nine months ended September 30, 2004, the Company had two major
customers which accounted for approximately 27.2%, or $239.3 million, of total
revenues. For the nine months ended September 30, 2003, TSYS had two major
customers that accounted for 29.1%, or $225.8 million, of total revenues.
Revenues from major customers for the periods reported are attributable to the
domestic-based services segment.
Nine months ended September 30,
-----------------------------------------------------------------------------
2004 2003
------------------------------------- -------------------------------------
Revenue % of Total % of Total
(in millions) Dollars Revenues Dollars Revenues
--------------------------------------------------------------------------- -------------------------------------
Customer One $ 162.5 18.5 % $ 142.5 18.4 %
Customer Two 76.8 8.7 83.3 10.7
--------------------------------------------------------------------- -------------------------------
Totals $ 239.3 27.2 % $ 225.8 29.1 %
=============================== ===============================
Note 5 - Stock-Based Compensation
The Company maintains stock-based compensation plans for purposes of
incenting and retaining employees. The Company accounts for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25 (APB
No. 25), "Accounting for Stock Issued to Employees," and related
Interpretations. Under APB No. 25, TSYS does not recognize compensation expense
for a stock option grant if the exercise price is equal to or greater than the
fair market value of the common stock on the grant date.
The following table illustrates the effect on net income and earnings per
share for the three months ended September 30, 2004 and 2003, respectively, if
the Company had applied the fair value recognition provisions of SFAS No. 123
(SFAS No. 123), "Accounting for Stock-Based Compensation," to stock-based
employee compensation granted in the form of TSYS and Synovus Financial Corp.
(Synovus) stock options.
- 15 -
Notes to Unaudited Consolidated Financial Statements (continued)
(in thousands, except per share data) September 30, 2004 September 30, 2003
------------------------------------------------------------------------------- ------------------------------
Net income, as reported $ 39,141 $ 35,512
Stock-based employee compensation expense
determined under the fair value based
method for all awards, net of related
income tax effects 1,357 1,238
-------------------------- ------------------------------
Net income, as adjusted $ 37,784 $ 34,274
========================== ==============================
Earnings per share:
Basic - as reported $ 0.20 $ 0.18
========================== ==============================
Basic - as adjusted $ 0.19 $ 0.17
========================== ==============================
Diluted - as reported $ 0.20 $ 0.18
========================== ==============================
Diluted - as adjusted $ 0.19 $ 0.17
========================== ==============================
The following table illustrates the effect on net income and earnings per
share for the nine months ended September 30, 2004 and 2003, respectively, if
the Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation granted in the form of TSYS and Synovus stock
options.
(in thousands, except per share data) September 30, 2004 September 30, 2003
------------------------------------------------------------------------------- ------------------------------
Net income, as reported $ 107,588 $ 101,555
Stock-based employee compensation expense
determined under the fair value based
method for all awards, net of related
income tax effects 3,857 3,679
-------------------------- ------------------------------
Net income, as adjusted $ 103,731 $ 97,876
========================== ==============================
Earnings per share:
Basic - as reported $ 0.55 $ 0.52
========================== ==============================
Basic - as adjusted $ 0.53 $ 0.50
========================== ==============================
Diluted - as reported $ 0.55 $ 0.51
========================== ==============================
Diluted - as adjusted $ 0.53 $ 0.50
========================== ==============================
Note 6 - Long-Term Debt
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
September 30, 2004 and December 31, 2003, TSYS did not have an outstanding
balance on the line of credit.
On March 31, 2004, the Company paid in full the obligations that were in
effect on December 31, 2003 related to licensed mainframe software.
- 16 -
Notes to Unaudited Consolidated Financial Statements (continued)
Note 7 - Supplementary Cash Flow Information
Cash used for contract acquisition costs for the nine months ended
September 30, 2004 and 2003 are summarized as follows:
(in thousands) September 30, 2004 September 30, 2003
------------------------------------------------------------------------------ ----------------------------
Conversion costs $ 6,441 $ 13,404
Payments for processing rights 16,000 4,500
------------------------------------------------------------------------------ ----------------------------
Total $ 22,441 $ 17,904
========================== ============================
Note 8 - Legal Proceedings
The Company has received notification from the United States Attorneys'
Office for the Northern District of California that the United States Department
of Justice is investigating whether the Company and/or one of its large credit
card processing clients violated the False Claims Act, 31 U.S.C. SS3729-33, in
connection with mailings made on behalf of the client from July 1997 through
November 2001. The subject matter of the investigation relates to the U.S.
Postal Service's Move Update Requirements. In general, the Postal Service's Move
Update Requirements are designed to reduce the volume of mail that is returned
to sender as undeliverable as addressed. In effect, these requirements provide,
among other things, various procedures that may be utilized to maintain the
accuracy of mailing lists in exchange for discounts on postal rates. The Company
has received a subpoena from the Office of the Inspector General of the U.S.
Postal Service, and has produced documents responsive to the subpoena, and
expects to provide further documentation to the government in connection with
this investigation. The Company intends to fully cooperate with the Department
of Justice in the investigation, and there can be no assurance as to the timing
or outcome of the investigation, including whether the investigation will result
in any criminal or civil fines, penalties, judgments or treble damages or other
claims against the Company. The Company is not in a position to estimate whether
or not any loss may arise out of this investigation. As a result, no reserve or
accrual has been recorded in the Company's financial statements relating to this
matter.
Note 9 - Guarantees
The Company and Visa U.S.A. (Visa) are guarantors, jointly and severally,
for the lease payments on Vital's Tempe, Arizona facility. The lease on the
facility expires in July 2007. The total future minimum lease payments remaining
at September 30, 2004 is $4.1 million. If Vital fails to perform its obligations
with regard to the lease, TSYS and Visa will be required to perform in the same
manner and to the same extent as is required by Vital.
Note 10 - Business Combinations
On August 2, 2004, TSYS completed the acquisition of Clarity Payment
Solutions, Inc. (Clarity) for $53.0 million in cash and began including
Clarity's results of operations in the consolidated statements of income. The
Company is in the process of finalizing the purchase price allocation and has
preliminarily allocated approximately $43.8 million to goodwill, approximately
$10.9 million to other intangibles and the remaining amount to the assets and
liabilities acquired. Of the $10.9 million intangibles, the Company has
allocated $8.5 million to computer software and the remaining amount to other
prepaid expenses. Clarity is a leading provider of prepaid card solutions that
utilize the Visa, MasterCard, EFT and ATM networks for Fortune 500 companies as
well as domestic and international financial institutions. TSYS will merge its
existing prepaid division with Clarity and has branded the combined entity as
TSYS Prepaid, Inc. The Company believes the acquisition of TSYS Prepaid, Inc.
- 17 -
Notes to Unaudited Consolidated Financial Statements (continued)
enhances TSYS' processing services by adding enhanced functionality and
distinct value differentiation for TSYS and its clients. TSYS Prepaid, Inc.
operates as a separate subsidiary of TSYS.
On April 28, 2003, TSYS completed the acquisition of Enhancement Services
Corporation (ESC) for $36.0 million in cash and began including ESC's results of
operations in the consolidated statements of income. The Company has allocated
approximately $26.0 million to goodwill, approximately $8.2 million to
intangibles and the remaining amount to the net assets acquired. ESC provides
targeted loyalty consulting and travel, as well as gift card and merchandise
reward programs to more than 40 national and regional financial institutions in
the United States. The Company believes the acquisition of ESC enhances TSYS'
processing services by adding distinct value differentiation for TSYS and its
clients. ESC operates as a separate subsidiary of TSYS.
Presented below are the pro forma consolidated results of operations for
the three and nine months ended September 30, 2004 and 2003, respectively, as
though the acquisition of ESC and TSYS Prepaid, Inc. had occurred on January 1,
2003.
(in thousands, except per share
data) Three months ended September 30, Nine months ended September 30,
- ------------------------------------- -- ------------------------------------------- ------------------------------------------
2004 2003 2004 2003
- ------------------------------------- -- ---------------------- -------------------- --------------------- --------------------
Revenues $ 306,288 266,840 886,723 782,283
Net income 38,764 33,783 103,966 95,033
Basic earnings per share 0.20 0.17 0.53 0.48
Diluted earnings per share 0.20 0.17 0.53 0.48
- 18 -
TOTAL SYSTEM SERVICES, INC.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Overview
Total System Services, Inc.'s (TSYS' or The Company's) revenues are derived
from providing electronic payment processing and related services to financial
and nonfinancial institutions, generally under long-term processing contracts.
TSYS' services are provided primarily through the Company's cardholder systems,
TS2 and TS1, to financial institutions and other organizations throughout the
United States, Mexico, Canada, Honduras, the Caribbean and Europe. The Company
currently offers merchant services to financial institutions and other
organizations in Japan through its majority owned subsidiary, GP Network
Corporation (GP Net). TSYS also provides back-end processing services for its
joint venture, Vital Processing Services L.L.C. (Vital), to support merchant
processing in the United States.
Due to the somewhat seasonal nature of the credit card industry, TSYS'
revenues and results of operations have generally increased in the fourth
quarter of each year because of increased transaction and authorization volumes
during the traditional holiday shopping season. Furthermore, growth or declines
in card portfolios of existing clients, the conversion of cardholder accounts of
new clients to the Company's processing platforms, and the loss of cardholder
accounts impact the results of operations from period to period. Another factor
which may affect TSYS' revenues and results of operations from time to time, is
the sale by a client of its business, its card portfolio or a segment of its
accounts to a party which processes cardholder accounts internally or uses
another third-party processor. Consolidation in either the financial services or
retail industries, a change in the economic environment in the retail sector, or
a change in the mix of payments between cash and cards could favorably or
unfavorably impact TSYS' financial position, results of operations and cash
flows in the future.
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including certain major customers. Processing
contracts with large clients, representing a significant portion of the
Company's total revenues, generally provide for discounts on certain services
based on the size and activity of clients' portfolios. Therefore, electronic
payment processing revenues and the related margins are influenced by the client
mix relative to the size of client card portfolios, as well as the number and
activity of individual cardholder accounts processed for each client.
Consolidation among financial institutions has resulted in an increasingly
concentrated client base, which results in a changing client mix toward larger
clients and increasing pressure on the Company's operating profit margins.
The Company provides services to its clients including processing consumer,
retail, commercial, debit and stored value cards, as well as student loan
account processing. Consumer cards include Visa and MasterCard credit cards as
well as American Express cards. Retail cards include private label and gift
cards. Commercial cards include purchasing cards, corporate cards and fleet
cards for employees. Government services/EBT accounts on file consist mainly of
student loan processing accounts. Debit/Stored value accounts include debit
cards and stored value cards. The tables on page 24 summarize TSYS' accounts on
file (AOF) information as of September 30, 2004 and 2003.
- 19 -
Financial Overview (continued)
Significant highlights for 2004 include:
o The Company signed a definitive agreement with JPMorgan Chase &
Co. (Chase) to service the combined card portfolios of Chase Card
Services, the second-largest card issuer in the world.
o Bank of America selected TSYS to process the 12 million accounts
recently acquired with FleetBoston.
o Payments remaining under the Company's software obligations at
December 31, 2003 were extinguished on March 31, 2004.
o Accounts on file processed on TSYS' systems increased 17.7% to
315.3 million at September 30, 2004, compared to 267.9 million at
September 30, 2003.
o TSYS' board of directors approved a doubling of the quarterly
dividend to $0.04 per share from $0.02 per share.
Consolidation among financial institutions, particularly in the area of
credit card operations continued to be the major industry development occurring
in 2003 and the first nine months of 2004. In 2003, Circuit City sold its Visa
and MasterCard portfolio to FleetBoston Financial (FleetBoston); Sears' credit
card business was sold to Citigroup, Inc.; and Bank of America announced it was
acquiring FleetBoston. In 2004, Circuit City sold its private label card
business to Bank One; and Chase and Bank One merged. The impact of the
transaction between Sears and Citigroup on the financial position, results of
operations and cash flows of TSYS cannot be determined at this time.
Financial Review
This Financial Review provides a discussion of critical accounting
policies, 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 and Estimates
The Company's financial position, results of operations and cash flows are
impacted by the accounting policies the Company has adopted. In order to gain a
full understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed.
Factors that could affect the Company's future operating results and cause
actual results to vary materially from expectations include, but are not limited
to, lower than anticipated growth from existing customers, an inability to
attract new customers and grow internationally, loss of one of the Company's
major customers or other significant clients, an inability to grow through
acquisitions or successfully integrate acquisitions, an inability to control
expenses, technology changes, financial services consolidation, change in
regulatory mandates, a decline in the use of cards as a payment mechanism, a
decline in the financial stability of the Company's clients and uncertain
economic conditions. Negative developments in these or other risk factors could
have a material adverse effect on the Company's financial position, results of
operations and cash flows.
- 20 -
Critical Accounting Policies and Estimates (continued)
The Company has prepared the accompanying consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America. In preparing financial statements, it is necessary for management to
make assumptions and estimates affecting the amounts reported in the
consolidated financial statements and related notes. These estimates and
assumptions are developed based upon all information available. Actual results
could differ from estimated amounts.
For a detailed discussion regarding the Company's critical accounting
policies and estimates, see "Item 7: Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003. There have been no material
changes to the Company's critical accounting policies, estimates and assumptions
or the judgments affecting the application of those estimates and assumptions in
2004.
Related Party Transactions
The Company provides electronic payment processing and other services to
its parent company, Synovus Financial Corp. (Synovus) and its affiliates, and
for Vital Processing Services L.L.C. (Vital). The services are performed under
contracts that are similar to its contracts with other customers. The Company
believes the terms and conditions of transactions between the Company and these
related parties are comparable to those which could have been obtained in
transactions with unaffiliated parties. The Company's margins with respect to
related party transactions are comparable to margins recognized in transactions
with unrelated third parties. The amounts related to these transactions are
disclosed on the face of TSYS' consolidated financial statements.
Lease Guarantee
To assist Vital in leasing its corporate facility, the Company and Visa
U.S.A. (Visa) are guarantors, jointly and severally, for the lease payments on
Vital's Tempe, Arizona facility. The lease on the facility expires in July 2007.
The total future minimum lease payments remaining at September 30, 2004 is $4.1
million. If Vital fails to perform its obligations with regard to the lease,
TSYS and Visa will be required to perform in the same manner and to same extent
as is required by Vital.
Line of Credit
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
September 30, 2004 and December 31, 2003, TSYS did not have an outstanding
balance on the line of credit. As the LIBOR rate changes, TSYS will be subject
to interest rate risk.
Off-Balance Sheet Arrangements
Operating Leases: As a method of funding its operations, TSYS employs
noncancelable operating leases for computer equipment, software and facilities.
These leases allow the Company to provide the latest technology while avoiding
the risk of ownership because of potential rapid technological obsolescence.
Neither the assets nor obligations related to these leases are included on the
balance sheet.
- 21 -
Results of Operations
The following table sets forth certain income statement captions as a
percentage of total revenues and the percentage increases or decreases in those
items for the three months ended September 30, 2004 and 2003:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2004 2003 2004 vs. 2003
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 67.3 % 67.4 % 14.5 %
Other services 14.1 11.6 39.1
------------ ----------
Revenues before reimbursable items 81.4 79.0 18.1
Reimbursable items 18.6 21.0 1.5
------------- ----------
Total revenues 100.0 100.0 14.6
------------- ----------
Expenses:
Salaries and other personnel expense 32.6 30.6 22.2
Net occupancy and equipment expense 19.3 19.2 15.4
Other operating expenses 12.5 10.8 31.1
------------- ----------
Expenses before reimbursable items 64.4 60.6 21.6
Reimbursable items 18.6 21.0 1.5
------------- ----------
Total expenses 83.0 81.6 16.5
------------- ----------
Operating income 17.0 18.4 6.3
Nonoperating income 0.2 0.1 nm
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 17.2 18.5 7.4
Income taxes 6.7 6.6 16.6
Minority interest in consolidated subsidiary's net (0.0) (0.1) nm
Equity in income of joint ventures 2.3 1.5 76.4
------------- ----------
Net income 12.8 % 13.3 % 10.2 %
============= ==========
nm = not meaningful
- 22 -
Results of Operations (continued)
The following table sets forth certain income statement captions as a
percentage of total revenues and the percentage increases or decreases in those
items for the nine months ended September 30, 2004 and 2003:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2004 2003 2004 vs. 2003
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 66.0 % 67.7 % 10.8 %
Other services 14.3 10.5 53.8
------------- ----------
Revenues before reimbursable items 80.3 78.2 16.6
Reimbursable items 19.7 21.8 2.5
------------- ----------
Total revenues 100.0 100.0 13.5
------------- ----------
Expenses:
Salaries and other personnel expense 30.6 31.1 11.8
Net occupancy and equipment expense 20.9 19.7 19.9
Other operating expenses 12.5 9.7 46.4
------------- ----------
Expenses before reimbursable items 64.0 60.5 20.0
Reimbursable items 19.7 21.8 2.5
------------- ----------
Total expenses 83.7 82.3 15.4
------------- ----------
Operating income 16.3 17.7 4.8
Nonoperating income 0.1 0.4 (72.7)
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 16.4 18.1 3.0
Income taxes 6.3 6.6 8.8
Minority interest in consolidated subsidiary's net (0.1) (0.1) 8.1
Equity in income of joint ventures 2.2 1.7 48.6
------------- ----------
Net income 12.2 % 13.1 % 5.9 %
============= ==========
nm = not meaningful
Revenues
Total revenues increased $38.9 million and $104.7 million, or 14.6% and
13.5%, respectively, during the three and nine months ended September 30, 2004,
compared to the same periods in 2003. The increase in revenues for the three and
nine months ended September 30, 2004 includes increases of $3.4 million and $9.2
million, respectively, related to the effects of currency translation of its
foreign-based subsidiaries and branches. Excluding reimbursable items, revenues
increased $38.0 million and $100.4 million, or 18.1% and 16.6%, respectively,
during the three and nine months ended September 30, 2004, compared to the same
periods in 2003.
- 23 -
Results of Operations (continued)
Accounts on File (AOF) Data (in millions):
AOF
2004 2003 % Change
------------- ------------ -----------------
At September 30, 315.3 267.9 17.7
QTD Average 304.9 265.9 14.7
YTD Average 289.3 259.6 11.5
AOF by Portfolio Type
<c>
September 30, 2004 September 30, 2003
---------------------------- --------------------------
AOF % AOF % % Change
----------------------------------- ------------- -------------- ------------ ------------- ----------------
Consumer 170.7 54.1 142.2 53.1 20.0
Retail 88.8 28.2 83.7 31.3 6.1
Commercial 24.9 7.9 21.0 7.8 18.7
Government services/EBT 15.7 5.0 13.1 4.9 19.8
Stored value 8.5 2.7 2.3 0.8 276.6
Debit 6.7 2.1 5.6 2.1 19.6
----------------------------------- ------------- -------------- ------------ -------------
Total 315.3 100.0 267.9 100.0 17.7
============= ============== ============ =============
AOF by Geographic Area
<c>
September 30, 2004 September 30, 2003
----------------------------- ------------------------------
AOF % AOF % % Change
---------------------------------- ----------------------------- ------------------------------ ------------------
Domestic 267.2 84.7 221.9 82.8 20.4
International 48.1 15.3 46.0 17.2 4.5
---------------------------------- ----------------------------- ------------------------------
Total 315.3 100.0 267.9 100.0 17.7
============================= ==============================
Note: The accounts on file distinction between domestic and international is
based on the geographic domicile of processing clients.
nm = not meaningful
Activity in AOF
September 2003 to September 2002 to
September 2004 September 2003
---------------------- ----------------------
Beginning balance 267.9 235.8
Internal growth of existing clients 33.0 25.1
New clients 18.9 19.8
Purges/Sales (0.6) (0.3)
Deconversions (3.9) (12.5)
---------------------- ----------------------
Ending balance 315.3 267.9
====================== ======================
International Revenues
TSYS provides services to its clients worldwide and plans to continue to
expand its service offerings internationally in the future. Total revenues from
clients domiciled outside the United States for the three months and nine months
ended September 30, 2004 and 2003, respectively, are summarized below:
- 24 -
Results of Operations (continued)
Three months ended September 30, Nine months ended September 30,
------------------------------------------------------- ---------------------------------------------
(in thousands) 2004 2003 % Change 2004 2003 % Change
----------------- ----------------- -------------- ---------------- ------------- --------------
Europe $ 28,215 16,894 67.0 73,711 49,249 49.7
Canada 21,395 20,052 6.7 62,354 55,181 13.0
Japan 3,447 2,992 15.2 10,302 8,724 18.1
Mexico 3,349 10,693 (68.7) 9,163 27,779 (67.0)
Other 668 684 (2.3) 2,021 1,814 11.4
----------------- ----------------- ---------------- -------------
Totals $ 57,074 51,315 11.2 157,551 142,747 10.4
================= ================= ================ =============
Total revenues from clients based in Mexico were $3.3 million for the three
months ended September 30, 2004, a 68.7% decrease compared to the $10.7 million
for the same period last year. Total revenues from clients based in Mexico were
$9.2 million for the nine months ended September 30, 2004, a 67.0% decrease
compared to the $27.8 million for the same period last year. During 2003, the
Company's largest client in Mexico notified TSYS that the client would be
utilizing its internal global platform and deconverted in the fourth quarter of
2003. This client represented approximately 70% of TSYS' revenues from Mexico.
Another Mexican client notified the Company of its intentions to utilize its
internal global platform and to deconvert in mid-2004. This client represented
approximately 21% of TSYS' revenues from Mexico prior to the deconversion of
TSYS' largest client in Mexico. As a result, electronic payment processing
revenues for 2004 from Mexico has decreased significantly when compared to
electronic payment processing revenues from Mexico for 2003.
Value Added Products and Services
The Company's revenues are also impacted by the use of optional value added
products and services of TSYS' processing systems. Value added products and
services are optional features to which each client can choose to subscribe in
order to potentially increase the financial performance of its portfolio. Value
added products and services include: risk management tools and techniques, such
as credit evaluation, fraud detection and prevention, and behavior analysis
tools; and revenue enhancement tools and customer retention programs, such as
loyalty programs and bonus rewards. These revenues can increase or decrease over
time as clients subscribe to or cancel these services. Value added products and
services are included mainly in electronic payment processing services revenues.
For both the three months ended September 30, 2004 and 2003, value added
products and services represented 14.0%, respectively, of total revenues.
Revenues from these products and services, which include some reimbursable items
paid to third-party vendors, increased 14.8%, or $5.5 million, for the three
months ended September 30, 2004 compared to the same period last year.
For the nine months ended September 30, 2004 and 2003, value added products
and services represented 13.5% and 14.0%, respectively, of total revenues.
Revenues from these products and services increased 9.6%, or $10.4 million, for
the nine months ended September 30, 2004 compared to the same period last year.
- 25 -
Results of Operations (continued)
Major Customers
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including certain major customers. For the three
months ended September 30, 2004, the Company had two major customers. The major
customers for the three months ended September 30, 2004 accounted for
approximately 25.6%, or $78.3 million, of total revenues. For the three months
ended September 30, 2003, TSYS had two major customers that accounted for 27.4%,
or $72.8 million, of total revenues.
For the nine months ended September 30, 2004, the Company had two major
customers. The major customers for the nine months ended September 30, 2004
accounted for approximately 27.2%, or $239.3 million, of total revenues. For the
nine months ended September 30, 2003, TSYS had two major customers that
accounted for 29.1%, or $225.8 million, of total revenues. The loss of one of
the Company's major customers, or other significant clients, could have a
material adverse effect on the Company's financial position, results of
operations and cash flows.
Electronic Payment Processing Services
Electronic payment processing revenues are generated primarily from charges
based on the number of accounts on file, transactions and authorizations
processed, statements mailed, credit bureau reports, cards embossed and mailed,
and other processing services for cardholder accounts on file. Cardholder
accounts on file include active and inactive consumer credit, retail, debit,
stored value, student loan and commercial card accounts. Due to the number of
cardholder accounts processed by TSYS and the expanding use of cards as well as
increases in the scope of services offered to clients, revenues relating to
electronic payment processing services have continued to grow. Revenues from
electronic payment processing services increased $26.0 million, or 14.5%, for
the three months ended September 30, 2004, compared to the same period in 2003.
Revenues from electronic payment processing services increased $56.5 million, or
10.8%, for the nine months ended September 30, 2004, compared to the same period
in 2003.
On March 3, 2003, the Company announced that Bank One had selected TSYS to
upgrade its credit card processing. Under the long-term software licensing and
services agreement, TSYS is to provide electronic payment processing services to
Bank One's credit card accounts for at least two years starting in 2004
(excluding statement and card production services). Following the provision of
processing services, TSYS is to license a modified version of its TS2 consumer
and commercial software to Bank One through a perpetual license with a six-year
payment term. This agreement has been superseded by the agreement with Chase
described below. The Company used the percentage-of-completion accounting method
for its agreement with Bank One and recognized revenues in proportion to costs
incurred. TSYS' revenues from Bank One were approximately 6.3% of total revenues
for the nine months ended September 30, 2004.
On January 14, 2004, Chase and Bank One announced an agreement to merge. On
January 20, 2004, Circuit City announced an agreement to sell its private-label
credit card business to Bank One. TSYS has a long-term agreement with Circuit
City Stores, Inc. (Circuit City) until April 2006. On July 1, 2004, Bank One and
Chase merged under the name of Chase.
- 26 -
Results of Operations (continued)
On October 13, 2004, TSYS finalized a definitive agreement with Chase to
service the combined card portfolios of Chase Card Services and to upgrade its
card-processing technology. The agreement extends a relationship that started
with TSYS and the former Bank One Corp. in March 2003. Pursuant to the revised
agreement, the first phase of the project was executed successfully and Bank
One's remaining accounts will be converted to the TS2 processing platform during
the fourth quarter of 2004, according to the project's original schedule. Chase
is expected to convert its consumer and commercial accounts to TS2 in the second
half of 2005, after which TSYS expects to maintain the card-processing functions
of Chase Card Services for at least two years. Chase Card Services then has the
option to migrate the portfolio in-house, under a perpetual license of TS2 with
a six-year payment term.
As a result of the revised agreement with Chase, TSYS will discontinue its
use of the percentage of completion accounting method for the original agreement
with Bank One. The revised agreement will be accounted for in accordance with
Emerging Issues Task Force (EITF) 00-21, "Accounting for Revenue Arrangements
with Multiple Deliverables", and other applicable guidance.
TSYS expects that the 2004 earnings per share (EPS) impact of the agreement
will be $0.03-$0.04, the 2005 impact will be $0.05-$0.06 and the 2006 impact
will be $0.06-$0.07. Beyond 2006, the annual EPS impact of the agreement will
depend upon Chase Card Services' decision to continue the processing agreement
or to exercise its option to license the software.
In October 2003, Circuit City announced that it had sold its Visa and
MasterCard portfolio, which includes credit card receivables and related cash
reserves, to FleetBoston. On March 31, 2004, Bank of America merged with
FleetBoston. TSYS has been informed by Bank of America that TSYS will continue
to process the Circuit City portfolio acquired by FleetBoston and that
FleetBoston will be converting its card portfolio to TSYS in March 2005.
TSYS anticipates that it will execute an amendment to its processing
agreement with Bank of America to encompass the processing of the FleetBoston
portfolio, including the Circuit City portfolio acquired by FleetBoston. The
impact of the yet unsigned amendment between the Company and Bank of America on
the financial position, results of operations and cash flows of TSYS cannot be
determined at this time.
In July 2003, Sears and Citigroup announced an agreement for the sale by
Sears to Citigroup of the Sears credit card and financial services businesses.
Sears and Citigroup are both clients of TSYS, and TSYS considers its
relationships with both companies to be very positive. TSYS and Sears are
parties to a 10-year agreement, which was renewed in January of 2000, under
which TSYS provides transaction processing for more than 84.4 million Sears
accounts. For the nine months ended September 30, 2004, TSYS' revenues from the
TSYS/Sears agreement represented 5.7% of TSYS' consolidated revenues. The
agreement includes provisions for termination for convenience prior to its
expiration upon the payment of a termination fee. The TSYS/Sears agreement also
grants to Sears the one-time right to market test TSYS' pricing and
functionality after May 1, 2004. Potential results of such market test, in which
TSYS would be a participant, include continuation of the processing agreement
under its existing terms, continuation of the processing agreement under
mutually agreed modified terms, or termination of the processing agreement after
May 1, 2006 without a termination fee. The impact of the transaction between
Sears and Citigroup on the financial position, results of operations and cash
flows of TSYS cannot be determined at this time.
- 27 -
Results of Operations (continued)
Revenues associated with ProCard are included in electronic payment
processing services. These services include providing customized, Internet,
Intranet and client/server software solutions for commercial card management
programs. Revenues from these services increased 10.5% to $6.9 million for the
three months ended September 30, 2004, compared to $6.2 million for the same
period last year. For the nine months ended September 30, 2004, revenues from
these services increased 17.2% to $20.2 million compared to $17.2 million for
the same period last year.
On August 2, 2004, TSYS completed the acquisition of Clarity Payment
Solutions, Inc. (Clarity) for $53.0 million in cash and began including
Clarity's results of operations in the consolidated statements of income. The
Company is in the process of finalizing the purchase price allocation and has
preliminarily allocated approximately $43.8 million to goodwill, approximately
$10.9 million to other intangibles and the remaining amount to the assets and
liabilities acquired. Of the $10.9 million intangibles, the Company has
allocated $8.5 million to computer software and the remaining amount to other
prepaid expenses. Clarity is a leading provider of prepaid card solutions that
utilize the Visa, MasterCard, EFT and ATM networks for Fortune 500 companies as
well as domestic and international financial institutions. TSYS will merge its
existing prepaid division with Clarity and has branded the combined entity as
TSYS Prepaid, Inc. The Company believes the acquisition of TSYS Prepaid, Inc.
enhances TSYS' processing services by adding enhanced functionality and distinct
value differentiation for TSYS and its clients. TSYS Prepaid, Inc. operates as a
separate subsidiary of TSYS. The results of TSYS Prepaid, Inc. are included in
the domestic-based segment. For the three and nine months ended September 30,
2004, TSYS' revenues include $2.8 million of TSYS Prepaid, Inc.'s revenues.
Other Services
Revenues from other services consist primarily of revenues generated by
TSYS' wholly owned subsidiaries not included in electronic payment processing
services. Revenues from other services increased $12.1 million, or 39.1%, for
the three months ended September 30, 2004, compared to the same period in 2003.
Revenues from other services increased $43.9 million, or 53.8%, for the nine
months ended September 30, 2004, compared to the same period in 2003. Other
service revenues increased primarily as a result of increased debt collection
services performed by TSYS Total Debt Management, Inc. and the revenues
associated with Enhancement Services Corporation (ESC).
On April 28, 2003, TSYS completed the acquisition of ESC for $36.0 million
in cash. ESC provides targeted loyalty consulting and travel, as well as gift
card and merchandise reward programs to more than 40 national and regional
financial institutions in the United States. The Company believes the
acquisition of ESC enhances TSYS processing services by adding distinct value
differentiation for TSYS and its clients. For the three months ended September
30, 2004, TSYS' revenues include $5.4 million related to ESC's revenues and are
included in other services, compared to $4.1 million for the same period in
2003. For the nine months ended September 30, 2004, TSYS' revenues include $14.9
million of ESC's revenues, compared to $7.2 million for the same period in 2003.
- 28 -
Results of Operations (continued)
Reimbursable Items
Reimbursable items increased $837,000, or 1.5%, for the three months ended
September 30, 2004, as compared to the same period last year. Reimbursable items
increased $4.3 million, or 2.5%, for the nine months ended September 30, 2004,
as compared to the same period last year. The majority of reimbursable items
relates to the Company's domestic-based clients and is primarily costs
associated with postage.
Operating Expenses
Total expenses increased 16.5% and 15.4% for the three and nine months
ended September 30, 2004, respectively, compared to the same periods in 2003.
The increases in expenses for the three and nine months ended September 30, 2004
includes an increase of $2.7 million and $7.3 million, respectively, related to
the effects of currency translation of its foreign-based subsidiaries and
branches. Excluding reimbursable items, total expenses increased 21.6% and 20.0%
for the three and nine months ended September 30, 2004, respectively, compared
to the same periods in 2003. The increases in operating expenses are
attributable to changes in each of the expense categories as described below.
Salaries and other personnel expenses increased $18.1 million, or 22.2%,
for the three months ended September 30, 2004 compared to the same period in
2003. For the nine months ended September 30, 2004, salaries and other personnel
expenses increased $28.5 million, or 11.8%, compared to the same period in 2003.
The change in employment expenses is associated with the normal salary increases
and related benefits, as well as lower levels of employment costs categorized as
software development and contract acquisition costs. The growth in employment
expenses included an increase in the accrual for performance-based incentive
benefits. The number of employees decreased at September 30, 2004 when compared
to September 30, 2003 as a result of the workforce reduction announced in
February 2004.
Employee Data:
(Full-time Equivalents) 2004 2003 % Change
----------------------------------- ------------- ------------ -----------------
At September 30, 5,626 5,632 (0.1)
QTD Average 5,571 5,607 (0.6)
YTD Average 5,571 5,447 2.3
During the third quarter of 2004, TSYS added 67 employees associated with
the TSYS Prepaid, Inc. acquisition. During the second quarter of 2003, TSYS
added approximately 220 employees associated with the ESC acquisition and the
creation of a wholly-owned subsidiary named TSYS Technology Center, Inc. (TTC)
in Boise, Idaho. The TTC team members support technology efforts throughout
TSYS, including government services, customer care, programming, and systems
development.
Net occupancy and equipment expense increased $7.9 million, or 15.4%, for
the three months ended September 30, 2004 over the same period in 2003. For the
nine months ended September 30, 2004, net occupancy and equipment expense
increased $30.4 million, or 19.9%, over the same period in 2003. Due to rapidly
changing technology in computer equipment, TSYS' equipment needs are met to a
large extent through operating leases. Computer equipment and software rentals,
which represent the largest component of net occupancy and equipment expense,
increased approximately $1.2 million and $4.8 million for the three and nine
months ended September 30, 2004, respectively, compared to the
- 29 -
Results of Operations (continued)
same periods in 2003. Depreciation and amortization increased $397,000 and $3.8
million during the three and nine months ended September 30, 2004, respectively,
compared to the same periods in 2003, mainly the result of increased
amortization of licensed computer software from vendors. Repairs and maintenance
expenses for software and equipment increased $5.1 million and $9.9 million for
the three and nine months ended September 30, 2004, compared to the same periods
last year.
During the second quarter of 2004, the Company decided to change its
approach for entry into the Asia-Pacific market. As a result, the Company
recognized a $10.1 million charge to net occupancy and equipment expense for the
write-off of the double-byte software development project. The $10.1 million
impairment charge is reflected in the domestic-based services segment.
Other operating expenses for the three and nine months ended September 30,
2004 increased $9.0 million and $34.9 million, or 31.1% and 46.4%, respectively,
as compared to the same periods in 2003. Other operating expenses include, among
other things, amortization of conversion costs, professional advisory fees and
court costs associated with its debt collection business. The Company's
amortization of conversion costs increased $589,000 and $3.3 million for the
three and nine months ended September 30, 2004, as compared to the same periods
last year. As a result of a new debt-collection agreement with an existing
client signed in the third quarter of 2003, the Company recognized $8.3 million
and $3.7 million of attorney court costs and commissions in operating expenses
for the three months ended September 30, 2004 and 2003, respectively. The
Company recognized $26.3 million and $3.7 million of attorney court costs and
commissions in operating expenses for the nine months ended September 30, 2004
and 2003, respectively.
Other operating expenses also include charges for processing errors,
contractual commitments and bad debt expense. As described in the Critical
Accounting Policies section in the 2003 Form 10-K, management's evaluation of
the adequacy of its transaction processing reserves and allowance for doubtful
accounts is based on a formal analysis which assesses the probability of losses
related to contractual contingencies, processing errors and uncollectible
accounts. Increases and decreases in transaction processing provisions and
charges for bad debt expense are reflected in other operating expenses. For the
three months ended September 30, 2004, the Company's transaction processing
expenses decreased $411,000, compared to the same period in 2003. For the nine
months ended September 30, 2004, the Company's transaction processing expenses
increased $2.5 million, compared to the same period in 2003.
Operating Income
Operating income remained fairly stable for the three and nine months ended
September 30, 2004, respectively, over the same periods in 2003. The Company's
operating profit margin for the three months ended September 30, 2004 was 17.0%,
compared to 18.4% for the same period last year. The Company's operating profit
margin for the nine months ended September 30, 2004 was 16.3%, compared to 17.7%
for the same period last year. The margins for 2004 decreased when compared to
the same periods in 2003 mainly as a result of the impact of the new debt
collections agreement by TDM, the impairment charge for the double-byte project,
increase in the accrual for performance-based incentive benefits and the
decrease in revenues from clients in Mexico.
- 30 -
Results of Operations (continued)
Management believes that reimbursable items distort operating profit margin
as defined by generally accepted accounting principles. Management evaluates the
Company's operating performance based upon operating margin excluding
reimbursable items. Management believes that operating profit margin excluding
reimbursable items is more useful because reimbursable items do not impact
profitability as the Company receives reimbursement for expenses incurred on
behalf of its clients. Excluding reimbursable items, the Company's operating
profit margin for the three months ended September 30, 2004 was 20.9%, compared
to 23.2% for the three months ended September 30, 2003; for the nine months
ended September 30, 2004, the Company's operating margin excluding reimbursables
was 20.3%, compared to 22.6% for the same period last year.
Below is the reconciliation between reported operating margin and adjusted
operating margin excluding reimbursable items for the three and nine months
ended September 30, 2004 and 2003, respectively:
Three months ended Nine months ended
September 30, September 30,
- ---------------------------------------------------- --- ----------------------------------- ------------------------------------
2004 2003 2004 2003
- ---------------------------------------------------- --- ----------------- ----------------- ------------------ -----------------
Operating income (a) $ 51,995 48,899 143,409 136,823
================= ================= ================== =================
Total revenues (b) $ 304,993 266,114 879,851 775,166
================= ================= ================== =================
Operating margin (as reported) (a)/(b) 17.0 % 18.4 % 16.3 % 17.7 %
================= ================= ================== =================
Revenue before reimbursable items (c) $ 248,416 210,374 706,710 606,314
================= ================= ================== =================
Adjusted operating margin (a)/(c) 20.9 % 23.2 % 20.3 % 22.6 %
================= ================= ================== =================
Nonoperating Income (Expense)
Interest income for the three months ended September 30, 2004 was $667,000,
an increase of $183,000, compared to $484,000 for the same period in 2003.
Interest income for the nine months ended September 30, 2004 was $1.7 million, a
decrease of approximately $656,000, compared to $2.4 million for the same period
in 2003. The decrease is related to less cash available to invest.
Interest expense for the three months ended September 30, 2004 was $95,000,
an increase of $59,000, compared to $36,000 for the same period in 2003.
Interest expense for the nine months ended September 30, 2004 was $877,000, an
increase of $811,000, compared to $66,000 for the same period in 2003. The
increase is the result of the interest expense related to the Company's software
obligations. On March 31, 2004, TSYS paid the remaining obligations for
mainframe software licenses. As a result, quarterly interest expense for the
remainder of 2004 will decrease as compared to the first quarter of 2004.
The Company records foreign currency translation adjustments on
foreign-denominated balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British
Pounds Sterling (BPS). As the Company translates the foreign-denominated cash
balances into US dollars, the translated cash balance is adjusted upward or
downward depending upon the foreign currency exchange movements. The upward or
downward adjustment is recorded as a gain or loss on foreign currency
translation in the Company's statements of income. As those cash accounts have
increased, the upward or downward adjustments have increased. The majority of
the translation gain of $146,000 and $45,000 for the three and nine months ended
September 30,
- 31 -
Results of Operations (continued)
2004, respectively, relates to the translation of cash accounts. The balance of
the Company's foreign-denominated cash accounts subject to risk of translation
gains or losses at September 30, 2004 was approximately $1.9 million, the
majority of which is denominated in BPS.
Income Taxes
TSYS' effective income tax rate for the three months ended September 30,
2004 was 34.6%, compared to 33.2% for the same period in 2003. TSYS' effective
income tax rate for the nine months ended September 30, 2004 was 34.4%, compared
to 33.6% for the same period in 2003. The increase in the effective income tax
rate for the nine months ended September 30, 2004, as compared to the same
period in 2003, is the result of a change in tax credits expected to be
realized. The calculation of the effective tax rate is income taxes divided by
TSYS' pretax income adjusted for minority interest in consolidated subsidiary's
net income and equity earnings of the Vital joint venture. The Company expects
its effective income tax rate for 2004 to be approximately 34%.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $6.9 million
and $3.9 million for the three months ended September 30, 2004 and 2003,
respectively. TSYS' share of income from its equity in joint ventures was $19.2
million and $12.9 million for the nine months ended September 30, 2004 and 2003,
respectively. The increase for the quarter and the first nine months is
primarily attributable to the improvement in Vital's operating results as a
result of increased volumes.
Vital Processing Services L.L.C. (Vital)
Vital, a limited liability company, is a merchant processing joint venture
of TSYS and Visa U.S.A. ("VISA"). The Company is a leader in providing
integrated end-to-end electronic transaction processing services primarily to
large financial institutions and other merchant acquirers. Vital processes all
payment forms including credit, debit, electronic benefit transfer and check
truncation for merchants of all sizes across a wide array of retail market
segments. Vital's unbundled products and services include: authorization and
capture of electronic transactions; clearing and settlement of electronic
transactions; information reporting services related to electronic transactions;
merchant billing services; and point of sale terminal sales and service. Vital's
products and services are marketed to merchant acquirers through a direct sales
force, which concentrates on developing long-term relationships with existing
and prospective clients.
The Company considers Vital to be an integral part of its overall
processing operations and an important part of its overall market strategy.
Prior to forming the joint venture, TSYS performed back-end merchant processing
services for its clients. The revenues and expenses associated with merchant
processing were included in operating profits. In the ordinary course of
business, TSYS, which still owns the merchant processing software, provides
back-end processing services to Vital. For the three months ended September 30,
2004 and 2003, TSYS generated $5.6 million and $5.3 million of revenue from
Vital, respectively. For each of the nine months ended September 30, 2004 and
2003, TSYS generated $16.6 million and $16.4 million of revenue from Vital,
respectively.
- 32 -
Results of Operations (continued)
During the three months ended September 30, 2004, the company's equity in
income of joint ventures related to Vital was $6.4 million, a 76.0% increase, or
$2.8 million, compared to $3.6 million for the same period last year. During the
nine months ended September 30, 2004, the company's equity in income of joint
ventures related to Vital was $17.9 million, a 48.1% increase, or $5.8 million,
compared to $12.1 million for the same period last year.
The following is a summary of Vital's consolidated statements of income for
the three and nine months ended September 30, 2004 and 2003:
Three months ended September 30, Nine months ended September 30,
------------------------------------------- -------------------------------------
(in thousands) 2004 2003 2004 2003
------------------ -------------- -------------- ----------------
Revenues before reimbursable items $61,761 56,398 186,241 168,847
Total revenues 69,537 63,493 210,216 188,989
Operating income 12,423 7,530 35,152 24,736
Net income* 12,563 7,618 35,540 25,101
*Vital is a limited liability company and is taxed in a manner similar
to a partnership; therefore, net income related to Vital does not
include income tax expense.
** Certain reclassifications have been made to the 2003 financial
statements of Vital to conform to the presentation adopted in 2004.
Vital provides products and services through its merchant services
offerings. The company's revenues are primarily generated from charges based on:
the number of transactions processed; the number of merchant accounts on its
systems; the number of reports provided (electronic and paper) to acquirers and
merchants; and the sale and service of point of sale terminal equipment.
Revenues generated by these activities depend upon a number of factors, such as
demand for and price of Vital's services, the technological competitiveness of
its product offerings, its reputation for providing timely and reliable service,
competition within the industry, and general economic conditions.
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 volume of transactions processed by the client.
Transaction volumes are influenced by both the number and type of merchants. The
growth or loss of merchants impacts the results of operations from period to
period. Operating results may also be significantly impacted by a customer who
sells all, or a portion of, its merchant acquiring business. Consolidation among
financial institutions has resulted in an increasingly concentrated client base,
which results in revenues being concentrated in a smaller number of customers.
Vital's revenues increased $6.0 million, or 9.5%, for the three months
ended September 30, 2004 compared to the same period in 2003. Vital's revenues
increased $21.2 million, or 11.2%, for the nine months ended September 30, 2004,
compared to the same periods in 2003. The increase in 2004, as compared to the
same period in 2003, included increases of $0.7 million and $3.8 million in
reimbursable items for the three and nine months ended September 30, 2004,
respectively. The remaining increase was primarily the result of increases in
the number of transactions processed in revenues associated with the company's
terminal deployment business.
- 33 -
Results of Operations (continued)
Vital's major expense items include salaries and other personnel expense
and cost of network and telecommunication expense. Salaries and other personnel
expense consists of the cost of personnel who develop and maintain processing
applications, operate computer networks and provide customer support; wages and
related expenses paid to sales personnel; and costs associated with non-revenue
producing customer support functions, administrative employees and management.
Other expenses consist primarily of the cost of network telecommunications
capability; transaction processing systems including depreciation and
amortization, maintenance and other system costs; third party service providers
including TSYS and VISA; and terminal equipment cost of sales. Vital has
agreements with both TSYS and VISA to provide key services related to its
business. Vital is dependent on both TSYS and VISA to perform on their
obligations under these agreements. Vital's results of operation could be
significantly impacted by material changes in the terms and conditions of the
agreements with TSYS and VISA, changes in performance standards and the
financial condition of both TSYS and VISA.
Vital, as a limited liability company, is treated similar to a partnership
for income tax purposes. As a result, no provision for current or deferred
income taxes has been made in Vital's financial statements. Vital's taxable
income or loss is reportable on the tax returns of its owners based on their
proportionate interest in Vital.
TSYS de Mexico
The Company has a joint venture with a number of Mexican banks and records
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),
prints statements and provides card-issuing support services to the joint
venture clients.
During the three months ended September 30, 2004, the Company's equity in
income of joint ventures related to TSYS de Mexico was $549,000, an 82.2%
increase, or $248,000 compared to $301,000 for the same period last year. During
nine months ended September 30, 2004, the Company's equity in income of joint
ventures related to TSYS de Mexico was $1.2 million representing a 55.8%
increase, or $445,000 compared to $797,000, for the same period last year.
TSYS pays TSYS de Mexico a processing support fee for certain client
relationship and network services that TSYS de Mexico has assumed from TSYS.
TSYS paid TSYS de Mexico a processing support fee of $45,400 and $180,500 for
the three months ended September 30, 2004 and 2003, respectively. TSYS paid TSYS
de Mexico a processing support fee of $153,800 and $560,400 for the nine months
ended September 30, 2004 and 2003, respectively. This processing support fee
decreased as a result of the deconversion of TSYS' largest client in Mexico.
Net Income
Net income for the three months ended September 30, 2004 increased 10.2% to
$39.1 million, or basic and diluted earnings per share of $0.20, compared to
$35.5 million, or basic and diluted earnings per share of $0.18, for the same
period in 2003. Net income for the nine months ended September 30, 2004
increased 5.9% to $107.6 million, or basic and diluted earnings per share of
$0.55, compared to $101.6 million, or basic earnings per share of $0.52 and
diluted earnings per share of $0.51, for the same period in 2003.
- 34 -
Results of Operations (continued)
Net Profit Margin
The Company's net profit margin for the three months ended September 30,
2004 was 12.8%, compared to 13.3% for the same period last year. The Company's
net profit margin for the nine months ended September 30, 2004 was 12.2%,
compared to 13.1% for the same period last year.
Management believes that reimbursable items distort net profit margin as
defined by generally accepted accounting principles. Management evaluates the
Company's operating performance based upon net margin excluding reimbursable
items. Management believes that net profit margin excluding reimbursable items
is more useful because reimbursable items do not impact profitability as the
Company receives reimbursement for expenses incurred on behalf of its clients.
Excluding reimbursable items, the Company's net profit margin for the three
months ended September 30, 2004 was 15.8%, compared to 16.9% for the three
months ended September 30, 2003. Excluding reimbursable items, the Company's net
profit margin for the nine months ended September 30, 2004 was 15.2%, compared
to 16.7% for the nine months ended September 30, 2003.
Below is the reconciliation between reported net profit margin and adjusted
net profit margin excluding reimbursable items for the three and nine months
ended September 30, 2004 and 2003:
Three months ended Nine months ended
September 30, September 30,
- --------------------------------------------------- --- ----------------------------------- ------------------------------------
2004 2003 2004 2003
- --------------------------------------------------- --- ----------------- ----------------- ----------------- ------------------
Net income (a) $ 39,141 35,512 107,588 101,555
================= ================= ================= ==================
Total revenues (b) $ 304,993 266,114 879,851 775,166
================= ================= ================= ==================
Net profit margin (as reported) (a)/(b) 12.8 % 13.3 % 12.2 % 13.1 %
================= ================= ================= ==================
Revenue before reimbursable items (c) $ 248,416 210,374 706,710 606,314
================= ================= ================= ==================
Adjusted net profit margin (a)/(c) 15.8 % 16.9 % 15.2 % 16.7 %
================= ================= ================= ==================
Projected Outlook for 2004 and 2005
TSYS expects its 2004 earnings per share (EPS) to exceed its 2003 EPS by
5-7% and its revenues (excluding reimbursables) to exceed its 2003 revenues by
11-13%. The forecast does not include any revenues or expenses associated with
signing and converting any new major clients and does not include the effect of
any potential changes to relationships with certain large clients.
TSYS anticipates 10-15% growth in EPS in 2005, based on the following
assumptions: revenue before reimbursable items increasing between 10-12%, driven
by 6-9% growth in revenue from existing electronic payment processing clients,
no significant client losses or additions occurring through 2005 and Vital's
earnings growing by at least 5%.
Financial Position, Liquidity and Capital Resources
The Consolidated Statements of Cash Flows detail the Company's cash flows
from operating, investing and financing activities. TSYS' primary method of
funding its operations and growth has been cash generated from current
operations and the use of leases. TSYS has occasionally used borrowed funds to
supplement financing of capital expenditures.
- 35 -
Financial Position, Liquidity and Capital Resources (continued)
Cash Flows From Operating Activities
TSYS' main source of funds is derived from operating activities,
specifically net income. During the nine months ended September 30, 2004, the
Company generated $179.7 million in cash from operating activities compared to
$169.7 million for the same period last year. The cash from operating activities
for 2004 included refunds of $13.0 million from taxing authorities for
overpayment of taxes for prior years. The cash from operating activities for
2003 included a payment from Bank One. On March 3, 2003, the Company announced
that Bank One selected TSYS to upgrade its credit card processing. As part of
that agreement, the Company received a $30 million payment from Bank One, which
was included in billings in excess of costs and profit on uncompleted contracts
on the balance sheet.
Cash Flows From Investing Activities
The major uses of cash for investing activities have been the addition of
property and equipment, the internal development and purchase of computer
software and investments in contract acquisition costs associated with the
servicing of new and existing clients. The major source of funds from investing
activities is the dividend payment from its joint ventures. The Company used
$130.2 million in cash for investing activities for the nine months ended
September 30, 2004, compared to $207.3 million for the same period in 2003.
Property and Equipment
Capital expenditures for property and equipment during the three month
periods ended September 30, 2004 and 2003 were $10.5 million and $6.1 million,
respectively. For the nine month period ended September 30, 2004, capital
expenditures for property and equipment were $49.8 million compared to $113.5
million during the same period last year. On July 30, 2003, the Company
announced the groundbreaking for a new TSYS data center in Knaresborough,
England. The facility replaces the center in Harrogate, England. On October 6,
2004, the Company announced the completion of the new data center. The Company
invested approximately (GBP)16.6 million, or approximately $30.2 million, in the
new building, land and equipment.
On April 30, 2003, the Company provided written notice that it intended to
terminate its lease agreement with a special purpose entity for the Company's
corporate campus. On September 30, 2003, the Company terminated the lease
arrangement and purchased the corporate campus for $93.5 million through a
combination of cash and long-term debt financing through a banking affiliate of
Synovus.
Licensed Computer Software from Vendors
Expenditures for licensed computer software from vendors were $5.2 million
and $15.7 million for the three months ended September 30, 2004 and 2003,
respectively. Expenditures for licensed computer software from vendors for the
nine months ended September 30, 2004 were $19.2 million, compared to $35.7
million for the same period in 2003. These additions relate to annual site
licenses for mainframe processing systems whose fees are based upon a measure of
TSYS' computer processing capacity, commonly referred to as millions of
instructions per second or MIPS.
- 36 -
Financial Position, Liquidity and Capital Resources (continued)
Software Development Costs
Additions to capitalized software development costs, including enhancements
to and development of TS2 processing systems, were $293,000 and $4.9 million for
the three month periods ended September 30, 2004 and 2003, respectively.
Additions to capitalized software development costs for the nine months ended
September 30, 2004 were $4.0 million, compared to $13.9 million for the same
period in 2003. The decline in the amount capitalized as software development
costs in 2004, as compared to 2003, is the result of several projects being
completed in 2003.
The following is a summary of the additions to software development costs
by project for the three and nine months ended September 30, 2004 and 2003,
respectively:
Three months ended Nine months ended
Software Development Projects September 30, September 30,
--------------------------- -------------------------
(in millions) 2004 2003 2004 2003
---------------------------------------------- ------------ ---------- --------- ------------
TSYS ProphIT $0.1 3.6 1.7 10.4
Other Capitalized Software Development Costs 0.2 1.3 2.3 3.5
---------------------------------------------- ------------ ---------- --------- ------------
Total $0.3 4.9 4.0 13.9
============ ========== ========= ============
The Company continues to develop TSYS ProphITSM, a Web-based process
management system that provides direct access to account information and other
system interfaces to help streamline an organization's business processes. TSYS
ProphIT is currently being offered to TSYS' processing clients with general
release of the core platform having occurred in the fourth quarter of 2003.
Continued development of TSYS ProphIT provides increased and enhanced
functionality to the core platform, to include additional customer service
functions. The Company capitalized approximately $111,000 for the three months
ended September 30, 2004, bringing the total amount capitalized for 2004 to $1.7
million on TSYS ProphIT. The Company has invested a total of $30.0 million since
the project began.
The Company is developing its Integrated Payments Platform supporting the
online and offline debit and stored value markets, which will give clients
access to all national and regional networks, EBT programs, ATM driving and
switching services for online debit processing. The Company has invested a total
of $7.3 million since the project began. The Company expects to complete the
system in phases.
Due to the complexity of the differences between the English language and
Asian languages, computer systems require two bytes to store an Asian character
compared to one byte in the English language. With the opening of a branch
office in Japan to facilitate its marketing of card processing services, TSYS
began modifying its current TS2 system to be able to accommodate language and
currency differences with Asia, commonly referred to as the "double byte
project." The Company had invested a total of $10.1 million since the project
began.
As discussed earlier, during the second quarter of 2004, the Company
decided to change its approach for entry into the Asia-Pacific market. As a
result, the Company recognized a $10.1 million impairment charge in net
occupancy and equipment expense for the write-off of the double-byte software
development project. The $10.1 million impairment charge is reflected in the
domestic-based services segment.
- 37 -
Financial Position, Liquidity and Capital Resources (continued)
Cash Used in Acquisitions
During the nine months ended September 30, 2004, the Company purchased TSYS
Prepaid, Inc. for approximately $53.0 million. During the nine months ended
September 30, 2003, the Company purchased Enhancement Services Corporation, Inc.
for approximately $36.0 million.
Dividends Received from Joint Ventures
During the nine months ended September 30, 2004, the Company received a
dividend payment of $15.0 million from its Vital joint venture, and the Company
received a dividend payment of $0.9 million from TSYS de Mexico. During the nine
months ended September 30, 2003, the Company received $5.3 million in dividend
payments from its joint ventures.
Contract Acquisition Costs
TSYS makes cash payments for processing rights, third-party development
costs and other direct salary related costs in connection with converting new
customers to the Company's processing systems. The Company's investments in
contract acquisition costs were $19.2 million for the three months ended
September 30, 2004, bringing the total for 2004 to $22.4 million, compared to
$17.9 million for the nine months ended September 30, 2003. The Company had cash
payments for processing rights of $16.0 million and $4.5 million during the nine
months ended September 30, 2004 and 2003, respectively. Conversion cost
additions were $6.4 million and $13.4 million for the nine months ended
September 30, 2004 and 2003, respectively. The decrease in the amount of
conversion cost additions for 2004, as compared to 2003, is the result of the
use of the percentage-of-completion accounting method for TSYS' agreement with
Bank One. TSYS recognizes revenues in proportion to costs incurred.
Cash Flows From Financing Activities
The major use of cash for financing activities has been the principal
payments on capital lease and software obligations, the payment of dividends and
the purchase of stock under the stock repurchase plan as described below. The
main source of cash from financing activities has been the occasional use of
borrowed funds. Net cash used in financing activities for the nine months ended
September 30, 2004 was $58.1 million mainly as a result of the payments related
to the software obligations, and to a lesser extent, the purchases of common
stock and payments of dividends. Financing activities used $16.5 million in cash
for the nine months ended September 30, 2003 primarily the result of the
purchase of common stock and dividends paid on common stock.
Software Obligations
On March 31, 2004, the Company paid in full the obligations related to
licensed mainframe software. The effective interest rates related to the
software obligations were well above current market rates.
Stock Repurchase Plan
On April 15, 2003, TSYS announced that its board had approved a stock
repurchase plan to purchase up to 2 million shares, which represents slightly
more than five percent of the shares of TSYS stock held by shareholders other
than Synovus. The shares may be purchased from time to time over the next two
years and will depend on various factors including price, market conditions,
acquisitions and the general financial position of TSYS. Repurchased shares will
be used for general corporate purposes. For the first nine months of 2004, the
Company purchased 52,200 shares at an average cost of $22.76
- 38 -
Financial Position, Liquidity and Capital Resources (continued)
per share. Since the plan was announced, the Company has purchased
577,491 shares at an average cost of $19.07 per share.
Dividends
Dividends on common stock of $7.9 million were paid during the three months
ended September 30, 2004, bringing the total for 2004 to $15.7 million. On April
15, 2004, the Company announced it would double its quarterly dividend from
$0.02 to $0.04 per share, payable on July 1, 2004.
Foreign Exchange
TSYS operates internationally and is subject to potentially adverse
movements in foreign currency exchange rates. Since December 2000, TSYS has not
entered into foreign exchange forward contracts to reduce its exposure to
foreign currency rate changes.
Impact of Inflation
Although the impact of inflation on its operations cannot be precisely
determined, the Company believes that by controlling its operating expenses, and
by taking advantage of more efficient computer hardware and software, it can
minimize the impact of inflation.
Working Capital
TSYS may seek additional external sources of capital in the future. The
form of any such financing will vary depending upon prevailing market and other
conditions and may include short-term or long-term borrowings from financial
institutions or the issuance of additional equity and/or debt securities such as
industrial revenue bonds. However, there can be no assurance that funds will be
available on terms acceptable to TSYS. Management expects that TSYS will
continue to be able to fund a significant portion of its capital expenditure
needs through internally generated cash in the future, as evidenced by TSYS'
current ratio of 1.6:1. At September 30, 2004, TSYS had working capital of
$126.0 million compared to $127.4 million at December 31, 2003.
Legal Proceedings
The Company has received notification from the United States Attorneys'
Office for the Northern District of California that the United States Department
of Justice is investigating whether the Company and/or one of its large credit
card processing clients violated the False Claims Act, 31 U.S.C. SS3729-33, in
connection with mailings made on behalf of the client from July 1997 through
November 2001. The subject matter of the investigation relates to the U.S.
Postal Service's Move Update Requirements. In general, the Postal Service's Move
Update Requirements are designed to reduce the volume of mail that is returned
to sender as undeliverable as addressed. In effect, these requirements provide,
among other things, various procedures that may be utilized to maintain the
accuracy of mailing lists in exchange for discounts on postal rates. The Company
has received a subpoena from the Office of the Inspector General of the U.S.
Postal Service, and has produced documents responsive to the subpoena, and
expects to provide further documentation to the government in connection with
this investigation. The Company intends to fully cooperate with the Department
of Justice in the investigation, and there can be no assurance as to the timing
or outcome of the investigation, including whether the investigation will result
in any criminal or civil fines, penalties, judgments or treble damages or other
claims against the Company. The Company is not in a position to estimate whether
or not any loss may arise out of this investigation. As a result, no reserve or
accrual has been recorded in the Company's financial statements relating to this
matter.
- 39 -
Recently Issued Accounting Standards
The Company's Annual Report on Form 10-K for the year ended December 31,
2003, as filed with the Securities and Exchange Commission, contains a
discussion of recently issued accounting standards and the expected impact on
our financial statements. There have been no accounting standards issued since
then that are expected to have a material impact on the financial statements of
the Company.
On March 31, 2004, the Financial Accounting Standards Board (FASB) issued
an Exposure Draft titled "Share-Based Payment, an amendment of FASB Statements
No. 123 and 95," that would be called "FAS 123r", that addresses accounting for
equity based compensation arrangements. The proposed Statement would eliminate
the ability to account for share-based compensation transactions using
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and replace some of the existing requirements under FASB No. 123,
"Accounting for Stock-Based Compensation." The proposed statement would require
that such arrangements are accounted for using a fair-value-based method of
accounting and the related cost expensed over the corresponding service period.
The issuance of a final statement in the same format as the exposure draft would
have a significant impact on the Company's results of operations. It is
anticipated that the final statement will be issued in the fourth quarter of
2004. On October 13, 2004, the FASB announced that the proposed standard would
be adopted by public companies the first fiscal quarter beginning after June 15,
2005.
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, TSYS' expected conversions of the Chase Card
Services portfolios in the fourth quarter of 2004 and the second half of 2005,
TSYS' expectation that it will maintain the card processing functions of Chase
Card Services for at least two years, the expected earnings per share impact of
the Chase Card Services agreement in 2004, 2005 and 2006, TSYS' anticipated
execution of an amendment to its processing agreement with Bank of America to
encompass the processing of the FleetBoston portfolio, TSYS' expected growth in
earnings per share and revenues for 2004, TSYS' expected growth in earnings per
share for 2005, any matter that may arise out of the United States Department of
Justice's investigation, and the assumptions underlying such statements,
including, with respect to TSYS' expected growth in earnings per share for 2005,
an increase in revenues before reimbursable items of 10-12%, a 6-9% growth in
revenues from existing electronic payment processing clients, Vital Processing
Services growing earnings by at least 5% and no significant client losses or
additions through 2005. 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.
- 40 -
Forward-Looking Statements (continued)
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) revenues are lower than anticipated; (ii) internal growth rates from
TSYS' existing customers are lower than anticipated; (iii) Vital's earnings are
lower than anticipated; (iv) TSYS does not convert the Chase Card Services
portfolios as expected; (v) TSYS does not process the Chase Card Services
portfolios for at least two years as expected; (vi) the number of active
accounts that TSYS processes for Chase Card Services is less than anticipated;
(vii) adverse developments with respect to TSYS' sub-prime or retail clients;
(viii) TSYS' inability to control expenses and increase market share; (ix) 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; (x) the inability of TSYS to grow its business
through acquisitions or successfully integrate acquisitions; (xi) TSYS'
inability to increase the revenues derived from international sources; (xii)
adverse developments with respect to entering into contracts with new clients
and retaining current clients; (xiii) 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, including the acquisition by Citigroup of the Sears
portfolio (xiv) TSYS' inability to anticipate and respond to technological
changes, particularly with respect to ecommerce; (xv) adverse developments with
respect to the successful conversion of clients; (xvi) 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; (xvii) changes in consumer spending,
borrowing and saving habits, including the mix of payments between cash and
cards; (xviii) changes in laws, regulations, credit card association rules or
other industry standards affecting TSYS' business which require significant
product redevelopment efforts; (xix) 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; (xx) the costs and effects of
litigation or adverse facts and developments relating thereto; (xxi) adverse
developments with respect to the credit card industry in general; (xxii) TSYS'
inability to successfully manage any impact from slowing economic conditions or
consumer spending; (xxiii) 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; (xxiv) successfully managing
the potential both for patent protection and patent liability in the context of
rapidly developing legal framework for expansive software patent protection;
(xxv) hostilities increase in the Middle East or elsewhere; and (xxvi) 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.
- 41 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
TSYS is exposed to foreign exchange risk because it has assets,
liabilities, revenues and expenses denominated in foreign currencies including
the Euro, British Pound, Mexican Peso, Canadian Dollar and Japanese Yen. These
currencies are translated into U.S. dollars at current exchange rates, except
for revenues, costs and expenses, and net income, which are translated at the
average exchange rates for each reporting period. Net exchange gains or losses
resulting from the translation of assets and liabilities of TSYS' foreign
operations, net of tax, are accumulated in a separate section of shareholders'
equity titled accumulated other comprehensive income or loss. The amount of
other comprehensive loss for the three months ended September 30, 2004 was $1.2
million. The amount of other comprehensive income for the three months ended
September 30, 2003 was $470,000. The amount of other comprehensive income for
the nine months ended September 30, 2004 was $1.3 million compared to $2.1
million for the nine months ended September 30, 2003. Currently, TSYS does not
use financial instruments to hedge its exposure to exchange rate changes.
The carrying value of the net assets of its foreign operations in Europe,
Mexico, Canada and Japan was approximately (in U.S. dollars) $140.2 million,
$4.2 million, $328,000 and $13.0 million, respectively, at September 30, 2004.
The Company also records foreign currency translation adjustments
associated with other balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British Pound
Sterling (BPS). As the Company translates the foreign-denominated cash balances
into US dollars, the translated cash balance is adjusted upward or downward
depending upon the foreign currency exchange movements. The upward or downward
adjustment is recorded as a gain or loss on foreign currency translation in the
Company's statements of income. As those cash accounts have increased, the
upward or downward adjustments have increased. The majority of the translation
gain of $45,000 for the nine months ended September 30, 2004 relates to the
translation of cash accounts. The balance of the foreign-denominated cash
accounts subject to risk of translation gains or losses at September 30, 2004
was approximately $1.9 million, the majority of which is denominated in BPS.
The following represents the potential effect on income before income taxes
of hypothetical shifts in the foreign currency exchange rate between the BPS and
the U.S. dollar of plus or minus 100 basis points, 500 basis points and 1,000
basis points based on the foreign-denominated cash account balance at September
30, 2004.
---------------------------------------------------------------------------------------------
Effect of Basis Point Change
---------------------------------------------------------------------------------------------
Increase in basis point of Decrease in basis point of
--------------- ----------------- ---------------- ------------ -------------- --------------
(in thousands) 100 500 1,000 100 500 1,000
- ---------------------------------- --- --------------- ----------------- ---------------- ------------ -------------- --------------
Effect on income before income
taxes $ (19) (96) (192) 19 96 192
--------------- ----------------- ---------------- ------------ -------------- --------------
The foreign currency risks associated with other currencies is not
significant.
- 42 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk (continued)
Interest Rate Risk
TSYS is also exposed to interest rate risk associated with the investing of
available cash and the use of long-term debt associated with its line of credit
as discussed below. TSYS invests available cash in conservative short-term
instruments and is primarily subject to changes in the short-term interest
rates.
In connection with the purchase of the campus, TSYS obtained a $45.0
million long-term line of credit from a banking affiliate of Synovus. The line
is an automatic draw down facility. The interest rate for the line of credit is
the London Interbank Offered Rate (LIBOR) plus 150 basis points. In addition,
there is a charge of 15 basis points on any funds unused. As the LIBOR rate
changes, TSYS will be subject to interest rate risk. At September 30, 2004, TSYS
did not have an outstanding balance on the line of credit.
Concentration of Credit Risk
TSYS works to maintain a large and diverse client base across various
industries to minimize the credit risk of any one client to TSYS' accounts
receivable amounts. In addition, TSYS performs ongoing credit evaluations of its
certain clients' and certain suppliers' financial condition. TSYS does, however,
have two major customers that account for a large portion of its revenues, which
subject it to credit risk.
- 43 -
TOTAL SYSTEM SERVICES, INC.
Item 4 -Controls and Procedures
We have evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period covered by this
quarterly report as required by Rule 13a-15 of the Securities Exchange Act of
1934, as amended. This evaluation was carried out under the supervision and with
the participation of our management, including our chief executive officer and
chief financial officer. Based on this evaluation, these officers have concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to TSYS (including its consolidated
subsidiaries) required to be included in our periodic Securities and Exchange
Commission filings. No change in TSYS' internal control over financial reporting
occurred during the period covered by this report that materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
- 44 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth information regarding the Company's
purchases of its common stock on a monthly basis during the three months ended
September 30, 2004:
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
Total Number of Shares Maximum Number of
Purchased as Part of Shares That May Yet Be
Total Number of Shares Average Price Paid per Publicly Announced Purchased Under the
Period Purchased Share Plans or Programs Plans or Programs
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
1,422,509
July 2004 - $ - - 1,422,509
August 2004 - - - 1,422,509
September 2004 - - - 1,422,509
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
Total - $ -
======================== ========================
In April 2003, the Company announced a plan to purchase up to 2.0 million
shares of its common stock from time to time and at various prices over the
ensuing two years. During the nine months ended September 30, 2004, the Company
repurchased 52,200 shares of its common stock at an average price of $22.76.
Over the course of the plan, through September 30, 2004, the Company has
repurchased 577,491 shares of its common stock at a cost of $11,013,106, or an
average cost of $19.07 per share.
- 45 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 6 - Exhibits
a) Exhibits
Exhibit Number Description
--------------------- ---------------------------------------------------------------------------
10.1 Form of Stock Option Agreement for the Total System Services, Inc. 1992
Long-Term Incentive Plan, which plan was previously filed as Exhibit 10.5
of TSYS' Annual Report on Form 10-K for the fiscal year ended December
31, 1992
10.2 Form of Stock Option Agreement for the:(i) Synovus Financial Corp. 1994
Long-Term Incentive Plan, which plan was previously filed as Exhibit 10.11
of TSYS'Annual Report on Form 10-K for the fiscal year ended December 31,
1994; (ii) Synovus Financial Corp. 2000 Long-Term Incentive Plan, which plan
was previously filed as Exhibit 10.16 of TSYS' Annual Report on Form 10-K
for the fiscal year ended December 31, 1999; and (iii) Synovus Financial
Corp. 2002 Long-Term Incentive Plan, which plan was filed as Exhibit 10.3 of
TSYS' Annual Report on Form 10-K for the fiscal year ended December 31, 2001
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
- 46 -
TOTAL SYSTEM SERVICES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL SYSTEM SERVICES, INC.
Date: November 5, 2004 by: /s/ Philip W. Tomlinson
-----------------------------
Philip W. Tomlinson
Chief Executive Officer
Date: November 5, 2004 by: /s/ James B. Lipham
-----------------------------
James B. Lipham
Chief Financial Officer
- 47 -
TOTAL SYSTEM SERVICES, INC.
Exhibit Index
Exhibit Number Description
--------------------- --------------------------------------------------------------------------
10.1 Form of Stock Option Agreement for the Total System Services, Inc. 1992
Long-Term Incentive Plan, which plan was previously filed as Exhibit
10.5 of TSYS' Annual Report on Form 10-K for the fiscal year ended
December 31, 1992
10.2 Form of Stock Option Agreement for the:(i) Synovus Financial Corp. 1994
Long-Term Incentive Plan, which plan was previously filed as Exhibit 10.11
of TSYS' Annual Report on Form 10-K for the fiscal year ended December 31,
1994; (ii) Synovus Financial Corp. 2000 Long-Term Incentive Plan, which plan
was previously filed as Exhibit 10.16 of TSYS' Annual Report on Form 10-K for
the fiscal year ended December 31, 1999; and (iii) Synovus Financial Corp.
2002 Long-Term Incentive Plan, which plan was filed as Exhibit 10.3 of TSYS'
Annual Report on Form 10-K for the fiscal year ended December 31, 2001
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
- 48 -