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: June 30, 2005
----------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from To
____________________________________________
Commission file number 1-10254
____________________________________________
TSYS LOGO (OBJECT OMITTED)
Total System Services, Inc.
www.tsys.com
(Exact name of registrant as specified in its charter)
Georgia 58-1493818
------------------------------ ------------------------------------
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation ororganization)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
(Address of principal executive offices) (Zip Code)
(706) 649-2262
----------------------------------------------------
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AS OF: August 1, 2005
- ----------------------------- ---------------------------------
Common Stock, $0.10 par value 197,202,781
TSYS LOGO (OBJECT OMITTED)
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
Part I. Financial Information --------
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - June 30, 2005 and December 31,
2004 3
Consolidated Statements of Income (unaudited) - Three and six months ended
June 30, 2005 and 2004 5
Consolidated Statements of Cash Flows (unaudited) - Six months ended June
30, 2005 and 2004 7
Notes to Unaudited Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 46
Item 4. Controls and Procedures 48
Part II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 49
Item 4. Submissions of Matters to a Vote of Security Holders 50
Item 6. Exhibits 51
Signatures 52
Exhibit Index 53
- 2 -
<Page>
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(in thousands, except per share information) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $86.2 million and $176.6 million on
deposit with a related party at 2005 and 2004, respectively) $ 143,725 231,806
Restricted cash (includes $5.3 million and $5.7 million on deposit with a
related party at 2005 and 2004, respectively) 27,841 24,993
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $12.5 million and $6.8 million at 2005 and 2004,
respectively; (includes $0.1 million and $0.9 million from a related party
at 2005 and 2004, respectively) 209,546 144,827
Deferred income tax assets 6,169 10,791
Prepaid expenses and other current assets 48,135 35,739
-------------------------------------------
Total current assets 435,416 448,156
Computer software, net of accumulated amortization of $284.7 million and $252.9
million at 2005 and 2004, respectively 290,585 268,647
Property and equipment, net of accumulated depreciation and amortization of
$174.1 million and $158.7 million at 2005 and 2004, respectively 272,092 263,584
Contract acquisition costs, net 159,767 132,428
Goodwill, net 111,988 70,561
Other intangible assets, net of accumulated amortization of $3.7 million and
$2.2 million at 2005 and 2004, respectively 15,323 4,692
Equity investments 3,888 54,400
Other assets 33,751 39,475
-------------------------------------------
Total assets $ 1,322,810 1,281,943
===========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Balance Sheets (continued)
(Unaudited)
- ---------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(in thousands, except per share information) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable (includes $0.1 million and $0.3 million payable to related
parties at 2005 and 2004, respectively) $ 45,762 75,188
Accrued salaries and employee benefits 47,821 46,725
Current portion of long-term debt, obligations under capital leases and
software obligations 2,123 1,828
Other current liabilities (includes $9.6 million and $6.6 million payable to
related parties at 2005 and 2004, respectively) 155,760 154,162
------------------------------------------
Total current liabilities 251,466 277,903
Obligations under capital leases and software obligations, excluding current
portion 3,455 4,508
Long-term debt 91 -
Deferred income tax liabilities 126,698 131,106
------------------------------------------
Total liabilities 381,710 413,517
------------------------------------------
Minority interests in consolidated subsidiaries 3,809 3,814
------------------------------------------
Shareholders' equity:
Common stock - $0.10 par value. Authorized 600,000 shares; 197,809 and
197,587 issued at 2005 and 2004, respectively; 197,092 and 196,849
outstanding at 2005 and 2004, respectively 19,781 19,759
Additional paid-in capital 49,906 44,732
Unamortized restricted stock awards (4,549) -
Accumulated other comprehensive income 10,006 15,373
Treasury stock (shares of 717 and 738 at 2005 and 2004, respectively) (13,233) (13,573)
Retained earnings 875,380 798,321
------------------------------------------
Total shareholders' equity 937,291 864,612
------------------------------------------
Total liabilities and shareholders' equity $ 1,322,810 1,281,943
==========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Three months ended
June 30,
------------------------------------------
(in thousands, except per share information) 2005 2004
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $1.2 million and $1.3
million from related parties for 2005 and 2004, respectively) $ 217,048 184,987
Merchant services (includes $3.9 million from related parties for 2004) 68,696 6,876
Other services (includes $1.5 million and $1.7 million from related parties
for 2005 and 2004, respectively) 45,324 41,827
------------------------------------------
Revenues before reimbursable items 331,068 233,690
Reimbursable items (includes $0.4 million and $2.4 million from related
parties for 2005 and 2004, respectively) 79,175 55,932
------------------------------------------
Total revenues 410,243 289,622
------------------------------------------
Expenses:
Salaries and other personnel expense 117,201 82,224
Net occupancy and equipment expense 68,496 66,493
Other operating expenses (includes $2.2 million and $2.3 million to related
parties for 2005 and 2004, respectively) 69,025 37,701
------------------------------------------
Expenses before reimbursable items 254,722 186,418
Reimbursable items 79,175 55,932
------------------------------------------
Total expenses 333,897 242,350
------------------------------------------
Operating income 76,346 47,272
------------------------------------------
Nonoperating income (expense):
Interest income (includes $0.3 million and $0.1 million from related parties
for 2005 and 2004, respectively) 1,078 537
Interest expense (105) (39)
Loss on foreign currency translation, net (494) (30)
------------------------------------------
Total nonoperating income 479 468
------------------------------------------
Income before income taxes, minority interest and equity in income of
joint ventures 76,825 47,740
Income taxes 26,729 18,471
Minority interests in consolidated subsidiaries' net income (43) (67)
Equity in income of joint ventures 590 6,684
------------------------------------------
Net income $ 50,643 35,886
==========================================
Basic earnings per share $ 0.26 0.18
==========================================
Diluted earnings per share $ 0.26 0.18
==========================================
Weighted average common shares outstanding 197,078 196,846
Increase due to assumed issuance of shares related to stock options
outstanding 217 329
------------------------------------------
Weighted average common and common equivalent shares outstanding 197,295 197,175
==========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
-------------------------------------------
(in thousands, except per share information) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $2.4 million from related
parties for both 2005 and 2004, respectively) $ 421,805 362,378
Merchant services (includes $2.4 million and $7.1 million from related
parties for 2005 and 2004, respectively) 95,801 13,241
Other services (includes $3.0 million and $2.9 million from related parties
for 2005 and 2004, respectively) 93,838 82,675
-------------------------------------------
Revenues before reimbursable items 611,444 458,294
Reimbursable items (includes $2.2 million and $4.6 million from related
parties for 2005 and 2004, respectively) 148,783 116,564
-------------------------------------------
Total revenues 760,227 574,858
-------------------------------------------
Expenses:
Salaries and other personnel expense 214,718 170,086
Net occupancy and equipment expense 133,889 124,542
Other operating expenses (includes $4.4 million and $4.6 million to related
parties for 2005 and 2004, respectively) 120,185 72,252
-------------------------------------------
Expenses before reimbursable items 468,792 366,880
Reimbursable items 148,783 116,564
-------------------------------------------
Total expenses 617,575 483,444
-------------------------------------------
Operating income 142,652 91,414
-------------------------------------------
Nonoperating income (expense):
Interest income (includes $0.8 million and $0.3 million from related parties
for 2005 and 2004, respectively) 2,297 1,042
Interest expense (175) (782)
Loss on foreign currency translation, net (827) (101)
-------------------------------------------
Total nonoperating income 1,295 159
-------------------------------------------
Income before income taxes, minority interest and equity in income of
joint ventures 143,947 91,573
Income taxes 51,409 35,226
Minority interests in consolidated subsidiaries' net income (112) (160)
Equity in income of joint ventures 4,340 12,260
-------------------------------------------
Net income $ 96,766 68,447
===========================================
Basic earnings per share $ 0.49 0.35
===========================================
Diluted earnings per share $ 0.49 0.35
===========================================
Weighted average common shares outstanding 197,050 196,845
Increase due to assumed issuance of shares related to stock options
outstanding 215 350
-------------------------------------------
Weighted average common and common equivalent shares outstanding 197,265 197,195
===========================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
-------------------------------------------
(in thousands) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 96,766 68,447
Adjustments to reconcile net income to net cash provided by operating
activities:
Minority interests in consolidated subsidiaries' net income 112 160
Loss on foreign currency translation, net 827 101
Equity in income of joint ventures (4,340) (12,260)
Depreciation and amortization 69,522 52,781
Impairment of developed software 3,137 10,059
Provisions for (recoveries of) bad debt expenses and billing
adjustments 2,688 (1,373)
Charges for transaction processing provisions 4,595 4,865
Deferred income tax expense 4,622 9,938
Loss on disposal of equipment, net 1,725 378
(Increase) decrease in:
Accounts receivable (35,538) 4,950
Prepaid expenses and other assets 1,142 (17,645)
Increase (decrease) in:
Accounts payable (47,132) 10,759
Accrued salaries and employee benefits (15,124) (13,811)
Billings in excess of costs and profits on uncompleted contracts - (16,166)
Other current liabilities (45,249) 11,272
-------------------------------------------
Net cash provided by operating activities 37,753 112,455
-------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment, net (20,383) (39,326)
Additions to licensed computer software from vendors (10,647) (14,001)
Additions to internally developed computer software (10,388) (3,703)
Cash acquired in acquisition 38,799 -
Cash used in acquisition (95,782) -
Dividends received from joint ventures 1,659 15,876
Contract acquisition costs (10,981) (3,283)
-------------------------------------------
Net cash used in investing activities (107,723) (44,437)
-------------------------------------------
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 7 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
-------------------------------------------
(in thousands) 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from borrowing of long-term debt $ 48,142 -
Principal payments on long-term debt borrowings (48,132) -
Principal payments on capital lease obligations and software obligations (791) (42,039)
Dividends paid on common stock (includes $12.8 million and $6.4 million paid
to related parties during 2005 and 2004, respectively) (15,757) (7,873)
Proceeds from exercise of stock options 427 1,192
Purchases of common stock - (1,188)
-------------------------------------------
Net cash used in financing activities (16,111) (49,908)
-------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (2,000) 946
-------------------------------------------
Net (decrease) increase in cash and cash equivalents $ (88,081) 19,056
Cash and cash equivalents at beginning of year 231,806 122,874
-------------------------------------------
Cash and cash equivalents at end of period $ 143,725 141,930
===========================================
Cash paid for interest $ 175 782
===========================================
Cash paid for income taxes (net of refunds) $ 64,439 17,667
===========================================
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), TSYS Prepaid, Inc. (TPI) and Vital Processing Services, L.L.C. (Vital)
and its wholly owned and majority owned subsidiaries; and TSYS' majority owned
foreign subsidiary, GP Network Corporation (GP Net).
These financial statements have been prepared in accordance with the
instructions to Form 10-Q and do not include all information and footnotes
necessary for a fair presentation of financial position, results of operations
and cash flows in conformity with accounting principles generally accepted in
the United States of America. In preparing financial statements, it is necessary
for management to make assumptions and estimates affecting the amounts reported
in the consolidated financial statements and related notes. These estimates and
assumptions are developed based upon all information available. Actual results
could differ from estimated amounts. All adjustments, consisting of normal
recurring accruals, which, in the opinion of management, are necessary for a
fair presentation of financial position and results of operations for the
periods covered by this report have been included.
The accompanying unaudited consolidated financial statements should be read
in conjunction with the Company's summary of significant accounting policies,
consolidated financial statements and related notes appearing in the Company's
2004 annual report previously filed on Form 10-K. Results of interim periods are
not necessarily indicative of results to be expected for the year.
Certain reclassifications have been made to the 2004 financial statements
to conform to the presentation adopted in 2005.
Note 2 - Supplementary Balance Sheet Information
Cash and cash equivalent balances are summarized as follows:
(in thousands) June 30, 2005 December 31, 2004
-------------------------------------------------------------------------------- --------------------------
Cash and cash equivalents in domestic accounts $ 110,065 177,117
Cash and cash equivalents in foreign accounts 33,660 54,689
-------------------------- --------------------------
Total $ 143,725 231,806
========================== ==========================
- 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) June 30, 2005 December 31, 2004
----------------------------------------------------------------------------- ---------------------------
Prepaid expenses $ 16,213 11,767
Supplies Inventory 13,962 7,646
Other 17,960 16,326
------------------------- ---------------------------
Total $ 48,135 35,739
========================= ===========================
Significant components of contract acquisition costs, net of accumulated
amortization, are summarized as follows:
(in thousands) June 30, 2005 December 31, 2004
----------------------------------------------------------------------------- ---------------------------
Payments for processing rights, net $ 115,349 91,787
Conversion costs, net 44,418 40,641
------------------------- ---------------------------
Total $ 159,767 132,428
========================= ===========================
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $3.7 million and $3.4 million for the three
months ended June 30, 2005 and 2004, respectively. For the six months ended June
30, 2005 and 2004, amortization related to payments for processing rights was
$7.1 million and $6.8 million, respectively.
Amortization related to conversion costs, which is recorded in other
operating expenses, was $3.1 million and $2.8 million for the three months ended
June 30, 2005 and 2004, respectively. For the six months ended June 30, 2005 and
2004, amortization expense related to conversion costs was $6.0 million and $5.5
million, respectively.
Significant components of other current liabilities are summarized as follows:
(in thousands) June 30, 2005 December 31, 2004
------------------------------------------------------------------------------- ----------------------------
Accrued expenses $ 55,854 43,229
Client liabilities 27,765 24,660
Deferred revenues 22,324 27,720
Dividends payable 11,824 7,874
Transaction processing provisions 9,521 9,284
Client postage deposits 6,020 6,184
Income taxes payable 3,278 21,279
Other 19,174 13,932
-------------------------- ----------------------------
Total $ 155,760 154,162
========================== ============================
Note 3 - Comprehensive Income
Comprehensive income for TSYS consists of net income and foreign currency
translation adjustments recorded as a component of shareholders' equity.
- 10 -
Notes to Unaudited Consolidated Financial Statements (continued)
Comprehensive income for the three and six months ended June 30 is as
follows:
Three months ended Six months ended
June 30, June 30,
----------------------------------- ------------------------------------
(in thousands) 2005 2004 2005 2004
- --------------------------------------- ----------------------------------- ------------------------------------
Net income $ 50,643 35,886 96,766 68,447
Other comprehensive income (loss):
Foreign currency translation
adjustments, net of tax (2,944) 632 (5,367) 2,562
----------------------------------- ------------------------------------
Total $ 47,699 36,518 91,399 71,009
=================================== ====================================
The income tax effects allocated to and the cumulative balance of
accumulated other comprehensive income are as follows:
Balance at December 31, Pretax Balance at
(in thousands) 2004 amount Tax effect June 30, 2005
- ---------------------------------------------------------------------------------------------------------------------------
Foreign currency translation
adjustments $15,373 (8,334) 2,967 $10,006
=======================================================================================
Note 4 - Segment Reporting and Major Customer
The Company reports selected information about operating segments in
accordance with Statement of Financial Accounting Standards No. 131 (SFAS No.
131). The Company's segment information reflects the information that the chief
operating decision maker (CODM) uses to make resource allocation and strategic
decisions. The CODM at TSYS consists of the chairman of the board, the chief
executive officer, the president and the three senior executive vice presidents.
On March 1, 2005, TSYS acquired the remaining 50% equity stake that Visa
U.S.A. held in Vital. As a result of the acquisition, the Company revised its
segment information to reflect the information that the CODM uses to make
resource allocations and strategic decisions. The revision included adding a new
segment, merchant processing services, to include the information regarding
Vital.
Through online accounting and electronic payment processing systems, TSYS
provides electronic payment processing and other related services to
card-issuing institutions in the United States, Mexico, Canada, Honduras, Europe
and Puerto Rico. The Company has three reportable segments: domestic-based
support services, international-based support services and merchant processing
services. Domestic-based support services include electronic payment processing
services and other services provided from the United States. Domestic-based
support services segment includes the financial results of TSYS, excluding its
foreign branch offices, and including the following subsidiaries: CDEC, CPI,
TSYS Canada, TDM, ProCard, ESC, TTC and TPI.
International-based support services include electronic payment processing
and other services provided outside the United States. International-based
support services include the financial results of GP Net, TSYS Japan and TSYS'
branch offices in Europe and Japan. TSYS' share of the equity earnings of its
Total System Services de Mexico, S.A. de C.V. joint venture is included in
international-based
- 11 -
Notes to Unaudited Consolidated Financial Statements (continued)
support services. Merchant processing services include the financial results of
Vital. For periods prior to the acquisition, TSYS has reclassified TSYS' share
of its equity earnings of Vital from domestic-based support services to merchant
processing services.
Domestic- International- Merchant
based support based support processing
Operating Segments (in thousands) services services services Consolidated
- -------------------------------------------------------------------------------------------------------------------------
At June 30, 2005
- -------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,239,956 180,384 200,936 $ 1,621,276
Intersegment eliminations (298,461) (1) (4) (298,466)
------------------ ----------------- ----------------- -----------------
Total assets $ 941,495 180,383 200,932 $ 1,322,810
================== ================= ================= =================
- -------------------------------------------------------------------------------------------------------------------------
At December 31, 2004
- -------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,265,567 169,877 - $ 1,435,444
Intersegment eliminations (153,501) - - (153,501)
------------------ ----------------- ----------------- -----------------
Total assets $ 1,112,066 169,877 - $ 1,281,943
================== ================= ================= =================
- -------------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2005
- -------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 239,567 30,480 64,864 $ 334,911
Intersegment revenue (3,797) - (46) (3,843)
------------------ ----------------- ----------------- -----------------
Revenues before reimbursables
from external customers $ 235,770 30,480 64,818 $ 331,068
================== ================= ================= =================
Segment total revenue $ 305,284 35,128 76,103 $ 416,515
Intersegment revenue (6,226) - (46) (6,272)
------------------ ----------------- ----------------- -----------------
Revenue from external customers $ 299,058 35,128 76,057 $ 410,243
================== ================= ================= =================
Depreciation and amortization $ 28,096 4,248 4,439 $ 36,783
================== ================= ================= =================
Intersegment expenses $ (10,709) 9,383 7,605 $ (6,279)
================== ================= ================= =================
Segment operating income $ 63,099 (835) 14,082 $ 76,346
================== ================= ================= =================
Income taxes $ 21,897 (572) 5,404 $ 26,729
================== ================= ================= =================
Equity in income of joint venture $ - 590 - $ 590
================== ================= ================= =================
Net income $ 42,118 (336) 8,861 $ 50,643
================== ================= ================= =================
- -------------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2004
- -------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 207,894 25,796 - $ 233,690
Intersegment revenue - - - -
------------------ ----------------- ----------------- -----------------
Revenues before reimbursables
from external customers $ 207,894 25,796 - $ 233,690
================== ================= ================= =================
Segment total revenue $ 262,113 27,511 - $ 289,624
Intersegment revenue (2) - - (2)
------------------ ----------------- ----------------- -----------------
Revenue from external customers $ 262,111 27,511 - $ 289,622
================== ================= ================= =================
Depreciation and amortization $ 23,484 3,187 - $ 26,671
================== ================= ================= =================
Intersegment expenses $ (578) 578 - $ -
================== ================= ================= =================
Segment operating income $ 40,498 6,774 - $ 47,272
================== ================= ================= =================
Income taxes $ 13,758 2,537 2,176 $ 18,471
================== ================= ================= =================
Equity in income of joint ventures $ - 318 6,366 $ 6,684
================== ================= ================= =================
Net income $ 27,212 4,485 4,189 $ 35,886
================== ================= ================= =================
- 12 -
Notes to Unaudited Consolidated Financial Statements (continued)
Domestic- International- Merchant
based support based support processing
services services services Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Six months ended June 30 , 2005
- -------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 469,089 61,328 86,152 $ 616,569
Intersegment revenue (5,079) - (46) (5,125)
------------------ ----------------- ----------------- -----------------
Revenues before reimbursables
from external customers $ 464,010 61,328 86,106 $ 611,444
================== ================= ================= =================
Segment total revenue $ 595,810 71,743 100,929 $ 768,482
Intersegment revenue (8,209) - (46) (8,255)
------------------ ----------------- ----------------- -----------------
Revenue from external customers $ 587,601 71,743 100,883 $ 760,227
================== ================= ================= =================
Depreciation and amortization $ 55,555 8,016 5,951 $ 69,522
================== ================= ================= =================
Intersegment expenses $ (19,234) 17,538 9,958 $ 8,262
================== ================= ================= =================
Segment operating income $ 123,511 2,006 17,135 $ 142,652
================== ================= ================= =================
Income taxes $ 42,628 1,067 7,714 $ 51,409
================== ================= ================= =================
Equity in income of joint ventures $ - 1,099 3,241 $ 4,340
================== ================= ================= =================
Net income $ 82,441 1,419 12,906 $ 96,766
================== ================= ================= =================
- -------------------------------------------------------------------------------------------------------------------------
Six months ended June 30 , 2004
- -------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 409,512 48,782 - $ 458,294
Intersegment revenue - - - -
------------------ ----------------- ----------------- -----------------
Revenues before reimbursables
from external customers $ 409,512 48,782 - $ 458,294
================== ================= ================= =================
Segment total revenue $ 522,733 52,129 - $ 574,862
Intersegment revenue (4) - - (4)
------------------ ----------------- ----------------- -----------------
Revenue from external customers $ 522,729 52,129 - $ 574,858
================== ================= ================= =================
Depreciation and amortization $ 46,763 6,018 - $ 52,781
================== ================= ================= =================
Intersegment expenses $ (1,148) 1,148 - $ -
================== ================= ================= =================
Segment operating income $ 80,071 11,343 - $ 91,414
================== ================= ================= =================
Income taxes $ 27,140 4,130 3,956 $ 35,226
================== ================= ================= =================
Equity in income of joint ventures $ - 693 11,567 $ 12,260
================== ================= ================= =================
Net income $ 53,236 7,602 7,609 $ 68,447
================== ================= ================= =================
Revenues for domestic-based support services include electronic payment
processing and other services provided from the United States to clients
domiciled in the United States or other countries. Revenues from
international-based support services include electronic payment processing and
other services provided outside the United States to clients domiciled mainly
outside the United States.
The following geographic area data represent revenues for the three and six
months ended June 30, 2005 and 2004, respectively, based on the domicile of
customers.
- 13 -
Notes to Unaudited Consolidated Financial Statements (continued)
Three months ended Six months ended
June 30, June 30,
---------------------------------------------------------------------------------------------
(in millions) 2005 2004 2005 2004
---------------------------------------------------------------------------------------------
United States $ 350.1 237.2 640.1 474.3
Europe 31.3 24.2 64.4 45.5
Canada* 22.4 21.3 43.5 41.0
Japan 3.9 3.4 7.6 6.9
Mexico 1.7 2.9 3.4 5.8
Other 0.8 0.6 1.2 1.4
------------------- --------------------- ---------------------- --------------------
Totals $ 410.2 289.6 760.2 574.9
=================== ===================== ====================== ====================
* These revenues in 2004 include those generated from the Caribbean
accounts owned by a Canadian institution.
The following table reconciles geographic revenues to revenues by reporting
segment for the three months ended June 30, 2005 and 2004, respectively, based
on the domicile of customers.
------------------------------------------------------------------------------------------
Domestic-based International-based Merchant processing
support services support services services
------------------------------------------------------------------------------------------
(in millions): 2005 2004 2005 2004 2005 2004
------------------------------------------------------------------------------------------
United States $ 274.3 237.2 - - 75.8 -
Europe 0.1 0.1 31.2 24.1 - -
Canada* 22.3 21.3 - - 0.1 -
Japan - - 3.9 3.4 - -
Mexico 1.7 2.9 - - - -
Other 0.6 0.6 - - 0.2 -
------------------------------------------------------------------------------------------
$ 299.0 262.1 35.1 27.5 76.1 -
==========================================================================================
The following table reconciles geographic revenues to revenues by reporting
segment for the six months ended June 30, 2005 and 2004, respectively, based on
the domicile of customers.
-----------------------------------------------------------------------------------------
Domestic-based International-based Merchant processing
support services support services services
-----------------------------------------------------------------------------------------
(in millions): 2005 2004 2005 2004 2005 2004
-----------------------------------------------------------------------------------------
United States $ 539.6 474.3 - - 100.5 -
Europe 0.3 0.2 64.1 45.3 - -
Canada* 43.3 41.0 - - 0.2 -
Japan - - 7.6 6.9 - -
Mexico 3.4 5.8 - - - -
Other 1.0 1.4 - - 0.2 -
-----------------------------------------------------------------------------------------
$ 587.6 522.7 71.7 52.2 100.9 -
=========================================================================================
* 2004 revenues include those generated from the Caribbean accounts owned
by a Canadian institution.
- 14 -
Notes to Unaudited Consolidated Financial Statements (continued)
The Company maintains property and equipment in the United States, Europe,
Japan and Canada. The following geographic area data represent net property and
equipment balances by region:
At June 30, At December 31,
(in millions) 2005 2004
--------------------------------------------------------------- ----------------------------
United States $ 211.3 200.6
Europe 58.9 60.8
Japan 1.8 2.1
Canada 0.1 0.1
--------------------------------------------------------------- ----------------------------
Totals $ 272.1 263.6
========================== ============================
Major Customer
For the three months ended June 30, 2005, the Company had one major
customer which accounted for approximately 23.8%, or $97.8 million, of total
revenues. For the three months ended June 30, 2004, TSYS had one major customer
that accounted for 19.0%, or $54.9 million, of total revenues. Revenues from
this major customer for the periods reported are attributable to the
domestic-based support services segment and merchant processing services.
For the six months ended June 30, 2005, the Company had one major customer
which accounted for approximately 22.4%, or $170.0 million, of total revenues.
For the six months ended June 30, 2004, TSYS had one major customer that
accounted for 18.6%, or $107.2 million, of total revenues.
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 and six months ended June 30, 2005 and 2004, respectively,
if the Company had applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting for
Stock-Based Compensation," to stock-based employee compensation granted in the
form of TSYS and Synovus Financial Corp. (Synovus) stock options.
- 15 -
Notes to Unaudited Consolidated Financial Statements (continued)
Three months ended Six months ended
June 30 June 30
--------------------------------------------------------------------------
(in thousands, except per share data) 2005 2004 2005 2004
--------------------------------------------------------------------------
Net income, as reported $ 50,643 35,886 96,766 68,447
Add: Stock-based employee
compensation expense, net of tax 184 - 365 -
Deduct: Stock-based employee
compensation expense determined under
the fair value based method for all awards,
net of related income tax effects 1,236 1,182 2,623 2,509
--------------------------------------------------------------------------
Net income, as adjusted $ 49,591 34,704 94,508 65,938
============== ================ ============== ===============
Earnings per share:
Basic - as reported $ 0.26 0.18 0.49 0.35
============== ================ ============== ===============
Basic - as adjusted $ 0.25 0.18 0.48 0.33
============== ================ ============== ===============
Diluted - as reported $ 0.26 0.18 0.49 0.35
============== ================ ============== ===============
Diluted - as adjusted $ 0.25 0.18 0.48 0.33
============== ================ ============== ===============
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123 (revised) (SFAS No. 123R)
"Share-Based Payment." SFAS No. 123R will require the Company to recognize
compensation expense for the unvested portion for outstanding stock-based
compensation granted in the form of stock options based on the grant-date fair
value of those awards calculated under SFAS No. 123 for pro forma disclosures.
On April 14, 2005, the Securities and Exchange Commission (SEC) approved a
rule that delays the effective date of SFAS No. 123R for public companies that
do not file as small business issuers until the first annual or interim
reporting period of the first fiscal year that begins on or after June 15, 2005.
The Company plans to adopt SFAS No. 123R on January 1, 2006.
Note 6 - Long-Term Debt
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
June 30, 2005, TSYS did not have an outstanding balance on the line of credit.
- 16 -
Notes to Unaudited Consolidated Financial Statements (continued)
Note 7 - Supplementary Cash Flow Information
Cash used for contract acquisition costs for the six months ended June 30,
2005 and 2004, respectively, are summarized as follows:
(in thousands) June 30, 2005 June 30, 2004
----------------------------------------------------------------------------- -----------------------------
Conversion costs $ 10,981 3,283
Payments for processing rights - -
----------------------------------------------------------------------------- -----------------------------
Total $ 10,981 3,283
========================= =============================
Note 8 - Legal Proceedings
The Company is subject to lawsuits, claims and other complaints arising out
of the ordinary conduct of its business. In the opinion of management, based in
part upon the advise of legal counsel, all matters are believed to be adequately
covered by insurance, or if not covered, are believed to be without merit or are
of such kind or involve such amounts that would not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company if disposed of unfavorably. The Company establishes reserves for
expected future litigation exposures that TSYS determines to be both probable
and reasonably estimable.
The Company has received notification from the United States Attorneys'
Office for the Northern District of California that the United States Department
of Justice is investigating whether the Company and/or one of its large credit
card processing clients violated the False Claims Act, 31 U.S.C. SS3729-33, in
connection with mailings made on behalf of the client from July 1997 through
November 2001. The subject matter of the investigation relates to the U.S.
Postal Service's Move Update Requirements. In general, the Postal Service's Move
Update Requirements are designed to reduce the volume of mail that is returned
to sender as undeliverable as addressed. In effect, these requirements provide,
among other things, various procedures that may be utilized to maintain the
accuracy of mailing lists in exchange for discounts on postal rates. The Company
has received a subpoena from the Office of the Inspector General of the U.S.
Postal Service, and has produced documents responsive to the subpoena. The
Company continues to cooperate with the Department of Justice in the
investigation, and there can be no assurance as to the timing or outcome of the
investigation, including whether the investigation will result in any criminal
or civil fines, penalties, judgments or treble damages or other claims against
the Company. The Company established a reserve during the quarter ended March
31, 2005 relating to this investigation. However, there can be no assurance that
the Company will not suffer a loss in connection with this investigation in an
amount exceeding such reserve or that the Company will not be required to
reserve additional amounts in future periods.
Note 9 - Business Combinations
Vital Processing Services, L.L.C.
Vital Processing Services, L.L.C, a limited liability company, was
established in May 1996 as a 50/50 merchant processing joint venture between
TSYS and Visa U.S.A. ("Visa"). Vital is a leader in providing integrated
end-to-end electronic transaction processing services primarily to large
financial institutions and other merchant acquirers. Vital processes all payment
forms including credit, debit, electronic benefit transfer and check truncation
for merchants of all sizes across a wide array of retail market segments.
- 17 -
Notes to Unaudited Consolidated Financial Statements (continued)
On March 1, 2005, TSYS acquired the remaining 50% of Vital from Visa for
$95.8 million in cash, including $782,000 of direct acquisition costs. Vital is
now a separate, wholly owned subsidiary of TSYS. As a result of the acquisition
of control of Vital, TSYS changed from the equity method of accounting for the
investment in Vital and began consolidating Vital's balance sheet and results of
operations in the statements of income effective March 1, 2005. In accordance
with authoritative accounting guidelines, TSYS recorded the acquisition of the
incremental 50% interest as a business combination, requiring that TSYS allocate
the purchase price to the assets acquired and liabilities assumed based on their
relative fair values. The Company is in the process of finalizing the purchase
price allocation and has preliminarily allocated approximately $37.8 million to
goodwill, approximately $30.5 million to other identifiable intangible assets
and the remaining amount to the assets and liabilities acquired. Of the $30.5
million other identifiable intangible assets, the Company has allocated $18.5
million to computer software and the remaining amount to other intangible
assets. The Company believes the acquisition of Vital allows TSYS to be a
complete provider of value-based services at both ends of the payment chain and
strengthens the relationship TSYS enjoys with some of world's largest card
issuers by placing them closer to the point of sale. Revenues associated with
Vital are included in merchant services and are classified in merchant
processing services for segment reporting purposes.
The Company is in the process of completing its purchase price allocation
related to the acquisition. Since TSYS acquired less than 100% of the
outstanding shares of the acquired enterprise, the valuation of assets acquired
and liabilities assumed in the acquisition was based on a pro rata allocation of
the fair values of the assets acquired and liabilities assumed and the
historical financial statement carrying amounts of the assets and liabilities of
the acquired enterprise. As a result, TSYS recorded the fair value of the 50%
interest of Vital's assets acquired and liabilities assumed as of March 1, 2005.
The Company recorded the remaining 50% interest of Vital's assets and
liabilities at historical carrying values. The preliminary purchase price
allocation is presented below:
(in thousands)
-----------------------------------------------------
Cash and cash equivalents $19,399
Intangible assets 30,500
Goodwill 37,757
Other assets 39,332
---------------
Total assets acquired 126,988
---------------
Other liabilities 31,157
---------------
Total liabilities assumed 31,157
---------------
Minority interest 49
---------------
Net assets acquired $95,782
===============
TSYS Prepaid, Inc.
On August 2, 2004, TSYS completed the acquisition of Clarity Payment
Solutions, Inc. (Clarity) for $53.0 million in cash and had direct acquisition
costs in the amount of $515,000. Clarity was renamed TSYS Prepaid, Inc. (TSYS
Prepaid). The Company is in the process of finalizing the purchase price
allocation and has preliminarily allocated approximately $39.6 million to
goodwill, approximately $10.9 million to other intangibles and the remaining
amount to the assets and liabilities acquired. Of the $10.9 million intangibles,
the Company has allocated $8.5 million to computer software and the remaining
amount to other intangible assets. TSYS Prepaid is a leading provider of prepaid
card
- 18 -
Notes to Unaudited Consolidated Financial Statements (continued)
solutions that utilize the Visa, MasterCard, EFT and ATM networks for Fortune
500 companies as well as domestic and international financial institutions. The
Company believes the acquisition of TSYS Prepaid enhances TSYS' processing
services by adding enhanced functionality and distinct value differentiation for
TSYS and its clients. TSYS Prepaid operates as a separate, wholly owned
subsidiary of TSYS. Revenues associated with TSYS Prepaid are included in
electronic payment processing services and are classified in domestic-based
support services for segment reporting purposes.
The Company is in the process of completing its purchase price allocation
related to the acquisition. The preliminary purchase price allocation is
presented below:
(in thousands)
-----------------------------------------------------
Cash and cash equivalents $ 2,422
Restricted cash 16,672
Intangible assets 10,900
Goodwill 39,619
Other assets 4,817
---------------
Total assets acquired 74,430
---------------
Other liabilities 20,915
---------------
Total liabilities assumed 20,915
---------------
Net assets acquired $53,515
===============
Pro forma
Presented below are the pro forma consolidated results of operations for
the three and six months ended June 30, 2005 and 2004, respectively, as though
the acquisitions of Vital and TSYS Prepaid had occurred on January 1, 2004. This
pro forma information is based on the historical financial statements of Vital
and TSYS Prepaid. Pro forma results do not include any actual or anticipated
cost savings or expenses of the planned integration of TSYS, Vital and TSYS
Prepaid, and are not necessarily indicative of the results which would have
occurred if the business combinations had been in effect on the dates indicated,
or which may result in the future.
Three months ended Six months ended
(in thousands, except per share data) June 30, June 30,
- ----------------------------------------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- ----------------------------------------------------------------------------------------------------------------------------------
Revenues $ 410,243 364,114 803,817 721,134
Net income 50,643 35,944 98,775 71,383
Basic earnings per share 0.26 0.18 0.50 0.36
Diluted earnings per share 0.26 0.18 0.50 0.36
- 19 -
TOTAL SYSTEM SERVICES, INC.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Overview
Total System Services, Inc.'s (TSYS' or the Company's) revenues are derived
from providing electronic payment processing and related services to financial
and nonfinancial institutions, generally under long-term processing contracts.
TSYS' services are provided primarily through the Company's cardholder systems,
TS2 and TS1, to financial institutions and other organizations throughout the
United States, Mexico, Canada, Honduras, Puerto Rico and Europe. The Company
currently offers merchant services to financial institutions and other
organizations through its majority owned subsidiary, GP Network Corporation (GP
Net), and its wholly owned subsidiary, Vital Processing Services, L.L.C.
(Vital).
Due to the somewhat seasonal nature of the credit card industry, TSYS'
revenues and results of operations have generally increased in the fourth
quarter of each year because of increased transaction and authorization volumes
during the traditional holiday shopping season. Furthermore, growth or declines
in card portfolios of existing clients, the conversion of cardholder accounts of
new clients to the Company's processing platforms, and the loss of cardholder
accounts impact the results of operations from period to period. Another factor
which may affect TSYS' revenues and results of operations from time to time, is
the sale by a client of its business, its card portfolio or a segment of its
accounts to a party which processes cardholder accounts internally or uses
another third-party processor. Consolidation in either the financial services or
retail industries, a change in the economic environment in the retail sector, or
a change in the mix of payments between cash and cards could favorably or
unfavorably impact TSYS' financial position, results of operations and cash
flows in the future.
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including certain major customers. Processing
contracts with large clients, representing a significant portion of the
Company's total revenues, generally provide for discounts on certain services
based on the size and activity of clients' portfolios. Therefore, electronic
payment processing revenues and the related margins are influenced by the client
mix relative to the size of client card portfolios, as well as the number and
activity of individual cardholder accounts processed for each client.
Consolidation among financial institutions has resulted in an increasingly
concentrated client base, which results in a changing client mix toward larger
clients and increasing pressure on the Company's operating profit margins.
The Company provides services to its clients including processing consumer,
retail, commercial, government services, stored value and debit cards. Consumer
cards include Visa and MasterCard credit cards as well as American Express
cards. Retail cards include private label and gift cards. Commercial cards
include purchasing cards, corporate cards and fleet cards for employees.
Government services accounts on file consist mainly of student loan processing
accounts. Stored value accounts include prepaid cards, including loyalty
incentive cards and flexible spending cards, and stored value cards. Debit cards
consist mainly of on-line (PIN-based) and off-line (signature-based) accounts.
The tables on page 27 summarize TSYS' accounts on file (AOF) information as of
June 30, 2005 and 2004.
- 20 -
Financial Overview (continued)
A summary of the financial highlights occurring during 2005, as compared to
2004, is provided below:
Three months ended Six months ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------------------------
Percent Percent
2005 2004 Change 2005 2004 Change
- -------------------------------------------------------------------------------------------------------------------
Revenues Before
Reimbursables $ 331,068 233,690 41.7% $ 611,444 458,294 33.4%
Total Revenues 410,243 289,622 41.6 760,227 574,858 32.2
Operating Income 76,346 47,272 61.5 142,652 91,414 56.0
Net Income 50,643 35,886 41.1 96,766 68,447 41.4
Basic EPS 0.26 0.18 41.0 0.49 0.35 41.2
Diluted EPS 0.26 0.18 41.0 0.49 0.35 41.3
Significant highlights for 2005 include:
TSYS has ended its negotiations with Citibank related to continuing
its processing services for the Sears, Roebuck and Co. card portfolio. TSYS
received official notification that Citibank plans to migrate all of the
Sears consumer MasterCard and private-label accounts from TSYS in a
deconversion that is expected to occur in the second quarter of 2006. TSYS
expects to continue supporting commercial-card accounts for Citibank, as
well as Citibank's California Commerce consumer accounts, according to the
terms of the existing agreements for those portfolios.
TSYS reached an agreement in principle with Capital One Financial
Corporation to provide processing services for its North American portfolio
of consumer and small business credit card accounts. TSYS continues its
exclusive negotiations with Capital One.
TSYS signed Fifth Third Bancorp and successfully converted its Visa
and MasterCard consumer credit portfolio to TS2.
TSYS approved a quarterly cash dividend of $0.06 per share, an
increase of 50 percent from the previous dividend rate. TSYS has increased
its dividend payment for 6 consecutive years.
TSYS renewed its agreement with Navy Federal Credit Union, the world's
largest credit union, to continue processing more than 1 million credit
card accounts for an additional five years.
The Company acquired the remaining 50% interest from Visa U.S.A.
(Visa) of Vital Processing Services, L.L.C. (Vital) for $95.8 million.
TSYS signed a seven-year contract with ABN AMRO Bank, Barneveld,
Netherlands, which represents the first processing agreement with a card
issuer based in continental Europe. Additionally, TSYS will provide
customer care services on behalf of ABN AMRO by managing a customer contact
center in The Netherlands. The center will support full end-to-end customer
service, including general customer service queries, application
processing, chargebacks and dispute handling, fraud and collections.
TSYS and Bank of America agreed to add five years to the current
agreement to provide exclusive processing services through 2014. The
expanded relationship covers all consumer and commercial credit Visa and
MasterCard accounts issued by Bank of America, as well as
- 21 -
Financial Overview (continued)
the recently acquired portfolio of FleetBoston Financial Corp.
(FleetBoston), which was converted to TSYS in mid-March.
MBNA, based in Wilmington, Delaware, extended its existing seven-year
relationship with TSYS for commercial card processing services by an
additional three years.
TSYS successfully implemented two retail gift card programs in Europe
- one for HMV, the largest retailer of music, DVD and games in the UK and
another for Hunkemoller, a leading specialist retailer in The Netherlands,
with outlets in Germany, Denmark, France, Luxembourg and Belgium.
TSYS Prepaid announced it was sponsoring the creation of an
industry-wide prepaid card trade association. The trade association will
help advance the rapidly evolving prepaid market, focusing primarily on
branded cards using open networks such as Visa and MasterCard, as well as
EFT and ATM networks.
TSYS announced that Answers, etc. will use TSYS Prepaid's platform to
power the Zoomcard Prepaid MasterCard. The Zoomcard, issued by KeyBank, is
accepted at more than 900,000 ATMs and more than 24 million merchant
locations worldwide.
Industry Developments
Consolidation among financial institutions, particularly in the area of
credit card operations continued to be a major industry risk. During 2005,
the following consolidations and industry events occurred:
Bank of America Corporation announced a definitive agreement to
acquire MBNA Corporation. With the acquisition, Bank of America will become
one of the largest card issuers in the United States.
Washington Mutual Inc., the nation's largest savings and loan,
announced it was buying Providian Financial Corp.
Multiple data breaches, including credit card data security breaches,
were announced that allowed unauthorized access to consumer profiles. A
bill under consideration in the Senate would require U.S. businesses to
make data-security breaches public, with those failing to do so facing
possible criminal prosecution.
Financial Review
This Financial Review provides a discussion of critical accounting policies
and estimates, related party transactions and off-balance sheet arrangements.
This Financial Review also discusses the results of operations, financial
position, liquidity and capital resources of TSYS and outlines the factors that
have affected its recent earnings, as well as those factors that may affect its
future earnings.
Critical Accounting Policies and Estimates
The Company's financial position, results of operations and cash flows are
impacted by the accounting policies the Company has adopted. In order to gain a
full understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed.
Factors that could affect the Company's future operating results and cause
actual results to vary materially from expectations include, but are not limited
to, lower than anticipated growth from existing customers, an inability to
attract new customers and grow internationally, loss of one of the Company's
major customers or other significant clients, an inability to grow through
acquisitions or
- 22 -
Critical Accounting Policies and Estimates (continued)
successfully integrate acquisitions, an inability to control expenses,
technology changes, financial services consolidation, change in regulatory
mandates, a decline in the use of cards as a payment mechanism, a decline in the
financial stability of the Company's clients and uncertain economic conditions.
Negative developments in these or other risk factors could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
The Company has prepared the accompanying consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America. In preparing financial statements, it is necessary for management to
make assumptions and estimates affecting the amounts reported in the
consolidated financial statements and related notes. These estimates and
assumptions are developed based upon all information available. Actual results
could differ from estimated amounts.
For a detailed discussion regarding the Company's critical accounting
policies and estimates, see "Item 7: Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2004. There have been no material
changes to the Company's critical accounting policies, estimates and assumptions
or the judgments affecting the application of those estimates and assumptions in
2005.
GOODWILL: The Company's annual impairment analyses of its unamortized goodwill
balance as of May 31, 2005 did not result in any impairment.
Related Party Transactions
The Company provides electronic payment processing and other services to
its parent company, Synovus Financial Corp. (Synovus) and its affiliates, and to
the Company's joint venture, Total System Services de Mexico, S.A. de. C.V.
(TSYS de Mexico). The services are performed under contracts that are similar to
its contracts with other customers. The Company believes the terms and
conditions of transactions between the Company and these related parties are
comparable to those which could have been obtained in transactions with
unaffiliated parties. The Company's margins with respect to related party
transactions are comparable to margins recognized in transactions with unrelated
third parties. The amounts related to these transactions are disclosed on the
face of TSYS' consolidated financial statements.
Line of Credit
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
June 30, 2005, TSYS did not have an outstanding balance on the line of credit.
Off-Balance Sheet Arrangements
Operating Leases: As a method of funding its operations, TSYS employs
noncancelable operating leases for computer equipment, software and facilities.
These leases allow the Company to provide the latest technology while avoiding
the risk of ownership. Neither the assets nor obligations related to these
leases are included on the balance sheet.
- 23 -
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 June 30, 2005 and 2004:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2005 2004 2005 vs. 2004
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 52.9 % 63.9 % 17.3 %
Merchant services 16.8 2.4 899.0
Other services 11.0 14.4 8.4
------------- ----------
Revenues before reimbursable items 80.7 80.7 41.7
Reimbursable items 19.3 19.3 41.6
------------- ----------
Total revenues 100.0 100.0 41.6
------------- ----------
Expenses:
Salaries and other personnel expense 28.6 28.4 42.6
Net occupancy and equipment expense 16.7 23.0 3.0
Other operating expenses 16.8 13.0 83.0
------------- ----------
Expenses before reimbursable items 62.1 64.4 36.6
Reimbursable items 19.3 19.3 41.6
------------- ----------
Total expenses 81.4 83.7 37.8
------------- ----------
Operating income 18.6 16.3 61.5
Nonoperating income 0.1 0.2 2.3
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 18.7 16.5 60.9
Income taxes 6.5 6.4 44.7
Minority interests in consolidated subsidiaries' net
income (0.0) (0.0) (36.3)
Equity in income of joint ventures 0.1 2.3 (91.2)
------------- ----------
Net income 12.3 % 12.4 % 41.1 %
============= ==========
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 six months ended June 30, 2005 and 2004:
- 24 -
Results of Operations (continued)
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2005 2004 2005 vs. 2004
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 55.5 % 63.0 % 16.4 %
Merchant services 12.6 2.3 623.5
Other services 12.3 14.4 13.5
------------- ----------
Revenues before reimbursable items 80.4 79.7 33.4
Reimbursable items 19.6 20.3 27.6
------------- ----------
Total revenues 100.0 100.0 32.2
------------- ----------
Expenses:
Salaries and other personnel expense 28.2 29.6 26.2
Net occupancy and equipment expense 17.6 21.6 7.5
Other operating expenses 15.8 12.6 66.3
------------- ----------
Expenses before reimbursable items 61.6 63.8 27.8
Reimbursable items 19.6 20.3 27.6
------------- ----------
Total expenses 81.2 84.1 27.7
------------- ----------
Operating income 18.8 15.9 56.0
Nonoperating income 0.1 0.0 717.1
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 18.9 15.9 57.2
Income taxes 6.8 6.1 45.9
Minority interests in consolidated subsidiaries' net
income (0.0) (0.0) (29.8)
Equity in income of joint ventures 0.6 2.1 (64.6)
------------- ----------
Net income 12.7 % 11.9 % 41.4 %
============= ==========
Revenues
Total revenues increased $120.6 million and $185.4 million, or 41.6% and
32.2%, respectively, during the three and six months ended June 30, 2005,
compared to the same periods in 2004. The increase in revenues for the three
months and six months ended June, 2005 includes an increase of $0.9 million and
$2.0 million related to the effects of currency translation of its foreign-based
subsidiaries and branches. Excluding reimbursable items, revenues increased
$97.4 million and $153.2 million, or 41.7% and 33.4%, respectively, during the
three and six months ended June 30, 2005, compared to the same periods in 2004.
International Revenues
TSYS provides services to its clients worldwide and plans to continue to
expand its service offerings internationally in the future. Total revenues from
clients domiciled outside the United States for the three and six months ended
June, 2005 and 2004, respectively, are summarized below:
- 25 -
Results of Operations (continued)
Three months ended Six months ended
June 30, June 30,
------------------------------------------------------------------------------------------------
(in millions) 2005 2004 % Change 2005 2004 % Change
--------------------------------------- ---------------------------------------------
Europe $ 31.3 24.2 29.4% $ 64.4 45.5 41.5%
Canada 22.4 21.3 5.5 43.5 41.0 6.1
Japan 3.9 3.4 15.0 7.6 6.9 11.4
Mexico 1.7 2.9 (41.0) 3.4 5.8 (42.1)
Other 0.8 0.6 12.2 1.2 1.4 (6.0)
--------------------------------------- ---------------------------------------------
Totals $ 60.1 52.4 14.6% $ 120.1 100.6 19.5%
======================================= =============================================
Total revenues from clients based in Europe were $31.3 million and $64.4
million for the three and six months ended June 30, 2005, a 29.4% and 41.5%
increase compared to the $24.2 million and $45.5 million for the same periods
last year. The growth in revenues in 2005 from clients based in Europe was a
result of the growth of existing clients, the conversion of new accounts, the
effect of currency translation and the increased use of value added products and
services by clients in Europe.
Total revenues from clients based in Mexico were $1.7 million and $3.4
million for the three and six months ended June 30, 2005, a 41.0% and 42.1%
decrease compared to the $2.9 million and $5.8 million for the same periods last
year. During 2003, a Mexican client notified the Company of its intentions to
utilize its internal global platform and to deconvert in mid-2004. As a result,
revenues for 2005 from Mexico have decreased significantly when compared to
revenues from Mexico for 2004.
Value Added Products and Services
The Company's revenues are impacted by the use of optional value added
products and services of TSYS' processing systems. Value added products and
services are optional features to which each client can choose to subscribe in
order to potentially increase the financial performance of its portfolio. Value
added products and services include: risk management tools and techniques, such
as credit evaluation, fraud detection and prevention, and behavior analysis
tools; and revenue enhancement tools and customer retention programs, such as
loyalty programs and bonus rewards. These revenues can increase or decrease over
time as clients subscribe to or cancel these services. Value added products and
services are included mainly in electronic payment processing services revenue.
For the three months ended June 30, 2005 and 2004, value added products and
services represented 12.1% and 12.9%, respectively, of total revenues. For the
six months ended June 30, 2005 and 2004, value added products and services
represented 12.6% and 13.3%, respectively, of total revenues. Revenues from
these products and services, which include some reimbursable items paid to
third-party vendors, increased 33.1%, or $12.3 million and 25.2% and $19.2
million, for the three and six months ended June 30, 2005 compared to the same
periods last year.
Major Customer
A significant amount of the Company's revenues are derived from long-term
contracts with large clients, including certain major customers. For the three
months ended June 30, 2005, the Company had one major customer which accounted
for approximately 23.8%, or $97.8 million, of total revenues. For the three
months ended June 30, 2004, TSYS had one major customer that accounted for
19.0%, or $54.9 million, of total revenues. For the six months ended June 30,
2005, the Company had one major
- 26 -
Results of Operations (continued)
customer which accounted for approximately 22.4%, or $170.0 million, of total
revenues. For the six months ended June 30, 2004, TSYS had one major customer
that accounted for 18.6%, or $107.2 million, of total revenues.
As previously mentioned, on January 25, 2005, the Company announced that it
had extended its agreement with its major customer for an additional five years
through 2014.
Electronic Payment Processing Services
Electronic payment processing revenues are generated primarily from charges
based on the number of accounts on file, transactions and authorizations
processed, statements mailed, cards embossed and mailed, and other processing
services for cardholder accounts on file. Cardholder accounts on file include
active and inactive consumer credit, retail, debit, stored value, government
services and commercial card accounts. Due to the number of cardholder accounts
processed by TSYS and the expanding use of cards, as well as increases in the
scope of services offered to clients, revenues relating to electronic payment
processing services have continued to grow. Revenues from electronic payment
processing services increased $32.1 million, or 17.3% and $59.4 million, or
16.4%, for the three and six months ended June 30, 2005, respectively, compared
to the same periods in 2004.
Accounts on File (AOF) Data (in millions):
AOF
2005 2004 % Change
------------- ------------ -----------------
At June 30, 388.6 287.0 35.4%
QTD Average 380.7 285.0 33.6%
YTD Average 371.8 281.6 32.0%
AOF by Portfolio Type
2005 2004
---------------------------- --------------------------
At June 30, AOF % AOF % % Change
----------------------------------- ------------- -------------- ------------ ------------- ----------------
Consumer 230.0 59.2 152.0 53.0 51.3
Retail 92.2 23.7 86.5 30.1 6.5
Commercial 28.8 7.4 22.9 8.0 26.1
Government services 17.1 4.4 14.6 5.1 16.9
Stored value 13.2 3.4 4.5 1.5 196.2
Debit 7.3 1.9 6.5 2.3 11.5
----------------------------------- ---------------------------- --------------------------
Total 388.6 100.0 287.0 100.0 35.4
============================ ==========================
AOF by Geographic Area
2005 2004
----------------------------- -----------------------------
At June 30, AOF % AOF % % Change
---------------------------------- ----------------------------- ----------------------------- ------------------
Domestic 335.5 86.3 240.1 83.7 39.7
International 53.1 13.7 46.9 16.3 13.2
---------------------------------- ----------------------------- -----------------------------
Total 388.6 100.0 287.0 100.0 35.4
============================= =============================
Note: The accounts on file distinction between domestic and international is
based on the geographic domicile of processing clients.
- 27 -
Results of Operations (continued)
Activity in AOF
June 2004 to June June 2003 to June
2005 2004
---------------------- ----------------------
Beginning balance 287.0 262.5
Internal growth of existing clients 38.5 29.6
New clients 69.3 6.6
Purges/Sales (5.0) (7.4)
Deconversions (1.2) (4.3)
---------------------- ----------------------
Ending balance 388.6 287.0
====================== ======================
On March 3, 2003, the Company announced that Bank One had selected TSYS to
upgrade its credit card processing. Under the long-term software licensing and
services agreement, TSYS is to provide electronic payment processing services to
Bank One's credit card accounts for at least two years starting in 2004
(excluding statement and card production services). Following the provision of
processing services, TSYS is to license a modified version of its TS2 consumer
and commercial software to Bank One through a perpetual license with a six-year
payment term. This agreement has been superseded by the agreement with JP Morgan
Chase & Co. (Chase) as described below. The Company used the
percentage-of-completion accounting method for its agreement with Bank One and
recognized revenues in proportion to costs incurred. TSYS' revenues from Bank
One were less than 10% of total revenues for the three and six months ended June
30, 2005.
On July 1, 2004, Bank One and Chase merged under the name Chase. On October
13, 2004, TSYS finalized a definitive agreement with Chase to service the
combined card portfolios of Chase Card Services and to upgrade its
card-processing technology. The agreement extends a relationship that started
with TSYS and the former Bank One Corp. in March 2003. Pursuant to the revised
agreement, the first phase of the project was executed successfully and Bank
One's remaining accounts were converted to a modified version of TS2 processing
platform during the fourth quarter of 2004, according to the project's original
schedule. TSYS converted the consumer accounts of Chase to the modified version
of TS2 in July 2005. TSYS expects to maintain the card-processing functions of
Chase Card Services for at least two years. Chase Card Services then has the
option to either extend the processing agreement for up to five additional
two-year periods or migrate the portfolio in-house, under a perpetual license of
a modified version of TS2 with a six-year payment term.
As a result of the new agreement with Chase, TSYS discontinued its use of
the percentage-of- completion accounting method for the original agreement with
Bank One. The revised agreement is being accounted for in accordance with
Financial Accounting Standards Board's (FASB's) Emerging Issues Task Force No.
00-21 (EITF No. 00-21), "Accounting for Revenue Arrangements with Multiple
Deliverables," and other applicable guidance.
TSYS expects that the 2005 earnings per share (EPS) impact of the Chase
agreement will be $0.05-$0.06 per share and the 2006 EPS impact will be
$0.06-$0.07 per share. Beyond 2006, the annual EPS impact of the agreement will
depend upon Chase Card Services' decision to continue the processing agreement
or to exercise its option to license the software.
- 28 -
Results of Operations (continued)
On March 31, 2004, Bank of America acquired FleetBoston. In connection with
the extended agreement with Bank of America, TSYS converted the FleetBoston card
portfolio to TSYS' processing system in March 2005.
In July 2003, Sears and Citigroup announced an agreement for the sale by
Sears to Citigroup of the Sears credit card and financial services businesses.
For the three and six months ended June 30, 2005, TSYS' revenues from the
agreement with Sears represented less than 10% of TSYS' consolidated revenues.
The TSYS/Sears agreement granted to Sears the one-time right to market test
TSYS' pricing and functionality after May 1, 2004, which right was exercised by
Citigroup. In June 2005, TSYS announced that Citigroup will move the Sears
consumer MasterCard and private-label accounts from TSYS in a deconversion that
is expected to occur in the second quarter of 2006. TSYS expects to continue
supporting commercial card accounts for Citibank, as well as Citibank's
California Commerce consumer accounts, according to the terms of the existing
agreements for those portfolios. The impact of the expected deconversion of the
Sears portfolio on the financial position, results of operation and cash flows
of TSYS cannot be determined at this time.
On August 2, 2004, TSYS completed the acquisition of Clarity Payment
Solutions, Inc. (Clarity) for $53.0 million in cash and had direct acquisition
costs in the amount of $515,000. Clarity was renamed TSYS Prepaid. Refer to Note
9 in the notes to unaudited consolidated financial statements for more
information on the acquisition of TSYS Prepaid. For the three and six months
ended June 30, 2005, TSYS' electronic payment processing services revenues
include $6.4 million and $12.9 million, respectively, of TSYS Prepaid's
revenues.
Merchant Services
Merchant services revenues are derived from electronic transaction
processing services primarily to large financial institutions and other merchant
acquirers. Revenues from merchant services include processing all payment forms
including credit, debit, electronic benefit transfer and check truncation for
merchants of all sizes across a wide array of retail market segments. Merchant
services' products and services include: authorization and capture of electronic
transactions; clearing and settlement of electronic transactions; information
reporting services related to electronic transactions; merchant billing
services; and point of sale terminal sales and service.
Revenues from merchant services consist of revenues generated by TSYS'
wholly owned subsidiary Vital and majority owned subsidiary GP Net. Merchant
services revenue for the three and six months ended June 30, 2005 was $68.7
million and $95.8 million, respectively, compared to $6.9 million and $13.2
million for the same periods last year. The increase is completely attributable
to the consolidation of Vital's results effective March 1, 2005. Prior to the
acquisition of Vital, TSYS' revenues included fees TSYS charged to Vital for
back-end processing support.
On March 1, 2005, TSYS acquired the remaining 50% of Vital from Visa for
$95.8 million in cash, including $782,000 of direct acquisition costs. Vital is
now a separate, wholly owned subsidiary of TSYS. As a result of the acquisition
of control of Vital, TSYS changed from the equity method of accounting for the
investment in Vital and began consolidating Vital's balance sheet and results of
operations. Refer to Note 9 in the notes to unaudited consolidated financial
statements for more information on the acquisition of Vital.
- 29 -
Results of Operations (continued)
Other Services
Revenues from other services consist primarily of revenues generated by
TSYS' wholly owned subsidiaries not included in electronic payment processing
services or merchant services, as well as TSYS' business process management
services. Revenues from other services increased $3.5 million, or 8.4%, for the
three months ended June 30, 2005, compared to the same period in 2004. Revenues
from other services increased $11.2 million, or 13.5%, for the six months ended
June 30, 2005, compared to the same period in 2004. Other services revenue
increased primarily due to increased loyalty services from ESC and from new
customers added since last year for business process management services.
Reimbursable Items
As a result of the FASB's Emerging Issues Task Force No. 01-14 (EITF No.
01-14), "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenues and expenses. Reimbursable items
increased $23.2 million, or 41.6%, for the three months ended June 30, 2005, as
compared to the same period last year. Reimbursable items increased $32.2
million, or 27.6 %, for the six months ended June 30, 2005, as compared to the
same period last year. Of the $23.2 million and $32.2 million increase for the
three and six months ended June 30, 2005, $11.7 million and $15.7 million,
respectively is attributable to Vital and TSYS Prepaid. The majority of
reimbursable items relates to the Company's domestic-based clients and is
primarily costs associated with postage.
A summary of the reimbursable revenues for the three and six months ended
June 30, 2005, as compared to 2004, is provided below:
Three months ended Six months ended
June 30, June 30,
- ----------------------------------------------------------------------------------------------------------------------------
Percent Percent
(in thousands) 2005 2004 Change 2005 2004 Change
- -----------------------------------------------------------------------------------------------------------------------------
Postage $ 41,581 37,621 10.5% $ 82,637 80,230 3.0%
Card association access fees 18,440 4,468 312.7 28,295 8,323 240.0
Other 19,154 13,843 38.4 37,851 28,011 35.1
----------------------------- --------------------------------
Total $ 79,175 55,932 41.6% $ 148,783 116,564 27.6%
============================= ================================
Operating Expenses
Total expenses increased 37.8% and 27.7% for the three and six months ended
June 30, 2005, respectively, compared to the same periods in 2004. The increase
in expense includes an increase of $1.0 million and $2.1 million for the three
and six months ended June 30, 2005 and 2004, respectively, related to the
effects of currency translation of its foreign-based subsidiaries and branches.
Excluding reimbursable items, total expenses increased 36.6% and 27.8% for the
three and six months ended June 30, 2005, respectively, compared to the same
periods in 2004. The increase in operating expenses is attributable to changes
in each of the expense categories as described below.
Salaries and Other Personnel Expense
Summarized below are the major components of salaries and other personnel
expenses for the three and six months ended June 30, 2005:
- 30 -
Results of Operations (continued)
Three months ended Six months ended
June 30, June 30,
------------------------------------------------------------------------------------
(in thousands) 2005 2004 % Change 2005 2004 % Change
---------------------------------------- ----------------------------------------
Salaries $ 86,644 67,919 27.6% $ 164,723 136,838 20.4%
Employee benefits 27,979 12,073 131.7 48,802 28,962 68.5
Nonemployee wages 4,840 3,647 32.7 8,354 7,764 7.6
Other 2,556 1,682 52.0 3,279 2,659 23.3
Less capitalized expenses (4,818) (3,097) 55.6 (10,440) (6,137) 70.6
--------------------------- ---------------------------
Totals $ 117,201 82,224 42.6% $ 214,718 170,086 26.2%
=========================== ===========================
Salaries and other personnel expenses increased $35.0 million, or 42.6%,
for the three months ended June 30, 2005, compared to the same period in 2004.
For the six months ended June 30, 2005, salaries and other personnel expenses
increased $44.6 million, or 26.2%, compared to the same period in 2004. Of the
$35.0 million and $44.6 million increase for the three and six months for 2005,
respectively, $19.3 million and $27.4 million are the result of employee related
expenses of Vital and TSYS Prepaid. In addition, the change in employment
expenses is associated with the normal salary increases and related benefits, as
well as higher levels of employment costs capitalized as software development
and contract acquisition costs. The growth in employment expenses included an
increase in the accrual for performance-based incentive benefits.
The Company's salaries and personnel expense is greatly influenced by the
number of employees. Below is a summary of the Company's employee data:
Employee Data:
(Full-time Equivalents) 2005 2004 % Change
----------------------------------- -------------- ------------- ----------------
At June 30, 6,475 5,519 17.3
QTD Average 6,432 5,504 16.9
YTD Average 6,111 5,564 9.8
Through the first six months of 2005, TSYS added 783 employees associated
with the acquisition of Vital. At June 30, 2005, TSYS had 89 employees
associated with the TSYS Prepaid acquisition.
Net Occupancy and Equipment Expense
Summarized below are the major components of net occupancy and equipment
expenses:
- 31 -
Results of Operations (continued)
Three months ended Six months ended
June 30, June 30,
---------------------------------------------------------------------------------------
(in thousands) 2005 2004 % Change 2005 2004 % Change
----------------------------------------- -----------------------------------------
Depreciation and amortization $ 26,267 19,984 31.4% $ 49,768 39,426 26.2%
Equipment and software rentals 21,144 24,330 (13.1) 45,732 46,775 (2.2)
Repairs and maintenance 13,657 6,952 96.5 21,803 18,362 18.7
Impairment of developed software - 10,059 (100.0) 3,137 10,059 (68.8)
Other 7,428 5,168 43.9 13,449 9,920 35.6
---------------------------- ----------------------------
Totals $ 68,496 66,493 3.0% $ 133,889 124,542 7.5%
============================ ============================
Net occupancy and equipment expense increased $2.0 million, or 3.0%, and
$9.3 million, or 7.5%, for the three and six months ended June 30, 2005 over the
same periods in 2004, respectively. Of the $2.0 million and $9.3 million
increase for the three and six months ended June 30, 2005, respectively, $5.5
million and $7.2 million are the result of occupancy and equipment related
expenses of Vital and TSYS Prepaid.
In March 2005, TSYS recognized an impairment loss on developed software of
$3.1 million. Also, the results for 2005 include expenses associated with the
new data centre in Europe, which became operational in August 2004.
The Company was developing its Integrated Payments (IP) Platform supporting
the on-line and off-line debit and stored value markets, which would have given
clients access to all national and regional networks, EBT programs, ATM driving
and switching services for online debit processing. Through 2004, the Company
invested a total of $6.3 million since the project began.
Development relating specifically to the IP on-line debit platform
primarily consisted of a third-party software solution. During the first quarter
of 2005, the Company evaluated its debit solution and decided to modify its
approach in the debit processing market. With the acquisition of Vital and debit
alternatives now available, TSYS determined that it would no longer market this
third-party software product as its on-line debit solution. TSYS will continue
to support this product for existing clients and will enhance and develop a new
solution. As a result, TSYS recognized an impairment charge in net occupancy and
equipment expense of approximately $3.1 million related to this asset. The
impairment charge is reflected in the domestic-based support services segment.
As a result of the impairment charge, TSYS now has $3.2 million capitalized as
of June 30, 2005 related to IP on-line debit platform.
The Company has decided to construct a 102,000 square foot data centre in
the Western part of the United States as part of its disaster recovery plan. The
Company expects to break ground on a $35-40 million facility located in
Chandler, Arizona in September 2005. Construction is expected to take
approximately one year. Management has decided to bring the disaster recovery
function in-house instead of relying on third-party providers. The savings from
bringing this service in-house will offset some of the expenses associated with
the new facility.
- 32 -
Results of Operations (continued)
Other Operating Expenses
Summarized below are the major components of other operating expenses for
the three and six months ended June 30, 2005 and 2004:
Three months ended Six months ended,
June 30, June 30,
---------------------------------- ----------------------------------
(in thousands) 2005 2004 % Change 2005 2004 % Change
---------------------------------- ----------------------------------
Professional advisory services $ 11,876 2,065 475.2 % $ 16,384 3,708 341.9 %
Third-party data processing services 11,653 1,317 784.0 16,450 2,616 529.0
Court costs associated with debt
collection services 8,295 8,225 0.8 16,276 18,032 (9.7)
Terminal deployment costs 7,413 - nm 9,711 - nm
Supplies and stationery 7,389 6,379 15.8 14,070 13,082 7.6
Travel and business development 6,069 2,422 150.6 7,387 4,468 65.3
Amortization of conversion costs 3,720 2,797 33.0 7,174 5,515 30.1
Management fees 2,026 2,231 9.2 4,097 4,481 (8.6)
Amortization of acquisition intangibles 1,931 467 314.4 3,222 933 245.6
Transaction processing provisions 1,486 3,940 (62.3) 4,595 4,865 (5.5)
Bad debt expense and billing adjustments (490) (669) (26.6) 2,688 (1,373) (295.8)
Other 15,863 8,527 86.2 28,388 15,960 77.9
Less capitalized expenses (8,206) - nm (10,257) (35) nm
------------------- ---------------------
Totals $ 69,025 37,701 83.0 % $ 120,185 72,252 66.3 %
=================== =====================
nm = not meaningful
Other operating expenses for the three and six months ended June 30, 2005
increased $31.3 million and $47.9 million, or 83.0% and 66.3%, respectively, as
compared to the same periods in 2004. Of the $31.3 million and $47.9 million
increases, $32.2 million and $47.0 million, respectively, is the result of other
operating related expenses of Vital and TSYS Prepaid.
Other operating expenses include, among other things, amortization of
conversion costs, costs associated with delivering merchant services,
professional advisory fees and court costs associated with its debt collection
business. Other operating expenses also include charges for processing errors,
contractual commitments and bad debt expense. As described in the Critical
Accounting Policies section in the 2004 Form 10-K, management's evaluation of
the adequacy of its transaction processing reserves and allowance for doubtful
accounts is based on a formal analysis which assesses the probability of losses
related to contractual contingencies, processing errors and uncollectible
accounts. Increases and decreases in transaction processing provisions and
charges for bad debt expense are reflected in other operating expenses.
Operating Income
Operating income increased 61.5% and 56.0% for the three and six months
ended June 30, 2005, respectively, over the same periods in 2004. The Company's
operating profit margin for the three and six months ended June 30, 2005 was
18.6% and 18.8%, respectively, compared to 16.3% and 15.9% for the same periods
last year. The margins for 2005 increased when compared to the same period in
2004
- 33 -
Results of Operations (continued)
mainly as a result of the consolidated results of Vital, increased revenues and
benefits associated with increased operating leverage.
The Company's operating profit is impacted by the acquisition of Vital.
Prior to acquiring control, TSYS accounted for its investment in Vital using the
equity method of accounting. Only TSYS' share of Vital's earnings was included
in TSYS' net income. After acquiring control of Vital, TSYS began consolidating
Vital's results of operations. By consolidating the results of Vital, the impact
will increase operating profit as compared to periods that TSYS used the equity
method of accounting.
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 June 30, 2005 was 23.1%, compared to
20.2% for the three months ended June 30, 2004; for the six months ended June
30, 2005, the Company's operating margin excluding reimbursables was 23.3%,
compared to 19.9% for the same period last year.
Below is the reconciliation between reported operating margins and adjusted
operating margins excluding reimbursable items for the three and six months
ended June 30, 2005 and 2004, respectively:
Three months ended Six months ended
June 30, June 30,
- ---------------------------------------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------- -----------------
Operating income (a) $ 76,346 47,272 142,652 91,414
================= ================= ================== =================
Total revenues (b) $ 410,243 289,622 760,227 574,858
================= ================= ================== =================
Operating margin (as reported) (a)/(b) 18.6% 16.3% 18.8% 15.9%
================= ================= ================== =================
Revenue before reimbursable items (c) $ 331,068 233,690 611,444 458,294
================= ================= ================== =================
Adjusted operating margin (a)/(c) 23.1% 20.2% 23.3% 19.9%
================= ================= ================== =================
Nonoperating Income (Expense)
Interest income for the three months ended June 30, 2005 was $1.1 million,
an increase of $541,000, compared to $537,000 million for the same period in
2004. Interest income for the six months ended June 30, 2005 was $2.3 million,
an increase of approximately $1.3 million, compared to $1.0 million for the same
period in 2004. The increase in interest income is primarily attributable to the
fluctuations in cash available for investment and changes in short-term interest
rates.
Interest expense for the three months ended June 30, 2005 was $105,000, an
increase of $66,000, compared to $39,000 for the same period in 2004. Interest
expense for the six months ended June 30, 2005 was $175,000, a decrease of
$607,000, compared to $782,000 for the same period in 2004. The decrease is the
result of the interest expense in 2004 related to the Company's software
obligations. On March 31, 2004, TSYS paid the remaining obligations for
mainframe software licenses.
- 34 -
Results of Operations (continued)
The Company records foreign currency translation adjustments on
foreign-denominated balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British
Pounds Sterling (BPS). As the Company translates the foreign-denominated cash
balances into US dollars, the translated cash balance is adjusted upward or
downward depending upon the foreign currency exchange movements. The upward or
downward adjustment is recorded as a gain or loss on foreign currency
translation in the Company's statements of income. As those cash accounts have
increased, the upward or downward adjustments have increased. The majority of
the translation loss of $494,000 and $827,000 for the three and six months ended
June 30, 2005, 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 June 30, 2005 was approximately $5.3 million, the
majority of which is denominated in Euros.
Income Taxes
TSYS' effective income tax rate for the three months ended June 30, 2005
was 34.8%, compared to 34.2% for the same period in 2004. TSYS' effective income
tax rate for the six months ended June 30, 2005 was 35.0%, compared to 34.2% for
the same period in 2004. The increase in the effective tax rate for the three
and six months ended June 30, 2005 is a result of increased foreign earnings.
The calculation of the effective tax rate is income taxes divided by TSYS'
pretax income adjusted for minority interests in consolidated subsidiaries' net
income and equity earnings of the Vital joint venture. The Company expects its
effective income tax rate for 2005 to be approximately 34%-35%.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $590,000 and
$6.7 million for the three months ended June 30, 2005 and 2004, respectively.
TSYS' share of income from its equity in joint ventures was $4.3 million and
$12.3 million for the six months ended June 30, 2005 and 2004, respectively. The
decreases for the quarter and first six months are primarily attributable to the
purchase of the remaining 50% of Vital on March 1, 2005 and the inclusion of
Vital's operating results in TSYS' statement of income. Refer to Note 9 in the
notes to unaudited consolidated financial statement for more information on the
acquisition of Vital.
Vital Processing Services, L.L.C.
As a result of the acquisition of control of Vital, TSYS changed from the
equity method of accounting for the investment in Vital and began consolidating
Vital's balance sheet and results of operations in the statements of income
beginning March 1, 2005. For the two months in 2005 prior to the acquisition,
the Company's equity in income of joint ventures related to Vital was $3.2
million.
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 and six months ended June 30, 2005, the Company's equity
in income of joint ventures related to TSYS de Mexico was $590,000 and $1.1
million, respectively, representing an 84.9% and 58.3% increase, or $272,000 and
$405,000, compared to $318,000 and $693,000, respectively, for the same periods
in the prior year.
- 35 -
Results of Operations (continued)
TSYS pays TSYS de Mexico a processing support fee for certain client
relationship and network services that TSYS de Mexico has assumed from TSYS.
This processing support fee decreased as a result of the deconversion of a TSYS
client in Mexico. Below is a summary of the fee for the three and six months
ended June 30, 2005 and 2004, respectively.
Processing support fee 2005 2004
---------------------------------------------------------------------------------------
For the three months ended June 30, $35,600 46,000
For the six months ended June 30, 69,000 108,000
Net Income
Net income for the three months ended June 30, 2005 increased 41.1% to
$50.6 million, or basic and diluted earnings per share of $0.26, compared to
$35.9 million, or basic and diluted earnings per share of $0.18, for the same
period in 2004. Net income for the six months ended June 30, 2005 increased
41.4% to $96.8 million, or basic and diluted earnings per share of $0.49,
compared to $68.4 million, or basic and diluted earnings per share of $0.35, for
the same period in 2004.
Net Profit Margin
The Company's net profit margin for the three months ended June 30, 2005
was 12.3%, compared to 12.4% for the same period last year. The Company's net
profit margin for the six months ended June 30, 2005 was 12.7%, compared to
11.9% for the same period last year.
The Company's net profit margin is also impacted by the acquisition of
Vital. Prior to acquiring control, TSYS accounted for its investment in Vital
using the equity method of accounting. Only TSYS' share of Vital's earnings was
included in TSYS' net income. After acquiring control of Vital, TSYS began
consolidating Vital's results of operations on March 1, 2005. By consolidating
the results of Vital, the impact will be a lower net profit margin as compared
to periods that used the equity method of accounting.
Management believes that reimbursable items distort net profit margin as
defined by generally accepted accounting principles. Management evaluates the
Company's operating performance based upon net profit margin excluding
reimbursable items. Management believes that net profit margin excluding
reimbursable items is more useful because reimbursable items do not impact
profitability as the Company receives reimbursement for expenses incurred on
behalf of its clients.
Excluding reimbursable items, the Company's net profit margin for the three
months ended June 30, 2005 was 15.3%, compared to 15.4% for the three months
ended June 30, 2004. Excluding reimbursable items, the Company's net profit
margin for the six months ended June 30, 2005 was 15.8%, compared to 14.9% for
the six months ended June 30, 2004.
Below is the reconciliation between reported net profit margin and adjusted
net profit margin excluding reimbursable items for the three and six months
ended June 30, 2005 and 2004, respectively:
- 36 -
Results of Operations (continued)
Three months ended Six months ended
June 30, June 30,
- --------------------------------------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Net income (a) $ 50,643 35,886 96,766 68,447
================= ================= ================= ==================
Total revenues (b) $ 410,243 289,622 760,227 574,858
================= ================= ================= ==================
Net profit margin (as reported) (a)/(b) 12.3% 12.4% 12.7% 11.9%
================= ================= ================= ==================
Revenue before reimbursable items (c) $ 331,068 233,690 611,444 458,294
================= ================= ================= ==================
Adjusted net profit margin (a)/(c) 15.3% 15.4% 15.8% 14.9%
================= ================= ================= ==================
Projected Outlook for 2005
On July 19, 2005, TSYS announced it was raising its projected outlook for
2005. TSYS now expects its 2005 net income growth to be in the range of 25%-28%,
based on the following assumptions: total revenues increasing 31%-33% in 2005;
revenues before reimbursable items increasing 33%-35%; Vital adding $225-$235
million in annual revenue; and accounts on file at the end of 2005 increasing to
approximately 430-435 million.
On April 14, 2005, the Securities and Exchange Commission (SEC) approved a
rule that delays the effective date of SFAS No. 123R for public companies that
do not file as small business issuers until the first annual or interim
reporting period of the first fiscal year that begins on or after June 15, 2005.
The Company plans on adopting SFAS No. 123R on January 1, 2006. The Company
expects that the impact of adopting SFAS No. 123R for expensing existing stock
options will have a negative impact upon its results of operations and statement
of financial position. The Company expects that the impact of expensing existing
stock option grants, as well as the impact of any anticipated stock option
grants to be approximately $0.02-$0.03 per share in 2006. The Company does not
expect the impact of adopting SFAS No. 123R to have a material impact upon its
cash flow.
Financial Position, Liquidity and Capital Resources
The Consolidated Statements of Cash Flows detail the Company's cash flows
from operating, investing and financing activities. TSYS' primary method of
funding its operations and growth has been cash generated from current
operations and the use of leases. TSYS has occasionally used borrowed funds to
supplement financing of capital expenditures.
Cash Flows From Operating Activities
Six months ended
June 30,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Net income $ 96,766 68,447
Depreciation and amortization 69,522 52,781
Other non cash items and charges, net 13,366 11,868
Working capital items (141,901) (20,641)
----------------- -----------------
Net cash provided from operating activities $ 37,753 112,455
================= =================
TSYS' main source of funds is derived from operating activities,
specifically net income. During the six months ended June 30, 2005, the Company
generated $37.8 million in cash from operating activities compared to $112.5
million for the same period last year. The decrease in 2005 in net cash provided
from operating activities was the result of the use of cash for working capital
items.
- 37 -
Financial Position, Liquidity and Capital Resources (continued)
Working capital items include accounts receivable, prepaid expenses and
other assets, accounts payable, accrued salaries and employee benefits and other
current liabilities. The change in accounts receivable at June 30, 2005 as
compared to December 31, 2004 is the result of timing of collections compared to
billings. The change in accounts payable and other liabilities for the same
period is the result of the timing of payments for long-term software contracts,
funding of performance-based incentives and payments of vendor invoices.
Cash Flows From Investing Activities
Six months ended
June 30,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
-------------------------------------------------------------------------------------------------------------------
Purchase of property and equipment, net $ (20,383) (39,326)
Additions to licensed computer software from vendors (10,647) (14,001)
Additions to internally developed computer software (10,388) (3,703)
Cash used in acquisitions, net of cash acquired (56,983) -
Dividends from joint ventures 1,659 15,876
Contract acquisition costs (10,981) (3,283)
----------------- -----------------
Net cash used in investing activities $ (107,723) (44,437)
================= =================
The major uses of cash for investing activities have been the addition of
property and equipment, primarily computer equipment, the purchase of licensed
and internal development of computer software, investments in contract
acquisition costs associated with obtaining and servicing new or existing
clients, and business acquisitions. The major source of funds from investing
activities is the dividend payment from its joint ventures. The Company used
$107.7 million in cash for investing activities for the six months ended June
30, 2005, compared to $44.4 million for the same period in 2004. The major use
of cash for investing activities in 2005 was for the purchase of Vital.
Property and Equipment
Capital expenditures for property and equipment during the three month
periods ended June 30, 2005 and 2004 were $9.7 million and $20.4 million,
respectively. For the six month period ended June 30, 2005, capital expenditures
for property and equipment were $20.4 million compared to $39.3 million during
the same period last year. The majority of the capital expenditure amounts in
2004 relate to computer equipment and the completion of the new European data
centre.
As previously discussed on page 32, the Company has decided to construct a
102,000 square foot data centre in Chandler, AZ as part of its disaster recovery
plan. The Company expects to break ground on the $35-40 million facility in
September 2005 and should be completed in one year.
Licensed Computer Software from Vendors
Expenditures for licensed computer software from vendors were $4.7 million
and $6.6 million for the three months ended June 30, 2005 and 2004,
respectively. Expenditures for licensed computer software from vendors for the
six months ended June 30, 2005 were $10.6 million, compared to $14.0 million for
the same period in 2004. 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.
- 38 -
Financial Position, Liquidity and Capital Resources (continued)
Internally Developed Computer Software Costs
Additions to capitalized software development costs for the six months
ended June 30, 2005 were $10.4 million, compared to $3.7 million for the same
period in 2004. The following table is a summary of the additions to internally
developed computer software costs by project for the six months ended June 30,
2005 and 2004, respectively:
Six months ended
June 30,
-------------------------------------------
(in millions) 2005 2004
------------------------------------------------------------------------------------
Vital Express $ 8.2 -
MSII 1.8 -
Other 0.4 3.7
----------------- ------------------
Total $ 10.4 3.7
================= ==================
The increase in the amount capitalized as software development costs in
2005, as compared to 2004, is mainly attributable to Vital's development of
Vital Express and MSII. The Company remains committed to developing and
enhancing its processing solutions to expand its service offerings. In addition
to developing solutions, the Company has expanded its service offerings through
strategic acquisitions, such as TSYS Prepaid.
Through its Vital subsidiary, the Company is internally developing two
software projects - MSII and Vital Express. MSII is the enhanced version of the
current Merchant Accounting System Initiator (MAS) system that was originally
developed by TSYS in the mid-1970's. This project had reached technological
feasibility prior to TSYS' acquisition of control of Vital and is expected to be
introduced in the marketplace in 2006. The Company capitalized approximately
$1.8 million since acquiring Vital, and has a total of $2.3 million capitalized
since the project began.
Vital Express is currently being developed by Vital and is a tool that will
provide a single point of entry system which enables acquirers to more easily
load and maintain their merchant populations. Vital Express is expected to be
introduced in the marketplace in 2006. This project had reached technological
feasibility prior to TSYS' acquisition of control of Vital. The Company
capitalized approximately $8.2 million since acquiring Vital, and has a total of
$16.6 million capitalized since the project began.
The Company continues to develop TSYS ProphIT, a Web-based process
management system that provides direct access to account information and other
system interfaces to help streamline an organization's business processes. TSYS
ProphIT is currently being offered to TSYS' processing clients with general
release of the core platform having occurred in the fourth quarter of 2003.
Continued development of TSYS ProphIT provides increased and enhanced
functionality to the core platform, to include additional customer service
functions. The Company has invested a total of $30.4 million since the project
began.
- 39 -
Financial Position, Liquidity and Capital Resources (continued)
The Company was developing its Integrated Payments Platform supporting the
on-line and off-line debit and stored value markets, which would have given
clients access to all national and regional networks, EBT programs, ATM driving
and switching services for online debit processing. The Company invested a total
of $6.3 million since the project began. As previously mentioned on page 32, the
Company evaluated its debit solution and decided to modify its approach in the
debit processing market. In March 2005, TSYS recognized an impairment charge in
net occupancy and equipment expense of approximately $3.1 million related to its
on-line debit solution. As of June 30, 2005, the Company has $3.2 million
capitalized related to this asset.
Cash Used in Acquisitions
During the first quarter of 2005, the Company purchased Vital for
approximately $95.8 million, and had direct acquisition costs of $782,000.
Dividends Received from Joint Ventures
During 2005, the Company received a dividend payment of $1.7 million from
TSYS de Mexico, compared to $876,000 for the same period last year. In 2004, the
Company received a dividend payment of $15.0 million from its Vital joint
venture.
Contract Acquisition Costs
TSYS makes cash payments for processing rights, third-party development
costs and other direct salary related costs in connection with converting new
customers to the Company's processing systems. The Company's investments in
contract acquisition costs were $5.6 million for the three months ended June 30,
2005, bringing the total for 2005 to $11.0 million, compared to $3.3 million for
the six months ended June 30, 2004. The Company did not have a cash payment for
processing rights for the six months ended June 30, 2005 or 2004.
Conversion cost additions were $11.0 million and $3.3 million for the six
months ended June 30, 2005 and 2004, respectively. The increase in the amount of
conversion cost additions for 2005, as compared to 2004, is the result of the
discontinued use of the percentage-of-completion accounting method for TSYS'
agreement with Bank One.
Cash Flows From Financing Activities
Six months ended
June 30,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Proceeds from borrowings of long-term debt $ 48,142 -
Principal payments on long-term debt borrowings, capital lease obligations
and software obligations (48,923) (42,039)
Dividends paid on common stock (15,757) (7,873)
Purchase of common stock - (1,188)
Other 427 1,192
----------------- -----------------
Net cash used in financing activities $ (16,111) (49,908)
================= =================
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
- 40 -
Financial Position, Liquidity and Capital Resources (continued)
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 six months ended June 30, 2005 was $16.1 million mainly as a result of
the payments of dividends. Net cash used in financing activities for the six
months ended June 30, 2004 was $49.9 million mainly as a result of the payments
related to the software obligations, and to a lesser extent, the purchases of
common stock and payments of dividends.
Software Obligations
On March 31, 2004, the Company paid in full the obligations related to
licensed mainframe software. The effective interest rates related to the
software obligations were well above current market rates.
Line of Credit
TSYS has a $45.0 million long-term line of credit from a banking affiliate
of Synovus. A detailed discussion related to the line of credit is in Note 6 in
the notes to the unaudited consolidated financial statements on page 16. During
the six months ended June 30, 2005, the Company utilized the automatic draw-down
facility for temporary funding and repaid the balances within days of borrowing.
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 were to be purchased from time to time over a two year
period and depended on various factors including price, market conditions,
acquisitions and the general financial position of TSYS. Repurchased shares will
be used for general corporate purposes. Between January 2005 and April 2005, the
Company did not purchase any shares. Since the plan was announced, the Company
purchased 577,491 shares at an average cost of $19.07 per share. The plan
expired on April 15, 2005.
Dividends
Dividends on common stock of $7.9 million were paid during the three months
ended June 30, 2005, bringing the total for 2005 to $15.8 million compared to
$7.9 million paid during the six months ended June 30, 2004. On April 21, 2005,
the Company announced an increase in its quarterly dividend of 50% from $0.04 to
$0.06 per share. This dividend amount was paid on July 1, 2005, to shareholders
of record at the close of business on June 23, 2005. On April 15, 2004, the
Company announced it would double its quarterly dividend from $0.02 to $0.04 per
share.
Significant Noncash Transactions
During the first quarter of 2005, the Company issued 221,902 shares of
common stock with a market value of $5.1 million to certain key executive
officers and non-management members of its board of directors under restricted
stock bonus awards for services to be provided by such officers and directors in
the future. The market value of the common stock at the date of issuance is
included in the shareholders' equity section of the Company's consolidated
balance sheet and is amortized as compensation expense over the vesting period
of the awards. Common stock issued under restricted stock bonus awards is
considered outstanding for purposes of the computation of basic and diluted
earnings per share.
- 41 -
Financial Position, Liquidity and Capital Resources (continued)
On July 19, 2005, the Company issued 5,000 shares of common stock with a
market value of $120,000 to a certain key officer under a restricted stock bonus
award for services to be provided by such officer in the future. The market
value of the common stock is amortized as compensation expense over the vesting
period of the award.
Foreign Exchange
TSYS operates internationally and is subject to potentially adverse
movements in foreign currency exchange rates. Since December 2000, TSYS has not
entered into foreign exchange forward contracts to reduce its exposure to
foreign currency rate changes. TSYS continues to analyze potential hedging
instruments to safeguard it from significant foreign currency translation risks.
Impact of Inflation
Although the impact of inflation on its operations cannot be precisely
determined, the Company believes that by controlling its operating expenses, and
by taking advantage of more efficient computer hardware and software, it can
minimize the impact of inflation.
Working Capital
TSYS may seek additional external sources of capital in the future. The
form of any such financing will vary depending upon prevailing market and other
conditions and may include short-term or long-term borrowings from financial
institutions or the issuance of additional equity and/or debt securities such as
industrial revenue bonds. However, there can be no assurance that funds will be
available on terms acceptable to TSYS. Management expects that TSYS will
continue to be able to fund a significant portion of its capital expenditure
needs through internally generated cash in the future, as evidenced by TSYS'
current ratio of 1.7. At June 30, 2005, TSYS had working capital of $184.0
million compared to $170.3 million at December 31, 2004.
Legal Proceedings
The Company is subject to lawsuits, claims and other complaints arising out
of the ordinary conduct of its business. In the opinion of management, based in
part upon the advise of legal counsel, all matters are believed to be adequately
covered by insurance, or if not covered, are believed to be without merit or are
of such kind or involve such amounts that would not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company if disposed of unfavorably. The Company establishes reserves for
expected future litigation exposures that TSYS determines to be both probable
and reasonably estimable.
The Company has received notification from the United States Attorneys'
Office for the Northern District of California that the United States Department
of Justice is investigating whether the Company and/or one of its large credit
card processing clients violated the False Claims Act, 31 U.S.C. SS3729-33, in
connection with mailings made on behalf of the client from July 1997 through
November 2001. The subject matter of the investigation relates to the U.S.
Postal Service's Move Update Requirements. In general, the Postal Service's Move
Update Requirements are designed to reduce the volume of mail that is returned
to sender as undeliverable as addressed. In effect, these requirements provide,
among other things, various procedures that may be utilized to maintain the
accuracy of mailing lists in exchange for discounts on postal rates. The Company
has received a subpoena from the Office of the Inspector
- 42 -
Legal Proceedings (continued)
General of the U.S. Postal Service, and has produced documents responsive to the
subpoena. The Company continues to cooperate with the Department of Justice in
the investigation, and there can be no assurance as to the timing or outcome of
the investigation, including whether the investigation will result in any
criminal or civil fines, penalties, judgments or treble damages or other claims
against the Company. The Company established a reserve during the quarter ended
March 31, 2005 relating to this investigation. However, there can be no
assurance that the Company will not suffer a loss in connection with this
investigation in an amount exceeding such reserve or that the Company will not
be required to reserve additional amounts in future periods.
Recent Accounting Pronouncements
The Company's Annual Report on Form 10-K for the year ended December 31,
2004, as filed with the Securities and Exchange Commission (SEC), contains a
discussion of recent accounting pronouncements and the expected impact on the
Company's financial statements. The following accounting standards have been
modified during this year and are expected to have a material impact on the
financial statements of the Company.
On April 14, 2005, the Securities and Exchange Commission (SEC) approved a
rule that delays the effective date of SFAS No. 123R for public companies that
do not file as small business issuers until the first annual or interim
reporting period of the first fiscal year that begins on or after June 15, 2005.
The Company plans on adopting SFAS No. 123R on January 1, 2006. The Company
expects that the impact of adopting SFAS No. 123R for expensing existing stock
options will have a negative impact upon its results of operations and statement
of financial position. The Company expects that the impact of expensing existing
stock option grants to be approximately $0.02-$0.03 per share in 2006. The
Company does not expect the impact of adopting SFAS No. 123R to have a material
impact upon its cash flow.
In May 2005, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 154 (SFAS No. 154), "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No.
3." SFAS No. 154 replaces APB Opinion No. 20, "Accounting Changes," and
Statement of Financial Accounting Standards No. 3, "Reporting Accounting Changes
in Interim Financial Statements," and changes the requirements for the
accounting for and reporting of a change in accounting principle. SFAS No. 154
applies to all voluntary changes in accounting principle by requiring
retrospective application to prior periods' financial statements, unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. The provisions of this Statement shall be effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company does not expect the impact of SFAS No. 154
on its financial position, results of operations or cash flows to be material.
Forward-Looking Statements
Certain statements contained in this filing which are not statements of
historical fact constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act (the Act). These forward-looking
statements include, among others, statements regarding the expected deconversion
of the Sears consumer MasterCard and private-label accounts in the second
quarter of 2006, TSYS' expectation that it will maintain the card-processing
functions of Chase for at least two years, TSYS' expectation with respect to the
impact of the Chase contract on its earnings per share
- 43 -
Forward-Looking Statements (continued)
growth for 2005 and 2006, TSYS' expectation that it will continue supporting
commercial card accounts for Citibank, as well as Citibank's California Commerce
consumer accounts, the expected adoption date of expensing stock options and the
expected financial impact of expensing options, TSYS' expected growth in net
income for 2005, the expected time of introduction to the market of certain
Vital software products, any matter that may arise out of the United States
Department of Justice's investigation, and the assumptions underlying such
statements, including, with respect to TSYS' expected increase in net income for
2005, an increase in total revenues of 31%-33%; Vital Processing Services adding
$225-$235 million in annual revenues; accounts on file at the end of 2005 will
be between 430 and 435 million; and revenue before reimbursable items increasing
33%-35%. In addition, certain statements in future filings by TSYS with the
Securities and Exchange Commission, in press releases, and in oral and written
statements made by or with the approval of TSYS which are not statements of
historical fact constitute forward-looking statements within the meaning of the
Act. Examples of forward-looking statements include, but are not limited to: (i)
projections of revenue, income or loss, earnings or loss per share, the payment
or nonpayment of dividends, capital structure and other financial items; (ii)
statements of plans and objectives of TSYS or its management or Board of
Directors, including those relating to products or services; (iii) statements of
future economic performance; and (iv) statements of assumptions underlying such
statements. Words such as "believes," "anticipates," "expects," "intends,"
"targeted," "estimates," "projects," "plans," "may," "could," "should," "would,"
and similar expressions are intended to identify forward-looking statements but
are not the exclusive means of identifying these statements.
These statements are based upon the current beliefs and expectations of
TSYS' management and are subject to significant risks and uncertainties. Actual
results may differ materially from those contemplated by the forward-looking
statements. A number of important factors could cause actual results to differ
materially from those contemplated by our forward-looking statements. Many of
these factors are beyond TSYS' ability to control or predict. These factors
include, but are not limited to: (i) revenues that are lower than anticipated;
(ii) Vital's addition to revenue is lower than anticipated; (iii) accounts on
file at the end of 2005 are lower than anticipated; (iv) TSYS incurs expenses
associated with the signing of a significant client; (v) internal growth rates
for TSYS' existing customers are lower than anticipated; (vi) TSYS does not
convert clients' portfolios as scheduled; (vii) adverse developments with
respect to foreign currency exchange rates; (viii) adverse developments with
respect to entering into contracts with new clients and retaining current
clients; (ix) the merger of TSYS clients with entities that are not TSYS clients
or the sale of portfolios by TSYS clients to entities that are not TSYS clients;
(x) TSYS is unable to control expenses and increase market share; (xi) adverse
developments with respect to the credit card industry in general; (xii) TSYS is
unable to successfully manage any impact from slowing economic conditions or
consumer spending; (xiii) the impact of acquisitions, including their being more
difficult to integrate than anticipated; (xiv) the costs and effects of
litigation, investigations or similar matters or adverse facts and developments
relating thereto; (xv) the impact of changes in accounting principles; (xvi)
TSYS' inability to timely, successfully and cost-effectively improve and
implement processing systems to provide new products, increased functionality
and increased efficiencies; (xvii) TSYS' inability to anticipate and respond to
technological changes, particularly with respect to e-commerce; (xviii) changes
occur in laws, regulations, credit card associations rules or other industry
standards affecting TSYS' business which require significant product
redevelopment efforts or reduce the market for or value of its products; (xix)
successfully managing the potential both for patent protection and patent
liability in the context of rapidly developing legal framework for expansive
patent protection; (xx) no material breach of security of any of our systems;
(xxi) overall market conditions;
- 44 -
Forward-Looking Statements (continued)
(xxii) the impact on TSYS' business, as well as on the risks set forth above, of
various domestic or international military or terrorist activities or conflicts;
and (xxiii) TSYS' ability to manage the foregoing and other risks.
These forward-looking statements speak only as of the date on which they
are made, and TSYS undertakes no obligation to update any forward-looking
statement as a result of new information, future developments or otherwise.
- 45 -
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 June 30, 2005 was $3.0
million. The amount of other comprehensive income for the three months ended
June 30, 2004 was $632,000. The amount of other comprehensive loss for the six
months ended June 30, 2005 was $5.4 million. The amount of other comprehensive
income for the six months ended June 30, 2004 was $2.6 million. Currently, TSYS
does not use financial instruments to hedge its exposure to exchange rate
changes.
The carrying value of the net assets of its foreign operations in Europe,
Mexico, Canada and Japan was approximately (in U.S. dollars) $135.3 million,
$3.9 million, $0.8 million and $13.4 million, respectively, at June 30, 2005.
The Company also records foreign currency translation adjustments
associated with other balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British Pound
Sterling (BPS). As the Company translates the foreign-denominated cash balances
into US dollars, the translated cash balance is adjusted upward or downward
depending upon the foreign currency exchange movements. The upward or downward
adjustment is recorded as a gain or loss on foreign currency translation in the
Company's statements of income. As those cash accounts have increased, the
upward or downward adjustments have increased. The majority of the translation
loss of $494,000 and $827,000 for the three and six months ended June 30, 2005,
respectively, relates to the translation of cash accounts. The balance of the
foreign-denominated cash accounts subject to risk of translation gains or losses
at June 30, 2005 was approximately $5.3 million, the majority of which is
denominated in Euros.
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 June 30,
2005.
---------------------------------------------------------------------------------------------
Effect of Basis Point Change
---------------------------------------------------------------------------------------------
Increase in basis point of Decrease in basis point of
---------------------------------------------------------------------------------------------
(in thousands) 100 500 1,000 100 500 1,000
- ------------------------------------------------------ ----------------- ---------------- ------------ -------------- --------------
Effect on income before income
taxes $ (53) (267) (534) 53 267 534
--------------- ----------------- ---------------- ------------ -------------- --------------
The foreign currency risks associated with other currencies is not
significant.
- 46 -
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 June 30, 2005, 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 one major customer that accounts for a large portion of its revenues, which
subject it to credit risk.
Concentration of Volume of Business Transacted Risk
TSYS works to maintain a large and diverse client base across various
industries to minimize the risk of any one client accounting for a large portion
of its revenues. TSYS does, however, have one major customer that accounts for a
large portion of its revenues. This one major customer has a long-term
relationship with the Company.
TSYS utilizes several large and diverse suppliers across various industries
to minimize its reliance on any one supplier. However, TSYS does rely on a
relatively few major suppliers for a significant portion of its licensed
computer software and hardware needs. The relationship with these particular
vendors is well established. These particular vendors are large, well-known and
respected entities in their industry.
- 47 -
TOTAL SYSTEM SERVICES, INC.
Item 4 - Controls and Procedures
We have evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period covered by this
quarterly report as required by Rule 13a-15 of the Securities Exchange Act of
1934, as amended. This evaluation was carried out under the supervision and with
the participation of our management, including our chief executive officer and
chief financial officer. Based on this evaluation, these officers have concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to TSYS (including its consolidated
subsidiaries) required to be included in our periodic Securities and Exchange
Commission filings. No change in TSYS' internal control over financial reporting
occurred during the period covered by this report that materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.
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TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth information regarding the Company's
purchases of its common stock on a monthly basis during the three months ended
June 30, 2005:
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
Maximum Number of
Total Number of Shares Shares That May Yet Be
Purchased as Part of Purchased Under the
Total Number of Shares Average Price Paid per Publicly Announced Plans or Programs
Period Purchased Share Plans or Programs
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
1,422,509
April 2005 - $- - -
May 2005 - - - -
June 2005 - - - -
- --------------------------- ------------------------ ------------------------ ------------------------ ------------------------
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. Through April 15, 2005, the Company did not repurchase any
shares of its common stock during the current year. Over the course of the plan,
through April 15, 2005, the Company repurchased 577,491 shares of its common
stock at a cost of $11.0 million, or an average cost of $19.07 per share. The
plan expired on April 15, 2005.
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TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 4 - Submission of Matters to a Vote of Security Holders
The annual shareholders' meeting of Total System Services, Inc. was held
April 21, 2005. There were two proposals voted on at the meeting.
Proposal I voted on at the meeting was the election of five directors.
Following is a tabulation of votes for each nominee:
VOTES
NOMINEE FOR WITHHELD AUTHORITY TO VOTE
------------------------------------ -------------------------- -----------------------------
Kriss Cloninger III 184,321,565 2,811,994
G. Wayne Clough 186,856,587 276,972
H. Lynn Page 186,796,086 337,473
Philip W. Tomlinson 185,995,464 1,138,095
Richard W. Ussery 186,000,456 1,133,103
Proposal II voted on at the meeting was the ratification of the appointment
of KPMG LLP as the Independent Auditor. Following is a tabulation of votes:
FOR 186,849,961
AGAINST 240,307
ABSTAIN 43,291
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TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 6 - Exhibits
a) Exhibits
Exhibit Number Description
--------------------- ---------------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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TOTAL SYSTEM SERVICES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL SYSTEM SERVICES, INC.
Date: August 1, 2005 by: /s/ Philip W. Tomlinson
-------------------------------------------------------------
Philip W. Tomlinson
Chief Executive Officer
Date: August 1, 2005 by: /s/ James B. Lipham
-------------------------------------------------------------
James B. Lipham
Chief Financial Officer
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TOTAL SYSTEM SERVICES, INC.
Exhibit Index
Exhibit Number Description
-------------------- --------------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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