UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 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 or organization)
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 Exchange Act).
Yes [X] No [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
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: November 3, 2005
- ------------------------------ -------------------------------------
Common Stock, $0.10 par value 197,274,881
TSYS LOGO (OBJECT OMITTED)
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
Part I. Financial Information --------
Item 1. Financial Statements
Consolidated Balance Sheets (unaudited) - September 30, 2005 and December
31, 2004 3
Consolidated Statements of Income (unaudited) - Three and nine months ended
September 30, 2005 and 2004 5
Consolidated Statements of Cash Flows (unaudited) - Nine months ended
September 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 47
Item 4. Controls and Procedures
49
Part II. Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 50
Item 6. Exhibits 51
Signatures 52
Exhibit Index 53
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Consolidated Balance Sheets
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(in thousands, except per share information) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $127.5 million and $176.6 million on
deposit with a related party at 2005 and 2004, respectively) $ 199,356 231,806
Restricted cash (includes $7.3 million and $5.7 million on deposit with a
related party at 2005 and 2004, respectively) 29,382 24,993
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $14.3 million and $6.8 million at 2005 and 2004,
respectively; (includes $0.2 million and $0.9 million from a related party
at 2005 and 2004, respectively) 210,162 144,827
Deferred income tax assets 18,734 10,791
Prepaid expenses and other current assets 48,667 35,739
-----------------------------------------------
Total current assets 506,301 448,156
Computer software, net of accumulated amortization of $300.1 million and $252.9
million at 2005 and 2004, respectively 278,450 268,647
Property and equipment, net of accumulated depreciation and amortization of
$179.6 million and $158.7 million at 2005 and 2004, respectively 272,696 263,584
Contract acquisition costs, net 159,234 132,428
Goodwill, net 108,798 70,561
Other intangible assets, net of accumulated amortization of $4.5 million and
$2.2 million at 2005 and 2004, respectively 14,467 4,692
Equity investments 5,084 54,400
Other assets 30,994 39,475
-----------------------------------------------
Total assets $ 1,376,024 1,281,943
===============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Balance Sheets (continued)
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
September 30, December 31,
(in thousands, except per share information) 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) $ 33,237 75,188
Accrued salaries and employee benefits 67,349 46,725
Current portion of obligations under capital leases and software obligations 2,005 1,828
Other current liabilities (includes $9.6 million and $6.6 million payable to
related parties at 2005 and 2004, respectively) 133,145 148,124
-----------------------------------------------
Total current liabilities 235,736 271,865
Obligations under capital leases and software obligations, excluding current
portion 3,139 4,508
Deferred income tax liabilities 140,064 131,106
Other long-term liabilities 19,351 6,038
-----------------------------------------------
Total liabilities 398,290 413,517
-----------------------------------------------
Minority interests in consolidated subsidiaries 3,765 3,814
-----------------------------------------------
Shareholders' equity:
Common stock - $0.10 par value. Authorized 600,000 shares; 197,969 and
197,587 issued at 2005 and 2004, respectively; 197,275 and 196,849
outstanding at 2005 and 2004, respectively 19,808 19,759
Additional paid-in capital 52,132 44,732
Unamortized restricted stock awards (4,381) -
Accumulated other comprehensive income 7,681 15,373
Treasury stock (shares of 694 and 738 at 2005 and 2004, respectively) (12,874) (13,573)
Retained earnings 911,603 798,321
-----------------------------------------------
Total shareholders' equity 973,969 864,612
-----------------------------------------------
Total liabilities and shareholders' equity $ 1,376,024 1,281,943
===============================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended
September 30,
-------------------------------------
(in thousands, except per share information) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $1.3 million from related parties for
both 2005 and 2004, respectively) $ 224,394 198,892
Merchant services (includes $3.4 million from related parties for 2004) 74,207 6,518
Other services (includes $1.6 million and $1.5 million from related parties for 2005
and 2004, respectively) 43,499 43,006
-------------------------------------
Revenues before reimbursable items 342,100 248,416
Reimbursable items (includes $0.4 million and $2.4 million from related parties for
2005 and 2004, respectively) 79,869 56,577
-------------------------------------
Total revenues 421,969 304,993
-------------------------------------
Expenses:
Salaries and other personnel expense 121,389 99,561
Net occupancy and equipment expense 77,134 59,301
Other operating expenses (includes $2.2 million and $2.3 million to related parties for
2005 and 2004, respectively) 71,245 37,559
-------------------------------------
Expenses before reimbursable items 269,768 196,421
Reimbursable items 79,869 56,577
-------------------------------------
Total expenses 349,637 252,998
-------------------------------------
Operating income 72,332 51,995
-------------------------------------
Nonoperating income (expense):
Interest income (includes $867 and $183 from related parties for 2005 and 2004,
respectively) 1,592 667
Interest expense (84) (95)
Gain on foreign currency translation, net 66 146
-------------------------------------
Total nonoperating income 1,574 718
-------------------------------------
Income before income taxes, minority interest and equity in income of
joint ventures 73,906 52,713
Income taxes 26,777 20,410
Minority interests in consolidated subsidiaries' net income (64) (80)
Equity in income of joint ventures 991 6,918
-------------------------------------
Net income $ 48,056 39,141
=====================================
Basic earnings per share $ 0.24 0.20
=====================================
Diluted earnings per share $ 0.24 0.20
=====================================
Weighted average common shares outstanding 197,198 196,849
Increase due to assumed issuance of shares related to stock options outstanding 185 361
-------------------------------------
Weighted average common and common equivalent shares outstanding 197,383 197,210
=====================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Income
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
-------------------------------------
(in thousands, except per share information) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $3.7 million from related parties for
both 2005 and 2004, respectively) $ 646,199 561,270
Merchant services (includes $2.4 million and $10.6 million from related parties for
2005 and 2004, respectively) 170,008 19,759
Other services (includes $4.7 million and $4.8 million from related parties for 2005
and 2004, respectively) 137,337 125,681
-------------------------------------
Revenues before reimbursable items 953,544 706,710
Reimbursable items (includes $2.6 million and $7.1 million from related parties for
2005 and 2004, respectively) 228,652 173,141
-------------------------------------
Total revenues 1,182,196 879,851
-------------------------------------
Expenses:
Salaries and other personnel expense 334,341 269,647
Net occupancy and equipment expense 212,770 184,214
Other operating expenses (includes $6.7 million and $6.9 million to related parties for
2005 and 2004, respectively) 191,449 109,440
-------------------------------------
Expenses before reimbursable items 738,560 563,301
Reimbursable items 228,652 173,141
-------------------------------------
Total expenses 967,212 736,442
-------------------------------------
Operating income 214,984 143,409
-------------------------------------
Nonoperating income (expense):
Interest income (includes $1.7 million and $0.5 million from related parties for 2005
and 2004, respectively) 3,889 1,709
Interest expense (259) (877)
(Loss) gain on foreign currency translation, net (761) 45
-------------------------------------
Total nonoperating income 2,869 877
-------------------------------------
Income before income taxes, minority interest and equity in income of
joint ventures 217,853 144,286
Income taxes 78,186 55,636
Minority interests in consolidated subsidiaries' net income (176) (240)
Equity in income of joint ventures 5,331 19,178
--------------------------------------
Net income $ 144,822 107,588
=====================================
Basic earnings per share $ 0.73 0.55
=====================================
Diluted earnings per share $ 0.73 0.55
=====================================
Weighted average common shares outstanding 197,100 196,846
Increase due to assumed issuance of shares related to stock options outstanding 224 367
-------------------------------------
Weighted average common and common equivalent shares outstanding 197,324 197,213
=====================================
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
-------------------------------------
(in thousands) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 144,822 107,588
Adjustments to reconcile net income to net cash provided by operating
activities:
Minority interests in consolidated subsidiaries' net income 176 240
Loss (gain) on foreign currency translation, net 761 (45)
Equity in income of joint ventures (5,331) (19,178)
Depreciation and amortization 109,547 79,517
Impairment of developed software 3,619 10,059
Provisions for (recoveries of) bad debt expenses and billing
adjustments 5,451 (1,147)
Charges for transaction processing provisions 7,634 5,621
Deferred income tax expense 6,574 29,590
Loss on disposal of equipment, net 1,802 384
(Increase) decrease in:
Accounts receivable (40,072) (36,139)
Costs and profits in excess of billings on uncompleted contracts - (7,272)
Prepaid expenses and other assets 6,962 (4,822)
Increase (decrease) in:
Accounts payable (59,241) 6,066
Accrued salaries and employee benefits 4,408 4,584
Billings in excess of costs and profits on uncompleted contracts - (17,573)
Other liabilities (63,175) 22,210
-------------------------------------
Net cash provided by operating activities 123,937 179,683
-------------------------------------
Cash flows from investing activities:
Purchases of property and equipment, net (33,540) (49,815)
Additions to licensed computer software from vendors (10,049) (19,237)
Additions to internally developed computer software (17,435) (3,996)
Cash acquired in acquisitions 38,798 2,422
Cash used in acquisitions (95,796) (53,000)
Dividends received from joint ventures 1,658 15,876
Contract acquisition costs (11,756) (22,441)
-------------------------------------
Net cash used in investing activities (128,120) (130,191)
-------------------------------------
See accompanying Notes to Unaudited Consolidated Financial Statements.
- 7 -
TOTAL SYSTEM SERVICES, INC.
Consolidated Statements of Cash Flows (continued)
(Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended
September 30,
-------------------------------------
(in thousands) 2005 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from borrowing of long-term debt $ 48,143 -
Principal payments on long-term debt borrowings (48,135) -
Principal payments on capital lease obligations and software obligations (1,225) (42,321)
Dividends paid on common stock (includes $22.4 million and $12.8 million
paid to related parties during 2005 and 2004, respectively) (27,582) (15,747)
Proceeds from exercise of stock options 2,920 1,193
Purchases of common stock - (1,188)
------------------------------------------
Net cash used in financing activities (25,879) (58,063)
------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (2,388) 575
------------------------------------------
Net decrease in cash and cash equivalents $ (32,450) (7,996)
Cash and cash equivalents at beginning of year 231,806 122,874
------------------------------------------
Cash and cash equivalents at end of period $ 199,356 114,878
==========================================
Cash paid for interest $ 259 877
==========================================
Cash paid for income taxes (net of refunds) $ 100,839 17,621
==========================================
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 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) September 30, 2005 December 31, 2004
-------------------------------------------------------------------------------- --------------------------
Cash and cash equivalents in domestic accounts $ 170,023 177,117
Cash and cash equivalents in foreign accounts 29,333 54,689
-------------------------- --------------------------
Total $ 199,356 231,806
========================== ==========================
- 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) September 30, 2005 December 31, 2004
----------------------------------------------------------------------------- ---------------------------
Prepaid expenses $ 15,031 11,767
Supplies inventory 13,117 7,646
Other 20,519 16,326
------------------------- ---------------------------
Total $ 48,667 35,739
========================= ===========================
Significant components of contract acquisition costs, net of accumulated
amortization, are summarized as follows:
(in thousands) September 30, 2005 December 31, 2004
----------------------------------------------------------------------------- ---------------------------
Payments for processing rights, net $ 115,329 91,787
Conversion costs, net 43,905 40,641
------------------------- ---------------------------
Total $ 159,234 132,428
========================= ===========================
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $3.5 million and $3.4 million for the three
months ended September 30, 2005 and 2004, respectively. For the nine months
ended September 30, 2005 and 2004, amortization related to payments for
processing rights was $10.6 million and $10.2 million, respectively.
Amortization related to conversion costs, which is recorded in other
operating expenses, was $3.2 million and $2.8 million for the three months ended
September 30, 2005 and 2004, respectively. For the nine months ended September
30, 2005 and 2004, amortization expense related to conversion costs was $9.3
million and $8.3 million, respectively.
Significant components of other current liabilities are summarized as
follows:
(in thousands) September 30, 2005 December 31, 2004
------------------------------------------------------------------------------- ----------------------------
Accrued expenses $ 55,280 43,229
Client liabilities 29,304 24,660
Dividends payable 11,832 7,874
Transaction processing provisions 11,119 9,284
Client postage deposits 6,252 6,184
Deferred revenues 5,013 21,682
Other 14,345 35,211
-------------------------- ----------------------------
Total $ 133,145 148,124
========================== ============================
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 nine months ended September 30 is as
follows:
Three months ended Nine months ended
September 30, September 30,
---------------------------------------------------------------------------
(in thousands) 2005 2004 2005 2004
----------------- ----------------- ----------------- ------------------
Net income $ 48,056 39,141 144,822 107,588
Other comprehensive income (loss):
Foreign currency translation
adjustments, net of tax (2,325) (1,227) (7,692) 1,335
----------------- ----------------- ----------------- ------------------
Total $ 45,731 37,914 137,130 108,923
================= ================= ================= ==================
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 September 30, 2005
- ---------------------------------------------------------------------------------------------------------------------------
Foreign currency translation
adjustments $15,373 (11,938) 4,246 $7,681
=======================================================================================
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
(in thousands) based support based support processing
Operating Segments services services services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
At September 30, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,282,288 177,276 222,050 $ 1,681,614
Intersegment eliminations (305,569) (6) (15) (305,590)
---------------- ---------------- ---------------- ---------------
Total assets $ 976,719 177,270 222,035 $ 1,376,024
================ ================ ================ ===============
- ------------------------------------------------------------------------------------------------------------------------------------
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 September 30, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 244,302 31,389 70,333 $ 346,024
Intersegment revenues (3,867) - (57) (3,924)
---------------- ---------------- ---------------- ---------------
Revenues before reimbursables
from external customers $ 240,435 31,389 70,276 $ 342,100
================ ================ ================ ===============
Segment total revenue $ 308,889 37,862 81,948 $ 428,699
Intersegment revenue (6,673) - (57) (6,730)
---------------- ---------------- ---------------- ---------------
Revenue from external customers $ 302,216 37,862 81,891 $ 421,969
================ ================ ================ ===============
Depreciation and amortization $ 29,503 4,399 7,587 $ 41,489
================ ================ ================ ===============
Intersegment expenses $ 5,627 (4,294) (8,064) $ (6,731)
================ ================ ================ ===============
Segment operating income $ 52,834 6,137 13,361 $ 72,332
================ ================ ================ ===============
Income taxes $ 18,381 3,227 5,169 $ 26,777
================ ================ ================ ===============
Equity in income of joint venture $ - 991 - $ 991
================ ================ ================ ===============
Net income $ 36,238 3,353 8,465 $ 48,056
================ ================ ================ ===============
- ------------------------------------------------------------------------------------------------------------------------------------
Three months ended September 30, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 218,530 29,886 - $ 248,416
Intersegment revenues - - - -
---------------- ---------------- ---------------- ---------------
Revenues before reimbursables
from external customers $ 218,530 29,886 - $ 248,416
================ ================ ================ ===============
Segment total revenue $ 273,496 31,499 - $ 304,995
(2) - - (2)
---------------- ---------------- ---------------- ---------------
Revenue from external customers $ 273,494 31,499 - $ 304,993
================ ================ ================ ===============
Depreciation and amortization $ 23,188 3,549 - $ 26,737
================ ================ ================ ===============
Intersegment expenses $ 3,119 (3,119) - $ -
================ ================ ================ ===============
Segment operating income $ 45,328 6,667 - $ 51,995
================ ================ ================ ===============
Income taxes $ 14,737 3,469 2,204 $ 20,410
================ ================ ================ ===============
Equity in income of joint venture $ - 549 6,369 $ 6,918
================ ================ ================ ===============
Net income $ 29,959 5,015 4,167 $ 39,141
================ ================ ================ ===============
- 12 -
Notes to Unaudited Consolidated Financial Statements (continued)
Domestic- International- Merchant
(in thousands) based support based support processing
Operating Segments services services services Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 713,390 92,717 156,486 $ 962,593
Intersegment revenues (8,946) - (103) (9,049)
---------------- ---------------- ---------------- ---------------
Revenues before reimbursables
from external customers $ 704,444 92,717 156,383 $ 953,544
================ ================ ================ ===============
Segment total revenue $ 904,700 109,604 182,877 $ 1,197,181
Intersegment revenue (14,882) - (103) (14,985)
---------------- ---------------- ---------------- ---------------
Revenue from external customers $ 889,818 109,604 182,774 $ 1,182,196
================ ================ ================ ===============
Depreciation and amortization $ 85,058 12,416 12,073 $ 109,547
================ ================ ================ ===============
Intersegment expenses $ 24,861 (21,833) (18,022) $ (14,994)
================ ================ ================ ===============
Segment operating income $ 176,346 8,143 30,495 $ 214,984
================ ================ ================ ===============
Income taxes $ 61,003 4,294 12,889 $ 78,186
================ ================ ================ ===============
Equity in income of joint venture $ - 2,090 3,241 $ 5,331
================ ================ ================ ===============
Net income $ 118,692 4,773 21,357 $ 144,822
================ ================ ================ ===============
- ------------------------------------------------------------------------------------------------------------------------------------
Nine months ended September 30, 2004
- ------------------------------------------------------------------------------------------------------------------------------------
Revenue before reimbursables $ 628,042 78,668 - $ 706,710
Intersegment revenues - - - -
---------------- ---------------- ---------------- ---------------
Revenues before reimbursables
from external customers $ 628,042 78,668 - $ 706,710
================ ================ ================ ===============
Segment total revenue $ 796,229 83,628 - $ 879,857
Intersegment revenue (6) - - (6)
---------------- ---------------- ---------------- ---------------
Revenue from external customers $ 796,223 83,628 - $ 879,851
================ ================ ================ ===============
Depreciation and amortization $ 69,950 9,567 - $ 79,517
================ ================ ================ ===============
Intersegment expenses $ 4,268 (4,268) - $ -
================ ================ ================ ===============
Segment operating income $ 125,399 18,010 - $ 143,409
================ ================ ================ ===============
Income taxes $ 41,876 7,600 6,160 $ 55,636
================ ================ ================ ===============
Equity in income of joint venture $ - 1,242 17,936 $ 19,178
================ ================ ================ ===============
Net income $ 83,195 12,617 11,776 $ 107,588
================ ================ ================ ===============
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
nine months ended September 30, 2005 and 2004, respectively, based on the
domicile of customers.
- 13 -
Notes to Unaudited Consolidated Financial Statements (continued)
Three months ended Nine months ended
September 30, September 30,
-------------------------------------------------------------------------------------
(in millions) 2005 2004 2005 2004
------------------- --------------------- ---------------------- -------------------
United States $ 358.3 247.9 998.4 722.3
Europe 34.0 28.2 98.3 73.7
Canada* 23.2 21.4 66.6 62.4
Japan 4.0 3.4 11.6 10.3
Mexico 1.9 3.4 5.3 9.2
Other 0.6 0.7 2.0 2.0
------------------- --------------------- ---------------------- -----------------
Totals $ 422.0 305.0 1,182.2 879.9
=================== ===================== ====================== =================
* 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 September 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 $ 276.7 247.9 - - 81.6 -
Europe 0.1 0.2 33.9 28.0 - -
Canada* 23.0 21.4 - - 0.2 -
Japan - - 4.0 3.4 - -
Mexico 1.9 3.3 - - - -
Other 0.5 0.7 - - 0.1 -
------------------------------------------------------------------------------------------
$ 302.2 273.5 37.9 31.4 81.9 -
==========================================================================================
The following table reconciles geographic revenues to revenues by reporting
segment for the nine months ended September 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 $ 816.3 722.3 - - 182.1 -
Europe 0.3 0.4 98.0 73.3 - -
Canada* 66.3 62.4 - - 0.3 -
Japan - - 11.6 10.3 - -
Mexico 5.3 9.2 - - - -
Other 1.6 2.0 - - 0.4 -
------------------------------------------------------------------------------------------
$ 889.8 796.3 109.6 83.6 182.8 -
==========================================================================================
* 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 September 30, At December 31,
(in millions) 2005 2004
--------------------------------------------------------------- ----------------------------
United States $ 213.7 200.6
Europe 57.2 60.8
Japan 1.7 2.1
Canada 0.1 0.1
--------------------------------------------------------------- ----------------------------
Totals $ 272.7 263.6
========================== ============================
Major Customer
For the three months ended September 30, 2005, the Company had one major
customer, Bank of America, which accounted for approximately 21.7%, or $91.5
million, of total revenues. For the three months ended September 30, 2004, this
same major customer accounted for 18.1%, or $55.3 million, of total revenues.
For the nine months ended September 30, 2005, Bank of America accounted for
approximately 22.1%, or $261.5 million, of total revenues. For the nine months
ended September 30, 2004, this same major customer accounted for 18.5%, or
$162.5 million, of total revenues.
Revenues from Bank of America for the periods reported are attributable to
the domestic-based support services and merchant processing services segments.
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 nine months ended September 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 Nine months ended
September 30, September 30,
------------------------------- ----------------------------
2005 2004 2005 2004
-------------- ------------- ------------ ------------
(in thousands, except per share data)
Net Income $ 48,056 39,141 144,822 107,588
Add: Stock-based employee
compensation expense, net of
related income tax effects 185 - 549 -
Deduct: Stock-based employee compensation expense
determined under the fair value based method for
all awards, net of related income tax effects
1,201 1,357 3,927 3,857
-------------- ------------- ------------ ------------
Net income, as adjusted $ 47,040 37,784 141,444 103,731
============== ============= ============ ============
Earnings per share:
Basis - as reported $ 0.24 0.20 0.73 0.55
============== ============= ============ ============
Basic - as adjusted $ 0.24 0.19 0.72 0.53
============== ============= ============ ============
Diluted - as reported $ 0.24 0.20 0.73 0.55
============== ============= ============ ============
Diluted - as adjusted $ 0.24 0.19 0.72 0.53
============== ============= ============ ============
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
September 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 nine months ended
September 30, 2005 and 2004, respectively, are summarized as follows:
(in thousands) September 30, 2005 September 30, 2004
----------------------------------------------------------------------------- -----------------------------
Conversion costs $ 11,756 6,441
Payments for processing rights - 16,000
----------------------------------------------------------------------------- -----------------------------
Total $ 11,756 22,441
========================= =============================
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 received notification from the United States Attorneys' Office
for the Northern District of California that the United States Department of
Justice was 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 related 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. The Company produced documents and
information in response to a subpoena that it received from the Office of the
Inspector General of the United States Postal Service and otherwise cooperated
with the Department of Justice during the investigation. The involved parties
agreed to a settlement of the matter without any party admitting liability. The
matter was settled during the third quarter for amounts that were not material
to TSYS' financial condition, results of operations or cash flows.
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.
On March 1, 2005, TSYS acquired the remaining 50% of Vital from Visa for
$95.8 million in cash, including $794,000 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 statement of income effective March 1, 2005. In accordance
with authoritative
- 17 -
Notes to Unaudited Consolidated Financial Statements (continued)
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 $34.6 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 34,571
Other assets 43,830
---------------
Total assets acquired 128,300
---------------
Other liabilities 32,457
---------------
Total liabilities assumed 32,457
---------------
Minority interest 49
---------------
Net assets acquired $95,794
===============
Effective October 1, 2005, TSYS acquired the remaining 49% of Merlin
Solutions, LLC, a subsidiary of Vital for approximately $2.0 million. TSYS will
record the acquisition of the incremental 49% interest as a business combination
requiring the Company to allocate the purchase price of the assets acquired and
liabilities assumed based on their relative fair values.
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 finalized the purchase price allocation and 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 allocated $8.5 million to computer
software and the remaining amount to other intangible assets. TSYS Prepaid is a
leading provider of prepaid card solutions that utilize the Visa, MasterCard,
EFT and ATM networks for Fortune 500 companies as well as domestic and
international financial
- 18 -
Notes to Unaudited Consolidated Financial Statements (continued)
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 completed its purchase price allocation related to the
acquisition. The 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 months ended September 30, 2004 and nine months ended September 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 Nine months ended
(in thousands, except per share data) September 30, September 30,
- ------------------------------------------------------------------------------------------------------------------
2004 2005 2004
- ------------------------------------------------------------------------------------------------------------------
Revenues $ 377,031 1,225,786 1,027,422
Net income 39,366 146,819 109,473
Basic earnings per share 0.20 0.74 0.56
Diluted earnings per share 0.20 0.74 0.56
- 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 other stored value cards. Debit
cards consist mainly of on-line (PIN-based) and off-line (signature-based)
accounts. The tables on page 28 summarize TSYS' accounts on file (AOF)
information as of September 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 Nine months ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------------------------
Percent Percent
2005 2004 Change 2005 2004 Change
- -------------------------------------------------------------------------------------------------------------------
Revenues Before
Reimbursables $ 342.1 248.4 37.7% $ 953.5 706.7 34.9%
Total Revenues 422.0 305.0 38.4 1,182.2 879.9 34.4
Operating Income 72.3 52.0 39.1 215.0 143.4 49.9
Net Income 48.1 39.1 22.8 144.8 107.6 34.6
Basic EPS 0.24 0.20 22.6 0.73 0.55 34.4
Diluted EPS 0.24 0.20 22.7 0.73 0.55 34.5
Significant highlights for 2005 include:
TSYS 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 signed an agreement with Capital One Financial Corporation to provide
processing services for its North American portfolio of consumer and small
business credit card accounts.
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. Subsequent to this agreement, Bank of
America announced its intention to acquire MBNA Corporation. TSYS and Bank of
America are in discussions to determine TSYS' future role in providing consumer
credit card processing to Bank of America. See "Major Customer" on page 27 for
additional information with respect to TSYS' relationship with Bank of America.
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.
TSYS successfully converted the account portfolio of JPMorgan Chase.
TSYS renewed agreements with C&A Modas in Mexico as well as agreements with
Juniper Bank, Wilmington, DE; Trustmark National Bank, Jackson, MS and Allied
Irish Bank, Dublin, Ireland.
Vital Processing Services announced a renewal of its service agreement with
Bank of America.
On October 24, 2005, TSYS announced an agreement with Toronto-Dominion Bank
to provide a range of processing and support services for its consumer and
commercial credit card accounts.
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 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, acquired
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.
JPMorgan Chase has entered into an agreement to purchase the credit card
operation, including both its private-label Sears credit card accounts and its
co-branded Sears MasterCard accounts, from Sears Canada Inc.
- 22 -
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 the Company's major
customer or other significant clients, an inability to grow through acquisitions
or successfully integrate acquisitions, an inability to control expenses,
technology changes, financial services consolidation, change in regulatory
mandates, a decline in the use of cards as a payment mechanism, a decline in the
financial stability of the Company's clients and uncertain economic conditions.
Negative developments in these or other risk factors could have a material
adverse effect on the Company's financial position, results of operations and
cash flows.
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.
- 23 -
Related Party Transactions (continued)
Line of Credit
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
September 30, 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.
Results of Operations
The following table sets forth certain income statement captions as a
percentage of total revenues and the percentage increases or decreases in those
items for the three months ended September 30, 2005 and 2004:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2005 2004 2005 vs. 2004
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 53.2 % 65.2 % 12.8 %
Merchant services 17.6 2.1 nm
Other services 10.3 14.1 1.1
------------- ----------
Revenues before reimbursable items 81.1 81.4 37.7
Reimbursable items 18.9 18.6 41.2
------------- ----------
Total revenues 100.0 100.0 38.4
------------- ----------
Expenses:
Salaries and other personnel expense 28.8 32.6 21.9
Net occupancy and equipment expense 18.3 19.4 30.1
Other operating expenses 16.9 12.4 89.7
------------- ----------
Expenses before reimbursable items 64.0 64.4 37.3
Reimbursable items 18.9 18.6 41.2
------------- ----------
Total expenses 82.9 83.0 38.2
------------- ----------
Operating income 17.1 17.0 39.1
Nonoperating income 0.4 0.2 nm
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 17.5 17.2 40.2
Income taxes 6.3 6.7 31.2
Minority interests in consolidated subsidiaries' net
income 0.0 (0.0) (20.9)
Equity in income of joint ventures 0.2 2.3 (85.7)
------------- ----------
Net income 11.4 % 12.8 % 22.8 %
============= ==========
- 24 -
Results of Operations (continued)
The following table sets forth certain income statement captions as a
percentage of total revenues and the percentage increases or decreases in those
items for the nine months ended September 30, 2005 and 2004:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------- ------------------------
2005 2004 2005 vs. 2004
------------- ---------- ------------------------
Revenues:
Electronic payment processing services 54.7 % 63.8 % 15.1 %
Merchant services 14.4 2.2 nm
Other services 11.6 14.3 9.3
------------- ----------
Revenues before reimbursable items 80.7 80.3 34.9
Reimbursable items 19.3 19.7 32.1
------------- ----------
Total revenues 100.0 100.0 34.4
------------- ----------
Expenses:
Salaries and other personnel expense 28.3 30.6 24.0
Net occupancy and equipment expense 18.0 20.9 15.5
Other operating expenses 16.2 12.5 74.9
------------- ----------
Expenses before reimbursable items 62.5 64.0 31.1
Reimbursable items 19.3 19.7 32.1
------------- ----------
Total expenses 81.8 83.7 31.3
------------- ----------
Operating income 18.2 16.3 49.9
Nonoperating income 0.2 0.1 nm
------------- ----------
Income before income taxes, minority
interest and equity in income of joint
ventures 18.4 16.4 51.0
Income taxes 6.6 6.3 40.5
Minority interests in consolidated subsidiaries' net
income 0.0 (0.1) (26.8)
Equity in income of joint ventures 0.5 2.2 (72.2)
------------- ----------
Net income 12.3 % 12.2 % 34.6 %
============= ==========
nm=not meaningful
Revenues
Total revenues increased $117.0 million and $302.3 million, or 38.4% and
34.4%, respectively, during the three and nine months ended September 30, 2005,
compared to the same periods in 2004. The increase in revenues for the three
months and nine months ended September 30, 2005 includes a decrease of $280,000
and an increase of $1.7 million, respectively, related to the effects of
currency translation of its foreign-based subsidiaries and branches. Excluding
reimbursable items, revenues increased $93.7 million and $246.8 million, or
37.7% and 34.9%, respectively, during the three and nine months ended September
30, 2005, compared to the same periods in 2004.
- 25 -
Results of Operations (continued)
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 nine months ended
September 30, 2005 and 2004, respectively, are summarized below:
Three months ended Nine months ended
September 30, September 30,
-------------------------------------------------------------------------------------------
(in millions) 2005 2004 % Change 2005 2004 % Change
--------------------------------------- ---------------------------------------------
Europe $ 34.0 28.2 20.5 % $ 98.3 73.7 33.5 %
Canada 23.2 21.4 8.2 66.6 62.4 6.8
Japan 4.0 3.4 15.5 11.6 10.3 12.8
Mexico 1.9 3.4 (42.1) 5.3 9.2 (42.1)
Other 0.6 0.7 (2.5) 2.0 2.0 (4.9)
----------------------------- -------------------------------
Totals $ 63.7 57.1 11.7 % $ 183.8 157.6 16.7 %
============================= ===============================
Total revenues from clients based in Europe were $34.0 million and $98.3
million for the three and nine months ended September 30, 2005. This constituted
a 20.5% and 33.5% increase compared to the $28.2 million and $73.7 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 $1.9 million and $5.3
million for the three and nine months ended September 30, 2005, a 42.1% decrease
over the same periods last year. Total revenues from clients based in Mexico
were $3.4 million and $9.2 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 September 30, 2005 and 2004, value added
products and services represented 12.4% and 14.0%, respectively, of total
revenues. For the nine months ended September 30, 2005 and 2004, value added
products and services represented 12.5% and 13.5%, respectively, of total
revenues. Revenues from these products and services, which include some
reimbursable items paid to third-party vendors, increased 22.5%, or $9.6 million
and 24.2% or $28.8 million, for the three and nine months ended September 30,
2005 compared to the same periods last year.
- 26 -
Results of Operations (continued)
Major Customer
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including its major customer, Bank of America.
TSYS derives revenues from providing various processing and other services to
this client, including processing of consumer and commercial accounts, as well
as revenues for reimbursable items. With the acquisition of Vital on March 1,
2005, the Company's revenues include revenues derived from providing merchant
processing services to Bank of America. Refer to Note 9 in the notes to
unaudited consolidated financial statements for more information on the
acquisition of Vital.
At the end of the second quarter, Bank of America announced its planned
acquisition of MBNA. Bank of America is currently evaluating the various
consumer credit card processing alternatives available to it and MBNA. TSYS and
Bank of America are in discussions to determine the Company's future role in
providing consumer credit card processing to Bank of America. TSYS cannot
predict the outcome of its discussions with Bank of America or of the evaluation
process Bank of America is conducting. TSYS' processing agreement with Bank of
America provides that Bank of America may terminate its agreement with TSYS for
consumer credit card services upon the payment of a termination fee. The loss of
Bank of America, or any significant client, could have a material adverse effect
on the Company's financial position, results of operations and cash flows.
For the three months ended September 30, 2005, Bank of America accounted
for approximately 21.7%, or $91.5 million, of total revenues. This amount
consists of processing revenues for consumer, commercial and merchant services,
as well as reimbursable items. Of this $91.5 million, approximately $32.0
million, or 34.9%, was derived from Bank of America for reimbursable items. Bank
of America accounted for approximately $59.5 million, or 17.4%, of revenues
before reimbursable items for the three months ended September 30, 2005. For the
three months ended September 30, 2004, Bank of America accounted for 18.1%, or
$55.3 million, of total revenues.
For the nine months ended September 30, 2005, Bank of America accounted for
approximately 22.1%, or $261.5 million, of total revenues. Of this $261.5
million, approximately $91.8 million, or 35.1%, was derived from Bank of America
for reimbursable items. Bank of America accounted for approximately $169.8
million, or 17.8%, of revenues before reimbursable items for the nine months
ended September 30, 2005. For the nine months ended September 30, 2004, Bank of
America accounted for 18.5%, or $162.5 million, of total revenues.
The majority of the increase in revenues derived from Bank of America for
2005, as compared to 2004, is the result of including Vital's revenues for
merchant services from Bank of America.
Revenues from Bank of America for the periods reported are attributable to
the domestic-based support services segment and merchant processing services.
As previously mentioned, on January 25, 2005, the Company announced that it
had extended its agreement with Bank of America for an additional five years
through 2014. Additionally, during the third quarter of 2005, Vital announced
the renewal of its agreement to provide merchant processing services to Bank of
America.
- 27 -
Results of Operations (continued)
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 $25.5 million, or 12.8% and $84.9 million, or
15.1%, for the three and nine months ended September 30, 2005, respectively,
compared to the same periods in 2004.
Accounts on File (AOF) Data (in millions):
2005 2004 % Change
------------- ------------ -----------------
At September 30, 430.1 315.3 36.4%
QTD Average 424.6 304.9 39.2%
YTD Average 389.4 289.3 34.6%
AOF by Portfolio Type
2005 2004
---------------------------- --------------------------
At September 30, AOF % AOF % % Change
----------------------------------- ---------------------------- -------------------------- ----------------
Consumer 264.1 61.4 170.7 54.1 54.7
Retail 96.5 22.4 88.8 28.2 8.5
Commercial 30.1 7.0 24.9 7.9 21.0
Government services 18.2 4.3 15.7 5.0 16.8
Stored value 13.7 3.2 8.5 2.7 61.3
Debit 7.5 1.7 6.7 2.1 11.1
----------------------------------- ---------------------------- --------------------------
Total 430.1 100.0 315.3 100.0 36.4
============================ ==========================
AOF by Geographic Area
2005 2004
----------------------------- -----------------------------
At September 30, AOF % AOF % % Change
---------------------------------- ----------------------------- ----------------------------- ----------------
Domestic 375.3 87.4 267.2 84.7 40.5
International 54.8 12.6 48.1 15.3 13.8
---------------------------------- ----------------------------- -----------------------------
Total 430.1 100.0 315.3 100.0 36.4
============================= =============================
Note: The accounts on file distinction between domestic and international is
based on the geographic domicile of processing clients.
- 28 -
Results of Operations (continued)
Activity in AOF
September 2004 to September 2003 to
September 2005 September 2004
------------------------- ------------------------
Beginning balance 315.3 267.9
Internal growth of existing clients 44.5 33.0
New clients 79.3 18.9
Purges/Sales (7.9) (0.6)
Deconversions (1.1) (3.9)
------------------------- ------------------------
Ending balance 430.1 315.3
========================= ========================
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 was 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 was 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 JPMorgan
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 nine months ended
September 30, 2005. This agreement was superseded by the agreement with JPMorgan
Chase & Co. (Chase) described below.
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 (Bank One and Chase) and to
upgrade its card-processing technology. The new agreement replaced the agreement
TSYS and the former Bank One Corp. agreed to 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.
- 29 -
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 nine months ended September 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. TSYS' management believes that the loss of
revenues from the Sears portfolio for the months of 2006 subsequent to the
expected deconversion, combined with decreased expenses from the reduction in
hardware and software and the redeployment of personnel, should not have a
material adverse effect on the Company's financial position, results of
operations or cash flows for the year ending December 31, 2006.
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 nine months
ended September 30, 2005, TSYS' electronic payment processing services revenues
include $5.3 million and $19.2 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 nine months ended September 30, 2005 was
$74.2 million and $170.0 million, respectively, compared to $6.5 million and
$19.8 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.
Vital's results are driven by the transactions processed at the
point-of-sale and the number of outgoing transactions. Vital's main
point-of-sale service deals with authorizations and data capture transactions
primarily through dial-up or the Internet.
- 30 -
Results of Operations (continued)
On March 1, 2005, TSYS acquired the remaining 50% of Vital from Visa for
$95.8 million in cash, including $794,000 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.
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 $0.5 million, or 1.1%, for the
three months ended September 30, 2005, compared to the same period in 2004.
Revenues from other services increased $11.7 million, or 9.3%, for the nine
months ended September 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 $23.3 million, or 41.2%, for the three months ended September 30,
2005, as compared to the same period last year. Reimbursable items increased
$55.5 million, or 32.1 %, for the nine months ended September 30, 2005, as
compared to the same period last year. Of the $23.3 million and $55.5 million
increase for the three and nine months ended September 30, 2005, $11.7 million
and $27.4 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.
The Company's reimbursable items are impacted with changes in postal rates
and changes in the volume of mailing activities by its clients.
A summary of reimbursable item revenues for the three and nine months ended
September 30, 2005, as compared to
2004, is provided below:
(in thousands) Three months ended Nine months ended
September 30, September 30,
- ----------------------------------------------------------------------------------------------------------------------------
Percent Percent
2005 2004 Change 2005 2004 Change
- -----------------------------------------------------------------------------------------------------------------------------
Postage $37,955 36,750 3.3% $120,592 116,981 3.1%
Card association access fees 19,635 4,867 nm 47,930 13,190 nm
Other 22,279 14,960 48.9 60,130 42,970 39.9
----------------------------- --------------------------------
Total $79,869 56,577 41.2% $228,652 173,141 32.1%
============================= ================================
Nm=not meaningful
- 31 -
Results of Operations (continued)
Operating Expenses
Total expenses increased 38.2% and 31.3% for the three and nine months
ended September 30, 2005, respectively, compared to the same periods in 2004.
The increase in expense includes a decrease of $146,000 and an increase of $1.9
million for the three and nine months ended September 30, 2005, respectively,
related to the effects of currency translation of its foreign-based subsidiaries
and branches. Excluding reimbursable items, total expenses increased 37.3% and
31.1% for the three and nine months ended September 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 nine months ended September 30:
Three months ended Nine months ended
September 30, September 30,
--------------------------------------------------------------------------------------
(in thousands) 2005 2004 % Change 2005 2004 % Change
------------------------------------------ -----------------------------------------
Salaries $ 90,946 71,800 26.7 % $ 255,670 208,638 22.5 %
Employee benefits 27,276 25,358 7.6 76,079 54,321 40.1
Nonemployee wages 7,730 3,710 108.3 24,575 11,474 114.2
Other 2,488 1,833 35.7 5,765 4,491 28.4
Less capitalized expenses (7,051) (3,140) 124.6 (27,748) (9,277) 199.1
----------------------------- ----------------------------
Totals $ 121,389 99,561 21.9 % $ 334,341 269,647 24.0 %
============================= ============================
Salaries and other personnel expenses increased $21.8 million, or 21.9%,
for the three months ended September 30, 2005, compared to the same period in
2004. For the nine months ended September 30, 2005, salaries and other personnel
expenses increased $64.7 million, or 24.0%, compared to the same period in 2004.
Of the $21.8 million and $64.7 million increase for the three and nine months
for 2005, respectively, $16.9 million and $42.5 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 September 30, 6,522 5,631 15.8
QTD Average 6,483 5,576 16.3
YTD Average 6,223 5,574 11.6
Through the first nine months of 2005, TSYS added 789 employees associated
with the acquisition of Vital. At September 30, 2005, TSYS had 94 employees
associated with the TSYS Prepaid acquisition.
- 32 -
Results of Operations (continued)
Net Occupancy and Equipment Expense
Summarized below are the major components of net occupancy and equipment
expenses:
Three months ended Nine months ended
September 30, September 30,
------------------------------------------------------------------------------------------
(in thousands) 2005 2004 % Change 2005 2004 % Change
----------------------------------------- --------------------------------------------
Depreciation and amortization $ 28,864 20,085 43.7 % $ 80,381 59,880 34.2 %
Equipment and software rentals 28,687 22,560 27.2 74,420 69,335 7.3
Repairs and maintenance 11,855 11,132 6.5 33,657 29,494 14.1
Impairment of developed software 482 - na 3,619 10,059 (64.0)
Other 7,246 5,524 31.1 20,693 15,446 34.0
---------------------------- ------------------------------
Totals $ 77,134 59,301 30.1 % $ 212,770 184,214 15.5 %
============================ ==============================
na=not applicable
Net occupancy and equipment expense increased $17.8 million, or 30.1%, and
$28.6 million, or 15.5%, for the three and nine months ended September 30, 2005
over the same periods in 2004, respectively. Of the $17.8 million and $28.6
million increase for the three and nine months ended September 30, 2005,
respectively, $8.0 million and $16.7 million are the result of occupancy and
equipment related expenses of Vital and TSYS Prepaid.
In September 2005, TSYS recognized an impairment loss on developed software
of $482,000. 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 of September 30, 2005, the Company has $1.5 million capitalized, net of
amortization, related to this asset.
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 plans to build a $35-40 million facility located in Chandler, Arizona.
Construction is expected to take approximately one year. Management has decided
to bring the disaster recovery function in-house instead of relying on third-
- 33 -
Results of Operations (continued)
party providers. The savings from bringing this service in-house will offset
some of the expenses associated with the new facility.
Other Operating Expenses
Summarized below are the major components of other operating expenses for
the three and nine months ended September 30, 2005 and 2004:
Three months ended Nine months ended
September 30, September 30,
--------------------------------- ----------------------------------
% Change % Change
2005 2004 2005 2004
--------- ----------- ----------- ---------- ----------- -----------
(in thousands)
Third-party data processing services $ 14,055 1,389 nm % $ 30,505 4,005 661.7 %
Court costs associated with debt collection
services 8,211 8,301 (1.1) 24,487 26,333 (7.0)
Professional advisory services 7,824 3,640 115.0 15,717 7,348 113.9
Supplies and stationery 7,109 6,123 16.1 21,179 19,206 10.3
Terminal deployment costs 6,772 - nm 16,483 - nm
Travel and business development 4,181 3,703 12.9 11,567 8,171 41.6
Amortization of conversion costs 4,142 2,828 46.4 11,315 8,344 35.6
Transaction processing provisions 3,039 801 279.2 7,634 5,621 34.7
Management fees 2,054 2,216 (7.3) 6,151 6,697 (8.2)
Bad debt expense 1,637 226 nm 4,124 (1,147) nm
Amortization of acquisition intangibles 868 415 109.5 2,343 977 139.8
Other 11,353 7,917 43.4 39,944 23,885 67.5
--------- ----------- ---------- -----------
Totals $ 71,245 37,559 89.7 % $ 191,449 109,440 74.9 %
========= =========== ========== ===========
nm = not meaningful
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.
Other operating expenses for the three and nine months ended September 30,
2005 increased $33.7 million and $82.0 million, or 89.7% and 74.9%,
respectively, as compared to the same periods in 2004. Of the $33.7 million and
$82.0 million increases, $32.4 million and $77.4 million, respectively, is the
result of other operating related expenses of Vital and TSYS Prepaid.
- 34 -
Results of Operations (continued)
Operating Income
Operating income increased 39.1% and 49.9% for the three and nine months
ended September 30, 2005, respectively, over the same periods in 2004. The
Company's operating profit margin for the three and nine months ended September
30, 2005 was 17.1% and 18.2%, respectively, compared to 17.0% and 16.3% for the
same periods last year. The margins for 2005 increased when compared to the same
period in 2004 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 September 30, 2005 was 21.1%, compared to 20.9% for the three
months ended September 30, 2004; for the nine months ended September 30, 2005,
the Company's operating margin excluding reimbursables was 22.5%, compared to
20.3% 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 nine months
ended September 30, 2005 and 2004, respectively:
Three months ended Nine months ended
September 30, September 30,
- -------------------------------------------------------------------------------------------- ------------------------------------
2005 2004 2005 2004
- -------------------------------------------------------------------------- ----------------- ------------------ -----------------
Operating income (a) $ 72,332 51,995 214,984 143,409
================= ================= ================== =================
Total revenues (b) $ 421,969 304,993 1,182,196 879,851
================= ================= ================== =================
Operating margin (as reported) (a)/(b) 17.1% 17.0% 18.2% 16.3%
================= ================= ================== =================
Revenue before reimbursable items (c) $ 342,100 248,416 953,544 706,710
================= ================= ================== =================
Adjusted operating margin (a)/(c) 21.1% 20.9% 22.5% 20.3%
================= ================= ================== =================
Nonoperating Income (Expense)
Interest income for the three months ended September 30, 2005 was $1.6
million, an increase of $925,000, compared to $667,000 for the same period in
2004. Interest income for the nine months ended September 30, 2005 was $3.9
million, an increase of approximately $2.2 million, compared to $1.7 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.
- 35 -
Results of Operations (continued)
Interest expense for the three months ended September 30, 2005 was $84,000,
a decrease of $11,000, compared to $95,000 for the same period in 2004. Interest
expense for the nine months ended September 30, 2005 was $259,000, a decrease of
$618,000, compared to $877,000 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.
The Company records foreign currency translation adjustments on
foreign-denominated balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British
Pounds Sterling (BPS). As the Company translates the foreign-denominated cash
balances into US dollars, the translated cash balance is adjusted upward or
downward depending upon the foreign currency exchange movements. The upward or
downward adjustment is recorded as a gain or loss on foreign currency
translation in the Company's statements of income. As those cash accounts have
increased, the upward or downward adjustments have increased. The majority of
the translation gain of $66,000 and loss of $761,000 for the three and nine
months ended September 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 September 30, 2005 was
approximately $5.2 million, the majority of which is denominated in Euros.
Income Taxes
TSYS' effective income tax rate for the three months ended September 30,
2005 was 36.3%, compared to 34.6% for the same period in 2004. TSYS' effective
income tax rate for the nine months ended September 30, 2005 was 35.4%, compared
to 34.4% for the same period in 2004. The increase in the effective tax rate for
the three and nine months ended September 30, 2005 is a result of increased
foreign earnings. The calculation of the effective tax rate is income taxes plus
income taxes associated with equity income divided by TSYS' pretax income
adjusted for minority interests in consolidated subsidiaries' net income and
equity pre-tax earnings of its joint ventures. The Company expects its effective
income tax rate for 2005 to be approximately 35%.
Equity in Income of Joint Ventures
TSYS' share of income from its equity in joint ventures was $991,000 and
$6.9 million for the three months ended September 30, 2005 and 2004,
respectively. TSYS' share of income from its equity in joint ventures was $5.3
million and $19.2 million for the nine months ended September 30, 2005 and 2004,
respectively. The decreases for the quarter and first nine 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
- 36 -
Results of Operations (continued)
Services de Mexico, S.A. de C.V. (TSYS de Mexico), prints statements and
provides card-issuing support services to the joint venture clients.
During the three months ended September 30, 2005, the Company's equity in
income of joint ventures related to TSYS de Mexico was $991,000, an 80.8%
increase, or $442,000 compared to $549,000 for the same period last year. During
the nine months ended September 30, 2005, the Company's equity in income of
joint ventures related to TSYS de Mexico was $2.1 million representing a 68.2%
increase, or $847,000 compared to $1.2 million, for the same period last year.
TSYS pays TSYS de Mexico a processing support fee for certain client
relationship and network services that TSYS de Mexico has assumed from TSYS.
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 nine months
ended September 30, 2005 and 2004, respectively.
Processing support fee 2005 2004
---------------------------------------------------------------------------------------------
For the three months ended September 30, $36,000 45,000
For the nine months ended September 30, 105,000 154,000
Net Income
Net income for the three months ended September 30, 2005 increased 22.8% or
$8.9 million, to $48.1 million or basic and diluted earnings per share of $0.24,
compared to $39.1 million, or basic and diluted earnings per share of $0.20, for
the same period in 2004. Net income for the nine months ended September 30, 2005
increased 34.6% or $37.2 million, to $144.8 million or basic and diluted
earnings per share of $0.73, compared to $107.6 million, or basic and diluted
earnings per share of $0.55, for the same period in 2004.
Net Profit Margin
The Company's net profit margin for the three months ended September 30,
2005 was 11.4%, compared to 12.8% for the same period last year. The Company's
net profit margin for the nine months ended September 30, 2005 was 12.3%,
compared to 12.2% 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.
- 37 -
Results of Operations (continued)
Excluding reimbursable items, the Company's net profit margin for the three
months ended September 30, 2005 was 14.0%, compared to 15.8% for the three
months ended September 30, 2004. Excluding reimbursable items, the Company's net
profit margin for the nine months ended September 30, 2005 and 2004 was 15.2%
for both periods.
Below is the reconciliation between reported net profit margin and adjusted
net profit margin excluding reimbursable items for the three and nine months
ended September 30, 2005 and 2004, respectively:
Three months ended Nine months ended
September 30, September 30,
- --------------------------------------------------------------------------------------------------------------------------------
2005 2004 2005 2004
- --------------------------------------------------------------------------------------------------------------------------------
Net income (a) $ 48,056 39,141 144,822 107,588
================= ================= ================= ==================
Total revenues (b) $ 421,969 304,993 1,182,196 879,851
================= ================= ================= ==================
Net profit margin (as reported) (a)/(b) 11.4% 12.8% 12.3% 12.2%
================= ================= ================= ==================
Revenue before reimbursable items (c) $ 342,100 248,416 953,544 706,710
================= ================= ================= ==================
Adjusted net profit margin (a)/(c) 14.0% 15.8% 15.2% 15.2%
================= ================= ================= ==================
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 at the higher end of the
range of 25%-28%, based on the following assumptions: total revenues increasing
32%-34% 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 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.
- 38 -
Financial Position, Liquidity and Capital Resources (continued)
Cash Flows From Operating Activities
Nine months ended
September 30,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Net income $ 144,822 107,588
Depreciation and amortization 109,547 79,517
Other non cash items and charges, net 20,686 25,524
Working capital items (151,118) (32,946)
----------------- -----------------
Net cash provided from operating activities $ 123,937 179,683
================= =================
TSYS' main source of funds is derived from operating activities,
specifically net income. During the nine months ended September 30, 2005, the
Company generated $123.9 million in cash from operating activities compared to
$179.7 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.
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 September 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
Nine months ended
September 30,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Purchases of property and equipment, net $ (33,540) (49,815)
Additions to licensed computer software from vendors (10,049) (19,237)
Additions to internally developed computer software (17,435) (3,996)
Cash used in acquisitions, net of cash acquired (56,998) (50,578)
Dividends from joint ventures 1,658 15,876
Contract acquisition costs (11,756) (22,441)
----------------- -----------------
Net cash used in investing activities $ (128,120) (130,191)
================= =================
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
$128.1 million in cash for investing activities for the nine months ended
September 30, 2005, compared to $130.2 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 September 30, 2005 and 2004 were $13.1 million and $10.5 million,
respectively. For the nine month period ended September 30, 2005, capital
expenditures for property and equipment were $33.5 million
- 39 -
Financial Position, Liquidity and Capital Resources (continued)
compared to $49.8 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 33, the Company has decided to construct a
102,000 square foot data centre in Chandler, AZ as part of its disaster recovery
plan.
Licensed Computer Software from Vendors
Expenditures for licensed computer software from vendors were $598,000 and
$5.2 million for the three months ended September 30, 2005 and 2004,
respectively. Expenditures for licensed computer software from vendors for the
nine months ended September 30, 2005 were $10.0 million, compared to $19.2
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.
Internally Developed Computer Software Costs
Additions to capitalized software development costs for the nine months
ended September 30, 2005 were $17.4 million, compared to $4.0 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 nine months
ended September 30, 2005 and 2004, respectively:
Nine months ended
September 30,
-------------------------------------
(in millions) 2005 2004
----------------------------------------------------------------- ------------------
Vital Express $ 9.3 -
MSII 2.2 -
TLP 4.2 -
Other 1.7 4.0
----------------- ------------------
Total $ 17.4 4.0
================= ==================
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 and ESC's development of TSYS Loyalty Platform (TLP). 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
$2.2 million since acquiring Vital, and has a total of $2.7 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. The Company expects to complete
Vital Express in phases, with the first phase being introduced in the
- 40 -
Financial Position, Liquidity and Capital Resources (continued)
marketplace in July 2005. The remaining phases continue to be developed and are
expected to be introduced in the marketplace between the fourth quarter of 2005
and the end of 2006. This project had reached technological feasibility prior to
TSYS' acquisition of control of Vital. The Company capitalized approximately
$9.3 million since acquiring Vital, and has a total of $19.5 million capitalized
since the project began.
Through its ESC subsidiary, the Company is internally developing an
advanced loyalty platform - TSYS Loyalty Platform (TLP). TLP is designed to
support transactional speed, complex reward programs and robust analytics tool.
The platform offers critical support to all elements of loyalty management,
including points processing, tracking, communications, redemption systems and
analytics. The Company capitalized approximately $1.5 million during the three
months ended September 30, 2005, and has a total of $4.2 million capitalized
since the project began. The project is expected to be fully operational and
introduced to market by July 2006.
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.
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 33, 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 September 30, 2005, the Company has $1.5 million
capitalized, net of amortization, 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 $794,000.
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 $775,000 for the three months ended September
30, 2005, bringing the total for 2005 to $11.8 million, compared to $22.4
million for the nine months ended September 30, 2004. The Company did not have a
cash payment for processing rights for
- 41 -
Financial Position, Liquidity and Capital Resources (continued)
the nine months ended September 30, 2005. The Company had a cash payment for
processing rights for the nine months ended September 30, 2004 of $16.0 million.
Conversion cost additions were $11.8 million and $6.4 million for the nine
months ended September 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
Nine months ended
September 30,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2005 2004
--------------------------------------------------------------------------------------------------------------------
Proceeds from borrowings of long-term debt $ 48,143 -
Principal payments on long-term debt borrowings, capital lease obligations
and software obligations (49,360) (42,321)
Dividends paid on common stock (27,582) (15,747)
Purchase of common stock - (1,188)
Other 2,920 1,193
----------------- -----------------
Net cash used in financing activities $ (25,879) (58,063)
================= =================
The major use of cash for financing activities has been the principal
payments on capital lease and software obligations, the payment of dividends and
the purchase of stock under the stock repurchase plan as described below. The
main source of cash from financing activities has been the occasional use of
borrowed funds. Net cash used in financing activities for the nine months ended
September 30, 2005 was $25.9 million mainly as a result of the payments of
dividends. Net cash used in financing activities for the nine months ended
September 30, 2004 was $58.1 million mainly as a result of the payments related
to the software obligations, and to a lesser extent, the purchases of common
stock and payments of dividends.
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 nine months ended September 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
- 42 -
Financial Position, Liquidity and Capital Resources (continued)
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 $11.8 million were paid during the three
months ended September 30, 2005, bringing the total for 2005 to $27.6 million
compared to $15.7 million paid during the nine months ended September 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. 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.
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
- 43 -
Working Capital (continued)
evidenced by TSYS' current ratio of 2.1. At September 30, 2005, TSYS had working
capital of $270.6 million compared to $176.3 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 received notification from the United States Attorneys' Office
for the Northern District of California that the United States Department of
Justice was 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 related 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. The Company produced documents and
information in response to a subpoena that it received from the Office of the
Inspector General of the United States Postal Service and otherwise cooperated
with the Department of Justice during the investigation. The involved parties
agreed to a settlement of the matter without any party admitting liability. The
matter was settled during the third quarter for amounts that were not material
to TSYS' financial condition, results of operations or cash flows.
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 or issued during 2005.
On April 14, 2005, the 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
- 44 -
Recent Accounting Pronouncements (continued)
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.
In September 2004, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on EITF Issue No. 04-10 (EITF 04-10), "Determining Whether to
Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds". EITF
04-10 clarified that operating segments can be aggregated only if aggregation is
consistent with the objective and basic principles of FASB Statement No. 131
(SFAS No. 131), "Disclosures about Segments of an Enterprise and Related
Information," the segments have similar economic characteristics, and the
segments share a majority of the aggregation criteria listed in paragraph 17 of
SFAS No. 131. The consensus in EITF 04-10 should be applied for fiscal years
ending after September 15, 2005. The corresponding information for earlier
periods, including interim periods, should be restated unless it is impractical
to do so. The Company has determined that adoption of EITF 04-10 will not have
an impact on its currently reportable segments.
In June 2005, the EITF reached a consensus on EITF Issue No. 05-6 (EITF
05-6), "Determining the Amortization Period for Leasehold Improvements." This
guidance provides that leasehold improvements acquired in a business combination
and those acquired after the inception of a lease should be amortized over the
shorter of the useful life of the assets or a term that includes renewals that
are reasonably assured at the date of acquisition of the leasehold improvements.
The guidance is effective for periods beginning after June 29, 2005. The Company
does not expect the impact of EITF 05-6 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 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 growth for 2005 and 2006, TSYS' expectation that the
deconversion of the Sears consumer MasterCard and private-label accounts will
occur in the second quarter of 2006, TSYS' expectation that it will continue
supporting commercial card accounts for Citibank, as well as Citibank's
California Commerce consumer accounts, management's belief with respect to the
financial impact of the loss of the Sears accounts for 2006, 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
decision that might arise out of the evaluation process Bank of America is
conducting, and the assumptions underlying such statements, including, with
respect to TSYS' expected increase in net income for 2005, an increase in total
revenues of 32%-34%; Vital Processing Services adding $225-$235 million in
annual revenues; accounts on file at the end of 2005 increasing to between 430
and 435 million; and revenues 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
- 45 -
Forward-Looking Statements (continued)
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; (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.
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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 Pounds Sterling (BPS), Mexican Peso, Canadian Dollar and
Japanese Yen. These currencies are translated into U.S. dollars at current
exchange rates, except for revenues, costs and expenses, and net income, which
are translated at the average exchange rates for each reporting period. Net
exchange gains or losses resulting from the translation of assets and
liabilities of TSYS' foreign operations, net of tax, are accumulated in a
separate section of shareholders' equity titled accumulated other comprehensive
income or loss. The amount of other comprehensive loss for the three months
ended September 30, 2005 was $2.3 million. The amount of other comprehensive
loss for the three months ended September 30, 2004 was $1.2 million. The amount
of other comprehensive loss for the nine months ended September 30, 2005 was
$7.7 million. The amount of other comprehensive income for the nine months ended
September 30, 2004 was $1.3 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) $134.1 million,
$5.1 million, $0.6 million and $13.0 million, respectively, at September 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 BPS. As the
Company translates the foreign-denominated cash balances into US dollars, the
translated cash balance is adjusted upward or downward depending upon the
foreign currency exchange movements. The upward or downward adjustment is
recorded as a gain or loss on foreign currency translation in the Company's
statements of income. As those cash accounts have increased, the upward or
downward adjustments have increased. The majority of the translation gain of
$66,000 and loss of $761,000 for the three and nine months ended September 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 September 30, 2005 was approximately $5.2 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 rates and the U.S.
dollar of plus or minus 100 basis points, 500 basis points and 1,000 basis
points based on the foreign-denominated cash account balance at September 30,
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 $ (52) (258) (516) 52 258 516
--------------- ----------------- ---------------- ------------ -------------- --------------
The foreign currency risks associated with other currencies is not
significant.
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TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk (continued)
Interest Rate Risk
TSYS is also exposed to interest rate risk associated with the investing of
available cash and the use of long-term debt associated with its line of credit
as discussed below. TSYS invests available cash in conservative short-term
instruments and is primarily subject to changes in the short-term interest
rates.
In connection with the purchase of the campus, TSYS obtained a $45.0
million long-term line of credit from a banking affiliate of Synovus. The line
is an automatic draw down facility. The interest rate for the line of credit is
the London Interbank Offered Rate (LIBOR) plus 150 basis points. In addition,
there is a charge of 15 basis points on any funds unused. As the LIBOR rate
changes, TSYS will be subject to interest rate risk. At September 30, 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' processing agreement with Bank of America
provides that Bank of America may terminate its agreement with TSYS for consumer
credit card services upon the payment of a termination fee.
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.
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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
September 30, 2005:
- -------------------------------------------------------------------------------------------------------------------------------
Total Number of Shares Maximum Number of
Purchased as Part of Shares That May Yet Be
Total Number of Shares Average Price Paid per Publicly Announced Purchased Under the
Period Purchased Share Plans or Programs Plans or Programs
- -------------------------------------------------------------------------------------------------------------------------------
July 2005 - $- - -
August 2005 - - - -
September 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 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: November 3, 2005 by: /s/ Philip W. Tomlinson
---------------------------------------------------------------
Philip W. Tomlinson
Chief Executive Officer
Date: November 3, 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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