FIRST DATA CORPORATION
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(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, 1999
------------------
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 1-11073
-------
FIRST DATA CORPORATION
----------------------
(Exact name of registrant as specified in its charter)
DELAWARE 47-0731996
------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5660 NEW NORTHSIDE DRIVE, SUITE 1400, ATLANTA, GA 30328-5800
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (770) 857-0001
___________________________
NOT APPLICABLE
-------------------------------------------------------------------
(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 Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No____
------
Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of the latest practicable date.
Title of each class Number of Shares Outstanding
------------------------- as of November 1, 1999
Common Stock, $.01 par value ----------------------
419,068,488
-----------
1
FIRST DATA CORPORATION
INDEX
-----
PAGE
PART I FINANCIAL INFORMATION NUMBER
------
Item 1. Financial Statements:
Consolidated Statements of Income for the three and
nine months ended September 30, 1999 and 1998................ 3
Consolidated Balance Sheets at September 30, 1999
and December 31, 1998........................................ 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 1999 and 1998..................... 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk.................................................. 22
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................. 24
Item 6. Exhibits and Reports on Form 8-K.............................. 25
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
FIRST DATA CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share amounts)
(Unaudited)
Three months ended September 30, Nine months ended September 30,
----------------------------------- ----------------------------------
1999 1998 1999 1998
-------------- ----------------- --------------- ---------------
REVENUES
Service revenues $1,373.5 $1,255.8 $3,991.9 $3,682.9
Product sales and other 26.7 26.3 75.8 85.8
-------------- ----------------- --------------- ---------------
1,400.2 1,282.1 4,067.7 3,768.7
-------------- ----------------- --------------- ---------------
EXPENSES
Operating 883.7 799.4 2,629.9 2,406.2
Selling, general & administrative 197.6 181.3 603.7 564.5
Provision for loss on contract --- --- --- 125.2
Restructuring, business divestitures,
litigation and impairment, net 6.1 --- 41.0 38.9
Interest 27.4 25.5 74.4 80.3
-------------- ----------------- --------------- ---------------
1,114.8 1,006.2 3,349.0 3,215.1
-------------- ----------------- --------------- ---------------
Income before income taxes 285.4 275.9 718.7 553.6
Income taxes 78.3 88.7 177.3 190.3
-------------- ----------------- --------------- ---------------
Net income $ 207.1 $ 187.2 $ 541.4 $ 363.3
============== ================= =============== ===============
Earnings per common share-basic $ 0.49 $ 0.42 $ 1.26 $ 0.81
============== ================= =============== ===============
Earnings per common share-diluted $ 0.48 $ 0.42 $ 1.24 $ 0.81
============== ================= =============== ===============
Weighted Average Shares Outstanding:
Basic 425.8 446.5 430.7 446.8
============== ================= =============== ===============
Diluted 433.8 449.0 438.2 450.2
============== ================= =============== ===============
See notes to consolidated financial statements.
3
FIRST DATA CORPORATION
CONSOLIDATED BALANCE SHEETS
(In millions)
(Unaudited)
September 30, December 31,
1999 1998
------------------- ------------------
ASSETS
Cash and cash equivalents $ 520.6 $ 459.5
Settlement assets 8,987.4 9,758.0
Accounts receivable, net of allowance for doubtful accounts
of $32.2 (1999) and $27.9 (1998) 889.1 940.1
Property and equipment, net 740.3 781.0
Goodwill, less accumulated amortization of $584.8 (1999) and
$542.7 (1998) 2,694.3 2,885.4
Other intangibles, less accumulated amortization of $673.2
(1999) and $548.5 (1998) 1,062.9 1,107.9
Other assets 1,236.8 655.1
---------------- ---------------
$16,131.4 $16,587.0
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Settlement obligations $ 9,032.7 $ 9,617.0
Accounts payable and other liabilities 1,486.7 1,642.4
Borrowings 2,194.6 1,571.7
---------------- ---------------
Total Liabilities 12,714.0 12,831.1
---------------- ---------------
Commitments and contingencies
Stockholders' Equity:
Common Stock, $.01 par value; authorized 600.0 shares,
issued 448.9 shares in 1999 and 1998 4.5 4.5
Additional paid-in capital 2,174.5 2,143.2
---------------- ---------------
Paid-in capital 2,179.0 2,147.7
Retained earnings 2,342.4 1,893.9
Accumulated other comprehensive income (59.4) 54.1
Less treasury stock at cost, 28.6 shares (1999) and 13.4
shares (1998) (1,044.6) (339.8)
---------------- ---------------
Total Stockholders' Equity 3,417.4 3,755.9
---------------- ---------------
$16,131.4 $16,587.0
================ ===============
See notes to consolidated financial statements.
4
FIRST DATA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine months ended September 30,
---------------------------------------
1999 1998
------------------ ----------------
Cash and cash equivalents at beginning of period $ 459.5 $ 410.5
------------------ ----------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income 541.4 363.3
Adjustments to reconcile to net cash provided by operating
activities:
Depreciation and amortization 462.5 433.7
Noncash portion of provision for loss on contract,
restructuring, business divestitures, litigation and
impairment, net 41.0 153.9
Other noncash items 41.8 23.0
Increase (decrease) in cash, excluding the effects of
acquisitions and dispositions, resulting from changes in:
Accounts receivable 36.6 (38.4)
Other assets 9.4 (41.1)
Accounts payable and other liabilities (101.9) 11.6
Income tax accounts (91.4) 15.4
------------------ ----------------
Net cash provided by operating activities 939.4 921.4
------------------ ----------------
CASH FLOWS FROM INVESTING ACTIVITIES
Current year acquisitions, net of cash acquired (459.8) (97.2)
Payments related to other businesses previously acquired (40.3) (53.9)
Proceeds from dispositions, net of expenses paid 242.2 150.0
Additions to property and equipment, net (163.6) (272.6)
Payments to secure customer service contracts, including
outlays for conversion, and capitalized systems
development costs (177.3) (256.5)
Other investing activities (102.8) (7.3)
------------------ ----------------
Net cash used in investing activities (701.6) (537.5)
------------------ ----------------
CASH FLOWS FROM FINANCING ACTIVITIES
Short-term borrowings, net 680.4 4.5
Long-term debt borrowings 100.0 ---
Payments on long-term debt (158.1) (153.6)
Proceeds from issuance of common stock 144.1 72.7
Purchase of treasury shares (917.0) (179.7)
Cash dividends (26.1) (26.8)
Other financing activities --- (0.6)
------------------ ----------------
Net cash used for financing activities (176.7) (283.5)
------------------ ----------------
Change in cash and cash equivalents 61.1 100.4
------------------ ----------------
Cash and cash equivalents at end of period $ 520.6 $ 510.9
================== ================
See notes to consolidated financial statements.
5
FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The accompanying consolidated financial statements of First Data Corporation
("FDC" or the "Company") should be read in conjunction with the Company's
consolidated financial statements for the year ended December 31, 1998.
Significant accounting policies disclosed therein have not changed.
The accompanying consolidated financial statements are unaudited; however,
in the opinion of management, they include all normal recurring adjustments
necessary for a fair presentation of the consolidated financial position of
the Company at September 30, 1999 and the consolidated results of its
operations for the three and nine months ended September 30, 1999 and 1998
and cash flows for the nine months ended September 30, 1999 and 1998.
Results of operations reported for interim periods are not necessarily
indicative of results for the entire year.
FDC recognizes revenues from its information processing services as such
services are performed, recording revenues net of certain costs not
controlled by the Company (primarily interchange fees and assessments
charged by credit card associations of $492.9 million and $415.8 million for
the three months ended September 30, 1999 and 1998, respectively, and
$1,361.4 million and $1,134.0 million for the nine months ended September
30, 1999 and 1998, respectively).
2. In September 1999, the Company recorded a pre-tax loss of $13.5 million
($8.4 million after tax) related to the termination of a specialty services
joint venture. The charge represents the funding required for the joint
venture shutdown and payment of a customer termination fee. Also in
September 1999, a $7.4 million merger accrual related to the 1995 merger of
FDC and First Financial Management Corporation (with no tax effect) was
reversed due to the favorable resolution of a contingency in the third
quarter.
In July 1999, the Company announced that it had entered into a definitive
agreement with PNC Bank Corp. to sell its Investor Services Group subsidiary
for approximately $1.1 billion in cash. This sale allows FDC to further
concentrate its efforts on electronic payment services and e-commerce
solutions. Upon completion of the sale, the Company will record a one-time
pre-tax gain of approximately $700 million (approximately $370 million after
tax) and will realize net after tax cash proceeds of approximately $700
million. This transaction, which is subject to customary regulatory
approvals, is expected to be completed during the fourth quarter of 1999.
In July 1999, the Company completed the sale of its Donnelley Marketing
subsidiary to infoUSA for approximately $200 million in cash. As a result of
this transaction a pre-tax loss of $29.8 million ($14.7 million after tax)
was recorded in the second quarter of 1999 upon the signing of a definitive
purchase agreement in June 1999.
In May 1999, the Company announced that its Western Union business unit
received preliminary approval for a proposed settlement of all claims in
several class action lawsuits pertaining to the Company's U.S.-to-Mexico
money transfer business. Under the terms of the settlement, FDC will
establish a charitable fund for the advancement of Mexican and Mexican-
American causes in the amount of $2 million. In addition, Western Union will
issue discount coupons to its customers who transferred money from the U.S.
to Mexico after January 1, 1987. These coupons will be for future money
transfers to Mexico. Discount coupons for future Western Union transactions
will also be issued to MoneyGram (previously an FDC subsidiary) customers
who transferred money to Mexico from January 1,
6
FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
1988 to December 10, 1996. FDC recorded a second quarter pre-tax charge of
$34.1 million ($21.1 million after tax) to reflect legal fees, the
charitable fund and other outside administrative costs in connection with
the settlement. Future discounts related to coupon redemption will be
recorded as incurred.
In May 1999, the Company sold its EBP Life business unit for $14.5 million
cash. As a result of this transaction FDC recorded a pre-tax gain of $4.5
million ($3.9 million after tax) in the second quarter of 1999. Included in
this pre-tax gain amount is $2.9 million related to the reversal of an
impairment charge previously recorded by the Company in anticipation of its
exit from the insurance line of business.
In April 1999, the Company sold Innovis Inc. (formerly Consumer Credit
Associates, Inc.) to CBC Companies, Inc. for $20 million. As a result of
selling Innovis certain tax benefits will be realized. Results for second
quarter 1999 include recognition of a pre-tax benefit of $24.5 million ($40
million after tax) for Innovis that relates primarily to the receipt of the
net proceeds from its sale. The remaining shutdown reserve at September 30,
1999 of $6.4 million includes $2.1 million for severance and $4.3 million
for other exit costs.
During the second quarter of 1998, the Company amended its agreement with
HSBC Holdings, plc ("HSBC") and recorded a $125.2 million loss contract
provision. In September 1998, the Company announced the termination of its
Hong Kong card-processing contract with HSBC. Such termination caused an
Australian card-processing contract to become a loss contract. Of the $19.1
million HSBC accrual at December 31, 1998, $14.9 million was utilized during
the first nine months of 1999, including $12.4 million for the Australian
loss contract and $2.5 million for Hong Kong wind down costs.
In January 1998, the Company announced its intention to sell First Image
Management Company ("First Image"), its imaging and document management
business, and recorded a 1997 pre-tax impairment charge of $106.7 million,
reflecting the anticipated loss on the disposition. In June 1998, the
Company completed the sale of First Image for $150.0 million in cash. The
finalization of the transaction resulted in the reversal of $9.8 million of
the 1997 impairment charge in the second quarter of 1998.
Also reported on the "Restructuring, business divestitures, litigation and
impairment, net" line in the Consolidated Statements of Income is a 1998
first quarter $28.5 million pre-tax gain on the sale of the NTS
transportation services unit.
During the first nine months of 1998, the Company incurred restructuring
charges of $30.9 million ($7.8 million in the second quarter and $23.1
million in the first quarter); $19.1 million related to merchant processing
services, $4.7 million related to card issuer services and $7.1 million
related to all other and corporate. The charges consisted of severance
accruals for approximately 681 employees of $15.1 million, facility closure
and related costs of $9.8 million and $6.0 million for settlement of a legal
matter associated with the merger with FFMC. During the first nine months of
1998, the Company also recorded impairment charges totaling $46.3 million
($40.5 million in the second quarter and $5.8 million in the first quarter).
These charges consisted of $38.5 million of platform development costs
related to the HSBC project and other potential non-U.S. clients that may
not be recoverable in the near to medium term, and thus were written off in
the second quarter of 1998, $7.1 million related to merchant processing
services as a result of facility closures and terminated conversion efforts
and $0.7 million related to all other and corporate.
7
FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. The following table summarizes the Company's utilization of restructuring
accruals for the nine months ended September 30, 1999 (in millions):
Employee Facility Other Exit
Severance Closure Costs
---------------- --------------- ---------------
Remaining Accrual at December 31, 1998 $7.9 $7.9 $2.0
Cash Payments and Other Charges 5.4 0.9 ---
---------------- --------------- ---------------
Remaining Accrual at September 30, 1999* $2.5 $7.0 $2.0
================ =============== ===============
*Excludes Hong Kong and Innovis activities.
4. In July 1999, the Company completed the acquisition of Paymentech, Inc.'s
16.4 million publicly held shares (45% of total outstanding shares) for a
cash payment of approximately $430 million. This payment included
consideration for the cancellation of outstanding options to purchase shares
of Paymentech's common stock. In conjunction with this transaction,
Paymentech's operations were combined with the existing Bank One/First Data
alliance, BancOne Payment Services, LLC, resulting in a larger alliance with
greater market presence. Paymentech provides full-service electronic payment
solutions for merchants and third-party transaction processing.
Additionally, during the first nine months of 1999 the Company acquired four
other businesses expanding FDC's markets and services. All 1999
acquisitions, including the investment in Paymentech which is accounted for
under the equity method of accounting as part of the Bank One alliance, have
been accounted for as purchases and their results are included in the
Company's results from the effective date of each acquisition. No pro forma
financial information with respect to the above acquisitions is presented as
the aggregate impact is not material.
5. The Company's commercial paper borrowings at September 30, 1999 were $1.1
billion under its $1.5 billion commercial paper program and supporting
revolving credit facilities. Pursuant to a 1998 agreement, $175.0 million of
the facilities have been designated to be used solely for the purpose of
meeting certain of the Company's settlement obligations, if necessary. At
September 30, 1999, the Company also had $525 million available under shelf
registrations providing for the issuance of debt and equity securities and
$235 million available under its uncommitted bank lines.
During March 1999, the Company entered into a $100 million, 5-year bullet
maturity debt financing with a floating interest rate. Under certain
circumstances the financing may be prepaid.
8
FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. Earnings per common share amounts are computed by dividing net income
amounts by weighted average common and common equivalent shares (when
dilutive) outstanding during the period.
Amounts utilized in per share computations are as follows (in millions):
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
1999 1998 1999 1998
-------------- ------------- ------------- --------------
Weighted average shares outstanding:
Basic weighted average shares 425.8 446.5 430.7 446.8
Stock options 7.8 2.4 7.3 3.3
Restricted stock awards 0.2 0.1 0.2 0.1
-------------- ------------- ------------- --------------
433.8 449.0 438.2 450.2
============== ============= ============= ==============
Diluted earnings per common share was calculated based on weighted-average
shares outstanding including the dilutive impact of common stock equivalents
which consist of outstanding stock options and restricted stock awards.
7. The components of comprehensive income are as follows (in millions):
Three months ended Nine months ended
September 30, September 30,
-------------------------------- -----------------------------------
1999 1998 1999 1998
-------------- ------------- --------------- ---------------
Net income $207.1 $187.2 $ 541.4 $363.3
Foreign exchange effect 15.5 (2.5) 2.9 (3.4)
Unrealized (loss) gain on securities (18.7) 35.6 (116.4) 34.6
-------------- ------------- --------------- ---------------
Total comprehensive income $203.9 $220.3 $ 427.9 $394.5
============== ============= =============== ===============
8. First Data Corporation classifies its businesses into three principal
segments: payment instruments, card issuer services and merchant processing
services. See the Company's 1998 Annual Report on Form 10-K for a detailed
description of each segment and the accounting policies of the operating
segments.
As stated in Note 2, the Company sold its Donnelley Marketing business unit
and has announced the impending sale of its Investor Services Group business
unit. To appropriately reflect these divestitures, segment information has
been restated to represent the move of Donnelley Marketing and Investor
Services Group to "divested or to be divested" from the "card issuer
services" and "all other and corporate" segment, respectively. Additionally,
other small information businesses were moved to "all other and corporate"
from the "card issuer services" segment to reflect current management
reporting relationships.
9
FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
The following table presents the Company's operating segment results for the
three months and nine months ended September 30, 1999 and 1998 (in
millions):
Three months ended September 30, Nine months ended September 30,
-------------------------------------- -----------------------------------
1999 1998 1999 1998
----------------- ---------------- --------------- ---------------
Revenues:
Payment Instruments $ 521.2 $ 440.3 $1,483.4 $1,240.8
Card Issuer Services 360.0 322.9 1,005.6 925.3
Merchant Processing Services 387.9 347.6 1,126.0 1,005.0
All Other and Corporate 79.5 83.9 239.0 246.5
----------------- ---------------- --------------- ---------------
Subtotal 1,348.6 1,194.7 3,854.0 3,417.6
----------------- ---------------- --------------- ---------------
Divested or To Be Divested 93.0 117.2 331.3 441.0
Eliminations (a) (41.4) (29.8) (117.6) (89.9)
----------------- ---------------- --------------- ---------------
Consolidated $1,400.2 $1,282.1 $4,067.7 $3,768.7
================= ================ =============== ===============
Operating Profit:
Payment Instruments $ 163.1 $ 139.6 $ 416.8 $ 353.3
Card Issuer Services 60.3 63.0 174.6 173.4
Merchant Processing Services 108.0 78.9 275.8 212.9
All Other and Corporate 12.4 29.0 35.5 90.8
----------------- ---------------- --------------- ---------------
Subtotal 343.8 310.5 902.7 830.4
----------------- ---------------- --------------- ---------------
Divested or To Be Divested 16.5 20.7 49.0 57.5
Corporate Interest Expense, net (27.4) (25.5) (74.4) (80.3)
Restructuring, Business
Divestitures, Litigation and
Impairments, net (6.1) --- (41.0) (164.1)
Eliminations (a) (41.4) (29.8) (117.6) (89.9)
----------------- ---------------- --------------- ---------------
Consolidated $ 285.4 $ 275.9 $ 718.7 $ 553.6
================= ================ =============== ===============
Depreciation & Amortization:
Payment Instruments $ 28.4 $ 24.7 $ 80.2 $ 70.5
Card Issuer Services 63.2 56.2 187.3 165.7
Merchant Processing Services 48.2 47.3 145.9 137.9
All Other and Corporate 4.9 4.3 13.8 12.3
----------------- ---------------- --------------- ---------------
Subtotal 144.7 132.5 427.2 386.4
Divested or To Be Divested 9.6 13.0 35.3 47.3
----------------- ---------------- --------------- ---------------
Consolidated $ 154.3 $ 145.5 $ 462.5 $ 433.7
================= ================ =============== ===============
(a) Represents principally the elimination of an adjustment to record tax-
exempt revenues (primarily in Payment Instruments) on a pre-tax equivalent
basis.
10
FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
September 30, 1999 December 31, 1998
-------------------------- --------------------------
Segment Assets (in millions):
Payment Instruments $10,277.4 $10,875.3
Card Issuer Services 1,515.0 1,537.5
Merchant Processing Services 3,415.5 3,153.8
All Other and Corporate 468.9 330.7
-------------------------- --------------------------
Subtotal 15,676.8 15,897.3
Divested or To Be Divested 454.6 689.7
-------------------------- --------------------------
Consolidated $16,131.4 $16,587.0
========================== ==========================
9. In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires
companies to record derivatives on the balance sheet as assets or
liabilities at fair value. SFAS 137 "Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement
No. 133 - an Amendment of FASB Statement No. 133" was issued in June 1999,
which delayed the effective date of SFAS 133 to fiscal years beginning after
June 15, 2000. The Company is evaluating the impact of SFAS 133 on the
Company's future earnings and financial position, but does not expect it to
be material.
11
FIRST DATA CORPORATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- ---------------------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
Significant Developments
During the first nine months of 1999, First Data Corporation ("FDC" or the
"Company") continued to emphasize its three principal business segments: payment
instruments, card issuer services and merchant processing services. The Company
has continued this emphasis to further its overarching strategic objective: to
process every electronic transaction worldwide from the point of occurrence to
the point of settlement. FDC is keenly focused on improving execution of
strategic plans, enhancing sales and marketing activities, identifying
operational efficiencies and building on the fundamental strengths of its
business.
In the payment instruments segment, Western Union continues to experience strong
growth. Western Union now offers money transfer services at nearly 78,000 agent
locations (a 48% increase since September 30, 1998) in 176 countries worldwide.
The dramatic growth in agent locations is due in part to the signing of Postbank
of Germany - which added 12,000 locations in the second quarter of 1999.
Development efforts continued on several new products and services, including
TransPoint, the Company's Internet-based bill presentment and payment service
joint venture, of which service went live with a limited number of billers in
the second quarter of 1999. During the third quarter of 1999, TransPoint
continued to sign new billers and has scheduled additional companies to go
"live" during the fourth quarter of 1999.
In May 1999, the Company announced that its Western Union business unit had
received preliminary approval for a proposed settlement of all claims in several
class action lawsuits pertaining to the Company's U.S.-to-Mexico money transfer
business. Under the terms of the settlement, FDC will establish a charitable
fund for the advancement of Mexican and Mexican-American causes in the amount of
$2 million. In addition, Western Union will issue discount coupons to its
customers who transferred money from the U.S. to Mexico after January 1, 1987.
These coupons will be for future money transfers to Mexico. Discount coupons for
future Western Union transactions will also be issued to MoneyGram (previously
an FDC subsidiary) customers who transferred money to Mexico from January 1,
1988 to December 10, 1996. FDC recorded a second quarter pre-tax charge of $34.1
million ($21.1 million after tax) to reflect legal fees, the charitable fund and
other outside administrative costs in connection with the settlement. Future
discounts related to coupon redemption will be recorded as incurred.
Card issuer services volume trends remained positive in the first nine months of
1999 with total accounts on file growing to 260 million -- up 24% from September
30, 1998. This growth was fueled by the conversion of a record number of
accounts in the third quarter of 1999 (approximately 38 million accounts)
including the First Chicago bankcard portfolio now owned by BankOne, the First
Consumers retail card portfolio (featuring the Spiegel and Eddie Bauer brands)
and First Union.
The merchant processing segment continued to experience strong revenue growth in
the third quarter and first nine months of 1999 (12%) compared to the same
periods in 1998. This growth in revenues is attributable to significant
increases in merchant dollar volume processed which grew 36% in the third
quarter of 1999 (19% excluding the impact of the Paymentech acquisition
discussed below) and 25% in the first nine months of 1999 (18% excluding
Paymentech) compared to the third quarter and first nine months of 1998.
In July 1999, the Company completed the acquisition of Paymentech, Inc.'s 16.4
million publicly held shares (45% of total outstanding shares) for a cash
payment of approximately $430 million. This payment included consideration for
the cancellation of outstanding options to purchase shares of Paymentech's
common stock. In conjunction with this transaction, Paymentech's operations were
combined with the existing Bank One/ First Data alliance, BancOne Payment
Services, LLC, resulting in a larger alliance with greater market presence.
Paymentech provides full-service electronic payment solutions for merchants and
third party transaction processing. This transaction is expected to be
approximately one cent dilutive to First Data's earnings per share in 1999 and
to have an immediate accretive impact to cash flow. The impact of this
transaction was considered in the Company's previously stated 1999 financial
outlook and the Company remains comfortable with its earnings per share guidance
of $1.68 to $1.76.
12
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
FDC continues to aggressively expand its e-commerce activities. During the third
quarter 1999, the Company announced the creation of an Internet Commerce group
to focus on development and management of Internet-based electronic commerce
solutions and related initiatives across all First Data subsidiaries. At the
same time, the Company unveiled the industry's first stand-alone payment gateway
- - SurePay (SM) - supporting credit card, check and cash payments over the
Internet.
The Company also continues to build critical relationships with Internet-related
companies. In the third quarter of 1999, the Company announced a strategic
marketing agreement between Excite@Home and FDC to enable merchants to quickly
-----------
establish an online commerce storefront with transaction capabilities and access
to Excite's daily users. This agreement coincided with Excite's agreement to
acquire iMall, Inc. in which FDC held an 11% ownership stake before the
transaction, which closed on October 27, 1999. As a result of this transaction
FDC will recognize a gain of approximately $20 million ($12 million after tax)
in fourth quarter 1999 results.
Also in third quarter of 1999, the Company (along with Wells Fargo & Co.)
announced the launch of the One-Stop e-Store, an extensive, affordable e-
commerce solution for small and mid-sized businesses. The One-Stop e-Store
package provides all the tools for businesses to create a virtual storefront,
from Web design, development and hosting, to payment processing and traffic
building. The bundled solution allows a business to create a secure dynamic,
sales-ready Internet presence in a matter of days.
More recently, the Company announced an agreement with Passlogix, Inc. to
develop advanced electronic wallet technology for Web merchants, credit card
issuers and online consumers. The wallet technology will enable users to
register and shop online with one click and instantly logon to all of their
websites and applications. This results in decreased work for users and a
complete identity management system, providing them with enhanced security and
privacy while generating greater revenues for e-commerce sites. Passlogix
creates software that enables businesses to manage and verify electronic
identities of their customers and employees.
Several significant actions were taken in the first nine months of 1999 as the
Company continues to streamline its operations and focus on its three primary
lines of business.
In April 1999, the Company sold Innovis, Inc. (formerly Consumer Credit
Associates, Inc.) to CBC Companies, Inc. for $20 million. As a result of selling
Innovis certain tax benefits will be realized. Results for the second quarter
1999 include recognition of a pre-tax benefit of $24.5 million ($40 million
after tax) for Innovis that relates primarily to the receipt of the net proceeds
from its sale. The remaining shutdown reserve at September 30, 1999 of $6.4
million includes $2.1 million for severance and $4.3 million for other exit
costs.
In May 1999, the Company sold its EBP Life business unit for $14.5 million cash.
As a result of this transaction FDC recorded a pre-tax gain amount of $4.5
million ($3.9 million after tax) in the second quarter of 1999. Included in this
pre-tax gain amount is $2.9 million related to the reversal of an impairment
charge previously recorded by the Company in anticipation of its exit from the
insurance line of business.
In July 1999, the Company completed the sale of its Donnelley Marketing
subsidiary to infoUSA for approximately $200 million in cash. As a result of
this transaction a pre-tax loss of $29.8 million ($14.7 million after tax) was
recorded in the second quarter of 1999 upon the signing of a definitive purchase
agreement. Also in July 1999, the Company announced a definitive agreement with
PNC Bank Corp. to sell its Investor Services Group business unit for
approximately $1.1 billion in cash. This sale allows FDC to further concentrate
its efforts on electronic payment services and e-commerce solutions. Upon
completion of the sale, the Company will record a one-time pre-tax gain of
approximately $700 million (approximately $370 million after tax) and will
realize net after tax cash proceeds of approximately $700 million. This
transaction, which is subject to customary regulatory approvals, is expected to
be completed during the fourth quarter of 1999.
13
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
In September 1999, the Company recorded a pre-tax loss of $13.5 million ($8.4
million after tax) related to the termination of a specialty services joint
venture. The charge represents the funding required for the joint venture
shutdown and payment of a customer termination fee. Also in September 1999, a
$7.4 million merger accrual related to the 1995 merger of FDC and First
Financial Management Corporation (with no tax effect) was reversed due to the
favorable resolution of a contingency in the third quarter.
FDC remains the market leader in its three major segments: payment instruments,
card issuer services and merchant processing services. The Company will continue
to focus on these core business areas throughout 1999 and will continue to
assess how best to serve its customer base. Among the actions the Company
believes are necessary to continue its leadership position is a focused effort
to develop new products and services and to enhance its processing platforms in
response to Company growth, client requirements and changing technology. In this
regard, the Company also anticipates it will need to upgrade and redevelop its
business continuity plans to reflect new systems and platforms developed to
support these actions. Also, the Company may take future actions to further
streamline operations and reduce costs.
Results of Operations
The Company derives revenues in each of its reportable segments based
principally on the number of transactions processed, a percentage of dollar
volume processed or on a combination thereof. Lesser amounts of revenue are
generated from foreign currency exchange on money transfer transactions and
sharing in investment earnings on fiduciary funds. For the quarter ended
September 30, 1999, total revenues increased 9% to $1.40 billion from $1.28
billion in the prior year quarter, and for the nine months ended September 30,
1999, total revenues increased 8% to $4.07 billion from $3.77 billion in the
prior year nine months. Revenues continued to be impacted by significant
divestiture activity over the last year as the Company has focused on its core
payment services businesses. The Company's internal growth rate (excluding the
effects of business acquisitions and business divestitures) in revenues for
third quarter 1999 was 11% and for the first nine months of 1999 was 12%.
Product sales and other revenues increased 2% from $26.3 million in the third
quarter 1998 to $26.7 million in the third quarter of 1999. This increase is due
primarily to an increase in incentive payments received from one of the
Company's merchant alliance partners partially offset by a decline in IBT branch
installations. Product sales and other revenues decreased 12% from $85.8 million
in the first nine months of 1998 to $75.8 million in the first nine months of
1999. The largest component of the decline for the nine month period is
attributable to decreases in IBT branch installations.
For the third quarter of 1999, operating expenses increased 11% to $883.7
million compared to $799.4 million in the 1998 third quarter. For the nine
months ended September 30, 1999, operating expenses increased 9% to $2,629.9
million from $2,406.2 million in the nine month period in 1998. The increase in
operating expenses as a percent of revenue over 1998 was driven in part by an
increase in Year 2000 ("Y2K") readiness expenses which for the 1999 third
quarter approximated $24.2 million as compared to $20.7 million in 1998's third
quarter. Y2K expenses were $74.3 million and $53.2 million for the nine months
ended September 30, 1999 and 1998, respectively. An increase in non-capitalized
systems investment was also a factor in the increase in operating expenses as a
percent of revenue for the quarter and nine month period ended September 30,
1999 compared to the same periods in 1998.
Selling, general and administrative expenses increased 9% to $197.6 million in
1999's third quarter compared to $181.3 million for the same period in 1998. For
the nine month period, selling, general and administrative expenses increased 7%
to $603.7 million in 1999 from $564.5 million in 1998. As a percentage of
revenue, selling, general and administrative expenses were flat on a quarter to
date and year to date basis. The dollar increase for both periods reflects
increased advertising and promotion spending, especially in the payment
instruments segment, and increased general and administrative costs to support
higher overall revenue.
Interest expense increased 7% to $27.4 million in the third quarter of 1999 from
$25.5 million in the third quarter of 1998, and decreased 7% to $74.4 million
for the nine month period of 1999 from $80.3 million for the first nine month
14
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
period of 1998. The third quarter 1999 increase is attributable to an increase
in short term borrowings as the Company began the repurchase of its stock under
its $750 million stock buyback program. The decrease for the nine month period
is due primarily to overall reductions in debt balances during the first six
months of 1999 achieved through strong cash flow from operations and reduced
capital expenditures.
FDC's effective tax rate (excluding the impact of divestitures, restructuring
charges and other one-time items) for the third quarter of 1999 was 28.6%, a
decrease of 3.5 percentage points from 1998's third quarter rate. Similarly, the
1999 year-to-date effective tax rate excluding the items mentioned above was
29.7%, down 2.8 percentage points from 1998. This decrease is primarily due to
an increase in the amount of non-taxable interest generated from investments in
debt instruments issued by state and local governments and a lower effective
state tax rate.
Net income of $207.1 million and $541.4 million for the third quarter and nine
months ended September 30, 1999, respectively, was up from $187.2 million and
$363.3 million in the comparable periods of 1998. These increases were primarily
the result of margin improvement in the combined core businesses and the
provision for loss on contract which impacted the results for the 1998 nine
month period.
Diluted earnings per share ("EPS") increased significantly to $0.48 and $1.24
for the third quarter and first nine months of 1999, respectively. Excluding
the impact of restructuring, impairment charges and other one-time items,
diluted EPS increased 14% to $0.48 in the third quarter and 13% to $1.22 for the
nine month period of 1999. This growth in EPS was driven by strong performance
in the core businesses, the divestiture of less profitable businesses and the
implementation of cost reduction and profit improvement programs.
Payment Instruments
Total revenues in the payment instruments segment increased by 18% (on a tax-
equivalent basis) to $521.2 million in the third quarter of 1999, as compared to
$440.3 million in the same period of 1998. Year-to-date revenues increased by
20% to $1,483.4 million in 1999 from $1,240.8 million in 1998. This increase
reflects continuing strong underlying volume increases principally related to
international and commercial money transfer. Aggregate money transfer
transactions grew 18% (to 18.7 million) over the third quarter of 1998. At
September 30, 1999, the agent base had grown 48% as compared to a year ago, with
nearly 78,000 agents in 176 countries. The dramatic growth in agent locations is
due in part to signing of Postbank of Germany - which added 12,000 locations in
the second quarter of 1999.
Operating profits for the third quarter of 1999 grew 17% over last year's third
quarter, from $139.6 million to $163.1 million. For the nine month period,
operating profits grew by 18% from the prior year, from $353.3 million to $416.8
million. Established product lines continue to gain operating leverage through
cost efficiencies and price increases in certain markets, offset by price
declines in the Mexican markets, increased Y2K spending and investment in new
businesses and products.
Card Issuer Services
Total revenues in the card issuer services segment grew 11% for the third
quarter of 1999 to $360.0 million as compared to $322.9 million for 1998's third
quarter. For the nine month period, card issuer services segment revenues grew
9% to $1,005.6 million in 1999 from $925.3 million in 1998. Card accounts on
file as of September 30, 1999 were 260 million (a 24% increase from September
30, 1998) with domestic card accounts growing to 233 million (26% growth) and
international card accounts growing to 27 million. Revenues continue to grow
more slowly than accounts on file due to an increased proportion of accounts
processed for large issuers with lower than average prices and growth in debit
and retail card accounts on file which generate lower revenue per account.
Operating profit for the card issuer services segment decreased 4% from $63.0
million in 1998's third quarter to $60.3 million in 1999. Year-to-date operating
profit increased 1% to $174.6 million in 1999 from $173.4 million in 1998.
15
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Improved performance driven by strong volume trends was offset by increased
systems investments and non-capitalized expenses incurred as a result of a
record number of third quarter 1999 client conversions (approximately 38
million accounts). These non-capitalized expenses had a significant impact on
both the third quarter and year-to-date 1999 operating profit.
During the first nine months of 1999, the card issuer services segment entered
into several new agreements to provide processing services. The Company also
anticipates deconversion of several clients, the most significant of which were
due to the acquisition of clients by financial institutions which process card
portfolios in-house. None of these terminations, individually or in the
aggregate, are expected to have a significant impact on the Company's results of
operations.
For several years, it has been uncertain whether the U.K. could impose a value
added tax (VAT) on the processing services provided by the Company's First Data
Resources Limited (FDRL) business unit. Imposition of a VAT could put FDRL at a
competitive disadvantage to in-house credit card processing solutions, which
would not be subject to the tax. FDRL recently received a favorable opinion in a
pending legal matter that held that the VAT could not be imposed by the U.K.
taxing authorities in that case. However, the U.K. recently adopted new
legislation that purports to impose a VAT on third-party credit card processors
such as FDRL. The court decision received by FDRL indicates that the European
Community doctrines prevent the U.K. from imposing a VAT on processing services
such as those provided by FDRL. U.K. authorities are appealing the decision;
therefore, the imposition of a VAT in the U.K. remains uncertain.
Merchant Processing Services
Revenues in the merchant processing services segment grew 12% to $387.9 million
for the third quarter of 1999 compared to $347.6 million for third quarter 1998.
Total merchant dollar volume processed grew 36% (19% excluding the results for
Paymentech) to $86.6 billion as compared to the third quarter of 1998. Revenues
grew 12% to $1,126.0 million for the first nine months of 1999 compared to
$1,005.0 million for the same period in 1998. Total merchant dollar volume grew
25% (18% excluding Paymentech) over the first nine month period of 1998 to
$223.9 billion. Revenue growth was driven by growth in the dollar volume
processed and the impact of revenue enhancement initiatives implemented in the
second half of 1998; however, revenues may not continue to grow at this level as
these initiatives anniversary. Note that revenues grew more slowly than dollar
volume processed because the increased dollar volume also includes volume of the
Company's alliances, which are generally accounted for under the equity method
of accounting.
Operating profits increased 37% to $108.0 million for the third quarter of 1999
from $78.9 million for the 1998 third quarter. Operating profits increased 30%
to $275.8 million for the first nine month period of 1999 as compared to $212.9
million for the same period last year. This improvement is reflective of strong
volume and the impact of significant cost reduction and revenue enhancement
initiatives implemented in 1998, somewhat offset by an increase in Y2K expenses.
Key elements of FDC's strategy in the merchant processing services segment
involve its joint venture alliances with its bank partners and its internet
commerce initiatives. Each joint venture alliance is a separately managed
business that requires a close relationship and a cooperative effort between the
Company and the bank partner and could be affected by further consolidation
among financial institutions. Internet commerce, while accounting for a very
small portion of the segment's transactions currently, is growing rapidly.
However, internet commerce is still evolving industry-wide and its ultimate
impact on merchant processors and acquirers is uncertain.
All Other and Corporate
Revenues from these operations decreased 5% to $79.5 million for the third
quarter of 1999 from $83.9 million in third quarter 1998. For the first nine
month period, revenues decreased 3% to $239.0 million in 1999 from $246.5
million in
16
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
1998. IBT revenues were down approximately $18.0 million from the prior year
nine months due to a decline in branch installations, while Call Interactive and
First Data Solutions revenues increased over last year's nine month period.
Operating profits declined 57% and 61% in the third quarter and first nine
months of 1999, respectively, from $29.0 million and $90.8 million in the third
quarter and first nine months of 1998 to $12.4 million and $35.5 million in
1999. Operating profit declined at IBT as a result of lower revenues and at
Teleservices due to expenses associated with a start-up contract. Additionally,
the extent and timing of certain corporate initiatives focused on improving the
effectiveness of the Company's overall operations increased corporate expenses.
Capital Resources and Liquidity
FDC continues to generate significant cash flow from operations, aggregating
$939.4 million in the nine months ended September 30, 1999, as compared to
$921.4 million for the nine months ended September 30, 1998. FDC utilized this
cash flow to reinvest in its existing businesses, to contribute to the financing
of business expansion and to fund treasury stock purchases.
FDC reinvests cash in its existing businesses principally to expand its
processing capabilities through property and equipment additions, to establish
customer-processing relationships through contract payments and costs for
conversion and to acquire or develop software for use in its operations. These
cash outlays decreased to $340.9 million for the first nine months of 1999 as
compared to $529.1 million for the first nine months of 1998. For the full year
1999, the Company expects such total non-acquisition spending to be less than
1998's full year total of $649.8 million. The Company currently expects total
Year 2000 related systems spending for the full year 1999, which will be
expensed as incurred, to be approximately $90-$100 million, as compared to $75
million incurred for the full year 1998. (See the Year 2000 section following
Capital Resources and Liquidity for additional information.) Although some of
the Company's Year 2000 spending is incremental, the Company expects to redeploy
much of its Year 2000 spending to make significant investments in new and
enhanced operating platforms after completion of its Year 2000 program. Such
investments will encompass all segments, but are likely to be concentrated in
the card issuer services segment.
Overall, FDC's operating cash flow for the nine months ended September 30, 1999
exceeded its investing activities associated with additions to property and
equipment and capitalized contract and systems development costs by $598.5
million. These cash sources contributed to funds utilized for treasury stock
purchases.
In the first nine months of 1999, the Company had net expenditures of $257.9
million on acquisitions and divestitures including $40.3 million in cash outlays
for businesses previously acquired and proceeds of $242.2 million for 1999
dispositions. During the comparable period of 1998, proceeds from dispositions
were $150.0 million, with a net total of $151.1 million in cash spending on
acquisitions and businesses previously acquired.
The Company's net use of cash for financing activities was due to share
repurchases under the Company's $750 million and $550 million share repurchase
programs discussed below and dividend payments partially offset by proceeds from
stock option exercises and other employee stock benefit programs. Net cash used
in financing activities was $176.7 million during the first nine months of 1999,
as compared to $283.5 million in the 1998 period.
The Company made cash outlays totaling $917.0 million in the nine months ended
September 30, 1999 to buy back shares of its common stock. Proceeds from stock
option exercises totaling $144.1 million partially offset these outlays. The
Company had a net cash inflow of $622.3 million in its borrowings during the
first nine months of 1999 as compared to a net cash outflow of $149.1 million in
the same 1998 period. In addition, the Company continued its practice of paying
quarterly cash dividends, resulting in $26.1 million of cash payments to the
Company's common stockholders during the first nine months of 1999.
In September 1998, the Company announced that its Board of Directors authorized
management to purchase up to $500 million of its outstanding common stock. In
December 1998, the Board increased the total authorization to $550 million in
conjunction with the issuance of a convertible note. In July 1999, the Board of
Directors authorized management to purchase an additional $750 million of the
Company's outstanding common stock. Funding for these purchases is expected to
come from operating cash flow and proceeds from current year divestitures.
17
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
During the third quarter 1999, the Company purchased a total of 9.5 million of
its common shares at a cost of $446 million. Included in this total were
purchases of 2.0 million shares at a cost of $95 million under the $550 million
authorization and 7.5 million shares at a cost of $351 million under the $750
million authorization. Note that in July 1999, the Company completed the
utilization of the $550 million provided for repurchases under the 1998
authorization. A total of 15.1 million shares were repurchased under this
program.
The Company has two outstanding shelf registration facilities, one providing for
the issuance of debt and equity securities up to $1.0 billion in the aggregate
(of which $525 million remains available) and the other providing for the
issuance of approximately 10 million shares of the Company's common stock in
connection with certain types of acquisitions. During March 1999, the Company
entered into a $100 million, 5-year, bullet maturity debt financing with a
floating interest rate. Under certain circumstances the financing may be
prepaid.
Included in cash and cash equivalents on the Consolidated Balance Sheet at
September 30, 1999 is $92.1 million related to required investments of cash in
connection with the Company's merchant card settlement operation and additional
amounts used to support the operations of certain business areas; the remainder
is available for general corporate purposes. Also, FDC has remaining available
short-term borrowing capability of approximately $401 million at September 30,
1999 under the Company's commercial paper program and through its bank credit
lines.
In November 1999, the Company established an extendible commercial note program
in the amount of $300 million. These additional funds will be used to fund the
Company's stock repurchases and investing activities.
The Company believes that its current level of cash and financing capability
along with future cash flows from operations are sufficient to meet the needs of
its existing businesses. However, the Company may from time to time seek longer-
term financing to support additional cash needs or reduce its short-term
borrowings.
Year 2000
State of Readiness. The Company's Y2K preparedness efforts are differentiated
between information technology ("IT") systems and non-IT systems. Non-IT
systems are embedded systems that support facilities infrastructures. The
Company has completed the upgrade of non-IT systems for the Company's mission
critical buildings and has substantially completed the upgrade for non-mission
critical buildings. However, new facilities may be added that will be assessed
and upgraded in the fourth quarter.
IT systems include primarily computer hardware and software and related systems.
The Company has implemented a five phase Y2K readiness plan for IT systems: (i)
Phase 1- Impact Analysis and Inventory, (ii) Phase 2- Code Renovation/Operating
System Upgrade, (iii) Phase 3- Data-Aged Test Execution, (iv) Phase 4- Client
Test Execution, and (v) Phase 5- Production Implementation. A description of
each phase may be found on page 25 of the Company's 1998 Annual Report on Form
10-K. The following Status Chart indicates the approximate percentage of work
completed for the mission-critical systems of the following material business
units by phase as of September 30, 1999.
18
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Business Unit Phase 1 Phase 2 Phase 3 Phase 4* Phase 5
- ------------- -------- -------- -------- --------- --------
Target Completion Date
For each phase 12/31/97 12/31/98 3/31/99 6/30/99 6/30/99
Card Issuer Units
First Data Resources 100% 100% 100% 100% 100%
First Data Australia 100% 100% 100% 100% 100%
First Data Resources Limited 100% 100% 100% 100% 100%
First Data Oil Services 100% 100% 100% 100% 100%
Hogan Information Services 100% 100% 100% 100% 100%
Merchant Processing Units
First Data Merchant Services 100% 100% 100% 100% 100%
BMCF Gaming joint venture 100% 100% 100% 100% 100%
First Data POS (MicroBilt) 100% 100% 100% 100% 100%
TeleCheck 100% 100% 100% 100% 100%
Payment Instruments Units
Western Union 100% 100% 100% 100% 100%
Orlandi Valuta 100% 100% 100% 100% 100%
Integrated Payment Systems 100% 100% 100% 100% 100%
CashTax 100% 100% 100% 100% 100%
Other
Call Interactive 100% 100% 100% 100% 100%
Investor Services Group 100% 100% 100% 100% 100%
TeleServices 100% 100% 100% 100% 100%
*Phase 4 client testing was conducted with a representative sample of the
Company's clients and transactions to test the Company's IT systems interface.
However, the sample only included a portion of the Company's clients.
Although the five phases for the mission critical systems are complete, the
Company will continue its efforts to prepare for the Year 2000 date change. For
the remainder of 1999, the Company expects to (i) perform additional selected
client testing and internal testing, (ii) employ an outside party to perform a
second independent validation and verification of the Company's source code to
insure that it is Year 2000 ready, (iii) further test and refine its business
contingency plans, and (iv) continue to coordinate with third parties regarding
Year 2000 issues. The Company also has delayed all changes to the source code
for new business initiatives until after January 1, 2000 and has established a
clean management program for any essential programming changes that may be
needed prior to that date. The clean management program includes an internal
review of any proposed change but depending upon the timing of such changes full
testing of the code prior to the Year 2000 date change may not be possible.
Material Relationships. The Company's material third-party relationships
include: (i) providers of hardware/software products, (ii) service / network
/gateway providers, and (iii) clients. The Company has assessed client and
vendor issues, identified required changes, and tested with material third
parties when possible. Coordination with third parties regarding Y2K issues will
continue to the Year 2000 and beyond and the Company is working with material
third parties to minimize service interruptions that could occur in connection
with the Year 2000. Notwithstanding these efforts, unexpected third-party
failures could occur and, despite testing procedures, erroneous or corrupted
data received from third parties could impact internal systems and cause
material service disruptions.
Third-party relationships believed to be most material to the Company are
described below. (i) Clients- The Company does not control clients' remediation
efforts or whether they test on the Company's systems. The Company offered to
test with all material clients but, although substantially all of the card
issuer clients tested with the
19
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Company, the number of clients that accepted the offer to test varied among
other business units. However, the Company believes it has tested a
representative sample of each type of transaction it conducts with material
clients. (ii) Telecommunications -Domestic- Telecommunication services are
critical to all of the Company's businesses. The Company has contracts for
telecommunication services with AT&T, MCI and Sprint and is reliant on regional
bell operating companies and other local service providers. The Company has
participated in Y2K testing programs with various telecommunication companies
and all issues discovered during the testing have been addressed. Two of the
three U.S. based long-distance carriers used by the Company also have provided
contractual agreements that they will be Y2K ready in a timely manner. The third
U.S. based long distance carrier has provided assurance that it has completed
all five phases of its Year 2000 program. (iii) Telecommunications -
International- Several of the Company's businesses are similarly reliant upon
telecommunication providers in foreign countries. The assurance provided by
those providers varies from country to country. Based on the assurances that
were obtained, the Western Union International business unit identified 43
countries as presenting a high risk for telecommunication Y2K problems and the
Company has established satellite phones in a number of foreign locations as
part of its contingency planning; (iv) Postal Service- Postal services are
critical to many of the Company's businesses. By law, no alternative for first-
class mail service is available. The Postal Service has provided assurances that
it will be Y2K ready in a timely manner. (v) Electronic Money Transfer Networks-
Most of the Company's businesses require settlement of financial transactions
through various electronic networks. Transfers using the Federal Reserve Board's
Fedwire(R) Funds Transfer System and the Automated Clearing House have been
tested through the Company's clearing banks. The Company has also participated
in tests with the Bank Automated Clearing Services in the U.K. (vi) Association
Networks and Similar Proprietary Third-Party Networks- Several of the Company's
business units provide services related to credit and debit card transactions
which occur over association and proprietary third-party networks. The Company
has tested with VISA, MasterCard, Discover, American Express and EuroPay
networks and has indirectly tested regional Automated Teller Machine networks
through VISA and MasterCard. (vii) Utilities- All businesses are reliant upon
utilities for electricity, gas, water, and sewers. The Company has been working
with utility providers to assess their Y2K readiness and has made contingency
plans based on these assessments. The Company's major data centers have power
generation systems to provide electrical backup for reasonable periods of time
based on accepted business practices for the relevant business unit and the
Company expects to have additional fuel reserves on site to power the
generators. (viii) Internal Revenue Service- CashTax processes EFTPS
transactions for the IRS and has tested its systems with the IRS using future-
dated test data. (ix) EDS-Electronic Data Systems provides data center services
for Western Union including application development and maintenance. In
addition, EDS provides certain gateway services to First Data Resources. The
Company has tested its systems with EDS. (x) Internet- Numerous of the Company's
businesses offer Internet-based products and services. Moreover, an increasing
amount of corporate communication occurs over the Internet. The Internet is
reliant upon telecommunication and data transmission services and, therefore, it
is subject to the telecommunication risks noted above. The decentralized nature
of the Internet makes it difficult to obtain assurances concerning Y2K
compliance. (xi) SIAC- Investor Services Group has a relationship with the
Securities Industry Automation Corporation ("SIAC") which provides clearing
services for mutual fund trading. ISG has completed its testing with the
Securities Industry Automation Corporation (SIAC) and no Year 2000 issues were
reported as a result of the testing. (xii) Credit Bureaus-Several of the
Company's business units and most of the Company's financial institution clients
use the services of one of the three national credit reporting bureaus. Failure
of credit bureau services for an extended period of time could adversely affect
the Company's ability to deliver certain services to clients. The Company has
conducted tests with all three national credit reporting bureaus.
Year 2000 Risks. Management believes that the most likely Y2K risks relate to
third parties with which it has material relationships. A failure or disruption
of (i) the Company's mission-critical computer systems caused by third-party
hardware / software, (ii) third-party service / network / gateway providers, or
(iii) significant clients for an extended period, could adversely affect the
financial condition and results of operations of the Company. Moreover, any mass
public reaction to events surrounding Y2K, such as a mass testing of the
availability of the credit card or telecommunication networks, could overwhelm
these systems and create a service disruption that would have an adverse effect
on the Company's business, operations and financial results. In addition, the
Company's Y2K contingency staffing plans could be adversely affected in specific
locations if utility or other Y2K interruptions
20
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
occurred in those locations, although the Company has tried to address this
issue by including consideration of employees' families in its contingency
plans. However, based on currently available information, while management
anticipates there could be isolated and intermittent disruptions of various
services and interfaces at its businesses, there is no expectation of extensive
or protracted systemic failures that would have a material adverse effect on the
financial condition or results of operations of the Company.
Contingency Plans. The business contingency plans have been completed and
tested. The Company is currently updating the plans based on the test results
and expects to revise the plans throughout 1999 as needed. Although each
business unit has its own unique plan, the plans generally call for obtaining
goods and services from alternative sources and utilizing alternative methods to
perform functions. The Company's five major data centers have power generation
systems to provide electrical backup for reasonable periods of time based on
accepted business practices for the relevant business unit. The Company expects
to have additional fuel reserves on site to power the generators. The Company
may also establish additional short-term liquidity facilities as part of its
contingency plan for any disruptions in the settlement networks.
To manage the actual rollover to the Year 2000, the Company has established
approximately thirty-eight command centers that will be in operation before
December 31, 1999 and will continue as needed. The corporate and seven major
command centers will report to senior executive management of the Company who
will be available to assist in managing the actual rollover. The business units
also have developed staffing support plans to ensure that appropriate on-site
staff are in place and have established procedures to implement any contingency
plan and address issues that may arise.
Costs to Address the Company's Year 2000 Issues. Through September 30, 1999, the
Company has spent in aggregate approximately $182.5 million in connection with
preparing for the Year 2000, of which approximately $24.2 million was spent in
the third quarter of 1999. The Company anticipates that Y2K expenditures for the
remainder of 1999 will be approximately $20-$30 million. Y2K expenditures for
1999 are slightly more than originally projected due to additional efforts to
prepare for the Year 2000, including the two independent verifications and
validations of the Company's source code. Of the 1999 spending, approximately
92% has been spent on software remediation and testing and approximately 8% has
been spent to replace systems and equipment and to add testing capacity. The
Company anticipates that Y2K expenses will be approximately 11% of the IT budget
for 1999. To date, the Company has financed its Y2K expenses from cash flow and
expects to continue to do so.
Regulatory Supervision; Independent Validation/Verification. In addition to
engaging the Gartner Group to assist with Year 2000 issues, in May 1999, the
Company engaged Silverline Technologies, Inc. to perform an independent
verification and validation of all of the approximately 172 million lines of
source code used by the Company to ensure that the code is Year 2000 ready. The
Company has reviewed all suspect code identified by Silverline Technologies,
Inc. and remediated the suspect code that was determined to be flawed.
Silverline Technologies, Inc. is now performing a second verification and
validation review of the source code.
Safe Harbor for Year 2000 Forward-Looking Statements. All forward-looking
statements regarding Y2K readiness, including estimates, forecasts and
expectations, are inherently uncertain as they are based on various expectations
and assumptions concerning future events and are subject to numerous risks and
uncertainties which could cause actual events or results to differ materially
from those projected. Important factors upon which the Company's Y2K forward-
looking statements are premised include: (a) retention of employees and
contractors working on Y2K projects; (b) customers' remediation of their
internal systems to be Y2K ready and their cooperation in timely testing; (c) no
material disruption of telecommunication, data transmission networks, payment
networks, government services, utilities or other infrastructure services and no
unexpected failure of third-party products; (d) no unexpected failures by third-
parties providing services to the Company; (e) no unanticipated material flaws
in the Company's business contingency plans; (f) no undiscovered sabotage of
systems or program code affecting the Company's systems; and (g) no undiscovered
material flaws in the Company's test, validation and verification processes.
The Company undertakes no obligation to update forward-looking statements.
21
FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Item 3. Quantitative and Qualitative Disclosures About Market Risk
- ------------------------------------------------------------------
There have been no material changes from the 1998 Annual Report on Form 10-K
related to the Company's exposure to market risk from interest rates.
22
Independent Accountants' Review Report
The Stockholders and Board of Directors
First Data Corporation
We have reviewed the accompanying consolidated balance sheet of First Data
Corporation as of September 30, 1999 and the related consolidated statements of
income for the three-month and nine-month periods ended September 30, 1999 and
1998, and the consolidated statements of cash flows for the nine-month periods
ended September 30, 1999 and 1998. These financial statements are the
responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in accordance with generally accepted auditing standards, which will be
performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated financial statements referred to above
for them to be in conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of First Data Corporation as of
December 31, 1998, and the related consolidated statements of income,
stockholders' equity, and cash flows for the year then ended (not presented
herein) and in our report dated January 28, 1999, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying consolidated balance sheet as of
December 31, 1998, is fairly stated, in all material respects, in relation to
the consolidated balance sheet from which it has been derived.
Ernst & Young LLP
Atlanta, Georgia
October 21, 1999
23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
From time to time the Company is involved in various litigation matters arising
in the ordinary course of its business. None of these matters, either
individually or in the aggregate, currently is material to the Company except as
reported below and in the Company's Annual Report on Form 10-K for the year
ended December 31, 1998 and the Company's Quarterly Report on Form 10-Q for the
quarterly periods ended March 31, 1999 and June 30, 1999. There were no
material developments in the litigation matters previously disclosed except for
the developments discussed below.
Integrated Payment Systems, Inc. ("IPS"), a subsidiary of the Company, has been
added as a defendant in an action in which claims are asserted that are similar
to the claims asserted in the actions previously reported in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998. In April 1998,
Plaintiff Raul Ross Pineda, individually and on behalf of all others similarly
situated, filed a putative class action in the United States District Court for
the Northern District of Illinois naming MoneyGram Payment Systems, Inc. as the
defendant (the "Pineda action"). IPS subsequently has been added as a defendant
------
in that action. IPS operated an electronic money transfer service under the
name "MoneyGram" prior to December 1996. Mr. Pineda claimed that the
defendants charged an undisclosed commission when they transmitted consumers'
money by wire to Mexico, in that the exchange rate used in these transactions
was less favorable than the exchange rate that defendants received when they
traded dollars in the international money market. Mr. Pineda further asserted
that the defendants' failure to disclose this so called commission in their
advertising and in the transactions violated federal and state law. Mr.
Pineda seeks declaratory and injunctive relief, damages in an amount to be
proven at trial, treble damages, punitive damages, attorneys fees, and cost of
suit.
The parties in the Pineda action reached a tentative settlement as part of the
------
proposed settlement of the action filed by Luis Pelayo that was previously
reported in the Company's Quarterly Report on Form 10-Q for the period ended
June 30, 1999 (the "Pelayo action"). The Court in Pelayo and Pineda
------ ------ ------
preliminarily approved the proposed settlement and a fairness hearing is
scheduled for December 10, 1999, to determine the fairness, reasonableness, and
adequacy of the proposed settlement. The Court also barred the continued
prosecution and commencement of any new actions in any state or federal court
that assert any claims that would be released and discharged upon final approval
of the settlement. On September 7, 1999, the Company began to give notice of
the settlement to the members of the settlement class.
On July 22, 1999, Raul Garcia, a class member residing in California who had
filed an action previously reported in the Company's Annual Report on Form 10-K
for the year ended December 31, 1998 (the Garcia action), and Lydia Bueno, a
------
class member residing in California who had filed a similar action against
MoneyGram Payment Systems, Inc., filed motions to intervene in the Pelayo and
------
Pineda actions. The motions to intervene were subsequently granted. They also
- ------
filed motions to vacate the preliminary injunction staying the Garcia action but
------
the motions were denied.
24
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
- ---- --------
12 Computation of Ratio of Earnings to Fixed Charges
15 Letter from Ernst & Young LLP Regarding Unaudited Interim Financial
Information
27.1 Financial Data Schedule (for SEC use only)
99.1 Private Securities Litigation Reform Act of 1995
Safe Harbor Compliance Statement for Forward-Looking Statements
(b) Reports on Form 8-K
- ---- --------------------
None.
25
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.
FIRST DATA CORPORATION
---------------------------
(Registrant)
Date: November 11, 1999 By /s/ Lee Adrean
----------------- --------------
Lee Adrean
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: November 11, 1999 By /s/ Jeffrey W. Holtz
----------------- --------------------
Jeffrey W. Holtz
Vice President and
Corporate Controller
(Principal Accounting Officer)
26
FIRST DATA CORPORATION
INDEX TO EXHIBITS
-----------------
Exhibit
Number Description
- ------
12 Computation of Ratio of Earnings to Fixed Charges
15 Letter from Ernst & Young LLP Regarding Unaudited Interim Financial
Information
27.1 Financial Data Schedule (for SEC use only)
99.1 Private Securities Litigation Reform Act of 1995
Safe Harbor Compliance Statement for Forward-Looking Statements
27