1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
F O R M 8-K/A
AMENDMENT NO. 2
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
January 23, 1998
National Processing, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 1-11905 61-1303983
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(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.)
One Oxmoor Place, 101 Bullitt Lane, Suite 450, Louisville, Kentucky 40222
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(Address of principal executive officer)
502-326-7000
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(Registrant's telephone number, including area code)
2
Item 2. Acquisition or Disposition of Assets.
-------------------------------------
As previously reported on Form 8-K on November 10, 1997, on October 24, 1997,
the Registrant completed the initial stage of a step acquisition of FA Holdings,
Inc. and its subsidiary, Financial Alliance Processing Services, Inc. ("FA").
The initial stage involved the acquisition of 68.3% of the then issued and
outstanding common stock of FA and the purchase of 60,001 newly issued shares of
common stock directly from FA. The Registrant paid $30,000,000 to FA for the
60,001 newly issued shares and $37,219,244 to various holders of FA common stock
for the 68.3% of the then issued and outstanding shares of FA. Upon completion
of the initial stage, the Registrant owned 79.6% of the total shares of common
stock of FA.
The final stage of the step acquisition was completed on January 2, 1998 when
the Registrant purchased the remaining 20.4% of the issued and outstanding
common stock of FA for $26,780,756 thereby increasing the Registrant's ownership
of FA to 100%.
FA is a provider of credit and debit card processing services and markets its
services through a direct sales force as well as through a network of
independent sales organizations. Prior to the acquisition of FA's common stock,
the Registrant was providing credit and debit card processing services to FA
under a contractual agreement with minimum processing revenue guarantees
aggregating $53 million through the year 2004. John Leehy, the chief executive
officer of FA, was appointed Executive Vice President of Merchant Services by
the Registrant.
The cash used in the acquisition of FA common stock was from funds raised in the
Registrant's initial public offering of 7,475,000 shares of common stock on
August 14, 1996.
3
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
------------------------------------------------------------------
(a) Financial Statements of the Business Acquired Page
FA HOLDINGS, INC. AND SUBSIDIARY
Report of KPMG Peat Marwick LLP, Independent Auditors 1
Consolidated Balance Sheets of FA Holdings, Inc. and Subsidiary as
of December 31, 1996, and September 30, 1997 (unaudited). 2
Consolidated Statements of Operations of FA Holdings, Inc. and Subsidiary
for the nine months ended September 30, 1997 (unaudited). 3
Consolidated Statements of Shareholder's Equity of FA Holdings, Inc. and
Subsidiary for the year ended December 31, 1996 and for the nine months
ended September 30, 1997 (unaudited). 4
Consolidated Statements of Cash Flows of FA Holdings, Inc. and Subsidiary
for the year ended December 31, 1996, and for the nine months ended
September 30, 1997 (unaudited). 5
Notes to Consolidated Financial Statements 6
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Report of KPMG Peat Marwick LLP, Independent Auditors 1
Balance Sheets of Financial Alliance Processing Services, Inc.
as of December 31, 1996 and September 30, 1997 (unaudited). 2
Statements of Operations of Financial Alliance Processing Services, Inc.
for the year ended December 31, 1996 and for the nine months ended
September 30, 1997 (unaudited). 3
Statements of Shareholder's Equity of Financial Alliance Processing
Services, Inc. for the year ended December 31, 1996 and for the nine
months ended September 30, 1997 (unaudited). 4
4
Statements of Cash Flows of Financial Alliance Processing Services, Inc.
for the year ended December 31, 1996, and for the nine months ended
September 30, 1997 (unaudited). 5
Notes to Financial Statements 6
(b) Unaudited Pro Forma Financial Information of National Processing, Inc.
and FA Holdings, Inc. 1
Unaudited Pro Forma Condensed Consolidated Balance Sheet of National Processing,
Inc. as of September 30, 1997. 2
Unaudited Pro Forma Condensed Consolidated Statements of Income
of National Processing, Inc. for the year ended December 31, 1996, and
for the nine months ended September 30, 1997. 4
(c) Exhibits:
23.1 Consent of KPMG Peat Marwick LLP, Independent Auditors
23.2 Consent of KPMG Peat Marwick LLP, Independent Auditors
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Independent Auditors' Report
----------------------------
To the Board of Directors and Stockholders of
FA Holdings, Inc.
Louisville, Kentucky:
We have audited the accompanying consolidated balance sheet of FA Holdings, Inc.
and Subsidiary as of December 31, 1996 and the related consolidated statements
of stockholders' equity and cash flows for the acquisition closing period ended
December 31, 1996 (see note 3). These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of FA Holdings, Inc.
and Subsidiary as of December 31, 1996 and their cash flows for the acquisition
closing period ended December 31, 1996, in conformity with generally accepted
accounting principles.
Lousville, Kentucky
June 4, 1997 /s/ KPMG Peat Marwick LLP
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6
FA HOLDINGS, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(In Thousands, Except Share Information)
Assets (note 6)
December 31, 1996 September 30, 1997
----------------- ------------------
(Unaudited)
Current assets:
Cash (note 4) $ 2,419 $2,986
Accounts receivable:
Merchants 3,490 4,734
Equipment 467 69
Other 83 201
Inventory 875 608
Deferred income taxes (note 8) 392 747
Prepaid expenses and other current assets 260 215
-------- --------
Total current assets 7,986 9,560
Fixed assets (note 5) 2,183 1,975
Acquired merchant portfolios, less accumulated amortization 28,750 27,608
of $2,289 at September 30, 1997
Goodwill, less accumulated amortization of $625 at September 30, 1997 16,712 16,264
Other assets 1,090 981
-------- --------
Total assets $ 56,721 $ 56,388
======== ========
Liabilities and Stockholders' Equity Current liabilities:
Accounts payable:
Interchange, authorization and deposit charges $ 3,436 $ 4,030
Vendors 1,160 809
Current installments of long-term debt (note 6) 1,000 4,000
Current installments of obligations under capital leases (note 7) 225 237
Other current liabilities 1,297 2,492
-------- --------
Total current liabilities 7,118 11,568
Long-term debt, excluding current installments (note 6) 24,149 21,391
Obligations under capital lease, excluding current installments (note 7) 184 24
Deferred income (note 9) 5,100 4,951
Deferred income taxes (note 8) 6,144 5,777
Other (note 11) 990 1,317
-------- --------
Total liabilities 43,685 45,028
-------- --------
Stockholders' equity (note 10):
Class A common stock, $.01 par value. Authorized 20,000 shares;
9,565 and 9,732 issued and outstanding at 1996 and 1997 respectively; 1 1
Common stock, $.01 par value. Authorized 200,000 shares; 69,101 and
70,269 issued and outstanding at 1996 and 1997 respectively 1 1
Additional paid-in capital 14,349 14,599
Notes receivable from management (1,315) (1,402)
Accumulated deficit -- (1,839)
-------- --------
Total stockholders' equity 13,036 11,360
-------- --------
Commitments and contingencies (notes 7 and 9)
Total liabilities and stockholders' equity $ 56,721 $ 56,388
======== ========
See accompanying notes to consolidated financial statements.
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FA HOLDINGS, INC. AND SUBSIDIARY
Consolidated Statement of Operations
Nine month period ended September 30, 1997
(Unaudited)
(In Thousands)
Revenues:
Processing fees $ 51,109
Terminal sales 6,139
Application fees 1,253
Other 735
--------
Total revenues 59,236
Direct operating expenses:
Processing expenses 33,055
Salaries and wages 5,530
Residuals 2,431
Cost of terminals sold 2,329
Provision for bad debts 1,160
Commissions 2,897
Depreciation and amortization 3,752
Other 7,898
--------
Total direct operating expenses 59,052
Interest expense 2,107
Loss before income taxes 1,923
Income tax benefit (84)
--------
Net loss $ 1,839
========
See accompanying notes to consolidated financial statements.
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FA HOLDINGS, INC. AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
For the acquisition closing period ended December 31, 1996 and the
nine months ended September 30, 1997 (unaudited)
(In Thousands, Except Share Information)
Shares Amount
--------------------------- ------------------------- Notes
Class A Class A Additional Receivable Total
Common Common Common Common Paid-in from Accumulated Stockholder's
Stock Stock Stock Stock Capital Management Deficit Equity
----- ----- ----- ----- ------- ---------- -------
Issuance of Stock 9,565 69,101 $ 1 1 14,349 (1,315) - 13,036
----- ------ ------ ----- ------ ------ -------- ------
Balances at
December 31, 1996 9,565 69,101 1 1 14,349 (1,315) - 13,036
Net Loss - - - - - - (1,839) (1,839)
Issuance of
Stock 167 1,168 - - 250 (87) - 163
----- ------ ------ ----- ------ ------ -------- ------
Balances at
September 30, 1997 9,732 70,269 $ 1 1 14,599 (1,402) (1,839) 11,360
===== ====== ====== ===== ====== ====== ======== ======
See accompanying notes to consolidated financial statements.
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FA HOLDINGS, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the acquisition closing period ended December 31, 1996
and the nine month period ended September 30, 1997 (Unaudited)
(In Thousands)
September 30,1997
December 31, 1996 (Unaudited)
----------------- -----------
Cash flows from operating activities:
Net Loss $ -- $(1,839)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Provision for bad debts 1,160
Depreciation and amortization 3,724
Non-cash interest on long-term debt 391
Deferred income taxes (721)
Changes in operating assets and liabilities:
Account receivable (2,125)
Inventory 267
Prepaid expenses and other assets (169)
Accounts payable and other current liabilities 1,439
Deferred income (149)
Other liabilities 327
-------- -------
Net cash provided by operating activities 2,305
Cash flows from investing activities:
Cash paid for Financial Alliance Processing Services, Inc.,
net of cash received of $2,419 in 1996 (34,836) (181)
Purchases of fixed assets -- (603)
Purchase of business and residual portfolios -- (820)
-------- -------
Net cash used in investing activities (34,836) (1,604)
-------- -------
Cash flows from financing activities:
Proceeds from issuance of stock 13,036 163
Proceeds from long-term debt, net of financing costs of $1,030
in 1996 19,119
Proceeds from conversion bonus 5,100 --
Payments on capital leases -- (148)
Payments on long term debt -- (149)
-------- -------
Net cash provided (used) by financing activities 37,255 (134)
-------- -------
Net increase in cash 2,419 567
Cash, beginning of period -- 2,419
-------- -------
Cash, end of period $ 2,419 $ 2,986
======== =======
Supplemental cash flow information:
Non cash financing and investing activities:
Note payable to Deluxe issued in connection with acquisition $ 5,000 $ --
Other liabilities incurred in connection with acquisition 337 255
Accrued acquisition costs 572 55
======== =======
See accompanying notes to consolidated financial statements.
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
Year Ended December 31, 1996 and
nine months ended September 30, 1997 (Unaudited)
(1) Basis of Presentation
---------------------
Nature of Business
------------------
FA Holdings, Inc. (Holdings) is a holding company formed for the purpose
of acquiring its wholly-owned subsidiary, Financial Alliance Processing
Services, Inc. (Financial Alliance or the Company) (note 3). Financial
Alliance provides third-party credit and debit card processing services
to retail merchants located throughout the United States pursuant to a
contract between the Company and a processing bank. Financial Alliance's
services include terminal sales, merchant servicing, transaction
authorization, data capture, merchant accounting, funds settlement,
draft storage and retrieval and charge-back processing.
Unaudited Interim Financial Information
---------------------------------------
The accompanying unaudited consolidated financial statements at
September 30, 1997 and for the nine months ended September 30, 1997 have
been prepared in accordance with generally accepted accounting
principles for the interim financial information and with Article 10 of
Regulation S-X. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the nine
month period ended September 30, 1997 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1997.
(2) Summary of Significant Accounting Policies
------------------------------------------
Principles of Consolidation
The consolidated financial statements include the accounts of FA
Holdings, Inc. and Financial Alliance. All significant intercompany
balances have been eliminated in consolidation.
Accounts Receivable
-------------------
Accounts receivable are primarily comprised of amounts due from the
Company's merchants and represent the discount earned, after related
interchange fees on transactions processed during the month ending on
the balance sheet date. Such balances are received from the Company's
clearing and settlement bank approximately three days following the end
of each month.
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(2) Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
The Company's customers (retail merchants) have liability for charges
disputed by cardholders. In the normal course of business, the Company
is exposed to the risk of chargebacks in the case of fraud, insolvency
or bankruptcy by the merchant, which may be significant. The Company
provides for possible losses on chargebacks based upon past loss
experience adjusted for management's evaluation of current factors
affecting the adequacy of the allowance.
Inventory
---------
Inventory, which consists primarily of electronic point-of-sale
equipment, is stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
Acquired Merchant Portfolios and Goodwill
-----------------------------------------
In connection with the acquisition (note 3), acquired merchant
portfolios were valued at the present value of estimated cash flows from
the Company's retail merchant credit and debit card processing business.
Amortization periods range from seven to ten years.
Goodwill which represents the excess of purchase price over fair value
of net assets acquired, is amortized on a straight line basis over
twenty years.
The Company assesses the recoverability of intangible assets by a
comparison of the carrying amount of the asset to future net cash flows
expected to be generated by the asset. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount
by which the carrying amount of the assets exceeds the fair value of the
assets.
Fixed Assets
------------
Fixed assets are stated at cost. Equipment under capital leases is
stated at the present value of minimum lease payments.
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(2) Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
Other Assets
------------
Other assets include $1,030,000 and $868,000, at December 31, 1996 and
September 30, 1997 (unaudited), respectively, of deferred financing
costs associated with the Company's borrowings under the credit facility
described in note 6. These costs are being amortized over the term of
the related loans.
Income Taxes
------------
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences of differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Estimates
---------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements. Actual results could differ from those estimates.
(3) Acquisition of Financial Alliance
---------------------------------
As of the close of business December 31, 1996, Holdings acquired
Financial Alliance pursuant to a Purchase and Sale Agreement, dated
November 22, 1996, between Holdings and Deluxe Corporation (Deluxe). The
total purchase price, including acquisition costs of $1,621,000 and
liabilities incurred of $337,000, amounted to $43,724,000. The excess
purchase price over net assets acquired is reflected as goodwill. The
acquisition has been accounted for using the purchase method of
accounting.
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(4) Restricted Cash
---------------
Included in cash balances at December 31, 1996, and September 30, 1997
(unaudited) are $1,583,000 and $1,903,000 respectively is restricted
cash for the future settlement of transaction processing liabilities.
(5) Fixed Assets
------------
Fixed assets consist of the following:
(In thousands)
December 31, 1996 September 30, 1997
----------------- ------------------
(Unaudited)
Equipment $ 2,091 2,575
Furniture and fixtures 92 104
Less accumulated depreciation -- (704)
-------------- ------------
Total $ 2,183 $ 1,975
============== ============
Equipment under capital leases amounted to $373,000 and $209,000 at
December 31, 1996 and September 30, 1997 (unaudited) respectively.
(6) Long-Term Debt
--------------
Long-term debt consists of the following:
(In thousands) December 31, 1996 September 30, 1997
----------------- ------------------
(Unaudited)
Revolving line of credit $ 149 $ -
Term loan 20,000 20,000
Subordinated note payable to Deluxe 5,000 5,391
-------------- ------------
Total long-term debt 25,149 25,391
Current installments of long-term debt 1,000 4,000
-------------- ------------
Long-term debt, excluding
current installments $ 24,149 $ 21,391
============== ============
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(6) Long-Term Debt (Continued)
--------------------------
The revolving line of credit and term loan are pursuant to a credit
agreement with General Electric Capital Corporation, dated as of
December 31, 1996 (Credit Agreement), for an amount up to $25,000,000 in
the aggregate for the purpose of funding the acquisition and providing
working capital financing and funds for other corporate purposes of the
Company and consists of a revolving line of credit, term loan and swing
line facility. The long-term debt is secured by the assets of Financial
Alliance.
Revolving credit advances outstanding at any time may not exceed
$5,000,000, less the sum of any letter of credit obligations and swing
line loan advances outstanding, and such reserve as the lender may
establish.
The term loan is repayable in quarterly principal installments of
$1,000,000 beginning October 1, 1997 and of $1,250,000 beginning January
1, 1999 through October 1, 2001.
Swing line advances outstanding at any time shall not exceed the lesser
of the swing line commitment ($500,000), or $5,000,000 less the sum of
any letter of credit obligations and revolving loan advances outstanding
at such time. The unpaid balance of the swing line is payable in full on
October 1, 2001.
The Credit Agreement provides that the Company, at its option, make
voluntary prepayments for all or a part of the term loan and revolving
loan, including permanent reduction of the revolving loan commitment. In
addition, mandatory prepayments are required as follows: (i) if at any
time the outstanding balance of the revolving line exceeds the maximum
amount less the outstanding swing line loan advances, then at that time,
revolving credit advances will be immediately repaid to the extent
required to eliminate the excess, (ii) upon receipt of any cash proceeds
from an asset disposition, the Company shall repay the loans equal to
all such proceeds, (iii) if Holdings issues common stock, the Company
shall repay loans in an amount equal to all such proceeds, except that
if such stock issuance is in a private placement in an amount that does
not exceed $5,000,000, only 50% of the proceeds shall be repaid, and
(iv) on the earlier of the date which is ten days after the delivery of
the annual audited financial statements for the immediately preceding
year or the date on which such annual audited financial statements were
required to be delivered, seventy-five percent of excess cash flow, as
defined, for the immediately preceding fiscal year.
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(6) Long-Term Debt (Continued)
--------------------------
Interest on the revolving and term loans under the Credit Agreement is
at either the index rate plus the applicable index margin or, at the
Company's election, the applicable LIBOR rate plus the applicable LIBOR
rate margin. Interest on the swing line loan advances is at the index
rate plus the applicable revolver index margin. The applicable margins
are as follows so long as an event of default has not occurred:
Index LIBOR
Margin Margin
------ ------
Revolver 2.25% 3.50%
Term loan 2.50% 3.75%
The interest rates in effect for the revolving line of credit at
December 31, 1996 and September 30, 1997 (unaudited) were 10.5% and
11.8%, respectively. The interest rates in effect for the term loan at
December 31, 1996 and September 30, 1997 (unaudited) were 10.75% and
12.13%, respectively.
Additionally, an unused line fee margin of 0.50% is payable monthly and
an annual letter of credit fee of 2.00% is payable with respect to any
outstanding letter of credit obligations. The Credit Agreement also
provides that if an event of default shall occur, the interest rates
applicable to the loans and the letter of credit fees shall be increased
by two percentage points above the rates of interest or fees otherwise
applicable.
The Credit Agreement provides that the Company establish and maintain
cash management systems consisting of lock boxes, borrower accounts,
disbursement accounts and concentration accounts in order to facilitate
payment of the loans pursuant to the security agreement.
The Credit Agreement contains a number of negative covenants which limit
the Company's ability to acquire or merge, incur additional
indebtedness, make any change in its capital structure, dispose of
assets, or make certain restricted payments. Additionally, the Company
is required to meet certain financial covenants related to maximum
capital expenditures, fixed charge coverage, minimum EDITDA, minimum net
worth, and funded debt to EBITDA.
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(6) Long-Term Debt (Continued)
--------------------------
Subordinated note payable to Deluxe. The note is subordinated to the
prior performance and final payment, in full, of the obligations under
the Credit Agreement. Interest is payable quarterly at 10%. For the
period from the inception of the note until its fifth anniversary, at
Holdings' option, interest is payable either in cash or by adding the
interest payable to the principal amount outstanding. Subsequent to the
fifth anniversary and up to but not including the maturity date,
interest shall be payable quarterly, subject to the prior written
consent of the lenders under the credit agreement. Twenty-five percent
of the principal amount outstanding is payable on the seventh
anniversary of the note (December 31, 2003) with the remainder of the
principal and any related accrued interest payable due on December 31,
2004.
The subordinated note provides for prepayments at Holdings' option and
mandatory prepayment in the event of a change in control. Additionally,
the subordinated note contains certain restrictions related to the
merger or consolidation of Holdings and certain restricted payments.
The aggregate maturities of long-term debt for each of the five years
subsequent to December 31, 1996 are as follows: 1997, $1,000,000; 1998,
$4,000,000; 1999, $5,000,000; 2000, $5,000,000; and 2001 and thereafter,
$10,149,000.
(7) Lease Obligations
-----------------
The Company leases certain equipment under capital leases. Future
minimum lease obligations for capital leases at December 31, 1996 are as
follows:
(In thousands) December 31, 1996
-----------------
Year ended December 31:
1997 $244
1998 189
----
Total minimum lease payments 433
Less amount representing interest 24
----
Present value of net minimum capital lease payments 409
Current installments of obligations under capital leases 225
----
Obligation under capital leases, excluding current
installments $184
====
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(7) Lease Obligations (Continued)
----------------------------
The Company leases its headquarters and regional offices under various
operating lease agreements that require monthly payments. Future minimum
payments for noncancelable operating leases having a remaining term in
excess of one year at December 31, 1996 are as follows:
(In thousands)
December 31, 1996
-----------------
Year ended December 31:
1997 $ 282
1998 165
--------------
Total $ 447
==============
(8) Income Taxes
------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31,
1996 and September 30 1997 (unaudited) are presented below:
(In thousands)
December 31, 1996 September 30, 1997
----------------- ------------------
(Unaudited)
Deferred tax assets:
Deferred income $ 1,938 $ 1,887
Bad debt allowances 374 436
Merchant portfolios 263 263
Other 81 373
--------------- ---------------
Total gross deferred tax assets 2,656 2,959
Less valuation allowance - -
--------------- --------------
Net deferred tax assets 2,656 2,959
--------------- ---------------
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(8) Income Taxes (Continued)
------------------------
Deferred tax liabilities:
Purchase accounting adjustments related
to merchant portfolios 8,365 7,806
Other 43 183
--------------- ------------------
Total gross deferred tax liabilities 8,408 7,989
--------------- ------------------
Net deferred tax liability $ 5,752 $ 5,030
============== ==================
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences
become deductible. Management considers the scheduled reversal of
deferred tax liabilities and projected future taxable income in making
this assessment. Based upon projections for future taxable income over
the periods which the deferred tax assets are deductible, management
believes it is more likely than not the Company will realize the
benefits of these deductible differences. Accordingly, no valuation
allowance for deferred tax assets was recorded at December 31, 1996 and
September 30, 1997.
(9) Processing Agreement with National Processing Company
-----------------------------------------------------
The Company is party to an agreement with National Processing Company
(NPC) for processing and transmitting electronic data services through
2004, with minimum processing guarantees as follows:
(In thousands)
Twelve months ended April 30:
1998 $ 3,900
1999 5,100
2000 6,100
2001 7,200
2002 8,600
2003 10,200
2004 12,200
------------------
Total $ 53,300
==================
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FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(9) Processing Agreement with National Processing Company (Continued)
-----------------------------------------------------------------
Minimums are calculated on a cumulative basis, such that the fees paid
by the Company in any given contract year in excess of the minimum for
that same year may be applied toward the satisfaction of subsequent
years' minimums. To the extent the Company falls short of meeting the
minimum processing guarantees in any period, the shortfall may be
deferred to subsequent periods during the term of the agreement. Any
deferrals will bear interest at the prime rate plus two percent, which
interest is due within 30 days after the month incurred.
Additionally, NPC advanced $5,100,000 to the Company on December 31,
1996 as bonus consideration for the Company's conversion of their
merchant portfolio to NPC. The amount has been deferred and will be
recognized as a reduction in transaction processing expense over the
life of the processing agreement.
(10) Stock Option and Management Agreements
--------------------------------------
Holdings established the 1996 Stock Option Plan to provide incentives to
certain participants at the discretion of the Board of Directors. Twenty
thousand shares of Holdings common stock are issuable under the plan.
In connection with the acquisition of the Company by Holdings (note 3),
certain members of the Company's executive management entered into
management agreements pursuant to which (i) such executives would
purchase shares of Holdings' Class A Common Stock and Common Stock, and
(ii) Holdings would grant additional options to the executives to
acquire common stock. Under the terms of the management agreements,
2,000 and 14,000 shares of Holdings Class A common and common stock,
respectively, were issued for $3,000,006, and 15,302 options to purchase
Holdings common stock were granted at an exercise price of $1.429 per
share.
Of the options granted, 11,476 options were options which vest 20% per
year beginning December 31, 1997. The time options provide for
accelerated vesting under certain circumstances, including the closing
of a public sale of Holdings common stock, the termination of the
executive's employment by the Company without cause or by the executive
for good reason. The options expire on December 31, 2006, subject to
earlier expiration in connection with the termination of the executive's
employment.
15
20
FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(10) Stock Option and Management Agreements (Continued)
--------------------------------------------------
The remaining 3,826 options granted were target options. The target
options become immediately exerciseable on November 30, 2004, provided
that in the event that a Liquidity Event; defined as a sale of Holdings,
a sale of Holdings common stock by any of the investors to an
independent third party, or an initial public offering; occurs prior to
that time, the target option will become exerciseable if the investor
return multiple, as defined, as of the closing of such Liquidity Event
is greater than those prescribed by the agreement.
The management agreements provide for repurchase options by Holdings and
the investors in the event that the executive is no longer employed by
the Company. The agreements also provide for executive employment
provisions, including base salary, benefits, bonuses and term; and for a
noncompete agreement during the employment period and any renewal period
and for two years thereafter.
(11) Deferred Compensation Agreements
--------------------------------
Deferred compensation agreements in an aggregate amount of $937,500
exist for certain Company executives. The agreements represent the
assumption of retention bonuses to be paid pursuant to management
agreements and other sums owed by Deluxe to certain of the executives.
The deferred compensation agreements accrue interest at 9.75% annually
on the unpaid amount, which interest will be added to the unpaid amount.
The deferred compensation is payable on the earlier to occur of (i) the
tenth anniversary of the date of the agreement, (ii) a sale of Holdings,
or (iii) the termination of the executive's employment with Financial
Alliance.
(12) Management Services Agreement and Fees
--------------------------------------
The Company is party to a management services agreement with FA Capital
LLC (FA Capital) wherein FA Capital will perform certain management
services, including acquisition assistance, analysis of financing
alternatives and certain finance, marketing and human resource functions
for an annual fee of $250,000, plus expenses, until such time as FA
Investors I, LP or an affiliate closes a private equity fund with
aggregate commitments of at least $100 million.
In connection with the acquisition of the Company by Holdings, fees and
expenses of approximately $926,000 were paid to affiliates of Holdings.
Additionally, the Company is required to pay FA Partners II and FA
Capital a contingent fee of $398,961 over a period not to exceed ten
years and which payment will be equal to 2.678% of the total
distributions and payments made to the holders of Holdings Class A
common stock.
16
21
FA HOLDINGS, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
(13) Common Stock
------------
Holders of the Class A (nonvoting) common stock are entitled to receive
all or any portion of distributions equal to the unreturned value,
defined as the excess, if any, of $1,490 per share over the aggregate
amount of distributions made by Holdings that constitute a return of
value, until the entire amount of the unreturned value has been paid in
full prior to any distributions to the holder of common stock
outstanding.
17
22
Independent Auditors' Report
----------------------------
To the Board of Directors and Stockholder of
Financial Alliance Processing Services, Inc.
Louisville, Kentucky:
We have audited the accompanying balance sheet of Financial Alliance Processing
Services, Inc., a wholly-owned subsidiary of FA Holdings, Inc., (New Company;
see note 3) as of December 31, 1996 post-acquisition, and the related statements
of stockholder's equity and cash flows for the post acquisition period ended
December 31, 1996, and the statements of operations, stockholder's equity, and
cash flows of Old Company (see note 3) for the pre-acquisition period from
January 1, 1996 to December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of New Company, as of December 31,
1996, post-acquisition, and its cash flows for the post-acquisition period ended
December 31, 1996, and the results of operations and cash flows of Old Company
for the pre-acquisition period from January 1, 1996 to December 31, 1996, in
conformity with generally accepted accounting principles.
Louisville, Kentucky
June 4, 1997 /s/ KPMG Peat Marwick LLP
1
23
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Balance Sheets
(In Thousands, except share information)
December 31, 1996 September 30, 1997
----------------- ------------------
(New Company)
Assets (note 6) (Unaudited)
------
Current assets:
Cash (note 4) $ 2,419 $ 2,986
Accounts receivable:
Merchants 3,490 4,734
Equipment 467 69
Other 83 201
Inventory 875 608
Deferred income taxes (note 8) 392 747
Prepaid expenses and other current assets 260 215
-------- --------
Total current assets 7,986 9,560
Fixed assets (note 5) 2,183 1,975
Acquired merchant portfolios, less accumulated amortization 28,750 27,608
of $2,289 at September 30, 1997
Goodwill, less accumulated amortization of $625 at September 30, 1997 16,712 16,264
Other assets 1,090 981
-------- --------
Total assets $ 56,721 $ 56,388
======== ========
Liabilities and Stockholder's Equity
------------------------------------
Current liabilities:
Accounts payable:
Interchange, authorization and deposit charges $ 3,436 $ 4,030
Vendors 1,160 809
Current installments of long-term debt (note 6) 1,000 4,000
Current installments of obligations under capital leases (note 7) 225 237
Other current liabilities 1,297 2,492
-------- --------
Total current liabilities 7,118 11,568
Long-term debt, excluding current installments (note 6) 19,149 16,000
Obligations under capital lease, excluding current installments (note 7) 184 24
Deferred income (note 12) 5,100 4,951
Deferred income taxes (note 8) 6,144 5,777
Other (note 13) 990 1,317
-------- --------
Total liabilities 38,685 39,637
Stockholder's equity:
Common stock, no par value. 2,500 shares authorized,
issued and outstanding 18,036 18,199
Accumulated deficit -- (1,448)
-------- --------
Commitments and contingencies (notes 7 and 12)
Total stockholder's equity 18,036 16,751
Total liabilities and stockholder's equity $ 56,721 $ 56,388
======== ========
See accompanying notes to financial statements.
2
24
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Statements of Operations
(In Thousands)
Year End Nine months Ended
December 31, 1996 September 30, 1997
----------------- ------------------
(Old Company) (New Company)
(Unaudited)
Revenues:
Processing fees $ 65,290 $ 51,109
Terminal sales (note 11) 9,929 6,139
Application fees 2,019 1,253
Other 927 735
-------- --------
Total revenues 78,165 59,236
Direct operating expenses (note 10):
Processing expenses 43,748 33,055
Salaries and wages 10,142 5,530
Residuals 3,824 2,431
Cost of terminals sold (note 11) 3,833 2,329
Provision for bad debts 2,412 1,160
Commissions 4,276 2,897
Depreciation and amortization 6,263 3,752
Other 5,222 7,898
-------- --------
Total direct operating expenses 79,720 59,052
-------- --------
Other income (expense):
Interest expense allocation from Deluxe (note 10) (845) --
Interest Expense 1,716
Loss on sale of leasing portfolio (note 11) (335) --
Interest income from leasing portfolio 1,439 --
-------- --------
Loss before income taxes 1,296 1,532
Income tax expense (benefit) (note 8) 1,059 (84)
-------- --------
Net loss $ 2,355 $ 1,448
======== ========
See accompanying notes to financial statements.
3
25
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Statements of Stockholder's Equity
Year ended December 31, 1996 and the nine months ended September 30, 1997
(Unaudited)
(In Thousands)
(Old Company)
Common Stock Total
------------ Accumulated Stockholder's
Shares Amount Deficit Equity
----- ------- ------- -------
Balance at
December 31, 1995 2,500 $36,990 (11,055) 25,935
Net loss -- -- (2,355) (2,355)
----- ------- ------- -------
Balances at
December 31, 1996 2,500 $36,990 (13,410) 23,580
===== ======= ======= =======
============================================================================================
(New Company)
Balance at December 31, 1996
after applying push-down
accounting 2,500 $18,036 -- 18,036
Net Loss -- -- (1,448) (1,448)
Capital Contribution -- 163 -- 163
----- ------- ------- -------
Balances at
September 30, 1997 2,500 $18,199 (1,448) 16,751
===== ======= ======= =======
See accompanying notes to financial statements.
4
26
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Statement of Cash Flows
For the year ended December 31, 1996 and the nine month
period ended September 30, 1997 (Unaudited)
(In Thousands)
December 31, 1996
-----------------
(Old Company)
Cash flows from operating activities:
Net loss $ (2,355)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Provision for bad debts 2,412
Loss on sale of leasing portfolio 335
Depreciation and amortization 6,263
Write down of acquired portfolios 217
Deferred income taxes (706)
Operating expenses allocated from Deluxe 2,466
Changes in operating assets and liabilities:
Accounts receivable (4,162)
Inventory 67
Prepaid expenses and other assets (441)
Accounts payable and other current liabilities (368)
Deferred income 5,100
Other liabilities (913)
--------
Net cash provided by operating activities 7,915
--------
Cash flows from investing activities:
Purchases of fixed assets (129)
Proceeds from sale of leasing portfolio 7,851
--------
Net cash provided by investing activities 7,722
--------
Cash flows from financing activities:
Principal payments under capital lease obligations (307)
Repayment to Deluxe, net (15,643)
--------
Net cash used in financing activities (15,950)
--------
Net decrease in cash (313)
Cash, beginning of period 2,732
--------
Cash, end of period $ 2,419
========
See accompanying notes to financial statements.
5
27
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Statement of Cash Flows
For the year ended December 31, 1996 and the nine month period
ended September 30, 1997
(Unaudited)
(In Thousands)
December 31, 1996 September 30, 1997
----------------- ------------------
(New Company) (New Company)
Cash flows from operating activities:
Net Loss $ -- $(1,448)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Provision for bad debts 1,160
Depreciation and amortization 3,724
Deferred income taxes (721)
Changes in operating assets and liabilities:
Account receivable (2,125)
Inventory 267
Prepaid expenses and other assets (169)
Accounts payable and other current liabilities 1,439
Deferred income (149)
Other liabilities 327
-------- -------
Net cash provided by operating activities $ 2,305
Cash flows from investing activities:
Cash paid for Financial Alliance Processing Services, Inc.,
net of cash received of $2,419 $(39,836) $ (181)
Purchases of fixed assets -- (603)
Purchase of business and residual portfolios -- (820)
-------- -------
Net cash used in investing activities (39,836) (1,604)
-------- -------
Cash flows from financing activities:
Investment by FA Holdings, Inc. 18,036 163
Proceeds from long-term debt, net of financing costs of $1,030 19,119 --
Proceeds from conversion bonus 5,100 --
Payments on capital leases -- (148)
Payment of long term debt -- (149)
-------- -------
Net cash provided (used) by financing activities 42,255 (134)
-------- -------
Net increase in cash 2,419 567
Cash, beginning of period -- 2,419
-------- -------
Cash, end of period $ 2,419 2,986
======== =======
Supplemental cash flow information:
Non cash financing and investing activities:
Other liabilities incurred in connection with acquisition $ 337 $ 255
Accrued acquisition costs 572 55
======== =======
See accompanying notes to consolidated financial statements.
6
28
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
Year Ended December 31, 1996 and nine months ended September 30, 1997
(Unaudited)
(1) Basis of Presentation
---------------------
Nature of Business
------------------
FA Holdings, Inc. (Holdings) is a holding company formed for the purpose
of acquiring its wholly-owned subsidiary, Financial Alliance Processing
Services, Inc. (Financial Alliance or the Company) (note 3). Financial
Alliance provides third-party credit and debit card processing services
to retail merchants located throughout the United States pursuant to a
contract between the Company and a processing bank. Financial Alliance's
services include terminal sales, merchant servicing, transaction
authorization, data capture, merchant accounting, funds settlement,
draft storage and retrieval and charge-back processing.
Unaudited Interim Financial Information
---------------------------------------
The accompanying unaudited financial statements at September 30, 1997
and for the nine months ended September 30, 1997 have been prepared in
accordance with generally accepted accounting principles for the interim
financial information and with Article 10 of Regulation S-X. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been
included. Operating results for the nine month period ended September
30, 1997 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1997.
(2) Summary of Significant Accounting Policies
------------------------------------------
Accounts Receivable
-------------------
Accounts receivable are primarily comprised of amounts due from the
Company's merchants and represent the discount earned, after related
interchange fees on transactions processed during the month ending on
the balance sheet date. Such balances are received from the Company's
clearing and settlement bank approximately three days following the end
of each month.
The Company's customers (retail merchants) have liability for charges
disputed by cardholders. In the normal course of business, the Company
is exposed to the risk of chargebacks in the case of fraud, insolvency
or bankruptcy by the merchant, which may be significant. The Company
provides for possible losses on chargebacks based upon past loss
experience adjusted for management's evaluation of current factors
affecting the adequacy of the allowance.
7
29
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(2) Summary of Significant Accounting Policies (Continued)
-----------------------------------------------------
Inventory
---------
Inventory, which consists primarily of electronic point-of-sale
equipment, is stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.
Acquired Merchant Portfolios and Goodwill
-----------------------------------------
In connection with the acquisition (note 3), acquired merchant
portfolios were valued at the present value of estimated cash flows from
the Company's retail merchant credit and debit card processing business.
Amortization periods ranged from seven to ten years.
Goodwill, which represents the excess of purchase price over fair value
of net assets acquired, is amortized on a straight-line basis over
twenty years.
The Company assesses the recoverability of intangible assets by a
comparison of the carrying amount of the asset to future net cash flows
expected to be generated by the asset. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount
by which the carrying amount of the assets exceeds the fair value of the
assets.
Fixed Assets
------------
Fixed assets are stated at cost. Equipment under capital leases is
stated at the present value of minimum lease payments.
Depreciation of fixed assets is calculated on the straight-line method
over the estimated useful lives of the assets. Equipment held under
capital leases is amortized on a straight-line method over the shorter
of the lease term or estimated useful life of the asset.
Other Assets
------------
Other assets include $1,030,000 and $868,000 at December 31, 1996, and
September 30, 1997 (unaudited) respectively, of deferred financing costs
associated with the Company's borrowings under the credit facility
described in note 6. These costs are being amortized over the term of
the related loans.
8
30
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(2) Summary of Significant Accounting Policies (Continued)
------------------------------------------------------
Income Taxes
------------
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences of differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Estimates
---------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
(3) Acquisition of Financial Alliance
---------------------------------
As of the close of business December 31, 1996, Holdings acquired
Financial Alliance pursuant to a Purchase and Sale Agreement, dated
November 22, 1996, between Holdings and Deluxe Corporation (Deluxe). The
total purchase price, including acquisition costs of $1,621,000 and
lliabilities incurred of $337,000, amounted to $43,724,000. The
acquisition has been accounted for using the purchase method of
accounting.
The accompanying statements of operations, stockholder's equity and cash
flows which reflect the pre-acquisition period from January 1, 1996 to
December 31, 1996 are captioned "Old Company". The accompanying balance
sheet and statements of stockholder's equity and cash flows as of and
for the post-acquisition period ended December 31, 1996 and the
accompanying unaudited balance sheets and statements of operations, and
cash flows as of and for the nine month period ended September 30, 1997
reflect a new basis of accounting and are captioned "New Company". The
new basis of accounting reflects the total cost of the purchase
allocated to the assets and liabilities of New Company using estimates
of fair value (known as "push-down" accounting). The excess purchase
price over net assets acquired is reflected as goodwill.
9
31
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(4) Restricted Cash
---------------
Included in cash balances at December 31, 1996, and September 30, 1997
(unaudited) are $1,583,000 and $1,903,000 respectively, in restricted
cash for the future settlement of transaction processing liabilities.
(5) Fixed Assets
------------
Fixed assets consist of the following:
(In thousands) December 31, 1996 September 30, 1997
(New Company) (Unaudited)
(New Company)
Equipment $ 2,091 $ 2,575
Furniture and fixtures 92 104
Less accumulated depreciation - (704)
------------------ ------------------
Total $ 2,183 $ 1,975
================== ==================
Equipment under capital leases amounted to $373,000 and $209,000 at
December 31, 1996, and September 30, 1997 respectively.
Amortization of assets held under capital leases is included with
depreciation expense.
(6) Long-Term Debt
--------------
Long-term debt consists of the following:
(In thousands) December 31, 1996 September 30, 1997
----------------- ------------------
(New Company) (Unaudited)
(New Company)
Revolving line of credit $ 149 $ -
Term loan 20,000 $ 20,000
-------------- -----------------
20,149 20,000
Current installments of long-term debt 1,000 4,000
-------------- -----------------
Obligations under long-term debt
excluding current installments $ 19,149 $ 16,000
============== =================
10
32
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(6) Long-Term Debt (Continued)
--------------------------
The Company's long-term debt is pursuant to a Credit Agreement with
General Electric Capital Corporation dated as of December 31, 1996
(Credit Agreement) for an amount up to $25,000,000 in the aggregate for
the purpose of funding the acquisition and providing working capital
financing and funds for other corporate purposes of the Company and
consists of a revolving line of credit, term loan and swing line
facility. The long-term debt is a secured by the assets of Financial
Alliance.
Revolving credit advances outstanding at any time may not exceed
$5,000,000, less the sum of any letter of credit obligations and swing
line loan outstanding and such reserve as the lender may establish.
The term loan is repayable in quarterly principal installments of
$1,000,000 beginning October 1, 1997 and of $1,250,000 beginning January
1, 1999 through October 1, 2001.
Swing line advances outstanding at any time shall not exceed the lesser
of the swing line commitment ($500,000), or $5,000,000 less the sum of
any letter of credit obligations and revolving loan advances outstanding
at such time. The unpaid balance of the swing line is payable in full on
October 1, 2001.
The Credit Agreement provides that the Company, at its option, make
voluntary prepayments for all or a part of the term loan and revolving
loan, including permanent reduction of the revolving loan commitment. In
addition, mandatory prepayments are required as follows: (i) if at any
time the outstanding balance of the revolving line exceeds the maximum
amount less the outstanding swing line loan advances, then at that time,
revolving line advances will be immediately repaid to the extent
required to eliminate the excess, (ii) upon receipt of any cash proceeds
from an asset disposition, the Company shall repay the loans equal to
all such proceeds, (iii) if Holdings issues common stock, the Company
shall repay loans in an amount equal to all such proceeds, except that
if such stock issuance is in a private placement in an amount that does
not exceed $5,000,000, only 50% of the proceeds shall be repaid, and
(iv) on the earlier of the date which is ten days after the delivery of
the annual audited financial statements for the immediately preceding
year or the date on which such annual audited financial statements were
required to be delivered, seventy-five percent of excess cash flow, as
defined, for the immediately preceding fiscal year.
11
33
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(6) Long-Term Debt (Continued)
--------------------------
Interest on the revolving and term loans under the Credit Agreement is
at either the index rate plus the applicable index margin or, at the
Company's election, the applicable LIBOR rate plus the applicable LIBOR
rate margin. Interest on the swing line loan advances is at the index
rate plus the applicable revolver index margin. The applicable margins
are as follows so long as an event of default has not occurred:
Index LIBOR
Margin Margin
------ ------
Revolver 2.25% 3.50%
Term loan 2.50% 3.75%
The interest rates in effect for the revolving line of credit at
December 31, 1996 and September 30, 1997 (unaudited) were 10.5% and
10.75%, respectively. The interest rates in effect for the term loan at
December 31, 1996 and September 30, 1997 (unaudited) were 10.75% and
9.75%, respectively.
Additionally, an unused line fee margin of 0.50% is payable monthly and
an annual letter of credit fee of 2.00% is payable with respect to any
outstanding letter of credit obligations. The Credit Agreement also
provides that if an event of default shall occur, the interest rates
applicable to the loans and the letter of credit fees shall be increased
by two percentage points above the rates of interest or fees otherwise
applicable.
The Credit Agreement provides that the Company establish and maintain
cash management systems consisting of lock boxes, borrower accounts,
disbursement accounts and concentration accounts in order to facilitate
payment of the loans pursuant to the security agreement.
The Credit Agreement contains a number of covenants which limit the
Company's ability to acquire or merge, incur additional indebtedness,
make any change in its capital structure, dispose of assets, or make
certain restricted payments. Additionally, the Company is required to
meet certain financial covenants related to maximum capital
expenditures, fixed charge coverage, minimum EDITDA, minimum net worth,
and funded debt to EBITDA.
The aggregate maturities of long-term debt for each of the five years
subsequent to December 31, 1996 as follows: 1997, $1,000,000; 1998,
$4,000,000; 1999, $5,000,000; 2000, $5,000,000; and 2001 and thereafter,
$5,149,000.
12
34
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(7) Lease Obligations
-----------------
The Company leases certain equipment under capital leases. Future
minimum lease obligations for capital leases at December 31, 1996 are as
follows:
December 31, 1996
-----------------
(New Company)
(In thousands)
Year ended December 31:
1997 $ 244
1998 189
--------------
Total minimum lease payments 433
Less amount representing interest 24
--------------
Present value of net minimum capital lease payments 409
--------------
Current installments of obligations under
capital leases 225
--------------
Obligation under capital leases, excluding current
installments. $ 184
==============
The Company leases its headquarters and regional offices under various operating
lease agreements that require monthly payments. Future minimum payments for
noncancelable operating leases having a remaining term in excess of one year at
December 31, 1996 are as follows:
December 31, 1996
-----------------
(New Company)
(In thousands)
Year ended December 31:
1997 $ 282
1998 165
--------------
Total $ 447
==============
Total rent expense recorded under operating lease agreements was
$652,000 during the year ended December 31, 1996 and $451,000 during the
nine month period ended September 30, 1997 (unaudited).
13
35
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(8) Income Taxes
------------
Income tax expense (benefit) for the year ended December 31, 1996 and
nine month period ended September 30, 1997 (unaudited) consists of the
following:
December 31, 1996 September 30, 1997
----------------- ------------------
(Old Company) (New Company)
(In thousands) (Unaudited)
Current Deferred Total Current Deferred Total
----------- ---------- ------ ------ ------ -------
Federal $ 1,579 (632) 947 493 (721) (228)
State 186 (74) 112 144 - 144
----------- ---------- ------ ------ ------ -------
$ 1,765 (706) 1,059 637 (721) (84)
=========== ========== ====== ======= ====== =======
Income tax expense was $1,059,000 for the year ended December 31, 1996
and a $84,000 benefit for the nine month period ended September 30, 1997
(unaudited) and differed from the amounts computed by applying the U.S.
Federal income tax rate of 34 percent to pretax income as a result of
the following:
December 31, 1996 September 30, 1997
----------------- ------------------
(Old Company) (New Company)
(In thousands) (Unaudited)
Computed "expected" tax benefit $ (441) $ (521)
Increase in income taxes resulting from:
Amortization of goodwill 1,373 214
State taxes, net of federal income tax benefit 74 95
Other, net 54 128
----------- ------------
$ 1,060 $ (84)
=========== ============
14
36
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(8) Income Taxes (Continued)
------------------------
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at December 31,
1996, and September 30, 1997 are presented below:
December 31, 1996 September 30, 1997
----------------- ------------------
(New Company) (New Company)
(Unaudited)
(In thousands)
Deferred tax assets:
Deferred income $ 1,938 $ 1,887
Bad debt allowances 374 436
Merchant portfolios 263 263
Other 81 373
----------------- ------------
Total gross deferred tax assets 2,656 2,959
Less valuation allowance - -
----------------- ------------
Net deferred tax assets 2,656 2,959
----------------- ------------
Deferred tax liabilities:
Purchase accounting adjustments related
to merchant portfolios 8,365 7,806
Other 43 183
----------------- ------------
Total gross deferred tax liabilities 8,408 7,989
----------------- ------------
Net deferred tax liability $ 5,752 $ 5,030
================= ============
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences
become deductible. Management considers the scheduled reversal of
deferred tax liabilities and projected future taxable income in making
this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods which the
deferred tax assets are deductible, management believes it is more
likely than not the Company will realize the benefits of these
deductible differences. Accordingly, no valuation allowance for deferred
tax assets was recorded at December 31, 1996 or September 30, 1997.
15
37
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(9) Employee Benefit Plan
---------------------
The Company has a defined contribution savings plan under the provisions
of Section 401(k) of the Internal Revenue Code that provides retirement
benefits to substantially all employees. The Company's contribution,
which is based upon the salary redirection contributions of the eligible
employees was $48,000 for the year ended December 31, 1996 and $39,587
for the nine month period ended September 30, 1997 (unaudited).
(10) Related Party Transactions
--------------------------
The accompanying statement of operations for the year ended December 31,
1996 includes intercompany allocations from Deluxe of $2,466,000 for
various expenses including interest expense charged to the Company for
advances from Deluxe, insurance, taxes and executive compensation. The
allocated expenses are not necessarily indicative of the costs and
expenses that would have resulted had the Company been operated as a
separate company.
(11) Terminal Sales and Cost of Terminals Sold
-----------------------------------------
Included in 1996 revenues from terminal sales and related cost of
terminals sold were $6,597,000 and $2,002,000, respectively, accounted
for as sales-type capital leases. In December 1996, the Company sold its
leasing portfolio to a third-party for $7,851,000 and recognized a loss
on the sale of $335,000. The leasing portfolio was sold without future
recourse to the Company as all chargeback repurchase obligations were
retained by Deluxe.
(12) Processing Agreement with National Processing Company
-----------------------------------------------------
The Company is party to an agreement with National Processing Company
(NPC) for processing and transmitting electronic data services through
2004, with minimum processing guarantees as follows:
(In thousands) (New Company)
Twelve months ended April 30:
1998 $ 3,900
1999 5,100
2000 6,100
2001 7,200
2002 8,600
2003 10,200
2004 12,200
------------------
Total $ 53,300
==================
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38
FINANCIAL ALLIANCE PROCESSING SERVICES, INC.
Notes to Consolidated Financial Statements
(12) Processing Agreement with National Processing Company (Continued)
-----------------------------------------------------------------
Minimums are calculated on a cumulative basis, such that the fees paid
by the Company in any given contract year in excess of the minimum for
that same year may be applied toward the satisfaction of subsequent
years' minimums. To the extent the Company falls short of meeting the
minimum processing guarantees in any period, the shortfall may be
deferred to subsequent periods during the term of the agreement. Any
deferrals will bear interest at the prime rate plus two percent, which
interest is due within 30 days after the month incurred.
Additionally, NPC advanced $5,100,000 to the Company on December 31,
1996 as bonus for the Company's conversion of their merchant portfolio
to NPC. The amount has been recorded as deferred income and will be
recognized as a reduction in transaction processing expense over the
life of the processing agreement.
(13) Deferred Compensation Agreements
--------------------------------
Deferred compensation agreements in an aggregate amount of $937,500 at
December 31, 1996 and September 30, 1997 exist for certain Company
executives. The agreements represent the assumption of retention bonuses
to be paid pursuant to management agreements and other sums owed by
Deluxe to certain of the executives. The deferred compensation
agreements accrue interest at 9.75% annually on the unpaid amount, which
interest will be added to the unpaid amount. The deferred compensation
is payable on the earlier to occur of (i) the tenth anniversary of the
date of the agreement, (ii) a sale of Holdings, or (iii) the termination
of the executive's employment with Financial Alliance.
(14) Management Services Agreement and Fees
--------------------------------------
The Company is party to a management services agreement with FA Capital
LLC (FA Capital) wherein FA Capital will perform certain management
services, including acquisition assistance, analysis of financing
alternatives and certain finance, marketing and human resource functions
for an annual fee of $250,000, plus expenses, until such time as FA
Investors I, LP or an affiliate closes a private equity fund with
aggregate commitments of at least $100 million.
In connection with the acquisition of the Company by Holdings, fees and
expenses of approximately $926,000 were paid to affiliates of Holdings.
Additionally, the Company is required to pay FA Partners II and FA
Capital a contingent fee of $398,961 over a period not to exceed ten
years and which payment will be equal to 2.678% of the total
distributions and payments made to the holders of Holdings Class A
common stock.
17
39
National Processing, Inc.
Unaudited Pro Forma Financial Statements
The unaudited pro forma condensed consolidated balance sheet as of
September 30, 1997 includes the historical accounts of the National
Processing, Inc. (the Company) and gives effect to the acquisition of FA
Holdings, Inc. and its subsidiary Financial Alliance Processing
Services, Inc. ("FA") as if it occurred as of September 30, 1997. The
unaudited pro forma condensed consolidated statements of income of the
Company for the year ended December 31, 1996 and for the nine months
ended September 30, 1997, include the historical operations of the
Company and give effect to the acquisition of FA as if it occurred as of
the beginning of the period presented. The unaudited pro forma
consolidated financial information has been prepared by the Company's
management. The information is not designed to represent what the
Company's results of operations actually would have been had the
acquisition been completed as of the beginning of the period indicated,
or to project the Company's results of operations for any future period.
The pro forma adjustments are based on available information and certain
assumptions that the Company currently believes are reasonable in the
circumstances. The pro forma adjustments are subject to change upon
completion of the final determination of fair values of the assets
acquired and the liabilities assumed.
1
40
National Processing, Inc.
Unaudited Pro Forma Condensed Consolidated Balance Sheet
September 30, 1997
(In thousands)
National FA Holdings, Pro Forma Pro Forma
Processing, Inc. Inc. Adjustments As Adjusted
---------------- ---- ----------- -----------
Assets
Current assets:
Cash and cash equivalents $ 18,737 $ 1,083 $ 4,586 (1) $ 24,406
Securities available for sale 109,408 -- (94,000)(1) 15,408
Accounts receivable-trade 68,739 5,004 (87)(7) 73,656
Restricted deposits-client funds 113,338 -- 113,338
Other current assets 12,344 3,473 (476)(4) 19,946
4,705 (6)
(100)(7)
-------- ------- --------- ---------
Total current assets 322,566 9,560 (85,372) 246,754
Property and Equipment, net 65,093 1,975 (1,681)(4) 65,387
Other assets:
Goodwill 97,144 16,264 (16,264)(2) 172,918
75,774 (9)
Acquired merchant portfolio -- 27,608 (11,807)(3) 15,801
Other assets 18,073 981 542 (4) 14,645
(4,951) (8)
-------- ------- --------- ---------
Total other assets 115,217 44,853 43,294 203,364
-------- ------- --------- ---------
Total assets $502,876 $56,388 $ (43,759) $ 515,505
======== ======= ========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Restricted deposits-client funds $113,338 -- $ 113,338
Other current liabilities 51,535 $11,568 $ (4,023)(1) 61,261
2,181 (7)
-------- ------- --------- ---------
Total current liabilities 164,873 11,568 (1,842) 174,599
Long-term debt 4,000 21,391 (21,391)(1) 4,000
Other long-term liabilities 3,140 12,069 (4,215)(6) 6,043
(4,951)(8)
-------- ------- --------- ---------
Total liabilities 172,013 45,028 (32,399) 184,642
Total shareholders' equity 330,863 11,360 (11,360)(5) $ 330,863
-------- ------- --------- ---------
Total liabilities and shareholders'
equity $502,876 $56,388 $ (43,759) $ 515,505
======== ======= ========== =========
2
41
National Processing, Inc.
Notes to Unaudited Pro Forma Condensed Consolidated Balance Sheet
September 30, 1997
(In thousands)
(1) Reflects $64 million paid by NPI on October 24, 1997 and January 2, 1998
to acquire 100% of the outstanding common stock of FA and $30 million
paid by NPI to FA on October 24, 1997 for 60,001 newly issued shares.
The $30 million in proceeds were used by FA to retire-term debt and
certain other liabilities aggregating $25,414 leaving an additional
$4,586 for operating cash.
(2) Eliminates goodwill previously recorded by FA.
(3) Adjusts acquired merchant portfolio of FA to estimated fair value.
(4) Adjusts property and equipment and other assets to estimated fair value.
(5) Eliminates acquired shareholders' equity of FA.
(6) Reflects estimated impact of purchase accounting adjustments on deferred
taxes.
(7) Records accrual of certain liabilities and reserves.
(8) Reflects elimination of intercompany prepaid processing fees and
deferred revenue.
(9) Reflects new goodwill due to the application of purchase accounting.
3
42
National Processing, Inc.
Unaudited Pro Forma Condensed Consolidated Statements of Income
Nine Months Ended September 30, 1997
(In thousands, except per share amounts)
National FA Holdings, Pro Forma Pro Forma
Processing, Inc. Inc. Adjustments as Adjusted
---------------- ---- ----------- -----------
Revenues $284,169 $59,236 $(3,255) (5) $307,595
(32,555) (6)
Operating expenses 136,543 43,323 (32,555) (6) 144,056
(3,255) (5)
Wages and other personnel expenses 70,639 7,108 77,747
General and administrative expenses 44,965 4,869 (1,588) (3) 48,246
Depreciation and amortization 12,171 3,752 (524) (2) 15,399
------- -------- -------- -------
Operating Profit 19,851 184 2,112 22,147
Net interest income (expense) 3,527 (2,107) (2,291) (4) 1,236
2,107 (1)
------- -------- -------- -------
Income before income taxes 23,378 (1,923) 1,928 23,383
Provision (benefit) for income taxes 8,214 (84) 1,810 (7) 9,940
------- -------- -------- -------
Net Income (Loss) $15,164 $ (1,839) $ 118 $13,443
======= ======== ======== =======
Net Income Per Share $0.30 $0.27
===== =====
Shares used in computation 50,575 50,575
4
43
National Processing, Inc.
Notes to Unaudited Pro Forma Condensed Consolidated Statements of Income
Nine Months Ended September 30, 1997
(In thousands)
(1) Eliminates interest expense related to retired debt.
(2) Adjusts amortization of intangibles and depreciation of property and
equipment resulting from purchase accounting.
(3) Eliminates incremental costs incurred in connection with the
acquisition.
(4) Reflects the loss of non-taxable interest income to NPI from the use of
securities available for sale for the acquisition.
(5) Eliminates intercompany revenues and expenses.
(6) Reduces processing revenues by processing fees consistent with National
Processing, Inc.'s presentation.
(7) Reflects the tax impact of adjustments.
(8) Management expects to achieve certain synergies in relation to the
business combination which are not yet identified and are, therefore,
not reflected here.
5
44
National Processing, Inc.
Unaudited Pro Forma Condensed Consolidated Statement of Income
Year Ended December 31, 1996
(In thousands, except per share amounts)
National FA Holdings, Pro Forma Pro Forma
Processing, Inc. Inc. Adjustments as Adjusted
---------------- ---- ----------- -----------
Revenues $377,561 $ 78,165 $(43,748) (4) $411,978
Operating expenses 201,942 58,571 (43,748) (4) 216,765
Wages and other personnel 63,569 10,289 73,858
expenses
General and administrative 48,959 4,932 53,891
expenses
Depreciation and amortization 12,847 6,263 (648) (2) 18,462
------- -------- -------- --------
Operating income (Loss) 50,244 (1,890) 648 49,002
Net interest income (expense) 2,783 594 845 (1) (243)
(4,465) (3)
------- -------- -------- --------
Income (loss) before income taxes 53,027 (1,296) (2,972) 48,759
Provision (credit) for income taxes 21,674 1,059 (884) (5) 21,849
------- -------- -------- --------
Net Income (loss) $31,353 $ (2,355) $ (2,088) $ 26,910
======= ======== ======== ========
Net Income Per Share $ 0.68 $ 0.58
======= ========
Shares used in computation 46,090 46,090
6
45
National Processing, Inc.
Notes to Unaudited Pro Forma Condensed Consolidated Statement of Income
Year Ended December 31, 1996
(In thousands)
(1) Eliminates interest expense related to retired debt.
(2) Adjusts amortization of intangibles and depreciation of property and
equipment resulting from purchase accounting.
(3) Reflects the loss of interest income to NPI from the use of securities
available for sale for the acquisition.
(4) Reduces processing revenues by processing fees consistent with National
Processing, Inc's. presentation.
(5) Reflects the tax impact of adjustments.
(6) Management expects to achieve certain synergies in relation to the
business combination which are not yet identified and are, therefore,
not reflected here.
7
46
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 hereunto duly authorized.
Date: January 22, 1998
By: /s/ Jim W. Cate
-------------------------------
Jim W. Cate
Executive Vice President
and Chief Financial Officer
8