1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
/X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
of 1934
For the quarterly period ended September 30, 1998
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: 1-11905
NATIONAL PROCESSING, INC.
(Exact name of Registrant as specified in its charter)
OHIO 61-1303983
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
ONE OXMOOR PLACE
101 BULLITT LANE, SUITE 450
LOUISVILLE, KENTUCKY 40222
(Address of principal executive offices) (Zip Code)
(502) 326-7000
(Registrant's telephone number, including area code)
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
--- ---
The number of shares outstanding of the Registrant's Common Stock as of November
13, 1998 was 50,644,651.
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NATIONAL PROCESSING, INC.
INDEX
PART I. FINANCIAL INFORMATION
Page No.
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Item 1. Condensed Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets - September 30, 1998
and December 31, 1997 3
Consolidated Statements of Income -
Three Months and Nine Months Ended
September 30, 1998 and 1997 4
Condensed Consolidated Statements of
Cash Flows -Nine Months Ended September 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial
Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
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NATIONAL PROCESSING, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
Unaudited
September 30 December 31
1998 1997
------------ -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 37,458 $ 38,887
Securities available for sale -- 1,188
Accounts receivable-trade 71,555 104,752
Check inventory 3,989 7,395
Restricted deposits-client funds 99,798 83,183
Deferred tax assets 8,768 10,941
Other current assets 9,188 10,064
-------- --------
Total current assets 230,756 256,410
Property and equipment:
Furniture and equipment 113,537 94,976
Building and leasehold improvements 23,233 15,679
Software 20,184 16,219
Property leased from affiliate 4,173 4,173
Land and improvements 2,535 1,591
-------- --------
163,662 132,638
Accumulated depreciation and amortization 78,474 66,467
-------- --------
85,188 66,171
Other Assets:
Goodwill, net of accumulated amortization of
$14,295 in 1998 and $10,616 in 1997 174,929 170,327
Acquired merchant portfolios 18,930 21,115
Other assets 8,903 8,004
-------- --------
Total other assets 202,762 199,446
-------- --------
TOTAL ASSETS $518,706 $522,027
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Restricted deposits-client funds $ 99,798 $ 83,183
Accounts payable-trade 4,127 5,209
Merchant payable-check services 3,647 7,271
Accrued bankcard assessments 16,065 19,806
Income tax payable to NCC 5,215 4,262
Acquisition balance due -- 26,781
Other accrued liabilities 33,350 30,551
-------- --------
Total current liabilities 162,202 177,063
Obligation under property leased from affiliate 2,310 2,591
Other long-term liabilities 1,896 2,674
Deferred tax liabilities 5,028 2,874
-------- --------
Total liabilities 171,436 185,202
Shareholders' equity:
Preferred stock, without par value; 5,000,000
shares authorized; no shares issued or outstanding -- --
Common stock, without par value; 95,000,000 shares
authorized; 50,644,651 and 50,575,000 shares issued and 1 1
outstanding in 1998 and 1997, respectively
Contributed capital 175,799 175,215
Retained earnings 171,470 161,609
-------- --------
Total shareholders' equity 347,270 336,825
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $518,706 $522,027
======== ========
See notes to condensed consolidated financial statements
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NATIONAL PROCESSING, INC.
CONSOLIDATED STATEMENTS OF INCOME
Unaudited
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30 September 30
1998 1997 1998 1997
-------- -------- -------- --------
Revenues $121,430 $100,780 $354,257 $284,169
Other income 4,000 -- 4,000 --
Operating expenses 64,642 47,929 176,717 136,543
Wages and other personnel expenses 31,977 24,702 96,576 70,639
General and administrative expenses 16,760 12,856 49,308 38,625
Restructuring charges -- -- -- 6,340
Depreciation and amortization 6,718 4,194 19,789 12,171
-------- -------- -------- --------
INCOME FROM OPERATIONS 5,333 11,099 15,867 19,851
Net interest income 116 1,214 589 3,527
-------- -------- -------- --------
Income before income taxes 5,449 12,313 16,456 23,378
Provision for income taxes 2,068 4,676 6,595 8,214
-------- -------- -------- --------
NET INCOME $ 3,381 $ 7,637 $ 9,861 $ 15,164
======== ======== ======== ========
BASIC AND DILUTED INCOME PER COMMON SHARE $ .06 $ .15 $ .19 $ .30
======== ======== ======== ========
See notes to condensed consolidated financial statements
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NATIONAL PROCESSING, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
Nine Months Ended
September 30
1998 1997
-------- ---------
OPERATING ACTIVITIES
Net income $ 9,861 $ 15,164
Items not requiring cash currently:
Depreciation and amortization 19,789 12,171
Restructuring charge -- 4,163
Deferred income taxes 4,327 --
Loss on retirement of fixed assets 2,267
Change in current assets and liabilities:
Accounts receivable 33,833 26,074
Check inventory 3,406 1,322
Accounts payable-trade (1,193) (5,682)
Merchant payable-check services (3,624) (1,527)
Accrued bankcard assessments (3,741) (329)
Income taxes payable 953 1,658
Other current assets/liabilities 3,631 271
Other, net (1,964) (2,685)
-------- ---------
Net cash provided by operating activities 67,545 50,600
-------- ---------
INVESTING ACTIVITIES
Capital expenditures (34,442) (17,773)
Purchases of securities available for sale -- (423,958)
Proceeds from sales and maturity of securities
available for sale 1,188 436,987
Acquisitions, net of cash acquired (36,023) (30,343)
-------- ---------
Net cash used by investing activities (69,277) (35,087)
-------- ---------
FINANCING ACTIVITIES
Principal payments under property leased from affiliate (281) (106)
Net cash proceeds from exercise of stock options 584 --
-------- ---------
Net cash provided (used) by financing activities 303 (106)
-------- ---------
Net (decrease) increase in cash and cash equivalents (1,429) 15,407
Cash and cash equivalents, beginning of period 38,887 3,330
-------- ---------
Cash and cash equivalents, end of period $ 37,458 $ 18,737
======== =========
Supplemental Disclosure
Taxes paid $ 4,431 $ 10,071
See notes to condensed consolidated financial statements
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NATIONAL PROCESSING, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
1. ACCOUNTING POLICIES
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles for interim information and with the instructions
to Form 10-Q and Article 10 of regulation S-X. Accordingly, although
the balance sheet at December 31, 1997 has been derived from the
audited consolidated financial statements at that date, the
accompanying condensed consolidated financial statements do not include
all the information and footnotes required by generally accepted
accounting principles. These financial statements should be read in
conjunction with National Processing Inc.'s (the "Company") audited
consolidated financial statements for the year ended December 31, 1997
which include full disclosure of relevant financial policies and
information.
In the opinion of management, the accompanying condensed
consolidated financial statements have been prepared on a basis
consistent with accounting principles applied in the prior periods and
include all adjustments (consisting of normal recurring accruals)
considered necessary for fair presentation of the financial position,
results of operations and cash flows for the interim periods presented.
The results of operations for the interim periods are not necessarily
indicative of the results that may be expected for the full year or any
other interim period.
2. RESTRUCTURING CHARGE
During the three month period ended March 31, 1997, the
Company recorded non-recurring expenses of $6,340,000 for severance pay
and other costs related to organizational restructuring. These charges
decreased net income and earnings per share by approximately $3,867,000
and $.08, respectively. At September 30, 1998, other accrued
liabilities include $800,000 related to the restructuring charge.
3. RECLASSIFICATIONS
Certain 1997 amounts have been reclassified to conform with
the 1998 presentation.
4. ACQUISITIONS
On January 2, 1998, the Company acquired the remaining 20.4%
of the common stock of FA Holdings, Inc., the sole owner of Financial
Alliance Processing Services, Inc., an independent sales organization
specializing in selling credit and debit card processing services, for
$26.8 million.
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On January 15, 1998, the Company acquired all of the
outstanding shares of JBH Travel Audit Inc. ("JBH"), a company which
audits fees payable to travel agencies, for $6.3 million in cash. The
purchase price is subject to increase by as much as $2.0 million based
upon the earnings of the acquired company during its next 2 years of
operation. The acquisition, which has been accounted for as a purchase,
increased the Company's goodwill by $4.6 million which is being
amortized over 40 years. The results of JBH's operations since its
acquisition are included in the Company's results of operations. The
combined pro forma effect of the JBH transaction was not material to
previously reported periods.
Supplemental cash flow information related to the acquisition
is as follows:
(Dollars in thousands)
Net assets other than cash acquired $1,384
Purchase price in excess of net assets acquired 4,632
-----
Net cash used to acquire JBH $6,016
======
5. IMPAIRMENT OF LONG-LIVED ASSETS
In June 1998, the Company wrote-off $2,600,000 of internally developed
software and related costs following the cancellation of a significant
customer processing contract. The write-off decreased net income by
$1,558,000 or $.03 per share.
6. COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company is involved in litigation
from time to time. In the opinion of management, the ultimate
liability, if any, arising from this litigation is not expected to have
a material adverse effect on the Company's financial condition, results
of operations or liquidity.
7. PROVISION FOR REMITTANCE CHARGEBACKS
The Company's remittance operation accepts checks received on behalf of
customers and remits the funds to the customer. Certain amounts are
charged back by banks to the Company for errors in deposits, NSF
checks, etc. The Company maintains an in-process inventory of these
items which it normally settles without significant charges. As a
result of problems associated with the conversion of the remittance
product to a new image based system, the in-process inventory of bank
charge backs increased over normal operating levels. The consolidated
statements of income for the three and nine month periods ended
September 30, 1998 reflect charges of $4.3 million and $5.9 million
respectively for chargebacks deemed to be unrecoverable. Management
believes these provisions are adequate to cover losses related to
chargebacks.
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8. NET INCOME PER COMMON SHARE
The calculation of net income per common share follows (in thousands
except per share amounts):
Three Months Nine Months
------------ -----------
Ended Sept 30 Added Sept 30
------------- -------------
1998 1997 1998 1997
------ ------ ------ ------
BASIC
Net Income $ 3,381 $ 7,637 $ 9,861 $15,164
Average common shares outstanding 50,644 50,575 50,614 50,575
Net income per common share - basic $ .06 $ .15 $ .19 $ .30
DILUTED
Net income $ 3,381 $ 7,637 $ 9,861 $15,164
Average common shares outstanding 50,644 50,575 50,614 50,575
Stock option adjustment 47 189 163 105
Average common shares outstanding - diluted 50,691 50,764 50,777 50,680
Net income per common share - diluted $ .06 $ .15 $ .19 $ .30
9. COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income. This statement establishes standards for
reporting the components of comprehensive income and requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income be included in a financial statement
that is displayed with the same prominence as other financial
statements. Comprehensive income includes net income as well as certain
items that are reported directly within a separate component of
shareholders' equity and bypass net income. The Company adopted the
provisions of SFAS No. 130 in the first quarter of 1998; however, any
differences between net income and comprehensive income are not
material.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
GENERAL STATEMENT
National Processing, Inc. (the "Company") provides low-cost,
high-volume transaction processing services and customized processing solutions.
The Company deploys technology and applications software primarily to merchants
and other commercial businesses, corporations and providers of travel-related
services.
The Company is an Ohio corporation that was formerly a wholly owned
subsidiary of National City Corporation, an Ohio-headquartered bank holding
company. Following the Company's initial public offering in August 1996,
National City Corporation continued to own 85% of the Company's outstanding
common stock. In May 1997, National City Corporation purchased 1,265,000 shares
of the Company's common stock in the open market and currently owns
approximately 88% of the Company's outstanding common stock.
The financial information and related discussion included herein
reflect the results of operations of the following acquisitions from their
respective acquisition dates: on February 4, 1997, the Company acquired NTA,
Inc. a freight payment processing company; on June 18, 1997, the Company
acquired the operating assets and liabilities of Intracon, Inc., a freight
payment processing company; on June 20, 1997, the Company acquired the operating
assets and liabilities of MRS Jamaica, Inc., a data processing company; on
September 30, 1997, the Company acquired Caribbean Data Services, Ltd., a data
processing company; on October 24, 1997, the Company acquired 79.6% of the
outstanding shares of FA Holdings, Inc., a debit and credit card processor (the
Company acquired the remaining outstanding shares of FA Holdings, Inc. on
January 2, 1998); on January 15, 1998 the Company acquired JBH Travel Audit,
Inc., a travel fee auditing company.
COMPONENTS OF REVENUE AND EXPENSES
Revenues. The Company's revenues are generated from a variety of
sources through the Company's wholly owned subsidiary National Processing
Company. Merchant Services revenues are primarily derived from fees paid by
merchants for the authorization, processing, and settlement of credit and debit
card transactions, exclusive of interchange fees, and for the acceptance of
checks. Merchant fees include assessment fees, which are amounts charged by
credit card associations for clearing services, advertising and other expenses.
Revenues from Corporate Services are derived from transaction fees for the
processing of remittances, accounts payable and freight bills, and for providing
integrated document solutions involving electronic imaging, archival, processing
and payment settlement. Revenues from Travel Services depend primarily on the
volume of ticket sales by travel agents on behalf of airlines. A small portion
of revenues are derived from earnings on cash balances which are maintained by
customers pursuant to contract terms. Revenues derived from services provided to
affiliates are immaterial.
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Expenses. Operating expenses include all direct costs of providing
services to customers, excluding hourly labor. The most significant components
of operating expenses are assessment fees, authorization fees and data
processing expenses. Wages and other personnel expenses include wages and
personnel expenses for hourly employees. General and administrative expenses
include management salaries and benefits, facilities maintenance and software
applications programming. Depreciation of property and equipment and software
amortization are recognized on a straight-line basis over the estimated useful
life of the related asset. Amortization of goodwill associated with acquisitions
is recognized over forty years. Amortization of other costs associated with the
purchase of contracts or other business assets is recognized over varying
periods from three to fifteen years based upon the contract period and projected
revenue stream.
RESULTS OF OPERATIONS
The following table summarizes the Company's operating results as a
percentage of revenues:
Three Months Ended Nine Months Ended
Sept 30 Sept 30
-------------------------------------------------
1998 1997 1998 1997
------ ------- ------ ------
Revenues 100.0% 100.0% 100.0% 100.0%
Other income 3.3% - 1.1% -
Operating expenses 53.2% 47.6% 49.9% 48.0%
Wages and other personnel expenses 26.3% 24.5% 27.2% 24.9%
General and administrative expenses 13.8% 12.8% 13.9% 13.6%
Restructuring charges 0.0% 0.0% 0.0% 2.2%
Depreciation and amortization 5.6% 4.1% 5.6% 4.3%
----- ----- ----- -----
Income from operations 4.4% 11.0% 4.5% 7.0%
Net interest income .1% 1.2% 0.2% 1.2%
----- ----- ----- -----
Income before income taxes 4.5% 12.2% 4.7% 8.2%
Provision for income taxes 1.7% 4.6% 1.9% 2.9%
----- ----- ----- -----
Net income 2.8% 7.6% 2.8% 5.3%
===== ===== ===== =====
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THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Revenues. Consolidated revenue increased $20.7 million, or 20.5%, to
$121.4 million for the quarter ended September 30, 1998, from $100.8 million for
the comparable 1997 period. The increase is primarily due to revenues from the
Company's last three acquisitions, the fourth quarter 1997 acquisitions of FA
Holdings, Inc. and Caribbean Data Services, Ltd. and the first quarter 1998
acquisition of JBH Travel Audit, Inc., which contributed $20.3 million.
Consolidated revenues from the core business group increased $.4 million, or
0.4%. Core business increases resulted principally from increases in the
merchant card operations offset by decreases in the remittance, merchant check,
travel and freight operations.
Other Revenues. Other revenues in 1998 reflect a settlement for the
cancellation of a merchant card processing contract.
Costs and Expenses. Consolidated costs and expenses increased $30.4
million, or 33.9%, to $120.1 million for the quarter ended September 30, 1998
from $89.7 million during the comparable 1997 period.
Operating expenses increased $16.7 million, or 34.9%, to $64.6 million
for the quarter ended September 30, 1998 from $47.9 million in 1997. The
increase was due in part to the last three acquisitions which contributed $6.8
million in operating expenses. The Company's core businesses reflected increases
in operating expense of $9.9 million principally due to $4.3 for chargebacks at
remittance operations and $3.4 million at merchant card operations due to
increased volumes and expanded sales distribution channels, information
technology and customer services. The Company's freight, merchant check and
travel operations also experienced increases in operating expenses.
Wages and other personnel expenses increased $7.3 million, or 29.5%, to
$32.0 million for the quarter ended September 30, 1998, from $24.7 million in
1997. This increase is due primarily to the last three acquisitions which added
$8.7 million in 1998. These increases were partially offset by wage decreases at
remittance, travel and freight operations resulting from decreases in processing
volumes.
General and administrative expenses increased $3.9 million, or 30.4%,
to $16.8 million for the quarter ended September 30, 1998, from $12.9 million in
1997. This increase resulted principally from increases in information
technology expenses, including $1.0 million for Year 2000 and increases in sales
and support services related to the company's last three acquisitions.
Depreciation and amortization increased $2.5 million, or 60.2%, to $6.7
million for the quarter ended September 30, 1998, from $4.2 million in 1997. The
increase was primarily due to the amortization of intangibles and the
depreciation of fixed assets acquired in the last three acquisitions, which
contributed $1.9 million, and additions of fixed assets at the Company's core
businesses.
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Net Interest Income. The Company earned net interest of $.1 million in
the 1998 period compared to $1.2 million in 1997. This decrease resulted from
decreased investment balances reflecting the cash used for the 1997 and 1998
acquisitions.
Tax Provision. Income tax expense for the quarter ended September 30,
1998 was $2.1 million compared to $4.7 million in 1997. The decrease resulted
principally from the decrease in taxable income of $6.9 million to $5.4 million
for the quarter ended September 30, 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Revenues. Consolidated revenue increased $70.1 million, or 24.7%, to
$354.3 million for the nine month period ended September 30, 1998, from $284.2
million for the comparable 1997 period. The increase is primarily due to
revenues from the last five acquisitions which contributed $64.5 million.
Consolidated revenues from the core business group increased $5.6 million, or
2.0%. Core business increases resulted principally from increases in the
merchant card operations offset by decreases in the remittance and merchant
check operations.
Other Revenues. Other revenues in 1998 reflect a settlement for the
cancellation of a merchant card processing contract.
Costs and Expenses. Consolidated costs and expenses increased $78.1
million, or 29.5%, to $342.4 million for the nine month period ended September
30, 1998 from $264.3 million during the comparable 1997 period.
Operating expenses increased $40.2 million, or 29.4%, to $176.7 million
for the nine month period ended September 30, 1998 from $136.5 million in 1997.
The increase was primarily due to the last five acquisitions which contributed
$20.0 million in operating expenses. The Company's core businesses reflected
increases in operating expense of $20.2 million principally due to increased
volumes and expanded sales distribution channels, information technology and
customer services at the merchant card operations and increases at the
remittance operations due to $5.9 million for chargebacks and $2.4 million in
additional expenses due to delays in converting to its new imaging technology.
Additional increases resulted from the write-off of internally developed
software and related costs following the cancellation of a significant customer
contract at the freight operations. These increases were offset by decreases at
the merchant check operations.
Wages and other personnel expenses increased $25.9 million, or 36.7%,
to $95.6 million for the nine month period ended September 30, 1998, from $70.6
million in 1997. This increase is due primarily to the last five acquisitions
which added $27.3 million in 1998. These increases were partially offset by wage
decreases at the remittance and travel operations resulting from decreases in
processing volumes.
General and administrative expenses increased $10.7 million, or 27.7%,
to $49.3 million
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for the nine month period ended September 30, 1998, from $38.6 million in 1997.
This increase resulted principally from increases in information technology
including $3.0 million for Year 2000 compliance, $1.2 million of the total $2.6
million freight software write-off discussed above, and increases in sales and
support services related to the company's last three acquisitions.
Restructuring charges of $6.3 million in 1997 resulted from $5.1
million for severance pay and $1.2 million for other costs, related to
organizational restructuring.
Depreciation and amortization increased $7.6 million, or 62.6%, to
$19.8 million for the nine month period ended September 30, 1998, from $12.2
million in 1997. The increase was primarily due to the amortization of
intangibles and the depreciation of fixed assets acquired in the last five
acquisitions, which contributed $6.4 million, and additions of fixed assets at
the Company's core businesses.
Net Interest Income. The Company earned net interest of $0.6 million in
the 1998 period compared to $3.5 million in 1997. This decrease resulted from
decreased investment balances reflecting the cash used for the 1997 and 1998
acquisitions.
Tax Provision. Income tax expense for the nine month period ended
September 30, 1998 was $6.6 million compared to $8.2 million in 1997. The
decrease resulted from the decrease in taxable income of $6.9 million to $16.5
million. The 1997 effective tax rate was lower than the 1998 rate due to
non-taxable interest income from investments in 1997.
LINE OF BUSINESS REVIEW
The composition of the Company's statements of income by line of
business follows:
- ---------------------------------------------------------------------------------------------------------------------------
Merchant Travel Corporate
Services Services Services Corporate Consolidated
- ---------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30
- ---------------------------------------------------------------------------------------------------------------------------
(In thousands) 1998 1997 1998 1997 1998 1997 1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
Revenues $72,480 $57,210 $ 12,285 $11,586 $ 36,665 $31,984 $ -- $ -- $121,430 $100,780
Other Income 4,000 -- -- -- -- -- -- -- 4,000 --
Operating expenses 48,377 39,400 2,725 2,253 13,540 6,276 -- -- 64,642 47,929
Wages and other
personnel expenses 9,593 4,383 4,607 4,893 17,777 15,426 -- -- 31,977 24,702
General and
Administrative
expenses 8,138 5,996 1,603 1,802 7,019 5,058 -- -- 16,760 12,856
Depreciation and
amortization 3,121 1,940 795 585 2,802 1,669 -- -- 6,718 4,194
------- ------- -------- ------- -------- ------- ------ ------ -------- --------
Income (loss) from
operations 7,251 5,491 2,555 2,053 (4,473) 3,555 -- -- 5,333 11,099
Net interest income
(expense) 264 76 (80) 34 (68) 32 -- 1,072 116 1,214
------- ------- -------- ------- -------- ------- ------ ------ -------- --------
Income (loss)
before income taxes 7,515 5,567 2,475 2,087 (4,541) 3,587 -- 1,072 5,449 12,313
Provision for
(benefit from)
income taxes 2,750 2,349 801 823 (1,483) 1,367 -- 137 2,068 4,676
------- ------- -------- ------- -------- ------- ------ ------ -------- --------
Net income (loss) $ 4,765 $ 3,218 $ 1,674 $ 1,264 $ (3,058) $ 2,220 $ -- $ 935 $ 3,381 $ 7,637
------- ------- -------- ------- -------- ------- ------ ------ -------- --------
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- ----------------------------------------------------------------------------------------------------------------------------------
Merchant Travel Corporate
Services Services Services Corporate Consolidated
- ----------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30
(In thousands) 1998 1997 1998 1997 1998 1997 1998 1997 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Revenues $206,050 $162,605 $ 37,898 $34,270 $ 110,309 $87,294 $ -- $ -- $354,257 $284,169
Other Income 4,000 -- -- -- -- -- -- -- 4,000 --
Operating expenses 134,526 112,191 8,047 6,804 34,144 17,491 -- 57 176,717 136,543
Wages and other
personnel expenses 25,626 13,296 15,336 14,763 55,614 42,580 -- -- 96,576 70,639
General and
Administrative
expenses 23,760 19,259 5,119 5,176 20,429 14,190 -- -- 49,308 38,625
Restructuring charge -- -- -- -- -- -- -- 6,340 -- 6,340
Depreciation and
amortization 9,360 5,854 2,311 1,715 8,118 4,602 -- -- 19,789 12,171
-------- -------- -------- ------- ---------- ------- ------ -------- -------- --------
Income (loss) from
operations 16,778 12,005 7,085 5,812 (7,996) 8,431 -- (6,397) 15,867 19,851
Net interest income
(expense) 878 153 (196) 73 (93) 57 -- 3,244 589 3,527
-------- -------- -------- ------- ---------- ------- ------ -------- -------- --------
Income (loss)
before income taxes 17,656 12,158 6,889 5,885 (8,089) 8,488 -- (3,153) 16,456 23,378
Provision for
(benefit from)
income taxes 6,931 5,173 2,359 2,298 (2,695) 3,158 -- (2,415) 6,595 8,214
-------- -------- -------- ------- ---------- ------- ------ -------- -------- --------
Net income (loss) $ 10,725 $ 6,985 $ 4,530 $ 3,587 $ (5,394) $ 5,330 $ -- $ (738) $ 9,861 $ 15,164
======== ======== ======== ======= ========== ======= ====== ======== ======== ========
Indirect general and administrative expenses are allocated to the lines
of business based upon various methods determined by the nature of the expenses.
The Corporate entity reflects interest income and related expenses from the
proceeds of the Company's August 1996 initial public offering, a $6.3 million
non-recurring charge during the first quarter of 1997 for severance pay and
other costs related to organizational restructuring, and the related income tax
expenses.
The following is an analysis of the Company's income as derived from
its three lines of business, Merchant Services, Travel Services and Corporate
Services.
Merchant Services.
Merchant Services authorizes, processes and settles credit and debit
card transactions and authorizes and collects checks for a variety of merchants.
Historically, the Company has derived a substantial portion of its merchant card
revenues from larger merchants. The October 1997 acquisition of FA Holdings,
Inc., a debit and credit card processor specializing in smaller merchants
increased revenues from smaller merchants. In this competitive pricing
environment, the Company is continually negotiating customer contracts during
which it encounters both client gains and losses. The ability to successfully
renew and obtain merchant contracts is significant to preserving and growing
marginal profit.
Revenues for the three month period ended September 30, 1998 increased
by $15.3 million due to merchant card revenue increases of $12.0 million from
the FA Holdings acquisition and additional increases at core operations, offset
in part by lower merchant check revenues from the elimination of certain
unprofitable customers and re-pricing of some continuing customers. Other income
increased due to a $4.0 million ($2.4 million after tax) settlement for the
cancellation of a merchant card contract. This contract represented
approximately 2% of the 1998 merchant card revenues prior to the cancellation.
Higher expenses were driven by expanded sales distribution channels, information
technology and customer service enhancements.
Revenues for the nine month period ended September 30, 1998 increased
$43.4 million due to merchant card revenue increases of $32 million from the FA
Holdings acquisition and additional increases at core operations, partially
offset by lower merchant check revenues as discussed above.
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Travel Services.
Travel Services principally settles airline ticket purchases made
through travel agents on behalf of airlines and thus derives a substantial
portion of its revenues from an exclusive long-term contract with the Airlines
Reporting Corporation ("ARC"). The Company is compensated on a "cost plus" basis
under this contract which expires in December 2001.
Net income was $1.7 million and $4.5 million for the three month and
nine month periods ended September 30, 1998, compared to $1.3 million and $3.6
million for the comparable 1997 periods. The increases for both the three and
nine month periods resulted principally from the Company's January 1998
acquisition of JBH Travel Audit, Inc. Additional increases recorded at the core
travel operations were due to cost savings bonuses which exceeded decreases in
volumes and income from the ARC contract.
Corporate Services.
Corporate Services processes remittances, accounts payable and freight
bills and provides integrated document solutions involving electronic imaging,
archival, processing and payment settlement.
The three month period ended September 30, 1998 reflected a net loss of
$3.1 million compared to net income of $2.2 million for the comparable 1997
period. The decrease was primarily due to $4.3 million for chargebacks and
additional expenses related to the implementation of imaging technologies and
reduced revenues at the remittance operations.
The nine month period ended September 30, 1998 reflected a net loss of
$5.4 million compared to net income of $5.3 million for the comparable 1997
period. The decrease was primarily due to a $5.9 million reserve for chargebacks
and additional expenses related to the implementation of imaging technologies
and reduced revenues at the remittance operations. Additional decreases resulted
from a $2.6 million write-off of internally developed software and related costs
following the cancellation in June of a significant customer contract at the
freight operations. This contract represented approximately 10% of 1998 freight
revenues prior to the cancellation. It is anticipated that the higher costs and
other operating problems associated with the remittance operations will persist
through the fourth quarter of 1998, with the likely result that corporate
services will continue to incur losses.
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SEASONALITY
The Company experiences seasonality in its businesses, particularly in
its Merchant Services and Travel Services businesses. The Company typically
realizes higher revenues in the third and fourth calendar quarters and lower
revenues in the first calendar quarter, reflecting increased transaction volumes
and travel in the summer and holiday months and a decrease in transaction volume
during the quarter immediately following the holiday season.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary uses of capital includes acquisitions, capital
expenditures and working capital. Future business acquisitions may be funded
through current liquidity, borrowed funds, and/or issuances of common stock.
The Company's capital expenditures include amounts for computer systems
hardware and software, office furniture, and building expansion and remodeling.
During the three and nine month periods ended September 30, 1998, the Company's
capital expenditures totaled $14.1 million and $34.4 million respectively. Such
expenditures were principally financed from operating cash flow, which totaled
approximately $23.3 million and $67.5 million for the three and nine month
periods respectively. Operating cash flow during the three and nine month
periods ended September 30, 1997, totaled $20.0 million and $50.6 million and
capital expenditures were $4.5 million and $17.8 million. The Company expects
capital expenditures for the remainder of 1998 to be approximately $14 million.
It is anticipated that these expenditures will be funded with operating cash
flows.
As the Company does not carry significant amounts of inventory and
historically has experienced short collection periods for its accounts
receivable, it does not require substantial working capital to support its
revenue growth. Working capital requirements will vary depending upon future
acquisition activity. Increases in working capital needs are expected to be
financed through operating cash flow and current cash and investment balances.
The Company maintains restricted cash balances held on behalf of
clients pending distribution to vendors which are shown on the balance sheet as
assets and equivalent, offsetting liabilities. These cash balances totaled
approximately $99 million and $83 million as of September 30, 1998 and December
31, 1997, respectively.
RECENT DEVELOPMENTS
On October 28, 1998, the Board of Directors authorized management to
investigate potential strategic options for various product and business lines.
Such options could include restructuring, divestiture or liquidation of certain
lines.
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YEAR 2000
Management initiated the process of preparing its computer systems and
applications for the Year 2000 in February 1996. The process involves
identifying and remediating date recognition problems in computer systems and
software and other operating equipment that could be caused by the date change
from December 31, 1999 to January 1, 2000.
Management has completed its assessment of all business processes that
could be affected by the Year 2000 issue. Each business process assessment
included a review of the information systems used in that process, including
related hardware and software, the involvement of any third parties, and any
affected operating equipment. To date, approximately 70% of the work necessary
to complete the assessment, remediation and testing of those business processes
determined to be "mission critical" has been completed. As part of the testing
process, the Company established a separate isolated testing environment that
further tests the functioning of modified systems when linked together.
Management expects to complete the remediation and testing of all affected
systems within the critical business processes by the end of the second quarter
of 1999.
Management is also working with significant customers, vendors, and
business counterparties to monitor the progress of their Year 2000 efforts.
Despite those efforts, the ultimate effect on the Company of non-compliance by
these third parties is not determinable.
Management believes it has an effective plan in place to resolve the
Year 2000 issue in a timely manner, and, thus far, The Company's Year 2000
remediation activities have tracked in accordance with its plan. Management is
in the process of modifying its existing business continuity plans and is also
developing contingency plans to address potential risks in the event of Year
2000 failures, including non-compliance by third parties. Despite the Company's
efforts to date to remediate affected systems and develop contingency plans for
potential risks, management has not yet completed all activities associated with
resolving its Year 2000 issues. Under the unlikely scenario that the additional
phases are not completed, the Company could be materially adversely affected as
a result of not being able to process transactions related to its core business
activities. In addition, non-compliance by third parties and disruptions to the
economy in general resulting from Year 2000 issues could also have a material
negative impact of undeterminable magnitude on the Company.
The revised estimate of the total cost of the Year 2000 project is
approximately $8.5 million. The increase from the previous estimate of $5
million primarily relates to the increased use of contract labor and outside
consultants. To date, $4.0 million of the total project costs have been
incurred. During the third quarter and the first nine months of 1998,
incremental expense associated with the project totaled approximately $1.0
million and $3.0 million, respectively.
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FORWARD LOOKING STATEMENT
The sections entitled "Corporate Services" and "Year 2000" contain
certain forward-looking statements (as defined in the Private Securities
Litigation Reform Act of 1995). These forward-looking statements involve risks
and uncertainties, including changes in general economic conditions, the
Company's ability to execute its business plans, including its plan to address
the Year 2000 issue, the ability of third parties to effectively address their
Year 2000 issues, and its ability to timely resolve the operating issues in
corporate services. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, actual results may
differ materially.
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PART II - OTHER INFORMATION
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K:
A. EXHIBITS
27.1 Financial Data Schedule.
B. REPORTS ON FORM 8-K
July 7, 1998: On July 7, 1998, National Processing, Inc. announced
that earnings were expected to fall below the July 1, 1998 consensus
estimate of $.45 per share for the full year 1998 by as much as $.05
per share.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL PROCESSING, INC.
Date: November 13, 1998 By:
Jim W. Cate
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
By:
Danny L. McDaniel
Vice President and Controller
(Principal Accounting Officer)
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