UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: March 31, 2006
----------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from To
____________________________________________
Commission file number 1-10254
____________________________________________
[TSYS LOGO OMITTED]
Total System Services, Inc.
www.tsys.com
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(Exact name of registrant as specified in its charter)
Georgia 58-1493818
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
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(Address of principal executive offices) (Zip Code)
(706) 649-2262
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OUTSTANDING AS OF: May 8, 2006
---------------------------------------- ------------------------------
Common Stock, $0.10 par value 197,433,706 shares
[TSYS LOGO OMITTED]
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited)
- March 31, 2006 and December 31, 2005 3
Condensed Consolidated Statements of Income
(unaudited) - Three months ended
March 31, 2006 and 2005 5
Condensed Consolidated Statements of Cash Flows
(unaudited) - Three months ended
March 31, 2006 and 2005 6
Notes to Unaudited Condensed Consolidated
Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 45
Item 4. Controls and Procedures 47
Part II. Other Information
Item 1A. Risk Factors 48
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 48
Item 6. Exhibits 49
Signatures 50
Exhibit Index 51
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Condensed Consolidated Balance Sheets
(Unaudited)
---------------------------------------------------------------------------------------------------------------------------------
March 31, December 31,
(in thousands, except per share information) 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $146.7 million and $152.6 million on
deposit with a related party at 2006 and 2005, respectively) $ 242,857 237,569
Restricted cash (includes $5.4 million and $4.1 million on deposit with a
related party at 2006 and 2005, respectively) 31,596 29,688
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $11.4 million and $12.6 million at 2006 and 2005,
respectively (includes $0.1 million and $0.1 million due from a related
party at 2006 and 2005, respectively) 206,619 184,532
Deferred income tax assets 20,305 15,264
Prepaid expenses and other current assets 43,816 45,236
--------------------------------------------
Total current assets 545,193 512,289
Property and equipment, net of accumulated depreciation and amortization of
$195.1 million and $188.1 million at 2006 and 2005, respectively 263,646 267,979
Computer software, net of accumulated amortization of $336.7 million and $317.1
million at 2006 and 2005, respectively 253,852 267,988
Contract acquisition costs, net 162,129 163,861
Goodwill, net 106,388 112,865
Equity investments 43,865 42,731
Other intangible assets, net of accumulated amortization of $6.2 million and
$5.4 million at 2006 and 2005, respectively 12,721 13,580
Other assets 27,075 29,604
--------------------------------------------
Total assets $ 1,414,869 1,410,897
============================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Balance Sheets (continued)
(Unaudited)
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March 31, December 31,
(in thousands, except per share information) 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable (includes $0.2 million and $0.1 million payable to related
parties at 2006 and 2005, respectively) $ 37,904 29,464
Accrued salaries and employee benefits 39,465 84,348
Current portion of obligations under capital leases and software obligations 2,208 2,078
Other current liabilities (includes $9.6 million and $9.9 million payable to
related parties at 2006 and 2005, respectively) 164,466 161,122
--------------------------------------------
Total current liabilities 244,043 277,012
Obligations under capital leases and software obligations, excluding current
portion 3,028 3,555
Deferred income tax liabilities 86,865 89,478
Other long-term liabilities 23,192 24,398
--------------------------------------------
Total liabilities 357,128 394,443
--------------------------------------------
Minority interests in consolidated subsidiaries 3,743 3,682
--------------------------------------------
Shareholders' equity:
Common stock - $0.10 par value. Authorized 600,000 shares; 198,126 and
197,975 issued at 2006 and 2005, respectively; 197,434 and 197,283
outstanding at 2006 and 2005, respectively 19,813 19,797
Additional paid-in capital 52,917 50,666
Accumulated other comprehensive income 6,097 5,685
Treasury stock (692 shares at 2006 and 2005) (12,841) (12,841)
Retained earnings 988,012 949,465
--------------------------------------------
Total shareholders' equity 1,053,998 1,012,772
--------------------------------------------
Total liabilities and shareholders' equity $ 1,414,869 1,410,897
============================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Income
(Unaudited)
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Three months ended
March 31,
-------------------------------------
(in thousands, except per share information) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $1.3 million and
$1.2 million from related parties for 2006 and 2005, respectively) $ 221,061 204,757
Merchant services (includes $2.4 million from related parties for 2005) 63,949 27,105
Other services (includes $1.6 million and $1.5 million from related parties
for 2006 and 2005, respectively) 44,542 48,514
-------------------------------------
Revenues before reimbursable items 329,552 280,376
Reimbursable items (includes $0.4 million and $1.8 million from related
parties for 2006 and 2005, respectively) 82,738 69,608
-------------------------------------
Total revenues 412,290 349,984
-------------------------------------
Expenses:
Salaries and other personnel expense 119,966 96,978
Net occupancy and equipment expense 75,350 66,069
Other operating expenses (includes $2.6 million and $2.0 million to
related parties for 2006 and 2005, respectively) 62,379 51,023
-------------------------------------
Expenses before reimbursable items 257,695 214,070
Reimbursable items 82,738 69,608
-------------------------------------
Total expenses 340,433 283,678
-------------------------------------
Operating income 71,857 66,306
-------------------------------------
Nonoperating income (expense):
Interest income (includes $1.4 million and $511 from related parties
for 2006 and 2005, respectively) 2,508 1,219
Interest expense (44) (70)
Gain (loss) on foreign currency, net 276 (333)
-------------------------------------
Total nonoperating income 2,740 816
-------------------------------------
Income before income taxes, minority interest and equity in income of
equity investments 74,597 67,122
Income taxes 24,965 24,680
Minority interests in consolidated subsidiaries' net income (91) (69)
Equity in income of equity investments 852 3,750
-------------------------------------
Net income $ 50,393 46,123
=====================================
Basic earnings per share $ 0.26 0.23
=====================================
Diluted earnings per share $ 0.26 0.23
=====================================
Weighted average common shares outstanding 197,086 197,023
Increase due to assumed issuance of shares related to common equivalent
shares 240 210
-------------------------------------
Weighted average common and common equivalent shares outstanding 197,326 197,233
=====================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
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Three months ended
March 31,
------------------------------------------
(in thousands) 2006 2005
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Cash flows from operating activities:
Net income $ 50,393 46,123
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Minority interests in consolidated subsidiaries' net income 91 69
(Gain) loss on foreign currency, net (276) 333
Equity in income of equity investments (852) (3,750)
Depreciation and amortization 43,161 32,461
Share-based compensation 2,267 278
Impairment of developed software - 3,137
Provisions for bad debt expenses and billing adjustments 567 679
Charges for transaction processing provisions 4,161 3,109
Deferred income tax (benefit) expense (5,069) 10,566
Loss on disposal of equipment, net 92 323
(Increase) decrease in:
Accounts receivable (22,684) (15,398)
Prepaid expenses and other assets 4,405 2,932
Increase (decrease) in:
Accounts payable 8,718 (53,610)
Accrued salaries and employee benefits (44,884) (32,546)
Other liabilities (1,705) (39,241)
------------------------------------------
Net cash provided by (used in) operating activities $ 38,385 (44,535)
------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment, net (5,786) (10,702)
Additions to licensed computer software from vendors (1,776) (3,694)
Additions to internally developed computer software (3,773) (2,884)
Cash acquired in acquisitions - 38,799
Cash used in acquisitions - (95,782)
Contract acquisition costs (9,554) (5,442)
------------------------------------------
Net cash used in investing activities $ (20,889) (79,705)
------------------------------------------
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Cash Flows (continued)
(Unaudited)
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Three months ended
March 31,
------------------------------------------
(in thousands) 2006 2005
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Cash flows from financing activities:
Dividends paid on common stock (includes $9.8 million and $6.4 million paid
to related parties during 2006 and 2005, respectively) $ (11,837) (7,874)
Principal payments on long-term debt borrowings and capital lease
obligations (402) (13,704)
Proceeds from borrowings of long-term debt - 14,125
------------------------------------------
Net cash used in financing activities (12,239) (7,453)
------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 31 (2,197)
------------------------------------------
Net increase (decrease) in cash and cash equivalents $ 5,288 (133,890)
Cash and cash equivalents at beginning of year 237,569 231,806
------------------------------------------
Cash and cash equivalents at end of period $ 242,857 97,916
==========================================
Cash paid for interest $ 44 70
==========================================
Cash paid for income taxes, net of refunds $ 13,604 21,359
==========================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 7 -
TOTAL SYSTEM SERVICES, INC.
Notes to Unaudited Condensed Consolidated Financial Statements
Note 1 - Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
Total System Services, Inc.[registered trademark] (TSYS [registered trademark]
or the Company) include the accounts of TSYS and its wholly owned subsidiaries,
Columbus Depot Equipment Company [service mark] (CDEC [service mark]), Columbus
Productions, Inc. [service mark] (CPI), TSYS Canada, Inc. [service mark] (TSYS
Canada), TSYS Total Debt Management, Inc. (TDM), ProCard, Inc. (ProCard), TSYS
Japan Co., Ltd. (TSYS Japan), Enhancement Services Corporation (ESC) and its
wholly owned subsidiary, TSYS Technology Center, Inc. (TTC), TSYS Prepaid, Inc.
(TPI), Merlin Solutions, L.L.C. (Merlin), TSYS Acquiring Solutions, L.L.C. (TSYS
Acquiring), formerly named Vital Processing Services, L.L.C., and its wholly
owned subsidiary, and TSYS Servicos De Transacoes Eletronicas Ltda. (TSYS
Brazil); and TSYS' majority owned foreign subsidiary, GP Network Corporation (GP
Net). All significant intercompany accounts and transactions have been
eliminated in consolidation. In addition, the Company evaluates its relationship
with other entities to identify whether they are variable interest entities as
defined by the Financial Accounting Standards Board's (FASB's) Interpretation
No. 46(R) (FIN No. 46R), "Consolidation of Variable Interest Entities," and to
assess whether it is the primary beneficiary of such entities. If the
determination is made that the Company is the primary beneficiary, then that
entity is included in the consolidated financial statements in accordance with
FIN No. 46R.
These financial statements have been prepared in accordance with the
instructions to Form 10-Q and do not include all information and footnotes
necessary for a fair presentation of financial position, results of operations
and cash flows in conformity with accounting principles generally accepted in
the United States of America. The preparation of the consolidated financial
statements requires management of the Company to make a number of estimates and
assumptions relating to the reported amounts of assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues and expenses during the period. These estimates and assumptions are
developed based upon all information available. Actual results could differ from
estimated amounts. All adjustments, consisting of normal recurring accruals,
which, in the opinion of management, are necessary for a fair presentation of
financial position and results of operations for the periods covered by this
report have been included.
The accompanying unaudited condensed consolidated financial statements
should be read in conjunction with the Company's summary of significant
accounting policies, consolidated financial statements and related notes
appearing in the Company's 2005 annual report previously filed on Form 10-K.
Results of interim periods are not necessarily indicative of results to be
expected for the year.
Certain reclassifications have been made to the 2005 financial statements
to conform to the presentation adopted in 2006.
Note 2 - Supplementary Balance Sheet Information
Cash and Cash Equivalents
Cash and cash equivalent balances are summarized as follows:
- 8 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(in thousands) March 31, 2006 December 31, 2005
---------------------------------------------------------------------------------------------- ---------------------------
Cash and cash equivalents in domestic accounts $ 202,349 191,837
Cash and cash equivalents in foreign accounts 40,508 45,732
---------------------- ---------------------------
Total $ 242,857 237,569
====================== ===========================
The Company maintains accounts outside the United States denominated in
U.S. dollars, Euros, British Pounds Sterling (BPS), Canadian dollars and
Japanese Yen. All amounts in domestic accounts are denominated in U.S. dollars.
Prepaid Expenses and Other Current Assets
Significant components of prepaid expenses and other current assets are
summarized as follows:
(in thousands) March 31, 2006 December 31, 2005
--------------------------------------------------------------------------------------------- --------------------------
Prepaid expenses $ 13,977 15,053
Supplies inventory 6,784 9,742
Other 23,055 20,441
----------------------- --------------------------
Total $ 43,816 45,236
======================= ==========================
Contract Acquisition Costs, net
Significant components of contract acquisition costs, net of accumulated
amortization, are summarized as follows:
(in thousands) March 31, 2006 December 31, 2005
--------------------------------------------------------------------------------------------- --------------------------
Payments for processing rights, net $ 114,233 120,015
Conversion costs, net 47,896 43,846
----------------------- --------------------------
Total $ 162,129 163,861
======================= ==========================
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $6.6 million and $3.5 million for the three
months ended March 31, 2006 and 2005, respectively.
Amortization expense related to conversion costs was $4.9 million and $3.4
million for the three months ended March 31, 2006 and 2005, respectively.
The increase in the amortization of contract acquisition costs is the
result of the acceleration of amortization costs related to client's portfolios
scheduled to deconvert in 2006 and the consolidation of the financial results of
TSYS Acquiring.
Other Current Liabilities
Significant components of other current liabilities are summarized as
follows:
- 9 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(in thousands) March 31, 2006 December 31, 2005
------------------------------------------------------------------------------------------- ----------------------------
Client liabilities $ 36,162 34,381
Accrued income taxes 33,360 25,443
Accrued expenses 32,817 39,882
Transaction processing provisions 13,214 9,453
Dividends payable 11,841 11,832
Deferred revenues 7,789 6,421
Client postage deposits 6,255 7,459
Other 23,028 26,251
--------------------- ----------------------------
Total $ 164,466 161,122
===================== ============================
Note 3 - Comprehensive Income
Comprehensive income for TSYS consists of net income and foreign currency
translation adjustments recorded as a component of shareholders' equity.
Comprehensive income for the three months ended March 31 is as follows:
(in thousands) 2006 2005
-------------------------------------------------------------------------------------------------------- -------------------
Net income $ 50,393 46,123
Other comprehensive income (loss):
Foreign currency translation
adjustments, net of tax 412 (2,423)
----------------- -------------------
Total $ 50,805 43,700
================= ===================
The income tax effects allocated to and the cumulative balance of
accumulated other comprehensive income are as follows:
Balance at Pretax Tax Balance at
(in thousands) December 31, 2005 amount effect March 31, 2006
------------------------------------------------------------------------------------------------------------------------------------
Foreign currency translation adjustments $5,685 678 (266) $6,097
====================================================
Note 4 - Segment Reporting and Major Customers
The Company reports selected information about operating segments in
accordance with Statement of Financial Accounting Standards No. 131 (SFAS No.
131), "Disclosures about Segments of an Enterprise and Related Information." The
Company's segment information reflects the information that the chief operating
decision maker (CODM) uses to make resource allocations and strategic decisions.
The CODM at TSYS consists of the chairman of the board and chief executive
officer, the president and the three senior executive vice presidents.
Effective January 1, 2006, Golden Retriever Systems L.L.C. became a wholly
owned subsidiary of ESC. Also effective January 1, 2006, Merlin Solutions,
L.L.C. became a wholly owned subsidiary of TSYS. Both entities were previously
wholly owned subsidiaries of TSYS Acquiring and were reported under the merchant
processing services segment. Effective January 1, 2006, the financial results of
the
- 10 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
two entities are included in the domestic-based support services segment. The
results for previous periods have been reclassified to reflect the change.
On March 1, 2005, TSYS acquired the remaining 50% equity stake that Visa
U.S.A. held in TSYS Acquiring. As a result of the acquisition, the Company
revised its segment information to reflect the information that the CODM uses to
make resource allocations and strategic decisions. The revision included adding
a new segment, merchant processing services, to include the financial
information of TSYS Acquiring.
Through online accounting and electronic payment processing systems, TSYS
provides electronic payment processing and other services to card-issuing
institutions in the United States, Mexico, Canada, Honduras, Europe and Puerto
Rico. The Company has three reportable segments: domestic-based support
services, international-based support services and merchant processing services.
Domestic-based support services include electronic payment processing services
and other services provided from the United States. Domestic-based support
services segment includes the financial results of TSYS, excluding its foreign
branch offices, and including the following subsidiaries: CDEC, CPI, TSYS
Canada, TDM, ProCard, ESC and its wholly owned subsidiary, TTC, TPI and Merlin.
International-based support services include electronic payment processing
and other services provided outside the United States. International-based
support services include the financial results of GP Net, TSYS Japan, TSYS
Brazil and TSYS' branch offices in Europe, Japan and China. TSYS' share of the
equity earnings of its equity investments, Total System Services de Mexico, S.A.
de C.V. (TSYS de Mexico) and China UnionPay Data Co., Ltd. (CUP Data), are
included in international-based support services because TSYS de Mexico's and
CUP Data's operations and client bases are located outside the United States.
Merchant processing services include the financial results of TSYS
Acquiring. For periods prior to the acquisition, TSYS has reclassified TSYS'
share of its equity earnings of TSYS Acquiring from domestic-based support
services to merchant processing services.
Domestic- International-
based based Merchant
(in thousands) support support processing
Operating Segments services services services Consolidated
------------------------------------------------------------------------------------------------------------------------------------
At March 31, 2006
------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,323,429 171,529 230,649 $ 1,725,607
Intersegment eliminations (310,706) (22) (10) (310,738)
------------ ---------- ----------- ------------
Total assets $ 1,012,723 171,507 230,639 $ 1,414,869
============ ========== =========== ============
------------------------------------------------------------------------------------------------------------------------------------
At December 31, 2005
------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,320,552 178,135 230,712 $ 1,729,399
Intersegment eliminations (318,475) (1) (26) (318,502)
------------ ---------- ----------- ------------
Total assets $ 1,002,077 178,134 230,686 $ 1,410,897
============ ========== =========== ============
------------------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2006
------------------------------------------------------------------------------------------------------------------------------------
Revenues before reimbursables $ 244,443 30,713 58,862 $ 334,018
Intersegment revenues (4,434) - (32) (4,466)
------------ ---------- ----------- ------------
Revenues before reimbursables from external customers $ 240,009 30,713 58,830 $ 329,552
============ ========== =========== ============
Segment total revenues $ 312,830 36,246 70,332 $ 419,408
- 11 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Domestic- International-
based based Merchant
(in thousands) support support processing
Operating Segments services services services Consolidated
------------------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2006
------------------------------------------------------------------------------------------------------------------------------------
Intersegment revenues $ (7,086) - (32) $ (7,118)
----------- ------------ ----------- ------------
Revenues from external customers $ 305,744 36,246 70,300 $ 412,290
=========== ============ =========== ============
Depreciation and amortization $ 31,910 3,978 7,273 $ 43,161
=========== ============ =========== ============
Intersegment expenses $ 8,690 (7,575) (8,219) $ (7,104)
=========== ============ =========== ============
Segment operating income $ 60,966 879 10,012 $ 71,857
=========== ============ =========== ============
Income before income taxes, minority interest and equity income of equity
investments $ 63,479 728 10,390 $ 74,597
=========== ============ =========== ============
Income tax expense $ 20,471 567 3,927 $ 24,965
=========== ============ =========== ============
Equity in income of equity investments $ - 852 - $ 852
=========== ============ =========== ============
Net income $ 42,819 1,111 6,463 $ 50,393
=========== ============ =========== ============
------------------------------------------------------------------------------------------------------------------------------------
Three months ended March 31, 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues before reimbursables $ 230,012 30,847 20,798 $ 281,657
Intersegment revenues (1,281) - - (1,281)
----------- ------------ ----------- ------------
Revenues before reimbursables from external customers $ 228,731 30,847 20,798 $ 280,376
=========== ============ =========== ============
Segment total revenues $ 291,017 36,614 24,335 $ 351,966
Intersegment revenues (1,982) - - (1,982)
----------- ------------ ----------- ------------
Revenues from external customers $ 289,035 36,614 24,335 $ 349,984
=========== ============ =========== ============
Depreciation and amortization $ 27,215 3,768 1,478 $ 32,461
=========== ============ =========== ============
Intersegment expenses $ 8,525 (8,155) (2,353) $ (1,983)
=========== ============ =========== ============
Segment operating income $ 60,492 2,841 2,973 $ 66,306
=========== ============ =========== ============
Income before income taxes, minority interest and equity income of equity
investments $ 61,597 2,492 3,033 $ 67,122
=========== ============ =========== ============
Income tax expense $ 20,726 1,639 2,315 $ 24,680
=========== ============ =========== ============
Equity in income of equity investments $ - 509 3,241 $ 3,750
=========== ============ =========== ============
Net income $ 40,406 1,756 3,961 $ 46,123
=========== ============ =========== ============
Revenues for domestic-based support services and merchant processing
services include electronic payment processing and other services provided from
the United States to clients domiciled in the United States or other countries.
Revenues for international-based support services include electronic payment
processing and other services provided from facilities outside the United States
to clients based predominantly outside the United States.
The following geographic area data represent revenues for the three months
ended March 31, 2006 and 2005, respectively, based on the domicile of customers.
- 12 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Three months ended March 31,
------------------------------------------------------------------------------------------------------------------------------------
(in millions) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
United States $ 349.8 290.0
Europe 32.5 33.0
Canada 22.1 21.0
Japan 3.9 3.7
Mexico 2.5 1.7
Other 1.5 0.6
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 412.3 350.0
====================================================
The following table reconciles geographic revenues to revenues by reporting
segment for the three months ended March 31, 2006 and 2005, respectively, based
on the domicile of customers.
----------------------------------------------------
Domestic- International-
based based Merchant
support support processing
services services services
------------------------------------------------------------------------------------------------------------------------------------
(in millions) 2006 2005 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
United States $ 279.8 265.7 - - 70.0 24.2
Europe 0.1 0.1 32.4 33.0 - -
Canada 22.0 21.0 - - 0.1 -
Japan - - 3.9 3.7 - -
Mexico 2.5 1.7 - - - -
Other 1.3 0.5 - - 0.2 0.1
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 305.7 289.0 36.3 36.7 70.3 24.3
====================================================
Note: Geographic revenues by operating segment have been reclassified in
2005 to reflect the changes in operating segments.
The Company maintains property and equipment, net of accumulated
depreciation and amortization, in the following geographic areas:
At March 31, At December 31,
(in millions) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
United States $ 207.8 211.2
Europe 54.3 55.3
Japan 1.3 1.4
Canada 0.1 0.1
Other 0.1 -
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 263.6 268.0
====================================================
Major Customers
For the three months ended March 31, 2006, the Company had two major
customers which accounted for approximately 34.2%, or $141.0 million, of total
revenues. Bank of America, one of TSYS' major customers, accounted for
approximately 23.4%, or $96.3 million of total revenues for the three months
ended March 31, 2006. For the three months ended March 31, 2005, the Company had
one major customer that accounted for 20.6%, or $72.2 million, of total
revenues.
- 13 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Revenues from major customers for the periods reported are attributable to
the domestic-based support services and merchant processing services segments.
Note 5 - Share-Based Compensation
Accounting Policy
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised) (SFAS No. 123R), "Share-Based Payment." SFAS
No. 123R establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. This Statement
requires a public entity to measure the cost of employee services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award (with limited exceptions). That cost will be recognized over the
period during which an employee is required to provide service in exchange for
the award.
SFAS No. 123R is effective for all awards granted on or after January 1,
2006, and to awards modified, repurchased or cancelled after that date. SFAS No.
123R requires the Company to recognize compensation costs for the nonvested
portion of outstanding share-based compensation granted in the form of stock
options based on the grant-date fair value of those awards calculated under
Statement of Financial Accounting Standards No. 123 (SFAS No. 123), "Accounting
for Stock-Based Compensation," for pro forma disclosures. Share-based
compensation expenses include the impact of expensing the fair value of stock
options in 2006, as well as expenses associated with nonvested shares. In the
future, the Company expects nonvested share awards to replace stock options as
TSYS' primary method of share-based compensation. TSYS adopted the provisions of
SFAS No. 123R effective January 1, 2006 using the
modified-prospective-transition method.
Prior to 2006, the Company applied the intrinsic-value based method of
accounting prescribed by Accounting Principles Board APB) Opinion No. 25 (APB
25), "Accounting for Stock Issued to Employees," and related interpretations,
including FASB Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation, an Interpretation of APB Opinion No. 25," to
account for its fixed-plan stock options. Under this method, compensation
expense was recorded only if, on the date of grant, the market price of the
underlying stock exceeded the exercise price. The Company elected to adopt only
the disclosure requirements of SFAS No. 123.
The following table illustrates the effect on net income and earnings per
share for the three months ended March 31, 2005 if the Company had applied the
fair value recognition provisions of SFAS No. 123, to share-based employee
compensation granted in the form of TSYS and Synovus Financial Corp. (Synovus)
stock options.
- 14 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(in thousands, except per share data) March 31, 2005
------------------------------------------------------------------------------------------------------------------------------------
Net Income $ 46,123
Add: Stock-based employee compensation expense, net of related income tax
effects 180
Deduct: Stock-based employee compensation expense determined under the
fair value based method for all awards, net of related income tax effects (1,576)
---------------------
Net income, as adjusted $ 44,727
=====================
Earnings per share:
Basic - as reported $ 0.23
=====================
Basic - as adjusted $ 0.23
=====================
Diluted - as reported $ 0.23
=====================
Diluted - as adjusted $ 0.23
=====================
Prior to the adoption of SFAS No. 123R, the Company elected to recognize
compensation cost assuming all options would vest and reverse any recognized
compensation costs for forfeited awards when the awards are actually forfeited.
SFAS No. 123R eliminates this option and requires companies to estimate
forfeitures when recognizing compensation cost. The estimate of forfeitures will
be adjusted by a company as actual forfeitures differ from its estimates,
resulting in compensation cost only for those awards that actually vest. The
effect of the change in estimated forfeitures is recognized as compensation
costs in the period of the change in estimate. In estimating its forfeiture
rate, the Company stratified its data based upon historical experience to
determine separate forfeiture rates for the different award grants. The Company
currently estimates a 7.5% forfeiture rate for existing Synovus stock option
grants to TSYS non-executive employees, and a 0.0% forfeiture rate for all other
TSYS and Synovus share-based awards.
General Description of Share-Based Compensation Plans
TSYS has various long-term incentive plans under which the Compensation
Committee of the Board of Directors has the authority to grant share-based
compensation to TSYS employees. Long-term performance awards can be granted to
TSYS employees under the TSYS Long-Term Incentive Plans as well as the Synovus
Long-Term Incentive Plans.
Vesting for stock options granted during 2006 accelerates upon retirement
for plan participants who have reached age 62 and who also have no less than
fifteen years of service at the date of their election to retire. For stock
options granted in 2006, share-based compensation expense is fully recognized
for plan participants upon meeting the retirement eligibility requirements of
age and service.
Stock options granted prior to 2006 generally become exercisable at the end
of a two to three-year period and expire ten years from the date of grant.
Vesting for stock options granted prior to 2006 accelerates upon retirement for
plan participants who have reached age 50 and who also have no less than fifteen
years of service at the date of their election to retire. Prior to adoption of
SFAS No. 123R on January 1, 2006, share-based compensation expense was
recognized in the pro forma disclosure over the nominal vesting period without
consideration for retirement eligibility. Following adoption of SFAS No.
- 15 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
123R, stock-based compensation expense is recognized in income over the
remaining nominal vesting period with consideration for retirement eligibility.
The Company historically issues new shares or uses treasury shares to
satisfy share option exercises. On April 20, 2006, TSYS announced that its board
had approved a stock repurchase plan to purchase up to 2 million shares. The
shares will be purchased from time to time over a two year period and purchases
will depend on various factors including price, market conditions, acquisitions
and the general financial position of TSYS. Repurchased shares will be used for
general corporate purposes, including, but not limited to, fulfilling stock
option exercises and the granting of nonvested shares.
Long-Term Incentive Plans - TSYS
TSYS 2002 Long-Term Incentive Plan: TSYS' compensation program includes
long-term performance awards under the Total System Services, Inc. 2002
Long-Term Incentive Plan (TSYS 2002 Plan), which is used to attract, retain,
motivate and reward employees and non-employee directors who make a significant
contribution to the Company's long-term success. The TSYS 2002 Plan is
administered by the Compensation Committee of the Company's Board of Directors
and enables the Company to grant stock options, stock appreciation rights,
restricted stock and performance awards; 9.4 million shares of TSYS common stock
are reserved for distribution under the TSYS 2002 Plan. Options granted under
the TSYS 2002 Plan may be incentive stock options or nonqualified stock options
as determined by the Committee at the time of grant.
Incentive stock options are granted at a price not less than 100% of the
fair market value of the stock on the grant date, and nonqualified options are
granted at a price to be determined by the Committee. Option vesting terms are
established by the Committee at the time of grant and presently range from one
to five years.
The expiration date of options granted under the TSYS 2002 Plan is
determined at the time of grant and may not exceed ten years from the date of
the grant. At March 31, 2006, there were options outstanding under the TSYS 2002
Plan to purchase 348,671 shares of the Company's common stock, of which 326,171
were exercisable. The Company has issued its common stock to directors and to
certain employees under nonvested stock awards. There were 8.5 million shares
available for grant at December 31, 2005 under the TSYS 2002 plan.
2000 Long-Term Incentive Plan: TSYS maintains a 2000 Long-Term Incentive Plan
(LTI Plan) to attract, retain, motivate and reward employees who make a
significant contribution to the Company's long-term success and to enable such
employees to acquire and maintain an equity interest in the Company. The LTI
Plan is administered by the Compensation Committee of the Company's Board of
Directors and enables the Company to grant stock options, stock appreciation
rights, restricted stock and performance awards; 3.2 million shares of common
stock were reserved for distribution under the LTI Plan. Options granted under
the LTI Plan may be incentive stock options or nonqualified stock options as
determined by the Committee at the time of grant.
Incentive stock options are granted at a price not less than 100% of the
fair market value of the stock on the grant date, and nonqualified options are
granted at a price to be determined by the Committee. Option vesting terms are
established by the Committee at the time of grant and presently range from one
to five years. The expiration date of options granted under the LTI Plan is
determined at
- 16 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
the time of grant and may not exceed ten years from the date of the grant. At
March 31, 2006, there were options outstanding under the LTI Plan to purchase
989,700 shares of the Company's common stock, all of which were exercisable.
There were no shares available for grant at March 31, 2006 under the LTI
Plan.
Other Share-Based Issuances: TSYS has granted options to purchase 37,500 shares
of the Company's common stock to attract a key individual to the Company. At
December 31, 2005, options to purchase 37,500 shares with a weighted average
price of $18.50 were outstanding and exercisable.
Share-Based Compensation
TSYS' share-based compensation costs are included as expenses and
classified as salaries and other personnel expenses. For the three months ended
March 31, 2006, share-based compensation was $2.3 million, compared to $0.3
million for the same period in 2005. Included in the $2.3 million amount for
2006 is approximately $1.8 million related to expensing the fair value of stock
options.
Nonvested Awards: During the first three months of 2006, the Company issued
150,775 shares of TSYS common stock with a market value of $3.0 million to
certain key executive officers and non-management members of its board of
directors under nonvested stock bonus awards for services to be provided by such
officers and directors in the future. The market value of the common stock at
the date of issuance is amortized as compensation expense over the vesting
period of the awards.
During the first three months of 2005, the Company issued 95,815 shares of
TSYS common stock with a market value of $2.2 million to certain key executive
officers and non-management members of its board of directors under nonvested
stock bonus awards for services to be provided by such officers and directors in
the future.
A summary of the status of TSYS' nonvested shares as of March 31, 2006 and
changes during the three months ended March 31, 2006 is presented below:
(in thousands) Weighted Average
Nonvested shares: Shares Grant-Date Fair Value
------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 101 $ 23.11
Granted 151 19.64
Vested (12) 23.00
Forfeited/Canceled - -
------------------------------------------------------------------------------------------------------------------------------------
Outstanding at end of period 240 $ 20.93
====================================================
As of March 31, 2006, there was approximately $4.4 million of total
unrecognized compensation cost related to nonvested share-based compensation
arrangements. That cost is expected to be recognized over a weighted average
period of 2.9 years.
During 2005, TSYS granted 126,087 shares of nonvested stock to two key
executives with a performance-vesting schedule (performance-vesting shares).
These performance-vesting shares have seven one-year performance periods
(2005-2011) during which the Compensation Committee establishes an earnings per
share goal. Compensation expense for each year's award is measured on the
- 17 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
grant date based on the quoted market price of TSYS common stock and is expensed
on a straight-line basis for the year.
A summary of the status of TSYS' performance-based nonvested shares as of
March 31, 2006 and changes during the three months ended March 31, 2006 is
presented below:
(in thousands)
Performance-based Weighted Average
Nonvested shares: Shares Grant-Date Fair Value
------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 126 $ 23.00
Granted - -
Vested (25) 23.00
Forfeited/Canceled - -
----------------------------------------------------
Outstanding at end of period 101 $ 23.00
====================================================
As of March 31, 2006, there was approximately $2.2 million of total
unrecognized compensation cost related to nonvested share-based compensation
arrangements. That cost is expected to be recognized over a weighted average
period of 3.8 years.
Stock Option Awards
The Company did not grant any TSYS stock options during the three months
ended March 31, 2006 and 2005, respectively. A summary of the TSYS stock option
activity as of March 31, 2006 and changes during the three months ended on March
31, 2006 is presented below:
Weighted
Average
Remaining
Weighted Contractual Aggregate
(in thousands) Average Exercise Life Intrinsic
Options: Options Price (in years) Value
------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 1,382 $ 15.19
Granted - -
Exercised - -
Forfeited/Canceled (6) 20.10
-----------------------------------------------------------------------------------------------------------
Outstanding at end of period 1,376 $ 15.17 2.8 $13,522
--------------------------------------------------------------------------------====================================================
Options exercisable at period-end 1,353 $ 14.96 2.7 $13,091
--------------------------------------------------------------------------------====================================================
Weighted average fair value of options granted during the period $ -
-------------------------------------------------------------------------------- ============
There were no TSYS stock options that were exercised during the three
months ended March 31, 2006 and 2005, respectively. As a result, the Company did
not realize any tax benefits from stock option exercises. In the future, if the
Company does realize any tax benefits from the exercise of stock options, TSYS
will record the tax benefits as increases to the "Additional paid-in capital"
line item of the Consolidated Balance Sheets. The company will record any tax
benefits from share-based compensation costs as cash inflows in the financing
section in the Statement of Cash Flows. The Company has elected
- 18 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
to use the short-cut method to calculate its historical pool of windfall tax
benefits, and as a result, will not record any benefits received from previous
stock option exercises in the operating section in the Statement of Cash Flows.
As of March 31, 2006, there was approximately $138,000 of total
unrecognized compensation expense cost related to TSYS stock options that is
expected to be recognized over a weighted average period of 1.0 year.
Long-Term Incentive Plans - Synovus
During the first three months of 2006, Synovus granted stock options to key
TSYS executive officers. The fair value of the option grant was estimated on the
date of grant using the Black-Scholes-Merton option-pricing model with the
following weighted average assumptions: risk-free interest rate of 4.48%;
expected volatility of 25.1%; expected life of 6.0 years; and dividend yield of
2.80%. The expected life of 6.0 years was determined using the "simplified"
method, as prescribed by SEC's Staff Accounting Bulletin No. 107.
A summary of the option activity related to option grants of Synovus common
stock to TSYS employees as of March 31, 2006 and changes during the three months
ended on March 31, 2006 is presented below:
Weighted
Average
Remaining
Weighted Contractual Aggregate
(in thousands) Average Exercise Life Intrinsic
Options: Options Price (in years) Value
------------------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 6,451 $ 25.79
Granted 305 27.67
Exercised (175) 20.32
Net Synovus/TSYS employee transfers between entities (4) 21.82
Forfeited/Canceled (29) 24.82
----------------------------------------------------------------------------------------------------------
Outstanding at end of period 6,548 $ 26.03 5.47 $ 56,330
--------------------------------------------------------------------------------====================================================
Options exercisable at period-end 3,058 $ 23.24 4.04 $ 23,216
--------------------------------------------------------------------------------====================================================
Weighted average fair value of options granted during the period $ 6.57
-------------------------------------------------------------------------------- ===========
The total intrinsic value of Synovus options exercised during the three
months ended March 31, 2006 was $1.0 million. As of March 31, 2006, there was
$13.6 million of total unrecognized compensation expense cost related to Synovus
stock options that is expected to be recognized over a weighted average period
of 2.1 years.
During the first three months of 2005, Synovus granted 203,440 stock
options to key TSYS executive officers. The fair value of the option grant was
$7.56 and was estimated on the date of grant using the Black-Scholes-Merton
option-pricing model with the following weighted average assumptions:
- 19 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
risk-free interest rate of 4.43%; expected volatility of 25.6%; expected life of
8.8 years; and dividend yield of 2.60%.
The total intrinsic value of Synovus options exercised during the three
months ended March 31, 2005 was $0.8 million.
Note 6 - Long-Term Debt
On June 30, 2003, TSYS obtained a $45.0 million long-term line of credit
from a banking affiliate of Synovus. The line is an automatic draw down
facility. The interest rate for the line of credit is the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there is a charge of 15
basis points on any funds unused. The line of credit is unsecured and includes
covenants requiring the Company to maintain certain minimum financial ratios. At
March 31, 2006, TSYS did not have an outstanding balance on the line of credit.
Note 7 - Supplementary Cash Flow Information
Contract Acquisition Costs
Cash used for contract acquisition costs for the three months ended March
31, 2006 and 2005, respectively, are summarized as follows:
(in thousands) March 31, 2006 March 31, 2005
------------------------------------------------------------------------------------------------------------------------------------
Conversion costs $ 8,879 5,442
Payments for processing rights 675 -
------------------------------------------------------------------------------------------------------------------------------------
Total $ 9,554 5,442
====================================================
Nonvested Awards
During the first quarter of 2006, the Company issued nonvested shares of
common stock to certain key executive officers and non-management members of its
board of directors under nonvested shares for services to be provided by such
officers and directors in the future. Refer to Note 5 for more information.
Note 8 - Legal Proceedings
The Company is subject to lawsuits, claims and other complaints arising out
of the ordinary conduct of its business. In the opinion of management, based in
part upon the advice of legal counsel, all matters are believed to be adequately
covered by insurance, or if not covered, are believed to be without merit or are
of such kind or involve such amounts that would not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company if disposed of unfavorably. The Company establishes reserves for
expected future litigation exposures that TSYS determines to be both probable
and reasonably estimable.
Note 9 - Business Combinations
China UnionPay Data Co., Ltd.
Effective November 1, 2005, TSYS purchased an initial 34% equity interest
in China UnionPay Data Co., Ltd., the payments-processing subsidiary of China
UnionPay Co., Ltd. (CUP). TSYS plans to increase its ownership interest to 45%
upon receipt of regulatory approval which is expected to occur in 2006. CUP is
sanctioned by the People's Bank of China, China's central bank, and has become
one of
- 20 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
the world's largest and fastest-growing payments networks. CUP Data currently
provides transaction processing, disaster recovery and other services for banks
and bankcard issuers in China. In its first two years of business, CUP Data has
signed numerous processing agreements for several of China's largest financial
institutions.
The Company is using the equity method of accounting to account for its
investment in CUP Data. The difference between the cost of an investment and the
amount of underlying equity in net assets of CUP Data is recognized as goodwill.
The preliminary purchase price allocation related to the acquisition is
presented below:
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Total assets acquired $ 7,948
Goodwill 29,026
------------------------------------------------------------------------------------------------------------------------------------
Net assets acquired $ 36,974
=====================
The goodwill associated with CUP Data is not reported as goodwill in the
Company's balance sheet, but is reported as a component of the equity
investment.
TSYS Acquiring Solutions, L.L.C.
Vital Processing Services, L.L.C. (Vital), a limited liability company, was
established in May 1996 as a 50/50 merchant processing joint venture between
TSYS and Visa U.S.A. (Visa). In April 2006, TSYS renamed Vital TSYS Acquiring
Solutions, L.L.C. (TSYS Acquiring). TSYS Acquiring is a leader in providing
integrated end-to-end electronic transaction processing services primarily to
large financial institutions and other merchant acquirers. TSYS Acquiring
processes all payment forms including credit, debit, electronic benefit transfer
and check truncation for merchants of all sizes across a wide array of retail
market segments.
On March 1, 2005, TSYS acquired the remaining 50% of TSYS Acquiring from
Visa for $95.8 million in cash, including direct acquisition costs of $794,000.
TSYS Acquiring is now a separate, wholly owned subsidiary of TSYS. As a result
of the acquisition of control of TSYS Acquiring, TSYS changed from the equity
method of accounting for the investment in TSYS Acquiring and began
consolidating TSYS Acquiring's balance sheet and results of operations in the
statement of income effective March 1, 2005. In accordance with authoritative
accounting guidelines, TSYS recorded the acquisition of the incremental 50%
interest as a business combination, requiring that TSYS allocate the purchase
price to the assets acquired and liabilities assumed based on their relative
fair values. The Company finalized the purchase price allocation during the
first quarter of 2006 and has allocated $30.2 million to goodwill, $30.5 million
to other identifiable intangible assets and the remaining amount to the assets
and liabilities acquired. Of the $30.5 million other identifiable intangible
assets, the Company has allocated $18.5 million to computer software and the
remaining amount to other intangible assets. The Company believes the
acquisition of TSYS Acquiring allows TSYS to be a complete provider of
value-based services at both ends of the payment chain and strengthens the
relationship TSYS enjoys with some of world's largest card issuers by placing
them closer to the point of sale. Revenues associated with TSYS Acquiring are
included in merchant services and are classified in merchant processing services
for segment reporting purposes.
- 21 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Since TSYS acquired less than 100% of the outstanding shares of the
acquired enterprise, the valuation of assets acquired and liabilities assumed in
the acquisition was based on a pro rata allocation of the fair values of the
assets acquired and liabilities assumed and the historical financial statement
carrying amounts of the assets and liabilities of the acquired enterprise. As a
result, TSYS recorded the fair value of the 50% interest of TSYS Acquiring's
assets acquired and liabilities assumed as of March 1, 2005. The Company
recorded the remaining 50% interest of TSYS Acquiring's assets and liabilities
at historical carrying values. The purchase price allocation is presented below:
(in thousands)
------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents $ 19,399
Intangible assets 30,500
Goodwill 30,211
Other assets 47,563
---------------
Total assets acquired 127,673
---------------
Other liabilities 31,830
---------------
Total liabilities assumed 31,830
---------------
Minority interest 49
---------------
Net assets acquired $ 95,794
===============
Pro forma
Presented below are the pro forma consolidated results of operations for
the three months ended March 31, 2005, as though the acquisition of TSYS
Acquiring had occurred on January 1, 2005. This pro forma information is based
on the historical financial statements of TSYS Acquiring. Pro forma results do
not include any actual or anticipated cost savings or expenses of the planned
integration of TSYS and TSYS Acquiring, and are not necessarily indicative of
the results which would have occurred if the business combinations had been in
effect on the dates indicated, or which may result in the future.
Three months ended
(in thousands, except per share data) March 31, 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues $ 393,573
Net income 48,127
Basic earnings per share 0.24
Diluted earnings per share 0.24
- 22 -
TOTAL SYSTEM SERVICES, INC.
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations
Financial Overview
Total System Services, Inc.'s (TSYS' or the Company's) revenues are derived
from providing electronic payment processing and related services to financial
and nonfinancial institutions, generally under long-term processing contracts.
TSYS' services are provided primarily through the Company's cardholder systems,
TS2 and TS1, to financial institutions and other organizations throughout the
United States, Mexico, Canada, Honduras, Puerto Rico and Europe. The Company
currently offers merchant services to financial institutions and other
organizations through its majority owned subsidiary, GP Network Corporation (GP
Net), and its wholly owned subsidiary, TSYS Acquiring Solutions, L.L.C. (TSYS
Acquiring).
Due to the somewhat seasonal nature of the credit card industry, TSYS'
revenues and results of operations have generally increased in the fourth
quarter of each year because of increased transaction and authorization volumes
during the traditional holiday shopping season. Furthermore, growth or declines
in card portfolios of existing clients, the conversion of cardholder accounts of
new clients to the Company's processing platforms, and the loss of cardholder
accounts impact the results of operations from period to period. Another factor
which may affect TSYS' revenues and results of operations from time to time, is
the sale by a client of its business, its card portfolio or a segment of its
accounts to a party which processes cardholder accounts internally or uses
another third-party processor. Consolidation in either the financial services or
retail industries, a change in the economic environment in the retail sector, or
a change in the mix of payments between cash and cards could favorably or
unfavorably impact TSYS' financial position, results of operations and cash
flows in the future.
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including certain major customers. Processing
contracts with large clients, representing a significant portion of the
Company's total revenues, generally provide for discounts on certain services
based on the size and activity of clients' portfolios. Therefore, electronic
payment processing revenues and the related margins are influenced by the client
mix relative to the size of client card portfolios, as well as the number and
activity of individual cardholder accounts processed for each client.
Consolidation among financial institutions has resulted in an increasingly
concentrated client base, which results in a change in client mix directed
toward larger clients and increasing pressure on the Company's operating profit
margins.
The Company provides services to its clients including processing consumer,
retail, commercial, government services, stored value and debit cards. Consumer
cards include Visa and MasterCard credit cards, as well as American Express
cards. Retail cards include private label and gift cards. Commercial cards
include purchasing cards, corporate cards and fleet cards for employees.
Government services accounts on file consist mainly of student loan processing
accounts. Stored value accounts include prepaid cards, including loyalty
incentive cards and flexible spending cards. Debit cards consist mainly of
on-line (PIN-based) and off-line (signature-based) accounts. The table on page
29 summarizes TSYS' accounts on file (AOF) information as of March 31, 2006 and
2005, respectively.
- 23 -
Financial Overview (continued)
A summary of the financial highlights occurring during 2006, as compared to
2005, is provided below:
(in millions, except per share data) Three months ended March 31,
------------------------------------------------------------------------------------------------------------------------------------
Percent
2006 2005 Change
------------------------------------------------------------------------------------------------------------------------------------
Revenues Before Reimbursables $ 329.6 280.4 17.5%
Total Revenues 412.3 350.0 17.8
Operating Income 71.9 66.3 8.4
Net Income 50.4 46.1 9.3
Basic EPS 0.26 0.23 9.2
Diluted EPS 0.26 0.23 9.2
Significant highlights for 2006 include:
o Announced that its Board of Directors approved a share repurchase plan to
purchase up to 2 million shares of the Company's stock.
o Entered the healthcare payments market by signing a long-term agreement
with Exante Bank, a wholly owned subsidiary of UnitedHealth Group, Inc., to
provide a broad range of payment processing and related services.
o Continued assisting China UnionPay Data Co., Ltd. (CUP Data) in expanding
its client list and strategically positioning for long-term growth in the
Chinese credit card market.
o Renewed its multi-year agreement to provide CompuCredit Corp. of Atlanta,
Ga., one of the nation's largest credit card providers, processing and
related services for its portfolio of nearly 6 million cardholder accounts.
Financial Review
This Financial Review provides a discussion of critical accounting policies
and estimates, related party transactions and off-balance sheet arrangements.
This Financial Review also discusses the results of operations, financial
position, liquidity and capital resources of TSYS and outlines the factors that
have affected its recent earnings, as well as those factors that may affect its
future earnings.
Critical Accounting Policies and Estimates
The Company's financial position, results of operations and cash flows are
impacted by the accounting policies the Company has adopted. In order to gain a
full understanding of the Company's financial statements, one must have a clear
understanding of the accounting policies employed.
The Company has prepared the accompanying consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America. The preparation of the consolidated financial statements requires
management of the Company to make a number of estimates and assumptions relating
to the reported amounts of assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the period. These estimates and assumptions are developed based
upon all information available. Actual results could differ from estimated
amounts.
- 24 -
Critical Accounting Policies and Estimates (continued)
Factors that could affect the Company's future operating results and cause
actual results to vary materially from expectations include, but are not limited
to, lower than anticipated growth from existing customers, an inability to
attract new customers and grow internationally, loss of the Company's major
customers or other significant clients, an inability to grow through
acquisitions or successfully integrate acquisitions, an inability to control
expenses, technology changes, financial services consolidation, change in
regulatory mandates, a decline in the use of cards as a payment mechanism, a
decline in the financial stability of the Company's clients and uncertain
economic conditions. Negative developments in these or other risk factors could
have a material adverse effect on the Company's financial position, results of
operations and cash flows. For a detailed discussion regarding the Company's
risk factors, see "Item 1A: Risk Factors" in the Company's Annual Report on Form
10-K for the year ended December 31, 2005.
For a detailed discussion regarding the Company's critical accounting
policies and estimates, see "Item 7: Management's Discussion and Analysis of
Financial Condition and Results of Operations" in the Company's Annual Report on
Form 10-K for the year ended December 31, 2005. There have been no material
changes to the Company's critical accounting policies, estimates and assumptions
or the judgments affecting the application of those estimates and assumptions in
2006.
Related Party Transactions
The Company provides electronic payment processing and other services to
its parent company, Synovus Financial Corp. (Synovus) and its affiliates, and to
the Company's equity investment, Total System Services de Mexico, S.A. de. C.V.
(TSYS de Mexico). The services are performed under contracts that are similar to
its contracts with other customers. The Company believes the terms and
conditions of transactions between the Company and these related parties are
comparable to those which could have been obtained in transactions with
unaffiliated parties. The Company's margins with respect to related party
transactions are comparable to margins recognized in transactions with unrelated
third parties. The amounts related to these transactions are disclosed on the
face of TSYS' consolidated financial statements.
Line of Credit
TSYS has a $45.0 million long-term line of credit from a banking affiliate
of Synovus. The line is an automatic draw down facility. Refer to Note 6 of
Notes to Unaudited Condensed Consolidated Financial Statements for more
information on TSYS' line of credit.
Off-Balance Sheet Arrangements
Operating Leases: As a method of funding its operations, TSYS employs
noncancelable operating leases for computer equipment, software and facilities.
These leases allow the Company to provide the latest technology while avoiding
the risk of ownership. Neither the assets nor obligations related to these
leases are included on the balance sheet.
Results of Operations
The following table sets forth certain income statement captions as a
percentage of total revenues and the percentage increases or decreases in those
items for the three months ended March 31, 2006 and 2005, respectively:
- 25 -
Results of Operations (continued)
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------------------------------
2006 2005 2006 vs. 2005
----------- ----------- --------------------
Revenues:
Electronic payment processing services 53.6 % 58.5 % 8.0 %
Merchant services 15.5 7.7 nm
Other services 10.8 13.9 (8.2)
----------- ------------
Revenues before reimbursable items 79.9 80.1 17.5
Reimbursable items 20.1 19.9 18.9
----------- ------------
Total revenues 100.0 100.0 17.8
----------- ------------
Expenses:
Salaries and other personnel expense 29.1 27.7 23.7
Net occupancy and equipment expense 18.3 18.9 14.0
Other operating expenses 15.1 14.6 22.3
----------- ------------
Expenses before reimbursable items 62.5 61.2 20.4
Reimbursable items 20.1 19.9 18.9
----------- ------------
Total expenses 82.6 81.1 20.0
----------- ------------
Operating income 17.4 18.9 8.4
Nonoperating income 0.7 0.3 nm
----------- ------------
Income before income taxes, minority interest and equity in income
of equity investments 18.1 19.2 11.1
Income taxes 6.1 7.1 1.2
Minority interests in consolidated subsidiaries' net income 0.0 0.0 31.2
Equity in income of equity investments 0.2 1.1 (77.3)
----------- ------------
Net income 12.2 % 13.2 % 9.3 %
=========== ============
nm=not meaningful
Revenues
Total revenues increased $62.3 million, or 17.8%, during the three months
ended March 31, 2006, compared to the same period in 2005. The increase in
revenues for the three months ended March 31, 2006 includes a decrease of $3.1
million related to the effects of currency translation of its foreign-based
subsidiaries and branches. Excluding reimbursable items, revenues increased
$49.2 million, or 17.5%, during the three months ended March 31, 2006, compared
to the same period in 2005.
International Revenues
TSYS provides services to its clients worldwide and plans to continue to
expand its service offerings internationally in the future. Total revenues from
clients domiciled outside the United States for the three months ended March 31,
2006 and 2005, respectively, are summarized below:
- 26 -
Results of Operations (continued)
Three months ended March 31,
----------------------------------------------------
(in millions) 2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Europe $ 32.5 33.0 (1.5)%
Canada 22.1 21.0 5.2
Japan 3.9 3.7 4.0
Mexico 2.5 1.7 48.3
Other 1.5 0.6 138.0
------------------------------------------------------------------------------------------------------------------
Totals $ 62.5 60.0 4.0 %
==================================
Note:TSYS' international revenues are generated by TSYS and its
consolidated entities. The Company has two equity investments located in
Mexico and China that are accounted for under the equity method of
accounting and therefore, TSYS does not include the revenues of its equity
investments in consolidated revenues.
Total revenues from clients based in Europe were $32.5 million for the
three months ended March 31, 2006. This constituted a 1.5% decrease compared to
the $33.0 million for the same period last year. The decline in revenues in 2006
from clients based in Europe was a result of the effects of currency
translation, which was approximately $2.6 million.
Total revenues from clients based in Mexico were $2.5 million for the three
months ended March 31, 2006, a 48.3% increase over the same period last year.
Total revenues from clients based in Mexico were $1.7 million for the same
period last year. The growth in revenues in 2006 from clients based in Mexico
was a result of the conversion of new accounts and the growth of existing
clients.
Value Added Products and Services
The Company's revenues are impacted by the use of optional value added
products and services of TSYS' processing systems. Value added products and
services are optional features to which each client can choose to subscribe in
order to potentially increase the financial performance of its portfolio. Value
added products and services include: risk management tools and techniques, such
as credit evaluation, fraud detection and prevention, and behavior analysis
tools; and revenue enhancement tools and customer retention programs, such as
loyalty programs and bonus rewards. These revenues can increase or decrease from
period to period as clients subscribe to or cancel these services. Value added
products and services are included mainly in electronic payment processing
services revenue.
For the three months ended March 31, 2006 and 2005, value added products
and services represented 12.6% and 13.1%, respectively, of total revenues.
Revenues from these products and services, which include some reimbursable items
paid to third-party vendors, increased 13.3%, or $6.1 million, for the three
months ended March 31, 2006 compared to the same period last year.
Major Customers
A significant amount of the Company's revenues is derived from long-term
contracts with large clients, including its major customers, one of which is
Bank of America. TSYS derives revenues from providing various processing and
other services to these clients, including processing of consumer and commercial
accounts, as well as revenues for reimbursable items. With the acquisition of
TSYS Acquiring on March 1, 2005, the Company's revenues include revenues derived
from providing merchant processing services to one of these clients, Bank of
America. Refer to Notes 4 and 9 in the
- 27 -
Results of Operations (continued)
Notes to Unaudited Condensed Consolidated Financial Statements for more
information on the major customers and the acquisition of TSYS Acquiring,
respectively.
On January 25, 2005, the Company announced that it had extended its
agreement with Bank of America for an additional five years through 2014.
Additionally, during the third quarter of 2005, TSYS Acquiring announced the
renewal of its agreement to provide merchant processing services to Bank of
America.
During the second quarter of 2005, Bank of America announced its planned
acquisition of MBNA. In December 2005, TSYS received official notification from
Bank of America of its intent, pending its acquisition of MBNA, to shift the
processing of its consumer card portfolio in house in October 2006. On January
1, 2006, Bank of America's acquisition of MBNA was completed. TSYS expects to
continue providing commercial and small business card processing for Bank of
America and MBNA, as well as merchant processing for Bank of America, according
to the terms of the existing agreements for those services.
TSYS' processing agreement with Bank of America provides that Bank of
America may terminate its agreement with TSYS for consumer credit card services
upon the payment of a termination fee, the amount of which is dependent upon
several factors. Based upon the expected October 2006 deconversion date, this
fee is estimated to be approximately $69 million. As a result of the expected
deconversion in October 2006, TSYS is accelerating the amortization of
approximately $7 million in contract acquisition costs. The loss of Bank of
America, or any significant client, could have a material adverse effect on the
Company's financial position, results of operations and cash flows. TSYS'
management believes that the loss of revenues from the Bank of America consumer
card portfolio for the months of 2006 subsequent to the expected deconversion,
combined with decreased expenses from the reduction in hardware and software and
the redeployment of personnel, should not have a material adverse effect on the
Company's financial position, results of operations or cash flows for the year
ending December 31, 2006. However, the Company's management believes that the
termination fee associated with the Bank of America deconversion, offset by the
loss of processing revenues subsequent to the deconversion and the acceleration
of amortization of contract acquisition costs, will have a positive effect on
the Company's financial position, results of operations and cash flows for the
year ending December 31, 2006.
For the three months ended March 31, 2006, Bank of America accounted for
approximately 23.4%, or $96.3 million, of total revenues. This amount consists
of processing revenues for consumer, commercial and merchant services, as well
as reimbursable items. Of this $96.3 million, approximately $35.5 million, or
36.9%, was derived from Bank of America for reimbursable items. Bank of America
accounted for approximately $60.8 million, or 18.4%, of revenues before
reimbursable items for the three months ended March 31, 2006. For the three
months ended March 31, 2005, Bank of America accounted for 20.6%, or $72.2
million, of total revenues. The majority of the increase in revenues derived
from Bank of America for 2006, as compared to 2005, is the result of including
TSYS Acquiring's revenues for merchant services from Bank of America.
For the three months ended March 31, 2006, the Company had another major
client that accounted for approximately 10.8%, or $44.7 million, of total
revenues. For the three months ended March 31, 2005, this client accounted for
9.9%, or $34.7 million, of total revenues. The loss of this
- 28 -
Results of Operations (continued)
client, or any significant client, could have a material adverse effect on the
Company's financial position, results of operations and cash flows.
Revenues from major customers for the periods reported are attributable to
the domestic-based support services segment and merchant processing services.
Electronic Payment Processing Services
Electronic payment processing services revenues are generated primarily
from charges based on the number of accounts on file, transactions and
authorizations processed, statements mailed, cards embossed and mailed, and
other processing services for cardholder accounts on file. Cardholder accounts
on file include active and inactive consumer credit, retail, debit, stored
value, government services and commercial card accounts. Due to the number of
cardholder accounts processed by TSYS and the expanding use of cards, as well as
increases in the scope of services offered to clients, revenues relating to
electronic payment processing services have continued to grow. Revenues from
electronic payment processing services increased $16.3 million, or 8.0%, for the
three months ended March 31, 2006, compared to the same period in 2005.
Accounts on File (AOF) Data (in millions):
2006 2005 % Change
------------- ------------ --------------
At March 31, 440.4 370.6 18.8
YTD Average 439.3 362.9 21.0
AOF by Portfolio Type (in millions):
2006 2005
---------------- ----------------
At March 31, AOF % AOF % % Change
------------------------------------------------------------------------------------------------ ---------------- ------------
Consumer 272.5 61.8 213.4 57.6 27.7
Retail 94.7 21.5 94.1 25.4 0.6
Commercial 31.2 7.1 26.8 7.2 16.4
Government services 19.2 4.4 16.7 4.5 14.8
Stored value 14.9 3.4 12.6 3.4 18.0
Debit 7.9 1.8 7.0 1.9 13.2
------------------------------------------------------------------------------------------------ ----------------
Total 440.4 100.0 370.6 100.0 18.8
================ ================
AOF by Geographic Area (in millions):
2006 2005
---------------- ----------------
At March 31, AOF % AOF % % Change
------------------------------------------------------------------------------------------------ ---------------- -------------
Domestic 383.5 87.1 319.7 86.3 20.0
International 56.9 12.9 50.9 13.7 11.7
------------------------------------------------------------------------------------------------ ----------------
Total 440.4 100.0 370.6 100.0 18.8
================ ================
Note: The accounts on file distinction between domestic and international
is based on the geographic domicile of processing clients.
- 29 -
Results of Operations (continued)
Activity in AOF (in millions):
March 2005 to March 2004 to
March 2006 March 2005
------------------------ ------------------------
Beginning balance 370.6 280.4
Internal growth of existing clients 44.1 34.0
New clients 39.3 62.5
Purges/Sales (12.3) (5.1)
Deconversions (1.3) (1.2)
-------------------------------------------------------------------------------------------------------- ------------------------
Ending balance 440.4 370.6
======================== ========================
On March 31, 2004, Bank of America acquired FleetBoston. In connection with
the extended agreement with Bank of America, TSYS converted the FleetBoston card
portfolio to TSYS' processing system in March 2005. See further discussion under
Major Customers.
On October 13, 2004, TSYS finalized a definitive agreement with JPMorgan
Chase & Co. (Chase) to service the combined card portfolios of Chase Card
Services and to upgrade its card-processing technology. Pursuant to the
agreement, TSYS converted the consumer accounts of Chase to the modified version
of TS2 in July 2005. TSYS expects to maintain the card-processing functions of
Chase Card Services for at least two years. Chase Card Services then has the
option to either extend the processing agreement for up to five additional
two-year periods or migrate the portfolio in-house, under a perpetual license of
a modified version of TS2 with a six-year payment term.
In August 2005, TSYS finalized a five year definitive agreement with
Capital One Financial Corporation (Capital One) to provide processing services
for its North American portfolio of consumer and small business credit card
accounts. TSYS plans to complete the conversion of Capital One's portfolio from
its in house processing system to TS2 in phases, beginning in mid-2006 and
ending in early 2007. TSYS expects to maintain the card processing functions of
Capital One for at least five years. After a minimum of three years of
processing with TSYS, the agreement provides Capital One the opportunity to
license TS2 under a long-term payment structure.
Current 2006 earnings estimates assume that TSYS will recognize revenues
and costs associated with converting, processing and servicing the Capital One
portfolio beginning in the fourth quarter of 2006.
In July 2003, Sears and Citigroup announced an agreement for the sale by
Sears to Citigroup of the Sears credit card and financial services businesses.
For the three months ended March 31, 2006, TSYS' revenues from the agreement
with Sears represented less than 10% of TSYS' consolidated revenues. The
TSYS/Sears agreement granted to Sears the one-time right to market test TSYS'
pricing and functionality after May 1, 2004, which right was exercised by
Citigroup. In June 2005, TSYS announced that Citigroup will move the Sears
consumer MasterCard and private-label accounts from TSYS in a deconversion that
is expected to occur in the second quarter of 2006. TSYS expects to continue
supporting commercial card accounts for Citibank, as well as Citibank's Banamex
USA consumer accounts, according to the terms of the existing agreements for
those portfolios. TSYS' management believes that the loss of revenues from the
Sears portfolio for the months of 2006 subsequent to the expected deconversion,
combined with decreased expenses from the reduction in hardware and software and
the redeployment of personnel, should not have a material adverse effect on
- 30 -
Results of Operations (continued)
the Company's financial position, results of operations or cash flows for the
year ending December 31, 2006.
Merchant Services
Merchant services revenues are derived from providing electronic
transaction processing services primarily to large financial institutions and
other merchant acquirers. Revenues from merchant services include processing all
payment forms including credit, debit, electronic benefit transfer and check
truncation for merchants of all sizes across a wide array of retail market
segments. Merchant services' products and services include: authorization and
capture of electronic transactions; clearing and settlement of electronic
transactions; information reporting services related to electronic transactions;
merchant billing services; and point-of-sale terminal sales and service.
On March 1, 2005, TSYS acquired the remaining 50% of TSYS Acquiring,
formerly operating as Vital Processing Services, L.L.C., from Visa for $95.8
million in cash, including direct acquisition costs of $794,000. TSYS Acquiring
is now a separate, wholly owned subsidiary of TSYS. As a result of the
acquisition of control of TSYS Acquiring, TSYS changed from the equity method of
accounting for the investment in TSYS Acquiring and began consolidating TSYS
Acquiring's balance sheet and results of operations. Refer to Note 9 in the
Notes to Unaudited Condensed Consolidated Financial Statements for more
information on the acquisition of TSYS Acquiring.
Revenues from merchant services consist of revenues generated by TSYS'
wholly owned subsidiary TSYS Acquiring and majority owned subsidiary GP Net.
Merchant services revenue for the three months ended March 31, 2006 was $63.9
million compared to $27.1 million for the same period last year. The increase is
completely attributable to the consolidation of TSYS Acquiring's results
effective March 1, 2005. Prior to the acquisition of TSYS Acquiring, TSYS'
revenues included fees TSYS charged to TSYS Acquiring for back-end processing
support.
TSYS Acquiring's results are driven by the transactions processed at the
point-of-sale and the number of outgoing transactions. TSYS Acquiring's primary
point-of-sale service deals with authorizations and data capture transactions
primarily through dial-up or the Internet.
Effective January 1, 2006, Golden Retriever Systems L.L.C. became a wholly
owned subsidiary of Enhancement Services Corporation. Also effective January 1,
2006, Merlin Solutions, L.L.C. became a wholly owned subsidiary of TSYS. Both
entities were previously wholly owned subsidiaries of TSYS Acquiring and were
reported under the merchant processing services segment. Effective January 1,
2006, the financial results of the two entities are included in the
domestic-based support services segment. The results for previous periods have
been reclassified to reflect the change.
Other Services
Revenues from other services consist primarily of revenues generated by
TSYS' wholly owned subsidiaries not included in electronic payment processing
services or merchant services, as well as TSYS' business process management
services. Revenues from other services decreased $4.0 million, or 8.2%, for the
three months ended March 31, 2006, compared to the same period in 2005. Other
services revenue decreased primarily due to the loss of call center revenue.
- 31 -
Results of Operations (continued)
Reimbursable Items
As a result of the FASB's Emerging Issues Task Force No. 01-14 (EITF No.
01-14), "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred," the Company has included reimbursements
received for out-of-pocket expenses as revenues and expenses. Reimbursable items
increased $13.1 million, or 18.9%, for the three months ended March 31, 2006, as
compared to the same period last year. Of the $13.1 million increase, $7.3
million is attributable to TSYS Acquiring. The majority of reimbursable items
relates to the Company's domestic-based clients and is primarily costs
associated with postage.
The Company's reimbursable items are impacted with changes in postal rates
and changes in the volumes of all mailing activities by its clients. Effective
January 8, 2006, the United States Postal Service increased the rate of first
class mail. The increase in reimbursable items due to the increase in postal
rates is expected to be offset by the decrease in reimbursable items associated
with the deconversion of the Citibank Sears portfolio in the second quarter of
2006 and Bank of America's consumer card portfolio in October 2006.
A summary of reimbursable item revenues for the three months ended March
31, 2006, as compared to 2005, is provided below:
(in thousands) Three months ended March 31,
------------------------------------------------------------------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Postage $41,983 41,056 2.3%
Card association access fees 19,685 9,856 99.7
Other 21,070 18,696 12.7
-----------------------------------------------------------------------------------------------------------------
Total $82,738 69,608 18.9%
=================================
Operating Expenses
Total expenses increased 20.0% for the three months ended March 31, 2006,
compared to the same period in 2005. The increase in expense includes a decrease
of $3.0 million related to the effects of currency translation of its
foreign-based subsidiaries and branches. Excluding reimbursable items, total
expenses increased 20.4% for the three months ended March 31, 2006, compared to
the same period in 2005. The increase in operating expenses is attributable to
changes in each of the expense categories as described below.
Salaries and Other Personnel Expense
Summarized below are the major components of salaries and other personnel
expenses for the three months ended March 31:
- 32 -
Results of Operations (continued)
(in thousands) Three months ended March 31,
------------------------------------------------------------------------------------------------------------------------------------
2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Salaries $ 90,986 78,014 16.6 %
Employee benefits 25,448 20,824 22.2
Nonemployee wages 8,664 5,043 71.8
Share-based compensation 2,267 278 nm
Other 2,899 980 nm
Less capitalized expenses (10,298) (8,161) 26.2
-----------------------------------------------------------------------------------------------------------------
Totals $ 119,966 96,978 23.7 %
=================================
nm = not meaningful
Salaries and other personnel expenses increased $23.0 million, or 23.7%,
for the three months ended March 31, 2006, compared to the same period in 2005.
Of the $23.0 million increase, $10.9 million is the result of employee-related
expenses of TSYS Acquiring. In addition, the change in employment expenses is
associated with the normal salary increases and related benefits, offset by
higher levels of employment costs capitalized as software development and
contract acquisition costs. The growth in employment expenses included a
decrease in the accrual for performance-based incentive benefits, which includes
salary bonuses, profit sharing and employer 401(k) expenses. For the three
months ended March 31, 2006 and 2005, the Company accrued $4.7 million and $5.3
million, respectively, of performance-based incentives.
The Company's salaries and other personnel expense is greatly influenced by
the number of employees. Below is a summary of the Company's employee data:
Employee Data:
(Full-time Equivalents) 2006 2005 % Change
----------------------------------------------------------------------------------------------- -------------- ----------------
At March 31, 6,583 6,421 2.5
YTD Average 6,644 5,867 13.2
The Company maintains share-based employee compensation plans for purposes
of incenting and retaining employees. In December 2004, the FASB issued
Statement of Financial Accounting Standards No. 123 (revised) (SFAS No. 123R)
"Share-Based Payment," which the Company adopted on January 1, 2006. SFAS No.
123R requires the Company to recognize compensation expense for the nonvested
portion of outstanding share-based compensation granted in the form of stock
options based on the grant-date fair value of those awards. Refer to Note 5 of
Notes to Unaudited Condensed Consolidated Financial Statements for more
information on share-based compensation.
Share-based compensation expenses include the impact of expensing the fair
value of stock options in 2006, as well as expenses associated with nonvested
shares. For the three months ended March 31, 2006, share-based compensation was
$2.3 million, compared to $0.3 million for the same period in 2005.
- 33 -
Results of Operations (continued)
Net Occupancy and Equipment Expense
Summarized below are the major components of net occupancy and equipment
expenses:
Three months ended March 31,
----------------------------------------------------
(in thousands) 2006 2005 % Change
----------------------------------------------------
Depreciation and amortization $ 30,791 24,183 27.3 %
Equipment and software rentals 28,408 24,589 15.5
Repairs and maintenance 10,445 8,146 28.2
Impairment of developed software - 3,137 nm
Other 5,706 6,014 (5.1)
---------------------------------------------------------------------------------------------------------------
Totals $ 75,350 66,069 14.0 %
===============================
nm = not meaningful
Net occupancy and equipment expense increased $9.3 million, or 14.0%, for
the three months ended March 31, 2006 over the same period in 2005. Of the $9.3
million increase, $5.7 million is the result of occupancy and equipment related
expenses of TSYS Acquiring.
Depreciation and amortization increased for the three months ended March
31, 2006, as compared to the same period in 2005, as a result of the
depreciation and amortization associated with TSYS Acquiring, as well as the
acceleration of amortization of software licenses that are under processing
capacity or MIPS agreements. These licenses are amortized using a
units-of-production basis. As a result of the deconversions scheduled later this
year, TSYS' total future MIPS are expected to decline, resulting in an increase
in software amortization for the periods prior to the deconversion dates.
The Company was developing its Integrated Payments (IP) Platform supporting
the on-line and off-line debit and stored value markets, which would have given
clients access to all national and regional networks, EBT programs, ATM driving
and switching services for online debit processing. Through December 2004, the
Company invested a total of $6.3 million since the project began.
Development relating specifically to the IP on-line debit platform
primarily consisted of a third-party software solution. During the first quarter
of 2005, the Company evaluated its debit solution and decided to modify its
approach in the debit processing market. With the acquisition of TSYS Acquiring
and debit alternatives now available, TSYS determined that it would no longer
market this third-party software product as its on-line debit solution. TSYS
will continue to support this product for existing clients and will enhance and
develop a new solution. As a result, TSYS recognized an impairment charge in net
occupancy and equipment expense of approximately $3.1 million related to this
asset. The impairment charge is reflected in the domestic-based support services
segment. As of March 31, 2006, the Company has $1.1 million capitalized, net of
amortization, related to this asset.
Other Operating Expenses
Summarized below are the major components of other operating expenses for
the three months ended March 31, 2006 and 2005:
- 34 -
Results of Operations (continued)
Three months ended March 31,
----------------------------------------------------
2006 2005 % Change
----------------------------------------------------
(in thousands)
Third-party data processing services $ 10,273 4,797 nm %
Court costs associated with debt collection
services 7,605 7,981 (4.7)
Professional advisory services 7,135 2,979 nm
Supplies and stationery 6,950 6,681 4.0
Amortization of conversion costs 4,875 3,476 40.2
Transaction processing provisions 4,161 3,109 33.8
Terminal deployment costs 3,992 2,298 73.7
Travel and business development 3,870 1,335 nm
Management fees 2,410 2,077 16.0
Amortization of acquisition intangibles 859 609 41.0
Bad debt expense 38 1,929 (98.0)
Other 10,211 13,752 (16.7)
-----------------------------------------------------------------------------------------------------------------
Totals $ 62,379 51,023 22.3 %
=================================
nm = not meaningful
Other operating expenses include, among other things, amortization of
conversion costs, costs associated with delivering merchant services,
professional advisory fees and court costs associated with its debt collection
business. Other operating expenses also include charges for processing errors,
contractual commitments and bad debt expense. As described in the Critical
Accounting Policies section in the 2005 Form 10-K, management's evaluation of
the adequacy of its transaction processing reserves and allowance for doubtful
accounts is based on a formal analysis which assesses the probability of losses
related to contractual contingencies, processing errors and uncollectible
accounts. Increases and decreases in transaction processing provisions and
charges for bad debt expense are reflected in other operating expenses.
Other operating expenses for the three months ended March 31, 2006
increased $11.4 million, or 22.3%, as compared to the same period in 2005. Of
the $11.4 million increase, $7.8 million is the result of other operating
expenses of TSYS Acquiring.
Operating Income
Operating income increased 8.4% for the three months ended March 31, 2006
over the same period in 2005. The Company's operating profit margin for the
three months ended March 31, 2006 was 17.4%, compared to 18.9% for the same
period last year. The margins for 2006 decreased when compared to the same
period in 2005 mainly as a result of the consolidated results of TSYS Acquiring.
Nonoperating Income (Expense)
Interest income for the three months ended March 31, 2006 was $2.5 million,
an increase of $1.3 million, compared to $1.2 million for the same period in
2005. The increase in interest income is primarily attributable to the
fluctuations in cash available for investment and changes in short-term interest
rates.
- 35 -
Results of Operations (continued)
Interest expense for the three months ended March 31, 2006 was $44,000, a
decrease of $26,000, compared to $70,000 for the same period in 2005.
The Company records foreign currency translation adjustments on
foreign-denominated balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and British
Pounds Sterling (BPS). As the Company translates the foreign-denominated cash
balances into US dollars, the translated cash balance is adjusted upward or
downward depending upon the foreign currency exchange movements. The upward or
downward adjustment is recorded as a gain or loss on foreign currency
translation in the Company's statements of income. As those cash accounts have
increased, the upward or downward adjustments have increased. The majority of
the translation gain of $276,000 for the three months ended March 31, 2006
relates to the translation of cash accounts. The balance of the Company's
foreign-denominated cash accounts subject to risk of translation gains or losses
at March 31, 2006 was approximately $4.0 million, the majority of which is
denominated in Euros.
Income Taxes
TSYS' effective income tax rate for the three months ended March 31, 2006
was 33.4%, compared to 35.1% for the same period in 2005. The calculation of the
effective tax rate is income taxes plus income taxes associated with equity
income divided by TSYS' pretax income adjusted for minority interests in
consolidated subsidiaries' net income and equity pre-tax earnings of its equity
investments.
In the normal course of business, TSYS is subject to examinations from
various tax authorities. These examinations may alter the timing or amount of
taxable income or deductions or the allocation of income among tax
jurisdictions. During the three months ended March 31, 2006, TSYS received
notices of proposed adjustments relating to taxes due for the years 2000 through
2003. As a result, TSYS recorded a reduction in previously recorded income tax
liabilities of $1.7 million which reduced income tax expense for the three
months ended March 31, 2006 and lowered the effective rate by 2.3%.
TSYS continually monitors and evaluates the potential impact of current
events and circumstances on the estimates and assumptions used in the analysis
of its income tax positions, and, accordingly, TSYS' effective tax rate may
fluctuate in the future. Based on current estimates, we believe that TSYS'
effective income tax rate for the remainder of 2006 will be in the 35%-36%
range.
Equity in Income of Equity Investments
TSYS' share of income from its equity in equity investments was $852,000
and $3.8 million for the three months ended March 31, 2006 and 2005,
respectively. The decrease for the quarter is primarily attributable to the
purchase of the remaining 50% of TSYS Acquiring on March 1, 2005 and the
inclusion of TSYS Acquiring's operating results in TSYS' statement of income.
Refer to Note 9 in the Notes to Unaudited Condensed Consolidated Financial
Statements for more information on the acquisition of TSYS Acquiring.
TSYS Acquiring Solutions, L.L.C.
As a result of the acquisition of control of TSYS Acquiring, TSYS changed
from the equity method of accounting for the investment in TSYS Acquiring and
began consolidating TSYS Acquiring's balance sheet and results of operations in
the statements of income beginning March 1, 2005. For the two months in 2005
prior to the acquisition, the Company's equity in income of equity investments
related to TSYS Acquiring was $3.2 million.
- 36 -
Results of Operations (continued)
Total System Services de Mexico, S.A. de C.V.
The Company has an equity investment with a number of Mexican banks and
records its 49% ownership in the equity investment using the equity method of
accounting. The operation, Total System Services de Mexico, S.A. de C.V. (TSYS
de Mexico), prints statements and provides card-issuing support services to the
equity investment clients.
During the three months ended March 31, 2006, the Company's equity in
income of equity investments related to TSYS de Mexico was $793,000, a 55.8%
increase, or $284,000, compared to $509,000 for the same period last year.
TSYS pays TSYS de Mexico a processing support fee for certain client
relationship and network services that TSYS de Mexico has assumed from TSYS.
TSYS paid TSYS de Mexico a processing support fee of $39,000 and $34,000 for the
three months ended March 31, 2006 and 2005, respectively.
China UnionPay Data Co., Ltd.
Effective November 1, 2005, the Company purchased an initial 34% equity
interest in China UnionPay Data Co., Ltd. (CUP Data), the payments-processing
subsidiary of China UnionPay Co., Ltd. (CUP). CUP is sanctioned by the People's
Bank of China, China's central bank, and has become one of the world's largest
and fastest growing payments networks. CUP Data currently provides transaction
processing, disaster recovery and other services for banks and bankcard issuers
in China. TSYS' equity in income of equity investments related to CUP Data was
approximately $59,000 for the three months ended March 31, 2006.
TSYS plans to increase its ownership interest to 45% upon its receipt of
regulatory approval. Refer to Note 9 in the Notes to Unaudited Condensed
Consolidated Financial Statements for more information on the acquisition of CUP
Data.
Net Income
Net income for the three months ended March 31, 2006 increased 9.3% or $4.3
million, to $50.4 million, or basic and diluted earnings per share of $0.26,
compared to $46.1 million, or basic and diluted earnings per share of $0.23, for
the same period in 2005.
Net Profit Margin
The Company's net profit margin for the three months ended March 31, 2006
was 12.2%, compared to 13.2% for the same period last year.
The Company's net profit margin is also impacted by the acquisition of TSYS
Acquiring. Prior to acquiring control, TSYS accounted for its investment in TSYS
Acquiring using the equity method of accounting. Only TSYS' share of TSYS
Acquiring's earnings was included in TSYS' net income. After acquiring control
of TSYS Acquiring, TSYS began consolidating TSYS Acquiring's results of
operations on March 1, 2005. By consolidating the results of TSYS Acquiring, the
impact will be a lower net profit margin as compared to periods that used the
equity method of accounting.
- 37 -
Results of Operations (continued)
Profit Margins and Reimbursable Items
Management believes that reimbursable items distort operating and net
profit margins as defined by generally accepted accounting principles.
Management evaluates the Company's operating performance based upon operating
and net profit margins excluding reimbursable items. Management believes that
operating and net profit margins excluding reimbursable items are more useful
because reimbursable items do not impact profitability as the Company receives
reimbursement for expenses incurred on behalf of its clients.
Below is the reconciliation between reported margins and adjusted margins
excluding reimbursable items for the three months ended March 31, 2006 and 2005:
Three months ended March 31,
--------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
--------------------------------------------------------------------------------------------------------------------
Operating income $ 71,857 66,306
================ ==============
Net income $ 50,393 46,123
================ ==============
Total revenues $ 412,290 349,984
================ ==============
Operating margin (as reported) 17.4 % 18.9 %
================ ==============
Net profit margin (as reported) 12.2 % 13.2 %
================ ==============
Revenue before reimbursable items $ 329,552 280,376
================ ==============
Adjusted operating margin 21.8 % 23.6 %
================ ==============
Adjusted net profit margin 15.3 % 16.5 %
================ ==============
Projected Outlook for 2006
TSYS expects its 2006 earnings growth to be in the range of 21%-23%, based
on the following assumptions: total revenues increasing 6%-8% in 2006; accounts
on file at the end of 2006 will be approximately 395 million to 405 million;
deconverting the Citigroup Sears portfolio as scheduled in May 2006;
deconverting Bank of America's consumer portfolio as scheduled in October 2006,
with a one-time contract-termination payment of approximately $69 million and an
acceleration of amortization of approximately $7 million in contract-acquisition
costs; and the recognition of revenues and expenses associated with the Capital
One agreement beginning in the fourth quarter of 2006.
Financial Position, Liquidity and Capital Resources
The Consolidated Statements of Cash Flows detail the Company's cash flows
from operating, investing and financing activities. TSYS' primary method of
funding its operations and growth has been cash generated from current
operations and the use of leases. TSYS has occasionally used borrowed funds to
supplement financing of capital expenditures and acquisitions.
Cash Flows From Operating Activities
Three months ended March 31,
----------------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
----------------------------------------------------------------------------------------------------------------------------
Net income $ 50,393 46,123
Depreciation and amortization 43,161 32,461
Other noncash items and charges, net 981 14,744
Working capital items (56,150) (137,863)
----------------------- --------------------
Net cash provided by (used in) operating activities $ 38,385 (44,535)
======================= ====================
- 38 -
Financial Position, Liquidity and Capital Resources (continued)
TSYS' main source of funds is derived from operating activities,
specifically net income. During the three months ended March 31, 2006, the
Company generated $38.4 million in cash from operating activities compared to
using $44.5 million for the same period last year. The increase in 2006 in net
cash provided by operating activities was the result of the change in the use of
cash related to working capital items.
Working capital items include accounts receivable, prepaid expenses and
other assets, accounts payable, accrued salaries and employee benefits and other
current liabilities. The change in accounts receivable at March 31, 2006 as
compared to December 31, 2005 is the result of timing of collections compared to
billings. The change in accounts payable and other liabilities for the same
period is the result of the timing of payments, funding of performance-based
incentives and payments of vendor invoices.
Cash Flows From Investing Activities
Three months ended March 31,
-----------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
-----------------------------------------------------------------------------------------------------------------------
Purchases of property and equipment, net $ (5,786) (10,702)
Additions to licensed computer software from vendors (1,776) (3,694)
Additions to internally developed computer software (3,773) (2,884)
Cash used in acquisitions, net of cash acquired - (56,983)
Contract acquisition costs (9,554) (5,442)
-------------------- ------------------
Net cash used in investing activities $ (20,889) (79,705)
==================== ==================
The major uses of cash for investing activities have been the addition of
property and equipment, primarily computer equipment, the purchase of licensed
computer software and internal development of computer software, investments in
contract acquisition costs associated with obtaining and servicing new or
existing clients, and business acquisitions. The Company used $20.9 million in
cash for investing activities for the three months ended March 31, 2006,
compared to $79.7 million for the same period in 2005. The major use of cash for
investing activities in 2005 was for the purchase of TSYS Acquiring.
Property and Equipment
Capital expenditures for property and equipment during the three month
periods ended March 31, 2006 and 2005 were $5.8 million and $10.7 million,
respectively.
Licensed Computer Software from Vendors
Expenditures for licensed computer software from vendors were $1.8 and $3.7
million for the three months ended March 31, 2006 and 2005, respectively. These
additions relate to annual site licenses for mainframe processing systems whose
fees are based upon a measure of TSYS' computer processing capacity, commonly
referred to as millions of instructions per second or MIPS.
Internally Developed Computer Software Costs
Additions to capitalized software development costs for the three months
ended March 31, 2006 were $3.8 million, compared to $2.9 million for the same
period in 2005.
- 39 -
Financial Position, Liquidity and Capital Resources (continued)
The increase in the amount capitalized as software development costs in
2006, as compared to 2005, is mainly attributable to TSYS Acquiring's
development of Express and MSII and ESC's development of TSYS Loyalty Platform
(TLP). The Company remains committed to developing and enhancing its processing
solutions to expand its service offerings. In addition to developing solutions,
the Company has expanded its service offerings through strategic acquisitions,
such as TSYS Acquiring.
Through its TSYS Acquiring subsidiary, the Company is internally developing
two software projects - MSII and Express. MSII is the enhanced version of the
current Merchant Accounting System Initiator (MAS) system that was originally
developed by TSYS in the mid-1970's. This project had reached technological
feasibility prior to TSYS' acquisition of control of TSYS Acquiring and is
expected to be introduced in the marketplace in 2006. The Company capitalized
approximately $41,000 during the three months ended March 31, 2006, and has a
total of $3.1 million capitalized since the project began.
Express is currently being developed by TSYS Acquiring and is a tool that
will provide a single point of entry system which enables acquirers to more
easily load and maintain their merchant populations. The Company expects to
complete Express in phases, and the first phase was introduced in the
marketplace in July 2005. The remaining phases continue to be developed and are
expected to be introduced in the marketplace by the end of 2006. This project
had reached technological feasibility prior to TSYS' acquisition of control of
TSYS Acquiring. The Company capitalized approximately $2.8 million during the
three months ended March 31, 2006, and has a total of $23.4 million capitalized
since the project began.
Through its ESC subsidiary, the Company is internally developing an
advanced loyalty platform - TSYS Loyalty Platform (TLP). TLP is designed to
support transactional speed, complex reward programs and robust analytics tools.
The platform offers critical support to all elements of loyalty management,
including points processing, tracking, communications, redemption systems and
analytics. The Company capitalized approximately $249,000 during the three
months ended March 31, 2006, and has a total of $6.3 million capitalized since
the project began. The project is expected to be fully operational and
introduced in the marketplace by July 2006.
The Company was developing its Integrated Payments Platform supporting the
on-line and off-line debit and stored value markets, which would have given
clients access to all national and regional networks, EBT programs, ATM driving
and switching services for online debit processing. The Company invested a total
of $6.3 million since the project began. As previously mentioned on page 34, the
Company evaluated its debit solution and decided to modify its approach in the
debit processing market. In March 2005, TSYS recognized an impairment charge in
net occupancy and equipment expense of approximately $3.1 million related to its
on-line debit solution. As of March 31, 2006, the Company has $1.1 million
capitalized, net of amortization, related to this asset.
Cash Used in Acquisitions
During the first quarter of 2005, the Company purchased TSYS Acquiring for
approximately $95.8 million, including direct acquisition costs of $794,000.
- 40 -
Financial Position, Liquidity and Capital Resources (continued)
Contract Acquisition Costs
TSYS makes cash payments for processing rights, third-party development
costs and other direct salary related costs in connection with converting new
customers to the Company's processing systems. The Company's investments in
contract acquisition costs were $9.6 million for the three months ended March
31, 2006, compared to $5.4 million for the three months ended March 31, 2005.
The Company had a cash payment for processing rights of approximately $675,000
during the three months ended March 31, 2006. The Company did not have any cash
payments for processing rights during the same period last year.
Conversion cost additions were $8.9 million and $5.4 million for the three
months ended March 31, 2006 and 2005, respectively. The increase in the amount
of conversion cost additions for 2006, as compared to 2005, is the result of
capitalized costs related to conversions scheduled to occur later in the year.
Cash Flows From Financing Activities
Three months ended March 31,
---------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
---------------------------------------------------------------------------------------------------------------------
Dividends paid on common stock $ (11,837) (7,874)
Principal payments on long-term debt borrowings and capital lease
obligations (402) (13,704)
Proceeds from borrowings of long-term debt - 14,125
------------------- -----------------
Net cash used in financing activities $ (12,239) (7,453)
=================== =================
The major use of cash for financing activities has been the principal
payments on long-term debt borrowings and capital lease obligations and the
payment of dividends. The main source of cash from financing activities has been
the occasional use of borrowed funds. Net cash used in financing activities for
the three months ended March 31, 2006 was $12.2 million mainly as a result of
the payments of dividends. Net cash used in financing activities for the three
months ended March 31, 2005 was $7.5 million mainly as a result of the payments
of dividends.
Line of Credit
TSYS has a $45.0 million long-term line of credit from a banking affiliate
of Synovus. A detailed discussion related to the line of credit is in Note 6 in
the Notes to Unaudited Condensed Consolidated Financial Statements on page 20.
At March 31, 2006, TSYS did not have an outstanding balance on the line of
credit.
Stock Repurchase Plan
On April 20, 2006, TSYS announced that its board had approved a stock
repurchase plan to purchase up to 2 million shares, which represents slightly
more than five percent of the shares of TSYS stock held by shareholders other
than Synovus. The shares may be purchased from time to time over a two year
period and will depend on various factors including price, market conditions,
acquisitions and the general financial position of TSYS. Repurchased shares will
be used for general corporate purposes.
Dividends
Dividends on common stock of $11.8 million were paid during the three
months ended March 31, 2006 compared to $7.9 million paid during the three
months ended March 31, 2005. On April 21,
- 41 -
Financial Position, Liquidity and Capital Resources (continued)
2005, the Company announced an increase in its quarterly dividend of 50% from
$0.04 to $0.06 per share.
Significant Noncash Transactions
During the first quarter of 2006, the Company issued 150,775 shares of
common stock with a market value of $3.0 million compared to 221,902 shares of
common stock with a market value of $5.1 million in the first quarter of 2005.
These shares are issued to certain key executive officers and non-management
members of its board of directors under nonvested shares for services to be
provided by such officers and directors in the future. The market value of the
common stock at the date of issuance is amortized as compensation expense over
the vesting period of the awards. Common stock issued under nonvested shares is
considered outstanding for purposes of the computation of diluted EPS.
Refer to Notes 5 and 7 of Notes to Unaudited Condensed Consolidated
Financial Statements for more information about share-based compensation.
Foreign Exchange
TSYS operates internationally and is subject to potentially adverse
movements in foreign currency exchange rates. Since December 2000, TSYS has not
entered into foreign exchange forward contracts to reduce its exposure to
foreign currency rate changes. TSYS continues to analyze potential hedging
instruments to safeguard it from significant foreign currency translation risks.
Impact of Inflation
Although the impact of inflation on its operations cannot be precisely
determined, the Company believes that by controlling its operating expenses, and
by taking advantage of more efficient computer hardware and software, it can
minimize the impact of inflation.
Working Capital
TSYS may seek additional external sources of capital in the future. The
form of any such financing will vary depending upon prevailing market and other
conditions and may include short-term or long-term borrowings from financial
institutions or the issuance of additional equity and/or debt securities such as
industrial revenue bonds. However, there can be no assurance that funds will be
available on terms acceptable to TSYS. Management expects that TSYS will
continue to be able to fund a significant portion of its capital expenditure
needs through internally generated cash in the future, as evidenced by TSYS'
current ratio of 2.2:1. At March 31, 2006, TSYS had working capital of $301.2
million compared to $235.3 million at December 31, 2005.
Legal Proceedings
The Company is subject to lawsuits, claims and other complaints arising out
of the ordinary conduct of its business. In the opinion of management, based in
part upon the advice of legal counsel, all matters are believed to be adequately
covered by insurance, or if not covered, are believed to be without merit or are
of such kind or involve such amounts that would not have a material adverse
effect on the financial position, results of operations or cash flows of the
Company if disposed of unfavorably. The Company establishes reserves for
expected future litigation exposures that TSYS determines to be both probable
and reasonably estimable.
- 42 -
Recent Accounting Pronouncements
The Company's Annual Report on Form 10-K for the year ended December 31,
2005, as filed with the SEC, contains a discussion of recent accounting
pronouncements and the expected impact on the Company's financial statements.
Forward-Looking Statements
Certain statements contained in this filing which are not statements of
historical fact constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act (the Act). These forward-looking
statements include, among others: (i) TSYS' expectation that it will deconvert
Citigroup's Sears and Bank of America's consumer accounts in the second quarter
of 2006 and October of 2006, respectively; (ii) TSYS' expectation that it will
continue providing commercial and small business card processing for Bank of
America and MBNA, as well as merchant processing for Bank of America; (iii) the
estimated termination fee to be paid by Bank of America in connection with
termination of its processing agreement; (iv) TSYS' belief that the loss of
revenues from the Bank of America consumer card portfolio for 2006 should not
have a material adverse effect on TSYS for 2006 and that the payment of the
termination fee associated with the deconversion should have a positive effect
on TSYS for 2006; (v) TSYS' expectation that it will convert Capital One's
portfolio in phases beginning in mid-2006 and ending in early 2007; (vi) TSYS'
expectation that it will maintain the card processing functions of Capital One
for at least five years; (vii) TSYS' expectation that it will maintain the card
processing functions of Chase for at least two years; (viii) TSYS' expectation
that it will continue to process commercial card accounts for Citibank, as well
as Citibank's Banamex USA consumer accounts; (ix) TSYS' belief that the loss of
revenue from the Sears portfolio for 2006 should not have a material adverse
effect on TSYS for 2006; (x) TSYS' expected earnings growth for 2006; (xi) TSYS'
belief with respect to lawsuits, claims and other complaints; (xii) TSYS'
expectation that total future MIPS will decline resulting in an increase in
software amortization; (xiii) the expected market introduction dates of various
development projects; and the assumptions underlying such statements, including,
with respect to TSYS' expected increase in earnings for 2006, an increase in
revenues of 6% to 8%, accounts on file at the end of 2006 will be approximately
395 million to 405 million, deconversion of the Citigroup Sears portfolio as
scheduled in May of 2006, deconversion of Bank of America's consumer portfolio
in October 2006 with a one-time termination payment of approximately $69 million
and an acceleration of amortization of approximately $7 million in
contract-acquisition costs and recognition of revenues and expenses associated
with the Capital One agreement beginning in the fourth quarter of 2006. In
addition, certain statements in future filings by TSYS with the Securities and
Exchange Commission, in press releases, and in oral and written statements made
by or with the approval of TSYS which are not statements of historical fact
constitute forward-looking statements within the meaning of the Act. Examples of
forward-looking statements include, but are not limited to: (i) projections of
revenue, income or loss, earnings or loss per share, the payment or nonpayment
of dividends, capital structure and other financial items; (ii) statements of
plans and objectives of TSYS or its management or Board of Directors, including
those relating to products or services; (iii) statements of future economic
performance; and (iv) statements of assumptions underlying such statements.
Words such as "believes," "anticipates," "expects," "intends," "targeted,"
"estimates," "projects," "plans," "may," "could," "should," "would," and similar
expressions are intended to identify forward-looking statements but are not the
exclusive means of identifying these statements.
These statements are based upon the current beliefs and expectations of
TSYS' management and are subject to significant risks and uncertainties. Actual
results may differ materially from those
- 43 -
Forward-Looking Statements (continued)
contemplated by the forward-looking statements. A number of important factors
could cause actual results to differ materially from those contemplated by our
forward-looking statements. Many of these factors are beyond TSYS' ability to
control or predict. These factors include, but are not limited to: (i) revenues
that are lower than anticipated; (ii) Bank of America does not deconvert as
anticipated, amortization of related contract acquisition costs is not
accelerated as anticipated and the termination fee is not in the amount
anticipated; (iii) accounts on file at the end of 2006 are lower than
anticipated; (iv) TSYS incurs expenses associated with the signing of a
significant client; (v) internal growth rates for TSYS' existing clients are
lower than anticipated; (vi) TSYS does not convert and deconvert clients'
portfolios as scheduled; (vii) adverse developments with respect to foreign
currency exchange rates; (viii) adverse developments with respect to entering
into contracts with new clients and retaining current clients; (ix) continued
consolidation in the financial services industry, including the merger of TSYS
clients with entities that are not TSYS clients or the sale of portfolios by
TSYS clients to entities that are not TSYS clients; (x) TSYS is unable to
control expenses and increase market share, both domestically and
internationally; (xi) adverse developments with respect to the credit card
industry in general, including a decline in the use of cards as a payment
mechanism; (xii) TSYS is unable to successfully manage any impact from slowing
economic conditions or consumer spending; (xiii) the impact of acquisitions,
including their being more difficult to integrate than anticipated; (xiv) the
costs and effects of litigation, investigations or similar matters or adverse
facts and developments relating thereto; (xv) the impact of the application of
and/or changes in accounting principles; (xvi) TSYS' inability to timely,
successfully and cost-effectively improve and implement processing systems to
provide new products, increased functionality and increased efficiencies; (xvii)
TSYS' inability to anticipate and respond to technological changes, particularly
with respect to e-commerce; (xviii) changes occur in laws, regulations, credit
card associations rules or other industry standards affecting TSYS' business
which require significant product redevelopment efforts or reduce the market for
or value of its products; (xix) successfully managing the potential both for
patent protection and patent liability in the context of rapidly developing
legal framework for expansive patent protection; (xx) no material breach of
security of any of our systems; (xxi) overall market conditions; (xxii) the loss
of a major supplier; (xxiii) the impact on TSYS' business, as well as on the
risks set forth above, of various domestic or international military or
terrorist activities or conflicts; and (xxiv) TSYS' ability to manage the
foregoing and other risks.
These forward-looking statements speak only as of the date on which they
are made and TSYS undertakes no obligation to update any forward-looking
statement as a result of new information, future developments or otherwise.
- 44 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Exchange Risk
TSYS is exposed to foreign exchange risk because it has assets,
liabilities, revenues and expenses denominated in foreign currencies including
the Euro, British Pounds Sterling (BPS), Mexican Peso, Canadian Dollar, Japanese
Yen and Chinese Renminbi. These currencies are translated into U.S. dollars at
current exchange rates, except for revenues, costs and expenses, and net income,
which are translated at the average exchange rates for each reporting period.
Net exchange gains or losses resulting from the translation of assets and
liabilities of TSYS' foreign operations, net of tax, are accumulated in a
separate section of shareholders' equity, titled "accumulated other
comprehensive income or loss." The amount of other comprehensive gain for the
three months ended March 31, 2006 was $412,000. The amount of other
comprehensive loss for the three months ended March 31, 2005 was $2.4 million.
Currently, TSYS does not use financial instruments to hedge its exposure to
exchange rate changes.
The carrying value of the net assets of its foreign operations in Europe,
Mexico, Brazil, Canada, Japan and China was approximately (in U.S. dollars)
$133.2 million, $6.5 million, $0.2 million, $0.8 million, $14.6 million and
$37.5 million, respectively, at March 31, 2006.
The Company also records foreign currency translation adjustments
associated with other balance sheet accounts. The Company maintains several cash
accounts denominated in foreign currencies, primarily in Euros and BPS. As the
Company translates the foreign-denominated cash balances into US dollars, the
translated cash balance is adjusted upward or downward depending upon the
foreign currency exchange movements. The upward or downward adjustment is
recorded as a gain or loss on foreign currency translation in the Company's
statements of income. As those cash accounts have increased, the upward or
downward adjustments have increased. The majority of the translation gain of
$276,000 for the three months ended March 31, 2006 relates to the translation of
cash accounts. The balance of the foreign-denominated cash accounts subject to
risk of translation gains or losses at March 31, 2006 was approximately $4.0
million, the majority of which is denominated in Euros.
The following represents the potential effect on income before income taxes
of hypothetical shifts in the foreign currency exchange rates and the U.S.
dollar of plus or minus 100 basis points, 500 basis points and 1,000 basis
points based on the foreign-denominated cash account balance at March 31, 2006.
----------------------------------------------------
Effect of Basis Point Change
----------------------------------------------------
Increase in basis Decrease in basis
point of point of
----------------------------------------------------
(in thousands) 100 500 1,000 100 500 1,000
--------------------------------------------------------------------------------------------------------- -------------------------
Effect on income before income taxes $ (40) (199) (398) 40 199 398
------------------------- -------------------------
The foreign currency risks associated with other currencies is not
significant.
- 45 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk (continued)
Interest Rate Risk
TSYS is also exposed to interest rate risk associated with the investing of
available cash and the use of long-term debt associated with its line of credit
as discussed below. TSYS invests available cash in conservative short-term
instruments and is primarily subject to changes in the short-term interest
rates.
In connection with the purchase of the TSYS campus, TSYS obtained a $45.0
million long-term line of credit from a banking affiliate of Synovus. The line
is an automatic draw down facility. The interest rate for the line of credit is
the London Interbank Offered Rate (LIBOR) plus 150 basis points. In addition,
there is a charge of 15 basis points on any funds unused. The line of credit is
unsecured debt and includes covenants requiring us to maintain certain minimum
financial ratios. At March 31, 2006, TSYS did not have an outstanding balance on
the line of credit. As the LIBOR rate changes, TSYS will be subject to interest
rate risk.
Concentration of Credit Risk
TSYS works to maintain a large and diverse client base across various
industries to minimize the credit risk of any one client to TSYS' accounts
receivable amounts. In addition, TSYS performs ongoing credit evaluations of its
certain clients' and certain suppliers' financial condition. TSYS does, however,
have two major customers that account for a large portion of its revenues, which
subjects it to credit risk.
Concentration of Client Base
A significant amount of TSYS' revenues are derived from long-term contracts
with large clients, including certain major customers. Processing contracts with
large clients, representing a significant portion of TSYS' total revenues,
generally provide for discounts on certain services based on the size and
activity of clients' portfolios. Therefore, electronic payment and merchant
services processing revenues and the related margins are influenced by the
client mix relative to the size of client card portfolios, as well as the number
and activity of individual cardholder accounts processed for each client.
Consolidation among financial institutions has resulted in an increasingly
concentrated client base, which results in a change in client mix directed
toward larger clients.
TSYS works to minimize the risk of any one client accounting for a large
portion of its revenues. TSYS has two major customers that account for a large
portion of its revenues. In addition to the two major customers, the Company has
other large clients representing a significant portion of its total revenues.
The loss of any one of its large clients could have a material adverse effect on
the financial position, results of operations and cash flows.
Concentration of Suppliers
TSYS utilizes several large and diverse suppliers across various industries
to minimize its reliance on any one supplier. However, TSYS does rely on a
relatively few major suppliers for a significant portion of its licensed
computer software and hardware needs. The relationship with these particular
vendors is well established. These particular vendors are large, well-known and
respected entities in their industry, which is believed to minimize the
Company's risk, but the loss of any one of these major licensed computer
software and hardware suppliers could have a material adverse effect on the
financial position, results of operations and cash flows.
- 46 -
TOTAL SYSTEM SERVICES, INC.
Item 4 - Controls and Procedures
We have evaluated the effectiveness of the design and operation of our
disclosure controls and procedures as of the end of the period covered by this
quarterly report as required by Rule 13a-15 of the Securities Exchange Act of
1934, as amended. This evaluation was carried out under the supervision and with
the participation of our management, including our chief executive officer and
chief financial officer. Based on this evaluation, these officers have concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to TSYS (including its consolidated
subsidiaries) required to be included in our periodic SEC filings. No change in
TSYS' internal control over financial reporting occurred during the period
covered by this report that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
- 47 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 1A - Risk Factors
In addition to the other information set forth in this report, you should
carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in
the Company's Annual Report on Form 10-K for the year ended December 31, 2005,
which could materially affect the Company's financial position, results of
operations or cash flows. The risks described in the Company's Annual Report on
Form 10-K are not the only risks facing the Company. Additional risks and
uncertainties not currently known to the Company or that the Company currently
deems to be immaterial also may materially adversely affect the Company's
financial position, results of operations or cash flows.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds
The following table sets forth information regarding the Company's
purchases of its common stock on a monthly basis during the three months ended
March 31, 2006:
------------------------------------------------------------------------------------------------------------------------------------
Maximum
Total Number of
Number of Shares
Shares Purchased That May Yet
Total Average as Part of Be Purchased
Number of Price Publicly Under the
Shares Paid per Announced Plans Plans or
Period Purchased Share or Programs Programs
------------------------------------------------------------------------------------------------------------------------------------
January 2006 - $- - -
February 2006 - - - -
March 2006 - - - -
------------------------------------------------------------------------------------------------------------------------------------
Total - $-
=========================
In April 2006, the Company announced a plan to purchase up to 2.0 million
shares of its common stock from time to time and at prices attractive to
management over the ensuing two years.
- 48 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 6 - Exhibits
a) Exhibits
Exhibit Number Description
--------------------------------------------------------------------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and
Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- 49 -
TOTAL SYSTEM SERVICES, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TOTAL SYSTEM SERVICES, INC.
Date: May 8, 2006 by: /s/ Philip W. Tomlinson
----------------------------------------------------
Philip W. Tomlinson
Chairman of the Board and
Chief Executive Officer
Date: May 8, 2006 by: /s/ James B. Lipham
----------------------------------------------------
James B. Lipham
Senior Executive Vice President and
Chief Financial Officer
- 50 -
TOTAL SYSTEM SERVICES, INC.
Exhibit Index
Exhibit Number Description
------------------------------------------------------------------------------------------------------------------------------------
31.1 Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification of Chief Executive Officer and
Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- 51 -