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: June 30, 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
_______________________________________________________________________________
(Exact name of registrant as specified in its charter)
Georgia 58-1493818
_______________________________________________________________________________
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1600 First Avenue, Post Office Box 1755, Columbus, Georgia 31902
_______________________________________________________________________________
(Address of principal executive offices) (Zip Code)
(706) 649-2262
_______________________________________________________________________________
(Registrant's telephone number, including area code)
_______________________________________________________________________________
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X] No [ ]
Indicate by check mark whether the registrant is 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: August 4, 2006
---------------------------------------- ---------------------------------
Common Stock, $0.10 par value 196,612,906 shares
[TSYS LOGO OMITTED]
TOTAL SYSTEM SERVICES, INC.
INDEX
Page
Number
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited)
- June 30, 2006 and December 31, 2005 3
Condensed Consolidated Statements of Income
(unaudited) - Three and six months ended
June 30, 2006 and 2005 5
Condensed Consolidated Statements of Cash Flows
(unaudited) - Six months ended
June 30, 2006 and 2005 7
Notes to Unaudited Condensed Consolidated
Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 27
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 53
Item 4. Controls and Procedures 56
Part II. Other Information
Item 1A. Risk Factors 57
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 57
Item 4. Submissions of Matters to a Vote of Security Holders 58
Item 6. Exhibits 59
Signatures 60
Exhibit Index 61
- 2 -
TOTAL SYSTEM SERVICES, INC.
Part I - Financial Information
Condensed Consolidated Balance Sheets
(Unaudited)
---------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(in thousands, except per share information) 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents (includes $192.8 million and $152.6 million on
deposit with a related party at 2006 and 2005, respectively) $ 295,483 237,569
Restricted cash (includes $5.8 million and $4.1 million on deposit with a
related party at 2006 and 2005, respectively) 37,326 29,688
Accounts receivable, net of allowance for doubtful accounts and billing
adjustments of $12.7 million and $12.6 million at 2006 and 2005,
respectively (includes $0.6 million and $0.1 million due from a related
party at 2006 and 2005, respectively) 189,808 184,532
Deferred income tax assets 20,597 15,264
Prepaid expenses and other current assets 47,452 45,236
--------------------------------------------
Total current assets 590,666 512,289
Property and equipment, net of accumulated depreciation and amortization of
$206.9 million and $188.1 million at 2006 and 2005, respectively 264,897 267,979
Computer software, net of accumulated amortization of $357.7 million and $317.1
million at 2006 and 2005, respectively 241,449 267,988
Contract acquisition costs, net 165,346 163,861
Goodwill, net 106,390 112,865
Equity investments 42,757 42,731
Other intangible assets, net of accumulated amortization of $7.0 million and
$5.4 million at 2006 and 2005, respectively 11,865 13,580
Other assets 24,077 29,604
--------------------------------------------
Total assets $ 1,447,447 1,410,897
============================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 3 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Balance Sheets (continued)
(Unaudited)
---------------------------------------------------------------------------------------------------------------------------------
June 30, December 31,
(in thousands, except per share information) 2006 2005
---------------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable (includes $0.1 million and $0.1 million payable to related
parties at 2006 and 2005, respectively) $ 30,057 29,464
Accrued salaries and employee benefits 42,776 84,348
Current portion of obligations under capital leases 2,317 2,078
Other current liabilities (includes $11.3 million and $9.9 million payable to
related parties at 2006 and 2005, respectively) 158,414 161,122
--------------------------------------------
Total current liabilities 233,564 277,012
Obligations under capital leases, excluding current portion 2,261 3,555
Deferred income tax liabilities 77,509 89,478
Other long-term liabilities 25,239 24,398
--------------------------------------------
Total liabilities 338,573 394,443
--------------------------------------------
Minority interests in consolidated subsidiary 3,964 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 55,954 50,666
Accumulated other comprehensive income 10,391 5,685
Treasury stock (692 shares at 2006 and 2005) (12,841) (12,841)
Retained earnings 1,031,593 949,465
--------------------------------------------
Total shareholders' equity 1,104,910 1,012,772
--------------------------------------------
Total liabilities and shareholders' equity $ 1,447,447 1,410,897
============================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 4 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Income
(Unaudited)
------------------------------------------------------------------------------------------------------------------------------------
Three months ended
June 30,
-----------------------------------------
(in thousands, except per share information) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $1.2 million and
$1.2 million from related parties for 2006 and 2005, respectively) $ 232,301 217,048
Merchant services 65,820 68,696
Other services (includes $2.2 million and $1.6 million from related
parties for 2006 and 2005, respectively) 44,670 45,324
-----------------------------------------
Revenues before reimbursable items 342,791 331,068
Reimbursable items (includes $0.5 million and $0.4 million from related
parties for 2006 and 2005, respectively) 86,374 79,175
-----------------------------------------
Total revenues 429,165 410,243
-----------------------------------------
Expenses:
Salaries and other personnel expense 120,433 115,974
Net occupancy and equipment expense 75,703 69,568
Other operating expenses (includes $2.6 million and $2.2 million to
related parties for 2006 and 2005, respectively) 61,924 69,180
-----------------------------------------
Expenses before reimbursable items 258,060 254,722
Reimbursable items 86,374 79,175
-----------------------------------------
Total expenses 344,434 333,897
-----------------------------------------
Operating income 84,731 76,346
-----------------------------------------
Nonoperating income (expense):
Interest income (includes $1.8 million and $0.3 million from related
parties for 2006 and 2005, respectively) 3,425 1,078
Interest expense (85) (105)
Loss on foreign currency, net (363) (494)
-----------------------------------------
Total nonoperating income 2,977 479
-----------------------------------------
Income before income taxes, minority interest and equity in income of
equity investments 87,708 76,825
Income taxes 31,148 26,729
Minority interests in consolidated subsidiaries' net income (173) (43)
Equity in income of equity investments 1,019 590
-----------------------------------------
Net income $ 57,406 50,643
=========================================
Basic earnings per share $ 0.29 0.26
=========================================
Diluted earnings per share $ 0.29 0.26
=========================================
Weighted average common shares outstanding 197,093 197,078
Increase due to assumed issuance of shares related to common
equivalent shares 237 217
-----------------------------------------
Weighted average common and common equivalent shares outstanding 197,330 197,295
=========================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 5 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Income
(Unaudited)
------------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
-------------------------------------
(in thousands, except per share information) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues:
Electronic payment processing services (includes $2.5 million and
$2.4 million from related parties for 2006 and 2005, respectively) $ 453,362 421,805
Merchant services (includes $2.4 million from related parties for 2005) 129,769 95,801
Other services (includes $3.8 million and $3.3 million from related
parties for 2006 and 2005, respectively) 89,212 93,838
-----------------------------------------
Revenues before reimbursable items 672,343 611,444
Reimbursable items (includes $0.9 million and $2.2 million from
related parties for 2006 and 2005, respectively) 169,112 148,783
-----------------------------------------
Total revenues 841,455 760,227
-----------------------------------------
Expenses:
Salaries and other personnel expense 241,763 212,952
Net occupancy and equipment expense 151,053 135,637
Other operating expenses (includes $5.2 million and $4.2 million to
related parties for 2006 and 2005, respectively) 122,939 120,203
-----------------------------------------
Expenses before reimbursable items 515,755 468,792
Reimbursable items 169,112 148,783
-----------------------------------------
Total expenses 684,867 617,575
-----------------------------------------
Operating income 156,588 142,652
-----------------------------------------
Nonoperating income (expense):
Interest income (includes $3.2 million and $0.8 million from related
parties for 2006 and 2005, respectively) 5,933 2,297
Interest expense (129) (175)
Loss on foreign currency, net (87) (827)
-----------------------------------------
Total nonoperating income 5,717 1,295
-----------------------------------------
Income before income taxes, minority interest and equity in income of
equity investments 162,305 143,947
Income taxes 56,113 51,409
Minority interests in consolidated subsidiaries' net income (264) (112)
Equity in income of equity investments 1,871 4,340
-----------------------------------------
Net income $ 107,799 96,766
=========================================
Basic earnings per share $ 0.55 0.49
=========================================
Diluted earnings per share $ 0.55 0.49
=========================================
Weighted average common shares outstanding 197,089 197,050
Increase due to assumed issuance of shares related to common
equivalent shares 245 215
-----------------------------------------
Weighted average common and common equivalent shares outstanding 197,334 197,265
=========================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 6 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
------------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
-------------------------------------------
(in thousands) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 107,799 96,766
Adjustments to reconcile net income to net cash provided by operating
activities:
Minority interests in consolidated subsidiaries' net income 264 112
Loss on foreign currency, net 87 827
Equity in income of equity investments (1,871) (4,340)
Depreciation and amortization 86,148 68,962
Share-based compensation 4,445 560
Impairment of developed software - 3,137
Provisions for bad debt expenses and billing adjustments 224 2,688
Charges for transaction processing provisions 7,501 4,595
Deferred income tax (benefit) expense (17,041) 4,622
Loss on disposal of equipment, net 105 1,725
(Increase) decrease in:
Accounts receivable (4,442) (35,538)
Prepaid expenses and other assets 3,830 1,142
Increase (decrease) in:
Accounts payable 451 (47,132)
Accrued salaries and employee benefits (41,590) (15,124)
Other liabilities (17,338) (45,249)
-------------------------------------------
Net cash provided by operating activities 128,572 37,753
-------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment, net (14,306) (20,383)
Additions to licensed computer software from vendors (4,437) (10,647)
Additions to internally developed computer software (8,999) (10,388)
Cash acquired in acquisitions - 38,799
Cash used in acquisitions - (95,782)
Dividends received from equity investments 2,371 1,659
Additions to contract acquisition costs (22,339) (10,981)
-------------------------------------------
Net cash used in investing activities (47,710) (107,723)
-------------------------------------------
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 7 -
TOTAL SYSTEM SERVICES, INC.
Condensed Consolidated Statements of Cash Flows (continued)
(Unaudited)
------------------------------------------------------------------------------------------------------------------------------------
Six months ended
June 30,
-------------------------------------------
(in thousands) 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Dividends paid on common stock (includes $19.2 million and $12.8 million
paid to related parties during 2006 and 2005, respectively) $ (23,683) (15,757)
Principal payments on long-term debt borrowings and capital lease
obligations (1,060) (48,923)
Proceeds from borrowings of long-term debt - 48,142
Proceeds from exercise of stock options - 427
-------------------------------------------
Net cash used in financing activities (24,743) (16,111)
-------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 1,795 (2,000)
-------------------------------------------
Net increase (decrease) in cash and cash equivalents $ 57,914 (88,081)
Cash and cash equivalents at beginning of year 237,569 231,806
-------------------------------------------
Cash and cash equivalents at end of period $ 295,483 143,725
===========================================
Cash paid for interest $ 129 175
===========================================
Cash paid for income taxes, net of refunds $ 81,886 64,439
===========================================
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
- 8 -
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
and TSYS' majority owned foreign subsidiary. 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:
(in thousands) June 30, 2006 December 31, 2005
------------------------------------------------------------------------------------------------ --------------------
Cash and cash equivalents in domestic accounts $ 252,507 191,837
Cash and cash equivalents in foreign accounts 42,976 45,732
------------------------ --------------------
Total $ 295,483 237,569
======================== ====================
- 9 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
The Company maintains accounts outside the United States denominated in
U.S. dollars, Euros, British Pounds Sterling (BPS), Canadian dollars, Japanese
Yen, Chinese Renminbi and Brazilian Real. 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) June 30, 2006 December 31, 2005
--------------------------------------------------------------------------------------------- --------------------------
Prepaid expenses $ 17,889 15,053
Supplies inventory 9,292 9,742
Other 20,271 20,441
----------------------- --------------------------
Total $ 47,452 45,236
======================= ==========================
Contract Acquisition Costs, net
Significant components of contract acquisition costs, net of accumulated
amortization, are summarized as follows:
(in thousands) June 30, 2006 December 31, 2005
--------------------------------------------------------------------------------------------- --------------------------
Payments for processing rights, net $ 111,180 120,015
Conversion costs, net 54,166 43,846
----------------------- --------------------------
Total $ 165,346 163,861
======================= ==========================
Amortization related to payments for processing rights, which is recorded
as a reduction of revenues, was $7.2 million and $3.7 million for the three
months ended June 30, 2006 and 2005, respectively. For the six months ended June
30, 2006 and 2005, amortization related to payments for processing rights was
$13.8 million and $7.1 million, respectively.
Amortization expense related to conversion costs was $4.5 million and $3.1
million for the three months ended June 30, 2006 and 2005, respectively. For the
six months ended June 30, 2006 and 2005, amortization related to conversion
costs was $9.4 million and $6.0 million, 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 Solutions, L.L.C. (TSYS Acquiring).
Other Current Liabilities
Significant components of other current liabilities are summarized as
follows:
- 10 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(in thousands) June 30, 2006 December 31, 2005
------------------------------------------------------------------------------------------- ----------------------------
Client liabilities $ 41,744 34,381
Accrued expenses 37,156 39,882
Accrued income taxes 14,912 25,443
Transaction processing provisions 14,129 9,453
Dividends payable 13,820 11,832
Client postage deposits 6,431 7,459
Deferred revenues 6,385 6,421
Other 23,837 26,251
--------------------- ----------------------------
Total $ 158,414 161,122
===================== ============================
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 and six months ended June 30 is as
follows:
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
(in thousands) 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Net income $ 57,406 50,643 107,799 96,766
Other comprehensive income (loss):
Foreign currency translation
adjustments, net of tax 4,295 (2,944) 4,706 (5,367)
----------------------------------------------------
Total $ 61,701 47,699 112,505 91,399
====================================================
The income tax effects allocated to and the cumulative balance of
accumulated other comprehensive income are as follows:
Balance at Pretax Balance at
(in thousands) December 31, 2005 amount Tax effect June 30, 2006
------------------------------------------------------------------------------------------------------------------------------------
Foreign currency translation adjustments $5,685 7,297 (2,591) $10,391
====================================================
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.
In April 2006, TSYS renamed Vital Processing Services, L.L.C. as TSYS
Acquiring.
- 11 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
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.
Effective January 1, 2006, Golden Retriever Systems L.L.C. became a wholly
owned subsidiary of Enhancement Services Corporation (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 two entities are included in the
domestic-based support services segment. The results for previous periods have
been reclassified to reflect these changes.
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.
Domestic-based support services include electronic payment processing
services and other services provided from within the United States.
Domestic-based support services segment includes the financial results of TSYS,
excluding its foreign branch offices, and including the following subsidiaries:
Columbus Depot Equipment Company (CDEC), Columbus Productions, Inc. (CPI), TSYS
Canada, Inc. (TSYS Canada), TSYS Total Debt Management, Inc. (TDM), ProCard,
Inc. (ProCard), TSYS Technology Center, Inc. (TTC), TSYS Prepaid, Inc. (TPI),
Merlin Solutions, L.L.C. (Merlin) and ESC and its wholly owned subsidiary,
Golden Retriever Systems, L.L.C.
International-based support services include electronic payment processing
and other services provided from outside the United States. International-based
support services include the financial results of GP Network Corporation (GP
Net), TSYS Japan Co., Ltd. (TSYS Japan), TSYS Servicos De Transacoes Eletronicas
Ltda. (TSYS Brazil) , TSYS Europe (Netherlands) B.V., TSYS Europe (Spain) S.L.
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 June 30, 2006
------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 1,361,896 188,752 238,180 $ 1,788,828
Intersegment eliminations (341,199) - (182) (341,381)
------------ --------- --------- -------------
Total assets $ 1,020,697 188,752 237,998 $ 1,447,447
============ ========= ========= =============
- 12 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Domestic- International-
based based Merchant
(in thousands) support support processing
Operating Segments services services services Consolidated
------------------------------------------------------------------------------------------------------------------------------------
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 June 30, 2006
------------------------------------------------------------------------------------------------------------------------------------
Revenues before reimbursables $ 253,313 34,145 60,144 $ 347,602
Intersegment revenues (4,778) - (33) (4,811)
------------ -------- ---------- ----------
Revenues before reimbursables from external customers $ 248,535 34,145 60,111 $ 342,791
============ ======== ========== ============
Segment total revenues $ 325,105 40,326 70,736 $ 436,167
Intersegment revenues (6,969) - (33) (7,002)
------------ -------- ---------- ------------
Revenues from external customers $ 318,136 40,326 70,703 $ 429,165
============ ======== ========== ============
Depreciation and amortization $ 31,692 4,795 6,499 $ 42,986
============ ======== ========== ============
Intersegment expenses $ 6,591 (5,536) (8,046) $ (6,991)
============ ======== ========== ============
Segment operating income $ 66,780 3,204 14,747 $ 84,731
============ ======== ========== ============
Income before income taxes, minority interest and equity in income of
equity investments $ 70,001 2,389 15,318 $ 87,708
============ ======== ========== ============
Income taxes $ 23,443 1,926 5,779 $ 31,148
============ ======== ========== ============
Equity in income of equity investments $ - 1,019 - $ 1,019
============ ======== ========== ============
Net income $ 46,712 1,155 9,539 $ 57,406
============ ======== ========== ============
------------------------------------------------------------------------------------------------------------------------------------
Three months ended June 30, 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues before reimbursables $ 241,118 30,480 63,313 $ 334,911
Intersegment revenues (3,812) - (31) (3,843)
------------ -------- ---------- ------------
Revenues before reimbursables from external customers $ 237,306 30,480 63,282 $ 331,068
============ ======== ========== ============
Segment total revenues $ 306,835 35,128 74,552 $ 416,515
Intersegment revenues (6,241) - (31) (6,272)
------------ -------- ---------- -------------
Revenues from external customers $ 300,594 35,128 74,521 $ 410,243
============ ======== ========== ============
Depreciation and amortization $ 28,203 4,248 4,325 $ 36,776
============ ======== ========== ============
Intersegment expenses $ 10,709 (9,383) (7,605) $ (6,279)
============ ======== ========== ============
Segment operating income $ 63,417 (835) 13,764 $ 76,346
============ ======== ========== ============
Income before income taxes, minority interest and equity in income of
equity investments $ 64,528 (1,630) 13,927 $ 76,825
============ ======== ========== ============
Income taxes $ 21,897 (572) 5,404 $ 26,729
============ ======== ========== ============
Equity in income of equity investments $ - 590 - $ 590
============ ======== ========== ============
Net income $ 42,430 (336) 8,549 $ 50,643
============ ======== ========== ============
------------------------------------------------------------------------------------------------------------------------------------
Six months ended June 30, 2006
------------------------------------------------------------------------------------------------------------------------------------
Revenues before reimbursables $ 497,756 64,858 119,006 $ 681,620
Intersegment revenues (9,212) - (65) (9,277)
------------ -------- ---------- ------------
Revenues before reimbursables from external customers $ 488,544 64,858 118,941 $ 672,343
============ ======== ========== ============
Segment total revenues $ 637,935 76,572 141,068 $ 855,575
Intersegment revenues $ (14,055) - (65) $ (14,120)
------------ -------- ---------- ------------
Revenues from external customers $ 623,880 76,572 141,003 $ 841,455
============ ======== ========== ============
- 13 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Domestic- International-
based based Merchant
(in thousands) support support processing
Operating Segments services services services Consolidated
------------------------------------------------------------------------------------------------------------------------------------
Six months ended June 30, 2006
------------------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 63,603 8,773 13,772 $ 86,148
============ ======== ========== ============
Intersegment expenses $ 15,282 (13,111) (16,265) $ (14,094)
============ ======== ========== ============
Segment operating income $ 127,745 4,083 24,760 $ 156,588
============ ======== ========== ============
Income before income taxes, minority interest and equity in income of
equity investments $ 133,481 3,116 25,708 $ 162,305
============ ======== ========== ============
Income taxes $ 43,914 2,493 9,706 $ 56,113
============ ======== ========== ============
Equity in income of equity investments $ - 1,871 - $ 1,871
============ ======== ========== ============
Net income $ 89,531 2,266 16,002 $ 107,799
============ ======== ========== ============
------------------------------------------------------------------------------------------------------------------------------------
Six months ended June 30, 2005
------------------------------------------------------------------------------------------------------------------------------------
Revenues before reimbursables $ 471,131 61,328 84,111 $ 616,570
Intersegment revenues (5,095) - (31) (5,126)
------------ -------- ---------- ------------
Revenues before reimbursables from external customers $ 466,036 61,328 84,080 $ 611,444
============ ======== ========== ============
Segment total revenues $ 597,852 71,743 98,887 $ 768,482
Intersegment revenues (8,224) - (31) (8,255)
------------ -------- ---------- ------------
Revenues from external customers $ 589,628 71,743 98,856 $ 760,227
============ ======== ========== ============
Depreciation and amortization $ 55,143 8,016 5,803 $ 68,962
============ ======== ========== ============
Intersegment expenses $ 19,234 (17,538) (9,958) $ (8,262)
============ ======== ========== ============
Segment operating income $ 123,909 2,006 16,737 $ 142,652
============ ======== ========== ============
Income before income taxes, minority interest and equity in income of
equity investments $ 126,125 862 16,960 $ 143,947
============ ======== ========== ============
Income taxes $ 42,628 1,067 7,714 $ 51,409
============ ======== ========== ============
Equity in income of equity investments $ - 1,099 3,241 $ 4,340
============ ======== ========== ============
Net income $ 82,831 1,419 12,516 $ 96,766
============ ======== ========== ============
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 data presents revenues for the three and six
months ended June 30, 2006 and 2005, respectively, based on the domicile of the
Company's customers.
- 14 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
(in millions) 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
United States $ 360.3 350.0 710.2 639.8
Europe 36.2 31.5 68.9 64.7
Canada 24.0 22.4 46.1 43.5
Japan 4.5 3.9 8.4 7.6
Mexico 2.9 1.7 5.4 3.4
Other 1.3 0.7 2.5 1.2
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 429.2 410.2 841.5 760.2
====================================================
The following table reconciles geographic revenues to revenues by reporting
segment for the three months ended June 30, 2006 and 2005, respectively, based
on the domicile of the Company's customers.
Domestic- International-
based based Merchant
support support processing
services services services
----------------------------------------------------
(in millions) 2006 2005 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
United States $ 289.9 275.8 - - 70.4 74.2
Europe 0.3 0.3 35.9 31.2 - -
Canada 23.9 22.3 - - 0.1 0.1
Japan - - 4.5 3.9 - -
Mexico 2.9 1.7 - - - -
Other 1.1 0.5 - - 0.2 0.2
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 318.1 300.6 40.4 35.1 70.7 74.5
====================================================
Note: The 2005 geographic revenues by operating segment have been
reclassified to reflect the changes in operating segments.
The following table reconciles geographic revenues to revenues by reporting
segment for the six months ended June 30, 2006 and 2005, respectively, based on
the domicile of the Company's customers.
Domestic- International-
based based Merchant
support support processing
services services services
----------------------------------------------------
(in millions) 2006 2005 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
United States $ 569.8 541.3 - - 140.4 98.5
Europe 0.7 0.6 68.2 64.1 - -
Canada 45.8 43.3 - - 0.3 0.2
Japan - - 8.4 7.6 - -
Mexico 5.4 3.4 - - - -
Other 2.2 1.0 - - 0.3 0.2
------------------------------------------------------------------------------------------------------------------------------------
Totals $ 623.9 589.6 76.6 71.7 141.0 98.9
====================================================
Note: The 2005 geographic revenues by operating segment have been
reclassified to reflect the changes in operating segments.
- 15 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
The Company maintains property and equipment, net of accumulated
depreciation and amortization, in the following geographic areas:
At June 30, At December 31,
(in millions) 2006 2005
---------------------------------------------------------------------------------------------------------------------------
United States $ 206.8 211.2
Europe 55.7 55.3
Japan 2.1 1.4
Canada 0.1 0.1
Other 0.2 -
---------------------------------------------------------------------------------------------------------------------------
Totals $ 264.9 268.0
====================================================
Major Customers
For the three months ended June 30, 2006, the Company had two major
customers which accounted for approximately 33.8%, or $145.1 million, of total
revenues. Bank of America, one of TSYS' major customers, accounted for
approximately 23.7%, or $101.8 million of total revenues for the three months
ended June 30, 2006. For the three months ended June 30, 2005, the Company had
one major customer that accounted for approximately 23.8%, or $97.8 million, of
total revenues.
For the six months ended June 30, 2006, the Company had two major customers
which accounted for approximately 34.0%, or $286.1 million, of total revenues.
Bank of America, one of TSYS' major customers, accounted for approximately
23.5%, or $198.1 million of total revenues for the six months ended June 30,
2006. For the six months ended June 30, 2005, the Company had one major customer
that accounted for approximately 22.4%, or $170.0 million, of total revenues.
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
- 16 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
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 and six months ended June 30, 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.
Three months ended Six months ended
June 30, 2005 June 30, 2005
(in thousands, except per share data) ------------------------- ------------------------
Net Income $ 50,643 96,766
Add: Stock-based employee compensation expense, net of related
income tax effects 184 365
Deduct: Stock-based employee compensation expense determined under the
fair value based method for all awards, net of related income tax effects (1,236) (2,623)
------------------------- ------------------------
Net income, as adjusted $ 49,591 94,508
========================= ========================
Earnings per share:
Basic - as reported $ 0.26 0.49
========================= ========================
Basic - as adjusted $ 0.25 0.48
========================= ========================
Diluted - as reported $ 0.26 0.49
========================= ========================
Diluted - as adjusted $ 0.25 0.48
========================= ========================
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 were 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 forfeiture rate for existing Synovus stock
- 17 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
option grants to TSYS non-executive employees, and a forfeiture rate for all
other TSYS and Synovus share-based awards. Currently, TSYS estimates a
forfeiture rate in the range of 0% to 7.5%.
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. 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.
- 18 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
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 June 30, 2006, there were options outstanding under the TSYS 2002
Plan to purchase 342,721 shares of the Company's common stock, of which 320,221
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 June 30, 2006 under the TSYS 2002 plan.
2000 Long-Term Incentive Plan: TSYS maintains the 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 the time of grant and may not exceed ten years from the date of
the grant. At June 30, 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 June 30, 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
June 30, 2006, options to purchase 37,500 shares 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
June 30, 2006, share-based compensation was $2.2 million, compared to $0.3
million for the same period in 2005. Included in the $2.2 million amount for
2006 is approximately $1.7 million related to expensing the fair value of stock
options. For the six months ended June 30, 2006, share-based compensation was
$4.4 million, compared to $0.6 million for the same period in 2005. Included in
the $4.4 million amount for 2006 is approximately $3.5 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.
- 19 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
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.
The Company did not grant any shares under nonvested stock bonus awards
during the three months ended June 30, 2006 or 2005.
A summary of the status of TSYS' nonvested shares as of June 30, 2006 and
changes during the six months ended June 30, 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 June 30, 2006, there was approximately $4.0 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 2.7 years.
During 2005, TSYS authorized a total grant of 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. Each year's award is 20% of the total
authorized shares. Compensation expense for each year's award is measured on the
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
June 30, 2006 and changes during the six months ended June 30, 2006 is presented
below:
(in thousands)
Performance-based Weighted Average
Nonvested shares: Shares Grant-Date Fair Value
---------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 25 $ 24.93
Granted 25 20.00
Vested (25) 24.93
Forfeited/Canceled - -
----------------------------------------------------
Outstanding at end of period 25 $ 20.00
====================================================
As of June 30, 2006, there was approximately $0.3 million of total
unrecognized compensation cost related to nonvested performance-vesting
share-based compensation arrangements. That cost is expected to be recognized
over the remainder of 2006.
- 20 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Stock Option Awards
The Company did not grant any TSYS stock options during the six months
ended June 30, 2006 and 2005, respectively. A summary of the TSYS stock option
activity as of June 30, 2006 and changes during the six months ended on June 30,
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 (12) 20.10
-------------------------------------------------------------------------------------------------------------
Outstanding at end of period 1,370 $ 15.15 2.5 $13,453
--------------------------------------------------------------------------------====================================================
Options exercisable at period-end 1,347 $ 14.94 2.4 $13,022
--------------------------------------------------------------------------------====================================================
Weighted average fair value of options granted during the period $ -
-------------------------------------------------------------------------------- =================
There were no TSYS stock options that were exercised during the six months
ended June 30, 2006 and 2005, respectively. As a result, the Company did not
realize any tax benefits from stock option exercises. For awards granted before
January 1, 2006 that were not fully vested on January 1, 2006, the Company will
record the tax benefits from the exercise of stock options as increases to the
"Additional paid-in capital" line item of the Consolidated Balance Sheets. The
Company will record these tax benefits from share-based compensation costs as
cash inflows in the financing section in the Statement of Cash Flows. The
Company has elected 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 June 30, 2006, there was approximately $102,000 of total unrecognized
compensation expense cost related to TSYS stock options that is expected to be
recognized over a weighted average period of 0.7 year.
Long-Term Incentive Plans - Synovus
During the first six 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 June 30, 2006 and changes during the six months
ended on June 30, 2006 is presented below:
- 21 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
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 (343) 20.64
Net Synovus/TSYS employee transfers between entities (3) 22.13
Forfeited/Canceled (51) 24.21
------------------------------------------------------------------------------------------------------------
Outstanding at end of period 6,359 $ 26.17 5.3 $55,396
--------------------------------------------------------------------------------====================================================
Options exercisable at period-end 2,687 $ 23.40 4.0 $22,409
--------------------------------------------------------------------------------====================================================
Weighted average fair value of options granted during the period $ 6.57
-------------------------------------------------------------------------------- ============
The total intrinsic value of Synovus options exercised during the six
months ended June 30, 2006 was $1.9 million. As of June 30, 2006, there was
$11.9 million of total unrecognized compensation expense cost related to Synovus
stock options that is expected to be recognized over a weighted average period
of 1.8 years.
During the first six 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: 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 six
months ended June 30, 2005 was $1.6 million.
Earnings Per Share
The diluted earnings per share calculation excludes stock options and
nonvested awards that are convertible into 387,339 common shares for the three
and six months ended June 30, 2006, respectively, and excludes 22,500 common
shares for the three and six months ended June 30, 2005, respectively because
their inclusion would have been anti-dilutive.
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 was an automatic draw down
facility. The interest rate for the line of credit was the London Interbank
Offered Rate (LIBOR) plus 150 basis points. In addition, there was a charge of
15 basis points on any funds unused. The line of credit was unsecured and
included covenants requiring the Company to maintain certain minimum financial
ratios. The line of credit expired on June 30, 2006.
- 22 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
Note 7 - Supplementary Cash Flow Information
Contract Acquisition Costs
Cash used for contract acquisition costs for the six months ended June 30,
2006 and 2005, respectively, are summarized as follows:
(in thousands) June 30, 2006 June 30, 2005
--------------------------------------------------------------------------------------------------------------------------
Conversion costs $ 19,176 10,981
Payments for processing rights 3,163 -
--------------------------------------------------------------------------------------------------------------------------
Total $ 22,339 10,981
====================================================
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 - Guarantees and Indemnifications
The Company has entered into processing and licensing agreements with
clients that include intellectual property indemnification clauses. The Company
generally agrees to indemnify its clients, subject to certain exceptions,
against legal claims that TSYS' services or systems infringes on certain third
party patents, copyrights or other proprietary rights. In the event of such a
claim, the Company is generally obligated to hold the client harmless and pay
for related losses, liabilities, costs and expenses, including, without
limitation, court costs and reasonable attorney's fees. The Company has not made
any indemnification payments in relation to these indemnification clauses.
The Company has not recorded a liability for guarantees or indemnities in
the accompanying consolidated balance sheet since the maximum amount of
potential future payments under such guarantees and indemnities is not
determinable.
Note 10 - 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. CUP is sanctioned by the People's Bank of
China, China's central bank, to perform payments-processing. CUP Data currently
- 23 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
provides transaction processing, disaster recovery and other services for banks
and bankcard issuers in China.
The Company is using the equity method of accounting to account for its
investment in CUP Data. The difference between the cost of the 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). TSYS Acquiring provides 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 Vital from Visa for
$95.8 million in cash, including direct acquisition costs of $794,000. In April
2006, TSYS renamed Vital as TSYS Acquiring. 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 TSYS' consolidated financial statements. 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 acquisition of TSYS Acquiring allows TSYS to be a provider of
value-based services at both ends of the payment chain and allows TSYS to expand
the services offered to the Company's largest customers. Revenues associated
with TSYS Acquiring are included in merchant services and are classified in
merchant processing services for segment reporting purposes.
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
- 24 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
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 six months ended June 30, 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.
Six months ended
(in thousands, except per share data) June 30, 2005
------------------------------------------------------------------------------------------------------
Revenues $ 803,817
Net income 98,770
Basic earnings per share 0.50
Diluted earnings per share 0.50
Note 11 - Subsequent Events
TSYS Card Tech
On July 11, 2006, TSYS acquired Card Tech, Ltd., a privately owned London
based payments firm, and related companies, adding issuing and acquiring
capabilities and extending its geographic reach to Asia Pacific, Europe, the
Middle East and Africa. TSYS paid an aggregate consideration of approximately
$58 million.
Card Tech, Ltd. was established in 1989 and keeps service centers in
London; Dubai, United Arab Emirates; Nicosia, Cyprus; and Kuala Lumpur,
Malaysia. TSYS operates facilities in North America, Europe and the Asia-Pacific
for a combined total of 12 countries worldwide.
Card Tech has implemented its payments software for six of the 25 largest
global banks and three of the largest global card issuers. Worldwide, the
company has approximately 190 clients from 70 countries - primarily banks. Its
applications are certified by all of the major global payment networks.
- 25 -
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
TSYS formed and/or acquired five companies in connection with the Card Tech,
Ltd. acquisition, which the Company collectively refers to as TSYS Card Tech.
TSYS Card Tech's software applications are utilized globally. TSYS Card
Tech offers a server-based system with an established global footprint for
comprehensive issuing and acquiring services. TSYS Card Tech offers products and
services for installment loans, credit, debit, merchant acquiring and prepaid
payment platforms in addition to fraud, risk management, authorizations,
chargebacks, e-commerce and m-commerce solutions designed for the bankcard
market. TSYS Card Tech's applications are browser-based, multilingual,
multicurrency and multi-country (including double-byte-enabled).
Revenues associated with TSYS Card Tech will be included in electronic
payment processing services and will be included in international-based support
services for segment reporting purposes.
Share Repurchase
On July 24, 2006, TSYS purchased 820,800 shares of TSYS stock in a
privately negotiated transaction pursuant to its previously announced stock
repurchase plan for an aggregate purchase price of approximately $16.4 million
and an average per share price of $20. The Company has approximately 1.2 million
shares remaining that could be repurchased under the share repurchase plan.
- 26 -
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. Below is
a general description of each type of account:
----------------------------- --------------------------------------------------
Account type Description
----------------------------- --------------------------------------------------
Consumer Visa and MasterCard credit cards;
American Express cards
----------------------------- --------------------------------------------------
Retail Private label
----------------------------- --------------------------------------------------
Commercial Purchasing cards, corporate cards and fleet cards
for employees
----------------------------- --------------------------------------------------
Government services Student loan processing accounts
----------------------------- --------------------------------------------------
Stored value Prepaid cards, including loyalty incentive cards,
flexible spending cards and gift cards
----------------------------- --------------------------------------------------
Debit On-line (PIN-based) and off-line (signature-based)
accounts
----------------------------- --------------------------------------------------
- 27 -
Financial Overview (continued)
The table on page 35 summarizes TSYS' accounts on file (AOF) information as
of June 30, 2006 and 2005, respectively.
A summary of the financial highlights occurring during 2006, as compared to
2005, is provided below:
Three months ended Six months ended
June 30, June 30,
------------------------------------------------------------------------------------------------------------------------------------
Percent Percent
(in millions, except per share data) 2006 2005 Change 2006 2005 Change
------------------------------------------------------------------------------------------------------------------------------------
Revenues Before Reimbursables $ 342.8 331.1 3.5 % $ 672.3 611.4 10.0%
Total Revenues 429.2 410.2 4.6 841.5 760.2 10.7
Operating Income 84.7 76.3 11.0 156.6 142.7 9.8
Net Income 57.4 50.6 13.4 107.8 96.8 11.4
Basic EPS 0.29 0.26 13.3 0.55 0.49 11.4
Diluted EPS 0.29 0.26 13.3 0.55 0.49 11.4
Significant highlights for 2006 include:
Corporate
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 Announced that its Board of Directors approved a quarterly cash
dividend of $0.07 per share, an increase of 16.7 percent from the
previous dividend rate of $0.06 per share.
Domestic
o Reached a long-term agreement with Wachovia Corporation to provide
core-processing and other related services in support of their
re-entry into the consumer credit-card line of business.
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 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 7 million
cardholder accounts.
International
o Continued expansion of TSYS' global footprint with the acquisition of
London-based Card Tech, Ltd., now known as TSYS Card Tech, for an
aggregate consideration of approximately $58 million. The acquisition
enables TSYS to offer more technology choices with the right
combination of scale and functionality that are attractive to small,
medium and large banks in global emerging markets. The acquisition of
TSYS Card Tech expands the number of countries in which TSYS has
clients to 76.
- 28 -
Financial Overview (continued)
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.
Merchant
o Reached agreements through TSYS Acquiring Solutions with Delta Payment
Solutions and New England Bankcard Association to provide merchant
processing services.
o Renewed a long term relationship through TSYS Acquiring Solutions with
Heartland Payment Systems, one of the nation's largest providers of
merchant acquiring services.
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 unaudited condensed 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.
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.
- 29 -
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 had a $45.0 million long-term line of credit from a banking affiliate
of Synovus. The line was 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 June 30, 2006 and 2005, respectively:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------------------------------
2006 2005 2006 vs. 2005
--------- ---------- ------------------------
Revenues:
Electronic payment processing services 54.2 % 52.9 % 7.0 %
Merchant services 15.3 16.8 (4.2)
Other services 10.4 11.0 (1.4)
--------- ----------
Revenues before reimbursable items 79.9 80.7 3.5
Reimbursable items 20.1 19.3 9.1
--------- ----------
Total revenues 100.0 100.0 4.6
--------- ----------
Expenses:
Salaries and other personnel expense 28.1 28.2 3.8
Net occupancy and equipment expense 17.6 17.0 8.8
Other operating expenses 14.5 16.9 (10.5)
--------- ----------
Expenses before reimbursable items 60.2 62.1 1.3
Reimbursable items 20.1 19.3 9.1
--------- ----------
- 30 -
Results of Operations (continued)
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------------------------------
2006 2005 2006 vs. 2005
---------- ---------- ------------------------
Total expenses 80.3 81.4 3.2
---------- ----------
Operating income 19.7 18.6 11.0
Nonoperating income 0.8 0.1 nm
---------- ----------
Income before income taxes, minority interest and equity in
income of equity investments 20.5 18.7 14.2
Income taxes 7.3 6.5 16.5
Minority interests in consolidated subsidiaries' net income 0.0 0.0 nm
Equity in income of equity investments 0.2 0.1 72.9
---------- ----------
Net income 13.4 % 12.3 % 13.4 %
========== ==========
nm=not meaningful
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 six months ended June 30, 2006 and 2005, respectively:
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------------------------------
2006 2005 2006 vs. 2005
----------- ----------- -----------------------
Revenues:
Electronic payment processing services 53.9 % 55.5 % 7.5 %
Merchant services 15.4 12.6 35.5
Other services 10.6 12.3 (4.9)
----------- -----------
Revenues before reimbursable items 79.9 80.4 10.0
Reimbursable items 20.1 19.6 13.7
----------- -----------
Total revenues 100.0 100.0 10.7
----------- -----------
Expenses:
Salaries and other personnel expense 28.7 28.0 13.5
Net occupancy and equipment expense 18.0 17.8 11.4
Other operating expenses 14.6 15.8 2.3
----------- -----------
Expenses before reimbursable items 61.3 61.6 10.0
Reimbursable items 20.1 19.6 13.7
----------- -----------
Total expenses 81.4 81.2 10.9
----------- -----------
Operating income 18.6 18.8 9.8
Nonoperating income 0.7 0.1 nm
----------- -----------
Income before income taxes, minority interest and equity in
income of equity investments 19.3 18.9 12.8
Income taxes 6.7 6.8 9.1
- 31 -
Results of Operations (continued)
Percentage of Percentage Change
Total Revenues in Dollar Amounts
----------------------------------------------------
2006 2005 2006 vs. 2005
---------- ----------- -----------------------
Minority interests in consolidated subsidiaries' net income 0.0 0.0 nm
Equity in income of equity investments 0.2 0.6 (56.9)
--------- -----------
Net income 12.8 % 12.7 % 11.4 %
========= ===========
nm=not meaningful
Revenues
Total revenues increased $18.9 million and $81.2 million, or 4.6% and
10.7%, respectively, during the three and six months ended June 30, 2006,
compared to the same periods in 2005. The increase in revenues for the three and
six months ended June 30, 2006 includes a decrease of $1.0 million and $4.0
million related to the effects of currency translation of its foreign-based
subsidiaries and branches. Excluding reimbursable items, revenues increased
$11.7 million and $60.9 million, or 3.5% and 10.0%, respectively, during the
three and six months ended June 30, 2006, compared to the same periods 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 and six months ended
June 30, 2006 and 2005, respectively, are summarized below:
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
(in millions) 2006 2005 % Change 2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Europe $ 36.2 31.5 14.5 % $ 68.9 64.7 6.5 %
Canada 24.0 22.4 7.0 46.1 43.5 6.1
Japan 4.5 3.9 14.9 8.4 7.6 9.6
Mexico 2.9 1.7 70.9 5.4 3.4 59.6
Other 1.3 0.7 94.2 2.5 1.2 116.7
----------------------------------------------------------------------------------------------- ---------------
Totals $ 68.9 60.2 14.2 % $131.3 120.4 9.1 %
=============== ===============
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 $36.2 million and $68.9
million for the three and six months ended June 30, 2006, a 14.5% and 6.5%
increase compared to $31.5 million and $64.7 million for the same periods last
year. The increase in revenues in 2006 from clients based in Europe was a result
of internal growth of existing clients and the increased use of value added
products and services, netted against the effects of currency translation, which
was approximately $3.3 million for the six months ended June 30, 2006.
- 32 -
Results of Operations (continued)
Total revenues from clients based in Mexico were $2.9 million and $5.4
million for the three and six months ended June 30, 2006, a 70.9% and 59.6%
increase compared to the $1.7 million and $3.4 million for the same periods 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 June 30, 2006 and 2005, value added products and
services represented 13.0% and 12.1%, respectively, of total revenues. For the
six months ended June 30, 2006 and 2005, value added products and services
represented 12.8% and 12.6%, respectively, of total revenues. Revenues from
these products and services, which include some reimbursable items paid to
third-party vendors, increased 11.7%, or $5.8 million, and 12.6%, or $12.0
million, for the three and six months ended June 30, 2006 compared to the same
periods 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 10 in the 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.
- 33 -
Results of Operations (continued)
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 $6 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 and six months ended June 30, 2006, Bank of America accounted
for approximately 23.7%, or $101.8 million, and 23.5%, or $198.1 million,
respectively, of total revenues. This amount consists of processing revenues for
consumer, commercial and merchant services, as well as reimbursable items. Of
the $101.8 million for the three months ended June 30, 2006, approximately $36.6
million, or 35.9%, was derived from Bank of America for reimbursable items. Of
the $198.1 million for the six months ended June 30, 2006, approximately $72.1
million, or 36.4%, was derived from Bank of America for reimbursable items. Bank
of America accounted for approximately $65.2 million, or 19.0%, and $126.0
million, or 18.7%, of revenues before reimbursable items for the three and six
months ended June 30, 2006, respectively. For the three and six months ended
June 30, 2005, Bank of America accounted for 23.8%, or $97.8 million, and 22.4%,
or $170.0 million, respectively, 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 and six months ended June 30, 2006, the Company had another
major client that accounted for approximately 10.1%, or $43.3 million, and
10.5%, or $88.0 million, respectively, of total revenues. For the three and six
months ended June 30, 2005, this client accounted for approximately 7.3%, or
$29.8 million, and 8.5%, or $64.5 million, respectively, of total revenues. The
loss of this 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
- 34 -
Results of Operations (continued)
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 $15.3 million, or 7.0%, and $31.6 million, or
7.5%, for the three and six months ended June 30, 2006, respectively, compared
to the same periods in 2005.
Accounts on File (AOF) Data (in millions):
2006 2005 % Change
--------- ------------ -----------------
At June 30, 366.5 388.6 (5.7)
QTD Average 415.8 380.7 9.2
YTD Average 427.5 371.8 15.0
AOF by Portfolio Type (in millions):
2006 2005
-------------- ---------------
At June 30, AOF % AOF % % Change
----------------------------------------------------------------------------------------- --------------- --------------
Consumer 241.2 65.8 230.0 59.2 4.9
Retail 36.8 10.1 83.0 21.3 (55.6)
Commercial 31.4 8.6 28.8 7.4 9.0
Stored value 29.3 8.0 22.4 5.8 30.6
Government services 19.6 5.3 17.1 4.4 14.4
Debit 8.2 2.2 7.3 1.9 12.7
----------------------------------------------------------------------------------------- ---------------
Total 366.5 100.0 388.6 100.0 (5.7)
============== ===============
Note: Certain accounts previously classified as Retail have been
reclassified as Stored Value to conform with the presentation adopted in
the second quarter of 2006.
AOF by Geographic Area (in millions):
2006 2005
-------------- -----------------
At June 30, AOF % AOF % % Change
---------------------------------------------------------------------------------------- ----------------- -------------
Domestic 308.5 84.2 335.5 86.3 (8.0)
International 58.0 15.8 53.1 13.7 9.2
---------------------------------------------------------------------------------------- -----------------
Total 366.5 100.0 388.6 100.0 (5.7)
============== =================
Note: The accounts on file distinction between domestic and international
is based on the geographic domicile of the Company's processing clients.
Activity in AOF (in millions):
June 2005 to June 2004 to
June 2006 June 2005
----------------------- ------------------------
Beginning balance 388.6 287.0
Internal growth of existing clients 36.5 38.4
New clients 40.0 69.3
Purges/Sales (12.3) (5.0)
Deconversions (86.3) (1.1)
----------------------- ------------------------
Ending balance 366.5 388.6
======================= ========================
- 35 -
Results of Operations (continued)
On March 31, 2004, Bank of America acquired FleetBoston. In connection with
the extended agreement with Bank of America, TSYS converted the FleetBoston card
portfolio to TSYS' processing system in March 2005. 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. TSYS expects that Chase
will discontinue its processing agreement according to the original schedule and
will license TSYS' processing software in 2007.
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 July 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 June 30, 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 would move the Sears consumer MasterCard and
private-label accounts from TSYS in a deconversion that occurred in June 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 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.
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
- 36 -
Results of Operations (continued)
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 10 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 mainly generated by
TSYS' wholly owned subsidiary TSYS Acquiring and majority owned subsidiary GP
Net. Merchant services revenue for the three and six months ended June 30, 2006
was $65.8 million and $129.8 million, respectively, compared to $68.7 million
and $95.8 million for the same periods last year. The increase for the six
months 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.
Revenues from merchant services are down for the three months of June 30,
2006, as compared to the same period in 2005, as the result of closing a sales
office for point of sale systems and services during the first quarter of 2006.
TSYS Acquiring is also experiencing a reduction of revenues in certain products
and services.
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 segment 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 $654,000, or 1.4%, for the
three months ended June 30, 2006, compared to the same period in 2005. Revenues
from other services decreased $4.6 million, or 4.9%, for the six months ended
June 30, 2006, compared to the same period in 2005. Other services revenue for
the second quarter decreased as a result of lower volume for attorney services
and bankruptcy, which was offset by greater growth in redemption services from
ESC Loyalty. Other services revenue decreased for the six months primarily due
to the loss of call center revenue.
- 37 -
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 $7.2 million, or 9.1%, for the three months ended June 30, 2006, as
compared to the same period last year. Reimbursable items increased $20.3
million, or 13.7%, for the six months ended June 30, 2006, as compared to the
same period last year. Of the $20.3 million increase for the six months ended
June 30, 2006, $7.3 million is attributable to TSYS Acquiring.
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 June 2006 and Bank of
America's consumer card portfolio in October 2006.
The majority of reimbursable items relates to the Company's domestic-based
clients and is primarily costs associated with postage.
A summary of reimbursable item revenues for the three and six months ended
June 30, 2006, as compared to 2005, is provided below:
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
Percent Percent
(in thousands) 2006 2005 Change 2006 2005 Change
--------------------------------------------------------------------------------------------------------------------------------
Postage $43,618 41,581 4.9 % $ 85,601 82,637 3.6%
Card association access fees 18,209 18,440 (1.3) 37,893 28,295 33.9
Other 24,547 19,154 28.2 45,618 37,851 20.5
---------------- ------------------
Total $86,374 79,175 9.1 % $169,112 148,783 13.7%
================ ==================
Operating Expenses
Total expenses increased 3.2% and 10.9% for the three and six months ended
June 30, 2006, compared to the same periods in 2005. The increase in expense
includes a decrease of $1.0 million and $4.0 million for the three and six
months ended June 30, 2006, respectively, related to the effects of currency
translation of its foreign-based subsidiaries and branches. Excluding
reimbursable items, total expenses increased 1.3% and 10.0% for the three and
six months ended June 30, 2006, respectively, compared to the same periods 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
expense for the three and six months ended June 30:
- 38 -
Results of Operations (continued)
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
(in thousands) 2006 2005 % Change 2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Salaries $ 92,994 87,139 6.7 % $183,980 165,153 11.4 %
Employee benefits 23,371 27,979 (16.5) 48,819 48,802 0.0
Nonemployee wages 10,738 12,675 (15.3) 20,768 17,718 17.2
Share-based compensation 2,179 282 nm 4,446 560 nm
Other 3,321 2,297 44.5 6,219 3,278 89.7
Less capitalized expenses (12,170) (14,398) nm (22,469) (22,559) nm
------------------ ------------------
Totals $120,433 115,974 3.8 % $241,763 212,952 13.5 %
================== ==================
nm = not meaningful
Salaries and other personnel expense increased $4.5 million, or 3.8%, for
the three months ended June 30, 2006, compared to the same period in 2005. For
the six months ended June 30, 2006, salaries and other personnel expense
increased $28.8 million, or 13.5%, compared to the same period in 2005. Of the
$28.8 million increase for the six months for 2006, $11.8 million is the result
of employee-related expenses of TSYS Acquiring. In addition, the change in
salaries and other personnel expense is associated with the normal salary
increases and related benefits, offset by the level of employment costs
capitalized as software development and contract acquisition costs. Salaries and
other personnel expense include the accrual for performance-based incentive
benefits, which includes salary bonuses, profit sharing and employer 401(k)
expenses. For the three months ended June 30, 2006 and 2005, the Company accrued
$6.8 million and $14.1 million, respectively, for performance-based incentives.
For the six months ended June 30, 2006 and 2005, the Company accrued $11.4
million and $19.4 million, respectively, for 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 June 30, 6,549 6,475 1.1
QTD Average 6,545 6,432 1.8
YTD Average 6,596 6,111 7.9
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 June
- 39 -
Results of Operations (continued)
30, 2006, share-based compensation was $2.2 million, compared to $282,000 for
the same period in 2005. For the six months ended June 30, 2006, share-based
compensation was $4.4 million, compared to $560,000 for the same period in 2005.
Net Occupancy and Equipment Expense
Summarized below are the major components of net occupancy and equipment
expense:
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
(in thousands) 2006 2005 % Change 2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Depreciation and amortization $ 30,407 27,333 11.2 % $ 61,199 51,516 18.8%
Equipment and software rentals 28,636 21,144 35.4 57,044 45,732 24.7
Repairs and maintenance 10,952 13,657 (19.8) 21,396 21,803 (1.9)
Impairment of developed software - - na - 3,137 nm
Other 5,708 7,434 (23.2) 11,414 13,449 (15.1)
------------------ ------------------
Totals $ 75,703 69,568 8.8 % $ 151,053 135,637 11.4%
================== ==================
nm = not meaningful
na = not applicable
Net occupancy and equipment expense increased $6.1 million, or 8.8%, and
$15.4 million, or 11.4%, for the three and six months ended June 30, 2006 over
the same periods in 2005, respectively. Of the $15.4 million increase for the
six months ended June 30, 2006, $5.7 million is the result of occupancy and
equipment related expenses of TSYS Acquiring.
Depreciation and amortization increased for the three and six months ended
June 30, 2006, as compared to the same periods 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 and next 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's equipment and software rentals increased in 2006, as compared
to 2005, as a result of software licenses that are leased under processing
capacity or MIPS agreements, as well as increased equipment expenses associated
with providing additional capacity for the scheduled Capital One portfolio
conversions.
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
- 40 -
Results of Operations (continued)
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 during the first quarter of 2005. The impairment charge is reflected in
the domestic-based support services segment. As of June 30, 2006, the Company
has $1.0 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 and six months ended June 30, 2006 and 2005:
Three months ended Six months ended
June 30, June 30,
----------------------------------------------------
(in thousands) 2006 2005 % Change 2006 2005 % Change
------------------------------------------------------------------------------------------------------------------------------------
Third-party data processing services $ 10,512 11,652 (9.8)% $ 20,758 16,450 26.2%
Supplies and stationery 7,233 7,389 (2.1) 14,183 14,070 0.8
Court costs associated with debt collection services 6,466 8,295 (22.1) 14,071 16,276 (13.5)
Professional advisory services 5,931 4,914 20.7 11,701 7,893 48.2
Travel and business development 5,070 6,052 (16.2) 8,941 7,387 21.0
Amortization of conversion costs 4,506 3,782 19.1 9,380 7,257 29.2
Terminal deployment costs 3,643 7,413 (50.9) 7,634 9,711 (21.4)
Transaction processing provisions 3,340 1,486 124.7 7,501 4,595 63.2
Management fees 2,420 2,020 19.8 4,830 4,097 17.9
Amortization of acquisition intangibles 856 865 (1.1) 1,715 1,475 16.3
Bad debt expense (255) 559 nm (217) 2,487 nm
Other 12,202 14,753 (17.3) 22,442 28,505 (21.3)
----------------- -----------------
Totals $ 61,924 69,180 (10.5)% $122,939 120,203 2.3%
================= =================
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 the Company's 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 June 30, 2006 decreased
$7.3 million, or 10.5%, as compared to the same period in 2005. Other operating
expenses for the six months ended
- 41 -
Results of Operations (continued)
June 30, 2006 increased $2.7 million, or 2.3%, as compared to the same period in
2005. Of the $2.7 million increase, $8.0 million is the result of other
operating expenses of TSYS Acquiring.
Operating Income
Operating income increased 11.0% and 9.8% for the three and six months
ended June 30, 2006 over the same periods in 2005. The Company's operating
profit margin for the three and six months ended June 30, 2006 was 19.7% and
18.6%, respectively, compared to 18.6% and 18.8% for the same periods last year.
TSYS' operating margin increased for the quarter as the result of increased
usage of value added products and services and management's focus on expense
controls offset by increased expenses associated with share-based compensation
and increased amortization. The margin for the first six months of 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 June 30, 2006 was $3.4 million,
an increase of $2.3 million, compared to $1.1 million for the same period in
2005. Interest income for the six months ended June 30, 2006 was $5.9 million,
an increase of $3.6 million, compared to $2.3 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.
Interest expense for the three months ended June 30, 2006 was $85,000, a
decrease of $20,000, compared to $105,000 for the same period in 2005. Interest
expense for the six months ended June 30, 2006 was $129,000, a decrease of
$46,000, compared to $175,000 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 loss of $363,000 and $87,000 for the three and six months ended
June 30, 2006, respectively, relates to the translation of cash accounts. The
balance of the Company's foreign-denominated cash accounts subject to risk of
translation gains or losses at June 30, 2006 was approximately $7.0 million, the
majority of which is denominated in Euros.
Income Taxes
TSYS' effective income tax rate for the three months ended June 30, 2006
was 35.3%, compared to 34.8% for the same period in 2005. TSYS' effective income
tax rate for the six months ended June 30, 2006 was 34.4%, compared to 35.0% 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 first quarter of 2006, TSYS received notices of
proposed
- 42 -
Results of Operations (continued)
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 first quarter of 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, TSYS' effective income tax
rate for the remainder of 2006 is expected to be in the 35%-36% range.
Equity in Income of Equity Investments
TSYS' share of income from its equity in equity investments was $1.0
million and $590,000 for the three months ended June 30, 2006 and 2005,
respectively. TSYS' share of income from its equity in equity investments was
$1.9 million and $4.3 million for the six months ended June 30, 2006 and 2005,
respectively. The decrease for the first six months 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 10 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
TSYS' consolidated financial statements 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.
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 and six months ended June 30, 2006, the Company's equity
in income of equity investments related to TSYS de Mexico was $819,000 and $1.6
million, respectively, representing a 3.2% and 46.8% increase, or $25,000 and
$514,000, compared to $794,000 and $1.1 million, respectively, for the same
periods 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 $41,000 and $35,000 for the
three months ended June 30, 2006 and 2005, respectively. TSYS paid TSYS de
Mexico a processing support fee of $80,000 and $69,000 for the six months ended
June 30, 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
- 43 -
Results of Operations (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. TSYS' equity in income of equity investments
related to CUP Data was approximately $200,000 and $259,000 for the three and
six months ended June 30, 2006.
TSYS plans to increase its ownership interest in CUP Data to 45% upon its
receipt of regulatory approval. Refer to Note 10 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 June 30, 2006 increased 13.4%, or
$6.8 million, to $57.4 million, or basic and diluted earnings per share of
$0.29, compared to $50.6 million, or basic and diluted earnings per share of
$0.26, for the same period in 2005. Net income for the six months ended June 30,
2006 increased 11.4%, or $11.0 million, to $107.8 million, or basic and diluted
earnings per share of $0.55, compared to $96.8 million, or basic and diluted
earnings per share of $0.49, for the same period in 2005.
Net Profit Margin
The Company's net profit margin for the three months ended June 30, 2006
was 13.4%, compared to 12.3% for the same period last year. The Company's net
profit margin for the six months ended June 30, 2006 was 12.8%, compared to
12.7% 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. TSYS' net profit margin increased for the quarter
as the result of management's focus on expense controls and increased interest
income offset by increased expenses associated with share-based compensation and
increased amortization.
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 and six months ended June 30, 2006
and 2005, respectively:
- 44 -
Results of Operations (continued)
Three months ended Six months ended
June 30, June 30,
------------------------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Operating income $ 84,731 76,346 156,588 142,652
========== ========== ========== ==========
Net income $ 57,406 50,643 107,799 96,766
========== ========== ========== ==========
Total revenues $429,165 410,243 841,455 760,227
========== ========== ========== ==========
Operating margin (as reported) 19.7 % 18.6 % 18.6 % 18.8 %
========== ========== ========== ==========
Net profit margin (as reported) 13.4 % 12.3 % 12.8 % 12.7 %
========== ========== ========== ==========
Revenue before reimbursable items $342,791 331,068 672,343 611,444
========== ========== ========== ==========
Adjusted operating margin 24.7 % 23.1 % 23.3 % 23.3 %
========== ========== ========== ==========
Adjusted net profit margin 16.7 % 15.3 % 16.0 % 15.8 %
========== ========== ========== ==========
Projected Outlook for 2006
TSYS expects its 2006 earnings growth to be at the high end of the range of
21%-23%, based on the following assumptions: total revenues will increase 6%-8%
in 2006; accounts on file at the end of 2006 will be approximately 395 million
to 405 million; deconversion of 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
$6 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.
Projected Outlook for 2007
TSYS' estimated 2007 earnings are expected to decline between 16-14% as
compared to estimated 2006 earnings, based on the following assumptions: (1)
2006 earnings growth will be at the high end of the 21-23% range; (2)
deconversion of Bank of America's consumer portfolio will occur as scheduled in
October 2006, with a one-time contract termination payment of approximately $69
million and an acceleration of amortization of contract-acquisition costs of
approximately $6 million; (3) including the Bank of America termination payment,
estimated total revenues will decline 9-7% in 2007; (4) the conversion of the
Capital One portfolio which will begin in July 2006 and end in early 2007 will
be successfully completed and recognition of revenues and expenses associated
with the agreement will begin in the fourth quarter of 2006; (5) J.P. Morgan
Chase & Co. will discontinue its processing agreement according to the original
schedule and will license TSYS' processing software in 2007; (6) expense
reductions in employment, equipment, leases and other areas which are included
in 2007 estimates will be accomplished; and (7) TSYS will not incur significant
expenses associated with the conversion of new large clients and/or
acquisitions.
Financial Position, Liquidity and Capital Resources
The Condensed 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.
- 45 -
Financial Position, Liquidity and Capital Resources (continued)
Cash Flows From Operating Activities
Six months ended June 30,
------------------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
------------------------------------------------------------------------------------------------------------------------------
Net income $ 107,799 96,766
Depreciation and amortization 86,148 68,962
Other noncash items and charges, net (6,286) 13,926
Working capital items (59,089) (141,901)
----------------------------------------------------
Net cash provided by operating activities $ 128,572 37,753
====================================================
TSYS' main source of funds is derived from operating activities,
specifically net income. During the six months ended June 30, 2006, the Company
generated $128.6 million in cash from operating activities compared with $37.8
million for the same period last year. The increase in 2006 in net cash provided
by operating activities was primarily 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 June 30, 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
Six months ended June 30,
------------------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
------------------------------------------------------------------------------------------------------------------------------
Purchases of property and equipment, net $ (14,306) (20,383)
Additions to licensed computer software from vendors (4,437) (10,647)
Additions to internally developed computer software (8,999) (10,388)
Cash used in acquisitions, net of cash acquired - (56,983)
Dividends from equity investments 2,371 1,659
Additions to contract acquisition costs (22,339) (10,981)
----------------------------------------------------
Net cash used in investing activities $ (47,710) (107,723)
====================================================
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 $47.7 million in
cash for investing activities for the six months ended June 30, 2006, compared
to $107.7 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 June 30, 2006 and 2005 were $8.5 million and $9.7 million,
respectively. For the six month period ended June 30, 2006, capital expenditures
for property and equipment were $14.3 million compared to $20.4 million for the
same period last year.
- 46 -
Financial Position, Liquidity and Capital Resources (continued)
Licensed Computer Software from Vendors
Expenditures for licensed computer software from vendors were $2.7 million
and $4.7 million for the three months ended June 30, 2006 and 2005,
respectively. Expenditures for licensed computer software from vendors were $4.4
million and $10.6 million for the six months ended June 30, 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 six months
ended June 30, 2006 were $9.0 million, compared to $10.4 million for the same
period in 2005.
The amount capitalized as software development costs in 2006, is mainly
attributable to TSYS Acquiring's development of Express 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
Express, which is a tool that will provide a single point of entry system which
will enable 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 $2.9 million during the three months ended June 30, 2006, and has
a total of $26.3 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 $1.3 million during the three
months ended June 30, 2006, and has a total of $7.6 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 pages 40-41,
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 June 30, 2006, the Company has $1.0 million
capitalized, net of amortization, related to this asset.
- 47 -
Financial Position, Liquidity and Capital Resources (continued)
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.
On July 11, 2006, TSYS acquired Card Tech, Ltd. and related companies for
an aggregate consideration of approximately $58 million and has renamed the
business as TSYS Card Tech. Refer to Note 11 in the notes to Unaudited Condensed
Consolidated Financial Statements for more information on the acquisition of
TSYS Card Tech.
Dividends Received from Equity Investments
During 2006, the Company received a dividend payment of $2.4 million from
TSYS de Mexico, compared to $1.7 million for the same period last year.
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 $12.8 million for the three months ended June
30, 2006, bringing the total for 2006 to $22.3 million, compared to $11.0
million for the six months ended June 30, 2005. The Company had cash payments
for processing rights of approximately $675,000 and $3.1 million during the
three and six months ended June 30, 2006, respectively. The Company did not have
any cash payments for processing rights during the same periods last year.
Conversion cost additions were $19.2 million and $11.0 million for the six
months ended June 30, 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
Six months ended June 30,
------------------------------------------------------------------------------------------------------------------------------
(in thousands) 2006 2005
------------------------------------------------------------------------------------------------------------------------------
Dividends paid on common stock $ (23,683) (15,757)
Principal payments on long-term debt borrowings and capital lease
obligations (1,060) (48,923)
Proceeds from borrowings of long-term debt - 48,142
Other - 427
----------------------------------------------------
Net cash used in financing activities $ (24,743) (16,111)
====================================================
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 six months ended June 30, 2006 was $24.7 million mainly as a result of the
payments of dividends. Net cash used in financing activities for the six months
ended June 30, 2005 was $16.1 million mainly as a result of the payments of
dividends.
- 48 -
Financial Position, Liquidity and Capital Resources (continued)
Line of Credit
TSYS had 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 22.
During the six months ended June 30, 2005, the Company utilized the automatic
draw-down facility for temporary funding and repaid the balances within days of
borrowing. The line of credit expired on June 30, 2006.
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.
On July 24, 2006, TSYS purchased 820,800 shares of TSYS stock in a
privately negotiated transaction pursuant to its previously announced stock
repurchase plan for aggregate purchase price of approximately $16.4 million and
an average per share price of $20. The Company has approximately 1.2 million
shares remaining that could be repurchased under the share repurchase plan.
Dividends
Dividends on common stock of $11.9 million were paid during the three
months ended June 30, 2006, bringing the total for 2006 to $23.7 million
compared to $15.8 million paid during the six months ended June 30, 2005. On May
25, 2006, the Company announced an increase in its quarterly dividend of 16.7%
from $0.06 to $0.07 per share. This dividend amount was paid on July 1, 2006, to
shareholders of record at the close of business on June 22, 2006. On April 21,
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.
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.
- 49 -
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 2.5:1. At June 30, 2006, TSYS had working capital of $357.1
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.
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.
In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48),
"Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement
No. 109." FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in a company's financial statements in accordance with FASB Statement
No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
FIN 48 provides a two-step process in the evaluation of a tax position. The
first step is recognition. The Company determines whether it is
more-likely-than-not that a tax position will be sustained upon examination,
including a resolution of any related appeals or litigation processes, based
upon the technical merits of the position. The second step is measurement. A tax
position that meets the more- likely-than-not recognition threshold is measured
at the largest amount of benefit that is greater than 50 percent likely of being
realized upon ultimate settlement.
FIN 48 is effective for fiscal years beginning after December 15, 2006. The
Company is currently evaluating the impact of adopting FIN 48 on its financial
position, results of operations and cash flows, but has yet to complete its
assessment.
- 50 -
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
Bank of America's consumer accounts in October of 2006; (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 and that Chase will
discontinue its processing agreement according to the original schedule and
license TSYS' processing software in 2007; (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' estimated 2007
earnings; (xii) TSYS' belief with respect to lawsuits, claims and other
complaints; (xiii) TSYS' expectation that total future MIPS will decline
resulting in an increase in software amortization; (xiv) 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: (a) an increase in revenues of 6% to 8%; (b) accounts on
file at the end of 2006 will be approximately 395 million to 405 million; (c)
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 $6 million in contract-acquisition costs; and (d)
recognition of revenues and expenses associated with the Capital One agreement
beginning in the fourth quarter of 2006, and further including , with respect to
TSYS' estimated 2007 earnings: (a) 2006 earnings growth will be at the high end
of the 21-23% range; (b) deconversion of Bank of America's consumer portfolio
will occur as scheduled in October 2006, with a one-time contract termination
payment of approximately $69 million and an acceleration of amortization of
contract-acquisition costs of approximately $6 million; (c) including the Bank
of America termination payment, estimated total revenues will decline 9-7% in
2007; (d) the conversion of the Capital One portfolio which will begin in July
2006 and end in early 2007 will be successfully completed and recognition of
revenues and expenses associated with the agreement will begin in the fourth
quarter of 2006; (e) J.P. Morgan Chase & Co. will discontinue its processing
agreement according to the original schedule and will license TSYS' processing
software in 2007; (f) expense reductions in employment, equipment, leases and
other areas which are included in 2007 estimates will be accomplished; and (g)
TSYS will not incur significant expenses associated with the conversion of new
large clients and/or acquisitions. 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,"
- 51 -
Forward-Looking Statements (continued)
"should," "would," and similar expressions are intended to identify
forward-looking statements but are not the exclusive means of identifying these
statements.
These statements are based upon the current beliefs and expectations of
TSYS' management and are subject to significant risks and uncertainties. Actual
results may differ materially from those contemplated by the forward-looking
statements. A number of important factors could cause actual results to differ
materially from those contemplated by our forward-looking statements. Many of
these factors are beyond TSYS' ability to control or predict. These factors
include, but are not limited to: (i) revenues that are lower than anticipated;
(ii) 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 does not intend to update any forward-looking statement as a
result of new information, future developments or otherwise.
- 52 -
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, Chinese Renminbi and Brazilian Real. 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 following represents the amount of other
comprehensive gain and loss for the three and six months ended June 30, 2006 and
2005, respectively:
------------------------------------------------------------------------------------------------------------------------------------
Three months ended Six months ended
(in millions) June 30, June 30,
------------------------------------------------------------------------------------------------------------------------------------
2006 2005 2006 2005
----------------------------------------------------
Other comprehensive gain (loss) $ 4.3 (2.9) 4.7 (5.4)
Currently, TSYS does not use financial instruments to hedge its exposure to
exchange rate changes.
The following represents the carrying value of the net assets of its
foreign operations in U.S. dollars at June 30, 2006:
-----------------------------------------------------------------------------------------------------
(in millions) June 30, 2006
-----------------------------------------------------------------------------------------------------
Europe $ 141.1
China 37.9
Japan 14.1
Mexico 5.1
Canada 0.8
Brazil 0.3
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 loss of
$363,000 and $87,000 for the three and six months ended June 30, 2006,
respectively, relates to the translation of cash accounts. The balance of the
foreign-denominated cash accounts subject to risk of translation gains or losses
at June 30, 2006 was approximately $7.0 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
- 53 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk (continued)
basis points and 1,000 basis points based on the foreign-denominated cash
account balance at June 30, 2006.
----------------------------------------------------
Effect of Basis Point Change
----------------------------------------------------
Increase in Decrease in
basis point of basis point of
----------------------------------------------------
(in thousands) 100 500 1,000 100 500 1,000
------------------------------------------------------------------------------------------------------------------------------------
Effect on income before income taxes $ (70) (349) (698) 70 349 698
----------------------------------------------------
The foreign currency risks associated with other currencies is not
significant.
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
was an automatic draw down facility. The interest rate for the line of credit
was the London Interbank Offered Rate (LIBOR) plus 150 basis points. In
addition, there was a charge of 15 basis points on any funds unused. The line of
credit was unsecured debt and included covenants requiring us to maintain
certain minimum financial ratios. The line of credit expired on June 30, 2006.
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.
- 54 -
TOTAL SYSTEM SERVICES, INC.
Item 3 - Quantitative and Qualitative Disclosures About Market Risk (continued)
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.
- 55 -
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.
- 56 -
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
June 30, 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
------------------------------------------------------------------------------------------------------------------------------------
April 2006 - $- - 2,000,000
May 2006 - - - 2,000,000
June 2006 - - - 2,000,000
------------------------------------------------------------------------------------------------------------------------------------
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.
- 57 -
TOTAL SYSTEM SERVICES, INC.
Part II - Other Information
Item 4 - Submission of Matters to a Vote of Security Holders
The annual shareholders' meeting of Total System Services, Inc. was held
April 20, 2006. There were four proposals voted on at the meeting.
Proposal I voted on at the meeting was the election of six class II
directors. Following is a tabulation of votes for each nominee:
VOTES WITHHELD AUTHORITY
NOMINEE FOR TO VOTE
----------------------------------------------------------------------------------------------- --------------------------
James H. Blanchard 188,076,523 762,485
Richard Y. Bradley 187,304,475 1,534,533
Walter W. Driver Jr. 186,891,810 1,947,198
Gardiner W. Garrard Jr. 187,230,979 1,608,029
John P. Illges III 188,030,424 808,584
W. Walter Miller Jr. 185,969,201 2,869,807
Kriss Cloninger III, G. Wayne Clough, Sidney E. Harris, Alfred W.
Jones III, Mason H. Lampton, H. Lynn Page, Philip W. Tomlinson, John T. Turner,
Richard W. Ussery, M. Troy Woods, James D. Yancey and Rebecca K. Yarbrough also
continued to serve as directors following the annual shareholders' meeting.
Proposal II voted on at the meeting was setting the number of directors on
the Board at nineteen. Following is a tabulation of votes:
FOR 187,558,846
AGAINST 1,227,786
ABSTAIN 52,374
Proposal III voted on at the meeting was the approval of the Synovus
Financial Corp. Executive Cash Bonus Plan. Following is a tabulation of votes:
FOR 186,294,131
AGAINST 2,458,476
ABSTAIN 86,398
Proposal IV voted on at the meeting was the ratification of the appointment
of KPMG LLP as the Independent Auditor. Following is a tabulation of votes:
FOR 188,459,467
AGAINST 239,128
ABSTAIN 140,412
- 58 -
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
- 59 -
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: August 4, 2006 by: /s/ Philip W. Tomlinson
---------------------------------------
Philip W. Tomlinson
Chairman of the Board and
Chief Executive Officer
Date: August 4, 2006 by: /s/ James B. Lipham
---------------------------------------
James B. Lipham
Senior Executive Vice President and
Chief Financial Officer
- 60 -
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
- 61 -