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| ICPT > SEC Filings for ICPT > Form 10-Q on 4-Aug-2004 | All Recent SEC Filings |
4-Aug-2004
Quarterly Report
This Item 2 is composed of seven sections:
Recent Developments
Sale of Merchant Services Division in March 2004
As we have previously disclosed, on March 22, 2004, we sold our merchant services division, InterCept Payment Solutions ("IPS"), to two different entities. We sold the outstanding member interests of Internet Billing Company, LLC ("iBill") to Media Billing, L.L.C. ("Media Billing"), a 99%-owned subsidiary of Penthouse International, Inc. We sold the remainder of IPS, including our merchant portfolio management business based in Tennessee, to Solidus Networks, Inc. d/b/a Pay By Touch ("Pay By Touch").
Terms of Sale of iBill to Media Billing. Media Billing purchased all of the outstanding member interests of iBill for $745,251 in cash, a $793,749 short-term note due March 30, 2004 and assumption of a $22 million working capital deficit. Following the closing of the transaction, Media Billing defaulted in its obligations to repay the note and to obtain a release of a $3.0 million letter of credit held by First Data Merchant Services, Inc. that we had obtained for the benefit of iBill. First Data subsequently drew on the letter of credit in full. In addition, the sale price of iBill was subject to a final purchase price adjustment based on a determination of its working capital on the closing date. On June 18, 2004, according to the terms of the purchase agreement, we notified Media Billing of an $827,000 purchase price adjustment in our favor. In total, Media Billing owes us approximately $4.6 million that we are seeking to collect.
Terms of Sale of Remainder of IPS to Pay By Touch. Pay By Touch, a privately held provider of biometric authentication and payment solutions, purchased the remainder of the IPS business, including our wholly-owned subsidiary, InterCept Payment Solutions, LLC, and our merchant portfolio management business based in Tennessee. The sale price for that transaction was $30.5 million, with the initial terms composed of:
$12.0 million in cash;
a $15.5 million note due on September 20, 2004, that was guaranteed by three Pay By Touch stockholders;
a one year $2.5 million note that is convertible at our option into Pay By Touch preferred stock valued (as of closing) at $2.5 million; and
shares of Pay By Touch preferred stock valued at $500,000 as of closing.
As noted above, we received a note from Pay By Touch for $15.5 million, which was due and payable in two installments. In the event that Pay By Touch paid the first installment on or before the first installment date, May 21, 2004, the amount of principal remaining outstanding after the payment would be reduced by $3,000,000. Pay By Touch paid the first installment on May 21, 2004 as scheduled, and, in accordance with the terms of the
note, its principal amount was reduced by $3.0 million to $9.5 million. The remaining balance was due and payable on September 20, 2004. Subsequently, on June 30, 2004, Pay By Touch paid us $5.03 million, which included $4.75 million of the remaining principal balance and all accrued interest on the note. In consideration of that payment, we agreed to extend the maturity date of the remaining $4.75 million principal balance to December 31, 2004.
In light of the sale of our merchant services division, we have accounted for the operations of that business as discontinued operations for the three and six months ended June 30, 2004 and 2003. Accordingly, the analysis and discussion in this Item 2 focuses on the continuing operations of our financial institutions business. Although our overall financial results for the first six months of 2004 reflect our ownership of the merchant services business for almost all of the first quarter, investors should take the sale of that business into account in reviewing this report.
Retention in June 2004 of Investment Banker to Explore Strategic Alternatives; Settlement of Proxy Contest
On June 11, 2004, we announced that we are exploring strategic alternatives to enhance shareholder value, including a possible sale of the company, and that we have retained Jefferies & Company, Inc. as our financial advisor to assist us in doing so. In addition, we announced with JANA Partners LLC that we had agreed to settle the then pending proxy contest and related litigation with JANA and to jointly support a panel of director nominees for election at the 2004 annual meeting of our shareholders. Subsequently, on June 24, 2004, we announced that our annual shareholders meeting held that day had been convened and then immediately adjourned until September 14, 2004, when it will be reconvened at 9:00 a.m. at our offices. We also announced that our board of directors had increased the size of the board from six to nine members and filled the three vacant seats created by the expansion. For more information regarding these matters, please see our proxy materials filed with the SEC, which are available at no charge on the SEC's web site at http://www.sec.gov.
Exchange of Newly Issued Shares of Series B Preferred Stock for
Outstanding Shares of Series A Preferred Stock in June 2004
On September 16, 2003, we sold 100,000 shares of Series A preferred stock to the Sprout Group and related entities for $10,000,000. On June 23, 2004, we entered into an exchange agreement with the holders of the Series A preferred stock. Under this agreement, the holders of the Series A preferred stock received shares of a new class of Series B preferred stock in exchange for all of the outstanding Series A shares, which were cancelled. The terms of the previously outstanding Series A and the currently outstanding Series B preferred stock are as follows:
Series A Preferred Stock
The Series A preferred stock was convertible into our common stock at a fixed price of $13.97 per share at the holder's option at any time after the earliest of:
the date as of which the closing bid price of our common stock shall have been equal to or greater than $25 per share for at least 10 consecutive trading days;
the fifth anniversary of the issuance date; and
five business days prior to a liquidation of the company or the closing of:
any merger, consolidation, reorganization or other similar transaction, approved by the majority of the board, in which InterCept is not the surviving entity or in which securities of InterCept constituting in excess of 50% of the voting power of InterCept are exchanged for, or changed into, cash, property or securities of another person, or
the sale of all or substantially all of our assets in a transaction approved by the majority of the board.
Dividends on the Series A preferred stock accrued and were payable in kind at the rates of 5% per annum through March 31, 2004, 4% per annum from April 1, 2004 through March 31, 2005 and 3% per annum thereafter. Additionally, we were required to obtain the consent of a majority of the holders of Series A preferred stock before we could take certain actions, including an amendment to our articles of incorporation, a sale or liquidation of the company, or an issuance of additional shares of our capital stock, other than under existing employee benefit plans. We incurred $204,000 of expenses that were offset against the proceeds from the sale of the Series A preferred.
Series B Preferred Stock
We issued 100,000 shares of Series B preferred stock having a $100 per share liquidation preference over the common stock in exchange for all of the issued and outstanding shares of Series A preferred stock (and the accrued dividends thereon). The Series B preferred has rights and preferences substantially similar to the Series A preferred except:
the Series B preferred is not entitled to any preferred dividend;
the holders of the Series B preferred do not have the right to veto various proposed corporate actions approved by our board of directors (including certain mergers, acquisitions and amendments to the articles of incorporation and bylaws);
the conversion price of the Series B preferred is $10.50 per share, a reduction from the $13.97 per share conversion price of the Series A preferred.
Non-Cash Charge to Net Income
We had previously determined that the June 23, 2004 exchange of the Series A preferred stock for the shares of Series B preferred stock should be accounted for under EITF 98-5 and 00-27. At that time, we preliminarily calculated the beneficial conversion feature to be approximately $5.5 million. That previously determined beneficial conversion amount would have resulted in a non-cash charge to net income of $325,000 per quarter for each of the next 17 fiscal quarters. The amount of that charge and the formula used to calculate the charge were disclosed in our press releases regarding the exchange transaction and our Current Report on Form 8-K dated May 21, 2004 and filed on May 24, 2004.
After further analysis we continue to conclude that the exchange of Series A preferred stock to Series B preferred stock should be accounted for under EITF 98-5 and 00-27, but have calculated the resulting beneficial conversion feature to be approximately $3.6 million. That beneficial conversion will result in a non-cash charge attributable to common shareholders that we will amortize in the amount of approximately $214,600 per quarter for each of the next 17 fiscal quarters, the end of which period is the earliest known conversion date of the Series B Preferred Stock.
The value of the Series B Preferred was calculated as its liquidation value of $10,000,000 plus the product of (x) 952,381 (the number of common shares into which the Series B preferred stock may be converted) and (y) $6.07 (the amount by which the market price per share of InterCept common stock on the date of the exchange exceeded the $10.50 Series B conversion price per share).
The value of the Series A Preferred was calculated as its liquidation value of $10,000,000, plus (a) the product of (x) 715,821 (the number of shares of common stock into which the Series A was convertible) and (y) $2.60 (the difference between the Series A conversion price of $13.97 per share and the market price of InterCept common stock on the date of the exchange), and (b) $271,000 (the amount of the preferred dividends accrued through the date of the exchange, which were extinguished as a result of the exchange).
We may accelerate recognition of the entire unamortized portion of the charge in certain circumstances, including in connection with a sale of the company.
Overview
Our operations were comprised of two business segments until December 31, 2003:
financial institution services and merchant services. During the first quarter
of 2004, we sold our merchant services division and now account for those
financial results in discontinued operations. In our financial institution
services segment, we derive revenues primarily by providing software systems,
data processing services and related equipment and services to financial
institutions. This Overview section explains how we generate and recognize
revenues and also summarizes certain other information that we believe is useful
in evaluating our financial statements and performance.
Our products and services include:
Core data processing and check imaging systems, support, maintenance and related services and software sales,
EFT processing services,
Data communications management and
Equipment and product sales, services and other, including:
Sales of banking-related equipment and complementary products and
Equipment maintenance and technical support services
In our service bureau operations, we generate core data processing revenues from service and processing fees based primarily on the number of accounts and number of customer information files we service for our financial institution customers and the number of transactions we process. We recognize these revenues as we perform the services. We also generate revenues from the licensing of our core data processing systems. We recognize revenues for licensing these systems in accordance with Statement of Position 97-2 on "Software Revenue Recognition," using the residual method prescribed in SOP 98-9 issued by the American Institute of Certified Public Accountants. We recognize software license fees and hardware and installation revenue when we have signed a non-cancelable license agreement, installed the product and satisfied all significant obligations to the customer. We recognize maintenance fees over the term of the maintenance period. We sell some of our software and hardware products through five-year, sales-type lease agreements under which customers make annual installment payments. These annual payments include the initial installation and an ongoing license fee. We recognize revenue attributable to the sale of equipment upon installation. License and installation fees are deferred and recognized ratably over the period of the lease.
We license Renaissance Imaging check imaging software on an in-house basis, and we generate revenues from up-front license fees and recurring annual maintenance fees charged for this system. We recognize revenues primarily from the licensing of Renaissance Imaging in accordance with Statement of Position 97-2, as discussed above. We also provide check processing and imaging in a service bureau environment under which we generate recurring revenues. On a service bureau basis, we generate revenues primarily based on the volume of items processed. We recognize this revenue as we provide the service.
We derive EFT revenues principally from processing ATM and debit card transactions. We receive a base fee for providing our ATM processing services and an additional fee for each additional ATM and network serviced. For most of our customers, once the number of transactions exceeds established levels for that customer, we charge additional fees for these transactions. For some debit card transactions, we receive a portion of the interchange fees generated by our financial institution customers, and we charge a monthly fee if our customer's transactions do not meet a specified minimum dollar amount of transactions for a particular month. Most charges under our EFT service agreements are due and paid monthly. During the second quarter of 2002, we began to implement a new debit card pricing structure, under which we receive a flat fee for each transaction processed. Under this pricing structure, we do not receive a portion of the interchange fee for processing debit card transactions. Although this change in our EFT pricing structure has reduced our per-transaction earnings from debit card processing in excess of $50,000 per month, it has materially reduced our exposure to the changes in interchange fees that have been or may be implemented by Visa and MasterCard. We have converted 82% of our customers to the new pricing structure. Until all of our customers are converted to flat fee pricing, the revenues that we continue to derive from interchange fees may be affected by changes in interchange rates for debit transactions. We cannot currently estimate what changes to the interchange rate may occur and what the potential impact to our financial results may be. See Risk Factors - Our revenues may decrease as a result of legal actions against Visa and MasterCard.
We generate our data communications management service revenues principally from network management and from equipment configuration services and installation. We charge a regular monthly fee on an ongoing basis for providing telecommunications connectivity and network management. We recognize revenues from data communications management as we perform the services.
We recognize revenues from sales of equipment and complementary products at the time of shipment or, if we are responsible for installation, upon installation of the product. We recognize maintenance and technical support service ratably over the period during which we perform the services.
For the three months ended June 30, 2004, approximately 91% of our total revenues were recurring revenues. Recurring revenues result from regular monthly, quarterly or annual payments by our customers for ongoing services they use in connection with their businesses and for transaction processing of debit, ATM, credit and ACH transactions that occur under long-term agreements. These revenues do not include conversion or de-conversion fees, initial software license fees, installation fees, hardware sales or similar activities.
Disclosure Regarding Forward-Looking Statements
We make forward-looking statements throughout this report. These statements are subject to risks and uncertainties, and we can provide no assurances that they will prove to be correct. Forward-looking statements include assumptions as to how we may perform in the future. When we use words like "believe," "expect," "anticipate," "predict," "project," "potential," "seek," "continue," "will," "may," "could," "intend," "plan," "pro forma," "estimate," "goal," "strive" and similar expressions, we are making forward-looking statements. Forward-looking statements include some of the matters discussed in Recent Developments above and our expectations regarding our liquidity and capital resources and our critical accounting policies. We believe that the expectations reflected in our forward-looking statements are reasonable, but we cannot be sure that we will actually achieve these expectations. Projections or estimates of our future performance are necessarily subject to a high degree of uncertainty and may vary materially from actual results. In evaluating forward-looking statements, please carefully consider the various factors discussed below.
In evaluating our financial results, investors should take into account our sale of our merchant services business in March 2004. Because we agreed to indemnify the purchasers of the merchant services division for certain liabilities, including card association fines resulting from pre-closing activities, we will remain subject to those risks for the near future.
The process of considering strategic initiatives that we announced in June 2004 may adversely affect our operational results or our stock price.
On June 11, 2004, we announced that we intended to explore strategic alternatives to enhance shareholder value, including a possible sale of the company, and that we had retained Jefferies & Company, Inc. as our financial advisor to assist us in doing so. As long as this process continues, our competitors and other companies will use the uncertainty regarding the possible sale of the company against us to compete to win new business, retain existing customers and retain employees. Our employees may be distracted by the process and accordingly may be less effective than formerly. Our management is devoting a material amount of time to the process and consequently has less time to devote to operational matters. These and other possible negative effects of the process may harm our operational results. We can offer no assurances regarding either how long the process may continue or its ultimate result.
Additionally, the common stock trading price has increased subsequent to the commencement of the proxy contest with JANA Partners in April 2004 and the June 2004 press release announcing that our board is exploring strategic alternatives and has retained a financial advisor to assist in this regard. If we are unsuccessful in identifying and consummating such a strategic or sale transaction, we anticipate that any premium in our stock price resulting from the anticipation of a strategic or sale transaction would be lost.
Fluctuations in our operating results have negatively affected the trading price of our common stock and may do so again.
Our operating results have varied in the past and may fluctuate significantly in the future because of many factors. These factors include:
the possible negative impact of implementing our growth and acquisition strategies, including accounting charges and other expenses associated with our acquisitions;
the loss of customers or strategic relationships;
competition and pricing pressures;
a reduction in recurring revenues as a percentage of total revenues;
increases in operating expenses due to launches of new products and services and to sales and marketing efforts;
our inability to accurately forecast legal expenses; and
changes in interchange fees of MasterCard and Visa.
Many factors that affect our operating results are outside of our control. Because of these factors, it is likely that in some future period our financial results will again fall below the expectations of securities analysts or investors. In that event, the trading price of our common stock would likely decline, perhaps significantly.
We face risks in connection with our contract with Sovereign Bank.
In January 2003, we executed a definitive agreement with Sovereign Bank to provide Sovereign with item processing and check imaging services. Sovereign is now our largest customer. To accommodate the Sovereign business, we have incurred substantial costs to open four new item processing centers, expand two existing centers and add approximately 250 new employees. Sovereign has recently announced several acquisitions. While Sovereign's continued expansion could result in additional revenues for us, it could also require us to add additional processing centers or capacity that are not currently in our budget.
Sovereign can terminate the agreement at any time, including upon its acquisition or for convenience. In that event, Sovereign would be required to pay us liquidated damages. Although the amount of those damages would be significant, they may not compensate us adequately for the loss of the business. Sovereign also has the ability to terminate the agreement without paying liquidated damages for various events of default that include Sovereign's reasonable belief that its prospects of receiving services from us are materially impaired due to the occurrence of a material adverse change, as defined in the agreement. Depending on when a termination of the Sovereign agreement occurred, it could have a material adverse effect on our business, prospects, results of operations and financial condition.
The failure to sustain our current growth rate in our financial institutions business or to achieve expected growth rates could adversely affect the price of our common stock.
We have experienced significant growth since our inception. This growth has resulted from both internal growth of our business and through acquisitions we have completed. Either our internal growth rate or our total growth rate, or both, may decline in the future due to factors within or beyond our control. Our failure to sustain our growth rates, or achieve growth rates expected by stock market analysts, could again have a material adverse impact on the trading price of our common stock.
Because many of our competitors have significantly greater resources than we do, we may be unable to gain market share.
Because our business includes a variety of products and services, we generally face different competitors within each area of our business. In our core banking and data processing business, we compete with numerous companies that have national operations and significant assets. Our principal EFT competitors include regional ATM networks, regional and local banks that perform processing functions, non-bank processors and other independent technology and data communications organizations. In each of these areas, many of our competitors have longer operating histories, greater name recognition and substantially greater resources than we do. If we compete with them for the same geographic market, their financial strength could prevent us from capturing market share in those areas. In addition, the competitive pricing pressures that would result from an increase in competition from these companies could have a material adverse effect on our business, financial condition and results of operations. Some of our competitors have established cooperative relationships among themselves or with third parties to increase their ability to address customer needs. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share.
We can provide no assurances that we will be able to compete successfully with existing or new competitors. If we fail to adapt to emerging market demands or to compete successfully with existing and new competitors, our business, financial condition and results of operations would be materially adversely affected.
Our revenues may decrease as a result of legal actions against Visa and MasterCard.
We generate revenue from interchange fees, which are the interbank fees that merchants pay when they accept debit cards. Visa and MasterCard set the interchange rates. Visa and MasterCard have been sued by the Department of Justice, or DOJ, for alleged violation of the Federal antitrust laws arising out of their respective functionally identical policies of (a) not allowing members in the respective organization to issue cards participating in the other organization's system, and (b) prohibiting their members from issuing cards in competing systems other than Visa or MasterCard, the largest owner/member of Visa and MasterCard. The potential impact of this litigation on us depends upon whether or not the DOJ is successful, and if it is successful, the relief ordered by the court.
As a result of the settlement of a class action case brought by Wal-Mart and other merchants, Visa and MasterCard set new interchange rates for debit transactions that were approximately 33% lower than previous interchange rates. While those initial changes to the interchange rate took effect in August 2003, the settlement also allowed for a further change in the interchange rates effective April 1, 2004. As of April 2004, these interchange rates were increased approximately 29%. We have converted 82% of our customers to a new pricing structure, under which we receive a flat fee for each transaction. Until all of our customers are converted to flat fee pricing, the revenues that we continue to derive from interchange fees may be affected by changes in interchange rates for debit transactions. We cannot currently estimate what changes to the interchange rate may occur and what the potential impact to our financial results may be.
Financial institutions are subject to industry consolidation, and we may lose customers with little notice.
The banking industry is prone to consolidations that result from mergers and . . .
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