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TSS > SEC Filings for TSS > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for TOTAL SYSTEM SERVICES INC

Form 10-Q for TOTAL SYSTEM SERVICES INC


5-Nov-2012

Quarterly Report


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 payment processing, merchant services and related services to financial and nonfinancial institutions, generally under long-term processing contracts. The Company's services are provided through three of the Company's operating segments: North America Services, International Services and Merchant Services.

Through the Company's North America Services and International Services segments, TSYS processes information through its cardholder systems to financial and nonfinancial institutions throughout the United States and internationally. The Company's North America Services segment provides these services in the United States to clients in the United States, Canada, Mexico and the Caribbean. The Company's International Services segment provides services in England, Japan and Brazil to clients in Europe, Asia Pacific, and Brazil. The Company's Merchant Services segment provides merchant services to financial institutions and other organizations, primarily in the United States.

TSYS acquires other companies as part of its strategy for growth. Refer to Note 10 in the Notes to Unaudited Consolidated Financial Statements for more information on TSYS' acquisitions in 2012.

For a detailed discussion regarding the Company's operations, see "Item 7:
Management's Discussion and Analysis of Financial Condition and Results of Operations," which is included as Exhibit 13.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.

A summary of the financial highlights for 2012, as compared to 2011, is provided below:

                                                  Three months ended September 30,                           Nine months ended September 30,
(in millions)                              2012              2011            Percent Change            2012              2011          Percent Change
Total revenues                          $     468.1             459.7                    1.8 %          1,391.9          1,336.7                   4.1 %
Operating income                               90.9              81.2                   12.0              267.8            232.7                  15.1
Net income attributable to TSYS
common shareholders                            60.3              58.1                    3.7              183.4            160.7                  14.1

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. For a detailed discussion regarding these topics, refer to our Notes to Consolidated Financial Statements and "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations" which are included as Exhibit 13.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.

Critical Accounting Policies and Estimates

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 2012.

Related Party Transactions

The Company believes the terms and conditions of transactions between the Company and its equity investments, Total System Services de México, S.A. de. C.V. (TSYS de México) and China UnionPay Data Co., Ltd. (CUP Data), 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.


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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.

Contractual Obligations

The total liability for uncertain tax positions under Accounting Standards Codification (ASC) 740, "Income Taxes," at September 30, 2012 is $13.4 million. Refer to Note 6 in the Notes to Unaudited Consolidated Financial Statements for more information on income taxes. The Company is not able to reasonably estimate the amount by which the liability will increase or decrease over time; however, at this time, the Company does not expect a significant payment related to these obligations within the next year.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements, refer to Note 1 in the Notes to Unaudited Consolidated Financial Statements and see "Item 7:
Management's Discussion and Analysis of Financial Condition and Results of Operations," which is included as Exhibit 13.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.

In October 2012, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2012-04, "Technical Corrections and Improvements." ASU 2012-04 updates Accounting Standards Codification for technical corrections, clarifications, and improvements. The amendments in this update cover a wide range of topics in the Codification and are presented in two sections - Technical Corrections and Improvements (Section A) and Conforming Amendments Related to Fair Value Measurements (Section B). The amendments that will not have transition guidance will be effective upon issuance. For public entities, the amendments that are subject to the transition guidance will be effective for fiscal periods beginning after December 15, 2012. The Company has determined the impact of adopting ASU 2012-04 on its financial position, results of operations and cash flows to be immaterial.

In August 2012, the FASB issued ASU 2012-03, "Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22." The ASU is effective immediately. The Company has determined the impact of adopting ASU 2012-03 on its financial position, results of operations and cash flows to be immaterial.

In July 2012, the FASB issued ASU 2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment." ASU 2012-02 allows an entity to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test for indefinite-lived intangible assets. An entity that elects to perform a qualitative assessment is required to perform the quantitative impairment test for an indefinite-lived intangible asset if it is more likely than not that the asset is impaired. The ASU, which applies to all public, private, and not-for-profit organizations, is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company has determined the impact of adopting ASU 2012-02 on its financial position, results of operations and cash flows to be immaterial.

Results of Operations

Revenues

The Company generates revenues by providing transaction processing and other payment-related services. The Company's pricing for transactions and services is complex. Each category of revenue has numerous fee components depending on the types of transactions or services provided. TSYS reviews its pricing and implements pricing changes on an ongoing basis. In addition, standard pricing varies among its regional businesses, and such pricing can be customized further for customers through tiered pricing of various thresholds for volume activity. TSYS' revenues are based upon transactional information accumulated by its systems or reported by its customers. The Company's revenues are impacted by currency translation of foreign operations, as well as doing business in the current economic environment.

Total revenues increased $8.3 million and $55.1 million, or 1.8% and 4.1%, respectively, for the three and nine months ended September 30, 2012 compared to the same periods in 2011. The increase in revenues for the three and nine months ended September 30,


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2012 includes a decrease of $2.4 million and $6.1 million, respectively, related to the effects of currency translation of foreign-based subsidiaries and branches. The Company has included reimbursements received for out-of-pocket expenses as revenues and expenses. The largest reimbursable expense item for which TSYS is reimbursed by clients is postage. The Company's reimbursable items are impacted with changes in postal rates and changes in the volumes of all mailing activities by its clients. Reimbursable items for the three and nine months ended September 30, 2012 were $62.0 million and $192.0 million, a decrease of $7.6 million or 10.9% and $11.8 million or 5.8%, respectively, compared to $69.5 million and $203.7 million for the same periods last year.

Excluding reimbursable items, revenues increased $15.9 million and $66.9 million, or 4.1% and 5.9%, during the three and nine months ended September 30, 2012 compared to the same periods in 2011. The 5.9% increase in revenues excluding reimbursable items for the nine months ended September 30, 2012, as compared to the same period in 2011, is the result of increases of 3.1% in revenues associated with new business, 5.8% in internal growth and 1.4% in acquisitions, partially offset by decreases of 3.9% associated with client portfolio deconversions and price reductions and 0.5% in currency translation.

Major Customers

For a detailed discussion regarding the Company's major customers, refer to Note 7 in the Notes to Unaudited Consolidated Financial Statements and see "Item 7:
Management's Discussion and Analysis of Financial Condition and Results of Operations," which is included as Exhibit 13.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.

A significant amount of the Company's revenues is derived from long-term contracts with large clients by providing various processing and other services to these clients, including processing of consumer and commercial accounts, as well as revenues for reimbursable items. In 2011, the Company had one major customer. The loss of one of the Company's large clients could have a material adverse effect on the Company's financial position, results of operations and cash flows.

On July 19, 2012, TSYS announced that it finalized a master services agreement, with a minimum six year term, with Bank of America to provide processing services for its consumer credit card portfolios in the U.S. In addition, TSYS will continue to process Bank of America's commercial credit card portfolios in the U.S. and internationally. TSYS plans to complete the conversion of Bank of America's consumer card portfolio from its in-house processing system in mid-2014. Following the processing term, the agreement provides Bank of America the option to use the TS2 software pursuant to a license under a long-term payment structure for purposes of processing its consumer card portfolio.

The master services agreement with Bank of America provides for a tiered-pricing arrangement for both the consumer card portfolio, which is expected to be converted in 2014, and the existing commercial card portfolios.

Operating Segments

TSYS' services are provided through its three operating segments: North America Services, International Services and Merchant Services. Refer to Note 7 in the Notes to Unaudited Consolidated Financial Statements for more information on the Company's operating segments.

The Company's North America and International segments have many long-term customer contracts with card issuers providing account processing and output services for printing and embossing items. These contracts generally require advance notice prior to the end of the contract if a client chooses not to renew. Additionally, some contracts may allow for early termination upon the occurrence of certain events such as a change in control. The termination fees paid upon the occurrence of such events are designed primarily to cover balance sheet exposure related to items such as capitalized conversion costs or client incentives associated with the contract and, in some cases, may cover a portion of lost future revenue and profit. Although these contracts may be terminated upon certain occurrences, the contracts provide the segment with a steady revenue stream since a vast majority of the contracts are honored through the contracted expiration date.

A summary of each segment's results follows:

North America Services

The North America Services segment provides payment processing and related services to clients based primarily in North America. This segment has one major customer.


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Below is a summary of the North America Services segment:

                                            Three months ended September 30,                   Nine months ended September 30,
                                                                          Percent                                           Percent
(in millions)                             2012              2011          Change             2012             2011          Change
Total revenues                        $      237.6            243.9           (2.6 )%    $      717.8           708.4            1.3 %
Operating income                              69.6             68.0            2.3              209.8           187.3           12.0
Operating margin*                             29.3 %           27.9 %                            29.2 %          26.4 %
Key indicators:
Accounts on file (AOF)                                                                          413.4           341.9           20.9
Transactions                               2,036.6          1,860.2            9.5            5,907.7         5,270.6           12.1

* Segment operating margins do not include expenses associated with Corporate Administration. Refer to Note 7 in the Notes to the Unaudited Consolidated Financial Statements for more information on operating segments.

The 2.6% decrease in total segment revenues for the three months ended September 30, 2012, as compared to the same period in 2011, is primarily the result of a decrease in reimbursable items of $3.7 million. Excluding reimbursable items, revenues decreased $2.6 million or 1.3%. The decrease in revenues excluding reimbursable items for the three months ended September 30, 2012, as compared to the same period in 2011, is the result of decreases of 5.1% associated with client portfolio deconversions, 3.5% of price reductions and 0.5% in intrasegment transactions, partially offset by increases of 2.4% in revenues associated with new business and 5.4% in internal growth. The 3.5% decrease related to price reductions includes a price reduction related to a tiered-pricing arrangement signed in the third quarter of 2012.

The 1.3% increase in total segment revenues for the nine months ended September 30, 2012, as compared to the same period in 2011, is driven by an increase in revenues associated with new business and internal growth, partially offset by client portfolio deconversions and price reductions.

The increase in operating income for the three and nine months ended September 30, 2012, as compared to 2011, is driven by a decrease in employment expenses due to the dedication of more internal resources to the International Services segment that were previously shared between the North America Services and International Services segments.

International Services

The International Services segment provides issuer and merchant card solutions to financial institutions and other organizations primarily based outside the North America region. Changes in revenues in this segment are derived from retaining and growing the core business. Growing the core business comes primarily from an increase in account usage, growth from existing clients and sales to new clients and the related account conversions. This segment has one major customer.

Below is a summary of the International Services segment:

                                           Three months ended September 30,                 Nine months ended September 30,
                                                                         Percent                                        Percent
(in millions)                           2012              2011           Change           2012             2011          Change
Total revenues                       $    102.7              99.9             2.8 %    $     306.5           288.3           6.3 %
Operating income                            7.7               8.3            (6.7 )           21.3            29.4         (27.7 )
Operating margin*                           7.5 %             8.3 %                            6.9 %          10.2 %
Key indicators:
Accounts on file                                                                              53.0            50.5           4.9
Transactions                              415.1             360.5            15.1          1,200.5         1,027.2          16.9

* Segment operating margins do not include expenses associated with Corporate Administration. Refer to Note 7 in the Notes to the Unaudited Consolidated Financial Statements for more information on operating segments.

The increase in total segment revenues for the three and nine months ended September 30, 2012, as compared to 2011, is the result of new business and organic growth, which was partially offset by the impact of foreign currency translation, client deconversions, and price reductions.

The decrease in operating income for the three and nine months ended September 30, 2012, as compared to 2011, is driven by an increase in employment expenses due to the dedication of more internal resources to the International Services segment.


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Merchant Services

The Merchant Services segment provides merchant processing and related services to clients based primarily in the United States. Merchant services revenues are derived from providing processing services, acquiring solutions, related systems and integrated support services to merchant acquirers and merchants. Revenues from merchant services include processing all payment forms including credit, debit, prepaid, electronic benefit transfer and electronic check for merchants of all sizes across a wide array of market verticals. Merchant services include authorization and capture of transactions; clearing and settlement of transactions; information reporting services related to transactions; merchant billing services; and point-of-sale (POS) equipment sales and service. This segment has one major customer.

Below is a summary of the Merchant Services segment:

                                            Three months ended September 30,                  Nine months ended September 30,
                                                                          Percent                                          Percent
(in millions)                             2012              2011          Change            2012             2011          Change
Total revenues                        $      132.7            122.9            8.0 %    $      383.2           361.8            5.9 %
Operating income                              34.5             27.4           26.0             101.7            80.0           27.1
Operating margin*                             26.0 %           22.3 %                           26.5 %          22.1 %
Key indicators:
POS Transactions                           1,225.1          1,263.3           (3.0 )         3,724.5         3,739.1           (0.4 )

* Segment operating margins do not include expenses associated with Corporate Administration. Refer to Note 7 in the Notes to the Unaudited Consolidated Financial Statements for more information on operating segments.

The increase in total segment revenues for the three and nine months ended September 30, 2012, as compared to the same period in 2011, is the result of new business, organic growth and acquisitions, which was partially offset by a decrease for client deconversions and price reductions.

Merchant Services segment's results are driven by the authorization and capture transactions processed at the point-of-sale and clearing and settlement transactions. This segment's authorization and capture transactions are primarily through dial-up or Internet connectivity. The direct acquiring business is driven by dollar sales volume processed by merchants.

Operating Expenses

The Company's operating expenses consist of cost of services and selling, general and administrative expenses. Cost of services describes the direct expenses incurred in performing a particular service for our customers, including the cost of direct labor expense in putting the service in saleable condition. Selling, general and administrative expenses are incurred in selling or marketing and for the direction of the enterprise as a whole, including accounting, legal fees, officers' salaries, investor relations and mergers and acquisitions.

The Company's cost of services decreased 1.8% and increased 1.2% for the three and nine months ended September 30, 2012, compared to $321.5 million and $935.0 million for the same periods last year.

The Company's selling, general and administrative expenses increased 7.7% and 5.0% for the three and nine months ended September 30, 2012, compared to $57.1 million and $169.0 million for the same periods last year. The increase is the result of merit increases and the acquisitions of Central Payment and TermNet, including amortization of acquisition intangibles.

Operating Income

Operating income increased 12.0% and 15.1% for the three and nine months ended September 30, 2012, respectively, over the same periods in 2011. The Company's operating profit margin for the three and nine months ended September 30, 2012 was 19.4% and 19.2%, respectively, compared to 17.7% and 17.4% for the same periods last year. TSYS' operating margin increased for the three and nine months ended September 30, 2012, as compared to the same periods in 2011, as a result of gains in productivity.


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Nonoperating Income (Expense)

Interest income for the three months ended September 30, 2012 was $393,000, an increase of $238,000, compared to $155,000 for the same period in 2011. Interest income for the nine months ended September 30, 2012 was $1.1 million, an increase of $698,000, compared to $442,000 for the same period in 2011. The increase in interest income is primarily attributable to the increase in the amount of cash available for investing.

Interest expense for the three months ended September 30, 2012 was $671,000, a decrease of $123,000 compared to $794,000 for the same period in 2011. Interest expense for the nine months ended September 30, 2012 was $2.2 million, a decrease of $245,000 compared to $2.4 million for the same period in 2011. The decrease in interest expense in 2012 compared to 2011 relates to a decline in interest rates.

For the three months ended September 30, 2012 and 2011, the Company recorded a translation loss of approximately $0.6 million and $2.2 million, respectively, related to intercompany loans and foreign-denominated balance sheet accounts. For the nine months ended September 30, 2012 and 2011, the Company recorded a translation loss of approximately $2.3 million and $2.8 million, respectively, related to intercompany loans and foreign-denominated balance sheet accounts.

Occasionally, the Company will provide financing to its subsidiaries in the form of an intercompany loan, which is required to be repaid in U.S. dollars. For its subsidiaries whose functional currency is something other than the U.S. dollar, the translated balance of the financing (liability) is adjusted upward or downward to match the U.S. dollar obligation (receivable) on the Company's financial statements. The upward or downward adjustment is recorded as a gain or loss on foreign currency translation.

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. As the Company translates the foreign-denominated cash balances into U.S. 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 balance of the Company's foreign-denominated cash accounts subject to risk of translation gains or losses at September 30, 2012 was approximately $2.4 million, the majority of which is denominated in Euros and British Pounds Sterling.

Income Taxes

For a detailed discussion regarding these topics, refer to Notes 1 and 20 in the Notes to Consolidated Financial Statements and "Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations" which are included as Exhibit 13.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.

TSYS' effective income tax rate for the three months ended September 30, 2012 was 33.1%, compared to 29.4% for the same period in 2011. TSYS' effective income tax rate for the nine months ended September 30, 2012 was 31.3%, compared to 31.2% for the same period in 2011. The increase in the 2012 rates reflects changes in discrete items, tax credits and in the jurisdictional sources of income. The calculation of the effective tax rate is income taxes adjusted for income taxes associated with noncontrolling interest and 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. Refer to Note 6 in the Notes to Unaudited Condensed Consolidated Financial Statements for more information on income taxes.

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.

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 . . .

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