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TSS > SEC Filings for TSS > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for TOTAL SYSTEM SERVICES INC

Form 10-Q for TOTAL SYSTEM SERVICES INC


6-Nov-2013

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 also derives revenues by providing general-purpose reloadable (GPR) prepaid debit cards and payroll cards and alternative financial services to underbanked consumers. The Company's services are provided through four of the Company's operating segments: North America Services, International Services, Merchant Services and NetSpend.

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 to clients in Europe, India, Middle East, Africa, Asia Pacific and Brazil. The Company's Merchant Services segment provides merchant services to merchant acquirers and merchants mainly in the United States.

On July 1, 2013, TSYS completed its acquisition of all the outstanding stock of NetSpend Holdings, Inc. ("NetSpend"). NetSpend operates as a single reportable business segment and provides general GPR prepaid debit and payroll cards and alternative financial service solutions to the underbanked and other consumers in the United States. The products NetSpend manages provide underbanked consumers with access to FDIC-insured depository accounts with a menu of pricing and features specifically tailored to their needs. NetSpend has an extensive distribution and reload network comprised of financial service centers and other retail locations throughout 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' acquisition in 2013.

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, 2012, as filed with the Securities and Exchange Commission (SEC).

A summary of the financial highlights for 2013, as compared to 2012, is provided below:

                                                 Three months ended                        Nine months ended
                                                    September 30,                            September 30,
                                                                   Percent                                    Percent
(in millions)                              2013        2012        Change          2013          2012         Change
Total revenues                            $ 588.1       468.1          25.6 %      1,531.5       1,391.9          10.0 %
Operating income                            105.6        90.9          16.2          275.8         267.8           3.0
Net income attributable to TSYS common
shareholders                                 64.4        60.3           6.7          179.1         183.4          (2.4 )
Basic earnings per share (EPS)               0.34        0.32           5.8           0.95          0.97          (2.1 )
Diluted EPS                                  0.34        0.32           5.5           0.94          0.97          (2.3 )
Adjusted earnings before interest,
taxes, depreciation, and amortization
(Adjusted EBITDA)1                          182.1       137.9          32.1          449.9         407.5          10.4
Adjusted cash EPS2                           0.49        0.36          37.0           1.25          1.09          14.7

1 Adjusted EBITDA is net income excluding equity in income of equity investments, nonoperating income/(expense), income taxes, depreciation, amortization and stock-based compensation expenses and other non-recurring items.

2 Adjusted cash EPS is adjusted cash earnings divided by weighted average shares outstanding used for basic EPS calculations. Adjusted cash earnings is net income excluding the after-tax impact of stock-based compensation expenses, amortization of acquisition intangibles and other non-recurring items.


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Below is a summary of accounts on file (AOF) for the Company's North America Services and International Services segments:

             (in millions)                         At September 30,
                                                                    Percent
             AOF                            2013        2012        Change
             Consumer Credit                 224.2       195.0          15.0 %
             Retail                           26.8        24.1          11.2

             Total Consumer                  251.0       219.1          14.6
             Commercial                       38.9        36.3           7.2
             Other                            16.9        11.1          52.5

             Subtotal1                       306.8       266.5          15.1
             Prepaid/Stored Value2           110.7       114.3          (3.1 )
             Government Services3             61.6        48.8          26.2
             Commercial Card Single Use4      41.6        36.8          13.0

             Total AOF                       520.7       466.4          11.7 %

1 Traditional accounts include consumer, retail, commercial, debit and other accounts. These accounts are grouped together due to the tendency to have more transactional activity than prepaid, government services and single use accounts.

2 These accounts tend to have less transactional activity than the traditional accounts. Prepaid and stored value cards are issued by firms through retail establishments to be purchased by consumers to be used at a later date. These accounts tend to be the least active of all accounts on file.

3 Government services accounts are disbursements of student loan accounts issued by the Department of Education, which have minimal activity.

4 Commercial card single use accounts are one-time use accounts issued by firms to book lodging and other travel related expenses.

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, 2012, as filed with the SEC.

Critical Accounting Policies and Estimates

Refer to Note 1 in the Notes to Unaudited Consolidated Financial Statements for more information on changes to the Company's critical accounting policies, estimates and assumptions or the judgments affecting the application of those estimates and assumptions in 2013.

As a result of the acquisition of NetSpend, the Company adopted the following critical accounting policy:

Cardholders' reserve

The Company is exposed to losses due to cardholder fraud, payment defaults and other forms of cardholder activity, as well as losses, due to non-performance of third parties who receive cardholder funds for transmittal to the Issuing Banks (banks that issue MasterCard International or Visa USA, Inc. branded cards to customers). The Company establishes a reserve for the losses it estimates will arise from processing customer transactions, debit card overdrafts, chargebacks for unauthorized card use and merchant-related chargebacks due to non-delivery of goods or services. These reserves are established based upon historical loss and recovery rates and cardholder activity for which specific losses can be identified. The cardholders' reserve was approximately $7.2 million as of September 30, 2013. The provision for cardholder losses is included in cost of services in the Consolidated Statements of Income. The Company regularly updates its reserve estimate as new facts become known and events occur that may impact the settlement or recovery of losses.

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," as of September 30, 2013 is $2.5 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 change 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, 2012, as filed with the SEC.

In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2013-11 "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." ASU 2013-11 eliminates diversity in practice regarding financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. For public entities, this ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The Company does not expect the adoption of this ASU did not have a material impact on the its financial position, results of operations or cash flows.

In March 2013, the FASB issued ASU 2013-05 "Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." ASU 2013-05 addresses the accounting for the cumulative translation adjustment when a parent either sells part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity. For public entities, the ASU is effective prospectively for fiscal years, and interim periods, within those years, beginning after December 15, 2013. Early adoption is permitted. The Company does not expect the adoption of this ASU did not have a material impact on the its financial position, results of operations or cash flows.

In February 2013, the FASB issued ASU 2013-02, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." ASU 2013-02 requires that, for items reclassified out of accumulated other comprehensive income (AOCI) and into net income in their entirety, entities must disclose the effect of reclassification on each affected net income line item. For AOCI reclassification items not reclassified in their entirety into net income, entities must provide a cross reference to other required disclosures. ASU 2013-02 is effective for public companies for annual reporting periods beginning after December 15, 2012 and interim periods in those years. TSYS adopted this ASU on January 1, 2013. There were no reclassifications of AOCI to net income or to other accounts for the three and nine month periods ended September 30, 2013. The adoption of this ASU did not have a material impact on the Company's financial position, results of operations or cash flows.

Results of Operations

Revenues

The Company generates revenues from transaction processing, debit 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


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pricing varies among its regional businesses, and such pricing can be customized further for its clients 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 $120.0 million and $139.6 million, or 25.6% and 10.0%, respectively, for the three and nine months ended September 30, 2013, compared to the same periods in 2012. The increases in revenues for the three and nine months ended September 30, 2013 include decreases of $6.1 million and $16.5 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 mailing activities by its clients. Reimbursable items for the three and nine months ended September 30, 2013 were $61.1 million and $182.8 million, respectively, which decreased $944,000, or 1.5%, and $9.2 million, or 4.8%, respectively, compared to $62.0 million and $192.0 million for the same periods last year.

Excluding reimbursable items, revenues increased $121.0 million, or 29.8%, during the three months ended September 30, 2013, compared to the same period in 2012. The 29.8% increase was primarily driven by the acquisition of NetSpend.

Excluding reimbursable items, revenues increased $148.8 million, or 12.4%, during the nine months ended September 30, 2013, compared to 2012. The 12.4% increase in revenues excluding reimbursable items for the nine months ended September 30, 2013, as compared to the same period in 2012, is the result of increases of 13.0% in revenues associated with acquisitions, 5.5% in internal growth and 3.2% in new clients, partially offset by decreases of 7.8% associated with client deconversions and pricing concessions and 1.4% in currency translation.

Major Customers

For 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, 2012, 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 the first nine months of 2013 and 2012, the Company had no major customers. 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 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.

In June 2009, Bank of America announced that it formed a new joint venture to provide merchant services. In November 2010, TSYS and Bank of America agreed to a new agreement, during the term of which TSYS expects merchant services revenues from Bank of America to decline as Bank of America transitions its services to its new joint venture. Although the agreement was amended in June 2013 to provide for an extension of its term, TSYS continues to expect merchant services revenues from Bank of America to decline as the continuing deconversion of Bank of America merchants from TSYS progresses.

The loss of Bank of America as a merchant services client is not expected to have a material adverse effect on TSYS' financial position, results of operations or cash flows. However, the loss will have a significant adverse effect on the Merchant Services segment's financial position, results of operations and cash flows.


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Operating Segments

TSYS' services are provided through its four operating segments: North America Services, International Services, Merchant Services and NetSpend. 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.

These services are provided throughout the period of each account's use, starting from a card-issuing client processing an application for a card. Services may include processing the card application, initiating service for the cardholder, processing each card transaction for the issuing retailer or financial institution and accumulating the account's transactions. Fraud management services monitor the unauthorized use of accounts which have been reported to be lost, stolen, or which exceed credit limits. Fraud detection systems help identify fraudulent transactions by monitoring each accountholder's purchasing patterns and flagging unusual purchases. Other services provided include customized communications to cardholders, information verification associated with granting credit, debt collection and customer service.

TSYS' revenues in its North America Services and International Services segments are derived from electronic payment processing. There are certain basic core services directly tied to accounts on file and transactions. These are provided to all of TSYS' processing clients. The core services begin with an account on file.

The core services include housing an account on TSYS' system (AOF), authorizing transactions (authorizations), accumulating monthly transactional activity (transactions) and providing a monthly statement (statement generation). From these core services, TSYS' clients also have the option to use fraud and portfolio management services. Collectively, these services are considered volume-based revenues.

Non-volume related revenues include processing fees which are not directly associated with AOF and transactional activity, such as value added products and services, custom programming and certain other services, which are only offered to TSYS' processing clients.

Additionally, certain clients license the Company's processing systems and process in-house. Since the accounts are processed outside of TSYS for licensing arrangements, the AOF and other volumes are not available to TSYS. Thus, volumes reported by TSYS do not include volumes associated with licensing.

Output and managed services include offerings such as card production, statement production, correspondence and call center support services.

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. Growth in revenues and operating profit in this segment is derived from retaining and growing the core business and improving the overall cost structure. Growing the core business comes primarily from an increase in account usage, growth from existing clients (also referred to as internal growth) and sales to new clients and the related account conversions. This segment has one major customer for the three and nine month periods ended September 30, 2013.


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Below is a summary of the North America Services segment:

                                               Three months ended                            Nine months ended
                                                  September 30,                                September 30,
                                                                    Percent                                      Percent
(in millions)                          2013           2012          Change          2013           2012          Change
Total revenues                       $   252.6          237.6            6.3 %    $   741.0          717.8            3.2 %
Adjusted segment operating income1        82.3           70.1           17.3          229.4          210.7            8.9
Adjusted segment operating margin2        32.6 %         29.5 %                        31.0 %         29.4 %
Key indicators:
AOF                                                                                   461.4          413.4           11.6
Transactions                           2,395.8        2,036.6           17.6        6,644.2        5,907.7           12.5

1 Adjusted segment operating income excludes acquisition intangible amortization and expenses associated with Corporate Administration and Other.

2 Adjusted segment operating margin equals adjusted segment operating income divided by total revenues.

The 6.3% and 3.2% increases in total segment revenues for the three and nine months ended September 30, 2013, respectively, as compared to the same periods in 2012, are driven by increases in revenues associated with new business and internal growth, partially offset by client portfolio deconversions, pricing concessions, and decreases in reimbursable items. Reimbursable items for the three months ended September 30, 2013 were $35.3 million, an increase of $1.2 million, or 3.6%, compared to $34.1 million for the same period last year. Reimbursable items for the nine months ended September 30, 2013 were $103.6 million, a decrease $1.1 million, or 1.0%, compared to $104.7 million for the same period last year.

Excluding reimbursable items, revenues increased $13.7 million and $24.3 million, or 6.8% and 4.0%, respectively, for the three and nine months ended September 30, 2013, as compared to the same periods in 2012.

The increase in adjusted segment operating income for the three and nine months ended September 30, 2013, as compared to 2012, is driven by an increase in revenues while expenses remained flat.

For the nine months ended September 30, 2013, approximately 50.2% of revenues before reimbursable items of TSYS' North America Services segment are driven by the volume of accounts on file and transactions processed and approximately 49.8% are derived from non-volume based revenues, such as processing fees, value-added products and services, custom programming and licensing arrangements.

                                                   Three months ended                     Nine months ended
                                                     September 30,                          September 30,
                                                                    Percent                                Percent
(in millions)                                2013        2012        Change        2013        2012        Change
Volume-based revenues                       $ 111.3       101.6          9.6 %    $ 320.0       301.0           6.3 %

Non-volume related revenues:
Processing fees                                49.6        45.3          9.5        145.7       136.3           6.9
Value-added, custom programming,
licensing and other                            26.5        29.7        (10.9 )       83.7        90.8          (7.9 )
Output and managed services                    29.9        26.9         11.1         88.0        85.0           3.5

Total non-volume related revenues             106.0       101.9          4.0        317.4       312.2           1.7

Total revenues before reimbursable items      217.3       203.5          6.8        637.4       613.1           4.0
Reimbursable items                             35.3        34.1          3.6        103.6       104.7          (1.0 )

Total Revenues                              $ 252.6       237.6          6.3 %    $ 741.0       717.8           3.2 %

International Services

The International Services segment provides issuer and merchant card solutions to financial institutions and other organizations primarily based outside the . . .

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