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TSS > SEC Filings for TSS > Form 10-Q on 8-May-2014All Recent SEC Filings

Show all filings for TOTAL SYSTEM SERVICES INC

Form 10-Q for TOTAL SYSTEM SERVICES INC


8-May-2014

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 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 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. The Company's NetSpend segment provides GPR prepaid debit and payroll cards and alternative financial service solutions to the underbanked and other consumers in the United States.

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, 2013, as filed with the Securities and Exchange Commission (SEC).

A summary of the financial highlights for 2014, as compared to 2013, is provided below:

                                                           Three months ended March 31,
                                                                                     Percent
(in millions)                                            2014            2013         Change
Total revenues                                        $    592.8          448.8          32.1 %
Operating income                                            80.7           74.5           8.3
Net income attributable to TSYS common
shareholders                                                49.3           57.0         (13.5 )
Basic earnings per share (EPS)                              0.26           0.31         (14.0 )
Diluted EPS                                                 0.26           0.30         (14.6 )
Adjusted earnings before interest, taxes,
depreciation, and amortization (Adjusted EBITDA)1          149.6          123.4          21.2
Adjusted cash EPS2                                          0.38           0.38          (1.1 )
Cash flows from operating activities                       148.7           52.4            nm *

* not meaningful

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)                          As of March 31,
                                                                    Percent
             AOF                            2014        2013        Change
             Consumer Credit                 234.8       203.7          15.3 %
             Retail                           27.5        25.2           9.3

             Total Consumer                  262.3       228.9          14.6
             Commercial                       40.4        37.9           6.7
             Other                            19.7        13.4          46.5

             Subtotal1                       322.4       280.2          15.1
             Prepaid/Stored Value2           120.0       107.3          11.8
             Government Services3             63.0        59.4           6.1
             Commercial Card Single Use4      50.8        31.6          60.8

             Total AOF                       556.2       478.5          16.2 %

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 as of 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, 2013, 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 2014.

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 March 31, 2014 is $2.8 million. Refer to Note 7 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, as of this time, the Company does not expect a significant change related to these obligations within the next year.

Additionally, the Company has long-term obligations which consist of required minimum future payments under contracts with our distributors and other services providers for the NetSpend segment.

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, 2013, as filed with the SEC.

In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) ASU 2014-08 "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." ASU 2014-08 addresses the accounting for the disposal of a component of an entity or a group of components of an entity. The amendments in this Update address those issues by changing the criteria for reporting discontinued operations and enhancing convergence of the FASB's and the International Accounting Standard Board's (IASB) reporting requirements for discontinued operations. For public entities, the ASU is effective prospectively for fiscal years, and interim periods, within those years, beginning after December 15, 2014. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The Company has elected not to early adopt ASU 2014-08. The Company does not expect the adoption of this ASU to have a material impact on the its 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 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 $144.0 million, or 32.1%, respectively, for the three months ended March 31, 2014, compared to the same period in 2013. The increases in revenues for the three months ended March 31, 2014 include an increase of $4.4 million 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


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impacted with changes in postal rates and changes in the volumes of mailing activities by its clients. Reimbursable items for the three months ended March 31, 2014 were $60.1 million which decreased $661,000, or 1.1%, compared to $60.8 million for the same period last year.

Excluding reimbursable items, revenues increased $144.7 million, or 37.3%, during the three months ended March 31, 2014, compared to 2013. The 37.3% increase in revenues excluding reimbursable items for the three months ended March 31, 2014, as compared to the same period in 2013, is the result of increases of 34.2% in revenues associated with acquisitions, and 3.1% in organic growth.

Major Customers

For discussion regarding the Company's major customers, refer to Note 8 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, 2013, 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 three months of 2014 and 2013, 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 the third quarter of 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. Effective June 2013, the Company renewed its processing agreement, which includes revenue minimums, with Bank of America for an additional two years.

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.

Operating Segments

TSYS' services are provided through four operating segments: North America Services, International Services, Merchant Services and NetSpend. Refer to Note 8 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.


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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 month period ended March 31, 2014.

Below is a summary of the North America Services segment:

                                                 Three months ended March 31,
                                                                           Percent
      (in millions)                           2014           2013          Change
      Total revenues                       $    262.2          239.8            9.3 %
      Revenues before reimbursable items        224.4          205.6            9.1
      Adjusted segment operating income1         74.6           68.7            8.5
      Adjusted segment operating margin2         28.4 %         28.7 %
      Key indicators:
      AOF                                       495.5          422.8           17.2
      Transactions                            2,327.6        2,013.4           15.6

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 9.3% increase in total segment revenues for the three months ended March 31, 2014, as compared to the same period in 2013, is driven by increases in revenues associated with new business and internal growth, partially offset by client portfolio deconversions and pricing concessions. Reimbursable items for the three months ended March 31, 2014 were $37.8 million, an increase of $3.6 million, or 10.6%, compared to $34.2 million for the same period last year.


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Excluding reimbursable items, revenues increased $18.8 million or 9.1%, for the three months ended March 31, 2014, as compared to the same period in 2013.

The increase in adjusted segment operating income for the three months ended March 31, 2014, as compared to 2013, is driven by an increase in revenues while the operating margin remained relatively flat.

For the three months ended March 31, 2014, approximately 50.0% 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 50.0% are derived from non-volume based revenues, such as processing fees, value-added products and services, custom programming and licensing arrangements.

                                                               Three months ended March 31,
                                                                                          Percent
(in millions)                                              2014             2013          Change
Volume-based revenues                                   $    112.2            102.0           10.0 %

Non-volume related revenues:
Processing fees                                               50.5             47.0            7.4
Value-added, custom programming, licensing and other          27.5             27.2            1.0
Output and managed services                                   34.2             29.4           16.4

Total non-volume related revenues                            112.2            103.6            8.3

Total revenues before reimbursable items                     224.4            205.6            9.1
Reimbursable items                                            37.8             34.2           10.6

Total Revenues                                          $    262.2            239.8            9.3 %

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 two major customers for the three months ended March 31, 2014.

Below is a summary of the International Services segment:

                                                 Three months ended March 31,
                                                                          Percent
       (in millions)                          2014            2013         Change
       Total revenues                       $    82.4           80.9           1.8 %
       Revenues before reimbursable items        76.8           76.4           0.5
       Adjusted segment operating income1         4.6            6.9         (33.6 )
       Adjusted segment operating margin2         5.5 %          8.5 %
       Key indicators:
       AOF                                       60.7           55.7           9.0
       Transactions                             517.9          434.0          19.3

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.


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The 1.8% increase in total segment revenues for the three months ended March 31, 2014, as compared to the same period in 2013, is driven by an increase of $4.2 million associated with currency translation, offset by decreases associated with client deconversions. Reimbursable items for the three months ended March 31, 2014 were $5.6 million, an increase of $1.1 million, or 24.5%, compared to $4.5 million for the same period last year. Excluding reimbursable items, revenues increased approximately $386,000, or 0.5%, respectively, for the three months ended March 31, 2014, as compared to the same period in 2013. The 0.5% increase in revenues excluding reimbursable items for the three months ended March 31, 2014, as compared to the same period in 2013, is the result of an increase from internal growth, partially offset by decreases in client deconversions and pricing concessions.

The increases in adjusted segment operating income for the three months ended March 31, 2014, as compared to the same periods in 2013, are driven primarily from changes in foreign currency exchange rates and decreases in depreciation and amortization.

Movements in foreign currency exchange rates as compared to the U.S. Dollar can result in foreign denominated financial statements being translated into more or fewer U.S. Dollars, which impacts the comparison to prior periods when the U.S. Dollar was stronger or weaker.

For the three months ended March 31, 2014, approximately 41.8% of the revenues before reimbursable items of TSYS' International Services segment, are driven by the volume of accounts on file and transactions processed and approximately 58.2% are derived from non-volume based revenues, such as processing fees, value-added products and services, custom programming and licensing arrangements.

                                                              Three months ended March 31,
                                                                                        Percent
(in millions)                                              2014            2013          Change
Volume-based revenues                                    $    32.1            30.8           4.2 %

Non-volume related revenues:
Processing fees                                               14.5            16.2         (10.6 )
Value-added, custom programming, licensing and other          19.8            18.8           5.5
Output and managed services                                   10.4            10.6          (2.1 )

Total non-volume related revenues                             44.7            45.6          (2.0 )

Total revenues before reimbursable items                      76.8            76.4           0.5
Reimbursable items                                             5.6             4.5          24.4

Total Revenues                                           $    82.4            80.9           1.8 %

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 . . .

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