-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Gim7rQ/Dn3oJW5XeU1pbR+1YJDhULoTYogQfFZI0g1M+zNZ4c1ugGd0nlFiQVMcj L0eMJy7kfrV2xeGgy1uzFg== 0000929624-98-001874.txt : 19981118 0000929624-98-001874.hdr.sgml : 19981118 ACCESSION NUMBER: 0000929624-98-001874 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: BA MERCHANT SERVICES INC CENTRAL INDEX KEY: 0001024674 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 943252840 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 333-13985 FILM NUMBER: 98751784 BUSINESS ADDRESS: STREET 1: ONE SOUTH VAN NESS AVENUE CITY: SAN FRANCISCO STATE: CA ZIP: 94103 BUSINESS PHONE: 4152413390 MAIL ADDRESS: STREET 1: ONE SOUTH VAN NESS AVENUE CITY: SAN FRANCISCO STATE: CA ZIP: 94103 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 1998 or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 1-12365 EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER: BA Merchant Services, Inc. STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION: Delaware I.R.S. EMPLOYER IDENTIFICATION NUMBER: 94-3252840 ADDRESS OF PRINCIPAL EXECUTIVE OFFICES: One South Van Ness Avenue San Francisco, California 94103 REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 415-241-3390 FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class A Common Stock, $0.01 par value -- 16,267,042 outstanding on September 30, 1998 Class B Common Stock, $0.01 par value -- 32,400,000 outstanding on September 30, 1998
- ------------------------------------------------------------------------------- This document serves both as an analytical review for analysts, shareholders, and other interested persons, and as the quarterly report on Form 10-Q of BA Merchant Services, Inc. to the Securities and Exchange Commission, which has taken no action to approve or disapprove the report or to pass upon its accuracy or adequacy. Additionally, this document is to be read in conjunction with BA Merchant Services, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1997, including the consolidated financial statements and notes thereto. INDEX BA MERCHANT SERVICES, INC.
Page ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements: Balance Sheet............................................................................... 1 Statement of Operations..................................................................... 2 Statement of Cash Flows..................................................................... 3 Statement of Changes in Stockholders' Equity................................................ 4 Notes to Financial Statements............................................................... 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: Highlights.................................................................................. 9 Results of Operations....................................................................... 11 Balance Sheet Review........................................................................ 12 Liquidity and Capital Resources............................................................. 12 Year 2000................................................................................... 13 Forward-Looking Statements.................................................................. 13 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form-8-K............................................................. 14 Signatures................................................................................... 15 Exhibit Index................................................................................ 16
PART I FINANCIAL INFORMATION BA MERCHANT SERVICES, INC. BALANCE SHEET UNAUDITED (DOLLAR AMOUNTS IN THOUSANDS) Item 1. Financial Statements
SEPTEMBER 30, DECEMBER 31, 1998 1997 ------------ ----------- ASSETS Current assets: Cash and cash equivalents............................................................... $ 54,409 $ 29,426 Short-term investments.................................................................. 35,564 64,018 Drafts in transit....................................................................... 108,015 106,463 Accounts receivable..................................................................... 64,051 63,461 Other current assets.................................................................... 5,253 11,533 -------- -------- Total current assets................................................................. 267,292 274,901 Property and equipment, net............................................................... 30,145 27,762 Investment in joint venture............................................................... 27,212 -- Goodwill, net............................................................................. 8,162 -- Other assets.............................................................................. 21,482 25,422 -------- -------- Total assets............................................................................ $354,293 $328,085 ======== ======== Liabilities and Stockholders' Equity Current liabilities: Accounts payable........................................................................ $ 89 $ 32 Merchants payable....................................................................... 6,470 8,058 Accrued liabilities..................................................................... 7,963 6,050 Accrued credit card association and interchange fees.................................... 8,672 9,192 Income taxes payable.................................................................... 4,033 3,459 Other current liabilities............................................................... 5,620 9,225 -------- -------- Total current liabilities............................................................ 32,847 36,016 Other liabilities......................................................................... 885 816 -------- -------- Total liabilities....................................................................... 33,732 36,832 ======== ======== Stockholders' equity: Class A Common Stock, par value $0.01; authorized 200,000,000 shares; issued and Outstanding 16,267,042 shares at June 30, 1998 and 16,253,126 at December 31, 1997....................................................................... 162 162 Class B Common Stock, par value $0.01; authorized 50,000,000 shares; issued and Outstanding 32,400,000 shares........................................................... 324 324 Additional paid-in capital................................................................ 252,861 252,479 Retained earnings......................................................................... 67,372 38,280 Accumulated foreign currency translation adjustments, net of income taxes................. (158) 8 -------- -------- Total stockholders' equity.............................................................. 320,561 291,253 -------- -------- Total liabilities and stockholders' equity............................................. $354,293 $328,085 ======== ========
See Notes to Financial Statements. 1 BA MERCHANT SERVICES, INC. STATEMENT OF OPERATIONS (UNAUDITED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------- ---------------------- 1998 1997 1998 1997 --------- ---------- --------- ---------- Net revenue................................................................... $48,716 $41,192 $135,789 $116,043 ------- ------- -------- -------- Operating expense: Salaries and employee benefits.............................................. 10,082 8,703 29,997 25,209 Data processing and communications.......................................... 10,919 8,332 29,797 24,315 General and administrative.................................................. 5,719 6,105 19,286 18,321 Depreciation................................................................ 4,171 2,869 11,362 7,882 Amortization of intangibles................................................. 567 106 1,455 327 ------- ------- -------- -------- Total operating expense.................................................. 31,458 26,115 91,897 76,054 ------- ------- -------- -------- Income from operations........................................................ 17,258 15,077 43,892 39,989 Net interest income........................................................... 1,669 2,059 5,416 5,811 ------- ------- -------- -------- Income before income taxes............................................... 18,927 17,136 49,308 45,800 Provision for income taxes.................................................... 7,760 7,082 20,216 18,930 ------- ------- -------- -------- Net income............................................................... $11,167 $10,054 $ 29,092 $ 26,870 ======= ======= ======== ======== Earnings per common share..................................................... $0.23 $0.21 $0.60 $0.55 Diluted earnings per common share............................................. $0.23 $0.21 $0.60 $0.55
See Notes to Financial Statements. 2 BA MERCHANT SERVICES, INC. STATEMENT OF CASH FLOWS (Unaudited) (DOLLAR AMOUNTS IN THOUSANDS)
Nine Months Ended September, 30 --------------------------------- 1998 1997 ---------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income.......................................................................... $ 29,092 $ 26,870 Adjustments to net income to arrive at cash provided by operating activities: Depreciation...................................................................... 11,262 7,882 Amortization of intangibles....................................................... 1,455 327 Benefit from deferred income taxes................................................ (1,451) (1,051) Amortization of restricted stock.................................................. 323 479 Amortization of loan fees......................................................... -- 254 Changes in operating assets and liabilities: Decrease (increase) in drafts in transit....................................... (1,552) 23,755 Decrease in accounts receivable................................................ (590) (16,702) Decrease (increase) in other current assets.................................... 6,280 (7,477) Increase in accounts payable................................................... 57 2,189 Increase in current income taxes payable....................................... 574 821 Increase in merchants payable.................................................. (1,588) (8,285) Increase in accrued liabilities................................................ 1,913 1,278 (Decrease) increase in accrued credit card association and interchange fees............................................................. (520) 3,632 Other, net..................................................................... 26 4,769 -------- -------- Net cash provided by operating activities................................... 45,281 38,741 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment.................................................. (13,645) (12,870) Purchase of short-term investments.................................................. (11,674) (71,214) Maturities of short-term investments................................................ 40,128 -- Acquisition of portfolio of merchant processing contracts.......................... -- (11,000) Investment in joint venture........................................................ (35,000) -- -------- -------- Net cash provided by (used for) investing activities........................ (20,191) (95,084) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase in underwriting expense.................................................... -- (165) Issuance of common stock........................................................... 59 -- BAC's change in funding............................................................. -- (26,483) -------- -------- Net cash used for financing activities...................................... 59 (26,648) -------- -------- EXCHANGE RATE EFFECT ON CASH AND CASH EQUIVALENTS................................... (166) (236) -------- -------- Increase in cash and cash equivalents............................................... 24,983 (83,227) Cash and cash equivalents at beginning of period.................................... 29,426 138,413 -------- -------- Cash and cash equivalents at end of period.......................................... $ 54,409 $ 55,186 ======== ========
See Notes to Financial Statements. 3 BA MERCHANT SERVICES, INC. STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, --------------------------- 1998 1997 ------------ ------------ (dollar amounts in thousands) CLASS A COMMON STOCK: Balance at beginning of period.................................................. $ 162 $ 162 Issuance of additional stock.................................................... -- -- -------- -------- Balance at end of period.................................................... 162 162 CLASS B COMMON STOCK: Balance at beginning of period.................................................. 324 302 Issuance of additional common stock............................................. -- 22 -------- -------- Balance at end of period.................................................... 324 324 ADDITIONAL PAID-IN CAPITAL: Balance at beginning of period.................................................. 252,479 249,622 Amortization of unvested portion of restricted stock............................ 323 479 Additional underwriting expenses................................................ -- (165) Issuance of additional common stock............................................. 59 2,462 -------- -------- Balance at end of period.................................................... 252,861 252,398 CUMULATIVE FOREIGN CURRENCY TRANSLATION ADJUSTMENT: Balance at beginning of period.................................................. 8 -- Translation adjustments......................................................... (166) (236) -------- -------- Balance at end of period.................................................... (158) (236) RETAINED EARNINGS: Balance at beginning of period.................................................. 38,280 2,039 Net income...................................................................... 29,092 25,786 -------- -------- Balance at end of period.................................................... 67,372 27,825 BAC'S EQUITY INTEREST: Balance at beginning of period.................................................. -- 27,883 Net income...................................................................... -- 1,084 Transfer of net assets from BAC in exchange for Class B common stock........................................................ -- (2,484) BAC's change in funding......................................................... -- (26,483) -------- -------- Balance at end of period.................................................... -- -- -------- -------- Total stockholders' equity end of period.................................. $320,561 $280,473 ======== ========
See Notes to Financial Statements. 4 BA MERCHANT SERVICES, INC. NOTES TO FINANCIAL STATEMENTS Note 1--Description of Business, Organization and Basis of Presentation Description of Business - BA Merchant Services, Inc. ("BAMS" or the "Company") provides an array of payment processing and related information products and services to merchants throughout the United States and certain Asian countries who accept credit, charge and debit cards as payment for goods and services. BAMS is one of the largest processors of merchant debit and credit card transactions in the United States. Organization and Domestic Operations - BAMS was incorporated on October 11, 1996 and commenced operations December 4, 1996, upon the transfer by Bank of America National Trust & Savings Association (the "Bank") and Bank of America NW, National Association ("BANW", formerly Seattle-First National Bank) of their respective United States merchant processing businesses to BAMS in consideration for 30.2 million shares of Class B Common Stock. Effective January 1, 1997, BANW was merged into the Bank. The Bank is a wholly owned subsidiary of BankAmerica Corporation ("BAC"). References to "BAC" in these financial statements and notes thereto shall be deemed to be references to BankAmerica Corporation and its subsidiaries and affiliates, including the Bank and, prior to January 1, 1997, BANW. During December 1996, BAMS issued 16.1 million shares of Class A Common Stock in underwritten initial public offerings which generated net cash proceeds of $232.9 million. Asian Operations - On June 2, 1997, BAMS acquired BAC's merchant processing business in Thailand (net assets of approximately $91,000) in consideration for 150,000 shares of Class B Common Stock. On July 1, 1997, BAMS acquired BAC's merchant processing business in the Philippines (net assets of approximately $153,000) in consideration for 550,000 shares of Class B Common Stock. On September 30, 1997, BAMS acquired BAC's merchant processing business in Taiwan and merchant processing administrative office in Hong Kong (net assets of approximately $2.2 million) in consideration for 1,500,000 shares of Class B Common Stock. The acquisition of these entities will be collectively referred to as the "Asia Acquisitions". With the issuance by BAMS of additional shares of Class B Common Stock to BAC in connection with the Asia Acquisitions, BAC's financial interest in BAMS increased from 65.0% to 66.6%. On October 31, 1998, the Company closed its merchant processing operations in Thailand. For the first nine months of 1998, the Company's operations in Thailand lost approximately $0.3 million after tax. NationsBank Corporation Merger - On April 13, 1998, BAC and NationsBank Corporation ("NBC") announced a definitive agreement to merge in a stock-for- stock transaction. The merger closed on September 30, 1998. For further disclosure, see Management's Discussion and Analysis of Financial Condition and Results of Operations - "Highlights" on page 9. Basis of Presentation - The unaudited financial statements of BAMS are prepared in conformity with generally accepted accounting principles for interim financial information, the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included. All such adjustments are of a normal recurring nature. These unaudited financial statements should be read in conjunction with the audited consolidated financial statements included in BAMS' Annual Report on Form 10-K for the year ended December 31, 1997. Results for the interim periods should not be considered indicative of results to be expected for the full year. BAC's transfer to BAMS of certain assets and liabilities of its United States and certain Asian merchant processing businesses (net assets) was accounted for as a reorganization of entities under common control and, accordingly, the transfer of these net assets was accounted for at historical cost in a manner similar to a pooling of interests. Included in the transfer of net assets was Seafirst Merchant Services, Inc. ("SMSI"), a wholly owned subsidiary of BANW. SMSI was subsequently dissolved on December 29, 1997. The accompanying financial statements have been prepared as if the Company had operated as a separate entity for all periods presented. The financial statements include the combined 5 BA MERCHANT SERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) historical results of operations, assets and liabilities of BAC's merchant processing businesses in Thailand, the Philippines, Taiwan and the merchant processing administrative office in Hong Kong for all periods prior to the Asia Acquisitions. Prior to the respective dates of the Asia Acquisitions, changes in BAC's equity interest represented net income of the Company adjusted for net cash transfers to and from BAC. Additionally, prior to these dates, the financial statements include allocations of certain assets (primarily property and equipment) and expenses relating to the merchant processing businesses transferred from BAC. Management believes these allocations are reasonable. Certain of the pre-Asia Acquisition expenses in the financial statements are not necessarily indicative of the costs that would have been incurred if the Company had performed these functions as a stand-alone entity. Therefore, prior to the respective dates of the Asia Acquisitions, the financial statements may not necessarily reflect the Company's results of operations, changes in equity and cash flows as they would have been had the Company owned and operated the Asian operations. Subsequent to these dates, the Company performed these functions using its own resources and purchased services (from BAC and other companies) and was responsible for the cost and expenses associated with the management of the Asian operations. NOTE 2--INCOME TAXES The following is a summary of the components of income tax expense:
THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- -------------------------- 1998 1997 1998 1997 ------------ ---------- ----------- ----------- Provision for income taxes: Federal.............................................. $5,870 $5,208 $15,182 $13,931 State................................................ 1,718 1,597 4,443 4,269 Foreign.............................................. 172 277 591 730 ------ ------ ------- ------- Total........................................... $7,760 $7,082 $20,216 $18,930 ====== ====== ======= =======
The Company's estimated annual effective income tax rate for the 1998 and 1997 interim periods was 41.0% and 41.3%, respectively. These rates are higher than the federal statutory tax rate of 35% due principally to state income taxes. NOTE 3--EARNINGS PER COMMON SHARE Effective December 15, 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128). Under the new requirements, the Company's computation of earnings per common and common equivalent share is replaced by earnings per common share, which excludes any dilutive effect of stock options and warrants outstanding during the period. Earnings per common share is computed by dividing net income applicable to common stock by the average number of common shares outstanding during the period. Also, under SFAS No. 128, the Company's computation of earnings per common and common equivalent share, assuming full dilution, is replaced with diluted earnings per common share. Diluted earnings per common share is computed by dividing net income applicable to common stock by the average number of common shares outstanding 6 BA MERCHANT SERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) during the period including the dilutive effect of stock options and warrants outstanding during the period. The dilutive effect of stock options and warrants outstanding during the period is computed using the average market price of the Company's common stock for the period. Earnings per share for the three and nine month periods ended September 30, 1997 has been computed by dividing net income by the weighted average number of common shares outstanding assuming the stock issued in the Asia Acquisitions had been outstanding since January 1, 1994. The earnings per common share amount for each period presented below is the same as the diluted earnings per common share amount presented for the respective period.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------- --------------------------- 1998 1997 1998 1997 ------------ ------------ ----------- ----------- (amounts in thousands, except earnings per share data) Net income.................................................... $11,167 $10,054 $29,092 $26,870 Average number of common shares outstanding and common stock equivalents............................................ 48,751 48,787 48,783 48,730 Diluted earnings per common share.............................. $ 0.23 $ 0.21 $ 0.60 $ 0.55
Note 4--Related Parties The Company and BAC engage in various intercompany transactions and arrangements including the provision by BAC of various services to the Company. Such services are currently provided pursuant to various intercompany agreements which, among other things, grant to the Company a license to use the Bank of America name and certain trademarks and service marks in connection with the Company's business. Additional services provided under the intercompany agreements include product distribution, processing, system support, telecommunications, marketing, regulatory compliance, legal, tax and treasury, accounting and audit and other miscellaneous support and administrative services. The Company believes that the cost of services provided under the intercompany arrangements have not been materially different from the costs that would have been incurred if the Company was unaffiliated with BAC. NOTE 5--COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130), which requires companies to report and display comprehensive income and its components. The adoption of SFAS No. 130 did not have an impact on the Company's financial position or results of operations as reported herein. 7 BA MERCHANT SERVICES, INC. NOTES TO FINANCIAL STATEMENTS--(Continued) The following is a summary of the components of total comprehensive income, net of related income taxes:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ ---------------------------- 1998 1997 1998 1997 ------------ ------------ ----------- ----------- Net income.............................................. $11,167 $10,054 $29,092 $26,870 Foreign currency translation adjustment................. (33) (283) (158) (236) ------- ------- ------- ------- Total comprehensive income......................... $11,134 $ 9,771 $28,934 $26,634 ======= ======= ======= =======
NOTE 6--INVESTMENT IN JOINT VENTURE During the third quarter, the Company entered into an agreement to invest in a new limited liability company ("LLC") with First Data Financial Services, LLC and Global Cash Access. The joint venture will provide cash advance and related services to the gaming business. The Company invested $35 million in cash, in addition to its interest in existing gaming contracts and gaming related assets, for a 21 percent ownership in the LLC. The Company recorded assets in its investment in the joint venture in the amount of $27.2 million. The difference is goodwill, which represents the excess of the purchase price over the estimated fair value of identifiable net assets associated with the above transaction. Goodwill is amortized on a straight-line basis over 15 years. For further disclosure, see Management's Discussion and Analysis of Financial Condition and Results of Operations--"Highlights" on page 9. NOTE 7--SUBSEQUENT EVENT On October 22, 1998, at a meeting of the Board of Directors of the Company, a representative of the Bank presented a proposal to the Board of Directors of the Company regarding the possible acquisition for cash of all of the outstanding shares of Class A Common Stock of the Company. The Bank indicated at the meeting a willingness to acquire such shares at a cash price per share of $15.50. At the October 22, 1998 Board Meeting, the Board of Directors appointed a Committee of the Board of Directors comprised of individuals who are unaffiliated with the Bank and BAC. The Committee was empowered to review and evaluate the proposal made by the Bank and to engage special counsel and any other experts necessary to advise and aid the Committee in reviewing the proposal. For further disclosure, see Management's Discussion and Analysis of Financial Condition and Results of Operations--"Highlights" on page 9. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company has focused its marketing efforts on small and medium sized merchants due to lower acquisition costs, higher ongoing profitability and higher retention. The strategy has historically fit well with the Company's competitive advantage from its relationship with Bank of America. The Company will continue to refine its strategic focus by leveraging four key opportunities: First, extend the Company's marketing programs to the approximately 2,800 new full service banking centers which the Company can access as a result of the merger of Bank of America and NationsBank; second, focus sales efforts on value creating merchant accounts; third, utilize a more refined account valuation model to actively manage the Company's existing portfolio; and finally, continue to explore opportunities for expense reductions. The recently completed merger between BAC and NationsBank provides the Company with access to 2,800 additional full service banking centers, approximately 900,000 additional business banking relationships and significantly expanded On-Us capabilities. This will require recruiting and retaining new skilled sales associates and, likely, opening a regional sales and customer service facility in the Southeast. There can be no assurance that the Company will continue its current relationship as the principal merchant processing servicer for the combined organization or that the relationship will be profitable to the Company. The Company has historically focused its sales efforts on small and medium sized markets. The Company is increasing its sales efforts on businesses in this size range through a combination of life-of-relationship pricing strategies, sales incentives and joint marketing programs with Bank of America. Portfolio management responsibilities and compensation of the portfolio account managers will also be focused on retaining and growing merchant relationships in this market segment. The Company intends to maintain its focus on controlling expenses. The installation of HostLink II, the Company's enhanced in-house transaction processing system, will allow the Company to move merchants from third party vendors to the more cost-efficient HostLink system, providing the potential for additional cost per transaction savings to the Company. The Company faces market risks from potential economic downturns which could affect growth in retail transaction volumes or increase losses from chargebacks and further currency devaluation. Further, the Company may not be successful in implementing its strategies. Risk could also arise in unforeseen delays in Year 2000 compliance efforts, inability of the Company to hire or retain qualified sales staff and continued industry-wide compression in pricing margins. HIGHLIGHTS On April 13, 1998, BankAmerica Corporation (BAC) and NationsBank Corporation (NBC) announced a definitive agreement to merge in a stock-for-stock transaction. The merger closed on September 30, 1998. Under various contractual agreements with BAC (described on page 7 of the Company's Annual Report on Form 10-K under "Relationship with BankAmerica and the Bank"), the Company has access to BAC's client base, the Bank of America name and trademarks, the implementation of On-Us transaction processing and marketing, the Bank's distribution channels, and credit and debit card association and network sponsorships. 9 On May 29 1998, the Company announced that BAC and NBC had jointly determined that the Company will be the principal merchant processing servicer for the combined organization following the merger. The new BAC franchise will have approximately 4,800 retail branches in twenty-two states. The Company believes the opportunity to be the principal merchant acquirer for new business with access to the extended BAC retail branch network may be a significant source of potential revenue growth for the Company. However, the Company cannot at this time estimate the impact this may have on its financial position or results of operation. NBC previously offered merchant processing services through a minority-owned interest in a venture with another merchant processing provider. On November 13, 1998, BAC announced it had signed a letter of intent to sell its minority interest to its venture partner. At this time, the Company cannot determine what impact, if any, the proposed sale may have on its financial position or results of operations. On July 9, 1998, the Company entered into an agreement to invest in a new limited liability company ("LLC") with First Data Financial Services, LLC and Global Cash Access ("Global"). The joint venture will provide cash advance and related services, as described below, to the gaming business. The Company received its required regulatory approval and made its investments in the LLC on September 10, 1998. The name of the new entity is BMCF Gaming, LLC. The Company invested $35 million in cash, plus all interest earned during the escrow period of July 9, 1998 to September 10, 1998, in addition to its interest in existing gaming contracts and gaming-related assets, for a 21 percent ownership in the LLC. The LLC will provide the following services in gaming areas and to gaming establishments and/or patrons at gaming establishments: a) credit and debit card cash advance services, b) ATM Services, c) development and operation of a cashless gaming system for use in slot machines and similar gaming devices by gaming patrons, d) check verification and guarantee services at gaming establishments, e) operations of financial services booths located on the premises of gaming establishments, and f) single system financial services authorization platforms to be utilized by gaming establishments. On October 31, 1998, the Company closed its merchant processing operations in Thailand. For the first nine months of 1998, the Company's operations in Thailand lost approximately $0.3 million after tax. The Company's financial results for third quarter, 1998 includes a $260,000 pre-tax charge to pay for closure-related costs. On October 22, 1998, at a meeting of the Board of Directors of the Company, a representative of the Bank presented a proposal to the Board of Directors of the Company regarding the possible acquisition for cash of all of the outstanding shares of Class A Common Stock of the Company. The Bank indicated at the meeting a willingness to acquire such shares at a cash price per share of $15.50. The Bank's proposed transaction, as currently presented, would be structured as a merger. Consummation of the transaction would be subject to negotiation of a definitive agreement, the approval of the Board of Directors and the stockholders of the Company, as well as other customary conditions, including any necessary regulatory approvals. The Bank however has the option to acquire shares of Class A Stock on a basis other than a merger, including by a tender offer or otherwise. At the October 22, 1998 Board meeting, the Board of Directors appointed a Committee of the Board of Directors comprised of individuals who are unaffiliated with the Bank and BAC. The Committee was empowered to review and evaluate the proposal made by the Bank and to engage special counsel and any other experts necessary to advise and aid the Committee in reviewing the proposal. The Board of Directors, in a meeting held on November 10, 1998, further defined the Committee's role to include, among other matters, advising the Board of Directors on the Bank's proposal, engaging in negotiations with the Bank with respect to the proposal and taking such further actions as the Committee may deem appropriate. The Committee has retained legal counsel and investment bankers to assist it in fulfilling its responsibilities. The Bank is the record owner of all of the Company's currently outstanding Class B shares, which represents approximately 66.6% of the outstanding Class A and Class B Common Stock of the Company and approximately 95.2% of the combined voting power of the two classes of common stock. One share of Class B Common Stock is convertible into one share of Class A Common Stock under conditions set forth in the Company's Amended and Restated Certificate of Incorporation. 10 At this time, the Company cannot determine the outcome of the negotiations including the price and other terms of any transaction or whether a transaction will be completed. RESULTS OF OPERATIONS THIRD QUARTER REVIEW Net Revenue - For the three month period ended September 30, 1998, net revenue was $48.7 million, up $7.5 million, or 18 percent over the three month period ended September 30, 1997. The increase was primarily attributable to a $1.8 billion or 21 percent increase in sales volume processed over the comparable prior year quarter. Increased sales volume resulted primarily from growth in the Company's merchant base through continued emphasis on marketing and sales growth, including expansion into new sales territories. The growth rate in net revenue was lower than that for sales volume processed primarily as a result of greater sales volume growth in lower spread business (debit card and high volume merchants) and to a lesser degree, declining spreads in existing business consistent with historical competitive trends in the merchant processing industry. Operating Expense - Total operating expense was $31.5 million for the third quarter of 1998, an increase of $5.3 million, or 20 percent over the same period a year ago. On the same comparative basis, salaries and employee benefits increased $1.4 million or 16 percent, reflecting growth in direct sales staff and related support personnel. Data processing and communications expense increased $2.6 million, or 31 percent. This increase was primarily related to higher authorization expense and data processing contract services related to growth in transaction volume, net of reductions in other data processing costs as a result of the conversion of United States merchants from the old transaction processing system to HostLINK(TM) during the second quarter of 1997. Depreciation expense increased $1.3 million or 45 percent primarily due to the acquisition of merchant processing terminals required for the Company's expanded merchant base. Amortization of intangibles increased $0.5 million related to amortization of the portfolio of merchant processing contracts acquired in September 1997. Net Income - The Company earned net income of $11.2 million for the third quarter of 1998, an increase of $1.1 million or 11 percent over the same period a year ago. Net income from domestic operations for the third quarter of 1998 increased approximately $1.4 million or 14 percent over the comparable quarter in 1997. This improvement was a result of an increase in domestic net revenue of $7.9 million or 21 percent over the third quarter of 1997 on an increase in sales volume processed of $1.8 billion or 21 percent. Third quarter 1998 net income from the Company's Asian operations decreased 49 percent as compared to the third quarter of 1997, primarily related to a 15 percent decrease in net revenue, reflecting both increased competition and the area's economic turmoil. 11 NINE MONTH REVIEW Net Revenue - Net revenue was $135.8 million for the first nine months of 1998, up 17 percent over the 1997 comparable period. Sales volume processed for the nine months ended September 30, 1998 was $29.8 billion, an increase of $5.7 billion or 24 percent over the first nine months of 1997. The net revenue percentage growth rate was lower than the sales volume processed growth rate for the third quarter of 1998 for the same reasons discussed above. Operating Expense - Total operating expense for the first nine months of 1998 was $91.9 million, up 21 percent over the 1997 comparable period. On the same comparative basis, salaries and employee benefits increased $4.8 million (19 percent), data processing and communications increased $5.5 million (23 percent), general and administrative increased $1.0 million (5 percent), depreciation increased $3.5 million (44 percent) and amortization of intangibles increased $1.1 million. Increases in those expense categories were substantially due to the same reasons cited for the third quarter expense comparisons above. The Company has decreased expense per transaction from $.34 in 1993 to $.18 for the first nine months in 1998. Net Income - The Company earned net income of $29.1 million for the first nine months of 1998, an increase of $2.2 million or 8 percent over the same period a year ago. Net income from domestic operations for the 1998 period was $28.7 million, an increase of $3.2 million or 13 percent over the comparable 1997 period. This improvement was the result of an increase in domestic net revenue of $22.2 million or 21 percent over the comparable 1997 period on an increase in sales volume processed of $5.7 billion or 25 percent. Net income from the Company's Asian operations for the first nine months of 1998 decreased 70 percent from the same period in 1997 reflecting both increased competition and the area's economic turmoil. BALANCE SHEET REVIEW The Company's assets totaled $354.3 million as of September 30, 1998, up $26.2 million from December 31, 1997. The balances in cash and cash equivalents, short-term investments, drafts in transit and merchants payable can fluctuate greatly depending on the day of the week in which the reporting period ends. The timing of payments received from credit card associations and debit card networks, remittances to merchants and weekend processing influence these balances. While the individual balances in these accounts at September 30, 1998 were significantly different from the balances at December 31, 1997, the net total of these combined accounts was $191.5 million at September 30, 1998, versus $191.8 million at December 31, 1997. Investment in joint venture increased $27.2 million since December 31, 1997 as a result of the investment in BMCF Gaming, LLC. LIQUIDITY AND CAPITAL RESOURCES The Company generated net cash from operating activities of $45.3 million and $38.7 million for the nine month periods ended September 30, 1998 and 1997, respectively. The net cash provided by operating activities for the 1998 period was primarily related to net income adjusted for non-cash depreciation and amortization of $41.8 million. Prior to the time BAC transferred its merchant processing businesses to the Company, funds generated by the Company's operations and not used for investments were remitted to BAC. Working capital decreased by $4.4 million to $234.4 million at September 30, 1998. The Company anticipates that its cash and cash equivalent and short-term investment balances will be adequate for funding the daily cash needs of the business as well as for acquisitions, strategic technology investments and the funding of research and product development. The Company has a commitment for a $100 million revolving line of credit with Bank of America expiring May 31, 1999. Borrowings outstanding under the commitment amounted to $1.8 million as of September 30, 1998. 12 YEAR 2000 Because computers frequently use only two digits to recognize years, on January 1, 2000, many computer systems, as well as any equipment that uses embedded computer chips, may be unable to distinguish between 1900 and 2000. If not remediated, this problem could create system errors and failures resulting in the disruption of normal business operations. Since the Year 2000 is a leap year, there could also be business disruptions as a result of the inability of many computer systems to recognize February 29, 2000. The Company has instituted a comprehensive program to ensure that its computer systems and applications will be ready for the Year 2000. The program, headed by a senior officer of the Company, includes the following: . review and testing internally used software and systems for Year 2000 compliance; . remediating internally used software and systems that are not Year 2000 compliant; . certifying internally used software and systems for Year 2000 compliance; . reviewing the status of key business partners with Year 2000 compliance; . developing contingency plans in case the Company encounters any difficulties with the Year 2000 date change either from its internal systems or from key business partners. The Company expects that it will be ready for the Year 2000 date change, and its goal is to have all of its internal systems tested and certified for Year 2000 compliance by the end of 1998. BAMS has completed testing and certification of its back office operation system, all desktop environments and all of its point-of-sale terminal applications. BAMS has not completed testing and certification of its chargeback imaging system, but expects to have that system tested and certified for Year 2000 compliance by November 30, 1998. The testing and certification of its HostLINK system has been completed. The Company has undertaken to review the status of Year 2000 compliance of key suppliers. Letters of certification have been received from all major third- party processing vendors with the exception of Total Systems. A project plan has been received from Total Systems. The Company has been conducting internal testing on Total Systems since October 19, 1998. The Company expects to complete its testing and certification by year-end 1998. The Company estimates that it will spend a total of approximately $350,000 in preparation for the Year 2000. Of that amount, the Company has spent approximately $240,000 in its compliance efforts, including $80,000 in 1998 year-to-date. The Company does not believe the cost incurred in its Year 2000 compliance efforts will be material in any one quarter. Costs are expensed as they are incurred by the Company. At this time, Year 2000 has caused no significant delays or cancellations to any project having a material impact on the financial condition of the Company. The Company is taking inventory of equipment that uses embedded computer chips (i.e., "non-information technology systems" or "Infrastructure") and is in the process of scheduling remediation or replacement of this Infrastructure, as necessary. Examples of Infrastructure include building security systems, fire alarm systems, identification and access cards, date stamps and elevators. The Company believes it is taking all appropriate measures to prepare for the Year 2000 date change. Ultimately, the potential impact of the Year 2000 issue will depend not only on the corrective measures the Company undertakes, but also on the way in which the Year 2000 issue is addressed by businesses and other entities who provide data to, or receive data from the Company, or whose financial condition or operational capability is important to the Company as suppliers or customers. Consequences of a failure of the Company or its key business partners to be Year 2000 compliant include the Company having to resort to voice authorizations and paper draft processing for a portion of its merchants for purposes of maintaining ongoing business. Consequently, no assurances can be made that Year 2000 compliance can be achieved without costs and uncertainties that might have a material adverse effect on the Company's financial condition, business or results of operations. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements, usually containing the words "estimate", "project", "expect" or similar expressions. These statements are subject to uncertainties, including those discussed in this report and in Management's Discussion and Analysis of Financial Condition and Results of Operations - "Forward-Looking Statements" in BAMS' Annual Report on Form 10-K for the year ended December 31, 1997, that could cause actual results to differ materially. Readers are cautioned not to place undue reliance on these forward- looking statements, which speak only as of the date hereof. 13 PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K - ------------------------------------------- (a) Exhibits: 27 Financial Data Schedule 14 SIGNATURES - -------------------------------------------------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BA MERCHANT SERVICES, INC. (Registrant) By Principal Executive Officer and Duly Authorized Signatory: /s/ Sharif M. Bayyari ---------------------------------------- SHARIF M. BAYYARI President and Chief Executive Officer November 13, 1998 By Principal Financial Officer and Duly Authorized Signatory: /s/ James H. Williams ---------------------------------------- JAMES H. WILLIAMS Executive Vice President, Chief Financial Officer and Chief Accounting Officer November 13, 1998 15 EXHIBIT INDEX EXHIBIT REFERENCE DESCRIPTION - --------- ----------- 27 Financial Data Schedule 16 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS 9-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 SEP-30-1998 SEP-30-1997 54,409 29,426 35,564 64,018 172,066 169,924 0 0 0 0 267,292 274,901 81,692 68,133 51,547 40,371 354,293 328,085 32,847 36,016 0 0 0 0 0 0 486 486 0 0 354,293 328,085 0 0 135,789 116,043 0 0 0 0 91,897 76,054 0 0 (5,416) (5,811) 49,308 45,800 20,216 18,930 29,092 26,870 0 0 0 0 0 0 29,092 26,870 .60 .55 .60 .55
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