10-Q 1 tss-20170630x10q.htm 10-Q tss_Current_Folio_10Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the quarterly period ended June 30, 2017

 

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from                     To                    

 

Commission file number: 1-10254

 

Picture 1

Total System Services, Inc.

www.tsys.com

(Exact name of registrant as specified in its charter)

 

Georgia

58-1493818

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

One TSYS Way, Post Office Box 1755, Columbus, Georgia 31902

(Address of principal executive offices) (Zip Code)

 

(706) 644-6081

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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 ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☑ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer ☐ (Do not check if a smaller reporting company)

 

Smaller reporting company

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☑

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

CLASS

OUTSTANDING AS OF: July 31, 2017

Common Stock, $0.10 par value

184,238,052 shares

 

 

 

 


 

Picture 1

 

TOTAL SYSTEM SERVICES, INC.

Table of Contents

 

 

Page
Number

PART I. FINANCIAL INFORMATION 

 

Item 1. Financial Statements 

 

Consolidated Balance Sheets (unaudited) — June 30, 2017 and December 31, 2016 

3

Consolidated Statements of Income (unaudited) — Three and six months ended June 30, 2017 and 2016 

4

Consolidated Statements of Comprehensive Income (unaudited) — Three and six months ended June 30, 2017 and 2016 

5

Consolidated Statements of Cash Flows (unaudited) — Six months ended June 30, 2017 and 2016 

6

Notes to Unaudited Consolidated Financial Statements 

7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 

24

Item 3. Quantitative and Qualitative Disclosures About Market Risk 

41

Item 4. Controls and Procedures 

42

PART II. OTHER INFORMATION 

 

Item 1. Legal Proceedings 

42

Item 1A. Risk Factors 

42

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 

43

Item 6. Exhibits 

43

SIGNATURES 

44

EXHIBIT INDEX 

45

 

 

 


 

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

TOTAL SYSTEM SERVICES, INC.

Consolidated Balance Sheets

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands, except per share data)

    

June 30, 2017

    

December 31, 2016

    

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents (Note 3)

 

$

427,589

 

425,354

 

Accounts receivable, net of allowances for doubtful accounts and billing adjustments of $4.8 million as of 2017 and 2016, respectively

 

 

442,094

 

432,847

 

Prepaid expenses and other current assets (Note 3)

 

 

157,325

 

164,488

 

Total current assets

 

 

1,027,008

 

1,022,689

 

Goodwill (Note 2)

 

 

3,271,975

 

3,270,952

 

Other intangible assets, net of accumulated amortization of $513.0 million and $420.6 million as of 2017 and 2016, respectively

 

 

814,762

 

906,676

 

Intangible assets - computer software, net of accumulated amortization of $807.6 million and $757.4 million as of 2017 and 2016, respectively

 

 

401,014

 

423,188

 

Property and equipment, net of accumulated depreciation and amortization of $509.6 million and $480.7 million as of 2017 and 2016, respectively (Note 7)

 

 

280,636

 

282,345

 

Contract acquisition costs, net of accumulated amortization of $325.2 million and $309.7 million as of 2017 and 2016, respectively (Note 3)

 

 

227,659

 

235,700

 

Equity investments, net

 

 

158,540

 

133,556

 

Deferred income tax assets

 

 

7,215

 

7,055

 

Other assets

 

 

88,205

 

84,016

 

Total assets

 

$

6,277,014

 

6,366,177

 

Liabilities

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Current portion of long-term borrowings (Note 4)

 

$

571,007

 

48,040

 

Accounts payable

 

 

53,124

 

38,712

 

Accrued salaries and employee benefits

 

 

41,086

 

67,655

 

Current portion of obligations under capital leases and license agreements

 

 

3,972

 

2,687

 

Other current liabilities (Note 3)

 

 

273,991

 

263,259

 

Total current liabilities

 

 

943,180

 

420,353

 

Long-term borrowings, excluding current portion (Note 4)

 

 

2,560,277

 

3,312,215

 

Deferred income tax liabilities

 

 

402,088

 

419,552

 

Obligations under capital leases and license agreements, excluding current portion

 

 

3,791

 

1,061

 

Other long-term liabilities

 

 

90,040

 

88,983

 

Total liabilities

 

 

3,999,376

 

4,242,164

 

Redeemable noncontrolling interest in consolidated subsidiary

 

 

13,102

 

24,093

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

Shareholders' Equity

 

 

 

 

 

 

Common stock — $0.10 par value. Authorized 600,000 shares; 202,765 issued as of 2017 and 2016; 184,217 and 183,451 outstanding as of 2017 and 2016, respectively

 

 

20,277

 

20,276

 

Additional paid-in capital

 

 

238,148

 

279,627

 

Accumulated other comprehensive loss, net (Note 3)

 

 

(45,138)

 

(56,158)

 

Treasury stock, at cost (18,548 and 19,314 shares as of 2017 and 2016,
respectively)

 

 

(635,227)

 

(646,047)

 

Retained earnings

 

 

2,686,476

 

2,502,222

 

Total shareholders’ equity

 

 

2,264,536

 

2,099,920

 

Total liabilities and shareholders' equity

 

$

6,277,014

 

6,366,177

 

 

See accompanying Notes to Unaudited Consolidated Financial Statements

3


 

TOTAL SYSTEM SERVICES, INC.

Consolidated Statements of Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Three months ended June 30, 

 

Six months ended June 30, 

 

(in thousands, except per share data)

    

2017

    

2016

    

2017

    

2016

 

Total revenues (Note 7)

 

$

1,222,375

 

1,151,587

 

 

2,407,100

 

 

1,890,965

 

Cost of services

 

 

877,887

 

841,923

 

 

1,739,744

 

 

1,326,430

 

Selling, general and administrative expenses

 

 

151,240

 

173,843

 

 

306,925

 

 

277,027

 

Total operating expenses

 

 

1,029,127

 

1,015,766

 

 

2,046,669

 

 

1,603,457

 

Operating income

 

 

193,248

 

135,821

 

 

360,431

 

 

287,508

 

Nonoperating expenses, net

 

 

(30,042)

 

(29,760)

 

 

(59,945)

 

 

(51,857)

 

Income before income taxes and equity in income of equity investments

 

 

163,206

 

106,061

 

 

300,486

 

 

235,651

 

Income taxes

 

 

56,207

 

40,290

 

 

99,289

 

 

83,719

 

Income before equity in income of equity investments

 

 

106,999

 

65,771

 

 

201,197

 

 

151,932

 

Equity in income of equity investments, net of tax

 

 

9,513

 

5,977

 

 

22,422

 

 

12,224

 

Net income

 

 

116,512

 

71,748

 

 

223,619

 

 

164,156

 

Net income attributable to noncontrolling interests

 

 

(1,498)

 

(2,040)

 

 

(2,737)

 

 

(3,820)

 

Net income attributable to Total System Services, Inc. (TSYS) common shareholders

 

$

115,014

 

69,708

 

 

220,882

 

 

160,336

 

Basic earnings per share (EPS) attributable to TSYS common shareholders (Note 10)

 

$

0.62

 

0.38

 

 

1.20

 

 

0.87

 

Diluted EPS attributable to TSYS common shareholders (Note 10)

 

$

0.62

 

0.38

 

 

1.19

 

 

0.87

 

 

See accompanying Notes to Unaudited Consolidated Financial Statements

4


 

TOTAL SYSTEM SERVICES, INC.

Consolidated Statements of Comprehensive Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

 

(in thousands)

    

2017

    

2016

 

2017

    

2016

 

 

Net income

 

$

116,512

 

71,748

 

 

223,619

 

164,156

 

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

7,054

 

(11,159)

 

 

12,566

 

(13,927)

 

 

Postretirement healthcare plan adjustments

 

 

123

 

(391)

 

 

247

 

(781)

 

 

Unrealized gain (loss) on available-for-sale securities

 

 

66

 

682

 

 

(1,793)

 

643

 

 

Other comprehensive income (loss)

 

 

7,243

 

(10,868)

 

 

11,020

 

(14,065)

 

 

Comprehensive income

 

 

123,755

 

60,880

 

 

234,639

 

150,091

 

 

Comprehensive income attributable to noncontrolling interests

 

 

(1,499)

 

(2,040)

 

 

(2,738)

 

(3,488)

 

 

Comprehensive income attributable to TSYS common shareholders

 

$

122,256

 

58,840

 

 

231,901

 

146,603

 

 

 

See accompanying Notes to Unaudited Consolidated Financial Statements

5


 

TOTAL SYSTEM SERVICES, INC.

Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 

 

 

(in thousands)

    

2017

    

2016

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

223,619

 

164,156

 

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

203,537

 

172,552

 

 

Provisions for cardholder losses

 

 

27,587

 

25,216

 

 

Share-based compensation

 

 

20,055

 

20,724

 

 

Provisions for bad debt expenses and billing adjustments

 

 

4,906

 

2,938

 

 

Charges for transaction processing provisions

 

 

4,053

 

2,191

 

 

Amortization of debt issuance costs

 

 

2,163

 

11,451

 

 

Dividends received from equity investments

 

 

943

 

808

 

 

Loss (gain) on foreign currency

 

 

824

 

(1,469)

 

 

Amortization of bond discount

 

 

449

 

318

 

 

Loss on disposal of equipment, net

 

 

428

 

289

 

 

Excess tax benefit from share-based payment arrangements

 

 

 -

 

(8,034)

 

 

Deferred income tax (benefit) expense

 

 

(18,191)

 

18,519

 

 

Equity in income of equity investments, net of tax

 

 

(22,422)

 

(12,224)

 

 

Changes in operating assets and liabilities, net of effects of acquisitions:

 

 

 

 

 

 

 

Accrued salaries and employee benefits

 

 

(27,160)

 

(27,554)

 

 

Accounts receivable

 

 

(12,090)

 

(28,384)

 

 

Prepaid expenses, other current assets and other long-term assets

 

 

845

 

(20,115)

 

 

Accounts payable

 

 

13,177

 

(17,473)

 

 

Other current liabilities and other long-term liabilities

 

 

(21,931)

 

35,172

 

 

Net cash provided by operating activities

 

 

400,792

 

339,081

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(26,739)

 

(20,669)

 

 

Additions to contract acquisition costs

 

 

(14,655)

 

(31,276)

 

 

Additions to internally developed computer software

 

 

(13,581)

 

(18,484)

 

 

Additions to licensed computer software from vendors

 

 

(10,568)

 

(11,379)

 

 

Cash used in acquisitions, net of cash acquired

 

 

 -

 

(2,345,438)

 

 

Other investing activities

 

 

(759)

 

(1,730)

 

 

Net cash used in investing activities

 

 

(66,302)

 

(2,428,976)

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Principal payments on long-term borrowings, capital lease obligations and license agreements

 

 

(234,093)

 

(435,953)

 

 

Purchase of noncontrolling interest

 

 

(70,000)

 

(5,878)

 

 

Dividends paid on common stock

 

 

(36,734)

 

(36,622)

 

 

Subsidiary dividends paid to noncontrolling shareholders

 

 

(3,885)

 

(3,829)

 

 

Repurchase of common stock under plans and tax withholding

 

 

(24)

 

(5,034)

 

 

Debt issuance costs

 

 

 -

 

(26,554)

 

 

Excess tax benefit from share-based payment arrangements

 

 

 -

 

8,034

 

 

Proceeds from borrowings of long-term debt

 

 

 -

 

2,666,295

 

 

Proceeds from exercise of stock options

 

 

8,987

 

9,737

 

 

Net cash (used in) provided by financing activities

 

 

(335,749)

 

2,170,196

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

 

3,494

 

(4,310)

 

 

Net increase in cash and cash equivalents

 

 

2,235

 

75,991

 

 

Cash and cash equivalents at beginning of period

 

 

425,354

 

389,328

 

 

Cash and cash equivalents at end of period

 

$

427,589

 

465,319

 

 

 

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

 

 

Interest paid

 

$

57,405

 

81,808

 

 

Income taxes paid, net

 

$

121,620

 

26,134

 

 

See accompanying Notes to Unaudited Consolidated Financial Statements

 

6


 

TOTAL SYSTEM SERVICES, INC.

Notes to Unaudited Consolidated Financial Statements

 

Note 1  —Summary of Significant Accounting Policies

 

Business

 

Total System Services, Inc.’s (TSYS’ or the Company’s) revenues are derived from providing payment processing, merchant services and related payment 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 three operating segments: Issuer Solutions, Merchant Solutions and Netspend.

 

Through the Company's Issuer Solutions segment, TSYS processes information through its cardholder systems for financial and nonfinancial institutions throughout the United States and internationally. The Company's Merchant Solutions segment provides merchant services to merchant acquirers and merchants mainly in the United States. The Company’s Netspend segment provides prepaid program management services to consumers and businesses in the United States.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements of TSYS include the accounts of TSYS and its wholly- and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

These financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and, therefore, do not include all information and footnotes required by U.S. GAAP for complete financial statements. The preparation of the consolidated financial statements requires management of the Company to make estimates and assumptions relating to the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. These estimates and assumptions are developed based upon all information available. Actual results could differ from estimated amounts. All adjustments, consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair presentation of financial position and results of operations for the periods covered by this report, have been included.

 

Certain prior period amounts have been reclassified to conform to the current period’s presentation, which includes the following changes.

 

The Company reclassified an immaterial amount of operating expenses between cost of services and selling, general and administrative expense on the income statement due to an error in classification in 2016.

 

The Company had investments in private equity funds as of December 31, 2016 with a value of $22.6 million. During the six months ended June 30, 2017 and in prior periods, this investment was reclassified from other assets to equity investments on the balance sheets. The income statement impact was to reclassify an immaterial amount of gains and losses from nonoperating expenses to equity in income of equity investments.

 

The accompanying unaudited consolidated financial statements should be read in conjunction with the Company’s summary of significant accounting policies, consolidated financial statements and related notes appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission (SEC). Results of interim periods are not necessarily indicative of results to be expected for the year.

 

7


 

Recently Adopted Accounting Pronouncements

 

The Company adopted the following Accounting Standards Updates (ASUs) on January 1, 2017:

 

ASU 2015-05 “Intangibles – Goodwill and Other – Internal Use Software (Subtopic 350-04): Customers’ Accounting for Fees Paid in a Cloud Computing Agreement,” which required changes to clarify, correct errors and make minor improvements to the Accounting Standards Codification (ASC). Most of the amendments in this Update do not require transition guidance and were effective upon issuance of this Update. Six amendments in this update clarify guidance or correct references in the ASC that could potentially result in changes in current practice because of either misapplication or misunderstanding of current guidance. The adoption of this ASU resulted in the Company's recording of acquired software as an intangible asset at present value rather than treating the software as a lease arrangement. The Company expects the annual impact of adopting the amendment to result in approximately $6.4 million of assets being recorded and $6.1 million of expense being characterized as amortization expense instead of rental expense during 2017.

 

ASU 2016-09 “Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The adoption of this standard results in the excess tax benefits and deficiencies associated with share-based payments being recorded on the income statement at the time they are deducted on the income tax return instead of being recorded in additional paid-in capital. The excess tax benefits are recorded along with other income tax cash flows as an operating activity in the statement of cash flows. The Company recorded excess tax benefits of $6.8 million in its provision for income taxes rather than as an increase to additional paid-in capital for the six months ended June 30, 2017 on a prospective basis. Therefore, the prior period presented has not been adjusted. The Company excluded the excess tax benefits from the assumed proceeds available to repurchase shares in the computation of diluted earnings per share using the treasury stock method, which did not have a material impact on its diluted earnings per share for the three and six months ended June 30, 2017. The Company elected to apply the presentation requirement for cash flows related to excess tax benefits prospectively, and thus, the prior period presented has not been adjusted. This adoption resulted in an increase in net cash provided by operating activities and a decrease in net cash from financing activities of $6.8 million for the six months ended June 30, 2017.

 

ASU 2016-19 “Technical Corrections,” which required changes to clarify, correct errors or make minor improvements to the ASC. Most of the amendments in this Update do not require transition guidance and were effective upon issuance of this Update. Six amendments in this Update clarify guidance or correct references in the ASC that could potentially result in changes in current practice because of either misapplication or misunderstanding of current guidance. Early adoption is permitted for the amendments that require transition guidance. The Company was impacted by the amendment to Subtopic 350-40, Intangibles - Goodwill and Other - Internal-Use Software, which adds a reference to guidance to use when accounting for internal-use software licensed from third parties that is within the scope of Subtopic 350-40. The transition guidance for that amendment is the same as the transition guidance in ASU 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” to which the amendment relates and was adopted on a prospective basis. The adoption of this ASU resulted in the Company's recording of acquired software as an intangible asset at present value rather than treating the software as a lease arrangement.

 

ASU 2017-04 “Intangibles – Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment,” which modifies the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. An entity no longer will determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. An entity should apply the amendments in this Update on a prospective basis. The ASU is effective for the Company on January 1, 2020. Early adoption is permitted by all entities for interim or annual goodwill impairment test performed on testing dates after January 1, 2017. The Company early adopted this ASU in May 2017 in conjunction with its annual goodwill impairment testing. The

8


 

adoption of this ASU did not have a material impact on the Company’s financial position, results of operations or cash flows.

 

New Accounting Pronouncements

 

In May 2017, the Financial Accounting Standards Board (FASB) issued ASU 2017-09 “Compensation – Stock Compensation (Topic 718), Scope of Modification Accounting,” to provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all the following are met: 

1.

The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.

2.

The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.

3.

The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.

 

The ASU is effective for the Company on January 1, 2018. Early adoption is permitted, including adoption in any interim period, for (a) public business entities for reporting periods for which financial statements have not yet been issued and (b) all other entities for reporting periods for which financial statements have not yet been made available for issuance. The Company does not expect the adoption of this ASU to have a material impact on the Company’s financial position, results of operations or cash flows.

 

In January 2017, the FASB issued ASU 2017-01 “Business Combinations (Topic 805), Clarifying the Definition of a Business,” which provides a more robust framework to use in determining when a set of assets and activities is a business. The framework assists entities in evaluating whether both an input and a substantive process are present. The framework includes two sets of criteria to consider that depend on whether a set has outputs. Although outputs are not required for a set to be a business, outputs generally are a key element of a business; therefore, the FASB has developed more stringent criteria for sets without outputs. The ASU is effective for the Company on January 1, 2018. Early application of the amendments in this Update is allowed under certain circumstances. The Company does not expect the adoption of this ASU to have a material impact on the Company’s financial position, results of operations or cash flows.

 

In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842),” which introduces a lessee model that brings most leases on the balance sheet and aligns many of the underlying principles of the new lessor model with those in the FASB’s new revenue recognition standard. The ASU also addresses other concerns related to the current leases model. The new guidance will be effective for fiscal years and interim periods within those years beginning after December 15, 2018. Early adoption will be permitted for all entities. The adoption of the new standard will result in the recording of all leases on the balance sheet. The Company has not determined the remaining effect on its ongoing financial reporting for adoption of this ASU.

 

In February 2017, the FASB issued ASU 2017-05 “Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets,” which defines the term in substance nonfinancial assets as financial assets promised to a counterparty in a contract if substantially all of the fair value of the assets promised to the counterparty is concentrated in nonfinancial assets. If substantially all of the fair value of the assets that are promised to the counterparty in a contract is concentrated in nonfinancial assets, then all of the financial assets promised to the counterparty are in substance nonfinancial assets within the scope of Subtopic 610-20. The amendments in this Update exclude all business and nonprofit activities from the scope of Subtopic 610-20. The amendments in the Update may be applied either retrospectively to each period presented in the financial statements or retrospectively with a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. The ASU  is effective for the Company on January 1, 2020. Early adoption is permitted. The Company

9


 

does not expect the adoption of this ASU to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Recent Revenue Recognition Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09 “Revenue from Contracts with Customers,” which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective.

 

The FASB has issued several additional ASUs since this time that add additional clarification to certain issues existing after the original ASU was released. All of the new standards are effective for the Company on January 1, 2018, with early adoption permitted no sooner than January 1, 2017. The standards permit the use of either the retrospective or cumulative effect transition method. The Company is in the process of determining the effect on its ongoing financial reporting for adoption of these ASUs.

 

The Company is reviewing the requirements of the new revenue standard, and amendments described below, while following activities of the FASB and the American Institute of Certified Public Accountants (AICPA) for certain interpretive guidance applicable to IT outsourcers and payment processors. The Company is evaluating customer contracts under the new standard for each type of significant revenue stream (and related costs) to evaluate differences from current accounting. TSYS plans to adopt ASU 2014-09, as well as all other clarifications and technical guidance issued by the FASB and AICPA related to this new revenue standard, on January 1, 2018 using the modified retrospective transition method. Such adoption method will result in an adjustment to the opening balance of retained earnings (or other appropriate components of net assets in the statement of financial position) for the cumulative effect of applying the standard to contracts that are not completed on January 1, 2018. Under the modified retrospective transition method, the Company is required to disclose the impact of changes to financial statement line items due to the application of the new revenue standard, including an explanation of the reasons for any significant changes.

 

The new standard is likely to change the amount and timing of revenue and costs for certain revenue streams; accelerate revenue for certain license arrangements; extend the amortization of certain costs such as commissions, incentive payments, and conversion costs; increase areas of judgment and related internal controls requirements, such as whether the Company might avail itself of opportunities to continue recognizing processing revenue as invoiced; change the presentation of revenue for certain contract arrangements; and require changes to the Company’s software systems to assist in both internally capturing accounting differences and externally reporting such differences through enhanced disclosure requirements. In this respect, the Company has completed its review of representative contracts and identification of policy and gap differences resulting from the adoption of the new revenue standard. The Company continues to implement a new revenue tool solution to facilitate compliance with the standard and expects to have this completed by mid-fourth quarter 2017. Finally, the Company has begun its review of additional remaining contracts, both to help quantify the cumulative impact of the standards at year end, as well as, to evaluate internal controls surrounding the adoption of the standard. The Company is still assessing the materiality of the standard’s adoption, including its impact on disclosures.

 

In March 2016, the FASB issued ASU 2016-08 “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)," which improves the operability and understandability of the implementation guidance on principal versus agent considerations by providing indicators as to which party controls the good or service provided to a customer (the principal).

 

In April 2016, the FASB issued ASU 2016-10 “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing,” which clarifies two aspects of Topic 606: identifying performance obligations and the licensing implementation guidance, while retaining the related principles for those areas.

 

In May 2016, the FASB issued ASU 2016-12 “Revenue from Contracts with Customers (Topic 606): Narrow Scope Improvements and Practical Expedients,” which affects only the following narrow aspects of Topic 606: Assessing the Collectability Criterion; Presentation of Sales and Other Taxes Collected from Customers;

10


 

Noncash Consideration; Contract Modification at Transition; Completed Contracts at Transition; and Technical Correction.

 

In December 2016, the FASB issued ASU 2016-20 “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” which affects only the following narrow aspects of Topic 606: Disclosure of Remaining Performance Obligations as it relates to entities such as processors which may not be required to estimate revenue under ASU 2014-09 due to direct allocation of variable consideration; Disclosure of Prior - Period Performance Obligations; Loan Guarantee Fees; Contract Costs – Impairment Testing; Contract Costs - Interaction of Impairment Testing with Guidance in Other Topics; Provisions for Losses on Construction-Type and Production Type Contracts; Contracts within the scope of Topic 944 (insurance) are excluded from the scope of Topic 606; Contract Modifications; Contract Asset versus Receivable; Refund Liability; Advertising Costs; Fixed - Odds Wagering Contracts in the Casino Industry.

 

 

Note 2 — Fair Value Measurement    

 

Refer to Note 3 of the Company’s audited financial statements for the year ended December 31, 2016, which is included as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC, for a discussion regarding fair value measurement.

 

Level 1 – Quoted prices for identical assets and liabilities in active markets.

 

Level 2 – Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

 

Level 3 – Unobservable inputs for the asset or liability.

 

The Company had no transfers between Level 1, Level 2 or Level 3 assets during the six months ended June 30, 2017 and 2016.

 

As of June 30, 2017, the Company had recorded goodwill in the amount of $3.3 billion. The Company performed its annual impairment testing of its goodwill balance as of May 31, 2017, and this test did not indicate any impairment. The fair value of the reporting units substantially exceeds their carrying value.

 

Note 3 — Supplementary Balance Sheet Information

 

Cash and Cash Equivalents

 

The Company maintains accounts outside the United States denominated in currencies other than the U.S. dollar. All amounts in domestic accounts are denominated in U.S. dollars.

 

Cash and cash equivalent balances are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

June 30, 2017

 

December 31, 2016

Cash and cash equivalents in domestic accounts

 

$

372,201

 

375,122

 

Cash and cash equivalents in foreign accounts

 

 

55,388

 

50,232

 

Total

 

$

427,589

 

425,354

 

 

 

 

 

 

 

 

 

11


 

Prepaid Expenses and Other Current Assets

 

Significant components of prepaid expenses and other current assets are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

June 30, 2017

 

December 31, 2016

Prepaid expenses

 

$

81,483

 

84,173

 

Supplies inventory

 

 

14,027

 

17,105

 

Income taxes receivable

 

 

3,238

 

 -

 

Other

 

 

58,577

 

63,210

 

Total

 

$

157,325

 

164,488

 

 

 

 

 

 

 

 

 

Contract Acquisition Costs, Net

 

Significant components of contract acquisition costs, net of accumulated amortization, are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

June 30, 2017

 

December 31, 2016

 

Conversion costs, net of accumulated amortization of $168.5 million and $164.4 million as of 2017 and 2016, respectively

 

$

140,478

 

144,173

 

Payments for processing rights, net of accumulated amortization of $156.7 million and $145.3 million as of 2017 and 2016, respectively

 

 

87,181

 

91,527

 

Total

 

$

227,659

 

235,700

 

 

 

 

 

 

 

 

 

Amortization expense related to contract acquisition costs is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

(in thousands)

    

2017

    

2016

    

2017

    

2016

 

Amortization expense related to:

 

 

 

 

 

 

 

 

 

 

 

Conversion costs

 

$

7,157

 

7,282

 

 

15,330

 

14,440

 

Payments for processing rights

 

 

5,110

 

5,014

 

 

10,329

 

9,943

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Current Liabilities

 

Significant components of other current liabilities are summarized as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in thousands)

 

June 30, 2017

 

December 31, 2016

 

Deferred revenues

 

$

50,378

 

40,473

 

Accrued third-party commissions

 

 

31,763

 

28,310

 

Accrued expenses

 

 

30,008

 

32,861

 

Dividends payable

 

 

19,407

 

19,513

 

Litigation settlements

 

 

14,429

 

20,795

 

Accrued interest

 

 

18,974

 

19,029

 

Income taxes payable

 

 

 -

 

1,673

 

Other

 

 

109,032

 

100,605

 

Total

 

$

273,991

 

263,259

 

 

 

 

 

 

 

 

 

12


 

Accumulated Other Comprehensive Income (AOCI)

 

The income tax effects allocated to and the cumulative balance of accumulated other comprehensive income (loss) attributable to TSYS shareholders are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a)

 

 

(b)

 

(c)

 

(d)

 

(a+d)

 

(in thousands)

    

Beginning
Balance December 31, 2016

 

Pretax Amount

    

Tax Effect

 

Net-of-Tax
Amount
(b-c)

    

Ending Balance June 30, 2017

 

Foreign currency translation adjustments and transfers from noncontrolling interests

 

$

(65,482)

 

$

14,266

 

1,700

 

$

12,566

 

$

(52,916)

 

Unrealized gain (loss) on available-for-sale securities

 

 

9,862

 

 

(2,780)

 

(987)

 

 

(1,793)

 

 

8,069

 

Change in AOCI related to postretirement healthcare plans

 

 

(538)

 

 

388

 

141

 

 

247

 

 

(291)

 

Total

 

$

(56,158)

 

$

11,874

 

854

 

$

11,020

 

$

(45,138)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

There were no reclassifications of AOCI to net income or to other accounts for the six months ended June 30, 2017.

 

Note 4 — Long-Term Borrowings, Capital Lease Obligations and License Agreements

 

Refer to Note 12 of the Company’s audited financial statements for the year ended December 31, 2016, which is included as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC, for a discussion regarding long-term borrowings and capital lease obligations.

 

During the six months ended June 30, 2017, the Company repaid $234 million on outstanding debt, capital lease obligations and license agreements. In addition, $550 million of Senior Notes due June 1, 2018 became short term as of June 30, 2017.

 

Note 5 — Share-Based Compensation

 

Refer to Notes 1 and 18 of the Company’s audited financial statements for the year ended December 31, 2016, which are included as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC, for a discussion regarding the Company’s share-based compensation plans and policy.

 

Share-Based Compensation

 

Share-based compensation costs are classified as selling, general and administrative expenses on the Company’s statements of income and corporate administration and other expenses for segment reporting purposes. TSYS’ share-based compensation costs are expensed, rather than capitalized, as these awards are typically granted to individuals not involved in capitalizable activities.

 

Below is a summary of share-based compensation expense for the three and six months ended June 30, 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

 

(in thousands)

    

2017

    

2016

    

Percent Change

    

 

2017

    

2016

    

Percent Change

 

    

Share-based compensation

 

$

11,008

 

12,566

 

(12.4)

%  

 

$

20,055

 

20,724

 

(3.2)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13


 

 

Nonvested Share Awards - Time-Based

 

The Company granted shares of TSYS common stock to certain key employees. The nonvested stock bonus awards are typically for services to be provided in the future and vest over a period of up to four years. The market value of the TSYS common stock as of the date of issuance is charged as compensation expense over the vesting periods of the awards. As of June 30, 2017, there was approximately $29.7 million of unrecognized compensation cost related to time-based nonvested share awards.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 

 

 

    

2017

    

2016

 

Number of shares granted

 

 

322,926

 

326,678

 

Market value (in millions)

 

$

17.6

 

15.0

 

 

 

 

 

 

 

 

 

Performance- and Market-Based Awards

 

The Company granted performance- and market-based shares to certain key employees. The performance- and market-based goals are established by the Compensation Committee of the Board of Directors and will vest up to a maximum of 200%. During the first six months of 2017 and 2016, the Compensation Committee established performance goals based on adjusted diluted EPS, adjusted EPS, revenue growth, corporate accountability operating income (CAOI) growth, net revenue and revenues before reimbursable items. The Company’s market-based awards are based upon the Company’s Total Shareholder Return (TSR) as compared to the TSR of the companies in the S&P 500 over the performance period.

 

Compensation expense for performance shares is measured on the grant date based on the quoted market price of TSYS common stock. The Company estimates the probability of achieving the goals through the performance period and expenses the awards on a straight-line basis. The fair value of market-based awards is estimated on the grant date using a Monte Carlo simulation model. The Company expenses market-based awards on a straight-line basis. Compensation costs related to performance- and market-based shares are recognized through the longer of the performance period or the vesting period. As of June 30, 2017, there was approximately $20.9 million of unrecognized compensation cost related to TSYS performance-based awards that is expected to be recognized through December 2019. As of June 30, 2017, there was approximately $3.6 million of unrecognized compensation cost related to TSYS market-based awards that is expected to be recognized through December 2019.

 

14


 

The following table summarizes the performance-based awards granted during the first six months of 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

Year
Awarded

    

Performance
Period Ending

    

Performance
Measure

    

Number of
Shares
Granted

    

Period Expensed
Through

2017

 

December 2019

 

Net Revenue and Adjusted Diluted EPS1

 

103,485

 

December 2019

2017

 

December 2017

 

Net Revenue and Adjusted Diluted EPS1

 

249,845

 

December 2019

2016

 

December 2016

 

Revenues before Reimbursable Items4 and Adjusted EPS3

 

15,605

 

December 2016

2016

 

December 2017

 

Adjusted EPS3

 

14,940

 

December 2017

2016

 

December 2018

 

Merchant Segment Net Revenue, Corporate Accountability Operating Income and attainment of synergies from TransFirst acquisition

 

29,332

 

December 2018

2016

 

December 2018

 

Revenue Growth and CAOI Growth2

 

67,517

 

December 2018

2016

 

December 2018

 

Merchant Segment Net Revenue and Corporate Accountability Operating Income

 

78,220

 

December 2018

2016

 

December 2018

 

Adjusted EPS3

 

118,722

 

December 2018

2016

 

December 2016

 

Revenues before Reimbursable Items4 and Adjusted EPS3

 

144,995

 

December 2018

 

 

 

 

 

 

 

 

 

1

Adjusted Diluted EPS is adjusted earnings divided by weighted average diluted shares outstanding used for diluted EPS calculations. Adjusted earnings is net income excluding the after-tax impact of share-based compensation expenses, amortization of acquisition intangibles, merger and acquisition expenses for completed acquisitions and litigation claims, judgments or settlement expenses and related legal expenses.

2

CAOI is adjusted segment operating income and includes corporate administrative expenses. Adjusted segment operating income is defined in Note 7.

3

Adjusted EPS is adjusted earnings divided by weighted average shares outstanding used for basic EPS.

4

Revenues before Reimbursable Items is total revenue less reimbursable items which consist of out-of-pocket expenses which are reimbursed by the Company’s clients. These expenses consist primarily of postage, access fees and third-party software.

 

 

The following table summarizes the market-based awards granted during the first six months of 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

Year
Awarded

    

Performance
Period Ending

    

Performance
Measure

    

Number of
Shares
Granted

    

Period Expensed
Through

2017

 

December 2019

 

TSR

 

44,355

 

December 2019

2016

 

December 2017

 

TSR

 

6,403

 

December 2017

2016

 

December 2018

 

TSR

 

50,878

 

December 2018

 

 

Stock Option Awards

 

The Company granted stock options to certain key executives. The grants will vest over a period of up to three years.

 

15


 

The weighted average fair value of the option grants was estimated on the date of grant using the Black-Scholes-Merton option-pricing model with the following weighted average assumptions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

 

 

    

2017

 

    

2016

 

 

Number of options granted

 

 

548,265

 

 

687,685

 

 

Weighted average exercise price

 

$

54.90

 

 

47.01

 

 

Risk-free interest rate

 

 

1.78

%  

 

1.24

%

 

Expected volatility

 

 

21.71

%  

 

21.53

%

 

Expected term (years)

 

 

4.6

 

 

4.5

 

 

Dividend yield

 

 

0.73

%  

 

0.86

%

 

Weighted average fair value

 

$

10.83

 

 

8.50

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2017, there was approximately $6.3 million of unrecognized compensation cost related to TSYS stock options that is expected to be recognized over a remaining weighted average period of 1.8 years.

 

Note 6 — Income Taxes

 

Refer to Notes 1 and 14 of the Company’s audited financial statements for the year ended December 31, 2016, which are included as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC, for a discussion regarding income taxes.

 

TSYS is the parent of an affiliated group that files a consolidated U.S. federal income tax return and most state and foreign income tax returns on a separate entity basis. In the normal course of business, the Company is subject to examinations by these taxing authorities unless statutory examination periods lapse. TSYS is no longer subject to U.S. federal income tax examinations for years before 2011 and with few exceptions, the Company is no longer subject to income tax examinations from state and local or foreign tax authorities for years before 2010. There are currently federal income tax examinations in progress for the years 2011 through 2013. Additionally, a number of tax examinations are in progress by the relevant state tax authorities. Although TSYS is unable to determine the ultimate outcome of these examinations, TSYS believes that its liability for uncertain tax positions relating to these jurisdictions for such years is adequate.

 

TSYS’ effective tax rate was 34.4% and 38.0% for the three months ended June 30, 2017 and 2016, respectively. TSYS’ effective tax rate was 33.0% and 35.5% for the six months ended June 30, 2017 and 2016, respectively. The primary differences in the 2017 effective income tax rates compared to the 2016 effective income tax rates reflect changes from the favorable discrete items related to the adoption of new accounting guidance regarding the treatment of excess tax benefits from share-based compensation.

 

GAAP prescribes a recognition threshold and measurement attribute for the financial statement recognition, measurement and disclosure of a tax position taken or expected to be taken in a tax return. The amount of unrecognized tax benefits were $18.3 million and $16.5 million as of June 30, 2017 and December 31, 2016, respectively, which resulted in an increase of $1.8 million during the period.

 

TSYS recognizes potential interest and penalties related to the underpayment of income taxes as income tax expense in the consolidated statements of income. Gross accrued interest and penalties on unrecognized tax benefits totaled $1.6 million and $1.8 million as of June 30, 2017 and December 31, 2016, respectively. The total amounts of unrecognized income tax benefits as of June 30, 2017 and December 31, 2016, that, if recognized, would affect the effective tax rates are $18.7 million and $17.0 million (net of the federal benefit on state tax issues), respectively, which include interest and penalties of $1.1 million and $1.2 million, respectively. TSYS does not expect any significant changes to its calculation of uncertain tax positions during the next twelve months.

 

16


 

Note 7 — Segment Reporting and Major Customers 

 

Refer to Note 22 of the Company’s audited financial statements for the year ended December 31, 2016, which is included as Exhibit 13.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the SEC, for a discussion regarding segment reporting and major customers.

 

At TSYS, the chief operating decision maker (CODM) is a group consisting of Senior Executive Management and above. In the first quarter of 2017, the CODM combined the North America Services and International Services segments for purposes of segment reporting into the new Issuer Solutions segment, since they provide similar services to similar customers and to reflect the manner in which decisions on allocation of resources are made. All prior periods were restated to reflect this change. This change is used to evaluate performance and assess resources starting in the first quarter of 2017. The information utilized by the CODM consists of the financial statements and the main metrics monitored are revenue growth and growth in profitability.

 

The following table presents the Company’s total assets by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of

 

(in thousands)

 

 

 

 

June 30, 2017

    

December 31, 2016

 

Issuer Solutions

 

 

 

$

5,881,507

 

5,892,410

 

Merchant Solutions

 

 

 

 

3,198,527

 

3,295,509

 

Netspend

 

 

 

 

1,432,787

 

1,474,595

 

Intersegment assets

 

 

 

 

(4,235,807)

 

(4,296,337)

 

    Total assets

 

 

 

$

6,277,014

 

6,366,177

 

 

 

 

 

 

 

 

 

 

 

The Company maintains property and equipment, net of accumulated depreciation and amortization, in the following geographic areas:

 

 

 

 

 

 

 

 

 

 

As of

 

(in thousands)

 

June 30, 2017

 

December 31, 2016

 

United States

 

$

232,025

 

236,913

 

Europe

 

 

41,840

 

38,866

 

Other

 

 

6,771

 

6,566

 

Total

 

$

280,636

 

282,345

 

 

 

 

 

 

 

 

The following table presents the Company’s depreciation and amortization by segment:

 

<

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

(in thousands)

    

 

2017

    

2016

 

 

2017

    

2016

Depreciation and amortization by segment:

 

 

 

 

 

 

 

 

 

 

Issuer Solutions

 

$

35,735

 

35,649

 

 

72,588

 

71,268

Merchant Solutions

 

 

7,380

 

6,805

 

 

14,402

 

11,856

Netspend

 

 

4,180

 

3,116

 

 

8,272

 

6,224

Depreciation and amortization

 

 

47,295

 

45,570

 

 

95,262

 

89,348

Acquisition intangible amortization

 

 

50,943

 

58,486

 

 

106,111

 

81,407

Corporate Administration and Other

 

 

1,121

 

913

 

 

2,164

 

1,797