Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended JULY 31, 1994 Commission File No. 1-10411
SAFECARD SERVICES, INCORPORATED
(Exact Name of Registrant as Specified in its Charter)
Delaware 13-2650534
- - ------------------------------- -------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
3001 E. Pershing Blvd., Cheyenne, Wyoming 82001
- - ----------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(307) 771-2700
--------------
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 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
--- ---
Common Stock, $.01 Par Value
- - ----------------------------
Outstanding at July 31, 1994 28,920,649 Shares
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SafeCard Services, Incorporated
Consolidated Balance Sheet
July 31, October 31,
1994 1993
---- ----
(Unaudited)
ASSETS
Cash and cash equivalents $ 47,628,000 $ 3,335,000
Investment securities 168,068,000 166,704,000
Receivables,net 17,375,000 18,098,000
Deferred subscriber acquisition
costs and related commissions 190,517,000 180,937,000
Property and equipment, net 10,893,000 8,420,000
Other assets 1,847,000 793,000
----------- -----------
$436,328,000 $378,287,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable $ 15,178,000 $ 14,961,000
Accrued expenses 19,704,000 16,573,000
Allowance for cancellations 7,019,000 8,893,000
Subscribers' advance payments 157,286,000 142,063,000
Deferred income taxes 18,714,000 38,102,000
----------- -----------
217,901,000 220,592,000
----------- -----------
STOCKHOLDERS' EQUITY
Common stock - authorized 35,000,000
shares of $.01 par value; issued 34,946,000
shares (34,196,000 in 1993); outstanding
28,920,649 shares (24,118,184 in 1993) 350,000 342,000
Additional paid-in capital 41,010,000 15,990,000
Retained earnings 225,767,000 220,898,000
Less cost of common shares in
treasury (6,025,351 in 1994 and
10,077,816 in 1993) (48,700,000) (79,535,000)
----------- -----------
218,427,000 157,695,000
----------- -----------
$436,328,000 $378,287,000
=========== ===========
The accompanying notes are an integral part of these consolidated
financial statements.
SafeCard Services, Incorporated
Consolidated Statement of Earnings
<TABLE>
<CAPTION>
Third Quarter Ended Nine Months Ended
July 31, July 31,
------------------- -----------------
1994 1993 1994 1993
---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
REVENUES
Subscription revenue, net $44,169,000 $39,717,000 $128,115,000 $116,403,000
Interest and other income 2,246,000 2,338,000 7,050,000 8,239,000
Litigation settlements 4,257,000
---------- ---------- ----------- -----------
46,415,000 42,055,000 139,422,000 124,642,000
---------- ---------- ----------- -----------
COSTS AND EXPENSES
Subscriber acquisition costs 26,901,000 24,325,000 78,320,000 70,268,000
Research and product development costs 1,326,000 1,811,000
General, administrative and service costs 9,910,000 7,791,000 28,700,000 21,153,000
Restructuring costs 7,900,000
---------- ---------- ----------- -----------
38,137,000 32,116,000 116,731,000 91,421,000
---------- ---------- ----------- -----------
EARNINGS BEFORE INCOME TAXES 8,278,000 9,939,000 22,691,000 33,221,000
PROVISION FOR INCOME TAXES (1,643,000) (2,447,000) (5,808,000) (8,305,000)
---------- ---------- ---------- ----------
EARNINGS BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 6,635,000 7,492,000 16,883,000 24,916,000
--------- --------- ---------- ----------
CUMULATIVE EFFECT OF ACCOUNTING CHANGE 2,000,000
---------- ---------- ----------- -----------
NET EARNINGS $ 6,635,000 $ 7,492,000 $ 18,883,000 $ 24,916,000
========== ========== =========== ===========
EARNINGS PER SHARE
Earnings before cumulative effect
of accounting change $.23 $.27 $.60 $.86
Cumulative effect of accounting change .07
--- --- --- ---
Net earnings $.23 $.27 $.67 $.86
=== === === ===
Weighted average number of
common and common
equivalent shares 28,768,000 27,814,000 28,306,000 28,910,000
========== ========== ========== ==========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
SafeCard Services, Incorporated
Consolidated Statement of Cash Flows
<TABLE>
<CAPTION>
Nine Months Ended
July 31,
-------------------------
1994 1993
---- ----
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash received from subscribers $141,112,000 $136,918,000
Cash expenditures for subscriber
acquisition costs, commissions and operations (123,233,000) (102,387,000)
Interest received 11,508,000 12,096,000
Income taxes paid, net (1,699,000) (16,407,000)
Litigation settlements 4,257,000
----------- -----------
Net cash provided by operating activities 31,945,000 30,220,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of investment securities (62,431,000) (60,567,000)
Proceeds from sale of investment securities 48,759,000 69,236,000
Proceeds from maturing investment securities 8,925,000
Acquisition of property and equipment, net (3,177,000) (827,000)
----------- ----------
Net cash provided by (used in) investing activities (7,924,000) 7,842,000
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of employee stock options 24,627,000 4,522,000
Dividends paid (3,872,000) (3,878,000)
Purchase of treasury shares (483,000) (33,462,000)
---------- -----------
Net cash provided by (used in) financing activities 20,272,000 (32,818,000)
---------- -----------
Net increase in cash 44,293,000 5,244,000
Cash and equivalents at beginning
of period 3,335,000 8,208,000
----------- -----------
CASH AND EQUIVALENTS AT END OF PERIOD $ 47,628,000 $ 13,452,000
=========== ===========
<FN>
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
SafeCard Services, Incorporated
Notes To Consolidated Financial Statements
A. General
In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments
necessary to present fairly the Company's financial position as
of July 31, 1994 and the results of its operations and cash flows
for the periods ended July 31, 1994 and 1993. The accounting
policies used in the preparation of these financial statements
are consistent with those used in the Company's Annual Report for
the fiscal year ended October 31, 1993 except for the change in
accounting for income taxes described in Note F.
The notes presented herein are intended to provide
supplemental disclosure of items of significance occurring
subsequent to the issuance of the Company's Annual Report for the
fiscal year ended October 31, 1993 and should be read in
conjunction with the Notes to Consolidated Financial Statements
included in the Annual Report.
Results of operations for the interim periods ended July
31, 1994 are not necessarily indicative of the results to be
expected for the full year.
Price Waterhouse LLP has made a review, and not an audit,
of the unaudited consolidated financial information of the
Company for the third quarter and nine month periods ended July
31, 1994 and 1993 (based on procedures adopted by the American
Institute of Certified Public Accountants) as set forth in their
separate report dated August 18, 1994, which is included in this
Form 10-Q. This report is not a "report" within the meaning of
Sections 7 and 11 of the Securities Act of 1933 and the
independent accountant's liability under Section 11 does not
extend to it.
The Company has determined that a classified balance sheet
does not accurately reflect the Company's operating cycle, and
results in financial ratios that are not meaningful due to the
mix of its assets including marketable investment securities,
deferred subscriber acquisition costs and related commissions,
and deferred subscribers' advance payments. As a result, the
1994 presentation of the Company's balance sheet is presented in
an unclassified format. The applicable 1993 financial
information has been restated to conform to this change and
certain other changes. The portions of deferred subscriber
acquisition costs and related commissions, and subscribers'
advance payments which will amortize over the next twelve months
are $81,582,000 and $109,042,000, respectively. Investment
securities totaling $42,662,000 will mature over the next twelve
months.
B. Restricted Investments
The Company previously followed an internal policy of
restricting use of all advance payments for multi-year
subscriptions by placing them in escrow. In March 1994, the
Company changed its policy such that it will now place funds in
escrow when required contractually by credit card issuer clients.
The contractual requirement as of July 31, 1994 was approximately
$11.2 million. Restricted funds are released ratably over the
subscription period (which coincides with the period of revenue
recognition) and are invested primarily in tax-exempt municipal
securities.
Also restricted as of July 31, 1994 is approximately $1.6
million, pursuant to an agreement with CreditLine Corporation.
C. Supplemental Cash Flow Information
The reconciliation of net earnings to net cash provided by
operating activities, as presented in the Consolidated Statement
of Cash Flows, is as follows:
<TABLE>
<CAPTION> Nine Months Ended
July 31,
---------------------
1994 1993
---- ----
(Unaudited)
<S> <C> <C>
Net earnings $ 18,883,000 $ 24,916,000
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation 704,000 655,000
Provision for income taxes 5,808,000 8,305,000
Income tax payments, net (1,699,000) (16,407,000)
Cumulative effect of accounting change (2,000,000)
Decrease in receivables,net 723,000 3,524,000
Amortization of bond premiums/
discounts 3,986,000 3,926,000
Billings to subscribers, net 143,338,000 136,827,000
Amortization of subscribers' advance
payments to revenue (128,115,000) (116,403,000)
Expenditures for subscriber acquisition costs (48,082,000) (42,984,000)
Payment of commissions, net (39,818,000) (38,767,000)
Amortization of subscriber acquisition costs 41,311,000 37,716,000
Amortization of commissions 37,009,000 32,552,000
Increase (decrease) in allowance for cancellations (1,874,000) 2,300,000
Increase (decrease) in accounts payable
and accrued expenses 3,348,000 (5,354,000)
Gain on sale of investments (603,000) (1,278,000)
(Increase) decrease in other operating activities (974,000) 692,000
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES $ 31,945,000 $ 30,220,000
=========== ===========
</TABLE>
D. Dividends
On September 9, 1994, the Company declared a quarterly
dividend of $.05 per share payable on September 30, 1994 to
shareholders of record on September 21, 1994.
E. Restructuring Costs
In April 1994, the Company announced a reorganization of
its operations and named a new senior management team. As a part
of the reorganization, nine senior executives left the Company.
In addition, management decided to close the Ft. Lauderdale sales
office. The Company recorded, as a result of this
reorganization, a restructuring charge of $3.5 million to cover
all severance agreements and a lease termination.
On May 26, 1994, the Company reached a settlement with
Steven Halmos to terminate various agreements between the Company
and Mr. Halmos that provided for payments to Mr. Halmos of $2
million a year through March 31, 1998. The settlement, which
arose in connection with the Company's management restructuring
in April and a resulting decision to cease using Mr. Halmos'
services, resulted in a $4.4 million cash payment to Mr. Halmos
and charge to second quarter earnings. In connection with his
termination Mr. Halmos exercised options to purchase 3,900,000
shares of the Company's common stock. Stockholders' equity
increased $37.8 million resulting from the exercise of such
options and the related tax benefit.
F. Income Taxes
In February 1992, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes." Application of Statement No.
109 requires a change from the deferred method to the liability
method of accounting for income taxes. One of the principal
differences of the liability method from the deferred method used
in previous financial statements is that changes in tax rates and
laws are reflected in income from continuing operations in the
period such changes are enacted. Under the deferred method, such
changes were reflected over time, if at all. The Company adopted
Statement No. 109 in the first quarter of fiscal 1994, effective
November 1, 1993. The impact of the adoption had a cumulative
positive effect on the Company's reported earnings in fiscal 1994
of $2 million.
The following represents the components of the Company's
deferred income tax balances at July 31, 1994:
Subscriber acquisition costs, net $65,383,000
Multi-year subscription revenues, net (32,397,000)
Deferred merchandise revenues, net 1,763,000
Relocation expenses (3,204,000)
Tax benefit related to employee stock options (12,831,000)
-----------
Total deferred tax liability $18,714,000
==========
G. Commitments and Contingencies
The Company is defending or prosecuting three complex
litigations against Peter Halmos, former Chairman of the Board
and Executive Management Consultant to the Company, and parties
related to him. Peter Halmos is also a plaintiff in two other
lawsuits, one against an officer and one against a director of
the Company. The three cases in which the Company is a party are
as follows:
A suit initiated by Peter Halmos, related entities, and
Myron Cherry (a former lawyer for the Company) in April 1993 in
Cook County Circuit Court in Illinois against the Company and one
of its directors, purporting to state claims aggregating in
excess of $100 million, principally relating to alleged rights to
"incentive compensation," stock options or their equivalent,
indemnification, wrongful termination and defamation. The
Company and the director moved to dismiss this lawsuit. In
November 1993, the court granted the motions to dismiss all parts
of the complaint, but gave the plaintiffs leave to replead, which
they did. Again in March 1994, the court granted the motions to
dismiss all of the complaints but permitted the plaintiffs to
replead which they did in June 1994. The Company and the
director have filed motions seeking dismissal of the second
amended complaint.
A suit by Peter Halmos, purportedly in the name of Halmos
Trading & Investment Company, against the Company, one of its
officers and one of its directors in Circuit Court in Broward
County, Florida, making a variety of claims related to the
contested lease of its former Ft. Lauderdale headquarters. The
Company has vacated the building, ceased making payments related
to the Ft. Lauderdale lease and has filed counterclaims.
The court has denied motions to dismiss filed by both Peter
Halmos and the Company. In May 1994, the court dismissed Peter
Halmos' amended counterclaim for breach of contract for indemnity
and intentional infliction of emotional distress but gave leave
to amend. In June 1994 Peter Halmos filed a second amended
counterclaim purporting to state claims for intentional
infliction of emotional distress, fraud and negligent
misrepresentation and declaratory judgment based on alleged
breach of contract for indemnity or, in the alternative,
promissory estoppel, related to indemnification of legal
expenses in this lawsuit. The Company's motion to dismiss the
second amended counterclaim was denied, and it has filed an
answer to the second amended counterclaim. Discovery is
proceeding. No trial date has yet been set.
A suit which seeks monetary damages and certain equitable
relief, filed by the Company in August 1993 in Laramie County
Circuit Court in Wyoming against Peter Halmos and related
entities alleging that Peter Halmos dominated and controlled the
Company, breached his fiduciary duties to the Company, and
misappropriated material non-public information to make $48
million in profits on sales of Company stock. In March 1994,
Mr. Halmos and related entities filed a counterclaim in which
claims are made of conspiracy in restraint of trade,
monopolization and attempted monopolization, unfair
competition and restraint of trade, breach of contract for
indemnity and intentional infliction of emotional distress. The
Company's motion to sever the conspiracy, monopolization and
restraint of trade claims was granted in May 1994. The claims
for the conspiracy, monopolization, restraint of trade and unfair
competition were dismissed without prejudice in June 1994.
Discovery in the case has been extended until December 15, 1994.
Trial is expected to commence in the early part of calendar year
1995.
The Company believes that it has proper and meritorious
defenses in these lawsuits which it intends to vigorously pursue.
Resolution of any or all of the Peter Halmos-related litigation
could have a material impact -- either favorable or unfavorable
depending on the outcome --upon the results of operations and
financial condition of the Company.
During the second quarter of fiscal 1994, the Company settled
two lawsuits resulting in receipt of settlements reflected in
pre-tax income of $4.3 million.
The Company is involved in certain other claims and
litigation which are not considered material to the operations of
the Company.
On July 25, 1994, the Company and Wright Express
Corporation of South Portland, ME, jointly announced that they
had entered into a definitive merger agreement under which a
subsidiary of the Company will acquire Wright Express
Corporation, a leading provider of enhanced information services
to oil companies and commercial transportation fleets in the
United States, for $35.5 million in cash. The acquisition of
Wright Express Corporation closed on September 14, 1994 and will
be accounted for using the purchase method of accounting.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
SafeCard Services, Incorporated
We have reviewed the accompanying consolidated balance
sheet of SafeCard Services, Incorporated and Subsidiaries as of
July 31, 1994, the related consolidated statement of earnings for
the three and nine month periods ended July 31, 1994 and 1993,
and the consolidated statement of cash flows for the nine month
periods then ended appearing in the Company's Form 10-Q for the
quarter ended July 31, 1994. This financial information is the
responsibility of the Company's management.
We conducted our review in accordance with standards
established by the American Institute of Certified Public
Accountants. A review of interim financial information consists
principally of applying analytical procedures to financial data
and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing
standards, the objective of which is the expression of an opinion
regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material
modifications that should be made to the accompanying financial
information for it to be in conformity with generally accepted
accounting principles.
We previously audited in accordance with generally
accepted auditing standards, the consolidated balance sheet as of
October 31, 1993, and the related consolidated statements of
earnings, changes in stockholders' equity, and cash flows for the
year then ended (not presented herein), and in our report dated
December 10, 1993 we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the
accompanying consolidated balance sheet information as of October
31, 1993, is fairly stated in all material respects in relation
to the consolidated balance sheet from which it has been derived.
PRICE WATERHOUSE LLP
Denver, Colorado
August 18, 1994
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
-------------------------------------------------
1. RESULTS OF OPERATIONS
SUBSCRIPTION REVENUE, NET
Third Quarter Ended July 31, Nine Months Ended July 31,
1994 1993 1994 1993
---- ---- ---- ----
$44,169,000 $39,717,000 $128,115,000 $116,403,000
========== ========== =========== ===========
Percentage
increase 11.2% 10.1%
==== ====
The Company's subscription revenue is derived from
payments by subscribers for its service programs and is reported
net of an allowance for cancellations. Billings for
subscriptions, as well as expenditures for subscriber acquisition
costs and commissions, are deferred and amortized to revenue or
expense, as applicable. Billings and commissions are amortized
over the related subscription periods while subscriber
acquisition costs are amortized over the estimated future periods
of benefit. See Note A of Notes to Consolidated Financial
Statements in the Company's Annual Report for the year ended
October 31, 1993 for a description of the applicable accounting
policies.
Subscription revenue increased 11.2% (to a record $44.2
million) in the third quarter of 1994 and 10.1% for the nine
months ended July 31, 1994, compared to the same 1993 periods.
The increases are primarily due to an increase in the number of
Hot-Line, Fee Card and CreditLine subscribers. Also contributing
to the increase in revenues was the price increase which the
Company began implementing in mid-1993 to new and renewing Hot-
Line subscribers.
Commencing in July 1993, the Company discontinued
providing services on a wholesale -- i.e. flat fee per customer
with the Company incurring no marketing costs or commissions --
basis to a group of cardholders of one of its card issuer
clients. The decrease in earnings before income taxes for the
nine months ended July 31, 1994 as compared to the same period of
1993 from the elimination of the wholesale program was
approximately $1.6 million. Management expects that the
elimination of the wholesale program will not affect the
comparability of earnings after July 31, 1994. While the Company
does have the right to market to the same group of cardholders on
a retail -- i.e. with the Company receiving revenues and
incurring commissions and marketing costs -- basis, management is
unable to determine the extent of offset, if any.
Renewal rates of subscribers are affected by a variety of
factors including consumers' preference towards general purpose
and value added credit cards resulting in increasing attrition
rates with certain credit cards, changes in the credit card
industry and certain other factors, which may be beyond the
Company's control. To date, the Company's renewal rates for all
programs with the exception of Hot-Line multi-year have remained
consistent with the rates reported for 1993. As of July 1994,
renewal rates for Hot-Line multi-year subscriptions have
decreased from 50% to 48%, primarily resulting from the price
increase mentioned above. Renewal rates may decrease further in
fiscal 1994, however, the net effect of the price increase should
continue to have a positive effect on revenue and earnings.
In June 1993, the Company was notified by CreditLine
Corporation, a company controlled by Peter Halmos, that the
license agreement under which the Company markets certain credit
information products and services known as CreditLine was not
renewed on November 1, 1993. Notwithstanding its termination,
the CreditLine agreement gives the Company the perpetual right to
continue to service existing CreditLine subscribers and to
participate in the resulting income. In addition, the CreditLine
agreement provides that the Company has the perpetual right to
market CreditLine, and participate in the resulting income,
through all of its existing card issuer clients with which it
either has a CreditLine marketing agreement on the date the
CreditLine agreement otherwise terminates or enters into such a
marketing agreement within the following three years. The table
below sets forth the effect that CreditLine and certain services
marketed in conjunction with CreditLine accounted for with
respect to the Company's subscription revenues and gross margin
(subscription revenue, net less subscriber acquisition costs).
The CreditLine Agreement, including the continuing marketing
rights, is the subject of litigation between the Company and
Peter Halmos.
<TABLE>
<CAPTION>
Percentage
of Total Percentage
Subscription Subscription Gross of Total
Revenue Revenue Margin Gross Margin
------------ ------------ ---------- ------------
<S> <C> <C> <C> <C>
Quarter ended July 31,
1994 $2.3 million 4.9% $ .7 million 3.9%
1993 $1.8 million 4.3% $ .5 million 3.4%
Nine Months ended July 31,
1994 $6.6 million 4.7% $2.0 million 3.9%
1993 $4.5 million 3.6% $1.3 million 2.8%
</TABLE>
INTEREST AND OTHER INCOME
Third Quarter Ended July 31, Nine Months Ended July 31,
1994 1993 1994 1993
---- ---- ---- ----
$ 2,246,000 $ 2,338,000 $ 7,050,000 $ 8,239,000
Interest and other income is predominantly composed of
interest income and gains from sales of investments. Interest
and other income decreased in the third quarter 1994 from the
comparable quarter in 1993 as a result of gains from sales of
investments in 1993 which were not repeated in 1994.
The decrease in interest and other income for the nine
months ended July 31, 1994 was primarily the result of declining
yields on the portfolio, coupled with a shortening of the average
maturity. In addition, gains from sales of investments which
occurred in the nine months ended July 31, 1993 were not repeated
to the same extent in the nine months ended July 31, 1994 (see
"Financial Condition - Liquidity and Capital Resources").
LITIGATION SETTLEMENTS
During the second quarter of fiscal 1994, the Company settled two
lawsuits resulting in receipt of settlements reflected in pre-tax
income of $4.3 million.
SUBSCRIBER ACQUISITION COSTS
Third Quarter Ended July 31, Nine Months Ended July 31,
1994 1993 1994 1993
---- ---- ---- ----
$26,901,000 $24,325,000 $78,320,000 $70,268,000
========== ========== ========== ==========
As a percentage
of subscription
revenue 60.9% 61.2% 61.1% 60.4%
==== ==== ==== ====
The cost of subscriber acquisition, which
represents the amortization of deferred subscriber acquisition
costs and commissions, increased $2.6 million, or 10.6%, and $8.1
million, or 11.5%, in the third quarter and nine months of 1994,
respectively, primarily because of expenditures made to acquire
new subscribers (see "Financial Condition - Expenditures for
Subscriber Acquisition Costs and Commissions").
Subscriber acquisition costs, as a percentage of
subscription revenue, remained relatively constant for the
quarter and nine month periods, respectively. The relationship
of these costs to subscription revenues is dependent on a variety
of factors including subscription prices, net response rates
(gross enrollments less cancellations), marketing costs, renewal
rates, the effectiveness of subscriber acquisition concepts, copy
and marketing strategies, and other factors. In addition,
certain cardholder files respond more favorably than others to
similar promotions.
In 1993, the Company noted a decline in certain net
response rates, primarily in telemarketing of certain credit card
issuer customers. While the Company has made some progress in
this area, telemarketing response rates for certain credit card
issuer customers remain below response rates achieved in previous
periods. This decline in response rates, as well as the
discontinuance of the wholesale services discussed under
"Subscription Revenue, Net" and the change in amortization
described in the next paragraph, has increased subscriber
acquisition costs as a percentage of subscription revenue; however, the
impact of the price increase previously mentioned has offset the
effect of these changes. These changes may also cause increases in
subscriber acquisition costs as a percentage of subscription revenue
in future quarters.
In connection with a review conducted in 1992 of the
Company's contractual relationships, the Company decided to
shorten the period for amortization of subscriber acquisition
expenditures made under its contract with Sears, Roebuck & Co.
starting in fiscal 1993. This accelerated amortization will have
a negative impact on the next several years' reported earnings.
The change in amortization period did not have a material impact
in 1993. The Company currently estimates that the additional
amortization in the nine months ended July 31, 1994, as compared
to the same period in 1993, as a result of the change, was
approximately $.7 million; while the effect for the fiscal year
is anticipated to be less than one million dollars.
The U.S. Postal Board of Governors has requested a 10.3%
postal rate increase effective in 1995. Since postage represents
the largest component of direct mail costs, this postal increase
could cause an increase in expenditures for subscriber
acquisition costs of approximately $1.5 million. This increase
is being managed to reduce the impact through the marketing mix
between telemarketing and direct mail solicitation as well as by
combining outgoing mail to attain higher qualification rates for
improved postal discounts.
RESEARCH AND PRODUCT DEVELOPMENT COSTS
Third Quarter Ended July 31, Nine Months Ended July 31,
1994 1993 1994 1993
$1,326,000 -- $1,811,000 --
========= ======== ========= ========
Included in research and product development costs for the
quarter and nine months ended July 31, 1994, are costs related to
the Company placing greater emphasis in three strategic
directions; improvement of the core business, internal
development of new businesses, and growth by acquisition of
businesses within the Company's strategic vision. In connection
with improvement of the core business, the Company is redesigning
its marketing materials, focusing its targeting of customer
groups, emphasizing improved subscriber retention, and obtaining new card
issuer clients. During the third quarter of 1994, the Company
announced an agreement with Household Credit Services to market
selected Company programs to cardholders of the popular General
Motors MasterCard. The Company also announced in the third
quarter 1994, a significant new venture involving management of
the PGA Tour Partners program. Under the Company's direction,
this program, which currently has 85,000 members, will be
significantly expanded and is expected to include a unique co-
branded PGA Tour credit card and special access to PGA Tour
events and tournaments. Additionally, the Company entered into an
agreement with Wright Express Corporation, a company that
offers and supports the nation's most widely accepted universal
fleet charge card. This transaction closed on September 14, 1994.
GENERAL, ADMINISTRATIVE AND SERVICE COSTS
Third Quarter Ended July 31, Nine Months Ended July 31,
1994 1993 1994 1993
---- ---- ---- ----
$ 9,910,000 $ 7,791,000 $28,700,000 $21,153,000
General and administrative expenses increased by
approximately $2.1 million and $7.5 million for the third quarter
and nine months ended July 31, 1994, respectively. The increases
in the third quarter and nine months ended July 31, 1994 were
primarily the result of increases in payroll and other related
expenses of $1.3 million and $2.7 million, and other operating
expenses of $.8 million and $1.5 million, respectively. These
increases reflect costs associated with transforming the Company
from a single unit credit card enhancement provider to a
consumer-driven marketing and servicing organization with
multiple lines of business. Also affecting the nine months ended
July 31, 1994 was an increase of $2.9 million in legal expenses
from the comparable period of 1993.
Legal fees related primarily to the Company's litigation
with Peter Halmos. See Note G of Notes to the Consolidated
Financial Statements and "Results of Operations - Pending
Litigation".
RESTRUCTURING COSTS
In April 1994, the Company announced a reorganization of
its operations and named a new senior management team. As a part
of the reorganization, nine senior executives left the Company.
In addition, management decided to close the Ft. Lauderdale sales
office. The Company recorded, as a result of this
reorganization, a restructuring charge of $3.5 million to cover
all severance agreements and a lease termination.
On May 26, 1994, the Company reached a settlement with
Steven Halmos to terminate various agreements between the Company
and Mr. Halmos that provided for payments to Mr. Halmos of $2
million a year through March 31, 1998. The settlement, which
arose in connection with the Company's management restructuring
in April and a resulting decision to cease using Mr. Halmos'
services, resulted in a $4.4 million cash payment to Mr. Halmos
and charge to second quarter earnings. In connection with his
termination Mr. Halmos exercised options to purchase 3,900,000
shares of the Company's common stock. Stockholder's equity
increased $37.8 million resulting from the exercise of such
options and the related tax benefit.
PROVISION FOR INCOME TAXES
Third Quarter Ended July 31, Nine Months Ended July 31,
1994 1993 1994 1993
---- ---- ---- ----
$ 1,643,000 $ 2,447,000 $ 5,808,000 $ 8,305,000
Effective
tax rate 19.8% 24.6% 25.6% 25.0%
The increase in the effective tax rate in the nine months
ended July 31, 1994 resulted primarily from the adoption in the
first quarter of 1994 of Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" and by the
increase in the federal corporate income tax rate from 34% to
35%, offset by revised income projections based on increased
levels of investments in product development and new programs. The
decrease in the effective tax rate for the third quarter 1994 reflects
a change in the proportion of net income derived from tax-free
interest, and thereby lowering the overall effective tax rate.
See Note F of Notes to Consolidated Financial Statements and
"Financial Condition - Liquidity and Capital Resources".
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
See Note F of Notes to Consolidated Financial Statements
for discussion of the change in accounting method.
PENDING LITIGATION
The Company is defending or prosecuting three complex
litigations against Peter Halmos, former Chairman of the Board
and Executive Management Consultant to the Company, and parties
related to him. See Note G of Notes to Consolidated Financial
Statements. The Company believes that it has proper and
meritorious defenses in these lawsuits which it intends
vigorously to pursue. Peter Halmos is also a plaintiff in two
other lawsuits, one against an officer and one against a director
of the Company, in which the Company is not named as a defendant.
As a result of the Peter Halmos-related litigation, the
Company has incurred substantial legal fees, and the litigation
has also had an impact on the Company's expenses. Management has
endeavored to reduce, to the extent it deems reasonable and
feasible, the adverse effects of these lawsuits, but there can be
no assurance that such efforts will be successful. The Company
does not expect the litigation to affect its ability to service
its customers.
Resolution of any or all of the Peter Halmos-related
litigation could have a material impact -- either favorable or
unfavorable depending on the outcome -- upon the results of
operations and financial condition of the Company.
2. FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES
For the nine month period ended July 31, 1994 operations
provided $31.9 million in cash compared to $30.2 million for the
same period in 1993. The increase is primarily attributable to a
$4.2 million increase in cash received from subscribers, a $14.7
million decrease in income tax payments and the $4.3 million gain
from litigation settlements (See Note G of Notes to Consolidated
Financial Statements), partially offset by a $20.8 million
increase in operating expenditures which includes subscriber
acquisition costs and related commissions, product research and
development and general and administrative expenses associated
with transforming the Company from a single unit credit card
enhancement provider to a consumer-driven marketing and servicing
organization with multiple lines of business. The comparison of
cash provided by operations is also affected by the timing of the
various cash receipts and payments. Also affecting the increase
in cash for the period ending July 31, 1994 is the increase of
$20.1 million in proceeds from exercise of employee stock
options.
During 1993, the Board of Directors authorized the Company
to repurchase up to six million shares of its outstanding common
stock. The total authorized repurchases may be made from time to
time through October 31, 1994, depending on the then current
market, financial and corporate conditions, through open market
purchases, block trades or private negotiated transactions. The
Company repurchased 36,700 shares in the first quarter of 1994 at
an aggregate cost of $483,000. The total repurchases under the
plan through July 31, 1994 are approximately 3.5 million shares
at an aggregate cost of $41.7 million.
The Company believes that its cash flow from operations,
and the Company's cash and investment securities, which
aggregated $215.7 million, are adequate to meet the Company's
current liquidity needs. See Note B of Notes to the Consolidated
Financial Statements. The Company has no short or long-term
debt.
In connection with the acquisition of Wright Express
previously discussed, the Company will pay $35.5 million in cash
at closing on September 14, 1994 (See Note G of Notes to the
Consolidated Financial Statements). The cash needs of the other
new ventures previously discussed are expected to be offset by
growth in cash from operations from the core business.
BILLINGS
Net billings were $143.3 million in the nine months of
1994, an increase of $6.5 million, or 4.8%, from the
corresponding period in 1993. This increase is primarily due to
increase in single year Fee Card and CreditLine billings, offset
in part, by a decrease in multi-year Hot-Line and Fee Card
billings.
EXPENDITURES FOR SUBSCRIBER ACQUISITION COSTS AND COMMISSIONS
Subscriber acquisition expenditures directly relate to the
acquisition of new subscribers through "direct response" type
marketing campaigns and include payments for telemarketing,
printing, postage, mailing services, certain salaries and other
costs incurred to acquire new subscribers.
Expenditures for subscriber acquisition costs in the nine
months of 1994 increased 11.9% to $48.1 million compared to $43.0
million in the nine months of 1993. Total subscriber acquisition
campaign volume (mail and telephone contacts) decreased 5.5% in
the nine months of 1994 compared to the same period in 1993. The
decrease in volume, however, related to "insert" type mailings
which generally have significantly lower costs and response rates
(as compared to "solo" type mailings). The Company significantly
increased its volume of "solo" pieces mailed in the first nine
months of 1994.
Commissions paid to credit card issuers were $39.8
million, or 27.8% of billings to subscribers, in the nine months
of 1994 compared to $38.8 million, or 28.3% of billings to
subscribers, in the same period in 1993. Commission rates are
dependent on a variety of factors including client, service, type
of promotion, as well as first time or renewal billings.
MEMBERSHIP BASE
July 31, 1993 New Members Cancellations July 31, 1994*
------------- ----------- ------------- --------------
11,825,000 4,583,000 3,177,000 13,231,000
========== ========= ========= ==========
* Amounts have been restated from those presented in April
1994 to exclude free trial subscribers periodically used as a
marketing technique.
On a net basis, the Company's membership base increased
over the prior year. A substantial portion of new enrollments
essentially replaces existing subscribers who do not renew. This
portion of new enrollments, therefore, does not generate an
increase in total subscription revenue over the prior year.
However, the net member increase should contribute to increased
subscription revenue.
PART II. OTHER INFORMATION
- - ------- -----------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
The Company is defending or prosecuting three complex
litigations against Peter Halmos, former Chairman of the Board
and Executive Management Consultant to the Company and parties
related to him. These litigations are described in Note G of
Notes to Consolidated Financial Statements.
The Company is involved in certain other claims and
litigation which are not considered material to the operations of
the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
(11)a Computation of Primary Earnings Per Share.
(11)b Computation of Fully Diluted Earnings Per
Share.
(15) Letter re Unaudited Interim Financial
Information.
(27) Financial Data Schedule
(b) Reports on Form 8-K
On July 13, 1994, the Company announced that
Gerald R. Cahill, former Chief Operating Officer,
had resigned his position as a Director of the
Company.
On July 25, 1994, the Company and Wright Express
Corporation of South Portland, ME, jointly
announced that they had signed a definitive merger
agreement by which a subsidiary of the Company
will acquire Wright Express Corporation.
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.
SAFECARD SERVICES, INCORPORATED
-------------------------------
(Registrant)
Date: September 14, 1994 PAUL G. KAHN
----------------------------
Paul G. Kahn
Chairman and Chief Executive
Officer
Date: September 14, 1994 G. THOMAS FRANKLAND
-----------------------------
G. Thomas Frankland
Vice Chairman and Chief Financial
Officer
<TABLE>
Exhibit 11(a) - Computation of Primary Earnings Per Share
<CAPTION>
Third Quarter Ended Nine Months Ended
July 31, July 31,
------------------- -----------------
1994 1993 1994 1993
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net earnings $ 6,635,000 $ 7,492,000 $18,883,000 $24,916,000
Adjustment (1)
---------- ---------- ---------- ----------
Adjusted net earnings $ 6,635,000 $ 7,492,000 $18,883,000 $24,916,000
========== ========== ========== ==========
Average common shares
outstanding 27,225,000 24,632,000 25,461,000 25,862,000
Assumed equivalent shares
from stock options converted
to common shares (1) 1,543,000 3,182,000 2,845,000 3,048,000
--------- --------- --------- ---------
Total weighted average number
of common and common
equivalent shares 28,768,000 27,814,000 28,306,000 28,910,000
========== ========== ========== ==========
Earnings per share
Earnings before cumulative effect
of accounting change $.23 $.27 $.60 $.86
Cumulative effect of accounting change .07
--- --- --- ---
Net Earnings $.23 $.27 $.67 $.86
=== === === ===
<FN>
(1) Earnings per share are computed using the weighted average number of shares of common stock and common stock equivalents
(common stock issuable upon exercise of stock options) outstanding. In computing earnings per share, the Company utilizes
the treasury stock method. In computing primary earnings per share, this method assumes that stock options, under certain
conditions, are exercised and treasury shares are assumed to be purchased (not to exceed 20% of the common stock
outstanding) from the proceeds using the average market price of the Company's common stock for the period. Any excess
proceeds not utilized for the purchase of treasury shares are assumed first to reduce any outstanding capitalized lease
obligation and any remainder invested in interest-bearing securities with net earnings increased for the hypothetical
interest savings or interest income, net of income taxes. Because of the hypothetical interest savings or interest income,
net earnings divided by the weighted average number of common and common equivalent shares will not always equal earnings
per share.
</TABLE>
<TABLE>
Exhibit 11(b) - Computation of Fully Diluted Earnings Per Share
<CAPTION>
Third Quarter Ended Nine Months Ended
July 31, July 31,
------------------- -----------------
1994 1993 1994 1993
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net earnings $ 6,635,000 $ 7,492,000 $18,883,000 $24,916,000
Adjustment (1)
---------- ---------- ---------- ----------
Adjusted net earnings $ 6,635,000 $ 7,492,000 $18,883,000 $24,916,000
========== ========== ========== ==========
Average common shares
outstanding 27,225,000 24,632,000 25,461,000 25,862,000
Assumed equivalent shares
from stock options converted
to common shares (1) 1,406,000 3,290,000 2,636,000 3,573,000
--------- --------- --------- ---------
Total weighted average number
of common and common
equivalent shares 28,631,000 27,922,000 28,097,000 29,435,000
========== ========== ========== ==========
Earnings per share $.23 $.27(2) $.67 $.85(2)
=== === === ===
<FN>
(1) Earnings per share are computed consistent with (1) on Exhibit 11(a) - Computation of Primary Earnings Per Share except
in computing fully diluted earnings per share, the treasury stock method uses the market price of the Company's common stock
at the close of the period rather than the average market price during the period.
(2) This calculation is submitted in accordance with Regulation S-K item 601(b)(11) although not required by Footnote 2 to
paragraph 14 of APB Opinion No. 15 because it results in dilution of less than 3%.
</TABLE>
Exhibit 15
September 12, 1994
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
We are aware that SafeCard Services, Inc. has included our report
dated August 18, 1994 (issued pursuant to the provisions of
Statement on Auditing Standards No. 71) in the Prospectus
constituting part of its Registration Statements on Form S-3 and
S-8 (Nos. 33-39023, 33-48317 and 33-51439) filed on or about
February 14, 1991, June 2, 1992 and December 15, 1993. We are also
aware of our responsibilities under the Securities Act of 1933.
Yours very truly,
PRICE WATERHOUSE LLP
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-31-1994
<PERIOD-END> JUL-31-1994
<CASH> 47,628,000
<SECURITIES> 168,068,000
<RECEIVABLES> 17,375,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 10,893,000
<DEPRECIATION> 0
<TOTAL-ASSETS> 436,328,000
<CURRENT-LIABILITIES> 0
<BONDS> 0
<COMMON> 350,000
0
0
<OTHER-SE> 218,077,000
<TOTAL-LIABILITY-AND-EQUITY> 436,328,000
<SALES> 128,115,000
<TOTAL-REVENUES> 139,422,000
<CGS> 78,320,000
<TOTAL-COSTS> 116,731,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 22,691,000
<INCOME-TAX> 5,808,000
<INCOME-CONTINUING> 16,883,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 2,000,000
<NET-INCOME> 18,883,000
<EPS-PRIMARY> 0.67
<EPS-DILUTED> 0.67
</TABLE>
