SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO THE TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM NOVEMBER 1, 1994
TO DECEMBER 31, 1994
Commission File No. 1-10411
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SAFECARD SERVICES, INCORPORATED
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(Exact Name of Registrant as Specified in its Charter)
DELAWARE 13-2650534
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(State or Other Jurisdiction of (I.R.S. Employer Identification number)
Incorporation or Organization)
3001 E. PERSHING BLVD., CHEYENNE, WYOMING 82001
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (307) 771-2700
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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
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Outstanding at March 22, 1995 28,942,265 Shares
Total Number of Pages 22
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PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS
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CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, OCTOBER 31,
1994 1994
------------ -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,315 $ 17,921
Marketable securities, maturing
within one year 43,532 39,249
Receivables, net 58,337 42,449
Income taxes receivable 2,121 2,114
Deferred subscriber acquisition
costs and related commissions,
current portion 85,435 83,449
Deferred income taxes,
current portion 10,315 8,450
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Total current assets 209,055 193,722
Marketable securities, maturing
after one year 116,134 127,363
Deferred subscriber acquisition
costs and related commissions,
non-current portion 46,482 111,948
Property and equipment, net 23,381 16,410
Excess of cost over fair value
of net assets acquired 28,451 28,739
Other assets 5,211 2,191
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Total assets $ 428,714 $ 480,373
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
CURRENT LIABILITIES
Accounts payable $ 33,037 $ 30,833
Accrued expenses 30,535 24,654
Subscribers' advance payments,
current portion 117,203 106,563
Allowance for cancellations 9,197 7,656
Notes payable to bank 12,083 11,793
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Total current liabilities 202,055 181,499
Subscriber advance payments,
non-current portion 54,862 51,991
Deferred income taxes, non-
current portion 4,991 29,291
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Total liabilities 261,908 262,781
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STOCKHOLDERS' EQUITY
Common stock--authorized 35,000,000
shares ($.01 par value);34,946,000
shares issued; 28,933,599 shares
outstanding 349 349
Additional paid-in capital 41,058 41,058
Retained earnings 174,066 225,459
Unrealized loss on securities
available for sale (607)
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215,473 266,259
Less cost of common shares in
treasury (6,012,401 shares) (48,667) (48,667)
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Total stockholders' equity 166,806 217,592
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Total liabilities and
stockholders' equity $ 428,714 $ 471,833
======= =======
The accompanying notes are an integral part of these consolidated
financial statements.
CONSOLIDATED STATEMENT OF EARNINGS
(IN THOUSANDS, EXCEPT SHARE DATA)
TWO MONTHS ENDED
DECEMBER 31,
----------------------
1994 1993
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(UNAUDITED)
REVENUES
Subscription revenue, net $ 30,375 $ 27,518
Other operating revenue 2,915
Interest income 1,394 1,334
Other income 14 280
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34,698 29,132
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COSTS AND EXPENSES
Subscriber acquisition costs 18,566 16,891
General, administrative and
service costs 16,545 5,762
Research and product development costs 8,163
Unrealized loss on marketable securities 1,943
Effect of change in amortization periods
for deferred subscriber acquisition
costs 65,500
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110,717 22,653
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(LOSS) EARNINGS BEFORE INCOME TAXES (76,019) 6,479
BENEFIT FROM (PROVISION FOR) INCOME
TAXES 26,075 (1,652)
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(LOSS) EARNINGS BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING FOR INCOME
TAXES (49,944) 4,827
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING FOR INCOME TAXES 2,000
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NET (LOSS) EARNINGS $ (49,944) $ 6,827
======= =======
EARNINGS PER SHARE:
(Loss) Earnings before cumulative
effect of accounting change $ (1.70) $ .18
Cumulative effect of accounting change .07
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Net (loss) earnings $ (1.70) $ .25
======= ======
Weighted average number of common
and common equivalent shares 29,297,000 27,325,000
The accompanying notes are an integral part of these consolidated
financial statements.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
TWO MONTHS ENDED
DECEMBER 31,
---------------------
1994 1993
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(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash received from subscribers $ 29,833 $ 33,523
Net cash expended for other
operating revenue sources (196)
Cash expenditures for subscriber
acquisition costs, commissions,
new business development and
operations (37,330) (31,601)
Interest received 3,094 3,627
Interest paid (146)
Income tax (payments) refunds, net (7) 515
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Net cash (used in) provided by
operating activities (4,752) 6,064
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CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of investment securities (12,752) (18,350)
Proceeds from sales of investment
securities 17,463 15,438
Proceeds from maturing investment
securities 710
Acquisition of property and equipment,
net (7,406) (410)
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Net cash used in investing activities (2,695) (2,612)
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CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on notes payable to bank 290
Proceeds from exercise of stock options 36
Dividends paid (1,449) (1,207)
Payments for purchase of treasury
shares (483)
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Net cash used in financing activities (1,159) (1,654)
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Net (decrease) increase in cash and
cash equivalents (8,606) 1,798
Cash and cash equivalents at beginning
of period 17,921 3,335
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CASH AND CASH EQUIVALENTS AT END OF
PERIOD $ 9,315 $ 5,133
====== =======
The accompanying notes are an integral part of these consolidated
financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments necessary to present fairly the
financial position of SafeCard Services,Incorporated (the "Company") as of
December 31, 1994 and the results of its operations and its cash flows for
the two months ended December 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 on Form 10-K for the fiscal year ended
October 31, 1994 except for the change in amortization periods for deferred
subscriber acquisition costs described in Note 3. The financial statements
contained herein are filed on Form 10-Q for the two months ended December
31, 1994 and 1993 to effect a change in the Company's year end from October
31 to December 31. Results of operations for the two months ended December
31, 1994 are not necessarily indicative of the results to be expected for a
full year.
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 on Form 10-K for the fiscal year ended October
31, 1994 and should be read in conjunction with the Notes to Consolidated
Financial Statements included in the Form 10-K under Item 8. Financial
Statements and Supplementary Data.
The 1994 presentation of the Company's balance sheet had previously been
presented in an unclassified format. During a review of the Company's
Transition Period Form 10-Q, the Securities and Exchange Commission disagreed
with the unclassified presentation. As a result, the balance sheet is
presented in a classified format for December 31, 1994 and October 31,
1994.
Price Waterhouse LLP has made a review, and not an audit, of the
unaudited consolidated financial information of the Company for the two month
period ended December 31, 1994 (based on procedures adopted by the American
Institute of Certified Public Accountants) as set forth in their separate
report dated February 6, 1995, except as to Note 1, which is as of March 24,
1995, 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.
2. INVESTMENTS
On October 31, 1994, the Company adopted Statement of Financial
Accounting Standards No. 115 ("FAS 115"), "Accounting for Investments in
Certain Debt and Equity Securities." Upon adoption of FAS 115, the Company
classified its securities portfolio, consisting of municipal bonds, as
available for sale and disclosed the unrealized loss of $607,000 as a
separate component of stockholders' equity. During the two months ended
December 31, 1994, the Company experienced further market value declines in
its investment portfolio as a result of the increasing interest rate
environment. Given the Company's strategy to redeploy its investment
resources into operating assets and in view of the current interest rate
environment, management has elected to actively reposition the portfolio.
This repositioning will minimize additional market risk and complete the
Company's effort to shorten the overall maturity of the portfolio. By
reinvesting the proceeds of municipal bonds sold in short-term taxable
securities, the Company can also take advantage of its current tax net
operating loss position. Due to the decision to actively sell a significant
portion of the Company's investment portfolio, management determined that
there was an other than temporary decline in the market value of its
available for sale portfolio, and consequently the net unrealized losses of
$1,943,000 previously recognized as an offset to stockholders' equity were
charged against earnings for the two months ended December 31, 1994.
3. SUBSCRIBER ACQUISITION COSTS
Subscriber acquisition expenditures directly relate to the acquisition
of new subscribers through "direct-response" type marketing campaigns and
primarily include payments for telemarketing, printing, postage, mailing
services, certain direct salaries and other direct costs incurred to acquire
new subscribers. These expenditures have historically been deferred and
amortized to expense in proportion to expected revenues over the expected
subscription periods, including renewal periods (life of subscriber).
After a general review of the Company's business plans and related
accounting practices, the Company's Board of Directors approved a change in
the amortization periods for deferred subscriber acquisition costs. The
change was made in response to the Company's plans to incur additional
marketing expenditures to enhance renewal rates. Under generally accepted
accounting principles, if additional expenditures are incurred to maintain or
enchance the renewal stream, the Company would not be allowed to amortize
such subscriber acquisition costs over periods greater than the initial
subscription period. Accordingly, based on its proposed efforts to enhance
renewal rates, the Company changed its amortization periods. In prior
periods, subscriber acquisition costs were generally amortized up to 10 years
for single year subscriptions and up to 12 years for multi-year
subscriptions. These amortization periods represented the estimated life of
the subscriber. During the two months ended December 31, 1994, the
amortization periods were shortened to 1 year and 3 years for single year and
multi-year subscriptions, respectively (initial subscription period without
regard for anticipated renewals). The effect of reducing the amortization
periods resulted in a one-time, non-cash, pre-tax charge to earnings of
$65,500,000 during the two months ended December 31, 1994. The new
amortization periods are more conservative and result in a less complex
amortization computation than before.
The change in amortization period for deferred subscriber acquisition
costs does not affect the amortization of commissions which continue to be
amortized over the one to three year subscription period, as appropriate.
4. INCOME TAXES
The Company's effective income tax rate for the two months ended
December 31, 1994 and 1993 differs from the applicable statutory rate due to
tax-exempt interest received on investments in municipal debt securities and
the federal tax benefit of state income taxes. The effective income tax rate
for the two months ended December 31, 1994 was based on the estimated
effective income tax rate for the tax year ending October 31, 1995. The
effective income tax rate for the two months ended December 31, 1993 was
based on the effective tax rate reported for the year ended October 31, 1994.
At December 31, 1994, the Company had a net deferred tax asset of
$5,324,000. The deferred tax asset primarily relates to multi-year
subscription revenues and the Company's net operating loss carryforward. The
net deferred tax asset arose during the two months ended December 31, 1994
primarily as the result of a reduction in the Company's deferred tax
liability from the change in amortization periods for deferred subscriber
acquisition costs as described in Note 3. Management believes that based on
available information, it is more likely than not that the net deferred tax
asset will be realized and accordingly a valuation allowance has not been
recorded.
On November 1, 1993 the Company adopted Statement of Financial
Accounting Standards No. 109 ("FAS 109"), "Accounting for Income Taxes." The
adoption of FAS 109 resulted in a cumulative credit to earnings of $2,000,000
for the two months ended December 31, 1993.
5. 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:
Two months ended December 31, 1994 1993
----------- -----------
Net (loss) earnings $(49,944,000) $ 6,827,000
Adjustments to reconcile net earnings
to net cash provided by operating
activities:
Depreciation 435,000 141,000
Amortization of excess of cost over
fair value of net assets acquired 288,000
(Benefit from) provision for income
taxes (26,075,000) 1,652,000
Income tax (payments) refunds, net (7,000) 515,000
Cumulative effect of accounting
change (2,000,000)
Increase in receivables, net (15,888,000) (8,289,000)
Amortization of bond premiums/
discounts 802,000 866,000
Billings to subscribers, net 43,886,000 40,914,000
Amortization of subscribers' advance
payments to revenue (30,375,000) (27,518,000)
Effect of change in amortization
periods for deferred subscriber
acquisition costs 65,500,000
Expenditures for subscriber
acquisition costs (8,792,000) (8,669,000)
Payment of commissions, net (11,794,000) (11,760,000)
Amortization of subscriber
acquisition costs 10,001,000 8,877,000
Amortization of commissions 8,565,000 8,014,000
Increase in allowance for
cancellations 1,541,000 2,239,000
Increase (decrease) in accounts
payable and accrued expenses 8,085,000 (4,884,000)
Unrealized loss on marketable
securities 1,943,000
Realized loss (gain) on sale
ofinvestments 97,000 (195,000)
Increase in other assets (3,020,000) (666,000)
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NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES $ (4,752,000) $ 6,064,000
========= =========
6. COMMITMENTS AND CONTINGENCIES
The Company is defending or prosecuting five complex lawsuits involving
Peter Halmos, former Chairman of the Board and Executive Management
Consultant to the Company, and various 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 five 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. On February 7, 1995, the court dismissed with
prejudice Peter Halmos' claims regarding alleged rights to "incentive
compensation," stock options or their equivalent, wrongful termination
and defamation. Mr. Halmos has stated that he will appeal this ruling.
The Company has twenty-eight days to file an answer to the remaining
indemnification claims and the claims of Myron Cherry.
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 the Company's 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. In January 1995, Peter Halmos requested and
received permission to file a third amended counterclaim which was
identical in all respects to the second amended counter claim. On
January 17, 1995, the Company filed its answer to the third 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.
Discovery is proceeding. In March 1994, Mr. Halmos and related
entities filed a counterclaim in which claims were 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.
A suit by Peter Halmos, purportedly in his name and in the name of
CreditLine Corporation and Continuity Marketing Corporation against the
Company, one of its officers and three of its directors in United
States District Court in the Southern District of Florida, in September
1994 purporting to state various tort claims, state and federal
antitrust claims and claims of copyright infringement. The claims
principally relate to the allegation by Peter Halmos and his companies
that SafeCard has taken action to prevent him from being a successful
competitor. On December 9, 1994 the Company and its directors moved to
dismiss the lawsuit. A suit by Peter Halmos, as trustee for the Peter
A. Halmos revocable trust dated January 24, 1990 and the Halmos
Foundation, Inc., individually and James L. Binder as custodian for
Elizabeth Binder; Edward Dubois; Sheila Ann Dubois, as personal
representative of the Estate of Winifred Dubois; G. Neal Goolsby, John
E. Masters, individually and as custodian for Gregory Halmos and
Nicholas Halmos; and J.B. McKinney on behalf of themselves and all
others similarly situated against the Company, one of its officers, one
of its former officers and three of its directors in the United States
District Court for the Southern District of Florida in December 1994.
This litigation involves claims by a putative class of sellers of
Company stock for the period January 11, 1993 through December 8, 1994
for alleged violations of the federal and states securities laws in
connection with alleged improprieties in the Company's investor
relations program. Peter Halmos has filed individual claims in
connection with the sale of stock by the two trusts controlled by him.
The Company intends to file an appropriate response to the complaint.
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 Company's
operations, liquidity and financial condition.
7. SUBSEQUENT EVENT
On January 18, 1995, the Company announced that it signed a definitive
purchase agreement to acquire substantially all the assets of National
Leisure Group, a leading provider of vacation travel packages to credit card
companies, retailers and wholesale clubs in the United States for
$14,500,000 in cash at closing and up to $5,500,000 in additional
consideration (including restricted stock) based on performance and the
fulfillment of certain conditions. The acquisition, which will be accounted
for under the purchase method, was completed on February 10, 1995.
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
To the Board of Directors and Stockholders of
SafeCard Services, Incorporated
We have reviewed the accompanying consolidated balance sheet of SafeCard
Services, Incorporated as of December 31, 1994, and the related consolidated
statements of earnings and of cash flows for the two month period then ended,
appearing in the Company's Form 10-QA for the transition period ended
December 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, 1994, 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 5, 1994, except for Note 1, as to which the date is
March 24, 1995, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the accompanying
consolidated balance sheet information as of October 31, 1994, is fairly
stated in all material respects in relation to the consolidated balance sheet
from which it has been derived. The comparative interim financial
information for the period ended December 31, 1993 was not reviewed by us.
PRICE WATERHOUSE LLP
Denver, Colorado
February 6, 1995, except for Note 1,
as to which the date is March 24, 1995
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
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CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
References herein to the years 1994 and 1993 refer to the two month
transition period ended December 31.
RESULTS OF OPERATIONS
Subscription Revenue, Net
Two months ended December 31, 1994 1993
----------- -----------
$30,375,000 $27,518,000
The Company's subscription revenue is derived from payments by
subscribers for its credit card enhancement continuity services and is
reported net of an allowance for cancellations. Billings for subscriptions
are deferred and amortized to revenue over the related subscription periods.
Subscription revenue, net increased 10% to $30,375,000 in 1994, compared
to $27,518,000 in 1993. This increase was due to a combination of a price
increase for certain Hot-Line subscriptions beginning in 1993 and an increase
in the number of subscribers to the Company's Hot-Line, Fee Card and
CreditLine products.
Renewal rates for single year Hot-Line subscriptions were 76% and 75%
for 1994 and 1993, respectively. Renewal rates for multi-year Hot-Line
subscriptions (primarily three year subscriptions) remained constant at 47%
for the same periods. Renewal rates for Fee Card subscriptions (primarily
marketed as single year subscriptions) were 82% and 81% for 1994 and 1993,
respectively. Renewal rates are computed by comparing the number of paid
subscribers at the end of the period for each subscriber campaign pool in
existence at the beginning of the period to the number of paid subscribers at
the beginning of the period. The Company monitors renewal rates by product
by client on a monthly basis. Renewal rates of subscribers are affected by
a variety of factors including the mix of subscribers renewing, economic
factors, changes in the credit card industry and other factors which may be
beyond the Company's control.
The following table details subscriber activity for the two months ended
December 31, 1994 and 1993:
Beginning New Ending
Subscribers Subscribers Cancellations Subscribers
----------- ----------- ------------- -----------
1994 13,105,000 592,000 (651,000) 13,046,000
1993 12,043,000 768,000 (676,000) 12,135,000
The decline in subscribers during 1994 was the result of delays in
launching certain new marketing campaigns and the reduction in telephone
solicitation volumes in other campaigns. In addition, this change partially
reflects the normal seasonality of the business.
New subscribers represent fee-paying subscribers obtained through
various marketing channels. Cancellations consist of both voluntary and
involuntary membership losses. Voluntary cancellations result from members
electing to discontinue their subscriptions. Involuntary cancellations
result from the closure of card accounts or other events beyond the Company's
control.
Credit card issuers from time to time may adopt changes in business
strategy which may affect the Company. For example, certain card issuer
clients have changed the marketing emphasis from multi-year to single year
subscriptions. While changes in marketing emphasis may change the mix of
products sold, to date the Company has not noted any material impact on
earnings as a result of such changes in business strategy. However, future
adverse changes in business strategy by credit card issuers could have a
material impact on the earnings of the Company.
In 1993 and 1994, the Company began placing greater emphasis on the
development of additional products and services to enhance the Company's
existing range of services. The viability of products and services under
development is not assured. New products and services developed and test
marketed are frequently not successful. While the Company believes that
modest growth in Hot-Line subscription revenues through credit card issuers
may be achievable in the future, the Company anticipates that the successful
development of new products and services, new channels of distribution and
the development of new areas of business will become increasingly important
to the future revenue and earnings growth of the Company.
Other Operating Revenue
Two months ended December 31, 1994 1993
---------- ----------
$2,915,000 ----
Other operating revenue represents revenues derived from the operations
of Wright Express Corporation ("Wright Express"), which was acquired by the
Company in September 1994.
Wright Express provides transaction and information processing services
to commercial fleet owners primarily through a national credit card network
program. These services are generally provided through fueling stations
which are owned and operated by retail petroleum merchants. Substantially
all receivables from transportation fleet services represent the cost of
products purchased by the fleet owners. Other operating revenue represents
transaction fees deducted from amounts remitted to the retail merchants and
annual fees charged to fleet customers.
Interest Income
Two months ended December 31, 1994 1993
---------- ----------
$1,394,000 $1,334,000
Interest income increased $60,000 or 5% in 1994 compared to 1993. The
increase is primarily due to a decrease in the amount of premium amortization
from 1993 to 1994 and an increase in interest rates during 1994.
Other Income
Two months ended December 31, 1994 1993
-------- --------
$14,000 $280,000
Other income decreased $266,000 or 95% in 1994 compared to 1993. The
decrease is mainly due to a decrease in gains on sales of securities.
Subscriber Acquisition Costs
Two months ended December 31, 1994 1993
----------- -----------
$18,566,000 $16,891,000
As a percentage of
subscription revenue 61% 61%
The cost of subscriber acquisition, which represents the amortization of
deferred subscriber acquisition costs and commissions, increased $1,675,000
or 10% in 1994 compared to 1993 due to continuing increases in expenditures
in recent periods made to acquire new subscribers as well as the timing of
these new marketing campaigns. These expenditures increased 7% for the
fiscal year ended October 31, 1994 compared to the prior fiscal year (see
"Expenditures for Subscriber Acquisition Costs and Commissions"). The
relationship of these costs to subscription revenues is dependent on a
variety of factors including subscription fees, net response rates (gross
enrollments less cancellations), marketing costs and renewal rates. These
factors are affected by economic conditions, interest rates, the number of
credit cards in use, demographic trends, consumers' propensity to buy, the
degree of market penetration and the effectiveness of subscriber acquisition
concepts, copy and marketing strategies.
As discussed in Note 3 of Notes to Consolidated Financial Statements
under Item 1. Financial Statements, the Company changed the amortization
periods for subscriber acquisition costs. For further discussion of the
change, see "Effect of Change in Amortization Periods for Deferred Subscriber
Acquisition Costs."
A postal rate increase became effective in January 1995. Since postage
represents the largest component of direct mail costs (approximately 50%),
this will have a direct impact on the Company by increasing subscriber
acquisition costs. The Company is working with its card issuer clients to
better target its direct mailings, is considering changes in its mix of
direct mailings and is taking other steps to reduce the impact of the postal
rate increase.
General, Administrative and Service Costs
Two months ended December 31, 1994 1993
----------- ----------
$16,545,000 $5,762,000
General, administrative and service costs increased $10,783,000, or
187%, in 1994 compared to 1993. This increase reflects the continuing
investment in Company infrastructure (i.e., personnel and operations)
necessary to support the planned growth of the Company and the reorganization
of the Company's operations into strategic business units. The operations
of Wright Express accounted for $2,403,000 of the increase. Of the
remaining increase, personnel costs such as salaries and benefits increased
$1,353,000 from 1993 to 1994 and employee relocation cost increased
$2,259,000 over the same period. General operating costs increased
approximately $2,300,000 in 1994 over 1993. In addition, the Company
incurred approximately $1,600,000 more for consulting and other outside
services in 1994 compared to 1993.
Research and Product Development Costs
Two months ended December 31, 1994 1993
---------- ----------
$8,163,000 ----
As described under "Subscription Revenue, Net," the Company is placing
greater emphasis on the development of new products and services and the
development of new areas of business. The Company's strategy is to diversify
and broaden its scope to become an innovative marketing and services
organization operating through multiple strategic business units. While the
development of new products and services and the development of new areas of
business have not contributed significantly to revenues in 1994, the Company
has incurred certain direct expenses in developing these new products and
areas of business.
In 1994 the Company announced a partnership with the PGA TOUR and
entered into an exclusive multi-year licensing, marketing and servicing
agreement that provides for the Company to assume management of the PGA TOUR
Partners program. Under the Company's direction, the PGA TOUR Partners
program, which currently has approximately 85,000 members, is expected to be
significantly expanded and include access to PGA TOUR events and tournaments
and a unique co-branded PGA TOUR credit card. In December 1994, the Company
entered into an agreement with SunTrust BankCard, N.A., to issue the
co-branded credit card. The Company will be responsible for card marketing,
acquisition and servicing while SunTrust will fund the credit card
receivables. A significant portion of the research and new product
development costs relate to the Company's development of the new Partners
program and costs incurred in connection with the issuance of the PGA TOUR
credit card in 1995. These costs include the establishment of an operations
center and the hiring of new employees.
The Company's new product and business development, as well as future
acquisitions, is concentrated in four market segments: security and
convenience, travel and leisure, consumer direct marketing and financial
planning and management. The first acquisition under this focus was Wright
Express. In February 1995, the Company acquired National Leisure Group, a
leading provider of vacation travel packages to credit card companies,
retailers and wholesale clubs in the United States. The Company continues to
seek additional acquisition candidates which operate within these market
segments to complement the Company's long-term strategy. The Company also
expects to expand its credit card marketing and services business by
partnering with other national brands. However, there is no assurance as to
the success of such ventures.
Unrealized Loss on Marketable Securities
Two months ended December 31, 1994 1993
---------- ----------
$1,943,000 ----
As discussed in Note 2 of Notes to Consolidated Financial Statements
under Item 1. Financial Statements, the Company recognized an other than
temporary decline in the market value of its securities available for sale
portfolio as of December 31, 1994 due to management's decision to actively
reposition the Company's investments. Consequently, the net unrealized
losses previously recognized as an offset to stockholders' equity of
$1,943,000 were charged against 1994 earnings.
Management has evaluated the Company's current investment portfolio, tax
position, liquidity needs and current market conditions and has concluded
that a repositioning of the portfolio is warranted. This strategy is
consistent with the Company's plans to redeploy its investment resources into
operating assets. The planned repositioning will also create greater
liquidity and take advantage of higher interest rates now available. When
repositioning of the portfolio is complete, management expects that the
resulting investments will no longer be classified as trading account
securities.
Effect of Change in Amortization Periods for Deferred Subscriber
Acquisition Costs
Two months ended December 31, 1994 1993
----------- -----------
$65,500,000 ----
As discussed in Note 3 of Notes to Consolidated Financial Statements
under Item 1. Financial Statements, the Company's Board of Directors approved
a change in the amortization periods for deferred subscriber acquisition
costs as part of a general review of the Company's business plans and related
accounting practices. The change was made in response to the Company's plans
to incur additional marketing expenditures to enhance renewal rates. Under
generally accepted accounting principles, if additional expenditures are
incurred to maintain or enhance the renewal stream, the Company would not be
allowed to amortize such subscriber acquisition costs over periods greater
than the initial subscription period. Accordingly, based on its proposed
efforts to enhance renewal rates, the Company changed its amortization
periods. In prior periods, subscriber acquisition costs were
generally amortized over 10 years for single year subscriptions and 12 years
for multi-year subscriptions, which represented the estimated life of the
subscriber. During the two months ended December 31, 1994, the amortization
periods were shortened to 1 year and 3 years for single year and multi-year
subscriptions, respectively, which represents the initial subscription
period.
The effect of shortening the amortization periods for subscriber
acquisition costs was calculated as the difference between deferred
subscriber acquisition costs at December 31, 1994 using the previous
amortization periods and deferred subscriber acquisition costs at December
31, 1994 determined under the new amortization periods. The effect of
reducing the amortization periods resulted in a $65,500,000 pre-tax charge to
earnings for the two months ended December 31, 1994. The new amortization
periods are more conservative and result in a less complex amortization
computation than before.
Benefit from (Provision for)Income Taxes
Two months ended December 31, 1994 1993
---------- ----------
$26,075,000 $(1,652,000)
For interim reporting purposes, the Company provides income taxes based
upon an estimated effective income tax rate for the tax year containing the
interim reporting period. For information regarding the Company's effective
income tax rate and deferred income tax assets and liabilities, see Note 4 of
Notes to Consolidated Financial Statements under Item 1. Financial
Statements.
Effective November 1, 1993, the Company prospectively adopted Statement
of Financial Accounting Standards No. 109 ("FAS 109"), "Accounting For Income
Taxes." The adoption of FAS 109 required a change from the deferred method
to the liability method of accounting for income taxes. The impact of the
adoption of FAS 109 had a cumulative positive effect on the Company's
reported earnings of $2,000,000 in 1993. This positive impact was primarily
the result of deferred income taxes being provided in prior periods at tax
rates higher than those currently in effect.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has generated the cash needed to finance its
operations and growth from its earnings. The Company's primary liquidity
requirements are to fund subscriber acquisition marketing programs, support
the development of new products and services and fund acquisitions. In
addition, Wright Express requires resources to fund receivable balances on
its fleet credit cards.
Cash flow used in operating activities was $4,752,000 in 1994 compared
to $6,064,000 provided by operating activities in 1993. The decrease in cash
flow from operations is principally the result of a $3,690,000 decrease in
net cash received from subscribers and a $5,729,000 increase in cash
expenditures for subscriber acquisition costs, commissions and operations,
including research and product development. The decrease in net cash
received from subscribers was caused by the timing of the Company's annual
merchandise billings which were mailed one month later in 1994 compared to
1993. The increase in cash expenditures is due to a continued emphasis by
the Company on the development and launching of new products and services
which will provide a base for future growth. Cash flow from operating
activities is expected to increase as these new products and services are
introduced. Other changes in cash flows from operating activities are due to
the timing of receipt of interest earned and income tax refunds.
Cash flow used in investing activities was $2,695,000 in 1994 compared
to $2,612,000 in 1993. Net acquisitions of property and equipment increased
by $6,996,000 in 1994 over 1993, principally due to information technology
enhancements and the Company's expansion and renovation of its operations
center in Cheyenne, Wyoming. For the two months ended December 31, 1994,
approximately $4,600,000 has been expended by the Company on expansion of the
operations center. Expenditures through February 1995, the anticipated date
of completion, are expected to be approximately $10,000,000. This increase
in cash flow used in investing activities was offset by a $6,913,000 increase
in net cash provided by investment security transactions.
Cash flow used in financing activities amounted to $1,159,000 in 1994
compared to $1,654,000 in 1993. The decrease in cash flow used in financing
activities related primarily to the repurchase of approximately 37,000 shares
of the Company's common stock for $483,000 in 1993. The Company has
discontinued its stock repurchase program.
The Company incurred approximately $776,000 of litigation and other
legal expenses during the two months ended December 31, 1994. Litigation
expenses anticipated in future periods cannot be quantified. See Item 1.
"Legal Proceedings" under Part II. "Other Information."
The amount of the expected costs or commitments to develop new
businesses, products and services in future periods is not quantifiable;
however, such amounts could be material to liquidity or results of
operations. The Company believes that its cash flow from operations and the
Company's cash and investment balances (which totaled $168,981,000, of which
$11,900,000 is restricted, as of December 31, 1994) are adequate to meet the
Company's current liquidity needs.
Billings to Subscribers, Net
Net billings were $43,886,000 in 1994 compared to $40,914,000 in 1993.
The 7% increase in 1994 over 1993 was primarily due to the combination of
increases in subscribers and subscription fees as discussed in "Subscription
Revenue, Net."
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 direct salaries and other direct costs incurred to acquire new
subscribers. Expenditures for subscriber acquisition costs increased by
$123,000, or 1%, in 1994 as compared to 1993.
The volume and type of subscriber acquisition expenditures, as well as
enrollments, fluctuate periodically and such fluctuations are not unusual.
Due to timing differences between periods, there may not always be a direct
correlation between subscriber acquisition expenditures and new enrollments
in a particular period. In addition, historical response rates may not be an
indication of future response rates.
Commissions paid to credit card issuers were $11,794,000 in 1994 as
compared to $11,760,000 in 1993. (See "Billings to Subscribers, Net").
PART II. OTHER INFORMATION
-------- -----------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
The Company is defending or prosecuting five complex lawsuits against
Peter Halmos, former Chairman of the Board and Executive Management
Consultant to the Company, and parties related to him. These lawsuits are
described in Note 6 of Notes to Consolidated Financial Statements under Item
1. 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.
The Company is involved in certain other claims and litigation which
are not considered material to the operations of the Company.
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: March 24, 1995 G. THOMAS FRANKLAND
-------------------------------
G. Thomas Frankland
Vice Chairman and
Chief Financial Officer
EXHIBIT 15
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
We are aware that SafeCard Services, Incorporated has included our
report dated February 6, 1995, except for Note 1, as to which the date is
March 24, 1995 (issued pursuant to the provisions of Statement on Auditing
Standards No. 71) in the Prospectus constituting part of the Registration
Statements on Forms S-3 and S-8 (Nos. 33-39023, 33-48317, 33-51439, 33-55581,
33-55585 and 33-57071) filed on or about February 14, 1991, June 2, 1992,
December 15, 1993, September 22, 1994 and December 23, 1994. We are also
aware of our responsibilities under the Securities Act of 1933.
PRICE WATERHOUSE LLP
Denver, Colorado
March 24, 1995
