<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 1996
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file Number 1-10993
SPS TRANSACTION SERVICES, INC.
(Exact name of Registrant as specified in its charter)
Delaware 36-3798295
(State of incorporation) (I.R.S. Employer
Identification No.)
2500 Lake Cook Road, Riverwoods, IL 60015
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (847) 405-3400
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of April 30, 1996, the Registrant had 27,178,701 shares of common stock,
$0.01 par value, outstanding.
Page 1 of 17 pages
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
- - -------------------------------------------------------------------------------
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
March 31, December 31,
1996 1995
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS:
Cash and due from banks $ 15,770 $ 8,879
Cash and due from banks - restricted -- 29,000
Investments: Held to maturity - at amortized cost 52,426 47,430
Credit card loans 1,611,376 1,620,833
Allowance for loan losses (66,252) (63,704)
---------- ----------
Credit card loans, net 1,545,124 1,557,129
Accrued interest receivable 23,874 23,828
Accounts receivable 27,715 28,683
Due from affiliated companies 9,974 4,776
Premises and equipment, net 20,350 19,800
Deferred income taxes 27,639 26,276
Prepaid expenses and other assets 30,736 31,806
---------- ----------
TOTAL ASSETS $1,753,608 $1,777,607
========== ==========
LIABILITIES:
Deposits:
Noninterest-bearing $ 6,421 $ 10,270
Interest-bearing 386,125 372,073
---------- ----------
Total deposits 392,546 382,343
Accounts payable, accrued expenses and other 39,127 44,788
Income taxes payable 15,147 11,232
Due to affiliated companies 1,068,685 1,110,811
Notes payable -- 2,095
Accrued recourse obligation 26,718 27,128
---------- ----------
Total liabilities 1,542,223 1,578,397
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value, 100,000
shares authorized; none issued or outstanding
Common stock, $.01 par value, 40,000,000 and
40,000,000 shares authorized; 27,198,000 and
27,147,000 shares issued; 27,161,000 and
27,074,000 shares outstanding at March 31, 1996
and December 31, 1995, respectively 272 271
Capital in excess of par value 80,081 79,396
Retained earnings 132,134 121,099
Common stock held in treasury, at cost, $.01
par value, 37,000 and 73,000 shares at March 31,
1996 and December 31, 1995, respectively (1,032) (1,957)
Stock compensation plan 413 501
Employee stock benefit trust (413) --
Unearned stock compensation (70) (100)
---------- ----------
Total stockholders' equity 211,385 199,210
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,753,608 $1,777,607
========== ==========
<FN>
See notes to unaudited consolidated financial statements.
</TABLE> 2
<PAGE>
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
- - -------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
1996 1995
------- -------
(Unaudited)
<S> <C> <C>
Processing and service revenues $74,330 $55,228
Merchant discount revenue 7,844 7,678
------- -------
82,174 62,906
Interest revenue 55,952 20,088
Interest expense 22,643 9,104
------- -------
Net interest income 33,309 10,984
Provision for loan losses 26,472 4,319
------- -------
Net credit income 6,837 6,665
------- -------
Net operating revenues 89,011 69,571
Salaries and employee benefits 24,200 21,017
Processing and service expenses 26,671 18,560
Other expenses 20,341 13,026
------- -------
Total operating expenses 71,212 52,603
------- -------
Income before income taxes 17,799 16,968
Income tax expense 6,764 6,691
------- -------
Net income $11,035 $10,277
======= =======
Net Income per Common Share $ 0.41 $ 0.38
======= =======
Weighted Average Common Shares
Outstanding 27,117 27,078
<FN>
See notes to unaudited consolidated financial statements.
</TABLE>
3
<PAGE>
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- - -------------------------------------------------------------------------------
(In Thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1996 1995
-------- ---------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 11,035 $ 10,277
Adjustments to reconcile net income to
net cash flows from operating activities
Depreciation and amortization 3,467 1,370
Imputed interest on notes payable 15 2,486
Provision for loan losses 26,472 4,319
Deferred income taxes (1,363) (441)
(Increase) decrease in operating assets:
Cash and due from banks - restricted 29,000 (46,480)
Amounts due from affiliated companies (5,198) 254
Accrued interest receivable and accounts receivable 922 (1,316)
Prepaid expenses and other assets 425 (1,636)
Increase (decrease) in operating liabilities:
Accounts payable, accrued expenses and other (5,861) 5,697
Income taxes payable 3,919 6,958
Due to affiliated companies 7,163 876
Accrued recourse obligation (410) 16
-------- -------
Net cash from operating activities 69,586 (17,620)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments: Held to maturity - purchases (52,746) (10,661)
Investments: Held to maturity - maturities 47,750 10,570
Net principal disbursed on credit
card loans (15,934) (35,293)
Purchase of credit card portfolio -- (296,556)
Purchases of premises and equipment, net (1,905) (1,565)
-------- --------
Net cash from investing activities (22,835) (333,505)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in noninterest-bearing deposits (3,849) 2,110
Net increase in interest-bearing deposits 14,052 70,314
Due to affiliated companies (49,289) 358,197
Repayment of notes payable (2,110) (74,191)
Proceeds from exercise of stock options 411 265
Change in treasury stock, net 925 --
-------- --------
Net cash from financing activities (39,860) 356,695
-------- --------
Increase in cash and due from banks 6,891 5,570
Cash and due from banks, beginning of period 8,879 3,220
-------- --------
Cash and due from banks, end of period $ 15,770 $ 8,790
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Short-term note, net issued to purchase credit
card portfolios $ -- $ 48,333
======= ========
<FN>
See notes to unaudited consolidated financial statements.
</TABLE>
4
<PAGE>
SPS TRANSACTION SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTH PERIODS ENDED MARCH 31, 1996 AND 1995
- - -------------------------------------------------------------------------------
A. ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of SPS Transaction
Services, Inc. (the "Company") and its wholly owned subsidiaries. The Company
is a 73.6% majority owned subsidiary of NOVUS Credit Services Inc., which in
turn is a wholly owned, direct subsidiary of Dean Witter, Discover & Co.
("DWD"). The Company provides electronic processing of credit card
transactions; administers consumer private label credit card programs and
commercial account processing services; and provides operational outsourcing
services to commercial clients in the United States. SPS Payment Systems, Inc.
("SPS"), a wholly owned subsidiary of the Company, is incorporated in the State
of Delaware. Hurley State Bank ("HSB"), a wholly owned subsidiary of the
Company, is chartered as a bank by the State of South Dakota and is a member of
the Federal Deposit Insurance Corporation.
The Consolidated Balance Sheet as of March 31, 1996, and the Consolidated
Statements of Income and Cash Flows for the three months ended March 31, 1996
and 1995 are unaudited; however, in the opinion of management, all adjustments,
consisting only of normal recurring accruals necessary for fair presentation,
have been reflected. All material intercompany balances and transactions have
been eliminated. The consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 1995 Annual Report to Stockholders and Annual Report
on Form 10-K. The results of operations for the interim periods should not be
considered indicative of results to be expected for the full year.
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," which generally requires
that long-lived assets be reported at the lower of their carrying cost or net
realizable value. The effect of the adoption of this statement was not
material to the Company's consolidated financial position or results of
operations.
The Financial Accounting Standards Board has issued SFAS No. 123, "Accounting
for Stock-Based Compensation," effective for fiscal years beginning after
December 15, 1995. The Company has elected, as permitted by SFAS No. 123, to
adopt the disclosure requirements of that standard but continue to account for
stock-based compensation under APB Opinion No. 25, "Accounting for Stock Issued
to Employees."
B. RISKS AND UNCERTAINTIES
The preparation of the consolidated financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the financial statements.
Actual results could differ from these estimates.
5
<PAGE>
The allowance for loan losses on credit card loans is a significant estimate
that is regularly evaluated by management for adequacy on a portfolio by
portfolio basis. The evaluations take into consideration such factors as
changes in the nature and volume of the loan portfolio, overall portfolio
quality, review of specific problem loans and current economic conditions that
may affect the borrower's ability to pay.
The Company uses the results of these evaluations to provide an allowance for
loan losses for all loans, making no distinction between credit card loans that
are intended to be securitized and those that are not. However, the exposure
for credit losses for owned loans is influenced by the performance of the
portfolio and other factors discussed above, with the Company absorbing all
related losses. The exposure for credit losses for securitized loans is
represented by the Company retaining a contingent risk based on the amount of
credit enhancement provided.
Management believes that its estimates have been historically prudent in
light of the need to allow the market for asset securitizations, in particular
those backed by credit card receivables, to mature, and in light of the
uncertainty of accounting standards for asset securitizations. The Company is
now reassessing its estimate of the allowance for losses required for loans
intended to be securitized based on its experience with losses related to such
loans as the market has matured. This reassessment process has also been
affected by the standard-setting initiatives of the Financial Accounting
Standards Board relating to the accounting for securitization transactions.
Therefore, the Company may revise and reduce its estimate of the allowance for
losses related to loans intended to be securitized. The effect of this revision
in estimate would be to reduce the provision for loan losses on credit card
loans by an amount equal to the allowance that, absent such revision, would
have been provided for loans intended to be securitized. If the Company
implements this revision, it expects that the provision for loan losses on
credit card loans beginning with the third quarter of 1996 would be affected.
It is further expected that loss allowances for outstanding securitizations,
reflected in the accrued recourse obligation, as of the date of implementation
would continue to be maintained until the related loans were liquidated. Any
revision will be made in light of the facts and circumstances existing at that
time, and the effect of any such revision cannot currently be quantified.
C. CASH AND DUE FROM BANKS - RESTRICTED
Cash and due from banks - restricted as of December 31, 1995 represented cash
and invested cash derived from collections of certain securitized receivables.
Such collections, which include the investors' and a portion of the Company's
share of cash collections, were deposited with a third party and were paid out
in the month subsequent to collection. No such amounts existed at March 31,
1996.
6
<PAGE>
D. ALLOWANCE FOR LOAN LOSSES AND ACCRUED RECOURSE OBLIGATION
The changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
(In Thousands)
1996 1995
------- -------
<S> <C> <C>
Balance, beginning of period $63,704 $24,090
Additions:
Provision for loan losses 26,472 4,319
Purchase of credit card portfolios -- 29,843
------- -------
26,472 34,162
Deductions:
Charge-offs (30,646) (4,897)
Less: recoveries 6,722 1,415
------- -------
Net charge-offs (23,924) (3,482)
------- -------
Balance, end of period $66,252 $54,770
======= =======
</TABLE>
At March 31, 1996, there were $81.4 million in loans past due 30 days through
89 days, and $50.0 million in loans past due 90 days through 179 days.
The changes in the accrued recourse obligation were as follows:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
(In Thousands)
1996 1995
------- -------
<S> <C> <C>
Balance, beginning of period $27,128 $20,929
Additions:
Provision charged to processing
and service revenues 8,369 6,160
Deductions:
Net charge-offs (8,779) (6,144)
------- -------
Balance, end of period $26,718 $20,945
======= =======
</TABLE>
E. NOTES PAYABLE
The Company repaid a note payable to Tandy in the amount of $48.3 million,
relating to the purchase, during the first quarter of 1995, of the Radio Shack
and Tandy Name Brand credit card portfolios. This note had an imputed interest
rate of 6.5%.
7
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company's net operating revenues consist of processing and service
revenues, merchant discount revenue and net credit income, which are derived as
a result of its four principal business services: Network Services, Operational
Outsourcing Services, Commercial Account Processing and Consumer Private Label
Credit Card Programs.
Processing and service revenues consist of four components (as described
below): Transaction processing services, Managed Programs, HSB Programs and
Servicing fees on securitized loans.
Transaction processing services include revenues received as a result of
Network Services such as electronic transaction processing, the sale and
servicing of point-of-sale terminals, a System Access Agreement with NOVUS
Services, Inc., an affiliated company, and from Operational Outsourcing
Services. Revenues from electronic transaction processing typically are based
on the number of electronic point-of-sale transactions processed rather than
the dollar transaction amount. Revenues from Operational Outsourcing Services
typically are based upon the number of customer contacts processed through
service activities such as customer billing inquiries, dispatch services,
technical help-desk inquiries and catalog order processing.
Managed Programs includes revenues received as a result of Commercial Account
Processing and those Consumer Private Label Credit Card Programs which the
Company administers, but for which it does not act as the card issuer or own
the credit card loans. Managed Program revenues are derived from fees based on
the volume of the private label services provided and on services provided in
the administration of credit life insurance programs.
HSB Programs refers to those Consumer Private Label Credit Card Programs for
which HSB issues the credit card on behalf of the client and owns the credit
card loans that are generated through the use of the card. The revenues derived
from the administration of HSB Programs that are included as part of processing
and service revenues primarily consist of late fees.
Servicing fees on securitized loans are revenues derived from credit card
loans that have been sold to investors through asset securitizations. Such
revenues are the result of the fees earned for servicing the underlying credit
card accounts. Loan securitizations have the effect of converting portions of
net credit income and credit card fees to a component of processing and service
revenues for the credit card accounts that are securitized.
Merchant discount revenue is derived from the Company's owned Consumer
Private Label Credit Card Programs. Merchant clients pay the Company an agreed
upon percentage of each credit card sale charged by a cardholder.
Interest revenue represents finance charges derived from owned Consumer
Private Label Credit Card Programs and investment interest. Net credit income
is calculated by subtracting interest expense and the provision for loan losses
from interest revenue.
8
<PAGE>
The following table presents, for the periods indicated, the percentage
relationship that certain statement of income items bear to net operating
revenues and the period-to-period percentage dollar increase or decrease in
each item.
<TABLE>
<CAPTION>
Three Months Ended
March 31,
Period-to-Period
---------------------
1996 1995 Change
------ ------ ------
<S> <C> <C> <C>
NET OPERATING REVENUES:
Processing and service revenues 83.5% 79.4% 34.6%
Merchant discount revenue 8.8 11.0 2.2
Net credit income 7.7 9.6 2.6
----- -----
100.0 100.0 27.9
OPERATING EXPENSES:
Salaries and employee benefits 27.2 30.2 15.1
Processing and service expenses 30.0 26.7 43.7
Other expenses 22.8 18.7 56.2
----- -----
80.0 75.6 35.4
Income before income taxes 20.0 24.4 4.9
Income tax expense 7.6 9.6 1.1
----- -----
Net income 12.4% 14.8% 7.4%
===== =====
</TABLE>
Net income for the three months ended March 31, 1996 rose to $11.0 million,
an increase of $0.8 million, or 7.4%, over the same period a year ago. Net
income per common share for the three month period was $0.41, compared to $0.38
in the prior year's first quarter.
Net operating revenues for the first quarter of 1996 grew to a record $89.0
million, an increase of 27.9% over the same period last year. The increase in
net operating revenues resulted primarily from an increase in processing and
service revenues. The increase in processing and service revenues generally
reflects the growth of the major business drivers: active consumer and
commercial accounts, transactions processed and customer contacts processed.
The Company's active consumer private label accounts, both owned and managed,
grew 9.9% to 3.6 million at March 31, 1996, as compared with 3.3 million active
consumer accounts at March 31, 1995. Active commercial accounts grew 22.7% to
732,000 at March 31, 1996, as compared to 594,000 at March 31, 1995. For the
three months ended March 31, 1996, the number of point-of-sale transactions
processed totaled 97.2 million, up 16.1% from 83.7 million in the same period
in 1995. For the three months ended March 31, 1996, the number of customer
contacts processed totaled 2.6 million, up 22.7% from 2.1 million in the same
period in 1995. In addition, the increase in processing and service revenues
reflects higher HSB Program revenues and an increase in servicing fees on
securitized loans.
9
<PAGE>
Processing and service revenues increased 34.6% to $74.3 million for the
three months ended March 31, 1996, as compared to $55.2 million for the same
period last year. Processing and service revenues, representing 83.5% and
79.4% of net operating revenues for the three months ended March 31, 1996 and
1995, respectively, consisted of the following:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
(In Thousands)
1996 1995
------- -------
(Unaudited)
<S> <C> <C>
Transaction processing services $21,434 $18,419
Managed Programs 23,121 20,662
HSB Programs 11,640 3,305
Servicing fees on securitized loans 18,135 12,842
------- -------
$74,330 $55,228
======= =======
The increase in revenues from transaction processing services resulted
primarily from a higher volume of Network Services point-of-sale transactions
processed, increased revenues from Operational Outsourcing Services and the
sale and servicing of point-of-sale terminals. The increase in revenues from
Managed Programs resulted primarily from an increase in credit life insurance
program revenues, and an increase in the volume of Commercial Account
Processing Services provided, partially offset by the loss of managed revenues
from the conversion of the Radio Shack and Tandy Name Brand credit card
portfolios to HSB Programs in March 1995. The increase in revenues from HSB
Programs resulted from an increase in late fee revenue resulting from the
growth in credit card loan portfolios, coupled with a higher level of credit
card loan delinquencies, and the conversion of the Radio Shack and Tandy Name
Brand credit card portfolios in March 1995. The increase in servicing fees on
securitized loans resulted from a higher average balance of loans securitized.
Merchant discount revenue increased 2.2% to $7.8 million for the three months
ended March 31, 1996, as compared to $7.7 million for the same period last
year. The modest increase in merchant discount revenue is the result of a shift
in special payment plans, for certain merchant clients, from longer term plans
with higher discount rates to shorter term plans with lower discount rates, but
higher finance charge yields. Merchant discount revenue was 8.8% and 11.0% of
net operating revenues for the three months ended March 31, 1996 and 1995,
respectively.
10
<PAGE>
Net credit income of $6.8 million for the three months ended March 31, 1996,
was relatively flat on a period-to-period basis as higher net interest income
was offset by an increase in the provision for loan losses. The increase in
interest revenue resulted from a $924.4 million increase in average credit card
loans outstanding associated with growth in existing credit card portfolios and
the addition of new credit card portfolios since March 31, 1995. The increase
in interest expense was due to an increase in average borrowings to finance the
growth in credit card loans, partially offset by lower interest rates on
borrowings. The increase in the provision for loan losses is attributable to
increased charge-offs associated with a higher balance of credit card loans
outstanding, coupled with an increase in the net charge-off rate. The increase
in the Company's net charge-off rate was consistent with the industry-wide
trend of increasing credit loss rates. The Company believes that the current
industry-wide trend of increasing credit losses is related, in part, to
increased consumer debt levels. The Company believes this trend will continue
and expects to experience a higher net charge-off rate throughout 1996. In
addition, the Company is reassessing its estimate of the allowance for losses
related to securitized loans. A change in this estimate may affect future
provisions for loan losses on credit card loans as described in note B to the
consolidated financial statements on page 5.
For the three months ended March 31, 1996, total operating expenses of $71.2
million represented an increase of 35.4% over the same period last year. Total
operating expenses as a percentage of net operating revenues rose to 80.0% for
the three months ended March 31, 1996, as compared to 75.6% for the same period
a year ago.
For the three months ended March 31, 1996, salaries and employee benefits
totaled $24.2 million, an increase of 15.1% from $21.0 million in the same
period a year ago. The Company added approximately 475 additional full-time
equivalent employees since March 31, 1995. Approximately 80% of these new
employees were assigned to field processing facilities to handle an increased
volume of operational outsourcing services and private label accounts processed
by the Company. The remaining increase in personnel was primarily attributable
to business acquisitions during 1995 and an increase in systems development
personnel.
Processing and service expenses include data processing, communications and
account processing expenses, which are influenced, in part, by changes in
transaction volume. For the three months ended March 31, 1996, such expenses
rose to $26.7 million, or 43.7% on a period-to-period basis. The increase in
processing and service expenses resulted from a higher volume of transactions
processed and private label services provided as well as from ongoing
processing and service expenses associated with the integration of the Radio
Shack and Tandy Name Brand credit card portfolios purchased in March 1995.
Processing and service expenses as a percentage of net operating revenues
increased to 30.0% for the three months ended March 31, 1996, as compared to
26.7% for the comparable prior year period.
11
<PAGE>
Other expenses include expenses relating to business development, merchant
marketing, occupancy, advertising and promotion, cost of terminals sold, credit
card fraud and other miscellaneous employee and administrative expenses. For
the three months ended March 31, 1996 and 1995, other expenses totaled $20.3
million and $13.0 million, respectively. The increase in other expenses
resulted from increased collection expenses, costs associated with higher
terminal sales, occupancy expenses, administrative expenses and fraud losses
resulting from an increase in the incidence of fraudulent transactions. In
addition, ongoing expenses resulting from the integration of the Radio Shack
and Tandy Name Brand credit card portfolios purchased in March 1995 contributed
to the increase in other expenses. Other expenses were 22.8% and 18.7% of net
operating revenues for the three months ended March 31, 1996 and 1995,
respectively.
Credit card loans outstanding decreased $9.4 million from $1,620.8 million at
year-end to $1,611.4 million at March 31, 1996. At March 31, 1996, the
allowance for loan losses was $66.3 million, equal to 4.1% of total credit card
loans outstanding, compared with $63.7 million, or 3.9% of total credit card
loans outstanding at December 31, 1995. Accruing loans that were contractually
past due 90 days to 179 days represented 3.1% of total credit card loans
outstanding, at March 31, 1996, compared to 2.7% of total credit card loans
outstanding at December 31, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Through its liquidity policies, the Company seeks to ensure access to cost
effective funding in all business environments. This objective is accomplished
through diversification of funding sources, extension of funding terms and
staggering of liability maturities.
The Company's capital policies seek to maintain a strong balance sheet
consistent with the Company's business risks as well as regulatory
requirements. The Company's subsidiary bank, HSB, targets the maintenance of
capital levels considered for regulatory purposes to be "well-capitalized" as
defined by the FDIC Improvement Act of 1991.
The Company finances its operations from three principal sources: deposit
taking activities utilizing certificates of deposit ("CDs")in denominations of
$100,000 or more; securitizations of credit card loans; and borrowings from
DWD.
HSB administers a certificate of deposit program through which jumbo
certificates of deposit ("CDs") are issued to investors in denominations of
$100,000 or more. Such CDs are issued to investors under two programs - an
institutional CD program and a retail CD program. CDs under the institutional
CD program are issued directly by HSB to the investor and generally have a
maturity of one to twelve months. CDs under the retail CD program are issued
to investors through Dean Witter Reynolds Inc., a subsidiary of DWD, and
generally have a maturity of two to 10 years. As of March 31, 1996, CDs
outstanding were $386.1 million, of which institutional CDs represented $186.5
million and retail CDs represented $199.6 million.
12
<PAGE>
HSB maintains loan securitization programs with Receivables Capital
Corporation ("RCC") and at March 31, 1996, outstanding loans under such
programs were $280.0 million. HSB also maintains a loan securitization program
with Barton Capital Corporation ("BCC") and at March 31, 1996, outstanding
loans under such program were $300.0 million. Securitized loans are sold with
limited recourse to the Company. The maximum recourse obligation on such
securitized loans at March 31, 1996, was $109.4 million. Additionally, the
Company had servicer responsibility for securitized loans (investor
certificates), that were sold to public investors by Tandy, as a result of the
purchase of the Radio Shack and Tandy Name Brand credit card portfolios. Credit
support for the assumed securitization was provided by a subordinated
certificate that had been retained by the Company. The securitization assumed
from Tandy was in its scheduled amortization phase and as a result, the senior
investor interest in the securitization pool declined to zero during the first
quarter of 1996. At March 31, 1996, $580.0 million or 26.5% of the HSB Program
loans had been sold through loan securitizations.
The RCC and BCC loan securitization programs are scheduled to expire in
December 1996. If these programs are not extended on or prior to their
expiration dates, collections allocable to RCC and BCC following the
expiration dates of the programs will be paid to RCC or to BCC, as applicable,
and the interests of RCC and of BCC in the applicable securitization pool will
gradually decline to zero. Any receivables originated after the applicable
program's expiration date would remain on the Company's consolidated balance
sheet.
The Company has an Amended and Restated Borrowing Agreement (the "Borrowing
Agreement"), an Amended and Restated Bridge Agreement (the "Bridge Funding
Agreement") and a facility fee letter agreement (the "Facility Fee Agreement"),
(collectively, the "Financing Agreements") with DWD, pursuant to which DWD has
agreed to provide loans to the Company. The Borrowing Agreement, which was
scheduled to expire in May 1996, was recently amended to extend its term until
April 17, 1997 and to increase the maximum amount available under the Borrowing
Agreement from $400.0 million to $500.0 million (the "Commitment"). The
Facility Fee Agreement, under which the Company has agreed to pay certain
monthly facility fees in connection with its financing arrangements with DWD,
was also amended to reduce the monthly facility fee pertaining to the
Commitment. Pursuant to the Bridge Funding Agreement, DWD has agreed to supply
bridge funding to the Company in an amount sufficient to fund the Tandy
portfolios acquired on March 30, 1995. The maximum amount available under the
Bridge Funding Agreement may be reduced by DWD up to the amount of any
additional funds received by HSB pursuant to any new loan securitization
agreement covering Tandy credit card receivables implemented after the date of
the Bridge Funding Agreement. The Bridge Funding Agreement with DWD expires on
September 30, 1996. The terms of the Bridge Funding Agreement are similar to
the Borrowing Agreement. At April 30, 1996, the Company had $884.7 million
outstanding under the Borrowing Agreement and Bridge Funding Agreement.
The Company expects to renew or replace the Financing Agreements prior to the
expiration dates of such Agreements. The Company is continuing to evaluate
alternative sources of financing to replace all or a portion of its financing
arrangements with DWD. If the Company is unable to reach a satisfactory
agreement with DWD for the renewal or the replacement of the Financing
Agreements, the Company believes it will be able to meet its financial
requirements over the next twelve months from other sources, including
securitization of credit card loans and deposit taking activities.
13
<PAGE>
Cash flows from operating activities resulted in net proceeds of cash of
$69.6 million and net uses of cash of $17.6 million for the three months ended
March 31, 1996 and 1995, respectively. Cash flows from operating activities
for the three months ended March 31, 1996 were impacted by the elimination of a
restricted cash collection account, which was used in servicing the assumed
securitizations from Tandy Corporation, and a higher level of provision for
loan losses.
Investing activities for the three months ended March 31, 1996 resulted in
net uses of cash of $22.8 million, primarily consisting of net principal
disbursed on credit card loans, representing the difference between sales made
using the cards and payments received from cardholders ($15.9 million) and from
investments in short-term U.S. Treasury bills resulting in net uses of cash of
$5.0 million. Investing activities for the three months ended March 31, 1995
resulted in net uses of cash of $333.5 million, primarily consisting of the
purchase of the Radio Shack and Tandy Name Brand credit card portfolios from
Tandy Corporation on March 30, 1995 ($296.6 million) and net principal
disbursed on credit card loans ($35.3 million). The purchase of the two Tandy
credit card portfolios also included a short-term note, net of imputed interest
of $48.3 million issued as part of the purchase consideration.
Financing activities for the three months ended March 31, 1996 resulted in
net uses of cash of $39.9 million, primarily consisting of a net decrease in
borrowings due to affiliated companies ($49.3 million) and from final payments
made on short-term notes payable with Tandy Corporation ($2.1 million),
partially offset by a net increase in interest-bearing deposits resulting from
the issuance of jumbo certificates of deposit ($14.1 million). Financing
activities for the three months ended March 31, 1995 resulted in net proceeds
of cash of $356.7 million, primarily consisting of a net increase in borrowings
due to affiliated companies ($358.2 million) and a net increase in interest-
bearing deposits resulting from the issuance of jumbo certificates of deposit
($70.3 million), partially offset by payments made on short-term notes payable
with Tandy Corporation ($74.2 million). At March 31, 1996 and 1995, the Company
had cash and cash equivalents of $15.8 million and $8.8 million, respectively.
The Company currently has no material commitments requiring capital
expenditures. The Company has not paid any dividends on its Common Stock and
anticipates retaining future operating cash flows for the foreseeable future to
finance growth and business expansion rather than to pay dividends to its
stockholders. Any future determination as to the payment of dividends will
depend upon results of operations, capital requirements, financial condition of
the Company and such other factors as the Board of Directors of the Company in
its discretion shall determine. Periodically, SPS and HSB have paid dividends
to the Company. The amount of dividends that can be paid to the Company by HSB
is restricted by applicable banking regulations.
INTEREST RATE RISK
The Company's interest rate risk policies are designed to reduce the
volatility of earnings resulting from changes in interest rates. This is
accomplished primarily through matched financing, where possible, which entails
matching the repricing schedules of credit card loans and the related
financing. Matched financing includes the funding of variable rate credit card
loans that are primarily indexed to the prime rate with floating rate financing
that is primarily indexed to commercial paper rates and the federal funds rate.
The Company generally retains basis risk between the prime rate and commercial
paper/federal funds rates on variable rate credit card loans. Fixed rate credit
card loans are generally funded with fixed rate financing (financing with an
initial term of one year or greater).
14
<PAGE>
The Company also funds fixed rate credit card loans with floating rate
financing by utilizing interest rate swaps, cost of funds agreements and
interest rate caps to adjust the repricing characteristics of its financing to
fixed rate financing. Under interest rate swaps and cost of funds agreements,
the Company effectively exchanges the interest payments on its financing with
those of a counterparty. Interest rate cap agreements effectively establish a
maximum interest rate on certain of the Company's floating rate borrowings.
Interest rate swap agreements are entered into with an affiliate. Interest rate
cap agreements are entered into with institutions that are established dealers
in these instruments and that maintain certain minimum credit criteria
established by the Company. Costs of funds agreements are entered into as part
of agreements pursuant to which the Company owns the credit card loan portfolio
and provides private label credit card processing services to certain of its
credit card merchant clients.
To reduce the volatility of interest expense from changes in interest rates,
the Company had outstanding interest rate swaps and cost of funds agreements of
$746.3 million and $390.9 million at March 31, 1996 and 1995, respectively.
At March 31, 1996 and 1995, the Company had $40.0 million of interest rate
cap agreements. At March 31, 1996, the current variable rates on all interest
rate cap agreements exceeded the specified cap rates.
At March 31, 1996 and 1995, the Company's interest rate swap agreements had
maturities ranging from December 1996 to December 2000 and from November 1995
to October 1998, respectively. At March 31, 1996 and 1995, the Company's
interest rate cap agreements had maturities ranging from February 1997 to
September 1997 and from February 1997 to October 1997, respectively.
CAUTIONARY STATEMENTS
The Company from time to time may provide forward-looking statements relating
to anticipated events and the effect of those anticipated events on the
Company's major business drivers and operating results. The cautionary
statements provided below are made pursuant to the provisions of the Private
Securities Litigation Reform Act of 1995 (the "Act") and with the intention of
obtaining the benefits of the "safe harbor" provisions of the Act for any such
forward-looking statements. The Company cautions readers that any forward-
looking statements provided are not guarantees of future performance and that
actual results may differ materially from those in the forward-looking
statements as a result of various factors. In particular, with respect to
provision for loan losses on credit card loans, described in "- Results of
Operations," factors that may affect forward-looking statements include, but
are not limited to, the following:
Changes in consumer payment patterns and bankruptcy trends that affect the
level and direction of credit card loan delinquencies and write-offs.
The rate and magnitude of changes in the credit card loan portfolio.
Credit card loan portfolio mix.
The amount of credit card loans intended to be securitized and accessibility
to the securitization markets.
Changes in management's estimates of the adequacy of loan loss allowances.
Interest rate movements and other general economic conditions.
15
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company has previously disclosed certain litigation between HSB and
Lechmere, Inc. ("Lechmere") regarding Lechmere's 1994 election to terminate its
private label credit card agreement with HSB. Such litigation has been settled
pursuant to a settlement agreement dated as of March 13, 1996 and entered into
among HSB, Lechmere and Lechmere's parent, Montgomery Ward & Co., Incorporated.
As part of the settlement, HSB entered into an agreement dated as of March 13,
1996 to sell and transfer the Lechmere credit card portfolio to Lechmere's
designee. The sale and transfer of the portfolio closed as of April 26, 1996.
The Company believes that neither the sale of such portfolio nor the settlement
of the litigation with Lechmere will have a material adverse effect on the
Company's financial position or results of operations. The Company currently is
not involved in any other material legal proceedings.
Item 2. Changes in Securities.- None.
Item 3. Defaults Upon Senior Securities.- None
Item 4. Submission of Matters to a Vote of Security Holders.- None.
Item 5. Other Information.- None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
10.1 First Amendment to the Amended and Restated Borrowing Agreement dated
as of May 3, 1996, between the Company and DWD.
10.2 Amendment to the Facility Fee Letter Agreement dated as of May 3,
1996, between the Company and DWD.
27 Financial Data Schedule
(b) Reports on Form 8-K.
A Current Report on form 8-K, dated April 15, 1996, was filled with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's first quarter earnings release.
A Current Report on form 8-K, dated January 17, 1996, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's fourth quarter earnings release.
16
<PAGE>
SIGNATURE
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.
SPS TRANSACTION SERVICES, INC.
------------------------------
(Registrant)
Date: May 14, 1996 By:/s/ Russell J. Bonaguidi
------------ -----------------------------------
Russell J. Bonaguidi
Vice President and Controller (Duly
Authorized Officer and Principal
Accounting Officer)
17
<PAGE>
EDGAR
Exhibit Description of Exhibits
------- -----------------------
10 Exhibit 10.1, First Amendment to the Amended and Restated
Borrowing Agreement dated as of May 3, 1996, between the
Company and DWD.
10 Exhbit 10.2, Amendment to the Facility Fee Letter Agreement
dated as of May 3, 1996, between the Company and DWD.
27 Exhibit 27, Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> MAR-31-1996
<CASH> 15,770
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 52,426
<INVESTMENTS-MARKET> 0
<LOANS> 1,611,376
<ALLOWANCE> (66,252)
<TOTAL-ASSETS> 1,753,608
<DEPOSITS> 392,546
<SHORT-TERM> 1,068,685
<LIABILITIES-OTHER> 80,992
<LONG-TERM> 0
<COMMON> 272
0
0
<OTHER-SE> 211,113
<TOTAL-LIABILITIES-AND-EQUITY> 1,753,608
<INTEREST-LOAN> 55,054
<INTEREST-INVEST> 653
<INTEREST-OTHER> 245
<INTEREST-TOTAL> 55,952
<INTEREST-DEPOSIT> 6,062
<INTEREST-EXPENSE> 22,643
<INTEREST-INCOME-NET> 33,309
<LOAN-LOSSES> 26,472
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 71,212
<INCOME-PRETAX> 17,799
<INCOME-PRE-EXTRAORDINARY> 17,779
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,035
<EPS-PRIMARY> 0.41
<EPS-DILUTED> 0.41
<YIELD-ACTUAL> 0
<LOANS-NON> 0
<LOANS-PAST> 50,002
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 63,704
<CHARGE-OFFS> 30,646
<RECOVERIES> 6,722
<ALLOWANCE-CLOSE> 66,252
<ALLOWANCE-DOMESTIC> 66,252
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
FIRST AMENDMENT
TO THE
AMENDED AND RESTATED BORROWING AGREEMENT
THIS FIRST AMENDMENT TO THE AMENDED AND RESTATED BORROWING AGREEMENT (the
"Amendment") dated as of May 3, 1996, is between SPS TRANSACTION SERVICES, INC.
and DEAN WITTER, DISCOVER & CO.
WHEREAS, Borrower and Lender are parties to an Amended and Restated
Borrowing Agreement (the "Borrowing Agreement"), dated as of September 1, 1995,
pursuant to which Lender has made certain loans to the Borrower; and
WHEREAS, the Borrower and Lender desire to amend the Borrowing Agreement.
NOW THEREFORE, the Borrowing Agreement is amended as follows:
1. Each capitalized term used in this Amendment (and not otherwise
defined herein) shall have the same meaning as set forth in the
Borrowing Agreement.
2. The definition of "Commitment Termination Date" as set forth in
Section 1.01 of the Borrowing Agreement is hereby amended and
henceforth shall read as follows:
"Commitment Termination Date" shall mean April 17, 1997.
3. Section 2.01(a) of the Borrowing Agreement is hereby amended in its
entirety and henceforth shall read as follows:
(a) Revolving Loan Commitment. Subject to the terms and
conditions of this Borrowing Agreement and relying upon
representations, warranties and covenants of Borrower set forth
herein, Lender shall make loans (all such loans made pursuant to
this Section 2.01(a) being referred to herein collectively as the
"Loans") to Borrower at any time and from time to time prior to the
Commitment Termination Date, in an aggregate principal amount not
exceeding at any one time outstanding $500,000,000 (the
"Commitment"). Prior to the Commitment Termination Date, Lender
shall have no obligation to make advances to the extent any
requested advance would cause the principal amount outstanding under
the Revolving Notes to exceed the Commitment, provided, that Lender
may elect (but shall not be obligated) from time to time to make
advances in excess of the Commitment.
4. Except as provided herein, the terms and conditions of the
Borrowing Agreement shall remain in full force and effect.
IN WITNESS WHEREOF, the parties have caused this Amendment to be duly
executed as of the date first written above.
SPS TRANSACTION SERVICES, INC. DEAN WITTER, DISCOVER & CO.
By: /s/ Thomas M. Goldstein By: /s/ Birendra Kumar
---------------------------------- -----------------------------------
Title: Vice President, Finance Title: Senior Vice President, Treasury
------------------------------- --------------------------------
A:\BORROW.AGR
May 3, 1996
SPS Transaction Services, Inc.
2500 Lake Cook Road
Riverwoods, Illinois 60015
Dear Gentlemen:
This letter shall amend the letter agreement ("Facility Fee Agreement") dated
as of September 1, 1995, between Dean Witter, Discover & Co. ("Lender") and SPS
Transaction Services, Inc. ("Borrower") regarding the facility fee payable by
Borrower to Lender in connection with Loans made by Lender to Borrower under
the Financing Agreements. Capitalized terms used herein (and not otherwise
defined herein) shall have the same meanings as set forth in the Facility Fee
Agreement. Effective as of the date hereof, the parties agree that Schedule I
to the Facility Fee Agreement shall be amended in its entirety and henceforth
shall read as set forth in Schedule I attached hereto. Except as provided
herein, the Facility Fee Agreement shall remain in full force and effect.
If the foregoing is acceptable, please sign the enclosed copy of this letter
agreement and return it to my attention.
Very truly yours,
DEAN WITTER, DISCOVER & CO.
By: /s/ Birendra Kumar
---------------------------------
Its: Senior Vice President, Treasury
--------------------------------
ACCEPTED AND AGREED
SPS TRANSACTION SERVICES, INC.
By: /s/ Thomas M. Goldsein
-------------------------------
Its: Vice President, Finance
-------------------------------
S:\SPS_LAW\LETTERAG\CLIENTS\BORROW.LA
SCHEDULE I
For the purposes of this letter agreement, the "Facility Fee" for any
Payment Date shall mean the product of (x) the actual number of days in the
month in which such Payment Date falls divided by 365 or 366, as applicable,
and (y) the sum of (i) .00025 times the portion of the Average Loan Amount up
to or equal to $250,000,000, (ii) .0005 times the portion of the Average Loan
Amount greater than $250,000,000, but less than or equal to $500,000,000, (iii)
.001 times the portion of the Average Loan Amount greater than $500,000,000,
but less than or equal to $750,000,000, (iv) .0015 times the portion of the
Average Loan Amount greater than $750,000,000, but less than or equal to
$1,000,000,000, (v) .00175 times the portion of the Average Loan Amount greater
than $1,000,000,000, but less than or equal to $1,250,000,000, (vi) .002 times
the portion of the Average Loan Amount greater than $1,250,000,000, but less
than or equal to $1,500,000,000, (vii) .00225 times the portion of the Average
Loan Amount greater than $1,500,000,000, but less than or equal to
$1,750,000,000, (viii) .0025 times the portion of the Average Loan Amount
greater than $1,750,000,000 and (ix) .000862 times the maximum amount of the
Commitment (as defined in and pursuant to the Borrowing Agreement, as amended
or modified from time to time).
For the purposes of this letter agreement, the "Average Loan Amount" for
any Payment Date shall mean the sum of the principal amount of any Loans
outstanding for each day during the calendar month preceding such Payment Date
divided by the number of days during such month.
