<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 June 30, 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 July 31, 1996, the Registrant had 27,193,117 shares of common stock,
$0.01 par value, outstanding.
Page 1 of 19 pages
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS:
Cash and due from banks $ 9,448 $ 8,879
Cash and due from banks - restricted -- 29,000
Investments held to maturity - at amortized cost 52,394 47,430
Credit card loans 1,421,568 1,620,833
Allowance for loan losses (65,304) (63,704)
---------- ----------
Credit card loans, net 1,356,264 1,557,129
Accrued interest receivable 22,655 23,828
Accounts receivable 28,411 28,683
Due from affiliated companies 3,561 4,776
Premises and equipment, net 21,386 19,800
Deferred income taxes 26,507 26,276
Prepaid expenses and other assets 29,166 31,806
---------- ----------
TOTAL ASSETS $1,549,792 $1,777,607
========== ==========
LIABILITIES:
Deposits:
Noninterest-bearing $ 2,902 $ 10,270
Interest-bearing 411,668 372,073
---------- ----------
Total deposits 414,570 382,343
Accounts payable, accrued expenses and other 39,586 44,788
Income taxes payable 2,335 11,232
Due to affiliated companies 848,028 1,110,811
Notes payable -- 2,095
Accrued recourse obligation 26,623 27,128
---------- ----------
Total liabilities 1,331,142 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; 27,224,000 and
27,147,000 shares issued; 27,187,000 and
27,074,000 shares outstanding at June 30, 1996
and December 31, 1995, respectively 272 271
Capital in excess of par value 80,745 79,396
Retained earnings 138,727 121,099
Common stock held in treasury, at cost, $.01
par value, 37,000 and 73,000 shares at June 30,
1996 and December 31, 1995, respectively (1,032) (1,957)
Stock compensation plan 413 501
Employee stock benefit trust (413) --
Unearned stock compensation (62) (100)
---------- ----------
Total stockholders' equity 218,650 199,210
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,549,792 $1,777,607
========== ==========
</TABLE>
See notes to unaudited consolidated financial statements.
2
<PAGE>
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
- -------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1996 1995 1996 1995
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Processing and service revenues $64,766 $58,969 $139,096 $114,197
Merchant discount revenue 7,375 9,285 15,219 16,963
------- ------- -------- --------
72,141 68,254 154,315 131,160
Interest revenue 56,194 35,444 112,146 55,532
Interest expense 18,943 16,263 41,586 25,367
------- ------- -------- --------
Net interest income 37,251 19,181 70,560 30,165
Provision for loan losses 26,096 11,274 52,568 15,593
------- ------- -------- --------
Net credit income 11,155 7,907 17,992 14,572
------- ------- -------- --------
Net operating revenues 83,296 76,161 172,307 145,732
Salaries and employee benefits 24,471 21,480 48,671 42,497
Processing and service expenses 26,836 23,357 53,507 41,917
Other expenses 21,353 15,140 41,694 28,166
------- ------- -------- --------
Total operating expenses 72,660 59,977 143,872 112,580
------- ------- -------- --------
Income before income taxes 10,636 16,184 28,435 33,152
Income tax expense 4,043 6,399 10,807 13,090
------- ------- -------- --------
Net income $ 6,593 $ 9,785 $ 17,628 $ 20,062
======= ======= ======== ========
Net income per common share $ 0.24 $ 0.36 $ 0.65 $ 0.74
======= ======= ======== ========
Weighted average common shares
outstanding 27,183 27,114 27,150 27,096
</TABLE>
See notes to unaudited consolidated financial statements.
3
<PAGE>
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------
(In Thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------
1996 1995
-------- ---------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 17,628 $ 20,062
Adjustments to reconcile net income to
net cash flows from operating activities:
Depreciation and amortization 7,046 5,025
Imputed interest on notes payable 15 4,537
Provision for loan losses 52,568 15,593
Deferred income taxes (231) (6,500)
(Increase) decrease in operating assets:
Cash and due from banks - restricted 29,000 (36,635)
Amounts due from affiliated companies 1,215 (2,325)
Accrued interest receivable and accounts receivable 1,445 1,148
Prepaid expenses and other assets 1,373 (6,054)
Increase (decrease) in operating liabilities:
Accounts payable, accrued expenses and other (5,298) (1,125)
Income taxes payable (8,504) 6,375
Due to affiliated companies 6,339 3,431
Accrued recourse obligation (505) 62
-------- --------
Net cash from operating activities 102,091 3,594
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments held to maturity - purchases (181,564) (47,290)
Investments held to maturity - maturities 176,600 27,279
Net principal collected (disbursed) on credit
card loans 6,503 (148,475)
Purchase of credit card portfolios -- (296,556)
Proceeds from sale of credit card portfolio 138,861 --
Purchases of premises and equipment, net (4,432) (4,374)
-------- --------
Net cash from investing activities 135,968 (469,416)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in noninterest-bearing deposits (7,368) (1,512)
Net increase in interest-bearing deposits 39,595 96,476
Due to affiliated companies (269,122) 536,418
Repayment of notes payable (2,110) (161,659)
Proceeds from exercise of stock options 590 510
Change in treasury stock, net 925 --
-------- --------
Net cash from financing activities (237,490) 470,233
-------- --------
Increase in cash and due from banks 569 4,411
Cash and due from banks, beginning of period 8,879 3,220
-------- --------
Cash and due from banks, end of period $ 9,448 $ 7,631
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Short-term note, net issued to purchase credit
card portfolios $ -- $ 48,333
======== ========
</TABLE>
See notes to unaudited consolidated financial statements.
4
<PAGE>
SPS TRANSACTION SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 1996 AND 1995
- -------------------------------------------------------------------------------
A. ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of SPS Transaction
Services, Inc. (the "Company") and 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 June 30, 1996, the Consolidated
Statements of Income for the three and six months ended June 30, 1996 and 1995,
and the Consolidated Statements of Cash Flows for the six months ended June 30,
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.
B. ACCOUNTING PRONOUNCEMENTS
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards ("SFAS") 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 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."
5
<PAGE>
The Financial Accounting Standards Board has also issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," effective for transfers of financial assets made after
December 31, 1996. This statement provides financial reporting standards for
the derecognition and recognition of financial assets, including the
distinction between transfers of financial assets which should be recorded as
sales and those which should be recorded as secured borrowings. SFAS 125
supersedes and incorporates the essential provisions of SFAS 122. The Company
believes that the effect of the adoption of SFAS 125 will not be material to
its consolidated financial position or results of operations.
C. 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.
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, in particular the recent issuance of SFAS 125, which
eliminates the uncertainty surrounding the appropriate accounting treatment for
asset 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. The Company expects that the provision for loan
losses on credit card loans beginning with the third quarter of 1996 would be
affected by this revision. 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.
6
<PAGE>
D. 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 June 30,
1996.
E. ALLOWANCE FOR LOAN LOSSES AND ACCRUED RECOURSE OBLIGATION
The changes in the allowance for loan losses were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
(In Thousands) (In Thousands)
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance, beginning of period $66,252 $54,770 $63,704 $24,090
Additions:
Provision for loan losses 26,096 11,274 52,568 15,593
Purchase of credit card portfolios -- -- -- 29,843
------- ------- ------- -------
26,096 11,274 52,568 45,436
Deductions:
Charge-offs (32,335) (16,378) (62,981) (21,275)
Less: recoveries 5,291 5,710 12,013 7,125
------- ------- ------- -------
Net charge-offs (27,044) (10,668) (50,968) (14,150)
------- ------- ------- -------
Balance, end of period $65,304 $55,376 $65,304 $55,376
======= ======= ======= =======
</TABLE>
At June 30, 1996, on an owned loan basis, there were $74.4 million or 5.2% in
loans past due 30 days through 89 days, and $53.4 million or 3.8% in loans past
due 90 days through 179 days. At June 30, 1995, on an owned loan basis, there
were $43.1 million or 3.6% in loans past due 30 days through 89 days, and $26.5
million or 2.2% in loans past due 90 days through 179 days.
The changes in the accrued recourse obligation were as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
(In Thousands) (In Thousands)
1996 1995 1996 1995
------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance, beginning of period $26,718 $20,945 $27,128 $20,929
Additions:
Provision charged to processing
and service revenues 10,486 9,641 18,855 15,801
Deductions:
Net charge-offs (10,581) (9,595) (19,360) (15,739)
------- ------- ------- -------
Balance, end of period $26,623 $20,991 $26,623 $20,991
======= ======= ======= =======
</TABLE>
7
<PAGE>
F. NOTES PAYABLE
In February 1996, the Company made the final monthly installment on a note
payable to Tandy. This note related to the purchase, during the first quarter
of 1995, of the Radio Shack and Tandy Name Brand credit card portfolios. The
note had an imputed interest rate of 6.5%.
8
<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 includes 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 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, merchant discount revenue 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.
9
<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 Six Months Ended
June 30, June 30,
Period-to-period Period-to-Period
-------------------- --------------------
1996 1995 Change 1996 1995 Change
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
NET OPERATING REVENUES:
Processing and service revenues 77.8% 77.4% 9.8% 80.7% 78.4% 21.8%
Merchant discount revenue 8.8 12.2 (20.6) 8.9 11.6 (10.3)
Net credit income 13.4 10.4 41.1 10.4 10.0 23.5
----- ----- ----- -----
100.0 100.0 9.4 100.0 100.0 18.2
OPERATING EXPENSES:
Salaries and employee benefits 29.4 28.2 13.9 28.2 29.1 14.5
Processing and service expenses 32.2 30.7 14.9 31.1 28.8 27.6
Other expenses 25.6 19.9 41.0 24.2 19.3 48.0
----- ----- ----- -----
87.2 78.8 21.1 83.5 77.2 27.8
Income before income taxes 12.8 21.2 (34.3) 16.5 22.8 (14.2)
Income tax expense 4.9 8.4 (36.8) 6.3 9.0 (17.4)
----- ----- ----- -----
Net income 7.9% 12.8% (32.6)% 10.2% 13.8% (12.1)%
===== ===== ===== =====
</TABLE>
Net income for the three months ended June 30, 1996 was 6.6 million, a
decrease of $3.2 million, or 32.6%, over the same period a year ago. Net
income per common share for the three month period was $0.24, compared to $0.36
in the prior year's second quarter, which was consistent with the Company's
earnings outlook of between $0.22 and $0.25 announced on June 21, 1996. Net
income for the six months ended June 30, 1996 was $17.6 million, a decrease of
$2.4 million, or 12.1%, compared to the same period a year ago. Net income per
common share for the six month period was $0.65, compared to $0.74 for the same
period in 1995. The decline in earnings is primarily attributable to two
factors: an increase in charge-offs in the Company's private label credit card
portfolios related to an industry-wide deterioration in consumer credit
quality, and the mix and pricing of promotional payment plans offered to the
Company's consumer private label credit cardholders.
Net operating revenues for the second quarter of 1996 grew to $83.3 million,
an increase of 9.4% over the same period last year. Net operating revenues for
the six months ended June 30, 1996, grew to $172.3 million, an increase of
18.2% over the same period last year. The increase in net operating revenues
for both periods resulted primarily from increases in processing and service
revenues and net interest income, partially offset by a decrease in merchant
discount revenue and increased net charge-offs, which resulted in an increase
in provision for loan losses expense. The increase in processing and service
revenues and net interest income for both periods was primarily due to
increased revenues resulting from the administration of consumer and commercial
private label credit card programs and an increase in the volume of transaction
processing services and operational outsourcing services provided. The
Company's active consumer private label accounts, both owned and managed,
10
<PAGE>
decreased slightly to 3.3 million at June 30, 1996, as compared with 3.4
million active consumer accounts at June 30, 1995. A contributing factor to
the decline in active consumer private label accounts at June 30, 1996 was the
sale of a private label credit card portfolio during the second quarter of
1996. Active commercial accounts grew 19.8% to 727,000 at June 30, 1996, as
compared to 607,000 at June 30, 1995. For the three and six months ended June
30, 1996, the number of point-of-sale transactions processed totaled 104.8
million and 202.0 million, respectively, up 14.3% and 15.2%, respectively, from
the comparable prior periods. For the three and six months ended June 30,
1996, the number of customer contacts processed totaled 2.1 million and 4.7
million, respectively, up 1.8% and 12.4%, respectively, from the comparable
prior periods.
Processing and service revenues increased 9.8% to $64.8 million for the three
months ended June 30, 1996, as compared to $59.0 million for the same period
last year. For the six months ended June 30, 1996, processing and service
revenues increased 21.8% to $139.1 million as compared to $114.2 million for
the same period last year. Processing and service revenues represented 77.8%
and 77.4% of net operating revenues for the three months ended June 30, 1996
and 1995, respectively. For the six months ended June 30, 1996 and 1995,
processing and service revenues represented 80.7% and 78.4% of net operating
revenues, respectively. Processing and service revenues consisted of the
following:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
(In Thousands) (In Thousands)
1996 1995 1996 1995
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Transaction processing services $20,655 $18,881 $42,089 $37,300
Managed Programs 22,117 18,204 45,238 38,866
HSB Programs 11,561 6,052 23,201 9,357
Servicing fees on securitized loans 10,433 15,832 28,568 28,674
------- ------- -------- --------
$64,766 $58,969 $139,096 $114,197
======= ======= ======== ========
</TABLE>
The increase in revenues from transaction processing services for both the
three and six months ended June 30, 1996 resulted primarily from a higher
volume of Network Services point-of-sale transactions processed and increased
revenues from Operational Outsourcing Services. The increase in revenues for
the three months ended June 30, 1996 was partially offset by a decrease in
revenues from the sale and servicing of point-of-sale terminals. The increase
in revenues from Managed Programs for both the three and six months ended June
30, 1996 resulted primarily from an increase in credit life insurance program
revenues, and an increase in the volume of Commercial Account Processing
Services provided. The increase in revenues from HSB Programs for both the
three and six months ended June 30, 1996 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. The conversion of the Radio
Shack and Tandy Name Brand credit card portfolios in March 1995 further
contributed to the increase in HSB Program revenues for the six months ended
June 30, 1996. The decrease in servicing fees on securitized loans for the
three months ended June 30, 1996 was due to a lower average balance of loans
securitized which resulted in lower net interest income, coupled with a higher
rate of credit losses on securitized loans.
11
<PAGE>
Merchant discount revenue decreased 20.6% to $7.4 million for the three
months ended June 30, 1996, as compared to $9.3 million for the same period
last year. For the six months ended June 30, 1996, merchant discount revenue
decreased 10.3% to $15.2 million in 1996 compared to the same period last year.
The decrease in merchant discount revenue reflects the mix and pricing of
promotional payment plans offered to private label cardholders. There has been
a shift in promotional 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 12.2% of net operating revenues for the three months ended June 30, 1996
and 1995, respectively, and was 8.9% and 11.6% of net operating revenues for
the six months ended June 30, 1996 and 1995, respectively.
Net credit income increased 41.1% to $11.2 million for the three months ended
June 30, 1996, as compared to the same period last year, resulting from an
$18.1 million increase in net interest income partially offset by a $14.8
million increase in provision for loan losses expense. For the six months ended
June 30, 1996, net credit income increased 23.5% to $18.0 million over the same
period last year, resulting from a $40.4 million increase in net interest
income partially offset by a $37.0 million increase in provision for loan
losses expense. For both periods, the increase in interest revenue resulted
from an increase in average credit card loans outstanding associated with
growth in existing credit card portfolios and the addition of new credit card
portfolios since June 30, 1995. The increase in interest expense for both
periods 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
and bankruptcy rates. The Company believes this trend will continue and expects
to experience a higher net charge-off rate throughout 1996 as compared to 1995.
The Company is taking corrective measures to reduce future charge-offs by
tightening credit approval models; re-scoring existing accounts and reducing
credit lines or closing accounts as necessary; and by increasing collection
efforts by adding collectors, expanding call hours, and identifying high risk
accounts to accelerate contacts. 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 C to the consolidated financial statements on page 6.
For the three months ended June 30, 1996, total operating expenses of $72.7
million represented an increase of 21.1% over the same period last year. Total
operating expenses as a percentage of net operating revenues rose to 87.2% for
the three months ended June 30, 1996, as compared to 78.8% for the same period
a year ago. For the six months ended June 30, 1996, total operating expenses of
$143.9 million represented an increase of 27.8% over the same period last year.
Total operating expenses as a percentage of net operating revenues rose to
83.5% for the six months ended June 30, 1996, as compared to 77.2% for the same
period a year ago.
12
<PAGE>
For the three months ended June 30, 1996, salaries and employee benefits
totaled $24.5 million, an increase of 13.9% from $21.5 million in the same
period a year ago. For the six months ended June 30, 1996, salaries and
employee benefits totaled $48.7 million, an increase of 14.5% from $42.5
million in the same period a year ago. The Company added approximately 340
additional full-time equivalent employees since June 30, 1995. Approximately
75% 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.
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 June 30, 1996, such expenses
rose to $26.8 million, or 14.9% on a period-to-period basis. For the six months
ended June 30, 1996, processing and service expenses increased to $53.5
million, or 27.6% from the same period a year ago. The increase in processing
and service expenses for both periods 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
were 32.2% and 30.7% for the three months ended June 30, 1996 and 1995,
respectively. Processing and service expenses as a percentage of net operating
revenues were 31.1% and 28.8% for the six months ended June 30, 1996 and 1995,
respectively.
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 June 30, 1996 and 1995, other expenses totaled $21.4
million and $15.1 million, respectively. For the six months ended June 30,
1996 and 1995, other expenses totaled $41.7 million and $28.2 million,
respectively. The increase in other expenses for both periods resulted from
increased collection expenses, occupancy expenses, administrative expenses,
fraud losses resulting from an increase in the incidence of fraudulent
transactions and increased merchant marketing incentives expense. Other
expenses were 25.6% and 19.9% of net operating revenues for the three months
ended June 30, 1996 and 1995, respectively. Other expenses were 24.2% and 19.3%
of net operating revenues for the six months ended June 30, 1996 and 1995,
respectively.
Owned credit card loans outstanding decreased $199.2 million from $1,620.8
million at December 31, 1995 to $1,421.6 million at June 30, 1996. At June 30,
1996, the allowance for loan losses was $65.3 million, equal to 4.6% of total
owned credit card loans outstanding, compared with $63.7 million, or 3.9% of
total owned credit card loans outstanding at December 31, 1995. Accruing loans
that were contractually past due 90 days to 179 days represented 3.8% of total
owned credit card loans outstanding, at June 30, 1996, compared to 2.7% of
total owned credit card loans outstanding at December 31, 1995.
13
<PAGE>
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 June 30, 1996, CDs
outstanding were $411.7 million, of which institutional CDs represented $198.4
million and retail CDs represented $213.3 million.
HSB maintains loan securitization programs with Receivables Capital
Corporation ("RCC") and at June 30, 1996, outstanding loans under such programs
were $280.0 million. HSB also maintains a loan securitization program with
Barton Capital Corporation ("BCC") and at June 30, 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 June 30, 1996, was $118.5 million. At June 30, 1996, $580.0 million or
29.0% 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 expires on
April 17, 1997. The maximum amount available under the Borrowing Agreement is
$500.0 million. Under the Facility Fee Agreement, the Company has agreed to pay
certain monthly facility fees in connection with its financing arrangements
with DWD. 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
14
<PAGE>
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 is set to
expire on September 30, 1996. The Company and DWD have agreed in principle to
extend the Bridge Funding Agreement through January 31, 1997 and have agreed to
establish $750.0 million as the maximum amount available thereunder, which may
be reduced by DWD up to the amount of any additional funds received by HSB
pursuant to any new incremental loan securitization agreements. At July 31,
1996, the Company had $790.0 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.
Cash flows from operating activities resulted in net proceeds of cash of
$102.1 million and $3.6 million for the six months ended June 30, 1996 and
1995, respectively. Cash flows from operating activities for the six months
ended June 30, 1996 were impacted by a higher level of provision for loan
losses expense and the elimination of a restricted cash collection account,
which was used in servicing the assumed securitizations from Tandy Corporation.
Investing activities for the six months ended June 30, 1996 resulted in net
proceeds of cash of $136.0 million, primarily consisting of net proceeds of
cash from the sale of a private label credit card portfolio ($138.9 million).
Investing activities for the six months ended June 30, 1995 resulted in net
uses of cash of $469.4 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), net principal disbursed on credit card
loans representing the difference between sales made using the cards and
payments received from cardholders ($148.5 million) and from investments in
U.S. Treasury bills ($20.0 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 six months ended June 30, 1996 resulted in net
uses of cash of $237.5 million, primarily consisting of a net decrease in
borrowings due to affiliated companies ($269.1 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 ($40.0 million). Financing
activities for the six months ended June 30, 1995 resulted in net proceeds of
cash of $470.2 million, primarily consisting of a net increase in borrowings
due to affiliated companies ($536.4 million) and a net increase in interest-
bearing deposits resulting from the issuance of jumbo certificates of deposit
($96.5 million), partially offset by payments made on short-term notes payable
with Tandy Corporation ($161.7 million). At June 30, 1996 and 1995, the Company
had cash and cash equivalents of $9.4 million and $7.6 million, respectively.
15
<PAGE>
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).
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
$596.8 million and $435.3 million at June 30, 1996 and 1995, respectively.
At June 30, 1996 and 1995, the Company had $40.0 million of interest rate cap
agreements. At June 30, 1996, the current variable rates on all interest rate
cap agreements exceeded the specified cap rates.
At June 30, 1996 and 1995, the Company's interest rate swap agreements had
maturities ranging from December 1996 to December 2000 and from November 1995
to May 2000, respectively. At June 30, 1996 and 1995, the Company's interest
rate cap agreements had maturities ranging from February 1997 to September
1997.
16
<PAGE>
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.
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.
Neither the sale of such portfolio nor the settlement of the litigation with
Lechmere had a material adverse effect on the Company's financial position or
the results of its 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.
17
<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders.
The Registrant held its annual meeting of stockholders in Glencoe, Illinois
on April 16, 1996. The results of the matters submitted to a vote of
stockholders through the solicitation of proxies at the annual meeting were as
follows:
1. The following nominees for election as directors of the Company were elected
by the votes indicated below:
<TABLE>
<CAPTION>
Director Votes For Votes Withheld
- -------- ----------- --------------
<S> <C> <C>
Philip J. Purcell 25,297,145 222,655
Robert L. Wieseneck 25,296,104 223,696
Thomas R. Butler 25,293,045 226,755
Frank T. Cary 25,290,095 229,705
Mitchell M. Merin 25,291,045 228,755
Charles F. Moran 25,296,700 223,100
Thomas C. Schneider 25,292,945 226,855
Dennie M. Welsh 25,285,300 234,500
</TABLE>
2. Stockholders approved the appointment of Deloitte & Touche LLP as the
Company's independent auditors for the 1996 fiscal year by the following vote:
votes for - 24,485,283; votes against - 10,131; and abstentions - 24,386.
Item 5. Other Information.- None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K.
A Current Report on Form 8-K, dated August 7, 1996, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's 1996 Second Quarter Report to Stockholders.
A Current Report on Form 8-K, dated July 16, 1996, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's second quarter earnings release.
A Current Report on Form 8-K, dated June 21, 1996, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's earnings outlook.
A Current Report on Form 8-K, dated April 15, 1996, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's first quarter earnings release.
18
<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: August 13, 1996 By:/s/ Russell J. Bonaguidi
---------------- -----------------------------------
Russell J. Bonaguidi
Vice President and Controller (Duly
Authorized Officer and Principal
Accounting Officer)
19
<PAGE>
EDGAR
Exhibit Description of Exhibits
------- -----------------------
27 Exhibit 27, Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> JUN-30-1996
<CASH> 9,448
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 52,394
<INVESTMENTS-MARKET> 0
<LOANS> 1,421,568
<ALLOWANCE> (65,304)
<TOTAL-ASSETS> 1,549,792
<DEPOSITS> 414,570
<SHORT-TERM> 848,028
<LIABILITIES-OTHER> 68,544
<LONG-TERM> 0
0
0
<COMMON> 272
<OTHER-SE> 218,378
<TOTAL-LIABILITIES-AND-EQUITY> 1,549,792
<INTEREST-LOAN> 110,571
<INTEREST-INVEST> 1,326
<INTEREST-OTHER> 249
<INTEREST-TOTAL> 112,146
<INTEREST-DEPOSIT> 12,201
<INTEREST-EXPENSE> 41,586
<INTEREST-INCOME-NET> 70,560
<LOAN-LOSSES> 52,568
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 143,872
<INCOME-PRETAX> 28,435
<INCOME-PRE-EXTRAORDINARY> 28,435
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,628
<EPS-PRIMARY> 0.65
<EPS-DILUTED> 0.65
<YIELD-ACTUAL> 0
<LOANS-NON> 0
<LOANS-PAST> 53,359
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 63,704
<CHARGE-OFFS> 62,981
<RECOVERIES> 12,013
<ALLOWANCE-CLOSE> 65,304
<ALLOWANCE-DOMESTIC> 65,304
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
