<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 September 30, 1997
[ ] 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 October 31, 1997, the Registrant had 27,222,827 shares of common stock,
$0.01 par value, outstanding.
Page 1 of 18 pages
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PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
(In Thousands, Except Share Data)
[CAPTION]
<TABLE>
September 30, December 31,
1997 1996
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS:
Cash and due from banks $ 15,169 $ 15,205
Investments held to maturity - at amortized cost 41,576 41,675
Credit card loans 1,245,080 1,637,507
Allowance for loan losses (75,236) (88,397)
---------- ----------
Credit card loans, net 1,169,844 1,549,110
Accrued interest receivable 18,512 21,141
Accounts receivable 29,551 42,202
Due from affiliated companies 8,115 9,900
Amounts due from asset securitizations 56,915 --
Premises and equipment, net 29,431 25,294
Deferred income taxes 33,409 38,266
Prepaid expenses and other assets 14,672 17,992
---------- ----------
TOTAL ASSETS $1,417,194 $1,760,785
========== ==========
LIABILITIES:
Deposits:
Noninterest-bearing $ 4,500 $ 9,012
Interest-bearing 531,332 454,423
---------- ----------
Total deposits 535,832 463,435
Accounts payable, accrued expenses and other 47,016 50,019
Income taxes payable 3,383 17,756
Due to affiliated companies 557,262 982,547
Accrued recourse obligation 22,636 22,636
---------- ----------
Total liabilities 1,166,129 1,536,393
---------- ----------
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; 27,270,663 and
27,242,207 shares issued; 27,220,277 and
27,187,462 shares outstanding at September 30,
1997 and December 31, 1996, respectively 273 272
Capital in excess of par value 81,493 81,096
Retained earnings 170,559 144,345
Common stock held in treasury, at cost, $.01
par value, 50,386 and 54,745 shares at September
30, 1997 and December 31, 1996, respectively (1,242) (1,312)
Stock compensation plan 483 453
Employee stock benefit trust (483) (413)
Unearned stock compensation (18) (49)
---------- ----------
Total stockholders' equity 251,065 224,392
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,417,194 $1,760,785
========== ==========
<FN>
See notes to unaudited consolidated financial statements.
</TABLE>
2
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SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
- -------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
[CAPTION]
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
1997 1996 1997 1996
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Processing and service revenues $66,507 $65,712 $209,080 $204,808
Merchant discount revenue 3,981 10,163 10,797 25,382
------- ------- -------- --------
70,488 75,875 219,877 230,190
Interest revenue 58,038 53,972 184,515 166,118
Interest expense 17,695 18,238 57,521 59,824
------- ------- -------- --------
Net interest income 40,343 35,734 126,994 106,294
Provision for loan losses 28,480 32,037 86,273 84,605
------- ------- -------- --------
Net credit income 11,863 3,697 40,721 21,689
------- ------- -------- --------
Net operating revenues 82,351 79,572 260,598 251,879
Salaries and employee benefits 27,064 23,736 84,861 72,407
Processing and service expenses 22,153 26,589 74,849 80,096
Other expenses 17,110 20,221 58,194 61,915
------- ------- -------- --------
Total operating expenses 66,327 70,546 217,904 214,418
------- ------- -------- --------
Income before income taxes 16,024 9,026 42,694 37,461
Income tax expense 6,185 3,428 16,480 14,235
------- ------- -------- --------
Net income $ 9,839 $ 5,598 $ 26,214 $ 23,226
======= ======= ======== ========
Net income per common share $ 0.36 $ 0.21 $ 0.96 $ 0.85
======= ======= ======== ========
Weighted average common shares
outstanding 27,217 27,194 27,208 27,165
<FN>
See notes to unaudited consolidated financial statements.
</TABLE>
3
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SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------
(In Thousands)
[CAPTION]
<TABLE>
Nine Months Ended
September 30,
----------------------
1997 1996
-------- ---------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 26,214 $ 23,226
Adjustments to reconcile net income to
net cash flows from operating activities:
Depreciation and amortization 9,304 10,687
Imputed interest on notes payable -- 15
Provision for loan losses 86,273 84,605
Deferred income taxes 4,857 (1,598)
(Increase) decrease in operating assets:
Cash and due from banks - restricted -- 29,000
Due from affiliated companies 1,785 (35)
Accrued interest receivable and accounts receivable 15,280 3,797
Amounts due from asset securitizations (56,915) --
Prepaid expenses and other assets 2,383 1,623
Increase (decrease) in operating liabilities:
Accounts payable, accrued expenses and other (1,706) 8,520
Income taxes payable (14,373) (3,239)
Due to affiliated companies 6,272 2,903
Accrued recourse obligation -- (537)
-------- --------
Net cash from operating activities 79,374 158,967
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments held to maturity - purchases (167,284) (226,841)
Investments held to maturity - maturities 167,383 229,350
Net principal collected (disbursed) on credit card
portfolios 288,593 (38,462)
Proceeds from sale of credit card loan -- 138,861
Purchases of premises and equipment, net (9,056) (7,059)
-------- --------
Net cash from investing activities 279,636 95,849
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in noninterest-bearing deposits (4,512) (2,228)
Net increase in interest-bearing deposits 76,909 84,969
Due to affiliated companies (431,557) (328,477)
Repayment of notes payable -- (2,110)
Proceeds from exercise of stock options 44 622
Change in treasury stock, net 70 925
-------- --------
Net cash from financing activities (359,046) (246,299)
-------- --------
(Decrease) increase in cash and due from banks (36) 8,517
Cash and due from banks, beginning of period 15,205 8,879
-------- --------
Cash and due from banks, end of period $ 15,169 $ 17,396
======== ========
<FN>
See notes to unaudited consolidated financial statements.
</TABLE>
4
<PAGE>
SPS TRANSACTION SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1997 AND 1996
- -------------------------------------------------------------------------------
A. ORGANIZATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of SPS Transaction
Services, Inc. (the "Company") and its subsidiaries. The Company is a 73.5%
majority owned subsidiary of NOVUS Credit Services Inc., which in turn is a
wholly owned, direct subsidiary of Morgan Stanley, Dean Witter, Discover & Co.
("MSDWD").
On May 31, 1997, Morgan Stanley Group Inc. was merged with and into Dean
Witter, Discover & Co. At that time Dean Witter, Discover & Co. changed its
corporate name to Morgan Stanley, Dean Witter, Discover & Co.
The Company provides a range of technology outsourcing services including the
processing of credit and debit card transactions, consumer private label credit
card programs, commercial account processing services, and call center customer
service activities 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 September 30, 1997, and the Consolidated
Statements of Income for the three and nine months ended September 30, 1997 and
1996, and the Consolidated Statements of Cash Flows for the nine months ended
September 30, 1997 and 1996 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. Certain
reclassifications have been made to prior year amounts to conform to current
presentation. The preparation of the consolidated financial statements in
accordance with generally accepted accounting principles requires management to
make estimates and assumptions that affect the financial statements and related
disclosures. Management believes that the estimates utilized in the preparation
of the consolidated financial statements are prudent and reasonable. Actual
results could differ from these estimates.
The consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Company's
1996 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. RECENT ACCOUNTING PRONOUNCEMENTS
As of January 1, 1997, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," which is effective for
transfers of financial assets made after December 31, 1996, except for certain
financial assets for which the effective date has been delayed for one year.
SFAS No. 125 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
5
<PAGE>
recorded as secured borrowings. The adoption of the enacted provisions of SFAS
No. 125 had no material effect on the Company's financial position or results
of operations.
The Financial Accounting Standards Board has issued SFAS No. 128, "Earnings
per Share" ("EPS"), effective for periods ending after December 15, 1997, with
restatement required for all prior periods. SFAS No. 128 maintains the current
EPS category of net income per common share with "basic" EPS, which similarly
reflects no dilution from common stock equivalents, and requires "diluted" EPS
which reflects dilution from common stock equivalents based on the average
price per share of the Company's common stock during the period. The adoption
of SFAS No. 128 would not have had, and is not expected to have, a material
effect on the Company's EPS calculation.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." These statements, which are
effective for fiscal years beginning after December 15, 1997, establish
standards for the reporting and display of comprehensive income and disclosure
requirements related to segments.
C. ALLOWANCE FOR LOAN LOSSES AND ACCRUED RECOURSE OBLIGATION
The changes in the allowance for loan losses were as follows:
[CAPTION]
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
(In Thousands) (In Thousands)
1997 1996 1997 1996
------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance, beginning of period $79,120 $65,304 $88,397 $63,704
Additions:
Provision for loan losses 28,480 32,037 86,273 84,605
Deductions:
Charge-offs (37,819) (36,434) (116,586) (99,415)
Less: recoveries 5,455 4,741 17,152 16,754
------- ------- ------- -------
Net charge-offs (32,364) (31,693) (99,434) (82,661)
------- ------- ------- -------
Balance, end of period $75,236 $65,648 $75,236 $65,648
======= ======= ======= =======
</TABLE>
At September 30, 1997, there were $77.2 million in loans past due 30 days
through 89 days, and $57.0 million in loans past due 90 days through 179 days.
Credit card loans were reduced by $580.0 million at both September 30, 1997
and 1996, due to the sale with limited recourse of such loans through
securitization transactions. The accrued recourse obligation related to
securitized loans was $22.6 million and $26.6 million at September 30, 1997 and
1996, respectively.
6
<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 Transaction Services,
TeleServices, Commercial Accounts Processing and Consumer Credit Card Services.
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
TeleServices and Network Transaction Services such as call center processing,
electronic transaction processing, the sale and servicing of point-of-sale
terminals, and a System Access Agreement with NOVUS Services, Inc., an
affiliated company. Revenues from Network Transaction Services typically are
based on the number of electronic point-of-sale transactions processed rather
than the dollar transaction amount. Revenues from TeleServices typically are
based upon the number, type and length of customer contacts processed through
service activities such as technical help-desk inquiries, catalog order
processing, customer billing inquiries and dispatch services.
Managed programs includes revenues received as a result of Commercial Account
Processing and those Consumer Credit Card Services 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 Credit Card Services for which the
Company 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 Credit
Card Services, portions of which are currently deferred and accreted to
interest revenue. Generally, credit card sales are subject to a discount
charged to the merchant based upon contractual percentages. This percentage
varies by portfolio and by the type of credit plan offered.
Interest revenue represents finance charges derived from owned Consumer
Credit Card Services, investment interest and the accretion of deferred
merchant discount revenue. Net credit income is calculated by subtracting
interest expense and the provision for loan losses from interest revenue.
7
<PAGE>
Recent Events
On July 15, 1997, the Company announced receipt of notice of termination of
its System Access Agreement with NOVUS Services, Inc., an affiliated company.
The agreement will continue under current terms until July 31, 2000. For the
years ended December 31, 1995 and 1996, and for the nine months ended September
30, 1997, fees received under this licensing agreement have totaled $8.0
million, $8.0 million and $5.6 million, respectively. Although the Company
believes that termination of this agreement on July 31, 2000 will not have a
material adverse effect on the Company's financial position or results of
operations prior to that date, the Company is unable to predict the effects of
the termination thereafter.
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.
[CAPTION]
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
Period-to-Period Period-to-Period
-------------------- --------------------
1997 1996 Change 1997 1996 Change
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
NET OPERATING REVENUES:
Processing and service revenues 80.8% 82.6% 1.2% 80.2% 81.3% 2.1%
Merchant discount revenue 4.8 12.8 (60.8) 4.2 10.1 (57.5)
Net credit income 14.4 4.6 220.9 15.6 8.6 87.7
----- ----- ----- -----
100.0 100.0 3.5 100.0 100.0 3.5
OPERATING EXPENSES:
Salaries and employee benefits 32.9 29.9 14.0 32.6 28.7 17.2
Processing and service expenses 26.9 33.4 (16.7) 28.7 31.8 (6.6)
Other expenses 20.7 25.4 (15.4) 22.3 24.6 (6.0)
----- ----- ----- -----
80.5 88.7 (6.0) 83.6 85.1 1.6
Income before income taxes 19.5 11.3 77.5 16.4 14.9 14.0
Income tax expense 7.6 4.3 80.4 6.3 5.7 15.8
----- ----- ----- -----
Net income 11.9% 7.0% 75.8% 10.1% 9.2% 12.9%
===== ===== ===== =====
</TABLE>
Net income for the three months ended September 30, 1997 was $9.8 million, an
increase of $4.2 million, or 75.8%, over the same period a year ago. Net
income per common share for the three month period was $0.36, compared to $0.21
in the prior year's third quarter. Net income for the nine months ended
September 30, 1997 was $26.2 million, an increase of $3.0 million, or 12.9%,
over the same period a year ago. Net income per common share for the nine
month period was $0.96, compared to $0.85 for the same period a year ago.
Net operating revenues for the third quarter of 1997 grew to $82.4 million,
an increase of 3.5% over the same period last year. Net operating revenues for
the nine months ended September 30, 1997 were $260.6 million, an increase of
3.5% over the same period last year. The increase in net operating revenues
for both periods resulted from an increase in net credit income and processing
and service revenues partially offset by a decrease in merchant discount
revenue.
Processing and service revenues increased 1.2% to $66.5 million for the three
months ended September 30, 1997, as compared to $65.7 million for the same
period last year. For the nine months ended September 30, 1997, processing and
service revenues increased 2.1% to $209.1 million as compared to $204.8 million
for the same period last year. Processing and service revenues represented
80.8% and 82.6% of net operating revenues for the three months ended September
30, 1997 and 1996, respectively. For the nine months ended September 30, 1997
and 1996, processing and service revenues represented 80.2% and 81.3% of net
operating revenues, respectively.
9
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Processing and service revenues consisted of the following:
[CAPTION]
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
(In Thousands) (In Thousands)
1997 1996 1997 1996
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Transaction processing services $22,771 $20,698 $71,402 $62,787
Managed Programs 21,296 21,074 67,019 66,312
HSB Programs 12,310 13,107 37,905 36,308
Servicing fees on securitized loans 10,130 10,833 32,754 39,401
------- ------- -------- --------
$66,507 $65,712 $209,080 $204,808
======= ======= ======== ========
</TABLE>
SUPPLEMENTAL INFORMATION
Components of servicing fees on securitized loans:
[CAPTION]
<TABLE>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
(In Thousands) (In Thousands)
1997 1996 1997 1996
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Processing and service revenues $3,307 $3,463 $11,480 $10,497
Merchant discount revenue 1,086 1,283 3,031 3,255
Interest revenue 26,123 25,042 79,954 80,063
Interest expense (8,421) (8,231) (24,934) (24,835)
Provision for loan losses (11,965) (10,724) (36,777) (29,579)
------- ------- ------- -------
Servicing fees on securitized
loans $10,130 $10,833 $32,754 $39,401
======= ======= ======= =======
</TABLE>
The increase in revenues from transaction processing services for both the
three and nine months ended September 30, 1997, resulted primarily from
increased TeleServices revenue per customer contact processed and from a higher
volume of Network Transaction Services point-of-sale transactions processed.
Increased revenues from the sale and servicing of point-of-sale terminals
further contributed to the increase in transaction processing services revenues
for the nine months ended September 30, 1997. The number of TeleServices
customer contacts processed for the three months ended September 30, 1997,
totaled 1.9 million, down 3.8% from 2.0 million in the same period in 1996.
For the nine months ended September 30, 1997, the number of TeleServices
customer contacts processed totaled 6.6 million, down 2.2% from 6.8 million in
the same period in 1996. The decrease in the number of customer contacts was
offset by an increase in revenues per customer contact processed due to a
greater mix of technical help desk calls to total calls processed. TeleServices
minutes increased to 11.9 million and 42.2 million for the three and nine
months ended September 30, 1997 from 10.8 million and 35.5 million for the same
periods in 1996. (The number of contacts processed for the nine months ended
September 30, 1997 reflects a correction to previously reported numbers by
increasing the first and second quarters of 1997 by .1 million and .2 million,
10
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respectively. Also, the number of minutes for the nine months ended September
30, 1997 reflects a correction to previously reported numbers by increasing the
first and second quarters of 1997 by 5.9 million and 4.1 million,
respectively.) For the three months ended September 30, 1997, the number of
point-of-sale transactions processed totaled 118.5 million, up 7.6% from 110.1
million in the same period in 1996. For the nine months ended September 30,
1997, the number of point-of-sale transactions processed totaled 329.5 million,
up 5.6% from 312.1 million in the same period in 1996. The increase in
revenues from Managed programs for both the three and nine months ended
September 30, 1997, resulted primarily from an increase in the volume of
Commercial Account Processing Services provided, offset by a decrease in credit
life insurance program revenues. The decrease in revenues from HSB programs
for the three months ended September 30, 1997, was due to a decrease in late
fee revenue resulting primarily from a lower number of delinquent accounts.
The increase in revenues from HSB programs for the nine months ended September
30, 1997, was due to an increase in late fee revenue resulting primarily from
changes in late fee terms initiated in late 1996. The decrease in servicing
fees on securitized loans for the three months ended September 30, 1997 was due
primarily to a higher rate of credit losses on securitized loans, partially
offset by an increase in interest revenue on securitized loans. The decrease
in servicing fees on securitized loans for the nine months ended September 30,
1997 was due primarily to a higher rate of credit losses on securitized loans.
Merchant discount revenue decreased 60.8% to $4.0 million for the three
months ended September 30, 1997, as compared to $10.2 million for the same
period last year. For the nine months ended September 30, 1997 merchant
discount revenue decreased 57.5% to $10.8 million in 1997 compared to the same
period last year. The decrease in merchant discount revenue for the three and
nine months ended September 30, 1997, resulted from decreased sales activity
and from the deferral of $2.8 million of merchant discount revenues in the
third quarter of 1997 and the deferral of $6.3 million of merchant discount
revenues in the first nine months of 1997 related to interest-deferred
promotional payment plans. The deferral and accretion of merchant discount
revenue did not begin until the fourth quarter of 1996. As of September 30,
1997, $2.3 million of merchant discount revenue is deferred which will be
accreted as interest income over the life of the promotional payment plans.
Merchant discount revenue was 4.8% and 12.8% of net operating revenues for the
three months ended September 30, 1997 and 1996, respectively, and was 4.2% and
10.1% of net operating revenues for the nine months ended September 30, 1997
and 1996, respectively.
For the three months ended September 30, 1997, net credit income increased
220.9% to $11.9 million from the same period a year ago as a result of higher
net interest income and a lower provision for loan losses. For the nine months
ended September 30, 1997, net credit income increased 87.7% to $40.7 million
from the same period a year ago as a result of higher net interest income,
partially offset by an increase in the provision for loan losses.
The increase in interest revenue for the three and nine months ended
September 30, 1997, resulted primarily from the accretion of $3.3 million and
$13.2 million of deferred merchant discount revenue into interest income,
respectively, related to interest-deferred promotional payment plans and an
increase in the yield on credit card loans due in part to performance-based
pricing initiatives implemented in 1996, partially offset by higher charge-offs
of interest revenue.
11
<PAGE>
The decrease in interest expense for the three and nine months ended
September 30, 1997, resulted from a decrease in average borrowings due mainly
to a decrease in credit card loans, partially offset by higher interest rates
on borrowings. Furthermore, the decrease in interest expense for the nine
months ended September 30, 1997 also resulted from lower interest expense
associated with interest rate contracts.
The decrease in the provision for loan losses for the three months ended
September 30, 1997, is attributable to a decline in the amount of credit card
loans outstanding, partially offset by an increase in the net charge-off rate.
The increase in provision for loan losses for the nine months ended September
30, 1997, is attributable to an increase in the net charge-off rate, partially
offset by a decline in the amount of credit card loans outstanding. The
decline in credit card loans, which creates a provision benefit, is related to
certain portfolios that are in paydown such as the Incredible Universe and
McDuff portfolios, and to the Company's portfolio improvement program designed
to limit the Company's exposure to higher risk accounts. Net charge-offs as a
percentage of average credit card loans on an owned basis increased to 9.91% in
the third quarter of 1997 from 8.86% in the third quarter of 1996. For the
nine months ended September 30, 1997 and 1996, net charge-offs as a percentage
of average credit card loans on an owned basis increased to 9.25% from 7.44%.
The industry-wide trend of increasing net charge-off rates, which the Company
believes is related to increased consumer debt levels and bankruptcy rates,
contributed to the increase in the Company's net charge-off rate. The Company
believes that this industry-wide trend may continue and the Company expects to
experience a higher net charge-off rate for the full year 1997 as compared to
1996.
The Company continues to take corrective measures to reduce future charge-
offs through its portfolio improvement program which analyzes credit risk and
credit behavior scores for existing accounts, taking into consideration their
current financial condition; re-scoring existing accounts and reducing credit
lines or closing accounts as appropriate; accelerating the development schedule
for new credit scoring models; and increasing collection efforts by adding
collectors, expanding call hours, and identifying high-risk accounts to
accelerate contacts. In 1997, the Company intensified these efforts and
continues to implement measures designed to improve the credit quality of both
new and existing credit card accounts. To help mitigate the impact of higher
charge-offs, the Company has also instituted changes in cardholder terms and
has instituted the implementation of certain client pricing revisions,
including those for promotional programs. The Company believes these actions,
along with other operational changes, will have an increasingly positive impact
over time and will serve to moderate the effects of a difficult credit
environment.
The Company's expectations about future charge-off rates and portfolio
improvements are subject to uncertainties that could cause actual results to
differ materially from the Company's expectations, as described above. Factors
that influence the level and direction of credit card loan delinquencies and
charge-offs include changes in consumer spending and loan payment patterns,
bankruptcy trends, the seasoning of the Company's loan portfolio, interest rate
movements and their impact on consumer behavior, and the rate and magnitude of
changes in the Company's credit card loan portfolio, including the overall mix
of accounts, products and loan balances within the portfolio.
12
<PAGE>
For the three months ended September 30, 1997, total operating expenses of
$66.3 million represented a decrease of 6.0% over the same period last year.
Total operating expenses as a percentage of net operating revenues declined to
80.5% for the three months ended September 30, 1997, as compared to 88.7% for
the same period a year ago. For the nine months ended September 30, 1997,
total operating expenses of $217.9 million represented an increase of 1.6% over
the same period last year. Total operating expenses as a percentage of net
operating revenues declined to 83.6% for the nine months ended September 30,
1997, as compared to 85.1% for the same period a year ago.
For the three months ended September 30, 1997, salaries and employee benefits
totaled $27.1 million, an increase of 14.0% from $23.7 million from the same
period a year ago. For the nine months ended September 30, 1997, salaries and
employee benefits totaled $84.9 million, an increase of 17.2% from $72.4
million from the same period a year ago. The Company added approximately 185
additional full-time equivalent employees since September 30, 1996. Nearly all
of these new employees were assigned to field processing facilities to address
increased collection efforts and to provide for increased TeleServices volume.
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 September 30, 1997, such
expenses decreased by 16.7% to $22.2 million, on a period-to-period basis. For
the nine months ended September 30, 1997, processing and service expenses
decreased by 6.6% to $74.8 million, from the same period a year ago. The
decrease in processing and service expenses for both periods resulted from a
decrease in credit life insurance expenses, an adjustment resulting from the
sale of the Company's indirect interest in one of the Company's transaction
processing vendors and from a lower volume of private label transactions
processed. Processing and service expenses as a percentage of net operating
revenues declined to 26.9% for the three months ended September 30, 1997, as
compared to 33.4% for the comparable prior year period. Processing and service
expenses as a percentage of net operating revenues declined to 28.7% for the
nine months ended September 30, 1997, as compared to 31.8% for the comparable
prior year period.
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 September 30, 1997 and 1996, other expenses totaled
$17.1 million and $20.2 million, respectively. For the nine months ended
September 30, 1997 and 1996, other expenses totaled $58.2 million and $61.9
million, respectively. The decrease in other expenses for both periods
resulted from decreased merchant marketing expenses, an adjustment resulting
from the sale of the Company's indirect interest in one of the Company's
transaction processing vendors and decreased fraud losses. The expense
decreases for both periods were partially offset by increased occupancy,
outside collection agency and administrative expenses. Other expenses were
20.7% and 25.4% of net operating revenues for the three months ended September
30, 1997 and 1996, respectively. Other expenses were 22.3% and 24.6% of net
operating revenues for the nine months ended September 30, 1997 and 1996,
respectively.
13
<PAGE>
The table below sets forth owned credit card loan net charge-off and loan
delinquency information with supplemental total loan information regarding the
Company's credit card loan portfolio as of and for the year-to-date periods
indicated.
[CAPTION]
<TABLE>
September 30, 1997 September 30, 1996 December 31, 1996
----------------------------------------------------------------------
Total Total Total
Owned Loans* Owned Loans* Owned Loans*
----- ----- ----- ----- ----- -----
(Dollars in Thousands) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C> <C>
Average credit card loans $1,437,842 $2,017,842 $1,516,941 $2,099,666 $1,512,986 $2,095,026
Period-end credit card
loans $1,245,080 $1,825,080 $1,433,373 $2,013,373 $1,637,507 $2,217,507
Net charge-offs as a % of
average credit card loans 9.25% 9.02% 7.44% 7.29% 7.82% 7.66%
Accruing loans contractually
past due as to principal and
interest payments
30-89 days 6.20% 5.66% 5.74% 5.29% 4.97% 4.88%
90-179 days 4.58% 4.14% 4.15% 3.79% 4.15% 3.89%
* Total loans represents both owned and securitized credit card loans.
</TABLE>
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
MSDWD.
HSB administers a certificate of deposit program through which 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 MSDWD, and generally have a maturity of two to 10 years.
As of September 30, 1997, CDs outstanding were $531.3 million, of which
institutional CDs represented $259.4 million and retail CDs represented $271.9
million.
HSB maintains a loan securitization program with Receivables Capital
Corporation ("RCC"), and at September 30, 1997, outstanding loans sold under
such program were $280.0 million. HSB also maintains a loan securitization
program with Barton Capital Corporation ("BCC"), and at September 30, 1997,
outstanding loans sold under such program were $300.0 million. At September
30, 1997, $580.0 million or 31.8% of the HSB Program loans had been sold
through loan securitizations.
14
<PAGE>
The RCC loan securitization program has been amended so that it now expires
October 31, 1998. The BCC facility is scheduled to expire in April 1998. The
amended and restated agreements with RCC and BCC include the elimination of the
MSDWD guarantee (which provided credit support in the transaction) and its
replacement with a funded cash collateral account recorded on the balance sheet
as "amounts due from asset securitizations." Funding for this cash collateral
account is to be provided by a special purpose corporation established as a
subsidiary of the Company. The Company expects to renew or replace these
facilities on or prior to their expiration dates. If these programs are not
extended on or prior to their expiration dates, collections allocable to RCC
and BCC under 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 a program's
expiration date would remain on the Company's consolidated balance sheet.
The Company has an Amended and Restated Borrowing Agreement (as amended, the
"Borrowing Agreement") and a facility fee letter agreement (as amended, the
"Facility Fee Agreement")(collectively, the "Financing Agreements"), with
MSDWD, pursuant to which MSDWD has agreed to provide financing to the Company.
The maximum amount available under the Borrowing Agreement, which expires April
11, 1998, is $1.2 billion. At October 31, 1997, the Company had $550.2 million
outstanding under the Borrowing Agreement. Under the Facility Fee Agreement,
the Company has agreed to pay certain monthly facility fees in connection with
its financing arrangements with MSDWD.
The Company expects to renew or replace the Financing Agreements prior to the
expiration dates of such Financing Agreements. The Company is continuing to
evaluate alternative sources of financing to replace all or a portion of its
financing arrangements with MSDWD. If the Company were unable to reach a
satisfactory agreement with MSDWD for the renewal or the replacement of the
Financing Agreements, the Company believes it would be able to meet its
financial requirements over the next twelve months from other sources.
Cash flows from operating activities resulted in net proceeds of cash of
$79.4 million and $159.0 million for the nine months ended September 30, 1997
and 1996, respectively.
Cash flows from investing activities for the nine months ended September 30,
1997 resulted in net proceeds of cash of $279.6 million, primarily consisting
of net principal collected on credit card loans, representing the difference
between sales made using the cards and payments received from cardholders
($288.6 million), partially offset by purchases of premises and equipment
resulting in net uses of cash ($9.1 million). Cash flows from investing
activities for the nine months ended September 30, 1996 resulted in net
proceeds of cash of $95.8 million, primarily consisting of net proceeds of cash
from the sale of a private label credit card portfolio ($138.9 million)
partially offset by net uses of cash consisting of net principal disbursed on
credit card loans ($38.5 million) and the purchases of premises and equipment
($7.1 million).
Cash flows from financing activities for the nine months ended September 30,
1997 resulted in net uses of cash of $359.0 million, primarily consisting of a
net decrease in borrowings due to affiliated companies ($431.6 million),
partially offset by a net increase in interest-bearing deposits resulting from
the issuance of jumbo certificates of deposit ($76.9 million). Cash flows from
financing activities for the nine months ended September 30, 1996 resulted in
net uses of cash of $246.3 million, primarily consisting of a net decrease in
borrowings due to affiliated companies ($328.5 million), partially offset by a
net increase in interest-bearing deposits resulting from the issuance of jumbo
15
<PAGE>
certificates of deposit ($85.0 million). At September 30, 1997 and 1996, the
Company had cash and cash equivalents of $15.2 million and $17.4 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).
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
with notional amounts of $457.3 million and $499.1 million at September 30,
1997 and 1996, respectively.
At September 30, 1997, the Company had no interest rate cap agreements. At
September 30, 1996, the Company had outstanding interest rate cap agreements
with notional amounts of $40.0 million.
At September 30, 1997 and 1996, the Company's interest rate swap agreements
had maturities ranging from October 1997 to December 2000, and from December
1996 to December 2000, respectively.
16
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
In the normal course of business, the Company is involved in litigation
incidental to the business. The consequences of these matters are not
presently determinable but, in the opinion of management after consultation
with counsel, the ultimate liability, if any, will not have a material adverse
effect on the consolidated results of operations or financial position of the
Company.
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.
27.0 Financial Data Schedule
(b) Reports on Form 8-K.
A Current Report on form 8-K, dated October 22, 1997, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's third quarter earnings release.
A Current Report on form 8-K, dated July 31, 1997, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's 1997 Second Quarter Report to Stockholders.
A Current Report on form 8-K, dated July 15, 1997, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's second quarter earnings release.
17
<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: November 12, 1997 By:/s/ Russell J. Bonaguidi
----------------- -----------------------------------
Russell J. Bonaguidi
Vice President and Controller (Duly
Authorized Officer and Principal
Accounting Officer)
18
<PAGE>
EDGAR
Exhibit Description of Exhibits
- ------- -----------------------
27.0 Financial Data Schedule
18
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1997
<CASH> 15,169
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 41,576
<INVESTMENTS-MARKET> 0
<LOANS> 1,245,080
<ALLOWANCE> (75,236)
<TOTAL-ASSETS> 1,417,194
<DEPOSITS> 535,832
<SHORT-TERM> 557,262
<LIABILITIES-OTHER> 73,035
<LONG-TERM> 0
0
0
<COMMON> 273
<OTHER-SE> 250,792
<TOTAL-LIABILITIES-AND-EQUITY> 1,417,194
<INTEREST-LOAN> 181,237
<INTEREST-INVEST> 1,762
<INTEREST-OTHER> 24
<INTEREST-TOTAL> 184,515
<INTEREST-DEPOSIT> 23,491
<INTEREST-EXPENSE> 57,521
<INTEREST-INCOME-NET> 126,994
<LOAN-LOSSES> 86,273
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 217,904
<INCOME-PRETAX> 42,694
<INCOME-PRE-EXTRAORDINARY> 26,214
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 26,214
<EPS-PRIMARY> 0.96
<EPS-DILUTED> 0.96
<YIELD-ACTUAL> 0
<LOANS-NON> 0
<LOANS-PAST> 57,038
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 88,397
<CHARGE-OFFS> 116,586
<RECOVERIES> 17,152
<ALLOWANCE-CLOSE> 75,236
<ALLOWANCE-DOMESTIC> 75,236
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
