<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, 1998
[ ] 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, 1998, the Registrant had 27,312,030 shares of common stock,
$0.01 par value, outstanding.
Page 1 of 17 pages
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
(In thousands, except share data)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS:
Cash and due from banks $ 13,808 $ 14,730
Investments held to maturity - at amortized cost 36,753 36,617
Credit card loans 1,073,914 1,295,787
Allowance for loan losses (73,969) (79,726)
---------- ----------
Credit card loans, net 999,945 1,216,061
Accrued interest receivable 15,264 21,847
Accounts receivable 23,572 29,349
Due from affiliated companies 12,534 9,921
Amounts due from asset securitizations 90,489 93,260
Premises and equipment, net 30,904 32,895
Deferred income taxes 38,252 43,059
Prepaid expenses and other assets 14,483 14,664
---------- ----------
TOTAL ASSETS $1,276,004 $1,512,403
========== ==========
LIABILITIES:
Deposits:
Noninterest-bearing $ 7,354 $ 6,206
Interest-bearing 556,480 504,088
---------- ----------
Total deposits 563,834 510,294
Accounts payable, accrued expenses and other 75,963 80,283
Income taxes payable 19,057 19,725
Due to affiliated companies 332,303 639,066
---------- ----------
Total liabilities 991,157 1,249,368
---------- ----------
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; 27,338,694 and
27,276,269 shares issued; 27,311,030 and
27,206,883 shares outstanding at June 30, 1998
and December 31, 1997, respectively 273 273
Capital in excess of par value 82,725 81,586
Retained earnings 202,510 182,845
Common stock held in treasury, at cost, $.01
par value, 27,664 and 69,386 shares at June 30,
1998 and December 31, 1997, respectively (611) (1,662)
Stock compensation related adjustments (50) (7)
---------- ----------
Total stockholders' equity 284,847 263,035
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $1,276,004 $1,512,403
========== ==========
See notes to unaudited consolidated financial statements.
</TABLE>
2
<PAGE>
SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME
- -------------------------------------------------------------------------------
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1998 1997 1998 1997
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Processing and service revenues $63,966 $67,264 $132,108 $142,573
Merchant discount revenue 3,083 3,678 6,049 6,816
------- ------- -------- --------
67,049 70,942 138,157 149,389
Interest revenue 54,421 62,401 109,627 126,477
Interest expense 15,020 19,444 32,059 39,826
------- ------- -------- --------
Net interest income 39,401 42,957 77,568 86,651
Provision for loan losses 20,961 26,082 47,972 57,793
------- ------- -------- --------
Net credit income 18,440 16,875 29,596 28,858
------- ------- -------- --------
Net operating revenues 85,489 87,817 167,753 178,247
Salaries and employee benefits 27,159 28,274 55,346 57,797
Processing and service expenses 24,568 24,369 46,959 52,696
Other expenses 18,205 20,543 34,231 41,084
------- ------- -------- --------
Total operating expenses 69,932 73,186 136,536 151,577
------- ------- -------- --------
Income before income taxes 15,557 14,631 31,217 26,670
Income tax expense 5,727 5,647 11,490 10,295
------- ------- -------- --------
Net income $ 9,830 $ 8,984 $ 19,727 $ 16,375
======= ======= ======== ========
Basic earnings per common share $ 0.36 $ 0.33 $ 0.72 $ 0.60
Diluted earnings per common share $ 0.36 $ 0.33 $ 0.72 $ 0.60
Basic weighted average common
shares outstanding 27,289 27,209 27,269 27,203
Diluted weighted average common
shares outstanding 27,538 27,386 27,494 27,376
See notes to unaudited consolidated financial statements.
</TABLE>
3
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SPS TRANSACTION SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -------------------------------------------------------------------------------
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------
1998 1997
-------- ---------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 19,727 $ 16,375
Adjustments to reconcile net income to
net cash flows from operating activities:
Depreciation and amortization 5,892 6,735
Provision for loan losses 47,972 57,793
Compensation payable in common stock 826 --
Deferred income taxes 4,807 4,803
(Increase) decrease in operating assets:
Amounts due from affiliated companies (2,613) 2,405
Accrued interest receivable and accounts receivable 12,360 10,208
Amounts due from asset securitizations 2,771 (56,915)
Prepaid expenses and other assets (519) 2,392
Increase (decrease) in operating liabilities:
Accounts payable, accrued expenses and other (2,592) (963)
Income taxes payable (668) (9,722)
Amounts due to affiliated companies (2,680) 5,069
-------- --------
Net cash from operating activities 85,283 38,180
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments held to maturity - purchases (74,136) (105,932)
Investments held to maturity - maturities 74,000 98,100
Net principal collected on credit card loans 165,211 228,904
Purchases of premises and equipment, net (1,790) (4,647)
-------- --------
Net cash from investing activities 163,285 216,425
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in
noninterest-bearing deposits 1,148 (5,128)
Net increase in interest-bearing deposits 52,392 35,757
Net decrease in due to affiliated companies (304,083) (275,422)
Proceeds from exercise of stock options 1,053 25
Purchase of treasury stock, at cost -- 70
-------- --------
Net cash from financing activities (249,490) (244,698)
-------- --------
(Decrease) increase in cash and due from banks (922) 9,907
Cash and due from banks, beginning of period 14,730 15,205
-------- --------
Cash and due from banks, end of period $ 13,808 $ 25,112
======== ========
See notes to unaudited consolidated financial statements.
</TABLE>
4
<PAGE>
SPS TRANSACTION SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 1998 AND 1997
- -------------------------------------------------------------------------------
A. SALE OF ASSETS
On April 18, 1998, the Company and Associates First Capital Corporation
("The Associates") entered into a stock purchase agreement (the "Purchase
Agreement") pursuant to which the Company has agreed to sell and The
Associates has agreed to acquire substantially all of the assets of the
Company, consisting of all of the capital stock of the Company's two
wholly-owned operating subsidiaries - SPS Payment Systems, Inc. and
Hurley State Bank, for a price of approximately $896 million in cash,
upon the terms and subject to the conditions of the Purchase Agreement,
including approval by the Company's stockholders. As of April 18, 1998,
the operations of SPS Payment Systems, Inc. and Hurley State Bank, which
are considered discontinued operations, represent virtually all of the
operations of the Company. The Associates has also agreed to fund the
repayment of all intercompany indebtedness of SPS Payment Systems, Inc.
and Hurley State Bank, and their subsidiaries, owing to the Company or
its affiliates.
NOVUS Credit Services Inc. has entered into a voting agreement with The
Associates pursuant to which NOVUS has agreed to vote all shares of the Company
owned by it in favor of the transactions contemplated by the Purchase
Agreement. The voting agreement is terminable upon the earliest to occur of
(i) the prior termination of the Purchase Agreement, (ii) the consummation of
the sale transaction contemplated by the Purchase Agreement and (iii) January
18, 1999. Unless the Voting Agreement is terminated in accordance with its
terms, NOVUS's obligation to vote in favor of the transactions contemplated by
the Purchase Agreement is unconditional and absolute. The sale, which is
pending, is subject to certain closing conditions, and is expected to close by
the end of 1998.
The per share price that will be distributed to the Company's public
stockholders, which will be approximately $32, will be greater than the net per
share price to be received by MSDW, since MSDW will assume certain liabilities
and obligations incurred by the Company in connection with the sale. The
distribution of the purchase price to the Company's public stockholders will be
effected pursuant to a merger of the Company with an indirect subsidiary of
MSDW as soon as practical after the closing of the sale of assets. The per
share amount to be received by the public stockholders will be set forth in the
Company's proxy statement that will be mailed to stockholders in connection
with a special stockholders meeting to vote upon the sale and the merger.
Proxy materials will be mailed to stockholders following receipt of all
regulatory approvals. All outstanding options not otherwise previously
canceled by the option agreements will fully vest at the closing. Holders of
options to purchase Company common stock who have not previously exercised
their options will receive in the merger an amount of cash per share underlying
such option equal to the amount, if any, by which the per share purchase price
paid in the merger to public stockholders of Company stock exceeds the exercise
price of the options.
B. 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 73.2%
majority owned subsidiary of NOVUS Credit Services Inc., which in turn is a
wholly owned, direct subsidiary of Morgan Stanley Dean Witter & Co. ("MSDW").
5
<PAGE>
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 insured by the
Federal Deposit Insurance Corporation.
The Consolidated Balance Sheet as of June 30, 1998, and the Consolidated
Statements of Income for the three and six months ended June 30, 1998 and 1997,
and the Consolidated Statements of Cash Flows for the six months ended June 30,
1998 and 1997 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 consolidated financial statements are prepared in accordance with
generally accepted accounting principles, which require management to make
estimates and assumptions regarding credit card loan loss levels, the potential
outcome of litigation and other matters 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
1997 Annual Report to Stockholders and Annual Report on Form 10-K. The results
of operations for the interim periods are not necessarily indicative of results
to be expected for the entire year.
C. EARNINGS PER SHARE
The calculations of basic and diluted earnings per common share are based on
the weighted average number of common shares outstanding for basic earnings per
share and the total weighted average number of common shares and share
equivalents outstanding for diluted earnings per share. The difference between
basic and diluted earnings per share is the result of including weighted common
share equivalents in the computation of diluted earnings per share. Weighted
common share equivalents for the three months ended June 30, 1998 and 1997 were
248,851 and 177,203, respectively. Weighted common share equivalents for the
six months ended June 30, 1998 and 1997 were 225,478 and 172,559, respectively.
D. RECENT ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income," which
establishes standards for the reporting and presentation of comprehensive
income. SFAS No. 130 did not have any effect on the Company's financial
statements for the periods presented as net income represents total
comprehensive income.
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
This statement establishes standards for the disclosure requirements related to
segments. SFAS No. 131 is effective for fiscal years beginning after December
15, 1997, and interim reporting is not required until interim periods beginning
after initial year of application.
6
<PAGE>
As of January 1, 1998, the Company adopted Statement of Position ("SOP") 98-1
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." SOP 98-1 requires the capitalization of certain costs related
to the development or purchase of internal-use computer software. The adoption
of SOP 98-1 was not material to the Company's consolidated financial position
or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. The statement is
effective for fiscal years beginning after June 15, 1999.
E. ALLOWANCE FOR LOAN LOSSES
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)
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Balance, beginning of period $74,822 $84,394 $79,726 $88,397
Additions:
Provision for loan losses 20,961 26,082 47,972 57,793
Deductions:
Charge-offs (30,488) (37,406) (68,579) (78,767)
Less: recoveries 6,519 6,050 12,695 11,697
------- ------- ------- -------
Net charge-offs (23,969) (31,356) (55,884) (67,070)
------- ------- ------- -------
Other(1) 2,155 -- 2,155 --
------- ------- ------- -------
Balance, end of period $73,969 $79,120 $73,969 $79,120
======= ======= ======= =======
(1) Primarily reflects transfers related to asset securitizations.
At June 30, 1998, there were $58.2 million in loans past due 30 days through
89 days, and $44.1 million in loans past due 90 days through 179 days.
Credit card loans sold through asset securitization transactions and serviced
by the Company totaled $580.0 million at June 30, 1998 and 1997.
</TABLE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT DEVELOPMENTS
On April 18, 1998, the Company and The Associates entered into the Purchase
Agreement pursuant to which the Company has agreed to sell and The Associates
has agreed to acquire substantially all of the assets of the Company,
consisting of all of the capital stock of the Company's two wholly-owned
operating subsidiaries - SPS Payment Systems, Inc. and Hurley State Bank, for a
price of approximately $896 million in cash, upon the terms and subject to the
conditions of the Purchase Agreement, including approval by the Company's
stockholders. The Associates has also agreed to fund the repayment of all
intercompany indebtedness of SPS Payment Systems, Inc. and Hurley State Bank,
and their subsidiaries, owing to the Company or its affiliates.
7
<PAGE>
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: TeleServices, Network
Transaction Services, 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 call center processing and Network Transaction Services such as
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 TeleServices typically are based on the
length of service minutes and type of customer contacts processed through
activities such as technical help-desk inquiries, customer billing inquiries
and catalog order processing. Revenues from electronic transaction processing
typically are based on the number of electronic point-of-sale transactions
processed rather than the dollar transaction amount.
Managed programs include revenues received as a result of Commercial Accounts
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 primarily consist of late fee revenue assessed on those Consumer
Credit Card Services accounts 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.
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 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 certain deferred
merchant discount revenue. Net credit income is calculated by subtracting
interest expense and the provision for loan losses from interest revenue.
8
<PAGE>
The following table presents, for the periods indicated, the percentage
relationship that certain statement of income items bear to net operating
revenues and the period-to-period percentage dollar increase or decrease in
each item.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
Period-to-period Period-to-Period
-------------------- --------------------
1998 1997 Change 1998 1997 Change
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
NET OPERATING REVENUES:
Processing and service revenues 74.8% 76.6% (4.9)% 78.8% 80.0% (7.3)%
Merchant discount revenue 3.6 4.2 (16.2) 3.6 3.8 (11.3)
Net credit income 21.6 19.2 9.3 17.6 16.2 2.6
----- ----- ----- -----
100.0 100.0 (2.7) 100.0 100.0 (5.9)
OPERATING EXPENSES:
Salaries and employee benefits 31.8 32.2 (3.9) 33.0 32.4 (4.2)
Processing and service expenses 28.7 27.7 0.8 28.0 29.6 (10.9)
Other expenses 21.3 23.4 (11.4) 20.4 23.0 (16.7)
----- ----- ----- -----
81.8 83.3 (4.4) 81.4 85.0 (9.9)
Income before income taxes 18.2 16.7 6.3 18.6 15.0 17.0
Income tax expense 6.7 6.5 1.4 6.8 5.8 11.6
----- ----- ----- -----
Net income 11.5% 10.2% 9.4% 11.8% 9.2% 20.5%
===== ===== ===== =====
</TABLE>
Net income for the three months ended June 30, 1998 was $9.8 million, an
increase of $0.8 million, or 9.4%, over the same period a year ago. Basic and
diluted earnings per common share for the three month period was $0.36,
compared to $0.33 in the prior year's second quarter. Net income for the six
months ended June 30, 1998 was $19.7 million, an increase of $3.4 million, or
20.5%, over the same period a year ago. Basic and diluted earnings per common
share for the six month period was $0.72, compared to $0.60 for the same period
a year ago.
Net operating revenues for the second quarter of 1998 were $85.5 million, a
decrease of 2.7% over the same period last year. Net operating revenues for
the six months ended June 30, 1998, were $167.8 million, a decrease of 5.9%
over the same period last year. The decrease in net operating revenues for
both periods resulted primarily from a decrease in processing and service
revenues and merchant discount revenue partially offset by an increase in net
credit income.
Processing and service revenues decreased 4.9% to $64.0 million for the three
months ended June 30, 1998, as compared to $67.3 million for the same period
last year. For the six months ended June 30, 1998, processing and service
revenues decreased 7.3% to $132.1 million as compared to $142.6 million for the
same period last year. Processing and service revenues represented 74.8% and
76.6% of net operating revenues for the three months ended June 30, 1998 and
1997, respectively. For the six months ended June 30, 1998 and 1997,
processing and service revenues represented 78.8% and 80.0% of net operating
revenues, respectively.
9
<PAGE>
Processing and service revenues consisted of the following:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
(In Thousands) (In Thousands)
1998 1997 1998 1997
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Transaction processing services $22,300 $24,169 $44,554 $48,631
Managed Programs 21,411 22,328 44,176 45,723
HSB Programs 11,695 11,576 22,804 25,595
Servicing fees on securitized loans 8,560 9,191 20,574 22,624
------- ------- -------- --------
Processing and service revenues $63,966 $67,264 $132,108 $142,573
======= ======= ======== ========
</TABLE>
SUPPLEMENTAL INFORMATION
Components of servicing fees on securitized loans:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
(In Thousands) (In Thousands)
1998 1997 1998 1997
------- ------- -------- --------
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Processing and service revenues $3,279 $3,644 $6,734 $8,173
Merchant discount revenue 640 824 1,743 1,945
Interest revenue 25,765 25,760 53,457 53,831
Interest expense (8,318) (8,359) (16,634) (16,513)
Provision for loan losses (12,806) (12,678) (24,726) (24,812)
------- ------- ------- -------
Servicing fees on securitized loans $8,560 $9,191 $20,574 $22,624
======= ======= ======= =======
</TABLE>
The decrease in revenues from transaction processing services for both the
three and six months ended June 30, 1998, resulted primarily from a lower
volume of TeleServices minutes processed and decreased revenues from the sale
and servicing of point-of-sale terminals, partially offset by increased
revenues associated with a higher volume of Network Transaction Services point-
of-sale transactions processed. The number of TeleServices service minutes
processed for the three months ended June 30, 1998, totaled 10.6 million, down
19.9% from 13.2 million in the same period in 1997. For the six months ended
June 30, 1998, the number of TeleServices service minutes processed totaled
23.0 million, down 23.9% from 30.3 million in the same period in 1997. The
decrease in the number of service minutes for both periods primarily reflects a
change in service to a major client. For the three months ended June 30, 1998,
the number of point-of-sale transactions processed totaled 125.5 million, up
15.1% from 109.1 million in the same period in 1997. For the six months ended
June 30, 1998, the number of point-of-sale transactions processed totaled 239.2
million, up 13.4% from 210.9 million in the same period in 1997.
The decrease in revenues from Managed programs for both the three and six
months ended June 30, 1998, resulted primarily from a decrease in credit life
insurance program revenues attributable to the decline in credit card loans
outstanding and a lower number of cardholders enrolled in the program,
partially offset by an increase in the volume of Commercial Account Processing.
10
<PAGE>
The decrease in revenues from HSB programs for the six months ended June 30,
1998 was due to a decrease in late fee revenue resulting from a lower number of
delinquent accounts. The decrease in delinquent accounts was attributable to
the paydown of certain portfolios and the Company's portfolio improvement
programs, designed to limit the Company's exposure to higher risk accounts.
The Company had 2.8 million active consumer private label accounts, both owned
and managed, at June 30, 1998, compared with 3.1 million accounts at June 30,
1997. Active commercial accounts grew 6.2% to 1,004,000 at June 30, 1998,
compared to 945,000 at June 30, 1997.
The decrease in servicing fees on securitized loans for the three and six
months ended June 30, 1998 was due primarily to lower late fee revenue on
securitized loans which are a component of processing and service revenues.
Merchant discount revenue decreased 16.2% to $3.1 million for the three
months ended June 30, 1998, as compared to $3.7 million for the same period
last year. For the six months ended June 30, 1998 merchant discount revenue
decreased 11.3% to $6.0 million in 1998 compared to the same period last year.
The decrease in merchant discount revenue for the three and six months ended
June 30, 1998, resulted from decreased sales activity related to the decline in
credit card loans. As of June 30, 1998, $1.9 million of merchant discount
revenue has been deferred which will be amortized and recognized as interest
income over the life of the promotional payment plans. Merchant discount
revenue was 3.6% and 4.2% of net operating revenues for the three months ended
June 30, 1998 and 1997, respectively, and was 3.6% and 3.8% of net operating
revenues for the six months ended June 30, 1998 and 1997, respectively.
For the three months ended June 30, 1998, net credit income increased 9.3% to
$18.4 million from the same period a year ago. For the six months ended June
30, 1998, net credit income increased 2.6% to $29.6 million from the same
period a year ago. The increase for both periods resulted from a decline in
provision for loan losses that more than offset the decline in net interest
income.
The decrease in interest revenue for the three and six months ended June 30,
1998, resulted primarily from the decrease in credit card loans and the
accretion of $2.6 million and $6.0 million of deferred merchant discount
revenue into interest income, respectively, compared to $4.2 million and $9.9
million for the three and six months ended June 30, 1997, respectively, related
to interest-deferred promotional payment plans. The decrease in interest
revenue was partially offset by a higher yield on credit card loans for both
periods.
The decrease in interest expense for the three and six months ended June 30,
1998, was due to a decrease in average borrowings associated with the decline
in credit card loans, partially offset by a 19 and 30 basis point increase in
average interest rates on borrowings for the three and six months ended June
30, 1998, respectively.
The decrease in the provision for loan losses for the three and six months
ended June 30, 1998, is primarily attributable to a decrease in the amount of
net charge-offs due in part to a decline in the amount of credit card loans
outstanding.
The decline in credit card loans outstanding is related to certain portfolios
that are in paydown, such as the Incredible Universe and McDuff portfolios,
which were affected by Tandy Corporation's decision to close these formats
beginning in the first quarter of 1997, and to the Company's portfolio
improvement programs 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 decreased to 8.54% in the second quarter of 1998 from 8.81% in the
second quarter of 1997. For the six months ended June 30, 1998 and 1997, net
charge-offs as a percentage of average credit card loans on an owned basis
11
<PAGE>
increased to 9.48% from 8.96%, respectively. However, the Company did
experience a decrease in the net charge-off percentage from 10.33% in the first
quarter of 1998. For 1998, the Company expects to experience a charge-off rate
comparable to full year 1997. In 1997, the Company intensified its measures to
reduce future charge-offs and continues to implement measures designed to
improve the credit quality of both new and existing credit card accounts. The
Company's expectations about future charge-off rates and credit quality are
subject to uncertainties that could cause actual results to differ materially
from what has been described above. Factors that influence the level and
direction of credit card loan delinquencies and charge-offs include changes in
consumer spending and payment behaviors, 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.
For the three months ended June 30, 1998, total operating expenses of $69.9
million represented a decrease of 4.4% over the same period last year. Total
operating expenses as a percentage of net operating revenues declined to 81.8%
for the three months ended June 30, 1998, as compared to 83.3% for the same
period a year ago. For the six months ended June 30, 1998, total operating
expenses of $136.5 million represented a decrease of 9.9% over the same period
last year. Total operating expenses as a percentage of net operating revenues
declined to 81.4% for the six months ended June 30, 1998, as compared to 85.0%
for the same period a year ago.
For the three months ended June 30, 1998, salaries and employee benefits
totaled $27.2 million, a decrease of 3.9% from $28.3 million from the same
period a year ago. For the six months ended June 30, 1998, salaries and
employee benefits totaled $55.3 million, a decrease of 4.2% from $57.8 million
from the same period a year ago. The Company had approximately 495 fewer full-
time equivalent employees at June 30, 1998 compared to June 30, 1997,
reflective of reduced staffing levels in the Company's TeleServices and
Consumer Credit Card Services businesses.
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, 1998, such expenses
increased to $24.6 million, or 0.8% on a period-to-period basis. For the six
months ended June 30, 1998, processing and service expenses decreased to $47.0
million, or 10.9% from the same period a year ago. The decrease in processing
and service expenses for the six months ended June 30, 1998 as compared to the
same period in 1997 resulted from decreased credit life insurance expense and
expenses associated with a lower volume of TeleServices and Consumer Credit
Card Services. Processing and service expenses as a percentage of net
operating revenues increased to 28.7% for the three months ended June 30, 1998,
as compared to 27.7% for the comparable prior year period. Processing and
service expenses as a percentage of net operating revenues declined to 28.0%
for the six months ended June 30, 1998, as compared to 29.6% 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 June 30, 1998 and 1997, other expenses totaled $18.2
million and $20.5 million, respectively. For the six months ended June 30,
1998 and 1997, other expenses totaled $34.2 million and $41.1 million,
respectively. The decrease in other expenses for both periods resulted from
decreased credit card fraud losses, merchant marketing, cost of terminals sold
and collection fees, partially offset by increased credit marketing expense.
Other expenses were 21.3% and 23.4% of net operating revenues for the three
months ended June 30, 1998 and 1997, respectively. Other expenses were 20.4%
and 23.0% of net operating revenues for the six months ended June 30, 1998 and
1997, respectively.
12
<PAGE>
The table below presents certain information regarding the Company's credit
card loan net charge-offs, allowance for loan losses, and delinquency
information with supplemental total loan information regarding the Company's
credit card loan portfolio as of and for the year-to-date periods.
<TABLE>
<CAPTION>
June 30, 1998 June 30, 1997 December 31, 1997
----------------------------------------------------------------------
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 $1,188,779 $1,768,779 $1,510,234 $2,090,234 $1,390,998 $1,970,998
Period-end credit card
loans $1,073,914 $1,653,914 $1,338,600 $1,918,600 $1,295,787 $1,875,787
Net charge-offs as a % of
average credit card loans 9.48% 9.19% 8.96% 8.86% 9.42% 9.16%
Allowance for loan losses as a
% of period-end credit card
loans 6.89% 5.84% 5.91% 5.30% 6.15% 5.46%
Accruing loans contractually
past due as to principal and
interest payments
30-89 days $58,241 $82,290 $71,921 $95,401 $74,085 $100,413
5.42% 4.98% 5.37% 4.97% 5.72% 5.35%
90-179 days $44,067 $60,139 $54,145 $70,718 $60,360 $ 79,433
4.10% 3.64% 4.04% 3.69% 4.66% 4.23%
* Total loans represents both owned and securitized credit card loans.
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Funding and Capital Policies:
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's interest rate risk policies are designed to reduce the
potential volatility of earnings that arises 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.
Principal Sources of Funding:
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
MSDW.
HSB administers a CD program through which 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 12 months. CDs under the retail CD program
are issued to investors through Dean Witter Reynolds Inc., a subsidiary of
MSDW, and generally have had a maturity of two to 10 years. Currently, retail
13
<PAGE>
CDs with a maturity of two years are being offered. As of June 30, 1998, CDs
outstanding were $556.5 million, of which institutional CDs represented $279.1
million and retail CDs represented $277.4 million.
HSB maintains a loan securitization program with Barton Capital Corporation
("BCC"), and at June 30, 1998, outstanding loans under such program were $300.0
million. HSB also maintains a loan securitization program with Receivables
Capital Corporation ("RCC"), and at June 30, 1998, outstanding loans under such
program were $280.0 million. At June 30, 1998, $580.0 million or 35.1% of the
HSB program loans had been sold through loan securitizations.
The BCC loan securitization program, as amended, is scheduled to expire on
April 15, 1999. The RCC loan securitization program is scheduled to expire in
October 1998. The amended and restated agreements with BCC and RCC include a
limited guarantee of performance by MSDW and a funded cash collateral account
recorded on the consolidated balance sheets as "amounts due from asset
securitizations." 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 BCC and RCC under the
programs will be paid to BCC or to RCC, as applicable, and the interests of BCC
and of RCC 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 (the "Borrowing
Agreement") and a facility fee letter agreement (as amended, the "Facility Fee
Agreement")(collectively, the "Financing Agreements"), with MSDW, pursuant to
which MSDW has agreed to provide financing to the Company. The maximum amount
available under the Borrowing Agreement, which expires November 20, 1998, is
$1.1 billion. At July 31, 1998, the Company had $269.8 million outstanding
under the Borrowing Agreement. Under the Facility Fee Agreement, the Company
pays certain monthly facility fees in connection with its financing
arrangements with MSDW.
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 MSDW. If the Company were unable to reach a
satisfactory agreement with MSDW 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.
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 at
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 and the Purchase Agreement with
The Associates.
Cash flows from operating activities resulted in net proceeds of cash of
$85.3 million and $38.2 million for the six months ended June 30, 1998 and
1997, respectively.
Cash flows from investing activities primarily consist of the growth/decline
in credit card programs and short-term investments. Such investing activities
resulted in net proceeds of cash of $163.3 million and $216.4 million for the
six months ended June 30, 1998 and 1997, respectively. The net principal
14
<PAGE>
collected on credit card loans, representing the difference between payments
received from cardholders and sales made using the cards, provided cash of
$165.2 million and $228.9 million for the six months ended June 30, 1998 and
1997, respectively.
Cash flows from financing activities primarily consist of borrowings and
deposits. Such financing activities resulted in net uses of cash of $249.5
million and $244.7 million for the six months ended June 30, 1998 and 1997,
respectively. Amounts due to affiliated companies resulted in net uses of cash
of $304.1 million and $275.4 million for the six months ended June 30, 1998 and
1997, respectively, partially offset by interest-bearing deposits which
resulted in net proceeds of cash of $52.4 million and $35.8 million for the six
months ended June 30, 1998 and 1997, respectively. At June 30, 1998 and 1997,
the Company had cash equivalents of $13.8 million and $25.1 million,
respectively.
INTEREST RATE RISK
The Company's matched financing strategy targets 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 both 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 $426.9 million and $459.5 million at June 30, 1998 and
1997, respectively.
At June 30, 1998, the Company had no interest rate cap agreements. At June
30, 1997, the Company had outstanding interest rate cap agreements with
notional amounts of $10.0 million.
At June 30, 1998 and 1997, the Company's interest rate swap agreements had
maturities ranging from July 1998 to December 2000, and from October 1997 to
December 2000, respectively.
YEAR 2000 COMPLIANCE
Many of the world's computer systems and applications currently record years
in a two-digit format with the century assumed to be 1900. Consequently, they
will be unable to properly interpret dates beyond the year 1999, which could
lead to business disruptions (the "Year 2000" issue).
15
<PAGE>
The Company has established a Year 2000 Project Team to develop and manage a
company-wide compliance process. Based upon current information, the Company
estimates that company-wide Year 2000 expenditures for 1998 through 1999 will
be approximately $12 million. Costs relating to this project are being
expensed by the Company during the period in which they are incurred. The
Company's expectations about future costs associated with the Year 2000 issue
are subject to uncertainties that could cause actual results to differ
materially from what has been discussed above. Factors that could influence
the amount and timing of future costs include the success of the Company in
identifying systems and programs that contain two-digit year codes, the nature
and amount of programming and testing required to upgrade or replace each of
the affected programs, the rate and magnitude of related labor and consulting
costs and the success of the Company's external parties in addressing the Year
2000 issue.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
In the normal course of business, the Company is involved in routine
litigation incidental to the business. The consequences of these matters are
not presently determinable; however, in the opinion of management after
consultation with counsel, the ultimate liability, if any, will not have a
material adverse effect on the consolidated financial position or results of
operations 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.
11.0 Computation of Earnings per Common Share.
27.0 Financial Data Schedule.
(b) Reports on Form 8-K.
A Current Report on form 8-K, dated July 29, 1998, 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 April 21, 1998, was filed with the
Securities and Exchange Commission reporting Item 7 relating to the
Company's first quarter earnings release.
A Current Report on form 8-K, dated April 18, 1998, was filed with the
Securities and Exchange Commission reporting Items 5 and 7 relating to the
Company's agreement with Associates First Capital Corporation to sell
substantially all of the assets of the Company to Associates First Capital
Corporation.
16
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SPS TRANSACTION SERVICES, INC.
------------------------------
(Registrant)
Date: August 13, 1998 By:/s/ Russell J. Bonaguidi
--------------- -----------------------------------
Russell J. Bonaguidi
Vice President and Controller (Duly
Authorized Officer and Principal
Accounting Officer)
17
<PAGE>
EDGAR
Exhibit Description of Exhibits
- ------- -----------------------
11.0 Computation of Earnings per Common Share
27.0 Financial Data Schedule
18
<PAGE>
Exhibit 11.0
SPS Transaction Services, Inc.
Basic and Diluted Earnings per Common Share
Three and Six Months Ended June 30, 1998 and 1997
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1998 1997 1998 1997
------- ------- ------- -------
Net Income $ 9,830 $ 8,984 $19,727 $16,375
======= ======= ======= =======
BASIC EARNINGS PER COMMON SHARE:
Basic weighted average common shares
outstanding 27,289 27,209 27,269 27,203
======= ======= ======= =======
Basic earnings per common share $ 0.36 $ 0.33 $ 0.72 $ 0.60
======= ======= ======= =======
DILUTED EARNINGS PER COMMON SHARE:
Basic weighted average common shares
outstanding 27,289 27,209 27,269 27,203
Diluted effect of stock options 249 177 225 173
------- ------- ------- -------
Diluted weighted average common shares
outstanding 27,538 27,386 27,494 27,376
======= ======= ======= =======
Diluted earnings per common share $ 0.36 $ 0.33 $ 0.72 $ 0.60
======= ======= ======= =======
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 13,808
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 0
<INVESTMENTS-CARRYING> 36,753
<INVESTMENTS-MARKET> 0
<LOANS> 1,073,914
<ALLOWANCE> (73,969)
<TOTAL-ASSETS> 1,276,004
<DEPOSITS> 563,834
<SHORT-TERM> 95,020
<LIABILITIES-OTHER> 332,303
<LONG-TERM> 0
0
0
<COMMON> 273
<OTHER-SE> 284,574
<TOTAL-LIABILITIES-AND-EQUITY> 1,276,004
<INTEREST-LOAN> 105,956
<INTEREST-INVEST> 960
<INTEREST-OTHER> 2,711
<INTEREST-TOTAL> 109,627
<INTEREST-DEPOSIT> 17,192
<INTEREST-EXPENSE> 32,059
<INTEREST-INCOME-NET> 77,568
<LOAN-LOSSES> 47,972
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 136,536
<INCOME-PRETAX> 31,217
<INCOME-PRE-EXTRAORDINARY> 19,727
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 19,727
<EPS-PRIMARY> 0.72
<EPS-DILUTED> 0.72
<YIELD-ACTUAL> 0
<LOANS-NON> 0
<LOANS-PAST> 58,241
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 79,726
<CHARGE-OFFS> 68,579
<RECOVERIES> 12,695
<ALLOWANCE-CLOSE> 73,969
<ALLOWANCE-DOMESTIC> 73,969
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
