UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2011
OR
For the transition period from to
Commission File Number 0-14948
FISERV, INC.
(Exact Name of Registrant as Specified in Its Charter)
(State or Other Jurisdiction of
Incorporation or Organization)
(I. R. S. Employer
Identification No.)
(262) 879-5000
(Registrant’s Telephone Number, Including Area Code)
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 ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of July 29, 2011, there were 141,552,439 shares of common stock, $.01 par value, of the registrant outstanding.
INDEX
PART I - FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Statements of Income
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Cash Flows
Notes to Condensed Consolidated Financial Statements
Item 2.
Item 3.
Item 4.
PART II - OTHER INFORMATION
Item 6.
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In millions, except per share data)
(Unaudited)
Revenue:
Processing and services
Product
Total revenue
Expenses:
Cost of processing and services
Cost of product
Selling, general and administrative
Total expenses
Operating income
Interest expense, net
Loss on early debt extinguishment
Income from continuing operations before income taxes and income from investment in unconsolidated affiliate
Income tax provision
Income from investment in unconsolidated affiliate
Income from continuing operations
Loss from discontinued operations, net of income taxes
Net income
Net income (loss) per share - basic:
Continuing operations
Discontinued operations
Total
Net income (loss) per share - diluted:
Shares used in computing net income (loss) per share:
Basic
Diluted
See accompanying notes to condensed consolidated financial statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions)
Cash and cash equivalents
Trade accounts receivable, net
Deferred income taxes
Prepaid expenses and other current assets
Total current assets
Property and equipment, net
Intangible assets, net
Goodwill
Other long-term assets
Total assets
Accounts payable and accrued expenses
Current maturities of long-term debt
Deferred revenue
Total current liabilities
Long-term debt
Other long-term liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity:
Preferred stock, no par value: 25.0 million shares authorized; none issued
Common stock, $0.01 par value: 450.0 million shares authorized; 197.9 million shares issued
Additional paid-in capital
Accumulated other comprehensive loss
Retained earnings
Treasury stock, at cost, 56.4 million and 51.0 million shares
Total shareholders’ equity
Total liabilities and shareholders’ equity
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustment for discontinued operations
Adjustments to reconcile net income to net cash provided by operating activities from continuing operations:
Depreciation and other amortization
Amortization of acquisition-related intangible assets
Share-based compensation
Settlement of interest rate hedge contracts
Other non-cash items
Changes in assets and liabilities, net of effects from acquisitions:
Trade accounts receivable
Prepaid expenses and other assets
Accounts payable and other liabilities
Net cash provided by operating activities from continuing operations
Cash flows from investing activities:
Capital expenditures, including capitalization of software costs
Payment for acquisitions of businesses, net of cash acquired
Other investing activities
Net cash used in investing activities from continuing operations
Cash flows from financing activities:
Proceeds from long-term debt
Repayments of long-term debt, including premium and costs
Issuance of common stock and treasury stock
Purchases of treasury stock
Other financing activities
Net cash used in financing activities from continuing operations
Net change in cash and cash equivalents from continuing operations
Net cash flows from discontinued operations
Beginning balance
Ending balance
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Principles of Consolidation
The condensed consolidated financial statements for the three-month and six-month periods ended June 30, 2011 and 2010 are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the condensed consolidated financial statements have been included. Such adjustments consisted of normal recurring items. Interim results are not necessarily indicative of results for a full year. The condensed consolidated financial statements and accompanying notes are presented as permitted by Form 10-Q and do not contain certain information included in the annual consolidated financial statements and accompanying notes of Fiserv, Inc. (the “Company”). These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
The condensed consolidated financial statements include the accounts of Fiserv, Inc. and all 100% owned subsidiaries. Investments in less than 50% owned affiliates in which the Company has significant influence are accounted for using the equity method of accounting. All intercompany transactions and balances have been eliminated in consolidation.
2. Acquisitions
In June 2011, the Company entered into a definitive agreement to acquire CashEdge Inc. (“CashEdge”), a leading provider of consumer and business payments solutions such as account-to-account transfer, account opening and funding, data aggregation, small business payments, and person-to-person payments, for $465 million payable in cash at closing. The acquisition of CashEdge is expected to advance the Company’s digital payments and channel strategies. The Company anticipates the acquisition will close by the end of the third quarter of 2011 subject to the parties obtaining necessary regulatory approvals and other customary closing conditions.
In the first quarter of 2011, the Company completed the acquisition of Mobile Commerce Ltd. (“M-Com”), an international mobile banking and payments provider, and two other companies for an aggregate purchase price of $49 million, net of cash acquired. M-Com enhances the Company’s mobile channel and payments capabilities, and the other acquired companies add to or enhance specific products or services that the Company already provides. The preliminary purchase price allocations for these acquisitions resulted in technology and customer intangible assets of approximately $40 million. The remaining purchase price was primarily allocated to goodwill. The results of operations of all acquired businesses have been included in the accompanying condensed consolidated statements of income from the dates of acquisition. Pro forma information for these acquisitions is not provided because they did not have a material effect on the Company’s consolidated results of operations.
3. Fair Value Measurements
The Company applies fair value accounting for all assets and liabilities that are recognized or disclosed at fair value in its financial statements on a recurring basis. Fair value represents the amount that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, the Company considers the principal or most advantageous market and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability.
The fair values of cash equivalents, trade accounts receivable, settlement assets and obligations, accounts payable and accrued expenses approximate the carrying values due to the short period of time to maturity. The fair values of interest rate hedge contracts are described in Note 9 and were based on valuation models using inputs which are available through third party dealers and are related to market price risk, such as the LIBOR interest rate curve, credit risk and time value. The fair value of the Company’s total debt was $3.7 billion and $3.5 billion at June 30, 2011 and December 31, 2010, respectively, and was estimated using discounted cash flows based on the Company’s current incremental borrowing rates or quoted prices in active markets.
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4. Share-Based Compensation
The Company recognized $9 million and $21 million of share-based compensation expense during the three and six months ended June 30, 2011, respectively, and $10 million and $20 million of share-based compensation expense during the three and six months ended June 30, 2010, respectively. The Company’s annual grant of share-based awards generally occurs in the first quarter. During the six months ended June 30, 2011, the Company granted 1.0 million stock options and 0.3 million restricted stock units at weighted-average estimated fair values of $22.69 and $61.74, respectively. During the six months ended June 30, 2010, the Company granted 1.1 million stock options and 0.4 million restricted stock units at weighted-average estimated fair values of $17.46 and $47.77, respectively. During the six months ended June 30, 2011 and 2010, stock options to purchase 1.1 million shares and 0.9 million shares, respectively, were exercised.
5. Shares Used in Computing Net Income Per Share
The computation of shares used in calculating basic and diluted net income per common share is as follows:
Weighted-average shares outstanding used for the calculation of net income per share - basic
Common stock equivalents
Total shares used for the calculation of net income per share - diluted
For the three months ended June 30, 2011 and 2010, stock options for 1.0 million and 3.0 million shares, respectively, were excluded from the calculation of diluted weighted-average outstanding shares because their impact was anti-dilutive. For the six months ended June 30, 2011 and 2010, stock options for 0.8 million and 2.8 million shares, respectively, were excluded from the calculation of diluted weighted-average outstanding shares because their impact was anti-dilutive.
6. Comprehensive Income
Comprehensive income was as follows:
Other comprehensive income (loss), net of income taxes:
Fair market value adjustments on cash flow hedges
Reclassification adjustment for net realized losses on cash flow hedges included in interest expense
Foreign currency translation and other
Other comprehensive income (loss)
Comprehensive income
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7. Intangible Assets
Intangible assets consisted of the following:
June 30, 2011
Customer related intangible assets
Acquired software and technology
Trade names
Capitalized software development costs
Purchased software
December 31, 2010
With respect to the Company’s acquired intangible assets at June 30, 2011, annual amortization expense is estimated to be approximately $160 million in 2011, $150 million in each of 2012 and 2013, and $140 million in each of 2014 and 2015.
8. Long-Term Debt
In June 2011, the Company issued $1.0 billion of senior notes comprised of $600 million of 3.125% senior notes due in June 2016 and $400 million of 4.75% senior notes due in June 2021. The notes pay interest semi-annually on June 15 and December 15, commencing on December 15, 2011. The interest rates applicable to these notes are subject to an increase of up to two percent in the event that the Company’s credit rating is downgraded below investment grade. The indenture governing the senior notes contains covenants that, among other matters, limit: the Company’s ability to consolidate or merge into, or convey, transfer or lease all or substantially all of its properties and assets to, another person; the Company’s and certain of its subsidiaries’ ability to create or assume liens; and the Company’s and certain of its subsidiaries’ ability to engage in sale and leaseback transactions.
In June 2011, the Company purchased in a tender offer $700 million aggregate principal amount of its 6.125% senior notes due in November 2012 (“2012 Notes”) for $754 million. In the second quarter of 2011, the Company recorded a pre-tax loss on early debt extinguishment of $61 million for the premium paid and other costs associated with this tender offer. In July 2011, the Company redeemed the remaining $300 million aggregate principal amount of 2012 Notes, which amount was included in current maturities of long-term debt in the consolidated balance sheet at June 30, 2011. In the third quarter of 2011, the Company expects to record a pre-tax charge of approximately $25 million for the early repayment premium and other costs associated with redeeming the remaining 2012 Notes.
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9. Interest Rate Hedge Contracts
The Company maintains interest rate swap agreements (“Swaps”) with total notional values of $1.0 billion at June 30, 2011 and December 31, 2010 to hedge against changes in interest rates and forward-starting interest rate swap agreements (“Forward-Starting Swaps”) with total notional values of $550 million and $200 million at June 30, 2011 and December 31, 2010, respectively, to hedge against changes in interest rates applicable to forecasted fixed rate borrowings. The Swaps and Forward-Starting Swaps expire in September 2012 and have been designated by the Company as cash flow hedges. The Swaps effectively fix the interest rates on floating rate term loan borrowings at a weighted-average rate of approximately 5.0%, prior to financing spreads and related fees. The Forward-Starting Swaps effectively fix the benchmark interest rate on forecasted five-year and ten-year borrowings at weighted-average rates of approximately 3.2% and 3.9%, respectively. The fair values of the Swaps and Forward-Starting Swaps totaled $62 million at June 30, 2011 and were recorded in other long-term liabilities and in accumulated other comprehensive loss, net of income taxes, in the consolidated balance sheet. At December 31, 2010, the fair values of the Swaps and Forward-Starting Swaps totaled $65 million and were recorded as a $76 million long-term liability and an $11 million long-term asset, respectively. The components of other comprehensive income pertaining to interest rate hedge contracts are presented in Note 6. In the first six months of 2011 and 2010, interest expense recognized due to hedge ineffectiveness was not significant, and no amounts were excluded from the assessments of hedge effectiveness. Based on the amounts recorded in accumulated other comprehensive loss at June 30, 2011, the Company estimates that it will recognize approximately $40 million in interest expense during the next twelve months related to interest rate hedge contracts.
In conjunction with its issuance of senior notes in June 2011, the Company entered into a series of treasury lock agreements (“Treasury Locks”), which were designated as cash flow hedges, with total notional values of $600 million to hedge against changes in interest rates. Upon issuance of the senior notes, the Company paid $6 million to settle the Treasury Locks. This payment was recorded in accumulated other comprehensive loss, net of income taxes of $2 million, and will be recognized as interest expense over the terms of the senior notes.
10. Cash Flow Information
Supplemental cash flow information related to the Company’s continuing operations was as follows:
Interest paid
Income taxes paid
11. Business Segment Information
The Company’s operations are comprised of the Payments and Industry Products (“Payments”) segment, the Financial Institution Services (“Financial”) segment, and the Corporate and Other segment. The Payments segment primarily provides electronic bill payment and presentment services and debit and other card-based payment products and services to meet the electronic transaction processing needs of the financial services industry. The businesses in this segment also provide Internet banking, investment account processing services for separately managed accounts, card and print personalization services, and fraud and risk management products and services. The Financial segment provides banks, thrifts and credit unions with account processing services, item processing services, loan origination and servicing products, cash management and consulting services, and other products and services that support numerous types of financial transactions. The Corporate and Other segment primarily consists of unallocated corporate expenses, amortization of acquisition-related intangible assets and intercompany eliminations.
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Three Months Ended June 30, 2011
Processing and services revenue
Product revenue
Three Months Ended June 30, 2010
Six Months Ended June 30, 2011
Six Months Ended June 30, 2010
Goodwill in the Payments and Financial segments was $3.1 billion and $1.3 billion, respectively, as of June 30, 2011 and December 31, 2010.
12. Subsidiary Guarantors of Long-Term Debt
Certain of the Company’s 100% owned domestic subsidiaries (“Guarantor Subsidiaries”) jointly and severally, and fully and unconditionally guarantee the Company’s indebtedness under its revolving credit facility, senior term loan, and senior notes. The following condensed consolidating financial information is presented on the equity method and reflects summarized financial information for: (a) the Company; (b) the Guarantor Subsidiaries on a combined basis; and (c) the Company’s non-guarantor subsidiaries on a combined basis. In the fourth quarter of 2010, one of the Company’s subsidiaries, which was not previously a guarantor subsidiary, was merged with and into a guarantor subsidiary. The following condensed consolidating financial information reflects this merger for all periods presented.
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CONDENSED CONSOLIDATING STATEMENT OF INCOME
THREE MONTHS ENDED JUNE 30, 2011
Operating income (loss)
Income (loss) from continuing operations before income taxes and income from investment in unconsolidated affiliate
Income tax (provision) benefit
Income (loss) from continuing operations
Equity in earnings of consolidated affiliates
THREE MONTHS ENDED JUNE 30, 2010
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SIX MONTHS ENDED JUNE 30, 2011
(Loss) income from discontinued operations, net of income taxes
SIX MONTHS ENDED JUNE 30, 2010
Interest (expense) income, net
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CONDENSED CONSOLIDATING BALANCE SHEET
JUNE 30, 2011
Investments in consolidated affiliates
Goodwill and intangible assets, net
Due to (from) consolidated affiliates
DECEMBER 31, 2010
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Net cash provided by (used in) operating activities from continuing operations
Net cash (used in) provided by investing activities from continuing operations
Proceeds from (repayments of) long-term debt, net
Repayments of long-term debt
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Forward-Looking Statements
This quarterly report contains “forward-looking statements” intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. Forward-looking statements include those that express a plan, belief, expectation, estimation, anticipation, intent, contingency, future development or similar expression, and can generally be identified as forward-looking because they include words such as “believes,” “anticipates,” “expects,” “could,” “should” or words of similar meaning. Statements that describe our objectives or goals are also forward-looking statements. The forward-looking statements in this report involve significant risks and uncertainties, and a number of factors, both foreseen and unforeseen, that could cause actual results to differ materially from our current expectations. The factors that may affect our results include, among others: the impact on our business of the current state of the economy, including the risk of reduction in revenue resulting from decreased spending on the products and services we offer or from the elimination of existing or potential clients due to consolidation or financial failures in the financial services industry; legislative and regulatory actions in the United States, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations, and internationally; our ability to obtain regulatory approvals for, and to close, the CashEdge Inc (“CashEdge”) acquisition on our anticipated terms and timetable, and to successfully integrate CashEdge into our operations; changes in client demand for our products or services; pricing or other actions by competitors; the impact of our strategic initiatives; our ability to comply with government regulations, including privacy regulations; and other factors identified in our Annual Report on Form 10-K for the year ended December 31, 2010 and in other documents that we file with the Securities and Exchange Commission. You should consider these factors carefully in evaluating forward-looking statements and are cautioned not to place undue reliance on such statements, which speak only as of the date of this report. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.
Management’s discussion and analysis of financial condition and results of operations is provided as a supplement to our unaudited condensed consolidated financial statements and accompanying footnotes to help provide an understanding of our financial condition, the changes in our financial condition and our results of operations. Our discussion is organized as follows:
Overview. This section contains background information on our company and the services and products that we provide, our enterprise priorities, and the trends and business developments affecting our industry in order to provide context for management’s discussion and analysis of our financial condition and results of operations.
Results of operations. This section contains an analysis of our results of operations presented in the accompanying unaudited condensed consolidated statements of income by comparing the results for the three and six months ended June 30, 2011 to the comparable periods in 2010.
Liquidity and capital resources. This section provides an analysis of our cash flows and a discussion of our outstanding debt as of June 30, 2011.
Overview
Company Background
We provide financial services technology solutions, including electronic commerce systems and services such as transaction processing, electronic bill payment and presentment, business process outsourcing, document distribution services, and software and systems solutions. We serve approximately 16,000 clients worldwide including banks, thrifts, credit unions, investment management firms, leasing and finance companies, retailers, merchants, and government agencies. The majority of our revenue is generated from recurring account and transaction fees under contracts with terms ranging from three to five years, and we benefit from high contract renewal rates with our existing clients. The majority of the services we provide to our clients are non-discretionary in nature and are necessary for them to operate their business.
Our operations are primarily in the United States and are comprised of the Payments and Industry Products (“Payments”) segment, the Financial Institution Services (“Financial”) segment, and the Corporate and Other segment. The Payments segment primarily provides electronic bill payment and presentment services and debit and other card-based payment
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products and services to meet the electronic transaction processing needs of the financial services industry. The businesses in this segment also provide Internet banking, investment account processing services for separately managed accounts, card and print personalization services, and fraud and risk management products and services. The Financial segment provides banks, thrifts and credit unions with account processing services, item processing services, loan origination and servicing products, cash management and consulting services, and other products and services that support numerous types of financial transactions. The Corporate and Other segment primarily consists of unallocated corporate expenses, amortization of acquisition-related intangible assets and intercompany eliminations.
In June 2011, we entered into a definitive agreement to acquire CashEdge, a leading provider of consumer and business payments solutions such as account-to-account transfer, account opening and funding, data aggregation, small business payments, and person-to-person payments, for $465 million payable in cash at closing. The acquisition of CashEdge is expected to advance our digital payments and channel strategies. We anticipate the acquisition will close by the end of the third quarter of 2011 subject to the parties obtaining necessary regulatory approvals and other customary closing conditions.
In the first quarter of 2011, we completed the acquisition of Mobile Commerce Ltd. (“M-Com”), an international mobile banking and payments provider, and two other companies for an aggregate purchase price of $49 million. M-Com enhances our mobile channel and payments capabilities, and the other acquired companies add to or enhance specific products or services that we already provide.
Enterprise Priorities
We continue to implement a series of strategic initiatives to help accomplish our mission of providing integrated technology and services solutions which enable best-in-class results for our clients. These strategic initiatives include active portfolio management of our various businesses, enhancing the overall value of our existing client relationships, improving operational effectiveness, being disciplined in our allocation of capital, and differentiating through innovation in our products and services. Our three key enterprise priorities for 2011 are: (i) to deliver an increased level of high quality revenue growth and increase our earnings per share as compared to 2010; (ii) to further center the Fiserv culture on growth resulting in more clients, deeper client relationships and a higher share of strategic solutions; and (iii) to provide innovative solutions that increase differentiation and enhance results for our clients. We believe we are making progress toward achieving our 2011 enterprise priorities.
Industry Trends
Market and regulatory conditions have continued to create a difficult operating environment for financial institutions and other businesses in the United States and internationally. As a result, financial institutions have exercised caution in their information technology spending. Despite this environment, our revenue growth was 1% in 2010 and 4% in the first six months of 2011. We believe this revenue growth demonstrates the resilience of our recurring fee-based revenue model, the largely non-discretionary nature of our products and services, and, in 2011, mild improvement in the general condition of the financial industry. We believe that financial institutions are increasingly focused on technology solutions that can help them win and retain customers, generate incremental revenue and enhance their operating efficiency. We anticipate that we will benefit over the long term from the trend of financial institutions moving from in-house transaction processing solutions to outsourced solutions.
In each of 2010 and 2009, approximately 1% of all financial institutions in the United States failed or were subject to government action, which resulted in the loss of a small number of our clients. However, during the first six months of 2011 the number of government actions and the average size of institutions impacted by such actions decreased as compared to the same period in 2010. Bank failures and forced consolidations have been, to some extent, offset by a general decline in the level of acquisition activity among financial institutions. A consolidation benefits us when a newly combined institution is processed on our platform, or elects to move to one of our platforms, and negatively impacts us when a competing platform is selected. Consolidations and acquisitions also impact our financial results due to early contract termination fees in our multi-year client contracts. These fees are primarily generated when an existing client is acquired by another financial institution and can vary from period to period based on the number and size of clients that are acquired and how early in the contract term the contract is terminated. We generally do not receive contract termination fees when a financial institution is subject to a government action.
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In addition, legislation such as the Dodd-Frank Wall Street Reform and Consumer Protection Act will result in numerous new regulations that will impact the financial industry, although it is too early to fully determine the overall impact of this complex legislation on us or our clients over the long term.
Business Developments
We continue to invest in the development of new and strategic products in categories such as payments, including ZashPay®, our person-to-person payment service; mobile banking; account processing, including AcumenTM, our next generation account processing platform for large credit unions; and others that we believe will increase value to our clients and enhance the capabilities of our existing solutions. We believe our wide range of market-leading solutions along with the investments we are making in new and differentiated products will favorably position us and our clients to capitalize on the opportunities in the marketplace.
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Results of Operations
The following table presents certain amounts included in our condensed consolidated statements of income, the relative percentage that those amounts represent to revenue, and the change in those amounts from year to year. This information should be read together with the condensed consolidated financial statements and accompanying notes.
Sub-total
Percentage of revenue is calculated as the relevant revenue, expense, income or loss amount divided by total revenue, except for cost of processing and services and cost of product amounts which are divided by the related component of revenue.
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Total Revenue
Total revenue:
2011
2010
Revenue growth
Revenue growth percentage
Total revenue increased $43 million, or 4%, in the second quarter of 2011 compared to 2010 and increased $83 million, or 4%, in the first six months of 2011 compared to 2010. Revenue growth in 2011 was driven by improved growth in both our Payments and Financial segments as compared to 2010. Revenue from acquired companies contributed $5 million to revenue in the second quarter of 2011 and $7 million to revenue in the first six months of 2011.
Total revenue in our Payments segment during the second quarter and first six months of 2011 increased $40 million, or 7%, and $80 million, or 7%, respectively, compared to 2010. Payments segment revenue growth during 2011 was driven primarily by new clients and increased transaction volumes from existing clients in our electronic payments businesses, including our electronic banking and card services businesses. In addition, higher postage pass-through revenue, which is included in both product revenue and cost of product, in our output solutions business contributed approximately two percentage points of growth in this segment in the second quarter and first six months of 2011.
Total revenue in our Financial segment during the second quarter and first six months of 2011 increased $10 million, or 2%, and $18 million, or 2%, respectively, compared to 2010. Revenue growth in our Financial segment during 2011 was favorably impacted by increased processing and services revenue in our bank and credit union account processing businesses, partially offset by continued volume declines in our check processing business, which we expect will continue during the second half of 2011. A decline in contract termination fee revenue negatively impacted revenue growth in this segment by approximately one percentage point in the second quarter of 2011.
Total Expenses
Total expenses increased $43 million, or 6%, in the second quarter of 2011 compared to 2010 and increased $100 million, or 6%, in the first six months of 2011 compared to 2010. Total expenses as a percentage of total revenue were 76.4% and 75.4% in the second quarter of 2011 and 2010, respectively, and were 77.7% and 75.9% in the first six months of 2011 and 2010, respectively.
Cost of processing and services as a percentage of processing and services revenue of 54.2% and 53.4% in the second quarter of 2011 and 2010, respectively, and 54.6% and 54.5% in the first six months of 2011 and 2010, respectively, were relatively consistent in 2011 compared with the 2010 periods.
Cost of product as a percentage of product revenue increased from 77.7% and 77.3% in the second quarter and first six months of 2010, respectively, to 80.1% and 80.4% in the second quarter and first six months of 2011, respectively. The
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increase in cost of product as a percentage of product revenue was due primarily to an increase in postage pass-through revenue and expenses in our output solutions business.
Selling, general and administrative expenses increased $5 million, or 3%, in the second quarter of 2011 compared to 2010 and increased $36 million, or 10%, in the first six months of 2011 compared to 2010. The increase in selling, general and administrative expenses in the first six months of 2011 compared to 2010 was primarily due to $18 million of employee severance expenses recognized in the first quarter of 2011, higher legal costs of approximately $6 million, and a $5 million gain on the sale of a facility which reduced expenses in the first quarter of 2010.
Operating Income and Operating Margin
Operating income:
Operating income growth (decline)
Operating income growth percentage
Operating margin:
Operating margin growth (decline) (1)
Operating income growth (decline) percentage
Represents the percentage point improvement or decline in operating margin.
Total operating income of $251 million in the second quarter of 2011 was consistent with the second quarter of 2010 and total operating income of $472 million in the first six months of 2011 decreased $17 million, or 3%, compared to 2010. Operating income in our Payments and Financial segments increased 7% and 2%, respectively, and the operating loss in our Corporate and Other segment increased $43 million in the first six months of 2011 compared to 2010. Our operating margin decreased 90 basis points and 180 basis points to 23.6% and 22.3% in the second quarter and first six months of 2011, respectively, primarily due to increased operating losses in our Corporate and Other segment.
Operating income in our Payments segment increased $13 million, or 9%, in the second quarter of 2011 compared to 2010. Operating margin increased 40 basis points to 28.4% in the second quarter of 2011 compared to 28.0% in the second quarter of 2010. In the first six months of 2011, operating income in our Payments segment increased $21 million, or 7%, and operating margin decreased 10 basis points to 27.6% compared to 2010. Operating margins in 2011 were favorably
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impacted by increased operating leverage and scale efficiencies in our electronic payments businesses and negatively impacted by increased expenses associated with the development and support of new and existing products and services and an increase in postage pass-through costs, which are included in both revenue and expenses.
Operating income in our Financial segment in the second quarter and first six months of 2011 increased $2 million, or 1%, and $5 million, or 2%, respectively, compared to 2010. Operating margin decreased 10 basis points to 30.8% in the second quarter of 2011 compared to the second quarter of 2010 and was consistent at 29.9% in the first six months of 2011 and 2010. Operating income and operating margins in 2011 were positively impacted by revenue growth and scale efficiencies in our account processing businesses and were negatively impacted by a decrease in higher margin contract termination fee revenue.
The operating loss in our Corporate and Other segment increased $15 million and $43 million in the second quarter and first six months of 2011, respectively, compared to 2010. The increase in the second quarter of 2011 was due primarily to higher legal, merger and integration related costs and an increase in amortization of acquisition-related intangible assets. In the first six months of 2011, the increase was due primarily to employee severance costs of $18 million in the first quarter of 2011, higher legal, merger and integration related expenses totaling $12 million, a $4 million increase in amortization of acquisition-related intangible assets, and a $5 million gain on the sale of a facility recorded in the first quarter of 2010.
Interest Expense, Net
In the second quarter and first six months of 2011, net interest expense increased $2 million in each period compared to 2010 and was $48 million and $93 million, respectively.
Loss on Early Debt Extinguishment
In June 2011, we issued $1 billion of senior notes in a public offering with a weighted-average interest rate of 3.8% and used the proceeds from this offering to repay our 6.125% senior notes due in 2012 (the “2012 Notes”). In June 2011, we purchased in a tender offer $700 million aggregate principal amount of 2012 Notes and, as a result, we recorded a pre-tax loss on early debt extinguishment of $61 million in the second quarter of 2011 for the premium paid and other costs associated with the tender offer. In July 2011, we redeemed the remaining $300 million aggregate principal amount of 2012 Notes, and we expect to record a pre-tax loss on early debt extinguishment of approximately $25 million in the third quarter of 2011.
Income Tax Provision
Our effective income tax rate was 34.7% and 35.6% in the second quarter and first six months of 2011, respectively, and 38.3% and 38.1% in the second quarter and first six months of 2010, respectively. The lower effective tax rates in 2011 were primarily due to increased research and development credits and an approximate two percentage point benefit to our effective tax rate in the second quarter of 2011 associated with changes in state tax laws. Because the research and development tax credit was enacted in the fourth quarter of 2010, the related benefit was not included in the determination of our effective tax rate for the six month period ended June 30, 2010.
Net Income Per Share – Diluted from Continuing Operations
Net income per share-diluted from continuing operations was $0.67 and $0.85 in the second quarter of 2011 and 2010, respectively, and was $1.45 and $1.65 in the first six months of 2011 and 2010, respectively. Net income per share-diluted from continuing operations in the second quarter and first six months of 2011 was negatively impacted by $0.26 per share due to a loss on early debt extinguishment. In addition, net income per share-diluted from continuing operations in the first six months of 2011 was negatively impacted by $0.08 per share due to employee severance expenses in the first quarter of 2011. The amortization of acquisition-related intangible assets reduced net income per share-diluted from continuing operations by $0.18 per share and $0.15 per share in the second quarter of 2011 and 2010, respectively, and $0.34 per share and $0.30 per share in the first six months of 2011 and 2010, respectively.
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Liquidity and Capital Resources
General
Our primary liquidity needs are: (i) to fund normal operating expenses; (ii) to meet the interest and principal requirements of our outstanding indebtedness; (iii) to fund capital expenditures and operating lease payments; and (iv) to fund acquisitions. We believe these needs will be satisfied using cash flow generated by our operations, our cash and cash equivalents of $675 million at June 30, 2011, and available borrowings under our revolving credit facility of $972 million at June 30, 2011.
Depreciation and amortization
Net changes in working capital and other
Operating cash flow
Capital expenditures
Our net cash provided by operating activities from continuing operations, or operating cash flow, was $418 million in the first six months of 2011, a decrease of 3% compared with $431 million in 2010. This decrease was primarily due to the timing of working capital, including accounts receivable and accounts payable. Our current policy is to use our operating cash flow primarily to repay debt and fund capital expenditures, acquisitions and share repurchases, rather than to pay dividends. Capital expenditures increased $18 million in the first six months of 2011, compared to 2010, and were less than 5% of our total revenue in the first six months of 2011 and 2010. The increase in capital expenditures was primarily due to equipment purchases associated with a new data center.
In the first six months of 2011, we acquired three companies for an aggregate purchase price of $49 million, and we entered into a definitive agreement to acquire CashEdge for $465 million payable in cash at closing. We anticipate that the acquisition of CashEdge will close by the end of the third quarter of 2011, subject to regulatory approvals and customary closing conditions, and we expect to fund the acquisition with cash and, to the extent necessary, with borrowings under our revolving credit facility.
In the first six months of 2011, we purchased $433 million of our common stock. As of June 30, 2011, we had approximately 6.7 million shares remaining under our existing authorization. Shares repurchased are generally held for issuance in connection with our equity plans.
In July 2011, we received a $54 million dividend from StoneRiver Group, L.P., an entity of which we own 49%, and we redeemed the remaining $300 million aggregate principal amount of our senior notes due in 2012.
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Long-Term Debt
Senior term loan
6.125% senior notes due 2012 (1)
3.125% senior notes due 2015
3.125% senior notes due 2016
6.8% senior notes due 2017
4.625% senior notes due 2020
4.75% senior notes due 2021
Other borrowings
Long-term debt (including current maturities)
In July 2011, we redeemed the remaining $300 million aggregate principal amount of our senior notes due in 2012, which reduced our long-term debt, including current maturities, to $3.35 billion at July 31, 2011.
In June 2011, we issued senior notes due in 2016 and 2021 for a total of $1.0 billion with a weighted-average interest rate of 3.8% and used the proceeds to repay our 2012 Notes. In June 2011, we purchased in a tender offer $700 million aggregate principal amount of 2012 Notes for $754 million and recorded a pre-tax loss on early debt extinguishment of $61 million for the premium paid and other costs associated with the tender offer. In July 2011, we redeemed the remaining $300 million aggregate principal amount of 2012 Notes for approximately $325 million including the early repayment premium and other costs associated with redeeming the remaining 2012 Notes.
At June 30, 2011, our long-term debt consisted primarily of $2.55 billion of senior notes (including $300 million aggregate principal amount of 2012 Notes redeemed in July 2011) and $1.1 billion under our unsecured senior term loan facility. Interest on our senior notes is paid semi-annually. The unsecured senior term loan bears interest at a variable rate based on LIBOR plus a specified margin or the bank’s base rate and matures in November 2012. The term loan facility contains various restrictions and covenants substantially similar to those contained in the revolving credit facility described below.
To manage exposure to fluctuations in interest rates, we maintain a series of interest rate swap agreements (“Swaps”) with total notional values of $1.0 billion. The Swaps effectively fix interest rates on floating rate term loan borrowings at a weighted-average rate of approximately 5.0%, prior to financing spreads and related fees, and expire in September 2012. In addition, we maintain a series of forward-starting interest rate swap agreements (“Forward-Starting Swaps”) with total notional values of $550 million to hedge against changes in interest rates applicable to forecasted fixed rate borrowings. The Forward-Starting Swaps, which expire in September 2012, effectively fix the benchmark interest rate on forecasted five-year and ten-year borrowings at weighted-average rates of approximately 3.2% and 3.9%, respectively.
We maintain a $1.0 billion revolving credit facility with a syndicate of banks. Borrowings under this revolving credit facility bear interest at a variable rate based on LIBOR plus a specified margin or the bank’s base rate. There are no significant commitment fees and no compensating balance requirements. The revolving credit facility contains various restrictions and covenants that require us, among other things, to (i) limit our consolidated indebtedness to no more than three and one-half times consolidated net earnings before interest, taxes, depreciation and amortization and certain other adjustments, and (ii) maintain consolidated net earnings before interest, taxes, depreciation and amortization and certain other adjustments of at least three times consolidated interest expense. The facility expires in September 2014. As of June 30, 2011, there were letters of credit totaling $28 million outstanding under the facility, and we had available borrowings of $972 million. During the first six months of 2011, we were in compliance with all financial debt covenants, including those contained in our senior term loan and our senior notes.
The quantitative and qualitative disclosures about market risk required by this item are incorporated by reference to Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2010 and have not materially changed since December 31, 2010.
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Evaluation of disclosure controls and procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), our management, with the participation of our chief executive officer and chief financial officer, evaluated the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of June 30, 2011.
Changes in internal control over financial reporting
There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
In the normal course of business, we and our subsidiaries are named as defendants in lawsuits in which claims are asserted against us. In the opinion of management, the liabilities, if any, which may ultimately result from such lawsuits are not expected to have a material adverse effect on our financial statements.
The table below sets forth information with respect to purchases made by or on behalf of the company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of shares of our common stock during the quarter ended June 30, 2011:
Period
April 1-30, 2011
May 1-31, 2011
June 1-30, 2011
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The exhibits listed in the accompanying exhibit index are filed as part of this Quarterly Report on Form 10-Q.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ THOMAS J. HIRSCH
Exhibit Index
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Exhibit Description