Business Context and Reporting Period
This summary covers the Form 10-Q filed by Certegy Inc. for the quarterly period ended September 30, 2005. Certegy provides credit card, debit card, and check risk management services through two primary segments: Card Services and Check Services. The filing highlights a definitive merger agreement entered into on September 14, 2005, with Fidelity National Information Services, Inc. (FIS), which will result in Certegy changing its name to FIS and paying a special cash dividend of $3.75 per share to pre-merger shareholders.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2005 | Three Months Ended Sep 30, 2004 | Nine Months Ended Sep 30, 2005 | Nine Months Ended Sep 30, 2004 |
|---|---|---|---|---|
| Revenues | $282.8 million | $262.7 million | $821.3 million | $757.7 million |
| Operating Income | $43.0 million | $44.6 million | $123.4 million | $112.1 million |
| Net Income | $23.3 million | $27.3 million | $94.0 million | $68.2 million |
| Diluted EPS (Total) | $0.37 | $0.43 | $1.49 | $1.06 |
| Operating Margin | 15.2% | 17.0% | 15.0% | 14.8% |
| Cash and Equivalents | $105.3 million (as of Sep 30, 2005) | |||
| Long-Term Debt | $225.9 million (as of Sep 30, 2005) |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenues increased 7.7% in Q3 and 8.4% for the nine-month period, driven by strong growth in North American and international card issuing operations and favorable currency rates.
- Merger and Acquisition (M&A) Costs: The company incurred $7.0 million in M&A costs in Q3 and $8.3 million for the nine months, primarily related to the proposed merger with FIS and a potential joint venture in Brazil. These costs reduced operating income and net income.
- Discontinued Operations: The company completed the sale of its merchant acquiring business in 2005. This resulted in a significant after-tax gain of $27.3 million in the nine-month period, offset by a $6.8 million after-tax write-down of the remaining portfolio. Income from discontinued operations was $0.6 million in Q3 2005 compared to $1.3 million in Q3 2004.
- Segment Performance:
- Card Services: Revenues grew 11.4% in Q3. Operating income increased slightly, but margins compressed due to M&A costs and a shift toward lower-margin products.
- Check Services: Revenues grew 2.8% in Q3. Operating income surged 22.6% due to reduced check guarantee net losses from improved fraud modeling and collection rates.
- Accounting Changes: The company adopted SFAS 123(R) regarding share-based compensation on January 1, 2005, using the modified retrospective method. This adoption reduced diluted EPS by $0.02 in Q3 2005 and $0.06 for the nine-month period.
Guidance, Outlook, and Risks
- Merger Outlook: The merger with FIS is subject to shareholder approval. Upon closing, Certegy will pay a special dividend of $3.75 per share (estimated at $235 million total). The company expects to use proceeds from the sale of its merchant acquiring business to fund taxes on the gain, merger costs, and a portion of the special dividend.
- Brazil Joint Venture: Certegy is in exclusive negotiations to form a joint venture with two major Brazilian banks. While expected to improve revenue growth, contributing existing Brazilian operations could result in a material non-cash charge against net income.
- Risks and Contingencies:
- Impairment Risk: Brazilian operations have net assets of $129.2 million, including a $65.2 million reduction from currency translation. Failure to improve profitability could lead to impairment charges.
- Legal: The company is defending a patent infringement lawsuit filed in October 2004; management believes it has meritorious defenses.
- Synthetic Leases: The company has residual value guarantees on synthetic leases in Florida and Wisconsin with maximum exposures of approximately $18.1 million and $8.1 million, respectively, though no payments are currently expected.
- Liquidity: The company maintains strong cash flows. As of September 30, 2005, cash balances were $105.3 million, and the revolving credit facility was fully repaid. A $100 million share repurchase program remains active with $43.3 million of authority remaining.
Investor Verification Checklist
- Verify the status of shareholder approval for the merger with Fidelity National Information Services, Inc. (FIS) and the expected closing timeline.
- Confirm the final tax treatment of the $8.3 million in M&A costs, as no tax benefit was recorded due to uncertainty.
- Monitor the outcome of the Brazilian joint venture negotiations and any potential non-cash charges associated with contributing existing assets.
- Review the progress of the patent infringement litigation (USA Payments, Inc. v. U.S. Bancorp) for any material developments.
- Assess the sustainability of the margin expansion in the Check Services segment, noting management's expectation that margin growth may moderate in the fourth quarter.