Business context and reporting period
Global Payments Inc. provides electronic payment processing and check-related services through its North America Merchant Services and International Merchant Services segments. This Form 10-Q covers the three months ended August 31, 2012, the first quarter of fiscal 2013; comparisons are with the three months ended August 31, 2011.
Financial performance and position
- Revenue: $590.3 million, up 9% from $542.8 million. North America revenue rose 13% to $426.8 million; International revenue was approximately flat at $163.5 million.
- Profit: Operating income fell 26% to $80.5 million from $108.6 million. Net income was $54.2 million versus $72.1 million; net income attributable to Global Payments was $46.7 million versus $64.0 million. Diluted EPS was $0.59 versus $0.79.
- Margins and expenses: Consolidated operating margin declined to 13.6% from 20.0%, primarily reflecting the processing-system intrusion. SG&A increased 16% to $281.4 million, including higher ISO commissions and corporate intrusion costs. North America segment operating margin was 15.7%, down from 19.0%; International segment margin increased to 34.9% from 33.9%.
- Cash flow: Operations provided $68.6 million, compared with $605.9 million used in the prior-year quarter; the substantial year-over-year change was primarily due to settlement-processing asset and obligation movements. Investing used $28.7 million, including $29.2 million of capital expenditures. Financing provided $6.0 million.
- Liquidity and debt: Cash and cash equivalents were $841.3 million at August 31, including $323.4 million of merchant reserves; management identified $278.0 million as available cash. Total debt was $542.3 million, up from $528.4 million at May 31. The company reported $905.1 million of incremental borrowing capacity and compliance with debt covenants.
- Other metrics: Effective tax rate was 31.4% versus 32.7%. Foreign-exchange movements reduced quarterly revenue by $15.9 million and diluted EPS by $0.04.
Material changes versus the prior comparable period
- Revenue growth was led by the U.S. ISO channel, gaming, direct sales, and lower debit interchange expense following the Durbin amendment. U.S. direct credit and debit transactions grew 12%; Canadian revenue fell 11%, while Canadian transactions grew 3% amid pricing pressure and unfavorable currency.
- The processing-system intrusion added $24.0 million of expense in the quarter and drove much of the decline in consolidated operating income and margin.
- Operating cash flow improved sharply from the prior-year use of cash, principally because settlement-processing movements differed substantially between periods.
- On July 26, the company agreed to buy HSBC’s remaining 44% interest in its Asia-Pacific business for $242.0 million; the amount was recorded as a current liability and the prior redeemable noncontrolling interest was derecognized.
Outlook, risks, contingencies, and unusual items
- Security incident: The company reported unauthorized access to part of its North American processing system in March 2012. Certain card networks removed it from their PCI DSS-compliant service-provider lists; remediation and an independent security review were ongoing. The company continued processing transactions and signing merchants. Potential access to personal information was identified, but whether information was exported was unclear.
- Life-to-date intrusion expense was reported as $108.4 million, including a $67.4 million accrual for estimated network fraud losses, fines, and other charges, and $43.0 million of incurred investigation, remediation, partner-incentive, and customer-protection costs, less $2.0 million of recorded insurance recoveries. The company anticipated $55–$65 million of fiscal 2013 intrusion-related costs, including the quarter’s $24.0 million, before potential insurance recoveries; it estimated possible additional recoveries of up to $28 million. Final network assessments and other exposure could differ materially, and additional possible network losses could not be estimated.
- A putative class action related to the incident was pending; the company had not accrued a loss because it did not consider one probable and could not estimate a range. Further lawsuits or governmental investigations were possible, with potential losses not estimable from the filing.
- Management expected fiscal 2013 capital expenditures of approximately $110 million and stated that cash, borrowing capacity, and operating cash flows should meet foreseeable needs. It cautioned that currency fluctuations and lower consumer spending could affect results.
- After quarter-end, the company closed a new $700 million five-year term loan and increased its revolving facility by $150 million. On October 1, it acquired APT for $413 million plus preliminary working capital of $1.2 million, funded with the new financing; management said revenue was not expected to change materially because it already processed most APT transactions.
- The company’s $150 million share-repurchase authorization was approved in July; 110,000 shares were repurchased in the quarter for $4.5 million. It also disclosed a $92.1 million UK deferred tax asset and $49.1 million of liabilities for unrecognized tax benefits.
Important facts for investors to verify
- Progress on PCI DSS remediation and restoration to card-network compliance lists, final network assessments, and the amount and timing of insurance recoveries.
- Whether intrusion-related costs exceed the $55–$65 million fiscal 2013 estimate, and the outcome or potential exposure from litigation and governmental inquiries.
- Closing and funding of the $242 million purchase of HSBC’s Asia-Pacific interest, and the resulting debt, earnings attribution, and liquidity effects.
- Post-acquisition debt levels and integration results for APT, including whether the expected limited revenue impact and strategic benefits are realized.
- Underlying operating trends by region and channel, particularly ISO commission costs, Canadian pricing and currency effects, and the sustainability of growth following interchange changes.