Total System Services Q2 2006 Earnings Conference Call Transcript (TSS)

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Total System Services (NYSE:TSS)

Q2 2006 Earnings Conference Call

July 19, 2006 8:30 am ET

Executives

Phil Tomlinson - Chief Executive Officer

Jim Lipham - Chief Financial Officer

Analysts

Tony Wible - Citigroup

Paul Bartolai - Credit Suisse

Cannon Carr - CIBC World Markets

Robert Dodd - Morgan Keegan

Tim Willi - AG Edwards

David Scharf - JMP Securities

David Parker - Merrill Lynch

Operator

Good morning, ladies and gentlemen and welcome to TSYS second quarter 2006 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Phil Tomlinson. Sir, the floor is yours.

Phil Tomlinson

Thank you very much, and welcome to our second quarter earnings call. We’re sitting here in Columbus, Georgia. The high today, temperature-wise is suppose to be about 100 degrees here, so I hope it’s a little more comfortable wherever you are at.

Before I get started, as usual, I need to call your attention to the fact that we’ll be making a lot of forward-looking statements about the future operating results of TSYS, and these forward-looking statements involve some risk and uncertainties. Factors that could cause TSYS’ actual results to differ materially from the forward-looking statements are set forth in our reports as filed with the SEC.

We’re very excited about our second quarter. We feel like we’ve really started to see some fruit from our efforts here. It certainly met, and in some ways, exceeded our expectations. As you know, for the second quarter earnings per share growth increased 13.3% to $0.29 a share. Core organic growth increased 9%, and that is a very important number for us every month. That’s back to historic levels. Revenues increased 4.6% to $429.2 million. A fact that we’re very proud of is we had a pretty significant increase in our operating margin quarter-over-quarter, 23.1% to 24.7%.

For the first six months, our earnings per share increased 11.4% to $0.55 a share. Our core organic revenues increased 8% for the six months. Total revenues increased 10.7% to $841 million. The drivers, of course, for a lot of that growth was the fact that JPMorgan Chase was not with us during the second quarter of 2005, and that is certainly reflected in this quarter. The discounts that we gave Citi Sears in the second quarter of 2005 were not given during this quarter, which has been a positive impact on our financials.

Also, probably a little known fact, Citi Sears did stay for an additional month. They didn’t convert when they had anticipated. It was about a month late, and that has occurred in late June. They have moved on. As a result of that, total accounts on file are down 16% compared to year-end 2005.

We had strong internal account growth on file of 12.6% or $36.5 million. When you start looking at our transaction growth, it continues to grow on both sides of the house. The card issuing and acquiring on TSYS Acquiring Solutions, transaction volume on the front end was up 14% during the second quarter year-over-year. As a part of that process over the course of the last two quarters, TSYS Acquiring Solutions has renewed long-term agreements with four of their top 15 clients. Most recently that was Heartland Payments which, as you know, went public several months ago.

We continue to execute contract addendums with existing clients for additional products and services such as gift cards, enhanced statements, e-connections, electronic products. As you’ve heard me say over the years, this cross-selling effort is something that we are working very hard on, and it pays strong dividends as we make good progress.

I know you are interested in getting to the numbers, and I’m going to go ahead and turn it over to our Chief Financial Officer, Jim Lipham.

Jim Lipham

Thank you, Phil. I’ll ask everyone to look at the P&L that was with the press release, and I’ll add some color to the line items there. I’m going to be repeating a few things that Phil said, I apologize for that, but just so you get the picture on each line items.

I’d like to start with the electronic payment processing revenue line. It’s up 7% for the quarter at $15.3 million, up 7.5% year-to-date for the six months. Phil mentioned that we didn’t have the Chase revenues last year at this time. There’s also convergence that went on last year with ABN Amro, Fleet, Fifth Third, all those added extra revenues to our line this quarter.

Also, he mentioned the strong internal growth on accounts on file of 12.6%. At the end of June you will see our account totals are down to $366.8 million, and that’s when Sears left around June 26. The loss of Sears didn’t really impact the earnings during this quarter.

International revenue for the quarter, it increased 8.8%. For the six months it is up 10.9%, and I’ll talk a little bit later about the CTA effects on that. We had strong growth in our revenues from our mix in clients as we mentioned in the first quarter. They continue to show good growth; 71% for the quarter and 60% year-to-date. That’s all as a result of anniversarying those client deconversions that we had, and the addition of new clients such as Fero.

I mentioned the international revenues, especially in Europe, negatively impacted by the currency translation first quarter is about $1 million. This second quarter, for the year-to-date, it’s about $4 million. So it’s $1 million for the quarter and $4 million for the year-to-date.

Our value-added service lines continue to show good growth, it’s up $5.8 million or 11.7% for the quarter; $12 million or 12.6% for the year-to-date.

Phil mentioned our authorization growth. Our billable authorizations grew at 9.8% for the quarter, and 13.4% year-to-date. Our transaction volumes grew at 8.4% for the quarter and 13% for the year-to-date. The total authorizations billed were approximately $1.3 billion for the quarter and $2.5 billion for the year. Transactions ran about 1.4 billion for the quarter and 2.7 billion for the year, so we’re seeing some growth in the second quarter over what we had in the first.

Dropping down to the merchant services line, for the quarter, it is down when you compare it to last year. When you look at the six month number, you’ll remember that we only had Vital for four months last year.

During the first quarter of this year, we told you we closed the San Diego sales office of our POS and System Services unit. It was very low to no margin business. It did have $4.4 million in revenues in the second quarter of ’05, and that’s a lot of what the drop is for the second quarter. Then we’re also still expensing some reduction in revenue associated with the Bath and [MDEX] product implementation.

The good news on TSYS Acquiring is that the revenue growth is there sequentially from the merchant services line. Front end transaction volumes, as Phil mentioned, grew at 14% for the second quarter and they have renewed four of their top 15 Acquiring clients. They’re also expanding their products and service offerings with existing clients for gift cards, enhanced settlements and e-commerce.

They continue to develop new products to be introduced later this year in the merchant cash advance services area in the third quarter, enhanced merchant statement capabilities, and promoting the contactless payment, and continuing to expand on gift cards.

Their service area is outstanding for the quarter. They were at the high end of all of their service indices with POS and the Acquiring service side. We are very pleased with where TSYS Acquiring Solutions is headed. We continue to expect great things from them as the year goes on.

The other services line, revenue for the second quarter decreased 1.4%. For the six months, it decreased 4.9%. The decrease there is a result of the lower volume in the attorney fees and the bankruptcy business. Total Debt Management is about $2.1 million for the quarter. We did experience some greater growth in our ESC redemption business for the loyalty product of about $1.2 million.

Year-to-date we’re down because of lost volumes in the call center. If you remember back in the first quarter, we talked about a loss of AT&T, Advanced Auto. We also had a one-time item hit in the first quarter of ’05 of a $1.5 million termination fee associated with a backup servicing arrangement. So year-over-year, we’re down about 4.9% on that line.

I will mention during the quarter we did renegotiate a contract with Capital One for our Total Debt Management unit, and it’s going to change the way we recognize our court costs and attorney fees. As you know, these fees will now be treated as reimbursable items and there will be a reduction in revenue. You’ll see in this line for the rest of the year as we move what was previously being recorded as revenue, it will go into the reimbursable line for revenues and expense. So for the third and fourth quarter it will be reclassed. That was about $1.6 million again for the second quarter.

Total revenues for the second quarter increased 4.6%, and for the year, 10.7%. When you exclude reimbursables, we experienced fundamental growth in revenue of 3.5% for the quarter and 10% year-to-date. The valuation adjustments that came into play for the second quarter, we had a decrease of about $1 million related to the translation, and for the six months we’re down about $4 million on the CTA. So it’s has gotten better during the year, but we were hit pretty hard in the first quarter.

As we continue down the page, this is the first quarter that we’ve had comparisons with the full quarter of Vital in our numbers. We’re very excited about where we are with this almost flat growth in total expenses. The employment line is up 3.8% or $4.5 million for the quarter, and 13.5% for the year, about $28.8 million. Included in the second quarter, we had results again of recording stock option expense. That resulted in an additional $1.7 million of expense in the quarter, and $3.5 million for the first six months.

We continue to make great strides in redeploying our resources and making efficient use of our people. Our headcount is being managed through attrition as we lowered the number of employees by 150 since December.

Our occupancy and equipment expense grew at 8.8%, roughly $75.7 million in the second quarter. We did add some more equipment as we continue to work toward the convergence later on this year. As you remember, some of our software licenses are under processing or MIP arrangement, amortized using the units production basis. It has required us, because of the scheduled deconversions, to accelerate some of the amortization. This all should pass as we go through these deconversions. Since the deconversion of Citi Sears in June, we have started our MIP reduction as planned, and are expecting to see some reductions there going forward.

The other expense line was down 10.5% for the second quarter, and was up only 2.3% for the first six months. There are two or three big items in there. We mentioned earlier about closing the Vital POS business, and it was very low margin to zero in the first quarter. So we saw a reduction in their cost of goods sold, about $4 million. We had some one-time expenses in ’05 that hit us related to some litigation that was going on that is not there now.

Then on the re-class of TDM, Total Debt Management fees, the attorney and court costs were about $1 million, almost close to $2 million. That’s what resulted in that decrease. We should see some decreases or some real low growth there as we go forward with these re-classes and the loss of that business with Vital.

Excluding reimbursables, our profit margins increased for the quarter to 24.7% from 23.1% in second quarter ’05. This is mainly due to the real focus on controlling our largest expense of people. For the first six months our operating margins remain the same, as they were year-to-date last year, 23.3%. We do expect our margins to remain in the 23% or 25% range as we continue through the year.

As a result of increasing our amount of cash available for investment and the changes in the short-term interest rates, interest income increased $2.3 million for the quarter and $3.6 million for these first six months.

Income taxes for the quarter increased 16.5% and 9.2% for the first six months. During the first quarter we settled items, as you will remember, regarding our multi-year federal income tax review with the government, and recognized a net benefit in the quarter. We still anticipate our effective tax rate for the year to be in the 35% to 36% range. The effective tax rate for the quarter was 35.3% compared to 34.8% last year.

Net income for the quarter was up 13.4% or $6.8 million and 11.4%, or $11 million for the year-to-date. The earnings per share, $0.29, up 13% over the 26% for the second quarter last year. Very good quarter and very good six months.

I’d like to mention just a few things on the balance sheet and the cash flow before turning it back to Phil. If you look at the balance sheet, you’ll see our cash is at $295.5 million. We increased it since December $57.9 million, and since the end of the quarter, we did purchase TSYS Card Tech for a total consideration of around $58 million, so we used up that increase right here after the quarter. Still good growth in our cash.

Looking at the cash flow statement, you’ll note our significant contribution when compared to last year of cash generated from operating activities of $129 million roughly. We invested about $14 million in property and equipment, mainly in hardware, and $13 million in software, $4 million of it being purchased and $9 million being developed. We do not anticipate any major capital expenditures in the next six months, and probably will end the year in the $50 million to $70 million range, which will probably be mainly in software.

Free cash flow analysis, our free cash flow was $63.4 million for the quarter compared to $54.3 million last year during the second quarter, and $80.9 million for the first six months compared to a deficit last year of $13 million. As a result of our management’s continued focus on controlling expenses and redeploying headcount, we believe we are on target to achieve the high end of our earnings forecast, 21% to 23%.

With that Phil, I’ll turn it back over to you.

Phil Tomlinson

Thank you, Jimmy. Good report. I just want to go over a few other things that I thought were just great highlights for the quarter. Obviously, the first one that I want to talk about is our recent acquisition, really last week, of Card Tech Limited out of London. As you know, their operations are in Cypress.

We think this acquisition is incredibly strategic to us. They have 190 customers; the vast majority of them are banks in the card business. They are in 76 countries. They are not a new kid on the block; they’ve been around 16 years. It will allow us a couple of options that we have just never had in the past.

One; it gives us a piece of software that we can sell, particularly into smaller banks as well as into countries that we’re just not prepared to build TSYS to go to that country. In other words, we’re not prepared to spend the money on the functionality and all that would be needed to go to that country.

That doesn’t limit Card Tech to just small countries. These guys have contracts with some of the biggest banks in the world. They have great products. They have a credit card processing product, a debit card processing product, a merchant processing, installment loan, all the peripheral products that go along with that such as fraud, customer service, credit approvals and such. So it gives us just another great set of tools in our kit to be able to go to the marketplace and it really enlarges, it really expands our global footprint around the world.

You’ve heard us talk on many occasions before that long term we are going to have to be better at growing our international business. This is one of the things that we just felt was necessary. As I say, we are very excited about it. I think the team members at Card Tech are also very excited, so we’re just going to turn them loose and tell them to keep doing what they’ve been doing, which is good.

We didn’t change our numbers because of Card Tech. We’re looking at it on a very conservative basis, but they are profitable. They are going to do well, and as I said earlier, we’re excited about it.

Also, we announced that we had signed a long-term card processing agreement with Wachovia, who you all know very well is the fourth-largest bank holding company. We are going to be providing their core processing. They are re-entering the business after about a seven or eight year hiatus. I think they are really excited about it and we believe that in several years they will be one of our largest customers.

We also signed an agreement with MoneyGram Payment Systems for our real-time loading of TSYS process prepaid in Visa and MasterCard at MoneyGram’s 26,000 locations in the US. We still believe very strongly that this prepaid business, as it matures, is going to be a great business to be in, and we’re going to be a key player.

TSYS Acquiring Solutions also signed agreements with new customers, Delta Payment Solutions in Texas and the New England Bankcard Association in the Boston area. So we are very excited about that.

One thing that we talked about a lot after the announcements of those losses last year was how we were going to control expenses. I will promise you this: I don’t think I’ve ever seen a team that could galvanize any more or any better, and come together on dealing with our expenses. Our people are doing a great job. There has been a culture shift here. We’ve had a lot of growth for a lot of years, so it’s difficult sometimes to change the way that ship is turning.

We believe our expense controls are working and we think you are going to see the benefits of that as time goes by. We have re-negotiated with most all of our key vendors. We’re happy with those relationships. We believe that they have treated us fairly in a difficult time and we will remember that.

As Jimmy said, transactions for active accounts continue to grow and more transactions are good for TSYS. Our internal growth continues to be strong. The big conversions that we are working on with Capital One and Toronto Dominion and a large retailer are all on track. I cannot see at this point, any reason that they would come off track.

Of course, I wanted to tell you, Bank of America, as far as we know, is still scheduled to leave in early October. We fully expect that to happen and we're planning for that to happen. We continue to look at available opportunities out there, new business, acquisitions such as the Card Tech. We are very cash rich right now. We've got a little over $300 million in cash in the bank.

We have, I think, as I said before, the gold standard in technology and service and in people. So while we've had a rough six or seven months, I had to laugh this morning when I saw that cruise line with a ship that tilted about 30 degrees, I think about last October. I felt like the captain of that ship where I thought this ship had tilted 30 degrees. But we're up right, we’ve got smooth sailing ahead, we're moving forward and TSYS is going to be fine. We've got the right attitude and we've got a lot of positive things going on. So with that I think I'll just open it up for questions and see what you want to talk about.

Question-and-Answer Session

Operator

(Operator Instructions) Our next question comes from Tony Wible – Citigroup.

Tony Wible - Citigroup

Hi guys.

Phil Tomlinson

Hi. how are you, Tony?

Tony Wible - Citigroup

Very well. I was hoping to spend a little bit of time on some of the guidance comments that you made during the course of the call. Did I hear correctly that the new margin outlook is for 23% to 25% which compares to the old of 21% to 22%?

Jim Lipham

That's correct.

Tony Wible - Citigroup

Okay, and then you mentioned on this real quickly, but the Card Tech acquisition plus the fact that you have Sears for an extra month, you're not changing the top line. Is that really just a function of conservatism or is that the reflection of just the mix of revenues becoming more profitable but yet lower revenue per account?

Jim Lipham

It's really a little bit of all of the above. I mean, we've said before that we believe we'll be at the high end of that range.

Tony Wible - Citigroup

So should we expect for the reimbursable items you indicated that should be going higher, by how much per quarter?

Jim Lipham

It is going to probably be in the neighborhood of $4 million a quarter associated with the Total Debt Management.

Tony Wible - Citigroup

Great. Then on Chase, you guys had provided guidance before your Analyst Day that incorporated Chase into the guidance. Is it possible just to breakout that component of guidance that's related to just Chase? Meaning what are your assumptions on that particular contract? Are you assuming that it goes in-house and would that be a neutral event in that guidance? Or would you anticipate that to be a little bit of a hit?

Jim Lipham

Obviously when they take it in-house, we have to continue our expense reduction moves that we have going on today, or reallocating or redeploying resources. Obviously the license fee will kick in once they take it in-house, and we'll have very high margins on that license fee due to the amount of support that will be required will be very low.

Phil Tomlinson

Tony, the difference in the Chase deal is we have planned from day one for that deal. I mean, we've got a people plan, we've got an equipment plan, we've got a space plan. So when they walk out the door late next summer, which is the date -- we don't have an exact date yet, but we will at some point. We've been planning for that since the day we signed the contract. I think we're going to be fine with that.

Now we'd love to keep them and certainly we tell them that every day, but we're planning on them leaving. That was the way the deal was signed and I expect that's the way it would happen.

Tony Wible - Citigroup

Is it fair to say that you're anticipating it to be just a net neutral event after cost reductions and getting licensing fees?

Jim Lipham

I would think so, Tony.

Tony Wible - Citigroup

Last question: at the Analysts Day you guys had mentioned a lot of new contract prospects. I was hoping you could bring us up to date as to how many accounts could be in the pipeline and how much of that account mix is international?

Phil Tomlinson

Well, we've announced several. Obviously we announced Wachovia while we were in New York. But we have some good business in the pipeline, we just have not consummated contracts on it. I think you'll start seeing some things fall here in the next quarter. But today we probably have 75 million accounts in the pipeline that will start converting here in the very near future. It really starts in the next couple of weeks.

Tony Wible - Citigroup

The 75 million you have signed in the pipeline, is there a way of putting a rough estimate on unsigned prospects?

Phil Tomlinson

No, I wish there was. I've been down that road too many times where I just would have bet you my house that the guy was going to sign the contract and something blew up in the process.

Tony Wible - Citigroup

Understood. Great quarter, guys.

Phil Tomlinson

Thank you.

Operator

Our next question comes from Your next question is coming from Paul Bartolai - Credit Suisse.

Paul Bartolai - Credit Suisse

Thanks, good morning, guys. First question just on the revenue side. Were there any one-time fees or termination fees from Sears or Citi or anyone else?

Jim Lipham

No.

Paul Bartolai - Credit Suisse

Then just looking at the volume numbers, looks like they were -- for both the bank card side and Vital -- were down a little bit from the first quarter. Can you just talk about any trends you're seeing there on either of those, or is there some type of other factors impacting that?

Phil Tomlinson

Well on the Vital side, we talked about the change in Vital Merchant Services, but there's no real change in loss of customers. Vital had some renegotiated contract price concessions, but no, there's nothing really that I can think of.

Paul Bartolai - Credit Suisse

On the transaction authorization side for the bank card side? What did you say those numbers were?

Phil Tomlinson

I think the transactions are, it's good growth in the season. I know Vital’s was up for the second quarter and billable transactions in the 8% to 9%, that's good growth.

Paul Bartolai - Credit Suisse

Okay, great. And then on the international side, looks like the profitability improved pretty nicely there. Can you just talk about what you're seeing in terms of profitability and what your expectations are going forward?

Phil Tomlinson

Well, I think it has increased and I do believe that we have some, as I said earlier, some great opportunities on the international side. And I think you'll see some announcements coming in the third quarter on the international side that will, at least make our day. As far as trying to project out where that's going to be -- we have said on numerous occasions that we have to have international growth in order to be successful long term. It's one of the key tenets to our business. So we're pushing very hard on international, as you can see by the Card Tech acquisition.

We think that is going to be a catalyst. We've already had great reviews on that transaction from the business side of the house or the industry. I think you're going to see us make some good progress as a result of that. It gives us options that we just have never had.

As an example, this software is double byte enabled. That allows us to go to any of the countries in the Asia Pacific today as opposed to having to go spend $30 million to $50 million in retrofitting systems that we have. Now, does that mean that TS2 is not a great system? No, TS2 is still a fabulous system. I think we've always said TS2 is not made for every card-issuing bank in the world. It's really built for larger issuers.

Paul Bartolai - Credit Suisse

On Card Tech, can you give some sense of the revenue magnitude? Will that be in the electronic payment processing line?

Jim Lipham

The Card Tech revenues, they're on line for their forecast and what they had told us they would do for '06 was $32 million. They are on line to do that at this point.

Paul Bartolai - Credit Suisse

And which line item will that show up?

Jim Lipham

It will show up in the electronic payment processing line.

Paul Bartolai - Credit Suisse

Okay, great. Thanks.

Operator

Our next question comes from Cannon Carr - CIBC World Markets.

Cannon Carr - CIBC World Markets

I just wanted to understand a little bit more just on the margin for the quarter. Sounds like you haven't really been able to take out the cost side ahead of B of A, obviously, and even with Citi and Sears, right? So no real cost reduction progress there yet?

Phil Tomlinson

Yes, you can't take it out until the day they leave. You can't even start.

Cannon Carr - CIBC World Markets

So the stronger margins this quarter, would you attribute most of that then to just the extra time that Citi Sears was on the books and a little bit from the JP Morgan Chase impact?

Jim Lipham

I think, yes, Citi Sears being online for another month was good. But I think if you remember the reductions that we had in the other expense line, as well as the 150 reduction in headcount, I think that was what really contributed to the margin increase.

Cannon Carr - CIBC World Markets

Great. Thanks. Just anecdotally, transaction volumes generally sounds like they are staying relatively solid. Any view on how the consumer is spending in terms of using credit and debit? Is that still, in terms of number transactions, staying robust like you thought it would at this point in the year, given just the concerns about the economy?

Phil Tomlinson

Well, I think that what we're seeing -- and you can probably get better stats from Visa and MasterCard because they publish this, but -- transactions are increasing, not necessarily the dollar amount of the transaction. Although, obviously at the gas pump that number is increasing. But we like where we are with transaction progress.

Cannon Carr - CIBC World Markets

You don't feel like you're seeing transaction volumes change even as of June or anything like that?

Phil Tomlinson

No, but Cannon, they are somewhat cyclical. If you took the last 15 years of transaction volumes, authorizations and transactions, that trend you can just overlay it. Some months are certainly better than others. Obviously around the big holidays we have huge increases. You may not think it's a big deal, but Nordstrom’s is one of our great customers and they have that once a year sale that's going on right now. It is a really, really big deal for us and them. That can make a difference almost by itself.

Cannon Carr - CIBC World Markets

Right. Okay. Great, thanks, Phil.

Phil Tomlinson

Thank you.

Operator

Our next question comes from Robert Dodd - Morgan Keegan.

Robert Dodd - Morgan Keegan

A question on additional acquisitions beyond Card Tech. Obviously that's going to strengthen your position, by the sound of it, somewhat in Cypress and the Far East. What about the large markets like Western Europe, which are currently dominated by a consortia of banks? What are the opportunities for you to acquire or buy into JVs in those markets and how is your financial capability to do that if an opportunity does arise?

Phil Tomlinson

Well, Robert, we've got $300 million in cash sitting here that we really would like to do something with most of it, as opposed to just leaving it in the bank. But we do think that there are opportunities in Western Europe. Western Europe reminds us a lot of the US 25 or 30 years ago when the US had all of these associations and they did not survive because they frankly just weren't competitive. They just couldn't compete with the real aggressive players.

I fully expect that to happen in Western Europe. I don't think that they will survive long term. We know a lot of them and we've talked to a lot of them. So we do think there's some opportunities there. We think that with this Card Tech software, I can't recall off the top of my head how many clients they have in Europe, but it's 50 or 60 at least. That gives us entry, we believe, into a lot of card-issuing organizations that we would have had to start from scratch.

So all of a sudden we have relationships, business relationships with 190 customers in Eastern and Western Europe, India -- which certainly you have to keep your eye on -- China, Japan. It really gives us a different view of the globe.

So we're very excited about Western Europe. Obviously the big difference in Europe and the U.S. is you just don't have the mega-issuers that you have in the U.S. But we're excited about it and we do think there's great opportunities there for JVs and we have a good history of being able to put those together and make them work.

Robert Dodd - Morgan Keegan

On the merchant side there are the mega-acquirers, it's a much more concentrated market than we've got in the US. So how would the Vital type model, how do you think that would work in Western Europe? Or would you have to buy into a JV with one of the large existing acquirers?

Phil Tomlinson

Well, like I say, we believe there are opportunities on both sides of the house, really on three sides: on the credit card issuing, the merchant side of the house and the debit processing side of the house. We know most of those mega-issuers or acquirers well. We certainly are trying to build strong relationships with them. And I would just say stay tuned. We think Europe right now is a great land of opportunity.

Robert Dodd - Morgan Keegan

Okay. Thanks.

Phil Tomlinson

Thank you.

Operator

Our next question comes from Tim Willi – AG Edwards.

Tim Willi - AG Edwards

Hi, it's Tim Willi with AG Edwards, good morning.

Phil Tomlinson

Hi, Tim.

Tim Willi - AG Edwards

Good morning. Two questions. One is, Phil, I was just wondering on the heels of that prior discussion there, as you look at Card Tech and it's vast geographic expanse, are there any one or two areas where you really expect to push the franchise versus just letting it grow as it had been?

Phil Tomlinson

Yes, I think there is, Tim, and I think it's a good question. One is the Pan European marketplace and as I said, India. We have never really pushed hard in India. They have some very fine customers in India. What we would like to do is, they're primarily in the software sales business and they've got a great product. As I said earlier, they do business with not only a lot of smaller issuers, but some very, very large issuers.

We really have been somewhat surprised by their latest prospect list. We're very excited about some things that are happening there. The model that we would like to be able to do is take those 190 customers that they have, and as they mature, as their business changes, give them the opportunity to move to a long-term processing relationship.

Now, that's easier said than done. Some people would have no interest in that whatsoever. It's just a timing issue. So we do believe that it gives us great, great options that we have never had in the past. Our competitors have always had some software to sell to issuers. I think it's been a smart move on their behalf. They've done well with that and they have sold a lot of it. I think it's helped them with relationships down the road. I just think this really adds another arrow to our quiver of sales tools that we have.

While it's not a small Company, it's not a large Company, they are very good at what they do. And we have been very impressed. This thing has taken a year to get done. It took longer than what we had ever imagined. I think the management is going to stay. I'm sure the management is going to stay. We've spent a lot of time with their key people. They're excited about the prospects.

So I would say we're very opportunistic, but Eastern and Western Europe, Latin America, India, and the Asia Pacific region is exploding. We don't need this software for our CUP Data deal in China, but we could take it there at some point if we needed to. This software does function in China.

Tim Willi - AG Edwards

Okay. Second question I had is just asking you to repeat some numbers. Jim, I'm sorry I missed the earlier part of the call. Regarding Merchant Services or TSYS Acquiring, could you add any comments or repeat comments you had regarding pricing trends in that business? Whether there are any other sizable contracts up for renewal in the next year or so that could impact the revenue growth you report, because of the likelihood of price and concessions?

On that point, as well, when you would expect to see reported year-over-year growth for TSYS Acquiring, understanding that to shut down that one unit, which does hurt you for another quarter or two?

Jim Lipham

As far as the contracts go, I don't know of anything that's up for renewal. I think as far as the quarters, we will not see much growth for the remaining two quarters of this year as we close that unit down, as you mentioned. That will kind of hold it down. Also we had some price concessions on some of these renewals that we did, that will have to anniversary which will be probably in the first quarter of next year.

Tim Willi - AG Edwards

Okay. You look at just the existing pricing environments for all of the other moderately-sized contracts that you're renewing or as you pitch new business? Is there any change from the traditional pressure that we see in the marketplace?

Phil Tomlinson

Tim, this is Phil, I don't think there's been any changes. Always downward pressure and particularly from the very large acquirers. I think Vital's real bread and butter is the medium to small acquirers who really just want a great product at a very, very good price. So they have really done well in that market.

The large acquirers will always be putting pressure on us and they'll always be considering whether they should move for a couple of basis points. So it's a great business to be in, but it's a very hard business to be in. We have to leverage every expense we can, particularly things like network costs and people costs. I mean you just have to be smart enough in that business to be a low-cost provider to be successful.

I think that our folks at Total Acquiring Solutions are absolutely in that category. They run a very lean, clean shop.

Jim Lipham

I think that's one thing I'd like to add on, since you missed the first part of it, is that even though their revenues will not be growing that much, their margins will be improving. The business that's not there anymore had no margin to it.

Tim Willi - AG Edwards

Okay. Great. Thank you very much.

Jim Lipham

Thank you, Tim.

Operator

Our next question comes from David Scharf - JMP Securities.

David Scharf - JMP Securities

Phil, a couple of directional or strategic questions. First, taking a step back and looking at the Chase business heading in-house and then the acquisition of Card Tech, another license provider; as you look at your acquisition pipeline and perhaps the pace of outsourcing trends in some countries -- or lack of pace -- is there a point in time just a couple of years out where we could be seeing as much as 15%, 20% of TSYS business model being an in-house license model? Do you see the Company ultimately trending towards that or potentially, is the reverse true? Is Card Tech ultimately something you can provide on a host basis?

Phil Tomlinson

I don't see that trend, David. We've had a couple of guys go in-house. We have really sat down and really examined the process and what happened and the reasons for that. We think that the outsourcing model is stronger than ever. We believe that Card Tech will ultimately be a tool that we can use to, as I said earlier, to take some of these 190 customers to a processing model. We know we can do that. We've talked to some of these clients. We think this will just help us through that process.

But we think the outsourcing model is strong as it's ever been. We are better at it than we've ever been. I think the key to our deal is we absolutely have to be a low-cost provider with a high, high level of service and great technology. That's what we're working on. We've also got to figure out how to continue to grow this business, and we believe things like Card Tech gives us just more options.

When you look at the list of Card Tech customers, if we were to move two or three of those to the processing model, we've more than paid for Card Tech - day one. It's just that attractive to us. So we're excited about that. We do think the outsourcing model is healthy and we're going to continue to push. Now will we sell software? Yes, we've said before, there are three or four people in the world that we would sell TS2 to. That's about it, though. We don't consider ourselves as a software vendor, as far as selling software.

We wanted to do this deal with Chase, it was important to us. We've done a deal like that two or three times over our 30-year history. Nobody really up until this point has ever seriously considered taking us up on the option, but I do expect these guys at Chase to do it.

David Scharf - JMP Securities

Got you. I was referring not so much to the Chase model, but rather in combination with acquiring Card Tech, an in-house provider, whether you saw a pretty active pipeline of licensed providers and if that was in the cards.

Phil Tomlinson

We do see an active pipeline. They have a strong pipeline. But we see that as an extended pipeline to some degree. In other words, as they continue to add and continue to grow -- and they do have good products. We're very happy with the products that they have built. In some ways, you can get these smaller banks up faster.

But we do believe there's a market to take these banks that are processing in-house on Card Tech software to our processing model over a period of time. We're going to be working hard on that.

David Scharf - JMP Securities

Perfect. Can you give us a general sense of the growth at Card Tech in the last couple of years?

Jim Lipham

The last couple of years their revenues have grown in the 15% range. They were formed, I think, in 1989, so like I said, this is not some three-year-old company that just showed up.

David Scharf - JMP Securities

Perfect. The last question relates to the other services line. Total Debt Management, some of the output services. I know there's been some revenue reclass, but it's essentially been in that flattish $45 million of revenue per quarter range for close to seven or eight quarters in a row. Have you been rethinking strategically whether looking forward those are still businesses you want to be in? Conversely, are you looking at other outsource processing businesses you want to expand into in that line?

Phil Tomlinson

We are looking at some other processing businesses, but those businesses that you're talking about, TSYS Prepaid and TSYS Loyalty, we absolutely want to be in those businesses. I'll give you a great example, if I can just be straightforward. When we look at our TSYS Loyalty company, we bought them and they were a very small company. They had a great product, they didn't have a lot of capital.

We have been in a build-up phase with TSYS Loyalty now for about 18 months. That's about to come to fruition. You have this small 150-person Company in Atlanta that has had to totally integrate into our systems to where we're not running two systems. At the same time, they're in the process of dealing with how do you deal with monster customers such as CapOne and Washington Mutual and Home Depot and Toronto Dominion? We are on the cusp of moving a lot of that business into that little company.

They've been shell-shocked, to be honest. We've had to send them a lot of help and, I think as a result of it, they're going to be a much better operator. So that's an example of a company that really is going to go from doing okay to doing very well almost in a six-month period, because all of that business is moving to them.

That's the model that we wanted to play with, that we felt like we could sell our customers on doing a totally consolidated process; doing all the card processing here, the Loyalty processing, the Prepaid processing. This is just a grand example of how that is successful at this point.

Now, I think you'll have to look at what I'm saying in a year from now, or six months from now, and say gosh, you really knew what you were talking about, or you didn't. But we believe that we're making great progress there.

On the Prepaid side, we've had some problems. We have had some management issues. We've changed management. We believe that we are just about to get there. We've had some difficult issues. We have some new people on site. The people that are there are all fine folks. We're thrilled, but we've just had some issues that we've had to deal with.

I'm still incredibly optimistic about TSYS Prepaid and the prepaid business in general. What we had primarily at TSYS Prepaid was one-time deals, if you will, where you had to go out and sell a product to typically some consumer company. We're trying to change that model to a recurring revenue model, much like the card processing business.

We'll certainly sell to one-time projects, these rebate cards and these things like that. But we're really trying to focus in on people and prospects who would have some sort of recurring revenue model. Frankly, it's a business that we've had to learn because we really didn't know much about either one of those businesses. But we're optimistic that we're about to turn the corner on those.

David Scharf - JMP Securities

Perfect. That's all. Great quarter, guys.

Phil Tomlinson

Thank you.

Operator

Our next question comes from David Parker - Merrill Lynch.

David Parker - Merrill Lynch

Good morning, everyone.

Phil Tomlinson

Hi, David.

David Parker - Merrill Lynch

You've said that the CapOne portfolio is set to convert some time in the fourth quarter. Can you remind us when Toronto Dominion and the large retailer are set to come on the TS2 platform?

Phil Tomlinson

Around the same time.

David Parker - Merrill Lynch

So none of those relationships are going to impact Q3 results?

Jim Lipham

No.

David Parker - Merrill Lynch

Can you just provide an update on the business in China and your relationship with CUP Data?

Phil Tomlinson

As a matter of fact, we've just moved another key individual from Columbus to China. He's on his way there as we speak. We're very excited about where China is. Obviously as you know, they still have not issued millions and millions of cards there. But I think the latest stat that I saw is there are 30 to 32 card-issuing organizations in China today and CUP Data has got 26 of them.

It's going to take some time to build this thing up. We have said that. We continue to believe that you have to be in China if you're going to be in this business. We do have the strongest partner in the land; they are the national, they are the Visa and MasterCard all rolled into one. We are one of the largest shareholders of that.

I think our working relationship is really starting to happen now. One of the things they wanted from us is, how do you become a world-class processing organization? That's what we're trying to deal with in China right now.

We're very excited. We've had a couple of board meetings. Any time you go there, you cannot help but get excited about it. But we're still very bullish on our opportunities in China.

David Parker - Merrill Lynch

You're still set to increase your ownership in CUP Data at some point?

Phil Tomlinson

Well, we're certainly trying to. Anything that happens in China, it can change on the hour. Nothing is as simple as it seems on the surface. But we do fully expect to go forward with that. If anything were to change on that issue, we would certainly let you know.

David Parker - Merrill Lynch

Great, thank you, guys.

Phil Tomlinson

Thank you, David. We've got time for about one more question and then we're going to let you guys go to work.

Operator

Mr. Tomlinson, there are no further questions in the queue.

Phil Tomlinson

Well good. Listen, we have really enjoyed it. We're proud of the progress we're making. We're excited about our future opportunities. We appreciate your interest and encouragement and look forward to chatting with you in the meantime. So thank you for taking time to be with us this morning.

Operator

Thank you, ladies and gentlemen, this does conclude today's conference call, you may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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