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Global Payments, Inc. (NYSE:GPN)

F4Q09 Earnings Call

July 23, 2009 5:00 pm ET

Executives

Jane Elliott – Vice President, Investor Relations

Paul Garcia – Chief Executive Officer

James Kelly – President, Chief Operating Officer

David Mangum – Executive Vice President, Chief Financial Officer

Analysts

James Friedman – Susquehanna

Thomas McCrohan – Janney Montgomery Scott

Tien-tsin Huang - JP Morgan

Darrin Peller – Barclays Capital

Andrew Jeffrey – Suntrust

Bryan Keane – Credit Suisse

Julio Quinteros - Goldman Sachs

Kartik Mehta – Northcoast Research

David Koning - Robert W. Baird

Moshe Katri – Cowen and Company

Larry Berlin – First Analysis

Greg Smith – Duncan-Williams

Jason Kupferberg – UBS

Robert Dodd – Morgan Keegan

Jason Deleeuw - Piper Jaffray

Operator

Welcome to Global Payments’ fourth quarter fiscal 2009 earnings conference call. (Operator Instructions) At this time I would like to turn the conference over to your host, Vice President of Investor Relations, Ms. Jane Elliott. Please go ahead.

Jane Elliott

Good afternoon and welcome to Global Payments fiscal 2009 fourth quarter and year-end conference call. (Operator Instructions) Our call today is scheduled for one hour. Joining me on the call are Paul Garcia, Chairman and CEO; Jim Kelly, President and COO; and David Mangum, EVP and CFO.

Before we begin, I’d like to remind you that some of the comments made by management during the conference call contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to vary which are discussed in our public releases including our most recent 10-K. We caution you not to put undue reliance on forward-looking statements.

Forward-looking statements made during this call speak only as of the date of this call. In addition, some of the comments made on this call may refer to normalized results which are not in accordance with GAAP. Management believes that normalized results more clearly reflect comparative operating performance.

For a full reconciliation of normalized to GAAP results in accordance with Regulation G, please see our press release filed as an exhibit to our Form 8K dated today, July 23, 2009 which may be located under the Investor Relations area on our website at www.globalpaymentsinc.com.

Now, I’d like to introduce Paul Garcia.

Paul Garcia

For our fiscal 2009 full year, we posted strong financial performance with revenue growth of 26% to $1.602 billion and normalized diluted earnings per share growth of 13% to $2.23. On a constant currency basis, our full year revenue and EPS growth are 32% and 24% respectively.

For our Q4, we received revenue of $402 million which represents 17% growth, and EPS results of $0.46 representing a modest decline over last year. We’re pleased with our recent acquisitions of United Card Service or UCS in the Russian Federation and the remaining 49% ownership interest in the United Kingdom joint venture with HSBC. Our overall growth strategy remains the same. To grow market share in each of our existing geographies, to expand our global footprint via acquisitions, and to drive improved economies of scale with investments in systems and back-office integration.

The adoption of card-based payments around the world continues to fuel both our industry’s overall growth and our organic growth. We believe that our mix of business in mature markets that yield higher margins and early stage long-term growth markets such as China and Russia provide a solid platform for long-term growth. We plan to continue to augment our businesses with targeted investments and acquisitions focusing on Europe, Asia-Pacific and North America. We will, however, continue to be disciplined in our approach, and we will focus on core merchant services businesses or portfolios with solid market share and potential to deliver long-term return to our shareholders.

We also continue to make progress consolidating our technology platforms around the world. We continue to see tangible benefits from these consolidations beginning in our fiscal 2011.

Our merchant transaction growth rates for the quarter across all of our geographies were generally about as we expected, with transaction growth of 16%, primarily generated by our ISO channel, solid single digit transaction growth in the UK, and low single digit growth in Canada. Our market presence, our distribution channels, and our ability to deliver high-quality service and products to our customers and partners all play an important role in delivering strong financial results.

Finally and as we discussed in last quarter’s conference call, the money transfer business continues to face challenging macroeconomic immigrant labor trends. Despite these difficulties, I’m pleased to report that we maintained double digit operating margins in that business. Our goal is to continue to drive solid margin performance in this business in fiscal 2010, but this may be difficult given the ongoing market conditions.

Now, here’s David Mangum to discuss the financial details.

David Mangum

I plan to cover the financial impact of the recent acquisitions, segment results, margins, and some balance sheet and cash flow highlights.

In the fourth quarter, UCS performed about as we expected overall and posted revenue a little above our $2.5 million expectation. For fiscal 2010, we continue to expect UCS to be neutral to 2010 normalized earnings per share. Our acquisition of the remaining 49% of our UK business on June 12, 2009, will have no impact on revenue, operating income, or operating margin as the business was already fully consolidated based on our majority ownership and control. However, since we now own 100%, we will no longer record any minority interest expense related to this business.

In addition, due to the transition provisions of FAS-141R business combinations and FAS-160 noncontrolling interest in consolidated financial statements which adopted as of June 1st 2009, we treated the acquisition of the remaining 40% as an equity transaction. That means we did not apply purchase accounting to this transaction. As a result, we will not increase the intangible assets for the UK and will not record any incremental amortization expense for the business. We did, however, take on additional debt resulting in interest expense for this acquisition.

We expect the 49% acquisition to add approximately $0.09 to $0.12 of earnings per share in fiscal 2010. At the risk of stating the obvious, this is not a one-time gain, but rather reflects ongoing accretion from the business.

The US dollar weakened a bit against our key currencies in late May and early June and then strengthened in July. Our full year fiscal 2010 revenue and earnings per share assumes that the US dollar will likely weaken just a bit from current levels over the course of fiscal 2010. This weakening could result in about 1 percentage point of earning growth in fiscal 2010 which is already factored into our EPS range for the full year.

We likely will see quarterly fluctuations in growth primarily in Q1 and Q2 as we annualize the major currency movements from last fall, and we will discuss those with you when we report our results for those quarters. Any fluctuations in currency rates of course may cause variances to our outlook.

Our North America segment reported revenue growth of 33% for the quarter driven by our US ISO channel and some modest pricing initiatives offset by the unfavorable impact of the weakened Canadian dollar. As we look ahead, please remember that the majority of last year’s Canadian pricing initiatives annualized in April, and as a result, we expect revenue growth in Canada to return to traditional mid single digits for fiscal 2010.

We saw solid performance from our international merchant this quarter. Growth there was primarily driven by our original 51% acquisition joint venture acquisition in the UK, which added $55 million of revenue in the quarter. Asia-Pacific continues to deliver strong results, and we anticipate fiscal 2010 revenue growth in the mid teens from that region.

Operating margins for the fourth quarter and the full year were about what we expected at 16.5% and 10.3% respectively. Consistent with our overall strategy, we expect the combination of flat to modestly declining margin performance in North America in money transfer and expanding margins in international to drive the opportunity for modest expanding operating margins for the total company for the full fiscal year of 2010, as we position ourselves to execute our strategy and drive further margin expansion in subsequent years.

We expect our net interest and other expense line to significantly increase in fiscal 2010 due to the additional interest expense for the new term loan. We expect LIBOR to increase over the course of the year and be about double current levels by the end of the fiscal year. We expect our normalized effective tax rate for the full year in fiscal 2010 to be similar to the 33.2% rate we recorded for the full year of fiscal 2009.

Turning now to balance sheet and cash flow, at the end of the quarter, our available cash totaled about $100 million. As we recently reported, we completed a new $300 million unsecured 3-year term loan which has a $230 million US tranche and a $70 million equivalent British pound sterling tranche to better leverage cash flow generated by our UK operations. We used the proceeds to pay off our revolver, thus providing us an additional untapped $350 million line of credit and significant remaining debt capacity.

During the quarter, we spent $15 million on capital expenditures and spent $41 million on capital expenditures for the full year of 2009. For 2010, we anticipate full year capital expenditures to total about $45 million, with approximately half of that from merchant terminals. Canada represents the largest portion of the terminal spending due to industry requirements to replace existing point of sale devices with chip compliant devices.

On a final note, for those of you interested in calculating cash earnings, we want to provide you with the data to assist you in doing so should you choose. Many of you currently use the amortization of acquired intangibles from our cash flow statement in calculating cash earnings, but that misses the impact of minority interest accounting. Therefore, to adjust income before taxes in your models for the impact of amortization, you add back about $20 million of amortization expense to 2009 and about $29 million to fiscal 2010. To keep this simple for now, I would suggest just keeping your tax rate the same. Please note though that amortization will fluctuate over the course of the year due to currency translation.

Now I will turn the call back over to Paul.

Paul Garcia

Based on our current outlook, we are providing 2010 annual revenue guidance of $1.690 billion to $1.740 billion or 6-9% growth over fiscal 2009. We are also providing fiscal ’10 normalized diluted EPS guidance to $2.43 to $2.54, reflecting 9-14% growth over fiscal 2009. We are pleased to provide this guidance and at the prospect of expanding margins. We expect margin leverage to be driven primarily by our international segment with margin expansion in the US and improved operating leverage in Asia Pacific.

Operator, we will now go to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of James Friedman – Susquehanna.

James Friedman – Susquehanna

In terms of the Canada contribution, I think you mentioned on the call that the pricing benefit that you received in the past annualized in April. Are you seeing any potential for new price increases, and there is a lot of discussion there related to Interac; I was wondering if you could give us an update as to the pricing environment in Canada.

David Mangum

In terms of relating to the financials, there are price increases at the margin assumed over the course of 2010; nothing remotely resembling the scale of what you saw in 2009. Just more of the typical management of the market and management of the operation which we do a pretty nice job of in Canada. In terms of the ongoing change with Interac or anything else we see on the horizon, maybe I’ll turn it over to Paul and Jim to comment on that.

Paul Garcia

I’ll be happy to comment on the Interac. Interac as you know is the one debit brand in Canada, and Visa and Mastercard recognized that Canadian consumers would benefit from a brand that has more global acceptance, and consequently they are in the throes of entering that market and that would in fact have some opportunity for processors, and you’re exactly right. We’re not in a position to quantify it at present, but we do think there is some upside opportunity if that in fact is successful.

James Kelly

In terms of the timing, the fourth quarter was the Visa annualization, and Mastercard will be during this first or second quarter of 2010. As Paul alluded to, as the debit networks gain traction and the cards are issued, we will see an interchange where Interac today does not have an interchange. We will see an interchange in the market, and the likelihood is that will provide us some opportunity as well.

James Friedman – Susquehanna

David, I know you had alluded to the revenue impact related to Canadian dollar. How should we think about the margin impact vis-à-vis Canada?

David Mangum

Relative to the quarter or the year 2010?

James Friedman – Susquehanna

Fiscal Q4.

David Mangum

Fiscal Q4 really sees one more of the full quarter effect on a year over year basis of the movement in the dollar that we saw starting in Q2. At the end of the day, you’ve got a business that would have grown in the 20s in local currency reduced down to some of the numbers you see in our release by basically FX and nothing else. Does that help enough?

James Friedman – Susquehanna

That is revealing with regard to the revenue you are describing, but how about the margin? My understanding was that you had fewer costs there than you might have revenue.

David Mangum

Sure. We don’t quote the margin by country as you know, but Canada operates essentially for translation purposes on a contribution margin, having a great deal of its expenses for operations and back office support in the US and our Baltimore operation center as well as some of the US headquarter. So while I can’t quote you a number, it operates at what I would call a contribution margin, looking a little bit more like a gross margin than anything else, and I think if you shape it that way in your model, you’ll get a sense for how that rolls through earnings line for the full year and what that really means Schedule 9 in the back of the earnings release.

James Friedman – Susquehanna

Occasionally, you’ll share some qualitative observations about debit versus credit, Paul. I was wondering if you could share your observations about those two payment card methodologies.

David Mangum

Sure. As reported by those that report these numbers, debit is growing a little bit faster than credit, in fact significantly faster than credit, and I think what we perhaps haven’t clear in the past is not only do we process a significant amount of debit in the UK and in Canada and in emerging markets, we have over 50% of our transactions that are either signature or PIN-based debit in the US, so as that debit usage does expand, we do benefit from that, and we’re seeing a pickup in debit more quickly than credit.

Operator

Your next question comes from the line of Thomas McCrohan – Janney Montgomery Scott.

Thomas McCrohan – Janney Montgomery Scott

Can you give us a revenue contribution expectation from the HSBC joint venture that is now completely owned and UCS? Have we just begun with the $55 million run rate and the $2.5 million quarterly run rate for both companies, or is there anything else that is coming online that’s not in those numbers?

James Kelly

In reverse order, for the Russian acquisition for UCS, you should use the $2.5 as your jumping-off point and annualize that. For the UK, rather than talk about $55 as the jumping-off point, what I’d point you to is a business that now we’ve got fully in 2009 and obviously it will be in 2010 heading back toward above market growth for the UK market, but that means probably mid single digit revenue growth above what’s a low single digit transaction volume growing market on organic basis.

Thomas McCrohan – Janney Montgomery Scott

In regard to the new term loan facility, I couldn’t figure out from the credit agreement what the actual interest rate is on the loan. Is it LIBOR plus a spread, and if so, what’s the spread at current pricing to you for that term loan?

David Mangum

Sure, and then you’re missing fees and things like that as well, Tom. If you look at the first tier, leverage will say something like LIBOR plus 300 or just north of that. We’re kind of in that range right now, along with the fees on top which would add a little to it, but that’s the general way to get at the interest. I’m probably not going to part the interest rates on a quarterly basis, but I’m pretty sure you can get it from that color.

Thomas McCrohan – Janney Montgomery Scott

The negative covenant that’s most binding or most restrictive is total debt to EBITDA of 3.25 times? Is that the most restrictive covenant?

David Mangum

Yes. It’s probably the one to watch for in terms of capacity, and it’s certainly not a capacity level we intend to head toward. Less than that would be comfortable for us, but that’s probably the one to watch.

Thomas McCrohan – Janney Montgomery Scott

Is there an accordion feature in that term loan? Could you expand that at your option?

David Mangum

No. We cannot.

Operator

Your next question comes from the line of Tien-Tsin Huang - JP Morgan.

Tien-Tsin Huang - JP Morgan

On the transaction growth in the US, it actually picked up a little bit in the quarter. How much of this was due to market share gains or new ISOs coming on versus just a pickup in the underlying macro trends?

James Kelly

I think it’s probably a combination of the last two. We’re not seeing the declines we saw before in the market, as David or Paul on previously calls talked about. The third quarter was probably the bottoming piece, so maybe a small improvement there. The rest of it is just associated with the ISOs growing and our direct business for new signing this year, and our Comerica had a strong year.

Tien-tsin Huang - JP Morgan

On the international side, the operating profit dollars there were flat sequentially. It looked like the revenues were up quite a bit sequentially, so what’s driving the delta there? Was there anything unusual?

James Kelly

Nothing particularly unusual. The thing that’s dragging margins a little bit in international is the central Europe business, the indirect business with the major customer renewals we talked about. As a general rule, trends in the UK and Asia kind of held. Asia is a little more challenging given our exposure to T&E there, but there is sort of an underlying a bit and Central Europe given the indirect model there.

Tien-tsin Huang - JP Morgan

David, can you directionally tell us where Asia Pacific margins exited the year at?

David Mangum

I’d probably rather stick with just the international margin. It continues to expand on a full year basis. Q4 over Q3 did not move materially, which may be what you’re struggling with when you stare at your model with the preliminary results, but I’m not sure I’m ready to quote to that level of detail the margins. The trajectory long-term as we go through 2010 is of course upward and upward pretty rapidly.

Paul Garcia

Tien-Tsin, I’ve said in the past that Asia in the not too distant past had no margins. So Asia has grown to have a margin that is dilutive of course to the company, but I’ve gone on record as saying I believe Asia given enough time will actually have accretive margins.

Tien-tsin Huang - JP Morgan

The implications of the Bank of America-First Data deal, was that something Global Payments looked at, and how could that change the landscape competitively?

Paul Garcia

Let me take the last part. In terms of changing the landscape, you have a big competitor in BoA, and you have a big competitor in First Data, and they are going to put these two businesses together. It doesn’t change the game necessarily. In fact, I think it’s fair to say that that is a fairly large effort, and I think there are perhaps opportunities for competition while they attempt to put these two together. In terms our taking a look at this transaction or being interested in it, you know that the unique structure of this transaction basically limited the parties to these two parties, so I think that’s the best answer.

Tien-tsin Huang - JP Morgan

Has your appetite to do deal changes at all on the M&A front?

Paul Garcia

No. In fact, I think that one of the nice things from a challenging economy sometimes is that interesting opportunities arise, and I think there are some great opportunities for us literally in every market, including North America. So I would encourage you to stay tuned.

Operator

Your next question comes from the line of Darrin Peller – Barclays Capital.

Darrin Peller – Barclays Capital

Could you just talk quickly a bit about HSBC’s rationale behind selling to you the remaining JV, and whether there might be any similar opportunities perhaps in the big JV in Asia?

Paul Garcia

I can’t speak exactly; I can tell you what they told us. First of all, they are very happy with the deal. You of course know that they actually extended the marketing agreement, so we have a long-term relationship with these guys where they’ll refer business through all their UK operations. Although they were happy with that and willing to extend that deal, I think that they probably came to the realization this is well run, they don’t need to have a management role, have a JV board, and they always contemplated monetizing their other piece. It was actually in the agreement. They just said let’s get on with that more quickly. We were of course delighted to buy 51, even more delighted to buy 100, so I think that’s basically it. This is a huge bank, probably arguable the most secure financial institution in the world—I think the only really large bank that didn’t take any government assistance. That said and done, every little bit helps towards their Tier 1 issues too, so that could be a small part of it.

Darrin Peller – Barclays Capital

Any potential for following on another maybe in Asia?

Paul Garcia

It’s a very different operation. It’s two different people making those decisions, but sure. The Asian operation contemplated the same opportunity, and we would be interested in doing that as well, but that’s all bank driven. As of now, they don’t have any interest in exercising that.

Darrin Peller – Barclays Capital

You mentioned the high-level data, the transaction growth trends in UK, Canada, and Asia. Is there any way to get a little more specific color on the numbers behind it, where they were trending through the quarter?

Paul Garcia

Probably not, other than just to tell you maybe in a different way that we saw a declining transaction growth as we headed out of the calendar year 2008 and into early ’09. That kind of stabilized around February and March, and quite honestly the trends haven’t changed materially since then when you look across the board. You know enough about the Canadian Markets. You know it’s a low single digit transaction market, and we’re a fair amount of the market relatively speaking, but as a general rule, not a lot of changes really in the last few months.

Darrin Peller – Barclays Capital

The 16% in the US, how did that trend in the past three months of the quarter?

Paul Garcia

Over the course of the quarter, it was consistent.

Darrin Peller – Barclays Capital

Following the First Data deal, if it was going to have an impact on pricing from that, we have heard some anecdotes about some of the larger acquirers having been extremely competitive, have you seen that increase at all, or is that status quo?

James Kelly

I think in each of the markets, the mature markets, there is always competitiveness especially at the high end, but I would not say that anything abnormal has occurred recently.

Operator

Your next question comes from the line of Andrew Jeffrey – Suntrust.

Andrew Jeffrey – Suntrust

As I look at the guidance for flat year over year consolidated operating margin, particularly in light of what’s happening in Eastern Europe right now with no necessary indication for a turning point, can you be a little more granular in terms of how you’re going to drive margin in the UK and in Asia? Is it just scaling some of the investments you’ve made to date? The implication obviously is that you’re going to get a pretty big lift internationally from you were in the fourth quarter, so how do you get there and is it ratable through the year or is going to be backend loaded?

Paul Garcia

I’m going to let David answer that in one second, Andrew, but the one thing you didn’t throw in was Dollex too. Although we did a pretty good job with margins, there are some headwinds. Housing sales are up, but construction starts need to follow suit, and we need some more encouragement from immigrant labor in sending money home, so that could be a headwind too, but with that said and done, go ahead David.

David Mangum

In reverse order, Andrew, it is kind of ratable over the course of the year, so maybe said another way, it ticks up steadily over the course of the year. To put it in a little bit better perspective, if you look at the two broad international markets that you mentioned, Asia is probably the more ratable of the markets in terms of the expansion that we expect to see, largely because that’s a scale conversation. It’s more volume moving through the system. It’s leveraging the backend migrations we’ve done to date beginning to leverage a little bit at the margin. There are a couple of markets we’ve moved to the front end G2 authorization system, and then for the UK, it’s a couple of things—it’s rationalizing the expenses in general as we move through the expense base and investment base we migrated over from the bank. It’s beginning now to have that salesforce be a little more effective. It’s now a salesforce we’ve doubled, and it’s been on board a good six months or so, so it ought to be more effective as we head through the year without adding incremental salespeople to the model, and then finally it’s the introduction of a couple of price increases, actually this is true in both markets by the way, but a couple of price increases in the UK that obviously should they be successful would be 100% margin. As a result, you kind of end up with the UK expansion maybe being a little lumpier than the more ratable Asia margin expansion you’ll be modeling.

Andrew Jeffrey – Suntrust

Are you assuming a status quo in Russia? I assume those margins are pretty low right now?

David Mangum

Yes. It’s effectively earnings neutral, which means the margins are certainly quite low, and we don’t assume a radical change. It may exit and it will exit if we execute in a better position, but on a full year basis, it’s easier to assume it as a breakeven business, the way you probably have it already.

Andrew Jeffrey – Suntrust

Paul, without being specific, at a very high level conceptually, would Global ever consider buying an ISO?

Paul Garcia

I think the short answer is year. There are scenarios. There are ISOs that fit a model that would be attractive, and I’ll tell you what is not attractive for us. What is not attractive is for us to buy an ISO and then operate thousands of independent salespeople and then in fact be competing with our ISO base, but ISOs have had different models. There are levels of attractiveness, so yes, the answer is yes.

Operator

Your next question comes from the line of Bryan Keane – Credit Suisse.

Bryan Keane – Credit Suisse

What exchange rate are you using for fiscal year ’10 guidance with some of the key currencies like the Canadian dollar and the pound?

James Kelly

What we’ve done Brian is we’ve kind of looked at the June rates on average in the major geographies and had them weaken just a little bit—a point or two—over the course of the year. It’s kind of interesting when you look at ’10 versus ’09. With all the jumping around in FX in places like Canada and UK in ’09 quarter by quarter, by the time you get out to kind of average rate for ’09 and an average rate for ’10, they look a lot alike, and they look a lot like the June ’09 rate, so we’re starting with June ’09 and kind of trending that to have it weaken a little bit, which mask 5 or 6 sources we look at. It’s anybody guess as to where FX really goes. We have absolutely no expertise, but we look at a couple of sources, off of Bloomberg and some of the other guys, and that’s the assumption right now that’s implicit in the guidance.

Bryan Keane – Credit Suisse

The US dollar to the Canadian dollar closed at $1.09. I guess that’s a significantly stronger Canadian dollar than you had modeled?

James Kelly

I’m sorry, closed when?

Bryan Keane – Credit Suisse

Today.

James Kelly

I’d have to go back and look at June versus that. To tell you the truth, I didn’t look it up today, so wherever June was was our assumptions, and then we assumed weakening from there, so I don’t know that it’s significantly different at all. In fact, I’d suspect that it’s pretty much right on what we’re looking at.

David Mangum

You mean the Canadian dollar at 91 cents against the US dollar?

Bryan Keane – Credit Suisse

Yes.

David Mangum

We missed a big movement. That was a big day on the FX.

Bryan Keane – Credit Suisse

No. I flipped it for you. David, then is there a way to look at FX and probably it will be a positive for earnings this year? It was a drag of $0.23 last year, so what would it be if it’s positive for earnings in fiscal year ’10?

David Mangum

If you look at the two years side by side and say what kind of growth in earnings do you have, first off you have to play with the range a little bit, but if you’re looking at where you want to be in our range, say it’s in the upper quartile of our range or something along those lines, it’s worth about 1% or thereabouts of earnings growth, which means it’s worth a couple of cents, and that’s our assumption for the moment.

Bryan Keane – Credit Suisse

So, if I took out currency especially on the Canadian dollar, would margins still be able to go up this year or would they be more flat or down?

David Mangum

They still have the opportunity to go up because remember those couple of pennies of earnings is a couple of million dollars, so they still have the opportunity we’re describing to go up, and then the complexity of it all is that you can’t just focus on Canada. What happens in the UK and Central Europe and other places are going to matter as well, and they all don’t necessarily move in concert, which makes this occasionally a mind-bending exercise.

Bryan Keane – Credit Suisse

The transaction growth looks like it picked up a little bit, 15-16, but the revenue growth in the US kind of dropped down to 7% from 13%. Is there anything to read in there?

David Mangum

The thing to remember when you look at the US by itself is remember we had a number of ISO fees in the third quarter. That did not recur again in the fourth quarter, so what you actually saw if you look at it sequentially without the ISO fees, enough to pull some $10 odd million or so out of revenue of the US because of the fees from the December-January timeframe, if you looked at that, you’d see nice solid sequential growth from an ISO perspective compared to Q3, and that explains also your two deltas in year over year performance.

Operator

Your next question comes from the line of Julio Quinteros - Goldman Sachs.

Julio Quinteros - Goldman Sachs

David, the accounting for the HSBC piece, just to be clear, no intangibles amortization impact, and when we’re thinking about it, and the only impact through to P&L is going to be the reversal of the minority interest expense, and I think that’s what you suggested?

David Mangum

That’s right, Julio. You likely in your ’09 model have built in some assumption as to what new minority interest expense came in with the UK acquisition. You can essentially take that out of your formula for Q1 and roll from there, if that makes sense.

Julio Quinteros - Goldman Sachs

So for fiscal ’10, the only piece then that we would have to adjust would be the UK piece. Any sort of ballpark range on what you guys are estimating as left from minority interest perspective?

David Mangum

No, not really. I guess you have the tools to do this because you had to add in a lump of the UK on top of whatever you assumed Asia growth is, and now Asia is going grow again, and that’s the only thing left for you to model in ’10.

Julio Quinteros - Goldman Sachs

You did give us the Capex number for fiscal year 2010?

David Mangum

$45 milllion.

Julio Quinteros - Goldman Sachs

That’s all in, right?

David Mangum

Yes.

Julio Quinteros - Goldman Sachs

Just go back to the question regarding margins, excluding currency, if we adjust currency, your view is that the underlying operating margin of this business, you’re thinking about the US and the other parts of the world, could expand if you take all the currency situation out of the equation?

Paul Garcia

Yes. Let me say this again. My view is that currency doesn’t necessarily drive this expansion, and we’ll see where currency turns out. You’re talking about a combination of flat to maybe modest decline in North American margins, flat to declining margins in money transfer, and then expanding margins internationally. At the same time, you’re going to keep you corporate expenses flat year over year, and all in, that give us the opportunity for basis point expansion in margin when you’re starting to model the high end of our range.

Julio Quinteros - Goldman Sachs

That’s what I was trying to understand.

Operator

Your next question comes from the line of Kartik Mehta – Northcoast Research.

Kartik Mehta – Northcoast Research

Paul, I had a question on your UK joint venture. If you look at this transaction and now that you own 100% of it, does this change strategically or structurally for you in Europe or UK or is this just a financial transaction that’s beneficial for Global Payments?

Paul Garcia

There are some things that have changed because we own 100% of this business. We had a noncompete with HSBC that was part of that; we no longer have that, but I wouldn’t want you to jump into an assumption that we’re going to go buy someone else in the UK. We have a pretty big market share of the UK today, and I’m very happy with our market position. Other than that, it’s pretty much the same. It was an attractive opportunity for us and it make sense for the bank, and we executed on it, Kartik.

Kartik Mehta – Northcoast Research

You talked about the North American margins being flat or declining in 2010. Is that just a function of more ISO business and so that’s why it stays there, or are there other inputs other than that also in that?

James Kelly

The single biggest driver, Kartik, continues to be the growth the ISO channel and the impact of that on the margin.

Kartik Mehta – Northcoast Research

The recent credit card legislation and the impact on your business, will there be any impact on the merchant acquiring business because of that, and if so, do you have to change your strategy in anyway to benefit from that?

Paul Garcia

The short answer is no. We don’t see any immediate impact. We are of course staying very close to everything that’s happening. Most of is focused on issuing. By definition, it’s a three-legged stool. The card issuing is a very important process, so anything that really discouraged card issuers would be negative for us, but we don’t see anything clearly in the next couple of quarters or even for fiscal ’10 that would have any impact. Let’s all stay tuned to that one.

Operator

Your next question comes from the line of David Koning - Robert W. Baird.

David Koning - Robert W. Baird

Coming back to Kartik’s question a little bit about margins flat to down a little in North America, that’s a lot less decline, I guess, than last year when it was I think over 200 basis points of margin decline. Is that reduction in margin decline, is that a function of ISOs not growing as quite as fast in 2010 or maybe the direct business starting to grow a little better?

Paul Garcia

We are certainly benefiting from direct business. They had a pretty reasonable sales year in 2009, so the volume will come on 2010. We still are anticipating nice growth from the ISOs and not a change in the trends you’ve seen. I’d suggest to you that we’ve done a fairly nice job probably of rightsizing and cost base to support those businesses as we head into the year as well, and that’s probably the one thing that it’s not visible to you, but is sort of the missing factor in that equation for you.

David Koning – Robert W. Baird

Secondly, the G2 savings, it sounds like there are comments that fiscal 2011 is going to be where more of a tangible benefit comes from G2. Is that the right way to think about 2010? We can’t really see it in the numbers, but maybe in 2011 it will be a little more visible.

Paul Garcia

That’s exactly right.

David Koning – Robert W. Baird

Finally, if we look at the full year free cash flow and adjust out the settlement stuff and the minority interest distribution stuff, it looks like free cash flow is about $3 per share this year compared to I guess $2.20 or whatever it was of EPS, so a pretty big gap. Should we at least think of free cash flow being quite a bit higher, I guess, going forward than earnings? That was really a big year.

David Mangum

Free cash flow was a tough one for us right now, and I’d confess to you that the reason we talked about a bit about cash earnings on this call was we’re getting our arms around that, and we will see where that goes, but I know a lot of guys and you particularly model that in and talk about it. Free cash flow is a little bit further away for us in terms of being able to very crystally define it for you and explain moments, so your numbers by the way because I know your definition are not far off from what you are seeing. I still believe we are a solid free cash flow generator, but the moving parts make that a little difficult for me to explain to you in a really quick sound-bite the way it needs to be, so I probably stay away answering your specific question for just that reason, but you’re not on the wrong track if that helps enough Dave. I’m sorry.

Operator

The next question comes from the line of Moshe Katri with Cowen and Company.

Moshe Katri – Cowen and Company

Paul, going over some of the recent trends on the regulatory side, maybe you can give us your view on the recent events taking place related to interchange regulation. Where do you think we are on that part? Has there been any impact on volume growth because of the credit card act that came through about a month to two months ago?

Paul Garcia

Moshe, firstly I think your credit act and a lot of the things that were discussed in that were at least in my thinking, and I’m not a card issuer, but I think a lot of that stuff was appropriate, and I think at the end of the day, if it’s consumer friendly, you might actually stimulate some credit usage. In terms of the interchange, I’ve always maintained that interchange rates will decline over time. I’m still holding to that, and there is nothing legislative that I can point to that would cause that. I think that will be one of the factors, but over time, interchange rates will clearly decline, and I think that’s one of the investment thesis that everyone should have for our company and others in our space.

Moshe Katri – Cowen and Company

Maybe talk in that context in terms of what happens or the potential impact or benefits to Global Payments from that scenario.

Paul Garcia

In the past it has happened, and Master card in particular had a big movement. You saw what happened in Canada with just introductions of a much more complicated multi-tiered interchange level, so when these opportunities happen because of the broad base of medium-sized customers, we are able to mark up a little bit, round a little bit, and at the end of the day, although it’s a highly competitive market, and you clearly have to be appropriate with your customers, or you’ll lose them, you can take advantage of that, and a basis point here and basis point there on tens of billions of dollars of volume is significant amount of earnings, so that’s exactly what we have seen in the past. I maintain we’ll see it in the future. With that said and done, we’re not forecasting any of that in for 2010. I’m not saying that interchange goes down and we get some benefit of that, nothing like that for 2010. You’re really discussing more of a long-term trend and a prognosis for the future.

Operator

The next question comes from the line of Larry Berlin with First Analysis.

Larry Berlin – First Analysis

I have been reading too many newspapers and magazines recently, but one of them mentioned that the pricing for ISOs and the way you guys pay them, they didn’t mention you in specific but all merchant acquires in general, is changing so there’s a bigger upfront fee and less residual. Are you guys seeing that, and if so, how does that affect you?

Paul Garcia

You’ll have to tell me what magazine you have been reading.

Larry Berlin – First Analysis

Transaction World.

Paul Garcia

It has not come to my attention. We’re not offering that type of structure here. I would be surprised to see that because the number of transactions that an ISO is going to sent to us as a processor is largely out of their control. It’s based upon the merchant’s performance, so it would be hard for us to get a number to prepay, but our pricing structure has been the same for the last 10 years that we have been in this business, and no we don’t see a change.

Larry Berlin – First Analysis

I’m just curious about what you guys are doing to alter/approve or whatever with US direct sales.

Paul Garcia

Larry, we haven’t had a big change in the last quarter or even last year. We have the same relative number of salespeople in North America we had at the beginning the year. We’ve beefed up a lot in Asia. We intend to double the effort in Russia, but in the UK, we’ve also increased that fairly significantly, but pretty much domestically, it’s been straightforward. Now if you are alluding to opportunities, potentially with the BoA merger with First Data, we do think there are opportunities there, and we think that our salesforce is focused on that, and that may offer an ability to augment those forces somewhat, so we’ll let you know.

Operator

The next question comes from the line of Greg Smith with Duncan-Williams.

Greg Smith – Duncan-Williams

David, the $20 million in amortization you gave to kind of calculate cash EPS, that was $20 for fiscal 2009, $29 million for fiscal 2010. That’s an after tax number, correct?

David Mangum

No. That’s the number you’d add back to pretax income or I think what we call income before taxes on the face of P&L. That’s the formal name for it.

Greg Smith – Duncan-Williams

Okay, so we should add that essentially to pretax and then tax that whole number.

David Mangum

Right. That’s for simplicity sake Greg.

Greg Smith – Duncan-Williams

That does not include stock comp expense, does it?

David Mangum

No. We have not pulled it up. This is a very simple definition of just the exclusion of acquisition-related intangibles.

Greg Smith – Duncan-Williams

Most of your competitors also exclude the stock comp expense.

David Mangum

Well, at the end of day, I want to give you the simplest number possible since we’re not talking about guiding to cash earnings or something. I didn’t want to give you a complex definition, and when I read the bulk of the notes and talk to the bulk of the folks on the buy side who are interested in this kind of metric, it’s really all about acquisition-related intangibles. We’ll keep looking at this and we want to make sure that it is really useful and helping describe our underlying performance, and to the extent it is, we’ll talk about it a bit, but it is just amortization.

Greg Smith – Duncan-Williams

Do you have any rough ballpark estimates for share-based compensation expense?

David Mangum

Off the top of my head, I do not. I can easily get that to you when we chat either later tonight or tomorrow.

Greg Smith – Duncan-Williams

There is essentially no reason you’re expecting that to change dramatically from the trends that we have been seeing?

David Mangum

No. Quite the opposite. It’s a great question.

Greg Smith – Duncan-Williams

Paul, just any update on China and the ability to acquire in local currencies?

Paul Garcia

It’s a great question Greg. We have passed a number of regulatory hurdles. There are other things we need to do. We’re in the process of meeting with a lot of Chinese institutions. CUP has been supportive to date, and we’re hoping to bring that to conclusion in the not too distant future, so just a very exciting opportunity for us in PRC.

Greg Smith – Duncan-Williams

We don’t seem to see this in your numbers nor your guidance, but anything unusual going on with loss rates, fraud at merchants in this environment, or on the check business side?

Paul Garcia

No. We’re pleased to report no, no, and no to that.

Operator

The next question comes from the line of Jason Kupferberg with UBS.

Jason Kupferberg – UBS

Regarding just the overall small business environment, obviously US transaction growth has really held in nicely here, but have you guys taken any kind of close look at measuring the impact of the increased bankruptcies across small businesses in the US, any way to describe that for us?

Paul Garcia

We measure same-store sales to a degree, and we also look at how many merchants leave us, and then we try to measure why they leave us, and going out of business is clearly a reason. Now that typically impacts our ISOs a little more because they a smaller merchant base than we. Our mid-sized merchants, we’ve seen some tick up in that area, but nothing extraordinary. I think the proof of the pudding here is that we are able to produce these results and have this growth in this environment and live with all those realities, so I don’t know if that’s helpful. No one asked yet, but we will volunteer. June looks the same as May. We’re not seeing any worsening, we not seeing a double dip. If anything, we have some optimism.

Jason Kupferberg – UBS

That is helpful. Obviously, it’s early here, but since you guys talked about the fact that the platform consolidation should really start to drive some margin improvement in fiscal ’11, anyway you can point us towards thinking about order of magnitude there?

Paul Garcia

I would say large.

David Mangum

I would say more specifically, I guess stay tuned, but we’re probably unlikely to put ourselves in a position of reconciling that for you dollar for dollar on a quarterly basis, but stay tuned. We owe you more information.

Paul Garcia

But clearly, not to be flippant, we’ve talked about this for a long time, so everyone is saying where is the beef here. You’re going to get the beef in fiscal ’11. It is going to be meaningful. We kind of guided just generally what meaningful is and, as David said, we will give some more data when we can.

Jason Kupferberg – UBS

Just any further thoughts on the strategic value of the money transfer business. I know you’re going to try and keep margins hanging in there, but macroenvironment is what it is, and maybe they’ll slip a little bit in fiscal ’10, so once the overall environment picks up, does it make sense for you guys to consider trying to monetize the asset?

Paul Garcia

It’s a great question. We have some wonderful people who run this business, and they’re doing a great job at a difficult time, but the business is not core, and I think everyone knows that, but I wouldn’t expect us to selling this asset anytime soon. In fact, we have a commitment to the management to give them the assets to run this thing, and we have expectations. We’ll continue to do the best job in a challenging environment.

Operator

The next question comes from the line of Robert Dodd with Morgan, Keegan.

Robert Dodd – Morgan Keegan

I know you don’t normally give much color about trends during a quarter, and you just gave a little bit a moment ago, but I don’t know if you’ve seen the Amex results. They highlighted that June was the best month of their quarter. Is there any additional color you can give us on trends that you’ve seen, not just obviously in the US but the UK as well and may be even in Canada?

David Mangum

I think there probably isn’t much more additional color. If you think back to some of the questions we’ve answered though, really in almost all the markets we serve, whether it’s Canada, the UK, across the Asian markets, and the US, the trends in June are not wildly different from May, and the trends have been fairly consistent really since the end of the first calendar quarter of the year. They haven’t gotten better by the way, but haven’t gotten materially worse anywhere either.

Robert Dodd – Morgan Keegan

Onto the UK business, obviously, now you own it. You got complete control so you can decide exactly how you want to go about growing that. What’s your view, and you have discussed this a little bit in the past about expanding into Europe and where would you stand from a salesforce/platform position to be able to do that?

Paul Garcia

There are two ways to expand into Europe. The first way is to follow your trans-European merchants, and we’re very focused on that, and the second is to do strategic deals on the continent, and we’re focused on that as well.

James G. Kelly

Part of the expansion to Europe was supposed to be now in place until they rationalized the debit scheme throughout the major countries. Bricks and mortar customers are more challenging, but one of the reasons beyond of the fact that we think this is a terrific business that we made the investment in UK and just doubled down on it is it gives us the management team similar to Canada, gives us a management team in the region to be able to expand across Europe, so it’s our expectation that we will be making investments in those markets. We will follow our customers into those markets. SEPA will help and opportunities to buy will be things that we’re gong to pay close attention to.

Robert Dodd – Morgan Keegan

Looking at the margin compression last year in North America, the vast majority of that looked to be coming from just the Canadian dollar exchange rate. Is that the biggest reason this year if you’re factoring essentially flattish exchange rate over the course of the year, we should be looking for basically flat margins?

Paul Garcia

Well, it helps you at the margin, but it’s really not a material contributor to holding flat or the upturn a little bit for basis point expansion. It comes down to some of the items we talked about earlier, really sold progress in the US, also some nice direct sales, solid cost management, and continued nice operating performance from Canada, but you’re correct in thinking that the FX makes that a bit of odd conversation. It can help you a little bit depending on where rates go, maybe it keeps you to flat or holds you back a little bit depending on if you go the other direction.

Operator

Your next question comes from the line of Jason Deleeuw - Piper Jaffray.

Jason Deleeuw - Piper Jaffray

You guys spoke about with Visa and Mastercard making a push into debit in Canada, you talked about the opportunities there. Do you see those as more of a potential pricing benefit or volume benefits?

Paul Garcia

I think it’s a pricing benefit primarily. It’s a huge debit market today. It’s probably the largest—maybe Iceland has just taken over the number one spot, but Canada is a huge debit market. It clearly was an early adopter, and it’s very penetrated. I think that this would be someone using a different brand for other reasons, and there’ll be some pricing opportunities.

James Kelly

At the point of sale, we generally control all credit and debit. Ten years ago, they had split market between Visa and Mastercard acquirers. That’s long since gone, so if there is a different card type that becomes available in the market or different structure under Visa or Mastercard, it would be likely that we would just take that additional volume and then it would be priced appropriately.

Paul Garcia

I believe it’s in the consumer’s interest, and that’s why this could be an interesting argument to watch. The consumer clearly is benefited by allowing those brands into Canada, because today they’re disadvantaged. Interac brand does not have universal acceptability the way Visa and Mastercard brands do, and a Canadian citizen if that’s their only choice, they are at a disadvantage so interesting stuff.

Jason Deleeuw - Piper Jaffray

Thank you.

Paul Garcia

Thank you so much for joining us on the call today, and we appreciate your support of Global Payments.

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Source: Global Payments, Inc. F4Q09 (Qtr End 05/31/09) Earnings Call Transcript
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