Total System Services' CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.23.14 | About: Total System (TSS)

Total System Services, Inc. (NYSE:TSS)

Q1 2014 Results Earnings Conference Call

April 22, 2014, 05:00 PM ET

Executives

Shawn Roberts - Director of Investor Relations

Phil W. Tomlinson - Chairman and CEO

M. Troy Woods - President and COO

Jim B. Lipham - Senior EVP and CFO

Analysts

David Togut - Evercore Partners Inc.

Bryan Keane - Deutsche Bank

Chris Brendler - Stifel Nicolaus

Tulu Yunus - Nomura Securities

George Mihalos - Credit Suisse

Ramsey El-Assal - Jefferies & Company

Smitti Srethapramote - Morgan Stanley

Kevin McVeigh - Macquarie Research

Steven Kwok - Keefe, Bruyette & Woods

Timothy W. Willi - Wells Fargo

Ashwin Shirvaikar - Citigroup

Operator

Good afternoon. At this time, I would like to welcome everyone to the TSYS First Quarter 2014 Earnings Conference Call. All participants are in a listen-only mode until the question-and-answer session.

I would now like to turn the conference over to our host, Mr. Shawn Roberts, Senior Director of Investor Relations. Mr. Roberts, the floor is now yours.

Shawn Roberts

Thank you, Hannah, and welcome, everyone. On the call today, our Chairman and Chief Executive Officer, Phil Tomlinson is going to begin with his opening remarks. Then he is going to turn it over to Troy Woods, who will provide business highlights on our four segments. And then Jim Lipham, our CFO, will review our consolidated financials. After that we're going to open it up for Q&A as usual.

I'd like to now call your attention to the fact that we'll be making some forward-looking statements about the future operating results of TSYS. These forward-looking statements involve risks and uncertainties. Factors that could cause TSYS' actual results to differ materially from the forward-looking statements are set forth in TSYS' reports filed with the SEC.

At this time, I'd like to introduce TSYS' CEO, Phil Tomlinson.

Phil W. Tomlinson

Good afternoon, everybody. Shawn, thank you. We're glad you're on the phone with us. I'm happy to report that our weather was much, much better than it was the last time we did this. We're certainly not used to having conference calls in ice storms which we did in January. It's a typical warm day here in the spring in South Georgia, so we're ready to get on with it.

Welcome again to our first quarter earnings call. I hope you have had plenty of time to read our press release and go over the financials in some detail. Happy to note, though, that we've met all of our internal goals for the quarter.

As usual, we had a few moving parts in the quarter including on the disposition front, the sale of our majority stake in GP Network Corporation and our wholly-owned subsidiary, TSYS Japan Inc.

I hope that these dispositions didn't surprise anybody as I've mentioned on numerous occasions over the past several years that we were not happy with our progress and our growth in Japan.

Also on the acquisition front, during the first quarter, we purchased an additional 15% of the Central Payment's business, bringing our total to 75% ownership. I'm happy to tell you that they continue to outperform our expectations in the direct acquiring space.

And we're also delighted that as a part of the CPAY transaction, we've extended the employment terms of the CPAY Executive Management team, really happy about that.

On the new business front, we just announced a major internal international win with Virgin Money in the U.K. a week or so ago and yesterday we announced NetSpend's exciting -- really a big opportunity with Western Union.

And with that I am going to turn it over to Troy Woods who will go through the four segments. Troy?

M. Troy Woods

Thank you, Phil, and good evening. We've had a very busy and productive first quarter and I think our actions and progress this quarter represent a very aggressive and deliberate approach to how we run our business.

As Phil indicated, there are many details and moving parts to our first quarter, so let me just jump right in. First, I'd like to begin our segment reviews with North America which begins on slide six.

The North America segment produced its largest year-over-year quarter revenue growth in over five years, coming in at 9.1% to $224.4 million. This 9.1% revenue growth is equally impressive when you consider that we had Chase licensing revenue of $3.75 million included in the first quarter of 2013.

Our revenue growth for the quarter was probably driven by a 16% increase in transactions and a 17% increase in accounts on file.

Also during the quarter, we saw improved sales in broad services and in card production services. And almost half of our increase in card production services was the result of the re-issuances of cards due to several retailer breaches.

One of the synergy opportunities identified with NetSpend was card production. During the first quarter, TSYS produced over 30% of NetSpend's cards and we expect to produce at least 30% of card production for NetSpend for the remainder of the year.

As expected for the quarter, our expenses grew faster than our revenue growth producing an adjusted operating margin of 33.2%, down 20 basis points from the same quarter last year. These extra expenses are primarily the result of increased incentive pay and Phase 1 and 2 of our market salary adjustments that I mentioned during last quarter's call.

Historically, our first quarter margin is the lowest margin quarter of the year and this year will be no different for this segment. We still expect the margins for North America to be in the 34% to 36% range for the full year.

On the business development front, we signed new agreements in the community and regional bank stays with Iberia Bank and TrustCo Bank as well as contract extensions with Toronto-Dominion, Canadian Tire, and Bank of Nova Scotia.

And finally, all of our conversion activities are green and on schedule.

Operator

Due to technical issues, your conference will resume momentarily. Please do not disconnect. Due to technical difficulties, your call will resume momentarily.

You may proceed with your conference call.

Shawn Roberts

Thank you, Hannah. This is Shawn Roberts of Investor Relations. I apologize for the fact that we got disconnected on the line. I'm going to reintroduce Troy Woods, our COO, and he'll pick up with his presentation from the beginning.

M. Troy Woods

I don't really plan to go back to the beginning, Shawn. I'll do back up, I'm not sure when we lost, but I'm going to back up a little bit. I'm still on the North America segment and I was indicating that, as we expected for the first quarter, our expenses grew faster than our revenue growth, producing an adjusted operating margin of 33.2%, down 20 basis points from the first quarter of last year. These extra expenses are primarily the result of increased incentive pay and Phase 1 and Phase 2 of our market salary adjustments that I mentioned during last quarter's call.

Historically, our first quarter margin is the lowest margin quarter of the year and this year will be no different. We still expect the margins for the North American segment to be in the 34% to 36% range for the full year.

On the business development front, we signed new agreements in the community and regional bank space with Iberia Bank and TrustCo Bank, as well as contract extensions with Toronto-Dominion, Canadian Tire, Bank of Nova Scotia.

And finally, all of our conversion activities are green and on schedule. We have converted just over 800,000 accounts already this quarter, leaving approximately 4.2 million left to be converted. This will leave us with approximately 91 million accounts to convert in the third quarter, finishing up the largest conversion pipeline in our history.

All in all, it's another good quarter for the North American segment and we're all very excited about the many opportunities that are ahead of us for the remainder of this year.

I now would like to move to slides eight and nine for a review of the international segment. I mentioned earlier that this quarter had many moving parts and no segment probably had more moving parts than the international segment.

As we look at the quarterly financial comparisons, revenues for the quarter were $76.8 million, up 0.5% of 1% over the same quarter last year. However, unlike previous quarters, currency had a positive impact this quarter of $3.9 million. So, on a constant currency basis, our revenues for the quarter were down 4.6% compared to last year.

I think it is very important to note and point out that the first quarter of 2013 had approximately $2.3 million of non-recurring de-conversion and penalty fees as well as approximately $1 million of additional non-recurring items that has made this quarter a very difficult revenue comp quarter.

In addition to these items, as I have mentioned before, we're deliberately continuing to close some of our least profitable lines of business as part of our continued efforts to eliminate less profitable revenue and improve our margin profile. These closures and sun setting of services resulted in approximately $1.4 million of less revenue in the first quarter of this year versus last year.

As a result of these many moving parts, our margin this quarter, as expected was below our quarterly numbers for 2013. Our adjusted operating margin for the quarter was 5.9% versus 9% for last year.

While the metrics for the quarter are lumpy when compared to last year, we believe the underlying trends for this quarter like 8.9% account on final growth and 19% transaction growth as well as our other growth initiatives will keep us on track to deliver both our revenue growth and margin targets for the full year.

As Phil indicated, one of the most exciting business development activities for the quarter was the announcement that TSYS would begin the processing and servicing of credit card accounts with one of the best-known brands in Europe, Virgin.

Virgin's newly established U.K.-based retail bank, Virgin Money will be receiving a comprehensive suite of services from TSYS to include core processing, analytical solutions, Internet self-service, as well as a full set of managed services capabilities from our call center facilities in Milton Keynes, U.K.

Our current plans are to launch a start-up program for Virgin Money in the fourth quarter and then convert approximately 600,000 accounts in the first quarter of 2015.

Now, I'd like to add some additional color to our Japan announcement. In 2011, we began a process to strategically assess all lines of business and all geographies served on the international segment.

One of the outcomes of this exercise was a plan to streamline our operations into the markets and business lines that we felt would give us the highest returns and the line with our long-term strategic goals. This assessment included the need for us to make a decision on the future direction of our operations in Japan.

Our operations in Japan have consisted of two lines of businesses. The first was our issuer processing business using our prime technology, operating out of our operations facility in Knaresborough, U.K. and (indiscernible), a payment solution operated out of a leased data center in Okinawa, Japan.

The second line of business was our 54% stake of GP Net, which provides POS terminal services to the Japanese market, and certain businesses that was related to the sharing of Japanese domestic processing fees with Visa and other shareholders in the joint venture.

Although Japan is a very large card market, it is heavily conciliated and concentrated among a handful of very large financial institutions, almost all of which process internally. For almost 14 years, TSYS has been trying to build a profitable issuer processing business in Japan with very limited success.

After assessing the size of the investment required to enhance our processing platforms and balancing that investment against the low likelihood of successful penetration of scale needed in the domestic processing market, we decided to exit the Japanese issuer processing segment.

We accomplished this by transferring our existing issuer processing business to a local entity created by former leaders of our TSYS Japan business. In conjunction with exiting the issuer processing business, we also decided to sell our 54% stake in GP Net to Visa who is also a minority owner of GP Net.

Domestic interchange is not a core strategic business line to TSYS, nor one that we could expand or replicate to other markets around the globe. And while GP Net has been a good venture for TSYS and for TSYS shareholders, we felt that by disposing of our interest in GP Net now, we could move faster in aligning our various markets with our strategic agenda in the longer term.

The highlights for the merchant segment, again on slide 10. Consistent with recent trends reported in 2013, our merchant segment revenues were $104.6 million, up 4.3% for the quarter. The operating margin for the quarter was 28.8%.

As I mentioned last quarter, the movement in revenue growth and operating margin were both expected. Revenue profile and margin will both continue to improve each quarter for the remainder of the year.

Slide 11 provides additional detail around our direct versus indirect revenue growth for the quarter. Also during the quarter, as Phil indicated, we were very pleased to have had the opportunity to increase our stake in CPAY joint venture to 75% from 60%.

In addition, as a result of this equity increase, CPAY company founders Matt and Zach Hyman have agreed to continue to lead the company as co-managing directors for an additional three years.

Continuing on the direct side, we signed nine new national accounts and a new referral agreement with Navy Federal Credit Union, a long-standing TSYS customer on the issuing side. This is a great example of the synergies we can realize when we package our services across the larger enterprise.

Our direct growth plans have a multi-pronged approach. One, establishing new referral partners and expanding upon those already in place. Two, expanding into adjacent verticals such as rent and charities.

Three, providing enhanced products to differentiate us in the market such as tablet-based POS, restaurant solutions, mobile solutions, and tools to improve merchant growth and engagement with their customers through social channels.

Four, increasing sales productivity of our W-2 employees as well as our independent sales agents. And five, strategic acquisitions.

On the indirect side, we're all familiar with the headwinds we continue to experience. But we're pleased with the increased attraction in the market in an industry where the addressable market is shrinking.

We're beginning to see increased activity with the top 100 non-bank acquirers and are pleased to announce that we signed three new indirect processing clients and renewed three clients during the quarter.

We will continue to focus on this market and leverage our competitive advantages of leading reputation, strong balance sheet, fraud and devalue-added reseller certifications, expanded capability set and scale through a single platform.

Speaking of scale through a single platform, we have completed our backend clearing and settlement conversion this quarter and have now processed two up ends. This has been a long and arduous journey, but this consolidation will provide us many efficiencies, new capabilities, and cost savings going forward.

And finally our NetSpend segment review begins on slide 12. NetSpend turned in another exceptional performance for the first quarter. NetSpend produced record revenues for the quarter of $132.6 million, representing a 13.1% increase over the same period last year.

A very strong and successful tax season was clearly a contributing factor on the revenue growth for the quarter. The tax volume and our public growth initiatives also helped produce record direct deposit cards at $2.1 million and industry-leading gross dollar volume of $6.6 billion, representing increases of 21% and 22% respectively.

It has been our experience that revenue in card metrics declined from the first quarter to the second of each calendar year as tax volumes subside and single use account holders acquired during the tax season that's right during the second quarter. We do expect this trend to continue during 2014.

Also as part of the seasonality and the NetSpend segment, marketing investments paid in the first quarter are usually higher than other quarters which are intended to drive results within the calendar year. As such, the margin for the first quarter is usually the lowest margin quarter year.

As it relates to our revenue expectations, I thought it might be helpful to provide some additional color on a few initiatives we're working on. As you might expect, NetSpend intentionally focuses on maximizing lifetime profit per account, starting with our focus on direct deposit to pricing to our products and, ultimately, to the partners we work with.

Beginning in the fourth quarter of 2013, we began to focus on two very important initiatives that we believe will have significant meaningful impact on our customer satisfaction and will also have the result of increasing the lifetime of our accounts and ultimately, drive higher long-term profitability.

First, as you know, we offer both a pay-as-you-go plan and a monthly plan for our cardholders. Through aggressive partner promotions and customer service communications, we're beginning to see a positive shift across our cardholder base from pay-as-you-go to monthly fee plans and this should be very good news for lifetime value.

Second, if the successful migration of our PayCard platform in November, our PayCard and GPR accounts are now on one platform which will allow us, among other things, to deliver a consistent product experience across program.

This migration also allowed us to proactively make some adjustments to the overdraft protection plans we offer on our payroll cards to align more closely with the overdraft protection plans we offer on our GPR cards which we have designed to be the most consumer-friendly options in the industry today.

These lifetime value and overdraft change initiatives both have the effect of impacting short-term revenue. With these initiatives gaining traction, we expect to see low to mid teen revenue growth for all of 2014. We're also firmly convinced that these initiatives will yield long-term gains on retention, customer satisfaction, and lifetime value.

On the business development front, we added 2,000 new retail locations bringing our total now to 66,000. And we added over 70 new PayCard clients bringing the total number of trusted companies who distribute our PayCard products to their employees to approximately 1,900.

Of course, one of the biggest business development news for the segment was the announcement yesterday of a new agreement with Western Union. This is an incredible opportunity for both companies to jointly develop an innovative cobranded prepaid card to be launched later this year.

NetSpend's industry-leading expertise and product capabilities, coupled with Western Union's global brand and expertise at moving money, is very compelling and very exciting.

We're also equally excited to announce today that we have signed a new agreement with PayChex to launch a new PayCard product later this quarter. PayChex is one of the nation's leading providers of payroll, human resource, and benefits outsourcing solutions to small-to-medium sized businesses and serves more than 570,000 payroll clients.

As I mentioned earlier today, we provide our PayCard products and services through 1,900 companies. So, having the opportunity to work with 570,000 payroll clients is significant. Western Union and PayChex are two great names in their respective businesses and we're very excited about the many opportunities that we will have working with both of them.

Although the ramp-up of these new initiatives will require some additional upfront investments. We're still expecting our adjusted operating margins to be in the high 20s to low 30s for the year.

We continue to be focused on high growth opportunities, flawless execution, and driving innovative products that will help us reach more than 68 million people who need alternative financial services.

Now, I'd like to turn it over to Jim Lipham for a more in-depth financial review of the first quarter and revised guidance for 2014 as a result of our Japanese business dispositions. Jimmy?

Jim B. Lipham

Thank you, Troy. Let me say up front on the financial data that we will be presenting, we have the -- excluded all our operations in Japan.

Let's take a look at the slide on -- slide 15 with consolidated results for the quarter. And as Phil said we're very pleased with our reported results as we met or exceeded our planned quarterly results.

Total revenues were up $144.1 million or 32.1% to $592.8 million in revenues before reimbursable is up $144.7 million or 37.3% to $532.8 million. Both total revenues and revenues before reimbursable items exclude $16.2 million of revenues as a result of the move of our Japanese businesses to discontinued ops.

As Troy just covered, NetSpend contributed $132.6 million in revenue for the quarter. North America had an outstanding quarter and had one of its best ever in terms of revenue growth. Our consolidated organic revenues were up 3% and were in line with our expectations.

Troy mentioned currencies that had a favorable impact on revenues before reimbursables with an increase of $4 million in the quarter. The difference in rates year over year also added $2.5 million to operating income and $3.1 million in adjusted EBITDA.

Our adjusted EBITDA for the quarter excludes $7.6 million of stock-based comp and $1.3 million of M&A expenses related to NetSpend and amounted to $149.6 million with a 28.1% margin. It was up 26.1% or 21.2% over last year. The adjusted cash earnings per share from continuing ops was $0.38.

Our tax expense for the quarter is approximately $6 million higher than last year, primarily due to the discrete items in 2013's first quarter of $7.2 million versus $1.4 million this year, which was a difference of about $0.03 a share on earnings per share.

Net of one-time items adjusted cash earnings were also negatively impacted by the incremental interest expense this quarter over 2013 of $9.5 million pretax and $6.2 million after-tax. These two items negatively impacted our year-over-year adjusted cash earnings by approximately $0.06 per share. If you adjusted for those two items, adjusted cash earnings per share would have been up 17% year-over-year.

The next slide, on slide 16, our segments report their results on an adjusted segment operating income basis which excludes amortization of acquisition intangibles, amortization and NetSpend M&A expenses. This slide is a bridge between the adjusted segment operating income for each of our segments and our consolidated adjusted operating income.

As you see, adjusted operating income is $113.9 million with a margin of 21.4. We expect the adjusted operating margins to be in the range of 25 to 27 on a full year basis. The lower margin in the first quarter is where we expected it to be and is due to the result of the increased expenses Troy spoke about earlier. The margin for 2013 was 26.9%.

The next slide is our roll forward on quarterly cash balance. Slide 17 shows our cash balance excluded from both the beginning and ending balances is approximately $34.5 million and $33.5 million respectively as we move the cash in our Japanese operations to the discontinued line on our balance sheet.

We had $149 million of cash flow from operations and used $47 million of it for CapEx, roughly a third going towards conversion cost, a third going toward property and equipment, and the remaining third going toward developed software and licensed software.

We had $22 million worth of principal payments on debts; $38 million on increasing our own ship of Central Payment's joint venture from 60% to 75% ownership; dividends to our shareholders, $19 million; and various miscellaneous items of $3 million resulting in a balance of $274 million at quarter end. We will say our scheduled principal payments on debt for the full year is $54.5 million and we're scheduled to pay approximately $10 million per quarter for the rest of 2014.

During the quarter, we had a net increase in cash of $26 million and still had an outstanding NetSpend shareholder liability of $26 million waiting to be resolved.

Also during the quarter, we had many moving parts that we wanted to get through the Japanese deposition, the CPAY equity increase, as well as a few other things that are now behind us. We expect to be active in the market in the second quarter in regards to share repurchases, as our cash has strengthened since the end of the quarter.

On the next slide, cash flow, our trailing 12 months on financial highlights as we anniversary a number of items from the early months of 2013 when our free cash flow was slightly negative. We're beginning to see our more normal cash flow.

If you recall we mentioned during last year's first quarter earnings call that we made investments to obtain software licensing and maintenance agreements for our core processing systems to secure pricing arrangements to benefit us over the long-term, which resulted in an unusually high CapEx and low cash from operating activities.

For this quarter, our cash flow from operations was $149 million, up $96 million over 2013. And our free cash flow was $101 million, up $104 million. These results significantly improved our trailing 12-month numbers on this slide.

We continue to expect our free cash flow for all of 2014 to be in the range of $35 million to $37 million per month or $420 million to $444 million for the full year. We do not see any change to our CapEx estimate of $200 million to $210 million for the full year.

I will say also we're comfortable with our overall current debt level. Our strategy to use our capital remains the same, scheduled debt reductions in dividends, and then we will look to acquisitions to stock buyback as use of our capital going forward.

The next slide is our revised guidance for 2014 and is due solely to the sale of both of our businesses in Japan. We're changing our 2014 guidance as well as reported results in 2013. The financial results for these two businesses were moved to discontinued ops.

Total revenue ranges included in our original guidance for 2014 were reduced approximately $70 million and $68 million in 2013 reported total revenues. We also reduced our revenues before reimbursements by the same amounts.

2014 adjusted EBITDA guidance was reduced by approximately $13 million due to the sale and 2013's by $10.1 million. We maintain our estimated 2014 tax rate to be the same at 34% to 35%.

Our adjusted cash earnings per share from continuing operations guidance remains the same at $1.90 to $1.93, unchanged from our original guidance. Due to removing Japan's operations from our 2013 reported results, our year-over-year growth rate is now estimated at 10% to 12% versus our original growth rate of 11% to 13%.

The growth rate changed as a result of adjusted cash earnings increasing in 2013 by approximately $0.01 when Japan's financial results were all moved to the discontinued outline. Our estimated share count remains the same as original guidance. We would have reaffirmed our original guidance for the full year if the transaction had not occurred.

With that, Hannah, we'll open it up for questions.

Question-and-Answer session

Operator

(Operator Instructions)

And your first question comes from David Togut.

David Togut - Evercore Partners Inc.

Thank you, and good afternoon, Phil, Troy, and Jim.

Phil W. Tomlinson

Good afternoon.

David Togut - Evercore Partners Inc.

Appreciate the detailed analysis of why margins were down significantly in three of your four businesses. My question really relates to given the year-over-year change in the quarter in margins in international merchant and NetSpend, what underlines your confidence that we'll see a substantial recovery in all three for the balance of the year?

M. Troy Woods

Well, a couple of things, David. One is we look at all of our operating plans for all of our segments as we put these plans together for the year. I've indicated this on the road on several occasions through webcasts that, without exception, all of our segments show increased operating margins from the second half of the year. No exceptions.

So, we feel very confident about these plans. We've talked about many of these activities that anniversary throughout the course of 2014. Some of these one-offs that we had in international in 2013 will also anniversary. So, again, this shouldn't be a surprise to anyone that each quarter here on out without exception these segments will improve their operative margins.

David Togut - Evercore Partners Inc.

And you mean on a year-over-year basis. Understood that the seasonality points to weaker trends in the first quarter every year, anyway, but you're saying on a year-over-year basis we should see significant improvement in margins for three of the four segments?

M. Troy Woods

I'm specifically speaking, David, to the sequential quarter improvements with the margins. As you go through these four segments that I went through a minute ago, each one, each subsequent quarter will improve over the previous quarter -- go ahead.

David Togut - Evercore Partners Inc.

I was going to ask how should we think about the year-over-year trends as we go to 2Q, 3Q, and 4Q.

M. Troy Woods

It was up. I've indicated on several occasions when you think of North America, we've guided 34% to 36% margin. We don't come off of it at all. We guided international segments with [year] (ph) low 14s, which is a significant improvement year-over-year.

NetSpend margin we said will be in the high 20s to low 30s. So, again, you've got that compared to last year. And we said the merchant segment will be 31% to 33%. And we've given I think a lot of color on why that margin is lower than last year, but significantly higher than the first quarter. Does that help?

David Togut - Evercore Partners Inc.

That is very helpful. Thanks. Just shifting gears for a minute over the North American business, you highlighted the 91 million accounts you are converting in Q3. What will the revenue and margin profile look like as we shift from Q2 to Q3 in the North American business? We've never seen such a large convergence -- conversion before, at least not that I can recall at TSYS.

M. Troy Woods

We haven't either. It is the first rollout as -- David and everyone is working mighty hard and as I said earlier pretty excited about getting the rest of these accounts in the pipeline over the finish line.

When you think about North America, when you look at the revenue guidance range that we provided of 8 to 10, what I've been consistent in saying that the second half of the year, revenue growth will be higher than that range.

So that will help you look at third and fourth quarter. Same with margin. The margins in the third and fourth quarter shouldn't be higher than the range that we provided. Does that answer your question?

David Togut - Evercore Partners Inc.

It does. Thank you. Just a final question. You indicated the nice win, the Virgin Money win in the quarter. Can you quantify for us how many accounts Virgin Money has?

M. Troy Woods

Well, as I indicated in my prepared statement, David, we'll launch them in the fourth quarter, start-up program with old and new accounts and we'll convert about 600,000 accounts the first quarter of 2015.

David Togut - Evercore Partners Inc.

Is that the total amount you expect from Virgin Money?

M. Troy Woods

That's the total number that we expect to convert.

David Togut - Evercore Partners Inc.

Understood. Thank you very much.

M. Troy Woods

Yes sir.

Operator

Your next question comes from the line of Bryan Keane [Deutsche Bank].

Phil W. Tomlinson

Hey, Brian.

Bryan Keane - Deutsche Bank

Hi, guys. How are you doing? Just A couple of follow-ups on the guidance. On the international segment, what should we expect for the revenue on a constant currency basis for the year? I understand it is going to improve sequentially, but is there a full-year number we can think about on a constant currency basis?

Phil W. Tomlinson

I don’t have a pulled number right here with me for the whole year on constant currency.

Bryan Keane - Deutsche Bank

Well, how about on total revenue then?

Jim B. Lipham

What we said before, for full year it will be low to mid single digits.

Bryan Keane - Deutsche Bank

Low to mid single. So when we go forward in international, is there some drivers we should think about that’s going to pick up the overall revenue growth as your accounts coming on? I just want to make sure I have my arms around it. Besides the Virgin business, of course, yes.

Phil W. Tomlinson

Yeah. I’ve indicated before, we are working on three conversions and five launches one of which that I’ve just mentioned is Virgin money representing about two million accounts. So I’ve given you the answer to 600,000 of the two million.

We’ve got some ramp-up of some product stand in Brazil. We’ll bring it on pro in the Brazil’s projects, I don’t have it all in front of me Bryan, but I’ll say we will finish the year in the low to mid single digits revenue growth for the segment.

Bryan Keane - Deutsche Bank

No, that helps. And then I missed it, but I think you just said what the adjusted segment margin should be for the year for international. I know it picks up quite a bit, but I missed the number?

Phil W. Tomlinson

It ramps up significantly in the third and fourth quarter and what we’re indicating before is that it will be in the low 14% range.

Bryan Keane - Deutsche Bank

Okay. And so if I think about it, the only real change on -- the revenue stays the same, but the only real change, it sounds like NetSpend revenue -- I know we originally thought high teens, now it is low to mid teens -- but the revenue stays the same for the full year.

If I had to guess I would guess that the North American segment's a little bit ahead of game plan and obviously that being bigger and so net net, those are the moving pieces that kind of -- everything else stays the same so net net that keeps us at the same revenue for the year.

Phil W. Tomlinson

You are correct, Bryan.

Bryan Keane - Deutsche Bank

Okay. All right. Super. Thanks guys.

Operator

Your next question comes from the line of Chris Brendler [Stifel Nicolaus].

Phil W. Tomlinson

Chris Brendler - Stifel Nicolaus

All right, thanks. Good evening. First on the international segment, the divestiture in Japan. Is that the first many or do you think you are – this is just a one-off in terms of consolidating some of your international operations?

Phil W. Tomlinson

Can you repeat the question?

Chris Brendler - Stifel Nicolaus

In international segment, is the decision to exit Japan more of a one-off or is it this first of many sort of strategic actions trying to refine the profitability of your international segment?

Phil W. Tomlinson

Oh, no, it's just clearly a one-off. As we’ve indicated before, I’ve telegraphed this that going all the way back in 2011, we’re looking at all of our geographies. Now there’s probably one more area very, very relatively small area that we’re not happy with, but there are no other geographies that we’re looking to exit.

Chris Brendler - Stifel Nicolaus

Okay. Great. And then in the merchant segment, some decent trends in the direct business continue. Talk about any sort of -- anything that may have contributed to the growth this quarter? I haven’t really seen a lot of acquisition activity. You seem to be getting some good traction with direct business. Anything new to talk about there?

Phil W. Tomlinson

Well, nothing really new, what we’ve indicated before, I think I told you last quarter that we’re looking to get the low – I mean the mid to high single digit growth out of our direct business.

We’ve got a lot of activities going on that space. We talked about the increased productivity of our sales people. We rollout the tablets and we’ll talked about merchant inside product to help our customers, look at their revenue trends and take better advantage of the social channels.

So hopefully we can continue to click with all of that to generate the revenue we’ve outlined for the direct business. I’ve also indicated in the past that we’re not getting into quarterly guidance, but what I have said before that our expectations are that the revenue growth for direct should increase slightly each quarter for the rest of the year from what you’ve seen this quarter.

Chris Brendler - Stifel Nicolaus

And that is a function for new product and some of the new relationships?

Phil W. Tomlinson

It’s a combination of new relationship, new products. We’ve got one relatively large direct piece of business that will anniversary latter in the year. So it’s a combination of all of those things, sales productivity increases.

Chris Brendler - Stifel Nicolaus

Great. Thanks. I appreciate it.

Phil W. Tomlinson

Yes, sir.

Operator

You next question comes from the line of Tulu Yunus [Nomura Securities].

Tulu Yunus - Nomura Securities

Yeah. Hi, good evening guys. Just question on -- staying on merchant segment, can you tell us what the impact of bands was in terms of deconversion there?

Shawn Roberts

Well, as you know, they’re still reconverting. It was about little over $3 million less in the first quarter of ’14 than it was in the first of ’13. It’s still on a significant one-off mode. We do expect the revenues that they will pay us in 2014 will be about 30% to 35% less than they paid us in 2013.

Tulu Yunus - Nomura Securities

How much less, I’m sorry?

Shawn Roberts

30% to 35% less.

Tulu Yunus - Nomura Securities

30% to 35%, okay. Got it. Thanks. And then actually more broadly on pricing and lost business overall. Can you just remind us if there’s anything, any other large impacts coming up in 2Q, 3Q particularly that we should be mindful of across any of your segments?

Phil W. Tomlinson

If you look at our projection for the rest of this year on lost grants and price concessions is probably going to run somewhere in the neighborhood of 5% whereas last year it was 7.8%. So we’ve got about 36% or some percent improvement.

I think the exciting thing there for us as we’ve talked about this before is when we think about our lost business that we’ve looked at for ’14, we’re projecting about $20 million less than ’13 and for price concessions about 20% to 25% less and price concession to ’14 than we had in ’13. So those are the components you kind of come back to what Jimmy just said.

Tulu Yunus - Nomura Securities

Got it. Thank you very much.

Operator

Your next question comes from the line of Georgios Mihalos [Credit Suisse].

George Mihalos - Credit Suisse

Hey, guys thanks for taking my question. Just wanted to circle back on the guidance specifically you were reiterating your margin outlook per segment. But it looks like now you are striping out at least in your presentation the stock-based compensation. So I just want to make sure we’re talking apples-for-apples. When you say 34% to 36% margins for North America that would be adding back the stock-based comp?

Shawn Roberts

Yes.

George Mihalos - Credit Suisse

Okay. Okay. Thank you. And then just looking at the international segment, appreciate the color you gave there as it relates to the one-timers from a year ago, but if I sort of adjust for the math there, you are still up only slightly year-over-year on an absolute basis in terms of revenue. What is causing that sort of divergence from the very strong account on file growth and very strong transaction volume growth that you saw in the first quarter?

Shawn Roberts

George, I’m not sure I really followed that question.

George Mihalos - Credit Suisse

Sure. So, if I look at your year-over-year revenue growth at international, even if I sort of add back though the $4 plus million of one-timers to remove them from the first quarter of ’13, the rate of growth year-on-year were significantly lower than what we’re looking at for your accounts on file growth and your transaction volume growth. So I’m just sort of wondering how to reconcile the two?

Shawn Roberts

Well, I think I follow with him George. There’s a couple of things I might just throw out there that might help. I think on accounts on file, we did purchase 600,000, 700,000 accounts in the first quarter. I would say, number two that when you think about the revenue mix of the international segment, only about half of revenue comes from account on files and transaction.

And I think we talked about this before too that about 27% of the transactions and about 28% of the accounts on file for the segment are bundled pricing. So you are not going to get the same correlation of account on file and transaction growth revenue that you would for individual items.

Also I might add and we talked that this now for couple of quarters, we've added a significant amount of debit accounts and debit activity over the past several quarters. Clearly they don’t carry the same type of revenue profile is our credit portfolio. So I think those will be the – If I understood you question and tell me if I didn’t.

George Mihalos - Credit Suisse

No, that is exactly right. That's the color that I was looking for. And maybe one last question. You mentioned card reissuance being a driver in the North America segment. Did you find a substantial portion of the cards reissued because of the breaches were chip-enabled or even V-compliant.

Phil W. Tomlinson

No, George we have not. We are running zero to low 5% of all the card re-issuance that we do here thesis or EMV capable of plastic. So it hasn’t been in the push pull uptake in any shape on the fashion.

George Mihalos - Credit Suisse

Okay, great. Thank you.

Operator

Your next question comes from line of Jason Kupferberg.

Ramsey El-Assal - Jefferies & Company

This is Ramsey El-Assal for Jason. Following up on that last question. In the North America segment you mentioned that some of the revenue outperformance was driven by that increase in car production related to reissuance from the breaches. How meaningful of a contributor was that to that 9.1% growth rate? And I guess, would you expect that to tail off pretty sharply next quarter or are you still seeing some of this occurring and will continue for a little bit?

Phil W. Tomlinson

We are in the scheme of the North American segment. It’s not a significant amount of money that generated that 9.1% increase number one. Number two, no, I wouldn’t say that we are expecting that to continue this quarter from what we are seeing at least through mid late April. And that doesn’t mean over the next months and months to come, people get in the queue.

We do that -- a significant queue that is built up around EMV trying to better understand what they need to do at TSYS to get into the project queue to get it going.

But it was not a significant contributor to the number. What I said earlier was we did experience increased activity around sales I mean fraud, as well as card production. So there were three or four things that really drove the 9% increase.

Ramsey El-Assal - Jefferies & Company

All right. Got it. That's helpful. Thanks. Switching gears over to the merchant business, you mentioned I think last quarter that 2013 was the first year you saw your direct merchant business generating more revenues than the indirect side. I think you also threw out an 80% target in terms of total merchant revs is to come from direct versus indirect in the not too distant future.

Can you give us a little color in terms of where that mix sort of shook out in Q1 and how soon we can expect you to get to that 80% target?

Phil W. Tomlinson

Sure. What we said, was, it is our expectations, our aspirations if you will to move that mix close to that 80% in the near term. We never did put a timeline on it. We ended the first quarter at 57%.

Ramsey El-Assal - Jefferies & Company

57%, okay. All right. And last for me also on the merchant business. You have been seeing an ongoing mix shift in bundle pricing from the bundle pricing. Can you also give us a sense of where that mix stands today and where it might end up let’s say by the end of the year?

Phil W. Tomlinson

Well, as I've indicated a few times before I wish I had a crystal ball. This continued to move down the percentage of bundled versus unbundled. We've been seeing about 200 basis points per quarter over the past three quarters.

I think the good news in that is if you can call a good news is where we were little over a year ago, we've seen that slow up. We put in some mitigating factors that we talked about before some incentive programs, etcetera, some training. So we are still moving south just not as fast.

Ramsey El-Assal - Jefferies & Company

Great. That’s very helpful. Thanks for taking my questions.

Operator

Your next question comes from the line of Smitti Srethapramote [Morgan Stanley].

Smitti Srethapramote - Morgan Stanley

Thank you. Just had a couple questions on NetSpend. So based on some of the new initiatives that you guys spoke about, should we think about revenues for NetSpend as being higher this year than in the previous guidance, or will most of the benefits show up in 2015 and beyond?

James B. Lipham

Can you repeat that for me? I am so sorry, I missed that.

Smitti Srethapramote - Morgan Stanley

Yes, so, based on some of the new initiatives on NetSpend that you guys spoke about today, should we think about revenues for NetSpend as being higher than in the previous guidance? Or will most of the benefits, the new initiatives show up in 2015 and beyond?

James B. Lipham

Well I think if I had been. Bryan, I mentioned this earlier in the question, but what I have indicated is that we are looking for the NetSpend segment to produce revenues in the low to mid teens increased over '13 and Bryan was correct.

Earlier we had talked about NetSpend segment producing revenues in the mid to high teens. So we have come off that number solved. And it’s as I said earlier primarily driven by the two initiatives that I mentioned earlier.

Smitti Srethapramote - Morgan Stanley

And then maybe can you also give us an update on competitive dynamics? Green Dot seems to be making more of an aggressive expansion into the distribution, into the check-cashing channels over the past couple of months?

James B. Lipham

I really can’t to be honest with you. I think their earnings call is maybe later next week, but we have not really seen any significant inroads into our alternative financial group the check-cashing channel as you called it.

As I've indicated before, we have the top guys under exclusive contracts, so we wouldn’t be necessary be privy to some of the check-cashers, so we don’t have exclusivity with that they moved into and perhaps I've signed them up during the quarter. But beyond that, I don’t really have anything to add to it.

Smitti Srethapramote - Morgan Stanley

Okay, great. Thank you.

Operator

Your next question comes from the line of Kevin McVeigh [Macquarie Research].

Kevin McVeigh - Macquarie Research

Great. Thanks. I know you spent a lot of time, but I just wanted to make sure I was clear. It looks like you tweaked the EBITDA guidance but were able to reaffirm the EPS. Is that a function of a lower tax rate or how should we think about that?

James B. Lipham

No, we've reaffirmed our cash earnings per share and tax rate still around 34%.

Kevin McVeigh - Macquarie Research

But the adjusted EBITDA, did that come down or am I misreading that?

James B. Lipham

Well, we have a little bit of Japan. Basically the change, basically on Japan and cost us penny.

Kevin McVeigh - Macquarie Research

Okay. And then in terms of Central Payment your step up in that, did that impact the guidance at all or no?

James B. Lipham

No.

Kevin McVeigh - Macquarie Research

Okay. Thank you.

James B. Lipham

We’re already consolidating the revenue side of that given 11% of revenue.

Operator

Your next question comes from the line of Steven Kwok [Keefe, Bruyette & Woods]

Steven Kwok - Keefe, Bruyette & Woods

Hi. Thanks for taking my question. I had a quick question around the CFPB and was wondering, are there any proposals that you expect out there around the prepaid space this year? And the follow-up is with regards to NetSpend, how much of your revenues come from overdraft fees? Thanks.

Phil W. Tomlinson

Steven as it relates to the CFPB, the short answer is yes. We do expect something out of them this year. This is their own pronounced. They indicated at one time that they would out by now and they’ve delighted it. So I am not sure what their expectation maybe over the next month or two.

We would expect to get something from it and I think we will have 60 to 90 days as an industry to respond and look at it. As it relates to overdraft, no that’s not a number that we have provided in the past from overdraft revenue.

Steven Kwok - Keefe, Bruyette & Woods

Is there anything around how material it is to you?

Phil W. Tomlinson

Again this is not a number that we provided either for this segment or the percentage of consolidated revenue.

Steven Kwok - Keefe, Bruyette & Woods

Okay. Fair enough. Thanks.

Operator

Your next question comes from the line of Tim Willi [Wells Fargo].

Timothy W. Willi - Wells Fargo

Hi thanks. Good afternoon. A couple of questions. First on North America, Troy. Even though it's on the backside of '15, once you lap BoA and the other big conversions, how do you think about the growth in North America?

Obviously there's still a couple of large institutions that seem to be resistant to outsourcing. Do you think that what you are seeing with Community and Regional Banks will be building enough momentum that account on file Europe and North America on the backside of all these big conversions and will be a pretty decent metric or do you think that will have to be a different sort of driver of revenue growth in North America once we get out past that?

I know it's a little bit out there, but just sort of your thoughts as we start to bring on those accounts and people start to think about the encore if you will once we anniversary all that stuff up. And I have a follow-up on NetSpend.

M. Troy Woods

Hey Tim, we are counting on you to help us with your bank.

Timothy W. Willi - Wells Fargo

I'm sure I can help you out with this.

Phil W. Tomlinson

I like that a lot. I had a guy tell me one time Tim that you eat you eat a watermelon truck by eating one watermelon at a time, and my goodness, we got to get this digested and we still have 19 paying accounts to get converted. So I think it's just a little bit early for us to start talking about expectations growth for the North American sector, but yes…

Timothy W. Willi - Wells Fargo

Maybe I can phrase it differently, then. So in the here and now, do you feel like the efforts -- I think it's a renewed focus or heightened focus to go to these community and regional banks, is that tracking? Are you happy with where the momentum is in the reception and the productivity, the salesforce for that effort?

Phil W. Tomlinson

Well, we've talked on several occasions that we've been extremely fortunate and successful in what we call the TPS space. As you well know, we've signed up some very large names like Huntington Bank and Regions Bank. We've got about 30 or 30 pound new customers large and small in that group.

I think time will tell what kind of scale they can build and growth they could produce, but it's not a small number of customers that are beginning to get into that group and I said 30 to 35.

Timothy W. Willi - Wells Fargo

Okay, fair enough. I didn't mean to put you on the spot. I guess it is sort of…

M. Troy Woods

I was sitting in here with those and you choked on that I think when you were talking about growth being on '14.

Phil W. Tomlinson

One way of looking at it is the large base that will put on and what we have seen preliminaries is these customers are growing faster than our other traditional customers as an aggregate. So we look at that as a feeder to growth.

Timothy W. Willi - Wells Fargo

Okay. That's very helpful color. Thank you. On NetSpend. Just one thing I wanted to ask there. So the direct sales channel prior to when NetSpend was independent, able to talk a bit more in depth about the business outlook of the channel I think to talk about, really starting to come on and get leverage out of this unknown.

I think it was something like one third of new accounts were coming from the direct marketing channels that they had built as opposed to PayCard or check-cashing, what have you. Just an update, has the active momentum remained strong or has it gotten stronger with those direct channels they have been building.

Phil W. Tomlinson

Tim, all in all, the direct channel is the fastest growing channel that we have and it continues to be -- now there is significant opportunity for us to reach out if you will for direct mail, through online account capability. So I mean it's expensive from one standpoint, but at the same time, it's a channel that we don't have to share commissions and that type of thing like we do in some of the other channels. So again it is the fastest growing channel we have of the four.

Timothy W. Willi - Wells Fargo

Yes, perfect. That is all I was looking for. Thanks very much for the time.

Phil W. Tomlinson

Thank you, Tim.

Operator

And your last question today comes from Ashwin Shirvaikar [Citigroup].

Ashwin Shirvaikar – Citigroup

Thank you, guys. I guess my first question is to ask you a clarification on the -- ordinarily I would not ask you for timing within a quarter when you are going to convert a set of accounts. But given the magnitude that we are looking at with 3Q, is it more towards the beginning of the quarter, more towards the end of the quarter in terms of conversions? Could you help with that?

Phil W. Tomlinson

Yes, Ashwin, we'll give you a little bit more color on that. What we've said is when you look at the accounts and the conversion pipeline, we've indicated that BMO is scheduled in May and Bank of America is scheduled in August and TD is scheduled in September. So…

Ashwin Shirvaikar – Citigroup

Okay. So that's not changed from before.

Phil W. Tomlinson

It has not changed.

Ashwin Shirvaikar – Citigroup

Okay, got it. The second question I had was you took out, if I'm not mistaken, roughly $13 million out of your adjusted operating income. That is associated with the discontinued business. But you kept your EPS the same. And I am looking at -- and that's -- it is not that significant, it is a couple of percent, but I am looking to see where you are making that up.

It is about $0.04 or so, $0.035 to $0.04. Is that a bigger buyback that is going to help you? Obviously the tax rate does not change from before. Are you looking for higher equity income? I mean, can you help with that?

Jim B. Lipham

Yes, the real profit that was being made in Japan had to be with GP net, which we own 54%. So we had to exclude when you get to the bottom line, the minority interest there and that was once you excluded that and put the loss from the issue and piece together, you had no effect on the bottom line.

Ashwin Shirvaikar – Citigroup

Great. No that is extremely helpful. The last question I have is with regards to the NetSpend changes. The two reasons you specified for lowering the revenue growth rate, one was trying to move clients to a monthly plan basis and the second was lower overlap charges. And my question is why? Why now? Is this -- are you trying to preempt any potential CFPB action? What's the intent with the timing here?

M. Troy Woods

So Ashwin, the fact that two particularly were initiatives. The first one was around the switch from the pay as you go to the monthly plan and really working with several of our significant partners and we give a lot of credit to our partners because they also go though and experience a short term revenue hit.

But we all want to be in this for the longer term. So our goal is to find ways to increase the longevity of an account and one of the things that several of our partners and they stay on working on, is to how do we drive or how do we move, how do we ship some of these pay-as-you-go to more monthly type planned accounts.

So in the short term, you may experience a revenue shipped, but long term everyone should come out better with lifetime value because you keep the account much longer.

As to the overdraft question, there was just a coincidental timing issue really more than anything else. As I indicated when we had the opportunity to convert to PayCard business back in November from the Skylight platform to the NetSpend Austin platform, we took that opportunity to more align the PayCard overdraft program with the GPR overdraft program that existed on the go-to platform.

Things like grace periods and things like that we wanted to get aligned and as a result of that alignment, and getting them together on one platform, we made some decisions that will cost us some short term revenue on overdraft. So that's the only reason.

Ashwin Shirvaikar – Citigroup

Okay, understood. That's very helpful explanation. Thank you, guys, and all the best.

M. Troy Woods

Thank you, Ashwin.

Phil W. Tomlinson

Thank you. I want to take just a few minutes and try to close this out and do a housekeeping at the same time. As we continue to review our operating plans for the remaining three quarters against the current consensus for those same periods and as evidenced by the day two, we see the need to reset the street’s quarterly expectations somewhat.

So all along, we have indicated our guidance of $1.90 to $1.93 was certainly second half weighted and it's a fairly substantially more backend loaded than most of you have apparently built into your models.

Hopefully, we've cleared up some of that today. We are not going to provide quarterly guidance and we won't be as transparent as we can and felt the need to may be just provide a little more clarity regarding the remainder of the year, particularly the third and fourth quarter. I hope that's a little bit helpful.

As you’ve heard, we continue to win in the marketplace. Our cash flow was stronger than ever. Got 90-plus million accounts in the pipeline. It's the biggest pipeline we've very had in our history. All that is scheduled for the third and, really, the third quarter and you just heard about Virgin Money, Western Union and Paychex.

Those are all I think will be big deals for us, big wins. As Troy said, we expect these conversions to be on time and happen with quality. We've completed the total rewrite of our merchant accounting system. It's alive, it's doing well and the conversion is complete.

The surround project on only issuing side of the business is on target and I think is a long term game changer to a lot of -- in a lot of ways. We'll probably talk more about that as time goes by.

Synergies and cross-selling relationships are taking hold with NetSpend as we expected. And really in an economy that's experiencing a weak rebound, we are doing what is necessary to ensure our continued success. We have tried today to clarify and reaffirm our annual guidance.

We are well positioned for continue to move forward with our growth strategies. So we really do appreciate your interest and participation on this call today and remember Shawn Roberts and Investor Relations is here to serve your need. So please don't hesitate to call him with any follow-up questions that you might have. And with that, we'll close the first quarter call down. Thank you very much.

Operator

This does conclude today's conference call. You may now disconnect.

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